SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                                     10-KSB
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
     For the fiscal year ended December 31, 1998 Commission File No. 0-11255


                            Heritage Bankshares, Inc.


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


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


Registrant's telephone number, including area code:         (757) 523-2600



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

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

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

                  Yes   X                            No

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

State the aggregate market value of the voting stock held by  non-affiliates  of
the registrant as of March 22, 1999: $10,763,888*

Indicate the number of shares outstanding of each of the registrant's classes of
common stock as of March 22, 1999:

         Common Stock,     $5 Par Value - 803,150
-----------------------

o    In  calculating  the aggregate  market value,  we have used the most recent
     sales price of Common Stock known to the Company, which is $16.00 per share
     and voting stock held by non-affiliates of the registrant at March 22, 1999
     of 672,743 shares.


<PAGE>

Part I

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

Item 1.  BUSINESS

GENERAL

         Heritage  Bankshares,  Inc. (the "Company") was incorporated  under the
laws  of  the  Commonwealth  of  Virginia  in  1983.  In  August  of  1992,  two
wholly-owned subsidiaries, Princess Anne Bank and The Heritage Bank-McLean, were
spun off, and the Company has operated as a one bank holding  company since that
time. The principal executive office of the Company is located at 200 East Plume
Street, Norfolk, Virginia. Currently, the Company does not transact any material
business  other than  through its  wholly-owned  banking  subsidiary.  The total
consolidated assets of the Company on December 31, 1998 were $87.3 million.

THE BANK

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

         Heritage  Bank & Trust  is a state  banking  corporation.  The Bank was
incorporated  as a Virginia  corporation  on September  19, 1975,  and commenced
business at 841 North Military Highway in Norfolk, Virginia on February 7, 1977.
On December 31, 1998, the Bank had assets of  $87.1million,  with loans of $56.6
million and deposits of $77.5 million.

IBV REAL ESTATE HOLDINGS, INC.

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


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

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



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<PAGE>

COMPETITION

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

EMPLOYEES

         The  Company  and the Bank have 42  employees.  Of this  total,  35 are
full-time and 7 are part-time. Management considers its employee relations to be
excellent.

REGULATION AND SUPERVISION

THE BANK

Regulatory Matters

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

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

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

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

         The  Federal  Reserve  and the  Bureau  of  Financial  Institutions  of
Virginia requires the Bank to maintain certain minimum capital ratios.  The Bank
and the Company are  required to maintain  minimum  risk-based  capital to asset
ratios, as defined by the regulations, of 4.00% for the Tier 1 capital ratio and
8.00% for the Total (Tier 1 plus Tier 2) capital ratio. Additionally, a leverage


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<PAGE>

capital ratio, defined as Tier 1 capital divided by average assets, must also be
maintained by financial  institutions.  For financial institutions with the best
regulatory  rating,  generally,  a  minimum  leverage  ratio  of  5.00%  must be
maintained.  The  Bank  and the  Company  met  the  minimum  risk-based  capital
requirements  at December 31, 1998.  See Note 15 of the  Consolidated  Financial
Statements for additional information on regulatory capital matters.

Mergers and Acquisitions

         The Bank Holding  Company Act formerly  prohibited the Federal  Reserve
from approving an application from a bank holding company to acquire shares of a
bank located outside the state in which the operations of the holding  company's
banking subsidiaries were principally conducted,  unless such an acquisition was
specifically  authorized  by statute of the state in which the bank whose shares
were to be acquired was located. The restriction on interstate  acquisitions was
abolished  effective  September 29, 1997,  and bank holding  companies  from any
state may now  acquire  banks and bank  holding  companies  located in any other
state.  Banks may branch  across state lines  effective  June 1, 1998,  provided
certain  conditions are met,  including that applicable state law must expressly
permit such interstate  branching.  Under Virginia law,  effective July 1, 1995,
Virginia banks can branch across state lines in those states with which Virginia
has reciprocal  agreements.  Although this will have a significant impact on the
banking industry, it is not possible to determine, with any degree of certainty,
its impact on individual institutions.

Deposit Insurance

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

         The FDIC has  implemented  a risk-based  deposit  insurance  assessment
system  under  which the  assessment  rate for an insured  institution  may vary
according to  regulatory  capital  levels of the  institution  and other factors
(including  supervisory  evaluations).  Effective  January 1,  1997,  depository
institutions insured by the Bank Insurance Fund ("BIF"),  ranked in the top risk
classification  category  of well  capitalized,  are  required  to pay  only the
statutory minimum assessment of $2,000 annually for deposit insurance, while all
other banks are required to pay premiums  ranging from .03% to .30% annually per
$100  of  domestic  deposits.   These  rate  schedules  are  subject  to  future
adjustments by the FDIC. In addition,  as more fully  disclosed in the following
paragraph,  the FDIC has authority to impose  special  assessments  from time to
time.

         The Deposit  Insurance Funds Act of 1997 ( the "Funds Act") was enacted
on September 30, 1997. Among other provisions,  the Funds Act: (1) requires that
certain  depository  institutions pay a one-time special  assessment (65.7 cents
per $100 of  SAIF-assessable  deposits)  to the FDIC to  capitalize  the Savings
Association Insurance Fund ("SAIF") at its statutorily required reserve ratio of


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<PAGE>

1.25% of insurable  deposits;  (2) exempts certain depository  institutions with
SAIF assessable deposits that meet any of several specified criteria from paying
the special  assessment,  (3) authorizes the Financing  Corporation  ("FICO") to
impose periodic assessments on depository  institutions that are members of BIF,
in addition to institutions that are members of the SAIF, in order to spread the
cost of the interest payments on the outstanding FICO bonds over a larger number
of  institutions.  Until this change in the law, only  SAIF-member  institutions
bore the cost of funding these interest payments.  FICO assessment rates for the
first  semiannual  period  of 1998 were set at 1.30%  (per  $100)  annually  for
BIF-assessable  deposits  and 6.48%  (per  $100)  annually  for  SAIF-assessable
deposits. These rates may be adjusted quarterly to reflect changes in assessment
bases for the BIF and the SAIF. By law, the FICO rate on BIF-assessable deposits
must be  one-fifth  the rate on SAIF  assessable  deposits  until the  insurance
fiends  are  merged or until  January 1, 2000,  whichever  occurs  first.  These
changes in FDIC  insurance  are not  expected  to have a material  effect on the
Bank's financial condition and results of operation for the foreseeable future.

Regulations

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

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

         On October 1, 1997, the banking agencies issued new guidelines amending
the Interagency Guidelines  Establishing Standards for Safety and Soundness (the
"Safety  and  Soundness  Guidelines")  to include  asset  quality  and  earnings
standards.  The Safety and  Soundness  Guidelines  were adopted  pursuant to the
requirements of Section 39 of the Federal Deposit  Insurance Act. The Safety and
Soundness  Guidelines require financial  institutions to identify problem assets
and estimate inherent losses. In order to comply with these Safety and Soundness


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<PAGE>

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

         On December  20, 1997 the FDIC Board of  Directors  adopted the FFIEC's
updated  statement of policy  entitled  Uniform  Financial  Institutions  Rating
System  ("UFIRS").  The  updated  UFIRS  replaces  the  previous  rating  system
established in the 1979 statement of policy,  and is effective  January 1, 1998.
Under the existing  UFIRS,  each  financial  institution is assigned a composite
rating based on an  evaluation  and rating of five  essential  components  of an
institution's  financial condition and operations.  The five component areas are
Capital adequacy, Asset quality,  Management,  Earnings and Liquidity ("CAMEL").
The updated UFIRS includes the addition of a sixth  component for Sensitivity to
market risk  ("CAMELS").  The new sixth component  addresses the degree to which
changes in interest rates,  foreign  exchange rates,  commodity prices or equity
prices can adversely affect a financial  institution's  earnings or capital. The
new  component  focuses on an  institution's  ability to monitor  and manage its
market risk,  and will provide an  institution's  management  with a clearer and
more focused indication of supervisory  concerns in this area. The Bank does not
believe that this statement of policy will  materially  effect its operations in
the foreseeable future.





THE COMPANY

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



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<PAGE>

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

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

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

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

Federal Securities Laws

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



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<PAGE>

FEDERAL AND STATE TAXATION

General

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

         Under the  applicable  statutes of  limitation,  the Company's  federal
income tax returns for 1994 through 1998 are open to examination by the Internal
Revenue Service (the "Service"). The Company is unaware, however, of any current
or pending Service  examinations of the Company's  returns for any of those open
years.

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

Corporate Minimum Tax

         The Company  and its  subsidiaries  could be subject to an  alternative
minimum  tax  ("AMT")  which  is  imposed  to the  extent  that it  exceeds  the
consolidated  group's regular tax liability for a year. The alternative  minimum
tax generally  will apply at a rate of 20% to a base of regular  taxable  income
plus certain tax  preferences  and  adjustments  ("alternative  minimum  taxable
income" or "AMTI"), less an exemption amount.  Currently no more than 90% of the
AMTI may be offset by net operating  losses (as determined  for AMTI  purposes).
Payment of the AMT may be used as a credit  against a portion of the regular tax
liabilities in future years.  The Code provisions  relating to the AMT also: (i)
treat as a preference item interest on certain tax exempt private activity bonds
issued on or after August 8, 1986; (ii) include in AMTI (for tax years beginning
after  1989) an  amount  equal  to 75% of the  amount  by which a  corporation's
adjusted  current  earnings exceed its AMTI  (determined  without regard to this
preference and before  reduction for the alternative tax net operating  losses.)
In addition,  an environmental tax of 0.12% of the excess, if any, of AMTI (with
certain  modifications)  over $2 million is imposed on corporations,  whether or
not an AMT is paid. The consolidated group was not subject to the AMT in 1998.

Corporate Dividends Received Deduction

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



                                       8
<PAGE>

State and Local Taxation

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

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

Item 2. PROPERTIES

         The  Bank  owns  four of its  banking  locations,  841  North  Military
Highway,  200 East  Plume  Street,  4815  Colley  Avenue and 735 East Ocean View
Avenue (opening  spring 1999) in Norfolk,  Virginia.  Management  believes these
locations are in excellent  condition.  A fifth banking  location and the bank's
operations  center are  located at 1450 South  Military  Highway in  Chesapeake,
Virginia.  See "IBV  Real  Estate  Holdings,  Inc."  under  Item 1 and  "Certain
Relationships and Related Transactions" under Item 12.

Item 3. LEGAL PROCEEDINGS

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

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

         No matters were  submitted to a vote of securities  holders  during the
fourth quarter of 1998.



                                       9
<PAGE>


PART II

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


         The  Company's  common stock is listed on the OTC Bulletin  Board under
the  symbol  HBKS.  At March 22,  1999,  there are 1,216  record  holders of the
803,150  outstanding  shares of common  stock.  As of March 22,  1999,  the most
recent sales price of common stock known to the Company is $16.00 per share.

         The following table sets forth the closing high and low sales price for
the common stock by calendar  quarters for the past two years as reported to the
Company by Scott & Stringfellow Inc.

Calendar Quarter

                             HIGH            LOW
        1998
Fourth Quarter              $16.00          $13.50
Third Quarter                18.37           14.00
Second Quarter               18.75           17.75
First Quarter                19.00           17.50

        1997
Fourth Quarter              $18.00          $17.13
Third Quarter                13.75           13.75
Second Quarter               13.25           13.25
First Quarter                11.63           11.25


         The  Company's  Board  of  Directors   determines  whether  to  declare
dividends  and the amount of such  dividends.  Determinations  by the Board take
into account the Company's financial condition,  results of operations,  capital
requirements,  general  business  conditions  and other  relevant  factors.  The
Company's  principal source of funds for cash dividends is the dividends paid to
the Company by the Bank. The Company  declared and paid annual dividends of $.17
and $.14 per share in 1998 and 1997,  respectively.  Regulatory  restrictions on
the payment of dividends  by the Bank to the Company are  disclosed in Note 3 to
the   Consolidated   Financial   Statements   for   additional   information  on
restrictions.


                                       10
<PAGE>

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

         The following sets forth certain  selected  financial data with respect
to the Company.  The data presented  below for the years ended December 31, 1998
and 1997,  respectively,  should be read in  conjunction  with the  Consolidated
Financial  Statements  and notes  thereto,  which have been audited by Goodman &
Company, L.L.P. independent accountants.  (The Consolidated Financial Statements
and notes  thereto  for the years  ended  December  31,  1998 and 1997 are filed
herewith).  This data should also be read in conjunction with the discussion and
analysis that follows.

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


                                                   1998               1997

FOR THE YEAR
Interest income                                   $6,567             $6,185
Interest expense                                   3,051              2,909
Net interest income                                3,516              3,277
Provision for loan losses                             66                 88
Noninterest income                                   355                287
Noninterest expense                                2,322              2,056
Income taxes                                         421                440
Net income                                         1,063                980

AT YEAR END
Assets                                           $87,291            $83,002
Loans, net                                        55,671             51,242
Federal funds sold                                 3,457              1,697
Securities                                        19,437             22,595
Deposits                                          77,283             72,797
Stockholders' equity                               8,079              7,081

AVERAGE BALANCES
Assets                                           $86,510            $81,376
Loans, net                                        52,679             47,322
Federal funds sold                                 6,108              6,122
Securities                                        20,877             22,490
Deposits                                          75,903             71,322
Stockholders' equity                               7,618              6,607

PER SHARE DATA
Basic earnings per common share                    $1.33              $1.24
Diluted earnings per common share                  $1.25              $1.17
Cash dividends declared                                      
                                                    0.17               0.14
Book value at year end                             10.08               8.91
Shares outstanding at year end                   801,250            795,050
Weighted average shares                          799,496            790,450
Diluted average common shares outstanding        851,391            836,920

RATIOS
Return on average assets                           1.23%              1.20%
Return on average equity                          13.95%             14.83%
Dividend payout ratio                             12.78%             11.29%
Average equity to average assets                   8.81%              8.12%
Allowance to year end loans                        1.58%              1.71%
Net loans charged-off to average loans             0.11%              0.09%


                                       11
<PAGE>


FINANCIAL OVERVIEW:

         In 1998,  net income for  Heritage  Bankshares,  Inc.  (the  "Company")
totaled $1.06 million compared to $980 thousand earned in 1997.  Heritage Bank &
Trust's (the "Bank") net income was $1.06 million and net holding company income
was $3 thousand.  In 1997,  Heritage Bank & Trust's net income was $972 thousand
and net holding company income was $8 thousand.  Basic earnings per common share
in 1998 was $1.33 compared to $1.24 in 1997.  Diluted  earnings per common share
was $1.25 and 1.17 at December  31, 1998 and 1997,  respectively.  Increases  in
both net income and earnings per share during 1998  primarily  reflect growth in
loans as well as continued expense control and efficient capital management.

          Net  interest  income  on a taxable  equivalent  basis  totaled  $3.59
million in 1998 and $3.31 million in 1997. The net interest  margin for 1998 was
4.46% compared with 4.32% in 1997. This modest increase was primarily due to the
increase  in  gross  loans  of  $5.37  million  and  the  relatively  flat  rate
environment of 1998.

         The 1998  provision  for loan losses was $66  thousand  compared to the
1997  provision of $88 thousand.  The allowance for loan losses of $895 thousand
at year-end  1998 and $889  thousand in 1997  reflect an  allowance  to year-end
loans ratio of 1.58% and 1.71%, respectively.

         Non-interest  income  increased $67 thousand to $355 thousand.  Service
charges on deposit accounts  increased $29 thousand primarily due to an increase
in the number of  accounts.  Fees  related to merchant  credit  card  processing
increased $5 thousand and fees related to credit and debit cards  increased  $18
thousand.   Both  of  these  increases  were  due  to  increased  volume.  Also,
approximately  $7 thousand in fees were  generated from the Colley Avenue office
during its first full year of operations.

         Non-interest  expense  totaled  $2.32  million for 1998,  compared with
$2.06 million in 1997.  Expense levels reflect the addition of the Colley Avenue
branch. A refund of $45 thousand for Franchise Taxes previously paid by the bank
was  recorded in 1998.  The refund  represents  a portion of an  enterprise-zone
credit for the Colley Avenue branch location.  The ratio of non-interest expense
to average assets was 2.68% in 1998 and 2.74% in 1997.  These ratios reflect the
Company's successful cost containment efforts.

               Total loans at December 31, 1998 were $56.6 million compared with
$52.0 million at December 31, 1997. The increase is  attributable to strong loan
growth in commercial loans and real estate loans each of which increased over $2
million in 1998.

         Total deposits  increased $4.49 million primarily due to the opening of
the  Colley   Avenue   branch  and  to  the   expansion  of  existing   customer
relationships.

LIQUIDITY:

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

               The Company's  Consolidated Statement of Cash Flows, found in the
Consolidated Financial Statements,  provides information as to cash provided and
used from operating,  investing and financing activities.  At December 31, 1998,
cash and cash  equivalents  available  to meet  immediate  liquidity  needs  and
reserve requirements were $7.06 million. The Bank also has borrowing capacity of
$5.9 million,  as a member of the Federal Home Loan Bank System.  As of December
31, 1998, no amounts have been drawn on this line of credit.



                                       12
<PAGE>

         The Company's cash and cash  equivalents  increased  $1.35 million from
$5.72  million at December 31, 1997.  This  increase  was  primarily  due to the
increase  in  deposits  of  $4.49  million  combined  with the  decrease  in the
investment portfolio of $3.16 million.  These increases were partially offset by
the increase in gross loans of $5.37 million and a decrease in  securities  sold
under agreements to repurchase of $964 thousand.

PARENT HOLDING COMPANY LIQUIDITY:

              The    parent    holding    company    incurred    expenses    for
stockholder-related activities, stock transfer and other functions necessary for
the  administration  of the Company.  See Note 3 of the  Consolidated  Financial
Statements for the parent company's Cash Flow Statement for further  information
on cash  provided or used by the parent for  operating,  financing and investing
activities.  In addition,  certain  restrictions  on cash  dividends,  loans and
advances are imposed by regulation of the Bank, which are also disclosed in Note
3.


Table 2: Selected Liquidity Statistics
For the year ended December 31,

                                               1998                      1997
                                                    (Dollars in thousands)

Available short-term assets (1)               $9,954                    $7,272
Certificates of deposit $100,000 and over     10,406                     8,128
                                              ------                     -----
Net available short-term assets               ($452)                    ($856)

Ratio of available short-term assets to                            
certificates $100,000 and over                   96%                       89%  

Ratio of loans to deposits                       73%                       72%  

Ratio of certificates $100,000 and over to
   total assets                                  12%                       10%

(1)  As of December 31, 1998,  available short-term assets include federal funds
     sold of $3,457,000 and held -to-maturity and available-for-sale  securities
     maturing  within one year of  $750,000  and  $5,747,000,  respectively.  At
     December 31, 1997,  available short-term assets included federal funds sold
     of  $1,697,000  and  held-to-maturity  and  available-for-sale   securities
     maturing within one year of $1,019,000 and $4,556,000


CAPITAL:

         Stockholders' equity at December 31, 1998 was $8.08 million compared to
$7.08 million at the end of the prior year.  Book value per share increased from
$8.91 at December 31, 1997 to $10.08 at December 31, 1998.

               Table  3  provides  information  on  the  Company's   risk-based,
leverage  and  capital  ratios at  December  31,  1998 and 1997.  The Company is
considered  well-capitalized  and in  compliance  with all  relevant  regulatory
capital requirements.  See Note 15 of the Consolidated  Financial Statements for
additional  information  with  respect to  compliance  with  regulatory  capital
requirements.



                                       13
<PAGE>

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

                                               1998                     1997
                                                 (Dollars in thousands)
Risk-based capital:                      
Tier I Capital
   Stockholders' equity                       $7,991                   $7,024
Tier II Capital
    Allowance for loan losses (limited)          743                      639
                                                 ---                      ---
Total                                         $8,734                   $7,663

Risk adjusted assets                         $59,277                  $50,848

Risk-based capital ratios:
   Tier I                                      13.48%                   13.81%
   Total                                       14.73%                   15.07%

Leverage ratio                                  9.24%                    8.63%
Primary capital ratio                          10.18%                    9.50%

RATE SENSITIVITY:

               At December  31, 1998,  the Company  had, on a cumulative  basis,
$10.71  million more in liabilities  subject to re-pricing  within one year than
assets.  Table 4 provides an interest  sensitivity  analysis as of December  31,
1998.


                                       14
<PAGE>
<TABLE>
 Table 4:  Interest Sensitivity Analysis
 December 31, 1998
<CAPTION>


                                      Within       Over 3   Over 1 Yr  Over 3 Yr  Over 5 Yr   Total               
                                    1 through 3   through     through    through    through  through     Over
                                      months     12 months     3 yrs      5 yrs     10 yrs    10 yrs   10 yrs(4)     Total
                                    ----------------------------------------------------------------------------------------
<S>                                  <C>          <C>        <C>        <C>         <C>       <C>        <C>        <C>   
Earning assets: (1)
  Federal funds                      $3,457       $    -     $   -      $    -      $   -     $3,457     $   -      $3,457
  Investment securities (2)           2,728        5,604     8,573       1,421        193     18,519       784      19,303
  Loans                              19,572        3,346     6,182       7,477      6,697     43,274    13,292      56,566
                                    ----------------------------------------------------------------------------------------
Total Earning Assets                $25,757       $8,950   $14,755      $8,898     $6,890    $65,250   $14,076     $79,326
                                    ----------------------------------------------------------------------------------------

Interest and non-interest bearing                                                                                 
liabilities: (1)

  Commercial DDA (3)                $ 6,070       $    -    $3,642      $2,428      $   -    $12,140     $   -     $12,140
   Personal DDA (3)                       -            -     1,429         476        476      2,381         -       2,381
  TT&L Note                              63            -         -           -          -         63         -          63
  Savings(3)                              -            -     2,593         864        864      4,321         -       4,321
  Money Market(3)                         -        2,866     2,866          -           -      5,732         -       5,732
  NOW(3)                                  -            -     5,950       1,983      1,983      9,916         -       9,916
  Certificates                       10,382       25,056     3,966       3,363         25     42,792         -      42,792
  Repurchase Agreements                 981            -         -           -          -        981         -         981
                                    ----------------------------------------------------------------------------------------
Total Interest and non interest                                                                                   
  bearing liabilities               $17,496      $27,922   $20,446      $9,114     $3,348    $78,326     $   -     $78,326
                                    ----------------------------------------------------------------------------------------


Interest sensitivity                  8,261      (18,972)   (5,691)       (216)     3,542    (13,076)   14,076       1,000
gap

Cumulative gap                        8,261      (10,711)  (16,402)    (16,618)   (13,076)

Ratio interest sensitive assets
to interest-sensitive liabilities      1.47         0.32      0.72        0.98       2.06       0.83

Ratio of cumulative gap to
 total earning assets                 10.41%      -13.50%   -20.68%     -20.95%    -16.48%
</TABLE>

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

NET INTEREST INCOME:

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

            Table 5 presents  the  components  of net interest  income.  Table 6
allocates changes in volume and rate on net interest earnings.


                                       15
<PAGE>
<TABLE>
Table 5:  Components of Net Interest Income
For the years ended December 31,                                          1998                                  1997
 (Dollars in thousands)
                                                         Average                Average          Average              Average
                                                         Balance(1)   Interest     yield/rate    Balance(1) Interest yield/rate
<S>                                                      <C>          <C>            <C>         <C>         <C>      <C>  
Interest earning assets: (taxable equivalent basis (2))
Loans (net of unearned discount (3))                     $  53,597    $  5,030       9.33%       $ 48,166    $ 4,531  9.41%
Investment securities-taxable (4)                           19,868       1,212       6.10%         21,818      1,330  6.10%
Investment securities- non-taxable (1) (4)                   1,009          70       6.93%            672         31  4.61%
Federal Funds                                                6,108         332       5.44%          6,122        334  5.46%
                                                         ---------    --------       ----        --------    -------  ----
Total Interest earning assets                            $  80,582    $  6,643       8.21%       $ 76,778    $ 6,226  8.11%
                                                         ---------    --------       ----        --------    -------  ----
Noninterest earning assets:                                         
Cash and due from banks                                      2,919                                  2,644
Allowance for loan losses                                                                      
                                                             (919)                                  (843)
Other real estate owned                                        429                                    442
Premises and equipment                                       1,541                                    831
Other assets                                                 1,958                                  1,524
                                                         ---------                               -------- 
Total Assets                                             $  86,510                               $ 81,376
                                                         =========                               ========

Liabilities and stockholders' equity 
 Interest bearing liabilities:
Money Market and NOW accounts                            $  12,988     $   341      2.63%        $ 12,849     $  341  2.65%
Savings Deposits                                             4,609         147      3.19%           5,050        176  3.49%
Savings Certificates                                        36,572       2,002      5.47%          34,599      1,937  5.60%
Large denomination certificates                              8,436         474      5.62%           6,482        379  5.85%
Securities sold under agreements to repurchase               2,081          84      4.04%           1,810         73  4.03%
Short-term borrowings                                           70           3      4.29%              75          3  4.00%
                                                         ---------    --------       ----        --------    -------  ----
Total interest bearing liabilities                       $  64,756    $  3,051       4.71%       $ 60,865    $ 2,909  4.78%
                                                         ---------    --------       ----        --------    -------  ----

Noninterest bearing liabilities:
Demand deposits                                             13,297                                 12,341
Other                                                                                               1,563
                                                         ---------                               -------- 
                                                              839
 Total Liabilities                                          78,892                                 74,769
Stockholders' equity                                         7,618                                  6,607
                                                         ---------                               -------- 

  Total liabilities and stockholders'
      equity                                             $  86,510                               $ 81,376
                                                         =========                               ========

Net interest earnings                                                 $  3,592                               $ 3,317
                                                                      ========                               =======

Net interest yield  margin on average interest earning
 assets (taxable equivalent basis)                                                   4.46%                            4.32%
                                                                                     ====                             ====

Less tax equivalent adjustment                                        $    (76)                              $   (41)
                                                                      --------                               -------
Net interest income                                                   $  3,516                               $ 3,276
                                                                      ========                               =======

 Net interest spread (taxable
    equivalent basis)                                                                3.53%                            3.33%
                                                                                     ====                            ====
</TABLE>
(1)  Daily average  balances are  calculated  using the aggregate  daily average
     balances on a monthly basis.
(2)  Tax equivalent  adjustments  (using 34% federal income tax rates) have been
     made in calculating the yields on tax-free loans and investments.  Virginia
     banks are exempt from state income tax.
(3)  For the purposes of these computations,  non-accruing loans are included in
     the daily average loan amounts outstanding.
(4)  The yield/rate of the investment securities is computed using the amortized
     cost basis.


                                       16
<PAGE>
<TABLE>
Table 6: Effect of Changes in Volume and Rate on Net  Interest  Earnings For the
years ended December 31, (1) (Dollars in thousands)
<CAPTION>
                                               1998 / 1997                                     1997 / 1996
                                                                    (Dollars in thousands)
                                            Increase (Decrease)                             Increase (Decrease)
                                           Due to Change In (1):                            Due to Change In (1):

                                      Volume       Rate        Total                    Volume      Rate        Total
<S>                                    <C>         <C>          <C>                      <C>        <C>          <C> 
Interest income (2):
  Loans                                $513        ($14)        $499                     $412        ($26)       $386
  Taxable securities                   (119)          1         (118)                     454          23         477
  Non-taxable securities                 19          20           39                       23          (2)         21
  Federal funds sold                     (1)         (1)          (2)                    (136)         14        (122)
                                       ----         ----        ----                     ----        ----        ----
    Total interest income              $412         ($6)        $418                     $753          $9        $762
                                       ----         ----        ----                     ----        ----        ----

Interest expense:
  Money Market and NOW
    accounts                              3          (3)          (0)                     (38)        (28)        (66)
  Savings                               (15)        (14)         (29)                      11           7          18
  Certificates                          110         (45)          65                      365         (27)        338
  Certificates of $100,000
    or more                             109         (14)          95                        2          49          51
  Securities sold under
   agreements to repurchase              11           -           11                       72           -          72
  Short-term borrowings                   -           -            -                        -           -           -
                                       ----         ----        ----                     ----        ----        ----
    Total interest expense              218         (76)         142                      412           1         413
                                       ----         ----        ----                     ----        ----        ----

Net change in interest
  earnings                         $   194      $    82      $   276                   $  341      $    8     $   349
                                   =======      =======      =======                   ======      ======     =======
</TABLE>
(1)  The change in interest  due to both rate and volume has been  allocated  to
     volume and rate changes in proportion to the  relationship  of the absolute
     dollar of the changes in each.
(2)  Interest income includes taxable equivalent  adjustments of $76,000 in 1998
     and $41,000 in 1997, which are used to adjust interest on tax exempt assets
     to a fully taxable basis.

ASSET QUALITY

PROVISION AND ALLOWANCE FOR LOAN LOSSES:

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

         In 1998, the provision for loan losses was $66 thousand compared to the
$88 thousand  provision for loan losses in 1997.  Net loans  charged-off in 1998
were $60 thousand compared to $42 thousand in 1997.



                                       17
<PAGE>
<TABLE>

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

Table 7:  Summary of the Allowance For Loan Losses
                Non-performing Assets and Past Due Loans
                and Selected Loan Loss Statistics

For The Years Ended
December 31,                                                        1998               1997
(Dollars in Thousands)                                       
<S>                                                              <C>                <C>    
Allowance for Loan Losses:
Balance, December 31                                             $   889            $   843
Charge-offs:
   Commercial                                                          0                  0
   Real estate                                                        41                  2
   Consumer                                                           40                 47
                                                                   -----              -----
      Total loans charged-off                                         81                 49
                                                                   -----              -----
Recoveries:
   Commercial                                                          0                  0
   Real estate                                                        15                  5
   Consumer                                                            6                  2
                                                                   -----              -----
      Total recoveries                                                21                  7
Net charge-offs                                                       60                 42
                                                                   =====              =====
Provision for loan losses                                             66                 88
                                                                   -----              -----
Balance, December 31, 1998                                          $895               $889
                                                                   -----              -----

Ratio of net charge-offs to average loans outstanding               0.11%              0.09%
                                                                   -----              -----

Ratio of allowance for loan losses to loans at period-end           1.58%              1.71%
                                                                   -----              -----


Non-performing Assets and Loans Past Due 90 Days
   Non-accrual loans                                             $   424            $    27
   Other real estate owned                                           429                429
                                                                   -----              -----

      Total non-performing assets                                $   853            $   456
                                                                 =======            =======


   Ratio of non-performing assets to total assets                   0.98%              0.55%

   Non-accrual loans:
      Interest income that would have been recorded
      under original terms                                           $57                 $4
                                                                 =======            =======

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

   Loans 90 days past due and still accruing                        $162                $15
                                                                 =======            =======
</TABLE>



                                       18
<PAGE>

         A breakdown of the  allowance is provided in Table 8;  however,  such a
breakdown has not  historically  been maintained by the Company,  and management
does not believe the  allowance can be fragmented by category with any precision
that  would be useful to  investors.  The  entire  amount  of the  allowance  is
available to absorb losses occurring in any category. The allowance is allocated
below based on the relative percent of loans in each category to total loans.
<TABLE>
Table 8:  Allocation of the Allowance for Loan Losses
As of December 31, 1998 and 1997
<CAPTION>

                                                     1998                                 1997

                                                           Percent                              Percent
                                               Amount     of Total                  Amount     of Total
                                            -------------------------            -------------------------
<S>                                            <C>               <C>                 <C>              <C>
Commercial                                     $ 188             21%                 $ 160            18%
Real estate - mortgage                           618             69%                   640            72%
Real estate - construction                        18              2%                    27             3%
Consumer                                          71              8%                    62             7%
                                               -----            ---                  -----           ---

                                               $ 895            100%                 $   889         100%
                                               =====            ===              =   ========        === 
</TABLE>

POTENTIAL PROBLEM LOANS

          At December 31, 1998 and 1997, loans on either  non-accrual  status or
loans past due 90 days or more and still accruing  amounted to $586 thousand and
$42 thousand,  respectively.  In addition to these loans,  at December 31, 1998,
the Company had  approximately  $738 thousand of loans that have been internally
classified,  and $313 thousand which require more than normal  attention and are
potential  problem loans. The Company has considered these loans in establishing
the level of the allowance for loan losses. At December 31, 1997, loans that had
been internally classified or which required more than normal attention and were
potential problem loans were $828 thousand $823 thousand, respectively.

CREDIT RISK AND REGULATORY MATTERS:

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

               Reports of  examinations  furnished by state and federal  banking
authorities are also considered by management.  Regulatory agencies periodically
review the  allowance for loan losses as part of their  examination  process and
may require the Bank to  recognize  additions  to the  allowance  based on their
judgment of information  available to them at the time of their  examination.  A
federal  examination  of the  Company and the Bank was  conducted  in the second
quarter of 1998 for the balance  sheet dated March 31, 1998. No additions to the
allowance  for loan  losses  were  recommended  as a result of the  examination.
Regulators  did not perform a regular  examination of the Company or the Bank in
1997.



                                       19
<PAGE>

NONPERFORMING ASSETS:

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

               Table 9 provides an analysis of the size,  number and  collateral
composition of non-performing assets at December 31, 1998.
<TABLE>
Table 9:  Non-performing Assets
<CAPTION>

                                                        Number                                  Total
                                                      of items            Balance              Dollars
                                                      --------            -------              -------
<S>                                                          <C>           <C>                     <C>
Non-performing assets by dollar amount:
$100,000 - $200,000                                          6             $  712                  83%
$50,000 - $100,000                                           1                 76                   9%
$50,000 and under                                           43                 65                   8%
                                                      --------             ------                 ---
                                                            50             $  853                 100%
                                                      --------             ------                 --- 

Non-performing assets by collateral composition:
 1 - 4 Family residential                                    1             $  127
Multi-family residential                                     3                302
Automobile, equipment and other                              4                396
Uncollateralized                                            42                 28
                                                      --------             ------                 
                                                            50             $  853
                                                      --------             ------                 
</TABLE>

LOAN PORTFOLIO:

         The loan  portfolio is the largest  category of the  Company's  earning
assets. Table 10 shows the type and maturity of loans outstanding as of December
31, 1998.

Table 10:  Loan Maturities
 (Dollars in
thousands)
                                                        After 1
                                       Within          but within         After
                                       1 year           5 years          5 years
                                       ------           -------          -------
Commercial                            $ 6,313           $ 2,838          $ 2,450
Real estate-mortgage                    6,698            12,679           19,678
Real estate-construction                1,422              -                -
Consumer                                  323             4,062              103
                                       ------           -------          -------
                                      $14,756           $19,579          $22,231

Loans maturing after 1 year with:
Fixed interest rates                                    $14,899          $19,831
Variable interest                                         4,680            2,400
rates
                                                        -------          -------
                                                        $19,579          $22,231



                                       20
<PAGE>
<TABLE>
Table 11 includes loans collateralized by real estate at December 31, 1998. Some
of these loans are included in commercial loans for purposes of Table 10.

Table 11:  Loans Collateralized By Real Estate

<CAPTION>
                                                                                 Percentage
                                                                                  of total
                                                              Amount            loan portfolio
                                                                 (Dollars in thousands)
                                                          -------------------------------------
<S>                                                          <C>                      <C>
Construction and land development                            $ 1,455                  3%
Collateralized by 1 - 4 family residential properties         17,302                 33%
Collateralized by multi-family residential properties          2,065                  4%
Collateralized by non-farm non-residential properties         19,655                 38%
                                                             -------
                                                             $40,477                 78%

INVESTMENT PORTFOLIO:

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

               Table  12  shows  the  maturities  of  investment  securities  at
December  31,1998,   and  the  weighted  average  yields  to  maturity  of  such
securities:

Table 12:  Investment Securities (1)
                December 31, 1998
                Dollars in thousands
<CAPTION>
                    1 year or less        1 - 2 years (2)     2 - 3 years      3 - 4 years(3     4 - 5 years   Over 5 years (4)
                    ------------------------------------------------------------------------------------------------------------
<S>                 <C>        <C>         <C>       <C>     <C>      <C>      <C>      <C>     <C>      <C>    <C>     <C>  
U.S.Treasury, 
government
agencies, state     Amount     Yield       Amount    Yield   Amount   Yield    Amount   Yield   Amount   Yield  Amount  Yield
and political  
subdivisions        $6,496     6.06%       $5,186    5.79%   $2,522   5.77%    $1,550   6.31%   $1,252   6.03%  $1,448  5.62%
Other               $    -        -        $   65    6.00%   $    -      -     $    -      -    $    -      -   $  784  8.25%
                    ------------------------------------------------------------------------------------------------------------
                    $6,496     6.06%       $5,251    5.89%   $2,522   5.77%    $ 1,550  6.31%   $1,252   6.03%  $2,232  6.93%
</TABLE>
(1)  Presented on an amortized cost basis
(2)  Includes a $225,938 tax-exempt security with a yield of 4.30%
(3)  Includes a $252,026 tax-exempt security with a yield of 4.50%
(4)  Includes $537,040 in tax-exempt securities with a weighted average yield of
     4.78%


DEPOSITS:

               The   Company's   deposit  base   includes   large   denomination
certificates of deposit of $100,000 or more which represent approximately 14% of
total deposits at December 31, 1998. The Bank pays market rates for these funds.
Management  of the Bank  attempts to match large  denomination  certificates  of
deposit with rate-sensitive  assets. At December 31, 1998,  available short-term
assets totaled $9.9 million.


Table 13:  Remaining Maturities of Large Denomination Certificates of
December 31, 1998
(Dollars in thousands)


Three months or less                                 Amount
                                                --------------
Over three through six months                       $   3,226
Over six through twelve months                          4,002
Over twelve months                                      2,035
    Total                                               1,143
                                                    ---------
                                                    $  10,406
                                                    ---------


                                       21
<PAGE>

NON-INTEREST  INCOME:

             A comparison of non-interest income may be found in Table 14.

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

                                  1998                 1997        1998 over
                                                                   1997
                          ---------------------------------------------------
Service charges                 $ 224,781         $195,865       $ 28,916
Other income                      130,148           91,874         38,274
                                ---------         --------       --------
                                $ 354,929         $287,739       $ 67,190

NONINTEREST EXPENSE:

              A comparison of noninterest expense may be found in Table 15.

Table 15:  Non-interest Expense
(Dollars in thousands)
For the years ended December 31,
                                                              1998 over
                                        1998       1997     (under) 1997
                                    -------------------------------------
Salaries and employee benefits        $ 1,316    $ 1,169        $ 147
Other                                                                       48
                                    318          270
Occupancy                                                                   20
                                    185          165
Automated services                                                          21
                                    133          112
Furniture and equipment                                                     35
                                    130          95
Taxes & licenses                                                           (32)
                                    44           76
Stationery and supplies                                                     16
                                    72           56
Director's fees                                                               7
                                    54           47
Accounting and audit                                            
                                    38           38            -
Marketing                                                                     4
                                    -----------  ------------- ----------------
                                    32           28
                                    --           --
                                    $    2,322   $             $         266
                                    ----------   -------       -------------
                                                 2,056

INCOME TAXES:

         For the year ended December 31, 1998, the Company recognized an expense
of $421 thousand. This represents a $19 thousand decrease from the $440 thousand
expense  for 1997.  See Note 11 of the  Consolidated  Financial  Statements  for
additional information with respect to income taxes.

RECENT ACCOUNTING PRONOUNCEMENTS

         Financial  Accounting Standards Board Statement No. 133, Accounting for
Derivative  Instruments  and Hedging  Activities,  was issued in June 1998. This
Statement   establishes   accounting  and  reporting  standards  for  derivative
instruments,   including  certain  derivative   instruments  embedded  in  other
contracts, (collectively referred to as derivatives) and for hedging activities.


                                       22
<PAGE>

It  requires  that an entity  recognize  all  derivatives  as  either  assets or
liabilities in the statement of financial position and measure those instruments
at fair value.  This  Statement is effective  for all fiscal  quarters of fiscal
years beginning after June 15, 1999.  Management will assess the impact,  if any
on the consolidated Company's financial statements.

         The American Institute of Certified Public Accountants issued Statement
of Position (SOP) 98-1,  Accounting for Costs of Computer Software  Developed or
Obtained for Internal Use. This SOP is effective  for financial  statements  for
fiscal years  beginning  after December 31, 1998.  The SOP requires  entities to
capitalize  certain  internal-use  software costs once certain criteria are met.
Generally,  internal costs with respect to software configuration and interface,
coding,  installation to hardware, testing (including parallel processing),  and
data  conversion  costs  allowing  access of old data by new  systems  should be
capitalized. All other data conversion costs, training, application maintenance,
and ongoing support  activities should be expensed.  The Company will adopt this
SOP in 1999 and does not  expect it to have a material  effect on the  Company's
consolidated financial condition or consolidated results of operations.

         The American Institute of Certified Public Accountants issued Statement
of Position (SOP) 98-5, Reporting on the Costs of Start-up Activities,  in April
1998.  The SOP requires  such costs to be expensed as incurred  instead of being
capitalized  and  amortized.  It applies  to  start-up  activities  and costs of
organization of both development stage and established operating activities, and
it changes  existing  practice  for some  industries.  The SOP  broadly  defines
start-up activities as those one-time activities that relate to the opening of a
new facility,  introduction of a new product or service, doing business in a new
territory, initiating a new process in an existing facility, doing business with
a new class of customer or beneficiary,  or commencing  some new operation.  The
SOP is effective  for  financial  statements  for fiscal years  beginning  after
December  15,  1998.  Consistent  with  banking  industry  practice  it  is  the
consolidated Company's policy to expenses such costs. Therefore, this SOP is not
expected to materially affect the consolidated  Company's  financial position or
results of operations.

YEAR 2000 PROJECT:

              The Company  continues to monitor and revise its Year 2000 project
plan to ensure  there  will be no  material  adverse  effects  on  customers  or
disruption  of  operations  as a result of a  failure  of the  Company  or third
parties to properly process data, on or after January 1, 2000.

         The  Company's  project  team  developed  a plan that  consists of five
phases: Awareness, Assessment,  Renovation,  Validation and Implementation.  The
plan was patterned after the Federal Financial  Institution  Examination Council
interagency  statement of May 5, 1997. The Awareness,  Assessment and Renovation
phases are substantially  complete; the Validation and Implementation phases are
currently in process and on schedule.  The core  application  processing  system
(demand and time deposit accounting, loan accounting,  general ledger accounting
and the customer information processing systems) of the Company and the hardware
upon which it is  processed  were tested  during the third  quarter of 1998 and,
based upon the  results,  the  Company  believes  these  systems  will  function
properly on and after January 1, 2000.

         The company has drafted a Year 2000 business  recovery  contingency and
testing  plan in  accordance  with  FFIEC  directives.  This  plan  defines  the
infrastructure that will be put in place for managing a failure after January 1,
2000. At this time, the Company  anticipates  that even the worst case Year 2000
scenario  (loss of support from the Company's  service  bureau) would not have a
long lasting,  significant  adverse effect on the Company's  financial condition
and results of operations for the year ending December 31, 2000 and beyond.



                                       23
<PAGE>

         The company will concentrate its efforts on customer communications and
business  resumption  contingency  plan testing during 1999. The Company expects
that  expenditures  related to Y2K compliance will not exceed $10 thousand.  The
Federal  Reserve Bank of Richmond  reviewed  the  Company's  compliance  efforts
regarding Year 2000 issues in February of 1999.


Item 7:  FINANCIAL STATEMENTS

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


Item 8:  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
              AND FINANCIAL DISCLOSURES
                None.



                                       24
<PAGE>
<TABLE>
PART III

Item 9.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         On January 5, 1990,  the Board of Directors  voted to amend the by-laws
to increase  the size of the Board of  Directors  from 12 to 14  members.  As of
December 31, 1998, there were 10 directors.

         The following  schedule sets forth-certain  information  concerning the
directors and executive officers of the Company.
<CAPTION>
                                   Term to                                                         Director
Director's Name              Age   Expire                 Principal Occupation                      Since
---------------              ---   ------                 --------------------                      -----
<S>                           <C>   <C>     <C>                                                      <C> 
Lisa F. Chandler              44    2000    Executive Vice-President of Nancy Chandler Associates,   1998
                                            Inc.

James A. Cummings             56    2001    Vice-President of Southern Atlantic Label Company, Inc.  1992

F. Dudley Fulton              50    1999    President and Chief Executive Officer of Henderson and   1991
                                            Phillips, Inc.

Henry U. Harris, III          47    2000    President of Virginia Investment Counselors, Inc.        1992
                                            Vice-Chairman of the Board since 1995.

Stephen A. Johnsen            53    2000    President of Flagship Group, LTD.  Secretary of the      1988
                                            Board since 1995.

Robert J. Keogh               50    2001    President and Chief Executive Officer of the Company     1988
                                            since 1992; President and Chief Executive Officer of
                                            Heritage Bank & Trust since 1988.

Peter M. Meredith, Jr.        47    2001    Chairman and Chief Executive Officer of Meredith         1992
                                            Construction Company, Inc.  Chairman of the Board
                                            since 1995.

Gerald L. Parks               65    1999    Chairman of the Board of Capes Shipping Agencies, Inc.   1987

Ross C. Reeves                50    1999    Member of the law firm of Willcox & Savage, P.C.         1994

Harvey W. Roberts, III        54    2001    Partner in the accounting firm of McPhillips, Roberts    1993
                                            and Deans.
</TABLE>




                                       25
<PAGE>
<TABLE>
Item 10.  EXECUTIVE COMPENSATION

1.  CASH COMPENSATION:

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




Summary Compensation Table
Annual Compensation (1)
<CAPTION>
                                                                                      Director's
Name and Principal Position                  Year         Salary          Bonus          Fees
----------------------------------------------------------------------------------------------------------------
<S>                                          <C>         <C>             <C>            <C>    
Robert J. Keogh
 President & Chief Executive Officer         1998        $ 97,190        $ 29,800       $ 4,800
                                             1997        $ 94,725        $ 34,800       $ 4,800
                                             1996        $ 93,450        $ 23,700       $ 4,800
</TABLE>
(1)  No compensation earned in either year was deferred.

2.  COMPENSATION PURSUANT TO PLANS:


EMPLOYEE STOCK OPTION PLAN

         As  of  December  31,  1998,   stock  options  for  96,650  shares  are
outstanding and, of these shares,  78,575 are  exercisable.  Options are granted
and are exercisable at option prices ranging from $4.60 to $9.50 per share.  See
disclosures  regarding  stock  option  plans  in  Note  10 to  the  Consolidated
Financial Statements.

DEFERRED COMPENSATION AND RETIREMENT ARRANGEMENTS

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

         Upon  reaching  age 70,  each  participant  will  receive a  retirement
benefit  ranging  from $391 to $3,355 per month for each of the next 120 months.
If the  participant  dies prior to reaching age 70, his  beneficiary  will begin
receiving the monthly retirement benefits. The bank has purchased life insurance
contracts  in  order  to  fund  the  expected  liabilities  under  the  deferred
compensation  arrangements.  As of December 31, 1998,  Heritage Bank & Trust had
accrued $190,489 to reflect the anticipated liability.

         In 1990, Robert J. Keogh,  President of Heritage Bank & Trust, became a
participant in the Heritage Bank & Trust  Executive  Security Plan. In the event
Mr. Keogh dies prior to age 65, his beneficiary will receive monthly payments of
$4,167 for each of the next 180 months. Upon his retirement at age 65, Mr. Keogh
will  receive  $4,167  per  month  for each of the next 180  months or until his
death, and thereafter other beneficiaries will receive such retirement benefits.
Heritage Bank & Trust funds this obligation  through a life insurance  contract.
Heritage Bank & Trust had accrued $72,811 as of December 31, 1998 to reflect the
anticipated liability.

         Effective January 1, 1984, the Board of Directors adopted an Employee's
Stock Bonus Plan and Trust (the  "ESOP").  The ESOP  covered  substantially  all
employees,  whereby funds contributed were used to purchase  outstanding  common
stock of the Company.  Contributions were allocated to the participants based on
the employee/participant's annual compensation. The Company made no contribution
to the plan for years ending December 31, 1998 and 1997. In October of 1995, the
trustees of the ESOP voted to  terminate  the plan and the  participants  in the
plan were notified of their options  concerning  distribution of their shares in
the plan in accordance with the terms of the ESOP and applicable law.
At December 31, 1998, all shares in the plan had been distributed.



                                       26
<PAGE>

         Effective  January 1, 1993, the Board of Directors adopted a Retirement
Program (the "401K").  The Company may contribute cash to the 401K annually,  as
determined  each year by the Board of Directors.  Contributions  to the 401K are
allocated to its participants based on the employee/participant's  contributions
to the plan.  Eligible  participants  in the 401K include all employees who have
completed six months of service (500 hours) beginning with the effective date of
the  401K.  Benefits  will be  payable  upon  separation  from  service  or upon
retirement,  disability  or death.  Employees are 20% vested with respect to the
benefits  under the 401K in two years and the  vested  percentage  is  increased
annually,  reaching 100% after six years.  Participants are  automatically  100%
vested in the 401K upon  reaching age 65, death or  disability.  The Company has
the right to amend or  terminate  the 401K.  The  Company  expensed  $55,000 and
$36,000 for plan  contributions  for the years ended December 31, 1998 and 1997,
respectively.

         Effective January 1, 1998, the Board of Directors adopted an Employee's
Stock Ownership Plan (the "ESOP").  The ESOP covers substantially all employees,
whereby funds contributed are used to purchase  outstanding  common stock of the
Company.   Contributions  are  allocated  to  the  participants   based  on  the
employee/participant's  annual compensation.  Employee  participants in the ESOP
includes all employees who have  completed six months of service  beginning with
the  effective  date of the ESOP.  Benefits  are payable  upon  separation  from
service or upon retirement,  disability or death.  Employees are 20% vested with
respect to the benefits under the ESOP in three years and the vested  percentage
increases   annually,   reaching  100%  after  seven  years.   Participants  are
automatically 100% vested in the ESOP upon reaching age 65, death or disability.
Participants  vote all shares  allocated  to their  respective  accounts and the
trustees of the ESOP vote any unallocated  shares. The Board of Directors of the
Company has the right to amend or  terminate  the ESOP at any time.  The Company
expensed $18,000 and $12,000 for plan contributions for the years ended December
31, 1998 and 1997, respectively.

COMPENSATION OF DIRECTORS:

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


ITEM 11:  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                  MANAGEMENT

         The following schedule sets forth information  regarding the beneficial
ownership of the Company's common stock as of March 10, 1999, of (i) each of the
Company's  directors;  (ii) each person known by the Company to be the holder of
5% or more of the  Company's  outstanding  common  stock;  and  (iii) all of the
Company's directors and executive officers as a group.


                                       27
<PAGE>


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


James A.Cummings                                 5,128 (1)           0.64%
2073 Thomas Bishop Lane
Virginia Beach, VA  23454 USA

Lisa F. Chandler                                   642               0.08%
6127 Studeley Avenue
Norfolk, VA  USA  23508

F. Dudley Fulton                                 2,700               0.37%
5306 Lakeside Avenue
Virginia Beach, VA  23451 USA

Henry U. Harris, III                            28,205  (2)          3.51%
1503 North Shore Road
Norfolk, VA  23505 USA

Stephen A. Johnsen                               3,618  (3)          0.45%
401 College Place
Norfolk, VA  23510 USA

Robert J. Keogh                                  8,695 (4)           1.08%
6146 Sylvan Street
Norfolk, VA  23508 USA

Peter M. Meredith, Jr.                          42,703 (5)           5.32%
5320 Edgewater Drive
Norfolk, VA  23508 USA

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

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

Harvey W. Roberts, III                          29,079 (8)           3.62%
7612 North Shore Road
Norfolk, VA  23505 USA

Directors and Executive Officers as a
     group (10 persons)                        130,407              16.24%

(1)  Includes  1,500 shares owned  jointly with his wife.  Also  includes  3,628
     shares held in an investment account for Mr. Cummings
(2)  Includes 3,555 shares owned by his wife. Also includes 4,249 shares held as
     custodian for others and 4,500 shares held in trust.
(3)  Includes 1,650 shares owned jointly with his wife.
(4)  Includes  1,335 shares owned  jointly with his wife.  Also  includes  1,998
     shares  owned by Scott &  Stringfellow  as an IRA for Mr.  Keogh.  Does not
     include  34,400  shares that may be acquired by Mr.  Keogh  pursuant to the
     Stock  Option Plan for key  employees  of the  Company.  See  "Compensation
     Pursuant to Plans." If such shares were included, Mr. Keogh would own 5.37%
     of the outstanding shares.
(5)  Includes  10,960 shares held as Meredith  Realty  Company,  L.L.C.,  13,208
     shares  held as Pomar  Holding,  L.L.C.  and 3,000  shares held as Meredith
     Realty Associates.  Also includes 8,203 shares owned by Davenport & Company
     for Mr. Meredith.
(6)  Includes 4,614 shares owned jointly with his wife.
(7)  Includes 3,142 shares held as custodian for others.
(8)  Includes  17,280  shares owned by his wife and 3,000  shares owned  jointly
     with his wife.  Also  includes  2,112 shares owned by Scott &  Stringfellow
     consisting of 257 shares as an IRA for Roberts & Speece,  CPA,  P.L.C.  and
     1,825 owned for Mr. Roberts.



                                       28
<PAGE>

ITEM 12:  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:

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

         Heritage Bank & Trust occupies 7,581 square feet of space in a building
located at 1450 South Military Highway in Chesapeake,  Virginia. The building is
owned by IBV Partners,  L.P., a Virginia limited  partnership,  which has as its
sole general partner IBV Real Estate Holdings,  Inc., a wholly-owned  subsidiary
of the Company.  Former and current  directors  of Heritage  Bank & Trust own an
aggregate of approximately 34% of the partnership interests.  IBV Partners, L.P.
and  Heritage  Bank & Trust  entered  into a lease in  December  1986  which was
modified in December 1997.  See  disclosures  regarding the lease  commitment in
Note 12 of the Consolidated Financial Statements.

         The  Company  and  Heritage  Bank & Trust  purchase  various  types  of
business  insurance  through the Flagship Group LTD, of which Stephen A. Johnsen
is President. Mr. Johnsen is a director and Secretary of the Company.  Insurance
premiums  paid to the  Flagship  Group  LTD as agent  for  commercial  insurance
providers  was $27,393  during 1998.  The Bank has also sold  securities  to the
Flagship   Group  LTD  under   agreements  to   repurchase,   which   constitute
approximately  43% of the  securities  sold under  agreements  to  repurchase at
December 31,  1998.  See Note 9 of the  Consolidated  Financial  Statements  for
additional information.

         Heritage  Bank & Trust has  retained  the law firm of Willcox & Savage,
P.C. in connection with certain legal representations and expects to continue to
do so in the future. Ross C. Reeves, a director of the Company is an attorney in
the law firm.  Fees paid to Willcox & Savage,  P.C. by Heritage Bank & Trust was
$12,917 in 1998.


                                       29
<PAGE>

PART IV

Item 13:  EXHIBITS AND REPORTS ON FORM 8-K

(A) (3) Exhibits:

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

          3.2       Bylaws, as amended.

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

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

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

          10.4      Lease dated December 29, 1996, between IBV Partners, L.P. as
                    landlord,  and  Heritage  Bank & Trust,  as Tenant,  for the
                    lease of 7,581 square feet of space in a building located at
                    1450   South   Military   Highway,   Chesapeake,   Virginia.
                    (Incorporated  herein by reference to the Corporation's Form
                    10-K for 1986 filed March 1987.

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

          10.6      Employee's  Stock  Ownership Plan.  (Incorporated  herein by
                    reference  to the  Corporation's  Form 10-KSB for 1997 filed
                    March 30, 1998.)


(B)        Reports on Form 8-K

No reports were filed on Form 8-K during the year ended December 31, 1998.


                                       30
<PAGE>
                                POWER OF ATTORNEY


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

                                   SIGNATURES

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

                                    Heritage Bankshares, Inc.
                                         (Registrant)

Date:  March 24,1999                by /s/ Robert J. Keogh
                                      -----------------------------------------
                                         Robert J. Keogh, President and Chief
                                         Executive Officer

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


                                       31
<PAGE>


         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Registrant and in the capacities indicated on March 24, 1999.

SIGNATURES

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

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

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

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

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

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

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

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

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

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


                                       32
<PAGE>


                            HERITAGE BANKSHARES, INC
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



ITEM                                                                       PAGE

Report of Independent Accountants.......................................    F-1

FINANCIAL STATEMENTS:
          
         Consolidated Balance Sheets....................................    F-2

         Consolidated Statements of Income..............................    F-3

         Consolidated Statements of Stockholders' Equity ...............    F-4

         Consolidated Statements of Cash Flows .........................    F-5

         Notes to Consolidated Financial Statements ....................    F-6




<PAGE>




                                                     Consolidated
                                                     Financial Statements
                                                     Years Ended December 31,
                                                     1998 and 1997












                                               HERITAGE BANKSHARES, INC.


<PAGE>



                        REPORT OF INDEPENDENT ACCOUNTANTS


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


           We have  audited  the  accompanying  consolidated  balance  sheets of
Heritage  Bankshares,  Inc. and its  subsidiaries at December 31, 1998 and 1997,
and the related consolidated statements of income, stockholders' equity and cash
flows for the years then ended. These consolidated  financial statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

           In our opinion,  the consolidated  financial  statements  referred to
above present  fairly,  in all material  respects,  the  consolidated  financial
position of Heritage  Bankshares,  Inc. and its  subsidiaries as of December 31,
1998 and 1997, and the  consolidated  results of their operations and their cash
flows for the years then ended in conformity with generally accepted  accounting
principles.


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


One Commercial Place
Norfolk, Virginia
January 28, 1999









                                       F-1


<PAGE>
<TABLE>
HERITAGE BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS

<CAPTION>

December 31,                                                                  1998                  1997
------------------------------------------------------------------------------------------------------------------

                               ASSETS

<S>                                                                     <C>                    <C>               
Cash and due from banks                                                 $        3,603,916     $        4,019,169
Federal funds sold                                                               3,457,492              1,697,207
Securities available for sale                                                   14,318,091             15,729,585
Securities held to maturity                                                      5,118,715              6,865,595
Loans, net                                                                      55,670,814             51,131,833
Loans held for sale                                                                938,456                110,000
Accrued interest receivable                                                        578,616                692,488
Other real estate owned                                                            428,500                428,500
Premises and equipment, net                                                      2,010,228              1,328,297
Other assets                                                                     1,166,670                998,846
                                                                      --------------------------------------------

                                                                        $       87,291,498     $       83,001,520
                                                                      ============================================


                LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits:
     Noninterest bearing deposits                                       $       14,521,488     $       12,902,336
     Interest-bearing deposits                                                  62,761,449             59,894,701
                                                                      --------------------------------------------
                                                                                77,282,937             72,797,037
Securities sold under agreements to repurchase                                     981,271              1,945,212
Short-term borrowings                                                               63,234                 52,248
Accrued interest payable                                                           317,995                342,306
Other liabilities                                                                  567,109                783,971
                                                                      --------------------------------------------
                                                                                79,212,546             75,920,774
                                                                      --------------------------------------------

Stockholders' equity:
     Common stock,  $5 par  value -  authorized  3,000,000  shares;  issued  and
         outstanding:
         1998 - 801,250 shares; 1997 - 795,050 shares                            4,006,250              3,975,250
     Additional paid-in capital                                                   (351,757)              (360,790)
     Retained earnings                                                           4,336,068              3,409,668
     Accumulated other comprehensive income                                         88,391                 56,618
                                                                      --------------------------------------------
                                                                                 8,078,952              7,080,746
                                                                      --------------------------------------------

                                                                        $       87,291,498     $       83,001,520
                                                                      ============================================


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

                                                        F- 2

<PAGE>


HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

<CAPTION>

Years Ended December 31,                                                                1998                1997
-------------------------------------------------------------------------------------------------------------------------

Interest income:
     Interest and fees on loans                                                   $       4,976,458    $       4,490,735
                                                                                 ----------------------------------------
     Interest on investment securities:
         Available for sale                                                                 890,310              912,280
         Held to maturity                                                                   367,637              448,749
                                                                                 ----------------------------------------
                                                                                          1,257,947            1,361,029
                                                                                 ----------------------------------------

     Interest on federal funds sold                                                         332,250              333,650
                                                                                 ----------------------------------------
             Total interest income                                                        6,566,655            6,185,414
                                                                                 ----------------------------------------

Interest expense:
     Interest on deposits                                                                 2,964,137            2,832,417
     Interest on short-term borrowings                                                       86,770               76,247
                                                                                 ----------------------------------------
            Total interest expense                                                        3,050,907            2,908,664
                                                                                 ----------------------------------------

               Net interest income                                                        3,515,748            3,276,750

Provision for loan losses                                                                    65,500               88,333
                                                                                 ----------------------------------------

            Net interest income after provision for loan losses                           3,450,248            3,188,417
                                                                                 ----------------------------------------

Noninterest income:
     Services charges                                                                       224,781              195,865
     Other                                                                                  130,148               91,874
                                                                                 ----------------------------------------
                                                                                            354,929              287,739
                                                                                 ----------------------------------------

Noninterest expense:
     Salaries and employee benefits                                                       1,315,750            1,169,148
     Other                                                                                  442,481              382,528
     Occupancy expenses                                                                     185,443              164,786
     Automated services                                                                     132,961              112,003
     Furniture and equipment expense                                                        130,121               94,746
     Taxes & licenses                                                                        43,460               76,018
     Stationery and supplies                                                                 71,813               57,211
                                                                                 ----------------------------------------
                                                                                          2,322,029            2,056,440
                                                                                 ----------------------------------------

Income before income taxes                                                                1,483,148            1,419,716

Income tax expense                                                                          420,637              439,746
                                                                                 ----------------------------------------

Net income                                                                        $       1,062,511    $         979,970
                                                                                 ========================================

Earnings per common share - basic                                                 $            1.33    $            1.24
                                                                                 ========================================

Earnings per common share - assuming dilution                                     $            1.25    $            1.17
                                                                                 ========================================



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

                                                        F- 3

<PAGE>


HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY



Years Ended December 31, 1998 and 1997
---------------------------------------------------------------------------------------------------------------------------

<CAPTION>
                                                                                                                           
                                                                                       Additional                          
                                                       Common Stock                    Paid-in              Retained       
                                           --------------------------------------
                                                Shares             Amount              Capital              Earnings       
                                           -----------------  -------------------  -------------------  -------------------

Balance, December 31, 1996                          784,150    $       3,920,750    $        (380,330)    $      2,539,941 
                                                                                                                           

Net income for 1997                                       -                    -                    -              979,970 

Net changes in unrealized appreciation
     on securities available-for-sale,
     net of applicable income taxes
            of $14,384                                                                                                     
Total comprehensive income                                                                                                 

Stock options exercised in 1997                      10,900               54,500               19,540                    - 

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

Balance, December 31, 1997                          795,050            3,975,250             (360,790)           3,409,668 
                                                                                                                           


Net income for 1998                                       -                    -                    -            1,062,511 

Net changes in unrealized appreciation
     on securities available-for-sale,
     net of applicable income taxes
     of $16,368                                           -                    -                    -                    - 
Total comprehensive income                                                                                                 

Stock options exercised in 1998                       6,200               31,000                9,033                    - 

Less:  Dividends paid in 1998                             -                    -                    -             (136,111)
                                           --------------------------------------------------------------------------------

Balance, December 31, 1998                          801,250    $       4,006,250    $        (351,757)    $      4,336,068 
                                           ================================================================================
<CAPTION>

                                                          Accumulated
                                                             Other
                                                         Comprehensive
                                                             Income              Total
                                                       -------------------  -------------------

Balance, December 31, 1996                                         31,414    $       6,313,761
                                                                            -------------------

Net income for 1997                                                                  7,262,317

Net changes in unrealized appreciation
   on securities available-for-sale,
   net of applicable income taxes
   of $14,384                                                      25,204            7,262,317
                                                                            -------------------
Total comprehensive income                                                          14,524,634
                                                                            -------------------

Stock options exercised in 1997                                         -            7,311,153

Less: Dividends paid in 1997                                            -            7,200,910
                                                          -------------------------------------

Balance, December 31, 1997                                         56,618           35,350,458
                                                                            -------------------


Net income for 1998                                                     -           15,230,931

Net changes in unrealized appreciation
   on securities available-for-sale,
   net of applicable income taxes
   of $16,368                                                      31,773           15,230,931
                                                                            -------------------
Total comprehensive income                                                          30,461,862
                                                                            -------------------


Stock options exercised in 1998                                         -               40,033

Less:  Dividends paid in 1998                                           -           15,103,080
                                                          -------------------------------------

Balance, December 31, 1998                                         88,391    $      80,955,433
                                                          =====================================


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

                                      F- 4

<PAGE>


HERITAGE BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<CAPTION>

Years Ended December 31,                               1998                                                            1997
------------------------------------------------------------------------------------------------------------------------------------

Operating activities:
     Net income                                                                              $       1,062,511    $         979,970
     Adjustments to reconcile to net cash
         provided by operating activities:
         Provision for loan losses                                                                      65,500               88,333
         Provision for losses on real estate owned                                                           -               15,231
         Provision for depreciation and amortization                                                   116,307               71,226
         Amortization of investment security premiums,
            net of discounts                                                                            15,105                8,065
         Deferred loan origination fees, net of costs                                                   (7,538)             (15,604)
         Changes in:
            Interest receivable                                                                        113,872             (157,316)
            Interest payable                                                                           (24,311)              51,723
            Loans held for sale                                                                       (828,456)            (110,000)
            Other assets                                                                              (123,884)            (178,898)
            Other liabilities                                                                         (216,862)             246,757
                                                                                           -----------------------------------------
                Net cash provided by operating activities                                              172,244              999,487
                                                                                           -----------------------------------------

Investing activities:
     Proceeds from maturities of available-for-sale securities                                       6,154,865            2,669,820
     Proceeds from maturities, prepayments and calls of
         held- to-maturity securities                                                                2,454,675            2,625,314
     Purchases of available-for-sale securities                                                     (4,758,877)          (3,993,939)
     Purchases of held-to-maturity securities                                                         (707,394)          (3,668,293)
     Loan originations, net of principal repayments                                                 (4,596,943)          (5,945,172)
     Proceeds from condemnation of land                                                                      -                9,503
     Purchases of land, premises and equipment                                                        (810,405)            (826,055)
                                                                                           -----------------------------------------
                Net cash used by investing activities                                               (2,264,079)          (9,128,822)
                                                                                           -----------------------------------------

Financing activities:
     Net increase (decrease) in demand deposits,
         NOW accounts and savings accounts                                                           5,131,125              (92,597)
     Net increase (decrease) in certificates of deposit                                               (645,225)           4,463,043
     Net increase (decrease) in securities sold under
         agreements to repurchase                                                                     (963,941)             596,121
     Net increase (decrease) in short-term borrowings                                                   10,986              (78,304)
     Net proceeds from exercise of stock options                                                        40,033               74,040
     Cash dividends paid                                                                              (136,111)            (110,243)
                                                                                           -----------------------------------------
                Net cash provided by financing activities                                            3,436,867            4,852,060
                                                                                           -----------------------------------------

Increase (decrease) in cash and cash equivalents                                                     1,345,032           (3,277,275)

Cash and cash equivalents at beginning of year                                                       5,716,376            8,993,651
                                                                                           -----------------------------------------

Cash and cash equivalents at end of year                                                     $       7,061,408    $       5,716,376
                                                                                           =========================================

Supplemental schedules and cash flow information:

     Cash paid for:
         Interest on deposits and other borrowings                                         $         3,075,544  $         2,856,941
                                                                                           =========================================

         Income taxes                                                                      $   775,579          $           279,922
                                                                                           =========================================

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

                                                        F- 5
</TABLE>

<PAGE>

HERITAGE BANKSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1998 AND 1997
--------------------------------------------------------------------------------


NOTE 1 - ORGANIZATION AND BUSINESS

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

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

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

           Sentinel Title Services, Inc. and Sentinel Trust Services, L.L.C. are
wholly-owned subsidiaries, which own an interest in providers of title and trust
services.  As these  subsidiaries  own a less than ten percent (10%) interest in
other  companies,  the financial  activities  pertaining to these  interests are
recorded  on the cost  method  of  accounting  for  investments.  The  Company's
strategic relationship with these entities provides the Bank with the ability to
provide title and trust services to its customers.


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        Basis of Statement Presentation and Principles of Consolidation

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


                         (Notes continued on next page)

                                      F- 6


<PAGE>



NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Cash Equivalents

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

        Securities

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

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

        Loans

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

        Loans Held For Sale

        Mortgage loans  originated and intended for sale in the secondary market
are carried at the lower of cost or estimated market value in the aggregate. Net
unrealized  losses,  if any,  are  recognized  through a valuation  allowance by
charges to income.

        Allowance for Loan Losses

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

        Large  groups of  smaller  balance  homogeneous  loans are  collectively
evaluated for  impairment.  Accordingly,  the Bank does not separately  identify
individual consumer and residential loans for impairment disclosures.

                         (Notes continued on next page)

                                      F- 7
<PAGE>

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Allowance for Loan Losses (continued)

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

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

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

        Income Recognition on Impaired and Nonaccrual Loans

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

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

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


                         (Notes continued on next page)

                                      F- 8
<PAGE>

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Other Real Estate Owned

        Other real estate  owned is comprised  of real estate  acquired  through
foreclosure,  acceptance of a deed in lieu of foreclosure, or loans in which the
Bank 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 less estimated costs to sell.

        Restructured Loans

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

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

        Premises and Equipment

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

        Transfers of Financial Assets

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



                         (Notes continued on next page)

                                      F- 9
<PAGE>

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Income Taxes

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

        Deferred Compensation Plans

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

        Off-Balance-Sheet Financial Instruments

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

        Use of Estimates

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

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


                         (Notes continued on next page)

                                      F-10
<PAGE>

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

        Earnings per Share

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

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

        Comprehensive Income

        The Company  adopted  newly-issued  FASB  Statement  No. 130,  Reporting
Comprehensive  Income, as of January 1, 1998.  Accounting  principles  generally
require that recognized revenue,  expenses,  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. The adoption of FASB Statement
No. 130 had no effect on the Corporation's net income or shareholders' equity.

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

<TABLE>
<CAPTION>
                                                                                    1998              1997
                                                                               --------------    --------------

        <S>                                                                    <C>               <C>           
        Unrealized holding gains on available-for-sale securities              $       50,346    $       41,947
        Reclassification adjustment for gains realized in income                       (2,205)           (2,359)
                                                                               -----------------------------------
        Net unrealized gains                                                           48,141            39,588

        Tax effect                                                                    (16,368)          (14,384)
                                                                               -----------------------------------

        Net-of-tax amount                                                      $       31,773    $       25,204
                                                                               ===================================
</TABLE>

        Reclassifications

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




                         (Notes continued on next page)

                                      F-11
<PAGE>
<TABLE>
NOTE 3 - CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.
           (PARENT COMPANY ONLY)

        The financial position, results of operations and cash flows of Heritage
Bankshares,  Inc.  are  presented  below on a parent  company only basis for the
years indicated.
<CAPTION>
                                                                                    December 31,            
                                                                          -----------------------------------
Condensed Balance Sheets

Assets                                                                       1998                    1997
                                                                          -----------------------------------

<S>                                                                      <C>                      <C>        
Cash on deposit with Heritage Bank and Trust                             $   257,382              $    39,920
Investment in Heritage Bank and Trust                                      7,675,357                6,720,165
Investment in non-bank subsidiaries                                          217,549                  217,549
Premises and equipment                                                         3,559                   11,755
Other assets                                                                  79,783                  509,497
                                                                          -----------------------------------

        Total assets                                                     $ 8,233,630              $ 7,498,886
                                                                         ====================================


Liabilities and Stockholders' Equity

Other liabilities                                                        $   154,678              $   418,140
Common stock                                                               4,006,250                3,975,250
Additional paid-in capital                                                  (351,757)                (360,790)
Retained earnings                                                          4,336,068                3,409,668
Accumulated other comprehensive income                                        88,391                   56,618
                                                                          -----------------------------------

        Total liabilities and stockholders' equity                       $ 8,233,630              $ 7,498,886
                                                                         ====================================


                                                                               Years Ended December 31,
Condensed Statements of Income                                                1998                    1997
                                                                          -----------------------------------

Income:
   Dividends from subsidiary bank                                        $   136,111              $   195,243
   Other                                                                      12,000                   12,759
                                                                          -----------------------------------
                                                                             148,111                  208,002
Expenses:
   Other                                                                      30,082                   27,443
                                                                          -----------------------------------

Income before income taxes and equity in undistributed net
     income of subsidiaries                                                  118,029                  180,559
Applicable income tax benefit                                                 21,063                   22,693
                                                                          -----------------------------------

Income before equity in undistributed net income of subsidiaries             139,092                  203,252

Equity in undistributed net income of subsidiaries                           923,419                  776,718
                                                                          -----------------------------------

        Net income                                                       $ 1,062,511              $   979,970
                                                                         ====================================

</TABLE>

                         (Notes continued on next page)

                                      F-12
<PAGE>
<TABLE>
NOTE 3 - CONDENSED FINANCIAL INFORMATION OF HERITAGE BANKSHARES, INC.
           (PARENT COMPANY ONLY) (Continued)
<CAPTION>

                                                                               Years Ended December 31,
Condensed Statements of Cash Flows                                           1998                    1997
                                                                          -----------------------------------

Operating activities:
<S>                                                                      <C>                      <C>        
Net income                                                               $ 1,062,511              $   979,970
Adjustments to reconcile to net cash provided by operating activities:
   Depreciation                                                                8,196                    8,196
   Undistributed net income of subsidiaries                                 (923,419)                (776,718)
   Changes in:
      Other assets                                                           429,714                 (264,464)
      Other liabilities                                                     (263,462)                (205,524)
                                                                          -----------------------------------
Net cash provided by operating activities                                    313,540                  152,508
                                                                          -----------------------------------


Investing activities:
   Investment in Sentinel Trust Services, L.L.C                                 --                    (85,000)
                                                                          -----------------------------------


Financing activities:
Net proceeds from exercise of stock options                                   40,033                   74,040
Cash dividends paid                                                         (136,111)                (110,243)
                                                                          -----------------------------------

Net cash used by financing activities                                        (96,078)                 (36,203)
                                                                          -----------------------------------


Net increase (decrease) in cash and cash equivalents                         217,462                   31,305

Cash and cash equivalents at beginning of year                                39,920                    8,615
                                                                          -----------------------------------

Cash and cash equivalents at end of year                                 $   257,382              $    39,920
                                                                          -----------------------------------
</TABLE>

        Certain  restrictions  exist  regarding the ability of Heritage Bank and
Trust  to  transfer  funds  to  Heritage  Bankshares,  Inc.  in the form of cash
dividends,  loans or advances.  Pursuant to Federal  Regulations,  dividends are
generally  restricted to net profits,  as defined,  for the current  year,  plus
retained net profits for the previous two years. At December 31, 1998, dividends
from the Bank to the Company are limited to approximately $2,130,000 under these
regulations.  The maximum  amount  available for transfer from Heritage Bank and
Trust to the Company in the form of loans and  advances is 10% of Heritage  Bank
and Trust's  stockholder's  equity.  At December 31, 1998,  such maximum  amount
available is approximately $768,000.


NOTE 4 - RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS

        The Bank is  required by the Federal  Reserve  Bank to maintain  average
reserve  balances.  The  average  amount  of  maintained  reserve  balances  was
approximately  $746,000 for the year ended  December 31, 1998,  with the average
reserve  requirement  for the  same  period  being  approximately  $726,000.  On
December 31, 1998, the reserve balance was approximately $753,000.


                         (Notes continued on next page)

                                      F-13
<PAGE>
<TABLE>
NOTE 5 - SECURITIES

        Securities at December 31, 1998 and 1997 are as follows:

<CAPTION>
                                                              Gross                   Gross
                                    Amortized              Unrealized               Unrealized          Estimated
                                       Cost                   Gains                   Losses            Fair Value
                                    ---------              ----------               ----------          ---------
<S>                                <C>                     <C>                      <C>                 <C>        
December 31, 1998:
   Securities available for sale
     U.S. Treasury                 $ 5,999,454             $    83,666              $       -           $ 6,083,120
     U.S. government agencies        7,038,469                  51,222                7,083,240               6,451
     Mortgage-backed securities      1,180,599                   8,528                  959,947
     States and political
        subdivisions                   193,643                 191,784                      -                 1,859
                                   -----------             -----------              -----------         -----------

                                   $14,184,165             $14,318,091              $   143,416         $     9,490
                                   ===========             ===========              ===========         ===========


   Securities held to maturity:
     U.S. Treasury                 $ 1,742,557             $    28,856              $       -           $ 1,771,413
     U.S. government agencies        1,706,042                  18,671                      -             1,724,713
     States and political
        subdivisions                   821,361                  27,118                      -               848,479
     Other                             848,755                     -                        -               848,755
                                   -----------             -----------              -----------         -----------

                                   $ 5,118,715             $    74,645              $       -           $ 5,193,360
                                   ===========             ===========              ===========         ===========

December 31, 1997:
   Securities available for sale
     U.S. Treasury                 $ 9,997,043             $    50,198              $       121         $10,047,120
     U.S. government agencies        4,817,324                  25,776                    2,359           4,840,741
     Mortgage-backed securities        829,433                 841,724                   13,082                 791
                                   -----------             -----------              -----------         -----------

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

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

                                   $ 6,865,595             $    47,569              $     1,881         $ 6,911,283
                                   ===========             ===========              ===========         ===========
</TABLE>

         Other  securities  include  restricted   investments  of  $846,300  and
$646,300 at December 31, 1998 and 1997,  respectively.  These  securities do not
have a readily  determinable fair value and lack a market.  Therefore,  they are
carried at cost and periodically evaluated for impairment.


                         (Notes continued on next page)

                                      F-14
<PAGE>

NOTE 5 - SECURITIES (Continued)

          Investment   securities  having  carrying  values  of  $3,910,064  and
$4,363,566  at December 31, 1998 and 1997,  respectively,  are pledged to secure
deposits of the U.S. Government and the Commonwealth of Virginia.  The estimated
fair values of these  securities  were $3,969,068 and $4,395,129 at December 31,
1998 and 1997, respectively.

          The  amortized  cost and fair value of  securities  by maturity  date,
including the contractual maturities of mortgage-backed  securities, at December
31, 1998 are as follows:
<TABLE>
<CAPTION>
                                              Securities Held to Maturity     Securities Available for Sale
                                              ---------------------------     -----------------------------
                                              Amortized       Estimated         Amortized       Estimated
                                                Cost          Fair Value          Cost          Fair Value
                                             ------------    ------------     ------------     ------------
     <S>                                     <C>             <C>              <C>              <C>         
     Due in one year or less                 $    749,669    $    754,223     $  5,746,761     $  5,782,573
     Due from one year to five years            3,241,794       3,295,629        7,333,183        7,428,860
     Due from five years to ten years                 -               -            324,910          330,073
     Due after ten years                        1,127,252       1,143,509          779,311          776,585
                                             ------------    ------------     ------------     ------------
                                             $  5,118,715    $  5,193,360      $ 14,184,165    $ 14,318,091
                                             ============    ============      ============    ============



NOTE 6 - LOANS

Loans consist of the following:
<CAPTION>

                                                                                     December 31,
                                                                         ------------------------------------
                                                                             1998                     1997
                                                                         -----------              -----------
Gross loans:
  Commercial                                                             $11,600,892              $ 9,359,223
  Real estate - mortgage                                                  39,055,029               37,317,500
  Real estate - construction                                               1,421,877                1,626,634
  Installment and consumer loans                                           4,487,861                3,717,860
                                                                         -----------              -----------
     Total gross loans                                                    56,565,659               52,021,217

  Less - allowance for loan losses                                          (894,845)                (889,384)
                                                                         -----------              -----------

     Loans, net                                                          $55,670,814              $51,131,833
                                                                         ===========              ===========

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

<CAPTION>

                                                                                 Years Ended December 31,
                                                                         ------------------------------------
                                                                             1998                     1997
                                                                         -----------              -----------

Balance, beginning of year                                               $   889,384              $   842,715
Provision charged to operations                                               65,500                   88,333
Loans charged-off                                                            (81,338)                 (48,690)
Recoveries                                                                    21,299                    7,026
                                                                                                  -----------

   Balance, end of year                                                  $   894,845              $   889,384
                                                                         ===========              ===========
</TABLE>

                                          (Notes continued on next page)

                                      F-15
<PAGE>
<TABLE>
NOTE 6 - LOANS (Continued)

         The following is a summary of information pertaining to impaired loans:
<CAPTION>
                                                                                              December 31,
                                                                                     -------------------------------
                                                                                          1998              1997
                                                                                     -------------      ------------
<S>                                                                                  <C>                <C>       
           Impaired loans without a valuation allowance                              $         -        $        -
           Impaired loans with a valuation allowance                                       424,210            26,866
                                                                                     -------------      ------------

           Total impaired loans                                                      $     424,210      $     26,866
                                                                                     =============      ============

           Valuation allowance related to impaired loans                             $     212,100      $     550
                                                                                     =============      ============
<CAPTION>

                                                                                         Years Ended December 31,
                                                                                     -------------------------------
                                                                                          1998              1997
                                                                                     -------------      ------------

           Average investment in impaired loans                                      $     490,000      $     20,000
                                                                                     =============      ============

           Interest income recognized on impaired loans                              $         -        $        -
                                                                                     =============      ============

           Interest income recognized on a cash basis on impaired
              loans                                                                  $         -        $        -    
                                                                                     =============      ============

         No additional  funds are  committed to be advanced in  connection  with
impaired loans.

         Loans on which the accrual of interest has been discontinued  amount to
$424,210 and $26,866 at December 31, 1998 and 1997, respectively. If interest on
these loans had been accrued,  such income would have  approximated  $56,922 and
$3,545 for 1998 and 1997,  respectively.  No interest  income was  recognized or
received on these loans in 1998 and 1997.


NOTE 7 - PREMISES AND EQUIPMENT

         Premises and equipment consist of the following:

<CAPTION>
                                                                                                December 31,
                                                                                    ------------------------------------  
                                                                                           1998                1997
                                                                                    ----------------    ----------------  
               Land and improvements                                                $        612,567    $        252,829
               Buildings                                                                   1,505,217           1,166,522
               Leasehold improvements                                                          7,951               7,951
               Equipment, furniture and fixtures                                           1,043,663           1,182,723
                                                                                    ----------------    ----------------  
                                                                                           3,169,398           2,610,025
               Less - accumulated depreciation                                            (1,159,170)         (1,281,728)
                                                                                    ----------------    ----------------

                                                                                    $      2,010,228    $      1,328,297
                                                                                    ================    ================  
</TABLE>

         Depreciation  charged to operating expense for the years ended December
31, 1998 and 1997 was $116,307 and $71,226, respectively.

                         (Notes continued on next page)

                                      F-16
<PAGE>
<TABLE>
NOTE 8 - DEPOSITS

         Interest bearing deposits consist of the following:

<CAPTION>
                                                                                                December 31,
                                                                                    ------------------------------------  
                                                                                           1998                1997
                                                                                    ----------------    ----------------  
           <S>                                                                      <C>                 <C>             
           Money Market and NOW account deposits                                    $     15,648,268    $     11,870,772
           Savings deposits                                                                4,321,485           4,587,008
           Certificates of deposit $100,000 and over                                      10,405,870           8,128,297
           Other time deposits                                                            32,385,826          35,308,624
                                                                                    ----------------    ----------------

                                                                                    $     62,761,449    $     59,894,701
                                                                                    ================    ================

         At December 31, 1998, the scheduled  maturities of time deposits are as
follows:

           1999                               $   35,489,924
           2000                                    3,913,845
           2001                                    3,362,927
           2002                                          -
           2003                                          -
           Thereafter                                 25,000
                                              --------------

                                              $   42,791,696


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

        Securities sold under  agreements to repurchase  generally mature within
one to four days from the transaction date.  Investment securities with carrying
values of $3,002,067 and $3,019,065 at December 31, 1998 and 1997, respectively,
are pledged to secure these agreements.  Information  concerning securities sold
under agreements to repurchase is summarized, as follows:

<CAPTION>
                                                                                                December 31,
                                                                                    ------------------------------------  
                                                                                           1998                1997
                                                                                    ----------------    ----------------  
           Average balance during the year                                          $     2,081,131     $     1,809,640
                                                                                    ===============     ===============
           Average interest rate during the year                                               4.05%               4.05%
                                                                                    ===============     ===============
           Maximum month end balance during the year                                $     3,149,029     $     2,555,645
                                                                                    ===============     ===============
</TABLE>

        Short-term  borrowings  consist of U.S.  Treasury  tax and loan  deposit
notes,  which are  payable  on demand  and fully  collateralized  by  investment
securities.

        The Bank is a member of the Federal  Home Loan Bank of  Atlanta.  One of
the benefits of membership is a borrowing  capacity of $5.9 million secured by a
blanket floating lien on the unpaid principal balance of the Bank's  one-to-four
unit  residential,  real estate loans. As of December 31, 1998, the Bank had not
borrowed any amounts on this line of credit.



                         (Notes continued on next page)

                                      F-17
<PAGE>
<TABLE>
NOTE 10 - STOCK COMPENSATION PLANS

        At December 31, 1998,  the Bank has fixed stock  compensation  plans for
its officers.  The Bank applies Accounting  Principles Board Opinion No. 25 (APB
25),  Accounting for Stock Issued to Employees,  and related  interpretations in
accounting for its plans. Accordingly,  no compensation cost has been recognized
for these plans  against  earnings.  For those  companies  applying APB 25, FASB
Statement No. 123,  Accounting for Stock-Based  Compensation,  requires  certain
pro-forma  disclosures  of net income  and  earnings  per share.  Net income and
earnings  per share  computed  under FASB  Statement  No. 123 do not  materially
differ from the amounts reported.

        All options have ten year terms,  vest and become fully  exercisable  in
three years. The option exercise price equals or exceeds the market price of the
stock as of the date the option was granted.  The  following is a summary of the
Bank's  stock  option  activity,  and  related  information  for the years ended
December 31,:

<CAPTION>
                                                        1998                               1997
                                              --------------------------          --------------------------
                                                               Weighted-                           Weighted-
                                                               Average                             Average
                                                               Exercise                            Exercise
                                              Options           Price             Options           Price
                                              -------           -----             -------           -----
<S>                                            <C>              <C>               <C>               <C>  
Outstanding - Beginning of year                99,850           $7.45             110,750           $7.39
Granted                                           -               -                   -               -
Exercised                                      (6,200)           6.32             (10,900)           6.79
Forfeited                                         -               -                   -               -

Outstanding - End of year                      93,650           $7.52              99,850           $7.45

Exercisable - End of year                      78,575           $6.87              67,913           $6.87



NOTE 11 - INCOME TAXES

        The principal components of income tax expense are as follows:

<CAPTION>
                                                                                         Years Ended December 31,
                                                                                    --------------------------------  
                                                                                          1998               1997
                                                                                    -------------       ------------
        Federal income tax expense - current                                          $  444,824         $  479,492

        Deferred federal income tax expense (benefit)                                    (24,187)           (39,758)
                                                                                      ----------         ---------- 

        Income tax expense                                                            $  420,637         $  439,746
                                                                                      ==========         ==========
</TABLE>

                         (Notes continued on next page)

                                      F-18
<PAGE>
<TABLE>
NOTE 11 - INCOME TAXES (Continued)

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

<CAPTION>
                                                                                         Years Ended December 31,
                                                                                    --------------------------------  
                                                                                          1998               1997
                                                                                    -------------       ------------

        <S>                                                                           <C>              <C>         
        Federal income tax expense - at statutory rate                                $  458,061       $    459,276
        Tax effect of:
           Tax exempt interest                                                           (44,763)           (21,003)
           Exercised stock options                                                        25,030             20,228
           Other                                                                         (17,691)           (18,755)
                                                                                      ----------       ------------

        Income tax expense                                                            $  420,637       $    439,746
                                                                                      ==========       ============

         The Company has the following  deferred tax assets and  liabilities  at
December 31, 1998 and 1997:
<CAPTION>
                                                                                          1998               1997
                                                                                    -------------       ------------
            Deferred tax assets:
               Deferred compensation                                                  $   89,522       $     94,028 
               Bad debts and other provisions                                            288,603            276,116
               Other                                                                      19,208             11,895
               Interest income                                                            23,467              3,991
                                                                                    -------------       ------------

            Total deferred tax asset                                                     420,800            386,030
                                                                                    -------------       ------------

            Deferred tax liabilities:
            Deferred loan fees                                                           (36,247)           (41,666)
            Discount accretion on securities                                             (14,423)           (17,300)
            Net unrealized appreciation on available-for-
               sale securities                                                           (47,394)           (29,167)
            Fixed assets                                                                 (39,800)           (21,101)
                                                                                    -------------       ------------
                                                                                        (137,864)          (109,234)
                                                                                    -------------       ------------

            Net deferred tax asset                                                     $  282,936           $276,796
                                                                                      ==========       ============
</TABLE>

NOTE 12 - COMMITMENTS AND CONTINGENCIES- RELATED PARTY

        The Company has entered into a long-term  lease with a related  party to
provide space for one branch and the Bank's  operations  center.  This lease has
been classified as an operating lease for financial reporting  purposes.  Future
minimum  lease  payments of $64,439 are required  each year for five years under
the long-term  non-cancellable  lease  agreement as of December 31, 1996,  which
expires in December,  2001.  Total lease  expense was $64,439 for the years 1998
and 1997, respectively.



                         (Notes continued on next page)

                                      F-19
<PAGE>

NOTE 13 - OTHER RELATED PARTY TRANSACTIONS

        The Bank  has  loan and  deposit  transactions  with  its  officers  and
directors,  and with  companies  in which  the  officers  and  directors  have a
financial interest.  Related party deposits amounted to approximately $5,640,000
and  $7,270,000  at  December  31, 1998 and 1997,  respectively.  In addition to
related party  deposits,  securities  sold under  agreements to repurchase  with
related parties  amounted to  approximately  $646,000 and $1,840,000 at December
31, 1998 and 1997,  respectively.  A summary of related  party loan activity for
Heritage Bank and Trust is as follows during 1998:


Balance, December 31, 1997              $   4,272,012
Originations - 1998                         3,333,165
Repayments - 1998                          (2,699,969)
                                        -------------

Balance, December 31, 1998              $   4,905,208
                                        =============

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

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

        Commitments  to extend  credit and letters of credit to related  parties
amounted  to  $1,365,800   and   $1,181,800  at  December  31,  1998  and  1997,
respectively.


NOTE 14 - CREDIT COMMITMENTS AND CONCENTRATIONS OF CREDIT RISK

        The Bank has  outstanding  at any time a  significant  dollar  amount of
commitments to extend  credit.  To accommodate  major  customers,  the Bank also
provides  standby  letters  of credit and  guarantees  to third  parties.  Those
arrangements  are subject to strict credit control  assessments.  Guarantees and
standby letters of credit specify limits to the Bank's obligations.  The amounts
of loan commitments, guarantees and standby letters of credit are set out in the
following table as of December 31, 1998 and 1997.  Because many  commitments and
almost all standby letters of credit and guarantees  expire without being funded
in whole or in part,  the  contract  amounts  are not  estimates  of future cash
flows.  The majority of  commitments to extend credit have terms up to one year.
Interest rates on fixed-rate commitments range from 14% to 18%.
<TABLE>
<CAPTION>
                                                                    1998                                 1997
                                             ----------------------------------------------------------------
                                               Variable Rate       Fixed Rate      Variable Rate     Fixed Rate
                                                Commitments       Commitments       Commitments      Commitments

     <S>                                          <C>               <C>               <C>              <C>       
     Loan Commitments                             $  10,492,268     $  2,149,258      $  8,651,143     $  904,068

     Standby letters of credit and
        guarantees written                        $  400,465        $  47,000         $  100,000       $  223,166
</TABLE>

     All of the guarantees outstanding at December 31, 1998 expire during 1999.

                         (Notes continued on next page)

                                      F-20
<PAGE>

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

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

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

        The credit risk amounts represent the maximum accounting loss that would
be recognized  at the  reporting  date if  counterparties  failed  completely to
perform as contracted and any  collateral or security  proved to be of no value.
The  Bank  has  experienced  little  difficulty  in  accessing  collateral  when
required. The amounts of credit risk shown,  therefore,  greatly exceed expected
losses, which are included in the allowance for loan losses.


NOTE 15 - REGULATORY MATTERS

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


                         (Notes continued on next page)

                                      F-21
<PAGE>

NOTE 15 - REGULATORY MATTERS (Continued)

         Quantitative  measures  established  by  regulation  to ensure  capital
adequacy  require the Bank to maintain  minimum amounts and ratios (set forth in
the table below) of total and Tier I capital (as defined in the  regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as  defined).  Management  believes,  as of December 31, 1998,  the Bank
meets all capital adequacy requirements to which it is subject.

         As of March 31,  1998,  the most recent  notification  from the Federal
Reserve  Bank of Richmond  categorized  the Bank as well  capitalized  under the
regulatory  framework for prompt  corrective  action.  To be categorized as well
capitalized,   the  Bank  must  maintain  minimum  total  risk-  based,  Tier  I
risk-based,  and Tier I leverage ratios as set forth in the table.  There are no
conditions  or events since that  notification  that  management  believes  have
changed the institution's category.

         The Bank's actual capital  amounts and ratios are also presented in the
table.
<TABLE>
<CAPTION>
                                                                                              To Be Well
                                                                                          Capitalized Under
                                                                    For Capital           Prompt Corrective
                                              Actual              Adequacy Purposes       Action Provisions
                                         ----------------         -----------------       -----------------
                                         Amount     Ratio         Amount     Ratio         Amount     Ratio 
                                         ------     -----         ------     -----         ------     ----- 
<S>                                   <C>           <C>        <C>           <C>        <C>           <C>   
As of December 31, 1998:
   Total Capital
   (to Risk-Weighted Assets)          $ 8,734,000   14.73%     $ 4,711,000   8.00%      $ 5,889,000   10.00%
   Tier I Capital                                                                  
   (to Risk-Weighted Assets)          $ 7,991,000   13.48%     $ 2,355,000   4.00%      $ 3,533,000    6.00%
   Tier I Capital
   (to Average Assets)                $ 7,991,000    9.24%     $ 3,460,000   4.00%      $ 4,326,000    5.00%

<CAPTION>
                                                                                              To Be Well
                                                                                          Capitalized Under
                                                                    For Capital           Prompt Corrective
                                              Actual              Adequacy Purposes       Action Provisions
                                         ----------------         -----------------       -----------------
                                         Amount     Ratio         Amount     Ratio         Amount     Ratio 
                                         ------     -----         ------     -----         ------     ----- 
As of December 31, 1997:
   Total Capital
   (to Risk-Weighted Assets)          $ 7,663,000   15.07%     $ 4,068,000   8.00%      $ 5,085,000   10.00%
   Tier I Capital                                                                  
   (to Risk-Weighted Assets)          $ 7,024,000   13.81%     $ 2,034,000   4.00%      $ 3,051,000    6.00%
   Tier I Capital
   (to Average Assets)                $ 7,024,000    8.63%     $ 3,255,000   4.00%      $ 4,069,000    5.00%
</TABLE>

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


                         (Notes continued on next page)

                                      F-22
<PAGE>

NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS

        The following table presents the carrying  amounts and fair value of the
Bank's  financial  instruments at December 31, 1998 and 1997. FASB Statement No.
107,  Disclosures  about Fair Value of Financial  Instruments,  defines the fair
value of a financial  instrument as the amount at which the instrument  could be
exchanged in a current  transaction  between  willing  parties,  other than in a
forced or liquidation  sale.  The carrying  amounts in the table are included in
the balance sheet under the indicated captions.

<TABLE>
<CAPTION>
                                                          1998                      1997
                                                -----------------------   ----------------------
                                                 Carrying       Fair        Carrying     Fair
                                                  Amount        Value        Amount      Value
                                                ---------     ---------   ---------    ---------
                                                 (Dollars in thousands)    (Dollars in thousands)
<S>                                             <C>           <C>         <C>          <C>      
Financial Assets:
        Cash and cash equivalents               $   7,061     $   7,061   $   5,716    $   5,716
        Loans (net)                                56,609        58,806      51,242       52,688
        Investment securities                      19,434        19,509      22,595       22,641
        Accrued interest receivable                   579           579         692          692

Financial Liabilities:                                                         
        Deposit liabilities                        77,540        78,095      72,797       73,049
        Accrued interest payable                      318           318         342          342
        Short-term borrowings                          63            63          52           52
        Securities sold under
          agreements to repurchase                    981           981       1,945        1,945
</TABLE>

        Estimation of Fair Values

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

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

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

                         (Notes continued on next page)

                                      F-23
<PAGE>

NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

        Estimation of Fair Values (continued)

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

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

        The carrying amounts of accrued interest approximate fair value.

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


NOTE 17 - EARNINGS PER SHARE RECONCILIATION

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

<TABLE>
<CAPTION>
                                                                               1998               1997
                                                                         -----------------  ----------------
<S>                                                                      <C>                <C>             
Net income (numerator, basic and diluted)                                $      1,062,511   $        979,970

Weighted average shares outstanding (denominator)                                 799,496            790,450
                                                                         ----------------   ----------------

        Earnings per common share-basic                                  $           1.33      $        1.24
                                                                         ================   ================

Effect of dilutive securities:

Weighted average shares outstanding                                      $        799,496   $        790,450
Effect of stock options                                                            51,895             46,470
                                                                         ----------------   ----------------
Diluted average shares outstanding (denominator)                                  851,391            836,920
                                                                         ----------------   ----------------

        Earnings per comon share-assuming dilution                       $           1.25   $           1.17                       
                                                                         ================   ================
</TABLE>



                                                     * * * * *







                                      F-24