FORM 10-Q. -- QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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 June 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.
HERITAGE COMMERCE CORP
(Exact name of registrant as specified in its charter)
California 77-0469558
(State or other jurisdiction of (I.R.S. 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 3,295,896 shares of Common Stock outstanding on
July 1, 1998.
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 June 30, 1998 and December 31, 1997 1
Condensed Consolidated Statements of Income
For the three and six months ended June 30, 1998 and 1997 2
Condensed Consolidated Statements of Cash Flows
For the three and six months ended June 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 14
Part II - Other Information
Item 1. Legal Proceedings 15
Item 2. Submission of Matters to a Vote of Security Holders 15
Item 3. Other Information 15
Item 4. Exhibits and Reports on Form 8-K 16
Signatures 17
HERITAGE COMMERCE CORP AND SUBSIDIARY
Condensed Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
ASSETS (Unaudited)
<S> <C> <C>
Cash and due from banks $ 21,284,000 $ 16,060,000
Federal funds sold 44,121,000 27,125,000
Total cash and cash equivalents 65,405,000 43,185,000
Securities available-for-sale, at fair value 75,857,000 61,166,000
Securities held-to-maturity, at amortized cost 28,182,000 26,531,000
(fair value of $28,522,000 and $26,938,000,
respectively)
Loans:
Commercial 75,202,000 64,102,000
Real estate - mortgage 43,778,000 38,279,000
Real estate - land and construction 40,671,000 25,562,000
Consumer 10,621,000 827,000
Total loans 170,272,000 128,770,000
Allowance for loan losses (2,884,000) (2,285,000)
Loans, net 167,388,000 126,485,000
Premises and equipment, net 2,935,000 1,971,000
Accrued interest receivable and other assets 4,625,000 3,764,000
Other investments 5,282,000 4,473,000
TOTAL $ 349,674,000 $ 267,575,000
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Demand, non-interest bearing $ 122,461,000 $ 97,736,000
Demand, interest bearing 7,557,000 6,319,000
Savings and money market 117,706,000 96,713,000
Time deposits, $100,000 and over 60,591,000 34,948,000
Time deposits less than $100,000 15,335,000 7,262,000
Total deposits 323,650,000 242,978,000
Accrued interest payable and other liabilities 2,576,000 2,261,000
Total liabilities 326,226,000 245,239,000
Shareholders' equity:
Common Stock, no par value; 30,000,000 shares
authorized; shares issued and outstanding:
3,295,896 at June 30, 1998 and
at December 31, 1997 23,447,000 23,447,000
Accumulated other comprehensive income 546,000 418,000
Accumulated deficit (545,000) (1,529,000)
Total shareholders' equity 23,448,000 22,336,000
TOTAL $ 349,674,000 $ 267,575,000
See notes to condensed consolidated financial statements.
</TABLE>
HERITAGE COMMERCE CORP AND SUBSIDIARY
Condensed Consolidated Statements of Income (Unaudited)
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $ 4,206,000 $ 2,357,000 $ 7,756,000 $ 4,489,000
Interest on investment securities - taxable 1,380,000 1,190,000 2,613,000 2,324,000
Interest on investment securities - non taxable 168,000 19,000 288,000 33,000
Interest on federal funds sold 295,000 181,000 512,000 295,000
Interest on other investments 57,000 --- 109,000 ---
Total interest income 6,106,000 3,747,000 11,278,000 7,141,000
Interest expense:
Savings and other interest-bearing deposits 1,063,000 670,000 1,916,000 1,304,000
Time certificates, $100,000 and over 604,000 302,000 1,093,000 570,000
Total interest expense 1,667,000 972,000 3,009,000 1,874,000
Net interest income 4,439,000 2,775,000 8,269,000 5,267,000
Provision for loan losses 350,000 145,000 510,000 365,000
Net interest income after provision for loan losses 4,089,000 2,630,000 7,759,000 4,902,000
Other income:
Service charges and other fees 48,000 46,000 98,000 91,000
Other income 138,000 69,000 167,000 98,000
Total other income 186,000 115,000 265,000 189,000
Other expenses:
Salaries and employee benefits 1,790,000 1,182,000 3,370,000 2,148,000
Client services 559,000 293,000 919,000 541,000
Occupancy 191,000 115,000 342,000 212,000
Advertising and promotion 189,000 114,000 369,000 205,000
Furniture and equipment 183,000 125,000 353,000 239,000
Professional fees 29,000 67,000 193,000 142,000
Deferred loan costs 114,000 71,000 195,000 134,000
Other 357,000 216,000 689,000 374,000
Total other expenses 3,412,000 2,183,000 6,430,000 3,995,000
Net income before income taxes 863,000 562,000 1,594,000 1,096,000
Provision for income taxes 333,000 197,000 611,000 384,000
Net income $ 530,000 $ 365,000 $ 983,000 $ 712,000
Net income per share (basic) $ 0.16 $ 0.11 $ 0.28 $ 0.22
Average number of common shares 3,295,896 3,291,653 3,295,896 3,289,738
Net income per share (diluted) $ 0.14 $ 0.11 $ 0.26 $ 0.21
Average number of common shares and common
share equivalents 3,677,108 3,457,143 3,669,636 3,449,395
See accompanying notes to condensed consolidated financial statements.
</TABLE>
HERITAGE COMMERCE CORP
Condensed Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Six Months ended June 30,
1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net income $ 983,000 $ 712,000
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization 271,000 177,000
Provision for loan losses 510,000 365,000
Gain on sale of investments available-for-sale (67,000) (16,000)
Amortization / accretion of discounts and premiums 37,000 86,000
Proceeds from sales of loans (33,000) (65,000)
Originations of loans held for sale (2,157,000) (2,464,000)
Maturities of loans held for sale 67,000 814,000
Increase in accrued interest receivable and other assets (861,000) (853,000)
Increase in accrued interest payable and other liabilities 225,000 73,000
Net cash used by operating activities (1,025,000) (1,171,000)
Cash flows from investing activities:
Net increase in loans (39,290,000) (12,902,000)
Purchases of investment securities available-for-sale (23,971,000) (20,222,000)
Maturities of investment securities available-for-sale 7,513,000 7,018,000
Sales of investment securities available-for-sale 2,067,000 4,573,000
Purchases of investment securities held-to-maturity (7,014,000) (2,617,000)
Maturities of investment securities held-to-maturity 5,311,000 3,179,000
Purchases of corporate owned life insurance (809,000) ---
Capital expenditures (1,235,000) (453,000)
Net cash used by investing activities (57,428,000) (21,424,000)
Cash flows from financing activities:
Net increase in deposits 80,673,000 49,716,000
Proceeds from sale of securities under agreement to repurchase --- (5,010,000)
Proceeds from issuance of common stock --- 27,000
Net cash provided by financing activities 80,673,000 44,733,000
Net increase in cash and cash equivalents 22,150,000 22,138,000
Cash and cash equivalents, beginning of period 43,185,000 12,615,000
Cash and cash equivalents, end of period $ 65,335,000 $ 34,753,000
Other cash flow information:
Interest paid $ 2,876,000 $ 1,830,000
Income taxes paid 521,000 463,000
Non-cash financing activity:
Transfer from accumulated deficit to common stock
due to stock dividend $ --- $ 1,304,000
See accompanying notes to condensed consolidated financial statements.
</TABLE>
HERITAGE COMMERCE CORP AND SUBSIDIARY
Notes to Condensed Consolidated Financial Statements
June 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 six months ended June 30, 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 Form 10-Q, the balances are
included in the commercial loan totals.
4) Deferred Loan Fees
Loan totals in the balance sheet above are net of deferred loan fees
totalling $143,000 and $113,000 at June 30, 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 three
months ended June 30, 1998 and 1997 was $623,000 and $751,000,
respectively. For the six months ended June 30, 1998 and 1997, total
comprehensive income was $1,111,000 and $598,000, respectively.
The following is a summary of the components of accumulated other
comprehensive income:
<TABLE>
<CAPTION>
For the Three Months Ended For The Six Months Ended
June 30, 1998 June 30, 1997 June 30, 1998 June 30, 1997
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net Income $ 530 $ 365 $ 983 $ 712
Other comprehensive income, net of tax
Net unrealized gain (loss) on available-
for-sale securities during the period 142 386 195 (98)
Less: reclassification adjustment
for realized gains on available for
sale securities included in net income
during the period (49) --- (67) (16)
Other comprehensive income 93 386 128 (114)
Comprehensive income $ 623 $ 751 $ 1,111 $ 598
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Net income for the quarter and six months ended June 30, 1998 was $530,000 and
$983,000, or $0.16 and $0.28 per share (basic), as compared to net income of
$365,000 and $712,000, or $0.11 and $0.22 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 six months of 1998 was 0.8%, compared to 0.7% for the first six months of
1997. Annualized return on average equity for the first six months of 1998 was
10.1%, compared to 7.1% for the first six months of 1997.
Average interest-earning assets for the quarter and six months ended June 30,
1998 were up $100,701,000 and $82,765,000 or 55% and 47% 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 $9,262,000 and $7,661,000
of this growth during the six months and three months ended June 30, 1998. The
average rate earned on loans in the second quarter and first six 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 8.62% and 8.71% for the
quarter and six months ended June 30, 1998, up from 8.20% and 8.12% for the same
periods in 1997.
Average interest-bearing liabilities were up $65,685,000 and $53,648,000 or 58%
and 49% from the quarter and six months ended June 30,1997 to the same periods
in 1998, with the increase attributable to growth in savings and money market
accounts, growth in time deposits of $100,000 or more and growth in time
deposits related to the internet credit card product. For the six months and
three months ended June 30, 1998, time deposits related to the internet credit
card were $9,990,000 and zero. The average rate paid on interest-bearing
liabilities increased to 3.74% and 3.70% from 3.44% and 3.40% at the quarter and
six months ended June 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 6.26% and 6.31% in the second quarter and first six
months of 1998 from 6.07% and 6.00% 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
June 30, 1998, December 31, 1997, and June 30, 1997.
Shareholders' equity increased $1,112,000 to $23,448,000, or 6.71% of assets, at
June 30, 1998, from $22,336,000 million , or 8.35% of assets, at December 31,
1997. The increase was due to an increase in net earnings. The Company's Tier
1 and total risk-based capital ratios were 11.5% and 13.0%, respectively, at
June 30, 1998, compared to 14.6% and 15.8%, respectively, at December 31, 1997,
and 18.5% and 19.7%, respectively, at June 30, 1997. The Company's leverage
capital ratio decreased to 7.4% at June 30, 1998 from 10.3% at December 31, 1997
and 10.6% at June 30, 1997. At June 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.
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
June 30, 1998 June 30, 1997
Average Interest Average Yield or Average Interest Average Yield or
Balance Earned or Paid Rate Paid Balance Earned or Paid Rate Paid
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Net loans $ 153,661 $ 4,206 10.95% $ 93,329 $ 2,357 10.10%
Investments 107,924 1,604 5.94% 76,106 1,209 6.35%
Federal funds sold 21,925 295 5.38% 13,374 181 5.41%
Total interest-earning assets $ 283,510 $ 6,106 8.62% $ 182,809 $ 3,747 8.20%
Interest-Bearing Liabilities
Deposits:
Money market and Interest-bearing
demand $ 85,391 $ 620 2.90% $ 54,732 $ 359 2.62%
Savings 34,661 321 3.70% 24,774 220 3.55%
Time deposits, $100,000 and over 48,999 604 4.93% 25,642 302 4.71%
Time deposits, less than $100,000 9,708 121 4.99% 7,917 91 4.60%
Other borrowings --- --- 0.00% 10 --- 0.00%
Total interest-bearing liabilities $ 178,759 $ 1,666 3.74% $ 113,075 $ 972 3.45%
Net interest income / margin $ 4,439 6.28% $ 2,775 6.09%
</TABLE>
Note: Yields and amounts earned on loans include loan fees of $362,000 and
$137,000 for the three month periods ended June 30, 1998 and 1997,
respectively.
<TABLE>
<CAPTION>
For the Six Months Ended For the Six Months Ended
June 30, 1998 June 30, 1997
Average Interest Average Yield or Average Interest Average Yield or
Balance Earned or Paid Rate Paid Balance Earned or Paid Rate Paid
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets:
Net loans $ 143,917 $ 7,755 10.87% $ 90,235 $ 4,489 10.03%
Investments 95,721 2,901 6.11% 74,592 2,357 6.37%
Federal funds sold 19,075 512 5.42% 11,121 295 5.35%
Total interest-earning assets $ 258,712 $ 11,169 8.71% $ 175,947 $ 7,141 8.18%
Interest-Bearing Liabilities
Deposits:
Money market and Interest-bearing
demand $ 78,747 $ 1,122 2.87% $ 53,386 $ 679 2.56%
Savings 32,231 587 3.67% 24,345 430 3.56%
Time deposits, $100,000 and over 44,271 1,093 4.98% 24,420 570 4.71%
Time deposits, less than $100,000 8,609 207 4.84% 7,986 192 4.85%
Other borrowings 6 --- 11.35% 80 2 5.93%
Total interest-bearing liabilities $ 163,865 $ 3,009 3.70% $ 110,217 $ 1,874 3.43%
Net interest income / margin $ 8,160 6.36% $ 5,267 6.04%
</TABLE>
Note: Yields and amounts earned on loans include loan fees of $639,000 and
$274,000 for the six month periods ended June 30, 1998 and 1997,
respectively.
The Company's net interest income for the second quarter of 1998 was $4,439,000,
an increase of $1,664,000 over the second quarter of 1997. The Company's net
interest income for the six month period ended June 30, 1998 was $8,269,000 an
increase of $3,002,000 over the six month period ended June 30, 1997. When
compared to the second quarter of 1997, average earning assets increased by
$100,701,000, while the net yield on average earning assets increased from 6.09%
in the second quarter of 1997 to 6.28% in the second quarter of 1998. When
compared to the first six months of 1997, average earning assets increased by
$82,765,000, while the net yield on average earning assets increased from 6.04%
in the first six months of 1997 to 6.36% in the first six 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>
<CAPTION>
Three Months Ended June 30
1998 vs. 1997
Increase (Decrease) Due to Change In:
Volume Rate Net Change
<S> <C> <C> <C>
Interest-earning assets
Net loans $ 1,637 $ 212 $ 1,849
Investments 477 (82) 395
Federal funds sold 115 (1) 114
Total interest-earning assets $ 2,229 $ 129 $ 2,358
Interest-bearing liabilities
Money market and interest bearing demand $ 219 $ 42 $ 261
Savings 91 10 101
Time deposits, $100,000 and over 288 15 302
Time deposits, less than $100,000 22 8 30
Other borrowings --- --- ---
Total interest-bearing liabilities $ 619 $ 75 $ 694
Change in net interest income $ 1,664
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended June 30
1998 vs. 1997
Increase (Decrease) Due to Change In:
Volume Rate Net Change
<S> <C> <C> <C>
Interest-earning assets
Net loans $ 2,865 $ 401 $ 3,266
Investments 644 (100) 544
Federal funds sold 214 4 217
Total interest-earning assets $ 3,724 $ 305 $ 4,027
Interest-bearing liabilities
Money market and interest bearing demand $ 354 $ 90 $ 444
Savings 143 13 156
Time deposits, $100,000 and over 488 35 523
Time deposits, less than $100,000 15 (1) 14
Other borrowings (3) 1 (2)
Total interest-bearing liabilities $ 997 $ 138 $ 1,135
Change in net interest income $ 2,892
</TABLE>
Provision for Loan Losses
During the second quarter of 1998, the provision for loan losses was $350,000,
up $205,000 from $145,000 for the second quarter of 1997. The increase in the
provision was due to the overall growth of the loan portfolio.
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 June 30, 1998 versus 1997
(Dollars in thousands) 1998 1997 Amount Percent
<S> <C> <C> <C> <C>
Service charges and other fees 48 46 2 4%
Gain on securities available-for-sale 49 --- 49 100
Gain on sale of loans held-for sale 49 60 (11) (18)
Other income 40 9 31 344
Total 186 115 71 62%
</TABLE>
Fee income from service charges rose 5% from the second 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)
Six months ended June 30, 1998 versus 1997
(Dollars in thousands) 1998 1997 Amount Percent
<S> <C> <C> <C> <C>
Service charges and other fees 98 91 7 8%
Gain on securities available-for-sale 67 16 51 319
Gain on sale of loans held-for sale 50 65 (15) (23)
Other income 50 17 33 194
Total 265 189 76 40%
</TABLE>
Fee income from service charges rose 7% 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.
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 June 30,
Increase Percent Increase
(Dollars in thousands) 1998 1997 (Decrease) (Decrease)
<S> <C> <C> <C> <C>
Salaries and benefits $ 1,790 $ 1,182 $ 608 51%
Client services 559 293 266 91%
Advertising and promotion 189 114 75 66%
Furniture and equipment 183 125 58 46%
Professional fees 29 67 (38) (57)%
Occupancy 191 115 76 66%
Loan origination costs 114 71 43 61%
All other 357 216 141 65%
Total $ 3,412 $ 2,183 $ 1,229 56%
</TABLE>
<TABLE>
<CAPTION>
For The Six Months Ended June 30,
Increase Percent Increase
(Dollars in thousands) 1998 1997 (Decrease) (Decrease)
<S> <C> <C> <C> <C>
Salaries and benefits $ 3,370 $ 2,148 $ 1,222 57%
Client services 919 541 378 70%
Advertising and promotion 369 205 164 80%
Furniture and equipment 353 239 114 48%
Professional fees 193 142 51 36%
Occupancy 342 212 130 61%
Loan origination costs 195 134 61 46%
All other 689 374 315 84%
Total $ 6,430 $ 3,995 $ 2,435 61%
</TABLE>
Non-interest expenses for the second quarter of 1998 were $3,412,000, up
$1,229,000 (or 56%) from $2,183,000 for the second quarter of 1997.
Non-interest expenses for the first six months of 1998 were $6,430,000, up
$2,435,000 (or 61%) from $3,995,000 for the first six 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 (52%
and 54% of total non-interest expenses for the second quarter of 1998 and 1997,
respectively; 52% and 54% of total non-interest expenses for the six months
ended June 30, 1998 and 1997, respectively) and client services (16% and 13% of
total non-interest expenses for the second quarter of 1998 and 1997,
respectively; 14% and 14% of total non-interest expenses for the first six
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 113 people at June 30, 1998, up 37 from 76 employees at
June 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 should be substantially complete by
September 30, 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 has communicated with a vendor 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.
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 31% to $349,604,000 at June 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 32% to $170,272,000 June 30, 1998, as compared to
$128,770,000 at December 31, 1997. The increase in loan volume was due to the
business development
The following table indicates the Company's loan portfolio for the periods
indicated:
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
<S> <C> <C>
Installment $ 1,185,000 $ 691,000
Commercial 44,313,000 39,353,000
Small Business Administration 24,908,000 21,965,000
Technology Loans 644,000 621,000
Factored Loans 5,266,000 1,865,000
Land and Construction 40,671,000 25,780,000
Equity Lines 4,958,000 4,275,000
Real Estate Loans 38,820,000 34,171,000
Internet Credit Card 9,262,000 ---
Other 245,000 49,000
Total $ 170,272,000 $ 128,721,000
</TABLE>
The Company's loan portfolio is concentrated in commercial (primarily
manufacturing, wholesale, and service) and real estate lending, with the balance
in consumer loans. 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.
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>
Year Ended
Three months ended June 30, December 31,
(Dollars in thousands) 1998 1997 1997
<S> <C> <C> <C>
Balance, beginning of period $ 2,540 $ 1,622 $ 1,402
Charge-offs - Commercial loans (6) --- (224)
Recoveries - Commercial loans --- --- 47
Net charged-offs (6) --- (177)
Provision for loan losses 350 145 1,060
Balance, end of period $ 2,884 $ 1,767 $ 2,285
Ratios:
Net charge-offs to average loans
outstanding 0.00% 0.00% 0.18%
Allowance for possible loan losses
to average loans 1.88 1.89 2.31
Allowance for possible loan losses
to total loans at end of period 1.69 1.81 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>
June 30, December 31,
1998 1997 1997
Allowance Allowance Allowance
as a % of as a % of as a % of
Loans Loans Loans
Outstanding in Outstanding in Outstanding in
Allowance Category Allowance Category Allowance Category
<S> <C> <C> <C> <C> <C> <C>
Commercial $ 1,256 1.67% $ 516 1.11% $ 821 1.28%
Real estate - mortgage 175 0.40 221 0.67 205 0.54
Real estate - land and
construction 614 1.51 268 1.53 379 1.48
Consumer 105 0.99 5 0.95 7 0.85
Unallocated 734 756 873
Total $ 2,884 1.69% $ 1,766 1.81% $ 2,285 1.77%
</TABLE>
The Bank maintains an allowance for possible loan losses to provide for
estimated 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.
Deposits
Deposits totaled $323,650,000 at June 30, 1998, an increase of 33%, 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 $122,461,000 at June 30, 1998, an increase of
25% as compared to $97,736,000 at December 31, 1997. Interest-bearing deposits
were $201,189,000 at June 30, 1998, an increase of 39% as compared to
$145,242,000 at December 31, 1997.
In addition to the internet credit card, the Company has introduced new time
deposits to be sold on the internet. For the six months and three months ended
June 30, 1998 the Company has collected $9,990,000 and $7,661,000 from the sale
of these deposits. 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.
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 June 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>
<CAPTION>
Within Due in Due After
Three Three to One to Due After Not Rate-
(Dollars in thousands) Months Twelve Months Five Years Five Years Sensitive Total
<S> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Federal funds sold $ 44,121 $ --- $ --- $ --- $ --- $ 44,121
Securities 4,311 10,363 51,659 37,705 --- 104,038
Total loans 129,662 16,780 16,565 7,056 209 170,272
Other assets --- 5,282 --- --- --- 5,282
Total interest earning assets 178,094 32,425 68,224 44,761 209 323,713
Cash and due from banks --- --- --- --- $ 21,285 21,285
Other assets --- --- --- --- 4,676 4,676
Total assets $ 178,094 $ 32,425 $ 68,224 $ 44,761 $ 26,170 $ 349,674
Interest bearing liabilities:
Demand, interest-bearing $ 7,557 $ --- $ --- $ --- --- $ 7,557
Savings and money market 117,706 --- --- --- --- 117,706
Time deposits 36,333 37,398 2,195 --- --- 75,926
Total interest bearing liabilities 161,596 37,398 2,195 --- --- 201,189
Non-interest demand deposits $122,461 $ 122,461
Other liabilities 2,576 2,576
Shareholders' equity 23,448 23,448
Total liabilities and shareholders'
equity $ 161,596 $ 37,398 $ 2,195 $ --- $148,485 $ 349,674
Interest rate sensitivity gap $ 16,498 $ (4,973) $ 66,029 $ 44,761 $(122,315) ---
Cumulative interest rate
sensitivity gap $ 16,498 $ 11,525 $ 77,554 $122,315 --- ---
Cumulative interest rate
sensitivity gap ratio 4.72% 3.30% 22.18% 34.99%
</TABLE>
The foregoing table demonstrates that the Company had a positive cumulative one
year gap of $11.5 million, or 3.30% of total assets, at June 30, 1998. In
theory, this would indicate that $11.5 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.
Capital Resources
The following table summarizes risk-based capital, risk-weighted assets, and
risk-based capital ratios of the Company:
<TABLE>
<CAPTION>
June 30, December 31, Minimum Regulatory
(Dollars in thousands) 1998 1997 1997 Requirements
<S> <C> <C> <C> <C>
Capital components:
Tier 1 Capital $ 22,817 $ 21,018 $ 21,899
Tier 2 Capital 2,884 1,428 1,885
Total risk-based capital $ 25,701 $ 22,446 $ 23,784
Risk-weighted assets 198,183 113,889 150,418
Average assets 315,095 197,930 251,767
Capital ratios:
Total risk-based capital 13.0% 19.7% 15.8% 8.0%
Tier 1 risk-based capital 11.5 18.5 14.6 4.0
Leverage ratio (1) 7.4 10.6 10.3 4.0
(1) Tier 1 capital divided by average assets (excluding goodwill).
</TABLE>
With the approval of the Securities and Exchange Commission, on June 17, 1998
the Company commenced an offering on Form S-1 of 387,097 shares of Common Stock
at a price of $15.50 per share. As of June 30, 1998 the Offering was still
open.
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.
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
The Company held its 1998 Annual Meeting of Shareholders on May 21, 1998 (the
"1998 Annual Meeting"). There were 3,295,898 issued and outstanding shares of
Company Common Stock on April 3, 1998, the Record Date for the 1998 Annual
Meeting.
At the 1998 Annual Meeting, the following actions were taken:
Election of Directors
At the 1998 Annual Meeting, fifteen directors of the Company were elected. The
following chart indicates the number of shares cast for each elected director:
<TABLE>
<CAPTION>
Director Votes For Votes Withheld
<S> <C> <C>
Frank G. Bisceglia 2,440,504 865
James R. Blair 2,440,504 865
Arthur C. Carmichael, Jr. 2,440,504 865
William Del Biaggio, Jr. 2,438,772 865
Anneke Dury 2,440,504 865
Tracey A. Enfantino 2,438,004 3,365
Glenn A. George 2,440,504 865
Robert P. Gionfriddo 2,438,391 2,978
P. Michael Hunt 2,433,357 8,012
Louis O. Normandin 2,438,929 2,440
Jack L. Peckham 2,440,504 865
Robert W. Peters 2,440,504 865
Humphrey P. Polanen 2,440,504 865
John E. Rossell III 2,440,504 865
Kirk Rossman 2,440,504 865
</TABLE>
Amendment of the Company's Stock Option Plan:
The following chart indicates the results of the vote on the approval of the
amendment to the Company's Restated 1994 Tandem Stock Option Plan. This
amendment is for an increase in the number of shares available for grants of
stock options to directors and key employees of the Company.
FOR 2,363,446
AGAINST 52,912
Ratification of Auditors
The following chart indicates the result of the vote on the ratification of the
Board of Directors' selection of Deloitte & Touche, LLP to serve as the
Company's independent auditors for the fiscal year ending December 31, 1998.
FOR 2,413,988
AGAINST 7,852
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 May 6, 1998, the Registrant filed Form 8-K with the SEC to report a $300,000
dividend payment by Heritage Bank of Commerce to its parent holding company,
Heritage Commerce Corp.
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)
August 15, 1998 /s/ John E. Rossell
Date John E. Rossell, III, President and CEO
August 15, 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 JUNE 30, 1998 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 21,284,257
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 44,121,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 74,906,330
<INVESTMENTS-CARRYING> 28,181,991
<INVESTMENTS-MARKET> 28,522,252
<LOANS> 170,272,222
<ALLOWANCE> 2,883,814
<TOTAL-ASSETS> 349,674,000
<DEPOSITS> 323,650,540
<SHORT-TERM> 0
<LIABILITIES-OTHER> 2,019,464
<LONG-TERM> 0
0
0
<COMMON> 23,446,581
<OTHER-SE> 1,000
<TOTAL-LIABILITIES-AND-EQUITY> 349,674,000
<INTEREST-LOAN> 7,756,000
<INTEREST-INVEST> 2,901,000
<INTEREST-OTHER> 621,000
<INTEREST-TOTAL> 11,278,000
<INTEREST-DEPOSIT> 0
<INTEREST-EXPENSE> 3,009,000
<INTEREST-INCOME-NET> 8,269,000
<LOAN-LOSSES> 510,000
<SECURITIES-GAINS> 117,000
<EXPENSE-OTHER> 6,430,000
<INCOME-PRETAX> 1,594,000
<INCOME-PRE-EXTRAORDINARY> 1,594,000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 983,000
<EPS-PRIMARY> 0.28
<EPS-DILUTED> 0.26
<YIELD-ACTUAL> 8.71
<LOANS-NON> 34,437
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,540,000
<CHARGE-OFFS> 6,000
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 2,884,000
<ALLOWANCE-DOMESTIC> 2,150,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 734,000
</TABLE>
