Heritage Commerce Corp Reports Record Earnings for the Third Quarter of 2018

Date : 10/25/2018 @ 5:00PM
Source : GlobeNewswire Inc.
Stock : Heritage Commerce Corp (HTBK)
Quote : 14.59  0.17 (1.18%) @ 3:23PM

Heritage Commerce Corp Reports Record Earnings for the Third Quarter of 2018

Heritage Commerce Corp (NASDAQ:HTBK)
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SAN JOSE, Calif., Oct. 25, 2018 (GLOBE NEWSWIRE) -- Heritage Commerce Corp (Nasdaq: HTBK), the holding company (the “Company”) for Heritage Bank of Commerce (the “Bank” or “HBC”), today reported net income increased 44% to $12.4 million, or $0.28 per average diluted common share for the third quarter of 2018, compared to $8.6 million, or $0.22 per average diluted common share for the third quarter of 2017.  For the nine months ended September 30, 2018, net income was $22.1 million, or $0.53 per average diluted common share, compared to $22.6 million, or $0.59 per average diluted common share, for the nine months ended September 30, 2017.  Merger-related costs for the third quarter of 2018 and the first nine months of 2018 totaled $199,000 and $9.0 million, respectively.  All results are unaudited. 

“We delivered record profits for the third quarter of 2018, highlighted by a 4.36% net interest margin, a 19.36% return on tangible common equity and solid growth in net interest income.  We also recognized $1.2 million in net recoveries during the third quarter of 2018 from loans that were previously charged off,” said Walter Kaczmarek, President and Chief Executive Officer.  “We continue to invest for the future, and we are pleased with the progress made to date.  Customers and employees from the recent acquisitions of Tri-Valley Bank (“Tri-Valley”) and United American Bank (“United American”) are now fully integrated into our Bank, and we are now focused on growing our customer base in those markets.”

“Deposits are up 11% year-over-year with noninterest-bearing deposits growing 15% and representing 39% of our total deposits,” said Mr. Kaczmarek.  “Our loan portfolio consists of seasoned quality loans, and we will benefit from a rising interest rate environment.  In the meantime, asset quality remains stable with nonperforming assets declining 7% on a linked quarter basis,” added Mr. Kaczmarek.  The allowance for loan losses totaled $27.4 million, at September 30, 2018, or 1.44% of total loans. 

Third Quarter 2018 Highlights (as of, or for the periods ended September 30, 2018, compared to June 30, 2018 and September 30, 2017, except as noted):

  • Diluted earnings per share were $0.28 for the third quarter of 2018, compared to $0.22 for the third quarter of 2017, and $0.02 for the second quarter of 2018.  Diluted earnings per share totaled $0.53 for the first nine months of 2018, compared to $0.59 per diluted share for the first nine months of 2017.  

  • For the third quarter of 2018, the return on average tangible assets increased to 1.59%, and the return on average tangible equity increased to 19.36%, compared to 1.22% and 15.41%, respectively, for the third quarter of 2017, and 0.12% and 1.49%, respectively, for the second quarter of 2018.  The return on average tangible assets was 1.01%, and the return on average tangible equity was 12.33%, for the first nine months of 2018, compared to 1.14% and 14.11%, respectively, for the first nine months of 2017.

  • Net interest income, before provision for loan losses, increased 23% to $32.5 million for the third quarter of 2018, compared to $26.3 million for the third quarter of 2017, and increased 8% from $30.2 million for the second quarter of 2018. For the first nine months of 2018, net interest income increased 18% to $89.0 million, compared to $75.1 million for the first nine months of 2017. 

    -- For the third quarter of 2018, the fully tax equivalent (“FTE”) net interest margin improved 38 basis points to 4.36% from 3.98% for the third quarter of 2017.  The improvement was primarily due to a higher average balance of loans, an increase in the accretion of the loan purchase discount into loan interest income from the Tri-Valley and United American acquisitions in the second quarter of 2018, and the impact of increases in the prime rate, and the rate on overnight funds.  The net interest margin improved 6 basis points to 4.36% for the third quarter of 2018, from 4.30% for the second quarter of 2018.  The improvement was primarily due to a higher average balance of loans, the impact of increases in the prime rate, and the rate on overnight funds. 

    -- For the first nine months of 2018, the net interest margin increased 24­­ basis points to 4.27%, compared to 4.03% for the first nine months of 2017, primarily due to a higher average balance of loans and securities, an increase in the accretion of the loan purchase discount into loan interest income from the Tri-Valley and United American acquisitions in the second quarter of 2018, and the impact of increases in the prime rate, and the rate on overnight funds.
  • The total purchase discount on loans from Focus Business Bank (“Focus”) loan portfolio was $5.4 million on the acquisition date of August 20, 2015, of which $790,000 remains outstanding as of September 30, 2018.  The total purchase discount on loans from Tri-Valley loan portfolio was $2.6 million on the acquisition date of April 6, 2018, of which $2.4 million remains outstanding as of September 30, 2018.  The total purchase discount on loans from United American loan portfolio was $4.7 million on the acquisition date of May 4, 2018, of which $4.0 million remains outstanding as of September 30, 2018.

    -- The accretion of the loan purchase discount into loan interest income from the three acquisitions was $506,000 for the third quarter of 2018, compared to $270,000 for the third quarter of 2017, and $669,000 for the second quarter of 2018.

    -- The accretion of the loan purchase discount into loan interest income from the three acquisitions was $1.2 million for the first nine months of 2018, compared to $741,000 for the first nine months of 2017.
  • Loans, excluding loans held-for-sale, increased $333.4 million, or 21%, to $1.90 billion at September 30, 2018, compared to $1.57 billion at September 30, 2017, which included $208.8 million in loans, at fair value, from United American, $115.2 million in loans, at fair value, from Tri-Valley, and an increase of $20.3 million, or 1% in the Company’s legacy portfolio, partially offset by a decrease of $7.5 million in purchased residential mortgage loans, and a decrease of $3.4 million of purchased commercial real estate (“CRE”) loans. Loans, excluding loans held-for-sale, declined (3%) to $1.90 billion at September 30, 2018, compared to $1.96 billion June 30, 2018, primarily due to payoffs in the CRE and commercial loan portfolios.

  • The allowance for loan losses (“ALLL”) was 1.44% of total loans at September 30, 2018, compared to 1.26% at September 30, 2017, and 1.36% at June 30, 2018.  The ALLL to total nonperforming loans decreased to 110.97% at September 30, 2018, compared to 565.68% at September 30, 2017, primarily due to a single large lending relationship that was placed on nonaccrual during the second quarter of 2018. The ALLL to total nonperforming loans was 100.45% at June 30, 2018.

    -- Nonperforming assets (“NPAs”) totaled $24.7 million, or 0.77% of total assets, at September 30, 2018, compared to $3.5 million, or 0.12% of total assets, at September 30, 2017, and $26.5 million, or 0.85% of total assets, at June 30, 2018.

    -- Net recoveries totaled $1.2 million for the third quarter of 2018, compared to net recoveries of $236,000 for the third quarter of 2017, and net charge-offs of $673,000 for the second quarter of 2018.

    -- Classified assets were $30.5 million, or 0.95% of total assets, at September 30, 2018, compared to $10.9 million, or 0.38% of total assets, at September 30, 2017.  This was primarily due to a single large lending relationship that was moved to classified assets during the fourth quarter of 2017.  Classified assets were $32.3 million, or 1.03% of total assets, at June 30, 2018.

    -- There was a ($425,000) credit to the provision for loan losses for the third quarter of 2018, compared to a provision for loan losses of $115,000 for the third quarter of 2017, and a provision for loan losses of $7.2 million for the second quarter of 2018.  The credit to the provision for loan losses for the third quarter of 2018 was primarily due to net recoveries of $1.2 million and a slightly smaller loan portfolio compared to the second quarter of 2018. There was a $7.3 million provision for loan losses for the nine months ended September 30, 2018, compared to a provision for loan losses of $390,000 for the nine months ended September 30, 2017. 
  • Total deposits increased $264.7 million, or 11%, to $2.75 billion at September 30, 2018, compared to $2.48 billion at September 30, 2017, which included $266.6 million in deposits, at fair value, from United American, $91.4 million in deposits, at fair value, from Tri-Valley, a decrease of $65.1 million in State of California certificates of deposit due to maturity, and a decrease of $28.2 million, or (1%), in the Company’s legacy deposits.  Total deposits increased $61.7 million, or 2%, from $2.68 billion at June 30, 2018.

    -- Deposits, excluding all time deposits and CDARS deposits, increased $318.0 million, or 14%, to $2.58 billion at September 30, 2018, compared to $2.26 billion at September 30, 2017, which included $231.9 million of deposits added from United American, $83.0 million of deposits added from Tri-Valley, and an increase of $3.1 million in the Company’s legacy deposits.  Deposits, excluding all time deposits and CDARS deposits, at September 30, 2018 increased $67.6 million, or 3%, compared to $2.51 billion at June 30, 2018.
  • The cost of total deposits was 0.23% for the third quarter of 2018, compared to 0.17% for the third quarter of 2017 and 0.19% for the second quarter of 2018. The total cost of deposits was 0.19% for the nine months ended September 30, 2018, compared to 0.16% for the nine months ended September 30, 2017.
  • Tangible equity increased to $257.2 million at September 30, 2018, compared to $223.9 million at September 30, 2017, primarily due to the Tri-Valley and United American acquisitions.  Tangible equity was $249.6 million at June 30, 2018.  Tangible book value per share was $5.94 at September 30, 2018, compared to $5.86 at September 30, 2017, and $5.77 at June 30, 2018.
  • The Company’s consolidated capital ratios exceeded regulatory guidelines and the Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at September 30, 2018.
             
        Well-capitalized Fully Phased-in
        Financial Basel III
        Institution Minimum
  Heritage Heritage Basel III Requirement (1)
  Commerce Bank of Regulatory Effective
CAPITAL RATIOS Corp Commerce Guidelines January 1, 2019
Total Risk-Based  14.4  13.4  10.0  10.5%
Tier 1 Risk-Based  11.5  12.2  8.0  8.5%
Common Equity Tier 1 Risk-Based  11.5  12.2  6.5  7.0%
Leverage  8.6  9.1  5.0  4.0%
             
             


(1)Fully phased in Basel III requirements for both the Company and the Bank include a 2.5% capital conservation buffer, except the leverage ratio.
  

Operating Results

Net interest income, before the provision for loan losses, increased 23% to $32.5 million for the third quarter of 2018, compared to $26.3 million for the third quarter of 2017, and increased 8% from $30.2 million for the second quarter of 2018. Net interest income increased 18% to $89.0 million for the first nine months of 2018, compared to $75.1 million for the first nine months of 2017. Net interest income increased for the third quarter of 2018 and the first nine months of 2018, compared to the respective periods in 2017, primarily due to the impact of the increase in loans and deposits from the Tri-Valley and United American acquisitions, in addition to organic loan growth and the positive impact of rising interest rates.

For the third quarter of 2018, the net interest margin (FTE) increased 38 basis points to 4.36% from 3.98% for the third quarter of 2017. The improvement was primarily due to a higher average balance of loans, an increase in the accretion of the loan purchase discount into loan interest income from the Tri-Valley and United American acquisitions in the second quarter of 2018, and the impact of increases in the prime rate, and the rate on overnight funds.  The net interest margin improved 6 basis points to 4.36% for the third quarter of 2018, from 4.30% for the second quarter of 2018.  The improvement was primarily due to a higher average balance of loans, the impact of increases in the prime rate, and the rate on overnight funds. 

For the first nine months of 2018, the net interest margin increased 24 basis points to 4.27%, compared to 4.03% for the first nine months of 2017, primarily due to a higher average balance of loans and securities, an increase in the accretion of the loan purchase discount into loan interest income from the Tri-Valley and United American acquisitions in the second quarter of 2018, and the impact of increases in the prime rate, and the rate on overnight funds.

There was a ($425,000) credit to the provision for loan losses for the third quarter of 2018, compared to a provision for loan losses of $115,000 for the third quarter of 2017, and a provision for loan losses of $7.2 million for the second quarter of 2018. The credit to the provision for loan losses for the third quarter of 2018 was primarily due to net recoveries of $1.2 million and a slightly smaller loan portfolio compared to the second quarter of 2018. There was a $7.3 million provision for loan losses for the nine months ended September 30, 2018, compared to a provision for loan losses of $390,000 for the nine months ended September 30, 2017. 

Total noninterest income decreased to $2.2 million for the third quarter of 2018, compared to $2.5 million for the third quarter of 2017 and $2.8 million for the second quarter of 2018.  The decrease in noninterest income for third quarter of 2018, compared to the second quarter of 2018, was primarily due to a legal settlement recovery and a gain on sales of securities of $179,000 for the second quarter of 2018.  The Company received $1.3 million in proceeds from a legal settlement during the second quarter of 2018, of which $377,000 was recorded in other noninterest income, and $922,000 was credited to professional fees for recaptured legal fees previously paid by the Company.  For the nine months ended September 30, 2018, noninterest income increased to $7.2 million, compared to $7.0 million for the nine months ended September 30, 2017, primarily due to proceeds from a legal settlement during the second quarter of 2018, higher service charges and fees on deposit accounts and gain on sales of securities for the first nine months of 2018, partially offset by a lower increase in cash surrender value of life insurance proceeds, servicing income, and gain on sale of SBA loans for the first nine months of 2018.  The first nine months of 2017 also include higher fee income from Bay View Funding compared to the first nine months of 2018 which was included in other noninterest income. 

Total noninterest expense for the third quarter of 2018 was $17.7 million, compared to $14.8 million for the third quarter of 2017 and $24.9 million the second quarter of 2018.  Noninterest expense for the nine months ended September 30, 2018 was $58.6 million, compared to $45.4 million for the nine months ended September 30, 2017. The increase in noninterest expense in the first nine months of 2018, compared to first nine months of 2017, was primarily due to costs related to the merger transactions and higher salaries and employee benefits as a result of annual salary increases, and additional operating costs of Tri-Valley and United American, partially offset by lower professional fees.  Other noninterest expense included pre-tax acquisition and integration costs of $16,000, $4.8 million, and $5.5 million for the third quarter of 2018, the second quarter of 2018, and the first nine months of 2018, respectively. In addition, salaries and employee benefits included severance and retention expense of $183,000, $3.4 million, and $3.6 million for the third quarter of 2018, the second quarter of 2018, and the first nine months of 2018, respectively, related to the Tri-Valley and United American acquisitions.  Total severance, retention, acquisition and integration costs were $199,000, $8.2 million, and $9.0 million for the third quarter of 2018, the second quarter of 2018, and the first nine months of 2018, respectively. Professional fees totaled $1.1 million for the first nine months of 2018, compared to $2.4 million for the first nine months of 2017, primarily due to the recovery of $922,000 of professional fees from a legal settlement in the second quarter of 2018.   Full time equivalent employees were 296 at September 30, 2018, 282 at September 30, 2017, and 303 at June 30, 2018. 

The efficiency ratio for the third quarter of 2018 was 51.15%, compared to 51.54% for the third quarter of 2017, and 75.47% for the second quarter of 2018.  The efficiency ratio for the nine months ended September 30, 2018 was 60.93%, compared to 55.30% for the nine months ended September 30, 2017.   

The income tax expense for the third quarter of 2018 was $5.0 million, compared to income tax expense of $5.2 million for the third quarter of 2017, and an income tax benefit of ($31,000) for the second quarter of 2018.  The effective tax rate for the third quarter of 2018 decreased to 28.7%, compared to 37.9% for the third quarter of 2017, primarily due to a lower federal corporate tax rate for the third quarter of 2018.  On December 22, 2017 the Tax Cuts and Jobs Act (the “Tax Act”), was signed into law, which among other items reduced the federal corporate tax rate to 21% from 35%, effective January 1, 2018.  The effective tax rate was (3.5%) for the second quarter of 2018, primarily due to lower income before income taxes in the second quarter of 2018 compared to the first quarter of 2018, resulting in a year-to-date tax adjustment for the second quarter of 2018.  Income tax expense for the nine months ended September 30, 2018 was $8.2 million, compared to $13.8 million for the nine months ended September 30, 2017. The effective tax rate for the nine months ended September 30, 2018 was 27.0%, compared to 37.9% for the nine months ended September 30, 2017. The difference in the effective tax rate for the periods reported compared to the combined Federal and state statutory tax rate of 29.6% for the third quarter of 2018 and the first nine months of 2018, and 42% for the third quarter of 2017 and the first nine months of 2017, is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds. 

Balance Sheet Review, Capital Management and Credit Quality

Total assets increased 12% to $3.19 billion at September 30, 2018, compared to $2.84 billion at September 30, 2017, primarily due to the Tri-Valley and United American acquisitions.  Tri-Valley added $115.2 million in loans, at fair value, and $91.4 million in deposits, at fair value, at September 30, 2018.  United American added $208.8 million in loans, at fair value, and $266.6 million in deposits, at fair value, at September 30, 2018.  Total assets increased 2% from $3.12 billion at June 30, 2018. 

Securities available-for-sale, at fair value, totaled $319.1 million at September 30, 2018, compared to $390.1 million at September 30, 2017, and $335.9 million at June 30, 2018.  At September 30, 2018, the Company’s securities available-for-sale portfolio was comprised of $311.7 million agency mortgage-backed securities (all issued by U.S. Government sponsored entities) and $7.4 million U.S. Government sponsored entities debt securities. The pre-tax unrealized loss on securities available-for-sale at September 30, 2018 was ($12.7) million, compared to a pre-tax unrealized gain on securities available-for-sale of $1.0 million at September 30, 2017, and a pre-tax unrealized loss on securities available-for-sale of ($10.8) million at June 30, 2018.  All other factors remaining the same, when market interest rates are rising, the Company will experience a lower unrealized gain (or a higher unrealized loss) on the securities portfolio.

At September 30, 2018, securities held-to-maturity, at amortized cost, totaled $375.7 million, compared to $379.5 million at September 30, 2017, and $388.6 million at June 30, 2018.  At September 30, 2018, the Company’s securities held-to-maturity portfolio was comprised of $288.6 million agency mortgage-backed securities, and $87.1 million tax-exempt municipal bonds.  

Loans, excluding loans held-for-sale, increased $333.4 million, or 21%, to $1.90 billion at September 30, 2018, compared to $1.57 billion at September 30, 2017, which included $208.8 million in loans from United American, $115.2 million in loans from Tri-Valley, and an increase of $20.3 million, or 1% in the Company’s legacy portfolio, partially offset by a decrease of $7.5 million in purchased residential mortgage loans, and a decrease of $3.4 million of purchased CRE loans. Loans, excluding loans held-for-sale, declined (3%) to $1.90 billion at September 30, 2018, compared to $1.96 billion June 30, 2018, primarily due to payoffs in the CRE and commercial loan portfolios.

The loan portfolio remains well-diversified with commercial and industrial (“C&I”) loans accounting for 31% of the loan portfolio at September 30, 2018, which included $71.0 million of factored receivables. CRE loans accounted for 52% of the total loan portfolio, of which 39% were occupied by businesses that own them.  Land and construction loans accounted for 7% of total loans, consumer and home equity loans accounted for 7% of total loans, and residential mortgage loans accounted for the remaining 3% of total loans at September 30, 2018.  

The commercial loan portfolio increased $13.3 million to $600.6 million at September 30, 2018, from $587.3 million at September 30, 2017, which included $21.7 million of loans added from United American, and $10.2 million of loans added from Tri-Valley, partially offset by a decrease of $18.6 million, or (3%) in the Company’s legacy portfolio.  The commercial loan portfolio decreased $8.9 million from $609.5 million at June 30, 2018.  C&I line usage was 36% at September 30, 2018, compared to 37% at both September 30, 2017 and June 30, 2018.

The CRE loan portfolio increased $233.6 million, or 31%, to $988.5 million at September 30, 2018, compared to $754.9 million at September 30, 2017, which included $135.9 million of loans added from United American, $93.7 million of loans added from Tri-Valley, and an increase of $7.3 million, or 1%, in the Company’s legacy portfolio, partially offset by a decrease of $3.3 million in purchased CRE loans.  The CRE loan portfolio decreased $42.4 million, or (4%), from $1.03 billion at June 30, 2018. 

Land and construction loans increased $39.2 million, or 43%, to $131.5 million at September 30, 2018, compared to $92.3 million at September 30, 2017, primarily due to organic growth of $35.1 million, and $4.1 million of loans added from United American.  Land and construction loans increased $2.7 million, or 2%, from $128.9 million at June 30, 2018.

Home equity lines of credit increased $42.5 million, or 57%, to $116.7 million at September 30, 2018, compared to $74.2 million at September 30, 2017, which included $32.9 million of loans added from United American, and $11.4 million of loans added from Tri-Valley, partially offset by a decrease of $1.8 million in the Company’s legacy portfolio.  Home equity lines of credit decreased $4.6 million, from $121.3 million at June 30, 2018.

Residential mortgage loans increased $5.9 million, 13%, to $52.4 million at September 30, 2018, compared to $46.5 million at September 30, 2017, primarily due to $13.4 million of loans added from United American, partially offset by a $7.5 million decrease in purchased residential mortgage loans.  Residential mortgage loans decreased $2.0 million, from $54.4 million at June 30, 2018.

The average yield on the loan portfolio increased to 5.92% for the third quarter of 2018, compared to 5.72% for the third quarter of 2017, primarily due to an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions, and increases in the prime rate.  The average loan yield increased to 5.92% for the third quarter of 2018, compared to 5.75% for the second quarter of 2018.  The average yield on the Company’s legacy loan portfolio (excluding the purchased residential loans, purchased CRE loans, factored receivables portfolio, and accretion of the loan purchase discount from the acquisitions) increased 10 basis points for the third quarter of 2018, compared to the third quarter of 2017, and increased 13 basis points from the second quarter of 2018.  The average yield on the purchased residential loans was 2.68% for the third quarter of 2018, compared to 2.67% for the third quarter of 2017, and 2.71% for the second quarter of 2018.  The average yield on the purchased CRE loans was 3.24% for the third quarter of 2018, compared to 3.52% the third quarter of 2017, and 3.58% the second quarter of 2018.

The yield on the loan portfolio increased to 5.82% for the first nine months of 2018, compared to 5.63% for the first nine months of 2017, primarily due to an increase in accretion of the loan purchase discount into loan interest income from the acquisitions and increases in the prime rate.  The yield on the Company’s legacy loan portfolio (excluding the purchased residential loans, purchased CRE loans, factored receivables portfolio, and accretion of the loan purchase discount from the acquisitions) increased 9 basis points for the first nine months of 2018, compared to the first nine months of 2017.  The yield on the purchased residential loans was 2.71% for the first nine months of 2018, compared to 2.67% for the first nine months of 2017.  The yield on the purchased CRE loans was 3.45% for the first nine months of 2018, compared to 3.51% for the first nine months of 2017.

The accretion of the loan purchase discount into loan interest income from the three acquisitions was $506,000 for the third quarter of 2018, compared to $270,000 for the third quarter of 2017, and $669,000 for the second quarter of 2018.  The accretion of the loan purchase discount into loan interest income from the three acquisitions was $1.2 million for the first nine months of 2018, compared to $741,000 for the first nine months of 2017.  The total purchase discount on loans from Focus loan portfolio was $5.4 million on the acquisition date of August 20, 2015, of which $790,000 remains outstanding as of September 30, 2018.  The total purchase discount on loans from Tri-Valley loan portfolio was $2.6 million on the acquisition date of April 6, 2018, of which $2.4 million remains outstanding as of September 30, 2018.  The total purchase discount on loans from United American loan portfolio was $4.7 million on the acquisition date of May 4, 2018, of which $4.0 million remains outstanding as of September 30, 2018.

At September 30, 2018, NPAs were $24.7 million, or 0.77% of total assets, at September 30, 2018, compared to $3.5 million, or 0.12% of total assets, at September 30, 2017, and $26.5 million, or 0.85% of total assets, at June 30, 2018.  The increase in NPAs at September 30, 2018, compared to September 30, 2017, was primarily due to the previously discussed single large lending relationship that was placed on nonaccrual during the second quarter of 2018.  At September 30, 2018, the recorded investment of this lending relationship was $21.8 million, and the Company had a $7.0 million specific loan loss reserve allocated for this lending relationship.  Additionally, subsequent to the end of the third quarter of 2018, the recorded investment of this lending relationship was reduced to $17.4 million prior to this earnings release date.  There were no foreclosed assets at September 30, 2018, September 30, 2017, or June 30, 2018.  The following is a breakout of NPAs at the periods indicated:

                 
  End of Period: 
NONPERFORMING ASSETS September 30, 2018 June 30, 2018 September 30, 2017 
(in $000’s, unaudited) Balance % of Total Balance % of Total Balance % of Total 
Commercial and industrial loans $ 17,134  69$ 19,545  74$ 1,206  35%
CRE loans   5,639  23  5,801  22  501  14%
Restructured and loans over 90 days past due and still accruing   1,373  6  511  2  931  27%
Home equity and consumer loans   342  1  351  1  389  11%
SBA loans   227  1  337  1  281  8%
Land and construction loans   —  —   —  —   183  5%
Total nonperforming assets $ 24,715  100$ 26,545  100$ 3,491  100%
                 

Classified assets increased to $30.5 million, or 0.95% of total assets, at September 30, 2018, compared to $10.9 million, or 0.38% of total assets, at September 30, 2017, and decreased compared to $32.3 million, or 1.03% of total assets, at June 30, 2018. 

The following table summarizes the allowance for loan losses:

                 
  For the Quarter Ended For the Nine Months Ended  
ALLOWANCE FOR LOAN LOSSES September 30,  June 30,  September 30,  September 30,  September 30,  
(in $000’s, unaudited) 2018  2018 2017 2018 2017 
Balance at beginning of period $ 26,664  $ 20,139  $ 19,397 $ 19,658 $ 19,089 
Provision (credit) for loan losses during the period   (425)   7,198    115   7,279   390 
Net recoveries (charge-offs) during the period   1,187    (673)   236   489   269 
Balance at end of period $ 27,426  $ 26,664  $ 19,748 $ 27,426 $ 19,748 
                 
Total loans, net of deferred fees $ 1,899,387  $ 1,956,633  $ 1,565,950 $ 1,899,387 $ 1,565,950 
Total nonperforming loans $ 24,715  $ 26,545  $ 3,491 $ 24,715 $ 3,491 
Allowance for loan losses to total loans   1.44   1.36   1.26%  1.44  1.26%
Allowance for loan losses to total nonperforming loans   110.97   100.45   565.68%  110.97  565.68%
                   

The ALLL at September 30, 2018 was 1.44% of total loans, compared to 1.26% at September 30, 2017, and 1.36% at June 30, 2018.  The ALLL to total nonperforming loans decreased to 110.97% at September 30, 2018, compared to 565.68% at September 30, 2017, primarily due to a single lending relationship that was placed on nonaccrual during the second quarter of 2018.  The loans acquired from Tri-Valley and United American are included in total loans; however, there was minimal allowance for loan losses attributed to these loans at September 30, 2018 because upon acquisition they were marked to fair value.  The ALLL to total nonperforming loans was 100.45% at June 30, 2018.

Net recoveries totaled $1.2 million for the third quarter of 2018, compared to net recoveries of $236,000 for the third quarter of 2017, and net charge-offs of $673,000 for the second quarter of 2018. 

Total deposits increased $264.7 million, or 11%, to $2.75 billion at September 30, 2018, compared to $2.48 billion at September 30, 2017, which included $266.6 million in deposits from United American, $91.4 million in deposits from Tri-Valley, a decrease of $65.1 million in State of California certificates of deposit due to maturity, and a decrease of $28.2 million, or (1%), in the Company’s legacy deposits.  Total deposits increased $61.7 million, or 2%, from $2.68 billion at June 30, 2018.

Deposits, excluding all time deposits and CDARS deposits, increased $318.0 million, or 14%, to $2.58 billion at September 30, 2018, compared to $2.26 billion at September 30, 2017, which included $231.9 million of deposits added from United American, $83.0 million of deposits added from Tri-Valley, and an increase of $3.1 million in the Company’s legacy deposits.  Deposits, excluding all time deposits and CDARS deposits, at September 30, 2018 increased $67.6 million, or 3%, compared to $2.51 billion at June 30, 2018.

Time deposits of $250,000 and over decreased $62.7 million, or (43%), to $84.8 million at September 30, 2018, compared to $147.4 million at September 30, 2017, which included the maturity of $65.1 million of State of California certificates of deposits, and a  decrease of $17.6 million, or (21%), in the Company’s legacy deposits, partially offset by $16.2 million of deposits added from United American, and $3.8 million of deposits added from Tri-Valley.  Time deposits of $250,000 and over at September 30, 2018 increased $3.4 million, or 4%, compared to $81.4 million at June 30, 2018.

The cost of total deposits was 0.23% for the third quarter of 2018, compared to 0.17% for the third quarter of 2017 and 0.19% for the second quarter of 2018. The total cost of deposits was 0.19% for the nine months ended September 30, 2018, and 0.16% for the nine months ended September 30, 2017.

Tangible equity increased to $257.2 million at September 30, 2018, compared to $223.9 million at September 30, 2017, primarily due to the Tri-Valley and United American acquisitions.  Tangible equity was $249.6 million at June 30, 2018.  Tangible book value per share was $5.94 at September 30, 2018, compared to $5.86 at September 30, 2017, and $5.77 at June 30, 2018. 

Accumulated other comprehensive loss was ($17.2) million at September 30, 2018, compared to ($6.1) million at September 30, 2017, and ($15.9) million at June 30, 2018. The unrealized gain (loss) on securities available-for-sale, net of taxes, included in accumulated other comprehensive loss was ($9.0) million at September 30, 2018, compared to unrealized gain of $614,000 at September 30, 2017, and an unrealized loss of ($7.7) million at June 30, 2018.  The components of accumulated other comprehensive loss, net of taxes, at September 30, 2018 include the following: an unrealized loss on securities available-for-sale of ($9.0) million; the remaining unamortized unrealized gain on securities available-for-sale transferred to held-to-maturity of $351,000; a split dollar insurance contracts liability of ($3.7) million; a supplemental executive retirement plan liability of ($5.4) million; and an unrealized gain on interest-only strip from SBA loans of $613,000.

Heritage Commerce Corp, a bank holding company established in February 1998, is the parent company of Heritage Bank of Commerce, established in 1994 and headquartered in San Jose, CA with full-service branches in Danville, Fremont, Gilroy, Hollister, Livermore, Los Altos, Los Gatos, Morgan Hill, Pleasanton, Redwood City, San Jose, San Mateo, Sunnyvale, and Walnut Creek.  Heritage Bank of Commerce is an SBA Preferred Lender.  Bay View Funding, a subsidiary of Heritage Bank of Commerce, is based in Santa Clara, CA and provides business-essential working capital factoring financing to various industries throughout the United States.  For more information, please visit www.heritagecommercecorp.com.

Forward-Looking Statement Disclaimer

These forward-looking statements are subject to various risks and uncertainties that may be outside our control and our actual results could differ materially from our projected results.  Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the Securities and Exchange Commission, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, and the following: (1) current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values, high unemployment rates and overall slowdowns in economic growth should these events occur; (2) effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Open Market Committee of the Federal Reserve Board; (3) changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources; (4) volatility in credit and equity markets and its effect on the global economy; (5) changes in the competitive environment among financial or bank holding companies and other financial service providers; (6) changes in consumer and business spending and saving habits and the related effect on our ability to increase assets and to attract deposits; (7) our ability to develop and promote customer acceptance of new products and services in a timely manner; (8) risks associated with concentrations in real estate related loans; (9) an oversupply of inventory and deterioration in values of California commercial real estate; (10) a prolonged slowdown in construction activity; (11) other than temporary impairment charges to our securities portfolio; (12) changes in the level of nonperforming assets and charge-offs and other credit quality measures, and their impact on the adequacy of the Company’s allowance for loan losses and the Company’s provision for loan losses; (13) our ability to raise capital or incur debt on reasonable terms; (14) regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company; (15) changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases, among others; (16) operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which we are highly dependent; (17) our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, “denial of service” attacks, “hacking” and identity theft; (18) inability of our framework to manage risks associated with our business, including operational risk and credit risk; (19) risks of loss of funding of Small Business Administration or SBA loan programs, or changes in those programs; (20) effect and uncertain impact on the Company of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations promulgated by supervisory and oversight agencies implementing the new legislation; (21) significant changes in applicable laws and regulations, including those concerning taxes, banking and securities; (22) effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; (23) costs and effects of legal and regulatory developments, including resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews; (24) availability of and competition for acquisition opportunities; (25) risks resulting from domestic terrorism; (26) risks of natural disasters and other events beyond our control; and (27) our success in managing the risks involved in the foregoing factors.

Member FDIC

                        
  For the Quarter Ended: Percent Change From:  For the Nine Months Ended:
CONSOLIDATED INCOME STATEMENTS September 30,  June 30,  September 30, June 30,  September 30,   September 30, September 30,  Percent 
(in $000’s, unaudited) 2018 2018 2017 2018 2017  2018 2017 Change 
Interest income $ 34,610  $ 31,980  $ 27,955 8 24 % $ 94,467 $ 78,759  20 %
Interest expense   2,159    1,816    1,634 19 32 %   5,504   3,679  50 %
Net interest income before provision for loan losses   32,451    30,164    26,321 8 23 %   88,963   75,080  18 %
Provision (credit) for loan losses   (425)   7,198    115 (106)(470)%   7,279   390  1766 %
Net interest income after provision                       
  for loan losses   32,876    22,966    26,206 43 25 %   81,684   74,690  9 %
Noninterest income:                       
Service charges and fees on deposit accounts   1,107    972    869 14 27 %   2,981   2,410  24 %
Gain on sales of SBA loans   236    80    147 195 61 %   551   635  (13)%
Increase in cash surrender value of                       
  life insurance   216    237    417 (9)(48)%   816   1,259  (35)%
Servicing income   163    189    246 (14)(34)%   533   736  (28)%
Gain (loss) on sales of securities   —    179    — (100)N/A    266   (6) 4533 %
Other   484    1,123    781 (57)(38)%   2,034   2,014  1 %
Total noninterest income   2,206    2,780    2,460 (21)(10)%   7,181   7,048  2 %
Noninterest expense:                       
Salaries and employee benefits   10,719    14,806    9,071 (28)18 %   35,302   27,766  27 %
Occupancy and equipment   1,559    1,262    1,142 24 37 %   3,927   3,426  15 %
Professional fees   721    (289)   695 (349)4 %   1,116   2,439  (54)%
Other   4,729    9,083    3,926 (48)20 %   18,235   11,785  55 %
Total noninterest expense   17,728    24,862    14,834 (29)20 %   58,580   45,416  29 %
Income before income taxes   17,354    884    13,832 1863 25 %   30,285   36,322  (17)%
Income tax (benefit) expense   4,979    (31)   5,249 16161 (5)%   8,186   13,752  (40)%
  Net income $ 12,375  $ 915  $ 8,583 1252 44 % $ 22,099 $ 22,570  (2)%
                        
PER COMMON SHARE DATA                       
(unaudited)                       
Basic earnings per share $ 0.29  $ 0.02  $ 0.22 1350 32 % $ 0.54 $ 0.59  (8)%
Diluted earnings per share $ 0.28  $ 0.02  $ 0.22 1300 27 % $ 0.53 $ 0.59  (10)%
Weighted average shares outstanding - basic   43,230,016    41,925,616    38,152,633 3 13 %   41,132,043   38,060,224  8 %
Weighted average shares outstanding - diluted   43,731,370    42,508,674    38,581,298 3 13 %   41,683,044   38,565,134  8 %
Common shares outstanding at period-end   43,271,676    43,222,184    38,199,006 0 13 %   43,271,676   38,199,006  13 %
Dividend per share $ 0.11  $ 0.11  $ 0.10 0 10 % $ 0.33 $ 0.30  10 %
Book value per share $ 8.17  $ 8.01  $ 7.21 2 13 % $ 8.17 $ 7.21  13 %
Tangible book value per share $ 5.94  $ 5.77  $ 5.86 3 1 % $ 5.94 $ 5.86  1 %
                        
KEY FINANCIAL RATIOS                       
(unaudited)                       
Annualized return on average equity   14.03   1.11   12.491164 12 %   9.31  11.35 (18)%
Annualized return on average tangible equity   19.36   1.49   15.411199 26 %   12.33  14.11 (13)%
Annualized return on average assets   1.54   0.12   1.201183 28 %   0.98  1.12 (13)%
Annualized return on average tangible assets   1.59   0.12   1.221225 30 %   1.01  1.14 (11)%
Net interest margin (fully tax equivalent)   4.36   4.30   3.981 10 %   4.27  4.03 6 %
Efficiency ratio   51.15   75.47   51.54(32)(1)%   60.93  55.30 10 %
                        
AVERAGE BALANCES                       
(in $000’s, unaudited)                       
Average assets $ 3,193,139  $ 3,046,566  $ 2,836,807 5 13 % $ 3,004,230 $ 2,698,549  11 %
Average tangible assets $ 3,096,703  $ 2,961,335  $ 2,785,092 5 11 % $ 2,926,453 $ 2,646,446  11 %
Average earning assets $ 2,965,926  $ 2,826,786  $ 2,657,081 5 12 % $ 2,798,567 $ 2,519,308  11 %
Average loans held-for-sale $ 7,076  $ 3,410  $ 3,737 108 89 % $ 4,591 $ 4,837  (5)%
Average total loans $ 1,911,715  $ 1,835,001  $ 1,556,684 4 23 % $ 1,771,955 $ 1,516,610  17 %
Average deposits $ 2,749,026  $ 2,622,580  $ 2,470,015 5 11 % $ 2,593,240 $ 2,357,217  10 %
Average demand deposits - noninterest-bearing $ 1,071,638  $ 991,902  $ 980,554 8 9 % $ 1,003,590 $ 924,841  9 %
Average interest-bearing deposits $ 1,677,388  $ 1,630,678  $ 1,489,461 3 13 % $ 1,589,650 $ 1,432,376  11 %
Average interest-bearing liabilities $ 1,716,813  $ 1,670,033  $ 1,528,665 3 12 % $ 1,628,972 $ 1,450,356  12 %
Average equity $ 349,971  $ 331,210  $ 272,666 6 28 % $ 317,464 $ 265,975  19 %
Average tangible equity $ 253,535  $ 245,979  $ 220,951 3 15 % $ 239,687 $ 213,872  12 %
                              


               
  End of Period: Percent Change From: 
CONSOLIDATED BALANCE SHEETS September 30,  June 30,  September 30,  June 30,  September 30,  
(in $000’s, unaudited) 2018 2018 2017 2018  2017  
ASSETS              
Cash and due from banks $ 40,831  $ 46,340  $ 37,133  (12)10 %
Other investments and interest-bearing deposits              
  in other financial institutions   340,198    177,448    308,987  92 10 %
Securities available-for-sale, at fair value   319,071    335,923    390,107  (5)(18)%
Securities held-to-maturity, at amortized cost   375,732    388,603    379,550  (3)(1)%
Loans held-for-sale - SBA, including deferred costs   6,344    5,745    4,602  10 38 %
Loans:              
Commercial   600,594    609,468    587,276  (1)2 %
Real estate:              
CRE   988,491    1,030,884    754,856  (4)31 %
Land and construction   131,548    128,891    92,310  2 43 %
Home equity   116,657    121,278    74,171  (4)57 %
Residential mortgages   52,441    54,367    46,489  (4)13 %
Consumer   9,932    12,060    11,749  (18)(15)%
Loans   1,899,663    1,956,948    1,566,851  (3)21 %
Deferred loan fees, net   (276)   (315)   (901) (12)(69)%
Total loans, net of deferred fees   1,899,387    1,956,633    1,565,950  (3)21 %
Allowance for loan losses   (27,426)   (26,664)   (19,748) 3 39 %
Loans, net   1,871,961    1,929,969    1,546,202  (3)21 %
Company-owned life insurance   61,630    61,414    60,407  0 2 %
Premises and equipment, net   7,246    7,355    7,539  (1)(4)%
Goodwill   83,752    84,417    45,664  (1)83 %
Other intangible assets   12,614    12,293    5,867  3 115 %
Accrued interest receivable and other assets   73,531    73,700    57,890  0 27 %
Total assets $ 3,192,910  $ 3,123,207  $ 2,843,948  2 12 %
               
LIABILITIES AND SHAREHOLDERS’ EQUITY              
Liabilities:              
Deposits:              
Demand, noninterest-bearing $ 1,081,846  $ 1,002,053  $ 943,723  8 15 %
Demand, interest-bearing   670,624    683,805    605,301  (2)11 %
Savings and money market   828,297    827,304    713,693  0 16 %
Time deposits-under $250   68,194    72,030    53,479  (5)28 %
Time deposits-$250 and over   84,763    81,379    147,422  4 (43)%
CDARS - money market and time deposits   11,575    17,048    16,986  (32)(32)%
Total deposits   2,745,299    2,683,619    2,480,604  2 11 %
Subordinated debt, net of issuance costs   39,322    39,275    39,137  0 0 %
Accrued interest payable and other liabilities   54,723    54,044    48,762  1 12 %
Total liabilities   2,839,344    2,776,938    2,568,503  2 11 %
               
Shareholders’ Equity:              
Common stock   300,208    299,224    217,906  0 38 %
Retained earnings   70,531    62,911    63,679  12 11 %
Accumulated other comprehensive loss   (17,173)   (15,866)   (6,140) (8)(180)%
  Total Shareholders' Equity   353,566    346,269    275,445  2 28 %
  Total liabilities and shareholders’ equity $ 3,192,910  $ 3,123,207  $ 2,843,948  2 12 %
                    




               
  End of Period: Percent Change From: 
CREDIT QUALITY DATA September 30,  June 30,  September 30,  June 30,  September 30  
(in $000’s, unaudited) 2018 2018 2017 2018 2017 
Nonaccrual loans - held-for-investment $ 23,342  $ 26,034 $ 2,560  (10)812 %
Restructured and loans over 90 days past due and still accruing   1,373    511   931  169 47 %
Total nonperforming loans   24,715    26,545   3,491  (7)608 %
Foreclosed assets   —    —   —  N/A  N/A  
Total nonperforming assets $ 24,715  $ 26,545 $ 3,491  (7)608 %
Other restructured loans still accruing $ 334  $ 265 $ 325  26 3 %
Net charge-offs (recoveries) during the quarter $ (1,187) $ 673 $ (236) (276)(403)%
Provision (credit) for loan losses during the quarter $ (425) $ 7,198 $ 115  (106)(470)%
Allowance for loan losses $ 27,426  $ 26,664 $ 19,748  3 39 %
Classified assets $ 30,456  $ 32,264 $ 10,909  (6)179 %
Allowance for loan losses to total loans   1.44   1.36  1.26 6 14 %
Allowance for loan losses to total nonperforming loans   110.97   100.45  565.68 10 (80)%
Nonperforming assets to total assets   0.77   0.85  0.12 (9)542 %
Nonperforming loans to total loans   1.30   1.36  0.22 (4)491 %
Classified assets to Heritage Commerce Corp Tier 1              
  capital plus allowance for loan losses   10   11  4 (9)150 %
Classified assets to Heritage Bank of Commerce Tier 1              
  capital plus allowance for loan losses   10   11  4 (9)150 %
               
OTHER PERIOD-END STATISTICS              
(in $000’s, unaudited)              
Heritage Commerce Corp:              
Tangible common equity (1) $ 257,200  $ 249,559 $ 223,914  3 15 %
Shareholders’ equity / total assets   11.07   11.09  9.69 0 14 %
Tangible common equity / tangible assets (2)   8.31   8.25  8.02 1 4 %
Loan to deposit ratio   69.19   72.91  63.13 (5)10 %
Noninterest-bearing deposits / total deposits   39.41   37.34  38.04 6 4 %
Total risk-based capital ratio   14.4   13.5  14.6 7 (1)%
Tier 1 risk-based capital ratio   11.5   10.7  11.6 7 (1)%
Common Equity Tier 1 risk-based capital ratio   11.5   10.7  11.6 7 (1)%
Leverage ratio   8.6   8.7  8.3 (1)4 %
Heritage Bank of Commerce:              
Total risk-based capital ratio   13.4   12.5  13.4 7 0 %
Tier 1 risk-based capital ratio   12.2   11.4  12.3 7 (1)%
Common Equity Tier 1 risk-based capital ratio   12.2   11.4  12.3 7 (1)%
Leverage ratio   9.1   9.3  8.8 (2)3 %
                   


(1) Represents shareholders’ equity minus goodwill and other intangible assets
  
(2)Represents shareholders’ equity minus goodwill and other intangible assets divided by total assets minus goodwill and other intangible assets

   

             
             

                  
  For the Quarter Ended For the Quarter Ended 
  September 30, 2018 September 30, 2017 
     Interest Average    Interest Average 
NET INTEREST INCOME AND NET INTEREST MARGIN Average Income/ Yield/ Average Income/ Yield/ 
(in $000’s, unaudited) Balance Expense Rate Balance Expense Rate 
Assets:                 
Loans, gross (1)(2) $ 1,918,791 $ 28,632   5.92$ 1,560,421 $ 22,507   5.72%
Securities - taxable  624,352  3,483   2.21  671,528   3,596   2.12%
Securities - exempt from Federal tax (3)   87,410  702   3.19  89,426   866   3.84%
Other investments and interest-bearing deposits                 
  in other financial institutions  335,373  1,940   2.29  335,706   1,289   1.52%
Total interest earning assets (3)   2,965,926   34,757   4.65  2,657,081   28,258   4.22%
Cash and due from banks   40,704        35,173      
Premises and equipment, net   7,320        7,609      
Goodwill and other intangible assets   96,436        51,715      
Other assets   82,753        85,229      
Total assets $ 3,193,139      $ 2