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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NO.
HERITAGE COMMERCE CORP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
CALIFORNIA 77-0469558
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER IDENTIFICATION NO.)
ORGANIZATION)
150 ALMADEN BOULEVARD
SAN JOSE, CALIFORNIA 95113
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 947-6900
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
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COMMON STOCK (NO PAR VALUE) NASDAQ
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
</TABLE>
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 last 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing price of its common stock on March 9,
2000 on the Nasdaq National Market was $87,933,525.
As of March 9, 2000, 7,034,682 shares of the registrant's common stock (no
par value) were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
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DOCUMENTS INCORPORATED PARTS OF FORM 10-K INTO WHICH INCORPORATED
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Definitive proxy statement for the Company's 2000 Part III
Annual Meeting of Shareholders to be filed within
120 days of the end of the fiscal year ended
December 31, 1999.
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HERITAGE COMMERCE CORP
INDEX TO
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 1999
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PAGE
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PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 16
Item 3. Legal Proceedings........................................... 17
Item 4. Submission of Matters to a Vote of Security Holders......... 17
PART II
Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters......................................... 17
Item 6. Selected Financial Data..................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results
of Operations............................................... 21
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 35
Item 8. Financial Statements and Supplementary Data................. 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 36
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 37
Item 11. Executive Compensation...................................... 37
Item 12. Security Ownership of Certain Beneficial Owners and
Management -- Beneficial Ownership of Common Stock.......... 37
Item 13. Certain Relationships and Related Transactions.............. 37
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 38
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PART I
ITEM 1. BUSINESS
GENERAL
Heritage Commerce Corp (the "Company") is registered with the Board of
Governors of the Federal Reserve System ("FRB") as a Bank Holding Company under
the Bank Holding Company Act ("BHCA"). The Company was organized in 1997 to be
the holding company for Heritage Bank of Commerce ("HBC"). In 1998 the Company
also became the holding company for Heritage Bank East Bay ("HBEB"), and in
January 2000 the Company became the holding company for Heritage Bank South
Valley ("HBSV"). HBC, HBEB, and HBSV are sometimes collectively referred to
herein as the "Banks".
On January 27, 1999, the Company's Board of Directors announced the
declaration of a 3-for-2 stock split effective for shareholders of record on
February 5, 1999, and paid on February 19, 1999. Accordingly, all historical
financial information has been restated as if the stock split had been in effect
for all periods presented.
On June 1, 1999, the Company commenced a public stock offering with the
intent of selling up to 700,000 new shares of the Company's common stock at a
price of $15.00 per share on a best effort basis. On August 16, 1999, the
Company completed the public stock offering, having sold 758,138 new shares
including a portion of the over allotment option at a price of $15.00 per share.
This resulted in an increase in the shareholders' equity of the Company in the
amount of $11,200,000, net of issuance costs.
On February 21, 2000, a 10 percent stock dividend was paid to shareholders
of record as of February 7, 2000. Historical share and per share information has
not been restated to reflect this stock dividend.
New Branches and Subsidiaries
The Company's primary strategy is to establish de novo banks, branches, or
representative offices in contiguous geographic areas. By virtue of each
subsidiary's local ownership, management, and decision making, the Company hopes
to benefit from the continuing trend in the banking industry towards merger and
consolidation. The Company's, as well as the Banks', business strategy and
promotional activities emphasize service and responsiveness to local needs.
On December 22, 1998, HBC received authorization from the California
Department of Financial Institutions to open a full service branch in the city
of Morgan Hill, California. HBC's Board of Directors saw this geographic
expansion as a continuation into HBC's primary market area, Santa Clara County,
since Morgan Hill has a high concentration of potential clients with banking
service requirements similar to those of HBC's current client mix. HBC opened
the branch on March 1, 1999.
On January 18, 2000, HBSV commenced business as a California
state-chartered commercial bank and a subsidiary of the Company in the premises
previously occupied by the Morgan Hill branch of HBC.
General Banking Services
The Company's customer base consists primarily of small to medium-sized
businesses and their owners, managers, and employees residing in Santa Clara,
Alameda, and Contra Costa counties. Businesses served include manufacturers,
distributors, contractors, professional corporations/partnerships, and service
businesses. The Company had approximately 4,900 deposit accounts at December 31,
1999.
The Company offers a range of loans, primarily commercial, including real
estate, construction, Small Business Administration (SBA), inventory and
accounts receivable, and equipment loans. The Company 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 Company issues VISA and MasterCard credit cards through the
Independent Bankers Association. The Company does not have a trust department.
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HBC's main and executive offices and the Company's offices are located at
150 Almaden Boulevard, San Jose, California 95113. In addition, HBEB is located
at 3077 Stevenson Blvd., Fremont, California 94538, and HBSV is located at 18625
Sutter Drive, Morgan Hill, California 95037. See Item 2 -- "PROPERTIES." The
Company's primary market area is Santa Clara, Alameda, and Contra Costa
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.
COMPETITION
The banking and financial services business in California generally, and in
the Company'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. The Company competes 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 Company. In order to compete with the other financial services providers,
the Company 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 Company is unable to accommodate a customer's needs,
the Company seeks to have those services provided in whole or in part by its
correspondent banks. See Item 1 -- "BUSINESS -- Supervision And Regulation."
SUPERVISION AND REGULATION
General
Bank holding companies and banks are extensively regulated under both
federal and state law. This regulation is intended primarily for the protection
of depositors and the deposit insurance fund and not for the benefit of
stockholders of the Company. Set forth below is a summary of certain laws which
relate to the regulation of the Company and Banks. The description does not
purport to be complete and is qualified in its entirety by reference to the
applicable laws and regulations.
As a registered bank holding company, the Company is subject to the
supervision of, and to regular inspection by, the FRB. Historically the
activities of bank holding companies such as the Company have been limited by
the BHCA to banking, managing or controlling banks, furnishing services to or
performing services for their subsidiaries, or any other activity which the FRB
deems to be so closely related to banking or managing or controlling banks as to
be a proper incident thereto. In making such determinations, the FRB is required
to consider whether the performance of such activities by a bank holding company
or its subsidiaries can reasonably be expected to produce benefits to the public
such as greater convenience, increased competition, or gains in efficiency that
outweigh the possible adverse effects, such as undue concentration of resources,
decreased or unfair competition, conflicts of interest, or unsound banking
practices. Generally, bank holding companies are required to give notice to or
obtain prior approval from FRB to engage in any new activity or to acquire more
than 5% of any class of voting stock of any bank. For discussion of recent
expansion of the powers of bank holding companies, see "Financial Services
Modernization Legislation" below. The Company is also a bank holding company
within the meaning of Section 3700 of the California Financial Code. As such,
the Company and its subsidiaries are subject to examination by, and may be
required to file reports with, the California Department of Financial
Institutions.
The Company's securities are registered with the Securities and Exchange
Commission under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). As such, the Company is subject to the information, proxy solicitation,
insider trading, and other requirements and restrictions of the Exchange Act.
Deposit accounts at the Banks are insured by the Federal Deposit Insurance
Corporation (FDIC), which currently insures deposits to a maximum of $100,000
per depositor. For this protection, the Banks pay a semi-
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annual assessment and are subject to the rules and regulations of the FDIC
pertaining to deposit insurance and other matters.
HBC is a California state-chartered bank that became a member of the
Federal Reserve System in January 2000. HBEB and HBSV are California
state-chartered banks, but are not members of the Federal Reserve System. State
banks chartered in California that are members of the Federal Reserve System are
subject to regulation, supervision and regular examination by the Department of
Financial Institutions (the "Department") and by the Federal Reserve Board.
State non-member banks chartered in California are subject to regulation,
supervision and regular examination by the Department and by the Federal Deposit
Insurance Corporation. The regulations of the Department, the FDIC and the FRB
govern most aspects of the Banks' business, including reporting requirements,
activities, investments, loans, borrowings, certain check-clearing activities,
branching, mergers and acquisitions, reserves against deposits, and other areas.
To a lesser extent, the Banks are also subject to certain regulations
promulgated by FRB.
Financial Services Modernization Legislation
On November 12, 1999, President Clinton signed into law the
Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization Act"). The
Financial Services Modernization Act repeals the two affiliation provisions of
the Glass-Steagall Act: Section 20, which restricted the affiliation of Federal
Reserve Member Banks with firms "engaged principally" in specified securities
activities; and Section 32, which restricts officer, director, or employee
interlocks between a member bank and any company or person "primarily engaged"
in specified securities activities. In addition, the Financial Services
Modernization Act also contains provisions that expressly preempt any state law
restricting the establishment of financial affiliations, primarily related to
insurance. The general effect of the law is to establish a comprehensive
framework to permit affiliations among commercial banks, insurance companies,
securities firms, and other financial service providers by revising and
expanding the BHCA framework to permit a holding company system to engage in a
full range of financial activities through a new entity known as a Financial
Holding Company. "Financial activities" is broadly defined to include not only
banking, insurance, and securities activities, but also merchant banking and
additional activities that the Federal Reserve, in consultation with the
Secretary of the Treasury, determines to be financial in nature, incidental to
such financial activities, or complementary activities that do not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally.
Generally, the Financial Services Modernization Act:
- Repeals historical restrictions on, and eliminates many federal and state
law barriers to, affiliations among banks, securities firms, insurance
companies, and other financial service providers;
- Provides a uniform framework for the functional regulation of the
activities of banks, savings institutions, and their holding companies;
- Broadens the activities that may be conducted by national banks, banking
subsidiaries of bank holding companies, and their financial subsidiaries;
- Provides an enhanced framework for protecting the privacy of consumer
information;
- Adopts a number of provisions related to capitalization, membership,
corporate governance, and other measures designed to modernize the
Federal Home Loan Bank system;
- Modifies the laws governing the implementation of the Community
Reinvestment Act ("CRA"); and
- Addresses a variety of other legal and regulatory issues affecting both
day-to-day operations and long-term activities of financial institutions.
In order for the Company to take advantage of the ability to affiliate with
other financial services providers, the Company must become a "Financial Holding
Company" as permitted under an amendment to BHCA. To become a Financial Holding
Company, the Company would file a declaration with the FRB, electing to engage
in activities permissible for Financial Holding Companies and certifying that it
is eligible to do so because all of its
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insured depository institution subsidiaries are well-capitalized and
well-managed. In addition, the FRB must also determine that each insured
depository institution subsidiary of the Company has at least a "Satisfactory"
CRA rating. The Company currently meets the requirements to make an election to
become a Financial Holding Company. The Company's management has not determined
at this time whether it will seek an election to become a Financial Holding
Company. The Company is examining its strategic business plan to determine
whether, based on market conditions, the relative financial conditions of the
Company and its subsidiaries, regulatory capital requirements, general economic
conditions, and other factors, the Company desires to utilize any of its
expanded powers provided in the Financial Services Modernization Act.
The Financial Services Modernization Act also permits national banks to
engage in expanded activities through the formation of financial subsidiaries. A
national bank may have a subsidiary engaged in any activity authorized for
national banks directly or any financial development, or merchant banking, which
may only be conducted through a subsidiary of a Financial Holding Company.
Financial activities include all activities permitted under new sections of the
BHCA or permitted by regulation.
A national bank seeking to have a financial subsidiary, and each of its
depository institution affiliates, must be "well-capitalized" and
"well-managed." The total assets of all financial subsidiaries may not exceed
the lesser of 45% of a bank's total assets, or $50 billion. A national bank must
exclude from its assets and equity all equity investments, including retained
earnings, in a financial subsidiary. The assets of the subsidiary may not be
consolidated with the bank's assets. The bank must also have policies and
procedures to assess financial subsidiary risk and protect the bank from such
risks and potential liabilities.
The Financial Services Modernization Act provides that designated federal
regulatory agencies, including the FDIC, the FRB, the OCC and the Securities and
Exchange Commission, are to publish regulations to implement certain provisions
of the Act. In February 2000 these agencies cooperated in the release of
proposed rules that would establish minimum requirements to be followed by
financial institutions for protecting the privacy of financial information
provided by consumers. The FDIC's proposed rule, which would establish privacy
standards to be followed by state nonmember banks such as the Banks, would
require a financial institution to (i) provide notice to customers about its
privacy policies and practices, (ii) describe the conditions under which the
institution may disclose nonpublic personal information about consumers to
nonaffiliated third parties, and (iii) provide a method for consumers to prevent
the financial institution from disclosing information to nonaffiliated third
parties by "opting out" of that disclosure.
The Financial Services Modernization Act also includes a new section of the
Federal Deposit Insurance Act governing subsidiaries of state banks that engage
in "activities as principal that would only be permissible" for a national bank
to conduct in a financial subsidiary. It expressly preserves the ability of a
state bank to retain all existing subsidiaries. Because California permits
commercial banks chartered by the state to engage in any activity permissible
for national banks, HBC, HBEB and HBSV will be permitted to form subsidiaries to
engage in the activities authorized by the Financial Services Modernization Act,
to the same extent as a national bank. In order to form a financial subsidiary,
the bank must be well-capitalized, and the bank would be subject to the same
capital deduction, risk management and affiliate transaction rules as applicable
to national banks.
The Company and the Banks do not believe that the Financial Services
Modernization Act will have a material adverse effect on our operations in the
near-term. However, to the extent that it permits banks, securities firms, and
insurance companies to affiliate, the financial services industry may experience
further consolidation. The Financial Services Modernization Act is intended to
grant to community banks certain powers as a matter of right that larger
institutions have accumulated on an ad hoc basis. Nevertheless, this act may
have the result of increasing the amount of competition that the Company and the
Banks face from larger institutions and other types of companies offering
financial products, many of which may have substantially more financial
resources than the Company and the Banks.
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Limitations on Dividends
The Company's ability to pay cash dividends is dependent on dividends paid
to it by the Banks. Under California law the holders of common stock of the
Company are entitled to receive dividends when and as declared by the Board of
Directors, out of funds legally available therefor, subject to certain
restrictions. A California corporation such as the Company may make a
distribution to its shareholders if its retained earnings will equal at least
the amount of the proposed distribution. California law further provides that 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, it meets two
conditions, which generally stated are as follows: (i) the corporation's assets
must equal at least 125% of its liabilities; and (ii) the corporation's current
assets must equal at least its current liabilities or, if the average of the
corporation's earnings before taxes on income and before interest expense for
the two preceding fiscal years was less than the average of the corporation's
interest expense for such fiscal years, then the corporation's current assets
must equal at least 125% of its current liabilities. Most bank holding companies
are unable to meet this test.
The payment of cash dividends by the Company depends on various factors,
including the earnings and capital requirements of itself and its subsidiaries,
and other financial conditions. The primary source of funds for payment of
dividends by the Company to its shareholders will be the receipt of dividends
and management fees from the Banks. The Company has no present intention of
paying cash dividends in the foreseeable future. The legal ability of the Banks
to pay dividends is subject to restrictions set forth in the California banking
law and regulations of the FDIC. No assurance can be given that the Banks will
pay dividends at any time. For restrictions applicable to the Banks, see Item
5 -- "MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS -- Dividends."
Safety and Soundness Standards
The federal banking agencies have adopted guidelines establishing standards
for safety and soundness. The guidelines are designed to assist the federal
banking agencies in identifying and addressing potential safety and soundness
concerns before capital becomes impaired. The guidelines set forth operational
and managerial standards relating to internal controls, information systems and
internal audit systems, loan documentation, credit underwriting, interest rate
exposure, earnings, asset quality, asset growth, and compensation, fees and
benefits. The guidelines establish the safety and soundness standards that the
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If an institution fails to comply with a safety
and soundness standard, the appropriate federal banking agency may require the
institution to submit a compliance plan. Failure to submit a compliance plan or
to implement an accepted plan may result in enforcement action.
"Source Of Strength" Policy
According to FRB policy, bank holding companies are expected to act as a
source of financial strength to each subsidiary bank and to commit resources to
support each such subsidiary.
Capital Adequacy Guidelines
Federal banking agencies have adopted risk-based capital guidelines for
insured banks and bank holding companies. These guidelines require a minimum
risk-based capital ratio of 8%, with at least 4% in the form of "Tier 1"
capital. Tier 1 capital consists of common equity, non-cumulative perpetual
preferred stock and minority interests in the equity accounts of consolidated
subsidiaries and excludes goodwill. "Tier 2" capital consists of cumulative
perpetual preferred stock, limited-life preferred stock, mandatory convertible
securities, subordinated debt and (subject to a limit of 1.25% of risk-weighted
assets) general loan loss reserves.
The guidelines make regulatory capital requirements more sensitive to the
differences in risk profiles among banking institutions, take off-balance sheet
items into account when assessing capital adequacy and minimize disincentives to
holding liquid low-risk assets. In addition, the regulations may require some
banking institutions to increase the level of their common shareholders' equity.
Banking regulators have also instituted
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minimum leverage ratio guidelines for financial institutions. The leverage ratio
guidelines require maintenance of a minimum ratio of 3% Tier 1 capital to total
assets for the most highly rated bank holding company organizations.
Institutions that are less highly rated, anticipating significant growth, or
subject to other significant risks will be required to maintain capital levels
ranging from 1% to 2% above the 3% minimum.
The following table presents the capital ratios of the Company 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, 1999:
<TABLE>
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DECEMBER 31, 1999
--------------------------------------------
FOR CAPITAL ADEQUACY
ACTUAL PURPOSES
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AMOUNT RATIO AMOUNT RATIO
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<S> <C> <C> <C> <C>
Total risk-based capital/risk-weighted
assets...................................... $49,176,000 13.2% $29,706,000 greater than
or equal to $8.0%
Tier 1 capital/risk-weighted assets........... $44,530,000 12.0% $14,853,000 greater than
or equal to $4.0%
Tier 1 capital/average assets................. $44,530,000 9.4% $19,012,000 greater than
or equal to $4.0%
</TABLE>
Federal banking agencies, including the FRB and the FDIC, have adopted
regulations implementing a system of prompt corrective action pursuant to the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). The
regulations establish five capital categories based on the capital measures
indicated below:
<TABLE>
<CAPTION>
TOTAL RISK-BASED TIER 1 RISK-BASED TIER 1
CAPITAL CATEGORY CAPITAL RATIO CAPITAL RATIO LEVERAGE RATIO
---------------- ---------------- ----------------- --------------
<S> <C> <C> <C>
Well capitalized........................... 10.0% 6.0% 5.0%
Adequately capitalized..................... 8.0% 4.0% 4.0%
Undercapitalized........................... <8.0% <4.0% <4.0%
Significantly undercapitalized............. <6.0% <3.0% <3.0%
Critically undercapitalized (1)............ N/A N/A N/A
</TABLE>
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(1) Tangible equity to total assets less than 2.0%
The regulations establish procedures for classification of financial
institutions within the capital categories, filing and reviewing capital
restoration plans required under the regulations and procedures for issuance of
directives by the appropriate regulatory agency, among other matters. See Item
1 -- "BUSINESS -- Supervision and Regulation -- Prompt Corrective Action."
The appropriate federal banking agency, after notice and an opportunity for
a hearing, is authorized to treat a well capitalized, adequately capitalized or
undercapitalized insured depository institution as if it had a lower
capital-based classification if it is in an unsafe or unsound condition or
engaging in an unsafe or unsound practice. Thus, an adequately capitalized
institution can be subject to the restrictions on undercapitalized institutions
(provided that a capital restoration plan cannot be required of the institution)
described below and an undercapitalized institution can be subject to the
restrictions applicable to significantly undercapitalized institutions described
below. See Item 1 -- "BUSINESS -- Supervision And Regulation -- Prompt
Corrective Action."
An insured depository institution cannot make a capital distribution (as
broadly defined to include, among other items, dividends, redemptions and other
repurchases of stock), or pay management fees to any person who controls the
institution, if thereafter it would be undercapitalized. The appropriate federal
banking agency, however, may (after consultation with the FDIC) permit an
insured depository institution to repurchase, redeem, retire or otherwise
acquire its shares if such action (i) is taken in connection with the issuance
of additional shares or obligations in at least an equivalent amount and (ii)
will reduce the institution's financial obligations or otherwise improve its
financial condition. An undercapitalized institution is also generally
prohibited from increasing its average total assets. An undercapitalized
institution is also generally prohibited from making any acquisitions,
establishing any branches or engaging in any new line of business except in
accordance with an accepted capital restoration plan or with the approval of the
FDIC. In
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addition, the appropriate federal banking agency is given authority with respect
to any undercapitalized depository institution to take any of the actions it is
required to or may take with respect to a significantly undercapitalized
institution as described below if it determines "that those actions are
necessary to carry out the purpose" of FDICIA.
The federal banking agencies have adopted a joint agency policy statement
to provide guidance on managing interest rate risk. The statement indicated that
the adequacy and effectiveness of a bank's interest rate risk management process
and the level of its interest rate exposures are critical factors in the
agencies' evaluation of the bank's capital adequacy. If a bank has material
weaknesses in its risk management process or high levels of exposure relative to
its capital, the agencies will direct it to take corrective action. Such
directives may include recommendations or directions to raise additional
capital, strengthen management expertise, improve management information and
measurement systems, reduce level of exposure or some combination of these
actions.
The federal banking agencies have issued an interagency policy statement
that, among other things, establishes certain benchmark ratios of loan loss
reserves to certain classified assets. The benchmark set forth by such policy
statement is the sum of (i) 100% of assets classified loss; (ii) 50% of assets
classified doubtful; (iii) 15% of assets classified substandard; and (iv)
estimated credit losses on other assets over the upcoming 12 months. This amount
is neither a "floor" nor a "safe harbor" level for an institution's allowance
for loan losses.
Insurance Premiums and Assessments
Pursuant to FDICIA, the FDIC has developed a risk-based assessment system,
under which the assessment rate for an insured depository institution will vary
according to the level of risk incurred on its activities. An institution's risk
category is based upon whether the institution is well capitalized, adequately
capitalized or less than adequately capitalized. Each insured depository
institution is also to be assigned to one of the following "supervisory
subgroups": group A, B or C. Group A institutions are financially sound
institutions with few minor weaknesses; Group B institutions are institutions
that demonstrate weaknesses which, if not corrected, could result in significant
deterioration; and Group C institutions are institutions for which there is a
substantial probability that the FDIC will suffer a loss in connection with the
institution unless effective action is taken to correct the areas of weakness.
The FDIC assigns each Bank Insurance Fund (BIF) member institution an
annual FDIC assessment rate, summarized below (assessment figures are expressed
in terms of cents per $100 in deposits):
<TABLE>
<CAPTION>
CAPITAL CATEGORY GROUP A GROUP B GROUP C
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<S> <C> <C> <C>
Well capitalized............................ 0(1) 3 17
Adequately capitalized...................... 3 10 24
Undercapitalized............................ 10 24 27
</TABLE>
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(1) Subject to a statutory minimum assessment of $2,000 per year (which also
applies to all other assessment risk classifications).
At December 31, 1999, HBC's and HBEB's assessment rate was equivalent to a
well capitalized, group A institution. HBSV did not commence operations until
January 18, 2000.
Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the
"Paperwork Reduction Act"), at January 1, 1997, the Banks began paying, in
addition to their normal deposit insurance premium as a member of the BIF, an
amount equal to approximately 1.3 basis points per $100 of insured deposits
toward the retirement of the Financing Corporation bonds ("FICO Bonds") issued
in the 1980s to assist in the recovery of the savings and loan industry. Members
of the Savings Association Insurance Fund ("SAIF"), by contrast, pay, in
addition to their normal deposit insurance premium, approximately 6.4 basis
points. Under the Paperwork Reduction Act, the FDIC is not permitted to
establish SAIF assessment rates that are lower than comparable BIF assessment
rates. Effective January 1, 2000, the rate paid to retire the FICO Bonds was
equal for members of the BIF and the SAIF and will result in an increase in the
amounts paid by the Banks towards
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the retirement of the FICO Bonds. The Paperwork Reduction Act also provided for
the merging of the BIF and the SAIF by January 1, 1999 provided there were no
financial institutions still chartered as savings associations at that time.
However, as of January 1, 1999, there were still financial institutions
chartered as savings associations.
In February 2000 the FDIC announced that it was refining the system by
which it assesses the risks that are presented to the deposit insurance fund by
certain financial institutions. The refinements are intended to identify
institutions with a typically high-risk profiles from among those institutions
in the best-rated premium category, and to determine whether there are
unresolved supervisory concerns regarding the risk-management practices of those
institutions. The FDIC is concerned about institutions that exhibit
characteristics such as rapid asset growth (especially when concentrated in
potentially risky, high-yielding lending areas), significant concentrations in
high-risk assets, and recent changes in business mix. The FDIC has noted that
although such institutions may be well-capitalized and exhibit good earnings
when the economy is strong, they often experience deteriorating financial
conditions when economic conditions are less favorable. As a result,
institutions whose practices are determined to exhibit risky traits under the
refined risk assessment system will be assessed higher insurance premiums. The
impact of these new rules on the Banks cannot be predicted.
Prompt Corrective Action
The FDIC has authority: (1) to request that an institution's regulatory
agency take enforcement action against it based upon an examination by the FDIC
or the agency, (2) if no action is taken within 60 days and the FDIC determines
that the institution is in an unsafe or unsound condition or that failure to
take the action will result in continuance of unsafe or unsound practices, to
order the action against the institution, and (3) to exercise this enforcement
authority under "exigent circumstances" merely upon notification to the
institution's appropriate regulatory agency. This authority gives the FDIC the
same enforcement powers with respect to any institution and its subsidiaries and
affiliates as such institution's appropriate regulatory agency has with respect
to those entities.
An undercapitalized institution is required to submit an acceptable capital
restoration plan to its appropriate federal banking agency. The plan must
specify (i) the steps the institution will take to become adequately
capitalized, (ii) the capital levels to be attained each year, (iii) how the
institution will comply with any regulatory sanctions then in effect against the
institution, and (iv) the types and levels of activities in which the
institution will engage. The banking agency may not accept a capital restoration
plan unless the agency determines, among other things, that the plan "is based
on realistic assumptions, and is likely to succeed in restoring the
institution's capital" and "would not appreciably increase the risk . . . to
which the institution is exposed". A requisite element of an acceptable capital
restoration plan for an undercapitalized institution is a guaranty by its parent
holding company that the institution will comply with such capital restoration
plan. Liability with respect to this guaranty is limited to the lesser of (i)
five percent of the institution's assets at the time when it became
undercapitalized and (ii) the amount necessary to bring the institution into
capital compliance with "all capital standards applicable to [it]" as of the
time when the institution fails to comply with the plan. The guaranty liability
is limited to companies controlling the undercapitalized institution and does
not affect other affiliates. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of a subsidiary bank will be assumed
by the bankruptcy trustee and entitled to priority of payment over the claims of
other creditors, including the holders of the company's long-term debt.
FDICIA provides that the appropriate federal regulatory agency must require
an insured depository institution that (i) is significantly undercapitalized or
(ii) is undercapitalized and either fails to submit an acceptable capital
restoration plan within the time period allowed by regulation or fails in any
material respect to implement a capital restoration plan accepted by the
appropriate federal banking agency to take one or more of the following actions:
(i) sell enough shares, including voting shares, to become adequately
capitalized; (ii) merge with (or be sold to) another institution (or holding
company), but only if grounds exist for appointing a conservator or receiver;
(iii) restrict certain transactions with banking affiliates as if the "sister
bank" exception to the requirements of Section 23A of the Federal Reserve Act
did not exist; (iv) otherwise restrict transactions with bank or non-bank
affiliates; (v) restrict interest rates that the institution pays on
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<PAGE> 11
deposits to "prevailing rates" in the institution's "region"; (vi) restrict
asset growth or reduce total assets; (vii) alter, reduce or terminate
activities; (viii) hold a new election of directors; (ix) dismiss any director
or senior executive officer who held office for more than 180 days immediately
before the institution became undercapitalized, provided that in requiring
dismissal of a director or senior executive officer, the agency must comply with
certain procedural requirements, including the opportunity for an appeal in
which the director or officer will have the burden of proving his or her value
to the institution; (x) employ "qualified" senior executive officers; (xi) cease
accepting deposits from correspondent depository institutions; (xii) divest
certain non-depository affiliates which pose a danger to the institution; (xiii)
be divested by a parent holding company; and (xiv) take any other action which
the agency determines would better carry out the purposes of the prompt
corrective action provisions.
In addition to the foregoing sanctions, without the prior approval of the
appropriate federal banking agency, a significantly undercapitalized institution
may not pay any bonus to any senior executive officer or increase the rate of
compensation for such an officer without regulatory approval. Furthermore, in
the case of an undercapitalized institution that has failed to submit or
implement an acceptable capital restoration plan, the appropriate federal
banking agency cannot approve any such bonus.
Not later than 90 days after an institution becomes critically
undercapitalized, the appropriate federal banking agency for the institution
must appoint a receiver or a conservator, unless the agency, with the
concurrence of the FDIC, determines that the purposes of the prompt corrective
action provisions would be better served by another course of action. Any
alternative determination must be documented by the agency and reassessed on a
periodic basis. Notwithstanding the foregoing, a receiver must be appointed
after 270 days unless the FDIC determines that the institution has a positive
net worth, is in compliance with a capital plan, is profitable or has a
sustainable upward trend in earnings and is reducing its ratio of non-performing
loans to total loans and the head of the appropriate federal banking agency and
the chairperson of the FDIC certify that the institution is viable and not
expected to fail.
The FDIC is required, by regulation or order, to restrict the activities of
such critically undercapitalized institutions. The restrictions must include
prohibitions on the institution's doing any of the following without prior FDIC
approval: entering into any material transactions not in the usual course of
business; extending credit for any highly leveraged transaction; engaging in any
"covered transaction" (as defined in Section 23A of the Federal Reserve Act)
with an affiliate; paying "excessive compensation or bonuses"; and paying
interest on "new or renewed liabilities" that would increase the institution's
average cost of funds to a level significantly exceeding prevailing rates in the
market.
Brokered Deposits
A bank cannot accept brokered deposits (defined to include payment of an
interest rate more than 75 basis points above prevailing rates) unless (i) it is
well capitalized or (ii) it is adequately capitalized and receives a waiver from
the FDIC. A bank that cannot receive brokered deposits also cannot offer "pass-
through" insurance on certain employee benefit accounts unless certain specified
procedures are followed. In addition, a bank that is "adequately capitalized"
may not pay an interest rate on any deposits in excess of 75 basis points over
certain prevailing market rates. There are no such restrictions on a bank that
is "well capitalized."
Federal Reserve Borrowings
The FRB may not make advances to an undercapitalized institution for more
than 60 days in any 120-day period without a viability certification by a
federal banking agency or by the Chairman of the FRB after an examination by the
FRB. If an institution is deemed critically undercapitalized, an extension of
FRB credit cannot continue for more than five days without demand for payment
unless the FRB is willing to accept responsibility for any resulting loss to the
FDIC. As a practical matter, this provision is likely to mean that FRB credit
will not be extended beyond the limitations in this provision.
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<PAGE> 12
Potential Enforcement Actions; Supervisory Agreements
Banks and their institution-affiliated parties may be subject to potential
enforcement actions by the FRB, the FDIC or the Office of the Comptroller of the
Currency (OCC) for unsafe or unsound practices in conducting their businesses,
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
Interstate Banking and Branching. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (Riegle-Neal Act) authorizes 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 became permitted
after June 1, 1997, unless a state adopted legislation before June 1,
1997 to "opt out" of interstate merger authority, provided any
limitations do not discriminate against out-of-state banks. Only Texas
opted out.
- Interstate acquisitions of branches are 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.
- Interstate de novo branching is permitted to a bank only if a state has
adopted 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 can 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. Banks are not 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. The Riegle-Neal Amendments Act of 1997 amended
federal law to provide that branches of state banks that operate in other states
will be governed in most cases by the laws of the home state, rather than the
laws of the host state. Exceptions are that a host state may apply its own laws
of community reinvestment, consumer protection, fair lending and interstate
branching. Host states cannot supplement or restrict powers granted by a bank's
home state. The amendment will assure state-chartered banks with interstate
branches uniform treatment in most areas of their operation.
Community Reinvestment Act. Community Reinvestment Act (CRA) evaluations
are required for each state in which an interstate bank has a branch. Interstate
banks are prohibited from using out-of-state branches "primarily for the purpose
of deposit production." Federal banking agencies have adopted regulations to
ensure that interstate branches are being operated with a view to the needs of
the host communities.
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Foreign Banks. Foreign banks are able to branch to the same extent as U.S.
domestic banks. Interstate branches acquired by foreign banks are subject to the
CRA to the extent the acquired branch was subject to the CRA before the
acquisition.
California Law. California has enacted state legislation in accordance with
authority under the Riegle-Neal Act. This 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. The 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.
Tie-in Arrangements and Transactions with Affiliated Persons
A bank is prohibited from certain tie-in arrangements in connection with
any extension of credit, sale or lease of property or furnishing of services.
For example, with certain exceptions, a bank may not condition an extension of
credit on a promise by its customer to obtain other services provided by it, its
holding company or other subsidiaries (if any), or on a promise by its customer
not to obtain other services from a competitor.
Directors, officers and principal shareholders of the Company, and the
companies with which they are associated, may conduct banking transactions with
the Company in the ordinary course of business. Any loans and commitments to
loans included in such transactions must be made in accordance with applicable
law, 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 on terms not involving more than the normal
risk of collectability or presenting other unfavorable features.
Community Reinvestment Act
Pursuant to the Community Reinvestment Act of 1977, the federal regulatory
agencies that oversee the banking industry are required to use their authority
to encourage financial institutions to help meet the credit needs of the local
communities in which such institutions are chartered, consistent with safe and
sound banking practices. When conducting an examination of a financial
institution such as the Bank, the agencies assess the institution's record of
meeting the credit needs of its entire community, including low- and
moderate-income neighborhoods. This record is taken into account in an agency's
evaluation of an application for creation or relocation of domestic branches or
for merger with another institution. Failure to address the credit needs of a
bank's community may also result in the imposition of certain other regulatory
sanctions, including a requirement that corrective action be taken.
The federal banking agencies determine a bank's CRA rating by evaluating
its performance on lending, service, and investment tests, with the lending test
as the most important. The tests are to be applied in an "assessment context"
that is developed by the agency for a particular institution. The assessment
context takes into account demographic data about the community, the community's
characteristics and needs, the institution's capacities and constraints, the
institution's product offerings and business strategy, the institution's prior
performance, and data on similarly situated lenders. Since the assessment
context is developed by the regulatory agencies, a particular bank will not know
until it is examined whether its CRA programs and efforts have been sufficient.
Larger institutions are required to compile and report certain data on
their lending activities in order to measure performance. Some of this data is
also required under other laws, such as the Equal Credit Opportunity Act. Small
institutions (those institutions with less than $250 million in assets) are now
being examined on a "streamlined assessment method." The streamlined method
focuses on the institution's loan to deposit ratio, degree of local lending,
record of lending to borrowers and neighborhoods of differing income levels, and
record of responding to complaints. Large and small institutions have the option
of being evaluated for CRA purposes in relation to their own pre-approved
strategic plan. Such a strategic plan must be
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<PAGE> 14
submitted to the institution's regulator three months before its effective date
and be published for public comment.
Environmental Regulation
Federal, state, and local regulations regarding the discharge of materials
into the environment may have an impact on the Company. Under federal law,
liability for environmental damage and the cost of cleanup may be imposed on any
person or entity who is an owner or operator of contaminated property. State law
provisions impose substantially similar requirements. Both federal and state
laws provide generally that a lender who is not actively involved in
contaminating a property will not be liable to clean up the property, even if
the lender has a security interest in the property or becomes an owner of the
property through foreclosure, provided certain conditions are observed.
The Economic Growth Act includes protection for lenders from liability
under the Comprehensive Environmental Response, Compensation, and Liability Act
of 1980. The Economic Growth Act specifies the actions a lender may take with
respect to lending and foreclosure activities without incurring environmental
cleanup liability or responsibility. Typical contractual provisions regarding
environmental issues in the loan documentation and due diligence inspections
will not lead to lender liability for cleanup, and a lender may foreclose on
contaminated property, so long as it merely maintains the property and moves to
divest it at the earliest possible time.
Under California law, a lender generally will not be liable to the State
for the cost associated with cleaning up contaminated property unless the lender
realized some benefit from the property, failed to divest the property promptly,
caused or contributed to the release of the hazardous materials, or made the
loan primarily for purposes of investing in the property.
The extent of the protection provided by both the federal and state lender
protection statutes depend on their interpretation by administrative agencies
and courts. The Company cannot predict whether it will be adequately protected
for the types of loans made by it. In addition, the Company is still subject to
the risks that a borrower's financial position will be impaired by liability
under the environmental laws and that property securing a loan made by the
Company may be environmentally impaired and not provide adequate security for
the Company. The Company attempts to protect its position against environmental
risks by performing prudent due diligence. Environmental questionnaires and
information on the use of toxic substances are requested as part of its
underwriting procedures. The Company lends based on its evaluation of the
collateral, net worth of the borrower, and the borrower's capacity for
unforeseen business interruptions or risks.
Limitation on Activities
FDICIA prohibits state chartered-banks and their subsidiaries from
engaging, as principal, in activities not permissible by national banks and
their subsidiaries, unless the bank's primary federal regulator determines the
activity poses no significant risk to the BIF and the state bank is and
continues to be adequately capitalized. Similarly, state bank subsidiaries may
not engage, as principal, in activities impermissible by subsidiaries of
national banks. This prohibition extends to acquiring or retaining any
investment, including those that would otherwise be permissible under California
law.
The State Bank Parity Act, eliminates certain disparities between
California state chartered banks and federally chartered national banks by
authorizing the Commissioner to address such disparities through a streamlined
rulemaking process. The Commissioner has taken action pursuant to the Parity Act
to authorize, among other matters, previously impermissible share repurchases by
state banks, subject to the prior approval of the Commissioner.
In November 1996, the OCC issued final regulations permitting national
banks to engage in a wider range of activities through subsidiaries. "Eligible
institutions" (those national banks that are well-capitalized, have a high
overall rating and a satisfactory CRA rating, and are not subject to an
enforcement order) may engage in activities related to banking through operating
subsidiaries after going through a new expedited application process. In
addition, the new regulations include a provision whereby a national bank may
apply to the OCC to
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<PAGE> 15
engage in an activity through a subsidiary in which the bank itself may not
engage. In determining whether to permit the subsidiary to engage in the
activity, the OCC will evaluate why the bank itself is not permitted to engage
in the activity and whether a Congressional purpose will be frustrated if the
OCC permits the subsidiary to engage in the activity. The State Bank Parity Act
may permit state-licensed banks to engage in similar new activities, subject to
the discretion of the Commissioner.
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.
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 the Company 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 Company cannot be accurately
predicted.
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.
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<PAGE> 16
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.
EMPLOYEES
At December 31, 1999, the Company employed 139 persons, primarily on a
full-time basis. The Company's employees are not represented by any union or
collective bargaining agreement and the Company believes its employee relations
are satisfactory.
ITEM 2. PROPERTIES
The Company's main office is located at 150 Almaden Boulevard, San Jose,
California. 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
13,500 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, California. This space also serves as the main office of HBC.
The lease arrangement for the primary operating area is a "partial gross lease"
for fifteen years commencing June 8, 1996 and expiring February 28, 2010. The
monthly rent under the lease for the first five-year term is $21,465. During the
second five-year term the monthly rent increases to $25,515 and will increase to
95 percent of fair rental value starting from year eleven until the term
expires. Provisions of the lease include the right to early termination after
120 months.
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. The monthly rent for this additional space is $2,259.
In August 1997, the Company leased an area on the second floor of the
Company's main office containing approximately 2,175 square feet of space. The
monthly rent is $4,024 until May 31, 2001, when the monthly rent will increase
to $4,785 for the following five-year period. The rent for the period from May
31, 2006 until the end of the lease will be 95 percent of fair rental value at
that time. The lease for this additional space is coterminous with the original
lease.
The Company has also leased space at 100 Park Center Plaza, Suite 300 and
430, San Jose, consisting of approximately 5,623 and 3,277 square feet of space.
The lease for Suite 300 commenced on June 1, 1998 and will terminate on May 31,
2003. The rent starts at $11,527 in the first year and ends at $12,651 in the
last year of the lease. The lease for Suite 430 commenced on April 21, 1997 and
will terminate on April 30, 2000. The rent for the entire term of the lease is
$5,243 per month.
In February 1998, the Company leased space for HBEB's primary office 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. The rent for the first
twelve-month period is $13,180 per month, and the rent increases annually
thereafter by 4%. In addition to the space in Fremont, the Company has leased
space at 12657 Alcosta Boulevard, San Ramon, California, for HBEB for use as a
branch office. The monthly rent for this lease is $3,231 and it expires on
August 31, 2001.
In March of 1999, the Company entered into an agreement to sub-lease an
additional 4,672 square feet of office space at 100 Park Center Plaza, Suite 365
in San Jose. The commencement date of the sub-lease was May 1, 1999 with monthly
rent payments set at $8,643 with no scheduled increases. The term of the
sub-lease is 10 months, expiring on February 28, 2000.
Also in March of 1999, the Company entered into an agreement to lease 7,260
square feet of office space for Heritage Bank South Valley's primary office in a
one-story building consisting of 26,353 square feet, located at 18625 Sutter
Boulevard in Morgan Hill, California. The commencement date of the lease was
November 1, 1999 with monthly rent payments beginning at $11,447, subject to
adjustments every 36 months thereafter based on the percentage increase in the
Consumer Price Index as defined in the lease agreement. The term of the lease is
15 years, expiring on October 31, 2014.
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In September of 1999, the Company entered into an agreement to sub-lease
approximately 2,700 square feet of office space in a one-story multi-tenant
building located at 310 Hartz Avenue in Danville, California in order to
relocate Heritage Bank East Bay's San Ramon office. The commencement date of the
sub-lease was September 15, 1999, with monthly rent payments beginning at
$7,025, subject to annual increases of 4%. The term of the sub-lease is
approximately 7 1/2 years, expiring on December 31, 2007.
Refer to Note 9 of the Company's Consolidated Financial Statements,
beginning on page F-1 of this Report on Form 10-K, for additional information on
rent expense.
ITEM 3. LEGAL PROCEEDINGS
To the best of the Company's knowledge, there are no pending or threatened
legal proceedings to which the Company is a party, which may have a materially
adverse effect on the Company's financial condition, results of operations, or
cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the Nasdaq National Market under
the symbol "HTBK." Everen Securities, Hoefer & Arnett, Incorporated, Sutro &
Co., Incorporated and Van Kasper & Company have acted as market makers for the
Common Stock. These market makers have committed to make a market for the
Company's Common Stock, although they may discontinue making a market at any
time. No assurance can be given that an active trading market will be sustained
for the Common Stock at any time in the future.
The information in the following table for 1999 and the third and fourth
quarters in 1998 indicates the high and low closing prices for the Common Stock,
based upon information provided by the Nasdaq National Market. The information
for quarters prior to the third quarter of 1998 is based upon information
provided by the market makers. These quotations reflect inter-dealer prices,
without retail mark-up, markdown, or commission, do not reflect actual
transactions, and do not include nominal amounts traded directly by shareholders
or through other dealers who are not market makers.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1999
Fourth Quarter............................................. $15.46 $12.61
Third Quarter.............................................. 14.77 12.05
Second Quarter............................................. 18.86 8.75
First Quarter.............................................. 20.68 12.12
1998
Fourth Quarter............................................. $13.34 $10.30
Third Quarter.............................................. 12.73 8.79
Second Quarter............................................. 10.30 8.79
First Quarter.............................................. 10.30 9.09
</TABLE>
Listed amounts are adjusted to reflect (i) a 3-for-2 stock split paid on
February 19, 1999 to shareholders of record as of February 5, 1999, and (ii) a
10 percent stock dividend which was paid on February 21, 2000 to shareholders of
record as of February 7, 2000.
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Effective February 17, 1998, and following the formation of the Company as
the bank holding company for HBC, HBC's stock was exchanged on a share for share
basis with the stock of the Company. As of February 15, 2000, there were
approximately 1,200 holders of shares of the Company's common stock.
DIVIDENDS
Under California law, the holders of common stock of a bank 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 of the Department of
Financial Institutions ("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. 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.
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. The FRB has
similar authority with respect to a bank holding company.
For regulatory restrictions on payment of dividends by the Company, see
Item 1 -- "BUSINESS -- Regulation and Supervision -- Limitations on Dividends."
In 1998, HBC paid a cash dividend to the Company. To date, the Company has
not paid cash dividends. It is the current policy of the Company to retain
earnings to increase its capital to support growth. Payment of cash dividends in
the future will depend upon the Company's earnings and financial condition and
other factors deemed relevant by management. Accordingly, it is likely that no
cash dividends from the Company will be declared in the foreseeable future.
In January 1999, the Company's Board of Directors declared a 3 for 2 stock
split payable to shareholders of record as of February 5, 1999. The Company
accounted for the transaction by restating all share information to reflect the
effect of the split. The payable date of the split was February 19, 1999.
In January 2000, the Company's Board of Directors declared a 10% stock
dividend payable to shareholders of record as of February 7, 2000. The payable
date of the dividend was February 21, 2000. The Company accounted for the
transaction in the first quarter of 2000 by decreasing retained earnings and
increasing the common stock by an amount equal to the fair value of the
additional shares issued which was $8,149,000 based on a marked value of $12.75
per share as of February 21, 2000.
18
<PAGE> 19
ITEM 6. SELECTED FINANCIAL DATA
The following table presents a summary of selected financial information
that should be read in conjunction with the Company's consolidated financial
statements and notes thereto included under Item 8 -- "FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA." Financial information for 1998 represents the consolidated
financial operation and condition of Heritage Commerce Corp. Financial
information for years prior to 1998 represents the financial operations and
condition of Heritage Bank of Commerce prior to formation of the Company.
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Interest income.................... $ 31,221 $ 26,678 $ 16,203 $ 10,525 $ 6,421
Interest expense................... 10,444 7,936 4,204 2,646 1,696
---------- ---------- ---------- ---------- ----------
Net interest income before
provision for loan losses....... 20,777 18,742 11,999 7,879 4,725
Provision for loan losses.......... 1,911 1,576 1,060 830 496
---------- ---------- ---------- ---------- ----------
Net interest income after provision
for loan losses................. 18,866 17,166 10,939 7,049 4,229
Noninterest income................. 4,984 1,914 638 296 71
Noninterest expenses............... 19,274 15,605 9,168 5,724 4,098
---------- ---------- ---------- ---------- ----------
Income before income taxes......... 4,576 3,475 2,409 1,621 202
Provision for income taxes......... 1,550 1,325 844 220 1
---------- ---------- ---------- ---------- ----------
Net income......................... $ 3,026 $ 2,150 $ 1,565 $ 1,401 $ 201
========== ========== ========== ========== ==========
PER SHARE DATA(1):
Basic net income(2)................ $ 0.51 $ 0.41 $ 0.32 $ 0.32 $ 0.05
Diluted net income(3).............. $ 0.45 $ 0.37 $ 0.30 $ 0.31 $ 0.05
Book value(4)...................... $ 6.97 $ 5.53 $ 4.52 $ 4.41 $ 4.02
Weighted average number of shares
outstanding -- basic............ 5,950,339 5,242,516 4,937,533 4,368,394 3,667,368
Weighted average number of shares
outstanding -- diluted.......... 6,706,726 5,844,038 5,221,857 4,550,929 3,715,393
BALANCE SHEET DATA:
Investment securities.............. $ 31,264 $ 76,793 $ 87,697 $ 75,268 $ 51,449
Net loans.......................... 266,852 232,482 117,120 74,789 37,771
Allowance for loan losses.......... 5,003 3,825 2,285 1,402 572
Total assets....................... 476,664 404,931 267,575 173,303 132,160
Total deposits..................... 418,540 368,958 242,978 146,379 118,746
Total shareholders' equity......... 44,531 30,697 22,336 20,524 12,829
SELECTED PERFORMANCE RATIOS:
Return on average assets(5)........ 0.75% 0.65% 0.74% 0.96% 0.22%
Return on average equity........... 8.26% 8.22% 7.38% 8.56% 1.67%
Net interest margin................ 5.64% 6.24% 6.17% 5.99% 5.81%
Average net loans as a percentage
of average deposits............. 67.22% 54.87% 47.48% 44.06% 34.58%
Average total shareholders' equity
as a percentage of average total
assets.......................... 9.10% 7.90% 9.98% 11.23% 13.25%
SELECTED ASSET QUALITY RATIOS(6):
Net loan charge-offs to average
loans........................... 0.30% 0.02% 0.19% -- --
Allowance for loan losses to total
loans........................... 1.84% 1.62% 1.92% 1.84% 1.50%
</TABLE>
19
<PAGE> 20
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CAPITAL RATIOS(7):
Tier 1 risk-based.................. 12.0% 9.2% 14.6% 21.4% 22.5%
Total risk-based................... 13.2% 10.4% 15.8% 22.6% 23.6%
Leverage........................... 9.4% 7.5% 10.3% 13.9% 13.5%
</TABLE>
- ---------------
Notes:
(1) 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 paid
to shareholders of record as of February 5, 1997; (iii) a 3-for-2 stock
split paid to shareholders of record as of August 1, 1997; and (iv) a
3-for-2 stock split paid to shareholders of record as of February 5, 1999.
(2) Represents net income divided by the average number of shares of common
stock outstanding for the respective period.
(3) Represents net income divided by the average number of shares of common
stock and common stock-equivalents outstanding for the respective period.
(4) Represents shareholders' equity divided by the number of shares of common
stock outstanding at the end of the period indicated.
(5) Average balances used in this table and throughout this Annual Report are
based on daily averages.
(6) Non-performing assets consist of non-accrual loans, loans past due 90 days
or more, restructured loans, and other real estate owned. As of December 31,
1999, the Company had $1,396,000 in non-performing assets. As of December
31, 1998, the Company had $1,288,000 in non-performing assets. As of
December 31, 1997, the Company had no non-performing assets.
(7) The Risk-Based and Leverage Capital ratios are defined in Item
1 -- "BUSINESS -- Supervision And Regulation -- Capital Adequacy
Guidelines."
20
<PAGE> 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain matters discussed or incorporated by reference in this Annual
Report on Form 10-K including, but not limited to matters described in this
section are forward looking statements that are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected.
Heritage Commerce Corp (the "Company") operates as the bank holding company
for three subsidiary banks: Heritage Bank of Commerce ("HBC"), Heritage Bank
East Bay ("HBEB"), and Heritage Bank South Valley ("HBSV") (collectively the
"Banks"). All are California state chartered banks which offer a full range of
commercial and personal banking services to residents and the
business/professional community in Santa Clara and Alameda Counties, California.
HBC was incorporated on November 23, 1993 and commenced operations on June 8,
1994. HBEB was incorporated on October 21, 1998 and commenced operations on
December 7, 1998. HBSV was incorporated on December 1, 1999 and commenced
operations on January 18, 2000. The accounting and reporting policies of the
Company and its subsidiary banks conform to generally accepted accounting
principles and prevailing practices within the banking industry. No customer
accounts for more than 10 percent of revenue for either HBC, HBEB, HBSV or the
Company. The Company and its subsidiary banks all operate as one commercial
banking business segment.
RESULTS OF OPERATIONS
OVERVIEW
Net income for the year ended December 31, 1999 was $3,026,000, or $0.45
per share (diluted) compared to $2,150,000, $0.37 per share (diluted) and
$1,565,000, $0.30 per share (diluted) for the years ended December 31, 1998 and
1997, respectively. The increase in 1999 over 1998 was primarily attributable to
the sale of the Internet credit card business and the growth in the level of
earning assets, funded by new deposits at favorable weighted average interest
rates, as well as to improvements in the Company's mix of earning assets in
favor of higher yielding assets, such as loans. The increase in 1998 over 1997
was primarily a result of the mix and the growth in earning assets funded by new
deposits at favorable rates.
On January 27, 1999, the Company's Board of Directors announced the
declaration of a 3-for-2 stock split effective for shareholders of record on
February 5, 1999. Accordingly, all historical financial information has been
restated as if the stock split had been in effect for all periods presented. On
January 20, 2000, the Board announced a 10% stock dividend payable to
shareholders of record on February 7, 2000. Historical share and per share
information has not been restated to reflect this stock dividend.
Average interest earning assets for 1999 were up 23% over 1998. The
increase was primarily attributable to growth in loans offset by a reduction in
the average yields earned on loans and, as a result, the average rate on
interest earning assets was 8.48% in 1999, compared to 8.89% in 1998. Average
interest bearing liabilities for 1999 were up 29% over 1998, with the increase
primarily attributable to growth in interest bearing demand deposits, savings
and money market accounts, time deposits and brokered deposits. The Company's
average rate paid on interest bearing liabilities increased to 4.09% in 1999, up
from 3.99% in 1998. As a result, net interest margin was 5.64% in 1999, compared
to 6.24% in 1998.
As of December 31, 1999, non-performing assets, comprised of loans past due
90 days or more, increased slightly to $1,396,000 from $1,288,000 as of December
31, 1998. As a result of the increase in total assets being greater than this
increase, non-performing assets as a percent of total assets declined to 0.29%
as of December 31, 1999, compared to 0.32% in the previous year. Net loan
charge-offs during 1999 were 0.30% of average loans outstanding, compared to
0.02% in 1998 and 0.19% in 1997.
Total noninterest income increased $3,070,000, or 160%, in 1999 from 1998,
following an increase of $1,276,000, or 200%, in 1998 from 1997. Fee income rose
50% in 1999 from 1998 following an increase of 32% in 1998 over 1997, primarily
due to the increase in total deposits. Many of the Company's deposit accounts
maintain balances at a level which service fees are not charged. Other
components of noninterest income such as gain on sale of securities
available-for-sale rose 27% in 1999 from 1998 following an increase of 382% in
1998 over 1997. Gains on sale of deposits and the Internet credit card portfolio
in 1999 were $240,000 and
21
<PAGE> 22
$289,000, respectively. The Company, as a policyholder of a life assurance
company, received a one-time pre-tax gain of $530,000 in 1999 as a result of the
demutualization of that company. Internet servicing revenue related to the
credit card portfolio was $1,576,000 in 1999.
Return on average equity in 1999 was 8.26%, compared to 8.22% in 1998 and
7.38% in 1997. The increase in 1999 over 1998 was the result of the increased
earnings offset by the increase in average equity of $10,494,000 primarily as a
result of the stock offering completed in 1999. Return on average assets in 1999
increased to 0.75% from 0.65% in 1998. Return on average assets was 0.74% in
1997.
NET INTEREST INCOME AND NET INTEREST MARGIN
The following table presents the average amounts outstanding for the major
categories of the Company's interest earning assets and interest bearing
liabilities, the average interest rates earned or paid thereon, and the net
yield on average interest earning assets for the periods indicated:
<TABLE>
<CAPTION>
1999 1998 1997
----------------------------- ----------------------------- -----------------------------
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, gross(1)................ $261,298 $25,727 9.85% $180,950 $19,777 10.93% $100,691 $10,376 10.31%
Investment securities(2)(3).... 45,096 2,370 5.26 93,944 5,594 5.95 83,671 5,275 6.27
Federal funds sold............. 61,853 3,124 5.05 25,309 1,307 5.16 10,233 552 5.39
-------- ------- ---- -------- ------- ----- -------- ------- -----
Total interest earning
assets................... $368,247 $31,221 8.48% $300,203 $26,678 8.89% $194,595 $16,203 8.33%
-------- ------- ---- -------- ------- ----- -------- ------- -----
Cash and due from banks........ 17,161 21,465 13,961
Premises and equipment, net.... 3,252 2,841 1,756
Other assets................... 14,224 6,893 2,350
-------- -------- --------
Total assets............... $402,884 $331,402 $212,662
======== ======== ========
LIABILITIES AND SHAREHOLDERS'
EQUITY:
Deposits:
Demand, interest bearing....... $ 9,476 $ 133 1.40% $ 7,368 $ 137 1.86% $ 4,988 $ 95 1.91%
Savings and money-market....... 133,890 4,562 3.41 122,157 4,230 3.46 80,168 2,401 3.00
Time deposits, under
$100,000..................... 38,295 2,046 5.34 16,638 878 5.28 7,530 361 4.79
Time deposits, $100,000 and
over......................... 64,696 3,160 4.88 48,861 2,463 5.04 27,314 1,330 4.87
Brokered deposits.............. 8,812 508 5.76 3,826 225 5.88 -- -- --
Other borrowings............... 458 35 7.64 41 3 7.32 297 17 5.72
-------- ------- ---- -------- ------- ----- -------- ------- -----
Total interest bearing
liabilities.............. $255,627 $10,444 4.09% $198,891 $ 7,936 3.99% $120,297 $ 4,204 3.49%
-------- ------- ---- -------- ------- ----- -------- ------- -----
Demand deposits................ 106,397 102,558 69,376
Other liabilities.............. 4,213 3,800 1,782
-------- -------- --------
Total liabilities.......... 366,237 305,249 191,455
Shareholders' equity........... 36,647 26,153 21,207
-------- -------- --------
Total liabilities and
shareholders' equity..... $402,884 $331,402 $212,662
======== ======== ========
Net interest income/margin..... $20,777 5.64% $18,742 6.24% $11,999 6.17%
======= ==== ======= ===== ======= =====
</TABLE>
- ---------------
(1) Yields and amounts earned on loans include loan fees of $1,961,000,
$1,500,000 and $709,000 for the years ended December 31, 1999, 1998, and
1997.
(2) Interest income is reflected on an actual basis, not a 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, 1999 was $20,777,000,
an increase of $2,035,000 (or 11%) over the $18,742,000 reported for 1998. Net
interest income for the year ended December 31, 1998
22
<PAGE> 23
was an increase of $6,743,000 (or 56%) over the $11,999,000 reported for 1997.
The increase in 1999 over 1998 occurred primarily as a result of growth that
occurred in the Company's earning assets offset by the decrease in yields,
primarily on loans. The Company's average interest earning assets were
$368,247,000 in 1999, up $68,044,000 (or 23%) from the average of $300,203,000
for 1998. The Company's average interest earning assets in 1998 were up
$105,608,000 (or 54%) from the average of $194,595,000 for 1997. The net yield
on interest earning assets in 1999 was 5.64%, compared to 6.24% in 1998 and
6.17% in 1997.
The following table sets forth an analysis of the changes in interest
income and interest expense:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------
1999 VERSUS 1998 1998 VERSUS 1997
-------------------------------------- --------------------------------------
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, gross............... $ 7,903 $(1,953) $ 5,950 $ 8,771 $ 630 $ 9,401
Investment securities...... (2,571) (653) (3,224) 616 (297) 319
Federal funds sold......... 1,846 (29) 1,817 779 (24) 755
------- ------- ------- ------- ----- -------
Total interest earning
assets..................... $ 7,178 $(2,635) $ 4,543 $10,166 $ 309 $10,475
======= ======= ======= ======= ===== =======
INTEREST BEARING LIABILITIES:
Demand, interest bearing... $ 30 $ (34) $ (4) $ 44 $ (2) $ 42
Savings and money-market... 396 (64) 332 1,456 373 1,829
Time deposits, under
$100,000................ 1,158 10 1,168 480 37 517
Time deposits, $100,000 and
over.................... 776 (79) 697 1,086 47 1,133
Brokered deposits.......... 288 (5) 283 225 -- 225
Other borrowings........... 32 -- 32 (19) 5 (14)
------- ------- ------- ------- ----- -------
Total interest bearing
liabilities................ 2,680 (172) 2,508 $ 3,272 $ 460 $ 3,732
------- ------- ------- ------- ----- -------
Net interest income.......... $ 4,498 $(2,463) $ 2,035 $ 6,894 $(151) $ 6,743
======= ======= ======= ======= ===== =======
</TABLE>
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. Changes due
to both volume and rate have been allocated to the change in volume.
PROVISIONS FOR LOAN LOSSES
During 1999, the provision for loan losses was $1,911,000, up $335,000 (or
21%) from $1,576,000 for 1998. The increase in the provision for 1999 and 1998
reflected the overall growth in the loan portfolio, the change in the mix of
loans, and the Company's policy of making provisions to the allowance for loan
losses. The provision for 1998 was up $516,000 (or 49%) from $1,060,000 during
1997.
The allowance for loan losses was 1.84%, 1.62%, and 1.92% of total loans at
December 31, 1999, 1998, and 1997, respectively. See Item 7 -- "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- Allowance for Loan Losses" for additional information.
23
<PAGE> 24
NONINTEREST INCOME
The following table sets forth the various components of the Company's
noninterest income:
<TABLE>
<CAPTION>
INCREASE (DECREASE)
--------------------------------------
YEARS ENDED DECEMBER 31, 1999 VERSUS 1998 1998 VERSUS 1997
------------------------ ----------------- -----------------
1999 1998 1997 AMOUNT PERCENT AMOUNT PERCENT
------ ------ ---- ------ ------- ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Servicing income...................... $1,576 $ -- $ -- $1,576 --% $ -- --%
Gain on securities.................... 1,004 790 164 214 27 626 382
Gain on sale of shares of demutualized
life insurance company.............. 530 -- -- 530 -- -- --
Service charges and other fees........ 343 229 173 114 50 56 32
Gain on sale of Internet credit card
portfolio........................... 289 -- -- 289 -- -- --
Other investment income............... 274 226 48 48 21 178 371
Gain on sale of deposits.............. 240 -- -- 240 -- -- --
Gain on sale of loans................. 143 332 205 (189) (57) 127 62
Other income.......................... 585 337 48 248 74 289 602
------ ------ ---- ------ --- ------ ---
Total........................ $4,984 $1,914 $638 $3,070 160% $1,276 200%
====== ====== ==== ====== === ====== ===
</TABLE>
Noninterest income for the year ended December 31, 1999 was $4,984,000, up
$3,070,000 (or 160%) from $1,914,000 for 1998. This increase was primarily due
to increased servicing income from Internet credit card portfolio (up
$1,576,000), gains on sale of securities available-for-sale (up $214,000), gain
on sale of shares of demutualized life insurance company (up $530,000), gain on
sale of Internet credit card portfolio (up $289,000), gain on sale of deposits
(up $240,000), and other income (up $248,000).
NONINTEREST EXPENSES
The following table sets forth the various components of the Company's
noninterest expenses:
<TABLE>
<CAPTION>
INCREASE (DECREASE)
--------------------------------------
YEARS ENDED DECEMBER 31, 1999 VERSUS 1998 1998 VERSUS 1997
---------------------------- ----------------- -----------------
1999 1998 1997 AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------ ------ ------- ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Salaries and benefits.............. $10,587 $ 7,722 $4,933 $2,865 37% $2,789 57%
Client services.................... 1,527 2,426 1,169 (899) (37) 1,257 108
Professional fees.................. 1,217 718 372 499 69 346 93
Furniture and equipment............ 1,191 828 542 363 44 286 53
Occupancy.......................... 1,168 792 440 376 47 352 80
Advertising and promotion.......... 826 786 450 40 5 336 75
Loan origination costs............. 539 449 326 90 20 123 38
Stationery and supplies............ 300 247 144 53 21 103 72
Telephone expense.................. 208 172 95 36 21 77 81
All other.......................... 1,711 1,465 697 246 17 768 110
------- ------- ------ ------ --- ------ ---
Total..................... $19,274 $15,605 $9,168 $3,669 24% $6,437 70%
======= ======= ====== ====== === ====== ===
</TABLE>
Noninterest expenses for the year ended December 31, 1999 were $19,274,000,
up $3,669,000 (or 24%) from $15,605,000 for the year ended December 31, 1998.
The overall increase in noninterest expenses reflects the growth in
infrastructure to support the Company's loan and deposit growth.
Noninterest expenses consist primarily of salaries and employee benefits
(55%, 49%, and 54% of total noninterest expenses for 1999, 1998, and 1997) and
client services (8%, 16%, and 13% of total noninterest expenses for 1999, 1998,
and 1997). The increase in salaries and benefits expenses was primarily
attributable to an increase in the number of employees. The Company employed 139
people at December 31, 1999, up 16 from 123 employees at December 31, 1998. The
Company had 88 employees at December 31, 1997. Client services expenses include
outside data processing service costs, courier and armored car costs, imprinted
check
24
<PAGE> 25
costs, and other client services costs, all of which are directly related to the
amount of funds on deposit at the Company. The increase in furniture and
equipment expenses and in occupancy expenses was primarily attributable to an
increase in the number of employees and new banking locations. The increase in
professional fees is primarily due to consultants the Company has used for a
variety of ongoing projects.
YEAR 2000 DATA PROCESSING ISSUES
The Company previously recognized the material nature of the business
issues surrounding computer processing of dates into and beyond the Year 2000
and began taking corrective action as required pursuant to the interagency
statements issued by the Federal Financial Institution Examination Council.
Management believes the Company has completed all of the activities within their
control to ensure that systems are Year 2000 compliant.
Year 2000 readiness costs were approximately $30,000. The Company does not
currently expect to apply any further funds to address Year 2000 issues.
The Company has not experienced any material disruptions of the internal
computer systems or software applications due to the start of the Year 2000 nor
have they experienced any problems with the computer systems or software
applications of their third party vendors, suppliers or service providers. The
Company will continue to monitor these third parties to determine the impact, if
any, on the business of the Company and the actions the Company must take, if
any, in the event of non-compliance by any of these third parties. Based upon
the Company's assessment of compliance by third parties, there does not appear
to be any material business risk posed by any such non-compliance.
Although the Company's Year 2000 rollover did not present any material
business disruption, there are some remaining Year 2000 related risks.
Management believes that appropriate actions have been taken to address these
remaining Year 2000 issues and contingency plans are in place to minimize the
financial impact to the Company. Management, however, cannot be certain that
Year 2000 issues affecting customers, suppliers or service providers of the
Company will not have a material adverse impact on the Company.
PROVISION FOR INCOME TAXES
Provisions for income taxes were $1,550,000, $1,325,000, and $844,000, for
the years ended December 31, 1999, 1998, and 1997, respectively. The Company's
effective tax rates were 33.8%, 38.1%, and 35.0% for the years ended December
31, 1999, 1998, and 1997, respectively. The lower effective for rate is due to
the Company purchasing additional corporate owned life insurance policies on
executive officers of the Company.
25
<PAGE> 26
FINANCIAL CONDITION
SECURITIES PORTFOLIO
The following table summarizes the amounts and distribution of the
Company's investment securities and the weighted average yields as of December
31, 1999:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
---------------------------------------------------------------------------------------
MATURITY
---------------------------------------------------------------------------------------
AFTER ONE YEAR AFTER FIVE YEARS TOTAL
WITHIN ONE AND AND WITHIN AFTER TEN AMORTIZED
YEAR WITHIN 5 YEARS TEN YEARS 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............ $3,012 4.79% $ 8,101 5.28% $ -- --% $ -- --% $11,113 5.15%
Municipals -- taxable.... -- -- 380 6.51 -- -- -- -- 380 6.51
Municipals -- tax
exempt................. -- -- -- -- 4,236 4.76 828 4.5 5,064 4.73
FHLB stock............... -- -- -- -- 1,074 5.25 -- -- 1,074 5.25
------ ---- ------- ---- ------- ---- ------ ---- ------- ----
Total
available-for-sale... $3,012 4.79% $ 8,481 5.34% $ 5,310 4.86% $ 828 4.5% $17,631 5.06%
Securities
held-to-maturity:
Municipals -- taxable.... $1,880 6.30% $ 4,021 6.54% $ 515 6.45% $ -- --% $ 6,416 6.46%
Municipals -- tax
exempt................. -- -- 461 4.86 6,346 4.51 611 4.62 7,418 4.54
------ ---- ------- ---- ------- ---- ------ ---- ------- ----
Total
held-to-maturity..... $1,880 6.30% $ 4,482 6.37% $ 6,861 4.66% $ 611 4.62% $13,834 5.43%
------ ---- ------- ---- ------- ---- ------ ---- ------- ----
Total securities....... $4,892 5.37% $12,963 5.69% $12,171 4.74% $1,439 4.55% $31,465 5.22%
====== ==== ======= ==== ======= ==== ====== ==== ======= ====
</TABLE>
Note: Yields on tax exempt municipal securities are not presented on a
fully tax equivalent basis.
During 1999, the Company transferred approximately $11.67 million of
certain securities from the held-to-maturity to available-for-sale
classification as allowed by SFAS No. 133 "Accounting for Derivative Instrument
and Hedging Activities." The gross realized and gross unrealized gains or losses
on the securities transferred were not significant to the Company.
As of December 31, 1999, the only securities held by the Company where the
aggregate book value of the Company's investment in securities of a single
issuer exceeded 10% of the Company'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 $11,100,000 and $43,296,000 as of December 31, 1999 and 1998 were pledged to
secure public and certain other deposits as required by law or contract.
LOANS
General. The following table presents the Company's loans outstanding at
year-end by loan type:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------------------------------------
% OF % OF % OF % OF % OF
1999 TOTAL 1998 TOTAL 1997 TOTAL 1996 TOTAL 1995 TOTAL
-------- ----- -------- ----- -------- ------ ------- ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial........................ $117,918 43% $ 79,567 34% $ 54,468 46% $37,724 49% $19,172 30%
Real estate -- mortgage........... 83,698 31 57,216 24 38,446 32 26,070 34 13,345 35
Real estate -- land and
construction.................... 68,152 25 49,270 21 25,780 21 11,918 16 5,105 13
Consumer.......................... 2,163 1 50,349 21 824 1 558 1 735 2
-------- --- -------- --- -------- --- ------- --- ------- ---
Total loans............... $271,931 100% $236,402 100% $119,518 100% $76,270 100% 38,357 100%
Deferred loan fees................ (76) (95) (113) (79) (14)
Allowance for loan losses......... (5,003) (3,825) (2,285) (1,402) (572)
-------- -------- -------- ------- -------
Loans, net........................ $266,852 $232,482 $117,120 $74,789 $37,771
======== ======== ======== ======= =======
</TABLE>
26
<PAGE> 27
The change in the Company's loan portfolio is primarily due to the increase
in the commercial and real estate loan portfolio offset by a decline in the
consumer portfolio resulting from the sale of the Internet credit card
portfolio.
The Company'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. 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 Company 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. The Company 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 Company retains the servicing rights for the sold portion. As of
December 31, 1999, 1998, and 1997, $8.4 million, $9.1 million, and $6.0 million,
respectively, in SBA loans were serviced by the Company for others. The Company
generally considers its SBA loans to be investment loans, but has from time to
time sold the guaranteed portion of certain loans.
The Company'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
Company's policy to restrict real estate term loans to no more than 80% of the
lower of the property's appraised value or the purchase price of the property,
depending on the type of property and its utilization. The Company 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 Company's real estate land and construction loans are primarily interim
loans made by the Company to finance the construction of commercial and single
family residential properties. These loans are typically short term. The Company
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.
Consumer loans are made for the purpose of financing automobiles, various
types of consumer goods, and other personal purposes. Additionally, the Company
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 Company'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 Banks are permitted to make extensions of its
credit to any one borrowing entity up to 15% of the Banks' capital and reserves
for unsecured loans and up to 25% of the Banks' capital and reserves for secured
loans. For HBC these lending limits were $8.5 million and $5.1 million at
December 31, 1999. For HBEB these lending limits were $1.6 million and $1.0
million at December 31, 1999. HBSV had not yet commenced operations at December
31, 1999.
Loan Concentrations. The Company does not have any concentrations in its
loan portfolio by industry or group of industries, however, 57% and 46% of its
net loans were secured by real property as of December 31, 1999 and 1998,
respectively. This increase is attributed to the large overall increase in the
loan portfolio.
27
<PAGE> 28
Loan Portfolio Maturities and Interest Rate Sensitivity. The following
table sets forth the maturity distribution of the Company's loans as of December
31, 1999:
<TABLE>
<CAPTION>
OVER ONE YEAR
BUT LESS
DUE IN ONE THAN OVER
YEAR OR LESS FIVE YEARS FIVE YEARS TOTAL
------------ ------------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial........................................ $110,111 $ 7,030 $ 701 $117,842
Real estate -- mortgage........................... 32,431 32,526 18,741 83,698
Real estate -- land and construction.............. 66,499 1,653 -- 68,152
Consumer.......................................... 1,219 934 10 2,163
-------- ------- ------- --------
Total loans............................. $210,260 $42,143 $19,452 $271,855
======== ======= ======= ========
Loans with variable interest rates................ $200,989 $13,993 $ 881 $215,863
Loans with fixed interest rates................... 9,271 28,150 18,571 55,992
-------- ------- ------- --------
Total loans............................. $210,260 $42,143 $19,452 $271,855
======== ======= ======= ========
</TABLE>
Note: Total shown is net of deferred loan fees of $76,000 as of December
31, 1999.
The table shows the distribution of such loans between those loans with
predetermined (fixed) interest rates and those with variable (floating) interest
rates. Floating rates generally fluctuate with changes in the prime rate as
reflected in the western edition of The Wall Street Journal. As of December 31,
1999, approximately 79% of the Company's loan portfolio consisted of floating
interest rate loans.
Credit Risk Management. The Company 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 Company
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 Company to increased risk are
appropriately downgraded and an increase in the allowance for loan losses is
established for such loans. Further, the Company is examined periodically by the
FDIC, FRB, and the California Department of Financial Institutions, at which
time a further review of loan quality 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 that 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. As of December 31, 1999, the Company had $1,396,000
in non-accrual loans, compared to $1,288,000 at December 31, 1998, and none at
December 31, 1997. Although the Company's Non-Performing Assets (NPA's)
increased $108,000 in 1999 from 1998, NPA's as a percentage of total portfolio
loans decreased from 0.55% to 0.51% from December 31, 1998 to December 31,1999.
As of December 31, 1999, 1998, and 1997, the Company had no assets classified as
"Other Real Estate Owned. As of December 31, 1999, 1998, and 1997, the Company
had no troubled debt restructuring and no significant loans 90 days past due and
still accruing interest.
For the year ended December 31, 1999, the Company had forgone interest
income of $63,000 related to non-accrual loans. For the year ended December 31,
1998, the Company had forgone interest income of $35,000 related to non-accrual
loans. For the year ended December 31, 1997, the Company had forgone interest
income of $17,000 related to non-accrual loans.
28
<PAGE> 29
As of December 31, 1999, the principal outstanding balances of loans
classified by the Company were $5,541,000. These loans constituted 2% of total
loans and 11% of the Company's capital and reserves as of that date. As of
December 31, 1998, loans classified by the Company were $7,819,000. These loans
constituted 3% of total loans and 23% of the Company's capital and reserves as
of that date. Other than those loans already classified at December 31, 1999,
the Company has not identified any other potential problem loans. As the Company
has made no changes to its methodology for classifying loans, the increase in
classified loans is with the increase in the total loan portfolio. Through
December 31, 1999, the Company has not made loans to any foreign entities.
ALLOWANCE FOR LOAN LOSSES
The following table summarizes the Company's loan loss experience as well
as transactions in the allowance for loan losses and certain ratios for the
periods indicated:
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
------ ------ ------ ------ ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance, beginning of period............................ $3,825 $2,285 $1,402 $ 572 $ 76
Charge-offs:
Domestic:
Commercial, financial and agricultural............. (203) (108) (223) -- --
Real estate -- construction........................ -- -- -- -- --
Real estate -- mortgage............................ -- -- -- -- --
Installment loans/credit card...................... (603) (65) (1) -- --
------ ------ ------ ------ ----
Total charge-offs....................................... (806) (173) (224) -- --
Recoveries:
Domestic:
Commercial, financial and agricultural............. 64 137 47 -- --
Real estate -- construction........................ -- -- -- -- --
Real estate -- mortgage............................ -- -- -- -- --
Installment loans/credit card...................... 9 -- -- -- --
------ ------ ------ ------ ----
Total recoveries........................................ 73 137 47 -- --
Net charge-offs......................................... (733) (36) (177) -- --
Provision for loan losses............................... 1,911 1,576 1,060 830 496
------ ------ ------ ------ ----
Balance, end of period.................................. $5,003 $3,825 $2,285 $1,402 $572
====== ====== ====== ====== ====
RATIOS:
Net charge-offs to average loans outstanding.......... 0.30% 0.02% 0.19% --% --%
Allowance for loan losses to average loans............ 2.04% 2.27% 2.49% 2.44% 2.08%
Allowance for loan losses to total loans at end of.... 1.84% 1.62% 1.92% 1.84% 1.50%
period Allowance for loan losses to non-performing
loans.............................................. 358% 297% -- -- --
</TABLE>
29
<PAGE> 30
The following table summarizes the allocation of the allowance for loan
losses (ALL) by loan type and the allocation as a percent of loans outstanding
in each loan category at the dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------------------------------------
1999 1998 1997 1996
-------------------- -------------------- -------------------- --------------------
PERCENT PERCENT PERCENT PERCENT
OF ALL OF ALL OF ALL OF ALL
IN EACH IN EACH IN EACH IN EACH
CATEGORY CATEGORY CATEGORY CATEGORY
TO TOTAL TO TOTAL TO TOTAL TO TOTAL
(DOLLARS IN THOUSANDS) ALLOWANCE LOANS ALLOWANCE LOANS ALLOWANCE LOANS ALLOWANCE LOANS
---------------------- --------- -------- --------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial................ $2,635 2.23% $1,567 1.98% $ 821 1.70% $ 512 1.74%
Real estate -- land and
construction............ 1,076 1.58 815 1.65 379 1.47 227 1.90
Real estate -- mortgage... 356 0.43 224 0.39 205 0.53 117 0.45
Consumer.................. 32 1.48 1,146 2.26 7 0.85 6 1.08
Unallocated............... 904 73 873 540
------ ---- ------ ---- ------ ---- ------ ----
Total............. $5,003 1.84% $3,825 1.62% $2,285 1.92% $1,402 1.84%
====== ==== ====== ==== ====== ==== ====== ====
<CAPTION>
DECEMBER 31,
--------------------
1995
--------------------
PERCENT
OF ALL
IN EACH
CATEGORY
TO TOTAL
(DOLLARS IN THOUSANDS) ALLOWANCE LOANS
---------------------- --------- --------
<S> <C> <C>
Commercial................ $267 1.46%
Real estate -- land and
construction............ 54 1.06
Real estate -- mortgage... 102 0.76
Consumer.................. 6 0.82
Unallocated............... 143
---- ----
Total............. $572 1.50%
==== ====
</TABLE>
The Company maintains an allowance for loan losses to absorb potential
credit losses inherent in the loan portfolio. The allowance is based on ongoing,
monthly assessments of the probable estimated losses, and to a lesser extent,
unused commitments to provide financing. Loans are charged against the allowance
when management believes that the collectibility of the principal is doubtful.
The allowance is increased by a provision for loan losses, which is charged
against current period operating results and decreased by the amount of
charge-offs, net of recoveries. The Company's methodology for assessing the
appropriateness of the allowance consists of several key elements, which include
the formula allowance, specific allowances and the unallocated allowance.
The formula allowance is calculated by applying loss factors to outstanding
loans and certain unused commitments. Loss factors are based on management's
experience and may be adjusted for significant factors that, in management's
judgment, affect the collectibility of the portfolio as of the evaluation date.
Due to the Company's limited historical loss experience, management utilizes
their prior industry experience to determine the loss factor for each category
of loan.
Specific allowances are established in cases where management has
identified significant conditions or circumstances related to a credit that
management believes indicate the probability that a loss may be incurred in
excess of the amount determined by the application of the formula allowance.
The unallocated allowance is based upon management's evaluation of various
conditions that are not directly measured in the determination of the formula
and specific allowances. The conditions evaluated in connection with the
unallocated allowance may include existing general economic and business
conditions affecting the key lending areas of the Company, credit quality
trends, collateral values, loan volumes and concentrations, seasoning of the
loan portfolio, specific industry conditions within portfolio segments, recent
loss experience in particular segments of the portfolio, duration of the current
business cycle, and bank regulatory examination results.
During 1999, the Company charged off thirty-nine loans with principal
balances totaling $806,000, and recovered nineteen of those loans for $73,000,
with accrued interest and cost. During 1998, the Company charged off eight loans
with principal balances totaling $173,000, and recovered four of those loans for
$137,000, with accrued interest and costs. During 1997, the Company charged off
three loans with principal balances totaling $224,000, and recovered two of
those loans for $47,000, with accrued interest and costs.
In an effort to improve its analysis of risk factors associated with its
loan portfolio, the Company continues to monitor and to make appropriate changes
to its internal loan policies. These efforts better enable the Company 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 Company's loan portfolio can be adversely affected
if California economic conditions and the real estate market in the Company'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
30
<PAGE> 31
non-performing loans and increased loan losses, which could adversely affect the
Company's future growth and profitability.
DEPOSITS
The following table summarizes the distribution of average deposits and the
average rates paid for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
1999 1998 1997
-------------------- -------------------- --------------------
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, noninterest bearing.......... $106,397 --% $102,558 --% $ 69,376 --%
Demand, interest bearing............. 9,476 1.40 7,368 1.86 4,988 1.91
Savings and money market............. 133,890 3.41 122,157 3.46 80,168 3.00
Time deposits, under $100,000........ 38,295 5.34 16,638 5.28 7,530 4.79
Time deposits, $100,000 and over..... 64,696 4.88 48,861 5.04 27,314 4.87
Time deposits -- Brokered deposits... 8,812 5.88 3,826 5.88 -- --
-------- ---- -------- ---- -------- ----
Total average deposits..... $361,566 2.88% $301,408 2.64% $189,376 2.21%
======== ==== ======== ==== ======== ====
</TABLE>
As of December 31, 1999, the Company had a deposit mix of 39% in savings
and money market accounts, 32% in time deposits, 3% in NOW accounts, and 26% in
demand deposits. On the same date, approximately $3,854,000, or less than 1%, of
the Company's deposits were from public sources and $22,334,000, or 5%, of the
Company's deposits were from title companies. As of December 31, 1998, the
Company had a deposit mix of 38% in savings and money market accounts, 25% in
time deposits, 3% in NOW accounts, and 34% in demand deposits. On the same date,
approximately $2,228,000, or less than 1%, of the Company's deposits were from
public sources and $63,893,000, or 17%, of the Company's deposits were from
title companies. As of December 31, 1997, the Company had a deposit mix of 40%
in savings and money market accounts, 17% in time deposits, 3% in NOW accounts,
and 40% in demand deposits. On the same date, approximately $758,000, or less
than 1%, of the Company's deposits were from public sources and approximately
$32,402,000, or 13%, were from title companies. The Company's net interest
income is enhanced by its percentage of non-interest bearing deposits.
The Company's deposits are obtained from a cross-section of the communities
it serves. The Company's business is not seasonal in nature. The Company had
brokered deposits totaling approximately $10,651,000 at December 31, 1999. These
brokered deposits generally mature within one year period. The Company 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 Company's time
deposits of $100,000 or more as of December 31, 1999:
<TABLE>
<CAPTION>
BALANCE % OF TOTAL
-------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Three months or less.................................... $38,673 44%
Over three months through six months.................... 16,887 19
Over six months through twelve months................... 26,678 30
Over twelve months...................................... 5,557 7
------- ---
Total......................................... $87,795 100%
======= ===
</TABLE>
The Company focuses primarily on servicing business deposit accounts that
are frequently over $100,000 in average size. Certain types of accounts that the
Company makes available are typically in excess of $100,000 in average balance
per account, and certain types of business clients whom the Company serves
typically carry deposits in excess of $100,000 on average. The account activity
for some account types and
31
<PAGE> 32
client types necessitates appropriate liquidity management practices by the
Company to ensure its ability to fund deposit withdrawals.
LIQUIDITY AND LIABILITY MANAGEMENT
To meet liquidity needs, the Company maintains a portion of its funds in
cash deposits in other banks, in Federal funds sold, and in investment
securities. As of December 31, 1999, the Company's primary liquidity ratio was
34.0%, comprised of $11.4 million in investment securities available-for-sale of
maturities (or probable calls) of up to five years, less $11 million of
securities that were pledged to secure public and certain other deposits as
required by law and contract; Federal funds sold of $128.1 million, and $10.0
million in cash and due from banks, as a percentage of total unsecured deposits
of $407.5 million. As of December 31, 1998, the Company's primary liquidity
ratio was 15.1%, comprised of $45.8 million in investment securities
available-for-sale of maturities (or probable calls) of up to five years, less
$43.3 million of securities that were pledged to secure public and certain other
deposits as required by law and contract; Federal funds sold of $28.6 million,
and $18.0 million in cash and due from banks, as a percentage of total unsecured
deposits of $325.7 million. As of December 31, 1997, the Company's primary
liquidity ratio was 26.3%, comprised of $40.6 million in investment securities
available-for-sale of maturities (or probable calls) of up to five years, less
$27.0 million of securities that were pledged to secure public and certain other
deposits as required by law and contract; Federal funds sold of $27.1 million,
and $16.1 million in cash and due from banks, as a percentage of total unsecured
deposits of $216.0 million. Liquid asset growth exceeded deposit growth in 1999
over 1998.
The following table summarizes the Company's borrowings under its federal
funds purchased, security repurchase arrangements and lines of credit for the
periods indicated:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ------- --------
<S> <C> <C> <C>
Average balance during the year............ $ 458,000 $41,000 $297,000
Average interest rate during the year...... 7.64% 7.32% 5.72%
Maximum month-end balance during the
year..................................... $9,000,000 $ -- --
Average rate at December 31................ 11.98% -- --
</TABLE>
The Company has Federal funds purchase lines and lines of credit of
totaling $35,000,000. As of December 31, 1999, the Company borrowed $7,000,000
from FHLB and $2,000,000 from a correspondent bank.
MARKET RISK
Market risk is the risk of loss to future earnings, to fair values, or to
future cash flows that may result from changes in the price of a financial
instrument. The value of a financial instrument may change as a result of
changes in interest rates, foreign currency exchange rates, commodity prices,
equity prices and other market changes that affect market risk sensitive
instruments. Market risk is attributed to all market risk sensitive financial
instruments, including securities, loans, deposits, borrowings, its trading
activities for its own account, and its role as a financial intermediary in
customer-related transactions. The objective of market risk management is to
avoid excessive exposure of the Company's earnings and equity to loss and to
reduce the volatility inherent in certain financial instruments.
INTEREST RATE SENSITIVITY
One method of measuring interest rate risk is by measuring the interest
rate sensitivity gap, which is the difference between earning assets and
liabilities maturing or repricing within specified periods.
The table below sets forth the interest rate sensitivity of the Company's
interest earning assets and interest bearing liabilities as of December 31,
1999, using the rate sensitivity GAP ratio. For purposes of the
32
<PAGE> 33
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>
DUE IN
WITHIN THREE TO DUE AFTER
THREE TWELVE ONE TO DUE AFTER NOT
MONTHS MONTHS FIVE YEARS FIVE YEARS RATE-SENSITIVE TOTAL
-------- -------- ---------- ---------- -------------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST EARNING ASSETS:
Federal funds sold.......... $128,100 $ -- $ -- $ -- $ -- $128,100
Securities.................. -- 4,871 12,872 13,521 -- 31,264
Total loans, including loans
held-for-sale............. 220,170 12,334 42,143 19,451 -- 294,098
-------- -------- ------- -------- --------- --------
Total interest
earning assets..... 348,270 17,205 55,015 32,972 -- 453,462
-------- -------- ------- -------- --------- --------
Cash and due from banks....... 10,049 10,049
Other assets.................. 13,153 13,153
-------- -------- ------- -------- --------- --------
Total assets......... $348,270 $ 17,205 $55,015 $ 32,972 $ 23,202 $476,664
======== ======== ======= ======== ========= ========
INTEREST BEARING LIABILITIES:
Demand, interest bearing.... $ 9,898 $ -- $ -- $ -- $ -- $ 9,898
Savings and money market.... 164,060 -- -- -- -- 164,060
Time deposits............... 49,181 76,502 9,467 -- -- 135,150
-------- -------- ------- -------- --------- --------
Total interest bearing
liabilities............... 223,139 76,502 9,467 -- -- 309,108
-------- -------- ------- -------- --------- --------
Demand noninterest bearing.... 32,596 -- -- -- 76,836 109,432
Accrual interest payable and
other liabilities........... -- -- -- -- 13,593 13,593
Shareholders' equity.......... -- -- -- -- 44,531 44,531
-------- -------- ------- -------- --------- --------
Total liabilities and
shareholders'
equity............. $255,735 $ 76,502 $ 9,467 $ -- $ 134,960 $476,664
======== ======== ======= ======== ========= ========
Interest rate sensitivity
GAP......................... $ 92,535 $(59,297) $45,548 $ 32,972 $(111,758) $ --
======== ======== ======= ======== ========= ========
Cumulative interest rate
sensitivity GAP............. $ 92,535 $ 33,238 $78,786 $111,758 $ -- $ --
Cumulative interest rate
sensitivity GAP ratio....... 19.41% 6.97% 16.53% 23.45% -- --
</TABLE>
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
Company 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.
Liquidity risk represents the potential for loss as a result of limitations
on the Company's ability to adjust for future cash flows, to meet the needs of
depositors and borrowers, and to fund operations on a timely and cost-effective
basis. The Liquidity Policy approved by the Board requires annual review of the
Company's liquidity by the Asset/Liability Committee, which is composed of
senior executives, and the Finance and Investment Committee of the Board of
Directors.
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 Company's interest rate sensitivity position. To supplement
traditional GAP analysis, the Company performs simulation modeling to estimate
the potential effects of changing interest rates. The process allows the Company
to explore the complex relationships within the GAP over time and various
interest rate environments. For additional information on the Company's
simulation model and the methodology used to estimate the potential effects of
changing interest rates, see Item 7A -- "QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK."
33
<PAGE> 34
The Company's internal Asset/Liability Committee and the Finance and
Investment Committee of the Board each meet monthly to monitor the Company's
investments, liquidity needs and to oversee its asset/liability management. The
Company 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:
<TABLE>
<CAPTION>
DECEMBER 31, MINIMUM
------------------------------------ REGULATORY
1999 1998 1997 REQUIREMENTS
-------- ------------ -------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Capital components:
Tier 1 Capital............................. $ 44,530 $ 29,850 $ 21,899
Tier 2 Capital............................. 4,646 3,825 1,885
-------- -------- --------
Total risk-based capital........... $ 49,176 $ 33,675 $ 23,784
======== ======== ========
Risk-weighted assets......................... $371,322 $323,117 $150,418
Average assets for the fourth quarter........ $475,295 $399,092 $251,767
Capital ratios:
Total risk-based capital................... 13.2% 10.4% 15.8% 8.0%
Tier 1 risk-based capital.................. 12.0% 9.2% 14.6% 4.0%
Leverage ratio(1).......................... 9.4% 7.5% 10.3% 4.0%
</TABLE>
- ---------------
(1) Tier 1 capital divided by average assets for the fourth quarter (excluding
goodwill).
The table above presents the capital ratios of the Company 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, 1999. The risk-based and leverage capital
ratios are defined in Item 1 -- "BUSINESS -- Supervision and
Regulation -- Capital Adequacy Guidelines."
At December 31, 1999 and 1998, the Company's capital met all minimum
regulatory requirements. As of December 31, 1999, HBC and HBEB were considered
"well capitalized". As of December 31, 1998, HBC was considered "adequately
capitalized", and HBEB was considered "well capitalized". HBSV had not yet
commenced operations as of December 31, 1999.
On August 16, 1999, the Company closed a best efforts public stock offering
after selling 758,138 registered shares at $15.00 per share. Total proceeds from
this offering were $11,200,000 after deducting expenses of $172,000. $7,000,000
of the proceeds of the offering were used to capitalized the Company's new
subsidiary bank, HBSV, which commenced operation on January 18, 2000.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". The Statement will require the Company to
recognize all derivatives on the balance sheet at fair value. SFAS No. 133
requires that derivative instruments used to hedge be identified specifically to
assets, liabilities, firm commitments or anticipated transactions and measured
as effective and ineffective when hedging changes in fair value or cash flows.
Derivative instruments that do not qualify as either a fair value or cash flow
hedge will be valued at fair value with the resultant gain or loss recognized in
current earnings. Changes in the effective portion of fair value hedges will be
recognized in current earnings along with the change in fair value of the hedged
item. Changes in the effective portion of the fair value of cash flow hedges
will be recognized in other comprehensive income until realization of the cash
flows of the hedged through current earnings. Any ineffective portion of hedges
will be recognized in current earnings. The Company adopted the provisions of
SFAS No. 133 in 1999. The adoption of SFAS No. 133 did not significantly impact
the Company's earnings or financial position.
34
<PAGE> 35
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a financial institution, the Company's primary component of market risk
is interest rate volatility. Fluctuations in interest rates will ultimately
impact both the level of income and expense recorded on most of the Company'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 Banks, all of the
Company's interest rate risk exposure lies at that level, as well. As a result,
all interest rate risk management procedures are performed at the Banks' level.
Based upon the nature of the Company's operations, the Company is not subject to
foreign exchange or commodity price risk. The Company does not own any trading
assets. As of December 31, 1999, the Company does not use interest rate
derivatives to hedge its interest rate risk.
The Company'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 Company has no market risk
sensitive instruments held for trading purposes.
The detail from the Company's GAP analysis is shown in Item 7, above, and
is not discussed here. The Company 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 and other 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 December 31, 1999, it was estimated that the Company's MV would increase
13.3% in the event of a 200 basis point increase in market interest rates. The
Company's MV at the same date would decrease 14.7% in the event of a 200 basis
point decrease in market interest rates.
Presented below, as of December 31, 1999, 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>
1999 1998
--------------------------------------------- ---------------------------------------------
MARKET VALUE AS A MARKET VALUE AS A
% OF PRESENT VALUE % OF PRESENT VALUE
OF ASSETS OF ASSETS
$ CHANGE % CHANGE IN ------------------- $ CHANGE % CHANGE IN -------------------
IN MARKET MARKET CHANGE IN MARKET MARKET CHANGE
CHANGE IN RATES VALUE VALUE MV RATIO (BP) VALUE VALUE MV RATIO (BP)
--------------- --------- ----------- --------- ------- --------- ----------- --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
+ 200 bp................... $ 9,448 13.3% 15.6% 184 $ 10,460 17.6% 17.2% 257
0 bp................... -- -- 13.8% -- -- -- 14.6% --
- - 200 bp................... $(10,450) (14.7)% 11.7% (203) $(12,021) (20.2)% 11.7% (295)
</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 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
35
<PAGE> 36
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.
Liquidity risk represents the potential for loss as a result of limitations
on our ability to adjust our future cash flows to meet the needs of depositors
and borrowers and to fund operations on a timely and cost-effective basis. The
Liquidity Policy approved by the Board requires annual review of the Company's
liquidity by the Asset/Liability Committee, which is composed of senior
executives, and the Finance and Investment Committee of the Board of Directors.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and independent auditors' report are set forth on
pages F-1 through F-24, which follows Item 14 -- "EXHIBITS, FINANCIAL STATEMENT
SCHEDULES, AND REPORTS ON FORM 8-K."
The following table discloses the Company's selected quarterly financial
data as required by Item 302 of Regulation S-K. 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 paid to shareholders of record as of
February 5, 1997; (iii) a 3-for-2 stock split paid to shareholders of record as
of August 1, 1997; and (iv) a 3-for-2 stock split paid to shareholders of record
as of February 5, 1999.
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
-------------------------------------------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
1999 1999 1999 1999 1998 1998
------------ ------------- ---------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Interest income...... $9,056,000 $7,876,000 $7,125,000 $7,164,000 $8,062,000 $7,469,000
Interest expense..... 3,416,000 2,646,000 2,211,000 2,171,000 2,592,000 2,350,000
---------- ---------- ---------- ---------- ---------- ----------
Net interest
income............. 5,640,000 5,230,000 4,914,000 4,993,000 5,470,000 5,119,000
Provision for loan
losses............. 428,000 356,000 484,000 643,000 516,000 550,000
---------- ---------- ---------- ---------- ---------- ----------
Net interest income
after provision.... 5,212,000 4,874,000 4,430,000 4,350,000 4,954,000 4,569,000
Noninterest income... 1,270,000 1,802,000 687,000 1,224,000 937,000 596,000
Noninterest
expense............ 5,021,000 5,503,000 4,163,000 4,587,000 4,977,000 4,148,000
---------- ---------- ---------- ---------- ---------- ----------
Net income before
taxes.............. 1,461,000 1,173,000 954,000 987,000 914,000 1,017,000
Provision for income
taxes.............. 490,000 420,000 280,000 360,000 321,000 443,000
---------- ---------- ---------- ---------- ---------- ----------
Net income........... $ 971,000 $ 753,000 $ 674,000 $ 627,000 $ 593,000 $ 574,000
========== ========== ========== ========== ========== ==========
Net income per share
basic.............. $ 0.15 $ 0.12 $ 0.12 $ 0.11 $ 0.10 $ 0.10
Net income per share
diluted............ $ 0.14 $ 0.11 $ 0.11 $ 0.10 $ 0.10 $ 0.09
<CAPTION>
FOR THE QUARTER ENDED
-----------------------
JUNE 30, MARCH 31,
1998 1998
---------- ----------
<S> <C> <C>
Interest income...... $6,049,000 $5,120,000
Interest expense..... 1,667,000 1,342,000
---------- ----------
Net interest
income............. 4,382,000 3,778,000
Provision for loan
losses............. 350,000 160,000
---------- ----------
Net interest income
after provision.... 4,032,000 3,618,000
Noninterest income... 243,000 131,000
Noninterest
expense............ 3,462,000 3,018,000
---------- ----------
Net income before
taxes.............. 813,000 731,000
Provision for income
taxes.............. 283,000 278,000
---------- ----------
Net income........... $ 530,000 $ 453,000
========== ==========
Net income per share
basic.............. $ 0.11 $ 0.09
Net income per share
diluted............ $ 0.09 $ 0.08
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
36
<PAGE> 37
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to the Company's Proxy Statement for the May 18, 2000
Annual Meeting of Shareholders for incorporation of information concerning
directors and persons nominated to become directors of the Company. Information
concerning executive officers of the Company as of March 1, 2000 is included in
Part I above in accordance with Instruction 3 to Item 401(b) of Regulation S-K.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated by reference
from the text under the caption "Executive Compensation" in the Proxy Statement
for the May 18, 2000 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT -- BENEFICIAL OWNERSHIP OF COMMON STOCK
Information concerning ownership of the equity stock of the Company by
certain beneficial owners and management is incorporated by reference from the
text under the caption "Proposal One -- Election of Directors" in the Proxy
Statement for the May 18, 2000 Annual Meeting of Shareholders
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions with
officers, directors, and the Company is incorporated by reference from the text
under the caption "Transactions with Management and Others" in the Proxy
Statement for the May 18, 2000 Annual Meeting of Shareholders.
37
<PAGE> 38
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
The Financial Statements of the Company, Management's Discussion and
Analysis of Financial Condition and Results of Operations, and the independent
auditors' report are set forth on pages F-1 through F-24.
(A)(2) FINANCIAL STATEMENT SCHEDULES
All schedules to the Financial Statements are omitted because of the
absence of the conditions under which they are required or because the required
information is included in the Financial Statements or accompanying notes.
(A)(3) EXHIBITS
<TABLE>
<CAPTION>
INCORPORATED BY REFERENCE TO
REPORT ON FORM
-----------------------------
FILED 8-A 10-K EXHIBIT
HEREWITH DATED DATED NO.
-------- ------- -------- --------
<C> <S> <C> <C> <C> <C>
3.1 Heritage Commerce Corp Articles of Incorporation: 3-5-98 4.1
[Incorporated herein by reference from Exhibit 4 to
Heritage Commerce Corp's Form 8-A: Registration of
Securities Pursuant to Section 12(g) of the Securities
Exchange Act of 1933 dated March 5, 1998 (File No.
000-23877).]
3.2 Heritage Commerce Corp Bylaws: [Incorporated herein by 3-5-98 4.2
reference from Exhibit 4 to Heritage Commerce Corp's
Form 8-A: Registration of Securities Pursuant to
Section 12(g) of the Securities Exchange Act of 1933
dated March 5, 1998 (File No. 000-23877).]
10.1 Real Property Leases for properties located at 150 3-5-98 1
Almaden Blvd., San Jose and 100 Park Center Plaza, San
Jose. [This exhibit is incorporated by reference to the
paper filing of Heritage Commerce Corp's Form 8-A filed
March 5, 1998 (File No. 000-23877).]
10.2 Employment agreement with Mr. Rossell dated June 8, 3-5-98 1
1994 [This exhibit is incorporated by reference to the
paper filing of Heritage Commerce Corp's Form 8-A filed
March 5, 1998 (File No. 000-23877).]
10.3 Employment agreement with Mr. Gionfriddo dated June 8, 3-5-98 1
1994 [This exhibit is incorporated by reference to the
paper filing of Heritage Commerce Corp's Form 8-A filed
March 5, 1998 (File No. 000-23877).]
10.4 Amendment No. 2 to Employment Agreement with Mr. 3-31-98 10.4
Gionfriddo.
10.5 Employment agreement with Mr. Conniff dated April 30, 3-31-98
1998.
10.6 Employment agreement with Mr. Nethercott dated April 3-31-98
16, 1998.
10.7 Employment agreement with Mr. McGovern dated July 16, 3-31-98
1998.
21.1 Subsidiaries of the registrant. X
23 Consent of Deloitte & Touche LLP dated March 28, 2000. X
27.1 Financial data schedule X
</TABLE>
(B) REPORTS ON FORM 8-K
On October 25, 1999, the Registrant filed Form 8-K with the Securities and
Exchange Commission to report third quarter 1999 financial results.
38
<PAGE> 39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report on Form 10-K to be
signed on its behalf by the undersigned thereunto duly authorized.
HERITAGE COMMERCE CORP
Date: March 29, 2000 By: /s/ JOHN E. ROSSELL
--------------------------------------
John E. Rossell
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report on Form 10-K has been signed below by the following persons on behalf of
the registrant and in the capacities and on the date indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ FRANK BISCEGLIA Director March 29, 2000
- -----------------------------------------------------
Frank Bisceglia
/s/ JAMES BLAIR Director March 29, 2000
- -----------------------------------------------------
James Blair
/s/ ARTHUR CARMICHAEL, JR. Director March 29, 2000
- -----------------------------------------------------
Arthur Carmichael, Jr.
/s/ RICHARD CONNIFF Director of the Company and March 29, 2000
- ----------------------------------------------------- Chief Executive Officer of
Richard Conniff Heritage Bank East Bay
/s/ WILLIAM DEL BIAGGIO, JR. Director March 29, 2000
- -----------------------------------------------------
William Del Biaggio, Jr.
/s/ ANNEKE DURY Director March 29, 2000
- -----------------------------------------------------
Anneke Dury
/s/ TRACEY ENFANTINO Director March 29, 2000
- -----------------------------------------------------
Tracey Enfantino
/s/ GLENN GEORGE Director March 29, 2000
- -----------------------------------------------------
Glenn George
/s/ ROBERT GIONFRIDDO Director March 29, 2000
- -----------------------------------------------------
Robert Gionfriddo
/s/ P. MICHAEL HUNT Director March 29, 2000
- -----------------------------------------------------
P. Michael Hunt
/s/ JOHN W. LARSEN Director March 29, 2000
- -----------------------------------------------------
John W. Larsen
/s/ LAWRENCE D. MCGOVERN Executive Vice President and March 29, 2000
- ----------------------------------------------------- Chief Financial Officer
Lawrence D. McGovern
</TABLE>
39
<PAGE> 40
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ LON NORMANDIN Director March 29, 2000
- -----------------------------------------------------
Lon Normandin
/s/ JACK PECKHAM Director March 29, 2000
- -----------------------------------------------------
Jack Peckham
/s/ ROBERT PETERS Director March 29, 2000
- -----------------------------------------------------
Robert Peters
/s/ HUMPHREY POLANEN Director March 29, 2000
- -----------------------------------------------------
Humphrey Polanen
/s/ JOHN E. ROSSELL III Director and Principal March 29, 2000
- ----------------------------------------------------- Executive Officer
John E. Rossell III
/s/ KIRK ROSSMAN Director March 29, 2000
- -----------------------------------------------------
Kirk Rossman
/s/ BRAD SMITH Director and Chairman of the March 29, 2000
- ----------------------------------------------------- Company and Chief Executive
Brad Smith Officer of Heritage Bank
South Valley
</TABLE>
40
<PAGE> 41
HERITAGE COMMERCE CORP
INDEX TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets as of December 31, 1999 and
1998...................................................... F-3
Consolidated Income Statements as of December 31, 1999, 1998
and 1997.................................................. F-4
Consolidated Statements of Shareholders' Equity as of
December 31, 1999, 1998 and 1997.......................... F-5
Consolidated Statements of Cash Flows as of December 31,
1999, 1998 and 1997....................................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 42
EXHIBIT (a)(1)
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Heritage Commerce Corp:
We have audited the accompanying consolidated balance sheets of Heritage
Commerce Corp and subsidiaries (the "Company") as of December 31, 1999 and 1998,
and the related consolidated statements of income, shareholders' equity, and
cash flows in each of the three years in the period ended December 31, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with 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, such consolidated financial statements present fairly, in
all material respects, the financial position of Heritage Commerce Corp and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years for the period ended
December 31, 1999 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
San Jose, California
January 21, 2000
F-2
<PAGE> 43
HERITAGE COMMERCE CORP
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
Cash and due from banks..................................... $ 10,049,000 $ 18,039,000
Federal funds sold.......................................... 128,100,000 28,600,000
------------ ------------
Total cash and cash equivalents................... 138,149,000 46,639,000
Securities available-for-sale, at fair value................ 17,430,000 50,249,000
Securities held-to-maturity, at amortized cost (fair value
of $13,614,000 and $27,240,000, respectively)............. 13,834,000 26,544,000
Loans held for sale, at fair value.......................... 22,243,000 33,079,000
Loans, net of deferred fees of $76,000 and $95,000 for 1999
and 1998.................................................. 271,855,000 236,307,000
Allowance for probable loan losses.......................... (5,003,000) (3,825,000)
------------ ------------
Loans, net........................................ 266,852,000 232,482,000
Premises and equipment, net................................. 3,459,000 3,238,000
Accrued interest receivable and other assets................ 5,211,000 7,240,000
Other investments........................................... 9,486,000 5,460,000
------------ ------------
TOTAL............................................. $476,664,000 $404,931,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Demand, noninterest bearing............................ $109,432,000 $120,854,000
Demand, interest bearing............................... 9,898,000 9,035,000
Savings and money market............................... 164,060,000 131,518,000
Time deposits, under $100,000.......................... 47,355,000 29,793,000
Time deposits, $100,000 and over....................... 87,795,000 58,847,000
------------ ------------
Total deposits............................................ 418,540,000 $350,047,000
Deposits held for sale.................................... -- 18,911,000
Accrued interest payable and other liabilities............ 13,593,000 5,276,000
------------ ------------
Total liabilities................................. 432,133,000 374,234,000
------------ ------------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value; 10,000,000 shares
authorized: none outstanding........................... -- --
Common stock, no par value; 30,000,000 shares authorized;
shares issued and outstanding: 6,392,342 in 1999 and
5,554,552 in 1998...................................... 41,021,000 29,418,000
Accumulated other comprehensive (loss) income, net of
taxes.................................................. (137,000) 658,000
Retained earnings......................................... 3,647,000 621,000
------------ ------------
Total shareholders' equity........................ 44,531,000 30,697,000
------------ ------------
TOTAL............................................. $476,664,000 $404,931,000
============ ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 44
HERITAGE COMMERCE CORP
CONSOLIDATED INCOME STATEMENTS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Interest income:
Loans, including fees............................. $25,727,000 $19,777,000 $10,376,000
Securities, taxable............................... 1,764,000 4,915,000 5,188,000
Securities, non-taxable........................... 606,000 679,000 87,000
Federal funds sold................................ 3,124,000 1,307,000 552,000
----------- ----------- -----------
Total interest income............................... 31,221,000 26,678,000 16,203,000
----------- ----------- -----------
Interest expense:
Deposits.......................................... 10,409,000 7,933,000 4,187,000
Other............................................. 35,000 3,000 17,000
----------- ----------- -----------
Total interest expense.............................. 10,444,000 7,936,000 4,204,000
----------- ----------- -----------
Net interest income before provision for probable
loan losses....................................... 20,777,000 18,742,000 11,999,000
Provision for probable loan losses.................. 1,911,000 1,576,000 1,060,000
----------- ----------- -----------
Net interest income after provision for probable
loan losses....................................... 18,866,000 17,166,000 10,939,000
----------- ----------- -----------
Noninterest income:
Servicing income.................................. 1,576,000 -- --
Gain on sales of securities available-for-sale.... 1,004,000 790,000 164,000
Gain on sale of shares of demutualized life
insurance company.............................. 530,000 -- --
Service charges and other fees.................... 343,000 229,000 173,000
Gain on sale of Internet credit card.............. 289,000 -- --
Other investments................................. 274,000 226,000 48,000
Gain on sale of deposits.......................... 240,000 -- --
Gain on sale of loans............................. 143,000 332,000 205,000
Other income...................................... 585,000 337,000 48,000
----------- ----------- -----------
Total other income.................................. 4,984,000 1,914,000 638,000
----------- ----------- -----------
Noninterest expenses:
Salaries and employee benefits.................... 10,587,000 7,722,000 4,933,000
Client services................................... 1,527,000 2,426,000 1,169,000
Professional fees................................. 1,217,000 718,000 372,000
Furniture and equipment........................... 1,191,000 828,000 542,000
Occupancy......................................... 1,168,000 792,000 440,000
Advertising and promotion......................... 826,000 786,000 450,000
Loan origination costs............................ 539,000 449,000 326,000
Stationery and supplies........................... 300,000 247,000 144,000
Telephone......................................... 208,000 172,000 95,000
Other............................................. 1,711,000 1,465,000 697,000
----------- ----------- -----------
Total other expenses................................ 19,274,000 15,605,000 9,168,000
----------- ----------- -----------
Income before income taxes.......................... 4,576,000 3,475,000 2,409,000
Provision for income taxes.......................... 1,550,000 1,325,000 844,000
----------- ----------- -----------
Net income.......................................... $ 3,026,000 $ 2,150,000 $ 1,565,000
=========== =========== ===========
Earnings per share:
Basic............................................. $ 0.51 $ 0.41 $ 0.32
Diluted........................................... $ 0.45 $ 0.37 $ 0.30
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 45
HERITAGE COMMERCE CORP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
COMMON STOCK INCOME RETAINED TOTAL OTHER
----------------------- (NET OF EARNING/ SHAREHOLDERS' COMPREHENSIVE
SHARES AMOUNT TAXES) (DEFICIT) EQUITY INCOME
--------- ----------- -------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1997...... 4,696,049 $22,093,000 $ 221,000 $(1,790,000) $20,524,000
Net income.................... -- -- -- 1,565,000 1,565,000 $1,565,000
Net change in unrealized gain
on securities
available-for-sale, net of
reclassification adjustment
and taxes................... -- -- 197,000 -- 197,000 197,000
----------
Total comprehensive
income.................... $1,762,000
==========
Stock dividend................ 234,523 1,304,000 -- (1,304,000) --
Cash paid for fractional
shares...................... (291) (2,000) -- (2,000)
Stock options exercised....... 13,567 52,000 -- -- 52,000
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31, 1997... 4,943,848 $23,447,000 $ 418,000 $(1,529,000) $22,336,000
Net income.................... -- -- -- 2,150,000 2,150,000 $2,150,000
Net change in unrealized gain
on securities
available-for-sale, net of
reclassification adjustment
and taxes................... -- -- 240,000 -- 240,000 240,000
----------
Total comprehensive
income.................... $2,390,000
==========
Common stock issued pursuant
to July 1998 offering (net
of issuance costs of
$154,000)................... 580,644 5,846,000 -- -- 5,846,000
Stock options exercised....... 30,060 125,000 -- -- 125,000
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31, 1998... 5,554,552 $29,418,000 $ 658,000 $ 621,000 $30,697,000
Net income.................... -- -- -- 3,026,000 3,026,000 $3,026,000
Net change in unrealized gain
/loss on securities
available-for-sale, net of
reclassification adjustment
and taxes................... -- -- (795,000) -- (795,000) (795,000)
----------
Total comprehensive
income.................... $2,231,000
==========
Common stock issued pursuant
to June 1999 offering (net
of issuance costs of
$172,000)................... 758,138 11,200,000 -- -- 11,200,000
Cash paid for fractional
shares...................... (199) (4,000) (4,000)
Stock options exercised....... 79,851 407,000 -- -- 407,000
--------- ----------- --------- ----------- -----------
BALANCES, DECEMBER 31, 1999... 6,392,342 $41,021,000 $(137,000) $ 3,647,000 $44,531,000
========= =========== ========= =========== ===========
</TABLE>
See notes to consolidated financial statements
F-5
<PAGE> 46
HERITAGE COMMERCE CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1999 1998 1997
------------ ------------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 3,026,000 $ 2,150,000 $ 1,565,000
Adjustments to reconcile net income to net cash used in
operating activities:
(Loss) in disposals of property and equipment........... (283,000) -- --
Depreciation and amortization........................... 827,000 639,000 388,000
Provision for probable loan losses...................... 1,911,000 1,576,000 1,060,000
Gain on sales of securities available-for-sale.......... (1,004,000) (790,000) (164,000)
Deferred income taxes................................... (709,000) (1,016,000) (448,000)
Amortization/accretion of discounts and premiums on
securities............................................ (239,000) 242,000 56,000
Proceeds from sales of loans held for sale.............. 4,317,000 3,932,000 4,198,000
Originations of loans held for sale..................... (17,941,000) (5,674,000) (4,626,000)
Maturities of loans held for sale....................... 7,839,000 694,000 45,000
Effect of changes in:
Accrued interest receivable and other assets.......... (801,000) (2,461,000) (952,000)
Accrued interest payable and other liabilities........ 11,156,000 2,869,000 605,000
------------ ------------- ------------
Net cash provided by (used in) operating activities....... 8,099,000 2,161,000 1,727,000
------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans..................................... (19,660,000) (139,604,000) (45,650,000)
Purchases of securities available-for-sale................ (26,334,000) (25,481,000) (49,116,000)
Maturities of securities available-for-sale............... 22,232,000 18,407,000 16,588,000
Proceeds from sales of securities available-for-sale...... 49,512,000 19,046,000 21,955,000
Purchases of securities held-to-maturity.................. -- (8,855,000) (7,659,000)
Proceeds from maturities or calls of securities
held-to-maturity........................................ 1,115,000 8,722,000 6,388,000
Purchase of corporate-owned life insurance................ (3,874,000) (987,000) (4,473,000)
Purchases of property and equipment....................... (765,000) (1,906,000) (829,000)
------------ ------------- ------------
Net cash used in investing activities..................... 22,226,000 (130,658,000) (62,796,000)
------------ ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits.................................. 49,582,000 125,981,000 96,599,000
Proceeds from sale of securities under agreements to
repurchase.............................................. -- -- (5,010,000)
Net proceeds from issuance of common stock................ 11,603,000 5,970,000 50,000
------------ ------------- ------------
Net cash provided by financing activities................. 61,185,000 131,951,000 91,639,000
------------ ------------- ------------
Net increase in cash and cash equivalents................. 91,510,000 3,454,000 30,570,000
Cash and cash equivalents, beginning of year.............. 46,639,000 43,185,000 12,615,000
------------ ------------- ------------
Cash and cash equivalents, end of year.................... $138,149,000 $ 46,639,000 $ 43,185,000
============ ============= ============
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest.............................................. $ 10,171,000 $ 7,198,000 $ 4,477,000
Income taxes.......................................... $ 2,083,000 $ 1,684,000 $ 1,536,000
Supplemental schedule of non-cash investing and financing
activity:
Transfer from accumulated deficit to common stock due to
stock dividend........................................ -- $ -- $ 1,304,000
Transfer of investment securities from HTM to AFS....... $ 11,669,000 $ -- $ --
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE> 47
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SIGNIFICANT ACCOUNTING POLICIES
Description of Business and Basis of Presentation
Heritage Commerce Corp (the "Company") operates as the bank holding company
for three subsidiary banks: Heritage Bank of Commerce ("HBC"), Heritage Bank
East Bay ("HBEB"), and Heritage Bank South Valley ("HBSV")(collectively the
"Banks"). All are California state chartered banks which offer a full range of
commercial and personal banking services to residents and the
business/professional community in Santa Clara and Alameda Counties, California.
HBC was incorporated on November 23, 1993 and commenced operations on June 8,
1994. HBEB was incorporated on October 21, 1998 and commenced operations on
December 7, 1998. HBSV was incorporated on December 1, 1999 and commenced
operations on January 18, 2000. The accounting and reporting policies of the
Company and its subsidiary banks conform to generally accepted accounting
principles and prevailing practices within the banking industry.
On January 27, 1999, the Company's Board of Directors announced the
declaration of a 3-for-2 stock split effective for shareholder of record on
February 5, 1999. Accordingly, all historical financial information has been
restated as if the stock split had been in effect for all periods presented.
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. Actual results could differ from those estimates.
Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiary banks. All material intercompany accounts and transactions
have been eliminated.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with
remaining terms to maturity of three months or less from the date of acquisition
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 Company 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, net of income taxes, as a net amount
within accumulated other comprehensive income, which is a separate component of
shareholders' equity, until realized. Securities held-to-maturity are measured
at amortized cost, based on the Company'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.
Premiums and discounts are amortized, or accreted, over the life of the
related investment security as an adjustment to income using a method that
approximates the interest method. Interest income is recognized
F-7
<PAGE> 48
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 Company holds for sale the guaranteed 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 SBA 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 guaranteed portion of the loan sold compared to
the relative fair value of the unguaranteed portion.
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.
The Company accounts for the transfer and servicing of financial assets
based on the financial and servicing assets it controls and liabilities it has
incurred, derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. Servicing assets are measured at
their fair value and are amortized in proportion to and over the period of net
servicing income and are assessed for impairment on an ongoing basis. Impairment
is determined by stratifying the servicing rights based on interest rates and
terms. Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions. Impairment is recognized through a valuation
allowance. Any servicing assets in excess of the contractually specified
servicing fees have been reclassified at fair value as an interest-only (I/O)
strip receivable and treated like an available for sale security. The servicing
asset, net of any required valuation allowance, and I/O strip receivable are
included in other assets.
Loans
Loans are stated at the principal amount outstanding. The majority of the
Company's loans are at variable interest rates. Interest on loans is credited to
income when earned.
Generally, if 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 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.
Renegotiated loans are those in which the Company has formally restructured
a significant portion of the loan. The remaining portion is charged off, with a
concession either in the form of below market rate financing, or debt
forgiveness on the charged off portion. Loans that have been renegotiated and
have not met specific performance standards for payment are classified as
renegotiated loans within the classification of nonperforming assets. Upon
payment performance, such loans may be transferred from nonperforming status to
accrual status. At December 31, 1999 and 1998 the Company did not have any
renegotiated loans outstanding.
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 Company maintains an allowance for loan losses to absorb probable
losses inherent in the loan portfolio. The allowance is based on ongoing,
monthly assessments of the probable estimated losses. Loans are
F-8
<PAGE> 49
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
charged against the allowance when management believes that the collectability
of the principal is doubtful. The allowance is increased by the provision for
loan losses, which is charged against current period operating results and
decreased by the amount of charge-offs, net of recoveries. The Company's
methodology for assessing the appropriateness of the allowance consists of
several key elements, which include the formula allowance, specific allowances
and the unallocated allowance.
The allowance is calculated by applying loss factors to outstanding loans
and certain unused commitments. Loss factors are based on the Company's
historical loss experience and may be adjusted for significant factors that, in
management's judgement, affect the collectibility of the portfolio as of the
evaluation date. Until additional historical data is available, management has
derived a matrix, based on management's prior experience, to determine the loss
factor for each category of loan.
Allowances can apply to some loans but not all loans. Specific allowances
are established in cases where management has identified significant conditions
or circumstances related to a credit that management believes indicate the
probability that a loss has been incurred in excess of the amount determined by
the application of the formula allowance. The allowance also incorporates the
results of measuring impaired loans. Management considers a loan to be impaired
when it is probable that the Company 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.
The unallocated allowance is based upon management's evaluation of various
conditions that are not directly measured in the determination of the formula
and specific allowances. The conditions evaluated in connection with the
unallocated allowance may include existing general economic and business
conditions affecting the key lending areas of the Company, credit quality
trends, collateral values, loan volumes and concentrations, seasoning of the
loan portfolio, specific industry conditions within portfolio segments, recent
loss experience in particular segments of the portfolio, duration of the current
business cycle, and bank regulatory examination results.
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, if appropriate. The Company
evaluates the recoverability of long-lived assets on an on-going basis.
Other Investments
Other investments consist of cash surrender value of life insurance
policies for certain officers and directors of the Company and its subsidiary
banks.
Income Taxes
The Company files consolidated federal and combined state income tax
returns. Amounts provided for income tax expense are based on income reported
for financial statement purposes and do not necessarily represent amounts
currently payable under tax laws. Deferred taxes, which arise principally from
temporary differences between the period in which certain income and expenses
are recognized for financial accounting purposes and the period in which they
affect taxable income, are included in the amounts provided for income taxes.
Under this method, the computation of the net deferred tax liability or asset
gives current recognition to changes in the tax laws.
F-9
<PAGE> 50
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock-Based Compensation
The Company 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. The Company presents
the required proforma disclosures of the effect of stock-based compensation on
net income and earnings per share using the fair value method in accordance with
SFAS No. 123, Accounting for Stock-Based Compensation.
Comprehensive Income
In 1998, the Company adopted 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.
The following is a summary of the components of other comprehensive income.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Net Income..................................... $3,026,000 $2,150,000 $1,565,000
---------- ---------- ----------
Other comprehensive income, net of tax:
Net unrealized holding gain (loss) on
available-for-sale securities during the
year...................................... (130,000) 729,000 303,000
Less: reclassification adjustment for
realized gains on available for sale
securities included in net income during
the year.................................. (665,000) (489,000) (106,000)
---------- ---------- ----------
Other comprehensive income..................... (795,000) 240,000 197,000
---------- ---------- ----------
Comprehensive income........................... $2,231,000 $2,390,000 $1,762,000
========== ========== ==========
</TABLE>
Segment Reporting
HBC, HBEB, and HBSV are commercial banks, which offer similar products to
customers located in Santa Clara and Alameda counties of California. No customer
accounts for more than 10 percent of revenue for HBC, HBEB, HBSV or the Company.
Management evaluates the Company's performance as a whole and does not allocate
resources based on the performance of different lending or transaction
activities. Accordingly, the Company and its subsidiary banks all operate as one
business segment.
Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted
average common shares outstanding. Diluted earnings per share reflects potential
dilution from outstanding stock options, using the treasury stock method. For
each of the years presented, net income is the same for basic and diluted
earnings per share. Reconciliation of weighted average shares used in computing
basic and diluted earnings per share is as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Weighted average common shares outstanding -- used
in computing basic earnings per share........... 5,950,339 5,242,516 4,937,533
Dilutive effect of stock options outstanding,
using the treasury stock method................. 756,387 601,522 284,324
--------- --------- ---------
Shares used in computing diluted earnings per
share........................................... 6,706,726 5,844,038 5,221,857
========= ========= =========
</TABLE>
F-10
<PAGE> 51
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Reclassifications
Certain amounts in the 1998 and 1997 financial statements have been
reclassified to conform to the 1999 presentation. These reclassifications had no
impact on shareholders' equity and net income.
Recently issued Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". The Statement will require the Company to
recognize all derivatives on the balance sheet at fair value. SFAS No. 133
requires that derivative instruments used to hedge be identified specifically to
assets, liabilities, firm commitments or anticipated transactions and measured
as effective and ineffective when hedging changes in fair value or cash flows.
Derivative instruments that do not qualify as either a fair value or cash flow
hedge will be valued at fair value with the resultant gain or loss recognized in
current earnings. Changes in the effective portion of fair value hedges will be
recognized in current earnings along with the change in fair value of the hedged
item. Changes in the effective portion of the fair value of cash flow hedges
will be recognized in other comprehensive income until realization of the cash
flows of the hedged through current earnings. Any ineffective portion of hedges
will be recognized in current earnings. The Company adopted the provisions of
SFAS No. 133 in 1999. The adoption of SFAS No. 133 did not significantly impact
the Company's earnings or financial position
(2) SECURITIES
The amortized cost and estimated fair value of securities as of December
31, 1999 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Securities available-for-sale:
U.S. Treasury.................... $11,113,000 $-- $110,000 $11,003,000
Municipals....................... 5,444,000 -- 91,000 5,353,000
FHLB Stock....................... 1,074,000 -- -- 1,074,000
----------- -- -------- -----------
Total securities
available-for-sale..... $17,631,000 $-- $201,000 $17,430,000
=========== == ======== ===========
Securities held-to-maturity:
Municipals....................... $13,834,000 $-- $220,000 $13,614,000
----------- -- -------- -----------
Total securities
held-to-maturity................. $13,834,000 $-- $220,000 $13,614,000
=========== == ======== ===========
</TABLE>
F-11
<PAGE> 52
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The amortized cost and estimated fair value of securities as of December
31, 1998 were as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Securities available-for-sale:
U.S. Treasury.................. $39,254,000 $ 869,000 $-- $40,123,000
U.S. Government agencies....... 3,007,000 44,000 -- 3,051,000
Municipals..................... 2,595,000 113,000 -- 2,708,000
Preferred Stock................ 2,015,000 57,000 -- 2,072,000
Commercial Paper............... 2,259,000 36,000 -- 2,295,000
----------- ---------- -- -----------
Total securities
available-for-
sale................. $49,130,000 $1,119,000 $-- $50,249,000
=========== ========== == ===========
Securities held-to-maturity:
Municipals..................... $23,001,000 $ 650,000 $-- $23,651,000
U.S. Government agencies....... 1,509,000 7,000 -- 1,516,000
U.S. Treasury.................. 2,034,000 39,000 -- 2,073,000
----------- ---------- -- -----------
Total securities
held-to-maturity..... $26,544,000 $ 696,000 $-- $27,240,000
=========== ========== == ===========
</TABLE>
The Company transferred $11,669,000 of certain securities from the
held-to-maturity to available-for-sale classification as allowed by SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities". The gross
realized and gross unrealized gains or losses on the securities transferred were
not significant to the Company.
The amortized cost and estimated fair values of securities as of December
31, 1999 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 HELD-TO-MATURITY SECURITIES AVAILABLE-FOR-SALE
----------------------------- -----------------------------
AMORTIZED ESTIMATED FAIR AMORTIZED ESTIMATED FAIR
COST VALUE COST VALUE
----------- -------------- ----------- --------------
<S> <C> <C> <C> <C>
Due within one year........... $ 1,880,000 $ 1,878,000 $ 3,012,000 $ 2,992,000
Due after one through five
years....................... 4,482,000 4,461,000 8,481,000 8,389,000
Due after five through ten
years....................... 6,861,000 6,696,000 5,310,000 5,255,000
Due after ten years........... 611,000 579,000 828,000 794,000
----------- ----------- ----------- -----------
Total............... $13,834,000 $13,614,000 $17,631,000 $17,430,000
=========== =========== =========== ===========
</TABLE>
Sales of securities available-for-sale resulted in gross realized gains of
$1,004,000, $670,000, and $170,000 during the years ended December 31, 1999,
1998, and 1997, respectively.
Sales of securities available-for-sale resulted in gross realized losses of
nil, $5,000, and $6,000, during the years ended December 31, 1999, 1998, and
1997, respectively.
Securities with amortized cost of $11,100,000 and $43,296,000 as of
December 31, 1999 and 1998 were pledged to secure public and certain other
deposits as required by law or contract.
F-12
<PAGE> 53
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) LOANS
Loans as of December 31 were as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Loans held for sale......................................... $ 22,243,000 $ 33,079,000
Loans held for investment
Commercial................................................ 117,918,000 79,566,000
Real estate -- term....................................... 83,698,000 57,216,000
Real estate -- land and construction...................... 68,152,000 49,270,000
Consumer.................................................. 2,163,000 50,350,000
------------ ------------
Total loans....................................... 271,931,000 236,402,000
Deferred loan fees.......................................... (76,000) (95,000)
Allowance for loan losses................................... (5,003,000) (3,825,000)
------------ ------------
Loans, net.................................................. $266,852,000 $232,482,000
============ ============
</TABLE>
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
AT OR FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Balance, beginning of year......................... $3,825,000 $2,285,000 $1,402,000
Loan charged-offs.................................. 806,000 173,000 224,000
Recoveries......................................... (73,000) (137,000) (47,000)
---------- ---------- ----------
Net loan charged-offs.............................. 733,000 36,000 177,000
Provision for loan losses.......................... 1,911,000 1,576,000 1,060,000
---------- ---------- ----------
Balance, end of year............................... $5,003,000 $3,825,000 $2,285,000
========== ========== ==========
</TABLE>
As of December 31, 1999, the Company had $1,396,000 in loans for which
interest is no longer being accrued, no loans past due 90 days or more and still
accruing interest, and no impaired loans. As of December 31, 1998, the Company
had $1,288,000 in loans for which interest is no longer being accrued, no
significant loans past due 90 days or more and still accruing interest, and no
impaired loans. For the year ended December 31, 1999, 1998 and 1997, the Company
had foregone $63,000 of interest income as a result of non-accrual loans. For
the year ended December 31, 1998, the Company had foregone $35,000 of interest
income as a result of non-accrual loans. For the years ended December 31, 1997,
the Company had recognized $17,000 of interest income when it was received from
non-accrual loans.
HBC's SBA loans serviced for others are not included in the accompanying
balance sheets. The unpaid principal balances of these loans as of December 31,
1999 and 1998 were approximately $8,435,000 and $9,130,000, 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. 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.
F-13
<PAGE> 54
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
During 1999 HBC sold the credit card portfolio established through its
contract with Internet Access Financial Corporation to that corporation. As a
result of the sale of the portfolio the Company removed the credit card loans
from its portfolio of consumer loans and recognized a gain of $289,000. The
Company continues to provide Internet Access Financial Corporation certain
administrative services related to the issuance of credit cards on a fee basis.
HBC and HBEB make 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 for the Bank. During 1999, advances on loans were
approximately $437,000. During 1998, new loans to related parties totaled
$188,000. During 1999 and 1998, $530,000 and $1,340,000, respectively, were
repaid to the Banks. As of December 31, 1999, and 1998 the Bank had $900,000 and
$993,000 in loans outstanding to related parties.
(4) PREMISES AND EQUIPMENT
Premises and equipment as of December 31 were as follows:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Furniture and equipment................................... $ 3,044,000 $ 2,677,000
Leasehold improvements.................................... 1,775,000 1,368,000
Software.................................................. 669,000 678,000
----------- -----------
5,488,000 4,723,000
Accumulated depreciation and amortization................. (2,029,000) (1,485,000)
----------- -----------
Premises and equipment, net............................... $ 3,459,000 $ 3,238,000
=========== ===========
</TABLE>
Depreciation expense was $828,000, $639,000, and $388,000 for the years
ended December 31, 1999, 1998, and 1997, respectively.
(5) DEPOSITS
At December 31, 1999, the scheduled maturities of time deposits was as
follows:
<TABLE>
<CAPTION>
YEAR
----
<S> <C>
2000........................................................ $125,683,000
2001........................................................ 7,643,000
2002 and after.............................................. 1,824,000
------------
Total time deposits............................... $135,150,000
============
</TABLE>
Deposits totaling $18,911,000 at December 31, 1998 representing a portion
of HBC's bankruptcy portfolio were held for sale. There were no deposits held of
sale at December 31, 1999.
(6) BORROWING ARRANGEMENTS
Available Lines of Credit
The Company has federal funds purchase lines and lines of credit of
totaling $35,000,000. As of December 31, 1999, the Company borrowed $7,000,000
from FHLB and $2,000,000 from a correspondent bank.
F-14
<PAGE> 55
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Information concerning borrowings under the above arrangements is as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ------- --------
<S> <C> <C> <C>
Average balance during the year.................... $ 458,000 $41,000 $297,000
Average interest rate during the year.............. 7.64% 7.32% 5.72%
Maximum month-end balance during the year.......... $9,000,000 $ -- --
Average rate at December 31........................ 11.98% -- --
</TABLE>
(7) INCOME TAXES
The provision for income taxes for the years ended December 31, consisted
of the following:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Current:
Federal...................................... $1,703,000 $1,734,000 $ 939,000
State........................................ 556,000 607,000 353,000
---------- ---------- ----------
Total current.................................. 2,259,000 2,341,000 1,292,000
---------- ---------- ----------
Deferred:
Federal...................................... (578,000) (814,000) (372,000)
State........................................ (131,000) (202,000) (76,000)
---------- ---------- ----------
Total deferred................................. (709,000) (1,016,000) (448,000)
---------- ---------- ----------
Provision for income taxes..................... $1,550,000 $1,325,000 $ 844,000
========== ========== ==========
</TABLE>
The effective tax rate differs from the federal statutory rate for the
years ended December 31, as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Statutory federal income tax rate........................... 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit.............. 6.0 7.7 7.5
Change in valuation allowance............................... -- -- (8.7)
Non-taxable interest income................................. (4.6) (5.8) (2.3)
Officers' life insurance.................................... (2.1) (2.2) --
Other....................................................... (0.5) 3.4 3.5
---- ---- ----
Effective tax rate.......................................... 33.8% 38.1% 35.0%
==== ==== ====
</TABLE>
F-15
<PAGE> 56
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net deferred tax asset as of December 31 consists of the following:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses................................. $2,070,000 $1,541,000
Excess servicing rights................................... 86,000 114,000
Deferred rent............................................. 66,000 77,000
Accrued expenses.......................................... 408,000 237,000
Securities available-for-sale............................. 73,000 --
Other..................................................... -- 31,000
---------- ----------
Total deferred tax assets......................... 2,703,000 2,000,000
---------- ----------
Deferred tax liabilities:
Securities available-for-sale............................. -- (448,000)
Accrual to cash adjustment................................ (96,000) (164,000)
Depreciation.............................................. (20,000) (76,000)
State income taxes........................................ (208,000) (163,000)
---------- ----------
Total deferred tax liabilities.................... (324,000) (851,000)
---------- ----------
Net deferred tax assets........................... $2,379,000 $1,149,000
========== ==========
</TABLE>
The Company believes that it is more likely than not that it will realize
the above deferred tax assets in future periods; therefore, no valuation
allowance has been provided against its deferred tax assets.
(8) STOCK BASED COMPENSATION
The Company 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 for both incentive and
non-qualified stock options 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. As of December 31, 1999, 94,501 shares are available for
future grants under the Plan.
F-16
<PAGE> 57
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Option activity under the Plan is as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER AVERAGE
OF SHARES EXERCISE PRICE
--------- --------------
<S> <C> <C>
Options Outstanding at January 1, 1997 (413,223 exercisable
at a weighted average exercise price of $3.89)............ 861,720 $4.01
Granted (weighted average fair value of $2.95)............ 120,928 6.48
Exercised................................................. (13,567) 3.87
Cancelled................................................. (10,298) 4.37
Option Outstanding at December 31, 1997 (652,924 exercisable
at a weighted average exercise price of $4.09)............ 958,783 4.32
Granted (weighted average fair value of $4.92)............ 425,400 11.54
Exercised................................................. (30,060) 4.15
Cancelled................................................. (12,009) 5.79
Option Outstanding at December 31, 1998 (902,867 exercisable
at a weighted average exercise price of $5.25)............ 1,342,114 6.60
Granted (weighted average fair value of $8.20)............ 155,800 16.00
Exercised................................................. (79,851) 5.10
Cancelled................................................. (11,108) 12.70
Option Outstanding at December 31, 1999 (1,078,928
exercisable at weighted average exercise price of
$6.27).................................................... 1,406,955 $7.67
</TABLE>
Additional information regarding options outstanding under the Plan as of
December 31, 1999 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------------------- ------------------------------
WEIGHTED AVERAGE
REMAINING
RANGE OF NUMBER CONTRACTUAL WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
EXERCISE PRICES OUTSTANDING LIFE (YRS.) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- --------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ 3.85 - 4.85 684,952 4.61 $ 3.89 683,651 $ 3.89
4.86 - 5.85 140,834 7.12 5.54 123,061 5.56
5.86 - 10.67 193,922 8.36 10.29 79,810 10.26
10.68 - 18.01 387,247 9.17 13.82 192,406 13.49
--------- ---- ------ --------- ------
$ 3.85 - 18.01 1,406,955 6.64 $ 7.67 1,078,928 $ 6.27
========= ==== ====== ========= ======
</TABLE>
As discussed in Note 1, the Company 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 Company
adopted the fair value method at the grant date of all stock options. 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 Company's stock option
awards. Those models also require subjective assumptions, which greatly affect
the calculated values. The Company'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, 5.5% for 1999,
4.70% for 1998, and 5.75% for 1997; stock volatility of 39% in 1999, and 30% in
1998 and 1997; and no dividends during the
F-17
<PAGE> 58
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
expected term. The Company's calculations are based on a multiple option
valuation approach, and forfeitures are recognized as they occur.
If the computed fair values of the 1999, 1998, and 1997 awards had been
amortized to expense over the vesting periods of the awards, pro forma net
income and earnings per common share would have been as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Net income
As reported.................................. $3,026,000 $2,150,000 $1,565,000
Pro forma.................................... $2,326,000 $1,146,000 $1,000,000
Net income per common share -- basic
As reported.................................. $ 0.51 $ 0.41 $ 0.32
Pro forma.................................... $ 0.39 $ 0.22 $ 0.20
Net income per common share -- diluted
As reported.................................. $ 0.45 $ 0.37 $ 0.30
Pro forma.................................... $ 0.35 $ 0.20 $ 0.19
</TABLE>
(9) LEASES
The Company 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>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
2000................................... $ 912,000
2001................................... 905,000
2002................................... 919,000
2003................................... 847,000
2004................................... 793,000
Thereafter............................... 4,493,000
----------
Total.................................... $8,869,000
==========
</TABLE>
Rent expense under operating leases was $853,000, $613,000, and $314,000,
during the years ended December 31, 1999, 1998, and 1997. Rent expense was
reduced by deferred rent concessions on one of the Company's locations of
$46,000, $47,000, and $50,000, during the years ended December 31, 1999, 1998,
and 1997.
(10) BENEFIT PLANS
The Company offers a 401(k) savings plan. All salaried employees are
eligible to contribute up to 20% of their pre-tax compensation (to a maximum of
$10,500 in 1999) to the plan through salary deductions under Section 401(k) of
the Internal Revenue Code. The Company does not match employee contributions.
The Company also sponsors an employee stock ownership plan. The plan allows
the Company 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 Company, or its subsidiaries,
on December 31. Awards under this plan generally vest over four years. During
1999, 1998 and 1997, the Company made contribution of $250,000, $200,000 and
$98,000 into the plan. The amount contributed into this plan was
F-18
<PAGE> 59
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
recognized as salaries and benefits expense in the Company's financial
statements. At December 31, 1999, the ESOP owned approximately 26,000 shares of
the Company's stock.
The Company also has a nonqualified deferred compensation plan for the
directors ("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 Company's deferred
compensation obligation of $170,000 and $135,000 as of December 31, 1999 and
1998 is included in accrued interest and other payable.
The Company 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
Company will receive death benefit payments upon the death of the director. The
proceeds will permit the Company 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.
During 1999 The Company converted its existing nonqualified key executive
and director defined contribution retirement and death benefit plan to a defined
benefit plan (Plan). The Plan is unsecured and unfunded and there are no Plan
assets. The Company has purchased insurance on the lives of the directors and
executive officers in the plan and intends to use the cash values of these
policies ($9,273,000 and $5,399,000 at December 31, 1999 and 1998, respectively)
to pay the retirement obligations. The accrued pension obligation was $395,000
and $55,000 as of December 31, 1999 and 1998, respectively. As a result of the
conversion, the Company recognized an additional $95,000 in expense to increase
the level of the accrued liability as a defined benefit plan. During 1999 the
Company contributed $340,000 to the Plan and the participants were not required
to contribute. The net periodic benefits cost of $262,128 was all related to
service cost. The net periodic cost was determined using a discount rate of 7%.
(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-19
<PAGE> 60
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The carrying amounts and estimated fair values of the Company's financial
instruments as of December 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
---------------------------- ------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNTS FAIR VALUE AMOUNTS FAIR VALUE
------------ ------------ ------------ --------------
<S> <C> <C> <C> <C>
Assets
Cash and cash
equivalents.......... $138,150,000 $138,150,000 $ 46,639,000 $ 46,639,000
Securities.............. 31,264,000 31,044,000 76,793,000 77,490,000
Loans, net.............. 289,094,000 288,526,000 265,561,000 265,513,000
Cash surrender value of
life insurance....... 9,273,000 9,273,000 5,399,000 5,399,000
Liabilities
Demand deposits,
noninterest
bearing.............. 109,432,000 109,432,000 124,995,000 124,995,000
Demand deposits,
interest bearing..... 9,898,000 9,898,000 9,061,000 9,061,000
Savings and money
market............... 164,060,000 164,060,000 143,518,000 143,518,000
Time deposits........... 135,150,000 135,465,000 91,384,000 91,578,000
</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.
Cash Surrender Value of Life Insurance
The carrying amount represents a reasonable estimate of fair value.
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
F-20
<PAGE> 61
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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.
(12) COMMITMENTS AND CONTINGENT LIABILITIES
Financial Instruments with Off-Balance Sheet Risk
Both HBC and HBEB are 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 Banks' 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 Banks use 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 Banks' control 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>
1999 1998
------------ ------------
<S> <C> <C>
Commitments to extend credit............................ $480,319,000 $114,816,000
Standby letters of credit............................... 2,845,000 4,619,000
------------ ------------
$483,164,000 $119,435,000
============ ============
</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
Banks evaluate each client's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Banks 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 is not material.
Standby letters of credit are written conditional commitments issued by the
Banks 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 is not
material.
F-21
<PAGE> 62
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(13) REGULATORY MATTERS
The Company and its subsidiary banks are 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 Company's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and the banks must meet specific capital guidelines that
involve quantitative measures of the Company's and the banks' assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Company's and the banks' 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 Company and the banks 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, 1999, the Company and the banks meets all capital adequacy
guidelines to which it is subject.
The most recent notification from the FDIC for the banks as of December 31,
1999 categorized HBC and HBEB as well capitalized under the regulatory framework
for prompt corrective action. As of December 31, 1998, FDIC categorized HBC as
adequately capitalized, and HBEB as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Company 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 bank's
category.
The Company's actual capital amounts and ratios are also presented in the
table.
<TABLE>
<CAPTION>
FOR CAPITAL
ACTUAL ADEQUACY PURPOSES:
------------------- ---------------------
AMOUNT RATIO AMOUNT RATIO
----------- ----- ----------- -------
<S> <C> <C> <C> <C>
As of December 31, 1999
Total Capital................................ $49,176,000 13.2% $29,706,000 greater than
(to risk-weighted assets) or equal to 8.0%
Tier 1 Capital............................... $44,530,000 12.0% $14,053,000 greater than
(to risk-weighted assets) or equal to 4.0%
Tier 1 Capital............................... $44,530,000 9.4% $19,012,000 greater than
(to average assets) or equal to 4.0%
As of December 31, 1998
Total Capital................................ $33,675,000 10.4% $25,880,000 greater than
(to risk-weighted assets) or equal to 8.0%
Tier 1 Capital............................... $29,850,000 9.2% $12,940,000 greater than
(to risk-weighted assets) or equal to 4.0%
Tier 1 Capital............................... $29,850,000 7.5% $15,971,000 greater than
or equal to 4.0%
(to average assets)
</TABLE>
F-22
<PAGE> 63
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
HBC'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, 1999
Total Capital........... $34,010,000 10.5% $25,558,000 greater than $31,948,000 greater than
(to risk-weighted or equal to $8.0% or equal to $10.0%
assets)
Tier 1 Capital.......... $29,611,000 9.3% $12,779,000 greater than $19,169,000 greater than
(to risk-wighted or equal to $4.0% or equal to $6.0%
assets)
Tier 1 Capital.......... $29,611,000 7.3% $16,187,000 greater than $20,234,000 greater than
(to average assets) or equal to $4.0% or equal to $5.0%
</TABLE>
<TABLE>
<CAPTION>
TO BE ADEQUATELY-
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE ACTION
ACTUAL ADEQUACY PURPOSES: PROVISIONS:
------------------- --------------------- -------------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ----- ----------- ------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total Capital.......... $27,697,000 9.3% $23,837,000 greater than $23,837,000 greater than
(to risk-weighted or equal to $8.0% or equal to $8.0%
assets)
Tier 1 Capital......... $24,172,000 8.1% $11,919,000 greater than $11,919,000 greater than
(to risk-wighted or equal to $4.0% or equal to $4.0%
assets)
Tier 1 Capital......... $24,172,000 6.2% $15,561,000 greater than $15,561,000 greater than
(to average assets) or equal to $4.0% or equal to $4.0%
</TABLE>
HBEB's actual capital amounts and ratios are also presented in the table.
<TABLE>
<CAPTION>
TO BE WELL-CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE ACTION
ACTUAL ADEQUACY PURPOSES: PROVISIONS:
------------------ -------------------- -----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- ----- ---------- ------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1999
Total Capital............ $6,212,000 11.8% $4,212,000 greater than $5,265,000 greater than
(to risk-weighted or equal to $8.0% or equal to $10.0%
assets)
Tier 1 Capital........... $5,608,000 10.7% $2,106,000 greater than $3,159,000 greater than
(to risk-wighted or equal to $4.0% or equal to $6.0%
assets)
Tier 1 Capital........... $5,608,000 8.1% $2,770,000 greater than $3,472,000 greater than
(to average assets) or equal to $4.0% or equal to $5.0%
As of December 31, 1998
Total Capital............ $5,402,000 18.9% $2,286,000 greater than $2,858,000 greater than
(to risk-weighted or equal to $8.0% or equal to $10.0%
assets)
Tier 1 Capital........... $5,102,000 17.9% $1,143,000 greater than $1,715,000 greater than
(to risk-wighted or equal to $4.0% or equal to $6.0%
assets)
Tier 1 Capital........... $5,102,000 15.2% $1,342,000 greater than $1,678,000 greater than
(to average assets) or equal to $4.0% or equal to $5.0%
</TABLE>
The Company is required to maintain reserves with the Federal Reserve Bank
of San Francisco. Reserve requirements are based on a percentage of certain
deposits. As of December 31, 1999, the Company maintained reserves of $1,152,000
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
F-23
<PAGE> 64
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. 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. At December 31, 1999,
the amount available for such dividend without prior written approval was
approximately $7,410,000 for HBC and zero for HBEB. Similar restrictions apply
to the amounts and sum of loans advances and other transfers of funds from the
banks to the Company.
(14) PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
As described in Note 1 to the consolidated financial statements, the merger
of Heritage Bank of Commerce with the Company became effective February 17,
1998. The condensed financial statements of Heritage Commerce Corp (parent
company only) follow:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED,
----------------------------
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
<S> <C> <C>
CONDENSED BALANCE SHEETS
Cash and cash equivalents................................. $11,230,000 $ 467,000
Investment in and advancements to subsidiaries............ 35,215,000 30,114,000
Other assets.............................................. 86,000 116,000
----------- -----------
Total........................................... $46,531,000 $30,697,000
=========== ===========
Liabilities............................................... $ 2,000,000 $ --
Shareholders' equity...................................... 44,531,000 30,697,000
----------- -----------
Total........................................... $46,531,000 $30,697,000
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED,
----------------------------
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
<S> <C> <C>
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Dividends from Bank subsidiaries........................... $ -- $ 300,000
Interest income............................................ 200,000 16,000
Interest expense........................................... (16,000) --
Other expenses............................................. (20,000) (618,000)
---------- ----------
Loss before equity in net income of subsidiary banks....... 164,000 (302,000)
Equity in undistributed net income of subsidiaries......... 2,917,000 2,336,000
Income tax expense (benefit)............................... (55,000) 116,000
---------- ----------
Net Income................................................. 3,026,000 2,150,000
---------- ----------
Other comprehensive income................................. (795,000) 240,000
---------- ----------
Comprehensive income....................................... $2,231,000 $2,390,000
========== ==========
</TABLE>
F-24
<PAGE> 65
HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED,
----------------------------
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
<S> <C> <C>
CONDENSED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Net Income................................................ $ 3,026,000 $ 2,150,000
Adjustments to reconcile net income to net cash provided
(used) by operations:
Provision for deferred income taxes..................... 55,000 --
Equity in undistributed income (losses) of
subsidiaries......................................... (2,917,000) (2,336,000)
Net change in other liabilities......................... (19,000) (116,000)
----------- -----------
Net cash used by operating activities..................... 145,000 (302,000)
Cash flows from investing activities
Other (dividends received from Bank subsidiaries)....... -- 300,000
Cash distributed to Bank subsidiaries................... (2,985,000) --
----------- -----------
Net cash provided by (used in) investing activities....... (2,985,000) 300,000
Cash flows from financing activities:
Proceeds from issuance of common stock.................. 11,603,000 5,969,000
Cash distributed to Bank subsidiaries................... -- (5,500,000)
Proceeds from other short-term borrowings............... 4,000,000 --
Repayments of other short-term borrowings............... (2,000,000) --
----------- -----------
Net cash provided by financing activities................. 13,603,000 469,000
Net increase in cash and cash equivalents................. 10,763,000 467,000
Cash and cash equivalents, beginning of year.............. 467,000 --
----------- -----------
Cash and cash equivalents, end of year.................... $11,230,000 $ 467,000
=========== ===========
</TABLE>
F-25
<PAGE> 66
EXHIBIT INDEX
<TABLE>
<CAPTION>
INCORPORATED BY REFERENCE TO
REPORT ON FORM
FILED ------------------------------------
HEREWITH 8-A DATED 10-K DATED EXHIBIT NO.
-------- --------- ---------- -----------
<C> <S> <C> <C> <C> <C>
3.1 Heritage Commerce Corp Articles of Incorporation: 3-5-98 4.1
[Incorporated herein by reference from Exhibit 4
to Heritage Commerce Corp's Form 8-A:
Registration of Securities Pursuant to Section
12(g) of the Securities Exchange Act of 1933
dated March 5, 1998 (File No. 000-23877).]
3.2 Heritage Commerce Corp Bylaws: [Incorporated 3-5-98 4.2
herein by reference from Exhibit 4 to Heritage
Commerce Corp's Form 8-A: Registration of
Securities Pursuant to Section 12(g) of the
Securities Exchange Act of 1933 dated March 5,
1998 (File No. 000-23877).]
10.1 Real Property Leases for properties located at 3-5-98 1
150 Almaden Blvd., San Jose and 100 Park Center
Plaza, San Jose. [This exhibit is incorporated by
reference to the paper filing of Heritage
Commerce Corp's Form 8-A filed March 5, 1998
(File No. 000-23877).]
10.2 Employment agreement with Mr. Rossell dated June 3-5-98 1
8, 1994 [This exhibit is incorporated by
reference to the paper filing of Heritage
Commerce Corp's Form 8-A filed March 5, 1998
(File No. 000-23877).]
10.3 Employment agreement with Mr. Gionfriddo dated 3-5-98 1
June 8, 1994 [This exhibit is incorporated by
reference to the paper filing of Heritage
Commerce Corp's Form 8-A filed March 5, 1998
(File No. 000-23877).]
10.4 Amendment No. 2 to Employment Agreement with Mr. 3-31-98 10.4
Gionfriddo.
10.5 Employment agreement with Mr. Conniff dated April 3-31-98
30, 1998.
10.6 Employment agreement with Mr. Nethercott dated 3-31-98
April 16, 1998.
10.7 Employment agreement with Mr. McGovern dated July 3-31-98
16, 1998.
21.1 Subsidiaries of the registrant. X
23 Consent of Deloitte & Touche LLP dated March 28, X
2000.
27.1 Financial data schedule. X
</TABLE>
<PAGE> 1
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-59277 of Heritage Commerce Corp on Form S-8 of our report dated January 21,
2000, appearing in this Annual Report on Form 10-K of Heritage Commerce Corp for
the year ended December 31, 1999.
/s/ Deloitte & Touche LLP
San Jose, California
March 28, 2000
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE HERITAGE
COMMERCE CORP AUDITED FINANCIAL STATEMENTS AT DECEMBER 31, 1999 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 10,049,000
<INT-BEARING-DEPOSITS> 309,108,000
<FED-FUNDS-SOLD> 128,100,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 13,834,000
<INVESTMENTS-CARRYING> 13,834,000
<INVESTMENTS-MARKET> 13,614,000
<LOANS> 271,855,000
<ALLOWANCE> 5,003,000
<TOTAL-ASSETS> 476,664,000
<DEPOSITS> 418,540,000
<SHORT-TERM> 0
<LIABILITIES-OTHER> 13,593,000
<LONG-TERM> 0
0
0
<COMMON> 41,021,000
<OTHER-SE> 3,510,000
<TOTAL-LIABILITIES-AND-EQUITY> 476,664,000
<INTEREST-LOAN> 25,727,000
<INTEREST-INVEST> 2,370,000
<INTEREST-OTHER> 3,124,000
<INTEREST-TOTAL> 31,221,000
<INTEREST-DEPOSIT> 10,409,000
<INTEREST-EXPENSE> 10,444,000
<INTEREST-INCOME-NET> 20,777,000
<LOAN-LOSSES> 1,911,000
<SECURITIES-GAINS> 1,004,000
<EXPENSE-OTHER> 19,724,000
<INCOME-PRETAX> 4,576,000
<INCOME-PRE-EXTRAORDINARY> 4,576,000
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,026,000
<EPS-BASIC> 0.51
<EPS-DILUTED> 0.45
<YIELD-ACTUAL> 5.64
<LOANS-NON> 1,396,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 3,825,000
<CHARGE-OFFS> 806,000
<RECOVERIES> 73,000
<ALLOWANCE-CLOSE> 5,003,000
<ALLOWANCE-DOMESTIC> 5,003,000
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 904,000
</TABLE>
