-----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, UQyKyGjtmB+cxL7qieW3XIgojp7P7fpnPgzFShXIsfRt9sHlmOL8ic9Tj3A+pM2H Ze6SanqEdsVqfWOFKGzAIg== 0001053352-98-000012.txt : 19981116 0001053352-98-000012.hdr.sgml : 19981116 ACCESSION NUMBER: 0001053352-98-000012 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 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: 98746317 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 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1998 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transitional period from to (Amended by Exch Act Rel No. 312905. eff 4/26/93.) Commission File No. 000-23877 HERITAGE COMMERCE CORP (Exact name of registrant as specified in its charter) California 77-0469558 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 150 Almaden Blvd., San Jose, California 95113 (Address of principal executive offices) (Zip Code) (408) 947-6900 (Registrant's telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No APPLICABLE ONLY TO CORPORATE ISSUERS: The Registrant had 3,700,341 shares of Common Stock outstanding on November 2, 1998. HERITAGE COMMERCE CORP AND SUBSIDIARY QUARTERLY REPORT ON FORM 10-Q Table of Contents Part I - Financial Information Page Item 1. Condensed Consolidated Statements of Financial Condition At September 30, 1998 and December 31, 1997 1 Condensed Consolidated Statements of Income For the three and nine months ended September 30, 1998 and 1997 2 Condensed Consolidated Statements of Cash Flows For the three and nine months ended September 30, 1998 and 1997 3 Condensed Consolidated Notes to Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 6 Item 3. Quantitative and Qualitative Disclosures About Market Risk 15 Part II - Other Information Item 1. Legal Proceedings 16 Item 2. Submission of Matters to a Vote of Security Holders 16 Item 3. Other Information 16 Item 4. Exhibits and Reports on Form 8-K 16 Signatures 17 HERITAGE COMMERCE CORP AND SUBSIDIARY Condensed Consolidated Statements of Financial Condition
September 30, 1998 December 31, 1997 ASSETS (Unaudited) Cash and due from banks $ 24,210,000 $ 16,060,000 Federal funds sold 45,070,000 27,125,000 Total cash and cash equivalents 69,280,000 43,185,000 Securities available-for-sale, at fair value 68,031,000 61,166,000 Securities held-to-maturity, at amortized cost 27,717,000 26,531,000 (fair value of $28,597,000 and $26,938,000, respectively) Loans: Commercial 86,015,000 64,102,000 Real estate - mortgage 59,689,000 38,279,000 Real estate - land and construction 40,256,000 25,562,000 Internet Credit Card 34,623,000 --- Consumer 1,415,000 827,000 Total loans 221,998,000 128,770,000 Allowance for loan losses (3,402,000) (2,285,000) Loans, net 218,596,000 126,485,000 Premises and equipment, net 3,048,000 1,971,000 Accrued interest receivable and other assets 7,030,000 3,764,000 Other investments 5,377,000 4,473,000 TOTAL $ 399,079,000 $ 267,575,000 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits: Demand, non-interest bearing $ 126,740,000 $ 97,736,000 Demand, interest bearing 4,040,000 6,319,000 Savings and money market 140,565,000 96,713,000 Time deposits, $100,000 and over 49,856,000 34,948,000 Time deposits less than $100,000 24,495,000 7,262,000 Brokered Deposits (principally time deposits, $100,000 and over) 18,172,000 --- Total deposits 363,868,000 242,978,000 Accrued interest payable and other liabilities 4,698,000 2,261,000 Total liabilities 368,566,000 245,239,000 Shareholders' equity: Common Stock, no par value; 30,000,000 shares authorized; shares issued and outstanding: 3,689,946 at September 30, 1998 and 3,295,896 at December 31, 1997 29,342,000 23,447,000 Accumulated other comprehensive income 1,142,000 418,000 Retained Earnings (Accumulated deficit) 29,000 (1,529,000) Total shareholders' equity 30,513,000 22,336,000 TOTAL $ 399,079,000 $ 267,575,000 See notes to condensed consolidated financial statements.
HERITAGE COMMERCE CORP AND SUBSIDIARY Condensed Consolidated Statements of Income (Unaudited)
Three months ended Nine months ended September 30, September 30, 1998 1997 1998 1997 Interest income: Interest and fees on loans 5,626,000 2,695,000 13,381,000 7,184,000 Interest on investment securities - taxable 1,304,000 1,399,000 3,917,000 3,722,000 Interest on investment securities - non taxable 191,000 55,000 479,000 88,000 Interest on federal funds sold 348,000 130,000 861,000 425,000 Interest on other investments 95,000 --- 203,000 --- Total interest income 7,564,000 4,279,000 18,841,000 11,419,000 Interest expense: Savings and other interest-bearing deposits 1,629,000 781,000 3,544,000 2,084,000 Time certificates, $100,000 and over 721,000 349,000 1,814,000 919,000 Total interest expense 2,350,000 1,130,000 5,358,000 3,003,000 Net interest income 5,214,000 3,149,000 13,483,000 8,416,000 Provision for loan losses 550,000 240,000 1,060,000 605,000 Net interest income after provision for loan losses 4,664,000 2,909,000 12,423,000 7,811,000 Other income: Service charges and other fees 62,000 43,000 161,000 134,000 Gain on sale of securities available for sale 254,000 25,000 273,000 42,000 Non-interest income 185,000 157,000 333,000 238,000 Total other income 501,000 225,000 767,000 414,000 Non-interest expenses: Salaries and employee benefits 2,078,000 1,324,000 5,448,000 3,473,000 Client services 511,000 332,000 1,430,000 873,000 Furniture and equipment 236,000 149,000 589,000 387,000 Occupancy 224,000 110,000 566,000 322,000 Advertising and promotion 221,000 114,000 588,000 309,000 Third party servicing 169,000 --- 169,000 --- Stock offering fees 154,000 --- 154,000 --- Deferred loan costs 109,000 96,000 304,000 230,000 Professional fees 97,000 89,000 290,000 232,000 Other 399,000 258,000 1,090,000 642,000 Total other expenses 4,198,000 2,472,000 10,628,000 6,468,000 Net income before income taxes 967,000 662,000 2,562,000 1,757,000 Provision for income taxes 393,000 233,000 1,005,000 616,000 Net income 574,000 429,000 1,557,000 1,141,000 Net income per share (basic) $ 0.16 $ 0.13 $ 0.45 $ 0.35 Average number of common shares 3,687,015 3,292,049 3,426,036 3,290,508 Net income per share (diluted) $ 0.14 $ 0.12 $ 0.41 $ 0.33 Average number of common shares and common share equivalents 4,116,279 3,552,581 3,783,300 3,467,267 See notes to condensed consolidated financial statements.
HERITAGE COMMERCE CORP Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months ended September 30, 1998 1997 Cash flows from operating activities: Net income $ 1,557,000 $ 1,141,000 Adjustments to reconcile net income to net cash used by operating activities: Depreciation and amortization 447,000 281,000 Provision for loan losses 1,060,000 605,000 Gain on sale of investments available-for-sale (358,000) (42,000) Net amortization of premiums / accretion of discounts 139,000 97,000 Proceeds from sales of loans (83,000) (205,000) Originations of loans held for sale (2,845,000) (2,529,000) Maturities of loans held for sale 117,000 2,548,000 Increase in accrued interest receivable and other assets (3,264,000) (1,158,000) Increase in accrued interest payable and other liabilities 1,969,000 351,000 Net cash provided by (used by) operating activities (1,261,000) 1,089,000 Cash flows from investing activities: Net increase in loans (90,360,000) (25,771,000) Purchases of investment securities available-for-sale (25,484,000) (46,549,000) Maturities of investment securities available-for-sale 12,486,000 13,036,000 Sales of investment securities available-for-sale 7,635,000 6,684,000 Purchases of investment securities held-to-maturity (8,898,000) (3,347,000) Maturities of investment securities held-to-maturity 7,617,000 5,027,000 Purchases of corporate owned life insurance (904,000) (4,425,000) Capital expenditures (1,523,000) (524,000) Net cash used by investing activities (99,431,000) (55,869,000) Cash flows from financing activities: Net increase in deposits 120,892,000 85,094,000 Repayments from sale of securities under agreement to repurchase --- (5,010,000) Proceeds from exercise of stock options 49,000 --- Proceeds from issuance of common stock 5,846,000 35,000 Net cash provided by financing activities 126,787,000 80,119,000 Net increase in cash and cash equivalents 26,095,000 25,339,000 Cash and cash equivalents, beginning of period 43,185,000 12,615,000 Cash and cash equivalents, end of period 69,280,000 37,954,000 Other cash flow information: Interest paid in cash $ 4,963,000 $ 2,866,000 Income taxes paid in cash 1,034,000 986,000 Non-cash financing activity: Transfer from accumulated deficit to common stock due to stock dividend $ --- $ 1,304,000 See notes to condensed consolidated financial statements.
HERITAGE COMMERCE CORP AND SUBSIDIARY Notes to Condensed Consolidated Financial Statements September 30, 1998 (Unaudited) 1) Basis of Presentation The unaudited condensed consolidated financial statements of Heritage Commerce Corp and its wholly owned subsidiary, Heritage Bank of Commerce, have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and notes required by generally accepted accounting principles for complete financial statements are not included herein. The interim statements should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K Annual Report for the year ended December 31, 1997. In the Company's opinion, all adjustments necessary for a fair presentation of these condensed consolidated financial statements have been included and are of a normal and recurring nature. Certain reclassifications have been made to prior year amounts to conform with current year presentation. The results for the three months and nine months ended September 30, 1998 are not necessarily indicative of the results expected for any subsequent period or for the entire year ending December 31, 1998. 2) Share and Per Share Amounts Earnings per common share (basic) are calculated based on the weighted average number of shares outstanding during the period. Earnings per common and common equivalent share (diluted) are calculated based on the weighted average number of shares outstanding during the period, plus equivalent shares representing the dilutive effect of stock options. There is no difference in net income for the purposes of calculating basic and diluted earnings per common share for each period presented. 3) Loan Classification The Bank classifies the guaranteed portion of Small Business Administration loans as "held for sale" according to generally accepted accounting principles, but for the purposes of this Form 10- Q, the balances are included in the commercial loan totals. The balances of these loans were $12,535,000 at September 30, 1998 and $9,365,000 at December 31, 1997. 4) Deferred Loan Fees Loan totals in the balance sheet are net of deferred loan fees totaling $146,000 and $113,000 at September 30, 1998 and December 31, 1997, respectively. 5) Comprehensive Income In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which requires that an enterprise report and display, by major components and as a single total, the change in its net assets during the period from non-owner sources. This Statement is effective for fiscal years beginning after December 15, 1997. The adoption of this Statement in the first quarter of 1998 resulted in a change in the financial statement presentation, but did not have an impact on the Company's consolidated financial position, results of operations or cash flows. Certain amounts in the prior period have been reclassified to conform to the current presentation under SFAS No. 130. Total comprehensive income for the three months ended September 30, 1998 and 1997 was $1,170,000 and $719,000, respectively. The following is a summary of the components of accumulated other comprehensive income:
For the Three Months Ended For The Nine Months Ended September September September September 30, 1998 30, 1997 30, 1998 30, 1997 (Dollars in thousands) (Unaudited) (Unaudited) (Unaudited) (Unaudited) Net Income $ 574 $ 429 $ 1,557 $ 1,141 Other comprehensive income, net of tax Net unrealized gain on securities available-for-sale during the period 633 314 828 216 Less: reclassification adjustment for realized gains on available for sale securities included in net income during the period 37 24 104 40 Other comprehensive income 596 290 724 176 Comprehensive income 1,170 719 2,281 1,317
6) Issuance of Common Stock On June 19, 1998, the Company commenced an Offering of 387,097 shares of common stock at a price of $15.50 per share. The Company closed the Offering on July 30, 1998 after selling all the shares and collecting approximately $5,895,000 after expenses. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Net income for the quarter and nine months ended September 30, 1998 was $574,000 and $1,557,000 (restated to reflect the capitalization of certain common stock offering costs), or $0.16 and $0.45 per share (basic), as compared to net income of $429,000 and $1,141,000, or $0.13 and $0.35 per share (basic) for the same periods in 1997. The increase was attributable to growth in the level of earning assets overall, and of loans in particular, funded by new deposits at favorable weighted average rates of interest. Return on average assets annualized for the first nine months of 1998 was 0.67%, compared to 0.76% for the first nine months of 1997. The main factor behind this decrease was a 70% increase in the loan portfolio from September 30, 1997 to the same period in 1998. Annualized return on average equity for the first nine months of 1998 was 8.49%, compared to 7.31% for the first nine months of 1997. Average interest-earning assets for the quarter and nine months ended September 30, 1998 were up $120,429,000 and $97,994,000 or 59% and 53% over 1997, with much of the increase primarily attributable to growth in loans. In January 1998, the Company's bank subsidiary, Heritage Bank of Commerce, launched its newest product, an internet credit card, which accounted for $25,361,000 and $34,623,000 of this loan growth during the three months and nine months ended September 30, 1998. The average rate earned on loans in the third quarter and first nine months of 1998 was up over 1997, and, as a result of the increase in both rate and volume of loans, the average rate on earning assets increased to 9.29% and 8.94% for the quarter and nine months ended September 30, 1998, up from 8.38% and 8.30% for the same periods in 1997. Average interest-bearing liabilities increased $95,320,000 and $66,278,000 or 75% and 57% from the quarter and nine months ended September 30,1997 to the same periods in 1998, with the increase attributable to growth in interest bearing demand deposit and money market accounts, growth in time deposits of $100,000 or more and growth in time deposits in support of the internet credit card product. For the three months and nine months ended September 30, 1998, the loan portfolio increase attributed to time deposits related to the internet credit card were $25,672,000 and $35,662,000. The average rate paid on interest-bearing liabilities increased to 4.20% and 3.94% from 3.54% and 3.47% at the quarter and nine months ended September 30, 1998 and 1997, respectively. However, due to the growth in interest-earning assets and the improvement in yield thereon, the net interest margin improved to 6.41% and 6.40% in the third quarter and first nine months of 1998 from 6.17% and 6.12% for the same periods in 1997. The Company had no non-performing assets (including nonaccrual loans, loans 90 days past due and still accruing and other real estate owned ("OREO")) at September 30, 1998, December 31, 1997, and September 30, 1997. Shareholders' equity increased $8,177,000 to $30,513,000, or 7.65% of assets, at September 30, 1998, from $22,336,000 million , or 8.35% of assets, at December 31, 1997. The increase was mainly due to a stock offering of 387,097 shares at $15.50 which closed on July 30, 1998. The Company's Tier 1 and total risk-based capital ratios were 11.6% and 12.9%, respectively, at September 30, 1998, compared to 14.6% and 15.8%, respectively, at December 31, 1997, and 16.8% and 18.0%, respectively, at September 30, 1997. Due to the overall growth in total assets, more specifically the growth in the loan portfolio, the Company's leverage capital ratio decreased to 8.30% at September 30, 1998 from 8.9% at December 31, 1997 and 9.6% at September 30, 1997. At September 30, 1998, the Company's risk-based capital and leverage ratios exceeded the ratios for a well-capitalized financial institution as defined in FDICIA under the prompt corrective action regulations. 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 September 30, 1998 September 30, 1997 Interest Average Interest Average Average Earned or Yield or Average Earned or Yield or Balance Paid Rate Paid Balance Paid Rate Paid Interest-Earning Assets: Net loans $ 190,663 $ 5,626 11.71% $ 101,158 $ 2,695 10.57% Investments 106,606 1,590 5.92% 91,868 1,453 6.28% Federal funds sold 25,667 348 5.38% 9,481 130 5.45% Total interest-earning assets $ 322,936 $ 7,564 9.29% $ 202,507 $ 4,278 8.38% Interest-Bearing Liabilities Deposits: Money market and Interest- bearing demand $ 117,568 $ 1,085 3.66% $ 63,740 $ 431 2.68% Savings 21,791 223 4.05% 27,548 262 3.78% Time deposits, $100,000 and over 59,717 721 4.79% 27,972 349 4.95% Time deposits, less than $100,000 18,643 253 5.39% 7,371 86 4.62% Brokered Deposits 4,166 66 6.32% --- --- 0.00% Other borrowings 148 2 5.81% 82 1 5.66% Total interest-bearing liabilities $ 222,033 $ 2,350 4.20% $ 126,713 $ 1,129 3.54% Net interest income / margin $ 5,214 6.41% $ 3,149 6.17% Note: Yields and amounts earned on loans include loan fees of $407,000 and $192,000 for the three month periods ended September 30, 1998 and 1997, respectively.
For the Nine Months Ended For the Nine Months Ended September 30, 1998 September 30, 1997 Interest Average Interest Average Average Earned or Yield or Average Earned or Yield or Balance Paid Rate Paid Balance Paid Rate Paid Interest-Earning Assets: Net loans $ 157,924 $ 13,381 11.33% $ 92,875 $ 7,184 10.34% Investments 102,596 4,600 5.99% 80,387 3,810 6.34% Federal funds sold 21,310 861 5.40% 10,574 425 5.37% Total interest-earning assets $ 281,830 $ 18,842 8.94% $ 183,836 $ 11,419 8.30% Interest-Bearing Liabilities Deposits: Money market and Interest- bearing demand $ 91,792 $ 2,206 3.21% $ 56,852 $ 1,110 2.61% Savings 28,738 809 3.77% 25,422 693 3.64% Time deposits, $100,000 and over 48,089 1,814 5.04% 25,615 919 4.80% Time deposits, less than $100,000 11,967 460 5.14% 7,779 278 4.77% Brokered Deposits 1,385 66 6.40% --- --- 0.00% Other borrowings 55 3 7.29% 80 4 6.68% Total interest-bearing liabilities $ 182,026 $ 5,358 3.94% $ 115,748 $ 3,004 3.47% Net interest income / margin $ 13,484 6.40% $ 8,415 6.12% Note: Yields and amounts earned on loans include loan fees of $1,046,000 and $466,000 for the nine month periods ended September 30, 1998 and 1997, respectively.
The Company's net interest income for the third quarter of 1998 was $5,214,000, an increase of $2,065,000 over the third quarter of 1997. The Company's net interest income for the nine month period ended September 30, 1998 was $13,483,000 an increase of $5,067,000 over the nine month period ended September 30, 1997. When compared to the third quarter of 1997, average earning assets increased by $120,429,000, while the net yield on average earning assets increased from 6.17% in the third quarter of 1997 to 6.41% in the third quarter of 1998. When compared to the first nine months of 1997, average earning assets increased by $97,994,000, while the net yield on average earning assets increased from 6.12% in the first nine months of 1997 to 6.40% in the first nine months of 1998. For both periods, the increase in net interest income was primarily due to an increase in the volume of interest- earning assets, predominantly loans. The following table sets forth an analysis of the changes in interest income and interest expense. The total change is shown in the column designated "Net Change" and is allocated in the columns to the left, to the portions respectively attributable to volume changes and rate changes that occurred during the period indicated. Changes due to both volume and rate have been allocated between the volume and rate categories in proportion to the relationship of the changes due solely to the changes in volume and rate, respectively. Three Months Ended September 30 1998 vs. 1997 Increase (Decrease) Due to Change In: Volume Rate Net Change Interest-earning assets Net loans 2,613 318 2,931 Investments 223 (87) 136 Federal funds sold 220 (2) 218 Total interest-earning assets 3,056 229 3,285 Interest-bearing liabilities Money market and interest bearing demand 457 196 653 Savings (58) 18 (40) Time deposits, $100,000 and over 384 (12) 372 Time deposits, less than $100,000 151 17 168 Brokered Deposits 66 --- 66 Other borrowings 1 --- 1 Total interest-bearing liabilities 1,001 219 1,220 Change in net interest income 2,065
Nine Months Ended September 30 1998 vs. 1997 Increase (Decrease) Due to Change In: Volume Rate Net Change Interest-earning assets Net loans 5,454 743 6,197 Investments 1,005 (216) 789 Federal funds sold 434 3 437 Total interest-earning assets 6,893 530 7,423 Interest-bearing liabilities Money market and interest bearing demand 797 299 1,096 Savings 93 24 117 Time deposits, $100,000 and over 845 49 894 Time deposits, less than $100,000 160 23 183 Other borrowings (1) --- (1) Brokered Deposits 66 --- 66 Total interest-bearing liabilities 1,960 395 2,355 Change in net interest income 5,068
Provision for Loan Losses During the third quarter of 1998, the provision for loan losses was $550,000, up $310,000 from $240,000 for the third quarter of 1997. The increase in the provision was due to the overall growth of the loan portfolio. 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 September 30, 1998 versus 1997 (Dollars in thousands) 1998 1997 Amount Percent Service charges and other fees 62 42 20 48% Gain on securities available-for-sale 291 26 265 1019% Gain on sale of loans 54 138 (84) (61%) Other income 94 19 75 408% Total 501 225 276 123%
The following table sets forth the various components of the Bank's non- interest income for the periods indicated: Increase (Decrease) Nine months ended September 30, 1998 versus 1997 (Dollars in thousands) 1998 1997 Amount Percent Service charges and other fees 161 134 27 20% Gain on securities available-for-sale 358 41 317 773% Gain on sale of loans held-for sale 104 203 (99) (49%) Other income 144 36 108 300% Total 767 414 353 85%
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 September 30, Increase Percent Increase (Dollars in thousands) 1998 1997 (Decrease) (Decrease) Salaries and benefits $ 2,078 $ 1,324 $ 754 57% Client services 511 332 179 54% Furniture and equipment 236 149 87 58% Occupancy 224 110 114 104% Advertising and promotion 221 114 107 94% Third party servicing 169 --- 169 100% Stock offering fees 154 --- 154 100% Loan origination costs 109 96 13 14% Professional fees 97 89 8 9% All other 399 258 141 55% Total 4,198 2,472 1,726 70%
For The Nine Months Ended September 30, Increase Percent Increase (Dollars in thousands) 1998 1997 (Decrease) (Decrease) Salaries and benefits $ 5,448 $ 3,473 $ 1,975 57% Client services 1,430 873 557 64% Furniture and equipment 589 387 202 52% Advertising and promotion 588 309 279 90% Occupancy 566 322 244 76% Loan origination costs 304 230 74 32% Professional fees 290 232 58 25% Third party servicing 169 --- 169 100% Stock offering fees 154 --- 154 100% All other 1,090 642 448 70% Total $ 10,628 $ 6,468 $ 4,160 64%
Non-interest expenses for the third quarter of 1998 were $4,198,000, up $1,726,000 (or 70%) from $2,472,000 for the third quarter of 1997. Non- interest expenses for the first nine months of 1998 were $10,628,000, up $4,160,000 (or 64%) from $6,468,000 for the first nine months of 1997. The increase in non-interest expenses reflects the growth in infrastructure to support the Bank's loan and deposit growth. Non-interest expenses consist primarily of salaries and employee benefits (49% and 54% of total non-interest expenses for the third quarter of 1998 and 1997, respectively; 51% and 54% of total non-interest expenses for the nine months ended September 30, 1998 and 1997, respectively) and client services (12% and 13% of total non-interest expenses for the third quarter of 1998 and 1997, respectively; 13% and 14% of total non-interest expenses for the first nine months of 1998 and 1997, respectively). The increase in salaries and benefits expenses was primarily attributable to an increase in the number of employees. The Bank employed 118 people at September 30, 1998, up 36 from 82 employees at September 30, 1997. Client services expenses include outside data processing service costs, courier and armored car costs, imprinted check costs, and other client services costs, all of which are directly related to the amount of funds on deposit at the Bank. The increase in furniture and equipment expenses and in occupancy expenses was primarily attributable to an increase in the number of employees. Year 2000 The inability of computers, software, and other equipment utilizing microprocessors to recognize and properly process data fields containing a two- digit year is commonly referred to as the Year 2000 Compliance issue. As the year 2000 approaches, such systems may be unable to process accurately certain date-based information. The Company has identified all significant technical and business systems that will require modification to ensure Year 2000 Compliance. These systems include all computer hardware, computer software and such systems as telephones and alarms. Internal and external resources are being used to make the required modifications and test Year 2000 Compliance. The modification process of all significant systems is underway and is approximately 90% complete as of September 30, 1998 with full completion expected by December 31, 1998. The Company is currently testing all significant technical and business systems and is on schedule to complete the testing process by March 31, 1999. In addition, the Company is in the process of, or has communicated with, all vendors with whom it does significant business to determine their Year 2000 Compliance readiness and the extent to which the Company is vulnerable to any third-party Year 2000 risks. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will be converted in a timely manner, or that a failure to convert by another company, or a conversion that is incompatible with the Company's systems, would not have a material adverse effect on the Company. The Company's bank subsidiary has begun the process of assessing the credit risk related to its borrowers' Year 2000 Compliance progress, and will integrate a Year 2000 Compliance element into its credit approval process by December 31, 1998. Depending on the outcomes of the testing process, the Company established several contingency plans should any system not be Year 2000 compliant. These contingency plans include the implementation of new vendors or applications, the installation of revised software and temporary reversions to less technology dependent systems. The total cost to the Company of Year 2000 Compliance issues, which includes testing, system replacement and any anticipated lost revenue, has not been and is not anticipated to be material to its financial position or results of operations in any given year. These costs and the date on which the Company plans to complete the Year 2000 modification and testing process are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third-party modification plans, and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ from those plans. FINANCIAL CONDITION Total assets increased 49% to $399,079,000 at September 30, 1998, compared to $267,575,000 at December 31, 1997. The growth was primarily due to increases in the Company's loan portfolio funded by growth in deposits. Loans Total gross loans increased 72% to $221,998,000 September 30, 1998, as compared to $128,770,000 at December 31, 1997. The increase in loan volume was due to the introduction of an internet credit card and the business development efforts of the Company's loan teams. The following table indicates the Company's loan portfolio for the periods indicated:
September 30, 1998 December 31, 1997 Installment $ 1,219,000 $ 691,000 Commercial 54,846,000 39,402,000 Small Business Administration 26,863,000 21,965,000 Technology Loans 680,000 621,000 Factored Loans 3,823,000 1,865,000 Land and Construction 40,256,000 25,780,000 Equity Lines 5,299,000 4,275,000 Real Estate Loans 54,389,000 34,171,000 Internet Credit Card 34,623,000 --- Total $ 221,998,000 $ 128,770,000
In February 1998, the Company's bank subsidiary, Heritage Bank of Commerce (the "Bank"), entered into a contract with Internet Access Financial Corporation to provide a credit card over the internet. These customers are not limited to Silicon Valley, the Company's primary market area, as the product is available to anyone across the country. It is the intention of the Bank to collect certificates of deposit generated through the same internet based system in an amount approximately equal to that loaned through the credit card program, however, no assurances can be made that these funds will be collected as indicated. The Company's loan portfolio is concentrated in commercial (primarily manufacturing, wholesale, and service) and real estate lending, with the balance in consumer loans. Due to increased customer dispersion outside of the Bank's primary market area attributed to the introduction of the internet credit card, the Company has decreased the geographic risks inherent in its loan portfolio. However, while no specific industry concentration is considered significant, the Company's lending operations are located in the Company's market areas that are dependent on the technology and real estate industries and their supporting companies. Thus, the Company's borrowers could be adversely impacted by a downturn in these sectors of the economy which could reduce the demand for loans and adversely impact the borrowers' abilities to repay their loans. 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:
Three months ended Year ended December 31, (Dollars in thousands) September 30, 1998 December 31, 1997 Balance, beginning of period $ 2,884 $ 1,402 Charge-offs - Commercial loans (35) (224) Recoveries - Commercial loans 3 47 Net charged-offs (32) (177) Provision for loan losses 550 1,060 Balance, end of period $ 3,402 $ 2,285 Ratios: Net charge-offs to average loans outstanding 0.02% 0.18% Allowance for possible loan losses to average loans 1.78% 1.94% Allowance for possible loan losses to total loans at end of period 1.53% 1.77%
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:
September 30, 1998 December 31, 1997 Allowance Allowance as a % of Loans as a % of Loans Outstanding in Outstanding in Allowance Category Allowance Category Commercial $ 1,486 1.73% $ 821 1.28% Real estate - mortgage 219 0.37% 205 0.54% Real estate - land and construction 776 1.93% 379 1.48% Consumer 13 0.89% 7 0.85% Internet Credit Card 445 1.29% --- --- Unallocated 463 873 Total $ 3,402 1.53% $ 2,285 1.77%
The Bank maintains an allowance for possible loan losses to provide for estimated losses in the loan portfolio. While the loan loss allowance as a percentage of total loans has decreased from December 31, 1997, management still deems the provision as adequate given the quality of the loan portfolio. Additions to the allowance are made by charges to operating expenses in the form of a provision for loan losses. All loans that are judged to be uncollectable are charged against the allowance and any recoveries are credited to the allowance. Deposits Deposits totaled $363,868,000 at September 30, 1998, an increase of 50%, as compared to total deposits of $242,978,000 at December 31, 1997. The increase in deposits was due to the Company's continued marketing efforts directed at commercial business clients, including the newly introduced internet products. Non-interest-bearing deposits were $126,740,000 at September 30, 1998, an increase of 30% as compared to $97,736,000 at December 31, 1997. Interest- bearing deposits were $237,128,000 at September 30, 1998, an increase of 63% as compared to $145,242,000 at December 31, 1997. In addition to the internet credit card, the Company has introduced time deposits to be marketed on the internet with the intention of using these deposits to fund the credit card loans. For the three months and nine months ended September 30, 1998 the Company has collected $25,672,000 and $35,662,000 from the sale of these deposits. Due to increased customer dispersion outside of the Bank's primary market area attributed to the introduction of the internet credit card, the Company has decreased the geographic risks inherent in its loan portfolio. The Company intends to collect funds in these internet time deposits in an amount approximately equal to that loaned through the internet credit card. However, in addition to the interest rate risk associated with these deposits, no assurances can be made that the Company will be able to collect these funds as indicated. Interest Rate Risk The careful planning of asset and liability maturities and the matching of interest rates to correspond with this maturity matching is an integral part of the active management of an institution's net yield. To the extent maturities of assets and liabilities do not match in a changing interest rate environment, net yields may change over time. Even with perfectly matched repricing of assets and liabilities, risks remain in the form of prepayment of loans or investments or in the form of delays in the adjustment of rates of interest applying to either earning assets with floating rates or to interest bearing liabilities. The Bank has generally been able to control its exposure to changing interest rates by maintaining primarily floating interest rate loans and a majority of its time certificates in relatively short maturities The following table sets forth the interest rate sensitivity of the Company's interest-earning assets and interest-bearing liabilities as of September 30, 1998, using the rate sensitivity gap ratio. For purposes of the following table, an asset or liability is considered rate-sensitive within a specified period when it can be repriced or when it is scheduled to mature within the specified time frame: Within Due in Three Due After Three to Twelve One to Five Due After Not Rate- (Dollars in thousands) Months Months Years Five Years Sensitive Total Interest earning assets: Federal funds sold $ 45,070 --- --- --- --- $ 45,070 Securities 2,292 $ 10,222 $ 51,893 $ 31,341 --- 95,748 Total loans 132,942 50,645 22,876 15,535 --- 221,998 Corp. Owned Life Insurance --- --- --- 5,377 --- 5,377 Total interest earning assets 180,304 60,867 74,769 52,253 --- 368,193 Cash and due from banks $ 24,210 24,210 Other assets 6,676 6,676 Total assets $ 180,304 $ 60,867 $ 74,769 $ 52,253 $ 30,886 $ 399,079 Interest bearing liabilities: Demand, interest-bearing $ 7,970 --- --- --- --- $ 7,970 Savings and money market 140,575 --- --- --- --- 140,575 Time deposits $ 31,331 $ 49,757 $ 6,823 --- --- 87,911 Total interest bearing liabilities 179,876 49,757 6,823 --- --- 236,456 Non-interest demand deposits $ 127,412 $ 127,412 Other liabilities 4,698 4,698 Shareholders' equity 30,513 30,513 Total liabilities and shareholders' equity $ 179,876 $ 49,757 $ 6,823 --- $ 162,623 $ 399,079 Interest rate sensitivity gap $ 428 $ 11,110 $ 67,946 $ 52,253 $ (131,737) --- Cumulative interest rate sensitivity gap $ 428 $ 11,538 $ 79,484 $ 131,737 --- Cumulative interest rate sensitivity gap ratio 0.11% 2.89% 19.92% 33.01%
The foregoing table demonstrates that the Company had a positive cumulative one year gap of $16,915,000 at September 30, 1998. In theory, this would indicate that $16,915,000 more in assets than liabilities would reprice if there was a change in interest rates over the next year. If interest rates were to increase, the positive gap would tend to result in a higher net interest margin. However, changes in the mix of earning assets or supporting liabilities can either increase or decrease the net margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing of both the asset and its supporting liability can remain the same, thus impacting net interest income. This characteristic is referred to as a basis risk and, generally, relates to the repricing characteristics of short- term funding sources such as certificates of deposit. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities which are not reflected in the interest sensitivity analysis table. These prepayments may have significant effects on the Company's net interest margin. Because of these factors, an interest sensitivity gap report may not provide a complete assessment of the Company's exposure to changes in interest rates. Capital Resources The following table summarizes risk-based capital, risk-weighted assets, and risk-based capital ratios of the Company:
"Well-Capitalized" September 30, December 31, Regulatory (Dollars in thousands) 1998 1997 1997 Requirements Capital components: Tier 1 Capital $ 29,359 $ 21,457 $ 21,899 Tier 2 Capital 3,164 1,604 1,885 Total risk-based capital $ 32,523 $ 23,061 $ 23,784 Risk-weighted assets $ 252,891 $ 127,961 $ 150,418 Average assets $ 365,896 $ 235,938 $ 251,767 Capital ratios: Total risk-based capital 12.9% 18.0% 15.8% 10.0% Tier 1 risk-based capital 11.6% 16.8% 14.6% 6.0% Leverage ratio (1) 8.0% 9.1% 10.3% 5.0% (1) Tier 1 capital divided by average assets (excluding goodwill).
On June 17, 1998 the Company received acceptance from the Securities and Exchange Commission of its Form S-1, enabling it to commence an offering of 387,097 shares of Common Stock at a price of $15.50 per share. As of September 30, 1998 the Company had sold all the shares and collected approximately $5,846,000 after expenses. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK No material changes have occurred during the quarter to the Company's market risk profile or information. For further information refer to the Company's Prospectus on Form S-1 and the Company's annual report on Form 10-K. Part II - Other Information Item 1. - Legal Proceedings To the best of the Bank's knowledge, there are no pending legal proceedings to which the Bank is a party which may have a materially adverse effect on the Bank's financial condition, results of operations, or cash flows. Item 2. - Changes in Securities and Use of Proceeds Not Applicable Item 3. - Defaults Upon Senior Securities Not Applicable Item 4. - Submission of Matters to a Vote of Security Holders Not Applicable Item 5. - Other Information Not Applicable Item 6. - Exhibits and Reports on Form 8-K (a) Exhibits included with this filing: Exhibit Number Name 27.1 Financial Data Schedule (b) Reports on Form 8-K On October 19, 1998, the Company filed its quarterly earnings press release with the SEC on Form 8-K. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Heritage Commerce Corp (Registrant) November 12, 1998 /s/ John E. Rossell Date John E. Rossell, III, President and CEO November 12, 1998 /s/ Lawrence D. McGovern Date Lawrence D. McGovern, Chief Financial Officer EX-27 2 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE HERITAGE COMMERCE CORP UNAUDITED FINANCIAL STATEMENTS AT SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 9-MOS DEC-31-1998 SEP-30-1998 24,210,000 237,128,000 45,070,000 0 27,717,000 27,717,000 28,597,000 221,998,000 3,402,000 399,079,000 363,868,000 0 4,698,000 0 0 0 29,342,000 1,171,000 399,079,000 13,381,000 4,396,000 1,064,000 18,841,000 5,358,000 5,358,000 13,483,000 1,060,000 273,000 10,628,000 2,562,000 2,562,000 0 0 1,557,000 0.45 0.41 6.41 0 0 0 0 2,285,000 41,000 98,000 3,402,000 2,939,000 0 463,000
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