Heritage Bank Of Commerce: Recent Interest By A PE Fund Makes For An Interesting Case

| About: Heritage Commerce (HTBK)

Summary

A PE fund has announced that they are going to acquire more than 10% of Heritage.

As of the most recent filing, the fund owns 8.06% of the bank.

Heritage has been able to grow its top and bottom lines at double-digit rates in the past few years. Furthermore, the company has a 3.47% dividend yield.

Continual open market purchases from the PE fund and improvements in the company's top and bottom line should provide for upside.

Heritage Bank of Commerce (NASDAQ:HTBK) is an interesting small-cap community bank due to their rapid top and bottom line growth, their 3.47% dividend yield, and the interest they have just received from Patriot Financial Partnership, a PE fund focused on community banks.

Recent Financials

The most recent quarter was a great quarter for the company. Total interest income grew from $17,366,000 to $23,062,000, a 32.79% increase. Additionally, the bottom line expanded 47.55% from $4,138,000 to $6,106,000.

Net interest income grew 32% YOY, mainly from the loans acquired in the recent Focus acquisition, organic growth in the loan portfolio, and an increase in the average balance of investable securities. In regards to the investable securities, the company grew its noninterest income from $1.9 million to $2.6 million due to a gain on the sales of securities, which helped funnel income to the bottom line.

Despite the notable growth in the total interest income and net income, the NIM contracted 36 basis points to 4.22% due to higher average balances of lower yielding excess funds at the Federal Reserve Bank, interest-bearing deposits in other financial institutions and lower yields on their securities portfolio.

In regards to the loan portfolio, the yield on the portfolio dropped from 5.71% to 5.64%. The decrease was mainly due to the decrease in the proportion of loans in the higher yielding Bay View Funding factored receivables portfolio, relative to the addition of the Focus loans and growth in the company's legacy portfolio. Although, if we exclude the accretion of the loan purchase discount in regards to the Bay Funding factored receivables portfolio, the yield on the loan portfolio would have been 4.78%, compared to 4.73%.

Notwithstanding the decrease in NIM and corresponding loan portfolio yield drawdown, the company improved its efficiency ratio from 65.35% to a low 58.93%. The lower efficiency ratio reflects better operating efficiencies from the recent Focus acquisition and attractive revenue growth during the past year.

The company also experienced a notable decrease in nonperforming assets, down to $4.6 million or 0.20%, from $8.4 million or 0.51% of total assets. This decrease shows management's ability to take on new loans while not adding extra risk.

Overall, the company posted a relatively good quarter on an income statement and balance sheet basis.

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Source: CompleteBankData HTBK

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Source: CompleteBankData HTBK

Patriot Financial Partnership makes for an interesting bull case

On 5-31-16, Patriot Financial Partnership filed that they were buying 10% or more of HTBK. This is interesting for a few reasons. However, before we go into details on why we think this deal is interesting, let's briefly look at Patriot Financial Partnership.

Patriot Financial Partnership is a private equity firm that is focused on investing in community banks, thrifts, and financial service related companies throughout the US.

Source: Patriot Financial Partners Home Page

They were founded in 2007 in order to seek risk-adjusted returns within the community banking sector. As a PE firm, they are looking for banks with historically based asset, loan and core deposit growth, a strong credit culture, net income growth and acceptable levels of capital. In addition, the companies they seek to invest typically have strong management teams with a good track record.

The investment Patriot Financial Partners makes are non-control, yet the company will try to seek board representation. Furthermore, with each investment, the company will identify and prioritize key business initiatives and help grow the bank's franchise value by implementing key practices that have worked in the past.

Other banks that Patriot Financial Partners holds in their portfolio(s) are…

American Chartered Bank (Private)

Banc of California (NYSE:BANC)

Heritage Oaks Bank (NASDAQ:HEOP)

Cape Bancorp (NASDAQ:CBNJ)

Peapack-Gladstone Financial Corporation (NASDAQ:PGC)

Equity Bank (Private)

Porter Bancorp (NASDAQ:PBIB)

Guaranty Bank and Trust Company (NASDAQ:GBNK)

Sterling National Bank (PBNY)

1st United Bancorp (OTCPK:UBAB)

The Palmetto Bank (NASDAQ:PLMT)

Beneficial Bancorp (NASDAQ:BNCL)

Southern National Bancorp of Virginia (NASDAQ:SONA)

BNC Bancorp (NASDAQ:BNCN)

Square 1 Financial (Private)

Cardinal Financial Corporation (NASDAQ:CFNL)

TIB Financial Corp. (Private)

Central Valley Community Bancorp (NASDAQ:CVCY)

VIST Financial (Pending:VIST)

Florida Business BancGroup (Private)

Willow Financial Bancorp (Private)

Independent Bank Corporation (NASDAQ:IBCP)

Avenue Financial Holdings (Private)

Floridian Community Holdings (Private)

MBT Financial Corp. (NASDAQ:MBTF)

Bannockburn Global Forex (Private)

Meta Financial Group (NASDAQ:CASH)

Old Second Bancorp (NASDAQ:OSBC)

Empire Bancorp (OTCQB:EMPK)

US Century Bank (Private)

First Mariner Bank (FMAR)

Atlantic Capital Bancshares (Private)

First Foundation (Private)

An investment from Patriot Financial Partners is interesting for a few different reasons. First, according to the last filing, Patriot Financial Partners owned 2,595,000 shares in HTBK or a $26,547,000 position. As of the last quarterly filing, HTBK had 32,170,920 shares outstanding. Thus, Patriot Financial Partners has an 8.06% position in the company. What this means is that Patriot Financial Partners will most likely continue buying on the open market, putting potential upward pressure on the company as a whole.

Secondly, there are not that many PE funds with the knowledge base, and operating and regulatory expertise to invest a significant amount of capital in community banks. Furthermore, the investment from Patriot Financial Partners should give investors in HTBK an added boost of confidence to their investment decision.

Finally, HTBK is the fund's sixth largest position.

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Source: Whale Wisdom

Given that the company is likely to buy more shares, as stated, they are going to acquire more than 10%, it is very likely that HTBK will be in the top five positions in the near term.

The investment in HTBK from Patriot Financial Partners makes for an interesting case. Patriot will most likely continue to buy HTBK, achieve a board seat and help the company grow the top and bottom line in the midterm. Keeping an eye on both Patriot's position should prove to be beneficial.

Conclusion

HTBK is in a fascinating position right now. The company continues to increase its top and bottom lines at double-digit rates, they are on the acquiring side of the M&A playing field, and they have picked up interest from a PE fund that specializes in community banks. With a P/B of 1.42x, the company is a little richly priced for my deep value investment approach. However, the 3.47% dividend, potential for forward growth and a strong loan book has attracted me to the bank. I will continue to monitor the bank going forward, and may initiate a starter position if the stock price takes a swing downwards.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.