At September 30, 2009, the Company’s assets totaled $1.37 billion, compared to $1.51 billion a year ago and $1.44 billion at June 30, 2009. Loans, excluding loans held-for-sale, totaled $1.08 billion at September 30, 2009, compared to $1.25 billion at September 30, 2008 and $1.16 billion at June 30, 2009. SBA loans not held-for-sale, which are included in commercial loans or owner occupied commercial real estate loans, totaled $88.6 million at September 30, 2009, compared to $104.9 million a year ago.
Commercial and industrial loans account for 38% of the total loan portfolio. Commercial real estate loans account for another 38% of the portfolio, of which 51% were owner occupied by businesses. Land and construction loans decreased to 18% of the portfolio. Consumer and home equity loans account for the remaining 6% of the total. “We continue to see progress in the re-balancing of our loan portfolio, particularly in our reduction of land and construction loans,” said Mr. Kaczmarek.
The securities portfolio of $96.6 million at September 30, 2009 consisted primarily of U.S. government sponsored entities’ debt securities, short-term U.S. Treasury securities, mortgage-backed securities, collateralized mortgage obligations, and municipal bonds. “All of our mortgage-backed securities and collateralized mortgage obligations are issued by U.S. government sponsored entities. These high quality securities investments are managed to provide maximum liquidity,” commented Mr. Kaczmarek.
Nonperforming assets decreased to $58.2 million at September 30, 2009 from $61.7 million at June 30, 2009. Nonperforming assets were $25.1 million at September 30, 2008. Nonperforming assets were 4.26% of total assets at September 30, 2009, 4.30% at June 30, 2009 and 1.66% at September 30, 2008. At September 30, 2009, land and construction loans were 52% of nonperforming assets, commercial and industrial loans were 20%, commercial real estate loans were 13%, SBA loans were 10% and other real estate owned (“OREO”) was 5%.
Total OREO was $3.0 million at September 30, 2009 and $3.1 million at June 30, 2009. In the third quarter of 2009, three properties moved from nonaccrual status into OREO and four OREO properties were sold. The sales consisted of two SBA properties, one commercial real estate parcel and one land and construction property resulting in a loss of $44,000 in the third quarter of 2009.
The allowance for loan losses at September 30, 2009 was $29.0 million, or 2.68% of total loans, and 52.4% of nonperforming loans, while the allowance for loan losses a year ago was $22.3 million, or 1.79% of total loans, and 92.6% of nonperforming loans. The allowance for loan losses at June 30, 2009, was $31.4 million, or 2.70% of total loans, and 53.5% of nonperforming loans.
Deposits totaled $1.12 billion at September 30, 2009, compared to $1.19 billion at September 30, 2008 and $1.16 billion at June 30, 2009. Savings and money market deposits decreased $76.3 million, or 19%, from September 30, 2008. The decreases in savings and money market deposits were primarily due to lower balances in title insurance company, escrow, and real estate exchange facilitators’ accounts. At September 30, 2009, title insurance company, escrow, and real estate exchange facilitators’ accounts were $32.9 million, compared to $82.5 million at September 30, 2008. Time deposits $100,000 and over decreased $33.8 million, or 20% from September 30, 2008 and $36.3 million, or 21%, from June 30, 2009, primarily due to a reduction of public funds.
Heritage Bank of Commerce is a member of the Certificate of Deposit Account Registry Service (“CDARS”) program. The CDARS program allows customers with deposits in excess of FDIC insured limits to obtain coverage on time deposits through a network of banks within the CDARS program. Deposits gathered through this program have been considered brokered deposits under regulatory guidelines. Deposits in the CDARS program totaled $41.4 million at September 30, 2009, and $14.2 million at June 30, 2009. There were no deposits in the CDARS program at September 30, 2008.
Shareholders’ equity was $173.4 million, or $11.44 book value per common share, at September 30, 2009, compared to $144.3 million, or $12.21 book value per common share, a year ago. The increase in shareholders’ equity was due to the issuance of $40 million in preferred stock to the U.S. Treasury as a participant in its Capital Purchase Program during the fourth quarter of 2008. Shareholders’ equity was $174.6 million, or $11.55 book value per common share, at June 30, 2009. The Company’s consolidated leverage ratio at September 30, 2009, was 10.08%, compared to 8.48% at September 30, 2008, and 9.96% at June 30, 2009.
Operating Results
Operating results in 2009 compared to 2008 have been adversely impacted by net interest margin compression, reversals of interest income on nonaccrual loans and a higher provision for loan losses.
Net interest income decreased to $11.6 million for the third quarter of 2009 from $13.0 million for the third quarter of 2008 and remained flat compared to the second quarter of 2009. The net interest margin was 3.62% for the third quarter of 2009, compared to 3.83% for the third quarter a year ago and 3.55% for the second quarter of 2009. The 7 basis point increase in the net interest margin for the third quarter of 2009 compared to the second quarter of 2009 was primarily due to the higher average loan yields (a 14 basis points improvement) and a four basis points decline in the average cost of funds. The decrease in the net interest margin from the third quarter of 2008 was primarily the result of the 175 basis point decline in short-term interest rates from October 8, 2008 through December 16, 2008.
Noninterest income was $2.4 million for the third quarter of 2009, compared to $1.7 million for the third quarter of 2008 and $1.6 million for the second quarter of 2009. In the first nine months of 2009, noninterest income was $5.6 million, compared to $5.0 million in the first nine months a year ago. The increase in noninterest income in third quarter and first nine months of 2009 compared to the same periods in 2008 was primarily due to $643,000 in gains on sales of SBA loans.
The Company had a provision for loan losses of $7.1 million for the third quarter of 2009, compared to $1.6 million for the third quarter of 2008, and $10.7 million for the second quarter of 2009. The Company had a provision for loan losses of $28.3 million for the nine months ended September 30, 2009 and $11.0 million for the nine months ended September 30, 2008. The significant increase in provision for loan losses in 2009 reflects a higher volume of classified and nonperforming loans and an increase in loan charge-offs caused by challenging conditions in commercial lending and the residential housing market, turmoil in the financial markets, and the prolonged downturn in the overall economy.
Noninterest expense was $10.7 million for the third quarter of 2009, compared to $10.4 million in the third quarter of 2008 and $12.1 million in the second quarter of 2009. In the first nine months of 2009, noninterest expense was $34.2 million, compared to $32.0 million in the first nine months a year ago. Deposit insurance premiums and regulatory assessments were $631,000 in the third quarter of 2009, compared to $238,000 in the third quarter of 2008, and $1.2 million in the second quarter of 2009, which included a $657,000 charge for the FDIC special assessment levied on all FDIC insured banks. Professional fees were $691,000 in the third quarter of 2009, compared to $468,000 in the third quarter of 2008, and $1.2 million in the second quarter of 2009. Higher professional fees in the second quarter of 2009 related to problem loans and a branch acquisition transaction that was terminated.
The income tax benefit for the quarter ended September 30, 2009 was $1.8 million, as compared to an income tax expense of $309,000 in the third quarter a year ago, and an income tax benefit of $4.1 million in the second quarter of 2009. The negative effective income tax rates are due to the loss before income taxes. The difference in the effective tax rate compared to the combined federal and state statutory tax rate of 42% is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships, and interest income from tax-free municipal securities.
The efficiency ratio was 76.89% in the third quarter of 2009, compared to 70.56% in the third quarter of 2008 and 90.90% in the second quarter of 2009. The efficiency ratio for the first nine months of 2009 increased to 85.38% from 72.48% a year ago. The efficiency ratio increased in 2009 primarily due to compression of the net interest margin and an increase in noninterest expense, as discussed above.
Recent Regulatory Examination
The Company also announced that the Federal Reserve Board (“FRB”) recently completed the field work portion of its regularly scheduled examination in September 2009. As a result of the Company’s losses in 2009, primarily due to higher provisions for loan losses because of credit quality deterioration, the Company expects to enter into a written agreement with the FRB. The agreement will require the Company to develop an updated strategic plan to improve the quality of assets, maintain adequate capital and ensure sustained earnings, and to take some other actions to improve our appraisal policies, capital planning and liquidity contingency funding plan. The Company will also be required to request the approval of the FRB prior to incurring or increasing any debt, paying dividends on common and preferred stock, paying interest on trust preferred securities, repurchasing capital stock and making certain changes to its directors or senior executive officers. The Company believes the FRB will be finalizing the written agreement within the next 60 to 90 days.
Heritage Commerce Corp, a bank holding company established in February 1998, is the parent company of Heritage Bank of Commerce, established in 1994 and headquartered in San Jose with full-service branches in Los Gatos, Fremont, Danville, Pleasanton, Walnut Creek, Morgan Hill, Gilroy, Mountain View, and Los Altos. Heritage Bank of Commerce is an SBA Preferred Lender with Loan Production Offices in Sacramento, Oakland and Santa Rosa, California. For more information, please visit www.heritagecommercecorp.com.
