Market Overview

Heritage Commerce Corp Reports Record Earnings of $8.6 Million for the Third Quarter of 2017; an Increase of 27% Over the Third Quarter of 2016

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SAN JOSE, Calif., Oct. 26, 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 27% to $8.6 million, or $0.22 per average diluted common share for the third quarter of 2017, compared to $6.8 million, or $0.18 per average diluted common share for the third quarter of 2016, and increased 15% from $7.4 million, or $0.19 per average diluted common share for the second quarter of 2017.  For the nine months ended September 30, 2017, net income increased 12% to $22.6 million, or $0.59 per average diluted common share, from $20.2 million, or $0.53 per average diluted common share, for the nine months ended September 30, 2016.

"We continued to deliver strong financial results and achieved record profits for the second consecutive quarter," said Walter Kaczmarek, President and Chief Executive Officer.  "Solid earning assets and deposit growth resulted in higher net interest income.  That along with sound credit quality and cost controls resulted in record net income for the third quarter of 2017.  Credit quality continued to improve across the board with total nonperforming assets ("NPAs") declining 27% from the third quarter a year ago."  The ratio of NPAs to total assets was 0.12% and the allowance for loan losses to total loans was 1.26%, at September 30, 2017.

"We have maintained our momentum from the second quarter producing excellent performance metrics, including return on average tangible assets of 1.22%, return on average tangible equity of 15.41%, and an efficiency ratio of 51.54% for the third quarter of 2017," added Mr. Kaczmarek.  "We are well positioned to continue growing, as we focus on building a steady, well-diversified business bank in the vibrant San Francisco Bay Area.  At the same time, we maintain high levels of liquidity to fund internal growth or to provide capital for opportunities in our market."

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

♦ Diluted earnings per share totaled $0.22 for the third quarter of 2017, compared to $0.18 for the third quarter of 2016, and $0.19 for the second quarter of 2017. Diluted earnings per share totaled $0.59 for the first nine months of 2017, compared to $0.53 per diluted share for the first nine months of 2016.

♦ For the third quarter of 2017, the return on average tangible assets was 1.22%, and the return on average tangible equity was 15.41%, compared to 1.13% and 13.06%, respectively, for the third quarter of 2016, and 1.14% and 14.00%, respectively, for the second quarter of 2017. The return on average tangible assets was 1.14%, and the return on average tangible equity was 14.11%, for the first nine months of 2017, compared to 1.16% and 13.45%, respectively, for the first nine months of 2016.

♦ Net interest income before provision for loan losses increased 14% to $26.3 million for the third quarter of 2017, compared to $23.0 million for the third quarter of 2016, and increased 6% from $24.9 million for the second quarter of 2017. For the first nine months of 2017, net interest income increased 10% to $75.1 million, compared to $68.1 million for the first nine months of 2016. 

  • For the third quarter of 2017, the fully tax equivalent ("FTE") net interest margin contracted 12 basis points to 3.98% from 4.10% for the third quarter of 2016, and contracted 9 basis points from 4.07% for the second quarter of 2017.  The contraction was primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, and the full quarter impact from the issuance of subordinated debt during the second quarter of 2017.  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 average balance of other investments and interest-bearing deposits in other financial institutions increased $102.8 million to $335.7 million for the third quarter of 2017, compared to $232.9 million for the third quarter of 2016, and increased $73.5 million from $262.2 million for the second quarter of 2016.

  • For the first nine months of 2017, the net interest margin (FTE) contracted 16 basis points to 4.03%, compared to 4.19% for the first nine 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 average balance of other investments and interest-bearing deposits in other financial institutions increased $95.3 million to $291.2 million for the first nine months of 2017, compared to $195.9 million for the first nine months of 2016.

♦ 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 $3.7 million has been accreted into loan interest income from the acquisition date through September 30, 2017.

  • The accretion of the loan purchase discount into loan interest income from the Focus transaction was $270,000 for the third quarter of 2017, compared to $299,000 for the third quarter of 2016, and $257,000 for the second quarter of 2017.

  • The accretion of the loan purchase discount into loan interest income from the Focus transaction was $741,000 for the first nine months of 2017, compared to $1.1 million for the first nine months of 2016.

♦ Loans, excluding loans held-for-sale, increased $115.8 million, or 8%, to $1.57 billion at September 30, 2017, compared to $1.45 billion at September 30, 2016, which included an increase of $80.0 million, or 6% in the Company's legacy portfolio, $37.6 million of purchased commercial real estate ("CRE") loans, and an increase of $918,000 in the factored receivables portfolio, partially offset by a decrease of $2.8 million in purchased residential mortgage loans. Loans remained relatively unchanged at September 30, 2017, compared to June 30, 2017.

♦ The allowance for loan losses ("ALLL") was 1.26% of total loans at September 30, 2017, compared to 1.38% at September 30, 2016, and 1.24% at June 30, 2017.  The ALLL to total nonperforming loans was 565.68% at September 30, 2017, compared to 445.55% at September 30, 2016, and 614.22% at June 30, 2017.

  • NPAs were $3.5 million, or 0.12% of total assets, at September 30, 2017, compared to $4.8 million, or 0.19% of total assets, at September 30, 2016, and $3.3 million, or 0.12% of total assets, at June 30, 2017.

  • Classified assets were $10.9 million, or 0.38% of total assets, at September 30, 2017, compared to $18.7 million, or 0.74% of total assets, at September 30, 2016, and $7.5 million, or 0.27% of total assets, at June 30, 2017.

  • Net recoveries totaled $236,000 for the third quarter of 2017, compared to net charge-offs of $134,000 for the third quarter of 2016, and net recoveries of $308,000 for the second quarter of 2017.

  • There was a $115,000 provision for loan losses for the third quarter of 2017, compared to a $245,000 provision for loan losses for the third quarter of 2016, and a ($46,000) credit to the provision for loan losses for the second quarter of 2017.  There was a $390,000 provision for loan losses for the first nine months of 2017, compared to a $997,000 provision for loan losses for the first nine months of 2016.

♦ Total deposits increased $262.0 million, or 12%, to $2.48 billion at September 30, 2017, compared to $2.22 billion at September 30, 2016, and increased $105.9 million, or 4%, from $2.37 billion at June 30, 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 September 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   14.6 %   13.4 %   10.0 %   10.5 %
Tier 1 Risk-Based   11.6 %   12.3 %   8.0 %   8.5 %
Common Equity Tier 1 Risk-Based   11.6 %   12.3 %   6.5 %   7.0 %
Leverage   8.3 %   8.8 %   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 14% to $26.3 million for the third quarter of 2017, compared to $23.0 million for the third quarter of 2016, and increased 6% from $24.9 million for the second quarter of 2017. Net interest income increased 10% to $75.1 million for the nine months ended September 30, 2017, compared to $68.1 million for the nine months ended September 30, 2016. The increase in net interest income for the third quarter of 2017 and the first nine months of 2017, compared to the respective periods in 2016, was primarily due to an increase in the average balance of loans and investment securities.

For the third quarter of 2017, the net interest margin (FTE) contracted 12 basis points to 3.98% from 4.10% for the third quarter of 2016, and contracted 9 basis point for the third quarter of 2017 from 4.07% for the second quarter of 2017.  The contraction was primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, and the full quarter impact from the issuance of subordinated debt during the second quarter of 2017.  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 average balance of other investments and interest-bearing deposits in other financial institutions increased $102.8 million to $335.7 million for the third quarter of 2017, compared to $232.9 million for the third quarter of 2016, and increased $73.5 million from $262.2 million for the second quarter of 2016.

For the first nine months of 2017, the net interest margin (FTE) contracted 16 basis points to 4.03%, compared to 4.19% for the first nine 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 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. The average balance of other investments and interest-bearing deposits in other financial institutions increased $95.3 million to $291.2 million for the first nine months of 2017, compared to $195.9 million for the first nine months of 2016.

There was a $115,000 provision for loan losses for the third quarter of 2017, compared to a provision for loan losses of $245,000 for the third quarter of 2016, and a ($46,000) credit to the provision for loan losses for the second quarter of 2017. There was a $390,000 provision for loan losses for the nine months ended September 30, 2017, compared to a $997,000 provision for loan losses for the nine months ended September 30, 2016.

Total noninterest income was $2.5 million for the third quarter of 2017, compared to $2.3 million for the third quarter of 2016 and for the second quarter of 2017.  For the nine months ended September 30, 2017, total noninterest income was $7.0 million, compared to $8.6 million for the nine months ended September 30, 2016.  The decrease in total noninterest income for the first nine months of 2017, compared to the first nine months of 2016, was primarily due to a $1.0 million gain on proceeds from company-owned life insurance in the second quarter of 2016, and lower servicing income and gain on sales of securities in the first nine months of 2017.  The decrease was partially offset by increases in fee income from Bay View Funding during the first nine months of 2017, which is included in other noninterest income within the consolidated income statements.

Total noninterest expense for the third quarter of 2017 was $14.8 million, compared to $14.3 million for the third quarter of 2016, and $15.3 million for the second quarter of 2017.  Total noninterest expense for the nine months ended September 30, 2017 was $45.4 million, compared to $43.4 million for the nine months ended September 30, 2016. The increase in total noninterest expense in the third quarter of 2017 and the first nine 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 and hiring additional employees.  Full time equivalent employees were 282, 264, and 269, at September 30, 2017, September 30, 2016, and June 30, 2017, respectively. 

The efficiency ratio for the third quarter of 2017 was 51.54%, compared to 56.37% for the third quarter of 2016, and 56.03% for the second quarter of 2017. The efficiency ratio for the nine months ended September 30, 2017 was 55.30%, compared to 56.55% for the nine months ended September 30, 2016.   

Income tax expense for the third quarter of 2017 was $5.2 million, compared to $4.1 million for the third quarter of 2016, and $4.6 million for the second quarter of 2017. The effective tax rate for the third quarter of 2017 was 37.9%, compared to 37.5% for the third quarter of 2016, and 38.0% for the second quarter of 2017.  Income tax expense for the nine months ended September 30, 2017 was $13.8 million, compared to $12.2 million for the nine months ended September 30, 2016. The effective tax rate for the nine months ended September 30, 2017 was 37.9%, compared to 37.6% for the nine months ended September 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 12% to $2.84 billion at September 30, 2017, compared to $2.53 billion at September 30, 2016, and increased 4% from $2.73 billion at June 30, 2017. 

Securities available-for-sale, at fair value, totaled $390.1 million at September 30, 2017, compared to $370.0 million at September 30, 2016, and $369.9 million at June 30, 2017.  At September 30, 2017, the Company's securities available-for-sale portfolio was comprised of $373.2 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 September 30, 2017 was $1.0 million, compared to a pre-tax unrealized gain on securities available-for-sale of $8.0 million at September 30, 2016, and a pre-tax unrealized gain on securities available-for-sale of $472,000 at June 30, 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 third quarter of 2017, the Company purchased $35.9 million of agency mortgage-backed investment securities available-for-sale, with a weighted average book yield of 2.30%, and a weighted average duration of 4.60 years.

At September 30, 2017, securities held-to-maturity, at amortized cost, totaled $379.5 million, compared to $202.4 million at September 30, 2016, and $368.3 million at June 30, 2017.  At September 30, 2017, the Company's securities held-to-maturity portfolio was comprised of $89.1 million tax-exempt municipal bonds, and $290.4 million agency mortgage-backed securities.   During the third quarter of 2017, the Company purchased $24.6 million of agency mortgage-backed securities held-to-maturity, with a weighted average book yield of 2.39%, and a weighted average duration of 4.79 years.

Loans, excluding loans held-for-sale, increased $115.8 million, or 8%, to $1.57 billion at September 30, 2017, compared to $1.45 billion at September 30, 2016, which included an increase of $80.0 million, or 6% in the Company's legacy portfolio, $37.6 million of purchased CRE loans, and an increase of $918,000 in the factored receivables portfolio, partially offset by a decrease of $2.8 million in the purchased residential mortgage loans.  Loans remained relatively unchanged at September 30, 2017, compared to June 30, 2017.

The loan portfolio remains well-diversified with commercial and industrial ("C&I") loans accounting for 38% of the loan portfolio at September 30, 2017, which included $48.8 million of factored receivables. CRE loans accounted for 48% of the total loan portfolio, of which 42% were occupied by businesses that own them.  Land and construction loans accounted for 6%, consumer and home equity loans accounted for 5% of total loans, and residential mortgage loans accounted for the remaining 3% of total loans at September 30, 2017.  

The commercial loan portfolio of $587.3 million at September 30, 2017 decreased $19.0 million from $606.3 million at September 30, 2016, and decreased $23.4 million from $610.7 million at June 30, 2017.  C&I line usage was 37% at September 30, 2017, compared to 41% at September 30, 2016, and 40% at June 30, 2017.

The CRE loan portfolio increased $142.8 million, or 23%, to $754.8 million at September 30, 2017, compared to $612.0 million at September 30, 2016, which included an increase of $105.2 million, or 17%, in the Company's legacy portfolio, and $37.6 million of purchased CRE loans.  There were no purchased CRE loans at September 30, 2016.  The CRE loan portfolio increased $23.3 million, or 3%, from $731.5 million at June 30, 2017, primarily due to an increase in the Company's legacy portfolio. 

The average yield on the loan portfolio increased to 5.72% for the third quarter of 2017, compared to 5.60% for the third 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 average yield on the loan portfolio also increased from 5.64% for the second quarter of 2017.   The average 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 25 basis points for the third quarter of 2017, compared to the third quarter of 2016, and increased 1 basis point from the second quarter of 2017.  The average yield on the purchased residential loans was 2.67% for the third quarter of 2017, compared to 2.93% for the third quarter of 2016, and 2.82% for the second quarter of 2017.  The average yield on the purchased CRE loans was 3.52% for the third quarter of 2017, compared to 3.51% for the second quarter of 2017.

The average yield on the loan portfolio increased to 5.63% for the first nine months of 2017, compared to 5.61% for the first nine months of 2016, primarily due to increases in the prime rate, partially offset by 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.  The average 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 27 basis points for the first nine months of 2017, compared to the first nine months of 2016.  The average yield on the purchased residential loans was 2.67% for the first nine months of 2017, compared to 3.07% for the first nine months of 2016.  The yield on the purchased CRE loans was 3.51% for the first nine months of 2017. 

The accretion of the loan purchase discount in loan interest income from the Focus transaction was $270,000 for the third quarter of 2017, compared to $299,000 for the third quarter of 2016, and $257,000 for the second quarter of 2017.  The accretion of the loan purchase discount into loan interest income from the Focus transaction was $741,000 for the first nine months of 2017, compared to $1.1 million for the first nine 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 $3.7 million has been accreted to loan interest income from the acquisition date through September 30, 2017. 

At September 30, 2017, NPAs were $3.5 million, or 0.12% of total assets, compared to $4.8 million, or 0.19% of total assets, at September 30, 2016, and $3.3 million, or 0.12% of total assets, at June 30, 2017.  There were no foreclosed assets at September 30, 2017, compared to foreclosed assets of $292,000 at September 30, 2016, and $183,000 at June 30, 2017.  The following is a breakout of NPAs at the periods indicated:

                                       
    End of Period:    
NONPERFORMING ASSETS   September 30, 2017     June 30, 2017     September 30, 2016    
(in $000's, unaudited)   Balance   % of Total     Balance   % of Total     Balance   % of Total    
Commercial and industrial loans   $ 1,206   35 %   $ 1,512   45 %   $ 3,570   75 %  
Restructured and loans over 90 days past due and still accruing     931   27 %     171   5 %       0 %  
CRE loans     501   14 %     501   15 %     440   9 %  
Home equity and consumer loans     389   11 %     401   12 %     278   6 %  
SBA loans     281   8 %     384   11 %     7   0 %  
Land and construction loans     183   5 %     189   6 %     201   4 %  
Foreclosed assets       0 %     183   6 %     292   6 %  
Total nonperforming assets   $ 3,491   100 %   $ 3,341   100 %   $ 4,788   100 %  

Classified assets were $10.9 million at September 30, 2017, compared to $18.7 million at September 30, 2016, and $7.5 million at June 30, 2017. 

The following table summarizes the allowance for loan losses:

                                           
    For the Quarter Ended     For the Nine Months Ended    
ALLOWANCE FOR LOAN LOSSES   September 30,      June 30,      September 30,      September 30,      September 30,     
(in $000's, unaudited)   2017     2017
    2016
    2017     2016    
Balance at beginning of period   $ 19,397     $ 19,135       $ 19,921       $ 19,089     $ 18,926    
Provision (credit) for loan losses during the period     115       (46 )       245         390       997    
Net recoveries (charge-offs) during the period     236       308         (134 )       269       109    
Balance at end of period   $ 19,748     $ 19,397       $ 20,032       $ 19,748     $ 20,032    
                                           
Total loans, net of deferred fees   $ 1,565,950     $ 1,566,324       $ 1,450,176       $ 1,565,950     $ 1,450,176    
Total nonperforming loans   $ 3,491     $ 3,158       $ 4,496       $ 3,491     $ 4,496    
Allowance for loan losses to total loans     1.26 %     1.24   %     1.38   %     1.26 %     1.38 %  
Allowance for loan losses to total nonperforming loans     565.68 %     614.22   %     445.55   %     565.68 %     445.55 %  

The ALLL at September 30, 2017 was 1.26% of total loans, compared to 1.38% at September 30, 2016, and 1.24% at June 30, 2017.  The ALLL to total nonperforming loans was 565.68% at September 30, 2017, compared to 445.55% at September 30, 2016, and 614.22% at June 30, 2017.

Total deposits increased $262.0 million, or 12%, to $2.48 billion at September 30, 2017, compared to $2.22 billion at September 30, 2016, and increased $105.9 million, or 4%, from $2.37 billion at June 30, 2017.  Deposits, excluding all time deposits and CDARS deposits, increased $281.9 million, or 14%, to $2.26 billion at September 30, 2017, from $1.98 billion at September 30, 2016, and increased $105.4 million, or 5%, from $2.16 billion at June 30, 2017. 

The cost of total deposits increased two basis points to 0.17% for the third quarter of 2017, compared to 0.15% for the third quarter of 2016, and increased one basis point from 0.16% for the second quarter of 2017. The cost of total deposits was 0.16% for the nine months ended September 30, 2017, and 0.15% for the nine months ended September 30, 2016.

Subordinated debt, net of unamortized issuance costs, totaled $39.1 million at September 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 during the second quarter of 2017 resulted in an increase in the Company's total risk‑based capital ratio at September 30, 2017, compared to September 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 September 30, 2017, compared to September 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 $12.0 million from the Bank to the Company during the first nine months of 2017.

Tangible equity was $223.9 million at September 30, 2017, compared to $208.3 million at September 30, 2016, and $217.4 million at June 30, 2017.  Tangible book value per share was $5.86 at September 30, 2017, compared to $5.49 at September 30, 2016, and $5.70 at June 30, 2017. 

Accumulated other comprehensive loss was ($6.1) million at September 30, 2017, compared to ($2.0) million at September 30, 2016, and ($6.5) million at June 30, 2017. The unrealized gain (loss) on securities available-for-sale, net of taxes, included in accumulated other comprehensive loss was an unrealized gain of $614,000 at September 30, 2017, compared to an unrealized gain of $4.7 million September 30, 2016, and an unrealized gain of $280,000 at June 30, 2017.  The components of accumulated other comprehensive loss, net of taxes, at September 30, 2017 include the following: an unrealized gain on securities available-for-sale of $614,000; the remaining unamortized unrealized gain on securities available-for-sale transferred to held-to-maturity of $312,000; a split dollar insurance contracts liability of ($3.5) million; a supplemental executive retirement plan liability of ($4.1) million; and an unrealized gain on interest-only strip from SBA loans of $574,000.

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 Nine Months Ended:
CONSOLIDATED INCOME STATEMENTS   September 30, 
    June 30,    September 30,    June 30,    September 30,      September 30,    September 30,    Percent  
(in $000's, unaudited)   2017
    2017
  2016   2017   2016     2017   2016
  Change  
Interest income   $ 27,955       $ 26,107     $ 23,874     7 %   17 %     $ 78,759     $ 70,440     12 %  
Interest expense     1,634         1,174       826     39 %   98 %       3,679       2,344     57 %  
Net interest income before provision                                                  
for loan losses     26,321         24,933       23,048     6 %   14 %       75,080       68,096     10 %  
Provision (credit) for loan losses     115         (46 )     245     350 %   (53 )%       390       997     (61 )%  
Net interest income after provision                                                  
for loan losses     26,206         24,979       22,803     5 %   15 %       74,690       67,099     11 %  
Noninterest income:                                                  
Service charges and fees on deposit accounts     869         801       798     8 %   9 %       2,410       2,348     3 %  
Increase in cash surrender value of                                                  
life insurance     417         420       428     (1 )%   (3 )%       1,259       1,317     (4 )%  
Servicing income     246         205       364     20 %   (32 )%       736       1,106     (33 )%  
Gain on sales of SBA loans     147         164       69     (10 )%   113 %       635       653     (3 )%  
Gain on proceeds from company-                                                  
owned life insurance                       N/A   N/A             1,019     (100 )%  
Gain (loss) on sales of securities                       N/A   N/A       (6 )     527     (101 )%  
Other     781         703       653     11 %   20 %       2,014       1,616     25 %  
Total noninterest income     2,460         2,293       2,312     7 %   6 %       7,048       8,586     (18 )%  
Noninterest expense:                                                  
Salaries and employee benefits     9,071         9,209       8,363     (1 )%   8 %       27,766       26,052     7 %  
Occupancy and equipment     1,142         1,216       1,120     (6 )%   2 %       3,426       3,277     5 %  
Professional fees     695         673       1,086     3 %   (36 )%       2,439       2,619     (7 )%  
Other     3,926         4,156       3,727     (6 )%   5 %       11,785       11,414     3 %  
Total noninterest expense     14,834         15,254       14,296     (3 )%   4 %       45,416       43,362     5 %  
Income before income taxes     13,832         12,018       10,819     15 %   28 %       36,322       32,323     12 %  
Income tax expense     5,249         4,569       4,054     15 %   29 %       13,752       12,157     13 %  
Net income      8,583          7,449        6,765     15 %   27 %        22,570        20,166     12 %  
Dividends on preferred stock                   (504 )   N/A   (100 )%             (1,512 )   (100 )%  
Net income available to common shareholders     8,583         7,449       6,261     15 %   37 %       22,570       18,654     21 %  
Undistributed earnings allocated to                                                  
Series C preferred stock                   (300 )   N/A   (100 )%             (1,278 )   (100 )%  
Distributed and undistributed earnings                                                  
allocated to common shareholders   $ 8,583       $ 7,449     $ 5,961     15 %   44 %     $ 22,570     $ 17,376     30 %  
                                                   
PER COMMON SHARE DATA                                                  
(unaudited)                                                  
Basic earnings per share   $ 0.22       $ 0.20     $ 0.18     10 %   22 %     $ 0.59     $ 0.53     11 %  
Diluted earnings per share   $ 0.22       $ 0.19     $ 0.18     16 %   22 %     $ 0.59     $ 0.53     11 %  
Weighted average shares outstanding - basic     38,152,633         38,070,042       33,397,704     0 %   14 %       38,060,224       32,591,784     17 %  
Weighted average shares outstanding - diluted     38,581,298         38,579,134       33,693,328     0 %   15 %       38,565,134       32,863,855     17 %  
Common shares outstanding at period-end     38,199,006         38,120,263       37,915,736     0 %   1 %       38,199,006       37,915,736     1 %  
Dividend per share   $ 0.10       $ 0.10     $ 0.09     0 %   11 %     $ 0.30     $ 0.27     11 %  
Book value per share   $ 7.21       $ 7.06     $ 6.89     2 %   5 %     $ 7.21     $ 6.89     5 %  
Tangible book value per share   $ 5.86       $ 5.70     $ 5.49     3 %   7 %     $ 5.86     $ 5.49     7 %  
                                                   
KEY FINANCIAL RATIOS                                                  
(unaudited)                                                  
Annualized return on average equity     12.49 %       11.25 %     10.38 %   11 %   20 %       11.35 %     10.61 %   7 %  
Annualized return on average tangible equity     15.41 %       14.00 %     13.06 %   10 %   18 %       14.11 %     13.45 %   5 %  
Annualized return on average assets     1.20 %       1.12 %     1.11 %   7 %   8 %       1.12 %     1.13 %   (1 )%  
Annualized return on average tangible assets     1.22 %       1.14 %     1.13 %   7 %   8 %       1.14 %     1.16 %   (2 )%  
Net interest margin (fully tax equivalent)     3.98 %       4.07 %     4.10 %   (2 )%   (3 )%       4.03 %     4.19 %   (4 )%  
Efficiency ratio     51.54 %       56.03 %     56.37 %   (8 )%   (9 )%       55.30 %     56.55 %   (2 )%  
                                                   
AVERAGE BALANCES                                                  
(in $000's, unaudited)                                                  
Average assets   $ 2,836,807       $ 2,671,476     $ 2,431,303     6 %   17 %     $ 2,698,549     $ 2,375,958     14 %  
Average tangible assets   $ 2,785,092       $ 2,619,351     $ 2,378,045     6 %   17 %     $ 2,646,446     $ 2,322,317     14 %  
Average earning assets   $ 2,657,081       $ 2,489,074     $ 2,263,997     7 %   17 %     $ 2,519,308     $ 2,198,178     15 %  
Average loans held-for-sale   $ 3,737       $ 4,238     $ 5,992     (12 )%   (38 )%     $ 4,837     $ 4,568     6 %  
Average total loans   $ 1,556,684       $ 1,503,149     $ 1,436,014     4 %   8 %     $ 1,516,610     $ 1,405,069     8 %  
Average deposits   $ 2,470,015       $ 2,330,517     $ 2,121,469     6 %   16 %     $ 2,357,217     $ 2,065,170     14 %  
Average demand deposits - noninterest-bearing   $ 980,554       $ 906,570     $ 842,565     8 %   16 %     $ 924,841     $ 800,049     16 %  
Average interest-bearing deposits   $ 1,489,461       $ 1,423,947     $ 1,278,904     5 %   16 %     $ 1,432,376     $ 1,265,121     13 %  
Average interest-bearing liabilities   $ 1,528,665       $ 1,438,178     $ 1,278,959     6 %   20 %     $ 1,450,356     $ 1,265,722     15 %  
Average equity   $ 272,666       $ 265,566     $ 259,395     3 %   5 %     $ 265,975     $ 253,862     5 %  
Average tangible equity   $ 220,951       $ 213,441     $ 206,137     4 %   7 %     $ 213,872     $ 200,221     7 %  


                             
    End of Period:   Percent Change From:  
CONSOLIDATED BALANCE SHEETS   September 30,    June 30,    September 30,    June 30,    September 30,   
(in $000's, unaudited)   2017    2017    2016    2017    2016   
ASSETS                            
Cash and due from banks   $ 37,133     $ 36,223     $ 39,838     3 %   (7 )%  
Other investments and interest-bearing deposits                            
in other financial institutions     308,987       229,790       304,554     34 %   1 %  
Securities available-for-sale, at fair value     390,107       369,901       369,999     5 %   5 %  
Securities held-to-maturity, at amortized cost     379,550       368,266       202,404     3 %   88 %  
Loans held-for-sale - SBA, including deferred costs     4,602       3,720       6,741     24 %   (32 )%  
Loans:                            
Commercial     587,276       610,658       606,281     (4 )%   (3 )%  
Real estate:                            
CRE     754,856       731,537       612,030     3 %   23 %  
Land and construction     92,310       82,873       88,371     11 %   4 %  
Home equity     74,171       79,930       76,536     (7 )%   (3 )%  
Residential mortgages     46,489       48,732       49,255     (5 )%   (6 )  
Consumer     11,749       13,360       18,328     (12 )%   (36 )%  
Loans     1,566,851       1,567,090       1,450,801     0 %   8 %  
Deferred loan fees, net     (901 )     (766 )     (625 )   18 %   44 %  
Total loans, net of deferred fees     1,565,950       1,566,324       1,450,176     0 %   8 %  
Allowance for loan losses     (19,748 )     (19,397 )     (20,032 )   2 %   (1 )%  
Loans, net     1,546,202       1,546,927       1,430,144     0 %   8 %  
Company-owned life insurance     60,407       59,990       59,193     1 %
  2 %  
Premises and equipment, net     7,539       7,595       7,552     (1 )%   0 %  
Goodwill     45,664       45,664       45,664     0 %   0 %  
Other intangible assets     5,867       6,163       7,342     (5 )%   (20 )%  
Accrued interest receivable and other assets     57,890       58,661       54,531     (1 )%   6 %  
Total assets   $  2,843,948     $  2,732,900     $  2,527,962     4 %   12 %  
                             
LIABILITIES AND SHAREHOLDERS' EQUITY                            
Liabilities:                            
Deposits:                            
Demand, noninterest-bearing   $ 943,723     $ 948,774     $ 889,075     (1 )%   6 %  
Demand, interest-bearing     605,301       573,699       536,541     6 %   13 %  
Savings and money market     713,693       634,802       555,156     12 %   29 %  
Time deposits-under $250     53,479       54,129       57,718     (1 )%   (7 )%  
Time deposits-$250 and over     147,422       147,242       169,485     0 %   (13 )%  
Time deposits - brokered                 3,000     N/A   (100 )%  
CDARS - money market and time deposits     16,986       16,085       7,659     6 %   122 %  
Total deposits     2,480,604       2,374,731       2,218,634     4 %   12 %  
Subordinated debt, net of issuance costs     39,137       39,119           0 %   N/A  
Accrued interest payable and other liabilities     48,762       49,819       48,009     (2 )%   2 %  
Total liabilities     2,568,503       2,463,669       2,266,643     4 %   13 %  
                             
Shareholders' Equity:                            
Common stock     217,906       216,788       214,601     1 %   2 %  
Retained earnings     63,679       58,910       48,726     8 %   31 %  
Accumulated other comprehensive loss     (6,140 )     (6,467 )     (2,008 )   5 %   (206 )%  
Total shareholders' equity     275,445       269,231       261,319     2 %   5 %  
Total liabilities and shareholders' equity   $  2,843,948     $  2,732,900     $  2,527,962     4 %   12 %  


                               
    End of Period:   Percent Change From:  
CREDIT QUALITY DATA   September 30,    June 30,    September 30, 
  June 30,    September 30,   
(in $000's, unaudited)   2017   2017   2016
  2017   2016  
Nonaccrual loans - held-for-investment   $ 2,560     $ 2,987     $ 4,496     (14 )%   (43 )%  
Restructured and loans over 90 days past due and still accruing     931       171           444 %   N/A  
Total nonperforming loans     3,491       3,158       4,496     11 %   (22 )%  
Foreclosed assets           183       292     (100 )%   (100 )%  
Total nonperforming assets   $ 3,491     $ 3,341     $ 4,788     4 %   (27 )%  
Other restructured loans still accruing   $ 325     $ 121     $ 137     169 %   137 %  
Net charge-offs (recoveries) during the quarter   $ (236 )   $ (308 )   $ 134     23 %   (276 )%  
Provision (credit) for loan losses during the quarter   $ 115     $ (46 )   $ 245     350 %   (53 )%  
Allowance for loan losses   $ 19,748     $ 19,397     $ 20,032     2 %   (1 )%  
Classified assets   $ 10,909     $ 7,485     $ 18,693     46 %   (42 )%  
Allowance for loan losses to total loans     1.26 %     1.24 %     1.38 %   2 %   (9 )%  
Allowance for loan losses to total nonperforming loans     565.68 %     614.22 %     445.55 %   (8 )%   27 %  
Nonperforming assets to total assets     0.12 %     0.12 %     0.19 %   0 %   (37 )%  
Nonperforming loans to total loans     0.22 %     0.20 %     0.31 %   10
%   (29 )%  
Classified assets to Heritage Commerce Corp Tier 1                              
capital plus allowance for loan losses     4 %     3 %     8 %   33 %   (50 )%  
Classified assets to Heritage Bank of Commerce Tier 1                              
capital plus allowance for loan losses     4 %     3 %     8 %   33 %   (50 )%  
                               
OTHER PERIOD-END STATISTICS                              
(in $000's, unaudited)                              
Heritage Commerce Corp:                              
Tangible equity (1)   $ 223,914     $ 217,404     $ 208,313     3 %   7 %  
Tangible common equity (2)   $ 223,914     $ 217,404     $ 208,313     3 %   7 %  
Shareholders' equity / total assets     9.69 %     9.85 %     10.34 %   (2 )%   (6 )%  
Tangible equity / tangible assets (3)     8.02 %     8.11 %     8.42 %   (1 )%   (5 )%  
Tangible common equity / tangible assets (4)     8.02 %     8.11 %     8.42 %   (1 )%   (5 )%  
Loan to deposit ratio     63.13 %     65.96 %     65.36 %   (4 )%   (3 )%  
Noninterest-bearing deposits / total deposits     38.04 %     39.95 %     40.07 %   (5 )%   (5 )%  
Total risk-based capital ratio     14.6 %     14.4 %     12.7 %   1 %   15 %  
Tier 1 risk-based capital ratio     11.6 %     11.4 %     11.6 %   2 %   0 %  
Common Equity Tier 1 risk-based capital ratio     11.6 %     11.4 %     11.6 %   2 %   0 %  
Leverage ratio     8.3 %     8.5 %     8.9 %   (2 )%   (7 )%  
Heritage Bank of Commerce:                              
Total risk-based capital ratio     13.4 %     13.2 %     12.6 %   2 %   6 %  
Tier 1 risk-based capital ratio     12.3 %     12.2 %     11.4 %   1 %   8 %  
Common Equity Tier 1 risk-based capital ratio     12.3 %     12.2 %     11.4 %   1 %   8 %  
Leverage ratio     8.8 %     9.1 %     8.7 %   (3 )%   1 %  
                                       
                                       
(1) Represents shareholders' equity minus goodwill and other intangible assets  
(2) Represents shareholders' equity 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
    September 30, 2017   September 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)   $ 1,560,421   $ 22,507     5.72 %   $ 1,442,006   $ 20,312     5.60 %
Securities - taxable     671,528     3,596     2.12 %     497,821     2,401     1.92 %
Securities - exempt from Federal tax (3)     89,426     866     3.84 %     91,241     875     3.82 %
Other investments and interest-bearing deposits                                    
in other financial institutions     335,706     1,289     1.52 %     232,929     592     1.01 %
Total interest earning assets (3)     2,657,081     28,258     4.22 %     2,263,997     24,180     4.25 %
Cash and due from banks     35,173                 32,628            
Premises and equipment, net     7,609                 7,595            
Goodwill and other intangible assets     51,715                 53,258            
Other assets     85,229                 73,825            
Total assets   $ 2,836,807               $ 2,431,303            
                                     
Liabilities and shareholders' equity:                                    
Deposits:                                    
Demand, noninterest-bearing   $ 980,554               $ 842,565            
                                     
Demand, interest-bearing     583,363     290     0.20 %     515,296     259     0.20 %
Savings and money market     686,511     429     0.25 %     516,570     289     0.22 %
Time deposits - under $100     19,770     14     0.28 %     21,707     16     0.29 %
Time deposits - $100 and over     181,167     317     0.69 %     212,201     251     0.47 %
Time deposits - brokered             N/A     4,874     10     0.82 %
CDARS - money market and time deposits     18,650     1     0.02 %     8,256     1     0.05 %
Total interest-bearing deposits     1,489,461     1,051     0.28 %     1,278,904     826     0.26 %
Total deposits     2,470,015     1,051     0.17 %     2,121,469     826     0.15 %
                                     
Subordinated debt, net of issuance costs     39,120     583     5.91 %             N/A
Short-term borrowings     84         0.00 %     55         0.00 %
Total interest-bearing liabilities     1,528,665     1,634     0.42 %     1,278,959     826     0.26 %
Total interest-bearing liabilities and demand,                                    
noninterest-bearing / cost of funds     2,509,219     1,634     0.26 %     2,121,524     826     0.15 %
Other liabilities     54,922                 50,384            
Total liabilities     2,564,141                 2,171,908            
Shareholders' equity     272,666                 259,395            
Total liabilities and shareholders' equity   $ 2,836,807               $ 2,431,303            
                                     
Net interest income (3) / margin           26,624     3.98 %           23,354     4.10 %
Less tax equivalent adjustment (3)           (303 )                 (306 )      
Net interest income         $ 26,321                 $ 23,048        
                                         
                                         
(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 $200,000 for the third quarter of 2017, compared to $62,000 for the third quarter of 2016
(3) Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 35% tax rate.


                                     
    For the Nine Months Ended   For the Nine Months Ended
    September 30, 2017   September 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)   $  1,521,447   $  64,112      5.63   $  1,409,637   $  59,235      5.61 %
Securities - taxable      616,648      9,916      2.15      500,497      8,004      2.14 %
Securities - exempt from Federal tax (3)      89,991      2,606      3.87      92,194      2,651      3.84 %
Other investments and interest-bearing deposits                                    
  in other financial institutions      291,222      3,037      1.39      195,850      1,478      1.01 %
Total interest earning assets (3)      2,519,308      79,671      4.23      2,198,178      71,368      4.34 %
Cash and due from banks      33,656                  32,927            
Premises and equipment, net      7,581                  7,638            
Goodwill and other intangible assets      52,103                  53,641            
Other assets      85,901                  83,574            
Total assets   $  2,698,549               $  2,375,958            
                                     
Liabilities and shareholders' equity:                                    
Deposits:                                    
Demand, noninterest-bearing   $  924,841               $  800,049            
                                     
Demand, interest-bearing      574,966      880      0.20      505,442      731      0.19 %
Savings and money market      632,907      1,081      0.23      506,998      829      0.22 %
Time deposits - under $100      20,141      44      0.29      22,534      48      0.28 %
Time deposits - $100 and over      191,301      859      0.60      212,300      660      0.42 %
Time deposits - brokered      —      —     N/A      9,503      59      0.83 %
CDARS - money market and time deposits      13,061      3      0.03      8,344      5      0.08 %
Total interest-bearing deposits      1,432,376      2,867      0.27      1,265,121      2,332      0.25 %
Total deposits      2,357,217      2,867      0.16      2,065,170      2,332      0.15 %
                                     
Subordinated debt      17,912      811      6.05      —      —     N/A
Short-term borrowings, net of issuance costs      68      1      1.97      601      12      2.67 %
Total interest-bearing liabilities      1,450,356      3,679      0.34      1,265,722      2,344      0.25 %
Total interest-bearing liabilities and demand,                                     
  noninterest-bearing / cost of funds      2,375,197      3,679      0.21      2,065,771      2,344      0.15 %
Other liabilities      57,377                  56,325            
Total liabilities      2,432,574                  2,122,096            
Shareholders' equity      265,975                  253,862            
Total liabilities and shareholders' equity   $  2,698,549               $  2,375,958            
                                     
Net interest income (3) / margin            75,992      4.03            69,024      4.19 %
Less tax equivalent adjustment (3)            (912 )                  (928 )      
Net interest income         $  75,080                 $  68,096        
                                         
                                         
(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 $370,000 for the nine months ended September 30, 2017, compared to $170,000 for the nine months ended September 30, 2016
(3) Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 35% tax rate.


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

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