HTBK Heritage Commerce Corporation

Heritage Commerce Corp (Nasdaq:HTBK), the holding company (the “Company”) for Heritage Bank of Commerce (the “Bank”), today reported net income increased 63% to $7.2 million, or $0.19 per average diluted common share for the fourth quarter of 2016, compared to $4.4 million, or $0.12 per average diluted common share for the fourth quarter of 2015, and increased 7% from $6.8 million, or $0.18 per average diluted common share for the third quarter of 2016.  

For the year ended December 31, 2016, net income was $27.4 million, an increase of 66% from $16.5 million for the year ended December 31, 2015. Diluted earnings per share for the year ended December 31, 2016 increased to $0.72, compared to $0.48 for the year ended December 31, 2015.  All results are unaudited and the 2015 balances include the costs from the acquisition of Focus Business Bank (“Focus”) which was completed on August 20, 2015 (the “acquisition date”).

“We delivered another solid performance in 2016 with earnings growing by 66% to a record $27.4 million.  Our fourth quarter 2016 results were also strong with net income up 63% to $7.2 million, compared to the fourth quarter of 2015.  Robust deposit growth and continuing solid credit quality were highlights of our 2016 financial results,” said Walter Kaczmarek, President and Chief Executive Officer.  “Nonperforming assets were down 51% year-over-year and down 31% on a linked quarter basis, reflecting the strong economy in the San Francisco Bay Area.” 

“We continue to generate positive operating leverage, and are well positioned to capitalize on market opportunities as they arise,” added Mr. Kaczmarek.  “As we head into 2017, we remain focused on building long-term customer relationships, offering a diverse array of banking products and services, and creating value for our communities, customers, and shareholders.”

2016 Highlights (as of, or for the periods ended December 31, 2016, compared to December 31, 2015, and September 30, 2016, except as noted):

• Diluted earnings per share totaled $0.19 for the fourth quarter of 2016, compared to $0.12 for the fourth quarter of 2015, and $0.18 for the third quarter of 2016.  For the year ended December 31, 2016, diluted earnings per share increased 50% to $0.72, compared to $0.48 per diluted share for the year ended December 31, 2015.
• For the fourth quarter of 2016, the return on average tangible assets (“ROATA”) was 1.14%, and the return on average tangible equity (“ROATE”) was 13.81%, compared to 0.75% and 9.09%, respectively, for the fourth quarter of 2015, and 1.13% and 13.06%, respectively, for the third quarter of 2016.   For the year ended December 31, 2016, the ROATA was 1.15%, and the ROATE was 13.55%, compared to 0.88% and 9.41%, respectively, for the year ended December 31, 2015.- The 2016 results of operations included a pre-tax gain from company-owned life insurance totaling $100,000 for the fourth quarter of 2016, and $1.1 million for the year ended December 31, 2016. - The 2015 results of operations included pre-tax acquisition, severance and retention costs related to the Focus transaction totaling $3.0 million for the fourth quarter of 2015, and $6.4 million for the year ended December 31, 2015.
• Net interest income increased 4% to $23.1 million for the fourth quarter of 2016, compared to $22.1 million for the fourth quarter of 2015, and increased slightly from $23.0 million for the third quarter of 2016.  For the year ended December 31, 2016, net interest income increased 20% to $91.2 million, compared to $76.3 million for the year ended December 31, 2015.
• On a fully tax equivalent (“FTE”) basis, the net interest margin (“NIM”) contracted in both the fourth quarter of 2016 and the year ended December 31, 2016 from the comparable periods in 2015 primarily due to lower yields on loans and securities.- The NIM contracted 22 basis points to 3.91% for the fourth quarter of 2016 from 4.13% for the fourth quarter of 2015, due to lower yields on loans and securities, and also due to a decrease in the accretion of the loan purchase discount income from the Focus transaction.  - The NIM contracted 19 basis points for the fourth quarter of 2016, from 4.10% for the third quarter of 2016, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and a lower yield on loans, partially offset by an increase in the accretion of the loan purchase discount income from the Focus transaction. - For the year ended December 31, 2016, the NIM contracted 29 basis points to 4.12%, compared to 4.41% for the year ended December 31, 2015, due to lower yields on loans and securities, partially offset by an increase in the accretion of the loan purchase discount income from the Focus transaction.
• The total purchase discount on non-impaired loans from the Focus loan portfolio was $4.6 million at the acquisition date, of which $2.9 million has been accreted to loan interest income from the acquisition date through December 31, 2016.- The accretion of the loan purchase discount in loan interest income from the Focus transaction was $456,000 for the fourth quarter of 2016, compared to $1.1 million for the fourth quarter of 2015, and $299,000 for the third quarter of 2016. - The accretion of the loan purchase discount in loan interest income from the Focus transaction was $1.5 million for the year ended December 31, 2016, compared to $1.4 million for the year ended December 31, 2015.
• Loans (excluding loans held‑for‑sale) increased $143.9 million, or 11%, to $1.50 billion at December 31, 2016, compared to $1.36 billion at December 31, 2015, which included an increase of $60.0 million, or 4% in the Company’s legacy portfolio, $52.9 million of purchased residential mortgage loans, and $31.0 million of purchased commercial real estate (“CRE”) loans. - Loans increased $52.4 million, or 4%, to $1.50 billion at December 31, 2016, compared to $1.45 billion at September 30, 2016, which included an increase of $17.8 million, or 1% in the Company’s legacy portfolio, an increase of $3.6 million of purchased residential mortgage loans, and $31.0 million of purchased CRE loans.  
• The allowance for loan losses (“ALLL”) was 1.27% of total loans at December 31, 2016, compared to 1.39% at December 31, 2015, and 1.38% at September 30, 2016.  The ALLL to total nonperforming loans was 624.03% at December 31, 2016, compared to 296.74% at December 31, 2015, and 445.55% at September 30, 2016.- Nonperforming assets (“NPAs”) declined to $3.3 million, or 0.13% of total assets, at December 31, 2016, compared to $6.7 million, or 0.29% of total assets, at December 31, 2015, and $4.8 million, or 0.19% of total assets, at September 30, 2016.- Classified assets declined to $13.6 million, or 0.53% of total assets, at December 31, 2016, compared to $20.5 million, or 0.87% of total assets, at December 31, 2015, and $18.7 million, or 0.74% of total assets, at September 30, 2016.- Net charge-offs totaled $1.2 million for the fourth quarter of 2016, compared to $182,000 for the fourth quarter of 2015, and $134,000 for the third quarter of 2016.  Net charge-offs during the fourth quarter of 2016 included one $1.3 million commercial and industrial (“C&I”) loan relationship that was fully reserved prior to the fourth quarter of 2016.- There was a $240,000 provision for loan losses for the fourth quarter of 2016, compared to $371,000 for the fourth quarter of 2015, and $245,000 for the third quarter of 2016.  There was a $1.2 million provision for loan losses for the year ended December 31, 2016, compared to $32,000 for the year ended December 31, 2015.
• Total deposits increased $199.4 million, or 10%, to $2.26 billion at December 31, 2016, compared to $2.06 billion at December 31, 2015, and increased $43.5 million, or 2%, from $2.22 billion at September 30, 2016. - Deposits, excluding all time deposits and CDARS deposits, increased $216.7 million, or 12%, to $2.03 billion at December 31, 2016, from $1.81 billion at December 31, 2015, and increased $50.4 million, or 3%, from $1.98 billion at September 30, 2016. 
• The Company’s consolidated capital ratios exceeded regulatory guidelines and the Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at December 31, 2016.

								Well-capitalized				Fully Phased-in
								Financial				Basel III
								Institution				Minimal
		Heritage			Heritage			Basel III				Requirement(1)
		Commerce			Bank of			Regulatory				Effective
CAPITAL RATIOS		Corp			Commerce			Guidelines				January 1, 2019
Total Risk-Based		12.5	%		12.3	%			10.0	%			10.5	%
Tier 1 Risk-Based		11.5	%		11.3	%			8.0	%			8.5	%
Common Equity Tier 1 Risk-Based		11.5	%		11.3	%			6.5	%			7.0	%
Leverage		8.5	%		8.4	%			5.0	%			4.0	%
(1)Requirements for both the Company and the Bank include a 2.5% capital conservation buffer, except the leverage ratio.

Operating Results

Net interest income increased 4% to $23.1 million for the fourth quarter of 2016, compared to $22.1 million for the fourth quarter of 2015, and increased slightly from $23.0 million for the third quarter of 2016.   Net interest income increased 20% to $91.2 million for the year ended December 31, 2016, compared to $76.3 million for the year ended December 31, 2015.  Net interest income increased for the year ended December 31, 2016, compared to the year ended December 31, 2015, primarily due to the full year impact of the Focus loan portfolio, organic growth in the loan portfolio, the purchase of residential mortgage loan and CRE loan portfolios, and an increase in the average balance of investment securities.  

For the fourth quarter of 2016, the net interest margin (FTE) contracted 22 basis points to 3.91% from 4.13% for the fourth quarter of 2015, primarily due to lower yields on loans and securities, and a decrease in the accretion of the loan purchase discount income from the Focus transaction.   The net interest margin contracted 19 basis points for the fourth quarter of 2016, from 4.10% for the third quarter of 2016, primarily due to higher average balances of lower yielding funds at the Federal Reserve Bank, and a lower yield on loans, partially offset by an increase in the accretion of the loan purchase discount income from the Focus transaction.  For the year ended December 31, 2016, the net interest margin contracted 29 basis points to 4.12%, compared to 4.41% for the year ended December 31, 2015, primarily due to lower yields on loans and securities, partially offset by an increase in the accretion of the loan purchase discount income from the Focus transaction.

The provision for loan losses for the fourth quarter of 2016 was $240,000, compared to $371,000 for the fourth quarter of 2015, and $245,000 for the third quarter of 2016. The provision for loan losses for the year ended December 31, 2016 was $1.2 million, compared to $32,000 for the year ended December 31, 2015.

Noninterest income increased to $3.0 million for the fourth quarter of 2016, compared to $2.8 million for the fourth quarter of 2015, and $2.3 million for the third quarter of 2016.  For the fourth quarter of 2016, noninterest income included a gain on sales of securities of $572,000, compared to $642,000 for the fourth quarter of 2015, and no gain on sale of securities for the third quarter of 2016.  The fourth quarter of 2016 also included a $100,000 gain on proceeds from company-owned life insurance.  For the year ended December 31, 2016, noninterest income was $11.6 million, compared to $9.0 million for the year ended December 31, 2015.  The increase in noninterest income for the year ended December 31, 2016, compared to the year ended December 31, 2015, was primarily due to a $1.1 million gain on proceeds from company-owned life insurance, a $457,000 increase in the gain on sales of securities, a $313,000 increase in service charges and fees on deposit accounts, and a $255,000 increase in servicing income.

The Company maintains life insurance policies for some directors and officers that are subject to split-dollar life insurance agreements, which continue after the participant’s employment termination or retirement.  During the second quarter of 2016, the Company received death benefit proceeds of $3.1 million from the life insurance policy on a former officer of a bank acquired by the Company.  The cash surrender value of the policy was $2.1 million, which resulted in a gain on proceeds from company-owned life insurance of $1.0 million.  During the fourth quarter of 2016, the Company received death benefit proceeds of $572,000 from the life insurance policy on a former director.  The cash surrender value of the policy was $472,000, which resulted in a gain on proceeds from company-owned life insurance of $100,000. 

Total noninterest expense for the fourth quarter of 2016 declined to $14.3 million, compared to $17.4 million for the fourth quarter of 2015, and remained the same as the third quarter of 2016.  The decrease in noninterest expense in the fourth quarter of 2016, compared to the fourth quarter of 2015, was primarily due to pre-tax acquisition, severance and retention costs incurred by the Company related to the Focus transaction totaling $3.0 million for the fourth quarter of 2015.  Noninterest expense for the year ended December 31, 2016 decreased to $57.6 million, compared to $58.7 million for the year ended December 31, 2015, primarily due to $6.4 million of pre-tax acquisition, severance and retention costs incurred by the Company for the year ended December 31, 2015.  Noninterest expense for the year ended December 31, 2016 reflect former Focus employees retained by the Company, an increase in amortization of the core deposit intangible assets as a result of the Focus acquisition, annual salary increases, newly hired employees and higher professional fees.  Professional fees were significantly lower for the year ended December 31, 2015 due to recoveries of legal fees on problem loans that were paid off in 2015.  Full time equivalent employees were 263 at December 31, 2016, 260 at December 31, 2015, and 264 at September 30, 2016. 

The efficiency ratio for the fourth quarter of 2016 improved to 54.57%, compared to 69.54% for the fourth quarter of 2015, and 56.37% for the third quarter of 2016.  The efficiency ratio for the year ended December 31, 2016 was 56.04%, compared to 68.78% for the year ended December 31, 2015.  The higher efficiency ratio in the fourth quarter of 2015 and year ended December 31, 2015 was primarily due to one-time Focus acquisition, severance and retention costs.   

Income tax expense for the fourth quarter of 2016 was $4.4 million, compared to $2.8 million for the fourth quarter of 2015, and $4.1 million for the third quarter of 2016. The effective tax rate for the fourth quarter of 2016 was 38.0%, compared to 38.9% for the fourth quarter of 2015, and 37.5% for the third quarter of 2016.  Income tax expense for the year ended December 31, 2016 was $16.6 million, compared to $10.1 million for the year ended December 31, 2015. The effective tax rate for the year ended December 31, 2016 was 37.7%, compared to 38.0% for the year ended December 31, 2015.  The difference in the effective tax rate for the periods reported, compared to the combined Federal and state statutory tax rate of 42%, is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds. 

Balance Sheet Review, Capital Management and Credit Quality

Total assets increased to $2.57 billion at December 31, 2016, compared to $2.36 billion at December 31, 2015, and $2.53 billion at September 30, 2016.

The investment securities available-for-sale portfolio totaled $306.6 million at December 31, 2016, compared to $385.1 million at December 31, 2015, and $370.0 million at September 30, 2016.  At December 31, 2016, the Company’s securities available-for-sale portfolio was comprised of $291.0 million agency mortgage-backed securities (all issued by U.S. Government sponsored entities), and $15.6 million of single entity issue trust preferred securities. The pre-tax unrealized loss on securities available-for-sale at December 31, 2016 was ($2.0) million, compared to a pre-tax unrealized gain on securities available-for-sale of $501,000 at December 31, 2015, and a pre-tax unrealized gain on securities available-for-sale of $8.0 million at September 30, 2016.  All else being equal, when market interest rates are rising, the Company will experience a higher unrealized loss (or lower unrealized gain) on the securities available-for-sale portfolio.  The Company received gross proceeds of $33.2 million on securities available-for-sale it sold during the fourth quarter of 2016 with a book value totaling $32.6 million, resulting in a gain on sale of securities of $572,000.

At December 31, 2016, investment securities held-to-maturity totaled $324.0 million, compared to $109.3 million at December 31, 2015, and $202.4 million at September 30, 2016.  At December 31, 2016, the Company’s securities held-to-maturity portfolio, at amortized cost, was comprised of $90.6 million tax-exempt municipal bonds, and $233.4 million agency mortgage-backed securities.   During the fourth quarter of 2016, the Company purchased $129.5 million of investment securities agency mortgage-backed securities held-to-maturity, with a weighted average book yield of 2.01%.

Loans (excluding loans held‑for‑sale) increased $143.9 million, or 11%, to $1.50 billion at December 31, 2016, compared to $1.36 billion at December 31, 2015, which included an increase of $60.0 million, or 4% in the Company’s legacy portfolio, $52.9 million of purchased residential mortgage loans, and $31.0 million of purchased CRE loans.  Loans increased $52.4 million, or 4%, at December 31, 2016, compared to $1.45 billion at September 30, 2016, which included an increase of $17.8 million, or 1% in the Company’s legacy portfolio, an increase of $3.6 million of purchased residential mortgage loans, and $31.0 million of purchased CRE loans.

The loan portfolio remains well-diversified with C&I loans accounting for 40% of the loan portfolio at December 31, 2016, which included $49.6 million of factored receivables at Bay View Funding. CRE loans accounted for 44% of the total loan portfolio, of which 43% were owner-occupied by businesses.  Consumer and home equity loans accounted for 7% of total loans, land and construction loans accounted for 5% of total loans, and residential mortgage loans accounted for the remaining 4% of total loans at December 31, 2016.   

The commercial loan portfolio increased $47.8 million to $604.3 million at December 31, 2016, compared to $556.5 million at December 31, 2015, which was primarily the result of an increase of $26.3 million in the asset-based lending portfolio, an increase of $11.9 million in the C&I portfolio, and an increase of $9.6 million in the factored receivables portfolio. C&I line usage was 42% at December 31, 2016, compared to 39% at December 31, 2015, and 41% at September 30, 2016.

The CRE loan portfolio increased $36.5 million to $662.2 million at December 31, 2016, compared to $625.7 million at December 31, 2015, and increased $50.2 million from September 30, 2016.  During the fourth quarter of 2016, the Company purchased $31.1 million of CRE loans on properties located primarily in the San Francisco Bay Area, with an average loan principal amount of approximately $1.8 million, and weighted average yield of 3.88%, net of premium amortization and servicing fees to the servicer.  At December 31, 2016, the purchased CRE loans outstanding totaled $31.0 million.

Land and construction loans decreased $3.4 million to $81.0 million at December 31, 2016, compared to $84.4 million at December 31, 2015, and decreased $7.4 million from $88.4 million at September 30, 2016, primarily due to the payoff of construction loans during the fourth quarter of 2016.

During the year ended December 31, 2016, the Company purchased jumbo single family residential mortgage loans totaling $57.5 million, all of which are domiciled in California, with an average loan principal amount of approximately $834,000, and weighted average yield of 3.00%, net of premium amortization and servicing fees to the servicer. Residential mortgage loans outstanding at December 31, 2016 totaled $52.9 million, compared to $49.3 million at September 30, 2016.

The yield on the loan portfolio was 5.46% for the fourth quarter of 2016, compared to 5.92% for the fourth quarter of 2015, and 5.60% for the third quarter of 2016. The decrease in the yield on the loan portfolio for the fourth quarter of 2016, compared to the fourth quarter of 2015, reflects the impact of the lower yielding purchased residential mortgage loan and purchased CRE loan portfolios, a lower yield on the Bay View Funding factored receivables portfolio, and a decrease in the accretion of the loan purchase discount into loan interest income from the Focus transaction. The decrease in the yield on the loan portfolio for the fourth quarter of 2016, compared to the third quarter of 2016, reflects the impact of the lower yielding purchased residential mortgage loan and purchased CRE loan portfolios, and the payoff of construction loans, partially offset by an increase in the accretion of the loan purchase discount into loan interest income from the Focus transaction. The yield on the loan portfolio decreased to 5.57% for the year ended December 31, 2016, compared to 5.75% for the year ended December 31, 2015, primarily due to a lower yield on the Bay View Funding factored receivables portfolio, and the impact of the lower yielding purchased residential mortgage loan and purchased CRE loan portfolios.

The accretion of the loan purchase discount in loan interest income from the Focus transaction was $456,000 for the fourth quarter of 2016, compared to $1.1 million for the fourth quarter of 2015, and $299,000 for the third quarter of 2016.  The accretion of the loan purchase discount in loan interest income from the Focus transaction was $1.5 million for the year ended December 31, 2016, compared to $1.4 million for the year ended December 31, 2015.   The total purchase discount on non-impaired loans from the Focus loan portfolio was $4.6 million at the acquisition date, of which $2.9 million has been accreted to loan interest income from the acquisition date through December 31, 2016.

At December 31, 2016, NPAs declined to $3.3 million, or 0.13% of total assets, compared to $6.7 million, or 0.29% of total assets, at December 31, 2015, and $4.8 million, or 0.19% of total assets, at September 30, 2016. At December 31, 2016, the NPAs included no loans guaranteed by the SBA.  Foreclosed assets were $229,000 at December 31, 2016, compared to $364,000 at December 31, 2015, and $292,000 at September 30, 2016.  The following is a breakout of NPAs at the periods indicated:

		End of Period:
NONPERFORMING ASSETS		December 31, 2016						September 30, 2016						December 31, 2015
(in $000's, unaudited)		Balance			% of Total			Balance			% of Total			Balance			% of Total
Commercial and industrial loans		$	2,097		64	%		$	3,570		75	%		$	301		5	%
Commercial real estate loans			419		13	%			440		9	%			2,992		44	%
Home equity and consumer loans			270		8	%			278		6	%			781		12	%
Foreclosed assets			229		7	%			292		6	%			364		5	%
Land and construction loans			199		6	%			201		4	%			219		3	%
SBA loans			74		2	%			7		0	%			423		6	%
Restructured and loans over 90 days past due and still accruing			-		0	%			-		0	%			1,662		25	%
Total nonperforming assets		$	3,288		100	%		$	4,788		100	%		$	6,742		100	%

Classified assets declined to $13.6 million at December 31, 2016, compared to $20.5 million at December 31, 2015, and $18.7 million at September 30, 2016.  Classified assets include Small Business Administration (“SBA”) guarantees of $322,000 at December 31, 2016, $0 at December 31, 2015, and $10,000 at September 30, 2016.

The following table summarizes the allowance for loan losses:

		For the Quarter Ended												For the Year Ended
ALLOWANCE FOR LOAN LOSSES		December 31,				September 30,				December 31,				December 31,				December 31,
(in $000's, unaudited)			2016				2016				2015				2016				2015
Balance at beginning of period		$	20,032			$	19,921			$	18,737			$	18,926			$	18,379
Provision for loan losses during the period			240				245				371				1,237				32
Net (charge-offs) recoveries during the period			(1,183	)			(134	)			(182	)			(1,074	)			515
Balance at end of period		$	19,089			$	20,032			$	18,926			$	19,089			$	18,926
Total loans		$	1,502,607			$	1,450,176			$	1,358,716			$	1,502,607			$	1,358,716
Total nonperforming loans		$	3,059			$	4,496			$	6,378			$	3,059			$	6,378
Allowance for loan losses to total loans			1.27	%			1.38	%			1.39	%			1.27	%			1.39	%
Allowance for loan losses to total nonperforming loans			624.03	%			445.55	%			296.74	%			624.03	%			296.74	%

The ALLL at December 31, 2016 was 1.27% of total loans, compared to 1.39% at December 31, 2015, and 1.38% at September 30, 2016.  The ALLL to total nonperforming loans was 624.03% at December 31, 2016, compared to 296.74% at December 31, 2015, and 445.55% at September 30, 2016.

Total deposits increased $199.4 million, or 10%, to $2.26 billion at December 31, 2016, compared to $2.06 billion at December 31, 2015, and increased $43.5 million, or 2%, compared to $2.22 billion at September 30, 2016.  Deposits excluding all time deposits and CDARS deposits increased $216.7 million, or 12%, to $2.03 billion at December 31, 2016, from $1.81 billion at December 31, 2015, and increased $50.4 million, or 3%, from $1.98 billion at September 30, 2016.

The total cost of deposits increased one basis point to 0.15% for the fourth quarter of 2016, from 0.14% for the fourth quarter of 2015, and remained the same as the third quarter of 2016.  The total cost of deposits was at 0.15% for the year ended December 31, 2016 and for the year ended December 31, 2015.

Tangible equity was $207.2 million at December 31, 2016, compared to $191.3 million at December 31, 2015, and $208.3 million at September 30, 2016.  Tangible book value per common share was $5.46 at December 31, 2016, compared to $5.35 at December 31, 2015, and $5.49 at September 30, 2016.  There was no Series C Preferred Stock outstanding at December 31, 2016 and September 30, 2016, compared to 21,004 shares of Series C Preferred Stock outstanding at December 31, 2015.  Pro forma tangible book value per common share, assuming the outstanding Series C Preferred Stock was converted into common stock, was $5.07 at December 31, 2015.

On September 12, 2016, the Company entered into Exchange Agreements with Castle Creek Capital Partners IV, LP, Patriot Financial Partners, L.P. and Patriot Financial Partners Parallel, L.P. (collectively “Preferred Stockholders”) providing for the exchange of 21,004 shares of the Series C Preferred Stock, for 5,601,000 shares of the Company’s common stock. The exchange ratio was equal to the equivalent number of shares the Preferred Stockholders would have received upon conversion of the Series C Preferred Stock.  During the fourth quarter of 2016, Castle Creek Capital Partners IV, LP, Patriot Financial Partners, L.P. and Patriot Financial Partners Parallel, L.P. sold all of their shares of common stock.

Accumulated other comprehensive loss was ($7.9) million at December 31, 2016, compared to ($6.2) million at December 31, 2015, and ($2.0) million at September 30, 2016. The unrealized gain (loss) on securities available-for-sale, net of taxes, included in accumulated other comprehensive loss was an unrealized loss of ($1.2) million December 31, 2016, compared to an unrealized gain of $296,000 at December 31, 2015, and an unrealized gain of $4.7 million at September 30, 2016.  The components of accumulated other comprehensive loss, net of taxes, at December 31, 2016 include the following: an unrealized loss on available-for-sale securities of ($1.2) million; the remaining unamortized unrealized gain on securities available-for-sale transferred to held-to-maturity of $335,000; a split dollar insurance contracts liability of ($3.4) million; a supplemental executive retirement plan liability of ($4.2) million; and an unrealized gain on interest-only strip from SBA loans of $620,000.

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

Forward Looking Statement Disclaimer

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

Member FDIC

		For the Quarter Ended:										Percent Change From:					For the Year Ended:
CONSOLIDATED INCOME STATEMENTS		December 31,			September 30,			December 31,				September 30,		December 31,			December 31,			December 31,				Percent
(in $000's, unaudited)			2016			2016			2015			2016		2015				2016			2015			Change
Interest income		$	23,991		$	23,874		$	22,896			0	%	5	%		$	94,431		$	78,743			20	%
Interest expense			867			826			758			5	%	14	%			3,211			2,422			33	%
Net interest income before provision for loan losses			23,124			23,048			22,138			0	%	4	%			91,220			76,321			20	%
Provision (credit) for loan losses			240			245			371			-2	%	-35	%			1,237			32			3766	%
Net interest income after provision for loan losses			22,884			22,803			21,767			0	%	5	%			89,983			76,289			18	%
Noninterest income:
Service charges and fees on deposit accounts			768			798			717			-4	%	7	%			3,116			2,803			11	%
Gain on sales of securities			572			-			642			N/A		-11	%			1,099			642			71	%
Increase in cash surrender value of life insurance			430			428			472			0	%	-9	%			1,747			1,697			3	%
Servicing income			292			364			324			-20	%	-10	%			1,398			1,143			22	%
Gain on sales of SBA loans			143			69			183			107	%	-22	%			796			843			-6	%
Gain on proceeds from company owned life insurance			100			-			-			N/A		N/A				1,119			-			N/A
Other			734			653			491			12	%	49	%			2,350			1,857			27	%
Total noninterest income			3,039			2,312			2,829			31	%	7	%			11,625			8,985			29	%
Noninterest expense:
Salaries and employee benefits			8,608			8,363			9,034			3	%	-5	%			34,660			35,146			-1	%
Occupancy and equipment			1,101			1,120			1,174			-2	%	-6	%			4,378			4,336			1	%
Professional fees			852			1,086			882			-22	%	-3	%			3,471			1,828			90	%
Other			3,716			3,727			6,271			0	%	-41	%			15,130			17,363			-13	%
Total noninterest expense			14,277			14,296			17,361			0	%	-18	%			57,639			58,673			-2	%
Income before income taxes			11,646			10,819			7,235			8	%	61	%			43,969			26,601			65	%
Income tax expense			4,431			4,054			2,812			9	%	58	%			16,588			10,104			64	%
Net income			7,215			6,765			4,423			7	%	63	%			27,381			16,497			66	%
Dividends on preferred stock			-			(504	)		(448	)		-100	%	-100	%			(1,512	)		(1,792	)		-16	%
Net income available to common shareholders			7,215			6,261			3,975			15	%	82	%			25,869			14,705			76	%
Undistributed earnings allocated to Series C preferred stock			-			(300	)		(209	)		-100	%	-100	%			(1,278	)		(912	)		40	%
Distributed and undistributed earnings allocated to common
shareholders		$	7,215		$	5,961		$	3,766			21	%	92	%		$	24,591		$	13,793			78	%
PER COMMON SHARE DATA
(unaudited)
Basic earnings per share		$	0.19		$	0.18		$	0.12			6	%	58	%		$	0.72		$	0.48			50	%
Diluted earnings per share		$	0.19		$	0.18		$	0.12			6	%	58	%		$	0.72		$	0.48			50	%
Weighted average shares outstanding - basic			37,931,317			33,397,704			32,109,440			14	%	18	%			33,933,806			28,567,213			19	%
Weighted average shares outstanding - diluted			38,270,110			33,693,328			32,389,213			14	%	18	%			34,219,121			28,786,078			19	%
Common shares outstanding at period-end			37,941,007			37,915,736			32,113,479			0	%	18	%			37,941,007			32,113,479			18	%
Pro forma common shares outstanding at period-end, assuming Series C preferred stock was converted into common stock			N/A			N/A			37,714,479			N/A		N/A				N/A			37,714,479			N/A
Dividend per share		$	0.09		$	0.09		$	0.08			0	%	13	%		$	0.36		$	0.32			13	%
Book value per share		$	6.85		$	6.89		$	7.03			-1	%	-3	%		$	6.85		$	7.03			-3	%
Tangible book value per share		$	5.46		$	5.49		$	5.35			-1	%	2	%		$	5.46		$	5.35			2	%
Pro forma tangible book value per share, assuming Series C preferred stock was converted into common stock			N/A			N/A		$	5.07			N/A		N/A				N/A		$	5.07			N/A
KEY FINANCIAL RATIOS
(unaudited)
Annualized return on average equity			11.01	%		10.38	%		7.11	%		6	%	55	%			10.71	%		8.04	%		33	%
Annualized return on average tangible equity			13.81	%		13.06	%		9.09	%		6	%	52	%			13.55	%		9.41	%		44	%
Annualized return on average assets			1.12	%		1.11	%		0.74	%		1	%	51	%			1.13	%		0.86	%		31	%
Annualized return on average tangible assets			1.14	%		1.13	%		0.75	%		1	%	52	%			1.15	%		0.88	%		31	%
Net interest margin			3.91	%		4.10	%		4.13	%		-5	%	-5	%			4.12	%		4.41	%		-7	%
Efficiency ratio			54.57	%		56.37	%		69.54	%		-3	%	-22	%			56.04	%		68.78	%		-19	%
AVERAGE BALANCES
(in $000's, unaudited)
Average assets		$	2,572,595		$	2,431,303		$	2,378,578			6	%	8	%		$	2,425,201		$	1,912,421			27	%
Average tangible assets		$	2,519,733		$	2,378,045		$	2,324,661			6	%	8	%		$	2,371,756		$	1,882,641			26	%
Average earning assets		$	2,381,141		$	2,263,997		$	2,159,447			5	%	10	%		$	2,244,169		$	1,757,892			28	%
Average loans held-for-sale		$	6,074		$	5,992		$	8,289			1	%	-27	%		$	4,947		$	3,574			38	%
Average total loans		$	1,455,558		$	1,436,014		$	1,325,872			1	%	10	%		$	1,417,760		$	1,182,522			20	%
Average deposits		$	2,245,336		$	2,121,469		$	2,042,654			6	%	10	%		$	2,110,458		$	1,643,385			28	%
Average demand deposits - noninterest-bearing		$	898,367		$	842,565		$	785,876			7	%	14	%		$	824,763		$	630,198			31	%
Average interest-bearing deposits		$	1,346,969		$	1,278,904		$	1,256,778			5	%	7	%		$	1,285,695		$	1,013,187			27	%
Average interest-bearing liabilities		$	1,347,032		$	1,278,959		$	1,259,033			5	%	7	%		$	1,286,185		$	1,013,816			27	%
Average equity		$	260,723		$	259,395		$	246,921			1	%	6	%		$	255,587		$	205,154			25	%
Average tangible equity		$	207,861		$	206,137		$	193,004			1	%	8	%		$	202,142		$	175,374			15	%

 

		End of Period:										Percent Change From:
CONSOLIDATED BALANCE SHEETS		December 31,			September 30,			December 31,				September 30,		December 31,
(in $000's, unaudited)			2016			2016			2015			2016		2015
ASSETS
Cash and due from banks		$	27,993		$	39,838		$	24,112			-30	%	16	%
Other investments and interest-bearing deposits in other financial institutions			238,110			304,554			319,980			-22	%	-26	%
Securities available-for-sale, at fair value			306,589			369,999			385,079			-17	%	-20	%
Securities held-to-maturity, at amortized cost			324,010			202,404			109,311			60	%	196	%
Loans held-for-sale - SBA, including deferred costs			5,705			6,741			7,297			-15	%	-22	%
Loans:
Commercial			604,331			606,281			556,522			0	%	9	%
Real estate:
Commercial			662,228			612,030			625,665			8	%	6	%
Land and construction			81,002			88,371			84,428			-8	%	-4	%
Home equity			82,459			76,536			76,833			8	%	7	%
Residential mortgages			52,887			49,255			-			7	%	N/A
Consumer			20,460			18,328			16,010			12	%	28	%
Loans			1,503,367			1,450,801			1,359,458			4	%	11	%
Deferred loan fees			(760	)		(625	)		(742	)		22	%	2	%
Total loans, net of deferred fees			1,502,607			1,450,176			1,358,716			4	%	11	%
Allowance for loan losses			(19,089	)		(20,032	)		(18,926	)		-5	%	1	%
Loans, net			1,483,518			1,430,144			1,339,790			4	%	11	%
Company owned life insurance			59,148			59,193			60,021			0	%	-1	%
Premises and equipment, net			7,490			7,552			7,773			-1	%	-4	%
Goodwill			45,664			45,664			45,664			0	%	0	%
Other intangible assets			6,950			7,342			8,518			-5	%	-18	%
Accrued interest receivable and other assets			65,703			54,531			54,034			20	%	22	%
Total assets		$	2,570,880		$	2,527,962		$	2,361,579			2	%	9	%
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Deposits:
Demand, noninterest-bearing		$	917,187		$	889,075		$	821,405			3	%	12	%
Demand, interest-bearing			541,282			536,541			496,278			1	%	9	%
Savings and money market			572,743			555,156			496,843			3	%	15	%
Time deposits-under $250			57,857			57,718			62,026			0	%	-7	%
Time deposits-$250 and over			163,670			169,485			160,815			-3	%	2	%
Time deposits - brokered			-			3,000			17,825			-100	%	-100	%
CDARS - money market and time deposits			9,401			7,659			7,583			23	%	24	%
Total deposits			2,262,140			2,218,634			2,062,775			2	%	10	%
Borrowings			-			-			3,000			N/A		-100	%
Accrued interest payable and other liabilities			48,890			48,009			50,368			2	%	-3	%
Total liabilities			2,311,030			2,266,643			2,116,143			2	%	9	%
Shareholders' Equity:
Series C preferred stock, net			-			-			19,519			N/A		-100	%
Common stock			215,237			214,601			193,364			0	%	11	%
Retained earnings			52,527			48,726			38,773			8	%	35	%
Accumulated other comprehensive loss			(7,914	)		(2,008	)		(6,220	)		-294	%	-27	%
Total shareholders' equity			259,850			261,319			245,436			-1	%	6	%
Total liabilities and shareholders' equity		$	2,570,880		$	2,527,962		$	2,361,579			2	%	9	%

  

		End of Period:										Percent Change From:
CREDIT QUALITY DATA		December 31,			September 30,			December 31,				September 30,		December 31,
(in $000's, unaudited)			2016			2016			2015			2016		2015
Nonaccrual loans - held-for-investment		$	3,059		$	4,496		$	4,716			-32	%	-35	%
Restructured and loans over 90 days past due and still accruing			-			-			1,662			N/A		-100	%
Total nonperforming loans			3,059			4,496			6,378			-32	%	-52	%
Foreclosed assets			229			292			364			-22	%	-37	%
Total nonperforming assets		$	3,288		$	4,788		$	6,742			-31	%	-51	%
Other restructured loans still accruing		$	131		$	137		$	149			-4	%	-12	%
Net charge-offs during the quarter		$	1,183		$	134		$	182			783	%	550	%
Provision for loan losses during the quarter		$	240		$	245		$	371			-2	%	-35	%
Allowance for loan losses		$	19,089		$	20,032		$	18,926			-5	%	1	%
Classified assets		$	13,553		$	18,693		$	20,493			-27	%	-34	%
Allowance for loan losses to total loans			1.27	%		1.38	%		1.39	%		-8	%	-9	%
Allowance for loan losses to total nonperforming loans			624.03	%		445.55	%		296.74	%		40	%	110	%
Nonperforming assets to total assets			0.13	%		0.19	%		0.29	%		-32	%	-55	%
Nonperforming loans to total loans			0.20	%		0.31	%		0.47	%		-35	%	-57	%
Classified assets to Heritage Commerce Corp Tier 1 capital plus allowance for loan losses			6	%		8	%		9	%		-25	%	-33	%
Classified assets to Heritage Bank of Commerce Tier 1 capital plus allowance for loan losses			6	%		8	%		9	%		-25	%	-33	%
OTHER PERIOD-END STATISTICS
(in $000's, unaudited)
Heritage Commerce Corp:
Tangible equity(1)		$	207,236		$	208,313		$	191,254			-1	%	8	%
Tangible common equity(2)		$	207,236		$	208,313		$	171,735			-1	%	21	%
Shareholders' equity / total assets			10.11	%		10.34	%		10.39	%		-2	%	-3	%
Tangible equity / tangible assets(3)			8.23	%		8.42	%		8.29	%		-2	%	-1	%
Tangible common equity / tangible assets(4)			8.23	%		8.42	%		7.44	%		-2	%	11	%
Loan to deposit ratio			66.42	%		65.36	%		65.87	%		2	%	1	%
Noninterest-bearing deposits / total deposits			40.55	%		40.07	%		39.82	%		1	%	2	%
Total risk-based capital ratio			12.5	%		12.7	%		12.5	%		-2	%	0	%
Tier 1 risk-based capital ratio			11.5	%		11.6	%		11.4	%		-1	%	1	%
Common Equity Tier 1 risk-based capital ratio			11.5	%		11.6	%		10.4	%		-1	%	11	%
Leverage ratio			8.5	%		8.9	%		8.6	%		-4	%	-1	%
Heritage Bank of Commerce:
Total risk-based capital ratio			12.3	%		12.6	%		12.6	%		-2	%	-2	%
Tier 1 risk-based capital ratio			11.3	%		11.4	%		11.4	%		-1	%	-1	%
Common Equity Tier 1 risk-based capital ratio			11.3	%		11.4	%		11.4	%		-1	%	-1	%
Leverage ratio			8.4	%		8.7	%		8.6	%		-3	%	-2	%
(1)Represents shareholders' equity minus goodwill and other intangible assets
(2)Represents shareholders' equity minus preferred stock, minus goodwill and other intangible assets
(3)Represents shareholders' equity minus goodwill and other intangible assets divided by total assets minus goodwill and other intangible assets
(4)Represents shareholders' equity minus preferred stock, minus goodwill and other intangible assets divided by total assets minus goodwill and other intangible assets

 

		For the Quarter Ended										For the Quarter Ended
		December 31, 2016										December 31, 2015
					Interest				Average						Interest				Average
NET INTEREST INCOME AND NET INTEREST MARGIN		Average			Income/				Yield/			Average			Income/				Yield/
(in $000's, unaudited)		Balance			Expense				Rate			Balance			Expense				Rate
Assets:
Loans, gross(1)		$	1,461,632		$	20,049			5.46	%		$	1,334,161		$	19,899			5.92	%
Securities - taxable			503,881			2,428			1.92	%			291,106			1,880			2.56	%
Securities - tax exempt(2)			90,714			872			3.82	%			94,463			914			3.84	%
Federal funds sold, other investments, and interest-bearing deposits in other financial institutions			324,914			947			1.16	%			439,717			523			0.47	%
Total interest earning assets(2)			2,381,141			24,296			4.06	%			2,159,447			23,216			4.27	%
Cash and due from banks			36,786										43,374
Premises and equipment, net			7,581										7,689
Goodwill and other intangible assets			52,862										53,917
Other assets			94,225										114,151
Total assets		$	2,572,595									$	2,378,578
Liabilities and shareholders' equity:
Deposits:
Demand, noninterest-bearing		$	898,367									$	785,876
Demand, interest-bearing			529,922			295			0.22	%			471,893			236			0.20	%
Savings and money market			583,495			298			0.20	%			521,368			271			0.21	%
Time deposits - under $100			20,722			17			0.33	%			23,062			17			0.29	%
Time deposits - $100 and over			203,041			253			0.50	%			212,294			172			0.32	%
Time deposits - brokered			1,891			3			0.63	%			20,960			42			0.79	%
CDARS - money market and time deposits			7,898			1			0.05	%			7,201			1			0.06	%
Total interest-bearing deposits			1,346,969			867			0.26	%			1,256,778			739			0.23	%
Total deposits			2,245,336			867			0.15	%			2,042,654			739			0.14	%
Short-term borrowings			63			-			0.00	%			2,255			19			3.34	%
Total interest-bearing liabilities			1,347,032			867			0.26	%			1,259,033			758			0.24	%
Total interest-bearing liabilities and demand, noninterest-bearing / cost of funds			2,245,399			867			0.15	%			2,044,909			758			0.15	%
Other liabilities			66,473										86,748
Total liabilities			2,311,872										2,131,657
Shareholders' equity			260,723										246,921
Total liabilities and shareholders' equity		$	2,572,595									$	2,378,578
Net interest income(2) / margin						23,429			3.91	%						22,458			4.13	%
Less tax equivalent adjustment(2)						(305	)									(320	)
Net interest income					$	23,124									$	22,138
(1)Includes loans held-for-sale.  Yield amounts earned on loans include loan fees and costs.  Nonaccrual loans are included in average balance.
(2)Reflects the fully tax equivalent ("FTE") adjustment for tax exempt income based on a 35% tax rate.
		For the Year Ended										For the Year Ended
		December 31, 2016										December 31, 2015
					Interest				Average						Interest				Average
NET INTEREST INCOME AND NET INTEREST MARGIN		Average			Income/				Yield/			Average			Income/				Yield/
(in $000's, unaudited)		Balance			Expense				Rate			Balance			Expense				Rate
Assets:
Loans, gross(1)		$	1,422,707		$	79,284			5.57	%		$	1,186,096		$	68,259			5.75	%
Securities - taxable			501,347			10,432			2.08	%			246,084			6,707			2.73	%
Securities - tax exempt(2)			91,822			3,523			3.84	%			86,589			3,358			3.88	%
Federal funds sold, other investments, and interest-bearing
deposits in other financial institutions			228,293			2,425			1.06	%			239,123			1,594			0.67	%
Total interest earning assets(2)			2,244,169			95,664			4.26	%			1,757,892			79,918			4.55	%
Cash and due from banks			33,899										34,196
Premises and equipment, net			7,624										7,463
Goodwill and other intangible assets			53,445										29,780
Other assets			86,064										83,090
Total assets		$	2,425,201									$	1,912,421
Liabilities and shareholders' equity:
Deposits:
Demand, noninterest-bearing		$	824,763									$	630,198
Demand, interest-bearing			511,595			1,026			0.20	%			317,219			585			0.18	%
Savings and money market			526,227			1,127			0.21	%			433,123			894			0.21	%
Time deposits - under $100			22,079			65			0.29	%			20,631			61			0.30	%
Time deposits - $100 and over			209,972			913			0.43	%			204,982			658			0.32	%
Time deposits - brokered			7,590			62			0.82	%			25,154			199			0.79	%
CDARS - money market and time deposits			8,232			6			0.07	%			12,078			6			0.05	%
Total interest-bearing deposits			1,285,695			3,199			0.25	%			1,013,187			2,403			0.24	%
Total deposits			2,110,458			3,199			0.15	%			1,643,385			2,403			0.15	%
Short-term borrowings			490			12			2.45	%			629			19			3.02	%
Total interest-bearing liabilities			1,286,185			3,211			0.25	%			1,013,816			2,422			0.24	%
Total interest-bearing liabilities and demand, noninterest-bearing / cost of funds			2,110,948			3,211			0.15	%			1,644,014			2,422			0.15	%
Other liabilities			58,666										63,253
Total liabilities			2,169,614										1,707,267
Shareholders' equity			255,587										205,154
Total liabilities and shareholders' equity		$	2,425,201									$	1,912,421
Net interest income(2) / margin						92,453			4.12	%						77,496			4.41	%
Less tax equivalent adjustment(2)						(1,233	)									(1,175	)
Net interest income					$	91,220									$	76,321
(1)Includes loans held-for-sale.  Yield amounts earned on loans include loan fees and costs.  Nonaccrual loans are included in average balance.
(2)Reflects the fully tax equivalent ("FTE") adjustment for tax exempt income based on a 35% tax rate.

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