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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-K







|x | ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------

For the fiscal year ended December 31, 2008



| ̈ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------

For the transition period from             to

Commission File Number: 0-11255





HERITAGE BANKSHARES, INC.

(Exact Name of Registrant as Specified in its
Charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Virginia                                                       |  | 54-1234322                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|150 Granby Street Norfolk, Virginia                            |  | 23510                               
|(Address of Principal Executive Offices)                       |  | (Zip Code)                          

Registrants telephone number (757) 648-1700

Securities registered pursuant to Section 12(b) of the Exchange Act: None

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $5.00 par value





Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Section 405 of the Securities Act.    Yes   ̈    No  x

Indicate by check mark if the registrant is not
required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.    Yes   ̈    No  x

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

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K 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
this Form 10-K or any amendment to this Form 10-K.   ̈

Indicate by check mark whether the registrant is a
large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in
Rule 12b-2 of the Exchange Act. (Check one):



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  |  ̈
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | Smaller reporting company |  | x

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

The aggregate market value of the registrants stock held by non-affiliates of the registrant as of June 30, 2008 was approximately $24,435,000, computed by reference to the sales price of the Common Stock of the Company on
June 30, 2008 of $13.50 per share, and 1,810,000 shares of voting stock held by non-affiliates of the Company on June 30, 2008.

As of
February 27, 2009, 2,279,252 shares of Common Stock of the Company, par value $5.00 per share, were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrants definitive Proxy Statement for the 2009 Annual Meeting of
Shareholders (the 2009 Proxy Statement), currently scheduled for June 16, 2009, are incorporated by reference into Part III hereof.









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Table of Contents



|         |  |                                                                                                              |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                              |  | Page
|PART I   |  |                                                                                                              |  |     
|         |  |                                                                                                             
|Item 1.  |  | Description Of Business                                                                                      |  | 3   
|         |  |                                                                                                             
|Item 1A. |  | Risk Factors                                                                                                 |  | 10  
|         |  |                                                                                                             
|Item 1B. |  | Unresolved Staff Comments                                                                                    |  | 12  
|         |  |                                                                                                             
|Item 2.  |  | Description Of Property                                                                                      |  | 13  
|         |  |                                                                                                             
|Item 3.  |  | Legal Proceedings                                                                                            |  | 13  
|         |  |                                                                                                             
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 13  
|         |  |                                                                                                             
|PART II  |  |                                                                                                              |  |     
|         |  |                                                                                                             
|Item 5.  |  | Market For Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 14  
|         |  |                                                                                                             
|Item 6.  |  | Selected Financial Data                                                                                      |  | 15  
|         |  |                                                                                                             
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 15  
|         |  |                                                                                                             
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 39  
|         |  |                                                                                                             
|Item 8.  |  | Financial Statements and Supplementary Data                                                                  |  | 40  
|         |  |                                                                                                             
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 69  
|         |  |                                                                                                             
|Item 9A. |  | Controls and Procedures                                                                                      |  | 69  
|         |  |                                                                                                             
|Item 9B. |  | Other Information                                                                                            |  | 69  
|         |  |                                                                                                             
|PART III |  |                                                                                                              |  |     
|         |  |                                                                                                             
|Item 10. |  | Directors, Executive Officers and Corporate Governance                                                       |  | 70  
|         |  |                                                                                                             
|Item 11. |  | Executive Compensation                                                                                       |  | 70  
|         |  |                                                                                                             
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 70  
|         |  |                                                                                                             
|Item 13. |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 70  
|         |  |                                                                                                             
|Item 14. |  | Principal Accounting Fees and Services                                                                       |  | 70  
|         |  |                                                                                                             
|PART IV  |  |                                                                                                              |  |     
|         |  |                                                                                                             
|Item 15. |  | Exhibits, Financial Statement Schedules                                                                      |  | 71  



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PART I

As used in this annual report on Form 10-K, the Company, we, our and us refer to Heritage Bankshares,
Inc. and its subsidiaries, unless the context requires otherwise.

Forward-Looking Statements

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

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



| |  |  | the demand for our products and services;
| | - |  | -----------------------------------------



| |  |  | actions taken by our competitors;
| | - |  | ---------------------------------



| |  |  | changes in the prevailing interest rates;
| | - |  | -----------------------------------------



| |  |  | changes in delinquencies and defaults by our borrowers;
| | - |  | -------------------------------------------------------



| |  |  | changes in loan quality and performance;
| | - |  | ----------------------------------------



| |  |  | changes in FDIC insurance premiums;
| | - |  | -----------------------------------



| |  |  | legislative or regulatory changes or actions that affect our business;
| | - |  | ----------------------------------------------------------------------



| |  |  | our ability to achieve financial goals and strategic plans;
| | - |  | -----------------------------------------------------------



| |  |  | litigation; and
| | - |  | ---------------



| |  |  | credit and other risks of lending activities.
| | - |  | ---------------------------------------------

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



|ITEM 1. | DESCRIPTION OF BUSINESS
|------- | -----------------------

General

Heritage Bankshares, Inc. (the Company) is a bank holding company incorporated under the laws of the Commonwealth of Virginia in 1983, and
serves as the holding company for its wholly-owned subsidiary, Heritage Bank. Since 1992, the Company has operated as a one bank holding company. The principal executive office of the Company is located at 150 Granby Street, Norfolk, Virginia.
Currently, the Company does not transact any material business other than through Heritage Bank. Information concerning the Company and Heritage Bank may be found at www.heritagebankva.com.

Heritage Bank (the Bank) is a wholly-owned subsidiary of the Company and is a state banking corporation engaged in the general commercial and
retail banking business. The Bank was incorporated in Virginia on September 19, 1975 and commenced business at 841 North Military Highway in Norfolk, Virginia on February 7, 1977. On December 31, 2008, the Bank had assets of $265.5
million, with total loans held for investment, net, of $176.6 million and deposits of $215.8 million.



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The Bank has one wholly-owned subsidiary, Sentinel Financial Group, Inc. (Sentinel
Financial). At December 31, 2008, Sentinel Financial owned an interest in each of Infinex Investments, Inc. (formerly Bankers Investment Group, LLC), and Bankers Insurance, LLC, each of which offer various insurance and investment
services. Our ownership interest in these companies, through Sentinel Financial, allows the Bank to provide various investment and insurance services to its customers. The Bank does not market insurance services to its customers at this time. In
addition, at December 31, 2008, Sentinel Financial Group, Inc. owned other real estate owned, which had been acquired by the Bank earlier in the month.

IBV Real Estate Holdings, Inc., formerly a wholly-owned subsidiary of the Company that was formed for the sole purpose of owning additional real estate assets acquired by the Company or the Bank, was voluntarily
dissolved and terminated by the Company in 2008.

Principal Products or Services

The Company, through the Bank, engages in a general community and commercial banking business, targeting the banking needs of individuals and small to
medium sized businesses in its primary service area which includes Chesapeake, Norfolk, and Virginia Beach, Virginia. The principal business of the Company is to attract deposits and to lend or invest those deposits on profitable terms. These
deposits are in varied forms of both demand and time accounts including checking accounts, interest checking, money market accounts, savings accounts, certificates of deposit, and IRA accounts.

The Company is involved in the construction and real estate lending market and actively extends both consumer and commercial credit. Loans consist of
varying terms and may be secured or unsecured. Loans to individuals are for personal, household, and family purposes. Loans to businesses are made for purposes such as working capital, plant expansion, and equipment purchases. See Item 6,
Managements Discussion and Analysis or Plans of Operations, for a breakdown of loans by classification.

Market Area

The Company is located in the Norfolk-Virginia Beach-Newport News Metropolitan Statistical Area
(MSA), which extends approximately 65 miles from Williamsburg, Virginia, to Virginia Beach, Virginia, and Currituck County, North Carolina. This MSA is the 31stlargest Metropolitan Statistical Area in the United States with a population of approximately 1.6 million persons. The Companys principal market within this MSA is the Hampton Roads area, which comprises
the cities of Norfolk, Portsmouth, Virginia Beach, Chesapeake, Suffolk, Hampton, and Newport News. The Company maintains its corporate headquarters in Norfolk, Virginia, and as of December 31, 2008, the Bank has a total of five retail offices
located in the cities of Norfolk and Virginia Beach, Virginia. One of the Companys Norfolk offices also includes a mortgage loan origination office.

Although the Hampton Roads area supports a wide range of industrial and commercial activities, the areas principal employer is the United States Navy and other branches of the Armed Forces of the United States.
Significant cutbacks in defense spending and consolidations of domestic military installations could affect the general economy of the Companys market area. Depending on whether the Hampton Roads area experiences an overall increase or
decrease in military and federal wages and salaries, the potential future impact of any such cutbacks or consolidations could be either favorable or unfavorable.

Competition

The banking business in the MSA, and the Companys principal market area, is highly competitive, and the
Company faces significant competition both in making loans and in attracting deposits. At June 30, 2008, the Companys deposit market share as a percentage of FDIC-insured institutions deposits in the MSA was 1.05%. The
Companys competition for loans comes from commercial banks, savings banks, mortgage banking subsidiaries of regional commercial banks, national mortgage bankers, insurance companies, and other institutional lenders. The Companys most
direct competition for deposits has historically come from savings banks, commercial banks, credit unions and other financial institutions. The Company may face an increase in competition as a result of the continuing reduction in the restrictions
on the interstate operations of financial institutions. The Company also faces competition for deposits from short-term money market mutual funds and other corporate and government securities funds. (For additional discussion regarding competition
facing the Company, see Item 1A, Risk Factors, below.)

Employees

At December 31, 2008, we employed 63 full-time equivalent employees.



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Supervision and Regulation

Bank holding companies and banks are extensively regulated under both federal and state law. The following summary briefly describes certain significant provisions of applicable federal and state laws and applicable
regulations and the potential impact of such provisions on the Company and the Bank. This summary is not complete, and we refer you to the particular statutory or regulatory provisions or proposals for more information. Because federal regulation of
financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future and impact the operations of the Company and the Bank.

The Company

Bank Holding Company
Act. The Company is registered with the Federal Reserve Bank (Federal Reserve) as a financial holding company under the Bank Holding Company Act of 1956 (the BHCA), as amended by the Gramm-Leach-Bliley Act of 1999, and is
subject to ongoing regulation, supervision and examination by the Federal Reserve. The Company is required to file with the Federal Reserve periodic and annual reports and other information concerning its own business operations and those of its
subsidiaries. The Federal Reserve also supervises the Companys operations and major transactions affecting its capital structure, including mergers, acquisitions and share redemptions.

Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank
company or any of its subsidiaries, or investments in the stock or other securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. Further, a holding company and any subsidiary bank are prohibited
from engaging in certain tie-in arrangements in connection with the extension of credit. A subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the
condition that: (i) the customer obtain or provide some additional credit, property or services from or to such bank other than a loan, discount, deposit or trust service; (ii) the customer obtain or provide some additional credit,
property or service from or to company or any other subsidiary of the company; or (iii) the customer not obtain some other credit, property or service from competitors, except for reasonable requirements to assure the soundness of credit
extended.

Certain other provisions of the BHCA are described below under Change of Control.

Capital Adequacy. The Federal Reserve has promulgated capital adequacy regulations for all bank holding companies with assets in excess of
$150 million. The Federal Reserves capital adequacy regulations are based upon a risk-based capital determination, whereby a bank holding companys capital adequacy is determined in light of the risk, both on- and off-balance sheet,
contained in the companys assets. Different categories of assets are assigned risk weightings and are counted at a percentage of their book value.

The regulations divide capital between Tier 1 capital (core capital) and Tier 2 capital. For a bank holding company, Tier 1 capital consists primarily of common stock, related surplus, noncumulative
perpetual preferred stock, minority interests in consolidated subsidiaries and a limited amount of qualifying cumulative preferred securities. Goodwill and certain other intangibles are excluded from Tier 1 capital. Tier 2 capital consists
of an amount equal to the allowance for loan and lease losses up to a maximum of 1.25% of risk-weighted assets, limited other types of preferred stock not included in Tier 1 capital, hybrid capital instruments and term subordinated debt.
Investments in and loans to unconsolidated banking and finance subsidiaries that constitute capital of those subsidiaries are excluded from capital. The sum of Tier 1 and Tier 2 capital constitutes qualifying total capital. The Tier 1
component must comprise at least 50% of qualifying total capital.

Every bank holding company has to achieve and maintain a minimum Tier 1
capital ratio (Tier 1 capital to risk-weighted assets) of at least 4.0% and a minimum total capital ratio of at least 8.0%. In addition, banks and bank holding companies are required to maintain a minimum leverage ratio of Tier 1 capital
to average total consolidated assets (leverage capital ratio) of at least 3.0% for the most highly-rated, financially sound banks and bank holding companies, and a minimum leverage ratio of at least 4.0% for all other banks. The Federal Deposit
Insurance Corporation (FDIC) and the Federal Reserve define Tier 1 capital for banks in the same manner for both the leverage ratio and the risk-based capital ratio. However, the Federal Reserve defines Tier 1 capital for bank holding
companies in a slightly different manner.

The guidelines also provide that banking organizations experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory level, without significant reliance on intangible assets. The guidelines also indicate that the Federal Reserve will continue to consider
a Tangible Tier 1 Leverage Ratio in evaluating proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to quarterly average total
assets.



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Source of Strength for Subsidiary.Bank holding companies are required to serve as a source of
financial strength for their depository institution subsidiaries, and, if their depository institution subsidiaries become undercapitalized, bank holding companies may be required to guarantee the subsidiaries compliance with capital
restoration plans filed with their bank regulators, subject to certain limits.

Dividends.As a holding company that does not, as an
entity, currently engage in separate business activities of a material nature, the Companys ability to pay cash dividends to its shareholders depends upon the cash dividends it receives from the Bank. The Company must pay operating expenses
from funds it receives from the Bank. Therefore, shareholders may receive cash dividends from the Company only to the extent that funds are available after payment of operating expenses. In addition, the Federal Reserve generally prohibits bank
holding companies from paying cash dividends except out of operating earnings, and permits dividends only if the prospective rate of earnings retention appears consistent with the bank holding companys capital needs, asset quality and overall
financial condition. As a Virginia corporation, our payment of cash dividends also is subject to the restrictions under Virginia law on the declaration of cash dividends. Under such provisions, cash dividends may not be paid if a corporation will
not be able to pay its debts as they become due in the usual course of business after paying such a cash dividend or if the corporations total assets would be less than the sum of its total liabilities plus the amount that would be needed to
satisfy certain preferential liquidation rights. (See The Bank - Dividends below for discussion regarding regulatory considerations for dividends payable by the Bank.)

Change of Control.State and federal banking law restricts the amount of voting stock of a bank that a person may acquire without the prior
approval of banking regulators. The BHCA requires that a bank holding company obtain the approval of the Federal Reserve before it may merge with a bank holding company, acquire a subsidiary bank, acquire substantially all of the assets of any bank,
or before it may acquire ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of that bank or bank holding
company. The overall effect of such laws is to make it more difficult to acquire the Company by tender offer or similar means than it might be to acquire control of another type of corporation. Consequently, the Companys shareholders may be
less likely to benefit from rapid increases in stock prices that often result from tender offers or similar efforts to acquire control of other types of companies.

In addition, under certain amendments to the Virginia Financial Institutions Holding Company Act that became effective July 1, 1983, no corporation, partnership or other business entity may acquire, or make any
public offer to acquire, more than 5% of the stock of any Virginia financial institution, or any Virginia financial institution holding company, unless it first files an application with the Virginia State Corporation Commission (the
SCC). The SCC is directed by the statute to solicit the views of the affected financial institution, or financial institution holding company, with respect to such stock acquisition, and is empowered to conduct an investigation during
the 60 days following receipt of such an application. If the SCC takes no action within the prescribed period, or if during the prescribed period it issues notice of its intent not to disapprove an application, the acquisition may be completed.

Legislation

Sarbanes-Oxley Act.On July 30, 2002, the Sarbanes-Oxley Act (SOX) was enacted. SOX is not a banking law, but applies to all public companies, including the Company. The stated goals of SOX are to increase corporate responsibility, to provide for
enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. Given the extensive role of the
Securities and Exchange Commission (the SEC) in implementing and interpreting the rules relating to many of SOXs requirements, and the continuing evolution of SOXs requirements, the impact on the Company of these requirements
may continue to change for some time. SOX includes additional disclosure requirements and corporate governance rules for public companies, extensive additional disclosure, corporate governance and other related rules adopted by the SEC for public
companies, increases criminal penalties for violations of the securities laws, and mandates further studies of specified issues by the SEC and other federal government agencies. SOX also provides for the federal regulation of accounting firms that
provide services to public companies and mandates additional listing standards for the securities exchanges. Not all of the rules that the SEC has adopted implementing the provisions of SOX presently apply to the Company because certain of the rules
have delayed effective dates and/or do not apply to companies, like us, whose securities are quoted on over-the counter securities markets (see Item 5, Market for Common Equity and Related Stockholder Matters below). The SEC has
also extended the effective dates of certain rules after their adoption.

Bank Secrecy Act; USA PATRIOT Act.Under the Bank Secrecy
Act (BSA), a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report to the United States
Treasury cash transactions involving more than $10,000. In addition, financial institutions are required to file suspicious activity reports for any transaction that involves more than $5,000 and which the financial institution knows, suspects or
otherwise has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The USA PATRIOT Act of 2001 (the Patriot Act), enacted in response to the September 11, 2001,
terrorist attacks, strengthens the anti-money laundering provisions of the BSA. Many of the new provisions added by the Patriot Act apply to accounts at or held by foreign banks, or accounts of or transactions with foreign entities, and thus do not
apply to the Bank because it does not have significant foreign business. However, the Patriot Act does require federal banking regulators to consider a banks record of compliance under the BSA in acting on any application filed with such
federal regulators. The Banks record of compliance with the BSA will be an additional factor in any applications filed with federal regulators in the future.



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The Bank

General. The Bank operates as a state bank subject to supervision and regulation by the Bureau of Financial Institutions of the SCC. The Bureau of Financial Institutions regulates all areas of a Virginia state
banks commercial banking operations, including reserves, loans, mergers, payment of dividends, establishment of branches and other aspects of operations.

Transactions with Affiliates. The Bank may not engage in specified transactions (including, for example, loans) with its affiliates unless the terms and conditions of those transactions are substantially the
same or at least as favorable to the Bank as those prevailing at the time for comparable transactions with or involving other nonaffiliated entities. In the absence of comparable transactions, any transaction between the Bank and its affiliates must
be on terms and under circumstances, including credit standards, which in good faith would be offered or would apply to nonaffiliated companies. In addition, transactions referred to as covered transactions between the Bank and its
affiliates may not exceed 10% of the Banks capital and surplus per affiliate and an aggregate of 20% of its capital and surplus for covered transactions with all affiliates. Certain transactions with affiliates, such as loans, also must be
secured by collateral of specific types and amounts. The Bank also is prohibited from purchasing low-quality assets from an affiliate. Every company under common control with the Bank, including the Company, is deemed to be an affiliate of the Bank.

Loans to Insiders. Federal law also constrains the types and amounts of loans that the Bank may make to its executive officers,
directors and principal shareholders. Among other things, these loans are limited in amount, must be approved by the Banks board of directors in advance, and must be on terms and conditions as favorable to the Bank as those available to an
unrelated person.

Regulation of Lending Activities. Loans made by the Bank are also subject to numerous federal and state laws and
regulations, including the Truth-In-Lending Act, the Federal Consumer Credit Protection Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and adjustable rate mortgage disclosure requirements. Remedies are available to
the borrower or consumer and the Bank is subject to penalties if the Bank fails to comply with these laws and regulations. The scope and requirements of these laws and regulations have expanded significantly in recent years.

Branch Banking. All banks located in Virginia are authorized to branch statewide. Accordingly, a bank located anywhere in Virginia has the
ability, subject to regulatory approval, to establish branch facilities near any of our facilities and within the Banks market area. Federal law provides for nationwide interstate banking and branching, subject to certain aging and deposit
concentration limits that may be imposed under applicable state laws. Applicable Virginia statutes permit regulatory authorities to approve de novo branching in Virginia by institutions located in states that would permit Virginia institutions to
branch on a de novo basis into those states. Federal regulations prohibit an out-of-state bank from using interstate branching authority primarily for the purpose of deposit production. These regulations include guidelines to ensure that interstate
branches operated by an out-of-state bank in a host state are reasonably helping to meet the credit needs of the host state communities served by the out-of-state bank.

Reserve Requirements.Pursuant to regulations of the Federal Reserve, the Bank must maintain average daily reserves against its transaction accounts. No reserves are required to be maintained on the first
$6.6 million of transaction accounts, but reserves equal to 3.0% must be maintained on the aggregate balances of those accounts between $6.6 million and $45.4 million, and reserves equal to 10.0% plus $1.2 million must be
maintained on aggregate balances in excess of $45.4 million. These percentages are subject to adjustment by the Federal Reserve. Because required reserves must be maintained in the form of vault cash or in a noninterest-bearing account at a
Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institutions interest-earning assets. As of December 31, 2008, the Bank met its reserve requirements.

Community Reinvestment.Under the Community Reinvestment Act (CRA), as implemented by regulations of the
federal bank regulatory agencies, an insured bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The
CRA does not establish specific lending requirements or programs for banks, nor does it limit a banks discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the
CRA. The CRA requires the federal bank regulatory agencies, in connection with their examination of insured banks, to assess the banks records of meeting the credit needs of their communities, using the ratings of outstanding,
satisfactory, needs to improve, or substantial noncompliance, and to take that record into account in its evaluation of certain applications by those banks. All banks are required to make public disclosure of
their CRA performance ratings. The Banks current CRA performance rating is satisfactory.

Governmental
Monetary Policies. The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve. Changes in the discount rate on member bank borrowings, control of borrowings, open
market transactions in United States government securities, the imposition of and changes in reserve requirements



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against member banks and deposits and assets of foreign bank branches, and the imposition of and changes in reserve requirements against certain borrowings
by banks and their affiliates are some of the monetary policies available to the Federal Reserve. Those monetary policies influence to a significant extent the overall growth of all bank loans, investments and deposits and the interest rates charged
on loans or paid on time and savings deposits in order to mitigate recessionary and inflationary pressures. These techniques are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and
their use may also affect interest rates charged on loans or paid for deposits.

The monetary policies of the Federal Reserve have had a
significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary
and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Bank.

Dividends. All dividends paid by the Bank are paid to the Company, the sole shareholder of the Bank. The general dividend policy of the Bank is to pay dividends at levels consistent with maintaining liquidity
and preserving applicable capital ratios and servicing obligations. The dividend policy of the Bank is subject to the discretion of the board of directors of the Bank and will depend upon such factors as future earnings, financial condition, cash
needs, capital adequacy, compliance with applicable statutory and regulatory requirements and general business conditions.

The ability of
the Bank to pay dividends is restricted under applicable law and regulations. Under Virginia banking law, dividends must be paid out of retained earnings and no cash dividends may be paid if the Banks surplus is less than 50% of its paid-in
capital. Also, under federal banking law, no cash dividend may be paid if the Bank is undercapitalized or insolvent or if payment of the cash dividend would render the Bank undercapitalized or insolvent, and no cash dividend may be paid by the Bank
if it is in default of any deposit insurance assessment due to the FDIC.

Capital Adequacy. The capital adequacy regulations which
apply to state banks, such as the Bank, are similar to the Federal Reserve requirements promulgated with respect to bank holding companies discussed above.

Enforcement Authority. The federal banking laws also contain civil and criminal penalties available for use by the appropriate regulatory agency against certain institution-affiliated parties,
primarily including management, employees and agents of a financial institution, as well as independent contractors such as attorneys and accountants and others who participate in the conduct of the financial institutions affairs and who
caused or are likely to cause more than minimum financial loss to or a significant adverse effect on the institution, in each case who knowingly or recklessly violate a law or regulation, breach a fiduciary duty or engage in unsafe or unsound
practices. These practices can include the failure of an institution to timely file required reports or the submission of inaccurate reports. These laws authorize the appropriate banking agency to issue cease and desist orders that may, among other
things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification or guarantees against loss. A financial institution may also be ordered to restrict its growth,
dispose of certain assets or take other action as determined by the primary federal banking agency to be appropriate. The Bank is current in its quarterly filings with the Federal Reserve.

Prompt Corrective Action. Banks are subject to restrictions on their activities depending on their level of capital. Federal prompt
corrective action regulations divide banks into five different categories, depending on their level of capital:



| |  |  | A bank is deemed to be well-capitalized if it has a total risk-based capital ratio of 10% or more, a core capital ratio of 6% or more and a leverage
ratio of 5% or more, and if the bank is not subject to an order or capital directive to meet and maintain a certain capital level.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A bank is deemed to be adequately capitalized if it has a total risk-based capital ratio of 8% or more, a core capital ratio of 4% or more and a
leverage ratio of 4% or more (unless it receives the highest composite rating at its most recent examination and is not experiencing or anticipating significant growth, in which instance it must maintain a leverage ratio of 3% or more).
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A bank is deemed to be undercapitalized if it has a total risk-based capital ratio of less than 8%, a core capital ratio of less than 4% or a leverage
ratio of less than 3%.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A bank is deemed to be significantly undercapitalized if it has a risk-based capital ratio of less than 6%, a core capital ratio of less than 3% and a
leverage ratio of less than 3%.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



8



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##### Table of Contents

| |  |  | A bank is deemed to be critically undercapitalized if it has a leverage ratio of less than or equal to 2%. In addition, the applicable federal banking
agency has the ability to downgrade a banks classification (but not to critically undercapitalized) based on other considerations even if the bank meets the otherwise applicable capital guidelines.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If a state member bank, such as the Bank, is classified as undercapitalized, the bank is required to submit a capital restoration plan to the
Federal Reserve. An undercapitalized bank is prohibited from increasing its assets, engaging in a new line of business, acquiring any interest in any company or insured depository institution, or opening or acquiring a new branch office, except
under certain circumstances, including the acceptance by the Federal Reserve of a capital restoration plan for that bank. In addition, if a state member bank is classified as undercapitalized, the Federal Reserve may take certain actions to correct
the capital position of the bank.

If a state member bank is classified as significantly undercapitalized, the Federal Reserve
would be required to take one or more prompt corrective actions. These actions would include, among other things, requiring sales of new securities to bolster capital, changes in management, limits on interest rates paid, prohibitions on
transactions with affiliates, termination of certain risky activities and restrictions on compensation paid to executive officers. Moreover, if a bank is classified as critically undercapitalized, the bank must be placed into
conservatorship or receivership within 90 days, unless the FDIC determines otherwise.

The capital classification of a bank affects
the frequency of examinations of the bank and impacts the ability of the bank to engage in certain activities and affects the deposit insurance premiums paid by the bank.

Banks also may be restricted in their ability to accept brokered deposits, depending on their capital classification. Well-capitalized banks are permitted to accept brokered deposits, but all banks that
are not well-capitalized are not permitted to accept such deposits. The Federal Reserve may, on a case-by-case basis, permit member banks that are adequately capitalized to accept brokered deposits if the Federal Reserve determines that acceptance
of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank. At December 31, 2008, the Bank was classified as well-capitalized.

Deposit Insurance.The Banks deposits are insured up to $250,000 per insured account by the Bank Insurance Fund of the FDIC. The FDIC
assesses insurance premiums on a banks deposits at a variable rate depending on the probability that the deposit insurance fund will incur a loss with respect to the bank. The FDIC determines the deposit insurance assessment rates on the basis
of the banks capital classification and supervisory evaluations. Pursuant to deposit insurance reform legislation, in December 2006, the FDIC adopted a new risk based assessment system for determining deposit insurance premiums. Under the new
requirements, four risk categories (I-IV), each subject to different premium rates, are established, based upon an institutions status as well capitalized, adequately capitalized or undercapitalized, and the institutions supervisory
rating. Under the new rules, all insured depository institutions will pay deposit insurance premiums, currently ranging between 5 and 7 basis points on an institutions assessment base for institutions in risk category I (well capitalized
institutions perceived as posing the least risk to the insurance fund), and 10, 28 and 43 basis points for institutions in risk categories II, III, and IV. The level of rates are subject to periodic adjustment by the FDIC. The Banks
deposit insurance assessments may increase depending upon the risk category and subcategory, if any, to which the Bank is assigned.

On
February 27, 2009, the FDIC approved a final rule that raises, beginning in the second quarter of 2009, the initial base assessment rate for deposit insurance premiums for well-managed, well-capitalized banks (Risk Category I) to 12 to 16 basis
points. The initial base assessment rate for insured institutions that are classified in Risk Category II, III and IV was increased to 22, 32 and 45 basis points, respectively. In addition to the initial base assessment rates described above,
there will be other adjustments to the base rates for insured institutions (either up or down) for various items including, but not limited to, levels of unsecured debt, secured liabilities and brokered deposits. Accordingly, the total assessment
rate can range from 7 to 24 basis points for a Risk Category I institution; from 17 to 43 basis points for a Risk Category II institution; from 27 to 58 basis points for a Risk Category III institution; and from 40 to 77.5 basis
points for a Risk Category IV institution. These total assessment rates are in addition to the approximately 1.0 to 1.2 basis point annual rates that institutions are assessed to pay the interest of Financing Corporation (FICO) bonds.

In addition, the FDIC adopted an interim rule imposing a 20 basis point special emergency assessment on every insured institution, to be
assessed on June 30, 2009 but payable on September 30, 2009, and authorized the imposition of an additional 10 basis point special assessment in any quarter, if needed. Comments on the interim rule on special assessments are due no later
than 30 days after publication in the Federal Register.

Accordingly, based on these FDIC premium increases, in 2009 the Bank expects a
substantial increase in its FDIC insurance expense over that of 2008.



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Available Information

We maintain an Internet website at www.heritagebankva.com. Among other Company-related information, this website contains a link to our current and prior-period filings with the SEC on Form 10-K (formerly on
Form 10-KSB), Form 10-Q (formerly on Form 10-QSB), and Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The reports are made available on our
website as soon as practicable following the filing of the reports with the SEC. The information is free of charge and may be reviewed, downloaded and printed from our website at any time. You may also read and copy any material we file with the SEC
at the SECs Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the SECs Public Reference Room by calling the SEC at (202) 942-8090. Copies of these materials may be
obtained at prescribed rates from the SEC at such address. These materials can also be inspected on the SECs web site at www.sec.gov.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

Our business, operations and
financial condition are subject to various risks. In addition to the other information contained in this Form 10-K, you should carefully consider the risks, uncertainties and other factors described below because they could materially and
adversely affect our business, financial condition, operating results, cash flow and prospects, and/or the market price of our common stock. This section does not describe all risks that may be applicable to us, our business or our industry, and is
included solely as a summary of certain material risk factors.



| |  |  | Our need to comply with extensive and complex government regulation could have an adverse effect on our business. The banking industry is subject to
extensive regulation by state and federal authorities to protect depositors, the public or the insurance funds maintained by the FDIC. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and
many other aspects of our business. These requirements may constrain our rate of growth and changes in regulations could adversely affect us. The burden imposed by these federal and state regulations may place banks, including the Bank, at a
competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate profitably. See Item 1, Description of Business 
Supervision and Regulation above, for more information about applicable banking laws and regulations. In addition, because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we
cannot forecast how federal regulation of financial institutions may change in the future nor the impact those changes may have on our operations. Although Congress in recent years has sought to reduce the regulatory burden on financial institutions
in certain respects, we fully expect that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We rely heavily on our management team and on our ability to attract and retain key personnel.We are a customer-focused and relationship-driven
organization. We expect our future growth to be driven in large part by the relationships maintained with our customers by our Chief Executive Officer, and our other executive and senior lending officers. We also rely heavily on our management team
to maintain and evolve our internal controls, accounting and reporting systems. We have entered into employment agreements with our Chief Executive Officer, Chief Financial Officer and certain other key executives. The existence of such agreements,
however, does not necessarily ensure that we will be able to continue to retain their services. The loss of our Chief Executive Officer, Chief Financial Officer or other key employees for any reason could have a material adverse effect on our
business and possibly result in reduced revenues and earnings.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We depend on the profitability of the Bank. We are a single bank holding company and our business is owning all of the outstanding stock of the Bank. As a
result, our operating results and financial position depend on the operating results and financial position of the Bank. Many factors could adversely affect our short- and long-term operating performance, including those described below.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We may incur losses if we are unable to successfully manage interest rate risk.Our profitability will depend in substantial part upon the spread between the
interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities. We occasionally engage in marketing and promotions that offer above-market rates to attract deposits. Changes in interest
rates will affect our operating performance and financial condition in diverse ways, including the pricing of loans and deposits, the volume of loan originations in our mortgage banking business and the value we can recognize on the sale of mortgage
loans in the secondary market. We attempt to minimize our exposure to interest rate risk, but we will be unable to eliminate it. Our net interest spread will depend on many factors that are partly or entirely outside our control, including
competition, federal economic, monetary and fiscal policies, and economic conditions generally.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



10



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##### Table of Contents

| |  |  | We may be adversely affected by economic conditions in our market area.We are headquartered in Norfolk, Virginia, and our market includes the greater
Hampton Roads metropolitan area. Because our lending is concentrated in this market, we will be affected by the general economic conditions in the greater southeast Virginia area. Changes in the economy may influence the growth rate of our loans and
deposits, and the quality of our loan portfolio and loan and deposit pricing. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control would impact these local economic
conditions and the demand for banking products and services generally, which could negatively affect our financial condition and performance.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our loans secured by real estate may increase our credit losses, which would adversely affect our financial results.We offer a variety of secured loans,
including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area. A major downturn in the
real estate market could adversely affect the value of our collateral for real estate loans and our customers ability to pay these loans, which in turn could impact us. Risk of loan defaults and foreclosures are unavoidable in the banking
industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. We cannot fully eliminate credit risk, however, and as a result credit losses may occur in the future.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.We maintain an allowance for loan losses that we
believe is a reasonable estimate of known and inherent losses in our loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market
conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of our customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and
other conditions, including changes in interest rates, that may be beyond our control, and these losses may exceed our current estimates. Although we believe our allowance for loan losses is a reasonable estimate of known and inherent losses in our
loan portfolio, we cannot fully predict such losses or that our loan loss allowance will be adequate in the future. Excessive loan losses could have a material impact on our financial performance. Federal and state regulators periodically review our
allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in the amount of our loan loss provision or loans
charged-off as required by these regulatory agencies could have a negative effect on our operating results.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We may suffer losses in the Banks loan portfolio despite our underwriting practices.We seek to mitigate the risks inherent in our loan portfolio by
adhering to specific underwriting practices. These practices include analysis of a borrowers prior credit history, financial statements, tax returns and cash flow projections, valuation of collateral based on reports of independent appraisers,
and verification of liquid assets. Although we believe that our underwriting criteria are appropriate for our loans, the Bank may incur losses on loans that meet these criteria.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.We face vigorous competition from other
banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions, for deposits, loans and other financial services in our market area. Most of these banks and other financial
institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services. We also compete with other
providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations, which may be able to offer financing on more favorable terms than we can. Many of
our non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors have advantages over us in providing certain services. This competition may reduce or limit our margins and our market
share and may adversely affect our results of operations and financial condition.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The costs of being a public bank holding company are proportionately higher for small companies like us. The U.S. Patriot Act, the Bank Secrecy Act and the
Sarbanes-Oxley Act of 2002 and related regulations of the Securities and Exchange Commission have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. Many of these regulations are or will become
applicable to our company. As a result, we have experienced and expect to continue to incur increased compliance costs, including costs related to implementing, maintaining and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



11



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##### Table of Contents

| | periodically assessing and evaluating our internal controls and the pending requirement that our independent auditors attest to and report on
managements assessment of internal controls. These necessary compliance costs are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our ability to operate profitably may be affected by our ability to implement technologies into our operations.The market for financial services, including
banking services and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and telebanking. Our ability to compete
successfully in our market may be affected by the extent to which we are able to utilize technological changes. If we are not able to implement new technologies at a cost that is reasonable and appropriate for a bank of our size, properly or timely
anticipate them, or properly train our staff to use them, our business, financial condition or operating results could be adversely affected.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | There is a limited trading market for our common stock; it may be difficult to sell our shares after you have purchased them.The trading in the shares of
our common stock has historically been limited. Our common stock is quoted on both the OTC Bulletin Board (OTCBB) and the Pink Sheets over-the-counter markets. Trading on the OTCBB and Pink Sheets is more limited than on the national
exchanges such as the New York Stock Exchange or NASDAQ, so there is, and likely will continue to be, a limited trading market for our stock. Even if a more active market for our stock develops, there can be no assurance that it will continue, or
that you will be able to sell your shares at the desired price.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|ITEM 1B. | UNRESOLVED STAFF COMMENTS
|-------- | -------------------------

The Company is a smaller
reporting company and thus is not required to provide the information specified by Item 1B in this Form 10-K.



12



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|ITEM 2. | DESCRIPTION OF PROPERTY
|------- | -----------------------

At December 31, 2008,
the Bank operated from seven locations:



|                                                  |  |                                                                              |  |              |  |                          
|------------------------------------------------- |  | ---------------------------------------------------------------------------- |  | ------------ |  | -------------------------
|Office Location                                   |  | Type of Facility                                                             |  | Owned/Leased |  | ApproximateSquare Footage
|150 Granby Street, Suite 175, Norfolk, Virginia   |  | Retail Banking Office                                                        |  | Leased       |  | 3,739 sq. ft             
|                                                  |  |                                                                              | 
|150 Granby Street, Suite 150, Norfolk, Virginia   |  | Corporate Headquarters (Executive, Commercial Loans
and Loan Administration) |  | Leased       |  | 8,403 sq. ft.            
|                                                  |  |                                                                              | 
|841 North Military Highway, Norfolk, Virginia     |  | Retail Banking Office and Real Estate Finance                                |  | Owned        |  | 6,250 sq. ft.            
|                                                  |  |                                                                              | 
|815 Colley Avenue, Norfolk, Virginia              |  | Retail Banking Office                                                        |  | Owned        |  | 3,000 sq. ft.            
|                                                  |  |                                                                              | 
|735 East Ocean View Avenue, Norfolk, Virginia     |  | Retail Banking Office                                                        |  | Owned        |  | 3,000 sq. ft.            
|                                                  |  |                                                                              | 
|601 Lynnhaven Parkway, Virginia Beach, Virginia   |  | Retail Banking Office                                                        |  | Owned        |  | 3,165 sq. ft.            
|                                                  |  |                                                                              | 
|1450 South Military Highway, Chesapeake, Virginia |  | Operations Center                                                            |  | Leased       |  | 11,119 sq. ft.           

The Companys operations center at 1450 South Military Highway is being consolidated with the Companys
corporate headquarters and its North Military Highway office. There are two separate leases for the South Military Highway location, which leases will terminate in February and July 2009.

In January 2009, the Bank opened its new retail banking office at 1756 Laskin Road, in the Hilltop section of Virginia Beach. The office is owned by the Company and
consists of approximately 5,640 square feet.

We believe that all of our properties are adequately covered by insurance, are in good operating condition
(ordinary wear and tear excepted) and are adequate and suitable for the ordinary and regular conduct of our business.



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

At the date of this Form 10-K,
the Company is not a party to any legal proceedings, the adverse outcome of which, in managements opinion, individually or in the aggregate, would have a material effect on the Companys results of operations or financial position.



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

None



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PART II



|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ------------------------------------------------------------------------------------------------------------

Market Information

The Companys common stock is
currently quoted on the OTC Bulletin Board and Pink Sheets over-the-counter markets under the symbol HBKS. During 2007 through November 18, 2007, the Companys common stock was quoted solely on the Pink Sheets over-the-counter
securities market under the symbol HBKS.PK. The following table sets forth the high and low closing sales price for our common stock, as reported by the OTC Bulletin Board or Pink Sheets (as applicable), by calendar quarter for 2008 and
2007. These quotations represent inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.



|               |  |      |       |     |   |      
|-------------- |  | ---- | ----- | --- | - | -----
|               |  | HIGH |       | LOW
|2008           |  |      |       |     |   |      
|               |  |     
|Fourth Quarter |  | $    | 12.25 |     | $ | 8.00 
|Third Quarter  |  |      | 13.50 |     |   | 10.00
|Second Quarter |  |      | 13.50 |     |   | 11.00
|First Quarter  |  |      | 12.50 |     |   | 10.55
|               |  |     
|2007           |  |      |       |     |   |      
|               |  |     
|Fourth Quarter |  | $    | 25.00 |     | $ | 11.00
|Third Quarter  |  |      | 15.70 |     |   | 11.25
|Second Quarter |  |      | 16.10 |     |   | 15.00
|First Quarter  |  |      | 17.00 |     |   | 15.50

Holders of Stock

At December 31, 2008, there were approximately 908 holders of record of the 2,279,252 outstanding shares of the Companys common stock.

Dividends

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, including applicable law, and the
Companys dividend policy may change from time to time at the discretion of the Board of Directors depending on such factors. The Companys principal source of funds for cash dividends are the dividends paid to the Company by the Bank. The
Company declared cash dividends of $0.24 per share, in aggregate, in each of 2008 and 2007. Regulatory restrictions on the payment of dividends by both the Bank to the Company and the Company to its shareholders are discussed above in Item 1,
Description of BusinessSupervision and Regulation, and described in Note 17 to the Consolidated Financial Statements under Financial Statements.

Recent Sales of Unregistered Securities

No securities were sold by the Company within the past three
years that were not registered under the Securities Act that were not previously reported in a Quarterly Report on Form 10-Q or in a Current Report on Form 8-K.



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Equity Compensation Plan Information

The Company makes grants of options to purchase common stock of the Company pursuant to its stock option plans. Information regarding the Companys outstanding executive compensation plans as of December 31,
2008 is set forth in the following table:



|                                                           |  |                                                                        |  |                                                        |       |                                                                                                                                          |       
|---------------------------------------------------------- |  | ---------------------------------------------------------------------- |  | ------------------------------------------------------ | ----- | ---------------------------------------------------------------------------------------------------------------------------------------- | ------
|Plan Category                                              |  | Number of Securitiesto be Issued UponExercise ofOutstanding Options(a) |  | Weighted-AverageExercise Price ofOutstandingOptions(b) |       | Number of SecuritiesRemaining Available forFuture Issuance UnderEquity CompensationPlans(Excluding
SecuritiesReflected in Column (a))(c)
|Equity Compensation Plans Approved by Security Holders (1) |  | 295,000                                                                |  | $                                                      | 14.10 |                                                                                                                                          | 50,000
|                                                           |  |                                                                        | 
|Equity Compensation Plans Not Approved by Security Holders |  |                                                                       |  |                                                        |      |                                                                                                                                          |      
|                                                           |  |                                                                        |  |                                                        |       |                                                                                                                                          |       
|                                                           |  |                                                                        | 
|Total                                                      |  | 295,000                                                                |  | $                                                      | 14.10 |                                                                                                                                          | 50,000
|                                                           |  |                                                                        |  |                                                        |       |                                                                                                                                          |       



|(1) | On December 28, 2006, at the Companys Combined 2005 and 2006 Annual Meeting of Shareholders, the Companys shareholders approved the Heritage 2006 Equity Incentive
Plan (2006 Incentive Plan), which authorizes the grant of stock options, stock appreciation rights, restricted stock and certain other equity awards with respect to not more than 250,000 shares of the Companys common stock. The
Companys ability to issue new awards under its 1987 Stock Option Plan and 1999 Stock Option Plan was terminated concurrently with approval of the 2006 Incentive Plan.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Repurchases of Equity Securities by Issuer and Affiliated Purchasers

None.



|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------

The Company is a smaller
reporting company and thus is not required to provide the information specified by Item 6 in this Form 10-K.



|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

Managements discussion and analysis is intended to assist readers in the understanding and evaluation of the financial condition and results of
operations of Heritage Bankshares, Inc. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this annual report on Form 10-K and the supplemental financial data appearing
throughout this discussion and analysis.

Overview

The Company, through the Bank, engages in a general community and commercial banking business, targeting the banking needs of individuals and small to medium sized businesses in its primary service area. The principal
business of the Company is to attract deposits and to lend or invest those deposits on profitable terms. These deposits are in varied forms of both demand and time accounts including checking accounts, interest checking, money market accounts,
savings accounts, certificates of deposit, and IRA accounts.



15



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##### Table of Contents

The Company is involved in the construction and real estate lending market and actively extends both
personal and commercial credit. Loans consist of varying terms and can be secured or unsecured. Loans to individuals are for personal, household, and family purposes. Loans to businesses are for such purposes as working capital, plant expansion, and
equipment purchases.

Critical Accounting Policies

The preparation of the Companys consolidated financial statements and accompanying notes are governed by accounting principles generally accepted in the United States of America. The preparation of these
financial statements requires management to use judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. While we believe our
judgments, estimates and assumptions are reasonable under the circumstances, actual results may differ materially under different conditions, or using different assumptions.

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

Allowance for Loan Losses. The allowance for loan losses is maintained at a level which, in managements judgment, is adequate to absorb
estimated credit losses on existing loans. If judgments and assumptions were to differ significantly from those used by management to estimate the allowance, the allowance for loan losses and the provision for loan losses on the income statement
could be impacted materially. In addition, the allowance for loan losses is subject to review by various regulators who conduct examinations of the allowance for loan losses and may require adjustments to the allowance based upon the
regulators assessment regarding its adequacy and the methodology used. (For further discussion of the Companys allowance for loan losses, see Lending Activities  Allowance for Loan Losses located in Managements
Discussion and Analysis below.)

Impairment of Loans. A loan is considered impaired when it is probable that the Company will be
unable to collect all interest and principal payments due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loans effective interest
rate, or the fair value of the collateral if the loan is collateral dependent. A valuation allowance is maintained to the extent that the measure of the impaired loan is less than the recorded investment.

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

Deferral of Loan Fees and Origination Costs. SFAS No. 91, Accounting for
Non-Refundable Fees and Costs Associated with Originating or Acquiring Loans and Indirect Costs of Leases, generally requires that loan fees and direct loan origination costs be deferred and recognized as an adjustment to the loans
yield. While the amount of fees to be deferred is generally apparent in the origination of a loan, the Company utilizes estimates to determine the amount of deferred direct origination costs, especially payroll costs, that are attributable to the
loan origination process. Managements estimates of the amount of costs associated with successful loan origination activities are reviewed and updated annually.

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



16



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Selected Financial Ratios

The information presented below is derived in part from the audited consolidated financial statements and notes thereto of the Company, which appear elsewhere in this annual report on Form 10-K (see Item 8,
Financial Statements, below). This information should be read in conjunction with the Companys consolidated financial statements.



|                                     |  |                                  |   |  |       |   |  |        |  
|------------------------------------ |  | -------------------------------- | - |  | ----- | - |  | ------ | -
|                                     |  | FOR THE YEARS ENDED DECEMBER 31, |  
|                                     |  | 2008                             |   |  | 2007  |   |  | 2006   |  
|Return on average assets (1)         |  | 0.30                             | % |  | 0.42  | % |  | 0.09   | %
|Return on average equity (2)         |  | 2.71                             | % |  | 3.74  | % |  | 1.03   | %
|Average equity to average assets (3) |  | 10.90                            | % |  | 11.36 | % |  | 8.36   | %
|Dividend payout ratio (4)            |  | 80.00                            | % |  | 60.00 | % |  | 240.00 | %



|(1) | Net income divided by average total assets.
|--- | -------------------------------------------

|(2) | Net income divided by average equity.
|--- | -------------------------------------

|(3) | Average equity divided by average total assets.
|--- | -----------------------------------------------

|(4) | Represents dividends declared per share divided by basic net income per share.
|--- | ------------------------------------------------------------------------------

Financial Condition of the Company

Total Assets. The Companys total assets increased by $44.3 million, or
20.0%, from $221.2 million at December 31, 2007 to $265.5 million at the end of 2008.

Federal Funds Sold and Investment
Securities. Total federal funds sold and investment securities increased by $21.1 million, from $47.7 million at December 31, 2007 to $68.8 million at December 31, 2008, primarily attributable to an increase in mortgage-backed security
balances. During the fourth quarter of 2008, the Company purchased $27.9 million of FNMA and FHLMC mortgage-backed securities, including $15.8 million that settled in January 2009 and are reflected on the balance sheet included at Item 8,
Financial Statements and Supplementary Data, as pending settlement at December 31, 2008. At December 31, 2008, the Companys $60.7 million balance of available for sale securities consisted of $2.3 million of balloon and
$58.4 million of new and seasoned ten-year fully amortizing FNMA and FHLMC mortgage backed securities.

Loans. Loans held for
investment at December 31, 2008 were $176.6 million, which represents an increase of $22.7 million, or 14.8%, from the loan balance of $153.9 million at December 31, 2007.

Asset Quality. The Companys total nonperforming assets were $218,000, or 0.08% of assets, at December 31, 2008, compared to $163,000,
or 0.07% of assets, at December 31, 2007. The increase was attributable to an increase of $178,000 in the balance of other real estate owned, partially offset by a $122,000 decrease in nonperforming loans.

Deposits. Total year-end deposits increased by $29.8 million, or 16.0%, from $186.0 million at December 31, 2007 to $215.8 million at
December 31, 2008. Core deposits, which are comprised of noninterest-bearing, money market, NOW and savings deposits, increased by $28.7 million, or 21.4%, from $134.4 million at December 31, 2007 to $163.1 million at December 31,
2008. Certificate of deposit balances also increased by $1.1 million between the two twelve-month periods.

Average total deposits
increased by $7.7 million, or 4.1%, from $188.5 million during the twelve months ended December 31, 2007 to $196.2 million during the twelve months ended December 31, 2008. Average core deposits increased by $11.2 million, offset by a $3.5
million decrease in the average balance of certificates of deposit, between the comparable twelve-month periods.

Borrowed Funds.
Borrowed funds decreased by $2.0 million, from $8.2 million at December 31, 2007 to $6.2 million at December 31, 2008, attributable to a decrease in the balance of FHLB advances.

Other Liabilities. The Companys $17.3 million balance of other liabilities at December 31, 2008 includes $15.8 million reflecting the
January 2009 settlement of the mortgage-backed securities purchase as described above. The Company funded the settlement with a combination of deposits and FHLB advances.

Capital. Stockholders equity increased by $761,000, or 3.0%, from $25.1 million at December 31, 2007 to $25.9 million at December 31, 2008. Stockholders equity increased primarily as a
result of increases in retained earnings, additional paid-in capital related to stock-based compensation, and in accumulated after-tax comprehensive income attributable to an increase in the market value of the Companys available-for-sale
investment securities portfolio.



17



---

##### Table of Contents

Net Interest Income

Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, primarily from loan and investment securities
portfolios, and interest expense, primarily on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For purposes of determining such changes in net interest income, volume refers to the
average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net
interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of noninterest-bearing liabilities. During the years ended
December 31, 2008 and 2007, average interest-earning assets were $214.4 million and $201.3 million, respectively. During these same years, the Companys net interest margins were 3.74% and 3.72%, respectively.



18



---

##### Table of Contents

Average Balances and Average Rates Earned and Paid. The following table sets forth for the
Company, for the periods indicated, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities,
resultant yields or costs, net interest income, net interest spread, net interest margin and ratio of average interest-earning assets to average interest-bearing liabilities. In preparing the table, nonaccrual loans are included in the average loan
balance.



|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|-------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | --------------------------- | - | ---------- | --------------------------- | ---- | ------------------ |  | - | -------- | - | ---------- | - | ------ | ------------------ | ---- | - | -------- | - | ---------- | - |  | - | ------ |  | ---- | -
|                                                                                 |  | YEAR ENDEDDECEMBER 31, 2008 |         |   | YEAR ENDEDDECEMBER 31, 2007 |   |            | YEAR ENDEDDECEMBER 31, 2006 |     
|                                                                                 |  | AverageBalance (1)          |         |   | Interest                    |   | Yield/Cost |                             |      | AverageBalance (1) |  |   | Interest |   | Yield/Cost |   |        | AverageBalance (1) |      |   | Interest |   | Yield/Cost |  
|                                                                                 |  | (Dollars in Thousands)      |        
|Interest-earning assets (2)                                                      |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|Loans (2) (3)                                                                    |  | $                           | 167,596 |   |                             | $ | 9,848      |                             | 5.86 | %                  |  | $ | 145,088  |   |            | $ | 9,963  |                    | 6.87 | % |          | $ | 136,779    |   |  | $ | 9,677  |  | 7.08 | %
|Investment securities-taxable                                                    |  |                             | 36,377  |   |                             |   | 1,663      |                             | 4.57 | %                  |  |   | 37,633   |   |            |   | 1,888  |                    | 5.01 | % |          |   | 15,022     |   |  |   | 651    |  | 4.29 | %
|Investment securities-non-taxable (2)                                            |  |                             | 765     |   |                             |   | 33         |                             | 4.28 | %                  |  |   | 1,157    |   |            |   | 50     |                    | 4.33 | % |          |   | 1,128      |   |  |   | 49     |  | 4.34 | %
|FHLB and Federal Reserve Stock                                                   |  |                             | 1,054   |   |                             |   | 47         |                             | 4.48 | %                  |  |   | 733      |   |            |   | 44     |                    | 5.98 | % |          |   | 830        |   |  |   | 48     |  | 5.74 | %
|Federal funds sold                                                               |  |                             | 8,008   |   |                             |   | 143        |                             | 1.76 | %                  |  |   | 16,391   |   |            |   | 817    |                    | 4.91 | % |          |   | 40,876     |   |  |   | 2,007  |  | 4.84 | %
|Other interest income                                                            |  |                             | 563     |   |                             |   | 7          |                             | 1.28 | %                  |  |   | 250      |   |            |   | 12     |                    | 4.77 | % |          |   | 67         |   |  |   | 3      |  | 4.93 | %
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Total interest-earning assets                                                    |  |                             | 214,363 |   |                             |   | 11,741     |                             | 5.46 | %                  |  |   | 201,252  |   |            |   | 12,774 |                    | 6.34 | % |          |   | 194,702    |   |  |   | 12,435 |  | 6.37 | %
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Noninterest-earning assets                                                       |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|Other assets                                                                     |  |                             | 18,828  |   |                             |   |            |                             |      |                    |  |   | 15,421   |   |            |   |        |                    |      |   |          |   | 14,776     |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Total assets                                                                     |  | $                           | 233,191 |   |                             |   |            |                             |      |                    |  | $ | 216,673  |   |            |   |        |                    |      |   |          | $ | 209,478    |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Interest-bearing liabilities                                                     |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|Money market, NOW accounts                                                       |  | $                           | 88,469  |   |                             | $ | 1,419      |                             | 1.60 | %                  |  | $ | 79,698   |   |            | $ | 2,608  |                    | 3.27 | % |          | $ | 66,475     |   |  | $ | 2,033  |  | 3.06 | %
|Savings deposits                                                                 |  |                             | 2,459   |   |                             |   | 22         |                             | 0.92 | %                  |  |   | 2,305    |   |            |   | 26     |                    | 1.11 | % |          |   | 3,546      |   |  |   | 35     |  | 0.99 | %
|Certificates of deposit                                                          |  |                             | 52,609  |   |                             |   | 2,035      |                             | 3.86 | %                  |  |   | 56,121   |   |            |   | 2,565  |                    | 4.57 | % |          |   | 66,498     |   |  |   | 2,745  |  | 4.13 | %
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Total interest-bearing deposits                                                  |  |                             | 143,537 |   |                             |   | 3,476      |                             | 2.42 | %                  |  |   | 138,124  |   |            |   | 5,199  |                    | 3.76 | % |          |   | 136,519    |   |  |   | 4,813  |  | 3.53 | %
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Other borrowings                                                                 |  |                             | 9,147   |   |                             |   | 236        |                             | 2.54 | %                  |  |   | 1,922    |   |            |   | 81     |                    | 4.21 | % |          |   | 11,600     |   |  |   | 563    |  | 4.84 | %
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Total interest-bearing liabilities                                               |  |                             | 152,684 |   |                             |   | 3,712      |                             | 2.43 | %                  |  |   | 140,046  |   |            |   | 5,280  |                    | 3.77 | % |          |   | 148,119    |   |  |   | 5,376  |  | 3.63 | %
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Noninterest-bearing liabilities                                                  |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|Demand deposits                                                                  |  |                             | 52,660  |   |                             |   |            |                             |      |                    |  |   | 50,370   |   |            |   |        |                    |      |   |          |   | 42,128     |   |  |   |        |  |      |  
|Other liabilities                                                                |  |                             | 2,418   |   |                             |   |            |                             |      |                    |  |   | 1,646    |   |            |   |        |                    |      |   |          |   | 1,723      |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Total liabilities                                                                |  |                             | 207,762 |   |                             |   |            |                             |      |                    |  |   | 192,062  |   |            |   |        |                    |      |   |          |   | 191,970    |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Stockholders equity                                                             |  | $                           | 25,429  |   |                             |   |            |                             |      |                    |  | $ | 24,611   |   |            |   |        |                    |      |   |          | $ | 17,508     |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Total liabilities and Stockholders equity                                       |  | $                           | 233,191 |   |                             |   |            |                             |      |                    |  | $ | 216,673  |   |            |   |        |                    |      |   |          | $ | 209,478    |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Net interest income and interest rate spread                                     |  |                             |         |   |                             |   | 8,029      |                             | 3.03 | %                  |  |   |          |   |            | $ | 7,494  |                    | 2.57 | % |          |   |            |   |  | $ | 7,059  |  | 2.74 | %
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Net interest margin                                                              |  |                             |         |   |                             |   |            |                             | 3.74 | %                  |  |   |          |   |            |   |        |                    | 3.72 | % |          |   |            |   |  |   |        |  | 3.63 | %
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |     
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                             | 140.40  | % |                             |   |            |                             |      |                    |  |   | 143.70   | % |            |   |        |                    |      |   |          |   | 131.45     | % |  |   |        |  |      |  
|                                                                                 |  |                             |         |   |                             |   |            |                             |      |                    |  |   |          |   |            |   |        |                    |      |   |          |   |            |   |  |   |        |  |      |  



|(1) | The calculations are based on daily average balances. Certain reclassification and yield calculations have been made to 2006 to conform that year to the 2007 and 2008 presentation.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Yields on tax-free loans and investments have not been adjusted for tax equivalency.
|--- | ------------------------------------------------------------------------------------

|(3) | For the purposes of these computations, nonaccruing loans are included in the average loan balances.
|--- | ----------------------------------------------------------------------------------------------------



19



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##### Table of Contents

Rate/Volume Analysis

The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between
(i) changes attributable to volume (changes in volume multiplied by the prior periods rate), (ii) changes attributable to rate (changes in rate multiplied by the prior periods volume), and (iii) net change (the sum of the
previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) has been allocated equally to both the changes attributable to volume and the changes attributable to rate.



|                                        |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|--------------------------------------- |  | -------------------------------------------------------------- | ----- | - | -------------------------------------------------------------- | - | ------ | ----- |  | - | ------ | - |  | ---- | ------ | - | ----- | - | ---- | - |  | - | ------ | -
|                                        |  | Year EndedDecember 31, 2008 vs. 2007Increase (Decrease) Due to |       |   | Year EndedDecember 31, 2007 vs. 2006Increase (Decrease) Due to |  
|                                        |  | Volume                                                         |       |   | Rate                                                           |   |        | Total |  |   | Volume |   |  | Rate |        |   | Total |  
|                                        |  | (Dollars in Thousands)                                         |      
|Interest income                         |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Loans                                   |  | $                                                              | 1,443 |   |                                                                | $ | (1,558 | )     |  | $ | (115   | ) |  | $    | 576    |   |       | $ | (290 | ) |  | $ | 286    |  
|Investment securities taxable           |  |                                                                | (64   | ) |                                                                |   | (161   | )     |  |   | (225   | ) |  |      | 1,112  |   |       |   | 125  |   |  |   | 1,237  |  
|Investment securities non-taxable       |  |                                                                | (16   | ) |                                                                |   | (1     | )     |  |   | (17    | ) |  |      | 1      |   |       |   |     |   |  |   | 1      |  
|FHLB & FRB stock                        |  |                                                                | 16    |   |                                                                |   | (13    | )     |  |   | 3      |   |  |      | (6     | ) |       |   | 2    |   |  |   | (4     | )
|Federal funds sold                      |  |                                                                | (299  | ) |                                                                |   | (375   | )     |  |   | (674   | ) |  |      | (1,219 | ) |       |   | 29   |   |  |   | (1,190 | )
|Other interest income                   |  |                                                                | 9     |   |                                                                |   | (14    | )     |  |   | (5     | ) |  |      | 9      |   |       |   |     |   |  |   | 9      |  
|                                        |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|                                        |  |                                                                |       |   |                                                                |  
|Total interest income                   |  |                                                                | 1,089 |   |                                                                |   | (2,122 | )     |  |   | (1,033 | ) |  |      | 473    |   |       |   | (134 | ) |  |   | 339    |  
|                                        |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|                                        |  |                                                                |       |   |                                                                |  
|Interest expense                        |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Deposits:                               |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|Money Market/NOW accounts               |  |                                                                | 261   |   |                                                                |   | (1,451 | )     |  |   | (1,190 | ) |  |      | 425    |   |       |   | 150  |   |  |   | 575    |  
|Savings deposits                        |  |                                                                | 2     |   |                                                                |   | (5     | )     |  |   | (3     | ) |  |      | (13    | ) |       |   | 4    |   |  |   | (9     | )
|Certificates of deposit                 |  |                                                                | (152  | ) |                                                                |   | (378   | )     |  |   | (530   | ) |  |      | (456   | ) |       |   | 276  |   |  |   | (180   | )
|Borrowings                              |  |                                                                | 198   |   |                                                                |   | (43    | )     |  |   | 155    |   |  |      | (509   | ) |       |   | 27   |   |  |   | (482   | )
|                                        |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|                                        |  |                                                                |       |   |                                                                |  
|Total interest expense                  |  |                                                                | 309   |   |                                                                |   | (1,877 | )     |  |   | (1,568 | ) |  |      | (553   | ) |       |   | 457  |   |  |   | (96    | )
|                                        |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  
|                                        |  |                                                                |       |   |                                                                |  
|Net interest income Increase (decrease) |  | $                                                              | 780   |   |                                                                | $ | (245   | )     |  | $ | 535    |   |  | $    | 1,026  |   |       | $ | (591 | ) |  | $ | 435    |  
|                                        |  |                                                                |       |   |                                                                |   |        |       |  |   |        |   |  |      |        |   |       |   |      |   |  |   |        |  

Comparison of Operating Results for the Twelve Months Ended December 31, 2008 and 2007

Overview. The Companys pre-tax income was $1.1 million for the year ended December 31, 2008 as compared to $1.4 million in 2007, a
decrease of $320,000. During 2008, net interest income increased by $535,000, the provision for loan losses increased by $348,000, noninterest income decreased by $530,000, and noninterest expense decreased by $23,000. Net income, after tax, in 2008
was $688,000, representing a decrease of $232,000 compared to after-tax income of $920,000 in 2007. Diluted earnings per share decreased by $0.10, from $0.40 per share in 2007 to $0.30 per share in 2008.

Net Interest Income. Even as interest rates declined during 2008, the Companys net interest income, before provision for loan losses,
increased by $535,000. This increase resulted from a $1.6 million decrease in interest expense that was partially offset by a $1.0 million decrease in interest income, as compared to 2007. The increase in net interest income was attributable
primarily to a 46 basis point increase in interest rate spread and a $13.1 million increase in interest-earning assets. The average cost of the Companys interest-bearing liabilities decreased by 134 basis points, from 3.77% in 2007 to 2.43% in
2008. This decrease exceeded the decline of 88 basis points in the average yield of interest-earning assets, from 6.34% in 2007 to 5.46% in 2008.

Interest on loans decreased by $115,000, or 1.2%, from $10.0 million in 2007 to $9.9 million in 2008. This decrease was attributable to a decrease in the yield on the Companys loan portfolio from 6.87% in 2007 to 5.86% in 2008,
partially offset by a $22.5 million increase in the average balance of loans.

Interest on investment securities decreased by $242,000 in
2008 as compared to 2007. This decrease resulted primarily from a decrease in year-over-year average yield from 4.99% to 4.56%, as well as a $1.7 million decrease in the average balance of the portfolio, from $38.8 million in 2007 to $37.1 million
in 2008. Interest on federal funds sold decreased by $674,000 in 2008, attributable to both a decrease in the average balance from $16.4 million in 2007 to $8.0 million in 2008, and a decrease in the average yield from 4.91% in 2007 to 1.76% in
2008.



20



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##### Table of Contents

The Companys interest expense in 2008 decreased by $1.6 million, from $5.3 million in 2007 to $3.7
million in 2008. Although our average balance of interest-bearing deposits increased by $5.4 million in 2008, interest paid on deposits decreased by $1.7 million, resulting from a decrease in the average cost of interest-bearing deposits from 3.76%
in 2007 to 2.42% in 2008. Interest paid on borrowed funds increased by $155,000, from $81,000 in 2007 to $236,000 in 2008, as the $7.2 million increase in the average balance of borrowed funds more than offset the decrease in the cost of borrowings
from 4.21% in 2007 to 2.54% in 2008.

Provision for Loan Losses.The Companys provision for loan losses increased by
$348,000, from $105,000 in 2007 to $453,000 in 2008. The increase in the provision for loan losses in 2008 was largely a result of $201,000 in net charge-offs incurred during the year.

Noninterest Income. Total noninterest income decreased by $530,000, from $1.9 million in 2007 to $1.4 million in 2008:



| |  |  | Gains on the sale of fixed assets decreased by $524,000 in 2008, primarily due to the Banks sale of its former Plume Street office in 2007, which resulted in
a gain of $526,000 that did not recur in 2008.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Company similarly recorded non-recurring income of $345,000 in 2007, resulting from payment received in connection with a settlement with a former professional
services provider.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Service charges on deposit accounts decreased by $91,000, from $506,000 in 2007 to $415,000 in 2008, due primarily to a decrease in non-sufficient fund checking
fees.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Gains on the sale of mortgage loans held for sale decreased by $28,000, from $120,000 in 2007 to $92,000 in 2008, due to reduced mortgage loan origination volume.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Net gains on the sale of investment securities increased by $517,000, from $1,000 in 2007 to $518,000 in 2008. As previously reported, in July 2008 the Company sold
approximately $28.5 million of FNMA and FHLMC balloon mortgage-backed securities in light of management concerns surrounding the financial viability of FNMA and FHLMC prior to their being placed in conservatorship.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Noninterest Expense. Total noninterest expense was $8.0 million in 2008, essentially unchanged from 2007:



| |  |  | Compensation expense and professional fees decreased by $90,000 and $91,000, respectively, from 2007 to 2008.
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | Courier expense increased by $141,000 from 2007 to 2008. The Company moved its courier operations in-house in late 2008 and, as a result, we expect that courier
expense will decrease in 2009.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expenses for taxes and licenses increased by $53,000 from 2007 to 2008, primarily due an increase in state franchise tax expense.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------

Income Taxes. The Companys income tax expense for the year ended December 31, 2008 was $391,000 compared to $479,000 for 2007, which
represented effective tax rates of 36.2% and 34.3%, respectively.



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##### Table of Contents

The following tables set forth, for the periods indicated, components of noninterest income and
noninterest expense:



|                                                      |  |                          |           |      |   |          
|----------------------------------------------------- |  | ------------------------ | --------- | ---- | - | ---------
|                                                      |  | Years Ended December 31,
|                                                      |  | 2008                     |           | 2007
|Noninterest income                                    |  |                          |           |      |   |          
|Service charges on deposit accounts                   |  | $                        | 415,093   |      | $ | 505,615  
|Gains on sale of fixed assets                         |  |                          | 6,030     |      |   | 529,530  
|Settlement from former professional services provider |  |                          |          |      |   | 345,000  
|Gains on sale of loans, net                           |  |                          | 91,533    |      |   | 120,215  
|Income from bank-owned life insurance, net            |  |                          | 20,270    |      |   | 21,008   
|Late charges and other fees on loans                  |  |                          | 51,732    |      |   | 66,030   
|Credit card interchange fees                          |  |                          | 37,312    |      |   | 35,707   
|ATM fees                                              |  |                          | 123,584   |      |   | 129,989  
|Merchant discount fees                                |  |                          | 50,268    |      |   | 46,445   
|Gain on sale of other real estate owned               |  |                          | 36,702    |      |   |         
|Net gain on sale of securities                        |  |                          | 518,148   |      |   | 1,170    
|Other                                                 |  |                          | 97,179    |      |   | 177,635  
|                                                      |  |                          |           |      |   |          
|Total noninterest income                              |  | $                        | 1,447,851 |      | $ | 1,978,344
|                                                      |  |                          |           |      |   |          



|                                               |  |                          |           |      |   |           |  
|---------------------------------------------- |  | ------------------------ | --------- | ---- | - | --------- | -
|                                               |  | Years Ended December 31, |          
|                                               |  | 2008                     |           | 2007 |  
|Noninterest expense                            |  |                          |           |      |   |           |  
|Compensation                                   |  | $                        | 4,088,588 |      | $ | 4,179,058 |  
|Data processing                                |  |                          | 527,317   |      |   | 519,427   |  
|Occupancy                                      |  |                          | 798,033   |      |   | 780,143   |  
|Furniture and equipment                        |  |                          | 554,504   |      |   | 531,452   |  
|Taxes and licenses                             |  |                          | 269,586   |      |   | 217,300   |  
|Professional fees                              |  |                          | 346,701   |      |   | 438,592   |  
|ATM transaction                                |  |                          | 108,444   |      |   | 122,343   |  
|Credit card                                    |  |                          | 3,780     |      |   | (59       | )
|Stationery and supplies                        |  |                          | 78,954    |      |   | 130,417   |  
|Telephone                                      |  |                          | 101,363   |      |   | 119,439   |  
|Postage                                        |  |                          | 74,678    |      |   | 70,563    |  
|Courier                                        |  |                          | 262,802   |      |   | 121,331   |  
|Marketing                                      |  |                          | 118,758   |      |   | 138,239   |  
|Service bureau expense                         |  |                          | 93,934    |      |   | 66,775    |  
|Insurance expense                              |  |                          | 46,717    |      |   | 46,287    |  
|Travel                                         |  |                          | 28,157    |      |   | 24,261    |  
|Shareholder                                    |  |                          | 38,765    |      |   | 43,513    |  
|Training                                       |  |                          | 15,960    |      |   | 17,816    |  
|Loan servicing                                 |  |                          | 20,779    |      |   | 36,357    |  
|FDIC insurance                                 |  |                          | 96,277    |      |   | 64,508    |  
|Loss on disposal or impairment of fixed assets |  |                          | 69,778    |      |   | 66,351    |  
|Other miscellaneous                            |  |                          | 201,160   |      |   | 234,116   |  
|                                               |  |                          |           |      |   |           |  
|Total noninterest expense                      |  | $                        | 7,945,035 |      | $ | 7,968,229 |  
|                                               |  |                          |           |      |   |           |  

Lending Activities

Loans held for investment, net of allowance for loan losses and unearned fees and costs, at December 31, 2008 were $176.6 million compared with $153.9 million at December 31, 2007, an increase of
$22.7 million or 14.8%, primarily attributable to a $16.1 million increase in loans secured by real estate. As a percentage of average earning assets, average loans were 78.2% at December 31, 2008, and 72.1% at December 31, 2007.



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##### Table of Contents

General. The Bank engages in a wide range of lending activities, which include the origination,
primarily in the Banks market area, of (1) commercial business loans, (2) commercial real estate loans, (3) construction loans, (4) land acquisition and development loans, and (5) home equity, consumer and residential
mortgage loans.

Commencing in early 2005, the Bank has taken a number of steps, such as the recruitment of highly knowledgeable and
experienced lending officers, the introduction of centralized loan processing, the implementation of new underwriting and documentation requirements and the regular utilization of the loan committee process, to improve the underwriting,
documentation, and administration of the Banks loan portfolio. The discussion in this section relates to the lending practices utilized by the Bank since early 2005.

Loan Policy. The Banks Loan Policy provides general guidance on underwriting of loans, risk management, credit approval, loan administration
and problem asset management. The Policy is designed to help ensure that loan growth is accompanied by acceptable asset quality with uniform and consistently applied approval, administration, and documentation practices and standards.

Commercial Business Lending. The Bank actively solicits commercial business loans of all types. Commercial business loans include revolving lines
of credit to provide working capital, term loans to finance the purchase of vehicles and equipment, letters of credit to guarantee payment and performance, and other loans to assist businesses in cash management or growth opportunities.

Revolving lines of credit are typically secured by various assets of the borrower, provide for the acceleration of repayment upon any event of
default, are monitored monthly or quarterly to ensure compliance with loan covenants, when appropriate, and are re-underwritten annually before renewal. Interest rates on revolving lines of credit generally are variable. Term loans are generally
advanced for the purchase of, and are secured by, vehicles and equipment and are normally fully amortized over a term of two to five years, on either a fixed or variable rate basis. In general, these credit facilities carry the unconditional
guarantees of the owners and/or stockholders of the borrower.

Commercial Real Estate Lending. The Banks commercial real
estate loans are primarily secured by real property and the income arising from such property. The proceeds of commercial real estate loans are generally used by the borrower to finance or refinance the cost of acquiring and/or improving a
commercial property. The properties that typically secure these loans are office and warehouse facilities, retail facilities, and other commercial properties. In addition, the Bank will on a more limited basis make loans secured by special purpose
facilities such as hotels, mini-storage warehouses and manufacturing facilities. The Bank actively seeks to make commercial real estate loans to borrowers who will occupy or use the financed property in connection with their normal business
operations. The Bank also makes commercial real estate loans for other purposes if the borrower is in strong financial condition and presents a substantial business opportunity for the Bank or if the borrower is creditworthy and has substantially
leased or pre-leased the improvements to tenants acceptable to the Bank.

The Banks commercial real estate loans are usually
amortized over a period of time ranging from 15 years to 25 years and usually have a term to maturity ranging from five years to 15 years. These loans normally include provisions for interest rate adjustments after the loan is three to five years
old. The Banks maximum loan-to-value ratio for a commercial real estate loan is 85%; however, this maximum can be waived for particularly strong borrowers on an exception basis. Most commercial real estate loans are further secured by one or
more unconditional personal guarantees.

The Bank structures some of its commercial real estate loans as mini-permanent loans. The
amortization period, term and interest rates for these loans vary based on borrower preferences and the Banks assessment of the loan and the degree of risk involved. If the borrower prefers a fixed rate of interest, the Bank usually offers a
loan with a fixed rate of interest for a term of three to five years with an amortization period of up to 25 years and the remaining balance of the loan due and payable in a single balloon payment at the end of the initial term. If the borrower
prefers a variable or floating rate of interest, the Bank usually offers a loan with a variable interest rate tied to a readily recognizable index, such as the Banks prime rate, for a term of three to five years with an amortization period of
up to 25 years and the remaining balance of the loan due and payable in a single balloon payment at the end of the initial term.

Loans
secured by commercial real estate are generally larger and involve a greater degree of risk than residential mortgage loans. Because payments on loans secured by commercial real estate are usually dependent on successful operation or management of
the properties securing such loans, repayment of such loans is subject to changes in both general and local economic conditions and the borrowers business and income. As a result, events beyond the control of the Bank, such as a downturn in
the local economy, could adversely affect the performance of the Banks commercial real estate loan portfolio. The Bank seeks to minimize these risks by lending to established customers or experienced real estate developers and generally
restricting its commercial real estate loans to its primary market area. Emphasis is placed on the income producing characteristics and repayment capacity of the collateral.



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Construction Lending. The Bank has an active construction lending program. The Bank makes loans
primarily for the construction of one-to-four family residences and, to a lesser extent, multi-family dwellings. The Bank also makes construction loans for office and warehouse facilities and other nonresidential projects, generally limited to
borrowers who are owner-occupants or who present other business opportunities for the Bank.

The amounts, interest rates and terms for
construction loans vary, depending upon market conditions, the size and complexity of the project, and the financial strength of the borrower and any guarantors of the loan. The term for the Banks typical construction loan ranges from nine
months to 15 months for the construction of an individual residence and from 15 months to a maximum of three years for larger residential or commercial projects. The Bank does not typically amortize its construction loans, and the borrower pays
interest monthly on the outstanding principal balance of the loan. The Banks construction loans generally have a floating or variable rate of interest but occasionally have a fixed interest rate. The Bank does not generally finance the
construction of commercial real estate projects built on a purely speculative basis. For residential builder loans, the Bank limits the number of models and/or speculative units allowed depending on market conditions, the builders financial
strength and track record and other factors. Generally, the maximum loan-to-value ratio for one-to-four family residential construction loans is 80% of the propertys fair market value, or 85% of the propertys fair market value if the
property will be the borrowers primary residence. The fair market value of a project is determined on the basis of an appraisal of the project usually conducted by an independent, outside appraiser acceptable to the Bank or an internal
evaluation when permitted under the Banks policies and regulatory guidelines. For larger projects, where unit absorption or leasing is a concern, the Bank may also obtain a feasibility study or other acceptable information from the borrower or
other sources about the likely disposition of the property following the completion of construction.

Construction loans for nonresidential
projects and multi-unit residential projects are generally larger and involve a greater degree of risk to the Bank than residential mortgage loans. The Bank attempts to minimize such risks by (1) making construction loans in accordance with the
Banks underwriting standards to established customers or experienced real estate developers in its primary market area and (2) monitoring the quality, progress and cost of construction. The maximum loan-to-value ratio established by the
Bank for non-residential construction projects and multi-unit residential construction projects is 80%; however, this maximum can be waived for particularly strong borrowers on an exception basis.

Land Acquisition and Development Lending. Land acquisition and development loans are made to builders and developers for the purpose of acquiring
unimproved land to be developed for residential building sites, residential housing subdivisions, multi-family dwellings and a variety of commercial uses. The Bank generally does not make land acquisition and development loans for commercial
developments but does make such loans for borrowers seeking to build owner-occupied facilities on the subject land.

The Bank underwrites
and processes land acquisition and development loans in much the same manner as commercial construction loans and commercial real estate loans. For residential land acquisition and development loans, the Bank uses a lower loan-to-value ratio, which
is a maximum of 65% for unimproved land and 75% of the appraised value of the developed lots as determined in accordance with the Banks appraisal policies for developed lots for single-family or townhouse construction and discounted, when
appropriate, to reflect absorption periods in excess of one year. The Bank can waive the maximum loan-to-value ratio for particularly strong borrowers on an exception basis. The term of land acquisition and development loans ranges from a maximum of
two years for loans relating to the acquisition of unimproved land to, generally, a maximum of three years for other types of projects. All land acquisition and development loans generally are further secured by one or more unconditional personal
guarantees. Because these loans are usually larger in amount and involve more risk than individual lot loans, the Bank carefully evaluates the borrowers assumptions and projections about market conditions and absorption rates in the community
in which the property is located and the borrowers ability to carry the loan if the borrowers assumptions prove inaccurate.

Home Equity and Consumer Lending and Residential Mortgage Lending. The Bank offers its customers home equity lines of credit and home equity loans that enable customers to borrow funds secured by the equity in their homes. Home
equity lines of credit are offered with adjustable rates of interest on an open-end revolving basis. Home equity loans are offered with fixed rates for a fixed period of time, usually between five and 15 years. Home equity lines of credit and home
equity loans are secured by liens on personal residences and generally do not present as much risk to the Bank as other types of consumer loans.

The Bank offers a variety of consumer loans, including automobile loans, personal secured and unsecured loans, credit card loans, loans secured by savings accounts or certificates of deposit, and loans to purchase residential lots for the
later construction of owner-occupied residences. The shorter terms and generally higher interest rates on consumer loans help the Bank maintain a profitable spread between its average loan yield and its cost of funds. Consumer loans secured by
collateral other than a personal residence generally involve more credit risk than residential mortgage loans because of the type and nature of the collateral or, in certain cases, the absence of collateral. However, the Bank believes the higher
yields generally earned on such loans compensate for the increased credit risk associated with such loans.

The Bank originates residential
mortgage loans secured by properties located in its primary market area in Hampton Roads, Virginia. The Bank offers various types of residential mortgage loans in addition to traditional long-term, fixed-rate or adjustable-rate



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##### Table of Contents

mortgage loans. The Bank generally underwrites loans to be retained by the Bank on terms consistent with secondary mortgage market standards. The Bank
underwrites loans to be sold to secondary market investors after closing on terms specified by the investors. Most of the Banks residential mortgage loans are sold to secondary market investors promptly after closing.

The following table sets forth, at the dates indicated, the Companys loan portfolio composition by type of loan:



|                           |  |                 |             |   |      |   |             |      |  |   |             |   |  |      |             |   |  |   |             |  
|-------------------------- |  | --------------- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | - |  | ---- | ----------- | - |  | - | ----------- | -
|                           |  | At December 31, |            
|                           |  | 2008            |             |   | 2007 |   |             | 2006 |  |   | 2005        |   |  | 2004 |            
|Commercial                 |  | $               | 32,847,457  |   |      | $ | 26,108,173  |      |  | $ | 19,752,244  |   |  | $    | 17,927,074  |   |  | $ | 19,582,518  |  
|                           |  |                 |             |   |     
|Real estate - mortgage     |  |                 | 112,371,561 |   |      |   | 101,095,900 |      |  |   | 92,513,346  |   |  |      | 98,801,013  |   |  |   | 90,513,054  |  
|                           |  |                 |             |   |     
|Real estate - construction |  |                 | 27,883,927  |   |      |   | 23,104,633  |      |  |   | 23,780,496  |   |  |      | 10,013,033  |   |  |   | 9,042,071   |  
|Installment and consumer   |  |                 | 4,385,595   |   |      |   | 4,149,881   |      |  |   | 4,731,529   |   |  |      | 4,665,853   |   |  |   | 5,595,735   |  
|                           |  |                 |             |   |      |   |             |      |  |   |             |   |  |      |             |   |  |   |             |  
|                           |  |                 |             |   |     
|Total gross loans          |  |                 | 177,488,540 |   |      |   | 154,458,587 |      |  |   | 140,777,615 |   |  |      | 131,406,973 |   |  |   | 124,733,378 |  
|                           |  |                 |             |   |     
|Allowance for loan losses  |  |                 | (1,652,174  | ) |      |   | (1,399,875  | )    |  |   | (1,373,000  | ) |  |      | (1,335,001  | ) |  |   | (1,264,000  | )
|Unearned loan costs (fees) |  |                 | 725,238     |   |      |   | 791,439     |      |  |   | 713,894     |   |  |      | 348,354     |   |  |   | 59,245      |  
|                           |  |                 |             |   |      |   |             |      |  |   |             |   |  |      |             |   |  |   |             |  
|                           |  |                 |             |   |     
|Loans, net                 |  | $               | 176,561,604 |   |      | $ | 153,850,151 |      |  | $ | 140,118,509 |   |  | $    | 130,420,326 |   |  | $ | 123,528,623 |  
|                           |  |                 |             |   |      |   |             |      |  |   |             |   |  |      |             |   |  |   |             |  

The following table presents, at December 31, 2008, (i) the aggregate maturities of
loans in the named categories of the Companys loan portfolio and (ii) the aggregate amounts of such loans maturing after one year by fixed and variable rates:

Loan Portfolio Composition and Maturities at December 31, 2008



|                         |  |              |            |                                |   |              |  |       |            |                                   |   |             |  |        |  
|------------------------ |  | ------------ | ---------- | ------------------------------ | - | ------------ |  | ----- | ---------- | --------------------------------- | - | ----------- |  | ------ | -
|                         |  | Within1 Year |            | After 1 Year butWithin 5 Years |   | After5 Years |  | Total |            | Percentage of Total LoanPortfolio |  
|Commercial               |  | $            | 13,021,287 |                                | $ | 15,272,352   |  | $     | 4,553,818  |                                   | $ | 32,847,457  |  | 18.51  | %
|Real Estate-mortgage     |  |              | 10,446,610 |                                |   | 8,340,285    |  |       | 93,584,666 |                                   |   | 112,371,561 |  | 63.31  | %
|Real Estate-construction |  |              | 13,380,818 |                                |   | 13,225,409   |  |       | 1,277,700  |                                   |   | 27,883,927  |  | 15.71  | %
|Installment and consumer |  |              | 1,983,019  |                                |   | 2,116,605    |  |       | 285,971    |                                   |   | 4,385,595   |  | 2.47   | %
|                         |  |              |            |                                |   |              |  |       |            |                                   |   |             |  |        |  
|                         |  | $            | 38,831,734 |                                | $ | 38,954,651   |  | $     | 99,702,155 |                                   | $ | 177,488,540 |  | 100.00 | %
|                         |  |              |            |                                |   |              |  |       |            |                                   |   |             |  |        |  



|                                                     |  |       |            
|---------------------------------------------------- |  | ----- | -----------
|                                                     |  | Total
|Loans Maturing After 1 Year                          |  |       |            
|Fixed rate loans                                     |  | $     | 29,184,448 
|Variable rate loans (includes loans subject to call) |  |       | 109,472,358
|                                                     |  |       |            
|                                                     |  | $     | 138,656,806
|                                                     |  |       |            

Allowance For Loan Losses

The Bank maintains an allowance for loan losses at a level which, in managements judgment, is adequate to absorb estimated credit losses on existing loans. The amount of the allowance is affected by:
(1) loan charge-offs, which decrease the allowance, (2) recoveries on loans previously charged-off, which increase the allowance, and (3) the provision for loan losses charged to income, which increases the allowance.

The Bank analyzes its loan portfolio through ongoing credit review processes and constructs a comprehensive allowance analysis for its loan portfolio at
least quarterly. This analysis includes two basic elements: (1) specific allowances for individual loans, and (2) general allowances for loan portfolio segments, which factor in historical loan loss experience and delinquency rates for the
Bank and the banking industry and numerous other environmental factors.



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##### Table of Contents

The Bank evaluates various loans individually for impairment as required by Statement of Financial
Accounting Standard (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan. An evaluation is based upon either discounted cash flows or collateral evaluations. If the evaluation shows that a particular
loan is impaired, then a specific reserve is established, or a charge-off is made, for the amount of any impairment.

For loans without an
individual measure of impairment, the Bank makes estimates of losses for groups of loans as required by SFAS No. 5, Accounting for Contingencies. As part of the loan loss reserve methodology, loans are placed into one of four
major categories or segments of loans: (1) commercial and industrial loans, (2) consumer loans, (3) 1-4 family residential loans (including home equity loans and lines), and (4) multi-family and other commercial real estate
loans.

The Bank then considers the impact of various bank, industry, economic and other environmental factors and documents which factors
are used in the analysis.

The Banks allowance for loan losses is divided into four distinct portions: (1) Historical  an
amount based on the Banks actual net charge-offs; (2) Impaired Loans  an amount for specific allocations on significant individual credits under SFAS 114; (3) Loan Segments  an amount to adjust the historical allocation
for the four loan segments based on environmental factors under SFAS 5; and (4) Unallocated  an amount to reflect the imprecision inherent in these calculations.

The Companys allowance for loan losses was $1,652,174, or 0.93% of total loans held for investment, net of unearned fees and costs, at
December 31, 2008. This compares to an allowance of $1,399,875, or 0.90% of such loans, at year-end 2007 as reflected in the table below.

Management currently believes that our allowance for loan losses is adequate. However, the allowance is subject to regulatory examinations and determination as to adequacy, which may take into account such factors as the methodology used to
calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies. Such agencies may require the Company to recognize additions to the allowance for loan losses based on their judgments about
information available at the time of their examinations.

The following table sets forth, for the periods indicated, a summary of activity
in the Companys allowance for loan losses:



|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | -- |  | - | --------- | -
|                                                                                                                           |  | At or for the Year Ended December 31, |          
|                                                                                                                           |  | 2008                                  |           |   | 2007 |   |           | 2006 |  |   | 2005      |   |  | 2004 |          
|Balance at beginning of year                                                                                               |  | $                                     | 1,399,875 |   |      | $ | 1,373,000 |      |  | $ | 1,335,001 |   |  | $    | 1,264,000 |    |  | $ | 1,186,854 |  
|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|                                                                                                                           |  |                                       |           |   |     
|Charge-offs:                                                                                                               |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|Commercial                                                                                                                 |  |                                       | 130,429   |   |      |   | 188,911   |      |  |   | 28,623    |   |  |      | 14,963    |    |  |   | 353,697   |  
|Real estate                                                                                                                |  |                                       | 231,370   |   |      |   |          |      |  |   |          |   |  |      | 4,093     |    |  |   |          |  
|Consumer                                                                                                                   |  |                                       | 36,019    |   |      |   | 8,030     |      |  |   | 62,228    |   |  |      | 31,572    |    |  |   | 32,616    |  
|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|Total charge-offs                                                                                                          |  |                                       | 397,818   |   |      |   | 196,941   |      |  |   | 90,851    |   |  |      | 50,628    |    |  |   | 386,313   |  
|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|Recoveries                                                                                                                 |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|Commercial                                                                                                                 |  |                                       | 186,740   |   |      |   | 106,245   |      |  |   | 42,606    |   |  |      | 80,000    |    |  |   |          |  
|Real estate                                                                                                                |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |          |    |  |   |          |  
|Consumer                                                                                                                   |  |                                       | 10,607    |   |      |   | 12,927    |      |  |   | 21,982    |   |  |      | 8,619     |    |  |   | 10,459    |  
|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|Total recoveries                                                                                                           |  |                                       | 197,347   |   |      |   | 119,172   |      |  |   | 64,588    |   |  |      | 88,619    |    |  |   | 10,459    |  
|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|                                                                                                                           |  |                                       |           |   |     
|Net (recoveries) charge-offs                                                                                               |  |                                       | 200,471   |   |      |   | 77,769    |      |  |   | 26,263    |   |  |      | (37,991   | )  |  |   | 375,854   |  
|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|Provision for loan losses                                                                                                  |  |                                       | 452,770   |   |      |   | 104,644   |      |  |   | 64,262    |   |  |      | 33,010    |    |  |   | 453,000   |  
|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|                                                                                                                           |  |                                       |           |   |     
|Balance at end of period:                                                                                                  |  | $                                     | 1,652,174 |   |      | $ | 1,399,875 |      |  | $ | 1,373,000 |   |  | $    | 1,335,001 |    |  | $ | 1,264,000 |  
|                                                                                                                           |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |    |  |   |           |  
|                                                                                                                           |  |                                       |           |   |     
|Ratio of net charge-offs to average loans outstanding                                                                      |  |                                       | 0.12      | % |      |   | 0.05      | %    |  |   | 0.02      | % |  |      | (0.03     | )% |  |   | 0.33      | %
|                                                                                                                           |  |                                       |           |   |     
|Ratio of allowance for loan losses to outstanding loans held for investment, net of unearned fees and costs at end of year |  |                                       | 0.93      | % |      |   | 0.90      | %    |  |   | 0.97      | % |  |      | 1.01      | %  |  |   | 1.01      | %



26



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##### Table of Contents

Breakdown of Allowance for Loan Losses by Category

The following table presents an allocation of the Companys allowance for loan losses and the percentage of loans in each category to the total
amount of loans at December 31, 2008, 2007, 2006, 2005 and 2004. The allocation presented for each year reflects an allocation methodology recommended by management in 2005 and adopted by the Company effective for the year ended
December 31, 2004 and utilized in all subsequent years.



|                           |  |                        |       |                          |        |   |        |      |                          |  |        |        |  |                          |       |  |        |   |                          |   |       |        |        |                          |  |   |       |  |        |  
|-------------------------- |  | ---------------------- | ----- | ------------------------ | ------ | - | ------ | ---- | ------------------------ |  | ------ | ------ |  | ------------------------ | ----- |  | ------ | - | ------------------------ | - | ----- | ------ | ------ | ------------------------ |  | - | ----- |  | ------ | -
|                           |  | At December 31         |      
|                           |  | 2008                   |       |                          | 2007   |   |        | 2006 |                          |  | 2005   |        |  | 2004                     |      
|                           |  | Amount                 |       | Percentof TotalLoans (1) |        |   | Amount |      | Percentof TotalLoans (1) |  |        | Amount |  | Percentof TotalLoans (1) |       |  | Amount |   | Percentof TotalLoans (1) |   |       | Amount |        | Percentof TotalLoans (1) | 
|                           |  | (Dollars in Thousands) |      
|Loan Type Allocation       |  |                        |       |                          |        |   |        |      |                          |  |        |        |  |                          |       |  |        |   |                          |   |       |        |        |                          |  |   |       |  |        |  
|Real estate  mortgage     |  | $                      | 991   |                          | 63.31  | % |        | $    | 856                      |  | 65.45  | %      |  | $                        | 812   |  | 65.72  | % |                          | $ | 654   |        | 75.19  | %                        |  | $ | 551   |  | 72.56  | %
|Real estate  construction |  |                        | 246   |                          | 15.71  | % |        |      | 188                      |  | 14.96  | %      |  |                          | 18    |  | 16.89  | % |                          |   | 15    |        | 7.62   | %                        |  |   | 4     |  | 7.25   | %
|Commercial                 |  |                        | 266   |                          | 18.51  | % |        |      | 241                      |  | 16.90  | %      |  |                          | 365   |  | 14.03  | % |                          |   | 450   |        | 13.64  | %                        |  |   | 450   |  | 15.70  | %
|Consumer                   |  |                        | 68    |                          | 2.47   | % |        |      | 24                       |  | 2.69   | %      |  |                          | 75    |  | 3.36   | % |                          |   | 121   |        | 3.55   | %                        |  |   | 164   |  | 4.49   | %
|                           |  |                        |       |                          |        |   |        |      |                          |  |        |        |  |                          |       |  |        |   |                          |   |       |        |        |                          |  |   |       |  |        |  
|                           |  |                        |       |                          |        |   |        |      |                          | 
|                           |  |                        | 1,571 |                          | 100.00 | % |        |      | 1,309                    |  | 100.00 | %      |  |                          | 1,270 |  | 100.00 | % |                          |   | 1,240 |        | 100.00 | %                        |  |   | 1,169 |  | 100.00 | %
|                           |  |                        |       |                          |        |   |        |      |                          |  |        |        |  |                          |       |  |        |   |                          |   |       |        |        |                          |  |   |       |  |        |  
|Specific problem loans     |  |                        |      |                          |        |   |        |      | 20                       |  |        |        |  |                          |      |  |        |   |                          |   |      |        |        |                          |  |   |      |  |        |  
|Unallocated                |  |                        | 81    |                          |        |   |        |      | 71                       |  |        |        |  |                          | 103   |  |        |   |                          |   | 95    |        |        |                          |  |   | 95    |  |        |  
|                           |  |                        |       |                          |        |   |        |      |                          |  |        |        |  |                          |       |  |        |   |                          |   |       |        |        |                          |  |   |       |  |        |  
|                           |  |                        |       |                          |        |   |        |      |                          | 
|                           |  | $                      | 1,652 |                          |        |   |        | $    | 1,400                    |  |        |        |  | $                        | 1,373 |  |        |   |                          | $ | 1,335 |        |        |                          |  | $ | 1,264 |  |        |  
|                           |  |                        |       |                          |        |   |        |      |                          |  |        |        |  |                          |       |  |        |   |                          |   |       |        |        |                          |  |   |       |  |        |  



|(1) | Represents total of all outstanding loans in each category as a percent of total loans outstanding.
|--- | ---------------------------------------------------------------------------------------------------

Nonperforming Assets

The Companys nonperforming assets include nonperforming loans (nonaccrual
and restructured loans) and other real estate owned (REO). The Company generally does not accrue interest on loans that are 90 days or more past due and reverses all previously accrued, but uncollected, interest on loans that are placed
in nonaccrual status (with the exception of credit card loans on which the Company does not accrue interest over 120 days).

REO is
recorded at the lower of cost or estimated fair value as determined generally by appraisals. If the fair value of REO is less than the book value of the loan formerly secured by such REO, the fair value becomes the new cost basis of the REO, and the
difference is charged against the allowance for loan losses on the date of foreclosure or completion of the appraisal. Subsequent valuations are periodically performed and valuation allowances are established if the carrying value of the real estate
exceeds estimated fair value less estimated costs of sale. Other repossessed assets are carried at the lower of cost or estimated fair value as determined by independent surveys or appraisals at the time of repossession. If the fair value of the
repossessed asset is less than the book value of the loan formerly secured by such repossessed asset, the difference between the book value and the fair value is charged to the allowance for loan losses on the date of repossession.



27



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##### Table of Contents

The following table sets forth, for the date indicated, information with respect to the Companys
nonaccrual loans, restructured loans, total nonperforming loans (nonaccrual loans plus restructured loans), and total nonperforming assets:



|                                           |  |                 |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------ |  | --------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                           |  | At December 31, |        
|                                           |  | 2008            |         |   | 2007 |   |         | 2006 |  |   | 2005    |   |  | 2004 |        
|Nonaccrual loans (1)                       |  | $               | 30,754  |   |      | $ | 136,650 |      |  | $ | 169,642 |   |  | $    | 225,934 |   |  | $ | 648,658 |  
|Accruing loans past due 90 days or more    |  |                 | 9,937   |   |      |   | 26,709  |      |  |   | 7,865   |   |  |      | 4,476   |   |  |   | 14,629  |  
|                                           |  |                 |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                           |  |                 |         |   |     
|Total nonperforming loans                  |  |                 | 40,691  |   |      |   | 163,359 |      |  |   | 177,507 |   |  |      | 230,410 |   |  |   | 663,287 |  
|                                           |  |                 |         |   |     
|Real estate owned, net                     |  |                 | 177,500 |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   | 297,295 |  
|                                           |  |                 |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                           |  |                 |         |   |     
|Total nonperforming assets                 |  | $               | 218,191 |   |      | $ | 163,359 |      |  | $ | 177,507 |   |  | $    | 230,410 |   |  | $ | 960,582 |  
|                                           |  |                 |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                           |  |                 |         |   |     
|Total nonperforming assets to total assets |  |                 | 0.08    | % |      |   | 0.07    | %    |  |   | 0.08    | % |  |      | 0.11    | % |  |   | 0.62    | %



|(1) | Includes restructured loans of $136,650 and $169,642 at December 31, 2007 and 2006, respectively. There were no restructured loans at December 31, 2008.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------

At December 31, 2008 the Company had approximately $3.4 million in loans that are not disclosed in the above
table, but where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms. These loans may result later in being
disclosed as nonaccrual, accruing but past due 90 days or more, or troubled debt restructurings.

Loans Held for Sale

There were no loans held for sale at December 31, 2008, compared to loans held for sale of $878,200 at December 31, 2007. These loans were
pre-committed for sale to investors.

Investment Securities

The Companys investment portfolio is a source of liquidity and is its second largest category of earning assets. At December 31, 2008, the portfolio included U.S. Treasury and FNMA and FHLMC mortgage-backed
securities. In addition to the investment securities, the Company also invests in federal funds sold. Securities available for sale, including those pending settlement, were $60.7 million at December 31, 2008, compared with $38.1 million
at December 31, 2007. There were no securities held to maturity at December 31, 2008, compared to $676,000 at December 31, 2007.



28



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##### Table of Contents

The following table summarizes the amortized cost, gross unrealized gains and losses and the estimated
fair value of securities available for sale and held to maturity for the years ended December 31, 2008, 2007 and 2006:



|                                    |  |               |            |                      |   |                       |  |            |       |  |   |           
|----------------------------------- |  | ------------- | ---------- | -------------------- | - | --------------------- |  | ---------- | ----- |  | - | ----------
|                                    |  | AmortizedCost |            | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | Fair Value
|At December 31, 2008                |  |               |            |                      |   |                       |  |            |       |  |   |           
|                                    |  |               |            |                     
|Securities available for sale       |  |               |            |                      |   |                       |  |            |       |  |   |           
|                                    |  |               |            |                     
|U.S. Treasury Securities            |  | $             | 1,761,259  |                      | $ | 12,493                |  | $          | 3     |  | $ | 1,773,749 
|Mortgage-backed securities          |  |               | 57,961,180 |                      |   | 1,011,768             |  |            | 3,751 |  |   | 58,969,197
|                                    |  |               |            |                      |   |                       |  |            |       |  |   |           
|Total securities available for sale |  | $             | 59,722,439 |                      | $ | 1,024,261             |  | $          | 3,754 |  | $ | 60,742,946
|                                    |  |               |            |                      |   |                       |  |            |       |  |   |           
|Total securities(1)                 |  | $             | 59,722,439 |                      | $ | 1,024,261             |  | $          | 3,754 |  | $ | 60,742,946
|                                    |  |               |            |                      |   |                       |  |            |       |  |   |           



|(1) | At December 31, 2008, the Company held no securities classified as held to maturity.
|--- | ------------------------------------------------------------------------------------



|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|------------------------------------------------ |  | - | ---------- |  | - | ------- |  | - | ------ |  | - | ----------
|At December 31, 2007                             |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Securities available for sale                    |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|U.S. Treasury Securities                         |  | $ | 999,226    |  | $ | 5,614   |  | $ |       |  | $ | 1,004,840 
|U.S. government sponsored enterprises            |  |   | 5,002,563  |  |   | 27,137  |  |   |       |  |   | 5,029,700 
|Mortgage-backed securities                       |  |   | 31,098,629 |  |   | 264,500 |  |   |       |  |   | 31,363,129
|Obligations of states and political subdivisions |  |   | 689,831    |  |   | 27,089  |  |   |       |  |   | 716,920   
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Total securities available for sale              |  |   | 37,790,249 |  |   | 324,340 |  |   |       |  |   | 38,114,589
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Securities held to maturity                      |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Mortgage-backed securities                       |  |   | 6,512      |  |   | 91      |  |   |       |  |   | 6,603     
|Obligations of states and political subdivisions |  |   | 469,749    |  |   | 10,286  |  |   |       |  |   | 480,035   
|Preferred trust securities                       |  |   | 200,000    |  |   | 9,200   |  |   |       |  |   | 209,200   
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Total securities held to maturity                |  |   | 676,261    |  |   | 19,577  |  |   |       |  |   | 695,838   
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Total securities                                 |  | $ | 38,466,510 |  | $ | 343,917 |  | $ |       |  | $ | 38,810,427
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|At December 31, 2006                             |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Securities available for sale                    |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|U.S. Treasury Securities                         |  | $ | 16,108,728 |  | $ | 6,221   |  | $ |       |  | $ | 16,114,949
|U.S. government sponsored enterprises            |  |   | 27,976,529 |  |   | 11,239  |  |   | 15,578 |  |   | 27,972,190
|Mortgage-backed securities                       |  |   | 135,905    |  |   | 631     |  |   |       |  |   | 136,536   
|Obligations of states and political subdivisions |  |   | 661,387    |  |   | 16,445  |  |   |       |  |   | 677,832   
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Total securities available for sale              |  |   | 44,882,549 |  |   | 34,536  |  |   | 15,578 |  |   | 44,901,507
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Securities held to maturity                      |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Mortgage-backed securities                       |  |   | 9,257      |  |   | 106     |  |   |       |  |   | 9,363     
|Obligations of states and political subdivisions |  |   | 469,615    |  |   | 8,654   |  |   |       |  |   | 478,269   
|Preferred trust securities                       |  |   | 200,000    |  |   | 12,000  |  |   |       |  |   | 212,000   
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Total securities held to maturity                |  |   | 678,872    |  |   | 20,760  |  |   |       |  |   | 699,632   
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           
|                                                 |  |   |            | 
|Total securities                                 |  | $ | 45,561,421 |  | $ | 55,296  |  | $ | 15,578 |  | $ | 45,601,139
|                                                 |  |   |            |  |   |         |  |   |        |  |   |           



29



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##### Table of Contents

The following table presents the contractual maturity distribution and estimated weighted average yields,
based on amortized cost, of the Companys investment securities portfolio at December 31, 2008. Actual maturities will differ from contractual maturities because mortgage-backed securities will amortize and may be prepaid prior to their
contractual maturity.



|                           |  |                |           |       |                                 |   |               |                                   |            |  |                |               |  |       |            |  |               |   |       |   |            |               |      |       |  |   |            |  |      |  
|-------------------------- |  | -------------- | --------- | ----- | ------------------------------- | - | ------------- | --------------------------------- | ---------- |  | -------------- | ------------- |  | ----- | ---------- |  | ------------- | - | ----- | - | ---------- | ------------- | ---- | ----- |  | - | ---------- |  | ---- | -
|                           |  | 1 Year or Less |           |       | After 1 Year butthrough 5 Years |   |               | After 5 Years butthrough 10 Years |            |  | After 10 Years |               |  | Total |           
|                           |  | AmortizedCost  |           | Yield |                                 |   | AmortizedCost |                                   | Yield      |  |                | AmortizedCost |  | Yield |            |  | AmortizedCost |   | Yield |   |            | AmortizedCost |      | Yield | 
|U.S. Treasury Securities   |  | $              | 1,761,258 |       | 2.29                            | % |               | $                                 |           |  |               |               |  | $     |           |  |              |   |       | $ |           |               |     |       |  | $ | 1,761,258  |  | 2.29 | %
|Mortgage-backed securities |  |                |          |       |                                |   |               |                                   | 19,138,285 |  | 4.01           | %             |  |       | 20,963,426 |  | 4.82          | % |       |   | 17,859,470 |               | 4.00 | %     |  |   | 57,961,181 |  | 4.30 | %
|                           |  |                |           |       |                                 |   |               |                                   |            |  |                |               |  |       |            |  |               |   |       |   |            |               |      |       |  |   |            |  |      |  
|Total                      |  | $              | 1,761,258 |       | 2.29                            | % |               | $                                 | 19,138,285 |  | 4.01           | %             |  | $     | 20,963,426 |  | 4.82          | % |       | $ | 17,859,470 |               | 4.00 | %     |  | $ | 59,722,439 |  | 4.24 | %
|                           |  |                |           |       |                                 |   |               |                                   |            |  |                |               |  |       |            |  |               |   |       |   |            |               |      |       |  |   |            |  |      |  

At December 31, 2008, there were no securities of any issuer (other than FNMA and FHLMC
mortgage-backed securities) that exceeded 10% of the Companys stockholders equity.



30



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##### Table of Contents

SOURCES OF FUNDS

Deposit Activities

The Company provides a range of deposit services, including noninterest-bearing checking accounts,
interest-bearing checking and savings accounts, money market accounts and certificates of deposit. These accounts generally earn interest at rates established by management based on competitive market factors and managements desire to increase
or decrease certain types or maturities of deposits. The Company strives to establish customer relationships to attract core deposits in noninterest-bearing and other transactional accounts and thus to reduce its costs of funds.

The Banks deposit base includes large denomination certificates of deposit of $100,000 or more. These deposits represented approximately 2.2% and
3.9% of total deposits at December 31, 2008 and 2007, respectively.

The following table sets forth, for the periods indicated, the
average balance outstanding and average interest rates for each major category of deposits:



|                                                        |  |                 |             |             |      |   |                |      |             |  |      |                |  |             |             |  |      |  
|------------------------------------------------------- |  | --------------- | ----------- | ----------- | ---- | - | -------------- | ---- | ----------- |  | ---- | -------------- |  | ----------- | ----------- |  | ---- | -
|                                                        |  | At December 31, |            
|                                                        |  | 2008            |             |             | 2007 |   |                | 2006 |            
|                                                        |  | AverageBalance  |             | AverageRate |      |   | AverageBalance |      | AverageRate |  |      | AverageBalance |  | AverageRate |            
|Interest-bearing NOW, money market and savings accounts |  | $               | 90,928,206  |             | 1.59 | % |                | $    | 82,003,291  |  | 3.21 | %              |  | $           | 70,020,852  |  | 2.95 | %
|Time deposits                                           |  |                 | 52,609,295  |             | 3.86 | % |                |      | 56,120,790  |  | 4.57 | %              |  |             | 66,498,503  |  | 4.13 | %
|                                                        |  |                 |             |             |      |   |                |      |             |  |      |                |  |             |             |  |      |  
|                                                        |  |                 |             |             |      |  
|Total interest-bearing deposits                         |  |                 | 143,537,501 |             | 2.42 | % |                |      | 138,124,081 |  | 3.76 | %              |  |             | 136,519,355 |  | 3.53 | %
|Demand and other noninterest- bearing deposits          |  |                 | 52,660,199  |             |     |   |                |      | 50,370,040  |  |     |                |  |             | 42,128,134  |  |     |  
|                                                        |  |                 |             |             |      |   |                |      |             |  |      |                |  |             |             |  |      |  
|                                                        |  |                 |             |             |      |  
|Total average deposits                                  |  | $               | 196,197,700 |             | 1.77 | % |                | $    | 188,494,121 |  | 2.76 | %              |  | $           | 178,647,489 |  | 2.69 | %
|                                                        |  |                 |             |             |      |   |                |      |             |  |      |                |  |             |             |  |      |  

The following table sets forth the amounts and maturities of certificates of deposit with balances
of $100,000 or more at December 31, 2008:

Remaining maturity



|                                     |  |   |          
|------------------------------------ |  | - | ---------
|Less than three months               |  | $ | 545,008  
|Over three months through six months |  |   | 1,112,825
|Over six months through one year     |  |   | 744,251  
|Over twelve months                   |  |   | 2,302,815
|                                     |  |   |          
|Total                                |  | $ | 4,704,899
|                                     |  |   |          

Borrowings

As additional sources of funding, the Company utilizes unsecured credit lines from correspondent banks, advances from the Federal Home Loan Bank of Atlanta (FHLB) under a secured line of credit, and
securities sold under agreements to repurchase which are secured transactions with customers and generally mature the day following the day sold. At December 31, 2008, borrowings included $1.2 million in securities sold under agreements to
repurchase, and $5.0 million in medium-term borrowings under the FHLB secured line of credit.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Liquidity refers to the availability of
sufficient funds to meet the needs of depositors, borrowers, creditors and investors and to fund operations. The Companys primary sources of funds are customer deposits, cash, investment securities available for sale, loan repayments and
borrowings. These funds are used to make loans, purchase investment securities, meet depositor withdrawals and fund operations.

Liquid
assets, which include cash and due from banks, fed funds sold and nonpledged securities available for sale, totaled $51.8 million at December 31, 2008. In addition, the Banks funding sources at December 31, 2008 consisted of
established borrowing capacity, subject to qualifying collateral availability, with the FHLB equal to 20% of the Banks total assets, or $49.9 million, and established federal funds lines with correspondent banks. At December 31,
2008, there was a $5.0 million outstanding balance with the FHLB and a $1,000 balance under the federal funds lines.



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Certificates of deposit that are scheduled to mature within one year totaled $47.3 million at
December 31, 2008. These deposits are generally considered to be rate sensitive. While the Companys liquidity could be impacted by a decrease in the renewals of deposits or general deposit runoff, the Company believes it has the ability
to raise additional deposits by conducting deposit promotions. In the event the Company requires funds beyond its ability to generate them internally, the Company could borrow from its established lines or obtain funds through the sale of investment
securities from its available for sale portfolio. Management believes the Companys liquidity sources are sufficient to satisfy the Companys current operational requirements and obligations. The Company maintains a high level of liquidity
due to a concentration in some customer deposits, which can fluctuate significantly as depositor needs change.

Capital Resources

The Companys capital is reflected in its stockholders equity, which was $25.9 million, or 9.8% of assets, at December 31, 2008,
compared to $25.1 million, or 11.4% of assets, at December 31, 2007. Stockholders equity increased primarily as a result of increases in retained earnings, additional paid-in capital related to stock-based compensation, and in accumulated
after-tax comprehensive income attributable to an increase in the market value of the Companys available-for-sale investment securities portfolio. The Company paid aggregate dividends of $0.24 per share in each of 2008 and 2007. The dividend
payout ratio was 80.0% in 2008, compared to 60.0% in 2007.

The Companys capital continues to exceed regulatory requirements for
total capital to risk weighted assets, Tier 1 capital to risk weighted assets, and Tier 1 capital to tangible assets (leverage ratio). The Companys total capital ratio was 13.43% at December 31, 2008, compared to 14.99% at
December 31, 2007; the Tier 1 capital ratio was 12.61% at December 31, 2008, compared to 14.19% at December 31, 2007; and the leverage ratio was 10.13% at December 31, 2008, compared to 11.13% at December 31, 2007.
These ratios all exceed the mandated minimum requirements.

The Company will consider additional sources of capital, through the issuance
of stock, debt or otherwise, as needs arise. For instance, the Company previously announced that it has received preliminary approval for a $5.7 million capital investment from the U.S. Treasury Department under the TARP Capital Purchase Program, a
voluntary program designed to provide capital for healthy banks to improve the flow of funds from banks to their customers. Consummation of the investment transaction is subject to several conditions, including final approval of our participation by
the Treasury, shareholder approval of an amendment to our Articles of Incorporation to authorize the preferred stock the Treasury would receive, and the negotiation and execution of definitive investment documents. Furthermore, participation in the
TARP Capital Purchase Program is voluntary and we may elect not to participate even if we receive final approval from the Treasury and our shareholders approve the requisite amendment to our Articles of Incorporation. Accordingly, at this time the
Companys participation in the Program is not certain.



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The following table presents information on the Companys and the Banks capital amounts and
ratios as of December 31, 2008 and 2007.



|                                         |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|---------------------------------------- |  | ------ | ------ | ----- | --------------------------- | - | ------ | -------------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|(Dollars in thousands)                   |  | Actual |        |       | For CapitalAdequacyPurposes |   |        | Minimum To BeWell CapitalizedUnder PromptCorrective ActionProvisions |       
|                                         |  | Amount |        | Ratio |                             |   | Amount |                                                                      | Ratio  |  |     | Amount |  | Ratio |       
|At December 31, 2008                     |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|                                         |  |        |        |       |                             |  
|Total Capital (to Risk-Weighted Assets)  |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 26,865 |       | 13.43                       | % |        | $                                                                    | 16,000 |  | 8.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 26,393 |       | 13.20                       | % |        | $                                                                    | 15,997 |  | 8.0 | %      |  | $     | 19,997 |  | 10.0 | %
|Tier 1 Capital (to Risk-Weighted Assets) |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 25,212 |       | 12.61                       | % |        | $                                                                    | 8,000  |  | 4.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 24,741 |       | 12.37                       | % |        | $                                                                    | 7,999  |  | 4.0 | %      |  | $     | 11,998 |  | 6.0  | %
|Tier 1 Capital (to Average Assets)       |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 25,212 |       | 10.13                       | % |        | $                                                                    | 9,957  |  | 4.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 24,741 |       | 9.94                        | % |        | $                                                                    | 9,956  |  | 4.0 | %      |  | $     | 12,445 |  | 5.0  | %
|                                         |  |        |        |       |                             |  
|At December 31, 2007                     |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Total Capital (to Risk-Weighted Assets)  |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 26,310 |       | 14.99                       | % |        | $                                                                    | 14,043 |  | 8.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 25,591 |       | 14.61                       | % |        | $                                                                    | 14,015 |  | 8.0 | %      |  | $     | 17,519 |  | 10.0 | %
|Tier 1 Capital (to Risk-Weighted Assets) |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 24,911 |       | 14.19                       | % |        | $                                                                    | 7,022  |  | 4.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 24,191 |       | 13.81                       | % |        | $                                                                    | 7,007  |  | 4.0 | %      |  | $     | 10,511 |  | 6.0  | %
|Tier 1 Capital (to Average Assets)       |  |        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 24,911 |       | 11.13                       | % |        | $                                                                    | 8,956  |  | 4.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 24,191 |       | 10.81                       | % |        | $                                                                    | 8,954  |  | 4.0 | %      |  | $     | 11,193 |  | 5.0  | %

Federal and state banking regulations place certain restrictions on dividends paid and loans or
advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. Loans or advances to the Company
are limited to 10% of the Banks stockholders equity. For additional detail, see Item 1, Description of Business  Supervision and Regulation, above.

Contractual Obligations and Commitments

In the normal course of business there are various
outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit, that may or may not require future cash outflows. The
following table reflects contractual obligations of the Company outstanding as of December 31, 2008.



|                                               |  |                        |         |                         |   |          |  |          |        |                 |   |       |  |   |      
|---------------------------------------------- |  | ---------------------- | ------- | ----------------------- | - | -------- |  | -------- | ------ | --------------- | - | ----- |  | - | -----
|                                               |  | Payments Due by Period
|Contractual Obligations                        |  | Total                  |         | OnDemandOr Within1 Year |   | 1-3Years |  | 3-5Years |        | Morethan 5Years
|                                               |  | (dollars in thousands)
|Securities sold under agreements to repurchase |  | $                      | 1,247   |                         | $ | 1,247    |  | $        |       |                 | $ |      |  | $ |     
|Other borrowings                               |  |                        | 5,001   |                         |   | 1        |  |          | 5,000  |                 |   |      |  |   |     
|Operating lease obligations                    |  |                        | 2,085   |                         |   | 230      |  |          | 474    |                 |   | 493   |  |   | 888  
|Deposits                                       |  |                        | 215,782 |                         |   | 210,451  |  |          | 4,812  |                 |   | 519   |  |   |     
|Deferred compensation                          |  |                        | 1,023   |                         |   | 68       |  |          | 135    |                 |   | 121   |  |   | 699  
|Purchase obligations                           |  |                        | 4,221   |                         |   | 1,740    |  |          | 1,651  |                 |   | 830   |  |   |     
|                                               |  |                        |         |                         |   |          |  |          |        |                 |   |       |  |   |      
|Total contractual cash obligations             |  | $                      | 229,359 |                         | $ | 213,737  |  | $        | 12,072 |                 | $ | 1,963 |  | $ | 1,587
|                                               |  |                        |         |                         |   |          |  |          |        |                 |   |       |  |   |      



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

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

The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet instruments. Unless otherwise noted, the Company requires collateral or other security to support financial instruments with credit risk.

The following table reflects other commitments of the Company outstanding as of December 31, 2008:



|                             |  |   |           
|---------------------------- |  | - | ----------
|Commitments to extend credit |  | $ | 42,365,456
|Standby letters of credit    |  |   | 2,155,080 
|Commitments to sell loans    |  |   |          
|                             |  |   |           
|                             |  | $ | 44,520,536
|                             |  |   |           

Asset/Liability Management

The Companys primary market risk exposure is interest rate risk. Fluctuations in interest rates will impact both the level of interest income and interest expense and the market value of the Companys
interest-earning assets and interest-bearing liabilities.

The primary goal of the Companys asset/liability management strategy is to
maximize its net interest income over time while limiting exposure to interest rate fluctuations. The Companys ability to manage its interest rate risk depends generally on the Companys ability to match the maturities and repricing
characteristics of its assets and liabilities while taking into account the separate goals of maintaining asset quality and liquidity and achieving the desired level of net interest income. The principal variables that affect the Companys
management of its interest rate risk include the Companys existing interest rate gap position, managements assessment of future interest rates, the need for the Company to replace assets that may prepay before their scheduled maturities,
and the withdrawal of liabilities over time.

One technique used by the Company to manage its interest rate risk exposure is the management
of the Companys interest sensitivity gap. The interest sensitivity gap is defined as the difference between the amount of interest-earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period
and the amount of interest-bearing liabilities anticipated, based upon certain assumptions, to mature or reprice within that same time period. At December 31, 2008, the Companys one year negative gap (interest-bearing
liabilities maturing or repricing within a period in excess of interest-earning assets repricing within the same period) was (20.2%) of total assets. Thus, during periods of rising interest rates, this implies that the Companys net
interest income would be negatively affected because the cost of the Companys interest-bearing liabilities is likely to rise faster than the yield on its interest-earning assets. In periods of falling interest rates, the opposite effect on net
interest income is likely to occur because the cost of interest-bearing liabilities likely would fall faster than the yield of interest-earning assets. The interest sensitivity gap position of the Company is a static analysis at December 31,
2008. Because many factors affect the composition of the Companys assets and liabilities, a change in prevailing interest rates will not necessarily result in a corresponding change in net interest income that would be projected using only the
interest sensitivity gap table for the Company at December 31, 2008.

The Company manages its interest rate risk by influencing the
adjustable and fixed rate mix of its loans, securities, deposits and borrowings. The Company can add loans or securities with adjustable, balloon or call features, as well as fixed rate loans and mortgage securities, if the yield on such loans and
securities is consistent with the Companys asset/liability management strategy. Also, the Company can manage its interest rate risk by extending the maturity of its borrowings or selling certain assets and repaying borrowings.

Certain shortcomings are inherent in any method of analysis used to estimate a financial institutions interest rate gap. The analysis is based at a
given point in time and does not take into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, although certain assets and liabilities may have similar maturities or repricing, they may react
differently to changes in market interest rates. The interest rates on certain types of assets and liabilities also may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market
rates. The interest rates on



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loans with balloon or call features may or may not change depending on their interest rates relative to market interest rates. Additionally, certain assets,
such as adjustable-rate mortgages, have features that may restrict changes in interest rates on a short-term basis and over the life of the asset.

The Company is also subject to prepayment risk, particularly in falling interest rate environments or in environments where the slope of the yield curve is relatively flat or negative. Such changes in the interest rate environment can cause
substantial changes in the level of prepayments of loans and mortgage-backed securities, which may also affect the Companys interest rate gap position.



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The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities
outstanding at December 31, 2008, that are subject to repricing or that mature in each of the future time periods shown. Money market, NOW, and savings deposits are assumed to be subject to immediate pricing and depositor availability and have
been placed in the shortest repricing period. In making the gap table computations, none of the assumptions sometimes made regarding loan prepayment rates and deposit decay rates have been used. In addition, the table does not reflect scheduled loan
principal payments. The interest rate sensitivity of the Companys assets and liabilities illustrated in the Interest Sensitivity Analysis below would vary substantially if different assumptions were used or if actual experience differs from
that indicated by the assumption used. Loans, borrowings and securities with balloon provisions, or that are subject to a call provision, are included in the period in which they balloon or may first be called. Except as stated above, the amount of
assets and liabilities shown that reprice or mature during a particular period were determined in accordance with the contractual terms of the asset or liability.



|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|------------------------------------------------------------------------------------------------------------------------------ |  | ------------------- | ----------- | -- | ------------------------------------ | - | ----------- | -------------------------- |  | - | ---------------------------- | -- |  | ------------------------------ | ---------- | - | ----- | - | ---------- | - |  | - | -----------
|Interest Sensitivity Analysis                                                                                                  |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |  
|December 31, 2008                                                                                                              |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|                                                                                                                               |  | Three Monthsor Less |             |    | OverThree MonthsthroughTwelve Months |   |             | OverOne Year toThree Years |  |   | OverThree Yearsto Five Years |    |  | OverFive Years orNon-Sensitive |            |   | Total
|Interest-earning assets:                                                                                                       |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|Loans (1)                                                                                                                      |  | $                   | 78,113,538  |    |                                      | $ | 15,733,341  |                            |  | $ | 20,474,369                   |    |  | $                              | 36,785,508 |   |       | $ | 27,076,268 |   |  | $ | 178,183,024
|Investment securities                                                                                                          |  |                     | 149,999     |    |                                      |   | 1,623,750   |                            |  |   | 2,312,647                    |    |  |                                | 17,102,875 |   |       |   | 39,553,675 |   |  |   | 60,742,946 
|Federal funds sold                                                                                                             |  |                     | 8,113,693   |    |                                      |   |            |                            |  |   |                             |    |  |                                |           |   |       |   |           |   |  |   | 8,113,693  
|Other investments                                                                                                              |  |                     |            |    |                                      |   | 240,000     |                            |  |   | 720,000                      |    |  |                                |            |   |       |   |            |   |  |   | 960,000    
|Federal Home Loan, Federal Reserve stock                                                                                       |  |                     |            |    |                                      |   |            |                            |  |   |                             |    |  |                                |           |   |       |   | 945,500    |   |  |   | 945,500    
|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|Total interest-earning assets                                                                                                  |  | $                   | 86,377,230  |    |                                      | $ | 17,597,091  |                            |  | $ | 23,507,016                   |    |  | $                              | 53,888,383 |   |       | $ | 67,575,443 |   |  | $ | 248,945,163
|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|                                                                                                                               |  |                     |             |    |                                      |  
|Interest-bearing liabilities:                                                                                                  |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|Interest-bearing deposits:                                                                                                     |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|Savings accounts                                                                                                               |  | $                   | 2,753,441   |    |                                      | $ |            |                            |  | $ |                             |    |  | $                              |           |   |       | $ |           |   |  | $ | 2,753,441  
|Checking accounts (2)                                                                                                          |  |                     | 18,826,675  |    |                                      |   |            |                            |  |   |                             |    |  |                                |           |   |       |   |           |   |  |   | 18,826,675 
|Money market deposits                                                                                                          |  |                     | 87,559,799  |    |                                      |   |            |                            |  |   |                             |    |  |                                |           |   |       |   |           |   |  |   | 87,559,799 
|Certificates of deposit                                                                                                        |  |                     | 9,947,160   |    |                                      |   | 37,375,245  |                            |  |   | 4,811,551                    |    |  |                                | 519,400    |   |       |   |           |   |  |   | 52,653,356 
|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|Total interest-bearing deposits                                                                                                |  |                     | 119,087,075 |    |                                      |   | 37,375,245  |                            |  |   | 4,811,551                    |    |  |                                | 519,400    |   |       |   |           |   |  |   | 161,793,271
|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|                                                                                                                               |  |                     |             |    |                                      |  
|Federal Home Loan Bank Advance                                                                                                 |  |                     |            |    |                                      |   |            |                            |  |   | 5,000,000                    |    |  |                                |           |   |       |   |           |   |  |   | 5,000,000  
|Securities sold under agreements to repurchase                                                                                 |  |                     | 1,246,536   |    |                                      |   |            |                            |  |   |                             |    |  |                                |           |   |       |   |           |   |  |   | 1,246,536  
|Other borrowings                                                                                                               |  |                     | 1,000       |    |                                      |   |            |                            |  |   |                             |    |  |                                |           |   |       |   |           |   |  |   | 1,000      
|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|Total interest-bearing liabilities                                                                                             |  | $                   | 120,334,611 |    |                                      | $ | 37,375,245  |                            |  | $ | 9,811,551                    |    |  | $                              | 519,400    |   |       | $ |           |   |  | $ | 168,040,807
|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|                                                                                                                               |  |                     |             |    |                                      |  
|Interest sensitivity gap                                                                                                       |  | $                   | (33,957,381 | )  |                                      | $ | (19,778,154 | )                          |  | $ | 13,695,465                   |    |  | $                              | 53,368,983 |   |       | $ | 67,575,443 |   |  | $ | 80,904,356 
|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|                                                                                                                               |  |                     |             |    |                                      |  
|Cumulative interest sensitivity gap                                                                                            |  | $                   | (33,957,381 | )  |                                      | $ | (53,735,535 | )                          |  | $ | (40,040,070                  | )  |  | $                              | 13,328,913 |   |       | $ | 80,904,356 |   |  |   |            
|                                                                                                                               |  |                     |             |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            
|                                                                                                                               |  |                     |             |    |                                      |  
|Cumulative interest sensitivity gap as a percentage of total assets                                                            |  |                     | (12.8       | )% |                                      |   | (20.2       | )%                         |  |   | (15.1                        | )% |  |                                | 5.0        | % |       |   | 30.5       | % |  |   |            
|                                                                                                                              
|(1)    Excludes $30,754 of nonaccrual loans at December 31, 2008. (2)    Excludes $53,988,420 of noninterest-bearing deposits.
|                                                                                                                               |  |                     |             |    |                                      |  
|Total Period-End Assets                                                                                                        |  | $                   | 265,494,396 |    |                                      |   |             |                            |  |   |                              |    |  |                                |            |   |       |   |            |   |  |   |            



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Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115 (SFAS 159).
This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting provisions. The Company adopted SPAS 159 effective January 1, 2008, but is not applying this fair value option to any instruments currently.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, (SFAS 141(R)) which replaces SFAS 141 SFAS
141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and
measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business
combination. FAS 141(R) is effective for acquisitions by the Company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations
following existing accounting guidance until January 1, 2009. The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51 (SFAS 160). SFAS 160 establishes new
accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting noncontrolling interests (minority interest). As a result,
diversity in practice exists. In some cases minority interest is reported as a liability and in others it is reported in the mezzanine section between liabilities and equity. Specifically, SFAS 160 requires the recognition of a noncontrolling
interest (minority interest) as equity in the consolidated financials statements and separate from the parents equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face
of the income statement. SFAS 160 clarifies that changes in a parents ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition,
this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160
also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interests. SFAS 160 is effective for the Company on January 1, 2009. Earlier adoption is prohibited. The Company is currently evaluating
the impact, if any, the adoption of SFAS 160 will have on its consolidated financial statements.

In March 2008, the FASB issued SFAS
No. 161, Disclosure about Derivative Instruments and Hedging Activities, which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Because companies use derivative instruments to
manage certain financial risks, SFAS No. 161 is designed to provide qualitative and quantitative information to users of financial statements regarding the purpose and use of derivative instruments, how the company is accounting for these
instruments, and how these derivative instruments affect the companys financial position, performance, and cash flows. According to SFAS No. 161, disclosures of derivative instruments must be in a tabular format, must segregate the
instruments as to use, must include fair values of derivative instruments, as well as their related gains or losses, and must be cross-referenced in the footnotes as to the location within the financial statements. SFAS No. 161 is effective for
the Company on January 1, 2009. As of September 30, 2008, the Company carried no derivative instruments on its balance sheet and had no derivative activity during the quarter.

In May 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS)
No. 162, The Hierarchy of Generally Accepted Accounting Principles, (SFAS 162). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). SFAS 162 will be effective 60 days following the SECs approval of the
Public Company Accounting Oversight Boards amendments to AU Section 411, The Meaning ofPresent Fairly in Conformity With Generally Accepted Accounting Principles. The FASB has stated that it does not expect SFAS 162
will result in a change in current practice. The application of SFAS 162 will have no effect on the Companys financial position, results of operations or cash flows.

The SECs Office of the Chief Accountant and the staff of the FASB issued press release 2008-234 on September 30, 2008 (the September
Press Release) to provide clarifications on fair value accounting. The September Press Release includes guidance on the use of managements internal assumptions and the use of market quotes. It also reiterates the factors set
forth in SEC Staff Accounting Bulletin (SAB) Topic 5M that should be considered when determining other-than-temporary impairment; the length of time and extent to which the market value has been less than cost; the financial
condition and near-term prospects of the issuer; and the intent and ability of the holder to retain its investment for a period of time sufficient to allow for any anticipated recovery in market value.



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On October 10, 2008, the FASB issued FSP SFAS 157-3, Determining the Fair Value of a Financial
Asset When the Market for That Asset Is Not Active (FSP SFAS 157-3). FSP SFAS 157-3 clarifies the application of SFAS No. 157, Fair Value Measurements (see Note 5), in a market that is not active and provides
an example to illustrate key considerations in determining the fair value of a financial asset when the market for that asset is not active. FSP SFAS 157-3 is effective upon issuance, and covers prior periods for which financial statements have not
been issued. For the Company, FSP SFAS 157-3 is effective commencing with the quarter ended September 30, 2008.

The Company
considered the guidance in the September Press Release and in FSP SFAS 157-3 when conducting its review for other-than-temporary impairment as of September 30, 2008, and determined that such guidance would not result in a change to the
Companys impairment estimation techniques.

FSP EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue
No. 99-20 (the Staff Position), was issued in January 2009. Prior to the Staff Position, other-than-temporary impairment was determined by using either EITF Issue No. 99-20, Recognition of Interest Income and
Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transferor in Securitized Financial Assets (EITF 99-20), or SFAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities (SFAS 115), depending on the type of security. EITF 99-20 required the use of market participant assumptions regarding future cash flows regarding the probability of collecting all cash flows previously projected.
SFAS 115 determined impairment to be other than temporary if it was probable that the holder would be unable to collect all amounts due according to the contractual terms. To achieve a more consistent determination of other-than-temporary
impairment, the Staff Position amends EITF 99-20 to determine any other-than-temporary impairment based on the guidance in SFAS 115, allowing management to use more judgment in determining any other-than-temporary impairment. The Staff Position
is effective for interim and annual reporting periods ending after December 15, 2008 and shall be applied prospectively. Retroactive application is not permitted. Management has reviewed the Companys security portfolio and evaluated the
portfolio for any other-than-temporary impairments as reflected in Note 4.

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

Off Balance Sheet Arrangements

In the normal course
of business, the Company is a party to financial instruments with off-balance-sheet risk. Those financial instruments, designed to meet the financing needs of customers, include commitments to sell loans, issue standby letters of credit and
otherwise extend credit. Those instruments involve both credit and interest rate risk in addition to the amount recognized on the balance sheet. The contractual amounts of these financial instruments reflect the extent of involvement in the event of
nonperformance by the other party to the financial instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments, and we obtain collateral based on our credit
assessment of the customer in each instance.

The Company historically sells to third-party investors substantially all of the residential
mortgage loans it originates, some of whom require the repurchase of loans in the event of early default or faulty documentation. Mortgage loans and their related servicing rights are sold under agreements that define certain eligibility criteria
for the mortgage loans. Recourse periods vary from 30 days up to 1 year and conditions for repurchase vary with the investor. Mortgages subject to recourse are collateralized by single-family residences and generally either have loan-to-value ratios
of 80% or less or have private mortgage insurance or are insured or guaranteed by an agency of the U.S. Government. Recourse considerations are a component of our calculation of the Companys capital adequacy. We did not make any payments under
these recourse provisions in 2008 or 2007. Risks also arise from the possible inability of counterparties to meet the terms of their contracts. The Company has procedures in place to evaluate the credit risk of investors and does not expect any
counterparty to fail to meet its obligations.

At December 31, 2008, the Company had no rate lock commitments to originate mortgage
loans. Commitments to sell loans, where they exist, are designed to eliminate the Companys exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.

Additional information related to the Companys off-balance-sheet risk exposure is detailed in Note 16 to the accompanying consolidated financial
statements.

Effects of Inflation

The
effect of changing prices is typically different for financial institutions than for other companies because a financial institutions assets and liabilities are monetary in nature. Interest rates are significantly impacted by inflation, but
neither the timing nor the magnitude of the changes is directly related to price-level indices. The Companys consolidated financial statements reflect the impact of inflation on interest rates, loan demands and deposits.



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|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------

The Company is a smaller reporting company and thus is not required to provide the information specified by Item 7A in this Form 10-K.



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|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------

Report of
Independent Registered Public Accounting Firm

The Stockholders and Board of Directors

Heritage Bankshares, Inc.

Norfolk, Virginia

We have audited the consolidated balance sheets of Heritage Bankshares, Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders equity and
cash flows for each of the two years in the period ended December 31, 2008. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 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 financial
position of Heritage Bankshares, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2008, in conformity with U.S.
generally accepted accounting principles.

We were not engaged to examine managements assertion about the effectiveness of Heritage Bankshares, Inc.
internal control over financial reporting as of December 31, 2008 included in the accompanying Form 10-K, Item 9A and, accordingly, we do not express an opinion thereon.



|                     
|---------------------
|/s/ Elliott Davis LLC
|                     
|Galax, Virginia      
|March 24, 2009       



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HERITAGE BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS

At December 31, 2008 and 2007



|                                                                                                                                                               |  |      |             |      |   |            
|-------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | ---- | - | -----------
|                                                                                                                                                               |  | 2008 |             | 2007
|ASSETS                                                                                                                                                         |  |      |             |      |   |            
|                                                                                                                                                               |  |     
|Cash and due from banks                                                                                                                                        |  | $    | 5,304,046   |      | $ | 5,463,202  
|Federal funds sold                                                                                                                                             |  |      | 8,113,693   |      |   | 8,956,822  
|                                                                                                                                                               |  |      |             |      |   |            
|Cash and cash equivalents                                                                                                                                      |  |      | 13,417,739  |      |   | 14,420,024 
|Securities available for sale, at fair value                                                                                                                   |  |      | 60,742,946  |      |   | 38,114,589 
|Securities held to maturity, at cost                                                                                                                           |  |      |            |      |   | 676,261    
|Loans, net                                                                                                                                                     |  |      |             |      |   |            
|Held for investment, net of allowance for loan losses of $1,652,174 and $1,399,875, respectively                                                               |  |      | 176,561,604 |      |   | 153,850,151
|Held for sale                                                                                                                                                  |  |      |            |      |   | 878,200    
|Accrued interest receivable                                                                                                                                    |  |      | 734,821     |      |   | 811,644    
|Stock in Federal Reserve Bank, at cost                                                                                                                         |  |      | 322,800     |      |   | 312,900    
|Stock in Federal Home Loan Bank of Atlanta, at cost                                                                                                            |  |      | 622,700     |      |   | 716,000    
|Premises and equipment, net                                                                                                                                    |  |      | 11,908,044  |      |   | 9,962,768  
|Other real estate owned                                                                                                                                        |  |      | 177,500     |      |   |           
|Other assets                                                                                                                                                   |  |      | 1,006,242   |      |   | 1,503,077  
|                                                                                                                                                               |  |      |             |      |   |            
|Total assets                                                                                                                                                   |  | $    | 265,494,396 |      | $ | 221,245,614
|                                                                                                                                                               |  |      |             |      |   |            
|                                                                                                                                                               |  |     
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                           |  |      |             |      |   |            
|Liabilities                                                                                                                                                    |  |      |             |      |   |            
|                                                                                                                                                               |  |     
|Deposits                                                                                                                                                       |  |      |             |      |   |            
|Noninterest-bearing                                                                                                                                            |  | $    | 53,988,420  |      | $ | 48,390,271 
|Interest-bearing                                                                                                                                               |  |      | 161,793,271 |      |   | 137,624,213
|                                                                                                                                                               |  |      |             |      |   |            
|Total deposits                                                                                                                                                 |  |      | 215,781,691 |      |   | 186,014,484
|                                                                                                                                                               |  |      |             |      |   |            
|Federal Home Loan Bank Advance                                                                                                                                 |  |      | 5,000,000   |      |   | 7,000,000  
|Securities sold under agreements to repurchase                                                                                                                 |  |      | 1,246,536   |      |   | 1,130,780  
|Other borrowings                                                                                                                                               |  |      | 1,000       |      |   | 50,000     
|Accrued interest payable                                                                                                                                       |  |      | 236,636     |      |   | 320,957    
|Pending settlement, securities available for sale                                                                                                              |  |      | 15,846,233  |      |   |           
|Other liabilities                                                                                                                                              |  |      | 1,496,350   |      |   | 1,604,789  
|                                                                                                                                                               |  |      |             |      |   |            
|Total liabilities                                                                                                                                              |  |      | 239,608,446 |      |   | 196,121,010
|                                                                                                                                                               |  |      |             |      |   |            
|                                                                                                                                                               |  |     
|Commitments and contingent liabilities                                                                                                                         |  |      |             |      |   |            
|Stockholders equity                                                                                                                                           |  |      |             |      |   |            
|Common stock, $5 par value  authorized 3,000,000 shares; issued and outstanding: 2,279,252 shares at December 31, 2008; 2,278,652
shares at December 31, 2007 |  |      | 11,396,260  |      |   | 11,393,260 
|Additional paid-in capital                                                                                                                                     |  |      | 6,329,854   |      |   | 6,172,256  
|Retained earnings                                                                                                                                              |  |      | 7,486,301   |      |   | 7,345,024  
|Accumulated other comprehensive income, net                                                                                                                    |  |      | 673,535     |      |   | 214,064    
|                                                                                                                                                               |  |      |             |      |   |            
|Total stockholders equity                                                                                                                                     |  |      | 25,885,950  |      |   | 25,124,604 
|                                                                                                                                                               |  |      |             |      |   |            
|Total liabilities and stockholders equity                                                                                                                     |  | $    | 265,494,396 |      | $ | 221,245,614
|                                                                                                                                                               |  |      |             |      |   |            

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



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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31, 2008 and 2007



|                                                        |  |      |            |      |   |           
|------------------------------------------------------- |  | ---- | ---------- | ---- | - | ----------
|                                                        |  | 2008 |            | 2007
|Interest income                                         |  |      |            |      |   |           
|Loans and fees on loans                                 |  | $    | 9,847,868  |      | $ | 9,963,316 
|Taxable investment securities                           |  |      | 1,662,764  |      |   | 1,887,600 
|Nontaxable investment securities                        |  |      | 32,726     |      |   | 50,153    
|Dividends on FRB and FHLB stock                         |  |      | 47,224     |      |   | 43,832    
|Interest on federal funds sold                          |  |      | 142,944    |      |   | 816,758   
|Other interest income                                   |  |      | 7,228      |      |   | 11,917    
|                                                        |  |      |            |      |   |           
|Total interest income                                   |  |      | 11,740,754 |      |   | 12,773,576
|                                                        |  |     
|Interest expense                                        |  |      |            |      |   |           
|Deposits                                                |  |      | 3,476,331  |      |   | 5,198,529 
|Borrowings                                              |  |      | 235,615    |      |   | 81,160    
|                                                        |  |      |            |      |   |           
|Total interest expense                                  |  |      | 3,711,946  |      |   | 5,279,689 
|                                                        |  |     
|Net interest income                                     |  |      | 8,028,808  |      |   | 7,493,887 
|                                                        |  |     
|Provision for loan losses                               |  |      | 452,770    |      |   | 104,644   
|                                                        |  |      |            |      |   |           
|                                                        |  |     
|Net interest income after provision for loan losses     |  |      | 7,576,038  |      |   | 7,389,243 
|                                                        |  |      |            |      |   |           
|                                                        |  |     
|Noninterest income                                      |  |      |            |      |   |           
|Service charges on deposit accounts                     |  |      | 415,093    |      |   | 505,615   
|Late charges and other fees on loans                    |  |      | 51,732     |      |   | 66,030    
|Gains on sale of loans held for sale, net               |  |      | 91,533     |      |   | 120,215   
|Net gains on sale of investment securities              |  |      | 518,148    |      |   | 1,170     
|Gain on sale of fixed assets                            |  |      | 6,030      |      |   | 529,530   
|Gain on sale of other real estate owned                 |  |      | 36,702     |      |   |          
|Settlement with a former professional services provider |  |      |           |      |   | 345,000   
|Other                                                   |  |      | 328,613    |      |   | 410,784   
|                                                        |  |      |            |      |   |           
|Total noninterest income                                |  |      | 1,447,851  |      |   | 1,978,344 
|                                                        |  |      |            |      |   |           
|                                                        |  |     
|Noninterest expense                                     |  |      |            |      |   |           
|Compensation                                            |  |      | 4,088,588  |      |   | 4,179,058 
|Occupancy                                               |  |      | 798,033    |      |   | 780,143   
|Furniture and equipment                                 |  |      | 554,504    |      |   | 531,452   
|Data processing                                         |  |      | 527,317    |      |   | 519,427   
|Professional fees                                       |  |      | 346,701    |      |   | 438,592   
|Taxes and licenses                                      |  |      | 269,586    |      |   | 217,300   
|Marketing                                               |  |      | 118,758    |      |   | 138,239   
|Telephone                                               |  |      | 101,363    |      |   | 119,439   
|Stationery and supplies                                 |  |      | 78,954     |      |   | 130,417   
|FDIC insurance                                          |  |      | 96,277     |      |   | 64,508    
|Loss on disposal or impairment of fixed assets          |  |      | 69,778     |      |   | 66,351    
|Other                                                   |  |      | 895,176    |      |   | 783,303   
|                                                        |  |      |            |      |   |           
|Total noninterest expense                               |  |      | 7,945,035  |      |   | 7,968,229 
|                                                        |  |      |            |      |   |           
|                                                        |  |     
|Income before provision for income taxes                |  |      | 1,078,854  |      |   | 1,399,358 
|                                                        |  |     
|Provision for income taxes                              |  |      | 390,665    |      |   | 479,314   
|                                                        |  |      |            |      |   |           
|                                                        |  |     
|Net income                                              |  | $    | 688,189    |      | $ | 920,044   
|                                                        |  |      |            |      |   |           
|                                                        |  |     
|Earnings per common share                               |  |      |            |      |   |           
|Basic                                                   |  | $    | 0.30       |      | $ | 0.40      
|                                                        |  |      |            |      |   |           
|Diluted                                                 |  | $    | 0.30       |      | $ | 0.40      
|                                                        |  |      |            |      |   |           
|Dividends per share                                     |  | $    | 0.24       |      | $ | 0.24      
|                                                        |  |      |            |      |   |           
|                                                        |  |     
|Weighted average shares outstanding  basic             |  |      | 2,278,849  |      |   | 2,278,579 
|Effect of dilutive stock options                        |  |      | 15,471     |      |   | 15,965    
|                                                        |  |      |            |      |   |           
|Weighted average shares outstanding  assuming dilution |  |      | 2,294,320  |      |   | 2,294,544 
|                                                        |  |      |            |      |   |           

The notes to consolidated financial statements are an integral part of these statements



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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

Years
Ended December 31, 2008 and 2007



|                                                                                                                   |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  
|------------------------------------------------------------------------------------------------------------------ |  | ------------ |  | ------------------------ | ---------- | ---------------- | - | --------- | ----------------------------------- | - | --------- | - |  | - | ------- |  | - | ---------- | -
|                                                                                                                   |  | Common Stock |  | AdditionalPaid-inCapital |            | RetainedEarnings |   |           | AccumulatedOtherComprehensiveIncome |   | Total     |  
|                                                                                                                   |  | Shares       |  | Amount                   |            |                  |   |          
|Balance, December 31, 2006                                                                                         |  | 2,277,652    |  | $                        | 11,388,260 |                  | $ | 6,031,549 |                                     | $ | 6,971,856 |   |  | $ | 12,513  |  | $ | 24,404,178 |  
|Comprehensive income:                                                                                              |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  
|Net income for 2007                                                                                                |  |             |  |                          |           |                  |   |          |                                     |   | 920,044   |   |  |   |        |  |   | 920,044    |  
|Change in unrealized gain on securities available-for-sale, net of tax of $103,831                                 |  |             |  |                          |           |                  |   |          |                                     |   |          |   |  |   | 201,551 |  |   | 201,551    |  
|                                                                                                                   |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  
|Total comprehensive income                                                                                         |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   | 1,121,595  |  
|Exercise of stock options and related tax benefits                                                                 |  | 1,000        |  |                          | 5,000      |                  |   | 5,281     |                                     |   |          |   |  |   |        |  |   | 10,281     |  
|Equity-based compensation expense                                                                                  |  |             |  |                          |           |                  |   | 135,426   |                                     |   |          |   |  |   |        |  |   | 135,426    |  
|Cash dividends ($0.24 per share)                                                                                   |  |             |  |                          |           |                  |   |          |                                     |   | (546,876  | ) |  |   |        |  |   | (546,876   | )
|                                                                                                                   |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  
|Balance, December 31, 2007                                                                                         |  | 2,278,652    |  | $                        | 11,393,260 |                  | $ | 6,172,256 |                                     | $ | 7,345,024 |   |  | $ | 214,064 |  | $ | 25,124,604 |  
|                                                                                                                   |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  
|Comprehensive income:                                                                                              |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  
|Net income for 2008                                                                                                |  |             |  |                          |           |                  |   |          |                                     |   | 688,189   |   |  |   |        |  |   | 688,189    |  
|Change in unrealized gain on securities available-for-sale, net of reclassification adjustment and tax of $236,697 |  |             |  |                          |           |                  |   |          |                                     |   |          |   |  |   | 459,471 |  |   | 459,471    |  
|                                                                                                                   |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  
|Total comprehensive income                                                                                         |  |             |  |                          |           |                  |   |          |                                     |   |          |   |  |   |        |  |   | 1,147,660  |  
|Exercise of stock options and related tax benefits                                                                 |  | 600          |  |                          | 3,000      |                  |   | 2,319     |                                     |   |          |   |  |   |        |  |   | 5,319      |  
|Equity-based compensation expense                                                                                  |  |             |  |                          |           |                  |   | 155,279   |                                     |   |          |   |  |   |        |  |   | 155,279    |  
|Cash dividends ($0.24 per share)                                                                                   |  |              |  |                          |            |                  |   |           |                                     |   | (546,912  | ) |  |   |         |  |   | (546,912   | )
|                                                                                                                   |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  
|Balance, December 31, 2008                                                                                         |  | 2,279,252    |  | $                        | 11,396,260 |                  | $ | 6,329,854 |                                     | $ | 7,486,301 |   |  | $ | 673,535 |  | $ | 25,885,950 |  
|                                                                                                                   |  |              |  |                          |            |                  |   |           |                                     |   |           |   |  |   |         |  |   |            |  

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



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HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

Years Ended December 31, 2008 and 2007



|                                                                                   |  |      |             |   |      |   |             |  
|---------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                   |  | 2008 |             |   | 2007 |  
|Cash flows from operating activities:                                              |  |      |             |   |      |   |             |  
|Net Income                                                                         |  | $    | 688,189     |   |      | $ | 920,044     |  
|Adjustments to reconcile net income to net cash provided by operating activities:  |  |      |             |   |      |   |             |  
|Provision for loan loss                                                            |  |      | 452,770     |   |      |   | 104,644     |  
|Amortization of loan yield adjustments, net                                        |  |      | 414,086     |   |      |   | 475,091     |  
|Depreciation, amortization and accretion, net                                      |  |      | 371,426     |   |      |   | (21,512     | )
|Stock based compensation                                                           |  |      | 155,279     |   |      |   | 135,426     |  
|Exercise of stock options tax benefit                                              |  |      | 969         |   |      |   | 3,461       |  
|Lease incentive                                                                    |  |      |            |   |      |   | 242,840     |  
|Net (gains) losses on sale of:                                                     |  |      |             |   |      |   |             |  
|Securities                                                                         |  |      | (518,147    | ) |      |   | (1,170      | )
|Property, plant, and equipment                                                     |  |      | 69,778      |   |      |   | (529,530    | )
|Other assets                                                                       |  |      |            |   |      |   | (20,480     | )
|Other real estate owned                                                            |  |      | (36,702     | ) |      |   |            |  
|Loss on sale, disposal or impairment of long-lived assets                          |  |      |            |   |      |   | 66,351      |  
|Changes in assets/liabilities, net                                                 |  |      |             |   |      |   |             |  
|Decrease(Increase) in interest receivable and other assets                         |  |      | 336,961     |   |      |   | (479,027    | )
|Increase in interest payable and other liabilities                                 |  |      | 15,661,708  |   |      |   | 358,168     |  
|Decrease(Increase) in loans held for sale                                          |  |      | 878,200     |   |      |   | (358,200    | )
|                                                                                   |  |      |             |   |      |   |             |  
|Net cash provided by operating activities                                          |  |      | 18,474,517  |   |      |   | 896,106     |  
|                                                                                   |  |      |             |   |      |   |             |  
|Cash flows from investing activities:                                              |  |      |             |   |      |   |             |  
|Proceeds from maturities and principal repayments of securities available for sale |  |      | 18,202,267  |   |      |   | 33,611,191  |  
|Proceeds from maturities and principal repayments of securities held to maturity   |  |      | 105,941     |   |      |   | 2,737       |  
|Purchases of securities available for sale                                         |  |      | (68,670,418 | ) |      |   | (40,822,941 | )
|Proceeds from sales of securities available for sale                               |  |      | 29,228,364  |   |      |   | 14,815,500  |  
|Proceeds from sales of securities held to maturity                                 |  |      | 568,771     |   |      |   |            |  
|Proceeds from sale of other assets                                                 |  |      |            |   |      |   | 73,431      |  
|Proceeds from sale of other real estate owned                                      |  |      | 552,202     |   |      |   |            |  
|Net increase in loans held for investment                                          |  |      | (24,271,310 | ) |      |   | (14,311,377 | )
|Purchases of Federal Home Loan Bank stock and Federal Reserve Bank stock           |  |      | (2,417,400  | ) |      |   | (1,125,000  | )
|Redemption of Federal Home Loan Bank stock                                         |  |      | 2,500,800   |   |      |   | 818,300     |  
|Purchases of premises and equipment                                                |  |      | (2,573,450  | ) |      |   | (3,955,848  | )
|Proceeds from sales of premises and equipment                                      |  |      | 6,030       |   |      |   | 736,769     |  
|                                                                                   |  |      |             |   |      |   |             |  
|Net cash used for investing activities                                             |  |      | (46,768,203 | ) |      |   | (10,157,238 | )
|                                                                                   |  |      |             |   |      |   |             |  
|Cash flows from financing activities:                                              |  |      |             |   |      |   |             |  
|Proceeds from exercise of stock options                                            |  |      | 4,350       |   |      |   | 6,820       |  
|Net increase(decrease) in deposits                                                 |  |      | 29,767,207  |   |      |   | (2,382,801  | )
|Proceeds from Federal Home Loan Bank advances                                      |  |      | 56,500,000  |   |      |   | 25,000,000  |  
|Repayments of Federal Home Loan Bank advances                                      |  |      | (58,500,000 | ) |      |   | (18,000,000 | )
|Net increase(decrease) in securities sold under agreements to repurchase           |  |      | 115,756     |   |      |   | (2,585,212  | )
|Proceeds from federal funds purchased                                              |  |      | 48,002,000  |   |      |   |            |  
|Repayment of federal funds purchased                                               |  |      | (48,001,000 | ) |      |   |            |  
|Repayments of other borrowings                                                     |  |      | (50,000     | ) |      |   | (5,000,000  | )
|Cash dividends paid                                                                |  |      | (546,912    | ) |      |   | (546,876    | )
|                                                                                   |  |      |             |   |      |   |             |  
|Net cash provided by (used for) financing activities                               |  |      | 27,291,401  |   |      |   | (3,508,069  | )
|                                                                                   |  |      |             |   |      |   |             |  
|Decrease in cash and cash equivalents                                              |  |      | (1,002,285  | ) |      |   | (12,769,201 | )
|                                                                                   |  |     
|Cash and cash equivalents, beginning of period                                     |  |      | 14,420,024  |   |      |   | 27,189,225  |  
|                                                                                   |  |      |             |   |      |   |             |  
|Cash and cash equivalents, end of period                                           |  | $    | 13,417,739  |   |      | $ | 14,420,024  |  
|                                                                                   |  |      |             |   |      |   |             |  
|Supplemental disclosure:                                                           |  |      |             |   |      |   |             |  
|Interest paid                                                                      |  | $    | 3,796,267   |   |      | $ | 5,335,212   |  
|Income Taxes paid                                                                  |  | $    | 465,000     |   |      | $ | 345,000     |  
|Noncash financing activities:                                                      |  |      |             |   |      |   |             |  
|Transfer of loans to other real estate owned                                       |  | $    | 1,078,000   |   |      | $ |            |  
|Transfer of other real estate owned to loans                                       |  | $    | 385,000     |   |      | $ |            |  

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



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HERITAGE BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2008 AND 2007

NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Heritage Bankshares,
Inc. and its wholly-owned subsidiary, Heritage Bank. All significant intercompany balances and transactions have been eliminated in consolidation.

Nature of Operations

Heritage Bankshares, Inc. (the Company) is a bank holding company incorporated under the
laws of the Commonwealth of Virginia in 1983, and at December 31, 2008, serves as the holding company for its wholly-owned subsidiary, Heritage Bank.

Heritage Bank (the Bank) is a wholly-owned subsidiary of the Company and is a state banking corporation engaged in the general commercial and retail banking business. The Bank is a full-service bank
conducting a general commercial and consumer banking business with its customers located throughout the Hampton Roads area of Virginia. The Bank has one wholly-owned subsidiary, Sentinel Financial Group, Inc. (Sentinel Financial). At
December 31, 2008, Sentinel Financial owned an interest in each of Infinex Investments, Inc. (formerly Bankers Investment Group, LLC), and Bankers Insurance, LLC, providers of various insurance and investment products. The financial activities
pertaining to these interests are recorded on the cost method of accounting for investments. In addition, at December 31, 2008, Sentinel Financial owned other real estate owned. This real estate is recorded at fair value.

IBV Real Estate Holdings, Inc. (IBV), formerly a wholly-owned subsidiary of the Company formed for the sole purpose of owning additional real
estate assets acquired by the Company or the Bank, was voluntarily dissolved and terminated by the Company. The accompanying consolidated financial statements of the Company include, where applicable, the results of operations and accounts of IBV
prior to its dissolution and termination in 2008.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans, the valuation of real estate acquired in connection with foreclosures or in satisfaction of
loans, and the valuation of deferred tax assets.

Significant Group Concentrations of Credit Risk

Substantially all of the Companys lending activities are with customers located in southeastern Virginia. Note 5 presents the Companys lending
activities. The Company invests in a variety of securities, principally obligations of the U.S., U.S. government sponsored enterprises, mortgage-backed securities and obligations of states and political subdivisions. Note 4 presents the
Companys investment activities. The Company does not have any significant concentrations of loans in any one industry or customer.

Cash and Cash
Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds
sold and overnight investments with Federal Home Loan Bank.

Investment Securities

Investment securities are classified in three categories and accounted for as follows:



| |  |  | Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized
cost.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported
at fair value, with unrealized gains and losses included in earnings.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for-sale securities and reported at fair
value, with unrealized gains and losses excluded from earnings and reported as other comprehensive income, a separate component of stockholders equity.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Gains and losses on sales of securities are computed based on specific identification of the adjusted cost of each security and included in other income.
Amortization of premiums and accretion of discounts are computed by the effective yield method and recognized in interest income.

Declines
in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary would result in write-downs of the individual securities to fair value. These write-downs would be included in earnings
as realized losses.

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.

Loans Held For Sale

Mortgage loans originated and
intended for sale in the secondary market are carried at cost. Loans held for sale are pre-committed to secondary market investors and, subsequent to being closed, are held for short holding periods pending receipt of loan documents.

Allowance For Loan Losses

The Bank maintains an
allowance for loan losses at a level which, in managements judgment, is adequate to absorb estimated credit losses on existing loans. The amount of the allowance is affected by: (1) loan charge-offs, which decrease the allowance,
(2) recoveries on loans previously charged-off, which increase the allowance, and (3) the provision for loan losses charged to income, which increases the allowance.

The Bank analyzes its loan portfolio through ongoing credit review processes and constructs a comprehensive allowance analysis for its loan portfolio at
least quarterly. This analysis includes two basic elements: (1) specific allowances for individual loans, and (2) general allowances for loan portfolio segments, which factor in historical loan loss experience and delinquency rates for the
Bank and the banking industry and numerous other environmental factors.

The Bank evaluates various loans individually for impairment as
required by Statement of Financial Accounting Standard (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan. An evaluation is based upon either discounted cash flows or collateral evaluations. If the
evaluation shows that a particular loan is impaired, then a specific reserve is established, or a charge-off is made, for the amount of any impairment.

For loans without an individual measure of impairment, the Bank makes estimates of losses for groups of loans as required by SFAS No. 5, Accounting for Contingencies. As part of the loan loss
reserve methodology, loans are placed into one of four major categories or segments of loans: (1) commercial and industrial loans, (2) consumer loans, (3) 1-4 family residential loans (including home equity loans and lines), and
(4) multi-family and other commercial real estate loans.

The Bank then considers the impact of various bank, industry, economic and
other environmental factors and documents which factors are used in the analysis.

The Banks allowance for loan losses is divided
into four distinct portions: (1) Historical  an amount based on the Banks actual net charge-offs; (2) Impaired Loans  an amount for specific allocations on significant individual credits under SFAS 114; (3) Loan
Segments  an amount to adjust the historical allocation for the four loan segments based on environmental factors under SFAS 5; and (4) Unallocated  an amount to reflect the imprecision inherent in these calculations.



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##### Table of Contents

Income Recognition on Nonaccrual Loans

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 by
the borrower.

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.

Other Real Estate Owned

Other real estate owned is
comprised of real estate acquired through foreclosure, acceptance of a deed in lieu of foreclosure, or loans in which the Company receives physical possession of the debtors real estate. Other real estate owned is carried at the lower of the
recorded investment in the loan or the fair value of the real estate less estimated costs to sell. Net operating income of such properties, exclusive of depreciation, is included in other income and related depreciation expense is included in other
expense.

Restructured Loans

Loans are
considered 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 Company would not have otherwise considered. The Company
restructures certain loans in instances where a determination is 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 assets or equity interest received from the borrower,
if any. Prior to demonstrating performance, the Company generally classifies restructured loans 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 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.

Off Balance Sheet Credit Related Financial Instruments

In the ordinary course of business, the Company has entered into commitments to extend credit and issue standby letters of credit. Such financial instruments are recorded when they are funded.

Rate Lock Commitments

The Company enters into
commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e., rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to
be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 15 to 90 days. The Company protects itself from changes in interest rates through the use of best efforts forward
delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. In such instances, the Company is not exposed to losses
nor will it realize gains related to its rate lock commitments due to changes in interest rates.

The market values of rate lock
commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between rate lock commitments and best efforts
contracts, no gain or loss is recognized on the rate lock commitments.

Sale of Loans

Transfers of loans are accounted for as sales when control over the loans has been surrendered. Control over transferred loans is deemed to be surrendered
when (1) the loans have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred loans, and (3) the Company
does not maintain effective control over the transferred loans through an agreement to repurchase them before their maturity.



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Premises and Equipment

Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets, ranging from 2 years to 40 years.

Federal Reserve Bank Stock and Federal Home Loan Bank Stock

As a member of the Federal Reserve Bank (FRB), the Company is required to hold shares of FRB capital stock, $100 par value, in an amount equal to 6% of the Banks total common stock and capital
surplus.

As a member of the Federal Home Loan Bank (FHLB) of Atlanta, the Company is required to hold shares of capital stock
in the FHLB in an amount equal to 0.18% of total assets plus 4.50% of borrowings from the FHLB.

FRB stock and FHLB stock are carried at
cost.

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, premises and equipment 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. An allowance is provided if it is more likely than not that the Company will not realize the benefits of a deferred tax asset.
Through December 31, 2008, no valuation allowance has been provided against the Companys deferred tax asset.

The Company
analyzes tax positions taken or expected to be taken on its tax returns to determine if it has any liability related to uncertain tax positions in accordance with FIN 48. Liabilities, if any, resulting from this evaluation are recorded in the
current period.

Deferred Compensation Plans

The Company maintains deferred compensation agreements with certain current and former directors and the beneficiary of its former chief executive officer. The Companys policy is to accrue the present value of estimated amounts to be
paid under the contracts over the required service period to the date the participant is fully eligible to receive the benefits. At December 31, 2008, the discount rate the Company utilized to determine the deferred compensation liability was
determined by computing the average of the last three year-end periods AA corporate bond yield, whose approximate maturity corresponded to the approximate time remaining to pay out the expected benefits for each participant.

Bank-Owned Life Insurance

The Company has purchased
life insurance policies on certain current and former directors. Company-owned life insurance is recorded at its cash surrender value, or the amount that can be realized.

Stock Compensation Plans

At December 31, 2008, the Company has one stock-based compensation
plan, the Heritage 2006 Equity Incentive Plan (the 2006 Incentive Plan). Prior to January 1, 2006, the Company had elected to account for stock options pursuant to APB No. 25, Accounting for Stock Issued to Employees.Effective January 1, 2006, the Company adopted SFAS No. 123(R), Accounting for Stock-Based Compensation (SFAS 123(R)). SFAS 123(R) requires that the fair value of equity instruments, such as stock options, be
recognized as an expense in the financial statements as services are performed. The Company elected to follow the modified prospective transition method, under which compensation expense is recognized prospectively for all unvested options
outstanding at January 1, 2006 and for all awards modified or granted after that date. The Company had no existing stock options that remained unvested as of January 1, 2006. A description of the 2006 Incentive Plan and additional
disclosures required by SFAS No. 123(R) are included in Note 10.



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##### Table of Contents

Earnings Per Common Share

Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common
shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method. Earnings
per share calculations are presented in Note 9.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, and realized gains and losses be included in net income. Although certain
changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of
comprehensive income. Components of other comprehensive income are presented in Note 2.

Business Segments

The Company currently reports its activities as a single business segment. In determining appropriate segment definition and reporting, the Company
considers components of the business about which financial information relating to performance and resource allocation is available and regularly evaluated by management. Management determines components for which it will implement performance and
resource measurement procedures based upon criteria of relative importance and materiality to the organization.

Reclassifications

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

NOTE 2  OTHER COMPREHENSIVE INCOME

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



|                                                          |  |                          |          |   |      |   |          |  
|--------------------------------------------------------- |  | ------------------------ | -------- | - | ---- | - | -------- | -
|                                                          |  | Years Ended December 31, |         
|                                                          |  | 2008                     |          |   | 2007 |  
|Unrealized holding gains on available-for-sale securities |  | $                        | 696,168  |   |      | $ | 305,382  |  
|                                                          |  |                         
|Tax Effect                                                |  |                          | (236,697 | ) |      |   | (103,831 | )
|                                                          |  |                          |          |   |      |   |          |  
|                                                          |  |                         
|Net of tax amount                                         |  | $                        | 459,471  |   |      | $ | 201,551  |  
|                                                          |  |                          |          |   |      |   |          |  

NOTE 3  RESTRICTIONS ON CASH AND DUE FROM BANKS

The Bank is required to maintain average balances on hand or with the Federal Reserve Board. At December 31, 2008 and 2007, these reserve balances
amounted to $0 and $412,000, respectively.



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##### Table of Contents

NOTE 4  SECURITIES



|                                    |  |                |            |                      |   |                       |  |            |       |  |   |           
|----------------------------------- |  | -------------- | ---------- | -------------------- | - | --------------------- |  | ---------- | ----- |  | - | ----------
|                                    |  | Amortized Cost |            | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | Fair Value
|At December 31, 2008                |  |                |            |                      |   |                       |  |            |       |  |   |           
|                                    |  |                |            |                     
|Securities available for sale       |  |                |            |                      |   |                       |  |            |       |  |   |           
|                                    |  |                |            |                     
|U.S. Treasury Securities            |  | $              | 1,761,259  |                      | $ | 12,493                |  | $          | 3     |  | $ | 1,773,749 
|Mortgage-backed securities          |  |                | 57,961,180 |                      |   | 1,011,768             |  |            | 3,751 |  |   | 58,969,197
|                                    |  |                |            |                      |   |                       |  |            |       |  |   |           
|                                    |  |                |            |                     
|Total securities available for sale |  | $              | 59,722,439 |                      | $ | 1,024,261             |  | $          | 3,754 |  | $ | 60,742,946
|                                    |  |                |            |                      |   |                       |  |            |       |  |   |           
|                                    |  |                |            |                     
|Total securities(1)                 |  | $              | 59,722,439 |                      | $ | 1,024,261             |  | $          | 3,754 |  | $ | 60,742,946
|                                    |  |                |            |                      |   |                       |  |            |       |  |   |           



|(1) | At December 31, 2008, the Company held no securities classified as held to maturity.
|--- | ------------------------------------------------------------------------------------



|                                                 |  |   |            |  |   |         |  |   |   |  |   |           
|------------------------------------------------ |  | - | ---------- |  | - | ------- |  | - | - |  | - | ----------
|At December 31, 2007                             |  |   |            |  |   |         |  |   |   |  |   |           
|                                                 |  |   |            | 
|Securities available for sale                    |  |   |            |  |   |         |  |   |   |  |   |           
|U.S. Treasury securities                         |  | $ | 999,226    |  | $ | 5,614   |  | $ |  |  | $ | 1,004,840 
|U.S. government sponsored enterprises            |  |   | 5,002,563  |  |   | 27,137  |  |   |  |  |   | 5,029,700 
|Mortgage-backed securities                       |  |   | 31,098,629 |  |   | 264,500 |  |   |  |  |   | 31,363,129
|Obligations of states and political subdivisions |  |   | 689,831    |  |   | 27,089  |  |   |  |  |   | 716,920   
|                                                 |  |   |            |  |   |         |  |   |   |  |   |           
|                                                 |  |   |            | 
|Total securities available for sale              |  |   | 37,790,249 |  |   | 324,340 |  |   |  |  |   | 38,114,589
|                                                 |  |   |            |  |   |         |  |   |   |  |   |           
|                                                 |  |   |            | 
|Securities held to maturity                      |  |   |            |  |   |         |  |   |   |  |   |           
|Mortgage-backed securities                       |  |   | 6,512      |  |   | 91      |  |   |  |  |   | 6,603     
|Obligations of states and political subdivisions |  |   | 469,749    |  |   | 10,286  |  |   |  |  |   | 480,035   
|Preferred trust securities                       |  |   | 200,000    |  |   | 9,200   |  |   |  |  |   | 209,200   
|                                                 |  |   |            |  |   |         |  |   |   |  |   |           
|                                                 |  |   |            | 
|Total securities held to maturity                |  |   | 676,261    |  |   | 19,577  |  |   |  |  |   | 695,838   
|                                                 |  |   |            |  |   |         |  |   |   |  |   |           
|                                                 |  |   |            | 
|Total securities                                 |  | $ | 38,466,510 |  | $ | 343,917 |  | $ |  |  | $ | 38,810,427
|                                                 |  |   |            |  |   |         |  |   |   |  |   |           

Investment securities having carrying value of $150,001 and $1,483,201 at December 31, 2008
and 2007, respectively, were made available to secure deposits of the U.S. government and the Commonwealth of Virginia. The fair values of these securities were $149,998 and $1,499,266 at December 31, 2008 and 2007, respectively.

Investment securities having carrying values of $6,079,726 and $5,002,563 at December 31, 2008 and 2007, respectively, are made available for retail
repurchase agreements. The estimated fair values of these securities were $6,300,249 and $5,029,700 at December 31, 2008 and 2007, respectively.



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The following tables show gross unrealized losses and fair value on investment securities, aggregated by
investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2008 and 2007. The current year unrealized losses on investment securities, if any, are a result of changes in
interest rates during the periods. All unrealized losses on investment securities are considered by management to be temporary given the credit ratings on these investment securities and the short duration of the unrealized loss.



|                                      |  |                      |           |                   |   |            |  |                  |   |            |   |                  |  |   |           |  |   |      
|------------------------------------- |  | -------------------- | --------- | ----------------- | - | ---------- |  | ---------------- | - | ---------- | - | ---------------- |  | - | --------- |  | - | -----
|                                      |  | At December 31, 2008
|                                      |  | Less Than 12 Months  |           | 12 Months or More |   | Total     
|                                      |  | Fair Value           |           | UnrealizedLosses  |   | Fair Value |  | UnrealizedLosses |   | Fair Value |   | UnrealizedLosses
|U.S. Treasury Securities              |  | $                    | 149,998   |                   | $ | 3          |  | $                |  |            | $ |                 |  | $ | 149,998   |  | $ | 3    
|Mortgage-backed securities            |  |                      | 3,376,929 |                   |   | 3,751      |  |                  |  |            |   |                 |  |   | 3,376,929 |  |   | 3,751
|                                      |  |                      |           |                   |   |            |  |                  |   |            |   |                  |  |   |           |  |   |      
|Total temporarily impaired securities |  | $                    | 3,526,927 |                   | $ | 3,754      |  | $                |  |            | $ |                 |  | $ | 3,526,927 |  | $ | 3,754
|                                      |  |                      |           |                   |   |            |  |                  |   |            |   |                  |  |   |           |  |   |      
|                                      | 
|                                      |  | At December 31, 2007
|                                      |  | Less Than 12 Months  |           | 12 Months or More |   | Total     
|                                      |  | Fair Value           |           | UnrealizedLosses  |   | Fair Value |  | UnrealizedLosses |   | Fair Value |   | UnrealizedLosses
|U.S. Treasury Securities              |  | $                    |          |                   |   |           |  | $                |  |            | $ |                 |  | $ |          |  | $ |     
|Mortgage-backed Securities            |  |                      |          |                   |   |           |  |                  |  |            |   |                 |  |   |          |  |   |     
|                                      |  |                      |           |                   |   |            |  |                  |   |            |   |                  |  |   |           |  |   |      
|Total temporarily impaired securities |  | $                    |          |                   | $ |           |  | $                |  |            | $ |                 |  | $ |          |  | $ |     
|                                      |  |                      |           |                   |   |            |  |                  |   |            |   |                  |  |   |           |  |   |      

The amortized cost and fair value of investment securities at December 31, 2008, by
contractual maturity, are shown below. Actual maturities will differ from contractual maturities since some securities may be called or prepaid prior to their contractual maturity:



|                                       |  |                               |            |                                 |   |                |  |            |   |  |   |  
|-------------------------------------- |  | ----------------------------- | ---------- | ------------------------------- | - | -------------- |  | ---------- | - |  | - | -
|                                       |  | Securities Available for Sale |            | Securities Held to Maturity (1)
|                                       |  | Amortized Cost                |            | Fair Value                      |   | Amortized Cost |  | Fair Value
|Due in one year or less                |  | $                             | 1,761,258  |                                 | $ | 1,773,749      |  | $          |  |  | $ | 
|Due after one year through five years  |  |                               | 19,138,285 |                                 |   | 19,415,522     |  |            |  |  |   | 
|Due after five years through ten years |  |                               | 20,963,426 |                                 |   | 21,490,459     |  |            |  |  |   | 
|Due after ten years                    |  |                               | 17,859,470 |                                 |   | 18,063,216     |  |            |  |  |   | 
|                                       |  |                               |            |                                 |   |                |  |            |   |  |   |  
|                                       |  |                               |            |                                
|Total                                  |  | $                             | 59,722,439 |                                 | $ | 60,742,946     |  | $          |  |  | $ | 
|                                       |  |                               |            |                                 |   |                |  |            |   |  |   |  



|(1) | At December 31, 2008, the Company held no securities classified as held to maturity.
|--- | ------------------------------------------------------------------------------------



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NOTE 5  LOANS

Loans consist of the following:



|                           |  |                 |             |   |      |   |             |  
|-------------------------- |  | --------------- | ----------- | - | ---- | - | ----------- | -
|                           |  | At December 31, |            
|                           |  | 2008            |             |   | 2007 |  
|Commercial                 |  | $               | 32,847,457  |   |      | $ | 26,108,173  |  
|Real estate - mortgage     |  |                 | 112,371,561 |   |      |   | 101,095,900 |  
|Real estate - construction |  |                 | 27,883,927  |   |      |   | 23,104,633  |  
|Installment and consumer   |  |                 | 4,385,595   |   |      |   | 4,149,881   |  
|                           |  |                 |             |   |      |   |             |  
|Total loans:               |  |                 | 177,488,540 |   |      |   | 154,458,587 |  
|                           |  |                
|Allowance for loan losses  |  |                 | (1,652,174  | ) |      |   | (1,399,875  | )
|Unearned loan fees/costs   |  |                 | 725,238     |   |      |   | 791,439     |  
|                           |  |                 |             |   |      |   |             |  
|Loans net                  |  | $               | 176,561,604 |   |      | $ | 153,850,151 |  
|                           |  |                 |             |   |      |   |             |  

Nonperforming assets were:



|                                        |  |                 |         |      |   |        
|--------------------------------------- |  | --------------- | ------- | ---- | - | -------
|                                        |  | At December 31,
|                                        |  | 2008            |         | 2007
|Nonaccrual loans (1)                    |  | $               | 30,754  |      | $ | 136,650
|Accruing loans past due 90 days or more |  |                 | 9,937   |      |   | 26,709 
|                                        |  |                 |         |      |   |        
|                                        |  |                
|Total nonperforming loans               |  |                 | 40,691  |      |   | 163,359
|                                        |  |                
|Real estate owned, net                  |  |                 | 177,500 |      |   |       
|                                        |  |                 |         |      |   |        
|                                        |  |                
|Total nonperforming assets              |  | $               | 218,191 |      | $ | 163,359
|                                        |  |                 |         |      |   |        



|(1) | At December 31, 2008 and 2007, includes restructured loans of $0 and $136,650, respectively.
|--- | --------------------------------------------------------------------------------------------

If interest on nonaccrual loans had been accrued, such income would have approximated $21,502 and $35,216 in 2008 and 2007, respectively, none of which
was recognized in income.

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



|                           |  |                 |           |   |      |   |           |  
|-------------------------- |  | --------------- | --------- | - | ---- | - | --------- | -
|                           |  | At December 31, |          
|                           |  | 2008            |           |   | 2007 |  
|Balance, beginning of year |  | $               | 1,399,875 |   |      | $ | 1,373,000 |  
|Provision for loan losses  |  |                 | 452,770   |   |      |   | 104,644   |  
|Loans charged-off          |  |                 | (397,818  | ) |      |   | (196,941  | )
|Recoveries                 |  |                 | 197,347   |   |      |   | 119,172   |  
|                           |  |                 |           |   |      |   |           |  
|                           |  |                
|Balance, end of year       |  | $               | 1,652,174 |   |      | $ | 1,399,875 |  
|                           |  |                 |           |   |      |   |           |  



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The following is a summary of information pertaining to impaired loans:



|                                                      |  |                         |           |      |   |        
|----------------------------------------------------- |  | ----------------------- | --------- | ---- | - | -------
|                                                      |  | At December 31,        
|                                                      |  | 2008                    |           | 2007
|Impaired loans without a valuation allowance          |  | $                       | 30,754    |      | $ |       
|                                                      |  |                        
|Impaired loans with a valuation allowance             |  |                         |          |      |   | 136,650
|                                                      |  |                         |           |      |   |        
|                                                      |  |                        
|Total impaired loans:                                 |  | $                       | 30,754    |      | $ | 136,650
|                                                      |  |                         |           |      |   |        
|                                                      |  |                        
|Valuation allowance related to impaired loans         |  | $                       |          |      | $ | 20,497 
|                                                      |  |                         |           |      |   |        
|                                                      | 
|                                                      |  | Years EndedDecember 31,
|                                                      |  | 2008                    |           | 2007
|Average investment in impaired loans (while impaired) |  | $                       | 1,253,432 |      | $ | 175,499
|                                                      |  |                        
|Interest income recognized on impaired loans          |  | $                       |          |      | $ |       

NOTE 6  PREMISES AND EQUIPMENT

Premises and equipment consist of the following:



|                                  |  |                 |            |   |      |   |            |  
|--------------------------------- |  | --------------- | ---------- | - | ---- | - | ---------- | -
|                                  |  | At December 31, |           
|                                  |  | 2008            |            |   | 2007 |  
|Land and improvements             |  | $               | 3,915,500  |   |      | $ | 3,915,500  |  
|                                  |  |                
|Buildings and improvements        |  |                 | 2,941,100  |   |      |   | 1,414,381  |  
|                                  |  |                
|Leasehold improvements            |  |                 | 1,710,267  |   |      |   | 1,875,159  |  
|                                  |  |                
|Equipment, furniture and fixtures |  |                 | 3,137,027  |   |      |   | 3,131,775  |  
|                                  |  |                
|Fixed assets not in service       |  |                 | 2,462,485  |   |      |   | 1,713,278  |  
|                                  |  |                 |            |   |      |   |            |  
|                                  |  |                
|                                  |  |                 | 14,166,379 |   |      |   | 12,050,093 |  
|                                  |  |                
|Less - accumulated depreciation   |  |                 | (2,258,335 | ) |      |   | (2,087,325 | )
|                                  |  |                 |            |   |      |   |            |  
|                                  |  | $               | 11,908,044 |   |      | $ | 9,962,768  |  
|                                  |  |                 |            |   |      |   |            |  

Depreciation expense for the years ended December 31, 2008 and 2007 was $552,366 and $497,866, respectively.

In 2008 and 2007, the Company incurred losses on disposal and impairment charges related to equipment of $69,778 and $66,351, respectively.

Total rent expense for the years ended December 31, 2008 and 2007 amounted to $353,379 and $333,781, respectively.

Future minimum lease payments, by year and in the aggregate, under noncancelable leases with remaining terms of one year or more at December 31, 2008 were as
follows:



|           |  |   |          
|---------- |  | - | ---------
|2009       |  | $ | 229,998  
|2010       |  |   | 234,598  
|2011       |  |   | 239,290  
|2012       |  |   | 244,076  
|2013- 2017 |  |   | 1,137,000
|           |  |   |          
|           |  | $ | 2,084,962
|           |  |   |          



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NOTE 7  DEPOSITS

Interest-bearing deposits consist of the following:



|                                          |  |              |             |      |   |            
|----------------------------------------- |  | ------------ | ----------- | ---- | - | -----------
|                                          |  | December 31,
|                                          |  | 2008         |             | 2007
|Money Market and NOWs                     |  | $            | 106,386,474 |      | $ | 83,858,366 
|Savings                                   |  |              | 2,753,441   |      |   | 2,139,648  
|Certificates of deposit $100,000 and over |  |              | 4,704,899   |      |   | 7,281,976  
|Other time deposits                       |  |              | 47,948,457  |      |   | 44,344,223 
|                                          |  |              |             |      |   |            
|                                          |  |             
|                                          |  | $            | 161,793,271 |      | $ | 137,624,213
|                                          |  |              |             |      |   |            

At December 31, 2008 the scheduled maturities of time deposits are as follows:



|                    |  |   |           
|------------------- |  | - | ----------
|2009                |  | $ | 47,322,405
|2010                |  |   | 3,180,015 
|2011                |  |   | 1,631,536 
|2012                |  |   | 263,205   
|2013 and thereafter |  |   | 256,195   
|                    |  |   |           
|                    | 
|                    |  | $ | 52,653,356
|                    |  |   |           

NOTE 8  SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER BORROWINGS

Investment securities having carrying values of $6,079,726 and $5,002,563 and fair values of $6,300,248 and $5,029,700 were made available to secure
deposits of the U.S. Government, the Commonwealth of Virginia and retail repurchase agreements at December 31, 2008 and December 31, 2007, respectively. Information concerning securities sold under agreements to repurchase is summarized as
follows:



|                                               |  |              |           |   |      |   |           |  
|---------------------------------------------- |  | ------------ | --------- | - | ---- | - | --------- | -
|                                               |  | December 31, |          
|                                               |  | 2008         |           |   | 2007 |  
|Balance at end of year                         |  | $            | 1,246,536 |   |      | $ | 1,130,780 |  
|Average balance during the year                |  | $            | 1,662,391 |   |      | $ | 1,461,922 |  
|Weighted average interest rate during the year |  |              | 1.48      | % |      |   | 3.80      | %
|Interest expense during the year               |  | $            | 24,667    |   |      | $ | 55,592    |  
|Maximum month-end balance during the year      |  | $            | 2,324,857 |   |      | $ | 2,109,625 |  

The Bank is a member of the FHLB of Atlanta, which had established, at December 31, 2008, a
credit availability for the Bank in an amount equal to 20% of total assets. At December 31, 2008, the Bank had a $5.0 million outstanding medium term advance which will mature on March 4, 2013. At December 31, 2008, other
short-term borrowings consisted of $1,000 of Federal Funds purchased from correspondent banks.



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NOTE 9  EARNINGS PER SHARE RECONCILIATION

The Company calculates its basic and diluted earnings per share (EPS) in accordance with SFAS No. 128  Earnings Per Share.
The components of the Companys EPS calculations are as follows:



|                                                  |  |                          |           |      |   |          
|------------------------------------------------- |  | ------------------------ | --------- | ---- | - | ---------
|                                                  |  | Years Ended December 31,
|                                                  |  | 2008                     |           | 2007
|Net income (numerator, basic and diluted)         |  | $                        | 688,189   |      | $ | 920,044  
|Weighted average shares outstanding (denominator) |  |                          | 2,278,849 |      |   | 2,278,579
|Earnings per common share  basic                 |  | $                        | 0.30      |      | $ | 0.40     
|                                                  |  |                         
|Effect of dilutive securities                     |  |                          |           |      |   |          
|Weighted average shares outstanding               |  |                          | 2,278,849 |      |   | 2,278,579
|Effect of stock options                           |  |                          | 15,471    |      |   | 15,965   
|                                                  |  |                          |           |      |   |          
|Diluted average shares outstanding (denominator)  |  |                          | 2,294,320 |      |   | 2,294,544
|                                                  |  |                          |           |      |   |          
|Earnings per common share  assuming dilution     |  | $                        | 0.30      |      | $ | 0.40     

Basic earnings per common share is calculated by dividing net income by the weighted average
number of common shares outstanding during the period. Diluted earnings per common share is calculated by applying the treasury stock method. Under the treasury stock method, the exercise of dilutive stock options is assumed. The sum of the assumed
proceeds of (a) the stock option exercises, (b) the amount of any tax benefits that would be credited to additional paid-in capital assuming exercise of the options, and (c) the unamortized compensation expense on in-the-money options
not yet recognized pursuant to FAS 123(R) (see Note 10  Employee and Director Benefit Plans  Stock Compensation Plans) are assumed to be used to purchase common stock at the average market price during the period. The incremental shares
(the difference between the number of shares assumed issued and the number of shares assumed purchased), if any, are included in the denominator of the diluted earnings per share calculation.

Any difference in the number of shares used for basic earnings per share and diluted earnings per share for each of the two years results solely from the
dilutive effect of stock options. Options on an average of 222,500 shares and 157,000 shares were not included in computing diluted earnings per share for the years ended December 31, 2008 and December 31, 2007, respectively, because the
effects of the options were antidilutive.

NOTE 10  EMPLOYEE AND DIRECTOR BENEFIT PLANS

Stock Compensation Plans

Effective January 1,
2006, the Company adopted SFAS No. 123(R), Accounting for Stock-Based Compensation (SFAS 123(R)). SFAS 123(R) requires that the fair value of equity instruments, such as stock options, be recognized as an expense in the
financial statements as services are performed. The Company elected to follow the modified prospective transition method, under which compensation expense is recognized prospectively for all unvested options outstanding at January 1, 2006 and
for all awards modified or granted after that date. The Company had no existing stock options that remained unvested as of January 1, 2006.

Under the Heritage 2006 Equity Incentive Plan (2006 Incentive Plan), the Board of Directors may grant up to 250,000 stock options, stock appreciation rights, restricted stock and certain other equity awards, in the aggregate, to
officers and nonemployee directors of the Company and the Bank. The Board of Directors may approve the grant of nonstatutory stock options and options qualifying as incentive stock options, and the option price of both a nonstatutory stock option
and an incentive stock option will be the fair market value of the Companys common stock on the date of grant. Prior to January 28, 2009, Fair Market Value was defined generally as the weighted average (based on daily trading
volume) during the thirty (30) day period next preceding the date of grant of the last sale prices of a share of the Companys common stock on the five (5) days nearest preceding the date of grant on which at least 300
shares were traded. On January 28, 2009, the Board amended the definition of Fair Market Value under the 2006 Incentive Plan to consist of the following: (i) the closing price of a share of the Companys common stock on
the OTC Bulletin Board on the grant date of the applicable award, if the grant date is a trading day; or (ii) if shares of the Companys common stock are not traded on the grant date of the applicable award, then the closing price of a
share of common stock on the OTC Bulletin Board on the next preceding date on which a trade occurred; or (iii) if (i) and (ii) are inapplicable, the fair market value as determined in good faith by the Board.

A total of 200,000 options were outstanding at December 31, 2008 under the 2006 Incentive Plan. For purposes of determining the fair
value under SFAS 123(R) of options granted under the 2006 Incentive Plan, the measurement date will be the date of grant.



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The fair value of each stock option award is estimated on the measurement date using a Black-Scholes valuation model that uses assumptions described below.
Expected volatility is based on the historical volatility of the Companys stock, using weekly price observations over the expected term of the stock options. The expected term represents the period of time that stock options granted are
expected to be outstanding and is estimated based on managements business plan and provisions of the grant including the contractual term and vesting schedule. The expected dividend yield is based on recent dividend history. The risk-free
interest rate is the U.S. Treasury zero coupon yield curve in effect at the measurement date for the period corresponding to the expected life of the option.

All options granted will become exercisable earlier upon a change in control (as defined in the 2006 Incentive Plan) of the Company. The options may also become exercisable earlier upon the optionees retirement,
disability or death, and in the case of an optionee who is an employee, the optionees termination without cause or resignation for good reason. No option may be exercised after ten (10) years from the date of grant.

The estimates of fair value derived from the Black-Scholes option pricing model are theoretical values for stock options, and changes in assumptions used
in the model could result in materially different fair value estimates. The actual value of the stock options will depend on the market value of the Companys common stock when the options are exercised. There were no options granted in 2008.
The fair value of options granted during 2007 were estimated with the following assumptions:



|                                                                 |  |                      
|---------------------------------------------------------------- |  | ---------------------
|                                                                 |  | Year EndedDecember 31
|                                                                 |  | 2007                 
|Expected dividend yield                                          |  | 1.6%                 
|Expected stock price volatility                                  |  | 21.2%                
|Risk-free interest rate                                          |  | 3.76%                
|Expected life of options                                         |  | 6.5 years            
|Weighted average fair value of options granted during the period |  | $3.54                

The following table presents a summary of stock option activity during 2008 and 2007:



|                                 |  |         |   |  |                              |       |                                      |     |                         |   |    
|-------------------------------- |  | ------- | - |  | ---------------------------- | ----- | ------------------------------------ | --- | ----------------------- | - | ---
|                                 |  | Shares  |   |  | WeightedAverageExercisePrice |       | WeightedAverageRemainingTerm (Years) |     | AggregateIntrinsicValue
|                                 |  |         |   |  |                              |       |                                      |     | (in thousands)         
|Outstanding at January 1, 2008   |  | 297,600 |   |  | $                            | 14.08 |                                      |    |                         |   |   
|Granted                          |  |        |   |  |                              |      |                                      |    |                         |   |   
|Exercised                        |  | (600    | ) |  |                              | 7.25  |                                      |    |                         |   |   
|Forfeited/expired                |  | (2,000  | ) |  |                              | 12.12 |                                      |    |                         |   |   
|Outstanding at December 31, 2008 |  | 295,000 |   |  | $                            | 14.10 |                                      | 6.3 |                         | $ | 92 
|                                 |  |         |   |  |                              |       |                                      |     |                         |   |    
|Exercisable at December 31, 2008 |  | 184,600 |   |  | $                            | 13.25 |                                      | 5.2 |                         | $ | 92 
|                                 |  |         |   |  |                              |       |                                      |     |                         |   |    
|                                 |  |         |   | 
|Outstanding at January 1, 2007   |  | 258,600 |   |  | $                            | 14.35 |                                      |    |                         |   |   
|Granted                          |  | 40,000  |   |  |                              | 12.12 |                                      |    |                         |   |   
|Exercised                        |  | (1,000  | ) |  |                              | 6.82  |                                      |    |                         |   |   
|Forfeited/expired                |  |        |   |  |                              |      |                                      |    |                         |   |   
|                                 |  |         |   |  |                              |       |                                      |     |                         |   |    
|Outstanding at December 31, 2007 |  | 297,600 |   |  | $                            | 14.08 |                                      | 6.6 |                         | $ | 292
|                                 |  |         |   |  |                              |       |                                      |     |                         |   |    
|Exercisable at December 31, 2007 |  | 142,000 |   |  | $                            | 12.58 |                                      | 5.4 |                         | $ | 292
|                                 |  |         |   |  |                              |       |                                      |     |                         |   |    

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the
difference between the Companys closing stock price on the last trading day of the applicable year and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option
holders exercised their options on December 31, 2008 and December 31, 2007, respectively. The amount changes based on the fair market value of the Companys stock. The Companys current policy is to issue new shares to satisfy
share option exercises.



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The aggregate intrinsic value of options exercised for the twelve months ended December 31, 2008 and
December 31, 2007 was $2,850 and $10,180, respectively. Cash received from option exercises during 2008 and 2007 was $4,350 and $6,820, respectively. The total fair value of shares vested for the same periods was $162,056 and $125,224,
respectively.



57



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The amount charged against income, before income tax benefit of $14,475, in relation to the stock-based
payment arrangement was $155,279 for the year ended December 31, 2008. The amount charged against income, before income tax benefit of $16,785, in relation to the stock-based payment arrangement, was $135,426 for the year ended
December 31, 2007. At December 31, 2008, unrecognized compensation expense, net of estimated forfeitures, related to unvested stock option grants was $354,395 and is currently expected to be recognized over a weighted average period of 1.4
years as follows:



|                                |  |                                |    
|------------------------------- |  | ------------------------------ | ---
|                                |  | Stock-BasedCompensationExpense
|                                |  | (in thousands)                
|For the year ended December 31: |  |                                |    
|2009                            |  | $                              | 141
|2010                            |  |                                | 136
|2011                            |  |                                | 68 
|2012                            |  |                                | 9  
|                                |  |                                |    
|Total                           |  | $                              | 354
|                                |  |                                |    

Stock option awards granted in 2008 and 2007 under the 2006 Incentive Plan provide for accelerated
vesting under certain circumstances as defined in the Plan, such as a change of control with respect to the Company, the optionees retirement, death, permanent disability and, if the optionee is an employee of the Company, resignation for good
reason or termination without cause. Occurrence of these events may cause the requisite service period to be less than reflected in the schedule above, and unamortized stock-based compensation expense recognized at that time.

Deferred Compensation Plan

In 1985, the Company
entered into a deferred compensation and retirement arrangement with certain directors and subsequently with one officer. The Companys policy is to accrue the present value of estimated amounts to be paid under the contracts over the required
service period to the date the participant is fully eligible to receive the benefit. At December 31, 2008 and 2007, other liabilities included $669,222 and $707,059, respectively, related to the deferred compensation plans. Compensation expense
related to this plan was $29,692 and $36,919, for the years ended December 31, 2008 and 2007, respectively.

Employee Stock Ownership Plan

The Board of Directors adopted an Employees Stock Ownership Plan (the ESOP) effective January 1, 1998. The ESOP
covers substantially all employees after they have met eligibility requirements, and funds contributed to the plan are used to purchase outstanding common stock of the Company.

The Company recognized no compensation expense related to the ESOP for the years ended December 31, 2008 and 2007, respectively. Dividends received
by the ESOP are used for administrative expenses of the plan. At both December 31, 2008 and 2007, the ESOP owned 10,271 shares of common stock of the Company. There were no stock purchases for the year ended December 31, 2008 and 786
shares purchased for the year ended December 31, 2007. No shares were distributed to terminated employees during either year. At December 31, 2008 and 2007, the fair market value of the total shares held by the ESOP totaled $82,168 and
$114,522, respectively.

401(k) Retirement Program

Effective January 1, 1993, the Board of Directors adopted a Retirement Program (the 401(k)). Eligible employees who have completed the required months of service are eligible to participate and make
contributions. The Company makes employer matching contributions. The Company expensed $95,657 and $134,673 for the years ended December 31, 2008 and December 31, 2007, respectively.

NOTE 11  OTHER REAL ESTATE OWNED

In December
2008, the Company foreclosed on three properties, two of which were sold during that month. At December 31, 2008, the Company had other real estate owned in the amount of $177,500. The Company had no other real estate owned at December 31,
2007.



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NOTE 12  OTHER NONINTEREST INCOME AND EXPENSE

The components of other noninterest income are as follows:



|                                           |  |                          |         |      |   |        
|------------------------------------------ |  | ------------------------ | ------- | ---- | - | -------
|                                           |  | Years Ended December 31,
|                                           |  | 2008                     |         | 2007
|Credit card interchange fees               |  | $                        | 37,312  |      | $ | 35,707 
|ATM fees                                   |  |                          | 123,584 |      |   | 129,989
|Merchant discount fees                     |  |                          | 50,268  |      |   | 46,445 
|Income from bank-owned life insurance, net |  |                          | 20,270  |      |   | 21,008 
|Other                                      |  |                          | 97,179  |      |   | 177,635
|                                           |  |                          |         |      |   |        
|Total other noninterest income             |  | $                        | 328,613 |      | $ | 410,784
|                                           |  |                          |         |      |   |        

The components of other noninterest expense are as follows:



|                                |  |                          |         |      |   |         |  
|------------------------------- |  | ------------------------ | ------- | ---- | - | ------- | -
|                                |  | Years Ended December 31, |        
|                                |  | 2008                     |         | 2007 |  
|ATM transaction                 |  | $                        | 108,444 |      | $ | 122,343 |  
|Credit card                     |  |                          | 3,780   |      |   | (59     | )
|Postage                         |  |                          | 74,678  |      |   | 70,563  |  
|Courier                         |  |                          | 262,802 |      |   | 121,331 |  
|Service bureau expense          |  |                          | 93,934  |      |   | 66,775  |  
|Insurance expense               |  |                          | 46,717  |      |   | 46,287  |  
|Travel                          |  |                          | 28,157  |      |   | 24,261  |  
|Shareholder                     |  |                          | 38,765  |      |   | 43,513  |  
|Training                        |  |                          | 15,960  |      |   | 17,816  |  
|Loan servicing                  |  |                          | 20,779  |      |   | 36,357  |  
|Other miscellaneous             |  |                          | 201,160 |      |   | 234,116 |  
|                                |  |                          |         |      |   |         |  
|Total other noninterest expense |  | $                        | 895,176 |      | $ | 783,303 |  
|                                |  |                          |         |      |   |         |  

NOTE 13  INCOME TAXES

The principal components of income tax expense are as follows:



|                                              |  |                          |         |   |      |   |        
|--------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | -------
|                                              |  | Years Ended December 31,
|                                              |  | 2008                     |         |   | 2007
|Federal income tax expense/(benefit)-current  |  | $                        | 402,070 |   |      | $ | 446,839
|                                              |  |                         
|Deferred Federal income tax expense/(benefit) |  |                          | (11,405 | ) |      |   | 32,475 
|                                              |  |                          |         |   |      |   |        
|                                              |  |                         
|Income tax expense                            |  | $                        | 390,665 |   |      | $ | 479,314
|                                              |  |                          |         |   |      |   |        



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A reconciliation of income tax expense calculated at the federal statutory rate and that shown in the
statements of income is summarized as follows:



|                                                                         |  |                          |         |   |      |   |         |  
|------------------------------------------------------------------------ |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                                                         |  | Years Ended December 31, |        
|                                                                         |  | 2008                     |         |   | 2007 |  
|Federal income tax expense  at 34% statutory rate                       |  | $                        | 366,810 |   |      | $ | 475,782 |  
|                                                                         |  |                         
|Effect of tax-exempt interest                                            |  |                          | (19,689 | ) |      |   | (28,780 | )
|                                                                         |  |                         
|Effect of Life insurance proceeds, premiums, and increases in value, net |  |                          | (4,458  | ) |      |   | (4,708  | )
|                                                                         |  |                         
|Effect of FAS 123(R)  incentive stock options                           |  |                          | 37,805  |   |      |   | 29,259  |  
|                                                                         |  |                         
|Other                                                                    |  |                          | 10,197  |   |      |   | 7,761   |  
|                                                                         |  |                          |         |   |      |   |         |  
|                                                                         |  |                         
|                                                                         |  | $                        | 390,665 |   |      | $ | 479,314 |  
|                                                                         |  |                          |         |   |      |   |         |  

A cumulative net deferred tax asset is included in other assets at December 31, 2008 and
2007. The components of the asset are as follows:



|                                                  |  |                 |         |      |   |        
|------------------------------------------------- |  | --------------- | ------- | ---- | - | -------
|                                                  |  | At December 31,
|                                                  |  | 2008            |         | 2007
|Deferred Tax Assets                               |  |                 |         |      |   |        
|                                                  |  |                
|Deferred compensation                             |  | $               | 227,536 |      | $ | 240,400
|                                                  |  |                
|Allowance for loan losses                         |  |                 | 490,994 |      |   | 405,213
|                                                  |  |                
|FAS 123(R)  non-qualifying options               |  |                 | 46,363  |      |   | 31,887 
|                                                  |  |                
|Investment in partnerships                        |  |                 | 12,530  |      |   | 12,228 
|                                                  |  |                
|Other                                             |  |                 | 7,182   |      |   | 57,999 
|                                                  |  |                 |         |      |   |        
|                                                  |  |                
|Total Deferred Tax Assets                         |  |                 | 784,605 |      |   | 747,727
|                                                  |  |                 |         |      |   |        
|                                                  |  |                
|Deferred Tax Liabilities                          |  |                 |         |      |   |        
|                                                  |  |                
|Deferred loan costs, net                          |  |                 | 246,581 |      |   | 269,089
|                                                  |  |                
|Net appreciation on available-for-sale securities |  |                 | 330,610 |      |   | 110,275
|                                                  |  |                
|Premises and equipment                            |  |                 | 133,689 |      |   | 83,435 
|                                                  |  |                
|Other                                             |  |                 | 646     |      |   | 646    
|                                                  |  |                 |         |      |   |        
|                                                  |  |                
|Total Deferred Tax Liabilities                    |  |                 | 711,526 |      |   | 463,445
|                                                  |  |                 |         |      |   |        
|                                                  |  |                
|Net Deferred Tax Assets                           |  | $               | 73,079  |      | $ | 284,282
|                                                  |  |                 |         |      |   |        

NOTE 14  COMMITMENTS AND CONTINGENCIES  RELATED PARTY

During 2007 and prior years, the Company was a party to a lease with a related party to provide space for the Banks operations center. This lease
was classified as an operating lease for financial reporting purposes. The facility that housed the operations center was sold in August 2007 to an unrelated party, and the Company leased the facility from the unrelated party from August 2007 until
the lease was terminated in December 2008. Total rent expense paid by the Bank in 2007 in respect of the related party lease was $72,996 (the Company did not have any such related party lease expense in 2008).

In December 2006, the Bank contracted with Meredith Construction Company, Inc. (Meredith Construction) as general contractor to build, for a
maximum price of $1.4 million (which includes approximately a $127,000 fee to Meredith Construction), the Banks new retail banking office at its Lynnhaven Parkway site in Virginia Beach. Peter M. Meredith, Jr. is Chairman and CEO of Meredith
Construction, and Mr. Meredith also is Chairman of the Board of the Company. Meredith Construction is utilizing ColonialWebb Contractors Co. (ColonialWebb) as the heating and air conditioning subcontractor related to construction of
the Lynnhaven office for a price of $82,454. Howard W. Webb is a director of ColonialWebb, and Mr. Webb also was a director of the Company, having retired at the end of January 2009.



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In December 2007, the Board approved signage for the Banks Lynnhaven office with Southern Atlantic
Screenprint & Sign Company (Southern) for less than $1,000, and similarly in December of 2008 the Board approved signage to be provided by Southern for the Banks Laskin Road office for less than $1,000. James A. Cummings
is a director of Southern, and Mr. Cummings also is a director of the Company.

In May 2007, the Bank again contracted with Meredith
Construction as general contractor to build, for a maximum price of $2.3 million (which includes approximately a $208,000 fee to Meredith Construction), the Banks new retail banking office at its Laskin Road site in Virginia Beach. Meredith
Construction again has utilized ColonialWebb as the heating and air conditioning subcontractor related to construction of the Laskin office for a price of $195,659.

The Bank also contracted in December 2008 with Meredith Construction as general contractor to renovate, for a maximum price of $111,076 (which includes approximately a $14,488 fee to Meredith Construction), the
Banks retail banking office at its North Military Highway site in Norfolk.

NOTE 15  OTHER RELATED PARTY TRANSACTIONS

The Bank has loan and deposit transactions with certain of its executive officers and directors, and with companies in which the officers and directors
have a financial interest.

A summary of related party loan activity for the Bank is as follows:



|                                                                                                   |  |      |            |      |   |           
|-------------------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ----------
|                                                                                                   |  | 2008 |            | 2007
|Balance, December 31                                                                               |  | $    | 12,788,685 |      | $ | 11,557,471
|                                                                                                   |  |     
|Originations                                                                                       |  |      | 7,617,776  |      |   | 1,349,286 
|                                                                                                   |  |     
|Repayments                                                                                         |  |      | 3,570,789  |      |   | 3,718,072 
|                                                                                                   |  |     
|Other*                                                                                             |  |      |           |      |   | 3,600,000 
|                                                                                                   |  |      |            |      |   |           
|                                                                                                   |  |     
|Balance, December 31                                                                               |  | $    | 16,835,672 |      | $ | 12,788,685
|                                                                                                   |  |      |            |      |   |           
|                                                                                                  
|*       The Other balance above includes loans for which related parties are
partial guarantors.

In the opinion of management, such related party loans are made in the ordinary course of business
on substantially the same terms, including interest rate and collateral, as those prevailing at the same time for comparable loans to unrelated persons and did not involve more than the normal risk of collectibility or present other unfavorable
features.

Commitments to extend credit and letters of credit to related parties amounted to $4,319,009 and $4,287,678 at December 31,
2008 and 2007, respectively. (See Note 14 for additional commitments to related parties.)

NOTE 16  COMMITMENTS AND FINANCIAL INSTRUMENTS WITH
OFF-BALANCE SHEET CREDIT RISK

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

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



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The Company uses the same credit policies in making commitments and conditional obligations as it does
for on-balance-sheet instruments. Unless otherwise noted, the Company requires collateral or other security to support financial instruments with credit risk. Contractual amounts for financial instruments whose contract amounts represent credit risk
at December 31, 2008 and December 31, 2007 were as follows:



|                             |  |      |            |      |   |           
|---------------------------- |  | ---- | ---------- | ---- | - | ----------
|                             |  | 2008 |            | 2007
|Commitments to extend credit |  | $    | 42,365,456 |      | $ | 48,572,911
|Standby letters of credit    |  |      | 2,155,080  |      |   | 2,061,113 
|Commitments to sell loans    |  |      |           |      |   | 417,000   
|                             |  |      |            |      |   |           
|                             |  | $    | 44,520,536 |      | $ | 51,051,024
|                             |  |      |            |      |   |           

As of December 31, 2008, the Company had $7.6 million in deposits in financial
institutions in excess of amounts insured by the FDIC, the majority of which was on deposit at the Federal Home Loan Bank of Atlanta.

NOTE 17 
REGULATORY MATTERS

The Bank is subject to various regulatory capital requirements administered by the federal and state banking
agencies. Failure to meet minimum capital requirements may result in 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 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital) to average assets (as defined). Management believes that, as of
December 31, 2008, the Bank meets all capital adequacy requirements to which it is subject.

The Bank is well capitalized
under the applicable regulatory framework. To be categorized as well capitalized, the Bank must maintain the minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios set forth in the table below. There are no conditions or
events that management believes have changed the Banks categorization. Additionally, management believes that, as of December 31, 2008, the Company meets all capital adequacy requirements to which it is subject. At December 31, 2008,
the Companys total risk-based capital, Tier 1 risk-based capital, and Tier 1 capital (leverage) ratios were 13.43%, 12.61% and 10.13%, respectively.



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The capital amounts and ratios for the Company (consolidated) and the Bank as of December 31, 2008
and 2007 are presented in the following table:



|                                         |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|---------------------------------------- |  | ------ | ------ | ----- | ---------------------------- | - | ------ | --------------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|(Dollars in thousands)                   |  | Actual |        |       | For Capital AdequacyPurposes |   |        | Minimum To Be WellCapitalized UnderPrompt Corrective ActionProvisions |       
|                                         |  | Amount |        | Ratio |                              |   | Amount |                                                                       | Ratio  |  |     | Amount |  | Ratio |       
|At December 31, 2008                     |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|                                         |  |        |        |       |                              |  
|Total Capital (to Risk-Weighted Assets)  |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 26,865 |       | 13.43                        | % |        | $                                                                     | 16,000 |  | 8.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 26,393 |       | 13.20                        | % |        | $                                                                     | 15,997 |  | 8.0 | %      |  | $     | 19,997 |  | 10.0 | %
|Tier 1 Capital (to Risk-Weighted Assets) |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 25,212 |       | 12.61                        | % |        | $                                                                     | 8,000  |  | 4.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 24,741 |       | 12.37                        | % |        | $                                                                     | 7,999  |  | 4.0 | %      |  | $     | 11,998 |  | 6.0  | %
|Tier 1 Capital (to Average Assets)       |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 25,212 |       | 10.13                        | % |        | $                                                                     | 9,957  |  | 4.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 24,741 |       | 9.94                         | % |        | $                                                                     | 9,956  |  | 4.0 | %      |  | $     | 12,445 |  | 5.0  | %
|                                         |  |        |        |       |                              |  
|At December 31, 2007                     |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|                                         |  |        |        |       |                              |  
|Total Capital (to Risk-Weighted Assets)  |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 26,310 |       | 14.99                        | % |        | $                                                                     | 14,043 |  | 8.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 25,591 |       | 14.61                        | % |        | $                                                                     | 14,015 |  | 8.0 | %      |  | $     | 17,519 |  | 10.0 | %
|Tier 1 Capital (to Risk-Weighted Assets) |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 24,911 |       | 14.19                        | % |        | $                                                                     | 7,022  |  | 4.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 24,191 |       | 13.81                        | % |        | $                                                                     | 7,007  |  | 4.0 | %      |  | $     | 10,511 |  | 6.0  | %
|Tier 1 Capital (to Average Assets)       |  |        |        |       |                              |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated Company                     |  | $      | 24,911 |       | 11.13                        | % |        | $                                                                     | 8,956  |  | 4.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                                     |  | $      | 24,191 |       | 10.81                        | % |        | $                                                                     | 8,954  |  | 4.0 | %      |  | $     | 11,193 |  | 5.0  | %

Federal and state banking regulations place certain restrictions on dividends paid and loans or
advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. Loans or advances are limited to
10.0% of the Banks stockholders equity.

NOTE 18  DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The following summary presents the methodologies and assumptions used to estimate the fair value of the Companys financial instruments presented
below. Because no active market readily exists for a portion of the Companys financial instruments, fair values of some financial instruments are based on estimates using present value and other valuation techniques. Much of the information
used to determine fair value is highly subjective in nature and therefore the results may not be precise. The subjective factors include, among other things, estimates of cash flows, risk characteristics, credit quality, and interest rates, all of
which are subject to change. Accordingly, the amounts which will actually be realized or paid upon settlement or maturity of the various instruments could be significantly different.

Cash, Due From Banks and Federal Funds Sold

For cash due from banks and federal funds sold, the
carrying amount is a reasonable estimate of fair value.

Investment Securities

Fair values are based on quoted market prices. For unquoted securities, the fair value is estimated by the Company on the basis of financial and other
information. Securities available for sale are recorded at fair value.



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Loans

The fair value of loans is estimated by discounting the future estimated scheduled cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings.

The fair value of loans does not include the value of the customer relationship or the right to fees generated by the account.

Accrued Interest Receivable

The carrying amount of
accrued interest approximates fair value.

Stock in Federal Reserve Bank and Federal Home Loan Bank

The carrying value for FRB and FHLB stock approximates fair value.

Bank-Owned Life Insurance

The carrying value of life insurance approximates fair value, as this investment is carried at
cash surrender value.

Deposit Liabilities

The fair value of deposits with no stated maturities (which includes demand deposits, savings accounts, and money market deposits) is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of
deposit was estimated using a discounted cash flow model based on the rates offered for deposits of similar remaining maturities. Weighted average rates paid and posted rates were used for December 2008 and 2007.

Deposit liabilities with no stated maturity are reported at the amount payable on demand without regard for the inherent funding value of these
instruments. The Company believes that significant value exists in this funding source. The fair value of deposits does not include the value of the customer relationship or the rights to fees generated by the account.

Federal Home Loan Bank Advances

The fair value of
FHLB advances is estimated using discounted cash flow analysis based on rates offered at the reporting date for borrowings of similar remaining maturities.

Other Borrowings and Securities Sold Under Agreements to Repurchase

The carrying amount for other borrowings and securities
sold under agreements to repurchase is a reasonable estimate of fair value.

Accrued Interest Payable

The carrying value of accrued interest payable is a reasonable estimate of fair value.

Loan Commitments and Standby Letters of Credit

The carrying value of notional principal amounts of
loan commitments and standby letters of credit are reasonable estimates of fair value.



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The following table presents the carrying amounts and fair value of the Companys financial
instruments at December 31, 2008 and December 31, 2007.



|                                                                   |  |                        |         |            |   |                |  |            |         |  |   |        
|------------------------------------------------------------------ |  | ---------------------- | ------- | ---------- | - | -------------- |  | ---------- | ------- |  | - | -------
|                                                                   |  | 2008                   |         | 2007      
|                                                                   |  | CarryingAmount         |         | Fair Value |   | CarryingAmount |  | Fair Value
|                                                                   |  | (Dollars in Thousands)
|Financial assets:                                                  |  |                        |         |            |   |                |  |            |         |  |   |        
|Cash and due from banks                                            |  | $                      | 5,304   |            | $ | 5,304          |  | $          | 5,463   |  | $ | 5,463  
|Federal funds sold                                                 |  |                        | 8,114   |            |   | 8,114          |  |            | 8,957   |  |   | 8,957  
|Securities available for sale                                      |  |                        | 60,743  |            |   | 60,743         |  |            | 38,115  |  |   | 38,115 
|Securities held to maturity                                        |  |                        |        |            |   |               |  |            | 676     |  |   | 696    
|Loans held for investment                                          |  |                        | 176,562 |            |   | 178,458        |  |            | 153,850 |  |   | 155,544
|Loans held for sale                                                |  |                        |        |            |   |               |  |            | 878     |  |   | 878    
|Accrued interest receivable                                        |  |                        | 735     |            |   | 735            |  |            | 812     |  |   | 812    
|Stock in FRB and FHLB                                              |  |                        | 946     |            |   | 946            |  |            | 1,029   |  |   | 1,029  
|Bank-owned life insurance                                          |  |                        | 619     |            |   | 619            |  |            | 584     |  |   | 584    
|                                                                   |  |                        |         |           
|Financial Liabilities:                                             |  |                        |         |            |   |                |  |            |         |  |   |        
|Deposits                                                           |  |                        | 215,782 |            |   | 216,150        |  |            | 186,014 |  |   | 186,004
|Federal Home Loan Bank Advance                                     |  |                        | 5,000   |            |   | 5,140          |  |            | 7,000   |  |   | 7,000  
|Other borrowing and securities sold under agreements to repurchase |  |                        | 1,248   |            |   | 1,248          |  |            | 1,131   |  |   | 1,131  
|Accrued interest payable                                           |  |                        | 237     |            |   | 237            |  |            | 321     |  |   | 321    

During 2008, the Bank converted to a model that calculates the fair value of loans and deposits in
greater detail. Utilizing that model, the fair value of loans and deposits at December 31, 2007 was $155,544 and $186,004, respectively, rather than $157,044 and $185,949, respectively, as previously reported.

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements, which provides a framework for measuring and
disclosing fair value under generally accepted accounting principles. SFAS 157 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the
measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an
orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring
fair value.

Fair Value Hierarchy

SFAS 157 establishes three levels of inputs that may be used to measure fair value:

Level 1: Valuation is
based on quoted prices in active markets for identical assets or liabilities.

Level 2: Valuation is based on observable inputs other than
Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets
or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are
observable in the market or can be derived principally from or corroborated by observable market data.

Level 3: Valuation is based on
unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing
models, discounted cash flow methodologies or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

Investment Securities Available for Sale

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



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valuation techniques such as the present value of future cash flows, adjusted for the securitys credit rating, prepayment assumptions and other factors
such as credit loss assumptions. Level 2 securities include Treasury notes and bills, mortgage-backed securities issued by government sponsored entities, municipal bonds and other securities issued by government sponsored agencies.

Loans

The Company does not record
loans at fair value on a recurring basis. From time to time, a loan is considered impaired. Loans which are deemed to be impaired are valued according to SFAS 114, Accounting by Creditors for Impairment of a Loan. The fair value of
impaired loans is estimated using one of several methods, including collateral value, liquidation value, and discounted cash flows. When the fair value of collateral is based on an observable market price or a current appraised value, the Company
records the impaired loan as Level 2. If the fair value of the loan is based on criteria other than observable market prices or current appraised value, the loan is recorded as Level 3. The Company had three impaired loans at
December 31, 2008.

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Foreclosed assets are carried at the lower of the carrying value or fair value. Fair value is based upon independent
observable market prices or appraised values of the collateral, which the Company considers to be Level 2 inputs. The Company had foreclosed assets at December 31, 2008 with a fair value of $177,500.

General

The Company has no
liabilities carried at fair value or measured at fair value on a nonrecurring basis.

The Company has no assets or liabilities whose fair
values are measured using Level 3 inputs.

FASB Staff Position No. FAS 157-2 delays the implementation of SFAS 157 until the first
quarter of 2009 with respect to goodwill, other intangible assets, real estate and other assets acquired through foreclosure and other non-financial assets measured at fair value on a nonrecurring basis.



|                                                       |  |       |        |         |   |         |  |         |        |  |   |  
|------------------------------------------------------ |  | ----- | ------ | ------- | - | ------- |  | ------- | ------ |  | - | -
|Assets Recorded at Fair Value on a Recurring Basis    
|                                                       |  |       |        |        
|December 31, 2008 in thousands                         |  | Total |        | Level 1 |   | Level 2 |  | Level 3
|Investment in securities available for sale            |  | $     | 60,743 |         | $ |        |  | $       | 60,743 |  | $ | 
|                                                       |  |       |        |         |   |         |  |         |        |  |   |  
|Total Assets at Fair Value                             |  | $     | 60,743 |         | $ |        |  | $       | 60,743 |  | $ | 
|                                                       |  |       |        |         |   |         |  |         |        |  |   |  
|                                                      
|Assets Recorded at Fair Value on a Non-Recurring Basis
|                                                       |  |       |        |        
|December 31, 2008 in thousands                         |  | Total |        | Level 1 |   | Level 2 |  | Level 3
|Impaired loans                                         |  | $     | 31     |         | $ |        |  | $       | 31     |  | $ | 
|Other real estate owned                                |  |       | 178    |         |   |        |  |         | 178    |  |   | 
|                                                       |  |       |        |         |   |         |  |         |        |  |   |  
|Total Assets at Fair Value                             |  | $     | 209    |         | $ |        |  | $       | 209    |  | $ | 
|                                                       |  |       |        |         |   |         |  |         |        |  |   |  



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NOTE 19  CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.

(Parent Company Only)

The following condensed
financial statements of Heritage Bankshares, Inc. are presented below on a parent company only basis for the years indicated.



|                                                        |  |                          |            |   |      |   |            |  
|------------------------------------------------------- |  | ------------------------ | ---------- | - | ---- | - | ---------- | -
|                                                        |  | At December 31,          |           
|                                                        |  | 2008                     |            |   | 2007 |  
|Condensed Balance Sheets                                |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Assets                                                  |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Cash                                                    |  | $                        | 44,715     |   |      | $ | 127,863    |  
|                                                        |  |                         
|Investment in Heritage Bank                             |  |                          | 25,414,562 |   |      |   | 24,404,878 |  
|                                                        |  |                         
|Other assets                                            |  |                          | 478,699    |   |      |   | 660,336    |  
|                                                        |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Total Assets                                            |  | $                        | 25,937,976 |   |      | $ | 25,193,077 |  
|                                                        |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Liabilities and Stockholders Equity                    |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Other liabilities                                       |  | $                        | 52,026     |   |      | $ | 68,473     |  
|                                                        |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Total Liabilities                                       |  | $                        | 52,026     |   |      | $ | 68,473     |  
|                                                        |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Common stock                                            |  |                          | 11,396,260 |   |      |   | 11,393,260 |  
|                                                        |  |                         
|Additional paid-in capital                              |  |                          | 6,329,854  |   |      |   | 6,172,256  |  
|                                                        |  |                         
|Retained earnings                                       |  |                          | 7,486,301  |   |      |   | 7,345,024  |  
|                                                        |  |                         
|Accumulated other comprehensive income                  |  |                          | 673,535    |   |      |   | 214,064    |  
|                                                        |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Stockholders equity                                    |  | $                        | 25,885,950 |   |      | $ | 25,124,604 |  
|                                                        |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Total Liabilities and Stockholders Equity              |  | $                        | 25,937,976 |   |      | $ | 25,193,077 |  
|                                                        |  |                          |            |   |      |   |            |  
|                                                        | 
|                                                        |  | Years Ended December 31, |           
|                                                        |  | 2008                     |            |   | 2007 |  
|Condensed Statements of Income                          |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Dividends from subsidiary bank                          |  | $                        | 410,193    |   |      | $ |           |  
|                                                        |  |                         
|Equity in undistributed net income of subsidiaries      |  |                          | 394,933    |   |      |   | 816,523    |  
|                                                        |  |                         
|Other income                                            |  |                          |           |   |      |   | 39,716     |  
|                                                        |  |                         
|Settlement with a former professional services provider |  |                          |           |   |      |   | 345,000    |  
|                                                        |  |                         
|Interest and dividend income                            |  |                          |           |   |      |   | 256        |  
|                                                        |  |                         
|Interest expense                                        |  |                          |           |   |      |   | (3,229     | )
|                                                        |  |                         
|Other expenses                                          |  |                          | (177,178   | ) |      |   | (224,985   | )
|                                                        |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Income before income taxes                              |  |                          | 627,948    |   |      |   | 973,281    |  
|                                                        |  |                         
|Income tax expense (benefit)                            |  |                          | (60,241    | ) |      |   | 53,237     |  
|                                                        |  |                          |            |   |      |   |            |  
|                                                        |  |                         
|Net Income                                              |  | $                        | 688,189    |   |      | $ | 920,044    |  
|                                                        |  |                          |            |   |      |   |            |  

Certain restrictions exist regarding the ability of the Bank to transfer funds to the Company 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. The maximum amount available
for transfer from the Bank to the Company in the form of loans and advances is 10.0% of the Banks stockholders equity.



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Heritage Bankshares, Inc.

Statements of Cash Flows



|                                                      |  |                          |          |   |      |   |            |  
|----------------------------------------------------- |  | ------------------------ | -------- | - | ---- | - | ---------- | -
|                                                      |  | Years Ended December 31, |         
|                                                      |  | 2008                     |          |   | 2007 |  
|Cash flows from operating activities                  |  |                          |          |   |      |   |            |  
|                                                      |  |                         
|Net income                                            |  | $                        | 688,189  |   |      | $ | 920,044    |  
|Add (deduct) items not affecting cash during the year |  |                          |          |   |      |   |            |  
|Stock-based compensation                              |  |                          | 155,279  |   |      |   | 135,426    |  
|Undistributed net income of subsidiaries              |  |                          | (394,933 | ) |      |   | (816,523   | )
|Exercise of stock options tax benefit                 |  |                          | 969      |   |      |   | 3,461      |  
|Net gain on sale of other investments                 |  |                          |         |   |      |   | (22,361    | )
|Changes in assets/liabilities, net                    |  |                          |          |   |      |   |            |  
|(Increase) decrease in other assets                   |  |                          | 26,357   |   |      |   | (293,384   | )
|Increase (decrease) in other liabilities              |  |                          | (16,447  | ) |      |   | 26,368     |  
|                                                      |  |                          |          |   |      |   |            |  
|Net cash (used for) operating activities              |  |                          | 459,414  |   |      |   | (46,969    | )
|                                                      |  |                          |          |   |      |   |            |  
|                                                      |  |                         
|Cash flows from investing activities                  |  |                          |          |   |      |   |            |  
|Proceeds from sale of other investments               |  |                          |         |   |      |   | 73,431     |  
|                                                      |  |                          |          |   |      |   |            |  
|Net cash provided by investing activities             |  |                          |         |   |      |   | 73,431     |  
|                                                      |  |                          |          |   |      |   |            |  
|                                                      |  |                         
|Cash flows from financing activities                  |  |                          |          |   |      |   |            |  
|Proceeds from exercise of stock options               |  |                          | 4,350    |   |      |   | 6,820      |  
|Repayment of other borrowings                         |  |                          |         |   |      |   | (5,000,000 | )
|Cash dividends paid                                   |  |                          | (546,912 | ) |      |   | (546,876   | )
|                                                      |  |                          |          |   |      |   |            |  
|Net cash provided by (used for) financing activities  |  |                          | (542,562 | ) |      |   | (5,540,056 | )
|                                                      |  |                          |          |   |      |   |            |  
|Increase (decrease) in cash and cash equivalents      |  |                          | (83,148  | ) |      |   | (5,513,594 | )
|                                                      |  |                         
|Cash and cash equivalents at beginning of year        |  |                          | 127,863  |   |      |   | 5,641,457  |  
|                                                      |  |                          |          |   |      |   |            |  
|Cash and cash equivalents at end of year              |  | $                        | 44,715   |   |      | $ | 127,863    |  
|                                                      |  |                          |          |   |      |   |            |  

* * * * *



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|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------

None



|ITEM 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------

Disclosure Controls and Procedures

The Company, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial
Officer have concluded that the Companys disclosure controls and procedures are effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the Exchange
Act), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to the Companys
management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures. Furthermore, our controls and procedures can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control, and misstatements due to error or fraud may
occur and not be detected on a timely basis.

Managements Report on Internal Control over Financial Reporting.

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance to the Companys management and board of directors regarding the preparation and fair
presentation of published financial statements and the reliability of financial reporting.

Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2008. In making this assessment, management
used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control  Integrated Framework. Based on our assessment, we believe that, as of December 31, 2008,
the Companys internal control over financial reporting is effective based on those criteria.

This annual report does not include an attestation
report of the Companys registered public accounting firm regarding internal control over financial reporting. Managements report was not subject to attestation by the Companys registered public accounting firm pursuant to temporary
rules of the Securities and Exchange Commission that permit the Company to provide only managements report in this annual report.

Changes in
Internal Control Over Financial Reporting

There were no changes in the Companys internal control over financial reporting in the quarter ended
December 31, 2008 that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



|ITEM 9B. | OTHER INFORMATION
|-------- | -----------------

None.



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PART III

Explanatory Note

The Company will
file a definitive proxy statement for its 2009 Annual Meeting of Shareholders pursuant to Regulation 14A (the 2009 Proxy Statement) within 120 days after the end of the fiscal year covered by this annual report on Form 10-K (i.e., by
April 30, 2009); accordingly, certain information that is required under Part III of this annual report on Form 10-K is omitted from this report and will be included in the Proxy Statement, and is incorporated herein by reference to the
Proxy Statement.



|ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|-------- | ------------------------------------------------------

The information concerning our Directors, Executive Officers and Corporate Governance, as well as any other information required by this Item 10, shall be included in the 2009 Proxy Statement and is hereby incorporated herein by
reference.

Code of Ethics

The Company
has adopted a Code of Ethics that applies to its Chief Executive Officer and Chief Financial Officer. The Code of Ethics summarizes the legal, ethical and regulatory standards that such individuals must follow and is a reminder to all of the
Companys directors and executive officers of the seriousness of that commitment. As adopted, the Code of Ethics sets forth written standards that are designed, among other things, to deter wrongdoing and to promote:



| |  |  | honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | compliance with applicable governmental laws, rules and regulations;
| | - |  | --------------------------------------------------------------------



| |  |  | the prompt internal reporting of violations of the Code of Ethics to an appropriate person or persons identified in the Code of Ethics; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | accountability for adherence to the Code of Ethics.
| | - |  | ---------------------------------------------------

A copy of the Companys Code of Ethics may be obtained by any person, without charge, by accessing the Companys web site at: http://www.heritagebankva.com/CorporateNews/CodeOfEthics.aspx.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------

The information concerning
Executive Compensation required by this Item 11 shall be included in the 2009 Proxy Statement and is hereby incorporated herein by reference.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------

The information concerning Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters required by this Item 12
shall be included in the 2009 Proxy Statement and is hereby incorporated herein by reference.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|-------- | -------------------------------------------------------------------------

The information concerning Certain Relationships and Related Transactions, and Director Independence, required by this Item 13 shall be included in the 2009 Proxy Statement and is hereby incorporated herein by
reference.



|ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES
|-------- | --------------------------------------

The
information concerning Principal Accounting Fees and Services required by this Item 14 shall be included in the 2009 Proxy Statement and is hereby incorporated herein by reference.



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PART IV



|ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES
|-------- | ---------------------------------------

The
financial statements and financial statement schedules for Heritage Bankshares, Inc. are included under Item 8 of this Annual Report on Form 10-K.



|          |  |                                                                                                                                                                                                                                                                   
|--------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits: |  |                                                                                                                                                                                                                                                                   
|3.1       |  | Articles of Incorporation. (Incorporated herein by reference to the Companys Form 10-K for 1983 filed March 29, 1984.)                                                                                                                                           
|          | 
|3.2       |  | Articles of Amendment to Articles of Incorporation filed on December 31, 1985. (Incorporated herein by reference to the Companys Form S-8 filed January 26, 2004.)                                                                                               
|          | 
|3.3       |  | Articles of Amendment to Articles of Incorporation filed on August 9, 1990. (Incorporated herein by reference to the Companys Form S-8 filed January 26, 2004.)                                                                                                  
|          | 
|3.4       |  | Articles of Amendment to Articles of Incorporation filed on August 12, 1992. (Incorporated herein by reference to the Companys Form S-8 filed January 26, 2004.)                                                                                                 
|          | 
|*10.1     |  | 1987 Stock Option Plan. (Incorporated herein by reference to the Companys Form S-8 filed January 26, 2004.)                                                                                                                                                      
|          | 
|*10.3     |  | Amendment to 1987 Employees Stock Ownership Plan, which provided for certain changes required by IRS regulations including changes in participant vesting schedules. (Incorporated
herein by reference to the Companys Form 10-K for 1990 filed March 30, 1991.)
|          | 
|*10.4     |  | Employees Stock Ownership Plan. (Incorporated herein by reference to the Companys Form 10-K for 1997 filed March 30, 1998.)                                                                                                                                      
|          | 
|*10.5     |  | 1999 Stock Option Plan for Employees. (Incorporated herein by reference to the Companys Form S-8 filed January 26, 2004.)                                                                                                                                        
|          | 
|*10.6     |  | Amendment to the 1999 Stock Option Plan. (Incorporated herein by reference to the Companys Form S-8 filed January 26, 2004.)                                                                                                                                     
|          | 
|*10.7     |  | Employment Agreement of Michael S. Ives. (Incorporated herein by reference to the Companys Form 8-K filed on February 11, 2005.)                                                                                                                                 
|          | 
|10.8      |  | Amended and Restated Bylaws of Heritage Bankshares, Inc. (Incorporated herein by reference to the Companys Form 8-K filed on May 3, 2005.)                                                                                                                       
|          | 
|*10.9     |  | Employment Agreement of John O. Guthrie. (Incorporated herein by reference to the Companys Form 10-K filed on June 9, 2006.)                                                                                                                                     
|          | 
|*10.10    |  | Amendment to Employment Agreement of Michael S. Ives. (Incorporated herein by reference to the Companys Form 8-K filed on July 5, 2006.)                                                                                                                         
|          | 
|10.11     |  | Amendment to Bylaws of Heritage Bankshares, Inc. (Incorporated herein by reference to the Companys Form 8-K filed on August 1, 2006.)                                                                                                                            
|          | 
|*10.12    |  | Limited Alternative Stock Appreciation Right Agreement of Michael S. Ives. (Incorporated herein by reference to the Companys Form 8-K filed on August 28, 2006.)                                                                                                 
|          | 
|*10.15    |  | Amendment to Employment Agreement of Michael S. Ives. (Incorporated herein by reference to the Companys Form 8-K filed on December 26, 2006.)                                                                                                                    



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|          |  |                                                                                                                                                                                                                
|--------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits: |  |                                                                                                                                                                                                                
|*10.16    |  | Heritage 2006 Equity Incentive Plan. (Incorporated herein by reference to the Companys Form 8-K filed on December 29, 2006.)                                                                                  
|          | 
|10.17     |  | Amended and Restated Deed of Lease between Heritage Bank and Dominion Enterprises dated November 21, 2006. (Incorporated herein by reference to the Companys Form 10-K filed on March 30,
2007.)              
|          | 
|10.18     |  | Construction Contract between Heritage Bankshares, Inc. and Meredith Construction Company, Inc. dated October 25, 2007. (Incorporated herein by reference to the Companys Form 8-K filed on
October 26, 2007.)
|          | 
|*10.19    |  | Amendment to Employment Agreement of Michael S. Ives. (Incorporated herein by reference to the Companys Form 8-K filed on March 5, 2009.)                                                                     
|          | 
|*10.20    |  | Amended Employment Agreement of Sharon Curling Lessard.                                                                                                                                                        
|          | 
|*10.21    |  | Amended Employment Agreement of Leigh C. Keogh.                                                                                                                                                                
|          | 
|21.1      |  | Subsidiaries of the Registrant.                                                                                                                                                                                
|          | 
|23.2      |  | Consent of Elliott Davis LLC.                                                                                                                                                                                  
|          | 
|31.1      |  | Certification of Principal Executive Officer, Pursuant to Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                   
|          | 
|31.2      |  | Certification of Principal Financial Officer, Pursuant to Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                   
|          | 
|32.1      |  | Certification of Principal Executive Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                        
|          | 
|32.2      |  | Certification of Principal Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                        



|* | Indicates management contract or compensatory plan or arrangement.
|- | ------------------------------------------------------------------



72



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##### Table of Contents

SIGNATURES

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



|                     |  |                                      
|-------------------- |  | -------------------------------------
|                     |  | HERITAGE BANKSHARES, INC.            
|                     |  | (Registrant)                         
|                     | 
|Date: March 25, 2009 |  | /s/ Michael S. Ives                  
|                     |  | Michael S. Ives,                     
|                     |  | President and Chief Executive Officer

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



|               |  |                                                 
|-------------- |  | ------------------------------------------------
|March 25, 2009 |  | /s/ Michael S. Ives                             
|               |  | Michael S. Ives,                                
|               |  | President and Chief Executive Officer           
|               |  | (Principal Executive Officer) and Director      
|               | 
|March 25, 2009 |  | /s/ John O. Guthrie                             
|               |  | John O. Guthrie,                                
|               |  | Chief Financial Officer                         
|               |  | (Principal Financial and Accounting Officer)    
|               | 
|March 25, 2009 |  | /s/ Peter M. Meredith, Jr.                      
|               |  | Peter M. Meredith, Jr.,                         
|               |  | Chairman of the Board of Directors and Director 
|               | 
|March 25, 2009 |  | /s/ Stephen A. Johnsen                          
|               |  | Stephen A. Johnsen,                             
|               |  | Secretary of the Board of Directors and Director
|               | 
|March 25, 2009 |  | /s/ Lisa F. Chandler                            
|               |  | Lisa F. Chandler,                               
|               |  | Director                                        
|               | 
|March 25, 2009 |  | /s/ James A. Cummings                           
|               |  | James A. Cummings,                              
|               |  | Director                                        



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|               |  |                           
|-------------- |  | --------------------------
|March 25, 2009 |  | /s/ Wendell C. Franklin   
|               |  | Wendell C. Franklin,      
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ F. Dudley Fulton      
|               |  | F. Dudley Fulton,         
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ Thomas G. Johnson, III
|               |  | Thomas G. Johnson, III,   
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ David L. Kaufman      
|               |  | David L. Kaufman,         
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ Charles R. Malbon, Jr.
|               |  | Charles R. Malbon, Jr.,   
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ L. Allan Parrott      
|               |  | L. Allan Parrott,         
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ H. Donald Perry       
|               |  | H. Donald Perry,          
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ Ross C. Reeves        
|               |  | Ross C. Reeves,           
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ Harvey W. Roberts, III
|               |  | Harvey W. Roberts, III,   
|               |  | Director                  
|               | 
|March 25, 2009 |  | /s/ Barbara Zoby          
|               |  | Barbara Zoby,             
|               |  | Director                  



74