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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 000-23877
Heritage Commerce Corp
(Exact name of Registrant as Specified in its Charter)
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California
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77-0469558
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(State or Other Jurisdiction of Incorporation or Organization)
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(I.R.S. Employer Identification Number)
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150 Almaden Boulevard
San Jose, California 95113
(Address of Principal Executive Offices including Zip Code)
(408) 947-6900
(Registrant's Telephone Number, Including Area Code)
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 reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indeicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). YES [X] NO [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The Registrant had 11,233,650 shares of Common
Stock outstanding on April 30, 2003.
Heritage Commerce Corp and Subsidiaries
Quarterly Report on Form 10-Q
Table of Contents
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PART I. FINANCIAL INFORMATION
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Page No.
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Item 1. Financial Statements
(unaudited):
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Condensed Consolidated Balance Sheets
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2
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Condensed Consolidated Income Statements
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3
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Condensed Consolidated Statements of Cash Flows
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4
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Condensed Consolidated Notes to Financial Statements
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5
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Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
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7
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
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23
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Item 4. Controls and Procedures
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23
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PART II. OTHER INFORMATION
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Item 6. Exhibits and Reports on Form 8-K
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23
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Signatures
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24
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Certifications Under Section 302 of the Sarbanes - Oxley Act of 2002
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25
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Exhibit Index
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29
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Part I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HERITAGE COMMERCE CORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, December 31,
(Dollars in thousands) 2003 2002
------------ ------------
ASSETS
Cash and due from banks......................................... $ 35,141 $ 35,610
Interest bearing deposits in other financial institutions....... 7,522 7,022
Federal funds sold.............................................. 81,300 44,000
------------ ------------
Total cash and cash equivalents.................. 123,963 86,632
Securities available-for-sale, at fair value.................... 99,436 126,443
Loans held for sale, at lower of cost or market................. 26,776 28,084
Loans, net of deferred costs.................................... 651,526 673,907
Allowance for probable loan losses.............................. (14,247) (13,227)
------------ ------------
Loans, net....................................... 637,279 660,680
Premises and equipment, net..................................... 4,880 5,194
Accrued interest receivable and other assets.................... 23,593 24,549
Other investments............................................... 27,188 27,170
------------ ------------
TOTAL............................................ $ 943,115 $ 958,752
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Demand, noninterest bearing............................... $ 245,203 $ 248,616
Demand, interest bearing.................................. 94,499 94,309
Savings and money market.................................. 303,278 290,417
Time deposits, under $100................................. 45,154 46,341
Time deposits, $100 and over.............................. 106,816 114,613
Brokered deposits......................................... 29,676 47,640
------------ ------------
Total deposits............................................... 824,626 841,936
Accrued interest payable and other liabilities............... 10,773 10,951
Mandatorily redeemable cumulative trust preferred
securities of subsidiary grantor trust.................... 23,000 23,000
------------ ------------
Total liabilities................................ 858,399 875,887
------------ ------------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value; 10,000,000 shares authorized;
none outstanding.......................................... -- --
Common stock, no par value; 30,000,000 shares authorized;
shares issued and outstanding: 11,222,564 at
March 31, 2003 and 11,214,414 at December 31, 2002........ 64,231 63,957
Accumulated other comprehensive income, net of taxes......... 1,362 1,714
Retained earnings............................................ 19,123 17,194
------------ ------------
Total shareholders' equity....................... 84,716 82,865
------------ ------------
TOTAL............................................ $ 943,115 $ 958,752
============ ============
See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
Three Months Ended
March 31,
------------------------
(Dollars in thousands, except per share data) 2003 2002
----------- -----------
Interest income:
Loans, including fees...................................... $ 11,185 $ 11,609
Securities, taxable....................................... 1,069 1,064
Securities, non-taxable................................... 96 141
Interest bearing deposits in other financial institutions.. 16 27
Federal funds sold......................................... 82 230
----------- -----------
Total interest income 12,448 13,071
----------- -----------
Interest expense:
Deposits................................................... 2,279 3,800
Mandatorily redeemable trust preferred securities.......... 490 481
Other...................................................... -- 11
----------- -----------
Total interest expense........................................ 2,769 4,292
----------- -----------
Net interest income before provision for probable
loan losses................................................. 9,679 8,779
Provision for probable loan losses............................ 1,300 675
----------- -----------
Net interest income after provision for probable
loan losses................................................. 8,379 8,104
----------- -----------
Noninterest income:
Gain on sale of loans...................................... 557 421
Servicing income........................................... 425 268
Gain on sale of securities available-for-sale.............. 425 287
Service charges and other fees on deposit accounts......... 411 316
Other investment .......................................... 334 275
Other ..................................................... 812 323
----------- -----------
Total noninterest income...................................... 2,964 1,890
----------- -----------
Noninterest expenses:
Salaries and employee benefits............................. 4,712 4,534
Occupancy.................................................. 819 718
Furniture and equipment.................................... 395 356
Loan origination costs..................................... 317 290
Professional fees.......................................... 271 225
Client services............................................ 250 158
Advertising and promotion.................................. 171 130
Stationery & supplies...................................... 106 76
Telephone.................................................. 83 74
Other...................................................... 1,380 1,140
----------- -----------
Total noninterest expenses.................................... 8,504 7,701
----------- -----------
Income before provision for income taxes...................... 2,839 2,293
Provision for income taxes.................................... 910 780
----------- -----------
Net income.................................................... $ 1,929 $ 1,513
=========== ===========
Earnings per share:
Basic.................................................... $ 0.17 $ 0.14
=========== ===========
Diluted.................................................. $ 0.17 $ 0.13
=========== ===========
See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended
March 31,
--------------------------
(Dollars in thousands) 2003 2002
------------ ------------
Cash flows from operating activities:
Net income.......................................................... $ 1,929 $ 1,513
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization....................................... 429 392
Provision for probable loan losses.................................. 1,300 675
Gain on sale of securities available-for-sale....................... (425) (287)
Amortization of premiums / accretion of discounts................... 350 190
Gains on sales of loans held for sale............................... (557) (421)
Proceeds from sales of loans held for sale......................... 10,855 11,624
Originations of loans held for sale................................. (18,341) (18,745)
Maturities of loans held for sale................................... 9,351 6,425
Appreciation of corporate owned life insurance...................... (334) (275)
Effect of changes in:
Accrued interest receivable and other assets.................... 956 (3,418)
Accrued interest payable and other liabilities.................. 171 202
------------ ------------
Net cash provided by (used in) operating activities................. 5,684 (2,125)
------------ ------------
Cash flows from investing activities:
Net decrease (increase) in loans.................................... 22,101 (1,577)
Purchases of securities available-for-sale.......................... (4,087) (9,597)
Maturities/paydowns/calls of securities available-for-sale.......... 9,098 6,776
Proceeds from sales of securities available-for-sale............... 21,370 7,783
Maturities/paydowns/calls of securities held-to-maturity............ -- 852
Redemption (purchases) of other investments......................... 316 (694)
Purchases of premises and equipment................................. (115) (101)
------------ ------------
Net cash provided by investing activities........................... 48,683 3,442
------------ ------------
Cash flows from financing activities:
Net (decrease) increase in deposits................................. (17,310) 16,131
Net proceeds from issuance of common stock.......................... 274 169
------------ ------------
Net cash (used in) provided by financing activities................. (17,036) 16,300
------------ ------------
Net increase in cash and cash equivalents........................... 37,331 17,617
Cash and cash equivalents, beginning of period...................... 86,632 106,319
------------ ------------
Cash and cash equivalents, end of period............................ $ 123,963 $ 123,936
============ ============
Supplemental disclosures of cash paid during the period for:
Interest......................................................... $ 3,385 $ 5,407
Income taxes..................................................... $ 350 $ 3,650
See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND
SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
March 31, 2003
(Unaudited)
1)
Basis of
Presentation
The unaudited condensed consolidated financial statements
of Heritage Commerce Corp (the "Company") and its wholly owned
subsidiary: Heritage Bank of Commerce (HBC) have been prepared pursuant to the
rules and regulations for reporting on Form 10-Q. Accordingly, certain
information and notes required by accounting principles generally accepted in
the United States of America ("GAAP") for complete financial statements are not
included herein. The interim statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
Form 10-K for the year ended December 31, 2002. The Company has also
established the following subsidiary trusts: Heritage Capital Trust I; Heritage
Statutory Trust I; Heritage Statutory Trust II; and Heritage Commerce Corp
Statutory Trust III which are Delaware Statutory business trusts formed for the
exclusive purpose of issuing and selling trust preferred securities.
HBC is a commercial bank serving customers located in Santa
Clara, Alameda, and Contra Costa counties of California. No customer accounts
for more than 10 percent of revenue for HBC or the Company. Management
evaluates the Company's performance as a whole and does not allocate resources
based on the performance of different lending or transaction activities.
Accordingly, the Company and its subsidiary operate as one business segment.
In the Company's opinion, all adjustments necessary for a
fair presentation of these condensed consolidated financial statements have been
included and are of a normal and recurring nature. Certain reclassifications
have been made to prior year amounts to conform to current year
presentation.
The results for the three months ended March 31, 2003 are not
necessarily indicative of the results expected for any subsequent period or for
the entire year ending December 31, 2003.
2) Earnings Per
Share
Basic earnings per share is computed by dividing net
income by the weighted average common shares outstanding. Diluted earnings per
share reflects potential dilution from outstanding stock options, using the
treasury stock method. For each of the periods presented, net income is the
same for basic and diluted earnings per share. Reconciliation of weighted
average shares used in computing basic and diluted earnings per share is as
follows:
Three Months Ended
March 31,
------------------------
2003 2002
----------- -----------
Weighted average common shares outstanding - used
in computing basic earnings per share..................... 11,220,369 11,122,179
Dilutive effect of stock options outstanding,
using the treasury stock method........................... 261,432 272,544
----------- -----------
Shares used in computing diluted earnings per share........... 11,481,801 11,394,723
=========== ===========
3)
Comprehensive
Income
Comprehensive Income includes net income and other
comprehensive income, which represents the change in the Company's net assets
during the period from non-owner sources. The Company's sources of other
comprehensive income are unrealized gains and losses on securities available-
for-sale and I/O strips, which are treated like available-for-sale securities,
and are presented net of tax. Reclassification adjustments resulting from gains
or losses on investment securities that were realized and included in net income
of the current period that also had been included in other comprehensive income
as unrealized holding gains or losses in the period in which they arose are
excluded from comprehensive income of the current period. The Company's total
comprehensive income was as follows:
Three Months Ended
March 31,
------------------------
2003 2002
(Dollars in thousands) ----------- -----------
Net income.................................................... $ 1,929 $ 1,513
Other comprehensive loss, net of tax:
Net unrealized holding losses on available-for-sale
securities and I/O strips during the period.............. (63) (176)
Less: reclassification adjustment for realized
losses on available-for-sale securities
included in net income during the period.................. (289) (189)
----------- -----------
Other comprehensive loss...................................... (352) (365)
----------- -----------
Comprehensive income.......................................... $ 1,577 $ 1,148
=========== ===========
4) Stock-Based Compensation
The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.
No compensation expense has been recognized in the financial statements for
employee stock arrangements, as the Company's stock option plan provides for the
issuance of options at a price of no less than the fair market value at the date
of the grant.
SFAS No. 123, Accounting for Stock-Based Compensation,
requires the disclosure of pro forma net income and earnings per share had the
Company adopted the fair value method at the grant date of all stock options.
Under SFAS No. 123, the fair value of stock-based awards to employees is
calculated through the use of option pricing models, even though such models
were developed to estimate the fair value of freely tradable, fully transferable
options without vesting restrictions, which differ significantly from the
Company's stock option awards. Those models also require subjective assumptions,
which greatly affect the calculated values. The Company's calculations were made
using the Black-Scholes option pricing model with the following weighted average
assumptions: expected life, 84 months; risk-free interest rate, 1.1% and 1.8% for March
31, 2003 and 2002; stock volatility of
22% and 26% in March 31, 2003 and 2002; and no dividends
during the expected term. The Company's calculations are based on a multiple
option valuation approach, and forfeitures are recognized as they occur.
Had compensation expense for the Company's stock option plan
been determined under the requirements of SFAS No. 123 the Company's pro forma
net income and earnings per common share would have been as follows:
Three Months Ended
March 31,
2003 2002
(Amounts in thousands, except per share data) --------- ---------
Net income
As reported................................................... $ 1,929 $ 1,513
Less: Compensation expense for amortization of fair value of
stock awards, net of taxes.................................. (186) (159)
----------- -----------
Pro forma..................................................... $ 1,743 $ 1,354
=========== ===========
Net income per common share - basic
As reported................................................... $ 0.17 $ 0.14
Pro forma..................................................... $ 0.16 $ 0.12
Net income per common share - diluted
As reported................................................... $ 0.17 $ 0.13
Pro forma..................................................... $ 0.15 $ 0.12
5) Recent Accounting Pronouncements
Effective January 1, 2003, the Company adopted SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal
Activities" which addresses accounting for restructuring and similar
costs. SFAS No. 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force Issue No. 94-3. SFAS No. 146 requires that the
liability for costs associated with an exit or disposal activity be recognized
when the liability is incurred. Under Issue 94-3, a liability for an exit cost
was recognized at the date of the Company's commitment to an exit plan. SFAS
No. 146 also establishes that the liability should initially be measured and
recorded at fair value. The adoption of SFAS No. 146 did not have a material
effect on the Company's financial position, results of operations, or cash
flows.
6) Reclassifications
Certain amounts in the December 31, 2002 and March 31,
2002 financial statements have been reclassified to conform to the March 31,
2003 financial statement presentation.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Discussions of certain matters in this Report on
Form 10-Q may constitute forward looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and as such,
may involve risks and uncertainties. Forward-looking statements, which are
based on certain assumptions and describe future plans, strategies, and
expectations, are generally identifiable by the use of words such as "believe",
"expect", "intend", "anticipate", "estimate", "project", or similar expressions.
These forward-looking statements relate to, among other things, expectations of
the business environment in which the Company operates, projections of future
performance, potential future performance, potential future credit experience,
perceived opportunities in the market, and statements regarding the Company's
mission and vision. The Company's actual results, performance, and achievements
may differ materially from the results, performance, and achievements expressed
or implied in such forward-looking statements due to a wide range of factors.
The factors include, but are not limited to changes in interest rates, general
economic conditions, legislative and regulatory changes, monetary and fiscal
policies of the US Government, real estate valuations, competition in the
financial services industry, and other risks. All of the Company's operations
and most of its customers are located in California. During the past year, the
availability of a sufficient supply of electrical power in California has been
unreliable at times. In addition, other events, including those of September
11, 2001, have increased the uncertainty related to the national and California
economic outlook and could have an effect on the future operations of the
Company or its customers, including borrowers. The Company does not undertake,
and specifically disclaims any obligation, to update any forward-looking
statements to reflect occurrences or unanticipated events or circumstances after
the date of such statements.
Heritage operates as the bank
holding company for its subsidiary bank: Heritage Bank of Commerce (the "Bank").
HBC is California state chartered bank, which offers a full range of commercial
and personal banking services to residents and the business/professional
community in Santa Clara, Contra Costa and Alameda Counties, California. The
accounting and reporting policies of Heritage Commerce Corp and its subsidiary
conform to accounting principles generally accepted in the United States of
America and prevailing practices within the banking industry.
CRITICAL ACCOUNTING POLICIES
General
Heritage Commerce Corp's financial statements are
prepared in accordance with accounting principles generally accepted in the
United States of America (GAAP). The financial information contained within our
financial statements is, to a significant extent, based on approximate measures
of the financial effects of transactions and events that have already occurred.
A variety of factors could affect the ultimate value that is obtained either
when earning income, recognizing an expense, recovering an asset or relieving a
liability. In certain instances, the Company uses the discount factor and
prepayment assumptions to determine the present value of assets and liabilities.
A change in the discount factor or prepayment spreads could increase or decrease
the values of those assets and liabilities which would result in either a
beneficial or adverse impact to the Company's financial results. The Company
used historical loss experience as one factor in determining the inherent loss
that may be present in the Company's loan portfolio. Actual losses could differ
significantly from the historical factors that we use. Other estimates that the
Company used are related to the expected useful lives of the Company's
depreciable assets. In addition GAAP itself may change from one previously
acceptable method to another method. Although the economics of the Company's
transactions would be the same, the timing of events that would impact the
Company's transactions could change.
Allowance for Probable Loan Losses
The allowance for probable loan losses is an estimate
of the losses that may be sustained in the Company's loan portfolio. The
allowance is based on two basic principles of accounting. (1) Statement of
Financial Accounting Standards (SFAS) No. 5 "Accounting for
Contingencies", which requires that losses be accrued when they are
probable of occurring and estimable and (2) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued
based on the differences between the value of collateral, present value of
future cash flows or values that are observable in the secondary market and the
loan balance.
The Company's allowance for probable loan losses has
three basic components: the formula allowance, the specific allowance and the
unallocated allowance. Each of these components is determined based upon
estimates that can and do change when the actual events occur. The formula
allowance uses an historical loss view as an indicator of future losses and as a
result could differ from the losses incurred in the future. The specific
allowance uses various techniques to arrive at an estimate of loss. Historical
loss information, and fair market value of collateral are used to estimate those
losses. The use of these values is inherently subjective and our actual losses
could be greater or less than the estimates. The unallocated allowance captures
losses that are attributable to various economic events, industry or geographic
sectors whose impact on the portfolio have occurred but have yet to be
recognized in either the formula or specific allowances. For further
information regarding our allowance for credit losses, see Allowance for
Probable Loan Losses on page 17.
Loan Sales and Servicing
The amounts of gains recorded on sales of loans and the
initial recording of servicing assets and interest only strips is based on the
estimated fair values of the respective components. In recording the initial
value of the servicing assets and the fair value of the Interest-Only (I/O)
strips receivable, the Company uses estimates which are made based on
management's expectations of future prepayment and discount rates. For the
quarter ended March 31, 2003, management's estimate of constant prepayment rate
("CPR") was 14% and the weighted average discount rate assumption was
10%. These prepayment and discount rates were based on current market
conditions and historical performance of the various pools of loans. If actual
prepayments with respect to sold loans occur more quickly than projected the
carrying value of the servicing assets may have to be adjusted through a charge
to earnings. Variations in prevailing interest rates on borrowed funds, changes
in general economic conditions, among other factors, could cause changes in the
prepayment experience. A corresponding decrease in the value of the I/O strip
receivable would also be expected.
Stock Based Awards
The Company accounts for its stock based awards using the
intrinsic value method in accordance with Accounting Principles Board
("APB") Opinion No. 25 and related interpretations. Since the
Company's stock option plans provide for the issuance of options at a price of
no less than the fair market value at the date of the grant, no compensation
expense has been recognized in the financial statements at the date of grant.
RESULTS OF OPERATIONS
Overview
Net income for the three months ended March 31, 2003
was $1,929,000, up 27% from $1,513,000 for the three months ended March 31,
2002. Earnings per diluted share for the three months ended March 31, 2003 were
$0.17, up 31% from $0.13 per diluted share for the three months ended March 31,
2002. Annualized return on average assets and return on average equity for the
quarter ended March 31, 2003 were 0.85% and 9.32%, compared with returns of
0.67% and 8.11%, for the same period in the prior year.
For the three months ended March 31, 2003, as compared with
the same period in the prior year, net interest income increased from $8,779,000
to $9,679,000, an increase of $900,000, or 10%. The Company's net interest
margin was 4.64% for the three months ended March 31, 2003, compared with 4.23%
for the three months ended March 31, 2002, reflecting the result of a decrease
in both the average level and cost of interest bearing liabilities and the
change in mix of earning assets, primarily the increase in the volume of average
loans.
Total assets as of March 31, 2003 were $943,115,000, an
increase of $14,797,000, or 2%, from $928,318,000 as of March 31, 2002, and a
decrease of $15,637,000, or 2%, from total assets of $958,752,000 as of December
31, 2002. Total deposits as of March 31, 2003 were $824,626,000, an increase of
$587,000, or less than 1%, from $824,039,000 as of March 31, 2002, and a
decrease of $17,310,000, or 2%, from total deposits of $841,936,000 as of
December 31, 2002.
Total portfolio loans as of March 31, 2003 were $651,526,000,
an increase of $17,342,000, or 3%, from $634,184,000 as of March 31, 2002 and a
decrease of 3% from $673,907,000 as of December 31, 2002. The Company's
allowance for probable loan losses was $14,247,000, or 2.19%, of total loans at
March 31, 2003. This compares with an allowance for probable loan losses of
$11,519,000, or 1.82%, and $13,227,000, or 1.96% of total loans at March 31,
2002 and December 31, 2002. The increase in the allowance for probable loan
losses was due to increases in the Company's level of nonperforming assets and
additional provisions to reflect the continued weaknesses in the economy. The
Company's nonperforming assets increased to $4,800,000, compared to $1,026,000
as of March 31, 2002 and $4,571,000 as of December 31, 2002.
The Company's shareholders' equity at March 31, 2003 was
$84,716,000, up from $75,891,000 at March 31, 2002 and $82,865,000 as of
December 31, 2002. The increase in shareholders' equity is a result of the
income generated over the period and the exercise of common stock options offset
by a decline in other comprehensive income from fair value changes. Book value
per share increased to $7.55 at March 31, 2003, from $6.82 at March 31, 2002 and
$7.39 at December 31, 2002. The Company's leverage capital ratio was 11.31% at
March 31, 2003 compared to 10.22% at March 31, 2002 and 10.80% at December 31,
2002.
Net Interest Income and Net Interest Margin
The following table presents the Company's average balance sheet, net
interest income and the resultant yields and rates paid for the period
presented:
For the Three Months Ended For the Three Months Ended
March 31, 2003 March 31, 2002
--------------------------------- ---------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
(Dollars in thousands) Balance Expense Rate Balance Expense Rate
- ---------------------------------------------------------- ---------- ---------- --------- ---------- ---------- ---------
Assets:
Loans, gross.............................................. $ 693,852 $ 11,185 6.54% $ 673,105 $ 11,609 6.99%
Investment securities..................................... 116,921 1,165 4.04% 102,611 1,205 4.76%
Interest bearing deposits in other financial institutions. 7,312 16 0.89% 8,059 27 1.36%
Federal funds sold........................................ 28,014 82 1.19% 57,352 230 1.63%
---------- ---------- ---------- ----------
Total interest earning assets.......................... 846,099 $ 12,448 5.97% 841,127 $ 13,071 6.30%
---------- ----------
Cash and due from banks................................... 37,211 36,367
Premises and equipment, net............................... 5,215 5,356
Other assets.............................................. 34,431 26,627
---------- ----------
Total assets........................................... $ 922,956 $ 909,477
========== ==========
Liabilities and shareholders' equity:
Deposits:
Demand, interest bearing.................................. $ 92,657 $ 146 0.64% $ 81,377 $ 187 0.93%
Savings and money market.................................. 302,756 976 1.31% 241,945 1,138 1.91%
Time deposits, under $100................................. 45,165 243 2.18% 67,459 636 3.82%
Time deposits, $100 and over.............................. 107,853 550 2.07% 143,247 1,175 3.33%
Brokered deposits......................................... 37,947 365 3.90% 68,032 664 3.96%
Other borrowings.......................................... 24,022 489 8.26% 21,301 492 9.37%
---------- ---------- ---------- ----------
Total interest bearing liabilities..................... 610,400 $ 2,769 1.84% 623,361 $ 4,292 2.79%
---------- ----------
Demand deposits........................................... 217,630 200,010
Other liabilities......................................... 10,978 10,437
---------- ----------
Total liabilities...................................... 843,354 833,808
Shareholders' equity...................................... 83,948 75,669
---------- ----------
Total liabilities and
shareholders' equity................................ $ 922,956 $ 909,477
========== ==========
Net interest income / margin.......................................... $ 9,679 4.64% $ 8,779 4.23%
========== ==========
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Note: |
|
Yields and amounts earned on loans include loan fees of
$1,101,000 and $1,142,000 for the three month periods ended March 31, 2003 and
2002, respectively. Interest income is reflected on an actual basis, not a
fully taxable equivalent basis, and does not include a fair value adjustment.
Nonaccrual loans of $4,800,000 and $1,026,000 for the period ended March 31,
2003 and 2002, respectively, are included in the average balance calculation
above. |
The Company's net interest income for the three
months ended March 31, 2003 was $9,679,000, an increase of $900,000 or 10% over
the same three month period in the prior year. For the three months ended March
31, 2003 compared to the same periods in the prior year, average interest
earning assets increased by $4,972,000, or 1%. For the three months ended March
31, 2003, the average yield on interest earning assets was 5.97%, down 33 basis
points from 6.30% for the same period in 2002. Over the same period the rates
paid on interest bearing liabilities declined 95 basis points to 1.84% from
2.79%. As a result, the net interest margin increased 41 basis points to 4.64%
for the three months ended March 31, 2003, from 4.23% for the same period in the
prior year. This increase was primarily attributable to the increase in average
earning assets and the change in mix as average loan and investment balances
increased while average federal funds decreased, coupled with a decrease in
average interest bearing liabilities, primarily in time and brokered deposits,
resulting in a decrease in the cost of interest bearing liabilities. These
factors resulted in an increase in net interest margin of 41 basis points and an
increase in net interest income of 10%, or $900,000.
The following table sets forth an
analysis of the changes in interest income resulting from changes in the average
volume of interest earning assets and liabilities and changes in the average
rates earned and paid. The total change is shown in the column designated
"Net Change" and is allocated in the columns to the left, to the
portions respectively attributable to volume changes and rate changes that
occurred during the period indicated. Changes due to both volume and rate have
been allocated to the change in volume.
Three Months Ended March 31,
2003 vs. 2002
----------------------------------
Increase (Decrease) Due to Change In:
Average Average Net
(Dollars in thousands) Volume Rate Change
- -------------------------------------------------------------- ---------- ---------- ----------
Interest earning assets
Loans, gross.............................................. $ 334 $ (758) $ (424)
Investment securities..................................... 143 (183) (40)
Interest bearing deposits in other financial institutions. (2) (9) (11)
Federal funds sold........................................ (86) (62) (148)
---------- ---------- ----------
Total interest earning assets................................ $ 389 $ (1,012) $ (623)
---------- ---------- ----------
Interest bearing liabilities
Demand, interest bearing.................................. 18 $ (59) $ (41)
Savings and money market.................................. 196 (358) (162)
Time deposits, under $100................................. (120) (273) (393)
Time deposits, $100 and over.............................. (180) (445) (625)
Brokered Deposits......................................... (289) (10) (299)
Other borrowings.......................................... 55 (58) (3)
---------- ---------- ----------
Total interest bearing liabilities........................... $ (320) $ (1,203) $ (1,523)
---------- ---------- ----------
Net interest income.......................................... $ 709 $ 191 $ 900
========== ========== ==========
Provision for Probable Loan Losses
The provision for probable loan losses represents the current
period expense associated with maintaining an appropriate allowance for credit
losses. The loan loss provision and level of allowance for each period is
dependent upon many factors, including loan growth, net charge-offs, changes in
the composition of the loan portfolio, delinquencies, management's assessment of
the quality of the loan portfolio, the valuation of problem loans and the
general economic conditions in the Company's market area. Periodic fluctuations
in the provision for loan losses result from management's assessment of the
adequacy of the allowance for probable loan losses; however, actual loan losses
may vary from current estimates. For the three months ended March 31, 2003, the
provision for probable loan losses was $1,300,000, up $625,000, from $675,000
for the same periods in the prior year. See additional discussion at Allowance
for Probable Loan Losses.
Noninterest Income
The following table sets forth the various components of the Company's
noninterest income for the periods indicated:
Three Months Ended Increase
March 31, 2003 versus 2002
-------------------- --------------------
(Dollars in thousands) 2003 2002 Amount Percent
- ---------------------------------------------------- --------- --------- --------- ---------
Gain on sale of loans............................... $ 557 $ 421 $ 136 32 %
Servicing income.................................... 425 268 157 59 %
Gain on sale of securities available-for-sale....... 425 287 138 48 %
Service charges and other fees on deposits accounts. 411 316 95 30 %
Other investment.................................... 334 275 59 21 %
Other............................................... 812 323 489 151 %
--------- --------- ---------
Total............................................... $ 2,964 $ 1,890 $ 1,074 57 %
========= ========= =========
Noninterest income for the three months ended March 31, 2003
was $2,964,000, up 57% from $1,890,000 for the same periods in the prior year.
The increases were primarily due to the increases in service charges and fees of
$95,000 from an increase in the level of certain fees, increases in gain on sale
of securities available-for-sale of $138,000 as the interest rate environment in
the first quarter of 2003 provided the opportunity for the Company to realize
gains on the sale of securities, increases in servicing income of $157,000, and
increases in gain on sale of loans of $136,000. The increase in servicing
income and in gains on sales of loans was primarily the result of expansion of
the SBA lending operation into additional geographic areas of California and the
overall increase in the level of loans serviced. The first quarter of 2003 also
includes $310,000 of other income from the leasing of equipment. There was no
income from equipment leasing in the first quarter of 2002.
Noninterest Expense
The following table sets forth the various components of the Company's
noninterest expenses for the periods indicated:
Three Months Ended Increase
March 31, 2003 versus 2002
-------------------- --------------------
(Dollars in thousands) 2003 2002 Amount Percent
- ---------------------------------------------------- --------- --------- --------- ---------
Salaries and employee benefits...................... $ 4,712 $ 4,534 $ 178 4 %
Occupancy........................................... 819 718 101 14 %
Furniture and equipment............................. 395 356 39 11 %
Loan origination costs.............................. 317 290 27 9 %
Professional fees................................... 271 225 46 20 %
Client services..................................... 250 158 92 58 %
Advertising and promotion........................... 171 130 41 32 %
Stationery & supplies............................... 106 76 30 39 %
Telephone........................................... 83 74 9 12 %
Other............................................... 1,380 1,140 240 21 %
--------- --------- ---------
Total............................................... $ 8,504 $ 7,701 $ 803 10 %
========= ========= =========
The following table indicates the percentage of
noninterest expense in each category:
For The Three Months Ended March 31,
-------------------------------------------
Percent Percent
(Dollars in thousands) 2003 of Total 2002 of Total
- ---------------------------------------------------- --------- --------- --------- ---------
Salaries and employee benefits...................... $ 4,712 55 % $ 4,534 59 %
Occupancy........................................... 819 10 % 718 9 %
Furniture and equipment............................. 395 5 % 356 5 %
Loan origination costs.............................. 317 4 % 290 4 %
Professional fees................................... 271 3 % 225 3 %
Client services..................................... 250 3 % 158 2 %
Advertising and promotion........................... 171 2 % 130 1 %
Stationery & supplies............................... 106 1 % 76 1 %
Telephone........................................... 83 1 % 74 1 %
Other............................................... 1,380 16 % 1,140 15 %
--------- --------- --------- ---------
Total............................................... $ 8,504 100 % $ 7,701 100 %
========= ========= ========= =========
Noninterest expenses for the three months ended March 31,
2003 were $8,504,000, up $803,000, or 10%, from $7,701,000 for the same period
in the prior year. For the three month ended March 31, 2003, salaries and
benefits increased $178,000, or 4%, to $4,712,000, as compared to the same
period in the prior year. The increases were primarily due to normal merit
increases, and in activity-based commissions related to the Company's
residential mortgage brokerage operations. For the comparative three month
periods, occupancy increased by $101,000, or 14%, primarily as a result of
increased rental costs. Occupancy costs, as a percentage of total noninterest
expenses remained fairly constant over the comparative three month periods. For
the comparative three month periods, professional fees increased $46,000, or
20%, to $271,000. The increases were primarily due to increased costs from
professional service providers. For the comparative three month periods,
furniture and equipment increased by $39,000, or 11%, to $395,000. The increase
in furniture and equipment in 2003 from 2002 was due to costs for the addition
of new facilities. For the comparative three month periods, loan origination
costs increased by $27,000, or 9%, to $317,000. The increase from 2002 was
primarily due to continued growth in the loan portfolio. For the comparative
three month periods, client services increased $92,000, or 58%, to $250,000.
The increase from 2002 was primarily as a result of the increase in services
fees charged to the Company from third party vendors in 2003. For the
comparative three month periods, advertising and promotion increased $41,000,
or 32%, to $171,000. The increase from 2002 was primarily as a result of
several new sponsorships in 2003. For the comparative three month periods,
stationery and supplies increased by $30,000, or 39%, to $106,000, and telephone
expense increased by $9,000, or 12%, to $83,000. The increase in stationery and
supplies and phone expense from 2002 was primarily due to the addition of new
facilities in 2003. For the comparative three month period, other noninterest
expense increased $240,000, or 21%, to $1,380,000 in support of the overall
growth of the Company and expenses related to the Company's investment in a low
income housing project and leasing equipment.
Income Taxes
The provision for income taxes for the three months ended
March 31, 2003 was $910,000, as compared to $780,000 for the same periods in the
prior year. The following table shows the income tax rate for each period
indicated.
Three Months Ended
March 31,
--------------------
2003 2002
--------- ---------
Income tax rate..................................... 32.05 % 34.02 %
The difference in the effective tax rate compared to the
statutory tax rate of 42% is primarily the result of the Company's receipt of
tax fee distributions from certain life insurance contracts, low income housing
tax credits, and changes in the Company's level of investments in municipal
securities.
FINANCIAL CONDITION
Total assets decreased $15,637,000, or 2%, to $943,115,000 at
March 31, 2003 from $958,752,000 at December 31, 2002, and increased
$14,797,000, or 2%, from $928,318,000 at March 31, 2002. Total portfolio loans
decreased $22,381,000, or 3%, to $651,526,000 at March 31, 2003 from
$673,907,000 at December 31, 2002, but increased $17,342,000, or 3%, from
$634,184,000 at March 31, 2002. Total deposits decreased $17,310,000 or 2% to
$824,626,000 at March 31, 2003 from $841,936,000 at December 31, 2002, and
up slightly from $824,039,000 at March 31, 2002. The overall increase from March
31, 2002 reflects the continued internal growth of the Company. The decreases
from December 31, 2002 reflects the Company's decision to reduce its reliance on
interest rate sensitive deposits, including brokered deposits, and grow core
deposits.
Securities Portfolio
The following table sets forth the carrying value of investment securities at
the dates indicated:
March 31,
---------------------- December 31
(Dollars in thousands) 2003 2002 2002
- ----------------------------------------------- ---------- ---------- ----------
Securities available-for-sale (at fair value)
U.S. Treasury.................................. $ 4,631 3,556 $ 4,740
U.S. Government Agencies....................... 33,434 52,162 48,029
Mortgage-backed securities..................... 40,335 19,526 44,774
Municipals..................................... 9,115 4,147 12,134
Corporate bonds................................ -- 2,573 2,632
CMOs........................................... 11,921 4,034 14,134
---------- ---------- ----------
Total securities available-for-sale............ $ 99,436 $ 85,998 $ 126,443
========== ========== ==========
Securities held-to-maturity (at amortized cost)
Mortgage-backed securities..................... $ -- $ 4,053 $ --
CMOs........................................... -- 378 --
Municipals..................................... -- 9,996 --
---------- ---------- ----------
Total securities held-to-maturity......... $ -- $ 14,427 $ --
========== ========== ==========
The following table summarizes the composition of the Company's
investment securities and the weighted average yields at March 31, 2003:
March 31, 2003
Maturity
----------------------------------------------------------------------------------------
After One and After Five and
Within One Year Within Five Years Within Ten Years After Ten Years Total
--------------- --------------- --------------- --------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
(Dollars in thousands) -------- ------ -------- ------ -------- ------ -------- ------ --------- ------
Securities available-for-sale:
U.S. Treasury.................. $ 1,312 1.54 % $ 3,319 2.09 % $ -- -- % $ -- -- % $ 4,631 1.94 %
U.S. Government Agencies....... 7,033 5.23 % 26,401 3.27 % -- -- % -- -- % 33,434 3.68 %
Mortgage-backed securities..... -- -- % -- -- % 1,568 5.62 % 38,767 4.31 % 40,335 4.36 %
Municipals - taxable.......... 1,115 6.67 % 557 6.45 % -- -- % -- -- % 1,672 6.59 %
Municipals - nontaxable....... 411 4.82 % 4,960 4.59 % 2,072 4.53 % -- -- % 7,443 4.58 %
CMOs........................... -- -- % -- -- % 2,040 3.92 % 9,881 2.19 % 11,921 2.49 %
-------- -------- -------- -------- ---------
Total available-for-sale....... $ 9,871 4.88 % $ 35,237 3.38 % $ 5,680 4.60 % $ 48,648 3.88 % $ 99,436 3.85 %
======== ======== ======== ======== =========
|
Note: |
|
Yield on non-taxable municipal securities are not presented on a
fully tax equivalent basis. |
Loans
Total loans (exclusive of loans held for sale) decreased
$22,381,000, or 3%, to $651,526,000 as of March 31, 2003 from $673,907,000 as of
December 31, 2002, but increased $17,342,000, or 3%, from $634,184,000 as of
March 31, 2002.
For the three months ended March 31, 2003 $18,341,000 in
loans guaranteed by the U.S. Small Business Administration (SBA) were generated
and held for sale, and $10,298,000 of SBA loans held for sale was sold into the
secondary market.
At March 31, 2003 and December 31, 2002, the Company serviced
SBA loans, which it had sold into the secondary market of approximately
$91,219,000 and $83,008,000. At March 31, 2003 and December 31, 2002, the
carrying amount of the servicing assets was $1,615,000 and $1,538,000,
respectively. There was no valuation allowance as of March 31, 2003 or December
31, 2002. The carrying amount of Interest-Only (I/O) strip receivable at March
31, 2003 and December 31, 2002 was $2,682,000 and $2,839,000, respectively.
These assets represent the servicing spread generated from the sold guaranteed
portions of SBA loans. Servicing income from these loans was $425,000 for the
quarter ended March 31, 2003, compared to $268,000 for the same periods in 2002.
Amortization of the related assets was $297,000 for the quarter ended March 31,
2003, compared to $243,000 for the same periods in 2002. Heritage Bank of
Commerce is a preferred lender with the U.S. Small Business Administration,
which allows the Company to grant certain U.S. Small Business Administration
loans without the prior approval of the SBA.
The following table summarizes the composition of the Company's loan
portfolio at the dates indicated:
March 31, % of December 31, % of
(Dollars in thousands) 2003 Total 2002 Total
- ----------------------------------- ------------ ----------- ----------- -----------
Commercial......................... $ 256,359 39 % $ 263,144 39 %
Real estate - mortgage............. 250,668 38 % 259,974 38 %
Real estate - land and construction 141,165 22 % 147,822 22 %
Consumer........................... 2,823 1 % 2,850 1 %
------------ ----------- ----------- -----------
Total loans................... 651,015 100 % 673,790 100 %
=========== ===========
Deferred loan costs................ 511 117
Allowance for loan losses.......... (14,247) (13,227)
------------ -----------
Loans, net......................... $ 637,279 $ 660,680
============ ===========
The Company's loan portfolio is based on commercial
(primarily to companies engaged in manufacturing, wholesale, and service
businesses) and real estate lending, with the balance in consumer loans. While
no specific industry concentration is considered significant, the Company's
lending operations are dependent on the technology and real estate industries
and their supporting companies located within the Company's market area. Thus,
the Company's borrowers could be adversely impacted by a downturn in these
sectors of the economy, which could reduce the demand for loans and adversely
impact the borrowers' abilities to repay their loans.
The following table sets forth the maturity distribution of the Company's
loans at March 31, 2003:
Over One
Due in Year But
One Year Less Than Over
(Dollars in thousands) or Less Five Years Five Years Total
- ----------------------------------- ------------ ----------- ----------- -----------
Commercial......................... $ 243,156 $ 12,261 $ 942 $ 256,359
Real estate - mortgage............. 176,187 64,920 9,561 250,668
Real estate - land and construction 141,165 -- -- 141,165
Consumer........................... 2,564 259 -- 2,823
------------ ----------- ----------- -----------
Total loans................... $ 563,072 $ 77,440 $ 10,503 $ 651,015
============ =========== =========== ===========
Loans with variable interest rates. $ 542,634 $ 44,530 $ 2,107 $ 589,271
Loans with fixed interest rates.... 20,438 32,910 8,396 61,744
------------ ----------- ----------- -----------
Total loans................... $ 563,072 $ 77,440 $ 10,503 $ 651,015
============ =========== =========== ===========
The table above also 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
March 31, 2003, approximately 91% of the Company's loan portfolio consisted of
floating interest rate loans.
Nonperforming assets
Nonperforming assets consist of nonaccrual loans, loans past
due 90 days and still accruing, troubled debt restructurings and other real
estate owned. Management generally places loans on nonaccrual status when they
become 90 days past due, unless they are well secured and in the process of
collection. When a loan is placed on nonaccrual status, any interest previously
accrued but not collected is generally reversed from income. Loans are charged
off when management determines that collection has become unlikely. Restructured
loans are those where the Banks have granted a concession on the interest paid
or original repayment terms due to financial difficulties of the borrower. Other
real estate owned ("OREO") consists of real property acquired through
foreclosure on the related underlying defaulted loans. The following table shows
nonperforming assets at the dates indicated:
March 31,
---------------------- December 31,
(Dollars in thousands) 2003 2002 2002
- -------------------------------------------- ---------- ---------- -----------
Nonaccrual loans............................ $ 4,800 $ 1,026 $ 4,571
Loans 90 days past due and still accruing -- -- --
Restructured loans.......................... -- -- --
---------- ---------- -----------
Total nonperforming loans............... 4,800 1,026 4,571
Foreclosed assets........................... -- -- --
---------- ---------- -----------
Total nonperforming assets.............. $ 4,800 $ 1,026 $ 4,571
========== ========== ===========
Nonperforming assets as a percentage of
period end loans plus foreclosed assets... 0.74 % 0.16 % 0.68 %
As of March 31, 2003, the Company had $4,800,000 loans on nonaccrual status,
compared to $1,026,000 in the same period of the prior year, which were
considered impaired loans. The increase was primarily as a result of the
placement of one commercial real estate loan on nonaccrual status in third
quarter of 2002 and which continued on nonaccrual status through March 31, 2003.
The impaired loans had a related valuation allowance of $634,000 at March 31,
2003. The Company had no loans past due 90 days or more and still accruing
interest, no restructured loans and no foreclosed assets as of March 31, 2003
and 2002. The Company had $4,571,000 loans on nonaccrual status as of December
31, 2002, which were considered impaired loans. The Company had no loans past
due 90 days or more and still accruing interest, no restructured loans and no
foreclosed assets as of December 31, 2002. For the three months ended March 31,
2003, the Company had $106,000 foregone interest income on nonaccrual loans.
The Company had no foregone interest income on nonaccrual loans as of December
31, 2002. For the three months ended March 31, 2003, the Company recognized
$161,000 in interest income for cash payments received on nonaccrual loans. The
Company did not recognize any interest income for cash payments received on
nonaccrual loans for the three months ended March 31, 2002.
The Company assigns a risk grade consistent with
the system recommended by regulatory agencies to all of its loans. Grades range
from "Pass" to "Loss" depending on credit quality, with "Pass" representing
loans that involve an acceptable degree of risk. Management conducts a critical
evaluation of the loan portfolio monthly. This evaluation includes periodic loan
by loan review for certain loans to evaluate the level of impairment as well as
detailed reviews of other loans (either individually or in pools) based on 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,
size and complexity of the loans, recent loss experience in particular segments
of the portfolio, bank regulatory examination results, and current economic
conditions in the Company's marketplace, in particular the state of the
technology industry and the real estate market.
This process attempts to assess the risk of loss inherent in
the portfolio by segregating loans into four components for purposes of
determining an appropriate level of the allowance: "watch," "special mention,"
"substandard" and "doubtful." Additionally, the Company maintains a program for
regularly scheduled reviews of certain new and renewed loans by an outside loan
review consultant. Any loans identified during an external review process that
expose the Company to increased risk are appropriately downgraded and an
increase in the allowance for loan losses is established for such loans.
Further, the Company is examined periodically by the FDIC, FRB, and the
California Department of Financial Institutions at which time a further review
of loan quality is conducted.
Loans that demonstrate a weakness, for which there is a
possibility of loss if the weakness is not corrected, are categorized as
"classified." Classified loans include all loans graded substandard, doubtful
and loss and may result from problems specific to a borrower's business or from
economic downturns that affect the borrower's ability to repay or that cause a
decline in the value of the underlying collateral (particularly real
estate).
Allowance for Loan Losses
It is the policy of management to maintain the allowance for
probable loan losses at a level adequate for 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 allowance is adequate. However, the loan portfolio can be adversely
affected if California economic conditions and the real estate market in the
Company's market area were to continue to weaken. Additionally, any weakness of
a prolonged nature in the technology industry would have a negative impact on
the local market. The effect of such events although uncertain at this time,
could result in an increase in the level of nonperforming loans and increased
loan losses, which could adversely affect the Company's future growth and
profitability. No assurance of the ultimate level of credit losses can be given
with any certainty. Loans are charged against the allowance when management
believes that the collectibility of the principal is unlikely.
The following table summarizes the Company's loan loss experience as well as
provisions, charge-offs and recoveries to the allowance for loan losses and
certain pertinent ratios for the periods indicated:
Three Months Ended
March 31, For the Year Ended
-------------------- December 31,
(Dollars in thousands) 2003 2002 2002
- --------------------------------------- --------- --------- -------------
Balance, beginning of period / year.... $ 13,227 $ 11,154 $ 11,154
Net charge-offs........................ (280) (310) (590)
Provision for probable loan losses..... 1,300 675 2,663
--------- --------- -------------
Balance, end of period / year.......... $ 14,247 $ 11,519 $ 13,227
========= ========= =============
Ratios:
Net charge-offs to
average loans outstanding........... 0.17 % 0.20 % 0.09 %
Allowance for loan losses to average lo 2.15 % 1.80 % 2.07 %
Allowance for loan losses to total loan 2.19 % 1.82 % 1.96 %
Allowance for loan losses to
non-performing assets............... 297 % 1,123 % 289 %
Charge-offs reflect the realization of losses in the
portfolio that were recognized previously though provisions for probable loan
losses. The net charge-offs as of March 31, 2003 were $280,000, compared to
$310,000 as of March 31, 2002. Historical net charge-offs are not necessarily
indicative of the amount of net charge-offs that the Company will realize in the
future.
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:
March 31, 2003 March 31, 2002 December 31, 2002
-------------------- ------------------------ --------------------
Percent Percent Percent
of ALL by of ALL by of ALL by
category category category
to total to total to total
loans by loans by loans by
(Dollars in thousands) Amount category Amount category Amount category
- --------------------------------------- --------- --------- ------------- --------- --------- ---------
Commercial............................. $ 7,910 3.09 % $ 5,770 2.68 % $ 6,349 2.41 %
Real estate - mortgage................. 3,157 1.26 % 1,594 0.63 % 2,411 0.93 %
Real estate - land and construction.... 3,180 2.25 % 3,002 1.87 % 3,574 2.42 %
Consumer............................... 51 1.81 % 106 2.47 % 47 1.63 %
Unallocated............................ (51) -- % 1,047 -- % 846 -- %
--------- ------------- ---------
Total ............................ $ 14,247 2.19 % $ 11,519 1.82 % $ 13,227 1.96 %
========= ============= =========
The increase in the allowance for loan losses from December
31, 2002 reflects the growth in the Company's overall level of loans, primarily
in the commercial loan portfolio offset by decreases in the real estate land and
construction portfolio and the impact of this change in mix on the need for
additional allowances. The increase in the allowance from December 31, 2002
also reflects reserves attributed to an $8.3 million commercial loan with risk
characteristics that create uncertainty about repayment in full under the
original terms of the loan. Although the loan is still performing and on an
accrual basis and the borrower has provided additional collateral, the Company
has increased its loan loss reserve to mitigate the future impact in the event
that the loan is not paid in full. Other than this loan and the loans already
classified at March 31, 2003, the Company has not identified any potential
problem loans which result in these loans being included as nonperforming or
classified loans at a future date.
Loans are charged against the allowance when management
believes that the collectibility of the principal is doubtful. The Company's
methodology for assessing the appropriateness of the allowance consists of
several key elements, which include specific allowances, the formula allowance
and the unallocated allowance.
Specific allowances are established in cases where management
has identified significant conditions or circumstances related to a credit that
management believes indicate the probability that a loss may be incurred in
excess of the amount determined by the application of the formula allowance. As
of March 31, 2003, nonperforming loans had a related specific valuation
allowance of $634,000.
The formula allowance is calculated by applying loss factors
to outstanding loans and certain unused commitments. Loss factors are based on
management's experience and may be adjusted for significant factors that, in
management's judgment, may affect the collectibility of the portfolio as of the
evaluation date. Due to the Company's limited historical loss experience,
management utilizes their prior industry experience to determine the loss factor
for each category of loan. The formula allowance on March 31, 2003 was
$13,664,000, compared to $12,381,000 on December 31, 2002. The increase was
attributable to several factors, most notably the change in the mix of loans and
an increase in certain factors used to estimate the reserve allocations.
The unallocated allowance is based upon management's
evaluation of various conditions that are not directly measured in the
determination of the formula and specific allowances. The evaluation of the
inherent loss with respect to these conditions is subject to a higher degree of
uncertainty because they are not identified with specific problem credits or
portfolio segments. As of March 31, 2003, the Company's unallocated allowance
was below zero, compared to $846,000 on December 31, 2002. The Company had
$175,000 in related evaluation allowance on a nonperforming asset that was
classified as in process collection as of quarter end. A recovery of $275,000
was realized on this asset in April 2003. As a result of the recovery the
related evaluation allowance has been reduced to approximately $40,000 and the
unallocated allowance would have been $84,000 if the evaluation adjustment
occurred at March 31, 2003. In evaluating the appropriateness of the
unallocated allowance, management considered the changes in the trend of the
volume and severity of past due and classified loans; and trends in the volume
of nonaccrual loans, troubled debt restructurings and other loan modifications,
changes in national and local economic and business conditions, trends, and
developments, including the condition of various market segments, changes in
underwriting standards and collection, charge-off, and recovery practices, and
changes in the volume and mix of the loan portfolio and in credit concentrations
particularly in commercial and real estate land and construction lending. There
can be no assurance that the adverse impact of any of these conditions on the
Bank will not be in excess of the range set forth above.
In addition, the current business, economic, and real estate
markets along with the seasoning of the portfolio and the nature and duration of
the current business cycle will affect the amount of unallocated reserve.
In an effort to improve its analysis of risk factors
associated with its loan portfolio, the Company continues to monitor and to make
appropriate changes to its internal loan policies. These efforts better enable
the Company to assess risk factors prior to granting new loans and to assess the
sufficiency of the allowance for loan losses.
Management believes that it has adequately provided an
allowance for estimated probable losses in the credit portfolio. Significant
deterioration in Northern California real property values or economic downturns
could impact future operating results, liquidity or capital resources and
require additional provisions to the allowance or cause losses in excess of the
allowance.
Deposits
Deposits totaled $824,626,000 at March 31, 2003, down
2%, compared to deposits
of $841,936,000 at December 31, 2002, and slightly increase from $824,039,000 at
March 31, 2002. Compared to December 31, 2002, noninterest bearing demand
deposits decreased $3,413,000 or 1%, interest bearing demand deposits increased
$190,000 or less than 1%, savings and money market deposits increased
$12,861,000 or 4%, time deposits decreased $8,984,000 or 6%, and brokered
deposits decreased $17,964,000 or 38%.
The following table summarizes the distribution of average deposits and the
average rates paid for the periods indicated:
Three Months Ended Year Ended
March 31, 2003 December 31, 2002
-------------------- --------------------
Average Average
Average Rate Average Rate
(Dollars in thousands) Balance Paid Balance Paid
- ------------------------------------- ---------- -------- ---------- --------
Demand, noninterest bearing.......... $ 217,630 -- % $ 211,195 -- %
Demand, interest bearing............. 92,657 0.64 % 81,011 0.89 %
Saving and money market.............. 302,756 1.31 % 275,217 1.74 %
Time deposits, under $100............ 45,165 2.18 % 56,097 3.14 %
Time deposits, $100 and over......... 107,853 2.07 % 129,702 2.75 %
Brokered deposits.................... 37,947 3.90 % 65,183 3.87 %
---------- ----------
Total average deposits.......... $ 804,008 1.15 % $ 818,405 1.63 %
========== ==========
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 March 31, 2003.
% of
(Dollars in thousands) Balance Total
- ----------------------------------------------------------- ---------- --------
Three months or less....................................... $ 61,200 45 %
Over three months through twelve months.................... 52,463 38 %
Over twelve months......................................... 22,829 17 %
---------- --------
Total............................................... $ 136,492 100 %
========== ========
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.
Return on Equity and Assets
The following table indicates the ratios on the annualized return on
average assets and average equity and average equity to average assets for each
indicated period.
Three Months Ended
March 31,
------------------
2003 2002
-------- --------
Return on average assets............... 0.85 % 0.67 %
Return on average equity............... 9.32 % 8.11 %
Average equity to average assets ratio. 9.10 % 8.32 %
Annualized return on average assets and return on average
equity for the quarter ended March 31, 2003 were 0.85% and 9.32%, respectively,
compared with returns of 0.67% and 8.11%, respectively, for the same period in
2002. The equity to asset ratio for the quarter ended March 31, 2003 was 9.10%,
compared to 8.32% for the same period in 2002.
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
The following table sets forth the interest rate sensitivity
of the Company's interest-earning assets and interest-bearing liabilities at
March 31, 2003, using the rate sensitivity gap ratio. For purposes of the
following table, an asset or liability is considered rate-sensitive within a
specified period when it can be repriced or when it is scheduled to mature
within the specified time frame:
Due in Due After
Within Three to One to Due After Not
Three Twelve Five Five Rate-
(Dollars in thousands) Months Months Years Years Sensitive Total
- ------------------------------------------------------------- --------- --------- --------- --------- --------- ---------
Interest earning assets:
Federal funds sold......................................... $ 81,300 $ -- $ -- $ -- $ -- $ 81,300
Interest bearing deposits in other financial institutions.. 7,522 -- -- -- -- 7,522
Securities................................................. 6,290 3,581 35,237 54,328 -- 99,436
Total loans................................................ 520,607 69,752 77,440 10,503 -- 678,302
--------- --------- --------- --------- --------- ---------
Total interest earning assets............................ 615,719 73,333 112,677 64,831 -- 866,560
--------- --------- --------- --------- --------- ---------
Cash and due from banks...................................... -- -- -- -- 35,141 35,141
Other assets................................................. -- -- -- -- 41,414 41,414
--------- --------- --------- --------- --------- ---------
Total assets............................................. $ 615,719 $ 73,333 $ 112,677 $ 64,831 $ 76,555 $ 943,115
========= ========= ========= ========= ========= =========
Interest bearing liabilities:
Demand, interest bearing................................... $ 94,499 $ -- $ -- $ -- $ -- $ 94,499
Savings and money market................................... 303,278 -- -- -- -- 303,278
Time deposits.............................................. 79,069 74,035 28,542 -- -- 181,646
Mandatorily Redeemable Cumulative
Trust Preferred Securities............................... -- -- -- 23,000 -- 23,000
--------- --------- --------- --------- --------- ---------
Total interest bearing liabilities....................... 476,846 74,035 28,542 23,000 -- 602,423
--------- --------- --------- --------- --------- ---------
Noninterest demand deposits.................................. 96,567 -- -- -- 148,636 245,203
Other liabilities............................................ -- -- -- -- 10,773 10,773
Shareholders' equity......................................... -- -- -- -- 84,716 84,716
--------- --------- --------- --------- --------- ---------
Total liabilities and shareholders' equity............... $ 573,413 $ 74,035 $ 28,542 $ 23,000 $ 244,125 $ 943,115
========= ========= ========= ========= ========= =========
Interest rate sensitivity GAP................................ $ 42,306 $ (702) $ 84,135 $ 41,831 $(167,570) $ 943,115
========= ========= ========= ========= ========= =========
Cumulative interest rate sensitivity GAP..................... $ 42,306 $ 41,604 $ 125,739 $ 167,570 $ -- $ --
Cumulative interest rate sensitivity GAP ratio............... 4.49 % 4.41 % 13.33 % 17.77 % -- % -- %
The foregoing table demonstrates that the Company had a
positive cumulative one year gap of $41,604,000, or 4.41% of total assets, at
March 31, 2003. In theory, this would indicate that $41,604,000 more in assets
than liabilities would reprice if there were 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, conversely if interest rates were to
decline, the positive gap would tend to result in a lower 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 certain short-term funding
sources.
Interest rate changes do not affect all categories of assets
and liabilities equally or at the same time. Varying interest rate environments
can create unexpected changes in prepayment levels of assets and liabilities,
which may have a significant effect on the net interest margin and are not
reflected in the interest sensitivity analysis table. Because of these factors,
an interest sensitivity gap report may not provide a complete assessment of the
exposure to changes in interest rates. To supplement traditional GAP analysis,
the Company performs simulation modeling to estimate the potential effects of
changing interest rate environments. The process allows the Company to explore
the complex relationships within the GAP over time and various interest rate
environments.
Liquidity risk represents the potential for loss as a result
of limitations on the Company's ability to adjust for future cash flows, to meet
the needs of depositors and borrowers, and to fund operations on a timely and
cost-effective basis. The liquidity policy approved by the board of directors
requires annual review of the Company's liquidity by the asset/liability
committee, which is composed of senior executives, and the finance and
investment committee of the board of directors.
The Company's internal asset/liability committee and the
finance and investment committee of the board of directors each meet monthly to
monitor the Company's investments, liquidity needs and to oversee its
asset/liability management. The Company evaluates the rates offered on its
deposit products on a weekly basis.
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 March 31, 2003, the Company's primary liquidity ratio
was 19.44%, comprised of
$48,065,000 in investment securities available-for-sale with maturities (or
probable calls) of up to five years,
less $14,514,000 of securities that were pledged to secure
public and certain other deposits as required by law and contract; Federal funds sold of $81,300,000,
and $42,663,000 in cash and due from banks, as a percentage of total unsecured
deposits of $810,112,000.
Capital Resources
The following table summarizes risk-based capital, risk-weighted assets, and
risk-based capital ratios of the Company:
March 31,
---------------------- December 31,
(Dollars in thousands) 2003 2002 2002
- --------------------------------- ---------- ---------- ------------
Capital components:
Tier 1 Capital................ $ 104,739 $ 93,176 $ 102,614
Tier 2 Capital................ 10,117 9,686 10,563
---------- ---------- ------------
Total risk-based capital.... $ 114,856 $ 102,862 $ 113,177
========== ========== ============
Risk-weighted assets............. $ 803,951 $ 789,256 $ 842,399
Average assets................... $ 925,821 $ 913,780 $ 950,091
Minimum
Regulatory
Requirements
-----------
Capital ratios:
Total risk-based capital....... 14.3 % 13.0 % 13.4 % 8.0 %
Tier 1 risk-based capital...... 13.0 % 11.8 % 12.2 % 4.0 %
Leverage ratio (1)............. 11.3 % 10.2 % 10.8 % 4.0 %
|
(1) |
|
Tier 1 capital divided by average assets (excluding
goodwill). |
At March 31, 2003 and 2002, and December
31, 2002, the Company's capital met all minimum regulatory requirements. As of
March 31, 2003, management believes that HBC was considered "Well
Capitalized" under the Prompt Corrective Action Provisions.
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
Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
(a)
Under the supervision and with the participation
of our management, including our principal executive officer and principal
financial officer, we conducted an evaluation of our disclosure controls and
procedures, as such term is defined under Rule 13a-14(c) promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), within 90 days of the filing date of this report.
Based on their evaluation, our principal executive officer and principal
accounting officer concluded that Heritage Commerce Corp's disclosure controls
and procedures are effective.
(b) There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above.
Part II - OTHER INFORMATION
Exhibits included with this filing:
Exhibits Number Name
- Certification of Registrant's Chief Executive Officer Pursuant to 18
U.S.C. Section 1350
- Certification of Registrant's Chief Financial Officer Pursuant to 18
U.S.C. Section 1350
- Reports on Form 8-K
The Registrant filed a Current Report on Form 8-K dated
January 22, 2003 under item 5 to report its year end 2002 financial results, and
containing condensed summarized statements of financial position and results of
operations.
The Registrant furnished a Current Report on Form 8-K dated
April 24, 2003 under item 9 and item 12 to report its first quarter ended March
31, 2003 financial results, and condensed consolidated financial
information.
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.
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|
Heritage Commerce Corp
(Registrant)
|
|
May 14, 2003
Date |
|
/s/ Brad L. Smith
Brad L. Smith, Chief Executive Officer
|
|
May 14, 2003
Date |
|
/s/ Lawrence D. McGovern
Lawrence D. McGovern, Chief Financial Officer |
CERTIFICATION
(Section 302 of the Sarbanes-Oxley Act of 2002)
For the Quarter Ended March 31, 2003
I, Brad L. Smith, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Heritage Commerce Corp;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have
indicated in this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 14, 2003
/s/ Brad L. Smith
Brad L. Smith
Chief Executive Officer
CERTIFICATION
(Section 302 of the Sarbanes-Oxley Act of 2002)
For the Quarter Ended March 31, 2003
I, Lawrence D. McGovern, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Heritage Commerce Corp;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have
indicated in this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 14, 2003
/s/ Lawrence D. McGovern
Lawrence D. McGovern
Chief Financial Officer
Exhibit Index
Exhibit Description
99.1 Certification of Registrant's Chief
Executive Officer Pursuant To
18 U.S.C. Section 1350
99.2 Certification of Registrant's Chief
Financial Officer Pursuant To
18 U.S.C. Section 1350
-