2016 ANNUAL REPORT ON FORM 10-K
2017 Notice of Annual Meeting of Shareholders
2017 Annual Meeting Proxy Statement
150 Almaden Boulevard / San Jose, California 95113 / 408.947.6900
HERITAGECOMMERCECORP.COM
2016
annual report
To Our Shareholders
April 19, 2017
Dear Fellow Shareholders:
2016 was a strong year for Heritage Commerce Corp. We delivered the most profitable year since we opened our doors in 1994.
Net income was a record $27.4 million, a 66% increase over 2015. Total assets exceeded $2.57 billion at year end, the return on
average tangible assets was 1.15%, and the return on average tangible equity was 13.55%, for full year 2016. We made important
investments in our long-term growth strategy achieving robust deposit and loan increases while maintaining solid credit quality.
Our outstanding financial performance was a direct result of the tremendous efforts of our experienced management team and
banking professionals who work diligently with our customers to help them achieve their financial goals.
2016 Highlights:
• Our net income grew 66% for the year to $27.4 million, or $0.72 per diluted share.
• Total revenue was higher by 21% from 2015, reflecting solid earning asset growth.
• In the first quarter of 2016, we raised our quarterly cash dividend 12.5% to $0.09 per share and continued to pay $0.09
per share each consecutive quarter for the remainder of the year. The quarterly cash dividend was raised an additional
11% to $0.10 per share in January 2017.
• In April 2016, Heritage Commerce Corp was named one of the top performing banks for 2015, by S&P Global Market
Intelligence, measured by six core financial performance metrics that focus on profitability, asset quality and growth for the
12-month period ended December 31, 2015. We are delighted to have continued that momentum throughout 2016.
• We generated robust deposit growth for the year, increasing deposits 10% over 2015, with noninterest-bearing deposits increasing
12%. As a result of focusing on relationship banking, we have established a loyal customer base with stable deposits.
• In addition, we had solid loan growth with loans, excluding loans held-for-sale, increasing 11% for the year. Our specialization
in a variety of business lines including dental, nonprofit organizations, contractors, education, churches, and homeowner
associations has led to sustained loan and deposit growth over the years.
• Our credit metrics continued to improve with nonperforming assets decreasing 51% from December 31, 2015, to $3.3 million,
or 0.13% of total assets, at year end. We believe our allowance for loan losses at 1.27% of total loans, remains sufficient.
• Heritage Commerce Corp ended the year with a total risk-based capital ratio of 12.5%, Tier 1 risk-based capital ratio and
common equity Tier 1risk-based ratio of 11.5%, and a leverage ratio of 8.5%. All capital ratios exceeded regulatory guidelines
for a “well-capitalized” financial institution under the Basel III regulatory requirements.
Additionally, we support our communities by investing financially and with time/effort of our employees in many nonprofit
entities that benefit those areas. In 2016, we invested approximately $700,000 into our communities through nonprofits
and our employees volunteered over 2,500 hours. We are extremely proud of our employees who work hard to create value
for our customers, communities, and shareholders.
We had an exceptional year, and our fundamentals are solid. With a strong core funding base, we are well positioned for growth
as we enter 2017. We will continue providing quality products and services to our customers and offer exceptional value to our
shareholders from a position of strength and stability. Please join us for our annual meeting on Thursday, May 25, 2017, at 1:00 p.m.
at our corporate headquarters in San Jose.
Sincerely,
Board of Directors
Jack W. Conner, Chairman
Julianne Biagini-Komas
Frank G. Bisceglia
J. Philip DiNapoli
Steven L. Hallgrimson
Walter T. Kaczmarek
Robert T. Moles
Laura Roden
Ranson W. Webster
Executive Management
Walter T. Kaczmarek
President and Chief Executive Officer
Keith A. Wilton
President, Heritage Bank of Commerce
Chief Operating Officer
Michael E. Benito
Executive Vice President
Banking Division
William J. Del Biaggio, Jr .
Executive Vice President
Marketing & Community Relations
Robert P. Gionfriddo
Executive Vice President
Lawrence D. McGovern
Executive Vice President
Chief Financial Officer
David E. Porter
Executive Vice President
Chief Credit Officer
Teresa L. Powell
Executive Vice President
Director of HOA & Deposit Services
Deborah K. Reuter
Executive Vice President
Chief Risk Officer & Corporate Secretary
Larry G. St.Regis
Executive Vice President
Chief Technology Officer
May K.Y. Wong
Executive Vice President
Controller
Subsidiary Bank Offices
Heritage Bank of Commerce
San Jose Main
150 Almaden Boulevard
San Jose, CA 95113
408.947.6900
Danville
387 Diablo Road
Danville, CA 94526
925.314.2851
Fremont
3137 Stevenson Boulevard
Fremont, CA 94538
510.445.0400
Gilroy
7598 Monterey Street
Suite 110
Gilroy, CA 95020
408.842.8310
Hollister
351 Tres Pinos Road
Suite 102A
Hollister, CA 95023
831.637.2152
419 S. San Antonio Road
Los Altos, CA 94022
650.941.9300
Los Gatos
15575 Los Gatos Boulevard
Building B
Los Gatos, CA 95032
408.356.6190
Morgan Hill
18625 Sutter Boulevard
Suite 100
Morgan Hill, CA 95037
408.778.2320
Pleasanton
300 Main Street
Pleasanton, CA 94566
925.314.2876
Director of Business Development
Los Altos
Corporate Information
Sunnyvale
333 W. El Camino Real
Suite 150
Sunnyvale, CA 94087
650.919.2159
Walnut Creek
101 Ygnacio Valley Road
Suite 100
Walnut Creek, CA 94596
925.930.9287
Bay View Funding
Administrative Office
2933 Bunker Hill Lane
Suite 210
Santa Clara, CA 95054
650.294.6600
Heritage Commerce Corp
Investor Relations Contact
Deborah K. Reuter
Executive Vice President
Chief Risk Officer & Corporate Secretary
Transfer Agent
Wells Fargo Bank, N.A.
Shareowner Services
1110 Centre Pointe Curve
Suite 101
Mendota Heights, MN 55120
1.800.468.9716
Independent Auditors
Crowe Horwath LLP
400 Capitol Mall
Suite 1400
Sacramento, CA 95814
916.441.1000
Corporate Counsel
Buchalter
A Professional Corporation
1000 Wilshire Boulevard
Suite 1500
Los Angeles, CA 90017
213.891.0700
Jack W. Conner
Chairman of the Board
Walter T. Kaczmarek
President and Chief Executive Officer
To get further information on Heritage Commerce Corp, or to receive regular financial updates,
please visit our web site at HeritageCommerceCorp.com and click on “Information Request.”
Member FDIC
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HERITAGE COMMERCE CORP
Notice of 2017 Annual Meeting
and Proxy Statement
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HERITAGE COMMERCE CORP
April 19, 2017
Dear Shareholder:
You are cordially invited to attend the 2017 Annual Meeting of Shareholders, which will be held at
1:00 p.m., Pacific Daylight Time (PDT) on Thursday, May 25, 2017, at Heritage Commerce Corp’s offices,
located at 150 Almaden Boulevard, San Jose, California, 95113.
The accompanying Notice of Annual Meeting and proxy statement describe the business that will be
conducted at the meeting and provide information about Heritage Commerce Corp. We have also
enclosed our 2016 Annual Report on Form 10-K.
Your continued support is appreciated and we hope you will attend the Annual Meeting. Whether or
not you are personally present, it is very important that your shares be represented at the meeting.
Accordingly, please sign, date, and mail the enclosed proxy card promptly. You may also vote electronically
over the Internet or by telephone by following the instructions on the proxy card. If you attend the meeting
and prefer to vote in person, you may do so.
Sincerely,
19MAR200823211807
Jack W. Conner
Chairman of the Board
Walter T. Kaczmarek
President and Chief Executive Officer
5APR200519390533
150 Almaden Boulevard, San Jose, California 95113
(cid:2)
Telephone (408) 947-6900
(cid:2)
Fax (408) 947-6910
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HERITAGE COMMERCE CORP
150 Almaden Boulevard
San Jose, California 95113
Notice of Annual Meeting of Shareholders
Date and Time:
Thursday, May 25, 2017, at 1:00 p.m., Pacific Daylight Time (PDT).
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Place:
Company’s offices located at 150 Almaden Boulevard, San Jose, California 95113.
Items of Business:
1. To elect 9 members of the Board of Directors, each for a term of one year;
4APR201704404189
2. To approve an amendment to the Heritage Commerce Corp 2013 Equity
Incentive Plan to increase the number of shares for issuance under the Plan;
3. To ratify the selection of Crowe Horwath LLP as the Company’s independent
registered public accounting firm for the year ending December 31, 2017; and
4. To transact such other business as may properly come before the meeting, and
any adjournment or postponement.
You can vote if you are a shareholder of record on April 3, 2017.
The proxy materials are being distributed to our shareholders on or about April 19,
2017, and include our Annual Report on Form 10-K, Notice of Annual Meeting,
this proxy statement, and proxy or voting instruction card.
The proxy statement and Annual Report on Form 10-K are available at
www.heritagecommercecorp.com. Your Vote is Important. Please vote as promptly as
possible by using the Internet or telephone or by signing, dating and returning the
enclosed proxy card.
By Order of the Board of Directors,
24MAR201019341637
Debbie Reuter
Executive Vice President
and Corporate Secretary
Record Date:
Mailing Date:
Important Notice
Regarding the
Internet
Availability of
Proxy Materials:
April 19, 2017
San Jose, California
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TABLE OF CONTENTS
QUESTIONS & ANSWERS
Why did you send me this proxy statement? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Who is entitled to vote? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
What constitutes a quorum? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
How many votes do I have? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Is voting confidential? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
How do I vote by proxy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
What do I have to do to vote my shares if they are held in the name of my broker? . . . . . . . .
What are the procedures for attending the Annual Meeting? . . . . . . . . . . . . . . . . . . . . . . . . .
How do I vote in person? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
May I vote electronically over the Internet or by telephone? . . . . . . . . . . . . . . . . . . . . . . . . . .
What is cumulative voting and how do I cumulate my shares? . . . . . . . . . . . . . . . . . . . . . . . .
May I change my vote after I return my proxy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
What if I receive multiple proxy cards? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
What vote is required to approve each proposal? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
How will voting on any other business be conducted? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
What are the costs of soliciting these proxies? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
How do I obtain an Annual Report on Form 10-K? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
BENEFICIAL OWNERSHIP OF COMMON STOCK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
CORPORATE GOVERNANCE AND BOARD MATTERS . . . . . . . . . . . . . . . . . . . . . . . . . . .
Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Code of Ethics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reporting of Complaints/Concerns Regarding Accounting or Auditing Matters . . . . . . . . . . . .
INFORMATION ABOUT DIRECTORS AND EXECUTIVE OFFICERS . . . . . . . . . . . . . . . .
The Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Board Leadership Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Board Authority for Risk Oversight . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Committees of the Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Role of Compensation Consultant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Executive Officers of the Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Compliance with Section 16(a) of the Securities Exchange Act of 1934 . . . . . . . . . . . . . . . . . .
Transactions with Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Policies and Procedures for Approving Related Party Transactions . . . . . . . . . . . . . . . . . . . . .
Compensation Discussion and Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Overview of Compensation Philosophy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Compensation Program Objectives and Rewards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consideration of Say-On-Pay Vote Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Role of Compensation Committee in Determining Compensation . . . . . . . . . . . . . . . . . . . . . .
Role of the Chief Executive Officer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Role of Compensation Consultants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Market Positioning and Pay Benchmarking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Chief Executive Officer Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Base Salary Decisions for the Other Named Executive Officers . . . . . . . . . . . . . . . . . . . . . . . .
Management Incentive Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity Based Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retirement Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prohibition on Speculation in Company Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Termination of Employment and Change in Control Provisions . . . . . . . . . . . . . . . . . . . . . . . .
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Tax Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dodd-Frank and Regulating Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Compensation Committee Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Executive Compensation Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Executive Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Plan Based Awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity Compensation Plan Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding Equity Awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Option Exercises and Vested Stock Awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
401(k) Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Employee Stock Ownership Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplemental Retirement Plan for Executive Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Management Deferral Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change of Control Arrangements and Termination of Employment . . . . . . . . . . . . . . . . . . . . .
Director Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Director Outstanding Stock Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Director Compensation Benefits Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PROPOSAL 1—ELECTION OF DIRECTORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PROPOSAL 2—APPROVAL OF AMENDMENT TO HERITAGE COMMERCE CORP 2013
EQUITY INCENTIVE PLAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PROPOSAL 3—RATIFICATION OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
OTHER BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SHAREHOLDER PROPOSALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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EXHIBIT A—AMENDMENT NO. 1 TO HERITAGE COMMERCE CORP 2013 EQUITY
INCENTIVE PLAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1
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PROXY STATEMENT FOR HERITAGE COMMERCE CORP
2017 ANNUAL MEETING OF SHAREHOLDERS
INFORMATION ABOUT THE ANNUAL MEETING AND VOTING
Why did you send me this proxy statement?
We sent you this proxy statement and the enclosed proxy card because our Board of Directors is
soliciting your proxy to vote at the 2017 Annual Meeting of Shareholders. This proxy statement
summarizes the information you need to know to cast an informed vote at the Annual Meeting. However,
you do not need to attend the Annual Meeting to vote your shares. Instead, you may simply complete, sign
and return the enclosed proxy card. You may also vote electronically by telephone or the Internet by
following the instructions on the proxy card.
Along with this proxy statement, we are also sending you the Heritage Commerce Corp 2016 Annual
Report on Form 10-K, which includes our consolidated financial statements. Heritage Commerce Corp is
also referred to in this proxy statement as the ‘‘Company.’’
Who is entitled to vote?
We will begin sending this proxy statement, the attached Notice of Annual Meeting and the enclosed
proxy card on or about April 19, 2017, to all shareholders entitled to vote. Shareholders who were the
record owners of the Company’s common stock at the close of business on April 3, 2017, are entitled to
vote. On this record date, there were 37,995,085 shares of common stock outstanding.
What constitutes a quorum?
A majority of the outstanding shares of the common stock entitled to vote at the Annual Meeting
must be present, in person or by proxy, in order to constitute a quorum. We can only conduct the business
of the Annual Meeting if a quorum has been established. We will include proxies marked as abstentions
and broker non-votes in determining the number of shares present at the Annual Meeting.
How many votes do I have?
Each share of common stock entitles you to one vote in person or by proxy, for each share of common
stock outstanding in your name on the books of the Company as of April 3, 2017, the record date for the
Annual Meeting on any matter submitted to a vote of the shareholders, except that in connection with the
election of directors (Proposal 1), you may cumulate your shares (see ‘‘What is cumulative voting and how
do I cumulate my shares?’’ on page 3). The proxy card indicates the number of votes that you have as of the
record date.
Is voting confidential?
We have a confidential voting policy to protect the privacy of our shareholders’ votes. Under this
policy, ballots, proxy cards and voting instructions returned to banks, brokers and other nominees are kept
confidential. Only the proxy tabulator and the Inspector of Election have access to the ballots, proxy cards
and voting instructions.
How do I vote by proxy?
You may vote by granting a proxy or, for shares held in street name, by submitting voting instructions
to your broker or other nominee. If your shares are held by a broker or other nominee, you will receive
instructions that you must follow to have your shares voted. If you hold your shares as a shareholder of
record, you may vote by completing, signing and dating the enclosed proxy card and returning it promptly
in the envelope provided. You may also vote electronically by telephone or over the Internet (see page 3).
Returning the proxy card will not affect your right to attend the Annual Meeting and vote.
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If you properly fill in your proxy card and send it to us in time to vote, your ‘‘proxy’’ (one of the
individuals named on your proxy card) will vote your shares as you have directed. If you sign the proxy card
but do not make specific choices, your proxy will vote your shares as recommended by the Board of
Directors as follows:
(cid:129) ‘‘FOR’’ the election of all 9 nominees for director;
(cid:129) ‘‘FOR’’ the amendment to the Heritage Commerce Corp 2013 Equity Incentive Plan to increase the
number of shares for issuance; and
(cid:129) ‘‘FOR’’ the ratification of the selection of Crowe Horwath LLP as our independent registered
public accounting firm for 2017.
For the election of directors (Proposal 1), a shareholder may withhold authority for the proxy holders
to vote for any one or more of the nominees by marking the enclosed proxy card in the manner instructed
on the proxy card. Unless authority to vote for the nominees is withheld, the proxy holders will vote the
proxies received by them for the election of the nominees listed on the proxy card as directors of the
Company. Your proxy does not have an obligation to vote for nominees not identified on the preprinted
proxy card (that is, write-in candidates). Should any shareholder attempt to ‘‘write in’’ a vote for a nominee
not identified on the preprinted card (and described in these proxy materials), your proxy will NOT vote
the shares represented by your proxy card for any such write-in candidate, but will instead vote the shares
for any and all other indicated candidates. If any of the nominees should be unable or decline to serve,
which is not now anticipated, your proxy will have discretionary authority to vote for a substitute who shall
be designated by the present Board of Directors to fill the vacancy. In the event that additional persons are
nominated for election as directors, your proxy intends to vote all of the proxies in such a manner, in
accordance with the cumulative voting, as will assure the election of as many of the nominees identified on
the proxy card as possible. In such event, the specific nominees to be voted for will be determined by the
proxy holders, in their sole discretion.
What do I have to do to vote my shares if they are held in the name of my broker?
If your shares are held by your broker, sometimes called ‘‘street name’’ shares, you must vote your
shares through your broker. You should receive a form from your broker asking how you want to vote your
shares. Follow the instructions on that form to give voting instructions to your broker. Under the rules that
govern brokers who are voting with respect to shares held in street name, brokers have the discretion to
vote such shares on routine, but not on non-routine matters. A ‘‘broker non-vote’’ occurs when your broker
does not vote on a particular proposal because the broker does not receive instructions from the beneficial
owner and does not have discretionary authority. Proposal 1 (election of directors) and Proposal 2
(approval of amendment to the 2013 Equity Incentive Plan) are non-routine items on which a broker may
vote only if the beneficial owner has provided voting instructions. Proposal 3 (ratification of independent
registered public accounting firm) is a routine item.
What are the procedures for attending the Annual Meeting?
Only shareholders owning the Company’s common stock at the close of business on April 3, 2017, or
their legal proxy holders, are entitled to attend the Annual Meeting. You must present photo identification
for admittance. If you are a shareholder of record, your name will be verified against the list of
shareholders of record on the Record Date prior to your admission to the Annual Meeting. If you are not a
shareholder of record but hold shares through a bank, broker or other nominee, you must provide proof of
beneficial ownership on the Record Date, such as your most recent account statement prior to April 3,
2017, or other similar evidence of ownership. If you do not provide photo identification or comply with the
other procedures outlined above, you will not be admitted to the Annual Meeting.
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How do I vote in person?
If you plan to attend the Annual Meeting and desire to vote in person, we will give you a ballot form
when you arrive. However, if your shares are held in the name of your broker, bank or other nominee, you
must bring a power of attorney from your nominee in order to vote at the Annual Meeting.
May I vote electronically over the Internet or by telephone?
Shareholders whose shares are registered in their own names may vote either over the Internet or by
telephone. Special instructions for voting over the Internet or by telephone are set forth on the enclosed
proxy card. The Internet and telephone voting procedures are designed to authenticate the shareholder’s
identity and to allow shareholders to vote their shares and confirm that their voting instructions have been
properly recorded.
If your shares are registered in the name of a bank or brokerage firm, you may be eligible to vote your
shares electronically by telephone or over the Internet. Most U.S. banks and brokerage firms are clients of
Broadridge Financial Solutions (‘‘Broadridge’’). As such, shareholders who receive either a paper copy of
their proxy statement or electronic delivery notification have the opportunity to vote by telephone or over
the Internet. If your bank or brokerage firm is a Broadridge client, your proxy card or Voting Instruction
Form (‘‘VIF’’) will provide the instructions. If your proxy card or VIF does not provide instructions for
Internet and telephone voting, please complete and return the proxy card in the self-addressed,
postage-paid envelope provided.
What is cumulative voting and how do I cumulate my shares?
For the election of directors (Proposal 1), California law provides that a shareholder of a California
corporation, or his/her proxy, may cumulate votes in the election of directors. That is, each shareholder
may cast that number of votes equal to the number of shares owned by him/her, multiplied by the number
of directors to be elected, and he/she may cumulate such votes for a single candidate or distribute such
votes among as many candidates as he/she deems appropriate.
Certain affirmative steps must be taken by you in order to be entitled to vote your shares cumulatively
for the election of directors. At the shareholders’ meeting at which directors are to be elected, no
shareholder is entitled to cumulate votes (i.e., cast for any one or more candidates a number of votes
greater than the number of the shareholder’s shares) unless the candidates’ names have been placed in
nomination at the meeting and prior to the commencement of the voting and at least one shareholder has
given notice at the meeting and prior to commencement of the voting of the shareholder’s intention to
cumulate votes. If any shareholder has given such notice, then every shareholder entitled to vote may
cumulate votes for candidates in nomination and give one candidate a number of votes equal to the
number of directors to be elected multiplied by the number of votes to which that shareholder’s shares are
entitled, or distribute the shareholder’s votes on the same principle among any or all of the candidates, as
the shareholder thinks appropriate. The candidates receiving the highest number of votes, up to the
number of directors to be elected, will be elected.
The proxies designated on your proxy card do not, at this time, intend to cumulate votes, to the extent
they have the shareholder’s discretionary authority to do so, pursuant to the proxies solicited in this proxy
statement unless another shareholder gives notice to cumulate, in which case your proxy may cumulate
votes in accordance with the recommendations of the Board of Directors. Therefore, discretionary
authority to cumulate votes in such an event is solicited in this proxy statement.
3
May I change my vote after I return my proxy?
If you fill out and return the enclosed proxy card, or vote by telephone or over the Internet, you may
change your vote at any time before the vote is conducted at the Annual Meeting. You may change your
vote in any one of four ways:
(cid:129) You may send to the Company’s Corporate Secretary another completed proxy card with a later
date.
(cid:129) You may notify the Company’s Corporate Secretary in writing before the Annual Meeting that you
have revoked your proxy.
(cid:129) You may attend the Annual Meeting and vote in person.
(cid:129) If you have voted your shares by telephone or over the Internet, you can revoke your prior
telephone or Internet vote by recording a different vote, or by signing and returning a proxy card
dated as of a date that is later than your last telephone or Internet vote.
What if I receive multiple proxy cards?
If you receive multiple proxy cards, your shares are probably registered differently or are in more than
one account. Vote all proxy cards received to ensure that all your shares are voted. Unless you need
multiple accounts for specific purposes, we recommend that you consolidate as many of your accounts as
possible under the same name and address. If the shares are registered in your name, contact our transfer
agent, Wells Fargo Shareowner Services, 1-800-468-9716; otherwise, contact your bank, broker or other
nominee.
What vote is required to approve each proposal?
Approval of Proposal 1 (election of directors) requires a plurality of votes cast for each nominee. This
means that the 9 nominees who receive the most votes will be elected. So, if you do not vote for a
particular nominee, or you indicate ‘‘WITHHOLD AUTHORITY’’ to vote for a particular nominee on
your proxy card, your vote will not count either ‘‘for’’ or ‘‘against’’ the nominee. Abstentions will not have
any effect on the outcome of the vote. You may cumulate your votes in the election of directors as
described under ‘‘What is cumulative voting and how do I cumulate my shares?’’ on page 3. Broker non-votes
will not count as a vote on the proposal and will not affect the outcome of the vote.
Approval of Proposal 2 (approval of amendment to the 2013 Equity Incentive Plan) and Proposal 3
(ratification of independent registered public accounting firm) each requires a vote that satisfies two
criteria: (i) the affirmative vote for the proposal must constitute a majority of the common shares present
or represented or by proxy and voting on the proposal at the Annual Meeting; and (ii) the affirmative vote
for the proposal must constitute a majority of the common shares required to constitute the quorum. For
purposes of Proposal 2 and 3, abstentions and broker non-votes will not affect the outcome under
clause (i), which recognizes only actual votes cast. However, abstentions and broker non-votes will affect
the outcome under clause (ii) if the number of affirmative votes, though a majority of the votes
represented and cast, does not constitute a majority of the voting power required to constitute a quorum.
The ratification of the appointment of the independent registered public accounting firm for 2017 is a
matter on which a broker or other nominee is generally empowered to vote and, therefore, no broker
non-votes are expected to exist with respect to Proposal 3.
How will voting on any other business be conducted?
Your proxy card confers discretionary authority to your proxy to vote your shares on the matters which
may properly be presented for action at the Annual Meeting, and may include action with respect to
procedural matters pertaining to the conduct of the Annual Meeting.
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What are the costs of soliciting these proxies?
We will pay all the costs of soliciting these proxies. In addition to mailing proxy soliciting material, our
directors, officers and employees also may solicit proxies in person, by telephone or by other electronic
means of communication for which they will receive no compensation. We will ask banks, brokers and
other institutions, nominees and fiduciaries to forward the proxy materials to their principals and to obtain
authority to execute proxies. We will then reimburse them for their reasonable expenses. We have hired
Advantage Proxy to seek the proxies of custodians, such as brokers, which hold shares which belong to
other people. This service will cost the Company approximately $4,250 plus expenses.
How do I obtain an Annual Report on Form 10-K?
A copy of our 2016 Annual Report on Form 10-K accompanies this proxy statement. If you would like
another copy of this report, we will send you one without charge. The Annual Report on Form 10-K
includes a list of exhibits filed with the Securities and Exchange Commission (‘‘SEC’’), but does not
include the exhibits. If you wish to receive copies of the exhibits, we will send them to you; however,
expenses for copying and mailing them to you will be your responsibility. Please write to:
Heritage Commerce Corp
150 Almaden Boulevard
San Jose, California 95113
Attention: Executive Vice President and Corporate Secretary
You can also find out more information about us at our website www.heritagecommercecorp.com. Our
website is available for information purposes only and should not be relied upon for investment purposes,
nor is it incorporated by reference into this proxy statement. On our website you can access electronically
filed copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, Section 16 filings, and amendments to those reports and filings, free of charge. The SEC also
maintains a website at www.sec.gov that contains reports, proxy statements and other information regarding
SEC registrants, including the Company.
5
BENEFICIAL OWNERSHIP OF COMMON STOCK
The following table sets forth information as of February 28, 2017, pertaining to beneficial ownership
of the Company’s common stock by persons known to the Company to own 5% or more of the Company’s
common stock, nominees to be elected to the Board of Directors, the executive officers named in the
Summary Compensation Table presented in this proxy statement, and all directors and executive officers of
the Company, as a group. This information has been obtained from the Company’s records, or from
information furnished directly by the individual or entity to the Company.
For purposes of the following table, shares issuable pursuant to stock options which may be exercised
within 60 days of February 28, 2017, are deemed to be issued and outstanding and have been treated as
outstanding in determining the amount and nature of beneficial ownership and in calculating the
percentage of ownership of those individuals possessing such interest, but not for any other individuals.
Name of Beneficial Owner(1)
Position
Michael E. Benito . . . . . . . . . . . . Executive Vice President/
Banking Division
Julianne M. Biagini-Komas . . . . . . Director
Frank G. Bisceglia . . . . . . . . . . . . Director
Jack W. Conner . . . . . . . . . . . . . . Director and Chairman of the
. . . . . . . . . . . . Director
J. Philip DiNapoli
Steven L. Hallgrimson . . . . . . . . . Director
Walter T. Kaczmarek . . . . . . . . . . Chief Executive Officer,
Board
Shares
Beneficially
Owned(2)(3)
Exercisable Percent of
Class(3)
Options
73,512(14)
27,965
136,411(4)
130,093(5)
496,125
125,184(6)
42,689
—
28,472
27,097
—
5,427
0.19%
0.07%
0.36%
0.34%
1.31%
0.33%
President and Director
168,652(7)(14)
36,875
0.44%
Lawrence D. McGovern . . . . . . . . Executive Vice President and
Robert T. Moles . . . . . . . . . . . . . . Director
David E. Porter . . . . . . . . . . . . . . Executive Vice President and
Chief Financial Officer
Chief Credit Officer
Laura Roden . . . . . . . . . . . . . . . . Director
Ranson W. Webster . . . . . . . . . . . Director
Keith A. Wilton . . . . . . . . . . . . . . Executive Vice President and
98,616(8)(14)
121,978(9)
41,566
27,972
58,389(14)
24,784
634,752
19,689
11,082
28,472
0.26%
0.32%
0.15%
0.07%
1.67%
Chief Operating Officer
79,207(10)(14)
—
0.21%
All directors, and executive
officers (13 individuals) . . . . . . .
. . . . . . . . . . . . . .
. . .
BlackRock Inc.
T. Rowe Price Associates, Inc.
Wellington Management
Group LLP . . . . . . . . . . . . . . .
2,175,668
2,663,199(11)
3,207,601(12)
3,010,759(13)
5.69%
7.02%
8.45%
7.93%
1. Except as otherwise noted, the address for all persons is c/o Heritage Commerce Corp, 150 Almaden
Boulevard, San Jose, California, 95113.
2.
3.
4.
Subject to applicable community property laws and shared voting and investment power with a spouse,
the persons listed have sole voting and investment power with respect to such shares unless otherwise
noted. Listed amounts reflect all previous stock splits and stock dividends.
Includes shares beneficially owned (including options exercisable within 60 days of February 28, 2017,
as shown in the ‘‘Exercisable Options’’ column).
Includes 93,237 shares as one of two trustees of the Bisceglia Family Trust, and 11,000 shares held by
Mr. Bisceglia in a personal Individual Retirement Account.
5.
Includes 7,783 shares held by Mr. Conner’s spouse.
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Includes 81,057 shares held directly, 3,500 shares held in a SEP IRA account, 2,000 shares held in a
personal IRA account and 4,000 shares held in Mr. Hallgrimson’s private foundation. Also includes
3,000 shares held by Mr. Hallgrimson’s spouse, 7,000 shares in a limited liability company with his son,
2,900 shares that Mr. Hallgrimson holds as trustee of various trusts and 16,300 shares held in accounts
of others over which Mr. Hallgrimson has voting and investment power.
Includes 41,000 shares held in a personal Individual Retirement Account.
Includes 4,980 shares held by Mr. McGovern in a personal Individual Retirement Account.
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6.
7.
8.
9.
10. Includes 45,250 shares of restricted stock that have not vested and of which Mr. Wilton has the right to
vote.
11. BlackRock, Inc. is an investment management firm and may be deemed to beneficially own 2,663,199
shares of the Company which are held of record by clients of BlackRock, Inc. The address for
BlackRock, Inc. is 55 East 52nd Street, New York, NY 10055. All of the foregoing information has
been obtained by Schedule 13G filed with the SEC on January 24, 2017.
12. T. Rowe Price Associates, Inc. is an investment management firm and may be deemed to beneficially
own 3,207,601 shares of the Company which are held of record by clients of T. Rowe Price
Associates, Inc. The address for T. Rowe Price Associates, Inc. is 100 East Pratt Street, Baltimore,
MD 21202. All of the foregoing information has been obtained by Schedule 13G filed with the SEC on
February 7, 2017.
13. Wellington Management Group LLP is an investment management firm and may be deemed to
beneficially own 3,010,759 shares of the Company which are held of record by clients of Wellington
Management Group LLP. The address for Wellington Management Group LLP is 280 Congress
Street, Boston, MA 02210. All of the foregoing information has been obtained by Schedule 13G filed
with the SEC on February 9, 2017.
14. The Company’s Employee Stock Ownership Plan owns 123,707 shares of our common stock, all of
which have been allocated. These include shares held for the account of the following named
executive officers and included in the table for: Mr. Kaczmarek 1,850 shares, Mr. McGovern 5,350
shares, Mr. Benito 2,223 shares, and zero shares for Mr. Porter and Mr. Wilton. Mr. Kaczmarek and
Mr. McGovern are two of the three trustees of the Employee Stock Ownership Plan. As trustees, they
have the power to vote any unallocated shares of Employee Stock Ownership Plan (currently no
shares are unallocated) and allocated shares for which voting instructions are not otherwise provided.
7
CORPORATE GOVERNANCE AND BOARD MATTERS
The Board of Directors is committed to good business practices, transparency in financial reporting
and the highest level of corporate governance. To that end, the Board continually reviews its governance
policies and practices, as well as the requirements of the Sarbanes-Oxley Act of 2002 and the listing
standards of The NASDAQ Stock Market, to help ensure that such policies and practices are compliant
and up to date.
Board of Directors
Board Independence
In 2016 ten (10) out of eleven (11) members of the Board of Directors were independent directors, as
defined by the applicable rules and regulations of The NASDAQ Stock Market, as follows:
Julianne M. Biagini-Komas
Frank G. Bisceglia
Jack W. Conner, Chairman of the Board
J. Philip DiNapoli
John M. Eggemeyer*
Steven L. Hallgrimson
Robert T. Moles
Laura Roden
Ranson W. Webster
W. Kirk Wycoff*
*
John M. Eggemeyer resigned from the Board effective December 15, 2016. W. Kirk Wycoff
resigned from the Board effective February 15, 2017.
Board and Committee Meeting Attendance
During the fiscal year ended December 31, 2016, our Board of Directors held a total of 10 meetings.
Each incumbent director who was a director during 2016 attended at least 75% of the aggregate of (a) the
total number of such meetings and (b) the total number of meetings held by the standing committees of
the Board on which such director served.
Director Attendance at Annual Meetings of Shareholders
The Board believes it is important for all directors to attend the Annual Meeting of Shareholders in
order to show their support for the Company and to provide an opportunity for shareholders to
communicate any concerns to them. The Company’s policy is to encourage, but not require, attendance by
each director at the Company’s Annual Meeting of Shareholders. All of the directors of the Company are
encouraged to attend the Annual Meeting of Shareholders and at the 2016 Annual Meeting of
Shareholders, all of the directors attended.
Communications with the Board
Shareholders may communicate with the Board of Directors, including a committee of the Board or
individual directors, by writing to the Corporate Secretary, Heritage Commerce Corp, 150 Almaden
Boulevard, San Jose, California 95113. Each communication from a shareholder should include the
following information in order to permit shareholder status to be confirmed and to provide an address to
forward a response if deemed appropriate:
(cid:129) The name, mailing address and telephone number of the shareholder sending the communication;
and
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(cid:129) If the shareholder is not a record holder of our common stock, the name of the record holder of our
common stock beneficially owned must be identified along with the shareholder.
Our Corporate Secretary will forward all appropriate communications to the Board or individual
members of the Board specified in the communication. Our Corporate Secretary may (but is not required
to) review all correspondence addressed to the Board or any individual member of the Board, for any
inappropriate correspondence more suitably directed to management. Communications may be deemed
inappropriate for this purpose if it is reasonably apparent from the face of the correspondence that it
relates principally to a customer dispute. Our policies regarding the handling of security holder
communications were approved by a majority of our independent directors.
Nomination of Directors
The Company has a Corporate Governance and Nominating Committee. The duties of the Corporate
Governance and Nominating Committee include the recommendation of candidates for election to the
Company’s Board of Directors.
The Corporate Governance and Nominating Committee’s minimum qualifications for a director are
persons of high ethical character who have both personal and professional integrity, which is consistent
with the image and values of the Company. The Corporate Governance and Nominating Committee
considers some or all of the following criteria in considering candidates to serve as directors:
(cid:129) commitment to ethical conduct and personal and professional integrity as evidenced through the
person’s business associations, diversity, service as a director or executive officer or other
commitment to ethical conduct and personal and professional integrity as evidenced in
organizations and/or education;
(cid:129) objective perspective and mature judgment developed through business experiences and/or
educational endeavors;
(cid:129) the candidate’s ability to work with other members of the Board of Directors and management to
further our goals and increase shareholder value;
(cid:129) the ability and commitment to devote sufficient time to carry out the duties and responsibilities as a
director;
(cid:129) demonstrated experience at policy making levels in various organizations and in areas that are
relevant to our activities;
(cid:129) the skills and experience of the potential nominee in relation to the capabilities already present on
the Board of Directors; and
(cid:129) such other attributes, including independence, relevant in constituting a board that also satisfies the
requirements imposed by the SEC and The NASDAQ Stock Market.
The Corporate Governance and Nominating Committee does not have a separate policy for
consideration of any director candidates recommended by shareholders. Instead, the Corporate
Governance and Nominating Committee considers any candidate meeting the requirements for
nomination by a shareholder set forth in the Company’s Bylaws (as well as applicable laws and regulations)
in the same manner as any other director candidate. The Corporate Governance and Nominating
Committee believes that requiring shareholder recommendations for director candidates to comply with
the requirements for nominations in accordance with the Company’s Bylaws ensures that the Corporate
Governance and Nominating Committee receives at least the minimum information necessary for it to
begin an appropriate evaluation of any such director nominee.
Section 5.14 of the Company’s Bylaws provide that any shareholder must give advance written notice
to the Company of an intention to nominate a director at a shareholder meeting. Notice of intention to
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make any nominations must be delivered to the Secretary of the Company at the principal executive offices
of the Company not later than the close of business on the ninetieth (90th) day nor earlier than the close of
business on the one hundred twentieth (120th) day prior to the first anniversary of the preceding year’s
annual meeting. If the date of the annual meeting is more than thirty (30) days before or more than sixty
(60) days after such anniversary date of the annual meeting, notice by the shareholder must be delivered
not earlier than the close of business on the one hundred twentieth (120th) day prior to such annual
meeting and not later than the close of business on the later of the ninetieth (90th) day prior to such
annual meeting or the tenth (10th) day following the day on which public announcement of the date of
such meeting is first made by the Company.
To be in proper written form, a shareholder’s notice to the Corporate Secretary must provide as to
each person, whom the shareholder proposes to nominate for election as a director (each referred to as the
‘‘Nominee’’): (1) all information relating to the Nominee that is required to be disclosed in solicitations of
proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to
and in accordance with Regulation 14A under the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’);
(2) the Nominee’s written consent to being named in the proxy statement as a nominee and to serving as a
director if elected; (3) the number of shares of capital stock of any bank, bank holding company, savings
and loan association or other depository institution owned beneficially by the Nominee and the identities
and locations of any such institutions; (4) whether the Nominee has ever been convicted of or pleaded nolo
contender to any criminal offensive involving dishonestly or breach of trust, filed a petition in bankruptcy
or been adjudged bankrupt; (5) a written statement executed by the Nominee acknowledging that as a
director of the Company, the Nominee will owe a fiduciary duty exclusively to the Company and its
shareholders; (6) a representation whether the Nominee satisfies the requirements of Section 2.2(b) of the
Company’s Bylaws (see below); (7) whether and the extent to which any hedging or other transaction or
series of transactions has been entered into by or on behalf of the Nominee respect to any securities of the
Company, and a description of any other agreement, arrangement or understanding (including any short
position or any borrowing or lending of shares), the effect or intent of which is to mitigate loss to, or to
manage the risk or benefit of share price changes for, or to increase or decrease the voting power of the
Nominee; and (8) a description of all arrangements or understandings between the shareholder and the
Nominee and any other person or persons (naming such person or persons) pursuant to which the
nomination is to be made by the shareholder.
The notice must also set forth with respect to the shareholder submitting the nomination: (1) the
name and address of the shareholder (and beneficial owner, if applicable), as it appears on the Company’s
books, (and of such beneficial owner, if applicable) and any other shareholders and beneficial owners
known by such shareholder to be supporting the Nominee(s) for election; (2) the class or series and
number of shares of capital stock of the Company that are, directly or indirectly, owned beneficially and of
record by such shareholder (and by such beneficial owner, if applicable); (3) any derivative positions with
respect to shares of capital stock of the Company held or beneficially held by or on behalf of such
shareholder (and by or on behalf of such beneficial owner), the extent to which any hedging or other
transaction or series of transactions has been entered into with respect to the shares of capital stock of the
Company by or on behalf of such shareholder (and by or on behalf of such beneficial owner), and the
extent to which any other agreement, arrangement or understanding has been made, the effect or intent of
which is to increase or decrease the voting power of such shareholder (and such beneficial owner) with
respect to shares of capital stock of the Company; (4) a representation that the shareholder is a holder of
record of stock of the Company entitled to vote at the meeting and intends to appear in person or by proxy
at the meeting to propose the Nominee; and (5) a representation whether the shareholder (or the
beneficial owner, if any), intends or is part of a group that intends to deliver a proxy statement and/or form
of proxy to holders of at least the percentage of the Company’s outstanding capital stock required to elect
the nominee or otherwise to solicit proxies from shareholders in support of such nomination (and a copy of
such documents must be provided with the notice). The information required of clauses (3) and (4) must
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be supplemented not later than ten days following the record date to disclose the information contained in
clauses (3) and (4) above as of the record date.
The Company may require any proposed nominee to furnish such other information as it may
reasonably require to determine: (1) the eligibility of the Nominee to serve as a director of the Company
(including the information required to be set forth in the shareholder’s notice of nomination of such
person as a director as of a date subsequent to the date on which the notice of such person’s nomination
was given); and (2) whether the Nominee qualifies as an ‘‘independent director’’ or ‘‘audit committee
financial expert’’ under applicable law, securities exchange rule or regulation, or any publicly-disclosed
corporate governance guideline or committee charter of the Company.
Nominees for the Board of Directors must also meet certain qualifications set forth in Section 2.2(b)
of our Bylaws, which prohibit the election as a director of any person who is a director, executive officer,
branch manager or trustee for any unaffiliated commercial bank, savings bank, trust company, savings and
loan association, building and loan association, industrial bank or credit union that is engaged in business
in: (1) any city, town or village in which the Company or any affiliate or subsidiary thereof has offices; or
(2) any city, town or village adjacent to a city, town or village in which the Company or any affiliate or
subsidiary thereof has offices.
When the Company acquired Focus Business Bank in 2015, it agreed to nominate and support the
election of Julianne M. Biagini-Komas and J. Philip DiNapoli, former directors of Focus Business Bank, to
the Company’s Board. The Corporate Governance and Nomination Committee has recommended the
election of Julianne M. Biagini-Komas and J. Philip DiNapoli as directors at the 2017 Annual Meeting.
Diversity of the Board of Directors
In considering diversity of the Board (in all aspects of that term) as a criteria for selecting nominees in
accordance with its charter, the Corporate Governance and Nominating Committee takes into account
various factors and perspectives, including differences of viewpoint, high quality business and professional
experience, education, skills and other individual qualities and attributes that contribute to Board
heterogeneity, as well as race, gender and national origin. The Committee does not assign specific weights
to particular criteria and no particular criterion is necessarily applicable to all prospective nominees. The
Committee seeks persons with leadership experience in a variety of contexts and industries. The
Committee believes that this expansive conceptualization of diversity is the most effective means to
implement Board diversity. The Corporate Governance and Nominating Committee will assess the
effectiveness of this approach as part of its annual review of its charter.
Term of Office
Directors serve for a one-year term or until their successors are elected. The Board does not have
term limits, instead preferring to rely upon the evaluation procedures described herein as the primary
methods of ensuring that each director continues to act in a manner consistent with the best interests of
the shareholders and the Company.
Board Committees
The Board may delegate portions of its responsibilities to committees of its members. These standing
committees of the Board meet at regular intervals to attend to their particular areas of responsibility. Our
Board has five standing committees: Audit Committee, Compensation Committee, Corporate Governance
and Nominating Committee, Finance and Investment Committee, and Strategic Initiatives Committee. In
addition, Heritage Bank of Commerce maintains a Loan Committee. An independent director, as defined
by the applicable rules and regulations of The NASDAQ Stock Market, chairs the Board and its other
standing committees (including Heritage Bank of Commerce’s Loan Committee). The Chair determines
the agenda, the frequency and the length of the meetings and receives input from Board members.
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Executive Sessions
Independent directors meet in executive sessions throughout the year including meeting annually to
consider and act upon the recommendation of the Compensation Committee regarding the compensation
and performance of the Chief Executive Officer.
Evaluation of Board Performance
A Board assessment and director self-evaluations are conducted annually in accordance with an
established evaluation process and includes performance of committees. The Corporate Governance and
Nominating Committee oversees this process and reviews the assessment and self-evaluation with the full
Board.
Management Performance and Compensation
The Compensation Committee reviews and approves the Chief Executive Officer’s evaluation of the
top management team on an annual basis. The Board (largely through the Compensation Committee)
evaluates the compensation plans for senior management and other employees to ensure they are
appropriate, competitive and properly reflect the Company’s objectives and performance.
Director Stock Ownership Guidelines
The Board has adopted a policy that each member of the Board is expected to hold, at a minimum,
$200,000 market value shares of the Company’s common stock. Any director not meeting the minimum
level as of the effective date of their election to the Board has three years to bring his or her holdings up to
this minimum level. The Corporate Governance and Nominating Committee will review this policy on an
annual basis.
Code of Ethics
The Board expects all directors, as well as officers and employees, to display the highest standard of
ethics, consistent with the principles that have guided the Company over the years.
The Board has adopted an Executive and Principal Financial Officer’s Code of Ethics that applies to
the Chief Executive Officer, Chief Financial Officer and the senior financial officers of the Company to
help ensure that the financial affairs of the Company are conducted honestly, ethically, accurately,
objectively, consistent with generally accepted accounting principles and in compliance with all applicable
governmental law, rules and regulations. We will disclose any amendment to, or a waiver from a provision
of our Code of Ethics on our website. The Executive and Principal Financial Officer’s Code of Ethics is
available on our website at www.heritagecommercecorp.com.
Reporting of Complaints/Concerns Regarding Accounting or Auditing Matters
The Company’s Board of Directors has adopted procedures for receiving and responding to
complaints or concerns regarding accounting and auditing matters. These procedures were designed to
provide a channel of communication for employees and others who have complaints or concerns regarding
accounting or auditing matters involving the Company.
Employee concerns may be communicated in a confidential or anonymous manner to the Audit
Committee of the Board. The Audit Committee Chairman will make a determination on the level of
inquiry, investigation or disposal of the complaint. All complaints are discussed with the Company’s senior
management and monitored by the Audit Committee for handling, investigation and final disposition. The
Chairman of the Audit Committee will report the status and disposition of all complaints to the Board of
Directors.
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INFORMATION ABOUT DIRECTORS AND EXECUTIVE OFFICERS
The Board of Directors
The Board of Directors oversees our business and monitors the performance of management. In
accordance with corporate governance principles, the Board does not involve itself in day-to-day
operations. The directors keep themselves informed through, among other things, discussions with the
Chief Executive Officer, other key executives and our principal outside advisors (legal counsel, outside
auditors, and other consultants), by reading reports and other materials that we send them and by
participating in Board and committee meetings.
The Company’s Bylaws currently permit the number of Board members to range from 9 to 15, leaving
the Board authority to fix the exact number of directors within that range. The Board has fixed the number
of directors at 9.
Board Leadership Structure
The Board of Directors is committed to maintaining an independent Board, and a majority of the
Board has been comprised of independent directors. It has further for many years been the practice of the
Company to separate the roles of Chief Executive Officer and Chairman of the Board in recognition of the
differences between the two roles. The Chief Executive Officer is responsible for setting the strategic
direction for the Company and the day-to-day leadership and performance of the Company. The Chairman
of the Board provides guidance to the Chief Executive Officer, sets the agenda for Board meetings,
presides over meetings of the full Board (including executive sessions), and facilitates communication
among the independent directors and between the independent directors and the Chief Executive Officer.
The Board further believes that the separation of the duties of the Chief Executive Officer and the
Chairman of the Board eliminates any inherent conflict of interest that may arise when the roles are
combined, and that an independent director who has not served as an executive of the Company can best
provide the necessary leadership and objectivity required as Chairman of the Board.
Board Authority for Risk Oversight
The Board has active involvement and responsibility for overseeing risk management of the Company
arising out of its operations and business strategy. The Board monitors, reviews and reacts to material
enterprise risks identified by management. The Board receives specific oral and written reports from
officers with oversight responsibility for particular risks within the Company. Reports cover executive
management on financial, credit, liquidity, interest rate, capital, operational, legal and regulatory
compliance and reputation risks and the Company’s degree of exposure to those risks. The Board helps
ensure that management is properly focused on risk by, among other things, reviewing and discussing the
performance of senior management and business line leaders.
Board committees also have responsibility for risk oversight in specific areas. The Audit Committee
oversees financial, accounting and internal control risk management policies. The Company’s internal Risk
Management Steering Committee reports directly to the Audit Committee. The Audit Committee is
responsible for monitoring the Company’s overall risk program. The Audit Committee receives quarterly
reports from the Risk Management Steering Committee and the Company’s internal audit department.
The Audit Committee reports periodically to the Board on the effectiveness of risk management processes
in place, risk trends, and the overall risk assessment of the Company’s activities. The Compensation
Committee assesses and monitors risks in the Company’s compensation program. The Corporate
Governance and Nominating Committee recommends director candidates with appropriate experience
and skills who will set the proper tone for the Company’s risk profile and provide competent oversight over
our material risks.
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The Committees of the Board
The Board may delegate portions of its responsibilities to committees of its members. These standing
committees of the Board meet at regular intervals to attend to their particular areas of responsibility. Our
Board has five standing committees: the Audit Committee, Compensation Committee, Corporate
Governance and Nominating Committee, Finance and Investment Committee, and Strategic Initiatives
Committee. In addition, Heritage Bank of Commerce also maintains a Loan Committee.
Audit Committee. The Company has a separately designated standing Audit Committee established
in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The Audit
Committee charter adopted by the Board sets out the responsibilities, authority and specific duties of the
Audit Committee. The Audit Committee charter
is available on the Company’s website at
www.heritagecommercecorp.com.
The responsibilities of the Audit Committee include the following:
(cid:129) oversight of our financial, accounting and reporting process, our system of internal accounting and
financial controls, and our compliance with related legal and regulatory requirements;
(cid:129) the appointment, compensation, retention and oversight of our independent auditors, including
conducting a review of their independence, reviewing and approving the planned scope of our
annual audit, overseeing the independent auditors’ work, and reviewing and pre-approving any
audit and non-audit services that may be performed by them;
(cid:129) review with management and our independent auditors the effectiveness of our internal controls
over financial reporting;
(cid:129) approve the scope and engagement of external audit services and review significant accounting
policies and adjustments recommended by the independent auditors and address any significant,
unresolved disagreements between the independent auditors and management;
(cid:129) review and discuss the annual audited financial statements with management and the independent
auditors prior to publishing the annual report and filing the Annual Report on Form 10-K with the
SEC;
(cid:129) review and discuss with management and the independent auditors any significant changes,
significant deficiencies and material weaknesses regarding internal controls over financial reporting
required by the Sarbanes-Oxley Act of 2002, and oversee the corrective action taken to mitigate any
significant deficiencies and material weaknesses identified;
(cid:129) review with management and the independent auditors the effect of significant regulatory and
accounting initiatives, changes, and pronouncements as well as significant and unique transactions
and financial relationships;
(cid:129) review with the independent auditors the matters required to be discussed by Auditing Standards
No. 61, and receive and discuss with the independent auditors disclosures regarding the auditors’
independence;
(cid:129) oversee the internal audit function and the audits directed under its auspices;.
(cid:129) establish policies to ensure all non-audit services provided by the independent auditors are
approved prior to work being performed; and
(cid:129) oversee and report to the full Board on the effectiveness of the Company’s risk management
processes and overall risk assessment of the Company’s activities.
Each member of the Audit Committee meets the independence criteria as defined by applicable rules
and regulations of the SEC for audit committee membership and is independent and is ‘‘financially
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sophisticated’’ as defined by the applicable rules and regulations of The NASDAQ Stock Market. The
members of the Audit Committee are Julianne M. Biagini-Komas, Steven L. Hallgrimson (Committee
Chair), and Laura Roden. The Audit Committee met 12 times during 2016.
During 2016, the Board of Directors determined that Mr. Steven L. Hallgrimson has: (i) an
understanding of generally accepted accounting principles and financial statements; (ii) an ability to assess
the general application of such principles in connection with the accounting for estimates, accruals and
reserves; (iii) an experience preparing, auditing, analyzing or evaluating financial statements that present a
breadth and level of complexity of accounting issues that are generally comparable to the breadth and
complexity of issues that can reasonably be expected to be raised by our financial statements, or experience
actively supervising one or more persons engaged in such activities; (iv) an understanding of internal
control over financial reporting; and (v) an understanding of audit committee functions.
Therefore, in 2016 the Board determined that Mr. Hallgrimson meets the definition of ‘‘audit
committee financial expert’’ under the applicable rules and regulations of the SEC and is ‘‘financially
sophisticated’’ as defined by the applicable rules and regulations of The NASDAQ Stock Market. The
designation of a person as an audit committee financial expert does not result in the person being deemed
an expert for any purpose, including under Section 11 of the Securities Act of 1933. The designation does
not impose on the person any duties, obligations or liability greater than those imposed on any other audit
committee member or any other director and does not affect the duties, obligations or liability of any other
member of the Audit Committee or Board of Directors.
The Audit Committee Report for 2016 appears on page 60 of this proxy statement.
Compensation Committee. The Company has a separately designated Compensation Committee,
which consists entirely of independent directors as defined by the applicable rules and regulations of The
NASDAQ Stock Market. The Compensation Committee has adopted a charter, which is available on the
Company’s website at www.heritagecommercecorp.com. The Compensation Committee has the following
responsibilities:
(cid:129) review and approve our compensation philosophy;
(cid:129) review industry compensation practices and our relative compensation positioning;
(cid:129) review the incentive compensation programs by the Company to evaluate and ensure that none of
them encourage excessive risk;
(cid:129) retain compensation consultants to provide independent professional advice;
(cid:129) approve compensation paid to our Chief Executive Officer and other executive officers;
(cid:129) review and approve the Compensation Discussion and Analysis appearing in our proxy statement;
(cid:129) review director compensation programs, plans and awards;
(cid:129) administer our short-term and long-term executive incentive plans and stock or stock-based plans;
and
(cid:129) review and approve general employee welfare benefit plans and other plans on an as needed basis.
The members of the Compensation Committee are Julianne M. Biagini-Komas (Committee Chair),
Frank G. Bisceglia, Robert T. Moles, and Ranson W. Webster. The Committee met 8 times during 2016.
Corporate Governance and Nominating Committee. The Company has a separately designated
Corporate Governance and Nominating Committee, which consists of entirely independent directors as
defined by the applicable rules and regulations of The NASDAQ Stock Market. The Corporate
Governance and Nominating Committee have adopted a charter, which is available on the Company’s
website at www.heritagecommercecorp.com.
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The purposes of the Corporate Governance and Nominating Committee include the following
responsibilities:
(cid:129) identifying individuals qualified to become Board members and making recommendations to the
full Board of candidates for election to the Board;
(cid:129) recommending to the Board corporate governance guidelines;
(cid:129) leading the Board in an annual review of its performance; and
(cid:129) recommending director appointments to Board committees.
The members of the Corporate Governance and Nominating Committee are J. Philip DiNapoli,
Robert T. Moles, and Ranson W. Webster (Committee Chair). The Committee met 5 times during 2016.
Finance and Investment Committee. The Finance and Investment Committee is responsible for the
development of policies and procedures related to liquidity, asset-liability management, and supervision of
the Company’s investments. The Committee also oversees and reviews internal financial reports including
annual forecasts and budgets, and stress test analysis prepared by management. The members of the
Finance and Investment Committee are Frank G. Bisceglia, Jack W. Conner (Committee Chair), Walter T.
Kaczmarek, and Laura Roden. The Finance and Investment Committee met 8 times during 2016.
Strategic Initiatives Committee. The principal duties of the Strategic Initiatives Committee are to
provide oversight and guidance to senior management regarding the strategic direction of the Company,
including development of an overall strategic business plan. The members of the Strategic Initiatives
Committee are Jack W. Conner, J. Philip DiNapoli, Walter T. Kaczmarek, Laura Roden (Committee
Chair), and Ranson W. Webster. The Strategic Initiatives Committee met 4 times during 2016.
Heritage Bank of Commerce Loan Committee. The Heritage Bank of Commerce Loan Committee is
responsible for the approval and supervision of loans and the development of the Company’s loan policies
and procedures. The members of the Loan Committee are Julianne M. Biagini-Komas, Frank G. Bisceglia
(Committee Chair), Steven L. Hallgrimson, Walter T. Kaczmarek, Robert T. Moles, and J. Philip DiNapoli
(alternate). The Loan Committee met 36 times during 2016.
Role of Compensation Consultant
The Compensation Committee of the Board of Directors retained McLagan, an Aon Hewitt Company
(‘‘McLagan’’) as its independent compensation consultant in the first quarter of 2017.
The Compensation Committee has the authority to obtain assistance and advice from advisors to
assist it with the evaluation of compensation matters without the approval or permission of management or
the Board. The Compensation Committee uses advisors to obtain candid and direct advice independent of
management, and takes steps to satisfy this objective. First, in evaluating firms to potentially provided
advisory services to the Compensation Committee, the Compensation Committee considers if the firm
provides any other services to the Company. In addition, while members of management may assist the
Compensation Committee in the search for advisors, the Compensation Committee ultimately and in its
sole discretion makes the decision to hire or engage a consultant and provides direction as to the scope of
work to be conducted. The Chairman of the Compensation Committee has evaluated the relationship of
the compensation consultant with both the Company and the Compensation Committee, including the
nature and amount of work performed for the Compensation Committee during the year. The
Compensation Committee retained McLagan, to:
(cid:129) review existing compensation programs for executive officers;
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(cid:129) provide information based on third-party data and analysis of compensation programs at
comparable financial institutions for the design and implementation of our executive compensation
programs;
(cid:129) assist the Compensation Committee in forming a peer group; and
(cid:129) provide
independent
information as to the reasonableness and appropriateness of the
compensation levels and compensation programs of the Company as compared to comparable
financial services companies.
Executive Officers of the Company
Set forth below is certain information with respect to the executive officers of the Company:
Name
Position
Walter T. Kaczmarek . . . . . . . . . . . . . . . . . . . President and Chief Executive Officer
Keith A. Wilton . . . . . . . . . . . . . . . . . . . . . . Executive Vice President and Chief Operating Officer,
President of Heritage Bank of Commerce
Michael E. Benito . . . . . . . . . . . . . . . . . . . . . Executive Vice President/Banking Division
Lawrence D. McGovern . . . . . . . . . . . . . . . . Executive Vice President and Chief Financial Officer
David E. Porter . . . . . . . . . . . . . . . . . . . . . . . Executive Vice President and Chief Credit Officer
Biographical information for Walter T. Kaczmarek is found under ‘‘Proposal 1—Election of
Directors.’’
Keith A. Wilton, age 59, has served as Executive Vice President and Chief Operating Officer of the
Company and Heritage Bank of Commerce since February 2014. He was promoted to President of
Heritage Bank of Commerce effective April 1, 2017. Prior to joining the Company and Heritage Bank of
Commerce, Mr. Wilton was an Executive Vice President with Pacific Capital Bancorp from 2010 through
2013. Mr. Wilton was a consultant from 2008 to 2010 for several private equity firms assisting with
investment and acquisition opportunities in the financial industry. He was with Greater Bay Bancorp
holding positions of Executive Vice President and President of the Specialty Finance Group from 2002 to
2007. Mr. Wilton has over 30 years’ experience with bank and finance companies.
Michael E. Benito, age 56, has served as Executive Vice President/Banking Division of Heritage Bank
of Commerce since January 2012. Mr. Benito joined Heritage Bank of Commerce in 2003 as Senior Vice
President/Director of Sales & Business Development. From 1998 through 2003, Mr. Benito served as a
Managing Director for Greater Bay Bank and from December 1986 through 1998, he served as Regional
Vice President with Imperial Bancorp. Mr. Benito began his banking career more than 32 years ago at
Union Bank.
Lawrence D. McGovern, age 62, has served as Executive Vice President and Chief Financial Officer
of the Company and Heritage Bank of Commerce since July, 1998.
David E. Porter, age 67, has served as Executive Vice President and Chief Credit Officer of Heritage
Bank of Commerce since June 2012. Prior to joining Heritage Bank of Commerce, Mr. Porter was with
Pacific Capital Bancorp from August 2003 through May 2012, where his last position was Executive Vice
President/Regional Credit Manager (following the company’s recapitalization in August 2010), after
serving four years as Chief Credit Officer. Prior to joining Pacific Capital Bancorp, Mr. Porter had over
30 years of prior banking experience holding positions of increasing responsibility primarily with
community banks.
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Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s directors,
executive officers and persons who own more than 10% of a registered class of the Company’s equity
securities, to file with the SEC initial reports of ownership and reports of changes in ownership of common
stock and other equity securities. They are required by SEC rules and regulations to furnish the Company
with copies of all Section 16(a) forms they file.
To the Company’s knowledge, except as disclosed below, based solely on review of the copies of such
reports furnished to the Company and written representations that no other reports were required, all
Section 16(a) filing requirements applicable to our executive officers and directors were complied with
during the year ended December 31, 2016. J. Philip DiNapoli filed a Form 5 in February 2017 to correct an
inadvertent error on his initial Form 3 filed in 2015.
Transactions with Management
Some of the Company’s directors and executive officers, as well as other related persons (as defined
under ‘‘Policies and Procedures for Approving Related Party Transactions’’ below), are customers of, and
have banking transactions with, the Company’s subsidiary, Heritage Bank of Commerce, in the ordinary
course of business, and Heritage Bank of Commerce expects to have such ordinary banking transactions
with these persons in the future. In the opinion of the management of the Company and Heritage Bank of
Commerce, all loans and commitments to lend included in such transactions were made in the ordinary
course of business, on substantially the same terms, including interest rates and collateral, as those
prevailing for comparable transactions with other persons of similar creditworthiness, and do not involve
more than the normal risk of collectability or present other unfavorable features. Loans to individual
directors, officers and related persons must comply with Heritage Bank of Commerce’s lending policies
and statutory lending limits. In addition, prior approval of Heritage Bank of Commerce’s Board of
Directors is required for all loans advanced to directors and executive officers. These loans are exempt
from the loan prohibitions of the Sarbanes-Oxley Act.
In 2013, Heritage Bank of Commerce entered into an arms-length 5-year lease for office space in
Sunnyvale, California with Sunnyvale Village Associates, a California general partnership. One of the
general partners is the father of director Julianne M. Biagini-Komas. Heritage Bank of Commerce entered
into the lease prior to Ms. Biagini-Komas joining the Board of Directors in August 2015. Heritage Bank of
Commerce paid $147,632 in rent to the partnership in 2016.
Policies and Procedures for Approving Related Party Transactions
The Board of Directors has adopted a written Statement of Policy with Respect to Related Party
Transactions. Under this policy, any ‘‘related party transaction’’ may be consummated or may continue
only if the Audit Committee approves or ratifies the transaction in accordance with the guidelines in the
policy and if the transaction is on terms comparable to those that could be obtained in arm’s length
dealings with an unrelated third party. For purposes of this policy, a ‘‘related person’’ means: (i) any person
who is, or at any time since the beginning of the Company’s last fiscal year was, a director or executive
officer of the Company or a nominee to become a director of the Company; (ii) any person who is known
to be the beneficial owner of more than 5% of any class of the Company’s voting securities; (iii) any
immediate family member of any of the foregoing persons, which means any child, stepchild, parent,
stepparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or
sister-in-law of the director, executive officer, nominee or more than 5% beneficial owner, and any person
(other than a tenant or employee) sharing the household of such director, executive officer, nominee or
more than 5% beneficial owner; and (iv) any firm, corporation or other entity in which any of the foregoing
persons is employed or is a partner, principal or in a similar position, or in which such person has a 10% or
greater beneficial ownership interest.
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A ‘‘related party transaction’’ is a transaction in which the Company or any of its subsidiaries is a
participant and in which a related person had or will have a direct or indirect interest, other than
transactions involving: (i) less than $5,000 when aggregated with all similar transactions; (ii) customary
bank deposits and accounts (including certificates of deposit); and (iii) loans and commitments to lend
included in such transactions that are made in the ordinary course of business on substantially the same
terms, including interest rates and collateral, as those prevailing for comparable transactions with other
persons of similar creditworthiness, and do not involve more than the normal risk of collectability or
present other unfavorable features to the Company.
A related party who has a position or relationship with a firm, corporation, or other entity that
engaged in a transaction with the Company shall not be deemed to have an indirect material interest within
the meaning of this policy where the interest in the transaction arises only: (i) from such related party’s
position as a director of another corporation or organization that is party to the transaction; (ii) from the
direct or indirect ownership by the related party of less than a 10% equity interest in another person (other
than a partnership) which is a party to the transaction; or (iii) from the related party’s position as a limited
partner in a partnership in which the related party has an interest of less than 10%, and the related party is
not a general partner of and does not hold another position in the partnership.
The Board of Directors has determined that the Audit Committee is best suited to review and approve
related party transactions. The Committee considers all of the relevant facts and circumstances available to
the Committee, including (if applicable) but not limited to: (i) the benefits to the Company; (ii) the impact
on a director’s independence in the event the related person is a director, an immediate family member of
a director or an entity in which a director is a partner, shareholder or executive officer; (iii) the availability
of other sources for comparable products or services; (iv) the terms of the transaction; and (v) the terms
available to unrelated third parties or to employees generally. No member of the Audit Committee may
participate in any review, consideration or approval of any related person transaction with respect to which
such member or any of his or her immediate family members is the related person. The Committee will
approve only those related person transactions that are in, or are not inconsistent with, the best interests of
the Company and its shareholders, as the Committee determines in good faith. The Audit Committee
conveys its decision to the Chief Executive Officer, who conveys the decision to the appropriate persons
within the Company.
During 2016, the Company did not enter into any related party transactions that require review,
approval or ratification under our related party transaction policy.
Compensation Discussion and Analysis
This Compensation Discussion and Analysis identifies the Company’s current compensation
philosophy and objectives and describes the various methodologies, policies and practices for establishing
and administering the compensation programs for our executives including the named executive officers.
The strategies and policies of the Compensation Committee have been developed so that there is a direct
correlation between executive compensation and the Company’s overall performance and individual
performance. The individuals who served as the Company’s Chief Executive Officer and Chief Financial
Officer during 2016, as well as, the other individuals included in the Summary Compensation Table, are
referred to as the ‘‘named executive officers.’’
Overview of Compensation Philosophy
The Compensation Committee believes executive compensation packages provided by the Company
to its executives, including the named executive officers, should include base salary, variable performance
based cash awards and equity based compensation in order to achieve three primary goals.
The Compensation Committee believes that the first goal of our compensation program is that a
reasonable percentage of executive compensation program should be linked to the financial performance
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of the Company. The Compensation Committee believes that a properly structured compensation program
will focus on performance to motivate and support individuals to achieve specific short-term and long-term
objectives while taking into consideration potential risk implications. We achieve this goal by providing our
named executive officers the opportunity to significantly increase their annual cash compensation through
our variable performance based cash award incentive plan. The plan awards improvement in the
Company’s performance in key financial metrics on an annual basis. We also expect that as those
improvements are maintained and built upon, they will be reflected in the Company’s stock price.
The second goal of our compensation program is to align the interests of our executive officers with
the interests of our shareholders. We use equity awards (stock options and/or restricted stock) to reward
the long-term efforts of management and to retain management. These equity awards serve to increase the
ownership stake of our management in the Company, further aligning the interests of the executives with
those of our shareholders.
The third goal of our compensation program is to attract and retain highly competent executives. Our
executives, and particularly our named executive officers, are talented managers and they are often
presented with opportunities at other institutions, including opportunities at potentially higher
compensation levels. We seek to attract and retain our executives by setting base compensation and
incentives at competitive levels and awarding equity based awards. We also consider other forms of
executive pay, including severance arrangements (including change of control provisions) as a means to
attract and retain our executive officers including the named executive officers.
Compensation Program Objectives and Rewards
The components of Company’s compensation and benefits programs are driven by our business
environment and are designed to enable us to achieve the goals of our compensation program within a
framework that adheres to the Company’s mission and values. The programs’ objectives are to:
(cid:129) Reflect our position as a leading community bank in our service areas;
(cid:129) Attract, engage and retain the workforce that helps ensure our future success;
(cid:129) Motivate and inspire employee behavior that fosters a high performance culture;
(cid:129) Support a one company culture;
(cid:129) Support overall business objectives;
(cid:129) Provide shareholders with a superior rate of return over the long term; and
(cid:129) Create shareholder value through the continuous provision of quality service to our customers.
Consequently, the guiding principles of our programs are to:
(cid:129) Promote and maintain a high performance banking organization;
(cid:129) Remain competitive in our marketplace for talent;
(cid:129) Balance our compensation costs with our desire to provide value to employees and shareholders;
and
(cid:129) Avoid encouraging excessive risk taking.
To this end, we will measure success of our programs by:
(cid:129) Overall business performance and employee engagement;
(cid:129) Ability to attract and retain key talent;
(cid:129) Costs and business risks that are limited to levels that optimize risk and return; and
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(cid:129) Employee understanding and perceptions that ensure program value equals or exceeds program
cost.
All of our compensation and benefits for our named executive officers described below have as a
primary purpose our need to attract, retain and motivate the highly talented individuals whose
performance will enable us to succeed in creating shareholder value in a highly competitive marketplace.
Beyond that, different elements have specific purposes designed to reward different performance and
retention goals.
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(cid:129) Reward core competence in the executive role relative to position, performance, experience
and responsibility;
(cid:129) Provide fixed cash compensation with merit increases competitive with the market place; and
(cid:129) Control fixed expenses.
(cid:129) Annual incentive variable cash awards are designed to:
(cid:129) Focus employees on annual financial objectives derived from the business plan that lead to
long-term success;
(cid:129) Provide annual variable performance based cash awards to reward and motivate achievement
of critical annual performance metrics selected by the Compensation Committee; and
(cid:129) Foster a pay for performance culture that aligns our compensation programs with our overall
business and strategic strategy.
(cid:129) Equity based compensation awards are designed to:
(cid:129) Link compensation rewards to the creation of shareholder wealth;
(cid:129) Promote teamwork by tying compensation significantly to the value of our common stock;
(cid:129) Attract the next generation of management by providing significant capital accumulation
opportunities; and
(cid:129) Retain executives by providing a long-term-oriented program whose value could only be
achieved by remaining with and performing for the Company.
(cid:129) Change of control and separation benefits:
(cid:129) Individual employment contracts with certain executives provide for change of control and
separation benefits;
(cid:129) Separation benefits provide benefits to ease an employee’s transition due to an unexpected
employment termination by the Company due to ongoing changes in the Company’s
employment needs; and
(cid:129) Change in control benefits encourage key executives to remain focused on the Company’s
business in the event of rumored or actual fundamental corporate changes which will enhance
shareholder value.
(cid:129) Manage excessive risk-taking through plan design and oversight of incentive plans:
(cid:129) Incentive awards are capped;
(cid:129) Performance objectives are aligned with annual financial plan approval by the Board of
Directors;
(cid:129) Multiple financial metrics are used taking into account performance and risk;
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(cid:129) A ‘‘claw-back policy’’ is applied to performance based cash payments;
(cid:129) Payouts are modified through the use of risk-based capital ratio metrics;
(cid:129) Long-term incentive equity awards are deferred through vesting requirements; and
(cid:129) The Compensation Committee has discretion to reduce cash bonus payments.
The use of
to reinforce our
these compensation programs and benefits enables us
pay-for-performance philosophy, align our executives’ interests with shareholders, and strengthen our
ability to attract, retain and motivate highly qualified executives. We believe that this combination of
programs provides an appropriate mix of fixed and variable pay, balances short-term operational
performance with long-term shareholder value, and encourages executive recruitment and retention.
Consideration of Say-On-Pay Vote Results
At our 2012 Annual Shareholders Meeting, the shareholders approved a non-binding shareholder
advisory proposal to hold say-on-pay proposals every three years. The Company’s Board of Directors at
that time agreed that holding say-on-pay proposals every three years was in the best interest of
shareholders. At the time the Board believed that three years provides shareholders with sufficient time to
evaluate the effectiveness of our overall compensation philosophy, policies and practices in the context of
our long-term business results for the corresponding period, while avoiding over emphasis on short term
variations in compensation and business results. The Compensation Committee has been mindful of the
strong support our shareholders expressed for our compensation program when making executive
compensation decisions, including base salary adjustments and long-term incentive awards. In making
these executive compensation decisions, which are discussed more fully below, the Compensation
Committee’s main considerations included our shareholders’ support for our executive compensation
program, and the peer and market information provided by the Compensation Committee’s compensation
consultant. The Compensation Committee will continue to consider our shareholders’ views when making
executive compensation decisions in the future.
The last time we held a non-binding shareholder advisory vote on executive compensation was at the
2015 Annual Meeting. At that meeting our shareholders approved our 2015 executive compensation (as
they had in each prior year where we had a say-on-pay vote), with approximately 98% of voting
shareholders casting their vote in favor of the say-on-pay resolution.
Role of Compensation Committee in Determining Compensation
The Compensation Committee of the Board of Directors has strategic and oversight responsibility for
the overall compensation and benefits programs for executives of the Company. These responsibilities
include establishing, implementing, and continually monitoring the compensation structure, policies, and
programs of the Company. The Compensation Committee also periodically reviews, assesses and monitors
the performance, and regularly reviews the design and function, of the Company’s incentive compensation
arrangements to ensure that any risk-taking incentives are consistent with regulatory guidance and the
safety and soundness of the organization. The Compensation Committee is responsible for assessing and
approving the total compensation paid to the Chief Executive Officer and all executive officers. The
Compensation Committee is responsible for determining whether the compensation paid to each of these
executives is fair, reasonable and competitive, and whether the compensation program serves the interests
of the Company’s shareholders.
The Compensation Committee generally targets compensation in relation to the Company’s
Compensation Peer Group (discussed under ‘‘Market Positioning and Pay Benchmarking’’). Base salary is
targeted at the 60th percentile, total cash (salary and incentive cash awards) is targeted at the
70th percentile, and total direct compensation (total cash plus the three-year average value of equity
awards) is targeted at the 75th percentile. We target above the median because of the competition in our
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market for talented executives and our desire to attract and, more importantly, retain and motivate
talented individuals we believe are necessary to achieve the goals and objectives of our Board of Directors.
The Compensation Committee is comprised of four independent directors who satisfy The NASDAQ
Stock Market listing requirements and relevant Internal Revenue Service and SEC regulations on
independence. The Compensation Committee’s Chair regularly reports to the Board of Directors on the
Compensation Committee actions and recommendations. To evaluate and administer the compensation
practices of the Chief Executive Officer and other executive officers, the Compensation Committee meets
a minimum of four times a year. The Compensation Committee also holds special meetings and meets
telephonically to discuss extraordinary items, such as the hiring or dismissal of executive officers.
Role of the Chief Executive Officer
The Chief Executive Officer is not a member of the Compensation Committee, but is invited to attend
meetings as necessary to provide input and recommendations on compensation for the other named
executive officers. The Chief Executive Officer provides the Compensation Committee with his assessment
of the performance of each named executive officer and his perspective on the factors described above in
developing his recommendations for the executive’s compensation, including salary adjustments, incentive
bonuses, annual equity grants and equity grants awarded in conjunction with promotions. Because the
Chief Executive Officer works closely with and supervises our executive team, the Compensation
Committee believes that the Chief Executive Officer provides valuable insight in evaluating their
performance. The Chief Executive Officer also provides the Compensation Committee with additional
information regarding the effect, if any, of market competition and changes in business strategy or
priorities. The Compensation Committee discusses the Chief Executive Officer’s recommendations and
then approves or modifies the recommendations in collaboration with the Chief Executive Officer.
Role of Compensation Consultants
Generally, at least every two years the Compensation Committee retains the services of an
independent executive compensation consultant to assess the competitiveness of our compensation
programs, conduct other research as directed by the Compensation Committee, and support the
Compensation Committee in the design and implementation of executive and Board of Director
compensation. In the fourth quarter of 2016, the Compensation Committee retained McLagan, an Aon
Hemitt Company (‘‘McLagan’’) to: (i) review existing compensation programs; (ii) provide market
benchmark information pertaining to both cash and noncash compensation for executives; (iii) provide
recommendations and guidance to the Compensation Committee to support its oversight over such
compensation programs; and (iv) provide other advice and consultation, including guidance relative to
evolving compensation-related regulatory requirements and industry best practices. McLagan reported
directly to the Compensation Committee and did not provide services to, or on behalf of, any other part of
the Company’s business. There are no known conflicts of interests between McLagan and the Company.
Market Positioning and Pay Benchmarking
The Compensation Committee generally aims to position compensation relative to market for the
Chief Executive Officer and the other named executive officers at the 60th percentile for base salary,
70th percentile for total cash compensation and 75th percentile for total direct compensation. Many
factors are taken into account in determining the actual positioning of each executive officer’s
compensation, including the executive’s experience, responsibilities, management abilities and job
performance, overall performance of the Company, current market conditions and competitive pay for
similar positions at comparable companies. In addition, the Compensation Committee reviews the
relationship of various positions between departments, the affordability of desired pay levels and the
importance of each position within the Company. These factors are considered by the Compensation
Committee in a subjective manner without any specific formula or weighting.
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In the first quarter of 2015, McLagan provided its report (‘‘2015 Report’’) and the Compensation
Committee undertook a review of the Company’s compensation programs for executive officers. The 2015
Report was reviewed and considered for compensation decisions in make for 2016. McLagan, in
consultation with the Compensation Committee, selected a custom peer group of financial institutions to
establish a ‘‘Compensation Peer Group’’ for the 2015 Report. The companies included in the
Compensation Peer Group were selected from publicly traded banks in California, Oregon and
Washington based on: (i) compatibility of the bank based on size as measured through total assets between
$900 million and $3.5 billion (median of $1.3 billion); (ii) similarity of their product lines and business
focus; and (iii) comparable performance criteria relating to return on annual assets and nonperforming
assets. In addition to the Compensation Peer Group, McLagan’s primary data sources also included its
proprietary regional and community banking database and published industry survey data for national and
California banks. McLagan adjusted national survey data for regional salary differentials, and also to
reflect higher costs of salaries in the Company’s principal market.
The Comparative Peer Group and the comparative survey data were used to benchmark executive
compensation levels against banks that have executive positions with responsibilities similar in breadth and
scope to ours and that compete with us for executive talent. With such information and recognition that
the public company data reflected compensation levels for 2014 and estimated levels for 2015, the
Compensation Committee reviewed and analyzed compensation for the Chief Executive Officer and the
other named executive officers for the 2016 compensation program.
The Compensation Peer Group component companies used in the evaluation of the Company’s
executive compensation programs in the 2015 Report for executive officers were as follows:
Bank of Marin Bancorp
Bridge Capital Holdings*
Farmers & Merchants Bancorp
Heritage Oaks Bancorp*
CU Bancorp
Preferred Bank
Pacific Premier Bancorp
Provident Financial Holdings
Sierra Bancorp
TriCo Bancshares
Bank of Commerce Holdings
HomeStreet Inc.
Pacific Continental Corp.
Heritage Financial Corp.
Central Valley Community Bancorp
First Foundation Inc.
FNB Bancorp
First Northern Community Bancorp
*
Since acquired by another financial institution.
In the fourth quarter of 2016, the Committee again engaged McLagan to provide a report for the
Committee’s review and consideration (‘‘2017 Report’’) the Compensation Committee undertook a review
of the Company’s compensation programs for executive officers. McLagan, in consultation with the
Compensation Committee, selected a custom peer group of financial institutions to establish a
‘‘Compensation Peer Group’’ for the 2017 Report. The companies included in the Compensation Peer
Group were selected from publicly traded banks in California, Oregon and Washington based on:
(i) compatibility of the bank based on size as measured through total assets between $1.1 billion and
$5.0 billion (median of $2.6 billion); (ii) similarity of their product lines and business focus; and
(iii) comparable performance criteria relating to nonperforming assets (less than 4% of assets). In addition
to the Compensation Peer Group, McLagan’s primary data sources also included its proprietary regional
and community banking database and published industry survey data for national and California banks.
The American Bankers Association (ABA) Compensation and benefits survey was also reviewed by
McLagan. Compensation Peer Group and proprietary survey data represented actual 2015 compensation
information. The ABA data represented actual 2014 compensation information, adjusted to 2015 at an
24
annual rate of 3%. McLagan adjusted national survey data upwards by 27.4% for regional salary
differentials, and also to reflect higher costs of salaries in the Company’s principal market.
The Comparative Peer Group and the comparative survey data were used to benchmark executive
compensation levels against banks that have executive positions with responsibilities similar in breadth and
scope to ours and that compete with us for executive talent. The Compensation Committee reviewed and
analyzed compensation for the Chief Executive Officer and the other named executive officers for the 2017
Compensation Program.
The Compensation Peer Group component companies used in the evaluation of the Company’s
executive compensation programs in the 2017 Report for executive officers were as follows:
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Bank of Marin Bancorp
Farmers & Merchants Bancorp
Heritage Oaks Bancorp*
CU Bancorp
Preferred Bank
Pacific Premier Bancorp
Provident Financial Holdings
Sierra Bancorp
TriCo Bancshares
Bank of Commerce Holdings
Pacific Continental Corp.
Heritage Financial Corp.
Central Valley Community Bancorp
First Foundation Inc.
FNB Bancorp
First Northern Community Bancorp
Hanmi Financial Corp
Cascade Bancorp
*
Since acquired by another financial institution.
Chief Executive Officer Compensation
typically considers corporate financial performance,
The Compensation Committee meets with the other independent directors each year in an executive
session without management present to evaluate the performance of the Chief Executive Officer. The
Compensation Committee also confers with the Chief Executive Officer when setting his base salary. The
Chief Executive Officer does not participate in any deliberations regarding his own compensation. The
Compensation Committee annually reviews and approves goals and objectives relevant to the Chief
Executive Officer and evaluates the Chief Executive’s performance against those objectives. The
Compensation Committee
the Company’s
achievement of its short and long-term goals versus its strategic objectives and financial targets. With the
assistance of the compensation consultant, the Compensation Committee also considers the compensation
data related to the Compensation Peer Group for base pay, total cash compensation, and total direct
compensation. The Compensation Committee approves the Chief Executive Officer’s compensation level
based on its evaluation. In 2016, the Compensation Committee approved a salary increase to $440,000. In
its review the Committee believes that the CEO’s performance has been exemplary and that his leadership
and management have been critical to the continual improvement and success of the Company. The 2017
Report concluded that the CEO base salary in 2016 was 18% below the 60th percentile, his total cash
compensation was 27th percent below the 70th percentile and his direct compensation was 51% below the
75th percentile. The Committee in its review of the 2017 Report approved an increase in the CEO base
salary to $480,000. Although this will bring the CEO’s base salary to approximately 10% below the
60th percentile based on the 2017 report, the Committee anticipates a gradual increase in the next and
following years to reach the 60% target.
25
Base Salary Decisions for the Other Named Executive Officers
Generally the Compensation Committee believes that executive base salaries should be targeted so as
not to be substantially below the 60th percentile of the Compensation Peer Group for executives in similar
positions with similar responsibilities. Base salaries are reviewed annually and adjusted as necessary to
realign them with market levels after taking into account the value of the position in the marketplace,
career experience, and the contribution and performance of the individual. Although each of the named
executive officers has an employment agreement with the Company, the initial base salary in each of the
agreements may be increased (and has been in the past) in accordance with the Chief Executive Officer’s
evaluation of the executive’s performance and the Compensation Committee’s evaluation of the
Company’s overall compensation programs and policies.
In 2016, the Compensation Committee considered the pay practices of the Compensation Peer Group
and the analyses and recommendations provided by its independent consultant in the 2015 Report. In the
evaluation of base salaries for 2016 for the named executive officers, the Compensation Committee also
considered the minimum, mid-range and maximum salaries paid to similarly situated positions at
companies in the Compensation Peer Group as well as the performance levels of the named executive
officers. As a result of its review the Compensation Committee made the following changes to the base
salary of the named executive officers effective April 1, 2016:
Named Executive
2015 Salary
2016 Salary
Walter T. Kaczmarek . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lawrence D. McGovern . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Michael E. Benito . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
David E. Porter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Keith A. Wilton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$421,212
$274,574
$255,852
$271,843
$308,000
$440,000
$285,574
$265,852
$281,843
$323,000
*
Based on the McLagan 2017 Report for Compensation Peer Group salaries for 2016.
2016 Salary
Variance to
60th Percentile*
18% below
2% above
6% above
10% above
1% above
At its March 2017 meeting, the Committee approved the following salary increases after consideration
of the performance of the Company in 2016 and the information provided in the 2017 Report:
Named Executive
Walter T. Kaczmarek . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lawrence D. McGovern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Michael E. Benito . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
David E. Porter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Keith A. Wilton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2017 Salary
$480,000
$296,574
$273,852
$290,843
$348,000
Base salary drives the formula used in the Management Incentive Plan as discussed below under
‘‘Management Incentive Plan.’’ Base salary is the only element of compensation that is used in determining
the amount of contributions permitted under the Company’s 401(k) plan.
Management Incentive Plan
We believe that a portion of the annual incentive compensation for named executive officers should
be based on performance against pre-defined financial metrics and performance objectives. The
Company’s Management Incentive Plan (‘‘Incentive Plan’’) plays a key role in fulfilling the objective. In
2016, each of our named executive officers was eligible to receive a bonus under the Incentive Plan.
Annual performance bonuses are designed to focus participants on, and reward them for, the achievement
of specific annual financial, strategic and/or operational objectives of the Company. The incentive levels
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(as a percent of salary) are designed to provide for the achievement of threshold, target and maximum
performance objectives. The financial metrics, performance objectives, and the formula for computing the
performance bonus are established by the Compensation Committee in the first quarter of each fiscal year.
The award opportunities under the Incentive Plan were derived in part from our Compensation Peer
Group and other comparative data provided by our independent consultant, and in part by the
Compensation Committee’s judgment on internal equity of the positions, their relative value to the
Company and the desire to maintain a consistent annual incentive target for the Chief Executive Officer
and the other named executive officers.
The payouts for executives under the Incentive Plan are targeted to provide aggregate cash
compensation together with base salary at the 70th percentile of our Compensation Peer Group when we
reach our target annual financial performance (‘‘Target’’). Smaller payouts can be awarded if we reach
90% to 95% of our target performance (‘‘Threshold’’). Larger payouts can be awarded if we achieve 105%
to 110% of target performance (‘‘Maximum’’). Payouts generally are not calculated by mathematical
interpolation (on a continuous scale), therefore an incentive level must be reached or exceeded for a cash
award.
The incentive levels assigned as a percentage of base salary for 2016 were as follows:
Named Executive
As a percent of
base salary
Threshold
Target Maximum
Walter T. Kaczmarek . . . . . . . . . . . . . . . . . . . . . . . . . .
Lawrence D. McGovern . . . . . . . . . . . . . . . . . . . . . . .
Michael E. Benito . . . . . . . . . . . . . . . . . . . . . . . . . . . .
David E. Porter . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Keith A. Wilton . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10%
10%
10%
10%
10%
45%
40%
40%
40%
40%
60%
60%
60%
60%
60%
Management recommends, and the Compensation Committee reviews and approves, the financial
metrics for each plan year that must be met in order for awards to be paid. These financial metrics are
weighted and are intended to motivate and reward eligible executives to strive for continued financial
improvement of the Company, consistent with performance based compensation and increasing
shareholder value. The Compensation Committee typically identifies from three to six financial metrics
which may be revised from year to year to reflect the Company’s business and strategic goals. The
Compensation Committee determines the weighting of financial metrics each year based upon
recommendations from the Chief Executive Officer. For 2016, the following financial metrics along with
the relative weights of each financial metric were established by the Compensation Committee:
Financial Metrics
Pre-Tax Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonperforming Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loan Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deposit Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weight
20%
15%
20%
15%
15%
15%
The Compensation Committee believes pre-tax income is a valid measurement in assessing how the
Company is performing from a financial standpoint. Pre-tax income is an accepted accounting measures
that drives earnings per share and shareholder returns over the long term. Noninterest income and
noninterest expense are important components of net income that senior management and the Board of
Directors sought to improve upon in 2016. In addition, the Compensation Committee, in consultation with
the Chief Executive Officer, concluded that management should continue its focus on credit quality and
loan and deposit growth. Financial metrics for noninterest income and noninterest expense are financial
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metrics that drive overall net income. The Compensation Committee believes that nonperforming assets
are an effective measure to monitor the Company’s progress in improving its credit quality. Further, in
view of the Company’s plans to continue its focus on growth, the Compensation Committee sought to
incentivize and measure growth by increases in outstanding loans and deposits.
The Compensation Committee did not realign the weighting of the mix of the financial metrics in 2016
from 2015. Because the Compensation Committee believed that the Incentive Plan should also balance
risk-taking with performance, the Compensation Committee maintained a risk-based capital element to
the plan. If the total risk-based capital ratio was below 10% at year-end 2016, bonus payments would be
reduced to zero.
Performance objectives were generally identified through our annual financial planning and budget
process. Senior management developed a financial plan for 2016, and the financial plan was reviewed and
approved by the Board of Directors. The Compensation Committee received recommendations from
senior management for financial performance objective ranges. In making the determination of the
Threshold, Target and Maximum levels, the Compensation Committee considered specific circumstances
anticipated to be encountered by the Company during the coming year and the level of improvement from
year-to-year required to achieve the performance of levels. The Compensation Committee believed that
the Threshold, Target and Maximum levels established for the Incentive Plan in 2016 were sufficiently
challenging given the economic climate and the level of growth and improvement in the various financial
metrics that would have to occur to meet the various performance objectives.
For 2016, performance was assessed relative to performances for the year ended December 31, 2016,
as shown below and compared to actual results:
Financial Metrics
Threshold
(90% of Plan)
Target
(Plan)
Pre-Tax Income . . . . . . . . . . . . . . .
Nonperforming Assets . . . . . . . . . .
Loans Outstanding(1) . . . . . . . . . .
Noninterest Income(2) . . . . . . . . . .
Noninterest Expense(3) . . . . . . . . .
Deposits Outstanding(4) . . . . . . . .
38,376,000
$
$
14,300,000
$1,422,718,000
$
8,622,000
60,698,000
$
$1,959,936,000
42,640,000
$
$
13,000,000
$1,497,598,000
$
9,580,000
59,198,000
$
$2,063,091,000
Maximum
(110% of Plan)
46,904,000
$
$
11,700,000
$1,572,478,000
$
10,538,000
57,698,000
$
$2,166,246,000
2016 Actual
43,969,000
$
$
3,288,000
$1,397,728,000
$
9,407,000
57,639,000
$
$2,167,659,000
(1) Threshold and Maximum at 95% and 105% of plan. Includes Bayview factored accounts receivable,
but excludes loan portfolios purchased during 2016 and loans held-for-sale.
(2) Excluding securities gains and losses.
(3) 90% and 110% of plan not used. A $1.5 million differential below and over Target was used for
Threshold and Maximum.
(4) Threshold and Maximum at 95% and 105% of plan. Excludes Brokered Deposits, CDARS and State
CDs.
During the first quarter of the following fiscal year, the Compensation Committee assesses the
performance of the Company for each financial metric comparing the actual fiscal year results to the
pre-determined performance objectives for each financial metric calculated with reference to the
pre-determined weight accorded the financial metric, and an overall percentage amount for the award is
calculated. In addition, the Compensation Committee has discretionary authority to include qualitative
subjective measures which may increase or decrease an award by an additional 15% of base salary. The
positive discretion may be utilized to address completion of special projects, department initiatives, or
favorable achievements reflected in regulatory exam results. The Compensation Committee may also use
its discretion in adjusting financial metrics and performance objectives for unexpected economic
conditions or changes in the business of the Company.
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In 2016, the Company reached the ‘‘Maximum’’ for Nonperforming Assets, Noninterest Expense, and
Deposits Outstanding, ‘‘Target’’ for Pre-Tax Income, and ‘‘Threshold’’ for Noninterest Income. After
consideration of these performance levels for 2016, the Committee awarded the following bonuses which
were paid in the first quarter of 2017:
Named Executive
Walter Kaczmarek . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Larry McGovern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Michael Benito . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
David Porter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Keith A. Wilton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bonus
Award
$163,238
$103,231
$ 96,123
$101,960
$116,526
Percentage
of 2016
Base Salary
37.5%
36.5%
36.5%
36.5%
36.5%
Equity Based Compensation
The Compensation Committee believes that equity based compensation should be a significant
component of total executive compensation to align executive compensation with the long-term
performance of the Company and to encourage executives to make value enhancing decisions for the
benefit of our shareholders. Each of the named executive officers is eligible to receive equity
compensation. The Compensation Committee is responsible for determining equity grants to all staff
members, including named executive officers. The Compensation Committee may also grant equity-based
awards to award performance, coincide with promotions and hirings, and for recruiting and retention
purposes.
In considering whether to grant an equity award and the size of the grants to be awarded, the
Compensation Committee considers, with respect to each executive officer, the salary level, the
contributions expected toward the growth and profitability of the Company and, to the extent available,
survey data indicating grants made to similarly situated officers at comparable financial institutions. The
Compensation Committee decides whether to approve the grant of equity awards, and the terms of such
grant, after deliberation in executive session with respect to grants to the Chief Executive Officer, and after
discussion with the Chief Executive Officer, with respect to grants to other executive officers.
The Company’s Amended and Restated 2004 Equity Plan (the ‘‘2004 Plan’’) provided for the grant of
non-qualified and incentive stock options, and restricted stock. In 2013, the Board of Directors and
shareholders approved the 2013 Equity Incentive Plan (the ‘‘2013 Plan’’) and the 2004 Plan was
terminated. Stock options and restricted stock awards issued under the 2004 Plan remain outstanding. The
Compensation Committee approved all awards under the 2004 Plan and continues to do so under the 2013
Plan. The Compensation Committee is the administrator of the 2004 and 2013 Plans.
Stock options provide for financial gain derived from the potential appreciation in stock price from
the date that the option is granted until the date that the option is exercised. The exercise price of stock
option grants is set at fair market value on the grant date. We do not grant stock options at a discount to
fair market value or reduce the exercise price of outstanding stock options except in the case of a stock
split or other similar event. We do not grant stock options with a so-called ‘‘reload’’ feature, nor do we loan
funds to employees to enable them to exercise stock options. The Board has also never re-priced stock
options. Stock options granted to date generally vest pro rata on a daily basis over four years and expire ten
years from the grant date, and vesting accelerates on a change of control. Our long-term performance
ultimately determines the value of stock options, because gains from stock option exercises are entirely
dependent on the long-term appreciation of our stock price.
In addition to stock options, both the 2004 and 2013 Plans authorize the issuance of restricted stock.
An award of restricted stock involves the immediate transfer by the Company to a participant of ownership
of a specific number of shares of common stock. The restricted stock is valued at its fair market value on
29
the date of grant. Restricted stock is subject to a ‘‘substantial risk of forfeiture’’ within the meaning of
Section 83 of the Internal Revenue Code of 1986, as amended. To date, the Compensation Committee has
chosen to grant time-based restricted stock awards. Restricted stock awarded by the Compensation
Committee have vesting periods that vary, and vesting accelerates on a change of control of the Company,
or the holder’s death or disability.
The Compensation Committee has established a stock option and restricted stock policy which
recognizes that stock options and restricted stock have an impact on the profits of the Company under
current accounting rules and also have a dilutive effect on the Company’s shareholders. Accordingly, they
are recognized as a scarce resource and option grants and awards of restricted stock are given the same
consideration as any other form of compensation. The Compensation Committee has established ranges
for the amount of options that may be granted that depend on the individual’s position with the Company
and whether the option is awarded as an incentive to attract an individual, to retain an individual or to
reward performance. The Compensation Committee approves primarily nonstatutory stock options instead
of incentive stock options because of the tax advantages available to the Company for nonstatutory options
and because employees generally do not take full advantage of the tax benefits available to them from
incentive stock options.
We do not backdate options or grant options or award restricted stock retroactively. In addition, we
do not plan to coordinate grants of options or awards of restricted stock so that they are made before
announcement of favorable information, or after announcement of unfavorable information. The
Company’s options and restricted stock are granted at fair market value on a fixed date or event (the first
day of service for new hires and the date of Compensation Committee approval for existing employees),
with all required approvals obtained in advance of or on the actual grant date. All grants to executive
officers require the approval of the Compensation Committee and the Board of Directors. Fair market
value has been consistently determined as the closing price on The Nasdaq Global Select Market on the
grant date. In order to ensure that an option exercise price or restricted stock date of grant valuation fairly
reflects all material information, without regard to whether the information seems positive or negative,
every grant of options and restricted stock is contingent upon an assurance by management and legal
counsel that the Company is not in possession of material undisclosed information. If the Company is in a
‘‘black-out’’ period for trading under its trading policy or otherwise in possession of inside information, the
date of grant is suspended until the second business day after public dissemination of the information.
The Company’s general practice has been to grant options and restricted stock only on the annual
grant date at a Compensation Committee and Board of Directors’ regular meeting held during the first
quarter for the named executive officers as well as current staff, and at any other Compensation
Committee meeting (whether a regular meeting or otherwise) held on the same date as a regularly
scheduled Board meeting (which are held monthly) as required to attract new staff, retain staff or
recognize key specific achievements.
Based on the 2015 Report, the Chief Executive Officer and the other named executive officers
received total direct compensation below the 75th percentile in 2015.
The following awards of restricted stock were granted in 2016:
Named Executive
Walter T. Kaczmarek . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lawrence D. McGovern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Michael E. Benito . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
David E. Porter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Keith A. Wilton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Restricted
Shares
15,000
8,200
7,500
8,000
9,000
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According to the 2017 Report, the Company’s direct compensation for 2016 was on average 12%
above the median but 14% below the targeted 75th percentile. In response and in connection with its
annual consideration of the grant of equity awards the Committee approved the following restricted stock
awards for 2017 which were issued in the first quarter of 2017:
Named Executive
Walter T. Kaczmarek . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lawrence D. McGovern . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Michael E. Benito . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
David E. Porter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Keith A. Wilton . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Restricted
Shares
15,000
9,000
6,000
8,000
12,000
Retirement Plans
Our Amended and Restated Supplemental Retirement Plan (‘‘SERP’’) is an element of our
compensation program offered to certain executive officers. These types of plans have been commonly
offered in the community bank industry for some time. The SERP is a nonqualified defined benefit plan
and is unsecured and unfunded and there are no plan assets. When the Company offers key employees
participation in the SERP, including some but not all of the named executive officers, the supplemental
retirement benefit awarded is based on the individual’s position within the Company and a vesting
schedule determined by the desirability of incenting the retention element of the program. The participant
receives his or her vested benefit at retirement. A participant whose employment terminates after the
normal retirement date will receive 100% of his or her supplemental retirement benefit, payable monthly,
commencing on the first of the month following retirement (unless selected otherwise by the participant
and except executive officers who will receive their benefit six months following retirement) and continuing
until the death of the participant (unless the joint survivor option is selected). For information on the plan,
see ‘‘Supplemental Retirement Plan for Executive Officers.’’
Prohibition on Speculation in Company Stock
Our stock trading guidelines prohibit executives from speculating in our stock, which includes, but is
not limited to, short selling (profiting if the market price of the securities decreases), buying or selling
publicly traded options, including writing covered calls, and hedging or any other type of derivative
arrangement that has a similar economic effect.
Termination of Employment and Change in Control Provisions
The Compensation Committee believes that a change in control transaction, or potential change in
control transaction, would create uncertainty regarding the continued employment of our executives. This
is because many change in control transactions result in significant organizational changes, particularly at
the senior executive level. In order to encourage our executives to remain employed with us during an
important time when their continued employment in connection with or following a transaction is often
uncertain and to help keep our executives focused on our business rather than on their personal financial
security, we believe that providing certain of our executives with severance benefits upon certain
terminations of employment is in the best interests of our Company and our shareholders.
The Company does not have company-wide separate change of control agreements with its executive
officers. Instead, the Chief Executive Officer and the other named executive officers have specific change
of control and severance provisions in their respective employment agreements. The Compensation
Committee considers the use of change of control provisions and severance provisions on a case by case
basis depending on the individual’s position with the Company and the need to attract and/or retain the
individuals.
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The severance benefits provided for our named executive officers were determined by the
Compensation Committee based on its judgment of prevailing market practices at the time each
agreement was entered into. At present, we have employment agreements with the Chief Executive Officer
and the other named executive officers, which detail their eligibility for payments under various
termination scenarios. In addition, certain equity grants made to the named executive officers provide for
vesting of stock options and restricted stock upon a change of control. We have disclosed the severance
and/or change in control payouts that would be payable to each named executive officer if the triggering
event occurred on December 31, 2016, in the ‘‘Change in Control Arrangements and Termination of
Employment’’ section in this proxy statement.
Tax Considerations
Section 162(m) (‘‘Section 162(m)’’) of the Internal Revenue Code of 1986, as amended, limits the
allowable deduction for compensation paid or accrued with respect to the Chief Executive Officer and
each of the four other most highly compensated executive officers of a publicly held corporation to no
more than $1 million per year. Certain compensation is exempt from this deduction limitation, including
performance based compensation paid under a plan administered by a committee of outside directors,
which has been approved by shareholders.
In light of Section 162(m), it is the policy of the Compensation Committee to modify, where
necessary, our executive compensation program to maximize the tax deductibility of compensation paid to
our executive officers when and if the $1 million threshold becomes an issue. At the same time, the
Compensation Committee also believes that the overall performance of our executives cannot in all cases
be reduced to a fixed formula and that the prudent use of discretion in determining pay levels is in our best
interests and those of our shareholders. Under some circumstances, the Compensation Committee’s use of
discretion in determining appropriate amounts of compensation may be essential. In those situations
where discretion is or can be used by the Compensation Committee, compensation may not be fully
deductible.
Section 409A (‘‘Section 409A’’) of the Internal Revenue Code of 1986, as amended, among other
things, limits flexibility with respect to the time and form of payment of deferred compensation. If a
payment or award is subject to Section 409A, but does not meet the requirements that exempt such
amounts from taxation under such section, the recipient is subject to: (i) income tax at the time the
payment or award is not subject to a substantial risk of forfeiture; (ii) an additional 20% tax at that time;
and (iii) an additional tax equal to the amount of interest (at the underpayment rate under the Internal
Revenue Code plus one percentage point) on the underpayment that would have occurred had the award
been includable in the recipient’s income when first deferred or, if later, when not subject to a substantial
risk of forfeiture. We have made modifications to our plans and arrangements such that payments or
awards under those arrangements either are intended to not constitute ‘‘deferred compensation’’ for
Section 409A purposes (and will thereby be exempt from Section 409A’s requirements) or, if they
constitute ‘‘deferred compensation,’’ are intended to comply with the Section 409A statutory provisions
and final regulations.
Accounting Considerations
Accounting considerations play an important role in the design of our executive compensation
program. Accounting rules require us to expense the fair value of restricted stock awards and the estimated
fair value of our stock option grants which reduces the amount of our reported profits. The Compensation
Committee considers the amount of this expense in determining the amount of equity compensation
awards.
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Dodd-Frank and Regulating Considerations
The Compensation Committee undertakes to review, consider and approve compensation decisions in
accordance with proposed regulations and guidelines set forth under Dodd-Frank and bank regulators.
Dodd-Frank requires the federal bank regulators and the SEC to establish joint regulations or guidelines
prohibiting incentive-based payment arrangements at specified regulated entities, including the Company
and Heritage Bank of Commerce, having at least $1 billion in total assets that encourage inappropriate
risks by providing an executive officer, employee, director or principal stockholder with excessive
compensation, fees, or benefits or that could lead to material financial loss to the entity. The proposed
regulations apply to incentive compensation paid to ‘‘covered persons’’ at covered financial institutions,
including executive officers. The proposed regulations prohibit a covered financial institution from
creating or maintaining an incentive-based compensation arrangement that encourages inappropriate risks
by providing a covered person either: (i) with excessive compensation; or (ii) with incentive-based
compensation that could lead to material financial loss to the financial institution. A compensation
arrangement would be considered able to lead to material financial loss unless: (i) it balances risk and
financial reward; (ii) is compatible with effective controls and risk management; and (iii) is supported by
strong corporate governance.
The Federal Reserve and Federal Deposit Insurance Corporation have also issued comprehensive
final guidance on incentive compensation policies intended to ensure that the incentive compensation
policies of banking organizations do not undermine the safety and soundness of such organizations by
encouraging excessive risk-taking.
Compensation Committee Report
The Compensation Committee has reviewed and discussed the Compensation Discussion and
Analysis required by Item 401(b) of Regulation S-K with management and, based on such review and
discussions, the Compensation Committee recommended to the Board that the Compensation Discussion
and Analysis be included in this proxy statement.
Compensation Committee of the Board
Julianne M. Biagini-Komas, Chairman
Frank G. Bisceglia
Robert T. Moles
Ranson W. Webster
Executive Compensation Tables
The following table provides for the periods shown, information as to compensation for services of the
Company’s principal executive officer, principal financial officer, and the three other executive officers of
the Company who had the highest total compensation (as defined in accordance with applicable
33
regulations) with respect to the year ended 2016 (collectively referred to as the ‘‘named executive
officers’’):
Summary Compensation Table
Change in
Pension
Value and
Non-Equity Nonqualified
Name and
Principal Position
(a)
Year
(b)
Salary
($)
(c)(1)
Bonus
($)
(d)
Stock
Awards Awards Compensation
Option
Incentive
Plan
($)
(e)(2)
($)
(f)(2)
($)
(g)(3)
Walter T. Kaczmarek . . . . . . . . . . . . 2016 $435,303 — $155,100
2015 $408,712 — $ 74,197
2014 $368,509 —
President & Chief Executive
Officer
— $58,397
Lawrence D. McGovern . . . . . . . . . . 2016 $282,824 — $ 84,788
2015 $271,618 — $ 93,600
2014 $260,753 —
Executive Vice President &
Chief Financial Officer
— $58,397
Michael E. Benito . . . . . . . . . . . . . 2016 $263,352 — $ 77,550
2015 $253,689 — $ 70,200
2014 $244,826 —
Executive Vice President/
Banking Division
— $48,664
David E. Porter . . . . . . . . . . . . . . . 2016 $279,343 — $ 82,720
2015 $269,545 — $ 70,200
2014 $260,738 —
Executive Vice President &
Chief Credit Officer
— $48,664
— $163,238
— $130,787
$149,246
— $103,231
— $ 86,918
$102,997
— $ 96,123
— $ 81,181
$ 96,706
— $101,960
— $ 86,255
$102,992
Keith A. Wilton . . . . . . . . . . . . . . . 2016 $319,250 — $ 93,060
2015 $301,000 — $ 93,600
2014 $243,025 — $542,450
Executive Vice President &
Chief Operating Officer(6)
— $116,526
— $ 96,320
— $110,600
Deferred
Compensation
Earnings
($)
(h)(4)
All Other
Compensation
($)
(i)(5)
Total
($)
(j)
$ 11,200
—
$250,900
$152,200
$ 71,200
$268,000
$101,000
$ 55,900
$146,700
—
—
—
—
—
—
$25,305
$24,263
$22,458
$19,125
$18,263
$16,087
$20,011
$19,147
$17,185
$20,796
$22,272
$21,595
$12,722
$12,222
$10,307
$790,146
$637,959
$849,510
$642,168
$541,599
$706,234
$558,036
$480,117
$554,081
$484,819
$448,272
$433,989
$541,558
$503,142
$906,382
(1) The amounts in column (c) include amounts voluntarily deferred by each of the named executive
officers into their 401(k) plan accounts. For 2016, Mr. Kaczmarek deferred $24,000, Mr. McGovern
deferred $24,000, Mr. Benito deferred $24,000, Mr. Porter deferred $24,000 and Mr. Wilton deferred
$24,000.
(2) The amounts shown in columns (e) and (f) reflect the applicable full grant date fair values for stock
options and stock awards in accordance with ASC 718 (excluding the effect of forfeitures), and are
reported for the fiscal year during which the stock options and stock awards were issued. The
assumptions used in calculating the valuation for stock options and stock awards may be found in
Note 13 to the Company’s consolidated financial statements for the year ended December 31, 2016,
included in the Company’s Annual Report on Form 10-K, filed with the SEC on March 3, 2017.
(3) The amounts shown in column (g) for 2016 reflect payments made under the terms of the
Management Incentive Plan for 2016 performance and paid in the first quarter of 2017.
(4) The amounts shown in column (h) for 2016 represent only the aggregate change in the actuarial
present value of the accumulated benefit under the Company’s Supplemental Executive Retirement
Plan from December 31, 2015 to December 31, 2016. The amounts in column (h) were determined
using interest rate and mortality rate assumptions consistent with those used in the Company’s
consolidated financial statements and include amounts which the named executive officer may not
currently be entitled to receive because such amounts are not vested. Assumptions used in the
calculation of these amounts are included in Note 14 to the Company’s consolidated financial
statements for the year ended December 31, 2016, included in the Company’s Annual Report on
Form 10-K, filed with the SEC on March 3, 2017.
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(5) The amounts shown in column (i) include the following for each named executive:
Named Executive
Economic Value
of Death Benefit
of Life
Insurance for
Beneficiaries(*) Contributions
401(k) Plan
Company
Matching
Walter T. Kaczmarek . . . . . . .
Lawrence D. McGovern . . . . .
Michael E. Benito . . . . . . . .
David E. Porter . . . . . . . . . .
Keith A. Wilton . . . . . . . . . .
$7,741
$1,922
$2,080
—
—
$2,000
$2,000
$2,000
$2,000
$2,000
Other
Insurance
Benefit
$3,564
$3,712
$2,419
$7,144
$2,322
Employee
Stock
Ownership
Plan
Company
Contributions Vacation Compensation
Auto
—
—
—
—
—
—
$5,491
$5,112
$3,252
—
$12,000
$ 6,000
$ 8,400
$ 8,400
$ 8,400
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Total
$25,305
$19,125
$20,011
$20,796
$12,722
*
The economic value of the death benefit amounts shown above reflects the annual income
imputed to each executive in connection with Company owned split-dollar life insurance policies
for which the Company has fully paid the applicable premiums. These policies are discussed
under ‘‘Supplemental Retirement Plan for Executive Officers.’’
(6) Mr. Wilson was also promoted to President of Heritage Bank of Commerce effective April 1, 2017.
Executive Contracts
Walter T. Kaczmarek—On October 17, 2007, the Company entered into an Amended and Restated
Employment Agreement with Walter T. Kaczmarek. The employment contract is for three years and is
automatically renewed each month for three additional years. Under the agreement, Mr. Kaczmarek
receives an annual salary of $480,000 with annual increases, if any (last increased in April 2017), as
determined by the Board of Directors’ annual review of executive salaries. In addition to his salary, he is
eligible to participate in the Management Incentive Plan. Mr. Kaczmarek participates in the Company’s
401(k) plan, under which he may receive matching contributions up to $2,000. He also participates in the
Company’s Employee Stock Ownership Plan. The Company provides Mr. Kaczmarek, at no cost to him,
group life, health, accident and disability insurance coverage for himself and his dependents.
Mr. Kaczmarek is provided with life insurance coverage in the amount of two times his then current salary
but no more than $700,000. He is provided with long-term care insurance, with a lifetime benefit of up to
$432,000. The Company reimburses Mr. Kaczmarek for up to $1,200 for tax consultation and tax return
preparation. He is also reimbursed for expenses that exceed insurance coverage for an annual physical
examination, monthly dues for one country club membership and one business club membership. He
receives an automobile allowance in the amount of $1,000 per month, together with reimbursements for
gasoline and maintenance expenditures.
Under his employment agreement, Mr. Kaczmarek is entitled to certain severance benefits on
termination of his employment, including a change of control. See ‘‘Change of Control Arrangements and
Termination of Employment.’’
Lawrence D. McGovern—On July 21, 2011, the Company entered into an Employment Agreement
with Lawrence D. McGovern. The employment contract is for one year and is automatically renewed for
one year terms. Under the agreement, Mr. McGovern receives an annual salary of $296,574 with annual
increases, if any (last increased in April 2017), as determined by the Company’s Chief Executive Officer
and Board of Directors’ Compensation Committee annual review of executive salaries. In addition to his
salary, he is eligible to participate in the Management Incentive Plan. Mr. McGovern participates in the
Company’s 401(k) plan, under which he may receive matching contributions up to $2,000. He also
participates in the Company’s Employee Stock Ownership Plan. The Company provides to Mr. McGovern,
at no cost to him, group life, health, accident and disability insurance coverage for himself and his
dependents. Mr. McGovern receives an automobile allowance in the amount of $500 per month, together
with reimbursements for gasoline expenditures. Mr. McGovern is provided with life insurance coverage in
35
the amount of two times his salary but not to exceed $700,000. He is also provided with long-term care
insurance, with a lifetime benefit of up to $72,000.
Under his employment agreement, Mr. McGovern is entitled to certain severance benefits on
termination of his employment, including a change of control. See ‘‘Change of Control Arrangements and
Termination of Employment.’’
Michael E. Benito—On February 1, 2012, the Company entered into an employment agreement with
Michael E. Benito when he was promoted to Executive Vice President/Banking Division. The employment
contract is for one year and is automatically renewed for one year terms. Under the Agreement,
Mr. Benito receives an annual salary of $273,852 with annual increases, if any (last increased in April
2017), as determined by the Company’s Chief Executive Officer and Board of Directors’ Compensation
Committee annual review of executive salaries. In addition to his salary, he is eligible to participate in the
Management Incentive Plan. Mr. Benito participates in the Company’s 401(k) plan, under which he may
receive matching contributions up to $2,000. Mr. Benito also participates in the Company’s Employee
Stock Ownership Plan. The Company provides to Mr. Benito, at no cost to him, group life, health, accident
and disability insurance coverage for himself and his dependents. Mr. Benito receives an automobile
allowance in the amount of $700 per month, together with reimbursements for gasoline expenditures.
Mr. Benito is provided with life insurance coverage in the amount of two times his salary not to exceed
$700,000. He is also provided with long-term care insurance, with a lifetime benefit of up to $72,000.
Under his employment agreement, Mr. Benito is entitled to certain severance benefits on termination
of his employment, including a change of control. See ‘‘Change of Control Arrangements and Termination
of Employment.’’
David E. Porter—On June 25, 2012, the Company entered into an employment agreement with
David E. Porter when he joined the Company as Executive Vice President and Chief Credit Officer. The
employment contract is for one year and is automatically renewed for one year terms. Under the
agreement, Mr. Porter receives an annual salary of $290,843 with annual increases, if any (last increased in
April 2017), as determined by the Company’s Chief Executive Officer and Board of Directors’
Compensation Committee annual review of executive salaries. In addition to his salary, he is eligible to
participate in the Management Incentive Plan. Mr. Porter participates in the Company’s 401(k) plan,
under which he could receive matching contributions up to $2,000. Mr. Porter also participates in the
Company’s Employee Stock Ownership Plan. The Company provides to Mr. Porter, at no cost to him,
group life, health, accident and disability insurance coverage for himself and his dependents. Mr. Porter
also receives an automobile allowance in the amount of $700 per month. Mr. Porter is provided with life
insurance coverage in the amount of two times his salary not to exceed $700,000. He is also provided with
long-term care insurance, with a lifetime benefit of up to $72,000. Under his employment agreement
Mr. Porter received a $50,000 signing bonus.
Under his employment agreement, Mr. Porter is entitled to certain severance benefits on termination
of his employment, including a change of control. See ‘‘Change of Control Arrangements and Termination
of Employment.’’
Keith A. Wilton—On February 18, 2014, the Company entered into an Employment Agreement with
Keith Wilton, when Mr. Wilton joined the Company as Executive Vice President and Chief Operating
Officer. Effective April 1, 2017, Mr. Wilton was also promoted to President of Heritage Bank of
Commerce. The employment contract is for one year and is automatically renewed for one year terms.
Under the agreement, Mr. Wilton receives an annual salary of $348,000 (last increased in April 2017) with
annual increases, if any, as determined by the Company’s Chief Executive Officer and Board of Directors’
Compensation Committee annual review of executive salaries. In addition to his salary, he is eligible to
participate in the Management Incentive Plan. Mr. Wilton participates in the Company’s 401(k) plan,
under which he may receive matching contributions up to $2,000. He also participates in the Company’s
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Employee Stock Ownership Plan. The Company provides to Mr. Wilton, at no cost to him, group life,
health, accident and disability insurance coverage for himself and his dependents. He also receives an
automobile allowance in the amount of $700 per month. Mr. Wilton is provided with life insurance
coverage in the amount of two times his salary not to exceed $700,000. He is also provided with long-term
care insurance, with a lifetime benefit of up to $72,000.
Under his employment agreement, Mr. Wilton is entitled to certain severance benefits on termination
of his employment, including a change of control. See ‘‘Change of Control Arrangements and Termination
of Employment.’’
Plan Based Awards
Equity Based Plans.
In 2004, the Board of Directors adopted the Heritage Commerce Corp 2004
Stock Option Plan (the ‘‘2004 Plan’’), which was approved by the Company’s shareholders at the 2004
Annual Meeting. The 2004 Plan authorized the Company to grant stock options to officers, employees and
directors of the Company and its affiliates. In 2009, the 2004 Plan was amended and restated as the 2004
Equity Plan to authorize the issuance of restricted stock in addition to stock options. The 2004 Equity Plan
was approved by the Company’s shareholders at the 2009 Annual Meeting.
In 2013, the Board of Directors approved the 2013 Equity Incentive Plan (‘‘2013 Equity Plan’’) to
replace the 2004 Equity Plan. The 2013 Equity Plan was approved by the Company’s shareholders at the
2013 Annual Meeting. The purpose of the Equity Plan is to promote the long-term success of the Company
and the creation of shareholder value. The Board of Directors believes that the availability of stock awards
is a key factor in the ability of the Company to attract and retain qualified individuals to serve as directors,
officers and employees. Under the 2013 Equity Plan incentives are provided through the grant of stock
options, stock appreciation rights, restricted stock awards, restricted stock units, performance shares, and
performance units (individually, an ‘‘Award’’). The 2013 Equity Plan is also intended to permit the
Company to grant Awards that qualify as performance based compensation under Section 162(m) of the
Internal Revenue Code, 1986, as amended.
Management Incentive Plan. The Company maintains a Management Incentive Plan adopted by the
Board of Directors in 2005. Executive officers are eligible for target bonuses which are expressed as a
percentage of their respective base salaries which increase as the level of performance of established goals
increases. The bonuses are tied directly to the satisfaction of overall Company performance for the year.
See ‘‘Compensation Discussion and Analysis’’ for information about the Management Incentive Plan.
37
The following table provides information on the potential performance based awards available if
defined performance objectives were achieved in 2016 for each of the Company’s named executive officers
under the Company’s Management Incentive Plan, and stock options or other stock awards granted to the
named executive officers for the year ended December 31, 2016:
Grants of Plan-Based Awards
Estimated Future Payouts
Under Non-Equity
Estimated Future Payouts
Under Equity
Incentive Plan Awards(1)
Incentive Plan Awards
All Other All Other
Stock
Awards:
Option
Awards: Exercise
Number of Number of or Base
Shares of Securities Price of of Stock
Underlying Option
Stock
and
Grant
Date
Fair
Value
Name
(a)
Grant
Date
(b)
Threshold Target Maximum Threshold Target Maximum or Units
($)
(c)
($)
(d)
($)
(e)
(#)
(f)
(#)
(g)
(#)
(h)
Walter T. Kaczmarek . . . . 5/3/2016
— —
1/28/2016 $44,000 $198,000 $254,000 —
—
—
Lawrence D. McGovern . . 5/3/2016
— —
1/28/2016 $28,557 $114,230 $171,344 —
—
—
Michael E. Benito . . . . . . 5/3/2016
— —
1/28/2016 $26,585 $106,341 $159,511 —
—
—
David E. Porter . . . . . . . 5/3/2016
— —
1/28/2016 $28,184 $112,737 $169,106 —
—
—
Keith A. Wilton . . . . . . . 5/3/2016
—
1/28/2016 $32,300 $129,200 $193,800 —
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(#)
(i)(2)
15,000
—
8,200
—
7,500
—
8,000
—
9,000
—
Options
(#)
(j)
Awards Options
Awards
($/Sh)
(l)(3)
(k)
—
—
—
—
—
—
—
—
—
—
— $155,100
—
—
— $ 84,788
—
—
— $ 77,550
—
—
— $ 82,720
—
—
— $ 93,060
—
—
(1) These potential performance-based awards were established under the Management Incentive Plan if
the indicated level of performance was achieved in 2016 as described further in the ‘‘Compensation
and Discussion Analysis’’ and in the discussion under ‘‘Plan Based Awards—Management Incentive
Plan.’’ They do not represent the actual payments made to the named executive officers. The
payments made for actual performance in 2016 are reflected in column (g) in the Summary
Compensation Table.
(2) This column reflects restricted stock award granted in 2016 pursuant to the 2013 Equity Incentive
Plan.
(3) The amounts shown in column (l) reflect the applicable full grant date fair values for restricted stock
award in accordance with ASC 718 (excluding the effect of forfeitures), and are reported for the fiscal
year during which the restricted stock awards were issued. The assumptions used in calculating the
valuation for stock and options awards may be found in Note 13 to the Company’s consolidated
financial statements for the year ended December 31, 2016, included in the Company’s Annual Report
on Form 10-K, filed with the SEC on March 3, 2017.
38
Equity Compensation Plan Information
The following table shows the number and weighted-average exercise price of securities to be issued
upon exercise of outstanding options, warrants and rights, and the number of securities remaining available
for future issuance under equity compensation plans at December 31, 2016:
Number of securities to
be issued upon exercise of
outstanding options,
warrants and rights
(a)
Weighted average
exercise price of
outstanding options,
warrants and rights
(b)
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(c)
Equity compensation plans approved
by security holders . . . . . . . . . . . .
Equity compensation plans not
approved by security holders
. . . .
1,719,091(1)
N/A
$9.79
N/A
601,765(2)
N/A
(1) Consists of 875,450 options to acquire shares under the Company’s 2004 Equity Incentive Plan and
843,641 options to acquired shares under the Company’s 2013 Equity Incentive Plan.
(2) Available under the Company’s 2013 Equity Incentive Plan.
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Outstanding Equity Awards
The following table shows the number of Company shares of common stock covered by exercisable
and unexercisable stock options and the number of Company unvested shares of restricted common stock
held by the Company’s named executive officers as of December 31, 2016:
Outstanding Equity Awards at Year End
Option Awards
Stock Awards
Equity
Incentive
Plan Awards:
Number of
Securities
Underlying Options
Number of Number of
Securities
Securities
Underlying Underlying
Unexercised Unexercised Unexercised Exercise Options
Options (#) Options (#)
Exercisable Unexercisable Options (#)
(c)
Price
($)
(e)
Unearned
Date
(f)
(d)
(b)
Equity
Incentive
Plan Awards:
Number of
Unearned
Shares,
Units or
Other
Equity
Incentive
Plan Awards:
Market or
Payout
Value of
Unearned
Shares,
Units or
Other
Market
Number of Value of
Shares
or Units
of
Shares
or Units
of
Stock That Stock That Rights That Rights That
Expiration Have Not Have Not
Have Not
Vested (#) Vested ($) Vested (#)
(h)(2)
(g)(1)
(i)
Name
(a)
Walter T. Kaczmarek . . . . .
Lawrence D. McGovern . .
Michael E. Benito . . . . . .
David E. Porter . . . . . . . .
10,625
25,000
10,625
13,767
15,000
8,853
9,178
4,500
4,500
7,000
7,000
8,853
9,178
4,375(3)
—
4,375(3)
1,233(4)
—
3,647(3)
822(4)
—
—
—
—
3,647(3)
822(4)
Keith A. Wilton . . . . . . . .
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$ 8.07 02/27/2024
$23.89 05/04/2017
20,945
—
$302,236
—
$ 8.07 02/27/2024
$ 6.57 04/30/2023
$23.89 05/04/2017
$ 8.07 02/27/2024
$ 6.57 04/30/2023
$ 3.57 07/26/2020
$ 7.43 05/04/2019
$16.00 05/22/2018
$23.89 05/04/2017
15,700
—
—
13,125
—
—
—
—
—
$226,551
—
—
$189,394
—
—
—
—
—
$ 8.07 02/27/2024
$ 6.57 04/30/2023
13,625
—
$196,609
—
—
— 49,000
$707,070
—
—
—
—
—
—
—
—
—
—
—
—
—
—
Have Not
Vested ($)
(j)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(1) This column represents the unvested shares for restricted stock awards granted. Restricted stock
awards vest 25% per year from the date of grant.
(2) The market value of the shares of restricted stock that have not vested is calculated by multiplying the
number of shares of stock that have not vested by the closing price of our common stock at
December 31, 2016, as reported on The NASDAQ Global Select Market, which was $14.43.
(3) The options vest daily over 4 years beginning February 27, 2014, and have a term of 10 years.
(4) The options vest daily over 4 years beginning April 30, 2013, and have a term of 10 years.
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Option Exercises and Vested Stock Awards
The following table sets forth information with regard to the exercise and vesting of stock options and
vesting of shares of restricted stock for the year ended December 31, 2016, for each of the named executive
officers:
Option Exercises and Stock Vested
Option Awards
Stock Awards
Name
(a)
Number of
Shares Acquired
on Exercise
(#)
(b)
Value
Realized upon
Exercise
($)
(c)
Number of
Shares Acquired
on Vesting
(#)
(d)
Walter T. Kaczmarek . . . . . . . . . . . . . . . . . . .
Lawrence D. McGovern . . . . . . . . . . . . . . . .
Michael E. Benito . . . . . . . . . . . . . . . . . . . . .
David E. Porter
. . . . . . . . . . . . . . . . . . . . . .
Keith A. Wilton . . . . . . . . . . . . . . . . . . . . . .
—
—
—
—
—
—
—
—
—
—
1,982
2,500
1,875
1,875
18,750
Value
Realized
on Vesting
($)
(e)(1)
$ 20,652
$ 26,050
$ 19,538
$ 19,538
$215,363
(1) The number of vested shares reflects the gross amount of shares, without netting any shares
surrendered to pay taxes. The aggregate dollar amount realized upon vesting was calculated by
multiplying the number of shares by the fair market value on the vesting date.
401(k) Plan
The Company has established a broad-based employee benefit plan under Section 401(k) of the
Internal Revenue Code of 1986 (‘‘401(k) Plan’’). The purpose of the 401(k) Plan is to encourage
employees to save for retirement. Eligible employees may make contributions to the plan subject to the
limitations of Section 401(k). The 401(k) Plan trustees administer the Plan. The Company matched up to
$2,000 of each employee’s contributions in 2016. The 401(k) Plan allows highly compensated employees to
contribute up to a maximum percentage of their base salary, up to the limits imposed by the Internal
Revenue Code, on a pre-tax basis. Participants choose to invest their account balances from an array of
investment options as selected by plan fiduciaries. The 401(k) Plan is designed to provide for distributions
in a lump sum after termination of service. However, loans and in-service distributions under certain
circumstances such as hardship, attainment of age 591⁄2, or a disability are permitted. For named executive
officers, these amounts are
‘‘All Other
Compensation.’’
in the Summary Compensation Table under
included
Employee Stock Ownership Plan
In 1997, Heritage Bank of Commerce initiated a broad-based employee stock ownership plan (‘‘Stock
Ownership Plan’’). The Stock Ownership Plan was subsequently adopted by the Company as the successor
corporation to Heritage Bank of Commerce. The Stock Ownership Plan allows the Company, at its option,
to purchase shares of the Company common stock on the open market. To be eligible to receive an award
of shares under the Stock Ownership Plan, an employee must have worked at least 1,000 hours during the
year and must be employed by the Company on December 31. The executive officers have the same
eligibility to receive awards as other employees of the Company. Awards under the Stock Ownership Plan
generally vest over four years. In addition, the value of a participant’s account becomes fully vested upon
reaching the age of 65 or termination of employment by death or disability. The Company has suspended
contributions to the Stock Ownership Plan since 2010. The amounts of contributions to the Stock
Ownership Plan for named executive officers are included in the Summary Compensation Table in the
column entitled ‘‘All Other Compensation.’’
41
Supplemental Retirement Plan for Executive Officers
The Company has established the 2005 Amended and Restated Supplemental Executive Retirement
Plan (the ‘‘SERP’’ or the ‘‘Plan’’) covering key employees, including several of the named executive
officers. The SERP is a nonqualified defined benefit plan and is unsecured and unfunded and there are no
plan assets. When the Company offers key executives participation in the SERP, the supplemental
retirement benefit awarded is based on the individual’s position within the Company and a vesting
schedule determined by the desirability of incentivizing the retention element of the program. The
participant is 100% vested in his or her benefit at normal retirement, upon termination within two years
from a change in control, or upon disability. However, the participant’s vested benefit is reduced for
payment prior to normal retirement age in accordance with the Plan terms.
The Company has reduced its use of the SERP as a program to attract and retain executives and key
employees. It has been more than five years since the Company has offered SERP benefits to executives
and key employees and does not intend to offer these benefits in the future.
Normal Retirement. A participant whose employment terminates after normal retirement (as defined
in the Plan) will receive 100% of his or her supplemental retirement benefit, payable monthly,
commencing on the first of the month following retirement (unless selected otherwise by the participant
and except executive officers who receive their benefit six months from retirement) and continuing until
the death of the participant (unless the joint survivor option is selected).
Early Retirement.
In order to be eligible for early retirement benefits, the plan requires the
participant to terminate employment (for reasons other than for cause or within two years from a change
of control) after the date that the participant is at least 55 years old but prior to normal retirement as
defined in the participant’s participation agreement. The participant will then receive the portion of the
supplemental retirement benefit that has vested as of the actual early retirement date. However, for each
year (or partial year) before normal retirement age the participant receives an early retirement benefit, the
vested benefit is reduced by five percent. Unless otherwise selected by the participant, the early retirement
benefit will be paid monthly, with payments to commence on the first day of the month following the
participant’s separation from service (except executive officers who receive their benefit six months from
retirement) and continuing until the death of the participant (unless the joint survivor option is selected).
Termination Before Early Retirement.
If a participant’s employment is terminated without cause or the
participant resigns, the participant shall be eligible to receive the portion of the supplemental retirement
benefit that has vested as of the effective date of termination reduced by 5% for each year (or partial year)
that the participant’s benefits are paid prior to the participant’s normal retirement age. Benefits are
payable monthly commencing on the first of the month elected by the participant but not before the
participant’s early retirement age (except executive officers who receive their benefit six months from
retirement), and continuing until the death of the participant (unless the joint survivor option is selected).
Disability.
In the event a participant becomes disabled, the participant will receive the actuarial
equivalent of his or her supplemental retirement benefit, payable monthly, commencing on the first of the
month following determination that the participant is disabled and continuing until the death of the
participant.
Cause.
If a participant’s employment is terminated for cause, the participant forfeits any rights the
participant may have under the SERP.
Change of Control.
If a participant’s employment is terminated for any reason (except cause or after
qualifying for normal retirement) within two years following a change of control, the participant will
receive 100% of his or her supplemental retirement benefit commencing at the later of the first month
following the age selected by the participant or the first month following the participant’s separation from
service (except executive officers who receive their benefit six months from separation of service), and
continuing until the death of the participant (unless the joint survivor option is selected). In the event
payments commence prior to the participant’s normal retirement age, then the benefit due to the
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participant will be reduced by 5% for each year (or partial year) that the participant’s benefit is paid prior
to the participant’s normal retirement age.
The Company has purchased life insurance contracts on the participants in order to finance the cost of
these benefits and it is anticipated that, because of the tax-advantaged effect of this life insurance
investment, the return on the life insurance contracts will be approximately equal to the accrued benefits to
the participants under the SERP, other than in the event of accelerated vesting because of the change of
control.
The following table shows the present value of the accumulated benefit payable to each of the named
executive officers that participate in the SERP, including the number of service years credited to each
named executive officer at December 31, 2016:
Name
(a)
Plan Name
(b)
Number of
Years Credited
Service
(#)
(c)
Walter T. Kaczmarek . . . . . Heritage Commerce Corp SERP
Lawrence D. McGovern . . Heritage Commerce Corp SERP
Michael E. Benito(3) . . . . Heritage Commerce Corp SERP
12
18
13
Present Value of During Last
Payments
Accumulated
Benefit(1)(2)
($)
(d)
$3,903,300
$1,304,800
$ 578,300
Fiscal
Year
($)
(e)
—
—
—
(1) The amounts in column (d) were determined using interest rate and mortality rate assumptions
consistent with those used in the Company’s consolidated financial statements and include amounts
which the named executive officer may not currently be entitled to receive because such amounts are
not vested. Assumptions used in the calculation of these amounts are included in Note 14 to the
Company’s consolidated financial statements for the fiscal year ended December 31, 2016, included in
the Company’s Annual Report on Form 10-K, filed with the SEC on March 3, 2017.
(2) The following vesting percentages apply to the named executive officers who participate in the SERP:
End of the year prior
to termination
Walter T.
Kaczmarek
Lawrence D.
McGovern
Michael E.
Benito(3)
12/31/2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12/31/2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12/31/2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12/31/2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12/31/2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
96% 50%
100% 60%
100% 70%
100% 80%
100% 90%
(3) Mr. Benito has two separate SERP agreements.
Management Deferral Plan
In January 2004, the Company adopted the Heritage Commerce Corp Nonqualified Deferred
Compensation Plan for certain executive officers. The purpose of the plan is to offer those employees an
opportunity to elect to defer the receipt of compensation in order to provide termination of employment
and related benefits taxable pursuant to Section 451 of the Internal Revenue Code of 1986, as amended.
The plan is intended to be a ‘‘top-hat’’ plan (i.e., an unfunded deferred compensation plan maintained for
a select group of management or highly-compensated employees) under Sections 201(2), 301(a)(3)
and 401(a)(1) of the Employee Retirement Income Security Act of 1974. The executive may elect to defer
up to 100% of any bonus and 50% of any regular salary into the Management Deferral Plan. Amounts
deferred are invested in a portfolio of approved investment choices as directed by the executive. Under the
Management Deferral Plan, the Company may make discretionary contributions for the executive, but has
not done so. Amounts deferred by executives to the plan will be distributed at a future date they have
selected or upon termination of employment. The executive can select a distribution schedule of up to
fifteen years. Mr. Benito and Mr. Porter elected to participate in the plan during 2016.
43
Change of Control Arrangements and Termination of Employment
Equity Plans. Each of the named executive officers holds options granted under the 2004 Equity Plan
and the 2013 Equity Plan. Under these plans, option holders will be given 30 days advance notice of the
consummation of a change of control transaction during which time the option holders will have the right
to exercise their options, and all outstanding options become immediately vested. The options terminate
on the consummation of the change of control. In the event the option holder dies or becomes disabled,
the option holder or his or her estate will have 12 months to exercise those options that have vested as of
the date of termination of employment from a disability or death.
Restricted Stock. Several of the named executive officers hold shares of restricted stock subject to
vesting requirement. Under the terms of the restricted stock awards the vesting of the shares will
accelerated upon a change of control of the Company, or the holder’s death or disability.
Supplemental Executive Retirement Plan. Several of the named executives are participants in the 2005
Amended and Restated Supplemental Executive Plan. If a participant’s employment is terminated without
cause or the participant resigns, the participant shall be eligible to receive the portion of the supplemental
retirement benefit that has vested as of the effective date of termination reduced by 5% for each year (or
partial year) that the participant’s benefits are paid prior to the participant’s normal retirement age.
Benefits are payable monthly commencing on the first of the month elected by the participant (except
executive officers who receive their benefits six months from separation from service), but not before the
participant’s early retirement age, and continuing until the death of the participant (unless the joint
survivor option is selected). In the event a participant becomes disabled, the participant will receive the
actuarial equivalent of his or her supplemental retirement benefit, payable monthly, commencing on the
first of the month following determination that the participant is disabled and continuing until the death of
the participant. If a participant’s employment is terminated for cause, the participant forfeits any rights the
participant may have under the plan. If a participant’s employment is terminated for any reason (except
cause or after qualifying for normal retirement) within two years following a change of control, the
participant will receive 100% of his or her supplemental retirement benefits commencing at the later of the
first month following the age selected by the participant, or the first month following the participant’s
separation from service (except executive officers who receive their benefits six months from separation
from service), and continuing until the death of the participant (unless the joint survivor option is
selected). In the event payments commence prior to the participant’s normal retirement age, then the
benefit due to the participant will be reduced by 5% for each year (or partial year) that the participant’s
benefit is paid prior to the participant’s normal retirement age.
Mr. Kaczmarek’s Employment Agreement.
If Mr. Kaczmarek’s employment is terminated without
cause or he resigns for good reason, he will be entitled to a lump sum payment equal to two times his base
salary and his highest annual bonus in the last three years. If Mr. Kaczmarek’s employment is terminated
or he resigns for good reason 120 days before, or within two years after, a change of control, he will be paid
a lump sum of 2.75 times his base salary and highest annual bonus in the last three years. If his
employment is terminated by the Company without cause, or he resigns for good reason, or as a result of a
change of control the Company terminates his employment or he resigns for good reason, his participation
in group insurance coverages will continue on at least the same level as at the time of termination for a
period of 36 months from the date of termination. In the event that the amounts payable to
Mr. Kaczmarek under the agreement constitute ‘‘excess parachute payments’’ under the Internal Revenue
Code of 1986, as amended, that are subject to an excise or similar tax, the amounts payable to
Mr. Kaczmarek will be increased so that he receives substantially the same economic benefit under the
agreement had there been no such tax imposed. Additionally, following the termination of his
employment, Mr. Kaczmarek has agreed to refrain from certain activities that would be competitive with
the Company within the counties in California in which the Company has located its headquarters or
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branch offices, including refraining for 12 months from the date of termination from soliciting Company
employees and customers.
Mr. McGovern’s Employment Agreement.
If Mr. McGovern’s employment is terminated without
cause, he will be entitled to a lump sum payment equal to one times his base salary, his highest annual
bonus in the last three years and his annual automobile allowance. If Mr. McGovern’s employment is
terminated by the Company or he resigns for good reason 120 days before, or within two years after, a
change in control, he will be entitled to a lump sum payment of two times his base salary, his highest
annual bonus in the last three years and his annual automobile allowance. If the employment agreement is
terminated by the Company without cause, his participation in group insurance coverage will continue on
at least the same level as at the time of termination for a period of 12 months from the date of termination.
If Mr. McGovern’s employment is terminated as a result of a change in control during the change of
control period, or he resigns for a good reason as a result of a change in control, these benefits will
continue for an additional 24 months from the date of termination. In the event that the amounts payable
to Mr. McGovern under the agreement constitute ‘‘excess parachute payments’’ under the Internal
Revenue Code of 1986, as amended, that are subject to an excise or similar tax, the amounts payable to
Mr. McGovern will be increased so that he receives substantially the same economic benefit under the
agreement had there been no such tax imposed. Additionally, following the termination of his
employment, Mr. McGovern has agreed to refrain from certain activities that would be competitive with
the Company within the counties in California in which the Company has located its headquarters or
branch offices, including refraining for 12 months from the date of termination from soliciting Company
employees or customers.
Mr. Benito’s Employment Agreement.
If Mr. Benito’s employment agreement is terminated without
cause, he will be entitled to a lump sum payment equal to one times his base salary and his average annual
bonus during the last three years. If Mr. Benito’s employment is terminated by the Company or he resigns
for good reason 120 days before or within two years after a change in control, he will be entitled to a lump
sum payment of two times his base salary and his average annual bonus during the last three years. If
Mr. Benito’s employment is terminated by the Company without cause, his participation in group
insurance coverage will continue on at least the same level as at the time of termination for a period of
12 months from the date of termination. If Mr. Benito’s employment is terminated by the Company as a
result of a change in control, or he resigns for a good reason as a result of a change in control, these
benefits will continue for an additional 24 months from the date of termination. In the event that the
amounts payable to Mr. Benito under the agreement constituted ‘‘excess parachute payments’’ under the
Internal Revenue Code of 1986, as amended, that are subject to an excise or similar tax, the amounts
payable to Mr. Benito will be increased so that he receives substantially the same economic benefit under
the agreement had there been no such tax imposed. Additionally, following the termination of his
employment, Mr. Benito has agreed to refrain from certain activities that would be competitive with the
Company within the counties in California in which the Company has located its headquarters or branch
offices, including refraining for 12 months from the date of termination from soliciting Company
employees or customers.
Mr. Porter’s Employment Agreement.
If Mr. Porter’s employment agreement is terminated without
cause, he will be entitled to a lump sum payment equal to one times his base salary and his average annual
bonus during the last three years. If Mr. Porter’s employment is terminated by the Company or he resigns
for good reason 120 days before or within two years after a change in control, he will be entitled to a lump
sum payment of two times his base salary and his average annual bonus during the last three years. If
Mr. Porter’s employment is terminated by the Company without cause, his participation in group insurance
coverage will continue on at least the same level as at the time of termination for a period of 12 months
from the date of termination. If Mr. Porter’s employment is terminated by the Company as a result of a
change in control, or he resigns for a good reason as a result of a change in control, these benefits will
continue for an additional 24 months from the date of termination. Additionally, following the termination
45
of his employment, Mr. Porter has agreed to refrain from certain activities that would be competitive with
the Company within the counties in California in which the Company has located its headquarters or
branch offices, including refraining for 12 months from the date of termination from soliciting Company
employees or customers.
Mr. Wilton’s Employment Agreement.
If Mr. Wilton’s employment is terminated without cause, he will
be entitled to a lump sum payment equal to one times his base salary and his average annual bonus in the
last three years. If Mr. Wilton’s employment is terminated by the Company or he resigns for good reason
120 days before or within two years after a change in control, he will be entitled to a lump sum payment of
two times his base salary and his average annual bonus in the last three years. If his employment is
terminated by the Company without cause, his participation in group insurance coverage will continue on
at least the same level as at the time of termination for a period of 12 months from the date of termination.
If Mr. Wilton’s employment is terminated by the Company as a result of a change in control, or he resigns
for a good reason as a result of a change in control, these benefits will continue for an additional
24 months from the date of termination. Additionally, following the termination of his employment,
Mr. Wilton has agreed to refrain from certain activities that would be competitive with the Company within
the counties in California in which the Company has located its headquarters or branch offices, including
refraining for 12 months from the date of termination from soliciting Company employees or customers.
The following tables summarize the payments which would be payable to our named executive officers
in the event of various termination scenarios as of December 31, 2016. This information is for illustrative
purposes only. Regardless of the manner in which a named executive’s employment terminates, the officer
would be entitled to: (i) the vested portion of any stock option or restricted stock; and (ii) the vested
portion of the officer’s benefit under the Supplemental Executive Retirement Plan.
Change in
Control
Involuntary
Termination
Without
Cause
Termination
for
Good Reason
Death
Disability
Walter T. Kaczmarek
Cash severance under employment
agreement . . . . . . . . . . . . . . . . . . . . . .
Health and life insurance premiums . . . . .
Health and life insurance benefits . . . . . .
Long-term care insurance benefits . . . . . .
Split-dollar death benefits (upon death) . .
Unvested stock options (accelerated) . . . .
Unvested restricted stock awards
(accelerated) . . . . . . . . . . . . . . . . . . . .
Outplacement services (layoff) . . . . . . . . .
IRC 280(G) excise tax gross-up . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Lawrence D. McGovern
Cash severance under employment
agreement . . . . . . . . . . . . . . . . . . . . . .
Health and life insurance premiums . . . . .
Health and life insurance benefits . . . . . .
Long-term care insurance benefits . . . . . .
Split-dollar death benefits (upon death) . .
Unvested stock options (accelerated) . . . .
Unvested restricted stock awards
(accelerated) . . . . . . . . . . . . . . . . . . . .
IRC 280(G) excise tax gross-up . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,620,427
101,775
—
—
—
27,825
$1,178,492
101,775
—
—
—
—
$
— $
$1,178,492
—
101,775
700,000
—
—
—
— 3,034,827
—
—
—
—
180,000(3)
72,000
—
—
302,236
5,000
1,040,914
$3,098,176
302,236
—
—
$1,582,503
302,236
—
—
$1,582,503
302,236
—
—
$4,037,063
302,236
—
—
$554,236
$ 789,142
96,836
—
—
—
37,516
226,551
486,375
$1,636,421
$ 394,571
48,418
—
—
—
—
—
—
442,989
$
$
— $
—
—
—
—
—
— $
—
571,148
—
913,881
—
—
—
180,000(3)
72,000
—
—
226,551
—
—
—
— $1,711,580
226,551
—
$478,551
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Change in
Control
Involuntary
Termination
Without
Cause
Termination
for
Good Reason
Death
Disability
Michael E. Benito
Cash severance under employment
agreement . . . . . . . . . . . . . . . . . . . . . .
Health and life insurance premiums . . . . .
Health and life insurance benefits . . . . . .
Long-term care insurance benefits . . . . . .
Supplemental executive retirement
plan(1)(2) . . . . . . . . . . . . . . . . . . . . . .
Split-dollar death benefits (upon death) . .
Unvested stock options (accelerated) . . . .
Unvested restricted stock awards
(accelerated) . . . . . . . . . . . . . . . . . . . .
IRC 280(G) excise tax gross-up . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . .
David E. Porter
Cash severance under employment
agreement . . . . . . . . . . . . . . . . . . . . . .
Health and life insurance premiums . . . . .
Health and life insurance benefits . . . . . .
Long-term care insurance benefits . . . . . .
Unvested stock options (accelerated) . . . .
Unvested restricted stock awards
(accelerated) . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Total
Keith A. Wilton
Cash severance under employment
agreement . . . . . . . . . . . . . . . . . . . . . .
Health and life insurance premiums . . . . .
Health and life insurance benefits . . . . . .
Long-term care insurance benefits . . . . . .
Unvested restricted stock awards
(accelerated) . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Total
$ 702,356
37,631
—
—
$ 351,178
18,815
—
—
95,566
—
29,656
56,514
—
—
189,394
482,466
$1,537,068
—
—
$ 426,507
$ 742,292
96,792
—
—
29,656
$ 371,146
48,396
—
—
—
196,609
$1,065,349
—
$ 419,542
$ 852,920
6,811
—
—
$ 426,460
3,405
—
—
707,070
$1,566,801
—
$ 429,865
$
$
$
$
$
$
— $
—
—
—
— $
—
531,148
—
—
—
177,217(3)
72,000
—
—
— 1,274,663
—
—
57,710
—
—
189,394
—
—
—
— $1,995,760
189,394
—
$496,321
— $
—
—
—
—
— $
—
563,686
—
—
—
—
180,000(4)
72,000
—
196,609
—
— $ 760,295
196,609
$448,609
— $
—
—
—
— $
—
646,000
—
—
—
180,000(3)
72,000
707,070
—
— $1,353,070
707,070
$959,070
(1) Assumes executive selected age 62 for commencement of the payment of this benefit.
(2) The amount reflected in the table is the incremental increase in the benefit payable to the named
executive officer in addition to the benefit payable under the terms of the Supplemental Executive
Retirement Plan. See ‘‘Supplemental Retirement Plan for Executive Officers’’ and the tables included
therein for information about the value of the accumulated benefit payable to each named executive
officer.
(3) This balance represents the annual payment of long-term disability for the named executive officers.
This long-term payment would begin after an elimination period and a twenty-five week short term
disability period. This long-term disability payment will increase by 3% (cost of living adjustment)
over the first ten years of payments and cease at age 65.
(4) The payment represents one year of benefits. The second year would increase 3% (cost of living
adjustment). Only 18 months of payments are granted since the executive is currently 67 years old.
47
Director Compensation
This section provides information regarding the compensation policies for non-employee directors
and amounts paid to these directors in 2016. Mr. Kaczmarek does not receive any separate compensation
for his service as a director.
The Company has a policy of compensating non-employee directors for their service on the Board and
Board committees of the Company. On an annual basis, the Compensation Committee reviews director
compensation, including the individual fees and retainers, the components of compensation, as well as the
total amount of director compensation appropriate for the Company.
In 2016, each director received an annual retainer fee of $50,000. The chairman of each standing
committee of the Board received an additional $4,000 per year, and the Chairman of the Board receives an
additional $15,000 per year. Board Members are not paid separate fees for attending Board or committee
meetings.
In 2016, at the recommendation of the Company’s compensation consultant, the Compensation
Committee adopted a policy to grant directors restricted stock on an annual basis in lieu of stock options.
Under this policy directors are entitled to awards of restricted stock with an economic value on the date of
grant not to exceed the following:
Board Chairman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Board members (non-chairman) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$25,000
$20,000
In 2016, each of the directors received restricted stock in accordance with the above schedule.
The following table summarizes the compensation of non-employee directors for the year ended
December 31, 2016:
Director Compensation Table
Name
(a)
Fees
Earned or
Paid in
Cash
($)
(b)
Stock
Awards
($)
(c)
Non-Equity
Incentive
Plan
Options
Awards Compensation
($)
(d)(1)
Julianne M. Biagini-Komas . . . $50,000 $19,998 —
Frank G. Bisceglia . . . . . . . . . $54,000 $19,998 —
Jack W. Conner . . . . . . . . . . . $69,000 $25,002 —
. . . . . . . . . $50,000 $19,998 —
J. Philip DiNapoli
John M. Eggemeyer(4) . . . . . . $50,000 $19,998 —
Steven L. Hallgrimson . . . . . . $52,667 $19,998 —
Robert T. Moles . . . . . . . . . . . $54,000 $19,998 —
Laura Roden . . . . . . . . . . . . . $52,333 $19,998 —
Ranson W. Webster . . . . . . . . $54,000 $19,998 —
W. Kirk Wycoff(5) . . . . . . . . . $50,000 $19,998 —
Change in
Pension
Value and
Nonqualified
Deferred
Compensation
Earnings
($)
(f)(2)
—
$10,500
$ 4,800
—
—
—
$14,300
—
$10,400
—
All Other
Compensation
($)
(g)(3)
Total
($)
(h)
$ 602
$1,136
— $69,998
$85,100
$99,938
— $69,998
— $69,998
— $72,665
$88,298
— $72,331
$85,015
— $69,998
$ 617
($)
(e)
—
—
—
—
—
—
—
—
—
—
(1) The amounts shown in column (c) reflect the applicable full grant date value for stock awards in
accordance with ASC 718 (excluding the effect of forfeitures). See Note 13 to the Company’s
consolidated financial statements for the year ended December 31, 2016, included in the Company’s
Annual Report on Form 10-K, filed with the SEC on March 3, 2017.
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(2) The amounts shown in column (f) represent only the aggregate change in the actuarial present value
of the accumulated benefit measured from December 31, 2015 to December 31, 2016, under the
respective director compensation benefits agreements. The amounts in column (f) were determined
using interest rate and mortality rate assumptions, consistent with those used in the Company’s
consolidated financial statements, and include amounts which the named director may not currently
be entitled to receive because such amounts are not vested. Assumptions used in the calculation of
these amounts are included in Note 4 to the Company’s consolidated financial statements for the year
ended December 31, 2016, included in the Company’s Annual Report on Form 10-K filed with the
SEC on March 3, 2017.
(3) The amounts shown reflect the annual income imputed to each director in connection with Company
owned split-dollar life insurance policies for which the Company has fully paid the applicable
premiums.
(4) Mr. Eggemeyer resigned from the Board of Directors effective December 15, 2016.
(5) Mr. Wycoff resigned from the Board of Directors effective February 15, 2017.
Director Outstanding Stock Options
Each of the non-employee directors owned the following stock options and stock awards as of
December 31, 2016:
Director
Stock Options
Stock Awards
Julianne M. Biagini-Komas . . . . . . . . . . . . . . . . . . . . . . .
Frank G. Bisceglia . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Jack W. Conner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
J. Philip DiNapoli
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
John M. Eggemeyer(1) . . . . . . . . . . . . . . . . . . . . . . . . . .
Steven L. Hallgrimson . . . . . . . . . . . . . . . . . . . . . . . . . .
Robert T. Moles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Laura Roden . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ranson W. Webster . . . . . . . . . . . . . . . . . . . . . . . . . . . .
W. Kirk Wycoff(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
29,500
28,484
—
14,427
6,345
29,000
12,000
29,500
16,000
1,934
3,260
4,305
1,934
3,260
3,260
3,260
3,260
3,260
3,260
(1) Mr. Eggemeyer resigned from the Board of Directors effective December 15, 2016.
(2) Mr. Wycoff resigned from the Board of Directors effective February 15, 2017.
Director Compensation Benefits Agreement
Prior to 2007, the Company entered into individual director compensation benefits agreements with
each of its then directors. These agreements were amended and restated in December, 2008 (‘‘Benefit
Agreements’’). The Benefit Agreements provide an annual benefit equal to a designated applicable
percentage of $1,000 times each year served as a director, subject to a 2% increase each year from the date
of the commencement of payments. The applicable percentage increases over time and equals 100% after
nine years of service. In the event of a disability, or a resignation or termination pursuant to a change of
control, the director’s applicable percentage will be accelerated to 100%. Payments of benefits will be
made in equal monthly payments on the first day of each month, commencing on the later of the director’s
attaining the age of 62 or the month following the month in which the director separates from service on
the Board and continuing until the director’s death. If a director is removed from the Board for cause he or
she will forfeit any benefits under the Benefit Agreement.
49
Company-owned split-dollar life insurance policies support the Company’s obligations under the
Benefit Agreements. The premiums on the policies are paid by the Company. The cash value accrued on
the policies supports the payment of the supplemental benefits for each participant. In the case of death of
the participant, the participant’s designated beneficiaries will receive 80% of the net-at-risk insurance
(which means the amount of the death benefit in excess of the cash value of the policy).
The following table shows the present value of the accumulated benefit payable to each director who
has a director compensation benefit agreement, including the number of service years credited to each
director under the Benefit Agreements:
Name
(a)
Plan Name
(b)
Number of
Years Credited
Service
(#)
(c)
Present Value of
Accumulated
Benefit(1)(2)
($)
(d)
Payments
During Last
Fiscal Year
($)
(e)
Frank G. Bisceglia . . . . . Heritage Commerce Corp SERP
Jack W. Conner . . . . . . . Heritage Commerce Corp SERP
Robert T. Moles . . . . . . . Heritage Commerce Corp SERP
Ranson W. Webster . . . . Heritage Commerce Corp SERP
23
13
13
13
$302,800
$120,300
$220,000
$165,500
—
—
—
—
(1) The amounts in column (d) were determined using interest rate and mortality rate assumptions
consistent with those used in the Company’s consolidated financial statements and include amounts
which the director may not currently be entitled to receive because such amounts are not vested.
Assumptions used in the calculation of these amounts are included in Note 14 to the Company’s
consolidated financial statements for the year ended December 31, 2016, included in the Company’s
Annual Report on Form 10-K, filed with the SEC on March 3, 2017.
(2) Each participant is fully vested.
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PROPOSAL 1—ELECTION OF DIRECTORS
The Bylaws of the Company provide that the number of directors shall not be less than 9 nor more
than 15. By resolution, the Board of Directors has fixed the number of directors at 9 effective on the date
of and prior to the Annual Meeting. All of our directors serve one year terms that expire at the next
following annual meeting. The Bylaws of the Company provide the procedure for nominations and election
of the Board of Directors. For information on these procedures see ‘‘Corporate Governance and Board
Matters—Nomination of Directors.’’ Nominations not made in accordance with the procedures may be
disregarded by the Chairman of the Annual Meeting and upon his instructions, the inspector of election
will disregard all votes cast for such nominees.
The Board of Directors, upon the recommendation of the Corporate Governance and Nominating
Committee, has recommended the nomination of 9 of the current members of the Board of Directors for
one year terms that will expire at the Annual Meeting to be held in 2018. If any nominee should become
unable or unwilling to serve as a director, the proxies will be voted at the Annual Meeting for substitute
nominees designated by the Board. The Board presently has no knowledge that any of the nominees will be
unable or unwilling to serve.
The following provides information with respect to each person nominated and recommended to be
elected to the Board of Directors:
JULIANNE M. BIAGINI-KOMAS, age 54, was formerly a member on the Focus Business Bank board
of directors and joined the Board of Directors of the Company in August 2015. Ms. Biagini-Komas is
currently the Vice President, Finance and Human Resources of CNEX Labs, Inc., San Jose, California.
She was the Chief Financial Officer of Quantumscape Corporation, San Jose, California, from 2011 to
2014. Previously, she was the Chief Financial Officer of Endwave Corporation, a NASDAQ-listed
company, from 1994 to 2007. Ms. Biagini-Komas is the Treasurer of Downtown College Prep, a non-profit
organization. Ms. Biagini-Komas has a Bachelor of Science degree in Accounting from San Jose State
University and a Masters in Business Administration degree from Santa Clara University. Ms. Biagini-
Komas is a Certified Public Accountant. With over 20 years of human resource administration experience,
Ms. Biagini-Komas is particularly suited to serve as Chairman of the Compensation Committee. With her
experience as a chief financial officer and her accounting background, Ms. Biagini-Komas provides
valuable insight and perspective regarding accounting and tax issues and is particularly suited to serve as a
member of the Board’s Audit Committee and the Loan Committee.
FRANK G. BISCEGLIA, age 71, became a director of the Company in 1994. Mr. Bisceglia is a Senior
Vice President—Investments, Advisory and Brokerage Services, Senior Portfolio Manager, Portfolio
Management Program at UBS Financial Services, Inc., a full-service securities firm. Mr. Bisceglia has a
Bachelor of Science degree in Industrial Management from San Jose State University. Mr. Bisceglia
contributes to the Board a substantial understanding of finance and investments from over 31 years of
experience as a financial advisor to corporate and high-wealth individuals. As a long-term member of the
Board and Chairman of the Loan Committee, he has a broad based understanding of the Company’s
business and he has developed a general knowledge of the Company’s credit administration and loan
underwriting process.
JACK W. CONNER, age 77, became a director of the Company in 2004. Mr. Conner was elected
Chairman of the Board in July, 2006. Mr. Conner was Chairman and Chief Executive Officer of Comerica
California from 1991 until his retirement in 1998, and remained a director until 2002. He was President
and a director of Plaza Bank of Commerce from 1979 to 1991. Prior to joining Plaza Bank of Commerce,
he held various positions with Union Bank of California where he began his banking career in 1964.
Mr. Conner has a Bachelor of Arts degree from San Jose State University. Mr. Conner contributes to the
Board over 20 years of executive leadership and substantial experience in the community banking industry.
Having served as a Chief Executive Officer and President at several successful community banks in the
Company’s primary market, he brings a wide-ranging understanding of bank management, finance,
51
operations and strategic planning. His demonstrated leadership ability, judgment and executive experience
led the Board to elect him as Chairman of the Board.
J. PHILIP DINAPOLI, age 77, was a member of the Focus Business Bank board of directors from
2006 until 2015, and joined the Board of Directors of the Company in August 2015. Mr. DiNapoli is a
director of J. P. DiNapoli Companies, Inc., a real estate investment, development and property
management organization based in San Jose, California. Mr. DiNapoli has been a director of SJW Corp, a
utility company listed on the NYSE, from 1989 until 2012, and served on the board of Comerica
Incorporated, a NYSE listed bank holding company, from 1993 until 2006. He was also a founder of Plaza
Commerce Corp and, from 1979 to 1993, served on the board of directors of Plaza Bank of Commerce.
Mr. DiNapoli has a Bachelor of Arts degree from Stanford University and a Bachelor of Law degree from
University of Santa Clara Law School. He is a member of the California State Bar Association. The Board
benefits from Mr. DiNapoli’s deep understanding of banking from his prior banking background and his
knowledge of the local economy and his involvement in the local community. He is active in philanthropic
activities in Santa Clara county.
STEVEN L. HALLGRIMSON, age 75, had been practicing law in the San Jose, California area since
1969 in the areas of real estate, taxation and general business planning and is a certified public accountant.
He is currently of counsel with the law firm of Berliner Cohen located in San Jose, California.
Mr. Hallgrimson has founded and served as a board member for several private business entities engaged
in automobile lending, commercial real estate brokerage and telecommunications. He has been an
instructor at San Jose State University Business School and University of California, Santa Cruz teaching a
variety of business, real estate and tax courses. Mr. Hallgrimson is a member of the California State Bar
and California Society of Certified Public Accountants. He serves as a trustee and President of the Santa
Clara County Law Library and is a director of Loaves & Fishes and the San Jose Sports Hall of Fame.
Mr. Hallgrimson has a Bachelor of Arts degree from Claremont McKenna College and a Juris Doctor
degree from the University of California at Berkeley, Boalt Hall School of Law. Mr. Hallgrimson brings
legal, accounting and tax knowledge and experience to the Board and provides a valuable perspective to
the Board as a result of his involvement and extensive relationships in the community in which the
Company serves. His background is particularly suited to serve as Chairman of the Audit Committee and
as the committee’s ‘‘financial expert.’’
WALTER T. KACZMAREK, age 65, is President, Chief Executive Officer and a director of the
Company and Chief Executive Officer and a director of Heritage Bank of Commerce. Prior to joining the
Company in 2005, Mr. Kaczmarek was Executive Vice President of Comerica Bank and of Plaza Bank of
Commerce from 1990. Prior to joining Plaza Bank of Commerce he served in various positions with Union
Bank of California and also The Martin Group, a real estate investment development company.
Mr. Kaczmarek has a Bachelor of Science in Commerce degree from Santa Clara University, and a
Masters in Business Administration degree from San Jose State University. Mr. Kaczmarek contributes to
the Board his breadth of knowledge of the Company’s business, industry and strategy. He brings to the
Board a full understanding of the Company’s banking business, markets, community and culture. He
provides the Board with an overall perspective of all facets of the Company’s business, financial condition
and its strategic direction. Mr. Kaczmarek’s leadership, communication, and decision-making skills are of
particular value to the Board.
ROBERT T. MOLES, age 62, became a director of the Company in 2004. Mr. Moles has been the
Chairman of the Board of Intero Real Estate Services, Inc., a full-service real estate firm since 2002. Prior
to joining Intero, he served as President and Chief Executive Officer of the Real Estate Franchise Group
of Cendant Corporation, the largest franchiser of residential and commercial real estate brokerage offices
in the world. Prior to joining Cendant, he served as President and Chief Executive Officer of Contempo
Realty, Inc. in Santa Clara, California. Mr. Moles contributes to the Board a substantial expertise in the
real estate industry in the Company’s primary market. With over 33 years of experience in executive and
managerial positions, he brings to the Board his skills in dealing with business and financial planning and
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personnel management. With his background, Mr. Moles is particularly suited to serve as a member of the
Compensation Committee.
LAURA RODEN, age 58,
is the founder and managing director of Capital Formation
Consultants LLC, an advisor to alternative asset funds including venture capital, private equity, hedge and
debt funds. Prior to founding Capital Formation Consultants LLC, Ms. Roden was the managing director
for The Angels’ Forum (Palo Alto, CA), an early stage angel and venture capital investing group for high
net worth individuals. For most of Ms. Roden’s prior career she was engaged as chief financial officer at
both established and emerging corporations, including most notably Chronicle Broadcasting Company
(San Francisco, CA) and PowerTV, Inc (acquired by Cisco Corporation, San Jose, CA). Ms. Roden has
expertise in general management, finance, fundraising and marketing. Ms. Roden has taught courses on
finance at San Jose State University, and is a frequent speaker for angel investment and venture capital
groups and associations. Ms. Roden has a Bachelor of Arts degree from Harvard College and Masters in
Business Administration degree from Harvard Business School. Ms. Roden has extensive management
experience in a full range of business operations, strategic planning, marketing strategies and capital
formation for entrepreneurial companies in the technology industry. In addition, with her prior experience
as a chief financial officer, she is particularly suited to chair the Board’s Strategic Initiatives Committee,
serve as a member of the Audit Committee and the Finance and Investment Committee.
RANSON W. WEBSTER, age 72, became a director of the Company in 2004. Mr. Webster founded
Computing Resources, Inc. (‘‘CRI’’) in 1978, a privately-held general purpose data processing service
bureau specializing in payroll processing for small business nationwide. He served as CRI’s Chief
Executive Officer and Chief Financial Officer. In 1999, CRI merged with Intuit, Inc., the maker of
QuickBooks and Quicken financial software. In 1998, Mr. Webster founded Evergreen Capital, LLC, an
early stage investment company focused on Internet and biotech companies. In 2012, Mr. Webster became
the Chief Executive Officer for Chargerback, Inc. a cloud based startup company dedicated to automating
the lost and found process at hotels, airlines, rental car companies and other public spaces. Mr. Webster
contributes to the Board substantial business acumen, executive strategic planning and financial experience
developed through years of proven entrepreneurial success. Mr. Webster has a unique perspective of the
Company from his long-standing service on the Board. He has a general understanding of corporate
governance principles as Chairman of the Board’s Nominating and Corporate Governance Committee.
Recommendation of the Board of Directors
The Board of Directors recommends the election of each nominee. The proxy holders intend to vote all
proxies they hold in favor of the election of each of the nominees. If no instruction is given, the proxy holders
intend to vote FOR each nominee listed.
53
PROPOSAL 2—APPROVAL OF AMENDMENT TO HERITAGE COMMERCE CORP 2013 EQUITY
INCENTIVE PLAN
In 2013 the Board of Directors approved the 2013 Equity Incentive Plan (‘‘2013 Equity Plan’’) to
replace the 2004 Equity Plan. The 2013 Equity Plan was approved by the Company’s shareholders at the
2013 Annual Meeting. When approved, the 2013 Equity Plan authorized the issuance of 1,750,000 shares
of common stock for future issuance of stock awards granted under the 2013 Equity Plan. As of April 3,
2017, under the 2013 Equity Plan 129,202 shares had been issued pursuant to stock awards granted and the
exercise of option, stock options to purchase 1,013,862 shares were outstanding, and 606,936 shares were
available for further grant under the 2013 Equity Plan.
The Board upon recommendation of the Compensation Committee is proposing an amendment to
increase the number of shares available for issuance under the 2013 Equity Plan from 1,750,000 to
3,000,000.
The purpose of the 2013 Equity Plan is to promote the long-term success of the Company and the
creation of shareholder value. The Board of Directors believes that the availability of stock awards is a key
factor in the ability of the Company to attract and retain qualified individuals to serve as directors, officers
and employees. The Board believes that it would be in the best interest of the Company to replenish the
number of shares available for issuance under the 2013 Equity Plan. The additional shares made available
for issuance will increase the number available to 3,000,000 shares. As of April 3, 2017, this represents
approximately 7.9% of our issued and outstanding shares. A copy of the 2013 Equity Plan and the
proposed amendment is attached as Exhibit A to this proxy statement. The following discussion is qualified
in its entirety by reference to the text of the 2013 Equity Plan.
Description of the 2013 Equity Incentive Plan
Under the 2013 Equity Plan incentives are provided through the grant of stock options, stock
appreciation rights, restricted stock awards, restricted stock units, performance shares, and performance
units (individually, an ‘‘Award’’). The 2013 Equity Plan is also intended to permit the Company to grant
Awards that qualify as performance based compensation under Section 162(m) of the Internal Revenue
Code, 1986, as amended.
Shares Subject to 2013 Equity Plan
The 2013 Equity Plan, as amended, will set aside an additional 1,250,000 authorized, but unissued,
shares of common stock for issuance.
Appropriate adjustments will be made in the number of authorized shares and in outstanding Awards
to prevent dilution or enlargement of participants’ rights in the event of a merger, consolidation,
reorganization, reincorporation, recapitalization, reclassification, stock dividend, stock split, reverse stock
split, split-up, split-off, spin-off, combination of shares, exchange of shares or other change in our capital
structure that is effected without receipt of consideration by the Company. Shares subject to Awards which
expire or are cancelled or forfeited will again become available for issuance under the 2013 Equity Plan.
The shares available will not be reduced by Awards settled in cash or by shares withheld to satisfy tax
withholding obligations. Only the net number of shares issued upon the exercise of stock appreciation
rights or options exercised by tender of previously owned shares will be deducted from the shares available
under the 2013 Equity Plan.
Administration. The administrator of our 2013 Equity Plan will be the Compensation Committee.
Subject to the provisions of the 2013 Equity Plan, the Compensation Committee determines in its
discretion the persons to whom and the times at which Awards are granted, the types and sizes of such
Awards, and all of their terms and conditions. All Awards must be evidenced by a written agreement
between us and the participant. The Compensation Committee may amend, cancel or renew any Award,
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waive any restrictions or conditions applicable to any Award, and accelerate, continue, extend or defer the
vesting of any Award. The Committee will not have the authority to reprice, adjust or amend the exercise
price of options or the grant price of stock appreciation rights previously awarded to any participant,
whether through amendment, cancellation and replacement grant, or any other means. The Compensation
Committee has the authority to construe and interpret the terms of the 2013 Equity Plan and Awards
granted under it.
Eligibility. Awards may be granted under the 2013 Equity Plan to our employees, officers, directors,
or consultants or those of any present or future parent or subsidiary corporation or other affiliated entity.
While we grant incentive stock options only to employees, we may grant nonstatutory stock options, stock
appreciation rights, restricted stock awards, restricted stock units, performance shares and performance
units to any eligible participant. The actual number of individuals who will receive an Award under the
2013 Equity Plan cannot be determined in advance because the Compensation Committee has the
discretion to select the participants. The maximum number of shares of stock with respect to an Award or
Awards that may be granted to any participant may not exceed 5% of the total outstanding shares of
common stock issued and outstanding.
Stock Options. The Compensation Committee may grant nonstatutory stock options, ‘‘incentive
stock options,’’ within the meaning of Section 422 of the Code, or any combination of these. The number
of shares of our common stock covered by each option will be determined by the Compensation
Committee.
The exercise price of each option may not be less than the fair market value of a share of our common
stock on the date of grant. Any incentive stock option granted to a person who owns stock possessing more
than 10% of the total combined voting power of all classes of our stock or of any parent or subsidiary
corporation must have an exercise price equal to at least 110% of the fair market value of a share of our
common stock on the date of grant and a term not exceeding five years. In addition, the aggregate fair
market value of the shares (determined on the grant date) covered by incentive stock options which first
become exercisable by any participant during any calendar year may not exceed $100,000. The term of all
options other than any incentive stock option granted to a person who owns stock possessing more than
10% of the total combined voting power of all classes of our stock or of any parent or subsidiary
corporation may not exceed ten years.
Options vest and become exercisable at such times or upon such events and subject to such terms,
conditions, performance criteria or restrictions as specified by the Compensation Committee. Unless a
longer period is provided by the Compensation Committee, an option generally will remain exercisable for
ninety days following the participant’s termination of service, except that if service terminates as a result of
the participant’s death or disability, the option generally will remain exercisable for one year, but in any
event not beyond the expiration of its term.
The exercise price of each option must be paid in full in cash (or cash equivalent) at the time of
exercise, payment through the tender of shares of our common stock that are already owned by the
participant, or through cashless exercise, or by any combination thereof. At the time of exercise, a
participant who is an employee must pay any taxes that the Company is required to withhold.
Stock Appreciation Rights. A stock appreciation right gives a participant the right to receive the
appreciation in the fair market value of our common stock between the date of grant of the Award and the
date of its exercise. We may pay the appreciation either in cash or in shares of our common stock. We may
make this payment in a lump sum, or payment may be deferred in accordance with the terms of the
participant’s Award agreement. The Compensation Committee may grant stock appreciation rights under
the 2013 Equity Plan in tandem with a related stock option or as a freestanding Award. A tandem stock
appreciation right is exercisable only at the time and to the same extent that the related option is
exercisable, and its exercise causes the related option to be canceled. Freestanding stock appreciation
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rights vest and become exercisable at the times and on the terms established by the Compensation
Committee. The maximum term of any stock appreciation right granted under the 2013 Equity Plan is five
years.
Restricted Stock Awards. The Compensation Committee may grant Awards of restricted stock under
the 2013 Equity Plan. Awards of restricted stock may vest subject to the attainment of performance goals
similar to those described below or satisfaction of certain service-based or other vesting conditions as the
Compensation Committee specifies, and the shares acquired may not be transferred by the participant
until vested. Unless otherwise determined by the Compensation Committee, a participant will forfeit any
unvested shares upon voluntary or involuntary termination of service with us for any reason, including
death or disability. Except as otherwise provided in the 2013 Equity Plan or Award agreement, participants
holding restricted stock will have the right to vote the shares and to receive any dividends paid, except that
dividends or other distributions paid in shares will be subject to the same restrictions as the original Award.
Restricted Stock Units. Restricted stock units granted under the 2013 Equity Plan represent a right to
receive shares of our common stock at a future date determined in accordance with the participant’s
Award agreement. The Compensation Committee may grant restricted stock units subject to the
attainment of performance goals similar to those described below, or may make the Awards subject to
service-based and other vesting conditions.
Performance Shares and Performance Units. The Compensation Committee may grant performance
shares and performance units under the 2013 Equity Plan, which are Awards that will result in a payment
to a participant only if specified performance goals are achieved during a specified performance period.
Awards of performance shares are denominated in shares of our common stock, while Awards of
performance units are denominated in dollars. In granting an Award of performance shares or units, the
Compensation Committee establishes the applicable performance goals based on one or more measures of
business performance enumerated in the 2013 Equity Plan and described in the performance goal section
below.
To the extent earned, Awards of performance shares and units may be settled in cash, shares of our
common stock or any combination thereof. Unless otherwise determined by the Compensation
Committee, if a participant’s service terminates due to death or disability prior to completion of the
applicable performance period, the final Award value is determined at the end of the period on the basis of
the performance goals attained during the entire period, but payment is prorated for the portion of the
period during which the participant remained in service. Except as otherwise provided by the 2013 Equity
Plan, if a participant’s service terminates for any other reason, the participant’s performance shares or
units are forfeited.
Performance Goals. The Compensation Committee (in its discretion) may make performance goals
applicable to a participant with respect to an Award, including but not limited to performance shares and
performance units. If the Compensation Committee desires that an Award qualify as performance-based
compensation under Section 162(m), then, at the Compensation Committee’s discretion, one or more of
the following performance goals may apply: revenue, costs, expenses (including expense efficiency ratios
and other expense measures), earnings (including one or more of net profit after tax, gross profit,
operating profit, earnings before interest and taxes, earnings before interest, taxes, depreciation and
amortization and net earnings), earnings per share, earnings per share from continuing operations,
operating income, pre-tax income, operating income margin, net income, margins (including one or more
of gross, operating and net income margins), returns (including one or more of return on actual assets, net
assets, equity, investment, capital and net capital employed), shareholder return (including total
shareholder return relative to an index or peer group), stock price, growth of loans and deposits, economic
value added, cash generation, cash flow, unit volume, working capital, market share, cost reductions and
strategic plan development and implementation. Such goals may reflect absolute entity or business unit
performance or a relative comparison to the performance of a peer group of entities or other external
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measure of the selected performance criteria. Unless otherwise determined by the Compensation
Committee at the time of establishment of the performance goals applicable to an Award, the performance
measures shall be calculated in accordance with generally accepted accounting principles, but prior to the
accrual or payment of any Award subject to performance goals and excluding the effect (whether positive
or negative) of any change in accounting standards or any extraordinary, unusual or nonrecurring item, as
determined by the Compensation Committee, occurring after the establishment of the performance goals
applicable to the Award.
Change in Control. Upon a change of control (as defined in the 2013 Equity Plan) the Company will
notify each participant in writing, no less than thirty (30) days prior to the change of control of participant’s
right to exercise all outstanding options, whether or not vested, and all outstanding options will vest and
become immediately exercisable immediately prior to such change of control. All then outstanding options
will terminate upon the Change of Control; provided, however, that any outstanding options not exercised
as of the occurrence of the change of control will not terminate if there is a successor entity which assumes
the outstanding options or substitutes for such options, new options covering the stock of the successor
entity with appropriate adjustments as to the number and kind of shares and prices. Each restricted stock
award will provide in the event of a change in control for the lapse of the restriction period applicable to
restricted stock effective immediately prior to and conditioned upon the change in control. Each restricted
stock unit award will provide that the settlement of the restricted stock unit effective immediately prior to
and conditioned upon the Change in Control. The Committee, in its sole discretion, may provide in any
stock appreciation right or performance award for the acceleration of the exercisability and vesting of the
stock appreciation right or performance award in connection with a change in control.
Transferability. Awards granted under the 2013 Equity Plan shall not be subject in any manner to
anticipation, alienation, sale, exchange, transfer, assignment, pledge, encumbrance, or garnishment by
creditors of the participant or the participant’s beneficiary, except transfer by will or by the laws of descent
and distribution.
Amendment and Termination. The 2013 Equity Plan shall continue in effect until the earlier of its
termination by the Board of Directors or the date on which all of the shares of our common stock available
for issuance under the 2013 Equity Plan have been issued and all restrictions on such shares under the
terms of the 2013 Equity Plan and the agreements evidencing Awards granted under the 2013 Equity Plan
have lapsed. However, no Awards will be granted under the 2013 Equity Plan after the tenth anniversary of
the 2013 Equity Plan’s effective date.
In addition, the Compensation Committee may amend, suspend or terminate the Equity Plan at any
time, provided that without shareholder approval, the Equity Plan cannot be amended to increase the
number of shares authorized, change the class of persons eligible to receive incentive stock options or
effect any other change that would require shareholder approval under any applicable law or listing rule.
Amendment, suspension or termination of the Equity Plan may not adversely affect any outstanding
Award without the consent of the participant, unless such amendment, suspension or termination is
necessary to comply with applicable law.
Certain United States Federal Income Tax Information
The following paragraphs are a summary of the general federal income tax consequences to U.S.
taxpayers and the Company of Awards granted under the 2013 Equity Plan. Tax consequences for any
particular individual may be different.
The following discussion assumes that the fair market value of our common stock on the date of
exercise is greater than the per share exercise price.
Nonstatutory Stock Options. No taxable income is reportable when a nonstatutory stock option with
an exercise price equal to the fair market value of the underlying stock on the date of grant is granted to a
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participant. Upon exercise, the participant will recognize ordinary income in an amount equal to the excess
of the fair market value (on the exercise date) of the shares purchased over the exercise price of the
option. Any taxable income recognized in connection with an option exercise by an employee of the
Company is subject to tax withholding by the Company. Any additional gain or loss recognized upon any
later disposition of the shares would be long-term or short-term capital gain or loss depending on whether
the holding period for the shares is more than one year.
Incentive Stock Options. No taxable income is reportable when an incentive stock option is granted
or exercised (except that the difference between the value of the option shares at the time of exercise and
the exercise price is included in income for purposes of the federal alternative minimum tax). If the
participant exercises the option and then later sells or otherwise disposes of the shares more than two years
after the grant date and more than one year after the exercise date, the difference between the sale price
and the exercise price will be taxed as capital gain or loss. If the participant exercises the option and then
later sells or otherwise disposes of the shares before the end of the two- or one-year holding periods
described above, he or she generally will have ordinary income at the time of the sale equal to the fair
market value of the shares on the exercise date (or the sale price, if less) minus the exercise price of the
option. Subject to certain exceptions for death or disability, if an option holder exercises an incentive stock
option more than three months after termination of employment, the exercise of the option will be taxed as
the exercise of a nonqualified stock option.
Stock Appreciation Rights. No taxable income is reportable when a stock appreciation right with an
exercise price equal to the fair market value of the underlying stock on the date of grant is granted to a
participant. Upon exercise, the participant will recognize ordinary income (subject to withholding taxes in
the case of an employee) in an amount equal to the amount of cash received and the fair market value of
any shares received. Any additional gain or loss recognized upon any later disposition of the shares would
be long-term or short-term capital gain or loss depending on whether the withholding period for the shares
is more than one year.
Restricted Stock Awards, Restricted Stock Units, Performance Shares and Performance Units. A
participant generally will not have taxable income at the time an Award of restricted stock, restricted stock
units, performance shares, or performance units are granted. Instead, he or she will recognize ordinary
income in the first taxable year in which his or her interest in the shares underlying the Award becomes
either: (i) freely transferable; or (ii) no longer subject to a substantial risk of forfeiture. However, the
recipient of an Award of restricted stock may elect to recognize income at the time he or she receives the
Award in an amount equal to the fair market value of the shares underlying the Award (less any cash paid
for the shares on the date the Award is granted). A participant who makes an election under Section 83(b)
of the Code within thirty days of the date of grant of the restricted stock, will recognize ordinary income on
the date of grant of the shares equal to the excess of the fair market value of the restricted shares
(determined without regard to the risk of forfeiture or restrictions on transfer) over any purchase price
paid for the shares. If a Section 83(b) election has not been made, any dividends received with respect to
restricted shares of stock that are subject at that time to a risk of forfeiture or restrictions on transfer
generally will be treated as compensation that is taxable as ordinary income to the recipient.
Section 409A. Section 409A of the Code contains certain requirements for non-qualified deferred
compensation arrangements, which may include Awards under the 20136 Equity Plan, with respect to an
individual’s deferral and distribution elections and permissible distribution events. Awards granted under
the 2013 Equity Plan with a deferral feature will be subject to the requirements of Section 409A. If an
Award is subject to and fails to satisfy the requirements of Section 409A, the recipient of that Award may
recognize ordinary income on the amounts deferred under the Award, at the time of vesting, which may be
prior to when the compensation is actually or constructively received. Also, if an Award that is subject to
Section 409A fails to comply with Section 409A’s provisions, Section 409A imposes an additional 20%
federal income tax on compensation recognized as ordinary income, as well as interest on such deferred
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compensation. In addition, certain states (such as California) have laws similar to Section 409A and as a
result, failure to comply with such similar laws may result in additional state income, penalty and interest
charges.
Tax Effect for the Company. The Company generally will be entitled to a tax deduction in connection
with an Award under the 2013 Equity Plan in an amount equal to the ordinary income realized by a
participant and at the time the participant recognizes such income (for example, the exercise of a
nonstatutory stock option). Special rules limit the deductibility of compensation paid to the Company’s
Chief Executive Officer and to each of its three most highly compensated executive officers (other than its
Chief Executive Officer and Chief Financial Officer). Under Section 162(m), the annual compensation
paid to any of these specified executives will be deductible only to the extent that it does not exceed
$1,000,000. However, the Company can preserve the deductibility of certain compensation in excess of
$1,000,000 if the conditions of Section 162(m) are met. These conditions include stockholder approval of
the 2013 Equity Plan, setting limits on the amounts of Awards or formula under which Awards are granted
that any individual may receive and, for Awards other than certain stock options and stock appreciation
rights, establishing performance criteria that must be met before the Award actually will vest or be paid.
The 2013 Equity Plan has been designed to permit the Compensation Committee to grant Awards that
qualify as performance-based for purposes of satisfying the conditions of Section 162(m), thereby
permitting the Company to continue to receive a federal income tax deduction in connection with such
Awards.
THE FOREGOING IS ONLY A SUMMARY OF THE EFFECT OF UNITED STATES FEDERAL
INCOME TAXATION UPON PARTICIPANTS AND THE COMPANY WITH RESPECT TO THE
GRANT, EXERCISE AND/OR VESTING OF AWARDS UNDER THE 2013 EQUITY PLAN. IT
DOES NOT PURPORT TO BE COMPLETE, AND DOES NOT DISCUSS THE TAX
CONSEQUENCES OF A PARTICIPANT’S DEATH OR THE PROVISIONS OF THE INCOME TAX
LAWS OF ANY MUNICIPALITY, STATE OR FOREIGN COUNTRY IN WHICH THE
PARTICIPANT MAY RESIDE.
Recommendation of the Board of Directors
The Board recommends a vote FOR the amendment to the Heritage Commerce Corp 2013 Equity
Incentive Plan to increase the number of shares available for issuance. The proxy holders intend to vote all
proxies in favor of this proposal. If no instruction is given, the proxy holders intend to vote FOR the
proposal.
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PROPOSAL 3—RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors, upon the recommendation of its Audit Committee, has ratified the selection
of Crowe Horwath LLP to serve as our independent registered public accounting firm for 2017, subject to
ratification by our shareholders. A representative of Crowe Horwath LLP will be present at the Annual
Meeting to answer questions and will have the opportunity to make a statement if so desired.
We are asking our shareholders to ratify the selection of Crowe Horwath LLP as our independent
registered public accounting firm. Although ratification is not required by our Bylaws, the SEC or The
NASDAQ Stock Market, the Board is submitting the selection of Crowe Horwath LLP to our shareholders
for ratification because we value our shareholders’ views on the Company’s independent registered public
accounting firm and as a matter of good corporate practice. In the event that our shareholders fail to ratify
the selection of Crowe Horwath LLP, however, we reserve the discretion to retain Crowe Horwath LLP as
our independent registered public accounting firm for 2017. Even if the selection is ratified, the Audit
Committee, in its discretion, may select a different independent registered public accounting firm at any
time during the year if it determines that such a change would be in the best interests of the Company and
our shareholders.
Audit Committee Report
In accordance with its written charter adopted by the Company’s Board of Directors, the Audit
Committee assists the Board in fulfilling its responsibility for oversight of the quality and integrity of the
accounting, auditing, and financial reporting practices of the Company. During 2016, the Committee met
12 times. The Committee discussed the interim financial information contained in each quarterly earnings
announcement with the Chief Financial Officer prior to public release. The Committee also discussed the
interim financial statements with the Chief Financial Officer and the independent auditors prior to the
filing of each quarterly Form 10-Q and the annual report on Form 10-K.
In discharging its oversight responsibility as to the audit process, the Audit Committee obtained from
the independent auditors a formal written statement describing all relationships between the auditors and
the Company that might bear on the auditors’ independence, discussed with the auditors any relationships
that may impact their objectivity and independence and satisfied itself as to the auditors’ independence.
The Committee reviewed with both the independent auditors and the internal auditor’s audit plans, scope,
and results.
The Committee discussed and reviewed with the independent auditor all communications required by
the standards of the Public Company Accounting Oversights Board, including those described in Auditing
Standard No. 61, Communication with Audit Committees, and discussed and reviewed the results of the
independent auditor’s audit of the consolidated financial statements. The Committee also reviewed and
discussed the results of the internal audit examinations.
The Committee reviewed the audited financial statements of the Company as of and for the year
ended December 31, 2016, with management and the independent auditors. The Committee has also
reviewed ‘‘Management’s Assessment over Financial Reporting’’ and the independent registered public
accounting firm’s opinion on the effectiveness of the Company’s internal control over financial reporting,
and discussed these reports and opinions with management and the independent registered public
accounting firm prior to the Company’s filing of its Annual Report on Form 10-K for the year ended
December 31, 2016.
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Based on the above mentioned review and discussion with management and the independent auditors,
the Committee recommended to the Board of Directors that the Company’s audited financial statements
be included in its Annual Report on Form 10-K for the year ended December 31, 2016, for filing with the
SEC.
Heritage Commerce Corp
Audit Committee
Steven L. Hallgrimson, Chairman
Julianne M. Biagini-Komas
Laura Roden
March 2, 2017
The Audit Committee report shall not be deemed incorporated by reference by any general statement
incorporating by reference this proxy statement into any filing under the Securities Act of 1933 or the Securities
Act of 1934, and shall not otherwise be deemed filed under these Acts.
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Independent Registered Public Accounting Firm Fees
The following table summarizes the aggregate fees billed to the Company by its independent auditor:
Category of Services
Fiscal Year
2016
Fiscal Year
2015
Audit fees(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Audit-related fees(2)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax fees(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$385,000
72,100
127,350
40,000
$482,469
81,905
124,800
77,012
Total accounting fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$624,450
$766,186
(1) Fees for audit services for 2016 and 2015 consisted of the audit of the Company’s annual
financial statements, review of the consolidated financial statements included in the
Company’s Quarterly Reports on Form 10-Q, and the audit of the Company’s internal
control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of
2002.
(2) Fees for audit related services for 2016 and 2015 consisted of financial accounting and
reporting consultations, consents and other services related to SEC matters, and audits of
the consolidated financial statements of the Company’s employee benefit plans.
(3) Fees for tax services for 2016 and 2015 consisted of tax compliance and tax planning and
advice.
(cid:129) Fees for tax compliance services totaled $69,350 and $50,950 in 2016 and 2015,
respectively. Tax compliance services are those rendered based upon facts already in
existence or transactions that have already occurred to document, compute, and obtain
government approval for amounts to be included in tax filings. Such services consisted
primarily of preparation of the Company’s consolidated federal and state income tax
returns, trust preferred returns and a limited liability company tax return for a subsidiary
entity.
(cid:129) Tax planning and advice services are those rendered with respect to proposed transactions,
assistance regarding the Internal Revenue Code Section 280(G) ‘‘excise tax gross-up’’
disclosures in the proxy statement for hypothetical events, and consultation with
management regarding various internal control and accounting matters. Tax planning and
advice services totaled $58,000 and $73,850 in 2016 and 2015, respectively.
The ratio of tax planning and advice fees and all other fees to audit fees, audit-related fees and tax
compliance fees was 18.62% for 2016 and 24.52% for 2015.
In considering the nature of the services provided by the independent registered public accounting
firm, the Audit Committee determined that such services are compatible with the provision of independent
audit services. The Audit Committee discussed these services with the independent registered public
accounting firm and Company management to determine that they are permitted under the rules and
regulations concerning auditor independence promulgated by the SEC and the Public Company
Accounting Oversight Board.
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Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent
Registered Public Accounting Firm
Under applicable SEC rules, the Audit Committee is required to pre-approve the audit and non-audit
services performed by the independent registered public accountants in order to ensure that they do not
impair the auditors’ independence. The SEC’s rules specify the types of non-audit services that the
independent registered public accountants may not provide to its audit client and establish the Audit
Committee’s responsibility for administration of the engagement of the independent registered public
accountants.
Consistent with the SEC’s rules, the Audit Committee Charter requires that the Audit Committee
review and pre-approve all audit services and permitted non-audit services provided by the independent
registered public accountants to the Company or any of its subsidiaries. The Audit Committee may
delegate pre-approval authority to the Chair of the Audit Committee and if it does, the decisions of that
member must be presented to the full Audit Committee at its next scheduled meeting.
Recommendation of the Audit Committee and the Board of Directors
The Audit Committee of the Board of Directors and the Board of Directors recommends approval of the
ratification of the appointment of Crowe Horwath LLP as the Company’s independent registered public
accounting firm for the year ending December 31, 2017. The proxy holders intend to vote all proxies they
hold in favor of the proposal. If no instruction is given, the proxy holders intend to vote FOR approval of the
proposal.
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OTHER BUSINESS
If any matters not referred to in this proxy statement come before the meeting, including matters
incident to conducting the meeting, the proxy holders will vote the shares represented by proxies in
accordance with their best judgment. Management is not aware of any other business to come before the
meeting and, as of the date of the preparation of this proxy statement, no shareholder has submitted to
management any proposal to be acted upon at the meeting.
SHAREHOLDER PROPOSALS
Any shareholder that intends to propose business to be considered at the 2018 Annual Meeting must
comply with the Company’s Bylaws including providing the required notice to the Company’s Corporate
Secretary not later than the close of business on February 26, 2018 nor earlier than January 25, 2018. If a
shareholder gives notice of such a proposal before or after these deadlines, proxy holders will be allowed to
use their discretionary voting authority to vote against the shareholder proposal without discussion when
and if the proposal is raised at the 2018 Annual Meeting of Shareholders.
Proposals of shareholders intended to be presented for consideration at the 2018 Annual Meeting of
Shareholders, and to be included in the Company’s proxy statement for that meeting under SEC
Rule 14a-8, must be received by the Company for inclusion in the proxy statement and form of proxy for
that meeting no later than December 18, 2018, in a form that complies with applicable regulations.
HERITAGE COMMERCE CORP
24MAR201019341637
Debbie Reuter
Executive Vice President
and Corporate Secretary
April 19, 2017
San Jose, California
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EXHIBIT A
AMENDMENT NO. 1 TO HERITAGE COMMERCE CORP
2013 EQUITY INCENTIVE PLAN
This Amendment No. 1 to the Heritage Commerce Corp 2013 Equity Incentive Plan is dated as of
May 25, 2017.
RECITALS
1. The Heritage Commerce Corp 2013 Equity Incentive Plan (the ‘‘Plan’’) was approved by the
Heritage Commerce Corp (the ‘‘Company’’) shareholders on May 23, 2013.
2.
Pursuant to Section 15 of the Plan, the Board of Directors and shareholders may amend the Plan
from time to time.
3. The Board of Directors, upon recommendation of the Compensation Committee, believes it is in
the best interest of the Company and its shareholders to amend the Plan in accordance with the terms of
this Amendment No. 1, the form of which has been approved by the Board of Directors and shareholders.
AMENDMENT
SECTION 1. The first sentence of Section 4.1 is amended and restated in full to read as follows:
‘‘Subject to adjustment as provided in Section 4.2, the maximum aggregate number of shares of
Stock that may be issued under the Plan shall be three million (3,000,000) and shall consist of
authorized but unissued or reacquired shares of Stock or any combination thereof.’’
SECTION 2. This Amendment shall take effect as of May 25, 2017. Through May 25, 2017 the terms
of the Plan shall be applied without giving effect to this Amendment, subject to approval of the
Amendment by the Board of Directors and shareholders.
SECTION 3. Except as provided in this Amendment No. 1, the provisions, terms and conditions of
the Plan shall remain in full force and effect.
A-1
HERITAGE COMMERCE CORP
2013 Equity Incentive Plan
1. ESTABLISHMENT, PURPOSE AND TERM OF PLAN.
1.1 Establishment. The Heritage Commerce Corp 2013 Equity Incentive Plan (the ‘‘Plan’’) is
hereby established effective as of May 23, 2013, the date of its approval by the shareholders of the
Company (the ‘‘Effective Date’’).
1.2 Purpose. The purpose of the Plan is to advance the interests of the Company, its
subsidiaries, and its shareholders by providing an incentive to attract, retain and reward persons
performing services for the Company and its subsidiaries and by motivating such persons to contribute
to the growth and profitability of the Company and its subsidiaries. The Plan seeks to achieve this
purpose by providing for Awards in the form of Options, Stock Appreciation Rights, Restricted Stock,
Performance Shares, Performance Units and Restricted Stock Units.
1.3 Term of Plan. The Plan shall continue in effect until the earlier of its termination by the
Board or the date on which all of the shares of Stock available for issuance under the Plan have been
issued and all restrictions on such shares under the terms of the Plan and the agreements evidencing
Awards granted under the Plan have lapsed. However, all Awards shall be granted, if at all, within ten
(10) years from the Effective Date.
2. DEFINITIONS AND CONSTRUCTION.
2.1 Definitions. Whenever used herein, the following terms shall have their respective
meanings set forth below:
(a) ‘‘Affiliate’’ means (i) an entity, other than a Parent Corporation, that directly, or
indirectly through one or more intermediary entities, controls the Company or (ii) an entity,
other than a Subsidiary Corporation, that is controlled by the Company directly, or indirectly
through one or more intermediary entities. For this purpose, the term ‘‘control’’ (including the
term ‘‘controlled by’’) means the possession, direct or indirect, of the power to direct or cause the
direction of the management and policies of the relevant entity, whether through the ownership
of voting securities, by contract or otherwise; or shall have such other meaning assigned such
term for the purposes of registration on Form S-8 under the Securities Act.
(b) ‘‘Award’’ means any Option, SAR, Restricted Stock, Performance Share, Performance
Unit or Restricted Stock Unit granted under the Plan.
(c)
‘‘Award Agreement’’ means a written agreement between the Company and a Participant
setting forth the terms, conditions and restrictions of the Award granted to the Participant. An
Award Agreement may be an ‘‘Option Agreement,’’ an ‘‘SAR Agreement,’’ a ‘‘Restricted Stock
Agreement,’’ a ‘‘Performance Share Agreement,’’ a ‘‘Performance Unit Agreement’’ or a
‘‘Restricted Stock Unit Agreement.’’
(d) ‘‘Board’’ means the Board of Directors of the Company.
(e) ‘‘Cause’’ means, unless otherwise defined by the Participant’s Award Agreement or
contract of employment or service, any of the following: (i) the Participant’s theft, dishonesty, or
falsification of any Participating Company documents or records; (ii) the Participant’s improper
use or disclosure of a Participating Company’s confidential or proprietary information; (iii) any
action by the Participant which has a detrimental effect on a Participating Company’s reputation
or business; (iv) the Participant’s failure or inability to perform any reasonable assigned duties
after written notice from a Participating Company of, and a reasonable opportunity to cure, such
failure or inability; (v) any material breach by the Participant of any employment or service
agreement between the Participant and a Participating Company, which breach is not cured
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pursuant to the terms of such agreement; or (vi) the Participant’s conviction (including any plea
of guilty or nolo contendere) of any criminal act which impairs the Participant’s ability to perform
his or her duties with a Participating Company.
(f)
‘‘Change of Control’’ has the meaning set forth in Section 12.1(b).
(g) ‘‘Code’’ means the Internal Revenue Code of 1986, as amended, and any applicable
regulations promulgated thereunder.
(h) ‘‘Committee’’ means the Compensation Committee or other committee of the Board
duly appointed to administer the Plan and having such powers as shall be specified by the Board.
If no committee of the Board has been appointed to administer the Plan, the Board shall exercise
all of the powers of the Committee granted herein, and, in any event, the Board may in its
discretion exercise any or all of such powers.
(i)
‘‘Company’’ means Heritage Commerce Corp, a California corporation, or any
successor corporation thereto.
(j)
‘‘Consultant’’ means a person engaged to provide consulting or advisory services (other
than as an Employee or a member of the Board) to a Participating Company, provided that the
identity of such person, the nature of such services or the entity to which such services are
provided would not preclude the Company from offering or selling securities to such person
pursuant to the Plan in reliance on registration on a Form S-8 Registration Statement under the
Securities Act.
(k) ‘‘Director’’ means a member of the Board.
(l)
‘‘Disability’’ means the permanent and total disability of the Participant, within the
meaning of Section 22(e)(3) of the Code.
(m) ‘‘Dividend Equivalent’’ means a credit, made at the discretion of the Committee or as
otherwise provided by the Plan, to the account of a Participant in an amount equal to the cash
dividends paid on one share of Stock for each share of Stock represented by an Award held by
such Participant.
(n) ‘‘Employee’’ means any person treated as an employee (including an Officer or a
member of the Board who is also treated as an employee) in the records of a the Company and,
with respect to any Incentive Stock Option granted to such person, who is an employee for
purposes of Section 422 of the Code; provided, however, that neither service as a member of the
Board nor payment of a director’s fee shall be sufficient to constitute employment for purposes of
the Plan. The Company shall determine in good faith and in the exercise of its discretion whether
an individual has become or has ceased to be an Employee and the effective date of such
individual’s employment or termination of employment, as the case may be. For purposes of an
individual’s rights, if any, under the Plan as of the time of the Company’s determination, all such
determinations by the Company shall be final, binding and conclusive, notwithstanding that the
Company or any court of law or governmental agency subsequently makes a contrary
determination.
(o) ‘‘Exchange Act’’ means the Securities Exchange Act of 1934, as amended.
(p) ‘‘Fair Market Value’’ means, as of any date, the value of a share of Stock or other property
as determined by the Committee, in its discretion, or by the Company, in its discretion, if such
determination is expressly allocated to the Company herein, subject to the following:
(i)
If, on such date, the Stock is listed on a national or regional securities exchange or
market system, the Fair Market Value of a share of Stock shall be the closing price of a share
of Stock (or the mean of the closing bid and asked prices of a share of Stock if the Stock is so
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quoted instead) as quoted on The Nasdaq Stock Market, the New York Stock Exchange or
such other national or regional securities exchange or market system constituting the
primary market for the Stock, as reported in The Wall Street Journal or such other source as
the Company deems reliable. If the relevant date does not fall on a day on which the Stock
has traded on such securities exchange or market system, the date on which the Fair Market
Value shall be established shall be the last day on which the Stock was so traded prior to the
relevant date, or such other appropriate day as shall be determined by the Committee, in its
discretion.
(ii) If, on such date, the Stock is not readily tradable on an established securities
market, the Fair Market Value of a share of Stock shall be as determined by the Committee
by reasonable application of a reasonable valuation method, consistently applied.
Notwithstanding the foregoing, no Award granted under the Plan is intended to provide for
a deferral of compensation within the meaning of Section 409A such that the Fair Market
Value of a share of Stock shall be determined in all respects in a manner that is consistent
with that intention.
(q) ‘‘Incentive Stock Option’’ means an Option intended to be (as set forth in the Award
Agreement) and which qualifies as an incentive stock option within the meaning of
Section 422(b) of the Code.
(r)
‘‘Insider’’ means an Officer, a member of the Board or any other person whose
transactions in Stock are subject to Section 16 of the Exchange Act.
(s)
‘‘Nonstatutory Stock Option’’ means an Option not intended to be (as set forth in the
Award Agreement) an incentive stock option within the meaning of Section 422(b) of the Code.
(t)
‘‘Officer’’ means any person designated by the Board as an officer of the Company.
(u) ‘‘Option’’ means the right to purchase Stock at a stated price for a specified period of
time granted to a Participant pursuant to Section 6 of the Plan. An Option may be either an
Incentive Stock Option or a Nonstatutory Stock Option.
(v)
‘‘Ownership Change Event’’ has the meaning set forth in Section 12.1(a).
(w) ‘‘Parent Corporation’’ means any present or future ‘‘parent corporation’’ of the
Company, as defined in Section 424(e) of the Code.
(x)
‘‘Participant’’ means any eligible person who has been granted one or more Awards.
(y)
‘‘Participating Company’’ means the Company or any Parent Corporation, Subsidiary
Corporation or Affiliate.
(z)
‘‘Participating Company Group’’ means, at any point in time, all entities collectively
which are then Participating Companies.
(aa) ‘‘Performance Award’’ means an Award of Performance Shares or Performance Units.
(bb) ‘‘Performance Award Formula’’ means, for any Performance Award, a formula or table
established by the Committee pursuant to Section 9.3 of the Plan which provides the basis for
computing the value of a Performance Award at one or more threshold levels of attainment of
the applicable Performance Goal(s) measured as of the end of the applicable Performance
Period.
(cc) ‘‘Performance Goal’’ means a performance goal established by the Committee pursuant
to Section 9.3 of the Plan.
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(dd) ‘‘Performance Period’’ means a period established by the Committee pursuant to
Section 9.3 of the Plan at the end of which one or more Performance Goals are to be measured.
(ee) ‘‘Performance Share’’ means a bookkeeping entry representing a right granted to a
Participant pursuant to Section 9 of the Plan to receive a payment equal to the value of a
Performance Share, as determined by the Committee, based on performance.
(ff) ‘‘Performance Unit’’ means a bookkeeping entry representing a right granted to a
Participant pursuant to Section 9 of the Plan to receive a payment equal to the value of a
Performance Unit, as determined by the Committee, based upon performance.
(gg) ‘‘Restricted Stock Award’’ means an Award of a Restricted Stock.
(hh) ‘‘Restricted Stock Unit’’ means a bookkeeping entry representing a right granted to a
Participant pursuant to Section 10 of the Plan to receive a share of Stock on a date determined in
accordance with the provisions of Section 10 and the Participant’s Award Agreement.
(ii) ‘‘Restriction Period’’ means the period established in accordance with Section 8.5 of the
Plan during which shares subject to a Restricted Stock Award are subject to Vesting Conditions.
(jj) ‘‘Rule 16b-3’’ means Rule 16b-3 under the Exchange Act, as amended from time to time,
or any successor rule or regulation.
(kk) ‘‘SAR’’ or ‘‘Stock Appreciation Right’’ means a bookkeeping entry representing, for
each share of Stock subject to such SAR, a right granted to a Participant pursuant to Section 7 of
the Plan to receive payment of an amount equal to the excess, if any, of the Fair Market Value of
a share of Stock on the date of exercise of the SAR over the exercise price.
(ll) ‘‘Section 162(m)’’ means Section 162(m) of the Code.
(mm) ‘‘Securities Act’’ means the Securities Act of 1933, as amended.
(nn) ‘‘Service’’ means a Participant’s employment or service with the Participating Company
Group, whether in the capacity of an Employee, a Director or a Consultant. A Participant’s
Service shall not be deemed to have terminated merely because of a change in the capacity in
which the Participant renders such Service or a change in the Participating Company for which
the Participant renders such Service, provided that there is no interruption or termination of the
Participant’s Service. Furthermore, a Participant’s Service shall not be deemed to have
terminated if the Participant takes any military leave, sick leave, or other bona fide leave of
absence approved by the Company. However, if any such leave taken by a Participant exceeds
ninety (90) days, then on the one hundred eighty-first (181st) day following the commencement
of such leave any Incentive Stock Option held by the Participant shall cease to be treated as an
Incentive Stock Option and instead shall be treated thereafter as a Nonstatutory Stock Option,
unless the Participant’s right to return to Service with the Participating Company Group is
guaranteed by statute or contract. Notwithstanding the foregoing, unless otherwise designated by
the Company or required by law, a leave of absence shall not be treated as Service for purposes of
determining vesting under the Participant’s Award Agreement. A Participant’s Service shall be
deemed to have terminated upon an actual termination of Service. Subject to the foregoing, the
Company, in its discretion, shall determine whether the Participant’s Service has terminated and
the effective date of such termination.
(oo) ‘‘Specified Employee’’ means a
specified employee as defined
in Code
Section 409A(a)(2)(B) of the Code or Treasury Regulations under Code Section 409A.
(pp) ‘‘Stock’’ means the common stock of the Company, as adjusted from time to time in
accordance with Section 4.2 of the Plan.
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(qq) ‘‘Subsidiary Corporation’’ means any present or future ‘‘subsidiary corporation’’ of the
Company, as defined in Section 424(f) of the Code.
(rr) ‘‘Ten Percent Owner’’ means a Participant who, at the time an Option is granted to the
Participant, owns stock possessing more than ten percent (10%) of the total combined voting
power of all classes of stock of a Participating Company (other than an Affiliate) within the
meaning of Section 422(b)(6) of the Code.
(ss) ‘‘Treasury Regulations’’ means Proposed Temporary and Final Regulations of the United
States Treasury Department issued under Title 26 of the Code of Federal Regulations.
(tt) ‘‘Vesting Conditions’’ mean those conditions established in accordance with Section 6.2,
Section 8.5 or Section 10.3 of the Plan prior to the satisfaction of which Options, shares subject to
a Restricted Stock Award or Restricted Stock Unit Award, respectively, remain subject to
forfeiture in favor of the Company upon the Participant’s termination of Service.
2.2 Construction. Captions and titles contained herein are for convenience only and shall not
affect the meaning or interpretation of any provision of the Plan. Except when otherwise indicated by
the context, the singular shall include the plural and the plural shall include the singular. Use of the
term ‘‘or’’ is not intended to be exclusive, unless the context clearly requires otherwise. Reference to
any statute, law, regulation or rule means such statute, law, regulation, rule as amended, modified, or
replaced, in whole or in part, and in effect from time to time.
3. ADMINISTRATION.
3.1 Administration by the Committee. The Plan shall be administered by the Committee. All
questions of interpretation of the Plan or of any Award shall be determined by the Committee, and
such determinations shall be final and binding upon all persons having an interest in the Plan or such
Award.
3.2 Authority of Officers. Any Officer shall have the authority to act on behalf of the Company
with respect to any matter, right, obligation, determination or election which is the responsibility of or
which is allocated to the Company herein, provided the Officer has apparent authority with respect to
such matter, right, obligation, determination or election.
3.3 Administration with Respect to Insiders. With respect to participation by Insiders in the
Plan, at any time that any class of equity security of the Company is registered pursuant to Section 12
of the Exchange Act, the Plan shall be administered in compliance with the requirements, if any, of
Rule 16b-3.
3.4 Committee Complying with Section 162(m).
‘‘publicly held
corporation’’ within the meaning of Section 162(m), the Board may establish a Committee of ‘‘outside
directors’’ within the meaning of Section 162(m) to approve the grant of any Award which might
reasonably be anticipated to result in the payment of employee remuneration that alone or when
combined with other employee remuneration would otherwise exceed the limit on employee
remuneration deductible for income tax purposes pursuant to Section 162(m).
If the Company is a
3.5 Powers of the Committee.
In addition to any other powers set forth in the Plan and subject
to the provisions of the Plan, the Committee shall have the full and final power and authority, in its
discretion:
(a) to determine the persons to whom, and the time or times at which, Awards shall be
granted and the number of shares of Stock or units to be subject to each Award;
(b) to determine the type of Award granted and to designate Options as Incentive Stock
Options or Nonstatutory Stock Options;
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(c)
to determine the Fair Market Value of shares of Stock or other property;
(d) to determine the terms, conditions and restrictions applicable to each Award (which
need not be identical) and any shares acquired pursuant thereto, including, without limitation,
(i) the exercise or purchase price of shares purchased pursuant to any Award, (ii) the method of
payment for shares purchased pursuant to any Award, (iii) the method for satisfaction of any tax
withholding obligation arising in connection with any Award, including by the withholding or
delivery of shares of Stock, (iv) the timing, terms and conditions of the exercisability or vesting of
any Award or any shares acquired pursuant thereto, (v) the Performance Award Formula and
Performance Goals applicable to any Award and the extent to which such Performance Goals
have been attained, (vi) the time of the expiration of any Award, (vii) the effect of the
Participant’s termination of Service on any of the foregoing, and (viii) all other terms, conditions
and restrictions applicable to any Award or shares acquired pursuant thereto not inconsistent
with the terms of the Plan;
(e) to determine whether an Award of SARs, Performance Shares or Performance Units
will be settled in shares of Stock, cash, or in any combination thereof;
(f)
to approve one or more forms of Award Agreement;
(g) to amend, modify, extend, cancel or renew any Award or to waive any restrictions or
conditions applicable to any Award or any shares acquired pursuant thereto, except as otherwise
permitted in connection with an event as provided under Section 4.2, the Committee shall not
reprice, adjust or amend the exercise price of Options or the grant price of Stock Appreciation
Rights previously awarded to any Participant, whether through amendment, cancellation and
replacement grant, or any other means, nor shall the Committee have any authority to take such
action with respect to any Award subject to and not exempt from Section 409A;
(h) to accelerate, continue, extend or defer the exercisability or vesting of any Award or any
shares acquired pursuant thereto, including with respect to the period following a Participant’s
termination of Service, except that the Committee shall have no authority to take such action
with respect to any Award that is subject to and is not exempt from the application of
Section 409A;
(i)
to amend, modify or correct any defect in the Plan or any Award in order to avoid the
application of Sections 162(m), 280G or 409A of the Code to any Award or to the Plan;
(j)
to prescribe, amend or rescind rules, guidelines and policies relating to the Plan, or to
adopt sub-plans or supplements to, or alternative versions of, the Plan, including, without
limitation, as the Committee deems necessary or desirable to comply with the laws or regulations
of or to accommodate the tax policy, accounting principles or custom of, foreign jurisdictions
whose citizens may be granted Awards; and
(k) to correct any defect, supply any omission or reconcile any inconsistency in the Plan or
any Award Agreement and to make all other determinations and take such other actions with
respect to the Plan or any Award as the Committee may deem advisable to the extent not
inconsistent with the provisions of the Plan or applicable law.
3.6 Indemnification.
In addition to such other rights of indemnification as they may have as
members of the Board or the Committee or as officers or employees of the Participating Company
Group, members of the Board or the Committee and any officers or employees of the Participating
Company Group to whom authority to act for the Board, the Committee or the Company is delegated
shall be indemnified by the Company against all reasonable expenses, including attorneys’ fees,
actually and necessarily incurred in connection with the defense of any action, suit or proceeding, or in
connection with any appeal therein, to which they or any of them may be a party by reason of any
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action taken or failure to act under or in connection with the Plan, or any right granted hereunder,
and against all amounts paid by them in settlement thereof (provided such settlement is approved by
independent legal counsel selected by the Company) or paid by them in satisfaction of a judgment in
any such action, suit or proceeding, except in relation to matters as to which it shall be adjudged in
such action, suit or proceeding that such person is liable for gross negligence, bad faith or intentional
misconduct in duties; provided, however, that within sixty (60) days after the institution of such action,
suit or proceeding, such person shall offer to the Company, in writing, the opportunity at its own
expense to handle and defend the same.
4.
SHARES SUBJECT TO PLAN.
4.1 Maximum Number of Shares Issuable. Subject to adjustment as provided in Section 4.2,
the maximum aggregate number of shares of Stock that may be issued under the Plan shall be one
million seven hundred and fifty thousand (1,750,000) and shall consist of authorized but unissued or
reacquired shares of Stock or any combination thereof. If an outstanding Award for any reason
expires or is terminated or canceled without having been exercised or settled in full, or if shares of
Stock acquired pursuant to an Award subject to forfeiture or repurchase are forfeited or repurchased
by the Company at the Participant’s purchase price, the shares of Stock allocable to the terminated
portion of such Award or such forfeited or repurchased shares of Stock shall again be available for
issuance under the Plan. Shares of Stock shall not be deemed to have been issued pursuant to the Plan
(a) with respect to any portion of an Award that is settled in cash or (b) to the extent such shares are
withheld in satisfaction of tax withholding obligations pursuant to Section 14. Upon payment in shares
of Stock pursuant to the exercise of an SAR, the number of shares available for issuance under the
Plan shall be reduced only by the number of shares actually issued in such payment. If the exercise
price of an Option is paid by tender to the Company, or attestation to the ownership, of shares of
Stock owned by the Participant, the number of shares available for issuance under the Plan shall be
reduced by the net number of shares for which the Option is exercised.
the Company, whether
through merger, consolidation,
4.2 Adjustments for Changes in Capital Structure. Subject to any required action by the
shareholders of the Company, in the event of any change in the Stock effected without receipt of
consideration by
reorganization,
reincorporation, recapitalization, reclassification, stock dividend, stock split, reverse stock split,
split-up, split-off, spin-off, combination of shares, exchange of shares, or similar change in the capital
structure of the Company, or in the event of payment of a dividend or distribution to the shareholders
of the Company in a form other than Stock (excepting normal cash dividends) that has a material
effect on the Fair Market Value of shares of Stock, appropriate adjustments shall be made in the
number and class of shares subject to the Plan and to any outstanding Awards, and in the exercise or
purchase price per share under any outstanding Award in order to prevent dilution or enlargement of
Participants’ rights under the Plan. For purposes of the foregoing, conversion of any convertible
securities of the Company shall not be treated as ‘‘effected without receipt of consideration by the
Company.’’ Any fractional share resulting from an adjustment pursuant to this Section 4.2 shall be
rounded down to the nearest whole number, and in no event may the exercise or purchase price under
any Award be decreased to an amount less than the par value, if any, of the stock subject to such
Award. The adjustments determined by the Committee pursuant to this Section 4.2 shall be final,
binding and conclusive.
5. ELIGIBILITY AND AWARD LIMITATIONS.
5.1 Persons Eligible for Awards. Awards may be granted only to Employees, Consultants and
Directors. For purposes of the foregoing sentence, ‘‘Employees,’’ ‘‘Consultants’’ and ‘‘Directors’’ shall
include prospective Employees, prospective Consultants and prospective Directors to whom Awards
are granted in connection with written offers of an employment or other service relationship with the
Participating Company Group; provided, however, that no Stock subject to any such Award shall vest,
become exercisable or be issued prior to the date on which such person commences Service. The
maximum number of shares of Stock with respect to an Award or Awards may be granted to any
Participant under the Plan shall not exceed five percent (5%) of the total outstanding shares of Stock
issued and outstanding.
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5.2 Participation. Awards are granted solely at the discretion of the Committee. Eligible
persons may be granted more than one (1) Award. However, eligibility in accordance with this Section
shall not entitle any person to be granted an Award, or, having been granted an Award, to be granted
an additional Award.
5.3 Incentive Stock Option Limitations.
(a) Persons Eligible. An Incentive Stock Option may be granted only to a person who, on
the effective date of grant, is an Employee of the Company, a Parent Corporation or a Subsidiary
Corporation (each being an ‘‘ISO-Qualifying Corporation’’). Any person who is not an Employee
of an ISO-Qualifying Corporation on the date of the grant of an Option to such person may be
granted only a Nonstatutory Stock Option. An Incentive Stock Option granted to a prospective
Employee upon the condition that such person become an Employee of an ISO-Qualifying
Corporation shall be deemed granted effective on the date such person commences Service with
an ISO-Qualifying Corporation, with an exercise price determined as of such date in accordance
with Section 6.1.
(b) Fair Market Value Limitation. To the extent that options designated as Incentive Stock
Options (granted under all stock option plans of the Participating Company Group, including the
Plan) become exercisable by a Participant for the first time during any calendar year for stock
having a Fair Market Value greater than One Hundred Thousand Dollars ($100,000), the portion
of such options which exceeds such amount shall be treated as Nonstatutory Stock Options. For
purposes of this Section, options designated as Incentive Stock Options shall be taken into
account in the order in which they were granted, and the Fair Market Value of stock shall be
determined as of the time the option with respect to such stock is granted. If the Code is
amended to provide for a different limitation from that set forth in this Section, such different
limitation shall be deemed incorporated herein effective as of the date and with respect to such
Options as required or permitted by such amendment to the Code. If an Option is treated as an
Incentive Stock Option in part and as a Nonstatutory Stock Option in part by reason of the
limitation set forth in this Section, the Participant may designate which portion of such Option
the Participant is exercising. In the absence of such designation, the Participant shall be deemed
to have exercised the Incentive Stock Option portion of the Option first. Upon exercise, shares
issued pursuant to each such portion shall be separately identified.
6. TERMS AND CONDITIONS OF OPTIONS. Options shall be evidenced by Award
Agreements specifying the number of shares of Stock covered thereby, in such form as the Committee shall
from time to time establish. No Option or purported Option shall be a valid and binding obligation of the
Company unless evidenced by a fully executed Award Agreement. Award Agreements evidencing Options
may incorporate all or any of the terms of the Plan by reference and shall comply with and be subject to the
following terms and conditions:
6.1 Exercise Price. The exercise price for each Option shall be established in the discretion of
the Committee; provided, however, that (a) the exercise price per share shall be not less than the Fair
Market Value of a share of Stock on the date of grant of the Option and (b) no Incentive Stock
Option granted to a Ten Percent Owner shall have an exercise price per share less than one hundred
ten percent (110%) of the Fair Market Value of a share of Stock on the effective date of grant of the
Option. Notwithstanding the foregoing, an Option (whether an Incentive Stock Option or a
Nonstatutory Stock Option) may be substituted for another option or an Option may be assumed in a
corporate transaction and not be treated as the grant of an Option if the substitution or modification
qualifies under the provisions of Section 424(a) of the Code and the Treasury Regulations issued
thereunder or under Section 409A, as applicable.
6.2 Exercisability and Term of Options. Options shall be exercisable at such time or times, or
upon such event or events, and subject to such terms, conditions, performance criteria and restrictions
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as shall be determined by the Committee and set forth in the Award Agreement evidencing such
Option; provided, however, that (a) no Option shall be exercisable after the expiration of ten
(10) years after the effective date of grant of such Option, (b) no Incentive Stock Option granted to a
Ten Percent Owner shall be exercisable after the expiration of five (5) years after the effective date of
grant of such Option, and (c) no Option granted to a prospective Employee, prospective Consultant
or prospective Director may become exercisable prior to the date on which such person commences
Service. Subject to the foregoing, unless otherwise specified by the Committee in the grant of an
Option, any Option granted hereunder shall terminate ten (10) years after the effective date of grant
of the Option, unless earlier terminated in accordance with its provisions.
6.3 Payment of Exercise Price.
(a) Forms of Consideration Authorized. Except as otherwise provided below, payment of
the exercise price for the number of shares of Stock being purchased pursuant to any Option shall
be made (i) in cash, by check or in cash equivalent, (ii) by tender to the Company, or attestation
to the ownership, of shares of Stock owned by the Participant having a Fair Market Value not less
than the exercise price, (iii) by delivery of a properly executed notice of exercise together with
irrevocable instructions to a broker providing for the assignment to the Company of the proceeds
of a sale or loan with respect to some or all of the shares being acquired upon the exercise of the
Option (including, without limitation, through an exercise complying with the provisions of
Regulation T as promulgated from time to time by the Board of Governors of the Federal
Reserve System) (a ‘‘Cashless Exercise’’), (iv) by such other consideration as may be approved by
the Committee from time to time to the extent permitted by applicable law, or (v) by any
combination thereof. The Committee may at any time or from time to time grant Options which
do not permit all of the foregoing forms of consideration to be used in payment of the exercise
price or which otherwise restrict one or more forms of consideration.
(b) Limitations on Forms of Consideration.
(i) Tender of Stock. Notwithstanding the foregoing, an Option may not be exercised
by tender to the Company, or attestation to the ownership, of shares of Stock to the extent
such tender or attestation would constitute a violation of the provisions of any law,
regulation or agreement restricting the redemption of the Company’s stock. Unless
otherwise provided by the Committee, an Option may not be exercised by tender to the
Company, or attestation to the ownership, of shares of Stock unless such shares either have
been owned by the Participant for more than six (6) months (and not used for another
Option exercise by attestation during such period) or were not acquired, directly or
indirectly, from the Company.
(ii) Cashless Exercise. The Company reserves, at any and all times, the right, in the
Company’s sole and absolute discretion, to establish, decline to approve or terminate any
program or procedures for the exercise of Options by means of a Cashless Exercise,
including with respect to one or more Participants specified by the Company notwithstanding
that such program or procedures may be available to other Participants.
6.4 Effect of Termination of Service.
(a) Option Exercisability. Subject to earlier termination of the Option as otherwise
provided herein and unless otherwise provided by the Committee in the grant of an Option and
set forth in the Award Agreement, an Option shall be exercisable after a Participant’s termination
of Service only during the applicable time period determined in accordance with this Section and
thereafter shall terminate:
(i) Disability.
If the Participant’s Service terminates because of the Disability of the
Participant, the Option, to the extent unexercised and exercisable on the date on which the
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Participant’s Service terminated, may be exercised by the Participant (or the Participant’s
guardian or legal representative) at any time prior to the expiration of one (1) year) (or such
longer period of time as determined by the Committee, in its discretion) after the date on
which the Participant’s Service terminated, but in any event no later than the date of
expiration of the Option’s term as set forth in the Award Agreement evidencing such Option
(the ‘‘Option Expiration Date’’).
(ii) Death.
If the Participant’s Service terminates because of the death of the
Participant, the Option, to the extent unexercised and exercisable on the date on which the
Participant’s Service terminated, may be exercised by the Participant’s legal representative or
other person who acquired the right to exercise the Option by reason of the Participant’s
death at any time prior to the expiration of one (1) year) (or such longer period of time as
determined by the Committee, in its discretion) after the date on which the Participant’s
Service terminated, but in any event no later than the Option Expiration Date. The
Participant’s Service shall be deemed to have terminated on account of death if the
Participant dies within ninety (90) days (or such longer period of time as determined by the
Committee, in its discretion) after the Participant’s termination of Service.
(iii) Termination for Cause. Notwithstanding any other provision of the Plan to the
contrary, if the Participant’s Service is terminated for Cause, the Option shall terminate and
cease to be exercisable immediately upon such termination of Service.
(iv) Other Termination of Service.
If the Participant’s Service terminates for any
reason, except Disability, death or Cause, the Option, to the extent unexercised and
exercisable by the Participant on the date on which the Participant’s Service terminated, may
be exercised by the Participant at any time prior to the expiration of ninety (90) days (or such
longer period of time as determined by the Committee, in its discretion) after the date on
which the Participant’s Service terminated, but in any event no later than the Option
Expiration Date.
(b) Extension if Exercise Prevented by Law. Notwithstanding the foregoing, other than
termination of Service for Cause, if the exercise of an Option within the applicable time periods
set forth in Section 6.4(a) is prevented by the provisions of Section 13 below, the Option shall
remain exercisable until ninety (90) days (or with respect to a Nonstatutory Option such longer
period of time as determined by the Committee, in its discretion) after the date the Participant is
notified by the Company that the Option is exercisable, but in any event no later than the Option
Expiration Date.
(c) Extension if Participant Subject to Section 16(b). Notwithstanding the foregoing, other
than termination of Service for Cause, if a sale within the applicable time periods set forth in
Section 6.4(a) of shares acquired upon the exercise of a Nonstatutory Option would subject the
Participant to suit under Section 16(b) of the Exchange Act, the Nonstatutory Option shall
remain exercisable until the earliest to occur of (i) the tenth (10th) day following the date on
which a sale of such shares by the Participant would no longer be subject to such suit, (ii) the one
hundred and ninetieth (190th) day after the Participant’s termination of Service, or (iii) the
Option Expiration Date.
6.5 Transferability of Options. During the lifetime of the Participant, an Option shall be
exercisable only by the Participant or the Participant’s guardian or legal representative. Prior to the
issuance of shares of Stock upon the exercise of an Option, the Option shall not be subject in any
manner to anticipation, alienation, sale, exchange, transfer, assignment, pledge, encumbrance, or
garnishment by creditors of the Participant or the Participant’s beneficiary, except transfer by will or
by the laws of descent and distribution.
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7. TERMS AND CONDITIONS OF STOCK APPRECIATION RIGHTS. Stock Appreciation
Rights shall be evidenced by Award Agreements specifying the number of shares of Stock subject to the
Award, in such form as the Committee shall from time to time establish. No SAR or purported SAR shall
be a valid and binding obligation of the Company unless evidenced by a fully executed Award Agreement.
Award Agreements evidencing SARs may incorporate all or any of the terms of the Plan by reference and
shall comply with and be subject to the following terms and conditions:
7.1 Types of SARs Authorized. SARs may be granted in tandem with all or any portion of a
related Option (a ‘‘Tandem SAR’’) or may be granted independently of any Option (a ‘‘Freestanding
SAR’’).
7.2 Exercise Price. The exercise price for each SAR shall be established in the discretion of the
Committee; provided, however, that (a) the exercise price per share subject to a Tandem SAR shall be
the exercise price per share under the related Option and (b) the exercise price per share subject to a
Freestanding SAR shall be not less than the Fair Market Value of a share of Stock on the effective
date of grant of the SAR.
7.3 Exercisablity and Term of SARS.
(a) Tandem SARs. Tandem SARs shall be exercisable only at the time and to the extent,
and only to the extent, that the related Option is exercisable, subject to such provisions as the
Committee may specify where the Tandem SAR is granted with respect to less than the full
number of shares of Stock subject to the related Option. The Committee may, in its discretion,
provide in any Award Agreement evidencing a Tandem SAR that such SAR may not be exercised
without the advance approval of the Company and, if such approval is not given, then the Option
shall nevertheless remain exercisable in accordance with its terms. A Tandem SAR shall
terminate and cease to be exercisable no later than the date on which the related Option expires
or is terminated or canceled. Upon the exercise of a Tandem SAR with respect to some or all of
the shares subject to such SAR, the related Option shall be canceled automatically as to the
number of shares with respect to which the Tandem SAR was exercised. Upon the exercise of an
Option related to a Tandem SAR as to some or all of the shares subject to such Option, the
related Tandem SAR shall be canceled automatically as to the number of shares with respect to
which the related Option was exercised.
(b) Freestanding SARs. Freestanding SARs shall be exercisable at such time or times, or
upon such event or events, and subject to such terms, conditions, performance criteria and
restrictions as shall be determined by the Committee and set forth in the Award Agreement
evidencing such SAR; provided, however, that no Freestanding SAR shall be exercisable after the
expiration of five (5) years after the effective date of grant of such SAR.
7.4 Exercise of SARs. Upon the exercise (or deemed exercise pursuant to Section 7.5) of an
SAR, the Participant (or the Participant’s legal representative or other person who acquired the right
to exercise the SAR by reason of the Participant’s death) shall be entitled to receive payment of an
amount for each share with respect to which the SAR is exercised equal to the excess, if any, of the
Fair Market Value of a share of Stock on the date of exercise of the SAR over the exercise price.
Payment of such amount shall be made in cash, shares of Stock, or any combination thereof as
determined by the Committee. Unless otherwise provided in the Award Agreement evidencing such
SAR, payment shall be made in a lump sum as soon as practicable following the date of exercise of the
SAR. The Award Agreement evidencing any SAR may provide for payment in a lump sum or deferred
payment in installments. When payment is to be made in shares of Stock, the number of shares to be
issued shall be determined on the basis of the Fair Market Value of a share of Stock on the date of
exercise of the SAR. For purposes of Section 7, an SAR shall be deemed exercised on the date on
which the Company receives notice of exercise from the Participant.
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7.5 Deemed Exercise of SARs.
If, on the date on which an SAR would otherwise terminate or
expire, the SAR by its terms remains exercisable immediately prior to such termination or expiration
and, if so exercised, would result in a payment to the holder of such SAR, then any portion of such
SAR which has not previously been exercised shall automatically be deemed to be exercised as of such
date with respect to such portion and payment shall be made to the Participant (or such Participant’s
legal representative or other person who acquired the right to receive such payment by reason of the
Participant’s death).
7.6 Effect of Termination of Service. Subject to earlier termination of the SAR as otherwise
provided herein and unless otherwise provided by the Committee in the grant of an SAR and set forth
in the Award Agreement, an SAR shall be exercisable after a Participant’s termination of Service only
during the applicable time period determined in accordance with Section 6.4 (treating the SAR as if it
were an Option) and thereafter shall terminate.
7.7 Nontransferability of SARs. During the lifetime of the Participant, an SAR shall be
exercisable only by the Participant or the Participant’s guardian or legal representative. Prior to the
exercise of an SAR, the SAR shall not be subject in any manner to anticipation, alienation, sale,
exchange, transfer, assignment, pledge, encumbrance, or garnishment by creditors of the Participant
or the Participant’s beneficiary, except transfer by will or by the laws of descent and distribution.
8. TERMS AND CONDITIONS OF RESTRICTED STOCK AWARDS. Restricted Stock
Awards shall be evidenced by Award Agreements specifying the number of shares of Stock subject to the
Award, in such form as the Committee shall from time to time establish. No Restricted Stock Award or
purported Restricted Stock Award shall be a valid and binding obligation of the Company unless evidenced
by a fully executed Award Agreement. Award Agreements evidencing Restricted Stock Awards may
incorporate all or any of the terms of the Plan by reference and shall comply with and be subject to the
following terms and conditions:
8.1 Restricted Stock Awards Authorized. Restricted Stock Awards may be granted upon such
conditions as the Committee shall determine, including, without limitation, upon the attainment of
one or more Performance Goals described in Section 9.4. If either the grant of a Restricted Stock
Award or the lapsing of the Restriction Period is to be contingent upon the attainment of one or more
Performance Goals, the Committee shall follow procedures substantially equivalent to those set forth
in Sections 9.3 through 9.5(a).
8.2 Vesting and Restrictions on Transfer. Shares issued pursuant to any Restricted Stock
Award may or may not be made subject to Vesting Conditions based upon the satisfaction of such
Service requirements, conditions, restrictions or performance criteria, including, without limitation,
Performance Goals as described in Section 9.4, as shall be established by the Committee and set forth
in the Award Agreement evidencing such Award. During any Restriction Period in which shares
acquired pursuant to a Restricted Stock Award remain subject to Vesting Conditions, such shares may
not be sold, exchanged, transferred, pledged, assigned or otherwise disposed of other than pursuant to
an Ownership Change Event, as defined in Section 13.1, or as provided in Section 8.5. Upon request
by the Company, each Participant shall execute any agreement evidencing such transfer restrictions
prior to the receipt of shares of Restricted Stock and shall promptly present to the Company any and
all certificates representing shares of Restricted Stock acquired hereunder for the placement on such
certificates of appropriate legends evidencing any such transfer restrictions.
8.3 Voting Rights; Dividends and Distributions. Except as provided in this Section 8.3 and any
Award Agreement, during the Restriction Period applicable to shares subject to a Restricted Stock
Award, the Participant shall have all of the rights of a shareholder of the Company holding shares of
Stock, including the right to vote such shares and to receive all dividends and other distributions paid
with respect to such shares. However, in the event of a dividend or distribution paid in shares of Stock
or any other adjustment made upon a change in the capital structure of the Company as described
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in Section 4.2, then any and all new, substituted or additional securities or other property (other than
normal cash dividends) to which the Participant is entitled by reason of the Participant’s Restricted
Stock Award shall be immediately subject to the same Vesting Conditions as the shares subject to the
Restricted Stock Award with respect to which such dividends or distributions were paid or adjustments
were made.
8.4 Effect of Termination of Service. Unless otherwise provided by the Committee in the grant
of a Restricted Stock Award and set forth in the Award Agreement, if a Participant’s Service
terminates for any reason, whether voluntary or involuntary (including the Participant’s death or
disability), then the Participant shall forfeit to the Company any shares acquired by the Participant
pursuant to a Restricted Stock Award which remain subject to Vesting Conditions as of the date of the
Participant’s termination of Service.
8.5 Nontransferability of Restricted Stock Award Rights. Prior to the issuance of shares of
Stock pursuant to a Restricted Stock Award, rights to acquire such shares shall not be subject in any
manner to anticipation, alienation, sale, exchange, transfer, assignment, pledge, encumbrance or
garnishment by creditors of the Participant or the Participant’s beneficiary, except transfer by will or
the laws of descent and distribution. All rights with respect to a Restricted Stock Award granted to a
Participant hereunder shall be exercisable during his or her lifetime only by such Participant or the
Participant’s guardian or legal representative.
8.6 Issuance and Delivery of Shares. Any Restricted Stock granted under the Plan shall be
issued at the time such Awards are granted and may be evidenced in such manner as the Committee
may deem appropriate, including book-entry registration or issuance of a stock certificate or
certificates, which certificate or certificates shall be held by the Company (or in an escrow established
by the Company). Such certificate or certificates shall be registered in the name of the Participant and
shall bear an appropriate legend referring to the restrictions applicable to such Restricted Stock.
Shares representing Restricted Stock that is no longer subject to restrictions shall be delivered to the
Participant promptly after the applicable restrictions lapse or are waived.
9. TERMS AND CONDITIONS OF PERFORMANCE AWARDS. Performance Awards shall
be evidenced by Award Agreements in such form as the Committee shall from time to time establish. No
Performance Award or purported Performance Award shall be a valid and binding obligation of the
Company unless evidenced by a fully executed Award Agreement. Award Agreements evidencing
Performance Awards may incorporate all or any of the terms of the Plan by reference and shall comply
with and be subject to the following terms and conditions:
9.1 Types of Performance Awards Authorized. Performance Awards may be in the form of
either Performance Shares or Performance Units. Each Award Agreement evidencing a Performance
Award shall specify the number of Performance Shares or Performance Units subject thereto, the
Performance Award Formula, the Performance Goal(s) and Performance Period applicable to the
Award, and the other terms, conditions and restrictions of the Award.
9.2 Initial Value of Performance Shares and Performance Units. Unless otherwise provided by
the Committee in granting a Performance Award, each Performance Share shall have an initial value
equal to the Fair Market Value of one (1) share of Stock, subject to adjustment as provided in
Section 4.2, on the effective date of grant of the Performance Share, and each Performance Unit shall
have an initial value of one hundred dollars ($100). The final value payable to the Participant in
settlement of a Performance Award determined on the basis of the applicable Performance Award
Formula will depend on the extent to which Performance Goals established by the Committee are
attained within the applicable Performance Period established by the Committee.
9.3 Establishment of Performance Period, Performance Goals and Performance Award
In granting each Performance Award, the Committee shall establish in writing the
Formula.
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applicable Performance Period, Performance Award Formula and one or more Performance Goals
which, when measured at the end of the Performance Period, shall determine on the basis of the
Performance Award Formula the final value of the Performance Award to be paid to the Participant.
Unless otherwise permitted in compliance with the requirements under Section 162(m) with respect to
‘‘performance-based compensation,’’ the Committee shall establish the Performance Goal(s) and
Performance Award Formula applicable to each Performance Award no later than the earlier of
(a) the date ninety (90) days after the commencement of the applicable Performance Period or (b) the
date on which 25% of the Performance Period has elapsed, and, in any event, at a time when the
outcome of the Performance Goals remains substantially uncertain. Once established, the
Performance Goals and Performance Award Formula shall not be changed during the Performance
Period. The Company shall notify each Participant granted a Performance Award of the terms of such
Award, including the Performance Period, Performance Goal(s) and Performance Award Formula.
9.4 Measurement of Performance Goals. Performance Goals shall be established by the
Committee on the basis of targets to be attained (‘‘Performance Targets’’) with respect to one or more
measures of business or financial performance (each, a ‘‘Performance Measure’’), subject to the
following:
(a) Performance Measures. Performance Measures shall have the same meanings as used
in the Company’s financial statements, or, if such terms are not used in the Company’s financial
statements, they shall have the meaning applied pursuant to generally accepted accounting
principles, or as used generally in the financial banking industry. Performance Measures shall be
calculated with respect to the Company and each Subsidiary Corporation consolidated therewith
for financial reporting purposes or such division or other business unit as may be selected by the
Committee. For purposes of the Plan, unless otherwise determined by the Committee at the time
the Committee establishes the Performance Goal(s) and Performance Award Formula applicable
to a Performance Award, the Performance Measures applicable to a Performance Award shall be
calculated in accordance with generally accepted accounting principles, but prior to the accrual or
payment of any Performance Award for the same Performance Period and excluding the effect
(whether positive or negative) of any change in accounting standards or any extraordinary,
unusual or nonrecurring item, as determined by the Committee, occurring after the establishment
of the Performance Goals applicable to the Performance Award. Performance Measures may be
one or more of the following, as determined by the Committee: revenue, costs, expenses
(including expense efficiency ratios and other expense measures), earnings (including one or
more of net profit after tax, gross profit, operating profit, earnings before interest and taxes,
earnings before interest, taxes, depreciation and amortization and net earnings), earnings per
share, earnings per share from continuing operations, operating income, pre-tax income,
operating income margin, net income, margins (including one or more of gross, operating and net
income margins), returns (including one or more of return on actual or proforma assets, net
assets, equity, investment, capital and net capital employed), shareholder return (including total
shareholder return relative to an index or peer group), stock price, growth of loans and deposits,
economic value added, cash generation, cash flow, unit volume, working capital, market share,
cost reductions and strategic plan development and implementation. Such goals may reflect
absolute entity or business unit performance or a relative comparison to the performance of a
peer group of entities or other external measure of the selected performance criteria. Pursuant to
rules and conditions adopted by the Committee on or before the 90th day of the applicable
performance period for which Performance Goals are established, the Committee may
appropriately adjust (provided the outcome remains substantially uncertain) any evaluation of
performance under such goals to exclude the effect of certain events, including any of the
following events: asset write-downs; litigation or claim judgments or settlements; changes in tax
law, accounting principles or other such laws or provisions affecting reported results; severance,
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contract termination and other costs related to exiting certain business activities; and gains or
losses from the disposition of businesses or assets or from the early extinguishment of debt.
(b) Performance Targets. Performance Targets may include a minimum, maximum, target
level and intermediate levels of performance, with the final value of a Performance Award
determined under the applicable Performance Award Formula by the level attained during the
applicable Performance Period. A Performance Target may be stated as an absolute value or as a
value determined relative to a standard selected by the Committee.
9.5 Settlement of Performance Awards.
(a) Determination of Final Value. As soon as practicable following the completion of the
Performance Period applicable to a Performance Award, the Committee shall certify in writing
the extent to which the applicable Performance Goals have been attained and the resulting final
value of the Award earned by the Participant and to be paid upon its settlement in accordance
with the applicable Performance Award Formula.
(b) Discretionary Adjustment of Award Formula.
In its discretion, the Committee may,
either at the time it grants a Performance Award or at any time thereafter, provide for the
positive or negative adjustment of the Performance Award Formula applicable to a Performance
Award granted to any Participant who is not a ‘‘covered employee’’ within the meaning of
Section 162(m) (a ‘‘Covered Employee’’) to reflect such Participant’s individual performance in
his or her position with the Company or such other factors as the Committee may determine. If
permitted under a Covered Employee’s Award Agreement, the Committee shall have the
discretion, on the basis of such criteria as may be established by the Committee, to reduce some
or all of the value of the Performance Award that would otherwise be paid to the Covered
Employee upon its settlement notwithstanding the attainment of any Performance Goal and the
resulting value of the Performance Award determined in accordance with the Performance
Award Formula. No such reduction may result in an increase in the amount payable upon
settlement of another Participant’s Performance Award.
(c) Effect of Leaves of Absence. Unless otherwise required by law, payment of the final
value, if any, of a Performance Award held by a Participant who has taken in excess of thirty
(30) days in leaves of absence during a Performance Period shall be prorated on the basis of the
number of days of the Participant’s Service during the Performance Period during which the
Participant was not on a leave of absence.
(d) Notice
the Committee’s
determination and certification in accordance with Sections 9.5(a) and (b), the Company shall
notify each Participant of the determination of the Committee.
to Participants. As soon as practicable
following
(e) Payment in Settlement of Performance Awards. As soon as practicable following the
Committee’s determination and certification in accordance with Sections 9.5(a) and (b), payment
shall be made to each eligible Participant (or such Participant’s legal representative or other
person who acquired the right to receive such payment by reason of the Participant’s death) of
the final value of the Participant’s Performance Award. Payment of such amount shall be made in
cash, shares of Stock, or a combination thereof as determined by the Committee. Unless
otherwise provided in the Award Agreement evidencing a Performance Award, payment shall be
made in a lump sum. In no event shall payment of a Performance Award be made later than the
15th day of the third month following the taxable year of the Participant in which the Participant
has a legally binding right to the Performance Award.
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(f) Provisions Applicable to Payment in Shares.
If payment is to be made in shares of
Stock, the number of such shares shall be determined by dividing the final value of the
Performance Award by the Fair Market Value of a share of Stock. Shares of Stock issued in
payment of any Performance Award may be fully vested and freely transferable shares or may be
shares of Stock subject to Vesting Conditions as provided in Section 8.2. Any shares subject to
Vesting Conditions shall be evidenced by an appropriate Award Agreement and shall be subject
to the provisions of Sections 8.2 through 8.5 above.
9.6 Voting Rights; Dividend Equivalent Rights and Distributions. Participants shall have no
voting rights with respect to shares of Stock represented by Performance Share Awards until the date
of the issuance of such shares, if any (as evidenced by the appropriate entry on the books of the
Company or of a duly authorized transfer agent of the Company). However, the Committee, in its
discretion, may provide in the Award Agreement evidencing any Performance Share Award that the
Participant shall be entitled to receive Dividend Equivalents with respect to the payment of cash
dividends on Stock having a record date prior to the date on which the Performance Shares are settled
or forfeited. Such Dividend Equivalents, if any, shall be credited to the Participant in the form of
additional whole Performance Shares as of the date of payment of such cash dividends on Stock. The
number of additional Performance Shares (rounded to the nearest whole number) to be so credited
shall be determined by dividing (a) the amount of cash dividends paid on such date with respect to the
number of shares of Stock represented by the Performance Shares previously credited to the
Participant by (b) the Fair Market Value per share of Stock on such date. Dividend Equivalents may
be paid currently or may be accumulated and paid to the extent that Performance Shares become
nonforfeitable, as determined by the Committee in the Award Agreement. Settlement of Dividend
Equivalents may be made in cash, shares of Stock, or a combination thereof as determined by the
Committee in the Award Agreement, and may be paid on the same basis as settlement of the related
Performance Share as provided in Section 9.5. Dividend Equivalents shall not be paid with respect to
Performance Units. In the event of a dividend or distribution paid in shares of Stock or any other
adjustment made upon a change in the capital structure of the Company as described in Section 4.2,
appropriate adjustments shall be made in the Participant’s Performance Share Award so that it
represents the right to receive upon settlement any and all new, substituted or additional securities or
other property (other than normal cash dividends) to which the Participant would entitled by reason
of the shares of Stock issuable upon settlement of the Performance Share Award, and all such new,
substituted or additional securities or other property shall be immediately subject to the same
Performance Goals as are applicable to the Award.
9.7 Effect of Termination of Service. Unless otherwise provided by the Committee in the grant
of a Performance Award and set forth in the Award Agreement, the effect of a Participant’s
termination of Service on the Performance Award shall be as follows:
(a) Death or Disability.
If the Participant’s Service terminates because of the death or
Disability of the Participant before the completion of the Performance Period applicable to the
Performance Award, the final value of the Participant’s Performance Award shall be determined
by the extent to which the applicable Performance Goals have been attained with respect to the
entire Performance Period and shall be prorated based on the number of months of the
Participant’s Service during the Performance Period. Payment shall be made following the end of
the Performance Period within the time period specified by Section 9.5(e) in any manner
permitted by Section 9.5.
(b) Other Termination of Service.
If the Participant’s Service terminates for any reason
except death or Disability before the completion of the Performance Period applicable to the
Performance Award, such Award shall be forfeited in its entirety; provided, however, that in the
event of an involuntary termination of the Participant’s Service, the Committee, in its sole
discretion, may waive the automatic forfeiture of all or any portion of any such Award.
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9.8 Nontransferability of Performance Awards. Prior to settlement in accordance with the
provisions of the Plan, no Performance Award shall be subject in any manner to anticipation,
alienation, sale, exchange, transfer, assignment, pledge, encumbrance, or garnishment by creditors of
the Participant or the Participant’s beneficiary, except transfer by will or by the laws of descent and
distribution. All rights with respect to a Performance Award granted to a Participant hereunder shall
be exercisable during his or her lifetime only by such Participant or the Participant’s guardian or legal
representative.
10. TERMS AND CONDITIONS OF RESTRICTED STOCK UNIT AWARDS. Restricted Stock
Unit Awards shall be evidenced by Award Agreements specifying the number of Restricted Stock Units
subject to the Award, in such form as the Committee shall from time to time establish. No Restricted Stock
Unit Award or purported Restricted Stock Unit Award shall be a valid and binding obligation of the
Company unless evidenced by a fully executed Award Agreement. Award Agreements evidencing
Restricted Stock Units may incorporate all or any of the terms of the Plan by reference and shall comply
with and be subject to the following terms and conditions:
10.1 Grant of Restricted Stock Unit Awards. Restricted Stock Unit Awards may be granted
upon such conditions as the Committee shall determine, including, without limitation, upon the
attainment of one or more Performance Goals described in Section 9.4. If either the grant of a
Restricted Stock Unit Award or the Vesting Conditions with respect to such Award is to be contingent
upon the attainment of one or more Performance Goals, the Committee shall follow procedures
substantially equivalent to those set forth in Sections 9.3 through 9.5(a).
10.2
Purchase Price. No monetary payment (other than applicable tax withholding, if any)
shall be required as a condition of receiving a Restricted Stock Unit Award.
10.3 Vesting. Restricted Stock Units may or may not be made subject to Vesting Conditions
based upon the satisfaction of such Service requirements, conditions, restrictions or performance
criteria, including, without limitation, Performance Goals as described in Section 9.4, as shall be
established by the Committee and set forth in the Award Agreement evidencing such Award.
10.4 Voting Rights, Dividend Equivalent Rights and Distributions. Participants shall have no
voting rights with respect to shares of Stock represented by Restricted Stock Units until the date of
the issuance of such shares (as evidenced by the appropriate entry on the books of the Company or of
a duly authorized transfer agent of the Company). However, the Committee, in its discretion, may
provide in the Award Agreement evidencing any Restricted Stock Unit Award that the Participant
shall be entitled to receive Dividend Equivalents with respect to the payment of cash dividends on
Stock having a record date prior to date on which Restricted Stock Units held by such Participant are
settled. Such Dividend Equivalents, if any, shall be paid by crediting the Participant with additional
whole Restricted Stock Units as of the date of payment of such cash dividends on Stock. The number
of additional Restricted Stock Units (rounded to the nearest whole number) to be so credited shall be
determined by dividing (a) the amount of cash dividends paid on such date with respect to the number
of shares of Stock represented by the Restricted Stock Units previously credited to the Participant by
(b) the Fair Market Value per share of Stock on such date. Such additional Restricted Stock Units
shall be subject to the same terms and conditions and shall be settled in the same manner and at the
same time (or as soon thereafter as practicable) as the Restricted Stock Units originally subject to the
Restricted Stock Unit Award. In the event of a dividend or distribution paid in shares of Stock or any
other adjustment made upon a change in the capital structure of the Company as described in
Section 4.2, appropriate adjustments shall be made in the Participant’s Restricted Stock Unit Award
so that it represents the right to receive upon settlement any and all new, substituted or additional
securities or other property (other than normal cash dividends) to which the Participant would
entitled by reason of the shares of Stock issuable upon settlement of the Award, and all such new,
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substituted or additional securities or other property shall be immediately subject to the same Vesting
Conditions as are applicable to the Award.
10.5 Effect of Termination of Service. Unless otherwise provided by the Committee in the
grant of a Restricted Stock Unit Award and set forth in the Award Agreement, if a Participant’s
Service terminates for any reason, whether voluntary or involuntary (including the Participant’s death
or disability), then the Participant shall forfeit to the Company any Restricted Stock Units pursuant to
the Award which remain subject to Vesting Conditions as of the date of the Participant’s termination
of Service.
10.6
Settlement of Restricted Stock Unit Awards. The Company shall issue to a Participant
on the earlier of the date on which Restricted Stock Units subject to the Participant’s Restricted Stock
Unit Award satisfy applicable Vesting Conditions or on such other date determined by the Committee,
in its discretion and set forth in the Award Agreement but no later than the 15th day of the third
month following the taxable year of the Participant in which the Participant has satisfied the
applicable Vesting Conditions, one (1) share of Stock (and/or any other new, substituted or additional
securities or other property pursuant to an adjustment described in Section 10.4) for each Restricted
Stock Unit then becoming vested or otherwise to be settled on such date, subject to the withholding of
applicable taxes.
10.7 Nontransferability of Restricted Stock Unit Awards. Prior to the issuance of shares of
Stock in settlement of a Restricted Stock Unit Award, the Award shall not be subject in any manner to
anticipation, alienation, sale, exchange, transfer, assignment, pledge, encumbrance, or garnishment by
creditors of the Participant or the Participant’s beneficiary, except transfer by will or by the laws of
descent and distribution. All rights with respect to a Restricted Stock Unit Award granted to a
Participant hereunder shall be exercisable during his or her lifetime only by such Participant or the
Participant’s guardian or legal representative.
11. STANDARD FORMS OF AWARD AGREEMENT.
11.1 Award Agreements. Each Award shall comply with and be subject to the terms and
conditions set forth in the appropriate form of Award Agreement approved by the Committee and as
amended from time to time. Any Award Agreement may consist of an appropriate form of Notice of
Grant and a form of Agreement incorporated therein by reference, or such other form or forms as the
Committee may approve from time to time.
11.2 Authority to Vary Terms. The Committee shall have the authority from time to time to
vary the terms of any standard form of Award Agreement either in connection with the grant or
amendment of an individual Award or in connection with the authorization of a new standard form or
forms; provided, however, that the terms and conditions of any such new, revised or amended
standard form or forms of Award Agreement are not inconsistent with the terms of the Plan.
12. CHANGE IN CONTROL.
12.1 Definitions.
(a) An ‘‘Ownership Change Event’’ shall be deemed to have occurred if any of the following
occurs with respect to the Company: (i) the direct or indirect sale or exchange in a single or series
of related transactions by the shareholders of the Company of more than fifty percent (50%) of
the voting stock of the Company; (ii) a merger, reorganization or consolidation in which the
Company is a party; (iii) the sale, exchange, or transfer of all or substantially all of the assets of
the Company (other than a sale, exchange or transfer to one or more subsidiaries of the
Company); or (iv) a liquidation or dissolution of the Company.
(b) A ‘‘Change in Control’’ shall mean (i) an Ownership Change Event or series of related
Ownership Change Events (collectively, a ‘‘Transaction’’) in which the shareholders of the
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Company immediately before the Transaction do not retain immediately after or acquire in the
Transaction, in substantially the same proportions as their ownership of shares of the Company’s
voting stock immediately before the Transaction, direct or indirect beneficial ownership of more
than fifty percent (50%) of the total combined voting power of the outstanding voting securities
of the Company, or in the case of an Ownership Change Event described in Section 12.1(a)(iii),
the entity to which the assets of the Company were transferred (the ‘‘Transferee’’), (ii) a sale of
equity securities of the Company representing more than fifty percent (50%) of the total
combined voting power of the outstanding voting securities of the Company, or (iii) a liquidation
or dissolution of the Company. For purposes of the preceding sentence, indirect beneficial
ownership shall include, without limitation, an interest resulting from ownership of the voting
securities of one or more corporations or other business entities which own the Company or the
Transferee, as the case may be, either directly or through one or more subsidiary corporations or
other business entities. The Committee shall have the right to determine whether multiple sales
or exchanges of the voting securities of the Company or multiple Ownership Change Events are
related, and its determination shall be final, binding and conclusive. Notwithstanding the
foregoing, in the case of an Award that is not exempt from Section 409A but rather is subject to
Section 409A, (A) the exercise of the Committee’s discretion shall be strictly ministerial and not
involve the exercise of any discretionary authority, and (B) in no event shall a Transaction be
treated as a Change in Control unless such event also qualifies as a change in ownership or
effective control of a corporation, or a change in the ownership of a substantial portion of the
assets of a corporation within the meaning of Treasury Regulations Section 1.409A-3(i)(5).
12.2 Effect of Change in Control on Options. Upon a Change of Control (i) the Company
shall deliver to each Participant, no less than thirty (30) days prior to the consummation of the Change
of Control, written notification of the proposed Change of Control and the Participant’s right to
exercise all Options granted pursuant to this Plan, whether or not vested under the Plan or applicable
Option Award Agreement, and (ii) all outstanding Options granted pursuant to the Plan shall
completely vest and become immediately exercisable as to all shares granted pursuant to the Option
immediately prior to such Change of Control. This right of exercise shall be conditional upon
consummation of the Change of Control. Upon the occurrence of the Change of Control all then
outstanding Options shall terminate; provided, however, that any outstanding Options not exercised
as of the occurrence of the Change of Control shall not terminate if there is a successor corporation
which assumes the outstanding Options or substitutes for such Options, new options covering the
stock of the successor corporation with appropriate adjustments as to the number and kind of shares
and prices. Notwithstanding anything to the contrary herein, each adjustment made to an Incentive
Stock Option shall comply with the rules of Section 424(a) of the Code, and no adjustment shall be
made that would cause any Incentive Stock Option to become a Nonstatutory Stock Option.
12.3 Effect of Change of Control on SAR Awards. Notwithstanding any other provision of
the Plan to the contrary, the Committee, in its sole discretion, may provide in any Award Agreement
or, in the event of a Change in Control, may take such actions as it deems appropriate to provide for
the acceleration of the exercisability and vesting in connection with such Change in Control of any or
all outstanding SARs and shares acquired upon the exercise of such SARs upon such conditions and
to such extent as the Committee shall determine.
12.4 Effect of Change in Control on Restricted Stock Awards. Each Award Agreement
evidencing a Restricted Stock Award shall provide in the event of a Change in Control for the lapse of
the Restriction Period applicable to the shares subject to the Restricted Stock Award held by a
Participant whose Service has not terminated prior to the Change in Control, effective immediately
prior to and conditioned upon the Change in Control.
12.5 Effect of Change in Control on Performance Awards. The Committee may, in its
discretion, provide in any Award Agreement evidencing a Performance Award that, in the event of a
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Change in Control, the Performance Award held by a Participant whose Service has not terminated
prior to the Change in Control shall become payable effective as of the date of the Change in Control
to such extent as specified in such Award Agreement.
12.6 Effect of Change in Control on Restricted Stock Unit Awards. Each Award Agreement
evidencing a Restricted Stock Unit Award shall provide that the Restricted Stock Unit Award held by
a Participant whose Service has not terminated prior to the Change in Control shall be settled
effective immediately prior to and conditioned upon the Change in Control.
13. COMPLIANCE WITH SECURITIES LAW. The grant of Awards and the issuance of shares of
Stock pursuant to any Award shall be subject to compliance with all applicable requirements of federal,
state and foreign law with respect to such securities and the requirements of any stock exchange or market
system upon which the Stock may then be listed. In addition, no Award may be exercised or shares issued
pursuant to an Award unless (a) a registration statement under the Securities Act shall at the time of such
exercise or issuance be in effect with respect to the shares issuable pursuant to the Award or (b) in the
opinion of legal counsel to the Company, the shares issuable pursuant to the Award may be issued in
accordance with the terms of an applicable exemption from the registration requirements of the Securities
Act. The inability of the Company to obtain from any regulatory body having jurisdiction the authority, if
any, deemed by the Company’s legal counsel to be necessary to the lawful issuance and sale of any shares
hereunder shall relieve the Company of any liability in respect of the failure to issue or sell such shares as
to which such requisite authority shall not have been obtained. As a condition to issuance of any Stock, the
Company may require the Participant to satisfy any qualifications that may be necessary or appropriate, to
evidence compliance with any applicable law or regulation and to make any representation or warranty
with respect thereto as may be requested by the Company.
14. TAX WITHHOLDING.
14.1 Tax Withholding in General. The Company shall have the right to deduct from any and
all payments made under the Plan, or to require the Participant, through payroll withholding, cash
payment or otherwise, including by means of a Cashless Exercise of an Option, to make adequate
provision for, the federal, state, local and foreign taxes, if any, required by law to be withheld by the
Participating Company Group with respect to an Award or the shares acquired pursuant thereto. The
Company shall have no obligation to deliver shares of Stock, to release shares of Stock from an escrow
established pursuant to an Award Agreement, or to make any payment in cash under the Plan until
the Participating Company Group’s tax withholding obligations have been satisfied by the Participant.
14.2 Withholding in Shares. The Company shall have the right, but not the obligation, to
deduct from the shares of Stock issuable to a Participant upon the exercise or settlement of an Award,
or to accept from the Participant the tender of, a number of whole shares of Stock having a Fair
Market Value, as determined by the Company, equal to all or any part of the tax withholding
obligations of the Participating Company Group. The Fair Market Value of any shares of Stock
withheld or tendered to satisfy any such tax withholding obligations shall not exceed the amount
determined by the applicable minimum statutory withholding rates.
15. AMENDMENT OR TERMINATION OF PLAN. The Committee may amend, suspend or
terminate the Plan at any time. However, without the approval of the Company’s shareholders, there shall
be (a) no increase in the maximum aggregate number of shares of Stock that may be issued under the Plan
(except by operation of the provisions of Section 4.2), (b) no change in the class of persons eligible to
receive Incentive Stock Options, and (c) no other amendment of the Plan that would require approval of
the Company’s shareholders under any applicable law, regulation or rule. No amendment, suspension or
termination of the Plan shall affect any then outstanding Award unless expressly provided by the
Committee. In any event, no amendment, suspension or termination of the Plan may adversely affect any
then outstanding Award without the consent of the Participant unless necessary to comply with any
applicable law, regulation or rule.
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16. MISCELLANEOUS PROVISIONS.
16.1
Provision of Information. Each Participant shall be given access to information
concerning the Company equivalent to that information generally made available to the Company’s
common shareholders.
16.2 Rights as Employee, Consultant or Director. No person, even though eligible pursuant
to Section 5, shall have a right to be selected as a Participant, or, having been so selected, to be
selected again as a Participant. Nothing in the Plan or any Award granted under the Plan shall confer
on any Participant a right to remain an Employee, Consultant or Director or interfere with or limit in
any way any right of a Participating Company to terminate the Participant’s Service at any time. To the
extent that an Employee of a Participating Company other than the Company receives an Award
under the Plan, that Award shall in no event be understood or interpreted to mean that the Company
is the Employee’s employer or that the Employee has an employment relationship with the Company.
16.3 Rights as a Shareholder. A Participant shall have no rights as a shareholder with respect
to any shares covered by an Award until the date of the issuance of such shares (as evidenced by the
appropriate entry on the books of the Company or of a duly authorized transfer agent of the
Company). No adjustment shall be made for dividends, distributions or other rights for which the
record date is prior to the date such shares are issued, except as provided in Section 4.2 or another
provision of the Plan.
16.4
Section 409A Provisions. Notwithstanding anything in the Plan or any Award Agreement
to the contrary, to the extent that any amount or benefit that constitutes ‘‘deferred compensation’’ to a
Participant under Section 409A of the Code and applicable guidance thereunder is otherwise payable
or distributable to a Participant under the Plan or any Award Agreement solely by reason of the
occurrence of a Change in Control or due to the Participant’s disability or ‘‘separation from service’’
(as such term is defined under Section 409A), such amount or benefit will not be payable or
distributable to the Participant by reason of such circumstance unless the Committee determines in
good faith that (i) the circumstances giving rise to such Change in Control, disability or separation
from service meet the definition of a change in ownership or control, disability, or separation from
service, as the case may be, in Section 409A(a)(2)(A) of the Code and Treasury Regulations, or (ii) the
payment or distribution of such amount or benefit would be exempt from the application of
Section 409A by reason of the short-term deferral exemption or otherwise. Any payment or
distribution that otherwise would be made to a Participant who is a Specified Employee (as
determined by the Committee in good faith) on account of separation from service may not be made
before the date which is six (6) months after the date of the Specified Employee’s separation from
service unless the payment or distribution is exempt from the application of Section 409A by reason of
the short term deferral exemption or otherwise.
16.5
Fractional Shares. The Company shall not be required to issue fractional shares upon
the exercise or settlement of any Award.
16.6
Severability.
If any one or more of the provisions (or any part thereof) of this Plan shall
be held invalid, illegal or unenforceable in any respect, such provision shall be modified so as to make
it valid, legal and enforceable, and the validity, legality and enforceability of the remaining provisions
(or any part thereof) of the Plan shall not in any way be affected or impaired thereby.
16.7 Beneficiary Designation. Subject to applicable laws and procedures, each Participant
may file with the Company a written designation of a beneficiary who is to receive any benefit under
the Plan to which the Participant is entitled in the event of such Participant’s death before he or she
receives any or all of such benefit. Each designation will revoke all prior designations by the same
Participant, shall be in a form prescribed by the Company, and will be effective only when filed by the
Participant in writing with the Company during the Participant’s lifetime. If a married Participant
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designates a beneficiary other than the Participant’s spouse, the effectiveness of such designation may
be subject to the consent of the Participant’s spouse. If a Participant dies without an effective
designation of a beneficiary who is living at the time of the Participant’s death, the Company will pay
any remaining unpaid benefits to the Participant’s legal representative.
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HERITAGE COMMERCE CORP
2016 Annual Report on Form 10-K
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
(cid:95)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
or the fiscal year ended December 31, 2016
OR
(cid:134)
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
(Exact name of Registrant as Specified in its Charter)
California
(State or Other Jurisdiction of
Incorporation or Organization)
77-0469558
(I.R.S. Employer
Identification Number)
150 Almaden Boulevard
San Jose, California 95113
(Address of Principal Executive Offices including Zip Code)
(408) 947-6900
(Registrant’s Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock, no par value
Name of Each Exchange on which Registered
The NASDAQ Stock Market LLC
(NASDAQ Global Select Market)
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Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:134) No (cid:95)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes (cid:134) No (cid:95)
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 such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes (cid:95) No (cid:134)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the
Registrant was required to submit and post such files). Yes (cid:95) No (cid:134)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10 -K,
or any amendment to this Form 10 -K. (cid:134)
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer”, “accelerated filer” and “small reporting company” in Rule 12b -2 of the Exchange Act.
Large accelerated filer (cid:134)
Accelerated filer (cid:95)
Non-accelerated filer (cid:134)
(Do not check if a
smaller reporting
company)
Smaller reporting company (cid:134)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes (cid:134) No (cid:95)
The aggregate market value of the common stock held by non-affiliates of the Registrant as of June 30, 2016, based upon the closing price
on that date of $10.53 per share as reported on the NASDAQ Global Select Market, and 19,786,746 shares held, was approximately $208.4 million.
As of February 15, 2017, there were 37,944,319 shares of the Registrant’s common stock (no par value) outstanding.
Portions of the Registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in
connection with the 2017 Annual Meeting of Shareholders to be held on May 25, 2017 are incorporated by reference into Part III of this Report. The proxy
statement will be filed with the Securities and Exchange Commission not later than 120 days after the Registrant’s fiscal year ended December 31, 2016.
DOCUMENTS INCORPORATED BY REFERENCE
HERITAGE COMMERCE CORP
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2016
PART I.
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Mine Safety Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART II.
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
of Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . .
Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures . . . . . . . .
Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART III.
Directors, Executive Officers and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Certain Relationships and Related Transactions and Director Independence . . . . . . . . . . . . . . . . . . . . .
Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
PART IV.
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43
43
45
45
45
48
50
85
85
85
86
87
87
87
87
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Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Item 15.
Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
88
89
90
141
2
Cautionary Note Regarding Forward-Looking Statements
This Report on Form 10-K contains various statements that may constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, Rule 175 promulgated thereunder, and Section 21E of
the Securities Exchange Act of 1934, as amended, Rule 3b-6 promulgated thereunder and are intended to be covered by
the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements about our expectations,
beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking.
These forward-looking statements often can be, but are not always, identified by the use of words such as “assume,”
“expect,” “intend,” “plan,” “project,” “believe,” “estimate,” “predict,” “anticipate,” “may,” “might,” “should,” “could,”
“goal,” “potential” and similar expressions. We base these forward-looking statements on our current expectations and
projections about future events, our assumptions regarding these events and our knowledge of facts at the time the
statements are made. These statements include statements relating to our projected growth, anticipated future financial
performance, and management’s long-term performance goals, as well as statements relating to the anticipated effects on
results of operations and financial condition.
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 (“SEC”), Item 1A of this
Annual Report on Form 10-K, and the following listed below:
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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;
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;
changes in inflation, interest rates, and market liquidity which may impact interest margins and impact
funding sources;
volatility in credit and equity markets and its effect on the global economy;
changes in the competitive environment among financial or bank holding companies and other financial
service providers;
changes in consumer and business spending and saving habits and the related effect on our ability to increase
assets and to attract deposits;
our ability to develop and promote customer acceptance of new products and services in a timely manner;
risks associated with concentrations in real estate related loans;
an oversupply of inventory and deterioration in values of California commercial real estate;
a prolonged slowdown in construction activity;
other than temporary impairment charges to our securities portfolio;
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;
our ability to raise capital or incur debt on reasonable terms;
regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company;
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changes in our capital management policies, including those regarding business combinations, dividends,
and share repurchases, among others;
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;
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;
inability of our framework to manage risks associated with our business, including operational risk and credit
risk;
risks of loss of funding of Small Business Administration or SBA loan programs, or changes in those
programs;
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;
effect of lower corporate tax rates if enacted on the Company’s deferred tax asset;
significant changes in applicable laws and regulations, including those concerning taxes, banking and
securities;
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;
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;
availability of and competition for acquisition opportunities;
risks associated with merger and acquisition integration;
risks resulting from domestic terrorism;
risks of natural disasters and other events beyond our control; and
our success in managing the risks involved in the foregoing factors.
Forward-looking statements speak only as of the date they are made. The Company does not undertake to
update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking
statements are made or to reflect the occurrence of unanticipated events. You should consider any forward looking
statements in light of this explanation, and we caution you about relying on forward-looking statements.
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ITEM 1 — BUSINESS
General
PART I
Heritage Commerce Corp, a California corporation organized in 1997, is a bank holding company registered
under the Bank Holding Company Act of 1956, as amended. We provide a wide range of banking services through Heritage
Bank of Commerce, our wholly-owned subsidiary. Heritage Bank of Commerce is a California state-chartered bank
headquartered in San Jose, California and has been conducting business since 1994.
Heritage Bank of Commerce is a multi-community independent bank that offers a full range of commercial
banking services to small and medium-sized businesses and their owners, managers and employees. We operate through
11 full service branch offices located entirely in the southern and eastern regions of the general San Francisco Bay Area
of California in the counties of Santa Clara, Alameda, Contra Costa, and San Benito. Our market includes the headquarters
of a number of technology based companies in the region commonly known as “Silicon Valley.”
Our lending activities are diversified and include commercial, real estate, construction and land development,
consumer and Small Business Administration (“SBA”) guaranteed loans. We generally lend in markets where we have a
physical presence through our branch offices. We attract deposits throughout our market area with a customer-oriented
product mix, competitive pricing, and convenient locations. We offer a wide range of deposit products for business banking
and retail markets. We offer a multitude of other products and services to complement our lending and deposit services.
In addition, Bay View Funding provides factoring financing throughout the United States.
As a bank holding company, Heritage Commerce Corp is subject to the supervision of the Board of Governors of
the Federal Reserve System (the “Federal Reserve”). We are required to file with the Federal Reserve reports and other
information regarding our business operations and the business operations of our subsidiaries. As a California chartered
bank, Heritage Bank of Commerce is subject to primary supervision, periodic examination, and regulation by the
Department of Business Oversight — Division of Financial Institutions (“DBO”), and by the Federal Reserve, as its
primary federal regulator.
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Our principal executive office is located at 150 Almaden Boulevard, San Jose, California 95113, telephone
number: (408) 947-6900.
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At December 31, 2016, we had consolidated assets of $2.57 billion, deposits of $2.26 billion and shareholders’
equity of $259.8 million.
When we use “we”, “us”, “our” or the “Company”, we mean the Company on a consolidated basis with Heritage
Bank of Commerce. When we refer to “HCC” or the “holding company”, we are referring to Heritage Commerce Corp on
a standalone basis. When we use “HBC”, we mean Heritage Bank of Commerce on a standalone basis.
The Internet address of the Company’s website is “http://www.heritagecommercecorp.com,” and the Bank’s
website is “http://www.heritagebankofcommerce.com.” The Company makes available free of charge through the
Company’s website, the Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to these reports. The Company makes these reports available on its website on the same day
they appear on the SEC website.
Recent Acquisitions
We have grown over the past five years through the acquisitions discussed below, as well as through organic
growth.
Focus Business Bank
On August 20, 2015, we completed the acquisition of Focus Business Bank (“Focus Bank”) for an aggregate
transaction value of $66.6 million. We acquired from Focus Bank total assets, at fair value, of approximately
$438.8 million, loans (including loans held-for-sale) of $174.8 million, at fair value, and deposits of $405.1 million, at fair
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value. We issued approximately 5,456,713 shares of our common stock to Focus Bank shareholders, at an exchange ratio
of 1.8235 shares of Heritage Commerce Corp common stock per Focus Bank share.
Bay View Funding
On November 1, 2014, Heritage Bank of Commerce acquired CSNK Working Capital Finance Corp. d/b/a Bay
View Funding (“Bay View Funding”) for approximately $22.52 million. Bay View Funding provides business-essential
working capital factoring financing to various industries throughout the United States. Bay View Funding’s administrative
offices are located at 2933 Bunker Hill Lane, Suite 210, Santa Clara, CA 95054.
Heritage Bank of Commerce
HBC is a California state-chartered bank headquartered in San Jose, California. It was incorporated in November
1993 and opened for business in June 1994. HBC operates through eleven full service branch offices. The locations of
HBC’s current offices are:
Los Gatos:
Morgan Hill:
Pleasanton:
Sunnyvale:
Walnut Creek:
Branch Office
15575 Los Gatos Boulevard
Suite B
Los Gatos, CA 95032
Branch Office
18625 Sutter Boulevard
Suite 100
Morgan Hill, CA 95037
Branch Office
300 Main Street
Pleasanton, CA 94566
Branch Office
333 W. El Camino Real
Suite 150
Sunnyvale, CA 94087
Branch Office
101 Ygnacio Valley Road
Suite 100
Walnut Creek, CA 94596
San Jose:
Administrative Office
Main Branch
150 Almaden Boulevard
San Jose, CA 95113
Danville:
Branch Office
387 Diablo Road
Danville, CA 94526
Fremont:
Gilroy:
Hollister:
Branch Office
3137 Stevenson Boulevard
Fremont, CA 94538
Branch Office
7598 Monterey Street
Suite 110
Gilroy, CA 95020
Branch Office
351 Tres Pinos Road
Suite 102A
Hollister, CA 95023
Los Altos:
Branch Office
419 South San Antonio Road
Los Altos, CA 94022
Lending Activities
We offer a diversified mix of business loans encompassing the following loan products: (i) commercial and
industrial loans; (ii) commercial real estate loans; (iii) construction loans; and (iv) SBA loans. We also offer home equity
lines of credit (“HELOCS”), to accommodate the needs of business owners and individual clients, as well as consumer
loans (both secured and unsecured). In the event creditworthy loan customers’ borrowing needs exceed our legal lending
limit, we have the ability to sell participations in those loans to other banks. We encourage relationship banking, obtaining
a substantial portion of each borrower’s banking business, including deposit accounts.
As of December 31, 2016, the percentage of our total loans for each of the principal areas in which we directed
our lending activities were as follows: (i) commercial and industrial 40% (including SBA loans, asset-based lending, and
factored receivables); (ii) commercial real estate loans 44%; (iii) land and construction loans 5%; (iv) residential mortgage
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loans 4%; and (v) consumer (including home equity) 7%. While no specific industry concentration is considered
significant, our lending operations are located in market areas dependent on technology and real estate industries and their
supporting companies.
Commercial and Industrial Loans. Our commercial loan portfolio is comprised of operating secured and
unsecured loans advanced for working capital, equipment purchases and other business purposes. Generally short-term
loans have maturities ranging from thirty days to one year, and “term loans” have maturities ranging from one to five
years. Short-term business loans are generally intended to finance current transactions and typically provide for periodic
principal payments, with interest payable monthly. Term loans generally provide for floating or fixed interest rates, with
monthly payments of both principal and interest. Repayment of secured and unsecured commercial loans depends
substantially on the borrower’s underlying business, financial condition and cash flows, as well as the sufficiency of the
collateral. Compared to real estate, the collateral may be more difficult to monitor, evaluate and sell. It may also depreciate
more rapidly than real estate. Such risks can be significantly affected by economic conditions.
Our factoring receivables portfolio is originated by Bay View Funding. Factored receivables are receivables that
have been transferred by the originating organization and typically have not been subject to previous collection efforts.
These receivables are acquired from a variety of companies, including but not limited to service providers, transportation
companies, manufacturers, distributors, wholesalers, apparel companies, advertisers, and temporary staffing companies.
The average life of the factored receivables is 35 days.
HBC’s commercial loans, except for the asset-based lending and the factored receivables at Bay View Funding,
are primarily originated from locally-oriented commercial activities in communities where HBC has a physical presence
through its branch offices.
Commercial Real Estate Loans. The commercial real estate (“CRE”) loan portfolio is comprised of loans secured
by commercial real estate. These loans are generally advanced based on the borrower’s cash flow, and the underlying
collateral provides a secondary source of payment. HBC generally restricts real estate term loans to no more than 75% of
the property’s appraised value or the purchase price of the property, depending on the type of property and its utilization.
HBC offers both fixed and floating rate loans. Maturities on such loans are generally restricted to between five and ten
years (with amortization ranging from fifteen to twenty-five years and a balloon payment due at maturity); however, SBA
and certain real estate loans that can be sold in the secondary market may be advanced for longer maturities. CRE loans
typically involve large balances to single borrowers or groups of related borrowers. Since payments on these loans are
often dependent on the successful operation or management of the properties, as well as the business and financial
condition of the borrower, repayment of such loans may be subject to adverse conditions in the real estate market, adverse
economic conditions or changes in applicable government regulations. If the cash flow from the project decreases, or if
leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired.
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 servicing fees to the servicer. At December 31, 2016, the purchased CRE loans
outstanding totaled $31.0 million.
Construction Loans. We make commercial construction loans for rental properties, commercial buildings and
homes built by developers on speculative, undeveloped property. We also make construction loans for homes built by
owner occupants. The terms of commercial construction loans are made in accordance with our loan policy. Advances on
construction loans are made in accordance with a schedule reflecting the cost of construction, but are generally limited to
a 70% loan-to-value ratio, as completed. Repayment of construction loans on non-residential properties is normally
expected from the property’s eventual rental income, income from the borrower’s operating entity or the sale of the subject
property. In the case of income-producing property, repayment is usually expected from permanent financing upon
completion of construction. At times we provide the permanent mortgage financing on our construction loans on
income-producing property. Construction loans are interest-only loans during the construction period, which typically do
not exceed 18 months. If HBC provides permanent financing the short-term loan converts to permanent, amortizing
financing following the completion of construction. Generally, before making a commitment to fund a construction loan,
we require an appraisal of the property by a state-certified or state-licensed appraiser. We review and inspect properties
before disbursement of funds during the term of the construction loan. The repayment of construction loans is dependent
upon the successful and timely completion of the construction of the subject property, as well as the sale of the property
to third parties or the availability of permanent financing upon completion of all improvements. Construction loans expose
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us to the risk that improvements will not be completed on time, and in accordance with specifications and projected costs.
Construction delays, the financial impairment of the builder, interest rate increases or economic downturn may further
impair the borrower’s ability to repay the loan. In addition, the borrower may not be able to obtain permanent financing
or ultimate sale or rental of the property may not occur as anticipated. HBC utilizes underwriting guidelines to assess the
likelihood of repayment from sources such as sale of the property or permanent mortgage financing prior to making the
construction loan.
SBA Loans. SBA loans are made through programs designed by the federal government to assist the small
business community in obtaining financing from financial institutions that are given government guarantees as an incentive
to make the loans. HBC has been designated as an SBA Preferred Lender. Our SBA loans fall into three categories, loans
originated under the SBA’s 7a Program (“7a Loans”), loans originated under the SBA’s 504 Program (“504 Loans”) and
SBA “Express” Loans. SBA 7a Loans are commercial business loans generally made for the purpose of purchasing real
estate to be occupied by the business owner, providing working capital, and/or purchasing equipment or inventory. SBA
504 Loans are collateralized by commercial real estate and are generally made to business owners for the purpose of
purchasing or improving real estate for their use and for equipment used in their business. The SBA “Express” Loans or
lines of credit are for businesses that want to improve cash flow, refinance debt, or fund improvements, equipment, or real
estate. It features an abbreviated SBA application process and accelerated approval times, plus it can offer longer terms
and lower down payment requirements than conventional loans.
SBA lending is subject to federal legislation that can affect the availability and funding of the program. From
time to time, this dependence on legislative funding causes limitations and uncertainties with regard to the continued
funding of such programs, which could potentially have an adverse financial impact on our business.
Home Equity Loans. Our home equity line portfolio is comprised of home equity lines of credit to customers in
our markets. Home equity lines of credit are underwritten in a manner such that they result in credit risk that is substantially
similar to that of residential mortgage loans. Nevertheless, home equity lines of credit have greater credit risk than
residential mortgage loans because they are often secured by mortgages that are subordinated to the existing first mortgage
on the property, which we do not hold, and they are not covered by private mortgage insurance coverage.
Residential Mortgage Loans. 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 servicing fees to the servicer.
Residential mortgage loans outstanding at December 31, 2016 totaled $52.9 million. HBC does not originate first trust
deed home mortgage loans or home improvement loans, other than HELOCS.
Consumer Loans. The consumer loan portfolio is composed of miscellaneous consumer loans including loans
for financing automobiles, various consumer goods and other personal purposes. Consumer loans are generally secured.
Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding
loan, and the remaining deficiency may not warrant further substantial collection efforts against the borrower. In addition,
consumer loan collections are dependent on the borrower’s continued financial stability, which can be adversely affected
by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Deposit Products
As a full-service commercial bank, we focus deposit generation on relationship accounts, encompassing non-
interest bearing demand, interest bearing demand, and money market. In order to facilitate generation of non-interest
bearing demand deposits, we require, depending on the circumstances and the type of relationship, our borrowers to
maintain deposit balances with us as a typical condition of granting loans. We also offer certificates of deposit and savings
accounts. We offer a “remote deposit capture” product that allows deposits to be made via computer at the customer’s
business location. We also offer customers “e-statements” that allows customers to receive statements electronically,
which is more convenient and secure than receiving paper statements.
For customers requiring full Federal Deposit Insurance Corporation (“FDIC”) insurance on certificates of deposit
in excess of $250,000, we offer the CDARS® program, which allows HBC to place the certificates of deposit with other
participating banks to maximize the customers’ FDIC insurance. HBC also receives reciprocal deposits from other
participating financial institutions.
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Electronic Banking
While personalized, service-oriented banking is the cornerstone of our business plan, we use technology and the
Internet as a secondary means for servicing customers, to compete with larger banks and to provide a convenient platform
for customers to review and transact business. We offer sophisticated electronic or “internet banking” opportunities that
permit commercial customers to conduct much of their banking business remotely from their home or business. However,
our customers will always have the opportunity to personally discuss specific banking needs with knowledgeable bank
officers and staff who are directly accessible in the branches and offices as well as by telephone and email.
HBC offers multiple electronic banking options to its customers. It does not allow the origination of deposit
accounts through online banking, nor does it accept loan applications through its online services. All of the HBC’s
electronic banking services allow customers to review transactions and statements, review images of paid items, transfer
funds between accounts at HBC, place stop orders, pay bills and export to various business and personal software
applications. HBC online commercial banking also allows customers to initiate domestic wire transfers and ACH
transactions, with the added security and functionality of assigning discrete access and levels of security to different
employees of the client and division of functions to allow separation of duties, such as input and release.
We also offer our internet banking customers an additional third party product designed to assist in mitigating
fraud risk to both the customer and the Bank in internet banking and other internet activities conducted by the customer,
at no cost to the customer.
Other Banking Services
We offer a multitude of other products and services to complement our lending and deposit services. These
include cashier’s checks, bank by mail, night depositories, safe deposit boxes, direct deposit, automated payroll services,
electronic funds transfers, online bill pay, homeowner association services, and other customary banking services. HBC
currently operates ATMs at five different locations. In addition, we have established a convenient customer service group
accessible by toll free telephone to answer questions and promote a high level of customer service. HBC does not have a
trust department. In addition to the traditional financial services offered, HBC offers remote deposit capture, automated
clearing house origination, electronic data interchange and check imaging. HBC continues to investigate products and
services that it believes addresses the growing needs of its customers and to analyze other markets for potential expansion
opportunities.
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Investments
Our investment policy is established by the Board of Directors. The general investment strategies are developed
and authorized by our Finance and Investment Committee of the Board of Directors. The investment policy is reviewed
annually by the Finance and Investment Committee, and any changes to the policy are subject to approval by the full Board
of Directors. The overall objectives of the investment policy are to maintain a portfolio of high quality and diversified
investments to maximize interest income over the long term and to minimize risk, to provide collateral for borrowings,
and to provide additional earnings when loan production is low. The policy dictates that investment decisions take into
consideration the safety of principal, liquidity requirements and interest rate risk management. All securities transactions
are reported to the Board of Directors’ Finance and Investment Committee on a monthly basis.
Sources of Funds
Deposits traditionally have been our primary source of funds for our investment and lending activities. We also
are able to borrow from the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank of San Francisco to
supplement cash flow needs. Our additional sources of funds are scheduled loan payments, maturing investments, loan
repayments, income on other earning assets, and the proceeds of loan sales and securities sales.
Interest rates, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit
rates and terms are based primarily on current operating strategies and market interest rates, liquidity requirements and
our deposit growth goals.
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Correspondent Banks
Correspondent bank deposit accounts are maintained to enable the Company to transact types of activity that it
would otherwise be unable to perform or would not be cost effective due to the size of the Company or volume of activity.
The Company has utilized several correspondent banks to process a variety of transactions.
Competition
The banking and financial services business in California generally, and in the Company’s market areas
specifically, is highly competitive. The industry continues to consolidate and unregulated competitors have entered
banking markets with products targeted at highly profitable customer segments. Many larger unregulated competitors are
able to compete across geographic boundaries, and provide customers with meaningful alternatives to most significant
banking services and products. These consolidation trends are likely to continue. The increasingly competitive
environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the
consolidation among financial service providers.
With respect to commercial bank competitors, the business is dominated by a relatively small number of major
banks that operate a large number of offices within our geographic footprint. For the combined Santa Clara, Alameda
Contra Costa, and San Benito county region, the three counties within which the Company operates, the top three
institutions are all multi-billion dollar entities with an aggregate of 270 offices that control a combined 54.85% of deposit
market share based on June 30, 2016 FDIC market share data. HBC ranks sixteenth with 0.99% share of total deposits
based on June 30, 2016 market share data. These banks have, among other advantages, the ability to finance wide-ranging
advertising campaigns and to allocate their resources to regions of highest yield and demand. Larger banks are seeking to
expand lending to small businesses, which are traditionally community bank customers. They can also offer certain
services that we do not offer directly, but may offer indirectly through correspondent institutions. By virtue of their greater
total capitalization, these banks also have substantially higher lending limits than we do. For customers whose needs
exceed our legal lending limit, we arrange for the sale, or “participation,” of some of the balances to financial institutions
that are not within our geographic footprint.
In addition to other large regional banks and local community banks, our competitors include savings institutions,
securities and brokerage companies, asset management groups, mortgage banking companies, credit unions, finance and
insurance companies, internet-based companies, and money market funds. In recent years, we have also witnessed
increased competition from specialized companies that offer wholesale finance, credit card, and other consumer finance
services, as well as services that circumvent the banking system by facilitating payments via the internet, wireless devices,
prepaid cards, or other means. Technological innovations have lowered traditional barriers of entry and enabled many of
these companies to compete in financial services markets. Such innovation has, for example, made it possible for
non-depository institutions to offer customers automated transfer payment services that previously were considered
traditional banking products. In addition, many customers now expect a choice of delivery channels, including telephone
and smart phones, mail, personal computer, ATMs, self-service branches, and/or in-store branches.
Strong competition for deposits and loans among financial institutions and non-banks alike affects interest rates
and other terms on which financial products are offered to customers. Mergers between financial institutions have placed
additional pressure on other banks within the industry to remain competitive by streamlining operations, reducing
expenses, and increasing revenues. Competition has also intensified due to Federal and state interstate banking laws
enacted in the mid-1990’s, which permit banking organizations to expand into other states. The relatively large and
expanding California market has been particularly attractive to out of state institutions. The Gramm-Leach-Bliley Act of
1999 has made it possible for full affiliations to occur between banks and securities firms, insurance companies, and other
financial companies, and has also intensified competitive conditions.
In order to compete with the other financial service providers, the Company principally relies upon
community-oriented, personalized service, local promotional activities, personal relationships established by officers,
directors, and employees with its customers, and specialized services tailored to meet its customers’ needs. Our “preferred
lender” status with the Small Business Administration allows us to approve SBA loans faster than many of our competitors.
In those instances where the Company is unable to accommodate a customer’s needs, the Company seeks to arrange for
such loans on a participation basis with other financial institutions or to have those services provided in whole or in part
by its correspondent banks. See Item 1 — “Business — Correspondent Banks.”
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Employees
Full-time equivalent employees were 263, 260, and 242 at December 31, 2016, 2015, and 2014, respectively.
Supervision and Regulation
Introduction
Banking is a complex, highly regulated industry. Regulation and supervision by federal and state banking
agencies are intended to maintain a safe and sound banking system, protect depositors and the FDIC’s insurance fund, and
to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress and the states have created
several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies
and the financial services industry. Consequently, the growth and earnings performance of the Company can be affected
not only by management decisions and general economic conditions, but also by the requirements of applicable state and
federal statues, regulations and the policies of various governmental regulatory authorities, including the Federal Reserve,
FDIC, and the DBO.
The system of supervision and regulation applicable to financial services businesses governs most aspects of the
business of the Company, including: (i) the scope of permissible business; (ii) investments; (iii) reserves that must be
maintained against deposits; (iv) capital levels that must be maintained; (v) the nature and amount of collateral that may
be taken to secure loans; (vi) the establishment of new branches; (vii) mergers and consolidations with other financial
institutions; and (viii) the payment of dividends.
Set forth below is a description of the significant elements of the laws and regulations applicable to HCC and
HBC. The description is qualified in its entirety by reference to the full text of the statutes, regulations and policies that
are described. Also, such statutes, regulations and policies are continually under review by the U.S. Congress and state
legislatures and federal and state regulatory agencies. A change in statutes, regulations or regulatory policies applicable to
HCC or HBC could have a material effect on our business.
Heritage Commerce Corp
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General. As a bank holding company, HCC is registered under the Bank Holding Company Act of 1956, as
amended (“BHCA”), and is subject to regulation and periodic examination by the Federal Reserve. HCC is also required
to file with the Federal Reserve periodic reports of our operations and any additional information regarding HCC and its
subsidiaries as the Federal Reserve may require.
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HCC is also a bank holding company within the meaning of Section 1280 of the California Financial Code.
Consequently, HCC is subject to examination by, and may be required to file reports with, the DBO. The DBO approval
may be required for certain mergers and acquisitions.
SEC and Nasdaq. HCC’s stock is traded on the NASDAQ Global Select Market (under the trading symbol
“HTBK”), and HCC is subject to rules and regulations of The NASDAQ Stock Market, including those related to corporate
governance. HCC is also subject to the periodic reporting requirements of Section 13 of the Securities Exchange Act of
1934, as amended (the “Exchange Act”), which requires HCC to file annual, quarterly and other current reports with the
SEC. HCC is subject to additional regulations including, but not limited to, the proxy and tender offer rules promulgated
by the SEC under Sections 13 and 14 of the Exchange Act, the reporting requirements of directors, executive officers and
principal shareholders regarding transactions in the HCC’s common stock and short swing profits rules promulgated by
the SEC under Section 16 of the Exchange Act, and certain additional reporting requirements by principal shareholders of
HCC promulgated by the SEC under Section 13 of the Exchange Act.
The Sarbanes Oxley Act of 2002. HCC is subject to the accounting oversight and corporate governance
requirements of the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”), including: (i) required executive
certification of financial presentations; (ii) increased requirements for board audit committees and their members;
(iii) enhanced disclosure of controls and procedures and internal control over financial reporting; (iv) enhanced controls
over and reporting of insider trading; and (v) increased penalties for financial crimes and forfeiture of executive bonuses
in certain circumstances.
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Permitted Activities. In general, the BHCA limits the business of bank holding companies to banking, managing
or controlling banks and other activities that the Federal Reserve has determined to be so closely related to banking as “to
be a proper incident thereto.” We are also prohibited, with certain exceptions, from acquiring direct or indirect ownership
or control of more than 5% of the voting shares of any company unless the company is engaged in banking activities or
the Federal Reserve determines that the activity is so closely related to banking as to be a proper incident to banking. The
Federal Reserve’s approval must be obtained before the shares of any such company can be acquired and, in certain cases,
before any approved company can open new offices.
Bank holding companies that qualify and elect to be treated as “financial holding companies” may engage in a
broad range of additional activities that are: (i) financial in nature or incidental to such financial activities; or
(ii) complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository
institutions or the financial system generally. These activities include securities underwriting and dealing, insurance
underwriting and making merchant banking investments. We have not elected to be treated as a financial holding company
status and have not engaged in any activities determined by the Federal Reserve to be financial in nature or incidental or
complementary to activities that are financial in nature.
The BHCA does not place territorial restrictions on permissible non-banking activities of bank holding
companies. The Federal Reserve has the power to order any bank holding company or its subsidiaries to terminate any
activity or to terminate its ownership or control of any subsidiary when the Federal Reserve has reasonable grounds to
believe that continuing such activity, ownership or control constitutes a serious risk to the financial soundness, safety or
stability of any bank subsidiary of the bank holding company.
Affiliate Transactions. Transactions between banking subsidiaries and their affiliates are regulated by Sections
23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. The Federal Reserve Act imposes quantitative
and qualitative requirements and collateral requirements on covered transactions by HBC with, or for the benefit of, its
affiliates including HCC. Generally, Sections 23A and 23B limit the extent to which HBC or its subsidiaries may engage
in “covered transactions” with any one affiliate to an amount equal to 10% of HBC’s capital stock and surplus, and contain
an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus,
and requires those transactions to be on terms at least as favorable to HBC as if the transaction were conducted with an
unaffiliated third party. Covered transactions are defined by statute to include a loan or extension of credit, as well as a
purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the Federal Reserve) from
the affiliate, certain derivative transactions that create a credit exposure to an affiliate, the acceptance of securities issued
by the affiliate as collateral for a loan, and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
In addition, any credit transactions with an affiliate must be secured by designated amounts of specified collateral.
Source of Strength Doctrine. Federal Reserve policy historically required bank holding companies to act as a
source of financial and managerial strength to their subsidiary banks. Dodd-Frank codified this policy as a statutory
requirement. Under this requirement the holding company is expected to commit resources to support its bank subsidiary,
including at times when the holding company may not be in a financial position to provide it. Bank holding companies
must stand ready to use their available resources to provide adequate capital to their subsidiary banks during periods of
financial stress or adversity. Bank holding companies must also maintain the financial flexibility and capital raising
capacity to obtain additional resources for assisting their subsidiary bank. A bank holding company’s failure to meet its
source-of-strength obligations may constitute an unsafe and unsound practice or a violation of the Federal Reserve’s
regulations or both. The source-of-strength doctrine most directly affects bank holding companies where a bank holding
company’s subsidiary bank fails to maintain adequate capital levels. In such a situation, the subsidiary bank will be required
by the bank’s federal regulator to take “prompt corrective action.” Any capital loans by a bank holding company to its
subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank.
The BHCA provides that in the event of a bank holding company’s bankruptcy any commitment by the bank holding
company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy
trustee and entitled to priority of payment.
Sound Banking Practices. Bank holding companies and their non-banking subsidiaries are prohibited from
engaging in activities that represent unsafe and unsound banking practices or that constitute violation of law or regulations.
Under certain conditions the Federal Reserve may conclude that certain actions of a bank holding company such as a
payment of a cash dividend, would constitute an unsafe and unsound banking practice. The Federal Reserve also has the
authority to regulate the debt of bank holding companies, including the authority to impose interest rate ceilings and reserve
requirements on such debt. Under certain circumstances the Federal Reserve may require a bank holding company to file
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written notice and obtain its approval prior to purchasing or redeeming its equity securities, unless certain conditions are
met.
Acquisitions. The BHCA, the Bank Merger Act, the California Financial Code and other federal and state statutes
regulate acquisitions of commercial banks and other FDIC-insured depository institutions. HCC must obtain the prior
approval of the Federal Reserve before: (i) acquiring direct or indirect ownership control more than 5% of the voting stock
of any FDIC-insured depository institution or other bank holding company (unless we own a majority of such bank’s
voting shares); (ii) acquiring all or substantially all of the assets of any bank or bank holding company; or (iii) merging or
consolidating with any other bank holding company. Under the Bank Merger Act, the prior approval of the Federal Reserve
is required for HBC to merge with another bank or purchase all or substantially all of the assets or assume any of the
deposits of another FDIC-insured depository institution. In reviewing applications seeking approval of merger and
acquisition transactions, bank regulators consider, among other things, the competitive effect and public benefits of the
transactions, the capital position and managerial resources of the combined organization, the risks to the stability of the
U.S. banking or financial system, the applicant’s performance record under the Community Reinvestment Act of 1977, as
amended (“CRA”), the applicant’s compliance with fair housing and other consumer protection laws and the effectiveness
of all organizations involved in combating money laundering activities. In addition, failure to implement or maintain
adequate compliance programs could cause bank regulators not to approve an acquisition where regulatory approval is
required or to prohibit an acquisition even if approval is not required.
HCC is also subject to the Change in Bank Control Act of 1978, as amended (the “Control Act”), and related
Federal Reserve regulations, which provide that any person who proposes to acquire at least 10% (but less than 25%) of
any class of a bank holding company’s voting securities is presumed to control the company (unless the company is not
publicly held and some other shareholder owns a greater percentage of voting stock). Any person who would be presumed
to acquire control or who proposes to acquire control of more than 25% of any class of a bank holding company’s voting
securities or who proposes to acquire actual control must provide the Federal Reserve with at least 60 days prior written
notice of the acquisition. The Federal Reserve may disapprove a proposed acquisition if: (i) it would result in adverse
competitive effects; (ii) the financial condition of the acquiring person might jeopardize the target institution’s financial
stability or prejudice the interests of depositors; (iii) the competence, experience or integrity of any acquiring person
indicates that the proposed acquisition would not be in the best interests of the depositors or the public; or (iv) the acquiring
person fails to provide all of the information required by the Federal Reserve Board. Any proposed acquisition of the
voting securities of a bank holding company that is subject to approval under the BHCA is not subject to the Control Act
notice requirements. Any company that proposes to acquire “control”, as those terms are defined in the BHCA and Federal
Reserve regulations, of a bank holding company or to acquire 25% or more of any class of voting securities of a bank
holding company would be required to seek the Federal Reserve’s prior approval under the BHCA to become a bank
holding company.
Tie-in Arrangements. Federal law prohibits a bank holding company and any subsidiary banks from engaging in
certain tie-in arrangements in connection with the extension of credit. Thus, for example, HBC may not extend credit,
lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition
that: (i) the customer must obtain or provide some additional credit, property or services from or to HBC other than a loan,
discount, deposit or trust services; (ii) the customer must obtain or provide some additional credit, property or service from
or to HCC or HBC; or (iii) the customer must not obtain some other credit, property or services from competitors, except
reasonable requirements to assure soundness of credit extended.
Heritage Bank of Commerce
General. As a California commercial bank whose deposits are insured by the FDIC, HBC is subject to regulation,
supervision, and regular examination by the FDIC, the DBO and by the Federal Reserve as HBC’s primary Federal
regulator. The regulations of these agencies govern most aspects of a bank’s business.
California banks are also subject to various federal statutes and regulations including Federal Reserve
Regulation O, Federal Reserve Act Sections 23A and 23B and Regulation W and similar state statutes, which restrict or
limit loans or extensions of credit to “insiders,” including officers, directors and principal shareholders, and loans or
extension of credit by banks to affiliates or purchases of assets from affiliates, including parent bank holding companies,
except pursuant to certain exceptions and terms and conditions at least as favorable to those prevailing for comparable
transactions with unaffiliated parties.
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Pursuant to the Federal Deposit Insurance Act, as amemded (“FDIA”), and the California Financial Code,
California state chartered commercial banks may generally engage in any activity permissible for national banks.
Therefore, HBC may form subsidiaries to engage in the many so-called “closely related to banking” or “nonbanking”
activities commonly conducted by national banks in operating subsidiaries or subsidiaries of bank holding companies.
Further, California banks may conduct certain “financial” activities in a subsidiary to the same extent as may a national
bank, provided the bank is and remains “well-capitalized,” “well-managed” and in satisfactory compliance with the CRA.
HBC is a member of the Federal Home Loan Bank (“FHLB”) of San Francisco. Among other benefits, each
FHLB serves as a reserve or central bank for its members within its assigned region and makes available loans or advances
to its members. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. As an
FHLB member HBC is required to own a certain amount of capital stock in the FHLB. At December 31, 2016, HBC was
in compliance with the FHLB’s stock ownership requirement. FHLB stock is carried at cost and classified as a restricted
security. Both cash and stock dividends are reported as income.
HBC is a member of the Federal Reserve Bank (“FRB”) of San Francisco. As a member of the FRB, the Bank is
required to own stock in the FRB of San Francisco based on a specified ratio relative to our capital. FRB stock is carried
at cost and may be sold back to the FRB at its carrying value. Cash dividends received are reported as income.
Depositor Preference. In the event of the “liquidation or other resolution” of an insured depository institution,
the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain
claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against
the institution. If an insured depository institution fails, insured and uninsured depositors along with the FDIC, will have
priority in payment ahead of unsecured, non-deposit creditors including the parent bank holding company with respect to
any extensions of credit they have made to such insured depository institution.
Brokered Deposit Restrictions. Well-capitalized institutions are not subject to limitations on brokered deposits,
while an adequately capitalized institution is able to accept, renew or roll over brokered deposits only with a waiver from
the FDIC and subject to certain restrictions on the yield paid on such deposits. Undercapitalized institutions are generally
not permitted to accept, renew, or roll over brokered deposits. HBC is eligible to accept brokered deposits without
limitations.
Loans to One Borrower. With certain limited exceptions, the maximum amount that a California bank may lend
to any borrower at any one time (including the obligations to the bank of certain related entities of the borrower) may not
exceed 25% (and unsecured loans may not exceed 15%) of the bank’s shareholders’ equity, allowance for loan loss, and
any capital notes and debentures of the bank.
Loans to Directors, Executive Officers and Principal Shareholders. The authority of HBC to extend credit to its
directors, executive officers and principal shareholders, including their immediate family members and corporations and
other entities that they control, is subject to substantial restrictions and requirements under Sections 22(g) and 22(h) of the
Federal Reserve Act and Regulation O promulgated thereunder, as well as the Sarbanes-Oxley Act. These statutes and
regulations impose specific limits on the amount of loans HBC may make to directors and other insiders, and specified
approval procedures must be followed in making loans that exceed certain amounts. In addition, all loans HBC makes to
directors and other insiders must satisfy the following requirements:
•
the loans must be made on substantially the same terms, including interest rates and collateral, as prevailing
at the time for comparable transactions with persons not affiliated with HCC or HBC;
• HBC must follow credit underwriting procedures at least as stringent as those applicable to comparable
transactions with persons who are not affiliated with HCC or HBC; and
•
the loans must not involve a greater than normal risk of non-payment or include other features not favorable
to HBC.
Furthermore, HBC must periodically report all loans made to directors and other insiders to the bank regulators,
and these loans are closely scrutinized by the regulators for compliance with Sections 22(g) and 22(h) of the Federal
Reserve Act and Regulation O. Each loan to directors or other insiders must be pre-approved by the HBC board of directors
with the interested director abstaining from voting.
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Community Reinvestment Act. The CRA is intended to encourage insured depository institutions, while operating
safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal bank
regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs
of their entire community, including low-and moderate-income neighborhoods, consistent with safe and sound banking
practices. The CRA further requires the agencies to take a financial institution’s record of meeting its community credit
needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or
acquisitions or holding company formations.
The federal banking agencies have adopted regulations which measure a bank’s compliance with its CRA
obligations on a performance based evaluation system. This system bases CRA ratings on an institution’s actual lending
service and investment performance rather than the extent to which the institution conducts needs assessments, documents
community outreach or complies with other procedural requirements. The ratings range from “outstanding” to a low of
“substantial noncompliance.” HBC had a CRA rating of “satisfactory” as of its most recent regulatory examination.
Environmental Regulation. Federal, state and local laws and regulations regarding the discharge of harmful
materials into the environment may have an impact on HBC. Since HBC is not involved in any business that manufactures,
uses or transports chemicals, waste, pollutants or toxins that might have a material adverse effect on the environment,
HBC’s primary exposure to environmental laws is through its lending activities and through properties or businesses HBC
may own, lease or acquire. Based on a general survey of HBC’s loan portfolio, conversations with local appraisers and the
type of lending currently and historically done by HBC, management is not aware of any potential liability for hazardous
waste contamination that would be reasonably likely to have a material adverse effect on the Company as of December 31,
2016.
Customer Information Security. The Federal Reserve and other bank regulatory agencies have adopted guidelines
for safeguarding confidential, personal customer information. These guidelines require financial institutions to create,
implement and maintain a comprehensive written information security program designed to ensure the security and
confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of
such information and protect against unauthorized access to or use of such information that could result in substantial harm
or inconvenience to any customer. HBC has adopted a customer information security program to comply with such
requirements.
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Privacy. The Gramm-Leach-Bliley Act of 1999 and the California Financial Information Privacy Act require
financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information
about consumers to non-affiliated third parties. In general, the statutes require explanations to consumers on policies and
procedures regarding the disclosure of such nonpublic personal information and, except as otherwise required by law,
prohibit disclosing such information, except as provided in HBC’s policies and procedures. HBC has implemented privacy
policies addressing these restrictions which are distributed regularly to all existing and new customers of HBC.
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Anti-Money Laundering and the USA PATRIOT ACT. A major focus of governmental policy on financial
institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT
Act of 2001, or the USA Patriot Act, substantially broadened the scope of United States anti-money laundering laws and
regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and
expanding the extra-territorial jurisdiction of the United States. Financial institutions are also prohibited from entering into
specified financial transactions and account relationships and must use enhanced due diligence procedures in their dealings
with certain types of high-risk customers and implement a written customer identification program. Financial institutions
must take certain steps to assist government agencies in detecting and preventing money laundering and report certain
types of suspicious transactions. Regulatory authorities routinely examine financial institutions for compliance with these
obligations, and failure of a financial institution to maintain and implement adequate programs to combat money
laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and
reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve
merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval
is not required. Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions
found to be violating these obligations.
Office of Foreign Assets Control Regulation. The U.S. Treasury Department’s Office of Foreign Assets Control
(“OFAC”), administers and enforces economic and trade sanctions against targeted foreign countries and regimes under
authority of various laws, including designated foreign countries, nationals and others. OFAC publishes lists of specially
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designated targets and countries. HCC and HBC are responsible for, among other things, blocking accounts of and
transactions with such targets and countries, prohibiting unlicensed trade and financial transactions with them and
reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal and
reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition
transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
The Dodd-Frank Wall Street Reform and Consumer Protection Regulation Act
The implementation and impact of legislation and regulations enacted since 2008 in response to the U.S.
economic downturn and financial industry instability continued through 2016 as modest recovery returned to many
institutions in the banking sector. Certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection
Regulation Act, as amended (“Dodd-Frank”), which was enacted in 2010, are now effective and have been fully
implemented, including: (i) revisions in the deposit insurance assessment base for FDIC insurance and a permanent
increase in coverage to $250,000; (ii) the permissibility of paying interest on business checking accounts; (iii) the removal
of barriers to interstate branching; (iv) required disclosure and shareholder advisory votes on executive compensation;
(v) final new capital rules; (vi) a final rule to implement the so called Volcker rule restrictions on certain proprietary trading
and investment activities; and (vii) final rules and increased enforcement action by the Consumer Financial Protection
Bureau.
Aspects of Dodd-Frank are still subject to rulemaking and will take effect over several years, making it difficult
to anticipate the overall financial impact on the Company, its customers or the financial services industry more generally.
However, certain provisions of Dodd-Frank will significantly impact, or already are, affecting our operations and expenses,
including but not limited to changes in FDIC assessments, the permitted payment of interest on demand deposits, and
enhanced compliance requirements. Some of the rules and regulations promulgated or yet to be promulgated under
Dodd-Frank will apply directly only to institutions much larger than ours, but could indirectly impact smaller banks, either
due to competitive influences or because certain required practices for larger institutions may subsequently become
expected “best practices” for smaller institutions. We have and expect that we may need to devote even more management
attention and resources to evaluate and make any changes necessary to comply with statutory and regulatory requirements
under Dodd-Frank.
The Volcker Rule
In December 2013, the federal bank regulatory agencies adopted final rules that implement a part of Dodd-Frank
commonly referred to as the “Volcker Rule.” Under these rules and subject to certain exceptions, banking entities are
restricted from engaging in activities that are considered proprietary trading and from sponsoring or investing in certain
entities, including hedge or private equity funds that are considered “covered funds.” These rules became effective April 1,
2014, although certain provisions are subject to delayed effectiveness under rules promulgated by the Federal Reserve.
HCC and HBC held no investment positions at December 31, 2016 or December 31, 2015, which were subject to the final
rule. Therefore, while these new rules may require us to conduct certain internal analysis and reporting, we believe that
they will not require any material changes in our operations or business.
Deposit Insurance
The FDIC is an independent federal agency that insures deposits up to prescribed statutory limits of federally
insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The
FDIC insures HBC’s customer deposits through the Deposit Insurance Fund (the “DIF”) up to prescribed limits for each
depositor. Pursuant to Dodd-Frank, the maximum deposit insurance amount has been permanently increased to $250,000.
The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured
by regulatory capital ratios and other supervisory factors.
As required by Dodd-Frank, the FDIC adopted a DIF restoration plan which became effective on January 1, 2011.
Among other things, the plan: (i) raises the minimum designated reserve ratio, which the FDIC is required to set each year,
to 1.35% and removes the upper limit on the designated reserve ratio and consequently on the size of the fund; (ii) requires
that the fund reserve ratio reach 1.35% by 2020; (iii) eliminates the requirement that the FDIC provide dividends from the
fund when the reserve ratio is between 1.35% and 1.50%; and (iv) continues the FDIC’s authority to declare dividends
when the reserve ratio at the end of a calendar year is at least 1.50%. The FDIC has set a long-term goal of getting its
reserve ratio up to 2.00% of insured deposits by 2027.
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In 2016 our FDIC insurance assessment was $1.2 million. We are generally unable to control the amount of
premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures or if
the FDIC otherwise determines, we may be required to pay even higher FDIC premiums than the recently increased levels.
These announced increases and any future increases in FDIC insurance premiums may have a material and adverse effect
on our earnings and could have a material adverse effect on the value of or market for our common stock.
In addition to DIF assessments, banks must pay quarterly assessments that are applied to the retirement of
Financing Corporation (“FICO”) bonds issued in the 1980’s to assist in the recovery of the savings and loan industry. The
FICO assessment amount fluctuates quarterly, but was 0.0014% of average total assets less average tangible equity for the
third quarter of 2016. As of the date of this report, the Company had not received the FICO assessment for the fourth
quarter of 2016. Those assessments will continue until the Financing Corporation bonds mature in 2019.
The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial
condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF
or that may prejudice the interest of the bank’s depositors. The termination of deposit insurance for a bank would also
result in the revocation of the bank’s charter by the DBO.
Capital Adequacy Requirements
Bank holding companies and banks are subject to similar regulatory capital requirements administered by state
and federal banking agencies. The federal bank regulatory agencies revised the previous risk-based and leverage capital
requirements for banking organizations to meet requirements of Dodd-Frank and to implement the international Basel
Committee on Banking Supervision Basel III agreements (the “Basel III capital rules”). These requirements became
effective on January 1, 2015, but many elements are being phased in over multiple future years. The risk-based capital
guidelines for bank holding companies and, additionally for banks, prompt corrective action regulations (See “Prompt
Corrective Action Provisions”), require capital ratios that vary based on the perceived degree of risk associated with a
banking organization’s operations for both transactions reported on the balance sheet as assets, such as loans, and those
recorded as off-balance sheet items, such as commitments, letters of credit and recourse agreements. The risk-based capital
ratio is determined by classifying assets and certain off-balance sheet financial instruments into weighted categories, with
higher levels of capital being required for those categories perceived as representing greater risks and dividing its
qualifying capital by its total risk-adjusted assets and off-balance sheet items. Capital amounts and classifications are also
subject to qualitative judgments by regulators about components, risk weighting, and other factors. Bank holding
companies and banks engaged in significant trading activity may also be subject to the market risk capital guidelines and
be required to incorporate additional market and interest rate risk components into their risk-based capital standards. To
the extent that the new rules are not fully phased in, the prior capital rules continue to apply.
Many of the requirements in the Basel III capital rules and other regulations and rules are applicable only to
larger or internationally active institutions and not to all banking organizations, including institutions currently with less
than $10 billion or assets, which includes the HCC and HBC.
Prior to January 1, 2015, the risk-based capital guidelines included a minimum required ratio of qualifying Tier 1
capital plus Tier 2 capital to total risk weighted assets of 8% or total risk-based capital ratio, and a minimum required ratio
of Tier 1 capital to total risk weighted assets of 4% or Tier 1 risk-based capital ratio. The guidelines also provided for a
minimum ratio of Tier 1 capital to average assets, or “leverage ratio,” of 3% for institutions having the highest regulatory
rating, and 4% for all other institutions.
The Basel III capital rules: (i) introduced a new capital measure called “common equity Tier 1” and related
regulatory capital ratio of common equity Tier 1 to risk-weighted assets; (ii) specified that Tier 1 capital consists of
common equity Tier 1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandated
that most deductions/adjustments to regulatory capital measures be made to common equity Tier 1 and not to the other
components of capital; and (iv) expanded the scope of the deductions from and adjustments to capital as compared to
existing regulations. Under the Basel III capital rules, for most banking organizations, the most common form of
Additional Tier 1 capital is noncumulative perpetual preferred stock and the most common form of Tier 2 capital is
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subordinated debt and a portion of the allowance for loan and lease losses, which in each case, are subject to new capital
rules’ specific requirements.
Under the Basel III capital rules, the following were the initial minimum capital ratios applicable to HCC and
HBC as of January 1, 2015:
•
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•
•
4.5% common equity Tier 1 (as a subset of Tier 1) to risk-weighted assets;
6.0% Tier 1 capital (common equity Tier 1 plus Additional Tier 1 capital) to risk-weighted assets;
8.0% total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets; and
4.0% Tier 1 non-risk based leverage ratio.
The Basel III capital rules also introduced a new “capital conservation buffer,” for banking organizations to
maintain a common equity Tier 1 ratio more than 2.5% above these minimum risk-weighted asset ratios. The capital
conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of
common equity Tier 1 to risk-weighted assets above the minimum but below the capital conservation buffer will face
constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The implementation
of the capital conservation buffer was phased in beginning on January 1, 2016 at 0.625% and will be phased in over a
four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). Thus,
when fully phased-in on January 1, 2019, HCC and HBC will be required to maintain this additional capital conservation
buffer of 2.5% of common equity Tier 1, resulting in the following minimum capital ratios:
•
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•
•
7.0% common equity Tier 1 to risk weighted assets;
8.5% Tier 1 capital to risk weighted assets;
10.5% total capital to risk weighted assets; and
4.0% Tier 1 non-risk based leverage ratio.
The Basel III capital rules provide for a number of deductions from and adjustments to common equity Tier 1.
These include, for example, the requirement that: (i) mortgage servicing rights; (ii) deferred tax assets arising from
temporary differences that could not be realized through net operating loss carrybacks, and (iii) significant investments in
non-consolidated financial entities be deducted from common equity Tier 1 to the extent that any one such category
exceeds 10% of common equity Tier 1 or all such items, in the aggregate, exceed 15% of common equity Tier 1.
Implementation of the deductions and other adjustments to common equity Tier 1 began on January 1, 2015 and will be
phased-in over a four-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The
risk-weights of certain assets for purposes of calculating the risk-based capital ratios are changed for high volatility
commercial real estate acquisition, development and construction loans, certain past due non-residential mortgage loans
and certain mortgage-backed and other securities exposures.
In 2015, HCC and HBC made a one-time election as permitted under the Basel III capital rules to continue the
current capital standards under which the effects of accumulated other comprehensive income or loss (“AOCI”) items
included in shareholders’ equity (for example, unrealized gains or losses on securities held in the available-for-sale
portfolio) under U.S. GAAP are excluded for the purposes of determining regulatory capital ratios. HCC and HBC made
this election in order to avoid significant variations in the level of capital depending upon the impact of interest rate
fluctuations on the fair value of its available-for-sale securities portfolio.
Based on existing capital levels at December 31, 2016, HCC and HBC meet all capital adequacy requirements
under the Basel III capital rules on a fully phased-in basis.
The appropriate federal banking agency may under certain circumstances reclassify a well capitalized insured
depository institution as adequately capitalized. An institution may be reclassified if the appropriate federal banking
agency determines (after notice and opportunity for a hearing) that the institution is in an unsafe or unsound condition or
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deems the institution to be engaging in an unsafe or unsound practice. The appropriate agency is also permitted to require
an adequately capitalized or undercapitalized institution to comply with the supervisory provisions as if the institution
were in the next lower category (but not treat a significantly undercapitalized institution as critically undercapitalized)
based on supervisory information other than the capital levels of the institution.
At each successively lower capital category, an insured bank is subject to increased restrictions on its operations.
For example, a bank is generally prohibited from paying management fees to any controlling persons or from making
capital distributions if to do so would make the bank “undercapitalized.” Asset growth and branching restrictions apply to
undercapitalized banks, which are required to submit written capital restoration plans meeting specified requirements
(including a guarantee by the parent holding company, if any). “Significantly undercapitalized” banks are subject to broad
regulatory authority, including among other things, capital directives, forced mergers, restrictions on the rates of interest
they may pay on deposits, restrictions on asset growth and activities, and prohibitions on paying bonuses or increasing
compensation to senior executive officers without FDIC approval. Even more severe restrictions apply to “critically
undercapitalized” banks. Most importantly, except under limited circumstances, not later than 90 days after an insured
bank becomes critically undercapitalized the appropriate federal banking agency is required to appoint a conservator or
receiver for the bank.
For more information on the Company’s capital, see Part II, Item 7, Management’s Discussion and Analysis of
Financial Condition and Results of Operation — Capital Resources.
Consumer Compliance and Fair Lending Laws
We are subject to a number of federal and state consumer protection laws that extensively govern our relationship
with our customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in
Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home
Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection
Practices Act, the Service Members Civil Relief Act, the Military Lending Act, and these laws’ respective state-law
counterparts, as well as state usury laws and laws regarding unfair and deceptive acts and practices. These and other federal
laws, among other things, require disclosures of the cost of credit and terms of deposit accounts, provide substantive
consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide
financial privacy protections, prohibit unfair, deceptive and abusive practices, restrict our ability to raise interest rates and
subject us to substantial regulatory oversight. Violations of applicable consumer protection laws can result in significant
potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees. Federal
bank regulators, state attorneys general and state and local consumer protection agencies may also seek to enforce
consumer protection requirements and obtain these and other remedies, including regulatory sanctions, customer rescission
rights, action by the state and local attorneys general in each jurisdiction in which we operate and civil money penalties.
Failure to comply with consumer protection requirements may also result in our failure to obtain any required bank
regulatory approval for merger or acquisition transactions we may wish to pursue or our prohibition from engaging in such
transactions even if approval is not required.
Dodd-Frank created a new, independent federal agency, the Consumer Financial Protection Bureau (“CFPB”),
which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial
protection laws. The CFPB is also authorized to engage in consumer financial education, track consumer complaints,
request data and promote the availability of financial services to underserved consumers and communities. Although all
institutions are subject to rules adopted by the CFPB and examination by the CFPB in conjunction with examinations by
the institution’s primary federal regulator, the CFPB has primary examination and enforcement authority over institutions
with assets of $10 billion or more. The Federal Reserve has primary responsibility for examination of HBC and
enforcement with respect to federal consumer protection laws so long as HBC has total consolidated assets of less than
$10 billion, and state authorities are responsible for monitoring our compliance with all state consumer laws. The CFPB
also has the authority to require reports from institutions with less than $10 billion in assets, such as HBC, to support the
CFPB in implementing federal consumer protection laws, supporting examination activities, and assessing and detecting
risks to consumers and financial markets.
The consumer protection provisions of Dodd-Frank and the examination, supervision and enforcement of those
laws and implementing regulations by the CFPB have created a more intense and complex environment for consumer
finance regulation. The CFPB has significant authority to implement and enforce federal consumer finance laws, including
the Truth in Lending Act, the Equal Credit Opportunity Act and new requirements for financial services products provided
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for in Dodd-Frank, as well as the authority to identify and prohibit unfair, deceptive or abusive acts and practices. The
review of products and practices to prevent such acts and practices is a continuing focus of the CFPB, and of banking
regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing,
practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and
examination, additional remediation efforts and possible penalties. In addition, Dodd-Frank provides the CFPB with broad
supervisory, examination and enforcement authority over various consumer financial products and services, including the
ability to require reimbursements and other payments to customers for alleged legal violations and to impose significant
penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also
has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. Dodd-Frank does
not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential
enforcement actions could also adversely affect our business, financial condition or results of operations.
Prompt Corrective Action Provisions
The Federal Deposit Insurance Act requires the federal bank regulatory agencies to take “prompt corrective
action” with respect to a depository institution if that institution does not meet certain capital adequacy standards, including
requiring the prompt submission of an acceptable capital restoration plan. Depending on the bank’s capital ratios, the
agencies’ regulations define five categories in which an insured depository institution will be placed: well-capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At each successive
lower capital category, an insured bank is subject to more restrictions, including restrictions on the bank’s activities,
operational practices or the ability to pay dividends or executive bonuses. Based upon its capital levels, a bank that is
classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower
capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.
The prompt corrective action standards were changed when the Basel III capital rules became effective in 2015.
Under the new rules, a financial institution will be: (i) “well capitalized” if the institution has a total risk-based capital
ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, common equity Tier 1 capital ratio of 6.5%
or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory
authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution
has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, common equity
Tier 1 capital ratio of 4.5% or greater, and a leverage ratio of 4.0% or greater; (iii) “undercapitalized” if the institution has
a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, common equity
Tier 1 capital ratio of less than 4.5%, or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the
institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, common
equity Tier 1 capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if
the institution’s tangible equity (defined as Tier 1 capital plus non-Tier 1 perpetual preferred stock) is equal to or less than
2.0% of average quarterly tangible assets. As of December 31, 2016, both HCC and HBC were deemed to be well
capitalized for regulatory purposes.
Enforcement Authority
The federal and California regulatory structure gives the bank regulatory agencies extensive discretion in
connection with their supervisory and enforcement activities and examination policies, including policies with respect to
the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. The regulatory
agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before an
institution’s capital becomes impaired. The guidelines establish operational and managerial standards generally relating
to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting;
(iv) interest rate exposure; (v) asset growth and asset quality; and (vi) compensation, fees, and benefits. Further, the
regulatory agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring
earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves.
If, as a result of an examination the DBO or the Federal Reserve should determine that the financial condition,
capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of HBC’s operations are
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unsatisfactory or that HBC or its management is violating or has violated any law or regulation, the DBO and the Federal
Reserve, and separately the FDIC as insurer of the HBC’s deposits, have residual authority to:
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require affirmative action to correct any conditions resulting from any violation or practice;
direct an increase in capital and the maintenance of higher specific minimum capital ratios, which may
preclude HBC from being deemed well capitalized and restrict its ability to accept certain brokered deposits;
restrict HBC’s growth geographically by products and services or by mergers and acquisitions, including
bidding in FDIC receiverships for failed banks;
enter into or issue informal or formal enforcement actions, including required board of directors’ resolutions,
memoranda of understanding, written agreements and consent or cease and desist orders or prompt corrective
action orders to take corrective action and cease unsafe and unsound practices;
require prior approval of senior executive officer or director changes, remove officers and directors and
assess civil monetary penalties; and
take possession of and close and liquidate HBC or appoint the FDIC as receiver.
Dividends
It is the Federal Reserve’s policy that bank holding companies should generally pay dividends on common stock
only out of income available over the past year, and only if prospective earnings retention is consistent with the
organization’s expected future needs and financial condition. It is also the Federal Reserve’s policy that bank holding
companies should not maintain dividend levels that undermine their ability to be a source of strength to its banking
subsidiaries. Additionally, in consideration of the current financial and economic environment, the Federal Reserve has
indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios
that are at maximum allowable levels unless both asset quality and capital are very strong.
HBC is a legal entity that is separate and distinct from its holding company. HCC receives cash through dividends
paid by HBC. Future cash dividends by HBC will depend upon management’s assessment of future capital requirements,
contractual restrictions, and other factors. The ability of the Board of Directors of HBC to declare a cash dividend to HCC
is subject to California law, which restricts the amount available for cash dividends to the lesser of a bank’s retained
earnings or net income for its last three fiscal years (less any distributions to shareholders made during such period). Where
this test is not met, cash dividends may still be paid, with the prior approval of the DBO in an amount not exceeding the
greatest of: (i) retained earnings of the bank; (ii) the net income of the bank for its last fiscal year; or (iii) the net income
of the bank for its current fiscal year. A California bank may also with the prior approval of the DBO and approval of the
bank’s shareholders distribute a dividend in connection with a reduction of capital of the bank. If the DBO determines that
the shareholders’ equity of the bank paying the dividend is not adequate or that the payment of the dividend would be
unsafe or unsound for the bank, the DBO may order the bank not to pay the dividend. Since HBC is a FDIC insured
institution, it is also possible, depending upon its financial condition and other factors that the FDIC could assert that the
payment of dividends or other payments might, under some circumstances, constitute an unsafe or unsound practice and
thereby prohibit such payments.
The California General Corporation Law prohibits HCC from making distributions, including dividends, to
holders of its common stock or preferred stock unless either of the following tests are satisfied: (i) the amount of retained
earnings immediately prior to the distribution equals or exceeds the sum of (A) the amount of the proposed distribution
plus (B) any cumulative dividends in arrears on all shares having a preference with respect to the payment of dividends
over the class or series to which the applicable distribution is being made; or (ii) immediately after the distribution, the
value of HCC’s consolidated assets would equal or exceed the sum of its total liabilities, plus the amounts that would be
payable to satisfy the preferential rights of other shareholders upon a dissolution that are superior to the rights of the
shareholders receiving the distribution.
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Stock Redemptions and Repurchases
It is an essential principle of safety and soundness that a banking organization’s redemption and repurchases of
regulatory capital instruments, including common stock, from investors be consistent with the organization’s current and
prospective capital needs. In assessing such needs, the board of directors and management of a bank holding company
should consider the factors discussed previously under “Dividends”. The risk-based capital rule directs bank holding
companies to consult with the Federal Reserve before redeeming any equity or other capital instrument included in Tier 1
or Tier 2 capital prior to stated maturity, if such redemption could have a material effect on the level or composition of the
organization’s capital base. Bank holding companies experiencing financial weaknesses, or that are at significant risk of
developing financial weaknesses, must consult with the appropriate Federal Reserve supervisory staff before redeeming
or repurchasing common stock or other regulatory capital instruments for cash or other valuable consideration. Similarly,
any bank holding company considering expansion, either through acquisitions or through new activities, also generally
must consult with the appropriate Federal Reserve supervisory staff before redeeming or repurchasing common stock or
other regulatory capital instruments for cash or other valuable consideration. In evaluating the appropriateness of a bank
holding company’s proposed redemption or repurchase of capital instruments, the Federal Reserve will consider the
potential losses that the holding company may suffer from the prospective need to increase reserves and write down assets
from continued asset deterioration and the holding company’s ability to raise additional common stock and other Tier 1
capital to replace capital instruments that are redeemed or repurchased. A bank holding company must inform the Federal
Reserve of a redemption or repurchase of common stock or perpetual preferred stock for cash or other value resulting in a
net reduction of the bank holding company’s outstanding amount of common stock or perpetual preferred stock below the
amount of such capital instrument outstanding at the beginning of the quarter in which the redemption or repurchase
occurs. In addition, a bank holding company must advise the Federal Reserve sufficiently in advance of such redemptions
and repurchases to provide reasonable opportunity for supervisory review and possible objection should the Federal
Reserve determine a transaction raises safety and soundness concerns.
Regulation Y requires that a bank holding company that is not well capitalized or well managed, or that is subject
to any unresolved supervisory issues, provide prior notice to the Federal Reserve for any repurchase or redemption of its
equity securities for cash or other value that would reduce by 10% or more the holding company’s consolidated net worth
aggregated over the preceding 12-month period.
Incentive Compensation
Dodd-Frank requires the federal bank regulators and the SEC to establish joint regulations or guidelines
prohibiting incentive-based payment arrangements at specified regulated entities, including HCC and HBC, having at least
$1 billion in total assets that encourage inappropriate risks by providing an executive officer, employee, director or
principal stockholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the
entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of
incentive-based compensation arrangements. The agencies have proposed such regulations, but the regulations have not
been finalized. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in
which we may structure compensation for our executives.
The proposed regulations apply to incentive compensation paid to “covered persons” at covered financial
institutions, including executive officers, employees, directors and principal shareholders (those who own 10% or more of
the institution’s shares). The proposed regulations prohibit a covered financial institution from creating or maintaining an
incentive-based compensation arrangement that encourages inappropriate risks by providing a covered person either:
(i) with excessive compensation; or (ii) with incentive-based compensation that could lead to material financial loss to the
financial institution. Under the proposed regulations incentive-based compensation is excessive if amounts paid are
unreasonable or disproportionate to the services provided by the covered person taking into consideration factors listed in
the regulations, including the financial condition of the covered financial institution and practices at comparable
institutions. A compensation arrangement would be considered able to lead to material financial loss unless, it: (i) balances
risk and financial reward (for example by using deferral of payment); (ii) is compatible with effective controls and risk
management; and (iii) is supported by strong corporate governance. Under the proposed regulations covered financial
institutions must also maintain policies and procedures governing the award of incentive-based compensation in line with
the institution’s size, complexity and business activities and the scope and nature of its use of incentive-based
compensation.
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The Federal Reserve and FDIC have also issued comprehensive final guidance on incentive compensation
policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety
and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that
have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based
upon the key principles that a banking organization’s incentive compensation arrangements should: (i) provide incentives
that appropriately balance risk and financial results in a manner that does not encourage employees to expose their
organizations to imprudent risk; (ii) be compatible with effective internal controls and risk management; and (iii) be
supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.
The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive
compensation arrangements of banking organizations, such as us, that are not “large, complex banking organizations.”
These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and
the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in
reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the
organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking
organization if its incentive compensation arrangements or related risk management control or governance processes, pose
a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct
the deficiencies.
The scope, content and application of the U.S. banking regulators’ policies on incentive compensation continue
to evolve. It cannot be determined at this time whether compliance with such policies will adversely affect the ability of
the Company to hire, retain and motivate key employees.
Other Pending and Proposed Legislation
Other legislative and regulatory initiatives which could affect HCC, HBC and the banking industry in general
may be proposed or introduced before the United States Congress, the California legislature and other governmental bodies
in the future. Such proposals, if enacted, may further alter the structure, regulation and competitive relationship among
financial institutions, and may subject HCC or HBC to increased regulation, disclosure and reporting requirements. In
addition, the various banking regulatory agencies often adopt new rules and regulations to implement and enforce existing
legislation. It cannot be predicted whether, or in what form, any such legislation or regulations may be enacted or the
extent to which the business of HCC or HBC would be affected thereby.
ITEM 1A — RISK FACTORS
Our business, financial condition and results of operations are subject to various risks, including those discussed
below. The risks discussed below are those that we believe are the most significant risks, although additional risks not
presently known to us or that we currently deem less significant may also adversely affect our business, financial condition
and results of operations, perhaps materially.
Our business may be adversely affected by business and economic conditions.
Risks Relating to Our Industry
Our business activities and earnings are affected by general business conditions in the United States and in our
local market area. These conditions include short-term and long-term interest rates, the prevailing yield curve, inflation,
unemployment levels, monetary policy, consumer confidence and spending, political issues, legislative and regulatory
changes, broad trends in industry and finance, fluctuations in both debt and equity capital markets, and the strength of the
economy in the United States generally and in our market area in particular, all of which are beyond the Company’s
control. While there are signs of economic conditions improving, the U.S. budget deficit and uncertainty in European
economies underline that the economy remains uncertain. Business activity across a wide range of industries and regions
is greatly affected. Financial institutions continue to be affected by long-term unemployment and underemployment rates
and a stricter regulatory environment. While our market areas have not experienced the same degree of challenge in
unemployment as other areas, the effects of these issues have trickled down to households and businesses in our markets.
In view of the concentration of our operations and the collateral securing our loan portfolio in the southern and eastern
regions of the general San Francisco Bay Area of California, we may be particularly susceptible to adverse economic
conditions in the State of California. There can be no assurance that the recent economic improvement is sustainable and
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credit worthiness of our borrowers will not deteriorate. Deterioration in economic conditions could result in an increase in
loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for the
Company’s products and services, among other things, any of which could adversely impact on our financial condition
and results of operations.
Additional requirements imposed by Dodd-Frank and related regulation could adversely affect us.
Dodd-Frank imposed additional regulatory requirements including the following:
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the establishment of strengthened capital and liquidity requirements for banks and bank holding companies,
including minimum leverage and risk-based capital requirements no less than the strictest requirements in
effect for depository institutions as of the date of enactment;
the requirement by statute that bank holding companies serve as a source of financial strength for their
depository institution subsidiaries;
enhanced regulation of financial markets, including the derivative and securitization markets, and the
elimination of certain proprietary trading activities by banks;
additional corporate governance and executive compensation requirements; enhanced financial institution
safety and soundness regulations, revisions in FDIC insurance assessments; and
the creation of new regulatory bodies, such as the Bureau of Consumer Financial Protection and the Financial
Services Oversight Counsel.
Some of the provisions remain subject to final rulemaking and/or implementation. Accordingly, we cannot fully
assess its impact on our operations and costs.
Current and future legal and regulatory requirements, restrictions, and regulations, including those imposed under
Dodd-Frank, may adversely impact our profitability and may have a material and adverse effect on our business, financial
condition, and results of operations. We may also be required to invest significant management attention and resources to
evaluate and make changes required by the legislation and related regulations and may make it more difficult for us to
attract and retain qualified executive officers and employees.
New capital and liquidity standards adopted by the U.S. banking regulators have resulted in banks and bank holding
companies needing to maintain more and higher quality capital than has historically been the case.
New capital standards, both as a result of Dodd-Frank and the U.S. Basel III capital rules have had a significant
effect on banks and bank holding companies. The Basel III capital rules require bank holding companies and their bank
subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. For additional information,
see “Capital Adequacy Requirements” under Part I, Item 1 “Business.”
The need to maintain more and higher quality capital going forward than historically has been required, and
generally increased regulatory scrutiny with respect to capital levels, could limit the Company’s business activities,
including lending, and its ability to expand, either organically or through acquisitions. It could also result in being required
to take steps to increase its regulatory capital that may be dilutive to shareholders or limit its ability to pay dividends or
otherwise return capital to shareholders, or sell or refrain from acquiring assets, the capital requirements for which are not
justified by the assets’ underlying risks.
We are subject to extensive government regulation that could limit or restrict our activities which in turn may
adversely impact our ability to increase our assets and earnings.
The banking industry is subject to extensive federal and state regulation. We are subject to supervision and
regulation by a number of governmental regulatory agencies, including the Federal Reserve, the DBO and the FDIC.
Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers
rather than for the benefit of shareholders, govern a comprehensive range of matters relating to ownership and control of
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our common stock, our acquisition of other companies and businesses, permissible activities for us to engage in,
maintenance of adequate capital levels, and other aspects of our operations. These bank regulators possess broad authority
to prevent or remedy unsafe or unsound practices or violations of law. The laws and regulations applicable to the banking
industry could change at any time and we cannot predict the effects of these changes on our business and profitability.
Increased regulation could increase our cost of compliance and adversely affect profitability. Moreover, certain of these
regulations contain significant punitive sanctions for violations, including monetary penalties and limitations on a bank’s
ability to implement components of its business plan, such as expansion through mergers and acquisitions or the opening
of new branch offices. In addition, changes in regulatory requirements may add costs associated with compliance efforts.
Furthermore, government policy and regulation, particularly as implemented through the Federal Reserve System,
significantly affect credit conditions. As a result of the negative financial market and general economic trends, there is a
potential for new federal or state laws and regulation regarding lending and funding practices and liquidity standards. Bank
regulatory agencies have been and are expected to be aggressive in responding to concerns and trends identified in
examinations, including the expected issuance of formal enforcement orders. Negative developments in the financial
industry and the impact of new legislation and regulation in response to those developments could negatively impact our
business, business, results of operations and financial condition.
We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti money laundering
statutes and regulations.
The Bank Secrecy Act, the USA Patriot Act of 2001, and other laws and regulations require financial institutions,
among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and
currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network (a bureau of the U.S.
Department of Treasury) is authorized to impose significant civil money penalties for violations of those requirements and
has recently engaged in coordinated enforcement efforts with the individual federal banking regulators as well as the U.S.
Department of Justice, Drug Enforcement Administration, and Internal Revenue Service. We are also subject to increased
scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control and compliance with the Foreign
Corrupt Practices Act. If our policies, procedures and systems are deemed deficient, we would be subject to liability,
including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to
obtain regulatory approvals to proceed with certain aspects of our business plan. Failure to maintain and implement
adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences
for us. Any of these results could materially and adversely affect our business, results of operations and financial condition.
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Increased deposit insurance costs and changes in deposit regulation may adversely affect our results of operations.
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As a result of recent economic conditions and the enactment of Dodd Frank, the FDIC has increased the deposit
insurance assessment rates in recent years and thus raised deposit premiums for insured depository institutions. If these
increases are insufficient for the Deposit Insurance Fund to meet its funding requirements, further special assessments or
increases in deposit insurance premiums may be required which we may be required to pay. We are generally unable to
control the amount of premiums that we are required to pay for FDIC insurance. If there are additional banks or financial
institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels. Any future
additional assessments, increases or required prepayments in FDIC insurance premiums may materially adversely affect
our results of operations.
Regulations relating to privacy, information security and data protection could increase our costs, affect or limit how
we collect and use personal information and adversely affect our business opportunities.
We are subject to various privacy, information security and data protection laws, including requirements
concerning security breach notification, and we could be negatively impacted by these laws. For example, our business is
subject to the Gramm-Leach-Bliley Act of 1999 which, among other things: (i) imposes certain limitations on our ability
to share nonpublic personal information about our customers with nonaffiliated third parties; (ii) requires that we provide
certain disclosures to customers about our information collection, sharing and security practices and afford customers the
right to “opt out” of any information sharing by us with nonaffiliated third parties (with certain exceptions); and (iii)
requires we develop, implement and maintain a written comprehensive information security program containing
safeguards appropriate based on our size and complexity, the nature and scope of our activities, and the sensitivity of
customer information we process, as well as plans for responding to data security breaches. Various state and federal
banking regulators and states have also enacted data security breach notification requirements with varying levels of
individual, consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach.
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Moreover, legislators and regulators in the United States are increasingly adopting or revising privacy, information security
and data protection laws that potentially could have a significant impact on our current and planned privacy, data protection
and information security-related practices, our collection, use, sharing, retention and safeguarding of consumer or
employee information, and some of our current or planned business activities. This could also increase our costs of
compliance and business operations and could reduce income from certain business initiatives. This includes increased
privacy-related enforcement activity at the federal level, by the Federal Trade Commission, as well as at the state level,
such as with regard to mobile applications.
Compliance with current or future privacy, data protection and information security laws (including those
regarding security breach notification) affecting customer or employee data to which we are subject could result in higher
compliance and technology costs and could restrict our ability to provide certain products and services, which could have
a material adverse effect on our business, financial conditions or results of operations. Our failure to comply with privacy,
data protection and information security laws could result in potentially significant regulatory or governmental
investigations or actions, litigation, fines, sanctions and damage to our reputation, which could have a material adverse
effect on our business, financial condition or results of operations.
Risks Related to Our Market and Business
Our profitability is dependent upon the economic conditions of the markets in which we operate.
We operate primarily in Santa Clara County, Contra Costa County, Alameda County, and San Benito County
and, as a result, our financial condition and results of operations are subject to changes in the economic conditions in those
areas. Our success depends upon the business activity, population, income levels, deposits and real estate activity in these
markets. Although our customers’ business and financial interests may extend well beyond these market areas, adverse
economic conditions that affect these market areas could reduce our growth rate, affect the ability of our customers to
repay their loans to us and generally affect our financial condition and results of operations. Our lending operations are
located in market areas dependent on technology and real estate industries and their supporting companies. Thus, our
borrowers could be adversely impacted by a downturn in these sectors of the economy that could reduce the demand for
loans and adversely impact the borrowers’ ability to repay their loans, which would, in turn, increase our nonperforming
assets. Because of our geographic concentration, we are less able than regional or national financial institutions to diversify
our credit risks across multiple markets.
Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial
performance.
Fluctuations in interest rates may negatively impact our banking business and may weaken demand for some of
our products. Our earnings and cash flows are largely dependent on net interest income, which is the difference between
the interest income we receive from interest-earning assets (e.g., loans and investment securities) and the interest expense
we pay on interest-bearing liabilities (e.g., deposits and borrowings). The level of net interest income is primarily a function
of the average balance of interest-earning assets, the average balance of interest-bearing liabilities and the spread between
the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of interest-
earning assets and interest-bearing liabilities. Interest rates are volatile and highly sensitive to many factors that are beyond
our control, such as economic conditions and policies of various governmental and regulatory agencies, and, in particular
the monetary policy of the Federal Open Market Committee of the Federal Reserve System (“FOMC”). In recent years, it
has been the policy of the FOMC and the U.S. Treasury to maintain interest rates at historically low levels through its
targeted Federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities. The average yield on our
interest-earning assets has decreased during the recent low interest rate environment. If a low interest rate environment
persists, our net interest income may further decrease. This would be the case because our ability to lower our interest
expense has been limited at these interest rate levels, while the average yield on our interest-earning assets has continued
to decrease. Moreover, as interest rates begin to increase, if our floating rate interest-earning assets do not reprice faster
than our interest-bearing liabilities in a rising rate environment, our net interest income could be adversely affected. If our
net interest income decreases, this could have an adverse effect on our profitability, including the value of our investments.
Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive
on loans and securities and the amount of interest we pay on deposits and borrowings, but also our ability to originate
loans and deposits. Historically, there has been an inverse correlation between the demand for loans and interest rates.
Loan origination volume usually declines during periods of rising or high interest rates and increases during periods of
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declining or low interest rates. Changes in interest rates also have a significant impact on the carrying value of certain of
our assets, including loans, real estate and investment securities, on our balance sheet. We may incur debt in the future and
that debt may also be sensitive to interest rates.
The cost of our deposits is largely based on short-term interest rates, the level of which is driven primarily by the
FOMC’s actions. However, the yields generated by our loans and securities are often difficult to re-price and are typically
driven by longer-term interest rates, which are set by the market or, at times, the FOMC’s actions, and vary over time. The
level of net interest income is therefore influenced by movements in such interest rates and the pace at which such
movements occur. If the interest rates paid on our deposits and other borrowings increase at a faster pace than the interest
rates on our loans and other investments, our net interest income may decline and, with it, a decline in our earnings may
occur. Our net interest income and earnings would be similarly affected if the interest rates on our interest-earning assets
declined at a faster pace than the interest rates on our deposits and other borrowings. Any substantial, unexpected,
prolonged change in market interest rates could have a material adverse effect on our business, financial condition or
results of operations.
Changes in interest rates can also affect the level of loan refinancing activity, which impacts the amount of
prepayment penalty income we receive on loans we hold. Because prepayment penalties are recorded as interest income
when received, the extent to which they increase or decrease during any given period could have a significant impact on
the level of net interest income and net income we generate during that time. A decrease in our prepayment penalty income
resulting from any change in interest rates or as a result of regulatory limitations on our ability to charge prepayment
penalties could therefore adversely affect our net interest income, net income or results of operations.
Changes in interest rates can also affect the slope of the yield curve. A decline in the current yield curve or a
flatter or inverted yield curve could cause our net interest income and net interest margin to contract, which could have a
material adverse effect on our net income and cash flows, as well as the value of our assets. An inverted yield curve may
also adversely affect the yield on investment securities by increasing the prepayment risk of any securities purchased at a
premium. A flattening or inversion of the yield curve or a negative interest rate environment in the United States could
create downward pressure on our net interest margin.
Changes in interest rates could also have a negative impact on our results of operations by reducing the ability of
borrowers to repay their current loan obligations or by reducing our margins and profitability. As of December 31, 2016,
55% of our loans were advanced to our customers on a variable or adjustable-rate basis and another 45% of our loans were
advanced to our customers on a fixed-rate basis. We do not use derivative instruments to swap our economic exposure to
a variable-rate basis. As a result, an increase in interest rates could result in increased loan defaults, foreclosures and
charge-offs and could necessitate further increases to the allowance for loan and lease losses, any of which could have a
material adverse effect on our business, financial condition or results of operations. In addition, a decrease in interest rates
could negatively impact our margins and profitability.
The prohibition restricting depository institutions from paying interest on demand deposits, such as checking
accounts, was repealed effective on July 21, 2011 as part of Dodd-Frank. Current interest rates for this product are very
low because of current market conditions and, so far, the impact of the repeal has not been significant to us. However, we
do not know what market rates will eventually be and, therefore, we cannot estimate at this time the long-term impact of
the repeal on our interest expense on deposits. If we need to offer higher interest rates on checking accounts to maintain
current clients or attract new clients, our interest expense will increase, perhaps materially. Furthermore, if we fail to offer
interest in a sufficient amount to keep these demand deposits, our core deposits may be reduced, which would require us
to obtain funding in other ways or risk slowing our future asset growth.
We are subject to liquidity risk that may affect our ability to meet our obligations and grow our business.
Liquidity risk is the risk that we will not be able to meet our obligations, including financial commitments, as
they come due and is inherent in our operations. This risk can increase due to a number of factors, including an over-
reliance on a particular source of funding (including, for example, short-term and overnight funding) or market-wide
phenomena such as market dislocation and major disasters. Like many banking companies, we rely on customer deposits
to meet a considerable portion of our funding, and we continue to seek customer deposits to maintain this funding base.
We obtain deposits directly from our commercial customers. In the past, we have obtained deposits from and “brokered
deposits” through third parties that offer our deposit products to their customers. As of December 31, 2016, we had $2.26
billion in direct deposits, $9.4 million in deposits originated through the CDARS program, and no deposits originated
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through brokerage firms. A key part of our liquidity plan and funding strategy is to expand our direct deposits as a source
of funding. However, these deposits are subject to potentially dramatic fluctuations in availability or price due to certain
factors outside our control, such as a loss of confidence by customers in us or the banking sector generally, customer
perceptions of our financial health and general reputation, increasing competitive pressures from other financial services
firms for retail or corporate customer deposits, changes in interest rates and returns on other investment classes, which
could result in significant outflows of deposits within short periods of time or significant changes in pricing necessary to
maintain current or attract additional deposits.
Competition among U.S. banks for customer deposits is intense, may increase the cost of retaining current
deposits or procuring new deposits, and may otherwise negatively affect our ability to grow our deposit base. Any changes
we make to the rates offered on our deposit products to remain competitive with other financial institutions may adversely
affect our profitability and liquidity. Interest-bearing accounts earn interest at rates established by management based on
competitive market factors. Maintaining and attracting new deposits is integral to our business and a major decline in
deposits or failure to attract deposits in the future, including any such decline or failure related to an increase in interest
rates paid by our competitors on interest-bearing accounts, could have an adverse effect on our results of operations and
financial condition. The demand for the deposit products we offer may also be reduced due to a variety of factors, such as
demographic patterns, changes in customer preferences, reductions in consumers’ disposable income, regulatory actions
that decrease customer access to particular products, or the availability of competing products. An inability to grow, or
any material decrease in, our deposits could have a material adverse effect on our cost of funds and our ability to satisfy
our liquidity needs. Maintaining a diverse and appropriate funding strategy remains challenging.
Our results of operations may be adversely affected by other than temporary impairment charges relating to our
securities portfolio.
We may be required to record future impairment charges on our securities if they suffer declines in value that we
consider other than temporary. Numerous factors, including the lack of liquidity for sales of certain securities, the absence
of reliable pricing information for securities, adverse changes in the business climate, adverse regulatory actions or
unanticipated changes in the competitive environment, could have a negative effect on our securities portfolio and results
of operations in future periods. Significant impairment accounting charges could also negatively impact our regulatory
capital ratios.
Our business depends on our ability to successfully manage credit risk.
The operation of our business requires us to manage credit risk. As a lender, we are exposed to the risk that our
borrowers will be unable to repay their loans according to their terms, and that the collateral securing repayment of their
loans, if any, may not be sufficient to ensure repayment. In addition, there are risks inherent in making any loan, including
risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting, risks
resulting from changes in economic and industry conditions and risks inherent in dealing with individual borrowers. In
order to successfully manage credit risk, we must, among other things, maintain disciplined and prudent underwriting
standards and ensure that our bankers follow those standards. The weakening of these standards for any reason, such as an
attempt to attract higher yielding loans, a lack of discipline or diligence by our employees in underwriting and monitoring
loans, the inability of our employees to adequately adapt policies and procedures to changes in economic or any other
conditions affecting borrowers and the quality of our loan portfolio, may result in loan defaults, foreclosures and additional
charge-offs and may necessitate that we significantly increase our allowance for loan and lease losses, each of which could
adversely affect our net income. As a result, our inability to successfully manage credit risk could have a material adverse
effect on our business, financial condition or results of operations.
An important feature of our credit risk management system is our use of an internal credit risk rating and control
system through which we identify, measure, monitor and mitigate existing and emerging credit risk of our customers. As
this process involves detailed analysis of the customer or credit risk, taking into account both quantitative and qualitative
factors, it is subject to human error. In exercising their judgment, our employees may not always be able to assign an
accurate credit rating to a customer or credit risk, which may result in our exposure to higher credit risks than indicated by
our risk rating and control system. Although our management seeks to address possible credit risk proactively, it is possible
that the credit risk rating and control system will not identify credit risk in our loan portfolio and that we may fail to
manage credit risk effectively. As a result of movements in watch and substandard loans during fiscal year 2016, it is
possible that loans on such status will result in future charge-offs.
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Some of our tools and metrics for managing credit risk and other risks are based upon our use of observed
historical market behavior and assumptions. We rely on quantitative models to measure risks and to estimate certain
financial values. Models may be used in such processes as determining the pricing of various products, grading loans and
extending credit, measuring interest rates and other market risks, predicting losses, assessing capital adequacy and
calculating regulatory capital levels, as well as estimating the value of financial instruments and balance sheet items.
Poorly designed or implemented models present the risk that our business decisions based on information incorporating
such models will be adversely affected due to the inadequacy of that information. Moreover, our models may fail to predict
future risk exposures if the information used in the model is incorrect, obsolete or not sufficiently comparable to actual
events as they occur, or if our model assumptions prove incorrect. We seek to incorporate appropriate historical data in
our models, but the range of market values and behaviors reflected in any period of historical data is not at all times
predictive of future developments in any particular period and the period of data we incorporate into our models may turn
out to be inappropriate for the future period being modeled. In such case, our ability to manage risk would be limited and
our risk exposure and losses could be significantly greater than our models indicated.
Our allowance for loan losses may not be adequate to cover actual loan losses which could adversely affect our
earnings.
We maintain an allowance for loan losses for probable incurred losses in the portfolio. The allowance is
established through a provision for loan losses based on management’s evaluation of the risks inherent in the loan portfolio
and the general economy. The allowance is also appropriately increased for new loan growth. The allowance is based upon
a number of factors, including the size of the loan portfolio, asset classifications, economic trends, industry experience
and trends, industry and geographic concentrations, estimated collateral values, management’s assessment of the credit
risk inherent in the portfolio, historical loan loss experience and loan underwriting policies. The allowance is only an
estimate of the probable incurred losses in the loan portfolio and may not represent actual losses realized over time, either
of losses in excess of the allowance or of losses less than the allowance.
In addition, we evaluate all loans identified as impaired loans and allocate an allowance based upon our estimation
of the potential loss associated with those problem loans. While we strive to carefully manage and monitor credit quality
and to identify loans that may be deteriorating, at any time there are loans included in the portfolio that may result in
losses, but that have not yet been identified as non-performing or potential problem loans. Through established credit
practices, we attempt to identify deteriorating loans and adjust the allowance for loan losses accordingly. However, because
future events are uncertain and because we may not successfully identify all deteriorating loans in a timely manner, there
may be loans that deteriorate in an accelerated time frame. We cannot be sure that we will be able to identify deteriorating
loans before they become nonperforming assets, or that we will be able to limit losses on those loans that have been so
identified. Changes in economic, operating and other conditions which are beyond our control, including interest rate
fluctuations, deteriorating values in underlying collateral (most of which consists of real estate), and changes in the
financial condition of borrowers, may cause our estimate of probable losses or actual loan losses to exceed our current
allowance. As a result, future additions to the allowance may be necessary. Further, because the loan portfolio contains a
number of commercial real estate, construction, and land development loans with relatively large balances, deterioration
in the credit quality of one or more of these loans may require a significant increase to the allowance for loan losses. Our
regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may
require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense,
or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such additional
provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on
our business, results of operations and financial condition.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update,
Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments. The standard is the final
guidance on the new current expected credit loss (“CECL”) model. The amendments in this update replace the incurred
loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires
consideration of a broader range of reasonable and supportable information to estimate future credit loss estimates. As
CECL encompasses all financial assets carried at amortized cost, the requirement that reserves be established based on
an organization’s reasonable and supportable estimate of expected credit losses extends to held-to-maturity debt
securities. The update amends the accounting for credit losses on available-for-sale securities, whereby credit losses will
be presented as an allowance as opposed to a write-down. In addition, CECL will modify the accounting for purchased
loans with credit deterioration since origination, so that reserves are established at the date of acquisition for purchased
loans. Lastly, the amendment requires enhanced disclosures on the significant estimates and judgments used to estimate
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credit losses, as well as on the credit quality and underwriting standards of an organization’s portfolio. These disclosures
require organizations to present the currently required credit quality disclosures disaggregated by the year of origination
or vintage. The guidance allows for a modified retrospective approach with a cumulative effect adjustment to the balance
sheet upon adoption (charge to retained earnings instead of the income statement). The new guidance is effective for
public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2019, and
early adoption is permitted. We are currently evaluating the impact of adopting the new guidance on our consolidated
financial statements.
Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial
condition.
At December 31, 2016, nonperforming loans were 0.20% of the total loan portfolio and nonperforming assets
were 0.13% of total assets. Nonperforming assets adversely affect our earnings in various ways. We do not record interest
income on nonaccrual loans or foreclosed assets, thereby adversely affecting our income, and increasing our loan
administration costs. Upon foreclosure or similar proceedings, we record the repossessed asset at the estimated fair value,
less costs to sell, which may result in a write down or losses. A significant increase in the level of nonperforming assets
from current levels would increase our risk profile and may impact the capital levels our regulators believe are appropriate
in light of the increased risk profile. While we reduce problem assets through collection efforts, asset sales, workouts,
restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or
financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our
business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires
significant commitments of time from management and our directors, which can be detrimental to the performance of their
other responsibilities.
The small to medium-sized businesses to which we lend may have fewer financial resources to weather a downturn in
the economy which could materially harm our operating results and financial condition.
We serve the banking and financial services needs of small and medium-sized businesses. Small to medium-sized
businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns,
often need substantial additional capital to expand and compete and may experience significant volatility in operating
results. Any one or more of these factors may impair a borrower’s ability to repay a loan. In addition, the success of a
small to medium-sized business often depends on the management talents and efforts of one or two persons or a small
group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse
impact on the business and its ability to repay a loan. Economic downturns and other events that negatively impact our
market areas could cause us to incur substantial credit losses that could negatively affect our results of business, results of
operations and financial condition.
We may suffer losses in our loan portfolio despite our underwriting practices.
We mitigate the risks inherent in our loan portfolio by adhering to sound and proven underwriting practices,
managed by experienced and knowledgeable credit professionals. These practices include analysis of a borrower’s prior
credit history, financial statements, tax returns, and cash flow projections, valuations of collateral based on reports of
independent appraisers and verifications of liquid assets. Although we believe that our underwriting criteria is appropriate
for the various kinds of loans we make, we may incur losses on loans that meet our underwriting criteria, and these losses
may exceed the amounts set aside as reserves in our allowance for loan loss.
Our loan portfolio has a large concentration of real estate loans in California which involve risks specific to real estate
values.
A downturn in our real estate markets in California could adversely affect our business because many of our loans
are secured by real estate. Real estate lending (including commercial, land development and construction, and purchased
residential mortgage loans) is a large portion of our loan portfolio. At December 31, 2016, approximately $878.6 million,
or 59% of our loan portfolio, was secured by various forms of real estate, including residential and commercial real estate.
Included in the $878.6 million of loans secured by real estate were $430.9 million (or 49%) of owner-occupied loans. The
real estate securing our loan portfolio is concentrated in California. The market value of real estate can fluctuate
significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is
located. Real estate values and real estate markets are generally affected by changes in national, regional or local economic
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conditions, the rate of unemployment, fluctuations in interest rates and the availability of loans to potential purchasers,
changes in tax laws and other governmental statutes, regulations and policies and acts of nature, such as earthquakes and
natural disasters particular to California. Additionally, commercial real estate lending typically involves larger loan
principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the
properties securing the loans to cover operating expenses and debt service. If real estate values including values of land
held for development decline, the value of real estate collateral securing our loans could be significantly reduced. Our
ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we
would be more likely to suffer losses on defaulted loans.
Our customers are reliant on the economic and financial health of their customers. Should their customers,
individually or collectively, experience economic or financial distress, for whatever reason, including but not limited to a
general downturn in the economy, it could negatively impact our customers’ ability to meet the terms and conditions of
their loan obligations to the Bank.
Our construction and land development loans are based upon estimates of costs and value associated with the complete
project. These estimates may be inaccurate and we may be exposed to more losses on these projects than on other loans.
At December 31, 2016, land and construction loans, including land acquisition and development totaled
$81.0 million or 5% of our loan portfolio. This amount was comprised of 16% owner occupied and 84% non-owner
occupied construction and land loans. Risk of loss on a construction loan depends largely upon whether our initial estimate
of the property’s value at completion of construction equals or exceeds the cost of the property construction (including
interest) and the availability of permanent take-out financing. During the construction phase, a number of factors can result
in delays and cost overruns. Because of the uncertainties inherent in estimating construction costs, as well as the market
value of the completed project, it is relatively difficult to evaluate accurately the total funds required to complete a project
and the related loan-to-value ratio. As a result, construction loans often involve the disbursement of substantial funds with
repayment dependent primarily on the completion of the project and the ability of the borrower to sell the property, rather
than the ability of the borrower or guarantor to repay principal and interest. If estimates of value are inaccurate or if actual
construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full
repayment. If our appraisal of the value of the completed project proves to be overstated, our collateral may be inadequate
for the repayment of the loan upon completion of construction of the project. If we are forced to foreclose on a project
prior to or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance
of and accrued interest on the loan as well as related foreclosure and holding costs. In addition, we may be required to
fund additional amounts to complete the project and may have to hold the property for an unspecified period of time.
Our use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of
the real property collateral.
In considering whether to make a loan secured by real property we generally require an appraisal of the property.
However, an appraisal is only an estimate of the value of the property at the time the appraisal is conducted, and an error
in fact or judgment could adversely affect the reliability of an appraisal. In addition, events occurring after the initial
appraisal may cause the value of the real estate to decrease. As a result of any of these factors the value of collateral
backing a loan may be less than estimated, and if a default occurs we may not recover the outstanding balance of the loan.
Supervisory guidance on commercial real estate concentrations could restrict our activities and impose financial
requirements or limits on the conduct of our business.
The federal banking agencies have issued guidance on sound risk management practices for concentrations in
commercial real estate lending intended to help ensure that institutions pursuing a significant commercial real estate
lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities. Recently
there have been concerns about commercial real estate lending and underwriting expressed by the agencies along with
historical concerns that rising commercial real estate loan concentrations may expose institutions to unanticipated earnings
and capital volatility in the event of adverse changes in commercial real estate markets. Existing guidance reinforces and
enhances existing regulations and guidelines for safe and sound real estate lending by providing supervisory criteria,
including numerical indicators to assist in identifying institutions with potentially significant commercial real estate loan
concentrations that may warrant greater supervisory scrutiny. The guidance does not limit banks’ commercial real estate
lending, but rather guides institutions in developing risk management practices and levels of capital that are commensurate
with the level and nature of their commercial real estate concentrations. Our lending and risk management practices will
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be taken into account in supervisory evaluation of capital adequacy. If our risk management practices with regard to this
portion of our portfolio are found to be deficient, it could result in increased reserves and capital costs or a need to reduce
this type of lending which could negatively impact earnings.
Repayment of our commercial loans is often dependent on the cash flows of the borrower, which may be unpredictable,
and the collateral securing these loans may fluctuate in value.
At December 31, 2016, commercial loans totaled $604.3 million or 40% of our loan portfolio, (including SBA
guaranteed loans and factored receivables). Commercial lending involves risks that are different from those associated
with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based
lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate
collateral being viewed as the primary source of repayment in the event of borrower default. Our commercial loans are
primarily made based on the cash flows of the borrowers and secondarily on any underlying collateral provided by the
borrowers. A borrower’s cash flows may be unpredictable, and collateral securing those loans may fluctuate in value.
Although commercial loans are often collateralized by equipment, inventory, accounts receivable, or other business assets,
the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable
may be uncollectible and inventories may be obsolete or of limited use, among other things.
We depend on cash dividends from our subsidiary bank to pay cash dividends to our shareholders and to meet our
cash obligations.
As a holding company, dividends from our subsidiary bank provide a substantial portion of our cash flow used
to pay cash dividends on our common and preferred stock and other obligations. Various statutory provisions restrict the
amount of dividends HBC can pay to HCC without regulatory approval. See “Item 1 — Business — Supervision and
Regulation — Dividends.”
We may need to raise additional capital in the future and such capital may not be available when needed or at all.
We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity
to meet our commitments and business needs. Our ability to raise additional capital, if needed, will depend on, among
other things, conditions in the capital markets at that time which are outside of our control, and our financial performance.
We cannot be assured that such capital will be available to us on acceptable terms or at all. Any occurrence that may limit
our access to the capital markets may adversely affect our capital costs and our ability to raise capital. Moreover, if we
need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise
capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable
terms when needed could have a material adverse effect on our business, results of operations and financial condition.
We must effectively manage our growth strategy.
We seek to expand our franchise safely and consistently. A successful growth strategy requires us to manage
multiple aspects of the business simultaneously, such as following adequate loan underwriting standards, balancing loan
and deposit growth without increasing interest rate risk or compressing our net interest margin, maintaining sufficient
capital, maintaining proper system and controls, and recruiting, training and retaining qualified professionals.
As part of our general growth strategy we may expand into additional communities or attempt to strengthen our
position in our current markets by opening new offices, subject to any regulatory constraints on our ability to open new
offices. To the extent that we are able to open additional offices, we are likely to experience the effects of higher operating
expenses relative to operating income from the new operations for a period of time which may have an adverse effect on
our levels of reported net income, return on average equity and return on average assets.
New lines of business or new products and services may subject us to additional risks.
From time to time, we may implement or may acquire new lines of business or offer new products and services
within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in
instances where the markets are not fully developed. In developing and marketing new lines of business and new products
and services we may invest significant time and resources. We may not achieve target timetables for the introduction and
development of new lines of business and new products or services and price and profitability targets may not prove
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feasible. External factors, such as regulatory compliance obligations, competitive alternatives, and shifting market
preferences, may also impact the successful implementation of a new line of business or a new product or service.
Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness
of our system of internal controls. Failure to successfully manage these risks in the development and implementation of
new lines of business or new products or services could have a material adverse effect on our business, results of operations
and financial condition.
There is risk related to acquisitions.
We plan to continue to grow our business organically. However, from time to time, we may consider potential
acquisition opportunities that we believe support our business strategy and may enhance our profitability. We face
significant competition from numerous other financial services institutions, many of which will have greater financial
resources than we do, when considering acquisition opportunities. Accordingly, attractive acquisition opportunities may
not be available to us. There can be no assurance that we will be successful in identifying or completing any future
acquisitions.
Acquisitions of financial institutions involve operational risks and uncertainties and acquired companies may
have unforeseen liabilities, exposure to asset quality problems, key employee and customer retention problems and other
problems that could negatively affect our organization. We may not be able to complete future acquisitions and, if we do
complete such acquisitions, we may not be able to successfully integrate the operations, management, products and
services of the entities that we acquire and eliminate redundancies. The integration process could result in the loss of key
employees or disruption of the combined entity’s ongoing business or inconsistencies in standards, controls, procedures,
and policies that adversely affect our ability to maintain relationships with customers and employees or achieve the
anticipated benefits of the transaction. The integration process may also require significant time and attention from our
management that they would otherwise direct at servicing existing business and developing new business. We may not be
able to realize any projected cost savings, synergies or other benefits associated with any such acquisition we complete.
While our management is experienced in acquisition strategy and implementation, acquisitions involve inherent
uncertainty and we cannot determine all potential events, facts and circumstances that could result in loss or give
assurances that our investigation or mitigation efforts will be sufficient to protect against any such loss.
In addition, we must generally satisfy a number of meaningful conditions prior to completing any acquisition,
including, in certain cases, federal and state bank-regulatory approval. Bank regulators consider a number of factors when
determining whether to approve a proposed transaction, including the effect of the transaction on financial stability and
the ratings and compliance history of all institutions involved, including the CRA, examination results and anti-money
laundering and Bank Secrecy Act compliance records of all institutions involved. The process for obtaining required
regulatory approvals has become substantially more difficult as a result of the financial crisis, which could affect our future
business. We may fail to pursue, evaluate or complete strategic and competitively significant business opportunities as a
result of our inability, or our perceived inability, to obtain any required regulatory approvals in a timely manner or at all.
Although we have historically shown the ability to grow organically as well as through acquisition, our ability to
grow may be limited if we cannot make acquisitions.
Issuing additional shares of our common stock to acquire other banks and bank holding companies may result in
dilution for existing shareholders and may adversely affect the market price of our stock.
In connection with our growth strategy, we have issued, and may issue in the future, shares of our common stock
to acquire additional banks or bank holding companies that may complement our organizational structure. Resales of
substantial amounts of common stock in the public market and the potential of such sales could adversely affect the
prevailing market price of our common stock and impair our ability to raise additional capital through the sale of equity
securities. We usually must pay an acquisition premium above the fair market value of acquired assets for the acquisition
of banks or bank holding companies. Paying this acquisition premium, in addition to the dilutive effect of issuing additional
shares, may also adversely affect the prevailing market price of our common stock.
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We may experience goodwill impairment.
If our estimates of segment fair value change due to changes in our businesses or other factors, we may determine
that impairment charges on goodwill recorded as a result of acquisitions are necessary. Estimates of fair value are
determined based on a complex model using cash flows, the fair value of our Company as determined by our stock price,
and company comparisons. If management’s estimates of future cash flows are inaccurate, fair value determined could be
inaccurate and impairment may not be recognized in a timely manner. If the fair value of the Company declines, we may
need to recognize goodwill impairment in the future which would have a material adverse effect on our results of operations
and capital levels.
Our decisions regarding the fair value of assets acquired could be different than initially estimated, which could
materially and adversely affect our business, financial condition, results of operations, and future prospects.
In business combinations, we acquire significant portfolios of loans that are marked to their estimated fair value.
There is no assurance that the acquired loans will not suffer deterioration in value. The fluctuations in national, regional
and local economic conditions, including those related to local residential, commercial real estate and construction
markets, may increase the level of charge-offs in the loan portfolio that we acquire and correspondingly reduce our net
income. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our
operations and financial condition, even if other favorable events occur.
We have a significant deferred tax asset and cannot assure that it will be fully realized.
Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the
carrying amounts and tax basis of assets and liabilities computed using enacted tax rates. We regularly assess available
positive and negative evidence to determine whether it is more likely than not that our net deferred tax asset will be
realized. Realization of a deferred tax asset requires us to apply significant judgment and is inherently speculative because
it requires estimates that cannot be made with certainty. At December 31, 2016, we had a net deferred tax asset of
$25.1 million. If we were to determine at some point in the future that we will not achieve sufficient future taxable income
to realize our net deferred tax asset, we would be required, under generally accepted accounting principles, to establish a
full or partial valuation allowance which would require us to incur a charge to operations for the period in which the
determination was made.
We currently hold a significant amount of company-owned life insurance.
At December 31, 2016, we held company-owned life insurance (“COLI”) on current and former senior employees
and executives, with a cash surrender value of $59.1 million, as compared with a cash surrender value of $60.0 million at
December 31, 2015. The eventual repayment of the cash surrender value is subject to the ability of the various insurance
companies to pay death benefits or to return the cash surrender value to us if needed for liquidity purposes. We continually
monitor the financial strength of the various companies with whom we carry these policies. However, any one of these
companies could experience a decline in financial strength, which could impair its ability to pay benefits or return our cash
surrender value. If we need to liquidate these policies for liquidity purposes, we would be subject to taxation on the increase
in cash surrender value and penalties for early termination, both of which would materially impact earnings adversely.
We may be adversely affected by the soundness of other financial institutions.
Our ability to engage in routine funding transactions could be adversely affected by the actions and liquidity of
other financial institutions. Financial institutions are often interconnected as a result of trading, clearing, counterparty, or
other business relationships. We have exposure to many different industries and counterparties, and routinely execute
transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers,
investment banks, and other institutional clients. Defaults by financial services institutions, even rumors or questions about
one or more financial institutions or the financial services industry in general, could lead to market wide liquidity problems
and further, could lead to losses or defaults by the Company or other institutions. Many of these transactions expose us to
credit risk in the event of default of the applicable counterparty or client. In addition, our credit risk may increase when
the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the
loan or derivative exposure due to us. Any such losses could materially and adversely affect our financial condition.
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We face strong competition from financial service companies and other companies that offer banking services.
We face substantial competition in all phases of our operations from a variety of different competitors. Our
competitors, including larger commercial banks, community banks, savings and loan associations, mutual savings banks,
credit unions, consumer finance companies, insurance companies, securities dealers, brokers, mortgage bankers,
investment advisors, money market mutual funds and other financial institutions, compete with lending and deposit
gathering services offered by us. Many of these competing institutions have much greater financial and marketing
resources than we have. Due to their size, many competitors can achieve larger economies of scale and may offer a broader
range of products and services than we can. If we are unable to offer competitive products and services, our business may
be negatively affected. Some of the financial services organizations with which we compete are not subject to the same
degree of regulation as is imposed on bank holding companies and federally insured financial institutions or are not subject
to increased supervisory oversight arising from regulatory examinations. As a result, these non-bank competitors have
certain advantages over us in accessing funding and in providing various services.
We anticipate intense competition will continue for the coming year due to the recent consolidation of many
financial institutions and more changes in legislature, regulation and technology. Further, we expect loan demand to
continue to be challenging due to the uncertain economic climate and the intensifying competition for creditworthy
borrowers, both of which could lead to loan rate concession pressure and could impact our ability to generate profitable
loans. We expect we may see tighter competition in the industry as banks seek to take market share in the most profitable
customer segments, particularly the small business segment and the mass-affluent segment, which offers a rich source of
deposits as well as more profitable and less risky customer relationships. Further, with the rebound of the equity markets
our deposit customers may perceive alternative investment opportunities as providing superior expected returns.
Technology and other changes have made it more convenient for bank customers to transfer funds into alternative
investments or other deposit accounts such as online virtual banks and non-bank service providers. The current low interest
rate environment could increase such transfers of deposits to higher yielding deposits or other investments. Efforts and
initiatives we undertake to retain and increase deposits, including deposit pricing, can increase our costs. When our
customers move money into higher yielding deposits or in favor of alternative investments, we can lose a relatively
inexpensive source of funds, thus increasing our funding costs.
New technology and other changes are allowing parties to effectuate financial transactions that previously
required the involvement of banks. For example, consumers can maintain funds in brokerage accounts or mutual funds
that would have historically been held as bank deposits. Consumers can also complete transactions such as paying bills
and transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known
as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related
income generated from those deposits. The loss of these revenue streams and access to lower cost deposits as a source of
funds could have a material adverse effect on our business, results of operations and financial condition.
Loans that we make through certain federal programs are dependent on the federal government’s continuation and
support of these programs and on our compliance with their requirements.
We participate in various U.S. government agency guarantee programs, including programs operated by the Small
Business Administration. We are responsible for following all applicable U.S. government agency regulations, guidelines
and policies whenever we originate loans as part of these guarantee programs. If we fail to follow any applicable
regulations, guidelines or policies associated with a particular guarantee program, any loans we originate as part of that
program may lose the associated guarantee exposing us to credit risk we would not otherwise be exposed to or underwritten
as part of our origination process for U.S. government agency guaranteed loans, or result in our inability to continue
originating loans under such programs. The loss of any guarantees for loans we have extended under U.S. government
agency guarantee programs or the loss of our ability to participate in such programs could have a material adverse effect
on our business, results of operations and financial condition.
Technology is continually changing and we must effectively implement new technologies.
The financial services industry is undergoing technological changes with frequent introductions of new
technology driven products and services. In addition to better serving customers, the effective use of technology increases
efficiency and enables us to reduce costs. Our future success will depend in part upon our ability to address the needs of
our customers by using technology to provide products and services that will satisfy customer demands for convenience
as well as to create additional efficiencies in our operations as we continue to grow and expand our market areas. In order
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to anticipate and develop new technology, we employ a qualified staff of internal information system specialists and
consider this area a core part of our business. We do not develop our own software products, but have been able to respond
to technological changes in a timely manner through association with leading technology vendors. Some of our competitors
have substantially greater resources to invest in technological improvements. We may not be able to effectively implement
new technology-driven products and services or be successful in marketing these products and services to our customers.
If we are unable to make such investments, or we are unable to respond to technological changes in a timely manner, our
operating costs may increase which could adversely affect our business, results of operations and financial condition.
If our information systems were to experience a system failure, our business and reputation could suffer.
We rely heavily on communications and information systems to conduct our business. The computer systems and
network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability
to minimize service disruptions by protecting our computer equipment, systems, and network infrastructure from physical
damage due to fire, power loss, telecommunications failure or a similar catastrophic event. We have protective measures
in place to prevent or limit the effect of the failure or interruption of our information systems, and will continue to upgrade
our security technology and update procedures to help prevent such events. However, if such failures or interruptions were
to occur, they could result in damage to our reputation, a loss of customers, increased regulatory scrutiny, or possible
exposure to financial liability, any of which could have a material adverse effect on our business, financial condition and
results of operations.
The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related
incidents could have a material adverse effect on our business, financial condition and results of operations.
As a financial institution we are susceptible to fraudulent activity, information security breaches and
cybersecurity-related incidents that may be committed against us or our customers which may result in financial losses or
increased costs to us or our customers, disclosure or misuse of our information or our customer information,
misappropriation of assets, privacy breaches against our customers, litigation, or damage to our reputation. Such fraudulent
activity may take many forms, including check fraud, electronic fraud, wire fraud, online banking, phishing, social
engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include
fraudulent or unauthorized access to systems used by us or our customers, denial or degradation of service attacks, and
malware or other cyber-attacks. In recent periods, there continues to be a rise in electronic fraudulent activity, security
breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber
criminals targeting commercial bank accounts. Consistent with industry trends we have also experienced an increase in
attempted electronic fraudulent activity, security breaches and cybersecurity-related incidents in recent periods. Moreover,
in recent periods, several large corporations, including financial institutions and retail companies, have suffered major data
breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial
and other personal information of their customers and employees and subjecting them to potential fraudulent activity.
Some of our customers may have been affected by these breaches which increase their risks of identity theft, credit card
fraud and other fraudulent activity that could involve their accounts with us.
Information pertaining to us and our customers is maintained and transactions are executed on the networks and
systems of ours, our customers and certain of our third party partners, such as our online banking or core systems. The
secure maintenance and transmission of confidential information as well as execution of transactions over these systems
are essential to protect us and our customers against fraud and security breaches and to maintain our customers’ confidence.
Breaches of information security also may occur, and in infrequent, incidental, cases have occurred, through intentional
or unintentional acts by those having access to our systems or our customers’ or counterparties’ confidential information,
including employees. Furthermore, our cardholders use their debit and credit cards to make purchases from third parties
or through third party processing services. As such, we are subject to risk from data breaches of such third party’s
information systems or their payment processors. Such a data security breach could compromise our account information.
We may suffer losses associated with reimbursing our customers for such fraudulent transactions on customers’ card
accounts, as well as for other costs related to data security breaches, such as replacing cards associated with compromised
card accounts.
In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new
discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments
could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent
transactions and to protect data about us, our customers and underlying transactions as well as the technology used by our
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customers to access our systems. Although we have developed and continue to invest in systems and processes that are
designed to detect and prevent security breaches and cyber-attacks and periodically test our security, our inability to
anticipate, or failure to adequately mitigate, breaches of security could result in losses to us or our customers; our loss of
business and/or customers; damage to our reputation; the incurrence of additional expenses; disruption to our business;
our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure
to civil litigation and possible financial liability — any of which could have a material adverse effect on our business,
financial condition and results of operations.
More generally, publicized information concerning security and cyber-related problems could inhibit the use or
growth of electronic or web-based applications or solutions as a means of conducting commercial transactions. Such
publicity may also cause damage to our reputation as a financial institution. As a result, our business, financial condition
and results of operations could be adversely affected.
We could be liable for breaches of security in our online banking services. Fear of security breaches (including
cybersecurity breaches) could limit the growth of our online services.
We offer various internet-based services to our clients, including online banking services. The secure transmission
of confidential information over the Internet is essential to maintain our clients’ confidence in our online services. In
certain cases, we are responsible for protecting customers’ proprietary information as well as their accounts with us. We
have security measures and processes in place to defend against these cybersecurity risks but these cyber attacks are rapidly
evolving (including computer viruses, malicious code, phishing or other information security breaches), and we may not
be able to anticipate or prevent all such attacks, which could result in the unauthorized release, gathering, monitoring,
misuse, loss or destruction of our or our customers’ confidential, proprietary and other information. Advances in computer
capabilities, new discoveries or other developments could result in a compromise or breach of the technology we use to
protect client transaction data. In addition, individuals, groups or sovereign countries may seek to intentionally disrupt our
online banking services or compromise the confidentiality of customer information with criminal intent. Although we have
developed systems and processes that are designed to recognize and assist in preventing security breaches (and periodically
test our security), failure to protect against or mitigate breaches of security could adversely affect our ability to offer and
grow our online services, constitute a breach of privacy or other laws, result in costly litigation and loss of customer
relationships, negatively impact our reputation, and could have an adverse effect on our business, results of operations and
financial condition. We may not be insured against all types of losses as a result of breaches and insurance coverage may
be inadequate to cover all losses resulting from breaches of security. We may also incur substantial increases in costs in
an effort to minimize or mitigate cyber security risks and to respond to cyber incidents.
We rely on communications, information, operating and financial control systems technology from third-party service
providers.
We rely heavily on third-party service providers for much of our communications, information, operating and
financial control systems technology, including customer relationship management, internet banking, website, general
ledger, deposit, loan servicing and wire origination systems. Any failure or interruption or breach in security of these
systems could result in failures or interruptions in our customer relationship management, internet banking, website,
general ledger, deposit, loan servicing and/or wire origination systems.
We cannot assure you that such failures or interruptions will not occur or, if they do occur, that they will be
adequately addressed by us or the third parties on which we rely. The Company may not be insured against all types of
losses as a result of third party failures and insurance coverage may be inadequate to cover all losses resulting from system
failures or other disruptions. The occurrence of any failures or interruptions could have a material adverse effect on our
business, financial condition, results of operations and cash flows. If any of our third-party service providers experience
financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we
may be required to locate alternative sources of such services, and we cannot assure you that we could negotiate terms that
are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need
to expend substantial resources, if at all. Any of these circumstances could have a material adverse effect on our business,
financial condition, results of operations and cash flows.
Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our
vendors’ performance, including aspects which they delegate to third parties. Disruptions or failures in the physical
infrastructure or operating systems that support our businesses and clients, or cyber attacks or security breaches of the
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networks, systems or devices that our clients use to access our products and services could result in client attrition,
regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or
additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.
We depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may
rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and
other financial information. We also may rely on representations of customers and counterparties as to the accuracy and
completeness of that information and, with respect to financial statements, on reports of independent auditors. For example,
under our accounts receivable financing arrangements, we rely on information, such as invoices, contracts and other
supporting documentation, provided by our customers and their account debtors to determine the amount of credit to
extend. Similarly, in deciding whether to extend credit, we may rely upon our customers’ representations that their
financial statements conform to U.S. GAAP (or other applicable accounting standards in foreign markets) and present
fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial
condition, results of operations, financial reporting or reputation could be negatively affected if we rely on materially
misleading, false, inaccurate or fraudulent information.
Our controls and procedures may fail or be circumvented.
Management regularly reviews and updates our internal controls, disclosure controls and procedures, and
corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in
part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are
met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related
to controls and procedures could have a material adverse effect on our business, financial condition and results of
operations.
Our accounting estimates and risk management processes rely on analytical and forecasting models.
Processes that management uses to estimate our probable credit losses and to measure the fair value of financial
instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on
our financial condition and results of operations, depend upon the use of analytical and forecasting models. These models
reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances.
Even if these assumptions are accurate, the models may prove to be inadequate or inaccurate because of other flaws in
their design or their implementation.
If the models that management uses for interest rate risk and asset-liability management are inadequate, we may
incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models that
management uses for determining our probable credit losses are inadequate, the allowance for loan losses may not be
sufficient to support future charge-offs. If the models that management uses to measure the fair value of financial
instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately
reflect what we could realize upon sale or settlement of such financial instruments. Any such failure in management’s
analytical or forecasting models could have a material adverse effect on our business, financial condition and results of
operations.
Changes in accounting standards could materially impact our financial statements.
From time to time, the Financial Accounting Standards Board or the SEC may change the financial accounting
and reporting standards that govern the preparation of our financial statements. In addition, the bodies that interpret the
accounting standards (such as banking regulators or outside auditors) may change their interpretations or positions on how
these standards should be applied. These changes may be beyond our control, can be difficult to predict and can materially
impact how we record and report our financial condition or results of operations. In some cases, we could be required to
apply a new or revised standard retrospectively, or apply an existing standard differently, also retrospectively, in each case
resulting in our revising or restating prior period financial statements.
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The costs and effects of litigation, investigations or similar matters, or adverse facts and developments related thereto,
could materially affect our business, operating results and financial condition.
We may be involved from time to time in a variety of litigation, investigations or similar matters arising out of
our business. Our insurance may not cover all claims that may be asserted against us and indemnification rights to which
we are entitled may not be honored, and any claims asserted against us, regardless of merit or eventual outcome, may harm
our reputation. Should the ultimate judgments or settlements in any litigation or investigation significantly exceed our
insurance coverage, they could have a material adverse effect on our business, financial condition and results of operations.
In addition, premiums for insurance covering the financial and banking sectors are rising. We may not be able to obtain
appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with
acceptable terms or at historic rates, if at all.
We may incur fines, penalties and other negative consequences from regulatory violations, which are possibly
inadvertent or unintentional violations.
We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations,
but there can be no assurance that these will be effective. We may incur fines, penalties and other negative consequences
from regulatory violations. We may suffer other negative consequences resulting from findings of noncompliance with
laws and regulations, that may also damage our reputation, and this in turn might materially affect our business and results
of operations.
Our risk management framework may not be effective which could have a material adverse effect on our strategic
planning and our mitigation of risks and/or losses as well as have adverse regulatory consequences.
Our risk management framework seeks to mitigate risk and loss to us. We have established processes and
procedures intended to identify, measure, monitor, report and analyze the types of risk to which we are subject, including
liquidity risk, credit risk, market risk, interest rate risk, operational risk, legal and compliance risk, and reputational risk,
among others. However, as with any risk management framework, there are inherent limitations to our risk management
strategies as there may exist or develop in the future risks that we have not appropriately anticipated or identified. If our
risk management framework is not effective, we could suffer unexpected losses and our business, results of operations and
financial condition could be materially adversely affected. We may also be subject to potentially adverse regulatory
consequences.
We are exposed to the risk of environmental liabilities with respect to properties to which we take title.
In the course of our business, when a borrower defaults on a loan secured by real property, we generally purchase
the property in foreclosure or accept a deed to the property surrendered by the borrower. We may also take over the
management of properties when owners have defaulted on loans. While we have guidelines intended to exclude properties
with an unreasonable risk of contamination, hazardous substances may exist on some of the properties that we own, manage
or occupy and unknown hazardous risks could impact the value of real estate collateral. We may be held liable to a
governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by
these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or
toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could
be substantial and exceed the value of the property. In addition, if we are the owner or former owner of a contaminated
site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental
contamination emanating from the property. If we become subject to significant environmental liabilities, business, results
of operations and financial condition could be adversely affected.
We are subject to a variety of operational risks, the manifestation of any one of which may adversely affect our business
and results of operations.
We are exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk
of fraud or theft by employees or outsiders and the risk of unauthorized transactions or operational errors by employees,
including clerical or record-keeping errors or errors resulting from faulty or disabled computer or telecommunications
systems.
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Because the nature of the financial services business involves a high volume of transactions, certain errors may
be repeated or compounded before they are discovered and successfully rectified. Our necessary dependence upon
automated systems to record and process transactions and our large transaction volume may further increase the risk that
technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.
We also may be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our
control (for example, computer viruses or electrical or telecommunications outages, natural disasters, disease pandemics
or other damage to property or physical assets), which may give rise to disruption of service to customers and to financial
loss or liability. The occurrence of any of these risks could diminish our ability to operate our business (for example, by
requiring us to expend significant resources to correct the defect), as well as potential liability to customers, reputational
damage and regulatory intervention, which in turn could materially and adversely affect our business, financial condition
and results of operations.
Reputational risk can adversely affect our business.
Threats to our reputation can come from many sources, including adverse sentiment about financial institutions
generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality,
compliance deficiencies, and questionable or fraudulent activities of our customers. We have policies and procedures in
place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective.
Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of
customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.
We may not be able to attract and retain key personnel and other skilled employees.
Our success depends, in large part, on the skills of our management team and our ability to retain, recruit and
motivate key officers and employees. Our senior management team has significant industry experience, and their
knowledge and relationships would be difficult to replace. Leadership changes will occur from time to time, and we cannot
predict whether significant resignations will occur or whether we will be able to recruit additional qualified personnel.
Competition for senior executives and skilled personnel in the financial services and banking industry is intense, which
means the cost of hiring, incentivizing and retaining skilled personnel may continue to increase. We need to continue to
attract and retain key personnel and to recruit qualified individuals to succeed existing key personnel to ensure the
continued growth and successful operation of our business. In addition, as a provider of relationship-based commercial
banking services, we must attract and retain qualified banking personnel to continue to grow our business, and competition
for such personnel can be intense. Our ability to effectively compete for senior executives and other qualified personnel
by offering competitive compensation and benefit arrangements may be restricted by applicable banking laws and
regulations as discussed in “Item 1. Business—Supervision and Regulation—Incentive Compensation.” The loss of the
services of any senior executive or other key personnel, or the inability to recruit and retain qualified personnel in the
future, could have a material adverse effect on our business, financial condition or results of operations. In addition, to
attract and retain personnel with appropriate skills and knowledge to support our business, we may offer a variety of
benefits, which could reduce our earnings or have a material adverse effect on our business, financial condition or results
of operations.
Severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact our
business.
Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a
significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the
ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property
damage, result in loss of revenue and/or cause us to incur additional expenses. For example, our primary market areas in
California are subject to earthquakes and fires. Operations in our market could be disrupted by both the evacuation of large
portions of the population as well as damage and or lack of access to our banking and operation facilities. While we have
not experienced such event to date, other severe weather or natural disasters, acts of war or terrorism or other adverse
external events may occur in the future. Although management has established disaster recovery policies and procedures,
the occurrence of any such event could have a material adverse effect on our business financial condition and results of
operations.
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Our securities are not an insured deposit.
Risks Related to Our Securities
Our securities are not bank deposits and, therefore, are not insured against loss by the FDIC, any other deposit
insurance fund or by any other public or private entity. Investment in our securities is inherently risky for the reasons
described in this section and elsewhere in this report and is subject to the same market forces that affect the price of
securities in any company.
The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell shares of
common stock owned by you at times or at prices you find attractive.
The stock market and, in particular, the market for financial institution stocks, has experienced significant
volatility. In some cases, the markets have produced downward pressure on stock prices for certain issuers without regard
to those issuers’ underlying financial strength. As a result, the trading volume in our common stock may fluctuate more
than usual and cause significant price variations to occur.
The trading price of the shares of our common stock will depend on many factors, which may change from time
to time and which may be beyond our control, including, without limitation, our financial condition, performance,
creditworthiness and prospects, future sales or offerings of our equity or equity related securities, and other factors
identified above under “Cautionary Note Regarding Forward Looking Statements” and “Risk Factors” below. These broad
market fluctuations have adversely affected and may continue to adversely affect the market price of our common stock.
Among the factors that could affect our stock price are:
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actual or anticipated quarterly fluctuations in our operating results and financial condition;
changes in financial estimates or publication of research reports and recommendations by financial analysts
or actions taken by rating agencies with respect to our common stock or those of other financial institutions;
failure to meet analysts’ revenue or earnings estimates;
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strategic actions by us or our competitors, such as acquisitions, restructurings, dispositions or financings;
actions by institutional investors;
fluctuations in the stock price and operating results of our competitors;
future sales of our equity, equity related or debt securities;
proposed or adopted regulatory changes or developments;
anticipated or pending investigations, proceedings, or litigation that involve or affect us;
trading activities in our common stock, including short selling;
deletion from well-known index or indices;
domestic and international economic factors unrelated to our performance; and
general market conditions and, in particular, developments related to market conditions for the financial
services industry.
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The trading volume in our common stock is less than that of other larger financial services companies.
Although our common stock is listed for trading on the Nasdaq, its trading volume is generally less than that of
other, larger financial services companies, and investors are not assured that a liquid market will exist at any given time
for our common stock. A public trading market having the desired characteristics of depth, liquidity and orderliness
depends on the presence in the marketplace at any given time of willing buyers and sellers of our common stock. This
presence depends on the individual decisions of investors and general economic and market conditions over which we
have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the
expectation of these sales, could cause our stock price to fall.
There are also various regulatory restrictions on the ability of HBC to pay dividends or make other payments to HCC
in particular, federal and state banking laws regulate the amount of dividends that may be paid by HBC without prior
approval.
Dodd-Frank requires federal banking agencies to establish more stringent risk-based capital guidelines and
leverage limits applicable to banks and bank holding companies. In July 2013, the federal banking regulators issued final
rules, which, among other things, are intended to implement in the United States the Basel Committee on Banking
Supervision’s regulatory capital guidelines, including the reforms known as Basel III. The Basel III capital rules issued by
the Federal Reserve provide that distributions (including dividend payments and redemptions) on additional Tier 1 capital
instruments may only be paid out of net income, retained earnings, or surplus related to other additional Tier 1 capital
instruments. The Basel III capital rules also introduced a new capital conservation buffer on top of the minimum risk-
based capital ratios. Failure to maintain a capital conservation buffer above certain levels will result in restrictions on
HCC’s ability to make dividend payments, redemptions or other capital distributions. These requirements, and any other
new regulations or capital distribution constraints, could adversely affect the ability of HBC to pay dividends to HCC and,
in turn, affect HCC’s ability to pay dividends on the HCC common stock.
The Federal Reserve may also, as a supervisory matter, otherwise limit HCC’s ability to pay dividends on the
HCC common stock.
In addition, the HCC common stock may be fully subordinate to interests held by the U.S. government in the
event of a receivership, insolvency, liquidation, or similar proceeding, including a proceeding under the “orderly
liquidation authority” provisions of Dodd-Frank.
Federal and state law may limit the ability of another party to acquire us, which could cause the price of our securities
to decline.
Federal law prohibits a person or group of persons “acting in concert” from acquiring “control” of a bank holding
company unless the Federal Reserve has been given 60 days prior written notice of such proposed acquisition and within
that time period the Federal Reserve has not issued a notice disapproving the proposed acquisition or extending for up to
another 30 days the period during which such a disapproval may be issued. An acquisition may be made prior to the
expiration of the disapproval period if the Federal Reserve issues written notice of its intent not to disapprove the action.
Under a rebuttable presumption established by the Federal Reserve, the acquisition of 10% or more of a class of voting
stock of a bank or bank holding company with a class of securities registered under Section 12 of the Exchange Act would,
under the circumstances set forth in the presumption, constitute the acquisition of control. In addition, any “company”
would be required to obtain the approval of the Federal Reserve under the BHCA, before acquiring 25% (5% in the case
of an acquirer that is, or is deemed to be, a bank holding company) or more of any class of voting stock, or such lesser
number of shares as may constitute control.
Under the California Financial Code, no person may, directly or indirectly, acquire control of a California state
bank or its holding company unless the DBO has approved such acquisition of control. A person would be deemed to have
acquired control of HBC if such person, directly or indirectly, has the power: (i) to vote 25% or more of the voting power
of HBC; or (ii) to direct or cause the direction of the management and policies of HBC. For purposes of this law, a person
who directly or indirectly owns or controls 10% or more of our outstanding common stock would be presumed to control
HBC.
These provisions of federal and state law may prevent a merger or acquisition that would be attractive to
shareholders and could limit the price investors would be willing to pay in the future for our securities.
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We may raise additional capital, which could have a dilutive effect on the existing holders of our securities and
adversely affect the market price of our securities.
We are not restricted from issuing additional shares of common stock or securities that are convertible into or
exchangeable for, or represent the right to receive shares of common stock. We frequently evaluate opportunities to access
the capital markets taking into account our regulatory capital ratios, financial condition and other relevant considerations
and, subject to market conditions, we may take further capital actions. Such actions could include, among other things, the
issuance of additional shares of common stock or other securities in public or private transactions in order to further
increase our capital levels above the requirements for a “well-capitalized” institution established by the federal bank
regulatory agencies as well as other regulatory targets. These issuances could dilute ownership interests of investors and
could dilute the per share book value of our common stock.
We issue stock options and shares of restricted stock to officers and other employees under the Company's
compensation programs which may have a dilutive effect on holders of our common stock.
The Company issues stock options and restricted stock to its officers and other employees in accordance with
its equity plans approved by the shareholders. The exercise of stock options and the issuance of restricted stock under the
Company's compensation program may dilute the ownership interests of existing holders of our common stock, and any
sales in the public market of any shares of our common stock issuable upon exercise or vesting of restricted stock could
adversely affect the prevailing market price of our common stock.
The issuance of shares of preferred stock could adversely affect holders of common stock, which may negatively impact
an investment in our securities.
Our board of directors is authorized to issue classes or series of preferred stock without any action on the part of
the shareholders, except in certain circumstances. Our board of directors also has the power, without shareholder approval
except in certain circumstances, to set the terms of any such classes or series of preferred stock that may be issued,
including voting rights, dividend rights and preferences over the common stock with respect to dividends or upon the
liquidation, dissolution or winding up of our business and other terms. If we issue preferred stock in the future that has a
preference over the common stock with respect to the payment of dividends or upon liquidation, dissolution or winding
up, or if we issue preferred stock with voting rights that dilute the voting power of the common stock, then the rights of
holders of the common stock or the market price of the common stock could be adversely affected.
ITEM 1B — UNRESOLVED STAFF COMMENTS
None.
ITEM 2 — PROPERTIES
The main and executive offices of HCC and HBC are located at 150 Almaden Boulevard in San Jose,
California 95113, with branch offices located at 15575 Los Gatos Boulevard in Los Gatos, California 95032, at 387 Diablo
Road in Danville, California 94526, at 3137 Stevenson Boulevard in Fremont, California 94538, at 300 Main Street in
Pleasanton, California 94566, at 101 Ygnacio Valley Road in Walnut Creek, California 94596, at 18625 Sutter Boulevard
in Morgan Hill, California 95037, at 7598 Monterey Street in Gilroy, California 95020, at 419 S. San Antonio Road in Los
Altos, California 94022, at 333 W. El Camino Real in Sunnyvale, California 94087, and at 351 Tres Pinos Road in
Hollister, California 95023. Bay View Funding’s administrative offices are located at 2933 Bunker Hill Lane, Santa Clara,
CA 95054.
Main Offices
The main office of HBC is located at 150 Almaden Boulevard in San Jose, California on the first three floors in
a fifteen-story Class-A type office building. All three floors, consisting of approximately 35,547 square feet, are subject
to a direct lease dated April 13, 2000, as amended, which expires on May 31, 2020. The current monthly rent payment is
$108,063 with annual increases of 3% until the lease expires. The Company has reserved the right to extend the term of
the lease for one additional period of five years.
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In January of 1997, the Company leased approximately 1,255 square feet (referred to as the “Kiosk”) located next
to the primary operating area at 150 Almaden Boulevard in San Jose, California to be used for meetings, staff training and
marketing events. The current monthly rent payment is $3,815 with annual increases of 3% until the lease expires on
May 31, 2020. The Company has reserved the right to extend the term of the lease for one additional period of five years.
In June of 2015, the Company amended its primary lease at 150 Almaden Boulevard in San Jose, California to
include 4,484 square feet of expansion space in a five-story Class-B type office building located at 100 W. San Fernando
Street, San Jose, California, adjacent to the main office. The current monthly rent payment is $11,075 with 3% annual
increases until the lease expires on May 31, 2020. The Company has reserved the right to extend the term of the lease for
one additional period of five years.
Branch Offices
In June of 2007, as part of the acquisition of Diablo Valley Bank, the Company took ownership of an 8,285 square
foot one-story commercial office building, including the land, located at 387 Diablo Road in Danville, California.
In June of 2008, the Company leased approximately 5,213 square feet on the first floor in a two-story multi-tenant
office building located at 419 S. San Antonio Road in Los Altos, California. The current monthly rent payment is $27,576
and is subject to annual increases of 3% until the lease expires on April 30, 2018. The Company has reserved the right to
extend the term of the lease for two additional periods of five years each.
In September of 2010, the Company extended its lease for approximately 4,096 square feet in an one-story
stand-alone office building located at 300 Main Street in Pleasanton, California. The current monthly rent payment is
$17,118 and is subject to annual increases of 3% until the lease expires on October 31, 2017.
In September of 2012, the Company leased, effective March 1, 2013, approximately 3,172 square feet in an
one-story multi-tenant multi-use building located at 3137 Stevenson Boulevard in Fremont, California. The monthly rent
payment is $7,676 and is subject to annual increases of 3% until the lease expires on February 29, 2020. The Company
has reserved the right to extend the term of the lease for one additional period of four years and another additional period
of three years.
In June of 2013, the Company leased approximately 3,022 square feet on the first floor of a three-story
multi-tenant office building located at 333 West El Camino Real in Sunnyvale, California. The current monthly rent
payment is $12,385 and is subject to annual increases of 3% until the lease expires on May 31, 2018. The Company has
reserved the right to extend the term of the lease for one additional period of five years.
In October of 2013, the Company extended its lease for approximately 1,920 square feet in a one story stand-alone
building located in an office complex at 15575 Los Gatos Boulevard in Los Gatos, California. The current monthly rent
payment is $6,189 and is subject to annual increases of 3% until the lease expires on November 30, 2018. The Company
has reserved the right to extend the term of the lease for one additional period of five years.
In April of 2014, the Company leased approximately 3,391 square feet in a multi-tenant commercial center located
at 351 Tres Pinos in Hollister, CA. The current monthly rent payment is $4,497 and is subject to annual increases of 3%
until the lease expires on June 30, 2019. The Company has reserved the right to extend the term of the lease for one
additional period of five years.
In May of 2014, the Company extended its lease for approximately 3,850 square feet on the first floor in a four
story multi-tenant office building located at 101 Ygnacio Valley Road in Walnut Creek, California. The current monthly
rent payment is $14,296 and is subject to 3% annual increases until the lease expires on August 15, 2021. In addition, the
Company modified its lease to include 1,461 square feet of expansion space. The current monthly rent for the expansion
space is $4,412 and is subject to annual increases of 3% until the lease expires. The Company has reserved the right to
extend the term of the lease for one additional period of five years.
In August of 2014, the Company amended and extended its lease at 18625 Sutter Boulevard in Morgan Hill,
California to include approximately 4,716 square feet in a one story multi-tenant office building located. The current
monthly rent payment is $6,113 with annual increases of 2% until the lease expires on October 31, 2021. The Company
has reserved the right to extend the term of the lease for one additional period of five years.
44
In September of 2016, the Company leased approximately 2,505 square feet on the first floor in a three-story
multi-tenant multi-use building located at 7598 Monterey Street in Gilroy, California. The current monthly rent payment
is $5,260 until the lease expires on September 30, 2019. The Company has reserved the right to extend the term of the
lease for two additional periods of five years each.
Bay View Funding Office
In July 15, 2016, Bay View Funding leased approximately 7,440 square feet in a two-story multi-tenant office
building located at 2933 Bunker Hill Lane, Santa Clara, CA 95054. The current monthly rent payment is $25,296 until the
lease expires on February 29, 2020. The Company has reserved the right to extend the term of the lease for one additional
period of two years.
For additional information on operating leases and rent expense, refer to Note 7 to the Consolidated Financial
Statements following “Item 15 — Exhibits and Financial Statement Schedules.”
ITEM 3 — LEGAL PROCEEDINGS
The Company is involved in certain legal actions arising from normal business activities. Management, based
upon the advice of legal counsel, believes the ultimate resolution of all pending legal actions will not have a material effect
on the financial statements of the Company.
ITEM 4 — MINE SAFETY DISCLOSURES
Not Applicable.
PART II
ITEM 5 — MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
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The Company’s common stock is listed on the NASDAQ Global Select Market under the symbol “HTBK.”
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The information in the following table for 2016 and 2015 indicates the high and low closing prices for the
common stock, based upon information provided by the NASDAQ Global Select Market and cash dividend payment for
each quarter presented.
Quarter
Year ended December 31, 2016:
Fourth quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 14.46 $ 10.71 $
Third quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11.90 $ 10.20 $
9.80 $
Second quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10.97 $
9.04 $
First quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11.55 $
High
Low
Stock Price
Dividend
Per Share
Year ended December 31, 2015:
Fourth quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12.25 $ 10.28 $
9.45 $
Third quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11.83 $
8.75 $
9.75 $
Second quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
8.21 $
9.14 $
First quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
0.09
0.09
0.09
0.09
0.08
0.08
0.08
0.08
The closing price of our common stock on February 15, 2017 was $14.27 per share as reported by the NASDAQ
Global Select Market.
As of February 15, 2017, there were approximately 613 holders of record of common stock. There are no other
classes of common equity outstanding.
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Dividend Policy
The amount of future dividends will depend upon our earnings, financial condition, capital requirements and
other factors, and will be determined by our board of directors on a quarterly basis. It is Federal Reserve policy that bank
holding companies generally pay dividends on common stock only out of income available over the past year, and only if
prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also
Federal Reserve policy that bank holding companies not maintain dividend levels that undermine the holding company’s
ability to be a source of strength to its banking subsidiaries. Additionally, in consideration of the current financial and
economic environment, the Federal Reserve has indicated that bank holding companies should carefully review their
dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and
capital are very strong. Under the federal Prompt Corrective Action regulations, the Federal Reserve or the FDIC may
prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as
undercapitalized.
As a holding company, our ability to pay cash dividends is affected by the ability of our bank subsidiary, HBC,
to pay cash dividends. The ability of HBC (and our ability) to pay cash dividends in the future and the amount of any such
cash dividends is and could be in the future further influenced by bank regulatory requirements and approvals and capital
guidelines.
The decision whether to pay dividends will be made by our board of directors in light of conditions then existing,
including factors such as our results of operations, financial condition, business conditions, regulatory capital requirements
and covenants under any applicable contractual arrangements, including agreements with regulatory authorities.
For information on the statutory and regulatory limitations on the ability of the Company to pay dividends and
on HBC to pay dividends to HCC see “Item 1 — Business — Supervision and Regulation — Dividends.”
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information as of December 31, 2016 regarding equity compensation plans under
which equity securities of the Company were authorized for issuance:
Equity compensation plans approved by security
holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,719,091 (1) $
Equity compensation plans not approved by
security holders . . . . . . . . . . . . . . . . . . . . . . . . . . .
N/A
Number of securities to Weighted average
be issued upon exercise of
outstanding options,
warrants and rights
(a)
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(c)
601,765 (2)
N/A
(b)
9.79
N/A
(1) Consists of 875,450 options to acquire shares under the Company’s Amended and Restated 2004 Equity Plan
and 843,641 options to acquire shares under the Company’s 2013 Equity Incentive Plan.
(2) Available under the Company’s 2013 Equity Incentive Plan.
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Performance Graph
The following graph compares the stock performance of the Company from December 31, 2011 to February 10,
2017, to the performance of several specific industry indices. The performance of the S&P 500 Index, NASDAQ Stock
Index and NASDAQ Bank Stocks were used as comparisons to the Company’s stock performance. Management believes
that a performance comparison to these indices provides meaningful information and has therefore included those
comparisons in the following graph.
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The following chart compares the stock performance of the Company from December 31, 2011 to February 10,
2017, to the performance of several specific industry indices. The performance of the S&P 500 Index, NASDAQ Stock
Index and NASDAQ Bank Stocks were used as comparisons to the Company’s stock performance.
Period Ending
Index
Heritage Commerce Corp * . . . . . . . . . . . . . . . . . . . . . . . .
S&P 500 * . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
NASDAQ - Total US* . . . . . . . . . . . . . . . . . . . . . . . . . . . .
NASDAQ Bank Index* . . . . . . . . . . . . . . . . . . . . . . . . . . .
12/31/11
100
100
100
100
12/31/12
143
112
114
114
12/31/13
173
146
160
161
12/31/14
189
166
185
166
12/31/15
252
163
192
176
12/31/16
304
178
207
238
02/10/17
292
184
220
236
* Source: SNL Financial Bank Information Group — (434) 977-1600
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ITEM 6 — SELECTED FINANCIAL DATA
The following table presents a summary of selected financial information that should be read in conjunction with
the Company’s Consolidated Financial Statements and notes thereto following Item 15 — Exhibits and Financial
Statement Schedules.
SELECTED FINANCIAL DATA
INCOME STATEMENT DATA:
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income before provision for loan losses . . . . . . . . . . . . . . .
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income after provision for loan losses. . . . . . . . . . . . . . . . .
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends and discount accretion on preferred stock . . . . . . . . . . . . . . .
Net income available to common shareholders . . . . . . . . . . . . . . . . . . .
Less: undistributed earnings allocated to Series C Preferred Stock . . . . . .
Distributed and undistributed earnings allocated to common shareholders
$
PER COMMON SHARE DATA:
Basic net income(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Diluted net income(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Book value per common share(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Tangible book value per common share(4) . . . . . . . . . . . . . . . . . . . . . . . $
Pro forma book value per common share assuming Series C
2016
94,431
3,211
91,220
1,237
89,983
11,625
57,639
43,969
16,588
27,381
(1,512)
25,869
(1,278)
24,591
0.72
0.72
6.85
5.46
Preferred Stock was converted into common stock(5) . . . . . . . . . . . . . . $
—
AT OR FOR YEAR ENDED DECEMBER 31,
2014
(Dollars in thousands, except per share data)
2013
2015
$
$
$
$
$
$
$
78,743
2,422
76,321
32
76,289
8,985
58,673
26,601
10,104
16,497
(1,792)
14,705
(912)
13,793
0.48
0.48
7.03
5.35
6.51
$
$
$
$
$
$
$
59,256
2,153
57,103
(338)
57,441
7,746
44,222
20,965
7,538
13,427
(1,008)
12,419
(1,342)
11,077
0.42
0.42
6.22
5.60
5.74
$
$
$
$
$
$
$
52,786
2,600
50,186
(816)
51,002
7,214
40,470
17,746
6,206
11,540
(336)
11,204
(1,687)
9,517
0.36
0.36
5.84
5.78
5.43
$
$
$
$
$
$
$
2012
52,565
4,187
48,378
2,784
45,594
8,865
39,061
15,398
5,489
9,909
(1,206)
8,703
(1,527)
7,176
0.27
0.27
5.71
5.63
5.32
Pro forma tangible book value per share, assuming Series C
Preferred Stock was converted into common stock(6) . . . . . . . . . . . . . . $
Dividend payout ratio(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted average number of shares outstanding — basic . . . . . . . . . . . . .
Weighted average number of shares outstanding — diluted . . . . . . . . . . . .
Common shares outstanding at period end . . . . . . . . . . . . . . . . . . . . . . .
Pro forma common shares outstanding at period end, assuming Series C
$
—
49.77 %
5.07
$
65.09 %
5.23
$
42.88 %
5.38
$
16.60 %
33,933,806
34,219,121
37,941,007
28,567,213
28,786,078
32,113,479
26,390,615
26,526,282
26,503,505
26,338,161
26,386,452
26,350,938
5.25
N/A
26,303,245
26,329,336
26,322,147
Preferred Stock was converted into common stock(8) . . . . . . . . . . . . . .
—
37,714,479
32,104,505
31,951,938
31,923,147
BALANCE SHEET DATA:
Securities (available-for sale and held-to-maturity) . . . . . . . . . . . . . . . . . $
630,599
Net loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,483,518
19,089
Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
52,614
Goodwill and other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,570,880
Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,262,140
—
Subordinated debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
—
Short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
259,850
Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
$
494,390
$ 1,339,790
18,926
$
54,182
$
$ 2,361,579
$ 2,062,775
—
$
3,000
$
245,436
$
$
301,697
$ 1,070,264
18,379
$
16,320
$
$ 1,617,103
$ 1,388,386
—
$
—
$
184,358
$
376,021
$
895,749
$
19,164
$
1,527
$
$ 1,491,632
$ 1,286,221
—
$
—
$
173,396
$
419,384
$
793,286
$
19,027
$
2,000
$
$ 1,693,312
$ 1,479,368
9,279
$
—
$
169,741
$
SELECTED PERFORMANCE RATIOS:(9)
Return on average assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on average tangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on average equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on average tangible equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest margin (fully tax equivalent) . . . . . . . . . . . . . . . . . . . . . . . .
Efficiency ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average net loans (excludes loans held-for-sale) as a percentage of average
deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average total shareholders’ equity as a percentage of average total assets . .
SELECTED ASSET QUALITY DATA:(10)
1.13 %
1.15 %
10.71 %
13.55 %
4.12 %
56.04 %
0.86 %
0.88 %
8.04 %
9.41 %
4.41 %
68.78 %
0.88 %
0.88 %
7.44 %
7.60 %
4.10 %
68.19 %
0.81 %
0.81 %
6.77 %
6.84 %
3.84 %
70.51 %
0.73 %
0.73 %
5.75 %
5.83 %
3.88 %
68.24 %
66.25 %
10.54 %
70.82 %
10.73 %
74.54 %
11.85 %
67.26 %
11.90 %
67.98 %
12.72 %
Net charge-offs (recoveries) to average loans . . . . . . . . . . . . . . . . . . . . .
Allowance for loan losses to total loans . . . . . . . . . . . . . . . . . . . . . . . . .
Nonperforming loans to total loans . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonperforming assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
0.08 %
1.27 %
0.20 %
$
3,288
(0.04)%
1.39 %
0.47 %
$
6,742
0.05 %
1.69 %
0.54 %
$
6,551
(0.11)%
2.09 %
1.29 %
$
12,393
0.57 %
2.34 %
2.24 %
19,464
HERITAGE COMMERCE CORP CAPITAL RATIOS:
Total risk-based . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tier 1 risk-based . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Common equity Tier 1 risk-based capital . . . . . . . . . . . . . . . . . . . . . . . .
Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.5 %
11.5 %
11.5 %
8.5 %
12.5 %
11.4 %
10.4 %
8.6 %
13.9 %
12.6 %
N/A
10.6 %
15.3 %
14.0 %
N/A
11.2 %
16.2 %
15.0 %
N/A
11.5 %
48
Notes:
(1) Represents distributed and undistributed earnings allocated to common shareholders, divided by the average number
of shares of common stock outstanding for the respective period. See Note 17 to the consolidated financial statements.
(2) Represents distributed and undistributed earnings allocated to common shareholders, divided by the average number
of shares of common stock and common stock-equivalents outstanding for the respective period. See Note 17 to the
consolidated financial statements.
(3) Represents shareholders’ equity minus preferred stock divided by the number of shares of common stock outstanding
at December 31, 2015, 2014, 2013, and 2012. See Item 7 — Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Series C Preferred Stock.
(4) Represents shareholders’ equity minus preferred stock, minus goodwill and other intangible assets divided by the
number of shares of common stock outstanding at December 31, 2015, 2014, 2013, and 2012. See Item 7 —
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Series C Preferred
Stock.
(5) Represents shareholders’ equity minus preferred stock divided by the number of shares of common stock outstanding
at December 31, 2015, 2014, 2013, and 2012, assuming 21,004 shares of Series C Preferred Stock were converted
into 5,601,000 shares of common stock. See Item 7 — Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Series C Preferred Stock.
(6) Represents shareholders’ equity minus preferred stock, minus goodwill and other intangible assets divided by the
number of shares of common stock outstanding at December 31, 2015, 2014, 2013, and 2012, assuming 21,004
shares of Series C Preferred Stock were converted into 5,601,000 shares of common stock. See Item 7 —
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Series C Preferred
Stock.
(7) Percentage is calculated based on dividends paid on common stock and Series C Preferred Stock for the year ended
December 31, 2016, 2015, 2014, 2013, and 2012 (on an as converted basis) divided by net income.
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(8) Assumes 21,004 shares of Series C Preferred Stock were converted into 5,601,000 shares of common stock at
December 31, 2015, 2014, 2013, and 2012.
(9) Average balances used in this table and throughout this Annual Report are based on daily averages.
(10) Average loans and total loans exclude loans held-for-sale.
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ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion provides information about the results of operations, financial condition, liquidity, and
capital resources of Heritage Commerce Corp (the “Company” or “HCC”), its wholly-owned subsidiary, Heritage Bank
of Commerce (the “Bank” or “HBC”), and HBC’s wholly-owned subsidiary, BVF/CSNK Acquisition Corp., a Delaware
corporation (“BVF”), and its subsidiary CSNK Working Capital Finance Corp, a California Corporation, dba Bay View
Funding (“CSNK”). BVF and CSNK are collectively referred to as “Bay View Funding.” This information is intended to
facilitate the understanding and assessment of significant changes and trends related to our financial condition and the
results of operations. This discussion and analysis should be read in conjunction with our consolidated financial statements
and the accompanying notes presented elsewhere in this report. Unless we state otherwise or the context indicates
otherwise, references to the “Company,” “Heritage,” “we,” “us,” and “our,” in this Report on Form 10-K refer to Heritage
Commerce Corp and its subsidiaries.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with the accounting principles generally accepted in the
United States (“U.S. GAAP”) requires management to make a number of judgments, estimates and assumptions that affect
the reported amount of assets, liabilities, income and expense in the financial statements. Various elements of our
accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions.
Some of these policies and estimates relate to matters that are highly complex and contain inherent uncertainties. It is
possible that, in some instances, different estimates and assumptions could reasonably have been made and used by
management, instead of those we applied, which might have produced different results that could have had a material
effect on the financial statements.
We have identified the following accounting policies and estimates that, due to the inherent judgments and
assumptions and the potential sensitivity of the financial statements to those judgments and assumptions, are critical to an
understanding of our financial statements. We believe that the judgments, estimates and assumptions used in the
preparation of the Company’s financial statements are appropriate. For a further description of our accounting policies,
see Note 1 — Summary of Significant Accounting Policies in the financial statements included in this Form 10-K.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses in our loan portfolio. The allowance is only an estimate
of the inherent loss in the loan portfolio and may not represent actual losses realized over time, either of losses in excess
of the allowance or of losses less than the allowance. Our accounting for estimated loan losses is discussed under the
heading “Allowance for Loan Losses” and disclosed primarily in Notes 1 and 4 to the consolidated financial statements.
Loan Sales and Servicing
The amounts of gains recorded on sales of loans and the initial recording of servicing assets and interest-only
(“I/O”) strips are based on the estimated fair values of the respective components. In recording the initial value of the
servicing assets and the fair value of the I/O strips receivable, the Company uses estimates which are made on
management’s expectations of future prepayment and discount rates as discussed in Notes 1 and 5 to the consolidated
financial statements.
Stock Based Compensation
We grant stock options to purchase our common stock and restricted stock to our employees and directors under
the 2013 Equity Incentive Plan. Additionally, we have outstanding options that were granted under option plans from
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which we no longer make grants. The benefits provided under all of these plans are subject to the provisions of accounting
guidance related to share-based payments. Our results of operations for fiscal years 2016, 2015, and 2014 were impacted
by the recognition of non-cash expense related to the fair value of our share-based compensation awards.
The determination of fair value of stock-based payment awards on the date of grant using the Black-Scholes
model is affected by our stock price, as well as the input of other subjective assumptions. These assumptions include, but
are not limited to, the expected term of stock options and our stock price volatility. Our stock options have characteristics
significantly different from those of traded options, and changes in the assumptions can materially affect the fair value
estimates.
Current accounting guidance requires forfeitures to be estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those estimates. If actual forfeitures vary from our estimates, we will
recognize the difference in compensation expense in the period the actual forfeitures occur.
Business Combinations
The Company accounts for acquisitions of businesses using the acquisition method of accounting. Under the
acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values at the date of
acquisition. This fair value may differ from the cost basis recorded on the acquired institution’s financial statements.
Management performs an initial assessment to determine which assets and liabilities must be designated for fair value
analysis. Management typically engages experts in the field of valuation to perform the valuation of significant assets and
liabilities and, after assessing the resulting fair value computation, will utilize such value in computing the initial purchase
accounting adjustments for the acquired assets. It is possible that these values could be viewed differently through
alternative valuation approaches or if performed by different experts. Management is responsible for determining that the
values derived by experts are reasonable. Any excess of the purchase price over amounts allocated to the acquired assets,
including identifiable intangible assets, and liabilities assumed is recorded as goodwill. The fair values of assets acquired
and liabilities assumed are subject to adjustment during the first twelve months after the acquisition date if additional
information becomes available to indicate a more accurate or appropriate value for an asset or liability. See Note 1 —
Summary of Significant Accounting Policies, Note 8 — Business Combinations and Note 9 — Goodwill and Other
Intangible Assets in the financial statements in this Form 10-K.
Goodwill and Other Intangible Assets
Goodwill and intangible assets are evaluated at least annually for impairment or more frequently if events or
circumstances, such as changes in economic or market conditions, indicate that impairment may exist. When required, the
goodwill impairment test involves a two-step process. The first test for goodwill impairment is done by comparing the
reporting unit’s aggregate fair value to its carrying value. Absent other indicators of impairment, if the aggregate fair value
exceeds the carrying value, goodwill is not considered impaired and no additional analysis is necessary. If the carrying
value of the reporting unit were to exceed the aggregate fair value, a second test would be performed to measure the amount
of impairment loss, if any. To measure any impairment loss the implied fair value would be determined in the same manner
as if the reporting unit were being acquired in a business combination. If the implied fair value of goodwill is less than the
recorded goodwill an impairment charge would be recorded for the difference.
During 2011, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2011-08,
Intangibles—Goodwill and Other (Topic 350). Under the ASU, an entity is not required to calculate the fair value of a
reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.
Thus, before the first step of goodwill impairment, the entity has the option to first assess qualitative factors to determine
whether the existence of events or circumstances leads to a determination that the fair value of goodwill is less than carrying
value. The qualitative assessment includes, but is not limited to, macroeconomic and State of California economic
conditions, industry and market conditions and trends, the Company's financial performance, market capitalization, stock
price, and any Company-specific events relevant to the assessment. If after assessing the totality of events or
circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its
carrying amount, then performing the two-step process is unnecessary. As of December 31, 2016, based on our qualitative
assessment, there were no reporting units where we believed that it was more likely than not that the fair value of a
reporting unit was less than its carrying amount, including goodwill. As a result, we had no reporting units where there
was a reasonable possibility of failing Step 1 of the goodwill impairment test. At December 31, 2016 and December 31,
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2015, goodwill from the Bay View Funding acquisition was $13.0 million, and goodwill from the Focus Business Bank
(“Focus”) acquisition was $32.6 million.
Intangible assets consist of core deposit and customer relationship intangible assets arising from the acquisition
of Diablo Valley Bank in June 2007, a core deposit intangible asset arising from the Focus acquisition in August 2015,
and a below market lease, customer relationship and brokered relationship, and a non-compete agreement intangible assets
arising from the acquisition of Bay View Funding in November 2014. These assets are amortized over their estimated
useful lives. Impairment testing of these assets is performed at the individual asset level. Impairment exists if the carrying
amount of the asset is not recoverable and exceeds its fair value at the date of the impairment test. For intangible assets,
estimates of expected future cash flows (cash inflows less cash outflows) that are directly associated with an intangible
asset are used to determine the fair value of that asset. Management makes certain estimates and assumptions in
determining the expected future cash flows from core deposit and customer relationship intangibles including account
attrition, expected lives, discount rates, interest rates, servicing costs and other factors. Significant changes in these
estimates and assumptions could adversely impact the valuation of these intangible assets. If an impairment loss exists,
the carrying amount of the intangible asset is adjusted to a new cost basis. The new cost basis is then amortized over the
remaining useful life of the asset.
Our accounting policy for goodwill and other intangible assets is disclosed primarily in Notes 1 and 9 to the
consolidated financial statements.
Deferred Tax Assets
Our net deferred income tax asset arises from temporary differences between the carrying amount of assets and
liabilities reported in the financial statements and the amounts used for income tax return purposes. Our accounting for
deferred tax assets is discussed under the heading “Income Tax Expense” and disclosed primarily in Notes 1 and 12 to the
consolidated financial statements.
Segment Reporting
HBC is a commercial bank serving customers located primarily in Santa Clara, Alameda, Contra Costa, and San
Benito counties of California. Bay View Funding provides business-essential working capital factoring financing to
various industries throughout the United States. No customer accounts for more than 10% of revenue for HBC or the
Company. The Company’s management uses segments results in its operating and strategic planning. The operating
segments are Banking and Factoring.
Executive Summary
This summary is intended to identify the most important matters on which management focuses when it evaluates
the financial condition and performance of the Company. When evaluating financial condition and performance
management looks at certain key metrics and measures. The Company’s evaluation includes comparisons with peer group
financial institutions and its own performance objectives established in the internal planning process.
The primary activity of the Company is commercial banking. The Company’s operations are located in the
southern and eastern regions of the general San Francisco Bay Area of California in the counties of Santa Clara, Alameda,
Contra Costa, and San Benito. The largest city in this area is San Jose and the Company’s market includes the headquarters
of a number of technology based companies in the region known commonly as Silicon Valley. The Company’s customers
are primarily closely held businesses and professionals.
Performance Overview
For the year ended December 31, 2016, net income was $27.4 million, or $0.72 per average diluted common
share, compared to $16.5 million, or $0.48 per average diluted common share, for the year ended December 31, 2015, and
$13.4 million, or $0.42 per average diluted common share, for the year ended December 31, 2014. The Company’s
annualized return on average tangible assets was 1.15% and annualized return on average tangible equity was 13.55% for
the year ended December 31, 2016, compared to 0.88% and 9.41%, respectively, for the year ended December 31, 2015,
and 0.88% and 7.60% for the year ended December 31, 2014. The results of operations included a pre-tax gain from
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company-owned life insurance totaling $1.1 million for 2016, and pre-tax acquisition, severance and retention costs related
to the Focus transaction totaling $6.4 million for 2015.
Bay View Funding Acquisition
On November 1, 2014, the Company acquired Bay View Funding by purchasing all of the outstanding common
stock from the stockholders of Bay View Funding for an aggregate purchase price of $22.52 million. Bay View Funding
became a wholly owned subsidiary of HBC. Based in Santa Clara, California, Bay View Funding provides business-
essential working capital factoring financing to various industries throughout the United States. Bay View Funding’s
results of operations have been included in the Company’s results beginning November 1, 2014. The following table
reflects selected financial information for Bay View Funding for the periods indicated:
Total factored receivables at December 31, . . . . . . . . . . . . . . . . . . . . . $ 49,616 $ 40,059
Average factored receivables for year ended December 31, . . . . . . . . $ 46,425 $ 42,091
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Total full time equivalent employees at December 31, . . . . . . . . . . . .
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2016
2015
(Dollars in thousands)
Focus Business Bank Merger
On August 20, 2015 (the “acquisition date”), the Company completed the merger of HBC with Focus for an
aggregate transaction value of $66.6 million. Shareholders of Focus received a fixed exchange ratio at closing of 1.8235
shares of the Company’s common stock for each share of Focus common stock. The Company issued 5,456,713 shares of
the Company’s common stock to Focus shareholders for a total value of $58.3 million based on the Company’s closing
stock price of $10.68 on August 20, 2015. In addition, the Company paid cash to the Focus holders of in-the-money stock
options totaling $8.3 million.
The Focus acquisition added total assets, at fair value, of approximately $438.8 million, $174.8 million in loans
(including loans held-for-sale), at fair value, and $405.1 million in deposits, at fair value, at August 20, 2015. Focus’s
results of operations have been included in the Company’s results of operations beginning August 21, 2015. The one-time
pre-tax severance, retention, acquisition and integration costs totaled $6.4 million for the year ended December 31, 2015.
Series C Preferred Stock
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 Company’s 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. The exchange of the Series C Preferred Stock for common stock resulted in an increase in the
Company’s common equity Tier 1 risk based capital ratio at December 31, 2016, but had no effect on HBC’s common
equity Tier 1 risk based capital ratio or other regulatory capital ratios of the Company or HBC.
2016 Highlights
The following are major factors that impacted the Company’s results of operations:
• The fully tax equivalent (“FTE”) net interest margin contracted 29 basis points to 4.12% for the year ended
December 31, 2016, 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 interest
income from the Focus acquisition.
• 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
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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.
• 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, 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 held-for-investment.
• There was a $1.2 million provision for loan losses for the year ended December 31, 2016, compared to a
$32,000 provision for loan losses for the year ended December 31, 2015.
• Noninterest income increased to $11.6 million for the year ended December 31, 2016, compared to $9.0
million for the year ended December 31, 2015, 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.
• 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 reflects 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.
• The efficiency ratio for the year ended December 31, 2016 improved to 56.04%, compared to 68.78% for the
year ended December 31, 2015, primarily due to higher net interest income and noninterest income, and
lower noninterest expense for 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.
• For the year ended December 31, 2016, the return on average tangible assets was 1.15%, and the return on
average tangible equity was 13.55%, compared to 0.88% and 9.41%, respectively, for the year ended
December 31, 2015.
The following are important factors in understanding our current financial condition and liquidity position:
• Cash, interest bearing deposits in other financial institutions and securities available-for-sale decreased 21%
to $572.7 million at December 31, 2016, from $729.2 million at December 31, 2015.
• Securities held-to-maturity, at amortized cost, were $324.0 million at December 31, 2016, compared to
$109.3 million at 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%,
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in the Company’s legacy loan portfolio, $52.9 million of purchased residential mortgage loans, and $31.0
million of purchased commercial real estate (“CRE”) loans.
• Nonperforming assets were $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.
• Classified assets declined to $13.6 million at December 31, 2016, compared to $20.5 million at December
31, 2015.
• The allowance for loan losses at December 31, 2016 was $19.1 million, or 1.27% of total loans, representing
624.03% of nonperforming loans. The allowance for loan losses at December 31, 2015 was $18.9 million,
or 1.39% of total loans, representing 296.74% of nonperforming loans.
• Net charge-offs totaled $1.1 million for the year ended December 31, 2016, compared to net recoveries of
$515,000 for the year ended December 31, 2015. Net charge-offs during 2016 included one commercial and
industrial (“C&I”) loan relationship of $1.3 million that was charged-off in the fourth quarter of 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. 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.
• The ratio of noncore funding (which consists of time deposits of $250,000 and over, CDARS deposits,
brokered deposits, securities under agreement to repurchase and short-term borrowings) to total assets was
6.73% at December 31, 2016, compared to 8.01% at December 31, 2015.
• The loan to deposit ratio was 66.42% at December 31, 2016, compared to 65.87% at December 31, 2015.
• 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.
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Capital Ratios
Total Risk-Based . . . . . . . . . . . . . . . .
Tier 1 Risk-Based . . . . . . . . . . . . . . .
Common Equity Tier 1 Risk-based .
Leverage . . . . . . . . . . . . . . . . . . . . . . .
Heritage
Commerce
Corp
12.5 %
11.5 %
11.5 %
8.5 %
Heritage
Bank of
Commerce
12.3 %
11.3 %
11.3 %
8.4 %
Well-capitalized
Financial Institution
Basel III Regulatory
Guidelines
10.0 %
8.0 %
6.5 %
5.0 %
Fully Phased-in
Basel III Minimal
Requirement(1)
Effective
January 1, 2019
10.5 %
8.5 %
7.0 %
4.0 %
(1) Requirements for both the Company and the Bank include a 2.5% capital conservation buffer, except leverage ratio.
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Deposits
The composition and cost of the Company’s deposit base are important in analyzing the Company’s net interest
margin and balance sheet liquidity characteristics. Except for brokered time deposits, the Company’s depositors are
generally located in its primary market area. Depending on loan demand and other funding requirements, the Company
also obtains deposits from wholesale sources including deposit brokers. HBC is a member of the Certificate of Deposit
Account Registry Service (“CDARS”) program. The CDARS program allows customers with deposits in excess of Federal
Deposit Insurance Corporation (“FDIC”) insured limits to obtain coverage on time deposits through a network of banks
within the CDARS program. Deposits gathered through this program are considered brokered deposits under regulatory
guidelines. The Company has a policy to monitor all deposits that may be sensitive to interest rate changes to help assure
that liquidity risk does not become excessive due to concentrations.
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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. 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.
The Company had no brokered deposits at December 31, 2016, compared to $17.8 million at December 31, 2015.
Deposits from title insurance companies, escrow accounts and real estate exchange facilitators increased to $63.9 million
at December 31, 2016, compared to $49.1 million at December 31, 2015. Certificates of deposit from the State of California
totaled $85.1 million at December 31, 2016, compared to $78.0 million at December 31, 2015. CDARS interest-bearing
demand deposits, money market and time deposits increased to $9.4 million at December 31, 2016, compared to $7.6
million at December 31, 2015.
Liquidity
Our liquidity position refers to our ability to maintain cash flows sufficient to fund operations and to meet
obligations and other commitments in a timely fashion. At December 31, 2016, we had $266.1 million in cash and cash
equivalents and approximately $544.6 million in available borrowing capacity from various sources including the Federal
Home Loan Bank (“FHLB”), the Federal Reserve Bank of San Francisco (“FRB”), and Federal funds facilities with several
financial institutions. The Company also had $496.5 million (at fair value) in unpledged securities available at December
31, 2016. Our loan to deposit ratio increased to 66.42% at December 31, 2016, compared to 65.87% at December 31, 2015.
Lending
Our lending business originates primarily through our branch offices located in our primary markets. In addition,
Bay View Funding provides factoring financing throughout the United States. Total 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.
The $143.9 million increase included an increase of $60.0 million, or 4%, in the Company’s legacy loan portfolio, $52.9
million of purchased residential mortgage loans, and $31.0 million of purchased CRE loans. The total loan portfolio
remains well diversified with C&I loans accounting for 40% of the 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 at December
31, 2016, 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. C&I line usage was 42% at December 31, 2016, compared to 39% at
December 31, 2015.
Net Interest Income
The management of interest income and expense is fundamental to the performance of the Company. Net interest
income, the difference between interest income and interest expense, is the largest component of the Company’s total
revenue. Management closely monitors both total net interest income and the net interest margin (net interest income
divided by average earning assets). 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, 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.
The Company, through its asset and liability policies and practices, seeks to maximize net interest income without
exposing the Company to an excessive level of interest rate risk. Interest rate risk is managed by monitoring the pricing,
maturity and repricing options of all classes of interest bearing assets and liabilities. This is discussed in more detail under
“Liquidity and Asset/Liability Management.” In addition, we believe there are measures and initiatives we can take to
improve the net interest margin, including increasing loan rates, adding floors on floating rate loans, reducing
nonperforming assets, managing deposit interest rates, and reducing higher cost deposits.
The net interest margin is also adversely impacted by the reversal of interest on nonaccrual loans and the
reinvestment of loan payoffs into lower yielding investment securities and other short-term investments.
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Management of Credit Risk
We continue to proactively identify, quantify, and manage our problem loans. Early identification of problem
loans and potential future losses helps us to resolve credit issues with potentially less risk and ultimate losses. We maintain
an allowance for loan losses in an amount that we believe is adequate to absorb probable incurred losses in the portfolio.
While we strive to carefully manage and monitor credit quality and to identify loans that may be deteriorating,
circumstances can change at any time for loans included in the portfolio that may result in future losses that, as of the date
of the financial statements, have not yet been identified as potential problem loans. Through established credit practices,
we adjust the allowance for loan losses accordingly. However, because future events are uncertain, there may be loans that
deteriorate, some of which could occur in an accelerated time frame. As a result, future additions to the allowance for loan
losses may be necessary. Because the loan portfolio contains a number of commercial loans, commercial real estate loans,
construction and land development loans with relatively large balances, deterioration in the credit quality of one or more
of these loans may require a significant increase to the allowance for loan losses. Future additions to the allowance may
also be required based on changes in the financial condition of borrowers, such as have resulted due to the current, and
potentially worsening, economic conditions. Additionally, Federal and state banking regulators, as an integral part of their
supervisory function, periodically review our allowance for loan losses. These regulatory agencies may require us to
recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from ours. Any
increase in the allowance for loan losses would have an adverse effect, which may be material, on our financial condition
and results of operation. Further discussion of the management of credit risk appears under “Provision for Loan Losses”
and “Allowance for Loan Losses.”
In June 2016, the Financial Accounting Standards Board issued new guidance on measurement of credit losses
on financial instruments, which is the final guidance on the new current expected credit loss (“CECL”) model. The new
guidance replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected
credit losses and requires consideration of a broader range of reasonable and supportable information to estimate future
credit loss estimates. Management is currently evaluating the impact of adopting CECL, which becomes effective for the
Company on January 1, 2020. The effect of the adoption of CECL is currently unknown and could result in an increase
to the allowance for loan losses and a charge to equity. Further discussion of the adoption of CECL appears in Note 1 –
Summary of Significant Accounting Policies – Newly Issued, but not yet Effective Accounting Standards in the financial
statements in this Form 10-K.
Noninterest Income
While interest income remains the largest single component of total revenues, noninterest income is an important
component. A portion of the Company’s noninterest income is associated with its SBA lending activity, consisting of gains
on the sale of loans sold in the secondary market and servicing income from loans sold with servicing retained. Other
sources of noninterest income include loan servicing fees, service charges and fees, cash surrender value from company
owned life insurance policies, and gains on the sale of securities.
Noninterest Expense
Management considers the control of operating expenses to be a critical element of the Company’s performance.
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
reflects 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.
Capital Management
As part of its asset and liability management process, the Company continually assesses its capital position to
take into consideration growth, expected earnings, risk profile and potential strategic activities that it may choose to pursue.
Results of Operations
The Company earns income from two primary sources. The first is interest income, which is interest income
generated by earning assets less interest expense on interest-bearing liabilities. The second is noninterest income, which
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primarily consists of gains on the sale of loans, loan servicing fees, customer service charges and fees, the increase in cash
surrender value of life insurance, and gains on the sale of securities. The majority of the Company’s noninterest expenses
are operating costs that relate to providing a full range of banking services to our customers.
Net Interest Income and Net Interest Margin
The level of net interest income depends on several factors in combination, including growth in earning assets,
yields on earning assets, the cost of interest-bearing liabilities, the relative volumes of earning assets and interest-bearing
liabilities, and the mix of products that comprise the Company’s earning assets, deposits, and other interest-bearing
liabilities. Net interest income can also be impacted by the reversal of interest on loans placed on nonaccrual status, and
recovery of interest on loans that have been on nonaccrual and are either sold or returned to accrual status. To maintain its
net interest margin, the Company must manage the relationship between interest earned and paid.
The following Distribution, Rate and Yield table presents for each of the past three years, the average amounts
outstanding for the major categories of the Company’s balance sheet, the average interest rates earned or paid thereon, and
the resulting net interest margin on average interest earning assets for the periods indicated. Average balances are based
on daily averages.
2016
Interest Average
Income / Yield /
Expense Rate
Year Ended December 31,
2015
Interest Average
Income / Yield /
Expense Rate
Average
Balance
Average
Balance
2014
Interest Average
Income / Yield /
Expense Rate
Average
Balance
(Dollars in thousands)
Assets:
Loans, gross(1) . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,422,707 $ 79,284
10,432
Securities — taxable . . . . . . . . . . . . . . . . . . . . . .
Securities — exempt from Federal tax (2) . . . . . . . .
3,523
Federal funds sold, other investments, and interest-
501,347
91,822
bearing deposits in other financial institutions . . .
Total interest earning assets(2) . . . . . . . . . . .
Cash and due from banks . . . . . . . . . . . . . . . . . . .
Premises and equipment, net . . . . . . . . . . . . . . . . .
Goodwill and other intangible assets . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .
228,293
2,244,169
33,899
7,624
53,445
86,064
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,425,201
2,425
95,664
5.57 % $ 1,186,096 $ 68,259
6,707
246,084
2.08 %
3,358
86,589
3.84 %
5.75 % $ 992,376 $ 49,207
7,117
251,077
2.73 %
3,115
79,939
3.88 %
4.96 %
2.83 %
3.90 %
1,594
79,918
1.06 %
239,123
4.26 % 1,757,892
34,196
7,463
29,780
83,090
$ 1,912,421
0.67 %
96,534
4.55 % 1,419,926
25,829
7,343
3,746
66,428
$ 1,523,272
907
60,346
0.94 %
4.25 %
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing . . . . . . . . . . . . . $ 824,763
511,595
Demand, interest-bearing . . . . . . . . . . . . . . . .
526,227
Savings and money market . . . . . . . . . . . . . . .
22,079
Time deposits — under $100 . . . . . . . . . . . . .
209,972
Time deposits — $100 and Over . . . . . . . . . . .
7,590
Time deposits — brokered . . . . . . . . . . . . . . .
CDARS — interest-bearing demand, money
1,026
1,127
65
913
62
$
0.20 %
0.21 %
0.29 %
0.43 %
0.82 %
630,198
317,219
433,123
20,631
204,982
25,154
585
894
61
658
199
0.18 %
0.21 %
0.30 %
0.32 %
0.79 %
$ 463,134
207,359
363,903
20,448
196,118
36,440
341
671
63
629
319
market and time deposits. . . . . . . . . . . . . . .
Total interest-bearing deposits . . . . . . . . .
Total deposits . . . . . . . . . . . . . . . . . .
8,232
1,285,695
2,110,458
6
3,199
3,199
0.07 %
12,078
0.25 % 1,013,187
0.15 % 1,643,385
6
2,403
2,403
15,380
0.05 %
0.24 %
839,648
0.15 % 1,302,782
9
2,032
2,032
0.16 %
0.18 %
0.31 %
0.32 %
0.88 %
0.06 %
0.24 %
0.16 %
Short-term borrowings . . . . . . . . . . . . . . . . . . . . .
Total interest-bearing liabilities . . . . . . . . . . . .
Total interest-bearing liabilities and demand,
490
1,286,185
12
3,211
629
2.45 %
0.25 % 1,013,816
19
2,422
3.02 %
0.24 %
4,003
843,651
121
2,153
3.02 %
0.26 %
noninterest-bearing / cost of funds . . . . . . .
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . .
Shareholders’ equity . . . . . . . . . . . . . . . . . . . . . .
2,110,948
58,666
2,169,614
255,587
Total liabilities and shareholders’ equity . . . . . . $ 2,425,201
3,211
2,422
0.15 % 1,644,014
63,253
1,707,267
205,154
$ 1,912,421
0.15 % 1,306,785
35,973
1,342,758
180,514
$ 1,523,272
2,153
0.16 %
Net interest income(2) / margin . . . . . . . . . . . . . . .
Less tax equivalent adjustment(2) . . . . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . .
92,453
(1,233)
$ 91,220
4.12 %
77,496
(1,175)
$ 76,321
4.41 %
58,193
(1,090)
$ 57,103
4.10 %
(1) Includes loans held-for-sale. Yields and amounts earned on loans include loan fees and costs. Nonaccrual loans are
included in average balance.
(2) Reflects tax equivalent adjustment (“FTE”) for tax exempt income based on a 35% Federal tax rate.
The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each
major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such
change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are
58
equal to the increase or decrease in the average balance multiplied by prior period rates and rate variances are equal to the
increase or decrease in the average rate multiplied by the prior period average balance. Variances attributable to both rate
and volume changes are equal to the change in rate multiplied by the change in average balance and are included below in
the average volume column.
2016 vs. 2015
Increase (Decrease)
Due to Change in:
2015 vs. 2014
Increase (Decrease)
Due to Change in:
Average Average
Volume Rate
Net
Average Average
Net
Change Volume Rate
Change
Income from the interest earning assets:
(Dollars in thousands)
Loans, gross . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,218 $ (2,193) $ 11,025 $ 11,197 $ 7,855 $ 19,052
(410)
Securities — taxable . . . . . . . . . . . . . . . . . . . . . . . .
243
Securities — exempt from Federal tax(1). . . . . . . .
Federal funds sold, other investements, and
interest-bearing deposits ino ther financial
institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total interest expense on interest-earning
5,313
198
3,725
165
(1,588)
(33)
(263)
(13)
(147)
256
(260)
(110)
947
831
941
687
assets(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
18,619
(2,873)
15,746
12,253
7,319
19,572
Expense from the interest-bearing liabilities:
Demand, interest-bearing . . . . . . . . . . . . . . . . . . . . .
Savings and money market . . . . . . . . . . . . . . . . . . .
Time deposits — under $100 . . . . . . . . . . . . . . . . . .
Time deposits — $100 and over . . . . . . . . . . . . . . .
Time deposits — brokered . . . . . . . . . . . . . . . . . . . .
CDARS — interest-bearing demand, money
market and time deposits . . . . . . . . . . . . . . . . . . .
Short-term borrowings . . . . . . . . . . . . . . . . . . . . . . .
Total interest expense on interest-bearing
392
217
5
32
(144)
(2)
(3)
49
16
(1)
223
7
2
(4)
441
233
4
255
(137)
212
130
—
30
(89)
—
(7)
(2)
(102)
32
93
(2)
(1)
(31)
(1)
—
244
223
(2)
29
(120)
(3)
(102)
liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
292
Net interest income(1) . . . . . . . . . . . . . . . . . . . $ 18,122 $ (3,165)
Less tax equivalent adjustment(1) . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . . . .
497
(58)
$ 14,899
789
90
14,957 $ 12,074 $ 7,229
179
269
19,303
(85)
$ 19,218
(1) Reflects tax equivalent adjustment (“FTE”) for tax exempt income based on a 35% Federal tax rate.
The Company’s net interest margin (FTE), expressed as a percentage of average earning assets, contracted 29
basis points to 4.12% for the year ended December 31, 2016, 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 Company’s net interest margin for the year ended December 31, 2015
increased 31 basis points from 4.10% for the year ended December 31, 2014, primarily due to revenue from the higher
yielding Bay View Funding factored receivables portfolio, the accretion of the loan purchase discount in loan interest
income, and a special dividend of $203,000 paid by the FHLB in the second quarter of 2015, partially offset by the
temporary investment of excess liquidity from the Focus acquisition.
The yield on the loan portfolio decreased to 5.57 % for the 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 yield on the loan portfolio was 5.75% for the year ended December 31, 2015, compared to 4.96% for the year ended
December 31, 2014. The increase in the yield on the loan portfolio for the year ended December 31, 2015 reflects the
accretion of the loan purchase discount of $1.4 million in loan interest income from the Focus transaction, and the full year
impact of the higher yielding Bay View Funding factored receivables portfolio.
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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.
Net interest income for the year ended December 31, 2016 increased 20% to $91.2 million, compared to $76.3
million for 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. Net interest income for the year ended December 31, 2015 increased 34% to
$76.3 million, compared to $57.1 million for the year ended December 31, 2014, primarily due to loans acquired in the
Focus acquisition, organic growth in the loan portfolio, contributions to interest income from Bay View Funding, and the
accretion of the loan purchase discount in loan interest income from the Focus transaction.
A majority of the Company’s earning assets are variable-rate loans that re-price when the Company’s prime
lending rate is changed, compared to a large base of core deposits that are generally slower to re-price. This causes the
Company’s balance sheet to be asset-sensitive, which means that all else being equal, the Company’s net interest margin
will be lower during periods when short-term interest rates are falling and higher when rates are rising.
Provision for Loan Losses
Credit risk is inherent in the business of making loans. The Company establishes an allowance for loan losses
through charges to earnings, which are shown in the statements of operations as the provision for loan losses. Specifically
identifiable and quantifiable known losses are promptly charged off against the allowance. The provision for loan losses
is determined by conducting a quarterly evaluation of the adequacy of the Company’s allowance for loan losses and
charging the shortfall or excess, if any, to the current quarter’s expense. This has the effect of creating variability in the
amount and frequency of charges to the Company’s earnings. The provision for loan losses and level of allowance for each
period are dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan
portfolio, delinquencies, management’s assessment of the quality of the loan portfolio, the valuation of problem loans and
the general economic conditions in the Company’s market area.
The provision for loan losses for the year ended December 31, 2016 was $1.2 million, compared to $32,000
provision for loan losses for the year ended December 31, 2015, and a $338,000 credit to the provision for loan losses for
the year ended December 31, 2014. Provisions for loan losses are charged to operations to bring the allowance for loan
losses to a level deemed appropriate by the Company based on the factors discussed under “Allowance for Loan Losses.”
The allowance for loan losses totaled $19.1 million, or 1.27 % of total loans at December 31, 2016, compared to
$18.9 million, or 1.39% of total loans at December 31, 2015, and $18.4 million, or 1.69% of total loans at December 31,
2014. The allowance for loan losses to total nonperforming loans was 624.03% at December 31, 2016, compared to
296.74% at December 31, 2015, and 313.90% at December 31, 2014. The allowance for loan losses to total loans decreased
at December 31, 2016, compared to December 31, 2015, primarily due to increasing loan balances with no default histories,
coupled with a decrease in nonperforming assets, improving the quality of the loan portfolio overall. The allowance for
loan losses to total loans decreased at December 31, 2015, compared to December 31, 2014, primarily due to the impact
of the Focus loan portfolio, which was marked to fair value on the acquisition date. Net charge-offs totaled $1.1 million
for the year ended December 31, 2016, compared to net recoveries of $515,000 for the year ended December 31, 2015,
and net charge-offs of $447,000 for the year ended December 31, 2014.
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Noninterest Income
The following table sets forth the various components of the Company’s noninterest income:
Year Ended December 31,
2015
2016
2014
Increase
(Decrease)
2016 versus 2015
Increase
(Decrease)
2015 versus 2014
Amount Percent Amount Percent
Service charges and fees on deposit
(Dollars in thousands)
accounts . . . . . . . . . . . . . . . . . . . . . . . $
3,116 $ 2,803 $ 2,519 $
313
11 % $
284
11 %
Increase in cash surrender value of
life insurance . . . . . . . . . . . . . . . . . . .
Servicing income . . . . . . . . . . . . . . . . .
Gain on proceeds from company-
1,747
1,398
1,697
1,143
1,600
1,296
50
255
3 %
22 %
97
(153)
6 %
(12)%
owned life insurance . . . . . . . . . . . .
Gain on sales of securities . . . . . . . . .
Gain on sales of SBA loans . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . .
457
(47)
493
Total . . . . . . . . . . . . . . . . . . . . . . . . $ 11,625 $ 8,985 $ 7,746 $ 2,640
—
97
971
1,263
—
642
843
1,857
1,119
1,099
796
2,350
545
71 %
(128)
(6)%
594
27 %
29 % $ 1,239
562 %
(13)%
47 %
16 %
1,119 N/A
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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, and $7.7 million for the year ended December 31, 2014. 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
increase in noninterest income for the year ended December 31, 2015, compared to the year ended December 31, 2014,
was primarily due to a $545,000 increase in the gain on the sale of securities and the full year impact of fee income from
Bay View Funding.
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.
The Company received gross proceeds of $75.7 million on investment securities available-for-sale it sold during
the year ended December 31, 2016 with a book value totaling $74.8 million, resulting in a gain on sale of securities of
$843,000. The Company also sold $6.7 million of investment securities available-for-sale which were pending settlement
at December 31, 2016, with a book value totaling $6.4 million, resulting in a gain on sale of securities of $256,000. The
Company received gross proceeds of $71.8 million on investment securities available-for-sale it sold during the year ended
December 31, 2015 with a book value totaling $71.2 million, resulting in a gain on sale of securities of $637,000. There
was also a $5,000 gain on a bond that was called in the fourth quarter of 2015 included in gain on sale of securities.
A portion of the Company’s noninterest income is associated with its SBA lending activity, as gain on sales of
loans sold in the secondary market and servicing income from loans sold with servicing rights retained. During 2016, SBA
loan sales resulted in a $796,000 gain, compared to a $843,000 gain on sales of SBA loans in 2015, and a $971,000 gain
on sales of SBA loans in 2014. The servicing assets that result from the sales of SBA loans with servicing retained are
amortized over the expected term of the loans using a method approximating the interest method. Servicing income
generally declines as the respective loans are repaid.
The increase in cash surrender value of life insurance approximates a 2.97% after tax yield on the policies. To
realize this tax advantaged yield the policies must be held until death of the insured individuals, who are current and former
officers and directors of the Company.
61
Noninterest Expense
The following table sets forth the various components of the Company’s noninterest expense:
Year Ended December 31,
2015
2014
2016
Increase
(Decrease)
2016 versus 2015
Increase
(Decrease)
2015 versus 2014
Amount Percent Amount Percent
(Dollars in thousands)
Salaries and employee benefits . . . . . . . . $ 34,660 $ 35,146 $ 26,250 $
Occupancy and equipment . . . . . . . . . . . .
Professional fees . . . . . . . . . . . . . . . . . . . .
Software subscriptions . . . . . . . . . . . . . . .
Amortization on intangible assets . . . . . .
Data processing . . . . . . . . . . . . . . . . . . . . .
Insurance expense . . . . . . . . . . . . . . . . . . .
FDIC deposit insurance premiums . . . . . .
Foreclosed assets . . . . . . . . . . . . . . . . . . . .
Acquisition and integration related
4,300
1,828
1,214
1,043
1,371
1,127
1,092
(94)
4,053
1,891
999
510
969
1,126
892
53
4,378
3,471
1,573
1,568
1,331
1,275
1,160
25
(486)
78
1,643
359
525
(40)
148
68
119
costs(1) . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(3,546)
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Total . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 57,639 $ 58,673 $ 44,222 $ (1,034)
3,546
8,100
895
6,584
—
8,198
(1)% $ 8,896
2 %
247
90 %
(63)
30 %
215
50 %
533
(3)%
402
13 %
1
6 %
200
127 %
(147)
(100)% 2,651
1 % 1,516
(2)% $ 14,451
34 %
6 %
(3)%
22 %
105 %
41 %
— %
22 %
(277)%
296 %
23 %
33 %
(1) Does not include one-time pre-tax severance and retention cost of $2.9 million, which is included in salaries and
employee benefits for the year ended December 31, 2015.
The following table indicates the percentage of noninterest expense in each category:
2016
2015
2014
Percent
Amount of Total Amount of Total Amount of Total
Percent
Percent
Salaries and employee benefits . . . . . . . . . . . . . . $ 34,660
4,378
Occupancy and equipment . . . . . . . . . . . . . . . . . .
3,471
Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . .
1,573
Software subscriptions . . . . . . . . . . . . . . . . . . . . .
1,568
Amortization on intangible assets . . . . . . . . . . . .
1,331
Data processing . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,275
Insurance expense . . . . . . . . . . . . . . . . . . . . . . . . .
1,160
FDIC deposit insurance premiums . . . . . . . . . . . .
25
Foreclosed assets . . . . . . . . . . . . . . . . . . . . . . . . . .
—
Acquisition and integration related costs(1) . . . .
8,198
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 57,639
(Dollars in thousands)
60 % $ 35,146
4,300
8 %
1,828
6 %
1,214
3 %
1,043
3 %
1,371
2 %
1,127
2
1,092
2 %
(94)
— %
3,546
— %
8,100
14 %
100 % $ 58,673
60 % $ 26,250
4,053
7 %
1,891
3 %
999
2 %
510
2 %
969
2 %
1,126
2
892
2 %
53
— %
895
6 %
6,584
14 %
100 % $ 44,222
59 %
9 %
4 %
2 %
1 %
2 %
3
2 %
— %
2 %
15 %
100 %
(1) Does not include one-time pre-tax severance and retention cost of $2.9 million, which is included in salaries and
employee benefits for the year ended December 31, 2015.
Noninterest expense for the year ended December 31, 2016 decreased 2% 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
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legal fees on problem loans that were paid off in 2015. Full-time equivalent employees were 263, 260, and 242 at December
31, 2016, 2015, and 2014, respectively.
Noninterest expense for the year ended December 31, 2015 increased 33% to $58.7 million, compared to $44.2
million for the year ended December 31, 2014. The increase from year to year was primarily due to costs related to the
integration of Focus, and the additional operating costs of Focus and Bay View Funding. Noninterest expense included
total Focus pre-tax acquisition and integration costs of $6.4 million for the year ended December 31, 2015. Of the total
acquisition and integration costs, salaries and employee benefits (including severance and retention expenses) were $2.9
million, and other expenses related to the Focus acquisition and integration were $3.5 million for the year ended December
31, 2015.
Income Tax Expense
The Company computes its provision for income taxes on a monthly basis. The effective tax rate is determined
by applying the Company’s statutory income tax rates to pre-tax book income as adjusted for permanent differences
between pre-tax book income and actual taxable income. These permanent differences include, but are not limited to
increases in the cash surrender value of life insurance policies, interest on tax-exempt securities, certain expenses that are
not allowed as tax deductions, and tax credits.
The Company’s Federal and state income tax expense in 2016 was $16.6 million, compared to $10.1 million in
2015, and $7.5 million in 2014. The following table shows the effective income tax rates for the dates indicated:
Effective income tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37.7% 38.0%
36.0%
The difference in the effective tax rate compared to the combined Federal and state statutory tax rate of 42% is
primarily the result of tax exempt securities, 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, and Enterprise Zone hiring
credits.
For the Year Ended
December 31,
2015
2014
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The Company adopted the proportional amortization method of accounting for its low income housing
investments in the third quarter of 2014. The Company quantified the impact of adopting the proportional amortization
method compared to the equity method to its current year and prior period financial statements. The Company determined
that the adoption of the proportional amortization method did not have a material impact to its financial statements. The
low income housing investment losses, net of the tax benefits received, are included in income tax expense for all periods
reflected on the consolidated income statements.
24FEB201611503668
Some items of income and expense are recognized in different years for tax purposes than when applying
generally accepted accounting principles leading to timing differences between the Company’s actual tax liability, and the
amount accrued for this liability based on book income. These temporary differences comprise the “deferred” portion of
the Company’s tax expense or benefit, which is accumulated on the Company’s books as a deferred tax asset or deferred
tax liability until such time as they reverse.
Realization of the Company’s deferred tax assets is primarily dependent upon the Company generating sufficient
future taxable income to obtain benefit from the reversal of net deductible temporary differences and the utilization of tax
credit carryforwards and the net operating loss carryforwards for Federal and California state income tax purposes. The
amount of deferred tax assets considered realizable is subject to adjustment in future periods based on estimates of future
taxable income. Under generally accepted accounting principles a valuation allowance is required to be recognized if it is
“more likely than not” that the deferred tax assets will not be realized. The determination of the realizability of the deferred
tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and
negative evidence, including forecasts of future income, cumulative losses, applicable tax planning strategies, and
assessments of current and future economic and business conditions.
The Company had the net deferred tax assets of $25.1 million and $22.2 million at December 31, 2016, and
December 31, 2015, respectively. After consideration of the matters in the preceding paragraph, the Company determined
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that it is more likely than not that the net deferred tax assets at December 31, 2016 and December 31, 2015 will be fully
realized in future years.
Adoption of reduced corporate tax rates as being discussed in the United States Congress could have a material
adverse effect on our deferred tax assets.
Business Segment Information
The following presents the Company’s operating segments. Transactions between segments consist primarily of
borrowed funds. Intersegment interest expense is allocated to the Factoring segment based on the Company’s prime rate
and funding costs. The provision for loan loss is allocated based on the segment’s allowance for loan loss determination
which considers the effects of charge-offs. Noninterest income and expense directly attributable to a segment are assigned
to it. Taxes are paid on a consolidated basis and allocated for segment purposes. The Factoring segment includes only
factoring originated by Bay View Funding, which has been included in the results of operations since the acquisition on
November 1, 2014.
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intersegment interest allocations . . . . . . . . . . . . . . . . . . .
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income after provision . . . . . . . . . . . . . . . . .
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intersegment expense allocations . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans, net of deferred fees . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
$
$
$
(1) Includes the holding company’s results of operations.
Banking(1)
82,175
1,163
3,211
80,127
1,181
78,946
10,821
50,298
804
40,273
15,036
25,237
2,507,121
1,452,991
32,620
At or for Year Ended
December 31, 2016
Factoring
(Dollars in thousands)
12,256
$
(1,163)
—
11,093
56
11,037
804
7,341
(804)
3,696
1,552
2,144
63,759
49,616
13,044
$
$
$
$
$
$
$
$
$
Consolidated
94,431
—
3,211
91,220
1,237
89,983
11,625
57,639
—
43,969
16,588
27,381
2,570,880
1,502,607
45,664
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Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intersegment interest allocations . . . . . . . . . . . . . . . . . . .
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . .
Net interest income after provision . . . . . . . . . . . . . . . . .
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intersegment expense allocations . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans, net of deferred fees . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1) Includes the holding company’s results of operations.
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intersegment interest allocations . . . . . . . . . . . . . . . . . . .
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . .
Net interest income after provision . . . . . . . . . . . . . . . . .
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans, net of deferred fees . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Banking(1)
66,306
1,087
2,422
64,971
(156)
65,127
8,234
51,438
386
22,309
8,301
14,008
2,306,543
1,318,657
32,620
At or for Year Ended
December 31, 2015
Factoring
(Dollars in thousands)
12,437
$
(1,087)
—
11,350
188
11,162
751
7,235
(386)
4,292
1,803
2,489
55,036
40,059
13,044
$
$
$
$
Banking(1)
57,178
31
2,033
55,176
(338)
55,514
7,662
43,132
20,044
7,151
12,893
1,561,911
1,048,631
—
At or for Year Ended
December 31, 2014
Factoring(2)
(Dollars in thousands)
2,078
$
(31)
120
1,927
—
1,927
84
1,090
921
387
534
55,192
40,012
13,044
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Consolidated
78,743
—
2,422
76,321
32
76,289
8,985
58,673
—
26,601
10,104
16,497
2,361,579
1,358,716
45,664
Consolidated
59,256
—
2,153
57,103
(338)
57,441
7,746
44,222
20,965
7,538
13,427
1,617,103
1,088,643
13,044
$
$
$
$
$
$
$
$
$
$
(1) Includes the holding company’s results of operations.
(2) Includes two months of Bay View Funding’s results of operations.
Banking. For the year ended December 31, 2016, our banking segment’s net income increased to $25.2 million,
compared with $14.0 million for the year ended December 31, 2015. Net interest income increased to $80.1 million for
the year ended December 31, 2016, compared to $65.0 million for the year ended December 31, 2015. The increase in net
interest income for the year ended December 31, 2016, compared to the the year ended December 31, 2015, was 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. The provision
for loan losses for the year ended December 31, 2016 increased to $1.2 million, compared to a $156,000 credit provision
for loan losses for the year ended December 31, 2015. Net charge-offs were $1.0 million for the year ended December
31, 2016, compared to net recoveries of $711,000 for the year ended December 31, 2015. Net charge-offs for the year
ended December 31, 2016 included one $1.3 million C&I loan relationship charged-off in the fourth quarter of 2016.
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Noninterest income increased to $10.8 million for the year ended December 31, 2016, compared to $8.2 million for the
year ended December 31, 2015, primarily due to a $1.1 million gain on proceeds from company-owned life insurance, and
an increase in the gain on sales of securities, service charges and fees on deposit accounts, and servicing income. For the
year ended December 31, 2016, noninterest expense was $50.3 million, compared to $51.4 million for year ended
December 31, 2015.
For the year ended December 31, 2015, our banking segment’s net income increased to $14.0 million, compared
with $12.9 million for the year ended December 31, 2014. Net interest income increased to $65.0 million for the year
ended ended December 31, 2015, compared to $55.2 million for the year ended ended December 31, 2014. The increase
in net interest income for the year ended ended December 31, 2015, compared to the year ended December 31, 2014, was
primarily as a result of the Focus acquisition and organic growth in the loan portfolio and core deposits. For the year ended
December 31, 2015, the credit provision for loan losses was $156,000, compared with a credit for loan losses of $338,000,
for the year ended ended December 31, 2014. For the year ended December 31, 2015, noninterest expense was $51.4
million, compared to $43.1 million for the year ended December 31, 2014. The increase in noninterest expense for the
year ended December 31, 2015, was primarily due to one-time costs related to the Focus transaction, and the additional
operating costs of Focus.
Factoring. Bay View Funding’s primary business operation is purchasing and collecting factored receivables.
Factored receivables are receivables that have been transferred by the originating organization and typically have not been
subject to previous collection efforts. In a factoring transaction, Bay View Funding directly purchases the receivables
generated by its clients at a discount to their face value. The transactions are structured to provide the clients with
immediate working capital when there is a mismatch between payments to the client for a good or service and the
incurrence of operating costs required to provide for such good or service. The average life of the factored receivables is
35 days. The balance of the purchased receivables as of December 31, 2016 and 2015 was $49.6 million and $40.1 million,
respectively. For the year ended December 31, 2016, Bay View Funding’s net income was $2.1 million, compared to $2.5
million for the year ended December 31, 2015. For the year ended December 31, 2016, net interest income decreased to
$11.1 million, compared to $11.4 million for the year ended December 31, 2015, primarily due to a decrease in the average
yield on the factored receivables portfolio, partially offset by an increase in the average balance of factored receivables
outstanding. The provision for loan losses decreased to $56,000 for the year ended December 31, 2016, compared to
$188,000 for the year ended December 31, 2015. Net charge-offs were $64,000 for the year ended December 31, 2016,
compared to $196,000 for the year ended December 31, 2015. Noninterest income was $804,000 for the year ended
December 31, 2016, compared to $751,000 for the year ended December 31, 2015. Noninterest expense was $7.3 million
for the year ended December 31, 2016, compared to $7.2 million for the year ended December 31, 2015.
The balance of the purchased receivables as of December 31, 2015 and 2014 was $40.1 million and $40.0 million,
respectively. For the year ended December 31, 2015, Bay View Funding provided net interest income of $11.3 million,
noninterest income of $751,000, and $2.5 million of the Company’s net income. For the year ended December 31, 2014,
two months of Bay View Funding’s results of operations provided net interest income of $1.9 million, noninterest income
of $84,000, and $534,000 of the Company’s net income.
Financial Condition
As of December 31, 2016, total assets increased to $2.57 billion, compared to $2.36 billion at December 31, 2015.
Securities available-for-sale (at fair value) were $306.6 million at December 31, 2016, a decrease of 20% from $385.1
million at December 31, 2015. Securities held-to-maturity (at amortized cost) were $324.0 million at December 31, 2016,
an increase of 196% from $109.3 million at December 31, 2015. Total 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.
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. 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.
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Securities Portfolio
The following table reflects the balances for each category of securities at year-end:
2016
December 31,
2015
(Dollars in thousands)
2014
Securities available-for-sale (at fair value):
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Trust preferred securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. Treasury . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. Government sponsored entities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 290,989
15,600
—
—
—
$ 306,589
$ 324,230
15,132
30,003
9,041
6,673
$ 385,079
$ 154,172
15,300
—
—
36,863
$ 206,335
Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Municipals — exempt from Federal tax . . . . . . . . . . . . . . . . . . . . . . . . .
$ 233,409
90,601
$ 324,010
$
15,793
93,518
$ 109,311
$
$
15,480
79,882
95,362
The table below summarizes the weighted average life and weighted average yields of securities as of
December 31, 2016:
Within One
Year or Less
Amount Yield
After One and
Within Five
Years
Weighted Average Life
After Five and
Within Ten
Years
After Ten
Years
Total
Amount
Yield
Amount
Yield Amount Yield
Amount
Yield
(Dollars in thousands)
Securities available-for-sale (at fair value):
Agency mortgage-backed securities . . . . . $
Trust preferred securities . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $
—
—
—
—
—
—
$ 287,223 1.98 % $
—
—
$ 287,223 1.98 % $
3,766 2.09 % $
$ 290,989 1.98 %
15,600 5.95 %
15,600 5.95 %
3,766 2.09 % $ 15,600 5.95 % $ 306,589 2.18 %
—
—
—
—
Securities held-to-maturity (at amortized cost):
Agency mortgage-backed securities . . . . . $
Municipals — exempt from Federal tax . . 1,945 2.35 %
$ 142,229 1.66 % $ 74,100 2.09 % $ 17,080 2.91 % $ 233,409 1.89 %
90,601 3.86 %
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,945 2.35 % $ 158,034 1.88 % $ 102,018 2.63 % $ 62,013 3.55 % $ 324,010 2.44 %
27,918 4.07 % 44,933 3.80 %
15,805 3.87 %
—
—
(1) Reflects tax equivalent yield based on a 35% Federal tax rate.
The securities portfolio is the second largest component of the Company’s interest-earning assets, and the
structure and composition of this portfolio is important to an analysis of the financial condition of the Company. The
portfolio serves the following purposes: (i) it provides a source of pledged assets for securing certain deposits and
borrowed funds, as may be required by law or by specific agreement with a depositor or lender; (ii) it provides liquidity to
even out cash flows from the loan and deposit activities of customers; (iii) it can be used as an interest rate risk management
tool, since it provides a large base of assets, the maturity and interest rate characteristics of which can be changed more
readily than the loan portfolio to better match changes in the deposit base and other funding sources of the Company; and
(iv) it is an alternative interest-earning use of funds when loan demand is weak or when deposits grow more rapidly than
loans.
The Company’s portfolio may include: (i) U.S. Treasury securities and U.S. Government sponsored entities’ debt
securities for liquidity and pledging; (ii) mortgage-backed securities, which in many instances can also be used for
pledging, and which generally enhance the yield of the portfolio; (iii) municipal obligations, which provide tax free income
and limited pledging potential; (iv) single entity issue trust preferred securities, which generally enhance the yield on the
portfolio; and (v) corporate bonds, which also enhance the yield on the portfolio.
The Company classifies its securities as either available-for-sale or held-to-maturity at the time of purchase.
Accounting guidance requires available-for-sale securities to be marked to fair value with an offset to accumulated other
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comprehensive income (loss), a component of shareholders’ equity. Monthly adjustments are made to reflect changes in
the fair value of the Company’s available-for-sale securities.
The investment securities available-for-sale portfolio totaled $306.6 million at December 31, 2016, a decrease of
20% from $385.1 million at December 31, 2015. At December 31, 2016, the Company’s securities available-for-sale
portfolio, at fair value, 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 $4.8 million at December 31, 2014. 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 $75.9 million on investment securities available-for-sale it sold during
the year ended December 31, 2016 with a book value totaling $74.8 million, resulting in a gain on sale of securities of
$843,000. The $74.8 million book value of investment securities sold included $30.1 million of U.S. Treasury securities,
$9.0 million of U.S. Government sponsored entities, $6.4 million of corporate bonds, and $29.3 million of agency
mortgage backed securities. The Company also sold $6.7 million of mortgage-backed securities available-for-sale which
were pending settlement at December 31, 2016, with a book value totaling $6.4 million, resulting in a gain on sale of
securities of $256,000.
During the year ended December 31, 2016, the Company purchased $75.8 million of investment securities
available-for-sale, which consisted of $51.8 million of Federal Home Loan Mortgage Corporation (“FHLMC”)
securities, with an average book yield of 1.96%, and $24.0 million of Federal National Mortgage Association (“FNMA”)
securities, with an average book yield of 1.95%.
At December 31, 2016, investment securities held-to-maturity totaled $324.0 million, an increase of 196% from
$109.3 million at December 31, 2015. At December 31, 2016, the Company’s securities held-to-maturity portfolio, at
amortized cost, was comprised $233.4 million agency mortgage-backed securities, and $90.6 million of tax-exempt
municipal bonds.
During the year ended December 31, 2016, the Company purchased $239.4 million of investment securities held-
to-maturity, with a weighted average book yield of 1.89%. The investment securities purchased during 2016 consisted of
$239.4 million of mortgage-backed securities with a weighted average book yield of 1.89%.
The Company has not used interest rate swaps or other derivative instruments to hedge fixed rate loans or
securities to otherwise mitigate interest rate risk.
Loans
The Company’s loans represent the largest portion of earning assets, substantially greater than the securities
portfolio or any other asset category, and the quality and diversification of the loan portfolio is an important consideration
when reviewing the Company’s financial condition. Gross loans, excluding loans held-for-sale, represented 58% of total
assets at December 31, 2016 and December 31, 2015. The ratio of loans to deposits increased to 66.42% at December 31,
2016 from 65.87% at December 31, 2015.
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Loan Distribution
The Loan Distribution table that follows sets forth the Company’s gross loans outstanding, excluding loans
held-for-sale, and the percentage distribution in each category at the dates indicated.
2016
% to Total
2015
% to Total
December 31,
2014
% to Total
2013
% to Total
2012
% to Total
Commercial . . . . . . . . . . . . . . . $
Real estate:
604,331
40 % $
556,522
41 % $
462,403
43 % $ 393,074
43 % $ 375,469
(Dollars in thousands)
Commercial . . . . . . . . . . . .
Land and construction . . . . .
Home equity . . . . . . . . . . . .
Residential mortgages . . . . .
Consumer . . . . . . . . . . . . . . . . .
662,228
81,002
82,459
52,887
20,460
Total Loans . . . . . . . . . . . 1,503,367
(760)
Deferred loan fees, net . . . . . . . .
Loans, including deferred
fees . . . . . . . . . . . . . . . . 1,502,607
44 %
5 %
6 %
4 %
1 %
625,665
84,428
76,833
—
16,010
100 % 1,359,458
(742)
—
46 %
6 %
6 %
— %
1 %
478,335
67,980
61,644
—
18,867
100 % 1,089,229
(586)
—
44 % 423,288
31,443
6 %
51,815
6 %
—
— %
15,677
1 %
100 % 915,297
(384)
—
46 % 354,934
3 % 22,352
6 % 43,865
—
2 % 15,714
100 % 812,334
(21)
—
— %
100 % 1,358,716
100 % 1,088,643
100 % 914,913
100 % 812,313
46 %
44 %
3 %
5 %
— %
2 %
100 %
—
100 %
Allowance for loan losses . . . . . .
(19,089)
Loans, net . . . . . . . . . . . . $ 1,483,518
(18,926)
$ 1,339,790
(18,379)
$ 1,070,264
(19,164)
$ 895,749
(19,027)
$ 793,286
The Company’s loan portfolio is concentrated in commercial (primarily manufacturing, wholesale, and services
oriented entities) and commercial real estate, with the remaining balance in land development and construction and home
equity and consumer loans. The Company does not have any concentrations by industry or group of industries in its loan
portfolio, however, 59% of its gross loans were secured by real property as of December 31, 2016, compared to 58% as of
December 31, 2015. While no specific industry concentration is considered significant, the Company’s lending operations
are located in areas that are dependent on the technology and real estate industries and their supporting companies.
The Company has established concentration limits in its loan portfolio for commercial real estate loans,
commercial loans, construction loans and unsecured lending, among others. All loan types are within established limits.
The Company uses underwriting guidelines to assess the borrowers’ historical cash flow to determine debt service, and
we further stress test the debt service under higher interest rate scenarios. Financial and performance covenants are used
in commercial lending to allow the Company to react to a borrower’s deteriorating financial condition, should that occur.
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The Company’s commercial loans are made for working capital, financing the purchase of equipment or for other
business purposes. Commercial loans include loans with maturities ranging from thirty days to one year and “term loans”
with maturities normally ranging from one to five years. Short-term business loans are generally intended to finance current
transactions and typically provide for periodic principal payments, with interest payable monthly. Term loans normally
provide for floating interest rates, with monthly payments of both principal and interest.
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The Company is an active participant in the SBA and U.S. Department of Agriculture guaranteed lending
programs, and has been approved by the SBA as a lender under the Preferred Lender Program. The Company regularly
makes such loans conditionally guaranteed by the SBA (collectively referred to as “SBA loans”). The guaranteed portion
of these loans is typically sold in the secondary market depending on market conditions. When the guaranteed portion of
an SBA loan is sold the Company retains the servicing rights for the sold portion. During 2016, loans were sold resulting
in a gain on sales of SBA loans of $796,000, compared to a gain on sales of SBA loans of $843,000 for 2015, and $971,000
for 2014.
The Company’s factoring receivables are from the operations of Bay View Funding whose primary business is
purchasing and collecting factored receivables. Factored receivables are receivables that have been transferred by the
originating organization and typically have not been subject to previous collection efforts. These receivables are acquired
from a variety of companies, including but not limited to service providers, transportation companies, manufacturers,
distributors, wholesalers, apparel companies, advertisers, and temporary staffing companies. The portfolio of factored
receivables is included in the Company’s commercial loan portfolio. The average life of the factored receivables is 35
days. The balance of the purchased receivables as of December 31, 2016 and 2015 was $49.6 million and $40.1 million,
respectively.
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
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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.
The Company’s CRE loans consist primarily of loans based on the borrower’s cash flow and are secured by deeds
of trust on commercial property to provide a secondary source of repayment. The Company generally restricts real estate
term loans to no more than 75% of the property’s appraised value or the purchase price of the property depending on the
type of property and its utilization. The Company offers both fixed and floating rate loans. Maturities on real estate
mortgage loans are generally between five and ten years (with amortization ranging from fifteen to twenty-five years and
a balloon payment due at maturity), however, SBA and certain other real estate loans that can be sold in the secondary
market may be granted for longer maturities.
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. These loans consist primarily of adjustable and fixed-rate loans secured by deeds of trust
on commercial property. The commercial real estate loans at December 31, 2016 consist of $287.5 million, or 43% of
commercial owner occupied properties, and $374.7 million, or 57%, of commercial investment properties. Properties
securing the commercial and residential real estate loans are primarily located in the Company’s primary market, which is
the Greater San Francisco Bay Area.
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 servicing fees to the servicer. At December 31, 2016, the purchased CRE loans
outstanding totaled $31.0 million.
The Company’s land and construction loans are primarily to finance the development/construction of commercial
and single family residential properties. The Company utilizes underwriting guidelines to assess the likelihood of
repayment from sources such as sale of the property or availability of permanent mortgage financing prior to making the
construction loan. Construction loans are provided primarily in our market area, and we have extensive controls for the
disbursement process. 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, primarily due to the payoff of construction loans during the year ended
December 31, 2016.
The Company makes home equity lines of credit available to its existing customers. Home equity lines of credit
are underwritten initially with a maximum 75% loan to value ratio. Home equity lines are reviewed semi-annually, with
specific emphasis on loans with a loan to value ratio greater than 70%. The Company takes measures to work with
customers to reduce line commitments and minimize potential losses.
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 servicing fees to the servicer. Residential mortgage
loans outstanding at December 31, 2016 totaled $52.9 million.
Additionally, the Company makes consumer loans for the purpose of financing automobiles, various types of
consumer goods, and other personal purposes. Consumer loans generally provide for the monthly payment of principal
and interest. Most of the Company’s consumer loans are secured by the personal property being purchased or, in the
instances of home equity loans or lines, real property.
With certain exceptions, state chartered banks are permitted to make extensions of credit to any one borrowing
entity up to 15% of the bank’s capital and reserves for unsecured loans and up to 25% of the bank’s capital and reserves
for secured loans. For HBC, these lending limits were $41.3 million and $68.8 million at December 31, 2016, respectively.
Loan Maturities
The following table presents the maturity distribution of the Company’s loans (excluding loans held-for-sale), as
of December 31, 2016. The table shows the distribution of such loans between those loans with predetermined (fixed)
interest rates and those with variable (floating) interest rates. Floating rates generally fluctuate with changes in the prime
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rate as reflected in the Western Edition of The Wall Street Journal. As of December 31, 2016, approximately 55% of the
Company’s loan portfolio consisted of floating interest rate loans.
Due in
One Year
or Less
Over One
Year But
Less than
Five Years
Over
Five Years
Total
$
493,030
$
(Dollars in thousands)
85,846
$
25,455
$
604,331
106,717
81,002
76,314
533
19,336
776,932
682,454
94,478
776,932
$
$
$
225,243
—
1,551
—
1,124
313,764
61,005
252,759
313,764
$
$
$
330,268
—
4,594
52,354
—
412,671
84,998
327,673
412,671
$
$
$
662,228
81,002
82,459
52,887
20,460
1,503,367
828,457
674,910
1,503,367
$
$
$
Commercial . . . . . . . . . . . . . . . . . . . . .
Real estate:
Commercial . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . .
Residential mortgages . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . .
Loans . . . . . . . . . . . . . . . . . . . . . .
Loans with variable interest rates . . . .
Loans with fixed interest rates . . . . . .
Loans . . . . . . . . . . . . . . . . . . . . . .
Loan Servicing
As of December 31, 2016, 2015, and 2014 there were $164.5 million, $175.5 million, and $130.6 million,
respectively, of SBA loans that were serviced by the Company for others. Activity for loan servicing rights was as follows:
2016
2015
2014
(Dollars in thousands)
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,209 $ 565 $ 525
319
Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(279)
Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
End of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,854 $ 2,209 $ 565
2,126
(482)
219
(574)
Loan servicing rights are included in accrued interest receivable and other assets on the unaudited consolidated
balance sheets and reported net of amortization. The increase in loan servicing rights for the year ended December 31,
2015 from December 31, 2014 was primarily due to the Focus acquisition of $1.9 million in serviced SBA loans at fair
value. There was no valuation allowance as of December 31, 2016 and 2015, as the fair market value of the assets was
greater than the carrying value.
Activity for the I/O strip receivable was as follows:
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2016
2015
(Dollars in thousands)
2014
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,367 $ 1,481 $ 1,647
(166)
Unrealized holding loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (300)
End of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,067 $ 1,367 $ 1,481
(114)
Management reviews the key economic assumptions used to estimate the fair value of I/O strip receivables on a
quarterly basis. The fair value of the I/O strip can be adversely impacted by a significant increase in either the prepayment
speed of the portfolio or the discount rate. At December 31, 2016, key economic assumptions and the sensitivity of the
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fair value of the I/O strip receivables to immediate changes to the CPR assumption of 10% and 20%, and changes to the
discount rate assumption of 1% and 2%, are as follows:
Carrying amount/fair value of Interest-Only (I/O) strip . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Prepayment speed assumption (annual rate) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impact on fair value of 10% adverse change in prepayment speed (CPR 8.1%) . . . . . . . . . . . . . . $
Impact on fair value of 20% adverse change in prepayment speed (CPR 8.9%) . . . . . . . . . . . . . . $
Residual cash flow discount rate assumption (annual) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impact on fair value of 1% adverse change in discount rate (14.3% discount rate) . . . . . . . . . . . . $
Impact on fair value of 2% adverse change in discount rate (15.6% discount rate) . . . . . . . . . . . . $
(Dollars in thousands)
1,067
7.4
(18)
(35)
13.0%
(33)
(64)
Credit Quality
Financial institutions generally have a certain level of exposure to credit quality risk, and could potentially receive
less than a full return of principal and interest if a debtor becomes unable or unwilling to repay. Since loans are the most
significant assets of the Company and generate the largest portion of its revenues, the Company’s management of credit
quality risk is focused primarily on loan quality. Banks have generally suffered their most severe earnings declines as a
result of customers’ inability to generate sufficient cash flow to service their debts and/or downturns in national and
regional economies and declines in overall asset values including real estate. In addition, certain debt securities that the
Company may purchase have the potential of declining in value if the obligor’s financial capacity to repay deteriorates.
The Company’s policies and procedures identify market segments, set goals for portfolio growth or contraction,
and establish limits on industry and geographic credit concentrations. In addition, these policies establish the Company’s
underwriting standards and the methods of monitoring ongoing credit quality. The Company’s internal credit risk controls
are centered in underwriting practices, credit granting procedures, training, risk management techniques, and familiarity
with loan customers as well as the relative diversity and geographic concentration of our loan portfolio.
The Company’s credit risk may also be affected by external factors such as the level of interest rates, employment,
general economic conditions, real estate values, and trends in particular industries or geographic markets. As an
independent community bank serving a specific geographic area, the Company must contend with the unpredictable
changes in the general California market and, particularly, primary local markets. The Company’s asset quality has
suffered in the past from the impact of national and regional economic recessions, consumer bankruptcies, and depressed
real estate values.
Nonperforming assets are comprised of the following: loans and loans held-for-sale for which the Company is no
longer accruing interest; restructured loans which have been current under six months; loans 90 days or more past due and
still accruing interest (although they are generally placed on nonaccrual when they become 90 days past due, unless they
are both well-secured and in the process of collection); and foreclosed assets. Past due loans 30 days or greater totaled
$8.0 million and $5.8 million at December 31, 2016 and December 31, 2015, respectively, of which $2.1 million and
$591,000 were on nonaccrual. There were also $1.0 million and $4.1 million loans less than 30 days past due included in
nonaccrual loans held-for-investment, at December 31, 2016 and December 31, 2015, respectively.
Management’s classification of a loan as “nonaccrual” is an indication that there is reasonable doubt as to the full
recovery of principal or interest on the loan. At that point, the Company stops accruing interest income, and reverses any
uncollected interest that had been accrued as income. The Company begins recognizing interest income only as cash
interest payments are received and it has been determined the collection of all outstanding principal is not in doubt. The
loans may or may not be collateralized, and collection efforts are pursued. Loans may be restructured by management
when a borrower has experienced some change in financial status causing an inability to meet the original repayment terms
and where the Company believes the borrower will eventually overcome those circumstances and make full restitution.
Foreclosed assets consist of properties and other assets acquired by foreclosure or similar means that management is
offering or will offer for sale.
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The following table summarizes the Company’s nonperforming assets at the dates indicated:
2016
2015
Nonaccrual loans — held-for-investment . . . . . . . . . . . $ 3,059
Restructured and loans 90 days past due and still
accruing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
Total nonperforming loans . . . . . . . . . . . . . . . . . . . . 3,059
229
Total nonperforming assets . . . . . . . . . . . . . . . . . . . . $ 3,288
Foreclosed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 4,716
1,662
6,378
364
$ 6,742
December 31,
2014
(Dollars in thousands)
$ 5,855
$ 11,326
2013
2012
—
5,855
696
$ 6,551
492
11,818
575
$ 12,393
$ 17,335
859
18,194
1,270
$ 19,464
Nonperforming assets as a percentage of loans plus
nonaccrual loans held-for-sale plus foreclosed assets
Nonperforming assets as a percentage of total assets . .
0.22 %
0.13 %
0.50 %
0.29 %
0.60 %
0.41 %
1.35 %
0.83 %
2.39 %
1.15 %
The following table presents nonperforming loans by class at year end:
2016
Restructured and
Loans Over 90 Days
Past Due and
Still Accruing
2015
Restructured and
Loans Over 90 Days
Past Due and
Still Accruing
Nonaccrual
Total
Nonaccrual
Total
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Commercial . . . . . . . . . . . . . . . . . . . . $ 2,171 $
Real estate:
Commercial. . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . .
419
199
267
3
Total . . . . . . . . . . . . . . . . . . . . . . $ 3,059 $
(Dollars in thousands)
— $ 2,171 $
724 $
1,378 $ 2,102
—
—
—
—
— $ 3,059 $ 4,716 $
2,992
219
777
4
419
199
267
3
—
—
284
—
2,992
219
1,061
4
1,662 $ 6,378
Nonperforming assets were $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. Included in total nonperforming assets were foreclosed assets of
$229,000 at December 31, 2016, compared to $364,000 at December 31, 2015.
Loans with a well defined weakness, which are characterized by the distinct possibility that the Company will
sustain a loss if the deficiencies are not corrected, are categorized as “classified.” Classified loans include all loans
considered as substandard, substandard nonaccrual, and doubtful and may result from problems specific to a borrower’s
business or from economic downturns that affect the borrower’s ability to repay or that cause a decline in the value of the
underlying collateral (particularly real estate). The principal balance of classified loans was $13.3 million at December 31,
2016, and $18.6 million at December 31, 2015. There were no loans held-for-sale included in classified loans at December
31, 2016, and December 31, 2015. Loans held-for-sale are carried at the lower of cost or estimated fair value, and are not
allocated an allowance for loan losses.
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The following table provides a summary of the loan portfolio by loan type and credit quality classification at the
dates indicated:
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Real estate:
594,255 $ 10,076 $
December 31, 2016
Nonclassified Classified
Total
(Dollars in thousands)
604,331 $
December 31, 2015
Nonclassified Classified
Total
547,536 $
8,986 $
556,522
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Residential mortgages . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
625,665
84,428
76,833
—
16,010
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,490,043 $ 13,324 $ 1,503,367 $ 1,340,826 $ 18,632 $ 1,359,458
617,865
84,209
75,511
—
15,705
662,228
81,002
82,459
52,887
20,460
659,777
80,803
81,866
52,887
20,455
7,800
219
1,322
—
305
2,451
199
593
—
5
Classified commercial loans increased to $10.1 million at December 31, 2016, from $9.0 million at
December 31, 2015, primarily due to commercial loan downgrades in excess of upgrades during the year ended
December 31, 2016. Classified commercial real estate loans decreased to $2.5 million at December 31, 2016, compared
to December 31, 2015, primarily as a result of upgrades and payoffs in the commercial real estate loan portfolio.
The following provides a rollforward of troubled debt restructurings (“TDRs”):
For the Year Ended December 31, 2016
Performing Nonperforming
TDRs
TDRs
Total
Balance at January 1, 2016 . . . . . . . . . . . . . . . . . . . . . . . . $
Principal repayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at December 31, 2016 . . . . . . . . . . . . . . . . . . . $
149 $
(18)
131 $
4 $ 153
(2)
(20)
2 $ 133
(Dollars in thousands)
Year Ended December 31, 2015
Performing Nonperforming
TDRs
TDRs
(Dollars in thousands)
Total
Balance at January 1, 2015 . . . . . . . . . . . . . . . . . . . . . . . . $
Principal repayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at December 31, 2015 . . . . . . . . . . . . . . . . . . . $
167 $
(18)
149 $
916 $ 1,083
(930)
(912)
153
4 $
Allowance for Loan Losses
The allowance for loan losses is an estimate of probable incurred losses in the loan portfolio. Loans are charged-
off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance for loan losses. Management’s methodology for estimating the allowance
balance consists of several key elements, which include specific allowances on individual impaired loans and the formula
driven allowances on pools of loans with similar risk characteristics. Allocations of the allowance may be made for specific
loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
Specific allowances are established for impaired loans. Management considers a loan to be impaired when it is
probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan
agreement, including scheduled interest payments. Loans for which the terms have been modified with a concession
granted, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and
classified as impaired. When a loan is considered to be impaired, the amount of impairment is measured based on the fair
value of the collateral, less costs to sell, if the loan is collateral dependent or on the present value of expected future cash
flows or values that are observable in the secondary market. If the measure of the impaired loans is less than the investment
in the loan, the deficiency will be charged off against the allowance for loan losses if the amount is a confirmed loss, or,
alternatively, a specific allocation within the allowance will be established. Loans that are considered impaired are
specifically excluded from the formula portion of the allowance for loan loss analysis.
The estimated loss factors for pools of loans that are not impaired are based on determining the probability of
default and loss given default for loans within each segment of the portfolio, adjusted for significant factors that, in
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management’s judgment, affect collectibility as of the evaluation date. The Company’s historical delinquency experience
and loss experience are utilized to determine the probability of default and loss given default for segments of the portfolio
where the Company has experienced losses in the past. For segments of the portfolio where the Company has no significant
prior loss experience, the Company uses quantifiable observable industry data to determine the probability of default and
loss given default.
The following provides a summary of the risks associated with various segments of the Company’s loan
portfolio, which are factors management regularly considers when evaluating the adequacy of the allowance:
• Commercial loans consist primarily of commercial and industrial loans (business lines of credit), and other
commercial purpose loans. Repayment of commercial and industrial loans is generally provided from the
cash flows of the related business to which the loan was made. Adverse changes in economic conditions may
result in a decline in business activity, which may impact a borrower’s ability to continue to make scheduled
payments. The factored receivables at Bay View Funding are included in the Company’s commercial loan
portfolio; however, they are evaluated for risk primarily based on the agings of the receivables. Faster turning
receivables imply less risk and therefore warrant a lower associated allowance. Should the overall aging for
the portfolio increase, this structure will by formula increase the allowance to reflect the increasing risk.
Should the portfolio turn more quickly, it would reduce the associated allowance to reflect the reducing risk.
• Real estate loans consist primarily of loans secured by commercial and residential real estate. Also included
in this segment are land and construction loans and home equity lines of credit secured by real estate. As the
majority of this segment is comprised of commercial real estate loans, risks associated with this segment lay
primarily within these loan types. Adverse economic conditions may result in a decline in business activity
and increased vacancy rates for commercial properties. These factors, in conjunction with a decline in real
estate prices, may expose the Company to the potential for losses if a borrower cannot continue to service
the loan with operating revenues, and the value of the property has declined to a level such that it no longer
fully covers the Company’s recorded investment in the loan.
• Consumer loans consist primarily of a large number of small loans and lines of credit. The majority of
installment loans are made for consumer and business purchases. Weakened economic conditions may result
in an increased level of delinquencies within this segment, as economic pressures may impact the capacity
of such borrowers to repay their obligations.
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economic conditions, historical loss experience and the condition of the various markets in which collateral may be sold,
may all affect the required level of the allowance for loan losses and the associated provision for loan losses.
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It is the policy of management to maintain the allowance for loan losses at a level adequate for risks inherent in
the loan portfolio. On an ongoing basis, we have engaged an outside firm to perform independent credit reviews of our
loan portfolio. The Federal Reserve Board and the California Department of Business Oversight — Division of Financial
Institutions also review the allowance for loan losses as an integral part of their examination process. Based on information
currently available, management believes that the allowance for loan losses is adequate. However, the loan portfolio can
be adversely affected if California economic conditions and the real estate market in the Company’s market area were to
weaken. Also, any weakness of a prolonged nature in the technology industry would have a negative impact on the local
market. The effect of such events, although uncertain at this time, could result in an increase in the level of nonperforming
loans and increased loan losses, which could adversely affect the Company’s future growth and profitability. No assurance
of the ultimate level of credit losses can be given with any certainty.
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The following table summarizes the Company’s loan loss experience, as well as provisions and charges to the
allowance for loan losses and certain pertinent ratios for the periods indicated:
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . $ 18,926
Charge-offs:
2016
2015
2014
(Dollars in thousands)
$ 19,164
$ 18,379
2013
2012
$ 19,027
$ 20,700
Commercial. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Real estate:
(1,966)
(527)
(815)
(1,676)
(3,935)
Commercial and residential . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
—
—
(41)
(2,007)
(2)
—
—
(9)
(538)
—
—
(87)
(25)
(927)
(173)
(1)
(102)
—
(1,952)
(1,362)
(133)
(33)
—
(5,463)
Recoveries:
Commercial. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Real estate:
365
877
418
2,621
776
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (charge-offs) recoveries . . . . . . . . . . . . . . . . . .
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . .
—
568
—
—
933
(1,074)
1,237
End of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 19,089
9
127
10
30
1,053
515
32
$ 18,926
35
26
1
—
480
(447)
(338)
$ 18,379
274
—
9
1
2,905
953
(816)
$ 19,164
230
—
—
—
1,006
(4,457)
2,784
$ 19,027
RATIOS:
Net charge-offs (recoveries) to average loans (1) . . .
Allowance for loan losses to total loans (1) . . . . . . . .
Allowance for loan losses to nonperforming loans . .
0.08 %
1.27 %
0.57 %
2.34 %
624.03 % 296.74 % 313.90 % 162.16 % 104.58 %
(0.11)%
2.09 %
(0.04)%
1.39 %
0.05 %
1.69 %
(1) Average loans and total loans exclude loans held-for-sale.
The following table provides a summary of the allocation of the allowance for loan losses by class at the dates
indicated. The allocation presented should not be interpreted as an indication that charges to the allowance for loan losses
will be incurred in these amounts or proportions, or that the portion of the allowance allocated to each category represents
the total amount available for charge-offs that may occur within these classes.
2016
2015
December 31,
2014
Percent
of Loans
in each
category
to total
loans
Percent
of Loans
in each
category
to total
loans
Allowance
Percent
of Loans
in each
category
to total
loans
Allowance
(Dollars in thousands)
2013
2012
Percent
of Loans
in each
category
to total
loans
Allowance
Percent
of Loans
in each
category
to total
loans
Allowance
40 % $ 10,748
41 % $ 11,187
43 % $ 12,533
43 % $ 12,866
46 %
44 %
5 %
6 %
4 %
1 %
4,980
1,504
1,592
—
102
100 % $ 18,926
46 %
6 %
6 %
— %
1 %
4,707
1,048
1,315
—
122
100 % $ 18,379
44 %
6 %
6 %
— %
1 %
4,922
356
1,270
—
83
100 % $ 19,164
46 %
3 %
6 %
— %
2 %
4,609
399
1,026
—
127
100 % $ 19,027
44 %
3 %
5 %
— %
2 %
100 %
Allowance
Commercial . . . . . . . . . $ 10,656
Real estate:
Commercial . . . . . .
Land and construction
Home equity . . . . . .
Residential mortgages
Consumer . . . . . . . . . . .
5,181
1,221
1,639
286
106
Total . . . . . . . . . . . . $ 19,089
The allowance for loan losses totaled $19.1 million, or 1.27% of total loans at December 31, 2016, compared to
$18.9 million, or 1.39% of total loans at December 31, 2015. The allowance for loan losses to total nonperforming loans
increased to 624.03% at December 31, 2016, compared to 296.74% at December 31, 2015. Loan charge-offs reflect the
realization of losses in the portfolio that were partially recognized previously through the provision for loan losses. The
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Company had net charge-offs of $1.1 million, or (0.08)% of average loans, for the year ended December 31, 2016,
compared to net recoveries of $515,000, or (0.04)% of average loans, for the year ended December 31, 2015.
The allowance for loan losses related to the commercial portfolio decreased $92,000 at December 31, 2016
from December 31, 2015, primarily due to net charge-offs of $1.6 million, resulting in a provision to the allowance for
loan losses of $1.5 million. Net charge-offs included one $1.3 million C&I loan relationship charged-off in the fourth
quarter of 2016. The allowance for loan losses related to the real estate portfolio increased $251,000 at September 30,
2016 from December 31, 2015, as a result of net recoveries of $568,000, partially offset by a credit provision for loan
losses of $317,000. The increase in the allowance for loan losses in the real estate portfolio was primarily related to the
purchased residential mortgages of $52.9 million and CRE loans of $31.1 million at December 31, 2016, partially offset
by improving credit quality factors.
Goodwill and Other Intangible Assets
On November 1, 2014, estimated goodwill of $13.0 million resulted from the acquisition Bay View Funding. On
August 20, 2015, estimated goodwill of $32.6 million resulted from the merger of Focus. Goodwill represents the excess
of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. The
fair values of assets acquired and liabilities assumed are subject to adjustment during the first twelve months after the
acquisition date if additional information becomes available to indicate a more accurate or appropriate value for an asset
or liability. Total goodwill at December 31, 2016 and December 31, 2015 was $45.6 million, which consisted of
$13.0 million related to the Bay View Funding acquisition, and $32.6 million related to the Focus acquisition.
Goodwill impairment exists when a reporting unit’s carrying value exceeds its fair value, which is determined
through a qualitative assessment whether it is more likely than not that the fair value of equity of the reporting unit exceeds
the carrying value (“Step Zero”). If the qualitative assessment indicates it is more likely than not that the fair value of
equity of a reporting unit is less than book value, than a quantitative two-step impairment test is required. Step 1 includes
the determination of the carrying value of the Company’s single reporting unit, including the existing goodwill and
intangible assets, and estimating the fair value of the reporting unit. If the carrying amount of a reporting unit exceeds its
fair value, the Company is required to perform a second step to the impairment test. Step 2 requires that the implied fair
value of the reporting unit goodwill be compared to the carrying amount of that goodwill. If the carrying amount of the
reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an
amount equal to that excess.
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The Company completed its annual impairment analysis on the goodwill from the Bay View Funding and Focus
acquisitions as of November 30, 2016 with the assistance of an independent valuation firm. Based on the Step Zero
qualitative analysis performed, the Company determined that it is more likely than not that the fair value of the Company’s
equity exceeded its reported book value of equity at November 30, 2016. As such, no impairment was indicated and no
further testing was required.
Other intangible assets were $7.0 million at December 31, 2016, compared to $8.5 million at December 31, 2015.
Core deposit and customer relationship intangible assets arising from the acquisition of Diablo Valley Bank in June 2007
were $195,000 at December 31, 2016 and $621,000 at December 31, 2015, net of accumulated amortization. The core
deposit intangible asset arising from the acquisition of Focus was $5.2 million at December 31, 2016 and $6.0 million at
December 31, 2015, net of accumulated amortization. A below market lease, customer relationship and brokered
relationship, and a non-compete agreement intangible assets arising from the acquisition of Bay View Funding in
November 2014 were $1.6 million at December 31, 2016 and $1.9 million at December 31, 2015, net of accumulated
amortization.
Deposits
The composition and cost of the Company’s deposit base are important components in analyzing the Company’s
net interest margin and balance sheet liquidity characteristics, both of which are discussed in greater detail in other sections
in this report. The Company’s liquidity is impacted by the volatility of deposits from the propensity of that money to leave
the institution for rate-related or other reasons. Deposits can be adversely affected if economic conditions weaken in
California, and the Company’s market area in particular. Potentially, the most volatile deposits in a financial institution
are jumbo certificates of deposit, meaning time deposits with balances that equal or exceed $250,000, as customers with
balances of that magnitude are typically more rate-sensitive than customers with smaller balances.
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The following table summarizes the distribution of deposits and the percentage of distribution in each category
of deposits for the periods indicated:
2016
Year Ended December 31,
2015
2014
Demand, noninterest-bearing . . . . . . . . . . . $
Demand, interest-bearing . . . . . . . . . . . . . .
Savings and money market . . . . . . . . . . . . .
Time deposits — under $250 . . . . . . . . . . .
Time deposits — $250 and over . . . . . . . . .
Time deposits — brokered . . . . . . . . . . . . .
CDARS — interest-bearing demand,
money market and time deposits . . . . . . . .
Balance
% to Total
917,187
541,282
572,743
57,857
163,670
—
41 % $
24 %
25 %
3 %
7 %
— %
% to Total
Balance
(Dollars in thousands)
821,405
496,278
496,843
62,026
160,815
17,825
40 % $
24 %
24 %
3 %
8 %
1 %
Balance
% to Total
517,662
225,821
384,644
57,443
163,452
28,116
37 %
16 %
28 %
4 %
12 %
2 %
9,401
Total deposits . . . . . . . . . . . . . . . . . . . . . $ 2,262,140
— %
7,583
100 % $ 2,062,775
— %
11,248
100 % $ 1,388,386
1 %
100 %
The Company obtains deposits from a cross-section of the communities it serves. The Company’s business is not
generally seasonal in nature. Public funds were 4% of deposits at December 31, 2016 and 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. Noninterest-bearing deposits increased $95.8 million at December 31, 2016 from December 31,
2015. Interest-bearing demand deposits increased $45.0 million at December 31, 2016 from December 31, 2015. Savings
and money market deposits increased $75.9 million at December 31, 2016 from December 31, 2015. At December 31,
2016, there were no brokered deposits, compared to $17.8 million of brokered deposits at December 31, 2015. 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.
At December 31, 2016, the Company had $94.1 million (at fair value) of securities pledged for $85.1 million in
certificates of deposits from the State of California. At December 31, 2015, the Company had $93.0 million (at fair value)
of securities pledged for $78.0 million in certificates of deposits from the State of California.
CDARS deposits were comprised of $2.5 million of interest-bearing demand deposits, $3.7 million of money
market accounts and $3.2 million of time deposits at December 31, 2016. CDARS deposits were comprised of $3.4 million
of money market accounts and $4.2 million of time deposits at December 31, 2015.
The following table indicates the contractual maturity schedule of the Company’s time deposits of $250,000 and
over, and all CDARS time deposits as of December 31, 2016:
Balance
% of Total
Three months or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Over three months through six months . . . . . . . . . . . . . . . . . . . . . . . . . . .
Over six months through twelve months . . . . . . . . . . . . . . . . . . . . . . . . . .
Over twelve months . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Dollars in thousands)
73,629
59,201
28,949
5,081
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 166,860
44 %
35 %
17 %
4 %
100 %
The Company focuses primarily on providing and servicing business deposit accounts that are frequently over
$250,000 in average balance per account. As a result, certain types of business clients that the Company serves typically
carry average deposits in excess of $250,000. The account activity for some account types and client types necessitates
appropriate liquidity management practices by the Company to ensure its ability to fund deposit withdrawals.
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Return on Equity and Assets
The following table indicates the ratios for return on average assets and average equity, and average equity to
average assets for the periods indicated:
Return on average assets . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on average tangible assets . . . . . . . . . . . . . . . . . . .
Return on average equity . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on average tangible equity . . . . . . . . . . . . . . . . . . .
Average equity to average assets ratio . . . . . . . . . . . . . . .
2016
1.13 %
1.15 %
10.71 %
13.55 %
10.54 %
2015
0.86 %
0.88 %
8.04 %
9.41 %
2014
0.88 %
0.88 %
7.44 %
7.60 %
10.73 % 11.85 %
Off-Balance Sheet Arrangements
In the normal course of business, the Company makes commitments to extend credit to its customers as long as
there are no violations of any conditions established in contractual arrangements. These commitments are obligations that
represent a potential credit risk to the Company, yet are not reflected in any form within the Company’s consolidated
balance sheets. Total unused commitments to extend credit were $596.5 million at December 31, 2016, as compared to
$573.7 million at December 31, 2015. Unused commitments represented 40% and 42% of outstanding gross loans at
December 31, 2016 and 2015, respectively.
The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of the
commitments to provide credit cannot be reasonably predicted, because there is no certainty that the lines of credit will
ever be fully utilized. For more information regarding the Company’s off-balance sheet arrangements, see Note 16 to the
consolidated financial statements located elsewhere herein.
The following table presents the Company’s commitments to extend credit for the periods indicated:
Unused lines of credit and commitments to
December 31, 2016
December 31, 2015
Fixed Rate Variable Rate Fixed Rate Variable Rate
(Dollars in thousands)
Standby letters of credit . . . . . . . . . . . . . . . .
make loans . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,556 $ 565,166 $ 16,917 $ 539,897
13,458
$ 19,477 $ 577,003 $ 20,319 $ 553,355
3,921
3,402
11,837
Contractual Obligations
The contractual obligations of the Company, summarized by type of obligation and contractual maturity, at
December 31, 2016, are as follows:
Less Than
One Year
One to
Three to
Three Years Five Years
After
Five Years
Total
(Dollars in thousands)
Deposits(1) . . . . . . . . . . . . . . . . . . . . . . $
Operating leases . . . . . . . . . . . . . . . . .
Other long-term liabilities(2) . . . . . . .
Total contractual obligations . . . . . $
2,251,398 $
3,000
1,133
2,255,531 $
10,292 $
4,938
3,108
18,338 $
450 $
1,241
3,266
4,957 $
— $ 2,262,140
9,179
—
9,712
17,219
9,712 $ 2,288,539
(1) Deposits with indeterminate maturities, such as demand, savings and money market accounts, are reflected as
obligations due in less than one year.
(2) Includes maximum payments related to employee benefit plans, assuming all future vesting conditions are met.
Additional information is provided in Note 14 to the consolidated financial statements.
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In addition to those obligations listed above, in the normal course of business, the Company will make cash
distributions for the payment of interest on interest-bearing deposit accounts and debt obligations, payments for quarterly
income tax estimates and contributions to certain employee benefit plans.
Liquidity and Asset/Liability Management
Liquidity refers to the Company’s ability to maintain cash flows sufficient to fund operations and to meet
obligations and other commitments in a timely and cost effective fashion. At various times the Company requires funds to
meet short-term cash requirements brought about by loan growth or deposit outflows, the purchase of assets, or liability
repayments. An integral part of the Company’s ability to manage its liquidity position appropriately is the Company’s
large base of core deposits, which are generated by offering traditional banking services in its service area and which have
historically been a stable source of funds. To manage liquidity needs properly, cash inflows must be timed to coincide
with anticipated outflows or sufficient liquidity resources must be available to meet varying demands. The Company
manages liquidity to be able to meet unexpected sudden changes in levels of its assets or deposit liabilities without
maintaining excessive amounts of balance sheet liquidity. Excess balance sheet liquidity can negatively impact the
Company’s interest margin. In order to meet short-term liquidity needs the Company may utilize overnight Federal funds
purchase arrangements and other borrowing arrangements with correspondent banks, solicit brokered deposits if cost
effective deposits are not available from local sources, and maintain collateralized lines of credit with the FHLB and FRB.
In addition, the Company can raise cash for temporary needs by selling securities under agreements to repurchase and
selling securities available-for-sale.
One of the measures of liquidity is our loan to deposit ratio. Our loan to deposit ratio was 66.42% at December
31, 2016, compared to 65.87% at December 31, 2015.
FHLB and FRB Borrowings and Available Lines of Credit
The Company has off-balance sheet liquidity in the form of Federal funds purchase arrangements with
correspondent banks, including the FHLB and FRB. The Company can borrow from the FHLB on a short-term (typically
overnight) or long-term (over one year) basis. The Company had no overnight borrowings from the FHLB at December
31, 2016 and December 31, 2015. The Company had $213.9 million of loans pledged to the FHLB as collateral on an
available line of credit of $172.5 million at December 31, 2016.
The Company can also borrow from FRB’s discount window. The Company had $496.4 million of loans pledged
to the Federal Reserve as collateral on an available line of credit of $312.1 million at December 31, 2016, none of which
was outstanding.
At December 31, 2016 and 2015, the Company had Federal funds purchase arrangements available of $55.0
million. There were no Federal funds purchased outstanding at December 31, 2016 or 2015.
The Company has a $5.0 million line of credit with a correspondent bank, of which none was outstanding at
December 31, 2016, and $3.0 million was outstanding at December 31, 2015.
The Company may also utilize securities sold under repurchase agreements to manage our liquidity position.
There were no securities sold under agreements to repurchase at December 31, 2016 or 2015.
The following table summarizes the Company’s borrowings under its Federal funds purchased, security
repurchase arrangements and lines of credit for the periods indicated:
December 31,
2016
2015
(Dollars in thousands)
2014
Average balance during the year . . . . . . . . . . . . . . .
Average interest rate during the year . . . . . . . . . . . .
Maximum month-end balance during the year . . . .
Average rate at December 31, . . . . . . . . . . . . . . . . . .
80
$
418
$
2.57 %
578
3.14 %
$ 3,953
3.06 %
$ 3,000
N/A
$ 3,000
$ 29,796
3.00 %
2.87 %
Capital Resources
The Company uses a variety of measures to evaluate capital adequacy. Management reviews various capital
measurements on a regular basis and takes appropriate action to ensure that such measurements are within established
internal and external guidelines. The external guidelines, which are issued by the Federal Reserve and the FDIC, establish
a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures.
The following table summarizes risk based capital, risk weighted assets, and risk based capital ratios of the
consolidated Company under the Basel III requirements as of December 31, 2016 and December 31, 2015, and under
Basel I as of December 31, 2014:
2016
December 31,
2015
(Dollars in thousands)
2014
Under Basel III
Under Basel I
Capital components:
Additional Tier 1 capital . . . . . . . . . . . . . . . .
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . . . .
Tier 2 Capital . . . . . . . . . . . . . . . . . . . . . . . . . .
Common equity Tier 1 capital . . . . . . . . . . . . . $ 214,924
—
214,924
19,705
Total risk-based capital . . . . . . . . . . . . . . . . . $ 234,629
$
$
181,222
18,077
199,299
19,616
218,915
N/A
N/A
169,278
16,790
186,068
$
Risk-weighted assets . . . . . . . . . . . . . . . . . . . . . . . $ 1,876,732
Average assets for capital purposes . . . . . . . . . . . $ 2,515,623
$ 1,750,515
$ 2,322,940
$ 1,341,094
$ 1,598,724
Capital ratios:
Total risk-based capital . . . . . . . . . . . . . . . . . .
Tier 1 risk-based capital . . . . . . . . . . . . . . . . . .
Common equity Tier 1 risk-based capital . . . .
Leverage(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.5 %
11.5 %
11.5 %
8.5 %
12.5 %
11.4 %
10.4 %
8.6 %
13.9 %
12.6 %
N/A
10.6 %
(1) Tier 1 capital divided by quarterly average assets (excluding intangible assets and disallowed deferred tax assets).
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The following table summarizes risk-based capital, risk-weighted assets, and risk-based capital ratios of HBC
under the Basel III requirements as of December 31, 2016 and December 2015, and under the Basel I requirements as of
December 31, 2014:
2016
December 31,
2015
(Dollars in thousands)
2014
Under Basel III
Under Basel I
Capital components:
Common equity Tier 1 capital . . . . . . . . . . . . . $
Additional Tier 1 capital . . . . . . . . . . . . . . . . .
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tier 2 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total risk-based capital . . . . . . . . . . . . . . . . . . $
211,364
—
211,364
19,705
231,069
$ 200,327
—
200,327
19,616
$ 219,943
N/A
N/A
158,976
16,789
$ 175,765
Risk-weighted assets . . . . . . . . . . . . . . . . . . . . . . . $ 1,876,024
Average assets for capital purposes . . . . . . . . . . . $ 2,514,922
$ 1,750,222
$ 2,322,232
$ 1,340,949
$ 1,599,173
Capital ratios:
Total risk-based capital . . . . . . . . . . . . . . . . . . .
Tier 1 risk-based capital . . . . . . . . . . . . . . . . . .
Common equity Tier 1 risk-based capital . . . .
Leverage(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.3 %
11.3 %
11.3 %
8.4 %
12.6 %
11.4 %
11.4 %
8.6 %
13.1 %
11.9 %
N/A
9.9 %
(1) Tier 1 capital divided by quarterly average assets (excluding intangible assets and disallowed deferred tax assets).
The following table presents the applicable well-capitalized regulatory guidelines and the standards for minimum
capital adequacy requirements under Basel III:
Under Basel III
Under Basel I
Transitional
Minimum
Regulatory
Fully Phased-in
Minimum
Regulatory
Requirement(1) Requirement(2)
Effective
Effective
January 1, 2016 January 1, 2019
Well-capitalized
Financial
Institution
Regulatory
Guidelines
Minimum
Regulatory
Requirements Requirements
Well-Capitalized
Regulatory
Capital ratios:
Total risk-based capital . . . . . . . .
Tier 1 risk-based capital . . . . . . . .
Common equity Tier 1 risk-based
capital . . . . . . . . . . . . . . . . . . . . . .
Leverage . . . . . . . . . . . . . . . . . . . .
8.625 %
6.625 %
5.125 %
4.000 %
10.5 %
8.5 %
7.0 %
4.0 %
10.00 %
8.00 %
6.50 %
5.00 %
8.00 %
4.00 %
N/A
4.00 %
10.00 %
6.00 %
N/A
5.00 %
(1) Includes 0.625% capital conservation buffer, except the leverage ratio.
(2) Includes 2.5% capital conservation buffer, except the leverage ratio.
The Basel III capital rules introduce a new “capital conservation buffer,” for banking organizations to maintain
a common equity Tier 1 ratio more than 2.5% above these minimum risk-weighted asset ratios. The capital conservation
buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity
Tier 1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on
dividends, equity repurchases and compensation based on the amount of the shortfall. The implementation of the capital
conservation buffer was phased in beginning on January 1, 2016 at 0.625% and will be phased in over a four-year period
(increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).
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The Company’s common equity Tier 1 risk-based capital ratio increased at December 31, 2016, compared to
December 31, 2015, primarily due to the exchange of the Company’s Series C convertible perpetual preferred stock, no
par value (“Series C Preferred Stock”) for 5,601,000 shares of the Company’s common stock during the third quarter of
2016, as discussed below. The exchange of the Company’s Series C Preferred Stock for common stock had no effect on
HBC’s common equity Tier 1 risk-based capital ratio. During the year ended December 31, 2016, HBC distributed
dividends totaling $18.0 million.
At December 31, 2016, the Company’s consolidated capital ratios exceeded regulatory guidelines and HBC’s
capital ratios exceed the highest regulatory capital requirement of “well-capitalized” under Basel III prompt corrective
action provisions. Quantitative measures established by regulation to help ensure capital adequacy require the Company
and HBC to maintain minimum amounts and ratios of total risk-based capital, Tier 1 capital, and common equity Tier 1
(as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined).
Management believes that, as of December 31, 2016, December 31, 2015, and December 31, 2014, the Company and HBC
met all capital adequacy guidelines to which they were subject. There are no conditions or events since December 31,
2016, that management believes have changed the categorization of the Company or HBC as well-capitalized.
At December 31, 2016, the Company had total shareholders’ equity of $259.8 million, compared to $245.4 million
at December 31, 2015. At December 31, 2016, total shareholders’ equity included $215.2 million in common stock, $52.5
million in retained earnings, and ($7.9) million of accumulated other comprehensive loss.
The accumulated other comprehensive loss was ($7.9) million at December 31, 2016, compared to ($6.2) million
at December 31, 2015. The unrealized loss on securities available-for-sale was ($1.2) million, net of taxes, at December
31, 2016, compared to an unrealized gain on securities available-for-sale of $296,000, net of taxes, at December 31, 2015.
The components of 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 $355,000; 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.
Series C Preferred Stock
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 Company’s 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. The exchange of the Series C Preferred Stock for common stock resulted in an increase in the
Company’s common equity Tier 1 risk based capital ratio at December 31, 2016, but had no effect on HBC’s common
equity Tier 1 risk based capital ratio or other regulatory capital ratios of the Company or HBC.
The book value per common share was $6.85 at December 31, 2016, compared to $7.03 at December 31, 2015.
The tangible book value per common share was $5.46 at December 31, 2016, compared to $5.35 at December 31, 2015.
On a full conversion of the Series C Preferred stock into common at December 31, 2015: (i) the book value per common
share would have been reduced to $6.51; and (ii) the tangible book value per common share would have been reduced to
$5.07.
Market Risk
Market risk is the risk of loss of future earnings, fair values, or future cash flows that may result from changes in
the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates,
foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market risk sensitive
instruments. Market risk is attributed to all market risk sensitive financial instruments, including securities, loans, deposits
and borrowings, as well as the Company’s role as a financial intermediary in customer-related transactions. The objective
of market risk management is to avoid excessive exposure of the Company’s earnings and equity to loss and to reduce the
volatility inherent in certain financial instruments.
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Interest Rate Management
Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The
Company’s market risk exposure is primarily that of interest rate risk, and it has established policies and procedures to
monitor and limit earnings and balance sheet exposure to changes in interest rates. The Company does not engage in the
trading of financial instruments, nor does the Company have exposure to currency exchange rates.
The principal objective of interest rate risk management (often referred to as “asset/liability management”) is to
manage the financial components of the Company in a manner that will optimize the risk/reward equation for earnings and
capital in relation to changing interest rates. The Company’s exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee. Interest rate risk is the potential of economic losses due to future interest rate changes. These
economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The
objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while
at the same time maximizing income. Management realizes certain risks are inherent, and that the goal is to identify and
manage the risks. Management uses two methodologies to manage interest rate risk: (i) a standard GAP analysis; and
(ii) an interest rate shock simulation model.
The planning of asset and liability maturities is an integral part of the management of an institution’s net interest
margin. To the extent maturities of assets and liabilities do not match in a changing interest rate environment, the net
interest margin may change over time. Even with perfectly matched repricing of assets and liabilities, risks remain in the
form of prepayment of loans or securities or in the form of delays in the adjustment of rates of interest applying to either
earning assets with floating rates or to interest bearing liabilities. The Company has generally been able to control its
exposure to changing interest rates by maintaining primarily floating interest rate loans and a majority of its time
certificates with relatively short maturities.
Interest rate changes do not affect all categories of assets and liabilities equally or at the same time. Varying
interest rate environments can create unexpected changes in prepayment levels of assets and liabilities, which may have a
significant effect on the net interest margin and are not reflected in the interest sensitivity analysis table. Because of these
factors, an interest sensitivity GAP report may not provide a complete assessment of the exposure to changes in interest
rates.
The Company uses modeling software for asset/liability management in order to simulate the effects of potential
interest rate changes on the Company’s net interest margin, and to calculate the estimated fair values of the Company’s
financial instruments under different interest rate scenarios. The program imports current balances, interest rates, maturity
dates and repricing information for individual financial instruments, and incorporates assumptions on the characteristics
of embedded options along with pricing and duration for new volumes to project the effects of a given interest rate change
on the Company’s interest income and interest expense. Rate scenarios consisting of key rate and yield curve projections
are run against the Company’s investment, loan, deposit and borrowed funds portfolios. These rate projections can be
shocked (an immediate and parallel change in all base rates, up or down) and ramped (an incremental increase or decrease
in rates over a specified time period), based on current trends and econometric models or stable economic conditions
(unchanged from current actual levels).
The following table sets forth the estimated changes in the Company’s annual net interest income that would
result from the designated instantaneous parallel shift in interest rates noted, as of December 31, 2016. Computations of
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prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of
market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
Increase/(Decrease) in
Estimated Net
Interest Income
Amount
Percent
(Dollars in thousands)
Change in Interest Rates (basis points)
+400 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
+300 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
+200 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
+100 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
$
23,995
18,559
12,621
6,373
—
(cid:237)100 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (10,270)
(cid:237)200 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (20,284)
0
25.6 %
19.8 %
13.5 %
6.8 %
— %
(10.9)%
(21.6)%
This data does not reflect any actions that we may undertake in response to changes in interest rates such as
changes in rates paid on certain deposit accounts based on local competitive factors, which could reduce the actual impact
on net interest income, if any.
As with any method of gauging interest rate risk, there are certain shortcomings inherent to the methodology
noted above. The model assumes interest rate changes are instantaneous parallel shifts in the yield curve. In reality, rate
changes are rarely instantaneous. The use of the simplifying assumption that short-term and long-term rates change by the
same degree may also misstate historic rate patterns, which rarely show parallel yield curve shifts. Further, the model
assumes that certain assets and liabilities of similar maturity or period to repricing will react in the same way to changes
in rates. In reality, certain types of financial instruments may react in advance of changes in market rates, while the reaction
of other types of financial instruments may lag behind the change in general market rates. Additionally, the methodology
noted above does not reflect the full impact of annual and lifetime restrictions on changes in rates for certain assets, such
as adjustable rate loans. When interest rates change, actual loan prepayments and actual early withdrawals from certificates
may deviate significantly from the assumptions used in the model. Finally, this methodology does not measure or reflect
the impact that higher rates may have on adjustable-rate loan borrowers’ ability to service their debt. All of these factors
are considered in monitoring the Company’s exposure to interest rate risk.
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ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a financial institution, the Company’s primary component of market risk is interest rate volatility. Fluctuations
in interest rates will ultimately impact both the level of income and expense recorded on most of the Company’s assets
and liabilities and the market value of all interest-earning assets, other than those which have a short term to maturity.
Based upon the nature of the Company’s operations, the Company is not subject to foreign exchange or commodity price
risk. The Company has no market risk sensitive instruments held for trading purposes. As of December 31, 2016, the
Company did not use interest rate derivatives to hedge its interest rate risk.
The information concerning quantitative and qualitative disclosure or market risk called for by Item 305 of
Regulation S-K is included as part of Item 7 of this report.
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and report of the Independent Registered Public Accounting Firm are set forth on
pages 90 through 140.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURES
None.
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ITEM 9A CONTROLS AND PROCEDURES
Disclosure Control and Procedures
The Company has carried out an evaluation, under the supervision and with the participation of the Company’s
management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the Company’s disclosure controls and procedures as of December 31, 2016. As defined in Rule 13a-15(e)
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), disclosure controls and procedures are
controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed or
submitted under the Exchange Act are recorded, processed, summarized and reported on a timely basis. Disclosure controls
are also designed to reasonably assure that such information is accumulated and communicated to our management,
including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. Based upon their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that
the Company’s disclosure controls were effective as of December 31, 2016, the period covered by this report.
Management’s Annual Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over
financial reporting. As defined in Rule 13a-15(f) under the Exchange Act, internal control over financial reporting is a
process designed by, or under the supervision of, a company’s principal executive and principal financial officers and
effected by a company’s board of directors, management and other personnel, to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. It includes those policies and procedures that:
• Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions
and dispositions of the assets of a company;
• Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures
of a company are being made only in accordance with authorizations of management and the board of
directors of the company; and
• Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or
disposition of a company’s assets that could have a material effect on its financial statements.
Because of the inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls
may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures
may deteriorate.
The Company’s management has used the criteria established in the 2013 Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) to evaluate
the effectiveness of the Company’s internal control over financial reporting. Management has selected the COSO
framework for its evaluation as it is a control framework recognized by the SEC and the Public Company Accounting
Oversight Board, that is free from bias, permits reasonably consistent qualitative and quantitative measurement of the
Company’s internal controls, is sufficiently complete so that relevant controls are not omitted and is relevant to an
evaluation of internal controls over financial reporting.
Based on our assessment, management has concluded that our internal control over financial reporting, based on
criteria established in the 2013 Internal Control — Integrated Framework issued by COSO was effective as of
December 31, 2016.
The independent registered public accounting firm of Crowe Horwath LLP, as auditors of our consolidated
financial statements, has issued an attestation report on the effectiveness of management’s internal control over financial
reporting based on criteria established in the 2013 “Internal Control — Integrated Framework,” issued by COSO.
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Inherent Limitations on Effectiveness of Controls
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect
that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and fraud. A
control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the
control system’s objectives will be met. The design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent
limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error
or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.
These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can
occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The design of any system of controls is based
in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls
effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with policies or procedures.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during the year ended
December 31, 2016 that has materially affected or is reasonably likely to materially affect our internal control over
financial reporting.
ITEM 9B OTHER INFORMATION
None.
ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
PART III
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Information required by this item will be contained in our Definitive Proxy Statement for our 2017 Annual
Meeting of Shareholders to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within
120 days of December 31, 2016. Such information is incorporated herein by reference.
24FEB201611503668
We have adopted a code of ethics that applies to our Chief Executive Officer, Chief Financial Officer, and to our
other principal financial officers. The code of ethics is available at the Governance Documents section of our website at
www.heritagecommercecorp.com. We intend to disclose future amendments to, or waivers from, certain provisions of our
code of ethics on the above website within four business days following the date of such amendment or waiver.
ITEM 11 EXECUTIVE COMPENSATION
Information required by this item will be contained in our Definitive Proxy Statement for our 2017 Annual
Meeting of Shareholders to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within
120 days of December 31, 2016. Such information is incorporated herein by reference.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information required by this item will be contained in our Definitive Proxy Statement for our 2017 Annual
Meeting of Shareholders to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120
days of December 31, 2016. Such information is incorporated herein by reference.
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ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information required by this item will be contained in our Definitive Proxy Statement for our 2017 Annual
Meeting of Shareholders to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120
days of December 31, 2016. Such information is incorporated herein by reference.
ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required by this item will be contained in our Definitive Proxy Statement for our 2017 Annual
Meeting of Shareholders to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120
days of December 31, 2016. Such information is incorporated herein by reference.
ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) FINANCIAL STATEMENTS
PART IV
The Financial Statements of the Company and the Report of Independent Registered Public Accounting Firm are
set forth on pages 90 through 140.
(a)(2) FINANCIAL STATEMENT SCHEDULES
All schedules to the Financial Statements are omitted because of the absence of the conditions under which they
are required or because the required information is included in the Financial Statements or accompanying notes.
(a)(3) EXHIBITS
The exhibit list required by this Item is incorporated by reference to the Exhibit Index included in this report.
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has
duly caused this report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized.
SIGNATURES
DATE: March 3, 2017
HERITAGE COMMERCE CORP
BY:
/s/ WALTER T. KACZMAERK
Walter T. Kaczmarek
Chief Executive Officer
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed below by the following persons on behalf of the registrant and in the capacities and on the date
indicated:
Signature
Title
Date
/s/ JULIANNE BIAGINI
Julianne Biagini
/s/ FRANK G. BISCEGLIA
Frank G. Bisceglia
/s/ JACK W. CONNER
Jack W. Conner
/s/ J. PHILLIP DINAPOLI
J. Phillip DiNapoli
/s/ STEVEN L. HALLGRIMSON
Steven L. Hallgrimson
Director
Director
March 3, 2017
March 3, 2017
Director and Chairman of the Board
March 3, 2017
Director
Director
March 3, 2017
March 3, 2017
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/s/ WALTER T. KACZMAREK
Walter T. Kaczmarek
Director and Chief Executive Officer and President
(Principal Executive Officer)
March 3, 2017
24FEB201611503668
/s/ LAWRENCE D. MCGOVERN
Lawrence D. McGovern
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
March 3, 2017
/s/ ROBERT T. MOLES
Robert T. Moles
/s/ LAURA RODEN
Laura Roden
/s/ RANSON W. WEBSTER
Ranson W. Webster
Director
Director
Director
March 3, 2017
March 3, 2017
March 3, 2017
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HERITAGE COMMERCE CORP
INDEX TO FINANCIAL STATEMENTS
DECEMBER 31, 2016
Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Balance Sheets as of December 31, 2016 and 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014 . . . . . . . . . . . . . . . . . .
Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014 . . . .
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2016, 2015
Page
91
92
93
94
and 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014 . . . . . . . . . . . . . .
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Heritage Commerce Corp
San Jose, California
We have audited the accompanying consolidated balance sheets of Heritage Commerce Corp (the “Company”)
as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes
in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. We also
have audited Heritage Commerce Corp’s internal control over financial reporting as of December 31, 2016, based on
criteria established in the 2013 Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Heritage Commerce Corp’s management is responsible for these
consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment
of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual
Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated
financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement and whether effective internal control over financial reporting
was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control
over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based
on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls
may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures
may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
financial position of Heritage Commerce Corp as of December 31, 2016 and 2015, and the results of its operations and its
cash flows for each of the years in the three-year period ended December 31, 2016 in conformity with accounting principles
generally accepted in the United States of America. Also in our opinion, Heritage Commerce Corp maintained, in all
material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established
in the 2013 Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission.
Sacramento, California
March 3, 2017
/s/ Crowe Horwath LLP
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HERITAGE COMMERCE CORP
CONSOLIDATED BALANCE SHEETS
December 31,
December 31,
2016
2015
(Dollars in thousands)
Assets
Cash and due from banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Other investments and interest-bearing deposits in other financial institutions . . . . . . . .
Total cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Securities available-for-sale, at fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Securities held-to-maturity, at amortized cost (fair value of $318,748 at
27,993 $
238,110
266,103
306,589
24,112
319,980
344,092
385,079
December 31, 2016 and $109,821 at December 31, 2015) . . . . . . . . . . . . . . . . . . . . . . .
Loans held-for-sale - SBA, at lower of cost or fair value, including deferred costs . . . . .
Loans, net of deferred fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
324,010
5,705
1,502,607
(19,089)
1,483,518
109,311
7,297
1,358,716
(18,926)
1,339,790
Federal Home Loan Bank and Federal Reserve Bank stock and other investments, at
cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Company-owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Premises and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest receivable and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12,694
60,021
7,773
45,664
8,518
41,340
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,570,880 $ 2,361,579
15,196
59,148
7,490
45,664
6,950
50,507
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Demand, noninterest-bearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Demand, interest-bearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Savings and money market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Time deposits-under $250 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Time deposits-$250 and over . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Time deposits-brokered . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
CDARS - interest-bearing demand, money market and time deposits . . . . . . . . . .
Total deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest payable and other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
917,187 $
541,282
572,743
57,857
163,670
—
9,401
2,262,140
—
48,890
2,311,030
821,405
496,278
496,843
62,026
160,815
17,825
7,583
2,062,775
3,000
50,368
2,116,143
Commitments and contingencies (Notes 7 and 16)
Shareholders' equity:
Preferred stock, no par value; 10,000,000 shares authorized
Series C convertible perpetual preferred stock, 21,004 shares issued and
outstanding at December 31, 2015 (liquidation preference of $21,004 at
December 31, 2015) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Common stock, no par value; 60,000,000 shares authorized; 37,941,007 shares
—
19,519
issued and outstanding at December 31, 2016 and 32,113,479 shares issued and
outstanding at December 31, 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
193,364
38,773
(6,220)
245,436
Total liabilities and shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,570,880 $ 2,361,579
215,237
52,527
(7,914)
259,850
See notes to consolidated financial statements
92
HERITAGE COMMERCE CORP
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31,
2015
(Dollars in thousands, except per share data)
2014
2016
Interest income:
Loans, including fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 79,284 $ 68,259 $ 49,207
7,117
Securities, taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,432
2,025
2,290
Securities, exempt from Federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
907
2,425
Other investments and interest-bearing deposits in other financial institutions .
59,256
Total interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94,431
6,707
2,183
1,594
78,743
Interest expense:
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,199
12
3,211
2,403
19
2,422
2,032
121
2,153
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income before provision for loan losses . . . . . . . . . . . . . . . . . . . 91,220
1,237
Net interest income after provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . 89,983
76,321
32
76,289
57,103
(338)
57,441
Noninterest income:
Service charges and fees on deposit accounts . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in cash surrender value of life insurance . . . . . . . . . . . . . . . . . . . . . . . .
Servicing income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gain on proceeds from company-owned life insurance . . . . . . . . . . . . . . . . . . .
Gain on sales of securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gain on sales of SBA loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,116
1,747
1,398
1,119
1,099
796
2,350
Total noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,625
2,803
1,697
1,143
—
642
843
1,857
8,985
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2,519
1,600
1,296
—
97
971
1,263
7,746
Noninterest expense:
24FEB201611503668
Salaries and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34,660
4,378
Occupancy and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,471
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,130
Total noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57,639
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43,969
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,588
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,381
(1,512)
25,869
(1,278)
26,250
4,053
1,891
12,028
44,222
20,965
7,538
13,427
Dividends on preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1,008)
Net income available to common shareholders . . . . . . . . . . . . . . . . . . . . . . . . . .
12,419
(1,342)
Undistributed earnings allocated to Series C preferred stock. . . . . . . . . . . . . . . . . .
Distributed and undistributed earnings allocated to common shareholders . . . . . . $ 24,591 $ 13,793 $ 11,077
35,146
4,300
1,828
17,399
58,673
26,601
10,104
16,497
(1,792)
14,705
(912)
Earnings per common share:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
0.72 $
0.72 $
0.48 $
0.48 $
0.42
0.42
See notes to consolidated financial statements
93
HERITAGE COMMERCE CORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Other comprehensive income (loss):
Change in net unrealized holding gains (losses) on available-for-sale
Year Ended December 31,
2016
2015
2014
27,381 $
(Dollars in thousands)
16,497 $
13,427
securities and I/O strips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1,711)
719
(3,809)
1,605
7,164
(3,012)
Change in net unamortized unrealized gain on securities available-for-
sale that were reclassified to securities held-to-maturity . . . . . . . . . . . . .
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reclassification adjustment for gains realized in income . . . . . . . . . . . . . .
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in unrealized gains (losses) on securities and I/O strips, net of
(116)
49
(1,099)
461
(55)
23
(642)
270
(54)
23
(97)
41
deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1,697)
(2,608)
4,065
Change in net pension and other benefit plan liability adjustment . . . . . . .
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6
(3)
(3,036)
1,275
Change in pension and other benefit plan liability, net of deferred
income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
3
(1,694)
25,687 $
(1,761)
(4,369)
12,128 $
(3,253)
1,366
(1,887)
2,178
15,605
See notes to consolidated financial statements
94
HERITAGE COMMERCE CORP
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Year Ended December 31, 2016, 2015, and 2014
Preferred Stock
Shares Amount
Common Stock
Shares
Amount
Accumulated
Other
Retained Comprehensive Shareholders’
Earnings Income / (Loss)
Equity
Total
Balance, January 1, 2014. . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . .
Other comprehensive income . . . . . .
Issuance of restricted stock awards,
net . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of restricted stock awards,
net of forfeitures and taxes . . . . . . .
Cash dividend declared $0.18 per
21,004 $ 19,519 26,350,938 $ 132,561 $ 25,345 $
— 13,427
—
—
—
—
—
—
—
—
(Dollars in thousands)
—
—
90,000
—
—
—
—
—
(9)
—
(4,029) $
—
2,178
173,396
13,427
2,178
—
—
—
(9)
share . . . . . . . . . . . . . . . . . . . . . . . .
—
—
—
—
(5,758)
—
(5,758)
Stock option expense, net of
fortfeitures and taxes . . . . . . . . . . .
Stock options exercised . . . . . . . . . . .
Balance, December 31, 2014 . . . . . .
Net income . . . . . . . . . . . . . . . . . . . .
Other comprehensive loss . . . . . . . . .
Issuance of 5,456,713 common shares
to acquire Focus Business Bank, net
of offering costs of $144 . . . . . . . . .
Issuance of restricted stock awards,
net . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of restricted stock awards,
net of forfeitures and taxes . . . . . . .
Cash dividend declared $0.32 per
—
—
—
—
—
62,567
862
262
—
—
21,004 19,519 26,503,505 133,676 33,014
—
—
—
—
—
—
— 16,497
—
—
—
—
(1,851)
—
(4,369)
862
262
184,358
16,497
(4,369)
—
—
5,456,713
58,134
—
—
58,134
—
—
98,855
—
—
—
—
—
—
—
265
—
—
265
share . . . . . . . . . . . . . . . . . . . . . . . .
—
—
—
— (10,738)
—
(10,738)
—
—
(6,220)
—
(1,694)
974
315
245,436
27,381
(1,694)
—
—
—
—
Stock option expense, net of
fortfeitures and taxes . . . . . . . . . . .
Stock options exercised . . . . . . . . . . .
Balance, December 31, 2015 . . . . . .
Net income . . . . . . . . . . . . . . . . . . . .
Other comprehensive loss . . . . . . . . .
Preferred stock exchanged for
—
—
—
—
—
54,406
21,004
19,519 32,113,479
974
315
—
—
193,364 38,773
— 27,381
—
—
—
—
—
—
—
—
common stock . . . . . . . . . . . . . . . .
(21,004) (19,519)
5,601,000
19,519
—
Issuance of restricted stock awards,
net . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of restricted stock awards,
net of forfeitures and taxes . . . . . . .
Cash dividend declared $0.36 per
—
—
79,112
—
—
—
—
—
479
—
—
479
share . . . . . . . . . . . . . . . . . . . . . . . .
—
—
—
— (13,627)
—
(13,627)
Stock option expense, net of
forfeitures and taxes . . . . . . . . . . . .
Stock options exercised . . . . . . . . . . .
Balance, December 31, 2016 . . . . . .
—
—
— $
—
147,416
—
—
—
—
— 37,941,007 $ 215,237 $ 52,527 $
937
938
—
—
(7,914) $
937
938
259,850
See notes to consolidated financial statements
95
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24FEB201611503668
HERITAGE COMMERCE CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of discounts and premiums on securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gain on sale of securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gain on sale of SBA loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from sale of SBA loans originated for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net change in SBA loans originated for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in cash surrender value of life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gain on proceeds from company owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Gains on sale of foreclosed assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock option expense, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of restricted stock awards, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of changes in:
2016
Year Ended December 31,
2015
(Dollars in thousands)
2014
27,381 $
16,497 $
13,427
4,265
(1,099)
(796)
11,371
(14,434)
1,237
(1,747)
(1,119)
763
1,568
—
937
479
1,384
(642)
(843)
11,497
(14,906)
32
(1,697)
—
685
1,043
(106)
974
265
16,274
(1,963)
28,494
1,163
(97)
(971)
15,858
(12,911)
(338)
(1,600)
(51)
725
510
—
862
(9)
(2,428)
5,244
19,384
Accrued interest receivable and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest payable and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1,238)
(1,669)
25,899
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(75,803)
Purchase of securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (239,441)
67,562
Maturities/paydowns/calls of securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
23,415
Maturities/paydowns/calls of securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from sales of securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
75,689
Net change in loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (139,792)
(2,502)
Changes in Federal Home Loan Bank stock and other investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(480)
Purchase of premises and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
49
Proceeds from sale of foreclosed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,739
Proceeds from company owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
Cash paid in bank acquisition, net of cash received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (287,564)
(232,644)
(9,482)
31,195
3,931
71,832
(97,898)
(1,788)
(1,007)
1,571
—
165,786
(68,504)
(53,292)
(4,595)
24,917
3,899
108,603
(131,648)
(163)
(817)
—
406
(21,918)
(74,608)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercise of stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Offering costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repayment of short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Payment of cash dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (decrease) increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
102,165
262
—
—
(31,647)
(5,758)
65,022
9,798
112,605
Cash and cash equivalents, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 266,103 $ 344,092 $ 122,403
269,266
315
(144)
3,000
—
(10,738)
261,699
221,689
122,403
199,365
938
—
(3,000)
—
(13,627)
183,676
(77,989)
344,092
Supplemental disclosures of cash flow information:
Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Income taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,214 $
16,530
2,427 $
6,904
2,166
4,280
Supplemental schedule of non-cash investing activity:
Due from broker for securities sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Transfer of loans held-for-sale to loan portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans transferred to foreclosed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Summary of assets acquired and liabilities assumed through acquisition:
Cash and cash equivalents, net of cash paid for acquisition. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Securities avaiable-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans held-for-sale - SBA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Company owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Premises and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill and other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Common stock issued to acquire Focus Business Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6,693 $
5,451
278
— $
2,543
1,236
—
—
229
—
—
—
—
—
—
—
—
—
—
—
—
—
165,786
53,940
8,665
4,416
170,353
7,067
—
38,905
20,250
(405,123)
—
(5,981)
58,278
—
—
—
—
42,300
—
119
15,303
738
—
(31,647)
(4,895)
—
See notes to consolidated financial statements
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HERITAGE COMMERCE CORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1) Summary of Significant Accounting Policies
Description of Business and Basis of Presentation
Heritage Commerce Corp (“HCC”) operates as a registered bank holding company for its wholly-owned
subsidiary Heritage Bank of Commerce (“HBC” or the “Bank”), collectively referred to as the “Company”. HBC was
incorporated on November 23, 1993 and commenced operations on June 8, 1994. HBC is a California state chartered bank
which offers a full range of commercial and personal banking services to residents and the business/professional
community in Santa Clara, Alameda, and Contra Costa counties, California.
The Company acquired BVF/CSNK Acquisition Corp., a Delaware corporation (“BVF/CSNK”) on November 1,
2014, the parent company of CSNK Working Capital Finance Corp. dba Bay View Funding (“Bay View Funding”).
BVF/CSNK was subsequently merged into Bay View Funding and Bay View Funding became a wholly owned subsidiary
of HBC.
The Company acquired Focus Business Bank (“Focus”) on August 20, 2015. Focus was merged with HBC, with
HBC as the surviving bank. Focus’s results of operations have been included in the Company’s results of operations
beginning August 21, 2015.
The consolidated financial statements are prepared in accordance with accounting policies generally accepted in
the United States of America and general practices in the banking industry. The financial statements include the accounts
of the Company. All inter-company accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, amounts held at the Federal Reserve
Bank, and Federal funds sold. The Company is required to maintain reserves against certain of the deposit accounts with
the Federal Reserve Bank. Federal funds are generally sold and purchased for one-day periods.
Cash Flows
Net cash flows are reported for customer loan and deposit transactions, notes payable, repurchase agreements and
other short-term borrowings.
Securities
The Company classifies its securities as either available-for-sale or held-to-maturity at the time of purchase. Debt
securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and
ability to hold them to maturity. Debt securities not classified as held-to-maturity are classified as available-for-sale.
Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in other
comprehensive income, net of taxes.
A decline in the fair value of any available-for-sale or held-to-maturity security below amortized cost that is
deemed other than temporary results in a charge to earnings and the corresponding establishment of a new cost basis for
the security. In estimating other-than-temporary losses, management considers (1) the length of time and extent that fair
value has been less than cost, (2) the financial condition and near -term prospects of the issuer, (3) whether the fair value
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decline was affected by macroeconomic conditions, and (4) whether the Company has the intention to sell the security or
more likely than not will be required to sell the security before any anticipated recovery in fair value.
Interest income includes amortization of purchase premiums or discounts. Premiums and discounts are amortized,
or accreted, over the life of the related security as an adjustment to income using a method that approximates the interest
method. Realized gains and losses are recorded on the trade date and determined using the specific identification method
for the cost of securities sold.
Loan Sales and Servicing
The Company holds for sale the conditionally guaranteed portion of certain loans guaranteed by the Small
Business Administration or the U.S. Department of Agriculture (collectively referred to as “SBA loans”). These loans are
carried at the lower of aggregate cost or fair value. Net unrealized losses, if any, are recorded as a valuation allowance and
charged to earnings.
Gains or losses on SBA loans held-for-sale are recognized upon completion of the sale, based on the difference
between the selling price and the carrying value of the related loan sold.
SBA loans are sold with servicing retained. Servicing assets recognized separately upon the sale of SBA loans
consist of servicing rights and, for loans sold prior to 2009, interest-only strip receivables (“I/O strips”). The Company
accounts for the sale and servicing of SBA loans based on the financial and servicing assets it controls and liabilities it has
incurred, reversing recognition of financial assets when control has been surrendered, and reversing recognition of
liabilities when extinguished. Servicing rights are initially recorded at fair value with the income statement effect recorded
in gains on sale of loans. Servicing rights are amortized in proportion to and over the period of net servicing income and
are assessed for impairment on an ongoing basis. Impairment is determined by stratifying the servicing rights based on
interest rates and terms. Any servicing assets in excess of the contractually specified servicing fees are reclassified at fair
value as an I/O strip receivable and treated like an available for sale security. Fair value is determined using prices for
similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based
assumptions. Impairment is recognized through a valuation allowance. The servicing rights, net of any required valuation
allowance, and I/O strip receivable are included in other assets on the consolidated balance sheets.
Servicing income, net of amortization of servicing rights, is recognized as noninterest income. The initial fair
value of I/O strip receivables is amortized against interest income on loans.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are
stated at the principal amount outstanding, net of deferred loan origination fees and costs on originated loans, or
unamortized premiums or discounts on purchased or acquired loans, and an allowance for loan losses. The majority of the
Company’s loans have variable interest rates. Interest on loans is accrued on the unpaid principal balance and is credited
to income using the effective yield interest method. Interest on purchased or acquired loans and the accretion
(amortization) of the related purchase discount (premium) is also credited to income using the effective yield interest
method.
A loan portfolio segment is defined as the level at which the Company uses a systematic methodology to
determine the allowance for loan losses. A loan portfolio class is defined as a group of loans having similar risk
characteristics and methods for monitoring and assessing risk.
For all loan classes, when a loan is classified as nonaccrual, the accrual of interest is discontinued, any accrued
and unpaid interest is reversed, and the amortization of deferred loan fees and costs is discontinued. For all loan classes,
loans are classified as nonaccrual when the payment of principal or interest is 90 days past due, unless the loan is well
secured and in the process of collection. Nonaccrual loans and loans past due 90 days still on accrual include both smaller
balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. In
certain circumstances, loans that are under 90 days past due may also be classified as nonaccrual. Any interest or principal
payments received on nonaccrual loans are applied toward reduction of principal. Nonaccrual loans generally are not
returned to performing status until the obligation is brought current, the loan has performed in accordance with the contract
98
terms for a reasonable period of time, and the ultimate collectability of the contractual principal and interest is no longer
in doubt.
Non-refundable loan fees and direct origination costs are deferred and recognized over the expected lives of the
related loans using the effective yield interest method.
Acquired Loans
Loans acquired through purchase or through a business combination are recorded at their fair value at the
acquisition date. Credit discounts or premiums are included in the determination of fair value; therefore, an allowance for
loan losses is not recorded at the acquisition date. Should the Company's allowance for loan losses methodology indicate
that the credit discount associated with acquired, non-purchased credit impaired loans, is no longer sufficient to cover
probable losses inherent in those loans, the Company will establish an allowance for those loans through a charge to
provision for loan losses. Acquired loans are evaluated upon acquisition for evidence of deterioration in credit quality
since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required
payments. Such loans are classified as purchased credit impaired loans ("PCI loans"), while all other acquired loans are
classified as non-PCI loans.
The Company has elected to account for PCI loans on an individual loan level. The Company estimates the
amount and timing of expected cash flows for each loan. The expected cash flow in excess of the loan's carrying value,
which is fair value on the date of acquisition, is referred to as the accretable yield, and is recorded as interest income over
the remaining expected life of the loan. The excess of the loan's contractual principal and interest over expected cash flows
is referred to as the non-accretable difference, and is not recorded in the Company's Consolidated Financial Statements.
Quarterly, management performs an evaluation of expected future cash flows for PCI loans. If current
expectations of future cash flows are less than management's previous expectations, other than due to decreases in interest
rates and prepayment assumptions, an allowance for loan losses is recorded with a charge to current period earnings
through provision for loan losses. If there has been a probable and significant increase in expected future cash flows over
that which was previously expected, the Company would first reduce any previously established allowance for loan and
lease losses, and then record an adjustment to interest income through a prospective increase in the accretable yield.
Allowance for Loan Losses
The allowance for loan losses is an estimate of probable incurred losses in the loan portfolio. Loans are
charged-off against the allowance when management believes the uncollectibility of a loan balance is confirmed.
Subsequent recoveries, if any, are credited to the allowance for loan losses. Management’s methodology for estimating
the allowance balance consists of several key elements, which include specific allowances on individual impaired loans
and the formula driven allowances on pools of loans with similar risk characteristics. Allocations of the allowance may be
made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be
charged off.
Specific allowances are established for impaired loans. Management considers a loan to be impaired when it is
probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan
agreement, including scheduled interest payments. Loans for which the terms have been modified with a concession
granted, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and
classified as impaired. When a loan is considered to be impaired, the amount of impairment is measured based on the fair
value of the collateral, less costs to sell, if the loan is collateral dependent, or on the present value of expected future cash
flows or values that are observable in the secondary market if the loan is not collateral dependent. The amount of any
impairment will be charged off against the allowance for loan losses if the amount is a confirmed loss or, alternatively, a
specific allocation within the allowance will be established. Loans that are considered impaired are specifically excluded
from the formula portion of the allowance for loan losses analysis.
The formula driven allowance on pools of loans covers all loans that are not impaired and is based on historical
losses of each loan segment adjusted for current factors. In calculating the historical component of our allowance, we
aggregate our loans into one of three loan segments: Commercial, Real Estate and Consumer. Each segment of loans in
the portfolio possess varying degrees of risk, based on, among other things, the type of loan being made, the purpose of
the loan, the type of collateral securing the loan, and the sensitivity the borrower has to changes in certain external factors
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such as economic conditions. The following provides a summary of the risks associated with various segments of the
Company’s loan portfolio, which are factors management regularly considers when evaluating the adequacy of the
allowance:
• Commercial loans consist primarily of commercial and industrial (“C&I”) loans (business lines of credit),
and other commercial purpose loans. Repayment of commercial and industrial loans is generally provided
from the cash flows of the related business to which the loan was made. Adverse changes in economic
conditions may result in a decline in business activity, which may impact a borrower’s ability to continue to
make scheduled payments. The factored receivables at Bay View Funding are included in the Company’s
commercial loan portfolio; however, they are evaluated for risk primarily based on the agings of the
receivables. Faster turning receivables imply less risk and therefore warrant a lower associated allowance.
Should the overall aging for the portfolio increase, this structure will by formula increase the allowance to
reflect the increasing risk. Should the portfolio turn more quickly, it would reduce the associated allowance
to reflect the reducing risk.
• Real estate loans consist primarily of loans secured by commercial real estate (“CRE”) and residential real
estate. Also included in this segment are land and construction loans and home equity lines of credit secured
by real estate. As the majority of this segment is comprised of commercial real estate loans, risks associated
with this segment lay primarily within these loan types. Adverse economic conditions may result in a decline
in business activity and increased vacancy rates for commercial properties. These factors, in conjunction with
a decline in real estate prices, may expose the Company to the potential for losses if a borrower cannot
continue to service the loan with operating revenues, and the value of the property has declined to a level
such that it no longer fully covers the Company’s recorded investment in the loan.
• Consumer loans consist primarily of a large number of small loans and lines of credit. The majority of
installment loans are made for consumer and business purchases. Weakened economic conditions may result
in an increased level of delinquencies within this segment, as economic pressures may impact the capacity
of such borrowers to repay their obligations.
As a result of the matters mentioned above, changes in the financial condition of individual borrowers, economic
conditions, historical loss experience and the condition of the various markets in which collateral may be sold may all
affect the required level of the allowance for loan losses and the associated provision for loan losses.
The estimated loss factors for pools of loans that are not impaired are based on determining the probability of
default and loss given default for loans within each segment of the portfolio, adjusted for significant factors that, in
management’s judgment, affect collectibility as of the evaluation date. The Company’s historical delinquency experience
and loss experience are utilized to determine the probability of default and loss given default for segments of the portfolio
where the Company has experienced losses in the past. For segments of the portfolio where the Company has no significant
prior loss experience, the Company uses quantifiable observable industry data to determine the probability of default and
loss given default. Risk factors impacting loans in each of the portfolio segments include broad deterioration of property
values, reduced consumer and business spending as a result of continued high unemployment and reduced credit
availability and lack of confidence in a sustainable recovery. The historical loss experience is adjusted for management’s
estimate of the impact of other factors based on the risks present for each portfolio segment. These other factors include
consideration of the following: the overall level of concentrations and trends of classified loans; loan concentrations within
a portfolio segment or division of a portfolio segment; identification of certain loan types with higher risk than other loans;
existing internal risk factors; and management’s evaluation of the impact of local and national economic conditions on
each of our loan types.
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and
commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the
exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when
they are funded.
100
Federal Home Loan Bank and Federal Reserve Bank Stock
As a member of the Federal Home Loan Bank (“FHLB”) system, the Bank is required to own common stock in
the FHLB based on the Bank’s level of borrowings and outstanding FHLB advances. FHLB stock is carried at cost and
classified as a restricted security. Both cash and stock dividends are reported as income.
As a member of the Federal Reserve Bank (“FRB”) of San Francisco, the Bank is required to own stock in the
FRB of San Francisco based on a specified ratio relative to our capital. FRB stock is carried at cost and may be sold back
to the FRB at its carrying value. Cash dividends received are reported as income.
Company-Owned Life Insurance and Split-Dollar Life Insurance Benefit Plan
The Company has purchased life insurance policies on certain directors and officers. Company-owned life
insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the
cash surrender value adjusted for other charges or other amounts due that are probable at settlement. The purchased
insurance is subject to split-dollar insurance agreements with the insured participants, which continues after the
participant’s employment and retirement.
Accounting guidance requires that a liability be recorded primarily over the participant’s service period when a
split-dollar life insurance agreement continues after a participant’s employment or retirement. The required accrued
liability is based on either the post-employment benefit cost for the continuing life insurance or the future death benefit
depending on the contractual terms of the underlying agreement.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost. Depreciation and amortization are computed
on the straight-line basis over the lesser of the respective lease terms or estimated useful lives. The Company owns one
building which is being depreciated over 40 years. Furniture, equipment, and leasehold improvements are depreciated over
estimated useful lives generally ranging from five to fifteen years. The Company evaluates the recoverability of long-lived
assets on an ongoing basis.
Business Combinations
The Company accounts for acquisitions of businesses using the acquisition method of accounting. Under the
acquisition method, assets acquired and liabilities assumed are recorded at their estimated fair values at the date of
acquisition. Management utilizes various valuation techniques including discounted cash flow analyses to determine these
fair values. Any excess of the purchase price over amounts allocated to the acquired assets, including identifiable intangible
assets, and liabilities assumed is recorded as goodwill.
Goodwill and Other Intangible Assets
Goodwill resulted from the acquisition of Bay View Funding on November 1, 2014 and Focus on August 20,
2015. Goodwill represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities
and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is
recognized in the period identified.
Other intangible assets consist of core deposit intangible assets arising from the Diablo Valley Bank acquisition
in June 2007, a core deposit intangible asset from the Focus acquisition in August 2015, and a below market value lease,
customer relationship and non-compete agreement intangible assets arising from the Bay View Funding acquisition in
November 2014. They are initially measured at fair value and then are amortized over their estimated useful lives. The
core deposits intangible assets from the acquisitions of Diablo Valley Bank and Focus are being amortized on an
accelerated method over ten years. The below market value lease, customer relationship and non-compete agreement
intangible assets from the acquisition of Bay View Funding are being amortized on the straight-line method over three,
ten, and three years, respectively.
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Foreclosed Assets
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when
acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded
through operations. Operating costs after acquisition are expensed. Gains and losses on disposition are included in
noninterest expense.
The carrying value of foreclosed assets was $229,000 and $364,000 at December 31, 2016 and 2015, respectively,
and is included in other assets on the consolidated balance sheets.
Retirement Plans
Expenses for the Company’s non-qualified, unfunded defined benefits plan consists of service and interest cost
and amortization of gains and losses not immediately recognized. Employee 401(k) and profit sharing plan expense is the
amount of matching contributions. Deferred compensation and supplemental retirement plan expense allocates the benefits
over years of service.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as
liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. The
Company’s accounting policy for legal costs related to loss contingencies is to accrue for the probable fees that can be
reasonably estimated. The Company’s accounting policy for uncertain recoveries is to recognize the anticipated recovery
when realization is deemed probable.
Income Taxes
The Company files consolidated Federal and combined state income tax returns. Income tax expense is the total
of the current year income tax payable or refunded, the change in deferred tax assets and liabilities, and low income housing
investment losses, net of tax benefits received. Some items of income and expense are recognized in different years for
tax purposes when applying generally accepted accounting principles, leading to timing differences between the
Company’s actual tax liability and the amount accrued for this liability based on book income. These temporary differences
comprise the “deferred” portion of the Company’s tax expense or benefit, which is accumulated on the Company’s books
as a deferred tax asset or deferred tax liability until such time as they reverse.
Realization of the Company’s deferred tax assets is primarily dependent upon the Company generating sufficient
taxable income to obtain benefit from the reversal of net deductible temporary differences and utilization of tax credit
carryforwards for Federal and California state income tax purposes. The amount of deferred tax assets considered
realizable is subject to adjustment in future periods based on estimates of future taxable income. Under generally accepted
accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax
asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent
upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future
income, cumulative losses, applicable tax planning strategies, and assessments of current and future economic and business
conditions.
The Company had net deferred tax assets of $25,058,000 and $22,218,000 at December 31, 2016, and
December 31, 2015, respectively. After consideration of the matters in the preceding paragraph, the Company determined
that it is more likely than not that the net deferred tax asset at December 31, 2016 and 2015 will be fully realized in future
years.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained
in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax
benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely
than not” test, no tax benefit is recorded. The Company recognizes interest and penalties related to uncertain tax positions
as income tax expense.
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Stock-Based Compensation
Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the
fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options,
while the market price of the Company’s common stock at the date of grant is used for restricted stock awards.
Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with
graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire
award. Compensation cost recognized reflects estimated forfeitures, adjusted as necessary for actual forfeitures.
Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other
comprehensive income (loss) refers to gains and losses that are included in comprehensive income (loss) but are excluded
from net income (loss) because they have been recorded directly in equity under the provisions of certain accounting
guidance. 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 the liabilities related to the
Company’s defined benefit pension plan and the split-dollar life insurance benefit plan. Reclassification adjustments result
from gains or losses on securities that were realized and included in net income (loss) of the current period that also had
been included in other comprehensive income as unrealized holding gains and losses.
Segment Reporting
HBC is a commercial bank serving customers located in Santa Clara, Alameda, Contra Costa, and San Benito
counties of California. Bay View Funding provides business essential working capital factoring financing to various
industries throughout the United States. No customer accounts for more than 10 percent of revenue for HBC or the
Company. With the acquisition of Bay View Funding, the Company now has two reportable segments consisting of
Banking and Factoring.
Reclassifications
Certain items in the consolidated financial statements for the years ended December 31, 2015 and 2014 were
reclassified to conform to the 2016 presentation. These reclassifications did not affect previously reported net income or
shareholders equity.
Newly Issued, but not yet Effective Accounting Standards
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update
(“ASU”) No. 2014-09, Revenue from Contracts with Customers, which was an update to the guidance for accounting for
revenue from contracts with customers. The guidance in this update affects any entity that either enters into contracts with
customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts
are within the scope of other standards (for example, insurance contracts or lease contracts). The core principle of the
guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an
amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to
enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows
arising from contracts with customers. Qualitative and quantitative information is required about contracts with customers,
significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. The
amendments in this update become effective for annual periods and interim periods within those annual periods beginning
after December 15, 2017. We are currently evaluating the impact of adopting the new guidance on the consolidated
financial statements. Our preliminary finding is that the new pronouncement will not have a significant impact on the
consolidated financial statements.
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Recognition and Measurement
of Financial Assets and Liabilities. The new guidance is intended to improve the recognition and measurement of
financial instruments by requiring: equity investments (other than equity method or consolidation) to be measured at fair
value with changes in fair value recognized in net income; public business entities to use the exit price notion when
measuring the fair value of financial instruments for disclosure purposes; separate presentation of financial assets and
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financial liabilities by measurement category and form of financial assets (i.e. securities or loans and receivables) on the
balance sheet or the accompanying notes to the financial statements; eliminating the requirement to disclose the fair value
of financial instruments measured at amortized cost for organizations that are not public business entities; eliminating the
requirement for non-public business entities to disclose the method(s) and significant assumptions used to estimate the fair
value that is to be required to be disclosed for financial instruments measured at amortized cost on the balance sheet; and
requiring a reporting organization to present separately in other comprehensive income the portion of the total change in
fair value of a liability resulting from the change in the instrument-specific credit risk (also referred to as “own credit”)
when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial
instruments. The new guidance is effective for public business entities for fiscal years beginning after December 15, 2017.
We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements. Our
preliminary finding is that the new pronouncement will not have a significant impact on our Statement of Operations. The
pronouncement will require some revision to our disclosures within the consolidated financial statements and we are
currently evaluating the impact.
In February 2016, the FASB issued ASU No. 2016-02, Leases. The standard requires a lessee to recognize assets
and liabilities on the balance sheet for leases with lease terms greater than 12 months. A lessee should recognize in the
statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing
its right to use the underlying asset for the lease term. When measuring assets and liabilities arising from a lease, a lessee
(and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise
an option to extend the lease or not to exercise an option to terminate the lease. Similarly, optional payments to purchase
the underlying asset should be included in the measurement of lease assets and lease liabilities only if the lessee is
reasonably certain to exercise that purchase option. Reasonably certain is a high threshold that is consistent with and
intended to be applied in the same way as the reasonably assured threshold in the previous leases guidance. In addition,
also consistent with the previous leases guidance, a lessee (and a lessor) should exclude most variable lease payments in
measuring lease assets and lease liabilities, other than those that depend on an index or a rate or are in substance fixed
payments. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class
of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize
lease expense for such leases generally on a straight-line basis over the lease term. The new guidance is effective for fiscal
years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. We are
currently evaluating the impact of adopting the new guidance on our consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation: Improvements to
Employee Share-Based Payment Accounting. The standard is intended to simplify several areas of accounting for
share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows
and forfeitures. All excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment
awards) should be recognized as income tax expense or benefit in the income statement. The tax effects of exercised or
vested awards should be treated as discrete items in the reporting period in which they occur. An entity also should
recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Excess tax
benefits should be classified along with other income tax cash flows as an operating activity. An entity can make an
entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP)
or account for forfeitures when they occur. The threshold to qualify for equity classification permits withholding up to the
maximum statutory tax rates in the applicable jurisdictions. Cash paid by an employer when directly withholding shares
for tax withholding purposes should be classified as a financing activity. A nonpublic entity can make an accounting policy
election to apply a practical expedient to estimate the expected term for all awards with performance or service conditions
that meet certain conditions. A nonpublic entity can make a one-time accounting policy election to switch from measuring
all liability-classified awards at fair value to intrinsic value. The new guidance became effective on January 1, 2017. Our
current evaluation is that the new pronouncement will create some volatility that could either increase or decrease the
effective tax rate reported as existing vested stock options are exercised. The amount of the impact on the effective tax
rate will be determined by the number of stock options exercised and the stock price of the Company when the stock
options are exercised.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses: Measurement of Credit
Losses on Financial Instruments. The standard is the final guidance on the new current expected credit loss (“CECL”)
model. The amendments in this update replace the incurred loss impairment methodology in current GAAP with a
methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and
supportable information to estimate future credit loss estimates. As CECL encompasses all financial assets carried at
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amortized cost, the requirement that reserves be established based on an organization’s reasonable and supportable
estimate of expected credit losses extends to held-to-maturity debt securities. The update amends the accounting for credit
losses on available-for-sale securities, whereby credit losses will be presented as an allowance as opposed to a write-down.
In addition, CECL will modify the accounting for purchased loans with credit deterioration since origination, so that
reserves are established at the date of acquisition for purchased loans. Lastly, the amendment requires enhanced disclosures
on the significant estimates and judgments used to estimate credit losses, as well as on the credit quality and underwriting
standards of an organization’s portfolio. These disclosures require organizations to present the currently required credit
quality disclosures disaggregated by the year of origination or vintage. The guidance allows for a modified retrospective
approach with a cumulative effect adjustment to the balance sheet upon adoption (charge to retained earnings instead of
the income statement). The new guidance is effective for public business entities for fiscal years, and interim periods
within those years, beginning after December 15, 2019, and early adoption is permitted. We have formed a committee that
is assessing our data and system needs and are evaluating the impact of adopting the new guidance. We expect to recognize
a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period
in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the
overall impact of the new guidance on the consolidated financial statements.
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2) Accumulated Other Comprehensive Income (“AOCI”)
The following table reflects the changes in AOCI by component for the periods indicated:
Year Ended December 31, 2016, 2015, and 2014
Unrealized
Gains (Losses) on
Available-
for-Sale
Securities
and I/O
Strips
Unamortized
Unrealized
Gain on
Available-
for-Sale
Securities
Reclassified
to Held-to-
Maturity
Defined
Benefit
Pension
Plan
Items
Total
Beginning balance January 1, 2016, net of taxes . . . . . . . . . . . . $
1,090 $
403 $ (7,713) $ (6,220)
Other comprehensive (loss) before reclassification, net of
taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(992)
—
(106)
(1,098)
Amounts reclassified from other comprehensive income
(loss), net of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net current period other comprehensive income (loss), net
of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(638)
(67)
109
(596)
(1,630)
(67)
3
(1,694)
(Dollars in thousands)
Ending balance December 31, 2016, net of taxes . . . . . . . . . . . . $
(540) $
336 $ (7,710) $ (7,914)
Beginning balance January 1, 2015, net of taxes . . . . . . . . . . . . $
3,666 $
435 $ (5,952) $ (1,851)
Other comprehensive (loss) before reclassification, net of
taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(2,204)
—
(1,919)
(4,123)
Amounts reclassified from other comprehensive income
(loss), net of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net current period other comprehensive loss, net of taxes .
(372)
(2,576)
(32)
(32)
158
(1,761)
(246)
(4,369)
Ending balance December 31, 2015, net of taxes . . . . . . . . . . . . $
1,090 $
403 $ (7,713) $ (6,220)
Beginning balance January 1, 2014, net of taxes . . . . . . . . . . . . $
(430) $
466 $ (4,065) $ (4,029)
Other comprehensive income (loss) before reclassification,
net of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4,152
—
(1,910)
2,242
Amounts reclassified from other comprehensive income
(loss), net of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net current period other comprehensive income (loss), net
of taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(56)
(31)
23
(64)
4,096
(31)
(1,887)
2,178
Ending balance December 31, 2014, net of taxes . . . . . . . . . . . . $
3,666 $
435 $ (5,952) $ (1,851)
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Details About AOCI Components
Amounts Reclassified from
AOCI(1)
Year Ended December 31, 2016
2015
2016
2014
(Dollars in thousands)
Affected Line Item Where
Net Income is Presented
Unrealized gains on available-for-sale securities and
I/O strips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,099 $ 642 $
(461)
638
(270)
372
97 Gain on sales of securities
(41) Income tax expense
56 Net of tax
Amortization of unrealized gain on securities
available-for-sale that were reclassified to
securities held-to-maturity . . . . . . . . . . . . . . . . . . .
Amortization of defined benefit pension plan
items(1)
Prior service cost . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior transition obligation . . . . . . . . . . . . . . . . . . .
Actuarial losses . . . . . . . . . . . . . . . . . . . . . . . . . . . .
116
(49)
67
55
(23)
32
54 Interest income on taxable securities
(23) Income tax expense
31 Net of tax
—
102
(142)
—
51
(239)
(188)
79
(109)
—
113
(386)
(273)
115
(158)
(40) Income before income tax
17 Income tax benefit
(23) Net of tax
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Total reclassification from AOCI for the year . . . . . $
596 $ 246 $
(1) This AOCI component is included in the computation of net periodic benefit cost (see Note 14 — Benefit Plans).
3) Securities
The amortized cost and estimated fair value of securities at year-end were as follows:
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Securities available-for-sale:
Amortized
Cost
Gross
Unrealized
Gains
(Dollars in thousands)
Gross
Unrealized
(Losses)
Estimated
Fair
Value
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Agency mortgage-backed securities . . . . . . . . . . . . . . . . . .
Trust preferred securities . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 293,598 $
15,000
$ 308,598 $
928
600
1,528
$ (3,537) $ 290,989
15,600
$ (3,537) $ 306,589
—
Securities held-to-maturity:
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . .
Municipals - exempt from Federal tax . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 233,409 $
90,601
$ 324,010 $
15
521
536
$ (3,554) $ 229,870
88,878
$ (5,798) $ 318,748
(2,244)
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2015
Securities available-for-sale:
Amortized
Cost
Gross
Unrealized
Gains
(Dollars in thousands)
Gross
Unrealized
(Losses)
Estimated
Fair
Value
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . .
US Treasury . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Trust preferred securities . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. Government sponsored entities . . . . . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 324,077 $
30,047
15,000
9,042
6,412
$ 384,578 $
2,457
—
132
13
261
2,863
$ (2,304) $ 324,230
30,003
15,132
9,041
6,673
$ (2,362) $ 385,079
(44)
—
(14)
—
Securities held-to-maturity:
Municipals - exempt from Federal tax . . . . . . . . . . . . . . . .
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
93,518 $
15,793
$ 109,311 $
1,517
24
1,541
$
(863) $
(168)
94,172
15,649
$ (1,031) $ 109,821
Securities with unrealized losses at year end, aggregated by investment category and length of time that individual
securities have been in an unrealized loss position are as follows:
2016
Securities available-for-sale:
Fair
Value
Less Than 12 Months
Unrealized
12 Months or More
Fair
(Losses) Value
Unrealized
Fair
(Losses) Value
Total
Unrealized
(Losses)
(Dollars in thousands)
Agency mortgage-backed securities . . . . . $ 245,045 $ (3,537) $
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 245,045 $ (3,537) $
— $
— $
— $ 245,045 $ (3,537)
— $ 245,045 $ (3,537)
Securities held-to-maturity:
Agency mortgage-backed securities . . . . . $ 222,132 $ (3,528) $
Municipals - exempt from Federal tax . . .
(2,026)
57,304
612 $
2,046
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 279,436 $ (5,554) $ 2,658 $
(26) $ 222,744 $ (3,554)
(218)
(2,244)
59,350
(244) $ 282,094 $ (5,798)
2015
Securities available-for-sale:
Fair
Value
Less Than 12 Months
Unrealized
12 Months or More
Fair
(Losses) Value
Unrealized
Fair
(Losses) Value
Total
Unrealized
(Losses)
(Dollars in thousands)
Agency mortgage-backed securities . . . . . $ 241,067 $ (2,258) $ 2,165 $
U.S. Treasury . . . . . . . . . . . . . . . . . . . . . . .
U.S. Government sponsored entities . . . . .
30,003
4,980
(44)
(14)
—
—
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 276,050 $ (2,316) $ 2,165 $
(46) $ 243,232 $ (2,304)
(44)
30,003
—
(14)
4,980
—
(46) $ 278,215 $ (2,362)
Securities held-to-maturity:
Municipals - exempt from Federal tax . . . $
Agency mortgage-backed securities . . . . .
9,920 $
7,152
(78) $ 24,412 $
(89)
4,409
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 17,072 $
(167) $ 28,821 $
(785) $ 34,332
(863)
(168)
11,561
(79)
(864) $ 45,893 $ (1,031)
There were no holdings of securities of any one issuer, other than the U.S. Government and its sponsored entities,
in an amount greater than 10% of shareholders’ equity. At December 31, 2016, the Company held 454 securities (149
available-for-sale and 305 held-to-maturity), of which 302 had fair values below amortized cost. At December 31, 2016,
there were $612,000 of agency mortgage-backed securities held-to-maturity, and $2,046,000 of municipals bonds held-to-
maturity carried with an unrealized loss for 12 months or greater. The total unrealized loss for securities 12 months or
greater was $244,000 at December 31, 2016. The unrealized losses were due to higher interest rates. The issuers are of
high credit quality and all principal amounts are expected to be paid when securities mature. The fair value is expected to
recover as the securities approach their maturity date and/or market rates decline. The Company does not believe that it is
more likely than not that the Company will be required to sell a security in an unrealized loss position prior to recovery in
value. The Company does not consider these securities to be other-than-temporarily impaired at December 31, 2016.
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The proceeds from sales of securities and the resulting gains and losses are listed below:
Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 75,689 $ 71,832 $ 108,603
1,008
Gross gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,144
(911)
(45)
Gross losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
751
(109)
2016
2015
2014
(Dollars in thousands)
The amortized cost and fair value of debt securities as of December 31, 2016, by contractual maturity, are shown
below. The expected maturities will differ from contractual maturities if borrowers have the right to call or prepay
obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.
Due after ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,000 $ 15,600
290,989
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 308,598 $ 306,589
293,598
Available-for-sale
Amortized Estimated
Fair Value
Cost
(Dollars in thousands)
Held-to-maturity
Amortized Estimated
Fair Value
Cost
(Dollars in thousands)
Due after 3 months or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Due after 3 months through one year . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after one through five years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after five through ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after ten years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Agency mortgage-backed securities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
336
1,118
3,992
17,273
66,159
229,870
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 324,010 $ 318,748
1,116
3,992
17,049
68,109
233,409
335 $
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Securities with amortized cost of $135,023,000 and $134,235,000 as of December 31, 2016 and 2015 were
pledged to secure public deposits and for other purposes as required or permitted by law or contract.
24FEB201611503668
4) Loans
Loans at year-end were as follows:
Loans held-for-investment:
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 604,331 $ 556,522
Real estate:
2016
2015
(Dollars in thousands)
CRE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Residential mortgages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
662,228
81,002
82,459
52,887
20,460
Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,503,367
(760)
Loans, net of deferred fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,502,607
(19,089)
625,665
84,428
76,833
—
16,010
1,359,458
(742)
1,358,716
(18,926)
Loans, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,483,518 $ 1,339,790
Deferred loan fees, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
At December 31, 2016 and December 31, 2015, total net loans included in the table above include $88,453,000
and $141,343,000, respectively, of the non-PCI loans acquired in the Focus transaction.
109
Changes in the allowance for loan losses were as follows:
Commercial Real Estate Consumer
Total
Year Ended December 31, 2016
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . .
Charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (charge-offs) recoveries . . . . . . . . . . . . . . . . . . . . .
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . . .
End of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
10,748
(1,966)
365
(1,601)
1,509
10,656
$
$
$
(Dollars in thousands)
8,076
—
568
568
(317)
8,327
102
(41)
—
(41)
45
106
$
$
$
18,926
(2,007)
933
(1,074)
1,237
19,089
Commercial Real Estate Consumer
Total
Year Ended December 31, 2015
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . .
Charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . . .
End of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
11,187
(527)
877
350
(789)
10,748
$
$
$
(Dollars in thousands)
7,070
(2)
146
144
862
8,076
122
(9)
30
21
(41)
102
$
$
$
18,379
(538)
1,053
515
32
18,926
Commercial Real Estate Consumer
Total
Year Ended December 31, 2014
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . .
Charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net charge-offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision (credit) for loan losses . . . . . . . . . . . . . . . . . . . .
End of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
12,533
(815)
418
(397)
(949)
11,187
$
$
$
(Dollars in thousands)
6,548
(87)
62
(25)
547
7,070
83
(25)
—
(25)
64
122
$
$
$
19,164
(927)
480
(447)
(338)
18,379
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by
portfolio segment, based on the impairment method as follows at year-end:
Commercial Real Estate
Consumer
Total
(Dollars in thousands)
December 31, 2016
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment . . . . . . . . .
Collectively evaluated for impairment . . . . . . . . .
Acquired with deterioriated credit quality . . . . . .
Total allowance balance . . . . . . . . . . . . . . . . . . .
Loans:
Individually evaluated for impairment . . . . . . . . .
Collectively evaluated for impairment . . . . . . . . .
Acquired with deterioriated credit quality . . . . . .
Total loan balance . . . . . . . . . . . . . . . . . . . . . . . .
$
$
$
$
329
10,327
—
10,656
2,057
602,029
245
604,331
$
$
$
$
—
8,327
—
8,327
885
877,691
—
878,576
$
$
$
$
—
106
—
106
$
$
329
18,760
—
19,089
3
20,457
—
20,460
$
2,945
1,500,177
245
$ 1,503,367
110
Commercial Real Estate
Consumer
Total
(Dollars in thousands)
December 31, 2015
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment . . . . . . . . .
Collectively evaluated for impairment . . . . . . . . .
Acquired with deterioriated credit quality . . . . . .
Total allowance balance . . . . . . . . . . . . . . . . . . .
Loans:
Individually evaluated for impairment . . . . . . . . .
Collectively evaluated for impairment . . . . . . . . .
Acquired with deterioriated credit quality . . . . . .
Total loan balance . . . . . . . . . . . . . . . . . . . . . . . .
$
$
$
$
174
10,574
—
10,748
2,014
554,271
237
556,522
$
$
$
$
112
7,964
—
8,076
4,272
782,654
—
786,926
$
$
$
$
—
102
—
102
$
$
286
18,640
—
18,926
4
16,006
—
16,010
$
6,290
1,352,931
237
$ 1,359,458
The following table presents loans held-for-investment individually evaluated for impairment by class of loans
as of December 31, 2016 and December 31, 2015. The recorded investment included in the following table represents loan
principal net of any partial charge-offs recognized on the loans. The unpaid principal balance represents the recorded
balance prior to any partial charge-offs.
December 31, 2016
December 31, 2015
Unpaid
Principal Recorded
Balance
Allowance
for Loan
Losses
Investment Allocated Balance
Unpaid
Principal Recorded
Allowance
for Loan
Losses
Investment Allocated
With no related allowance recorded:
Commercial. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,808 $ 1,808 $
Real estate:
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . . . . . . . . . . . . .
Home Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total with no related allowance recorded . . . . .
1,278
218
267
3
3,574
419
199
267
3
2,696
— $ 745 $
745 $
—
—
—
—
—
—
3,851
237
302
4
5,139
2,992
219
302
4
4,262
—
—
—
—
—
(Dollars in thousands)
With an allowance recorded:
Commercial. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Real estate:
494
494
329
1,506
1,506
174
Home Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total with an allowance recorded . . . . . . . . . . .
—
494
—
494
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,068 $ 3,190 $
759
2,265
—
329
329 $ 7,404 $ 6,527 $
759
2,265
112
286
286
The following table presents interest recognized and cash-basis interest earned on impaired loans for the periods
indicated:
Year Ended December 31, 2016
Real Estate
Commercial
CRE
Land and Home
Construction Equity Consumer
(Dollars in thousands)
Total
Average of impaired loans during the period . . . . . $
Interest income during impairment . . . . . . . . . . . . . $
Cash-basis interest earned . . . . . . . . . . . . . . . . . . . . . $
1,822 $ 1,922 $
— $
— $
— $
— $
208 $ 625 $
— $ — $
— $ — $
3 $ 4,580
—
—
— $
— $
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Commercial
CRE
Year Ended December 31, 2015
Real Estate
Land and
Construction
Home
Equity Consumer
Total
Average of impaired loans during the period . $
Interest income during impairment . . . . . . . . . $
Cash-basis interest earned . . . . . . . . . . . . . . . . . $
1,774 $
14 $
— $
3,006 $
— $
— $
764 $
— $
— $
475 $
2 $
— $
5 $ 6,024
16
—
— $
— $
(Dollars in thousands)
Nonperforming loans include both smaller dollar balance homogenous loans that are collectively evaluated for
impairment and individually classified loans. Nonperforming loans were as follows at year-end:
(Dollars in thousands)
Nonaccrual loans - held-for-investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,059 $ 4,716
1,662
Restructured and loans over 90 days past due and still accruing . . . . . . . . .
6,378
Total nonperforming loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other restructured loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
149
Total impaired loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,190 $ 6,527
—
3,059
131
2016
2015
The following table presents the nonperforming loans by class at year-end:
2016
Restructured and
Loans over 90 Days
Past Due and
Still Accruing
Nonaccrual
2015
Restructured and
Loans over 90 Days
Past Due and
Still Accruing
Nonaccrual
Total
Total
Commercial . . . . . . . . . . . . . . . . . . . . . $ 2,171 $
Real estate: . . . . . . . . . . . . . . . . . . . . . .
CRE . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . .
419
199
267
3
Total . . . . . . . . . . . . . . . . . . . . . . . . $ 3,059 $
(Dollars in thousands)
— $ 2,171 $
724 $
—
—
—
—
— $ 3,059 $ 4,716 $
2,992
219
777
4
419
199
267
3
1,378 $ 2,102
—
—
—
284
—
2,992
219
1,061
4
1,662 $ 6,378
The following table presents the aging of past due loans as of December 31, 2016 by class of loans:
30 - 59
Days
Past Due
60 - 89
Days
Past Due
90 Days or
Greater
Past Due
Total
Past Due
Loans Not
Past Due
Total
Commercial . . . . . . . . . . . . . . . . . . . . . . $ 3,998 $
Real estate:
CRE . . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . .
Residential mortgages . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . .
632
—
—
—
—
Total . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,630 $
857 $
(Dollars in thousands)
2,036 $ 6,891 $
597,440 $
604,331
—
199
—
—
—
662,228
81,002
82,459
52,887
20,460
2,235 $ 7,989 $ 1,495,378 $ 1,503,367
661,596
80,803
82,192
52,887
20,460
632
199
267
—
—
—
—
267
—
—
1,124 $
112
The following table presents the aging of past due loans as of December 31, 2015 by class of loans:
30 - 59
Days
Past Due
60 - 89
Days
Past Due
90 Days or
Greater
Past Due
Total
Past Due
Loans Not
Past Due
Total
Commercial . . . . . . . . . . . . . . . . . . . . . . $ 3,285 $
Real estate:
CRE . . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . .
—
219
—
—
Total . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,504 $
262 $
—
—
—
—
262 $
(Dollars in thousands)
1,704 $ 5,251 $
551,271 $
556,522
—
—
284
—
625,665
84,428
76,833
16,010
1,988 $ 5,754 $ 1,353,704 $ 1,359,458
625,665
84,209
76,549
16,010
—
219
284
—
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Past due loans 30 days or greater totaled $7,989,000 and $5,754,000 at December 31, 2016 and December 31,
2015, respectively, of which $2,057,000 and $591,000 were on nonaccrual. At December 31, 2016, there were also
$1,002,000 loans less than 30 days past due included in nonaccrual loans held-for-investment. At December 31, 2015,
there were also $4,125,000 loans less than 30 days past due included in nonaccrual loans held for investment.
Management’s classification of a loan as “nonaccrual” is an indication that there is reasonable doubt as to the full recovery
of principal or interest on the loan. At that point, the Company stops accruing interest income, and reverses any uncollected
interest that had been accrued as income. The Company begins recognizing interest income only as cash interest payments
are received and it has been determined the collection of all outstanding principal is not in doubt. The loans may or may
not be collateralized, and collection efforts are pursued.
Credit Quality Indicators
Concentrations of credit risk arise when a number of clients are engaged in similar business activities, or activities
in the same geographic region, or have similar features that would cause their ability to meet contractual obligations to be
similarly affected by changes in economic conditions. The Company’s loan portfolio is concentrated in commercial
(primarily manufacturing, wholesale, and service) and real estate lending, with the balance in consumer loans. While no
specific industry concentration is considered significant, the Company’s lending operations are located in the Company’s
market areas that are dependent on the technology and real estate industries and their supporting companies. Thus, the
Company’s borrowers could be adversely impacted by a continued downturn in these sectors of the economy which could
reduce the demand for loans and adversely impact the borrowers’ ability to repay their loans.
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers
to service their debt such as: current financial information; historical payment experience; credit documentation; public
information; and current economic trends, among other factors. The Company analyzes loans individually by classifying
the loans as to credit risk. This analysis is performed on a quarterly basis. Nonclassified loans generally include those
loans that are expected to be repaid in accordance with contractual loans terms. Classified loans are those loans that are
assigned a substandard, substandard-nonaccrual, or doubtful risk rating using the following definitions:
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses
that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain
some loss if the deficiencies are not corrected.
Substandard-Nonaccrual. Loans classified as substandard-nonaccrual are inadequately protected by the current
net worth and paying capacity of the obligor or of the collateral pledged, if any, and it is probable that the Company will
not receive payment of the full contractual principal and interest. Loans so classified have a well-defined weakness or
weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution
will sustain some loss if the deficiencies are not corrected. In addition, the Company no longer accrues interest on the loan
because of the underlying weaknesses.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with
the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts,
conditions, and values, highly questionable and improbable.
113
Loss. Loans classified as loss are considered uncollectable. In addition, loans of so little value that their
continuance as assets is not warranted are classified as loss. This classification does not necessarily mean that a loan has
no recovery or salvage value; but rather, there is much doubt about whether, how much, or when the recovery will occur.
Loans classified as loss are immediately charged off against the allowance for loan losses. Therefore, there is no balance
to report at December 31, 2016 or 2015.
The following table provides a summary of the loan portfolio by loan type and credit quality classification for the
periods indicated:
Commercial . . . . . . . . . . . . . . . . . . . . . $ 594,255 $ 10,076 $ 604,331 $ 547,536 $ 8,986 $
Real estate:
December 31, 2016
December 31, 2015
Nonclassified Classified
Total
Nonclassified Classified
Total
556,522
CRE . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . .
Residential mortgages . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . .
625,665
84,428
76,833
—
16,010
Total . . . . . . . . . . . . . . . . . . . . . . . . $ 1,490,043 $ 13,324 $ 1,503,367 $ 1,340,826 $ 18,632 $ 1,359,458
659,777
80,803
81,866
52,887
20,455
617,865
84,209
75,511
—
15,705
662,228
81,002
82,459
52,887
20,460
7,800
219
1,322
—
305
2,451
199
593
—
5
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the
probability that the borrower will be in payment default on any of its debt in the foreseeable future without the
modification. This evaluation is performed in compliance with the Company’s underwriting policy.
The book balance of troubled debt restructurings at December 31, 2016 was $133,000, which included $2,000 of
nonaccrual loans and $131,000 of accruing loans. The book balance of troubled debt restructurings at December 31, 2015
was $153,000, which included $4,000 of nonaccrual loans and $149,000 of accruing loans. Approximately $2,000 and
$3,000 in specific reserves were established with respect to these loans as of December 31, 2016 and December 31, 2015.
As of December 31, 2016 and December 31, 2015, the Company had no additional amounts committed on any loan
classified as a troubled debt restructuring.
There were no loans by class modified as troubled debt restructurings during the twelve month period ended
December 31, 2016 and 2015.
A loan is considered to be in payment default when it is 30 days contractually past due under the modified terms.
There were no defaults on troubled debt restructurings within twelve months following the modification during the years
ended December 31, 2016 and 2015.
HBC makes loans to executive officers, directors, and their affiliates. The following table presents the loans
outstanding to these related parties for the periods indicated:
2016
2015
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Advances on loans during the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Repayment on loans during the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
End of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
562 $
—
(15)
547 $
576
4,175
(4,189)
562
(Dollars in thousands)
5) Loan Servicing
At December 31, 2016 and 2015, the Company serviced SBA loans sold to the secondary market of approximately
$164,454,000 and $175,457,000, respectively.
Servicing assets represent the servicing spread generated from the sold guaranteed portions of SBA loans. The
weighted average servicing rate for all loans serviced was 1.17% and 1.16% at December 31, 2016 and 2015, respectively.
114
Servicing rights are included in “accrued interest receivable and other assets” on the consolidated balance sheets.
Activity for loan servicing rights follows:
2016
2015
(Dollars in thousands)
2014
565 $ 525
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,209 $
319
Additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(279)
End of year balance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,854 $ 2,209 $ 565
2,126
(482)
219
(574)
There was no valuation allowance for servicing rights at December 31, 2016 and 2015, because the estimated fair
value of the servicing rights was greater than the carrying value. The increase in loan servicing rights for the year ended
December 31, 2015 was primarily due to the Focus acquisition of $1,976,000 at fair value. The estimated fair value of loan
servicing rights was $5,217,000 and $3,650,000 at December 31, 2016 and 2015, respectively. The fair value of servicing
rights at December 31, 2016, was estimated using a weighted average constant prepayment rate ("CPR") assumption of
7.40%, and a weighted average discount rate assumption of 12.96%. The fair value of servicing rights at December 31,
2015, was estimated using a weighted average CPR assumption of 7.42%, and a weighted average discount rate assumption
of 12.52%.
The weighted average discount rate and CPR assumptions used to estimate the fair value of the I/O strip
receivables are the same as for the servicing rights. Management reviews the key economic assumptions used to estimate
the fair value of I/O strip receivables on a quarterly basis. The fair value of the I/O strip can be adversely impacted by a
significant increase in either the prepayment speed of the portfolio or the discount rate.
I/O strip receivables are included in “accrued interest receivable and other assets” on the consolidated balance
sheets. Activity for I/O strip receivables follows:
2016
2015
(Dollars in thousands)
2014
Beginning of year balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,367 $ 1,481 $ 1,647
Unrealized loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(166)
End of year balance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,067 $ 1,367 $ 1,481
(114)
(300)
6) Premises and Equipment
Premises and equipment at year-end were as follows:
2016
2015
(Dollars in thousands)
Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Furniture and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated depreciation and amortization . . . . . . . . . . . . . . . . . . .
Premises and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
3,400 $
2,900
8,788
5,295
20,383
(12,893)
3,279
2,900
8,468
5,257
19,904
(12,131)
7,773
7,490 $
Depreciation and amortization expense was $763,000, $685,000, and $725,000 in 2016, 2015, and 2014,
respectively.
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7) Leases
Operating Leases
The Company owns one of its offices and leases the others under non-cancelable operating leases with terms,
including renewal options, ranging from five to fifteen years. Future minimum payments under the agreements are as
follows:
Year ended December 31,
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
(Dollars in thousands)
3,000
2,569
2,369
1,031
210
—
9,179
Rent expense under operating leases was $2,947,000, $2,997,000, and $2,692,000 in 2016, 2015, and 2014,
respectively.
8) Business Combinations
Focus Business Bank
On April 23, 2015, the Company and Focus entered into a definitive agreement and plan of merger and
reorganization whereby Focus would merge into HBC. The Company completed the merger of its wholly-owned bank
subsidiary HBC with Focus on August 20, 2015 for an aggregate transaction value of $66,558,000. Shareholders of Focus
received a fixed exchange ratio at closing of 1.8235 shares of the Company’s common stock for each share of Focus
common stock. Upon closing of the transaction, the Company issued 5,456,713 shares of the Company’s common stock
to Focus shareholders for a total value of $58,278,000, based on the Company’s closing stock price of $10.68 on August
20, 2015. In addition, the Company paid cash to the Focus holders of in-the-money stock options on August 20, 2015
totaling $8,280,000.
Focus’s results of operations have been included in the Company’s results of operations beginning August 21,
2015. Pre-tax severance, retention, acquisition and integration costs totaled $6,398,000 for the year ended December 31,
2015.
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The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date
of acquisition.
(Dollars in thousands)
Assets acquired:
Cash and cash item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Federal funds sold and deposits in other financial institutions . . . . . . . . . .
Securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Securities held-to-maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans held-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Core deposit intangible asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate owned life insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Liabilities asssumed:
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net assets acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
5,651
168,415
53,940
8,665
4,416
170,353
32,620
6,285
7,067
20,250
477,662
405,123
5,981
411,104
66,558
The fair value of net assets acquired includes fair value adjustments to certain receivables of which some were
considered impaired and some were not considered impaired as of the acquisition date. The fair value adjustments were
determined using discounted contractual cash flows, adjusted for expected losses and prepayments, where appropriate.
The gross contractual amount of four purchased credit impaired loans as of the acquisition date totaled $1,124,000. As of
that date, contractual cash flows not expected to be collected on the purchased credit impaired loans totaled $819,000,
which represents 72.9% of their gross outstanding principal balances. The receivables that were not considered impaired
at the acquisition date were not subject to the guidance relating to purchased credit impaired loans, which have shown
evidence of credit deterioration since origination. Receivables acquired that were not subject to these requirements include
nonimpaired loans with a fair value and gross contractual amounts receivable of $170,048,000 and $174,660,000
respectively, on the date of acquisition. As of that date, the purchase discount on these nonimpaired loans totaled
$4,612,000, which represents 2.6% of their gross outstanding principal balances.
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Goodwill of $32,620,000 arising from the acquisition is largely attributable to synergies and cost savings resulting
from combining the operations of the companies. As this transaction was structured as a taxfree exchange, the goodwill
will not be deductible for tax purposes.
The following table summarizes the consideration paid for Focus:
August 20, 2015
Cash paid for Focus in-the-money stock options . . . . . . . . . . . . . . . . . . . . . . $
Common stock issued to Focus shareholders at $10.68 per share . . . . . . . . .
Total consideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
(Dollars in thousands)
8,280
58,278
66,558
The following table presents pro forma financial information as if the acquisition had occurred on January 1,
2014, which includes the pre-acquisition period for Focus, and continues through December 31, 2015. The historical
unaudited pro forma financial information has been adjusted to reflect supportable items that are directly attributable to
the acquisition and expected to have a continuing impact on consolidated results of operations, as such, one-time
acquisition costs are not included. The unaudited pro forma financial information is provided for informational purposes
only. The unaudited pro forma financial information is not necessarily, and should not be assumed to be, an indication of
the results that would have been achieved had the acquisition been completed as of the dates indicated or that may be
117
achieved in the future. The preparation of the unaudited pro forma combined consolidated financial statements and related
adjustments required management to make certain assumptions and estimates.
UNAUDITED
Year Ended December 31,
2015
2014
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Provision (credit) for loan losses . . . . . . . . . . . . . . . .
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Net income per share - basic . . . . . . . . . . . . . . . . . . . $
Net income per share - diluted . . . . . . . . . . . . . . . . . $
(Dollars in thousands, except per share amounts)
68,175
(38)
9,624
53,600
24,237
8,784
15,453
0.41
0.41
83,876 $
82
11,443
60,372
34,865
13,941
20,924 $
0.56 $
0.55 $
9) Goodwill and Other Intangible Assets
Goodwill
At December 31, 2016, the carrying value of goodwill was $45,664,000. The Company recognized $13,044,000
of goodwill upon its acquisition of Bay View Funding on November 1, 2014, and $32,620,000 from its acquisition of
Focus on August 20, 2015. During the fourth quarter of 2015, adjustments were made to the purchase price allocations
for the Focus transaction that affected the amounts allocated to goodwill and other assets.
Goodwill impairment exists when a reporting unit’s carrying value exceeds its fair value, which is determined
through a qualitative assessment whether it is more likely than not that the fair value of equity of the reporting unit exceeds
the carrying value (“Step Zero”). If the qualitative assessment indicates it is more likely than not that the fair value of
equity of a reporting unit is less than book value, than a quantitative two-step impairment test is required. Step 1 includes
the determination of the carrying value of the Company’s single reporting unit, including the existing goodwill and
intangible assets, and estimating the fair value of the reporting unit. If the carrying amount of a reporting unit exceeds its
fair value, the Company is required to perform a second step to the impairment test. Step 2 requires that the implied fair
value of the reporting unit goodwill be compared to the carrying amount of that goodwill. If the carrying amount of the
reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an
amount equal to that excess.
The Company completed its annual impairment analysis on the goodwill from the Bay View Funding and Focus
acquisitions as of November 30, 2016 with the assistance of an independent valuation firm. Based on the Step Zero
qualitative analysis performed, the Company determined that it is more likely than not that the fair value of the reporting
unit exceeded its reported book value of equity at November 30, 2016. As such, no impairment was indicated and no
further testing was required.
Other Intangible Assets
The core deposit intangible asset originally acquired in the 2007 acquisition of Diablo Valley Bank was
$5,049,000. This asset is amortized over its estimated useful life of 10 years. Accumulated amortization of this intangible
asset was $4,854,000 and $4,427,000 at December 31, 2016 and December 31, 2015, respectfully.
The core deposit intangible asset acquired in the acquisition of Focus in August 2015 was $6,285,000. This asset
is amortized over its estimated useful life of 10 years. Accumulated amortization of this intangible asset was $1,120,000
and $288,000 at December 31, 2016 and December 31, 2015, respectively.
Other intangible assets acquired in the acquisition of Bay View Funding in November 2014 included: a below
market value lease intangible asset of $109,000 (amortized over 3 years), customer relationship and brokered relationship
intangible assets of $1,900,000, (amortized over the 10 year estimated useful lives), and a non compete agreement
intangible asset of $250,000 (amortized over 3 years). Accumulated amortization of these intangible assets was $669,000
and $360,000 at December 31, 2016 and December 31, 2015, respectfully.
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Estimated amortization expense for each of the next five years follows:
Year
Diablo Valley
Bay View Funding
Customer &
Bank Core Focus Core Below Market
Deposit
Deposit
Intangible Intangible Intangible
Value Lease Relationship Agreement Amortization
Intangible Intangible
Expense
Brokered Non-Compete
Total
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
195 $
—
—
—
—
875 $
775
734
716
596
$
195 $ 3,696 $
(Dollars in thousands)
31 $
—
—
—
—
31 $
190 $
190
190
190
190
950 $
70 $
—
—
—
—
70 $
1,361
965
924
906
786
4,942
Impairment testing of the intangible assets is performed at the individual asset level. The Company’s intangibles
are tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be
recoverable. If such events or changes in circumstances are identified, an impairment loss is recognized only if the carrying
amount of the intangible asset is not recoverable and exceeds its fair value. For intangible assets, estimates of expected
future cash flows (cash inflows less cash outflows) that are directly associated with an intangible asset are used to
determine the fair value of that asset. Management makes certain estimates and assumptions in determining the expected
future cash flows from core deposit and customer relationship intangibles including account attrition, expected lives,
discount rates, interest rates, servicing costs and other factors. Significant changes in these estimates and assumptions
could adversely impact the valuation of these intangible assets. If an impairment loss exists, the carrying amount of the
intangible asset is adjusted to a new cost basis. The new cost basis is then amortized over the remaining useful life of the
asset. Based on its assessment, management did not identify any events or changes in circumstances indicating that such
intangible assets may not be recoverable at December 31, 2016 or 2015.
10) Deposits
Time deposits of $250,000 and over, including time deposits within the Certificate of Deposit Account Registry
Service (“CDARS”) and brokered deposits of $250,000 and over, were $163,670,000 and $178,640,000 at December 31,
2016 and 2015, respectively. The following table presents the scheduled maturities of all time deposits for the next five
years:
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2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
(Dollars in thousands)
213,976
6,835
3,457
228
221
224,717
At December 31, 2016, total CDARS deposits of $9,401,000 include money market deposits of $3,747,000, and
interest-bearing demand deposits of $2,464,000, which have no scheduled maturity date, and therefore, are excluded from
the table above.
At December 31, 2016, the Company had securities pledged with a fair value of $94,078,000 for $85,080,000 in
certificates of deposits (including accrued interest) with the State of California. At December 31, 2015, the Company had
securities pledged with a fair value of $93,042,000 for $78,026,000 in certificates of deposits (including accrued interest)
with the State of California.
The CDARS program allows customers with deposits in excess of FDIC-insured limits to obtain full coverage on
time deposits through a network of banks within the CDARS program. Deposits gathered through these programs are
considered brokered deposits under current regulatory reporting guidelines. CDARS deposits were comprised of
$2,464,000 of interest-bearing demand accounts, $3,747,000 of money market accounts and $3,190,000 of time deposits
119
at December 31, 2016. CDARS deposits were comprised of $3,388,000 of money market accounts and $4,195,000 of
time deposits at December 31, 2015.
Deposits from executive officers, directors, and their affiliates were $12,476,000 and $13,426,000 at December
31, 2016 and 2015, respectively.
11) Borrowing Arrangements
Federal Home Loan Bank Borrowings, Federal Reserve Bank Borrowings, and Available Lines of Credit
HBC maintains a collateralized line of credit with the FHLB of San Francisco. Under this line, the Company can
borrow from the FHLB on a short-term (typically overnight) or long-term (over one year) basis. As of December 31, 2016,
and December 31, 2015, HBC had no overnight borrowings from the FHLB. HBC had $213,938,000 of loans and no
securities pledged to the FHLB as collateral on a line of credit of $172,498,000 at December 31, 2016. HBC had
$245,607,000 of loans and no securities pledged to the FHLB as collateral on a line of credit of $141,875,000 at December
31, 2015.
HBC can also borrow from the FRB’s discount window. HBC had approximately $496,438,000 of loans pledged
to the FRB as collateral on an available line of credit of approximately $312,096,000 at December 31, 2016, none of which
was outstanding. HBC had approximately $395,006,000 of loans pledged to the FRB as collateral on an available line of
credit of approximately $243,156,000 at December 31, 2015, none of which was outstanding.
At December 31, 2016, HBC had Federal funds purchase arrangements available of $55.0 million. There were
no Federal funds purchased outstanding at December 31, 2016 and 2015.
HCC has a $5.0 million line of credit with a correspondent bank, of which none was outstanding at December 31,
2016.
HBC may also utilize securities sold under repurchase agreements to manage our liquidity position. There were
no securities sold under agreements to repurchase at December 31, 2016, and 2015.
12) Income Taxes
Income tax (benefit) consisted of the following for the year ended December 31, as follows:
2016
2015
(Dollars in thousands)
2014
Currently payable tax:
Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,373 $ 5,445 $ 4,392
818
State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5,210
Total currently payable . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4,748
18,121
2,544
7,989
Deferred tax (benefit):
Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,114
1,214
2,328
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 16,588 $ 10,104 $ 7,538
(1,029)
(504)
(1,533)
2,029
86
2,115
120
The effective tax rate differs from the Federal statutory rate for the years ended December 31, as follows:
2016 2015 2014
Statutory Federal income tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35.0 % 35.0 % 35.0 %
State income taxes, net of federal tax benefit . . . . . . . . . . . . . . . . . . . . 6.6 % 6.9 % 6.5 %
0.8 %
Low income housing credits, net of investment losses . . . . . . . . . . . . . (0.3)%
Increase in cash surrender value of life insurance . . . . . . . . . . . . . . . . (1.4)% (2.2) % (2.7)%
Non-taxable interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1.7)% (2.7) % (3.2)%
Split-dollar term insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.1 % 0.1 % 0.1 %
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (0.6)% 0.9 % (0.5)%
Effective tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37.7 % 38.0 % 36.0 %
—
Deferred tax assets and liabilities that result from the tax effects of temporary differences between the carrying
amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes at
December 31, are as follows:
2016
2015
(Dollars in thousands)
Deferred tax assets:
Defined postretirement benefit obligation . . . . . . . . . . . . . . . . . . . . . . . $ 11,476 $ 11,049
7,815
Allowance for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,689
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,397
Federal net operating loss carryforwards . . . . . . . . . . . . . . . . . . . . . . . .
2,008
Stock compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
889
State income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
945
Premises and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
Securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
591
California net operating loss carryforwards . . . . . . . . . . . . . . . . . . . . . .
107
Split-dollar life insurance benefit plan . . . . . . . . . . . . . . . . . . . . . . . . . .
57
Tax credit carryforwards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
742
28,289
Total deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7,886
1,787
1,740
1,698
1,515
990
598
454
102
101
1,069
29,416
Deferred tax liabilities:
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Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loan fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
I/O strips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
FHLB stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(2,101)
(1,331)
(1,022)
(574)
(505)
(245)
(293)
(6,071)
Net deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25,058 $ 22,218
(1,614)
(1,278)
(644)
(448)
—
(244)
(130)
(4,358)
At December 31, 2016, the Company's federal net operating loss carryforwards were $4,973,000 and the
Company's California net operating loss carryforwards were $6,584,000. These amounts are attributable to the Focus
transaction. The realization of these net operating loss carryforwards for federal and state tax purposes is limited under
current tax law with limitations placed on the amount of net operating losses that can be utilized annually. The Company
does not, however, believe that its annual limitation of $1,877,000 will impact the ultimate deductibility of the net
operating loss carry-forwards. The State tax credit carryforwards, net of Federal tax effects, were $57,000 as of December
31, 2016, which will begin to expire in 2019. As the Company will be able to fully utilize the net operating loss
carryforwards before they expire in 2035, no valuation allowance is required against the deferred tax assets.
Under generally accepted accounting principles, a valuation allowance is required if it is “more likely than not”
that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly
subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence,
including forecasts of future income, cumulative losses, applicable tax planning strategies, and assessments of current and
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future economic and business conditions. In accordance with Accounting Standards Codification (ASC) 740-10
Accounting for Uncertainty in Income Taxes. The Company does not expect this amount to significantly increase or
decrease in the next twelve months.
At December 31, 2016, and December 31, 2015, the Company had net deferred tax assets of $25,058,000 and
$22,218,000, respectively. At December 31, 2016, the Company determined that a valuation allowance for deferred tax
assets was not necessary.
The Company and its subsidiaries are subject to U.S. Federal income tax as well as income tax of the State of
California. The Company is no longer subject to examination by Federal and state taxing authorities for years before 2013,
and by the State of Californina taxing authority for years before 2012.
The Company adopted the proportional amortization method of accounting for its low income housing
investments in the third quarter of 2014. The Company quantified the impact of adopting the proportional amortization
method compared to the equity method to its current year and prior period financial statements. The Company determined
that the adoption of the proportional amortization method did not have a material impact to its financial statements. The
low income housing investment losses, net of the tax benefits received, are included in income tax expense for all periods
reflected on the consolidated income statements.
The following table reflects the carrying amounts of the low income housing investments included in accrued
interest receivable and other assets, and the future commitments for the periods indicated:
December 31,
Low income housing investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Future commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
2015
2016
(Dollars in thousands)
3,880 $
365 $
4,304
1,271
The Company expects $14,000 of the future commitments to be paid in 2017, $14,000 in 2018, and $337,000 in
2019 through 2023.
For tax purposes, the Company had low income housing tax credits of $459,000 and $685,000 for the years ended
December 31, 2016 and December 2015, respectively, and low income housing investment losses of $282,000 and
$916,000, respectively. The Company recognized low income housing investment expense as a component of income tax
expense.
13) Equity Plan
The Company maintained an Amended and Restated 2004 Equity Plan (the “2004 Plan”) for directors, officers,
and key employees. The 2004 Plan was terminated on May 23, 2013. On May 23, 2013, the Company’s shareholders
approved the 2013 Equity Incentive Plan (the “2013 Plan”). The equity plans provide for the grant of incentive and
nonqualified stock options and restricted stock. The equity plans provide that the option price for both incentive and
nonqualified stock options will be determined by the Board of Directors at no less than the fair value at the date of grant.
Options granted vest on a schedule determined by the Board of Directors at the time of grant. Generally options vest over
four years. All options expire no later than ten years from the date of grant. Restricted stock is subject to time vesting. In
2016, the Company granted 300,500 shares of nonqualified stock options and 85,024 shares of restricted stock subject to
time vesting requirements. There were 601,765 shares available for the issuance of equity awards under the 2013 Plan as
of December 31, 2016.
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Stock option activity under the equity plans is as follows:
Weighted
Average
Weighted
Average Remaining
Exercise Contractual
Life (Years)
Price
Aggregate
Intrinsic
Value
Number
of Shares
Total Stock Options
Outstanding at January 1, 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,775,027 $ 10.62
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
300,500 $ 10.36
(147,416) $ 6.36
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(209,020) $ 20.01
Forfeited or expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Outstanding at December 31, 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . 1,719,091 $ 9.79
Vested or expected to vest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,615,946
Exercisable at December 31, 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,220,052
Information related to the equity plans for each of the last three years:
5.97 $ 9,508,526
5.97 $ 8,938,015
4.91 $ 7,068,780
Intrinsic value of options exercised . . . . . . . . . . . . . . . . . . $ 606,359 $ 216,681 $ 258,467
Cash received from option exercise . . . . . . . . . . . . . . . . . . $ 938,057 $ 315,076 $ 262,035
Tax benefit realized from option exercises . . . . . . . . . . . . $ 242,303 $ 85,411 $ 102,710
3.90
Weighted average fair value of options granted . . . . . . . . $
2.12 $
3.15 $
2016
2015
2014
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As of December 31, 2016, there was $1,394,000 of total unrecognized compensation cost related to nonvested
stock options granted under the equity plans. That cost is expected to be recognized over a weighted-average period of
approximately 2.54 years.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model
that uses the assumptions noted in the following table, including the weighted average assumptions for the option grants
in each year.
2016 2015 2014
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Expected life in months(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Volatility(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
57 %
Weighted average risk-free interest rate(2) . . . . . . . . . . . . . . . . . . . . . 1.41 % 1.57 % 2.09 %
Expected dividends(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.48 % 3.37 % 2.06 %
72
47 %
72
31 %
(1) The expected life of employee stock options represents the weighted average period the stock options are expected to
remain outstanding based on historical experience. Volatility is based on the historical volatility of the stock price
over the same period of the expected life of the option.
(2) Based on the U.S. Treasury constant maturity interest rate with a term consistent with the expected life of the option
granted.
(3) Each grant’s dividend yield is calculated by annualizing the most recent quarterly cash dividend and dividing that
amount by the market price of the Company’s common stock as of the grant date
The Company estimates the impact of forfeitures based on historical experience. Should the Company’s current
estimate change, additional expense could be recognized or reversed in future periods. The Company issues authorized
shares of common stock to satisfy stock option exercises.
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Restricted stock activity under the equity plans is as follows:
Total Restricted Stock Award
Nonvested shares at January 1, 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . 167,605 $
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
85,024 $
Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (47,214) $
(5,912) $
Forfeited or expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonvested shares at December 31, 2016 . . . . . . . . . . . . . . . . . . . . . 199,503 $
9.28
10.34
9.18
9.68
9.74
Weighted
Average Grant
Date Fair
Value
Number
of Shares
As of December 31, 2016, there was $1,525,000 of total unrecognized compensation cost related to nonvested
restricted stock awards granted under the 2004 Plan and 2013 Plan. The cost is expected to be recognized over a weighted-
average period of approximately 2.51 years.
14) Benefit Plans
401(k) Savings Plan
The Company offers a 401(k) savings plan that allows employees to contribute up to a maximum percentage of
their compensation, as established by the Internal Revenue Code. The Company made a discretionary matching
contribution of up to $2,000 and $1,500 for each employee’s contributions in 2016 and 2015, respectively. The Company
made a discretionary matching contribution of up to $1,000 for each employee’s contributions in 2014. Contribution
expense was $454,000, $342,000, and $206,000 in 2016, 2015 and 2014, respectively.
Employee Stock Ownership Plan
The Company sponsors a non-contributory employee stock ownership plan. To participate in this plan, an
employee must have worked at least 1,000 hours during the year and must be employed by the Company at year-end.
Employer contributions to the ESOP are discretionary. The Company has suspended contributions to the ESOP since 2010.
At December 31, 2016, the ESOP owned 123,027 shares of the Company’s common stock.
Deferred Compensation Plan
The Company has a nonqualified deferred compensation plan for some of its employees (“Deferral Agreements”).
Under the Deferral Agreements, a participant may defer up to 100% of his or her board fees into a deferred account. The
participant may elect a distribution schedule of up to ten years. Amounts deferred earn interest. The Company’s deferred
compensation obligation of $0 and $20,000 as of December 31, 2016 and 2015 is included in “Accrued interest payable
and other liabilities.”
The Company has purchased life insurance policies on the life of one of its former directors who has a Deferral
Agreement. It is expected that the earnings on these policies will offset the cost of the program. In addition, the Company
will receive death benefit payments upon the death of the former director. The proceeds will permit the Company to
“complete” the deferral program as the former director originally intended if he dies prior to the completion of the deferral
program. The disbursement of deferred fees is accelerated at death and commences one month after the former director
dies.
In the event of the former director’s disability prior to attainment of his benefit eligibility date, the former director
may request that the Board permit him to receive an immediate disability benefit equal to the annualized value of the
director’s deferral account.
Nonqualified Defined Benefit Pension Plan
The Company has a supplemental retirement plan covering some current and some former key executives and
directors (“SERP”). The SERP is an unfunded, nonqualified defined benefit plan. The combined number of active and
retired/terminated participants in the SERP was 52 at December 31, 2016. The defined benefit represents a stated amount
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for key executives and directors that generally vests over nine years and is reduced for early retirement. The projected
benefit obligation is included in “Accrued interest payable and other liabilities” on the consolidated balance sheets. The
SERP has no assets and the entire projected benefit obligation is unfunded. The measurement date of the SERP is
December 31.
The following table sets forth the SERP’s status at December 31:
2016
2015
(Dollars in thousands)
Change in projected benefit obligation:
Projected benefit obligation at beginning of year . . . . . . . . . . . . . . $ 26,287 $ 24,570
862
Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
805
Actuarial loss (gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
883
Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(833)
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Projected benefit obligation at end of year . . . . . . . . . . . . . . . . . . $ 27,376 $ 26,287
534
425
1,035
(905)
Amounts recognized in accumulated other comprehensive loss:
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
7,335 $
7,149
Weighted-average assumptions used to determine the benefit obligation at year-end:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.85 % 4.00 %
Rate of compensation increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . N/A N/A
2016 2015
Estimated benefit payments over the next ten years, which reflect anticipated future events, service and other
assumptions, are as follows:
Year
2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2021 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2022 to 2026 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Estimated
Benefit
Payments
(Dollars in thousands)
1,133
1,549
1,559
1,608
1,658
9,712
17,219
$
The components of pension cost for the SERP follow:
Components of net periodic benefit cost:
Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
862
Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,035
883
Amortization of net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
239
386
Net periodic benefit cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,808 $ 2,131
534 $
2016
2015
(Dollars in thousands)
The estimated net actuarial loss and prior service cost for the SERP that will be amortized from Accumulated
Other Comprehensive Loss into net periodic benefit cost over the next fiscal year are $276,000 and $239,000 as of
December 31, 2016 and 2015, respectively.
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Net periodic benefit cost was determined using the following assumption:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rate of compensation increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2016
4.00 %
N/A
2015
3.65 %
N/A
Split-Dollar Life Insurance Benefit Plan
The Company maintains life insurance policies for some current and some former directors and officers that are
subject to split-dollar life insurance agreements, which continues after the participant’s employment and retirement. All
participants are fully vested in their split-dollar life insurance benefits. The accrued benefit liability for the split-dollar
insurance agreements represents either the present value of the future death benefits payable to the participants’
beneficiaries or the present value of the estimated cost to maintain life insurance, depending on the contractual terms of
the participant’s underlying agreement.
The split-dollar life insurance projected benefit obligation is included in “Accrued interest payable and other
liabilities” on the consolidated balance sheets. The measurement date of the split-dollar life insurance benefit plan is
December 31.
The following sets forth the funded status of the split dollar life insurance benefits:
Change in projected benefit obligation:
Projected benefit obligation at beginning of year . . . . . . . . . . . . . . . $
Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actuarial (gain) loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Projected benefit obligation at end of year . . . . . . . . . . . . . . . . . . . $
6,215 $
248
(162)
6,301 $
4,641
169
1,405
6,215
2016
2015
(Dollars in thousands)
Amounts recognized in accumulated other comprehensive loss at December 31 consist of:
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Prior transition obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . $
2016
2015
(Dollars in thousands)
2,126 $
1,328
3,454 $
2,147
1,418
3,565
Weighted-average assumption used to determine the benefit obligation at year-end follow:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2016
3.85 %
2015
4.00 %
Components of net periodic benefit cost during the year are:
Amortization of prior transition obligation . . . . . . . . . . . . . . . . . . . . . . . $
Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net periodic benefit cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
2016
2015
(Dollars in thousands)
(51) $
248
197 $
(113)
169
56
The estimated net actuarial loss and prior transition obligation for the split-dollar life insurance benefit plan that
will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year are
$90,000 as of December 31, 2016 and 2015.
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Weighted-average assumption used to determine the net periodic benefit cost:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.00 % 3.65 %
2016 2015
15) Fair Value
Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of
inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability
to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical assets or liabilities in markets that are not active; or other inputs
that are observable or can be corroborated by observable market data (for example, interest rates and yield curves
observable at commonly quoted intervals, prepayment speeds, credit risks, and default rates).
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions
that market participants would use in pricing an asset or liability.
Financial Assets and Liabilities Measured on a Recurring Basis
The fair values of securities available-for-sale are determined by obtaining quoted prices on nationally recognized
securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to
value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the
securities’ relationship to other benchmark quoted securities (Level 2 inputs). The Company uses matrix pricing (Level 2
inputs) to establish the fair value of its securities available-for-sale.
The fair value of interest-only (“I/O”) strip receivable assets is based on a valuation model used by a third party.
The Company is able to compare the valuation model inputs and results to widely available published industry data for
reasonableness (Level 2 inputs).
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Fair Value Measurements Using
Significant
Quoted Prices in
Active Markets for Obeservable Unobservable
Significant
Other
Balance
Identical Assets
(Level 1)
Inputs
(Level 2)
(Dollars in thousands)
Inputs
(Level 3)
Assets at December 31, 2016
Available-for-sale securities:
Agency mortgage-backed securities . . . . . . . . . . . . . . . $ 290,989 $
Trust preferred securities . . . . . . . . . . . . . . . . . . . . . . . .
I/O strip receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15,600
1,067
— $ 290,989 $
—
—
15,600
1,067
Assets at December 31, 2015
Available-for-sale securities:
Agency mortgage-backed securities . . . . . . . . . . . . . . . $ 324,230 $
U.S. Treasury . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Trust preferred securities . . . . . . . . . . . . . . . . . . . . . . . .
U.S. Government sponsored entities . . . . . . . . . . . . . .
Corporate bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
I/O strip receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
30,003
15,132
9,041
6,673
1,367
— $ 324,230 $
30,003
—
—
—
—
—
15,132
9,041
6,673
1,367
—
—
—
—
—
—
—
—
—
There were no transfers between Level 1 and Level 2 during the year for assets measured at fair value on a
recurring basis.
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Financial Assets and Liabilities Measured on a Non-Recurring Basis
The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on
recent real estate appraisals. The appraisals may utilize a single valuation approach or a combination of approaches
including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the
appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually
significant and typically result in a Level 3 classification of the inputs for determining fair value.
Foreclosed assets are valued at the time the loan is foreclosed upon and the asset is transferred to foreclosed
assets. The fair value is based primarily on third party appraisals, less costs to sell. The appraisals may utilize a single
valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are
routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income
data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining
fair value.
Fair Value Measurements Using
Quoted Prices in
Significant
Active Markets for Observable Unobservable
Significant
Other
Balance
Identical Assets
(Level 1)
Inputs
(Level 2)
Inputs
(Level 3)
(Dollars in thousands)
Assets at December 31, 2016
Impaired loans - held-for-investment:
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Real estate:
CRE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
165
419
199
783
—
—
—
—
Foreclosed assets:
Land and construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
$
229
229
—
—
Assets at December 31, 2015
Impaired loans - held-for-investment:
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,333
Real estate:
CRE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Land and construction . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Home equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
503
219
647
$ 2,702
—
—
—
—
—
— $
1,333
—
—
—
— $
503
219
647
2,702
The following table shows the detail of the impaired loans held-for-investment and the impaired loans held-for-
investment carried at fair value for the periods indicated:
December 31, 2016 December 31, 2015
(Dollars in thousands)
Impaired loans held-for-investment:
Book value of impaired loans held-for-investment carried at fair value
Book value of impaired loans held-for-investment carried at cost . . . . .
Total impaired loans held-for-investment . . . . . . . . . . . . . . . . . . . . . . .
Impaired loans held-for-investment carried at fair value:
Book value of impaired loans held-for-investment carried at fair value
Specific valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impaired loans held-for-investment carried at fair value, net . . . . . . .
$
$
$
$
1,112 $
2,078
3,190 $
1,112 $
(329)
783 $
2,988
3,539
6,527
2,988
(286)
2,702
Impaired loans held-for-investment were $3,190,000 at December 31, 2016. There were no partial charge-offs at
December 31, 2016. In addition, these loans had a specific valuation allowance of $329,000 at December 31, 2016.
Impaired loans held-for-investment totaling $1,112,000 at December 31, 2016 were carried at fair value as a result of the
128
— $
165
—
—
— $
419
199
783
229
229
aforementioned partial charge-offs and specific valuation allowances at year-end. The remaining $2,078,000 of impaired
loans were carried at cost at December 31, 2016, as the fair value of the collateral exceeded the cost basis of each respective
loan. Partial charge-offs and changes in specific valuation allowances during 2016 on impaired loans held-for-investment
carried at fair value at December 31, 2016 resulted in an additional provision for loan losses of $320,000.
At December 31, 2016, foreclosed assets had a carrying amount of $229,000, with no valuation allowance at
December 31, 2016.
Impaired loans held-for-investment were $6,527,000 at December 31, 2015. There were no partial charge offs at
December 31, 2015. In addition, these loans had a specific valuation allowance of $286,000 at December 31, 2015.
Impaired loans held for investment totaling $2,988,000 at December 31, 2015 were carried at fair value as a result of the
aforementioned partial charge offs and specific valuation allowances at year end. The remaining $3,539,000 of impaired
loans were carried at cost at December 31, 2015, as the fair value of the collateral exceeded the cost basis of each respective
loan. Partial charge offs and changes in specific valuation allowances during 2015 on impaired loans held for investment
carried at fair value at December 31, 2015 resulted in an additional provision for loan losses of $156,000.
At December 31, 2015, foreclosed assets had a carrying amount of $364,000, with no valuation allowance at
December 31, 2015.
The following table presents quantitative information about level 3 fair value measurements for financial
instruments measured at fair value on a non-recurring basis, except for consumer loans, at December 31, 2016 and 2015:
Fair Value
Valuation
Techniques
Impaired loans - held-for-investment:
Commercial. . . . . . . . . . . . . . . . . . .
$
165 Market Approach
Real estate:
CRE . . . . . . . . . . . . . . . . . . . . . . . . .
419 Market Approach
Land and construction . . . . . . . . . .
199 Market Approach
Foreclosed assets:
Land and construction . . . . . . . . . .
229 Market Approach
December 31, 2016
Unobservable
Inputs
(Dollars in thousands)
Discount adjustment for
differences between
comparable sales
Discount adjustment for
differences between
comparable sales
Discount adjustment for
differences between
comparable sales
Discount adjustment for
differences between
comparable sales
Range
(Weighted Average)
Less than 1 %
0 % to 3 % (3)%
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Fair Value
Valuation
Techniques
December 31, 2015
Unobservable
Inputs
(Dollars in thousands)
Impaired loans - held-for-investment:
Commercial. . . . . . . . . . . . . . . . . . .
$ 1,333 Market Approach
Real estate:
CRE . . . . . . . . . . . . . . . . . . . . . . . . .
503 Market Approach
Land and construction . . . . . . . . . .
219 Market Approach
Home equity . . . . . . . . . . . . . . . . . .
647 Market Approach
Foreclosed assets:
Land and construction . . . . . . . . . .
31 Market Approach
Discount adjustment for
differences between
comparable sales
Discount adjustment for
differences between
comparable sales
Discount adjustment for
differences between
comparable sales
Discount adjustment for
differences between
comparable sales
Discount adjustment for
differences between
comparable sales
Range
(Weighted Average)
0% to 5% (5)%
0% to 3% (3)%
Less than 1 %
0% to 2% (2)%
Less than 1%
The Company obtains third party appraisals on its impaired loans held-for-investment and foreclosed assets to
determine fair value. Generally, the third party appraisals apply the “market approach,” which is a valuation technique that
uses prices and other relevant information generated by market transactions involving identical or comparable (that is,
similar) assets, liabilities, or a group of assets and liabilities, such as a business. Adjustments are then made based on the
type of property, age of appraisal, current status of property and other related factors to estimate the current value of
collateral.
The carrying amounts and estimated fair values of the Company’s financial instruments, at year-end were as
follows:
Assets:
December 31, 2016 Estimated Fair Value
Significant
Quoted Prices in
Active Markets for Observable Unobservable
Significant
Other
Carrying
Amounts
Identical Assets
(Level 1)
Inputs
(Level 2)
Inputs
(Level 3)
Total
(Dollars in thousands)
Cash and cash equivalents . . . . . . . . . . . . $ 266,103 $
Securities available-for-sale . . . . . . . . . .
Securities held-to-maturity . . . . . . . . . . .
Loans (including loans held-for-sale), net
FHLB stock, FRB stock, and other
investments . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest receivable . . . . . . . . . . .
I/O strips receivables . . . . . . . . . . . . . . . .
306,589
324,010
1,489,223
15,196
6,859
1,067
266,103 $
— $
—
—
—
—
—
306,589
318,748
5,705
—
1,961
1,067
— $ 266,103
306,589
—
318,748
—
1,541,190
1,535,485
—
4,898
—
N/A
6,859
1,067
Liabilities:
Time deposits . . . . . . . . . . . . . . . . . . . . . . $ 224,717 $
Other deposits . . . . . . . . . . . . . . . . . . . . . .
Accrued interest payable . . . . . . . . . . . . .
2,037,423
168
— $ 225,047 $
—
—
2,037,423
168
— $ 225,047
2,037,423
—
168
—
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Assets:
Carrying
Amounts
Identical Assets
(Level 1)
Inputs
(Level 2)
Inputs
(Level 3)
Total
(Dollars in thousands)
December 31, 2015 Estimated Fair Value
Significant
Quoted Prices in
Active Markets for Observable Unobservable
Significant
Other
Cash and cash equivalents . . . . . . . . . . . . $ 344,092 $
Securities available-for-sale . . . . . . . . . .
Securities held-to-maturity . . . . . . . . . . .
Loans (including loans held-for-sale), net
FHLB stock, FRB stock, and other
investments . . . . . . . . . . . . . . . . . . . . . . . .
Accrued interest receivable . . . . . . . . . . .
I/O strips receivables . . . . . . . . . . . . . . . .
385,079
109,311
1,347,087
12,694
5,043
1,367
344,092 $
30,003
—
—
—
—
—
355,076
109,821
7,297
—
1,654
1,367
— $
— $ 344,092
385,079
—
109,821
—
1,345,236
1,337,939
—
3,389
—
N/A
5,043
1,367
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Liabilities:
Time deposits . . . . . . . . . . . . . . . . . . . . . . $ 244,861 $
Other deposits . . . . . . . . . . . . . . . . . . . . . .
Short-term borrowings . . . . . . . . . . . . . . .
Accrued interest payable . . . . . . . . . . . . .
1,817,914
3,000
195
— $ 245,279 $
—
—
—
1,817,914
3,000
195
— $ 245,279
1,817,914
—
3,000
—
195
—
The methods and assumptions, not previously discussed, used to estimate the fair value are described as follows:
Cash and Cash Equivalents
The carrying amounts of cash on hand, noninterest and interest bearing due from bank accounts approximate fair
values and are classified as Level 1.
Loans
The fair value of loans held-for-sale is estimated based upon binding contracts and quotes from third party
investors resulting in a Level 2 classification.
Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice
frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3
classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently
being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification.
Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the
fair value of loans do not necessarily represent an exit price.
FHLB and FRB Stock
It was not practical to determine the fair value of FHLB and FRB stock due to the restrictions placed on
transferability.
Accrued Interest Receivable/Payable
The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification.
Deposits
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and
certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date
(i.e., their carrying amount) resulting in a Level 2 classification. The carrying amounts of variable rate, fixed-term money
market accounts approximate their fair values at the reporting date resulting in a Level 2 classification. The carrying
amounts of variable rate, certificates of deposit approximate their fair values at the reporting date resulting in a Level 2
classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that
131
applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on
time deposits resulting in a Level 2 classification.
Off-Balance Sheet Items
Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter
into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.
The fair value of commitments is not material.
Limitations
Fair value estimates are made at a specific point in time, based on relevant market information about the financial
instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time
the entire holdings of a particular financial instrument. Fair value estimates are based on judgments regarding future
expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other
factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore
cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
16) Commitments and Contingencies
Financial Instruments with Off-Balance Sheet Risk
HBC is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the
financing needs of its clients. These financial instruments include commitments to extend credit and standby letters of
credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts
recognized in the balance sheets.
HBC’s exposure to credit loss in the event of non-performance of the other party to the financial instrument for
commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments.
HBC uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet
instruments. Credit risk is the possibility that a loss may occur because a party to a transaction failed to perform according
to the terms of the contract. HBC controls the credit risk of these transactions through credit approvals, limits, and
monitoring procedures. Management does not anticipate any significant losses as a result of these transactions.
Commitments to extend credit were as follows:
Unused lines of credit and commitments to
December 31, 2016
December 31, 2015
Fixed
Rate
Variable
Rate
Fixed
Rate
Variable
Rate
(Dollars in thousands)
Standby letters of credit . . . . . . . . . . . . . . . . . . .
make loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,556 $ 565,166 $ 16,917 $ 539,897
13,458
$ 19,477 $ 577,003 $ 20,319 $ 553,355
11,837
3,921
3,402
Commitments generally expire within one year.
Standby letters of credit are written with conditional commitments issued by HBC to guarantee the performance
of a client to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in
extending loan facilities to clients.
The Company is required to maintain interest-bearing reserves. Reserve requirements are based on a percentage
of certain deposits. As of December 31, 2016, the Company maintained reserves of $28,167,000 in the form of vault cash
and balances at the Federal Reserve Bank of San Francisco, which satisfied the regulatory requirements.
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Loss Contingencies
The Company’s policy is to accrue for legal costs associated with both asserted and unasserted claims when it is
probable that such costs will be incurred and such costs can be reasonably estimated. A number of parties filed
complaints in the Superior Court of California for the County of Santa Clara asserting certain claims against the
Company arising from the transfer of funds. During the fourth quarter the Company reached settlements with each of the
parties in amounts not material to the Company.
17) Shareholders’ Equity and Earnings Per Share
Series C Preferred Stock—On June 21, 2010, the Company issued to various institutional investors 21,004 shares
of Series C Convertible Perpetual Preferred Stock (“Series C Preferred Stock”). The Series C Preferred Stock was
mandatorily convertible into 5,601,000 shares of common stock at a conversion price of $3.75 per share upon a subsequent
transfer of the Series C Preferred Stock to third parties not affiliated with the holder in a widely dispersed offering. The
Series C Preferred Stock was non-voting except in the case of certain transactions that would affect the rights of the holders
of the Series C Preferred Stock or applicable law. The holders of Series C Preferred Stock received dividends on an as
converted basis when dividends were also declared for holders of common stock. The Series C Preferred Stock was not
redeemable by the Company or by the holders and had a liquidation preference of $1,000 per share. The Series C Preferred
Stock ranked senior to the Company’s common stock.
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 21,003.75 shares of the Company's Series C convertible perpetual stock, no par value
(“Series C Preferred Stock”) for 5,601,000 shares of the Company's common stock, no par value. 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.
Dividends—On January 26, 2017, the Company announced that its Board of Directors declared a $0.10 per share
quarterly cash dividend to holders of common stock and Series C preferred stock (on an as converted basis). The dividend
was paid on February 24, 2017, to shareholders of record at close of business day on February 10, 2017.
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Earnings Per Share—Basic earnings per common share is computed by dividing net income, less dividends and
discount accretion on preferred stock, by the weighted average common shares outstanding. The Series C Preferred Stock
participated in the earnings of the Company prior to the exchange for common stock and, therefore, the shares issued on
the conversion of the Series C Preferred Stock were considered outstanding under the two-class method of computing
basic earnings per common share during periods of earnings. Diluted earnings per share reflect potential dilution from
outstanding stock options using the treasury stock method. A reconciliation of these factors used in computing basic and
diluted earnings per common share is as follows:
Year Ended December 31,
2015
(Dollars in thousands, except per share amounts)
2014
2016
Net income available to common shareholders .
Less: undistributed earnings allocated to
Series C Preferred Stock . . . . . . . . . . . . . . . . . .
Distributed and undistributed earnings
$
25,869 $
14,705 $
$ 12,419
(1,278)
(912)
(1,342)
allocated to common shareholders . . . . . . . .
$
24,591 $
13,793 $
11,077
Weighted average common shares outstanding
for basic earnings per common share . . . . . . . .
33,933,806
28,567,213
26,390,615
Dilutive effect of stock options oustanding,
using the the treasury stock method . . . . . . . . .
Shares used in computing diluted earnings
285,315
218,865
135,667
per common share . . . . . . . . . . . . . . . . . . . .
34,219,121
28,786,078
26,526,282
Basic earnings per share . . . . . . . . . . . . . . . . . . . .
Diluted earnings per share . . . . . . . . . . . . . . . . . .
$
$
0.72 $
0.72 $
0.48 $
0.48 $
0.42
0.42
18) Capital Requirements
The Company and its subsidiary bank are subject to various regulatory capital requirements administered by the
banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional
discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial
statements and operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action,
the Company and HBC must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and
certain off balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. There are no
conditions or events since December 31, 2016, that management believes have changed the categorization of the Company
or HBC as well-capitalized.”
As of January 1, 2015, HCC and HBC along with other community banking organizations became subject to new
capital requirements and certain provisions of the new rules will be phased in from 2015 through 2019. The Federal
Banking regulators approved the new rules to implement the revised capital adequacy standards of the Basel Committee
on Banking Supervision, commonly called Basel III, and address relevant provisions of The Dodd Frank Wall Street
Reform and Consumer Protection Act of 2010, as amended. The Company’s consolidated capital ratios 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.
Quantitative measures established by regulation to help ensure capital adequacy require the Company and HBC
to maintain minimum amounts and ratios (set forth in the tables below) of total, Tier 1 capital, and common equity Tier 1
capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital to average assets (as
defined). Management believes that, as of December 31, 2016 and December 31, 2015, the Company and HBC met all
capital adequacy guidelines to which they were subject.
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The Company’s consolidated capital amounts and ratios are presented in the following table, together with capital
adequacy requirements, under the Basel III regulatory requirements as of December 31, 2016, and December 31, 2015.
As of December 31, 2016
Total Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(to risk-weighted assets)
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(to risk-weighted assets)
Common Equity Tier 1 Capital . . . . . . . . . . . . . . . . . . . . .
(to risk-weighted assets)
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(to average assets)
Required For
Capital
Adequacy
Purposes
Under Basel III
Ratio
(Dollars in thousands)
Amount
Ratio (1)
Actual
Amount
$ 234,629
12.5 % $ 161,868
8.625 %
$ 214,924
11.5 % $ 124,333
6.625 %
$ 214,924
11.5 % $
96,183
5.125 %
$ 214,924
8.5 % $ 100,625
4.000 %
(1) Includes 0.625% capital conservation buffer, effective January 1, 2016, except the Tier 1 Capital to average assets
ratio.
As of December 31, 2015
Total Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(to risk-weighted assets)
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(to risk-weighted assets)
Common Equity Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . .
(to risk-weighted assets)
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(to average assets)
Required For
Capital
Adequacy
Purposes
Under Basel III
Ratio
Amount
(Dollars in thousands)
Ratio
Actual
Amount
$ 218,915
12.5 % $ 140,041
8.0 %
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11.4 % $ 105,031
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$ 181,221
10.4 % $
78,773
4.5 %
$ 199,299
8.6 % $
92,918
4.0 %
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HBC’s actual capital amounts and ratios are presented in the following table, together with capital adequacy
requirements, under the Basel III regulatory requirements as of December 31, 2016, and December 31, 2015.
Actual
To Be Well-Capitalized
Under Basel III Regulatory
Requirements
Required For
Capital
Adequacy
Purposes
Under Basel III
Amount
Ratio
Amount
Ratio
Amount
Ratio (1)
(Dollars in thousands)
As of December 31, 2016
Total Capital . . . . . . . . . . . . . . . . . . . . . . . $ 231,069
(to risk-weighted assets)
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . $ 211,364
(to risk-weighted assets)
Common Equity Tier 1 Capital . . . . . . . . $ 211,364
(to risk-weighted assets)
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . $ 211,364
(to average assets)
12.3 % $ 187,602
10.0 % $ 161,807
8.625 %
11.3 % $ 150,082
8.0 % $ 124,287
6.625 %
11.3 % $ 121,942
6.5 % $ 96,146
5.125 %
8.4 % $ 125,746
5.0 % $ 100,597
4.000 %
(1) Includes 0.625% capital conservation buffer, effective January 1, 2016, except the Tier 1 Capital to average assets
ratio.
Actual
Amount
Ratio
To Be Well-Capitalized
Under Basel III Regulatory
Requirements
Amount
Ratio
(Dollars in thousands)
Required For
Capital
Adequacy
Purposes
Under Basel III
Amount
Ratio
As of December 31, 2015
Total Capital . . . . . . . . . . . . . . . . . . . . . . . $ 219,943
(to risk-weighted assets)
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . $ 200,327
(to risk-weighted assets)
Common Equity Tier 1 Capital . . . . . . . . $ 200,327
(to risk-weighted assets)
Tier 1 Capital . . . . . . . . . . . . . . . . . . . . . . . $ 200,327
(to average assets)
12.6 % $
175,022
10.0 % $ 140,018
8.0 %
11.4 % $
140,018
8.0 % $ 105,013
6.0 %
11.4 % $
113,764
6.5 % $ 78,760
4.5 %
8.6 % $
116,112
5.0 % $ 92,889
4.0 %
HCC is dependent upon dividends from HBC. Under California General Corporation Law, the holders of common
stock are entitled to receive dividends when and as declared by the Board of Directors, out of funds legally available. The
California Financial Code provides that a state licensed bank may not make a cash distribution to its shareholders in excess
of the lesser of the following: (i) the bank’s retained earnings; or (ii) the bank’s net income for its last three fiscal years,
less the amount of any distributions made by the bank to its shareholders during such period. However, a bank, with the
prior approval of the Commissioner of the California Department of Business Oversight—Division of Financial
Institutions (“DBO”) may make a distribution to its shareholders of an amount not to exceed the greater of (i) a bank’s
retained earnings; (ii) its net income for its last fiscal year; or (iii) its net income for the current fiscal year. Also with the
prior approval of the Commissioner of the DBO and the shareholders of the bank, the bank may make a distribution to its
shareholders, as a reduction in capital of the bank. In the event that the Commissioner determines that the shareholders’
equity of a bank is inadequate or that the making of a distribution by a bank would be unsafe or unsound, the Commissioner
may order a bank to refrain from making such a proposed distribution. As of December 31, 2016, HBC would not be
required to obtain regulatory approval, and the amount available for cash dividends is $4,361,000. Similar restrictions
applied to the amount and sum of loan advances and other transfers of funds from HBC to the parent company. HBC
distributed dividends totaling $18,000,000 for the year ended December 31, 2016.
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19) Noninterest Expense
The following table indicates the percentage of noninterest expense in each category for the periods indicated:
2016
Year Ended December 31,
2015
(Dollars in thousands)
2014
Salaries and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 34,660 $ 35,146 $ 26,250
4,053
Occupancy and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,891
Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
999
Software subscriptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
510
Amortization on intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
969
Data processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,126
Insurance expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
892
FDIC deposit insurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
53
Foreclosed assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
895
Acquisition and integration related costs(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6,584
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 57,639 $ 58,673 $ 44,222
4,300
1,828
1,214
1,043
1,371
1,127
1,092
(94)
3,546
8,100
4,378
3,471
1,573
1,568
1,331
1,275
1,160
25
—
8,198
(1) Does not include pre-tax severance and retention cost of $2,887,000, which is included in salaries and employee
benefits for the year ended December 31, 2015.
20) Business Segment Information
The following presents the Company’s operating segments. The Company operates through two business
segments: Banking segment and Factoring segment. Transactions between segments consist primarily of borrowed funds.
Intersegment interest expense is allocated to the Factoring segment based on the Company’s prime rate and funding costs.
The provision for loan loss is allocated based on the segment’s allowance for loan loss determination which considers the
effects of charge-offs. Noninterest income and expense directly attributable to a segment are assigned to it. Taxes are paid
on a consolidated basis and allocated for segment purposes. The Factoring segment includes only factoring originated by
Bay View Funding, which has been included in the results of operations since the acquisition on November 1, 2014.
At or for Year Ended December 31, 2016
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Consolidated
82,175 $
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
1,163
Intersegment interest allocations . . . . . . . . . . . . . .
3,211
Total interest expense . . . . . . . . . . . . . . . . . . . . . . .
80,127
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . .
1,181
Provision for loan losses . . . . . . . . . . . . . . . . . . . .
78,946
Net interest income after provision . . . . . . . . . . . .
10,821
Noninterest income. . . . . . . . . . . . . . . . . . . . . . . . .
50,298
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . .
804
Intersegment expense allocations . . . . . . . . . . . . .
40,273
Income before income taxes . . . . . . . . . . . . . . . . .
15,036
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . .
25,237 $
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,507,121 $
Loans, net of deferred fees . . . . . . . . . . . . . . . . . . $ 1,452,991 $
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
32,620 $
—
Factoring
(Dollars in thousands)
12,256 $
(1,163)
—
11,093
56
11,037
804
7,341
(804)
3,696
1,552
2,144 $
63,759 $
49,616 $
13,044 $
94,431
—
3,211
91,220
1,237
89,983
11,625
57,639
—
43,969
16,588
27,381
2,570,880
1,502,607
45,664
(1) Includes the holding company’s results of operations
137
At or for Year Ended December 31, 2015
Banking(1)
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
66,306 $
Intersegment interest allocations . . . . . . . . . . . . . .
1,087
Total interest expense . . . . . . . . . . . . . . . . . . . . . . .
2,422
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . .
64,971
Provision (credit) for loan losses . . . . . . . . . . . . . .
(156)
Net interest income after provision . . . . . . . . . . . .
65,127
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . .
8,234
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . .
51,438
Intersegment expense allocations . . . . . . . . . . . . . .
386
Income before income taxes . . . . . . . . . . . . . . . . .
22,309
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . .
8,301
14,008 $
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,306,543 $
Loans, net of deferred fees . . . . . . . . . . . . . . . . . . $ 1,318,657 $
32,620 $
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Consolidated
Factoring
(Dollars in thousands)
12,437 $
78,743
(1,087)
—
—
2,422
11,350
76,321
188
32
11,162
76,289
751
8,985
7,235
58,673
(386)
—
4,292
26,601
1,803
10,104
16,497
2,489 $
55,036 $ 2,361,579
40,059 $ 1,358,716
13,044 $
45,664
(1) Includes the holding company’s results of operations
At or for Year Ended December 31, 2014
Banking(1)
57,178 $
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
31
Intersegment interest allocations . . . . . . . . . . . . . .
2,033
Total interest expense . . . . . . . . . . . . . . . . . . . . . . .
55,176
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . .
(338)
Provision (credit) for loan losses . . . . . . . . . . . . . .
55,514
Net interest income after provision . . . . . . . . . . . .
7,662
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . .
43,132
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . .
20,044
Income before income taxes . . . . . . . . . . . . . . . . .
7,151
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . .
12,893 $
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,561,911 $
Loans, net of deferred fees . . . . . . . . . . . . . . . . . . $ 1,048,631 $
— $
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Factoring (2) Consolidated
(Dollars in thousands)
2,078 $
(31)
120
1,927
—
1,927
84
1,090
921
387
534 $
59,256
—
2,153
57,103
(338)
57,441
7,746
44,222
20,965
7,538
13,427
55,192 $ 1,617,103
40,012 $ 1,088,643
13,044 $
13,044
(1) Includes the holding company’s results of operations
(2) Includes two months of Bay View Funding’s results of operation
138
21) Parent Company only Condensed Financial Information
The condensed financial statements of Heritage Commerce Corp (parent company only) are as follows:
Condensed Balance Sheets
Assets
December 31,
2016
2015
(Dollars in thousands)
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Investment in subsidiary bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,686
246,357
400
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 259,850 $ 248,443
256,174
825
2,851 $
Liabilities and Shareholder’s Equity
Short-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shareholder’s equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,000
7
245,436
Total liabilities and shareholder’s equity . . . . . . . . . . . . . . . . . . . . . . . . $ 259,850 $ 248,443
—
—
259,850
Condensed Statements of Operations
2016
Year Ended December 31,
2015
(Dollars in thousands)
2014
Dividend from subsidiary bank . . . . . . . . . . . . . . . . . . . . . . . . . $ 18,000 $
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(11)
(2,568)
— $
(18)
(2,705)
—
—
(2,033)
Income (loss) before income taxes and equity in net
income of subsidiary bank . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity in net income of subsidiary bank:
15,421
(2,723)
(2,033)
Net income of subsidiary bank . . . . . . . . . . . . . . . . . . . . . . .
Income tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends and discount accretion on preferred stock . . . . . . . .
14,614
846
13,427
(1,008)
Net income available to common shareholders . . . . . . . . . . $ 25,869 $ 14,705 $ 12,419
10,897
1,063
27,381
(1,512)
18,081
1,139
16,497
(1,792)
Condensed Statements of Cash Flows
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Year Ended December 31,
2015
(Dollars in thousands)
2014
Cash flows from operating activities:
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 27,381 $ 16,497 $ 13,427
Adjustments to reconcile net income to net cash provided by (used in) operations:
Amortization of restricted stock award, net of forfeitures and taxes . . . . . . . . . . .
Equity in undistributed loss/(net income) of subsidiary bank . . . . . . . . . . . . . . . . .
Net change in other assets and liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by (used in) operating activities . . . . . . . . . . . . . . . . . . . . . . .
479
(10,897)
(109)
16,854
265
(18,081)
269
(1,050)
(9)
(14,614)
(2,158)
(3,354)
Cash flows from financing activities:
Net change in purchased funds and other short-term borrowings . . . . . . . . . . . . . .
Payment of cash dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Proceeds from issuance of common stock, net of issuance costs . . . . . . . . . . . . . .
Net cash used in financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
(5,758)
262
(5,496)
(8,850)
19,009
Cash and cash equivalents, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,851 $ 1,686 $ 10,159
3,000
(10,738)
315
(7,423)
(8,473)
10,159
(3,000)
(13,627)
938
(15,689)
1,165
1,686
139
22) Quarterly Financial Data (Unaudited)
The following table discloses the Company’s selected unaudited quarterly financial data:
12/31/2016 9/30/2016 6/30/2016 3/31/2016
Quarter Ended
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net interest income after provision for loan losses . . . . . . . . . . . . . .
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends on preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income available to common shareholders . . . . . . . . . . . . . . . . . . . .
Undistributed earnings allocated to Series C Preferred Stock . . . . . . . .
Distributed and undistributed earnings allocated to common
(Dollars in thousands, except per share amounts)
23,991 $ 23,874 $ 23,504 $ 23,062
758
22,304
401
21,903
2,614
14,685
9,832
3,726
6,106
(504)
5,602
(403)
760
22,744
351
22,393
3,660
14,381
11,672
4,377
7,295
(504)
6,791
(575)
867
23,124
240
22,884
3,039
14,277
11,646
4,431
7,215
—
7,215
—
826
23,048
245
22,803
2,312
14,296
10,819
4,054
6,765
(504)
6,261
(300)
shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
7,215 $
5,961 $ 6,216 $ 5,199
Earnings per common share
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
0.19 $
0.19 $
0.18 $
0.18 $
0.19 $
0.19 $
0.16
0.16
Quarter Ended (1)
12/31/2015 9/30/2015 6/30/2015 3/31/2015
(Dollars in thousands, except per share amounts)
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 22,896 $ 20,306 $ 18,175 $ 17,366
508
Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
16,858
Net interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(60)
Provision for loan losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
16,918
Net interest income after provision for loan losses . . . . . . . . . . . . . . .
1,926
Noninterest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12,276
Noninterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6,568
Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,430
Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4,138
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(448)
Dividends on preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,690
Net income available to common shareholders . . . . . . . . . . . . . . . . . . . . .
Undistributed earnings allocated to Series C Preferred Stock . . . . . . . . .
(274)
Distributed and undistributed earnings allocated to common
623
19,683
(301)
19,984
2,066
16,419
5,631
2,172
3,459
(448)
3,011
(111)
533
17,642
22
17,620
2,164
12,617
7,167
2,690
4,477
(448)
4,029
(331)
758
22,138
371
21,767
2,829
17,361
7,235
2,812
4,423
(448)
3,975
(209)
shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,766 $ 2,900 $ 3,698 $ 3,416
Earnings per common share
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
0.12 $
0.12 $
0.10 $
0.10 $
0.14 $
0.14 $
0.13
0.13
(1) Pre-tax severance, retention and acquisition and integration costs included in noninterest expense were $2,991,000,
$2,865,000, $423,000, and $119,000, for the fourth, third, second, and first quarters of 2015, respectively.
140
Exhibit
Number
Description
EXHIBIT INDEX
2.1 Agreement and Plan of Merger, dated April 23, 2015, by and among Heritage Commerce Corp, Heritage
Bank of Commerce and Focus Business Bank (incorporated by reference from the Registrant’s Current
Report on Form 8-K filed on April 23, 2015)
3.1 Restated Articles of Incorporation of Heritage Commerce Corp (incorporated by reference from the
Registrant’s Annual Report on Form 10-K filed on March 4, 2010)
3.2 Certificate of Amendment of Articles of Incorporation of Heritage Commerce Corp, as filed with the
California Secretary of State on June 1, 2010 (incorporated by reference from the Registration Statement on
Form S-1 filed July 23, 2010)
3.3 Bylaws, as amended, of Heritage Commerce Corp (incorporated by reference from the Registrant’s Current
Report Form 8-K filed June 28, 2013)
10.1 Real Property Lease for Registrant’s Principle Office dated April 13, 2000 (incorporated by reference from
Registrant’s Annual Report on Form 10-K filed on March 6, 2015)
10.2 Sixth Amendment to Lease for Registrant’s Principle Office dated November 17, 2014 (incorporated by
reference from Registrant’s Annual Report on Form 10-K filed on March 6, 2015)
*10.3 Heritage Commerce Corp Management Incentive Plan (incorporated herein by reference from the
Registrant’s Current Report on Form 8-K filed May 3, 2005)
*10.4 Amended and Restated 2004 Equity Plan (incorporated herein by reference from the Registrant’s Current
Report on Form 8-K filed June 2, 2009)
*10.5 Restricted Stock Agreement with Walter Kaczmarek dated March 17, 2005 (incorporated herein by reference
from the Registrant’s Current Report on Form 8-K filed March 22, 2005)
*10.6 2004 Stock Option Agreement with Walter Kaczmarek dated March 17, 2005 (incorporated herein by
reference from the Registrant’s Current Report on Form 8-K filed March 22, 2005)
*10.7 Non-qualified Deferred Compensation Plan (incorporated herein by reference from the Registrant’s Annual
Report on Form 10-K filed March 31, 2005)
*10.8 Amended and Restated Employment Agreement with Walter Kaczmarek, dated October 17, 2007
(incorporated herein by reference from the Registrant’s Current Report on Form 8-K filed October 22, 2007)
*10.9 Amended and Restated Employment Agreement with Lawrence McGovern, dated July 21, 2011
(incorporated herein by reference from the Registrant’s Current Report on Form 8-K filed July 21, 2011)
*10.10 Employment Agreement with Michael E. Benito, dated February 1, 2012 (incorporated by reference from
the Registrant’s Current Report on Form 8-K filed February 1, 2012)
*10.11 Employment Agreement with David Porter, dated June 25, 2012 (incorporated by reference from the
Registrant’s Current Report on Form 8-K filed June 25, 2012)
*10.12 Employment Agreement with Keith Wilton, dated February 18, 2014 (incorporated by reference from the
Registrant’s Current Report on Form 8-K filed February 20, 2014)
*10.13 Form of Stock Option Agreement For Amended and Restated 2004 Equity Plan (incorporated by reference
from the Registrant’s Annual Report on Form 10-K filed March 9, 2012)
*10.14 Form of Restricted Stock Agreement For Amended and Restated 2004 Equity Plan (incorporated by reference
from the Registrant’s Annual Report on Form 10-K filed March 9, 2012)
*10.15 2013 Equity Incentive Plan (incorporated by reference from the Registrant’s Registration Statement in
Form S-8 filed July 15, 2013)
*10.16 Form of Restricted Stock Agreement For 2013 Equity Incentive Plan (incorporated by reference from the
Registrant’s Registration Statement on Form S-8 filed July 15, 2013)
*10.17 Form of Stock Option Agreement for 2013 Equity Incentive Plan (incorporated by reference from the
Registrant’s Registration Statement on Form S-8 filed July 15, 2013)
*10.18 2005 Amended and Restated Heritage Commerce Corp Supplemental Retirement Plan (incorporated herein
by reference from the Registrant’s Current Report on Form 8-K filed September 30, 2008)
*10.19 Form of Endorsement Method Split Dollar Plan Agreement for Executive Officers (incorporated herein by
reference from the Registrant’s Annual Report on Form 10-K filed March 17, 2008)
*10.20 Form of Endorsement Method Split Dollar Plan Agreement for Directors (incorporated herein by reference
from the Registrant’s Annual Report on Form 10-K filed March 17, 2008)
*10.21 Amendment No. 1 to Employment Agreement, dated December 29, 2008 between the Company and Walter
T. Kaczmarek (incorporated herein by reference from the Registrant’s Current Report on Form 8-K filed
January 2, 2009)
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Exhibit
Number
Description
*10.22 First Amended and Restated Director Compensation Benefits Agreement dated December 29, 2008 between
Jack Conner and the Company (incorporated herein by reference from the Registrant’s Current Report on
Form 8-K filed January 2, 2009)
*10.23 First Amended and Restated Director Compensation Benefits Agreement dated December 29, 2008 between
Frank Bisceglia and the Company (incorporated herein by reference from the Registrant’s Current Report on
Form 8-K filed January 2, 2009)
*10.24 First Amended and Restated Director Compensation Benefits Agreement dated December 29, 2008 between
Robert Moles and the Company (incorporated herein by reference from the Registrant’s Current Report on
Form 8-K filed January 2, 2009)
*10.25 First Amended and Restated Director Compensation Benefits Agreement dated December 29, 2008 between
Ranson Webster and the Company (incorporated herein by reference from the Registrant’s Current Report
on Form 8-K filed January 2, 2009)
10.26 Form of Indemnification Agreement between the Registrant and its directors and executive officers
(incorporated herein by reference from the Registrant’s Current Report on Form 8-K filed December 23,
2009)
10.27 Stock Purchase Agreement, between Heritage Bank of Commerce, BVF Acquisition Corp and the
stockholders named therein dated October 8, 2014 (incorporated herein from the Registrant’s Current Report
on Form 8-K, as filed October 9, 2014)
21.1 Subsidiaries of the Registrant
23.1 Consent of Crowe Horwath LLP
31.1 Certification of Registrant’s Chief Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of
2002
31.2 Certification of Registrant’s Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act of
2002
32.1 Certification of Registrant’s Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2 Certification of Registrant’s Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
101.INS XBRL Instance Document, filed herewith
101.SCH XBRL Taxonomy Extension Schema Document, filed herewith
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document, filed herewith
101.DEF XBRL Taxonomy Extension Definition Linkbase Document, filed herewith
101.LAB XBRL Taxonomy Extension Label Linkbase Document, filed herewith
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document, filed herewith
* Management contract or compensatory plan or arrangement.
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Exhibit 31.1
CERTIFICATIONS UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
REGARDING THE ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2016
I, Walter T. Kaczmarek, certify that:
1.
Commerce Corp;
I have reviewed this Annual Report on Form 10-K for the Year Ended December 31, 2016 of Heritage
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of,
and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
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Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
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(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting
that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal
control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of
directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record,
process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 3, 2017
/s/ WALTER T. KACZMAREK
Walter T. Kaczmarek
President and Chief Executive Officer
Heritage Commerce Corp
Exhibit 31.2
CERTIFICATIONS UNDER SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
REGARDING THE ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2016
I, Lawrence D. McGovern, certify that:
1.
Commerce Corp;
I have reviewed this Annual Report on Form 10-K for the Year Ended December 31, 2016 of Heritage
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of,
and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting
that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of
an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal
control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of
directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record,
process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 3, 2017
/s/ LAWRENCE D. MCGOVERN
Lawrence D. McGovern
Executive Vice President and Chief Financial Officer
Heritage Commerce Corp
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
REGARDING THE ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2016
Exhibit 32.1
In connection with the Annual Report of Heritage Commerce Corp (the “Company”) on Form 10-K for the year
ended December 31, 2016 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I,
Walter T. Kaczmarek, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1)
(2)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934; and
The information contained in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
March 3, 2017
/s/ WALTER T. KACZMAREK
Walter T. Kaczmarek
President and Chief Executive Officer
Heritage Commerce Corp
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CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
REGARDING THE ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2016
Exhibit 32.2
In connection with the Annual Report of Heritage Commerce Corp (the “Company”) on Form 10-K for the year
ended December 31, 2016 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I,
Lawrence D. McGovern, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1)
(2)
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange
Act of 1934; and
The information contained in the Report fairly presents, in all material respects, the financial condition
and results of operations of the Company.
March 3, 2017
/s/ LAWRENCE D. MCGOVERN
Lawrence D. McGovern
Executive Vice President and Chief Financial Officer
Heritage Commerce Corp
To Our Shareholders
April 19, 2017
Dear Fellow Shareholders:
2016 was a strong year for Heritage Commerce Corp. We delivered the most profitable year since we opened our doors in 1994.
Net income was a record $27.4 million, a 66% increase over 2015. Total assets exceeded $2.57 billion at year end, the return on
average tangible assets was 1.15%, and the return on average tangible equity was 13.55%, for full year 2016. We made important
investments in our long-term growth strategy achieving robust deposit and loan increases while maintaining solid credit quality.
Our outstanding financial performance was a direct result of the tremendous efforts of our experienced management team and
banking professionals who work diligently with our customers to help them achieve their financial goals.
2016 Highlights:
• Our net income grew 66% for the year to $27.4 million, or $0.72 per diluted share.
• Total revenue was higher by 21% from 2015, reflecting solid earning asset growth.
• In the first quarter of 2016, we raised our quarterly cash dividend 12.5% to $0.09 per share and continued to pay $0.09
per share each consecutive quarter for the remainder of the year. The quarterly cash dividend was raised an additional
11% to $0.10 per share in January 2017.
• In April 2016, Heritage Commerce Corp was named one of the top performing banks for 2015, by S&P Global Market
Intelligence, measured by six core financial performance metrics that focus on profitability, asset quality and growth for the
12-month period ended December 31, 2015. We are delighted to have continued that momentum throughout 2016.
• We generated robust deposit growth for the year, increasing deposits 10% over 2015, with noninterest-bearing deposits increasing
12%. As a result of focusing on relationship banking, we have established a loyal customer base with stable deposits.
• In addition, we had solid loan growth with loans, excluding loans held-for-sale, increasing 11% for the year. Our specialization
in a variety of business lines including dental, nonprofit organizations, contractors, education, churches, and homeowner
associations has led to sustained loan and deposit growth over the years.
• Our credit metrics continued to improve with nonperforming assets decreasing 51% from December 31, 2015, to $3.3 million,
or 0.13% of total assets, at year end. We believe our allowance for loan losses at 1.27% of total loans, remains sufficient.
• Heritage Commerce Corp ended the year with a total risk-based capital ratio of 12.5%, Tier 1 risk-based capital ratio and
common equity Tier 1risk-based ratio of 11.5%, and a leverage ratio of 8.5%. All capital ratios exceeded regulatory guidelines
for a “well-capitalized” financial institution under the Basel III regulatory requirements.
Additionally, we support our communities by investing financially and with time/effort of our employees in many nonprofit
entities that benefit those areas. In 2016, we invested approximately $700,000 into our communities through nonprofits
and our employees volunteered over 2,500 hours. We are extremely proud of our employees who work hard to create value
for our customers, communities, and shareholders.
We had an exceptional year, and our fundamentals are solid. With a strong core funding base, we are well positioned for growth
as we enter 2017. We will continue providing quality products and services to our customers and offer exceptional value to our
shareholders from a position of strength and stability. Please join us for our annual meeting on Thursday, May 25, 2017, at 1:00 p.m.
at our corporate headquarters in San Jose.
Sincerely,
Board of Directors
Jack W. Conner, Chairman
Julianne Biagini-Komas
Frank G. Bisceglia
J. Philip DiNapoli
Steven L. Hallgrimson
Walter T. Kaczmarek
Robert T. Moles
Laura Roden
Ranson W. Webster
Executive Management
Walter T. Kaczmarek
President and Chief Executive Officer
Keith A. Wilton
President, Heritage Bank of Commerce
Chief Operating Officer
Michael E. Benito
Executive Vice President
Banking Division
William J. Del Biaggio, Jr .
Executive Vice President
Marketing & Community Relations
Robert P. Gionfriddo
Executive Vice President
Director of Business Development
Lawrence D. McGovern
Executive Vice President
Chief Financial Officer
David E. Porter
Executive Vice President
Chief Credit Officer
Teresa L. Powell
Executive Vice President
Director of HOA & Deposit Services
Deborah K. Reuter
Executive Vice President
Chief Risk Officer & Corporate Secretary
Larry G. St.Regis
Executive Vice President
Chief Technology Officer
May K.Y. Wong
Executive Vice President
Controller
Subsidiary Bank Offices
Heritage Bank of Commerce
San Jose Main
150 Almaden Boulevard
San Jose, CA 95113
408.947.6900
Danville
387 Diablo Road
Danville, CA 94526
925.314.2851
Fremont
3137 Stevenson Boulevard
Fremont, CA 94538
510.445.0400
Gilroy
7598 Monterey Street
Suite 110
Gilroy, CA 95020
408.842.8310
Hollister
351 Tres Pinos Road
Suite 102A
Hollister, CA 95023
831.637.2152
Los Altos
419 S. San Antonio Road
Los Altos, CA 94022
650.941.9300
Los Gatos
15575 Los Gatos Boulevard
Building B
Los Gatos, CA 95032
408.356.6190
Morgan Hill
18625 Sutter Boulevard
Suite 100
Morgan Hill, CA 95037
408.778.2320
Pleasanton
300 Main Street
Pleasanton, CA 94566
925.314.2876
Corporate Information
Sunnyvale
333 W. El Camino Real
Suite 150
Sunnyvale, CA 94087
650.919.2159
Walnut Creek
101 Ygnacio Valley Road
Suite 100
Walnut Creek, CA 94596
925.930.9287
Bay View Funding
Administrative Office
2933 Bunker Hill Lane
Suite 210
Santa Clara, CA 95054
650.294.6600
Heritage Commerce Corp
Investor Relations Contact
Deborah K. Reuter
Executive Vice President
Chief Risk Officer & Corporate Secretary
Transfer Agent
Wells Fargo Bank, N.A.
Shareowner Services
1110 Centre Pointe Curve
Suite 101
Mendota Heights, MN 55120
1.800.468.9716
Independent Auditors
Crowe Horwath LLP
400 Capitol Mall
Suite 1400
Sacramento, CA 95814
916.441.1000
Corporate Counsel
Buchalter
A Professional Corporation
1000 Wilshire Boulevard
Suite 1500
Los Angeles, CA 90017
213.891.0700
Jack W. Conner
Chairman of the Board
Walter T. Kaczmarek
President and Chief Executive Officer
To get further information on Heritage Commerce Corp, or to receive regular financial updates,
please visit our web site at HeritageCommerceCorp.com and click on “Information Request.”
Member FDIC
2016 ANNUAL REPORT ON FORM 10-K
2017 Notice of Annual Meeting of Shareholders
2017 Annual Meeting Proxy Statement
150 Almaden Boulevard / San Jose, California 95113 / 408.947.6900
HERITAGECOMMERCECORP.COM
2016
annual report