The FDIC
may terminate its insurance of deposits if it finds that HBC has engaged in
unsafe and unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC.
Money Laundering and Currency
Controls. Various federal statutory and regulatory provisions are
designed to enhance record-keeping and reporting of currency and foreign
transactions. Pursuant to the Bank Secrecy Act, financial
institutions must report high levels of currency transactions or face the
imposition of civil monetary penalties for reporting violations. The
Money Laundering Control Act imposes sanctions, including revocation of federal
deposit insurance, for institutions convicted of money laundering.
The
International Money Laundering Abatement and Financial Anti-Terrorism Act of
2001 (“IMLAFATA”), a part of the Patriot Act, authorizes the Secretary of the
Treasury, in consultation with the heads of other government agencies, to adopt
special measures applicable to banks and other financial institutions to enhance
record-keeping and reporting requirements for certain financial transactions
that are of primary money laundering concern. Among its other provisions,
IMLAFATA requires each financial institution to: (i) establish an
anti-money laundering program; (ii) establish due diligence policies,
procedures and controls with respect to its private banking accounts and
correspondent banking accounts involving individuals and certain foreign banks;
and (iii) avoid establishing, maintaining, administering, or managing
correspondent accounts in the Untied States for, or on behalf of, a foreign bank
that does not have a physical presence in any country. In addition,
IMLAFATA contains a provision encouraging cooperation among financial
institutions, regulatory authorities and law enforcement authorities with
respect to individuals, entities and organizations engaged in, or reasonably
suspected of engaging in, terrorist acts or money laundering
activities.
The
Treasury Department’s regulations implementing IMLAFATA mandate that
federally-insured banks and other financial institutions establish customer
identification programs designed to verify the identity of persons opening new
accounts, maintain the records used for verification, and determine whether the
person appears on any list of known or suspected terrorists or terrorist
organizations.
Community Reinvestment Act
(“CRA”). The CRA is intended to encourage insured depository
institutions, while operating safely and soundly, to help meet the credit needs
of their communities. The CRA specifically directs the federal bank
regulatory agencies, in examining insured depository institutions, to assess
their record of helping to meet the credit needs of their entire community,
including low-and moderate-income neighborhoods, consistent with safe and sound
banking practices. The CRA further requires the agencies to take a
financial institution’s record of meeting its community credit needs into
account when evaluating applications for, among other things, domestic branches,
consummating mergers or acquisitions, or holding company
formations.
The
federal banking agencies have adopted regulations which measure a bank’s
compliance with its CRA obligations on a performance-based evaluation
system. This system bases CRA ratings on an institution’s actual
lending service and investment performance rather than the extent to which the
institution conducts needs assessments, documents community outreach or complies
with other procedural requirements. The ratings range from “outstanding” to a
low of “substantial noncompliance.” HBC had a CRA rating of
“satisfactory” as of its most recent regulatory examination.
Other Consumer Protection Laws and
Regulations. The bank regulatory agencies are increasingly focusing
attention on compliance with consumer protection laws and
regulations. Banks have been advised to carefully monitor compliance
with various consumer protection laws and regulations. The federal
Interagency Task Force on Fair Lending issued a policy statement on
discrimination in home mortgage lending describing three methods that federal
agencies will use to prove discrimination: overt evidence of discrimination,
evidence of disparate treatment, and evidence of disparate impact. In
addition to CRA and fair lending requirements, HBC is subject to numerous other
federal consumer protection statutes and regulations. Due to
heightened regulatory concern related to compliance with consumer protection
laws and regulations generally, HBC may incur additional compliance costs or be
required to expend additional funds for investments in the local communities it
serves.
Environmental Regulation.
Federal, state and local laws and regulations regarding the discharge of
harmful materials into the environment may have an impact on
HBC. Since HBC is not involved in any business that manufactures,
uses or transports chemicals, waste, pollutants or toxins that might have a
material adverse effect on the environment, HBC’s primary exposure to
environmental laws is through its lending activities and through properties or
businesses HBC may own, lease or acquire. Based on a general survey
of HBC’s loan portfolio, conversations with local appraisers and the type of
lending currently and historically done by HBC, management is not aware of any
potential liability for hazardous waste contamination that would be reasonably
likely to have a material adverse effect on the Company as of December 31,
2007.
Safeguarding of Customer Information
and Privacy. The FRB and other bank regulatory agencies have
adopted guidelines for safeguarding confidential, personal customer
information. These guidelines require financial institutions to
create, implement and maintain a comprehensive written information security
program designed to ensure the security and confidentiality of customer
information, protect against any anticipated threats or hazards to the security
or integrity of such information and protect against unauthorized access to or
use of such information that could result in substantial harm or inconvenience
to any customer. HBC has adopted a customer information security
program to comply with such requirements.
Financial
institutions are also required to implement policies and procedures regarding
the disclosure of nonpublic personal information about consumers to
non-affiliated third parties. In general, financial institutions must
provide explanations to consumers on policies and procedures regarding the
disclosure of such nonpublic personal information, and, except as otherwise
required by law, prohibits disclosing such information except as provided in
HBC’s policies and procedures. HBC has implemented privacy policies
addressing these restrictions which are distributed regularly to all existing
and new customers of HBC.
USA Patriot Act of
2001. On October 26, 2001, President Bush signed the USA
Patriot Act of 2001 (the “Patriot Act”). Enacted in response to the terrorist
attacks in New York, Pennsylvania and Washington, D.C. on September 11,
2001, the Patriot Act is intended to strengthen the ability of U.S. law
enforcement agencies and intelligence communities to work cohesively to combat
terrorism on a variety of fronts. The impact of the Patriot Act on financial
institutions of all kinds has been significant and wide ranging. The Patriot Act
substantially enhanced existing anti-money laundering and financial transparency
laws, and required appropriate regulatory authorities to adopt rules to promote
cooperation among financial institutions, regulators, and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering. Under the Patriot Act, financial institutions are subject to
prohibitions regarding specified financial transactions and account
relationships, as well as enhanced due diligence and “know your customer”
standards in their dealings with foreign financial institutions and foreign
customers. For example, the enhanced due diligence policies, procedures, and
controls generally require financial institutions to take reasonable
steps:
·
|
to
conduct enhanced scrutiny of account relationships to guard against money
laundering and report any suspicious
transactions;
|
·
|
to
ascertain the identity of the nominal and beneficial owners of, and the
source of funds deposited into, each account as needed to guard against
money laundering and report any suspicious
transactions;
|
·
|
to
ascertain for any foreign bank, the shares of which are not publicly
traded, the identity of the owners of the foreign bank, and the nature and
extent of the ownership interest of each such owner;
and
|
·
|
to
ascertain whether any foreign bank provides correspondent accounts to
other foreign banks and, if so, the identity of those foreign banks and
related due diligence information.
|
The
Patriot Act also requires all financial institutions to establish anti money
laundering programs, which must include, at minimum:
·
|
the
development of internal policies, procedures, and
controls;
|
·
|
the
designation of a compliance
officer;
|
·
|
an
ongoing employee training program;
and
|
·
|
an
independent audit function to test the
programs.
|
HBC has
incorporated the requirements of the Patriot Act into its operating procedures,
and while these requirements have resulted in an additional time burden the
financial impact on HBC is difficult to quantify.
Other Aspects of Banking Law.
HBC is also subject to federal statutory and regulatory provisions covering,
among other things, security procedures, insider and affiliated party
transactions, management interlocks, electronic funds transfers, funds
availability, and truth-in-savings.
Other
Pending and Proposed Legislation
Other
legislative and regulatory initiatives which could affect the Company, HBC and
the banking industry in general are pending, and additional initiatives may be
proposed or introduced before the United States Congress, the California
legislature and other governmental bodies in the future. Such
proposals, if enacted, may further alter the structure, regulation and
competitive relationship among financial institutions, and may subject the
Company or HBC to increased regulation, disclosure and reporting
requirements. In addition, the various banking regulatory agencies
often adopt new rules and regulations to implement and enforce existing
legislation. It cannot be predicted whether, or in what form, any
such legislation or regulations may be enacted or the extent to which the
business of the Company or HBC would be affected.
At
December 31, 2007, the Company had 225 full-time equivalent employees. The
Company’s employees are not represented by any union or collective bargaining
agreement and the Company believes its employee relations are
satisfactory.
In
addition to the other information in this Annual Report on Form 10-K,
shareholders or prospective investors should carefully consider the following
risk factors:
Our profitability
is dependent upon the economic conditions of the markets in which we
operate. We operate primarily in Santa Clara County, Contra
Costa County and Alameda County and, as a result, our financial condition,
results of operations and cash flows are subject to changes in the economic
conditions in those areas. Our success depends upon the business activity,
population, income levels, deposits and real estate activity in these markets.
Although our customers’ business and financial interests may extend well beyond
these market areas, adverse economic conditions that affect these market areas
could reduce our growth rate, affect the ability of our customers to repay their
loans to us and generally affect our financial condition and results of
operations. While no specific industry concentration is considered significant,
our lending operations are located in market areas dependent on technology and
real estate industries and their supporting companies. Thus, the
Company’s borrowers could be adversely impacted by a downturn in these sectors
of the economy which could reduce the demand for loans and adversely impact the
borrower’s ability to repay their loans. Because of our geographic
concentration, we are less able than other regional or national financial
institutions to diversify our credit risks across multiple markets.
Our growth must
be effectively managed and our growth strategy involves risks that may impact
our net income. As part of our general
growth strategy, we may expand into additional communities or attempt to
strengthen our position in our current markets to take advantage of expanding
market share by opening new offices. To the extent that we undertake additional
office openings, we are likely to experience the effects of higher operating
expenses relative to operating income from the new operations for a period of
time, which may have an adverse effect on our levels of reported net income,
return on average equity and return on average assets. Our current
growth strategies involve internal growth from our current offices and the
addition of new branch offices over time, so that the additional overhead
expenses associated with these openings is absorbed prior to opening other new
offices.
We must compete
with other banks and financial institutions in all lines of
business. The banking and
financial services business in our market is highly competitive. Our competitors
include large regional banks, local community banks, savings institutions,
securities and brokerage companies, mortgage companies, insurance companies,
finance companies, money market mutual funds, credit unions and other non-bank
financial service providers. Many of these competitors are not subject to the
same regulatory restrictions we are and are able to provide customers with an
alternative to traditional banking services. In addition, there is an increased
importance on remaining current on technological changes because such
technological advances may diminish the importance of depository institutions
and financial intermediaries in the transfer of funds between
parties. Increased competition in our market and market changes, such
as interest rate changes, force management to better control costs in order to
absorb any resultant narrowing of our net interest margin, i.e., the spread
between the interest rates earned on investments and loans and the interest
rates paid on deposits and other interest-bearing liabilities. Without effective
management and cost controls, net income may be adversely impacted by changing
conditions and competition.
Interest rates
and other conditions impact our results of operations. The earnings of most
financial institutions depend largely on the relationship between the cost of
funds, primarily deposits and borrowings, and the yield on earning assets such
as loans and investment securities. This relationship, known as the interest
rate spread, is subject to fluctuation and is affected by economic, regulatory
and competitive factors that influence interest rates, the volume and mix of
interest-earning assets and interest-bearing liabilities, and the level of
non-performing assets. Many of these factors are beyond our control.
Fluctuations in interest rates affect the demand of customers for our products
and services, and we are subject to interest rate risk to the degree that our
interest-bearing liabilities re-price or mature more slowly or more rapidly or
on a different basis than our interest-earning assets. Given the current volume,
mix, and re-pricing characteristics of our interest-bearing liabilities and
interest-earning assets, our interest rate spread is expected to increase
slightly in a rising rate environment, and decrease slightly in a declining
interest rate scenario. However, there are scenarios where fluctuations in
interest rates in either direction could have a negative effect on net income.
For example, if funding rates rise faster than asset yields in a rising rate
environment (i.e., if basis compression occurs), or if we do not actively manage
certain loan index rates in a declining rate environment, we would be negatively
impacted.
We must
effectively manage our credit risk. There are risks inherent
in making any loan, including risks inherent in dealing with individual
borrowers, risks of nonpayment, risks resulting from uncertainties as to the
future value of collateral and risks resulting from changes in economic and
industry conditions. We attempt to minimize our credit risk through prudent loan
application approval procedures, careful monitoring of the concentration of our
loans within specific industries and periodic independent reviews of outstanding
loans by external parties. However, we cannot assure such approval and
monitoring procedures will eliminate these credit risks.
Our allowance for
loan losses must be managed to provide a sufficient amount to absorb probable
incurred losses in our loan portfolio. We maintain our
allowance for loan losses at a level considered adequate by management to absorb
probable incurred loan losses. The amount of future loan losses is susceptible
to changes in economic, operating and other conditions within our market, which
may be beyond our control, and such losses may exceed current estimates. At
December 31, 2007, our allowance for loan losses as a percentage of total loans
was 1.18%. Although management believes that the allowance for loan losses is
adequate to absorb probable incurred losses on existing loans, we cannot
predict loan losses with certainty, and we cannot assure that our allowance for
loan losses will prove sufficient to cover actual loan losses in the future.
Loan losses in excess of our allowance may adversely affect our business,
financial condition and results of operations. Additional information regarding
our allowance for loan losses and the methodology we use to determine an
appropriate level of the allowance is located in the “Management’s
Discussion and Analysis of Financial Condition and Operations” section included
under Item 7 of Part II of this Form 10-K.
Government
regulation can result in limitations on our operations. We
operate in a highly regulated environment and are subject to supervision and
regulation by a number of governmental regulatory agencies, including the Board
of Governors of the Federal Reserve System, the California Department of
Financial Institutions and the Federal Deposit Insurance Corporation.
Regulations adopted by these agencies, which are generally intended to provide
protection for depositors and customers rather than for the benefit of
shareholders, govern a comprehensive range of matters relating to ownership and
control of our shares, our acquisition of other companies and businesses,
permissible activities for us to engage in, maintenance of adequate capital
levels and other aspects of our operations. These bank regulators possess broad
authority to prevent or remedy unsafe or unsound practices or violations of law.
The laws and regulations applicable to the banking industry could change at any
time and we cannot predict the effects of these changes on our business and
profitability. Increased regulation could increase our cost of compliance and
adversely affect profitability.
Technology is
continually changing and we must effectively implement new
technologies. The financial services industry is undergoing
rapid technological changes with frequent introductions of new technology-driven
products and services. In addition to better serving customers, the effective
use of technology increases efficiency and enables us to reduce costs. Our
future success will depend in part upon our ability to address the needs of our
customers by using technology to provide products and services that will satisfy
customer demands for convenience as well as to create additional efficiencies in
our operations as we continue to grow and expand our market areas. In order to
anticipate and develop new technology, we employ a qualified staff of internal
information system specialists and consider this area a core part of our
business. We do not develop our own software products, but have been able to
respond to technological changes in a timely manner through association with
leading technology vendors. We must continue to make substantial investments in
technology which may affect our net income.
System failure or
breaches of our network security could subject us to increased operating costs
as well as litigation and other liabilities. The
computer systems and network infrastructure we use could be vulnerable to
unforeseen problems. Our operations are dependent upon our ability to protect
our computer equipment against damage from physical theft, fire, power loss,
telecommunications failure or a similar catastrophic event, as well as from
security breaches, denial of service attacks, viruses, worms and other
disruptive problems caused by hackers. Any damage or failure that causes an
interruption in our operations could have a material adverse effect on our
financial condition and results of operations. Computer break-ins and other
disruptions could also jeopardize the security of information stored in and
transmitted through our computer systems and network infrastructure, which may
result in significant liability to us and may cause existing and potential
customers to refrain from doing business with us. On an outsourced
basis, we engage auditors to conduct extensive auditing and testing for any
weaknesses in our systems, controls, firewalls and encryption to reduce the
likelihood of any security failures or breaches. Although we, with the help of
third-party service providers and auditors, intend to continue to implement
security technology and establish operational procedures to prevent such damage,
there can be no assurance that these security measures will be successful. In
addition, advances in computer capabilities, new discoveries in the field of
cryptography or other developments could result in a compromise or breach of the
algorithms we and our third-party service providers use to encrypt and protect
customer transaction data. A failure of such security measures could have a
material adverse affect on our financial condition and results of
operations.
Our loan
portfolio has a large concentration of real estate loans, which involve risks
specific to real estate value. Real estate lending (including
commercial and construction) is a large portion of our loan portfolio; however,
it is within recently established regulatory guidelines based on a percentage of
Tier 2 Capital. These categories constitute $621 million, or
approximately 60% of our total loan portfolio as of December 31, 2007. The
market value of real estate can fluctuate significantly in a short period of
time as a result of market conditions in the geographic area in which the real
estate is located. Although a significant portion of such loans is secured by
real estate as a secondary form of collateral, adverse developments affecting
real estate values in one or more of our markets could increase the credit risk
associated with our loan portfolio. Commercial and residential properties have
recently experienced a decrease in market value. Commercial real estate lending
typically involves larger loan principal amounts and the repayment of the loans
generally is dependent, in large part, on sufficient income from the properties
securing the loans to cover operating expenses and debt service. Economic events
or governmental regulations outside of the control of the borrower or lender
could negatively impact the future cash flow and market values of the affected
properties. If the loans that are collateralized by real estate
become troubled during a time when market conditions are declining or have
declined, we may not be able to realize the amount of security that we
anticipated at the time of originating the loan, which could cause us to
increase our provision for loan losses and adversely affect our operating
results and financial condition.
Our construction
and development loans are based upon estimates of costs and value associated
with the complete project. These estimates may be inaccurate and we may be
exposed to more losses on these projects than on other
loans. At December 31, 2007, residential
construction loans, including land acquisition and development, totaled $216
million or 21%, of our total loan portfolio. Of the $216
million, $157 million was construction loans comprised of $92 million
residential and $65 million commercial. The other $59 million of construction
loans represent land loans consisting of $46 million residential and $13
million commercial. Construction, land acquisition and development lending
involve additional risks because funds are advanced upon the security of the
project, which is of uncertain value prior to its completion. Because of the
uncertainties inherent in estimating construction costs, as well as the market
value of the completed project and the effects of governmental regulation on
real property, it is relatively difficult to evaluate accurately the total funds
required to complete a project and the related loan-to-value ratio. This process
has become more difficult as commercial and residential properties have recently
experienced decreases in market value. As a result, speculative construction
loans often involve the disbursement of substantial funds with repayment
dependent, in part, on the completion of the project and the ability of the
borrower to sell the property, rather than the ability of the borrower or
guarantor to repay principal and interest. If our appraisal of the value of the
completed project proves to be overstated, we may have inadequate security for
the repayment of the loan upon completion of construction of the project. If we
are forced to foreclose on a project prior to or at completion due to a default,
there can be no assurance that we will be able to recover all of the unpaid
balance of, and accrued interest on, the loan as well as related foreclosure and
holding costs. In addition, we may be required to fund additional amounts to
complete the project and may have to hold the property for an unspecified period
of time.
Acquisition
risks. We
have in the past and may in the future seek to grow our business by acquiring
other businesses. We cannot predict the frequency, size or timing of
our acquisitions, and we typically do not comment publicly on a possible
acquisition until we have signed a definitive agreement. There can be
no assurance that our acquisitions will have the anticipated positive results,
including results related to: the total cost of integration; the time
required to complete the integration; the amount of longer-term cost savings;
continued growth; or the overall performance of the acquired company or combined
entity. Integration of an acquired business can be complex and
costly. If we are not able to integrate successfully past or future
acquisitions, there is a risk that results of operations could be adversely
affected.
Impairment of
goodwill or amortizable intangible assets associated with acquisitions would
result in a charge to earnings. Goodwill is evaluated
for impairment at least annually, and amortizable intangible assets are
evaluated for impairment annually or when events or circumstances indicate that
the carrying value of those assets may not be recoverable. We may be
required to record a charge to the earnings during the period in which any
impairment of goodwill or intangibles is determined.
None
The main
and executive offices of the Company and Heritage Bank of Commerce are located
at 150 Almaden Boulevard in San Jose, California 95113, with branch offices
located at 15575 Los Gatos Boulevard in Los Gatos, California 95032, at 387
Diablo Road in Danville, California 94526, at 3077 Stevenson Boulevard in
Fremont, California 94538, at 300 Main Street in Pleasanton, California 94566,
at 101 Ygnacio Valley Road in Walnut Creek, California 94596, at 18625 Sutter
Boulevard in Morgan Hill, California 95037, at 7598 Monterey Street in Gilroy,
California 95020, at 4546 El Camino Real in Los Altos, California 94022, at 369
S. San Antonio Road in Los Altos, California 94022, and at 175 E. El Camino Real
in Mountain View, California 94040.
Main
Offices
The main
offices of Heritage Bank of Commerce are located at 150 Almaden Boulevard in San
Jose, California on the first three floors in a fifteen-story Class-A type
office building. The first two floors, which consist of approximately 22,417
square feet, were subleased from a non-affiliated third party under a lease
dated February 12, 1996, as amended. The third floor, which consists of
approximately 12,824 square feet, was acquired directly under a lease dated
April 13, 2000, as amended. The current monthly rent payment for the third floor
is $28,726 and is subject to annual increases of 3% until August 1, 2009, when
the monthly rent payment will become fixed at $53,861 until the lease expires on
May 31, 2015. The current monthly rent payment for the first two floors is
$42,592 until the sublease expires on February 28, 2010; however, after the
sublease expires, the first two floors will become part of the direct lease for
the third floor, subject to all of the terms and conditions therein, except that
the monthly rent will be based on the then prevailing market rate to be
determined no later than January 15, 2010. The Company has reserved the right to
extend the term of the direct lease for two additional periods of five years
each.
In
January of 1997, the Company leased approximately 1,255 square feet (referred to
as the “Kiosk”) located next to the primary operating area at 150 Almaden
Boulevard in San Jose, California to be used for meetings, staff training and
marketing events. The current monthly rent payment is $2,811 and is subject to
annual increases of 3% until August 1, 2009 when the monthly rent payment will
then become fixed at $5,271 until the lease expires on May 31, 2015. The Company
has reserved the right to extend the term of the lease for two additional
periods of five years each.
Branch
Offices
In March
of 1999, the Company leased approximately 7,260 square feet in a one-story
multi-tenant office building located at 18625 Sutter Boulevard in Morgan Hill,
California. The current monthly rent payment is $11,944 and is subject to
adjustment every 36 months, based on the Consumer Price Index of the Labor of
Statistics as defined in the lease agreement, until the lease expires on October
31, 2014.
In
October of 2000, as part of a merger the Company assumed a lease for
approximately 7,889 square feet in a two-story multi-tenant shopping center
located at 4546 El Camino Real in Los Altos, California. In October of 2001, the
lease was amended to return 795 square feet, leaving 7,094 square feet remaining
under the lease. The current monthly rent payment is $16,550 until the lease
expires on September 30, 2008.
In
October of 2000, as part of a merger the Company assumed a lease for
approximately 3,471 square feet in a one-story stand-alone office building
located at 369 S. San Antonio Road in Los Altos, California. The current monthly
rent payment is $17,291 until the lease expires on September 30, 2008. The
Company has reserved the right to extend the term of the lease for two
additional periods of five years each.
In
December of 2003, the Company leased approximately 1,920 square feet in a
one-story stand-alone building located in an office complex at 15575 Los Gatos
Boulevard in Los Gatos, California. The current monthly rent payment is $4,930
until the lease expires on November 30, 2008. The Company has reserved the right
to extend the term of the lease for two additional periods of five years
each.
In May of
2006, the Company leased approximately 2,505 square feet on the first floor in a
three-story multi-tenant multi-use building located at 7598 Monterey Street in
Gilroy, California. The current monthly rent payment is $4,509 and is subject to
annual increases of 2% until the lease expires on September 30, 2016. However,
as provided for in the lease, the monthly rent payment has been waived until
January of 2009 in exchange for a tenant improvement allowance equal to the
amount that would have been paid during the free rent period. The Company has
reserved the right to extend the term of the lease for two additional periods of
five years each.
In April
of 2007, the Company leased approximately 3,850 square feet in a four-story
multi-tenant office building located at 101 Ygnacio Valley Road in Walnut Creek,
California. The current monthly rent payment is $12,705 and is subject to annual
increases of 3% until the lease expires on August 15, 2014. The Company has
reserved the right to extend the term of the lease for an additional five
years.
In June
of 2007, as part of the acquisition of Diablo Valley Bank the Company took
ownership of an 8,300 square foot one-story commercial building, including the
land, located at 387 Diablo Road in Danville, California. The Company also
assumed a lease for approximately 4,096 square feet in a stand-alone office
building located at 300 Main Street in Pleasanton, California. The current
monthly rent payment is $14,983 and is subject to annual increases of 3% until
the lease expires on October 31, 2010. The Company has reserved the right to
extend the term of the lease for one additional period of seven
years.
In August
of 2007, the Company extended its lease for approximately 6,590 square feet in a
stand-alone office building located at 3077 Stevenson Boulevard in Fremont,
California. The current monthly rent payment is $13,180 and is subject to annual
increases of 3% until the lease expires on February 28, 2013. The Company has
reserved the right to extend the term of the lease for one additional period of
five years.
In
February 2008, the Company extended its lease for approximately 4,840 square
feet in a multi-tenant shopping center located at 175 E. El Camino Real in
Mountain View, California. The current monthly rent payment is $13,986 and is
subject to annual increases based on the Consumer Price Index of the Bureau of
Labor Statistics as defined in the lease agreement. The lease expires on May 30,
2013; however, the Company has reserved the right to extend the term of the
lease for one additional period of five years.
Loan
Production Offices
In
October of 2007, the Company lease approximately 250 square feet of office space
for a loan production office located at 740 Fourth Street in Santa Rosa,
California 95404. The current monthly rent payment is $1,250 until the lease
expires on October 7, 2008.
In
November of 2007, the Company lease approximately 243 square feet of office
space for a loan production office located at 1440 Broadway in Oakland,
California 94612. The current monthly rent payment is $535 until the lease
expires on November 18, 2008.
In
January of 2008, the Company extended its lease for approximately 225 square
feet of office space for a loan production office located at 8788 Elk Grove
Boulevard in Elk Grove, California 95624. The current monthly rent payment for
this space is $702 until the lease expires on January 31, 2009. The Company has
reserved the right to extend the term of the lease for one additional period of
one year.
In
February of 2008, the Company renewed its lease for a loan production office
located at 264 Clovis Avenue in Clovis, California 93612. The lease covers
approximately 140 square feet of office space and expires on March 31, 2009. The
current monthly rent payment for this space is $500.
For
additional information on operating leases and rent expense, refer to
Footnote 11 to the Consolidated Financial Statements following “Item 15 –
Exhibits and Financial
Statement Schedules.”
ITEM
3 - LEGAL PROCEEDINGS
|
The
Company is involved in certain legal actions arising from normal business
activities. Management, based upon the advice of legal counsel,
believes the ultimate resolution of all pending legal actions will not have a
material effect on the financial statements of the Company.
ITEM
4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
There was
no submission of matters to a vote of security holders during the fourth quarter
of the year ended December 31, 2007.
PART
II
ITEM
5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY
SECURITIES
|
Market
Information
The
Company’s common stock is listed on the NASDAQ Global Select Market under the
symbol “HTBK.” Management is aware of the following securities
dealers which make a market in the Company’s common stock: Citigroup
Global Markets Holdings Inc., Keefe, Brunette & Woods, Inc., Knight Equity
Markets, L.P., Merrill Lynch, Morgan Stanley & Company, Inc., RBC Dain
Rauscher Inc., UBS Capital Markets, Goldman Sachs & Co., Citadel Derivatives
Markets, Howe Barnes Hoefer & Arnett, and E-Trade Capital
Markets. These market makers have committed to make a market for the
Company’s common stock, although they may discontinue making a market at any
time. No assurance can be given that an active trading market will be sustained
for the common stock at any time in the future.
The
information in the following table for 2007 and 2006 indicates the high and low
closing prices for the common stock, based upon information provided by the
NASDAQ Global Select Market.
|
|
|
|
|
|
Dividends
Paid
|
Quarter
|
|
High
|
|
Low
|
|
Per
Share
|
Year ended December 31,
2007:
|
|
|
|
|
|
|
Fourth
quarter
|
|
$
|
21.97
|
|
$
|
15.45
|
|
$
|
0.08
|
Third
quarter
|
|
$
|
24.47
|
|
$
|
18.55
|
|
$
|
0.06
|
Second
quarter
|
|
$
|
25.54
|
|
$
|
21.72
|
|
$
|
0.06
|
First
quarter
|
|
$
|
27.34
|
|
$
|
24.68
|
|
$
|
0.06
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31,
2006:
|
|
|
|
|
|
|
|
|
|
Fourth
quarter
|
|
$
|
27.25
|
|
$
|
22.61
|
|
$
|
0.05
|
Third
quarter
|
|
$
|
24.95
|
|
$
|
22.55
|
|
$
|
0.05
|
Second
quarter
|
|
$
|
25.16
|
|
$
|
22.30
|
|
$
|
0.05
|
First
quarter
|
|
$
|
25.00
|
|
$
|
21.08
|
|
$
|
0.05
|
As of
February 15, 2008, there were approximately 2,500 holders of record of common
stock. There are no other classes of common equity
outstanding.
Dividends
As a bank
holding company that currently has no significant assets other than its equity
interest in HBC, the Company’s ability to declare dividends depends primarily
upon dividends it receives from HBC. HBC’s dividend practices in turn depend
upon legal restrictions, HBC’s earnings, financial position, current and
anticipated capital requirements, and other factors deemed relevant by HBC’s
Board of Directors at that time.
The
Company declared a $0.08 per share quarterly cash dividend on January 30,
2008. The dividend will be paid on March 19, 2008, to shareholders of
record on February 27, 2008.
The
Company paid cash dividends totaling $3.25 million, or $0.26 per share in 2007
representing 23% of 2007 earnings. The Company’s general dividend policy is to
pay cash dividends within the range of typical peer payout ratios, provided that
such payments do not adversely affect the Company’s financial condition and are
not overly restrictive to our growth capacity. However, no assurance can be
given that earnings and/or growth expectations in any given year will justify
the payment of such a dividend.
During
any period in which the Company has deferred payment of interest otherwise due
and payable on its subordinated debt securities, it may not make any dividends
or distributions with respect to its capital stock (see “Item 7, Management’s
Discussion and Analysis of Financial Condition and Results of Operations –
Capital Resources”). The ability of HBC’s Board of Directors to
declare cash dividends is also subject to statutory and regulatory restrictions
which limit the amount available for cash dividends depending upon the earnings,
financial condition and cash needs of HBC, as well as general business
conditions. Under California banking law, HBC may declare dividends in an amount
not exceeding the lesser of its retained earnings or its net income for the last
three years (reduced by dividends paid during such period) or, with the prior
approval of the California Commissioner of Financial Institutions, in an amount
not exceeding the greatest of (i) the retained earnings of HBC, (ii) the net
income of HBC for its last fiscal year, or (iii) the net income of HBC for its
current fiscal year. The payment of any cash dividends by HBC will depend not
only upon HBC’s earnings during a specified period, but also on HBC meeting
certain regulatory capital requirements.
The
Company’s ability to pay dividends is also limited by state corporation law. The
California General Corporation Law prohibits the Company from paying dividends
on the Common Stock unless: (i) its retained earnings, immediately prior to the
dividend payment, equals or exceeds the amount of the dividend or (ii)
immediately after giving effect to the dividend the sum of the Company’s assets
(exclusive of goodwill and deferred charges) would be at least equal to 125% of
its liabilities (not including deferred taxes, deferred income and other
deferred liabilities) and the current assets of the Company would be at least
equal to its current liabilities, or, if the average of its earnings before
taxes on income and before interest expense for the two preceding fiscal years
was less than the average of its interest expense for the two preceding fiscal
years, at least equal to 125% of its current liabilities.
Additionally,
the FRB’s policy regarding dividends provides that a bank holding company should
not pay cash dividends exceeding its net income or which can only be funded in
ways that weaken the bank holding company’s financial health, such as by
borrowing.
The FDIC
and the DFI have authority to prohibit a bank from engaging in business
practices that are considered to be unsafe or unsound. Depending upon the
financial condition of a bank and upon other factors, the FDIC or DFI could
assert that payments of dividends or other payments by a bank might be such an
unsafe or unsound practice. The FRB has similar authority with respect to a bank
holding company.
For
regulatory restrictions on payment of dividends by the Company, see Item 1-
“BUSINESS - Regulation and
Supervision – The Company - Limitations on Dividends
Payments.”
Performance
Graph
The
following graph compares the stock performance of the Company from
December 31, 2002 to December 31, 2007, to the performance of several
specific industry indices. The performance of the S&P 500 index, Nasdaq
Stock Index and Nasdaq Bank Stocks were used as comparisons to the Company’s
stock performance. Management believes that a performance comparison to these
indices provides meaningful information and has therefore included those
comparisons in the following graph.
The following chart compares the stock performance of the Company from
December 31, 2002 to December 31, 2007, to the performance of several
specific industry indices. The performance of the S&P 500 index, Nasdaq
Stock Index and Nasdaq Bank Stocks were used as comparisons to the Company’s
stock performance.
|
|
Period
Ending
|
|
Index
|
12/31/02
|
12/31/03
|
12/31/04
|
12/31/05
|
12/31/06
|
12/31/07
|
Heritage
Commerce Corp *
|
100
|
142
|
220
|
249
|
308
|
213
|
S&P
500 *
|
100
|
126
|
138
|
142
|
161
|
167
|
NASDAQ
- Total US*
|
100
|
150
|
163
|
165
|
181
|
199
|
NASDAQ
Bank Index*
|
100
|
130
|
144
|
138
|
153
|
119
|
*
Source: SNL Financial Bank Information Group – (434)
977-1600
Stock Repurchase
Program
In July
2007, the Company’s Board of Directors authorized the purchase of up to $30
million of its common stock, which represents approximately 1.48 million shares,
or 11%, of its outstanding shares at the current market price on the date of
authorization. The share repurchase authorization is valid through
July, 2009. The Company intends to continue to finance the repurchase of shares
using its available cash. Shares may be repurchased by the Company in
open market purchases or in privately negotiated transactions as permitted under
applicable rules and regulations. The repurchase program may be
modified, suspended or terminated by the Board of Directors at any time without
notice. The extent to which the Company repurchases its shares and
the timing of such repurchases will depend upon market conditions and other
corporate considerations.
The
following table provides information concerning the Company’s repurchase of its
common stock during the fourth quarter of 2007, which were all executed in
accordance with SEC Rule 10b-18 in 2007.
|
|
October
|
|
|
November
|
|
|
December
|
|
Total
Shares Purchased
|
|
- |
|
|
|
196,216 |
|
|
|
162,274 |
|
Average
Per Share Price
|
|
$ |
- |
|
|
$ |
16.57 |
|
|
$ |
18.02 |
|
Number
of Shares as Part of Announced Plan or Program
|
|
|
- |
|
|
|
196,216 |
|
|
|
162,274 |
|
Maximum
Amount Remaining for Purchase Under Plan or Program
|
|
$ |
24,021,440 |
|
|
$ |
20,769,336 |
|
|
$ |
17,844,363 |
|
Securities
Authorized for Issuance Under Equity Compensation Plan
The
information concerning our equity compensation plans is incorporated by
reference herein to the section of the proxy statement entitled “Equity
Compensation and Plan Information.”
ITEM
6 - SELECTED FINANCIAL DATA
The
following table presents a summary of selected financial information that should
be read in conjunction with the Company’s consolidated financial statements and
notes thereto included under Item 8 - “FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA.”
SELECTED
FINANCIAL DATA
|
|
AT OR
FOR YEAR ENDED DECEMBER 31,
|
|
(Dollars
in thousands, except per share amounts and ratios)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
2003
|
|
INCOME
STATEMENT DATA:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
$ |
78,712 |
|
|
$ |
72,957 |
|
|
$ |
63,756 |
|
|
$ |
50,685 |
|
|
$ |
46,447 |
|
Interest
expense
|
|
|
27,012 |
|
|
|
22,525 |
|
|
|
15,907 |
|
|
|
9,648 |
|
|
|
10,003 |
|
Net
interest income before provision for loan losses
|
|
|
51,700 |
|
|
|
50,432 |
|
|
|
47,849 |
|
|
|
41,037 |
|
|
|
36,444 |
|
Provision
for loan losses
|
|
|
(11 |
) |
|
|
(503 |
) |
|
|
313 |
|
|
|
666 |
|
|
|
2,900 |
|
Net
interest income after provision for loan losses
|
|
|
51,711 |
|
|
|
50,935 |
|
|
|
47,536 |
|
|
|
40,371 |
|
|
|
33,544 |
|
Noninterest
income
|
|
|
8,052 |
|
|
|
9,840 |
|
|
|
9,423 |
|
|
|
10,544 |
|
|
|
10,812 |
|
Noninterest
expense
|
|
|
37,530 |
|
|
|
34,268 |
|
|
|
35,233 |
|
|
|
39,238 |
|
|
|
33,084 |
|
Income
before income taxes
|
|
|
22,233 |
|
|
|
26,507 |
|
|
|
21,726 |
|
|
|
11,677 |
|
|
|
11,272 |
|
Income
tax expense
|
|
|
8,137 |
|
|
|
9,237 |
|
|
|
7,280 |
|
|
|
3,199 |
|
|
|
3,496 |
|
Net
income
|
|
$ |
14,096 |
|
|
$ |
17,270 |
|
|
$ |
14,446 |
|
|
$ |
8,478 |
|
|
$ |
7,776 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PER
SHARE DATA:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
net income (1)
|
|
$ |
1.14 |
|
|
$ |
1.47 |
|
|
$ |
1.22 |
|
|
$ |
0.73 |
|
|
$ |
0.69 |
|
Diluted
net income (2)
|
|
$ |
1.12 |
|
|
$ |
1.44 |
|
|
$ |
1.19 |
|
|
$ |
0.71 |
|
|
$ |
0.67 |
|
Book
value (3)
|
|
$ |
12.90 |
|
|
$ |
10.54 |
|
|
$ |
9.45 |
|
|
$ |
8.45 |
|
|
$ |
7.86 |
|
Tangible
book value per share
|
|
$ |
9.20 |
|
|
$ |
10.54 |
|
|
$ |
9.45 |
|
|
$ |
8.45 |
|
|
$ |
7.86 |
|
Weighted
average number of shares outstanding - basic
|
|
|
12,398,270 |
|
|
|
11,725,671 |
|
|
|
11,795,635 |
|
|
|
11,559,155 |
|
|
|
11,221,232 |
|
Weighted
average number of shares outstanding - diluted
|
|
|
12,536,740 |
|
|
|
11,956,433 |
|
|
|
12,107,230 |
|
|
|
11,986,856 |
|
|
|
11,572,588 |
|
Shares
outstanding at period end
|
|
|
12,774,926 |
|
|
|
11,656,943 |
|
|
|
11,807,649 |
|
|
|
11,669,837 |
|
|
|
11,381,037 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE SHEET DATA:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities
|
|
$ |
135,402 |
|
|
$ |
172,298 |
|
|
$ |
198,495 |
|
|
$ |
232,809 |
|
|
$ |
153,473 |
|
Net
loans
|
|
$ |
1,024,247 |
|
|
$ |
699,957 |
|
|
$ |
669,901 |
|
|
$ |
708,611 |
|
|
$ |
636,221 |
|
Allowance
for loan losses
|
|
$ |
12,218 |
|
|
$ |
9,279 |
|
|
$ |
10,224 |
|
|
$ |
12,497 |
|
|
$ |
13,451 |
|
Goodwill
and other intangible assets
|
|
$ |
48,153 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
Total
assets
|
|
$ |
1,347,472 |
|
|
$ |
1,037,138 |
|
|
$ |
1,130,509 |
|
|
$ |
1,108,173 |
|
|
$ |
1,005,982 |
|
Total
deposits
|
|
$ |
1,064,226 |
|
|
$ |
846,593 |
|
|
$ |
939,759 |
|
|
$ |
918,535 |
|
|
$ |
835,410 |
|
Securities
sold under agreement to repurchase
|
|
$ |
10,900 |
|
|
$ |
21,800 |
|
|
$ |
32,700 |
|
|
$ |
47,800 |
|
|
$ |
43,600 |
|
Short-term
borrowings
|
|
$ |
60,000 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
Notes
payable to subsidiary grantor trusts
|
|
$ |
23,702 |
|
|
$ |
23,702 |
|
|
$ |
23,702 |
|
|
$ |
23,702 |
|
|
$ |
23,702 |
|
Total
shareholders' equity
|
|
$ |
164,824 |
|
|
$ |
122,820 |
|
|
$ |
111,617 |
|
|
$ |
98,579 |
|
|
$ |
89,485 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SELECTED
PERFORMANCE RATIOS: (4)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Return
on average assets
|
|
|
1.18 |
% |
|
|
1.57 |
% |
|
|
1.27 |
% |
|
|
0.80 |
%
|
|
|
0.81
|
% |
Return
on average tangible assets
|
|
|
1.21
|
% |
|
|
1.57
|
% |
|
|
1.27
|
% |
|
|
0.80
|
%
|
|
|
0.81
|
% |
Return
on average equity
|
|
|
9.47
|
% |
|
|
14.62
|
% |
|
|
13.73
|
% |
|
|
9.04
|
% |
|
|
9.04
|
% |
Return
on average tangible equity
|
|
|
11.43
|
% |
|
|
14.62
|
% |
|
|
13.73
|
% |
|
|
9.04
|
% |
|
|
9.04
|
% |
Net
interest margin
|
|
|
4.86
|
% |
|
|
5.06
|
% |
|
|
4.58
|
% |
|
|
4.22
|
% |
|
|
4.15
|
% |
Efficiency
ratio
|
|
|
62.81
|
% |
|
|
56.86
|
% |
|
|
61.52
|
% |
|
|
76.07
|
%
|
|
|
70.01
|
% |
Average
net loans (excludes loans held for sale) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
as a percentage of average deposits
|
|
|
84.06
|
% |
|
|
77.61 |
% |
|
|
73.55
|
% |
|
|
77.11
|
% |
|
|
77.21
|
% |
Average
total shareholders' equity as a
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
percentage
of average total assets
|
|
|
12.47
|
% |
|
|
10.75
|
% |
|
|
9.25
|
% |
|
|
8.80
|
% |
|
|
8.95
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SELECTED
ASSET QUALITY RATIOS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loan charge-offs (recoveries) to average loans
|
|
|
(0.10) |
% |
|
|
0.06
|
% |
|
|
0.28
|
% |
|
|
0.19
|
% |
|
|
0.41
|
% |
Allowance
for loan losses to total loans
|
|
|
1.18
|
% |
|
|
1.31
|
% |
|
|
1.51
|
% |
|
|
1.73
|
% |
|
|
2.03
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CAPITAL
RATIOS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier
1 risk-based
|
|
|
11.5
|
% |
|
|
17.3
|
% |
|
|
14.2
|
% |
|
|
13.0
|
% |
|
|
13.3
|
% |
Total
risk-based
|
|
|
12.5
|
% |
|
|
18.4
|
% |
|
|
15.3
|
% |
|
|
14.3
|
% |
|
|
14.5
|
% |
Leverage
|
|
|
11.1
|
% |
|
|
13.6
|
% |
|
|
11.6
|
% |
|
|
10.9
|
% |
|
|
11.1
|
% |
Notes:
1)
|
Represents
net income divided by the average number of shares of common stock
outstanding for the respective
period.
|
2)
|
Represents
net income divided by the average number of shares of common stock and
common stock-equivalents outstanding for the respective
period.
|
3)
|
Represents
shareholders’ equity divided by the number of shares of common stock
outstanding at the end of the period
indicated.
|
4)
|
Average
balances used in this table and throughout this Annual Report are based on
daily averages.
|
ITEM
7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
|
Executive
Summary
This
summary is intended to identify the most important matters on which management
focuses when it evaluates the financial condition and performance of the
Company. When evaluating financial condition and performance,
management looks at certain key metrics and measures. The Company’s
evaluation includes comparisons with peer group financial institutions and with
its own performance objectives established in the internal planning
process.
The
primary activity of the Company is commercial banking. The Company’s
operations are located entirely in the southern and eastern regions of the
general San Francisco Bay area of California in the counties of Santa Clara,
Alameda and Contra Costa. The largest city in this area is San Jose
and the Company’s market includes the headquarters of a number of technology
based companies in the region known commonly as Silicon Valley. The
Company’s customers are primarily closely held businesses and
professionals.
Performance
Overview
Net
income in 2007 was $14.1 million, a decrease of $3.2 million, or 18%, compared
to $17.3 million in 2006. Net income in 2006 was $2.8 million higher
than 2005 net income of $14.4 million. Net income per diluted share
was $1.12 for 2007, as compared to $1.44 during 2006 and $1.19 in
2005. The Company’s Return on Average Assets was 1.18% and Return on
Average Equity was 9.47% in 2007, as compared to 1.57% and 14.62%, respectively
for 2006, and 1.27% and 13.73%, respectively in 2005. The Company’s return on
average tangible assets and return on average tangible equity were 1.21% and
11.43%, respectively, for 2007, compared to 1.57% and 14.62%, respectively, for
2006, and 1.27% and 13.73%, respectively, for 2005.
The
following are major factors impacting the Company’s results of operations in
recent years:
·
|
Net
interest income increased by $1.3 million, or 3%, in 2007, and by $3.4
million, or 7%, in 2006. The growth in 2007 was largely driven
by an increase in average interest earning assets and the growth in 2006
was largely driven by an increased rate on earning
assets.
|
·
|
Noninterest
income decreased by 18% in 2007 from 2006. The Company’s changed its
strategy regarding its SBA loan business. The Company is now
retaining most of its SBA production in lieu of selling
loans. The Company’s noninterest income declined in 2007 as a
result of the change in strategy.
|
·
|
The
efficiency ratio was 62.81% in 2007, compared to 56.86% in 2006 and 61.52%
in 2005. The higher efficiency ratio in 2007 reflects the
additional senior level bankers and a new SBA team the Company hired
during 2007 and costs associated with the acquisition of Diablo Valley
Bank.
|
·
|
Noninterest
expense increased to $37.5 million in 2007, compared to $34.3 million in
2006 and $35.2 million in 2005. Charges relative to the Diablo
Valley Bank acquisition accounted for $1.3 million of the increase,
including $352,000 for intangible asset amortization, $400,000
of consulting agreement expense, $40,000 of non-compete agreement expense,
and compensation expense of $461,000 for employees who are no longer with
the Company. Compensation expense increased 9% in 2007 compared to a year
ago. The increase in compensation expense was primarily due to
the merger with Diablo Valley Bank, the addition of senior level bankers
and hiring of a new SBA team during 2007. Up front costs associated with
the hiring of new bankers for the East Bay expansion and SBA team totaled
$970,000 in 2007.
|
·
|
A
credit provision for loan losses of $11,000 was recorded in 2007, compared
to a credit provision of $503,000 in 2006 and a provision of $313,000 in
2005. This is the result of a general improvement in credit
quality and recoveries in 2007 of loans previously charged
off.
|
The
following are important factors in understanding our current financial condition
and liquidity position:
·
|
Total
assets increased $310 million, or 30%, to $1.35 billion at the end of 2007
from $1.04 billion at the end of 2006. The increase in 2007 was
primarily due to the acquisition of Diablo Valley
Bank.
|
·
|
Total
loans increased $327 million, or 46%, to $1.04 billion at the end of
2007. Total loans were $709 million at the end of 2006. The
increase in 2007 was primarily due to the acquisition of Diablo Valley
Bank and the addition of several experienced loan producers hired in the
fourth quarter.
|
·
|
Nonperforming
assets remained at nominal levels. Nonperforming assets were
$4.5 million, or 0.34% of total assets, at December 31, 2007, compared to
$4.3 million, or 0.42% of total assets, at December 31, 2006, and $3.7
million, or 0.32% of total assets, at December 31, 2005. Approximately
$2.4 million of the nonperforming loans at year end of 2007 were acquired
in the acquisition of Diablo Valley
Bank.
|
·
|
Total
deposits increased $218 million, or 26%, to $1.06 billion at the end of
2007 from $847 million at the end of 2006. The increase in 2007
was primarily due to the acquisition of Diablo Valley
Bank.
|
Deposits
Growth in
deposits is an important metric management uses to measure market
share. The Company’s depositors are predominately located in its
primary market area. Depending on loan demand and other funding
requirements, the Company will occasionally obtain deposits from wholesale
sources including deposit brokers. The Company had $40 million in
brokered deposits at December 31, 2007. The Company also seeks
deposits from title insurance companies and real estate exchange
facilitators. The Company has a policy to monitor all deposits that
may be sensitive to interest rate changes to help assure that liquidity risk
does not become excessive due to concentrations. The Company’s acquisition of
Diablo Valley Bank during 2007 resulted a significant growth in deposits and
expanded the Company’s market area.
Lending
Our
lending business originates primarily through our branch offices located in our
primary market. The economy in our primary service area continued to
stabilize in 2007. Commercial loans increased from December 31, 2006
due to increased marketing focus and the acquisition of Diablo Valley
Bank. Commercial real estate mortgage loans slightly increased from
December 31, 2006 primarily due to general improvements in commercial income
property markets and the Diablo Valley Bank acquisition. We will
continue to use and improve existing products to expand market share at current
locations, including our new branch in Walnut Creek, California that opened in
2007.
Net
Interest Income
The
management of interest income and interest expense is fundamental to the
performance of the Company. Net interest income, the difference
between interest income and interest expense, is the largest component of the
Company’s total revenue. Management closely monitors both total net
interest income and the net interest margin (net interest income divided by
average earning assets).
Because
of its focus on commercial lending to closely held businesses, the Company will
continue to have a high percentage of floating rate loans and other
assets. Given the current volume, mix and repricing characteristics
of our interest-bearing liabilities and interest-earning assets, we believe our
interest rate spread is expected to increase in a rising rate environment,
and decrease in a declining interest rate scenario.
During
the fourth quarter of 2007, the Board of Governors of the Federal Reserve System
reduced short-term interest rates by 50 basis points. This decrease in
short-term rates immediately affected the rates applicable to the majority of
the Company’s loans. While the decrease in interest rates also lowered the cost
of interest bearing deposits, which represent the Company’s primary funding
source, these deposits tend to reprice more slowly than floating rate loans. The
Federal Reserve reduced short-term interest rates by another 125 points in
January 2008. Reductions in short-term interest rates can be expected
to negatively affect the Company’s net interest margin and net interest
income, at least in the near term.
The
Company, through its asset and liability policies and practices, seeks to
maximize net interest income without exposing the Company to an excessive level
of interest rate risk. Interest rate risk is managed by monitoring
the pricing, maturity and repricing options of all classes of interest bearing
assets and liabilities. This is discussed in more detail under Liquidity and Asset/Liability
Management.
Management
of Credit Risk
Because
of its focus on business banking, loans to single borrowing entities are often
larger than would be found in a more consumer oriented bank with many smaller,
more homogenous loans. The average size of its relationships makes
the Company more susceptible to larger losses. As a result of this
concentration of larger risks, the Company has maintained an allowance for loan
losses which is substantially higher than would be indicated by its actual
historic loss experience. The Company had a reverse provision for
loan losses each of the last two years because of a general improvement in
credit quality and net recoveries in 2007 of loans previously charged off. A
complete discussion of the management of credit risk appears under Provision for Loan Losses and
Allowance for Loan Losses.
Noninterest
Income
While net
interest income remains the largest single component of total revenues,
noninterest income is an important component. Prior to the third
quarter of 2007, a significant percentage of the Company’s noninterest income
was associated with its SBA lending activity, as gains on the sale of loans
sold in the secondary market and servicing income from loans sold in the
secondary market with servicing rights retained. However, beginning
in the third quarter of 2007, the Company started retaining new SBA loans in
lieu of selling. As a result, the Company’s noninterest income
declined in 2007 compared to 2006. SBA loan activity includes the origination,
sale, and servicing of loans guaranteed by the U.S. Department of Agriculture.
Noninterest income associated with SBA activity increased each year from
2003 through 2006.
Noninterest
Expense
Management
considers the control of operating expenses to be a critical element of the
Company’s performance. Prior to 2007 the Company had undertaken
several initiatives to reduce its noninterest expense and improve its
efficiency, including a reduction in staff and the consolidation of operations
under the common Heritage Bank brand and restructuring each
department. In 2007, however, the Company’s efficiency ratio was
significantly impacted by the acquisition of Diablo Valley Bank, the hiring of
additional experienced bankers and a new SBA team. Management monitors progress
in reducing expense through the review of the Company’s efficiency
ratio. The Company’s efficiency ratio was 62.81% in 2007 compared
with 56.86% in 2006, and 61.52% in 2005.
In the
fourth quarter of 2005, the Company recognized additional expenses of $1.05
million, representing the present value of term insurance for participants in
the Company’s Supplemental Executive Retirement Plan, substantially all of whom
have split dollar life insurance agreements with the
Company. Typically, under the split dollar life insurance agreements,
the insureds’ beneficiary receives 80% of the excess of the death benefit over
the cash surrender value of the policy. This accounting adjustment
was undertaken after the Company’s review of split dollar life insurance
agreements and recognition that the Company has contractually agreed with each
participant to provide a benefit. This charge reflected the term
insurance cost for all insureds.
Beginning
in 2008, the Company will be impacted by the FASB Emerging Issues Task Force
Issue No. 06-4, Accounting for
Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements. This issue requires
that a liability be recorded during the service period when a split-dollar life
insurance agreement continues after participants’ employment or
retirement. With its existing split dollar life insurance agreements,
the Company has contractually agreed with each participant to provide life
insurance on an ongoing basis. Therefore, the Company would have to obtain term
insurance for the remainder of the participant’s life, or a comparable death
benefit if the respective life insurance policy were ever terminated. The
required accrued liability will be based on either the post-employment benefit
cost for the continuing life insurance or on the future death benefit depending
on the contractual terms of the underlying agreement.
In
September 2006, FASB issued Statement 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements
No. 87, 88, 106 and 132 (R). Adoption of Statement 158 did not affect the
Company’s financial statements since the Company’s supplemental retirement plan
has no assets and the liability for benefits is measured as of December 31 and
recorded on the Company’s balance sheet.
Capital
Management and Share Repurchases
Heritage
Commerce Corp and Heritage Bank of Commerce meet the regulatory definition of
“well capitalized” at December 31, 2007. As part of its asset and
liability process, the Company continually assesses its capital position to take
into consideration growth, expected earnings, risk profile and potential
corporate activities that it may choose to pursue. As a part of this
process, the Company determined in the second quarter of 2004 that its capital
levels were higher than necessary. To adjust capital to levels
consistent with its view of current market conditions, the Company commenced a
stock repurchase plan of $10 million in June 2004. This
repurchase program was completed at the end of third quarter of
2005. On February 7, 2006, the Board of Directors authorized the
repurchase of up to an additional $10 million of common stock through June 30,
2007. This repurchase program was completed at the end of second
quarter of 2007. On July, 2007, the Board of Directors authorized to
purchase up to $30 million of common stock through July, 2009.
In 2006,
the Company initiated the payment of quarterly cash dividends. The
Company paid cash dividends totaling $3.25 million, or $0.26 per share in 2007,
representing 23% of 2007 earnings. The Company’s general policy is to
pay cash dividends within the range of typical peer payout ratios, provided that
such payments do not adversely affect our financial condition and are not overly
restrictive to our growth capacity. On January 30, 2008, the Company
declared an $0.08 per share quarterly cash dividend. The dividend
will be paid on March 19, 2008, to shareholders of record on February 27,
2008.
The
Company earns income from two primary sources. The first is net interest income,
which is interest income generated by earning assets less interest expense on
interest-bearing liabilities. The second is non-interest income,
which primarily consists of loan servicing fees, customer service charges and
fees, and increase in cash surrender value of life insurance. The
majority of the Company’s non-interest expenses are operating costs that relate
to providing a full range of banking services to our customers.
Net
Interest Income and Net Interest Margin
In 2007,
net interest income was $51.7 million, an increase of 3% compared to $50.4
million in 2006. The level of net interest income depends on several
factors in combination, including growth in earning assets, yields on earning
assets, the cost of interest-bearing liabilities, the relative volumes of
earning assets and interest-bearing liabilities, and the mix of products which
comprise the Company’s earning assets, deposits, and other interest-bearing
liabilities. To maintain its net interest margin, the Company must
manage the relationship between interest earned and paid.
The
following Distribution, Rate and Yield table presents for each of the past three
years, the average amounts outstanding for the major categories of the Company’s
balance sheet, the average interest rates earned or paid thereon, and the
resulting net interest margin on average interest earning assets for the periods
indicated. Average balances are based on daily averages.
Distribution, Rate and
Yield
|
|
Year Ended December
31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
|
|
|
|
Interest
|
|
Average
|
|
|
|
Interest
|
|
Average
|
|
|
|
Interest
|
|
Average
|
|
|
|
Average
|
|
Income /
|
|
Yield /
|
|
Average
|
|
Income /
|
|
Yield /
|
|
Average
|
|
Income /
|
|
Yield /
|
|
(Dollars in
thousands)
|
|
Balance
|
|
Expense
|
|
Rate
|
|
Balance
|
|
Expense
|
|
Rate
|
|
Balance
|
|
Expense
|
|
Rate
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans,
gross (1)
|
|
$
|
844,928
|
|
$
|
68,405
|
|
|
8.10%
|
|
$
|
738,297
|
|
$
|
61,859
|
|
|
8.38%
|
|
$
|
762,328
|
|
$
|
54,643
|
|
|
7.17
|
%
|
Securities
|
|
|
165,884
|
|
|
7,636
|
|
|
4.60%
|
|
|
191,220
|
|
|
7,796
|
|
|
4.08%
|
|
|
226,043
|
|
|
7,247
|
|
|
3.21
|
%
|
Interest
bearing deposits in other financial institutions
|
|
|
3,132
|
|
|
141
|
|
|
4.50%
|
|
|
2,826
|
|
|
132
|
|
|
4.67%
|
|
|
3,234
|
|
|
97
|
|
|
3.00
|
%
|
Federal
funds sold
|
|
|
49,118
|
|
|
2,530
|
|
|
5.15%
|
|
|
63,739
|
|
|
3,170
|
|
|
4.97%
|
|
|
52,438
|
|
|
1,769
|
|
|
3.37
|
%
|
Total interest earning assets
|
|
|
1,063,062
|
|
|
78,712
|
|
|
7.40%
|
|
|
996,082
|
|
|
72,957
|
|
|
7.32%
|
|
|
1,044,043
|
|
|
63,756
|
|
|
6.11
|
%
|
Cash
and due from banks
|
|
|
37,435
|
|
|
|
|
|
|
|
|
34,810
|
|
|
|
|
|
|
|
|
38,670
|
|
|
|
|
|
|
|
Premises
and equipment, net
|
|
|
6,218
|
|
|
|
|
|
|
|
|
2,482
|
|
|
|
|
|
|
|
|
2,879
|
|
|
|
|
|
|
|
Other
assets
|
|
|
87,175
|
|
|
|
|
|
|
|
|
64,904
|
|
|
|
|
|
|
|
|
51,593
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,193,890
|
|
|
|
|
|
|
|
$
|
1,098,278
|
|
|
|
|
|
|
|
$
|
1,137,185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders'
equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand,
interest bearing
|
|
$
|
143,801
|
|
$
|
3,154
|
|
|
2.19%
|
|
$
|
145,471
|
|
$
|
3,220
|
|
|
2.21%
|
|
$
|
134,412
|
|
$
|
1,749
|
|
|
1.30
|
%
|
Savings
and money market
|
|
|
393,750
|
|
|
12,368
|
|
|
3.14%
|
|
|
358,846
|
|
|
10,274
|
|
|
2.86%
|
|
|
363,570
|
|
|
6,058
|
|
|
1.67
|
%
|
Time
deposits, under $100
|
|
|
32,196
|
|
|
1,243
|
|
|
3.86%
|
|
|
31,967
|
|
|
1,037
|
|
|
3.24%
|
|
|
37,260
|
|
|
862
|
|
|
2.31
|
%
|
Time
deposits, $100 and over
|
|
|
119,812
|
|
|
5,151
|
|
|
4.30%
|
|
|
107,387
|
|
|
3,762
|
|
|
3.50%
|
|
|
115,104
|
|
|
2,867
|
|
|
2.49
|
%
|
Brokered
time deposits, $100 and over
|
|
|
49,846
|
|
|
2,295
|
|
|
4.60%
|
|
|
34,234
|
|
|
1,295
|
|
|
3.78%
|
|
|
35,764
|
|
|
1,313
|
|
|
3.67
|
%
|
Notes
payable to subsidiary grantor trusts
|
|
|
23,702
|
|
|
2,329
|
|
|
9.83%
|
|
|
23,702
|
|
|
2,310
|
|
|
9.75%
|
|
|
23,702
|
|
|
2,136
|
|
|
9.01
|
%
|
Securities
sold under agreement to repurchase
|
|
|
14,529
|
|
|
387
|
|
|
2.66%
|
|
|
25,429
|
|
|
627
|
|
|
2.47%
|
|
|
40,748
|
|
|
922
|
|
|
2.26
|
%
|
Other
short-term borrowings |
|
|
1,726 |
|
|
85 |
|
|
4.92% |
|
|
- |
|
|
- |
|
|
N/A |
|
|
- |
|
|
- |
|
|
N/ |
A |
Total interest bearing liabilities
|
|
|
779,362
|
|
|
27,012
|
|
|
3.47%
|
|
|
727,036
|
|
|
22,525
|
|
|
3.10%
|
|
|
750,560
|
|
|
15,907
|
|
|
2.12
|
%
|
Demand,
noninterest bearing
|
|
|
242,308
|
|
|
|
|
|
|
|
|
229,190
|
|
|
|
|
|
|
|
|
259,881
|
|
|
|
|
|
|
|
Other
liabilities
|
|
|
23,385
|
|
|
|
|
|
|
|
|
23,957
|
|
|
|
|
|
|
|
|
21,536
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
1,045,055
|
|
|
|
|
|
|
|
|
980,183
|
|
|
|
|
|
|
|
|
1,031,977
|
|
|
|
|
|
|
|
Shareholders'
equity
|
|
|
148,835
|
|
|
|
|
|
|
|
|
118,095
|
|
|
|
|
|
|
|
|
105,208
|
|
|
|
|
|
|
|
Total
liabilities and shareholders' equity
|
|
$
|
1,193,890
|
|
|
|
|
|
|
|
$
|
1,098,278
|
|
|
|
|
|
|
|
$
|
1,137,185
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income / margin
|
|
|
|
|
$
|
51,700
|
|
|
4.86%
|
|
|
|
|
$
|
50,432
|
|
|
5.06%
|
|
|
|
|
$
|
47,849
|
|
|
4.58
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Yields
and amounts earned on loans include loan fees and costs. Nonaccrual loans are
included in the average balance calculations above.
The
Volume and Rate Variances table below sets forth the dollar difference in
interest earned and paid for each major category of interest-earning assets and
interest-bearing liabilities for the noted periods, and the amount of such
change attributable to changes in average balances (volume) or changes in
average interest rates. Volume variances are equal to the increase or decrease
in the average balance times the prior period rate and rate variances are equal
to the increase or decrease in the average rate times the prior period average
balance. Variances attributable to both rate and volume changes are equal to the
change in rate times the change in average balance and are included below in the
average volume column.
Volume
and Rate Variances
|
|
2007
vs. 2006
|
|
2006
vs. 2005
|
|
|
Increase
(Decrease) Due to Change in:
|
|
Increase
(Decrease) Due to Change in:
|
|
|
Average
|
|
Average
|
|
Net
|
|
Average
|
|
Average
|
|
Net
|
(Dollars
in thousands)
|
|
Volume
|
|
Rate
|
|
Change
|
|
Volume
|
|
Rate
|
|
Change
|
Income
from the interest earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans,
gross
|
|
$ |
8,633 |
|
$ |
(2,087) |
|
$ |
6,546 |
|
$ |
(2,024) |
|
$ |
9,240 |
|
$ |
7,216 |
Securities
|
|
|
(1,160) |
|
|
1,000 |
|
|
(160) |
|
|
(1,427) |
|
|
1,976 |
|
|
549 |
Interest
bearing deposits in other financial institutions
|
|
|
14 |
|
|
(5) |
|
|
9 |
|
|
(19) |
|
|
54 |
|
|
35 |
Federal
funds sold
|
|
|
(753) |
|
|
113 |
|
|
(640) |
|
|
564 |
|
|
837 |
|
|
1,401 |
Total
interest income on interest earning assets
|
|
$ |
6,734 |
|
$ |
(979) |
|
$ |
5,755 |
|
$ |
(2,906) |
|
$ |
12,107 |
|
$ |
9,201 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense
from the interest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand,
interest bearing
|
|
$ |
(38) |
|
$ |
(28) |
|
$ |
(66) |
|
$ |
249 |
|
$ |
1,222 |
|
$ |
1,471 |
Savings
and money market
|
|
|
1,100 |
|
|
994 |
|
|
2,094 |
|
|
(124) |
|
|
4,340 |
|
|
4,216 |
Time
deposits, under $100
|
|
|
9 |
|
|
197 |
|
|
206 |
|
|
(170) |
|
|
345 |
|
|
175 |
Time
deposits, $100 and over
|
|
|
533 |
|
|
856 |
|
|
1,389 |
|
|
(267) |
|
|
1,162 |
|
|
895 |
Brokered
time deposits, $100 and over
|
|
|
720 |
|
|
280 |
|
|
1,000 |
|
|
(57) |
|
|
39 |
|
|
(18) |
Notes
payable to subsidiary grantor trusts
|
|
|
(1) |
|
|
20 |
|
|
19 |
|
|
- |
|
|
174 |
|
|
174 |
Securities
sold under agreement to repurchase
|
|
|
(350) |
|
|
110 |
|
|
(240) |
|
|
(379) |
|
|
84 |
|
|
(295) |
Other short-term borrowings |
|
|
85 |
|
|
- |
|
|
85 |
|
|
- |
|
|
- |
|
|
- |
Total
interest expense on interest bearing liabilities
|
|
$ |
2,059 |
|
$ |
2,428 |
|
$ |
4,487 |
|
$ |
(748) |
|
$ |
7,366 |
|
$ |
6,618 |
Net
interest income
|
|
$ |
4,675 |
|
$ |
(3,407) |
|
$ |
1,268 |
|
$ |
(2,158) |
|
$ |
4,741 |
|
$ |
2,583 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income for 2007 increased $1.3 million or 3% from 2006. The
increase in 2007 was primarily due to growth in the loan
portfolio. Average earning assets increased 7% in 2007 from
2006. This increase was primarily attributable to the acquisition of
Diablo Valley Bank. The Company’s net interest margin, expressed as a percentage
of average earning assets, was 4.86% in 2007 compared to 5.06% in 2006, a
decrease of 20 basis points. A substantial portion of the Company’s earning
assets are variable-rate loans that re-price when the Company’s prime lending
rate is changed, in contrast to a large base of core deposits that are generally
slower to re-price. This causes the Company’s balance sheet to be
asset-sensitive which means that, all else being equal, the Company’s net
interest margin will be lower during periods when short-term interest rates are
falling and higher when rates are rising. Management anticipates that the
Company’s net interest margin could experience some compression if short-term
interest rates continue to fall in 2008.
The net
interest margin increased 48 basis points to 5.06% in 2006 from 4.58% in 2005.
Net interest income increased $2.6 million, or 5%, for 2006 to $50.4 million
from $47.8 million for 2005, primarily due to higher in interest rate levels in
2006.
Provision
for Loan Losses
|
Credit
risk is inherent in the business of making loans. The Company sets aside an
allowance or reserve for loan losses through charges to earnings, which are
shown in the income statement as the provision for loan losses. Specifically
identifiable and quantifiable losses are immediately charged off against the
allowance. The loan loss provision is determined by conducting a monthly
evaluation of the adequacy of the Company’s allowance for loan losses and
charging the shortfall, if any, to the current month’s expense. This has the
effect of creating variability in the amount and frequency of charges to the
Company’s earnings. The loan loss provision and level of allowance
for each period are dependent upon many factors, including loan growth, net
charge-offs, changes in the composition of the loan portfolio, delinquencies,
management’s assessment of the quality of the loan portfolio, the valuation of
problem loans and the general economic conditions in the Company’s market
area.
For 2007,
the Company had a credit provision for loan losses of $11,000, compared to a
credit provision for loan losses of $0.5 million for 2006 and provision for loan
losses of $0.3 million for 2005. The allowance for loan losses
represented 1.18%, 1.31% and 1.51% of total loans at December 31, 2007, 2006 and
2005, respectively. See “Allowance for Loan Losses” on page 34 for additional
information.
Noninterest
Income
Beginning
in the third quarter of 2007, the Company decided to change its strategy
regarding its SBA loan business. The Company is now retaining most
new SBA production in lieu of selling the loans. Reflecting the strategic shift
to retain SBA loan production, gains from sale of loans dropped substantially in
2007.
The
following table sets forth the various components of the Company’s noninterest
income:
|
|
|
|
|
|
|
|
Increase
(decrease)
|
|
|
Increase
(decrease)
|
|
|
Year
Ended December 31,
|
|
2007
versus 2006
|
|
|
2006
versus 2005
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
Amount
|
|
Percent
|
|
|
Amount
|
|
Percent
|
Gain
on sale of SBA loans
|
|
$ |
1,766 |
|
$ |
3,337 |
|
$ |
2,871 |
|
$ |
(1,571) |
|
-47 |
% |
|
$ |
466 |
|
16% |
Gain
on sale Capital Group loan portfolio
|
|
|
- |
|
|
671 |
|
|
- |
|
|
(671) |
|
-100 |
% |
|
|
671 |
|
N/A |
Servicing
income
|
|
|
2,181 |
|
|
1,860 |
|
|
1,838 |
|
|
321 |
|
17 |
% |
|
|
22 |
|
1% |
Increase
in cash surrender value of life insurance
|
|
|
1,443 |
|
|
1,439 |
|
|
1,236 |
|
|
4 |
|
- |
% |
|
|
203 |
|
16% |
Service
charges and fees on deposit accounts
|
|
|
1,284 |
|
|
1,335 |
|
|
1,468 |
|
|
(51) |
|
-4 |
% |
|
|
(133) |
|
-9% |
Gain
on sale of leased equipment
|
|
|
- |
|
|
- |
|
|
299 |
|
|
- |
|
N/ |
A |
|
|
(299) |
|
-100% |
Equipment
leasing
|
|
|
- |
|
|
- |
|
|
131 |
|
|
- |
|
N/ |
A |
|
|
(131) |
|
-100% |
Other
|
|
|
1,378 |
|
|
1,198 |
|
|
1,580 |
|
|
180 |
|
15 |
% |
|
|
(382) |
|
-24% |
Total
|
|
$ |
8,052 |
|
$ |
9,840 |
|
$ |
9,423 |
|
$ |
(1,788) |
|
-18 |
% |
|
$ |
417 |
|
4% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
decrease in noninterest income in 2007 compared to 2006 was primarily
attributable to a $2.2 million decrease in gain on sale of loans. The
net gain on sale of SBA loans was $1.8 million for 2007, compared to $3.3
million for 2006. The reduction in noninterest income should be offset in future
years with higher interest income, as a result of retaining SBA loan
production..
For
periods the Company sold its SBA loan production, including the first nine
months of 2007, gains or losses on SBA loans held for sale were recognized upon
completion of the sale, and are based on the difference between the net sales
proceeds and the relative fair value of the guaranteed portion of the loan sold
compared to the relative fair value of the unguaranteed portion. The
servicing assets that resulted from the sale of SBA loans, with servicing rights
retained, are amortized over the term of the loans using a method approximating
the interest method.
Noninterest
Expense
The
following table sets forth the various components of the Company’s noninterest
expense:
Noninterest
Expense
|
|
|
|
|
|
|
|
Increase
(decrease)
|
|
|
Increase
(decrease)
|
|
|
Year
Ended December 31,
|
|
2007
versus 2006
|
|
|
2006
versus 2005
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
Amount
|
Percent
|
|
|
Amount
|
|
Percent
|
Salaries
and employee benefits
|
|
$ |
21,160 |
|
$ |
19,414 |
|
$ |
19,845 |
|
$ |
1,746 |
|
9 |
% |
|
$ |
(431) |
|
-2% |
Occupancy
|
|
|
3,557 |
|
|
3,110 |
|
|
3,254 |
|
|
447 |
|
14 |
% |
|
|
(144) |
|
-4% |
Professional
fees
|
|
|
2,342 |
|
|
1,688 |
|
|
1,617 |
|
|
654 |
|
39 |
% |
|
|
71 |
|
4% |
Advertising
and promotion
|
|
|
1,092 |
|
|
1,064 |
|
|
985 |
|
|
28 |
|
3 |
% |
|
|
79 |
|
8% |
Data
processing expense
|
|
|
867 |
|
|
806 |
|
|
661 |
|
|
61 |
|
8 |
% |
|
|
145 |
|
22% |
Low
income housing investment losses and writedowns
|
|
|
828 |
|
|
995 |
|
|
957 |
|
|
(167) |
|
-17 |
% |
|
|
38 |
|
4% |
Client
services
|
|
|
820 |
|
|
1,000 |
|
|
1,404 |
|
|
(180) |
|
-18 |
% |
|
|
(404) |
|
-29% |
Furniture
and equipment
|
|
|
638 |
|
|
517 |
|
|
734 |
|
|
121 |
|
23 |
% |
|
|
(217) |
|
-30% |
Intangible
asset amortization |
|
|
352 |
|
|
- |
|
|
- |
|
|
352 |
|
N/ |
A |
|
|
- |
|
N/A |
Retirement
plan expense
|
|
|
274 |
|
|
352 |
|
|
619 |
|
|
(78) |
|
-22 |
% |
|
|
(267) |
|
-43% |
Amortization
of leased equipment
|
|
|
- |
|
|
- |
|
|
334 |
|
|
- |
|
N/ |
A |
|
|
(334) |
|
-100% |
Other
|
|
|
5,600 |
|
|
5,322 |
|
|
4,823 |
|
|
278 |
|
5 |
% |
|
|
499 |
|
10% |
Total
|
|
$ |
37,530 |
|
$ |
34,268 |
|
$ |
35,233 |
|
$ |
3,262 |
|
10 |
% |
|
|
(965) |
|
-3% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
following table indicates the percentage of noninterest expense in each
category:
Noninterest
Expense by Category
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
|
|
Percent
|
|
|
|
|
Percent
|
|
|
|
|
Percent
|
(Dollars
in thousands)
|
|
Amount
|
|
of
Total
|
|
|
Amount
|
|
of
Total
|
|
|
Amount
|
|
of
Total
|
Salaries
and employee benefits
|
|
$ |
21,160 |
|
|
56 |
% |
|
$ |
19,414 |
|
|
57 |
% |
|
$ |
19,845 |
|
56% |
Occupancy
|
|
|
3,557 |
|
|
10 |
% |
|
|
3,110 |
|
|
9 |
% |
|
|
3,254 |
|
9% |
Professional
fees
|
|
|
2,342 |
|
|
6 |
% |
|
|
1,688 |
|
|
5 |
% |
|
|
1,617 |
|
5% |
Advertising
and promotion
|
|
|
1,092 |
|
|
3 |
% |
|
|
1,064 |
|
|
3 |
% |
|
|
985 |
|
3% |
Data
processing expense
|
|
|
867 |
|
|
2 |
% |
|
|
806 |
|
|
2 |
% |
|
|
661 |
|
2% |
Low
income housing investment losses and writedowns
|
|
|
828 |
|
|
2 |
% |
|
|
995 |
|
|
3 |
% |
|
|
957 |
|
3% |
Client
services
|
|
|
820 |
|
|
2 |
% |
|
|
1,000 |
|
|
3 |
% |
|
|
1,404 |
|
4% |
Furniture
and equipment
|
|
|
638 |
|
|
2 |
% |
|
|
517 |
|
|
1 |
% |
|
|
734 |
|
2% |
Intangible
asset amortization |
|
|
352 |
|
|
1 |
% |
|
|
- |
|
|
- |
% |
|
|
- |
|
-% |
Retirement
plan expense
|
|
|
274 |
|
|
1 |
% |
|
|
352 |
|
|
1 |
% |
|
|
619 |
|
2% |
Amortization
of leased equipment
|
|
|
- |
|
|
- |
% |
|
|
- |
|
|
- |
% |
|
|
334 |
|
1% |
Other
|
|
|
5,600 |
|
|
15 |
% |
|
|
5,322 |
|
|
16 |
% |
|
|
4,823 |
|
13% |
Total
|
|
$ |
37,530 |
|
|
100 |
% |
|
$ |
34,268 |
|
|
100 |
% |
|
$ |
35,233 |
|
100% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest
expense increased $3.3 million, or 10%, in 2007 compared to
2006. Noninterest expense for 2006 decreased $1.0 million, or 3%, from
2005. The efficiency ratio represents noninterest expense
divided by the sum of net interest and noninterest income. The Company’s
efficiency ratio was 62.81% in 2007, as compared to 56.86% in 2006 and 61.52% in
2005.
The
increase in compensation expense was primarily due to the acquisition of Diablo
Valley Bank and the Company hiring a number of experienced bankers during 2007.
Salary and severance benefits for former Diablo Valley Bank employees totaled
$461,000. Up-front costs associated with the hiring of new bankers for the East
Bay expansion and SBA teams totaled $970,000 in 2007. The increase in
occupancy, furniture and equipment was due to opening a new branch office in
Walnut Creek during 2007, as well as the addition of the Diablo Valley Bank
offices. The increase in professional fees and data processing fees
in 2007 were due to the acquisition of Diablo Valley Bank
and additional branches and customer accounts after the merger with
Diablo Valley Bank. The Company also incurred amortization expense of
$352,000 related to intangible assets from the Diablo Valley Bank
acquisition.
Income
Tax Expense
The
Company computes its provision for income taxes on a monthly
basis. As indicated in Note 9 to the Consolidated Financial
Statements, the amount of such provision is determined by applying the Company’s
statutory income tax rates to pre-tax book income as adjusted for permanent
differences between pre-tax book income and actual taxable
income. These permanent differences include, but are not limited to,
tax-exempt interest income, increases in the cash surrender value of life
insurance policies, California Enterprise Zone deductions, certain expenses that
are not allowed as tax deductions, and tax credits.
The
Company’s federal and state income tax expense was $8.1 million in 2007,
compared to $9.2 million and $7.3 million for 2006 and 2005,
respectively. This represents 36.6% of income before taxes in 2007,
34.8% in 2006, and 33.5% in 2005. The effective tax rate is higher in 2007, than
in 2006 and 2005, because of adjustments in 2007 resulting from the audit of the
Company’s California state tax returns by the State of California Franchise Tax
Board.
Tax-exempt interest income is generated
primarily by the Company’s investments in state, county and municipal
securities, which provided $0.2 million in federal tax-exempt income in 2007,
2006 and 2005. Although not reflected in the investment portfolio,
the Company also has total investments of $7.3 million in low-income housing
limited partnerships as of December 31, 2007. These investments have
generated tax credits for the past few years, with about $1.1 million in credits
available for the 2007 tax year and $1.0 million in tax credits realized in
2006. The investments are expected to generate an additional $6.2
million in aggregate tax credits from 2008 through 2016; however, the credits
are dependent upon the occupancy level of the housing projects and income of the
tenants and cannot be projected with certainty.
Some
items of income and expense are recognized in different years for tax purposes
than when applying generally accepted accounting principles, leading to timing
differences between the Company’s actual tax liability and the amount accrued
for this liability based on book income. These temporary differences
comprise the “deferred” portion of the Company’s tax expense, which is
accumulated on the Company’s books as a deferred tax asset or deferred tax
liability until such time as it reverses. At the end of 2007, the
Company had a net deferred tax asset of $10.1 million.
As of
December 31, 2007, total assets were $1.35 billion, an increase of 30% from
$1.04 billion at year-end 2006. Total securities
available-for-sale (at fair value) were $135 million, a decrease of 22% from
$172 million at year-end 2006. The total loan portfolio (excluding
loans held for sale) was $1.04 billion, an increase of 46% from $709 million at
year-end 2006. Total deposits were $1.064 billion, an increase of 26%
from $846 million at year-end 2006. Securities sold under agreement
to repurchase decreased $10.9 million, or 50%, to $10.9 million at December 31,
2007, from $21.8 million at year-end 2006.
Securities
Portfolio
The
following table reflects the estimated fair value for each category of
securities for the past three years.
Investment
Portfolio
|
|
December
31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
Securities
available-for-sale (at fair value)
|
|
|
|
|
|
|
U.S.
Treasury
|
|
$ |
4,991 |
|
$ |
5,963 |
|
$ |
6,920 |
U.S.
Government Agencies
|
|
|
35,803 |
|
|
59,396 |
|
|
82,041 |
Municipals
- Tax Exempt
|
|
|
4,114 |
|
|
8,142 |
|
|
8,268 |
Mortgage-Backed
Securities
|
|
|
83,046 |
|
|
90,186 |
|
|
91,868 |
Collateralized
Mortgage Obligations
|
|
|
7,448 |
|
|
8,611 |
|
|
9,398 |
Total
|
|
$ |
135,402 |
|
$ |
172,298 |
|
$ |
198,495 |
|
|
|
|
|
|
|
|
|
|
Securities
classified as U.S. Government Agencies as of December 31, 2007 were issued by
the Federal National Mortgage Association, Federal Home Loan Mortgage
Corporation, and the Federal Home Loan Bank.
The
following table summarizes the maturities and weighted average yields of
securities as of December 31, 2007:
|
|
December
31, 2007
|
|
|
Maturity
|
|
|
|
|
|
|
|
After
One and
|
|
|
After
Five and
|
|
|
|
|
|
|
|
|
|
|
|
|
Within
One Year
|
|
|
Within
Five Years
|
|
|
Within
Ten Years
|
|
|
After
Ten Years
|
|
|
Total
|
|
|
(Dollars
in thousands)
|
|
Amount
|
|
Yield
|
|
|
Amount
|
|
Yield
|
|
|
Amount
|
|
Yield
|
|
|
Amount
|
|
Yield
|
|
|
Amount
|
|
Yield
|
Securities
available-for-sale (at fair value):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Treasury
|
|
$ |
4,991 |
|
4.77 |
% |
|
$ |
- |
|
- |
|
|
$ |
- |
|
- |
|
|
$ |
- |
|
- |
|
|
$ |
4,991 |
|
4.77% |
U.S.
Government Agencies
|
|
|
24,260 |
|
4.92 |
% |
|
|
11,543 |
|
4.51 |
% |
|
|
- |
|
- |
|
|
|
- |
|
- |
|
|
|
35,803 |
|
4.79% |
Municipals
- non-taxable
|
|
|
3,421 |
|
3.04 |
% |
|
|
693 |
|
3.88 |
% |
|
|
- |
|
- |
|
|
|
- |
|
- |
|
|
|
4,114 |
|
3.18% |
Mortgage
Backed Securities
|
|
|
- |
|
- |
|
|
|
1,743 |
|
3.00 |
% |
|
|
12,497 |
|
4.64 |
% |
|
|
68,806 |
|
4.53 |
% |
|
|
83,046 |
|
4.51% |
Collateralized
Mortgage Obligations
|
|
|
- |
|
- |
|
|
|
- |
|
- |
|
|
|
5,001 |
|
5.50 |
% |
|
|
2,447 |
|
3.16 |
% |
|
|
7,448 |
|
4.73% |
Total
|
|
$ |
32,672 |
|
4.70 |
% |
|
$ |
13,979 |
|
4.29 |
% |
|
$ |
17,498 |
|
4.89 |
% |
|
$ |
71,253 |
|
4.48 |
% |
|
$ |
135,402 |
|
4.57% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
investment securities portfolio is the second largest component of the Company’s
interest earning assets, and the structure and composition of this portfolio is
important to any analysis of the financial condition of the
Company. The investment portfolio serves the following
purposes: (i) it can be readily reduced in size to provide
liquidity for loan balance increases or deposit balance decreases; (ii) it
provides a source of pledged assets for securing certain deposits and borrowed
funds, as may be required by law or by specific agreement with a depositor or
lender; (iii) it can be used as an interest rate risk management tool, since it
provides a large base of assets, the maturity and interest rate characteristics
of which can be changed more readily than the loan portfolio to better match
changes in the deposit base and other funding sources of the Company; (iv) it is
an alternative interest-earning use of funds when loan demand is weak or when
deposits grow more rapidly than loans; and (v) it can enhance the Company’s tax
position by providing partially tax exempt income.
The
Company uses two portfolio classifications for its securities:
“Held-to-maturity”, and “Available-for-sale”. Accounting rules also
allow for a trading portfolio classification, but the Company has no securities
that would be classified as such. The held-to-maturity portfolio can
consist only of securities that the Company has both the intent and ability to
hold until maturity, to be sold only in the event of concerns with an issuer’s
credit worthiness, a change in tax law that eliminates their tax exempt status,
or other infrequent situations as permitted by generally accepted accounting
principles. Since the Company does not have a trading portfolio, the
available-for-sale portfolio is comprised of all securities not included as
“held-to-maturity”. Even though management currently has the intent
and the ability to hold the Company’s securities for the foreseeable future,
they are all currently classified as available-for-sale to allow flexibility
with regard to the active management of the Company’s investment
portfolio. FASB Statement 115 requires available-for-sale securities
to be marked to market with an offset to accumulated other comprehensive
income, a component of shareholders’ equity. Monthly adjustments are
made to reflect changes in the market value of the Company’s available-for-sale
securities.
The
Company’s investment portfolio is currently composed primarily
of: (i) U.S. Treasury and Agency issues for liquidity and
pledging; (ii) mortgage-backed securities, which in many instances can also be
used for pledging, and which generally enhance the yield of the portfolio; (iii)
state, county and municipal obligations, which provide tax free income and
limited pledging potential; and (iv) collateralized mortgage obligations, which
generally enhance the yield of the portfolio. The amortized cost of securities
pledged as collateral for repurchase agreements, public deposits and for other
purposes as required or permitted by law was $42.2 million and $53.7 million at
December 31, 2007 and 2006, respectively.
Except
for obligations of the U.S. government or U.S. government agencies, no
securities of a single issuer exceeded 10% of shareholders’ equity at December
31, 2007. The Company has not used interest rate swaps or other
derivative instruments to hedge fixed rate loans or to otherwise mitigate
interest rate risk.
In 2007,
the investment portfolio declined by $37 million, or 21%, and decreased to 10%
of total assets at the end of 2007 from 16.6% at the end of
2006. U.S. Treasury and U.S. Government Agency securities decreased
to 30% of the portfolio at the end of 2007 from 38% at the end of
2006. The decrease was primarily due to maturities of U.S.
Government Agency securities during 2007. Municipal securities
also decreased by 49% in 2007, due to maturities. Mortgage-backed securities and
collateralized mortgage obligations remained fairly constant in the portfolio in
2007 compared to 2006.
Loans
The
Company’s loans represent the largest portion of earning assets, substantially
greater than the securities portfolio or any other asset category, and the
quality and diversification of the loan portfolio is an important consideration
when reviewing the Company’s financial condition.
Gross
loans represented 77% of total assets at December 31, 2007, as compared to 68%
of at December 31, 2006. The ratio of loans to deposits increased to
97% at the end of 2007 from 84% at the end of 2006. Demand for loans
remains relatively strong in many areas within the Company’s markets and
competition continues to intensify. To help ensure that we remain
competitive, we make every effort to be flexible and creative in our approach to
structuring loans.
The
Selected Financial Data table in Item 6 reflects the amount of loans outstanding
at December 31st for each year from 2003 through 2007, net of deferred fees and
origination costs and the allowance for loan losses. The Loan
Distribution table that follows sets forth the Company’s gross loans outstanding
and the percentage distribution in each category at the dates
indicated. The amounts shown in the table do not reflect any deferred
loan fees or deferred origination costs, nor is the allowance for loan loss
deducted.
|
|
December
31,
|
(Dollars
in thousands)
|
|
2007
|
|
%
to Total
|
|
2006
|
|
%
to Total
|
|
2005
|
|
%
to Total
|
|
2004
|
|
%
to Total
|
|
2003
|
|
%
to Total
|
Commercial
|
|
$ |
411,251 |
|
40 |
% |
|
$ |
284,093 |
|
40 |
% |
|
$ |
248,060 |
|
37 |
% |
|
$ |
296,030 |
|
41 |
% |
|
$ |
269,076 |
|
41% |
Real
estate - mortgage
|
|
|
361,211 |
|
35 |
% |
|
|
239,041 |
|
34 |
% |
|
|
237,566 |
|
35 |
% |
|
|
250,984 |
|
35 |
% |
|
|
227,474 |
|
35% |
Real
estate - land and construction
|
|
|
215,597 |
|
21 |
% |
|
|
143,834 |
|
20 |
% |
|
|
149,851 |
|
22 |
% |
|
|
118,290 |
|
17 |
% |
|
|
101,082 |
|
16% |
Home
equity
|
|
|
44,187 |
|
4 |
% |
|
|
38,976 |
|
6 |
% |
|
|
41,772 |
|
6 |
% |
|
|
52,170 |
|
7 |
% |
|
|
49,434 |
|
8% |
Consumer
|
|
|
3,044 |
|
0 |
% |
|
|
2,422 |
|
0 |
% |
|
|
1,721 |
|
0 |
% |
|
|
2,908 |
|
0 |
% |
|
|
1,743 |
|
0% |
Total
loans
|
|
|
1,035,290 |
|
100 |
% |
|
|
708,366 |
|
100 |
% |
|
|
678,970 |
|
100 |
% |
|
|
720,382 |
|
100 |
% |
|
|
648,809 |
|
100% |
Deferred
loan costs, net
|
|
|
1,175 |
|
|
|
|
|
870 |
|
|
|
|
|
1,155 |
|
|
|
|
|
726 |
|
|
|
|
|
863 |
|
|
Allowance
for loan losses
|
|
|
(12,218) |
|
|
|
|
|
(9,279) |
|
|
|
|
|
(10,224) |
|
|
|
|
|
(12,497) |
|
|
|
|
|
(13,451) |
|
|
Loans,
net
|
|
$ |
1,024,247 |
|
|
|
|
$ |
699,957 |
|
|
|
|
$ |
669,901 |
|
|
|
|
$ |
708,611 |
|
|
|
|
$ |
636,221 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans (excluding loans held for sale) were $1.035 billion at December 31, 2007,
an increase of 46% from $708 million at December 31, 2006. Total
loans increased by $386 million, or 60%, from the end of 2003 to the end
of 2007.
The
Company’s loan portfolio is concentrated in commercial, primarily manufacturing,
wholesale, and services and real estate, with the balance in land development
and construction and home equity and consumer loans. The loan
portfolio mix over the past five years has remained relatively the
same.
The
change in the Company’s loan portfolio in 2007 from 2006 is primarily due to the
acquisition of DVB. The Company does not have any concentrations by
industry or group of industries in its loan portfolio; however, 60% of its net
loans were secured by real property as of December 31, 2007 and 2006. While no
specific industry concentration is considered significant, the Company’s lending
operations are located in areas that are dependent on the technology and real
estate industries and their supporting companies. In the fourth
quarter of 2005, the Company entered into negotiations for the sale of its
Capital Group loan portfolio consisting primarily of “factoring” type
loans. In contemplation of the sale, $32 million, net of the
respective allowance loan loss, was moved from commercial loans into loans
held-for-sale. The sale of the Capital Group loan portfolio was
completed in 2006, resulting in a gain of $0.7 million.
The
Company’s commercial loans are made for working capital, financing the purchase
of equipment or for other business purposes. Such loans include loans with
maturities ranging from thirty days to one year and “term loans,” with
maturities normally ranging from one to five years. Short-term business loans
are generally intended to finance current transactions and typically provide for
periodic principal payments, with interest payable monthly. Term loans normally
provide for floating interest rates, with monthly payments of both principal and
interest. The Company’s commercial loans are centered in
locally-oriented commercial activities in markets where the Company has a
physical presence, and these markets have become more competitive as
business activity has moderated.
The
Company is an active participant in the Small Business Administration (“SBA”)
and U.S. Department of Agriculture guaranteed lending programs, and has been
approved by the SBA as a lender under the Preferred Lender Program. The Company
regularly makes SBA-guaranteed loans. Prior to third quarter of 2007, the
guaranteed portion of these loans were sold in the secondary market depending on
market conditions. Once it was determined that these loans would be sold, these
loans were classified as held for sale and carried at the lower of cost or
market. When the guaranteed portion of an SBA loan, was sold, the Company
retained the servicing rights for the sold portion. As of December
31, 2007, 2006, and 2005, $177 million, $189 million and $180 million,
respectively, in SBA and U.S. Department of Agriculture loans were serviced by
the Company for others. As discussed on page 28, beginning in the third quarter
of 2007, the Company changed its strategy regarding its SBA loan business by
retaining new SBA production in lieu of selling the loans.
As of
December 31, 2007, real estate mortgage loans of $360 million consist of
adjustable and fixed rate loans secured by commercial property, and loans
secured by first mortgages on 1-4 family residential properties of $1
million. Of the $216 million in land and construction loans at
Decemeber 31, 2007, $157 million was construction loans comprised of $92 million
residential and $65 million commercial. The other $59 million of land and
construction loans represent residential land loans of $46 million residential
and $13 million of commercial land loans. Properties securing the real
estate mortgage loans are primarily located in the Company’s market
area. While no specific industry concentration is considered
significant, the Company’s lending operations are located in market areas that
are dependent on the technology and real estate industries and their supporting
companies. Real estate values in portions of Santa Clara County and neighboring
San Mateo County are among the highest in the country at present but have
recently been experiencing a decrease in value from the levels experienced at
the beginning of 2007. The Company’s borrowers could be adversely impacted by a
downturn in these sectors of the economy, which could reduce the demand for
loans and adversely impact the borrowers’ ability to repay their
loans.
The
Company’s real estate term loans consist primarily of loans made based on the
borrower’s cash flow and are secured by deeds of trust on commercial and
residential property to provide a secondary source of repayment. The Company
generally restricts real estate term loans to no more than 80% of the property’s
appraised value or the purchase price of the property, depending on the type of
property and its utilization. The Company offers both fixed and floating rate
loans. Maturities on such loans are generally between five and ten years
(with amortization ranging from fifteen to twenty-five years and a balloon
payment due at maturity); however, SBA and certain other real estate loans that
are easily sold in the secondary market may be granted for longer
maturities.
The
Company’s land and construction loans are primarily short term interim
loans to finance the construction of commercial and single family residential
properties. The Company utilizes underwriting guidelines to assess
the likelihood of repayment from sources such as sale of the property or
permanent mortgage financing prior to making the construction loan.
The
Company makes consumer loans for the purpose of financing automobiles, various
types of consumer goods, and other personal purposes. Additionally, the Company
makes home equity lines of credit available to its clientele. Consumer loans
generally provide for the monthly payment of principal and interest. Most of the
Company’s consumer loans are secured by the personal property being purchased
or, in the instances of home equity loans or lines, real property.
With
certain exceptions, state chartered banks are permitted to make extensions of
credit to any one borrowing entity up to 15% of the bank’s capital and reserves
for unsecured loans and up to 25% of the bank’s capital and reserves for secured
loans. For HBC, these lending limits were $29 million and $48 million
at December 31, 2007, respectively.
The
following table presents the maturity distribution of the Company’s loans as of
December 31, 2007. The table shows the distribution of such loans between those
loans with predetermined (fixed) interest rates and those with variable
(floating) interest rates. Floating rates generally fluctuate with changes in
the prime rate as reflected in the western edition of The Wall Street Journal.
As of December 31, 2007, approximately 71% of the Company’s loan portfolio
consisted of floating interest rate loans.
Loan
Maturities
|
|
|
|
Over
One
|
|
|
|
|
|
|
Due
in
|
|
Year
But
|
|
|
|
|
|
|
One
Year
|
|
Less
than
|
|
Over
|
|
|
(Dollars
in thousands)
|
|
or
Less
|
|
Five
Years
|
|
Five
Years
|
|
Total
|
Commercial
|
|
$ |
369,575 |
|
$ |
30,378 |
|
$ |
11,298 |
|
$ |
411,251 |
Real
estate - mortgage
|
|
|
112,553 |
|
|
154,145 |
|
|
94,513 |
|
|
361,211 |
Real
estate - land and construction
|
|
|
213,565 |
|
|
2,032 |
|
|
- |
|
|
215,597 |
Home
equity
|
|
|
38,097 |
|
|
- |
|
|
6,090 |
|
|
44,187 |
Consumer
|
|
|
1,723 |
|
|
1,321 |
|
|
- |
|
|
3,044 |
Total
loans
|
|
$ |
735,513 |
|
$ |
187,876 |
|
$ |
111,901 |
|
$ |
1,035,290 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
with variable interest rates
|
|
$ |
668,970 |
|
$ |
52,081 |
|
$ |
9,333 |
|
$ |
730,384 |
Loans
with fixed interest rates
|
|
|
66,543 |
|
|
135,795 |
|
|
102,568 |
|
|
304,906 |
Total
loans
|
|
$ |
735,513 |
|
$ |
187,876 |
|
$ |
111,901 |
|
$ |
1,035,290 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonperforming
Assets
Financial
institutions generally have a certain level of exposure to asset quality risk,
and could potentially receive less than a full return of principal and interest
if a debtor becomes unable or unwilling to repay. Since loans are the
most significant assets of the Company and generate the largest portion of its
revenues, the Company’s management of asset quality risk is focused primarily on
loan quality. Banks have generally suffered their most severe
earnings declines as a result of customers’ inability to generate sufficient
cash flow to service their debts, or as a result of the downturns in national
and regional economies which have brought about declines in overall property
values. In addition, certain debt securities that the Company may
purchase have the potential of declining in value if the obligor’s financial
capacity to repay deteriorates.
To help
minimize credit quality concerns, we have established a sound approach to credit
that includes well-defined goals and objectives and well-documented credit
policies and procedures. The policies and procedures identify market
segments, set goals for portfolio growth or contraction, and establish limits on
industry and geographic credit concentrations. In addition, these
policies establish the Company’s underwriting standards and the methods of
monitoring ongoing credit quality. The Company’s internal credit risk
controls are centered in underwriting practices, credit granting procedures,
training, risk management techniques, and familiarity with loan and lease
customers as well as the relative diversity and geographic concentration of our
loan portfolio.
The
Company’s credit risk may also be affected by external factors such as the level
of interest rates, employment, general economic conditions, real estate values,
and trends in particular industries or geographic markets. As a
multi-community independent bank serving a specific geographic area, the Company
must contend with the unpredictable changes of both the general California and,
particularly, primary local markets. The Company’s asset quality has
suffered in the past from the impact of national and regional economic
recessions, consumer bankruptcies, and depressed real estate
values.
Nonperforming
assets are comprised of the following: Loans for which the Company is no longer
accruing interest; loans 90 days or more past due and still accruing interest
(although they are generally placed on non-accrual when they become 90 days past
due unless they are both well secured and in the process of collection); loans
restructured where the terms of repayment have been renegotiated, resulting in a
deferral of interest or principal; and other real estate owned
(“OREO”). Management’s classification of a loan as “non-accrual” is
an indication that there is reasonable doubt as to the full recovery of
principal or interest on the loan. At that point, the Company stops
accruing interest income, reverses any uncollected interest that had been
accrued as income, and begins recognizing interest income only as cash interest
payments are received as long as the collection of all outstanding principal is
not in doubt. The loans may or may not be collateralized, and
collection efforts are continuously pursued. Loans may be
restructured by management when a borrower has experienced some change in
financial status causing an inability to meet the original repayment terms and
where the Company believes the borrower will eventually overcome those
circumstances and make full restitution. OREO consists of properties
acquired by foreclosure or similar means that management is offering or will
offer for sale.
The
following table provides information with respect to components of the Company’s
non-performing assets at the dates indicated.
|
|
December
31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
Nonaccrual
loans
|
|
$ |
3,363 |
|
$ |
3,866 |
|
$ |
3,672 |
|
$ |
1,028 |
|
$ |
3,972 |
Loans
90 days past due and still accruing
|
|
|
101 |
|
|
451 |
|
|
- |
|
|
302 |
|
|
608 |
Total
nonperforming loans
|
|
|
3,464 |
|
|
4,317 |
|
|
3,672 |
|
|
1,330 |
|
|
4,580 |
Other
real estate owned
|
|
|
1,062 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
Total
nonperforming assets
|
|
$ |
4,526 |
|
$ |
4,317 |
|
$ |
3,672 |
|
$ |
1,330 |
|
$ |
4,580 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonperforming
assets as a percentage of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
loans
plus other real estate owned
|
|
|
0.44% |
|
|
0.61% |
|
|
0.54% |
|
|
0.18% |
|
|
0.70% |
The
balance of nonperforming assets at the end of 2007 represents an increase of
$0.2 million, or 5%, from year-end 2006 levels. Nonperforming assets
increased by $0.6 million, or 18%, in 2006 as compared to 2005.
While the
current level of nonperforming assets is relatively low, we recognize that an
increase in the dollar amount of nonaccrual loans is possible in the normal
course of business as we expand our lending activities.
Allowance
for Loan Losses
The
allowance for loan losses is an estimate of the losses in our loan
portfolio. The allowance is based on two basic principles of
accounting: (1) Statement of Financial Accounting Standards (“Statement”) No. 5
“Accounting for Contingencies,” which requires that losses be accrued when they
are probable of occurring and estimable and (2) Statement No. 114, “Accounting
by Creditors for Impairment of a Loan,” which requires that losses be accrued
based on the differences between the impaired loan balance and value of
collateral, if the loan is collateral dependent, or present value of future cash
flows or values that are observable in the secondary market.
Management
conducts a critical evaluation of the loan portfolio monthly. This evaluation
includes periodic loan by loan review for certain loans to evaluate the level of
impairment, as well as detailed reviews of other loans (either individually or
in pools) based on an assessment of the following factors: past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower’s ability to repay, collateral values, loan volumes and
concentrations, size and complexity of the loans, recent loss experience in
particular segments of the portfolio, bank regulatory examination and
independent loan review results, and current economic conditions in the
Company’s marketplace, in particular the state of the technology industry and
the real estate market. This process attempts to assess the
risk of loss inherent in the portfolio by segregating loans into two categories
for purposes of determining an appropriate level of the allowance: Loans graded
“Pass through Special Mention” and “Substandard.”
Loans are
charged against the allowance when management believes that the uncollectibility
of the loan balance is confirmed. The Company’s methodology for assessing the
appropriateness of the allowance consists of several key elements, which include
the formula allowance and specific allowances.
Specific
allowances are established for impaired loans. Management considers a
loan to be impaired when it is probable that the Company will be unable to
collect all amounts due according to the original contractual terms of the note
agreement. When a loan is considered to be impaired, the amount of impairment is
measured based on the fair value of the collateral if the loan is collateral
dependent or on the present value of expected future cash flow.
The
formula portion of the allowance is calculated by applying loss factors to pools
of outstanding loans. Loss factors are based on the Company's historical loss
experience, adjusted for significant factors that, in management's judgment,
affect the collectibility of the portfolio as of the evaluation date. The
adjustment factors for the formula allowance may include existing general
economic and business conditions affecting the key lending areas of the Company,
in particular the real estate market, credit quality trends, collateral values,
loan volumes and concentrations, the technology industry and specific industry
conditions within portfolio segments, recent loss experience in particular
segments of the portfolio, duration of the current business cycle, and bank
regulatory examination results. The evaluation of the inherent loss with respect
to these conditions is subject to a higher degree of uncertainty.
Loans
that demonstrate a weakness, for which there is a possibility of loss if the
weakness is not corrected, are categorized as “classified.” Classified loans
include all loans considered as substandard, doubtful, and loss and may result
from problems specific to a borrower’s business or from economic downturns that
affect the borrower’s ability to repay or that cause a decline in the value of
the underlying collateral (particularly real estate). The principal
balance of classified loans, which include all loans internally graded as
substandard, doubtful, and loss, was $25.2 million, $24.5 million, and $16.3
million, respectively, at December 31, 2007, 2006, and 2005. At
December 31, 2007 and 2006, all of the Company’s classified loans were graded as
substandard.
In
adjusting the historical loss factors applied to the respective segments of the
loan portfolio, management considered the following factors:
·
|
Levels
and trends in delinquencies, non-accruals, charge offs and
recoveries
|
·
|
Trends
in volume and loan terms
|
·
|
Lending
policy or procedural changes
|
·
|
Experience,
ability, and depth of lending management and
staff
|
·
|
National
and local economic trends and
conditions
|
·
|
Concentrations
of Credit
|
There can
be no assurance that the adverse impact of any of these conditions on HBC will
not be in excess of the current level of estimated losses.
It is the
policy of management to maintain the allowance for loan losses at a level
adequate for risks inherent in the loan portfolio. On an ongoing
basis, we have engaged outside firms to independently assess our methodology and
perform independent credit reviews of our loan portfolio. The
Company’s credit review consultants, the FRB and the DFI also review the
allowance for loan losses as an integral part of the examination
process. Based on information currently available to analyze loan
loss delinquency and a history of actual charge-offs, management believes that
the loan loss allowance is adequate. However, the loan portfolio can be
adversely affected if California economic conditions and the real estate market
in the Company’s market area were to weaken. Also, any weakness of a prolonged
nature in the technology industry would have a negative impact on the local
market. The effect of such events, although uncertain at this time, could result
in an increase in the level of nonperforming loans and increased loan losses,
which could adversely affect the Company’s future growth and profitability. No
assurance of the ultimate level of credit losses can be given with any
certainty.
The
following table summarizes the Company’s loan loss experience, as well as
provisions and charges to the allowance for loan losses and certain pertinent
ratios for the periods indicated:
Allowance
for Loan Losses
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
2004
|
|
|
2003
|
Balance,
beginning of year
|
|
$ |
9,279 |
|
$ |
10,224 |
|
$ |
12,497 |
|
|
$ |
13,451 |
|
|
$ |
13,227 |
Charge-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
|
(84) |
|
|
(291) |
|
|
(3,273) |
|
|
|
(2,901 |
) |
|
|
(2,906) |
Real
estate - mortgage
|
|
|
- |
|
|
- |
|
|
- |
|
|
|
- |
|
|
|
- |
Real
estate - land and construction
|
|
|
- |
|
|
- |
|
|
- |
|
|
|
- |
|
|
|
- |
Home
equity
|
|
|
(20) |
|
|
(540) |
|
|
- |
|
|
|
- |
|
|
|
- |
Consumer
|
|
|
- |
|
|
- |
|
|
- |
|
|
|
- |
|
|
|
- |
Total
charge-offs
|
|
|
(104) |
|
|
(831) |
|
|
(3,273) |
|
|
|
(2,901 |
) |
|
|
(2,906) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
|
929 |
|
|
389 |
|
|
1,358 |
|
|
|
1,562 |
|
|
|
230 |
Real
estate - mortgage
|
|
|
- |
|
|
- |
|
|
- |
|
|
|
- |
|
|
|
- |
Real
estate - land and construction
|
|
|
- |
|
|
- |
|
|
- |
|
|
|
- |
|
|
|
- |
Home
equity
|
|
|
- |
|
|
- |
|
|
- |
|
|
|
- |
|
|
|
- |
Consumer
|
|
|
- |
|
|
- |
|
|
- |
|
|
|
- |
|
|
|
- |
Total
recoveries
|
|
|
929 |
|
|
389 |
|
|
1,358 |
|
|
|
1,562 |
|
|
|
230 |
Net
recoveries (charge-offs)
|
|
|
825 |
|
|
(442) |
|
|
(1,915) |
|
|
|
(1,339 |
) |
|
|
(2,676) |
Provision
for loan losses
|
|
|
(11) |
|
|
(503) |
|
|
313 |
|
|
|
666 |
|
|
|
2,900 |
Reclassification
of allowance for loan losses
|
|
|
- |
|
|
- |
|
|
(671) |
(1) |
|
|
- |
|
|
|
- |
Reclassification
to other liabilities
|
|
|
- |
|
|
- |
|
|
- |
|
|
|
(281) |
(2) |
|
|
- |
Allowance
acquired in bank acquisition
|
|
|
2,125 |
|
|
- |
|
|
- |
|
|
|
- |
|
|
|
- |
Balance,
end of year
|
|
$ |
12,218 |
|
$ |
9,279 |
|
$ |
10,224 |
|
|
$ |
12,497 |
|
|
$ |
13,451 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RATIOS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
charge-offs to average loans *
|
|
|
(0.10)% |
|
|
0.06% |
|
|
0.28% |
|
|
|
0.19% |
|
|
|
0.41% |
Allowance
for loan losses to total loans *
|
|
|
1.18% |
|
|
1.31% |
|
|
1.51% |
|
|
|
1.73% |
|
|
|
2.03% |
Allowance
for loan losses to nonperforming loans
|
|
|
353% |
|
|
215% |
|
|
278% |
|
|
|
940% |
|
|
|
294% |
*
Average loans and total loans exclude loans held for
sale
|
(1)
|
The
Company reclassified $0.7 million of the allowance allocated to $32
million of commercial asset based loans that were reclassified to loans
held-for-sale as of December 31, 2005. Thus, the carrying value
of these loans held-for-sale includes an allowance for loan losses of $0.7
million.
|
(2)
|
The
Company reclassified estimated losses on unused commitments of $0.3
million to other liabilities as of December 31,
2004.
|
The
Company’s allowance for loan losses increased $2.9 million in 2007 as compared
to 2006. The allowance for loan losses increased primarily as a result
of the Diablo Valley Bank acquistion. The Company had $929,000 in
recoveries in 2007, which were partially offset by loan charge-offs of
$104,000. The Company had a credit provision of $11,000 in 2007,
compared to a credit provision of $503,000 in 2006. Previously, the Company’s
allowance for loan losses had steadily decreased from 2003 through
2006.
Net loans
charged-off reflect the realization of losses in the portfolio that were
recognized previously though provisions for loan losses. Net
recoveries were $0.8 million in 2007, compared to net charged-offs of $0.4
million, and $1.9 million in 2006 and 2005, respectively. The
decrease in net loan charge-offs in 2007 was primarily due to continued
improvement in credit quality and a $700,000 recovery on a loan charged off in
2005. Historical net loan charge-offs are not necessarily indicative
of the amount of net charge-offs that the Company will realize in the
future.
The
Company’s unallocated allowance was $1.4 million as of December 31, 2007 and
2006. The unallocated component of the allowance is maintained to
cover uncertainties that could affect management's estimate of probable
losses.
The
following table provides a summary of the allocation of the allowance for loan
losses for specific categories at the dates indicated. The allocation
presented should not be interpreted as an indication that charges to the
allowance for loan losses will be incurred in these amounts or proportions, or
that the portion of the allowance allocated to each category represents the
total amount available for charge-offs that may occur within these
categories.
Allocation
of Loan Loss Allowance
|
|
|
December
31,
|
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
|
|
|
Percent
|
|
|
|
Percent
|
|
|
|
Percent
|
|
|
|
Percent
|
|
|
|
Percent
|
|
|
|
|
of
Loans
|
|
|
|
of
Loans
|
|
|
|
of
Loans
|
|
|
|
of
Loans
|
|
|
|
of
Loans
|
|
|
|
|
in
each
|
|
|
|
in
each
|
|
|
|
in
each
|
|
|
|
in
each
|
|
|
|
in
each
|
|
|
|
|
category
|
|
|
|
category
|
|
|
|
category
|
|
|
|
category
|
|
|
|
category
|
|
|
|
|
to
total
|
|
|
|
to
total
|
|
|
|
to
total
|
|
|
|
to
total
|
|
|
|
to
total
|
(Dollars
in thousands)
|
|
Allowance
|
|
loans
|
|
Allowance
|
|
loans
|
|
Allowance
|
|
loans
|
|
Allowance
|
|
loans
|
|
Allowance
|
|
loans
|
Commercial
|
|
$ |
6,067 |
|
40% |
|
$ |
4,872 |
|
40% |
|
$ |
4,199 |
|
37% |
|
$ |
8,691 |
|
41% |
|
$ |
9,667 |
|
41% |
Real
estate - mortgage
|
|
|
2,416 |
|
35% |
|
|
1,507 |
|
34% |
|
|
2,631 |
|
35% |
|
|
1,498 |
|
35% |
|
|
1,846 |
|
35% |
Real
estate - land and construction
|
|
|
1,923 |
|
21% |
|
|
1,243 |
|
20% |
|
|
1,914 |
|
22% |
|
|
1,711 |
|
17% |
|
|
1,714 |
|
16% |
Home
equity
|
|
|
335 |
|
4% |
|
|
244 |
|
6% |
|
|
300 |
|
6% |
|
|
173 |
|
7% |
|
|
157 |
|
8% |
Consumer
|
|
|
88 |
|
0% |
|
|
24 |
|
0% |
|
|
33 |
|
0% |
|
|
38 |
|
0% |
|
|
37 |
|
0% |
Unallocated
|
|
|
1,389 |
|
0% |
|
|
1,389 |
|
0% |
|
|
1,147 |
|
0% |
|
|
386 |
|
0% |
|
|
30 |
|
0% |
%Total
|
|
$ |
12,218 |
|
100% |
|
$ |
9,279 |
|
100% |
|
$ |
10,224 |
|
100% |
|
$ |
12,497 |
|
100% |
|
$ |
13,451 |
|
100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
The
composition and cost of the Company’s deposit base are important components in
analyzing the Company’s net interest margin and balance sheet liquidity
characteristics, both of which are discussed in greater detail in other sections
herein. Our net interest margin is improved to the extent that growth
in deposits can be concentrated in historically lower-cost deposits such as
non-interest-bearing demand, NOW accounts, savings accounts and money market
deposit accounts. The Company’s liquidity is impacted by the
volatility of deposits or other funding instruments, or in other words, by the
propensity of that money to leave the institution for rate-related or other
reasons. Potentially, the most volatile deposits in a financial
institution are jumbo certificates of deposit, meaning time deposits with
balances that equal or exceed $100,000, as customers with balances of that
magnitude are typically more rate-sensitive than customers with smaller
balances.
The
following table summarizes the distribution of deposits and the percentage of
distribution in each category of deposits for the periods
indicated:
|
|
Years
Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
(Dollars
in thousands)
|
|
Balance
|
|
%
to Total
|
|
Balance
|
|
%
to Total
|
|
Balance
|
|
%
to Total
|
Demand,
noninterest bearing
|
|
$ |
268,005 |
|
25% |
|
$ |
231,841 |
|
27% |
|
$ |
248,009 |
|
26% |
Demand,
interest bearing
|
|
|
150,527 |
|
14% |
|
|
133,413 |
|
16% |
|
|
157,330 |
|
17% |
Savings
and money market
|
|
|
432,293 |
|
41% |
|
|
307,266 |
|
36% |
|
|
353,798 |
|
38% |
Time
deposits, under $100
|
|
|
34,092 |
|
3% |
|
|
31,097 |
|
4% |
|
|
35,209 |
|
4% |
Time
deposits, $100 and over
|
|
|
139,562 |
|
13% |
|
|
111,017 |
|
13% |
|
|
109,373 |
|
12% |
Brokered
deposits, $100 and over
|
|
|
39,747 |
|
4% |
|
|
31,959 |
|
4% |
|
|
36,040 |
|
4% |
Total
deposits
|
|
$ |
1,064,226 |
|
100% |
|
$ |
846,593 |
|
100% |
|
$ |
939,759 |
|
100% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
deposits were $1.06 billion at December 31, 2007, an increase of $218 million,
or 26%, compared to $846.6 million at December 31, 2006. The
increases primarily reflect the acquisition of Diablo Valley Bank. At December
31, 2007, compared to December 31, 2006, noninterest bearing demand deposits
increased $36 million, or 16%; interest bearing demand deposits increased $17
million, or 13%; savings and money market deposits increased $125 million, or
41%; time deposits increased $32 million, or 22%; and brokered deposits
increased $8 million, or 24%.
As of
December 31, 2007, approximately $7.7 million, or less than 1%, of deposits were
from public sources, and approximately $117.1 million, or 11%, of deposits were
from real estate exchange company and title company accounts. As of
December 31, 2006, approximately $2.4 million, or less than 1%, of deposits were
from public sources, and approximately $108.2 million, or 13%, of deposits were
from real estate exchange company and title company accounts.
Among
core deposits categories, noninterest demand deposits increased by $36 million
or 16% in 2007. Furthermore, relatively low-cost NOW accounts increased by $17
million or 13%. Savings and money market accounts increased by $125 million, or
41%, and time deposits increased in absolute dollars but remained flat as a
percentage of total deposits. Our increase in savings and money market accounts
was primarily the result of the acquisition of Diablo Valley Bank. While our
core deposit accounts increased in number to 15,400 at the end of 2007 from
13,200 at the end of 2006, the average balance per core deposit increased to
about $57,000 at the end of 2007 from $53,000 at the end of 2006.
Without
the acquisition of Diablo Valley Bank, total deposits would have been relatively
flat. The Company faces intensified competition for deposits as core deposits
migrate into higher-yielding alternatives, including equity
markets.
The
Company obtains deposits from a cross-section of the communities it serves. The
Company’s business is not seasonal in nature. The Company had brokered deposits
totaling approximately $39.7 million, and $32.0 million at December 31, 2007 and
2006, respectively. These brokered deposits generally mature within
one to three years. The Company is not dependent upon funds from
sources outside the United States.
The
following table indicates the maturity schedule of the Company’s time deposits
of $100,000 or more as of December 31, 2007:
Deposit
Maturity Distribution
|
(Dollars
in thousands)
|
|
Balance
|
|
%
of Total
|
Three
months or less
|
|
$ |
70,180 |
|
39% |
Over
three months through six months
|
|
|
52,505 |
|
30% |
Over
six months through twelve months
|
|
|
39,976 |
|
22% |
Over
twelve months
|
|
|
16,548 |
|
9% |
Total
|
|
$ |
179,209 |
|
100% |
|
|
|
|
|
|
The
Company focuses primarily on providing and servicing business deposit accounts
that are frequently over $100,000 in average balance per
account. As a result, certain types of business clients that
the Company serves typically carry average deposits in excess of $100,000. The
account activity for some account types and client types necessitates
appropriate liquidity management practices by the Company to ensure its ability
to fund deposit withdrawals.
Return
on Equity and Assets
The
following table indicates the ratios for return on average assets and average
equity, dividend payout, and average equity to average assets for 2007, 2006,
and 2005:
|
|
2007
|
|
|
2006
|
|
|
2005
|
Return
on average assets
|
|
1.18 |
% |
|
|
1.57 |
% |
|
1.27% |
Return
on average tangible assets
|
|
1.21 |
% |
|
|
1.57 |
% |
|
1.27% |
Return
on average equity
|
|
9.47 |
% |
|
|
14.62 |
% |
|
13.73% |
Return
on average tangible equity
|
|
11.43 |
% |
|
|
14.62 |
% |
|
13.73% |
Dividend
payout ratio
|
|
23.06 |
% |
|
|
13.65 |
% |
|
- |
Average
equity to average assets ratio
|
|
12.47 |
% |
|
|
10.75 |
% |
|
9.25% |
Off-Balance
Sheet Arrangements
In the
normal course of business, the Company makes commitments to extend credit to its
customers as long as there are no violations of any conditions established in
contractual arrangements. These commitments are obligations that represent a
potential credit risk to the Company, yet are not reflected in any form within
the Company’s consolidated balance sheets. Total unused commitments to extend
credit were $465.3 million at December 31, 2007, as compared to $322.2 million
at December 31, 2006. Unused commitments represented 45% of
outstanding gross loans at December 31, 2007 and 2006.
The
effect on the Company’s revenues, expenses, cash flows and liquidity from the
unused portion of the commitments to provide credit cannot be reasonably
predicted, because there is no certainty that the lines of credit will ever be
fully utilized. For more information regarding the Company’s off-balance sheet
arrangements, see Note 14 to the financial statements located elsewhere
herein.
The
following table presents the Company’s commitments to fund as of December 31,
2007, 2006, and 2005:
|
|
December
31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
Commitments
to extend credit
|
|
$ |
444,172 |
|
$ |
310,200 |
|
$ |
328,031 |
Standby
letters of credit
|
|
|
21,143 |
|
|
12,020 |
|
|
6,104 |
Commitments
to funds
|
|
$ |
465,315 |
|
$ |
322,220 |
|
$ |
334,135 |
|
|
|
|
|
|
|
|
|
|
Contractual
Obligations
The
contractual obligations of the Company, summarized by type of obligation and
contractual maturity, at December 31, 2007, are as
follows:
|
|
Less
Than
|
|
One
to
|
|
Three
to
|
|
After
|
|
|
(Dollars
in thousands)
|
|
One
Year
|
|
Three
Years
|
|
Five
Years
|
|
Five
Years
|
|
Total
|
Securities
sold under agreement to repurchase
|
|
$ |
10,900 |
|
$ |
- |
|
$ |
- |
|
$ |
- |
|
$ |
10,900 |
Notes
payable to subsidiary grantor trusts
|
|
|
- |
|
|
- |
|
|
- |
|
|
23,702 |
|
|
23,702 |
Other
short-term borrowings
|
|
|
60,000 |
|
|
- |
|
|
- |
|
|
- |
|
|
60,000 |
Operating
leases
|
|
|
2,142 |
|
|
4,197 |
|
|
4,077 |
|
|
4,203 |
|
|
14,619 |
Time
deposits of $100 or more
|
|
|
162,662 |
|
|
16,547 |
|
|
- |
|
|
- |
|
|
179,209 |
Total
debt and operating leases
|
|
$ |
235,704 |
|
$ |
20,744 |
|
$ |
4,077 |
|
$ |
27,905 |
|
$ |
288,430 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In
addition to those obligations listed above, in the normal course of business,
the Company will make cash distributions for the payment of interest on interest
bearing deposit accounts and debt obligations, payments for quarterly income tax
estimates and contributions to certain employee benefit plans.
Liquidity
and Asset/Liability Management
Liquidity
refers to the Company’s ability to maintain cash flows sufficient to fund
operations, and to meet obligations and other commitments in a timely and
cost-effective fashion. At various times the Company requires funds
to meet short-term cash requirements brought about by loan growth or deposit
outflows, the purchase of assets, or liability repayments. To manage
liquidity needs properly, cash inflows must be timed to coincide with
anticipated outflows or sufficient liquidity resources must be available to meet
varying demands. The Company manages liquidity in such a fashion as
to be able to meet unexpected sudden changes in levels of its assets or deposit
liabilities without maintaining excessive amounts of on-balance sheet
liquidity. Excess balance sheet liquidity can negatively impact the
interest margin.
An
integral part of the Company’s ability to manage its liquidity position
appropriately is the Company’s large base of core deposits, which are generated
by offering traditional banking services in its service area and which have,
historically, been a stable source of funds. In addition to core
deposits, the Company has the ability to raise deposits through various deposit
brokers if required for liquidity purposes. The Company’s net loan to
deposit ratio increased to 96% at the end of 2007 from 86% at the end of
2006.
To meet
liquidity needs, the Company maintains a portion of its funds in cash deposits
at other banks, in Federal funds sold and in securities available for
sale. The “primary liquidity ratio” is composed of net cash,
non-pledged securities, and other marketable assets, divided by total deposits
and short-term liabilities minus liabilities secured by investments or other
marketable assets. As of December 31, 2007, the Company’s
primary liquidity ratio was 7.7%, comprised of $46.7 million in securities
available-for-sale of maturities of up to five years, less $15.0 million of
securities that were pledged to secure public and certain other deposits as
required by law or contract, Federal funds sold of $9.3 million, and $39.8
million cash and due from banks, as a percentage of total unsecured deposits of
$1,049.3 million. The decrease in the liquidity ratio from 2006 was primarily
due to the growth of loans in 2007. As of December 31, 2006, the Company’s
“primary liquidity ratio” was 13.6%, comprised of $75.5 million in securities
available-for-sale of maturities of up to five years, less $10.9 million of
securities that were pledged to secure public and certain other deposits as
required by law and contract, Federal funds sold of $15.1 million and $34.3
million in cash and due from banks, as a percentage of total unsecured deposits
of $835.7 million.
The
following table summarizes the Company’s borrowings under its Federal funds
purchased, security repurchase arrangements and lines of credit for the periods
indicated:
|
|
December
31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
Average
balance during the year
|
|
$ |
16,255 |
|
$ |
25,429 |
|
$ |
40,748 |
Average
interest rate during the year
|
|
|
2.90% |
|
|
2.46% |
|
|
2.26% |
Maximum
month-end balance
|
|
$ |
70,900 |
|
$ |
32,700 |
|
$ |
57,800 |
Average
rate at December 31,
|
|
|
2.83% |
|
|
2.56% |
|
|
2.34% |
Because
most of the growth in loans in 2007 was funded with deposits, other liquidity
ratios tracked by the Company, such as unfunded loan commitments to secondary
reserves ratio, have been slightly outside of policy guidelines for several
months. We continue to watch these ratios closely, and expect that these ratios
will come back within guidelines.
Capital
Resources
At
December 31, 2007, the Company had total shareholders’ equity of $164.8 million
included $92.4 million in common stock, $73.3 million in retained earnings, and
$0.9 million of accumulated other comprehensive loss.
The
Company paid cash dividends totaling $3.25 million, or $0.26 per share in
2007. The Company anticipates paying future dividends within the
range of typical peer payout ratios provided, however, that no assurance can be
given that earnings and/or growth expectations in any given year will justify
the payment of such a dividend.
The
Company uses a variety of measures to evaluate capital adequacy. Management
reviews various capital measurements on a regular basis and takes appropriate
action to ensure that such measurements are within established internal and
external guidelines. The external guidelines, which are issued by the Federal
Reserve Board and the FDIC, establish a risk-adjusted ratio relating capital to
different categories of assets and off-balance sheet exposures. There are two
categories of capital under the Federal Reserve Board and FDIC guidelines: Tier
1 and Tier 2 Capital. Our Tier 1 Capital currently includes common shareholders’
equity and the proceeds from the issuance of trust preferred securities (trust
preferred securities are counted only up to a maximum of 25% of Tier 1 capital),
less intangible assets, and the addition of the unrealized net losses (after tax
adjustments) on securities available for sale and accumulated net losses on cash
flow hedges, which are carried at fair market value. Our Tier 2 Capital includes
the amount of trust preferred securities not includible in Tier 1 Capital,
and the allowances for loan losses and off balance sheet credit
losses.
The
following table summarizes risk-based capital, risk-weighted assets, and
risk-based capital ratios of the Company:
|
|
December
31,
|
|
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
|
Capital
components:
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
141,227 |
|
$ |
147,600 |
|
$ |
133,715 |
|
|
Tier
2 Capital
|
|
|
12,461 |
|
|
9,756 |
|
|
10,427 |
|
|
Total
risk-based capital
|
|
$ |
153,688 |
|
$ |
157,356 |
|
$ |
144,142 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-weighted
assets
|
|
$ |
1,227,628 |
|
$ |
855,715 |
|
$ |
941,567 |
|
|
Average
assets (regulatory purposes)
|
|
$ |
1,278,207 |
|
$ |
1,087,502 |
|
$ |
1,157,704 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Well
Capitalized
|
|
|
|
|
|
|
|
|
|
|
|
Regulatory
|
Capital
ratios:
|
|
|
|
|
|
|
|
|
|
|
Requirements
|
Total
risk-based capital
|
|
|
12.5% |
|
|
18.4% |
|
|
15.3% |
|
10.00% |
Tier
1 risk-based capital
|
|
|
11.5% |
|
|
17.3% |
|
|
14.2% |
|
6.00% |
Leverage
(1)
|
|
|
11.1% |
|
|
13.6% |
|
|
11.6% |
|
5.00% |
(1) Tier
1 capital divided by average assets (excluding goodwill).
The table
above presents the capital ratios of the Company computed in accordance with
applicable regulatory guidelines and compared to the standards for minimum
capital adequacy requirements under the FDIC’s prompt corrective action
authority as of December 31, 2007. The risk-based and leverage capital ratios
are defined in Item 1 - “Business - Supervision and
Regulation – Heritage Bank of Commerce” on page 10 and 11.
At
December 31, 2007, 2006 and 2005, the Company’s capital met all minimum
regulatory requirements. As of December 31, 2007, 2006 and 2005, management
believes that HBC was considered “well capitalized” under the regulatory
framework for prompt corrective action.
Mandatory
Redeemable Cumulative Trust Preferred Securities.
To
enhance regulatory capital and to provide liquidity, the Company, through
unconsolidated subsidiary grantor trusts, issued the following mandatory
redeemable cumulative trust preferred securities of subsidiary grantor trusts:
In the first quarter of 2000, the Company issued $7 million aggregate principal
amount of 10.875% subordinated debentures due on March 8, 2030 to a subsidiary
trust, which in turn issued a similar amount of trust preferred
securities. In the third quarter of 2000, the Company issued $7
million aggregate principal amount of 10.60% subordinated debentures due on
September 7, 2030 to a subsidiary trust, which in turn issued a similar amount
of trust preferred securities. In the third quarter of 2001, the
Company issued $5 million aggregate principal amount of Floating Rate Junior
Subordinated Deferrable Interest Debentures due on July 31, 2031 to a subsidiary
trust, which in turn issued a similar amount of trust preferred
securities. In the third quarter of 2002, the Company issued $4
million aggregate principal amount of Floating Rate Junior Subordinated
Deferrable Interest Debentures due on September 26, 2032 to a subsidiary
trust, which in turn issued a similar amount of trust preferred
securities. Under applicable regulatory guidelines, the trust
preferred securities currently qualify as Tier I capital. The
subsidiary trusts are not consolidated in the Company’s consolidated financial
statements and the subordinated debt payable to the subsidiary grantor trusts is
recorded as debt of the Company to the related trusts. See Footnote 8
the Consolidated Financial Statements.
Market
risk is the risk of loss to future earnings, to fair values, or to future cash
flows that may result from changes in the price of a financial instrument. The
value of a financial instrument may change as a result of changes in interest
rates, foreign currency exchange rates, commodity prices, equity prices and
other market changes that affect market risk sensitive instruments. Market risk
is attributed to all market risk sensitive financial instruments, including
securities, loans, deposits and borrowings, as well as the Company’s role as a
financial intermediary in customer-related transactions. The objective of market
risk management is to avoid excessive exposure of the Company’s earnings and
equity to loss and to reduce the volatility inherent in certain financial
instruments.
Market
risk arises from changes in interest rates, exchange rates, commodity prices and
equity prices. The Company’s market risk exposure is primarily that of interest
rate risk, and it has established policies and procedures to monitor and limit
earnings and balance sheet exposure to changes in interest rates. The Company
does not engage in the trading of financial instruments, nor does the Company
have exposure to currency exchange rates.
The
principal objective of interest rate risk management (often referred to as
“asset/liability management”) is to manage the financial components of the
Company in a manner that will optimize the risk/reward equation for earnings and
capital in relation to changing interest rates. The Company’s
exposure to market risk is reviewed on a regular basis by the Asset/Liability
Committee (“ALCO”). Interest rate risk is the potential of economic losses due
to future interest rate changes. These economic losses can be reflected as a
loss of future net interest income and/or a loss of current fair market values.
The objective is to measure the effect on net interest income and to adjust the
balance sheet to minimize the inherent risk while at the same time maximizing
income. Management realizes certain risks are inherent, and that the goal is to
identify and accept the risks. Management uses two methodologies to manage
interest rate risk: (i) a standard GAP analysis; and (ii) an interest
rate shock simulation model.
The
planning of asset and liability maturities is an integral part of the management
of an institution’s net interest margin. To the extent maturities of assets and
liabilities do not match in a changing interest rate environment, the net
interest margin may change over time. Even with perfectly matched repricing of
assets and liabilities, risks remain in the form of prepayment of loans or
securities or in the form of delays in the adjustment of rates of interest
applying to either earning assets with floating rates or to interest bearing
liabilities. The Company has generally been able to control its exposure to
changing interest rates by maintaining primarily floating interest rate loans
and a majority of its time certificates with relatively short
maturities.
Interest
rate changes do not affect all categories of assets and liabilities equally or
at the same time. Varying interest rate environments can create unexpected
changes in prepayment levels of assets and liabilities, which may have a
significant effect on the net interest margin and are not reflected in the
interest sensitivity analysis table. Because of these factors, an interest
sensitivity gap report may not provide a complete assessment of the exposure to
changes in interest rates.
The
Company uses modeling software for asset/liability management in order to
simulate the effects of potential interest rate changes on the Company’s net
interest margin, and to calculate the estimated fair values of the Company’s
financial instruments under different interest rate scenarios. The program
imports current balances, interest rates, maturity dates and repricing
information for individual financial instruments, and incorporates assumptions
on the characteristics of embedded options along with pricing and duration for
new volumes to project the effects of a given interest rate change on the
Company’s interest income and interest expense. Rate scenarios consisting of key
rate and yield curve projections are run against the Company’s investment, loan,
deposit and borrowed funds portfolios. These rate projections can be shocked (an
immediate and parallel change in all base rates, up or down), ramped (an
incremental increase or decrease in rates over a specified time period), based
on current trends and econometric models or economic conditions stable
(unchanged from current actual levels).
The
Company applies a market value (“MV”) methodology to gauge its interest rate
risk exposure as derived from its simulation model. Generally, MV is the
discounted present value of the difference between incoming cash flows on
interest earning assets and other investments and outgoing cash flows on
interest bearing liabilities and other liabilities. The application of the
methodology attempts to quantify interest rate risk as the change in the MV
which would result from a theoretical 200 basis point (1 basis point equals
0.01%) change in market interest rates. Both a 200 basis point increase and a
200 basis point decrease in market rates are considered.
At
December 31, 2007, it was estimated that the Company’s MV would increase 18.54%
in the event of a 200 basis point increase in market interest rates. The
Company’s MV at the same date would decrease 26.35% in the event of a 200 basis
point decrease in market interest rates.
Presented
below, as of December 31, 2007 and 2006, is an analysis of the Company’s
interest rate risk as measured by changes in MV for instantaneous and sustained
parallel shifts of 200 basis points in market interest rates:
|
|
2007
|
|
2006
|
|
|
$ Change
|
|
% Change
|
|
Market Value as a %
of
|
|
$ Change
|
|
% Change
|
|
Market Value as a %
of
|
|
|
in
Market
|
|
in
Market
|
|
Present Value of
Assets
|
|
in
Market
|
|
in
Market
|
|
Present Value of
Assets
|
(Dollars in
thousands)
|
|
Value
|
|
Value
|
|
MV Ratio
|
|
Change
(bp)
|
|
Value
|
|
Value
|
|
MV Ratio
|
|
Change
(bp)
|
Change in
rates
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
+
200 bp
|
|
$
|
38,716
|
|
|
18.54%
|
|
|
18.5%
|
|
|
290
|
|
$
|
31,607
|
|
|
17.16%
|
|
|
21.1%
|
|
|
309
|
0
bp
|
|
$
|
-
|
|
|
-%
|
|
|
15.6%
|
|
|
-
|
|
$
|
-
|
|
|
-%
|
|
|
18.0%
|
|
|
-
|
-
200 bp
|
|
$
|
(55,007)
|
|
|
-26.35%
|
|
|
11.5%
|
|
|
(412)
|
|
$
|
(45,606)
|
|
|
-24.76%
|
|
|
13.6%
|
|
|
(446)
|
Management
believes that the MV methodology overcomes three shortcomings of the typical
maturity gap methodology. First, it does not use arbitrary repricing intervals
and accounts for all expected future cash flows. Second, because the MV method
projects cash flows of each financial instrument under different interest rate
environments, it can incorporate the effect of embedded options on an
institution’s interest rate risk exposure. Third, it allows interest rates on
different instruments to change by varying amounts in response to a change in
market interest rates, resulting in more accurate estimates of cash
flows.
However,
as with any method of gauging interest rate risk, there are certain shortcomings
inherent to the MV methodology. The model assumes interest rate changes are
instantaneous parallel shifts in the yield curve. In reality, rate changes are
rarely instantaneous. The use of the simplifying assumption that short-term and
long-term rates change by the same degree may also misstate historic rate
patterns, which rarely show parallel yield curve shifts. Further, the model
assumes that certain assets and liabilities of similar maturity or period to
repricing will react in the same way to changes in rates. In reality, certain
types of financial instruments may react in advance of changes in market rates,
while the reaction of other types of financial instruments may lag behind the
change in general market rates. Additionally, the MV methodology does not
reflect the full impact of annual and lifetime restrictions on changes in rates
for certain assets, such as adjustable rate loans. When interest rates change,
actual loan prepayments and actual early withdrawals from certificates may
deviate significantly from the assumptions used in the model. Finally, this
methodology does not measure or reflect the impact that higher rates may have on
adjustable-rate loan clients’ ability to service their debt. All of these
factors are considered in monitoring the Company’s exposure to interest rate
risk.
CRITICAL
ACCOUNTING POLICIES
|
General
The
Company’s consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America
(“GAAP”). The financial information contained within our consolidated
financial statements is, to a significant extent, based on approximate measures
of the financial effects of transactions and events that have already
occurred. A variety of factors could affect the ultimate value that
is obtained either when earning income, recognizing an expense, recovering an
asset or relieving a liability. In certain instances, we use a
discount factor and prepayment assumptions to determine the present value of
assets and liabilities. A change in the discount factor or prepayment speeds
could increase or decrease the values of those assets and liabilities which
would result in either a beneficial or adverse impact to our financial results.
We use historical loss factors as one factor in determining the inherent loss
that may be present in our loan portfolio. Actual losses could differ
significantly from the historical factors that we use. The Company
adopted Statement 123R on January 1, 2006, and elected the modified prospective
method, under which prior periods are not revised for comparative
purposes. Other estimates that we use are related to the expected
useful lives of our depreciable assets. In addition, GAAP itself may
change from one previously acceptable method to another method, although the
economics of our transactions would be the same.
Allowance
for Loan Losses
The
allowance for loan losses is an estimate of the losses in our loan
portfolio. Our accounting for estimated loan losses is discussed
under the heading “Allowance for Loan Losses” beginning on page 34.
Loan
Sales and Servicing
The
amounts of gains recorded on sales of loans and the initial recording of
servicing assets and I/O strips are based on the estimated fair values of the
respective components. In recording the initial value of the
servicing assets and the fair value of the I/O strips receivable, the Company
uses estimates which are made on management’s expectations of future prepayment
and discount rates as discussed in Note 3 to the consolidated financial
statements.
Stock
Based Compensation
We grant stock options to purchase our common stock to
our employees and directors under the 2004 Plan. We also granted our
chief executive officer restricted stock when he joined the
Company. Additionally, we have outstanding options that were granted
under an option plan from which we no longer make grants. The
benefits provided under all of these plans are subject to the provisions of FASB
Statement 123(Revised), “Share-Based Payments,” which we adopted effective
January 1, 2006. We elected to use the modified prospective
application in adopting Statement 123R and therefore have not restated results
for prior periods. The valuation provisions of Statement 123R apply
to new awards and to awards that are outstanding on the adoption date and
subsequently modified or cancelled. Our results of operations for
2007 and 2006 were impacted by the recognition of non cash expense related to
the fair value of our share-based compensation awards as discussed in Notes 1
and 10 to the consolidated financial
statements.
The determination of fair value of stock-based payment
awards on the date of grant using the Black-Scholes model is affected by our
stock price, as well as the input of other subjective
assumptions. These assumptions include, but are not limited to, the
expected term of stock options and our expected stock price volatility over the
term of the awards. Our stock options have
characteristics significantly different
from those of traded options, and changes
in the assumptions can materially affect the fair value
estimates.
Statement 123R requires forfeitures to be estimated at
the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. If actual forfeitures vary
from our estimates, we will recognize the difference in compensation expense in
the period the actual forfeitures occur or when options
vest.
Our accounting for stock options is disclosed primarily
in Notes 1 and 10 to the consolidated financial statements.
Accounting
for goodwill and other intangible assets
The
Company accounts for acquisitions using the purchase method of
accounting. Under the purchase method, assets acquired and
liabilities assumed are recorded at their estimated fair values at the date of
acquisition. Management utilizes various valuation techniques
including discounted cash flow analyses to determine these fair
values. Any excess of the purchase price over amounts allocated to
the acquired assets, including identifiable intangible assets, and liabilities
assumed is recorded as goodwill.
Goodwill
and intangible assets are evaluated at least annually for impairment or more
frequently if events or circumstances, such as changes in economic or market
conditions, indicate that impairment may exist. Goodwill is tested
for impairment at the reporting unit level. A reporting unit is an
operating segment or one level below an operating segment for which discrete
financial information is available and regularly reviewed by
management. If the fair value of the reporting unit including
goodwill is determined to be less than the carrying amount of the reporting
unit, a further test is required to measure the amount of
impairment. If an impairment loss exists, the carrying amount of the
goodwill is adjusted to a new cost basis. For purposes of the
goodwill impairment test, fair value techniques based on multiples of earnings
or book value are used to determine the fair value of the Company’s reporting
units. Management believes the multiples used in these calculations
are consistent with current industry practice for valuing similar types of
companies.
Intangible
assets consist of core deposit intangibles and customer relationship
intangible assets arising from the acquisition of Diablo Valley Bank in
2007. These assets are amortized over their estimated useful
lives. Impairment testing of these assets is performed at the
individual asset level. Impairment exists if the carrying amount of
the asset exceeds its fair value at the date of the impairment
test. For intangible assets, estimates of expected future cash flows
(cash inflows less cash outflows) that are directly associated with an
intangible asset are used to determine the fair value of that
asset. Management makes certain estimates and assumptions in
determining the expected future cash flows from core deposit and customer
relationship intangibles including account attrition, expected lives, discount
rates, interest rates, servicing costs and other factors. Significant
changes in these estimates and assumptions could adversely impact the valuation
of these intangible assets.
If an
impairment loss exists, the carrying amount of the intangible asset is adjusted
to a new cost basis. The new cost basis is amortized over the
remaining useful life of the asset.
ITEM
7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
As a
financial institution, the Company’s primary component of market risk is
interest rate volatility. Fluctuations in interest rates will ultimately impact
both the level of income and expense recorded on most of the Company’s assets
and liabilities, and the market value of all interest-earning assets, other than
those which have a short term to maturity. Based upon the nature of the
Company’s operations, the Company is not subject to foreign exchange or
commodity price risk. The Company has no market risk sensitive instruments held
for trading purposes. As of December 31, 2007, the Company does not use interest
rate derivatives to hedge its interest rate risk.
The
information concerning quantitative and qualitative disclosure or market risk
called for by Item 305 of Regulation S-K is included as part of Item
7 above. See page 41.
ITEM
8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA
|
The
financial statements and report of the Independent Registered Public Accounting
Firm are set forth on pages 49 through 77.
ITEM
9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
|
ITEM
9A – CONTROLS AND PROCEDURES
|
The
Company has carried out an evaluation, under the supervision and with the
participation of the Company’s management, including the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
the Company’s disclosure controls and procedures as of December 31,
2007. As defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934, as amended (the “Exchange Act”), disclosure controls and procedures are
controls and procedures designed to reasonably assure that information required
to be disclosed in our reports filed or submitted under the Exchange Act are
recorded, processed, summarized and reported on a timely
basis. Disclosure controls are also designed to reasonably assure
that such information is accumulated and communicated to our management,
including the Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosure. Based upon their evaluation, our Chief Executive Officer
and Chief Financial Officer concluded the Company’s disclosure controls were
effective as of December 31, 2007, the period covered by this report on Form
10K.
Management’s
Annual Report on Internal Control over Financial Reporting
Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting. As defined in Rule 13a-15(f) under
the Exchange Act, internal control over financial reporting is a process
designed by, or under the supervision of, a company’s principal executive and
principal financial officers and effected by a company’s board of directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles. It includes those policies and procedures
that:
·
|
Pertain
to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of the assets of a
company;
|
·
|
Provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of a company are
being made only in accordance with authorizations of management and the
board of directors of the company;
and
|
·
|
Provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of a company’s assets that
could have a material effect on its financial
statements.
|
Because
of the inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
The
Company’s management has used the criteria established in “Internal
Control-Integrated Framework” issued by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”) to evaluate the effectiveness
of the Company’s internal control over financial reporting. Based on our
assessment, management has concluded that our internal control over financial
reporting, based on criteria established in “Internal Control-Integrated
Framework” issued by COSO was effective as of December 31, 2007.
The
Company’s independent registered public accounting firm has audited the
Company’s internal control over financial reporting. The report of Crowe Chizek
and Company LLP precedes the consolidated financial statements in this annual
report.
Inherent
Limitations on Effectiveness of
Controls
|
The
Company’s management, including the CEO and CFO, does not expect that our
disclosure controls or our internal control over financial reporting will
prevent or detect all error and all fraud. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance that
the control system’s objectives will be met. The design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Further, because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will not
occur or that all control issues and instances of fraud, if any, within the
company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur
because of simple error or mistake. Controls can also be circumvented by the
individual acts of some persons, by collusion of two or more people, or by
management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Projections of any evaluation of
controls effectiveness to future periods are subject to risks. Over
time, controls may become inadequate because of changes in conditions or
deterioration in the degree of compliance with policies or
procedures.
Changes
in Internal Control over Financial
Reporting
|
There was
no change in our internal control over financial reporting that occurred during
the quarter ended December 31, 2007 that has materially affected or is
reasonably likely to materially affect our internal control over financial
reporting.
ITEM
9B – OTHER INFORMATION
|
None
PART
III
ITEM
10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNACE
|
We have adopted a code of ethics that applies to our
Chief Executive Officer, Chief Financial Officer, and to our other principal
financial officers. The code of ethics is available at the Governance
Documents section of our website at www.heritagecommercecorp.com. We intend to disclose future amendments to,
or waivers from, certain provisions of our code of ethics on the above website
within four business days following the date of such amendment or
waiver.
ITEM
11 - EXECUTIVE COMPENSATION
|
ITEM
12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER
MATTERS
|
ITEM
13 - CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS
|
ITEM
14 – PRINCIPAL ACCOUNTANT FEES AND
SERVICES
|
Information
required by this item will be contained in our
Definitive Proxy Statement for our
2008 Annual Meeting of Shareholders, to be filed
pursuant to Regulation 14A, with the Securities and Exchange Commission
within 120 days of December 31,
2007. Such information is
incorporated herein by reference.
PART
IV
ITEM
15 - EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES
|
(a)(1)
FINANCIAL STATEMENTS
The
Financial Statements of the Company and the Report of Independent Registered
Public Accounting Firm are set forth on pages 49 through
77.
(a)(2)
FINANCIAL STATEMENT SCHEDULES
All
schedules to the Financial Statements are omitted because of the absence of the
conditions under which they are required or because the required information is
included in the Financial Statements or accompanying notes.
(a)(3)
EXHIBITS
The
exhibit list required by this Item is incorporated by reference to the Exhibit
Index included in this report.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Company has duly caused this report on Form 10-K to be signed on its
behalf by the undersigned thereunto duly authorized.
|
Heritage
Commerce Corp
|
DATE:
March 17, 2008
|
BY: /s/ Walter T.
Kaczmarek
Walter
T. Kaczmarek
Chief
Executive Officer
|
Pursuant
to the requirements of Section 13 of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed below by the following
persons on behalf of the registrant and in the capacities and on the date
indicated:
Signature
|
Title
|
Date
|
/s/ FRANK
BISCEGLIA
Frank
Bisceglia
|
Director
|
March
17, 2008
|
/s/ JAMES
BLAIR
James
Blair
|
Director
|
March
17, 2008
|
/s/ JACK
CONNER
Jack
Conner
|
Director
and Chairman of the Board
|
March
17, 2008
|
/s/ WILLIAM DEL
BIAGGIO, JR.
William
Del Biaggio, Jr.
|
Director
|
March
17, 2008
|
/s/ WALTER T.
KACZMAREK
Walter
T. Kaczmarek
|
Director
and Chief Executive Officer and President (Principle Executive
Officer)
|
March
17, 2008
|
/s/ LAWRENCE D.
MCGOVERN
Lawrence
D. McGovern
|
Executive
Vice President and Chief Financial Officer (Principal Financial and
Accounting Officer)
|
March
17, 2008
|
/s/ ROBERT
MOLES
Robert
Moles
|
Director
|
March
17, 2008
|
/s/ LON
NORMANDIN
Lon
Normandin
|
Director
|
March
17, 2008
|
/s/ JACK
PECKHAM
Jack
Peckham
|
Director
|
March
17, 2008
|
/s/
HUMPHREY POLANEN
Humphrey
Polanen
|
Director
|
March
17, 2008
|
/s/ CHARLES
TOENISKOETTER
Charles
Toeniskoetter
|
Director
|
March
17, 2008
|
/s/ RANSON
WEBSTER
Ranson
Webster
|
Director
|
March
17, 2008
|
/s/ JOHN J.
HOUNSLOW
John J. Hounslow
|
Director
|
March
17, 2008
|
/s/ MARK
LEFANOWICZ
Mark Lefanowicz
|
Director
|
March
17, 2008
|
INDEX TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
|
Page
|
Report
of Independent Registered Public Accounting Firm
|
49
|
Consolidated
Balance Sheets as of December 31, 2007 and 2006
|
50
|
Consolidated
Income Statements for the years ended December 31, 2007, 2006 and
2005
|
51
|
Consolidated
Statements of Changes in Shareholders’ Equity for the years ended December
31, 2007, 2006 and 2005
|
52
|
Consolidated
Statements of Cash Flows for the years ended December 31, 2007, 2006 and
2005
|
53
|
Notes
to Consolidated Financial Statements
|
55
|
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of
Directors
Heritage
Commerce Corp
San Jose,
California
We have
audited the accompanying consolidated balance sheets of Heritage Commerce Corp
as of December 31, 2007 and 2006, and the related consolidated income
statements, statements of changes in shareholders’ equity and statements of cash
flows for each of the three years in the period ended December 31, 2007. We also
have audited Heritage Commerce Corp’s internal control over financial reporting
as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Heritage
Commerce Corp’s management is responsible for these financial statements,
for maintaining effective internal control over financial reporting, and for its
assessment of the effectiveness of internal control over financial reporting in
the accompanying Management’s Annual Report on Internal Control over Financial
Reporting included in Item 9A in Form 10-K. Our responsibility is to
express an opinion on these financial statements and an opinion on the
Company’s internal control over financial reporting based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audits also included performing such other procedures as
we considered necessary in the circumestances. We believe that our audits
provide a reasonable basis for our opinions.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable aasurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the compnay’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Heritage Commerce Corp as of
December 31, 2007 and 2006, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2007 in conformity
with accounting principles generally accepted in the United States of
America. Also in our opinion, Heritage Commerce Corp maintained, in
all material
respects, effective internal control over financial reporting as of December 31,
2007, based on criteria established in Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
/s/ Crowe
Chizek and Company LLP
Oak
Brook, Illinois
March 17
, 2008
HERITAGE
COMMERCE CORP
|
CONSOLIDATED
BALANCE SHEETS
|
|
|
December
31,
|
|
December
31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Assets
|
|
|
|
|
Cash
and due from banks
|
|
$ |
39,793 |
|
$ |
34,285 |
Federal
funds sold
|
|
|
9,300 |
|
|
15,100 |
Total
cash and cash equivalents
|
|
|
49,093 |
|
|
49,385 |
Securities
available for sale, at fair value
|
|
|
135,402 |
|
|
172,298 |
Loans
held for sale, at lower of cost or market
|
|
|
- |
|
|
33,752 |
Loans,
net of deferred costs
|
|
|
1,036,465 |
|
|
709,236 |
Allowance
for loan losses
|
|
|
(12,218) |
|
|
(9,279) |
Loans,
net
|
|
|
1,024,247 |
|
|
699,957 |
Federal
Home Loan Bank and Federal Reserve Bank stock, at cost
|
|
|
7,002 |
|
|
6,113 |
Company
owned life insurance
|
|
|
38,643 |
|
|
36,174 |
Premises
and equipment, net
|
|
|
9,308 |
|
|
2,539 |
Goodwill
|
|
|
43,181 |
|
|
- |
Intangible
assets
|
|
|
4,972 |
|
|
- |
Accrued
interest receivable and other assets
|
|
|
35,624 |
|
|
36,920 |
Total
assets
|
|
$ |
1,347,472 |
|
$ |
1,037,138 |
|
|
|
|
|
|
|
Liabilities
and Shareholders' Equity
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
Demand,
noninterest bearing
|
|
$ |
268,005 |
|
$ |
231,841 |
Demand,
interest bearing
|
|
|
150,527 |
|
|
133,413 |
Savings
and money market
|
|
|
432,293 |
|
|
307,266 |
Time
deposits, under $100
|
|
|
34,092 |
|
|
31,097 |
Time
deposits, $100 and over
|
|
|
139,562 |
|
|
111,017 |
Brokered
deposits
|
|
|
39,747 |
|
|
31,959 |
Total
deposits
|
|
|
1,064,226 |
|
|
846,593 |
Notes
payable to subsidiary grantor trusts
|
|
|
23,702 |
|
|
23,702 |
Securities
sold under agreement to repurchase
|
|
|
10,900 |
|
|
21,800 |
Other
short-term borrowings
|
|
|
60,000 |
|
|
- |
Accrued
interest payable and other liabilities
|
|
|
23,820 |
|
|
22,223 |
Total
liabilities
|
|
|
1,182,648 |
|
|
914,318 |
|
|
|
|
|
|
|
Shareholders'
equity:
|
|
|
|
|
|
|
Preferred
stock, no par value; 10,000,000
|
|
|
|
|
|
|
shares
authorized; none outstanding
|
|
|
- |
|
|
- |
Common
Stock, no par value; 30,000,000 shares authorized;
|
|
|
|
|
|
|
shares
outstanding: 12,774,926 in 2007 and 11,656,943 in 2006
|
|
|
92,414 |
|
|
62,363 |
Retained
earnings
|
|
|
73,298 |
|
|
62,452 |
Accumulated
other comprehensive loss
|
|
|
(888) |
|
|
(1,995) |
Total
shareholders' equity
|
|
|
164,824 |
|
|
122,820 |
Total
liabilities and shareholders' equity
|
|
$ |
1,347,472 |
|
$ |
1,037,138 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
notes to consolidated financial statements
|
|
|
|
|
|
|
HERITAGE
COMMERCE CORP
|
CONSOLIDATED
INCOME STATEMENTS
|
|
|
Years
Ended December 31,
|
(Dollars
in thousands, except per share data)
|
|
2007
|
|
2006
|
|
2005
|
Interest
income:
|
|
|
|
|
|
|
Loans,
including fees
|
|
$ |
68,405 |
|
$ |
61,859 |
|
$ |
54,643 |
Securities,
taxable
|
|
|
7,481 |
|
|
7,614 |
|
|
7,042 |
Securities,
non-taxable
|
|
|
155 |
|
|
182 |
|
|
205 |
Interest
bearing deposits in other financial institutions
|
|
|
141 |
|
|
132 |
|
|
97 |
Federal
funds sold
|
|
|
2,530 |
|
|
3,170 |
|
|
1,769 |
Total
interest income
|
|
|
78,712 |
|
|
72,957 |
|
|
63,756 |
|
|
|
|
|
|
|
|
|
|
Interest
expense:
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
24,211 |
|
|
19,588 |
|
|
12,849 |
Notes
payable to subsidiary grantor trusts
|
|
|
2,329 |
|
|
2,310 |
|
|
2,136 |
Repurchase
agreements
|
|
|
387 |
|
|
627 |
|
|
922 |
Other
borrowings
|
|
|
85 |
|
|
- |
|
|
- |
Total
interest expense
|
|
|
27,012 |
|
|
22,525 |
|
|
15,907 |
|
|
|
|
|
|
|
|
|
|
Net
interest income before provision for loan losses
|
|
|
51,700 |
|
|
50,432 |
|
|
47,849 |
Provision
for loan losses
|
|
|
(11) |
|
|
(503) |
|
|
313 |
Net
interest income after provision for loan losses
|
|
|
51,711 |
|
|
50,935 |
|
|
47,536 |
|
|
|
|
|
|
|
|
|
|
Noninterest
income:
|
|
|
|
|
|
|
|
|
|
Gain
on sale of SBA loans
|
|
|
1,766 |
|
|
3,337 |
|
|
2,871 |
Gain
on sale of Capital Group loan portfolio
|
|
|
- |
|
|
671 |
|
|
- |
Servicing
income
|
|
|
2,181 |
|
|
1,860 |
|
|
1,838 |
Increase
in cash surrender value of life insurance
|
|
|
1,443 |
|
|
1,439 |
|
|
1,236 |
Service
charges and fees on deposit accounts
|
|
|
1,284 |
|
|
1,335 |
|
|
1,468 |
Gain
on sale of leased equipment
|
|
|
- |
|
|
- |
|
|
299 |
Equipment
leasing
|
|
|
- |
|
|
- |
|
|
131 |
Other
|
|
|
1,378 |
|
|
1,198 |
|
|
1,580 |
Total
noninterest income
|
|
|
8,052 |
|
|
9,840 |
|
|
9,423 |
|
|
|
|
|
|
|
|
|
|
Noninterest
expense:
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
|
21,160 |
|
|
19,414 |
|
|
19,845 |
Occupancy
|
|
|
3,557 |
|
|
3,110 |
|
|
3,254 |
Professional
fees
|
|
|
2,342 |
|
|
1,688 |
|
|
1,617 |
Advertising
and promotion
|
|
|
1,092 |
|
|
1,064 |
|
|
985 |
Data processing |
|
|
867 |
|
|
806 |
|
|
661 |
Low
income housing investment losses and writedowns
|
|
|
828 |
|
|
995 |
|
|
957 |
Client
services
|
|
|
820 |
|
|
1,000 |
|
|
1,404 |
Furniture
and equipment
|
|
|
638 |
|
|
517 |
|
|
734 |
Intangible asset amortization |
|
|
352 |
|
|
- |
|
|
- |
Retirement
plan expense
|
|
|
274 |
|
|
352 |
|
|
619 |
Amortization
of leased equipment
|
|
|
- |
|
|
- |
|
|
334 |
Other
|
|
|
5,600 |
|
|
5,322 |
|
|
4,823 |
Total
noninterest expense
|
|
|
37,530 |
|
|
34,268 |
|
|
35,233 |
|
|
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
|
22,233 |
|
|
26,507 |
|
|
21,726 |
Income
tax expense
|
|
|
8,137 |
|
|
9,237 |
|
|
7,280 |
Net
income
|
|
$ |
14,096 |
|
$ |
17,270 |
|
$ |
14,446 |
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
1.14 |
|
$ |
1.47 |
|
$ |
1.22 |
Diluted
|
|
$ |
1.12 |
|
$ |
1.44 |
|
$ |
1.19 |
|
|
|
|
|
|
|
|
|
|
See
notes to consolidated financial
statements
|
HERITAGE
COMMERCE CORP
|
CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|
YEARS
ENDED DECEMBER 31, 2007, 2006, AND 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unearned |
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
Restricted |
|
Unallocated |
|
Other
|
|
|
|
Total
|
|
|
|
|
Common
Stock
|
|
Stock
|
|
ESOP |
|
Comprehensive
|
|
Retained
|
|
Shareholders' |
|
Comprehensive |
(Dollars
in thousands, except shares) |
|
Shares
|
|
Amount
|
|
Award |
|
Shares
|
|
Income
(Loss)
|
|
Earnings |
|
Equity
|
|
Income |
Balance,
January 1, 2005
|
|
|
11,669,837 |
|
$ |
67,409 |
|
$ |
- |
|
$ |
(193 |
) |
$ |
(1,730) |
|
$ |
33,093 |
|
$ |
98,579 |
|
|
Net
Income
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
14,446 |
|
|
14,446 |
|
$ |
14,446 |
Net
change in unrealized gain/loss on securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
available-for-sale
and I/O strips, net of reclassification
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
adjustment
and deferred income taxes
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(664) |
|
|
- |
|
|
(664) |
|
|
(664) |
Increase
in pension liability, net of deferred income taxes
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(327) |
|
|
- |
|
|
(327) |
|
|
(327) |
Total
comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
13,455 |
ESOP
shares released
|
|
|
- |
|
|
284 |
|
|
- |
|
|
193 |
|
|
- |
|
|
- |
|
|
477 |
|
|
|
Restricted
stock award
|
|
|
51,000 |
|
|
926 |
|
|
(926) |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
|
Amortization
of restricted stock award
|
|
|
- |
|
|
- |
|
|
123 |
|
|
- |
|
|
- |
|
|
- |
|
|
123 |
|
|
|
Redemption
payment on common stock
|
|
|
- |
|
|
(12) |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(12) |
|
|
|
Common
stock repurchased
|
|
|
(300,160) |
|
|
(5,732) |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(5,732) |
|
|
|
Stock
options exercised, including related tax benefits
|
|
|
386,972 |
|
|
4,727 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
4,727 |
|
|
|
Balance,
December 31, 2005
|
|
|
11,807,649 |
|
|
67,602 |
|
|
(803) |
|
|
- |
|
|
(2,721) |
|
|
47,539 |
|
|
111,617 |
|
|
|
Net
Income
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
17,270 |
|
|
17,270 |
|
$ |
17,270 |
Net
change in unrealized gain/loss on securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
available-for-sale
and I/O strips, net of reclassification
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
adjustment
and deferred income taxes
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
377 |
|
|
- |
|
|
377 |
|
|
377 |
Decrease
in pension liability, net of deferred income taxes
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
349 |
|
|
- |
|
|
349 |
|
|
349 |
Total
comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
17,996 |
Reclassification
of unearned restricted stock award
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
upon
adoption of Statement 123 (revised 2004)
|
|
|
- |
|
|
(803) |
|
|
803 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
|
Amortization
of restricted stock award
|
|
|
- |
|
|
154 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
154 |
|
|
|
Cash
dividend declared on common stock, $0.20 per share
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(2,357) |
|
|
(2,357) |
|
|
|
Common
stock repurchased
|
|
|
(330,300) |
|
|
(7,888) |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(7,888) |
|
|
|
Stock
option expense
|
|
|
- |
|
|
780 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
780 |
|
|
|
Stock
options exercised, including related tax benefits
|
|
|
179,594 |
|
|
2,518 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
2,518 |
|
|
|
Balance,
December 31, 2006
|
|
|
11,656,943 |
|
|
62,363 |
|
|
- |
|
|
- |
|
|
(1,995) |
|
|
62,452 |
|
|
122,820 |
|
|
|
Net
Income
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
14,096 |
|
|
14,096 |
|
$ |
14,096 |
Net
change in unrealized gain/loss on securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
available-for-sale
and I/O strips, net of reclassification
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
adjustment
and deferred income taxes
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
1,028 |
|
|
- |
|
|
1,028 |
|
|
1,028 |
Decrease
in pension liability, net of deferred income taxes
|
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
79 |
|
|
- |
|
|
79 |
|
|
79 |
Total
comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
15,203 |
Issuance
of 1,732,298 shares to acquire Diablo
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Valley
Bank, net of offering costs of $214
|
|
|
1,732,298 |
|
|
41,183 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
41,183 |
|
|
|
Amortization
of restricted stock award
|
|
|
- |
|
|
154 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
154 |
|
|
|
Cash
dividend declared on common stock, $0.26 per share |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(3,250) |
|
|
(3,250) |
|
|
|
Common
stock repurchased
|
|
|
(698,190) |
|
|
(13,653) |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(13,653) |
|
|
|
Stock
option expense
|
|
|
- |
|
|
1,159 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
1,159 |
|
|
|
Stock
options exercised, including related tax benefits
|
|
|
83,875 |
|
|
1,208 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
1,208 |
|
|
|
Balance,
December 31, 2007
|
|
|
12,774,926 |
|
$ |
92,414 |
|
$ |
- |
|
$ |
- |
|
$ |
(888) |
|
$ |
73,298 |
|
$ |
164,824 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
notes to consolidated financial
statements
|
HERITAGE
COMMERCE CORP
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
|
Years
ended December 31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
Net
income
|
|
$ |
14,096 |
|
$ |
17,270 |
|
$ |
14,446 |
Adjustments
to reconcile net income to net cash provided by
|
|
|
|
|
|
|
|
|
|
operating
activities:
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
776 |
|
|
662 |
|
|
988 |
Provision
for loan losses
|
|
|
(11) |
|
|
(503) |
|
|
313 |
Gain
on sale of leased equipment
|
|
|
- |
|
|
- |
|
|
(299) |
Deferred
income tax benefit
|
|
|
(225) |
|
|
(319) |
|
|
(360) |
Non-cash
compensation expense related to ESOP plan
|
|
|
- |
|
|
- |
|
|
477 |
Stock
option expense
|
|
|
1,159 |
|
|
780 |
|
|
- |
Amortization
of other intangible assets
|
|
|
352 |
|
|
- |
|
|
- |
Amortization
of restricted stock award
|
|
|
154 |
|
|
154 |
|
|
123 |
Amortization
(accretion) of discounts and premiums on securities
|
|
|
95 |
|
|
(1,087) |
|
|
928 |
Gain
on sale of Capital Group loan portfolio
|
|
|
- |
|
|
(671) |
|
|
- |
Gain
on sale of SBA loans
|
|
|
(1,766) |
|
|
(3,337) |
|
|
(2,871) |
Proceeds
from sales of loans held for sale
|
|
|
35,529 |
|
|
65,466 |
|
|
51,176 |
Change
in SBA loans held for sale
|
|
|
(17,469) |
|
|
(51,100) |
|
|
(58,876) |
Increase
in cash surrender value of life insurance
|
|
|
(1,443) |
|
|
(1,439) |
|
|
(1,236) |
Other
non-cash income |
|
|
(230) |
|
|
- |
|
|
- |
Effect
of changes in:
|
|
|
|
|
|
|
|
|
|
Accrued
interest receivable and other assets
|
|
|
3,162 |
|
|
4,270 |
|
|
(7,181) |
Accrued
interest payable and other liabilities
|
|
|
352 |
|
|
1,562 |
|
|
4,909 |
Net
cash provided by operating activities
|
|
|
34,531 |
|
|
31,708 |
|
|
2,537 |
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Net
change in loans (including purchase of $10,306 in 2006)
|
|
|
(104,078) |
|
|
(27,591) |
|
|
11,768 |
Proceeds
from sale of Capital Group loan portfolio
|
|
|
- |
|
|
30,047 |
|
|
- |
Net
decrease in Capital Group loan portfolio prior to sale
|
|
|
- |
|
|
2,681 |
|
|
- |
Purchases
of securities available-for-sale
|
|
|
(9,322) |
|
|
(64,018) |
|
|
(26,087) |
Maturities/Paydowns/Calls
of securities available-for-sale
|
|
|
61,344 |
|
|
92,274 |
|
|
57,707 |
Sale
of leased equipment
|
|
|
- |
|
|
- |
|
|
687 |
Purchases
of company owned life insurance
|
|
|
- |
|
|
- |
|
|
(7,196) |
Purchase
of premises and equipment
|
|
|
(704) |
|
|
(660) |
|
|
(346) |
Redemption
(Purchase) of restricted stock and other investments
|
|
|
58 |
|
|
(254) |
|
|
(1,164) |
Cash
received in bank acquisition, net of cash paid
|
|
|
16,407 |
|
|
- |
|
|
- |
Net
cash provided by (used in) investing activities
|
|
|
(36,295) |
|
|
32,479 |
|
|
35,369 |
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Net
change in deposits
|
|
|
(31,390) |
|
|
(93,166) |
|
|
21,224 |
Payment
of other liability
|
|
|
(329) |
|
|
(1,469) |
|
|
(2,299) |
Exercise
of stock options
|
|
|
1,208 |
|
|
2,518 |
|
|
4,727 |
Stock
offering cost
|
|
|
(214) |
|
|
- |
|
|
- |
Common
stock repurchased
|
|
|
(13,653) |
|
|
(7,888) |
|
|
(5,744) |
Payment
of cash dividend
|
|
|
(3,250) |
|
|
(2,357) |
|
|
- |
Proceeds
from other short-term borrowings
|
|
|
60,000 |
|
|
- |
|
|
- |
Repayment
of securities under agreement to repurchase
|
|
|
(10,900) |
|
|
(10,900) |
|
|
(15,100) |
Net
cash provided by (used in) financing activities
|
|
|
1,472 |
|
|
(113,262) |
|
|
2,808 |
Net
increase (decrease) in cash and cash equivalents
|
|
|
(292) |
|
|
(49,075) |
|
|
40,714 |
Cash
and cash equivalents, beginning of year
|
|
|
49,385 |
|
|
98,460 |
|
|
57,746 |
Cash
and cash equivalents, end of year
|
|
$ |
49,093 |
|
$ |
49,385 |
|
$ |
98,460 |
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
Cash
paid during the year for:
|
|
|
|
|
|
|
Interest
|
|
$ |
27,216 |
|
$ |
22,285 |
|
$ |
15,291 |
Income
taxes
|
|
$ |
6,319 |
|
$ |
4,781 |
|
$ |
13,828 |
|
|
|
|
|
|
|
|
|
|
Supplemental
schedule of non-cash investing activity:
|
|
|
|
|
|
|
|
|
|
Transfer
of commercial loans (Capital Group loan portfolio) to loans
held-for-sale
|
|
$ |
- |
|
$ |
- |
|
$ |
32,057 |
Transfer
of portfolio loans to loans held for sale
|
|
$ |
972 |
|
$ |
- |
|
$ |
- |
Transfer
of loans held for sale to loan portfolio
|
|
$ |
18,430 |
|
$ |
1,962 |
|
$ |
5,428 |
Loans
transferred to foreclosed assets
|
|
$ |
1,062 |
|
$ |
- |
|
$ |
- |
Summary
of assets acquired, and liabilities assumed through
acquisition:
|
|
|
|
Cash
and cash equivalents
|
|
$ |
41,807 |
|
|
- |
|
|
- |
Securities
available-for-sale
|
|
$ |
12,214 |
|
|
- |
|
|
- |
Net
loans
|
|
$ |
203,805 |
|
|
- |
|
|
- |
Goodwill
and other intangible assets
|
|
$ |
48,506 |
|
|
- |
|
|
- |
Premises
and equipment
|
|
$ |
6,841 |
|
|
- |
|
|
- |
Company
owned life insurance
|
|
$ |
1,026 |
|
|
- |
|
|
- |
Federal
Home Loan Bank Stock
|
|
$ |
717 |
|
|
- |
|
|
- |
Other
assets, net
|
|
$ |
2,615 |
|
|
- |
|
|
- |
Deposits
|
|
$ |
(249,023) |
|
|
- |
|
|
- |
Other
liabilities
|
|
$ |
(1,711) |
|
|
- |
|
|
- |
Common
stock issued to acquire Diablo Valley Bank
|
|
$ |
41,397 |
|
|
- |
|
|
- |
|
|
|
|
|
|
|
|
|
|
See
notes to consolidated financial
statements
|
HERITAGE
COMMERCE CORP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(1)
Summary of Significant Accounting Policies
Description
of Business and Basis of Presentation
Heritage
Commerce Corp (the “Company”) operates as a bank holding company for its wholly
owned subsidy Heritage Bank of Commerce (“HBC” or “the Bank”). HBC is a
California state chartered bank which offers a full range of commercial and
personal banking services to residents and the business/professional community
in Santa Clara, Alameda, and Contra Costa counties, California. As discussed in
Note 6, the Company acquired Diablo Valley Bank (“DVB”) on June 20, 2007 and
merged DVB into HBC. HBC was incorporated on November 23, 1993 and commenced
operations on June 8, 1994.
The
consolidated financial statements include the accounts of the Company and its
subsidiary bank. All inter- company accounts and transactions have
been eliminated.
The
Company also has four other subsidiaries, Heritage Capital Trust I and Heritage
Statutory Trust I, formed in 2000, Heritage Statutory Trust II, formed in 2001,
and Heritage Statutory Trust III, formed in 2002, which are Delaware statutory
business trusts formed for the exclusive purpose of issuing trust preferred
securities. These subsidiary trusts are not consolidated in the
Company’s consolidated financial statements and the subordinated debt payable to
subsidiary grantor trusts is recorded as debt of the Company to the related
trusts.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates. The allowance for loan losses, loan servicing
rights, defined benefit pension obligation, interest-only strip receivables,
purchase accounting adjustments, and the fair values of financial instruments
are particularly subject to change.
Cash
and Cash Equivalents
Cash and
cash equivalents include cash on hand, amounts due from banks, and Federal funds
sold. Generally, Federal funds are sold and purchased for one-day
periods.
Cash
Flows
Net cash
flows are reported for customer loan and deposit transactions, Federal funds
purchased, repurchase agreements and other short-term borrowings.
Securities
The
Company classifies its securities as either available-for-sale or
held-to-maturity at the time of purchase. Securities
available-for-sale are recorded at fair value with a corresponding recognition
of the net unrealized holding gain or loss, net of deferred income taxes, as a
net amount within accumulated other comprehensive income (loss), which is a
separate component of shareholders’ equity. Securities held-to-maturity are
recorded at amortized cost, based on the Company’s positive intent and ability
to hold the securities to maturity. As of December 31, 2007 and 2006,
all the Company’s securities were classified as available-for-sale
securities.
A decline
in the fair value of any available-for-sale or held-to-maturity security below
amortized cost that is deemed other than temporary results in a charge to
earnings and the corresponding establishment of a new cost basis for the
security. In estimating other-than-temporary losses, management
considers (1) the length of time and extent that fair value has been less than
cost, (2) the financial condition and near-term prospects of the issuer, and (3)
the Company’s ability and intent to hold the security for a period sufficient to
allow for any anticipated recovery in fair value.
Interest
income includes amortization of purchase premiums or
discount. Premiums and discounts are amortized, or accreted, over the
life of the related security as an adjustment to income using a method that
approximates the interest method. Realized gains and losses are recorded on the
trade date and determined using the specific identification method for the cost
of securities sold.
Federal
Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock
The Bank
is a member of the FHLB system. Members are required to own a certain
amount of stock based on the level of borrowings and other factors, and may
invest in additional amounts. The FHLB stock is carried at cost,
classified as a restricted security, and periodically evaluated for
impairment. Because this stock is viewed as a long term investment,
impairment is based on ultimate recovery of par value. Both cash and
stock dividends are reported as income. The Bank is also member of
the FRB. FRB stock is classified as a restricted security, and cash
dividends are reported as income.
Loans
Held for Sale
The
Company held for sale the guaranteed portion of certain loans guaranteed by the
Small Business Administration or the U.S. Department of Agriculture
(collectively referred to as “SBA loans”). These loans were carried at the lower
of aggregate cost or market. Net unrealized losses, if any, were recorded as a
valuation allowance and charged to earnings.
Gains or
losses on SBA loans held for sale were recognized upon completion of the sale,
based on the difference between the net sales proceeds and the relative fair
value of the guaranteed portion of the loan sold compared to the relative fair
value of the unguaranteed portion.
SBA loans
were sold with servicing retained. The servicing assets that result
from the sale of SBA loans consist of servicing rights and interest-only strip
receivables (“I/O strips”).
The
Company accounts for the sale and servicing of SBA loans based on the financial
and servicing assets it controls and liabilities it has incurred, derecognizing
financial assets when control has been surrendered, and derecognizing
liabilities when extinguished. Servicing rights are measured at their fair value
and are amortized in proportion to and over the period of net servicing income
and are assessed for impairment on an ongoing basis. Impairment is determined by
stratifying the servicing rights based on interest rates and
terms. Any servicing assets in excess of the contractually specified
servicing fees are reclassified at fair value as an I/O strip receivable and
treated like an available for sale security. Fair value is determined
using prices for similar assets with similar characteristics, when available, or
based upon discounted cash flows using market-based assumptions. Impairment is
recognized through a valuation allowance. The servicing rights, net of any
required valuation allowance, and I/O strip receivable are included in other
assets.
In March,
2006, FASB issued Statement 156, Accounting for Servicing of
Financial Assets - An Amendment of FASB Statement No. 140. This standard
amends the guidance in Statement 140, with respect to the accounting for
separately recognized servicing assets and servicing
liabilities. Among other requirements, Statement 156 requires
an entity to recognize a servicing asset or servicing liability each time it
undertakes an obligation to service a financial asset by entering into a
servicing contract in certain situations, including a transfer of loans with
servicing retained that meets the requirements for sale
accounting. Statement 156 is effective as of the beginning of an
entity’s first fiscal year that begins after September 15, 2006. The
adoption of this standard did not have a material impact on the Company’s
financial statements.
Loans
Loans
that management has the intent and ability to hold for the foreseeable future or
maturity or payoff are stated at the principal amount outstanding, net of
deferred loan origination fees and costs. The majority of the
Company’s loans have variable interest rates. Interest on loans is accrued on
the unpaid principal balance and is credited to income using the effective yield
interest method.
Generally,
if a loan is classified as non-accrual, the accrual of interest is discontinued,
any accrued and unpaid interest is reversed, and the amortization of deferred
loan fees and costs is discontinued. Loans are classified as non-accrual when
the payment of principal or interest is 90 days past due, unless the amount is
well secured and in the process of collection. Any interest or principal
payments received on nonaccrual loans are applied toward reduction of principal.
Nonaccrual loans generally are not returned to performing status until the
obligation is brought current, the loan has performed in accordance with the
contract terms for a reasonable period of time, and the ultimate collectibility
of the contractual principal and interest is no longer in doubt.
Non-refundable
loan fees and direct origination costs are deferred and recognized over the
expected lives of the related loans using the effective yield interest
method.
Allowance
for Loan Losses
The
Company maintains an allowance for loan losses to absorb probable losses
incurred in the loan portfolio. The allowance is based on ongoing, quarterly
assessments of the probable estimated losses. Loans are charged against the
allowance when management believes that the uncollectibility of a loan balance
is confirmed. The allowance is increased by the provision for loan losses, which
is charged against current period operating results, and decreased by loan
charge-offs, net of recoveries. The Company’s methodology for assessing the
adequacy of the allowance consists of several key elements, which include the
formula allowance and specific allowances.
The
formula allowance is calculated by applying loss factors to pools of outstanding
loans. Loss factors are based on the Company’s historical loss experience,
adjusted for significant factors that, in management’s judgment, affect the
collectibility of the portfolio as of the evaluation date. The adjustment
factors for the formula allowance may include current economic and business
conditions affecting the key lending areas of the Company, in particular the
technology industry and the real estate market, credit quality trends,
collateral values, loan volumes and concentrations, specific industry conditions
within portfolio segments, recent loss experience in particular segments of the
portfolio, duration of the current business cycle, and bank regulatory
examination results. The evaluation of the inherent loss with respect to these
conditions is subject to a higher degree of uncertainty.
Specific
allowances are established for impaired loans, but the entire allowance is
available for any loan that, in management’s judgment, should be charged
off. Management considers a loan to be impaired when it is probable
that the Company will be unable to collect all amounts due according to the
original contractual terms of the loan agreement. When a loan is considered to
be impaired, the amount of impairment is measured based on the present value of
expected future cash flows discounted at the loan’s effective interest rate, or
the fair value of the collateral if the loan is collateral
dependent. Commercial, land and construction and commercial real
estate loans are individually evaluated for impairment. Large groups
of smaller balance homogeneous loans, such as consumer and residential real
estate loans, are collectively evaluated for impairment and, accordingly, they
are not separately identified for impairment disclosures.
Loan
Commitments and Related Financial Instruments
Financial
instruments include off-balance sheet credit instruments, such as commitments to
make loans and commercial letters of credit, issued to meet customer financing
needs. The face amount for these items represents the exposure to
loss, before considering customer collateral or ability to
repay. Such financial instruments are recorded when they are
funded.
Loss
Contingencies
Loss
contingencies, including claims and legal actions arising in the ordinary course
of business, are recorded as liabilities when the likelihood of loss is probable
and an amount or range of loss can be reasonably
estimated. Management does not believe that the ultimate loss from
such matters, if any, will have a material effect on the financial
statements.
Company
Owned Life Insurance
The
Company has purchased life insurance policies on certain directors and
officers. Upon adoption of EITF 06-5, which is discussed further
below, Company owned life insurance is recorded at the amount that can be
realized under the insurance contract at the balance sheet date, which is the
cash surrender value adjusted for other charges or other amounts due that are
probable at settlement. Prior to adoption of EITF 06-5, the Company
recorded owned life insurance at its cash surrender value.
In
September 2006, the FASB Emerging Issues Task Force (“EITF”) finalized Issue No.
06-5, Accounting for Purchases
of Life Insurance - Determining the Amount That Could Be Realized in Accordance
with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life
Insurance). This issue requires that a policyholder consider contractual
terms of a life insurance policy in determining the amount that could be
realized under the insurance contract. It also requires that if the
contract provides for a greater surrender value if all individual policies in a
group are surrendered at the same time, that the surrender value be determined
based on the assumption that policies will be surrendered on an individual
basis. Lastly, the issue discusses whether the cash surrender value
should be discounted when the policyholder is contractually limited in its
ability to surrender a policy. This issue is effective for fiscal
years beginning after December 15, 2006. The adoption of this issue
did not have a material impact on the financial statements.
In
September 2006, the EITF finalized Issue No. 06-4, Accounting for Deferred Compensation
and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements. This issue requires that a liability be recorded
during the service period when a split-dollar life insurance agreement continues
after participants’ employment or retirement. The required accrued
liability will be on either the post-employment benefit cost for the continuing
life insurance or based on the future death benefit depending on the contractual
terms of the underlying agreement. This issue is effective for fiscal
years beginning after December 15, 2007.
The
Company will adopt EITF 06-4 on January 1, 2008, which will result in a
cumulative effect adjustment to decrease retained
earnings. Management is in the process of completing its calculations
and estimates that the cumulative effect will be a decrease to retained earnings
in the range of $3.0 million to $4.0 million, net of deferred
taxes.
Goodwill
and Intangible Assets
Goodwill
results from the acquisition of Diablo Valley Bank and represents the excess of
the purchase price over the fair value of acquired tangible assets and
liabilities and identifiable intangible assets. Goodwill is assessed
at least annually for impairment and any such impairment will be recognized in
the period identified.
Other
intangible assets consist of core deposit and customer relationship
intangible assets arising from the Diablo Valley Bank
acquisition. They are initially measured at fair value and then are
amortized on an accelerated method over their estimated useful lives. The core
deposit and customer relationship intangible assets are being amortized over ten
and seven years, respectively.
Retirement
Plans
Pension
expense is the net of service and interest cost, return on plan assets and
amortization of gains and losses not immediately recognized. Employee
401(k) and profit sharing plan expense is the amount of matching
contributions. Deferred compensation and supplemental retirement plan
expense allocates the benefits over years of service.
Premises
and Equipment
Land is
carried at cost. Premises and equipment are stated at cost. Depreciation and
amortization are computed on a straight-line basis over the lesser of the
respective lease terms or estimated useful lives The Company owns one
building which is being depreciated over 40 years. Furniture, equipment, and
leasehold improvements are depreciated over estimated useful lives generally
ranging from five to fifteen years. The Company evaluates the recoverability of
long-lived assets on an on-going basis.
Income
Taxes
The
Company files consolidated Federal and combined state income tax
returns. Income tax expense is the total of the current year income
tax payable or refundable and the change in deferred tax assets and
liabilities. Deferred tax assets and liabilities are the expected
future tax amounts for the temporary differences between carrying amounts and
tax basis of assets and liabilities, computed using enacted tax
rates. A valuation allowance, if needed, reduces deferred tax assets
to the amount expected to be realized.
The
Company adopted FASB Interpretation 48 (“FIN 48”) “Accounting for Uncertainty in
Income Taxes”, as of January 1, 2007. Under FIN 48, a tax position is
recognized as a benefit only if it is “more likely than not” that the tax
position would be sustained in a tax examination, with a tax examination being
presumed to occur. The amount recognized is the largest amount of tax
benefit that is greater than 50% likely of being realized on
examination. For tax positions not meeting the “more likely than not”
test, no tax benefit is recorded. The adoption of this standard did not have a
material impact on the Company’s financial statements.
The
Company recognizes interest related to income tax matters as interest expense
and penalties related to income tax matters as other noninterest
expense.
Earnings
per Share
Basic
earnings per share are computed by dividing net income by the weighted average
common shares outstanding. Diluted earnings per share reflect potential dilution
from outstanding stock options, using the treasury stock
method. There were 447,526, 167,763 and 25,225 stock options
for 2007, 2006, and 2005 that were considered to be antidilutive and excluded
from the computation of diluted earnings per share. For each of the
years presented, net income is the same for basic and diluted earnings per
share. Reconciliation of weighted average shares used in computing basic and
diluted earnings per share is as follows
|
|
Year ended December
31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
Weighted
average common shares outstanding - used in computing basic
earnings per share
|
|
|
12,398,270
|
|
|
11,725,671
|
|
|
11,795,635
|
Dilutive
effect of stock options outstanding,using the treasury stock
method
|
|
|
138,470
|
|
|
230,762
|
|
|
311,595
|
Shares
used in computing diluted earnings per share
|
|
|
12,536,740
|
|
|
11,956,433
|
|
|
12,107,230
|
|
|
|
|
|
|
|
|
|
|
Stock-Based
Compensation
Prior to
2006, the Company accounted for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board (“APB”)
Opinion No. 25, “Accounting for Stock Issued to Employees.” No
compensation expense was recognized in the financial statements for stock option
arrangements, as the Company’s stock option plan provides for the issuance of
options at a price of no less than the fair market value at the date of the
grant.
Effective
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
(“SFAS”) No. 123R, Share-based Payment, using the modified prospective
transition method. Accordingly, the Company has recorded stock-based
employee compensation cost using the fair value method starting in
2006.
Prior to
January 1, 2006, employee compensation expense under stock options was reported
using the intrinsic value method; therefore, no stock-based compensation cost is
reflected in net income for the year ended December 31, 2005, as all options
granted had an exercise price equal to or greater than the market price of the
underlying common stock at date of grant.
The
following table presents the effect on net income and earnings per share if
expense was measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, for the year ended
December 31, 2005;
(Dollars
in thousands, except per share data)
|
|
December
31, 2005
|
Net
income as reported
|
|
$ |
14,446 |
Less:
Compensation expense for stock options determined under fair value
method
|
|
|
(438) |
Pro
forma net income
|
|
$ |
14,008 |
|
|
|
|
Net
income per common share - basic
|
|
|
|
As
reported
|
|
$ |
1.22 |
Pro
forma
|
|
$ |
1.19 |
Net
income per common share - diluted
|
|
|
|
As
reported
|
|
$ |
1.19 |
Pro
forma
|
|
$ |
1.16 |
Comprehensive
Income
Comprehensive
income includes net income and other comprehensive income. The Company’s sources
of other comprehensive income are unrealized gains and losses on securities
available-for-sale and I/O strips, which are treated like available-for-sale
securities, and the liability related to the Company’s supplemental retirement
plan. The items in other comprehensive income are presented net of
deferred income tax effects. Reclassification adjustments result from gains or
losses on securities that were realized and included in net income of the
current period that also had been included in other comprehensive income as
unrealized holding gains and losses.
The
following is a summary of the components of other comprehensive income
(loss):
|
|
Year
ended December 31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
Net
unrealized gains (losses) on available-for-sale of securities and I/O
strips during the year
|
|
$ |
1,766 |
|
$ |
650 |
|
$ |
(1,212) |
Less:
Deferred income tax
|
|
|
(738) |
|
|
(273) |
|
|
548 |
Net
unrealized gains (losses) on available-for-sale securities and I/O
strips, net of deferred income tax
|
|
|
1,028 |
|
|
377 |
|
|
(664) |
Pension
liability adjustment during the year
|
|
|
137 |
|
|
601 |
|
|
(563) |
Less:
Deferred income tax
|
|
|
(58) |
|
|
(252) |
|
|
236 |
Pension
liability adjustment, net of deferred income tax
|
|
|
79 |
|
|
349 |
|
|
(327) |
Other
comprehensive income (loss)
|
|
$ |
1,107 |
|
$ |
726 |
|
$ |
(991) |
|
|
|
|
|
|
|
|
|
|
Accumulated
other comprehensive income (loss) consisted of the following items, net of
deferred tax, at year-end.
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Unrealized
net losses on securities available-for-sale and I/O strips
|
|
$ |
136 |
|
$ |
(892) |
Pension
liability
|
|
|
(1,024) |
|
|
(1,103) |
Accumulated
other comprehensive income (loss)
|
|
$ |
(888) |
|
$ |
(1,995) |
|
|
|
|
|
|
|
Segment
Reporting
HBC is an
independent community business bank with eleven branch offices that offer
similar products to customers. No customer accounts for more than 10 percent of
revenue for HBC or the Company. Management evaluates the Company’s
performance as a whole and does not allocate resources based on the performance
of different lending or transaction activities. Accordingly, the
Company and its subsidiary bank all operate as one business
segment.
Reclassifications
Certain
amounts in the 2006 and 2005 financial statements have been reclassified to
conform to the 2007 presentation.
Adoption
of Other New Accounting Standards
In
February, 2006, FASB issued Statement 155, Accounting for Certain Hybrid
Instruments. This standard amended the guidance in Statement 133, Accounting for Derivative
Instruments and Hedging Activities, and Statement 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities.
Statement 155 permits fair value remeasurement for any hybrid financial
instrument that contains an embedded derivative that otherwise would require
bifurcation and clarifies which interest-only and principal-only strips are not
subject to the requirements of Statement 133. Statement 155 is
effective for all financial instruments acquired or issued after the beginning
of an entity’s first fiscal year that begins after September 15, 2006. The
adoption of this standard did not have a material impact on the Company’s
financial statements.
Newly
Issued but not yet Effective Accounting Standards
In
September 2006, FASB issued Statement 157, Fair Value Measurements. This
Statement defines fair value, establishes a framework for measuring fair value
in generally accepted accounting principles (“GAAP”), and expands disclosures
about fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, FASB having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. This Statement is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The adoption of this standard is not
expected to have a material impact on the Company’s financial
statements.
In
February 2007, FASB issued Statement 159, The Fair Value Option for Financial
Assets and Financial Liabilities. This statement provides companies with
an option to report selected financial assets and liabilities at fair
value. The Standard’s objective is to reduce both complexity in accounting
for financial instruments and the volatility in earnings caused by measuring
related assets and liabilities differently. The standard requires
companies to provide additional information that will help investors and other
users of financial statements to more easily understand the effect of the
company’s choice to use fair value on its earnings. It also requires entities to
display the fair value of those assets and liabilities for which the company has
chosen to use fair value on the face of the balance sheet. The new
Statement does not eliminate disclosure requirements included in other
accounting standards, including requirements for disclosures about fair value
measurements included in Statements 157, Fair Value Measurements, and
107, Disclosures about Fair
Value of Financial Instruments. This Statement is
effective as of the beginning of an entity’s first fiscal year that begins after
November 15, 2007. The Company elected to not implement Statement
159.
On
November 5, 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at
Fair Value through Earnings (“SAB 109”). Previously, SAB
105, Application of Accounting
Principles to Loan Commitments, stated that in measuring the fair value
of a loan commitment, a company should not incorporate the expected net future
cash flows related to the associated servicing of the loan. SAB 109
supersedes SAB 105 and indicates that the expected net future cash flows related
to the associated servicing of the loan should be included in measuring fair
value for all written loan commitments that are accounted for at fair value
through earnings. SAB 105 also indicated that internally-developed
intangible assets should not be recorded as part of the fair value of a
derivative loan commitment, and SAB 109 retains that view. SAB 109 is
effective for derivative loans commitments issued or modified in fiscal quarters
beginning after December 15, 2007. The Company does not expect the
impact of this standard to be material.
(2)
Securities
The
amortized cost and estimated fair value of securities at year-end were as
follows:
|
|
|
|
Gross
|
|
Gross
|
|
Estimated
|
2007
|
|
Amortized
|
|
Unrealized
|
|
Unrealized
|
|
Fair
|
(Dollars
in thousands)
|
|
Cost
|
|
Gains
|
|
Losses
|
|
Value
|
Securities
available-for-sale:
|
|
|
|
|
|
|
|
|
U.S.
Treasury
|
|
$ |
4,942 |
|
$ |
49 |
|
$ |
- |
|
$ |
4,991 |
U.S.
Government Agencies
|
|
|
35,578 |
|
|
256 |
|
|
(31) |
|
|
35,803 |
Municipals
- Tax Exempt
|
|
|
4,139 |
|
|
- |
|
|
(25) |
|
|
4,114 |
Mortgage-Backed
Securities
|
|
|
83,811 |
|
|
322 |
|
|
(1,087) |
|
|
83,046 |
Collateralized
Mortgage Obligations
|
|
|
7,369 |
|
|
162 |
|
|
(83) |
|
|
7,448 |
Total
securities available-for-sale
|
|
$ |
135,839 |
|
$ |
789 |
|
$ |
(1,226) |
|
$ |
135,402 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
Gross
|
|
Estimated
|
2006
|
|
Amortized
|
|
Unrealized
|
|
Unrealized
|
|
Fair
|
(Dollars
in thousands)
|
|
Cost
|
|
Gains
|
|
Losses
|
|
Value
|
Securities
available-for-sale:
|
|
|
|
|
|
|
|
|
U.S.
Treasury
|
|
$ |
6,000 |
|
$ |
- |
|
$ |
(37) |
|
$ |
5,963 |
U.S.
Government Agencies
|
|
|
59,610 |
|
|
27 |
|
|
(241) |
|
|
59,396 |
Municipals
- Tax Exempt
|
|
|
8,299 |
|
|
- |
|
|
(157) |
|
|
8,142 |
Mortgage-Backed
Securities
|
|
|
93,150 |
|
|
74 |
|
|
(3,038) |
|
|
90,186 |
Collateralized
Mortgage Obligations
|
|
|
8,683 |
|
|
76 |
|
|
(148) |
|
|
8,611 |
Total
securities available-for-sale
|
|
$ |
175,742 |
|
$ |
177 |
|
$ |
(3,621) |
|
$ |
172,298 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities
classified as U.S. Government Agencies as of December 31, 2007 were issued by
the Federal National Mortgage Association, Federal Home Loan Mortgage
Corporation, and the Federal Home Loan Bank.
At year
end 2007 and 2006, there were no holdings of securities of any one issuer, other
than the U.S. Government and its agencies, in an amount greater than 10% of
shareholders’ equity.
No
securities were sold in 2007, 2006 or 2005.
Securities
with unrealized losses at year end, aggregated by investment category and length
of time that individual securities have been in a continuous unrealized loss
position, are as follows:
|
|
Less Than 12
Months
|
|
12 Months or
More
|
|
Total
|
2007
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
(Dollars in
thousands)
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
U.S.
Government Agencies
|
|
|
1,251
|
|
|
(1)
|
|
|
2,969
|
|
|
(30)
|
|
|
4,220
|
|
|
(31)
|
Mortgage-Backed
Securities
|
|
|
2,132
|
|
|
(7)
|
|
|
55,817
|
|
|
(1,080)
|
|
|
57,949
|
|
|
(1,087)
|
Municipals
- Tax Exempt
|
|
|
-
|
|
|
-
|
|
|
4,117
|
|
|
(25)
|
|
|
4,117
|
|
|
(25)
|
Collateralized
Mortgage Obligations
|
|
|
-
|
|
|
-
|
|
|
2,447
|
|
|
(83)
|
|
|
2,447
|
|
|
(83)
|
Total
|
|
$
|
3,383
|
|
$
|
(8)
|
|
$
|
65,350
|
|
$
|
(1,218)
|
|
$
|
68,733
|
|
$
|
(1,226)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less Than 12
Months
|
|
12 Months or
More
|
|
Total
|
2006
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
(Dollars in
thousands)
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
U.S.
Treasury
|
|
$
|
-
|
|
$
|
-
|
|
$
|
5,963
|
|
$
|
(37)
|
|
$
|
5,963
|
|
$
|
(37)
|
U.S.
Government Agencies
|
|
|
35,078
|
|
|
(87)
|
|
|
11,456
|
|
|
(154)
|
|
|
46,534
|
|
|
(241)
|
Mortgage-Backed
Securities
|
|
|
11,691
|
|
|
(65)
|
|
|
68,421
|
|
|
(2,973)
|
|
|
80,112
|
|
|
(3,038)
|
Municipals
- Tax Exempt
|
|
|
-
|
|
|
-
|
|
|
8,142
|
|
|
(157)
|
|
|
8,142
|
|
|
(157)
|
Collateralized
Mortgage Obligations
|
|
|
-
|
|
|
-
|
|
|
3,257
|
|
|
(148)
|
|
|
3,257
|
|
|
(148)
|
Total
|
|
$
|
46,769
|
|
$
|
(152)
|
|
$
|
97,239
|
|
$
|
(3,469)
|
|
$
|
144,008
|
|
$
|
(3,621)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At
December 31, 2007, the Company held 78 securities, of which 34 had fair values
below amortized cost. Thirty-one securities have been carried with an unrealized
loss for over 12 months. Unrealized losses were primarily due to
higher interest rates. No security sustained a downgrade in credit
rating. The issuers are of high credit quality and all principal
amounts are expected to be paid when securities mature. The fair value is
expected to recover as the securities approach their maturity date and/or market
rates decline. Because the Company has the ability and intent to hold
these securities until a recovery of fair value, which may be maturity, the
Company does not consider these securities to be other-than-temporarily impaired
at December 31, 2007.
At
December 31, 2006, the Company held 99 securities, of which 73 had fair values
below amortized cost. Fifty-two securities have been carried with an unrealized
loss for over 12 months. Unrealized losses were primarily due to
higher interest rates. No security sustained a downgrade in credit
rating. The issuers are of high credit quality and all principal
amounts are expected to be paid when securities mature. The fair value is
expected to recover as the securities approach their maturity date and/or market
rates decline. Because the Company has the ability and intent to hold
these securities until a recovery of fair value, which may be maturity, the
Company did not consider these securities to be other-than-temporarily impaired
at December 31, 2006.
The
amortized cost and estimated fair values of securities as of December 31, 2007,
by contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or pre-pay
obligations with or without call or pre-payment penalties.
|
|
Available-for-sale
|
(Dollars
in thousands)
|
|
Amortized
Cost
|
|
Estimated
Fair Value
|
Due
within one year
|
|
$ |
32,570 |
|
$ |
32,672 |
Due
after one through five years
|
|
|
13,868 |
|
|
13,979 |
Due
after five through ten years
|
|
|
17,317 |
|
|
17,498 |
Due
after ten years
|
|
|
72,084 |
|
|
71,253 |
Total
|
|
$ |
135,839 |
|
$ |
135,402 |
|
|
|
|
|
|
|
Securities
with amortized cost of $42,174,000 and $53,708,000 as of December 31, 2007 and
2006 were pledged to secure public and certain other deposits as required by law
or contract.
(3)
Loans and Loan Servicing
Loans at
year-end were as follows:
|
|
|
|
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Loans
held for sale
|
|
$ |
- |
|
$ |
33,752 |
|
|
|
|
|
|
|
Loans
held for investment
|
|
|
|
|
|
|
Commercial
|
|
$ |
411,251 |
|
$ |
284,093 |
Real
estate - mortgage
|
|
|
361,211 |
|
|
239,041 |
Real
estate - land and construction
|
|
|
215,597 |
|
|
143,834 |
Home
equity
|
|
|
44,187 |
|
|
38,976 |
Consumer
|
|
|
3,044 |
|
|
2,422 |
Total
loans
|
|
|
1,035,290 |
|
|
708,366 |
Deferred
loan origination costs and fees, net
|
|
|
1,175 |
|
|
870 |
Allowance
for loan losses
|
|
|
(12,218) |
|
|
(9,279) |
Loans,
net
|
|
$ |
1,024,247 |
|
$ |
699,957 |
|
|
|
|
|
|
|
Real
estate mortgage loans are primarily secured by mortgages on commercial
property.
During
2006, HBC purchased $10,306,000 of home equity loans from another
bank. The premium that HBC paid over the face value of the loans was
insignificant. The purchased loans are considered to be of
satisfactory credit quality.
Changes
in the allowance for loan losses were as follows:
|
|
|
|
|
|
|
|
|
|
Year ended December
31,
|
|
(Dollars in
thousands)
|
|
2007
|
|
2006
|
|
2005
|
|
Balance,
beginning of year
|
|
$
|
9,279
|
|
$
|
10,224
|
|
$
|
12,497
|
|
Loans
charged-off
|
|
|
(104)
|
|
|
(831)
|
|
|
(3,273)
|
|
Recoveries
|
|
|
929
|
|
|
389
|
|
|
1,358
|
|
Net
recoveries (charge-offs)
|
|
|
825
|
|
|
(442)
|
|
|
(1,915)
|
|
Provision
for loan losses
|
|
|
(11)
|
|
|
(503)
|
|
|
313
|
|
Reclassification
of allowance for loan losses
|
|
|
-
|
|
|
-
|
|
|
671
|
(1) |
Allowance
acquired in bank acquisition
|
|
|
2,125
|
|
|
-
|
|
|
-
|
|
Balance,
end of year
|
|
$
|
12,218
|
|
$
|
9,279
|
|
$
|
10,224
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
The
Company reclassified $671,000 of the allowance allocated to $32 million of
commercial asset based loans that were reclassified to loans held-for-sale
as of December 31, 2005. Thus, the carrying value of these
loans held-for-sale includes an allowance for loan losses of
$671,000.
|
Impaired
loans were as follows:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Year-end
loans with no allocated allowance for loan losses
|
|
$ |
439 |
|
$ |
1,020 |
Year-end
loans with allocated allowance for loan losses
|
|
|
6,620 |
|
|
8,011 |
Total
|
|
$ |
7,059 |
|
$ |
9,031 |
|
|
|
|
|
|
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
Amount
of the allowance for loan losses allocated at year-end
|
|
$ |
1,478 |
|
$ |
1,226 |
|
$ |
2,656 |
Average
of impaired loans during the year
|
|
$ |
8,329 |
|
$ |
13,551 |
|
$ |
16,823 |
Cash
basis interest income recognized during impairment
|
|
$ |
103 |
|
$ |
28 |
|
$ |
110 |
Interest
income during impairment
|
|
$ |
1,031 |
|
$ |
1,012 |
|
$ |
885 |
Nonperforming
loans include both smaller dollar balance homogenous loans that are collectively
evaluated for impairment and individually classified
loans. Nonperforming loans were as follows at year-end:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Loans
past due over 90 days still on accrual
|
|
$ |
101 |
|
$ |
451 |
Nonaccrual
loans
|
|
$ |
3,363 |
|
$ |
3,866 |
Concentrations
of credit risk arise when a number of clients are engaged in similar business
activities, or activities in the same geographic region, or have similar
features that would cause their ability to meet contractual obligations to be
similarly affected by changes in economic conditions. The Company’s loan
portfolio is concentrated in commercial (primarily manufacturing, wholesale, and
service) and real estate lending, with the balance in consumer loans. While no
specific industry concentration is considered significant, the Company’s lending
operations are located in the Company’s market areas that are dependent on the
technology and real estate industries and their supporting companies. Thus, the
Company’s borrowers could be adversely impacted by a downturn in these sectors
of the economy which could reduce the demand for loans and adversely impact the
borrowers’ ability to repay their loans.
HBC makes
loans to executive officers, directors, and their affiliates. The following
table presents the loans outstanding to these related parties:
(Dollars
in thousands)
|
|
2007
|
Balance,
beginning of year
|
|
$ |
2 |
Advances
on loans during the year
|
|
|
1,300 |
Repayment
on loans during the year
|
|
|
(1,301) |
Balance,
end of year
|
|
$ |
1 |
|
|
|
|
At
December 31, 2007 and 2006, the Company serviced SBA loans sold to the secondary
market of approximately $177,161,000 and $188,844,000.
Activity
for loan servicing rights follows:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Beginning
of year balance
|
|
$ |
2,154 |
|
$ |
2,171 |
Additions
|
|
|
575 |
|
|
1,195 |
Amortization
|
|
|
(975) |
|
|
(1,212) |
End
of year balance
|
|
$ |
1,754 |
|
$ |
2,154 |
|
|
|
|
|
|
|
Loan
servicing income is reported net of amortization. There was no valuation
allowance as of December 31, 2007 and 2006, as the fair market value of the
assets was greater than the carrying value. The estimated fair value of loan
servicing rights was $2,333,000 and $3,562,000 at December 31, 2007 and
2006.
Servicing
assets represent the servicing spread generated from the sold guaranteed
portions of SBA and other guaranteed loans. The weighted average
servicing rate for all loans serviced was 1.60% and 1.70% at December 31, 2007
and 2006, respectively. In recording the initial value of the servicing rights
and the fair value of the I/O strip receivable, the Company uses estimates which
are based on management’s expectations of future prepayment and discount rates.
Management’s estimate of constant prepayment rate (“CPR”) was 18.7% and 17.7%
for the years ended December 31, 2007 and 2006, respectively. The
weighted average discount rate assumption was 9.7% and 9.8% for the years ended
December 31, 2007 and 2006, respectively. These prepayment and
discount rates were based on current market conditions and historical
performance of the various loan pools. If actual prepayments with
respect to sold loans occur more quickly than projected, the carrying value of
the servicing rights may have to be adjusted through a charge to
earnings. A corresponding decrease in the value of the I/O strip
receivable would also be expected.
Management
reviews key economic assumptions used in the FASB Statement 140 accounting model
to establish the value of the I/O strip on a quarterly basis. The Bank has
completed a sensitivity analysis to determine the impact on the value of the
asset in the event of a 10% and 20% adverse change, independently from any
change in another key assumption. This test involved the CPR assumption and the
discount rate assumptions. The value of the I/O strip can be
adversely impacted by a significant increase in either the prepayment speed of
the portfolio or a significant increase in the discount rate.
At
December 31, 2007, key economic assumptions and the sensitivity of the current
fair value of residual cash flows on the I/O strip to immediate 10 percent and
20 percent adverse changes in those assumptions are as follows:
(Dollars
in thousands)
|
|
|
Carrying
amount/fair value of Interest-Only (I/O) strip
|
|
$ |
2,332 |
Weighted
average life (in years)
|
|
|
3.4 |
Prepayment
speed assumption (annual rate)
|
|
|
21.4% |
Impact
on fair value of 10% adverse change in prepayment speed (CPR
23.5%)
|
|
$ |
(127) |
Impact
on fair value of 20% adverse change in prepayment speed (CPR
25.6%)
|
|
$ |
(245) |
Residual
cash flow discount rate assumption (annual)
|
|
|
20.0% |
Impact
on fair value of 10% adverse change in discount rate (22.0% discount
rate)
|
|
$ |
(96) |
Impact
on fair value of 20% adverse change in discount rate (24.0% discount
rate)
|
|
$ |
(184) |
Activity
for I/O strip receivables in 2007 and 2006 follows:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Beginning
of year balance
|
|
$ |
4,537 |
|
$ |
4,679 |
Additions
|
|
|
27 |
|
|
1,272 |
Amortization
|
|
|
(991) |
|
|
(1,229) |
Unrealized
loss
|
|
|
(1,241) |
|
|
(185) |
End
of year balance
|
|
$ |
2,332 |
|
$ |
4,537 |
|
|
|
|
|
|
|
(4)
Premises and Equipment
Premises
and equipment at year end were as follows:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Building
|
|
$ |
3,243 |
|
$ |
- |
Land
|
|
|
2,900 |
|
|
- |
Furniture
and equipment
|
|
|
6,031 |
|
|
4,704 |
Leasehold
improvements
|
|
|
4,864 |
|
|
4,420 |
|
|
|
17,038 |
|
|
9,124 |
|
|
|
|
|
|
|
Accumulated
depreciation and amortization
|
|
|
(7,730) |
|
|
(6,585) |
Premises
and equipment, net
|
|
$ |
9,308 |
|
$ |
2,539 |
|
|
|
|
|
|
|
Depreciation
expense was $776,000, $662,000, and $988,000 in 2007, 2006, and 2005,
respectively.
(5)
Goodwill and Intangible Assets
Goodwill
The
change in balance for goodwill during the year follows:
(Dollars
in thousands)
|
|
2007
|
Beginning
balance, January 1, 2007
|
|
$ |
- |
Recorded
amounts during the year
|
|
|
43,181 |
Ending
balance, December 31, 2007
|
|
$ |
43,181 |
|
|
|
|
Acquired
Intangible Assets
Core
deposit and customer relationship intangible assets acquired in the 2007
acquisition of Diablo Valley Bank were $5,049,000 and $276,000, respectively.
Accumulated amortization of these intangible assets was $352,000 at December 31,
2007.
Estimated
amortization expense for each of the next five years:
(Dollars
in thousands)
|
|
|
2008
|
|
$ |
741 |
2009
|
|
|
642 |
2010
|
|
|
575 |
2011
|
|
|
523 |
2012
|
|
|
492 |
(6)
Acquisition of Diablo Valley Bank
The
Company completed its acquisition of Diablo Valley Bank on June 20,
2007. The transaction was valued at approximately $65 million,
including payments for cancellation of options for Diablo Valley Bank common
stock. The merger consideration consisted of approximately $24
million in cash and the issuance of 1,732,298 shares of the Company’s common
stock in exchange for all outstanding Diablo Valley Bank shares and stock
options. Prior to closing, Diablo Valley Bank redeemed all of its
outstanding Series A Preferred Stock for an aggregate of approximately $6.7
million in cash (including dividend payments). The consolidated
financial statements of the Company for the year ended December 31, 2007 include
purchase accounting adjustments to record the assets and liabilities of Diablo
Valley Bank at their estimated fair values.
The
following table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of
acquisition.
Cash
and cash equivalents
|
|
$ |
41,807 |
Securities
available-for-sale
|
|
|
12,214 |
Net
loans
|
|
|
203,805 |
Goodwill
|
|
|
43,181 |
Core
deposit and customer relationship intangible assets
|
|
|
5,325 |
Premises
and equipment
|
|
|
6,841 |
Corporate
owned life insurance
|
|
|
1,026 |
Federal
Home Loan Bank Stock
|
|
|
717 |
Other
assets, net
|
|
|
2,615 |
Total
assets acquired
|
|
|
317,531 |
|
|
|
|
Deposits
|
|
|
(249,023) |
Other
liabilities
|
|
|
(1,711) |
Total
liabilities
|
|
|
(250,734) |
Net
assets acquired
|
|
$ |
66,797 |
|
|
|
|
None of
the goodwill is deductible for tax purposes.
The
Company’s cost to acquire Diablo Valley Bank is summarized as
follows:
Cash
paid to Diablo Valley Bank common shareholders and stock option
holders
|
|
$ |
24,002 |
Common
stock issued to Diablo Valley Bank shareholders
|
|
|
41,397 |
Total
consideration
|
|
|
65,399 |
Professional
fees and other acquisition costs
|
|
|
1,398 |
Net
assets acquired
|
|
$ |
66,797 |
|
|
|
|
Diablo
Valley Bank was acquired by the Company for several reasons. Diablo
Valley Bank was a profitable and fast growing bank in a geographic area where
the Company wants to expand. Diablo Valley Bank had experienced staff
and the acquisition also enhanced the Company’s position in the East Bay area in
the cities of Danville and Pleasanton. The Company believes it can
achieve significant cost savings from merging Diablo Valley Bank into Heritage
Bank of Commerce.
The
following table presents pro forma information as if the acquisition had
occurred at the beginning of 2007 and 2006. The pro forma financial
information is not necessarily indicative of the results of operations as they
would have been had the transaction been effected on the assumed date and is not
intended to be a projection of future results.
Unaudited
|
(Dollars
in thousands, except per share data)
|
|
2007
|
|
2006
|
Net
interest income
|
|
$ |
56,805 |
|
$ |
59,854 |
Net
income
|
|
$ |
15,193 |
|
$ |
18,360 |
Net
income per share - basic
|
|
$ |
1.15 |
|
$ |
1.36 |
Net
income per share - diluted
|
|
$ |
1.14 |
|
$ |
1.34 |
(7)
Deposits
The
following table presents the scheduled maturities of time deposits, including
brokered deposits, for the next five years:
(Dollars
in thousands)
|
|
December
31, 2007
|
2008
|
|
$ |
194,644 |
2009
|
|
|
17,482 |
2010
|
|
|
1,231 |
2011
|
|
|
44 |
2012
|
|
|
- |
Total
|
|
$ |
213,401 |
|
|
|
|
Deposits
from executive officers, directors, and their affiliates were $9,691,000 at
December 31, 2007.
(8)
Borrowing Arrangements
FHLB
Borrowings & Available Lines of Credit
The
Company maintains a collateralized line of credit with the Federal Home Loan
Bank (“the FHLB”) of San Francisco. Under this line, the Company can
borrow from the FHLB on a short-term (typically overnight) or long-term (over
one year) basis. As of December 31, 2007, the Company had $60 million of
overnight borrowings from the FHLB, bearing interest at 4.05%. There were no
outstanding advances at December 31, 2006. The Company has $164
million of loans and $11 million of securities pledged to the FHLB as
collarteral on a line of credit of $94 million at December 31,
2007.
At
December 31, 2007, the Company has Federal funds purchase arrangements and lines
of credit available of $72 million. There were no Fed Funds
purchased at December 31, 2007 and 2006.
Securities
sold under agreements to repurchase are secured by mortgage-backed securities
carried at $12,993,000 and $27,694,000, respectively, at December 31, 2007 and
2006. The repurchase agreements, totaling $10,900,000 at December 31, 2007
mature in 2008.
Notes
Payable to Subsidiary Grantor Trusts
The
following is a summary of the notes payable to the Company’s subsidiary grantor
trusts at December 31:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Subordinated
debentures due to Heritage Capital Trust I with
|
|
|
|
|
interest
payable semi-annually at 10.875%, redeemable with a
|
|
|
|
|
premium
beginning March 8, 2010 and with no premium beginning
|
|
|
|
|
March
8, 2020 and due March 8, 2030
|
|
$ |
7,217 |
|
$ |
7,217 |
|
|
|
|
|
|
|
Subordinated
debentures due to Heritage Statutory Trust I with
|
|
|
|
|
|
|
interest
payable semi-annually at 10.6%, redeemable with a
|
|
|
|
|
|
|
premium
beginning September 7, 2010 and with no premium beginning
|
|
|
|
|
|
|
September
7, 2020 and due September 7, 2030
|
|
|
7,206 |
|
|
7,206 |
|
|
|
|
|
|
|
Subordinated
debentures due to Heritage Statutory Trust II with
|
|
|
|
|
|
|
interest
payable semi-annually based on 3-month Libor plus 3.58%
|
|
|
|
|
|
|
(8.54%
at December 31, 2007), redeemable with a premium beginning
|
|
|
|
|
|
|
July
31, 2006 and with no premium beginning July 31, 2011 and
|
|
|
|
|
|
|
due
July 31, 2031
|
|
|
5,155 |
|
|
5,155 |
|
|
|
|
|
|
|
Subordinated
debentures due to Heritage Statutory Trust III with
|
|
|
|
|
|
|
interest
payable semi-annually based on 3-month Libor plus 3.40%
|
|
|
|
|
|
|
(8.26%
at December 31, 2007), redeemable with no premium
beginning
|
|
|
|
|
|
|
September
26, 2012 and due September 26, 2032
|
|
|
4,124 |
|
|
4,124 |
|
|
|
|
|
|
|
Total
|
|
$ |
23,702 |
|
$ |
23,702 |
|
|
|
|
|
|
|
The
Company has guaranteed, on a subordinated basis, distributions and other
payments due on the trust preferred securities issued by the subsidiary grantor
trusts.
(9)
Income Taxes
Income
tax expense consisted of the following:
|
|
December
31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
Currently
payable tax:
|
|
|
|
|
|
|
Federal
|
|
$ |
6,013 |
|
$ |
7,472 |
|
$ |
5,921 |
State
|
|
|
2,349 |
|
|
2,084 |
|
|
1,719 |
Total
currently payable
|
|
|
8,362 |
|
|
9,556 |
|
|
7,640 |
|
|
|
|
|
|
|
|
|
|
Deferred
tax (benefit)
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(223) |
|
|
(258) |
|
|
(292) |
State
|
|
|
(2) |
|
|
(61) |
|
|
(68) |
Total
deferred tax (benefit)
|
|
|
(225) |
|
|
(319) |
|
|
(360) |
Income
tax expense
|
|
$ |
8,137 |
|
$ |
9,237 |
|
$ |
7,280 |
|
|
|
|
|
|
|
|
|
|
The
effective tax rate differs from the federal statutory rate for the years ended
December 31, as follows:
|
|
2007
|
|
2006
|
|
2005
|
Statutory
Federal income tax rate
|
|
35.0%
|
|
35.0%
|
|
35.0%
|
State
income taxes, net of federal tax benefit
|
|
7.2%
|
|
5.6%
|
|
4.9%
|
Low
income housing credits
|
|
-4.9%
|
|
-3.9%
|
|
-4.3%
|
Non-taxable
interest income
|
|
-0.2%
|
|
-0.2%
|
|
-0.3%
|
Increase
in cash surrender value of life insurance
|
|
-2.3%
|
|
-1.9%
|
|
-2.0%
|
Stock
based compensation
|
|
1.1%
|
|
0.7%
|
|
-
|
Other
|
|
0.7%
|
|
-0.5%
|
|
0.2%
|
Effective
tax rate
|
|
36.6%
|
|
34.8%
|
|
33.5%
|
|
|
|
|
|
|
|
Net
deferred tax assets at year-end consist of the following:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Deferred
tax assets:
|
|
|
|
|
Allowance
for loan losses
|
|
$ |
5,061 |
|
$ |
3,901 |
Deferred
compensation
|
|
|
4,750 |
|
|
4,183 |
Net
operating loss carryforward
|
|
|
163 |
|
|
- |
Fixed
Assets
|
|
|
780 |
|
|
924 |
Postretirement
benefit obligation
|
|
|
741 |
|
|
799 |
Accrued
expenses
|
|
|
717 |
|
|
524 |
State
income taxes
|
|
|
715 |
|
|
729 |
Loans
|
|
|
373 |
|
|
- |
Loans
held for sale
|
|
|
- |
|
|
389 |
Securities
available-for-sale and I/O strips
|
|
|
- |
|
|
646 |
Other
|
|
|
561 |
|
|
322 |
Total
deferred tax assets
|
|
|
13,861 |
|
|
12,417 |
|
|
|
|
|
|
|
Deferred
tax liabilities:
|
|
|
|
|
|
|
FHLB
Stock
|
|
|
(253) |
|
|
(150) |
Loan
fees
|
|
|
(456) |
|
|
(606) |
Securities
available-for-sale and I/O strips
|
|
|
(95) |
|
|
- |
Intangible
assets
|
|
|
(2,091) |
|
|
- |
Prepaid
expenses
|
|
|
(332) |
|
|
(277) |
Other
|
|
|
(489) |
|
|
(215) |
Total
deferred tax liabilities
|
|
|
(3,716) |
|
|
(1,248) |
Net
deferred tax assets
|
|
$ |
10,145 |
|
$ |
11,169 |
|
|
|
|
|
|
|
The
Company and its subsidiaries are subject to U.S. Federal income tax as well as
income of the state of California. The Company is no longer subject
to examination by taxing authorities for years before 2004.
At year
end 2007, the Company has a California net operating loss carryforwards acquired
from the Diablo Valley Bank acquisition of approximately $2,300,000 which will
expire in 2022 if not utilized.
(10) Stock option
plan
The
Company has a stock option plan (the Plan) for directors, officers, and key
employees. The Plan provides for the grant of incentive and non-qualified stock
options. The Plan provides that the option price for both incentive and
non-qualified stock options will be determined by the Board of Directors at no
less than the fair value at the date of grant. Options granted vest on a
schedule determined by the Board of Directors at the time of grant. Generally,
options vest over four years. All options expire no later than ten years from
the date of grant. On May 25, 2006, the Company’s shareholders approved an
amendment to the Heritage Commerce Corp 2004 Stock Option Plan by authorizing
550,000 additional shares available for option grants. As of December
31, 2007, there are 73,134 shares available for future grants under the
Plan.
Option
activity under the Plan is as follows:
|
|
|
|
|
|
Weighted
Average
|
|
|
|
|
|
|
Weighted
|
|
Remaining
|
|
Aggregate
|
|
|
Number
|
|
Average
|
|
Contractual
|
|
Intrinsic
|
Total
Stock Options
|
|
of
Shares
|
|
Exercise
Price
|
|
Life
(Years)
|
|
Value
|
Outstanding
at January 1, 2007
|
|
|
752,983 |
|
$ |
16.56 |
|
|
|
|
Granted
|
|
|
384,000 |
|
$ |
21.97 |
|
|
|
|
Exercised
|
|
|
(83,875) |
|
$ |
9.56 |
|
|
|
|
Forfeited
or expired
|
|
|
(42,446) |
|
$ |
20.97 |
|
|
|
|
Outstanding
at December 31, 2007
|
|
|
1,010,662 |
|
$ |
19.02 |
|
|
7.5 |
|
$ |
1,993,000 |
Vested
or expected to vest
|
|
|
970,236 |
|
$ |
19.02 |
|
|
7.5 |
|
$ |
1,914,000 |
Exercisable
at December 31, 2007
|
|
|
492,664 |
|
$ |
16.02 |
|
|
6.0 |
|
$ |
1,854,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Information
related to the stock option plan during each year follows:
|
|
2007
|
|
2006
|
|
2005
|
Intrinsic
value of options exercised
|
|
$ |
1,105,000 |
|
$ |
2,435,000 |
|
$ |
3,791,000 |
Cash
received from option exercise
|
|
$ |
802,000 |
|
$ |
1,812,000 |
|
$ |
3,641,000 |
Tax
benefit realized from option exercises
|
|
$ |
406,000 |
|
$ |
706,000 |
|
$ |
1,086,000 |
Weighted
average fair value of options granted
|
|
$ |
6.10 |
|
$ |
7.57 |
|
$ |
5.93 |
As of
December 31, 2007, there was $3,545,000 of total unrecognized compensation cost
related to nonvested share-based compensation arrangements granted under the
Company’s stock option plan. That cost is expected to be recognized
over a weighted-average period of approximately 2.9 years. The total
fair value of options vested during 2007 is approximately
$1,159,000.
The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model that uses the assumptions noted in the
following table.
|
|
2007
|
|
2006
|
|
2005
|
Expected
life in months (1)
|
|
72
|
|
84
|
|
84
|
Volatility
(1)
|
|
22%
|
|
21%
|
|
21%
|
Weighted
average risk-free interest rate (2)
|
|
4.49%
|
|
4.85%
|
|
4.14%
|
Expected
dividends (3)
|
|
1.18%
|
|
0.85%
|
|
0%
|
(1)
|
The
expected life of employee stock options represents the weighted average
period the stock options are expected to remain outstanding. It
is estimated based on historical experience. Volatility is
based on the historical volatility of the stock price over the same period
of the expected life of the option.
|
(2)
|
Based
on the U.S. Treasury constant maturity interest rate with a term
consistent with the expected life of the option
granted.
|
(3)
|
The
Company began paying cash dividends on the common stock in
2006. Each grant’s dividend yield is calculated by annualizing
the most recent quarterly cash dividend and dividing that amount by the
market price of the Company’s common stock as of the grant
date.
|
Forfeitures
for options granted prior to 2006 were recognized as they
occurred. Beginning in 2006, the Company estimates the impact of
forfeitures based on historical experience, and has concluded that forfeitures
have no significant effect on stock option expense. The Company
issues new shares of common stock to satisfy stock option
exercises.
The
Company granted 51,000 restricted shares of its common stock to an executive
officer pursuant to the terms of a restricted stock agreement, dated March 17,
2005. The grant price was $18.15. Under the terms of the
agreement, the restricted shares will vest 25% per year at the end of years
three, four, five and six, provided the executive officer is still with the
Company, subject to accelerated vesting upon a change of control, termination
without cause, termination by the executive officer for good reason (as defined
by the executive employment agreement), death or disability. The fair
value of stock award at the grant date was $926,000, which is being amortized to
expense over the six-year vesting period on the straight-line
method. Amortization expense was $154,000 in 2007 and 2006, and
$123,000 in 2005.
(11)
Leases
Operating
Leases
The
Company owns one of its offices and leases the others under non-cancelable
operating leases with terms, including renewal options, ranging from five to
fifteen years. Future minimum payments under the agreements are as
follows:
(Dollars
in thousands)
|
|
|
Year
ending December 31,
|
|
|
2008
|
|
$ |
2,142 |
2009
|
|
|
2,022 |
2010
|
|
|
2,175 |
2011
|
|
|
2,033 |
2012
|
|
|
2,044 |
Thereafter
|
|
|
4,203 |
Total
|
|
$ |
14,619 |
|
|
|
|
Rent
expense under operating leases was $2,644,000, $2,375,000, and $2,402,000,
respectively, in 2007, 2006, and 2005.
(12)
Benefit Plans
The
Company offers a 401(k) savings plan that allows employees to contribute up to a
maximum percentage of their compensation, as established by the Internal Revenue
Code. The Company has made a discretionary matching contribution of up to $1,500
for each employee’s contributions in 2007, 2006 and
2005. Contribution expense was $315,000, $279,000, and $271,000 in
2007, 2006 and 2005.
The
Company sponsors a non contributory employee stock ownership plan. To
participate in this plan, an employee must have worked at least 1,000 hours
during the year and must be employed by the Company. Employer contributions to
the ESOP are discretionary. Contribution expense was $247,000, $400,000 and
$177,087 in 2007, 2006, and 2005. At December 31, 2007, the ESOP owned
approximately 142,000 shares of the Company’s stock.
On
September 7, 2001, the ESOP borrowed $1,000,000 from an unaffiliated third party
lender to fund the purchase of common stock of the Company. This loan
was paid off in June 2005. The loan was collateralized by the shares
of the Company’s common stock held by the ESOP.
The
Company has a nonqualified deferred compensation plan for its directors
(“Deferral Plan”). Under the Deferral Plan, a participating director may defer
up to 100% of his monthly board fees into the Deferral Plan for up to ten years.
Amounts deferred earn interest. The director may elect a distribution schedule
of up to ten years. The Company’s deferred compensation obligation of $562,000
and $484,000 as of December 31, 2007 and 2006 is included in “Accrued interest
payable and other liabilities.”
The
Company has purchased life insurance policies on the lives of directors who have
agreed to participate in the Deferral Plan. It is expected that the earnings on
these policies will offset the cost of the program. In addition, the Company
will receive death benefit payments upon the death of the director. The proceeds
will permit the Company to “complete” the deferral program as the director
originally intended if he dies prior to the completion of the deferral program.
The disbursement of deferred fees is accelerated at death and commences one
month after the director dies.
In the
event of the director’s disability prior to attainment of his benefit
eligibility date, the director may request that the Board permit him to receive
an immediate disability benefit equal to the annualized value of the director’s
deferral account.
The
Company has a supplemental retirement plan covering key executives and directors
(“Plan”). The Plan is a nonqualified defined benefit plan and is unsecured and
unfunded and there are no Plan assets. The combined number of active
and retired/terminated participants in the Plan was 52 at December 31, 2007. The
defined benefit represents a stated amount for key executives and directors that
generally vests over nine years and is reduced for early
retirement. The Company has purchased insurance on the lives of the
directors and executive officers in the plan. If the life insurance contract is
terminated by the Company, the Company will have the obligation to pay the
retirement and death benefits. The accrued pension obligation was $11,499,000
and $10,478,000 as of December 31, 2007 and 2006, respectively, and is included
in “Accrued interest payable and other liabilities”. The Plan had
accumulated other comprehensive loss before taxes of $1,765,000 and $1,902,000,
respectively, as of December 31, 2007 and 2006. The measurement date
of the plan is December 31.
The
following table sets forth the Plan’s status at December 31:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Change
in projected benefit obligation
|
|
|
|
|
Projected
benefit obligation at beginning of year
|
|
$ |
10,478 |
|
$ |
9,782 |
Service
cost
|
|
|
734 |
|
|
799 |
Interest
cost
|
|
|
619 |
|
|
552 |
Actuarial
(gain)/loss
|
|
|
(30) |
|
|
(422) |
Benefits
paid
|
|
|
(302) |
|
|
(233) |
Projected
benefit obligation at end of year
|
|
$ |
11,499 |
|
$ |
10,478 |
|
|
|
|
|
|
|
Unfunded
Status
|
|
$ |
(11,499) |
|
$ |
(10,478) |
Unrecognized
net actuarial (gain)/loss
|
|
|
1,765 |
|
|
1,902 |
Net
amount recognized
|
|
$ |
(9,734) |
|
$ |
(8,576) |
|
|
|
|
|
|
|
Amounts
recognized in accumulated other comprehensive loss
|
|
|
|
|
|
|
Net
acturial loss
|
|
$ |
1,594 |
|
$ |
1,694 |
Prior
service cost
|
|
|
171 |
|
|
208 |
Accumulated
other comprehensive loss
|
|
$ |
1,765 |
|
$ |
1,902 |
|
|
|
|
|
|
|
Weighted-average
assumptions as of December 31
|
|
|
|
|
|
|
Discount
rate
|
|
|
6.45% |
|
|
5.98% |
Rate
of compensation increase
|
|
|
N/A |
|
|
N/A |
Expected
return on Plan assets
|
|
|
N/A |
|
|
N/A |
Benefits,
which reflect anticipated future events, service and others, are expected to be
paid over the following years:
|
|
Estimated
|
Year
(Dollars in thousands)
|
|
Benefit
Payments
|
2008
|
|
$ |
430 |
2009
|
|
|
451 |
2010
|
|
|
477 |
2011
|
|
|
595 |
2012
|
|
|
728 |
2013
to 2017
|
|
|
5,162 |
The
components of pension cost for the nonqualified supplemental retirement defined
benefit plan were as follows:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Components
of net periodic benefits cost
|
|
|
|
|
Service
cost
|
|
$ |
734 |
|
$ |
799 |
Interest
cost
|
|
|
619 |
|
|
552 |
Amortization
of net acturial and prior serice cost loss
|
|
|
106 |
|
|
180 |
Net
periodic benefit cost
|
|
$ |
1,459 |
|
$ |
1,531 |
|
|
|
|
|
|
|
The net
periodic benefit cost was determined using the following
assumptions:
|
|
2007
|
|
2006
|
Discount
rate
|
|
5.98%
|
|
5.68%
|
Rate
of increase in future compensation levels for determining
expense
|
|
N/A
|
|
N/A
|
Expected
return on Plan assets
|
|
N/A
|
|
N/A
|
|
|
|
|
|
(13)
Disclosures of Fair Value of Financial Instruments
The
estimated fair value amounts have been determined by using available market
information and appropriate valuation methodologies. However, considerable
judgment is required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented are not necessarily indicative of
the amounts that could be realized in a current market exchange. The use of
different market assumptions and/or estimation techniques may have a material
effect on the estimated fair value amounts.
The
carrying amounts and estimated fair values of the Company’s financial
instruments at year-end were as follows:
|
|
2007
|
|
2006
|
|
|
|
|
Estimated
|
|
|
|
Estimated
|
|
|
Carrying
|
|
Fair
|
|
Carrying
|
|
Fair
|
(Dollars
in thousands)
|
|
Amounts
|
|
Value
|
|
Amounts
|
|
Value
|
Assets
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
49,093 |
|
$ |
49,093 |
|
$ |
49,385 |
|
$ |
49,385 |
Securities
|
|
|
135,402 |
|
|
135,402 |
|
|
172,298 |
|
|
172,298 |
Loans,
including loans held for sale, net
|
|
|
1,024,247 |
|
|
1,011,683 |
|
|
733,709 |
|
|
723,302 |
FHLB
and FRB Stock
|
|
|
7,002 |
|
|
N/A |
|
|
6,113 |
|
|
N/A |
Accrued
interest receivable
|
|
|
5,131 |
|
|
5,131 |
|
|
4,876 |
|
|
4,876 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Time
deposits
|
|
$ |
213,401 |
|
$ |
214,151 |
|
$ |
174,073 |
|
$ |
173,953 |
Other
deposits
|
|
|
850,825 |
|
|
850,825 |
|
|
672,520 |
|
|
672,520 |
Securities
sold under agreement to repurchase
|
|
|
10,900 |
|
|
10,881 |
|
|
21,800 |
|
|
21,421 |
Other
short-term borrowings
|
|
|
60,000 |
|
|
60,000 |
|
|
- |
|
|
- |
Notes
payable subsidiary grantor trusts
|
|
|
23,702 |
|
|
24,010 |
|
|
23,702 |
|
|
25,820 |
Accrued
interest payable
|
|
|
1,844 |
|
|
1,844 |
|
|
2,048 |
|
|
2,048 |
The
following methods and assumptions were used to estimate the fair value in the
table, above:
Cash
and Cash Equivalents and Accrued Interest Receivable and Payable
The
carrying amount approximates fair value because of the short maturities of these
instruments.
Securities
Security
fair values are based on market prices or dealer quotes and, if no such
information is available, on the rate and term of the security and information
about the issuer. It was not practical to determine the fair value of
FHLB and FRB stock due to the restrictions placed on
transferability.
Loans
Loans
with similar financial characteristics are grouped together for purposes of
estimating their fair value. Loans are segregated by type such as commercial,
term real estate, residential construction, and consumer. Each loan category is
further segmented into fixed and adjustable rate interest terms.
The fair
value of performing, fixed rate loans is calculated by discounting scheduled
future cash flows using estimated market discount rates that reflect the credit
and interest rate risk inherent in the loan. The fair value of variable rate
loans approximates the carrying amount as these loans generally reprice within
90 days. The fair value of loans held for sale is based on estimated
market values.
Deposits
The fair
value of deposits with no stated maturity, such as non-interest bearing demand
deposits, savings, and money market accounts, approximates the amount payable on
demand. The carrying amount approximates the fair value of time deposits with a
remaining maturity of less than 90 days. The fair value of all other time
deposits is calculated based on discounting the future cash flows using rates
currently offered by the Bank for time deposits with similar remaining
maturities.
Notes
Payable to Subsidiary Grantor Trusts and Securities Sold Under Agreement to
Repurchase
The fair
values of notes payable to subsidiary grantor trusts and securities sold under
agreement to repurchase were determined based on the current market value for
like kind instruments of a similar maturity and structure.
Other
Short-term Borrowings
The
carrying amount approximates the fair value of short-term borrowings that
reprice frequently and fully.
Commitments
to Fund Loans/Standby Letters of Credit
The fair
values of commitments are estimated using the fees currently charged to enter
into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. The amounts
of and differences between the carrying value of commitments to fund loans or
stand by letters of credit and their fair value is not significant and therefore
is not included in the table above.
Limitations
Fair
value estimates are made at a specific point in time, based on relevant market
information about the financial instruments. These estimates do not reflect any
premium or discount that could result from offering for sale at one time the
entire holdings of a particular financial instrument. Fair value estimates are
based on judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors. These estimates are subjective in nature and involve uncertainties and
matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the
estimates.
(14)
Commitments and Contingencies
Financial
Instruments with Off-Balance Sheet Risk
HBC is a
party to financial instruments with off-balance sheet risk in the normal course
of business to meet the financing needs of its clients. These financial
instruments include commitments to extend credit and standby letters of credit.
Those instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amounts recognized in the balance
sheets.
HBC’s
exposure to credit loss in the event of non-performance of the other party to
the financial instrument for commitments to extend credit and standby letters of
credit is represented by the contractual amount of those instruments. HBC uses
the same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments. Credit risk is the possibility that a
loss may occur because a party to a transaction failed to perform according to
the terms of the contract. HBC controls the credit risk of these transactions
through credit approvals, limits, and monitoring procedures. Management does not
anticipate any significant losses as a result of these
transactions.
Commitments
to extend credit as of December 31, 2007 and 2006 were as follows:
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Commitments
to extend credit
|
|
$ |
444,172 |
|
$ |
310,200 |
Standby
letters of credit
|
|
|
21,143 |
|
|
12,020 |
Commitments
to fund
|
|
$ |
465,315 |
|
$ |
322,220 |
|
|
|
|
|
|
|
Generally,
commitments to extend credit as of December 31, 2007 are at variable rates,
typically based on the prime rate (with a margin). Commitments generally expire
within one year.
Commitments
to extend credit are agreements to lend to a client as long as there is no
violation of conditions established in the contract. Commitments generally have
fixed expiration dates or other termination clauses. Since some of the
commitments are expected to expire without being drawn upon, the total
commitment amount does not necessarily represent future cash requirements. HBC
evaluates each client’s creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by HBC upon the extension of credit, is
based on management’s credit evaluation of the borrower. Collateral held varies
but may include cash, marketable securities, accounts receivable, inventory,
property, plant and equipment, income-producing commercial properties, and/or
residential properties. Fair value of these instruments is not
material.
Standby
letters of credit are written with conditional commitments issued by HBC to
guaranty the performance of a client to a third party. The credit risk involved
in issuing letters of credit is essentially the same as that involved in
extending loan facilities to clients.
The
Company is required to maintain noninterest bearing reserves. Reserve
requirements are based on a percentage of certain deposits. As of December 31,
2007, the Company maintained reserves of $3,289,000 in the form of vault cash
and balances at the Federal Reserve Bank of San Francisco, which satisfied the
regulatory requirements.
Claims
The
Company is involved in certain legal actions arising from normal business
activities. Management, based upon the advice of legal counsel,
believes the ultimate resolution of all pending legal actions will not have a
material effect on the financial statements of the Company.
(15)
Capital Requirements
The
Company and its subsidiary bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could have
a direct material effect on the Company’s financial statements and operations.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company and HBC must meet specific capital guidelines
that involve quantitative measures of assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative judgments by
the regulators about components, risk weightings, and other
factors.
Quantitative
measures established by regulation to ensure capital adequacy require the
Company and HBC to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital to average assets (as
defined). Management believes that, as of December 31, 2007 and 2006, the
Company and HBC meet all capital adequacy guidelines to which they are
subject.
The most
recent notification from the FDIC as of December 31, 2007 categorized HBC as
“well capitalized” under the regulatory framework for prompt corrective action.
There are no conditions or events since that notification that management
believes have changed the Bank’s category.
The
Company’s actual and required consolidated capital amounts and ratios are
presented in the following table:
|
|
Actual
|
|
For
Capital Adequacy Purposes
|
(Dollars
in thousands)
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
As
of December 31, 2007
|
|
|
|
|
|
|
|
|
Total
Capital
|
|
$ |
153,687 |
|
12.5% |
|
$ |
98,203 |
|
8.0% |
(to
risk-weighted assets)
|
|
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
141,226 |
|
11.5% |
|
$ |
49,122 |
|
4.0% |
(to
risk-weighted assets)
|
|
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
141,226 |
|
11.1% |
|
$ |
51,123 |
|
4.0% |
(to
average assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
Total
Capital
|
|
$ |
157,356 |
|
18.4% |
|
$ |
68,416 |
|
8.0% |
(to
risk-weighted assets)
|
|
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
147,600 |
|
17.3% |
|
$ |
34,127 |
|
4.0% |
(to
risk-weighted assets)
|
|
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
147,600 |
|
13.6% |
|
$ |
43,412 |
|
4.0% |
(to
average assets)
|
|
|
|
|
|
|
|
|
|
|
HBC’s
actual capital and required amounts and ratios are presented in the following
table:
|
|
|
|
|
|
|
|
|
|
To
Be Well-Capitalized Under Prompt
|
|
|
Actual
|
|
For
Capital Adequacy Purposes
|
|
Corrective
Action Provisions
|
(Dollars
in thousands)
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
Ratio
|
As
of December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital
|
|
$ |
144,154 |
|
11.8% |
|
$ |
98,064 |
|
8.0% |
|
$ |
122,580 |
|
10.0% |
(to
risk-weighted assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
131,693 |
|
10.7% |
|
$ |
49,048 |
|
4.0% |
|
$ |
73,572 |
|
6.0% |
(to
risk-weighted assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
131,693 |
|
10.4% |
|
$ |
50,798 |
|
4.0% |
|
$ |
63,497 |
|
5.0% |
(to
average assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Capital
|
|
$ |
154,711 |
|
18.1% |
|
$ |
68,381 |
|
8.0% |
|
$ |
85,476 |
|
10.0% |
(to
risk-weighted assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
144,955 |
|
17.0% |
|
$ |
34,107 |
|
4.0% |
|
$ |
51,161 |
|
6.0% |
(to
risk-weighted assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier
1 Capital
|
|
$ |
144,955 |
|
13.4% |
|
$ |
43,270 |
|
4.0% |
|
$ |
54,088 |
|
5.0% |
(to
average assets)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Under
California law, the holders of common stock are entitled to receive dividends
when and as declared by the Board of Directors, out of funds legally available
therefore. The California Banking Law provides that a state-licensed bank may
not make a cash distribution to its shareholders in excess of the lesser of the
following: (i) the bank’s retained earnings, or (ii) the bank’s net income for
its last three fiscal years, less the amount of any distributions made by the
bank to its shareholders during such period. However, a bank, with the prior
approval of the Commissioner, may make a distribution to its shareholders of an
amount not to exceed the greater of (i) a bank’s retained earnings, (ii) its net
income for its last fiscal year, or (iii) its net income for the current fiscal
year. In the event that the Commissioner determines that the shareholders’
equity of a bank is inadequate or that the making of a distribution by a bank
would be unsafe or unsound, the Commissioner may order a bank to refrain from
making such a proposed distribution. At December 31, 2007, the amount available
for such dividends without prior regulatory approval was approximately
$17,503,000 for HBC. Similar restrictions apply to the amounts and sum of loan
advances and other transfers of funds from HBC to the parent
Company.
(16)
Parent Company only Condensed Financial Information
The
condensed financial statements of Heritage Commerce Corp (parent company only)
are as follows:
Condensed
Balance Sheets
|
|
|
December
31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
Assets
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
9,391 |
|
$ |
2,104 |
Investment
in subsidiary bank
|
|
|
178,290 |
|
|
143,175 |
Investment
in subsidiary trusts
|
|
|
702 |
|
|
702 |
Other
assets
|
|
|
723 |
|
|
1,131 |
Total
assets
|
|
$ |
189,106 |
|
$ |
147,112 |
|
|
|
|
|
|
|
Liabilities
and Shareholders' Equity
|
|
|
|
|
|
|
Notes
payable to subsidiary trusts
|
|
$ |
23,702 |
|
$ |
23,702 |
Other
liabilities
|
|
|
580 |
|
|
590 |
Shareholders'
equity
|
|
|
164,824 |
|
|
122,820 |
Total
liabilities and shareholders' equity
|
|
$ |
189,106 |
|
$ |
147,112 |
|
|
|
|
|
|
|
Condensed
Statements of Income and Comprehensive Income
|
|
|
For
the Year Ended December 31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
Interest
income
|
|
$ |
24 |
|
$ |
27 |
|
$ |
63 |
Dividend
from subsidiary bank
|
|
|
25,699 |
|
|
10,000 |
|
|
- |
Interest
expense
|
|
|
(2,331) |
|
|
(2,310) |
|
|
(2,136) |
Other
expenses
|
|
|
(2,156) |
|
|
(1,431) |
|
|
(1,130) |
Income
(loss) before equity in undistributed net income of subsidiary
bank
|
|
|
21,236 |
|
|
6,286 |
|
|
(3,203) |
Equity
in undistributed net income of subsidiary bank
|
|
|
(8,739) |
|
|
9,666 |
|
|
16,576 |
Income
tax benefit
|
|
|
1,599 |
|
|
1,318 |
|
|
1,073 |
Net
income
|
|
$ |
14,096 |
|
$ |
17,270 |
|
$ |
14,446 |
|
|
|
|
|
|
|
|
|
|
Condensed
Statements of Cash Flows
|
|
|
For
the Year Ended December 31,
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
2005
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
Income
|
|
$ |
14,096 |
|
$ |
17,270 |
|
$ |
14,446 |
Adjustments
to reconcile net income to net cash provided by (used in)
operations:
|
|
|
|
|
|
|
|
|
|
Amortization
of restricted stock award
|
|
|
154 |
|
|
154 |
|
|
123 |
Equity
in undistributed net income of subsidiary bank
|
|
|
8,739 |
|
|
(9,666) |
|
|
(16,576) |
Net
change in other assets and liabilities
|
|
|
399 |
|
|
3 |
|
|
(944) |
Net
cash provided by (used in) operating activities
|
|
|
23,388 |
|
|
7,761 |
|
|
(2,951) |
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
Exercise
of stock options
|
|
|
802 |
|
|
1,812 |
|
|
3,641 |
Common
stock repurchased
|
|
|
(13,653) |
|
|
(7,888) |
|
|
(5,732) |
Dividends
paid
|
|
|
(3,250) |
|
|
(2,357) |
|
|
- |
Other,
net
|
|
|
- |
|
|
- |
|
|
(12) |
Net
cash provided by (used in) financing activities
|
|
|
(16,101) |
|
|
(8,433) |
|
|
(2,103) |
Net
increase (decrease) in cash and cash equivalents
|
|
|
7,287 |
|
|
(672) |
|
|
(5,054) |
Cash
and cash equivalents, beginning of year
|
|
|
2,104 |
|
|
2,776 |
|
|
7,830 |
Cash
and cash equivalents, end of year
|
|
$ |
9,391 |
|
$ |
2,104 |
|
$ |
2,776 |
|
|
|
|
|
|
|
|
|
|
(17)
Quarterly Financial Data (Unaudited)
The
following table discloses the Company’s selected unaudited quarterly financial
data:
|
|
For
the Quarters Ended
|
(Dollars
in thousands, except per share amounts)
|
|
12/31/2007
(1)
|
|
9/30/2007
(1)
|
|
06/30/07
|
|
03/31/07
|
Interest
income
|
|
$ |
21,056 |
|
$ |
22,105 |
|
$ |
18,317 |
|
$ |
17,234 |
Interest
expense
|
|
|
7,261 |
|
|
8,324 |
|
|
5,924 |
|
|
5,503 |
Net
interest income
|
|
|
13,795 |
|
|
13,781 |
|
|
12,393 |
|
|
11,731 |
Provision
for loan losses
|
|
|
725 |
|
|
(500) |
|
|
- |
|
|
(236) |
Net
interest income after provision for loan losses
|
|
|
13,070 |
|
|
14,281 |
|
|
12,393 |
|
|
11,967 |
Noninterest
income
(2)
|
|
|
1,636 |
|
|
1,639 |
|
|
2,262 |
|
|
2,515 |
Noninterest
expense
|
|
|
10,212 |
|
|
10,518 |
|
|
8,500 |
|
|
8,300 |
Income
before income taxes
|
|
|
4,494 |
|
|
5,402 |
|
|
6,155 |
|
|
6,182 |
Income
tax expense
|
|
|
1,686 |
|
|
2,162 |
|
|
2,140 |
|
|
2,149 |
Net
income
|
|
$ |
2,808 |
|
$ |
3,240 |
|
$ |
4,015 |
|
$ |
4,033 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.22 |
|
$ |
0.24 |
|
$ |
0.34 |
|
$ |
0.35 |
Diluted
|
|
$ |
0.21 |
|
$ |
0.24 |
|
$ |
0.33 |
|
$ |
0.34 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) As
Discussed in Note 1, the Company completed its acquisition of Diablo Valley Bank
on June 20, 2007. The acquisition significantly increased the
Company’s revenues and
expenses.
(2)
Noninterest income decreased in the third and fourth quarters due to a strategic
decision to cease loan sales in favor of retaining SBA loans.
|
|
For
the Quarters Ended
|
(Dollars
in thousands, except per share amounts)
|
|
12/31/06
|
|
09/30/06
|
|
06/30/06
|
|
03/31/06
|
Interest
income
|
|
$ |
18,737 |
|
$ |
18,568 |
|
$ |
18,392 |
|
$ |
17,260 |
Interest
expense
|
|
|
5,936 |
|
|
5,754 |
|
|
5,766 |
|
|
5,069 |
Net
interest income
|
|
|
12,801 |
|
|
12,814 |
|
|
12,626 |
|
|
12,191 |
Provision
for loan losses
|
|
|
100 |
|
|
- |
|
|
(114) |
|
|
(489) |
Net
interest income after provision for loan losses
|
|
|
12,701 |
|
|
12,814 |
|
|
12,740 |
|
|
12,680 |
Noninterest
income
|
|
|
2,390 |
|
|
2,299 |
|
|
2,257 |
|
|
2,894 |
Noninterest
expense
|
|
|
8,703 |
|
|
8,312 |
|
|
8,492 |
|
|
8,761 |
Income
before income taxes
|
|
|
6,388 |
|
|
6,801 |
|
|
6,505 |
|
|
6,813 |
Income
tax expense
|
|
|
2,036 |
|
|
2,448 |
|
|
2,316 |
|
|
2,437 |
Net
income
|
|
$ |
4,352 |
|
$ |
4,353 |
|
$ |
4,189 |
|
$ |
4,376 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.37 |
|
$ |
0.37 |
|
$ |
0.35 |
|
$ |
0.37 |
Diluted
|
|
$ |
0.37 |
|
$ |
0.36 |
|
$ |
0.35 |
|
$ |
0.36 |