HERITAGE COMMERCE CORP - Quarter Report: 2011 June (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


(MARK ONE)
ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2011
OR
o		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 No.)
150 Almaden Boulevard, San Jose, California (Address of Principal Executive Offices)		95113 (Zip Code)

(408) 947-6900
(Registrant's Telephone Number, Including Area Code)

N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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 ý NO o

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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ý NO o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO ý

The Registrant had 26,295,001 shares of Common Stock outstanding on July 22, 2011.

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HERITAGE COMMERCE CORP
QUARTERLY REPORT ON FORM 10-Q
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Cautionary Note on Forward-Looking Statements		3
PART I. FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (unaudited):	5
	Consolidated Balance Sheets	5
	Consolidated Statements of Operations	6
	Consolidated Statement of Changes in Shareholders' Equity	7
	Consolidated Statements of Cash Flows	8
	Notes to Consolidated Financial Statements	9
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	62
Item 4.	Controls and Procedures	62
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	64
Item 1A.	Risk Factors	64
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	64
Item 3.	Defaults Upon Senior Securities	64
Item 4.	Reserved	64
Item 5.	Other Information	64
Item 6.	Exhibits	65
SIGNATURES		66
EXHIBIT INDEX		67

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Cautionary Note Regarding Forward-Looking Statements

This Report on Form 10-Q contains various statements that may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, 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. In addition, our past results of operations do not necessarily indicate our future results. The forward-looking statements could be affected by many factors, including but not limited to:

•: Competition for loans and deposits and failure to attract or retain deposits and loans;
•: Local, regional, and national economic conditions and events and the impact they may have on us and our customers, and our assessment of that impact on our estimates including, the allowance for loan losses;
•: Risks associated with concentrations in real estate related loans;
•: 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;
•: The 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;
•: Stability of funding sources and continued availability of borrowings;
•: The effect of changes in laws and regulations with which the Company and Heritage Bank of Commerce must comply, including any increase in FDIC insurance premiums;
•: Our ability to raise capital or incur debt on reasonable terms;
•: Legal limits on Heritage Bank of Commerce's ability to pay dividends to the Company;
•: Future legislative or administrative changes to the U.S. Treasury Capital Purchase Program enacted under the Emergency Economic Stabilization Act of 2008;
•: The impact of the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009 and related rules and regulations on our business operations and competitiveness, including the impact of executive compensation restrictions, which may affect our ability to retain and recruit executives in competition with other firms who do not operate under those restrictions;
•: The impact of the Dodd Frank Wall Street Reform and Consumer Protection Act signed by President Obama on July 21, 2010;

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•: The 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;
•: Changes in the deferred tax asset valuation allowance in future quarters;
•: The 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;
•: The ability to increase market share and control expenses; and
•: Our success in managing the risks involved in the foregoing items.

We are not able to predict all the factors that may affect future results. You should not place undue reliance on any forward looking statement, which speaks only as of the date of this Report on Form 10-K. Except as required by applicable laws or regulations, we do not undertake any obligation to update or revise any forward looking statement, whether as a result of new information, future events or otherwise.

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Part I—FINANCIAL INFORMATION

ITEM 1—CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

HERITAGE COMMERCE CORP

CONSOLIDATED BALANCE SHEETS (Unaudited)

				June 30, 2011			December 31, 2010

				(Dollars in thousands, except per share data)
Assets
Cash and due from banks				$	20,334		$	7,692
Interest-bearing deposits in other financial institutions					67,928			64,485

			Total cash and cash equivalents		88,262			72,177
Securities available-for-sale, at fair value					302,968			232,165
Loans held-for-sale—SBA, at lower of cost or market, including deferred costs					3,657			8,750
Loans held-for-sale—other, at lower of cost or market, including deferred costs					435			2,260
Loans, including deferred costs					782,080			846,049
Allowance for loan losses					(23,167	)		(25,204	)

			Loans, net		758,913			820,845
Federal Home Loan Bank and Federal Reserve Bank stock, at cost					9,917			9,174
Company owned life insurance					44,776			43,682
Premises and equipment, net					8,086			8,397
Intangible assets					2,753			3,014
Accrued interest receivable and other assets					42,302			45,905

			Total assets	$	1,262,069		$	1,246,369

Liabilities and Shareholders' Equity
Liabilities:
	Deposits:
		Demand, noninterest-bearing		$	333,199		$	280,258
		Demand, interest-bearing			128,464			153,917
		Savings and money market			276,538			272,399
		Time deposits—under $100			30,676			33,499
		Time deposits—$100 and over			114,208			137,514
		Time deposits—CDARS			20,839			17,864
		Time deposits—brokered			94,631			98,467

			Total deposits		998,555			993,918
	Securities sold under agreement to repurchase				—			5,000
	Subordinated debt				23,702			23,702
	Short-term borrowings				—			2,445
	Securities purchased pending settlement				19,755			2,902
	Accrued interest payable and other liabilities				32,578			36,250

		Total liabilities			1,074,590			1,064,217
Shareholders' equity:
	Preferred stock, no par value; 10,000,000 shares authorized
		Series A fixed rate cumulative preferred stock, 40,000 shares issued and outstanding (liquidation preference of $43,816 at June 30, 2011 and $42,810 at December 31, 2010)			39,846			39,846
		Discount on Series A preferred stock			(1,033	)		(1,227	)
		Series C convertible perpetual preferred stock, 21,004 shares issued and outstanding at June 30, 2011 and December 31, 2010 (liquidation preference of $21,004 at June 30, 2011 and December 31, 2010)			19,519			19,519
	Common stock, no par value; 60,000,000 shares authorized; 26,295,001 shares issued and outstanding at June 30, 2011 and 26,233,001 shares issued and outstanding at December 31, 2010				130,836			130,531
	Retained earnings / (Accumulated deficit)				601			(1,866	)
	Accumulated other comprehensive loss				(2,290	)		(4,651	)

		Total shareholders' equity			187,479			182,152

			Total liabilities and shareholders' equity	$	1,262,069		$	1,246,369

See notes to consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

				Three Months Ended June 30,						Six Months Ended June 30,

				2011			2010			2011			2010
				(Dollars in thousands, except per share data)
Interest income:
	Loans, including fees			$	10,685		$	12,737		$	21,675		$	25,911
	Securities				2,278			1,459			4,240			2,621
	Interest-bearing deposits in other financial institutions				52			16			86			27

		Total interest income			13,015			14,212			26,001			28,559

Interest expense:
	Deposits				1,068			2,157			2,339			4,521
	Subordinated debt				467			468			932			934
	Repurchase agreements				—			113			24			244
	Short-term borrowings				8			46			38			63

		Total interest expense			1,543			2,784			3,333			5,762

		Net interest income before provision for loan losses			11,472			11,428			22,668			22,797
Provision for loan losses					955			18,600			1,725			23,695

	Net interest income (loss) after provision for loan losses				10,517			(7,172	)		20,943			(898	)

Noninterest income:
	Service charges and fees on deposit accounts				587			579			1,154			1,128
	Gain on sales of SBA loans				476			163			855			277
	Servicing income				435			425			846			846
	Increase in cash surrender value of life insurance				419			413			845			822
	Other				253			298			387			489

		Total noninterest income			2,170			1,878			4,087			3,562

Noninterest expense:
	Salaries and employee benefits				5,111			5,491			10,504			11,373
	Occupancy and equipment				1,031			983			2,069			1,942
	Professional fees				456			1,144			1,295			2,421
	FDIC deposit insurance premiums				383			1,019			907			2,210
	Software subscriptions				274			252			529			486
	Insurance expense				244			269			486			525
	Data processing				198			219			419			430
	Low income housing investment losses				40			133			202			358
	Other real estate owned expense				127			69			147			488
	Impairment of goodwill				—			43,181			—			43,181
	Other				1,608			1,792			3,345			3,337

		Total noninterest expense			9,472			54,552			19,903			66,751

			Income (loss) before income taxes		3,215			(59,846	)		5,127			(64,087	)
Income tax expense (benefit)					1,129			(5,753	)		1,460			(5,874	)

	Net income (loss)				2,086			(54,093	)		3,667			(58,213	)
Dividends and discount accretion on preferred stock					(604	)		(1,009	)		(1,200	)		(1,600	)

	Net income (loss) allocable to common shareholders			$	1,482		$	(55,102	)	$	2,467		$	(59,813	)

Earnings (loss) per common share:
	Basic			$	0.05		$	(4.66	)	$	0.08		$	(5.06	)
	Diluted			$	0.05		$	(4.66	)	$	0.08		$	(5.06	)

See notes to consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)

		Six Months Ended June 30, 2011 and 2010

		Preferred Stock							Common Stock					Retained Earnings/ (Accumulated Deficit)			Accumulated Other Comprehensive Loss
		Preferred Stock							Common Stock											Total Shareholders' Equity			Comprehensive Income (Loss)
		Shares		Amount		Discount			Shares		Amount									Total Shareholders' Equity			Comprehensive Income (Loss)
		(Dollars in thousands, except share data)
Balance, January 1, 2010			40,000	$	39,846	$	(1,598	)		11,820,509	$	80,222		$	56,389		$	(2,554	)	$	172,305
Net loss			—		—		—			—		—			(58,213	)		—			(58,213	)	$	(58,213	)
Net change in unrealized gain/(loss) on securities available-for-sale and interest-only strips, net of reclassification adjustment and deferred income taxes			—		—		—			—		—			—			1,848			1,848			1,848
Net change in liability and other postretirement obligations, net of deferred income taxes			—		—		—			—		—			—			137			137			137

	Total comprehensive loss																						$	(56,228	)

Issuance of Series B manditorily convertible cumulative perpetual preferred stock, net of issuance costs			53,996		50,385		—			—		—			—			—			50,385
Issuance of Series C convertible perpetual preferred stock, net of issuance costs			21,004		19,599		—			—		—			—			—			19,599
Amortization of restricted stock award, net of forfeitures and taxes			—		—		—			—		2			—			—			2
Cash dividends accrued on Series A preferred stock			—		—		—			—		—			(1,005	)		—			(1,005	)
Accretion of unearned discount on Series A preferred stock			—		—		183			—		—			(183	)		—			—
Stock option expense, net of forfeitures and taxes			—		—		—			—		586			—			—			586

Balance, June 30, 2010			115,000	$	109,830	$	(1,415	)		11,820,509	$	80,810		$	(3,012	)	$	(569	)	$	185,644

Balance, January 1, 2011			61,004	$	59,365	$	(1,227	)		26,233,001	$	130,531		$	(1,866	)	$	(4,651	)	$	182,152
Net income			—		—		—			—		—			3,667			—			3,667		$	3,667
Net change in unrealized gain/(loss) on securities available-for-sale and interest-only strips, net of reclassification adjustment and deferred income taxes			—		—		—			—		—			—			2,248			2,248			2,248
Net change in liability and other postretirement obligations, net of deferred income taxes			—		—		—			—		—			—			113			113			113

	Total comprehensive income																						$	6,028

Issuance of restricted stock awards			—		—		—			62,000		320			—			—			320
Amortization of restricted stock awards, net of forfeitures and taxes			—		—		—			—		(346	)		—			—			(346	)
Cash dividends accrued on Series A preferred stock			—		—		—			—		—			(1,006	)		—			(1,006	)
Accretion of discount on Series A preferred stock			—		—		194			—		—			(194	)		—			—
Stock option expense, net of forfeitures and taxes			—		—		—			—		331			—			—			331

Balance, June 30, 2011			61,004	$	59,365	$	(1,033	)		26,295,001	$	130,836		$	601		$	(2,290	)	$	187,479

See notes to consolidated financial statements

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HERITAGE COMMERCE CORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

			Six Months Ended June 30,

			2011			2010
			(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)			$	3,667		$	(58,213	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Amortization (accretion) of discounts and premiums on securities				533			(137	)
Gain on sale of SBA loans				(855	)		(277	)
Proceeds from sale of SBA loans originated for sale				8,967			5,504
Net change in SBA loans originated for sale				(3,019	)		(9,167	)
Writedowns on other loans held-for-sale				29			—
Provision for loan losses				1,725			23,695
Increase in cash surrender value of life insurance				(845	)		(822	)
Depreciation and amortization				390			402
Amortization of other intangible assets				261			287
(Gains) losses on sale of foreclosed assets, net				(42	)		416
Stock option expense, net				331			586
Amortization of restricted stock awards, net				(26	)		2
Goodwill impairment				—			43,181
Effect of changes in:
	Accrued interest receivable and other assets			891			(2,821	)
	Accrued interest payable and other liabilities			(7,385	)		(1,349	)

		Net cash provided by operating activities		4,622			1,287

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available-for-sale				(62,605	)		(39,351	)
Maturities/paydowns/calls of securities available-for-sale				14,775			10,333
Net change in SBA loans previously transferred to held-for-sale				—			(630	)
Net change in other loans transferred to held-for-sale				27			—
Net change in loans				59,136			91,493
Changes in Federal Home Loan Bank stock and other investments				(743	)		—
Purchase of premises and equipment				(79	)		(122	)
Redemption (Purchase) of restricted stock and other investments				—			155
Proceeds from sale of foreclosed assets				2,240			1,270
Proceeds from sale of SBA loans transferred to held-for-sale				—			1,079
Proceeds from sale of other loans transferred to held-for-sale				1,769			—
(Purchases) and redemptions of company owned life insurance				(249	)		308

	Net cash provided by investing activities			14,271			64,535

CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits				4,637			(51,860	)
Issuance of preferred stock, net of offering costs				—			69,984
Net change in securities sold under agreement to repurchase				(5,000	)		(5,000	)
Net change in short-term borrowings				(2,445	)		(16,008	)

Net cash used in financing activities				(2,808	)		(2,884	)

	Net increase in cash and cash equivalents			16,085			62,938
Cash and cash equivalents, beginning of period				72,177			45,562

	Cash and cash equivalents, end of period		$	88,262		$	108,500

Supplemental disclosures of cash flow information:
	Interest paid		$	5,887		$	4,864
	Income taxes paid			320			—
Supplemental schedule of non-cash investing activity:
	Due to broker for securities purchased		$	19,755		$	—
	Transfer from portfolio loans to loans held-for-sale			—			17,079
	Transfer of loans held-for-sale to loan portfolio			—			1,942
	Loans transferred to foreclosed assets			1,071			—
	Cash dividend accrued on Series A preferred stock			1,006			1,005

See notes to consolidated financial statements

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HERITAGE COMMERCE CORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

(Unaudited)

1) Basis of Presentation

The unaudited consolidated financial statements of Heritage Commerce Corp (the "Company") and its wholly owned subsidiary, Heritage Bank of Commerce (sometimes referred to as "HBC"), have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and notes required by accounting principles generally accepted in the United States of America ("GAAP") for annual financial statements are not included herein. The interim statements should be read in conjunction with the consolidated financial statements and notes that were included in the Company's Form 10-K for the year ended December 31, 2010. The Company has also established the following unconsolidated subsidiary grantor trusts: Heritage Capital Trust I; Heritage Statutory Trust I; Heritage Statutory Trust II; and Heritage Commerce Corp Statutory Trust III which are Delaware Statutory business trusts formed for the exclusive purpose of issuing and selling trust preferred securities.

HBC is a commercial bank serving customers located in Santa Clara, Alameda, and Contra Costa counties of California. No customer accounts for more than 10 percent of revenue for HBC or the Company. Management evaluates the Company's performance as a whole and does not allocate resources based on the performance of different lending or transaction activities. Accordingly, the Company and its subsidiary operate as one business segment.

In the Company's opinion, all adjustments necessary for a fair presentation of these consolidated financial statements have been included and are of a normal and recurring nature. All intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with GAAP 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ significantly from these estimates.

The results for the three and six months ended June 30, 2011 are not necessarily indicative of the results expected for any subsequent period or for the entire year ending December 31, 2011.

Reclassifications

Certain reclassifications of prior year balances have been made to conform to the current year presentation. These reclassifications had no impact on the Company's consolidated financial position, results of operations or net change in cash and cash equivalents.

Adoption of New Accounting Standards

In July 2010, the FASB updated disclosure requirements with respect to the credit quality of financing receivables and the allowance for credit losses. According to the guidance there are two levels of detail at which credit information will be presented—the portfolio segment and class levels. The portfolio segment level is defined as the level where financing receivables are aggregated in developing a Company's systematic method for calculating its allowance for credit losses. The class level is the second level at which credit information will be presented and represents the categorization of

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HERITAGE COMMERCE CORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2011

(Unaudited)

1) Basis of Presentation (Continued)

financing related receivables at a slightly less aggregated level than the portfolio segment level. Companies will now be required to provide the following disclosures as a result of this update: a rollforward of the allowance for credit losses at the portfolio segment level with the ending balances further categorized according to impairment method along with the balance reported in the related financing receivables at period end; additional disclosure of nonaccrual and impaired financing receivables by class as of period end; credit quality and past due/aging information by class as of period end; information surrounding the nature and extent of loan modifications and troubled-debt restructurings and their effect on the allowance for credit losses during the period; and detail of any significant purchases or sales of financing receivables during the period. The increased period-end disclosure requirements became effective for periods ending on or after December 15, 2010, with the exception of additional disclosures surrounding troubled-debt restructurings, which were deferred in December 2010 and become effective for periods ending on or after June 15, 2011. The increased disclosures for activity within a reporting period became effective for periods beginning on or after December 15, 2010. The provisions of this update expanded the Company's current disclosures with respect to the allowance for loan losses.

Newly Issued But Not Yet Effective Accounting Standards

In April 2011, the FASB issued an accounting standard to amend previous guidance with respect to troubled debt restructurings. This updated guidance is designed to assist creditors with determining whether or not a restructuring constitutes a troubled debt restructuring. In particular, additional guidance has been added to help creditors determine whether a concession has been granted and whether a debtor is experiencing financial difficulties. Both of these conditions are required to be met for a restructuring to constitute a troubled debt restructuring. The amendments in the update are effective for the first interim period beginning on or after June 15, 2011, and will be applied retrospectively to the beginning of the annual period of adoption. The provisions of this update are not expected to have a material impact on the Company's financial position, results of operations or cash flows.

In June 2011, the FASB issued an accounting standards update to increase the prominence of items included in Other Comprehensive Income and facilitate the convergence of US GAAP with IFRS. The update prohibits continued presentation of Other Comprehensive Income in the statement of Stockholders' Equity. The update requires that all non-owner changes in stockholders' equity be presented in either a single continuous statement of comprehensive income or in two separate but continuous statements. The amendments in the update are effective for interim and annual periods beginning on or after December 15, 2011. The provisions of this update are only expected to change the manner in which our other comprehensive income is disclosed.

2) Earnings Per Share

Basic earnings (loss) per common share is computed by dividing net income (loss), less dividends and discount accretion on preferred stock, by the weighted average common shares outstanding. The 21,004 shares of Series C Preferred Stock are convertible into 5,601,000 shares of common stock. The Series C Preferred Stock participates in the earnings of the Company and, therefore, the shares issued

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HERITAGE COMMERCE CORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2011

(Unaudited)

2) Earnings Per Share (Continued)

on the conversion of the Series C Preferred Stock would be considered outstanding under the two-class method of computing basic earnings per common share during periods of earnings. Due to the Company's net loss allocable to common shareholders for the three months and six months ended June 30, 2010, the shares issued on the conversion of the Series C Preferred Stock were excluded from the computation of basic loss per average common share. Diluted earnings (loss) per share reflect potential dilution from outstanding stock options and common stock warrants, using the treasury stock method. Due to the Company's net loss allocable to common shareholders for the three months and six months ended June 30, 2010, all stock options and common stock warrants were excluded from the computation of diluted loss per average common share. A reconciliation of the weighted average shares used in computing basic and diluted earnings (loss) per common share is as follows:

		For the Three Months Ended June 30,				For the Six Months Ended June 30,

		2011		2010		2011		2010
Weighted average common shares outstanding			26,243,334		11,820,509		26,238,168		11,820,509
Effect of convertible preferred stock			5,601,000		N/A		5,601,000		N/A

	Shares used in computing basic earnings (loss) per common share		31,844,334		11,820,509		31,839,168		11,820,509
Dilutive effect of stock options oustanding, using the treasury stock method			3,675		N/A		5,566		N/A

	Shares used in computing diluted earnings (loss) per common share		31,848,009		11,820,509		31,844,734		11,820,509

3) Securities

The amortized cost and estimated fair value of securities at June 30, 2011 and December 31, 2010 were as follows:

June 30, 2011		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value

		(Dollars in thousands)
Securities available-for-sale:
	Agency Mortgage-Backed Securities	$	302,150	$	3,104	$	(2,286	)	$	302,968

December 31, 2010		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value

		(Dollars in thousands)
Securities available-for-sale:
	Agency Mortgage-Backed Securities	$	235,099	$	1,079	$	(4,013	)	$	232,165

Table of Contents

HERITAGE COMMERCE CORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

June 30, 2011

(Unaudited)

3) Securities (Continued)

		Available-for-sale

		Amortized Cost		Estimated Fair Value
		(Dollars in thousands)
Due within one year		$	—	$	—
Due after one through five years			56,268		57,713
Due after five through ten years			211,879		211,260
Due after ten years			34,003		33,995

	Total	$	302,150	$	302,968

			June 30, 2011			December 31, 2010

			(Dollars in thousands)
Loans held-for-sale:
	Loans held-for-sale—SBA		$	3,657		$	8,750
	Loans held-for-sale—other			435			2,260

		Total loans held-for-sale	$	4,092		$	11,010

Loans held-for-investment:
	Commercial			358,227		$	378,412
	Real estate:
		Commercial and residential		315,426			337,457
		Land and construction		41,987			62,356
		Home equity		52,621			53,697
	Consumer			13,040			13,244

		Loans		781,301			845,166
Deferred loan origination costs and fees, net				779			883

	Loans, including deferred costs			782,080			846,049
Allowance for loan losses				(23,167	)		(25,204	)

	Loans, net		$	758,913		$	820,845

														Three Months Ended June 30, 2010 Total

		Three Months Ended June 30, 2011
		Commercial			Real Estate			Consumer			Total
		(Dollars in thousands)
Balance, beginning of period		$	13,594		$	9,539		$	876		$	24,009		$	26,527
Charge-offs			(1,681	)		(601	)		(8	)		(2,290	)		(18,681	)
Recoveries			91			401			1			493			307

	Net charge-offs		(1,590	)		(200	)		(7	)		(1,797	)		(18,374	)
Provision for loan losses			1,988			(1,177	)		144			955			18,600

	Balance, end of period	$	13,992		$	8,162		$	1,013		$	23,167		$	26,753

		Six Months Ended June 30, 2011

		Six Months Ended June 30, 2011												Six Months Ended June 30, 2010 Total
		Commercial			Real Estate			Consumer			Total			Six Months Ended June 30, 2010 Total
		(Dollars in thousands)
Balance, beginning of period		$	13,952		$	10,363		$	889		$	25,204		$	28,768
Charge-offs			(2,800	)		(1,596	)		(8	)		(4,404	)		(26,383	)
Recoveries			230			411			1			642			673

	Net charge-offs		(2,570	)		(1,185	)		(7	)		(3,762	)		(25,710	)
Provision for loan losses			2,610			(1,016	)		131			1,725			23,695

	Balance, end of period	$	13,992		$	8,162		$	1,013		$	23,167		$	26,753

				June 30, 2011

				Commercial		Real Estate		Consumer		Total
				(Dollars in thousands)
Allowance for loan losses:
	Ending allowance balance attributable to loans:
		Individually evaluated for impairment		$	4,296	$	621	$	880	$	5,797
		Collectively evaluated for impairment			9,696		7,541		133		17,370

			Total ending allowance balance	$	13,992	$	8,162	$	1,013	$	23,167

	Loans:
		Individually evaluated for impairment		$	13,038	$	10,034	$	983	$	24,055
		Collectively evaluated for impairment			345,189		400,000		12,057		757,246

			Total ending loan balance	$	358,227	$	410,034	$	13,040	$	781,301

			June 30, 2011						December 31, 2010

			Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
			(Dollars in thousands)
With no related allowance recorded:
	Commercial		$	4,478	$	4,184	$	—	$	5,557	$	5,125	$	—
	Real estate:
		Commercial and residential		2,396		2,396		—		4,392		2,431		—
		Land and construction		3,040		3,040		—		6,138		3,429		—
	Consumer			—		—		—		—		—		—

		Total with no related allowance recorded		9,914		9,620		—		16,087		10,985		—
With an allowance recorded:
	Commercial			9,940		8,854		4,296		9,695		9,249		3,427
	Real estate:
		Commercial and residential		198		198		71		4,753		4,753		1,002
		Land and construction		5,001		4,400		550		6,862		5,428		853
		Home Equity		—		—		—		—		—		—
	Consumer			983		983		880		898		898		778

		Total with an allowance recorded		16,122		14,435		5,797		22,208		20,328		6,060

		Total	$	26,036	$	24,055	$	5,797	$	38,295	$	31,313	$	6,060

	Six Months Ended June 30, 2011

			Real Estate										Six Months Ended June 30, 2010 Total
	Commercial		Commercial and Residential		Land and Construction		Home Equity		Consumer		Total		Six Months Ended June 30, 2010 Total
	(Dollars in thousands)
Average of impaired loans during the period	$	13,555	$	4,248	$	7,823	$	94	$	925	$	26,645	$	59,785
Interest income during impairment	$	1	$	—	$	—	$	1	$	—	$	2	$	36
Cash-basis interest earned	$	—	$	—	$	—	$	1	$	—	$	1	$	27

		June 30,

		June 30,				December 31, 2010
		2011		2010		December 31, 2010
		(Dollars in thousands)
Nonaccrual loans—held-for-sale		$	202	$	9,806	$	2,026
Nonaccrual loans—held-for-investment			21,607		47,263		28,821
Restructured and loans over 90 days past due and still accruing			2,448		2,516		2,492

	Total	$	24,257	$	59,585	$	33,339

		June 30, 2011						December 31, 2010

		Nonaccrual		Restructured and Loans Over 90 Days Past Due and Still Accruing		Total		Nonaccrual		Restructured and Loans Over 90 Days Past Due and Still Accruing		Total
		(Dollars in thousands)
Commercial		$	10,690	$	2,336	$	13,026	$	13,545	$	829	$	14,374
Real estate:
	Commercial and residential		2,594		—		2,594		6,450		1,663		8,113
	Land and construction		7,654		—		7,654		9,954		—		9,954
	Home equity		—		—		—		—		—		—
Consumer			871		112		983		898		—		898

	Total	$	21,809	$	2,448	$	24,257	$	30,847	$	2,492	$	33,339

		June 30, 2011

		30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or Greater Past Due		Total Past Due		Loans Not Past Due		Total
		(Dollars in thousands)
Commercial		$	1,912	$	3,860	$	5,921	$	11,693	$	346,534	$	358,227
Real estate:
	Commercial and residential		1,413		—		1,467		2,880		312,546		315,426
	Land and construction		—		1,876		5,564		7,440		34,547		41,987
	Home equity		282		—				282		52,339		52,621
Consumer			—		—		983		983		12,057		13,040

	Total	$	3,607	$	5,736	$	13,935	$	23,278	$	758,023	$	781,301

		June 30, 2011						December 31, 2010

		Nonclassified		Classified		Total		Nonclassified		Classified		Total
		(Dollars in thousands)
Commercial		$	324,910	$	33,317	$	358,227	$	340,319	$	38,093	$	378,412
Real estate:
	Commercial and residential		299,524		15,902		315,426		320,867		16,590		337,457
	Land and construction		17,683		24,304		41,987		32,664		29,692		62,356
	Home equity		51,689		932		52,621		50,757		2,940		53,697
Consumer			12,036		1,004		13,040		12,346		898		13,244

	Total	$	705,842	$	75,459	$	781,301	$	756,953	$	88,213	$	845,166

					Fair Value Measurements Using

			Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
			(Dollars in thousands)
Assets at June 30, 2011:
	Available-for-sale securities:
		Agency Mortgage-Backed Securities	$	302,968		—	$	302,968		—
	I/O strip receivables			2,185		—		2,185		—
Assets at December 31, 2010:
	Available-for-sale securities:
		Agency Mortgage-Backed Securities	$	232,165		—	$	232,165		—
	I/O strip receivables			2,140		—		2,140		—

						Fair Value Measurements Using

				Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
				(Dollars in thousands)
Assets at June 30, 2011:
	Impaired loans held-for-sale—other:
		Real estate:
			Land and construction	$	202		—	$	202		—

	Impaired loans—held-for-investment:
		Commercial		$	7,015		—		—	$	7,015
		Real estate:
			Commercial and residential		1,245		—		—		1,245
			Land and construction		4,135		—		—		4,135
		Consumer			104		—		—		104

				$	12,499		—		—	$	12,499

	Other real estate owned			$	248		—		—	$	248
Assets at December 31, 2010:
	Loans held-for-sale—other:
		Real estate:
			Commercial and residential	$	929		—	$	929		—
			Land and construction		1,097		—		1,097		—

				$	2,026		—	$	2,026		—

	Impaired loans—held-for-investment:
		Commercial		$	6,725		—		—	$	6,725
		Real estate:
			Commercial and residential		5,982		—		—		5,982
			Land and construction		8,005		—		—		8,005
		Consumer			120		—		—		120

				$	20,832		—		—	$	20,832

	Other real estate owned			$	1,296		—		—	$	1,296

			June 30, 2011			December 31, 2010

			(Dollars in thousands)
Impaired loans held-for-investment:
	Book value of impaired loans held-for-investment carried at fair value		$	18,296		$	26,892
	Book value of impaired loans held-for-investment carried at cost			5,759			4,421

		Total impaired loans held-for-investment	$	24,055		$	31,313

Impaired loans held-for-investment carried at fair value:
	Book value of impaired loans held-for-investment carried at fair value		$	18,296		$	26,892
	Specific valuation allowance			(5,797	)		(6,060	)

		Impaired loans held-for-investment carried at fair value, net	$	12,499		$	20,832

		June 30, 2011				December 31, 2010

		Carrying Amounts		Estimated Fair Value		Carrying Amounts		Estimated Fair Value
		(Dollars in thousands)
Assets:
	Cash and cash equivalents	$	88,262	$	88,262	$	72,177	$	72,177
	Securities available-for-sale		302,968		302,968		232,165		232,165
	Loans (including loans held-for-sale), net		763,005		766,296		831,855		855,327
	FHLB and FRB stock		9,917		N/A		9,174		N/A
	Accrued interest receivable		3,372		3,372		3,215		3,215
	Loan servicing rights and I/O strips receivables		3,021		5,424		3,055		5,340
Liabilities:
	Time deposits	$	260,354	$	260,970	$	287,344	$	288,798
	Other deposits		738,201		738,201		706,574		706,574
	Securities sold under agreement to repurchase		—		—		5,000		5,018
	Short-term borrowings		—		—		2,445		2,445
	Subordinated debt		23,702		18,078		23,702		14,445
	Accrued interest payable		256		256		2,810		2,810

			For the Three Months Ended June 30, 2011							For the Three Months Ended June 30, 2010

NET INTEREST INCOME AND NET INTEREST MARGIN			Average Balance		Interest Income/ Expense		Average Yield/ Rate			Average Balance		Interest Income/ Expense		Average Yield/ Rate
			(Dollars in thousands)
Assets:
Loans, gross(1)			$	806,839	$	10,685		5.31	%	$	1,002,987	$	12,737		5.09	%
Securities				278,908		2,278		3.28	%		149,254		1,458		3.92	%
Federal funds sold and interest-bearing deposits in other financial institutions				77,937		52		0.27	%		41,124		17		0.17	%

	Total interest earning assets			1,163,684		13,015		4.49	%		1,193,365		14,212		4.78	%

Cash and due from banks				20,932							20,821
Premises and equipment, net				8,160							8,825
Goodwill and other intangible assets				2,829							46,088
Other assets				70,542							63,828

	Total assets		$	1,266,147						$	1,332,927

Liabilities and shareholders' equity:
Deposits:
		Demand, noninterest-bearing	$	332,535						$	258,902
		Demand, interest-bearing		132,079		65		0.20	%		150,565		83		0.22	%
		Savings and money market		280,870		259		0.37	%		294,628		363		0.49	%
		Time deposits—under $100		32,194		61		0.76	%		38,514		133		1.39	%
		Time deposits—$100 and over		121,929		342		1.13	%		132,062		470		1.43	%
		Time deposits—CDARS		21,254		24		0.45	%		18,849		48		1.02	%
		Time deposits—brokered		92,131		317		1.38	%		177,184		1,060		2.40	%

	Total interest-bearing deposits			680,457		1,068		0.63	%		811,802		2,157		1.07	%

	Total deposits			1,012,992		1,068		0.42	%		1,070,704		2,157		0.81	%
Subordinated debt				23,702		467		7.90	%		23,702		468		7.92	%
Securities sold under agreement to repurchase				—		—		N/A			20,000		113		2.27	%
Short-term borrowings				1,005		8		3.29	%		5,393		46		3.42	%

	Total interest-bearing liabilities			705,164		1,543		0.88	%		860,897		2,784		1.30	%

	Total interest-bearing liabilities and demand, noninterest-bearing / cost of funds			1,037,699		1,543		0.60	%		1,119,799		2,784		1.00	%
Other liabilities				42,537							34,961

	Total liabilities			1,080,236							1,154,760
Shareholders' equity				185,911							178,167

	Total liabilities and shareholders' equity		$	1,266,147						$	1,332,927


Net interest income / margin					$	11,472		3.95	%			$	11,428		3.84	%

				Three Months Ended June 30, 2011 vs. 2010 Increase (Decrease) Due to Change In:

				Average Volume			Average Rate			Net Change
				(Dollars in thousands)
Income from interest earning assets:
	Loans, gross			$	(2,593	)	$	541		$	(2,052	)
	Securities				1,057			(237	)		820
	Federal funds sold and interest-bearing deposits in other financial institutions				24			11			35

		Total interest income from interest earnings assets			(1,512	)		315			(1,197	)

Expense on interest-bearing liabilities:
	Demand, interest-bearing				(10	)		(8	)		(18	)
	Savings and money market				(13	)		(91	)		(104	)
	Time deposits—under $100				(12	)		(60	)		(72	)
	Time deposits—$100 and over				(30	)		(98	)		(128	)
	Time deposits—CDARS				3			(27	)		(24	)
	Time deposits—brokered				(293	)		(450	)		(743	)
	Subordinated debt				—			(1	)		(1	)
	Securities sold under agreement to repurchase				(113	)		—			(113	)
	Short-term borrowings				(36	)		(2	)		(38	)

		Total interest expense on interest-bearing liabilities			(504	)		(737	)		(1,241	)

			Net interest income	$	(1,008	)	$	1,052		$	44

		For The Three Months Ended June 30,

		2011		Percent of Total			2010		Percent of Total
		(Dollars in thousands)
Salaries and employee benefits		$	5,111		54	%	$	5,491		10	%
Occupancy and equipment			1,031		11	%		983		2	%
Professional fees			456		5	%		1,144		2	%
FDIC deposit insurance premiums			383		4	%		1,019		2	%
Software subscriptions			274		3	%		252		1	%
Insurance expense			244		3	%		269		1	%
Data processing			198		2	%		219		0	%
Low income housing investment losses			40		0	%		133		0	%
Other real estate owned expense			127		1	%		69		0	%
Impairment of goodwill			—		0	%		43,181		79	%
Other			1,608		17	%		1,792		3	%

	Total noninterest expense	$	9,472		100	%	$	54,552		100	%

		Weighted Average Life

		Within One Year				After One and Within Five Years					After Five and Within Ten Years					After Ten Years					Total
		Amount		Yield		Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
		(Dollars in thousands)
Securities available-for-sale (at fair value):
	Agency Mortgage-Backed Securities	$	—		—	$	57,713		3.21	%	$	211,260		3.27	%	$	33,995		3.83	%	$	302,968		3.32	%

			June 30, 2011						June 30, 2010						December 31, 2010

			Balance			% to Total			Balance			% to Total			Balance			% to Total
			(Dollars in thousands)
Commercial			$	358,227			46	%	$	388,471			41	%	$	378,412			45	%
Real estate:
	Commercial and residential			315,426			40	%		373,000			40	%		337,457			40	%
	Land and construction			41,987			5	%		110,194			12	%		62,356			7	%
	Home equity			52,621			7	%		52,419			6	%		53,697			6	%
Consumer				13,040			2	%		12,837			1	%		13,244			2	%

		Total loans		781,301			100	%		936,921			100	%		845,166			100	%
Deferred loan costs				779			—			852			—			883			—

	Loans, including deferred costs			782,080			100	%		937,773			100	%		846,049			100	%

Allowance for loan losses				(23,167	)					(26,753	)					(25,204	)

Loans, net			$	758,913					$	911,020					$	820,845

			Due in One Year or Less		Over One Year But Less than Five Years		Over Five Years		Total

			(Dollars in thousands)
Commercial			$	243,376	$	33,852	$	80,999	$	358,227
Real estate:
	Commercial and residential			87,951		190,333		37,142		315,426
	Land and construction			40,683		1,304		—		41,987
	Home equity			50,783		417		1,421		52,621
Consumer				12,043		997		—		13,040

		Loans	$	434,836	$	226,903	$	119,562	$	781,301

Loans with variable interest rates			$	393,123	$	57,120	$	80,035	$	530,278
Loans with fixed interest rates				41,713		169,783		39,527		251,023

		Loans	$	434,836	$	226,903	$	119,562	$	781,301

		Balance

		(Dollars in thousands)
Three months or less		$	90,443	39	%
Over three months through six months			38,245	17	%
Over six months through twelve months			32,865	14	%
Over twelve months			68,125	30	%

	Total	$	229,678	100	%

		Increase/(Decrease) in Estimated Net Interest Income

		Amount			Percent
		(Dollars in thousands)
Change in Interest Rates (basis points)
	+400	$	14,050			28.4	%
	+300	$	10,424			21.1	%
	+200	$	6,763			13.7	%
	+100	$	3,174			6.4	%
	0	$	—			0.0	%
	-100	$	(3,950	)		-8.0	%
	-200	$	(9,020	)		-18.2	%

Exhibit			Description

	3.1		Heritage Commerce Corp Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to 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 to Exhibit 3.1 to the Registrant's Registration Statement on Form S-1 filed July 23, 2010).
	3.3		Heritage Commerce Corp Bylaws, as amended (incorporated by reference to the Registrant's Registration Statement Form S-1 filed on July 23, 2010)
	4.1		Certificate of Determination for Fixed Rate Cumulative Perpetual Preferred Stock, Series A (incorporated by reference to Exhibit 3.1 to the Registrant's Form 8-K filed November 26, 2008)
	4.2		Warrant to Purchase Common Stock dated November 21, 2008 (incorporated by reference to Exhibit 4.2 to the Registrant's Form 8-K filed on November 26, 2008)
	4.3		Certificate of Determination for Series C Convertible Perpetual Preferred Stock (incorporated by reference to the Registrant's Form 8-K filed on June 22, 2010)
	12.1		Calculation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Stock Dividends
	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, furnished herewith
	101.SCH		XBRL Taxonomy Extension Schema Document, furnished herewith
	101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document, furnished herewith
	101.DEF		XBRL Taxonomy Extension Definition Linkbase Document, furnished herewith
	101.LAB		XBRL Taxonomy Extension Label Linkbase Document, furnished herewith
	101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document, furnished herewith


		Heritage Commerce Corp (Registrant)
Date: August 8, 2011		/s/ WALTER T. KACZMAREK Walter T. Kaczmarek Chief Executive Officer
Date: August 8, 2011		/s/ LAWRENCE D. MCGOVERN Lawrence D. McGovern Chief Financial Officer