UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended
September 30, 1998
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transitional period from
to
(Amended by Exch Act Rel No. 312905. eff 4/26/93.)
Commission File No. 000-23877
HERITAGE COMMERCE CORP
(Exact name of registrant as specified in its charter)
California 77-0469558
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
150 Almaden Blvd., San Jose, California 95113
(Address of principal executive offices) (Zip Code)
(408) 947-6900
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
[X] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS:
The Registrant had 3,700,341 shares of Common Stock outstanding on
November 2, 1998.
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
Table of Contents
Part I - Financial Information Page
Item 1.
Condensed Consolidated Statements of Financial Condition
At September 30, 1998 and December 31, 1997 1
Condensed Consolidated Statements of Income
For the three and nine months ended September 30, 1998 and 1997 2
Condensed Consolidated Statements of Cash Flows
For the three and nine months ended September 30, 1998 and 1997 3
Condensed Consolidated Notes to Financial Statements 4
Item 2.
Management's Discussion and Analysis of Financial Condition and
Results of Operations 6
Item 3.
Quantitative and Qualitative Disclosures About Market Risk 15
Part II - Other Information
Item 1.
Legal Proceedings 16
Item 2.
Submission of Matters to a Vote of Security Holders 16
Item 3.
Other Information 16
Item 4.
Exhibits and Reports on Form 8-K 16
Signatures 17
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARY
Condensed Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
ASSETS (Unaudited)
<S> <C> <C>
Cash and due from banks $ 24,210,000 $ 16,060,000
Federal funds sold 45,070,000 27,125,000
Total cash and cash equivalents 69,280,000 43,185,000
Securities available-for-sale, at fair value 68,031,000 61,166,000
Securities held-to-maturity, at amortized cost 27,717,000 26,531,000
(fair value of $28,597,000 and $26,938,000,
respectively)
Loans:
Commercial 86,015,000 64,102,000
Real estate - mortgage 59,689,000 38,279,000
Real estate - land and construction 40,256,000 25,562,000
Internet Credit Card 34,623,000 ---
Consumer 1,415,000 827,000
Total loans 221,998,000 128,770,000
Allowance for loan losses (3,402,000) (2,285,000)
Loans, net 218,596,000 126,485,000
Premises and equipment, net 3,048,000 1,971,000
Accrued interest receivable and other assets 7,030,000 3,764,000
Other investments 5,377,000 4,473,000
TOTAL $ 399,079,000 $ 267,575,000
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Demand, non-interest bearing $ 126,740,000 $ 97,736,000
Demand, interest bearing 4,040,000 6,319,000
Savings and money market 140,565,000 96,713,000
Time deposits, $100,000 and over 49,856,000 34,948,000
Time deposits less than $100,000 24,495,000 7,262,000
Brokered Deposits (principally time
deposits, $100,000 and over) 18,172,000 ---
Total deposits 363,868,000 242,978,000
Accrued interest payable and other liabilities 4,698,000 2,261,000
Total liabilities 368,566,000 245,239,000
Shareholders' equity:
Common Stock, no par value; 30,000,000
shares authorized; shares issued and
outstanding: 3,689,946 at September 30, 1998
and 3,295,896 at December 31, 1997 29,342,000 23,447,000
Accumulated other comprehensive income 1,142,000 418,000
Retained Earnings (Accumulated deficit) 29,000 (1,529,000)
Total shareholders' equity 30,513,000 22,336,000
TOTAL $ 399,079,000 $ 267,575,000
See notes to condensed consolidated financial statements.
</TABLE>
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARY
Condensed Consolidated Statements of Income (Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans 5,626,000 2,695,000 13,381,000 7,184,000
Interest on investment securities - taxable 1,304,000 1,399,000 3,917,000 3,722,000
Interest on investment securities - non
taxable 191,000 55,000 479,000 88,000
Interest on federal funds sold 348,000 130,000 861,000 425,000
Interest on other investments 95,000 --- 203,000 ---
Total interest income 7,564,000 4,279,000 18,841,000 11,419,000
Interest expense:
Savings and other interest-bearing deposits 1,629,000 781,000 3,544,000 2,084,000
Time certificates, $100,000 and over 721,000 349,000 1,814,000 919,000
Total interest expense 2,350,000 1,130,000 5,358,000 3,003,000
Net interest income 5,214,000 3,149,000 13,483,000 8,416,000
Provision for loan losses 550,000 240,000 1,060,000 605,000
Net interest income after provision for loan
losses 4,664,000 2,909,000 12,423,000 7,811,000
Other income:
Service charges and other fees 62,000 43,000 161,000 134,000
Gain on sale of securities available for sale 254,000 25,000 273,000 42,000
Non-interest income 185,000 157,000 333,000 238,000
Total other income 501,000 225,000 767,000 414,000
Non-interest expenses:
Salaries and employee benefits 2,078,000 1,324,000 5,448,000 3,473,000
Client services 511,000 332,000 1,430,000 873,000
Furniture and equipment 236,000 149,000 589,000 387,000
Occupancy 224,000 110,000 566,000 322,000
Advertising and promotion 221,000 114,000 588,000 309,000
Third party servicing 169,000 --- 169,000 ---
Stock offering fees 154,000 --- 154,000 ---
Deferred loan costs 109,000 96,000 304,000 230,000
Professional fees 97,000 89,000 290,000 232,000
Other 399,000 258,000 1,090,000 642,000
Total other expenses 4,198,000 2,472,000 10,628,000 6,468,000
Net income before income taxes 967,000 662,000 2,562,000 1,757,000
Provision for income taxes 393,000 233,000 1,005,000 616,000
Net income 574,000 429,000 1,557,000 1,141,000
Net income per share (basic) $ 0.16 $ 0.13 $ 0.45 $ 0.35
Average number of common shares 3,687,015 3,292,049 3,426,036 3,290,508
Net income per share (diluted) $ 0.14 $ 0.12 $ 0.41 $ 0.33
Average number of common shares and common
share equivalents 4,116,279 3,552,581 3,783,300 3,467,267
See notes to condensed consolidated financial statements.
</TABLE>
<PAGE>
HERITAGE COMMERCE CORP
Condensed Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Nine Months ended
September 30,
1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,557,000 $ 1,141,000
Adjustments to reconcile net income to net cash used by operating activities:
Depreciation and amortization 447,000 281,000
Provision for loan losses 1,060,000 605,000
Gain on sale of investments available-for-sale (358,000) (42,000)
Net amortization of premiums / accretion of discounts 139,000 97,000
Proceeds from sales of loans (83,000) (205,000)
Originations of loans held for sale (2,845,000) (2,529,000)
Maturities of loans held for sale 117,000 2,548,000
Increase in accrued interest receivable and other assets (3,264,000) (1,158,000)
Increase in accrued interest payable and other liabilities 1,969,000 351,000
Net cash provided by (used by) operating activities (1,261,000) 1,089,000
Cash flows from investing activities:
Net increase in loans (90,360,000) (25,771,000)
Purchases of investment securities available-for-sale (25,484,000) (46,549,000)
Maturities of investment securities available-for-sale 12,486,000 13,036,000
Sales of investment securities available-for-sale 7,635,000 6,684,000
Purchases of investment securities held-to-maturity (8,898,000) (3,347,000)
Maturities of investment securities held-to-maturity 7,617,000 5,027,000
Purchases of corporate owned life insurance (904,000) (4,425,000)
Capital expenditures (1,523,000) (524,000)
Net cash used by investing activities (99,431,000) (55,869,000)
Cash flows from financing activities:
Net increase in deposits 120,892,000 85,094,000
Repayments from sale of securities under agreement
to repurchase --- (5,010,000)
Proceeds from exercise of stock options 49,000 ---
Proceeds from issuance of common stock 5,846,000 35,000
Net cash provided by financing activities 126,787,000 80,119,000
Net increase in cash and cash equivalents 26,095,000 25,339,000
Cash and cash equivalents, beginning of period 43,185,000 12,615,000
Cash and cash equivalents, end of period 69,280,000 37,954,000
Other cash flow information:
Interest paid in cash $ 4,963,000 $ 2,866,000
Income taxes paid in cash 1,034,000 986,000
Non-cash financing activity:
Transfer from accumulated deficit to common stock
due to stock dividend $ --- $ 1,304,000
See notes to condensed consolidated financial statements.
</TABLE>
<PAGE>
HERITAGE COMMERCE CORP AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
September 30, 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 included in the Company's Form 10-K Annual Report for the year
ended December 31, 1997.
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 and nine months ended September 30,
1998 are not necessarily indicative of the results expected for any
subsequent period or for the entire year ending 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 Form 10-
Q, the balances are included in the commercial loan totals. The
balances of these loans were $12,535,000 at September 30, 1998 and
$9,365,000 at December 31, 1997.
4) Deferred Loan Fees
Loan totals in the balance sheet are net of deferred loan fees
totaling $146,000 and $113,000 at September 30, 1998 and December 31,
1997, respectively.
<PAGE>
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 three months ended September
30, 1998 and 1997 was $1,170,000 and $719,000, respectively.
The following is a summary of the components of accumulated other
comprehensive income:
<TABLE>
<CAPTION>
For the Three Months Ended For The Nine Months Ended
September September September September
30, 1998 30, 1997 30, 1998 30, 1997
(Dollars in thousands) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net Income $ 574 $ 429 $ 1,557 $ 1,141
Other comprehensive income, net of tax
Net unrealized gain on securities
available-for-sale during the period 633 314 828 216
Less: reclassification adjustment
for realized gains on available for
sale securities included in net
income during the period 37 24 104 40
Other comprehensive income 596 290 724 176
Comprehensive income 1,170 719 2,281 1,317
</TABLE>
6) Issuance of Common Stock
On June 19, 1998, the Company commenced an Offering of 387,097 shares
of common stock at a price of $15.50 per share. The Company closed
the Offering on July 30, 1998 after selling all the shares and
collecting approximately $5,895,000 after expenses.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Net income for the quarter and nine months ended September 30, 1998 was
$574,000 and $1,557,000 (restated to reflect the capitalization of certain
common stock offering costs), or $0.16 and $0.45 per share (basic), as compared
to net income of $429,000 and $1,141,000, or $0.13 and $0.35 per share (basic)
for the same periods in 1997. The increase was attributable to growth in the
level of earning 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 nine months of 1998 was 0.67%, compared to
0.76% for the first nine months of 1997. The main factor behind this decrease
was a 70% increase in the loan portfolio from September 30, 1997 to the same
period in 1998. Annualized return on average equity for the first nine months
of 1998 was 8.49%, compared to 7.31% for the first nine months of 1997.
Average interest-earning assets for the quarter and nine months ended September
30, 1998 were up $120,429,000 and $97,994,000 or 59% and 53% over 1997, with
much of the increase primarily attributable to growth in loans. In January
1998, the Company's bank subsidiary, Heritage Bank of Commerce, launched its
newest product, an internet credit card, which accounted for $25,361,000 and
$34,623,000 of this loan growth during the three months and nine months ended
September 30, 1998. The average rate earned on loans in the third quarter and
first nine months 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
9.29% and 8.94% for the quarter and nine months ended September 30, 1998, up
from 8.38% and 8.30% for the same periods in 1997.
Average interest-bearing liabilities increased $95,320,000 and $66,278,000 or
75% and 57% from the quarter and nine months ended September 30,1997 to the
same periods in 1998, with the increase attributable to growth in interest
bearing demand deposit and money market accounts, growth in time deposits of
$100,000 or more and growth in time deposits in support of the internet credit
card product. For the three months and nine months ended September 30, 1998,
the loan portfolio increase attributed to time deposits related to the internet
credit card were $25,672,000 and $35,662,000. The average rate paid on
interest-bearing liabilities increased to 4.20% and 3.94% from 3.54% and 3.47%
at the quarter and nine months ended September 30, 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 6.41% and 6.40% in the third
quarter and first nine months of 1998 from 6.17% and 6.12% for the same periods
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
September 30, 1998, December 31, 1997, and September 30, 1997.
Shareholders' equity increased $8,177,000 to $30,513,000, or 7.65% of assets,
at September 30, 1998, from $22,336,000 million , or 8.35% of assets, at
December 31, 1997. The increase was mainly due to a stock offering of 387,097
shares at $15.50 which closed on July 30, 1998. The Company's Tier 1 and total
risk-based capital ratios were 11.6% and 12.9%, respectively, at September 30,
1998, compared to 14.6% and 15.8%, respectively, at December 31, 1997, and
16.8% and 18.0%, respectively, at September 30, 1997. Due to the overall
growth in total assets, more specifically the growth in the loan portfolio, the
Company's leverage capital ratio decreased to 8.30% at September 30, 1998 from
8.9% at December 31, 1997 and 9.6% at September 30, 1997. At September 30,
1998, the Company's risk-based capital and leverage ratios exceeded the ratios
for a well-capitalized financial institution as defined in FDICIA under the
prompt corrective action regulations.
<PAGE>
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 periods presented:
<TABLE>
<CAPTION>
For the Three Months Ended For the Three Months Ended
September 30, 1998 September 30, 1997
Interest Average Interest Average
Average Earned or Yield or Average Earned or Yield or
Balance Paid Rate Paid Balance Paid Rate Paid
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Net loans $ 190,663 $ 5,626 11.71% $ 101,158 $ 2,695 10.57%
Investments 106,606 1,590 5.92% 91,868 1,453 6.28%
Federal funds sold 25,667 348 5.38% 9,481 130 5.45%
Total interest-earning assets $ 322,936 $ 7,564 9.29% $ 202,507 $ 4,278 8.38%
Interest-Bearing Liabilities
Deposits:
Money market and Interest-
bearing demand $ 117,568 $ 1,085 3.66% $ 63,740 $ 431 2.68%
Savings 21,791 223 4.05% 27,548 262 3.78%
Time deposits, $100,000
and over 59,717 721 4.79% 27,972 349 4.95%
Time deposits, less than
$100,000 18,643 253 5.39% 7,371 86 4.62%
Brokered Deposits 4,166 66 6.32% --- --- 0.00%
Other borrowings 148 2 5.81% 82 1 5.66%
Total interest-bearing
liabilities $ 222,033 $ 2,350 4.20% $ 126,713 $ 1,129 3.54%
Net interest income / margin $ 5,214 6.41% $ 3,149 6.17%
Note: Yields and amounts earned on loans include loan fees of $407,000 and
$192,000 for the three month periods ended September 30, 1998 and 1997,
respectively.
</TABLE>
<TABLE>
<CAPTION>
For the Nine Months Ended For the Nine Months Ended
September 30, 1998 September 30, 1997
Interest Average Interest Average
Average Earned or Yield or Average Earned or Yield or
Balance Paid Rate Paid Balance Paid Rate Paid
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Net loans $ 157,924 $ 13,381 11.33% $ 92,875 $ 7,184 10.34%
Investments 102,596 4,600 5.99% 80,387 3,810 6.34%
Federal funds sold 21,310 861 5.40% 10,574 425 5.37%
Total interest-earning assets $ 281,830 $ 18,842 8.94% $ 183,836 $ 11,419 8.30%
Interest-Bearing Liabilities
Deposits:
Money market and Interest-
bearing demand $ 91,792 $ 2,206 3.21% $ 56,852 $ 1,110 2.61%
Savings 28,738 809 3.77% 25,422 693 3.64%
Time deposits, $100,000
and over 48,089 1,814 5.04% 25,615 919 4.80%
Time deposits, less than
$100,000 11,967 460 5.14% 7,779 278 4.77%
Brokered Deposits 1,385 66 6.40% --- --- 0.00%
Other borrowings 55 3 7.29% 80 4 6.68%
Total interest-bearing
liabilities $ 182,026 $ 5,358 3.94% $ 115,748 $ 3,004 3.47%
Net interest income / margin $ 13,484 6.40% $ 8,415 6.12%
Note: Yields and amounts earned on loans include loan fees of $1,046,000 and
$466,000 for the nine month periods ended September 30, 1998 and 1997,
respectively.
</TABLE>
The Company's net interest income for the third quarter of 1998 was $5,214,000,
an increase of $2,065,000 over the third quarter of 1997. The Company's net
interest income for the nine month period ended September 30, 1998 was
$13,483,000 an increase of $5,067,000 over the nine month period ended
September 30, 1997. When compared to the third quarter of 1997, average
earning assets increased by $120,429,000, while the net yield on average
earning assets increased from 6.17% in the third quarter of 1997 to 6.41% in
the third quarter of 1998. When compared to the first nine months of 1997,
average earning assets increased by $97,994,000, while the net yield on average
<PAGE>
earning assets increased from 6.12% in the first nine months of 1997 to 6.40%
in the first nine months of 1998. For both periods, the increase in net
interest income was primarily due to an increase in the volume of interest-
earning assets, predominantly loans.
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 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.
<TABLE>
<CAPION>
Three Months Ended September 30
1998 vs. 1997
Increase (Decrease) Due to Change In:
Volume Rate Net Change
<S> <C> <C> <C>
Interest-earning assets
Net loans 2,613 318 2,931
Investments 223 (87) 136
Federal funds sold 220 (2) 218
Total interest-earning assets 3,056 229 3,285
Interest-bearing liabilities
Money market and interest bearing demand 457 196 653
Savings (58) 18 (40)
Time deposits, $100,000 and over 384 (12) 372
Time deposits, less than $100,000 151 17 168
Brokered Deposits 66 --- 66
Other borrowings 1 --- 1
Total interest-bearing liabilities 1,001 219 1,220
Change in net interest income 2,065
</TABLE>
<TABLE>
Nine Months Ended September 30
1998 vs. 1997
Increase (Decrease) Due to Change In:
Volume Rate Net Change
<S> <C> <C> <C>
Interest-earning assets
Net loans 5,454 743 6,197
Investments 1,005 (216) 789
Federal funds sold 434 3 437
Total interest-earning assets 6,893 530 7,423
Interest-bearing liabilities
Money market and interest bearing demand 797 299 1,096
Savings 93 24 117
Time deposits, $100,000 and over 845 49 894
Time deposits, less than $100,000 160 23 183
Other borrowings (1) --- (1)
Brokered Deposits 66 --- 66
Total interest-bearing liabilities 1,960 395 2,355
Change in net interest income 5,068
</TABLE>
Provision for Loan Losses
During the third quarter of 1998, the provision for loan losses was $550,000,
up $310,000 from $240,000 for the third quarter of 1997. The increase in the
provision was due to the overall growth of the loan portfolio.
<PAGE>
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 September 30, 1998 versus 1997
(Dollars in thousands) 1998 1997 Amount Percent
<S> <C> <C> <C> <C>
Service charges and other fees 62 42 20 48%
Gain on securities available-for-sale 291 26 265 1019%
Gain on sale of loans 54 138 (84) (61%)
Other income 94 19 75 408%
Total 501 225 276 123%
</TABLE>
The following table sets forth the various components of the Bank's non-
interest income for the periods indicated:
<TABLE>
Increase (Decrease)
Nine months ended September 30, 1998 versus 1997
(Dollars in thousands) 1998 1997 Amount Percent
<S> <C> <C> <C> <C>
Service charges and other fees 161 134 27 20%
Gain on securities available-for-sale 358 41 317 773%
Gain on sale of loans held-for sale 104 203 (99) (49%)
Other income 144 36 108 300%
Total 767 414 353 85%
</TABLE>
Non-interest expense
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 September 30,
Increase Percent Increase
(Dollars in thousands) 1998 1997 (Decrease) (Decrease)
<S> <C> <C> <C> <C>
Salaries and benefits $ 2,078 $ 1,324 $ 754 57%
Client services 511 332 179 54%
Furniture and equipment 236 149 87 58%
Occupancy 224 110 114 104%
Advertising and promotion 221 114 107 94%
Third party servicing 169 --- 169 100%
Stock offering fees 154 --- 154 100%
Loan origination costs 109 96 13 14%
Professional fees 97 89 8 9%
All other 399 258 141 55%
Total 4,198 2,472 1,726 70%
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
For The Nine Months Ended September 30,
Increase Percent Increase
(Dollars in thousands) 1998 1997 (Decrease) (Decrease)
<S> <C> <C> <C> <C>
Salaries and benefits $ 5,448 $ 3,473 $ 1,975 57%
Client services 1,430 873 557 64%
Furniture and equipment 589 387 202 52%
Advertising and promotion 588 309 279 90%
Occupancy 566 322 244 76%
Loan origination costs 304 230 74 32%
Professional fees 290 232 58 25%
Third party servicing 169 --- 169 100%
Stock offering fees 154 --- 154 100%
All other 1,090 642 448 70%
Total $ 10,628 $ 6,468 $ 4,160 64%
</TABLE>
Non-interest expenses for the third quarter of 1998 were $4,198,000, up
$1,726,000 (or 70%) from $2,472,000 for the third quarter of 1997. Non-
interest expenses for the first nine months of 1998 were $10,628,000, up
$4,160,000 (or 64%) from $6,468,000 for the first nine months 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 (49%
and 54% of total non-interest expenses for the third quarter of 1998 and 1997,
respectively; 51% and 54% of total non-interest expenses for the nine months
ended September 30, 1998 and 1997, respectively) and client services (12% and
13% of total non-interest expenses for the third quarter of 1998 and 1997,
respectively; 13% and 14% of total non-interest expenses for the first nine
months of 1998 and 1997, respectively). The increase in salaries and benefits
expenses was primarily attributable to an increase in the number of employees.
The Bank employed 118 people at September 30, 1998, up 36 from 82 employees at
September 30, 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.
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 technical and business systems that
will require modification to ensure Year 2000 Compliance. These systems
include all computer hardware, computer software and such systems as telephones
and alarms. Internal and external resources are being used to make the
required modifications and test Year 2000 Compliance. The modification process
of all significant systems is underway and is approximately 90% complete as of
September 30, 1998 with full completion expected by December 31, 1998. The
Company is currently testing all significant technical and business systems and
is on schedule to complete the testing process by March 31, 1999.
In addition, the Company is in the process of, or has communicated with, all
vendors with whom it does significant business to determine their 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
converted in a timely manner, 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.
<PAGE>
Depending on the outcomes of the testing process, the Company established
several contingency plans should any system not be Year 2000 compliant. These
contingency plans include the implementation of new vendors or applications,
the installation of revised software and temporary reversions to less
technology dependent systems.
The total cost to the Company of Year 2000 Compliance issues, which includes
testing, system replacement and any anticipated lost revenue, 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.
FINANCIAL CONDITION
Total assets increased 49% to $399,079,000 at September 30, 1998, compared to
$267,575,000 at December 31, 1997. The growth was primarily due to increases
in the Company's loan portfolio funded by growth in deposits.
Loans
Total gross loans increased 72% to $221,998,000 September 30, 1998, as compared
to $128,770,000 at December 31, 1997. The increase in loan volume was due to
the introduction of an internet credit card and the business development
efforts of the Company's loan teams.
The following table indicates the Company's loan portfolio for the periods
indicated:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
<S> <C> <C>
Installment $ 1,219,000 $ 691,000
Commercial 54,846,000 39,402,000
Small Business Administration 26,863,000 21,965,000
Technology Loans 680,000 621,000
Factored Loans 3,823,000 1,865,000
Land and Construction 40,256,000 25,780,000
Equity Lines 5,299,000 4,275,000
Real Estate Loans 54,389,000 34,171,000
Internet Credit Card 34,623,000 ---
Total $ 221,998,000 $ 128,770,000
</TABLE>
In February 1998, the Company's bank subsidiary, Heritage Bank of Commerce (the
"Bank"), entered into a contract with Internet Access Financial Corporation to
provide a credit card over the internet. These customers are not limited to
Silicon Valley, the Company's primary market area, as the product is available
to anyone across the country. It is the intention of the Bank to collect
certificates of deposit generated through the same internet based system in an
amount approximately equal to that loaned through the credit card program,
however, no assurances can be made that these funds will be collected as
indicated.
The Company's loan portfolio is concentrated in commercial (primarily
manufacturing, wholesale, and service) and real estate lending, with the
balance in consumer loans. Due to increased customer dispersion outside of the
Bank's primary market area attributed to the introduction of the internet
credit card, the Company has decreased the geographic risks inherent in its
loan portfolio. However, while no specific industry concentration is
considered significant, the Company's lending operations are located in the
Company's market areas that are dependent on the technology and real estate
industries and their supporting companies. Thus, the Company's borrowers could
be adversely impacted by a downturn in these sectors of the economy which could
reduce the demand for loans and adversely impact the borrowers' abilities to
repay their loans.
<PAGE>
Allowance for loan losses
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. Management has
established an evaluation process designed to determine that adequacy of the
allowance for loan losses. This process attempts to assess the risk of loss
inherent in the portfolio by segregating the allowance for loan losses into
four components: "watch", "special mention", "substandard" and "doubtful".
It is the policy of management to maintain the allowance for possible loan
losses at a level adequate for known and future risks inherent in the loan
portfolio. Based on information currently available to analyze loan loss
delinquency and a history of actual charge-offs, management believes that the
loan loss provision and allowance are adequate; however, no assurance of the
ultimate level of credit losses can be given with any certainty. Loans are
charged against the allowance when management believes that the collectibility
of the principal is unlikely.
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 December 31,
(Dollars in thousands) September 30, 1998 December 31, 1997
<S> <C> <C>
Balance, beginning of period $ 2,884 $ 1,402
Charge-offs - Commercial loans (35) (224)
Recoveries - Commercial loans 3 47
Net charged-offs (32) (177)
Provision for loan losses 550 1,060
Balance, end of period $ 3,402 $ 2,285
Ratios:
Net charge-offs to average
loans outstanding 0.02% 0.18%
Allowance for possible loan
losses to average loans 1.78% 1.94%
Allowance for possible loan
losses to total loans at end of period 1.53% 1.77%
</TABLE>
The following table summarizes the allocation of the allowance for possible
loan losses by loan type and the allocated allowance as a percent of loans
outstanding in each loan category at the dates indicated:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
Allowance Allowance
as a % of Loans as a % of Loans
Outstanding in Outstanding in
Allowance Category Allowance Category
<S> <C> <C> <C> <C>
Commercial $ 1,486 1.73% $ 821 1.28%
Real estate - mortgage 219 0.37% 205 0.54%
Real estate - land and construction 776 1.93% 379 1.48%
Consumer 13 0.89% 7 0.85%
Internet Credit Card 445 1.29% --- ---
Unallocated 463 873
Total $ 3,402 1.53% $ 2,285 1.77%
</TABLE>
The Bank maintains an allowance for possible loan losses to provide for
estimated losses in the loan portfolio. While the loan loss allowance as a
percentage of total loans has decreased from December 31, 1997, management
still deems the provision as adequate given the quality of 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.
<PAGE>
Deposits
Deposits totaled $363,868,000 at September 30, 1998, an increase of 50%, 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, including the newly introduced internet products.
Non-interest-bearing deposits were $126,740,000 at September 30, 1998, an
increase of 30% as compared to $97,736,000 at December 31, 1997. Interest-
bearing deposits were $237,128,000 at September 30, 1998, an increase of 63% as
compared to $145,242,000 at December 31, 1997.
In addition to the internet credit card, the Company has introduced time
deposits to be marketed on the internet with the intention of using these
deposits to fund the credit card loans. For the three months and nine months
ended September 30, 1998 the Company has collected $25,672,000 and $35,662,000
from the sale of these deposits. Due to increased customer dispersion outside
of the Bank's primary market area attributed to the introduction of the
internet credit card, the Company has decreased the geographic risks inherent
in its loan portfolio. The Company intends to collect funds in these internet
time deposits in an amount approximately equal to that loaned through the
internet credit card. However, in addition to the interest rate risk
associated with these deposits, no assurances can be made that the Company will
be able to collect these funds as indicated.
<PAGE>
Interest Rate Risk
The careful planning of asset and liability maturities and the matching of
interest rates to correspond with this maturity matching is an integral part of
the active management of an institution's net yield. To the extent maturities
of assets and liabilities do not match in a changing interest rate environment,
net yields may change over time. Even with perfectly matched repricing of
assets and liabilities, risks remain in the form of prepayment of loans or
investments or in the form of delays in the adjustment of rates of interest
applying to either earning assets with floating rates or to interest bearing
liabilities. The Bank has generally been able to control its exposure to
changing interest rates by maintaining primarily floating interest rate loans
and a majority of its time certificates in relatively short maturities
The following table sets forth the interest rate sensitivity of the Company's
interest-earning assets and interest-bearing liabilities as of September 30,
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>
Within Due in Three Due After
Three to Twelve One to Five Due After Not Rate-
(Dollars in thousands) Months Months Years Five Years Sensitive Total
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Federal funds sold $ 45,070 --- --- --- --- $ 45,070
Securities 2,292 $ 10,222 $ 51,893 $ 31,341 --- 95,748
Total loans 132,942 50,645 22,876 15,535 --- 221,998
Corp. Owned Life Insurance --- --- --- 5,377 --- 5,377
Total interest earning assets 180,304 60,867 74,769 52,253 --- 368,193
Cash and due from banks $ 24,210 24,210
Other assets 6,676 6,676
Total assets $ 180,304 $ 60,867 $ 74,769 $ 52,253 $ 30,886 $ 399,079
Interest bearing liabilities:
Demand, interest-bearing $ 7,970 --- --- --- --- $ 7,970
Savings and money market 140,575 --- --- --- --- 140,575
Time deposits $ 31,331 $ 49,757 $ 6,823 --- --- 87,911
Total interest bearing liabilities 179,876 49,757 6,823 --- --- 236,456
Non-interest demand deposits $ 127,412 $ 127,412
Other liabilities 4,698 4,698
Shareholders' equity 30,513 30,513
Total liabilities and shareholders'
equity $ 179,876 $ 49,757 $ 6,823 --- $ 162,623 $ 399,079
Interest rate sensitivity gap $ 428 $ 11,110 $ 67,946 $ 52,253 $ (131,737) ---
Cumulative interest rate
sensitivity gap $ 428 $ 11,538 $ 79,484 $ 131,737 ---
Cumulative interest rate
sensitivity gap ratio 0.11% 2.89% 19.92% 33.01%
</TABLE>
The foregoing table demonstrates that the Company had a positive cumulative one
year gap of $16,915,000 at September 30, 1998. In theory, this would indicate
that $16,915,000 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.
<PAGE>
Capital Resources
The following table summarizes risk-based capital, risk-weighted assets, and
risk-based capital ratios of the Company:
<TABLE>
<CAPTION>
"Well-Capitalized"
September 30, December 31, Regulatory
(Dollars in thousands) 1998 1997 1997 Requirements
<S> <C> <C> <C> <C>
Capital components:
Tier 1 Capital $ 29,359 $ 21,457 $ 21,899
Tier 2 Capital 3,164 1,604 1,885
Total risk-based capital $ 32,523 $ 23,061 $ 23,784
Risk-weighted assets $ 252,891 $ 127,961 $ 150,418
Average assets $ 365,896 $ 235,938 $ 251,767
Capital ratios:
Total risk-based capital 12.9% 18.0% 15.8% 10.0%
Tier 1 risk-based capital 11.6% 16.8% 14.6% 6.0%
Leverage ratio (1) 8.0% 9.1% 10.3% 5.0%
(1) Tier 1 capital divided by average assets (excluding goodwill).
</TABLE>
On June 17, 1998 the Company received acceptance from the Securities and
Exchange Commission of its Form S-1, enabling it to commence an offering of
387,097 shares of Common Stock at a price of $15.50 per share. As of September
30, 1998 the Company had sold all the shares and collected approximately
$5,846,000 after expenses.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
No material changes have occurred during the quarter to the Company's market
risk profile or information. For further information refer to the Company's
Prospectus on Form S-1 and the Company's annual report on Form 10-K.
<PAGE>
Part II - Other Information
Item 1. - Legal Proceedings
To the best of the Bank's knowledge, there are no pending legal
proceedings to which the Bank is a party which may have a materially adverse
effect on the Bank's financial condition, results of operations, or cash flows.
Item 2. - Changes in Securities and Use of Proceeds
Not Applicable
Item 3. - Defaults Upon Senior Securities
Not Applicable
Item 4. - Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. - Other Information
Not Applicable
Item 6. - Exhibits and Reports on Form 8-K
(a) Exhibits included with this filing:
Exhibit Number Name
27.1 Financial Data Schedule
(b) Reports on Form 8-K
On October 19, 1998, the Company filed its quarterly earnings press release
with the SEC on Form 8-K.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Heritage Commerce Corp
(Registrant)
November 12, 1998 /s/ John E. Rossell
Date John E. Rossell, III,
President and CEO
November 12, 1998 /s/ Lawrence D. McGovern
Date Lawrence D. McGovern,
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE HERITAGE
COMMERCE CORP UNAUDITED FINANCIAL STATEMENTS AT SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 24,210,000
<INT-BEARING-DEPOSITS> 237,128,000
<FED-FUNDS-SOLD> 45,070,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 27,717,000
<INVESTMENTS-CARRYING> 27,717,000
<INVESTMENTS-MARKET> 28,597,000
<LOANS> 221,998,000
<ALLOWANCE> 3,402,000
<TOTAL-ASSETS> 399,079,000
<DEPOSITS> 363,868,000
<SHORT-TERM> 0
<LIABILITIES-OTHER> 4,698,000
<LONG-TERM> 0
0
0
<COMMON> 29,342,000
<OTHER-SE> 1,171,000
<TOTAL-LIABILITIES-AND-EQUITY> 399,079,000
<INTEREST-LOAN> 13,381,000
<INTEREST-INVEST> 4,396,000
<INTEREST-OTHER> 1,064,000
<INTEREST-TOTAL> 18,841,000
<INTEREST-DEPOSIT> 5,358,000
<INTEREST-EXPENSE> 5,358,000
<INTEREST-INCOME-NET> 13,483,000
<LOAN-LOSSES> 1,060,000
<SECURITIES-GAINS> 273,000
<EXPENSE-OTHER> 10,628,000
<INCOME-PRETAX> 2,562,000
<INCOME-PRE-EXTRAORDINARY> 2,562,000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,557,000
<EPS-PRIMARY> 0.45
<EPS-DILUTED> 0.41
<YIELD-ACTUAL> 6.41
<LOANS-NON> 0
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,285,000
<CHARGE-OFFS> 41,000
<RECOVERIES> 98,000
<ALLOWANCE-CLOSE> 3,402,000
<ALLOWANCE-DOMESTIC> 2,939,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 463,000
</TABLE>
