Heritage merce p(HTBK) - 2020 Q4 - Annual Report

Part I Business Heritage Commerce Corp provides commercial banking services in the San Francisco Bay Area, with $4.63 billion in consolidated assets as of December 31, 2020, expanding through strategic mergers - Heritage Commerce Corp is a bank holding company providing commercial banking services through its subsidiary, Heritage Bank of Commerce, primarily serving the San Francisco Bay Area[20][21] Key Financial Metrics (as of December 31, 2020) | Metric | Value (in billions) | | :--- | :--- | | Consolidated Assets | $4.63 | | Deposits | $3.91 | | Shareholders' Equity | $0.578 | - The company has expanded through strategic mergers, including Presidio Bank in 2019, and Tri-Valley Bank and United American Bank in 2018[26][29][30] Lending and Deposit Activities The company's diversified loan portfolio is heavily weighted towards real estate, with 48% in CRE and 32% in C&I loans, while deposit generation focuses on relationship-based accounts Loan Portfolio Composition (as of December 31, 2020) | Loan Category | Percentage of Total Loans | | :--- | :--- | | Commercial and Industrial (C&I) | 32% | | Commercial Real Estate (CRE) | 48% | | Land and Construction | 6% | | Residential Mortgage | 3% | | Consumer and Other | 11% | - The C&I loan portfolio includes operating loans, term loans, and $290.7 million in Paycheck Protection Program (PPP) loans at year-end 2020[35] - The company offers the Certificate of Deposit Account Registry Service (CDARS) to provide customers with FDIC insurance on deposits exceeding the standard $250,000 limit[49] Competition and Human Capital Operating in a highly competitive market, the company focuses on personalized service and local relationships, holding a 0.57% deposit market share as of June 30, 2020 - The company faces intense competition in the San Francisco Bay Area, where the top three institutions control nearly 60% of the deposit market share[61] - Heritage Bank of Commerce held the 16th position in deposit market share in its operating region at 0.57% as of June 30, 2020[61] - The company's employee count decreased from 357 full-time equivalent employees at the end of 2019 to 331 at the end of 2020[67] Supervision and Regulation Extensively regulated by federal and state agencies, the company and its bank subsidiary exceeded 'well capitalized' requirements as of December 31, 2020, with CRE loan concentration at 245% of total risk-based capital - The company and its bank subsidiary are subject to the Basel III Capital Rules and must maintain minimum capital ratios, including a CET1 ratio of at least 7.0% (including the capital conservation buffer)[82][84] - As of December 31, 2020, the company and its bank subsidiary met the requirements to be considered 'well-capitalized' under Prompt Corrective Action (PCA) regulations[92] - The company's Commercial Real Estate (CRE) loan concentration was 245% of total risk-based capital as of December 31, 2020, a decrease from 282% in the prior year and below the 300% regulatory guidance threshold[146] - The company is subject to numerous consumer protection laws, including the Community Reinvestment Act (CRA), under which it holds a 'satisfactory' rating from its most recent examination[141][148] Risk Factors The company faces significant risks from the COVID-19 pandemic, credit concentration in real estate loans (67%), operational vulnerabilities, interest rate fluctuations, and an evolving regulatory landscape - The COVID-19 pandemic poses a material risk, potentially leading to decreased loan demand, increased delinquencies, and declines in collateral value[189][193] - Participation in the SBA Paycheck Protection Program (PPP) exposes the company to litigation risk and the risk that the SBA may not honor its loan guarantees if origination deficiencies are found[197][199] - A significant portion of the loan portfolio (67% at year-end 2020) consists of real estate loans, concentrating risk in the California real estate market[218] - The company is exposed to risks from its SBA lending program, which is dependent on the federal government. The non-guaranteed portion of these loans, which the company retains, carries higher credit risk[228][234] - The company faces extensive government regulation, and changes to laws (like the Dodd-Frank Act) or capital requirements (Basel III) could increase costs and restrict activities[303][304] Unresolved Staff Comments The company reports no unresolved staff comments from the Securities and Exchange Commission - There are no unresolved staff comments[342] Properties The company's main executive offices are leased in San Jose, California, with most branch offices also leased, and one owned commercial building in Danville - The main office is located at 224 Airport Parkway, San Jose, CA, in a leased space of approximately 54,910 square feet with a lease expiring July 31, 2030[343][346] - The company owns one property, an 8,285 square foot office building in Danville, CA, acquired through the Diablo Valley Bank merger[347] - The company leases all other branch and administrative offices, with lease agreements detailed for locations across the Bay Area, including Fremont, Morgan Hill, Los Altos, and San Francisco[348][349][350][359] Legal Proceedings The company is involved in various legal claims and lawsuits arising in the ordinary course of business, with details referenced in Note 16 of the financial statements - The company is subject to various legal proceedings. For detailed information, refer to Note 16, "Commitments and Contingencies"[368][369] Mine Safety Disclosures This item is not applicable to the company - Not Applicable[370] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on NASDAQ under 'HTBK', with a $0.13 quarterly dividend per share in 2020, subject to board and regulatory discretion 2020 Quarterly Stock Price and Dividends (USD) | Quarter | High Price | Low Price | Dividend Per Share | | :--- | :--- | :--- | :--- | | Q1 2020 | $12.80 | $6.45 | $0.13 | | Q2 2020 | $9.36 | $6.74 | $0.13 | | Q3 2020 | $7.69 | $6.20 | $0.13 | | Q4 2020 | $9.33 | $6.67 | $0.13 | - As of February 10, 2021, there were approximately 839 holders of record of the company's common stock[374] - Future dividend payments are determined by the board of directors and are subject to the company's earnings, financial condition, and regulatory policies, including those from the Federal Reserve[375] Selected Financial Data This section summarizes five-year key financial data, showing $35.3 million net income, $4.63 billion total assets, and a 3.50% net interest margin for 2020 Selected Financial Data (2018-2020) | (In thousands, except per share data) | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Income Statement Data | | | | | Net interest income | $141,890 | $131,812 | $122,023 | | Provision for credit losses on loans | $13,233 | $846 | $7,421 | | Net income | $35,299 | $40,461 | $35,331 | | Per Common Share Data | | | | | Diluted net income | $0.59 | $0.84 | $0.84 | | Book value per common share | $9.64 | $9.71 | $8.49 | | Balance Sheet Data | | | | | Total assets | $4,634,114 | $4,109,463 | $3,096,562 | | Net loans | $2,574,861 | $2,510,559 | $1,858,557 | | Total deposits | $3,914,486 | $3,414,768 | $2,637,532 | | Performance Ratios | | | | | Return on average assets | 0.80% | 1.21% | 1.16% | | Net interest margin (FTE) | 3.50% | 4.28% | 4.31% | | Efficiency ratio | 58.96% | 59.76% | 57.39% | Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) Net income decreased to $35.3 million in 2020 due to a $13.2 million provision for credit losses, despite asset growth to $4.63 billion and strong capital levels - Net income for 2020 was $35.3 million, or $0.59 per diluted share, compared to $40.5 million, or $0.84 per diluted share, in 2019[400] - The decrease in earnings was primarily driven by a $13.3 million pre-tax provision for credit losses related to the adoption of CECL and the economic effects of the COVID-19 pandemic[401][408] - The company adopted the Current Expected Credit Loss (CECL) accounting standard on January 1, 2020, which requires estimating credit losses over the life of a loan[394] - The bank funded 1,105 PPP loans totaling $333.4 million, with an outstanding balance of $290.7 million at year-end[402] Results of Operations Net interest income increased 8% to $141.9 million in 2020, despite a 78 basis point drop in net interest margin, while provision for credit losses surged to $13.2 million Net Interest Income and Margin (in millions) | Metric | 2020 | 2019 | Change | | :--- | :--- | :--- | :--- | | Net Interest Income | $141.9M | $131.8M | +8% | | Net Interest Margin (FTE) | 3.50% | 4.28% | -78 bps | - The provision for credit losses was $13.2 million in 2020, a significant increase from $846,000 in 2019, primarily due to a deteriorated economic outlook from the COVID-19 pandemic[439] - Noninterest income was $9.9 million in 2020, a slight decrease from $10.2 million in 2019, due to lower service charges on deposits[443] - Noninterest expense increased 5% to $89.5 million in 2020, reflecting higher operating costs from the Presidio merger, although specific merger-related costs decreased from $11.1 million in 2019 to $2.6 million in 2020[410][452] Financial Condition Total assets grew 13% to $4.63 billion and deposits increased 15% to $3.91 billion in 2020, while asset quality improved with NPAs declining to $7.9 million Balance Sheet Highlights (Year-End, in billions) | Metric | 2020 | 2019 | % Change | | :--- | :--- | :--- | :--- | | Total Assets | $4.63B | $4.11B | +13% | | Total Loans (net) | $2.57B | $2.51B | +3% | | Total Deposits | $3.91B | $3.41B | +15% | Asset Quality Metrics (Year-End) | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Nonperforming Assets (NPAs) (in millions) | $7.9M | $9.8M | | NPAs / Total Assets | 0.17% | 0.24% | | ACLL / Total Loans | 1.70% | 0.92% | | ACLL / Nonperforming Loans | 564.24% | 236.93% | - The loan portfolio's largest segments are CRE non-owner occupied (27%), CRE owner-occupied (21%), and commercial (21%, excluding PPP loans)[473] - The adoption of CECL on Jan 1, 2020 resulted in an $8.6 million increase to the allowance for credit losses on loans[505] Liquidity and Capital Resources The company maintains strong liquidity with a 66.91% loan-to-deposit ratio and robust capital resources, exceeding 'well-capitalized' standards with a 16.5% total risk-based capital ratio - The loan-to-deposit ratio improved to 66.91% at year-end 2020 from 74.20% at year-end 2019, indicating a strong liquidity position[544] - The company has significant off-balance sheet liquidity, including a $160.5 million line of credit from the FHLB and a $528.1 million line from the FRB[545][546] Consolidated Capital Ratios (as of December 31, 2020) | Capital Ratio | Actual | Minimum Requirement (w/ buffer) | | :--- | :--- | :--- | | Total Risk-Based | 16.5% | 10.5% | | Tier 1 Risk-Based | 14.0% | 8.5% | | Common Equity Tier 1 | 14.0% | 7.0% | | Leverage | 9.1% | 4.0% | - The company elected the option to delay the regulatory capital impact of CECL adoption, phasing it in over a five-year period ending December 31, 2024[839] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate volatility, managed through asset/liability strategies, with a 100 basis point rate increase projected to boost net interest income by 12.8% - The company's principal market risk is interest rate risk, which it manages through its Asset/Liability Committee without the use of derivatives[563][564] Net Interest Income Sensitivity Analysis (as of December 31, 2020) | Change in Interest Rates (bps) | Estimated Change in NII ($ thousands) | Estimated Change in NII (%) | | :--- | :--- | :--- | | +400 | $59,450 | 50.0% | | +300 | $44,796 | 37.7% | | +200 | $30,037 | 25.3% | | +100 | $15,231 | 12.8% | | -100 | $(11,927) | (10.0)% | | -200 | $(22,135) | (18.6)% | Financial Statements and Supplementary Data This section presents the consolidated financial statements for 2020 and Crowe LLP's unqualified audit report, highlighting CECL adoption as a critical audit matter - The financial statements were audited by Crowe LLP, which issued an unqualified opinion on the financial statements and internal control over financial reporting as of December 31, 2020[611][612] - The auditor identified the adoption of the CECL standard (ASC 326) and the related modeling techniques and qualitative factors for the Allowance for Credit Losses on Loans (ACLL) as a critical audit matter[613][623] Note 4: Loans and Allowance for Credit Losses on Loans This note details the $2.62 billion loan portfolio and $44.4 million ACLL, which increased due to CECL adoption and pandemic-related economic forecasts, with past due loans decreasing Allowance for Credit Losses on Loans Roll-Forward (2020, in thousands) | Description | Amount | | :--- | :--- | | Beginning Balance (ALLL at 12/31/2019) | $23,285 | | Adoption of Topic 326 (CECL) | $8,570 | | Balance at Adoption (ACLL at 1/1/2020) | $31,855 | | Net Charge-offs | ($688) | | Provision for Credit Losses | $13,233 | | Ending Balance (ACLL at 12/31/2020) | $44,400 | - The increase in the ACLL during 2020 was primarily attributable to the change in projected economic conditions resulting from the COVID-19 pandemic, with elevated unemployment being a significant factor[730] - As of December 31, 2020, the company had $2.6 million in loans under short-term payment deferrals granted in response to the COVID-19 pandemic, which are not classified as TDRs under regulatory relief guidance[753] Note 8: Business Combinations This note details recent acquisitions, including the $185.6 million Presidio Bank merger in 2019, which resulted in $83.9 million in goodwill - The merger with Presidio Bank was completed on October 11, 2019, for a total consideration of $185.6 million, resulting in $83.9 million of goodwill[768][769] Merger-Related Costs (Pre-tax, in thousands) | Year | Presidio Merger | Tri-Valley & United American Mergers | | :--- | :--- | :--- | | 2020 | $2,601 | N/A | | 2019 | $11,080 | N/A | | 2018 | N/A | $9,167 | Note 16: Commitments and Contingencies The company discloses outstanding legal matters, including lawsuits related to D.C. Solar and a class-action, and $1.11 billion in off-balance sheet commitments to extend credit - The company is defending lawsuits related to its former deposit relationship with D.C. Solar, a former customer that allegedly perpetrated a Ponzi scheme[830] - A class-action lawsuit has been filed by employees alleging violations of the California Labor Code, with the company intending to defend the action vigorously[830][831] - As of December 31, 2020, the company had $1.11 billion in off-balance sheet commitments to extend credit, including unused lines of credit and standby letters of credit[834][835] Changes in and Disagreements with Accountants on Accounting and Financial Disclosures The company reports no disagreements with its accountants on accounting principles, financial disclosure, or auditing scope - None[576] Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2020, with no material changes reported - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2020[577] - Management's assessment, based on the 2013 COSO framework, concluded that internal control over financial reporting was effective as of December 31, 2020[582][583] - There were no changes in internal control over financial reporting during the year that materially affected, or are reasonably likely to materially affect, these controls[586] Other Information The company reports no other information for this item - None[587] Part III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the 2021 proxy statement, with a code of ethics available online - Required information is incorporated by reference from the definitive proxy statement for the 2021 Annual Meeting of Shareholders[589] - The company has adopted a code of ethics for its principal financial officers, available on its website[590] Executive Compensation Information regarding executive compensation is incorporated by reference from the 2021 Annual Meeting of Shareholders proxy statement - Required information is incorporated by reference from the definitive proxy statement for the 2021 Annual Meeting of Shareholders[592] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information on security ownership and related stockholder matters is incorporated by reference from the 2021 Annual Meeting of Shareholders proxy statement - Required information is incorporated by reference from the definitive proxy statement for the 2021 Annual Meeting of Shareholders[593] Certain Relationships and Related Transactions, and Director Independence Information on certain relationships, related transactions, and director independence is incorporated by reference from the 2021 Annual Meeting of Shareholders proxy statement - Required information is incorporated by reference from the definitive proxy statement for the 2021 Annual Meeting of Shareholders[594] Principal Accountant Fees and Services Information regarding principal accountant fees and services is incorporated by reference from the 2021 Annual Meeting of Shareholders proxy statement - Required information is incorporated by reference from the definitive proxy statement for the 2021 Annual Meeting of Shareholders[595] Part IV Exhibits and Financial Statement Schedules This section lists exhibits filed with the Form 10-K, including financial statements and the independent auditor's report, with all schedules either omitted or included elsewhere - The financial statements of the company and the Report of Independent Registered Public Accounting Firm are included starting on page 104 of the original document[597] - All financial statement schedules are omitted as they are not required or the information is included elsewhere[598] - A comprehensive list of exhibits filed with the report is provided, including governance documents, material contracts, and certifications[599][600][602] Form 10-K Summary This item is not applicable to the company's filing - Not applicable[605]