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Prospectus filed pursuant to rule 424(a)
Registration No. 333-50277
PROSPECTUS
HERITAGE LOGO
Up to 387,097 Shares of Common Stock
$15.50 Per Share
(Minimum Purchase 100 Shares)
Heritage Commerce Corp (the "Company") is hereby offering for sale (the
"Offering") up to 387,097 shares of the Company's common stock, no par value
(the "Common Stock"), at $15.50 per share. The Company was recently incorporated
as a bank holding company with Heritage Bank of Commerce (the "Bank") as its
only subsidiary. The Offering is not underwritten and is not conditioned on the
sale of any minimum number of shares.
Prior to this Offering, there has been a limited trading market for the
Common Stock of the Bank and the Company, and it is expected that this same
limited market will continue to exist for the Common Stock of the Company. See
"TRADING HISTORY AND DIVIDENDS." The Company's Common Stock is listed on the
Over-the-Counter Electronic Bulletin Board under the symbol "HTBK." No assurance
can be given that an active market will develop as a result of this Offering.
See "RISK FACTORS." On June 2, 1998 the Company applied to the National
Association of Securities Dealers for inclusion of the Common Stock for
quotation on the Nasdaq National Market as of the completion of the Offering. No
assurance can be given that the Common Stock will be approved for quotation on
the Nasdaq National Market.
THIS OFFERING INVOLVES CERTAIN RISK FACTORS TO PROSPECTIVE
PURCHASERS. SEE "RISK FACTORS" AT PAGE 5 HEREOF.
THE SHARES OF COMMON STOCK OFFERED HEREBY ARE NOT SAVINGS OR DEPOSIT
ACCOUNTS AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
BANK INSURANCE FUND OR ANY OTHER GOVERNMENTAL AGENCY.
THE SECURITIES OFFERED HEREBY HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION ("SEC") OR ANY STATE SECURITIES COMMISSION
NOR HAS THE SEC OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
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PRICE TO PROCEEDS TO PERCENT
PUBLIC THE COMPANY(1) OF TOTAL
- ---------------------------------------------------------------------------------------------------------
Per Share.............................. $15.50 $15.11 97.50%
Total Maximum(2)....................... $6,000,000 $5,850,000 97.50%
=========================================================================================================
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(1) After deducting direct Offering expenses payable by the Company estimated at
$150,000.
(2) Assuming sale of all 387,097 shares offered hereby. The Offering is not
subject to the sale of any minimum number of shares.
The shares of Common Stock are offered by the Company, subject to receipt
and acceptance by the Company and subject to the Company's right to reject any
order in whole or in part. It is expected that delivery of the certificates
representing such shares will be made 10 days following the closing date of the
Offering.
The Company intends to sell the shares through its directors and officers
on a "best efforts" basis. The Company will place subscription funds in an
impound account at the Bank. Upon completion of the Offering, subscription funds
representing accepted subscriptions will be paid from the impound account to the
Company. It is a condition of this Offering that the Common Stock be approved
for quotation on the Nasdaq National Market. Should Nasdaq not accept the
Company for listing, the Offering will be terminated and all subscription funds
returned to each respective subscriber.
The Offering commences immediately upon the effective date of this
Prospectus and shall remain open for up to 60 days thereafter except as follows:
This Offering may be terminated early or may be extended by up to 30 days. Any
extension or early termination of this Offering is at the discretion of the
Company. The Offering will be closed not later than 90 days from the date of
this Prospectus.
The date of this Prospectus is June 19, 1998.
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and notes thereto contained elsewhere in
this Prospectus. Prospective purchasers are urged to read carefully this entire
Prospectus before making any decision relating to the purchase of the shares
offered hereby. This Prospectus contains forward-looking statements. Heritage
Commerce Corp's actual results could differ materially from those anticipated in
such forward-looking statements as a result of a variety of factors, including
those set forth in the section entitled "Risk Factors" and elsewhere in this
Prospectus.
THE COMPANY
Heritage Commerce Corp (the "Company") was recently incorporated as a
for-profit corporation under the California General Corporation Law for the
principal purpose of engaging in activities permitted for a bank holding
company. The Company was formed by the directors and officers of Heritage Bank
of Commerce (the "Bank") for the purpose of acquiring and managing the Bank. To
complete the acquisition of the Bank, the Company exchanged 3,295,896 common
shares on a share-for-share basis for those outstanding common shares of the
Bank, effective February 17, 1998. The Company is registered with the Board of
Governors of the Federal Reserve System (the "FRB") as a bank holding company.
The Company acts as a holding company for the Bank and is a legal entity
separate and distinct from the Bank. The operations of the Company are conducted
at the same location and in the same facilities as the operations of the Bank.
The Company does not expect to engage in activities other than the operation of
subsidiary banks in the immediate future. The Company may receive income from
dividends made to it by the Bank. However, the Bank has no formal dividend
policy, and dividends are issued solely in the discretion of the Bank's Board of
Directors. There can be no assurance as to when or whether such a dividend will
be paid or the amount thereof. The Bank currently has an accumulated deficit
which precludes the payment of cash dividends to the Company without the consent
of the Commissioner of the Department of Financial Institutions (the
"Commissioner"). See "SUPERVISION AND REGULATION" for dividend restrictions.
Heritage Bank of Commerce, the Company's only subsidiary, commenced
operations on June 8, 1994. The Bank was organized to address the needs of
small, closely-held businesses and their owners in the community of San Jose,
California and the surrounding cities. Consolidation in the local banking
market, particularly among independent, community banks, left a competitive void
that the founders of the Bank sought to fill with an institution devoted to a
more highly customized service approach. The Bank offers financial solutions
tailored to the particular needs of its clients, rather than the less personal
approach used by many of the Bank's larger competitors. With an initial
capitalization in excess of $14 million, the Bank invested heavily in technology
to maximize employee efficiency.
As a result, the Bank has, in the intervening three and one-half years,
developed a wide array of products and services for small businesses and their
owners, such as factoring, SBA-guaranteed loans, construction loans, light
aircraft financing, and personal computer-based on-line cash management,
together with more common products such as accounts receivable lines of credit
and traditional passbook savings accounts. In addition, the Bank has developed
an expertise in other specialized areas such as deposit services for U.S.
bankruptcy trustees. The Bank's ability to develop such specialized expertise
has been instrumental in its rapid deposit growth. A second equity offering to
the public in 1996 that raised an additional $6,000,000 in capital provided a
base for continued asset growth and higher lending limits. Recently, the Bank
has expanded its geographic reach with the opening of a branch office in
Fremont, California.
At March 31, 1998, the Bank had total assets of $328,976,000, total
deposits of $304,165,000, total loans of $142,988,000, and total equity of
$22,825,000. As the Company's sole business is the management of the Bank, the
Company's balance sheet will generally mirror the Bank's.
The activities of the Company will be subject to the supervision of the
FRB. The Company may engage, directly or through subsidiary corporations, in
those activities closely related to banking which are specifically permitted
under the Bank Holding Company Act of 1956, as amended ("BHCA").
The mailing address of the Company is 150 Almaden Boulevard, San Jose,
California 95113. Its telephone number is (408) 947-6900.
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THE OFFERING
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Securities Offered........................... 387,097 shares of Common Stock (no par value)
Common Stock Outstanding at March 31, 1998... 3,295,896 shares
Common Stock to be Outstanding After the 3,682,993 (maximum) shares (1)
Offering...................................
Use of Proceeds.............................. For general corporate purposes except as required for
capital with which to organize a de novo bank in
Fremont, California. See "USE OF PROCEEDS."
Over-the-Counter Electronic Bulletin Board
Symbol..................................... "HTBK"
Expiration Date.............................. 60 days from the date of this Offering, unless
terminated earlier or extended by the Company by up to
30 days
Method of Subscription....................... By Subscription Application, with payment made to the
Impound Account subject to the terms described in this
Prospectus(2)
Minimum Subscription......................... 100 shares
Minimum to be Sold in the Offering........... This Offering is not conditioned on the sale of any
minimum number of shares
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(1) Based on 3,295,896 shares of common stock outstanding on March 31, 1998.
Assumes sale of all 387,097 shares offered hereby. This Offering is not
subject to the sale of any minimum number of shares. Excludes 484,692 shares
of Common Stock issuable upon exercise of outstanding options to purchase
Common Stock as of March 31, 1998. See "REMUNERATION AND OTHER TRANSACTIONS
WITH MANAGEMENT" and Note 8 to the financial statements.
(2) See STOCK SUBSCRIPTION APPLICATION, Appendix "A".
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SELECTED FINANCIAL DATA
The following table presents a summary of selected financial information
for the Company's only subsidiary, Heritage Bank of Commerce, and except for the
column entitled "for the Three Months Ended March 31, 1998" does not contain
information with regards to the Company since the Company did not become the
holding company for the Bank or commence operations until February 1998. This
information should be read in conjunction with the Bank's and the Company's
financial statements and notes thereto included within this Prospectus. The
financial information for the years ended December 31, 1997, 1996, 1995 and 1994
is derived from audited financial statements. The financial statements for March
31, 1998 and 1997 are unaudited. Results of operations for the three months
ended March 31, 1998 are not necessarily indicative of results of operations for
the remainder of 1998.
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<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
----------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 (1)
---------- ---------- ---------- ---------- ---------- ----------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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INCOME STATEMENT DATA:
Interest income................... $ 5,172 $ 3,394 $ 16,251 $ 10,525 $ 6,421 $ 1,244
Interest expense.................. 1,342 902 4,204 2,646 1,696 217
---------- ---------- ---------- ---------- ---------- ----------
Net interest income before
provision for loan losses....... 3,830 2.492 12,047 7,879 4,725 1,027
Provision for loan losses......... 160 220 1,060 830 496 76
---------- ---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan losses....... 3,670 2,272 10,987 7,049 4,229 951
Non-interest income 79 74 590 296 71 18
Non-interest expenses............. 3,018 1,812 9,168 5,724 4,098 2,976
---------- ---------- ---------- ---------- ---------- ----------
Income (loss) before income
taxes........................... 731 534 2,409 1,621 202 (2,007)
Provision for income taxes........ 278 187 844 220 1 1
---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)................. $ 453 $ 347 $ 1,565 $ 1,401 $ 201 $ (2,008)
========== ========== ========== ========== ========== ==========
PER SHARE DATA (2):
Basic net income (loss) (3)....... $ 0.14 $ 0.11 $ 0.48 $ 0.48 $ 0.08 $ (0.82)
Diluted net income (loss) (4)..... 0.12 0.10 0.45 0.46 0.08 (0.82)
Book value (5).................... 6.93 6.20 6.78 6.56 6.03 5.56
Average number of shares
outstanding during the year..... 3,295,896 3,287,823 3,291,689 2,912,263 2,444,912 2,440,147
Average number of shares and
equivalents outstanding during
the year........................ 3,665,846 3,288,120 3,480,237 3,033,953 2,476,929 2,440,147
Number of shares outstanding at
year-end........................ 3,295,896 3,287,239 3,295,896 3,130,696 2,125,534 2,112,681
BALANCE SHEET DATA:
Investment securities............. $ 97,588 $ 69,940 $ 87,697 $ 75,268 $ 51,449 $ 30,336
Total loans before allowance for
loan losses..................... 142,988 90,106 126,485 81,513 41,950 10,455
Allowance for loan losses......... 2,540 1,622 2,285 1,402 572 76
Total assets...................... 328,976 207,573 267,575 173,303 132,160 59,037
Total deposits.................... 304,165 186,005 242,978 146,379 118,746 47,082
Total shareholders' equity........ 22,825 20,377 22,336 20,524 12,829 11,741
SELECTED PERFORMANCE RATIOS:
Return on average assets (6)(7)... 0.68% 0.88% 0.74% 0.96% 0.22% n/m
Return on average equity (7)...... 8.10% 6.90% 7.38% 8.56% 1.67% n/m
Net interest margin............... 6.45% 5.97% 6.23% 5.99% 5.81% 5.13%
Average net loans after allowance
for loan losses as a percentage
of average deposits............. 55% 52% 52% 48% 37% 17%
Average total shareholders' equity
as a percentage of average total
assets.......................... 9% 11% 10% 11% 13% 31%
SELECTED ASSET QUALITY RATIOS (8):
Net loan charge-offs to average
loans(7)........................ -- -- 0.18% -- -- --
Allowance for loan losses to total
loans........................... 1.78% 1.80% 1.77% 1.69% 1.34% 0.73%
CAPITAL RATIOS (9):
Tier 1 risk-based................. 13.1% 19.1% 14.6% 21.4% 22.5% 75.9%
Total risk-based.................. 14.6% 20.4% 15.8% 22.6% 23.6% 76.4%
Leverage.......................... 8.4% 11.3% 10.3% 13.9% 13.5% 29.6%
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(1) Figures for 1994 are for the 207 day period from June 8 (inception) to
December 31, 1994 and include pre-opening expenses of $1,080,000.
(2) All share figures are adjusted to reflect (i) a 10% stock dividend paid to
shareholders of record as of February 5, 1996; (ii) a 5% stock dividend
payable to shareholders of record as of February 5, 1997; and (iii) a
3-for-2 stock split payable to shareholders of record as of August 1, 1997,
except number of shares outstanding at year-end, which are only adjusted
retroactively to reflect the 3-for-2 stock split. All prior period per share
amounts have been restated for the implementation of SFAS No. 128, as
described in Note 1 to the financial statements.
(3) Represents net income (loss) divided by the average number of shares of
common stock outstanding for the respective period.
(4) Represents net income (loss) divided by the average number of shares of
common stock and common stock-equivalents outstanding for the respective
period.
(5) Represents shareholders' equity divided by the number of shares of common
stock outstanding at the end of the period indicated.
(6) Average balances used in this table and throughout this Prospectus are based
on daily averages.
(7) Return on average assets, return on average equity and net loan charge-offs
to average loans for the three months ended March 31, 1998 and 1997 are
annualized.
(8) Non-performing assets consist of non-accrual loans, loans past due 90 days
or more, restructured loans, and other real estate owned. As of the dates
indicated, the Bank had no non-performing assets, accordingly no
non-performing asset to loan ratios are presented.
(9) The Risk-Based and Leverage Capital ratios are defined in "SUPERVISION AND
REGULATION -- Capital Adequacy Guidelines."
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RISK FACTORS
This Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in such forward-looking statements as a result of a variety of
factors, including those set forth in the following risk factors and elsewhere
in this Prospectus. In evaluating an investment in the Company's Common Stock,
prospective investors should consider carefully the following risk factors in
addition to the other information presented in this Prospectus.
Adverse Economic Conditions; Dependence on Technology Industry. Commencing
in 1990, and lasting until 1996, the California economy was affected by an
economic downturn. While improvement has been seen in the Company's service
area, should the economic recovery stall in the Company's Santa Clara Valley
market area (the southern portion of the San Francisco Bay Area), or should
economic conditions worsen, the Company's business could be adversely affected,
including the demand for new loans, refinancing activity, the ability of
borrowers to repay outstanding loans and the value of the property held as
collateral for outstanding loans. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Loan Portfolio." The economy of
the Company's service area is dominated by the technology industry. Any softness
in the technology industry could have an adverse effect on local market
conditions and on the Company's financial condition and results of operations.
The Company's Limited Operating History. At December 31, 1997, the Company
had only recently been incorporated and had yet to transact business, while the
Bank had completed just over three full years of operations. No assurance can be
given that the Company will be able to engage in any activity other than
ownership of the Bank. No assurance can be given that the Bank will continue to
increase in asset size at the rate it has grown since inception or that results
of future operations can be predicted from its past operating history. See
"TRADING HISTORY AND DIVIDENDS -- Dividends," "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," "COMPETITION" and
"USE OF PROCEEDS."
Limited Trading Market. While the Company's Common Stock is not subject to
any specific restrictions on transfer, prior to this Offering there has been
only a limited trading market for the Company's Common Stock. No assurance can
be given that an active public market will develop as a result of this Offering
or at any time in the future. See "TRADING HISTORY AND DIVIDENDS -- Trading
History."
Arbitrary Offering Price. The Offering Price has been set by the Company.
The Offering Price does not reflect the price at which the Company's Common
Stock currently trades, nor does the offering price necessarily reflect the
price at which the Company's Common Stock will trade following this Offering.
Immediate Dilution to Shareholders. The Offering Price per share exceeds
the Company's book value per share. Based upon the Offering Price and the book
value per share as of March 31, 1998, the sale of the Common Stock in this
Offering will result, for new shareholders, in an immediate dilution of $7.71
per share for each of the shares offered hereby (assuming a fully-subscribed
Offering). The exercise of outstanding stock options would result in additional
dilution of $0.19 per share to new shareholders. See "DILUTION." See
"DETERMINATION OF OFFERING PRICE." This Offering is not conditioned on the sale
of any minimum number of shares.
Lack of Dividends. The ability of the Company to pay cash dividends in the
future will depend on the Company's profitability, growth, capital needs and
compliance with regulatory capital requirements. The Board of Directors of the
Company currently intends to retain earnings, if any, to support growth and has
no present intention of paying dividends in the forseeable future. There can be
no assurance as to when or whether the Company will pay a dividend. See "TRADING
HISTORY AND DIVIDENDS -- Dividends."
Competition. In California generally, and in the Company's service area
specifically, major banks dominate the commercial banking industry. By virtue of
their larger capital bases, such institutions have substantially greater lending
limits than those of the Company's only subsidiary, the Bank, as well as more
locations, products and services. In obtaining deposits and in making loans, the
Bank competes with these larger commercial banks and other financial
institutions, such as savings and loan associations and credit unions, which
offer most services traditionally offered only by banks. In addition, the Bank
competes with
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other institutions such as money market funds, brokerage firms, and even retail
stores seeking to penetrate the financial services market. Such competition may
have an adverse effect on the Company. See "BUSINESS OF THE
BANK -- Competition."
General Lending Risks. The Bank is engaged primarily in commercial,
consumer and real estate lending. The risk of nonpayment of loans is inherent in
the lending business. The ability of borrowers to repay their obligations can be
adversely affected by factors beyond the control of the Bank, including local
and general economic and market conditions. A substantial portion of the Bank's
loans are secured by real estate. These same factors may adversely affect the
value of real estate as collateral. The Bank maintains an allowance for loan
losses and periodically makes additional provisions to the allowance to reflect
the level of losses determined by management to be inherent in the loan
portfolio. However, the level of the allowance and the amount of such provisions
are only estimates based on management's judgment, and there can be no assurance
that actual losses incurred will not exceed the amount of the allowance or
require substantial additional provisions to the allowance.
At March 31, 1998, land and construction loans comprised 20% of the Bank's
loan portfolio, compared to 20% and 14% at December 31, 1997 and 1996. Land and
construction loans are generally considered to involve greater risk of loss than
other forms of commercial lending. The increase in these types of loan
represents an increase in the risk profile of the Bank's loan portfolio.
Dependence on Key Personnel. The Company is dependent upon a limited number
of key management and technical personnel. The Company's future success will
depend in part upon its ability to attract and retain highly qualified
personnel. The Company competes for such personnel with other companies and
other organizations. There can be no assurance that the Company will be
successful in retaining or hiring qualified personnel. The loss of any of the
Company's senior management or sales and marketing personnel, particularly to
competitors, could have a material adverse effect on the Company's business,
financial condition, results of operations and cash flows. See "MANAGEMENT AND
PRINCIPAL SHAREHOLDERS."
Government Regulation and Legislation. The Company and its operations are
subject to extensive state and federal regulation, supervision and legislation,
and the laws that govern the Company and its operations are subject to change
from time to time. From time to time, legislation is enacted which has the
effect of increasing the cost of doing business, limiting or expanding
permissible activities or affecting the competitive balance between banks and
other financial institutions. Proposals to change the laws and regulations
governing the operations and taxation of banks, bank holding companies and other
financial institutions are frequently made in Congress, in the California
legislature and before various bank regulatory and other professional agencies.
For example, the legislature periodically considers legislation to repeal the
current statutory restrictions on affiliations between commercial banks and
securities firms. Should major legislative changes occur, the impact such
changes might have on the Company or the Bank are impossible to predict.
The Company is subject to the BHCA and to regulation and supervision by the
FRB. The Bank is subject to supervision and regulation by the Federal Deposit
Insurance Corporation ("FDIC") and by the commissioner. These regulations are
intended primarily for the protection of depositors and consumers, rather than
for the benefit of investors. The Company and the Bank are subject to changes in
federal and state law, as well as changes in regulation and governmental
policies, income tax laws and accounting principles. The effects of any
potential changes could adversely affect the business and operations of the
Company and the Bank in the future.
The commercial banking business is also influenced by the monetary and
fiscal policies of the federal government and the policies of regulatory
agencies, particularly the FRB. The FRB implements national monetary policies
(with objectives such as curbing inflation and combating recession) by its
open-market operations in United States government securities, by adjusting the
required level of reserves for financial institutions subject to its reserve
requirements, and by varying the interest rates applicable to borrowings by
depository institutions. The actions of the FRB in these areas influence the
growth of bank loans, investments, and deposits and also affect interest rates
charged on loans and paid on deposits. Future changes in monetary policies could
have an impact on the Company. See "SUPERVISION AND REGULATION."
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The FRB has adopted a policy which requires a bank holding company, such as
the Company, to serve as a source of financial strength to its banking
subsidiaries. The FRB has ordered bank holding companies to contribute cash to
their troubled bank subsidiaries based upon this "source of strength" policy.
This policy could have the effect of decreasing funds available for
distributions to shareholders. In addition, a bank holding company in certain
circumstances could be required to guaranty the capital plan of an
undercapitalized banking subsidiary. The Bank is not currently undercapitalized,
but there is no guarantee that it (or a de novo bank established by the Company)
will not be undercapitalized in the future.
External Factors Affecting Asset Quality. California is prone to
earthquakes, flooding, and other natural disasters some of which may not be
insurable. The Bank's properties and substantially all of the real and personal
property securing loans in the Bank's portfolio are located in California. The
Bank faces the risk that many of its borrowers may experience uninsured property
damage, sustained interruption of their businesses, or loss of their jobs from
earthquakes, floods or other disasters. As a result, these borrowers may be
unable to repay their loans in accordance with their original terms, and the
allowance for loan losses may not be adequate to cover losses resulting from
such external factors. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- Non-Performing Assets."
Possible Volatility of Stock Price. The Company believes that factors such
as announcements of developments related to the Company's business,
announcements by competitors, quarterly fluctuations in the Company's financial
results, and general conditions in the banking industry or economic conditions
in the areas in which the Company or the Bank does business, and other factors
could cause the price of the Company's Common Stock to fluctuate substantially.
In addition, in recent years the stock market in general and the market for
shares of small capitalization stocks in particular have experienced extreme
price fluctuations, which have often been unrelated to the operating performance
of affected companies. Such fluctuations could have a material adverse effect on
the market price of the Company's Common Stock.
Since this Offering is not underwritten, no transaction will occur that has
the effect of stabilizing bids. Without these types of bids, there are limited
controls over the volatility of Company Common Stock associated with this
Offering.
Risks Relating to Organizing a De Novo Bank. With a portion of the proceeds
of this Offering, the Company intends to organize a de novo bank in Fremont,
California. The Company filed an application to establish a new bank with the
Commissioner on May 22, 1998, and is in the process of filing the necessary
applications with the FDIC. However, no assurances can be given that the Company
will receive permission to organize a de novo bank. Also, no assurances can be
given that the Company will be able to recruit personnel necessary to manage and
operate a de novo bank, or that a de novo bank, if established, will be able to
operate profitability.
If the Company raises capital in the Offering but is not able to increase
its assets and deposit base, through either a new bank or existing operations,
the Company's return on average equity could decline. See "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." See
"SUPERVISION AND REGULATION."
Year 2000. The inability of computers, software, and other equipment
utilizing microprocessors to recognize and properly process data fields
containing a two-digit year is commonly referred to as the Year 2000 Compliance
issue. As the year 2000 approaches, such systems may be unable to process
accurately certain date-based information.
The Company's vendors have provided appropriate assurances with regard to
these issues. However, there can be no guarantee that these assurances will
prove to be accurate, or that the systems of other companies on which the
Company's systems rely will be timely converted, or that a failure to convert by
another company, or a conversion that is incompatible with the Company's
systems, would not have a material adverse effect on the Company. The Company's
bank subsidiary has begun the process of assessing the credit risk related to
its borrowers' Year 2000 Compliance progress and will integrate a Year 2000
Compliance element into its credit approval process by December 31, 1998.
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The costs of, and the date on which the Company plans to complete the Year
2000 modification and testing process, are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources, third-party modification plans,
and other factors. However, there can be no guarantee that these estimates will
be achieved, and actual results could differ from those plans.
No Underwriter. This Offering is not underwritten. The Offering is not
subject to the sale of any minimum number of shares. No assurance can be given
as to the number of shares, if any, that the Company will sell in the Offering.
The Company may terminate the offering after accepting subscriptions for any
number of shares less than the 387,097 shares offered hereby. Sale of less than
387,097 shares may impair the Company's ability to charter a de novo bank. The
Company's directors and officers have only limited experience in conducting an
offering of common stock.
Geographic Concentration. The Bank's loan portfolio consists almost
entirely of loans to businesses and are secured by real and personal property,
located in California and in particular in Santa Clara County. This lack of
geographic diversification in the loan portfolio could have a material adverse
effect on the Bank's financial condition and results of operation if a cyclical
downturn or natural disaster affected the local economy.
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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus includes forward-looking statements that are based on the
current beliefs of the Company's management as well as assumptions made by and
information currently available to the Company's management. All statements
other than statements of historical facts included in this Prospectus, including
without limitation, statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and "Business of the Company" regarding the Company's or the Bank's
financial position, business strategy and plans and objectives of management of
the Company and the Bank for future operations, are forward-looking statements.
When used in this Prospectus, the words "anticipate," "believe," "estimate,"
"expect" and "intend" and words or phrases of similar meaning, as they relate to
the Company or Bank management, are intended to identify forward-looking
statements.
Although the Company believes that the expectations reflected in such
forward-looking statements are reasonable, it can give no assurance that such
expectations will prove to have been correct. A discussion of important factors
that could cause actual results to differ materially from the Company's
expectations ("cautionary statements") is included under "Risk Factors" and
elsewhere in this Prospectus, including, without limitation, in conjunction with
the forward-looking statements included in this Prospectus. Based upon changing
conditions, if any one or more of these risks or uncertainties materialize, or
if any underlying assumptions prove incorrect, actual results may vary
materially from those described herein as anticipated, believed, estimated,
expected or intended. The Company does not intend to update these
forward-looking statements. All subsequent written and oral forward-looking
statements attributable to the Company or persons acting on its behalf are
expressly qualified in their entirety by the applicable cautionary statements.
USE OF PROCEEDS
The net proceeds from the sale of 387,097 shares of Common Stock offered
hereby are estimated to be approximately $5,850,000 (maximum). No minimum amount
of capital will be raised in the Offering. Although the Company is considered
well capitalized on a consolidated basis under applicable regulatory risk-based
capital guidelines at present, based upon the rate of growth evidenced to date
and on anticipated growth, and assuming current market conditions prevail, the
Company hopes to raise capital in this Offering to support future growth
prospects. The Company intends to use up to $5,500,000 to capitalize a de novo
bank in Fremont, California with the remaining amount to be used for general
corporate purposes. The Company believes, based on discussions with bank
regulators, that the regulators will require not less than this amount of
capital as a condition to approval of a new bank. If the Company does not
establish a de novo bank in Fremont or elsewhere for any reason, including
failure to raise sufficient funds in this Offering to capitalize a de novo bank,
the Company intends to retain any capital received in the Offering and to invest
part or all of such capital in the Bank to support growth in Southern Alameda
County as the Company deems appropriate. Proceeds retained in the Company and
not used to capitalize a new bank will initially be invested in government
securities or other permitted investments and ultimately used in the discretion
of the Board of Directors. No assurance can be given that all of any portion of
the 387,097 shares offered hereby will be sold.
The Company anticipates that future growth may take the form of additional
market share in its current markets, or it may involve geographic expansion. The
Bank recently opened a branch in Fremont, California, in an effort to expand its
market area. If the Company succeeds in opening a de novo bank in Fremont, it
expects (subject to regulatory restrictions) to cause the Bank to transfer the
assets, liabilities and operations of the Fremont branch to the de novo bank.
Certain risks relating to the organizing of a de novo bank are discussed in
"RISK FACTORS -- Risks Relating to Organizing a De Novo Bank." See also
"CAPITALIZATION." If the Company does not succeed in establishing a new bank in
Fremont, it will nevertheless attempt to increase its banking business in
southern Alameda County through its Fremont branch, and any proceeds of the
Offering may be used to support such growth. The Company may engage, directly or
through subsidiary corporations, in those activities closely related to banking
which are specifically permitted under the BHCA.
9
<PAGE> 11
The amount and timing of such uses of the net proceeds will depend on the
capital needs and financial requirements of the Company and on local loan demand
and expansion opportunities. In the interim, proceeds from the Offering will be
invested in securities issued by the U.S. Treasury. No assurance can be given
that any de novo bank will be established or that asset growth will otherwise be
achieved in the future or that, if a de novo bank is established or growth
otherwise achieved, the resulting impact on the Company's financial condition
will be favorable.
DILUTION
At March 31, 1998, the shareholders' equity, or net book value, of the
Company was $22,825,000, or $6.93 per share. Net book value per share represents
the Company's total assets less total liabilities divided by the total number of
shares of Common Stock outstanding, exclusive of shares subject to currently
exercisable options.
Net book value dilution per share represents the difference between the
amount per share paid by the purchasers of Common Stock in the Offering and the
pro forma net book value per share of Common Stock immediately after the
completion of the Offering. After giving effect to the sale by the Company of
the 387,097 shares of Common Stock offered herein at the public offering price
of $15.50 per share and receipt by the Company of the net proceeds therefrom,
the pro forma net book value of the Company at March 31, 1998, would have been a
maximum of approximately $28,675,000 ($7.79 per share). This represents an
immediate decrease in book value per share of $7.71 (maximum) per share to
purchasers of shares in the Offering, as illustrated by the following:
DILUTION IN NET BOOK VALUE PER SHARE TO NEW INVESTORS
<TABLE>
<CAPTION>
ASSUMING 387,097
NEW SHARES IN THE
OFFERING (MAXIMUM)
------------------
<S> <C>
Public offering price per share............................. $15.50
Net book value per share at March 31, 1998.................. 6.93
Increase per share attributable to new investors in the
Offering.................................................. 0.86
Pro forma net book value per share after the Offering....... 7.79
Dilution in net book value per share to new investors....... (7.71)
</TABLE>
In addition, exercise of outstanding stock options would result in
additional dilution to new investors of $0.19 per share (currently exercisable
options) or $0.18 per share (all options).
10
<PAGE> 12
CAPITALIZATION
The following table sets forth the capitalization and capital ratios of the
Company, at March 31, 1998, and as adjusted to give pro forma effect to the
Offering, assuming sale of all 387,097 shares offered hereby:
CAPITALIZATION AND CAPITAL RATIOS
<TABLE>
<CAPTION>
AT MARCH 31, 1998
-------------------------------
AS ADJUSTED FOR THE
ACTUAL OFFERING(1) (MAXIMUM)
------- ---------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Preferred Stock............................................. -- --
Common stock, no par value, 30,000,000 shares authorized;
shares outstanding: 3,295,896 at March 31, 1998 and
3,682,993
as adjusted............................................... $23,447 $29,447
Accumulated deficit......................................... (1,075) (1,075)
Accumulated other comprehensive income...................... 453 453
------- -------
Total shareholders' equity.................................. $22,825 $28,825
======= =======
Capital ratios for the Company(2):
Tier 1 risk-based capital................................... 13.1% 16.6%
Total risk-based capital.................................... 14.6% 18.0%
Leverage.................................................... 8.4% 10.6%
</TABLE>
- ---------------
(1) After payment of direct expenses of the Offering, estimated at $150,000.
(2) Table assumes proceeds of offering are invested in U.S. Treasuries, with a
0% risk factor.
The table above does not reflect shares of Common Stock subject to outstanding
stock options pursuant to the Company's Stock Option Plan. See "REMUNERATION AND
OTHER TRANSACTIONS WITH MANAGEMENT."
For a comparison of the Company's and the Bank's risk-adjusted capital
ratios to applicable regulatory guidelines at December 31, 1997, see footnote 13
to the financial statements.
DETERMINATION OF OFFERING PRICE
Prior to this Offering there has been only limited trading in the Bank's or
the Company's Common Stock. See "TRADING HISTORY AND DIVIDENDS -- Trading
History." The Offering Price per share was determined by the Board of Directors
of the Company after considering several factors, including but not limited to
recent trading prices of the Common Stock, book value per share, earnings per
share, historical results of operations, assessment of the Company's management
and financial condition and market activity of stock for other financial
institutions. The Offering Price does not reflect the price at which the Common
Stock currently trades, nor does the Offering Price necessarily reflect the
price at which the Common Stock will trade following this Offering.
TRADING HISTORY AND DIVIDENDS
TRADING HISTORY
The Company's Common Stock is traded on the Over the Counter Electronic
Bulletin Board under the symbol "HTBK." On June 2, 1998, the Company applied
with the Nasdaq stock market for inclusion of the Common Stock for quotation on
the Nasdaq National Market. It is a condition of this Offering that the Common
Stock be approved for quotation on the Nasdaq National Market. In any event, the
Company expects that there will only be a limited market for the Company's
Common Stock. No assurance can be given that an active trading market will
develop or be sustained for the Common Stock as a result of this Prospectus, or
at any other time in the future.
11
<PAGE> 13
The information in the following table indicates the high and low bid
quotations for the Company's Common Stock since February 17, 1998 and the Bank's
Common Stock before that date for each quarterly period for the last two fiscal
years, and is based upon information provided by certain brokerage firms
handling transactions in the Common Stock. These quotations reflect inter-dealer
prices, without retail mark-up, mark-down, or commission, do not reflect actual
transactions, and do not include nominal amounts traded directly by shareholders
or through other dealers.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1998
Second Quarter (through June 15, 1998)................... $17.00 $14.50
First Quarter............................................ 17.00 15.00
1997
Fourth Quarter........................................... 20.00 16.00
Third Quarter............................................ 14.50 8.67
Second Quarter........................................... 8.50 8.33
First Quarter............................................ 8.67 8.09
1996
Fourth Quarter........................................... 7.93 7.93
No activity
Third Quarter............................................ reported(1)
No activity
Second Quarter........................................... reported(1)
First Quarter............................................ 7.14 6.83
</TABLE>
- ---------------
(1) During the period indicated, the Bank was in the process of completing an
Offering for 825,495 shares at $7.93.
The listed prices reflect (i) a 10 percent stock dividend which was paid on
February 26, 1996, (ii) a 5 percent stock dividend which was paid on February
26, 1997 and (iii) a 3 for 2 stock split on August 15, 1997. Effective February
17, 1998, the Bank's stock was exchanged on a share for share basis with the
stock of the Company with the shares issued pursuant to this exchange mailed to
shareholders as they surrender their Heritage Bank of Commerce shares.
According to management's best knowledge, the most recent trade in the
Common Stock prior to the date of this Prospectus occurred on June 2, 1998 for
200 shares, at a sales price of $17.00 per share. As of March 31, 1998, the
Company had approximately 643 shareholders of record.
DIVIDEND POLICY AND HISTORY
The Company. The Company currently has no intention of paying cash
dividends in the foreseeable future. Payment of cash dividends is subject to the
Company's earnings, financial condition, cash needs, the discretion of the
Company's Board of Directors and compliance with regulatory requirements. For
discussion of regulatory requirements, see "-- Limitations on Dividends" below.
At present, the Board of Directors intends to consider payment of cash dividends
only when the Company achieves significant retained earnings and the Board
determines that retention of earnings is not necessary to support anticipated
growth in assets.
The Bank. The primary source of funds for payment of dividends by the
Company to its shareholders is expected to be the receipt of cash dividends from
the Bank. The Bank's ability to pay dividends to the Company is limited by
applicable state and federal law. See " -- Limitations on Dividends." At
present, the Board of Directors intends to consider payment of cash dividends
only when the Company has positive retained earnings and the Board determines
that retention of earnings is not necessary to support anticipated growth in
assets.
Payment of cash dividends in the future will depend upon the Bank's
earnings and financial condition and other factors deemed relevant by management
including compliance with regulatory requirements. The Bank has an accumulated
deficit which precludes the Bank from paying cash dividends without the consent
of the Commissioner. In April 1998, the Bank received permission from the
Commissioner to pay a cash dividend of
12
<PAGE> 14
$300,000 to the Company. The Company is using the funds to repay its costs of
organization (estimated at $100,000) and to pay costs of the Offering as
incurred.
In December 1995, the Bank's Board of Directors declared a 10% stock
dividend payable to shareholders of record as of February 5, 1996. The payable
date of the dividend was February 26, 1996. In accordance with generally
accepted accounting principles, the Bank accounted for the 1996 transaction by
increasing the recorded accumulated deficit and transferred $1,384,000, the fair
value of the additional shares issued, to permanent capital. All tables in this
document which include share price data, show the effect of this stock dividend.
In January, 1997, the Bank's Board of Directors declared a 5% stock
dividend payable to shareholders of record as of February 5, 1997. The payable
date of the dividend was February 26, 1997. In accordance with generally
accepted accounting principles, the Bank accounted for the 1997 transaction by
increasing the recorded accumulated deficit and transferred $1,304,000, the fair
value of the additional shares issued, to permanent capital. All tables in this
document which include share price data, show the effect of this stock dividend.
In August, 1997, the Bank's Board of Directors declared a 3 for 2 stock
split payable to shareholders of record as of August 1, 1997. In accordance with
generally accepted accounting principles, the Bank accounted for the transaction
by restating all share information to reflect the effect of the split. The
payable date of the split was August 15, 1997. All tables in this document which
include share price data, show the effect of this stock split.
LIMITATIONS ON DIVIDENDS
The Company. A California corporation such as the Company may make a
distribution to its shareholders if the corporation's retained earnings equal at
least the amount of the proposed distribution. In the event sufficient retained
earnings are not available for the proposed distribution, a corporation may
nevertheless make a distribution to its shareholders if, after giving effect to
the distribution, the corporation's assets equal at least 125% of its
liabilities and certain other conditions are met. Since the 125% ratio is
equivalent to a capital-to-assets ratio of 20%, most bank holding companies,
including the Company, based on its current capital ratios, are unable to meet
this last test and therefore may pay cash dividends only if they have sufficient
retained earnings.
A bank holding company may not pay a cash dividend if, as a result, its
capital ratios would fall below regulatory requirements. See "SUPERVISION AND
REGULATION -- Capital Adequacy Requirements." The FRB may prohibit payment of
cash dividends if it determines that such payment might be unsafe or unsound.
The Bank. The legal ability of the Bank to pay dividends to the Company is
subject to restrictions set forth in the California Banking Law and regulations
of the FDIC.
The California Banking Law provides that a state-licensed bank may not make
a cash distribution to its shareholders in excess of the lesser of the
following: (i) the bank's retained earnings, or (ii) the bank's net income for
its last three fiscal years, less the amount of any distributions made by the
bank to its shareholders during such period. However, a bank, with the prior
approval of the Commissioner, may make a distribution to its shareholders of an
amount not to exceed the greater of (i) a bank's retained earnings, (ii) its net
income for its last fiscal year, or (iii) its net income for the current fiscal
year.
The FDIC and the Commissioner have authority to prohibit a bank from
engaging in business practices which are considered to be unsafe or unsound.
Depending upon the financial condition of bank and upon other factors, the FDIC
or Commissioner could assert that payments of dividends or other payments by the
Bank might be such an unsafe or unsound practice.
13
<PAGE> 15
OFFERING AND METHOD OF SUBSCRIPTION
GENERAL
The Prospectus is dated June 19, 1998. The Offering commences this date and
shall remain open for 60 days thereafter, except as follows: this Offering may
be terminated early or may be extended by up to 30 days. Any extension or early
termination of this Offering is at the discretion of the Company.
The Company is offering up to 387,097 shares of its Common Stock for a cash
price of $15.50 per share. A minimum purchase of 100 shares ($1,550) is
required. The Company reserves the right to accept individual subscriptions for
fewer than 100 shares, or to reject or cancel any subscription, in whole or in
part, for any reason whatsoever. Under this Offering, except with the express
consent of the Company, the FRB and the Commissioner, no investor will be
allowed to purchase, directly or indirectly, shares which together with any
shares previously held by the investor, equal or exceed 10% of the Common Stock
of the Company to be outstanding immediately following completion of this
Offering. In addition, under this Offering, except with the express consent of
the Company, no investor will be allowed to purchase in this Offering, directly
or indirectly, shares which together with any shares previously held by the
investor, equal or exceed 5% of the Common Stock of the Company to be
outstanding immediately following completion of this Offering.
This Offering is not underwritten and is not conditioned on the sale of any
minimum number of shares. Only the directors and officers of the Company are
authorized to solicit subscriptions for shares. The directors and officers of
the Company intend to solicit by means of personal and telephone contact with
prospective subscribers, and by direct mailing of the Prospectus. Offers for
shares must be preceded or accompanied by this Prospectus. The persons
authorized to solicit subscriptions may be reimbursed for reasonable expenses,
if any, incurred in connection with the selling of shares.
The Prospectus includes one integral Appendix: Appendix "A," the Stock
Subscription Application ("Application"). Triplicate executable copies of the
Application, together with IRS Form W-9 accompany the Prospectus. The Prospectus
is incorporated by reference in the Application.
See Appendix "A" "STOCK SUBSCRIPTION APPLICATION".
APPLICATION FOR COMMON STOCK
A purchaser may subscribe to purchase shares hereunder by executing and
delivering an Application to the Company together with a check payable to
"Heritage Commerce Corp" in the amount of the purchase price and a completed IRS
Form W-9 Request for Taxpayer Identification Number and Certification.
The Company shall notify each purchaser in writing as to the extent to
which the purchaser's offer is accepted, not later than one month after receipt
of the Application. To the extent the purchaser's offer is not accepted by the
Company, and concurrently with such rejection, the Company will return the
purchaser's unaccepted funds together with interest actually earned thereon.
All funds received from purchasers for the Company's common stock, will be
deposited in an interest-bearing account at Heritage Bank of Commerce (the
"Impound Account"). Funds in the Impound Account will bear simple interest at a
rate of 3% per annum. Any funds in the Impound Account are insured by the FDIC
up to a maximum of $100,000 per purchaser; however, the Company's Common Stock
is not subject to FDIC insurance.
On the last day of the Offering, the Company will conduct a closing at its
premises (the "Closing"). Upon the Closing, funds in the Impound Account
(including any interest earned thereon) attributable to Applications accepted by
the Company shall be released to the Company.
The Company will mail to each purchaser whose application is accepted,
within 10 business days after the Closing, a stock certificate, registered in
the purchaser's name or as directed by the purchaser, representing the
respective Shares subscribed.
14
<PAGE> 16
If the Company does not accept an Application for any reason, the Company
will return funds submitted on account of the purchase price, plus interest
actually earned on such funds while on deposit in the Impound Account.
If for any reason whatsoever, the Offering does not close by 60 days from
the date of the Offering (or by 30 days thereafter, if the Company elects to
extend the Offering), the Company will deliver written notice to each purchaser,
together with funds submitted by each purchaser on account of the purchase
price, plus interest actually earned on such funds while on deposit in the
Impound Account.
See Appendix "A" "STOCK SUBSCRIPTION APPLICATION".
15
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements that involve risks
and uncertainties. The Bank's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in the section entitled "Risk Factors" and elsewhere
in this Prospectus.
OVERVIEW
COMPARISON OF FIRST QUARTER 1998 TO FIRST QUARTER 1997
Net income for the quarter ended March 31, 1998 was $453,000, ($0.14 per
share, basic; $0.12 per share, diluted) as compared to net income of
$347,000,($0.11 per share, basic; $0.10 per share, diluted) for the same period
in 1997. The increase was attributable to growth in the level of earnings assets
overall, and of loans in particular, funded by new deposits at favorable
weighted average rates of interest. Return on average assets annualized for the
first quarter of 1998 was 0.7%, compared to 0.9% for the first quarter of 1997.
Annualized return on average equity for the first quarter of 1998 was 8.1%,
compared to 6.9% for the first quarter of 1997.
Average interest-earning assets for the quarter ended March 31, 1998 were
up $67,348,000 or 40% over 1997, with much of the increase primarily
attributable to growth in loans. The average rate earned on loans in the first
quarter of 1998 was up over 1997, and, as a result of the increase in both rate
and volume of loans, the average rate on earning assets increased to 8.71% for
the quarter ended March 31, 1998, up from 8.15% for the same period of 1997.
Average interest-bearing liabilities were up $41,558,000 or 39% from 1997
to 1998, with the increase primarily attributable to growth in savings and money
market accounts, and secondarily to growth in time deposits of $100,000 or more.
The average rate paid on interest-bearing liabilities increased to 3.65% from
3.41% at March 31, 1998 and 1997, respectively. However, due to the growth in
interest-earning assets and the improvement in yield thereon, the net interest
margin improved to 6.45% in the first quarter of 1998 from 5.97% in 1997.
The Company had no non-performing assets (including nonaccrual loans, loans
90 days past due and still accruing and other real estate owned ("OREO")) at
March 31, 1998, December 31, 1997, and March 31, 1997.
Shareholders' equity increased $489,000 to $22,825,000, or 6.94% of assets,
at March 31, 1998, from $22,336,000 million, or 8.35% of assets, at December 31,
1997. The increase was due primarily to net earnings. The Company's Tier 1 and
total risk-based capital ratios were 13.1% and 14.6%, respectively, at March 31,
1998, compared to 14.6% and 15.8%, respectively, at December 31, 1997, and 19.1%
and 20.4%, respectively, at March 31, 1997. The Company's leverage capital ratio
decreased to 8.4% at March 31, 1998 from 10.3% at December 31, 1997 and 11.3% at
March 31, 1997. At March 31, 1998, the Company's risk-based capital and leverage
ratios exceeded the ratios for a well-capitalized financial institution as
defined in the Federal Deposit Insurance Corporation Improvement Act under the
prompt corrective action regulations.
COMPARISON OF 1997 VERSUS 1996
Net income for the year ended December 31, 1997 was $1,565,000, or $0.48
per share (basic), compared to $1,401,000 or $0.48 per share (basic) and
$201,000, or $0.08 per share (basic) for the years ended December 31, 1996 and
1995, respectively. This increase was primarily attributable to growth in the
level of earning assets, funded by new deposits at favorable weighted average
rates of interest, as well as to improvements in the Bank's mix of earning
assets in favor of higher yielding assets, such as loans.
Average interest-earning assets for 1997 were up 47% over 1996. The
increase was primarily attributable to growth in loans and, as a result, the
average rate on interest-earning assets increased to 8.40% in 1997, up from
8.00% in 1996. Average interest-bearing deposits for 1997 were up 49% over 1996,
with the increase primarily attributable to growth in savings and money market
accounts. The impact on the Bank's average rate
16
<PAGE> 18
paid on interest-bearing liabilities, however, was modest, an increase to 3.49%
in 1997, up from 3.28% in 1996. As a result, net interest margin improved to
6.23% in 1997 from 5.99% in 1996.
The Bank's loan quality remained high in 1997. As of December 31, 1997,
loans classified by the Bank constituted 2% and 11%, respectively, of total
loans and capital (shareholders' equity) and reserves (allowance for loan
losses), down from 5% and 18%, respectively, as of December 31, 1996. Net loan
charge-offs during 1997 were 0.18% of average loans outstanding; the Bank had no
loan charge-offs in any prior year.
Fee income rose 16% from 1996 to 1997. Many of the Bank's deposit accounts
maintain balances higher than that which is required to offset activity charges
and, as such, are not assessed fees. Other components of non-interest income
such as gain on sale of securities available-for-sale and on sale of SBA loans
rose more dramatically, up 681% and 103%, respectively, from 1996 to 1997.
Return on average equity in 1997 was 7.38%, compared to 8.56% in 1996.
Return on average equity fell in 1997, in spite of the fact that net income
increased on an absolute basis over 1996, due to an increase in average equity
that resulted from the Bank's second offering in the latter half of 1996.
Return on average assets in 1997 dropped to 0.74% from 0.96% in 1996. In
1997, average assets grew at a faster rate than net earnings, which were
adversely impacted by higher taxes as the Bank exhausted the remainder of its
operating loss carry forwards in 1996. Return on average assets was 0.22% in
1995.
COMPARISON OF 1996 VERSUS 1995
Net interest income for the year ended December 31, 1996 was $7,879,000, an
increase of $3,154,000 (or 67%) over the $4,725,000 reported for 1995. The
increase occurred primarily as a result of growth that occurred in the Bank's
earning assets, the yield on which was enhanced by an improvement in the net
yield on interest-earning assets during 1996 as compared with 1995. The increase
in net yield on interest earning assets in turn resulted from an improved mix of
assets (in favor of higher yielding assets such as loans) which offset the
effect of interest rate decreases that occurred during the first quarter of
1996. The Bank's average interest-earning assets were $131,511,000 in 1996, up
$50,195,000 (or 62%) from the average of $81,316,000 for 1995. The net interest
margin on interest-earning assets improved during 1996 to 5.99% from 5.81% for
1995.
Non-interest income for the year ended December 31, 1996 was $296,000, up
$225,000 (or 317%) from $71,000 for 1995. This increase was primarily the result
of sales of SBA-guaranteed loans and certain investment securities
available-for-sale, which resulted in profits on sale, as well as an increase in
deposit levels, which generate monthly service charges.
Non-interest expenses for the year ended December 31, 1996 were $5,724,000,
up $1,626,000 (or 40%) from $4,098,000 for the year ended December 31, 1995.
Growth in the Bank's infrastructure to support loan and deposit growth was
responsible for the increase in non-interest expenses. Salaries and benefits
expense rose 43% from 1995 to 1996, with the increase attributable to growth in
the number of employees. The Bank employed 55 people at December 31, 1996, up 22
from 33 employees at December 31, 1995. Furniture and equipment expenses and
occupancy expenses were similarly affected by the increase in employees. Client
services expenses were up as a result of additional funds on deposit at the
Bank.
17
<PAGE> 19
RESULTS OF OPERATIONS
NET INTEREST INCOME AND NET INTEREST MARGIN
The following table presents the Company's average balance sheet, net
interest income and the resultant yields for the quarterly periods presented:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED MARCH 31,
-------------------------------------------------------------------------
1998 1997
----------------------------------- -----------------------------------
INTEREST INTEREST
AVERAGE EARNED AVERAGE YIELD AVERAGE EARNED AVERAGE YIELD
BALANCE OR PAID OR RATE PAID BALANCE OR PAID OR RATE PAID
-------- -------- ------------- -------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Net loans............................... $131,672 $3,550 10.93% $ 86,993 $2,132 9.94%
Investments............................. 92,872 1,405 6.14 73,093 1,148 6.37
Federal funds sold...................... 16,193 217 5.43 8,806 114 5.25
-------- ------ ----- -------- ------ ----
Total interest-earning assets.... $240,737 $5,172 8.71% $168,892 $3,394 8.15%
======== ====== ===== ======== ====== ====
INTEREST-BEARING LIABILITIES:
Deposits:
Demand, interest-bearing.............. $ 6,205 $ 29 1.89% $ 4.227 $ 20 1.92%
Savings and money market.............. 95,640 739 3.13 71,712 512 2.90
Time deposits, $100,000 and over...... 39,523 489 5.01 23,189 268 4.69
Time deposits, less than $100,000..... 7.512 85 4.60 8.055 100 5.03
Other borrowings...................... 11 <1 5.58 150 2 5.41
-------- ------ ----- -------- ------ ----
Total interest-bearing
liabilities.................... $148,891 $1,342 3.65% $107,333 $ 902 3.41%
======== ====== ===== ======== ====== ====
Net interest income/margin................ $3,830 6.45% $2,492 5.97%
====== ===== ====== ====
</TABLE>
Note: Yields and amounts earned on loans include loan fees of $277,000 and
$137,000 for the three month periods ended March 31, 1998 and 1997,
respectively.
Note: The yield on investment securities does not include a fair value
adjustment.
The Company's net interest income for the first quarter of 1998 was
$3,830,000, an increase of $1,338,000 over the first quarter of 1997. When
compared to the first quarter of 1997, average earning assets increased by
$67,348,000, while the net yield on average earning assets increased from 5.97%
in the first quarter of 1997 to 6.45% in the first quarter of 1998. The increase
in net interest income was primarily due to an increase in the volume of
interest-earning assets, predominantly loans.
18
<PAGE> 20
The following table presents the average amounts outstanding for the major
categories of the Bank's interest-earning assets and interest-bearing
liabilities, the average interest rates earned or paid thereon, and the net
yield on average interest-earnings assets for the years ended 1997, 1996 and
1995:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------- ----------------------------- ----------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE
-------- -------- ------- -------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Loans, net(1).................... $ 98,930 $10,376 10.49% $ 61,130 $ 6,138 10.04% $29,419 $3,134 10.65%
Investment securities(2)(3)...... 84,196 5,323 6.32 57,769 3,724 6.45 40,388 2,623 6.49
Federal funds sold............... 10,233 552 5.39 12,612 663 5.26 11,509 664 5.77
-------- ------- ----- -------- ------- ----- ------- ------ -----
Total interest-earning
assets................. 193,359 $16,251 8.40% 131,511 $10,525 8.00% 81,316 $6,421 7.90%
-------- ------- ----- -------- ------- ----- ------- ------ -----
Cash and due from banks.......... 13,961 11,270 7,723
Premises and equipment, net...... 1,756 1,152 985
Other assets..................... 3,586 1,802 1,204
Total assets............. $212,662 $145,736 $91,228
======== ======== =======
LIABILITIES AND SHAREHOLDERS'
EQUITY:
Deposits:
Demand, interest-bearing....... $ 4,988 $ 95 1.91% $ 3,654 $ 68 1.86% $ 2,059 40 1.93%
Savings and money-market....... 80,168 2,401 3.00 60,686 1,772 2.92 40,871 1,332 3.26
Time deposits, $100,000 and
over......................... 27,314 1,330 4.87 11,220 557 4.96 4,486 221 4.92
Time deposits, less than
$100,000..................... 7,530 361 4.79 4,962 244 4.92 1,958 102 5.22
Other borrowings................. 297 17 5.72 85 5 5.88 11 1 6.04
-------- ------- ----- -------- ------- ----- ------- ------ -----
Total interest-bearing
liabilities............ 120,297 $ 4,204 3.49% 80,607 $ 2,646 3,28% 49,385 $1,696 3.43%
-------- ------- ----- -------- ------- ----- ------- ------ -----
Demand deposits.................. 69,376 47,696 29,362
Other liabilities................ 1,782 1,062 433
Total liabilities........ 191,455 129,351 79,180
Shareholders' equity............. 21,207 16,371 12,048
Total liabilities and
shareholders' equity... $212,662 $145,736 $91,228
======== ======== =======
Net interest income/margin....... $12,047 6.23% $ 7,879 5.99% $4,725 5.81%
======= ===== ======= ===== ====== =====
</TABLE>
- ---------------
(1) Yields and amounts earned on loans include loan fees of $709,000, $388,000,
and $115,000 for the years ended December 31, 1997, 1996, and 1995,
respectively. The Company had no non-accrual loans for the periods
presented.
(2) Interest income is reflected on an actual basis, not fully taxable
equivalent basis.
(3) The yield on investment securities does not include a fair value adjustment.
Net interest income for the year ended December 31, 1997 was $12,047,000,
an increase of $4,168,000 (or 53%) over the $7,879,000 reported for 1996. The
increase occurred primarily as a result of growth that occurred in the Bank's
earning assets, the yield on which was enhanced by an improvement in the net
yield on interest-earning assets during 1997 as compared with 1996. The increase
in net yield on interest earning assets in turn resulted from an improved mix of
assets (in favor of higher yielding assets such as loans). The Bank's average
interest-earning assets were $193,359,000 in 1997, up $61,848,000 (or 47%) from
the average of $131,511,000 for 1996. The net yield on interest-earning assets
improved during 1997 to 6.23% from 5.99% for 1996 and 5.81% for 1995.
19
<PAGE> 21
The following table sets forth an analysis of the changes in interest
income and interest expense. The total change is shown in the column designated
"Net Change" and is allocated in the columns to the left, to the portions
respectively attributable to volume changes and rate changes that occurred
during the period indicated. Changes due to both volume and rate categories in
proportion to the relationship of the changes due solely to the changes in
volume and rate, respectively.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31
1998 VS. 1997
----------------------------
INCREASE (DECREASE) DUE
TO CHANGE IN:
VOLUME RATE NET CHANGE
------ ---- ----------
<S> <C> <C> <C>
INTEREST-EARNINGS ASSETS
Net loans................................................. $1,187 $231 $1,418
Investments............................................... 301 (43) 257
Federal funds sold........................................ 99 4 103
------ ---- ------
Total interest-earning assets............................... $1,587 $192 $1,778
====== ==== ======
INTEREST-BEARING LIABILITIES
Demand, interest-bearing.................................. $ 9 $ 0 $ 9
Savings and money market.................................. 182 45 227
Time deposits, $100,000 and over.......................... 201 20 221
Time deposits, less than $100,000......................... (6) (8) (15)
Other borrowings.......................................... (2) -- (2)
------ ---- ------
Total interest-bearing liabilities.......................... $ 384 $ 56 $ 440
------ ---- ------
Change in net interest income............................... $1,338
======
</TABLE>
The following table sets forth an analysis of the changes in interest
income and interest expense:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
--------------------------------------------------------------------------------
1997 VERSUS 1996 1996 VERSUS 1995
-------------------------------------- --------------------------------------
INCREASE (DECREASE) DUE TO CHANGE IN: INCREASE (DECREASE) DUE TO CHANGE IN:
-------------------------------------- --------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
VOLUME RATE NET CHANGE VOLUME RATE NET CHANGE
--------- --------- ------------ --------- --------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans, net.................... $3,953 $285 $4,238 $3,194 $(190) $3,004
Investment securities......... 1,672 (72) 1,599 1,121 (20) 1,101
Federal funds sold............ (128) 16 (111) 61 (62) (1)
------ ---- ------ ------ ----- ------
Total interest-earning
assets.............. $5,497 $229 $5,726 $4,376 $(272) $4,104
====== ==== ====== ====== ===== ======
INTEREST-BEARING LIABILITIES:
Demand, interest-bearing...... $ 25 $ 2 $ 27 $ 30 $ (2) $ 28
Savings and money-market...... 583 46 629 590 (150) 440
Time deposits, $100,000 and
over....................... 784 (11) 773 334 2 336
Time deposits, less than
$100,000................... 123 (7) 117 148 (6) 142
Other borrowings.............. 12 -- 12 4 -- 4
------ ---- ------ ------ ----- ------
Total interest-bearing
liabilities......... $1,527 $ 31 $1,558 $1,106 $(156) $ 950
------ ---- ------ ------ ----- ------
Net interest income............. $3,970 $198 $4,168 $3,270 $(116) $3,154
====== ==== ====== ====== ===== ======
</TABLE>
Note: Yields and amounts earned on loans include loan fees of $709,000,
$388,000, and $115,000 for the years ended December 31, 1997, 1996, and
1995, respectively.
The total change is shown in the column designated "Net Change" and is
allocated in the columns to the left, to the portions respectively attributable
to volume changes and rate changes that occurred during the
20
<PAGE> 22
period. Changes due to both volume and rate have been allocated between the
volume and rate categories in proportion to the relationship of the changes due
solely to the changes in volume and rate, respectively.
PROVISIONS FOR LOAN LOSSES
During the first quarter of 1998, the provision for loan losses was
$160,000, down $60,000 from $220,000 for the first quarter of 1997. The decrease
in the provision, in spite of overall growth in the loan portfolio, was due to
the recovery during the first quarter of 1998 of a prior period charge-off of
$95,000. The recovery was added to the allowance for loan losses. The allowance
for loan losses was 1.78% of total loans outstanding at March 31, 1998.
During 1997, the provision for loan losses was $1,060,000, up $230,000 (or
28%) from $830,000 during 1996. The increase in the provision during 1997
reflected the overall growth in the loan portfolio and the Bank's policy of
making provisions to the allowance for estimated probable losses. The provision
for 1996 was up $334,000 (or 67%) from $496,000 during 1995.
The allowance for loan losses was 1.77%, 1.69%, and 1.34% of total loans at
December 31, 1997, 1996, and 1995, respectively.
NON-INTEREST INCOME
The following table sets forth the various components of the Bank's
non-interest income for the periods indicated.
<TABLE>
<CAPTION>
INCREASE (DECREASE)
THREE MONTHS -------------------
ENDED MARCH 31, 1998 VERSUS 1997
---------------- -------------------
1998 1997 AMOUNT PERCENT
---- ---- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Service charges and other fees.............................. 50 46 4 9%
Gain on securities available-for-sale....................... 18 16 2 13
Gain on sale of loans held-for-sale......................... -- 4 (4) (100)
Other income................................................ 11 8 2 30
-- -- -- ----
Total.............................................. 79 74 5 6%
== == == ====
</TABLE>
Fee income from service charges rose 9% from the first quarter of 1997 to
1998. Many of the Bank's deposit accounts maintain balances higher than that
which is required to offset activity charges and, as such, are not assessed
fees.
The following table sets forth the various components of the Bank's
non-interest income for the periods indicated:
<TABLE>
<CAPTION>
INCREASE (DECREASE)
YEARS ENDED --------------------------------------
DECEMBER 31, 1997 VERSUS 1996 1996 VERSUS 1995
-------------------- ----------------- -----------------
1997 1996 1995 AMOUNT PERCENT AMOUNT PERCENT
---- ---- ---- ------ ------- ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Gain on sale of loans held-for sale...... $205 $101 $-- $104 103% $101 --%
Service charges and other fees........... 173 149 59 24 16 90 153
Gain on securities available-for-sale.... 164 21 3 143 681 18 600
Other income............................. 48 25 9 23 92 16 178
---- ---- --- ---- --- ---- ---
Total........................... $590 $296 $71 $294 99% $225 317%
==== ==== === ==== === ==== ===
</TABLE>
Non-interest income for the year ended December 31, 1997 was $590,000, up
$294,000 (or 99%) from $296,000 for 1996. This increase was primarily the result
of gains recognized on the sale of securities available-for-sale (up $143,000),
sales of SBA loans (up $104,000), and an increase in deposit service charges (up
$24,000).
21
<PAGE> 23
NON-INTEREST EXPENSES
The following table sets forth the various components of the Bank's
non-interest expenses for the periods indicated:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED MARCH 31,
------------------------------------------------
1998 1997 INCREASE PERCENT INCREASE
------ ------ -------- ----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Salaries and benefits..................................... $1,580 $ 966 $ 614 64%
Client services........................................... 360 248 112 45%
Advertising and promotion................................. 173 91 82 91%
Furniture and equipment................................... 170 114 56 50%
Professional fees......................................... 164 75 89 118%
Occupancy................................................. 150 97 53 55%
Loan origination costs.................................... 82 64 18 28%
All other................................................. 339 157 182 114%
------ ------ ------ ---
Total............................................ $3,018 $1,812 $1,206 67%
====== ====== ====== ===
</TABLE>
Non-interest expenses for the first quarter of 1998 were $3,018,000, up
$1,206,000 (or 67%) from $1,812,000 for the first quarter of 1997. The increase
in non-interest expenses reflects the growth in infrastructure to support the
Bank's loan and deposit growth.
Non-interest expenses consist primarily of salaries and employee benefits
(52% and 53% of total non-interest expenses for the first quarter of 1998 and
1997, respectively) and client services (23% and 14% of total non-interest
expenses for the first quarter of 1997 and 1997, respectively). The increase in
salaries and benefits expenses was primarily attributable to an increase in the
number of employees. The Bank employed 105 people at March 31, 1998, up 36 from
69 employees at March 31, 1997. Client services expenses include outside data
processing service costs, courier and armored car costs, imprinted check costs,
and other client services costs, all of which are directly related to the amount
of funds on deposit at the Bank. The increase in furniture and equipment
expenses and in occupancy expenses was primarily attributable to an increase in
the number of employees. Advertising expenses increased due to the Bank's
co-sponsorship of a professional auto racing team.
The following table sets forth the various components of the Bank's
non-interest expense for the years ended December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
INCREASE (DECREASE)
--------------------------------------
YEARS ENDED DECEMBER 31, 1997 VERSUS 1996 1996 VERSUS 1995
-------------------------- ----------------- -----------------
1997 1996 1995 AMOUNT PERCENT AMOUNT PERCENT
------ ------ ------ ------ ------- ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Salaries and benefits............... $4,933 $2,942 $2,062 $1,991 68% $ 880 43%
Client services..................... 1,169 910 491 259 28 419 85
Furniture and equipment............. 542 330 220 212 64 110 50
Advertising and promotion........... 450 260 154 190 73 106 69
Occupancy........................... 440 293 296 147 50 (3) (1)
Professional fees................... 372 224 302 148 66 (78) (26)
Loan origination costs.............. 326 146 39 180 124 107 274
Other............................... 936 619 534 317 51 85 16
------ ------ ------ ------ --- ------ ---
Total...................... $9,168 $5,724 $4,098 $3,444 60% $1,626 40%
====== ====== ====== ====== === ====== ===
</TABLE>
Non-interest expenses for the year ended December 31, 1997 were $9,168,000,
up $3,444,000 (or 60%) from $5,724,000 for the year ended December 31, 1996. The
increase in non-interest expenses reflects the growth in infrastructure to
support the Bank's loan and deposit growth.
Non-interest expenses consist primarily of salaries and employee benefits
(54%, 51%, and 50% of total non-interest expenses for 1997, 1996, and 1995,
respectively) and client services (13%, 16%, and 12% of total non-interest
expenses for 1997, 1996, and 1995, respectively). The increase in salaries and
benefits expenses
22
<PAGE> 24
was primarily attributable to an increase in the number of employees. The Bank
employed 88 people at December 31, 1997, up 33 from 55 employees at December 31,
1996. Client services expenses include outside data processing service costs,
courier and armored car costs, imprinted check costs, and other client services
costs, all of which are directly related to the amount of funds on deposit at
the Bank. The increase in furniture and equipment expenses and in occupancy
expenses was primarily attributable to an increase in the number of employees.
Advertising expenses increased in 1997 due to broader advertising coverage and
to the Bank's co-sponsorship of a professional auto racing team.
YEAR 2000
The inability of computers, software, and other equipment utilizing
microprocessors to recognize and properly process data fields containing a
two-digit year is commonly referred to as the Year 2000 Compliance issue. As the
year 2000 approaches, such systems may be unable to process accurately certain
date-based information.
The Company has identified all significant applications that will require
modification to ensure Year 2000 Compliance. Internal and external resources are
being used to make the required modifications and test Year 2000 Compliance. The
modification process of all significant applications is underway and should be
substantially complete by June 30, 1998. The Company plans to complete the
testing process of all significant applications by December 31, 1998.
In addition, the Company has communicated with a vendor with whom it does
significant business to determine its Year 2000 Compliance readiness and the
extent to which the Company is vulnerable to any third-party Year 2000 risks.
However, there can be no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company. The
Bank has begun the process of assessing the credit risk related to its
borrowers' Year 2000 Compliance progress, and will integrate a Year 2000
Compliance element into its credit approval process by December 31, 1998.
The total cost to the Company of Year 2000 Compliance activities has not
been and is not anticipated to be material to its financial position or results
of operations in any given year. These costs and the date on which the Company
plans to complete the Year 2000 modification and testing process are based on
management's best estimates, which were derived utilizing numerous assumptions
of future events including the continued availability of certain resources,
third-party modification plans, and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results could differ
from those plans.
PROVISION FOR INCOME TAXES
The provision for income taxes for the quarter ended March 31, 1998 was
$278,000. Provision for income taxes was $844,000, $220,000, and $1,000, for the
years ended December 31, 1997, 1996, and 1995, respectively. The Bank's
effective tax rates were 35.0%, 13.6%, and 0.5%, for the years ended December
31, 1997, 1996, and 1995, respectively. The decrease in the effective tax rate
from the statutory tax rate in 1996 and 1995 was due to state income taxes,
change in the income tax valuation allowance, and non-taxable interest income.
The 1995 provision reflected state minimum income taxes due to utilization of
net operating losses.
23
<PAGE> 25
FINANCIAL CONDITION
SECURITIES PORTFOLIO
The following table summarizes the amounts and distribution of the Bank's
investment securities and the weighted average yields as of December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------------------------------------------------------------------------
MATURITY
------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS
AND AND WITHIN TEN TOTAL AMORTIZED
WITHIN ONE YEAR WITHIN 5 YEARS YEARS AFTER TEN YEARS COST
--------------- --------------- ----------------- ---------------- ---------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------- ----- ------- ----- -------- ------ ------- ------ ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. Treasury..................... $ 6,977 6.17% $25,217 6.27% $ 3,026 6.49% $ -- --% $35,220 6.27%
U.S. government agencies.......... 2,002 5.60 2,985 6.28 10,383 6.71 1,000 8.00 16,370 6.57
Municipals -- taxable............. -- -- -- -- -- -- 2,000 6.01 2,000 6.01
Municipals -- tax exempt.......... -- -- -- -- 735 4.67 1,861 4.89 2,596 4.83
Preferred stock................... -- -- 1,525 6.18 -- -- 687 5.46 2,212 5.96
Commercial paper.................. -- -- 1,515 6.43 -- -- 522 7.97 2,036 6.82
------- ---- ------- ---- ------- ---- ------ ---- ------- ----
Total Available-for-sale.... $ 8,979 6.04% $31,242 6.27% $14,144 6.56% $6,070 6.10% $60,434 6.29%
Securities held-to-maturity:
Municipals -- taxable............. $ 1,765 5.98% $ 5,816 6.36% $ 1,748 6.50% $ 269 6.30% $ 9,598 6.31%
Municipals -- tax exempt.......... 89 4.67 405 5.03 4,957 4.80 1,401 4.98 6,852 4.85
U.S. Government agencies.......... -- -- 1,731 6.94 4,302 7.11 -- -- 6,033 7.06
U.S. Treasury..................... 1,993 6.66 2,054 6.36 -- -- -- -- 4,048 6.51
------- ---- ------- ---- ------- ---- ------ ---- ------- ----
Total held-to-maturity...... $ 3,847 6.30% $10,006 6.41% 11,007 5.97% 1,670 5.19% $26,531 6.14%
------- ---- ------- ---- ------- ---- ------ ---- ------- ----
Total securities............ $12,826 6.12% $41,248 6.31% $25,150 6.30% $7,740 5.90% $86,965 6.24%
======= ==== ======= ==== ======= ==== ====== ==== ======= ====
</TABLE>
Note: Yields on tax exempt municipal securities are not on a fully tax
equivalent basis.
As of December 31, 1997, the only securities held by the Bank where the
aggregate book value of the Bank's investment in securities of a single issuer
exceeded 10% of the Bank's shareholders' equity were direct obligations of the
U.S. government or U.S. government agencies.
Securities are pledged to meet requirements imposed as a condition of
deposit by some depositors, such as political subdivisions (public funds) or of
other funds such as bankruptcy trustee deposits. Securities with amortized cost
of $27,470,000 as of December 31, 1997 were pledged to secure public and certain
other deposits as required by law or contract.
LOANS
General. The following table presents the Bank's loans outstanding at year
end by loan type:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------------------------------
MARCH 31, % OF % OF % OF % OF % OF
1998 TOTAL 1997 TOTAL 1996 TOTAL 1995 TOTAL 1994 TOTAL
--------- ----- -------- ----- ------- ----- ------- ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial........................... $ 68,596 48% $ 63,833 50% $44,448 54% $23,456 55% $ 6,538 62%
Real estate -- mortgage.............. 39,440 28 38,446 29 26,070 31 13,345 31 2,550 24
Real estate -- land and
construction....................... 32,752 23 25,780 20 11,918 14 5,105 12 1,370 13
Consumer............................. 2,333 1 824 1 558 1 735 2 110 1
-------- --- -------- --- ------- --- ------- --- ------- ---
Total loans.................. $143,121 100% $128,883 100% $82,994 100% $42,641 100% 10,568 100%
Deferred loan fees................... (133) (113) (79) (119) (37)
Allowance for loan losses............ (2,285) (2,285) (1,402) (572) (76)
-------- -------- ------- ------- -------
Net loans............................ $140,448 $126,485 $81,513 $41,950 $10,455
======== ======== ======= ======= =======
</TABLE>
The Bank's commercial loans are made for the purpose of providing working
capital, financing the purchase of equipment or for other business purposes.
Such loans include loans with maturities ranging from thirty days to one year
and "term loans," with maturities normally ranging from one to twenty-five
years.
24
<PAGE> 26
Short-term business loans are generally intended to finance current transactions
and typically provide for periodic principal payments, with interest payable
monthly. Term loans normally provide for floating interest rates, with monthly
payments of both principal and interest.
The Bank is an active participant in the Small Business Administration
(SBA) and California guaranteed lending programs, and has been approved by the
SBA as a lender under the Preferred Loan Program (PLP). The Bank regularly makes
SBA-guaranteed loans, the guaranteed portion of which is held for possible
resale in the secondary market. In the event of the sale of a guaranteed portion
SBA loan, the Bank retains the servicing rights for the sold portion. At March
31, 1998, the Bank serviced $5,800,000 in SBA loans for others. At December 31,
1997, 1996, and 1995, $6,000,000, $2,100,000 and $77,000, respectively, in SBA
loans for others. The Bank generally considers its SBA loans to be investment
loans, but has from time to time sold the guaranteed portion of certain loans.
The Bank's real estate term loans consist primarily of loans made based on
the borrower's cash flow and are secured by deeds of trust on commercial and
residential property to provide a secondary source of repayment. It is the
Bank's policy to restrict real estate term loans to no more than 80% of the
lower of the Bank's appraised value or the purchase price of the property,
depending on the type of property and its utilization. The Bank offers both
fixed and floating rate loans. Maturities on such loans are generally restricted
to between five and seven years (on an amortization ranging from fifteen to
twenty-five years with a balloon payment due at maturity); however, SBA and
certain other real estate loans easily sold in the secondary market may be
granted for longer maturities.
The Bank's real estate land and construction loans are primarily interim
loans made by the Bank to finance the construction of commercial and single
family residential properties. These loans are typically short term. The Bank
utilizes underwriting guidelines to assess the likelihood of repayment from
sources such as sale of the property or permanent mortgage financing prior to
making the construction loan. Land and construction loans have increased as a
percentage of the loan portfolio, from 14% as of December 31, 1996 to 20% and
20%, respectively, as of December 31, 1997 and March 31, 1998. These loans
generally involve a greater risk of loss than other forms of commercial lending.
The increase represents an increase in the risk profile of the Bank's loan
portfolio.
Consumer loans are made for the purpose of financing automobiles, various
types of consumer goods, and other personal purposes. Additionally, the Bank
makes equity lines of credit and equity loans available to its clientele.
Consumer loans generally provide for the monthly payment of principal and
interest. Most of the Bank's consumer loans are secured by the personal property
being purchased, or, in the instances of equity loans or lines, real property.
With certain exceptions, the Bank is permitted to make extensions of its
credit to any one borrowing entity up to 15% of the Bank's capital and reserves
for unsecured loans and up to 25% of the Bank's capital and reserves for secured
loans. These lending limits for the Bank were $3,800,000 and $6,300,000,
respectively, at March 31, 1998 and $3,700,000 and $6,200,000, respectively, at
December 31, 1997. The Bank sells participations in its loans when necessary to
stay within lending limits. The Bank generally maintains an "in-house limit" of
$3,000,000 for unsecured loans, and $5,000,000 for secured loans.
Loan Concentrations. The Bank does not have any concentrations in its loan
portfolio by industry or group of industries, however, 56%, 59% and 54% of its
net loans were secured by real property as of March 31, 1998 and December 31,
1997 and 1996, respectively. All of the Bank's loans are located in California
and most of them in Santa Clara County. The economy in Santa Clara County is
dependent to a significant extent on the technology industry. A slowdown in the
technology industry could have an adverse effect on the quality of the Bank's
loan portfolio.
25
<PAGE> 27
Loan Portfolio Maturities and Interest Rate Sensitivity. The following
table sets forth the maturity distribution of the Bank's loans at December 31,
1997:
<TABLE>
<CAPTION>
DUE IN OVER ONE YEAR
ONE YEAR OR BUT LESS THAN
LESS FIVE YEARS OVER FIVE YEARS TOTAL
---------------- ------------- --------------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial........................... $27,053 $13,313 $23,736 $ 64,102
Real estate -- mortgage.............. 6,276 17,706 14,297 38,279
Real estate -- land and
construction....................... 24,725 837 -- 25,562
Consumer............................. 158 669 -- 827
------- ------- ------- --------
Total loans................ $58,212 $32,525 $38,033 $128,770
======= ======= ======= ========
Loans with variable interest rates... $57,321 $22,210 $27,866 $107,397
Loans with fixed interest rates...... 891 10,315 10,167 21,373
------- ------- ------- --------
Total...................... $58,212 $32,525 $38,033 $128,770
======= ======= ======= ========
</TABLE>
Note: Total shown is net of deferred loan fees of $113,000 at December 31,
1997.
Credit Risk Management. The risk of non-payment of loans is an inherent
feature of the banking business. That risk varies with the type and purpose of
the loan, the collateral that is utilized to secure payment, and ultimately, the
creditworthiness of the borrower. In order to minimize this credit risk, the
Bank requires that all loans be approved by at least the Chief Credit Officer,
the Senior Loan Officer, or the Chief Executive Officer, who individually have
approval authority of $150,000 each, and in combination may approve loans of up
to $600,000. Loans in excess of $600,000 must be approved by the Officers' Loan
Committee. Loans over $1,000,000 must be approved by the Directors' Loan
Committee. The Bank has established an in-house lending limit of $3,000,000 for
unsecured transactions, and $5,000,000, for secured transactions, which is
subject to review or exception from time to time. The Bank's legal limit at
3/31/98 was $3,805,000 for unsecured loans and $6,341,000 for secured loans.
The Bank assigns a risk grade consistent with the system recommended by
regulatory agencies to all of its loans. Grades range from "Pass" to "Loss,"
depending on credit quality, with "Pass" representing loans that involve an
acceptable degree of risk. Additionally, the Bank maintains a program for
regularly scheduled reviews of certain new and renewed loans by an outside loan
review consultant. Any loans identified during an external review process that
expose the Bank to increased risk are appropriately downgraded and an increase
in the allowance for loan losses is established for such loans. Further, the
Bank is examined periodically by the FDIC, FRB, and the California Department of
Financial Institutions, at which time a further review of loans is conducted.
Loans that demonstrate a weakness, for which there is a possibility of loss
if the weakness is not corrected, are categorized as "classified." Classified
loans may result from problems specific to a borrower's business or from
economic downturns which affect the borrower's ability to repay or which cause a
decline in the value of the underlying collateral (particularly real estate).
Management believes that it has adequately provided an allowance to provide for
estimated probable losses in the credit portfolio. Significant deterioration in
Northern California real property values or economic downturns could impact
future operating results, liquidity, or capital resources and require additional
provisions to the allowance or cause losses in excess of the allowance.
Non-Performing Assets. At March 31, 1998, December 31, 1997, 1996 and 1995,
the Bank had no non-accrual loans. During the period ended March 31, 1998 the
average balance of non-accrual loans was zero. During the year ended December
31, 1997 the average balance of non-accrual loans was $100,000. At March 31,
1998, December 31, 1997, 1996 and 1995, the Bank had no assets classified as
other real estate owned. The Bank has no troubled debt restructuring and no
loans 90 days past-due and still accruing.
For the period ended March 31, 1998, the Bank had not foregone any interest
income as a result of non-accrual loans. For the year ended December 31, 1997,
the Bank had forgone interest income in the amount of
26
<PAGE> 28
$17,000 as a result of non-accrual loans. Through December 31, 1996, the Bank
had not foregone any interest income as a result of non-accrual loans or
restructured debt.
As of March 31, 1998, loans classified by the Bank were $3,698,000. These
loans constituted 3% of total loans and 15% of the Bank's shareholders' equity
and allowance for loan losses at that date. As of December 31, 1997, loans
classified by the Bank were $2,695,000. These loans constituted 2% of total
loans and 11% of the Bank's shareholders' equity and allowance for loan losses
as of that date. As of December 31, 1996, loans classified by the Bank were
$4,005,000. These loans constituted 5% of total loans and 18% of the Bank's
shareholders' equity and allowance for loan losses as of that date. As of
December 31, 1995, loans classified by the Bank were $296,804. These loans
constituted 1% of total loans and 2% of the Bank's capital and reserves as of
that date. Through March 31, 1998 and December 31, 1997, the Bank has not made
loans to any foreign entities.
ALLOWANCE FOR LOAN LOSSES
The following table summarizes the Bank's loan loss experience as well as
transactions in the allowance for loan losses and certain pertinent ratios for
the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED YEAR ENDED
MARCH 31, DECEMBER 31,
--------------- ----------------
1998 1997 1997 1996 1995 1994
------ ------ ------ ------ ---- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance, beginning of period................. $2,285 $1,402 $1,402 $ 572 $ 76 $ --
Charge-offs -- Commercial loans.............. -- -- (224) -- -- --
Recoveries -- Commercial loans............... 95 -- 47 -- -- --
------ ------ ------ ------ ---- -----
Net charged-offs/recoveries.................. 95 -- (177) -- -- --
------ ------ ------ ------ ---- -----
Provision for loan losses.................... 160 220 1,060 830 496 76
------ ------ ------ ------ ---- -----
Balance, end of period....................... $2,540 $1,622 $2,285 $1,402 $572 $ 76
====== ====== ====== ====== ==== =====
Ratios:
Net charge-offs to average loans
outstanding............................. (0.07)% 0.00% 0.18% --% --% --%
Allowance for loan losses to average
loans................................... 1.93 1.86 2.31% 2.29% 1.94% 1.60%
Allowance for loan losses to total loans at
end of period........................... 1.78 1.80 1.77% 1.69% 1.34% 0.72%
</TABLE>
The following table summarizes the allocation of the allowance for loan
losses by loan type and the allocation as a percent of loans outstanding in each
loan category at the dates indicated:
<TABLE>
<CAPTION>
MARCH 31,
---------------------------------------------------------
1998 1997
--------------------------- ---------------------------
ALLOCATION AS A ALLOCATION AS A
% OF LOANS % OF LOANS
OUTSTANDING OUTSTANDING
ALLOWANCE IN CATEGORY ALLOWANCE IN CATEGORY
--------- --------------- --------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial..................................... $1,091 1.58% $ 449 0.99%
Real estate -- mortgage........................ 172 0.44 204 0.63
Real estate -- land and construction........... 439 1.35 197 1.69
Consumer....................................... 23 0.98 5 1.00
Unallocated.................................... 815 767
------ ---- ------ ----
Total................................ $2,540 1.78% $1,622 1.80%
====== ==== ====== ====
</TABLE>
27
<PAGE> 29
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------------------------------------
1997 1996 1995 1994
----------------------- ----------------------- ----------------------- -----------------------
ALLOCATION ALLOCATION ALLOCATION ALLOCATION
AS A % OF AS A % OF AS A % OF AS A % OF
LOANS LOANS LOANS LOANS
OUTSTANDING OUTSTANDING OUTSTANDING OUTSTANDING
ALLOWANCE IN CATEGORY ALLOWANCE IN CATEGORY ALLOWANCE IN CATEGORY ALLOWANCE IN CATEGORY
--------- ----------- --------- ----------- --------- ----------- --------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial........... $ 821 1.29% $ 512 1.15% $ 267 1.14% $ -- --%
Real estate --
mortgage........... 205 0.53 117 0.45 102 0.76 -- --
Real estate -- land
and construction... 379 1.47 227 1.90 54 1.06 -- --
Consumer............. 7 0.85 6 1.08 6 0.82 -- --
Unallocated.......... 873 540 143 76
------ ---- ------ ---- ------ ---- ------ ----
Total....... $2,285 1.77% $1,402 1.69% $ 572 1.34% $ 76 0.72%
====== ==== ====== ==== ====== ==== ====== ====
</TABLE>
The Bank maintains an allowance for loan losses to provide for probable
losses in the loan portfolio. Additions to the allowance are made by charges to
operating expenses in the form of a provision for loan losses. All loans that
are judged to be uncollectable are charged against the allowance and any
recoveries are credited to the allowance. Management conducts a critical
evaluation of the loan portfolio monthly. This evaluation includes an assessment
of the following factors: past loan loss experience, known and inherent risks in
the portfolio, adverse situations that may affect the borrower's ability to
repay, the estimated value of any underlying collateral, and current economic
conditions. At March 31, 1998 and December 31, 1997, the allowance for loan
losses was 1.78%, and 1.77%, respectively, of gross loans then outstanding.
During 1997, the Bank charged off three loans with principal balance
totaling $224,000, and recovered two of those loans for $48,000, with accrued
interest and costs. Through December 31, 1996, the Bank had no loan charge-offs
and no charge-off recoveries.
In an effort to improve its analysis of risk factors associated with its
loan portfolio, the Bank continues to monitor and to make appropriate changes to
its internal loan policies. These efforts better enable the Bank to assess risk
factors prior to granting new loans and to assess the sufficiency of the
allowance for loan losses. The allowance for loan losses is deemed adequate by
the management for known and currently anticipated future risks inherent in the
loan portfolio. However, the Bank's loan portfolio can be adversely affected if
California economic conditions or the real estate market in the Bank's market
area were to weaken. The effect of such events although uncertain at this time,
could result in an increase in the level of non-performing loans and increased
loan losses which could adversely affect the Bank's future growth and
profitability.
28
<PAGE> 30
DEPOSITS
Deposits totaled $304,165,000 at March 31, 1998, an increase of 25%, as
compared to total deposits of $242,978,000 at December 31, 1997. The increase in
deposits was due to the Company's continued marketing efforts directed at
commercial business clients. Non-interest-bearing deposits were $127,078,000 at
March 31, 1998, an increase of 30% as compared to $97,736,000 at December 31,
1997. Interest-bearing deposits were $177,087,000 at March 31, 1998, an increase
of 22% as compared to $145,242,000 at December 31, 1997.
The following table summarizes the distribution of average deposits and the
average rates paid for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
MARCH 31, 1998 1997 1996
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID
-------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Demand, non-interest
bearing.................... $ 92,020 --% $ 69,376 --% $ 47,696 --%
Demand, interest bearing..... 6,205 1.86 4,988 1.91 3,654 1.86
Savings and money market..... 95,640 3.09 80,168 3.00 60,686 2.92
Time deposits, $100,000 and
over....................... 39,523 4.95 27,314 4.87 11,220 4.96
Time deposits less than
$100,000................... 7,512 4.54 7,530 4.79 4,962 4.92
-------- ---- -------- ---- -------- ----
Total average
deposits.............. $240,900 2.23% $189,376 2.22% $128,218 2.06%
======== ==== ======== ==== ======== ====
</TABLE>
At December 31, 1997, the Bank had a deposit mix of 26% in money market
accounts, 17% in time deposits, 14% in savings deposits, 3% in NOW accounts, and
40% in non-interest-bearing demand deposits. On the same date, $158,000 of the
Bank's deposits were from public sources. At December 31, 1996, the Bank had a
deposit mix of 24% in money market accounts, 20% in time deposits, 15% in
savings deposits, 3% in NOW accounts, and 38% in non-interest-bearing demand
deposits. On the same date, $200,000 of the Bank's deposits were from public
sources. The Bank's net interest income is enhanced by its percentage of non-
interest bearing deposits.
The Bank's deposits are obtained from a cross-section of the communities it
serves. The Bank's business is not seasonal in nature. The Bank had brokered
deposits totaling approximately $12,000,000 at December 31, 1997. The Bank is
not dependent upon funds from sources outside the United States.
DEPOSIT CONCENTRATION AND DEPOSIT VOLATILITY
The following table indicates the maturity schedule of the Bank's time
deposits of $100,000 or more at the periods indicated:
<TABLE>
<CAPTION>
MARCH 31, 1998 DECEMBER 31, 1997
BALANCE % OF TOTAL BALANCE % OF TOTAL
------- ---------- ------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Three months or less..................... $34,174 73% $20,836 60%
Over three months through six months..... 8,546 18 8,741 25
Over six months through twelve months.... 2,967 6 5,235 15
Over twelve months....................... 1,400 3 136 G1
------- ---- ------- ----
Total............................... $47,087 100% $34,948 100%
======= ==== ======= ====
</TABLE>
The Bank focuses primarily on servicing business accounts that are
frequently over $100,000 in average size. Certain types of accounts that the
Bank makes available are typically in excess of $100,000 in average balance per
account, and certain types of business clients whom the Bank serves typically
carry deposits in excess of $100,000 on average. The account activity for some
account types and client types necessitates appropriate liquidity management
practices by the Bank to ensure its ability to fund deposit withdrawals.
29
<PAGE> 31
LIQUIDITY AND LIABILITY MANAGEMENT
To meet liquidity needs, the Bank maintains a portion of its funds in cash
deposits in other banks, in federal funds sold, and in investment securities. As
of March 31, 1998, the Bank's primary liquidity ratio was 43.1% as a percentage
of total deposits of $304,200,000, comprised of $51,227,000 in investment
securities available-for-sale with maturities (or probable calls) of up to five
years, federal funds sold of $52,200,000, and $27,700,000 in cash and due from
Banks. As of December 31, 1997, the Bank's primary liquidity ratio was 37.6% as
a percentage of total deposits of $243,000,000, comprised of $48,200,000 in
investment securities available-for-sale of maturities (or probable calls) of up
to five years, federal funds sold of $27,100,000, and $16,100,000 in cash and
due from banks. As of December 31, 1996, the Bank's primary liquidity ratio was
37.9% as a percentage of total deposits of $146.4 million, comprised of
$42,900,000 in investment securities available-for-sale of maturities (or
probable calls) of up to five years, and $12,600,000 in cash and due from banks.
Liquidity was essentially unchanged from 1996 to 1997 as deposit growth was
matched by commensurate growth in liquid assets.
The following table summarizes the Bank's borrowings under its federal
funds purchased and security repurchase arrangements for the periods indicated:
<TABLE>
<CAPTION>
1997 1996
------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Average balance during the year......................... $ 297 $ 85
Average interest rate during the year................... 5.72% 5.64%
Maximum month-end balance during the year............... $ 300 $5,010
Average rate at December 31............................. -- 6.75%
</TABLE>
The Bank has federal funds purchase lines of $15,000,000 and $2,000,000,
respectively, from its two correspondent banks, and a repurchase arrangement of
$10,000,000 with a commercial brokerage firm. There were no borrowings under
these arrangements as of March 31, 1998, December 31, 1997 or December 31, 1996.
30
<PAGE> 32
INTEREST RATE SENSITIVITY
The following table sets forth the interest rate sensitivity of the
Company's interest-earning assets and interest-bearing liabilities as of March
31, 1998, using the rate sensitivity gap ratio. For purposes of the following
table, an asset or liability is considered rate-sensitive within a specified
period when it can be repriced or when it is scheduled to mature within the
specified time frame:
<TABLE>
<CAPTION>
MATURITY OR REPRICING
-------------------------------------------------------------------------
WITHIN DUE IN THREE DUE AFTER
THREE TO TWELVE ONE TO FIVE DUE AFTER NOT RATE-
MONTHS MONTHS YEARS FIVE YEARS SENSITIVE TOTAL
-------- ------------ ----------- ---------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS:
Federal funds sold............ $ 52,200 $ -- $ -- $ -- $ 52,200
Securities.................... 5,515 8,602 51,352 32,119 97,588
Total loans................... 110,934 10,625 14,718 6,711 142,988
Other assets.................. -- 4,525 -- -- 4,525
-------- ------- ------- -------- --------- --------
Total interest earning assets... 168,649 23,752 66,070 38,830 297,301
-------- ------- ------- -------- --------- --------
Cash and due from banks......... $ 27,696 27,696
Other assets.................... 3,979 3,979
-------- ------- ------- -------- --------- --------
Total assets.................... $168,649 $23,752 $66,070 $ 38,830 $ 31,675 $328,976
======== ======= ======= ======== ========= ========
INTEREST BEARING LIABILITIES:
Demand, interest-bearing...... $ 6,702 $ -- $ -- $ -- $ 6,702
Savings and money market...... 115,269 -- -- -- 115,269
Time deposits................. 39,019 14,024 2,072 -- 55,115
-------- ------- ------- -------- --------- --------
Total interest bearing
liabilities................... 160,990 14,024 2,072 -- 177,086
-------- ------- ------- -------- --------- --------
Non-interest demand deposits.... $ 127,079 127,079
Other liabilities............... 1,986 1,986
Shareholders' equity............ 22,825 22,825
-------- ------- ------- -------- --------- --------
Total liabilities and
shareholders' equity.......... $160,990 $14,024 $ 2,072 $ -- $ 151,890 $328,976
======== ======= ======= ======== ========= ========
Interest rate sensitivity gap... $ 7,659 $ 9,728 $63,998 $ 38,830 $(120,215) --
======== ======= ======= ======== ========= ========
Cumulative interest rate
sensitivity gap............... $ 7,659 $17,387 $81,385 $120,215 -- --
Cumulative interest rate
sensitivity gap ratio......... 2.33% 5.29% 24.74% 36.54%
</TABLE>
The foregoing table demonstrates that the Company had a positive cumulative
one year gap of $17.4 million, or 5.29% of total assets, at March 31, 1998. In
theory, this would indicate that $17.4 million more in assets than liabilities
would reprice if there was a change in interest rates over the next year. If
interest rates were to increase, the positive gap would tend to result in a
higher net interest margin. However, changes in the mix of earning assets or
supporting liabilities can either increase or decrease the net margin without
affecting interest rate sensitivity. In addition, the interest rate spread
between an asset and its supporting liability can vary significantly while the
timing of repricing of both the asset and its supporting liability can remain
the same, thus impacting net interest income. This characteristic is referred to
as a basis risk and, generally, relates to the repricing characteristics of
short-term funding sources such as certificates of deposit.
Varying interest rate environments can create unexpected changes in
prepayment levels of assets and liabilities which are not reflected in the
interest sensitivity analysis table. These prepayments may have significant
effects on the Company's net interest margin. Because of these factors, an
interest sensitivity gap report may not provide a complete assessment of the
Company's exposure to changes in interest rates.
Since interest rate changes do not affect all categories of assets and
liabilities equally or simultaneously, a cumulative gap analysis alone cannot be
used to evaluate the Bank's interest rate sensitivity position. To
31
<PAGE> 33
supplement traditional gap analysis, the Bank performs simulation modeling to
estimate the potential effects of changing interest rates. The process allows
the Bank to explore the complex relationships within the gap over time and
various interest rate environments. For additional information on the Bank's
simulation model and the methodology used to estimate the potential effects of
changing interest rates, see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK."
The Bank's internal Asset/Liability Committee and the Finance and
Investment Committee of the Board each meet monthly to monitor the Bank's
investments and liquidity needs and to oversee its asset/liability management.
The Bank evaluates the rates offered on its deposit products on a weekly basis.
CAPITAL RESOURCES
The following table summarizes risk-based capital, risk-weighted assets,
and risk-based capital ratios of the Company at March 31, 1998 and the Bank at
December 31, and March 31, 1997:
<TABLE>
<CAPTION>
MARCH 31, MINIMUM
------------------- DECEMBER 31, REGULATORY
1998 1997 1997 REQUIREMENTS
-------- -------- ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Capital components:
Tier 1 Capital.................................. $ 22,354 $ 20,629 21,899
Tier 2 Capital.................................. 2,540 1,350 1,885
-------- -------- -------
Total risk-based capital................ $ 24,894 $ 21,979 $23,784
======== ======== =======
Risk-weighted assets.............................. 170,353 107,728 150,418
Average assets.................................... 265,791 181,841 251,767
Capital ratios:
Total risk-based capital................ 14.6% 20.4% 15.8% 8.0%
Tier 1 risk-based capital....................... 13.1 19.1 14.6 4.0
Leverage ratio(1)............................... 8.4 11.3 10.3 4.0
</TABLE>
- ---------------
(1) Tier 1 capital divided by average assets (excluding goodwill).
At March 31, 1998 and December 31, 1997, the Bank's capital exceeded all
minimum regulatory requirements and the Bank was considered to be "well
capitalized," as defined in the regulations issued by the FDIC. The table above
presents the capital ratios of the Company as of March 31, 1998 and the Bank as
of December 31 and March 31, 1997 computed in accordance with applicable
regulatory guidelines and compared to the standards for minimum capital adequacy
requirements under the FDIC's prompt corrective action authority as of December
31, 1997. The risk-based and leverage capital ratios are defined in "SUPERVISION
AND REGULATION -- Capital Adequacy Guidelines."
The Company intends to raise equity capital in the Offering to capitalize a
proposed de novo bank in Fremont as part of its efforts to expand its banking
business in southern Alameda County. No assurance can be given that the Company
will be able to raise the additional capital needed to support the organization
of a new bank. Management believes that the Company has sufficient capital and
cash flows to fund operations for the next year regardless of its success in
raising capital in the Offering. The Company has no other plans to raise capital
beyond this Offering.
INFLATION
The impact of inflation on a financial institution can differ significantly
from that exerted on other companies. Banks, as financial intermediaries, have
many assets and liabilities that may move in concert with inflation both as to
interest rates and value. This is especially true for companies, such as the
Bank, with a high percentage of interest rate sensitive assets and liabilities.
It is the Bank's policy to have the majority of its loan portfolio be variable
interest rate loans. A bank can further reduce the impact of inflation if it can
manage its
32
<PAGE> 34
interest rate sensitivity gap. The Bank attempts to structure its mix of
financial instruments and manage its interest rate and sensitivity gap in order
to minimize the potential adverse effects of inflation or other market forces on
its net income and therefore, on its earnings and capital.
EXPANSION IN FREMONT
The Bank opened a branch in Fremont, California, in February, 1998. The
Bank intends to utilize the Fremont branch to obtain deposits and loans in
southern Alameda County. If the Company succeeds in raising $6,000,000 or more
in this Offering and in establishing a de novo bank in Fremont, the Company
intends to cause the Bank to transfer its assets, liabilities and operations of
the Fremont branch to the de novo bank. The Company expects that the de novo
bank, if established, will have its own board of directors consisting of
individuals who live or work in Fremont and whose community contacts will help
promote the interests of the de novo bank in Fremont. The Company believes that
a de novo bank with management drawn from the Fremont community will be better
able to attract and retain banking business in the Fremont community than the
Bank's existing Fremont branch and to compete with other financial institutions
without such ties to the local community. No assurance can be given that a de
novo bank will attract the amount of business anticipated by the Company or that
the de novo bank can operate at a profit in either the short term or long term.
33
<PAGE> 35
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a financial institution, the Company's primary component of market risk
is interest rate volatility. The primary source of the Company's interest rate
risk is the difference in the repricing characteristics of its assets and
liabilities. At December 31, 1997 and March 31, 1998, the Company's assets
generated interest rate risk that was principally tied to the U.S. Treasury rate
for securities and the Prime rate for the loan portfolio. Deposit rates are
based upon short term market rates. Most of the Company's loans reprice rapidly
in response to changes in the Prime rate, while the Company's deposit
liabilities reprice more slowly, if at all, in response to changes in market
interest rates.
Fluctuations in interest rates will ultimately impact both the level of
income and expense recorded on most of the Bank's assets and liabilities, and
the market value of all interest-earning assets, other than those which have a
short term to maturity. Since all of the Company's interest-bearing assets and
liabilities are located at the Bank, all of the Company's interest rate risk
exposure lies at the Bank level, as well. As a result, all interest rate risk
management procedures are performed at the Bank level. Based upon the nature of
the Bank's operations, the Bank is not subject to foreign exchange or commodity
price risk. The Company does not own any trading assets. As of December 31,
1997, the Company does not use interest rate derivatives to hedge its interest
rate risk.
The Bank's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee (ALCO). Interest rate risk is the potential of
economic losses due to future interest rate changes. These economic losses can
be reflected as a loss of future net interest income and/or a loss of current
fair market values. The objective is to measure the effect on net interest
income and to adjust the balance sheet to minimize the inherent risk while at
the same time maximize income. Management realizes certain risks are inherent,
and that the goal is to identify and accept the risks. Management uses two
methodologies to manage interest rate risk: 1) a standard GAP analysis; and 2)
an interest rate shock simulation model. The Bank has no market risk sensitive
instruments held for trading purposes.
The detail from the Bank's GAP analysis is shown above, and is not
discussed here. The Bank applies a market value (MV) methodology to gauge its
interest rate risk exposure as derived from its simulation model. Generally, MV
is the discounted present value of the difference between incoming cash flows on
interest earning assets and other investments and outgoing cash flows on
interest bearing liabilities. The application of the methodology attempts to
quantify interest rate risk as the change in the MV which would result from a
theoretical 200 basis point (1 basis point equals 0.01%) change in market
interest rates. Both a 200 basis point increase and a 200 basis point decrease
in market rates are considered.
At March 31, 1998, it was estimated that the Company's MV would increase
5.2% in the event of a 200 basis point increase in market interest rates. The
Company's MV at the same date would decrease 6.8% in the event of a 200 basis
point decrease in market interest rates.
Presented below, as of March 31, 1997, is an analysis of the Company's
interest rate risk as measured by changes in MV for instantaneous and sustained
parallel shifts of 200 basis points in market interest rates:
<TABLE>
<CAPTION>
MARKET VALUE AS A % OF
% CHANGE IN PRESENT VALUE OF ASSETS
MARKET ------------------------
CHANGE IN RATES $ CHANGE IN MARKET VALUE VALUE MV RATIO CHANGE (BP)
--------------- ------------------------ ----------- --------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
+200 bp $ 2,296 5.2% 17.3% 86
0 bp -- -- 16.4 --
-200 bp (3,002) (6.8) 15.3 (112)
</TABLE>
Management believes that the MV methodology overcomes three shortcomings of
the typical maturity gap methodology. First, it does not use arbitrary repricing
intervals and accounts for all expected future cash flows. Second, because the
MV method projects cash flows of each financial instrument under different
interest rate environments, it can incorporate the effect of embedded options on
an institutions interest rate
34
<PAGE> 36
risk exposure. Third, it allows interest rates on different instruments to
change by varying amounts in response to a change in market interest rates,
resulting in more accurate estimates of cash flows.
However, as with any method of gauging interest rate risk, there are
certain shortcomings inherent to the MV methodology. The model assumes interest
rate changes are instantaneous parallel shifts in the yield curve. In reality,
rate changes are rarely instantaneous. The use of the simplifying assumption
that short-term and long-term rates change by the same degree may also misstate
historic rate patterns, which rarely show parallel yield curve shifts. Further,
the model assumes that certain assets and liabilities of similar maturity or
period to repricing will react the same to changes in rates. In reality, certain
types of financial instruments may react in advance of changes in market rates,
while the reaction of other types of financial instruments may lag behind the
change in general market rates. Additionally, the MV methodology does not
reflect the full impact of annual and lifetime restrictions on changes in rates
for certain assets, such as adjustable rate loans. When interest rates change,
actual loan prepayments and actual early withdrawals from certificates may
deviate significantly from the assumptions used in the model. Finally, this
methodology does not measure or reflect the impact that higher rates may have on
adjustable-rate loan clients' ability to service their debt. All of these
factors are considered in monitoring the Company's exposure to interest rate
risk.
35
<PAGE> 37
The following "Business of the Company" section contains forward-looking
statements that involve risks and uncertainties. The Company's and the Bank's
actual results could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set
forth in the section entitled "Risk Factors" and elsewhere in this Prospectus.
BUSINESS OF THE COMPANY
GENERAL
The Company was recently incorporated as a for-profit corporation under the
California General Corporation Law for the principal purpose of engaging in
activities permitted for a bank holding company. The Company is the holding
company for the Bank and is a legal entity separate and distinct from the Bank.
The operations of the Company will be conducted at the same location and in the
same facilities as the operations of the Bank. The Company does not expect to
engage in activities other than the operation of subsidiary banks in the
immediate future. The Company may also receive income from dividends paid to it
by the Bank, subject to legal restriction. However, the Bank has no formal
dividend policy, and dividends are issued solely in the discretion of the Bank's
Board of Directors. There can be no assurance as to when or whether such a
dividend will be paid or the amount thereof. The Bank currently has a retained
deficit which precludes it from paying cash dividends without the consent of the
Commissioner. See "SUPERVISION AND REGULATION -- Limitations on Dividends." If
this Offering is completed, the Company may earn interest on investment of funds
not used to capitalize a de novo bank. See "USE OF PROCEEDS."
The activities of the Company will be subject to the supervision of the
FRB. The Company may engage, directly or through subsidiary corporations, in
those activities closely related to banking which are specifically permitted
under the Bank Holding Company Act of 1956, as amended. See "SUPERVISION AND
REGULATION."
THE BANK
Heritage Bank of Commerce commenced operations as a California
state-chartered bank on June 8, 1994. The Bank's deposit accounts are insured by
the FDIC, up to the applicable limits. The Bank is not a member of the Federal
Reserve System. The Bank's main office is located in the city of San Jose,
California.
The Bank offers a range of loans, primarily commercial loans, including
real estate loans, construction loans, SBA loans, inventory and accounts
receivable loans, and equipment loans. The Bank also accepts checking, savings,
and time deposits; NOW and money market deposit accounts; and provides
travelers' checks, safe deposit, and other customary non-deposit banking
services. The Bank issues VISA and MasterCard credit cards through a
correspondent. The Bank has no subsidiaries and does not have a trust
department.
BUSINESS AND MARKETING STRATEGY
Management believes that the Company will benefit from its location in the
downtown business district of the City of San Jose much the same as the Bank has
benefited from being in the same location. By virtue of its local ownership,
management, decision making, and subsidiary, the Company hopes to benefit from
the continuing trend in the banking industry towards merger and consolidation.
The Company's, as well as the Bank's, business strategy and promotional
activities emphasize service and responsiveness to local needs. Management
believes that the capital provided by this Offering can allow the Company to
implement its strategy of establishing new de novo banks, branches, or
representative offices in contiguous geographic areas.
The Bank's primary focus is on small to medium sized businesses, their
owners, operators and employees, operating in the Santa Clara Valley. The Bank's
marketing and sales are confined primarily to personal contacts and referrals in
the community, which are focused primarily on obtaining business from clients
who require an unusual degree of personal service and attention from their bank.
The Bank conducts a traditional banking business, including the acceptance of
demand, savings and time deposits and the making of
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commercial, real estate, and consumer loans. Businesses served include
manufacturers, distributors, contractors, professional
corporations/partnerships, and service businesses. The Bank had approximately
2,911 and 2,705 deposit accounts at March 31, 1998 and December 31, 1997,
respectively. In February 1998, the Bank opened a branch office in Fremont,
California.
MARKET AREA
Currently, the Company's primary market area is comprised of Santa Clara
and the southern portion of Alameda counties. The Company serves a secondary
market consisting of the South Bay portion of the San Francisco Bay area,
including portions of all counties contiguous to its primary market area. This
area is characterized by a high degree of urbanization and several
concentrations of the small industrial companies and small-to-medium service
companies that comprise the Bank's target market.
LITIGATION
From time to time, the Company will be involved in litigation as an
incident to its business. In the opinion of management, no pending or threatened
litigation is likely to have a material adverse effect on the Company's
financial condition, results of operations or cash flows.
COMPETITION
The banking and financial services business in California generally, and in
both the Company's and the Bank's market areas specifically, is highly
competitive. The increasingly competitive environment is a result primarily of
changes in regulation, changes in technology and product delivery systems, and
the accelerating pace of consolidation among financial services providers. While
the Company does not directly compete with any other business, the Bank does
compete for loans, deposits and customers for financial services with other
commercial banks, savings and loan associations, securities and brokerage
companies, mortgage companies, insurance companies, finance companies, money
market funds, credit unions, and other non-bank financial service providers.
Many of these competitors are much larger in total assets and capitalization,
have greater access to capital markets and offer a broader array of financial
services than the Bank. In order to compete with the other financial services
providers, the Bank principally relies upon local promotional activities,
personal relationships established by officers, directors, and employees with
its customers, and specialized services tailored to meet its customers' needs.
In those instances where the Bank is unable to accommodate a customer's needs,
the Bank will seek to have those services provided in whole or in part by its
correspondents. See "SUPERVISION AND REGULATION."
PREMISES
The Bank's main office is located at 150 Almaden Boulevard, San Jose,
California. The Company also conducts its operations in the same location and
facilities. In addition, the Bank established a branch office at 3077 Stevenson
Blvd., Fremont, California 94538.
The main office is leased under non-cancelable operating leases with a
non-affiliated third party with terms, including renewal options, ranging from
five to fourteen years. The primary operating area consists of approximately
15,700 square feet of space comprising the entire usable ground floor and a
portion of the second floor of a fifteen-story class-A office building in
downtown San Jose. In addition, approximately 1,255 square feet of space is
leased contiguous to the primary operating area for meetings, staff training,
and marketing events. The lease for this additional space commenced January 1,
1997 and expires December 31, 2001.
Since April 21, 1997, the Bank has also leased space at 100 Park Center
Plaza, Suite 430 consisting of approximately 3,277 square feet of space. The
space is in a five-story class-A office building on the same city block as the
Bank's main office; the Bank's SBA department occupies this space. The lease
commenced on April 21, 1997 and will terminate on April 30, 2000.
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In February, 1998, the Bank leased space at 3077 Stevenson Blvd., Fremont,
California, consisting of 6,590 square feet of space in a stand-alone office
building. The lease, which commenced February 1, 1998, is for a ten year period
expiring January, 2008.
EMPLOYEES
As of March 31, 1998, the Bank employed a total of 105 full-time equivalent
employees, including 4 executive officers and a total of 24 other officers. None
of the Bank's employees are presently represented by a union or covered by a
collective bargaining agreement. The Bank believes that employee relations are
excellent.
SUPERVISION AND REGULATION
GENERAL
The regulation and supervision of bank holding companies and their
subsidiaries is intended primarily for the protection of depositors, the deposit
insurance funds of the FDIC and the banking system as a whole, and not for the
protection of the bank holding company stockholders or creditors. The banking
agencies have broad enforcement power over bank holding companies and banks
including the power to impose substantial fines and other penalties for
violations of laws and regulations.
The following description summarizes some of the laws to which the Company
and the Bank are subject. References herein to applicable statutes and
regulations are brief summaries thereof, do not purport to be complete, and are
qualified in their entirety by reference to such statutes and regulations.
THE COMPANY
The Company is a bank holding company registered under the BHCA, and is
subject to regulation, supervision and examination by the FRB. The BHCA and
other federal laws subject bank holding companies to particular restrictions on
the types of activities in which they may engage, and to a range of supervisory
requirements and activities, including regulatory enforcement actions for
violations of laws and regulations.
Regulatory Restrictions on Dividends; Source of Strength. It is the policy
of the FRB that bank holding companies should pay cash dividends on common stock
only out of income available over the past year and only if prospective earnings
retention is consistent with the organization's expected future needs and
financial condition. The policy provides that bank holding companies should not
maintain a level of cash dividends that undermines the bank holding company's
ability to serve as a source of strength to its banking subsidiaries.
Under FRB policy, a bank holding company is expected to act as a source of
financial strength to each of its banking subsidiaries and commit resources to
their support. Such support may be required at times when, absent this FRB
policy, a holding company may not be inclined to provide it. As discussed below,
a bank holding company in certain circumstances could be required to guarantee
the capital plan of an undercapitalized banking subsidiary.
In the event of a bank holding company's bankruptcy under Chapter 11 of the
U.S. Bankruptcy Code, the trustee will be deemed to have assumed and is required
to cure immediately any deficit under any commitment by the debtor holding
company to any of the federal banking agencies to maintain the capital of an
insured depository institution, and any claim for breach of such obligation will
generally have priority over most other unsecured claims.
Activities "Closely Related" to Banking. The BHCA prohibits a bank holding
company, with certain limited exceptions, from acquiring direct or indirect
ownership or control of any voting shares of any company which is not a bank or
from engaging in any activities other that those of banking, managing or
controlling banks and certain other subsidiaries, or furnishing services to or
performing services for its subsidiaries. One principal exception to these
prohibitions allows the acquisition of interests in companies whose activities
are found by the FRB, by order or regulation, to be so closely related to
banking or managing or controlling banks,
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as to be a proper incident thereto. Some of the activities that have been
determined by regulation to be closely related to banking are making or
servicing loans, performing certain data processing services, acting as an
investment or financial advisor to certain investment trusts and investment
companies, and providing securities brokerage services. Other activities
approved by the FRB include consumer financial counseling, tax planning and tax
preparation, futures and options advisory services, check guaranty services,
collection agency and credit bureau services, and personal property appraisals.
In approving acquisitions by bank holding companies of companies engaged in
banking-related activities, the FRB considers a number of factors, and weighs
the expected benefits to the public (such as greater convenience and increased
competition or gains in efficiency) against the risks of possible adverse
effects (such as undue concentration of resources, decreased or unfair
competition, conflicts of interest, or unsound banking practices). The FRB is
also empowered to differentiate between activities commenced de novo and
activities commenced through acquisition of a going concern.
Safe and Sound Banking Practices. Banks and bank holding companies are not
permitted to engage in unsafe and unsound banking practices. The FRB's
Regulation Y, for example, generally requires a holding company to give the FRB
prior notice of any redemption or repurchase of its own equity securities, if
the consideration to be paid, together with the consideration paid for any
repurchases or redemptions in the preceding year, is equal to 10% or more of the
company's consolidated net worth. The FRB may oppose the transaction if it
believes that the transaction would constitute an unsafe or unsound practice or
would violate any law or regulation. Depending upon the circumstances, the FRB
could take the position that paying a dividend would constitute an unsafe or
unsound banking practice.
The FRB has broad authority to prohibit activities of bank holding
companies and their non-banking subsidiaries which represent unsafe and unsound
banking practices or which constitute violations of laws or regulations, and can
assess civil money penalties for certain activities conducted on a knowing and
reckless basis, if those activities caused a substantial loss to a depository
institution. The penalties can be as high as $1,000,000 for each day the
activity continues.
Anti-Tying Restriction. Bank holding companies and their affiliates are
prohibited from tying the provision of certain services, such as extensions of
credit, to other services offered by a holding company or its affiliates.
Capital Adequacy Requirements. The FRB has adopted a system using
risk-based capital guidelines to evaluate the capital adequacy of bank holding
companies. Under the guidelines, specific categories of assets are assigned
different risk weights, based generally on the perceived credit risk of the
asset. These risk weights are multiplied by corresponding asset balances to
determine a "risk-weighted" asset base. The guidelines require a minimum total
risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist
of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2
capital. As of March 31, 1998, the Company's ratio of Tier 1 capital to total
risk weighted assets was 13.1% and its ratio of total capital to total
risk-weighted assets was 14.6%. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Capital Resources."
In addition to the risk-based capital guidelines, the FRB uses a leverage
ratio as an additional tool to evaluate the capital adequacy of bank holding
companies. The leverage ratio is a company's Tier 1 capital divided be its
average total consolidated assets. Certain highly-rated bank holding companies
may maintain a minimum leverage ratio of 3.0%, but other bank holding companies
may be required to maintain a leverage ratio of up to 200 basis points above the
regulatory minimum. As of March 31, 1998, the Company's leverage ratio was 8.4%.
The federal banking agencies' risk-based and leverage ratios are minimum
supervisory ratios generally applicable to banking organizations that meet
certain specified criteria, assuming that they have the highest regulatory
rating. Banking organizations not meeting these criteria are expected to operate
with capital positions well above the minimum ratios. The federal bank
regulatory agencies may set capital requirements for a particular banking
organization that are higher than the minimum ratios when circumstances warrant.
FRB guidelines also provide that banking organizations experiencing internal
growth or making acquisitions will be expected to maintain strong capital
positions substantially above the minimum supervisory levels, without
significant reliance on intangible assets.
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Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators
are required to take "prompt corrective action" to resolve problems associated
with insured depository institutions whose capital declines below certain
levels. In the event an institution becomes "undercapitalized," it must submit a
capital restoration plan. The capital restoration plan will not be accepted by
the regulators unless each company having control of the undercapitalized
institution guarantees the subsidiary's compliance with the capital restoration
plan up to a certain specified amount. Any such guarantee from a depository
institution's holding company is entitled to a priority of payment in
bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank
is limited to the lesser of 5% of the institution's assets at the time it became
undercapitalized or the amount necessary to cause the institution to be
"adequately capitalized." The bank regulators have greater power in situations
where an institution becomes "significantly" or "critically" undercapitalized or
fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior FRB approval of
proposed dividends, or might be required to consent to a consolidation or to
divest the troubled institution or other affiliates.
Acquisitions by Bank Holding Companies. The BHCA requires every bank
holding company to obtain the prior approval of the FRB before it may acquire
all or substantially all of the assets of any bank, or 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% of the voting shares of such bank.
In approving bank acquisitions by bank holding companies, the FRB is required to
consider the financial and managerial resources and future prospects of the bank
holding company and the banks concerned, the convenience and needs of the
communities to be served, and various competitive factors.
Control Acquisitions. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company unless the
FRB has been notified and has not objected to the transaction. Under a
rebuttable presumption established by the FRB, the acquisition of 10% or more of
a class of voting stock of a bank holding company with a class of securities
registered under Section 12 of the Exchange Act, such as the Company, would,
under the circumstances set forth in the presumption, constitute acquisition of
control of the Company.
In addition, any company is required to obtain the approval of the FRB
under the BHCA before acquiring 25% (5% in the case of an acquirer that is a
bank holding company) or more of the outstanding Common Stock of the Company, or
otherwise obtaining control or a "controlling influence" over the Company.
Exposure to and Management of Risk. The FRB has announced proposals to
examine bank holding companies with respect to their exposure to and management
of different categories of risk. Categories of risk identified by the FRB
include legal risk, operational risk, market risk, credit risk, liquidity risk,
and reputation risk. If adopted, this approach would cause bank regulators to
focus on risk management procedures, rather than simply examining every asset
and transaction. This approach, if adopted, would supplement rather than replace
existing rating systems based on evaluation of an institution's capital, assets,
management, earnings, and liquidity. Although the FDIC has not announced its
intention to adopt this approach to risk evaluation, it is likely that the
different bank regulatory agencies will eventually adopt similar approaches to
this issue. No assurance can be given as to the effect, if any, that this
examination approach would have on the Company.
Limitations on Dividends. Under California law, the holders of common stock
are entitled to receive dividends when and as declared by the Board of
Directors, out of funds legally available therefor. A California corporation
such as the Bank may make a distribution to its shareholder, the Company, if the
corporation's retained earnings equal at least the amount of the proposed
distribution. In the event sufficient retained earnings are not available for
the proposed distribution, such a corporation may nevertheless make a
distribution to its shareholders if, after giving effect to the distribution,
the corporation's assets equal at least 125 percent of its liabilities and
certain other conditions are met. Since the 125 percent ratio is equivalent to a
capital-to-assets ratio of 20 percent, most banks and bank holding companies,
including the Bank and the Company, based on their current capital ratios, are
unable to meet this last test and so must have sufficient
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retained earnings to fund the proposed distribution and therefore may pay cash
dividends only if they have sufficient retained earnings.
THE BANK
The Bank is a member of the FDIC, which currently insures the deposits of
each member bank to a maximum of $100,000 per depositor. For this protection,
the bank pays a semi-annual assessment and is subject to the rules and
regulations of the FDIC pertaining to deposit insurance and other matters.
The Bank is a California state-chartered bank, but is not a member of the
Federal Reserve System. State banks are subject to regulation, supervision and
regular examination by the California Department of Financial Institutions. The
regulations of these agencies govern most aspects of the Bank's business,
including reporting requirements, activities, investments, loans, borrowings,
certain check-clearing activities, branching, mergers and acquisitions, reserves
against deposits, and other areas.
Restrictions on Transactions with Affiliates and Insiders. Transactions
between the Bank and its non-banking subsidiaries, including the Company, are
subject to Section 23A of the Federal Reserve Act. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain
levels of collateral for loans to affiliated parties. It also limits the amount
of advances to third parties which are collateralized by the securities or
obligations of the Company or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal
Reserve Act which generally requires that certain transactions between the Bank
and its affiliates be on terms substantially the same, or at least as favorable
to the Bank, as those prevailing at the time for comparable transactions with or
involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal
stockholders and their related interests (collectively referred to herein as
"insiders") contained in the Federal Reserve Act and Regulation O apply to all
insured institutions and their subsidiaries and holding companies. These
restrictions include limits on loans to one borrower and conditions that must be
met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the
institution's total unimpaired capital and surplus, and the DFI may determine
that a lesser amount is appropriate. Insiders are subject to enforcement actions
for knowingly accepting loans in violation of applicable restrictions.
Limitations on Dividends. The primary source of funds for payment of
dividends by the Company to its shareholders is the receipt of dividends and
management fees from the Bank. The Company's ability to receive dividends from
the Bank is limited by applicable state and federal law. Additionally, the FDIC
and the Commissioner have authority to prohibit a bank from engaging in business
practices that are considered to be unsafe or unsound. Depending upon the
financial condition of a bank and upon other factors, the FDIC or the
Commissioner could assert that payments of dividends or other payments by a bank
might be such an unsafe or unsound practice.
Because the Company is a legal entity separate and distinct from its
subsidiaries, its right to participate in the distribution of assets of any
subsidiary upon the subsidiary's liquidation or reorganization will be subject
to the prior claims of the subsidiary's creditors. In the event of a liquidation
or other resolution of an insured depository institution, the claims of
depositors and other general or subordinated creditors are entitled to a
priority of payment over the claims of holders of any obligation of the
institution to its stockholders, including any depository institution holding
company (such as the Company) or any stockholder or creditor thereof.
Corrective Measures for Capital Deficiencies. The federal banking
regulators are required to take "prompt corrective action" with respect to
capital-deficient institutions. Agency regulations define, for each capital
category, the levels at which institutions are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." A "well capitalized" bank has a total risk based
capital ratio of 10% or higher; a Tier 1 risk based capital ratio of 6% or
higher; a leverage ratio of 5% or higher; and is not subject to any written
agreement, order or directive requiring it to maintain a specific capital level
for any capital measure. An "adequately capitalized" bank has a total risk based
capital ratio of 8% or higher, a Tier 1 risk based capital ratio of 4% or
higher; a leverage ratio of 4% or higher (3% or
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higher if the bank was rated a CAMEL 1 in its most recent examination report and
is not experiencing significant growth); and does not meet the criteria for a
well capitalized bank. A bank is "undercapitalized" if it fails to meet any one
of the ratios required to be adequately capitalized.
In addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment, and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.
Banks with risk-based capital and leverage ratios below the required
minimums may also be subject to certain administrative actions, including the
termination of deposit insurance upon notice and hearing, or a temporary
suspension of insurance without a hearing in the event the institution has no
tangible capital.
At March 31, 1998, the Bank's risk-based capital ratios were substantially
identical to those of the Company.
Audit Requirements. All depository institutions are required to have an
annual, full-scope on-site examination. Those depository institutions with
assets greater than $500 million are required to have annual, independent audits
and to prepare all financial statements in accordance with generally accepted
accounting principles. Each institution is required to have an independent audit
committee comprised entirely of outside directors, independent of the
institution's management.
Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
each bank to identify the communities served by the bank's offices and to
identify the types of credit the bank is prepared to extend within such
communities. It also requires the bank's regulators to assess the bank's
performance in meeting the credit needs of its community and to take such
assessment into consideration in reviewing applications for mergers,
acquisitions and other transactions. An unsatisfactory rating may be the basis
for denying such an application. The Bank was rated "excellent" in its most
recent CRA examination.
Potential Enforcement Actions; Supervisory Agreements. The Bank may be
subject to potential enforcement actions by the FRB and the FDIC for unsafe or
unsound practices in conducting its business, or for violations of any law, rule
or regulation or provision, any consent order with any agency, any condition
imposed in writing by the agency or any written agreement with the agency.
Enforcement actions may include the imposition of a conservator or receiver,
cease-and-desist orders and written agreements, the termination of insurance of
deposits, the imposition of civil money penalties and removal and prohibition
orders against institution-affiliated parties.
INTERSTATE BANKING
RIEGLE-NEAL INTERSTATE BANKING AND BRANCHING EFFICIENCY ACT OF 1994
Interstate Banking and Branching. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Riegle-Neal Act") was enacted in
September 1994. Generally, provisions of this Act authorize interstate banking
and interstate branching, subject to certain state options.
- Interstate acquisition of banks became permissible in all states on and
after September 29, 1995; state law cannot vary this rule. However,
states may continue to prohibit acquisition of banks that have been in
existence less than five years and interstate chartering of new banks.
- Interstate mergers of affiliated or unaffiliated banks will be permitted
June 1, 1997, unless a state adopts legislation before June 1, 1997 to
"opt out" of interstate merger authority, provided any limitations do not
discriminate against out-of-state banks. Individual states may enact
legislation to permit interstate mergers earlier than that date.
- Interstate acquisition of branches will be permitted to a bank only if
the law of the state where the branch is located expressly permits
interstate acquisition of a branch without acquiring the entire bank.
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- Interstate de novo branching will be permitted to a bank only if a state
adopts legislation to "opt in" to interstate de novo branching authority.
Limitations on Concentrations. An interstate banking application may not be
approved if the applicant and its depository institution affiliates would
control more than 10% of insured deposits nationwide or more than 30% of insured
deposits in the state in which the bank to be acquired is located. These limits
do not apply to mergers solely between affiliates. States may waive the 30% cap
on a nondiscriminatory basis. Nondiscriminatory state caps on deposit market
share of a depository institution and its affiliates are not affected by the
regulation.
Agency Authority. A bank subsidiary of a bank holding company will be
authorized to receive deposits, renew time deposits, close loans, service loans
and receive payments on loans as an agent for a depository institution affiliate
without being deemed a branch of the affiliate. A bank will not be permitted to
engage, as agent for an affiliate, in any activity as agent that it could not
conduct as a principal, or to have an affiliate, as its agent, conduct any
activity that it could not conduct directly, under federal or state law.
Host State Regulation. Out-of-state banks seeking to acquire or establish a
branch will be required to comply with any nondiscriminatory filing requirements
of the host state where the branch is located. The host state may set
notification and reporting requirements for a branch of an out-of-state bank. A
branch of an out-of-state bank will be subject to all of the laws of the host
state regarding intrastate branching, consumer protection, fair lending and
community reinvestment. A branch of a out-of-state bank will not be permitted to
conduct any activities at the branch that are not permissible by a bank
chartered by the host state.
Community Reinvestment Act. Community Reinvestment Act ("CRA") evaluations
will be required for each state in which an interstate bank has a branch.
Interstate banks will be prohibited from using out-of-state branches "primarily
for the purpose of deposit production." Federal banking agencies are required to
adopt regulations by June 1, 1997 to ensure that interstate branches are being
operated with a view to the needs of the host communities.
Foreign Banks. Foreign banks will be able to branch to the same extent as
U.S. domestic banks. Interstate branches acquired by foreign banks will be
subject to the CRA to the extent the acquired branch was subject to the CRA
before the acquisition.
California Law. On September 28, 1995, California enacted state legislation
in accordance with authority under the Riegle-Neal Act. This new state law
permits banks headquartered outside California to acquire or merge with
California banks that have been in existence for at least five years, and
thereby establish one or more California branch offices. An out-of-state bank
may not enter California by acquiring one or more branches of a California bank
or other operations constituting less than the whole bank. The law authorizes
waiver of the 30% limit on state-wide market share for deposits as permitted by
the Riegle-Neal Act. This law also authorizes California state-licensed banks to
conduct certain banking activities (including receipt of deposits and loan
payments and conducting loan closings) on an agency basis on behalf of
out-of-state banks and to have out-of-state banks conduct similar agency
activities on their behalf.
Before this new legislation, California law allowed California banks and
bank holding companies to be acquired by banking organizations in other states
on a reciprocal basis (i.e., provided the other state's laws permitted
California banking organizations to acquire banking organizations in that state
on substantially the same terms and conditions applicable to banking
organizations whose operations were principally conducted within that state).
State Bank Sales of Non-Deposit Investment and Insurance
Products. Securities activities of state non-member banks, as well as the
activities of their subsidiaries and affiliates, are governed by guidelines and
regulations issued by the securities and financial institution regulatory
agencies. These agencies have taken the position that bank sales of alternative
investment products, such as mutual funds and annuities, raise substantial bank
safety and soundness concerns involving consumer confusion over the nature of
the products offered, as well as the potential for mismanagement of sales
programs which could expose a bank to liability under the antifraud provisions
of federal securities laws.
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Accordingly, the agencies have issued guidelines that require, among other
things, the establishment of a compliance and audit program to monitor a bank's
mutual funds sales activities and its compliance with applicable federal
securities laws; the provision of full disclosures to customers about the risks
of such investments, including the possible loss of the customer's principal
investment; and the conduct of securities activities of bank subsidiaries or
affiliates in separate and distinct locations. In addition, the guidelines
prohibit bank employees involved in deposit-taking activities from selling
investment products or giving investment advice. Banks are also required to
establish a qualitative standard for the selection and marketing of the
investments offered by the bank, and to maintain appropriate documentation
regarding the suitability of investments recommended to bank customers.
California state-licensed banks have authority to engage in the insurance
business as an agent or broker, but not as an insurance underwriter.
Change in Senior Executives or Board Members. Certain banks and bank
holding companies are required to file a notice with their primary regulator
prior to (i) adding or replacing a member of the board of directors, or (ii) the
employment of or a change in the responsibilities of a senior executive officer.
Notice is required if the bank or holding company is failing to meet its minimum
capital standards or is otherwise in a "troubled condition," as defined in FDIC
regulations, has undergone a change in control within the past two years, or has
received its bank charter within the past two years.
Impact of Economic Conditions and Monetary Policies. The earnings and
growth of both the Company and the Bank will be affected by general economic
conditions, both domestic and international, and by the monetary and fiscal
policies of the United States Government and its agencies, particularly the FRB.
One function of the FRB is to regulate the national supply of bank credit in
order to mitigate recessionary and inflationary pressures. Among the instruments
of monetary policy used to implement those objectives are open market
transactions in United States Government securities, changes in the discount
rate on member bank borrowings and changes in reserve requirements held by
depository institutions. The monetary policies of the FRB have had a significant
effect on the operating results of commercial banks in the past and are expected
to continue to do so in the future. However, the effect, if any, of such
policies on the future business and earnings of the Bank cannot be accurately
predicted.
Cross-Guarantee Provisions. The Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") contain a "cross-guarantee" provision which
generally makes commonly controlled insured depository institutions liable to
the FDIC for any losses incurred in connection with the failure of a commonly
controlled depository institution.
Consumer Laws and Regulations. In addition to the laws and regulations
discussed herein, the Bank is also subject to certain consumer laws and
regulations that are designed to protect consumers in transactions with banks.
While the list set forth herein is not exhaustive, these laws and regulations
include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds
Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity
Act, and the Fair Housing Act, among others. These laws and regulations mandate
certain disclosure requirements and regulate the manner in which financial
institutions must deal with customers when taking deposits or making loans to
such customers. The Bank must comply with the applicable provisions of these
consumer protection laws and regulations as part of their ongoing customer
relations.
Legislation and Proposed Changes. From time to time, legislation is enacted
which has the effect of increasing the cost of doing business, limiting or
expanding permissible activities, or affecting the competitive balance between
banks and other financial institutions. Proposals to change the laws and
regulations governing the operations and taxation of banks, bank holding
companies and other financial institutions are frequently made in Congress, in
the California legislature and before various bank regulatory agencies.
Typically, the intent of such legislation is to strengthen the banking industry,
even if it may on occasion prove a burden on management's plans. No prediction
can be made as to the likelihood of any major changes or the impact such changes
might have on the Company.
44
<PAGE> 46
MANAGEMENT AND PRINCIPAL SHAREHOLDERS
BENEFICIAL OWNERSHIP OF COMMON STOCK
The following table sets forth information as of March 31, 1998 pertaining
to beneficial ownership of the Company's common stock (the sole class of stock
outstanding) by persons known to the Company to own five percent or more of the
Company's common stock, current directors of the Company, and all directors and
officers of the Company as a group. This information has been obtained from the
Company's records, or from information furnished directly by the individual or
entity to the Company.
For purposes of the following table, shares issuable pursuant to stock
options which may be exercised within 60 days of March 31, 1998 are deemed to be
issued and outstanding and have been treated as outstanding in determining the
amount and nature of beneficial ownership and in calculating the percentage of
ownership of those individuals possessing such interest, but not for any other
individuals. Thus, the total number of shares considered to be outstanding for
the purposes of this table may vary depending upon the individual's particular
circumstance.
<TABLE>
<CAPTION>
RELATIONSHIP AMOUNT AND NATURE
WITH OF BENEFICIAL EXERCISABLE PERCENT
NAME OF BENEFICIAL OWNER(1) THE COMPANY OWNERSHIP(2,3) OPTIONS OF CLASS(3)
- --------------------------- ----------------------------- ----------------- ----------- -----------
<S> <C> <C> <C> <C>
Frank G. Bisceglia Director 56,908(4) 15,094 1.7
James R. Blair Director 22,233(5) 11,051 0.9
Arthur C. Carmichael, Jr. Director 36,838(6) 11,639 1.1
Kenneth A. Corsello Executive Vice President 17,637(7) 17,322 0.5
William J. Del Biaggio, Jr. Chairman & Director 94,159(8) 15,094 2.8
Anneke Dury Director 18,322(9) 15,094 0.5
Tracey A. Enfantino Director 22,458(10) 11,639 0.7
Glenn A. George Director 65,031(11) 7,064 2.0
Robert P. Gionfriddo Executive Vice President & 100,993(12) 59,306 2.7
Director
P. Michael Hunt Director 35,951(13) 10,678 1.1
Louis ("Lon") O. Normandin Director 69,914(14) 11,639 2.1
Jack L. Peckham Director 115,589(15) 11,639 3.5
Robert W. Peters Director 94,001(16) 15,094 2.8
Humphrey P. Polanen Director 35,538(17) 15,094 1.0
John E. Rossell III President, Chief Executive 70,888(18) 59,306 1.9
Officer & Director
Kirk M. Rossmann Director 40,223(19) 11,639 1.2
All directors and executive 932,819 332,797 25.0
officers as a group (18
in number)(20)
</TABLE>
- ---------------
(1) The address for all persons is c/o Heritage Commerce Corp, 150 Almaden
Boulevard, San Jose, California 95113.
(2) Subject to applicable community property laws and shared voting and
investment power with a spouse, the persons listed have sole voting and
investment power with respect to such shares unless otherwise noted. Listed
amounts reflect (i) a 10 percent stock dividend which was paid on February
26, 1996, (ii) a 5 percent stock dividend which was paid on February 26,
1997, and (iii) a 3 for 2 stock split on August 15, 1997.
45
<PAGE> 47
(3) Includes shares beneficially owned (including options exercisable within 60
days of March 31, 1998, as shown in the next column), both directly and
indirectly together with associates.
(4) Includes 2,598 shares held as trustee of the Edith Lico Simoni Trust, 2,874
shares as custodian for Thomas J. Bisceglia and 2,874 shares as custodian
for Laura M. Bisceglia under the Uniform Gifts to Minors Act, 30,318 shares
as one of two trustees of the Bisceglia Family Trust, and 3,150 shares held
in a personal Individual Retirement Account.
(5) Includes 8,032 shares held in a personal Individual Retirement Account and
3,150 shares held as trustee for the Blair Family Trust.
(6) Includes 21,657 shares held in a personal Individual Retirement Account,
1,968 shares held as trustee of the Arthur and Jean Carmichael Living
Trust, 787 shares held as trustee for Jennifer M. Carmichael, and 787
shares held as trustee for Arthur C. Carmichael, III.
(7) Includes a total of 315 shares held as custodian for each of his two
daughters.
(8) Includes 39,375 shares held in a personal Individual Retirement Account,
36,225 shares as one of two trustees of the Del Biaggio Family Trust, and
3,465 shares held in the name of Helen N. Del Biaggio, his wife.
(9) Includes 3,228 shares held in a personal Individual Retirement Account.
(10) Includes 9,954 shares held in the Environmental Systems, Inc. of California
Profit Sharing Plan, of which she is one of three trustees.
(11) Includes 47,887 shares held as one of two trustees for the George and
Noelle Trust, 9,450 shares held in a personal Individual Retirement
Account, and 630 shares held by Joseph George Distributor, Inc., of which
he is Chairman of the Board.
(12) Includes 34,650 shares held in a personal Individual Retirement Account and
1890 shares held in the Heritage Bank of Commerce 401K Plan.
(13) Includes 17,875 shares held by the Hunt and Associates Insurance Service,
Inc., Profit Sharing Plan, 865 shares held in the name of Allison L. Hunt,
865 shares held in the name of Jason M. Hunt, 865 shares held in the name
of Michelle L. Hunt, and 4,803 shares held in the Hunt Family Trust.
(14) Includes 58,275 shares as trustee of the Louis and Margaret Normandin
Trust.
(15) Includes 103,950 shares as one of two trustees for the Peckham Revocable
Trust.
(16) Includes 78,907 shares as one of two trustees for the Robert and Carolyn
Peters Trust.
(17) Includes 6,898 shares held in a personal Individual Retirement Account, and
378 shares held by Azieb Nicodimos, his wife.
(18) Includes 11,513 shares held in a personal Individual Retirement Account.
(19) Includes 17,324 shares held in a personal Individual Retirement Account,
and 2,598 shares held as custodian for Ty Rossmann under the Uniform Gifts
to Minor Act.
(20) Included in the total, but not individually listed, are two executive
officers, whose combined beneficial ownership totals 36,136 shares and
exercisable options (which equals approximately one percent of class).
DIRECTORS AND EXECUTIVE OFFICERS
The directors of the Company are the same as the directors of the Bank,
namely: Frank G. Bisceglia, James R. Blair, Arthur C. Carmichael, Jr., William
J. Del Biaggio, Jr., Anneke Dury, Tracey Enfantino, Glenn A. George, Robert P.
Gionfriddo, P. Michael Hunt, Louis O. (Lon) Normandin, Jack L. Peckham, Robert
W. Peters, Humphrey P. Polanen, John E. Rossell, III, and Kirk M. Rossmann. The
following table sets forth the names and certain information, concerning the
directors and executive officers of the Company. The directors are elected
annually by the Company's shareholders and serve until the next Annual Meeting
of Shareholders. Except as may be set forth in any applicable employment
agreement, officers serve at the pleasure of the Board. See "REMUNERATION AND
OTHER TRANSACTIONS WITH MANAGEMENT -- Employment Contracts."
46
<PAGE> 48
None of the directors or executive officers of the Company were selected
pursuant to any arrangement or understanding, other than with the directors and
executive officers of the Company, acting within their capacities as such.
DIRECTOR INFORMATION
<TABLE>
<CAPTION>
DIRECTOR OF
DIRECTOR OF THE PRINCIPAL OCCUPATION, BUSINESS
POSITION WITH THE BANK COMPANY EXPERIENCE DURING PAST FIVE YEARS
NAME AGE THE COMPANY SINCE SINCE AND OTHER INFORMATION
---- --- ------------------- ----------- ----------- ---------------------------------
<S> <C> <C> <C> <C> <C>
Frank G. Bisceglia 52 Director 1994 1997 Senior Vice President --
Investments Portfolio Manager at
Paine Webber, an independent,
full service securities firm.
James R. Blair 53 Director 1994 1997 President of Renco Properties,
Inc., a real estate development
company.
Arthur C. Carmichael, Jr. 57 Director 1994 1997 Chairman, Willis Corroon of San
Jose, an insurance brokerage
firm.
William J. Del Biaggio, 57 Chairman and 1994 1997 Chief Executive Officer of MED-
Jr. Director COR Health Information Systems,
Inc., a release of information
and staff outsourcing company,
since 1996; President of Heritage
Beverage Company, a beverage
importer-brokerage firm, since
1994; and from 1991 to 1994,
General Manager of Coors of Santa
Clara Valley.
Anneke Dury 53 Director 1994 1997 Independent financial consultant
for various Santa Clara County
technology companies.
Tracey Enfantino 37 Director 1994 1997 General Manager of Environmental
Systems, Inc., a mechanical
contracting company.
Glenn A. George 67 Director 1994 1997 Chairman of the Board of Joseph
George Distributor, a wine
distribution firm.
Robert P. Gionfriddo 52 Executive Vice 1994 1997 Executive Vice President,
President and Heritage Bank of Commerce since
Director 1994; from 1990 to 1993,
Executive Vice President at
Silicon Valley Bank; and from
1981 to 1990, Executive Vice
President at Comerica Bank-
California [formerly Plaza Bank
of Commerce].
P. Michael Hunt 54 Director 1994 1997 President, Hunt & Associates
Insurance Service, Inc., an
employee benefits, life insurance
and retirement planning firm.
Louis ["Lon"] O. Normandin 63 Director 1994 1997 Owner and President of Normandin
Chrysler-Plymouth Jeep Eagle.
Jack L. Peckham 56 Director 1994 1997 President and CEO of Lightspeed
Semiconductor from December 1997
to present, Vice
President/General Manager of
Atmel Corporation, a
semiconductor manufacturing
company from 1985 to 1997.
</TABLE>
47
<PAGE> 49
<TABLE>
<CAPTION>
DIRECTOR OF
DIRECTOR OF THE PRINCIPAL OCCUPATION, BUSINESS
POSITION WITH THE BANK COMPANY EXPERIENCE DURING PAST FIVE YEARS
NAME AGE THE COMPANY SINCE SINCE AND OTHER INFORMATION
---- --- ------------------- ----------- ----------- ---------------------------------
<S> <C> <C> <C> <C> <C>
Robert W. Peters 58 Director 1994 1997 Private investor in technology
companies since 1990; and from
1988 to 1990, Vice President of
Cisco Systems, a networking firm.
Humphrey P. Polanen 48 Director 1994 1997 President and CEO, Trustworks
Systems, an internet security
company since February 1998.
General Manager, Network Security
Products Group, Sun Microsystems,
a computer systems company, 1997
to February 1998; General
Manager, Internet Commerce Group,
Sun Microsystems, from 1995 to
1997; and from 1981 to 1995,
Director of Worldwide Business
Development at Tandem Computers.
John E. Rossell III 50 President, Chief 1994 1997 President and CEO of Heritage
Executive Officer & Bank of Commerce since 1994; and
Director from 1992 to 1993, Senior Credit
Officer at Silicon Valley Bank.
Kirk M. Rossmann 50 Director 1994 1997 Chief Executive Officer of B/T
Management Group, LLC since 1996;
and from 1975 to 1996, President
of American Welding Supply, an
industrial and electronic
industrial gas supplier.
</TABLE>
There are no family relationships among any of the Company's Executive
Officers, directors or director nominees.
No director or nominee chosen by the Board of Directors is a director of
any company with a class of securities registered pursuant to section 12 of the
Securities Exchange Act of 1934, as amended, or subject to the requirements of
section 15(d) of such Act or of any company registered as an investment company
under the Investment Company Act of 1940, as amended.
48
<PAGE> 50
EXECUTIVE OFFICERS OF THE COMPANY
Set forth below is certain information with respect to the executive
officers of the Company who are not also directors.
<TABLE>
<CAPTION>
OFFICER OF
OFFICER OF THE PRINCIPAL OCCUPATION, BUSINESS
THE BANK COMPANY EXPERIENCE DURING PAST FIVE YEARS
NAME AGE POSITION SINCE SINCE AND OTHER INFORMATION
---- --- ------------------- ----------- ----------- ---------------------------------
<S> <C> <C> <C> <C> <C>
Kenneth A. Corsello 47 Executive Vice 1995 1997 Since 1996, Mr. Corsello has
President and Chief served as Executive Vice
Credit Officer President and as Chief Credit
Officer of Heritage Bank of
Commerce since 1995. From 1994 to
1995 Mr. Corsello served as
Senior Vice President/Credit
Administrator with Cupertino
National Bank, and from 1990 to
1994 as a Department Head with
the Federal Deposit Insurance
Corporation
Kenneth B. Silveira 53 Executive Vice 1994 1997 Since 1997, Mr. Silveira has
President/Operations served as Executive Vice
and Administration President of Operations and
Administration and from 1994 to
1997 as Senior Vice
President/Operations and
Administration. From 1965 to 1993
Mr. Silveira served as Vice
President and Branch Manager, as
Secretary of the Corporate
Pricing Committee, and as
Division Controller at Bank of
America
Daniel A. Northway 38 Chief Financial 1994 1997 Vice President of Commercial
Officer Banking and Credit Administrator
of Heritage Bank of Commerce from
1994 to 1995, and as Vice
President of Finance from 1995 to
1997. From 1993 to 1994 Mr.
Northway served as Vice President
of Commercial Lending with
Cupertino National Bank.
</TABLE>
49
<PAGE> 51
REMUNERATION AND OTHER TRANSACTIONS WITH MANAGEMENT
SUMMARY COMPENSATION
The following table sets forth a summary of compensation for services to
the Bank for the Bank's President and Chief Executive Officer, the Bank's
Executive Vice President, and the Bank's Executive Vice President/Chief Credit
Officer who were the only executive officers of the Bank or the Company whose
1997 compensation exceeded $100,000:
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
-------------------------------
AWARDS PAYOUTS
ANNUAL COMPENSATION --------------------- -------
--------------------------------------- RESTRICTED
OTHER ANNUAL STOCK OPTIONS/ LTIP ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS(1) COMPENSATION(2) AWARDS SARS PAYOUTS COMPENSATION(3)
- --------------------------- ---- --------- --------- --------------- ---------- -------- ------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John E. Rossell............. 1997 $150,000 $37,500 $13,050 -- 3,000 -- --
President and CEO......... 1996 150,000 30,000 8,174 -- -- -- --
1995 150,000 7,500 8,415 -- -- -- --
Robert P. Gionfriddo........ 1997 $127,500 $37,500 $13,392 -- 3,000 -- $20,000
Executive Vice
President............... 1996 125,000 30,000 9,821 -- -- -- 20,000
1995 125,000 7,500 10,967 -- -- -- 20,000
Kenneth A. Corsello......... 1997 $ 95,229 $20,400 $10,326 -- -- -- --
Executive Vice
President............... 1996 86,833 17,060 4,875 -- 3,150 -- --
Chief Credit Officer...... 1995(4) -- -- -- -- 25,988 -- --
</TABLE>
- ---------------
(1) Amounts shown include cash and non-cash compensation earned and received by
executive officers as well as amounts earned but deferred at the election of
those officers.
(2) Amounts include an automobile allowance pursuant to the terms of each
executive officer's employment and payments for unused vacation.
(3) Amounts shown are earnings on LTIP compensation for an amount payable in
1999 if Mr. Gionfriddo remains employed by the Bank.
(4) Mr. Corsello's employment with the Bank began November 27, 1995. For the two
and one-half years prior to his employment with the Bank, Mr. Corsello was a
Senior Credit Officer of Cupertino National Bank.
The Bank pays the cost of premiums on life insurance policies insuring all
employees, including executive officers, in amounts approximately two times
their annual salaries. The policies are payable to the officers' designated
beneficiaries. A portion of the premium paid by the Bank is imputed as income
for tax purposes for the executive officers. Such amounts are included in the
compensation table above.
STOCK OPTION PLAN
Effective in the second quarter of 1994, the Board of Directors adopted the
Heritage Bank of Commerce 1994 Tandem Stock Option Plan ("Option Plan"). The
Option Plan authorizes the Bank to grant options that qualify as incentive stock
options (ISO) under the Internal Revenue Code of 1986 and non-qualified stock
options (NSO) to the key employees of the Bank. Non-employee directors are only
eligible to receive NSOs. The Option Plan was approved at the Bank's first
annual meeting of shareholders in April of 1995.
Originally the Option Plan had 623,700 shares (adjusted for stock dividends
and splits) authorized for issuance. During 1997, an additional 362,469 shares
were added to the Option Plan for future grants. At March 31, 1998, 305,289
shares are available for future grants under the Option Plan. Shares were
granted at prices that are the higher of $5.77 per share or an amount per share
that approximates the fair market value of the Bank's Common Stock at the time
of the grant. In addition, if an ISO is granted to an officer or key employee of
the Bank who at the time of the grant owns more than ten percent of the Bank's
Common Stock, the exercise price of the options must be not less than the
greater of $6.35 per share or 110 percent of the fair market value of the Bank's
Common Stock at the time the option is granted. All options granted expire ten
years from the date of grant. The exercise price of all options must be paid in
full in cash at the time of such exercise. The Personnel and Planning Committee,
a committee appointed by the Board, administers the Plan.
50
<PAGE> 52
The following tables delineate options granted to executive officers,
Messrs. Rossell, Gionfriddo, and Corsello:
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
% OF TOTAL
OPTION GRANTED EXERCISE
TO EMPLOYEES OR GRANT DATE
NAME OPTIONS GRANTED IN FISCAL YEAR BASE PRICE EXPIRATION DATE PRESENT VALUE
---- --------------- --------------- ---------- --------------- -------------
<S> <C> <C> <C> <C> <C>
John E. Rossell.......... 3,000 3.8% $8.67 07/01/07 $11,786.39
President and CEO
Robert Gionfriddo........ 3,000 3.8% $8.67 07/01/07 $11,786.39
Executive Vice
President
Kenneth A. Corsello...... -- -- -- -- --
Executive Vice
President
</TABLE>
Grant date present value is determined according to the option valuation
provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Under SFAS
No. 123, the fair value of stock-based awards to employees is calculated through
the use of option pricing models, even though such models were developed to
estimate the fair value of freely tradable, fully transferable options without
vesting restrictions, which differ significantly from the Bank's stock option
awards. Those models also require subjective assumptions, which greatly affect
the calculated values. The calculations were made using the Black-Scholes option
pricing model with the following weighted average assumptions: expected life, 84
months; risk-free interest rate, 5.75%; stock volatility of 30%; and no
dividends during the expected term. For the grants shown in the table above, and
using the assumptions previously described, the present value of an option to
purchase one share is $3.9288 at the date of grant.
AGGREGATED OPTIONS/SAR EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR-END
OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF VALUE OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS AT
YEAR END YEAR END
--------------- --------------------
SHARES ACQUIRED ON EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#) VALUE REALIZED($) UNEXERCISABLE UNEXERCISABLE
---- ------------------ ----------------- --------------- --------------------
<S> <C> <C> <C> <C>
John E. Rossell......... -- -- 54,975/34,650 $554,000/$354,000
Robert Gionfriddo....... -- -- 54,975/34,650 $554,000/$354,000
Kenneth A. Corsello..... -- -- 14,248/14,889 $136,000/$140,000
</TABLE>
EMPLOYMENT CONTRACTS
JOHN E. ROSSELL III, the Bank's President and CEO, is employed under the
terms of a written five-year employment contract with the Bank, terminating on
June 8, 1999, which, among other terms, provides for the following: combined
wages, including deferred compensation, of $150,000 per year, including an
annual review for salary increase; bonuses based upon the performance of the
Bank, awarded in the sole discretion of the Board of Directors; a car allowance;
insurance; and severance compensation and benefits in the event the Bank
terminates Mr. Rossell's employment without cause.
If Mr. Rossell is terminated without cause, he shall be paid a severance in
an amount equal to twelve months' base salary, plus cost of health insurance
premiums for one year, the cost of life insurance for one year, and the cost of
disability insurance for one year. There are no changes in control provisions in
Mr. Rossell's employment agreement.
In addition to the foregoing, the employment contract provided for the
grant effective upon execution of the agreement, of qualified incentive stock
options for the purchase of 86,625 shares of the Bank's common stock exercisable
at the initial common stock offering price of $5.77 per share. These options
vest quarterly over five years. In 1997, 3,000 non-qualified stock options were
granted at a price of $8.67 per share. These options vested immediately.
51
<PAGE> 53
ROBERT P. GIONFRIDDO, the Bank's Executive Vice President and Chief
Business Development officer, is employed under the terms of a written
three-year employment contract with the Bank, terminating on June 8, 2000,
which, among other terms, provides for the following: Combined wages, including
deferred compensation, averaging $145,000 per year; bonuses based upon the
performance of the Bank, awarded in the sole discretion of the Board of
Directors; a car allowance; insurance; the beneficial use of a proprietary
membership in a local country club; and severance compensation and benefits in
the event the Bank terminates Mr. Gionfriddo's employment without cause.
If Mr. Gionfriddo is terminated without cause, except as relating to a
change in control, he shall be paid a severance in an amount equal to six months
base salary plus health insurance premiums. If, in the event of a change in
control and in conjunction with, or by reason of such change in control, Mr.
Gionfriddo's employment is terminated without cause or materially reduced in
scope, he shall be paid severance in an amount equal to (i) twelve months' total
compensation (including base salary, performance bonus, and all other amounts
includable as taxable income) if he is required to sign a non-competition
agreement, or (ii) twelve months' base salary if he is not required to sign a
non-competition agreement.
In addition to the foregoing, the employment contract provided for the
grant effective upon execution of the agreement, of qualified incentive stock
options for the purchase of 86,625 shares of the Bank's common stock exercisable
at the initial common stock offering price of $5.77 per share. The options vest
quarterly over five years. In 1997, 3,000 non-qualified stock options were
granted at a price of $8.67 per share. The options vested immediately.
At present, the Bank is not a party to any other employment agreements.
401 (K) PLAN
The Board of Directors has established an employee profit sharing plan
(Plan) under Section 401(k) of the Internal Revenue Code. The purpose of the
Plan is to provide all eligible employees with supplemental income upon
retirement and to increase their proprietary interest in the Bank. Eligible
employees may make contributions to the Plan subject to annual limitations of
the Internal Revenue Code. The Bank does not provide any matching contributions
to the Plan. The Plan trustees, consisting of members of Bank management,
administer the Plan.
EMPLOYEE STOCK OWNERSHIP PLAN
During 1997, the Bank initiated an employee stock ownership plan (Stock
Ownership Plan). The Stock Ownership Plan allows the Bank to purchase shares on
the open market and award those shares to certain employees in lieu of paying
cash bonuses. To be eligible to receive an award of shares under the Stock
Ownership Plan, an employee must have worked at least 1,000 hours during the
year and must be employed by the Bank on December 31. Awards under the Stock
Ownership Plan generally vest over four years. During 1997, the Bank contributed
$98,000 to the Stock Ownership Plan with contributions to John E. Rossell, III,
Robert P. Gionfriddo and Kenneth A. Corsello totaling $4,500, $4,350 and $2,857
respectively. These amounts are included in the Summary Compensation table above
in the column entitled "Other Annual Compensation."
COMPENSATION OF DIRECTORS
SUPPLEMENTARY RETIREMENT PLAN FOR DIRECTORS, INCLUDING TWO EXECUTIVE OFFICERS
In June of 1997, the Bank provided each of its directors, including two
executive officers, with a non qualified, defined contribution retirement and
death benefit plan. The amount of each respective potential annual retirement
benefit is indexed to the financial performance of specific single premium life
insurance policies, owned by the Bank and insuring the life of the respective
director. The Bank books as income any earnings on the policies, however, it
retains only the amount of earnings which would have been earned had it
purchased a one year Treasury Bill in lieu of the insurance policy. The "excess
earnings" of each insurance
52
<PAGE> 54
policy (the amount earned by the policy over and above the amount determined by
the Treasury Bill "hurdle rate" just described), is credited to a liability
reserve account for the benefit of the director. Each plan participant earns a
vested interest in the balance of his or her respective liability reserve
account, at the rate of 12% per annum, beginning with that individual's first
year of service and cumulating for as long as the director remains in the
service of the Bank, or until the director achieves 100% vesting. The policies
corresponding to each of the directors are denominated in one of two uniform
premium amounts. One uniform premium amount is applicable to policies purchased
to insure the lives of directors who are not also executive officers and the
other is applicable to policies purchased to insure the lives of directors who
are also Executive Officers, namely John E. Rossell, III, President and CEO, and
Robert P. Gionfriddo, Executive Vice President. The benefits which will be
realized under the plan are uncertain. The Plan is a defined contribution plan.
Contributions to the plan are indexed to the performance of the insurance
policies, whose performance is unpredictable. However, as to the directors who
are also Executive Officers, it was the intention of the Board to design a plan
which will ultimately provide the Executive Officer Directors with annual
retirement benefits initially equal to approximately 50% of their respective
salaries in the year prior to retirement, payable for life. The uniform premium
amounts for each of the other directors was set, at the discretion of the Board,
at 20% of the premium outlay made for each Executive Officer Director. As the
non-Executive Officer directors are of widely different ages, these uniform
premium amounts did not lend themselves to any particular targeted benefit
amount.
The death benefit for each of the directors is an endorsement to the
executive's beneficiary of 80% of the net-at-risk insurance (death benefit in
excess of cash value), together with any remaining balance in the related
liability reserve account.
The policies did not perform at a rate in excess of the hurdle rate in
1997, the initial year of the Plan. Therefore, no credit was made to the
participant liability reserve accounts for the year, nor was any obligation
incurred on the part of the Bank for future retirement payments.
DIRECTOR FEES AND DIRECTOR FEE DEFERRAL PLAN
During 1997, the Bank paid $1,250 per month each to William Del Biaggio,
Jr., Chairman of the Board and Frank Bisceglia, Chairman of the Directors' Loan
Committee for their services during 1997, for a total of $30,000. In June, 1997,
the Board approved a director compensation program, effective July 1, 1997, that
extended the previous plan to include all non-Executive Officer directors. The
fee plan grants fees to each director for chairmanship responsibilities (if any)
on the Board's various committees, and based on the director's actual attendance
at the Board meetings and those committee meetings of which the director is a
member. If each director attends all of the meetings of the committees, and
receives a fee for committee chairmanship where applicable, the fees paid to
each director will range from $5,400 to $15,000 per year, and will total
$129,000 for all the directors as a group.
An option of the director compensation program is the deferral of fees
("Deferral Plan"). Under the Deferral Plan, a participating director may defer
up to 100% of his monthly board fees into the Deferral Plan for up to ten years.
Amounts deferred earn interest at the rate of 8% per annum. The director may
elect a distribution schedule of up to ten years with interest accruing (at the
same 8%) on the declining balance. The Bank has purchased life insurance
policies on the lives of directors who have agreed to participate in the
Deferral Plan. It is expected that the earnings on these policies will offset
the cost of the program. In addition, the Bank will receive death benefit
payments upon the death of the director. The proceeds will permit the Bank to
"complete" the deferral program as the director originally intended if he dies
prior to the completion of the deferral program. The disbursement of deferred
fees is accelerated at death and commences one month after the director dies.
In the event of the director's disability prior to attainment of his
benefit eligibility date, the director may request that the Board permit him to
receive an immediate disability benefit equal to the annualized value of the
director's deferral account.
To date, all directors except Messrs. Del Biaggio, Jr. and Bisceglia have
elected to defer their fees. Through December 31, 1996, the directors were paid
no attendance fee or retainer or other cash compensation
53
<PAGE> 55
for their participation on the Board or its committees. For the years 1996 and
1997 the Bank accrued expenses of zero and $50,000, respectively, to account for
its obligation to pay deferred fees. For 1997 the Bank paid or accrued a total
of $80,000 on account of directors fees.
For 1997, the fees actually earned by the directors were as follows:
<TABLE>
<S> <C>
Frank Bisceglia(1)....................................... $15,000
James Blair.............................................. 3,105
Arthur Carmichael........................................ 4,570
William Del Biaggio, Jr.(1).............................. 15,000
Anneke Dury.............................................. 3,450
Tracey Enfantino......................................... 2,700
Glenn George............................................. 4,425
P. Michael Hunt.......................................... 2,700
Louis O. Normandin....................................... 5,165
Jack Peckham............................................. 2,700
Robert Peters............................................ 4,140
Humphrey Polanen......................................... 3,300
Kirk Rossman............................................. 3,105
-------
Total.......................................... $71,825
=======
</TABLE>
- ---------------
(1) Messrs. Bisceglia and Del Biaggio, Jr. were paid fees for an entire year of
activities in 1997, under a fee arrangement dating from 1996 and continuing
through the end of 1997. All other directors were paid for the period
commencing with the effective date of the plan discussed above (June 1,
1997) to the end of 1997.
1997 DIRECTOR OPTION GRANTS
In 1997, the Company granted stock options to each director in the amount
of 3,000 shares at $8.67 per share, the fair market value at the time of the
grant. These options vested immediately and terminate ten years after the date
of the grant.
CERTAIN OTHER DIRECTOR AND EXECUTIVE OFFICER TRANSACTIONS
Some of the Company's directors and executive officers and their immediate
families, as well as the companies with which such directors and executive
officers are associated, are customers of, and have conducted banking
transactions with, the Bank in the ordinary course of business and anticipate
conducting such banking transactions with such persons in the future. In the
opinion of management, all loans and commitments to lend included in such
transactions were made in compliance with applicable laws on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other persons of similar creditworthiness
and did not involve more than a normal risk of collectability or present other
unfavorable features. As of March 31, 1998 and December 31, 1997, 1996, and
1995, the aggregate indebtedness of all of the Bank's directors and principal
officers (including associated companies) was $2,493,000, $2,145,000,
$2,565,000, and $2,408,000, respectively, constituting 10.9%, 9.6%, 12.5%, and
18.8%, respectively, of the Bank's total equity capital at those dates. During
1997, no individual director's or officer's indebtedness to the Bank exceeded
10% of the Bank's total equity capital at any time.
Except as noted above, there were no existing or proposed material
transactions between the Company or the Bank and any of its executive officers,
directors, or beneficial owners of 5% or more of the Common Stock, or the
immediate family or associates of any of the foregoing persons during 1997, and
none are proposed at present.
54
<PAGE> 56
DESCRIPTION OF SECURITIES OF THE COMPANY
GENERAL
The authorized capital stock of the Company consists of 30,000,000 shares
of Common Stock, no par value, of which 3,295,896 shares were issued and
outstanding as of March 31, 1998. In addition, 986,169 shares have been reserved
for issuance pursuant to the Option Plan, of which 680,880 have been granted,
30,654 have been exercised, and 305,289 remain available for grant as of March
31, 1998. Along with the common stock, the authorized capital of the Company
includes 10,000,000 shares of Preferred Stock, of which none were issued and
outstanding as of March 31, 1998. As of March 31, 1998, the Company had
approximately 643 shareholders of record.
COMMON STOCK
Each share of Common Stock has the same rights, privileges, and preferences
as every other share of Common Stock, and there are no pre-emptive, conversion
or redemption rights or sinking fund provisions applicable thereto. The shares
outstanding are fully paid, as described below.
Voting Rights. Each holder of the Common Stock is entitled to one vote per
share on any issue requiring a vote at any meeting, except that in connection
with the election of directors, the shares may be voted cumulatively. Cumulative
voting entitles a shareholder the right to vote the number of shares he or she
owns, multiplied by the number of directors to be elected. This total number of
votes may be cast for one candidate or may be distributed on the same principle
among as many candidates as the shareholder may desire.
The Company's Articles of Incorporation may be amended at any regular or
special meeting of the shareholders by the affirmative vote of the holders of a
majority of the outstanding shares.
Liquidation Rights. Upon liquidation or dissolution of the Company, holders
of the Common Stock are entitled to receive pro rata the net assets remaining
after payment of all creditors of the Company.
No Pre-emptive Rights. Holders of the Common Stock of the Company have no
pre-emptive or other rights to subscribe for additional shares.
Dividend Rights. Each share of the Company's Common Stock participates
equally in dividends on Common Stock, which are payable when, as, and if
declared by the Board of Directors out of funds legally available for that
purpose. See "TRADING HISTORY AND DIVIDENDS -- Dividends."
Transfer Agent. Gemisys serves as the registrar and transfer agent for the
Company's Common Stock.
Acquisition of Control. Both Federal and state law prohibit a person or
company from acquiring 10% or more of the outstanding equity securities of a
bank holding company without prior notice to and approval of the FDIC and
Commissioner, respectively. No corporation may acquire 25% or more of the
outstanding shares of a bank holding company without obtaining the prior
approval of the Board of Governors of the Federal Reserve System under the Bank
Holding Company Act.
PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of Preferred Stock.
The Preferred Stock is available for issuance from time to time for various
purposes as determined by the Company's Board of Directors, including, without
limitation, making future acquisitions, raising additional equity capital and
financing. Subject to certain limits set by the Company's Articles of
Incorporation, the Preferred Stock (or such convertible securities) may be
issued on such terms and conditions, and at such times and in such situations,
as the Board of Directors in its sole discretion determines to be appropriate,
without any further approval or action by the shareholders (unless otherwise
required by laws, rules, regulations or agreements applicable to the Company).
The effects of the issuance of the Preferred Stock on the holders of Common
Stock could include, among other things, (i) reduction of the amount otherwise
available for payments of dividends on Common Stock if dividends are payable on
the series of Preferred Stock; (ii) restrictions on dividends on Common Stock if
dividends on the series of Preferred Stock are in arrears; (iii) dilution of the
voting power of Common Stock if the series of Preferred Stock has voting rights,
including a possible "veto" power if the series of Preferred
55
<PAGE> 57
Stock has class voting rights; (iv) dilution of the equity interest of holders
of Common Stock if the series of Preferred Stock is convertible, and is
converted, into Common Stock; and (v) restrictions on the rights of holders of
Common Stock to share in the Company's assets upon liquidation until
satisfaction of any liquidation preference granted to the holder of the series
of Preferred Stock.
LIMITATION OF LIABILITY OF DIRECTORS AND OFFICERS; INDEMNIFICATION
Section 317 of the California Corporation Law ("Section 317") expressly
grants to each California corporation, including the Bank and the Company, the
power to indemnify its directors, officers and agents against certain
liabilities and expenses incurred in the performance of their duties. Rights to
indemnification beyond those provided by Section 317 may be valid to the extent
that such rights are authorized in the corporation's articles of incorporation.
Indemnification may not be made, however, with respect to liability incurred in
connection with any of the specific acts for which the liability of directors
may not be limited as discussed in the previous section.
With respect to all proceedings other than shareholder derivative actions,
Section 317 permits a California corporation to indemnify any of its directors,
officers or other agents only if such person acted in good faith and in a manner
such person reasonably believed to be in the best interests of the corporation
and, in the case of a criminal proceeding, had no reasonable cause to believe
the conduct of such person was unlawful. In the case of derivative actions, a
California corporation may indemnify any of its directors, officers or agents
only if such person acted in good faith and in a manner such person believed to
be in the best interests of the corporation and its shareholders. Furthermore,
in derivative actions, no indemnification is permitted (i) with respect to any
matter with respect to which the person to be indemnified has been held liable
to the corporation, unless such indemnification is approved by the court; (ii)
of amounts paid in settling or otherwise disposing of a pending action without
court approval; or (iii) of expenses incurred in defending a pending action
which is settled or otherwise disposed of without court approval. To the extent
that a director, officer or agent of a corporation has been successful on the
merits in defense of any proceeding for which indemnification is permitted by
Section 317, a corporation is obligated by Section 317 to indemnify such person
against expenses actually and reasonably incurred by him in connection with the
proceeding.
FDIC regulations prohibit the indemnification by insured banks and their
holding companies of their directors, officers and other institution-affiliated
persons for that portion of the costs sustained with regard to an administrative
or civil enforcement action commenced by any federal banking agency that results
in a final order or settlement pursuant to which a director, officer or other
party is assessed a civil money penalty, removed from office, prohibited from
participating in the affairs of an insured institution or required to cease and
desist from or to take an affirmative action under the Federal Deposit Insurance
Act. This regulation permits an institution to make an indemnification payment
to, or for the benefit of, a director, officer or other party only if the
institution's Board of Directors, in good faith, determines that the individual
acted in good faith and in a manner that he or she believed to be in the best
interests of the institution and that the payment of indemnification will not
adversely affect the institution's safety and soundness. The director, officer
or other party must agree in writing to reimburse the institution for any
indemnification payments received should the proceeding result in a final order
being instituted against the individual assessing a civil money penalty,
removing the individual from office, or requiring the individual to cease and
desist from certain institutional activity.
LEGAL MATTERS
SIGNIFICANT LITIGATION
The Company is not involved in any litigation outside the ordinary scope of
the Company's business.
OTHER LEGAL MATTERS
Certain legal matters in connection with this Offering have been reviewed
for the Company by the firm of McCutchen, Doyle, Brown & Enersen, LLP, San
Francisco, California. Such review should not be construed as constituting an
opinion as to the merits of this Offering, the accuracy or adequacy of the
disclosures
56
<PAGE> 58
contained herein, or the suitability of this investment for any investors or
class of investors by McCutchen, Doyle, Brown & Enersen, LLP.
EXPERTS
The financial statements as of December 31, 1997 and for the year then
ended included in this prospectus, have been audited by Deloitte & Touche LLP,
independent auditors, as stated in their report appearing herein and are
included in reliance upon the report of such firm given upon their authority as
experts in accounting and auditing.
The financial statements of the Bank as of December 31, 1996, and for each
of the two-years then ended included in this Prospectus have been audited by
KPMG Peat Marwick LLP, independent certified public accountants, stated in their
report appearing herein and are included herein in reliance upon the report of
such firm given upon their authority as experts in accounting and auditing.
AVAILABLE INFORMATION
Since March 5, 1998, the Company has been subject to the informational
requirements of the Securities Exchange Act of 1934 (the "1934 Act"). In
accordance with Sections 12, 13, and 14 of the Exchange Act, the Company files
certain reports, proxy materials, information statements and other information
with the SEC. Copies of these statements may be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, and at the Commission's regional offices located at the Northwestern
Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and
Seven World Trade Center, 13th Floor, New York, New York 10048, and copies of
all or any part of the Registration Statement may be obtained from such offices
upon the payment of the fees prescribed by the Commission. The Commission
maintains an internet web site (http://www.sec.gov) that contains reports, proxy
and information statements and other information regarding registrants which
file electronically with the Commission. From April 1997 to March 1998, the
Bank's Common Stock was registered under the 1934 Act with the FDIC. Copies of
the Bank's filings under the 1934 Act for this period can be obtained from the
FDIC at Division of Supervision, Regulation, Distribution and Securities
Operations Unit, 550 17th St. N.W., Washington, D.C., 20429.
57
<PAGE> 59
HERITAGE COMMERCE CORP
AND HERITAGE BANK OF COMMERCE
INDEX TO FINANCIAL STATEMENTS
MARCH 31, 1998 AND DECEMBER 31, 1997
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Heritage Commerce Corp Consolidated Statement of Financial
Condition dated March 31, 1998 (Unaudited)................ F-2
Heritage Commerce Corp Consolidated Statements of Income for
the three months ended March 31, 1998 and 1997............ F-3
Heritage Commerce Corp Consolidated Statements of Cash Flows
for the three months ended March 31, 1998 and 1997........ F-4
Notes to Consolidated Financial Statements dated March 31,
1998...................................................... F-5
Independent Auditors' Report for Statements dated December
31, 1997 and 1996......................................... F-13
Heritage Bank of Commerce Balance Sheets for the years ended
December 31, 1997 and 1996................................ F-15
Heritage Bank of Commerce Income Statements for the years
ended December 31, 1997, 1996 and 1995.................... F-16
Heritage Bank of Commerce Statements of Shareholders' Equity
for the years ended December 31, 1997, 1996 and 1995...... F-17
Heritage Bank of Commerce Statements of Cash Flows for the
years ended December 31, 1997, 1996 and 1995.............. F-18
Notes to Financial Statements for the years ended December
31, 1997, 1996 and 1995................................... F-19
</TABLE>
F-1
<PAGE> 60
HERITAGE COMMERCE CORP AND SUBSIDIARY
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
ASSETS
<TABLE>
<CAPTION>
MARCH 31,
1998
------------
<S> <C>
Cash and due from banks..................................... $ 27,696,000
Federal funds sold.......................................... 52,200,000
------------
Total cash and cash equivalents................... 79,896,000
Securities available-for-sale, at fair value................ 69,831,000
Securities held-to-maturity, at amortized cost
(fair value of $28,146,000 and $26,938,000,
respectively)............................................. 27,757,000
Loans:
Commercial................................................ 68,913,000
Real estate -- mortgage................................... 39,243,000
Real estate -- land and construction...................... 32,496,000
Consumer.................................................. 2,336,000
------------
Total loans................................................. 142,988,000
Allowance for possible loan losses.......................... (2,540,000)
------------
Loans, net........................................ 140,448,000
Premises and equipment, net................................. 2,655,000
Accrued interest receivable and other assets................ 3,864,000
Other investments........................................... 4,525,000
------------
TOTAL............................................. $328,976,000
============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Demand, non-interest bearing........................... $127,078,000
Demand, interest bearing............................... 6,702,000
Savings and money market............................... 115,270,000
Time deposits, $100,000 and over....................... 47,087,000
Time deposits less than $100,000....................... 8,028,000
------------
Total deposits.............................................. 304,165,000
Accrued interest payable and other liabilities.............. 1,986,000
------------
Total liabilities................................. 306,151,000
------------
Commitments and contingent liabilities
(See Notes 9 and 12 to financial statements dated December
31, 1997)
Preferred Stock, no par value; 10,000,000 shares
authorized; zero shares outstanding
Shareholders' equity:
Common Stock, no par value; 30,000,000 shares authorized;
shares issued and outstanding: 3,295,896
at March 31, 1998 and December 31, 1997................ 23,447,000
Accumulated other comprehensive income.................... 453,000
Accumulated deficit....................................... (1,075,000)
------------
Total shareholders' equity........................ 22,825,000
------------
TOTAL............................................. $328,976,000
============
</TABLE>
See notes to financial statements.
F-2
<PAGE> 61
HERITAGE COMMERCE CORP AND SUBSIDIARY
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Interest income:
Interest and fees on loans................................ $3,550,000 $2,132,000
Interest on investment securities -- taxable.............. 1,285,000 1,134,000
Interest on investment securities -- non taxable.......... 120,000 14,000
Interest on federal funds sold............................ 217,000 114,000
---------- ----------
Total interest income....................................... 5,172,000 3,394,000
---------- ----------
Interest expense:
Savings and other interest-bearing deposits............... 853,000 634,000
Time certificates, $100,000 and over...................... 489,000 268,000
---------- ----------
Total interest expense...................................... 1,342,000 902,000
---------- ----------
Net interest income......................................... 3,830,000 2,492,000
Provision for loan losses................................... 160,000 220,000
---------- ----------
Net interest income after provision for loan losses......... 3,670,000 2,272,000
---------- ----------
Other income:
Service charges and other fees............................ 50,000 46,000
Other income.............................................. 29,000 28,000
---------- ----------
Total other income.......................................... 79,000 74,000
---------- ----------
Other expenses:
Salaries and employee benefits............................ 1,580,000 966,000
Client services........................................... 325,000 248,000
Furniture and equipment................................... 171,000 114,000
Professional fees......................................... 164,000 75,000
Advertising and promotion................................. 152,000 91,000
Occupancy................................................. 150,000 97,000
Deferred loan costs and other loan original expenses...... 82,000 64,000
Other..................................................... 394,000 157,000
---------- ----------
Total other expenses........................................ 3,018,000 1,812,000
---------- ----------
Net income before income taxes.............................. 731,000 534,000
Provision for income taxes.................................. 278,000 187,000
---------- ----------
Net income.................................................. $ 453,000 $ 347,000
========== ==========
Net income per share (basic)................................ $0.14 $0.11
Average number of common shares............................. 3,295,896 3,287,823
Net income per share (diluted).............................. $0.12 $0.10
Average number of common shares and equivalents............. 3,665,846 3,444,558
</TABLE>
See notes to financial statements.
F-3
<PAGE> 62
HERITAGE COMMERCE CORP.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-----------------------------
1998 1997
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net Income.................................................. $ 453,000 $ 347,000
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization............................... 125,000 84,000
Provision for possible loan losses.......................... 160,000 220,000
Gain on sale of investments available-for-sale.............. (18,000) (16,000)
Amortization (accretion) of discounts and premiums.......... (27,000) 68,000
Proceeds from sales of loans................................ (18,000) (4,000)
Originations of loans held for sale......................... (1,813,000) (1,976,000)
Maturities of loans held for sale........................... 18,000 --
Increase in accrued interest receivable and other assets.... (97,000) (106,000)
Decrease in accrued interest payable and other
liabilities............................................... (299,000) (164,000)
------------ -----------
Net cash used in operating activities....................... (1,516,000) (1,547,000)
Cash flows from investing activities
Net increase in loans....................................... (12,310,000) (5,212,000)
Purchases of investment securities available-for-sale....... (11,637,000) (3,019,000)
Maturities of investment securities available-for-sale...... 3,046,000 2,018,000
Proceeds from sales of investment securities
available-for-sale........................................ 18,000 4,573,000
Purchases of investment securities held-to-maturity......... (3,083,000) (844,000)
Maturities of investment securities held-to-maturity........ 1,867,000 2,013,000
Purchases of corporate owned life insurance................. (57,000) --
Capital expenditures........................................ (809,000) (235,000)
------------ -----------
Net cash used in investing activities....................... (22,960,000) (706,000)
Cash flows from financing activities:
Net increase in deposits.................................... 61,187,000 39,627,000
Proceeds from sale of securities under agreement to
repurchase................................................ -- (5,010,000)
Proceeds from issuance of common stock...................... -- 6,000
------------ -----------
Net cash provided by financing activities................... 61,187,000 39,623,000
------------ -----------
Net increase in cash and cash equivalents................... 36,711,000 32,370,000
Cash and cash equivalents, beginning of period.............. 43,185,000 12,615,000
------------ -----------
Cash and cash equivalents, end of period.................... $ 79,896,000 $44,985,000
============ ===========
Other cash flow information:
Interest paid............................................... $ 1,239,000 $ 895,000
Income taxes paid........................................... 385,000 40,000
Non-cash financing activity:
Transfer from accumulated deficit to common stock due to
stock dividend............................................ $ -- $ 1,304,000
</TABLE>
See notes to financial statements.
F-4
<PAGE> 63
HERITAGE COMMERCE CORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
(1) BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements of Heritage
Commerce Corp and its wholly owned subsidiary, Heritage Bank of Commerce, have
been prepared pursuant to the rules and regulations for reporting on Form 10-Q.
Accordingly, certain information and notes required by generally accepted
accounting principles for complete financial statements are not included herein.
The interim statements should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 1997 included in
this Prospectus.
In the Company's opinion, all adjustments necessary for a fair presentation
of these condensed consolidated financial statements have been included and are
of a normal and recurring nature. Certain reclassifications have been made to
prior year amounts to conform with current year presentation.
The results for the three months ended March 31, 1998 are not necessarily
indicative of the results expected for any subsequent period or for the entire
year ended December 31, 1998.
(2) SHARE AND PER SHARE AMOUNTS
Earnings per common share (basic) are calculated based on the weighted
average number of shares outstanding during the period. Earnings per common and
common equivalent share (diluted) are calculated based on the weighted average
number of shares outstanding during the period, plus equivalent shares
representing the dilutive effect of stock options. There is no difference in net
income for the purposes of calculating basic and diluted earnings per common
share for each period presented.
(3) LOAN CLASSIFICATION
The Bank classifies the guaranteed portion of Small Business Administration
loans as "held for sale" according to generally accepted accounting principles,
but for the purposes of this Prospectus, the balances are included in the
commercial loan totals.
DEFERRED LOAN FEES
Total loans in the accompanying consolidated balance sheet are net of
deferred loan fees totaling $133,000 and $113,000 at March 31, 1998 and December
31, 1997, respectively.
(5) COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which requires that an enterprise report and display, by major
components and as a single total, the change in its net assets during the period
from non-owner sources. This Statement is effective for fiscal years beginning
after December 15, 1997. The adoption of this Statement in the first quarter of
1998 resulted in a change in the financial statement presentation, but did not
have an impact on the Company's consolidated financial position, results of
operations or cash flows. Certain amounts in the prior period have been
reclassified to conform to the current presentation under SFAS No. 130. Total
comprehensive income for the quarters ended March 31, 1998 and 1997 was $488,000
and (154,000), respectively.
F-5
<PAGE> 64
HERITAGE COMMERCE CORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
(UNAUDITED)
The following is a summary of the components of comprehensive income.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net Income.......................................... $453,000 $ 347,000
Other comprehensive income, net of tax;
Net unrealized holding gain (loss) on
available-for-sale securities during the
quarter........................................ 46,000 (491,000)
Less: Reclassification adjustment for realized
gains on available-for-sale securities included
in net income during the quarter............... (11,000) (10,000)
-------- ---------
Other comprehensive income (loss)................... 35,000 (501,000)
-------- ---------
Comprehensive income (loss)......................... $488,000 $(154,000)
======== =========
</TABLE>
F-6
<PAGE> 65
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Heritage Bank of Commerce
San Jose, California
We have audited the accompanying balance sheet of Heritage Bank of Commerce
as of December 31, 1997, and the related statements of income, shareholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Bank's management. Our responsibility is to express an
opinion on these financial statements based on our audit. The balance sheet of
the Bank for the year ended December 31, 1996 and the related statements of
income, shareholders' equity, and cash flows for each of the two years in the
period ended December 31, 1996 were audited by other auditors whose report,
dated January 10, 1997, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provide a reasonable basis for our opinion.
In our opinion, such 1997 financial statements present fairly, in all
material respects, the financial position of the Bank as of December 31, 1997,
and the results of its operations and its cash flows for the year then ended in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
San Jose, California
January 23, 1998 (June 3, 1998 as to Note 14)
F-7
<PAGE> 66
INDEPENDENT AUDITOR'S REPORT
The Board of Directors
Heritage Bank of Commerce:
We have audited the accompanying balance sheet of Heritage Bank of Commerce
(the Bank) as of December 31, 1996, and the related statements of income,
shareholders' equity, and cash flows for each of the years in the two-year
period then ended. These financial statements are the responsibility of the
Bank's management. Our responsibility is to express an opinion on these
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 audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion the financial statements referred to above present fairly,
in all material respects, the financial position of Heritage Bank of Commerce as
of December 31, 1996, and the results of its operations and its cash flows for
each of the years in the two-year period then ended in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
Mountain View, California
January 10, 1997
F-8
<PAGE> 67
HERITAGE BANK OF COMMERCE
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
Cash and due from banks..................................... $ 16,060,000 $ 12,615,000
Federal funds sold.......................................... 27,125,000 --
------------ ------------
Total cash and cash equivalents................... 43,185,000 12,615,000
Securities available-for-sale, at fair value................ 61,166,000 50,016,000
Securities held-to-maturity, at amortized cost (fair value
of $26,938,000 and $25,454,000, respectively)............. 26,531,000 25,252,000
Loans....................................................... 128,770,000 82,915,000
Allowance for loan losses................................... (2,285,000) (1,402,000)
------------ ------------
Loans, net........................................ 126,485,000 81,513,000
Premises and equipment, net................................. 1,971,000 1,530,000
Accrued interest receivable and other assets................ 3,764,000 2,377,000
Other investments........................................... 4,473,000 --
------------ ------------
Total............................................. $267,575,000 $173,303,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits.................................................. $242,978,000 $146,379,000
Securities sold under agreements to repurchase............ -- 5,010,000
Accrued interest payable and other liabilities............ 2,261,000 1,390,000
------------ ------------
Total liabilities................................. 245,239,000 152,779,000
------------ ------------
Commitments and contingent liabilities
(See Notes 9 and 12 to financial statements)
Shareholders' equity:
Common Stock, no par value; 10,000,000 shares authorized;
shares issued and outstanding: 3,295,896 in 1997 and
3,130,696 in 1996...................................... 23,447,000 22,093,000
Accumulated other comprehensive income.................... 418,000 221,000
Accumulated deficit....................................... (1,529,000) (1,790,000)
------------ ------------
Total shareholders' equity........................ 22,336,000 20,524,000
------------ ------------
Total............................................. $267,575,000 $173,303,000
============ ============
</TABLE>
See notes to financial statements.
F-9
<PAGE> 68
HERITAGE BANK OF COMMERCE
INCOME STATEMENTS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
Interest income:
Loans, including fees.............................. $10,376,000 $ 6,138,000 $3,134,000
Securities, taxable................................ 5,188,000 3,723,000 2,623,000
Securities, tax-exempt............................. 87,000 1,000 --
Federal funds sold................................. 552,000 663,000 664,000
Other investments.................................. 48,000 -- --
----------- ----------- ----------
Total interest income................................ 16,251,000 10,525,000 6,421,000
Interest expense:
Deposits........................................... 4,187,000 2,641,000 1,695,000
Other.............................................. 17,000 5,000 1,000
----------- ----------- ----------
Total interest expense............................... 4,204,000 2,646,000 1,696,000
----------- ----------- ----------
Net interest income before provision for loan
losses............................................. 12,047,000 7,879,000 4,725,000
Provision for loan losses............................ 1,060,000 830,000 496,000
----------- ----------- ----------
Net interest income after provision for loan
losses............................................. 10,987,000 7,049,000 4,229,000
----------- ----------- ----------
Other income:
Gain on sale of loans held for sale................ 205,000 101,000 --
Service charges and other fees..................... 173,000 149,000 59,000
Gain on sales of securities available-for-sale..... 164,000 21,000 3,000
Other income....................................... 48,000 25,000 9,000
----------- ----------- ----------
Total other income................................... 590,000 296,000 71,000
----------- ----------- ----------
Other expenses:
Salaries and employee benefits..................... 4,933,000 2,942,000 2,062,000
Client services.................................... 1,169,000 910,000 491,000
Furniture and equipment............................ 542,000 330,000 220,000
Advertising and promotion.......................... 450,000 260,000 154,000
Occupancy.......................................... 440,000 293,000 296,000
Professional fees.................................. 372,000 224,000 302,000
Loan origination costs............................. 326,000 146,000 39,000
Other.............................................. 936,000 619,000 534,000
----------- ----------- ----------
Total other expenses................................. 9,168,000 5,724,000 4,098,000
----------- ----------- ----------
Net income before income taxes....................... 2,409,000 1,621,000 202,000
Provision for income taxes........................... 844,000 220,000 1,000
----------- ----------- ----------
Net income........................................... $ 1,565,000 $ 1,401,000 $ 201,000
=========== =========== ==========
Earnings per share:
Basic........................................... $ 0.48 $ 0.48 $ 0.08
Diluted......................................... $ 0.45 $ 0.46 $ 0.08
</TABLE>
See notes to financial statements.
F-10
<PAGE> 69
HERITAGE BANK OF COMMERCE
STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK OTHER TOTAL
----------------------- COMPREHENSIVE ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT INCOME DEFICIT EQUITY
--------- ----------- ------------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1995.... 2,112,681 $14,085,000 $(336,000)
--------- ----------- --------- ----------- -----------
Stock options exercised..... 12,853 85,000 -- -- 85,000
Net income.................. -- -- -- 201,000 201,000
Accumulated other
comprehensive income...... -- -- 802,000 -- 802,000
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31,
1995...................... 2,125,534 14,170,000 466,000 (1,807,000) 12,829,000
--------- ----------- --------- ----------- -----------
Stock dividend.............. 212,535 1,384,000 -- (1,384,000) --
Stock options exercised..... 6,441 39,000 -- -- 39,000
Common Stock issued pursuant
to secondary offering (net
of issuance costs of
$51,000).................. 786,186 6,500,000 -- -- 6,500,000
Net income.................. -- -- -- 1,401,000 1,401,000
Accumulated other
comprehensive income...... -- -- (245,000) -- (245,000)
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31,
1996...................... 3,130,696 22,093,000 221,000 (1,790,000) 20,524,000
--------- ----------- --------- ----------- -----------
Stock dividend.............. 156,349 1,304,000 -- (1,304,000) --
Fractional shares canceled
due to stock split........ (194) (2,000) -- (2,000)
Stock options exercised..... 9,045 52,000 -- -- 52,000
Net income.................. -- -- -- 1,565,000 1,565,000
Accumulated other
comprehensive income...... -- -- 197,000 -- 197,000
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31,
1997...................... 3,295,896 $23,447,000 $ 418,000 $(1,529,000) $22,336,000
========= =========== ========= =========== ===========
</TABLE>
See notes to financial statements
F-11
<PAGE> 70
HERITAGE BANK OF COMMERCE
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income....................................... $ 1,565,000 $ 1,401,000 $ 201,000
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization.................. 388,000 260,000 193,000
Provision for possible loan losses............. 1,060,000 830,000 496,000
Gain on sales of securities
available-for-sale.......................... (164,000) (21,000) (3,000)
Amortization / accretion of discounts and
premiums on securities...................... 56,000 52,000 170,000
Proceeds from sales of loans held for sale..... 4,198,000 1,724,000 --
Originations of loans held for sale............ (4,626,000) (11,587,000) (4,220,000)
Maturities of loans held for sale.............. 45,000 -- --
Increase in accrued interest receivable and
other assets................................ (1,400,000) (939,000) (681,000)
Increase (decrease) in accrued interest payable
and other liabilities....................... 605,000 (295,000) 371,000
Proceeds from relocation....................... -- 1,100,000 --
------------ ------------ ------------
Net cash provided by (used in) operating
activities..................................... 1,727,000 (7,475,000) (3,473,000)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans............................ (45,650,000) (30,450,000) (27,771,000)
Purchases of securities available-for-sale....... (49,116,000) (27,611,000) (35,167,000)
Maturities of securities available-for-sale...... 16,588,000 13,683,000 14,268,000
Proceeds from sales of securities
available-for-sale............................. 21,955,000 5,081,000 3,016,000
Purchases of securities held-to-maturity......... (7,659,000) (16,248,000) (6,089,000)
Proceeds from maturities of securities
held-to-maturity............................... 6,388,000 1,000,000 3,494,000
Purchase of corporate-owned life insurance....... (4,473,000) -- --
Purchases of property and equipment.............. (829,000) (887,000) (105,000)
------------ ------------ ------------
Net cash used in investing activities............ (62,796,000) (55,432,000) (48,354,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits......................... 96,599,000 27,633,000 71,664,000
(Repayments) proceeds from sale of securities
under agreements to repurchase................. (5,010,000) 5,010,000 --
Net proceeds from issuance of common stock....... 50,000 6,539,000 85,000
------------ ------------ ------------
Net cash provided by financing activities........ 91,639,000 39,182,000 71,749,000
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents.................................... 30,570,000 (23,725,000) 19,922,000
Cash and cash equivalents, beginning of year..... 12,615,000 36,340,000 16,418,000
------------ ------------ ------------
Cash and cash equivalents, end of year........... $ 43,185,000 $ 12,615,000 $ 36,340,000
============ ============ ============
Supplemental disclosures of cash flow
information:
Cash paid during the year for:
Interest.................................... $ 4,477,000 $ 2,610,000 $ 1,660,000
Income taxes................................ $ 1,536,000 $ 218,000 $ 1,000
Supplemental schedule of non-cash investing and
financing activity:
Transfer from accumulated deficit to common
stock due to stock dividend................. $ 1,304,000 $ 1,384,000 $ --
</TABLE>
See notes to financial statements.
F-12
<PAGE> 71
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS
(L) SIGNIFICANT ACCOUNTING POLICIES
Description of Business and Basis of Presentation
Heritage Bank of Commerce (the Bank) is a California state chartered bank
which offers a full range of commercial and personal banking services to
residents and the business/professional community in Santa Clara County,
California, through a facility located in downtown San Jose, California. The
Bank was incorporated on November 23, 1993 as Heritage Bank of Commerce and
commenced operations on June 8, 1994. The accounting and reporting policies of
the Bank conform to generally accepted accounting principles and prevailing
practices within the banking industry.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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. The allowance for possible loan losses is a material estimate.
Actual results could differ from those estimates.
Cash and Cash Equivalents
The Bank considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Cash and cash
equivalents include cash on hand, amounts due from banks, and federal funds
sold. Generally, federal funds are sold and purchased for one-day periods.
Securities
The Bank classifies its securities into two categories, available-for-sale
and held-to-maturity, at the time of purchase. Securities available-for-sale are
measured at fair value with a corresponding recognition of the net unrealized
holding gain or loss as a separate component of shareholders' equity, net of
taxes, until realized. Securities held-to-maturity are measured at amortized
cost, based on the Bank's positive intent and ability to hold the securities to
maturity.
A decline in the market value of any available-for-sale or held-to-maturity
security below cost that is deemed other than temporary results in a charge to
earnings and the corresponding establishment of a new cost basis for the
security. No such declines have occurred.
Premiums and discounts are amortized, or accreted, over the life of the
related investment security as an adjustment to income using the straight-line
method. Interest income is recognized when earned. Realized gains and losses for
securities classified as available-for-sale are included in earnings and are
derived using the specific identification method for determining the cost of
securities sold.
Loans Held for Sale
The Bank holds for sale the guarantied portion of certain Small Business
Administration (SBA) loans. These loans are carried at the lower of cost or
market, determined in the aggregate.
Gains or losses on loans held for sale are recognized upon completion of
the sale, and are based on the difference between the net sales proceeds and the
relative fair value of the guarantied portion of the loan sold compared to the
relative fair value of the unguarantied portion. A portion of the gain is
deferred and amortized over the life of the loan based on the difference between
the principal retained and the relative value of the unguarantied portion of the
loan.
The servicing assets that result from the sale of SBA loans sold with
servicing rights retained are amortized over the lives of the loans using a
method approximating the interest method.
F-13
<PAGE> 72
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Loans
Loans are stated at the principal amount outstanding. The majority of the
Bank's loans are at variable interest rates. Interest on loans is credited to
income when earned.
Generally, a loan is classified as non-accrual, the accrual of interest is
discontinued, any accrued and unpaid interest is reversed, and the amortization
of deferred loan fees and costs is discontinued, when the payment of principal
or interest is 90 days past due, unless the amount is well secured and in the
process of collection. Any interest or principal payments received on
non-accrual loans are normally applied toward reduction of principal.
Non-accrual loans generally are not returned to performing status until the
obligation is brought current, has performed in accordance with the contract
terms for a reasonable period of time, and the ultimate collectability of the
total contractual principal and interest is no longer in doubt.
Management, considering current information and events, considers a loan to
be impaired when it is probable that the Bank will be unable to collect all
amounts due according to the contractual terms of the note agreement. When a
loan is considered to be impaired, the amount of impairment is measured based on
the present value of expected future cash flows discounted at the note's
effective interest rate, or the fair value of the collateral if the loan is
secured by real estate.
Non-refundable loan fees and direct origination costs are deferred and
recognized over the expected lives of the related loans using the effective
yield interest method.
Allowance for Loan Losses
The allowance for loan losses is established through a provision charged to
expense. Loans are charged against the allowance when management believes that
the collectability of the principal is doubtful. Recoveries are credited to the
allowance. The allowance for loan losses is a valuation allowance that
management believes will be adequate to absorb losses inherent in existing
loans, based on evaluations of collectability. These evaluations take into
consideration such factors as the composition of the portfolio, overall
portfolio quality, loan concentrations, specific problem loans, and current and
anticipated local economic conditions that may affect a borrower's ability to
repay.
Premises and Equipment
Premises and equipment are stated at cost. Depreciation and amortization
are computed on a straight-line basis over the lesser of the lease terms or
estimated useful lives of five to fifteen years.
Other Investments
Other investments consist of cash surrender value of life insurance
policies for certain officers and directors of the Bank.
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities
The Bank adopted Statement of Financial Accounting Standards (SFAS) No.
125, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, effective January 1, 1997. SFAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities based on consistent application of a
financial-components approach that focuses on control. It distinguishes
transfers of financial assets that are sales from transfers that are secured
borrowings. Under this approach, after a transfer of financial assets, an entity
recognizes all financial and servicing assets it controls and liabilities it has
incurred and derecognizes financial assets it no longer controls and liabilities
that have been extinguished. The adoption of this Statement did not have a
significant impact on the Bank's financial position or results of operations.
Long-Lived Assets
The Bank evaluates the recoverability of long-lived assets on an on-going
basis.
F-14
<PAGE> 73
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Income Taxes
Income taxes are provided at current rates. Deferred income taxes reflect
the net tax effects of temporary differences between carrying amounts of assets
and liabilities for financial reporting purposes and amounts used for income tax
purposes. A valuation allowance is established to reduce the deferred tax asset
if it is "more likely than not" that the related tax benefits will not be
realized in the future.
Stock-Based Compensation
As allowed for by SFAS No. 123, Accounting for Stock-Based Compensation,
the Bank accounts for stock-based awards to employees using the intrinsic value
method in accordance with Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees.
Earnings Per Share
Earnings per share are computed in compliance with SFAS No. 128, Earnings
Per Share. Basic earnings per share are computed by dividing net income by the
weighted average common shares outstanding. Diluted earnings per share reflect
potential dilution from outstanding stock options, using the treasury stock
method. For each of the years presented, net income is the same to basic and
diluted earnings per share. Reconciliation of weighted average shares used in
computing earnings per share are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Weighted average common shares
outstanding............................. 3,291,689 2,912,263 2,444,912
Dilutive effect of stock options
outstanding, using the treasury stock
method.................................. 188,548 121,690 34,744
--------- --------- ---------
Shares used in computing diluted earnings
per share............................... 3,480,237 3,033,953 2,479,656
</TABLE>
All share numbers have been retroactively restated for stock dividends and
stock splits.
Reclassifications
Certain amounts in the 1996 and 1995 financial statements have been
reclassified to conform to the 1997 presentation. These reclassifications had no
impact on shareholders' equity and net income.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130
Reporting Comprehensive Income, which requires that an enterprise report, by
major components and as a single total, the change in its net assets during the
period from non-owner sources; and SFAS No. 131 Disclosures about Segments of an
Enterprise and Related Information, which establishes annual and interim
reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas, and major customers.
The Bank is required to adopt these statements in 1998 and their adoption will
not impact the Bank's financial position, results of operations or cash flows.
F-15
<PAGE> 74
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(2) SECURITIES
The amortized cost and estimated fair value of securities as of December
31, 1997 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE-FOR-SALE:
U.S. Treasury.................... $35,220,000 $451,000 $ -- $35,671,000
U.S. Government Agencies......... 16,370,000 202,000 -- 16,572,000
Municipals....................... 4,596,000 67,000 -- 4,663,000
Preferred Stock.................. 2,212,000 48,000 -- 2,260,000
Commercial Paper................. 2,036,000 -- (36,000) 2,000,000
----------- -------- -------- -----------
Total securities
available-for-sale............... $60,434,000 $768,000 $(36,000) $61,166,000
=========== ======== ======== ===========
SECURITIES HELD-TO-MATURITY:
Municipals....................... $16,450,000 $255,000 $ -- $16,705,000
U.S. Government Agencies......... 6,033,000 118,000 -- 6,151,000
U.S. Treasury.................... 4,048,000 34,000 -- 4,082,000
----------- -------- -------- -----------
Total securities
held-to-maturity................. $26,531,000 $407,000 $ -- $26,938,000
=========== ======== ======== ===========
</TABLE>
The amortized cost and estimated fair value of securities as of December
31, 1996 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE-FOR-SALE:
U.S. Treasury.................... $28,092,000 $193,000 $(12,000) $28,273,000
U.S. Government Agencies......... 16,624,000 75,000 (31,000) 16,668,000
Municipals....................... 2,517,000 26,000 (2,000) 2,541,000
Commercial Paper................. 2,527,000 10,000 (3,000) 2,534,000
----------- -------- -------- -----------
Total securities
available-for-sale............... $49,760,000 $304,000 $(48,000) $50,016,000
=========== ======== ======== ===========
SECURITIES HELD-TO-MATURITY:
Municipals....................... $ 9,616,000 $ 57,000 $(38,000) $ 9,635,000
U.S. Treasury.................... 8,084,000 62,000 -- 8,146,000
U.S. Government Agencies......... 7,552,000 123,000 (2,000) 7,673,000
----------- -------- -------- -----------
Total securities
held-to-maturity................. $25,252,000 $242,000 $(40,000) $25,454,000
=========== ======== ======== ===========
</TABLE>
The amortized cost and estimated fair values of securities as of December
31, 1997 by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or pre-pay obligations with or without call or pre-payment penalties.
<TABLE>
<CAPTION>
SECURITIES AVAILABLE-FOR-SALE SECURITIES HELD-TO-MATURITY
------------------------------ ----------------------------
AMORTIZED ESTIMATED FAIR AMORTIZED ESTIMATED FAIR
COST VALUE COST VALUE
------------ --------------- ----------- --------------
<S> <C> <C> <C> <C>
Due within one year......................... $ 8,979,000 $ 8,996,000 $ 3,848,000 $ 3,856,000
Due after one through five years............ 31,241,000 31,583,000 10,006,000 10,138,000
Due after five through ten years............ 14,144,000 14,440,000 11,007,000 11,231,000
Due after ten years......................... 6,070,000 6,147,000 1,670,000 1,713,000
----------- ----------- ----------- -----------
Total............................. $60,434,000 $61,166,000 $26,531,000 $26,938,000
=========== =========== =========== ===========
</TABLE>
Sales of securities available-for-sale resulted in gross realized gains of
$170,000, $21,000, and $6,000 during the years ended December 31, 1997, 1996,
and 1995, respectively.
F-16
<PAGE> 75
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Sales of securities available-for-sale resulted in gross realized losses of
$6,000, nil, and $3,000 during the years ended December 31, 1997, 1996, and
1995, respectively.
Securities with amortized cost of $27,470,000 as of December 31, 1997 were
pledged to secure public and certain other deposits as required by law or
contract.
(3) LOANS
Loans as of December 31 were as follows:
<TABLE>
<CAPTION>
1997 1996
------------ -----------
<S> <C> <C>
Loans held for sale.............................. $ 15,411,000 $15,028,000
Loans held for investment
Commercial..................................... 48,422,000 29,420,000
Real estate -- mortgage........................ 38,446,000 26,070,000
Real estate -- land and construction........... 25,780,000 11,918,000
Consumer....................................... 824,000 558,000
------------ -----------
................................................. 128,883,000 82,994,000
Deferred loan fees............................... (113,000) (79,000)
------------ -----------
Total loans...................................... $128,770,000 $82,915,000
============ ===========
</TABLE>
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED
DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -----
<S> <C> <C> <C>
Balance, beginning of year......................... $1,402 $ 572 $ 76
Actual charge-offs................................. 224 -- --
Less recoveries.................................... 47 -- --
------ ------ ----
Net loans charged-off.............................. 177 -- --
Provision for loan losses.......................... 1,060 830 496
------ ------ ----
Balance, end of year............................... $2,285 $1,402 $572
====== ====== ====
</TABLE>
As of December 31, 1997, 1996, and 1995, the Bank had no loans for which
interest is no longer being accrued, no loans past due 90 days or more, and no
loans considered to be impaired. For the year ended December 31, 1997, the Bank
had foregone $17,000 of interest income as a result of non-accrual loans or
restructured debt. For the years ended December 31, 1996 and 1995, the Bank had
no forgone interest income as a result of non-accrual loans or restructured
debt.
The Bank had no non-accrual loans as of December 31, 1997 or 1996. SBA
loans serviced for others are not included in the accompanying balance sheets.
The unpaid principal balances of these loans as of December 31, 1997 and 1996
were approximately $5,961,000 and $2,105,000, respectively. Concentrations of
credit risk arise when a number of clients are engaged in similar business
activities, or activities in the same geographic region, or have similar
features that would cause their ability to meet contractual obligations to be
similarly affected by changes in economic conditions. Although the Bank has a
diversified loan portfolio, a substantial portion of its clients' ability to
honor contracts is reliant upon the economic stability of Santa Clara County,
California, including the real estate markets of the county. Loans are made on
the basis of a secure repayment source, which generally is based on a detailed
cash flow analysis; collateral is generally a secondary source for loan
qualification.
The Bank makes loans to executive officers, directors, and their affiliates
in the ordinary course of business. These transactions were on substantially the
same terms as those prevailing at the time for comparable transactions with
unrelated parties and do not involve more than normal risk or unfavorable terms
F-17
<PAGE> 76
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
for the Bank. At December 31, 1997, 1996 and 1995 the Bank had $2,145,000,
$2,565,000 and $2,408,000, respectively in loans outstanding to related parties.
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- ----------
<S> <C> <C> <C>
Balance, beginning of year....................... $ 2,565,000 $ 2,408,000 $1,150,000
New loan commitments............................. -- 1,917,000 2,031,000
Repayment of loans............................... (1,275,000) (1,013,000) (488,000)
(Increase) decrease in undisbursed commitments... 855,000 (747,000) (285,000)
----------- ----------- ----------
Balance, end of year............................. $ 2,145,000 $ 2,565,000 $2,408,000
=========== =========== ==========
</TABLE>
(4) PREMISES AND EQUIPMENT
Premises and equipment as of December 31 were as follows:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Furniture and equipment............................. $1,812,000 $1,245,000
Leasehold improvements.............................. 644,000 471,000
Software............................................ 361,000 276,000
---------- ----------
2,817,000 1,992,000
Accumulated depreciation and amortization........... (846,000) (462,000)
---------- ----------
Premises and equipment, net......................... $1,971,000 $1,530,000
========== ==========
</TABLE>
(5) DEPOSITS
Deposits as of December 31, were as follows:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Demand, non-interest bearing.................... $ 97,737,000 $ 55,372,000
Demand, interest bearing........................ 6,319,000 4,153,000
Savings and money market........................ 96,712,000 56,848,000
Time deposits, $100,000 and over................ 34,948,000 22,145,000
Time deposits, less than $100,000............... 7,262,000 7,861,000
------------ ------------
Total deposits.................................. $242,978,000 $146,379,000
============ ============
</TABLE>
At December 31, 1997, the scheduled maturities of time deposits was as
follows:
<TABLE>
<S> <C>
Year 1998....................................... $41,996,000
1999............................................ 167,000
2000............................................ 47,000
-----------
Total time deposits............................. $42,210,000
===========
</TABLE>
F-18
<PAGE> 77
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(6) BORROWING ARRANGEMENTS
Available Lines of Credit
The Bank has federal funds purchase lines of $15,000,000 and $2,000,000,
respectively, from two correspondent banks, and a repurchase arrangement of
$10,000,000 with a commercial brokerage firm. There were no borrowings under
these arrangements as of December 31, 1997. The repurchase agreement is an
overnight loan, with terms negotiated based on the nature of the securities
offered for repurchase.
Information concerning borrowings under the above arrangements is as
follows:
<TABLE>
<CAPTION>
1997 1996
-------- ----------
<S> <C> <C>
Average balance during the year........................ $297,000 $ 85,000
Average interest rate during the year.................. 5.72% 5.64%
Maximum month-end balance during the year.............. $300,000 $5,010,000
Average rate at December 31............................ -- 6.75%
</TABLE>
(7) INCOME TAXES
The provision for income taxes for the years ended December 31, consisted
of the following:
<TABLE>
<CAPTION>
1997 1996 1995
---------- --------- ------
<S> <C> <C> <C>
CURRENT:
Federal.......................................... $ 939,000 $ 135,000 $ --
State............................................ 353,000 218,000 1,000
---------- --------- ------
Total current...................................... 1,292,000 353,000 1,000
---------- --------- ------
DEFERRED:
Federal.......................................... (372,000) (104,000) --
State............................................ (76,000) (29,000) --
---------- --------- ------
Total deferred..................................... (448,000) (133,000) --
---------- --------- ------
Provision for income taxes......................... $ 844,000 $ 220,000 $1,000
========== ========= ======
</TABLE>
The effective tax rate differs from the federal statutory rate for the
years ended December 31, as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ----- -----
<S> <C> <C> <C>
Statutory federal income tax rate........................... 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit.............. 7.5 7.7 0.3
Change in valuation allowance............................... (8.7) (29.5) (42.0)
Non-taxable interest income................................. (2.3) -- --
Other....................................................... 3.5 0.4 7.2
---- ----- -----
Effective tax rate.......................................... 35.0% 13.6% 0.5%
==== ===== =====
</TABLE>
F-19
<PAGE> 78
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Net deferred tax asset as of December 31 consists of the following:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
DEFERRED TAX ASSETS:
Allowance for possible loan losses........................ 886,000 429,000
Servicing rights.......................................... 99,000 --
Deferred rent............................................. 89,000 161,000
Accrued compensation...................................... 20,000 --
State taxes............................................... -- 82,000
Other..................................................... 31,000 100,000
---------- ---------
Gross deferred tax asset.................................... 1,125,000 772,000
Valuation allowance......................................... -- (209,000)
---------- ---------
Deferred tax asset.......................................... 1,125,000 563,000
---------- ---------
DEFERRED TAX LIABILITIES:
Securities available-for-sale............................. (314,000) (35,000)
Accrual to cash adjustment................................ (278,000) (346,000)
Depreciation.............................................. (169,000) (84,000)
State income taxes........................................ (97,000) --
---------- ---------
Deferred tax liability...................................... (858,000) (465,000)
---------- ---------
Net deferred tax asset...................................... $ 267,000 $ 98,000
========== =========
</TABLE>
As it is more likely than not that the deferred tax assets would be
realized, the valuation allowance decreased by $209,000, $478,000, and $77,000
during the years ended December 31, 1997, 1996, and 1995, respectively.
(8) SHAREHOLDERS' EQUITY
Common Stock
In December, 1995, the Bank declared a 10% stock dividend payable to
shareholders of record as of February 5, 1996. In January, 1997, the Bank
declared a 5% stock dividend payable to shareholders of record as of February 5,
1997. In July, 1997, the Bank declared a three-for-two stock split for
shareholders of record as of August 1, 1997. All share numbers have been
retroactively restated for stock splits and stock dividends.
Stock Option Plan
The Bank has a stock option plan (the Plan) for directors, officers, and
key employees. The Plan provides for the grant of incentive and non-qualified
stock options. The Plan provides that the option price will be determined by the
Board of Directors at no less than the fair value at the date of grant. Options
granted vest on a schedule determined by the Board of Directors at the time of
grant. Generally, options vest over four years. All options expire no later than
ten years from the date of grant. The Plan had 623,700 shares (adjusted for
stock dividends and splits) originally authorized for issuance. During 1997, an
additional 362,469 shares were added to the Plan for future grants. At December
31, 1997, 316,289 shares are available for future grants under the Plan.
F-20
<PAGE> 79
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Option activity under the Plan is as follows:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
BALANCES, JANUARY 1, 1995................................... -- $ --
------- -----
Granted (weighted average fair value of $2.40).............. 576,056 5.80
Exercised................................................... (14,846) 5.77
Cancelled................................................... (34,963) 5.77
------- -----
BALANCES, DECEMBER 31, 1995................................. 526,247 5.80
(149,156 exercisable at a weighted average exercise price of
$5.77)
------- -----
Granted (weighted average fair value of $3.16).............. 65,363 7.63
Exercised................................................... (6,763) 5.77
Cancelled................................................... (10,326) 5.86
------- -----
BALANCES, DECEMBER 31, 1996................................. 574,521 6.01
(275,482 exercisable at a weighted average exercise price of
$5.83)
------- -----
Granted (weighted average fair value of $4.42).............. 80,620 9.70
Exercised................................................... (9,045) 5.80
Cancelled................................................... (6,870) 6.55
------- -----
BALANCES, DECEMBER 31, 1997................................. 639,226 $6.47
------- -----
</TABLE>
Additional information regarding options outstanding under the Plan as of
December 31, 1997 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ ----------------------------
WEIGHTED
AVERAGE
RANGE OF REMAINING WEIGHTED WEIGHTED
EXERCISE NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE
PRICES OUTSTANDING LIFE (YRS.) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ------------- ----------- ----------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$5.77 - 7.27 514,506 6.62 $ 5.84 388,974 $ 5.81
7.28 - 8.77 110,220 9.15 8.33 62,926 8.48
8.78 - 16.00 14,500 9.91 14.76 361 11.70
------- ---- ------ ------- ------
$5.77 - 16.00 639,226 7.13 $ 6.47 452,261 $ 6.19
------- ---- ------ ------- ------
</TABLE>
As discussed in Note 1, the Bank continues to account for its stock-based
awards using the intrinsic value method in accordance with APB Opinion No. 25,
Accounting for Stock Issued to Employees, and its related interpretations.
Accordingly, no compensation expense has been recognized in the financial
statements for employee stock option arrangements.
SFAS No. 123, Accounting for Stock-Based Compensation, requires the
disclosure of pro forma net income and earnings per share had the Bank adopted
the fair value method as of the beginning of fiscal 1995. Under SFAS No. 123,
the fair value of stock-based awards to employees is calculated through the use
of option pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options without vesting
restrictions, which differ significantly from the Bank's stock option awards.
Those models also require subjective assumptions, which greatly affect the
calculated values. The Bank's calculations were made using the Black-Scholes
option pricing model with the following weighted average assumptions: expected
life, 84 months; risk-free interest rate, 5.75% for 1997 and 6.60% for 1996 and
1995; stock volatility of 30% in 1997 and 20% in 1996 and 1995; and no dividends
during the expected term. The Bank's calculations are based on a multiple option
valuation approach, and forfeitures are recognized as they occur.
F-21
<PAGE> 80
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
If the computed fair values of the 1997, 1996, and 1995 awards had been
amortized to expense over the vesting periods of the awards, pro forma net
income and earnings per share would have been as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ---------
<S> <C> <C> <C>
Pro forma net income (loss)............ $1,000,000 $1,093,000 $(155,000)
Pro forma earnings (loss) per share
Basic................................ $ 0.30 $ 0.38 $ (0.06)
Diluted.............................. $ 0.29 $ 0.36 $ (0.06)
</TABLE>
(9) LEASES
The Bank leases its premises under non-cancelable operating leases with
terms, including renewal options, ranging from five to fifteen years. Future
minimum payments under the agreements are as follows:
<TABLE>
<S> <C>
Year ending December 31,
1998........................................ $ 537,000
1999........................................ 553,000
2000........................................ 542,000
2001........................................ 556,000
2002........................................ 540,000
Thereafter.................................... 3,905,000
----------
Total............................... $6,633,000
==========
</TABLE>
Rent expense under operating leases was $314,000, $225,000, and $250,000
during the years ended December 31, 1997, 1996, and 1995, respectively.
(10) EMPLOYEE BENEFIT PLANS
The Bank offers a 401(k) savings plan. All salaried employees are eligible
to contribute up to 20% of their pre-tax compensation to the plan through salary
deductions under Section 401(k) of the Internal Revenue Code. The Bank does not
match employee contributions.
During 1997, the Bank initiated an employee stock ownership plan. The plan
allows the Bank to purchase shares on the open market and award those shares to
certain employees in lieu of paying cash bonuses. To be eligible to receive an
award of shares under this plan, an employee must have worked at least 1,000
hours during the year and must be employed by the Bank on December 31. Awards
under this plan generally vest over four years. During 1997, the Bank funded
$98,000 into the plan. The amount funded into this plan was recognized as
salaries and benefits expense in the Bank's financial statements.
(11) DISCLOSURES OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by using available
market information and appropriate valuation methodologies. However,
considerable judgement is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented are not
necessarily indicative of the amounts that could be realized in a current market
exchange. The use of different market assumptions and/or estimation techniques
may have a material effect on the estimated fair value amounts.
F-22
<PAGE> 81
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The carrying amounts and estimated fair values of the Bank's financial
instruments as of December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
----------------------------- ----------------------------
CARRYING ESTIMATED FAIR CARRYING ESTIMATED FAIR
AMOUNTS VALUE AMOUNTS VALUE
------------ -------------- ----------- --------------
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents............... $ 43,185,000 $ 43,185,000 $12,615,000 $12,615,000
Securities.............................. 87,697,000 88,104,000 75,268,000 75,470,000
Loans, net.............................. 126,485,000 126,474,000 81,513,000 81,521,000
------------ ------------ ----------- -----------
LIABILITIES
Demand deposits, non-interest bearing... $ 97,737,000 $ 97,737,000 $55,372,000 $55,372,000
Demand deposits, interest bearing....... 6,319,000... 6,319,000 4,153,000 4,153,000
Savings and money market................ 96,712,000 96,712,000 56,848,000 56,848,000
Time deposits........................... 42,210,000 42,205,000 30,006,000 30,005,000
Securities sold under agreements to
repurchase........................... -- -- 5,010,000 5,010,000
</TABLE>
The following methods and assumptions were used to estimate the fair value
in the table, above:
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short maturities
of these instruments. Securities
The fair value of securities is estimated based on bid market prices. The
fair value of certain municipal securities is not readily available through
market sources other than dealer quotations, so fair value estimates are based
on such dealer quotations.
Loans, net
Loans with similar financial characteristics are grouped together for
purposes of estimating their fair value. Loans are segregated by type such as
commercial, term real estate, residential construction, and consumer. Each loan
category is further segmented into fixed and adjustable rate interest terms.
The fair value of performing, fixed rate loans is calculated by discounting
scheduled future cash flows using estimated market discount rates that reflect
the credit and interest rate risk inherent in the loan. The fair value of
variable rate loans is the carrying amount as these loans generally reprice
within 90 days. The fair value calculations are adjusted by the allowance for
possible loan losses.
Deposits
The fair value of deposits with no stated maturity, such as non-interest
bearing demand deposits, savings, and money market accounts, approximates the
amount payable on demand. The carrying amount approximates the fair value of
time deposits with a remaining maturity of less than 90 days. The fair value of
all other time deposits is calculated based on discounting the future cash flows
using rates currently offered by the Bank for time deposits with similar
remaining maturities.
Securities Sold Under Agreements to Repurchase
The fair value of securities sold under agreements to repurchase
approximates the carrying amount due to the short maturity.
F-23
<PAGE> 82
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Limitations
Fair value estimates are made at a specific point in time, based on
relevant market information about the financial instrument. These estimates do
not reflect any premium or discount that could result from offering for sale at
one time the Bank's entire holdings of a particular financial instrument. Fair
value estimates are based on judgements regarding future expected loss
experience, current economic conditions, risk characteristics of various
financial instruments, and other factors. These estimates are subjective in
nature and involve uncertainties and matters of significant judgement and
therefore cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
Fair value estimates are based on existing financial instruments, as of the
reporting dates, without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. In addition, tax ramifications related to the realization
of unrealized gains and losses can have a significant effect on fair value
estimates and have not been considered in the estimates.
(12) COMMITMENTS AND CONTINGENT LIABILITIES
Financial Instruments with Off-Balance Sheet Risk
The Bank is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its clients. These
financial instruments include commitments to extend credit and standby letters
of credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk, in excess of the amounts recognized in the balance sheets.
The Bank's exposure to credit loss in the event of non-performance of the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Bank uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments. Credit
risk is the possibility that a loss may occur because a party to a transaction
failed to perform according to the terms of the contract. The Bank controls the
credit risk of these transactions through credit approvals, limits, and
monitoring procedures. Management does not anticipate any significant losses as
a result of these transactions.
Commitments to extend credit as of December 31, were as follows:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Commitments to extend credit.............. $68,611,000 $36,598,000
Standby letters of credit................. 2,370,000 410,000
----------- -----------
$70,981,000 $37,008,000
=========== ===========
</TABLE>
Commitments to extend credit are agreements to lend to a client as long as
there is no violation of conditions established in the contract. Commitments
generally have fixed expiration dates or other termination clauses. Since some
of the commitments are expected to expire without being drawn upon, the total
commitment amount does not necessarily represent future cash requirements. The
Bank evaluates each client's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Bank upon extension of
credit, is based on management's credit evaluation of the borrower. Collateral
held varies but may include cash, marketable securities, accounts receivable,
inventory, property, plant and equipment, income-producing commercial
properties, and/or residential properties. Fair value of these instruments are
not considered material.
Standby letters of credit are written conditional commitments issued by the
Bank to guaranty the performance of a client to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to clients. Fair value of these instruments are not
considered material.
F-24
<PAGE> 83
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(13) 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
classifications are also subject to qualitative judgements by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes that, as of December 31, 1997, the Bank
meets all capital adequacy guidelines to which it is subject.
The most recent notification from the FDIC 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
FOR CAPITAL UNDER PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES: ACTION PROVISIONS:
------------------- -------------------- ------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ----- ----------- ------ ------------- -------
<S> <C> <C> <C> <C> <C> <C>
AS OF DECEMBER 31, 1997
Total Capital
(to Risk-Weighted Assets).... $23,784,000 15.8% $12,033,000 $ 8.0% $15,042,000 $ 10%
Tier I Capital
(to Risk-Weighted Assets).... $21,899,000 14.6% $ 6,017,000 $ 4.0% $ 9,025,000 $ 6%
Tier I Capital
(to Average Assets).......... $21,899,000 10.3% $ 8,499,000 $ 4.0% $10,624,000 $ 5%
AS OF DECEMBER 31, 1996
Total Capital
(to Risk-Weighted Assets).... $21,461,000 22.6% $ 7,582,000 $ 8.0% $ 9,478,000 $ 10%
Tier I Capital
(to Risk-Weighted Assets).... $20,273,000 21.4% $ 3,791,000 $ 4.0% $ 5,687,000 $ 6%
Tier I Capital
(to Average Assets).......... $20,273,000 13.9% $ 5,826,000 $ 4.0% $ 7,283,000 $ 5%
</TABLE>
The Bank is required to maintain reserves with the Federal Reserve Bank of
San Francisco. Reserve requirements are based on a percentage of certain
deposits. At December 31, 1997, the Bank maintained reserves of $3,449,000 in
the form of vault cash and balances at the Federal Reserve Bank of San
Francisco, which satisfied the regulatory requirements.
Under California law, the holders of common stock are entitled to receive
dividends when and as declared by the Board of Directors, out of funds legally
available therefor. The California Banking Law provides that a state licensed
bank may not make a cash distribution to its shareholders in excess of the
lesser of the following: (i) the bank's retained earnings, or (ii) the bank's
net income for its last three fiscal years, less the amount of any distributions
made by the bank to its shareholders during such period. However, a bank, with
the prior approval of the Commissioner, may make a distribution to its
shareholders of an amount not to exceed the
F-25
<PAGE> 84
HERITAGE BANK OF COMMERCE
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
greater of (i) a bank's retained earnings, (ii) its net income for its last
fiscal year, or (iii) its net income for the current fiscal year. In the event
that the Commissioner determines that the shareholders' equity of a bank is
inadequate or that the making of a distribution by a bank would be unsafe or
unsound, the Commissioner may order a bank to refrain from making such a
proposed distribution.
(14) COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income", which requires that an enterprise report and display, by major
components and as a single total, the change in its net assets during the period
from non-owner sources. This Statement is effective for fiscal years beginning
after December 15, 1997. The adoption of this Statement in the first quarter of
1998 resulted in a change in the financial statement presentation, but did not
have an impact on the Company's consolidated financial position, results of
operations or cash flows. Certain amounts in the prior period have been
reclassified to conform to the current presentation under SFAS No. 130. Total
comprehensive income for the years ended December 31, 1997, 1996 and 1995 was
$1,762,000, $1,156,000 and $1,003,000, respectively.
The following is a summary of the components of accumulated other
comprehensive income.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Net Income................................................. $1,565,000 $1,401,000 $ 201,000
Other comprehensive income, net of tax;
Net unrealized holding gain (loss) on available-for-sale
securities during the year, net of taxes of $301,000,
$35,000, and $72,000.................................. 303,000 (227,000) 805,000
Less: reclassification adjustment for gains on available
for sale securities included in net income during the
year.................................................. (106,000) (18,000) (3,000)
---------- ---------- ----------
Other comprehensive income................................. 197,000 (245,000) 802,000
---------- ---------- ----------
Comprehensive income....................................... $1,762,000 $1,156,000 $1,003,000
========== ========== ==========
</TABLE>
(15) OTHER MATTERS (UNAUDITED)
Formation of Bank Holding Company
On December 18, 1997, the shareholders of the Bank met at a special meeting
to approve the formation of a bank holding company by the adoption of a merger
agreement which provided for the merger of a merger subsidiary, a subsidiary of
the newly formed Heritage Commerce Corp, with and into the Bank under the name
and charter of the Bank. By this action, the Bank will become a wholly-owned
subsidiary of Heritage Commerce Corp. Shareholders of the Bank received one
share of Heritage Commerce Corp Common Stock for each share of Bank Common Stock
held. The merger was effective February 17, 1998.
New Branches
On February 9, 1998, the Bank opened a full-service branch in the city of
Fremont, California.
F-26
<PAGE> 85
APPENDIX A
STOCK SUBSCRIPTION APPLICATION
HERITAGE COMMERCE CORP
BY EXECUTING THIS STOCK SUBSCRIPTION APPLICATION, THE UNDERSIGNED AGREES TO
THE TERMS OF THE PROSPECTUS, WHICH IS INCORPORATED HEREIN BY REFERENCE.
The undersigned is aware that the purchase of the Common Stock involves a
high degree of risk.
The undersigned hereby subscribes for and offers to purchase the number of
shares of Common Stock, no par value, of Heritage Commerce Corp ("Common
Stock"), set forth below, upon the terms and conditions specified in the
Prospectus and Subscription Agreement at a purchase price of $15.50 per share.
All subscriptions must be for a minimum of 100 shares. NO FRACTIONAL SHARES WILL
BE ISSUED.
The undersigned acknowledges and agrees that this Application constitutes
an irrevocable offer and may not be withdrawn without the consent of Heritage
Commerce Corp. If any subscription is accepted only in part, any portion of
funds not required for partial subscription will be returned to the subscriber
together with interest actually earned on such portion. If any subscription is
declined, subscription funds will be returned upon declination, with any
interest actually earned thereon.
If this offering of Common Stock by Heritage Commerce Corp is canceled in
its entirety or the Company rejects the Application, this offer to purchase and
subscribe shall become void and any payments received from the subscriber will
be returned in full plus any actual interest earned on the amount returned. All
such refunds will be mailed immediately upon termination of the offering or
rejection of the Application.
SUBSCRIPTIONS MAY BE MADE BY COMPLETING AND SIGNING THIS STOCK SUBSCRIPTION
APPLICATION IN TRIPLICATE AND DELIVERING ALL THREE COPIES TO: HERITAGE COMMERCE
CORP, 150 ALMADEN BOULEVARD, SAN JOSE, CALIFORNIA 95113, BY 5:00 P.M., PACIFIC
STANDARD TIME, WITHIN 60 DAYS OF THE DATE OF THE OFFERING, UNLESS THIS DATE IS
EXTENDED BY 30 DAYS OR SHORTENED BY HERITAGE COMMERCE CORP, IN ITS DISCRETION.
THE STOCK SUBSCRIPTION APPLICATION MUST BE DELIVERED TOGETHER WITH A COMPLETED
FORM W-9 AND THE FULL AMOUNT OF THE PURCHASE PRICE FOR THE SHARES SUBSCRIBED, IN
UNITED STATES DOLLARS, BY CHECK, BANK DRAFT, OR MONEY ORDER, MADE PAYABLE TO
"HERITAGE IMPOUND ACCOUNT".
UPON CLOSING, ALL FUNDS RECEIVED FOR SUBSCRIPTIONS, WHICH ARE ACCEPTED BY
HERITAGE COMMERCE CORP, SHALL BECOME CAPITAL OF HERITAGE COMMERCE CORP TOGETHER
WITH INTEREST THEREON. THESE SECURITIES ARE NOT DEPOSITS AND ARE NOT INSURED BY
THE FDIC.
A-1
<PAGE> 86
HERITAGE COMMERCE CORP
STOCK SUBSCRIPTION APPLICATION
Name(s) of Subscribers: Date of Subscription
- ------------------------
Number of Shares Amount of Subscription $
- ---------------------------------
Social Security Number or Tax ID Number
Address of Subscriber
Telephone Number: Day: Evening
SHARE REGISTRATION: IF SHARES ARE NOT TO BE PURCHASED WITH AN IRA, SEP,
KEOGH OR UNDER THE UNIFORM GIFTS TO MINORS ACT, PLEASE CHECK AS APPROPRIATE AND
WRITE OUT THE WAY IN WHICH SHARES ARE TO BE REGISTERED:
[ ] INDIVIDUAL
[ ] JT TEN -- as joint tenants with right of survivorship and not as
tenants in common
[ ] TEN COM -- as tenants in common
[ ] OTHER
Registration Name
CHECK AS APPROPRIATE AND, IF CHECKED, COMPLETE AS INDICATED:
[ ] Uniform Gifts to Minors Act
(custodian)
Custodian for under Uniform Gifts to Minors Act, State of
- ------------------
(minor) (state)
[ ] IRA, SEP or Keogh Account #
Note: if the Subscription Application is on behalf of an IRA, SEP or KEOGH, the
Registration name above must read exactly as does the name of the IRA, SEP or
KEOGH account.
<TABLE>
<S> <C>
Brokerage Firm Broker
- --------------------------------------- ------------------------------------------------
Broker's Phone # ------------------------------------ Custodian Firm
---------------------------------------
</TABLE>
Mailing Address of Broker or Custodian
- --------------------------------------------------------------------------------
I have read and hereby agree to the terms of the this Application
Signature of Subscriber
---------------------------------------------
A-2
<PAGE> 87
<TABLE>
<S> <C> <C>
Form W-9 REQUEST FOR TAXPAYER
(Rev. December 1996) IDENTIFICATION NUMBER AND CERTIFICATION GIVE FORM TO THE
Department of the Treasury REQUESTER. DO NOT
Internal Revenue Service SEND TO THE IRS.
- ------------------------------------------------------------------------------------------------------------
PLEASE PRINT OR TYPE
Name (if a joint account or you changed your name, SEE SPECIFIC
INSTRUCTIONS ON PAGE 2.)
-------------------------------------------------------------------------
Business name, if different from above. (SEE SPECIFIC INSTRUCTIONS ON
PAGE 2.)
-------------------------------------------------------------------------
CHECK APPROPRIATE BOX: [ ] Individual/Sole proprietor
[ ] Corporation [ ] Partnership [ ] Other ...........................
-------------------------------------------------------------------------
Address (number, street, and apt. or suite no.)
-------------------------------------------------------------------------
City, state, and ZIP code
-------------------------------------------------------------------------
Requester's name and address (optional)
-------------------------------------------------------------------------
List account number(s) here (optional)
-------------------------------------------------------------------------
PART I TAXPAYER IDENTIFICATION NUMBER (TIN)
- -----------------------------------------------------------------------------------
Enter your TIN in the appropriate box. For ------------------------------
individuals, this is your social security SOCIAL SECURITY NUMBER
number (SSN). However, if you are a resident
alien OR a sole proprietor, see the -- --
instructions on page 2. For other entities, - - - - - - - - - - - - - - -
it is your employer identification number
(EIN). If you do not have a number, see HOW OR
TO GET A TIN on page 2.
NOTE: If the account is in more than one EMPLOYER IDENTIFICATION NUMBER
name, see the chart on page 2 for guidelines
on whose number to enter. ------------------------------
------------------------------
- -----------------------------------------------------------------------------------
PART II
- -----------------------------------------------------------------------------------
FOR PAYEES EXEMPT FROM BACKUP
WITHHOLDING (SEE INSTRUCTIONS
ON PAGE 2)
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
</TABLE>
PART III CERTIFICATION
- --------------------------------------------------------------------------------
Under penalties of perjury, I certify that:
1. The number shown on this form is my correct taxpayer identification number
(or I am waiting for a number to be issued to me), AND
2. I am not subject to backup withholding because: (a) I am exempt from backup
withholding, or (b) I have not been notified by the Internal Revenue Service
(IRS) that I am subject to backup withholding as a result of a failure to
report all interest or dividends, or (c) the IRS has notified me that I am no
longer subject to backup withholding.
CERTIFICATION INSTRUCTIONS -- You must cross out item 2 above if you have been
notified by the IRS that you are currently subject to backup withholding because
you have failed to report all interest and dividends on your tax return. For
real estate transactions, item 2 does not apply. For mortgage interest paid, the
acquisition or abandonment of secured property, cancellation of debt,
contributions to an individual retirement arrangement (IRA), and generally
payments other than interest and dividends, you are not required to sign the
Certification, but you must provide your correct TIN. (See the instructions on
page 2.)
- --------------------------------------------------------------------------------
SIGN
HERE SIGNATURE DATE
- --------------------------------------------------------------------------------
PURPOSE OF FORM.--A person who is required to file an information return with
the IRS must get your correct taxpayer identification number (TIN) to report,
for example, income paid to you, real estate transactions, mortgage interest you
paid, acquisition or abandonment of secured property, cancellation of debt, or
contributions you made to an IRA.
Use Form W-9 to give your correct TIN to the person requesting it (the
requester) and, when applicable, to:
1. Certify the TIN you are giving is correct (or you are waiting for a number
to be issued),
2. Certify you are not subject to backup withholding, or
3. Claim exemption from backup withholding if you are an exempt payee.
NOTE: If a requester gives you a form other than a W-9 to request your TIN, you
must use the requester's form if it is substantially similar to this Form W-9.
WHAT IS BACKUP WITHHOLDING?--Persons making certain payments to you must
withhold and pay to the IRS 31% of such payments under certain conditions. This
is called "backup withholding." Payments that may be subject to backup
withholding include interest, dividends, broker and barter exchange
transactions, rents, royalties, nonemployee pay, and certain payments from
fishing boat operators. Real estate transactions are not subject to backup
withholding.
If you give the requester your correct TIN, make the proper certifications,
and report all your taxable interest and dividends on your tax return, payments
you receive will not be subject to backup withholding. Payments you receive will
be subject to backup withholding if:
1. You do not furnish your TIN to the requester, or
2. The IRS tells the requester that you furnished an incorrect TIN, or
3. The IRS tells you that you are subject to backup withholding because you
did not report all your interest and dividends on your tax return (for
reportable interest and dividends only), or
4. You do not certify to the requester that you are not subject to backup
withholding under 3 above (for reportable interest and dividend accounts opened
after 1983 only), or
5. You do not certify your TIN. See the Part III instructions on page 2 for
details.
Certain payees and payments are exempt from backup withholding. See the Part
II instructions and the separate INSTRUCTION FOR THE REQUESTER OF FORM W-9.
PENALTIES
FAILURE TO FURNISH TIN.--If you fail to furnish your correct TIN to a requester,
you are subject to a penalty of $50 for each such failure unless your failure is
due to reasonable cause and not to willful neglect.
CIVIL PENALTY FOR FALSE INFORMATION WITH RESPECT TO WITHHOLDING.--If you make a
false statement with no reasonable basis that results in no backup withholding,
you are subject to a $500 penalty.
CRIMINAL PENALTY FOR FALSIFYING INFORMATION.--Willfully falsifying
certifications or affirmations may subject you to criminal penalties including
fines and/or imprisonment.
MISUSE OF TINS.--If the requester discloses or uses TINs in violation of Federal
law, the requester may be subject to civil and criminal penalties.
- --------------------------------------------------------------------------------
<PAGE> 88
Form W-9 (Rev. 12-96) Page 2
- --------------------------------------------------------------------------------
SPECIFIC INSTRUCTIONS
NAME.--If you are an individual, you must generally enter the name shown on your
social security card. However, if you have changed your last name, for instance,
due to marriage, without informing the Social Security Administration of the
name change, enter your first name, the last name shown on your social security
card, and your new last name.
If the account is in joint names, list first and then circle the name of the
person or entity whose number you enter in Part I of the form.
Sole Proprietor.--You must enter your individual name as shown on your social
security card. You may enter your business, trade, or "doing business as" name
on the business name line.
Other Entities.--Enter the business name as shown on required Federal tax
documents. This name should match the name shown on the charter or other legal
document creating the entity. You may enter any business, trade, or "doing
business as" name on the business name line.
PART I--TAXPAYER IDENTIFICATION NUMBER (TIN)
You must enter your TIN in the appropriate box. If you are a resident alien and
you do not have and are not eligible to get an SSN, your TIN is your IRS
individual taxpayer identification number (TIN). Enter it in the social security
number box. If you do not have an ITIN, see HOW TO GET A TIN below.
If you are a sole proprietor and you have an EIN, you may enter either your
SSN or EIN. However, using your EIN may result in unnecessary notices to the
requester.
NOTE: See the chart on this page for further clarification of name and TIN
combinations.
HOW TO GET A TIN.--If you do not have a TIN, apply for one immediately. To apply
for an SSN; get FORM SS-5 from your local Social Security Administration office.
Get FORM W-7 to apply for an ITIN or FORM SS-4 to apply for an EIN. You can get
Forms W-7 and SS-4 from the IRS by calling 1-800-TAX-FORM (1-800-829-3676).
If you do not have a TIN, write "Applied For" in the space for the TIN, sign
and date the form, and give it to the requester. For interest and dividend
payments, and certain payments made with respect to readily tradable
instruments, you will generally have 60 days to get a TIN and give it to the
requester. Other payments are subject to backup withholding.
NOTE: Writing "Applied For" means that you have already applied for a TIN OR
that you intend to apply for one soon.
PART II--FOR PAYEES EXEMPT FROM
BACKUP WITHHOLDING
Individuals (including sole proprietors) are NOT exempt from backup withholding.
Corporations are exempt from backup withholding for certain payments, such as
interest and dividends. For more information on exempt payees, see the separate
instructions for the Requester of Form W-9.
If you are exempt from backup withholding, you should still complete this form
to avoid possible erroneous backup withholding. Enter your correct TIN in Part
I, write "Exempt" in Part II, and sign and date the form.
If you are a nonresident alien or a foreign entity not subject to backup
withholding, give the requester a completed FORM W-8, Certificate of Foreign
Status.
PART III--CERTIFICATION
For a joint account, only the person whose TIN is shown in Part I should sign
(when required).
1. INTEREST, DIVIDEND, AND BARTER EXCHANGE ACCOUNTS OPENED BEFORE 1984 AND
BROKER ACCOUNTS CONSIDERED ACTIVE DURING 1983. You must give your correct TIN,
but you do not have to sign the certification.
2. INTEREST, DIVIDEND, BROKER, AND BARTER EXCHANGE ACCOUNTS OPENED AFTER 1983
AND BROKER ACCOUNTS CONSIDERED INACTIVE DURING 1983. You must sign the
certification or backup withholding will apply. If you are subject to backup
withholding and you are merely providing your correct TIN to the requester, you
must cross out Item 2 in the certification before signing the form.
3. REAL ESTATE TRANSACTIONS. You must sign the certification. You may cross
out Item 2 of the certification.
4. OTHER PAYMENTS. You must give your correct TIN, but you do not have to sign
the certification unless you have been notified that you have previously given
an incorrect TIN. "Other payments" include payments made in the course of the
requester's trade or business for rents, royalties, goods (other than bills for
merchandise), medical and health care services (including payments to
corporations), payments to a nonemployee for services (including attorney and
accounting fees), and payments to certain fishing boat crew members.
5. MORTGAGE INTEREST PAID BY YOU, ACQUISITION OR ABANDONMENT OF SECURED
PROPERTY, CANCELLATION OF DEBT, OR IRA CONTRIBUTIONS. You must give your correct
TIN, but you do not have to sign the certification.
PRIVACY ACT NOTICE
Section 6109 of the Internal Revenue Code requires you to give your correct TIN
to persons who must file information returns with the IRS to report interest,
dividends, and certain other income paid to you, mortgage interest you paid, the
acquisition or abandonment of secured property, cancellation of debt, or
contributions you made to an IRA. The IRS uses the numbers for identification
purposes and to help verify the accuracy of your tax return. The IRS may also
provide this information to the Department of Justice for civil and criminal
litigation and to cities, states, and the District of Columbia to carry out
their tax laws.
You must provide your TIN whether or not you are required to file a tax
return. Payers must generally withhold 31% of taxable interest, dividend, and
certain other payments to a payee who does not give a TIN to a payer. Certain
penalties may also apply.
WHAT NAME AND NUMBER
TO GIVE THE REQUESTER
<TABLE>
<CAPTION>
- -----------------------------------------------
<S> <C> <C>
FOR THIS TYPE OF ACCOUNT: GIVE NAME AND SSN
OF:
- -----------------------------------------------
1. Individual The individual
2. Two or more The actual owner of
individuals (joint the account or, if
account) combined funds, the
first individual on
the account(1)
3. Custodian account of The minor (2)
a minor (Uniform
Gift to Minors Act)
4. a. The usual The
revocable savings grantor-trustee(1)
trust (grantor is
also trustee)
b. So-called trust The actual owner(1)
account that is
not a legal or
valid trust under
state law
5. Sole proprietorship The owner (3)
- -----------------------------------------------
FOR THIS TYPE OF ACCOUNT: GIVE NAME AND EIN
OF:
- -----------------------------------------------
6. Sole proprietorship The owner (3)
7. A valid trust, Legal entity(4)
estate, or pension
trust.
8. Corporate The corporation
9. Association, club, The organization
religious,
charitable,
educational, or
other tax-exempt
organization
10. Partnership The partnership
11. A broker or The broker or
registered nominee nominee
12. Account with the The public entity
Department of
Agriculture in the
name of a public
entity (such as a
state or local
government, school
district, or prison)
that receives
agricultural program
payments
- -----------------------------------------------
</TABLE>
(1) List first and circle the name of the person whose number you furnish. If
only one person on a joint account has an SSN, that person's number must be
furnished.
(2) Circle the minor's name and furnish the minor's SSN.
(3) You must show your individual name, but you may also enter your business or
"doing business as" name. You may use either your SSN or EIN (if you have
one).
(4) List first and circle the name of the legal trust, estate, or pension trust.
(Do not furnish the TIN of the personal representative or trustee unless the
legal entity itself is not designated in the account title.)
NOTE: If no name is circled when more than one name is listed, the number will
be considered to be that of the first name listed.
<PAGE> 89
======================================================
NO DEALER, SALESMAN, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS, IN CONNECTION WITH THE OFFER BEING MADE HEREBY, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR ITS MANAGEMENT. THIS PROSPECTUS DOES NOT CONSTITUTE
AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN
THE SHARES TO WHICH IT RELATES, OR AN OFFER OF SUCH SHARES TO A PERSON IN ANY
STATE OR OTHER JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL. THE
DELIVERY OF THIS PROSPECTUS AT ANY TIME DOES NOT IMPLY THAT INFORMATION
CONTAINED HEREIN IS CORRECT AS TO ANY ITEM SUBSEQUENT TO ITS EFFECTIVE DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary..................... 1
The Offering........................... 2
Selected Financial Data................ 3
Risk Factors........................... 5
Disclosure Regarding Forward-Looking
Statements........................... 9
Use of Proceeds........................ 9
Dilution............................... 10
Capitalization......................... 11
Determination of Offering Price........ 11
Trading History and Dividends.......... 11
Offering and Method of Subscription.... 14
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 16
Quantitative and Qualitative
Disclosures about Market Risks....... 34
Business of the Company................ 36
Supervision and Regulation............. 38
Management and Principal
Shareholders......................... 45
Remuneration and Other Transactions
with Management...................... 50
Compensation of Directors.............. 52
Description of Securities of the
Company.............................. 55
Legal Matters.......................... 56
Experts................................ 57
Available Information.................. 57
Financial Statements................... F-1
</TABLE>
------------------------
UNTIL JULY 14, 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
======================================================
======================================================
UP TO 387,097 SHARES
HERITAGE LOGO
COMMON STOCK
------------------------------
PROSPECTUS
------------------------------
JUNE 19, 1998
======================================================
