Heritage Commerce (HTBK) 10-Q 2001 Q2 Quarterly report

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

FORM 10-Q

(Mark One)
[X]	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2001

Or

[   ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transitional period from _________________ to _________________

Commission File No. 000-23877

HERITAGE COMMERCE CORP

(Exact name of registrant as specified in its charter)

California (State or other jurisdiction of incorporation or organization)	77-0469558 (I.R.S. Employer Identification No.)
150 Almaden Blvd., San Jose, California (Address of principal executive offices)	95113 (Zip Code)

(408) 947-6900

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report.)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    [X] Yes     [   ] No

APPLICABLE ONLY TO CORPORATE ISSUERS:

The Registrant had 11,104,574 shares of Common Stock outstanding on August 9, 2001.

1

TABLE OF CONTENTS

		Condensed Consolidated Statements of Financial Condition
		Condensed Consolidated Income Statements (Unaudited)
		Condensed Consolidated Statements of Cash Flows (Unaudited)
		Notes to Condensed Consolidated Financial Statements
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Part II — Other Information
	Item 1. — Legal Proceedings
	Item 4. — Submissions of Matters to a Vote of Security Holders
	Item 6. — Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT INDEX
EXHIBIT 3.1
EXHIBIT 3.2

HERITAGE COMMERCE CORP AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q

Table of Contents

			Page
Part I	—	Financial Information
Item 1.		Financial Statements (Unaudited):
		Condensed Consolidated Statements of Financial Condition		3
		Condensed Consolidated Income Statements		4
		Condensed Consolidated Statements of Cash Flows		5
		Condensed Consolidated Notes to Financial Statements		6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		7
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		18
Part II	—	Other Information
Item 1.		Legal Proceedings		18
Item 4.		Submissions of Matters to a Vote of Security Holders		18
Item 6.		Exhibits and Reports on Form 8-K		20
Signatures				20

2

HERITAGE COMMERCE CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Financial Condition (Unaudited)

ASSETS

					June 30, 2001			December 31, 2000
Cash and due from banks					$	34,624,000		$	38,671,000
Interest bearing deposits in banks						5,414,000			2,098,000
Federal funds sold						67,900,000			19,300,000
				Total cash and cash equivalents		107,938,000			60,069,000
Securities available-for-sale, at fair value						62,072,000			90,894,000
Securities held-to-maturity, at amortized cost (fair value of $19,385,000 at June 30, 2001 and $20,075,000 at December 31, 2000						18,999,000			19,908,000
Loan held for sale, at fair value						40,680,000			35,931,000
Loans, net of deferred costs						605,132,000			610,781,000
Allowance for probable loan losses						(10,347,000	)		(9,651,000	)
				Loans, net		594,785,000			601,130,000
Premises and equipment, net						6,045,000			6,415,000
Accrued interest receivable and other assets						15,416,000			12,920,000
Other investments						21,696,000			18,957,000
				TOTAL	$	867,631,000		$	846,224,000
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
	Deposits
			Demand, noninterest bearing		$	234,125,000		$	207,885,000
			Demand, interest bearing			66,063,000			68,587,000
			Savings and money market			201,341,000			219,299,000
			Time deposits, under $100,000			82,950,000			70,552,000
			Time deposits, $100,000 and over			158,966,000			162,625,000
			Brokered deposits			26,723,000			9,238,000
	Total deposits					770,168,000			738,186,000
	Federal Home Loan Bank borrowing					—			18,000,000
	Mandatorily redeemable cumulative trust preferred securities of Subsidiary Grantor Trust					14,000,000			14,000,000
	Accrued interest payable and other liabilities					12,496,000			10,305,000
				Total liabilities		796,664,000			780,491,000
Commitments and contingencies
Shareholders’ equity:
		Preferred Stock, no par value; 10,000,000 shares authorized; none outstanding				—			—
		Common Stock, no par value; 30,000,000 shares authorized; Shares issued and outstanding: 11,104,574 at June 30, 2001 and 10,939,124 at December 31, 2000				63,491,000			62,469,000
		Accumulated other comprehensive income, net of taxes				656,000			515,000
		Retained Earnings				6,820,000			2,749,000
				Total shareholders’ equity		70,967,000			65,733,000
				TOTAL	$	867,631,000		$	846,224,000

See notes to condensed consolidated financial statements

3

HERITAGE COMMERCE CORP AND SUBSIDIARIES
Condensed Consolidated Income Statements (Unaudited)

			Three months ended June 30,				Six months ended June 30,
			2001		2000		2001		2000
Interest income:
	Loans, including fees		$	14,818,000	$	13,645,000	$	30,636,000	$	25,027,000
	Securities, taxable			1,130,000		1,457,000		2,546,000		2,652,000
	Securities, non-taxable			146,000		157,000		298,000		303,000
	Interest bearing deposit in banks			47,000		8,000		83,000		11,000
	Federal funds sold			710,000		1,034,000		1,450,000		2,285,000
Total interest income				16,851,000		16,301,000		35,013,000		30,278,000
Interest expense:
	Deposits			5,855,000		5,725,000		12,448,000		10,524,000
	Mandatorily redeemable trust preferred securities			376,000		190,000		752,000		209,000
	Other			—		6,000		113,000		47,000
Total interest expense				6,231,000		5,921,000		13,313,000		10,780,000
Net interest income before provision for loan losses				10,620,000		10,380,000		21,700,000		19,498,000
Provision for loan losses				528,000		534,000		1,055,000		1,214,000
Net interest income after provision for loan losses				10,092,000		9,846,000		20,645,000		18,284,000
Noninterest income:
	Gain on sale of securities available-for-sale			409,000		44,000		551,000		44,000
	Gain on sale of loans			278,000		—		551,000		—
	Other investments			242,000		148,000		510,000		362,000
	Service charges and other fees on deposits accounts			228,000		170,000		436,000		341,000
	Servicing income			118,000		70,000		232,000		70,000
	Other income			372,000		182,000		588,000		533,000
Total noninterest income				1,647,000		614,000		2,868,000		1,350,000
Noninterest expenses:
	Salaries and employee benefits			4,629,000		4,530,000		9,710,000		8,545,000
	Occupancy			681,000		514,000		1,361,000		1,057,000
	Client services			647,000		269,000		939,000		638,000
	Furniture and equipment			425,000		375,000		866,000		706,000
	Loan origination costs			360,000		155,000		659,000		361,000
	Professional fees			265,000		583,000		595,000		889,000
	Advertising and promotion			359,000		222,000		582,000		401,000
	Stationery & supplies			125,000		82,000		258,000		161,000
	Telephone			93,000		84,000		182,000		170,000
	Merger and integration costs			—		95,000		—		95,000
	Other			1,085,000		1,316,000		1,784,000		1,992,000
Total noninterest expenses				8,669,000		8,225,000		16,936,000		15,015,000
Net income before income taxes				3,070,000		2,235,000		6,577,000		4,619,000
Provision for income taxes				1,180,000		746,000		2,506,000		1,613,000
Net income			$	1,890,000	$	1,489,000	$	4,071,000	$	3,006,000
Earnings per share:
		Basic	$	0.17	$	0.14	$	0.37	$	0.29
		Diluted	$	0.17	$	0.13	$	0.36	$	0.27

See notes to condensed consolidated financial statements

4

HERITAGE COMMERCE CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows (Unaudited)

			Six months ended June 30,
			2001			2000
Cash flows from operating activities:
Net income			$	4,071,000		$	3,006,000
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization				803,000			721,000
Provision for probable loan losses				1,055,000			1,214,000
Gain on sale of securities available-for-sale				(551,000	)		(44,000	)
Net amortization of premiums / accretion of discounts				(59,000	)		4,000
Proceeds from sales of loans held for sale				14,611,000			—
Originations of loans held for sale				(19,516,000	)		(5,505,000	)
Maturities of loans held for sale				157,000			128,000
Effect of changes in:
		Accrued interest receivable and other assets		(2,612,000	)		(4,170,000	)
		Accrued interest payable and other liabilities		2,039,000			(4,184,000	)
Net cash used in operating activities				(2,000	)		(8,830,000	)
Cash flows from investing activities:
Net change in loans				5,290,000			(120,357,000	)
Purchases of securities available-for-sale				(38,211,000	)		(39,377,000	)
Maturities\paydowns\calls				12,782,000			1,370,000
Proceeds from sales of securities available-for-sale				55,297,000			10,367,000
Proceeds from maturities or calls of securities held-to-maturity				883,000			1,577,000
Purchases of corporate owned life insurance				(3,074,000	)		(1,655,000	)
Purchases (redemption) of other investments				334,000			(323,000	)
Purchases of property and equipment				(433,000	)		(649,000	)
Net cash provided by (used in) investing activities				32,868,000			(149,047,000	)
Cash flows from financing activities:
Net increase in deposits				31,982,000			135,696,000
Proceeds from issuance of mandatorily redeemable cumulative trust preferred securities of Subsidiary Grantor Trust				—			7,000,000
Proceeds from exercise of stock option				606,000			632,000
Net increase in additional paid-in capital option				415,000			146,000
Net change in FHLB borrowings				(18,000,000	)		(5,000,000	)
Net cash provided by financing activities				15,003,000			138,474,000
Net increase (decrease) in cash and cash equivalents				47,869,000			(19,403,000	)
Cash and cash equivalents, beginning of period				60,069,000			155,224,000
Cash and cash equivalents, end of period			$	107,938,000		$	135,821,000
Supplemental disclosures of cash paid during the period for:
	Interest			13,487,000			9,710,000
	Income taxes			2,890,000			3,277,000

See notes to condensed consolidated financial statements

5

HERITAGE COMMERCE CORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2001
(Unaudited)

1)	Basis of Presentation
	The unaudited condensed consolidated financial statements of Heritage Commerce Corp 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 and Heritage Statutory Trust I, 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 Annual Report for the year ended December 31, 2000, as amended by Form 10-K/A filed on April 6, 2001. The unaudited condensed financial information presented herein has been restated on a historical basis to reflect the merger with Western Holdings Bancorp, which closed in October 2000, as a pooling of interests as if the Companies had been combined for all periods presented.
	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, 2001 are not necessarily indicative of the results expected for any subsequent period or for the entire year ending December 31, 2001.
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,
	2001		2000		2001		2000
Weighted average common shares outstanding — used in computing basic earnings per share		11,096,230		10,472,289		11,053,894		10,429,176
Diluted effect of stock options outstanding, using the treasury stock method		303,808		804,345		316,414		798,600
Shares used in computing diluted earnings per share		11,400,038		11,276,634		11,370,308		11,227,776

6

3)	Comprehensive Income
	Comprehensive Income includes net income and other comprehensive income, which represents the change in its net assets during the period from non-owner sources.
	The Company’s only source of other comprehensive income is derived from unrealized gains and losses on investment securities available-for-sale. 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,			June 30,			June 30,
			2001			2000			2001			2000
Net Income			$	1,890,000		$	1,489,000		$	4,071,000		$	3,006,000
Other comprehensive income, net of tax:
	Net unrealized gain (loss) on securities available-for-sale during the period			(221,000	)		153,000			480,000			(22,000	)
		Less: reclassification adjustment for realized gains on available-for-sale securities included in net income during the period		(252,000	)		(30,000	)		(339,000	)		(30,000	)
Other comprehensive income (loss)				(473,000	)		123,000			141,000			(52,000	)
Comprehensive income			$	1,417,000		$	1,612,000		$	4,212,000		$	2,954,000

4)	New Accounting Pronouncements
	In June 2001, the Financial Accounting Standards Board approved for issuance Statement of Financial Accounting Standard (SFAS) No. 141,Business Combinations and SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method of accounting and address the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives will be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will be required to be tested at least annually for impairment. The Company will adopt SFAS No. 142 for its fiscal year beginning January 1, 2002. The Company has not completed its evaluation of the impact that the adoption of SFAS No. 142 will have on its financial position, results of operations and cash flows, however the Company did not have any goodwill or intangible assets at June 30, 2001 or December 31, 2000.
5)	Reclassifications
	Certain amounts in the December 31, 2000 and June 30, 2000 financial statements have been reclassified to conform to the June 30, 2001 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. 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.

7

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. The financial information presented herein has been restated on a historical basis to reflect the merger with Western Holdings Bancorp, which closed in October 2000, as a pooling of interests as if the Companies had been combined for all periods presented.

OVERVIEW

Net income for the three and six months ended June 30, 2001 was $1,890,000 and $4,071,000, up 27% and 35%, from $1,489,000 and $3,006,000 for the same periods in the prior year. Earnings per diluted share for the three and six months ended June 30, 2001 was $0.17 and $0.36, up 31% and 33%, from $0.13 and $0.27 per diluted share for same periods in the prior year. Annualized return on average assets and return on average equity for the six months ended June 30, 2001 were 0.95% and 11.90% compared with returns of 0.84% and 10.38% for the same period in the prior year. Annualized return on average assets and return on average equity for the quarter ended June 30, 2001 were 0.88% and 10.71%, compared with returns of 0.79% and 10.12%, for the same period in the prior year.

For the six months ended June 30, 2001, as compared with the same period in the prior year, net interest income increased from $19,498,000 to $21,700,000, an increase of $2,202,000, or 11%. For the three months ended June 30, 2001, as compared with the same period in the prior year, net interest income increased from $10,380,000 to 10,620,000, an increase of $240,000, or 2%. The increase is attributable to the growth in earning assets, primarily loans, offset by a decline in interest rates earned reflecting the Federal Reserve Board of Governors’ reduction in short term interest rates of 275 basis points during the first six months of 2001 and the timing of the Company's ability to reprice its interest bearing deposits. The Company’s net interest margin was 5.52% for the six months ended June 30, 2001, compared with 5.91% for the six months ended June 30, 2000, reflective of the overall decline in the interest rate environment and the fact that the Company’s assets reprice more quickly than its liabilities.

Total assets as of June 30, 2001 were $867,631,000, an increase of $53,336,000, or 7%, from $814,295,000 at June 30, 2000, and an increase of $21,407,000, or 3%, from total assets of $846,224,000 at December 31, 2000. Total deposits as of June 30, 2001 were $770,168,000, an increase of $33,052,000, or 4%, from $737,116,000 at June 30, 2000, and an increase of $31,982,000, or 4%, from total deposits of $738,186,000 at December 31, 2000.

Total portfolio loans as of June 30, 2001 were $605,132,000, an increase of $83,594,000, or 16%, from $521,538,000 June 30, 2000. Total portfolio loans as of December 31, 2000 were $610,781,000. The Company’s allowance for loan losses was $10,347,000, or 1.71%, of total loans as of June 30, 2001. This compares with an allowance for loan losses of $7,738,000, or 1.48%, and $9,651,000, or 1.58% of total loans at June 30, 2000 and December 31, 2000. The Company’s non-performing assets were $66,000 as of June 30, 2001 compared to $1,092,000 as of June 30, 2000 and none as of December 31, 2000.

The Company’s shareholders’ equity at June 30, 2001 was $70,967,000, up from $60,276,000 as of June 30, 2000 and $65,733,000 as of December 31, 2000. Book value per share was $6.39 as of June 30, 2001, up from $5.71 as of June 30, 2000 and $6.01 as of December 31, 2000. The Company’s leverage capital ratio was 9.78% at June 30, 2001 compared to 9.06% at June 30, 2000 and 9.30% at December 31, 2000.

8

RESULTS OF OPERATIONS

Net Interest Income and Net Interest Margin

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

		For the Three Months Ended June 30, 2001							For the Three Months Ended June 30, 2000
				Interest		Average					Interest		Average
		Average		Income/		Yield/			Average		Income/		Yield/
(Dollars in thousands)		Balance		Expense		Rate			Balance		Expense		Rate
Assets:
Loans, gross		$	633,886	$	14,818		9.48	%	$	520,469	$	13,645		10.54	%
Investment securities			88,052		1,276		5.88	%		104,702		1,614		6.20	%
Interest bearing deposits in banks			4,777		47		3.99	%		919		8		3.50	%
Federal funds sold			66,725		710		4.32	%		67,946		1,034		6.12	%
	Total interest earning assets		793,440	$	16,851		8.61	%		694,036	$	16,301		9.45	%
Cash and due from banks			34,813							30,590
Premises and equipment, net			6,144							6,591
Other assets			22,813							21,900
	Total assets	$	857,210						$	753,117
Liabilities and shareholders’ equity:
Deposits:
Noninterest bearing demand deposits		$	65,939	$	288		1.77	%	$	54,586	$	246		1.81	%
Savings and money market			220,553		1,799		3.31	%		217,745		2,203		4.07	%
Time deposits, under $100,000			78,048		1,119		5.81	%		73,312		1,014		5.56	%
Time deposits, $100,000 and over			161,412		2,293		5.76	%		144,585		2,069		5.76	%
Brokered deposits			23,568		356		6.13	%		12,292		193		6.32	%
Other borrowings			14,000		376		10.89	%		8,916		196		8.84	%
	Total interest bearing liabilities		563,520	$	6,231		4.48	%		511,436	$	5,921		4.66	%
Interest bearing demand deposits			209,771							176,418
Other liabilities			13,337							6,390
	Total liabilities		786,628							694,243
Shareholders’ equity			70,582							58,874
	Total liabilities and shareholders’ equity	$	857,210						$	753,117
Net interest income/margin				$	10,620		5.43	%			$	10,380		6.02	%

Note: Yields and amounts earned on loans include loan fees of $1,209,000 and $939,000 for the three month periods ended June 30, 2001 and 2000, 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 $66,000 and $1,092,000 for the period ended June 30, 2001 and 2000, respectively, are included in the average balance calculation above.

		For the Six Months Ended June 30, 2001							For the Six Months Ended June 30, 2000
				Interest		Average					Interest		Average
		Average		Income/		Yield/			Average		Income/		Yield/
(Dollars in thousands)		Balance		Expense		Rate			Balance		Expense		Rate
Assets:
Loans, gross		$	630,570	$	30,636		9.80	%	$	486,555	$	25,027		10.34	%
Investment securities			97,214		2,844		5.90	%		98,222		2,955		6.05	%
Interest bearing deposits in banks			3,808		83		4.40	%		562		11		3.94	%
Federal funds sold			61,128		1,450		4.78	%		78,005		2,285		5.89	%
	Total interest earning assets		792,720	$	35,013		8.91	%		663,344	$	30,278		9.18	%
Cash and due from banks			38,103							30,200
Premises and equipment, net			6,214							6,587
Other assets			21,604							17,658
	Total assets	$	858,641						$	717,789
Liabilities and shareholders’ equity:
Deposits:
Demand, interest bearing		$	66,221	$	633		1.93	%	$	53,497	$	494		1.86	%
Savings and money market			222,902		4,011		3.63	%		209,171		4,074		3.92	%
Time deposits, under $100,000			77,745		2,288		5.93	%		70,905		1,912		5.42	%
Time deposits, $100,000 and over			167,166		4,860		5.86	%		133,659		3,694		5.56	%
Brokered deposits			21,497		656		6.15	%		11,347		350		6.20	%
Other borrowings			17,291		865		10.09	%		5,854		256		8.79	%
	Total interest bearing liabilities		572,822	$	13,313		4.69	%		484,433	$	10,780		4.48	%
Interest bearing demand deposits			204,162							167,862
Other liabilities			12,599							7,801
	Total liabilities		789,583							660,096
Shareholders’ equity			69,058							57,693
	Total liabilities and shareholders’ equity	$	858,641						$	717,789
Net interest income/margin				$	21,700		5.52	%			$	19,498		5.91	%

9

Note: Yields and amounts earned on loans include loan fees of $2,353,000 and $1,837,000 for the six month periods ended June 30, 2001 and 2000, 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 $66,000 and $1,092,000 for the period ended June 30, 2001 and 2000, respectively, are included in the average balance calculation above.

The Company’s net interest income for the three and six months ended June 30, 2001 was $10,620,000 and $21,700,000, an increase of $240,000 and $2,202,000, or 2% and 11% over the same periods in the prior year. When compared to the three and six months ended June 30, 2001, average earning assets increased by $99,404,000 and $129,376,000, or 14% and 19%. For the second quarter of 2001, the average yield on earning assets was 8.61%, down 84 basis points from 9.45% for the same period in 2000. Over the same periods, the rates paid on interest bearing liabilities declined 18 basis points to 4.48% from 4.66%. For the six months ended June 30, 2001 the average yield on earning assets was 8.91%, down 27 basis points from 9.18% for the same period in 2000. Over the same periods, the rates paid on interest bearing liabilities increased 21 basis points to 4.69% from 4.48%. Overall, the net interest margin decreased to 5.43% and 5.52% for the three and six months ended June 30, 2001, from to 6.02% and 5.91% for the same periods in the prior year. Even with the above decrease in net interest margin, net interest income increased due to the increases in the level of average loans. The increased level of loans was funded by a decrease in Federal funds sold.

The following table sets forth an analysis of the changes in interest income resulting from increases in the volume of interest earning liabilities and increases 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,
		2001 vs. 2000
		Increase (Decrease) Due to Change In:
(Dollars in thousands)		Average Volume			Average Rate			Net Change
Interest earning assets
	Loans, gross	$	2,651		$	(1,478	)	$	1,173
	Investments securities		(241	)		(97	)		(338	)
	Interest bearing deposits in banks		38			1			39
	Federal funds sold		(13	)		(311	)		(324	)
Total interest earning assets		$	2,435		$	(1,885	)	$	550
Interest bearing liabilities
	Demand, interest bearing	$	50		$	(8	)	$	42
	Money Market and Savings		23			(427	)		(404	)
	Time deposits, under $100,000		68			37			105
	Time deposits, $100,000 and over		224			0			224
	Brokered Deposits		170			(7	)		163
	Other borrowings		137			43			180
Total interest bearing liabilities		$	672		$	(362	)	$	310
Net interest income		$	1,763		$	(1,523	)	$	240

		Six Months Ended June 30,
		2001 vs. 2000
		Increase (Decrease) Due to Change In:
(Dollars in thousands)		Average Volume			Average Rate			Net Change
Interest earning assets
	Loans, gross	$	6,997		$	(1,388	)	$	5,609
	Investments securities		(29	)		(81	)		(111	)
	Interest bearing deposits in banks		71			1			72
	Federal funds sold		(400	)		(436	)		(835	)
Total interest earning assets		$	6,639		$	(1,904	)	$	4,735
Interest bearing liabilities
	Demand, interest bearing	$	122		$	17		$	139
	Money Market and Savings		247			(310	)		(63	)
	Time deposits, under $100,000		201			175			376
	Time deposits, $100,000 and over		974			192			1,166
	Brokered Deposits		310			(4	)		306
	Other borrowings		572			37			609
Total interest bearing liabilities		$	2,426		$	107		$	2,533
Net interest income		$	4,213		$	(2,011	)	$	2,202

10

Provision for Loan Losses

For the three and six months ended June 30, 2001, the provision for loan losses was $528,000 and $1,055,000, down $6,000 and $159,000 from $534,000 and $1,214,000 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:

					Increase (decrease)
	Three months ended June 30,				2001 versus 2000
(Dollars in thousands)	2001		2000		Amount		Percent
Gain on sale of securities available-for-sale	$	409	$	44	$	365		830	%
Gain on sale of loans		278		—		278		—	%
Other investment income		242		148		94		64	%
Service charges and other fees on deposits accounts		228		170		58		34	%
Servicing income		118		70		48		69	%
Other income		372		182		190		104	%
Total	$	1,647	$	614	$	1,033		168	%

					Increase (decrease)
	Six months ended June 30,				2001 versus 2000
(Dollars in thousands)	2001		2000		Amount		Percent
Gain on sale of securities available-for-sale	$	551	$	44	$	507		1,152	%
Gain on sale of loans		551		—		551		—	%
Other investment income		510		362		148		41	%
Service charges and other fees on deposits accounts		436		341		95		28	%
Servicing income		232		70		162		231	%
Other income		588		533		55		10	%
Total	$	2,868	$	1,350	$	1,518		112	%

Noninterest income for the three and six months ended June 30, 2001 was $1,647,000 and $2,868,000, up 168% and 112% from $614,000 and $1,350,000 from the same periods in the prior year. The increase was primarily due to the increases in gains on sale of securities, SBA loans and servicing income recognized for the three and six months ended June 30, 2001 compared to the same period in 2000. The interest rate environment in 2001 has provided the opportunity for the Company to benefit from gains on sales of securities and increase its sales of SBA loans, resulting in gains and increased servicing income.

Noninterest Expense

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

	For The Three Months Ended June 30,
								Percent
					Increase			Increase
(Dollars in thousands)	2001		2000		(Decrease)			(Decrease)
Salaries and benefits	$	4,629	$	4,530	$	99			2	%
Occupancy		681		514		167			32	%
Client services		647		269		378			141	%
Furniture and equipment		425		375		50			13	%
Loan origination costs		360		155		205			132	%
Professional fees		265		583		(318	)		(55	%)
Advertising and promotion		359		222		137			62	%
Stationery & supplies		125		82		43			52	%
Telephone expense		93		84		9			11	%
Merger and integration costs		—		95		(95	)		(100	%)
All other		1,085		1,316		(231	)		(18	%)
Total	$	8,669	$	8,225	$	444			5	%

11

	For The Six Months Ended June 30,
								Percent
					Increase			Increase
(Dollars in thousands)	2001		2000		(Decrease)			(Decrease)
Salaries and benefits	$	9,710	$	8,545	$	1,165			14	%
Occupancy		1,361		1,057		304			29	%
Client services		939		638		301			47	%
Furniture and equipment		866		706		160			23	%
Loan origination costs		659		361		298			83	%
Professional fees		595		889		(294	)		(33	%)
Advertising and promotion		582		401		181			45	%
Stationery & supplies		258		161		97			60	%
Telephone expense		182		170		12			7	%
Merger and integration costs		—		95		(95	)		(100	%)
All other		1,784		1,992		(208	)		(10	%)
Total	$	16,936	$	15,015	$	1,921			13	%

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

	For The Three Months Ended June 30,
			% of					% of
(Dollars in thousands)	2001		Total			2000		Total
Salaries and benefits	$	4,629		53	%	$	4,530		55	%
Occupancy		681		8	%		514		6	%
Client services		647		8	%		269		3	%
Furniture and equipment		425		5	%		375		5	%
Loan origination costs		360		4	%		155		2	%
Professional fees		265		3	%		583		7	%
Advertising and promotion		359		4	%		222		3	%
Stationery & supplies		125		1	%		82		1	%
Telephone expense		93		1	%		84		1	%
Merger and integration costs		—		—	%		95		1	%
All other		1,085		13	%		1,316		16	%
Total	$	8,669		100	%	$	8,225		100	%

	For The Six Months Ended June 30,
			% of					% of
(Dollars in thousands)	2001		Total			2000		Total
Salaries and benefits	$	9,710		57	%	$	8,545		57	%
Occupancy		1,361		8	%		1,057		7	%
Client services		939		6	%		638		4	%
Furniture and equipment		866		5	%		706		5	%
Loan origination costs		659		4	%		361		2	%
Professional fees		595		4	%		889		6	%
Advertising and promotion		582		3	%		401		3	%
Stationery & supplies		258		2	%		161		1	%
Telephone expense		182		1	%		170		1	%
Merger and integration costs		—		—			95		1	%
All other		1,784		10	%		1,992		13	%
Total	$	16,936		100	%	$	15,015		100	%

Noninterest expenses for the three and six months ended June 30, 2001 were $8,669,000 and $16,936,000, up $444,000 and $1,921,000, or 5% and 13%, from $8,225,000 and $15,015,000 for the same periods in the prior year. The overall increase in noninterest expenses reflects the growth in infrastructure to support the Company’s loan and deposit growth.

In the second quarter ended June 30, 2001, salaries and benefits increased $99,000 reflecting normal salary and benefit increases and the growth in the level of full time equivalent employees from 215 at June 30, 2000 to 232 at June 30, 2001. Salaries and benefits increased $1,165,000, or 14%, to $9,710,000 in the first six months of 2001, as compared to the same period in the prior year. As a percentage of total noninterest expenses, salaries and benefits were 53% and 55%, respectively, for the three months ended June 30, 2001 and 2000, respectively. Occupancy increased by $167,000, or 32%, as a result of increased rental costs. The increase was $304,000, or 29%, to $1,361,000 in the first six months of 2001, as compared to the same period in the prior year. Furniture and equipment increased by $50,000, or 13%. Stationery and supplies increased by $43,000, or 52%. The increase was $97,000, or 60%, to $258,000 in the first six months of 2001, as compared to the same period in the prior year. This reflects the growth the Company has sustained. Loan origination costs increased by $205,000, or 132%, as a result of the overall growth in the loan portfolio and increased as a percentage of total noninterest expenses from 2% to 4%. The increase was $298,000, or 83%, to $659,000 in the first six months of 2001, as compared to the same period in the prior year. Professional fees decreased by $318,000, or 55%. The decrease was $294,000, or 33%, to $595,000 in the first six months of 2001, as compared to the same period in the prior year. Client services increased $378,000, or 141%, and increased as a percentage of total noninterest expenses from 3% to 8%. The increase was $301,000, or 47%, to $939,000 in the first six months of 2001, as compared to the same period in the prior year. Advertising and promotion increased $181,000, or 45%, to $582,000 in the first six months of 2001, as compared to the same period in the prior year.

12

Income Taxes

The provision for income taxes for the three and six months ended June 30, 2001 was $1,180,000 and $2,505,000, as compared to $746,000 and $1,613,000 for the same periods in the prior year. The difference in the effective tax rate compared to the statutory tax rate is primarily the result of the Company holding certain life insurance contracts and changes in the Company’s level of investments in municipal securities.

FINANCIAL CONDITION

Total assets increased $21,407,000, or 3%, to $867,631,000 at June 30, 2001 from $846,224,000 at December 31, 2000, and increased $53,336,000, or 7%, from $814,295,000 at June 30, 2000. Total portfolio loans decreased $5,649,000 or 1% to $605,132,000 at June 30, 2001 from $610,781,000 at December 31, 2000, but have increased $83,594,000 or 16% from $521,538,000 at June 30, 2000. Total deposits were $770,168,000 at June 30, 2001, an increase of 4% from $738,186,000 at December 31, 2000, and have increased 4% from $737,116,000 at June 30, 2000. The above reflects the continued strong internal growth of the Company, primarily in noninterest bearing demand deposits and brokered deposits, which used with the proceeds from investment securities sales and maturities and loan sales and payments funded the growth in Federal funds sold.

Securities Portfolio

The following table summarizes the composition of the Company’s investment securities and the weighted average yields at June 30, 2001:

				June 30, 2001
				Maturity
									After One Year and					After Five Years and
				Within One Year					Within Five Years					Within Ten Years					After Ten Years					Total
(Dollars in thousands)				Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Securities available-for-sale:
	Agencies			$	1,013		6.69	%	$	30,076		5.83	%	$	—		—	%	$	—		—	%	$	31,089		5.86	%
	U.S. Treasury				1,621		5.74	%		—		—	%		—		—	%		—		—	%		1,621		5.74	%
	Mortgage-backed securities				—		—	%		1,165		6.11	%		4,664		6.52	%		12,524		5.05	%		18,353		5.49	%
	Municipals — nontaxable				2,791		4.64	%		4,329		4.29	%		3,889		4.79	%		—		—	%		11,009		4.56	%
		Total available-for-sale		$	5,425		5.35	%	$	35,570		5.65	%	$	8,553		5.73	%	$	12,524		5.05	%	$	62,072		5.52	%
Securities held-to-maturity:
	CMOs			$	607		5.82	%	$	1,429		6.32	%	$	—		—	%	$	—		—	%	$	2,036		6.17	%
	Mortgage-backed securities				—		—	%		5,077		6.29	%		—		—	%		—		—	%		5,077		6.29	%
	Municipals — taxable				2,378		6.44	%		2,100		6.55	%		—		—	%		—		—	%		4,478		6.49	%
	Municipals — nontaxable				—		—	%		1,959		4.68	%		5,449		4.49	%		—		—	%		7,408		4.54	%
			Total held-to-maturity	$	2,985		6.31	%	$	10,565		6.05	%	$	5,449		4.49	%	$	—		—	%	$	18,999		5.64	%
			Total securities	$	8,410		5.69	%	$	46,135		5.74	%	$	14,002		5.25	%	$	12,524		5.05	%	$	81,071		5.55	%

Note: Yield on non-taxable municipal securities are not presented in a fully tax equivalent basis.

Loans

Total loans (exclusive of loans held for sale) decreased 1% to $605,132,000 at June 30, 2201, as compared to $610,781,000 at December 31, 2000. The decrease in loan balances was a result of loan payments and payoffs exceeding the level of new originations during the first six months of 2001.

13

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

(Dollars in thousands)		June 30, 2001			% of Total			December 31, 2000			% of Total
Commercial		$	202,125			33	%	$	200,846			33	%
Real estate — mortgage			231,712			38	%		230,468			38	%
Real estate — land and construction			165,468			28	%		171,325			28	%
Consumer			5,819			1	%		8,172			1	%
	Total loans		605,124			100	%		610,811			100	%
Deferred loan costs (fees)			8						(30	)
Allowance for loan losses			(10,347	)					(9,651	)
Loans, net		$	594,785					$	601,130

The Company’s loan portfolio is based in commercial (primarily to companies engaged in manufacturing, wholesale, and service businesses) and real estate lending, with the balance in consumer loans. Real estate construction loans have been paid off. However, while no specific industry concentration is considered significant, the Company’s lending operations are located in the Company’s market areas that are dependent on the technology and real estate industries and their supporting companies. Thus, the Company’s borrowers could be adversely impacted by a downturn in these sectors of the economy which could reduce the demand for loans and adversely impact the borrowers’ abilities to repay their loans.

The following table sets forth the maturity distribution of the Company’s loans at June 30, 2001:

	Due in		Over One Year
	One Year		But Less Than		Over
(Dollars in thousands)	or Less		Five Years		Five Years		Total
Commercial	$	190,175	$	11,545	$	405	$	202,125
Real estate — mortgage		132,670		82,882		16,160		231,712
Real estate — land and construction		165,377		91		—		165,468
Consumer		5,007		812		—		5,819
Total loans	$	493,229	$	95,330	$	16,565	$	605,124
Loans with variable interest rates	$	476,019	$	58,072	$	490	$	534,581
Loans with fixed interest rates		17,210		37,258		16,075		70,543
Total loans	$	493,229	$	95,330	$	16,565	$	605,124

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 ofThe Wall Street Journal. At June 30, 2001, approximately 88% 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. The following table shows nonperforming assets at the dates indicated:

		June 30,
								December 31,
(Dollars in thousands)		2001			2000			2000
Nonaccrual loans		$	66		$	1,092		$	—
Loans 90 days past due and still accruing			—			—			—
Restructured loans			—			—			—
	Total nonperforming loans		66			1,092			—
Foreclosed assets			—			—			—
	Total nonperforming assets	$	66		$	1,092		$	—
Nonperforming assets as a percentage of period end loans plus foreclosed assets			0.01	%		0.21	%		—	%

14

Allowance for Loan Losses

Management conducts a critical evaluation of the loan portfolio monthly. This evaluation includes an assessment of the following factors: past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, collateral value, loan volumes and concentrations, recent loss experience in particular segments of the portfolio, bank regulatory examination results, and current economic conditions. Management has established an evaluation process designed to determine the adequacy of the allowance for loan losses. This process attempts to assess the risk of loss inherent in the portfolio by segregating the allowance for loan losses into four components: “watch”, “special mention”, “substandard” and “doubtful”.

It is the policy of management to maintain the allowance for loan losses at a level adequate for known and future risks inherent in the loan portfolio. Based on information currently available to analyze loan loss delinquency and a history of actual charge-offs, management believes that the loan loss provision and allowance are adequate; however, no assurance of the ultimate level of credit losses can be given with any certainty. Loans are charged against the allowance when management believes that the collectibility of the principal is unlikely.

The following table summarizes the Company’s loan loss experience as well as transactions in the allowance for loan losses and certain pertinent ratios for the periods indicated:

		Six months ended June 30,						Year ended
								December 31,
(Dollars in thousands)		2001			2000			2000
Balance, beginning of period / year		$	9,651		$	6,511		$	6,511
Net (charge offs) recoveries			(359	)		13			(19	)
Provision for probable loan losses			1,055			1,214			3,159
Balance, end of period / year		$	10,347		$	7,738		$	9,651
Ratios:
	Net charge-offs to average loans outstanding		0.06	%		—	%		—	%
	Allowance for loan losses to average loans		1.67	%		1.62	%		1.80	%
	Allowance for loan losses to total loans		1.71	%		1.48	%		1.58	%
	Allowance for loan losses to non-performing loans		15,661	%		709	%		—	%

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, 2001					June 30, 2000					December 31, 2000
			Percent of ALL by					Percent of ALL by					Percent of ALL by
			category to total					category to total					category to total
(Dollars in thousands)	Amount		loans by category			Amount		loans by category			Amount		loans by category
Commercial	$	3,925		1.94	%	$	3,231		1.81	%	$	4,244		2.11	%
Real estate — mortgage		1,538		0.66	%		1,298		0.66	%		1,509		0.65	%
Real estate — land and construction		2,657		1.61	%		1,669		1.21	%		2,084		1.22	%
Consumer		161		2.77	%		165		2.25	%		158		1.93	%
Unallocated		2,066		—	%		1,375		—	%		1,656		—	%
Total	$	10,347		1.71	%	$	7,738		1.48	%	$	9,651		1.58	%

The increase in the allowance for loan losses reflects the growth in the Company’s commercial and real estate mortgage loan portfolio and the Company’s assessment of the increased inherent credit risk resulting from the current economic environment, particularly in the Company’s primary market area and lending focus, and the potential effects of the continuing California energy situation.

All of the Company’s operations and virtually all of its customers are located in California. The availability of a sufficient supply of electrical power in California has been called into question by recent events, including the bankruptcy of one of the state’s major utilities. While neither the Company nor any of its customers have been materially adversely affected by the electrical power crisis to date, power supply issues could have an affect on future operations of the Company or its customers, including borrowers.

Deposits

Deposits totaled $770,168,000 at June 30, 2001, an increase of 4%, compared to deposits of $738,186,000 at December 31, 2000 and an increase of 4% compared to $737,116,000 at June 30, 2000. The increase in deposits was primarily due to increases in noninterest bearing deposits and brokered deposits. Noninterest bearing deposits increased to $234,125,000 at June 30, 2001, from $207,885,000 at December 31, 2000. Brokered deposits increased to $26,723,000 at June 30, 2001, from $9,238,000 at December 31, 2000.

15

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, 20001					December 31, 2000
				Average					Average
		Average		Rate			Average		Rate
(Dollars in thousands)		Balance		Paid			Balance		Paid
Demand, noninterest bearing		$	204,162		—	%	$	183,422		—	%
Demand, interest bearing			66,221		1.93	%		55,616		1.82	%
Saving and money market			222,902		3.63	%		228,336		4.16	%
Time deposits, under $100,000			77,745		5.93	%		73,058		5.85	%
Time deposits, $100,000 and over			167,166		5.86	%		151,275		5.75	%
Brokered deposits			21,497		6.15	%		10,544		6.55	%
	Total average deposits	$	759,693		3.28	%	$	702,251		3.44	%

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, 2001.

(Dollars in thousands)		Balance		% of Total
Three months or less		$	72,110		39	%
Over three months through twelve months			96,965		52	%
Over twelve months			16,614		9	%
	Total	$	185,689		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.

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.

16

The following table sets forth the interest rate sensitivity of the Company’s interest-earning assets and interest-bearing liabilities at June 30, 2001, 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 Three			Due After
			Within Three				to Twelve			One to Five			Due After			Not Rate-
(Dollars in thousands)			Months				Months			Years			Five Years			Sensitive			Total
Interest earning assets:
	Federal funds sold		$	67,900		��	$	—		$	—		$	—		$	—		$	67,900
	Interest bearing deposits in banks			5,414				—			—			—			—			5,414
	Securities			2,182				5,165			39,594			34,130			—			81,071
	Total loans			510,649				42,480			75,937			16,746			—			645,812
		Total interest earning assets		586,145				47,645			115,531			50,876			—			800,197
Cash and due from banks				—				—			—			—			34,624			34,624
Other assets				—				—			—			—			32,810			32,810
		Total assets	$	586,145			$	47,645		$	115,531		$	50,876		$	67,434		$	867,631
Interest bearing liabilities:
	Demand, interest bearing		$	66,063			$	—		$	—		$	—		$	—		$	66,063
	Savings and money market			201,341				—			—			—			—			201,341
	Time deposits			96,685				148,700			23,254			—			—			268,639
	Mandatorily redeemable cumulative trust preferred securities			—				—			—			14,000			—			14,000
		Total interest bearing liabilities		364,089				148,700			23,254			14,000			—			550,043
Noninterest demand deposits				88,375				—			—			—			145,750			234,125
Other liabilities				—				—			—			—			12,496			12,496
Shareholders’ equity				—				—			—			—			70,967			70,967
		Total liabilities and shareholders’ equity	$	452,464			$	148,700		$	23,254		$	14,000		$	229,213		$	867,631
Interest rate sensitivity GAP			$	133,681			$	(101,055	)	$	92,277		$	36,876		$	(161,779	)	$	—
Cumulative interest rate sensitivity GAP			$	133,681			$	32,626		$	124,903		$	(161,779	)	$	—		$	—
Cumulative interest rate sensitivity GAP ratio				15.41	%			3.76	%		14.40	%		18.65	%		—	%		—	%

The foregoing table demonstrates that the Company had a positive cumulative one year gap of $32,626,000, or 3.76% of total assets, at June 30, 2001. In theory, this would indicate that $32,626,000 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 short-term funding sources such as certificates of deposit.

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.

17

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, 2001, the Company’s primary liquidity ratio was 17.88%, comprised of $38.2 million in investment securities available-for-sale with maturities (or probable calls) of up to five years, less $10.1 million of securities that were pledged to secure public and certain other deposits as required by law and contract; Federal funds sold of $67.9 million, and $40.0 million in cash and due from banks, as a percentage of total unsecured deposits of $748 million.

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)			2001			2000			2000
Capital components:
	Tier 1 Capital		$	83,754		$	67,748		$	78,982
	Tier 2 Capital			9,149			7,738			9,427
		Total risk-based capital	$	92,903		$	75,486		$	88,409
Risk-weighted assets			$	730,759		$	648,339		$	753,947
Average assets			$	856,653		$	753,117		$	850,072
												Minimum
												Regulatory
												Requirements
Capital ratios:
	Total risk-based capital			12.7	%		11.6	%		11.7	%		8.0	%
	Tier 1 risk-based capital			11.5	%		10.4	%		10.5	%		4.0	%
	Leverage ratio(1)			9.8	%		9.0	%		9.3	%		4.0	%

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

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 annual report on Form 10-K.

Part II — Other Information

Item 1. — Legal Proceedings

     To the best of the Company’s knowledge, there are no pending legal proceedings to which the Company is a party which may have a materially adverse effect on the Company’s financial condition, results of operations, or cash flows.

18

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

The Company held its 2001 Annual Meeting of Shareholders on May 24, 2001 and on June 21, 2001 (the “2000 Annual Meeting”). There were 11,076,965 issued and outstanding shares of Company Common Stock on April 10, 2001, the Record Date for the 2001 Annual Meeting. Each of the shares voting at the meeting was entitled to one vote.

At the 2001 Annual Meeting, the following actions were taken:

Election of Directors

At the 2001 Annual Meeting, fifteen 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
Hugh Barton		9,704,863		121,748
Frank G. Bisceglia		9,522,873		303,738
James R. Blair		9,711,243		115,368
Richard L. Conniff		9,510,986		315,625
William J. Del Biaggio, Jr.		9,517,923		308,688
Anneke Dury		9,518,033		308,578
Kurt Hammerstrom		9,710,033		116,578
Roy Lave		9,711,133		115,478
John Larsen		9,710,913		115,698
Louis O. Normandin		9,517,923		308,688
Jack L. Peckham		9,517,923		308,688
Robert W. Peters		9,517,922		308,689
Humphrey P. Polanen		9,711,133		115,478
Howard Weiland		9,711,133		115,478
Brad L. Smith		9,282,161		544,450

Heritage Commerce Corp’s Articles of Incorporation

The number of shares cast for and against to amend Commerce Corp’s Articles of Incorporation to eliminate the availability of cumulative voting in the election of Commerce Corp’s directors was as follows:

FOR	5,992,534
AGAINST	2,167,563

Heritage Commerce Corp’s Bylaws

The number shares cast for and against to amend Commerce Corp’s Bylaws to provide for classification of the Board of Directors into three classes for purposes of the election of directors was as followings:

FOR	6,358,048
AGAINST	1,807,842

Increase the number of shares for grants of stock options

The number shares cast for and against to amend Commerce Corp 1994 Tandem Stock Option Plan to increase the number of shares available for grants of stock options was as followings:

FOR	8,370,579
AGAINST	1,227,012

19

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, 2001 was as follows:

FOR	9,389,651
AGAINST	288,138

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

(a) Exhibits included with this filing:

Exhibit Number	Name
3.1	Heritage Commerce Corp Restated Articles of Incorporation as amended effective June 29, 2001
3.2	Heritage Commerce Corp By-laws as amended on May 24, 2001

(b) Reports on Form 8-K

On July 23, 2001, the Company filed its earnings press release for the second quarter ended June 30, 2001 with the SEC on Form 8-K.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Heritage Commerce Corp (Registrant)
August 14, 2001 Date	/s/ Brad L. Smith Brad L. Smith, Chairman of the Board and CEO
August 14, 2001 Date	/s/ Lawrence D. McGovern Lawrence D. McGovern, Chief Financial Officer

20

EXHIBIT INDEX

Exhibit Number	Name
3.1	Heritage Commerce Corp Articles of incorporation
3.2	Heritage Commerce Corp By-laws