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Heritage Commerce Corp Reports Strong Third Quarter 2016 Earnings of $6.8 Million

SAN JOSE, Calif., Oct. 27, 2016 (GLOBE NEWSWIRE) -- Heritage Commerce Corp (Nasdaq:HTBK), the holding company (the “Company”) for Heritage Bank of Commerce (the “Bank”), today reported net income increased 96% to $6.8 million, or $0.18 per average diluted common share, for the third quarter of 2016, compared to $3.5 million, or $0.10 per average diluted common share for the third quarter of 2015, and decreased 7% from $7.3 million, or $0.19 per average diluted common share for the second quarter of 2016. The second quarter of 2016 included a $1.0 million pre-tax gain from company-owned life insurance.

For the nine months ended September 30, 2016, net income was a record $20.2 million, or $0.53 per average diluted common share, an increase of 67% from $12.1 million, or $0.36 per average diluted common share, for the nine months ended September 30, 2015. All results are unaudited and the 2015 balances include the costs from the acquisition of Focus Business Bank (“Focus”) which was completed on August 20, 2015 (the “acquisition date”).

“We achieved record year-to-date earnings, along with strong third quarter 2016 earnings of $6.8 million,” said Walter Kaczmarek, President and Chief Executive Officer. “Deposits grew by $256.6 million, or 13% year-over-year, and the increased liquidity was invested in lower yielding funds at the Federal Reserve Bank. Asset quality was sound with nonperforming assets to total assets at 0.19%.”

“The strength of our Company continues to be driven by the commitment of our employees. Their hard work and dedication allow us to continue serving our clients and invest in the future of our franchise,” continued Mr. Kaczmarek. “As demonstrated by our financial results, we are building a significant and well-diversified community business bank in Northern California.”

Third Quarter 2016 Highlights (as of, or for the period ended September 30, 2016, except as noted):

  • Diluted earnings per share totaled $0.18 for the third quarter of 2016, compared to $0.10 for the third quarter of 2015, and $0.19 for the second quarter of 2016. Diluted earnings per share totaled $0.53 for the first nine months of 2016, compared to $0.36 per diluted share for the first nine months of 2015.
  • The return on average tangible assets was 1.13%, and the return on average tangible equity was 13.06%, for the third quarter of 2016, compared to 0.71% and 7.46%, respectively, for the third quarter of 2015, and 1.28% and 14.68%, respectively, for the second quarter of 2016. The return on average tangible assets was 1.16%, and the return on average tangible equity was 13.45%, for the first nine months of 2016, compared to 0.93% and 9.22%, respectively, for the first nine months of 2015.
  • The second quarter of 2016 included a $1.0 million pre-tax gain from company-owned life insurance. The 2015 balances included pre-tax acquisition, severance and retention costs incurred by the Company related to the Focus transaction totaling $2.9 million for the third quarter of 2015, and $3.4 million for the first nine months of 2015.
  • Net interest income increased 17% to $23.0 million for the third quarter of 2016, compared to $19.7 million for the third quarter of 2015, and increased 1% from $22.7 million for the second quarter of 2016. For the first nine months of 2016, net interest income increased 26% to $68.1 million, compared to $54.2 million for the first nine months of 2015.
  • For the third quarter of 2016, the fully tax equivalent (“FTE”) net interest margin contracted 29 basis points to 4.10% from 4.39% for the third quarter of 2015, primarily due to lower yields on loans and securities. The net interest margin contracted 17 basis points for the third quarter of 2016, from 4.27% for the second quarter of 2016, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and a lower yield on securities. For the first nine months of 2016, the net interest margin declined 35 basis points to 4.19%, compared to 4.54% for the first nine months of 2015, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and lower yields on loans and securities, which was partially offset by an increase in the accretion of the loan purchase discount income from the Focus transaction.
  • The accretion of the loan purchase discount in loan interest income from the Focus transaction was $299,000 for the third quarter of 2016, compared to $262,000 for the third quarter of 2015, and $276,000 for the second quarter of 2016. The accretion of the loan purchase discount in loan interest income from the Focus transaction was $1.1 million for the first nine months of 2016, compared to $262,000 for the first nine months of 2015. The total purchase discount on non-impaired loans from the Focus loan portfolio was $4.6 million at the acquisition date, of which $2.5 million has been accreted to loan interest income from the acquisition date through September 30, 2016.
  • Loans (excluding loans‑held‑for‑sale) increased $117.8 million, or 9%, to $1.45 billion at September 30, 2016, compared to $1.33 billion at September 30, 2015, which included an increase of $68.5 million, or 5% in the Company’s legacy portfolio, and $49.3 million of purchased residential mortgage loans at September 30, 2016. Loans decreased $13.9 million, or 1%, at September 30, 2016, compared to $1.46 billion at June 30, 2016, primarily due to a net $15.3 million decrease in land and construction loans as a result of the pay-off of $29.7 million in loans from the sale of projects at completion, and a net $7.5 million decrease in commercial real estate loans from $13.9 million in pay-offs, partially offset by an increase of $16.4 million in purchased residential mortgage loans.
  • Nonperforming assets (“NPAs”) were $4.8 million, or 0.19% of total assets, at September 30, 2016, compared to $5.9 million, or 0.26% of total assets, at September 30, 2015, and $4.7 million, or 0.20% of total assets, at June 30, 2016.
  • Classified assets were $18.7 million, or 0.74% of total assets, at September 30, 2016, compared to $18.0 million, or 0.79% of total assets, at September 30, 2015, and $22.8 million, or 0.96% of total assets, at June 30, 2016.
  • Net charge-offs totaled $134,000 for the third quarter of 2016, compared to net recoveries of $281,000 for the third quarter of 2015, and net recoveries of $112,000 for the second quarter of 2016.
  • There was a $245,000 provision for loan losses for the third quarter of 2016, compared to a $301,000 credit provision for loan losses for the third quarter of 2015, and a $351,000 provision for loan losses for the second quarter of 2016. There was a $997,000 provision for loan losses for the nine months ended September 30, 2016, compared to a $339,000 credit provision for loan losses for the nine months ended September 30, 2015.
  • The allowance for loan losses (“ALLL”) was 1.38% of total loans at September 30, 2016, compared to 1.41% at September 30, 2015, and 1.36% at June 30, 2016. The ALLL to total nonperforming loans was 445.55% at September 30, 2016, compared to 340.49% at September 30, 2015, and 456.90% at June 30, 2016.
  • Total deposits increased $256.6 million, or 13%, to $2.22 billion at September 30, 2016, compared to $1.96 billion at September 30, 2015, and increased $144.9 million, or 7%, from $2.07 billion at June 30, 2016. Deposits excluding all time deposits and CDARS deposits increased $291.2 million, or 17%, to $1.98 billion at September 30, 2016, from $1.69 billion at September 30, 2015, and increased $166.0 million, or 9%, from $1.81 billion at June 30, 2016.
  • The Company’s consolidated capital ratios exceeded regulatory guidelines and the Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at September 30, 2016.

Well-capitalized Fully Phased-in
Financial Basel III
Institution Minimal
Heritage Heritage Basel III Requirement(1)
Commerce Bank of Regulatory Effective
CAPITAL RATIOS Corp Commerce Guidelines January 1, 2019
Total Risk-Based 12.7% 12.6% 10.0% 10.5%
Tier 1 Risk-Based 11.6% 11.4% 8.0% 8.5%
Common Equity Tier 1 Risk-Based 11.6% 11.4% 6.5% 7.0%
Leverage 8.9% 8.7% 5.0% 4.0%
(1) Requirements for both the Company and the Bank include a 2.5% capital conservation buffer, except the leverage ratio.

Operating Results

Net interest income increased 17% to $23.0 million for the third quarter of 2016, compared to $19.7 million for the third quarter of 2015, and increased 1% from $22.7 million for the second quarter of 2016. Net interest income increased 26% to $68.1 million for the nine months ended September 30, 2016, compared to $54.2 million for the nine months ended September 30, 2015. Net interest income increased for the third quarter and first nine months of 2016, compared to the respective periods in 2015, primarily due to organic growth in the loan portfolio, the accretion of the loan purchase discount into interest income from the Focus transaction, and an increase in the average balance of investment securities.

For the third quarter of 2016, the net interest margin (FTE) contracted 29 basis points to 4.10% from 4.39% for the third quarter of 2015, primarily due to lower yields on loans and securities. The net interest margin contracted 17 basis points for the third quarter of 2016, from 4.27% for the second quarter of 2016, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and a lower yield on securities. For the first nine months of 2016, the net interest margin decreased 35 basis points to 4.19%, compared to 4.54% for the first nine months of 2015, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and lower yields on loans and securities, which was partially offset by an increase in the accretion of the loan purchase discount from the Focus transaction.

There was a $245,000 provision for loan losses for the third quarter of 2016, compared to a $301,000 credit provision for loan losses for the third quarter of 2015, and a $351,000 provision for loan losses for the second quarter of 2016. There was a $997,000 provision for loan losses for the nine months ended September 30, 2016, compared to a $339,000 credit provision for loan losses for the nine months ended September 30, 2015.

Noninterest income increased to $2.3 million for the third quarter of 2016, compared to $2.1 million for the third quarter of 2015, and decreased from $3.7 million for the second quarter of 2016. The decrease in noninterest income for the third quarter of 2016, compared to the second quarter of 2016, was primarily due to a $1.0 million gain from company owned life insurance and a $347,000 gain on sales of securities in the second quarter of 2016. For the nine months ended September 30, 2016, noninterest income was $8.6 million, compared to $6.2 million at September 30, 2015. The increase in noninterest income for the first nine months of 2016, compared to the first nine months of 2015, was primarily due to a $1.0 million gain on proceeds from company owned life insurance and higher gains on sales of securities.

The Company maintains life insurance policies for some directors and officers that are subject to split-dollar life insurance agreements, which continue after the participant’s employment termination or retirement. During the second quarter of 2016, the Company received death benefit proceeds of $3.1 million from the life insurance policy of a former officer of a bank acquired by the Company. The cash surrender value of the policy was $2.1 million, which resulted in a gain on proceeds from company owned life insurance of $1.0 million.

Total noninterest expense for the third quarter of 2016 was $14.3 million, compared to $16.4 million for the third quarter of 2015, and $14.4 million for the second quarter of 2016. The decrease in noninterest expense in the third quarter of 2016, compared to the third quarter of 2015, was primarily due to pre-tax acquisition, severance and retention costs incurred by the Company related to the Focus transaction totaling $2.9 million for the third quarter of 2015. Noninterest expense for the nine months ended September 30, 2016 increased to $43.4 million, compared to $41.3 million for the nine months ended September 30, 2015, primarily due to additional employees retained from Focus and an increase in amortization of the core deposit intangible assets as a result of the Focus acquisition, annual salary increases, newly hired employees and higher professional fees, partially offset by $3.4 million of pre-tax acquisition, severance and retention costs incurred by the Company for the first nine months of 2015. Professional fees were significantly lower in the first nine months of 2015 due to recoveries of legal fees on problem loans that were paid off. Full time equivalent employees were 264 at September 30, 2016, 272 at September 30, 2015, and 268 at June 30, 2016.

The efficiency ratio for the third quarter of 2016 was 56.37%, compared to 75.49% for the third quarter of 2015, and 54.47% for the second quarter of 2016. The efficiency ratio for the nine months ended September 30, 2016 was 56.55%, compared to 68.47% for the nine months ended September 30, 2015. The higher efficiency ratio in the third quarter of 2015 and nine months ended September 30, 2015 was primarily due to one-time Focus acquisition, severance and retention costs. Excluding the one-time Focus acquisition, severance and retention costs, the efficiency ratio was 62.32% for the third quarter of 2015, and 62.76% for the nine months ended September 30, 2015.

Income tax expense for the third quarter of 2016 was $4.1 million, compared to $2.2 million for the third quarter of 2015, and $4.4 million for the second quarter of 2016. The effective tax rate for the third quarter of 2016 was 37.5%, compared to 38.6% for the third quarter of 2015, and 37.5% for the second quarter of 2016. The effective tax rate for the third quarter of 2015 was higher primarily due to the impact of non-deductible merger related expenses. Income tax expense for the nine months ended September 30, 2016 was $12.2 million, compared to $7.3 million for the nine months ended September 30, 2015. The effective tax rate for the nine months ended September 30, 2016 was 37.6%, compared to 37.7% for the nine months ended September 30, 2015. The difference in the effective tax rate for the periods reported, compared to the combined Federal and state statutory tax rate of 42%, is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds.

Balance Sheet Review, Capital Management and Credit Quality

Total assets were $2.53 billion at September 30, 2016, compared to $2.26 billion at September 30, 2015, and $2.38 billion at June 30, 2016.

The investment securities available-for-sale portfolio totaled $370.0 million at September 30, 2016, compared to $257.4 million at September 30, 2015, and $390.4 million at June 30, 2016. At September 30, 2016, the Company’s securities available-for-sale portfolio was comprised of $352.6 million agency mortgage-backed securities (all issued by U.S. Government sponsored entities), $16.4 million of single entity issue trust preferred securities, and $1.0 million of corporate bonds. The pre-tax unrealized gain on securities available-for-sale at September 30, 2016 was $8.0 million, compared to a pre-tax unrealized gain on securities available-for-sale of $4.5 million at September 30, 2015, and a pre-tax unrealized gain on securities available-for-sale of $7.7 million at June 30, 2016.

At September 30, 2016, investment securities held-to-maturity totaled $202.4 million, compared to $111.0 million at September 30, 2015, and $210.2 million at June 30, 2016. At September 30, 2016, the Company’s securities held-to-maturity portfolio, at amortized cost, was comprised of $90.8 million tax-exempt municipal bonds, and $111.6 million agency mortgage-backed securities.

Loans (excluding loans‑held‑for‑sale) increased $117.8 million, or 9%, to $1.45 billion at September 30, 2016, compared to $1.33 billion at September 30, 2015, which included an increase of $68.5 million, or 5% in the Company’s legacy portfolio, and $49.3 million of purchased residential mortgage loans at September 30, 2016. Loans decreased $13.9 million, or 1%, at September 30, 2016, compared to $1.46 billion at June 30, 2016, primarily due to a net $15.3 million decrease in land and construction loans as a result of the pay-off of $29.7 million in loans from the sale of projects at completion, and a net $7.5 million decrease in commercial real estate loans from $13.9 million in pay-offs, partially offset by an increase of $16.4 million in purchased residential mortgage loans.

The loan portfolio remains well-diversified with commercial and industrial (“C&I”) loans accounting for 42% of the loan portfolio at September 30, 2016, which included $47.8 million of factored receivables at Bay View Funding. Commercial real estate loans accounted for 42% of the total loan portfolio, of which 43% were owner-occupied by businesses. Consumer and home equity loans accounted for 7% of total loans, land and construction loans accounted for 6% of total loans, and residential mortgage loans accounted for the remaining 3% of total loans at September 30, 2016. C&I line usage was 41% at September 30, 2016, compared to 42% at June 30, 2016.

During the second and third quarters of 2016, the Company purchased jumbo single family residential mortgage loans totaling $51.6 million, all of which are domiciled in California. The average loan principal amount is approximately $834,000, and the weighted average yield on the portfolio is 3.00%, net of servicing fees to the servicer. Residential mortgages outstanding at September 30, 2016 totaled $49.3 million, compared to $32.9 million at June 30, 2016.

The yield on the loan portfolio was 5.60% for the third quarter of 2016, compared to 5.70% for the third quarter of 2015, and 5.60% for the second quarter of 2016. The yield on the loan portfolio was 5.61% for the nine months ended September 30, 2016, compared to 5.69% for the nine months ended September 30, 2015. The decrease in the yield on the loan portfolio for the third quarter of 2016 and nine months ended September 30, 2016, compared to the respective periods in 2015, was primarily due to a decrease in the proportion of loans in the higher yielding Bay View Funding factored receivables portfolio relative to the addition of the Focus loans and growth in the Company’s legacy portfolio, partially offset by an increase in the accretion of the loan purchase discount into loan interest income from the Focus transaction.

At September 30, 2016, NPAs were $4.8 million, or 0.19% of total assets, compared to $5.9 million, or 0.26% of total assets, at September 30, 2015, and $4.7 million, or 0.20% of total assets, at June 30, 2016. At September 30, 2016, the NPAs included no loans guaranteed by the SBA. Foreclosed assets were $292,000 at September 30, 2016, compared to $393,000 at September 30, 2015, and $313,000 at June 30, 2016. The following is a breakout of NPAs at the periods indicated:

End of Period:
NONPERFORMING ASSETSSeptember 30, 2016 June 30, 2016 September 30, 2015
(in $000's, unaudited) Balance % of Total Balance % of Total Balance % of Total
Commercial and industrial loans $ 3,570 75% $ 504 11% $ 947 16%
Commercial real estate loans 440 9% 2,849 61% 3,075 52%
Foreclosed assets 292 6% 313 7% 393 7%
Home equity and consumer loans 278 6% 760 16% 316 5%
Land and construction loans 201 4% 207 4% 492 8%
SBA loans 7 0% 40 1% 673 12%
Total nonperforming assets $ 4,788 100% $ 4,673 100% $ 5,896 100%

Classified assets were $18.7 million at September 30, 2016, compared to $18.0 million at September 30, 2015, and $22.8 million at June 30, 2016. Classified assets include Small Business Administration (“SBA”) guarantees of $10,000 at September 30, 2016, $0 at September 30, 2015, and $14,000 at June 30, 2016.

The following table summarizes the allowance for loan losses:

For the Quarter Ended For the Nine Months Ended
ALLOWANCE FOR LOAN LOSSESSeptember 30, June 30, September 30, September 30, September 30,
(in $000's, unaudited) 2016 2016 2015 2016 2015
Balance at beginning of period$ 19,921 $ 19,458 $ 18,757 $ 18,926 $ 18,379
Provision (credit) for loan losses during the period 245 351 (301) 997 (339)
Net recoveries (charge-offs) during the period (134) 112 281 109 697
Balance at end of period$ 20,032 $ 19,921 $ 18,737 $ 20,032 $ 18,737
Total loans $ 1,450,176 $ 1,464,114 $ 1,132,405 $ 1,450,176 $ 1,332,405
Total nonperforming loans$ 4,496 $ 4,360 $ 5,503 $ 4,496 $ 5,503
Allowance for loan losses to total loans 1.38% 1.36% 1.41% 1.38% 1.41%
Allowance for loan losses to total nonperforming loans 445.55% 456.90% 340.49% 445.55% 340.49%

The ALLL at September 30, 2016 was 1.38% of total loans, compared to 1.41% at September 30, 2015, and 1.36% at June 30, 2016. The ALLL to total nonperforming loans was 445.55% at September 30, 2016, compared to 340.49% at September 30, 2015, and 456.90% at June 30, 2016.

Total deposits increased $256.6 million, or 13%, to $2.22 billion at September 30, 2016, compared to $1.96 billion at September 30, 2015, and increased $144.9 million, or 7%, at September 30, 2016, compared to $2.07 billion at June 30, 2016. Deposits excluding all time deposits and CDARS deposits increased $291.2 million, or 17%, to $1.98 billion at September 30, 2016, from $1.69 billion at September 30, 2015, and increased $166.0 million, or 9%, from $1.81 billion at June 30, 2016.

The total cost of deposits remained the same at 0.15 % for the third quarter of 2016, the third quarter of 2015, and the second quarter of 2016. The total cost of deposits was also at 0.15% for the nine months ended September 30, 2016 and September 30, 2015.

Tangible equity was $208.3 million at September 30, 2016, compared to $194.2 million at September 30, 2015, and $204.1 million at June 30, 2016. Tangible book value per common share was $5.49 at September 30, 2016, compared to $5.44 at September 30, 2015, and $5.72 at June 30, 2016. There was no Series C Preferred Stock outstanding at September 30, 2016, compared to 21,004 shares of Series C Preferred Stock outstanding at September 30, 2015 and June 30, 2016. Pro forma tangible book value per common share, assuming the outstanding Series C Preferred Stock was converted into common stock, was $5.15 at September 30, 2015, and $5.39 at June 30, 2016.

On September 12, 2016, the Company entered into Exchange Agreements with Castle Creek Capital Partners IV, LP , Patriot Financial Partners, L.P. and Patriot Financial Partners Parallel, L.P. (collectively “Preferred Stockholders”) providing for the exchange of 21,004 shares of the Series C Preferred Stock, for 5,601,000 shares of the Company’s common stock. The exchange ratio was equal to the equivalent number of shares the Preferred Stockholders would have received upon conversion of the Series C Preferred Stock.

Accumulated other comprehensive loss was ($2.0) million at September 30, 2016, compared to ($2.0) million at September 30, 2015, and ($2.1) million at June 30, 2016. The unrealized gain on securities available-for-sale, net of taxes, included in accumulated other comprehensive loss was an unrealized gain of $4.7 million September 30, 2016, compared to $2.6 million at September 30, 2015, and $4.5 million at June 30, 2016. The components of accumulated other comprehensive loss, net of taxes, at September 30, 2016 include the following: an unrealized gain on available-for-sale securities of $4.7 million; the remaining unamortized unrealized gain on securities available-for-sale transferred to held-to-maturity of $342,000; a split dollar insurance contracts liability of ($3.6) million; a supplemental executive retirement plan liability of ($4.0) million; and an unrealized gain on interest-only strip from SBA loans of $639,000.

Heritage Commerce Corp, a bank holding company established in February 1998, is the parent company of Heritage Bank of Commerce, established in 1994 and headquartered in San Jose with full-service branches in Danville, Fremont, Gilroy, Hollister, Los Altos, Los Gatos, Morgan Hill, Pleasanton, Sunnyvale, and Walnut Creek. Heritage Bank of Commerce is an SBA Preferred Lender. Bay View Funding, a subsidiary of Heritage Bank of Commerce, is based in Santa Clara and provides business‑essential working capital factoring financing to various industries throughout the United States. For more information, please visit www.heritagecommercecorp.com.

Forward Looking Statement Disclaimer

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. In addition, our past results of operations do not necessarily indicate our future results. The forward looking statements could be affected by many factors, including but not limited to: (1) local, regional, and national economic conditions and events and their impact on us and our customers; (2) changes in the financial performance or condition of the Company’s customers; (3) volatility in credit and equity markets and its effect on the global economy; (4) competition for loans and deposits and failure to attract or retain deposits and loans; (5) our ability to increase market share and control expenses; (6) our ability to develop and promote customer acceptance of new products and services in a timely manner; (7) risks associated with concentrations in real estate related loans; (8) other than temporary impairment charges to our securities portfolio; (9) an oversupply of inventory and deterioration in values of California commercial real estate; (10) a prolonged slowdown in construction activity; (11) changes in the level of nonperforming assets and charge offs and other credit quality measures, and their impact on the adequacy of the Company’s allowance for loan losses and the Company’s provision for loan losses; (12) the 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; (13) changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources; (14) our ability to raise capital or incur debt on reasonable terms; (15) regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company; (16) changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases, among others; (17) 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; (18) the ability to keep pace with, and implement on a timely basis, technological changes; (19) the impact of cyber security attacks or other disruptions to the Company’s information systems and any resulting compromise of data or disruptions in service; (20) changes in the competitive environment among financial or bank holding companies and other financial service providers; (21) the effect and uncertain impact on the Company of the enactment of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations promulgated by supervisory and oversight agencies implementing the new legislation; (22) significant changes in applicable laws and regulations, including those concerning taxes, banking and securities; (23) the 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; (24) the costs and effects of legal and regulatory developments, including resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews; (25) the successful integration of the business, employees and operations of Focus Business Bank with the Company and our ability to achieve the projected synergies of this acquisition within the expected time frame; and (26) our success in managing the risks involved in the foregoing factors.

Member FDIC


For the Quarter Ended: Percent Change From: For the Nine Months Ended:
CONSOLIDATED INCOME STATEMENTS September 30,June 30,September 30, June 30,September 30, September 30,September 30, Percent
(in $000's, unaudited) 2016 2016 2015 2016 2015 2016 2015 Change
Interest income$ 23,874 $ 23,504 $ 20,306 2% 18% $ 70,440 $ 55,847 26%
Interest expense 826 760 623 9% 33% 2,344 1,664 41%
Net interest income before provision for loan losses 23,048 22,744 19,683 1% 17% 68,096 54,183 26%
Provision (credit) for loan losses 245 351 (301) -30% 181% 997 (339) 394%
Net interest income after provision for loan losses 22,803 22,393 19,984 2% 14% 67,099 54,522 23%
Noninterest income:
Service charges and fees on deposit accounts 798 783 748 2% 7% 2,348 2,086 13%
Increase in cash surrender value of life insurance 428 440 429 -3% 0% 1,317 1,225 8%
Servicing income 364 371 214 -2% 70% 1,106 819 35%
Gain on sales of SBA loans 69 279 267 -75% -74% 653 660 -1%
Gain on proceeds from company owned life insurance - 1,019 - -100% N/A 1,019 - N/A
Gain on sales of securities - 347 - -100% N/A 527 - N/A
Other 653 421 408 55% 60% 1,616 1,366 18%
Total noninterest income 2,312 3,660 2,066 -37% 12% 8,586 6,156 39%
Noninterest expense:
Salaries and employee benefits 8,363 8,742 10,358 -4% -19% 26,052 26,112 0%
Occupancy and equipment 1,120 1,081 1,063 4% 5% 3,277 3,135 5%
Professional fees 1,086 708 612 53% 77% 2,619 946 177%
Other 3,727 3,850 4,386 -3% -15% 11,414 11,119 3%
Total noninterest expense 14,296 14,381 16,419 -1% -13% 43,362 41,312 5%
Income before income taxes 10,819 11,672 5,631 -7% 92% 32,323 19,366 67%
Income tax expense 4,054 4,377 2,172 -7% 87% 12,157 7,292 67%
Net income 6,765 7,295 3,459 -7% 96% 20,166 12,074 67%
Dividends on preferred stock (504 ) (504) (448) 0% 13% (1,512 ) (1,344) 13%
Net income available to common shareholders 6,261 6,791 3,011 -8% 108% 18,654 10,730 74%
Undistributed earnings allocated to Series C preferred stock (300 ) (576) (111) -48% 170% (1,278) (706) 81
%
Distributed and undistributed earnings allocated to common
shareholders$ 5,961
$ 6,215 $ 2,900 -4% 106% $ 17,376 $ 10,024 73
%
PER COMMON SHARE DATA
(unaudited)
Basic earnings per share$ 0.18 $ 0.19 $ 0.10 -5% 80% $ 0.53 $ 0.37 43%
Diluted earnings per share$ 0.18 $ 0.19 $ 0.10 -5% 80% $ 0.53 $ 0.36 47%
Weighted average shares outstanding - basic 33,397,704
32,243,935 29,075,782 4
% 15
% 32,591,784 27,386,471 19
%
Weighted average shares outstanding - diluted 33,693,328 32,512,611 29,332,452 4
% 15
% 32,863,855
27,589,464 19
%
Common shares outstanding at period-end 37,915,736 32,294,063 32,076,505 17% 18% 37,915,736 32,076,505 18%
Pro forma common shares outstanding at period-end, assuming
Series C preferred stock was converted into common stock N/A 37,895,063 37,677,505 N/A N/A N/A 37,677,505 N/A
Book value per share $ 6.89 $ 7.37 $ 7.12 -7% -3% $ 6.89 $ 7.12 -3%
Tangible book value per share$ 5.49 $ 5.72 $ 5.44 -4% 1% $ 5.49 $ 5.44 1%
Pro forma tangible book value per share, assuming Series C
preferred stock was converted into common stock N/A $ 5.39 $ 5.15 N/A N/A N/A $ 5.15 N/A
KEY FINANCIAL RATIOS
(unaudited)
Annualized return on average equity 10.38 % 11.58% 6.41% -10% 62% 10.61 % 8.25% 29%
Annualized return on average tangible equity 13.06 % 14.68% 7.46% -11% 75% 13.45 % 9.22% 46%
Annualized return on average assets 1.11 % 1.25% 0.70% -11% 59% 1.13 % 0.92% 23%
Annualized return on average tangible assets 1.13 % 1.28% 0.71% -12% 59% 1.16 % 0.93% 25%
Net interest margin 4.10 % 4.27% 4.39% -4% -7% 4.19 % 4.54% -8%
Efficiency ratio 56.37 % 54.47% 75.49% 3% -25% 56.55 % 68.47% -17%
AVERAGE BALANCES
(in $000's, unaudited)
Average assets$ 2,431,303 $ 2,345,874 $ 1,956,047 4% 24% $ 2,375,958 $ 1,752,778 36%
Average tangible assets$ 2,378,045 $ 2,292,248 $ 1,925,912 4% 23% $ 2,322,317 $ 1,732,057 34%
Average earning assets$ 2,263,997 $ 2,172,349 $ 1,805,801 4% 25% $ 2,198,178 $ 1,622,605 35%
Average loans held-for-sale$ 5,992 $ 2,951 $ 3,197 103% 87% $ 4,568 $ 1,985 130%
Average total loans$ 1,436,014 $ 1,415,001 $ 1,229,792 1% 17% $ 1,405,069 $ 1,134,223 24%
Average deposits$ 2,121,469 $ 2,042,524 $ 1,693,282 4% 25% $ 2,065,170 $ 1,509,210 37%
Average demand deposits - noninterest-bearing$ 842,565 $ 780,116 $ 652,529 8% 29% $ 800,049 $ 578,117 38%
Average interest-bearing deposits$ 1,278,904 $ 1,262,408 $ 1,040,753 1% 23% $ 1,265,121 $ 931,093 36%
Average interest-bearing liabilities$ 1,278,959 $ 1,262,415 $ 1,040,919 1% 23% $ 1,265,722 $ 931,173 36%
Average equity$ 259,395 $ 253,430 $ 214,105 2% 21% $ 253,862 $ 195,731 30%
Average tangible equity$ 206,137 $ 199,804 $ 183,970 3% 12% $ 200,221 $ 175,010 14%


End of Period: Percent Change From:
CONSOLIDATED BALANCE SHEETSSeptember 30,June 30,September 30, June 30,September 30,
(in $000's, unaudited) 2016 2016 2015 2016 2015
ASSETS
Cash and due from banks$ 39,838 $ 30,820 $ 28,691 29% 39%
Federal funds sold and interest-bearing
deposits in other financial institutions 304,554 128,024 364,247 138% -16%
Securities available-for-sale, at fair value 369,999 390,435 257,410 -5% 44%
Securities held-to-maturity, at amortized cost 202,404 210,170 111,004 -4% 82%
Loans held-for-sale - SBA, including deferred costs 6,741 4,879 7,873 38% -14%
Loans:
Commercial 606,281 610,385 554,169 -1% 9%
Real estate:
Commercial 612,030 619,539 606,819 -1% 1%
Land and construction 88,371 103,710 84,867 -15% 4%
Home equity 76,536 78,332 74,624 -2% 3%
Residential mortgages 49,255 32,852 - 50% N/A
Consumer 18,328 20,037 12,595 -9% 46%
Loans 1,450,801 1,464,855 1,333,074 -1% 9%
Deferred loan fees (625) (741) (669) -16% -7%
Total loans, net of deferred fees 1,450,176 1,464,114 1,332,405 -1% 9%
Allowance for loan losses (20,032) (19,921) (18,737) 1% 7%
Loans, net 1,430,144 1,444,193 1,313,668 -1% 9%
Company owned life insurance 59,193 58,765 59,549 1% -1%
Premises and equipment, net 7,552 7,542 7,513 0% 1%
Goodwill 45,664 45,664 44,898 0% 2%
Other intangible assets 7,342 7,734 8,906 -5% -18%
Accrued interest receivable and other assets 54,531 50,066 58,448 9% -7%
Total assets$ 2,527,962 $ 2,378,292 $ 2,262,207 6% 12%
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Demand, noninterest-bearing$ 889,075 $ 834,590 $ 758,440 7% 17%
Demand, interest-bearing 536,541 499,512 440,517 7% 22%
Savings and money market 555,156 480,677 490,572 15% 13%
Time deposits-under $250 57,718 60,761 65,626 -5% -12%
Time deposits-$250 and over 169,485 182,591 174,703 -7% -3%
Time deposits - brokered 3,000 6,079 24,150 -51% -88%
CDARS - money market and time deposits 7,659 9,574 8,015 -20% -4%
Total deposits 2,218,634 2,073,784 1,962,023 7% 13%
Borrowings - - 1,000 N/A -100%
Accrued interest payable and other liabilities 48,009 46,995 51,208 2% -6%
Total liabilities 2,266,643 2,120,779 2,014,231 7% 13%
Shareholders' Equity:
Series C preferred stock, net - 19,519 19,519 -100% -100%
Common stock 214,601 194,765 193,070 10% 11%
Retained earnings 48,726 45,371 37,366 7% 30%
Accumulated other comprehensive loss (2,008) (2,142) (1,979) 6% -1%
Total shareholders' equity 261,319 257,513 247,976 1% 5%
Total liabilities and shareholders' equity$ 2,527,962 $ 2,378,292 $ 2,262,207 6% 12%


End of Period: Percent Change From:
CREDIT QUALITY DATA September 30,June 30,September 30, June 30,September 30,
(in $000's, unaudited) 2016 2016 2015 2016 2015
Nonaccrual loans - held-for-investment$ 4,496 $ 4,360 $ 5,503 3% -18%
Foreclosed assets 292 313 393 -7% -26%
Total nonperforming assets$ 4,788 $ 4,673 $ 5,896 2% -19%
Other restructured loans still accruing$ 137 $ 141 $ 183 -3% -25%
Net (recoveries) charge-offs during the quarter$ 134 $ (112)$ (281) 220% 148%
Provision (credit) for loan losses during the quarter$ 245 $ 351 $ (301) -30% 181%
Allowance for loan losses$ 20,032 $ 19,921 $ 18,737 1% 7%
Classified assets$ 18,693 $ 22,811 $ 17,976 -18% 4%
Allowance for loan losses to total loans 1.38% 1.36% 1.41% 1% -2%
Allowance for loan losses to total nonperforming loans 445.55% 456.90% 340.49% -2% 31%
Nonperforming assets to total assets 0.19% 0.20% 0.26% -5% -27%
Nonperforming loans to total loans 0.31% 0.30% 0.41% 3% -24%
Classified assets to Heritage Commerce Corp Tier 1
capital plus allowance for loan losses 8% 10% 8% -20% 0%
Classified assets to Heritage Bank of Commerce Tier 1
capital plus allowance for loan losses 8% 10% 8% -20% 0%
OTHER PERIOD-END STATISTICS
(in $000's, unaudited)
Heritage Commerce Corp:
Tangible equity$ 208,313 $ 204,115 $ 194,172 2% 7%
Tangible common equity$ 208,313 $ 184,596 $ 174,653 13% 19%
Shareholders' equity / total assets 10.34% 10.83% 10.96% -5% -6%
Tangible equity / tangible assets 8.42% 8.78% 8.79% -4% -4%
Tangible common equity / tangible assets 8.42% 7.94% 7.91% 6% 6%
Loan to deposit ratio 65.36% 70.60% 67.91% -7% -4%
Noninterest-bearing deposits / total deposits 40.07% 40.24% 38.66% 0% 4%
Total risk-based capital ratio 12.7% 12.3% 12.3% 3% 3%
Tier 1 risk-based capital ratio 11.6% 11.2% 11.2% 4% 4%
Common Equity Tier 1 risk-based capital ratio 11.6% 10.2% 10.2% 14% 14%
Leverage ratio 8.9% 9.0% 10.4% -1% -14%
Heritage Bank of Commerce:
Total risk-based capital ratio 12.6% 12.2% 12.1% 3% 4%
Tier 1 risk-based capital ratio 11.4% 11.1% 11.0% 3% 4%
Common Equity Tier 1 risk-based capital ratio 11.4% 11.1% 11.0% 3% 4%
Leverage ratio 8.7% 8.9% 10.2% -2% -15%

For the Quarter Ended For the Quarter Ended
September 30, 2016 September 30, 2015
Interest Average Interest Average
NET INTEREST INCOME AND NET INTEREST MARGIN Average Income/ Yield/ Average Income/ Yield/
(in $000's, unaudited) Balance Expense Rate Balance Expense Rate
Assets:
Loans, gross(1) $1,442,006 $20,312 5.60% $1,232,989 $17,713 5.70%
Securities - taxable 497,821 2,401 1.92% 244,313 1,670 2.71%
Securities - tax exempt(2) 91,241 875 3.82% 91,127 874 3.80%
Other investments and interest-bearing
deposits in other financial institutions 232,929 592 1.01% 237,372 355 0.59%
Total interest earning assets(2) 2,263,997 24,180 4.25% 1,805,801 20,612 4.53%
Cash and due from banks 32,628 34,921
Premises and equipment, net 7,595 7,374
Goodwill and other intangible assets 53,258 30,135
Other assets 73,825 77,816
Total assets $2,431,303 $1,956,047
Liabilities and shareholders' equity:
Deposits:
Demand, noninterest-bearing $842,565 $652,529
Demand, interest-bearing 515,296 259 0.20% 326,922 144 0.17%
Savings and money market 516,570 289 0.22% 444,702 240 0.21%
Time deposits - under $100 21,707 16 0.29% 20,681 15 0.29%
Time deposits - $100 and over 212,201 251 0.47% 206,909 173 0.33%
Time deposits - brokered 4,874 10 0.82% 24,861 50 0.80%
CDARS - money market and time deposits 8,256 1 0.05% 16,678 1 0.02%
Total interest-bearing deposits 1,278,904 826 0.26% 1,040,753 623 0.24%
Total deposits 2,121,469 826 0.15% 1,693,282 623 0.15%
Short-term borrowings 55 - 0.00% 166 - 0.00%
Total interest-bearing liabilities 1,278,959 826 0.26% 1,040,919 623 0.24%
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds 2,121,524 826 0.15% 1,693,448 623 0.15%
Other liabilities 50,384 48,494
Total liabilities 2,171,908 1,741,942
Shareholders' equity 259,395 214,105
Total liabilities and shareholders' equity $2,431,303 $1,956,047
Net interest income(2) / margin 23,354 4.10% 19,989 4.39%
Less tax equivalent adjustment(2) (306) (306)
Net interest income $23,048 $19,683
(1)Includes loans held-for-sale. Yield amounts earned on loans include loan fees and costs. Nonaccrual loans are included in average balance.
(2)Reflects tax equivalent adjustment for tax exempt income based on a 35% tax rate.


For the Nine Months Ended For the Nine Months Ended
September 30, 2016 September 30, 2015
Interest Average Interest Average
NET INTEREST INCOME AND NET INTEREST MARGINAverage Income/ Yield/ Average Income/ Yield/
(in $000's, unaudited) Balance Expense Rate Balance Expense Rate
Assets:
Loans, gross(1) $1,409,637 $59,235 5.61% $1,136,208 $48,360 5.69%
Securities - taxable 500,497 8,004 2.14% 230,608 4,828 2.80%
Securities - tax exempt(2) 92,194 2,651 3.84% 84,286 2,444 3.88%
Federal funds sold and interest-bearing
deposits in other financial institutions 195,850 1,478 1.01% 171,503 1,070 0.83%
Total interest earning assets(2) 2,198,178 71,368 4.34% 1,622,605 56,702 4.67%
Cash and due from banks 32,927 28,647
Premises and equipment, net 7,638 7,388
Goodwill and other intangible assets 53,641 20,721
Other assets 83,574 73,417
Total assets $2,375,958 $1,752,778
Liabilities and shareholders' equity:
Deposits:
Demand, noninterest-bearing $800,049 $578,117
Demand, interest-bearing 505,442 731 0.19% 265,095 349 0.18%
Savings and money market 506,998 829 0.22% 403,385 623 0.21%
Time deposits - under $100 22,534 48 0.28% 19,812 45 0.30%
Time deposits - $100 and over 212,300 660 0.42% 202,512 485 0.32%
Time deposits - brokered 9,503 59 0.83% 26,578 157 0.79%
CDARS - money market and time deposits 8,344 5 0.08% 13,711 5 0.05%
Total interest-bearing deposits 1,265,121 2,332 0.25% 931,093 1,664 0.24%
Total deposits 2,065,170 2,332 0.15% 1,509,210 1,664 0.15%
Short-term borrowings 601 12 2.67% 80 - 0.00%
Total interest-bearing liabilities 1,265,722 2,344 0.25% 931,173 1,664 0.24%
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds 2,065,771 2,344 0.15% 1,509,290 1,664 0.15%
Other liabilities 56,325 47,757
Total liabilities 2,122,096 1,557,047
Shareholders' equity 253,862 195,731
Total liabilities and shareholders' equity $2,375,958 $1,752,778
Net interest income(2) / margin 69,024 4.19% 55,038 4.54%
Less tax equivalent adjustment(2) (928) (855)
Net interest income $68,096 $54,183
(1)Includes loans held-for-sale. Yield amounts earned on loans include loan fees and costs. Nonaccrual loans are included in average balance.
(2)Reflects tax equivalent adjustment for tax exempt income based on a 35% tax rate.

CONTACT: Heritage Commerce Corp Debbie Reuter, EVP, Corporate Secretary (408) 494-4542

Source:Heritage Commerce Corp