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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(MARK ONE)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 000-23877

Heritage Commerce Corp

(Exact name of Registrant as Specified in its Charter)

California
(State or Other Jurisdiction of
Incorporation or Organization)

77-0469558
(I.R.S. Employer Identification No.)

224 Airport Parkway, San Jose, California
(Address of Principal Executive Offices)

95110
(Zip Code)

(408) 947-6900

(Registrant’s Telephone Number, Including Area Code)

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:

    

Trading Symbol:

    

Name of each exchange on which registered:

Common Stock, No Par Value

HTBK

The NASDAQ Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES  NO 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES  NO 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES   NO 

The Registrant had 59,914,987 shares of Common Stock outstanding on October 30, 2020

Table of Contents

HERITAGE COMMERCE CORP

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

    

Page No.

Cautionary Note on Forward-Looking Statements

3

Part I. FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements (unaudited)

6

Consolidated Balance Sheets

6

Consolidated Statements of Income

7

Consolidated Statements of Comprehensive Income

8

Consolidated Statements of Changes in Shareholders’ Equity

9

Consolidated Statements of Cash Flows

11

Notes to Unaudited Consolidated Financial Statements

12

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

49

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

83

Item 4.

Controls and Procedures

83

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

84

Item 1A.

Risk Factors

84

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

86

Item 3.

Defaults Upon Senior Securities

86

Item 4.

Mine Safety Disclosures

86

Item 5.

Other Information

86

Item 6.

Exhibits

87

SIGNATURES

87

2

Table of Contents

Cautionary Note Regarding Forward-Looking Statements

This Report on Form 10-Q contains various statements that may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, Rule 3b-6 promulgated thereunder and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These forward-looking statements often can be, but are not always, identified by the use of words such as “assume,” “expect,” “intend,” “plan,” “project,” “believe,” “estimate,” “predict,” “anticipate,” “may,” “might,” “should,” “could,” “goal,” “potential” and similar expressions. We base these forward-looking statements on our current expectations and projections about future events, our assumptions regarding these events and our knowledge of facts at the time the statements are made. These statements include statements relating to our projected growth, anticipated future financial performance, and management’s long-term performance goals, as well as statements relating to the anticipated effects on results of operations and financial condition.

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 (“SEC”), Item 1A of the Heritage Commerce Corp’s (“the Company”) Annual Report on Form 10-K for the year ended December 31, 2019, and the following:

the rapidly changing uncertainties related to the novel Coronavirus (“COVID-19”) pandemic including, but not limited to, the potential adverse effect of the pandemic on the economy, our employees and customers, and our financial performance;
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 and overall slowdowns in economic growth should these events occur;
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;
our ability to anticipate interest rate changes and manage interest rate risk;
changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources;
volatility in credit and equity markets and its effect on the global economy;
our ability to effectively compete with other banks and financial services companies and the effects of competition in the financial services industry on our business;
our ability to achieve loan growth and attract deposits;
risks associated with concentrations in real estate related loans, including commercial real estate loans to borrowers associated with industries adversely impacted by the COVID-19 pandemic;

the relative strength or weakness of the commercial and real estate markets where our borrowers are located, including related asset and market prices;
other than temporary impairment charges to our securities portfolio;
changes in the level of nonperforming assets and charge offs and other credit quality measures, and their impact on the adequacy of our allowance for credit losses and our provision for credit losses;

3

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increased capital requirements for our continual growth or as imposed by banking regulators, which may require us to raise capital at a time when capital is not available on favorable terms or at all;
adverse impact of political instability;
if the goodwill that we recorded in connection with a business acquisition becomes impaired, it could require charges to earnings, which would have a negative impact on our financial condition and results of operations;
regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company; and therefore the Company’s ability to pay dividends to shareholders;
changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases;
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;
our inability to attract, recruit, and retain qualified officers and other personnel could harm our ability to implement our strategic plan, impair our relationships with customers and adversely affect our business, results of operations and growth prospects;
possible adjustment of the valuation of our deferred tax assets;
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;
inability to manage risks associated with our business, including operational risk and credit risk;
risks of loss of funding of Small Business Administration or SBA loan programs, or changes in those programs;
compliance with governmental and regulatory requirements, including the Dodd-Frank Act and others relating to banking, consumer protection, securities, accounting and tax matters;
significant changes in applicable laws and regulations, including those concerning taxes, banking and securities;
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;
costs and effects of legal and regulatory developments, including resolution of regulatory or other governmental inquiries, and the results of regulatory examinations or reviews;
the expense and uncertain resolution of litigation matters whether occurring in the ordinary course of business or otherwise;
availability of and competition for acquisition opportunities;
risks resulting from riots and domestic terrorism;
risks of natural disasters (including earthquakes) and other events beyond our control;
the rapidly changing uncertainties related to the COVID-19 pandemic including, but not limited to, the potential adverse effect of the pandemic on the economy, our employees and customers, and our financial performance;

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the impact of the Coronavirus Aid, Relief, and Economic Security Act and the significant additional lending activities undertaken by the Company in connection with the Small Business Administration’s Paycheck Protection Program (“PPP”) enacted thereunder, and the risks that borrowers may not have used funds appropriately or satisfied staffing or payment requirements to qualify for forgiveness of their loans in whole or part under PPP; and
our success in managing the risks involved in the foregoing factors.

Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. You should consider any forward looking statements in light of this explanation, and we caution you about relying on forward-looking statements.

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Part I—FINANCIAL INFORMATION

ITEM 1—CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

HERITAGE COMMERCE CORP

CONSOLIDATED BALANCE SHEETS (Unaudited)

September 30, 

December 31, 

    

2020

    

2019

(Dollars in thousands)

Assets

Cash and due from banks

$

33,353

$

49,447

Other investments and interest-bearing deposits in other financial institutions

 

926,915

 

407,923

Total cash and cash equivalents

 

960,268

 

457,370

Securities available-for-sale, at fair value

 

294,438

 

404,825

Securities held-to-maturity, at amortized cost, net of allowance for credit losses of $55 at September 30, 2020

(fair value of $303,996 at September 30, 2020 and $368,107 at December 31, 2019)

295,609

 

366,560

Loans held-for-sale - SBA, at lower of cost or fair value, including deferred costs

 

3,565

 

1,052

Loans, net of deferred fees

 

2,697,016

 

2,533,844

Allowance for credit losses on loans(1)

 

(45,422)

 

(23,285)

Loans, net

 

2,651,594

 

2,510,559

Federal Home Loan Bank, Federal Reserve Bank stock and other investments, at cost

 

33,518

 

29,842

Company-owned life insurance

 

77,059

 

76,027

Premises and equipment, net

 

10,412

 

8,250

Goodwill

167,631

167,420

Other intangible assets

 

17,628

 

20,415

Accrued interest receivable and other assets

 

95,063

 

67,143

Total assets

$

4,606,785

$

4,109,463

Liabilities and Shareholders' Equity

Liabilities:

Deposits:

Demand, noninterest-bearing

$

1,698,027

$

1,450,873

Demand, interest-bearing

 

926,041

 

798,375

Savings and money market

 

1,108,252

 

982,430

Time deposits - under $250

 

46,684

 

54,361

Time deposits - $250 and over

 

92,276

 

99,882

CDARS - interest-bearing demand, money market and time deposits

 

19,121

 

28,847

Total deposits

 

3,890,401

 

3,414,768

Subordinated debt, net of issuance costs

39,693

39,554

Other short-term borrowings

328

Accrued interest payable and other liabilities

 

98,884

 

78,105

Total liabilities

 

4,028,978

 

3,532,755

Shareholders' equity:

Preferred stock, no par value; 10,000,000 shares authorized; none issued and outstanding

at September 30, 2020 and December 31, 2019

Common stock, no par value; 100,000,000 shares authorized at September 30, 2020 and

authorized at December 31, 2019; 59,914,987 shares issued

and outstanding at September 30, 2020 and 59,368,156 shares issued and

outstanding at December 31, 2019

 

493,126

 

489,745

Retained earnings

 

91,065

 

96,741

Accumulated other comprehensive loss

 

(6,384)

 

(9,778)

Total shareholders' equity

 

577,807

 

576,708

Total liabilities and shareholders' equity

$

4,606,785

$

4,109,463

(1)Allowance for credit losses on loans at September 30, 2020, Allowance for loan losses at December 31, 2019

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2020

    

2019

2020

    

2019

(Dollars in thousands, except per share amounts)

Interest income:

Loans, including fees

$

32,635

$

27,264

$

100,262

$

81,321

Securities, taxable

 

2,481

 

3,504

 

9,584

 

12,149

Securities, exempt from Federal tax

 

463

 

530

 

1,458

 

1,624

Other investments, interest-bearing deposits

in other financial institutions and Federal funds sold

 

673

 

1,952

 

3,022

 

5,094

Total interest income

 

36,252

 

33,250

 

114,326

 

100,188

Interest expense:

Deposits

 

1,504

 

2,042

 

4,904

 

5,873

Subordinated debt

 

583

 

583

 

1,737

 

1,731

Short-term borrowings

1

Total interest expense

 

2,087

 

2,625

 

6,641

 

7,605

Net interest income before provision for credit losses on loans(1)

 

34,165

 

30,625

 

107,685

 

92,583

Provision (credit) for credit losses on loans(1)

 

197

 

(576)

 

14,581

 

(2,377)

Net interest income after provision for credit losses on loans(1)

 

33,968

 

31,201

 

93,104

 

94,960

Noninterest income:

Service charges and fees on deposit accounts

 

632

 

1,032

2,251

 

3,370

Increase in cash surrender value of life insurance

 

464

 

336

 

1,380

 

999

Gain on sales of SBA loans

 

400

 

156

 

467

 

331

Servicing income

 

187

 

139

 

575

 

480

Gain on sales of securities

 

 

330

 

270

 

878

Gain on the disposition of foreclosed assets

791

Other

 

912

 

625

 

2,132

 

1,793

Total noninterest income

 

2,595

 

2,618

 

7,866

 

7,851

Noninterest expense:

Salaries and employee benefits

 

11,967

 

10,467

 

38,470

 

31,935

Occupancy and equipment

 

2,283

 

1,550

 

5,821

 

4,634

Professional fees

 

1,352

 

789

 

3,942

 

2,360

Other

 

5,566

 

5,103

 

19,721

 

15,343

Total noninterest expense

 

21,168

 

17,909

 

67,954

 

54,272

Income before income taxes

 

15,395

 

15,910

 

33,016

 

48,539

Income tax expense

 

4,198

 

4,633

 

9,340

 

13,763

Net income

$

11,197

$

11,277

$

23,676

$

34,776

Earnings per common share:

Basic

$

0.19

$

0.26

$

0.40

$

0.81

Diluted

$

0.19

$

0.26

$

0.39

$

0.80

(1)Provision for credit losses on loans for the three and nine months ended September 30, 2020, Provision (credit) for loan losses for the

three and nine months ended September 30, 2019

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2020

    

2019

    

2020

    

2019

 

(Dollars in thousands)

Net income

$

11,197

$

11,277

$

23,676

$

34,776

Other comprehensive income:

Change in net unrealized holding (losses) gains on available-for-sale

securities and I/O strips

 

(1,783)

 

1,041

 

4,838

 

10,245

Deferred income taxes

 

517

 

(304)

 

(1,403)

 

(3,032)

Change in net unamortized unrealized gain on securities available-for-

sale that were reclassified to securities held-to-maturity

 

(13)

 

(13)

 

(39)

 

(52)

Deferred income taxes

 

4

 

4

 

12

 

16

Reclassification adjustment for gains realized in income

 

 

(330)

 

(270)

 

(878)

Deferred income taxes

 

 

98

 

79

 

260

Change in unrealized (losses) gains on securities and I/O strips, net of

deferred income taxes

 

(1,275)

 

496

 

3,217

 

6,559

Change in net pension and other benefit plan liability adjustment

 

101

 

11

 

251

 

34

Deferred income taxes

 

(30)

 

(3)

 

(74)

 

(10)

Change in pension and other benefit plan liability, net of

deferred income taxes

 

71

 

8

 

177

 

24

Other comprehensive (losses) income

 

(1,204)

 

504

 

3,394

 

6,583

Total comprehensive income

$

9,993

$

11,781

$

27,070

$

41,359

See notes to unaudited consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

Accumulated

Other

Total

Common Stock

Retained

Comprehensive

Shareholders’

Shares

    

Amount

    

Earnings

    

Loss

    

Equity

(Dollars in thousands)

Balance, January 1, 2019

43,288,750

$

300,844

$

79,003

$

(12,381)

$

367,466

Net income

12,146

12,146

Other comprehensive income

3,394

3,394

Amortization of restricted stock awards,

net of forfeitures and taxes

271

271

Cash dividend declared $0.12 per share

(5,196)

(5,196)

Stock option expense, net of forfeitures and taxes

166

166

Stock options exercised

35,003

269

269

Balance, March 31, 2019

43,323,753

301,550

85,953

(8,987)

378,516

Net income

11,353

11,353

Other comprehensive income

2,685

2,685

Issuance of restricted stock awards, net

134,653

Amortization of restricted stock awards,

net of forfeitures and taxes

303

303

Cash dividend declared $0.12 per share

(5,201)

(5,201)

Stock option expense, net of forfeitures and taxes

155

155

Stock options exercised

40,000

297

297

Balance, June 30, 2019

43,498,406

302,305

92,105

(6,302)

388,108

Net income

11,277

11,277

Other comprehensive income

504

504

Forfeiture of restricted stock awards, net

(6,000)

Amortization of restricted stock awards,

net of forfeitures and taxes

358

358

Cash dividend declared $0.12 per share

(5,221)

(5,221)

Stock option expense, net of forfeitures and taxes

163

163

Stock options exercised

17,000

157

157

Balance, September 30, 2019

43,509,406

$

302,983

$

98,161

$

(5,798)

$

395,346

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Accumulated

Other

Total

Common Stock

Retained

Comprehensive

Shareholders’

Shares

    

Amount

    

Earnings

    

Loss

    

Equity

(Dollars in thousands)

Balance, December 31, 2019

59,368,156

$

489,745

$

96,741

$

(9,778)

$

576,708

Cumulative effect of change in accounting principles (Note 1)

(6,062)

(6,062)

Balance, January 1, 2020

59,368,156

489,745

90,679

(9,778)

570,646

Net income

1,861

1,861

Other comprehensive income

5,069

5,069

Amortization of restricted stock awards,

net of forfeitures and taxes

348

348

Cash dividend declared $0.13 per share

(7,737)

(7,737)

Stock option expense, net of forfeitures and taxes

148

148

Stock options exercised

200,063

1,106

1,106

Balance, March 31, 2020

59,568,219

491,347

84,803

(4,709)

571,441