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Heritage Commerce Corp Reports Record Earnings of $7.4 Million for the Second Quarter 2017

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SAN JOSE, Calif., July 27, 2017 (GLOBE NEWSWIRE) -- Heritage Commerce Corp (NASDAQ:HTBK), the holding company (the "Company") for Heritage Bank of Commerce (the "Bank"), today reported net income increased 2% to $7.4 million, or $0.19 per average diluted common share for the second quarter of 2017, compared to $7.3 million, or $0.19 per average diluted common share for the second quarter of 2016, and increased 14% from $6.5 million, or $0.17 per average diluted common share for the first quarter of 2017. For the six months ended June 30, 2017, net income increased 4% to $14.0 million, or $0.36 per average diluted common share, from $13.4 million, or $0.35 per average diluted common share, for the six months ended June 30, 2016.

"We again demonstrated the effectiveness of our business strategy as we delivered record profits in the second quarter, up 14% on a linked quarter basis," said Walter Kaczmarek, President and Chief Executive Officer.  "Steady loan grown, with continued strength in commercial real estate ("CRE") loans, generated increased net interest income.  Deposit growth was robust increasing 15% with core deposits, excluding all time deposits and CDARS deposits, increasing 19% over the second quarter a year ago."

"Asset quality continued to be excellent with nonperforming assets ("NPAs") declining 29% from a year ago, and 40% on a linked quarter basis.  Classified assets declined 67% over the second quarter a year ago, and 28% from the preceding quarter," said Mr. Kaczmarek. 

"We continue to deliver solid financial results through the dedication of our employees and an unwavering focus  on our customers and shareholders," added Mr. Kaczmarek. 

Second Quarter 2017 Highlights (as of, or for the periods ended June 30, 2017, compared to March 31, 2017, and June 30, 2016, except as noted):

♦  Diluted earnings per share totaled $0.19 for the second quarter of 2017, compared to $0.19 for the second quarter of 2016, and $0.17 for the first quarter of 2017. The second quarter of 2016 included a $1.0 million gain on proceeds from company-owned life insurance. Diluted earnings per share totaled $0.36 for the first six months of 2017, compared to $0.35 per diluted share for the first six months of 2016.

♦  For the second quarter of 2017, the return on average tangible assets was 1.14%, and the return on average tangible equity was 14.00%, compared to 1.28% and 14.68%, respectively, for the second quarter of 2016, and 1.05% and 12.69%, respectively, for the first quarter of 2017. The return on average tangible assets was 1.10%, and the return on average tangible equity was 13.41%, for the first six months of 2017, compared to 1.17% and 13.66%, respectively, for the first six months of 2016.

♦  During the second quarter of 2017, the Company completed an underwritten public offering of $40.0 million aggregate principal amount of its fixed-to-floating rate subordinated notes ("Subordinated Debt") due June 1, 2027. The Subordinated Debt initially bears a fixed interest rate of 5.25% per year for five years and converts to floating rate of three month LIBOR plus 3.365% thereafter. The Subordinated Debt, net of unamortized issuance costs, totaled $39.1 million at June 30, 2017, and qualifies as Tier 2 capital for the Company under the guidelines established by the Federal Reserve Bank.

♦  Net interest income increased 10% to $24.9 million for the second quarter of 2017, compared to $22.7 million for the second quarter of 2016, and increased 5% from $23.8 million for the first quarter of 2017. For the first six months of 2017, net interest income increased 8% to $48.8 million, compared to $45.0 million for the first six months of 2016. 

  • For the second quarter of 2017, the fully tax equivalent ("FTE") net interest margin contracted 20 basis points to 4.07% from 4.27% for the second quarter of 2016.  The contraction was primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, and the issuance of the Subordinated Debt.  This was partially offset by higher average balances of loans and securities, and the impact of increases in the prime rate on loan yields and overnight funds. 
      
  • The net interest margin improved one basis point to 4.07% for the second quarter of 2017, from 4.06% for the first quarter of 2017.  The improvement was primarily due to higher average balances and yields on loans and securities, partially offset by the issuance of the Subordinated Debt. 
      
  • For the first six months of 2017, the net interest margin contracted 18 basis points to 4.06%, compared to 4.24% for the first six months of 2016.  The contraction was primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, the issuance of the Subordinated Debt, and a decrease in the accretion of the loan purchase discount into loan interest income from the Focus Business Bank ("Focus") acquisition.  This was partially offset by an increase in the average balances of loans and securities, and the impact of increases in the prime rate on loan yields and overnight funds. 
      
  • The impact of the Subordinated Debt and the related investment in excess funds at the Federal Reserve Bank resulted in a five basis points reduction to the net interest margin for the second quarter of 2017, and a three basis points reduction to the net interest margin for the first six months of 2017.             

♦  The total purchase discount on non-impaired loans from the Focus loan portfolio was $4.6 million at August 20, 2015 ("the acquisition date"), of which $3.4 million has been accreted into loan interest income from the acquisition date through June 30, 2017.

  • The accretion of the loan purchase discount into loan interest income from the Focus transaction was $257,000 for the second quarter of 2017, compared to $276,000 for the second quarter of 2016, and $213,000 for the first quarter of 2017.  
      
  • The accretion of the loan purchase discount into loan interest income from the Focus transaction was $470,000 for the first six months of 2017, compared to $794,000 for the first six months of 2016.

♦  Loans, excluding loans held-for-sale, increased $102.2 million, or 7%, to $1.57 billion at June 30, 2017, compared to $1.46 billion at June 30, 2016, which included an increase of $57.8 million, or 4% in the Company's legacy portfolio, $37.9 million of purchased CRE loans, and an increase of  $15.9 million of purchased residential mortgage loans, partially offset by a decrease of $9.4 million in the factored receivables portfolio.

  • Loans increased $53.0 million, or 4%, to $1.57 billion at June 30, 2017, compared to $1.51 billion at March 31, 2017.

♦  The allowance for loan losses ("ALLL") was 1.24% of total loans at June 30, 2017, compared to 1.36% at June 30, 2016, and 1.26% at March 31, 2017.  The ALLL to total nonperforming loans was 614.22% at June 30, 2017, compared to 456.90% at June 30, 2016, and 353.89% at March 31, 2017.

  • NPAs decreased to $3.3 million, or 0.12% of total assets, at June 30, 2017, compared to $4.7 million, or 0.20% of total assets, at June 30, 2016, and $5.6 million, or 0.21% of total assets, at March 31, 2017. 
      
  • Classified assets declined to $7.5 million, or 0.27% of total assets, at June 30, 2017, compared to $22.8 million, or 0.96% of total assets, at June 30, 2016, and $10.4 million, or 0.39% of total assets, at March 31, 2017.
      
  • Net recoveries totaled $308,000 for the second quarter of 2017, compared to net recoveries of $112,000 for the second quarter of 2016, and net charge-offs of $275,000 for the first quarter of 2017. 
      
  • There was a ($46,000) credit to the provision for loan losses for the second quarter of 2017, compared to a $351,000 provision for loan losses for the second quarter of 2016, and $321,000 provision for loan losses for the first quarter of 2017.  There was a $275,000 provision for loan losses for the six months ended June 30, 2017, compared to a $752,000 provision for loan losses for the six months ended June 30, 2016.

♦  Total deposits increased $300.9 million, or 15%, to $2.37 billion at June 30, 2017, compared to $2.07 billion at June 30, 2016, and increased $44.6 million, or 2%, from $2.33 billion at March 31, 2017. 

♦  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 June 30, 2017.

                         
                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    14.4    13.2    10.0    10.5 %
Tier 1 Risk-Based    11.4    12.2    8.0    8.5 %
Common Equity Tier 1 Risk-Based    11.4    12.2    6.5    7.0 %
Leverage    8.5    9.1    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 10% to $24.9 million for the second quarter of 2017, compared to $22.7 million for the second quarter of 2016, and increased 5% from $23.8 million for the first quarter of 2017. Net interest income increased 8% to $48.8 million for the six months ended June 30, 2017, compared to $45.0 million for the six months ended June 30, 2016. Net interest income increased for the second quarter of 2017 and the first six months of 2017, compared to the respective periods in 2016, primarily due to the impact of loan growth, and an increase in the average balance of investment securities.

For the second quarter of 2017, the net interest margin (FTE) contracted 20 basis points to 4.07% from 4.27% for the second quarter of 2016.  The contraction was primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, and the issuance of the Subordinated Debt.  This was partially offset by higher average balances of loans and securities, and the impact of increases in the prime rate on loan yields and overnight funds.  The net interest margin improved one basis point for the second quarter of 2017, from 4.06% for the first quarter of 2017.  The improvement was primarily due to higher average balances and yields on loans and securities, partially offset by the issuance of the Subordinated Debt. 

For the first six months of 2017, the net interest margin contracted 18 basis points to 4.06%, compared to 4.24% for the first six months of 2016.  The contraction was primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, the issuance of the Subordinated Debt, and a decrease in the accretion of the loan purchase discount into loan interest income from the Focus acquisition.  This was partially offset by an increase in the average balances of loans and securities, and the impact of increases in the prime rate on loan yields and overnight funds.

There was a ($46,000) credit to the provision for loan losses for the second quarter of 2017, compared to a provision for loan losses of $351,000 for the second quarter of 2016, and a provision for loan losses of $321,000 for the first quarter of 2017. There was a $275,000 provision for loan losses for the six months ended June 30, 2017, compared to a $752,000 provision for loan losses for the six months ended June 30, 2016.

Noninterest income was $2.3 million for the second quarter of 2017, compared to $3.7 million for the second quarter of 2016, and $2.3 million for the first quarter of 2017.  For the six months ended June 30, 2017, noninterest income was $4.6 million, compared to $6.3 million for the six months ended June 30, 2016. The decrease in noninterest income for the second quarter of 2017 and first six months of 2017, compared to the same periods in 2016, was primarily due to a $1.0 million gain on proceeds from company-owned life insurance in the second quarter of 2016, and gains on sales of investment securities of $347,000 and $527,000 in the second quarter of 2016 and first six months of 2016, respectively. The decrease was partially offset by a $200,000 termination fee received from one customer of Bay View Funding, which was included in other noninterest income in the second quarter of 2017.

Total noninterest expense for the second quarter of 2017 was $15.3 million, compared to $14.4 million for the second quarter of 2016, and $15.3 million for the first quarter of 2017.  Noninterest expense for the six months ended June 30, 2017 was $30.6 million, compared to $29.1 million for the six months ended June 30, 2016. The increase in noninterest expense in the second quarter of 2017 and the first six months of 2017, compared to the respective periods in 2016, was primarily due to higher salaries and employee benefits as a result of annual salary increases.  Noninterest expense was lower for the second quarter of 2017, compared to the first quarter of 2017, primarily due to lower salary and employee benefits and professional fees consistent with the cylical nature of these expenses.  Full time equivalent employees were 269 at June 30, 2017, 268 at June 30, 2016, and 269 at March 31, 2017. 

The efficiency ratio for the second quarter of 2017 was 56.03%, compared to 54.47% for the second quarter of 2016, and 58.68% for the first quarter of 2017. The efficiency ratio for the six months ended June 30, 2017 was 57.33%, compared to 56.63% for the six months ended June 30, 2016.   

Income tax expense for the second quarter of 2017 was $4.6 million, compared to $4.4 million for the second quarter of 2016, and $3.9 million for the first quarter of 2017. The effective tax rate for the second quarter of 2017 was 38.0%, compared to 37.5% for the second quarter of 2016, and 37.6% for the first quarter of 2017.  Income tax expense for the six months ended June 30, 2017 was $8.5 million, compared to $8.1 million for the six months ended June 30, 2016. The effective tax rate for the six months ended June 30, 2017 was 37.8%, compared to 37.7% for the six months ended June 30, 2016. 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 increased 15% to $2.73 billion at June 30, 2017, compared to $2.38 billion at June 30, 2016, and increased 3% from $2.64 billion at March 31, 2017. 

The investment securities available-for-sale portfolio totaled $369.9 million at June 30, 2017, compared to $390.4 million at June 30, 2016, and $341.6 million at March 31, 2017.  At June 30, 2017, the Company's securities available-for-sale portfolio was comprised of $353.0 million agency mortgage-backed securities (all issued by U.S. Government sponsored entities), and $16.9 million of single entity issue trust preferred securities. The pre-tax unrealized gain on securities available-for-sale at June 30, 2017 was $472,000, compared to a pre-tax unrealized gain on securities available-for-sale of $7.7 million at June 30, 2016, and a pre-tax unrealized loss on securities available-for-sale of ($1.1) million at March 31, 2017.  All other factors remaining the same, when market interest rates are rising, the Company will experience a lower unrealized gain (or a higher unrealized loss) on the securities portfolio. During the second quarter of 2017, the Company purchased $40.3 million of agency mortgage-backed investment securities available-for-sale, with a weighted average book yield of 2.33%, and an average duration of 4.78 years.

At June 30, 2017, investment securities held-to-maturity totaled $368.3 million, compared to $210.2 million at June 30, 2016, and $341.4 million at March 31, 2017.  At June 30, 2017, the Company's securities held-to-maturity portfolio, at amortized cost, was comprised of $278.4 million tax-exempt municipal bonds, and $89.9 million agency mortgage-backed securities.   During the second quarter of 2017, the Company purchased $37.2 million of agency mortgage-backed securities held-to-maturity, with a weighted average book yield of 2.38%, and an average duration of 4.96 years.

Loans, excluding loans held-for-sale, increased $102.2 million, or 7%, to $1.57 billion at June 30, 2017, compared to $1.46 billion at June 30, 2016, which included an increase of $57.8 million, or 4% in the Company's legacy portfolio, $37.9 million of purchased CRE loans, and an increase of $15.9 million of purchased residential mortgage loans, partially offset by a decrease of $9.4 million in the factored receivables portfolio.  Loans increased $53.0 million, or 4%, to $1.57 billion at June 30, 2017, compared to $1.51 billion at March 31, 2017.

The loan portfolio remains well-diversified with commercial and industrial ("C&I") loans accounting for 39% of the loan portfolio at June 30, 2017, which included $42.4 million of factored receivables. CRE loans accounted for 47% of the total loan portfolio, of which 42% were occupied by businesses that own them.  Consumer and home equity loans accounted for 6% of total loans, land and construction loans accounted for 5% of total loans, and residential mortgage loans accounted for the remaining 3% of total loans at June 30, 2017.  

The commercial loan portfolio of $610.7 million at June 30, 2017 remained relatively consistent at $610.4 million at June 30, 2016.  The commercial loan portfolio increased $1.3 million from $609.4 million at March 31, 2017.  C&I line usage was 40% at June 30, 2017, compared to 42% at June 30, 2016, and 40% at March 31, 2017.

The CRE loan portfolio increased $112.0 million, or 18%, to $731.5 million at June 30, 2017, compared to $619.5 million at June 30, 2016, which included an increase of $74.1 million, or 12%, in the Company's legacy portfolio, and $37.9 million of purchased CRE loans.  There were no purchased CRE loans at June 30, 2017.  The CRE loan portfolio increased $51.5 million, or 8%, from $680.0 million at March 31, 2017, primarily due to an increase in the Company's legacy portfolio. 

The yield on the loan portfolio increased to 5.64% for the second quarter of 2017, compared to 5.60% for the second quarter of 2016, primarily due to increases in the prime rate, partially offset by the impact of lower yielding purchased residential mortgage loans and purchased CRE loans.  The yield on the loan portfolio also increased from 5.53% for the first quarter of 2017. The yield on the Company's legacy loan portfolio (excluding the purchased residential loans, purchased CRE loans, factored receivables portfolio, and accretion of the loan purchase discount from the Focus transaction) increased 33 basis points for the second quarter of 2017, compared to the second quarter of 2016, and increased 10 basis points from the first quarter of 2017. The yield on the purchased residential loans was 2.82% for the second quarter of 2017, compared to 3.43% for the second quarter of 2016, and 2.52% for the first quarter of 2017.  The yield on the purchased CRE loans was 3.51% for the second quarter of 2017, compared to 3.49% for the first quarter of 2017.

The yield on the loan portfolio decreased to 5.59% for the first six months of 2017, compared to 5.60% for the first six months of 2016, primarily due to the impact of the lower yielding purchased residential mortgage loans and purchased CRE loans, a lower yield on the factored receivables portfolio, and a decrease in the accretion of the loan purchase discount into loan interest income from the Focus transaction, partially offset by the impact of increases in the prime rate. The yield on the Company's legacy loan portfolio (excluding the purchased residential loans, purchased CRE loans, factored receivables portfolio, and accretion of the loan purchase discount from the Focus transaction) increased 28 basis points for the first six months of 2017, compared to the first six months of 2016. The yield on the purchased residential loans was 2.66% for the first six months of 2017, compared to 3.43% for the first six months of 2016.  The yield on the purchased CRE loans was 3.50% for the first six months of 2017.

The accretion of the loan purchase discount in loan interest income from the Focus transaction was $257,000 for the second quarter of 2017, compared to $276,000 for the second quarter of 2016, and $213,000 for the first quarter of 2017.  The accretion of the loan purchase discount into loan interest income from the Focus transaction was $470,000 for the first six months of 2017, compared to $794,000 for the first six months of 2016.  The total purchase discount on non-impaired loans from the Focus loan portfolio was $4.6 million at the acquisition date, of which $3.4 million has been accreted to loan interest income from the acquisition date through June 30, 2017. 

At June 30, 2017, NPAs decreased to $3.3 million, or 0.12% of total assets, compared to $4.7 million, or 0.20% of total assets, at June 30, 2016, and $5.6 million, or 0.21% of total assets, at March 31, 2017.  Foreclosed assets were $183,000 at June 30, 2017, compared to $313,000 at June 30, 2016, and $183,000 at March 31, 2017.  The following is a breakout of NPAs at the periods indicated:

                                 
    End of Period:  
NONPERFORMING ASSETS   June 30, 2017   March 31, 2017   June 30, 2016  
(in $000's, unaudited)   Balance   % of Total   Balance   % of Total   Balance   % of Total  
Commercial and industrial loans   $  1,512    45 $  3,704    66 $  504    11 %
CRE loans      501    15    912    16    2,849    61 %
Home equity and consumer loans      401    12    252    5    760    16 %
SBA loans      384    11    137    2    40    1 %
Land and construction loans      189    6    195    4    207    4 %
Foreclosed assets      183    6    183    3    313    7 %
Restructured and loans over 90 days past due and still accruing      171    5    207    4    —    — %
Total nonperforming assets   $  3,341    100 $  5,590    100 $  4,673    100 %

Classified assets declined to $7.5 million at June 30, 2017, compared to $22.8 million at June 30, 2016, and $10.4 million at March 31, 2017. 

The following table summarizes the allowance for loan losses:

                                 
    For the Quarter Ended   For the Six Months Ended  
ALLOWANCE FOR LOAN LOSSES   June 30,    March 31,    June 30,    June 30,    June 30,   
(in $000's, unaudited)   2017   2017   2016   2017   2016  
Balance at beginning of period   $  19,135     $  19,089     $  19,458   $  19,089   $  18,926  
Provision (credit) for loan losses during the period      (46 )      321        351      275      752  
Net recoveries (charge-offs) during the period      308        (275 )      112      33      243  
Balance at end of period   $  19,397     $  19,135     $  19,921   $  19,397   $  19,921  
                                 
Total loans, net of deferred fees   $  1,566,324     $  1,513,287     $  1,464,114   $  1,566,324   $  1,464,114  
Total nonperforming loans   $  3,158     $  5,407     $  4,360   $  3,158   $  4,360  
Allowance for loan losses to total loans      1.24      1.26      1.36 %    1.24    1.36 %
Allowance for loan losses to total nonperforming loans      614.22      353.89      456.90 %    614.22    456.90 %

The ALLL at June 30, 2017 was 1.24% of total loans, compared to 1.36% at June 30, 2016, and 1.26% at March 31, 2017.  The ALLL to total nonperforming loans was 614.22% at June 30, 2017, compared to 456.90% at June 30 2016, and 353.89% at March 31, 2017.

Total deposits increased $300.9 million, or 15%, to $2.37 billion at June 30, 2017, compared to $2.07 billion at June 30, 2016, and increased $44.6 million, or 2%, from $2.33 billion at March 31, 2017.  Deposits, excluding all time deposits and CDARS deposits, increased $342.5 million, or 19%, to $2.16 billion at June 30, 2017, from $1.81 billion at June 30, 2016, and increased $58.5 million, or 3%, from $2.10 billion at March 31, 2017. 

The total cost of deposits increased one basis point to 0.16% for the second quarter of 2017, compared to 0.15% for the second quarter of 2016, and remained the same as the first quarter of 2017. The total cost of deposits was 0.16% for the six months ended June 30, 2017, and 0.15% for the six months ended June 30, 2016.

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

The Subordinated Debt, net of unamortized issuance costs, totaled $39.1 million at June 30, 2017, and qualifies as Tier 2 capital for the Company under the guidelines established by the Federal Reserve Bank.  The issuance of Subordinated Debt resulted in an increase in the Company's total risk‑based capital ratio at June 30, 2017, compared to March 31, 2017, and June 30, 2016, but had no effect on the other regulatory capital ratios of the Company.  All of the Bank's regulatory capital ratios increased at June 30, 2017, compared to March 31, 2017, and June 30, 2016, primarily due to the downstream of $20.0 million of the proceeds of the Subordinated Debt from the Company to the Bank, partially offset by distributed dividends totaling $8.0 million from the Bank to the Company during the first six months of 2017.

The Company's common equity Tier 1 risk‑based capital ratio increased at June 30, 2017, compared to June 30, 2016, primarily due to the exchange of 21,004 shares of the Company's Series C convertible perpetual preferred stock, no par value ("Series C Preferred Stock") for 5,601,000 shares of the Company's common stock during the third quarter of 2016. The exchange of the Company's Series C Preferred Stock for common stock had no effect on the Bank's common equity Tier 1 risk‑based capital ratio.

Tangible equity was $217.4 million at June 30, 2017, compared to $204.1 million at June 30, 2016, and $211.6 million at March 31, 2017.  Tangible book value per common share was $5.70 at June 30, 2017, compared to $5.72 at June 30, 2016, and $5.57 at March 31, 2017.  There was no Series C Preferred Stock outstanding at June 30, 2017, and March 31, 2017, compared to 21,004 shares of Series C Preferred Stock outstanding at June 30, 2016.  The exchange of 21,004 shares of Series C Preferred Stock for 5,601,000 shares of the Company's common stock during the third quarter of 2016, resulted in a lower tangible book value per common share at June 30, 2017 and March 31, 2017, compared to June 30, 2016.  Pro forma tangible book value per common share, assuming the outstanding Series C Preferred Stock was converted into common stock, was $5.39 at June 30, 2016.

Accumulated other comprehensive loss was ($6.5) million at June 30, 2017, compared to ($2.1) million at June 30, 2016, and ($7.4) million at March 31, 2017. The unrealized gain (loss) on securities available-for-sale, net of taxes, included in accumulated other comprehensive loss was an unrealized gain of $280,000 at June 30, 2017, compared to an unrealized gain of $4.5 million June 30, 2016, and an unrealized loss of ($653,000) at March 31, 2017.  The components of accumulated other comprehensive loss, net of taxes, at June 30, 2017 include the following: an unrealized gain on available-for-sale securities of $280,000; the remaining unamortized unrealized gain on securities available-for-sale transferred to held-to-maturity of $320,000; a split dollar insurance contracts liability of ($3.5) million; a supplemental executive retirement plan liability of ($4.2) million; and an unrealized gain on interest-only strip from SBA loans of $597,000.

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, CA with full-service branches in Danville, Fremont, Gilroy, Hollister, Los Altos, Los Gatos, Morgan Hill, Pleasanton, San Jose, 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, CA 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.  Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the Securities and Exchange Commission, Item 1A of the Company's Annual Report on Form 10-K, and the following: (1) current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values, high unemployment rates and overall slowdowns in economic growth should these events occur; (2) 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; (3) changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources; (4) volatility in credit and equity markets and its effect on the global economy; (5) changes in the competitive environment among financial or bank holding companies and other financial service providers; (6) changes in consumer and business spending and saving habits and the related effect on our ability to increase assets and to attract deposits; (7) our ability to develop and promote customer acceptance of new products and services in a timely manner; (8) risks associated with concentrations in real estate related loans; (9) an oversupply of inventory and deterioration in values of California commercial real estate; (10) a prolonged slowdown in construction activity; (11) other than temporary impairment charges to our securities portfolio; (12) 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; (13) our ability to raise capital or incur debt on reasonable terms; (14) regulatory limits on Heritage Bank of Commerce's ability to pay dividends to the Company; (15) changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases, among others; (16) 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; (17) our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, "denial of service" attacks, "hacking" and identity theft; (18) inability of our framework to manage risks associated with our business, including operational risk and credit risk; (19) risks of loss of funding of Small Business Administration or SBA loan programs, or changes in those programs; (20) 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; (21) effect of lower corporate tax rates if enacted on the Company's deferred tax asset; (22) significant changes in applicable laws and regulations, including those concerning taxes, banking and securities; (23) 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) 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) availability of and competition for acquisition opportunities; (26) risks associated with merger and acquisition integration; (27) risks resulting from domestic terrorism; (28) risks of natural disasters and other events beyond our control; and (29) our success in managing the risks involved in the foregoing factors.

Member FDIC

                                               
    For the Quarter Ended:   Percent Change From:     For the Six Months Ended :
CONSOLIDATED INCOME STATEMENTS   June 30,    March 31,    June 30,    March 31,    June 30,      June 30,    June 30,    Percent  
(in $000's, unaudited)   2017   2017   2016   2017    2016      2017   2016   Change  
Interest income   $  26,107     $  24,697     $  23,504     6   11     $  50,804     $  46,566     9  
Interest expense      1,174        871        760     35   54        2,045        1,518     35  
Net interest income before provision for loan losses      24,933        23,826        22,744     5   10        48,759        45,048     8  
Provision (credit) for loan losses      (46 )      321        351     (114 )%   (113 )%        275        752     (63 )%  
Net interest income after provision for loan losses      24,979        23,505        22,393     6   12        48,484        44,296     9  
Noninterest income:                                              
Service charges and fees on deposit accounts      801        740        783     8   2        1,541        1,550     (1 )%  
Increase in cash surrender value of life insurance      420        422        440     0   (5 )%        842        889     (5 )%  
Servicing income      205        285        371     (28 )%   (45 )%        490        742     (34 )%  
Gain on sales of SBA loans      164        324        279     (49 )%   (41 )%        488        584     (16 )%  
Gain on proceeds from company-owned life insurance      —        —        1,019     N/A     (100 )%        —        1,019     (100 )%  
Gain on sales of securities      —        (6 )      347     100 %   (100 )%        (6 )      527     (101 )%  
Other      703        530        421     33   67        1,233        963     28  
Total noninterest income      2,293        2,295        3,660     0   (37 )%        4,588        6,274     (27 )%  
Noninterest expense:                                              
Salaries and employee benefits      9,209        9,486        8,742     (3 )%   5        18,695        17,689     6  
Occupancy and equipment      1,216        1,068        1,081     14   12        2,284        2,157     6  
Professional fees      673        1,071        708     (37 )%   (5 )%        1,744        1,533     14  
Other      4,156        3,703        3,850     12   8        7,859        7,687     2  
Total noninterest expense      15,254        15,328        14,381     0   6        30,582        29,066     5  
Income before income taxes      12,018        10,472        11,672     15   3        22,490        21,504     5  
Income tax expense      4,569        3,934        4,377     16   4        8,503        8,103     5  
Net income      7,449        6,538        7,295     14   2        13,987        13,401     4  
Dividends on preferred stock      —        —        (504 )   N/A     (100 )%        —        (1,008 )   (100 )%  
Net income available to common shareholders      7,449        6,538        6,791     14   10        13,987        12,393     13  
Undistributed earnings allocated to Series C preferred stock      —        —        (576 )   N/A     (100 )%        —        (979 )   (100 )%  
Distributed and undistributed earnings allocated to common shareholders   $  7,449     $  6,538     $  6,215     14 %   20     $  13,987     $  11,414     23  
                                               
PER COMMON SHARE DATA                                              
(unaudited)                                              
Basic earnings per share   $  0.20     $  0.17     $  0.19     18   5     $  0.37     $  0.35     6  
Diluted earnings per share   $  0.19     $  0.17     $  0.19     12   0     $  0.36     $  0.35     3  
Weighted average shares outstanding - basic      38,070,042        37,957,999        32,243,935     0   18        38,014,020        32,184,825     18  
Weighted average shares outstanding - diluted      38,579,134        38,494,107        32,512,611     0   19        38,536,015        32,445,516     19  
Common shares outstanding at period-end      38,120,263        37,995,085        32,294,063     0   18        38,120,263        32,294,063     18  
Pro forma common shares outstanding at period-end, assuming Series C preferred stock was converted into common stock     N/A       N/A        37,895,063     N/A     N/A         N/A        37,714,479     N/A    
Dividend per share   $  0.10     $  0.10     $  0.09     0   11     $  0.20     $  0.18     11  
Book value per share   $  7.06     $  6.95     $  7.37     2   (4 )%     $  7.06     $  7.37     (4 )%  
Tangible book value per share   $  5.70     $  5.57     $  5.72     2   0     $  5.70     $  5.72     0  
Pro forma tangible book value per share, assuming assuming Series C preferred stock was converted into common stock     N/A       N/A     $  5.39     N/A     N/A         N/A      $  5.39     N/A    
                                               
KEY FINANCIAL RATIOS                                              
(unaudited)                                              
Annualized return on average equity      11.25      10.15      11.58   11   (3 )%        10.74      10.73   0  
Annualized return on average tangible equity      14.00      12.69      14.68   10   (5 )%        13.41      13.66   (2 )%  
Annualized return on average assets      1.12      1.03      1.25   9   (10 )%        1.07      1.15   (7 )%  
Annualized return on average tangible assets      1.14      1.05      1.28   9   (11 )%        1.10      1.17   (6 )%  
Net interest margin (fully tax equivalent)      4.07      4.06      4.27   0   (5 )%        4.06      4.24   (4 )%  
Efficiency ratio      56.03      58.68      54.47   (5 )%   3        57.33      56.63   1  
                                               
AVERAGE BALANCES                                              
(in $000's, unaudited)                                              
Average assets   $  2,671,476     $  2,584,749     $  2,345,874     3   14     $  2,628,076     $  2,347,549     12  
Average tangible assets   $  2,619,351     $  2,532,273     $  2,292,248     3   14     $  2,575,777     $  2,293,715     12  
Average earning assets   $  2,489,074     $  2,409,043     $  2,172,349     3   15     $  2,449,280     $  2,168,411     13  
Average loans held-for-sale   $  4,238     $  6,700     $  2,951     (37 )%   44     $  5,461     $  3,848     42  
Average total loans   $  1,503,149     $  1,489,123     $  1,415,001     1   6     $  1,496,176     $  1,392,931     7  
Average deposits   $  2,330,517     $  2,269,554     $  2,042,524     3   14     $  2,300,204     $  2,036,711     13  
Average demand deposits - noninterest-bearing   $  906,570     $  887,008     $  780,116     2   16     $  896,843     $  778,558     15  
Average interest-bearing deposits   $  1,423,947     $  1,382,546     $  1,262,408     3   13     $  1,403,361     $  1,258,153     12  
Average interest-bearing liabilities   $  1,438,178     $  1,382,622     $  1,262,415     4   14     $  1,410,553     $  1,259,030     12  
Average equity   $  265,566     $  261,344     $  253,430     2   5     $  262,572     $  251,065     5  
Average tangible equity   $  213,441     $  208,868     $  199,804     2   7     $  210,273     $  197,231     7  


                             
    End of Period:   Percent Change From:  
CONSOLIDATED BALANCE SHEETS   June 30,    March 31,    June 30,    March 31,    June 30,   
(in $000's, unaudited)   2017   2017   2016   2017    2016   
ASSETS                            
Cash and due from banks   $  36,223     $  31,724     $  30,820     14   18  
Other investments and interest-bearing deposits in other financial institutions      229,790        256,122        128,024     (10 )%   79  
Securities available-for-sale, at fair value      369,901        341,590        390,435     8   (5 )%  
Securities held-to-maturity, at amortized cost      368,266        341,383        210,170     8   75  
Loans held-for-sale - SBA, including deferred costs      3,720        3,911        4,879     (5 )%   (24 )%  
Loans:                            
Commercial      610,658        609,353        610,385     0   0  
Real estate:                            
CRE      731,537        679,989        619,539     8   18  
Land and construction      82,873        81,101        103,710     2   (20 )%  
Home equity      79,930        80,360        78,332     (1 )%   2 %  
Residential mortgages      48,732        49,569        32,852     (2 )%   48  
Consumer      13,360        13,807        20,037     (3 )%   (33 )%  
Loans      1,567,090        1,514,179        1,464,855     3   7  
Deferred loan fees, net      (766 )      (892 )      (741 )   (14 )%   3  
Total loans, net of deferred fees      1,566,324        1,513,287        1,464,114     4   7  
Allowance for loan losses      (19,397 )      (19,135 )      (19,921 )   1   (3 )%  
Loans, net      1,546,927        1,494,152        1,444,193     4   7 %  
Company-owned life insurance      59,990        59,570        58,765     1   2  
Premises and equipment, net      7,595        7,512        7,542     1   1  
Goodwill      45,664        45,664        45,664     0   0  
Other intangible assets      6,163        6,605        7,734     (7 )%   (20 )%  
Accrued interest receivable and other assets      58,661        53,558        50,066     10   17  
Total assets   $  2,732,900     $  2,641,791     $  2,378,292     3   15  
                             
LIABILITIES AND SHAREHOLDERS' EQUITY                            
Liabilities:                            
Deposits:                            
Demand, noninterest-bearing   $  948,774     $  917,037     $  834,590     3   14  
Demand, interest-bearing      573,699        575,637        499,512     0   15  
Savings and money market      634,802        606,116        480,677     5   32  
Time deposits-under $250      54,129        56,988        60,761     (5 )%   (11 )%  
Time deposits-$250 and over      147,242        164,824        182,591     (11 )%   (19 )%  
Time deposits - brokered      —        —        6,079     N/A     (100 )%  
CDARS - money market and time deposits      16,085        9,485        9,574     70   68  
Total deposits      2,374,731        2,330,087        2,073,784     2   15  
Subordinated debt, net of issuance costs      39,119        —        —     N/A     N/A    
Accrued interest payable and other liabilities      49,819        47,800        46,995     4   6  
Total liabilities      2,463,669        2,377,887        2,120,779     4   16  
                             
Shareholders' Equity:                            
Series C preferred stock, net      —        —        19,519     N/A     (100 )%  
Common stock      216,788        216,039        194,765     0   11  
Retained earnings      58,910        55,270        45,371     7   30  
Accumulated other comprehensive loss      (6,467 )      (7,405 )      (2,142 )   13   (202 )%  
Total shareholders' equity      269,231        263,904        257,513     2   5  
Total liabilities and shareholders' equity   $  2,732,900     $  2,641,791     $  2,378,292     3   15  


                             
    End of Period:   Percent Change From:  
CREDIT QUALITY DATA   June 30,    March 31,    June 30,    March 31,    June 30,   
(in $000's, unaudited)   2017    2017   2016
  2017    2016   
Nonaccrual loans - held-for-investment   $  2,987     $  5,200   $  4,360     (43 )%   (31 )%  
Restructured and loans over 90 days past due and still accruing      171        207      —     (17 )%   N/A    
Total nonperforming loans      3,158        5,407      4,360     (42 )%   (28 )%  
Foreclosed assets      183        183      313     0   (42 )%  
Total nonperforming assets   $  3,341     $  5,590   $  4,673     (40 )%   (29 )%  
Other restructured loans still accruing   $  121     $  126   $  141     (4 )%   (14 )%  
Net charge-offs (recoveries) during the quarter   $  (308 )   $  275   $  (112 )   (212 )%   (175 )%  
Provision (credit) for loan losses during the quarter   $  (46 )   $  321   $  351     (114 )%   (113 )%  
Allowance for loan losses   $  19,397     $  19,135   $  19,921     1   (3 )%  
Classified assets   $  7,485     $  10,368   $  22,811     (28 )%   (67 )%  
Allowance for loan losses to total loans      1.24      1.26    1.36   (2 )%   (9 )%  
Allowance for loan losses to total nonperforming loans      614.22      353.89    456.90   74   34  
Nonperforming assets to total assets      0.12      0.21    0.20   (43 )%   (40 )%  
Nonperforming loans to total loans      0.20      0.36    0.30   (44 )%   (33 )%  
Classified assets to Heritage Commerce Corp Tier 1 capital plus allowance for loan losses      3      4    10   (25 )%   (70 )%  
Classified assets to Heritage Bank of Commerce Tier 1 capital plus allowance for loan losses      3      4    10   (25 )%   (70 )%  
                             
OTHER PERIOD-END STATISTICS                            
(in $000's, unaudited)                            
Heritage Commerce Corp:                            
Tangible equity (1)   $  217,404     $  211,635   $  204,115     3 %   7  
Tangible common equity (2)   $  217,404     $  211,635   $  184,596     3   18  
Shareholders' equity / total assets      9.85 %      9.99    10.83   (1 )%   (9 )%  
Tangible equity / tangible assets (3)      8.11      8.17    8.78   (1 )%   (8 )%  
Tangible common equity / tangible assets (4)      8.11      8.17    7.94   (1 )%   2  
Loan to deposit ratio      65.96      64.95    70.60   2   (7 )%  
Noninterest-bearing deposits / total deposits      39.95      39.36    40.24   1   (1 )%  
Total risk-based capital ratio      14.4      12.5    12.3   15   17  
Tier 1 risk-based capital ratio      11.4      11.4    11.2   0   2  
Common Equity Tier 1 risk-based capital ratio      11.4      11.4    10.2   0   12  
Leverage ratio      8.5      8.6    9.0   (1 )%   (6 )%  
Heritage Bank of Commerce:                            
Total risk-based capital ratio      13.2      12.2    12.2   8   8  
Tier 1 risk-based capital ratio      12.2      11.2    11.1   9   10  
Common Equity Tier 1 risk-based capital ratio      12.2      11.2    11.1   9   10  
Leverage ratio      9.1      8.4    8.9   8   2  
 
(1) Represents shareholders' equity minus goodwill and other intangible assets.
(2) Represents shareholders' equity minus preferred stock, minus goodwill and other intangible assets.
(3) Represents shareholders' equity minus goodwill and other intangible assets divided by total assets minus goodwill and other intangible assets.
(4) Represents shareholders' equity minus preferred stock, minus goodwill and other intangible assets divided by total assets minus goodwill and other intangible assets.


                                   
    For the Quarter Ended   For the Quarter Ended  
    June 30, 2017   June 30, 2016  
          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)(2)   $  1,507,387   $  21,207      5.64 $  1,417,952   $  19,735      5.60 %
Securities - taxable      629,387      3,442      2.19    523,183      2,828      2.17 %
Securities - exempt from Federal tax (3)      90,144      869      3.87    92,230      885      3.86 %
Other investments and interest-bearing deposits in other financial institutions      262,156      893      1.37    138,984      366      1.06 %
Total interest earning assets (3)      2,489,074      26,411      4.26    2,172,349      23,814      4.41 %
Cash and due from banks      33,627                33,208            
Premises and equipment, net      7,606                7,589            
Goodwill and other intangible assets      52,125                53,626            
Other assets      89,044                79,102            
Total assets   $  2,671,476             $  2,345,874            
                                   
Liabilities and shareholders' equity:                                  
Deposits:                                  
Demand, noninterest-bearing   $  906,570             $  780,116            
                                   
Demand, interest-bearing      582,024      302      0.21    498,970      236      0.19 %
Savings and money market      619,017      359      0.23    505,697      269      0.21 %
Time deposits - under $100      20,246      15      0.30    22,618      16      0.28 %
Time deposits - $100 and over      191,127      269      0.56    217,586      219      0.40 %
Time deposits - brokered      —      —      N/A      8,861      19      0.86 %
CDARS - money market and time deposits      11,533      1      0.03    8,676      1      0.05 %
Total interest-bearing deposits      1,423,947      946      0.27    1,262,408      760      0.24 %
Total deposits      2,330,517      946      0.16    2,042,524      760      0.15 %
                                   
Subordinated debt, net of issuance costs      14,187      228      6.45    —      —      N/A  
Short-term borrowings      44      —      0.00    7      —      0.00 %
Total interest-bearing liabilities      1,438,178      1,174      0.33    1,262,415      760      0.24 %
Total interest-bearing liabilities and demand, noninterest-bearing / cost of funds      2,344,748      1,174      0.20    2,042,531      760      0.15 %
Other liabilities      61,162                49,913            
Total liabilities      2,405,910                2,092,444            
Shareholders' equity      265,566                253,430            
Total liabilities and shareholders' equity   $  2,671,476             $  2,345,874            
                                   
Net interest income (3) / margin            25,237      4.07          23,054      4.27 %
Less tax equivalent adjustment (3)            (304 )                (310 )      
Net interest income         $  24,933               $  22,744        
 
(1) Includes loans held-for-sale.  Nonaccrual loans are included in average balance.
(2) Yield amounts earned on loans include fees and costs. The accretion (amortization) of deferred loan fees (costs) into loan interest income was $59,000 for the second quarter of 2017, compared to $77,000 for the second quarter of 2016.
(3) Reflects the fully tax equivalent adjustment for Federal tax exempt income based on a 35% tax rate.


                                   
    For the Six Months Ended   For the Six Months Ended  
    June 30, 2017   June 30, 2016  
          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)(2)   $  1,501,637   $  41,605      5.59 $  1,396,779   $  38,923      5.60 %
Securities - taxable      588,753      6,319      2.16    501,850      5,603      2.25 %
Securities - exempt from Federal tax (3)      90,278      1,740      3.89    92,675      1,776      3.85 %
Other investments and interest-bearing deposits in other financial institutions      268,612      1,749      1.31    177,107      886      1.01 %
Total interest earning assets (3)      2,449,280      51,413      4.23    2,168,411      47,188      4.38 %
Cash and due from banks      33,233                33,078            
Premises and equipment, net      7,566                7,660            
Goodwill and other intangible assets      52,299                53,834            
Other assets      85,698                84,566            
Total assets   $  2,628,076             $  2,347,549            
                                   
Liabilities and shareholders' equity:                                  
Deposits:                                  
Demand, noninterest-bearing   $  896,843             $  778,558            
                                   
Demand, interest-bearing      570,697      590      0.21    500,461      472      0.19 %
Savings and money market      605,660      653      0.22    502,159      540      0.22 %
Time deposits - under $100      20,330      30      0.30    22,953      32      0.28 %
Time deposits - $100 and over      196,453      542      0.56    212,349      410      0.39 %
Time deposits - brokered      —      —     N/A      11,843      49      0.83 %
CDARS - money market and time deposits      10,221      2      0.04    8,388      4      0.10 %
Total interest-bearing deposits      1,403,361      1,817      0.26    1,258,153      1,507      0.24 %
Total deposits      2,300,204      1,817      0.16    2,036,711      1,507      0.15 %
                                   
Subordinated debt      7,133      228      6.45    —      —      N/A  
Short-term borrowings, net of issuance costs      59      —      0.00    877      11      2.52 %
Total interest-bearing liabilities      1,410,553      2,045      0.29    1,259,030      1,518      0.24 %
Total interest-bearing liabilities and demand, noninterest-bearing / cost of funds      2,307,396      2,045      0.18    2,037,588      1,518      0.15 %
Other liabilities      58,108                58,896            
Total liabilities      2,365,504                2,096,484            
Shareholders' equity      262,572                251,065            
Total liabilities and shareholders' equity   $  2,628,076             $  2,347,549            
                                   
Net interest income (3) / margin            49,368      4.06          45,670      4.24 %
Less tax equivalent adjustment (3)            (609 )                (622 )      
Net interest income         $  48,759               $  45,048        
 
(1) Includes loans held-for-sale.  Nonaccrual loans are included in average balance.
(2) Yield amounts earned on loans include fees and costs. The accretion (amortization) of deferred loan fees (costs) into loan interest income was $170,000 for the six months ended June 30, 2017, compared to $108,000 for the six months ended June 30, 2016.
(3) Reflects the fully tax equivalent adjustment for Federal tax exempt income based on a 35% tax rate.

Contact: Debbie Reuter/ EVP Corporate Secretary
408.494.4542

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