Heritage Commerce Corp Reports Strong Third Quarter 2016 Earnings of $6.8 Million

SAN JOSE, Calif., Oct. 27, 2016 (GLOBE NEWSWIRE) — Heritage Commerce Corp (Nasdaq:HTBK), the holding company (the “Company”) for Heritage Bank of Commerce (the “Bank”), today reported net income increased 96% to $6.8 million, or $0.18 per average diluted common share, for the third quarter of 2016, compared to $3.5 million, or $0.10 per average diluted common share for the third quarter of 2015, and decreased 7% from $7.3 million, or $0.19 per average diluted common share for the second quarter of 2016.  The second quarter of 2016 included a $1.0 million pre-tax gain from company-owned life insurance.

For the nine months ended September 30, 2016, net income was a record $20.2 million, or $0.53 per average diluted common share, an increase of 67% from $12.1 million, or $0.36 per average diluted common share, for the nine months ended September 30, 2015. All results are unaudited and the 2015 balances include the costs from the acquisition of Focus Business Bank (“Focus”) which was completed on August 20, 2015 (the “acquisition date”).

“We achieved record year-to-date earnings, along with strong third quarter 2016 earnings of $6.8 million,” said Walter Kaczmarek, President and Chief Executive Officer.  “Deposits grew by $256.6 million, or 13% year-over-year, and the increased liquidity was invested in lower yielding funds at the Federal Reserve Bank.  Asset quality was sound with nonperforming assets to total assets at 0.19%.” 

“The strength of our Company continues to be driven by the commitment of our employees.  Their hard work and dedication allow us to continue serving our clients and invest in the future of our franchise,” continued Mr. Kaczmarek.  “As demonstrated by our financial results, we are building a significant and well-diversified community business bank in Northern California.”

Third Quarter 2016 Highlights (as of, or for the period ended September 30, 2016, except as noted):

  • Diluted earnings per share totaled $0.18 for the third quarter of 2016, compared to $0.10 for the third quarter of 2015, and $0.19 for the second quarter of 2016.  Diluted earnings per share totaled $0.53 for the first nine months of 2016, compared to $0.36 per diluted share for the first nine months of 2015.
  • The return on average tangible assets was 1.13%, and the return on average tangible equity was 13.06%, for the third quarter of 2016, compared to 0.71% and 7.46%, respectively, for the third quarter of 2015, and 1.28% and 14.68%, respectively, for the second quarter of 2016.   The return on average tangible assets was 1.16%, and the return on average tangible equity was 13.45%, for the first nine months of 2016, compared to 0.93% and 9.22%, respectively, for the first nine months of 2015.
  • The second quarter of 2016 included a $1.0 million pre-tax gain from company-owned life insurance.  The 2015 balances included pre-tax acquisition, severance and retention costs incurred by the Company related to the Focus transaction totaling $2.9 million for the third quarter of 2015, and $3.4 million for the first nine months of 2015.
  • Net interest income increased 17% to $23.0 million for the third quarter of 2016, compared to $19.7 million for the third quarter of 2015, and increased 1% from $22.7 million for the second quarter of 2016.  For the first nine months of 2016, net interest income increased 26% to $68.1 million, compared to $54.2 million for the first nine months of 2015.
  • For the third quarter of 2016, the fully tax equivalent (“FTE”) net interest margin contracted 29 basis points to 4.10% from 4.39% for the third  quarter of 2015, primarily due to lower yields on loans and securities.   The net interest margin contracted 17 basis points for the third quarter of 2016, from 4.27% for the second quarter of 2016, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and a lower yield on securities.  For the first nine months of 2016, the net interest margin declined 35 basis points to 4.19%, compared to 4.54% for the first nine months of 2015, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and lower yields on loans and securities, which was partially offset by an increase in the accretion of the loan purchase discount income from the Focus transaction.
  • The accretion of the loan purchase discount in loan interest income from the Focus transaction was $299,000 for the third quarter of 2016, compared to $262,000 for the third quarter of 2015, and $276,000 for the second quarter of 2016.    The accretion of the loan purchase discount in loan interest income from the Focus transaction was $1.1 million for the first nine months of 2016, compared to $262,000 for the first nine months of 2015.   The total purchase discount on non-impaired loans from the Focus loan portfolio was $4.6 million at the acquisition date, of which $2.5 million has been accreted to loan interest income from the acquisition date through September 30, 2016. 
  • Loans (excluding loans‑held‑for‑sale) increased $117.8 million, or 9%, to $1.45 billion at September 30, 2016, compared to $1.33 billion at September 30, 2015, which included an increase of $68.5 million, or 5% in the Company’s legacy portfolio, and $49.3 million of purchased residential mortgage loans at September 30, 2016.  Loans decreased $13.9 million, or 1%, at September 30, 2016, compared to $1.46 billion at June 30, 2016, primarily due to a net $15.3 million decrease in land and construction loans as a result of the pay-off of $29.7 million in loans from the sale of projects at completion, and a net $7.5 million decrease in commercial real estate loans from $13.9 million in pay-offs, partially offset by an increase of $16.4 million in purchased residential mortgage loans.
  • Nonperforming assets (“NPAs”) were $4.8 million, or 0.19% of total assets, at September 30, 2016, compared to $5.9 million, or 0.26% of total assets, at September 30, 2015, and $4.7 million, or 0.20% of total assets, at June 30, 2016.
  • Classified assets were $18.7 million, or 0.74% of total assets, at September 30, 2016, compared to $18.0 million, or 0.79% of total assets, at September 30, 2015, and $22.8 million, or 0.96% of total assets, at June 30, 2016.
  • Net charge-offs totaled $134,000 for the third quarter of 2016, compared to net recoveries of $281,000 for the third quarter of 2015, and net recoveries of $112,000 for the second quarter of 2016.
  • There was a $245,000 provision for loan losses for the third quarter of 2016, compared to a $301,000 credit provision for loan losses for the third quarter of 2015, and a $351,000 provision for loan losses for the second quarter of 2016.  There was a $997,000 provision for loan losses for the nine months ended September 30, 2016, compared to a $339,000 credit provision for loan losses for the nine months ended September 30, 2015.
  • The allowance for loan losses (“ALLL”) was 1.38% of total loans at September 30, 2016, compared to 1.41% at September 30, 2015, and 1.36% at June 30, 2016.  The ALLL to total nonperforming loans was 445.55% at September 30, 2016, compared to 340.49% at September 30, 2015, and 456.90% at June 30, 2016.    
  • Total deposits increased $256.6 million, or 13%, to $2.22 billion at September 30, 2016, compared to $1.96 billion at September 30, 2015, and increased $144.9 million, or 7%, from $2.07 billion at June 30, 2016.  Deposits excluding all time deposits and CDARS deposits increased $291.2 million, or 17%, to $1.98 billion at September 30, 2016, from $1.69 billion at September 30, 2015, and increased $166.0 million, or 9%, from $1.81 billion at June 30, 2016. 
  • The Company’s consolidated capital ratios exceeded regulatory guidelines and the Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at September 30, 2016.
                 
            Well-capitalized   Fully Phased-in
            Financial   Basel III
            Institution    Minimal
    Heritage   Heritage   Basel III   Requirement(1)
    Commerce   Bank of   Regulatory   Effective
CAPITAL RATIOS   Corp   Commerce   Guidelines   January 1, 2019
Total Risk-Based     12.7 %     12.6 %       10.0 %         10.5 %  
Tier 1 Risk-Based     11.6 %     11.4 %       8.0 %         8.5 %  
Common Equity Tier 1 Risk-Based     11.6 %     11.4 %       6.5 %         7.0 %  
Leverage     8.9 %     8.7 %       5.0 %         4.0 %  
                         
(1) Requirements for both the Company and the Bank include a 2.5% capital conservation buffer, except the leverage ratio.                        
                         

Operating Results

Net interest income increased 17% to $23.0 million for the third quarter of 2016, compared to $19.7 million for the third quarter of 2015, and increased 1% from $22.7 million for the second quarter of 2016.   Net interest income increased 26% to $68.1 million for the nine months ended September 30, 2016, compared to $54.2 million for the nine months ended September 30, 2015.  Net interest income increased for the third quarter and first nine months of 2016, compared to the respective periods in 2015, primarily due to organic growth in the loan portfolio, the accretion of the loan purchase discount into interest income from the Focus transaction, and an increase in the average balance of investment securities.   

For the third quarter of 2016, the net interest margin (FTE) contracted 29 basis points to 4.10% from 4.39% for the third quarter of 2015, primarily due to lower yields on loans and securities.   The net interest margin contracted 17 basis points for the third quarter of 2016, from 4.27% for the second quarter of 2016, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and a lower yield on securities. For the first nine months of 2016, the net interest margin decreased 35 basis points to 4.19%, compared to 4.54% for the first nine months of 2015, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and lower yields on loans and securities, which was partially offset by an increase in the accretion of the loan purchase discount from the Focus transaction. 

There was a $245,000 provision for loan losses for the third quarter of 2016, compared to a $301,000 credit provision for loan losses for the third quarter of 2015, and a $351,000 provision for loan losses for the second quarter of 2016. There was a $997,000 provision for loan losses for the nine months ended September 30, 2016, compared to a $339,000 credit provision for loan losses for the nine months ended September 30, 2015.

Noninterest income increased to $2.3 million for the third quarter of 2016, compared to $2.1 million for the third quarter of 2015, and decreased from $3.7 million for the second quarter of 2016.  The decrease in noninterest income for the third quarter of 2016, compared to the second quarter of 2016, was primarily due to a $1.0 million gain from company owned life insurance and a $347,000 gain on sales of securities in the second quarter of 2016.  For the nine months ended September 30, 2016, noninterest income was $8.6 million, compared to $6.2 million at September 30, 2015.  The increase in noninterest income for the first nine months of 2016, compared to the first nine months of 2015, was primarily due to a $1.0 million gain on proceeds from company owned life insurance and higher gains on sales of securities.

The Company maintains life insurance policies for some directors and officers that are subject to split-dollar life insurance agreements, which continue after the participant’s employment termination or retirement.  During the second quarter of 2016, the Company received death benefit proceeds of $3.1 million from the life insurance policy of a former officer of a bank acquired by the Company.  The cash surrender value of the policy was $2.1 million, which resulted in a gain on proceeds from company owned life insurance of $1.0 million.

Total noninterest expense for the third quarter of 2016 was $14.3 million, compared to $16.4 million for the third quarter of 2015, and $14.4 million for the second quarter of 2016.   The decrease in noninterest expense in the third quarter of 2016, compared to the third quarter of 2015, was primarily due to pre-tax acquisition, severance and retention costs incurred by the Company related to the Focus transaction totaling $2.9 million for the third quarter of 2015.  Noninterest expense for the nine months ended September 30, 2016 increased to $43.4 million, compared to $41.3 million for the nine months ended September 30, 2015, primarily due to additional employees retained from Focus and an increase in amortization of the core deposit intangible assets as a result of the Focus acquisition, annual salary increases, newly hired employees and higher professional fees, partially offset by $3.4 million of pre-tax acquisition, severance and retention costs incurred by the Company for the first nine months of 2015.  Professional fees were significantly lower in the first nine months of 2015 due to recoveries of legal fees on problem loans that were paid off.  Full time equivalent employees were 264 at September 30, 2016, 272 at September 30, 2015, and 268 at June 30, 2016. 

The efficiency ratio for the third quarter of 2016 was 56.37%, compared to 75.49% for the third quarter of 2015, and 54.47% for the second quarter of 2016.  The efficiency ratio for the nine months ended September 30, 2016 was 56.55%, compared to 68.47% for the nine months ended September 30, 2015.  The higher efficiency ratio in the third quarter of 2015 and nine months ended September 30, 2015 was primarily due to one-time Focus acquisition, severance and retention costs.  Excluding the one-time Focus acquisition, severance and retention costs, the efficiency ratio was 62.32% for the third quarter of 2015, and 62.76% for the nine months ended September 30, 2015.

Income tax expense for the third quarter of 2016 was $4.1 million, compared to $2.2 million for the third quarter of 2015, and $4.4 million for the second quarter of 2016. The effective tax rate for the third quarter of 2016 was 37.5%, compared to 38.6% for the third quarter of 2015, and 37.5% for the second quarter of 2016.  The effective tax rate for the third quarter of 2015 was higher primarily due to the impact of non-deductible merger related expenses.  Income tax expense for the nine months ended September 30, 2016 was $12.2 million, compared to $7.3 million for the nine months ended September 30, 2015. The effective tax rate for the nine months ended September 30, 2016 was 37.6%, compared to 37.7% for the nine months ended September 30, 2015.  The difference in the effective tax rate for the periods reported, compared to the combined Federal and state statutory tax rate of 42%, is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds. 

Balance Sheet Review, Capital Management and Credit Quality

Total assets were $2.53 billion at September 30, 2016, compared to $2.26 billion at September 30, 2015, and $2.38 billion at June 30, 2016.  

The investment securities available-for-sale portfolio totaled $370.0 million at September 30, 2016, compared to $257.4 million at September 30, 2015, and $390.4 million at June 30, 2016.  At September 30, 2016, the Company’s securities available-for-sale portfolio was comprised of $352.6 million agency mortgage-backed securities (all issued by U.S. Government sponsored entities), $16.4 million of single entity issue trust preferred securities, and $1.0 million of corporate bonds. The pre-tax unrealized gain on securities available-for-sale at September 30, 2016 was $8.0 million, compared to a pre-tax unrealized gain on securities available-for-sale of $4.5 million at September 30, 2015, and a pre-tax unrealized gain on securities available-for-sale of $7.7 million at June 30, 2016.  

At September 30, 2016, investment securities held-to-maturity totaled $202.4 million, compared to $111.0 million at September 30, 2015, and $210.2 million at June 30, 2016.  At September 30, 2016, the Company’s securities held-to-maturity portfolio, at amortized cost, was comprised of $90.8 million tax-exempt municipal bonds, and $111.6 million agency mortgage-backed securities.

Loans (excluding loans‑held‑for‑sale) increased $117.8 million, or 9%, to $1.45 billion at September 30, 2016, compared to $1.33 billion at September 30, 2015, which included an increase of $68.5 million, or 5% in the Company’s legacy portfolio, and $49.3 million of purchased residential mortgage loans at September 30, 2016.  Loans decreased $13.9 million, or 1%, at September 30, 2016, compared to $1.46 billion at June 30, 2016, primarily due to a net $15.3 million decrease in land and construction loans as a result of the pay-off of $29.7 million in loans from the sale of projects at completion, and a net $7.5 million decrease in commercial real estate loans from $13.9 million in pay-offs, partially offset by an increase of $16.4 million in purchased residential mortgage loans.

The loan portfolio remains well-diversified with commercial and industrial (“C&I”) loans accounting for 42% of the loan portfolio at September 30, 2016, which included $47.8 million of factored receivables at Bay View Funding. Commercial real estate loans accounted for 42% of the total loan portfolio, of which 43% were owner-occupied by businesses.  Consumer and home equity loans accounted for 7% of total loans, land and construction loans accounted for 6% of total loans, and residential mortgage loans accounted for the remaining 3% of total loans at September 30, 2016.   C&I line usage was 41% at September 30, 2016, compared to 42% at June 30, 2016.

During the second and third quarters of 2016, the Company purchased jumbo single family residential mortgage loans totaling $51.6 million, all of which are domiciled in California.   The average loan principal amount is approximately $834,000, and the weighted average yield on the portfolio is 3.00%, net of servicing fees to the servicer.  Residential mortgages outstanding at September 30, 2016 totaled $49.3 million, compared to $32.9 million at June 30, 2016.

The yield on the loan portfolio was 5.60% for the third quarter of 2016, compared to 5.70% for the third quarter of 2015, and 5.60% for the second quarter of 2016. The yield on the loan portfolio was 5.61% for the nine months ended September 30, 2016, compared to 5.69% for the nine months ended September 30, 2015.  The decrease in the yield on the loan portfolio for the third quarter of 2016 and nine months ended September 30, 2016, compared to the respective periods in 2015, was primarily due to a decrease in the proportion of loans in the higher yielding Bay View Funding factored receivables portfolio relative to the addition of the Focus loans and growth in the Company’s legacy portfolio, partially offset by an increase in the accretion of the loan purchase discount into loan interest income from the Focus transaction.

At September 30, 2016, NPAs were $4.8 million, or 0.19% of total assets, compared to $5.9 million, or 0.26% of total assets, at September 30, 2015, and $4.7 million, or 0.20% of total assets, at June 30, 2016.  At September 30, 2016, the NPAs included no loans guaranteed by the SBA.  Foreclosed assets were $292,000 at September 30, 2016, compared to $393,000 at September 30, 2015, and $313,000 at June 30, 2016.  The following is a breakout of NPAs at the periods indicated:

    End of Period:
NONPERFORMING ASSETS September 30, 2016   June 30, 2016   September 30, 2015
(in $000’s, unaudited)   Balance   % of Total   Balance   % of Total   Balance   % of Total
Commercial and industrial loans   $   3,570       75 %   $   504       11 %   $   947       16 %
Commercial real estate loans       440       9 %       2,849       61 %       3,075       52 %
Foreclosed assets       292       6 %       313       7 %       393       7 %
Home equity and consumer loans     278       6 %       760       16 %       316       5 %
Land and construction loans        201       4 %       207       4 %       492       8 %
SBA loans       7       0 %       40       1 %       673       12 %
  Total nonperforming assets   $   4,788       100 %   $   4,673       100 %   $   5,896       100 %
                         

Classified assets were $18.7 million at September 30, 2016, compared to $18.0 million at September 30, 2015, and $22.8 million at June 30, 2016.  Classified assets include Small Business Administration (“SBA”) guarantees of $10,000 at September 30, 2016, $0 at September 30, 2015, and $14,000 at June 30, 2016.

The following table summarizes the allowance for loan losses:

    For the Quarter Ended   For the Nine Months Ended
ALLOWANCE FOR LOAN LOSSES September 30,   June 30,   September 30,   September 30,   September 30,
(in $000’s, unaudited)     2016       2016       2015       2016       2015  
Balance at beginning of period $   19,921     $   19,458     $   18,757     $   18,926     $   18,379  
Provision (credit) for loan losses during the period     245         351         (301 )       997         (339 )
Net recoveries (charge-offs) during the period     (134 )       112         281         109         697  
  Balance at end of period $   20,032     $   19,921     $   18,737     $   20,032     $   18,737  
                     
Total loans   $   1,450,176     $   1,464,114     $   1,132,405     $   1,450,176     $   1,332,405  
Total nonperforming loans $   4,496     $   4,360     $   5,503     $   4,496     $   5,503  
                     
Allowance for loan losses to total loans   1.38 %     1.36 %     1.41 %     1.38 %     1.41 %
Allowance for loan losses to total nonperforming loans   445.55 %     456.90 %     340.49 %     445.55 %     340.49 %
                     

The ALLL at September 30, 2016 was 1.38% of total loans, compared to 1.41% at September 30, 2015, and 1.36% at June 30, 2016.  The ALLL to total nonperforming loans was 445.55% at September 30, 2016, compared to 340.49% at September 30, 2015, and 456.90% at June 30, 2016.

Total deposits increased $256.6 million, or 13%, to $2.22 billion at September 30, 2016, compared to $1.96 billion at September 30, 2015, and increased $144.9 million, or 7%, at September 30, 2016, compared to $2.07 billion at June 30, 2016.  Deposits excluding all time deposits and CDARS deposits increased $291.2 million, or 17%, to $1.98 billion at September 30, 2016, from $1.69 billion at September 30, 2015, and increased $166.0 million, or 9%, from $1.81 billion at June 30, 2016.

The total cost of deposits remained the same at 0.15 % for the third quarter of 2016, the third quarter of 2015, and the second quarter of 2016.  The total cost of deposits was also at 0.15% for the nine months ended September 30, 2016 and September 30, 2015.

Tangible equity was $208.3 million at September 30, 2016, compared to $194.2 million at September 30, 2015, and $204.1 million at June 30, 2016.  Tangible book value per common share was $5.49 at September 30, 2016, compared to $5.44 at September 30, 2015, and $5.72 at June 30, 2016.  There was no Series C Preferred Stock outstanding at September 30, 2016, compared to 21,004 shares of Series C Preferred Stock outstanding at September 30, 2015 and June 30, 2016.  Pro forma tangible book value per common share, assuming the outstanding Series C Preferred Stock was converted into common stock, was $5.15 at September 30, 2015, and $5.39 at June 30, 2016.

On September 12, 2016, the Company entered into Exchange Agreements with Castle Creek Capital Partners IV, LP , Patriot Financial Partners, L.P. and Patriot Financial Partners Parallel, L.P. (collectively “Preferred Stockholders”) providing for the exchange of 21,004 shares of the Series C Preferred Stock, for 5,601,000 shares of the Company’s common stock. The exchange ratio was equal to the equivalent number of shares the Preferred Stockholders would have received upon conversion of the Series C Preferred Stock.

Accumulated other comprehensive loss was ($2.0) million at September 30, 2016, compared to ($2.0) million at September 30, 2015, and ($2.1) million at June 30, 2016. The unrealized gain on securities available-for-sale, net of taxes, included in accumulated other comprehensive loss was an unrealized gain of $4.7 million September 30, 2016, compared to $2.6 million at September 30, 2015, and $4.5 million at June 30, 2016.  The components of accumulated other comprehensive loss, net of taxes, at September 30, 2016 include the following: an unrealized gain on available-for-sale securities of $4.7 million; the remaining unamortized unrealized gain on securities available-for-sale transferred to held-to-maturity of $342,000; a split dollar insurance contracts liability of ($3.6) million; a supplemental executive retirement plan liability of ($4.0) million; and an unrealized gain on interest-only strip from SBA loans of $639,000.

Heritage Commerce Corp, a bank holding company established in February 1998, is the parent company of Heritage Bank of Commerce, established in 1994 and headquartered in San Jose with full-service branches in Danville, Fremont, Gilroy, Hollister, Los Altos, Los Gatos, Morgan Hill, Pleasanton, Sunnyvale, and Walnut Creek.  Heritage Bank of Commerce is an SBA Preferred Lender.  Bay View Funding, a subsidiary of Heritage Bank of Commerce, is based in Santa Clara and provides business‑essential working capital factoring financing to various industries throughout the United States.  For more information, please visit www.heritagecommercecorp.com.

Forward Looking Statement Disclaimer

These forward looking statements are subject to various risks and uncertainties that may be outside our control and our actual results could differ materially from our projected results. In addition, our past results of operations do not necessarily indicate our future results. The forward looking statements could be affected by many factors, including but not limited to: (1) local, regional, and national economic conditions and events and their impact on us and our customers; (2) changes in the financial performance or condition of the Company’s customers; (3) volatility in credit and equity markets and its effect on the global economy; (4) competition for loans and deposits and failure to attract or retain deposits and loans; (5) our ability to increase market share and control expenses; (6) our ability to develop and promote customer acceptance of new products and services in a timely manner; (7) risks associated with concentrations in real estate related loans; (8) other than temporary impairment charges to our securities portfolio; (9) an oversupply of inventory and deterioration in values of California commercial real estate; (10) a prolonged slowdown in construction activity; (11) changes in the level of nonperforming assets and charge offs and other credit quality measures, and their impact on the adequacy of the Company’s allowance for loan losses and the Company’s provision for loan losses; (12) the effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Open Market Committee of the Federal Reserve Board; (13) changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources; (14) our ability to raise capital or incur debt on reasonable terms; (15) regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company; (16) changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases, among others; (17) operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which we are highly dependent; (18) the ability to keep pace with, and implement on a timely basis, technological changes; (19) the impact of cyber security attacks or other disruptions to the Company’s information systems and any resulting compromise of data or disruptions in service; (20) changes in the competitive environment among financial or bank holding companies and other financial service providers; (21) the effect and uncertain impact on the Company of the enactment of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations promulgated by supervisory and oversight agencies implementing the new legislation; (22) significant changes in applicable laws and regulations, including those concerning taxes, banking and securities; (23) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; (24) the costs and effects of legal and regulatory developments, including resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews; (25) the successful integration of the business, employees and operations of Focus Business Bank with the Company and our ability to achieve the projected synergies of this acquisition within the expected time frame; and (26) our success in managing the risks involved in the foregoing factors.

Member FDIC

  For the Quarter Ended:   Percent Change From:   For the Nine Months Ended:    
CONSOLIDATED INCOME STATEMENTS  September 30, June 30, September 30,   June 30, September 30,   September 30, September 30,   Percent 
(in $000’s, unaudited)     2016       2016     2015       2016     2015         2016       2015     Change
Interest income $     23,874     $   23,504   $   20,306       2 %   18 %   $     70,440     $   55,847       26 %
Interest expense       826         760       623       9 %   33 %         2,344         1,664       41 %
  Net interest income before provision for loan losses       23,048         22,744       19,683       1 %   17 %         68,096         54,183       26 %
Provision (credit) for loan losses       245         351       (301 )     -30 %   181 %         997         (339 )     394 %
  Net interest income after provision for loan losses       22,803         22,393       19,984       2 %   14 %         67,099         54,522       23 %
Noninterest income:                      
  Service charges and fees on deposit accounts       798         783       748       2 %   7 %         2,348         2,086       13 %
  Increase in cash surrender value of life insurance       428         440       429       -3 %   0 %         1,317         1,225       8 %
  Servicing income       364         371       214       -2 %   70 %         1,106         819       35 %
  Gain on sales of SBA loans       69         279       267       -75 %   -74 %         653         660       -1 %
  Gain on proceeds from company owned life insurance       -          1,019       -        -100 %   N/A           1,019         -        N/A  
  Gain on sales of securities       -          347       -        -100 %   N/A           527         -        N/A  
  Other       653         421       408       55 %   60 %         1,616         1,366       18 %
  Total noninterest income       2,312         3,660       2,066       -37 %   12 %         8,586         6,156       39 %
                       
Noninterest expense:                      
  Salaries and employee benefits       8,363         8,742       10,358       -4 %   -19 %         26,052         26,112       0 %
  Occupancy and equipment       1,120         1,081       1,063       4 %   5 %         3,277         3,135       5 %
  Professional fees        1,086         708       612       53 %   77 %         2,619         946       177 %
  Other       3,727         3,850       4,386       -3 %   -15 %         11,414         11,119       3 %
  Total noninterest expense       14,296         14,381       16,419       -1 %   -13 %         43,362         41,312       5 %
Income before income taxes       10,819         11,672       5,631       -7 %   92 %         32,323         19,366       67 %
Income tax expense       4,054         4,377       2,172       -7 %   87 %         12,157         7,292       67 %
Net income       6,765         7,295       3,459       -7 %   96 %         20,166         12,074       67 %
Dividends on preferred stock       (504   )     (504 )     (448 )     0 %   13 %         (1,512   )     (1,344 )     13 %
Net income available to common shareholders       6,261         6,791       3,011       -8 %   108 %         18,654         10,730       74 %
Undistributed earnings allocated to Series C preferred stock       (300  )       (576 )     (111 )     -48 %   170 %         (1,278 )       (706 )     81 %
Distributed and undistributed earnings allocated to common                      
  shareholders $   5,961     $   6,215   $   2,900       -4 %   106 %   $    17,376     $   10,024       73 %
                       
PER COMMON SHARE DATA                      
(unaudited)                      
Basic earnings per share $     0.18     $   0.19   $   0.10       -5 %   80 %   $     0.53     $   0.37       43 %
Diluted earnings per share $     0.18     $   0.19   $   0.10       -5 %   80 %   $     0.53     $   0.36       47 %
Weighted average shares outstanding – basic     33,397,704         32,243,935       29,075,782       4 %   15 %        32,591,784         27,386,471       19 %
Weighted average shares outstanding – diluted      33,693,328         32,512,611       29,332,452       4 %   15 %       32,863,855         27,589,464       19 %
Common shares outstanding at period-end       37,915,736         32,294,063       32,076,505       17 %   18 %         37,915,736         32,076,505       18 %
Pro forma common shares outstanding at period-end, assuming                      
  Series C preferred stock was converted into common stock   N/A       37,895,063       37,677,505       N/A     N/A       N/A       37,677,505       N/A  
Book value per share  $     6.89     $   7.37   $   7.12       -7 %   -3 %   $     6.89     $   7.12       -3 %
Tangible book value per share $     5.49     $   5.72   $   5.44       -4 %   1 %   $     5.49     $   5.44       1 %
Pro forma tangible book value per share, assuming Series C                      
  preferred stock was converted into common stock   N/A   $   5.39   $   5.15       N/A     N/A       N/A   $   5.15       N/A  
                       
KEY FINANCIAL RATIOS                      
(unaudited)                      
Annualized return on average equity     10.38   %   11.58 %   6.41 %     -10 %   62 %       10.61   %   8.25 %     29 %
Annualized return on average tangible equity     13.06   %   14.68 %   7.46 %     -11 %   75 %       13.45   %   9.22 %     46 %
Annualized return on average assets     1.11   %   1.25 %   0.70 %     -11 %   59 %       1.13   %   0.92 %     23 %
Annualized return on average tangible assets     1.13   %   1.28 %   0.71 %     -12 %   59 %       1.16   %   0.93 %     25 %
Net interest margin     4.10   %   4.27 %   4.39 %     -4 %   -7 %       4.19   %   4.54 %     -8 %
Efficiency ratio     56.37   %   54.47 %   75.49 %     3 %   -25 %       56.55   %   68.47 %     -17 %
                       
AVERAGE BALANCES                      
(in $000’s, unaudited)                      
Average assets $     2,431,303     $   2,345,874   $   1,956,047       4 %   24 %   $     2,375,958     $   1,752,778       36 %
Average tangible assets $     2,378,045     $   2,292,248   $   1,925,912       4 %   23 %   $     2,322,317     $   1,732,057       34 %
Average earning assets $     2,263,997     $   2,172,349   $   1,805,801       4 %   25 %   $     2,198,178     $   1,622,605       35 %
Average loans held-for-sale $     5,992     $   2,951   $   3,197       103 %   87 %   $     4,568     $   1,985       130 %
Average total loans $     1,436,014     $   1,415,001   $   1,229,792       1 %   17 %   $     1,405,069     $   1,134,223       24 %
Average deposits $     2,121,469     $   2,042,524   $   1,693,282       4 %   25 %   $     2,065,170     $   1,509,210       37 %
Average demand deposits – noninterest-bearing $     842,565     $   780,116   $   652,529       8 %   29 %   $     800,049     $   578,117       38 %
Average interest-bearing deposits $     1,278,904     $   1,262,408   $   1,040,753       1 %   23 %   $     1,265,121     $   931,093       36 %
Average interest-bearing liabilities $     1,278,959     $   1,262,415   $   1,040,919       1 %   23 %   $     1,265,722     $   931,173       36 %
Average equity $     259,395     $   253,430   $   214,105       2 %   21 %   $     253,862     $   195,731       30 %
Average tangible equity $     206,137     $   199,804   $   183,970       3 %   12 %   $     200,221     $   175,010       14 %
                       

  End of Period:   Percent Change From:
CONSOLIDATED BALANCE SHEETS September 30, June 30, September 30,   June 30, September 30,
(in $000’s, unaudited)   2016     2016     2015       2016     2015  
ASSETS            
Cash and due from banks $   39,838   $   30,820   $   28,691       29 %   39 %
Federal funds sold and interest-bearing            
  deposits in other financial institutions     304,554       128,024       364,247       138 %   -16 %
Securities available-for-sale, at fair value     369,999       390,435       257,410       -5 %   44 %
Securities held-to-maturity, at amortized cost      202,404       210,170       111,004       -4 %   82 %
Loans held-for-sale – SBA, including deferred costs     6,741       4,879       7,873       38 %   -14 %
Loans:            
  Commercial     606,281       610,385       554,169       -1 %   9 %
  Real estate:            
  Commercial     612,030       619,539       606,819       -1 %   1 %
  Land and construction     88,371       103,710       84,867       -15 %   4 %
  Home equity     76,536       78,332       74,624       -2 %   3 %
  Residential mortgages     49,255       32,852       -        50 %   N/A  
  Consumer     18,328       20,037       12,595       -9 %   46 %
  Loans     1,450,801       1,464,855       1,333,074       -1 %   9 %
  Deferred loan fees     (625 )     (741 )     (669 )     -16 %   -7 %
  Total loans, net of deferred fees     1,450,176       1,464,114       1,332,405       -1 %   9 %
Allowance for loan losses     (20,032 )     (19,921 )     (18,737 )     1 %   7 %
  Loans, net     1,430,144       1,444,193       1,313,668       -1 %   9 %
Company owned life insurance     59,193       58,765       59,549       1 %   -1 %
Premises and equipment, net     7,552       7,542       7,513       0 %   1 %
Goodwill     45,664       45,664       44,898       0 %   2 %
Other intangible assets     7,342       7,734       8,906       -5 %   -18 %
Accrued interest receivable and other assets     54,531       50,066       58,448       9 %   -7 %
  Total assets $    2,527,962   $   2,378,292   $    2,262,207       6 %   12 %
             
LIABILITIES AND SHAREHOLDERS’ EQUITY            
Liabilities:            
  Deposits:            
  Demand, noninterest-bearing $   889,075   $   834,590   $   758,440       7 %   17 %
  Demand, interest-bearing     536,541       499,512       440,517       7 %   22 %
  Savings and money market      555,156       480,677       490,572       15 %   13 %
  Time deposits-under $250     57,718       60,761       65,626       -5 %   -12 %
  Time deposits-$250 and over     169,485       182,591       174,703       -7 %   -3 %
  Time deposits – brokered      3,000       6,079       24,150       -51 %   -88 %
  CDARS – money market and time deposits     7,659       9,574       8,015       -20 %   -4 %
  Total deposits     2,218,634       2,073,784       1,962,023       7 %   13 %
Borrowings     -        -        1,000       N/A     -100 %
Accrued interest payable and other liabilities     48,009       46,995       51,208       2 %   -6 %
  Total liabilities     2,266,643       2,120,779       2,014,231       7 %   13 %
             
Shareholders’ Equity:            
  Series C preferred stock, net     -        19,519       19,519       -100 %   -100 %
  Common stock     214,601       194,765       193,070       10 %   11 %
  Retained earnings     48,726       45,371       37,366       7 %   30 %
  Accumulated other comprehensive loss     (2,008 )     (2,142 )     (1,979 )     6 %   -1 %
  Total shareholders’ equity     261,319       257,513       247,976       1 %   5 %
  Total liabilities and shareholders’ equity $    2,527,962   $   2,378,292   $    2,262,207       6 %   12 %
             

  End of Period:   Percent Change From:
CREDIT QUALITY DATA  September 30, June 30, September 30,   June 30, September 30,
(in $000’s, unaudited)    2016     2016     2015       2016     2015  
Nonaccrual loans – held-for-investment $   4,496   $   4,360   $   5,503       3 %   -18 %
Foreclosed assets   292     313     393       -7 %   -26 %
  Total nonperforming assets $   4,788   $   4,673   $   5,896       2 %   -19 %
Other restructured loans still accruing $   137   $   141   $   183       -3 %   -25 %
Net (recoveries) charge-offs during the quarter $   134   $   (112 ) $   (281 )     220 %   148 %
Provision (credit) for loan losses during the quarter $   245   $   351   $   (301 )     -30 %   181 %
Allowance for loan losses $   20,032   $   19,921   $   18,737       1 %   7 %
Classified assets $   18,693   $   22,811   $   17,976       -18 %   4 %
Allowance for loan losses to total loans   1.38 %   1.36 %   1.41 %     1 %   -2 %
Allowance for loan losses to total nonperforming loans   445.55 %   456.90 %   340.49 %     -2 %   31 %
Nonperforming assets to total assets   0.19 %   0.20 %   0.26 %     -5 %   -27 %
Nonperforming loans to total loans   0.31 %   0.30 %   0.41 %     3 %   -24 %
Classified assets to Heritage Commerce Corp Tier 1            
  capital plus allowance for loan losses   8 %   10 %   8 %     -20 %   0 %
Classified assets to Heritage Bank of Commerce Tier 1            
  capital plus allowance for loan losses   8 %   10 %   8 %     -20 %   0 %
             
OTHER PERIOD-END STATISTICS            
(in $000’s, unaudited)            
Heritage Commerce Corp:            
  Tangible equity $   208,313   $   204,115   $   194,172       2 %   7 %
  Tangible common equity $   208,313   $   184,596   $   174,653       13 %   19 %
  Shareholders’ equity / total assets   10.34 %   10.83 %   10.96 %     -5 %   -6 %
  Tangible equity / tangible assets   8.42 %   8.78 %   8.79 %     -4 %   -4 %
  Tangible common equity / tangible assets   8.42 %   7.94 %   7.91 %     6 %   6 %
  Loan to deposit ratio   65.36 %   70.60 %   67.91 %     -7 %   -4 %
  Noninterest-bearing deposits / total deposits   40.07 %   40.24 %   38.66 %     0 %   4 %
  Total risk-based capital ratio   12.7 %   12.3 %   12.3 %     3 %   3 %
  Tier 1 risk-based capital ratio   11.6 %   11.2 %   11.2 %     4 %   4 %
  Common Equity Tier 1 risk-based capital ratio   11.6 %   10.2 %   10.2 %     14 %   14 %
  Leverage ratio   8.9 %   9.0 %   10.4 %     -1 %   -14 %
             
Heritage Bank of Commerce:            
  Total risk-based capital ratio   12.6 %   12.2 %   12.1 %     3 %   4 %
  Tier 1 risk-based capital ratio   11.4 %   11.1 %   11.0 %     3 %   4 %
  Common Equity Tier 1 risk-based capital ratio   11.4 %   11.1 %   11.0 %     3 %   4 %
  Leverage ratio   8.7 %   8.9 %   10.2 %     -2 %   -15 %
             

 

    For the Quarter Ended    For the Quarter Ended 
    September 30, 2016   September 30, 2015
        Interest   Average       Interest   Average
NET INTEREST INCOME AND NET INTEREST MARGIN   Average   Income/   Yield/   Average   Income/   Yield/
(in $000’s, unaudited)   Balance   Expense   Rate   Balance   Expense   Rate
Assets:                        
Loans, gross(1)   $ 1,442,006     $ 20,312       5.60 %   $ 1,232,989     $ 17,713       5.70 %
Securities – taxable     497,821       2,401       1.92 %     244,313       1,670       2.71 %
Securities – tax exempt(2)     91,241       875       3.82 %     91,127       874       3.80 %
Other investments and interest-bearing                        
  deposits in other financial institutions     232,929       592       1.01 %     237,372       355       0.59 %
  Total interest earning assets(2)     2,263,997       24,180       4.25 %     1,805,801       20,612       4.53 %
Cash and due from banks     32,628               34,921          
Premises and equipment, net     7,595               7,374          
Goodwill and other intangible assets     53,258               30,135          
Other assets     73,825               77,816          
  Total assets   $ 2,431,303             $ 1,956,047          
                         
Liabilities and shareholders’ equity:                        
Deposits:                        
  Demand, noninterest-bearing   $ 842,565             $ 652,529          
                         
  Demand, interest-bearing     515,296       259       0.20 %     326,922       144       0.17 %
  Savings and money market      516,570       289       0.22 %     444,702       240       0.21 %
  Time deposits – under $100     21,707       16       0.29 %     20,681       15       0.29 %
  Time deposits – $100 and over     212,201       251       0.47 %     206,909       173       0.33 %
  Time deposits – brokered      4,874       10       0.82 %     24,861       50       0.80 %
  CDARS – money market and time deposits     8,256       1       0.05 %     16,678       1       0.02 %
  Total interest-bearing deposits     1,278,904       826       0.26 %     1,040,753       623       0.24 %
  Total deposits     2,121,469       826       0.15 %     1,693,282       623       0.15 %
                         
Short-term borrowings     55             0.00 %     166             0.00 %
  Total interest-bearing liabilities     1,278,959       826       0.26 %     1,040,919       623       0.24 %
  Total interest-bearing liabilities and demand,                        
  noninterest-bearing / cost of funds     2,121,524       826       0.15 %     1,693,448       623       0.15 %
Other liabilities     50,384               48,494          
  Total liabilities     2,171,908               1,741,942          
Shareholders’ equity     259,395               214,105          
  Total liabilities and shareholders’ equity   $ 2,431,303             $ 1,956,047          
                         
Net interest income(2) / margin         23,354       4.10 %         19,989       4.39 %
Less tax equivalent adjustment(2)         (306 )             (306 )    
  Net interest income       $ 23,048             $ 19,683      
                         
(1)Includes loans held-for-sale.  Yield amounts earned on loans include loan fees and costs.  Nonaccrual loans are included in average balance.         
(2)Reflects tax equivalent adjustment for tax exempt income based on a 35% tax rate.                 
                         

    For the Nine Months Ended   For the Nine Months Ended
    September 30, 2016   September 30, 2015
        Interest   Average       Interest   Average
NET INTEREST INCOME AND NET INTEREST MARGIN Average   Income/   Yield/   Average   Income/   Yield/
(in $000’s, unaudited)   Balance   Expense   Rate   Balance   Expense   Rate
Assets:                        
Loans, gross(1)   $ 1,409,637     $ 59,235       5.61 %   $ 1,136,208     $ 48,360       5.69 %
Securities – taxable     500,497       8,004       2.14 %     230,608       4,828       2.80 %
Securities – tax exempt(2)     92,194       2,651       3.84 %     84,286       2,444       3.88 %
Federal funds sold and interest-bearing                        
  deposits in other financial institutions     195,850       1,478       1.01 %     171,503       1,070       0.83 %
  Total interest earning assets(2)     2,198,178       71,368       4.34 %     1,622,605       56,702       4.67 %
Cash and due from banks     32,927               28,647          
Premises and equipment, net     7,638               7,388          
Goodwill and other intangible assets     53,641               20,721          
Other assets     83,574               73,417          
  Total assets   $ 2,375,958             $ 1,752,778          
                         
Liabilities and shareholders’ equity:                        
Deposits:                        
  Demand, noninterest-bearing   $ 800,049             $ 578,117          
                         
  Demand, interest-bearing     505,442       731       0.19 %     265,095       349       0.18 %
  Savings and money market      506,998       829       0.22 %     403,385       623       0.21 %
  Time deposits – under $100     22,534       48       0.28 %     19,812       45       0.30 %
  Time deposits – $100 and over     212,300       660       0.42 %     202,512       485       0.32 %
  Time deposits – brokered      9,503       59       0.83 %     26,578       157       0.79 %
  CDARS – money market and time deposits     8,344       5       0.08 %     13,711       5       0.05 %
  Total interest-bearing deposits     1,265,121       2,332       0.25 %     931,093       1,664       0.24 %
  Total deposits     2,065,170       2,332       0.15 %     1,509,210       1,664       0.15 %
                         
Short-term borrowings     601       12       2.67 %     80             0.00 %
  Total interest-bearing liabilities      1,265,722       2,344       0.25 %     931,173       1,664       0.24 %
  Total interest-bearing liabilities and demand,                        
  noninterest-bearing / cost of funds     2,065,771       2,344       0.15 %     1,509,290       1,664       0.15 %
Other liabilities     56,325               47,757          
  Total liabilities     2,122,096               1,557,047          
Shareholders’ equity     253,862               195,731          
  Total liabilities and shareholders’ equity   $ 2,375,958             $ 1,752,778          
                         
Net interest income(2) / margin         69,024       4.19 %         55,038       4.54 %
Less tax equivalent adjustment(2)         (928 )             (855 )    
  Net interest income       $ 68,096             $ 54,183      
                         
(1)Includes loans held-for-sale.  Yield amounts earned on loans include loan fees and costs.  Nonaccrual loans are included in average balance.         
(2)Reflects tax equivalent adjustment for tax exempt income based on a 35% tax rate.                 
                         
CONTACT: CONTACT:
Heritage Commerce Corp
Debbie Reuter, EVP, Corporate Secretary
(408) 494-4542