Business Overview A Storied History of Organic and Inorganic Growth

Heritage Commerce Corp (HTBK) is a California-based bank holding company with a long-standing presence in the San Francisco Bay Area. Established in 1997, the company has steadily grown its footprint and reputation as a trusted community bank, serving the diverse financial needs of businesses and individuals across the region.

Heritage Commerce Corp's journey began in 1994 with the founding of its wholly-owned subsidiary, Heritage Bank of Commerce, which opened its doors in San Jose, California. Over the past three decades, the company has executed a strategic growth plan, both organically and through targeted acquisitions. In 2007, the company acquired Diablo Valley Bank, adding a branch in Danville, California to its network. This was followed by the acquisition of Presidio Bank in 2019, which further expanded the company's footprint with the addition of branches in Walnut Creek and San Mateo.

These strategic moves have allowed Heritage Commerce Corp to expand its geographic reach and enhance its product and service offerings. Today, the company operates a network of seventeen full-service branches across Alameda, Contra Costa, Marin, San Benito, San Francisco, San Mateo, and Santa Clara counties, serving the San Francisco Bay Area and Silicon Valley.

Throughout its history, Heritage Commerce Corp has demonstrated resilience in the face of various challenges. The company successfully navigated the aftermath of the 2008 financial crisis, managing the impact on its loan portfolio and credit quality through strong risk management practices and a disciplined lending approach. More recently, the company has had to address the evolving threat of cybersecurity, investing in robust security measures and technologies to protect its clients' information and safeguard its own operations.

The COVID-19 pandemic presented another significant challenge, requiring the company to adapt its operations and support its clients through the economic disruptions caused by the pandemic. Despite these obstacles, Heritage Commerce Corp has continued to grow its loan and deposit portfolios while maintaining a strong capital position and credit quality.

Financial Performance Navigating Challenging Market Conditions

Over the past few years, Heritage Commerce Corp has navigated a complex operating environment, characterized by rising interest rates, economic uncertainty, and increased competition. In the fiscal year ended December 31, 2024, the company reported net income of $40.5 million, or $0.66 per diluted share, compared to $64.4 million, or $1.05 per diluted share, in the prior year. This decline in profitability was largely attributable to a compression in the company's net interest margin, which fell from 3.70% in 2023 to 3.28% in 2024, as the cost of deposits increased more rapidly than the yield on earning assets.

Financials

Despite the challenges, Heritage Commerce Corp has maintained a strong balance sheet and capital position. As of December 31, 2024, the company reported total assets of $5.65 billion, with a common equity Tier 1 capital ratio of 13.40% and a total risk-based capital ratio of 15.60%, well above regulatory minimums. The company's loan portfolio has also remained relatively healthy, with nonperforming assets representing just 0.14% of total assets at the end of 2024.

For the fiscal year 2024, Heritage Commerce Corp reported total revenue of $242.7 million, with net income of $40.5 million. The company's net interest income decreased 11% to $163.6 million in 2024, compared to $183.2 million in 2023. This decline was primarily due to higher rates paid on client deposits, a decrease in the average balance of noninterest-bearing deposits, and a lower average yield on investment securities, partially offset by an increase in the average balances of loans and overnight funds.

In the most recent quarter (Q4 2024), the company reported revenue of $45 million and net income of $10.6 million. This represents a year-over-year revenue decrease of 4.8% compared to Q4 2023.

Noninterest income for the year ended December 31, 2024 decreased 3% to $8.7 million, compared to $9.0 million in 2023, primarily due to lower service charges and fees on deposit accounts, partially offset by higher income in various other noninterest income categories. Total noninterest expense increased 12% to $113.6 million in 2024, compared to $101.1 million in 2023, primarily due to higher salaries and employee benefits, rent expense, professional fees, marketing related expenses, insurance expense, homeowner association third-party vendor payments, and Insured Cash Sweep (ICS)/Certificates of Deposit Account Registry Service (CDARS) fee expense.

The company's loan portfolio, excluding loans held-for-sale, increased 4% to $3.5 billion at December 31, 2024, compared to $3.4 billion at December 31, 2023. Total deposits increased 10% to $4.8 billion at December 31, 2024, compared to $4.4 billion at December 31, 2023.

Liquidity

Heritage Commerce Corp has maintained a strong liquidity position, with ample cash and cash equivalents on hand to meet its operational needs and regulatory requirements. The company's diverse funding sources, including a stable core deposit base and access to various borrowing facilities, provide additional flexibility in managing its liquidity needs.

As of December 31, 2024, the company reported a debt-to-equity ratio of 0.0574, indicating a relatively low level of leverage. Cash and available credit lines totaled $3.34 billion, which represents 69% of total deposits and approximately 155% of estimated uninsured deposits. This strong liquidity position provides the company with a substantial buffer against potential market stress or unexpected withdrawals.

Operational Initiatives Investing in People, Technology, and Risk Management

To navigate the evolving market landscape, Heritage Commerce Corp has undertaken several strategic initiatives to strengthen its operations and position the company for long-term success. In 2024, the company made key additions to its leadership team, hiring a new Chief Operating Officer, Chief People and Culture Officer, and General Counsel. These hires are expected to enhance the company's operational efficiency, talent management, and legal and regulatory compliance.

Additionally, the company has continued to invest in its technology infrastructure and cybersecurity capabilities, recognizing the importance of staying ahead of the rapidly changing threats in the digital banking environment. These investments are aimed at improving the customer experience, streamlining internal processes, and ensuring the security and integrity of the company's systems and data.

Risk management has also been a key focus for Heritage Commerce Corp. The company has implemented robust credit underwriting standards, concentration limits, and stress testing procedures to monitor and mitigate potential risks in its loan portfolio. These efforts have helped the company maintain a relatively low level of nonperforming assets, even in the face of economic challenges.

Business Segments Banking and Factoring

Heritage Commerce Corp operates through two main business segments: Banking and Factoring.

The Banking segment provides a diversified mix of business loans, including commercial and industrial loans, commercial real estate loans, construction loans, and SBA loans. This segment also offers home equity lines of credit and consumer loans, both secured and unsecured, to accommodate the needs of business owners and individual clients. In terms of deposits, the Banking segment focuses on generating relationship accounts, such as non-interest bearing demand, interest-bearing demand, and money market accounts. The Bank requires its borrowers to maintain deposit balances as a typical condition of granting loans in order to facilitate the generation of non-interest bearing demand deposits. The Banking segment also offers certificates of deposit and savings accounts.

The Factoring segment consists of the factored receivables portfolio originated by the Company's subsidiary, Bay View Funding. Factored receivables are receivables that have been acquired from the originating company and typically have not been subject to previous collection efforts. These receivables are acquired from a variety of companies, including service providers, transportation companies, manufacturers, distributors, wholesalers, apparel companies, advertisers, and temporary staffing companies. The average life of the factored receivables was 34 days for the year ended December 31, 2024.

Outlook Cautiously Optimistic Amid Uncertain Conditions

As Heritage Commerce Corp looks ahead, the company is cautiously optimistic about its ability to navigate the ongoing market uncertainties. While the interest rate environment and economic conditions remain fluid, the company's diversified business model, strong capital position, and strategic investments in people, technology, and risk management provide a solid foundation for weathering the storm.

The company's management team has maintained a disciplined approach to growth, emphasizing organic expansion and targeted acquisitions that align with its strategic priorities. Additionally, the company's focus on serving the needs of small and medium-sized businesses in its local markets has helped to build a loyal customer base and mitigate some of the risks associated with broader economic fluctuations.

The banking industry as a whole has seen increasing competition from larger regional and national banks as well as non-bank financial service providers. However, Heritage Commerce Corp's focus on serving small-to-medium sized businesses in its local markets has allowed it to maintain a competitive position. The industry has also faced pressure from rising interest rates, which have impacted net interest margins.

Leadership Changes and Human Capital

In 2024, Heritage Commerce Corp announced that long-time Chief Financial Officer Lawrence McGovern would be departing in February 2025. Thomas A. Sa, the current Chief Operating Officer, will serve as interim CFO during the search for a permanent replacement. This transition represents a significant change in the company's leadership team and will be closely watched by investors and stakeholders.

Beyond the CFO transition, the company has made several key hires to strengthen its leadership team, including a new Chief Operating Officer, Chief People and Culture Officer, and General Counsel. These additions are expected to enhance the company's operations, HR functions, and legal/regulatory compliance, positioning the company for continued growth and success in the evolving banking landscape.

Conclusion A Resilient Community Bank Poised for the Future

Heritage Commerce Corp's story is one of steady growth, prudent risk management, and a steadfast commitment to serving its local communities. Despite the challenges posed by the current market environment, the company has demonstrated its ability to adapt and evolve, leveraging its strong foundations to navigate through periods of uncertainty.

As the company continues to invest in its people, technology, and risk management capabilities, Heritage Commerce Corp appears well-positioned to capture new opportunities and maintain its status as a trusted community bank in the San Francisco Bay Area. The company's focus on its core banking and factoring segments, along with its strong liquidity position and conservative approach to risk management, provide a solid foundation for future growth.

Investors will undoubtedly continue to monitor the company's performance and strategic execution, as it navigates the dynamic banking landscape in the years to come. While the company faces challenges from increased competition and a complex interest rate environment, its strong local presence, diverse product offerings, and commitment to serving small and medium-sized businesses in the San Francisco Bay Area position it well for continued success.