-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, J636mjIwSVRuLu30+k6rmz71PxV+FNv8+tqepw2RXPNpT4SfaNlQGo9I2T3j5wMH 4IdNTO0yNAk2GDY0wLBNSg== 0001053352-98-000008.txt : 19980817 0001053352-98-000008.hdr.sgml : 19980817 ACCESSION NUMBER: 0001053352-98-000008 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HERITAGE COMMERCE CORP CENTRAL INDEX KEY: 0001053352 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 770469558 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-23877 FILM NUMBER: 98689512 BUSINESS ADDRESS: STREET 1: 150 ALMADEN BOULEVARD CITY: SAN JOSE STATE: CA ZIP: 95113 BUSINESS PHONE: 4089476900 MAIL ADDRESS: STREET 1: 150 ALMADEN BOULEVARD CITY: SAN JOSE STATE: CA ZIP: 95113 10-Q 1 FORM 10-Q FORM 10-Q. -- QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 1998 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transitional period from to (Amended by Exch Act Rel No. 312905. eff 4/26/93.) Commission File No. HERITAGE COMMERCE CORP (Exact name of registrant as specified in its charter) California 77-0469558 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 150 Almaden Blvd., San Jose, California 95113 (Address of principal executive offices) (Zip Code) (408) 947-6900 (Registrant's telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No APPLICABLE ONLY TO CORPORATE ISSUERS: The Registrant had 3,295,896 shares of Common Stock outstanding on July 1, 1998. HERITAGE COMMERCE CORP AND SUBSIDIARY QUARTERLY REPORT ON FORM 10-Q Table of Contents Part I - Financial Information Page Item 1. Condensed Consolidated Statements of Financial Condition At June 30, 1998 and December 31, 1997 1 Condensed Consolidated Statements of Income For the three and six months ended June 30, 1998 and 1997 2 Condensed Consolidated Statements of Cash Flows For the three and six months ended June 30, 1998 and 1997 3 Condensed Consolidated Notes to Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 6 Item 3. Quantitative and Qualitative Disclosures About Market Risk 14 Part II - Other Information Item 1. Legal Proceedings 15 Item 2. Submission of Matters to a Vote of Security Holders 15 Item 3. Other Information 15 Item 4. Exhibits and Reports on Form 8-K 16 Signatures 17 HERITAGE COMMERCE CORP AND SUBSIDIARY Condensed Consolidated Statements of Financial Condition
June 30, 1998 December 31, 1997 ASSETS (Unaudited) Cash and due from banks $ 21,284,000 $ 16,060,000 Federal funds sold 44,121,000 27,125,000 Total cash and cash equivalents 65,405,000 43,185,000 Securities available-for-sale, at fair value 75,857,000 61,166,000 Securities held-to-maturity, at amortized cost 28,182,000 26,531,000 (fair value of $28,522,000 and $26,938,000, respectively) Loans: Commercial 75,202,000 64,102,000 Real estate - mortgage 43,778,000 38,279,000 Real estate - land and construction 40,671,000 25,562,000 Consumer 10,621,000 827,000 Total loans 170,272,000 128,770,000 Allowance for loan losses (2,884,000) (2,285,000) Loans, net 167,388,000 126,485,000 Premises and equipment, net 2,935,000 1,971,000 Accrued interest receivable and other assets 4,625,000 3,764,000 Other investments 5,282,000 4,473,000 TOTAL $ 349,674,000 $ 267,575,000 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits: Demand, non-interest bearing $ 122,461,000 $ 97,736,000 Demand, interest bearing 7,557,000 6,319,000 Savings and money market 117,706,000 96,713,000 Time deposits, $100,000 and over 60,591,000 34,948,000 Time deposits less than $100,000 15,335,000 7,262,000 Total deposits 323,650,000 242,978,000 Accrued interest payable and other liabilities 2,576,000 2,261,000 Total liabilities 326,226,000 245,239,000 Shareholders' equity: Common Stock, no par value; 30,000,000 shares authorized; shares issued and outstanding: 3,295,896 at June 30, 1998 and at December 31, 1997 23,447,000 23,447,000 Accumulated other comprehensive income 546,000 418,000 Accumulated deficit (545,000) (1,529,000) Total shareholders' equity 23,448,000 22,336,000 TOTAL $ 349,674,000 $ 267,575,000 See notes to condensed consolidated financial statements.
HERITAGE COMMERCE CORP AND SUBSIDIARY Condensed Consolidated Statements of Income (Unaudited)
Three months ended June 30, Six months ended June 30, 1998 1997 1998 1997 Interest income: Interest and fees on loans $ 4,206,000 $ 2,357,000 $ 7,756,000 $ 4,489,000 Interest on investment securities - taxable 1,380,000 1,190,000 2,613,000 2,324,000 Interest on investment securities - non taxable 168,000 19,000 288,000 33,000 Interest on federal funds sold 295,000 181,000 512,000 295,000 Interest on other investments 57,000 --- 109,000 --- Total interest income 6,106,000 3,747,000 11,278,000 7,141,000 Interest expense: Savings and other interest-bearing deposits 1,063,000 670,000 1,916,000 1,304,000 Time certificates, $100,000 and over 604,000 302,000 1,093,000 570,000 Total interest expense 1,667,000 972,000 3,009,000 1,874,000 Net interest income 4,439,000 2,775,000 8,269,000 5,267,000 Provision for loan losses 350,000 145,000 510,000 365,000 Net interest income after provision for loan losses 4,089,000 2,630,000 7,759,000 4,902,000 Other income: Service charges and other fees 48,000 46,000 98,000 91,000 Other income 138,000 69,000 167,000 98,000 Total other income 186,000 115,000 265,000 189,000 Other expenses: Salaries and employee benefits 1,790,000 1,182,000 3,370,000 2,148,000 Client services 559,000 293,000 919,000 541,000 Occupancy 191,000 115,000 342,000 212,000 Advertising and promotion 189,000 114,000 369,000 205,000 Furniture and equipment 183,000 125,000 353,000 239,000 Professional fees 29,000 67,000 193,000 142,000 Deferred loan costs 114,000 71,000 195,000 134,000 Other 357,000 216,000 689,000 374,000 Total other expenses 3,412,000 2,183,000 6,430,000 3,995,000 Net income before income taxes 863,000 562,000 1,594,000 1,096,000 Provision for income taxes 333,000 197,000 611,000 384,000 Net income $ 530,000 $ 365,000 $ 983,000 $ 712,000 Net income per share (basic) $ 0.16 $ 0.11 $ 0.28 $ 0.22 Average number of common shares 3,295,896 3,291,653 3,295,896 3,289,738 Net income per share (diluted) $ 0.14 $ 0.11 $ 0.26 $ 0.21 Average number of common shares and common share equivalents 3,677,108 3,457,143 3,669,636 3,449,395 See accompanying notes to condensed consolidated financial statements.
HERITAGE COMMERCE CORP Condensed Consolidated Statements of Cash Flows (Unaudited)
Six Months ended June 30, 1998 1997 Cash flows from operating activities: Net income $ 983,000 $ 712,000 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 271,000 177,000 Provision for loan losses 510,000 365,000 Gain on sale of investments available-for-sale (67,000) (16,000) Amortization / accretion of discounts and premiums 37,000 86,000 Proceeds from sales of loans (33,000) (65,000) Originations of loans held for sale (2,157,000) (2,464,000) Maturities of loans held for sale 67,000 814,000 Increase in accrued interest receivable and other assets (861,000) (853,000) Increase in accrued interest payable and other liabilities 225,000 73,000 Net cash used by operating activities (1,025,000) (1,171,000) Cash flows from investing activities: Net increase in loans (39,290,000) (12,902,000) Purchases of investment securities available-for-sale (23,971,000) (20,222,000) Maturities of investment securities available-for-sale 7,513,000 7,018,000 Sales of investment securities available-for-sale 2,067,000 4,573,000 Purchases of investment securities held-to-maturity (7,014,000) (2,617,000) Maturities of investment securities held-to-maturity 5,311,000 3,179,000 Purchases of corporate owned life insurance (809,000) --- Capital expenditures (1,235,000) (453,000) Net cash used by investing activities (57,428,000) (21,424,000) Cash flows from financing activities: Net increase in deposits 80,673,000 49,716,000 Proceeds from sale of securities under agreement to repurchase --- (5,010,000) Proceeds from issuance of common stock --- 27,000 Net cash provided by financing activities 80,673,000 44,733,000 Net increase in cash and cash equivalents 22,150,000 22,138,000 Cash and cash equivalents, beginning of period 43,185,000 12,615,000 Cash and cash equivalents, end of period $ 65,335,000 $ 34,753,000 Other cash flow information: Interest paid $ 2,876,000 $ 1,830,000 Income taxes paid 521,000 463,000 Non-cash financing activity: Transfer from accumulated deficit to common stock due to stock dividend $ --- $ 1,304,000 See accompanying notes to condensed consolidated financial statements.
HERITAGE COMMERCE CORP AND SUBSIDIARY Notes to Condensed Consolidated Financial Statements June 30, 1998 (Unaudited) 1) Basis of Presentation The unaudited condensed consolidated financial statements of Heritage Commerce Corp and its wholly owned subsidiary, Heritage Bank of Commerce, have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and notes required by generally accepted accounting principles for complete financial statements are not included herein. The interim statements should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K Annual Report for the year ended December 31, 1997. In the Company's opinion, all adjustments necessary for a fair presentation of these condensed consolidated financial statements have been included and are of a normal and recurring nature. Certain reclassifications have been made to prior year amounts to conform with current year presentation. The results for the three months and six months ended June 30, 1998 are not necessarily indicative of the results expected for any subsequent period or for the entire year ended December 31, 1998. 2) Share and Per Share Amounts Earnings per common share (basic) are calculated based on the weighted average number of shares outstanding during the period. Earnings per common and common equivalent share (diluted) are calculated based on the weighted average number of shares outstanding during the period, plus equivalent shares representing the dilutive effect of stock options. There is no difference in net income for the purposes of calculating basic and diluted earnings per common share for each period presented. 3) Loan Classification The Bank classifies the guaranteed portion of Small Business Administration loans as "held for sale" according to generally accepted accounting principles, but for the purposes of this Form 10-Q, the balances are included in the commercial loan totals. 4) Deferred Loan Fees Loan totals in the balance sheet above are net of deferred loan fees totalling $143,000 and $113,000 at June 30, 1998 and December 31, 1997, respectively. 5) Comprehensive Income In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which requires that an enterprise report and display, by major components and as a single total, the change in its net assets during the period from non-owner sources. This Statement is effective for fiscal years beginning after December 15, 1997. The adoption of this Statement in the first quarter of 1998 resulted in a change in the financial statement presentation, but did not have an impact on the Company's consolidated financial position, results of operations or cash flows. Certain amounts in the prior period have been reclassified to conform to the current presentation under SFAS No. 130. Total comprehensive income for the three months ended June 30, 1998 and 1997 was $623,000 and $751,000, respectively. For the six months ended June 30, 1998 and 1997, total comprehensive income was $1,111,000 and $598,000, respectively. The following is a summary of the components of accumulated other comprehensive income:
For the Three Months Ended For The Six Months Ended June 30, 1998 June 30, 1997 June 30, 1998 June 30, 1997 (Unaudited) (Unaudited) (Unaudited) (Unaudited) Net Income $ 530 $ 365 $ 983 $ 712 Other comprehensive income, net of tax Net unrealized gain (loss) on available- for-sale securities during the period 142 386 195 (98) Less: reclassification adjustment for realized gains on available for sale securities included in net income during the period (49) --- (67) (16) Other comprehensive income 93 386 128 (114) Comprehensive income $ 623 $ 751 $ 1,111 $ 598
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Net income for the quarter and six months ended June 30, 1998 was $530,000 and $983,000, or $0.16 and $0.28 per share (basic), as compared to net income of $365,000 and $712,000, or $0.11 and $0.22 per share (basic) for the same periods in 1997. The increase was attributable to growth in the level of earning assets overall, and of loans in particular, funded by new deposits at favorable weighted average rates of interest. Return on average assets annualized for the first six months of 1998 was 0.8%, compared to 0.7% for the first six months of 1997. Annualized return on average equity for the first six months of 1998 was 10.1%, compared to 7.1% for the first six months of 1997. Average interest-earning assets for the quarter and six months ended June 30, 1998 were up $100,701,000 and $82,765,000 or 55% and 47% over 1997, with much of the increase primarily attributable to growth in loans. In January 1998, the Company's bank subsidiary, Heritage Bank of Commerce, launched its newest product, an internet credit card, which accounted for $9,262,000 and $7,661,000 of this growth during the six months and three months ended June 30, 1998. The average rate earned on loans in the second quarter and first six months of 1998 was up over 1997, and, as a result of the increase in both rate and volume of loans, the average rate on earning assets increased to 8.62% and 8.71% for the quarter and six months ended June 30, 1998, up from 8.20% and 8.12% for the same periods in 1997. Average interest-bearing liabilities were up $65,685,000 and $53,648,000 or 58% and 49% from the quarter and six months ended June 30,1997 to the same periods in 1998, with the increase attributable to growth in savings and money market accounts, growth in time deposits of $100,000 or more and growth in time deposits related to the internet credit card product. For the six months and three months ended June 30, 1998, time deposits related to the internet credit card were $9,990,000 and zero. The average rate paid on interest-bearing liabilities increased to 3.74% and 3.70% from 3.44% and 3.40% at the quarter and six months ended June 30, 1998 and 1997, respectively. However, due to the growth in interest-earning assets and the improvement in yield thereon, the net interest margin improved to 6.26% and 6.31% in the second quarter and first six months of 1998 from 6.07% and 6.00% in 1997. The Company had no non-performing assets (including nonaccrual loans, loans 90 days past due and still accruing and other real estate owned ("OREO") at June 30, 1998, December 31, 1997, and June 30, 1997. Shareholders' equity increased $1,112,000 to $23,448,000, or 6.71% of assets, at June 30, 1998, from $22,336,000 million , or 8.35% of assets, at December 31, 1997. The increase was due to an increase in net earnings. The Company's Tier 1 and total risk-based capital ratios were 11.5% and 13.0%, respectively, at June 30, 1998, compared to 14.6% and 15.8%, respectively, at December 31, 1997, and 18.5% and 19.7%, respectively, at June 30, 1997. The Company's leverage capital ratio decreased to 7.4% at June 30, 1998 from 10.3% at December 31, 1997 and 10.6% at June 30, 1997. At June 30, 1998, the Company's risk-based capital and leverage ratios exceeded the ratios for a well-capitalized financial institution as defined in FDICIA under the prompt corrective action regulations. RESULTS OF OPERATIONS Net Interest Income and Net Interest Margin The following table presents the Company's average balance sheet, net interest income and the resultant yields for the periods presented:
For the Three Months Ended For the Three Months Ended June 30, 1998 June 30, 1997 Average Interest Average Yield or Average Interest Average Yield or Balance Earned or Paid Rate Paid Balance Earned or Paid Rate Paid Interest-Earning Assets: Net loans $ 153,661 $ 4,206 10.95% $ 93,329 $ 2,357 10.10% Investments 107,924 1,604 5.94% 76,106 1,209 6.35% Federal funds sold 21,925 295 5.38% 13,374 181 5.41% Total interest-earning assets $ 283,510 $ 6,106 8.62% $ 182,809 $ 3,747 8.20% Interest-Bearing Liabilities Deposits: Money market and Interest-bearing demand $ 85,391 $ 620 2.90% $ 54,732 $ 359 2.62% Savings 34,661 321 3.70% 24,774 220 3.55% Time deposits, $100,000 and over 48,999 604 4.93% 25,642 302 4.71% Time deposits, less than $100,000 9,708 121 4.99% 7,917 91 4.60% Other borrowings --- --- 0.00% 10 --- 0.00% Total interest-bearing liabilities $ 178,759 $ 1,666 3.74% $ 113,075 $ 972 3.45% Net interest income / margin $ 4,439 6.28% $ 2,775 6.09%
Note: Yields and amounts earned on loans include loan fees of $362,000 and $137,000 for the three month periods ended June 30, 1998 and 1997, respectively.
For the Six Months Ended For the Six Months Ended June 30, 1998 June 30, 1997 Average Interest Average Yield or Average Interest Average Yield or Balance Earned or Paid Rate Paid Balance Earned or Paid Rate Paid Interest-Earning Assets: Net loans $ 143,917 $ 7,755 10.87% $ 90,235 $ 4,489 10.03% Investments 95,721 2,901 6.11% 74,592 2,357 6.37% Federal funds sold 19,075 512 5.42% 11,121 295 5.35% Total interest-earning assets $ 258,712 $ 11,169 8.71% $ 175,947 $ 7,141 8.18% Interest-Bearing Liabilities Deposits: Money market and Interest-bearing demand $ 78,747 $ 1,122 2.87% $ 53,386 $ 679 2.56% Savings 32,231 587 3.67% 24,345 430 3.56% Time deposits, $100,000 and over 44,271 1,093 4.98% 24,420 570 4.71% Time deposits, less than $100,000 8,609 207 4.84% 7,986 192 4.85% Other borrowings 6 --- 11.35% 80 2 5.93% Total interest-bearing liabilities $ 163,865 $ 3,009 3.70% $ 110,217 $ 1,874 3.43% Net interest income / margin $ 8,160 6.36% $ 5,267 6.04%
Note: Yields and amounts earned on loans include loan fees of $639,000 and $274,000 for the six month periods ended June 30, 1998 and 1997, respectively. The Company's net interest income for the second quarter of 1998 was $4,439,000, an increase of $1,664,000 over the second quarter of 1997. The Company's net interest income for the six month period ended June 30, 1998 was $8,269,000 an increase of $3,002,000 over the six month period ended June 30, 1997. When compared to the second quarter of 1997, average earning assets increased by $100,701,000, while the net yield on average earning assets increased from 6.09% in the second quarter of 1997 to 6.28% in the second quarter of 1998. When compared to the first six months of 1997, average earning assets increased by $82,765,000, while the net yield on average earning assets increased from 6.04% in the first six months of 1997 to 6.36% in the first six months of 1998. For both periods, the increase in net interest income was primarily due to an increase in the volume of interest-earning assets, predominantly loans. The following table sets forth an analysis of the changes in interest income and interest expense. The total change is shown in the column designated "Net Change" and is allocated in the columns to the left, to the portions respectively attributable to volume changes and rate changes that occurred during the period indicated. Changes due to both volume and rate have been allocated between the volume and rate categories in proportion to the relationship of the changes due solely to the changes in volume and rate, respectively.
Three Months Ended June 30 1998 vs. 1997 Increase (Decrease) Due to Change In: Volume Rate Net Change Interest-earning assets Net loans $ 1,637 $ 212 $ 1,849 Investments 477 (82) 395 Federal funds sold 115 (1) 114 Total interest-earning assets $ 2,229 $ 129 $ 2,358 Interest-bearing liabilities Money market and interest bearing demand $ 219 $ 42 $ 261 Savings 91 10 101 Time deposits, $100,000 and over 288 15 302 Time deposits, less than $100,000 22 8 30 Other borrowings --- --- --- Total interest-bearing liabilities $ 619 $ 75 $ 694 Change in net interest income $ 1,664
Six Months Ended June 30 1998 vs. 1997 Increase (Decrease) Due to Change In: Volume Rate Net Change Interest-earning assets Net loans $ 2,865 $ 401 $ 3,266 Investments 644 (100) 544 Federal funds sold 214 4 217 Total interest-earning assets $ 3,724 $ 305 $ 4,027 Interest-bearing liabilities Money market and interest bearing demand $ 354 $ 90 $ 444 Savings 143 13 156 Time deposits, $100,000 and over 488 35 523 Time deposits, less than $100,000 15 (1) 14 Other borrowings (3) 1 (2) Total interest-bearing liabilities $ 997 $ 138 $ 1,135 Change in net interest income $ 2,892
Provision for Loan Losses During the second quarter of 1998, the provision for loan losses was $350,000, up $205,000 from $145,000 for the second quarter of 1997. The increase in the provision was due to the overall growth of the loan portfolio. Non-interest income The following table sets forth the various components of the Bank's non-interest income for the periods indicated:
Increase (Decrease) Three months ended June 30, 1998 versus 1997 (Dollars in thousands) 1998 1997 Amount Percent Service charges and other fees 48 46 2 4% Gain on securities available-for-sale 49 --- 49 100 Gain on sale of loans held-for sale 49 60 (11) (18) Other income 40 9 31 344 Total 186 115 71 62%
Fee income from service charges rose 5% from the second quarter of 1997 to 1998. Many of the Bank's deposit accounts maintain balances higher than that which is required to offset activity charges and, as such, are not assessed fees. The following table sets forth the various components of the Bank's non-interest income for the periods indicated:
Increase (Decrease) Six months ended June 30, 1998 versus 1997 (Dollars in thousands) 1998 1997 Amount Percent Service charges and other fees 98 91 7 8% Gain on securities available-for-sale 67 16 51 319 Gain on sale of loans held-for sale 50 65 (15) (23) Other income 50 17 33 194 Total 265 189 76 40%
Fee income from service charges rose 7% from the first quarter of 1997 to 1998. Many of the Bank's deposit accounts maintain balances higher than that which is required to offset activity charges and, as such, are not assessed fees. Non-interest expense The following table sets forth the various components of the Bank's non-interest expenses for the periods indicated:
For The Three Months Ended June 30, Increase Percent Increase (Dollars in thousands) 1998 1997 (Decrease) (Decrease) Salaries and benefits $ 1,790 $ 1,182 $ 608 51% Client services 559 293 266 91% Advertising and promotion 189 114 75 66% Furniture and equipment 183 125 58 46% Professional fees 29 67 (38) (57)% Occupancy 191 115 76 66% Loan origination costs 114 71 43 61% All other 357 216 141 65% Total $ 3,412 $ 2,183 $ 1,229 56%
For The Six Months Ended June 30, Increase Percent Increase (Dollars in thousands) 1998 1997 (Decrease) (Decrease) Salaries and benefits $ 3,370 $ 2,148 $ 1,222 57% Client services 919 541 378 70% Advertising and promotion 369 205 164 80% Furniture and equipment 353 239 114 48% Professional fees 193 142 51 36% Occupancy 342 212 130 61% Loan origination costs 195 134 61 46% All other 689 374 315 84% Total $ 6,430 $ 3,995 $ 2,435 61%
Non-interest expenses for the second quarter of 1998 were $3,412,000, up $1,229,000 (or 56%) from $2,183,000 for the second quarter of 1997. Non-interest expenses for the first six months of 1998 were $6,430,000, up $2,435,000 (or 61%) from $3,995,000 for the first six months of 1997. The increase in non-interest expenses reflects the growth in infrastructure to support the Bank's loan and deposit growth. Non-interest expenses consist primarily of salaries and employee benefits (52% and 54% of total non-interest expenses for the second quarter of 1998 and 1997, respectively; 52% and 54% of total non-interest expenses for the six months ended June 30, 1998 and 1997, respectively) and client services (16% and 13% of total non-interest expenses for the second quarter of 1998 and 1997, respectively; 14% and 14% of total non-interest expenses for the first six months of 1998 and 1997, respectively). The increase in salaries and benefits expenses was primarily attributable to an increase in the number of employees. The Bank employed 113 people at June 30, 1998, up 37 from 76 employees at June 30, 1997. Client services expenses include outside data processing service costs, courier and armored car costs, imprinted check costs, and other client services costs, all of which are directly related to the amount of funds on deposit at the Bank. The increase in furniture and equipment expenses and in occupancy expenses was primarily attributable to an increase in the number of employees. Year 2000 The inability of computers, software, and other equipment utilizing microprocessors to recognize and properly process data fields containing a two-digit year is commonly referred to as the Year 2000 Compliance issue. As the year 2000 approaches, such systems may be unable to process accurately certain date-based information. The Company has identified all significant technical and business systems that will require modification to ensure Year 2000 Compliance. These systems include all computer hardware, computer software and such systems as telephones and alarms. Internal and external resources are being used to make the required modifications and test Year 2000 Compliance. The modification process of all significant systems is underway and should be substantially complete by September 30, 1998. The Company is currently testing all significant technical and business systems and is on schedule to complete the testing process by March 31, 1999. In addition, the Company has communicated with a vendor with whom it does significant business to determine their Year 2000 Compliance readiness and the extent to which the Company is vulnerable to any third-party Year 2000 risks. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will be converted in a timely manner, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The Company's bank subsidiary has begun the process of assessing the credit risk related to its borrowers' Year 2000 Compliance progress, and will integrate a Year 2000 Compliance element into its credit approval process by December 31, 1998. Depending on the outcomes of the testing process, the Company established several contingency plans should any system not be Year 2000 compliant. These contingency plans include the implementation of new vendors or applications, the installation of revised software and temporary reversions to less technology dependent systems. The total cost to the Company of Year 2000 Compliance issues, which includes testing, system replacement and any anticipated lost revenue, has not been and is not anticipated to be material to its financial position or results of operations in any given year. These costs and the date on which the Company plans to complete the Year 2000 modification and testing process are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third-party modification plans, and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ from those plans. FINANCIAL CONDITION Total assets increased 31% to $349,604,000 at June 30, 1998, compared to $267,575,000 at December 31, 1997. The growth was primarily due to increases in the Company's loan portfolio funded by growth in deposits. Loans Total gross loans increased 32% to $170,272,000 June 30, 1998, as compared to $128,770,000 at December 31, 1997. The increase in loan volume was due to the business development The following table indicates the Company's loan portfolio for the periods indicated:
June 30, 1998 December 31, 1997 Installment $ 1,185,000 $ 691,000 Commercial 44,313,000 39,353,000 Small Business Administration 24,908,000 21,965,000 Technology Loans 644,000 621,000 Factored Loans 5,266,000 1,865,000 Land and Construction 40,671,000 25,780,000 Equity Lines 4,958,000 4,275,000 Real Estate Loans 38,820,000 34,171,000 Internet Credit Card 9,262,000 --- Other 245,000 49,000 Total $ 170,272,000 $ 128,721,000
The Company's loan portfolio is concentrated in commercial (primarily manufacturing, wholesale, and service) and real estate lending, with the balance in consumer loans. While no specific industry concentration is considered significant, the Company's lending operations are located in the Company's market areas that are dependent on the technology and real estate industries and their supporting companies. Thus, the Company's borrowers could be adversely impacted by a downturn in these sectors of the economy which could reduce the demand for loans and adversely impact the borrowers' abilities to repay their loans. Allowance for loan losses Management conducts a critical evaluation of the loan portfolio monthly. This evaluation includes an assessment of the following factors: past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. Management has established an evaluation process designed to determine that adequacy of the allowance for loan losses. This process attempts to assess the risk of loss inherent in the portfolio by segregating the allowance for loan losses into four components: "watch", "special mention", "substandard" and "doubtful". It is the policy of management to maintain the allowance for possible loan losses at a level adequate for known and future risks inherent in the loan portfolio. Based on information currently available to analyze loan loss delinquency and a history of actual charge-offs, management believes that the loan loss provision and allowance are adequate; however, no assurance of the ultimate level of credit losses can be given with any certainty. Loans are charged against the allowance when management believes that the collectibility of the principal is unlikely. The following table summarizes the Bank's loan loss experience as well as transactions in the allowance for loan losses and certain pertinent ratios for the periods indicated:
Year Ended Three months ended June 30, December 31, (Dollars in thousands) 1998 1997 1997 Balance, beginning of period $ 2,540 $ 1,622 $ 1,402 Charge-offs - Commercial loans (6) --- (224) Recoveries - Commercial loans --- --- 47 Net charged-offs (6) --- (177) Provision for loan losses 350 145 1,060 Balance, end of period $ 2,884 $ 1,767 $ 2,285 Ratios: Net charge-offs to average loans outstanding 0.00% 0.00% 0.18% Allowance for possible loan losses to average loans 1.88 1.89 2.31 Allowance for possible loan losses to total loans at end of period 1.69 1.81 1.77
The following table summarizes the allocation of the allowance for possible loan losses by loan type and the allocated allowance as a percent of loans outstanding in each loan category at the dates indicated:
June 30, December 31, 1998 1997 1997 Allowance Allowance Allowance as a % of as a % of as a % of Loans Loans Loans Outstanding in Outstanding in Outstanding in Allowance Category Allowance Category Allowance Category Commercial $ 1,256 1.67% $ 516 1.11% $ 821 1.28% Real estate - mortgage 175 0.40 221 0.67 205 0.54 Real estate - land and construction 614 1.51 268 1.53 379 1.48 Consumer 105 0.99 5 0.95 7 0.85 Unallocated 734 756 873 Total $ 2,884 1.69% $ 1,766 1.81% $ 2,285 1.77%
The Bank maintains an allowance for possible loan losses to provide for estimated losses in the loan portfolio. Additions to the allowance are made by charges to operating expenses in the form of a provision for loan losses. All loans that are judged to be uncollectable are charged against the allowance and any recoveries are credited to the allowance. Deposits Deposits totaled $323,650,000 at June 30, 1998, an increase of 33%, as compared to total deposits of $242,978,000 at December 31, 1997. The increase in deposits was due to the Company's continued marketing efforts directed at commercial business clients, including the newly introduced internet products. Non-interest-bearing deposits were $122,461,000 at June 30, 1998, an increase of 25% as compared to $97,736,000 at December 31, 1997. Interest-bearing deposits were $201,189,000 at June 30, 1998, an increase of 39% as compared to $145,242,000 at December 31, 1997. In addition to the internet credit card, the Company has introduced new time deposits to be sold on the internet. For the six months and three months ended June 30, 1998 the Company has collected $9,990,000 and $7,661,000 from the sale of these deposits. The Company intends to collect funds in these internet time deposits in an amount approximately equal to that loaned through the internet credit card. However, in addition to the interest rate risk associated with these deposits, no assurances can be made that the Company will be able to collect these funds as indicated. Interest Rate Risk The careful planning of asset and liability maturities and the matching of interest rates to correspond with this maturity matching is an integral part of the active management of an institution's net yield. To the extent maturities of assets and liabilities do not match in a changing interest rate environment, net yields may change over time. Even with perfectly matched repricing of assets and liabilities, risks remain in the form of prepayment of loans or investments or in the form of delays in the adjustment of rates of interest applying to either earning assets with floating rates or to interest bearing liabilities. The Bank has generally been able to control its exposure to changing interest rates by maintaining primarily floating interest rate loans and a majority of its time certificates in relatively short maturities. The following table sets forth the interest rate sensitivity of the Company's interest-earning assets and interest-bearing liabilities as of June 30, 1998, using the rate sensitivity gap ratio. For purposes of the following table, an asset or liability is considered rate-sensitive within a specified period when it can be repriced or when it is scheduled to mature within the specified time frame:
Within Due in Due After Three Three to One to Due After Not Rate- (Dollars in thousands) Months Twelve Months Five Years Five Years Sensitive Total Interest earning assets: Federal funds sold $ 44,121 $ --- $ --- $ --- $ --- $ 44,121 Securities 4,311 10,363 51,659 37,705 --- 104,038 Total loans 129,662 16,780 16,565 7,056 209 170,272 Other assets --- 5,282 --- --- --- 5,282 Total interest earning assets 178,094 32,425 68,224 44,761 209 323,713 Cash and due from banks --- --- --- --- $ 21,285 21,285 Other assets --- --- --- --- 4,676 4,676 Total assets $ 178,094 $ 32,425 $ 68,224 $ 44,761 $ 26,170 $ 349,674 Interest bearing liabilities: Demand, interest-bearing $ 7,557 $ --- $ --- $ --- --- $ 7,557 Savings and money market 117,706 --- --- --- --- 117,706 Time deposits 36,333 37,398 2,195 --- --- 75,926 Total interest bearing liabilities 161,596 37,398 2,195 --- --- 201,189 Non-interest demand deposits $122,461 $ 122,461 Other liabilities 2,576 2,576 Shareholders' equity 23,448 23,448 Total liabilities and shareholders' equity $ 161,596 $ 37,398 $ 2,195 $ --- $148,485 $ 349,674 Interest rate sensitivity gap $ 16,498 $ (4,973) $ 66,029 $ 44,761 $(122,315) --- Cumulative interest rate sensitivity gap $ 16,498 $ 11,525 $ 77,554 $122,315 --- --- Cumulative interest rate sensitivity gap ratio 4.72% 3.30% 22.18% 34.99%
The foregoing table demonstrates that the Company had a positive cumulative one year gap of $11.5 million, or 3.30% of total assets, at June 30, 1998. In theory, this would indicate that $11.5 million more in assets than liabilities would reprice if there was a change in interest rates over the next year. If interest rates were to increase, the positive gap would tend to result in a higher net interest margin. However, changes in the mix of earning assets or supporting liabilities can either increase or decrease the net margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing of both the asset and its supporting liability can remain the same, thus impacting net interest income. This characteristic is referred to as a basis risk and, generally, relates to the repricing characteristics of short-term funding sources such as certificates of deposit. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities which are not reflected in the interest sensitivity analysis table. These prepayments may have significant effects on the Company's net interest margin. Because of these factors, an interest sensitivity gap report may not provide a complete assessment of the Company's exposure to changes in interest rates. Capital Resources The following table summarizes risk-based capital, risk-weighted assets, and risk-based capital ratios of the Company:
June 30, December 31, Minimum Regulatory (Dollars in thousands) 1998 1997 1997 Requirements Capital components: Tier 1 Capital $ 22,817 $ 21,018 $ 21,899 Tier 2 Capital 2,884 1,428 1,885 Total risk-based capital $ 25,701 $ 22,446 $ 23,784 Risk-weighted assets 198,183 113,889 150,418 Average assets 315,095 197,930 251,767 Capital ratios: Total risk-based capital 13.0% 19.7% 15.8% 8.0% Tier 1 risk-based capital 11.5 18.5 14.6 4.0 Leverage ratio (1) 7.4 10.6 10.3 4.0 (1) Tier 1 capital divided by average assets (excluding goodwill).
With the approval of the Securities and Exchange Commission, on June 17, 1998 the Company commenced an offering on Form S-1 of 387,097 shares of Common Stock at a price of $15.50 per share. As of June 30, 1998 the Offering was still open. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK No material changes have occurred during the quarter to the Company's market risk profile or information. For further information refer to the Company's Prospectus on Form S-1 and the Company's annual report on Form 10-K. Part II - Other Information Item 1. - Legal Proceedings To the best of the Bank's knowledge, there are no pending legal proceedings to which the Bank is a party which may have a materially adverse effect on the Bank's financial condition, results of operations, or cash flows. Item 2. - Changes in Securities and Use of Proceeds Not Applicable Item 3. - Defaults Upon Senior Securities Not Applicable Item 4. - Submission of Matters to a Vote of Security Holders The Company held its 1998 Annual Meeting of Shareholders on May 21, 1998 (the "1998 Annual Meeting"). There were 3,295,898 issued and outstanding shares of Company Common Stock on April 3, 1998, the Record Date for the 1998 Annual Meeting. At the 1998 Annual Meeting, the following actions were taken: Election of Directors At the 1998 Annual Meeting, fifteen directors of the Company were elected. The following chart indicates the number of shares cast for each elected director:
Director Votes For Votes Withheld Frank G. Bisceglia 2,440,504 865 James R. Blair 2,440,504 865 Arthur C. Carmichael, Jr. 2,440,504 865 William Del Biaggio, Jr. 2,438,772 865 Anneke Dury 2,440,504 865 Tracey A. Enfantino 2,438,004 3,365 Glenn A. George 2,440,504 865 Robert P. Gionfriddo 2,438,391 2,978 P. Michael Hunt 2,433,357 8,012 Louis O. Normandin 2,438,929 2,440 Jack L. Peckham 2,440,504 865 Robert W. Peters 2,440,504 865 Humphrey P. Polanen 2,440,504 865 John E. Rossell III 2,440,504 865 Kirk Rossman 2,440,504 865
Amendment of the Company's Stock Option Plan: The following chart indicates the results of the vote on the approval of the amendment to the Company's Restated 1994 Tandem Stock Option Plan. This amendment is for an increase in the number of shares available for grants of stock options to directors and key employees of the Company. FOR 2,363,446 AGAINST 52,912 Ratification of Auditors The following chart indicates the result of the vote on the ratification of the Board of Directors' selection of Deloitte & Touche, LLP to serve as the Company's independent auditors for the fiscal year ending December 31, 1998. FOR 2,413,988 AGAINST 7,852 Item 5. - Other Information Not Applicable Item 6. - Exhibits and Reports on Form 8-K (a) Exhibits included with this filing: Exhibit Number Name 27.1 Financial Data Schedule (b) Reports on Form 8-K On May 6, 1998, the Registrant filed Form 8-K with the SEC to report a $300,000 dividend payment by Heritage Bank of Commerce to its parent holding company, Heritage Commerce Corp. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Heritage Commerce Corp (Registrant) August 15, 1998 /s/ John E. Rossell Date John E. Rossell, III, President and CEO August 15, 1998 /s/ Lawrence D. McGovern Date Lawrence D. McGovern, Chief Financial Officer EX-27 2 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE HERITAGE COMMERCE CORP UNAUDITED FINANCIAL STATEMENTS AT JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 6-MOS DEC-31-1998 JUN-30-1998 21,284,257 0 44,121,000 0 74,906,330 28,181,991 28,522,252 170,272,222 2,883,814 349,674,000 323,650,540 0 2,019,464 0 0 0 23,446,581 1,000 349,674,000 7,756,000 2,901,000 621,000 11,278,000 0 3,009,000 8,269,000 510,000 117,000 6,430,000 1,594,000 1,594,000 0 0 983,000 0.28 0.26 8.71 34,437 0 0 0 2,540,000 6,000 0 2,884,000 2,150,000 0 734,000
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