UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 000-23877
Heritage Commerce Corp
|
|
|
|
|
|
150 Almaden Boulevard
San Jose, California 95113
(408) 947-6900
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The Registrant had 11,693,577 shares of Common Stock outstanding on October 29, 2004.
Heritage Commerce Corp and Subsidiaries
Part I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
HERITAGE COMMERCE CORP AND SUBSIDIARIES
See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND SUBSIDIARIES
See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND SUBSIDIARIES
See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND SUBSIDIARIES
See notes to condensed consolidated financial statements
HERITAGE COMMERCE CORP AND SUBSIDIARIES 1) Basis of Presentation The unaudited condensed consolidated financial statements
of Heritage Commerce Corp (the "Company") and its wholly owned
subsidiary Heritage Bank of Commerce ("HBC" or the "Bank")
have been prepared pursuant to the rules and regulations for reporting on Form
10-Q. Accordingly, certain information and notes required by accounting
principles generally accepted in the United States of America ("GAAP") for
annual financial statements are not included herein. The interim statements
should be read in conjunction with the consolidated financial statements and
notes thereto included in the Company's Form 10-K for the year ended December
31, 2003. The Company has also established the following unconsolidated
subsidiary grantor trusts: Heritage Capital Trust I; Heritage Statutory Trust I;
Heritage Statutory Trust II; and Heritage Commerce Corp Statutory Trust III
which are Delaware Statutory business trusts formed for the exclusive purpose of
issuing and selling trust preferred securities. HBC is a commercial bank serving customers located in Santa
Clara, Alameda, and Contra Costa counties of California. 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 operate as one business segment. In the Company's opinion, all adjustments necessary for a
fair presentation of these condensed consolidated financial statements have been
included and are of a normal and recurring nature. Certain reclassifications
have been made to prior year amounts to conform to current year
presentation. The results for the three months and nine months ended
September 30, 2004 are not necessarily indicative of the results expected for
any subsequent period or for the entire year ending December 31, 2004. 2) Securities Available-for-Sale At the March 17-18, 2004 Emerging Issues Task Force
(EITF) meeting, the Task Force reached a consensus on Issue No. 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." Issue 03-1 provides guidance for the determination of when
an investment is other-than-temporarily impaired. The guidance for evaluating
whether an investment is other-than-temporarily impaired should be applied in
other-than-temporary impairment evaluations made in reporting periods beginning
after June 15, 2004. On September 30, 2004,
the FASB deferred the effective date of paragraphs 10 through 20 of EITF Issue
No. 03-1. Application of those paragraphs is deferred pending issuance of a
final FASB Staff Position. Management is in the process of evaluating the
impacts of EITF 03-1 guidance.
Other-than-temporary impairment that may need to be
recognized upon adoption of Issue 03-1 will be dependant on market conditions
and management's intent and ability at the time of the impairment evaluation to
hold investments with market values below amortized cost until a forecasted
recovery in fair value up to (or beyond) amortized cost. The following table shows the gross unrealized losses and
fair value of the Company's investments with unrealized losses that are not
deemed to be other-than-temporarily impaired, aggregated by investment category
and length of time that individual securities have been in a continuous
unrealized loss position, at September 30, 2004: As of September 30, 2004, the Company held 99 securities, of
which 50 had market values below amortized cost. Six securities have been
carried with an unrealized loss for over 12 months. Higher interest rates at
September 30, 2004 resulted in lower market values for the period. Other than
temporary loss was primarily due to interest rates. There was no security which sustained downgrades in credit ratings.
All principal amounts are expected to be paid when securities mature. 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 September 30, 2004. 3) Stock-Based Compensation The Company accounts 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 has been recognized in the financial statements for employee stock
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. Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation, requires the disclosure of pro forma
net income and earnings per share had the Company adopted the fair value method
at the grant date of all stock options. Under SFAS No. 123, the fair value of
stock-based awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options without vesting restrictions, which
differ significantly from the Company's stock option awards. Those models also
require subjective assumptions, which greatly affect the calculated values. The
Company's calculations were made using the Black-Scholes option pricing model
with the following weighted average assumptions: expected life, 84 months;
risk-free interest rate, 3.75% and 3.74% for September 30, 2004 and 2003; stock
volatility of 25% and
11% in September 30, 2004 and 2003; and no dividends during the expected term.
The Company's calculations are based on a multiple option valuation approach,
and forfeitures are recognized as they occur. Had compensation expense for the Company's stock option plan
been determined under the requirements of SFAS No. 123 the Company's pro forma
net income and earnings per common share would have been as follows: 4) Earnings Per Share Basic earnings per share is computed by dividing net
income by the weighted average common shares outstanding. Diluted earnings per
share reflects potential dilution from outstanding stock options, using the
treasury stock method. There were 11,557 and 182,328 stock
options for three months ended September 30, 2004 and 2003 and 17,699 and 353,028,
for nine months ended September 30, 2004 and 2003,respectively, that
were considered to be antidilutive and excluded from the
computation of diluted earnings per share. For each of the periods 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: 5) Comprehensive Income (Loss) Comprehensive income (loss) includes net income
and other comprehensive income (loss), which represents the change in the
Company's net assets during the period from non-owner sources. The Company's
sources of other comprehensive income (loss) are unrealized gains and losses on
securities available-for-sale and I/O strips, which are treated like
available-for-sale securities, and are presented net of tax. Reclassification adjustments
resulting from gains or losses on investment securities that were realized and
included in net income of the current period that also had been included in
other comprehensive income (loss) as unrealized holding gains or losses in the
period in which they arose are excluded from comprehensive income (loss) of the
current period. The Company's total comprehensive income (loss) was as
follows: 6) Supplemental Retirement Plan The Company has a supplemental retirement plan (Plan)
covering key executives and directors. The Plan is a nonqualified defined
benefit plan and is unsecured and unfunded and there are no Plan assets. For
the current fiscal year ending December 31, 2004, the Company estimates the
contributions to be paid to the Plan will be $1,800,000 of which $358,000 and
$1,576,000 were accrued for the three and nine months ended September 30, 2004.
The following table presents the amount of periodic benefit cost recognized for
three and nine months ended September 30, 2004 and 2003: 7) 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 notional 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 September 30, were as
follows: 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 considered significant. 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 has
a deferred liability of $23,000 as of September 30, 2004, which represents the
fees received on the outstanding financial standby letters of credit. The
Company recognizes these fees as income as the commitments are used or as they
expire. 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 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Discussions of certain matters in this Report on
Form 10-Q may constitute forward looking statements within the meaning of
Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and as
such, may involve risks and uncertainties. Forward-looking statements, which
are based on certain assumptions and describe future plans, strategies, and
expectations, are generally identifiable by the use of words such as "believe",
"expect", "intend", "anticipate", "estimate", "project", or similar expressions.
These forward-looking statements relate to, among other things, expectations of
the business environment in which the Company operates, projections of future
performance, potential future performance, potential future credit experience,
perceived opportunities in the market, and statements regarding the Company's
mission and vision. The Company's actual results, performance, and achievements
may differ materially from the results, performance, and achievements expressed
or implied in such forward-looking statements due to a wide range of factors.
The factors include, but are not limited to changes in interest rates, general
economic conditions, legislative and regulatory changes, monetary and fiscal
policies of the US Government, real estate valuations, competition in the
financial services industry, and other risks. For additional information
relating to the risks of the Company's business see "Risk Factors" in
the Company's Annual Report on Form 10-K. All of the Company's operations and
most of its customers are located in California. California economic outlook
could have an effect on the future operations of the Company or its customers,
including borrowers. The Company does not undertake, and specifically disclaims
any obligation, to update any forward-looking statements to reflect occurrences
or unanticipated events or circumstances after the date of such statements. Heritage operates as the bank
holding company for its subsidiary bank: Heritage Bank of Commerce. 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, Contra Costa and Alameda Counties. CRITICAL ACCOUNTING POLICIES General Heritage Commerce Corp's financial statements are
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). The financial information
contained within our 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, the Company uses the
discount factor and prepayment assumptions to determine the present value of
assets and liabilities. A change in the discount factor or prepayment spreads
could increase or decrease the values of those assets and liabilities which
would result in either a beneficial or adverse impact to the Company's financial
results. The Company used historical loss experience as one factor in
determining the inherent loss that may be present in the Company's loan
portfolio. Actual losses could differ significantly from the historical factors
that we use. Other estimates that the Company used are related to the expected
useful lives of the Company's depreciable assets. In addition GAAP itself may
change from one previously acceptable method to another method. Although the
economics of the Company's transactions would be the same, the timing of events
that would impact the Company's transactions could change. Allowance for Probable Loan Losses The allowance for probable loan losses is an estimate
of the losses that may be sustained in the Company's loan portfolio. The
allowance is based on two basic principles of accounting: (1) Statement of
Financial Accounting Standards ("SFAS") No. 5 "Accounting for
Contingencies", which requires that losses be accrued when they are
probable of occurring and estimable, and (2) SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan", which requires that losses be accrued
based on the differences between the value of collateral, present value of
future cash flows or values that are observable in the secondary market and the
loan balance. The Company's allowance for probable loan losses has
three basic components: the formula allowance, the specific allowance and the
unallocated allowance. Each of these components is determined based upon
estimates that can and do change when the actual events occur. The formula
allowance uses an historical loss view as an indicator of probable future losses
and as a result could differ from the losses incurred in the future. The
specific allowance uses various techniques to arrive at an estimate of loss.
Historical loss information and fair market value of collateral are used to
estimate those losses. The use of these values is inherently subjective and our
actual losses could be greater or less than the estimates. The unallocated
allowance captures losses that are attributable to various economic events,
industry or geographic sectors whose impact on the portfolio have occurred but
have yet to be recognized in either the formula or specific allowances. For
further information regarding our allowance for credit losses, see Allowance for
Probable Loan Losses on page 24. Loan Sales and Servicing The amount of gains recorded on sales of loans and the
initial recording of servicing assets and interest only strips is 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 Interest-Only (I/O)
strips receivable, the Company uses estimates which are made based on
management's expectations of future prepayment and discount rates. For the
quarter ended September 30, 2004, management's estimate of constant prepayment
rate ("CPR") was 14% and the weighted average discount rate assumption
was 9%. These prepayment and discount rates were based on current market
conditions and historical performance of the various pools of loans. If actual
prepayments with respect to sold loans occur more quickly than projected the
carrying value of the servicing assets may have to be adjusted through a charge
to earnings. Variations in prevailing interest rates on borrowed funds, changes
in general economic conditions, among other factors, could cause changes in the
prepayment experience. A corresponding decrease in the value of the I/O strip
receivable would also be expected. Stock Based Awards The Company accounts for its stock based awards using the
intrinsic value method in accordance with Accounting Principles Board
("APB") Opinion No. 25 and related interpretations. Since the
Company's stock option plans provide for the issuance of options at a price of
no less than the fair market value at the date of the grant, no compensation
expense has been recognized in the financial statements at the date of grant.
RESULTS OF OPERATIONS Overview Net income for the three and nine months ended
September 30, 2004 was $2,888,000 and $5,695,000, respectively, up $948,000, or
49%, but down $45,000, or less than 1%, as compared to the three and nine months
ended September 30, 2003. Earnings per diluted share for the three and nine
months ended September 30, 2004 were $0.24 and $0.48, respectively, up 41%, and
down 4%, from $0.17 and $0.50 per diluted share for the three and nine months
ended September 30, 2003. Annualized return on average assets and return on
average equity for the three months ended September 30, 2004 were 1.05% and
12.19%, up from 0.78% and 8.80%, for the same periods in the prior year.
Annualized return on average assets and return on average equity for the nine
months ended September 30, 2004 were 0.73% and 8.20%, down from 0.81% and 8.95%,
for the same periods in the prior year. For the three and nine months ended September 30, 2004, as
compared with the same periods in the prior year, net interest income before
provision for probable loan losses increased to $11,149,000 and $31,336,000 from
$9,187,000 and $28,183,000, an increase of $1,962,000, or 21% and $3,153,000, or
11%, respectively. The Company's net interest margin was 4.42% and 4.36% for
the three and nine months ended September 30, 2004, compared with 4.01% and
4.33% for the same periods in the prior year. Total assets as of September 30, 2004 were $1,082,332,000, an
increase of $97,612,000, or 10%, from $984,720,000 as of September 30, 2003, and
an increase of $79,131,000, or 8%, from total assets of $1,003,201,000 as of
December 31, 2003. Total deposits as of September 30, 2004 were $902,656,000,
an increase of $66,709,000, or 8%, from $835,947,000 as of September 30, 2003,
and an increase of $67,246,000, or 8%, from total deposits of $835,410,000 as of
December 31, 2003. The total loan portfolio as of September 30, 2004 was
$727,615,000, an increase of $85,435,000, or 13%, from $642,180,000 as of
September 30, 2003 and an increase of $61,527,000, or 9%, from $666,088,000 as
of December 31, 2003. The Company's allowance for probable loan losses was
$13,381,000, or 1.84%, of total loans at September 30, 2004. This compares with
an allowance for probable loan losses of $13,039,000, or 2.03%, and $13,451,000,
or 2.02% of total loans at September 30, 2003 and December 31, 2003. The
decrease in the overall level of the allowance of loan losses since December 31,
2003 is primarily the result of a $2,000,000 charge-off related to one unsecured
commercial loan in the first quarter of 2004 offset by the provisions made
during the period. The Company's nonperforming assets were $2,637,000 at
September 30, 2004, compared to $7,544,000 as of September 30, 2003 and
$4,580,000 as of December 31, 2003. The Company's shareholders' equity at September 30, 2004 was
$96,635,000, up from $87,484,000 at September 30, 2003 and $89,846,000 as of
December 31, 2003. The increase in shareholders' equity is a result of the
income generated over the period and the exercise of common stock options offset
by repurchase of common stock and a decline in other comprehensive income from
fair value changes. Book value per share increased to $8.29 at September 30,
2004, from $7.72 at September 30, 2003. Book value per share was $7.89 at
December 31, 2003. The Company's leverage capital ratio was 10.72% at September
30, 2004 compared to 10.99% at September 30, 2003 and 11.17% at December 31,
2003. Net Interest Income and Net Interest Margin The following table presents the Company's average balance sheet,
net interest income and the resultant yields and rates paid for the period presented: Note: Yields and amounts earned on loans include loan fees of $951,000
and $876,000 for the three month periods ended September 30, 2004 and 2003,
respectively. Interest income is reflected on an actual basis, not a fully
taxable equivalent basis, and does not include a fair value adjustment.
Nonaccrual loans of $1,926,000 and $6,497,000 for the period ended September 30,
2004 and 2003, respectively, are included in the average balance calculation
above. Note: Yields and amounts earned on loans include loan fees of
$2,991,000 and $2,932,000 for the nine month periods ended September 30, 2004
and 2003, respectively. Interest income is reflected on an actual basis, not a
fully taxable equivalent basis, and does not include a fair value adjustment.
Nonaccrual loans of $1,926,000 and $6,497,000 for the period ended September 30,
2004 and 2003, respectively, are included in the average balance calculation
above. The Company's net interest income before provision for
probable loan losses for the three and nine months ended September 30, 2004 was
$11,149,000 and $31,336,000, respectively, an increase of $1,962,000, or 21% and
$3,153,000 or 11% over the same periods in the prior year. For the three and
nine months ended September 30, 2004, average interest earning assets increased
by $95,760,000, or 11% and $91,257,000, or 10%, respectively. For the three
months ended September 30, 2004, the average yield on interest earning assets
was 5.40%, up 35 basis points from 5.05% for the same period in 2003. Over the
same period the rates paid on interest bearing liabilities declined 8 basis
points to 1.41% from 1.49%. For the nine months ended September 30, 2004, the
average yield on interest earning assets was 5.33%, down 19 basis points from
5.52% for the same period in 2003. Over the same period the rates paid on
interest bearing liabilities declined 29 basis points to 1.38% from 1.67%. As
a result, the net interest margin increased 41 basis points to 4.42% for the
three months ended September 30, 2004, from 4.01% for the same period in the
prior year and increased 3 basis points to 4.36% for the nine months ended
September 30, 2004 from 4.33% for the same period in the prior year. The
increase in net interest margin in the third quarter and for the nine month
period was primarily attributable to the increase in average earning assets and
increase in key market interest rates since June 30, 2004. During the third
quarter of 2004, there were three increases totaling 75 basis points in the
target interest rate for Federal funds sold set by the Federal Open Market
Committee (FOMC) and the prime rate of interest, which is the index for the
pricing on most of the Company's loan portfolio. The increase in average
interest bearing liabilities was primarily attributable to growth in demand
interest bearing, savings and money market deposits, offset by a decrease in
brokered and other time deposits. The changes in volume contributed $1,357,000
to net interest income while the effect of the changes in rates produced an
increase of $605,000 resulting in the overall increase of $1,962,000 for the
three months ended September 30, 2004, from September 30, 2003. The changes in
volume contributed $2,756,000 to net interest income while the effect of the
changes in rates produced an increase of $397,000 resulting in the overall
increase of $3,153,000 for the nine months ended September 30, 2004 from the
prior period. The following table sets forth an
analysis of the changes in interest income resulting from changes in the average
volume of interest earning assets and liabilities and changes in the average
rates earned and paid. The total change is shown in the column designated
"Net Change" and is allocated in the columns to the left, to the
portions respectively attributable to volume changes and rate changes that
occurred during the period indicated. Changes due to both volume and rate have
been allocated to the change in volume. Provision for Probable Loan Losses The provision for probable loan losses represents the current
period expense associated with maintaining an appropriate allowance for credit
losses. The loan loss provision and level of allowance for each period is
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. Periodic fluctuations
in the provision for loan losses result from management's assessment of the
adequacy of the allowance for probable loan losses; however, actual loan losses
may vary from current estimates. For the three and nine months ended September
30, 2004, the provision for probable loan losses was $600,000 and $1,800,000,
respectively, compared to $600,000 and $2,500,000 for the same periods in the
prior year. See additional discussion at Allowance for Probable Loan Losses on
page 22. Noninterest Income The following table sets forth the various components of the Company's
noninterest income for the periods indicated: Noninterest income for the three and nine months ended
September 30, 2004 was $2,363,000 and $7,141,000, down 4% and 10% from
$2,463,000 and $7,943,000 for the same periods in the prior year. The decrease
was primarily due to the amendment of an equipment lease agreement resulting in
a change in the classification from equipment under operating leases to a direct
financing lease arrangement, which is now included in the loan portfolio. As a
result, the payment amounts are now recorded as principal and interest payments
rather than as other noninterest income and expense. Mortgage brokerage fees
decreased $191,000 and $683,000 for the three and nine months ended September
30, 2004 from the prior year for the same periods, as a result of a lower demand
for mortgages as well as the Company discontinuing its residential mortgage
operation in June 2004. An increase in gain on sales of loans of $359,000 and
$580,000 and servicing income of $153,000 and $343,000 for the three and nine
months ended September 30, 2004, from the prior period, was primarily the result
of expansion of the SBA lending operation into additional geographic areas of
California and an overall increase in the level of loans serviced. The Company
has an onging program of originating SBA loans and selling the guarantee portion
in the secondary market, which retaining the services of whole loans. Gain on
sale of securities available-for-sale decreased $74,000 and $56,000,
respectively, for the comparative three and nine months periods ended September
30, 2004. The appreciation of corporate owned life insurance decreased $18,000
and $93,000, respectively, for the comparative three and nine month periods
ended September 30, 2004. Noninterest Expense The following table sets forth the various components of the Company's
noninterest expenses for the periods indicated: The following table indicates the percentage of
noninterest expense in each category: Noninterest expenses for the three and nine months ended
September 30, 2004 were $8,889,000 and $28,517,000, up $579,000 and $3,221,000,
or 7% and 13%, from $8,310,000 and $25,296,000 for the same period in the prior
year. The efficiency ratio was 65.79% and 74.11% for the three and nine months
ended September 30, 2004, compared to 71.33% and 70.02% for the three and nine
months ended September 30, 2003. For the three months ended September 30, 2004, salaries and
employee benefits decreased $122,000, or 3%, to $4,301,000, as compared to the
same period in the prior year. Salaries and employee benefits increased
$813,000, or 6%, to $14,477,000 for the nine months ended September 30, 2004, as
compared to the prior year. The increase for the nine months period was
primarily related to severance payments of $580,000 incurred as the result of
the elimination of 12 full time positions and $521,000 associated with the
resignation of the former CEO, partially offset by a decrease of $361,000 in
loan officer commissions. Salaries and employee benefits, as a percentage of
total noninterest expenses decreased to 48% and 51% from 53% and 54%,
respectively, over the comparative three and nine months periods. For the comparative three month periods, occupancy increased
by $26,000, or 3%, to $883,000, and for the nine month periods the increase was
$302,000, or 12%, to $2,813,000, primarily as a result of increased rental costs
related to the opening of a new branch office in Los Gatos in December 2003,
depreciation on leasehold improvements and write-offs associated with the
outsourcing of the data processing function. Occupancy costs as a percentage of
total noninterest expenses remained fairly constant over the comparative three
and nine month periods. For the comparative three month periods, professional fees
increased $332,000, or 98%, to $670,000, and for the nine month periods the
increase was $958,000, or 93%, to $1,986,000, primarily due to increased audit
and consulting expenses, legal expenses related to the proxy solicitation for
the 2004 annual meetings and other corporate governance matters. Professional
fees, as a percentage of total noninterest expenses increased to 7% from 4% over
the comparative three and nine month periods. For the comparative three month periods, retirement plan
expense increased $341,000, or 2,006%, to $358,000, and for the nine month
periods the increase was $1,048,000, or 198%, to $1,576,000, primarily due to
the elimination of certain full time positions and the resignation of the former
CEO. Retirement plan expense as a percentage of total noninterest expenses
increased to 4% and 6% from less than 1% and 2% over the comparative three and
nine month periods. For the comparative three month periods, loan origination
costs increased by $57,000, or 15%, to $426,000, and for the nine month periods
the increase was $148,000, or 14%, to $1,194,000, primarily due to continued
growth in the loan portfolio. Loan origination costs as a percentage of total
noninterest expenses increased to 5% from 4% over the comparative three month
periods and remained fairly constant over the comparative nine month
periods. For the comparative three month periods, advertising and
promotion increased $155,000, or 74%, to $364,000, and for the nine month
periods the increase was $254,000, or 42%, to $862,000, primarily due to several
new promotions and sponsorships in 2004 as well as expenses associated with the
consolidation of the Company's operations under the common brand Heritage Bank
of Commerce in the third quarter. Prior to the third quarter of 2004, the
Company had operated under 4 different trade names; Heritage Bank of Commerce,
Heritage Bank East Bay, Heritage Bank South Valley and Bank of Los Altos.
Advertising and promotion as a percentage of total noninterest expenses
increased to 4% and 3% from 3% and 2% over the comparative three and nine month
periods. For the comparative three month periods, furniture and
equipment decreased by $179,000, or 46%, to $206,000, and for the nine month
periods the decrease was $445,000, or 39%, to $698,000, primarily due to the
decrease in the level of purchase of small equipment, fewer equipment repairs,
and lower depreciation on furniture and equipment in 2004. Furniture and
equipment, as a percentage of total noninterest expenses decreased to 2% from 5%
over the comparative three and nine month periods. For the comparative three month periods, client services
decreased by $11,000, or 5%, to $228,000 and for the nine month periods
decreased by $70,000, or 10%, to $644,000 primarily due to a reduction in the
level and pricing for certain of these services such as imprinted check charges,
courier and armored car in 2004 compared to the same period in 2003. Client
services as a percentage of total noninterest expenses remained fairly constant
over the comparative three month periods but decreased to 2% from 3% over the
comparative nine month periods. For the comparative three month periods, data processing
expense increased by $144,000, or 554%, to $170,000 and for the nine month
periods increased by $421,000, or 593%, to $492,000 primarily due to
outsourcing of the core data and item processing functions in the first quarter
of 2004. As a result of the outsourcing arrangement, contracted data processing
costs are shown as data processing expenses in 2004. When the data processing
function was internal, prior to the first quarter of 2004, staffing and
depreciation costs, the two major expenses associated with this function, were
included in salaries and employee benefits and furniture and equipment expense,
respectively. The Company estimates that the outsourcing of core data and item
processing has reduced costs by an approximate pre-tax amount of $50,000 per
quarter, beginning with the second quarter of 2004. For the comparative three month periods, stationery and
supplies increased by $57,000, or 69%, to $140,000, and for the nine month
periods the increase was $46,000, or 19%, to $292,000. Stationery and supply
costs increased in the third quarter of 2004 as a result of the consolidation of
the Company's operations under the common brand Heritage Bank of Commerce.
Stationery and supplies as a percentage of total noninterest expenses increased
to 2% from 1% over the comparative three month periods, but remained fairly
constant over the comparative nine month periods. For the comparative three month periods, telephone expense
decreased by $13,000, or 15%, to $72,000, but for the nine month periods
increased by $36,000, or 15%, to $271,000. Telephone expense as a percentage of
total noninterest expenses remained fairly constant over the comparative three
and nine month periods. For the comparative three month period, other noninterest
expenses decreased $209,000, or 16%, to $1,071,000, and for the nine month
periods the decrease was $290,000, or 8%, to $3,212,000 primarily due to the
amendment of an equipment lease agreement resulting in a change in the
classification from equipment under operating leases to a direct financing lease
arrangement, which the amortization of the equipment was previously reported in
other noninterest expense. Other noninterest expenses as a percentage of total
noninterest expenses decrease to 12% and 11% from 16% and 14%, respectively,
over the comparative three and nine months periods. Income Taxes The provision for income taxes for the three and nine months
ended September 30, 2004 was $1,135,000 and $2,465,000, as compared to $800,000
and $2,590,000 for the same periods in the prior year. The following table shows
the effective income tax rate for each period indicated. The difference in the effective tax rate compared to the
statutory tax rate of 42% is primarily the result of the Company's investment in
Company Owned Life Insurance policies whose earnings are not subject to taxes,
low income housing tax credits and investments in municipal securities. FINANCIAL CONDITION Total assets increased $79,131,000, or 8%, to $1,082,332,000
at September 30, 2004, from $1,003,201,000 at December 31, 2003, and
increased $97,612,000, or 10%, from $984,720,000 at September 30, 2003. Total
securities available-for-sale increased $75,010,000, or 49%, to $228,483,000 at
September 30, 2004, from $153,473,000 at December 31, 2003, and increased
$56,473,000, or 33%, from $172,010,000 at September 30, 2003. Total loan
portfolio increased $61,527,000, or 9%, to $727,615,000 at September 30, 2004,
from $666,088,000 at December 31, 2003, and increased $85,435,000, or 13%,
from $642,180,000 at September 30, 2003. Total deposits increased $67,246,000,
or 8%, to $902,656,000 at September 30, 2004, from $835,410,000 at
December 31, 2003, and increased $66,709,000, or 8%, from $835,947,000 at
September 30, 2003. Other borrowings increased $4,200,000, or 10%, to
$47,800,000 at September 30, 2004, from $43,600,000 at December 31, 2003, and
increased $19,200,000, or 67%, from $28,600,000 at September 30, 2003. Securities Portfolio The following table sets forth the estimated fair value of investment
securities at the dates indicated: The following table summarizes the composition of the Company's investment
securities and the weighted average yields at September 30, 2004: Note: Yield on non-taxable municipal securities are not presented on a
fully tax equivalent basis. Loans Total loans increased $61,527,000, or 9%, to $727,615,000 as
of September 30, 2004, from $666,088,000 as of December 31, 2003, and increased
$85,435,000, or 13%, from $642,180,000, as of September 30, 2003. For the three and nine months ended September 30, 2004,
$24,189,000 and $57,936,000 in loans guaranteed by the U.S. Small Business
Administration (SBA) were generated and held for sale, and $16,895,000 and
$42,921,000 of SBA loans held for sale were sold into the secondary market.
Gain on sale of SBA loans was $920,000 and $2,285,000, respectively, for the
three and nine months ended September 30, 2004, compared to $561,000 and
$1,705,000, respectively, for the three and nine months ended September 30,
2003. At September 30, 2004 and December 31, 2003, the Company
serviced SBA loans of approximately $143,269,000 and $117,770,000, respectively,
which it had sold into the secondary market. At September 30, 2004 and December
31, 2003, the carrying amount of the servicing assets was $2,221,000 and
$1,876,000, respectively. There was no valuation allowance as of September 30,
2004 or December 31, 2003. The carrying amount of Interest-Only (I/O) strip
receivable at September 30, 2004 and December 31, 2003 was $3,854,000, net of
unrealized gain of $1,471,000, and $2,803,000, net of unrealized gain of
$925,000, respectively. These assets represent the servicing spread generated
from the sold guaranteed portions of SBA loans. Servicing income from these
loans was $616,000 and $1,682,000 for the three and nine months ended September
30, 2004, compared to $463,000 and $1,339,000 for the same periods in 2003.
Amortization of the related assets was $393,000 and $1,138,000, for the three
and nine months ended September 30, 2004, compared to $332,000 and $978,000 for
the same periods in 2003. HBC is a preferred lender with the SBA, which allows
the Company to grant certain SBA loans without the prior approval of the
SBA. The following table summarizes the composition of the Company's loan
portfolio at the dates indicated: The loan portfolio is primarily composed of
commercial loans to companies principally engaged in manufacturing, wholesale,
and service businesses and real estate lending, with the balance in direct
equipment finance leases and consumer loans. As of September 30, 2004, real
estate mortgage loans consists of loans secured by commercial property of
$246,231,000, loans secured by first mortgages on 1 - 4 family residential
properties of $2,260,000, and home equity lines of credit secured by junior
deeds of trust on 1 - 4 family residential properties of $52,758,000. Although
construction loans outstanding are down from September 30, 2003, unfunded
construction loan commitments have increased to $75 million from $56 million,
reflecting increased activity in this segment of the loan portfolio from
September 30, 2003. Properties securing the real estate mortgage loans are
primarily located in the Company's trade area. While no specific industry
concentration is considered significant, the Company's lending operations are
dependent on the technology and real estate industries and their supporting
companies. 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' abilities to repay their loans. The following table sets forth the maturity distribution of the Company's
loans at September 30, 2004: The table above also 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. At
September 30, 2004, approximately 84% of the Company's loan portfolio consisted
of floating interest rate loans. Nonperforming assets Nonperforming assets consist of nonaccrual loans, loans past
due 90 days and still accruing, troubled debt restructurings and other real
estate owned. Management generally places loans on nonaccrual status when they
become 90 days past due, unless they are well secured and in the process of
collection. When a loan is placed on nonaccrual status, any interest previously
accrued but not collected is generally reversed from income. Loans are charged
off when management determines that collection has become unlikely. Restructured
loans are those where HBC has granted a concession on the interest paid or
original repayment terms due to financial difficulties of the borrower. Other
real estate owned ("OREO") consists of real property acquired through
foreclosure on the related underlying defaulted loans. The following table shows
nonperforming assets at the dates indicated: As of September 30, 2004, the Company had $1,926,000
loans on nonaccrual status, compared to $6,497,000 in the same period of the
prior year, which were considered impaired loans. The impaired loans had a
related valuation allowance of $238,000 at September 30, 2004 and $1,139,000 at
September 30, 2003. The Company had $711,000 loans past due 90 days or more and
still accruing interest, no restructured loans and no other real estate owned
assets as of September 30, 2004, compared to $395,000 loans past due 90 days or
more and still accruing interest, no restructured loans and $652,000 other real
estate owned assets as of September 30, 2003. The Company had $3,972,000 loans
on nonaccrual status as of December 31, 2003, which were considered impaired
loans. The impaired loans had a related valuation allowance of $464,000 at
December 31, 2003. The Company had $608,000 loans past due 90 days or more and
still accruing interest, no restructured loans and no other real estate owned
assets as of December 31, 2003. As of September 30, 2004, the Company had
$303,000 foregone interest income on nonaccrual loans. For the three and nine
months ended September 30, 2004, the Company recognized zero and $27,000 in
interest income for cash payments received on nonaccrual loans. The Company
recognized $3,000 interest income for cash payments received on nonaccrual loans
for the three and nine months ended September 30, 2003. The Company assigns a risk grade consistent with
the system recommended by regulatory agencies to all of its loans. Grades range
from "Pass" to "Loss" depending on credit quality, with "Pass" representing
loans that involve an acceptable degree of risk. 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 value, loan volumes and concentrations,
size and complexity of the loans, recent loss experience in particular segments
of the portfolio, bank regulatory examination 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 four components for purposes of
determining an appropriate level of the allowance: "watch," "special mention,"
"substandard" and "doubtful." Additionally, the Company maintains a program for
regularly scheduled reviews of certain new and renewed loans by an outside loan
review consultant. Any loans identified during an external review process that
expose the Company to increased risk are appropriately downgraded and an
increase in the allowance for loan losses is established for such loans.
Further, the Company is examined periodically by the FDIC, FRB, and the
California Department of Financial Institutions at which time a further review
of loan quality is conducted. 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 graded 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). Allowance for Loan Losses It is the policy of management to maintain the allowance for
probable loan losses at a level adequate for risks inherent in the loan
portfolio. 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 continue to weaken. Additionally, 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. Loans are charged against the allowance when management
believes that the collectibility of the principal is unlikely. The following table summarizes the Company's loan loss
experience as well as provisions, charge-offs and recoveries to the allowance
for loan losses and certain pertinent ratios for the periods indicated: Charge-offs reflect the realization of losses in the
portfolio that were recognized previously though provisions for probable loan
losses. The net charge-offs for the nine months ended September 30, 2004 were
$1,870,000, compared to $2,688,000 for the nine months ended September 30, 2003.
Historical net charge-offs are not necessarily indicative of the amount of net
charge-offs that the Company will realize in the future. The following table summarizes the allocation of the allowance for loan
losses (ALL) by loan type and the allocated allowance as a percent of loans
outstanding in each loan category at the dates indicated: The decrease in the overall level of the allowance and in the
allowance as a percentage of total loans since December 31, 2003 is primarily
the result of the activity related to one unsecured commercial loan. As
reported in the Form 10-K for the fiscal year ended December 31, 2003, during
the first quarter of 2004 the Company identified a $4 million unsecured
commercial line of credit with risks that created doubt about full repayment
under the original terms of the agreement. The loan was placed on nonaccrual
and a specific reserve was established. Subsequent to placement on nonaccrual,
the Company was advised that the borrower had filed for bankruptcy protection
and $2.0 million was charged-off in the first quarter of 2004. The Company
continued to negotiate with the borrower within the framework of the bankruptcy
and the remaining $2.0 million of the loan was paid in full during the second
quarter of 2004. Other than the loans already classified at September 30, 2004,
the Company has not identified any potential problem loans. The increase in the
allowance related to direct financing lease is a result of a downgrade of a
lease loan from special mention to substandard during September 2004. Loans are charged against the allowance when management
believes that the collectibility of the principal is doubtful. The Company's
methodology for assessing the appropriateness of the allowance consists of
several key elements, which include specific allowances, the formula allowance
and the unallocated allowance. Specific allowances are established in cases where management
has identified significant conditions or circumstances related to a credit that
management believes indicate the probability that a loss may be incurred in
excess of the amount determined by the application of the formula allowance. As
of September 30, 2004, nonperforming loans had a related specific valuation
allowance of $342,000, compared to $474,000 at December 31, 2003. The formula allowance is calculated by applying loss factors
to outstanding loans and certain unused commitments. Loss factors are based on
management's experience and may be adjusted for significant factors that, in
management's judgment, may affect the collectibility of the portfolio as of the
evaluation date. Due to the Company's limited historical loss experience,
management utilizes their prior industry experience to determine the loss factor
for each category of loan. The formula allowance on September 30, 2004 was
$12,852,000, compared to $12,947,000 on December 31, 2003. The unallocated allowance is based upon management's
evaluation of various conditions that are not directly measured in the
determination of the formula and specific allowances. The evaluation of the
inherent loss with respect to these conditions is subject to a higher degree of
uncertainty because they are not identified with specific problem credits or
portfolio segments. As of September 30, 2004, the Company's unallocated
allowance was $187,000, compared to $30,000 on December 31, 2003. In evaluating
the appropriateness of the unallocated allowance, management considered the
changes in the trend of the volume and severity of past due and classified
loans; and trends in the volume of nonaccrual loans, troubled debt
restructurings and other loan modifications, changes in national and local
economic and business conditions, trends, and developments, including the
condition of various market segments, changes in underwriting standards and
collection, charge-off, and recovery practices, and changes in the volume and
mix of the loan portfolio and in credit concentrations particularly in
commercial and real estate land and construction lending. There can be no
assurance that the adverse impact of any of these conditions on the Bank will
not be in excess of the range set forth above. In addition, the current business, economic, and real estate
markets along with the seasoning of the portfolio and the nature and duration of
the current business cycle will affect the amount of unallocated reserve. In an effort to improve its analysis of risk factors
associated with its loan portfolio, the Company continues to monitor and to make
appropriate changes to its internal loan policies. These efforts better enable
the Company to assess risk factors prior to granting new loans and to assess the
sufficiency of the allowance for loan losses. Management believes that it has adequately provided an
allowance for estimated probable losses in the credit portfolio. Significant
deterioration in Northern California real property values or economic downturns
could impact future operating results, liquidity or capital resources and
require additional provisions to the allowance or cause losses in excess of the
allowance. Deposits Deposits totaled $902,656,000 at September 30, 2004, up
8%, compared to deposits
of $835,410,000 and $835,947,000, respectively, at December 31, 2003 and
September 30, 2003. Compared to December 31, 2003, noninterest bearing demand
deposits increased $52,422,000, or 22%, interest bearing demand deposits
increased $10,651,000, or 10%, savings and money market accounts increased
$3,118,000, or 1%, total time deposits increased $9,061,000, or 7%, and brokered
deposits decreased $8,006,000, or 67%. The following table summarizes the distribution of average
deposits and the average rates paid for the periods indicated: Deposit Concentration and Deposit Volatility The following table indicates the maturity schedule of the Company's time
deposits (including brokered deposits) of $100,000 or more as of September 30, 2004: The Company focuses primarily on servicing business accounts
that are frequently over $100,000 in average size. Certain types of accounts
that the Company makes available are typically in excess of $100,000 in average
balance per account, and certain types of business clients whom the Company
serves typically carry deposits in excess of $100,000 on average. 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 on the annualized return on
average assets and average equity and average equity to average assets for each
indicated period: Annualized return on average assets and return on average
equity for the quarter ended September 30, 2004 were 1.05% and 12.19%,
respectively, compared with returns of 0.78% and 8.80%, respectively, for the
same period in 2003. The average equity to average asset ratio for the quarter
ended September 30, 2004 was 8.61%, compared to 8.84% for the same period in
2003. Annualized return on average assets and return on average
equity for the nine months ended September 30, 2004 were 0.73% and 8.20%,
respectively, compared with returns of 0.81% and 8.95%, respectively, for the
same period in 2003. The average equity to average asset ratio for the nine
months ended September 30, 2004 was 8.86%, compared to 9.05% for the same period
in 2003. The decrease in return on average assets and return on
average equity for the nine months ended September 30, 2004, from 2003 was due
to non-recurring expenses of $2.05 million pre-tax for severance, annual meeting
and other corporate matters in 2004. Interest Rate Risk The planning of asset and liability maturities is an integral
part of the management of an institution's net yield. To the extent maturities
of assets and liabilities do not match in a changing interest rate environment,
net yields may change over time. Even with perfectly matched repricing of
assets and liabilities, risks remain in the form of prepayment of loans or
investments 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. The following table sets forth the interest rate sensitivity
of the Company's interest-earning assets and interest-bearing liabilities at
September 30, 2004, using the rate sensitivity gap ratio. For purposes of the
following table, an asset or liability is considered rate-sensitive within a
specified period when it can be repriced or when it is scheduled to mature
within the specified time frame: 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. To supplement traditional GAP analysis,
the Company performs simulation modeling to estimate the potential effects of
changing interest rate environments. The process allows the Company to explore
the complex relationships within the GAP over time and various interest rate
environments. Liquidity risk represents the potential for loss as a result
of limitations on the Company's ability to adjust for future cash flows, to meet
the needs of depositors and borrowers, and to fund operations on a timely and
cost-effective basis. The liquidity policy approved by the board of directors
requires annual review of the Company's liquidity by the asset/liability
committee, which is composed of senior executives, and the finance and
investment committee of the board of directors. The Company's internal asset/liability committee and the
finance and investment committee of the board of directors each meet monthly to
monitor the Company's investments, liquidity needs and to oversee its
asset/liability management. The Company evaluates the rates offered on its
deposit products on a weekly basis. Liquidity and Liability Management To meet liquidity needs, the Company maintains a portion
of its funds in cash deposits in other banks, in Federal funds sold, and in
investment securities. At September 30, 2004, the Company's primary liquidity
ratio was 16.06%. The liquidity ratio comprised of $106,492,000 of investment securities
available-for-sale with maturities (or probable calls) of up to five years, Federal funds sold of $5,800,000,
and $46,055,000 in cash and due from banks less $15,907,000 of securities that
were pledged to secure public and certain other deposits as required by law and
contract, as a percentage of total unsecured deposits of $886,749,000. The
Company has lines of credit of approximately $139,706,000 available from the
Federal Home Loan Bank and correspondent banks to meet short-term liquidity
needs. There were no balances outstanding on these lines of credit at September
30, 2004 and 2003. Capital Resources
Quarterly Report on Form 10-Q
Table of Contents
PART I. FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements
(unaudited):
Condensed Consolidated Balance Sheets
Condensed Consolidated Income Statements
Condensed Consolidated Statements of Changes in Shareholders' Equity
Condensed Consolidated Statements of Cash Flows
Condensed Consolidated Notes to Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 5. Other Information
Item 6. Exhibits
Signatures
CONDENSED CONSOLIDATED BLANCE SHEETS (UNAUDITED)
September 30, December 31,
(Dollars in thousands) 2004 2003
- ---------------------------------------------------------------- ------------ ------------
ASSETS
Cash and due from banks......................................... $ 46,055 $ 39,978
Interest bearing deposits in other financial institutions....... 1,292 2,039
Federal funds sold.............................................. 5,800 72,200
------------ ------------
Total cash and cash equivalents.................. 53,147 114,217
Securities available-for-sale, at fair value.................... 228,483 153,473
Loans held for sale, at lower of cost or market................. 28,782 30,638
Loans, net of deferred costs.................................... 727,615 666,088
Allowance for probable loan losses.............................. (13,381) (13,451)
------------ ------------
Loans, net....................................... 714,234 652,637
Premises and equipment, net..................................... 3,489 4,034
Accrued interest receivable and other assets.................... 23,470 20,425
Company owned life insurance.................................... 26,072 25,273
Other investments............................................... 4,655 2,504
------------ ------------
TOTAL............................................ $ 1,082,332 $ 1,003,201
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits
Demand, noninterest bearing............................... $ 290,845 $ 238,423
Demand, interest bearing.................................. 115,911 105,260
Savings and money market.................................. 349,004 345,886
Time deposits, under $100................................. 38,170 39,869
Time deposits, $100 and over.............................. 104,762 94,002
Brokered deposits......................................... 3,964 11,970
------------ -----------
Total deposits............................................... 902,656 835,410
Accrued interest payable and other liabilities............... 11,539 10,643
Other borrowings............................................. 47,800 43,600
Notes payable to subsidiary grantor trusts................... 23,702 23,702
------------ ------------
Total liabilities................................ 985,697 913,355
------------ ------------
Commitments and contingencies
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 issued and outstanding: 11,657,865 at
September 30, 2004 and 11,381,037 at December 31, 2003.... 66,490 65,234
Unallocated ESOP shares...................................... (255) (443)
Accumulated other comprehensive income (loss), net of taxes.. (271) 79
Retained earnings............................................ 30,671 24,976
------------ ------------
Total shareholders' equity....................... 96,635 89,846
------------ ------------
TOTAL............................................ $ 1,082,332 $ 1,003,201
============ ============
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
(Dollars in thousands, except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------- ----------- ----------- ----------- -----------
Interest income:
Loans, including fees..................................... $ 11,709 $ 10,138 $ 33,135 $ 32,121
Securities, taxable...................................... 1,788 1,154 4,686 3,036
Securities, non-taxable.................................. 56 112 241 292
Interest bearing deposits in other financial institutions. 3 5 7 40
Federal funds sold........................................ 77 147 238 388
----------- ----------- ----------- -----------
Total interest income 13,633 11,556 38,307 35,877
----------- ----------- ----------- -----------
Interest expense:
Deposits.................................................. 1,729 1,775 4,889 6,106
Subsidiary grantor trusts................................. 492 470 1,455 1,450
Other..................................................... 263 124 627 138
----------- ----------- ----------- -----------
Total interest expense....................................... 2,484 2,369 6,971 7,694
----------- ----------- ----------- -----------
Net interest income before provision for probable
loan losses................................................ 11,149 9,187 31,336 28,183
Provision for probable loan losses........................... 600 600 1,800 2,500
----------- ----------- ----------- -----------
Net interest income after provision for probable
loan losses................................................ 10,549 8,587 29,536 25,683
----------- ----------- ----------- -----------
Noninterest income:
Gain on sale of loans..................................... 920 561 2,285 1,705
Servicing income.......................................... 616 463 1,682 1,339
Service charges and other fees on deposit accounts........ 415 480 1,385 1,332
Appreciation of company owned life insurance ............. 236 254 798 891
Gain on sale of securities available-for-sale............. 0 74 476 532
Mortgage brokerage fees .................................. 19 210 168 851
Other..................................................... 157 421 347 1,293
----------- ----------- ----------- -----------
Total noninterest income..................................... 2,363 2,463 7,141 7,943
----------- ----------- ----------- -----------
Noninterest expenses:
Salaries and employee benefits............................ 4,301 4,423 14,477 13,664
Occupancy................................................. 883 857 2,813 2,511
Professional fees......................................... 670 338 1,986 1,028
Retirement plan expense................................... 358 17 1,576 528
Loan origination costs.................................... 426 369 1,194 1,046
Advertising and promotion................................. 364 209 862 608
Furniture and equipment................................... 206 385 698 1,143
Client services........................................... 228 239 644 714
Data processing expense................................... 170 26 492 71
Stationery & supplies..................................... 140 83 292 246
Telephone................................................. 72 85 271 235
Other..................................................... 1,071 1,279 3,212 3,502
----------- ----------- ----------- -----------
Total noninterest expenses................................... 8,889 8,310 28,517 25,296
----------- ----------- ----------- -----------
Income before provision for income taxes..................... 4,023 2,740 8,160 8,330
Provision for income taxes................................... 1,135 800 2,465 2,590
----------- ----------- ----------- -----------
Net income................................................... $ 2,888 $ 1,940 $ 5,695 $ 5,740
=========== =========== =========== ===========
Earnings per share:
Basic................................................... $ 0.25 $ 0.17 $ 0.49 $ 0.51
=========== =========== =========== ===========
Diluted................................................. $ 0.24 $ 0.17 $ 0.48 $ 0.50
=========== =========== =========== ===========
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
Accumulated
Other
Common Stock Comprehensive Total Other
----------------------- Unallocated Income (Loss) Retained Shareholders' Comprehensive
(Dollars in thousands) Shares Amount ESOP Shares Net of Taxes Earnings Equity Income
----------- --------- --------- ------------ --------- ------------ -----------
BALANCES, DECEMBER 31, 2002........ 11,214,414 $ 64,002 $ (693) $ 1,714 $ 17,194 $ 82,217
Net income......................... -- -- -- -- 5,740 5,740 $ 5,740
Net change in unrealized
loss on securities
available-for-sale, net of
reclassification adjustment
and taxes.......................... -- -- -- (1,725) -- (1,725) (1,725)
-----------
Total comprehensive income...... $ 4,015
===========
Additional paid-in-capital in ESOP. -- 104 -- -- -- 104
Amortization of stock compensation. -- -- 250 -- -- 250
Stock options exercised............ 111,749 898 -- -- -- 898
----------- --------- --------- ------------ --------- ------------
BALANCES, SEPTEMBER 30, 2003....... 11,326,163 $ 65,004 $ (443) $ (11) $ 22,934 $ 87,484
=========== ========= ========= ============ ========= ============
BALANCES, DECEMBER 31, 2003........ 11,381,037 $ 65,234 $ (443) $ 79 $ 24,976 $ 89,846
Net income......................... -- -- -- -- 5,695 5,695
Net change in unrealized
loss on securities $ 5,695
available-for-sale, net of
reclassification adjustment
and taxes.......................... -- -- -- (350) -- (350)
Total comprehensive income...... (350)
-----------
Additional paid-in-capital in ESOP. -- 170 -- -- -- 170 $ 5,345
Amortization of stock compensation. -- -- 188 -- -- 188 ===========
Common stock repurchased........... (176,528) (2,581) -- -- -- (2,581)
Stock options exercised............ 453,356 3,667 -- -- -- 3,667
----------- --------- --------- ------------ --------- ------------
BALANCES, SEPTEMBER 30, 2004....... 11,657,865 $ 66,490 $ (255) $ (271) $ 30,671 $ 96,635
=========== ========= ========= ============ ========= ============
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
>
Nine Months Ended
September 30,
--------------------------
(Dollars in thousands) 2004 2003
- ------------------------------------------------------------------ ------------ ------------
Cash flows from operating activities:
Net income........................................................$ 5,695 $ 5,740
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization..................................... 1,081 1,277
Provision for probable loan losses................................ 1,800 2,500
Non-cash compensation expense related to ESOP plan................ 358 354
Gain on sale of securities available-for-sale..................... (476) (532)
Net amortization of premiums / accretion of discounts............. 785 1,034
Gains on sales of loans held for sale............................. (2,285) (1,705)
Proceeds from sales of loans held for sale....................... 45,205 35,069
Originations of loans held for sale............................... (57,936) (60,895)
Maturities of loans held for sale................................. 16,871 24,940
Appreciation of company owned life insurance...................... (798) (891)
Effect of changes in:
Accrued interest receivable and other assets.................. (2,693) (373)
Accrued interest payable and other liabilities................ 1,364 (757)
------------ ------------
Net cash provided by operating activities......................... 8,971 5,761
------------ ------------
Cash flows from investing activities:
Net (increase) decrease in loans.................................. (63,397) 29,040
Purchases of securities available-for-sale........................ (117,735) (120,478)
Maturities/paydowns/calls of securities available-for-sale........ 18,605 43,715
Proceeds from sales of securities available-for-sale............. 22,641 27,664
Purchases of company owned life insurance......................... 0 (225)
(Purchases) Redemption of other investments....................... (2,151) 1,213
Purchases of premises and equipment............................... (536) (625)
------------ ------------
Net cash used in investing activities............................. (142,573) (19,696)
------------ ------------
Cash flows from financing activities:
Net increase (decrease) in deposits............................... 67,246 (5,989)
Net proceeds from issuance of common stock........................ 3,667 898
Common stock repurchased.......................................... (2,581) 0
Net change in other borrowings.................................... 4,200 28,600
------------ ------------
Net cash provided by financing activities......................... 72,532 23,509
------------ ------------
Net (decrease) increase in cash and cash equivalents.............. (61,070) 9,574
Cash and cash equivalents, beginning of period.................... 114,217 86,632
------------ ------------
Cash and cash equivalents, end of period.......................... $ 53,147 $ 96,206
============ ============
Supplemental disclosures of cash paid during the period for:
Interest....................................................... $ 7,362 $ 8,726
Income taxes................................................... $ 750 $ 2,735
Supplemental schedule on non-cash investing and financing activity:
Transfer of loans to other real estate owned................... $ 0 $ 652
Notes to Condensed Consolidated Financial Statements
September 30, 2004
(Unaudited)
Less Than 12 Months 12 Months or More Total
-------------------- --------------------- --------------------
Market Unrealized Market Unrealized Market Unrealized
(Dollars in thousands) Value Losses Value Losses Value Losses
- ------------------------------------------------ --------- --------- --------- --------- -------- --------
U.S. Treasury............................... $ 5,964 $ 33 $ -- $ -- $ 5,964 $ 33
U.S. Government Agencies.................... 63,003 418 2,912 88 65,915 506
Municipals.................................. 4,583 17 -- -- 4,583 17
FHLMC and FNMA mortgage-backed securities... 35,946 524 43,149 1,265 79,095 1,789
CMOs........................................ 19,717 185 -- -- 19,717 185
--------- --------- --------- --------- -------- --------
Total securities available-for-sale............. $ 129,213 $ 1,177 $ 46,061 $ 1,353 $ 175,274 $ 2,530
========= ========= ========= ========= ======== ========
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -----------------------
(Dollars in thousands, except per share data) 2004 2003 2004 2003
- --------------------------------------------------------------------- --------- --------- ---------- ----------
Net income
As reported...................................................... $ 2,888 $ 1,940 $ 5,695 $ 5,740
Less: Compensation expense for amortization of fair value of
stock awards, net of taxes................................. (209) (187) (605) (541)
--------- --------- ---------- ----------
Pro forma........................................................ $ 2,679 $ 1,753 $ 5,090 $ 5,199
========= ========= ========== ==========
Net income per common share - basic
As reported...................................................... $ 0.25 $ 0.17 $ 0.49 $ 0.51
Pro forma........................................................ $ 0.23 $ 0.16 $ 0.44 $ 0.46
Net income per common share - diluted
As reported...................................................... $ 0.24 $ 0.17 $ 0.48 $ 0.50
Pro forma........................................................ $ 0.22 $ 0.15 $ 0.43 $ 0.45
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Weighted average common shares outstanding - used
in computing basic earnings per share.................... 11,621,963 11,254,328 11,522,054 11,201,345
Dilutive effect of stock options outstanding,
using the treasury stock method.......................... 376,557 441,879 418,444 367,595
----------- ----------- ----------- -----------
Shares used in computing diluted earnings per share.......... 11,998,520 11,696,207 11,940,498 11,568,940
=========== =========== =========== ===========
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
(Dollars in thousands) 2004 2003 2004 2003
- ------------------------------------------------------------- ----------- ----------- ----------- -----------
Net income................................................... $ 2,888 $ 1,940 $ 5,695 $ 5,740
Other comprehensive income (loss), net of tax:
Net unrealized holding gain (loss) on available-for-sale
securities and I/O strips during the period............. 2,349 (1,464) (17) (1,358)
Less: reclassification adjustment for realized
gain on available-for-sale securities
included in net income during the period........... -- (52) (333) (367)
----------- ----------- ----------- -----------
Other comprehensive income (loss)............................ 2,349 (1,516) (350) (1,725)
----------- ----------- ----------- -----------
Comprehensive income......................................... $ 5,237 $ 424 $ 5,345 $ 4,015
=========== =========== =========== ===========
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
(Dollars in thousands) 2004 2003 2004 2003
- ------------------------------------------ --------- --------- --------- ---------
Components of net periodic benefits cost
Service cost........................... $ 310 $ 115 $ 652 $ 343
Interest cost.......................... 105 50 316 149
Amortization of (gain)/loss............ 38 (6) 119 (18)
--------- --------- --------- ---------
Net periodic benefit cost.............. $ 453 $ 159 $ 1,087 $ 474
========= ========= ========= =========
(Dollars in thousands) 2004 2003
- ------------------------------ ------------ ------------
Commitments to extend credit.. $ 311,017 $ 270,347
Standby letters of credit..... 5,125 2,290
------------ ------------
$ 316,142 $ 272,637
============ ============
For the Three Months Ended For the Three Months Ended
September 30, 2004 September 30, 2003
--------------------------------- ---------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
(Dollars in thousands) Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------- ---------- ---------- --------- ---------- ---------- ---------
Assets:
Loans, gross..................................................... $ 746,157 $ 11,709 6.24% $ 668,769 $ 10,138 6.01%
Investment securities............................................ 234,438 1,844 3.13% 175,338 1,266 2.86%
Interest bearing deposits in other financial institutions........ 1,026 3 1.16% 2,977 5 0.67%
Federal funds sold............................................... 22,282 77 1.37% 61,059 147 0.96%
---------- ---------- ---------- ----------
Total interest earning assets................................. 1,003,903 $ 13,633 5.40% 908,143 $ 11,556 5.05%
---------- ----------
Cash and due from banks.......................................... 51,147 41,990
Premises and equipment, net...................................... 3,661 4,803
Other assets..................................................... 35,619 34,494
---------- ----------
Total assets.................................................. $1,094,330 $ 989,430
========== ==========
Liabilities and shareholders' equity:
Deposits:
Demand, interest bearing......................................... $ 116,053 $ 134 0.46% $ 95,681 $ 106 0.44%
Savings and money market......................................... 370,398 1,011 1.09% 325,198 884 1.08%
Time deposits, under $100........................................ 38,006 140 1.47% 41,957 179 1.69%
Time deposits, $100 and over..................................... 99,178 381 1.53% 98,010 402 1.63%
Brokered deposits................................................ 5,745 63 4.36% 19,833 204 4.08%
Other borrowings................................................. 71,222 755 4.22% 51,600 594 4.57%
---------- ---------- ---------- ----------
Total interest bearing liabilities............................ 700,602 $ 2,484 1.41% 632,279 $ 2,369 1.49%
---------- ----------
Demand, noninterest bearing...................................... 288,096 259,000
Other liabilities................................................ 11,357 10,723
---------- ----------
Total liabilities............................................. 1,000,055 902,002
Shareholders' equity............................................. 94,275 87,428
---------- ----------
Total liabilities and
shareholders' equity....................................... $1,094,330 $ 989,430
========== ==========
Net interest income / margin..................................... $ 11,149 4.42% $ 9,187 4.01%
========== ==========
For the Nine Months Ended For the Nine Months Ended
September 30, 2004 September 30, 2003
--------------------------------- ---------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
(Dollars in thousands) Balance Expense Rate Balance Expense Rate
- ----------------------------------------------------------------- ---------- ---------- --------- ---------- ---------- ---------
Assets:
Loans, gross..................................................... $ 718,827 $ 33,135 6.16% $ 678,446 $ 32,121 6.33%
Investment securities............................................ 210,537 4,927 3.13% 137,107 3,328 3.25%
Interest bearing deposits in other financial institutions........ 1,223 7 0.76% 6,134 40 0.87%
Federal funds sold............................................... 30,056 238 1.06% 47,699 388 1.09%
---------- ---------- ---------- ----------
Total interest earning assets................................. 960,643 $ 38,307 5.33% 869,386 $ 35,877 5.52%
---------- ----------
Cash and due from banks.......................................... 48,808 39,418
Premises and equipment, net...................................... 3,819 4,987
Other assets..................................................... 33,438 33,664
---------- ----------
Total assets.................................................. $1,046,708 $ 947,455
========== ==========
Liabilities and shareholders' equity:
Deposits:
Demand, interest bearing......................................... $ 110,909 $ 368 0.44% $ 94,967 $ 389 0.55%
Savings and money market......................................... 352,402 2,718 1.03% 310,391 2,792 1.20%
Time deposits, under $100........................................ 38,943 419 1.44% 43,884 641 1.95%
Time deposits, $100 and over..................................... 97,962 1,078 1.47% 103,135 1,442 1.87%
Brokered deposits................................................ 9,166 306 4.46% 28,124 842 4.00%
Other borrowings................................................. 65,212 2,082 4.26% 33,721 1,588 6.30%
---------- ---------- ---------- ----------
Total interest bearing liabilities............................ 674,594 $ 6,971 1.38% 614,222 $ 7,694 1.67%
---------- ----------
Demand, noninterest bearing ..................................... 268,749 237,396
Other liabilities................................................ 10,600 10,116
---------- ----------
Total liabilities............................................. 953,943 861,734
Shareholders' equity............................................. 92,765 85,721
---------- ----------
Total liabilities and
shareholders' equity....................................... $1,046,708 $ 947,455
========== ==========
Net interest income / margin..................................... $ 31,336 4.36% $ 28,183 4.33%
========== ==========
Three Months Ended September 30,
2004 vs. 2003
----------------------------------
Increase (Decrease) Due to Change In:
Average Average Net
(Dollars in thousands) Volume Rate Change
- -------------------------------------------------------------- ---------- ---------- ----------
Interest earning assets
Loans, gross.............................................. $ 1,219 $ 352 $ 1,571
Investments securities.................................... 464 114 578
Interest bearing deposits in other financial institutions. (5) 3 (2)
Federal funds sold........................................ (135) 65 (70)
---------- ---------- ----------
Total interest earning assets................................ $ 1,543 $ 534 $ 2,077
---------- ---------- ----------
Interest bearing liabilities
Demand, interest bearing.................................. 23 5 28
Savings and money market.................................. 120 7 127
Time deposits, under $100................................. (14) (25) (39)
Time deposits, $100 and over.............................. 4 (25) (21)
Brokered Deposits......................................... (155) 14 (141)
Other borrowings.......................................... 208 (47) 161
---------- ---------- ----------
Total interest bearing liabilities........................... $ 186 $ (71) $ 115
---------- ---------- ----------
Net interest income.......................................... $ 1,357 $ 605 $ 1,962
========== ========== ==========
Nine Months Ended September 30,
2004 vs. 2003
----------------------------------
Increase (Decrease) Due to Change In:
Average Average Net
(Dollars in thousands) Volume Rate Change
- -------------------------------------------------------------- ---------- ---------- ----------
Interest earning assets
Loans, gross.............................................. $ 1,848 $ (834) $ 1,014
Investments securities.................................... 1,714 (115) 1,599
Interest bearing deposits in other financial institutions. (28) (5) (33)
Federal funds sold........................................ (140) (10) (150)
---------- ---------- ----------
Total interest earning assets................................ $ 3,394 $ (964) $ 2,430
---------- ---------- ----------
Interest bearing liabilities
Demand, interest bearing.................................. $ 53 $ (74) $ (21)
Savings and money market.................................. 324 (398) (74)
Time deposits, under $100................................. (54) (168) (222)
Time deposits, $100 and over.............................. (57) (307) (364)
Brokered Deposits......................................... (633) 97 (536)
Other borrowings.......................................... 1,005 (511) 494
---------- ---------- ----------
Total interest bearing liabilities........................... $ 638 $ (1,361) $ (723)
---------- ---------- ----------
Net interest income.......................................... $ 2,756 $ 397 $ 3,153
========== ========== ==========
Three Months Ended Increase (Decrease)
September 30, 2004 versus 2003
-------------------- --------------------
(Dollars in thousands) 2004 2003 Amount Percent
- ---------------------------------------------------- --------- --------- --------- ---------
Servicing income.................................... 616 463 153 33 %
Service charges and other fees on deposit accounts.. 415 480 (65) (14)%
Appreciation of company owned life insurance........ 236 254 (18) (7)%
Gain on sale of securities available-for-sale....... -- 74 (74) (100)%
Mortgage brokerage fees............................. 19 210 (191) (91)%
Other............................................... 157 421 (264) (63)%
--------- --------- ---------
Total............................................... $ 2,363 $ 2,463 $ (100) (4)%
========= ========= =========
Nine Months Ended Increase (Decrease)
September 30, 2004 versus 2003
-------------------- --------------------
(Dollars in thousands) 2004 2003 Amount Percent
- ---------------------------------------------------- --------- --------- --------- ---------
Gain on sale of loans............................... $ 2,285 $ 1,705 $ 580 34 %
Servicing income.................................... 1,682 1,339 343 26 %
Service charges and other fees on deposit accounts.. 1,385 1,332 53 4 %
Appreciation of company owned life insurance........ 798 891 (93) (10)%
Gain on sale of securities available-for-sale....... 476 532 (56) (11)%
Mortgage brokerage fees............................. 168 851 (683) (80)%
Other............................................... 347 1,293 (946) (73)%
--------- --------- ---------
Total............................................... $ 7,141 $ 7,943 $ (802) (10)%
========= ========= =========
Three Months Ended Increase (Decrease)
September 30, 2004 versus 2003
-------------------- --------------------
(Dollars in thousands) 2004 2003 Amount Percent
- ---------------------------------------------------- --------- --------- --------- ---------
Salaries and employee benefits...................... $ 4,301 $ 4,423 $ (122) (3)%
Occupancy........................................... 883 857 26 3 %
Professional fees................................... 670 338 332 98 %
Retirement plan expense............................. 358 17 341 2,006 %
Loan origination costs.............................. 426 369 57 15 %
Advertising and promotion........................... 364 209 155 74 %
Furniture and equipment............................. 206 385 (179) (46)%
Client services..................................... 228 239 (11) (5)%
Data processing expense............................. 170 26 144 554 %
Stationery & supplies............................... 140 83 57 69 %
Telephone........................................... 72 85 (13) (15)%
Other............................................... 1,071 1,279 (208) (16)%
--------- --------- ---------
Total............................................... $ 8,889 $ 8,310 $ 579 7 %
========= ========= =========
Nine Months Ended Increase (Decrease)
September 30, 2004 versus 2003
-------------------- --------------------
(Dollars in thousands) 2004 2003 Amount Percent
- ---------------------------------------------------- --------- --------- --------- ---------
Salaries and employee benefits...................... $ 14,477 $ 13,664 $ 813 6 %
Occupancy........................................... 2,813 2,511 302 12 %
Professional fees................................... 1,986 1,028 958 93 %
Retirement plan expense............................. 1,576 528 1,048 198 %
Loan origination costs.............................. 1,194 1,046 148 14 %
Advertising and promotion........................... 862 608 254 42 %
Furniture and equipment............................. 698 1,143 (445) (39)%
Client services..................................... 644 714 (70) (10)%
Data processing expense............................. 492 71 421 593 %
Stationery & supplies............................... 292 246 46 19 %
Telephone........................................... 271 235 36 15 %
Other............................................... 3,212 3,502 (290) (8)%
--------- --------- ---------
Total............................................... $ 28,517 $ 25,296 $ 3,221 13 %
========= ========= =========
For The Three Months Ended September 30,
-------------------------------------------
Percent Percent
(Dollars in thousands) 2004 of Total 2003 of Total
- ---------------------------------------------------- --------- --------- --------- ---------
Salaries and employee benefits...................... $ 4,301 48 % $ 4,423 53 %
Occupancy........................................... 883 10 % 857 10 %
Professional fees................................... 670 7 % 338 4 %
Retirement plan expense............................. 358 4 % 17 0 %
Loan origination costs.............................. 426 5 % 369 4 %
Advertising and promotion........................... 364 4 % 209 3 %
Furniture and equipment............................. 206 2 % 385 5 %
Client services..................................... 228 3 % 239 3 %
Data processing expense............................. 170 2 % 26 0 %
Telephone........................................... 72 1 % 85 1 %
Stationery & supplies............................... 140 2 % 83 1 %
Other............................................... 1,071 12 % 1,279 16 %
--------- --------- --------- ---------
Total............................................... $ 8,889 100 % $ 8,310 100 %
========= ========= ========= =========
For The Nine Months Ended September 30,
-------------------------------------------
Percent Percent
(Dollars in thousands) 2004 of Total 2003 of Total
- ---------------------------------------------------- --------- --------- --------- ---------
Salaries and employee benefits...................... $ 14,477 51 % $ 13,664 54 %
Occupancy........................................... 2,813 10 % 2,511 10 %
Professional fees................................... 1,986 7 % 1,028 4 %
Retirement plan expense............................. 1,576 6 % 528 2 %
Loan origination costs.............................. 1,194 4 % 1,046 4 %
Advertising and promotion........................... 862 3 % 608 2 %
Furniture and equipment............................. 698 2 % 1,143 5 %
Client services..................................... 644 2 % 714 3 %
Data processing expense............................. 492 2 % 71 0 %
Telephone........................................... 271 1 % 235 1 %
Stationery & supplies............................... 292 1 % 246 1 %
Other............................................... 3,212 11 % 3,502 14 %
--------- --------- --------- ---------
Total............................................... $ 28,517 100 % $ 25,296 100 %
========= ========= ========= =========
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Effective income tax rate........................... 28.21 % 29.20 % 30.21 % 31.09 %
September 30,
---------------------- December 31,
(Dollars in thousands) 2004 2003 2003
- ----------------------------------------------- ---------- ---------- -----------
Securities available-for-sale (at fair value)
U.S. Treasury.................................. $ 5,964 $ 8,564 $ 7,015
U.S. Government Agencies....................... 91,041 46,797 36,115
Mortgage-Backed Securities..................... 102,511 74,741 79,615
Municipals..................................... 9,250 16,748 15,704
Mutual Funds................................... -- 10,036 --
CMOs........................................... 19,717 15,124 15,024
---------- ---------- -----------
Total securities available-for-sale............ $ 228,483 $ 172,010 $ 153,473
========== ========== ===========
September 30, 2004
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:
U.S. Treasury.................. $ -- -- % $ 5,964 1.67 % $ -- -- % $ -- -- % $ 5,964 1.67 %
U.S. Government Agencies....... 5,589 1.75 % 85,452 2.35 % -- -- % -- -- % 91,041 2.31 %
Mortgage-Backed Securities..... -- -- % 238 5.06 % 11,905 3.85 % 90,368 3.96 % 102,511 3.95 %
Municipals - Nontaxable....... 458 4.71 % 8,792 2.30 % -- -- % -- -- % 9,250 2.42 %
CMOs........................... -- -- % -- -- % -- -- % 19,717 3.07 % 19,717 3.07 %
-------- -------- -------- -------- ---------
Total available-for-sale....... $ 6,047 1.97 % $100,446 2.31 % $ 11,905 3.85 % $110,085 3.80 % $ 228,483 3.10 %
======== ======== ======== ======== =========
September 30, % of September 30, % of December 31, % of
(Dollars in thousands) 2004 Total 2003 Total 2003 Total
- ----------------------------------- ------------- ------- ------------- ------- ------------- -------
Commercial......................... $ 314,007 43 % $ 268,607 42 % $ 281,561 42 %
Real estate - mortgage............. 301,249 41 % 252,664 39 % 276,908 42 %
Real estate - land and construction 106,303 15 % 117,441 18 % 101,082 15 %
Direct financing lease............... 3,538 1 % 0 0 % 3,931 1 %
Consumer........................... 2,051 0 % 2,487 1 % 1,743 0 %
------------- ------- ------------- ------- ------------- -------
Total loans................... 727,148 100 % 641,199 100 % 665,225 100 %
======= ======= =======
Deferred loan costs................ 467 981 863
Allowance for loan losses.......... (13,381) (13,039) (13,451)
------------- ------------- -------------
Loans, net......................... $ 714,234 $ 629,141 $ 652,637
============= ============= =============
Over One
Due in Year But
One Year Less Than Over
(Dollars in thousands) or Less Five Years Five Years Total
- ------------------------------------- ---------- ---------- ---------- ----------
Commercial........................... $ 297,557 $ 10,705 $ 5,745 $ 314,007
Real estate - mortgage............... 199,851 53,761 47,637 301,249
Real estate - land and construction.. 106,254 49 -- 106,303
Direct financing lease............... 999 2,500 39 3,538
Consumer............................. 1,841 210 -- 2,051
---------- ---------- ---------- ----------
Total loans..................... $ 606,502 $ 67,225 $ 53,421 $ 727,148
========== ========== ========== ==========
Loans with variable interest rates... $ 587,425 $ 23,079 $ 229 $ 610,733
Loans with fixed interest rates...... 19,077 44,146 53,192 116,415
---------- ---------- ---------- ----------
Total loans..................... $ 606,502 $ 67,225 $ 53,421 $ 727,148
========== ========== ========== ==========
September 30,
---------------------- December 31,
(Dollars in thousands) 2004 2003 2003
- ------------------------------------------------ ---------- ---------- -----------
Nonaccrual loans................................ $ 1,926 $ 6,497 $ 3,972
Loans 90 days past due and still accruing....... 711 395 608
Restructured loans.............................. -- -- --
---------- ---------- -----------
Total nonperforming loans................... 2,637 6,892 4,580
Other real estate owned......................... -- 652 --
---------- ---------- -----------
Total nonperforming assets.................. $ 2,637 $ 7,544 $ 4,580
========== ========== ===========
Nonperforming assets as a percentage of
period end loans plus other real estate owned. 0.36 % 1.17 % 0.69 %
Nine Months Ended For the Year
September 30, Ended
-------------------- December 31,
(Dollars in thousands) 2004 2003 2003
- -------------------------------------- --------- --------- -----------
Balance, beginning of period / year... $ 13,451 $ 13,227 $ 13,227
Net charge-offs....................... (1,870) (2,688) (2,676)
Provision for probable loan losses.... 1,800 2,500 2,900
--------- --------- -----------
Balance, end of period / year......... $ 13,381 $ 13,039 $ 13,451
========= ========= ===========
Ratios:
Net charge-offs to
average loans outstanding.......... 0.36 % 0.55 % 0.41 %
Allowance for loan losses to average
loans.............................. 1.94 % 2.01 % 2.07 %
Allowance for loan losses to total
loans.............................. 1.84 % 2.03 % 2.02 %
Allowance for loan losses to
nonperforming assets............... 507 % 173 % 294 %
September 30, 2004 September 30, 2003 December 31, 2003
-------------------- ---------------------- --------------------
Percent Percent Percent
of ALL by of ALL by of ALL by
category category category
to total to total to total
loans by loans by loans by
(Dollars in thousands) Amount category Amount category Amount category
- -------------------------------------- --------- --------- ----------- --------- --------- ---------
Commercial............................ $ 9,452 3.01 % $ 8,814 3.27 % $ 9,628 3.42 %
Real estate - mortgage................ 1,857 0.62 % 1,908 0.76 % 2,003 0.72 %
Real estate - land and construction... 1,436 1.35 % 2,259 1.92 % 1,714 1.70 %
Direct financing lease................ 408 11.54 % -- -- % 37 0.99 %
Consumer.............................. 41 2.00 % 58 2.33 % 39 2.12 %
Unallocated........................... 187 -- % -- -- % 30 -- %
--------- ----------- ---------
Total ........................... $ 13,381 1.84 % $ 13,039 2.03 % $ 13,451 2.02 %
========= =========== =========
Nine Months Ended Nine Months Ended Year Ended
September 30, 2004 September 30, 2003 December 31, 2003
-------------------- -------------------- --------------------
Average Average Average
Average Rate Average Rate Average Rate
(Dollars in thousands) Balance Paid Balance Paid Balance Paid
- ------------------------------------- ---------- -------- ---------- -------- ---------- --------
Demand, noninterest bearing.......... $ 268,749 -- % $ 237,396 -- % $ 238,467 -- %
Demand, interest bearing............. 110,909 0.44 % 94,967 0.55 % 96,772 0.51 %
Saving and money market.............. 352,402 1.03 % 310,391 1.20 % 318,774 1.16 %
Time deposits, under $100............ 38,943 1.44 % 43,884 1.95 % 43,060 1.85 %
Time deposits, $100 and over......... 97,962 1.47 % 103,135 1.87 % 101,406 1.79 %
Brokered deposits.................... 9,166 4.46 % 28,124 4.00 % 24,559 4.05 %
---------- ---------- ----------
Total average deposits.......... $ 878,131 0.74 % $ 817,897 1.00 % $ 823,038 0.95 %
========== ========== ==========
% of
(Dollars in thousands) Balance Total
- ----------------------------------------------------------- ---------- --------
Three months or less....................................... $ 48,841 45 %
Over three months through twelve months.................... 49,996 46 %
Over twelve months......................................... 9,889 9 %
---------- --------
Total............................................... $ 108,726 100 %
========== ========
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
2004 2003 2004 2003
-------- -------- -------- --------
Return on average assets............... 1.05 % 0.78 % 0.73 % 0.81 %
Return on average equity............... 12.19 % 8.80 % 8.20 % 8.95 %
Average equity to average assets ratio. 8.61 % 8.84 % 8.86 % 9.05 %
Due in Due After
Within Three to One to Due After Not
Three Twelve Five Five Rate-
(Dollars in thousands) Months Months Years Years Sensitive Total
- ------------------------------------------------------------- --------- --------- --------- --------- --------- ----------
Interest earning assets:
Federal funds sold......................................... $ 5,800 $ -- $ -- $ -- $ -- $ 5,800
Interest bearing deposits in other financial Institutions.. 1,292 -- -- -- -- 1,292
Securities................................................. -- 6,046 100,446 121,991 -- 228,483
Total loans................................................ 540,178 95,574 67,225 53,420 -- 756,397
--------- --------- --------- --------- --------- ----------
Total interest earning assets............................ 547,270 101,620 167,671 175,411 -- 991,972
--------- --------- --------- --------- --------- ----------
Cash and due from banks...................................... -- -- -- -- 46,055 46,055
Other assets................................................. -- 26,072 -- -- 18,233 44,305
--------- --------- --------- --------- --------- ----------
Total assets............................................. $ 547,270 $ 127,692 $ 167,671 $ 175,411 $ 64,288 $1,082,332
========= ========= ========= ========= ========= ==========
Interest bearing liabilities:
Demand, interest bearing................................... $ 115,911 $ -- $ -- $ -- $ -- $ 115,911
Savings and money market................................... 349,004 -- -- -- -- 349,004
Time deposits.............................................. 62,628 69,520 14,748 -- -- 146,896
Other borrowings........................................... -- 15,100 32,700 -- -- 47,800
Notes payable to subsidiary grantor trusts................. 9,279 -- -- 14,423 -- 23,702
--------- --------- --------- --------- --------- ----------
Total interest bearing liabilities....................... 536,822 84,620 47,448 14,423 -- 683,313
--------- --------- --------- --------- --------- ----------
Noninterest demand deposits.................................. 79,533 -- -- -- 211,312 290,845
Accrual interest payable and other liabilities............... -- -- -- -- 11,539 11,539
Shareholders' equity......................................... -- -- -- -- 96,635 96,635
--------- --------- --------- --------- --------- ----------
Total liabilities and shareholders' equity............... $ 616,355 $ 84,620 $ 47,448 $ 14,423 $ 319,486 $1,082,332
========= ========= ========= ========= ========= ==========
Interest rate sensitivity GAP................................ $ (69,085) $ 43,072 $ 120,223 $ 160,988 $(255,198) $ --
========= ========= ========= ========= ========= ==========
Cumulative interest rate sensitivity GAP..................... $ (69,085) $ (26,013) $ 94,210 $ 255,198 $ -- $ --
Cumulative interest rate sensitivity GAP ratio............... (6.38)% (2.40)% 8.70 % 23.58 % -- % -- %
The following table summarizes risk-based capital, risk-weighted assets, and risk-based capital ratios of the Company:
September 30,
----------------------- December 31,
(Dollars in thousands) 2004 2003 2003
- --------------------------------- ---------- ---------- -----------
Capital components:
Tier 1 Capital................ $ 117,686 $ 108,764 $ 110,891
Tier 2 Capital................ 11,295 10,286 10,403
---------- ---------- -----------
Total risk-based capital.... $ 128,981 $ 119,050 $ 121,294
========== ========== ===========
Risk-weighted assets............. $ 902,687 $ 820,875 $ 830,537
Average assets................... $1,098,123 $ 989,285 $ 992,608
Minimum
Regulatory
Requirements
-----------
Capital ratios:
Total risk-based capital....... 14.3 % 14.5 % 14.6 % 8.0 %
Tier 1 risk-based capital...... 13.0 % 13.3 % 13.4 % 4.0 %
Leverage ratio (1)............. 10.7 % 11.0 % 11.2 % 4.0 %
|
(1) |
|
Tier 1 capital divided by average assets (excluding goodwill). |
At September 30, 2004 and 2003, and December 31, 2003, the Company's capital met all minimum regulatory requirements. As of September 30, 2004, management believes that HBC was considered "Well Capitalized" under the Prompt Corrective Action Provisions.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
No material changes have occurred during the quarter to the Company's market risk profile or information. For further information refer to the Company's Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief (principal) Executive Officer and Chief (principal) Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(a) We carried out an evaluation under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as of the end of the period covered by this report, pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based on their review of our disclosure controls and procedures, the principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings.
(b) There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, such controls.
Part II - OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In June 2004, the Company's Board of Director authorized the purchase of up to $10 million of its common stock, which represents approximately 700,000 share, or 6%, of its outstanding shares at current market price. The share repurchase authorization is valid through June 1, 2005.
The Company intends to finance the purchase 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.
As of September 30, 2004, repurchases of equity securities are presented in the table below:
Total Number of Approximate Dollar
Total Number Shares Purchased Value of Shares That
of Shares Price Paid as Part of Publicly May Yet Be Purchased
Settlement Date Purchased Per Shares Announced Plans Under the Plans
- ---------------------- ------------ ----------- ----------------- ------------------
June 10, 2004......... 5,664 $ 14.29 5,664 $ 9,919,061
June 14, 2004......... 1,100 $ 14.30 1,100 $ 9,903,331
June 15, 2004......... 40,000 $ 14.62 40,000 $ 9,318,531
June 17, 2004......... 4,325 $ 14.40 4,325 $ 9,256,251
June 18, 2004......... 900 $ 14.40 900 $ 9,243,291
June 21, 2004......... 5,300 $ 14.48 5,300 $ 9,166,547
June 22, 2004......... 23,000 $ 14.90 23,000 $ 8,823,847
June 23, 2004......... 5,300 $ 14.51 5,300 $ 8,746,944
June 24, 2004......... 6,800 $ 14.48 6,800 $ 8,648,480
June 25, 2004......... 20,000 $ 14.40 20,000 $ 8,360,480
June 28, 2004......... 6,800 $ 14.31 6,800 $ 8,263,172
June 29, 2004......... 6,800 $ 14.50 6,800 $ 8,164,572
June 30, 2004......... 6,800 $ 14.51 6,800 $ 8,065,904
August 23, 2004....... 20,000 $ 14.68 20,000 $ 7,772,304
August 24, 2004....... 2,800 $ 14.67 2,800 $ 7,731,228
August 25, 2004....... 2,800 $ 14.73 2,800 $ 7,689,984
August 26, 2004....... 2,900 $ 14.87 2,900 $ 7,646,861
August 27, 2004....... 1,600 $ 14.85 1,600 $ 7,623,101
August 31, 2004....... 7,550 $ 14.90 7,550 $ 7,510,606
September 1, 2004..... 2,900 $ 15.00 2,900 $ 7,467,106
September 2, 2004..... 3,189 $ 15.00 3,189 $ 7,419,271
------------ -----------------
Total................. 176,528 176,528
============ =================
Report on Form 8-K
The Registrant furnished a Current Report on Form 8-K dated July 20, 2004 under item 7 and item 12 to report its second quarter ended June 30, 2004 financial results, and condensed consolidated financial information.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
|
Heritage Commerce Corp |
|
|
|
|
|
November 8, 2004 |
|
/s/ William Del Biaggio, Jr. Interim Chief Executive Officer |
|
|
|
|
|
November 8, 2004 |
|
/s/ Lawrence D. McGovern Chief Financial Officer |