Q2 2002 DOC

-----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, V+/1LdaVNgAjDS75KyQSwfE1Rw2HLsx0j38PfDoLPq4DsmGlADmjrE/spuYPyrFE dS3UXBNA6g0eI04C5SsjLA== 0001053352-02-000017.txt : 20020814 0001053352-02-000017.hdr.sgml : 20020814 20020814193455 ACCESSION NUMBER: 0001053352-02-000017 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020814 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: 1934 Act SEC FILE NUMBER: 000-23877 FILM NUMBER: 02738729 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 form10q.htm BODY Q2 2002 DOC

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2002

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________to _________

Commission file number 000-23877

Heritage Commerce Corp
(Exact name of Registrant as Specified in its Charter)

California 77-0469558

(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification Number)

150 Almaden Boulevard
San Jose, California 95113
(Address of Principal Executive Offices including Zip Code)

(408) 947-6900
(Registrant's Telephone Number, Including Area Code)

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 reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

The Registrant had 11,157,679 shares of Common Stock outstanding on August 9, 2002

Heritage Commerce Corp and Subsidiaries
Quarterly Report on Form 10-Q
Table of Contents

PART I. FINANCIAL INFORMATION Page No.



Item 1. Financial Statements (unaudited):



           Condensed Consolidated Balance Sheets 2



           Condensed Consolidated Income Statements 3



           Condensed Consolidated Statements of Cash Flows 4



           Condensed Consolidated Notes to Financial Statements 5



Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7



Item 3. Quantitative and Qualitative Disclosures About Market Risk 25



PART II. OTHER INFORMATION



Item 4. Submission of Matters to a Vote of Security Holders 25



Item 6. Exhibits and Reports on Form 8-K 27



Signatures 27


Exhibit Index 28

Part I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

HERITAGE COMMERCE CORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

June 30, December 31, (Dollars in thousands) 2002 2001 ------------ ------------ ASSETS Cash and due from banks......................................... $ 40,062 $ 27,015 Interest bearing deposits in banks.............................. 6,025 7,704 Federal funds sold.............................................. 55,500 71,600 ------------ ------------ Total cash and cash equivalents.................. 101,587 106,319 Securities available-for-sale, at fair value.................... 104,317 91,534 Securities held-to-maturity, at amortized cost (fair value of $13,839 at June 30, 2002 and $15,708 at December 31, 2001, respectively)................. 13,164 15,276 Loans held for sale, at lower of cost or market................. 36,799 32,461 Loans, net of deferred costs.................................... 629,423 632,917 Allowance for probable loan losses.............................. (11,856) (11,154) ------------ ------------ Loans, net....................................... 617,567 621,763 Premises and equipment, net..................................... 5,284 5,470 Accrued interest receivable and other assets.................... 23,079 15,128 Other investments............................................... 25,895 24,779 ------------ ------------ TOTAL............................................ $ 927,692 $ 912,730 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Deposits Demand, noninterest bearing............................... $ 216,467 $ 206,637 Demand, interest bearing.................................. 91,761 80,529 Savings and money market.................................. 266,032 229,994 Time deposits, under $100................................. 52,834 72,608 Time deposits, $100 and over.............................. 123,528 150,144 Brokered deposits......................................... 67,842 67,996 ------------ ------------ Total deposits............................................... 818,464 807,908 Accrued interest payable and other liabilities............... 12,130 11,248 Mandatorily redeemable cumulative trust preferred securities of subsidiary grantor trust.................... 19,000 19,000 ------------ ------------ Total liabilities................................ 849,594 838,156 ------------ ------------ Commitments and contingencies Shareholders' equity: Preferred stock, no par value; 10,000,000 shares authorized; none outstanding.......................................... -- -- Common stock, no par value; 30,000,000 shares authorized; shares issued and outstanding: 11,150,017 at June 30, 2002 and 11,114,967 at December 31, 2001......... 63,742 63,536 Accumulated other comprehensive income, net of taxes......... 1,265 1,021 Retained earnings............................................ 13,091 10,017 ------------ ------------ Total shareholders' equity....................... 78,098 74,574 ------------ ------------ TOTAL............................................ $ 927,692 $ 912,730 ============ ============

See notes to condensed consolidated financial statements

HERITAGE COMMERCE CORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)

Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ (Dollars in thousands, except per share data) 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Interest income: Loans, including fees................................ $ 11,700 $ 14,774 $ 23,309 $ 30,575 Securities, taxable................................. 1,209 1,130 2,273 2,546 Securities, non-taxable............................. 123 146 264 298 Interest bearing deposits in banks................... 21 47 48 83 Federal funds sold................................... 237 710 467 1,450 ----------- ----------- ----------- ----------- Total interest income 13,290 16,807 26,361 34,952 ----------- ----------- ----------- ----------- Interest expense: Deposits............................................. 3,547 5,855 7,347 12,448 Mandatorily redeemable trust preferred securities.... 446 376 927 752 Other................................................ 1 -- 12 113 ----------- ----------- ----------- ----------- Total interest expense.................................. 3,994 6,231 8,286 13,313 ----------- ----------- ----------- ----------- Net interest income before provision for probable loan losses........................................... 9,296 10,576 18,075 21,639 Provision for probable loan losses...................... 640 528 1,315 1,055 ----------- ----------- ----------- ----------- Net interest income after provision for probable loan losses........................................... 8,656 10,048 16,760 20,584 ----------- ----------- ----------- ----------- Noninterest income: Gain on sale of loans................................ 557 278 978 551 Service charges and other fees on deposit accounts... 371 228 687 436 Servicing income..................................... 310 162 578 293 Other investment income.............................. 277 242 551 510 Gain on sale of securities available-for-sale........ 138 409 425 551 Other income......................................... 334 372 658 588 ----------- ----------- ----------- ----------- Total noninterest income................................ 1,987 1,691 3,877 2,929 ----------- ----------- ----------- ----------- Noninterest expenses: Salaries and employee benefits....................... 4,648 4,638 9,182 9,456 Occupancy............................................ 790 681 1,508 1,361 Professional fees.................................... 347 265 572 595 Furniture and equipment.............................. 327 366 683 716 Loan origination costs............................... 308 360 598 659 Client services...................................... 282 647 440 939 Advertising and promotion............................ 200 359 330 582 Stationery & supplies................................ 110 125 186 258 Telephone............................................ 83 93 157 182 Other................................................ 1,222 1,135 2,362 2,188 ----------- ----------- ----------- ----------- Total noninterest expenses.............................. 8,317 8,669 16,018 16,936 ----------- ----------- ----------- ----------- Income before provision for income taxes................ 2,326 3,070 4,619 6,577 Provision for income taxes.............................. 765 1,180 1,545 2,506 ----------- ----------- ----------- ----------- Net income.............................................. $ 1,561 $ 1,890 $ 3,074 $ 4,071 =========== =========== =========== =========== Earnings per share: Basic.............................................. $ 0.14 $ 0.17 $ 0.28 $ 0.37 =========== =========== =========== =========== Diluted............................................ $ 0.14 $ 0.17 $ 0.27 $ 0.36 =========== =========== =========== ===========
See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Six Months Ended June 30, -------------------------- (Dollars in thousands) 2002 2001 ------------ ------------ Cash flows from operating activities: Net income........................................................ $ 3,074 $ 4,071 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization..................................... 753 803 Provision for probable loan losses................................ 1,315 1,055 Gain on sale of securities available-for-sale..................... (425) (551) Net amortization of premiums / accretion of discounts............. 388 (59) Gain on sale of loans held for sale............................... (978) (551) Proceeds from sales of loans held for sale....................... 22,846 15,162 Originations of loans held for sale............................... (33,435) (19,516) Maturities of loans held for sale................................. 7,229 157 Effect of changes in: Accrued interest receivable and other assets.................. (7,920) (2,612) Accrued interest payable and other liabilities................ 687 2,039 ------------ ------------ Net cash used in operating activities............................. (6,466) (2) ------------ ------------ Cash flows from investing activities: Net decreases in loans............................................ 2,881 5,290 Purchases of securities available-for-sale........................ (33,194) (38,211) Maturities/paydowns/calls of securities available-for-sale........ 10,466 12,782 Proceeds from sales of securities available-for-sale............. 10,356 55,297 Maturities/paydowns/calls of securities held-to-maturity.......... 2,146 883 Purchases of corporate owned life insurance....................... (951) (3,074) (Purchases)Redemption of other investments........................ (165) 334 Purchases of property and equipment............................... (567) (433) ------------ ------------ Net cash provided by (used in) investing activities............... (9,028) 32,868 ------------ ------------ Cash flows from financing activities: Net increase in deposits.......................................... 10,556 31,982 Net proceeds from issuance of common stock....................... 206 1,021 Net change in FHLB borrowings..................................... -- (18,000) ------------ ------------ Net cash provided by financing activities......................... 10,762 15,003 ------------ ------------ Net increase (decrease) in cash and cash equivalents.............. (4,732) 47,869 Cash and cash equivalents, beginning of period.................... 106,319 60,069 ------------ ------------ Cash and cash equivalents, end of period.......................... $ 101,587 $ 107,938 ============ ============ Supplemental disclosures of cash paid during the period for: Interest....................................................... $ 9,747 $ 13,487 Income taxes................................................... $ 3,840 $ 2,890

See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2002
(Unaudited)

1) Basis of Presentation

The unaudited condensed consolidated financial statements of Heritage Commerce Corp (the "Company") and its wholly owned subsidiaries: Heritage Bank of Commerce (HBC), Heritage Bank East Bay (HBEB), Heritage Bank South Valley (HBSV), and Bank of Los Altos (BLA), and Heritage Capital Trust I, Heritage Statutory Trust I and Heritage Statutory Trust II, which are Delaware Statutory business trusts formed for the exclusive purpose of issuing and selling trust preferred securities, have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and notes required by accounting principles generally accepted in the United States of America ("GAAP") 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 for the year ended December 31, 2001.

HBC, HBEB, HBSV, and BLA are commercial banks, which offer similar products to customers located in Santa Clara, Alameda, and Contra Costa counties of California. No customer accounts for more than 10 percent of revenue for HBC, HBEB, HBSV, BLA or the Company. Management evaluates the Company's performance as a whole and does not allocate resources based on the performance of different lending or transaction activities. Accordingly, the Company and its subsidiary banks all operate as one business segment.

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 to current year presentation.

The results for the three and six months ended June 30, 2002 are not necessarily indicative of the results expected for any subsequent period or for the entire year ending December 31, 2002.

2) Earnings Per Share

Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share reflects potential dilution from outstanding stock options, using the treasury stock method. For each of the periods presented, net income is the same for basic and diluted earnings per share. Reconciliation of weighted average shares used in computing basic and diluted earnings per share is as follows:

Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Weighted average common shares outstanding - used in computing basic earnings per share............... 11,139,219 11,096,230 11,130,699 11,053,894 Dilutive effect of stock options outstanding, using the treasury stock method..................... 346,292 303,808 301,935 316,414 ----------- ----------- ----------- ----------- Shares used in computing diluted earnings per share..... 11,485,511 11,400,038 11,432,634 11,370,308 =========== =========== =========== ===========

3) Comprehensive Income

Comprehensive Income includes net income and other comprehensive income, which represents the change in the Company's net assets during the period from non-owner sources.

The Company's only sources of other comprehensive income is derived from unrealized gains and losses on investment securities available-for- sale and I/O strips. Reclassification adjustments resulting from gains or losses on investment securities that were realized and included in net income of the current period that also had been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose are excluded from comprehensive income of the current period. The Company's total comprehensive income was as follows:

Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ 2002 2001 2002 2001 (Dollars in thousands) ----------- ----------- ----------- ----------- Net income.............................................. $ 1,561 $ 1,890 $ 3,074 $ 4,071 ----------- ----------- ----------- ----------- Other comprehensive income (loss), net of tax: Net unrealized holding gain (loss) on available-for-sale securities and I/O strips during the period........ 702 (221) 527 480 Less: reclassification adjustment for realized gains on available-for-sale securities included in net income during the period............ (93) (252) (283) (339) ----------- ----------- ----------- ----------- Other comprehensive income (loss)....................... 609 (473) 244 141 ----------- ----------- ----------- ----------- Comprehensive income.................................... $ 2,170 $ 1,417 $ 3,318 $ 4,212 =========== =========== =========== ===========

4) Subsequent Events

On August 6, 2002 the Company transferred all of its securities categorized as held-to-maturity to the available-for-sale category. The amortized cost of the transferred securities was $13,164,000 and the related unrealized holding gain was $675,000 as of June 30, 2002. Upon transfer, unrealized holding gain, net of taxes, included in accumulated other comprehensive income, which is a separate component of shareholders' equity. The Company transferred these securities to increase liquid assets and to increase the ability for possible sale of these securities in the future and currently intends to classify all new purchases of securities as available-for- sale.

5) Recent Accounting Pronouncements

In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". SFAS No. 145 rescinds and amends these statements to eliminate any inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions including clarification that gains or losses from normal extinguishments of debt need not be classified as extraordinary items. The Company adopted SFAS No. 145 as of April 1, 2002. The adoption did not have a significant impact on the Company's financial position, results of operations, or cash flows.

In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions of SFAS 146 for restructuring activities initiated after December 31, 2002. SFAS 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of the Company's commitment to an exit plan. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.

6) Reclassifications

Certain amounts in the December 31, 2001 and June 30, 2001 financial statements have been reclassified to conform to the June 30, 2002 financial statement presentation.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Discussions of certain matters in this Report on Form 10-Q may constitute forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and as such, may involve risks and uncertainties. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations, are generally identifiable by the use of words such as "believe", "expect", "intend", "anticipate", "estimate", "project", or similar expressions. These forward-looking statements relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, potential future performance, potential future credit experience, perceived opportunities in the market, and statements regarding the Company's mission and vision. The Company's actual results, performance, and achievements may differ materially from the results, performance, and achievements expressed or implied in such forward-looking statements due to a wide range of factors. The factors include, but are not limited to changes in interest rates, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the US Government, real estate valuations, competition in the financial services industry, and other risks. All of the Company's operations and most of its customers are located in California. During the past year, the availability of a sufficient supply of electrical power in California has been unreliable at times. In addition, other events, including those of September 11, 2001, have increased the uncertainty related to the national and California economic outlook and could have an effect on the future operations of the Company or its customers, including borrowers. The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

Heritage operates as the bank holding company for the four subsidiary banks: Heritage Bank of Commerce, Heritage Bank East Bay, Heritage Bank South Valley and Bank of Los Altos (collectively the "Banks"). All are California state chartered banks, which offer a full range of commercial and personal banking services to residents and the business/professional community in Santa Clara, Contra Costa and Alameda Counties, California. The accounting and reporting policies of Heritage Commerce Corp and its subsidiaries conform to accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. On July 12, 2002, the Company announced its plans to merge three of its wholly owned commercial bank subsidiaries into the Company's original wholly owned bank subsidiary. HBEB, HBSV, and BLA will operate as divisions of HBC and continue to serve their local markets and communities under their current names. The proposed transaction is expected to be completed by December 31, 2002 and is subject to regulatory approval.

CRITICAL ACCOUNTING POLICIES
General

Heritage Commerce Corp's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our financial statements is, to a significant extent, based on approximate measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. In certain instances, the Company uses the discount factor and prepayment assumptions to determine the present value of assets and liabilities. A change in the discount factor or prepayment spreads could increase or decrease the values of those assets and liabilities which would result in either a beneficial or adverse impact to the Company's financial results. The Company used historical loss experience as one factor in determining the inherent loss that may be present in the Company's loan portfolio. Actual losses could differ significantly from the historical factors that we use. Other estimates that the Company used are related to the expected useful lives of the Company's depreciable assets. In addition GAAP itself may change from one previously acceptable method to another method. Although the economics of the Company's transactions would be the same, the timing of events that would impact the Company's transactions could change.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in the Company's loan portfolio. The allowance is based on two basic principles of accounting. (1) Statement of Financial Accounting Standards (SFAS) No. 5 "Accounting for Contingencies", which requires that losses be accrued when they are probable of occurring and estimable and (2) SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The Company's allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses an historical loss view as an indicator of future losses and as a result could differ from the losses incurred in the future. The specific allowance uses various techniques to arrive at an estimate of loss. Historical loss information, and fair market value of collateral are used to estimate those losses. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowances. For further information regarding our allowance for credit losses, see Allowance for Probable Loan Losses on page 20.
Loan Sales and Servicing

The amounts of gains recorded on sales of loans and the initial recording of servicing assets and interest only strips is based on the estimated fair values of the respective components. In recording the initial value of the servicing assets and the fair value of the Interest-Only (I/O) strips receivable, the Company uses estimates which are made based on management's expectations of future prepayment and discount rates. For the quarter ended June 30, 2002, management's estimate of constant prepayment rate ("CPR") was 14% and the weighted average discount rate assumption was 10%. These prepayment and discount rates were based on current market conditions and historical performance of the various pools of loan. If actual prepayments with respect to sold loans occur more quickly than projected the carrying value of the servicing assets may have to be adjusted through a charge to earnings. Variations in prevailing interest rates on borrowed funds, changes in the unemployment rate and changes in general economic conditions, among other factors, could cause changes in the prepayment experience. A corresponding decrease in the value of the I/O strip receivable would also be expected.

Stock Based Awards

The Company accounts for its stock based awards using the intrinsic value method in accordance with Accounting Principles Board ("APB") Opinion No. 25 and related interpretations. Since the Company's stock option plans provide for the issuance of options at a price of no less than the fair market value at the date of the grant, no compensation expense has been recognized in the financial statements at the date of grant.

RESULTS OF OPERATIONS

Overview

Net income for the three and six months ended June 30, 2002 was $1,561,000 and $3,074,000, down 17% from $1,890,000 for the three months ended June 30, 2001 and 24% from $4,071,000 for the six months ended June 30, 2001. Earnings per diluted share for the three and six months ended June 30, 2002 were $0.14 and $0.27, down 18% from $0.17 for the three months ended June 30, 2001 and 25% from $0.36 per diluted share for the six months ended June 30, 2001. Annualized return on average assets and return on average equity for the quarter ended June 30, 2002 were 0.68% and 8.15%, compared with returns of 0.88% and 10.74%, for the same period in the prior year. Annualized return on average assets and return on average equity for the six months ended June 30, 2002 were 0.68% and 8.13% compared with returns of 0.95% and 11.89% for the same period in the prior year.

For the three months ended June 30, 2002, as compared with the same period in the prior year, net interest income decreased from $10,576,000 to $9,296,000, a decrease of $1,280,000, or 12%. For the six months ended June 30, 2002, as compared with the same period in the prior year, net interest income decreased from $21,639,000 to $18,075,000, a decrease of $3,564,000, or 16%. The decline in net interest income from the six month period and the three month period over the same periods in the prior year was primarily attributed to a lower net interest margin, resulting from the significant short term interest rate reduction during 2001 and the level of and the timing of repricing of the Company's interest bearing deposits, partially offset by the overall growth in the Company's level of earning assets, primarily in loans and investment securities. The Company's net interest margin was 4.41% and 4.32% for the three and six months ended June 30, 2002, compared with 5.35% and 5.50% for the three and six months ended June 30, 2001, reflecting both the significant reduction in interest rates that took place in 2001 and the stabilization of interest rates during 2002.

Total assets as of June 30, 2002 were $927,692,000, an increase of $60,061,000, or 7%, from $867,631,000 as of June 30, 2001, and an increase of $14,962,000, or 2%, from total assets of $912,730,000 as of December 31, 2001. Total deposits as of June 30, 2002 were $818,464,000, an increase of $48,296,000, or 6%, from $770,168,000 as of June 30, 2001, and an increase of $10,556,000, or 1%, from total deposits of $807,908,000 as of December 31, 2001.

Total portfolio loans as of June 30, 2002 were $629,423,000, an increase of $24,291,000, or 4%, from $605,132,000 as of June 30, 2001 and down slightly from $632,917,000 as of December 31, 2001. The Company's allowance for loan losses was $11,856,000, or 1.88%, of total loans at June 30, 2002. This compares with an allowance for loan losses of $10,347,000, or 1.71%, and $11,154,000, or 1.76% of total loans at June 30, 2001 and December 31, 2001. The Company's non-performing assets increased to $2,366,000 as of June 30, 2002 compared to $66,000 as of June 30, 2001 and none as of December 31, 2001.

The Company's shareholders' equity at June 30, 2002 was $78,098,000, up from $70,967,000 at June 30, 2001 and $74,574,000 as of December 31, 2001. The increase in shareholders' equity is a result of the income generated over the period, the exercise of common stock options and an increase in other comprehensive income from the net unrealized holding gains on the securities available-for-sale. Book value per share has increased to $7.00 at June 30, 2002, from $6.39 at June 30, 2001 and $6.71 at December 31, 2001. The Company's leverage capital ratio was 10.34% at June 30, 2002 compared to 9.78% at June 30, 2001 and 10.20% at December 31, 2001.

Net Interest Income and Net Interest Margin

The following table presents the Company's average balance sheet, net interest income and the resultant yields and rates paid for the period presented:

For the Three Months Ended For the Three Months Ended June 30, 2002 June 30, 2001 --------------------------------- --------------------------------- Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ (Dollars in thousands) Balance Expense Rate Balance Expense Rate - ---------------------------------------- ---------- ---------- --------- ---------- ---------- --------- Assets: Loans, gross............................ $ 669,956 $ 11,700 6.93% $ 633,886 $ 14,774 9.35% Investments securities.................. 113,548 1,332 4.71% 88,052 1,276 5.81% Interest bearing deposits in banks...... 6,121 21 1.37% 4,777 47 3.95% Federal funds sold...................... 56,797 237 1.67% 66,725 710 4.27% ---------- ---------- ---------- ---------- Total interest earning assets........ 846,422 $ 13,290 6.30% 793,440 $ 16,807 8.50% ---------- ---------- Cash and due from banks................. 36,934 34,813 Premises and equipment, net............. 5,444 6,144 Other assets............................ 32,519 22,813 ---------- ---------- Total assets......................... $ 921,319 $ 857,210 ========== ========== Liabilities and shareholders' equity: Deposits: Demand, interest bearing................ $ 81,327 $ 167 0.82% $ 65,939 $ 288 1.75% Savings and money market................ 268,751 1,290 1.93% 220,553 1,799 3.27% Time deposits, under $100............... 58,654 476 3.25% 78,048 1,119 5.75% Time deposits, $100 and over............ 133,237 948 2.85% 161,412 2,293 5.70% Brokered deposits....................... 69,069 666 3.87% 23,568 356 6.06% Other borrowings........................ 19,344 447 9.29% 14,000 376 10.77% ---------- ---------- ---------- ---------- Total interest bearing liabilities... 630,382 $ 3,994 2.54% 563,520 $ 6,231 4.44% ---------- ---------- Interest bearing demand deposits........ 202,174 209,771 Other liabilities....................... 11,894 13,337 ---------- ---------- Total liabilities.................... 844,450 786,628 Shareholders' equity.................... 76,869 70,582 ---------- ---------- Total liabilities and shareholders' equity.............. $ 921,319 $ 857,210 ========== ========== Net interest income / margin............ $ 9,296 4.41% $ 10,576 5.35% ========== ==========

Note:

Yields and amounts earned on loans include loan fees of $1,111,000 and $1,209,000 for the three month periods ended June 30, 2002 and 2001, respectively. Interest income is reflected on an actual basis, not a fully taxable equivalent basis, and does not include a fair value adjustment. Nonaccrual loans of $1,951,000 and $66,000 for the period ended June 30, 2002 and 2001, respectively, are included in the average balance calculation above.

For the Six Months Ended For the Six Months Ended June 30, 2002 June 30, 2001 --------------------------------- --------------------------------- Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ (Dollars in thousands) Balance Expense Rate Balance Expense Rate - ---------------------------------------- ---------- ---------- --------- ---------- ---------- --------- Assets: Loans, gross............................ $ 671,530 $ 23,309 7.00% $ 630,570 $ 30,575 9.78% Investments securities.................. 108,080 2,537 4.73% 97,214 2,844 5.90% Interest bearing deposits in banks...... 7,084 48 1.37% 3,808 83 4.40% Federal funds sold...................... 57,075 467 1.65% 61,128 1,450 4.78% ---------- ---------- ---------- ---------- Total interest earning assets........ 843,769 $ 26,361 6.30% 792,720 $ 34,952 8.89% ---------- ---------- Cash and due from banks................. 36,657 38,103 Premises and equipment, net............. 5,563 6,214 Other assets............................ 32,090 21,604 ---------- ---------- Total assets......................... $ 918,079 $ 858,641 ========== ========== Liabilities and shareholders' equity: Deposits: Demand, interest bearing................ $ 81,597 $ 354 0.87% $ 66,221 $ 633 1.93% Savings and money market................ 255,098 2,428 1.92% 222,902 4,011 3.63% Time deposits, under $100............... 63,056 1,112 3.55% 77,745 2,288 5.93% Time deposits, $100 and over............ 138,244 2,123 3.10% 167,166 4,860 5.86% Brokered deposits....................... 68,554 1,330 3.91% 21,497 656 6.15% Other borrowings........................ 20,323 939 9.33% 17,291 865 10.09% ---------- ---------- ---------- ---------- Total interest bearing liabilities... 626,872 $ 8,286 2.67% 572,822 $ 13,313 4.69% ---------- ---------- Interest bearing demand deposits........ 201,092 204,162 Other liabilities....................... 13,846 12,599 ---------- ---------- Total liabilities.................... 841,810 789,583 Shareholders' equity.................... 76,269 69,058 ---------- ---------- Total liabilities and shareholders' equity.............. $ 918,079 $ 858,641 ========== ========== Net interest income / margin............ $ 18,075 4.32% $ 21,639 5.50% ========== ==========

Note:

Yields and amounts earned on loans include loan fees of $2,252,000 and $2,353,000 for the six month periods ended June 30, 2002 and 2001, respectively. Interest income is reflected on an actual basis, not a fully taxable equivalent basis, and does not include a fair value adjustment. Nonaccrual loans of $1,951,000 and $66,000 for the period ended June 30, 2002 and 2001, respectively, are included in the average balance calculation above.

The Company's net interest income for the three and six months ended June 30, 2002 was $9,296,000 and $18,075,000, a decrease of $1,280,000 or 12% over the same three month period in the prior year and a decrease of $3,564,000, or 16% over the same six month period in the prior year. For the three and six months ended June 30, 2002 compared to the same periods in the prior year, average earning assets increased by $52,982,000, or 7%, and $51,049,000, or 6%. For the three months ended June 30, 2002, the average yield on earning assets was 6.30%, down 220 basis points from 8.50% for the same period in 2001. Over the same periods the rates paid on interest bearing liabilities declined 190 basis points to 2.54% from 4.44%. For the six months ended June 30, 2002, the average yield on earning assets was 6.30%, down 259 basis points from 8.89% for the same period in 2001. Over the same periods the rates paid on interest bearing liabilities decreased 202 basis points to 2.67% from 4.69%. Overall, the net interest margin decreased to 4.41% and 4.32% for the three and six months ended June 30, 2002, from 5.35% and 5.50% for the same periods in the prior year. The decrease in the interest rates for the three and six months ended June 30, 2002 compared to the same period in 2001 resulted in a reduction in net interest income of $1,824,000 and $4,507,000. The impact of the decrease in the interest rates was mitigated by the growth in the level of earning assets and interest bearing liablilities as overall volume increases added $544,000 and $943,000 to the net interest income for the three and six months ended June 30, 2002 compared to the same periods in 2001. The increased level of average loans was primarily funded by the increase in the deposits and other borrowings and by a decrease in the level of average Federal funds sold.

The following table sets forth an analysis of the changes in interest income resulting from changes in the average volume of interest earning assets and liabilities and changes in the average rates earned and paid. 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 to the change in volume.

Three Months Ended June 30, 2002 vs. 2001 ---------------------------------- Increase (Decrease) Due to Change In: Average Average Net (Dollars in thousands) Volume Rate Change - ---------------------------------------- ---------- ---------- ---------- Interest earning assets Loans, gross........................ $ 750 $ (3,824) $ (3,074) Investments securities.............. 299 (243) 56 Interest bearing deposits in banks.. 5 (31) (26) Federal funds sold.................. (41) (432) (473) ---------- ---------- ---------- Total interest earning assets.......... $ 1,013 $ (4,530) $ (3,517) ---------- ---------- ---------- Interest bearing liabilities Demand, interest bearing............ $ 32 $ (153) $ (121) Savings and money market............ 231 (740) (509) Time deposits, under $100........... (156) (487) (643) Time deposits, $100 and over........ (200) (1,145) (1,345) Brokered Deposits................... 439 (129) 310 Other borrowings.................... 123 (52) 71 ---------- ---------- ---------- Total interest bearing liabilities..... $ 469 $ (2,706) $ (2,237) ---------- ---------- ---------- Net interest income.................... $ 544 $ (1,824) $ (1,280) ========== ========== ==========

Six Months Ended June 30, 2002 vs. 2001 ---------------------------------- Increase (Decrease) Due to Change In: Average Average Net (Dollars in thousands) Volume Rate Change - ---------------------------------------- ---------- ---------- ---------- Interest earning assets Loans, gross........................ $ 1,422 $ (8,688) $ (7,266) Investments securities.............. 255 (562) (307) Interest bearing deposits in banks.. 22 (57) (35) Federal funds sold.................. (33) (950) (983) ---------- ---------- ---------- Total interest earning assets.......... $ 1,666 $ (10,257) $ (8,591) ---------- ---------- ---------- Interest bearing liabilities Demand, interest bearing............ $ 67 $ (346) $ (279) Savings and money market............ 306 (1,889) (1,583) Time deposits, under $100........... (258) (918) (1,176) Time deposits, $100 and over........ (444) (2,293) (2,737) Brokered Deposits................... 913 (239) 674 Other borrowings.................... 139 (65) 74 ---------- ---------- ---------- Total interest bearing liabilities..... $ 723 $ (5,750) $ (5,027) ---------- ---------- ---------- Net interest income.................... $ 943 $ (4,507) $ (3,564) ========== ========== ==========

Provision for Probable Loan Losses

The provision for probable loan losses represents the current period expense associated with maintaining an appropriate allowance for credit losses. The loan loss provision and level of allowance for each period is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of the quality of the loan portfolio, the valuation of problem loans and the general economic conditions in the Company's market area. Periodic fluctuations in the provision for loan losses result from management's assessment of the adequacy of the allowance for probable loan losses; however, actual loan losses may vary from current estimates. For the three and six months ended June 30, 2002, the provision for probable loan losses was $640,000 and $1,315,000, up $112,000 and $260,000, from $528,000 and $1,055,000 for the same periods in the prior year. See additional discussion at Allowance for Probable Loan Losses.

Noninterest Income

The following table sets forth the various components of the Company's noninterest income for the periods indicated:

Three Months Ended Increase (decrease) June 30, 2002 versus 2001 -------------------- -------------------- (Dollars in thousands) 2002 2001 Amount Percent - ---------------------------------------------------- --------- --------- --------- --------- Gain on sale of loans............................... $ 557 $ 278 $ 279 100 % Service charges and other fees on deposits accounts. 371 228 143 63 % Servicing income.................................... 310 162 148 91 % Other investment income............................. 277 242 35 14 % Gain on sale of securities available-for-sale....... 138 409 (271) (66)% Other income........................................ 334 372 (38) (10)% --------- --------- --------- Total............................................... $ 1,987 $ 1,691 $ 296 18 % ========= ========= =========

Six Months Ended Increase (decrease) June 30, 2002 versus 2001 -------------------- -------------------- (Dollars in thousands) 2002 2001 Amount Percent - ---------------------------------------------------- --------- --------- --------- --------- Gain on sale of loans............................... $ 978 $ 551 $ 427 77 % Service charges and other fees on deposits accounts. 687 436 251 58 % Servicing income.................................... 578 293 285 97 % Other investment income............................. 551 510 41 8 % Gain on sale of securities available-for-sale....... 425 551 (126) (23)% Other income........................................ 658 588 70 12 % --------- --------- --------- Total............................................... $ 3,877 $ 2,929 $ 948 32 % ========= ========= =========

Noninterest income for the three and six months ended June 30, 2002 was $1,987,000 and $3,877,000, up 18% and 32% from $1,691,000 and $2,929,000 for the same periods in the prior year. The increase for the three and six months ended June 30, 2002 compared to the same period in 2001 was primarily due to the increases in service charges and fees of $143,000 and $251,000 from increased activity, and increases in gain on sale of SBA loans of $279,000 and $427,000, and increases in servicing income recognized of $148,000 and $285,000, offset by a decrease in gain on sale of securities of $271,000 and $126,000.

Noninterest Expense

The following table sets forth the various components of the Company's noninterest expenses for the periods indicated:

Three Months Ended Increase (decrease) June 30, 2002 versus 2001 -------------------- -------------------- (Dollars in thousands) 2002 2001 Amount Percent - ---------------------------------------------------- --------- --------- --------- --------- Salaries and employee benefits...................... $ 4,648 $ 4,638 $ 10 0 % Occupancy........................................... 790 681 109 16 % Professional fees................................... 347 265 82 31 % Furniture and equipment............................. 327 366 (39) (11)% Loan origination costs.............................. 308 360 (52) (14)% Client services..................................... 282 647 (365) (56)% Advertising and promotion........................... 200 359 (159) (44)% Stationery & supplies............................... 110 125 (15) (12)% Telephone........................................... 83 93 (10) (11)% Other............................................... 1,222 1,135 87 8 % --------- --------- --------- Total............................................... $ 8,317 $ 8,669 $ (352) (4)% ========= ========= =========

Six Months Ended Increase (decrease) June 30, 2002 versus 2001 -------------------- -------------------- (Dollars in thousands) 2002 2001 Amount Percent - ---------------------------------------------------- --------- --------- --------- --------- Salaries and employee benefits...................... $ 9,182 $ 9,456 $ (274) (3)% Occupancy........................................... 1,508 1,361 147 11 % Professional fees................................... 572 595 (23) (4)% Furniture and equipment............................. 683 716 (33) (5)% Loan origination costs.............................. 598 659 (61) (9)% Client services..................................... 440 939 (499) (53)% Advertising and promotion........................... 330 582 (252) (43)% Stationery & supplies............................... 186 258 (72) (28)% Telephone........................................... 157 182 (25) (14)% Other............................................... 2,362 2,188 174 8 % --------- --------- --------- Total............................................... $ 16,018 $ 16,936 $ (918) (5)% ========= ========= =========

The following table indicates the percentage of noninterest expense in each category:

For The Six Months Ended June 30, ------------------------------------------- Percent Percent (Dollars in thousands) 2002 of Total 2001 of Total - ---------------------------------------------------- --------- --------- --------- --------- Salaries and employee benefits...................... $ 4,648 56 % $ 4,638 54 % Occupancy........................................... 790 9 % 681 8 % Professional fees................................... 347 4 % 265 3 % Furniture and equipment............................. 327 4 % 366 4 % Loan origination costs.............................. 308 4 % 360 4 % Client services..................................... 282 3 % 647 7 % Advertising and promotion........................... 200 2 % 359 4 % Stationery & supplies............................... 110 1 % 125 1 % Telephone........................................... 83 1 % 93 1 % Other............................................... 1,222 15 % 1,135 13 % --------- --------- --------- --------- Total............................................... $ 8,317 100 % $ 8,669 100 % ========= ========= ========= =========

For The Six Months Ended June 30, ------------------------------------------- Percent Percent (Dollars in thousands) 2002 of Total 2001 of Total - ---------------------------------------------------- --------- --------- --------- --------- Salaries and employee benefits...................... $ 9,182 57 % $ 9,456 56 % Occupancy........................................... 1,508 9 % 1,361 8 % Professional fees................................... 572 4 % 595 4 % Furniture and equipment............................. 683 4 % 716 4 % Loan origination costs.............................. 598 4 % 659 4 % Client services..................................... 440 3 % 939 6 % Advertising and promotion........................... 330 2 % 582 3 % Stationery & supplies............................... 186 1 % 258 2 % Telephone........................................... 157 1 % 182 1 % Other............................................... 2,362 15 % 2,188 13 % --------- --------- --------- --------- Total............................................... $ 16,018 100 % $ 16,936 100 % ========= ========= ========= =========

Noninterest expenses for the three and six months ended June 30, 2001 were $8,317,000 and $16,018,000, down $352,000 and $918,000, or 4% and 5%, from $8,669,000 and $16,936,000 for the same periods in the prior year.

For the three months ended June 30, 2002, salaries and benefits were flat as compared to the same period in the prior year. Salaries and benefits decreased $274,000, or 3%, to $9,182,000 for the first six months of 2002, as compared to the same period in the prior year. The decrease was primarily due to a decrease in employee bonuses in 2002 and reductions in salary expenses for temporary staff. For the comparative three month periods, occupancy increased by $109,000, or 16%, and for the six month periods the increase was $147,000, or 11%, to $1,508,000 primarily as a result of increased rental costs. Occupancy costs, as a percentage of total noninterest expenses remained fairly constant over the three and six month periods. For the comparative three months periods, professional fees increased $82,000, or 31%, and for the six months periods professional fees decreased $23,000, or 4%, to $572,000. For the comparative three month periods, furniture and equipment decreased by $39,000, or 11% and for the six month periods the decrease was $33,000, or 5%, to $683,000. For the comparative three month periods, loan origination costs decreased by $52,000, or 14%, and for the six months period decreased by $61,000, or 9%, to $598,000. For the comparative three months periods, client services decreased $365,000, or 56%, and for the six months periods the decrease was $499,000, or 53%, to $440,000. The decrease from 2001 was primarily as a result of the decrease in services fees charged to the Company from third party vendors in 2002. For the comparative three month periods, advertising and promotion decreased by $159,000, or 44%, and for the six month period decreased by $252,000, or 43%, to $330,000. The decrease from 2001 was primarily as a result of certain sponsorships no longer being continued in 2002. For the comparative three month periods, stationery and supplies decreased by $15,000, or 12%, and for the six month period the decrease was $72,000, or 28%, to $186,000. For the comparative three month periods, telephone expense decreased by $10,000, or 11%, and for the six month period decreased by $25,000, or 14%, to $157,000. Other noninterest expense increased $87,000 and $174,000 from the three months and six month periods of 2001 in support of the overall growth of the Company and expenses related to the Company's investment in a low income housing project during the first quarter of 2002.

Income Taxes

The provision for income taxes for the three and six months ended June 30, 2002 was $765,000 and $1,545,000, as compared to $1,180,000 and $2,506,000 for the same periods in the prior year. The following table shows the income tax rate for each period indicated.

Three Months Ended Six Months Ended June 30, June 30, -------------------- -------------------- 2002 2001 2002 2001 --------- --------- --------- --------- Income tax rate..................................... 32.89 % 38.44 % 33.45 % 38.10 %

The difference in the effective tax rate compared to the statutory tax rate is primarily the result of the Company's receipt of tax fee distributions from certain life insurance contracts, low income housing tax credits, and changes in the Company's level of investments in municipal securities.

FINANCIAL CONDITION

Total assets increased $14,962,000, or 2%, to $927,692,000 at June 30, 2002 from $912,730,000 at December 31, 2001, and increased $60,061,000, or 7%, from $867,631,000 at June 30, 2001. Total portfolio loans decreased $3,494,000, or 1% to $629,423,000 at June 30, 2002 from $632,917,000 at December 31, 2001, but have increased $24,291,000, or 4% from $605,132,000 at June 30, 2001. Total deposits were $818,464,000 at June 30, 2002, an increase of 1% from $807,908,000 at December 31, 2001, and an increase of 6% from $770,168,000 at June 30, 2001. The overall increase reflects the continued internal growth of the Company since December 31, 2001, primarily in noninterest and interest bearing demand deposits and saving and money market deposits, offset by a decrease in time deposits.

Securities Portfolio

The following table sets forth the carrying value of investment securities at the dates indicated:

June 30, ---------------------- December 31, (Dollars in thousands) 2002 2001 2001 - ---------------------------------------------- ---------- ---------- ---------- Securities available-for-sale (at fair value) U.S. Treasury................................. $ 3,126 $ 1,621 $ 3,593 U.S. Government Agencies...................... 63,007 31,089 53,762 Mortgage-backed securities.................... 17,120 18,353 22,839 Municipals.................................... 3,648 11,009 9,273 Corporate bonds............................... 2,617 -- 2,067 CMOs.......................................... 14,799 -- -- ---------- ---------- ---------- Total securities available-for-sale........... $ 104,317 $ 62,072 $ 91,534 ========== ========== ========== Securities held-to-maturity (at amortized cost) Mortgage-backed securities.................... $ 3,588 $ 5,077 $ 4,381 CMOs.......................................... 85 2,036 893 Municipals.................................... 9,491 11,886 10,002 ---------- ---------- ---------- Total securities held-to-maturity........ $ 13,164 $ 18,999 $ 15,276 ========== ========== ==========

The following table summarizes the composition of the Company's investment securities and the weighted average yields at June 30, 2002:

June 30, 2002 Maturity ---------------------------------------------------------------------------------------- After One and After Five and Within One Year Within Five Years Within Ten Years After Ten Years Total --------------- --------------- --------------- --------------- ---------------- Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield (Dollars in thousands) -------- ------ -------- ------ -------- ------ -------- ------ --------- ------ Securities available-for-sale: U.S. Treasury.................. $ 3,126 2.54 % $ -- -- % $ -- -- % $ -- -- % $ 3,126 2.54 % U.S. Government Agencies....... 17,417 4.81 % 45,590 4.15 % -- -- % -- -- % 63,007 4.33 % Mortgage-backed securities..... -- -- % -- -- % 978 5.10 % 16,142 5.34 % 17,120 5.32 % Municipals - nontaxable....... 2,361 4.45 % 1,287 3.85 % -- -- % -- -- % 3,648 4.24 % Corporates bonds............... -- -- % 2,617 4.36 % -- -- % -- -- % 2,617 4.36 % CMOs........................... -- -- % -- -- % -- -- % 14,799 4.86 % 14,799 4.86 % -------- -------- -------- -------- --------- Total available-for-sale....... $ 22,904 4.46 % $ 49,494 4.16 % $ 978 5.10 % $ 30,941 5.11 % $ 104,317 4.51 % -------- -------- -------- -------- --------- Securities held-to-maturity: CMOs........................... $ -- -- % $ -- -- % $ -- -- % $ 85 4.41 % $ 85 4.41 % Mortgage-backed securities..... -- -- % -- -- % 467 5.93 % 3121 6.24 % 3,588 6.20 % Municipals - taxable.......... 500 6.39 % 1,589 6.60 % -- -- % -- -- % 2,089 6.55 % Municipals - nontaxable....... 125 4.85 % 3,707 4.58 % 3,570 4.48 % -- -- % 7,402 4.54 % -------- -------- -------- -------- --------- Total held-to-maturity......... $ 625 6.08 % $ 5,296 5.19 % $ 4,037 4.65 % $ 3,206 6.19 % $ 13,164 5.31 % -------- -------- -------- -------- --------- Total securities............... $ 23,529 4.50 % $ 54,790 4.26 % $ 5,015 4.74 % $ 34,147 5.21 % $ 117,481 4.60 % ======== ======== ======== ======== =========

Note: Yield on non-taxable municipal securities are not presented in a fully tax equivalent basis.
On August 6, 2002 the Company transferred all of its securities categorized as held-to-maturity to the available-for-sale category. The amoritized cost of the transferred securities was $13,164,000 and the related unrealized holding gain was $675,000 as of June 30, 2002. The Company transferred these securities to increase liquid assets and to increase the ability for possible sale of these securities in the future and currently intends to classify all new purchases of securities as available-for-sale.

Loans

Total loans (exclusive of loans held for sale) decreased slightly to $629,423,000 as of June 30, 2002 from $632,917,000 as of December 31, 2001 but increased $24,291,000, or 4%, as compared to $605,132,000 as of June 30, 2001.

For the three and six months ended June 30, 2002, $14,690,000 and $33,435,000 in loans guaranteed by the U.S. Small Business Administration (SBA) were generated and held for sale. $10,665,000 and $21,868,000 of SBA loans held for sale were sold into the secondary market. At June 30, 2002 and December 31, 2001, the Company serviced SBA loans, which it had sold to the secondary market of approximately $61,703,000 and $50,718,000, respectively. At June 30, 2002 and December 31, 2001, the carrying amount of the servicing assets was $921,000 and $783,000, respectively. There was no valuation allowance as of June 30, 2002 or December 31, 2001. The carring amount of Interest-Only (I/O) strip receivable at June 30, 2002 and December 31, 2001 was $2,572,000 and $2,142,000, respectively. Servicing income from these loans was $310,000 and $573,000 for the quarter and six months ended June 30, 2002, compared to $44,000 and $61,000 for the same periods in 2001. Amortization of the related assets was $322,000 and $565,000 for the quarter and six months ended June 30, 2002, compared to $71,000 and $136,000 for the same periods in 2001. Heritage Bank of Commerce is a preferred lender under the U.S. Small Business Administration, which allows the Company to grant certain U.S. Small Business Administration loans without the prior approval of the SBA.

The following table summarizes the composition of the Company's loan portfolio at the rates indicated:

June 30, % of December 31, % of (Dollars in thousands) 2002 Total 2001 Total - ----------------------------------- ------------ ----------- ----------- ----------- Commercial......................... $ 213,908 34 % $ 208,713 33 % Real estate - mortgage............. 250,658 40 % 246,119 39 % Real estate - land and construction 160,368 25 % 174,077 27 % Consumer........................... 4,237 1 % 3,833 1 % ------------ ----------- ----------- ----------- Total loans................... 629,171 100 % 632,742 100 % =========== =========== Deferred loan costs................ 252 175 Allowance for loan losses.......... (11,856) (11,154) ------------ ----------- Loans, net......................... $ 617,567 $ 621,763 ============ ===========

The Company's loan portfolio is based on commercial (primarily to companies engaged in manufacturing, wholesale, and service businesses) and real estate lending, with the balance in consumer loans. While no specific industry concentration is considered significant, the Company's lending operations are dependent on the technology and real estate industries and their supporting companies located within the Company's market area. 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.

The following table sets forth the maturity distribution of the Company's loans at June 30, 2002:

Over One Due in Year But One Year Less Than Over (Dollars in thousands) or Less Five Years Five Years Total - ----------------------------------- ------------ ----------- ----------- ----------- Commercial......................... $ 201,147 $ 11,477 $ 1,284 $ 213,908 Real estate - mortgage............. 160,894 81,518 8,246 250,658 Real estate - land and construction 160,368 -- -- 160,368 Consumer........................... 3,681 556 -- 4,237 ------------ ----------- ----------- ----------- Total loans................... $ 526,090 $ 93,551 $ 9,530 $ 629,171 ============ =========== =========== =========== Loans with variable interest rates. $ 505,292 $ 53,954 $ 5,444 $ 564,690 Loans with fixed interest rates.... 20,798 39,597 4,086 64,481 ------------ ----------- ----------- ----------- Total loans................... $ 526,090 $ 93,551 $ 9,530 $ 629,171 ============ =========== =========== ===========

The table shows the distribution of such loans between those loans with predetermined (fixed) interest rates and those with variable (floating) interest rates. Floating rates generally fluctuate with changes in the prime rate as reflected in the western edition of The Wall Street Journal. At June 30, 2002, approximately 90% of the Company's loan portfolio consisted of floating interest rate loans.

Nonperforming assets

Nonperforming assets consist of nonaccrual loans, loans past due 90 days and still accruing, troubled debt restructurings and other real estate owned. Management generally places loans on nonaccrual status when they become 90 days past due, unless they are well secured and in the process of collection. When a loan is placed on nonaccrual status, any interest previously accrued but not collected is generally reversed from income. Loans are charged off when management determines that collection has become unlikely. Restructured loans are those where the Banks have granted a concession on the interest paid or original repayment terms due to financial difficulties of the borrower. Other real estate owned ("OREO") consists of real property acquired through foreclosure on the related underlying defaulted loans. The following table shows nonperforming assets at the dates indicated:

June 30, ---------------------- December 31, (Dollars in thousands) 2002 2001 2001 - -------------------------------------------- ---------- ---------- ----------- Nonaccrual loans............................ $ 1,951 $ 66 $ -- Loans 90 days past due and still accruing 415 -- -- Restructured loans.......................... -- -- -- ---------- ---------- ----------- Total nonperforming loans............... 2,366 66 -- Foreclosed assets........................... -- -- -- ---------- ---------- ----------- Total nonperforming assets.............. $ 2,366 $ 66 $ -- ========== ========== =========== Nonperforming assets as a percentage of period end loans plus foreclosed assets... 0.38 % 0.01 % -- %

As of June 30, 2002, the Company had $1,951,000 loans on nonaccrual status, compared to $66,000 in the same period of the prior year, which were considered impaired loans. The Company had $415,000 loans past due 90 days or more and still accruing interest, no restructured loans and no foreclosed assets as of June 30, 2002. The Company had no loans past due 90 days or more and still accruing interest, no restructured loans and no foreclosed assets as of June 30, 2001. The Company had no loans on nonaccrual status, no loans past due 90 days or more and still accruing interest, no restructured loans, no foreclosed assets, and no impaired loans as of December 31, 2001.
The Company assigns a risk grade consistent with the system recommended by regulatory agencies to all of its loans. Grades range from "Pass" to "Loss" depending on credit quality, with "Pass" representing loans that involve an acceptable degree of risk. Management conducts a critical evaluation of the loan portfolio monthly. This evaluation includes periodic loan by loan review for certain loans to evaluate the level of impairment as well as detailed reviews of other loans (either individually or in pools) based on 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, collateral value, loan volumes and concentrations, size and complexity of the loans, recent loss experience in particular segments of the portfolio, bank regulatory examination results, and current economic conditions in the Company's marketplace, in particular the state of the technology industry and the real estate market.

This process attempts to assess the risk of loss inherent in the portfolio by segregating loans into four components for purposes of determining an appropriate level of the allowance: "watch," "special mention," "substandard" and "doubtful." Additionally, the Company maintains a program for regularly scheduled reviews of certain new and renewed loans by an outside loan review consultant. Any loans identified during an external review process that expose the Company to increased risk are appropriately downgraded and an increase in the allowance for loan losses is established for such loans. Further, the Company is examined periodically by the FDIC, FRB, and the California Department of Financial Institutions at which time a further review of loan quality is conducted.

Loans that demonstrate a weakness, for which there is a possibility of loss if the weakness is not corrected, are categorized as "classified." Classified loans include all loans graded substandard, doubtful and loss and may result from problems specific to a borrower's business or from economic downturns that affect the borrower's ability to repay or that cause a decline in the value of the underlying collateral (particularly real estate).

Allowance for Loan Losses

It is the policy of management to maintain the allowance for probable loan losses at a level adequate for 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 allowance is adequate. However, the loan portfolio can be adversely affected if California economic conditions and the real estate market in the Company's market area were to weaken. Additionally, any weakness of a prolonged nature in the technology industry would have a negative impact on the local market. The effect of such events although uncertain at this time, could result in an increase in the level of nonperforming loans and increased loan losses, which could adversely affect the Company's future growth and profitability. 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 Company's loan loss experience as well as provisions, charge-offs and recoveries to the allowance for loan losses and certain pertinent ratios for the periods indicated:

Six Months Ended June 30, For the Year Ended -------------------- December 31, (Dollars in thousands) 2002 2001 2001 - -------------------------------------- --------- --------- ----------- Balance, beginning of period / year... $ 11,154 $ 9,651 $ 9,651 Net recoveries (charge-offs).......... (613) (359) (407) Provision for probable loan losses.... 1,315 1,055 1,910 --------- --------- ----------- Balance, end of period / year......... $ 11,856 $ 10,347 $ 11,154 ========= ========= =========== Ratios: Net recoveries (charge-offs) to average loans outstanding.......... 0.10 % 0.06 % 0.07 % Allowance for loan losses to average loans.............................. 1.86 % 1.74 % 1.84 % Allowance for loan losses to total loans.............................. 1.88 % 1.71 % 1.76 % Allowance for loan losses to non-performing assets.............. 501 % 15,677 % -- %

Charge-offs reflect the realization of losses in the portfolio that were recognized previously though provisions for probable loan losses. The net charge-offs as of June 30, 2002 were $613,000, compared to $359,000 as of June 30, 2001. The increase in net charge-offs in 2002 was primarily due to the increase in certain commercial loan charge-offs. Historical net charge-offs are not necessarily indicative of the amount of net charge-offs that the Company will realize in the future.

The following table summarizes the allocation of the allowance for loan losses (ALL) by loan type and the allocated allowance as a percent of loans outstanding in each loan category at the dates indicated:

June 30, 2002 June 30, 2001 December 31, 2001 -------------------- ---------------------- -------------------- Percent Percent Percent of ALL by of ALL by of ALL by category category category to total to total to total loans by loans by loans by (Dollars in thousands) Amount category Amount category Amount category - -------------------------------------- --------- --------- ----------- --------- --------- --------- Commercial............................ $ 5,834 2.72 % $ 3,925 1.94 % $ 5,489 2.63 % Real estate - mortgage................ 2,254 0.90 % 1,538 0.66 % 1,420 0.58 % Real estate - land and construction... 2,997 1.87 % 2,657 1.61 % 3,066 1.76 % Consumer.............................. 101 2.39 % 161 2.77 % 102 2.66 % Unallocated........................... 670 -- % 2,066 -- % 1,077 -- % --------- ----------- --------- Total ........................... $ 11,856 1.88 % $ 10,347 1.71 % $ 11,154 1.76 % ========= =========== =========

The increase in the allowance for loan losses from June 30, 2001 reflects the growth in the Company's overall level of loans, primarily in the commercial and real estate loan portfolio and the increase from December 31, 2001 reflects the increase in commercial loans which typically have the greatest inherent loss exposure.

Loans are charged against the allowance when management believes that the collectibility of the principal is doubtful. The Company's methodology for assessing the appropriateness of the allowance consists of several key elements, which include specific allowances, the formula allowance and the unallocated allowance.

Specific allowances are established in cases where management has identified significant conditions or circumstances related to a credit that management believes indicate the probability that a loss may be incurred in excess of the amount determined by the application of the formula allowance. There were no specific allowances allocated at June 30, 2002 and December 31, 2001 as none of the nonperforming loans at June 30, 2002 required specific allowances based on the underlying collateral values and there were no nonperforming loans at December 31, 2001.

The formula allowance is calculated by applying loss factors to outstanding loans and certain unused commitments. Loss factors are based on management's experience and may be adjusted for significant factors that, in management's judgment, may affect the collectibility of the portfolio as of the evaluation date. Due to the Company's limited historical loss experience, management utilizes their prior industry experience to determine the loss factor for each category of loan. The formula allowance on June 30, 2002 was $11,186,000, compared to $10,077,000 on December 31, 2001. The increase was attributable to several factors, most notably the change in the mix of loans and an increase in certain factors used to estimate the reserve allocations.

The unallocated allowance is based upon management's evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. As of June 30, 2002, the Company's unallocated allowance was $670,000, compared to $1,077,000 on December 31, 2001. In evaluating the appropriateness of the unallocated allowance, management considered the changes in the trend of the volume and severity of past due and classified loans; and trends in the volume of nonaccrual loans, troubled debt restructurings and other loan modifications, changes in national and local economic and business conditions, trends, and developments, including the condition of various market segments, changes in underwriting standards and collection, charge-off, and recovery practices, and changes in the volume and mix of the loan portfolio and in credit concentrations particularly in commercial and real estate land and construction lending. The range of potential impact for these factors is estimated to be from $470,000 - $840,000. There can be no assurance that the adverse impact of any of these conditions on the Bank will not be in excess of the range set forth above.

In addition, the current business, economic, and real estate markets along with the seasoning of the portfolio and the nature and duration of the current business cycle will affect the amount of unallocated reserve.

In an effort to improve its analysis of risk factors associated with its loan portfolio, the Company continues to monitor and to make appropriate changes to its internal loan policies. These efforts better enable the Company to assess risk factors prior to granting new loans and to assess the sufficiency of the allowance for loan losses.

Management believes that it has adequately provided an allowance for estimated probable losses in the credit portfolio. Significant deterioration in Northern California real property values or economic downturns could impact future operating results, liquidity or capital resources and require additional provisions to the allowance or cause losses in excess of the allowance.
Deposits

Deposits totaled $818,464,000 at June 30, 2002, an increase of 1%, compared to deposits of $807,908,000 at December 31, 2001 and an increase of 6% compared to $770,168,000 at June 30, 2001. Compared to December 31, 2001, noninterest bearing demand deposits increased $9,830,000 or 5%, interest bearing demand deposits increased $11,232,000 or 14%, savings and money market deposits increased $36,038,000 or 16%. These increases were offset by decreases in time deposits $46,390,000 or 21% and brokered deposits $154,000, or less than 1%.

The following table summarizes the distribution of average deposits and the average rates paid for the periods indicated:

Six Months Ended Year Ended June 30, 2002 December 31, 2001 -------------------- -------------------- Average Average Average Rate Average Rate (Dollars in thousands) Balance Paid Balance Paid - ------------------------------------- ---------- -------- ---------- -------- Demand, noninterest bearing.......... $ 201,092 -- % $ 204,114 -- % Demand, interest bearing............. 81,597 0.87 % 69,634 1.58 % Saving and money market.............. 255,098 1.92 % 227,344 3.09 % Time deposits, under $100............ 63,056 3.55 % 78,910 5.37 % Time deposits, $100 and over......... 138,244 3.10 % 166,268 5.18 % Brokered deposits.................... 68,554 3.91 % 30,843 5.32 % ---------- ---------- Total average deposits.......... $ 807,641 1.83 % $ 777,113 2.91 % ========== ==========

Deposit Concentration and Deposit Volatility

The following table indicates the maturity schedule of the Company's time deposits of $100,000 or more as of June 30, 2002.

% of (Dollars in thousands) Balance Total - ----------------------------------------------------------- ---------- -------- Three months or less....................................... $ 75,586 39 % Over three months through twelve months.................... 85,446 45 % Over twelve months......................................... 30,338 16 % ---------- -------- Total............................................... $ 191,370 100 % ========== ========

The Company focuses primarily on servicing business accounts that are frequently over $100,000 in average size. Certain types of accounts that the Company makes available are typically in excess of $100,000 in average balance per account, and certain types of business clients whom the Company serves typically carry deposits in excess of $100,000 on average. The account activity for some account types and client types necessitates appropriate liquidity management practices by the Company to ensure its ability to fund deposit withdrawals.

Return on Equity and Assets

The following table indicates the ratios on the return on average equity and average assets for each indicated period.

Three Months Ended Six Months Ended June 30, June 30, 2002 2001 2002 2001 ---------- -------- ---------- -------- Return on average assets................ 0.68 % 0.88 % 0.68 % 0.95 % Return on average equity................ 8.15 % 10.74 % 8.13 % 11.89 % Average equity to average assets ratio.. 8.34 % 8.23 % 8.31 % 8.04 %

Annualized return on average assets and return on average equity for the quarter ended June 30, 2002 were 0.68% and 8.15%, respectively, compared with returns of 0.88% and 10.74%, respectively, for the same period in 2001. The equity to asset ratio for the quarter ended June 30, 2002 was 8.34%, compared to 8.23% for the same period in 2001. Annualized return on average assets and return on average equity for the six months ended June 30, 2002 were 0.68% and 8.13%, respectively, compared with returns of 0.95% and 11.89%, respectively, for the same period in 2001. The equity to asset ratio for the six months ended June 30, 2002 was 8.31%, compared to 8.04% for the same period in 2001.

Interest Rate Risk

The planning of asset and liability maturities is an integral part of the management of an institution's net yield. To the extent maturities of assets and liabilities do not match in a changing interest rate environment, net yields may change over time. Even with perfectly matched repricing of assets and liabilities, risks remain in the form of prepayment of loans or investments or in the form of delays in the adjustment of rates of interest applying to either earning assets with floating rates or to interest bearing liabilities. The Company has generally been able to control its exposure to changing interest rates by maintaining primarily floating interest rate loans and a majority of its time certificates with relatively short maturities

The following table sets forth the interest rate sensitivity of the Company's interest-earning assets and interest-bearing liabilities at June 30, 2002, 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:

Due in Due After Within Three to One to Due After Not Three Twelve Five Five Rate- (Dollars in thousands) Months Months Years Years Sensitive Total - ---------------------------------------------- --------- --------- --------- --------- --------- --------- Interest earning assets: Federal funds sold.......................... $ 55,500 $ -- $ -- $ -- $ -- $ 55,500 Interest bearing deposits in banks.......... 6,025 -- -- -- -- 6,025 Securities.................................. 3,264 20,266 54,789 39,162 -- 117,481 Total loans................................. 492,489 70,652 93,551 9,530 -- 666,222 --------- --------- --------- --------- --------- --------- Total interest earning assets............. 557,278 90,918 148,340 48,692 -- 845,228 --------- --------- --------- --------- --------- --------- Cash and due from banks....................... -- -- -- -- 40,062 40,062 Other assets.................................. -- -- -- -- 42,402 42,402 --------- --------- --------- --------- --------- --------- Total assets.............................. $ 557,278 $ 90,918 $ 148,340 $ 48,692 $ 82,464 $ 927,692 ========= ========= ========= ========= ========= ========= Interest bearing liabilities: Demand, interest bearing.................... $ 91,761 $ -- $ -- $ -- $ -- $ 91,761 Savings and money market.................... 266,032 -- -- -- -- 266,032 Time deposits............................... 96,711 111,416 36,077 -- -- 244,204 Mandatorily Redeemable Cumulative Trust Preferred Securities................ -- -- -- 19,000 -- 19,000 --------- --------- --------- --------- --------- --------- Total interest bearing liabilities........ 454,504 111,416 36,077 19,000 -- 620,997 --------- --------- --------- --------- --------- --------- Noninterest demand deposits................... 63,925 -- -- -- 152,542 216,467 Other liabilities............................. -- -- -- -- 12,130 12,130 Shareholders' equity.......................... -- -- -- -- 78,098 78,098 --------- --------- --------- --------- --------- --------- Total liabilities and shareholders' equity $ 518,429 $ 111,416 $ 36,077 $ 19,000 $ 242,770 $ 927,692 ========= ========= ========= ========= ========= ========= Interest rate sensitivity GAP................. $ 38,849 $ (20,498) $ 112,263 $ 29,692 $(160,306) $ -- ========= ========= ========= ========= ========= ========= Cumulative interest rate sensitivity GAP...... $ 38,849 $ 18,351 $ 130,614 $ 160,306 $ -- $ -- Cumulative interest rate sensitivity GAP ratio 4.19 % 1.98 % 14.08 % 17.28 % -- % -- %

The foregoing table demonstrates that the Company had a positive cumulative one year gap of $18,351,000, or 1.98% of total assets, at June 30, 2002. In theory, this would indicate that $18,351,000 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. This characteristic is referred to as a basis risk and, generally, relates to the repricing characteristics of certain short-term funding sources.

Interest rate changes do not affect all categories of assets and liabilities equally or at the same time. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities, which may have a significant effect on the net interest margin and are not reflected in the interest sensitivity analysis table. Because of these factors, an interest sensitivity gap report may not provide a complete assessment of the exposure to changes in interest rates. To supplement traditional GAP analysis, the Company performs simulation modeling to estimate the potential effects of changing interest rate environments. The process allows the Company to explore the complex relationships within the GAP over time and various interest rate environments.

Liquidity risk represents the potential for loss as a result of limitations on the Company's ability to adjust for future cash flows, to meet the needs of depositors and borrowers, and to fund operations on a timely and cost-effective basis. The liquidity policy approved by the board requires annual review of the Company's liquidity by the asset/liability committee, which is composed of senior executives, and the finance and investment committee of the board of directors.

The Company's internal asset/liability committee and the finance and investment committee of the board each meet monthly to monitor the Company's investments, liquidity needs and to oversee its asset/liability management. The Company evaluates the rates offered on its deposit products on a weekly basis.
Liquidity and Liability Management

To meet liquidity needs, the Company maintains a portion of its funds in cash deposits in other banks, in Federal funds sold, and in investment securities. At June 30, 2002, the Company's primary liquidity ratio was 20.70%, comprised of $75,308,000 in investment securities available-for-sale with maturities (or probable calls) of up to five years, less $9,441,000 of securities that were pledged to secure public and certain other deposits as required by law and contract; Federal funds sold of $55,500,000, and $46,087,000 in cash and due from banks, as a percentage of total unsecured deposits of $809,023,000.

Capital Resources

The following table summarizes risk-based capital, risk-weighted assets, and risk-based capital ratios of the Company:

June 30, ---------------------- December 31, (Dollars in thousands) 2002 2001 2001 - --------------------------------- ---------- ---------- ------------ Capital components: Tier 1 Capital................ $ 94,912 $ 83,754 $ 91,598 Tier 2 Capital................ 9,921 9,149 9,664 ---------- ---------- ------------ Total risk-based capital.... $ 104,833 $ 92,903 $ 101,262 ========== ========== ============ Risk-weighted assets............. $ 793,424 $ 730,759 $ 779,060 Average assets................... $ 918,555 $ 856,653 $ 898,020 Minimum Regulatory Requirements ----------- Capital ratios: Total risk-based capital....... 13.2 % 12.7 % 13.0 % 8.0 % Tier 1 risk-based capital...... 12.0 % 11.5 % 11.8 % 4.0 % Leverage ratio (1)............. 10.3 % 9.8 % 10.2 % 4.0 %

(1)

Tier 1 capital divided by average assets (excluding goodwill).

At June 30, 2002 and 2001, and December 31, 2001, the Company's capital met all minimum regulatory requirements. As of June 30, 2002, management believes that HBC, HBEB, HBSV, and BLA were considered "Well Capitalized" under the Prompt Corrective Action Provisions.

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 Form 10-K.

Part II - Other Information

Item 4. - Submissions of Matters to a Vote of Security Holders

The Company held its 2002 Annual Meeting of Shareholders on May 23, 2002. There were 11,132,462 issued and outstanding shares of Company Common Stock on April 9, 2002, the Record Date for the 2002 Annual Meeting. Each of the shares voting at the meeting was entitled to one vote.

At the 2002 Annual Meeting, the following actions were taken:

Election of Directors

The Company's board is divided into three classes. At the 2002 Annual Meeting, five directors of the Company were elected. The following chart indicates the number of shares cast for each elected director:

Name of Director Votes For Votes Withheld

Phillip R. Boyce 8,959,103 298,491

Richard L. Conniff 8,813,602 443,992

Kirk M. Rossmann 8,983,809 273,785

Brad L. Smith 8,813,272 444,322

Charles J. Toeniskoetter 8,983,809 273,785

In addition to the above five individuals, the following previously elected directors' terms continued after the meeting:

Name of Director Title

Frank Bisceglia Director

Jim Blair Director

Bill Del Biaggo, Jr. Director/Business Development Officer

Anneke Dury Director

Roy Lave Director

Lon Normandin Director

Jack Peckham Director

Humphrey Polanen Director

Howard Weiland Director

Ratification of Deloitte & Touche, LLP as the Company's auditors

The number of shares cast for and against the ratification of the Board of Directors' selection of Deloitte & Touche, LLP to serve as the Company's auditors for the fiscal year ending December 31, 2002 was as follows:

FOR 9,239,142

AGAINST 5,372

ABSTENTIONS 13,080

Item 6. - Exhibits and Reports on Form 8-K

a. Exhibits included with this filing:

Exhibits Number Name

99.1 Certification of Registrant's Chief Executive Officer Pursuant to 18 U.S.C. Section 1350

99.2 Certification of Registrant's Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

b. Reports on Form 8-K

The Registrant filed Current Report on Form 8-K dated July 16, 2002 under item 5 to report the merger of three of its wholly owned commercial bank subsidiaries into the Company's original wholly owned bank susidiary.

The Registrant filed Current Report on Form 8-K dated July 24, 2002 under item 5 to report its second quarter ended June 30, 2002 financial results, and condensed summarized statements of financial position and results of operations.

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 14, 2002

/s/ Brad L. Smith

Date

Brad L. Smith, Chairman of the Board and CEO

August 14, 2002

/s/ Lawrence D. McGovern

Date

Lawrence D. McGovern, Chief Financial Officer

Exhibit Index

Exhibit Description

99.1 Certification of Registrant's Chief Executive Officer Pursuant To 18 U.S.C. Section 1350

99.2 Certification of Registrant's Chief Financial Officer Pursuant To 18 U.S.C. Section 1350

Exhibit 99.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Heritage Commerce Corp (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Brad L. Smith, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

August 14, 2002

/s/ Brad L. Smith

Brad L. Smith

Chief Executive Officer

Exhibit 99.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Heritage Commerce Corp (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Lawrence D. McGovern, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

August 14, 2002

/s/ Lawrence D. McGovern

Lawrence D. McGovern

Chief Financial Officer

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California	77-0469558
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)

PART I. FINANCIAL INFORMATION	Page No.

Item 1. Financial Statements (unaudited):

Condensed Consolidated Balance Sheets	2

Condensed Consolidated Income Statements	3

Condensed Consolidated Statements of Cash Flows	4

Condensed Consolidated Notes to Financial Statements	5

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	7

Item 3. Quantitative and Qualitative Disclosures About Market Risk	25

PART II. OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders	25

Item 6. Exhibits and Reports on Form 8-K	27

Signatures	27

Exhibit Index	28

		Heritage Commerce Corp
		(Registrant)
August 14, 2002		/s/ Brad L. Smith
Date		Brad L. Smith, Chairman of the Board and CEO

August 14, 2002		/s/ Lawrence D. McGovern
Date		Lawrence D. McGovern, Chief Financial Officer