UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1999
Or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transitional period from to
Commission File No.
000-23877
HERITAGE COMMERCE CORP
(Exact name of registrant as specified in its charter)
California 77-0469558
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
150 Almaden Blvd., San Jose, California 95113
(Address of principal executive offices) (Zip Code)
(408) 947-6900
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year, if
changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS:
The Registrant had 6,388,819 shares of Common Stock outstanding on
November 15, 1999.
HERITAGE COMMERCE CORP AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
Table of Contents
Part I - Financial Information Page
Item 1.
Condensed Consolidated Statements of Financial Condition
At September 30, 1999 and December 31, 1998 1
Condensed Consolidated Statements of Income
For the three months and nine months ended September 30, 1999 and 1998 2
Condensed Consolidated Statements of Cash Flows
For the nine months ended September 30, 1999 and 1998 3
Condensed Consolidated Notes to Financial Statements 4
Item 2.
Management's Discussion and Analysis of Financial
Condition and Results of Operations 6
Item 3.
Quantitative and Qualitative Disclosures About Market Risk 18
Part II - Other Information
Item 1.
Legal Proceedings 19
Item 2.
Changes in Securities and Use of Proceeds 19
Item 6.
Exhibits and Reports on Form 8-K 19
Signatures 20
- 1 -
HERITAGE COMMERCE CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Financial Condition
ASSETS
September 30, 1999 December 31, 1998
(Unaudited)
Cash and due from banks $ 18,892,000 $ 18,039,000
Federal funds sold 128,130,000 28,600,000
Total cash and cash equivalents 147,022,000 46,639,000
Securities available-for-sale,
at fair value 23,576,000 50,249,000
Securities held-to-maturity,
at amortized cost
(fair value of $13,791,000 and
$27,240,000, respectively) 13,845,000 26,544,000
Loan held for sale, at fair value 17,373,000 33,079,000
Loans, net of deferred fees 245,411,000 236,307,000
Allowance for loan losses (4,569,000) (3,825,000)
Loans, net 240,842,000 232,482,000
Premises and equipment, net 3,276,000 3,238,000
Accrued interest receivable
and other assets 12,153,000 7,240,000
Other investments 10,487,000 5,460,000
TOTAL $ 468,574,000 $ 404,931,000
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Demand, noninterest bearing $ 120,097,000 $ 120,854,000
Demand, interest bearing 8,209,000 9,035,000
Savings and money market 169,875,000 131,518,000
Time deposits, under $100,000 42,324,000 29,793,000
Time deposits, $100,000 and over 76,145,000 58,847,000
Total deposits 416,650,000 350,047,000
Deposits held for sale --- 18,911,000
Accrued interest payable and
other liabilities 8,294,000 5,276,000
Total liabilities 424,944,000 374,234,000
Commitments and contingencies
Shareholders' equity:
Preferred Stock, 10,000,000 shares
authorized; none outstanding --- ---
Common Stock, no par value;
30,000,000 shares authorized;
Shares issued and outstanding:
6,388,119 at September 30, 1999 and
5,554,552 at December 31, 1998 41,006,000 29,418,000
Accumulated other comprehensive (loss)
income, net of taxes (52,000) 658,000
Retained Earnings 2,676,000 621,000
Total shareholders' equity 43,630,000 30,697,000
TOTAL $ 468,574,000 $ 404,931,000
See notes to condensed consolidated financial statements
- 2 -
HERITAGE COMMERCE CORP AND SUBSIDIARIES
Condensed Consolidated Statements of Income (Unaudited)
Three months ended September 30, Nine months ended September 30,
1999 1998 1999 1998
Interest income:
Loans, including fees $ 6,545,000 $ 5,626,000 $ 18,794,000 $ 13,381,000
Securities, taxable 407,000 1,304,000 1,481,000 3,917,000
Securities, non-taxable 144,000 191,000 463,000 479,000
Federal funds sold 780,000 348,000 1,427,000 860,000
Total interest income 7,876,000 7,469,000 22,165,000 18,637,000
Interest expense:
Deposits 2,634,000 2,348,000 7,006,000 5,355,000
Other 12,000 2,000 22,000 3,000
Total interest expense 2,646,000 2,350,000 7,028,000 5,358,000
Net interest income before provision
for loan losses 5,230,000 5,119,000 15,137,000 13,279,000
Provision for loan losses 356,000 550,000 1,483,000 1,060,000
Net interest income after provision
for loan losses 4,874,000 4,569,000 13,654,000 12,219,000
Other income:
Gain on sale of loans 271,000 50,000 401,000 83,000
Gain on sale of securities
available-for-sale --- 291,000 1,004,000 358,000
Service charges and other fees 84,000 62,000 226,000 161,000
Servicing income 1,180,000 --- 1,180,000 ---
Other investment income 73,000 95,000 201,000 203,000
Other income 194,000 98,000 701,000 165,000
Total other income 1,802,000 596,000 3,713,000 970,000
Other expenses:
Salaries and employee benefits 2,714,000 2,078,000 7,678,000 5,448,000
Client services 362,000 511,000 1,158,000 1,430,000
Furniture and equipment 244,000 236,000 824,000 589,000
Advertising and promotion 215,000 221,000 592,000 588,000
Occupancy 300,000 224,000 793,000 566,000
Professional fees 884,000 97,000 1,129,000 410,000
Loan origination costs 145,000 109,000 401,000 304,000
Stationery & supplies 91,000 73,000 226,000 181,000
Telephone expense 56,000 38,000 159,000 119,000
Other 492,000 561,000 1,292,000 993,000
Total other expenses 5,503,000 4,148,000 14,252,000 10,628,000
Net income before income taxes 1,173,000 1,017,000 3,115,000 2,561,000
Income taxes 420,000 443,000 1,060,000 1,004,000
Net income $ 753,000 $ 574,000 $ 2,055,000 $ 1,557,000
Earnings per share:
Basic $ 0.12 $ 0.10 $ 0.35 $ 0.30
Diluted $ 0.11 $ 0.09 $ 0.31 $ 0.27
See notes to condensed consolidated financial statements
- 3 -
HERITAGE COMMERCE CORP
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months ended September 30,
1999 1998
Cash flows from operating activities:
Net income $ 2,055,000 $ 1,557,000
Adjustments to reconcile net income to
net cash used by operating activities:
Depreciation and amortization 616,000 447,000
Provision for loan losses 1,483,000 1,060,000
Gain on sale of securities
available-for-sale (1,004,000) (358,000)
Net amortization of premiums/
accretion of discounts (179,000) 139,000
Proceeds from sales of loans 4,317,000 358,000
Originations of loans held for sale (9,475,000) (3,203,000)
Maturities of loans held for sale 4,244,000 34,000
Increase in accrued interest
receivable and other assets (6,138,000) (3,264,000)
Decrease in accrued interest
payable and other liabilities 3,487,000 1,969,000
Net cash used by operating activities (594,000) (1,261,000)
Cash flows from investing activities:
Net decrease (increase) in loans 6,777,000 (90,360,000)
Purchases of investment securities
available-for-sale (26,334,000) (25,484,000)
Maturities of investment securities
available-for-sale 15,082,000 12,486,000
Sales of investment securities
available-for-sale 49,512,000 7,635,000
Purchases of investment securities
held-to-maturity --- (8,898,000)
Maturities of investment securities
held-to-maturity 1,115,000 7,617,000
Purchases of corporate owned life insurance (3,801,000) (904,000)
Capital expenditures (654,000) (1,523,000)
Net cash provided by (used by)
investing activities 41,697,000 (99,431,000)
Cash flows from financing activities:
Net increase in deposits 47,692,000 120,892,000
Proceeds from issuance of stock 11,200,000 5,846,000
Proceeds from exercise of stock options 388,000 49,000
Net cash provided by financing activities 59,280,000 126,787,000
Net increase in cash and cash equivalents 100,383,000 26,095,000
Cash and cash equivalents,
beginning of period 46,639,000 43,185,000
Cash and cash equivalents,
end of period $ 147,022,000 $ 69,280,000
Other cash flow information:
Interest paid in cash $ 7,385,000 $ 4,963,000
Income taxes paid in cash $ 1,835,000 $ 1,034,000
See notes to condensed consolidated financial statements
- 4 -
HERITAGE COMMERCE CORP AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 1999
(Unaudited)
1) Basis of Presentation
The unaudited condensed consolidated financial statements of Heritage
Commerce Corp and its wholly owned subsidiaries, Heritage Bank of Commerce
and Heritage Bank East Bay, have been prepared pursuant to the rules and
regulations for reporting on Form 10-Q. Accordingly, certain information and
notes required by generally accepted accounting principles for complete
financial statements are not included herein. The interim statements should
be read in conjunction with the financial statements and notes thereto
included the Company's Form 10-K Annual Report for the year ended December 31,
1998.
In the Company's opinion, all adjustments necessary for a fair presentation
of these condensed consolidated financial statements have been included and
are of a normal and recurring nature. Certain reclassifications have been
made to prior year amounts to conform to current year presentation.
The results for the three months and nine months ended September 30, 1999
are not necessarily indicative of the results expected for any subsequent
period or for the entire year ending December 31, 1999.
2) Share and Per Share Amounts
Earnings per common share (basic) are calculated based on the weighted
average number of shares outstanding during the period. Earnings per common
and common equivalent share (diluted) are calculated based on the weighted
average number of shares outstanding during the period, plus equivalent
shares representing the dilutive effect of stock options using the treasuring
stock method. There was no difference in net income used in the calculation of
basic and diluted earning per share. All share numbers have been restated
for the stock split in February, 1999. Reconciliation of weighted average
shares used earnings per share are as follows:
Three months ended September 30, Nine months ended September 30,
1999 1998 1999 1998
Weighted average common shares outstanding 6,272,202 5,530,522 5,803,809 5,139,054
Diluted effect of stock options outstanding 691,311 643,896 762,083 535,896
Shares used in computing diluted
earnings per share 6,963,513 6,174,418 6,565,892 5,674,950
3) Adoption of FAS 133
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 , "Accounting for Derivative
Instruments and Hedging Activities." The Company adopted the provisions of
SFAS No. 133 effective February 1, 1999. Because of the Company's minimal
use of derivatives, the adoption of SFAS No. 133 did not significantly impact
the Company's earnings or financial position. As allowed by SFAS No. 133 the
Company transferred approximately $11.67 million of certain serurities from the
held-to-maturity to available-for-sale classification. The gross realized
and gross unrealized gains or losses on the securities transferred were not
material to the Company.
- 5 -
4) Comprehensive Income
Comprehensive income includes net income and other comprehensive income.
The Company's only source of other comprehensive income is derived from
unrealized gains and losses on investment securities available-for-sale.
Reclassification adjustments resulting from gains and losses on investment
securities that were realized and included in net income of the current period
that also had been included in other comprehensive income as unrealized
holding gains or losses in the period in which they arose are excluded from
comprehensive income of the current period. The Company's total comprehensive
income was as follows:
The following is a summary of the components of accumulated other
comprehensive income:
For the Three Months Ended For the Nine Months Ended
September 30, 1999 September 30, 1998 September 30, 1999 September 30, 1998
Net Income $ 753,000 $ 574,000 $ 2,055,000 $ 1,557,000
Other comprehensive income, net of tax:
Net unrealized holding gain on securities
available-for-sale during the period 40,000 633,000 294,000 828,000
Less: reclassification adjustment for
realized gains on available-for-sale
securities included in net income
during the period --- (37,000) (1,004,000) (104,000)
Other comprehensive income (loss) 40,000 596,000 (710,000) 724,000
Comprehensive income $ 793,000 $ 1,170,000 $ 1,345,000 $ 2,281,000
5) Business Acquisition
On September 21, 1999, the Company, through its wholly owned subsidiary
Heritage Bank of Commerce signed a definitive agreement to acquire Business
Factors, Inc. ("BFI") for $11,000,000. Pending required regulatory approval,
the transaction is expected to close during the fourth quarter of 1999.
BFI specializes in accounts receivable financing, inventory loans,
equipment term loans, factoring, and other types of business loans.
BFI is expected to operate as a subsidiary of Heritage Bank of Commerce.
The operations of the Heritage Capital Group, a division of Heritage Bank of
Commerce, which provides asset-based financing and factoring, are expected to
be combined with those of BFI.
- 6 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Net income for the quarter and nine months ended September 30, 1999 was
$753,000 and $2,055,000, or $0.11 and $0.31 per diluted share, as compared to
net income of $574,000 and $1,557,000, or $0.09 and $0.27 per diluted share,
for the same period in 1998. The increase was attributable to the sale of the
Internet credit card business as well as the growth in the level of average
earning assets overall, and of loans in particular. Return on average assets
annualized for the first nine months of 1999 and 1998 was 0.72% and 0.67%.
Annualized return on average equity for the first nine months of 1999 was
8.06%, compared to 8.46% for the first nine months of 1998.
Average interest earning assets for the quarter and nine months ended
September 30, 1999 were up $45,208,000 and $63,951,000, or 14% and 23% over
1998, with much of the increase primarily attributable to growth in loans.
The average rate earned on loans in the third quarter and nine months of 1999
was 9.95% and 9.84%, compared to 11.53% and 11.14% in the third quarter and
nine months of 1998. The average rate on earning assets was 8.54% and 8.63%
for the quarter and nine months ended September 30, 1999, compared to 9.24% and
8.91% for the quarter and nine months ended September 30, 1998.
Average interest bearing liabilities increased $38,067,000 and
$56,474,000, or 17% and 31% from three months and nine months ended September
30, 1998 compared to the same periods in 1999, with the increase attributable
to growth in interest bearing demand deposits, saving and money market
accounts, and growth in time deposits. The average rate paid on interest
bearing liabilities was 4.10% and 3.94% at the three and nine months ended
September 30, 1999, compared to 4.28% and 3.94% in the three and nine months
ended September 30, 1998. The Company's net interest margin was 5.67% and
5.89% in the third quarter and nine months ended September 30, 1999, compared
with 6.34% both in the third quarter and the nine months ended September 30,
1998.
The Company's non-performing assets were $1,187,000 at September 30,
1999, compared to $1,288,000 at December 31, 1998.
Shareholders' equity increased $12,933,000 to $43,630,000, or 9.31% of
assets, at September 30, 1999, from $30,697,000 or 7.58% of assets, at
December 31, 1998, due to the Company selling 758,138 new shares of stock at
a price of $15.00 per share for the period ending September 30, 1999. The
Company's Tier 1 and total risk-based capital ratios were 12.6% and 13.9% at
September 30, 1999, compared to 9.2% and 10.4%, respectively, at December 31,
1998. Due to the stock offering closed in the quarter ended September 30,
1999, the Company's leverage capital ratio stood at 10.7% at September 30,
1999. This compares with a leverage ratio of 7.5% at December 31, 1998 and
8.3% at September 30, 1999.
- 7 -
RESULTS OF OPERATIONS
Net Interest Income and Net Interest Margin
The following table presents the Company's average balance sheet, net interest
income and the resultant yields for the periods presented:
For the three months ended September 30,1999 For the three months ended September 30,1998
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
(Dollars in thousands) Balance Expense Rate Balance Expense Rate
Assets:
Loans, gross $ 260,884 $ 6,545 9.95% $ 193,541 $ 5,626 11.53%
Investments securities 43,220 551 5.06% 101,324 1,495 5.85%
Federal fund sold 61,675 780 5.02% 25,706 348 5.37%
Total interest earning assets 365,779 $ 7,876 8.54% 320,571 $ 7,469 9.24%
Cash and due from banks 18,128 20,680
Premises and equipment, net 3,177 3,038
Other assets 20,093 7,562
Total assets $ 407,177 $ 351,851
Liabilities and shareholders'equity:
Deposits
Demand, interest bearing $ 8,751 $ 28 1.27% $ 7,822 $ 38 1.93%
Savings and money market 129,283 1,095 3.36% 131,499 1,269 3.83%
Time deposits, less than $100,000 41,261 549 5.28% 18,575 253 5.40%
Time deposits, $100,000 and over 64,310 790 4.87% 55,599 721 5.14%
Brokered deposits 11,913 173 5.76% 4,111 67 6.47%
Other borrowings 304 11 14.32% 149 2 5.74%
Total interest bearing liabilities 255,822 $ 2,646 4.10% 217,755 $ 2,350 4.28%
Demand deposits 105,924 102,612
Other liabilities 5,671 3,506
Total liabilities 367,417 323,873
Shareholders' equity 39,760 27,978
Total liabilities and
shareholders' equity $ 407,177 $ 351,851
Net interest income / margin $ 5,230 5.67% $ 5,119 6.34%
Note: Yields and amounts earned on loans include loan fees of $531,000 and
$407,000 for the three month periods ended September 30, 1999 and 1998,
respectively.
For the Nine Months Ended September 30,1999 For the Nine Months Ended September 30,1998
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
(Dollars in thousands) Balance Expense Rate Balance Expense Rate
Assets:
Loans, gross $ 255,228 $ 18,794 9.84% $ 160,640 $ 13,381 11.14%
Investments securities 48,946 1,944 5.31% 97,609 4,396 6.02%
Federal funds sold 39,336 1,427 4.85% 21,310 860 5.40%
Total interest earning assets 343,510 $ 22,165 8.63% 279,559 $ 18,637 8.91%
Cash and due from banks 16,867 20,618
Premises and equipment, net 3,182 2,719
Other assets 16,482 6,450
Total assets $ 380,041 $ 309,346
Liabilities and shareholders' equity:
Deposits:
Demand, interest bearing $ 9,493 $ 102 1.44% $ 6,989 $ 100 1.91%
Savings and money market 125,748 3,022 3.21% 113,541 2,915 3.43%
Time deposits, less than $100,000 35,687 1,406 5.27% 11,967 460 5.14%
Time deposits, $100,000 and over 59,011 2,130 4.83% 48,089 1,814 5.04%
Brokered deposits 8,092 346 5.72% 1,385 66 6.40%
Other borrowings 469 22 6.25% 55 3 6.17%
Total interest bearing liabilities 238,500 $ 7,028 3.94% 182,026 $ 5,358 3.94%
Demand deposits 101,720 99,913
Other liabilities 5,748 2,782
Total liabilities 345,968 284,721
Shareholders' equity 34,073 24,625
Total liabilities and
shareholders' equity $ 380,041 $ 309,346
Net interest income / margin $ 15,137 5.89% $ 13,279 6.34%
Note: Yields and amounts earned on loans include loan fees of $1,463,000 and
$1,046,000 for the nine month periods ended September 30, 1999 and 1998,
respectively.
- 8 -
The Company's net interest income for the third quarter and nine months
end of 1999 was $5,230,000 and $15,137,000, an increase of $111,000 and
$1,858,000 over the third quarter and nine months end of 1998. When compared
to the third quarter and nine months end of 1998, average earning assets
increased by $45,208,000 and $63,951,000. The net yield on average earning
assets was 5.67% and 5.89% in the third quarter and the first nine months of
1999, compared to 6.34% both in the third quarter and the first nine months of
1998
The following table sets forth an analysis of the changes in interest
income and increase in the volume of interest earning liabilities balanceed by
a decrease in the average rate earned and paid. The total change is shown in
the column designated "Net Change" and is allocated in the columns to the
left, to the portions respectively attributable to volume changes and rate
changes that occurred during the period indicated. Changes due to both
volume and rate have been allocated between the volume and rate categories in
proportion to the relationship of the changes due solely to the changes in
volume and rate, respectively.
Three Months Ended September 30
1999 vs. 1998
Increase (Decrease) Due to Change In:
Average Average Net
(Dollars in thousands) Volume Rate Change
Interest earning assets
Loans, gross $ 1,691 $ (772) $ 919
Investments securities (741) (203) (944)
Federal funds sold 455 (23) 432
Total interest earning assets $ 1,405 $ (998) $ 407
Interest bearing liabilities
Demand, interest bearing $ 3 $ (13) $ (10)
Money Market and Savings (19) (155) (174)
Time deposits, less than $100,000 302 (6) 296
Time deposits, $100,000 and over 108 (39) 69
Brokered Deposits 113 (7) 106
Other borrowings 6 3 9
Total interest bearing liabilities $ 513 $ (217) $ 296
Net interest income $ 892 $ (781) $ 111
Nine Months Ended September 30
1999 vs. 1998
Increase (Decrease) Due to Change In:
Average Average Net
(Dollars in thousands) Volume Rate Change
Interest earning assets
Loans, gross $ 6,971 $ (1,558) $ 5,413
Investments securities (1,933) (519) (2,452)
Federal funds sold 654 (87) 567
Total interest earning assets $ 5,692 $ (2,164) $ 3,528
Interest bearing liabilities
Demand, interest bearing $ 27 $ (25) $ 2
Money Market and Savings 296 (189) 107
Time deposits, less than $100,000 934 12 946
Time deposits, $100,000 and over 393 (77) 316
Brokered Deposits 287 (7) 280
Other borrowings 19 0 19
Total interest bearing liabilities $ 1,956 $ (286) $ 1,670
Net interest income $ 3,736 $ (1,878) $ 1,858
Provision for Loan Losses
During the third quarter of 1999, the provision for loan losses was
$356,000, down $194,000 from $550,000 for the third quarter of 1998, due to
the sale of Internet credit card portfolio.
- 9 -
Noninterest Income
The following table sets forth the various components of the Company's
noninterest income for the periods indicated:
Three months ended Increase
September 30 1999 versus 1998
(Dollars in thousands) 1999 1998 Amount Percent
Gain of sale of loans $ 271 $ 50 $ 211 442%
Gain on sale of securities
available-for-sale --- 291 (291) (100%)
Service charges and other fees 84 62 22 35%
Servicing income 1,180 --- 1,180 ---
Other investment income 73 95 (22) (23%)
Other income 194 98 96 98%
Total $ 1,802 $ 596 $ 1,206 202%
Nine months ended Increase
September 30 1999 versus 1998
(Dollars in thousands) 1999 1998 Amount Percent
Gain on sale of loans $ 401 $ 83 $ 318 383%
Gain on sale of securities
available-for-sale 1,004 358 646 180%
Service charges and other fees 226 161 65 40%
Servicing income 1,180 --- 1,180 ---
Other investment income 201 203 (2) (1%)
Other income 701 165 536 325%
Total $ 3,713 $ 970 $ 2,743 283%
Noninterest income for the third quarter and the first nine months
ended September 30, 1999 was $1,802,000 and $3,713,000, up $1,206,000, or
202%, and $2,743,000, or 283%, from $596,000 and $970,000 for the third
quarter and the nine months ended September 30, 1998. For the nine month
period, this increase was primarily the result of gains recognized on the
sale of securities available-for-sale and the sale of the Company's Internet
credit card portfolio.
Noninterest Expense
The following table sets forth the various components of the Company's
noninterest expenses for the periods indicated:
For The Three Months Ended September 30,
Percent
Increase Increase
(Dollars in thousands) 1999 1998 (Decrease)(Decrease)
Salaries and benefits $ 2,714 $ 2,078 $ 636 31%
Client services 362 511 (149) (29%)
Furniture and equipment 244 236 8 3%
Occupancy 300 224 76 34%
Advertising and promotion 215 221 (6) (2%)
Loan origination costs 145 109 36 33%
Professional fees 884 97 787 811%
Stationery & Supplies 91 73 18 25%
Telephone expense 56 38 18 47%
All other 492 561 (69) (12%)
Total $ 5,503 $ 4,148 $ 1,355 33%
- 10 -
For The Nine Months Ended September 30,
Percent
Increase Increase
(Dollars in thousands) 1999 1998 (Decrease)(Decrease)
Salaries and benefits $ 7,678 $ 5,448 $ 2,230 41%
Client services 1,158 1,430 (272) (19%)
Furniture and equipment 824 589 235 40%
Occupancy 793 566 227 40%
Advertising and promotion 592 588 4 1%
Loan origination costs 401 304 97 32%
Professional fees 1,129 410 719 175%
Stationery & Supplies 226 181 45 25%
Telephone expense 159 119 40 34%
All other 1,292 993 299 30%
Total $ 14,252 $ 10,628 $ 3,624 34%
Noninterest expenses for the third quarter of 1999 were $5,503,000,
up $1,355,000, or 33%, from $4,148,000 for the third quarter of 1998.
Noninterest expenses for the first nine months of 1999 were $14,252,000, up
$3,624,000,or 34%, from $10,628,000 for the first nine months of 1998, to
support the Company's loan and deposit growth and the opening of a branch
office in the South Valley in city of Morgan Hill, California.
Noninterest expenses consist primarily of salaries and employee benefits
(49% and 50% of total noninterest expenses for the third quarter of 1999 and
1998, respectively; 54% and 51% of total noninterest expenses for the nine
months ended September 30, 1999 and 1998, respectively) and client services
(7% and 12% of total non-interest expenses for the third quarter of 1999 and
1998, respectively; 8% and 13% of total noninterest expenses for the first
nine months of 1999 and 1998, respectively). The increase in salaries and
benefits expenses was primarily attributable to an increase in the number of
employees. The Company employed 135 people at September 30,1999, up 17 from
118 at September 30, 1998. Client services expenses included courier and
armored car costs, imprinted check costs, and other client services costs, all
of which are directly related to the amount of funds on deposit in accounts at
the Company. Due to lower balances in these accounts in the third quarter of
1999, the expense was less than the previous year. The increase in furniture
and equipment expenses and in occupancy expenses was primarily attributable
to an increase in the number of employees and new banking locations. The
increase in professional fees is primarily due to consultants the Company has
used for a variety of ongoing projects.
Income Taxes
The provision for income taxes for the nine months ended September 30,
1999 was $1,060,000 as compared to $1,004,000 for the same period in 1998.
The effecitve income tax rate for the state and federal income taxes for the
nine months ended September 30, 1999 was 34.0% as compared to 39.2% for the
same period in 1998. The difference in the effecitve tax rate compared to
the statutory tax rate and the reduction in the effective tax rate is primarily
the result of the Company holding certain life insurance contracts and the
Company's investment in municipal securities.
- 11 -
FINANCIAL CONDITION
Total assets increased 17% to $468,574,000 at September 30, 1999,
compared to $399,079,000 at September 30, 1998. The growth was primarily due
to increases in the Company's cash and cash equivalents and loan portfolio
funded by growth in deposits offset by decreases in investment securities.
Securities Portfolio
The following table summarizes the composition of the Company's
investment securities and the weighted average yields at September 30, 1999:
September 30, 1999
Maturity
After One Year After Five Years Total
Within and Within and Within After Amortized
One Year Five Years Ten Years Ten Years Cost
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
Securities available-for-sale:
U.S. Treasury $ 10,033 4.79% $ 8,119 5.28% $ --- --- $ --- --- $ 18,152 5.01%
Municipals - taxable --- --- 420 6.51% --- --- --- --- 420 6.51%
Municipals - non-taxable --- --- --- --- 3,485 4.71% 1,579 4.78% 5,064 4.73%
Total available-for-sale $ 10,033 4.79% $ 8,539 5.34% $ 3,485 4.71% $1,579 4.78% $ 23,636 4.98%
Securities held-to-maturity:
Municipals - taxable $ 1,880 6.30% $ 4,030 6.54% $ 515 6.45% $ --- --- $ 6,425 6.46%
Municipals - non taxable --- --- 461 4.86% 5,841 4.50% 1,118 4.59% 7,420 4.54%
Total held-to-maturity $ 1,880 6.30% $ 4,491 6.37% $ 6,356 4.66% $1,118 4.59% $ 13,845 5.43%
Total securities $ 11,913 5.03% $ 13,030 5.69% $ 9,841 4.68% $2,697 4.70% $ 37,481 5.14%
Note: Yield on non-taxable municipal securities are not presented in a
fully tax equivalent basis.
Loans
Total gross loans increased 4% to $245,411,000 at September 30, 1999, as
compared to $236,307,000 at December 31, 1998. The increase in loan balances
was due to the business development efforts of the Company's loan teams.
The following table indicates the Company's loan portfolio for the
periods indicated:
(Dollars in thousands) September 30, 1999 % of Total December 31, 1998 % of Total
Commercial $ 105,543 43% $ 79,567 34%
Real estate - mortgage 69,246 28% 57,216 24%
Real estate - land and construction 68,662 28% 49,270 21%
Consumer 2,022 1% 50,349 21%
Total loans 245,473 100% 236,402 100%
Deferred loan fees (62) (95)
Allowance for loan losses (4,569) (3,825)
Loans, net $ 240,842 $ 232,482
The change in the Company's loan portfolio is primarily due to the
increase in the commercial and real estate loan portfolio offset by a decline
in the consumer portfolio resulting from the sale of the Internet credit
card portfolio.
- 12 -
The Company's loan portfolio is based in commercial (primarily to
companies engaged in manufacturing, wholesale, and service businesses) and
real estate lending, with the balance in consumer loans. However, while no
specific industry concentration is considered significant, the Company's
lending operations are located in the Company's market areas that are
dependent on the technology and real estate industries and their supporting
companies. Thus, the Company's borrowers could be adversely impacted by a
downturn in these sectors of the economy which could reduce the demand for
loans and adversely impact the borrowers' abilities to repay their loans.
In February 1998, the Company entered into a contract with Internet Access
Financial Corporation to provide a credit card over the Internet. The
customers for the credit cards were not limited to Northern California, the
Companys' primarily market area, as the product was available to anyone
across the country. The growth in 1998 in the consumer loan portfolio was
attributable to the introduction of this Internet credit card. As noted in
the above table, the consumer loans category declined from $50,349,000 at
December 31, 1998 to $2,022,000 at September 30, 1999 as a result of the sale
of the Internet credit card portfolio.
The Company has continued its relationship with Internet Access Financial
Corporation as a provider of certain administrative services to them in
conjunction with the issuance of credit cards.
The following table sets forth the maturity distribution of the Company's
loans at September 30, 1999:
Over One Year
Due in One But Less Than Over
(Dollars in thousands) Year or Less Five Years Five Years Total
Commercial $ 98,739 $ 6,574 $ 168 $ 105,481
Real estate - mortgage 31,960 20,882 16,404 69,246
Real estate - land and construction 68,662 --- --- 68,662
Consumer 1,089 920 13 2,022
Total loans $ 200,450 $ 28,376 $ 16,585 $ 245,411
Loans with variable interest rates $ 190,360 $ 10,060 $ 307 $ 200,727
Loans with fixed interest rates 10,090 18,315 16,279 44,684
Total $ 200,450 $ 28,375 $ 16,586 $ 245,411
Note: Total shown is net of deferred loan fees of $62,000 at September 30,
1999.
The table shows the distribution of such loans between those loans with
predetermined (fixed) interest rates and those with variable (floating)
interest rates. Floating rates generally fluctuate with changes in the prime
rate as reflected in the western edition of The Wall Street Journal. At
September 30, 1999, approximately 82% of the Company's loan portfolio
consisted of floating interest rate loans.
Allowance for Loan Losses
Management conducts a critical evaluation of the loan portfolio monthly.
This evaluation includes an assessment of the following factors: past loan
loss experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower's ability to repay, collateral value,
loan volumes and concentrations, recent loss experience in particular segments
of the portfolio, bank regulatory examination results, and current economic
conditions. Management has established an evaluation process designed to
determine the adequacy of the allowance for loan losses. This process
attempts to assess the risk of loss inherent in the portfolio by segregating
the allowance for loan losses into four components:"watch", "special mention",
"substandard"and "doubtful".
It is the policy of management to maintain the allowance for loan losses
at a level adequate for known and future risks inherent in the loan
portfolio. Based on information currently available to analyze loan loss
delinquency and a history of actual charge-offs, management believes that the
loan loss provision and allowance are adequate; however, no assurance of the
ultimate level of credit losses can be given with any certainty. Loans are
charged against the allowance when management believes that the collectibility
of the principal is unlikely.
- 13 -
The following table summarizes the Companys' loan loss experience as well
as transactions in the allowance for loan losses and certain pertinent
ratios for the periods indicated:
Nine months ended Year ended
September 30, December 31,
(Dollars in thousands) 1999 1998 1998
Balance, beginning of period / year $ 3,825 $ 2,884 $ 2,285
Charge-offs (797) (35) (173)
Less recoveries 58 3 137
Net loans charged-off (739) (32) (36)
Provision for loan losses 1,483 550 1,576
Balance, end of period / year $ 4,569 $ 3,402 $ 3,825
Ratios:
Net charge-offs to
average loans outstanding 0.31% 0.02% 0.02%
Allowance for loan losses
to average loans 1.89% 2.37% 2.11%
Allowance for loan losses to total loans 1.86% 1.67% 1.62%
Allowance for loan losses
to non-performing loans 385% --- 297%
The increase in charge-offs relates primarily to the Company's consumer
credit card portfolio.
The following table summarizes the allocation of the allowance for loan
losses (ALL) by loan type and the allocated allowance as a percent of loans
outstanding in each loan category at the dates indicated:
September 30, 1999 September 30, 1998 December 31, 1998
Percent of ALL Percent of ALL Percent of ALL
in each category in each category in each category
(Dollars in thousands) Amount to total loans Amount to total loans Amount to total loans
Commercial $ 2,196 2.08% $ 1,486 2.19% $ 1,567 1.98%
Real estate - mortgage 293 0.42% 219 0.37% 224 0.39%
Real estate - land and construction 1,064 1.55% 776 1.93% 815 1.65%
Consumer 28 1.37% 458 1.27% 1,146 2.28%
Unallocated 988 --- 463 --- 73 ---
Total $ 4,569 1.86% $ 3,402 1.67% $ 3,825 1.62%
The increase in the allowance for loan losses reflects increasing on a
percentage basis the reserve for the Company's commercial and real estate loan
portfolio. It also reflects the increase in non-performing assets in the
general loan portfolio.
- 14 -
Deposits
Deposits totaled $416,650,000 at September 30, 1999, an increase of 19%,
as compared to total deposits of $350,047,000 at December 31, 1998. The
increase in deposits was primarily due to increases in saving and money
market accounts and time deposit accounts. Noninterest bearing deposits were
$120,097,000 at September 30, 1999, compared to $120,854,000 at December 31,
1998. Interest bearing deposits were $296,553,000 at September 30, 1999, an
increase of 29% as compared to $229,193,000 at December 31, 1998
The following table summarizes the distribution of average deposits and
the average rates paid for the periods indicated:
Nine months ended Year ended
September 30, 1999 December 31, 1998
Average Average Average Average
(Dollars in thousands) Balance Rate Paid Balance Rate Paid
Demand, non-interest bearing $ 101,720 --- $ 102,834 ---
Demand, interest bearing 9,493 1.44% 7,368 1.85%
Saving and money market 125,748 3.21% 122,157 3.46%
Time deposits less than $100,000 35,687 5.27% 16,638 5.28%
Time deposits, $100,000 and over 59,011 4.83% 48,861 5.04%
Brokered deposits 8,092 5.72% 3,826 5.87%
Total average deposits $ 339,751 2.76% $ 301,684 2.63%
Deposit Concentration and Deposit Volatility
The following table indicates the maturity schedule of the Company's
time deposits of $100,000 or more as of September 30, 1999.
(Dollars in thousands) Balance % of Total
Three months or less $ 30,436 40%
Over three months through twelve months 42,723 56%
Over twelve months 2,986 4%
Total $ 76,145 100%
The Company focuses primarily on servicing business accounts that are
frequently over $100,000 in average size. Certain types of accounts that
the Company makes available are typically in excess of $100,000 in average
balance per account, and certain types of business clients whom the Company
serves typically carry deposits in excess of $100,000 on average. The
account activity for some account types and client types necessitates
appropriate liquidity management practices by the Company to ensure its
ability to fund deposit withdrawals.
Interest Rate Risk
The planning of asset and liability maturities is an integral part of the
management of an institution's net yield. To the extent maturities of assets
and liabilities do not match in a changing interest rate environment, net
yields may change over time. Even with perfectly matched repricing of assets
and liabilities, risks remain in the form of prepayment of loans or
investments or in the form of delays in the adjustment of rates of interest
applying to either earning assets with floating rates or to interest bearing
liabilities. The Company has generally been able to control its exposure to
changing interest rates by maintaining primarily floating interest rate loans
and a majority of its time certificates with relatively short maturities.
- 15 -
The following table sets forth the interest rate sensitivity of the
Company's interest-earning assets and interest-bearing liabilities at
September 30, 1999, using the rate sensitivity gap ratio. For purposes of
the following table, an asset or liability is considered rate-sensitive
within a specified period when it can be repriced or when it is scheduled to
mature within the specified time frame:
Within Due in Three Due After
Three to Twelve One to Five Due After Not Rate-
(Dollars in thousands) Months Months Years Five Years Sensitive Total
Interest earning assets:
Federal funds sold $ 128,130 $ --- $ --- $ --- $ --- $ 128,130
Securities 7,018 4,883 13,006 12,514 --- 37,421
Total loans 204,556 13,266 28,375 16,587 --- 262,784
Total interest earning assets 339,704 18,149 41,381 29,101 --- 428,335
Cash and due from banks 18,892 18,892
Other assets 21,347 21,347
Total assets $ 339,704 $ 18,149 $ 41,381 $ 29,101 $ 40,239 $ 468,574
Interest bearing liabilities:
Demand, interest bearing $ 8,209 $ --- $ --- $ --- $ --- $ 8,209
Savings and money market 169,875 --- --- --- --- 169,875
Time deposits 39,705 72,229 6,535 --- --- 118,469
Total interest bearing liabilities 217,789 72,229 6,535 --- --- 296,553
Noninterest demand deposits 43,839 --- --- --- 76,258 120,097
Other liabilities 8,294 8,294
Shareholders' equity 43,630 43,630
Total liabilities and shareholders' equity $ 261,628 $ 72,229 $ 6,535 --- $128,182 $ 468,574
Interest rate sensitivity GAP $ 78,076 $ (54,080) $ 34,846 $ 29,101 $(87,943) ---
Cumulative interest rate sensitivity GAP $ 78,076 $ 23,996 $ 58,842 $ 87,943 --- ---
Cumulative interest rate sensitivity
GAP ratio 16.66% 5.12% 12.56% 18.77%
The foregoing table demonstrates that the Company had a positive
cumulative one year gap of $24 million, or 5.12% of total assets, at
September 30, 1999. In theory, this would indicate that $24 million more in
assets than liabilities would reprice if there was a change in interest rates
over the next year. If interest rates were to increase, the positive gap
would tend to result in a higher net interest margin. However, changes in
the mix of earning assets or supporting liabilities can either increase or
decrease the net margin without affecting interest rate sensitivity. This
characteristic is referred to as a basis risk and, generally, relates to the
repricing characteristics of short-term funding sources such as certificates
of credit.
Varying interest rate environments can create unexpected changes in
prepayment levels of assets and liabilities which are not reflected in the
interest sensitivity analysis table. These prepayments may have significant
effects on the Company's net interest margin. Because of these factors, an
interest sensitivity gap report may not provide a complete assessment of the
Company's exposure to changes in interest rates.
Liquidity and Liability Management
To meet liquidity needs, the Company maintains a portion of its funds in
cash deposits in other banks, in Federal funds sold, and in investment
securities. At September 30, 1999, the Company's primary liquidity ratio
was 38.39%, comprised of $18.5 million in investment securities
available-for-sale with maturity (or probable calls) of up to five years,
less $9.0 million of securities that were pledged to secure public and
certain other deposits as required by law and contract; Federal funds sold of
$128.1 million, and $18.9 million in cash and due from banks, as a percentage
of total unsecured deposits of $407.7 million.
- 16 -
Capital Resources
The following table summarizes risk-based capital, risk-weighted assets,
and risk-based capital ratios of the Company:
September 30, December 31,
(Dollars in thousands) 1999 1998 1998
Capital components:
Tier 1 Capital $ 43,531 $ 29,246 $ 29,850
Tier 2 Capital 4,313 3,402 3,825
Total risk-based capital $ 47,844 $ 32,648 $ 33,675
Risk-weighted assets $ 344,751 $ 290,383 $ 323,699
Average assets $ 406,686 $ 351,727 $ 399,092
Minimum
Regulatory
Requirements
Capital ratios:
Total risk-based capital 13.9% 11.2% 10.4% 8.0%
Tier 1 risk-based capital 12.6% 10.1% 9.2% 4.0%
Leverage ratio (1) 10.7% 8.3% 7.5% 4.0%
(1) Tier 1 capital divided by average assets (excluding goodwill).
The Company completed a public stock offering on August 16, 1999 resulting
in an increase of $11,200,000 net of issuance cost in equity. The Company
sold 758,138 new shares at a price of $15.00 per share.
Year 2000
The possible inability of computers, software, and other equipment
utilizing microprocessors to recognize and properly process data fields
containing a two-digit year is commonly referred to as the year 2000 problem.
On January 1, 2000, such systems may be unable to accurately process certain
date-based information.
This discussion of the implications of the year 2000 problem for the
Company contains numerous forward-looking statements based on inherently
uncertain information. The cost of the project and the date on which the
Company plans to complete the internal year 2000 modifications are based on
management's best estimates of future events. The Company cannot guarantee
these estimates and actual results could differ. Although management
believes it will be able to make the necessary modifications in advance,
failure to modify the systems may have a material adverse effect on the
Company.
The Company has developed a plan to assess its year 2000 preparedness,
consisting of the following phases:
- - Awareness of the year 2000 problems
- - Risk assessment of internal and external systems
- - Renovation of problems found in the risk assessment phase
- - Validation of renovated systems
- - Implementation of validated systems
- 17 -
Resolution of the year 2000 problem is among the Company's highest
priorities, and the Company is preparing for the century change with a
comprehensive enterprise-wide year 2000 program. The Company has identified
all of the major systems and has employed external and internal resources to
renovate and test the systems. The Company is testing purchased software and
systems supported by external parties as part of the program. The Company is
evaluating customers and vendors that have significant relationships with the
Company to determine whether they are adequately preparing for the year 2000.
In addition, the Company is developing contingency plans to reduce the impact
of some potential events that may occur. The Company cannot guarantee,
however, that the systems of vendors or customers with whom it does business
will be completed on a timely basis, or that contingency plans will shield
operations from failures that may occur.
The Company identified over 90 individual year-2000 projects. The
projects varied in size, importance and materiality, from large undertakings,
such as remediating complicated data systems, to smaller, but still
important, projects such as installing compliant computer utility systems.
All of the projects identified have been completed.
The Company assigned projects a priority, indicating the importance of
the function to the Company's continuing operation. This prioritization
facilitated reporting on projects based on their relative importance. The
Company prioritized projects as "High Priority - In House", "High Priority -
Not In House" and "Medium Priority". Both High Priority categories have
projects classified as "Mission Critical".
Mission Critical projects are defined as:
- - systems vital to the continuance of a broad core business activity;
- - functions, the interruption of which for longer than 3 days would threaten
the Company's viability; or
- - functions that provide the environment and infrastructure necessary to
continue the broad core business activities.
Testing of all mission critical systems was complete as of March 12, 1999
and the Company has completed a follow-up assessment of many of its clients'
year 2000 preparedness. Currently, the Company's focus is on vendor
follow-up and contingency plans. The Company has communicated with all
vendors with whom it does significant business to determine their year 2000
compliance readiness and the extent to which the Company is vulnerable to any
third-party year 2000 risks. All the vendors that present year 2000 risks
have completed or are substantially complete with their testing. The
Company does not significantly rely on "embedded technology" in its critical
processes. Most building systems in the Company's main offices use mechanical
systems rather than embedded technology and therefore do not pose any year
2000 risk.
Risks
The principal risks associated with the year 2000 problem can be grouped
into three categories:
- - the Company does not successfully ready its operations for the next century,
- - disruption of the Company's operations due to operational failures of third
parties, and
- - business interruption among fund providers and obligors such that expected
funding and repayment does not take place
The only risk largely under the Company's control is preparing the
Company's internal operations for the year 2000. The Company, like other
financial institutions, is heavily dependent on its computer systems. The
complexity of these systems and their interdependence make it impractical to
convert to alternative systems without interruptions if necessary
modifications are not completed on schedule. The Company believes it has
made all modifications necessary to continue operations into and beyond the
Year 2000.
- 18 -
Failure of third parties may jeopardize the Company's operations, but the
seriousness of this risk depends on the nature and duration of the failures.
The most serious impact on the Company's operations from vendors would result
if basic services such as telecommunications, electric power, and services
provided by other financial institutions and governmental agencies were
disrupted. Some public disclosure about readiness preparation among basic
infrastructure and other suppliers is now available. The Company is unable,
however, to estimate the likelihood of significant disruptions among its
basic infrastructure suppliers. In view of the unknown probability of
occurrence and impact on its operations, the Company considers the loss of
basic infrastructure services to be the most reasonably likely worst case
year 2000 scenario.
Operational failures among the Company's customers could affect their
ability to continue to provide funding or meet obligations when due. The
information the Company develops in the customer assessments described
earlier allows the Company to identify those customers that exhibit a risk of
not making adequate preparations for the century change. The Company is
taking appropriate actions to manage these risks.
Contingency Plans
The Company has developed a business resumption contingency plans for the
year 2000. Business resumption contingency plans address the actions that
the Company would take if critical business functions cannot be carried out
in the normal manner upon entering the next century due to system or supplier
failure.
Cost
The total cost to the Company of year 2000 compliance issues, which
includes testing, system replacement and any anticipated lost revenue, has
been approximately $30,000 and is not anticipated to increase substantially
through the completion of all projects. These costs and the date on which
the Company plans to complete the year 2000 modifications and testing process
are based on management's best estimates, which were derived utilizing
numerous assumptions of future events including the continued availability of
certain resources, third-party modification plans, and other factors. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ from those plans.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
No material changes have occurred during the quarter to the Company's
market risk profile or information. For further information refer to the
Company's annual report on Form 10-K.
- 19 -
Part II - Other Information
Item 1. - Legal Proceedings
To the best of the Company's knowledge, there are no pending legal
proceedings to which the Company is a party which may have a materially
adverse effect on the Company's financial condition, results of operations,
or cash flows.
Item 2. - Changes in Securities and Use of Proceeds
On August 16, 1999, the Company completed a public offering. The
Company sold 758,138 new shares at a price of $15.00 per share.
Item 6. - Exhibits and Reports on Form 8-K
(a) Exhibits included with this filing:
Exhibit Number Name
10.1 Executive Indexed Compensation Benefits Agreement and
The Split Dollar Agreement with John E. Rossell
10.2 Executive Indexed Compensation Benefits Agreement and
The Split Dollar Agreement with Richard L. Conniff
10.3 Executive Indexed Compensation Benefits Agreement and
The Split Dollar Agreement with Brad L. Smith
10.4 Form of Director Agreement
10.5 Form of Director Surrogate Agreement
27.1 Financial Data Schedule
(b) Reports on Form 8-K
On September 21, 1999 the Company filed Form 8-K to report the signing
of a definitive agreement to acquire Business Factors, Inc.
On September 25, 1999, the Company filed its quarterly earnings press
release with the SEC on Form 8-K.
- 20 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Heritage Commerce Corp
(Registrant)
November 15, 1999 /s/ John E. Rossell
Date John E. Rossell, III, President and CEO
November 15, 1999 /s/ Lawrence D. McGovern
Date Lawrence D. McGovern, Chief Financial Officer