Heritage Commerce 10Q 2022 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


	Washington, D.C. 20549

	FORM 10-Q


(MARK ONE)
☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2022
OR
☐	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 (State or Other Jurisdiction of Incorporation or Organization)	77-0469558 (I.R.S. Employer Identification No.)
224 Airport Parkway, San Jose, California (Address of Principal Executive Offices)	95110 (Zip Code)

(408) 947-6900

(Registrant’s Telephone Number, Including Area Code)

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class:	Trading Symbol:	Name of each exchange on which registered:
Common Stock, No Par Value	HTBK	The NASDAQ Stock Market LLC

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. YES ☒ NO ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES ☒ NO ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐	Smaller reporting company ☐
			Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒

The Registrant had 60,439,607 shares of Common Stock outstanding on April 29, 2022

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HERITAGE COMMERCE CORP

QUARTERLY REPORT ON FORM 10-Q

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		Page No.
Cautionary Note on Forward-Looking Statements		3

Part I. FINANCIAL INFORMATION

Item 1.	Consolidated Financial Statements (unaudited)	5

	Consolidated Balance Sheets	5

	Consolidated Statements of Income	6

	Consolidated Statements of Comprehensive Income	7

	Consolidated Statements of Changes in Shareholders’ Equity	8

	Consolidated Statements of Cash Flows	9

	Notes to Unaudited Consolidated Financial Statements	10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	66

Item 4.	Controls and Procedures	66

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	67

Item 1A.	Risk Factors	67

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	67

Item 3.	Defaults Upon Senior Securities	67

Item 4.	Mine Safety Disclosures	67

Item 5.	Other Information	67

Item 6.	Exhibits	68

SIGNATURES		69

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Cautionary Note Regarding Forward-Looking Statements

This Report on Form 10-Q contains various statements that may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, Rule 3b-6 promulgated thereunder and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These forward-looking statements often can be, but are not always, identified by the use of words such as “assume,” “expect,” “intend,” “plan,” “project,” “believe,” “estimate,” “predict,” “anticipate,” “may,” “might,” “should,” “could,” “goal,” “potential” and similar expressions. We base these forward-looking statements on our current expectations and projections about future events, our assumptions regarding these events and our knowledge of facts at the time the statements are made. These statements include statements relating to our projected growth, anticipated future financial performance, and management’s long-term performance goals, as well as statements relating to the anticipated effects on results of operations and financial condition.

These forward-looking statements are subject to various risks and uncertainties that may be outside our control and our actual results could differ materially from our projected results. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the Securities and Exchange Commission (“SEC”), Item 1A of the Heritage Commerce Corp’s (“the Company”) Annual Report on Form 10-K for the year ended December 31, 2021, and including, but not limited to the following:

●

geopolitical and domestic political developments that can increase levels of political and economic unpredictability and increase the volatility of financial markets;

●

conditions relating to the COVID-19 pandemic, and other infectious illness outbreaks that may arise in the future, on our customers, employees, businesses, liquidity, financial results and overall condition including severity and duration of the associated uncertainties in U.S. and global markets;

●

current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values and overall slowdowns in economic growth should these events occur;

●

effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Open Market Committee of the Federal Reserve Board;

●

inflation and changes in the interest rate environment that reduce our margins and yields, the fair value of financial instruments or our level of loan originations, or increase the level of defaults, losses and prepayments on loans we have made and make;

●

changes in the level of nonperforming assets and charge offs and other credit quality measures, and their impact on the adequacy of our allowance for credit losses and our provision for credit losses;

●

volatility in credit and equity markets and its effect on the global economy;

●

our ability to effectively compete with other banks and financial services companies and the effects of competition in the financial services industry on our business;

●

our ability to achieve loan growth and attract deposits in our market area;

●

risks associated with concentrations in real estate related loans;

●

the relative strength or weakness of the commercial and real estate markets where our borrowers are located, including related asset and market prices;

●

credit related impairment charges to our securities portfolio;

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●

increased capital requirements for our continual growth or as imposed by banking regulators, which may require us to raise capital at a time when capital is not available on favorable terms or at all;

●

regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Heritage Commerce Corp (the “Company”);

●

operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which we are highly dependent;

●

our inability to attract, recruit, and retain qualified officers and other personnel could harm our ability to implement our strategic plan, impair our relationships with customers and adversely affect our business, results of operations and growth prospects;

●

possible adjustment of the valuation of our deferred tax assets;

●

our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, “denial of service” attacks, “hacking” and identity theft;

●

inability of our framework to manage risks associated with our business, including operational risk and credit risk;

●

risks of loss of funding of Small Business Administration (“SBA”) or SBA loan programs, or changes in those programs;

●

compliance with applicable laws and governmental and regulatory requirements, including the Dodd-Frank Act and others relating to banking, consumer protection, securities, accounting and tax matters;

●

effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

●

the expense and uncertain resolution of litigation matters whether occurring in the ordinary course of business or otherwise;

●

availability of and competition for acquisition opportunities;

●

risks resulting from domestic terrorism;

●

risks resulting from social unrest and protests;

●

risks of natural disasters (including earthquakes and flooding) and other events beyond our control;

●

the lending activities undertaken by the Company in connection with the Small Business Administration’s Paycheck Protection Program, including risks to the Company with respect to the uncertain application by the Small Business Administration of loan eligibility, forgiveness and audit criteria;

●

our success in managing the risks involved in the foregoing factors.

Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. You should consider any forward looking statements in light of this explanation, and we caution you about relying on forward-looking statements.

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Part I—FINANCIAL INFORMATION

ITEM 1—CONSOLIDATED FINANCIAL STATEMENTS

HERITAGE COMMERCE CORP

CONSOLIDATED BALANCE SHEETS

(Unaudited)


	March 31,		December 31,
	2022		2021

	(Dollars in thousands)
Assets
Cash and due from banks	$	29,729	$	15,703
Other investments and interest-bearing deposits in other financial institutions		1,187,436		1,290,513
Total cash and cash equivalents		1,217,165		1,306,216
Securities available-for-sale, at fair value		111,217		102,252
Securities held-to-maturity, at amortized cost, net of allowance for credit losses of $39 at March 31, 2022
and $43 at December 31, 2021 (fair value of $690,784 at March 31, 2022 and $657,649 at December 31, 2021)		736,823		658,397
Loans held-for-sale - SBA, at lower of cost or fair value, including deferred costs		831		2,367
Loans, net of deferred fees		3,024,064		3,087,326
Allowance for credit losses on loans		(42,788)		(43,290)
Loans, net		2,981,276		3,044,036
Federal Home Loan Bank, Federal Reserve Bank stock and other investments, at cost		32,509		32,504
Company-owned life insurance		78,069		77,589
Premises and equipment, net		9,580		9,639
Goodwill		167,631		167,631
Other intangible assets		13,009		13,668
Accrued interest receivable and other assets		79,288		85,110
Total assets	$	5,427,398	$	5,499,409

Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Demand, noninterest-bearing	$	1,811,943	$	1,903,768
Demand, interest-bearing		1,268,942		1,308,114
Savings and money market		1,447,434		1,375,825
Time deposits - under $250		38,417		38,734
Time deposits - $250 and over		93,161		94,700
CDARS - interest-bearing demand, money market and time deposits		30,008		38,271
Total deposits		4,689,905		4,759,412
Subordinated debt, net of issuance costs		39,987		39,925
Accrued interest payable and other liabilities		96,450		102,044
Total liabilities		4,826,342		4,901,381

Shareholders' equity:
Preferred stock, 0 par value; 10,000,000 shares authorized; NaN issued and outstanding
at March 31, 2022 and December 31, 2021		—		—
Common stock, 0 par value; 100,000,000 shares authorized;
60,407,846 shares issued and outstanding at March 31, 2022 and
60,339,837 shares issued and outstanding at December 31, 2021		498,763		497,695
Retained earnings		116,347		111,329
Accumulated other comprehensive loss		(14,054)		(10,996)
Total shareholders' equity		601,056		598,028
Total liabilities and shareholders' equity	$	5,427,398	$	5,499,409

See notes to consolidated financial statements (unaudited).

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands, except per share amounts)
Interest income:
Loans, including fees	$	35,101	$	33,836
Securities, taxable		3,444		1,728
Securities, exempt from Federal tax		297		429
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		1,064		768
Total interest income		39,906		36,761

Interest expense:
Deposits		1,114		1,232
Subordinated debt		571		571
Total interest expense		1,685		1,803

Net interest income before provision for credit losses on loans		38,221		34,958
Provision for (recapture of) credit losses on loans		(567)		(1,512)
Net interest income after provision for credit losses on loans		38,788		36,470

Noninterest income:
Gain on warrants		637		—
Service charges and fees on deposit accounts		612		601
Increase in cash surrender value of life insurance		480		456
Gain on sales of SBA loans		156		550
Servicing income		106		182
Termination fees		—		90
Gain on proceeds from company owned life insurance		—		66
Other		469		356
Total noninterest income		2,460		2,301

Noninterest expense:
Salaries and employee benefits		13,821		13,958
Occupancy and equipment		2,437		2,274
Professional fees		1,080		1,719
Other		5,914		5,293
Total noninterest expense		23,252		23,244
Income before income taxes		17,996		15,527
Income tax expense		5,130		4,323
Net income	$	12,866	$	11,204

Earnings per common share:
Basic	$	0.21	$	0.19
Diluted	$	0.21	$	0.19

See notes to consolidated financial statements (unaudited).

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)


	Three Months Ended
	March 31,
	2022		2021

		(Dollars in thousands)
Net income	$	12,866	$	11,204
Other comprehensive income (loss):
Change in net unrealized holding (losses) gains on available-for-sale
securities and I/O strips		(4,405)		(849)
Deferred income taxes		1,277		247
Change in net unamortized unrealized gain on securities available-for-
sale that were reclassified to securities held-to-maturity		—		(13)
Deferred income taxes		—		4
Change in unrealized (losses) gains on securities and I/O strips, net of
deferred income taxes		(3,128)		(611)

Change in net pension and other benefit plan liability adjustment		104		89
Deferred income taxes		(34)		(29)
Change in pension and other benefit plan liability, net of
deferred income taxes		70		60
Other comprehensive loss		(3,058)		(551)

Total comprehensive income	$	9,808	$	10,653

See notes to consolidated financial statements (unaudited).

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)


						Accumulated
						Other		Total
	Common Stock			Retained		Comprehensive		Shareholders’
	Shares	Amount		Earnings		Loss		Equity

	(Dollars in thousands, except per share amounts)
Balance, January 1, 2021	59,917,457	$	493,707	$	94,899	$	(10,717)	$	577,889
Net income	—		—		11,204		—		11,204
Other comprehensive loss	—		—		—		(551)		(551)
Issuance (forfeitures) of restricted stock awards, net	(34,358)		—		—		—		—
Amortization of restricted stock awards,
net of forfeitures and taxes	—		458		—		—		458
Cash dividend declared $0.13 per share	—		—		(7,789)		—		(7,789)
Stock option expense, net of forfeitures and taxes	—		132		—		—		132
Stock options exercised	49,235		320		—		—		320
Balance March 31, 2021	59,932,334	$	494,617	$	98,314	$	(11,268)	$	581,663

Balance, January 1, 2022	60,339,837		497,695		111,329		(10,996)		598,028
Net income	—		—		12,866		—		12,866
Other comprehensive loss	—		—		—		(3,058)		(3,058)
Amortization of restricted stock awards,
net of forfeitures and taxes	—		518		—		—		518
Cash dividend declared $0.13 per share	—		—		(7,848)		—		(7,848)
Stock option expense, net of forfeitures and taxes	—		149		—		—		149
Stock options exercised	68,009		401		—		—		401
Balance March 31, 2022	60,407,846	$	498,763	$	116,347	$	(14,054)	$	601,056

See notes to consolidated financial statements (unaudited).

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	12,866	$	11,204
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of discounts and premiums on securities		675		1,071
Gain on sale of SBA loans		(156)		(550)
Proceeds from sale of SBA loans originated for sale		2,146		5,632
SBA loans originated for sale		(934)		(6,217)
Provision for (recapture of) credit losses on loans		(567)		(1,512)
Increase in cash surrender value of life insurance		(480)		(456)
Depreciation and amortization		283		243
Amortization of other intangible assets		659		733
Stock option expense, net		149		132
Amortization of restricted stock awards, net		518		458
Amortization of subordinated debt issuance costs		46		46
Gain on proceeds from company-owned life insurance		—		(66)
Effect of changes in:
Accrued interest receivable and other assets		7,053		623
Accrued interest payable and other liabilities		(5,475)		(1,085)
Net cash provided by operating activities		16,783		10,256

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available-for-sale		(21,656)		—
Purchase of securities held-to-maturity		(109,610)		(40,366)
Maturities/paydowns/calls of securities available-for-sale		8,099		37,765
Maturities/paydowns/calls of securities held-to-maturity		30,709		30,601
Net change in loans		63,807		(84,038)
Changes in Federal Home Loan Bank stock and other investments		(5)		(4)
Purchase of premises and equipment		(224)		(4)
Proceeds from redemption of company-owned life insurance		—		624
Net cash (used in) investing activities		(28,880)		(55,422)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits		(69,507)		364,616
Exercise of stock options		401		320
Payment of cash dividends		(7,848)		(7,789)
Net cash (used-in) provided by financing activities		(76,954)		357,147
Net increase in cash and cash equivalents		(89,051)		311,981
Cash and cash equivalents, beginning of period		1,306,216		1,131,073
Cash and cash equivalents, end of period	$	1,217,165	$	1,443,054

Supplemental disclosures of cash flow information:
Interest paid	$	1,112	$	1,242
Income taxes paid (refunds), net		(654)		(149)

Supplemental schedule of non-cash activity:
Transfer of loans held-for-sale to loan portfolio	$	480	$	—

See notes to consolidated financial statements (unaudited).

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HERITAGE COMMERCE CORP

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2022

(Unaudited)

1) Basis of Presentation

The unaudited consolidated financial statements of Heritage Commerce Corp (the “Company” or “HCC”) and its wholly owned subsidiary, Heritage Bank of Commerce (the “Bank” or “HBC”), 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 annual financial statements are not included herein. The interim statements should be read in conjunction with the consolidated financial statements and notes that were included in the Company’s Form 10-K for the year ended December 31, 2021.

HBC is a commercial bank serving customers primarily located in Alameda, Contra Costa, Marin, San Benito, San Francisco, San Mateo, and Santa Clara counties of California. CSNK Working Capital Finance Corp. a California corporation, dba Bay View Funding (“Bay View Funding”) is a wholly owned subsidiary of HBC, and provides business-essential working capital factoring financing to various industries throughout the United States. NaN customer accounts for more than 10% of revenue for HBC or the Company. The Company reports its results for 2 segments: banking and factoring. The Company’s management uses segment results in its operating and strategic planning.

In management’s opinion, all adjustments necessary for a fair presentation of these consolidated financial statements have been included and are of a normal and recurring nature. All intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ significantly from these estimates. Material estimates that are particularly susceptible to significant change include the determination of the allowance for credit losses and any impairment of goodwill or intangible assets. It is reasonably possible the Company’s estimate of the allowance for credit losses and evaluation of impairment of goodwill or intangible assets could change as a result of the continued impact of the COVID-19 pandemic on the economy. The resulting change in these estimates could be material to the Company’s consolidated financial statements.

The results for the three months ended March 31, 2022 are not necessarily indicative of the results expected for any subsequent period or for the entire year ending December 31, 2022.

Reclassifications

Certain reclassifications of prior year balances have been made to conform to the current year presentation. These reclassifications had no impact on the Company’s consolidated financial position, results of operations or net change in cash and cash equivalents.

Adoption of New Accounting Standards

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes to simplify various aspects of the current guidance to promote consistent application of the standard among reporting entities by moving certain exceptions to the general principles. The amendments are effective as of January 1, 2021 and had no material impact on the consolidated financial statements.

Accounting Guidance Issued But Not Yet Adopted

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The ASU provides optional expedients and exceptions for applying GAAP to loan and lease agreements, derivative contracts, and other transactions affected by the anticipated transition

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away from London Inter-Bank Offered Rate (“LIBOR”) toward new interest rate benchmarks. For transactions that are modified because of reference rate reform and that meet certain scope guidance (i) modifications of loan agreements should be accounted for by prospectively adjusting the effective interest rate and the modification will be considered "minor" so that any existing unamortized origination fees/costs would carry forward and continue to be amortized and (ii) modifications of lease agreements should be accounted for as a continuation of the existing agreement with no reassessments of the lease classification and the discount rate or remeasurements of lease payments that otherwise would be required for modifications not accounted for as separate contracts. ASU 2020-04 also provides numerous optional expedients for derivative accounting. ASU 2020-04 is effective March 12, 2020 through December 31, 2022. An entity may elect to apply ASU 2020-04 for contract modifications as of January 1, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic within the Codification, the amendments in this ASU must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The Company does not expect any material impact on its consolidated financial statements since the Company has an insignificant number of financial instruments applicable to this ASU.

In March 2022, the FASB issued ASU No. 2022-02 Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restrucurings and Vintage Disclosures, which 1) eliminates the accounting guidance for troubled debt restructurings ("TDRs") by creditors while enhancing the disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty; and 2) requires that an entity disclose current-period gross writeoffs by year of origination for financing receivables and net investments in leases. ASU 2022-02 is effective for fiscal years beginning after December 15, 2022 and the amendments should be applied prospectively, although the entity has the option to apply a modified retrospective transition method for the recognition and measurement of TDRs, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. The Company is currently evaluating the impact of adopting the new guidance on its consolidated financial statements.

2) Earnings Per Share

Basic earnings per common share is computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share reflect potential dilution from outstanding stock options using the treasury stock method. There were 1,048,267 and 1,019,481 weighted average stock options outstanding for the three months ended March 31, 2022 and 2021, respectively, considered to be antidilutive and excluded from the computation of diluted earnings per share. A reconciliation of these factors used in computing basic and diluted earnings per common share is as follows:


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands, except per share amounts)
Net income	$	12,866	$	11,204

Weighted average common shares outstanding for basic
earnings per common share		60,393,883		59,926,816
Dilutive potential common shares		527,952		477,397
Shares used in computing diluted earnings per common share		60,921,835		60,404,213

Basic earnings per share	$	0.21	$	0.19
Diluted earnings per share	$	0.21	$	0.19

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3) Accumulated Other Comprehensive Income (Loss) (“AOCI”)

The following table reflects the changes in AOCI by component for the periods indicated:


	Three Months Ended March 31, 2022 and 2021
			Unamortized
			Unrealized
	Unrealized		Gain on
	Gains (Losses) on		Available-
	Available-		for-Sale		Defined
	for-Sale		Securities		Benefit
	Securities		Reclassified		Pension
	and I/O		to Held-to-		Plan
	Strips		Maturity		Items(1)		Total

	(Dollars in thousands)
Beginning balance January 1, 2022, net of taxes	$	2,153	$	—	$	(13,149)	$	(10,996)
Other comprehensive (loss) before reclassification,
net of taxes		(3,128)		—		(3)		(3,131)
Amounts reclassified from other comprehensive income,
net of taxes		—		—		73		73
Net current period other comprehensive income (loss),
net of taxes		(3,128)		—		70		(3,058)

Ending balance March 31, 2022, net of taxes	$	(975)	$	—	$	(13,079)	$	(14,054)

Beginning balance January 1, 2021, net of taxes	$	3,929	$	261	$	(14,907)	$	(10,717)
Other comprehensive (loss) before reclassification,
net of taxes		(602)		—		(53)		(655)
Amounts reclassified from other comprehensive income (loss),
net of taxes		—		(9)		113		104
Net current period other comprehensive income (loss),
net of taxes		(602)		(9)		60		(551)

Ending balance March 31, 2021, net of taxes	$	3,327	$	252	$	(14,847)	$	(11,268)

(1)	This AOCI component is included in the computation of net periodic benefit cost (see Note 8—Benefit Plans) and includes split-dollar life insurance benefit plan.

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	Amounts Reclassified from
	AOCI
	Three Months Ended
	March 31,				Affected Line Item Where
Details About AOCI Components	2022		2021		Net Income is Presented

	(Dollars in thousands)
Amortization of unrealized gain on securities available-
for-sale that were reclassified to securities
held-to-maturity	$	—	$	13	Interest income on taxable securities
		—		(4)	Income tax expense
		—		9	Net of tax

Amortization of defined benefit pension plan items ⁽¹⁾
Prior transition obligation and actuarial losses ⁽²⁾		11		1
Prior service cost and actuarial losses ⁽³⁾		(114)		(161)
		(103)		(160)	Other noninterest expense
		30		47	Income tax benefit
		(73)		(113)	Net of tax
Total reclassification from AOCI for the period	$	(73)	$	(104)

(1)	This AOCI component is included in the computation of net periodic benefit cost (see Note 8—Benefit Plans).

(2)	This is related to the split dollar life insurance benefit plan.

(3)	This is related to the supplemental executive retirement plan.

4) Securities

The amortized cost and estimated fair value of securities were as follows for the periods indicated:


			Gross		Gross		Allowance		Estimated
	Amortized		Unrealized		Unrealized		for Credit		Fair
March 31, 2022	Cost		Gains		(Losses)		Losses		Value

	(Dollars in thousands)
Securities available-for-sale:
Agency mortgage-backed securities	$	91,059	$	19	$	(1,425)	$	—	$	89,653
U.S. Treasury		21,657		5		(98)		—		21,564
Total	$	112,716	$	24	$	(1,523)	$	—	$	111,217

			Gross		Gross		Estimated		Allowance
	Amortized		Unrecognized		Unrecognized		Fair		for Credit
March 31, 2022	Cost		Gains		(Losses)		Value		Losses

	(Dollars in thousands)
Securities held-to-maturity:
Agency mortgage-backed securities	$	696,161	$	28	$	(46,254)	$	649,935	$	—
Municipals - exempt from Federal tax		40,701		197		(49)		40,849		(39)
Total	$	736,862	$	225	$	(46,303)	$	690,784	$	(39)

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			Gross		Gross		Allowance		Estimated
	Amortized		Unrealized		Unrealized		for Credit		Fair
December 31, 2021	Cost		Gains		(Losses)		Losses		Value

	(Dollars in thousands)
Securities available-for-sale:
Agency mortgage-backed securities	$	99,359	$	2,893	$	—	$	—	$	102,252
Total	$	99,359	$	2,893	$	—	$	—	$	102,252

			Gross		Gross		Estimated		Allowance
	Amortized		Unrecognized		Unrecognized		Fair		for Credit
December 31, 2021	Cost		Gains		(Losses)		Value		Losses

	(Dollars in thousands)
Securities held-to-maturity:
Agency mortgage-backed securities	$	607,377	$	3,157	$	(4,752)	$	605,782	$	—
Municipals - exempt from Federal tax		51,063		804		—		51,867		(43)
Total	$	658,440	$	3,961	$	(4,752)	$	657,649	$	(43)

Securities with unrealized losses at March 31, 2022 and December 31, 2021, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position are as follows:


	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
March 31, 2022	Value		(Losses)		Value		(Losses)		Value		(Losses)

	(Dollars in thousands)
Securities available-for-sale:
Agency mortgage-backed securities	$	84,890	$	(1,425)	$	—	$	—	$	84,890	$	(1,425)
U.S. Treasury		11,858		(98)		—		—		11,858		(98)
Total	$	96,748	$	(1,523)	$	—	$	—	$	96,748	$	(1,523)

Securities held-to-maturity:
Agency mortgage-backed securities	$	620,134	$	(42,837)	$	25,465	$	(3,417)	$	645,599	$	(46,254)
Municipals — exempt from Federal tax		5,944		(49)		—		—		5,944		(49)
Total	$	626,078	$	(42,886)	$	25,465	$	(3,417)	$	651,543	$	(46,303)


	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2021	Value		(Losses)		Value		(Losses)		Value		(Losses)

	(Dollars in thousands)
Securities held-to-maturity:
Agency mortgage-backed securities	$	408,856	$	(3,319)	$	27,997	$	(1,433)	$	436,853	$	(4,752)
Total	$	408,856	$	(3,319)	$	27,997	$	(1,433)	$	436,853	$	(4,752)

There were 0 holdings of securities of any one issuer, other than the U.S. Government and its sponsored entities, in an amount greater than 10% of shareholders’ equity. At March 31, 2022, the Company held 395 securities (108 available-for-sale and 287 held-to-maturity), of which 266 had fair value below amortized cost. At March 31, 2022, there were $84,890,000 of agency mortgage-backed securities available-for-sale, and $11,858,000 of U.S. Treasury securities available-for-sale, carried with an unrealized loss for less than 12 months. At March 31, 2022, there were $620,134,000 of agency mortgage-backed securities held-to-maturity, and $5,944,000 of municipal securities, carried with an unrealized loss for less than 12 months, and $25,465,000 of agency mortgage-backed securities held-to-maturity, carried with an unrealized loss for 12 months or more. The total unrealized loss for securities carried less than 12 months was ($44,409,000), and the total unrealized loss for securities carried for 12 months or more was ($3,417,000) at March 31, 2022. The unrealized loss was due to higher interest rates in comparison to when the security was purchased. The issuers are of high credit quality and all principal amounts are expected to be paid when securities mature. The fair value is expected to recover as the securities approach their maturity date and/or market rates decline. The Company does not believe that it is more likely than not that the Company will be required to sell a security in an unrealized loss position prior to recovery in value. Therefore, the Company does not consider the agency mortgage-backed securities and U.S. Treasury securities to have credit-related losses as of March 31, 2022.

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The amortized cost and estimated fair values of securities as of March 31, 2022 are shown by contractual maturity below. The expected maturities will differ from contractual maturities if borrowers have the right to call or pre-pay obligations with or without call or pre-payment penalties. Securities not due at a single maturity date are shown separately.


	Available-for-sale
	Amortized		Estimated
	Cost		Fair Value

	(Dollars in thousands)
Due after one through five years	$	21,657	$	21,564
Agency mortgage-backed securities		91,059		89,653
Total	$	112,716	$	111,217


	Held-to-maturity
	Amortized		Estimated
	Cost		Fair Value

	(Dollars in thousands)
Due after three months through one year	$	545	$	548
Due after one through five years		7,348		7,402
Due after five through ten years		24,800		24,861
Due after ten years		8,008		8,038
Agency mortgage-backed securities		696,161		649,935
Total	$	736,862	$	690,784

Securities with amortized cost of $53,897,000 and $42,473,000 as of March 31, 2022 and December 31, 2021 were pledged to secure public deposits and for other purposes as required or permitted by law or contract.

The table below presents a roll-forward by major security type for the three months ended March 31, 2022 of the allowance for credit losses on debt securities held-to-maturity held at period end:


		Municipals
		(Dollars in thousands)
Beginning balance January 1, 2022	$	43
Provision for (recapture of) credit losses		(4)
Ending balance March 31, 2022	$	39

For the three months ended March 31, 2022, there was a reduction of $4,000 to the allowance for credit losses on the Company’s held-to-maturity municipal investment securities portfolio. This reduction was the result of a reduction in municipal securities amortized balances resulting from regular payments. The bond ratings for the Company’s municipal investment securities at March 31, 2022 were consistent with the ratings at December 31, 2021.

5) Loans and Allowance for Credit Losses on Loans

On January 1, 2020, the Company adopted the current expected credit loss (“CECL”) model under ASU 2016-13 (Topic 326) using the modified retrospective approach. The allowance for credit losses on loans is an estimate of the current expected credit losses in the loan portfolio. Loans are charged-off against the allowance when management determines that a loan balance has become uncollectible. Subsequent recoveries, if any, are credited to the allowance for credit losses on loans.

Management’s methodology for estimating the allowance balance consists of several key elements, which include pooling loans with similar characteristics into segments and using a discounted cash flow calculation to estimate losses. The discounted cash flow model inputs include loan level cash flow estimates for each loan segment based on peer and bank historic loss correlations with certain economic factors. Management uses a four quarter forecast of each economic factor that is used for each loan segment and the economic factors are assumed to revert to the historic mean over an eight quarter period after the forecast period. The economic factors management has selected include the California unemployment rate, California gross domestic product, California home price index, and a national CRE value index. These factors are evaluated and updated occasionally and as economic conditions change. Additionally, management uses qualitative adjustments to the discounted cash flow quantitative loss estimates in certain cases when management has assessed an adjustment is necessary. These qualitative adjustments are applied by pooled loan segment

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and have been made for increased risk due to loan quality trends, collateral risk, or other risks management determines are not adequately captured in the discounted cash flow loss estimation. Specific allowances on individually evaluated loans are combined to the allowance on pools of loans with similar risk characteristics to derive to total allowance for credit losses on loans.

Management has also considered other qualitative risks such as collateral values, concentrations of credit risk (geographic, large borrower, and industry), economic conditions, changes in underwriting standards, experience and depth of lending staff, trends in delinquencies, and the level of criticized loans to address asset-specific risks and current conditions that were not fully considered by the macroeconomic variables driving the quantitative estimate.

The allowance for credit losses on loans was calculated by pooling loans of similar credit risk characteristics and credit monitoring procedures. The loan portfolio is classified into eight segments of loans - commercial, commercial real estate – owner occupied, commercial real estate – non-owner occupied, land and construction, home equity, multifamily, residential mortgages and consumer and other.

The risk characteristics of each loan portfolio segment are as follows:

Commercial

Commercial loans primarily rely on the identified cash flows of the borrower for repayment and secondarily on the underlying collateral provided by the borrower. However, the cash flows of the borrowers may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable, inventory or equipment and may incorporate a personal guarantee; however, some loans may be unsecured. Included in commercial loans are $37,393,000 of Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans at March 31, 2022 and $88,726,000 at December 31, 2021. NaN allowance for credit losses has been recorded for PPP loans as they are fully guaranteed by the SBA.

Commercial Real Estate (“CRE”)

CRE loans rely primarily on the cash flows of the properties securing the loan and secondarily on the value of the property that is securing the loan. CRE loans comprise two segments differentiated by owner occupied CRE and non-owner CRE. Owner occupied CRE loans are secured by commercial properties that are at least 50% occupied by the borrower or borrower affiliate. Non-owner occupied CRE loans are secured by commercial properties that are less than 50% occupied by the borrower or borrower affiliate. CRE loans may be adversely affected by conditions in the real estate markets or in the general economy.

Land and Construction

Land and construction loans are generally based on estimates of costs and value associated with the complete project. Construction loans usually involve the disbursement of funds with repayment substantially dependent on the success of the completion of the project. Sources of repayment for these loans may be permanent loans from HBC or other lenders, or proceeds from the sales of the completed project. These loans are monitored by on-site inspections and are considered to have higher risk than other real estate loans due to the final repayment dependent on numerous factors including general economic conditions.

Home Equity

Home equity loans are secured by 1-4 family residences that are generally owner occupied. Repayment of these loans depends primarily on the personal income of the borrower and secondarily on the value of the property securing the loan which can be impacted by changes in economic conditions such as the unemployment rate and property values. These loans are generally revolving lines of credit.

Multifamily

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loan. The cash flows of these borrowers can fluctuate along with the values of the underlying property depending on general economic conditions.

Residential Mortgages

Residential mortgage loans are secured by 1-4 family residences which are generally owner-occupied. Repayment of these loans depends primarily on the personal income of the borrower and secondarily on the value of the property securing the loan which can be impacted by changes in economic conditions such as the unemployment rate and property values. These are generally term loans.

Consumer and Other

Consumer and other loans are secured by personal property or are unsecured and rely primarily on the income of the borrower for repayment and secondarily on the collateral value for secured loans. Borrower income and collateral values can vary depending on economic conditions.

Loan Distribution

Loans by portfolio segment and the allowance for credit losses on loans were as follows for the periods indicated:


	March 31,		December 31,
	2022		2021

	(Dollars in thousands)
Loans held-for-investment:
Commercial	$	605,446	$	682,834
Real estate:
CRE - owner occupied		597,542		595,934
CRE - non-owner occupied		928,220		902,326
Land and construction		153,323		147,855
Home equity		111,609		109,579
Multifamily		221,767		218,856
Residential mortgages		391,171		416,660
Consumer and other		17,110		16,744
Loans		3,026,188		3,090,788
Deferred loan fees, net		(2,124)		(3,462)
Loans, net of deferred fees		3,024,064		3,087,326
Allowance for credit losses on loans		(42,788)		(43,290)
Loans, net	$	2,981,276	$	3,044,036

Changes in the allowance for credit losses on loans were as follows for the periods indicated:


	Three Months Ended March 31, 2022
			CRE		CRE
			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgage		and Other		Total

	(Dollars in thousands)
Beginning of period balance	$	8,414	$	7,954	$	17,125	$	1,831	$	864	$	2,796	$	4,132	$	174	$	43,290
Charge-offs		(16)		—		—		—		—		—		—		—		(16)
Recoveries		54		3		—		—		24		—		—		—		81
Net recoveries		38		3		—		—		24		—		—		—		65
Provision for (recapture of) credit losses on loans		(1,651)		(1,560)		2,288		175		(166)		(252)		625		(26)		(567)
End of period balance	$	6,801	$	6,397	$	19,413	$	2,006	$	722	$	2,544	$	4,757	$	148	$	42,788

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	Three Months Ended March 31, 2021
			CRE		CRE
			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgage		and Other		Total

	(Dollars in thousands)
Beginning of period balance	$	11,587	$	8,560	$	16,416	$	2,509	$	1,297	$	2,804	$	943	$	284	$	44,400
Charge-offs		(263)		—		—		—		—		—		—		—		(263)
Recoveries		813		4		—		816		23		—		—		15		1,671
Net recoveries		550		4		—		816		23		—		—		15		1,408
Provision for (recapture of) credit losses on loans		(537)		(196)		15		(571)		(149)		(53)		(25)		4		(1,512)
End of period balance	$	11,600	$	8,368	$	16,431	$	2,754	$	1,171	$	2,751	$	918	$	303	$	44,296

The following tables present the amortized cost basis of nonperforming loans and loans past due over 90 days and still accruing at the periods indicated:


	March 31, 2022
						Restructured
	Nonaccrual		Nonaccrual			and Loans
	with no Specific		with Specific			over 90 Days
	Allowance for		Allowance for			Past Due
	Credit		Credit			and Still
	Losses		Losses			Accruing	Total

	(Dollars in thousands)
Commercial	$	236	$	761	$	527	$	1,524
Real estate:
CRE - Owner Occupied		1,126		—		—		1,126
Home equity		73		—		—		73
Multifamily		1,107		—		—		1,107
Total	$	2,542	$	761	$	527	$	3,830


	December 31, 2021
					Restructured
	Nonaccrual		Nonaccrual		and Loans
	with no Specific		with no Specific		over 90 Days
	Allowance for		Allowance for		Past Due
	Credit		Credit		and Still
	Losses		Losses		Accruing		Total

	(Dollars in thousands)
Commercial	$	94	$	1,028	$	278	$	1,400
Real estate:
CRE - Owner Occupied		1,126		—		—		1,126
Home equity		84		—		—		84
Multifamily		1,128		—		—		1,128
Total	$	2,432	$	1,028	$	278	$	3,738

The following tables present the aging of past due loans by class for the periods indicated:


	March 31, 2022
	30 - 59		60 - 89		90 Days or
	Days		Days		Greater		Total
	Past Due		Past Due		Past Due		Past Due		Current		Total

	(Dollars in thousands)
Commercial	$	5,522	$	1,508	$	578	$	7,608	$	597,838	$	605,446
Real estate:
CRE - Owner Occupied		—		—		1,126		1,126		596,416		597,542
CRE - Non-Owner Occupied		—		707		—		707		927,513		928,220
Land and construction		—		—		—		—		153,323		153,323
Home equity		—		—		—		—		111,609		111,609
Multifamily		—		—		—		—		221,767		221,767
Residential mortgages		4,690		—		—		4,690		386,481		391,171
Consumer and other		—		—		—		—		17,110		17,110
Total	$	10,212	$	2,215	$	1,704	$	14,131	$	3,012,057	$	3,026,188

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	December 31, 2021
	30 - 59		60 - 89		90 Days or
	Days		Days		Greater		Total
	Past Due		Past Due		Past Due		Past Due		Current		Total

	(Dollars in thousands)
Commercial	$	2,714	$	168	$	408	$	3,290	$	679,544	$	682,834
Real estate:
CRE - Owner Occupied		—		—		1,126		1,126		594,808		595,934
CRE - Non-Owner Occupied		—		—		—		—		902,326		902,326
Land and construction		—		—		—		—		147,855		147,855
Home equity		—		—		—		—		109,579		109,579
Multifamily		—		—		—		—		218,856		218,856
Residential mortgages		599		—		—		599		416,061		416,660
Consumer and other		—		—				—		16,744		16,744
Total	$	3,313	$	168	$	1,534	$	5,015	$	3,085,773	$	3,090,788

Past due loans 30 days or greater totaled $14,131,000 and $5,015,000 at March 31, 2022 and December 31, 2021, respectively, of which $1,362,000 and $1,258,000 were on nonaccrual, at March 31, 2022 and December 31, 2021, respectively. At March 31, 2022, there were also $1,941,000 of loans less than 30 days past due included in nonaccrual loans held-for-investment. At December 31, 2021, there were also $2,202,000 loans less than 30 days past due included in nonaccrual loans held-for-investment. Management’s classification of a loan as “nonaccrual” is an indication that there is reasonable doubt as to the full recovery of principal or interest on the loan. At that point, the Company stops accruing interest income, and reverses any uncollected interest that had been accrued as income. The Company begins recognizing interest income only as cash interest payments are received and it has been determined the collection of all outstanding principal is not in doubt.

Credit Quality Indicators

Concentrations of credit risk arise when a number of customers are engaged in similar business activities, or activities in the same geographic region, or have similar features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic conditions. The Company’s loan portfolio is concentrated in commercial (primarily manufacturing, wholesale, and service) and real estate lending, with the remaining balance in consumer loans. While no specific industry concentration is considered significant, the Company’s lending operations are located in the Company’s market areas that are dependent on the technology and real estate industries and their supporting companies. Thus, the Company’s borrowers could be adversely impacted by a downturn in these sectors of the economy which could reduce the demand for loans and adversely impact the borrowers’ ability to repay their loans.

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, and other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a quarterly basis. Nonclassified loans generally include those loans that are expected to be repaid in accordance with their contractual loan terms. Loans categorized as special mention have potential weaknesses that may, if not checked or corrected, weaken the credit or inadequately protect the Company’s position at some future date. These loans pose elevated risk, but their weaknesses do not yet justify a substandard classification. Classified loans are those loans that are assigned a substandard, substandard-nonaccrual, or doubtful risk rating using the following definitions:

Special Mention. A Special Mention asset has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in a deterioration of the repayment prospects for the asset or in the credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that will jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

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Substandard-Nonaccrual. Loans classified as substandard-nonaccrual are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any, and it is probable that the Company will not receive payment of the full contractual principal and interest. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. In addition, the Company no longer accrues interest on the loan because of the underlying weaknesses.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss. Loans classified as loss are considered uncollectable or of so little value that their continuance as assets is not warranted. This classification does not necessarily mean that a loan has no recovery or salvage value; but rather, there is much doubt about whether, how much, or when the recovery would occur. Loans classified as loss are immediately charged off against the allowance for credit losses on loans. Therefore, there is 0 balance to report as of March 31, 2022 and December 31, 2021.

Loans may be reviewed at any time throughout a loan’s duration. If new information is provided, a new risk assessment may be performed if warranted.

The following tables present term loans amortized cost by vintage and loan grade classification, and revolving loans amortized cost by loan grade classification at March 31, 2022 and December 31, 2021. The loan grade classifications are based on the Bank’s internal loan grading methodology. Loan grade categories for doubtful and loss rated loans are not included on the tables below as there are no loans with those grades at March 31, 2022 and December 31, 2021. The vintage year represents the period the loan was originated or in the case of renewed loans, the period last renewed. The amortized balance is the loan balance less any purchase discounts, plus any loan purchase premiums. The loan categories are based on the loan segmentation in the Company's CECL reserve methodology based on loan purpose and type.

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														Revolving
														Loans
		Term Loans Amortized Cost Basis by Originated Period as of March 31, 2022												Amortized
											2017 and			Cost
	03/31/2022		12/31/2021		12/31/2020		12/31/2019		12/31/2018		Prior			Basis		Total

	(Dollars in thousands)
Commercial:
Pass	$	83,467	$	90,076	$	51,230	$	12,145	$	10,818	$	10,799	$	333,283	$	591,818
Special Mention		2,020		1,283		496		213		706		417		1,888		7,023
Substandard		4		561		258		-		11		167		4,607		5,608
Substandard-Nonaccrual		-		548		362		-		-		87		-		997
Total		85,491		92,468		52,346		12,358		11,535		11,470		339,778		605,446

CRE - Owner Occupied:
Pass		39,671		163,716		125,993		58,738		51,196		127,282		13,022		579,618
Special Mention		568		-		6,657		668		-		347		-		8,240
Substandard		907		-		5,309		-		1,468		874		-		8,558
Substandard-Nonaccrual		-		-		1,101		-		-		25		-		1,126
Total		41,146		163,716		139,060		59,406		52,664		128,528		13,022		597,542

CRE - Non-Owner Occupied:
Pass		55,458		376,710		128,498		113,076		35,540		197,894		2,711		909,887
Special Mention		-		-		5,341		-		-		356				5,697
Substandard		-		707		5,798		-		-		6,131		-		12,636
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		55,458		377,417		139,637		113,076		35,540		204,381		2,711		928,220

Land and construction:
Pass		53,912		79,197		11,259		3,925		-		1,289		3,741		153,323
Special Mention		-		-		-		-		-		-		-		-
Substandard		-		-		-		-		-		-		-		-
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		53,912		79,197		11,259		3,925		-		1,289		3,741		153,323

Home equity:
Pass		-		-		-		-		40		-		109,329		109,369
Special Mention		-		-		-		-		-		-		1,932		1,932
Substandard		-		-		-		-		-		143		92		235
Substandard-Nonaccrual		-		-		73		-		-		-				73
Total		-		-		73		-		40		143		111,353		111,609

Multifamily:
Pass		7,949		100,952		27,780		28,548		16,062		28,204		-		209,495
Special Mention		-		6,880		-		4,285		-				-		11,165
Substandard		-		-		-		-		-		-		-		-
Substandard-Nonaccrual		-		1,107		-		-		-		-		-		1,107
Total		7,949		108,939		27,780		32,833		16,062		28,204		-		221,767

Residential mortgage:
Pass		765		338,359		17,742		7,643		3,022		23,413		-		390,944
Special Mention		-		-		-		-		-		-		-		-
Substandard		-		-		-		-		-		227		-		227
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		765		338,359		17,742		7,643		3,022		23,640		-		391,171

Consumer and other:
Pass		79		522		-		32		1,411		895		14,159		17,098
Special Mention		-		-		-		-		-		-		-		-
Substandard		-		12		-		-		-		-				12
Substandard-Nonaccrual		-		-		-		-		-		-		-		-
Total		79		534		-		32		1,411		895		14,159		17,110

Total loans	$	244,800	$	1,160,630	$	387,897	$	229,273	$	120,274	$	398,550	$	484,764	$	3,026,188

Risk Grades:
Pass	$	241,301	$	1,149,532	$	362,502	$	224,107	$	118,089	$	389,776	$	476,245	$	2,961,552
Special Mention		2,588		8,163		12,494		5,166		706		1,120		3,820		34,057
Substandard		911		1,280		11,365		-		1,479		7,542		4,699		27,276
Substandard-Nonaccrual		-		1,655		1,536		-		-		112		-		3,303
Grand Total	$	244,800	$	1,160,630	$	387,897	$	229,273	$	120,274	$	398,550	$	484,764	$	3,026,188

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													Revolving
													Loans
		Term Loans Amortized Cost Basis by Originated Period as of December 31, 2021											Amortized
													Cost
		2021	2020		2019		2018		2017		Prior Periods		Basis		Total

	(Dollars in thousands)
Commercial:
Pass	$	208,645	65,257	$	15,086	$	12,281	$	7,311	$	5,507	$	349,717	$	663,804
Special Mention		2,210	512		219		764		243		204		4,024		8,176
Substandard		3,709	930		-		13		302		2		4,776		9,732
Substandard-Nonaccrual		595	442		37		-		-		48		-		1,122
Total		215,159	67,141		15,342		13,058		7,856		5,761		358,517		682,834

CRE - Owner Occupied:
Pass		170,504	135,103		65,596		57,017		31,657		107,203		14,486		581,566
Special Mention		568	2,254		672		-		-		355		-		3,849
Substandard		985	6,042		-		1,477		-		889		-		9,393
Substandard-Nonaccrual		-	1,100		-		-		-		26		-		1,126
Total		172,057	144,499		66,268		58,494		31,657		108,473		14,486		595,934

CRE - Non-Owner Occupied:
Pass		374,470	141,404		115,170		45,959		68,125		134,454		2,068		881,650
Special Mention		-	5,388		-		-		1,133		3,816		-		10,337
Substandard		-	5,842		-		-		-		4,497		-		10,339
Substandard-Nonaccrual		-	-		-		-		-		-		-		-
Total		374,470	152,634		115,170		45,959		69,258		142,767		2,068		902,326

Land and construction:
Pass		125,844	11,401		4,385		-		-		1,300		3,566		146,496
Special Mention		1,359	-		-		-		-		-		-		1,359
Substandard		-	-		-		-		-		-		-		-
Substandard-Nonaccrual		-	-		-		-		-		-		-		-
Total		127,203	11,401		4,385		-		-		1,300		3,566		147,855

Home equity:
Pass		-	-		-		46		-		-		106,738		106,784
Special Mention		-	-		-		-		-		-		1,931		1,931
Substandard		-	-		-		-		-		54		726		780
Substandard-Nonaccrual		-	84		-		-		-		-		-		84
Total		-	84		-		46		-		54		109,395		109,579

Multifamily:
Pass		102,535	27,955		30,820		16,151		16,261		13,895		-		207,617
Special Mention		5,804	-		4,307		-		-		-		-		10,111
Substandard		-	-		-		-		-		-		-		-
Substandard-Nonaccrual		1,128	-		-		-		-		-		-		1,128
Total		109,467	27,955		35,127		16,151		16,261		13,895		-		218,856

Residential mortgage:
Pass		360,424	17,875		8,065		3,070		6,015		19,967		-		415,416
Special Mention		-	-		-		-		-		1,244		-		1,244
Substandard		-	-		-		-		-		-		-		-
Substandard-Nonaccrual		-	-		-		-		-		-		-		-
Total		360,424	17,875		8,065		3,070		6,015		21,211		-		416,660

Consumer and other:									��
Pass		491	2		40		1,426		14		1,000		13,756		16,729
Special Mention		-	-		-		-		-		-		-		-
Substandard		15	-		-		-		-		-		-		15
Substandard-Nonaccrual		-	-		-		-		-		-		-		-
Total		506	2		40		1,426		14		1,000		13,756		16,744

Total loans	$	1,359,286	421,591	$	244,397	$	138,204	$	131,061	$	294,461	$	501,788	$	3,090,788

Risk Grades:.
Pass	$	1,342,913	398,997	$	239,162	$	135,950	$	129,383	$	283,326	$	490,331	$	3,020,062
Special Mention		9,941	8,154		5,198		764		1,376		5,619		5,955		37,007
Substandard		4,709	12,814		-		1,490		302		5,442		5,502		30,259
Substandard-Nonaccrual		1,723	1,626		37		-		-		74		-		3,460
Grand Total	$	1,359,286	421,591	$	244,397	$	138,204	$	131,061	$	294,461	$	501,788	$	3,090,788

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The amortized cost basis of collateral-dependent loans by business assets was $761,000 and $1,028,000 at March 31, 2022 and December 31, 2021, respectfully.

When management determines that foreclosures are probable, expected credit losses for collateral-dependent loans are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. For loans for which foreclosure is not probable, but for which repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty, management has elected the practical expedient under ASC 326 to estimate expected credit losses based on the fair value of collateral, adjusted for selling costs as appropriate. The class of loan represents the primary collateral type associated with the loan. Significant quarter over quarter changes are reflective of changes in nonaccrual status and not necessarily associated with credit quality indicators like appraisal value.

The book balance of troubled debt restructurings at March 31, 2022 was $481,000 which included $355,000 of nonaccrual loans and $126,000 of accruing loans. The book balance of troubled debt restructurings at December 31, 2021 was $500,000 which included $372,000 of nonaccrual loans and $128,000 of accruing loans. Approximately $279,000 and $290,000 in specific reserves were established with respect to these loans as of March 31, 2022 and December 31, 2021, respectively.

There were 0 loans modified as a troubled debt restructuring during the three months ended March 31, 2022. There was 1 new loan with total recorded investment of $3,000 that was modified as a troubled debt restructuring during the three months ended March 31, 2021.

The following table presents loans by class modified as troubled debt restructurings for the period indicated:


	Three Months Ended
	March 31, 2021
				Pre-modification		Post-modification
		Number		Outstanding		Outstanding
		of		Recorded		Recorded
Troubled Debt Restructurings:		Contracts		Investment		Investment

	(Dollars in thousands)
Commercial		1	$	3	$	3
Total		1	$	3	$	3

A loan is considered to be in payment default when it is 30 days contractually past due under the modified terms. There were 0 defaults on troubled debt restructurings, within twelve months following the modification, during the three months ended March 31, 2022 and 2021.

A loan that is a troubled debt restructuring on nonaccrual status may return to accruing status after a period of at least six months of consecutive payments in accordance with the modified terms.

On April 7, 2020, U.S. banking agencies issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus. The statement describes accounting for COVID-19-related loan modifications and clarifies the interaction between current accounting rules and the temporary relief provided by the CARES Act. Initially, the Bank made accommodations for payment deferrals for a number of customers with a window of up to 90 days, with the potential of an additional 90 days of payment deferral (180 days maximum) upon application. The Bank also waived all customary applicable fees. Of the loans for which deferrals were originally granted, all have returned to regular payment status. At March 31, 2022, there were 0 remaining deferments.

6) Goodwill and Other Intangible Assets

Goodwill

At March 31, 2022, the carrying value of goodwill was $167,631,000, which included $13,044,000 of goodwill related to its acquisition of Bay View Funding, $32,619,000 from its acquisition of Focus Business Bank, $13,819,000 from its acquisition of Tri-Valley Bank, $24,271,000 from its acquisition of United American Bank and $83,878,000 from its acquisition of Presidio Bank.

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Goodwill impairment exists when a reporting unit’s carrying value exceeds its fair value, which is determined through a qualitative assessment whether it is more likely than not that the fair value of equity of the reporting unit exceeds the carrying value (“Step Zero”). If the qualitative assessment indicates it is more likely than not that the fair value of equity of a reporting unit is less than book value, then a quantitative two-step impairment test is required. Step 1 includes the determination of the carrying value of the Company’s reporting units, including the existing goodwill and intangible assets, and estimating the fair value of each reporting unit.

The Company completed its annual goodwill impairment analysis as of November 30, 2021 with the assistance of an independent valuation firm. The goodwill related to the acquisition of Bay View Funding was tested separately for impairment under this analysis. No events or circumstances since the November 30, 2021 annual impairment test were noted that would indicate it was more likely than not that a goodwill impairment exists, for either the Company’s banking or factoring reporting units.

The following table summarizes the carrying amount of goodwill by segment for the periods indicated:


	March 31,		December 31,
	2022		2021

	(Dollars in thousands)
Banking	$	154,587	$	154,587
Factoring		13,044		13,044
Total Goodwill	$	167,631	$	167,631

Other Intangible Assets

The Company’s intangible assets are summarized as follows for the periods indicated:


	March 31, 2022
	Gross
	Carrying		Accumulated
	Amount		Amortization		Total

	(Dollars in thousands)
Core deposit intangibles	$	25,023	$	(12,593)	$	12,430
Customer relationship and brokered relationship intangibles		1,900		(1,409)		491
Below market leases		110		(22)		88
Total	$	27,033	$	(14,024)	$	13,009


	December 31, 2021
	Gross
	Carrying		Accumulated
	Amount		Amortization		Total

	(Dollars in thousands)
Core deposit intangibles	$	25,023	$	(11,982)	$	13,041
Customer relationship and brokered relationship intangibles		1,900		(1,361)		539
Below market leases		110		(22)		88
Total	$	27,033	$	(13,365)	$	13,668

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As of March 31, 2022, the estimated amortization expense for future periods is as follows:


				Customer &	Below/
	Core			Brokered	(Above)		Total
	Deposit			Relationship	Market		Amortization
Year	Intangible			Intangible	Lease		Expense

		(Dollars in thousands)
2022 remaining	$	1,836		142	$	(2)	$	1,976
2023		2,217		190		(2)		2,405
2024		2,023		159		5		2,187
2025		1,795		—		18		1,813
2026		1,512		—		18		1,530
2027		1,438		—		18		1,456
Thereafter		1,609		—		33		1,642
	$	12,430	$	491	$	88	$	13,009

Impairment testing of the intangible assets is performed at the individual asset level. Impairment exists if the carrying amount of the asset is not recoverable and exceeds its fair value at the date of the impairment test. For intangible assets, estimates of expected future cash flows (cash inflows less cash outflows) that are directly associated with an intangible asset are used to determine the fair value of that asset. Management makes certain estimates and assumptions in determining the expected future cash flows from core deposit and customer relationship intangibles including account attrition, expected lives, discount rates, interest rates, servicing costs and other factors. Significant changes in these estimates and assumptions could adversely impact the valuation of these intangible assets. If an impairment loss exists, the carrying amount of the intangible asset is adjusted to a new cost basis. The new cost basis is then amortized over the remaining useful life of the asset. Based on its assessment, management concluded that there was 0 impairment of intangible assets at March 31, 2022 and December 31, 2021.

7) Income Taxes

Some items of income and expense are recognized in one year for tax purposes, and another when applying generally accepted accounting principles, which leads to timing differences between the Company’s actual current tax liability and the amount accrued for this liability based on book income. These temporary differences comprise the “deferred” portion of the Company’s tax expense or benefit, which is accumulated on the Company’s books as a deferred tax asset or deferred tax liability until such time as they reverse.

Under generally accepted accounting principles, a valuation allowance is required if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future income, cumulative losses, applicable tax planning strategies, and assessments of current and future economic and business conditions.

The Company had net deferred tax assets of $28,054,000, and $28,757,000, at March 31, 2022 and December 31, 2021, respectively. After consideration of the matters in the preceding paragraph, the Company determined that it is more likely than 0t that the net deferred tax assets at March 31, 2022 and December 31, 2021 will be fully realized in future years.

The following table reflects the carrying amounts of the low income housing investments included in accrued interest receivable and other assets, and the future commitments included in accrued interest payable and other liabilities for the periods indicated:


	March 31,		December 31,
	2022		2021

	(Dollars in thousands)
Low income housing investments	$	4,169	$	4,380
Future commitments	$	568	$	568

The Company expects $55,000 of the future commitments to be paid in 2022, and $513,000 in 2023 through 2025.

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For tax purposes, the Company had low income housing tax credits of $210,000 for both the three months ended March 31, 2022 and March 31, 2021, and low income housing investment expense of $211,000 and $208,000, respectively. The Company recognized low income housing investment expense as a component of income tax expense.

8) Benefit Plans

Supplemental Retirement Plan

The Company has a supplemental retirement plan (the “Plan”) covering some current and some former key employees and directors. The Plan is a nonqualified defined benefit plan. Benefits are unsecured as there are 0 Plan assets. The following table presents the amount of periodic cost recognized for the periods indicated:


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands)
Components of net periodic benefit cost:
Service cost	$	87	$	120
Interest cost		216		190
Amortization of prior service cost		—		25
Amortization of net actuarial loss		114		136
Net periodic benefit cost	$	417	$	471

The components of net periodic benefit cost other than the service cost component are included in the line item “other noninterest expense” in the Consolidated Statements of Income.

Split-Dollar Life Insurance Benefit Plan

The Company maintains life insurance policies for some current and former directors and officers that are subject to split-dollar life insurance agreements. The following table sets forth the funded status of the split-dollar life insurance benefits for the periods indicated:


	March 31,		December 31,
	2022		2021

	(Dollars in thousands)
Change in projected benefit obligation:
Projected benefit obligation at beginning of year	$	9,244	$	9,689
Interest cost		62		219
Actuarial loss		—		(664)
Projected benefit obligation at end of period	$	9,306	$	9,244


	March 31,		December 31,
	2022		2021

	(Dollars in thousands)
Net actuarial loss	$	4,633	$	4,601
Prior transition obligation		858		879
Accumulated other comprehensive loss	$	5,491	$	5,480


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands)
Amortization of prior transition obligation and actuarial losses	$	(11)	$	(1)
Interest cost		62		55
Net periodic benefit cost	$	51	$	54

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9) Fair Value

Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data (for example, interest rates and yield curves observable at commonly quoted intervals, prepayment speeds, credit risks, and default rates).

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Financial Assets and Liabilities Measured on a Recurring Basis

The fair values of securities available-for sale-are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The fair value of interest-only (“I/O”) strip receivable assets is based on a valuation model used by a third party. The Company is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs).

							��
			Fair Value Measurements Using
					Significant
			Quoted Prices in		Other			Significant
			Active Markets for		Observable			Unobservable
			Identical Assets		Inputs			Inputs
	Balance		(Level 1)		(Level 2)			(Level 3)

	(Dollars in thousands)
Assets at March 31, 2022
Available-for-sale securities:
Agency mortgage-backed securities	$	89,653	$	—	$	89,653		$	—
U.S. Treasury		21,564		21,564		—			—
I/O strip receivables		208		—		208			—

Assets at December 31, 2021
Available-for-sale securities:
Agency mortgage-backed securities	$	102,252	$	—	$	102,252		$	—
I/O strip receivables		221		—		221			—

There were 0 transfers between Level 1 and Level 2 during the period for assets measured at fair value on a recurring basis.

Assets and Liabilities Measured on a Non-Recurring Basis

The fair value of collateral dependent loans individually evaluated with specific allocations of the allowance for credit losses on loans is generally based on recent real estate appraisals. The appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. There were no material collateral dependent loans carried at fair value on a non-recurring basis at March 31, 2022 or December 31, 2021.

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Foreclosed assets are valued at the time the loan is foreclosed upon and the asset is transferred to foreclosed assets. The fair value is based primarily on third party appraisals, less costs to sell. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. At March 31, 2022 and December 31, 2021, there were 0 foreclosed assets on the balance sheet.

The carrying amounts and estimated fair values of financial instruments at March 31, 2022 are as follows:


			Estimated Fair Value
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Total

	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	1,217,165	$	1,217,165	$	—	$	—	$	1,217,165
Securities available-for-sale		111,217		21,564		89,653		—		111,217
Securities held-to-maturity		736,823		—		690,784		—		690,784
Loans (including loans held-for-sale), net		2,982,107		—		831		2,954,560		2,955,391
FHLB stock, FRB stock, and other
investments		32,509		—		—		—		N/A
Accrued interest receivable		11,120		52		1,998		9,070		11,120
I/O strips receivables		208		—		208		—		208
Liabilities:
Time deposits	$	137,203	$	—	$	137,417	$	—	$	137,417
Other deposits		4,552,702		—		4,552,702		—		4,552,702
Subordinated debt		39,987		—		39,587		—		39,587
Accrued interest payable		1,005		—		1,005		—		1,005

The carrying amounts and estimated fair values of the Company’s financial instruments at December 31, 2021:


			Estimated Fair Value
					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Total

	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	1,306,216	$	1,306,216	$	—	$	—	$	1,306,216
Securities available-for-sale		102,252		—		102,252		—		102,252
Securities held-to-maturity		658,397		—		657,649		—		657,649
Loans (including loans held-for-sale), net		3,046,403		—		2,367		3,061,558		3,063,925
FHLB stock, FRB stock, and other
investments		32,504		—		—		—		N/A
Accrued interest receivable		10,781		—		1,719		9,062		10,781
I/O strips receivables		221		—		221		—		221
Liabilities:
Time deposits	$	139,834	$	—	$	140,086	$	—	$	140,086
Other deposits		4,619,578		—		4,619,578		—		4,619,578
Subordinated debt		39,925		—		40,425		—		40,425
Accrued interest payable		477		—		477		—		477

10) Equity Plan

The Company maintained an Amended and Restated 2004 Equity Plan (the “2004 Plan”) for directors, officers, and key employees. The 2004 Plan was terminated on May 23, 2013. On May 23, 2013, the Company’s shareholders approved the 2013 Equity Incentive Plan (the “2013 Plan”). On May 21, 2020, the shareholders approved an amendment

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to the Heritage Commerce Corp 2013 Equity Incentive Plan to increase the number of shares available from 3,000,000 to 5,000,000 shares. The equity plans provide for the grant of incentive and nonqualified stock options and restricted stock. The equity plans provide that the option price for both incentive and nonqualified stock options will be determined by the Board of Directors at no less than the fair value at the date of grant. Options granted vest on a schedule determined by the Board of Directors at the time of grant. Generally, options vest over four years. All options expire no later than ten years from the date of grant. Restricted stock is subject to time vesting. There were no nonqualified stock options or shares of restricted stock granted for the three months ended March 31, 2022. There were 1,962,229 shares available for the issuance of equity awards under the 2013 Plan as of March 31, 2022.

Stock option activity under the equity plans is as follows:


				Weighted
		Weighted		Average
		Average		Remaining	Aggregate
	Number	Exercise		Contractual	Intrinsic
Total Stock Options	of Shares	Price		Life (Years)	Value
Outstanding at January 1, 2022	2,584,632	$	10.00
Exercised	68,009	$	5.90
Forfeited or expired	(14,969)	$	11.16
Outstanding at March 31, 2022	2,501,654	$	10.10	5.29	$	5,248,759
Vested or expected to vest	2,351,555			5.29	$	4,933,833
Exercisable at March 31, 2022	1,987,706			4.47	$	4,903,446

Information related to the equity plans for the periods indicated:


	Three Months Ended
	March 31,
	2022		2021
Intrinsic value of options exercised	$	415,117	$	167,420
Cash received from option exercise	$	401,136	$	319,862
Tax benefit (expense) realized from option exercises	$	31,971	$	(1,539)

As of March 31, 2022, there was $965,000 of total unrecognized compensation cost related to nonvested stock options granted under the equity plans. That cost is expected to be recognized over a weighted-average period of approximately 2.46 years.

Restricted stock activity under the equity plans is as follows:


		Weighted
		Average Grant
	Number	Date Fair
Total Restricted Stock Award	of Shares	Value
Nonvested shares at January 1, 2022	298,566	$	11.03
Vested	(4,255)	$	11.75
Nonvested shares at March 31, 2022	294,311	$	12.24

As of March 31, 2022, there was $1,638,000 of total unrecognized compensation cost related to nonvested restricted stock awards granted under the equity plans. The cost is expected to be recognized over a weighted-average period of approximately 1.68 years.

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11) Subordinated Debt

On May 26, 2017, the Company completed an underwritten public offering of $40,000,000 aggregate principal amount of its fixed-to-floating rate subordinated notes (“Subordinated Debt”) due June 1, 2027. The Subordinated Debt initially bears a fixed interest rate of 5.25% per year. Commencing on June 1, 2022, the interest rate on the Subordinated Debt resets quarterly to the three-month LIBOR rate plus a spread of 336.5 basis points, payable quarterly in arrears. Interest on the Subordinated Debt is payable semi-annually on June 1st and December 1st of each year through June 1, 2022 and quarterly thereafter on March 1st, June 1st, September 1st and December 1st of each year through the maturity date or early redemption date. The Subordinated Debt, net of unamortized issuance costs of $13,000, totaled $39,987,000 at March 31, 2022. The Company, at its option, may redeem the Subordinated Debt, in whole or in part, on any interest payment date on or after June 1, 2022 without a premium.

12) Capital Requirements

The Company and its subsidiary bank are subject to various regulatory capital requirements administered by the banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements and operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and HBC must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

The Company’s consolidated capital ratios and the HBC’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at March 31, 2022. There are no conditions or events since March 31, 2022, that management believes have changed the categorization of the Company or HBC as “well-capitalized.”

As permitted by the interim final rule issued on March 27, 2020 by our federal regulatory agency, we elected the option to delay the estimated impact of the adoption of the CECL Standard in our regulatory capital for two years. This two-year delay is in addition to the three-year transition period the agency had already made available. The adoption delayed the effects of CECL on our regulatory capital through the end of 2021. The effects are being phased-in over a three-year period from January 1, 2022 through December 31, 2024, with 75% recognized in 2022, 50% recognized in 2023, and 25% recognized in 2024. Under the interim final rule, the amount of adjustments to regulatory capital deferred until the phase-in period includes both the initial impact of adoption of the CECL Standard at January 1, 2020 and 25% of subsequent changes in our allowance for credit losses during each quarter of the two-year period ending December 31, 2021.

Quantitative measures established by regulation to help ensure capital adequacy require the Company and HBC to maintain minimum amounts and ratios (set forth in the tables below) of total, Tier 1 capital, and common equity Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes that, as of March 31, 2022 and December 31, 2021, the Company and HBC met all capital adequacy guidelines to which they were subject.

The Company’s consolidated capital amounts and ratios are presented in the following table, together with capital adequacy requirements, under the Basel III regulatory requirements for the periods indicated:

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					Required For
					Capital
					Adequacy
					Purposes
	Actual				Under Basel III
	Amount		Ratio		Amount		Ratio⁽¹⁾

	(Dollars in thousands)
As of March 31, 2022
Total Capital	$	513,272	14.6	%	$	370,203	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	438,203	12.4	%	$	299,688	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	438,203	12.4	%	$	246,802	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	438,203	8.3	%	$	210,246	4.0	%
(to average assets)

(1)	Includes 2.5% capital conservation buffer, except the Tier 1 Capital to average assets ratio.


					Required For
					Capital
					Adequacy
					Purposes
	Actual				Under Basel III
	Amount		Ratio		Amount		Ratio⁽¹⁾

		(Dollars in thousands)
As of December 31, 2021
Total Capital	$	506,209	14.4	%	$	369,711	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	433,488	12.3	%	$	299,290	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	433,488	12.3	%	$	246,474	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	433,488	7.9	%	$	220,193	4.0	%
(to average assets)

(2)	Includes 2.5% capital conservation buffer, except the Tier 1 Capital to average assets ratio.

HBC’s actual capital amounts and ratios are presented in the following table, together with capital adequacy requirements, under the Basel III regulatory requirements for the periods indicated:


									Required For
									Capital
					To Be Well-Capitalized				Adequacy
					Under Basel III PCA Regulatory				Purposes
	Actual				Requirements				Under Basel III
	Amount		Ratio		Amount		Ratio		Amount		Ratio⁽¹⁾

	(Dollars in thousands)
As of March 31, 2022
Total Capital	$	491,349	13.9	%	$	352,436	10.0	%	$	370,058	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	456,267	12.9	%	$	281,949	8.0	%	$	299,571	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	456,267	12.9	%	$	229,084	6.5	%	$	246,705	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	456,267	8.7	%	$	262,709	5.0	%	$	210,167	4.0	%
(to average assets)

(1)	Includes 2.5% capital conservation buffer, except the Tier 1 Capital to average assets ratio.

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									Required For
									Capital
					To Be Well-Capitalized				Adequacy
					Under Basel III PCA Regulatory				Purposes
	Actual				Requirements				Under Basel III
	Amount		Ratio		Amount		Ratio		Amount		Ratio⁽¹⁾

		(Dollars in thousands)
As of December 31, 2021
Total Capital	$	484,382	13.8	%	$	351,839	10.0	%	$	369,431	10.5	%
(to risk-weighted assets)
Tier 1 Capital	$	451,586	12.8	%	$	281,471	8.0	%	$	299,063	8.5	%
(to risk-weighted assets)
Common Equity Tier 1 Capital	$	451,586	12.8	%	$	228,695	6.5	%	$	246,287	7.0	%
(to risk-weighted assets)
Tier 1 Capital	$	451,586	8.2	%	$	275,109	5.0	%	$	220,087	4.0	%
(to average assets)

(1)	Includes 2.5% capital conservation buffer, except the Tier 1 Capital to average assets ratio.

The Subordinated Debt, net of unamortized issuance costs, totaled $39,987,000 at March 31, 2022, and qualifies as Tier 2 capital for the Company under the guidelines established by the Federal Reserve Bank.

Under California General Corporation Law, the holders of common stock are entitled to receive dividends when and as declared by the Board of Directors, out of funds legally available. The California Financial Code provides that a state licensed bank may not make a cash distribution to its shareholders in excess of the lesser of the following: (i) the bank’s retained earnings; or (ii) the bank’s net income for its last three fiscal years, less the amount of any distributions made by the bank to its shareholders during such period. However, a bank, with the prior approval of the Commissioner of the California Department of Financial Protection and Innovation (“DFPI”) may make a distribution to its shareholders of an amount not to exceed the greater of (i) a bank’s retained earnings; (ii) its net income for its last fiscal year; or (iii) its net income for the current fiscal year. Also with the prior approval of the Commissioner of the DFPI and the shareholders of the bank, the bank may make a distribution to its shareholders, as a reduction in capital of the bank. In the event that the Commissioner determines that the shareholders’ equity of a bank is inadequate or that the making of a distribution by a bank would be unsafe or unsound, the Commissioner may order a bank to refrain from making such a proposed distribution. As March 31, 2022, HBC would not be required to obtain regulatory approval, and the amount available for cash dividends is $41,140,000. HBC distributed to HCC dividends of $8,000,000, during the first quarter of 2022.

13) Commitments and Loss Contingencies

Loss Contingencies

Within the ordinary course of our business, we are subject to private lawsuits, government audits, administrative proceedings and other claims. A number of these claims may exist at any given time, and some of the claims may be pled as class actions. We could be affected by adverse publicity and litigation costs resulting from such allegations, regardless of whether they are valid or whether we are legally determined to be liable. A summary of proceedings outstanding at March 31, 2022 follows:

●

In January and February 2019, Double Jump, Inc. and a number of its affiliates (collectively, the “DC Solar Debtors”) each commenced bankruptcy cases in the United States Bankruptcy Court of Nevada. The chapter 7 trustee of the DC Solar Debtors had indicated that it may bring an adversary action against the Bank related to our former deposit relationships with the DC Solar Debtors and their sponsored investment funds. The Bank entered into a settlement agreement, dated July 7, 2021 with the trustee. The Bank settled all claims of the trustee against the Bank, its affiliates, past and current employees, including all direct and derivative claims arising out of the Bank’s allegedly negligent handling, supervision and management of depository accounts that were maintained for the DC Solar Debtors and related investment funds. The Bank denied all liability. The Bank received a full and complete release of the trustee’s claims. The Bank considers the settlement to be an insured event subject to reimbursement by liability insurance. The Bank reserved $4,000,000 toward the settlement amount in the second quarter of 2021, and the full settlement payment was made on October 26, 2021. The Bank

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is pursuing recovery of the $4,000,000 settlement amount plus $1,000,000 of legal costs and interest from an insurance carrier. All legal fees incurred in connection with the trustee action and the settlement agreement have been expensed to date.

●

In December 2020, Solar Eclipse Investment Fund III, et al v. Heritage Bank of Commerce, et al., was filed against the Bank, and others, in the Solano County Superior Court for the State of California. The case relates to the Bank’s former deposit relationships with investment funds sponsored by D.C. Solar and affiliates (collectively “D.C. Solar”). D.C. Solar is a former customer that allegedly perpetrated a Ponzi scheme and declared bankruptcy. In October 2021, the court sustained the Bank’s demurrer without leave to amend on all but 2 counts. Subsequently, the plaintiffs sought to overturn the court’s ruling in favor of the Bank by filing a petition for a writ of mandate in the California Court of Appeals, where the petition is pending as of the date of this report. We intend to vigorously defend this action.

●

In December 2021, East West Bank, et al. v. Heritage Bank of Commerce was filed against the Bank and one of its former employees in the Solano County Superior Court for the State of California. The case arose out of the Bank’s former deposit relationship with D.C. Solar and its sponsored investment funds. In March 2022, the plaintiffs dismissed its case against the Bank and its former employee.

●

In December 2020, Solarmore Management Services, Inc. v. Jeff Carpoff et al., (“Solarmore”) was filed as an amended complaint in the United States District Court for the Eastern District of California against the Bank, a former employee and other unrelated parties. The case arose out of the Bank’s former deposit relationship with D.C. Solar and its sponsored investment funds. On February 4, 2022, Solarmore voluntarily dismissed the Bank without prejudice, but not the Bank’s former employee. The Bank’s former employee remains a party to the action.

●

In November 2020, a former and a then-current bank employee purporting to represent a class of Bank employees, alleged in a lawsuit that the Bank violated the California Labor Code and California Business and Professions Code, by failing to permit required meal and rest breaks, and by failing to provide accurate wage statements, among other claims. The lawsuit seeks unspecified penalties under the California Private Attorneys General Act (“PAGA”) in addition to other monetary payments. Because the class/PAGA action alleges wage and hour claims, it is not covered by the Bank’s insurance.

●

In February 2021, the Bank was notified of a set of PAGA and potential class claims alleged by letter to the California Labor and Workforce Development Agency transmitted on behalf of a third claimant, who was also a former Bank employee. The notice to the California Labor and Workforce Development Agency, which is a prerequisite to a PAGA filing, alleged the same claims, class, and relief requests that are the subject of the lawsuit filed in November 2020, and disclosed no new claims. The third employee/claimant is being added as a plaintiff to the previously filed class/PAGA action.

●

In October 2021 the third employee/claimant filed a lawsuit alleging race, color, gender, and sex discrimination; disability discrimination; discrimination against an employee making a CFRA claim, violation of the Equal Pay Act, retaliation, and related claims. We intend to vigorously defend the filed class and PAGA complaint, and the action filed by the third employee/claimant.

The Company makes a provision for a liability relating to legal matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter. The outcomes of legal proceedings and other contingencies are, however, inherently unpredictable and subject to significant uncertainties. As a result, the Company is not able to reasonably estimate the amount or range of possible losses, including losses that could arise as a result of application of non-monetary remedies, with respect to the contingencies it faces, and the Company’s estimates may not prove to be accurate.

At this time, we believe that the amount of reasonably possible losses resulting from final disposition of any pending lawsuits, audits, proceedings and claims will not have a material adverse effect individually or in the aggregate on our financial position, results of operations or liquidity. It is possible, however, that our future results of operations for

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a particular quarter or fiscal year could be impacted by changes in circumstances relating to lawsuits, proceedings or claims. Legal costs related to such claims are expensed as incurred.

Off-Balance Sheet Arrangements

In the normal course of business the Company makes commitments to extend credit to its customers as long as there are no violations of any conditions established in the contractual arrangements. These commitments are obligations that represent a potential credit risk to the Company, but are not reflected on the Company’s consolidated balance sheets. Total unused commitments to extend credit were $1,154,361,000 at March 31, 2022, and $1,150,811,000 at December 31, 2021. Unused commitments represented 38% outstanding gross loans at March 31, 2022, 40% at March 31, 2021, and 37% at December 31, 2021.

The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted because there is no certainty that lines of credit and letters of credit will ever be fully utilized. The following table presents the Company’s commitments to extend credit for the periods indicated:


	March 31, 2022						December 31, 2021
	Fixed		Variable				Fixed		Variable
	Rate		Rate		Total		Rate		Rate		Total

	(Dollars in thousands)
Unused lines of credit and commitments
to make loans	$	114,333	$	1,027,606	$	1,141,939	$	119,071	$	1,015,588	$	1,134,659
Standby letters of credit		3,058		9,364		12,422		3,084		13,068		16,152
	$	117,391	$	1,036,970	$	1,154,361	$	122,155	$	1,028,656	$	1,150,811

For the three months ended March 31, 2022, there was a decrease of $40,000 to the allowance for credit losses on the Company’s off-balance sheet credit exposures. The decrease in the allowance for credit losses for off-balance sheet credit exposures in the first three months of 2022 was driven by lower loss factors as a result of improving economic outlook. The allowance for credit losses on the Company’s off-balance sheet credit exposures was $775,000 at March 31, 2022 and $815,000 at December 31, 2021.

14) Revenue Recognition

On January 1, 2018, the Company adopted ASU No. 2014-09 (Topic 606) and all subsequent ASUs that modified Topic 606. Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, gain on sale of securities, bank-owned life insurance, gain on sales of SBA loans, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, and merchant income. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. The following noninterest income revenue streams are in-scope of Topic 606:

Service charges and fees on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. We sometimes charge customers fees that are not specifically related to the customer accessing its funds, such as account maintenance or dormancy fees. The amount of deposit fees assessed varies based on a number of factors, such as the type of customer and account, the quantity of transactions, and the size of the deposit balance. We charge, and in some circumstances do not charge, fees to earn additional revenue and influence certain customer behavior. An example would be where we do not charge a monthly service fee, or do not charge for certain transactions, for customers that have a high deposit balance. Deposit fees are considered either transactional in nature (such as wire transfers, nonsufficient fund fees, and stop payment orders) or non-transactional (such as account maintenance and dormancy fees). These fees are recognized as earned or as transactions occur and services are provided. Check orders and other deposit account related fees are largely transactional based and, therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

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The Company currently accounts for sales of foreclosed assets in accordance with Topic 360-20. In most cases the Company will seek to engage a real estate agent for the sale of foreclosed assets immediately upon foreclosure. However, in some cases, where there is clear demand for the property in question, the Company may elect to allow for a marketing period on no more than six months to attempt a direct sale of the property. We generally recognize the sale, and any associated gain or loss, of a real estate property when control of the property transfers. Any gains or losses from the sale are recorded to noninterest income/expense.

The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the periods indicated:


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands)
Noninterest Income In-scope of Topic 606:
Service charges and fees on deposit accounts	$	612	$	601
Total noninterest income in-scope of Topic 606		612		601
Noninterest Income Out-of-scope of Topic 606		1,848		1,700
Total noninterest income	$	2,460	$	2,301

15) Noninterest Expense

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


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands)
Salaries and employee benefits	$	13,821	$	13,958
Occupancy and equipment		2,437		2,274
Professional fees		1,080		1,719
Insurance expense		1,043		663
Amortization of intangible assets		659		733
Data processing		651		534
Federal Deposit Insurance Corporation ("FDIC") assessments		479		146
Other		3,082		3,217
Total noninterest expense	$	23,252	$	23,244

16) Leases

The Company recognizes the following for all leases, at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. The Company is impacted as a lessee of the offices and real estate used for operations. The Company's lease agreements include options to renew at the Company's option. No lease extensions are reasonably certain to be exercised, therefore it was not considered in the calculation of the ROU asset and lease liability. As of March 31, 2022, operating lease ROU assets, included in other assets, and lease liabilities, included in other liabilities, totaled $33,669,000.

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The following table presents the quantitative information for the Company’s leases for the periods indicated:


		Three Months Ended
		March 31,
		2022		2021

	(Dollars in thousands)
Operating Lease Cost (Cost resulting from lease payments)	$	1,620	$	1,671
Operating Lease - Operating Cash Flows (Fixed Payments)	$	1,210	$	1,186
Operating Lease - ROU assets	$	33,669	$	37,405
Operating Lease - Liabilities	$	33,669	$	37,405
Weighted Average Lease Term - Operating Leases		7.19 years		8.17 years
Weighted Average Discount Rate - Operating Leases		4.49%		4.49%

The following maturity analysis shows the undiscounted cash flows due on the Company’s operating lease liabilities as of March 31, 2022:


	(Dollars in thousands)
2022	$	4,769
2023		5,724
2024		5,341
2025		4,929
2026		4,357
Thereafter		14,654
Total undiscounted cash flows		39,774
Discount on cash flows		(6,105)
Total lease liability	$	33,669

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17) Business Segment Information

The following presents the Company’s operating segments. The Company operates through 2 business segments: Banking segment and Factoring segment. Transactions between segments consist primarily of borrowed funds. Intersegment interest expense is allocated to the Factoring segment based on the Company’s prime rate and funding costs. The provision for credit losses on loans is allocated based on the segment’s allowance for loan loss determination which considers the effects of charge-offs. Noninterest income and expense directly attributable to a segment are assigned to it. Taxes are paid on a consolidated basis and allocated for segment purposes. The Factoring segment includes only factoring originated by Bay View Funding.


	Three Months Ended March 31, 2022
	Banking⁽¹⁾		Factoring		Consolidated

	(Dollars in thousands)

Interest income	$	37,113	$	2,793	$	39,906
Intersegment interest allocations		237		(237)		—
Total interest expense		1,685		—		1,685
Net interest income		35,665		2,556		38,221
Provision for (recapture of) credit losses on loans		(539)		(28)		(567)
Net interest income after provision		36,204		2,584		38,788
Noninterest income		2,398		62		2,460
Noninterest expense		21,767		1,485		23,252
Intersegment expense allocations		114		(114)		—
Income before income taxes		16,949		1,047		17,996
Income tax expense		4,821		309		5,130
Net income	$	12,128	$	738	$	12,866

Total assets	$	5,352,709	$	74,689	$	5,427,398
Loans, net of deferred fees	$	2,962,823	$	61,241	$	3,024,064
Goodwill	$	154,587	$	13,044	$	167,631

(1) Includes the holding company’s results of operations


	Three Months Ended March 31, 2021
	Banking⁽¹⁾		Factoring		Consolidated

	(Dollars in thousands)
Interest income	$	34,111	$	2,650	$	36,761
Intersegment interest allocations		211		(211)		—
Total interest expense		1,803		—		1,803
Net interest income		32,519		2,439		34,958
Provision (recapture) for credit losses on loans		(1,463)		(49)		(1,512)
Net interest income after provision		33,982		2,488		36,470
Noninterest income		2,160		141		2,301
Noninterest expense		21,897		1,347		23,244
Intersegment expense allocations		106		(106)		—
Income before income taxes		14,351		1,176		15,527
Income tax expense		3,975		348		4,323
Net income	$	10,376	$	828	$	11,204

Total assets	$	4,933,350	$	68,040	$	5,001,390
Loans, net of deferred fees	$	2,656,178	$	48,529	$	2,704,707
Goodwill	$	154,587	$	13,044	$	167,631

(1) Includes the holding company’s results of operations

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18) Subsequent Events

On April 28, 2022, the Company announced that its Board of Directors declared a $0.13 per share quarterly cash dividend to holders of common stock. The dividend will be payable on May 26, 2022, to shareholders of record at the close of the business day on May 12, 2022.

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ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of Heritage Commerce Corp (the “Company” or “HCC”), its wholly-owned subsidiary, Heritage Bank of Commerce (“HBC” or the “Bank”), and HBC’s wholly-owned subsidiary, CSNK Working Capital Finance Corp., a California Corporation, dba Bay View Funding (“Bay View Funding”). This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of operations. This discussion and analysis should be read in conjunction with our consolidated financial statements and the accompanying notes presented elsewhere in this report. Unless we state otherwise or the context indicates otherwise, references to the “Company,” “Heritage,” “we,” “us,” and “our,” in this Report on Form 10-Q refer to Heritage Commerce Corp and its subsidiaries.

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are discussed in our Form 10-K for the year ended December 31, 2021. There have been no changes in the Company's application of critical accounting policies since December 31, 2021.

EXECUTIVE SUMMARY

This summary is intended to identify the most important matters on which management focuses when it evaluates the financial condition and performance of the Company. When evaluating financial condition and performance, management looks at certain key metrics and measures. The Company’s evaluation includes comparisons with peer group financial institutions and its own performance objectives established in the internal planning process.

The primary activity of the Company is commercial banking. The Company’s operations are located entirely in the general San Francisco Bay Area of California in the counties of Alameda, Contra Costa, Marin, San Benito, San Francisco, San Mateo, and Santa Clara. The Company’s market includes the cities of Oakland, San Francisco and San Jose and the headquarters of a number of technology based companies in the region known commonly as Silicon Valley. The Company’s customers are primarily closely held businesses and professionals.

Performance Overview

For the three months ended March 31, 2022, net income was $12.9 million, or $0.21 per average diluted common share, compared to $11.2 million, or $0.19 per average diluted common share, for the three months ended March 31, 2021. The Company’s annualized return on average tangible assets was 0.99% and annualized return on average tangible equity was 12.47% for the three months ended March 31, 2022, compared to 0.99% and 11.50%, respectively, for the three months ended March 31, 2021.

Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”)

In response to economic stimulus laws passed by Congress in 2020 and 2021, the Bank funded two rounds of SBA PPP loans totaling $530.8 million. At March 31, 2022, after accounting for loan payoffs and SBA loan forgiveness, Round 1 PPP loans were $1.2 million and Round 2 PPP loans were $36.2 million. In total, the Bank had $37.4 million in outstanding PPP loan balances at March 31, 2022. The following table shows interest income, fee income and deferred origination costs generated by the PPP loans, and the PPP loan outstanding balances and related deferred fees and costs for the periods indicated:

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	At or For the Quarter Ended:
PPP LOANS	March 31,		December 31,		March 31,
(in $000’s, unaudited)	2022		2021		2021

	(Dollars in thousands)
Interest income	$	146	$	318	$	784
Fee income, net		1,346		2,211		3,401
Total	$	1,492	$	2,529	$	4,185

PPP loans outstanding at period end:
Round 1	$	1,186	$	1,717	$	170,391
Round 2		36,207		87,009		179,353
Total	$	37,393	$	88,726	$	349,744

Deferred fees outstanding at period end	$	(876)	$	(2,342)	$	(8,757)
Deferred costs outstanding at period end		69		189		1,099
Total	$	(807)	$	(2,153)	$	(7,658)

Factoring Activities - Bay View Funding

Based in San Jose, California, Bay View Funding provides business-essential working capital factoring financing to various industries throughout the United States. The following table reflects selected financial information for Bay View Funding for the periods indicated:


	March 31,		March 31,
	2022		2021

	(Dollars in thousands)
Total factored receivables at period-end	$	61,241	$	48,529
Average factored receivables:
For the three months ended	$	57,761	$	48,094
Total full time equivalent employees at period-end		30		30

First Quarter 2022 Highlights

The following are important factors that impacted the Company’s results of operations:

●

Net interest income, before provision for credit losses on loans, increased 9% to $38.2 million for the first quarter of 2022, compared to $35.0 million for the first quarter of 2021, primarily due to higher average balances of loans and investment securities, higher average yields on investment securities and overnight funds, and a lower cost of funds, partially offset by lower interest and fees on PPP loans, and a decrease in the accretion of the loan purchase discount into interest income from acquired loans.

●

The fully tax equivalent (“FTE”) net interest margin contracted 17 basis points to 3.05% for the first quarter of 2022, from 3.22% for the first quarter of 2021, primarily due to a decline in the average yield on loans, lower interest and fees on PPP loans, and a decrease in the accretion of the loan purchase discount into interest income from acquired loans, partially offset by increases in the average yields on investment securities and overnight funds, and a decline in the cost of funds.

●

The FTE net interest margin increased 21 basis points to 3.05% for the first quarter of 2022 from 2.84% for the fourth quarter of 2021, primarily due to a shift in the mix of earning assets as the Company invested its excess liquidity into higher yielding loans and investment securities, higher average yields on overnight funds, and a slightly lower cost of funds, partially offset by lower interest and fees on PPP loans, lower average balances of factored receivables, and a decrease in the accretion of the loan purchase discount into interest income from acquired loans.

●

The average yield on the total loan portfolio decreased to 4.70% for the first quarter of 2022, compared to 5.24% for the first quarter of 2021, primarily due to lower fees on PPP loans, higher average balances of lower yielding purchased residential mortgages, declines in the average yields of the core bank and asset-based lending and Bay View Funding factored receivables, and a decrease in the accretion of the loan purchase discount into interest income from acquired loans.

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●

In aggregate, the original total net purchase discount on loans from the Focus Business Bank (“Focus”), Tri-Valley Bank (“Tri-Valley”), United American Bank (“United American”), and Presidio Bank (“Presidio”) loan portfolios was $25.2 million. In aggregate, the remaining net purchase discount on total loans acquired was $6.6 million at March 31, 2022.

●

The average cost of total deposits was 0.10% for the first quarter of 2022, compared to 0.12% for the first quarter of 2021.

●

There was a $567,000 negative provision credit losses on loans for the first quarter of 2022, primarily due to recoveries on previously charged-off loans, improved economic forecasts and reductions in specific reserves on impaired loans, compared to a $1.5 million negative provision for credit losses on loans for the first quarter of 2021.

●

Total noninterest income increased to $2.5 million for the first quarter of 2022, compared to $2.3 million for the first quarter of 2021, primarily due to a realized gain on warrants of $637,000, partially offset by a lower gain on the sale of SBA loans during the first quarter of 2022.

●

Total noninterest expense for the first quarter of 2022 was relatively flat at $23.3 million, compared to $23.2 million for the first quarter of 2021, as higher insurance expense and Federal Deposit Insurance Corporation (“FDIC”) assessments were offset by lower professional fees during the first quarter of 2022.

●

The efficiency ratio for the first quarter of 2022 was 57.16%, compared to 62.38% for the first quarter of 2021.

●

Income tax expense for the first quarter of 2022 was $5.1 million, compared to $4.3 million for the first quarter of 2021. The effective tax rate for the first quarter of 2022 was 28.5%, compared to 27.8% for the first quarter of 2021.

The following are important factors in understanding our current financial condition and liquidity position:

●

Cash, other investments and interest-bearing deposits in other financial institutions and securities available-for-sale, at fair value, decreased (19%) to $1.328 billion at March 31, 2022, from $1.640 billion at March 31, 2021, and decreased (6%) from $1.408 billion at December 31, 2021.

●

At March 31, 2022, securities held-to-maturity, at amortized cost, totaled $736.8 million, compared to $306.5 million at March 31, 2021, and $658.4 million, at December 31, 2021.

●

Total loans at March 31, 2022 included $37.4 million of PPP loans, compared to $349.7 million at March 31, 2021 and $88.7 million at December 31, 2021. Total loans at March 31, 2022 included $391.2 million of residential mortgages, compared to $82.2 million at March 31, 2021, and $416.7 million at December 31, 2021.

●

Nonperforming assets (“NPAs”) were $3.8 million, or 0.07% of total assets, at March 31, 2022, compared to $5.6 million, or 0.11% of total assets, at March 31, 2021, and $3.7 million, or 0.07% of total assets, at December 31, 2021.

●

Classified assets were $30.6 million, or 0.56% of total assets, at March 31, 2022, compared to $33.4 million, or 0.67% of total assets, at March 31, 2021, and $33.7 million, or 0.61% of total assets, at December 31, 2021.

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●

Net recoveries totaled $65,000 for the first quarter of 2022, compared to net recoveries of $1.4 million for the first quarter of 2021, and net recoveries of $225,000 for the fourth quarter of 2021.

●

The allowance for credit losses on loans (“ACLL”) at March 31, 2022 was $42.8 million, or 1.41% of total loans, representing 1,117.18% of total nonperforming loans. The ACLL at March 31, 2021 was $44.3 million, or 1.64% of total loans, representing 791.99% of total nonperforming loans. The ACLL at December 31, 2021 was $43.3 million, or 1.40% of total loans, representing 1,158.11% of total nonperforming loans. The ACLL to total loans, excluding PPP loans, was 1.43% at March 31, 2022, 1.87% at March 31, 2021, and 1.44% at December 31, 2021.

●

Total deposits increased $410.8 million, or 10%, to $4.690 billion at March 31, 2022, compared to $4.279 billion at March 31, 2021, and decreased ($69.5) million, or (1%), from $4.759 billion at December 31, 2021. The decrease in total deposits at March 31, 2022, compared to December 31, 2021, was primarily due to a decline in temporary deposits from two customers. The deposits from those two customers decreased ($73.8) million to $194.8 million at March 31, 2022, compared to $268.6 million at December 31, 2021. The Company expects further decreases in the deposits of those two customers in the second quarter of 2022.

●

Deposits, excluding all time deposits and CDARS deposits, increased $423.0 million, or 10%, to $4.528 billion at March 31, 2022, compared to $4.105 billion at March 31, 2021, and decreased ($59.4) million, or (1%), compared to $4.588 billion at December 31, 2021.

●

The ratio of noncore funding (which consists of time deposits of $250,000 and over, CDARS deposits, brokered deposits, securities under an agreement to repurchase, subordinated debt, and short-term borrowings) to total assets was 3.01% at March 31, 2022, compared to 3.42% at March 31, 2021, and 3.14% at December 31, 2021.

●

The loan to deposit ratio was 64.48% at March 31, 2022, compared to 63.21% at March 31, 2021, and 64.87% at December 31, 2021.

●

The Company’s consolidated capital ratios exceeded regulatory guidelines and the HBC’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at March 31, 2022.




							Well-capitalized
	Heritage			Heritage			Financial Institution			Basel III Minimum
	Commerce			Bank of			Basel III PCA Regulatory			Regulatory
Capital Ratios	Corp			Commerce			Guidelines			Requirement(1)
Total Capital		14.6	%		13.9	%		10.0	%		10.5	%
Tier 1 Capital		12.4	%		12.9	%		8.0	%		8.5	%
Common Equity Tier 1 Capital		12.4	%		12.9	%		6.5	%		7.0	%
Tier 1 Leverage		8.3	%		8.7	%		5.0	%		4.0	%

(1)	Basel III minimum regulatory requirements for both HCC and HBC include a 2.5% capital conservation buffer, except the leverage ratio.

RESULTS OF OPERATIONS

The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on interest-bearing liabilities. The second is noninterest income, which primarily consists of gains on the sale of loans, loan servicing fees, customer service charges and fees, the increase in the cash surrender value of life insurance, and gains on the sale of securities. The majority of the Company’s noninterest expenses are operating costs that relate to providing a full range of banking and lending services to our customers.

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Net Interest Income and Net Interest Margin

The level of net interest income depends on several factors in combination, including yields on earning assets, the cost of interest-bearing liabilities, the relative volumes of earning assets and interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. To maintain its net interest margin the Company must manage the relationship between interest earned and paid.

The following Distribution, Rate and Yield table presents the average amounts outstanding for the major categories of the Company’s balance sheet, the average interest rates and amounts earned or paid thereon, and the resulting net interest margin on average interest earning assets for the periods indicated. Average balances are based on daily averages.

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Distribution, Rate and Yield


	Three Months Ended						Three Months Ended
	March 31, 2022						March 31, 2021
			Interest		Average				Interest		Average
	Average		Income /		Yield /		Average		Income /		Yield /
	Balance		Expense		Rate		Balance		Expense		Rate

	(Dollars in thousands)
Assets:
Loans, gross ⁽¹⁾⁽²⁾	$	3,028,589	$	35,101	4.70	%	$	2,620,334	$	33,836	5.24	%
Securities — taxable		781,689		3,444	1.79	%		436,858		1,728	1.60	%
Securities — exempt from Federal tax⁽³⁾		44,871		376	3.40	%		66,513		542	3.30	%
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		1,238,702		1,064	0.35	%		1,296,258		768	0.24	%
Total interest earning assets		5,093,851		39,985	3.18	%		4,419,963		36,874	3.38	%
Cash and due from banks		37,630						40,823
Premises and equipment, net		9,605						10,369
Goodwill and other intangible assets		181,065						184,017
Other assets		121,089						118,706
Total assets	$	5,443,240					$	4,773,878
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing	$	1,857,164					$	1,712,903

Demand, interest-bearing		1,279,989		459	0.15	%		1,026,210		479	0.19	%
Savings and money market		1,394,734		543	0.16	%		1,137,837		572	0.20	%
Time deposits — under $100		13,235		5	0.15	%		15,900		9	0.23	%
Time deposits — $100 and over		119,082		106	0.36	%		130,843		171	0.53	%
CDARS — interest-bearing demand, money
market and time deposits		32,932		1	0.01	%		25,260		1	0.02	%
Total interest-bearing deposits		2,839,972		1,114	0.16	%		2,336,050		1,232	0.21	%
Total deposits		4,697,136		1,114	0.10	%		4,048,953		1,232	0.12	%

Subordinated debt, net of issuance costs		39,951		571	5.80	%		39,757		571	5.82	%
Short-term borrowings		29		—	0.00	%		44		—	0.00	%
Total interest-bearing liabilities		2,879,952		1,685	0.24	%		2,375,851		1,803	0.31	%
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds		4,737,116		1,685	0.14	%		4,088,754		1,803	0.18	%
Other liabilities		106,769						105,967
Total liabilities		4,843,885						4,194,721
Shareholders’ equity		599,355						579,157
Total liabilities and shareholders’ equity	$	5,443,240					$	4,773,878

Net interest income / margin				38,300	3.05	%				35,071	3.22	%
Less tax equivalent adjustment				(79)						(113)
Net interest income			$	38,221					$	34,958

(1)	Includes loans held-for-sale. Nonaccrual loans are included in average balance.

(2)

Yield amounts earned on loans include fees and costs. The accretion of net deferred loan fees into loan interest income was $1,788,000 for the first quarter of 2022 (of which $1,346,000 was from PPP loans), compared to $3,689,000 for the first quarter of 2021 (of which $3,401,000 was from PPP loans). Prepayment fees totaled $510,000 for the first quarter of 2022, compared to $517,000 for the first quarter of 2021.

(3)	Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 21% tax rate.

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Volume and Rate Variances

The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance times the prior period rate, and rate variances are equal to the increase or decrease in the average rate times the prior period average balance. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance and are included below in the average volume column.


	Three Months Ended March 31,
	2022 vs. 2021
	Increase (Decrease)
	Due to Change in:
	Average		Average		Net
	Volume		Rate		Change

	(Dollars in thousands)
Income from the interest earning assets:
Loans, gross	$	4,734	$	(3,469)	$	1,265
Securities — taxable		1,516		200		1,716
Securities — exempt from Federal tax⁽¹⁾		(182)		16		(166)
Other investments, interest-bearing deposits
in other financial institutions and Federal funds sold		(55)		351		296
Total interest income on interest-earning assets		6,013		(2,902)		3,111

Expense from the interest-bearing liabilities:
Demand, interest-bearing		79		(99)		(20)
Savings and money market		94		(123)		(29)
Time deposits — under $100		(1)		(3)		(4)
Time deposits — $100 and over		(10)		(55)		(65)
CDARS — interest-bearing demand, money market
and time deposits		—		—		—
Subordinated debt, net of issuance costs		2		(2)		—
Short-term borrowings		—		—		—
Total interest expense on interest-bearing liabilities		164		(282)		(118)
Net interest income	$	5,849	$	(2,620)		3,229
Less tax equivalent adjustment						34
Net interest income					$	3,263

(1)	Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 21% tax rate.

The Company’s FTE net interest margin, expressed as a percentage of average earning assets, contracted 17 basis points to 3.05% for the first quarter of 2022, from 3.22% for the first quarter of 2021, primarily due to a decline in the average yield on loans, lower interest and fees on PPP loans, and a decrease in the accretion of the loan purchase discount into interest income from acquired loans, partially offset by increases in the average yields on investment securities and overnight funds, and a decline in the cost of funds. The FTE net interest margin increased 21 basis points to 3.05% for the first quarter of 2022 from 2.84% for the fourth quarter of 2021, primarily due to a shift in the mix of earning assets as the Company invested its excess liquidity into higher yielding loans and investment securities, higher average yields on overnight funds, and a slightly lower cost of funds, partially offset by lower interest and fees on PPP loans, lower average balances of factored receivables, and a decrease in the accretion of the loan purchase discount into interest income from acquired loans.

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The following tables present the average balance of loans outstanding, interest income, and the average yield for the periods indicated:


	For the Quarter Ended						For the Quarter Ended
	March 31, 2022						March 31, 2021
	Average		Interest		Average		Average		Interest		Average
	Balance		Income		Yield		Balance		Income		Yield

	(Dollars in thousands)
Loans, core bank and asset-based lending	$	2,553,325	$	27,047	4.30	%	$	2,225,342	$	25,064	4.57	%
Prepayment fees		—		510	0.08	%		—		517	0.09	%
PPP loans		60,264		146	0.98	%		319,168		784	1.00	%
PPP fees, net		—		1,346	9.06	%		—		3,401	4.32	%
Bay View Funding factored receivables		57,761		2,793	19.61	%		48,094		2,650	22.35	%
Residential mortgages		355,626		2,428	2.77	%		22,194		119	2.17	%
Purchased commercial ("CRE") loans		8,514		77	3.67	%		17,162		172	4.06	%
Loan fair value mark / accretion		(6,901)		754	0.12	%		(11,626)		1,129	0.21	%
Total loans (includes loans held-for-sale)	$	3,028,589	$	35,101	4.70	%	$	2,620,334	$	33,836	5.24	%


	For the Quarter Ended						For the Quarter Ended
	March 31, 2022						December 31, 2021
	Average		Interest		Average		Average		Interest		Average
	Balance		Income		Yield		Balance		Income		Yield

	(Dollars in thousands)
Loans, core bank and asset-based lending	$	2,553,325	$	27,047	4.30	%	$	2,496,026	$	27,167	4.32	%
Prepayment fees		—		510	0.08	%		—		397	0.06	%
PPP loans		60,264		146	0.98	%		127,592		318	0.99	%
PPP fees, net		—		1,346	9.06	%		—		2,211	6.87	%
Bay View Funding factored receivables		57,761		2,793	19.61	%		62,571		3,248	20.59	%
Residential mortgages		355,626		2,428	2.77	%		188,731		1,437	3.02	%
Purchased CRE loans		8,514		77	3.67	%		8,929		69	3.07	%
Loan fair value mark / accretion		(6,901)		754	0.12	%		(7,728)		915	0.15	%
Total loans (includes loans held-for-sale)	$	3,028,589	$	35,101	4.70	%	$	2,876,121	$	35,762	4.93	%

The average yield on the total loan portfolio decreased to 4.70% for the first quarter of 2022, compared to 4.93% for the fourth quarter of 2021, primarily due to lower fees on PPP loans, lower average balances and average yields on factored receivables, and a decrease in the accretion of the loan purchase discount into interest income from acquired loans. The loss of income from the lower average yield on the loan portfolio was offset by the purchase of residential mortgage loans late in the fourth quarter of 2021 and organic loan growth resulting in a higher average balance of loans for the first quarter of 2022.

In aggregate, the original total net purchase discount on loans from the Focus, Tri-Valley, United American, and Presidio loan portfolios was $25.2 million. In aggregate, the remaining net purchase discount on total loans acquired was $6.6 million at March 31, 2022.

The average cost of total deposits was 0.10% for the first quarter of 2022, compared to 0.12% for the first quarter of 2021.

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Provision for Credit Losses on Loans

Credit risk is inherent in the business of making loans. The Company establishes an allowance for credit losses on loans through charges to earnings, which are presented in the statements of income as the provision for credit losses on loans. Specifically identifiable and quantifiable known losses are promptly charged off against the allowance. The provision for credit losses on loans is determined by conducting a quarterly evaluation of the adequacy of the Company’s allowance for credit losses on loans and charging the shortfall or excess, if any, to the current quarter’s expense. This has the effect of creating variability in the amount and frequency of charges to the Company’s earnings. The provision for credit losses on loans and level of allowance for each period are 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. The provision for credit losses on loans and level of allowance for each period are also dependent on forecast data for the state of California including GDP and unemployment rate projections.

During the first quarter of 2022, there was a $567,000 negative provision for credit losses on loans, primarily due to recoveries of previously charged-off loans, improved economic forecasts and reductions in specific reserves on impaired loans, compared to a $1.5 negative provision for credit losses on loans for the first quarter of 2021. Provisions for credit losses on loans are charged to operations to bring the allowance for credit losses on loans to a level deemed appropriate by the Company based on the factors discussed under “Credit Quality and Allowance for Credit Losses on Loans.”

Noninterest Income



					Increase
	Three Months Ended				(decrease)
	March 31,				2022 versus 2021
	2022		2021		Amount		Percent

	(Dollars in thousands)
Gain on warrants	$	637	$	—	$	637	N/A
Service charges and fees on deposit accounts		612		601		11	2	%
Increase in cash surrender value of life insurance		480		456		24	5	%
Gain on sales of SBA loans		156		550		(394)	(72)	%
Servicing income		106		182		(76)	(42)	%
Termination fees		—		90		(90)	(100)	%
Gain on proceeds from company owned life insurance		—		66		(66)	(100)	%
Other		469		356		113	32	%
Total	$	2,460	$	2,301	$	159	7	%

A portion of the Company’s noninterest income has been associated with its SBA lending activity, as gains on the sale of loans sold in the secondary market and servicing income from loans sold with servicing rights retained. For the first quarter of 2022, SBA loan sales resulted in a $156,000 gain, compared to a $550,000 gain on sales of SBA loans for the first quarter of 2021.

The servicing assets that result from the sales of SBA loans with servicing retained are amortized over the expected term of the loans using a method approximating the interest method. Servicing income generally declines as the respective loans are repaid.

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Noninterest Expense

The following table sets forth the various components of the Company’s noninterest expense:



					Increase
	Three Months Ended				(Decrease)
	March 31,				2022 versus 2021
	2022		2021		Amount		Percent

	(Dollars in thousands)
Salaries and employee benefits	$	13,821	$	13,958	$	(137)	(1)	%
Occupancy and equipment		2,437		2,274		163	7	%
Professional fees		1,080		1,719		(639)	(37)	%
Insurance expense		1,043		663		380	57	%
Amortization of intangible assets		659		733		(74)	(10)	%
Data processing		651		534		117	22	%
FDIC assessments		479		146		333	228	%
Other		3,082		3,217		(135)	(4)	%
Total noninterest expense	$	23,252	$	23,244	$	8	0	%

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


	Three Months Ended March 31,
			Percent of				Percent of
	2022		Total		2021		Total

	(Dollars in thousands)
Salaries and employee benefits	$	13,821	59	%	$	13,958	60	%
Occupancy and equipment		2,437	11	%		2,274	10	%
Professional fees		1,080	5	%		1,719	7	%
Insurance expense		1,043	4	%		663	3	%
Amortization of intangible assets		659	3	%		733	3	%
Data processing		651	3	%		534	2	%
FDIC assessments		479	2	%		146	1	%
Other		3,082	13	%		3,217	14	%
Total noninterest expense	$	23,252	100	%	$	23,244	100	%

Total noninterest expense for the first quarter of 2022 was relatively flat at $23.3 million, compared to $23.2 million for the first quarter of 2021, as higher insurance expense and FDIC assessments were offset by lower professional fees during the first quarter of 2022.

Full time equivalent employees were 325 at both March 31, 2022 and March 31, 2021, and 326 at

December 31, 2021.

Income Tax Expense

The Company computes its provision for income taxes on a monthly basis. The effective tax rate is determined by applying the Company’s statutory income tax rates to pre-tax book income as adjusted for permanent differences between pre-tax book income and actual taxable income. These permanent differences include, but are not limited to, increases in the cash surrender value of life insurance policies, interest on tax-exempt securities, certain expenses that are not allowed as tax deductions, and tax credits.

The following table shows the Company’s effective income tax rates for the periods indicated:


	Three Months Ended
	March 31,
	2022		2021
Effective income tax rate	28.5	%	27.8	%

The difference in the effective tax rate for the periods reported compared to the combined Federal and state statutory tax rate of 29.6% is primarily the result of the Company’s investment in life insurance policies whose earnings

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are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds.

The Company’s Federal and state income tax expense for the first quarter of 2022 was $5.1 million, compared to $4.3 million for the first quarter of 2021.

Some items of income and expense are recognized in one year for tax purposes, and another when applying generally accepted accounting principles, which leads to timing differences between the Company’s actual tax liability, and the amount accrued for this liability based on book income. These temporary differences comprise the “deferred” portion of the Company’s tax expense or benefit, which is accumulated on the Company’s books as a deferred tax asset or deferred tax liability until such time as they reverse.

Realization of the Company’s deferred tax assets is primarily dependent upon the Company generating sufficient future taxable income to obtain benefit from the reversal of net deductible temporary differences and the utilization of tax credit carryforwards and the net operating loss carryforwards for Federal and state income tax purposes. The amount of deferred tax assets considered realizable is subject to adjustment in future periods based on estimates of future taxable income. Under generally accepted accounting principles a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax assets will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future income, cumulative losses, applicable tax planning strategies, and assessments of current and future economic and business conditions.

The Company had net deferred tax assets of $28.1 million at March 31, 2022, $26.2 million at March 31, 2021, and $28.8 million at December 31, 2021. After consideration of the matters in the preceding paragraph, the Company determined that it is more likely than not that the net deferred tax assets at March 31, 2022, March 31, 2021, and December 31, 2021 will be fully realized in future years.

FINANCIAL CONDITION

At March 31, 2022, total assets increased 9% to $5.427 billion, compared to $5.001 billion at March 31, 2021, and decreased (1%) from $5.499 billion at December 31, 2021.

Securities available-for-sale, at fair value, were $111.2 million at March 31, 2022, a decrease of (43%) from $196.7 million at March 31, 2021, and an increase of 9% from $102.3 million at December 31, 2021. Securities held-to-maturity, at amortized cost, were $736.8 million at March 31, 2022, an increase of 140% from $306.5 million at March 31, 2021, and an increase of 12% from $658.4 million at December 31, 2021.

Loans, excluding loans held-for-sale, increased $319.4 million, or 12%, to $3.024 billion at March 31, 2022, compared to $2.705 billion at March 31, 2021, and decreased ($63.3) million, or (2%), from $3.087 billion at December 31, 2021. The decrease in loans at March 31, 2022 from December 31, 2021, was primarily due to forgiveness of PPP loans and paydowns in the residential loan portfolio. Total loans at March 31, 2022 included $37.4 million of PPP loans, compared to $349.7 million at March 31, 2021 and $88.7 million at December 31, 2021. Total loans at March 31, 2022 included $391.2 million of residential mortgages, compared to $82.2 million at March 31, 2021, and $416.7 million at December 31, 2021.

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Securities Portfolio

The following table reflects the balances for each category of securities at the dates indicated:


	March 31,				December 31,
	2022		2021		2021

	(Dollars in thousands)
Securities available-for-sale (at fair value):
Agency mortgage-backed securities	$	89,653	$	151,509	$	102,252
U.S. Treasury		21,564		45,209		—
Total	$	111,217	$	196,718	$	102,252
Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities	$	696,161	$	242,747	$	607,377
Municipals — exempt from Federal tax		40,701		63,840		51,063
Total	$	736,862	$	306,587	$	658,440

The following table summarizes the weighted average life and weighted average yields of securities at March 31, 2022:


	Weighted Average Life
					After One and				After Five and
	Within One				Within Five				Within Ten				After Ten
	Year or Less				Years				Years				Years				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield

	(Dollars in thousands)
Securities available-for-sale (at fair value):
Agency mortgage-backed securities	$	401	2.26	%	$	89,252	2.19	%	$	—	—	%	$	—	—	%	$	89,653	2.19	%
U.S. Treasury		—	—	%		21,564	2.22	%		—	—	%		—	—	%		21,564	2.22	%
Total	$	401	2.26	%	$	110,816	2.20	%	$	—	—	%	$	—	—	%	$	111,217	2.20	%

Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities	$	—	—	%	$	132,034	1.85	%	$	455,751	1.71	%	$	108,376	2.02	%	$	696,161	1.78	%
Municipals — exempt from Federal tax (1)		26,593	3.38	%		9,922	3.53	%		3,693	3.11	%		493	3.23	%		40,701	3.39	%
Total	$	26,593	3.38	%	$	141,956	1.96	%	$	459,444	1.72	%	$	108,869	2.02	%	$	736,862	1.87	%

(1)	Reflects tax equivalent adjustment for Federal tax exempt income based on a 21% tax rate.

The securities portfolio serves the following purposes: (i) it provides a source of pledged assets for securing certain deposits and borrowed funds, as may be required by law or by specific agreement with a depositor or lender; (ii) it provides liquidity to even out cash flows from the loan and deposit activities of customers; (iii) it can be used as an interest rate risk management tool, since it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; and (iv) it is an alternative interest-earning use of funds when loan demand is weak or when deposits grow more rapidly than loans.

The Company’s portfolio may include: (i) U.S. Treasury securities and U.S. Government sponsored entities’ debt securities for liquidity and pledging; (ii) mortgage-backed securities, which in many instances can also be used for pledging, and which generally enhance the yield of the portfolio; (iii) municipal obligations, which provide tax free income and limited pledging potential; (iv) single entity issue trust preferred securities, which generally enhance the yield on the portfolio; (v) corporate bonds, which also enhance the yield on the portfolio; (vi) money market mutual funds; (vii) certificates of deposit; (viii) commercial paper; (ix) bankers acceptances; (x) repurchase agreements; (xi) collateralized mortgage obligations; and (xii) asset-backed securities.

The Company classifies its securities as either available-for-sale or held-to-maturity at the time of purchase. Accounting guidance requires available-for-sale securities to be marked to fair value with an offset to accumulated other comprehensive income (loss), a component of shareholders’ equity. Monthly adjustments are made to reflect changes in the fair value of the Company’s available-for-sale securities.

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During the first quarter of 2022, the Company purchased $21.6 million of U.S. Treasury securities (available-for-sale), with a book yield of 2.22% and an average life of 2.51 years. During the first quarter of 2022, the Company purchased $109.6 million of agency mortgage-backed securities (held-to-maturity), with a book yield of 2.12% and an average life of 6.52 years.

Loans

The Company’s loans represent the largest portion of invested assets, substantially greater than the securities portfolio or any other asset category, and the quality and diversification of the loan portfolio is an important consideration when reviewing the Company’s financial condition. Gross loans, excluding loans held-for-sale, represented 56% of total assets at both March 31, 2022 and December 31, 2021, and represented 54% at March 31, 2021. The loan to deposit ratio was 64.48% at March 31, 2022, compared to 63.21% at March 31, 2021, and 64.87% at December 31, 2021.

Loan Distribution

The Loan Distribution table that follows sets forth the Company’s gross loans, excluding loans held-for-sale, outstanding and the percentage distribution in each category at the dates indicated:


	March 31, 2022				March 31, 2021				December 31, 2021
	Balance		% to Total		Balance		% to Total		Balance		% to Total

	(Dollars in thousands)
Commercial	$	568,053	19	%	$	559,698	20	%	$	594,108	19	%
PPP loans		37,393	1	%		349,744	13	%		88,726	3	%
Real estate:
CRE - owner occupied		597,542	20	%		568,637	21	%		595,934	19	%
CRE - non-owner occupied		928,220	31	%		700,117	26	%		902,326	29	%
Land and construction		153,323	5	%		159,504	6	%		147,855	5	%
Home equity		111,609	3	%		104,303	4	%		109,579	4	%
Multifamily		221,767	7	%		168,917	6	%		218,856	7	%
Residential mortgages		391,171	13	%		82,181	3	%		416,660	13	%
Consumer and other		17,110	1	%		19,872	1	%		16,744	1	%
Total Loans		3,026,188	100	%		2,712,973	100	%		3,090,788	100	%
Deferred loan fees, net		(2,124)	—			(8,266)	—			(3,462)	—
Loans, net of deferred fees		3,024,064	100	%		2,704,707	100	%		3,087,326	100	%
Allowance for credit losses on loans		(42,788)				(44,296)				(43,290)
Loans, net	$	2,981,276			$	2,660,411			$	3,044,036

The Company’s loan portfolio is concentrated in commercial loans, (primarily manufacturing, wholesale, and services oriented entities), and CRE, with the remaining balance in land development and construction, home equity, purchased residential mortgages, and consumer loans. The Company does not have any concentrations by industry or group of industries in its loan portfolio, however, 79% of its gross loans were secured by real property at March 31, 2022, compared to 66% at March 31, 2021, and 77% at December 31, 2021. While no specific industry concentration is considered significant, the Company’s bank lending operations are substantially located in areas that are dependent on the technology and real estate industries and their supporting companies.

The Company has established concentration limits in its loan portfolio for CRE loans, commercial loans, construction loans and unsecured lending, among others. The Company uses underwriting guidelines to assess the borrower’s historical cash flow to determine debt service, and we further stress test the debt service under higher interest rate scenarios. Financial and performance covenants are used in commercial lending to allow the Company to react to a borrower’s deteriorating financial condition should that occur.

The Company’s commercial loans are made for working capital, financing the purchase of equipment or for other business purposes. Commercial loans include loans with maturities ranging from thirty days to one year and “term loans” with maturities normally ranging from one to five years. Short-term business loans are generally intended to finance current transactions and typically provide for periodic principal payments, with interest payable monthly. Term loans normally provide for floating interest rates, with monthly payments of both principal and interest.

The Company is an active participant in the SBA and U.S. Department of Agriculture guaranteed lending programs, and has been approved by the SBA as a lender under the Preferred Lender Program. The Company regularly makes such guaranteed loans (collectively referred to as “SBA loans”). The guaranteed portion of these loans is typically sold in the secondary market depending on market conditions. When the guaranteed portion of an SBA loan is sold, the

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Company retains the servicing rights for the sold portion. During the three months ended March 31, 2022 and 2021, loans were sold resulting in a gain on sales of SBA loans of $156,000 million and $550,000, respectively.

The Company’s factoring receivables are from the operations of Bay View Funding whose primary business is purchasing and collecting factored receivables. Factored receivables are receivables that have been transferred by the originating organization and typically have not been subject to previous collection efforts. These receivables are acquired from a variety of companies, including but not limited to service providers, transportation companies, manufacturers, distributors, wholesalers, apparel companies, advertisers, and temporary staffing companies. The portfolio of factored receivables is included in the Company’s commercial loan portfolio. The average life of the factored receivables was 38 days for the first three months of 2022, compared to 35 days for the first three months of 2021. The balance of the purchased receivables was $61.2 million at March 31, 2022, compared to $48.5 million at March 31, 2021, and $53.2 million at December 31, 2021.

The commercial loan portfolio, excluding PPP loans, increased $8.4 million, or 1%, to $568.1 million at March 31, 2022, from $559.7 million at March 31, 2021 and decreased ($26.0) million, or (4%), from $594.1 million at December 31, 2021. Commercial and industrial (“C&I”) line usage was 31% at both March 31, 2022 and December 31, 2021, compared to 28% at March 31, 2021. In addition, the Company had $37.4 million in PPP loans at March 31, 2022, compared to $349.7 million at March 31, 2021, and $88.7 million at December 31, 2021.

The Company’s CRE loans consist primarily of loans based on the borrower’s cash flow and are secured by deeds of trust on commercial property to provide a secondary source of repayment. The Company generally restricts real estate term loans to no more than 75% of the property’s appraised value or the purchase price of the property depending on the type of property and its utilization. The Company offers both fixed and floating rate loans. Maturities for CRE loans are generally between five and ten years (with amortization ranging from fifteen to twenty five years and a balloon payment due at maturity), however, SBA and certain other real estate loans that can be sold in the secondary market may be granted for longer maturities.

The CRE owner-occupied loan portfolio increased $28.9 million, or 5%, to $597.5 million at March 31, 2022, from $568.6 million at March 31, 2021, and increased $1.6 million from $595.9 million at December 31, 2021. CRE non-owner occupied loans increased $228.1 million, or 33%, to $928.2 million, compared to $700.1 million at March 31, 2021, and increased $25.9 million, or 3% from $902.3 million at December 31, 2021. At March 31, 2022, 39% of the CRE loan portfolio was secured by owner-occupied real estate.

The Company’s land and construction loans are primarily to finance the development and construction of commercial and single family residential properties. The Company utilizes underwriting guidelines to assess the likelihood of repayment from sources such as sale of the property or availability of permanent mortgage financing prior to making the construction loan. Construction loans are provided only in our market area, and the Company has extensive controls for the disbursement process. Land and construction loans decreased ($6.2) million, or (4%), to $153.3 million at March 31, 2022, compared to $159.5 million at March 31, 2021, and increased $5.4 million, or 4%, from $147.9 million at December 31, 2021.

The Company makes home equity lines of credit available to its existing customers. Home equity lines of credit are underwritten initially with a maximum 75% loan to value ratio. Home equity lines of credit increased $7.3 million, or 7%, to $111.6 million at March 31, 2022, compared to $104.3 million at March 31, 2021, and increased $2.0 million, or 2%, from $109.6 million at December 31, 2021.

Multifamily loans increased $52.9 million, or 31%, to $221.8 million, at March 31, 2022, compared to $168.9 million at March 31, 2021, and increased $2.9 million, or 1%, from $218.9 million at December 31, 2021.

From time to time the Company has purchased single family residential mortgage loans. Residential mortgage loans increased $309.0 million, or 376%, to $391.2 million at March 31, 2022, compared to $82.2 million at March 31, 2021, and decreased ($25.5) million, or (6%) from $416.7 million at December 31, 2021. The increase in residential mortgage loans at March 31, 2022, compared to March 31, 2021, was the result of the purchase of single family residential mortgage loan portfolios during 2021. During the year ended December 31, 2021, the Company purchased single family residential mortgage loans totaling $405.8 million, tied to homes all located in California, with average principal balances of approximately $853,000, and a weighted average yield of approximately 3.14% (net of servicing

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fees). Purchases of residential loans have been an attractive alternative for replacing mortgage-backed security paydowns in the investment securities portfolio.

Consumer and other loans decreased ($2.8) million, or (14%), to $17.1 million at March 31, 2022, compared to $19.9 million at March 31, 2021, and increased $366,000, or 2% from $16.7 million at December 31, 2021.

Additionally, the Company makes consumer loans for the purpose of financing automobiles, various types of consumer goods, and other personal purposes. Consumer loans generally provide for the monthly payment of principal and interest. Most of the Company’s consumer loans are secured by the personal property being purchased or, in the instances of home equity loans or lines, real property.

With certain exceptions, state chartered banks are permitted to make extensions of credit to any one borrowing entity totaling up to 15% of the bank’s capital and reserves for unsecured loans and up to 25% of the bank’s capital and reserves for secured loans. For HBC, these lending limits were $99.3 million and $165.5 million at March 31, 2022, respectively.

Loan Maturities

The following table presents the maturity distribution of the Company’s loans (excluding loans held-for-sale) as of March 31, 2022. 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. As of March 31, 2022, approximately 38% of the Company’s loan portfolio consisted of floating interest rate loans.


			Over One
	Due in		Year But
	One Year		Less than		Over
	or Less		Five Years		Five Years		Total

	(Dollars in thousands)
Commercial	$	340,625	$	167,741	$	59,687	$	568,053
PPP loans		1,186		36,207		—		37,393
Real estate:
CRE - owner occupied		14,057		124,053		459,432		597,542
CRE - non-owner occupied		33,941		253,057		641,222		928,220
Land and construction		130,257		12,924		10,142		153,323
Home equity		111,533		—		76		111,609
Multifamily		20,619		71,222		129,926		221,767
Residential mortgages		14,519		16,169		360,483		391,171
Consumer and other		8,561		6,934		1,615		17,110
Loans	$	675,298	$	688,307	$	1,662,583	$	3,026,188

Loans with variable interest rates	$	602,605	$	225,462	$	310,055	$	1,138,122
PPP loans with fixed interest rates		1,186		36,207		—		37,393
Other loans with fixed interest rates		71,507		426,638		1,352,528		1,850,673
Loans	$	675,298	$	688,307	$	1,662,583	$	3,026,188

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Loan Servicing

As of March 31, 2022 and 2021, $69.3 million and $80.2 million, respectively, in SBA loans were serviced by the Company for others. Activity for loan servicing rights was as follows:


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands)
Beginning of period balance	$	655	$	531
Additions		38		123
Amortization		(87)		(48)
End of period balance	$	606	$	606

Loan servicing rights are included in accrued interest receivable and other assets on the unaudited consolidated balance sheets and reported net of amortization. There was no valuation allowance as of March 31, 2022 and 2021, as the fair value of the assets was greater than the carrying value.

Activity for the I/O strip receivable was as follows:


	Three Months Ended
	March 31,
	2022		2021

	(Dollars in thousands)
Beginning of period balance	$	221	$	305
Unrealized holding (loss) gain		(13)		(9)
End of period balance	$	208	$	296

Credit Quality and Allowance for Credit Losses on Loans

Financial institutions generally have a certain level of exposure to credit quality risk, and could potentially receive less than a full return of principal and interest if a debtor becomes unable or unwilling to repay. Since loans are the most significant assets of the Company and generate the largest portion of its revenues, the Company’s management of credit quality risk is focused primarily on loan quality. Banks have generally suffered their most severe earnings declines as a result of customers’ inability to generate sufficient cash flow to service their debts, downturns in national and regional economies and declines in overall asset values including real estate collateral values. In addition, certain debt securities that the Company may purchase have the potential of declining in value if the obligor’s financial capacity to repay deteriorates.

The Company’s policies and procedures identify market segments, set goals for portfolio growth or contraction, and establish limits on industry and geographic credit concentrations. In addition, these policies establish the Company’s underwriting standards and the methods of monitoring ongoing credit quality. The Company’s internal credit risk controls are centered in underwriting practices, credit granting procedures, training, risk management techniques, and familiarity with loan customers as well as the relative diversity and geographic concentration of our loan portfolio.

The Company’s credit risk may also be affected by external factors such as the level of interest rates, employment, general economic conditions, real estate values, and trends in particular industries or geographic markets. As an independent community bank serving a specific geographic area, the Company must contend with the unpredictable changes in the general California market and, particularly, primary local markets. The Company’s asset quality has suffered in the past from the impact of national and regional economic recessions, consumer bankruptcies, and depressed real estate values.

Nonperforming assets are comprised of the following: loans for which the Company is no longer accruing interest; restructured loans which have been current under six months; loans 90 days or more past due and still accruing interest (although they are generally placed on nonaccrual when they become 90 days past due, unless they are both well-secured and in the process of collection); and foreclosed assets. Past due loans 30 days or greater totaled $14.1 million and $5.0 million at March 31, 2022 and December 31, 2021, respectively, of which $1.4 million and $1.3 million were on nonaccrual. At March 31, 2022, there were also $1.9 million loans less than 30 days past due included in

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nonaccrual loans held-for-investment. At December 31, 2021, there were also $2.2 million loans less than 30 days past due included in nonaccrual loans held-for-investment.

Management’s classification of a loan as “nonaccrual” is an indication that there is reasonable doubt as to the full recovery of principal or interest on the loan. At that point, the Company stops accruing interest income, and reverses any uncollected interest that had been accrued as income. The Company begins recognizing interest income only as cash interest payments are received and it has been determined the collection of all outstanding principal is not in doubt. The loans may or may not be collateralized, and collection efforts are pursued on all nonaccrual loans. Loans may be restructured by management when a borrower has experienced some change in financial status causing an inability to meet the original repayment terms and where the Company believes the borrower will eventually overcome those circumstances and make full restitution. Foreclosed assets consist of properties acquired by foreclosure or similar means that management is offering or will offer for sale.

The following table summarizes the Company’s nonperforming assets at the dates indicated:


	March 31,						December 31,
	2022			2021			2021

	(Dollars in thousands)
Nonaccrual loans — held-for-investment	$	3,303		$	5,542		$	3,460
Restructured and loans 90 days past due and
still accruing		527			51			278
Total nonperforming loans		3,830			5,593			3,738
Foreclosed assets		—			—			—
Total nonperforming assets	$	3,830		$	5,593		$	3,738

Nonperforming assets as a percentage of loans
plus foreclosed assets		0.13	%		0.21	%		0.12	%
Nonperforming assets as a percentage of total assets		0.07	%		0.11	%		0.07	%

Nonperforming assets were $3.8 million, or 0.07% of total assets, at March 31, 2022, compared to $5.6 million, or 0.11% of total assets, at March 31, 2021, and $3.7 million, or 0.07% of total assets, at December 31, 2021.

The following table presents the amortized cost basis of nonperforming loans and loans past due over 90 days and still accruing at the periods indicated:



	March 31, 2022
					Restructured
	Nonaccrual		Nonaccrual		and Loans
	with no Special		with Special		over 90 Days
	Allowance for		Allowance for		Past Due
	Credit		Credit		and Still
	Losses		Losses		Accruing		Total

	(Dollars in thousands)
Commercial	$	236	$	761	$	527	$	1,524
Real estate:
CRE - Owner Occupied		1,126		—		—		1,126
Home equity		73		—		—		73
Multifamily		1,107		—		—		1,107
Total	$	2,542	$	761	$	527	$	3,830

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	December 31, 2021
					Restructured
	Nonaccrual		Nonaccrual		and Loans
	with no Special		with Special		over 90 Days
	Allowance for		Allowance for		Past Due
	Credit		Credit		and Still
	Losses		Losses		Accruing		Total

	(Dollars in thousands)
Commercial	$	94	$	1,028	$	278	$	1,400
Real estate:
CRE - Owner Occupied		1,126		—		—		1,126
Home equity		84		—		—		84
Multifamily		1,128		—		—		1,128
Total	$	2,432	$	1,028	$	278	$	3,738

Loans with a well-defined weakness, which are characterized by the distinct possibility that the Company will sustain a loss if the deficiencies are not corrected, are categorized as “classified.” Classified loans include all loans considered as substandard, substandard-nonaccrual, and doubtful 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). Loans held-for-sale are carried at the lower of cost or estimated fair value, and are not allocated an allowance for loan losses.

The amortized cost basis of collateral-dependent commercial loans collateralized by business assets totaled $761,000 and $1.0 million at March 31, 2022 and December 31, 2021, respectively.

Classified loans decreased to $30.6 million, or 0.56% of total assets, at March 31, 2022, compared to $33.4 million, or 0.67% of total assets, at March 31, 2021, and $33.7 million, or 0.61% of total assets at December 31, 2021.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed in accordance with the Company’s underwriting policy.

Beginning January 1, 2020, the ACLL is calculated by using the current expected credit loss (“CECL”) methodology. The ACLL estimation process involves procedures to appropriately consider the unique characteristics of loan portfolio segments. These segments are further disaggregated into loan classes, the level at which credit risk is monitored. When computing the level of expected credit losses, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history, delinquency status, and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods, evaluations of the overall loan portfolio in light of the factors and forecasts then prevailing, may result in significant changes in the allowance and credit loss expense in those future periods.

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The allowance level is influenced by loan volumes, loan risk rating migration or delinquency status, changes in historical loss experience, and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics.

Loans are charged-off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for credit losses on loans.

The following provides a summary of the risks associated with various segments of the Company’s loan portfolio, which are factors management regularly considers when evaluating the adequacy of the allowance:

Commercial

Commercial loans primarily rely on the identified cash flows of the borrower for repayment and secondarily on the value of underlying collateral provided by the borrower. However, the cash flows of the borrowers may not be as expected and the collateral securing these loans may vary in value. Most commercial loans are secured by the assets being financed or on other business assets such as accounts receivable, inventory or equipment and may incorporate a personal guarantee; however, some loans may be unsecured. Included in commercial loans are $37.4 million of PPP loans at March 31, 2022, $349.7 million at March 31, 2021, and $88.7 million at December 31, 2021. No allowance for credit losses has been recorded for PPP loans as they are fully guaranteed by the SBA at March 31, 2022, March 31, 2021, and December 31, 2021.

CRE

Land and Construction

Home Equity

Multifamily

Multifamily loans are loans on residential properties with five or more units. These loans rely primarily on the cash flows of the properties securing the loan for repayment and secondarily on the value of the properties securing the loan. The cash flows of these borrowers can fluctuate along with the values of the underlying property depending on general economic conditions.

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Residential Mortgages

Residential mortgage loans are secured by 1-4 family residences which are generally owner-occupied. Repayment of these loans depends primarily on the personal income of the borrower and secondarily by the value of the property securing the loan which can be impacted by changes in economic conditions such as the unemployment rate and property values.

Consumer and Other

Allocation of Allowance for Credit Losses on Loans

As a result of the matters mentioned above, changes in the financial condition of individual borrowers, economic conditions, historical loss experience and the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for credit losses on loans and the associated provision for credit losses on loans.

On an ongoing basis, we have engaged an outside firm to perform independent credit reviews of our loan portfolio. The Federal Reserve Board and the California Department of Financial Protection and Innovation (“DFPI”) also review the allowance for credit losses on loans as an integral part of the examination process. Based on information currently available, management believes that the allowance for credit losses on loans 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 further. Also, 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.

Changes in the allowance for credit losses on loans were as follows for the periods indicated:


	Three Months Ended March 31, 2022
			CRE		CRE
			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgages		and Other		Total

	(Dollars in thousands)
Beginning of period balance	$	8,414	$	7,954	$	17,125	$	1,831	$	864	$	2,796	$	4,132	$	174	$	43,290
Charge-offs		(16)		-		-		-		-		-		-		-		(16)
Recoveries		54		3		-		-		24		-		-		-		81
Net recoveries		38		3		-		-		24		-		-		-		65
Provision for (recapture of) credit losses on loans		(1,651)		(1,560)		2,288		175		(166)		(252)		625		(26)		(567)
End of period balance	$	6,801	$	6,397	$	19,413	$	2,006	$	722	$	2,544	$	4,757	$	148	$	42,788


	Three Months Ended March 31, 2021
			CRE		CRE
			Owner		Non-owner		Land &		Home		Multi-		Residential		Consumer
	Commercial		Occupied		Occupied		Construction		Equity		Family		Mortgages		and Other		Total

	(Dollars in thousands)
Beginning of period balance	$	11,587	$	8,560	$	16,416	$	2,509	$	1,297	$	2,804	$	943	$	284	$	44,400
Charge-offs		(263)		-		-		-		-		-		-		-		(263)
Recoveries		813		4		-		816		23		-		-		15		1,671
Net (charge-offs) recoveries		550		4		-		816		23		-		-		15		1,408
Provision for (recapture of) credit losses on loans		(537)		(196)		15		(571)		(149)		(53)		(25)		4		(1,512)
End of period balance	$	11,600	$	8,368	$	16,431	$	2,754	$	1,171	$	2,751	$	918	$	303	$	44,296

The decrease in the allowance for credit losses on loans and related negative provision for credit losses on loans for the three months ended March 31, 2022, was primarily attributed to a net decrease of $426,000 in the reserve for pooled loans, driven by improvements in forecasted macroeconomic conditions offset by changes in the portfolio, and a $76,000 decrease in specific reserves for individually evaluated loans compared to December 31, 2021. The decrease in the allowance for credit losses for pooled loans from December 31, 2021 is largely the result of improvements in the

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economic factors used in our methodology and reductions in qualitative adjustments for risks such as collateral values, concentrations of credit risk (geographic, large borrower, and industry), economic conditions, changes in underwriting standards, experience and depth of lending staff, trends in delinquencies, and the level of criticized loans to address asset-specific risks and current conditions that were not fully considered by the macroeconomic variables driving the quantitative estimate.

The following table provides a summary of the allocation of the allowance for credit losses on loans by class at the dates indicated. The allocation presented should not be interpreted as an indication that charges to the allowance for credit losses on loans will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each category represents the total amount available for charge-offs that may occur within these classes.


	March 31,
	2022				2021				December 31, 2021
			Percent				Percent				Percent
			of Loans				of Loans				of Loans
			in each				in each				in each
			category				category				category
			to total				to total				to total
	Allowance		loans		Allowance		loans		Allowance		loans

	(Dollars in thousands)
Commercial	$	6,801	20	%	$	11,600	33	%	$	8,414	22	%
Real estate:
CRE - owner occupied		6,397	20	%		8,368	21	%		7,954	19	%
CRE - non-owner occupied		19,413	31	%		16,431	26	%		17,125	29	%
Land and construction		2,006	5	%		2,754	6	%		1,831	5	%
Home equity		722	3	%		1,171	4	%		864	4	%
Multifamily		2,544	7	%		2,751	6	%		2,796	7	%
Residential mortgages		4,757	13	%		918	3	%		4,132	13	%
Consumer and other		148	1	%		303	1	%		174	1	%
Total	$	42,788	100	%	$	44,296	100	%	$	43,290	100	%

The ACLL totaled $42.8 million, or 1.41% of total loans at March 31, 2022, compared to $44.3 million, or 1.64% of total loans at March 31, 2021, and $43.3 million, or 1.40% of total loans at December 31, 2021. The ACLL was 1,117.18% of nonperforming loans at March 31, 2022, compared to 791.99% of nonperforming loans at March 31, 2021, and 1,158.11% of nonperforming loans at December 31, 2021. The ACLL to total loans, excluding PPP loans, was 1.43% at March 31, 2022, 1.87% at March 31, 2021 and 1.44% at December 31, 2021. The Company had net recoveries of $65,000, or (0.01%) of average loans, for the first quarter of 2022, compared to net recoveries of $1.4 million, or (0.22%) of average loans, for the first quarter of 2021, and net recoveries of $225,000, or (0.03%) of average loans for the fourth quarter of 2021.

The following table shows the drivers of change in ACLL under CECL for each of the first quarter of 2022:


Drivers of Change in ACLL Under CECL	(Dollars in thousands)
ACLL at December 31, 2021	$	43,290
Net recoveries during the first quarter of 2022		65
Portfolio changes during the first quarter of 2022		(98)
Qualitative and quantitative changes during the first
quarter of 2022 including changes in economic forecasts		(469)
ACLL at March 31, 2022	$	42,788

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Leases

The Company recognizes the following for all leases, at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. While the new standard impacts lessors and lessees, the Company is impacted as a lessee of the offices and real estate used for operations. The Company's lease agreements include options to renew at the Company's discretion. The extensions are not reasonably certain to be exercised, therefore it was not considered in the calculation of the ROU asset and lease liability. Total assets and total liabilities were $33.7 million on its consolidated statement of financial condition at March 31, 2022, as a result of recognizing right-of-use assets, included in other assets, and lease liabilities, included in other liabilities, related to non-cancelable operating lease agreements for office space.

Deposits

The composition and cost of the Company’s deposit base are important components in analyzing the Company’s net interest margin and balance sheet liquidity characteristics, both of which are discussed in greater detail in other sections herein. The Company’s liquidity is impacted by the volatility of deposits from the propensity of that money to leave the institution for rate-related or other reasons. Deposits can be adversely affected if economic conditions weaken in California, and the Company’s market area in particular. Potentially, the most volatile deposits in a financial institution are jumbo certificates of deposit, meaning time deposits with balances that equal or exceed $250,000, as customers with balances of that magnitude are typically more rate-sensitive than customers with smaller balances.

The following table summarizes the distribution of deposits and the percentage of distribution in each category of deposits for the periods indicated:


	March 31, 2022				March 31, 2021				December 31, 2021
	Balance		% to Total		Balance		% to Total		Balance		% to Total

	(Dollars in thousands)
Demand, noninterest-bearing	$	1,811,943	38	%	$	1,813,962	42	%	$	1,903,768	40	%
Demand, interest-bearing		1,268,942	27	%		1,101,807	26	%		1,308,114	27	%
Savings and money market		1,447,434	31	%		1,189,566	28	%		1,375,825	29	%
Time deposits — under $250		38,417	1	%		42,596	1	%		38,734	1	%
Time deposits — $250 and over		93,161	2	%		102,508	2	%		94,700	2	%
CDARS — interest-bearing demand,
money market and time deposits		30,008	1	%		28,663	1	%		38,271	1	%
Total deposits	$	4,689,905	100	%	$	4,279,102	100	%	$	4,759,412	100	%

The Company obtains deposits from a cross-section of the communities it serves. The Company’s business is not generally seasonal in nature. Public funds were less than 1% of deposits at March 31, 2022, March 31, 2021, and December 31, 2021.

At March 31, 2022, the $30.0 million CDARS deposits comprised $22.9 million of interest-bearing demand deposits, $1.5 million of money market accounts and $5.6 million of time deposits. At March 31, 2021, the $28.7 million CDARS deposits comprised $21.4 million of interest-bearing demand deposits, $1.7 million of money market accounts and $5.6 million of time deposits. At December 31, 2021, the $38.3 million CDARS deposits comprised $30.9 million of interest-bearing demand deposits, $1.0 million of money market accounts and $6.4 million of time deposits.

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The following table indicates the contractual maturity schedule of the Company’s uninsured time deposits in excess of $250,000 as of March 31, 2022:


	Balance		% of Total

	(Dollars in thousands)
Three months or less	$	31,870	54	%
Over three months through six months		6,351	11	%
Over six months through twelve months		12,379	21	%
Over twelve months		8,061	14	%
Total	$	58,661	100	%

The Company focuses primarily on providing and servicing business deposit accounts that are frequently over $250,000 in average balance per account. As a result, certain types of business clients that the Company serves typically carry average deposits in excess of $250,000. The account activity for some account types and client types necessitates appropriate liquidity management practices by the Company to help ensure its ability to fund deposit withdrawals.

Return on Equity and Assets

The following table indicates the ratios for return on average assets and average equity, and average equity to average assets for the periods indicated:


	Three Months Ended
	March 31,
	2022		2021
Return on average assets	0.96	%	0.95	%
Return on average tangible assets	0.99	%	0.99	%
Return on average equity	8.71	%	7.85	%
Return on average tangible equity	12.47	%	11.50	%
Average equity to average assets ratio	11.01	%	12.13	%

Liquidity and Asset/Liability Management

The Company’s liquidity position supports its ability to maintain cash flows sufficient to fund operations, meet all of its financial obligations and commitments, and accommodate unexpected sudden changes in balances of loans and deposits in a timely manner. At various times the Company requires funds to meet short term cash requirements brought about by loan growth or deposit outflows, the purchase of assets, or repayment of liabilities. An integral part of the Company’s ability to manage its liquidity position appropriately is derived from its large base of core deposits which are generated by offering traditional banking services in its service area and which have historically been a stable source of funds.

The Company manages liquidity to be able to meet unexpected sudden changes in levels of its assets or deposit liabilities without maintaining excessive amounts of balance sheet liquidity. Excess balance sheet liquidity can negatively impact the Company’s net interest margin. In order to meet short term liquidity needs the Company utilizes overnight Federal funds purchase arrangements and other borrowing arrangements with correspondent banks, solicits brokered deposits if cost effective deposits are not available from local sources, and maintains collateralized lines of credit with the Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”). In addition, the Company can raise cash for temporary needs by selling securities under agreements to repurchase and selling securities available for sale.

One of the measures of liquidity is the loan to deposit ratio. The loan to deposit ratio was 64.48% at March 31, 2022, compared to 63.21% at March 31, 2021, and 64.87% at December 31, 2021.

FHLB and FRB Borrowings and Available Lines of Credit

HBC has off-balance sheet liquidity in the form of Federal funds purchase arrangements with correspondent banks, including the FHLB and FRB. HBC can borrow from the FHLB on a short-term (typically overnight) or long-term (over one year) basis. HBC had no overnight borrowings from the FHLB at March 31, 2022, March 31, 2021, and December 31, 2021. HBC had $279.8 million of loans pledged to the FHLB as collateral on an available line of credit of

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$195.0 million at March 31, 2022, none of which was outstanding. HBC also had $1.3 million of securities pledged to the FHLB as collateral on an available line of credit of $1.3 million at March 31, 2022, none of which was outstanding.

HBC can also borrow from the FRB’s discount window. HBC had $1.0 billion of loans pledged to the FRB as collateral on an available line of credit of $752.1 million at March 31, 2022, none of which was outstanding.

At March 31, 2022, HBC had Federal funds purchased arrangements available of $90.0 million. There were no Federal funds purchased outstanding at March 31, 2022, March 31, 2021, and December 31, 2021.

The Company has a $20.0 million line of credit with a correspondent bank, of which none was outstanding at March 31, 2022.

HBC may also utilize securities sold under repurchase agreements to manage its liquidity position. There were no securities sold under agreements to repurchase at March 31, 2022, March 31, 2021, and December 31, 2021.

Capital Resources

The Company uses a variety of measures to evaluate capital adequacy. Management reviews various capital measurements on a regular basis and takes appropriate action to ensure that such measurements are within established internal and external guidelines. The external guidelines, which are issued by the Federal Reserve and the FDIC, establish a risk adjusted ratio relating capital to different categories of assets and off balance sheet exposures.

On May 26, 2017, the Company completed an underwritten public offering of $40.0 million aggregate principal amount of fixed-to-floating rate subordinated notes (“Subordinated Debt”) due June 1, 2027. The Subordinated Debt initially bears a fixed interest rate of 5.25% per year. Commencing on June 1, 2022, the interest rate on the Subordinated Debt resets quarterly to the three-month LIBOR rate plus a spread of 336.5 basis points, payable quarterly in arrears. Interest on the Subordinated Debt is payable semi-annually on June 1st and December 1st of each year through June 1, 2022 and quarterly thereafter on March 1st, June 1st, September 1st and December 1st of each year through the maturity date or early redemption date. The Company, at its option, may redeem the Subordinated Debt, in whole or in part, on any interest payment date on or after June 1, 2022 without a premium.

The LIBOR index was phased-out at the end of 2021 and the Federal Reserve Bank of New York has established the Secured Overnight Financing Rate (“SOFR”) as its recommended alternative to LIBOR. U.S. LIBOR benchmark interest rates are expected to continue to be published through June, 2023 for existing LIBOR based contracts. We have created a sub-committee of our Asset Liability Management Committee to address LIBOR transition and phase-out issues. The Company continues to implement its transition plan toward the cessation of LIBOR and the modification of its loans and other financial instruments with attributes that are either directly or indirectly influenced by LIBOR.

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The following table summarizes risk-based capital, risk-weighted assets, and risk-based capital ratios of the consolidated Company under the Basel III requirements for the periods indicated:


	March 31,			March 31,			December 31,
	2022			2021			2021

	(Dollars in thousands)
Capital components:
Common Equity Tier 1 capital	$	438,203		$	415,545		$	433,488
Additional Tier 1 capital		—			—			—
Tier 1 Capital		438,203			415,545			433,488
Tier 2 Capital		75,069			73,571			72,721
Total Capital	$	513,272		$	489,116		$	506,209

Risk-weighted assets	$	3,525,741		$	2,960,057		$	3,521,058
Average assets for capital purposes	$	5,256,141		$	4,579,125		$	5,504,834

Capital ratios:
Total Capital		14.6	%		16.5	%		14.4	%
Tier 1 Capital		12.4	%		14.0	%		12.3	%
Common equity Tier 1 Capital		12.4	%		14.0	%		12.3	%
Tier 1 Leverage(1)		8.3	%		9.1	%		7.9	%

(1)	Tier 1 capital divided by quarterly average assets (excluding intangible assets and disallowed deferred tax assets).

The following table summarizes risk based capital, risk-weighted assets, and risk-based capital ratios of HBC under the Basel III requirements for the periods indicated:


	March 31,			March 31,			December 31,
	2022			2021			2021

	(Dollars in thousands)
Capital components:
Common Equity Tier 1 capital	$	456,267		$	433,639		$	451,586
Additional Tier 1 capital		—			—			—
Tier 1 Capital		456,267			433,639			451,586
Tier 2 Capital		35,082			33,785			32,796
Total Capital	$	491,349		$	467,424		$	484,382

Risk-weighted assets	$	3,524,365		$	2,957,908		$	3,518,391
Average assets for capital purposes	$	5,254,169		$	4,576,901		$	5,502,185

Capital ratios:
Total Capital		13.9	%		15.8	%		13.8	%
Tier 1 Capital		12.9	%		14.7	%		12.8	%
Common Equity Tier 1 Capital		12.9	%		14.7	%		12.8	%
Tier 1 Leverage(1)		8.7	%		9.5	%		8.2	%

(1)	Tier 1 capital divided by quarterly average assets (excluding intangible assets and disallowed deferred tax assets).

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The following table presents the applicable well-capitalized regulatory guidelines and the standards for minimum capital adequacy requirements under Basel III and the regulatory guidelines for a “well–capitalized” financial institution under Prompt Corrective Action (“PCA”):




			Well-capitalized
			Financial
	Minimum		Institution PCA
	Regulatory		Regulatory
	Requirement(1)		Guidelines
Capital ratios:
Total Capital	10.5	%	10.0	%
Tier 1 Capital	8.5	%	8.0	%
Common equity Tier 1 Capital	7.0	%	6.5	%
Tier 1 Leverage	4.0	%	5.0	%

(1)	Includes 2.5% capital conservation buffer, except the leverage capital ratio.

The Basel III capital rules introduced a new “capital conservation buffer,” for banking organizations to maintain a common equity Tier 1 ratio more than 2.5% above these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

At March 31, 2022, the Company’s consolidated capital ratio exceeded regulatory guidelines and HBC’s capital ratios exceed the highest regulatory capital requirement of “well-capitalized” under Basel III prompt corrective action provisions. Quantitative measures established by regulation to help ensure capital adequacy require the Company and HBC to maintain minimum amounts and ratios of total risk-based capital, Tier 1 capital, and common equity Tier 1 (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes that, as of March 31, 2022, March 31, 2021, and December 31, 2021, the Company and HBC met all capital adequacy guidelines to which they were subject.

At March 31, 2022, the Company had total shareholders’ equity of $601.1 million, compared to $581.7 million at March 31, 2021, and $598.0 million at December 31, 2021. At March 31, 2022, total shareholders’ equity included $498.8 million in common stock, $116.3 million in retained earnings, and ($14.0) million of accumulated other comprehensive loss. The book value per share was $9.95 at March 31, 2022, compared to $9.71 at March 31, 2021, and $9.91 at December 31, 2021. The tangible book value per share was $6.96 at March 31, 2022, compared to $6.64 at March 31, 2021, and $6.91 at December 31, 2021.

The following table reflects the components of accumulated other comprehensive loss, net of taxes, for the periods indicated:


	March 31,		December 31,		March 31,
Accumulated Other Comprehensive Loss	2022		2021		2021

	(Dollars in thousands)
Unrealized gain on securities available-for-sale	$	(1,127)	$	1,991	$	3,113
Remaining unamortized unrealized gain on securities
available-for-sale transferred to held-to-maturity		—		—		252
Split dollar insurance contracts liability		(5,491)		(5,480)		(6,148)
Supplemental executive retirement plan liability		(7,588)		(7,669)		(8,699)
Unrealized gain on interest-only strip from SBA loans		152		162		214
Total accumulated other comprehensive loss	$	(14,054)	$	(10,996)	$	(11,268)

Market Risk

Market risk is the risk of loss of future earnings, fair values, or future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market risk

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sensitive instruments. Market risk is attributed to all market risk sensitive financial instruments, including securities, loans, deposits and borrowings, as well as the Company’s role as a financial intermediary in customer-related transactions. The objective of market risk management is to avoid excessive exposure of the Company’s earnings and equity to loss and to reduce the volatility inherent in certain financial instruments. The Company’s exposure to market risk is reviewed on a regular basis by the Management’s Asset/Liability Committee and the Director’s Finance and Investment Committee.

Interest Rate Management

The Company’s market risk exposure is primarily that of interest rate risk, and it has established policies and procedures to monitor and limit earnings and balance sheet exposure to changes in interest rates. The Company does not engage in the trading of financial instruments, nor does the Company have exposure to currency exchange rates.

The principal objective of interest rate risk management (often referred to as “asset/liability management”) is to manage the financial components of the Company in a manner that will optimize the risk/reward equation for earnings and capital in relation to changing interest rates. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Management realizes certain risks are inherent, and that the goal is to identify and manage the risks. Management uses two methodologies to manage interest rate risk: (i) a standard GAP analysis; and (ii) an interest rate shock simulation model.

The planning of asset and liability maturities is an integral part of the management of an institution’s net interest margin. To the extent maturities of assets and liabilities do not match in a changing interest rate environment, the net interest margin may change over time. Even with perfectly matched repricing of assets and liabilities, risks remain in the form of prepayment of loans or securities 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.

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.

The Company uses modeling software for asset/liability management in order to simulate the effects of potential interest rate changes on the Company’s net interest margin, and to calculate the estimated fair values of the Company’s financial instruments under different interest rate scenarios. The program imports current balances, interest rates, maturity dates and repricing information for individual financial instruments, and incorporates assumptions on the characteristics of embedded options along with pricing and duration for new volumes to project the effects of a given interest rate change on the Company’s interest income and interest expense. Rate scenarios consisting of key rate and yield curve projections are run against the Company’s investment, loan, deposit and borrowed funds’ portfolios. These rate projections can be shocked (an immediate and parallel change in all base rates, up or down) and ramped (an incremental increase or decrease in rates over a specified time period), based on current trends and econometric models or stable economic conditions (unchanged from current actual levels).

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The following table sets forth the estimated changes in the Company’s annual net interest income that would result from the designated instantaneous parallel shift in interest rates noted, as of March 31, 2022. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Actual rates paid on deposits may differ from the hypothetical rates modeled due to competitive or market factors, which could reduce any actual impact on net interest income.


	Increase/(Decrease) in
	Estimated Net
	Interest Income
	Amount		Percent

	(Dollars in thousands)
Change in Interest Rates (basis points)
+400	$	52,129	34.7	%
+300	$	39,086	26.0	%
+200	$	26,071	17.4	%
+100	$	13,035	8.7	%
0		—	—
−100	$	(14,636)	(9.7)	%
−200	$	(25,760)	(17.2)	%

As with any method of gauging interest rate risk, there are certain shortcomings inherent to the methodology noted above. The model assumes interest rate changes are instantaneous parallel shifts in the yield curve. In reality, rate changes are rarely instantaneous. The use of the simplifying assumption that short-term and long-term rates change by the same degree may also misstate historic rate patterns, which rarely show parallel yield curve shifts. Further, the model assumes that certain assets and liabilities of similar maturity or period to repricing will react in the same way to changes in rates. In reality, certain types of financial instruments may react in advance of changes in market rates, while the reaction of other types of financial instruments may lag behind the change in general market rates. Additionally, the methodology noted above does not reflect the full impact of annual and lifetime restrictions on changes in rates for certain assets, such as adjustable rate loans. When interest rates change, actual loan prepayments and actual early withdrawals from certificates may deviate significantly from the assumptions used in the model. Finally, this methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan clients’ ability to service their debt. All of these factors are considered in monitoring the Company’s exposure to interest rate risk.

ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information concerning quantitative and qualitative disclosure or market risk called for by Item 305 of Regulation S-K is included as part of Item 2 above.

ITEM 4—CONTROLS AND PROCEDURES

Disclosure Control and Procedures

The Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of March 31, 2022. As defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed or submitted under the Exchange Act are recorded, processed, summarized and reported on a timely basis. Disclosure controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation, our Chief Executive Officer and Chief Financial Officer concluded the Company’s disclosure controls were effective at March 31, 2022, the period covered by this report on Form 10-Q.

During the three months ended March 31, 2022, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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Part II—OTHER INFORMATION

ITEM 1—LEGAL PROCEEDINGS

We evaluate all claims and lawsuits with respect to their potential merits, our potential defenses and counterclaims, settlement or litigation potential and the expected effect on us. The outcome of any claims or litigation, regardless of the merits, is inherently uncertain. Any claims and other lawsuits, and the disposition of such claims and lawsuits, whether through settlement or litigation, could be time-consuming and expensive to resolve, divert our attention from executing our business plan, result in efforts to enjoin our activities, and lead to attempts by third parties to seek similar claims.

For more information regarding legal proceedings, see Note 13 “Commitments and Loss Contingencies” to the consolidated financial statements.

ITEM 1A—RISK FACTORS

A discussion of risk factors affecting us as is set forth in Part I, Item 1A. Risk Factors, on pages 24 – 50 of our 2021 Annual Report on Form 10-K. The discussion of risk factors provides a description of some of the important risk factors that could affect our actual results and could cause our results to vary materially from those expressed in public statements or documents. However, other factors besides those included in the discussion of risk factors, or discussed elsewhere in any of our reports filed with or furnished to the SEC could affect our business or results. The readers should not consider any description of such factors to be a complete set of all potential risks that we may face.

ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3—DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4—MINE SAFETY DISCLOSURES

None

ITEM 5—OTHER INFORMATION

None

Table of Contents

ITEM 6—EXHIBITS


Exhibit		Description
3.1		Heritage Commerce Corp Restated Articles of Incorporation, (incorporated by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K filed on March 16, 2009)
3.2		Certificate of Amendment of Articles of Incorporation of Heritage Commerce Corp as filed with the California Secretary of State on June 1, 2010 (incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1 filed July 23, 2010).
3.3		Certificate of Amendment of Articles of Incorporation of Heritage Commerce Corp as filed with the Secretary of State on August 29, 2019 (incorporated by reference to Exhibit 3.3 to the Registrant’s Quarterly Report on Form 10-Q filed on November 11, 2019)
3.4		Heritage Commerce Corp Bylaws, as amended (incorporated by reference to the Registrant’s Current Report on Form 8-K filed on June 28, 2013)
31.1		Certification of Registrant’s Chief Executive Officer Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Registrant’s Chief Financial Officer Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Registrant’s Chief Executive Officer Pursuant To 18 U.S.C. Section 1350
32.2		Certification of Registrant’s Chief Financial Officer Pursuant To 18 U.S.C. Section 1350
101.INS		XBRL Instance Document Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH		XBRL Taxonomy Extension Schema
101.CAL		XBRL Taxonomy Extension Calculation Linkbase
101.DEF		XBRL Taxonomy Extension Definition Linkbase
101.LAB		XBRL Taxonomy Extension Label Linkbase
101.PRE		XBRL Taxonomy Extension Presentation Linkbase
104.		The cover page from Heritage Commerce Corp's Quarterly Report on Form 10-Q for the quarter ended March 31, 2022, formatted in Inline XBRL

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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)

Date: May 5, 2022	/s/ wALTER T. KACZMAREK
	Walter T. Kaczmarek
	Chief Executive Officer

Date: May 5, 2022	/s/ Lawrence D. mcgovern
	Lawrence D. McGovern
	Chief Financial Officer

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Heritage Commerce (HTBK) 10-Q2022 Q1 Quarterly report

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