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 Heritage Commerce Corp Earns $24.0 Million for the Full Year of 2017
   Thursday, January 25, 2018 4:45:22 PM ET

Heritage Commerce Corp (HTBK ), the holding company (the "Company") for Heritage Bank of Commerce (the "Bank"), today reported that for the fourth quarter of 2017, net income was $1.4 million, or $0.04 per average diluted common, which included a $7.1 million, or ($0.18) per average diluted common share, revaluation of its deferred tax assets in the fourth quarter of 2017 as described below. Net income for the fourth quarter of 2017 also included $671,000 of pre-tax acquisition costs incurred by the Company related to the Tri-Valley Bank (OTC: TRVB) and United American Bank (OTC: UABK) proposed mergers. Net income was $7.2 million, or $0.19 per average diluted common share for the fourth quarter of 2016, and $8.6 million, or $0.22 per average diluted common share for the third quarter of 2017. For the year ended December 31, 2017, net income was $24.0 million, or $0.62 per average diluted common share, compared to $27.4 million, or $0.72 per average diluted common share, for the year ended December 31, 2016. Net interest income before provision for loan losses increased 14% to $26.4 million for the fourth quarter of 2017, compared to $23.1 million for the fourth quarter of 2016. ?Income before income taxes increased 22% to $14.2 million for the fourth quarter of 2017, compared to $11.6 million for the fourth quarter of 2016. For the year ended December 31, 2017, net interest income increased 11% to $101.5 million, compared to $91.2 million for the year ended December 31, 2016. For the year ended December 31, 2017, income before income taxes increased 15% to $50.5 million, compared to $44.0 million for the year ended December 31, 2016. At December 31, 2017, total assets increased 11%, total loans increased 5%, and total deposits increased 10%, compared to December 31, 2016.

On December 22, 2017, H.R.1, commonly known as the Tax Cuts and Jobs Act (the "Tax Act"), was signed into law, which among other items reduces the federal corporate tax rate to 21% from 35%, effective January 1, 2018. U.S. generally accepted accounting principles requires companies to revalue certain tax-related assets and liabilities as of the date of enactment of the new legislation with resulting tax effects accounted for in the reporting period of enactment. While the benefits of lower tax rates in 2018 and beyond will be substantial for U.S. corporations, balance sheet adjustments for deferred tax assets and operating results for the fourth quarter of 2017 have had a material impact on financial institutions. We have concluded that the enactment of the Tax Act caused our net deferred tax assets ("DTA") to be revalued at the new lower tax rate. The Company performed an analysis and determined the value of the net DTA was reduced by $7.1 million, which was recognized as a one-time, non-cash, incremental income tax expense for the fourth quarter of 2017. The impact of the Tax Act on the Company’s 2017 financial results are not necessarily indicative of the results to be achieved for any future periods. However, the Company does anticipate that the reduced federal corporate tax rate of 21% will reduce the Company’s effective tax rate for financial reporting periods beginning in 2018.

"While the fourth quarter DTA adjustment reduced earnings by $7.1 million, we expect significant benefits in 2018 from reduced tax provisions," said Walter Kaczmarek, President and Chief Executive Officer. "Additionally, our pre-tax profit for the fourth quarter of 2017 and for the year ended December 31, 2017 was a record high at $14.2 million and $50.5 million, respectively, despite $671,000 of pre-tax acquisition costs related to the proposed mergers."

"As previously announced in December 2017, we entered into a definitive agreement to acquire Tri-Valley Bank, expanding our presence in the San Francisco East Bay Area. Three weeks later, in January 2018, we entered into another agreement to acquire United American Bank, extending our footprint into San Mateo County, which is just south of San Francisco," added Mr. Kaczmarek. "Both transactions will be accretive to earnings, once transaction costs have been assimilated in the first half of 2018. Going forward, we will continue with our strategic plan to deepen our presence in the Bay Area."

2017 Highlights (as of, or for the periods ended December 31, 2017, compared to December 31, 2016, and September 30, 2017, except as noted):

??? Diluted earnings per share was $0.04 for the fourth quarter of 2017, compared to $0.19 for the fourth quarter of 2016, and $0.22 for the third quarter of 2017. For the year ended December 31, 2017 diluted earnings per share was $0.62, compared to $0.72 per diluted share for the year ended December 31, 2016. The DTA adjustment reduced earnings per share by ($0.18) for both the fourth quarter of 2017 and the year ended December 31, 2017.

??? Due to the DTA adjustment, the return on average tangible assets decreased to 0.19%, and the return on average tangible equity decreased to 2.43% for the fourth quarter of 2017, compared to 1.14% and 13.81%, respectively, for the fourth quarter of 2016, and 1.22% and 15.41%, respectively, for the third quarter of 2017. For the year ended December 31, 2017 the return on average tangible assets was 0.89%, and the return on average tangible equity was 11.04%, compared to 1.15% and 13.55%, respectively, for the year ended December 31, 2016.

??? Net interest income before provision for loan losses increased 14% to $26.4 million for the fourth quarter of 2017, compared to $23.1 million for the fourth quarter of 2016, and remained relatively flat from $26.3 million for the third quarter of 2017. For the year ended December 31, 2017, net interest income increased 11% to $101.5 million, compared to $91.2 million for the year ended December 31, 2016.

-- For the fourth quarter of 2017, the fully tax equivalent ("FTE") net interest margin contracted 4 basis points to 3.87% from 3.91% for the fourth quarter of 2016, primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, and the impact from the issuance of subordinated debt during the second quarter of 2017. This was partially offset by an increase in the average balances of loans and securities, and the impact of increases in the prime rate on loan yields and overnight funds. The net interest margin contracted 11 basis points for the fourth quarter of 2017 from 3.98% for the third quarter of 2017, primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, and lower loan yields. The average balance of other investments and interest-bearing deposits in other financial institutions increased $72.6 million to $397.5 million for the fourth quarter of 2017, compared to $324.9 million for the fourth quarter of 2016, and increased $61.8 million from $335.7 million for the third quarter of 2017.

-- For the year ended December 31, 2017, the net interest margin (FTE) contracted 13 basis points to 3.99%, compared to 4.12% for the year ended December 31, 2016. The contraction was primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, the issuance of the subordinated debt, and a decrease in the accretion of the loan purchase discount into loan interest income from the 2015 Focus Business Bank ("Focus") acquisition. This was partially offset by an increase in the average balances of loans and securities, and the impact of increases in the prime rate on loan yields and overnight funds. The average balance of other investments and interest-bearing deposits in other financial institutions increased $89.7 million to $318.0 million for the year ended December 31, 2017, compared to $228.3 million for the year ended December 31, 2016.

??? The total purchase discount on loans from the Focus loan portfolio was $5.4 million at August 20, 2015 ("the acquisition date"), of which $1.2 million was remaining as of December 31, 2017.

-- The accretion of the loan purchase discount into loan interest income from the Focus transaction was $124,000 for the fourth quarter of 2017, compared to $456,000 for the fourth quarter of 2016, and $270,000 for the third quarter of 2017.

-- The accretion of the loan purchase discount into loan interest income from the Focus transaction was $865,000 for the year ended December 31, 2017, compared to $1.5 million for the year ended December 31, 2016.

??? Loans, excluding loans held-for-sale, increased $80.1 million, or 5%, to $1.58 billion at December 31, 2017, compared to $1.50 billion at December 31, 2016, which included an increase of $82.8 million, or 6% in the Company’s legacy portfolio, an increase of $6.4 million of purchased commercial real estate ("CRE") loans, partially offset by a decrease of $8.3 million of purchased residential mortgage loans, and a decrease of $790,000 in the factored receivables portfolio.

-- Loans increased $16.7 million, or 1%, to $1.58 billion at December 31, 2017, compared to $1.57 billion at September 30, 2017, which included an increase of $18.9 million, or 1% in the Company’s legacy portfolio, partially offset by decrease of $1.9 million of purchased residential mortgage loans, and a decrease of $292,000 of purchased CRE loans.

??? The allowance for loan losses ("ALLL") was 1.23% of total loans at December 31, 2017, compared to 1.27% at December 31, 2016, and 1.26% at September 30, 2017. The ALLL to total nonperforming loans was 782.94% at December 31, 2017, compared to 624.03% at December 31, 2016, and 565.68% at September 30, 2017.

-- Nonperforming assets ("NPAs") were $2.5 million, or 0.09% of total assets, at December 31, 2017, compared to $3.3 million, or 0.13% of total assets, at December 31, 2016, and $3.5 million, or 0.12% of total assets, at September 30, 2017.

-- Classified assets were $12.6 million, or 0.44% of total assets, at December 31, 2017, compared to $13.6 million, or 0.53% of total assets, at December 31, 2016, and $10.9 million, or 0.38% of total assets, at September 30, 2017.

-- Net recoveries totaled $201,000 for the fourth quarter of 2017, compared to net charge-offs of $1.2 million for the fourth quarter of 2016, and net recoveries of $236,000 for the third quarter of 2017.

-- There was a ($493,000) credit to the provision for loan losses for the fourth quarter of 2017, compared to a $240,000 provision for loan losses for the fourth quarter of 2016, and $115,000 provision for loan losses for the third quarter of 2017. There was a ($103,000) credit to the provision for loan losses for the year ended December 31, 2017, compared to a $1.2 million provision for loan losses for the year ended December 31, 2016.

-- Total deposits increased $220.8 million, or 10%, to $2.48 billion at December 31, 2017, compared to $2.26 billion at December 31, 2016, and remained relatively flat from $2.48 billion at September 30, 2017.

-- 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, 2017.

                                                       Well-capitalized  Fully Phased-in
                                                       Financial         Basel III
                                                       Institution       Minimal
                                 Heritage   Heritage   Basel III         Requirement
                                 Commerce   Bank of    Regulatory        Effective
CAPITAL RATIOS                   Corp       Commerce   Guidelines        January 1, 2019
Total Risk-Based                 14.3 %     13.2 %     10.0     %        10.5    %
Tier 1 Risk-Based                11.4 %     12.2 %     8.0      %        8.5     %
Common Equity Tier 1 Risk-Based  11.4 %     12.2 %     6.5      %        7.0     %
Leverage                         7.9  %     8.5  %     5.0      %        4.0     %

___________________

(1) Requirements for both the Company and the Bank include a 2.5% capital conservation buffer, except the leverage ratio.

___________________

Tri-Valley Bank and United American Bank Mergers

On December 20, 2017, the Company announced that it signed an agreement to acquire Tri-Valley Bank ("Tri-Valley"). The transaction is valued at approximately $31.6 million. Tri-Valley shareholders will receive an exchange ratio of 0.0489 of a share of the Company’s common stock, or an aggregate of approximately 1.9 million shares. The exchange ratio is fixed and the aggregate and per share values of the merger consideration will fluctuate between the date of the agreement and the date that the merger is completed, which is expected in the second quarter of 2018. Based on the Company’s stock price of $15.76 as of December 19, 2017, the last trading day before the announcement of the transaction, total consideration for each Tri-Valley share would be $0.77. The transaction is subject to the approval of state and federal bank regulatory agencies and the shareholders of Tri-Valley and other customary closing conditions. The Company does not need to obtain shareholder approval. Tri-Valley is a full-service commercial bank headquartered in San Ramon, California, and serves businesses, non-profits, entrepreneurs and professionals primarily in California’s Tri-Valley area, specifically the cities and communities of Pleasanton, Livermore, Dublin, San Ramon and Danville in the counties of Contra Costa and Alameda.

On January 11, 2018, the Company announced that it signed an agreement to acquire United American Bank ("United American"). The transaction is valued at approximately $44.2 million. United American common and preferred shareholders will receive an exchange ratio of 2.1644 of a share of the Company’s common stock and each common stock equivalent underlying the United American Series D Preferred Stock and Series E Preferred Stock, or an aggregate of approximately 2.8 million shares. The exchange ratio is fixed and the aggregate and per share values of the merger consideration will fluctuate between the date of the agreement and the date that the merger is completed which is expected in the second quarter of 2018. Based on the Company’s stock price of $15.65 as of January 9, 2018, the penultimate trading day before the announcement of the transaction, total consideration for each United American share would be $33.87. Additionally, holders of Series A Preferred Stock and Series B Preferred Stock will receive $1,000 per share in cash for a total of $9.1 million at closing. The transaction is subject to the approval of state and federal bank regulatory agencies and the shareholders of United American and other customary closing conditions. The Company does not need to obtain shareholder approval. United American Bank is a full-service commercial bank located in San Mateo County with full-service branches located in San Mateo, Redwood City and Half Moon Bay, California. The bank is dedicated to providing quality banking and financial services to businesses, professionals and individuals who prefer a high level of personalized client service and management.

At December 31, 2017, Tri-Valley had approximately $145.5 million in assets, $122.6 million in net loans and $126.6 million in deposits. At December 31, 2017, United American had approximately $330.3 million in assets, $225.9 million in net loans and $296.1 million in deposits. At December 31, 2017, on a pro forma consolidated basis the combined company, including the Company, Tri-Valley, and United American, would have approximately $3.3 billion in total assets, $1.9 billion in total loans, and $2.9 billion in total deposits. The pre-tax acquisition costs incurred by the Company related to the proposed mergers totaled $671,000 during the fourth quarter of 2017 and the year ended December 31, 2017.

Operating Results

Net interest income increased 14% to $26.4 million for the fourth quarter of 2017, compared to $23.1 million for the fourth quarter of 2016, and remained relatively flat from $26.3 million for the third quarter of 2017. Net interest income increased 11% to $101.5 million for the year ended December 31, 2017, compared to $91.2 million for the year ended December 31, 2016. The increase in net interest income for the fourth quarter of 2017 and for the year ended December 31, 2017, compared to the respective periods in 2016, was primarily due to an increase in the average balance of loans, investment securities, and other interest earning assets.

For the fourth quarter of 2017, the net interest margin (FTE) contracted 4 basis points to 3.87%, from 3.91% for the fourth quarter of 2016, primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, and the impact from the issuance of subordinated debt during the second quarter of 2017. This was partially offset by an increase in the average balances of loans and securities, and the impact of increases in the prime rate on loan yields and overnight funds. The net interest margin contracted 11 basis points for the fourth quarter of 2017 from 3.98% for the third quarter of 2017, primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, and lower loan yields. The average balance of other investments and interest-bearing deposits in other financial institutions increased $72.6 million to $397.5 million for the fourth quarter of 2017, compared to $324.9 million for the fourth quarter of 2016, and increased $61.8 million from $335.7 million for the third quarter of 2017.

For the year ended December 31, 2017, the net interest margin (FTE) contracted 13 basis points to 3.99%, compared to 4.12% for the year ended December 31, 2016. The contraction was primarily due to a higher average balance of lower yielding excess funds at the Federal Reserve Bank, the issuance of subordinated debt, and a decrease in the accretion of the loan purchase discount into loan interest income from the Focus acquisition. This was partially offset by an increase in the average balances of loans and securities, and the impact of increases in the prime rate on loan yields and overnight funds. The average balance of other investments and interest-bearing deposits in other financial institutions increased $89.7 million to $318.0 million for the year ended December 31, 2017, compared to $228.3 million for the year ended December 31, 2016.

There was a ($493,000) credit to the provision for loan losses for the fourth quarter of 2017, compared to a provision for loan losses of $240,000 for the fourth quarter of 2016, and a provision for loan losses of $115,000 for the third quarter of 2017. There was a ($103,000) credit to the provision for loan losses for the year ended December 31, 2017, compared to a provision for loan losses of $1.2 million for the year ended December 31, 2016.

Total noninterest income was $2.6 million for the fourth quarter of 2017, compared to $3.0 million for the fourth quarter of 2016 and $2.5 million for the third quarter of 2017. The decrease in noninterest income for the fourth quarter of 2017, compared to the fourth quarter of 2016, was primarily due to a $572,000 gain on sales of securities in the fourth quarter of 2016 not being repeated for the fourth quarter of 2017, partially offset by a $330,000 increase in gain on sales of SBA loans. For the year ended December 31, 2017, total noninterest income was $9.6 million, compared to $11.6 million for the year ended December 31, 2016. The decrease in total noninterest income for the year ended December 31, 2017, compared to the year ended December 31, 2016, was primarily due to a $1.1 million gain on proceeds from company-owned life insurance and a $1.1 million gain on sales of securities in the year ended December 31, 2016, and lower servicing income in the year ended December 31, 2017. The decrease was partially offset by increases in fee income from Bay View Funding during the year ended December 31, 2017, which is included in other noninterest income within the consolidated income statements.

Total noninterest expense for the fourth quarter of 2017 was $15.3 million, compared to $14.3 million for the fourth quarter of 2016, and $14.8 million for the third quarter of 2017. Total noninterest expense for the year ended December 31, 2017 was $60.7 million, compared to $57.6 million for the year ended December 31, 2016. The increase in total noninterest expense in the fourth quarter of 2017 and the year ended December 2017, compared to the respective periods in 2016, was primarily due to higher salaries and employee benefits as a result of annual salary increases and hiring additional employees, and costs related to the merger transactions, partially offset by lower professional fees. The increase in noninterest expense for the fourth quarter of 2017, compared to the third quarter of 2017, was primarily due to costs related to the merger transactions during the fourth quarter of 2017. The pre-tax acquisition costs incurred by the Company related to the proposed mergers totaled $671,000 during the fourth quarter of 2017 and the year ended December 31, 2017. Full time equivalent employees were 278 at December 31, 2017, 263 at December 31, 2016, and 282 at September 30, 2017.

The efficiency ratio for the fourth quarter of 2017 was 52.82%, compared to 54.57% for the fourth quarter of 2016, and 51.54% for the third quarter of 2017. The efficiency ratio for the year ended December 31, 2017 improved to 54.65%, compared to 56.04% for the year ended December 31, 2016.

On December 22, 2017, the Tax Act was signed into law, which among other items reduces the federal corporate tax rate to 21% from 35%, effective January 1, 2018. U.S. generally accepted accounting principles requires companies to revalue certain tax-related assets and liabilities as of the date of enactment of the new legislation with resulting tax effects accounted for in the reporting period of enactment. We have concluded that the enactment of the Tax Act caused our net DTA to be revalued at the new lower tax rate. The Company has performed an analysis and determined the value of the net DTA was reduced by $7.1 million, which was recognized as a one-time, non-cash, incremental income tax expense for the fourth quarter of 2017.

Income tax expense for the fourth quarter of 2017 increased to $12.8 million, compared to $4.4 million for the fourth quarter of 2016, and $5.2 million for the third quarter of 2017. Income tax expense for the year ended December 31, 2017 increased to $26.5 million, compared to $16.6 million for the year ended December 31, 2016. Excluding the DTA adjustment, income tax expense was $5.7 million for the fourth quarter of 2017 and $19.4 million for the year ended December 31, 2017. The effective tax rate for the fourth quarter of 2017 was 90.2%, compared to 38.0% for the fourth quarter of 2016, and 37.9% for the third quarter of 2017. The effective tax rate for the year ended December 31, 2017 was 52.6%, compared to 37.7% for the year ended December 31, 2016. Excluding the DTA adjustment, the effective tax rate was 40.2% for the fourth quarter of 2017 and 38.5% for the year ended December 31, 2017. The effective tax rate for the fourth quarter of 2017 was also higher due to some of the acquisition costs related to the Tri-Valley and United American transactions which are not tax deductible. The difference in the effective tax rate for the periods reported compared to the combined Federal and state statutory tax rate of 42%, is primarily the result of the Company’s investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds.

Balance Sheet Review, Capital Management and Credit Quality

Total assets increased 11% to $2.84 billion at December 31, 2017, compared to $2.57 billion at December 31, 2016, and remained relatively flat $2.84 billion at September 30, 2017.

Securities available-for-sale, at fair value, totaled $391.9 million at December 31, 2017, compared to $306.6 million at December 31, 2016, and $390.1 million at September 30, 2017. At December 31, 2017, the Company’s securities available-for-sale portfolio was comprised of $374.8 million agency mortgage-backed securities (all issued by U.S. Government sponsored entities), and $17.1 million of single entity issue trust preferred securities. The pre-tax unrealized loss on securities available-for-sale at December 31, 2017 was ($1.5) million, compared to a pre-tax unrealized loss on securities available-for-sale of ($2.0) million at December 31, 2016, and a pre-tax unrealized gain on securities available-for-sale of $1.0 million at September 30, 2017. All other factors remaining the same, when market interest rates are rising, the Company will experience a lower unrealized gain (or a higher unrealized loss) on the securities portfolio. During the fourth quarter of 2017, the Company purchased $21.3 million of agency mortgage-backed investment securities available-for-sale, with a weighted average book yield of 2.43%, and a weighted average duration of 4.57 years.

At December 31, 2017, securities held-to-maturity, at amortized cost, totaled $398.3 million, compared to $324.0 million at December 31, 2016, and $379.5 million at September 30, 2017. At December 31, 2017, the Company’s securities held-to-maturity portfolio was comprised of $309.6 million agency mortgage-backed securities, and $88.7 million tax-exempt municipal bonds. During the fourth quarter of 2017, the Company purchased $31.0 million of agency mortgage-backed securities held-to-maturity, with a weighted average book yield of 2.66%, and a weighted average duration of 5.21 years.

Loans, excluding loans held-for-sale, increased $80.1 million, or 5%, to $1.58 billion at December 31, 2017, compared to $1.50 billion at December 31, 2016, which included an increase of $82.8 million, or 6% in the Company’s legacy portfolio, an increase of $6.4 million of purchased commercial real estate ("CRE") loans, partially offset by a decrease of $8.3 million of purchased residential mortgage loans, and a decrease of $790,000 in the factored receivables portfolio. Loans increased $16.7 million, or 1%, to $1.58 billion at December 31, 2017, compared to $1.57 billion at September 30, 2017, which included an increase of $18.9 million, or 1% in the Company’s legacy portfolio, partially offset by repayments of $1.9 million of purchased residential mortgage loans, and repayments of $292,000 of purchased CRE loans.

The loan portfolio remains well-diversified with commercial and industrial ("C&I") loans accounting for 36% of the loan portfolio at December 31, 2017, which included $48.8 million of factored receivables. CRE loans accounted for 49% of the total loan portfolio, of which 41% were occupied by businesses that own them. Land and construction loans accounted for 6%, consumer and home equity loans accounted for 6% of total loans of total loans, and residential mortgage loans accounted for the remaining 3% of total loans at December 31, 2017.

The commercial loan portfolio of $573.3 million at December 31, 2017 decreased $31.0 million from $604.3 million at December 31, 2016, and decreased $14.0 million from $587.3 million at September 30, 2017. C&I line usage was 37% at December 31, 2017, compared to 42% at December 31, 2016, and 37% at September 30, 2017.

The CRE loan portfolio increased $110.6 million, or 17%, to $772.9 million at December 31, 2017, compared to $662.2 million at December 31, 2016, which included an increase of $104.3 million, or 17%, in the Company’s legacy portfolio, and an increase of $6.3 million of purchased CRE loans. The CRE loan portfolio increased $18.0 million, or 2%, from $754.9 million at September 30, 2017, primarily due to an increase in the Company’s legacy portfolio.

The average yield on the loan portfolio increased to 5.64% for the fourth quarter of 2017, compared to 5.46% for the fourth quarter of 2016, primarily due to increases in the prime rate, partially offset by a decrease in the accretion of the loan purchase discount into loan interest income from the Focus transaction. The average yield on the loan portfolio decreased from 5.72% for the third quarter of 2017. The average yield on the Company’s legacy loan portfolio (excluding the purchased residential loans, purchased CRE loans, factored receivables portfolio, and accretion of the loan purchase discount from the Focus transaction) increased 32 basis points for the fourth quarter of 2017, compared to the fourth quarter of 2016, and decreased 6 basis point from the third quarter of 2017. The average yield on the purchased residential loans was 2.72% for the fourth quarter of 2017, compared to 2.64% for the fourth quarter of 2016, and 2.67% for the third quarter of 2017. The average yield on the purchased CRE loans was 3.52% for the fourth quarter of 2017, the fourth quarter of 2016, and the third quarter of 2017.

The average yield on the loan portfolio increased to 5.64% for the year ended December 31, 2017, compared to 5.57% for the year ended December 31, 2016, primarily due to increases in the prime rate, partially offset by the impact of the lower yielding purchased residential mortgage loans and purchased CRE loans, a lower yield on the factored receivables portfolio, and a decrease in the accretion of the loan purchase discount into loan interest income from the Focus transaction. The average yield on the Company’s legacy loan portfolio (excluding the purchased residential loans, purchased CRE loans, factored receivables portfolio, and accretion of the loan purchase discount from the Focus transaction) increased 27 basis points for the year ended December 31, 2017, compared to the year ended December 31, 2016. The average yield on the purchased residential loans was 2.68% for the year ended December 31, 2017, compared to 2.85% for the year ended December 31, 2016. The yield on the purchased CRE loans was 3.51% for the year ended December 31, 2017, compared to 3.52% for the year ended December 31, 2016.

The accretion of the loan purchase discount in loan interest income from the Focus transaction was $124,000 for the fourth quarter of 2017, compared to $456,000 for the fourth quarter of 2016, and $270,000 for the third quarter of 2017. The accretion of the loan purchase discount into loan interest income from the Focus transaction was $865,000 for the year ended December 31, 2017, compared to $1.5 million for the year ended December 31, 2016. The total purchase discount on loans from the Focus loan portfolio was $5.4 million at the acquisition date, of which $1.2 million was remaining as of December 31, 2017.

At December 31, 2017, NPAs were $2.5 million, or 0.09% of total assets, compared to $3.3 million, or 0.13% of total assets, at December 31, 2016, and $3.5 million, or 0.12% of total assets, at September 30, 2017. There were no foreclosed assets at December 31, 2017, compared to foreclosed assets of $229,000 at December 31, 2016, and no foreclosed assets at September 30, 2017. The following is a breakout of NPAs at the periods indicated:

                                                                 End of Period:
NONPERFORMING ASSETS                                             December 31, 2017        September 30, 2017       December 31, 2016
(in $000’s, unaudited)                                           Balance     % of Total   Balance     % of Total   Balance     % of Total
Commercial and industrial loans                                  $    1,084  44         % $    1,206  35         % $    2,097  64         %
CRE loans                                                             501    20         %      501    14         %      419    13         %
Home equity and consumer loans                                        380    15         %      389    11         %      270    8          %
Restructured and loans over 90 days past due and still accruing       235    9          %      931    27         %      --     0          %
SBA loans                                                             166    7          %      281    8          %      74     2          %
Land and construction loans                                           119    5          %      183    5          %      199    6          %
Foreclosed assets                                                     --     0          %      --     --         %      229    7          %
Total nonperforming assets                                       $    2,485  100        % $    3,491  100        % $    3,288  100        %

Classified assets were $12.6 million at December 31, 2017, compared to $13.6 million at December 31, 2016, and $10.9 million at September 30, 2017.

The following table summarizes the allowance for loan losses:

                                                        For the Quarter Ended                                  For the Year Ended
ALLOWANCE FOR LOAN LOSSES                               December 31,      September 30,       December 31,     December 31,      December 31,
(in $000’s, unaudited)                                  2017              2017                2016             2017              2016
Balance at beginning of period                          $    19,748       $      19,397       $    20,032      $    19,089       $    18,926
Provision (credit) for loan losses during the period         (493)               115               240              (103)             1,237
Net recoveries (charge-offs) during the period               201                 236               (1,183)          470               (1,074)
Balance at end of period                                $    19,456       $      19,748       $    19,089      $    19,456       $    19,089
Total loans, net of deferred fees                       $    1,582,667    $      1,565,950    $    1,502,607   $    1,582,667    $    1,502,607
Total nonperforming loans                               $    2,485        $      3,491        $    3,059       $    2,485        $    3,059
Allowance for loan losses to total loans                     1.23      %         1.26      %       1.27      %      1.23      %       1.27      %
Allowance for loan losses to total nonperforming loans       782.94    %         565.68    %       624.03    %      782.94    %       624.03    %

The ALLL at December 31, 2017 was 1.23% of total loans, compared to 1.27% at December 31, 2016, and 1.26% at September 30, 2017. The ALLL to total nonperforming loans was 782.94% at December 31, 2017, compared to 624.03% at December 31, 2016, and 565.68% at September 30, 2017.

Total deposits increased $220.8 million, or 10%, to $2.48 billion at December 31, 2017, compared to $2.26 billion at December 31, 2016, and remained relatively flat from $2.48 billion at September 30, 2017. Deposits, excluding all time deposits and CDARS deposits, increased $244.6 million, or 12%, to $2.28 billion at December 31 2017, from $2.03 billion at December 31, 2016, and increased $13.1 million, or 1%, from $2.26 billion at September 30, 2017.

The cost of total deposits increased two basis points to 0.17% for the fourth quarter of 2017, compared to 0.15% for the fourth quarter of 2016, and remained the same at 0.17% for the third quarter of 2017. The cost of total deposits was 0.17% for the year ended December 31, 2017, and 0.15% for the year ended December 31, 2016.

Subordinated debt, net of unamortized issuance costs, totaled $39.2 million at December 31, 2017, and qualifies as Tier 2 capital for the Company under the guidelines established by the Federal Reserve Bank. The issuance of subordinated debt during the second quarter of 2017 resulted in an increase in the Company’s total risk??’based capital ratio at December 31, 2017, compared to December 31, 2016, but had no effect on the other regulatory capital ratios of the Company. All of the Bank’s regulatory capital ratios increased at December 31, 2017, compared to December 31, 2016, primarily due to the downstream of $20.0 million of the proceeds of the subordinated debt from the Company to the Bank, partially offset by distributed dividends totaling $16.0 million from the Bank to the Company during the year ended December 31, 2017.

Tangible equity was $220.1 million at December 31, 2017, compared to $207.2 million at December 31, 2016, and $223.9 million at September 30, 2017. Tangible book value per share was $5.76 at December 31, 2017, compared to $5.46 at December 31, 2016, and $5.86 at September 30, 2017. The decrease in tangible book value per share at December 31, 2017, compared to September 30, 2017, was primarily due to the DTA adjustment.

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

Forward-Looking Statement Disclaimer

These forward-looking statements are subject to various risks and uncertainties that may be outside our control and our actual results could differ materially from our projected results. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the Securities and Exchange Commission, Item 1A of the Company’s Annual Report on Form 10-K, and the following: (1) current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values, high unemployment rates and overall slowdowns in economic growth should these events occur; (2) effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Open Market Committee of the Federal Reserve Board; (3) changes in inflation, interest rates, and market liquidity which may impact interest margins and impact funding sources; (4) volatility in credit and equity markets and its effect on the global economy; (5) changes in the competitive environment among financial or bank holding companies and other financial service providers; (6) changes in consumer and business spending and saving habits and the related effect on our ability to increase assets and to attract deposits; (7) our ability to develop and promote customer acceptance of new products and services in a timely manner; (8) risks associated with concentrations in real estate related loans; (9) an oversupply of inventory and deterioration in values of California commercial real estate; (10) a prolonged slowdown in construction activity; (11) other than temporary impairment charges to our securities portfolio; (12) changes in the level of nonperforming assets and charge-offs and other credit quality measures, and their impact on the adequacy of the Company’s allowance for loan losses and the Company’s provision for loan losses; (13) our ability to raise capital or incur debt on reasonable terms; (14) regulatory limits on Heritage Bank of Commerce’s ability to pay dividends to the Company; (15) changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases, among others; (16) operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which we are highly dependent; (17) our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, "denial of service" attacks, "hacking" and identity theft; (18) inability of our framework to manage risks associated with our business, including operational risk and credit risk; (19) risks of loss of funding of Small Business Administration or SBA loan programs, or changes in those programs; (20) effect and uncertain impact on the Company of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations promulgated by supervisory and oversight agencies implementing the new legislation; (21) significant changes in applicable laws and regulations, including those concerning taxes, banking and securities; (22) effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; (23) costs and effects of legal and regulatory developments, including resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews; (24) availability of and competition for acquisition opportunities; (25) risks associated with the Tri-Valley Bank and United American Bank mergers, including obtaining related regulatory approvals and shareholder approvals, and the integration of Tri-Valley Bank and United American Bank; (26) risks resulting from domestic terrorism; (27) risks of natural disasters and other events beyond our control; and (28) our success in managing the risks involved in the foregoing factors.

Member FDIC

                                               For the Quarter Ended:                                         Percent Change From:               For the Year Ended:
CONSOLIDATED INCOME STATEMENTS                 December 31,          September 30,        December 31,        September 30,      December 31,    December 31,          December 31,          Percent
(in $000’s, unaudited)                         2017                  2017                 2016                2017               2016            2017                  2016                  Change
Interest income                                $    28,152           $      27,955        $      23,991       1             %    17           %  $    106,911          $    94,431           13      %
Interest expense                                    1,708                   1,634                867          5             %    97           %       5,387                 3,211            68      %
Net interest income before provision
for loan losses                                     26,444                  26,321               23,124       0             %    14           %       101,524               91,220           11      %
Provision (credit) for loan losses                  (493       )            115                  240          (529)         %    (305)        %       (103       )          1,237            (108)   %
Net interest income after provision
for loan losses                                     26,937                  26,206               22,884       3             %    18           %       101,627               89,983           13      %
Noninterest income:
Service charges and fees on deposit accounts        821                     869                  768          (6)           %    7            %       3,231                 3,116            4       %
Gain on sales of SBA loans                          473                     147                  143          222           %    231          %       1,108                 796              39      %
Increase in cash surrender value of
life insurance                                      407                     417                  430          (2)           %    (5)          %       1,666                 1,747            (5)     %
Servicing income                                    237                     246                  292          (4)           %    (19)         %       973                   1,398            (30)    %
Gain on proceeds from company-
owned life insurance                                --                      --                   100          N/A                (100)        %       --                    1,119            (100)   %
Gain (loss) on sales of securities                  --                      --                   572          N/A                (100)        %       (6         )          1,099            (101)   %
Other                                               626                     781                  734          (20)          %    (15)         %       2,640                 2,350            12      %
Total noninterest income                            2,564                   2,460                3,039        4             %    (16)         %       9,612                 11,625           (17)    %
Noninterest expense:
Salaries and employee benefits                      9,263                   9,071                8,608        2             %    8            %       37,029                34,660           7       %
Occupancy and equipment                             1,152                   1,142                1,101        1             %    5            %       4,578                 4,378            5       %
Professional fees                                   543                     695                  852          (22)          %    (36)         %       2,982                 3,471            (14)    %
Other                                               4,364                   3,926                3,716        11            %    17           %       16,149                15,130           7       %
Total noninterest expense                           15,322                  14,834               14,277       3             %    7            %       60,738                57,639           5       %
Income before income taxes                          14,179                  13,832               11,646       3             %    22           %       50,501                43,969           15      %
Income tax expense                                  12,796                  5,249                4,431        144           %    189          %       26,548                16,588           60      %
Net income                                          1,383                   8,583                7,215        (84)          %    (81)         %       23,953                27,381           (13)    %
Dividends on preferred stock                        --                      --                   --           N/A                N/A                  --                    (1,512     )     (100)   %
Net income available to common shareholders         1,383                   8,583                7,215        (84)          %    (81)         %       23,953                25,869           (7)     %
Undistributed earnings allocated to
Series C preferred stock                            --                      --                   --           N/A                N/A                  --                    (1,278     )     (100)   %
Distributed and undistributed earnings
allocated to common shareholders               $    1,383            $      8,583         $      7,215        (84)          %    (81)         %  $    23,953           $    24,591           (3)     %
PER COMMON SHARE DATA
(unaudited)
Basic earnings per share                       $    0.04             $      0.22          $      0.19         (82)          %    (79)         %  $    0.63             $    0.72             (13)    %
Diluted earnings per share                     $    0.04             $      0.22          $      0.19         (82)          %    (79)         %  $    0.62             $    0.72             (14)    %
Weighted average shares outstanding - basic         38,200,325              38,152,633           37,931,317   0             %    1            %       38,095,250            33,933,806       12      %
Weighted average shares outstanding - diluted       38,742,454              38,581,298           38,270,110   0             %    1            %       38,610,815            34,219,121       13      %
Common shares outstanding at period-end             38,200,883              38,199,006           37,941,007   0             %    1            %       38,200,883            37,941,007       1       %
Dividend per share                             $    0.10             $      0.10          $      0.09         0             %    11           %  $    0.40             $    0.36             11      %
Book value per share                           $    7.10             $      7.21          $      6.85         (2)           %    4            %  $    7.10             $    6.85             4       %
Tangible book value per share                  $    5.76             $      5.86          $      5.46         (2)           %    5            %  $    5.76             $    5.46             5       %
KEY FINANCIAL RATIOS
(unaudited)
Annualized return on average equity                 1.98       %            12.49      %         11.01      % (84)          %    (82)         %       8.91       %          10.71      %     (17)    %
Annualized return on average tangible equity        2.43       %            15.41      %         13.81      % (84)          %    (82)         %       11.04      %          13.55      %     (19)    %
Annualized return on average assets                 0.19       %            1.20       %         1.12       % (84)          %    (83)         %       0.87       %          1.13       %     (23)    %
Annualized return on average tangible assets        0.19       %            1.22       %         1.14       % (84)          %    (83)         %       0.89       %          1.15       %     (23)    %
Net interest margin (fully tax equivalent)          3.87       %            3.98       %         3.91       % (3)           %    (1)          %       3.99       %          4.12       %     (3)     %
Efficiency ratio                                    52.82      %            51.54      %         54.57      % 2             %    (3)          %       54.65      %          56.04      %     (2)     %
AVERAGE BALANCES
(in $000’s, unaudited)
Average assets                                 $    2,925,001        $      2,836,807     $      2,572,595    3             %    14           %  $    2,755,618        $    2,425,201        14      %
Average tangible assets                        $    2,873,576        $      2,785,092     $      2,519,733    3             %    14           %  $    2,703,686        $    2,371,756        14      %
Average earning assets                         $    2,743,706        $      2,657,081     $      2,381,141    3             %    15           %  $    2,575,869        $    2,244,169        15      %
Average loans held-for-sale                    $    4,030            $      3,737         $      6,074        8             %    (34)         %  $    4,634            $    4,947            (6)     %
Average total loans                            $    1,558,976        $      1,556,684     $      1,455,558    0             %    7            %  $    1,527,288        $    1,417,760        8       %
Average deposits                               $    2,550,500        $      2,470,015     $      2,245,336    3             %    14           %  $    2,405,717        $    2,110,458        14      %
Average demand deposits - noninterest-bearing  $    1,002,808        $      980,554       $      898,367      2             %    12           %  $    944,275          $    824,763          14      %
Average interest-bearing deposits              $    1,547,692        $      1,489,461     $      1,346,969    4             %    15           %  $    1,461,442        $    1,285,695        14      %
Average interest-bearing liabilities           $    1,586,940        $      1,528,665     $      1,347,032    4             %    18           %  $    1,484,783        $    1,286,185        15      %
Average equity                                 $    277,535          $      272,666       $      260,723      2             %    6            %  $    268,890          $    255,587          5       %
Average tangible equity                        $    226,110          $      220,951       $      207,861      2             %    9            %  $    216,958          $    202,142          7       %
                                                     End of Period:                                                 Percent Change From:
CONSOLIDATED BALANCE SHEETS                          December 31,         September 30,        December 31,         September 30,      December 31,
(in $000’s, unaudited)                               2017                 2017                 2016                 2017               2016
ASSETS
Cash and due from banks                              $    31,681          $    37,133          $    27,993          (15)          %    13           %
Other investments and interest-bearing deposits
in other financial institutions                           284,541              308,987              238,110         (8)           %    19           %
Securities available-for-sale, at fair value              391,852              390,107              306,589         0             %    28           %
Securities held-to-maturity, at amortized cost            398,341              379,550              324,010         5             %    23           %
Loans held-for-sale - SBA, including deferred costs       3,419                4,602                5,705           (26)          %    (40)         %
Loans:
Commercial                                                573,296              587,276              604,331         (2)           %    (5)          %
Real estate:
CRE                                                       772,867              754,856              662,228         2             %    17           %
Land and construction                                     100,882              92,310               81,002          9             %    25           %
Home equity                                               79,176               74,171               82,459          7             %    (4)          %
Residential mortgages                                     44,561               46,489               52,887          (4)           %    (16)         %
Consumer                                                  12,395               11,749               20,460          5             %    (39)         %
Loans                                                     1,583,177            1,566,851            1,503,367       1             %    5            %
Deferred loan fees, net                                   (510      )          (901      )          (760      )     (43)          %    (33)         %
Total loans, net of deferred fees                         1,582,667            1,565,950            1,502,607       1             %    5            %
Allowance for loan losses                                 (19,456   )          (19,748   )          (19,089   )     (1)           %    2            %
Loans, net                                                1,563,211            1,546,202            1,483,518       1             %    5            %
Company-owned life insurance                              60,814               60,407               59,148          1             %    3            %
Premises and equipment, net                               7,353                7,539                7,490           (2)           %    (2)          %
Goodwill                                                  45,664               45,664               45,664          0             %    0            %
Other intangible assets                                   5,589                5,867                6,950           (5)           %    (20)         %
Accrued interest receivable and other assets              51,112               57,890               65,703          (12)          %    (22)         %
Total assets                                         $    2,843,577       $    2,843,948       $    2,570,880       0             %    11           %
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits:
Demand, noninterest-bearing                          $    989,753         $    943,723         $    917,187         5             %    8            %
Demand, interest-bearing                                  601,929              605,301              541,282         (1)           %    11           %
Savings and money market                                  684,131              713,693              572,743         (4)           %    19           %
Time deposits-under $250                                  51,710               53,479               57,857          (3)           %    (11)         %
Time deposits-$250 and over                               138,634              147,422              163,670         (6)           %    (15)         %
CDARS - money market and time deposits                    16,832               16,986               9,401           (1)           %    79           %
Total deposits                                            2,482,989            2,480,604            2,262,140       0             %    10           %
Subordinated debt, net of issuance costs                  39,183               39,137               --              0             %    N/A
Accrued interest payable and other liabilities            50,041               48,762               48,890          3             %    2            %
Total liabilities                                         2,572,213            2,568,503            2,311,030       0             %    11           %
Shareholders’ Equity                                      271,364              275,445              259,850         (1)           %    4            %
Total liabilities and shareholders’ equity           $    2,843,577       $    2,843,948       $    2,570,880       0             %    11           %
                                                        End of Period:                                         Percent Change From:
CREDIT QUALITY DATA                                     December 31,       September 30,      December 31,     September 30,      December 31,
(in $000’s, unaudited)                                  2017               2017               2016             2017               2016
Nonaccrual loans - held-for-investment                  $    2,250         $    2,560         $      3,059     (12)          %    (26)         %
Restructured and loans over 90 days past due
and still accruing                                           235                931                  --        (75)          %    N/A
Total nonperforming loans                                    2,485              3,491                3,059     (29)          %    (19)         %
Foreclosed assets                                            --                 --                   229       N/A                (100)        %
Total nonperforming assets                              $    2,485         $    3,491         $      3,288     (29)          %    (24)         %
Other restructured loans still accruing                 $    289           $    325           $      131       (11)          %    121          %
Net charge-offs (recoveries) during the quarter         $    (201    )     $    (236    )     $      1,183     (15)          %    117          %
Provision (credit) for loan losses during the quarter   $    (493    )     $    115           $      240       (529)         %    (305)        %
Allowance for loan losses                               $    19,456        $    19,748        $      19,089    (1)           %    2            %
Classified assets                                       $    12,557        $    10,909        $      13,553    15            %    (7)          %
Allowance for loan losses to total loans                     1.23    %          1.26    %            1.27    % (2)           %    (3)          %
Allowance for loan losses to total nonperforming loans       782.94  %          565.68  %            624.03  % 38            %    25           %
Nonperforming assets to total assets                         0.09    %          0.12    %            0.13    % (25)          %    (31)         %
Nonperforming loans to total loans                           0.16    %          0.22    %            0.20    % (27)          %    (20)         %
Classified assets to Heritage Commerce Corp Tier 1
capital plus allowance for loan losses                       5       %          4       %            6       % 25            %    (17)         %
Classified assets to Heritage Bank of Commerce Tier 1
capital plus allowance for loan losses                       5       %          4       %            6       % 25            %    (17)         %
OTHER PERIOD-END STATISTICS
(in $000’s, unaudited)
Heritage Commerce Corp:
Tangible common equity                                  $    220,111       $    223,914       $      207,236   (2)           %    6            %
Shareholders’ equity / total assets                          9.54    %          9.69    %            10.11   % (2)           %    (6)          %
Tangible common equity / tangible assets                     7.88    %          8.02    %            8.23    % (2)           %    (4)          %
Loan to deposit ratio                                        63.74   %          63.13   %            66.42   % 1             %    (4)          %
Noninterest-bearing deposits / total deposits                39.86   %          38.04   %            40.55   % 5             %    (2)          %
Total risk-based capital ratio                               14.3    %          14.6    %            12.5    % (2)           %    14           %
Tier 1 risk-based capital ratio                              11.4    %          11.6    %            11.5    % (2)           %    (1)          %
Common Equity Tier 1 risk-based capital ratio                11.4    %          11.6    %            11.5    % (2)           %    (1)          %
Leverage ratio                                               7.9     %          8.3     %            8.5     % (5)           %    (7)          %
Heritage Bank of Commerce:
Total risk-based capital ratio                               13.2    %          13.4    %            12.3    % (1)           %    7            %
Tier 1 risk-based capital ratio                              12.2    %          12.3    %            11.3    % (1)           %    8            %
Common Equity Tier 1 risk-based capital ratio                12.2    %          12.3    %            11.3    % (1)           %    8            %
Leverage ratio                                               8.5     %          8.8     %            8.4     % (3)           %    1            %

____________________________

(1) Represents shareholders’ equity minus preferred stock, minus goodwill and other intangible assets

(2) Represents shareholders’ equity minus preferred stock, minus goodwill and other intangible assets divided by total assets minus goodwill and other intangible assets

                                                 For the Quarter Ended                  For the Quarter Ended
                                                 December 31, 2017                      December 31, 2016
                                                                Interest      Average                  Interest      Average
NET INTEREST INCOME AND NET INTEREST MARGIN      Average        Income/       Yield/    Average        Income/       Yield/
(in $000’s, unaudited)                           Balance        Expense       Rate      Balance        Expense       Rate
Assets:
Loans, gross                                     $   1,563,006  $  22,234     5.64    % $   1,461,632  $  20,049     5.46    %
Securities - taxable                                 694,061       3,808      2.18    %     503,881       2,428      1.92    %
Securities - exempt from Federal tax                 89,082        865        3.85    %     90,714        872        3.82    %
Other investments and interest-bearing deposits
in other financial institutions                      397,557       1,548      1.54    %     324,914       947        1.16    %
Total interest earning assets                        2,743,706     28,455     4.11    %     2,381,141     24,296     4.06    %
Cash and due from banks                              35,716                                 36,786
Premises and equipment, net                          7,470                                  7,581
Goodwill and other intangible assets                 51,425                                 52,862
Other assets                                         86,684                                 94,225
Total assets                                     $   2,925,001                          $   2,572,595
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing                      $   1,002,808                          $   898,367
Demand, interest-bearing                             621,830       328        0.21    %     529,922       295        0.22    %
Savings and money market                             715,148       452        0.25    %     583,495       298        0.20    %
Time deposits - under $100                           18,745        13         0.28    %     20,722        17         0.33    %
Time deposits - $100 and over                        175,416       329        0.74    %     203,041       253        0.50    %
Time deposits - brokered                             --            --         0.00    %     1,891         3          0.63    %
CDARS - money market and time deposits               16,553        2          0.05    %     7,898         1          0.05    %
Total interest-bearing deposits                      1,547,692     1,124      0.29    %     1,346,969     867        0.26    %
Total deposits                                       2,550,500     1,124      0.17    %     2,245,336     867        0.15    %
Subordinated debt, net of issuance costs             39,153        583        5.91    %     --            --         0.00    %
Short-term borrowings                                95            1          4.18    %     63            --         0.00    %
Total interest-bearing liabilities                   1,586,940     1,708      0.43    %     1,347,032     867        0.26    %
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds                  2,589,748     1,708      0.26    %     2,245,399     867        0.15    %
Other liabilities                                    57,718                                 66,473
Total liabilities                                    2,647,466                              2,311,872
Shareholders’ equity                                 277,535                                260,723
Total liabilities and shareholders’ equity       $   2,925,001                          $   2,572,595
Net interest income  / margin                                      26,747     3.87    %                   23,429     3.91    %
Less tax equivalent adjustment                                     (303   )                               (305   )
Net interest income                                             $  26,444                              $  23,124

_____________________

(1) Includes loans held-for-sale. Nonaccrual loans are included in average balance.

(2) Yield amounts earned on loans include fees and costs. The accretion (amortization) of deferred loan fees (costs) into loan interest income was $162,000 for the fourth quarter of 2017, compared to ($1,300) for the fourth quarter of 2016

(3) Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 35% tax rate.

                                                 For the Year Ended                      For the Year Ended
                                                 December 31, 2017                       December 31, 2016
                                                                Interest       Average                  Interest      Average
NET INTEREST INCOME AND NET INTEREST MARGIN      Average        Income/        Yield/    Average        Income/       Yield/
(in $000’s, unaudited)                           Balance        Expense        Rate      Balance        Expense       Rate
Assets:
Loans, gross                                     $   1,531,922  $  86,346      5.64    % $   1,422,707  $  79,284     5.57    %
Securities - taxable                                 636,160       13,724      2.16    %     501,347       10,432     2.08    %
Securities - exempt from Federal tax                 89,762        3,471       3.87    %     91,822        3,523      3.84    %
Other investments and interest-bearing deposits
in other financial institutions                      318,025       4,585       1.44    %     228,293       2,425      1.06    %
Total interest earning assets                        2,575,869     108,126     4.20    %     2,244,169     95,664     4.26    %
Cash and due from banks                              33,542                                  33,899
Premises and equipment, net                          7,553                                   7,624
Goodwill and other intangible assets                 51,932                                  53,445
Other assets                                         86,722                                  86,064
Total assets                                     $   2,755,618                           $   2,425,201
Liabilities and shareholders’ equity:
Deposits:
Demand, noninterest-bearing                      $   944,275                             $   824,763
Demand, interest-bearing                             586,778       1,208       0.21    %     511,595       1,026      0.20    %
Savings and money market                             653,636       1,534       0.23    %     526,227       1,127      0.21    %
Time deposits - under $100                           19,789        57          0.29    %     22,079        65         0.29    %
Time deposits - $100 and over                        187,298       1,188       0.63    %     209,972       913        0.43    %
Time deposits - brokered                             --            --          0.00    %     7,590         62         0.82    %
CDARS - money market and time deposits               13,941        4           0.03    %     8,232         6          0.07    %
Total interest-bearing deposits                      1,461,442     3,991       0.27    %     1,285,695     3,199      0.25    %
Total deposits                                       2,405,717     3,991       0.17    %     2,110,458     3,199      0.15    %
Subordinated debt, net of issuance costs             23,266        1,394       5.99    %     --            --         0.00    %
Short-term borrowings                                75            2           2.67    %     490           12         2.45    %
Total interest-bearing liabilities                   1,484,783     5,387       0.36    %     1,286,185     3,211      0.25    %
Total interest-bearing liabilities and demand,
noninterest-bearing / cost of funds                  2,429,058     5,387       0.22    %     2,110,948     3,211      0.15    %
Other liabilities                                    57,670                                  58,666
Total liabilities                                    2,486,728                               2,169,614
Shareholders’ equity                                 268,890                                 255,587
Total liabilities and shareholders’ equity       $   2,755,618                           $   2,425,201
Net interest income  / margin                                      102,739     3.99    %                   92,453     4.12    %
Less tax equivalent adjustment                                     (1,215  )                               (1,233 )
Net interest income                                             $  101,524                              $  91,220

___________________

(1) Includes loans held-for-sale. Nonaccrual loans are included in average balance.

(2) Yield amounts earned on loans include fees and costs. The accretion (amortization) of deferred loan fees (costs) into loan interest income was $533,000 for the year ended December 31, 2017, compared to $168,000 for the year ended December 31, 2016.

(3) Reflects the fully tax equivalent adjustment for Federal tax-exempt income based on a 35% tax rate.

CONTACT:

Heritage Commerce Corp

Debbie Reuter

Executive Vice President and Corporate Secretary

(408) 494-4542

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