PUBLIC DISCLOSURE. July 13, 2015 COMMUNITY REINVESTMENT ACT PERFORMANCE EVALUATION. Heritage Bank of Commerce RSSD #

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1 PUBLIC DISCLOSURE July 13, 2015 COMMUNITY REINVESTMENT ACT PERFORMANCE EVALUATION Heritage of Commerce RSSD # Almaden Boulevard San Jose, CA Federal Reserve of San Francisco 101 Market Street San Francisco, California NOTE: This document is an evaluation of this institution s record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of the institution. This evaluation is not, nor should it be construed as, an assessment of the financial condition of this institution. The rating assigned to this institution does not represent an analysis, conclusion, or opinion of the federal financial supervisory agency concerning the safety and soundness of this financial institution.

2 TABLE OF CONTENTS INSTITUTION RATING... 1 Institution s CRA Rating... 1 INSTITUTION... 2 Description of Institution... 2 Scope of Examination... 3 CONCLUSIONS WITH RESPECT TO PERFORMANCE TESTS... 5 Lending Test... 5 LENDING ACTIVITY... 5 ASSESSMENT AREA CONCENTRATION... 6 GEOGRAPHIC AND BORROWER DISTRIBUTION... 6 COMMUNITY DEVELOPMENT LENDING... 7 Investment Test... 7 Service Test... 8 RETAIL BANKING SERVICES... 8 COMMUNITY DEVELOPMENT SERVICES... 9 Fair Lending or Other Illegal Practices Review... 9 FULL-SCOPE ASSESSMENT AREA CONCLUSIONS Santa Clara-San Benito Assessment Area DESCRIPTION OF OPERATIONS IN SANTA CLARA-SAN BENITO ASSESSMENT AREA CONCLUSIONS WITH RESPECT TO PERFORMANCE TESTS IN SANTA CLARA-SAN BENITO Alameda-Contra Costa Assessment Area DESCRIPTION OF OPERATIONS IN ALAMEDA-CONTRA COSTA ASSESSMENT AREA CONCLUSIONS WITH RESPECT TO PERFORMANCE TESTS IN ALAMEDA-CONTRA COSTA APPENDICES Appendix A: Glossary of Terms Appendix B: CRA Core Tables i

3 INSTITUTION RATING Institution s CRA Rating Heritage of Commerce is rated "SATISFACTORY" The following table shows the performance level of Heritage of Commerce with respect to the lending, investment, and service tests. PERFORMANCE LEVELS LENDING TEST* PERFORMANCE TESTS INVESTMENT TEST SERVICE TEST OUTSTANDING HIGH SATISFACTORY x x x LOW SATISFACTORY NEEDS TO IMPROVE SUBSTANTIAL NONCOMPLIANCE * The lending test is weighted more heavily than the investment and service tests in determining the overall rating. The major factors supporting the institution s rating include: A relatively high level of lending, with a substantial majority of small business loans made within the assessment areas; A good geographic distribution of small business loans, particularly in the Santa Clara-San Benito assessment area; A poor borrower distribution of small business loans among businesses of different sizes. A relatively high level of community development loans that promoted economic development through the financing of small businesses, that addressed articulated needs for affordable housing, and that supported entities serving low- and moderate-income individuals; A significant level of community development investments meeting the needs of the bank s assessment areas; A relatively high level of community development services supporting low- and moderateincome individuals and small businesses; and Retail banking services that are reasonably accessible to essentially all portions of the bank s assessment areas. 1

4 INSTITUTION Description of Institution Heritage of Commerce (HBC), with total reported assets of $1.6 billion as of December 31, 2014, is a wholly owned subsidiary of Heritage Commerce Corporation and is headquartered in San Jose, California. HBC operates a total of 11 full-service branches. Six branches operate in Santa Clara County, with locations in Gilroy, Los Altos, Los Gatos, Morgan Hill, San Jose, and Sunnyvale, and an additional branch operates in Hollister within San Benito County. The bank also operates two branches each in Alameda County (in Fremont and Pleasanton) and Contra Costa County (in Danville and Walnut Creek). Effective June 30, 2013, HBC closed its only loan production office in Santa Rosa of Sonoma County. In November 2014, HBC expanded by acquiring CSNK Working Capital Finance Corporation, located in Santa Clara, California and which does business as Bay View Funding. In August 2015, HBC further expanded via the acquisition of Focus Business, a commercial lender headquartered in San Jose, California with a similar product offering and $407 million in assets. HBC principally serves as a commercial lender to the greater San Francisco Bay Area with a focus on small- and middle-market businesses. The bank offers a wide range of products to business customers, including: commercial and industrial loans and lines of credit; equipment loans; term financing; letters of credit; commercial real estate loans; commercial construction loans; Small Business Administrationguaranteed (SBA) loans under the 7A and 504 programs, for which HBC maintains preferred lender status; and business and industry loans guaranteed by the United States Department of Agriculture s (USDA) Rural Development Agency, with which HBC maintains certified status. With the acquisition of Bay View Funding, HBC expanded its portfolio to include asset-based lending and invoice-factoring lending to businesses throughout the United States, thereby expanding its product suite and operational footprint. In addition to these services, HBC has maintained a micro loan program initiated in October 2012 for small businesses referred by local community partners, with the mission of promoting economic development and providing community services to low- and moderate-income individuals. With respect to consumer offerings, HBC offers a comparatively limited range of lending products, including consumer loans, lines of credit, and home equity lines of credit. Exhibit 1 on the following page presents the bank s loan portfolio, as stated in the December 31, 2014 Consolidated Reports of Condition and Income, and highlights the bank s commercial lending focus. 2

5 EXHIBIT 1 LOANS AND LEASES AS OF DECEMBER 31, 2014 Loan Type $ ( 000s) % Commercial/Industrial & Non-Farm Non-Residential Real Estate 899, Construction & Land Development 72, Secured by 1-4 Family Residential Real Estate 66, Multi-Family Residential Real Estate 25, Consumer & Credit Cards 18, Farm Land & Agriculture 8, All Other Total (Gross) 1,089, Since the previous CRA examination, HBC has expanded its Santa Clara assessment area to include San Benito County with the opening of its Hollister, California branch office on June 23, The bank s two assessment areas, below, are part of the San Jose-San Francisco-Oakland Combined Statistical Area. Santa Clara-San Benito, which consists of Santa Clara County and San Benito County in their entireties and which is also known as the San Jose-Sunnyvale-Santa Clara Metropolitan Statistical Area (MSA), and Alameda-Contra Costa, which consists of Alameda County and Contra Costa County in their entireties and which is also known as the Oakland-Hayward-Berkeley Metropolitan Division (MD). HBC did not have any legal or financial impediments during the review period that would have prevented it from meeting the credit needs of its assessment areas in a manner consistent with its business strategy, size, financial capacity, and local economic conditions. The prior CRA examination, conducted as of April 8, 2013, resulted in a satisfactory rating using the Interagency Large Institution CRA Examination Procedures. Scope of Examination HBC s CRA performance was evaluated in accordance with the Interagency Large Institution CRA Examination Procedures. Under these procedures, performance was assessed under the lending, investment, and service tests. extended between January 1, 2013 and December 31, 2014, were used in evaluation under the lending test, representing all full calendar years since the ending date of the prior CRA examination. Community development lending, investments, and services were evaluated for the period of January 1, 2013 through July 13, 2015, representing the end date of the prior CRA evaluation period to the start date of the current examination. Both the Santa Clara-San Benito and Alameda-Contra Costa assessment areas received full-scope reviews. Activity in the Santa Clara-San Benito assessment area received slightly greater weight overall due to the bank s larger presence there in terms of its branch network and deposit base. HBC operated seven of its 11 branches in the Santa Clara-San Benito assessment area, representing 70 percent of its total deposits as of June 30, The lending test, which is weighted more heavily than either the investment or service tests, was based upon a review of small business, small farm, and Home Mortgage Disclosure Act (HMDA) real estate loans subject to reporting under the CRA and HMDA that were originated in either assessment area 3

6 during the evaluation period. A total of 1,050 small business loans, six small farm loans, and 33 home mortgage loans were used in the evaluation of Lending in the Assessment Area. Of these, 926 small business loans made within the assessment areas were used to evaluate the Lending Distribution by Geography and Lending Distribution by Business Revenue. Lending was weighted against the opportunities, credit needs, and overall level of bank activity within each assessment area. The nominal volume of small farm and HMDA loans was considered in the course of the review and is presented in the lending tables that follow. However, given that their limited volume was insufficient to draw meaningful conclusions, they did not influence the overall assessment and analysis focused on small business loans. All lending data is presented in the lending volume tables contained in Appendix B CRA Core Tables and these tables are referenced throughout the document. The investment test was based upon a review of investments originated during or held at the conclusion of the evaluation period that qualified as community development activity under definitions stipulated by the CRA. Similarly, the service test was based upon a review of services provided during the evaluation period that qualified as community development activity under definitions stipulated by the CRA. The service test additionally considered retail services offered by the bank against assessment area needs. No consumer complaints or other public comments regarding the bank s CRA performance were received during the evaluation period. 4

7 CONCLUSIONS WITH RESPECT TO PERFORMANCE TESTS Lending Test HBC s overall performance under the lending test is high satisfactory. Overall, lending levels reflect good responsiveness to assessment area credit needs, and a substantial majority of loans were made within the bank s assessment areas. The geographic distribution of loans reflects good penetration of geographies of all income levels throughout the bank s assessment areas overall, although HBC s performance on this measure varies between assessment areas. The distribution of loans among businesses of different sizes, however, is poor in both assessment areas, reflecting a relative weakness in serving the credit needs of very small businesses. In support of satisfactory performance, however, the bank has made a relatively high level of community development loans, which were responsive to economic development and affordable housing needs in the assessment areas. LENDING ACTIVITY HBC s levels of lending reflect good responsiveness to the need for credit within the bank s assessment areas. Overall, loan volumes in the assessment areas are reasonably commensurate with the bank s share of deposits in those markets. Exhibit 2 below presents the bank s lending activity by product category. EXHIBIT 2 SUMMARY OF LENDING ACTIVITY JANUARY 1, 2013 TO DECEMBER 31, 2014 Loan Type # % $ ( 000s) % Small Business 1, , Small Farm , Total Business Related 1, , HMDA Home Purchase , HMDA Home Improvement HMDA Refinance , HMDA Multifamily , Total HMDA Related , Total 1, , Note: Affiliate loans include only loans originated or purchased within the bank s assessment areas. 5

8 ASSESSMENT AREA CONCENTRATION A substantial majority of small business loans, both by number and by dollar volume, were made within the assessment areas. Exhibit 3 below and the tables in Appendix B provide additional information on lending volumes within each assessment area and overall. EXHIBIT 3 LENDING INSIDE AND OUTSIDE THE ASSESSMENT AREAS JANUARY 1, 2013 TO DECEMBER 31, 2014 Loan Type Inside Outside # % $ ( 000s) % # % $ ( 000s) % Small Business , , Small Farm , Total Business Related , , HMDA Home Purchase , HMDA Home Improvement HMDA Refinance , , HMDA Multifamily , , Total HMDA Related , , Total , , Note: Affiliate loans not included. GEOGRAPHIC AND BORROWER DISTRIBUTION The geographic distribution of small business loans exhibits good penetration of geographies of different income levels; however, the distribution among businesses of different sizes is poor. The facts and data supporting the overall conclusions are presented in Tables 2 through 10 and are discussed further within the respective assessment area analyses. HBC s performance in the Santa Clara-San Benito assessment area positively influenced the overall assessment of the bank s lending distribution by geography. Excellent penetration of low- and moderate-income geographies, well in excess of aggregate CRA reporters active in the Santa Clara-San Benito assessment area, augmented the adequate penetration of Alameda-Contra Costa assessment area geographies. Given consideration for natural barriers within the Alameda-Contra Costa assessment area, market competition, and branch locations relative to the geographic location of low- and moderate-income geographies, the bank s small business loans were reasonably distributed geographically throughout the combined assessment areas. On the other hand, the distribution of small business loans across businesses of different sizes was generally poor. In particular, the bank s frequency of lending to small businesses, defined as those with gross annual revenues of $1.0 million or less, was consistently below the relative percentage of small businesses and the performance achieved by aggregate CRA reporters active in both assessment areas. HBC did, however, extend a good percentage of loans in small dollar amounts, i.e., in amounts of less than $250,000, which was responsive to articulated needs of small businesses. The facts and data supporting these overall conclusions are presented in Table 7 and are discussed further within the respective assessment area analyses. 6

9 COMMUNITY DEVELOPMENT LENDING HBC made a relatively high level of community development loans throughout most of the combined assessment areas and larger regional area or state. The facts and data supporting the overall conclusions are presented in Table 1 and are discussed further within the respective assessment area analyses. HBC extended 46 community development loans, totaling $80.5 million that were generally distributed consistent with the bank s presence in each market, including five loans totaling $7.1 million benefitting a broader statewide or regional area that included the bank s assessment areas. The majority of loans promoted economic development by financing small businesses or by revitalizing or stabilizing low- or moderate-income geographies or designated enterprise zones. helped to support organizations providing qualified community development services to low- and moderate-income individuals and to support affordable housing (including multifamily rental housing) for low- and moderate-income individuals. The five loans benefitting either a broader statewide or regional area are discussed below. One loan and three lines of credit, totaling $6.0 million, were provided to an organization specializing in micro-lending and assisting working individuals earn, save, and invest in future growth. One commercial loan totaling $1.1 million was provided through the SBA s 504 Certified Development Company program to a small business operating outside of the bank s assessment areas. Investment Test HBC s overall performance under the investment test is high satisfactory. The facts and data supporting the overall conclusions are presented in Table 11 and are discussed further within the respective assessment area analyses. HBC made a significant level of qualified community development investments and grants that exhibited good responsiveness to credit and community development needs, making occasional use of innovative or complex instruments to support community development initiatives. Nearly the entirety of the investments supported affordable housing, including low-income housing tax credits that facilitated the development or rehabilitation of affordable housing complexes, which met a critical community need. HBC additionally provided numerous grants to a spectrum of organizations serving the needs of low- and moderate-income individuals within the bank s assessment areas. In total, HBC made 134 qualified community development investments, grants, and donations totaling $20.0 million. These investments consisted of $5.6 million in prior-period investments remaining on the bank s books at the end of the evaluation period and $14.4 million in current period investments, grants, and in-kind donations. In addition, the bank has approximately $2.2 million in unfunded commitments. The majority of the bank s prior-period investments were in the form of mortgage-backed securities and contributions to housing funds benefitting a larger regional area, which includes the bank s assessment areas, but new investments more pointedly targeted the bank s individual assessment areas. HBC also provided approximately $333,000 in grants and donations to organizations that directly benefitted each 7

10 assessment area and $116,000 that benefitted the larger regional area (San Francisco Bay Area) or the State of California. Highlights of HBC s community development investments benefitting a broader statewide/regional area include: Loan Pools. HBC invested in two loan pools maintained by a community development financial institution that provides loans throughout the San Francisco Bay Area. These pools were dedicated to providing micro loans to small businesses not eligible for bank financing as well as to providing affordable housing and community facilities. The bank s investments included a prior-period investment of $1.2 million and an additional $408,000 in unfunded commitments. Low-Income Housing Tax Credits. HBC maintained approximately $227,000 in prior-period investments in low-income housing tax credits. This investment assisted in the development of five affordable housing projects in the greater statewide area. Mortgage-Backed Securities. The bank purchased one new mortgage-backed security totaling $3.3 million backed by loans to low- and moderate-income individuals in Santa Clara, Alameda and Contra Costa counties. The bank also continues to maintain four such mortgage-backed securities from prior review periods, valued at the end of the evaluation period at $4.2 million. Interest on Lawyers Trust Accounts (IOLTAs). HBC provided innovative donations in the form of marked-up interest earnings of $114,638 for IOLTAs remitted to the California State Bar Association and used exclusively to provide legal services to low- and moderate-income individuals throughout California. Service Test HBC s performance under the service test is high satisfactory. HBC s retail banking services and delivery systems are reasonably accessible to its assessment areas, while the opening of a new branch in a moderate-income geography helped improve accessibility to the bank s delivery systems for those of low- or moderate income. Moreover, neither branch hours nor services vary in a way that inconveniences the bank s assessment area geographies. Finally, HBC employees provided a relatively high level of qualified community development services on behalf of the bank. RETAIL BANKING SERVICES HBC s delivery systems are reasonably accessible throughout the assessment areas and do not vary in ways that inconvenience low- and moderate- income geographies. The bank s full range of products and services are available at all branches. Furthermore, the bank offers alternative delivery systems including telephone banking, online banking, and automated teller machines (ATMs) to facilitate access to banking services from a distance and after branch business hours. HBC operates 11 full-service branches, two of which are located in low-income geographies (in Santa Clara County) and one of which is located in a moderate-income geography (in San Benito County). Two additional branches (one each in Alameda and Contra Costa counties) are located in close proximity to 8

11 low- or moderate-income geographies. The branch opening in San Benito County has improved the accessibility of HBC s delivery systems to low- and moderate-income individuals in the branch s vicinity. The only other branch opening, offset by a separate branch closing, consisted of the relocation of the Mountain View branch to Sunnyvale; both branches were situated among middle- and upper income geographies. In sum, changes in the organization of the bank s branch network did not adversely affect the accessibility of its delivery systems. Moreover, as business hours, products, and services remained consistent across branch locations, banking services did not vary in a way that inconvenienced low- and moderate-income geographies. COMMUNITY DEVELOPMENT SERVICES HBC employees provided a relatively high level of community development services that were responsive to community development needs in its assessment areas. employees provided over 1,800 hours of community development services benefitting the bank s combined assessment areas and their larger regional area. These hours were reasonably distributed across the bank s assessment areas, commensurate with the distribution of the bank s deposits and employees. In total, bank community development services benefitted 44 distinct organizations. The vast majority of these services benefitted organizations providing community services to low- and moderate-income individuals. Other services promoted economic development through support to small businesses, helped to revitalize or stabilize low- and moderate-income geographies, or helped provide affordable housing to low- and moderate-income individuals. Fair Lending or Other Illegal Practices Review Concurrent with this CRA evaluation, a review of the bank s compliance with consumer protection laws and regulations was conducted, and no violations of the substantive provisions of anti-discrimination, fair lending, or other illegal credit practice rules, laws or regulations were identified. 9

12 FULL-SCOPE ASSESSMENT AREA CONCLUSIONS For each assessment area where a full-scope review was performed using the examination procedures. Santa Clara-San Benito Assessment Area DESCRIPTION OF OPERATIONS IN SANTA CLARA-SAN BENITO ASSESSMENT AREA The Santa Clara-San Benito assessment area consists of the counties of Santa Clara and San Benito in their entireties. The assessment area is bordered by Alameda and San Mateo Counties to the north, Stanislaus, Merced, and Fresno Counties to the east, Monterey County to the south, and Santa Cruz County to the west. As of 2013, Santa Clara County had a population of 1,836,454 (97 percent of the assessment area population) and a median household income of $103,443; San Benito County had a population of 56,867 (3 percent of the assessment area population) and a median household income of $71, HBC has a relatively small presence and limited market share in this highly competitive assessment area, ranking 12 th among competing institutions. As of June 30, 2014, there were 49 Federal Deposit Insurance Corporation-insured institutions operating 372 offices within the assessment area, with total deposits of $99.8 billion. HBC s seven branches in the assessment area had total deposits of $898.3 million, representing 0.9 percent of the total deposit market share. In 2014, there were 122 business lenders within the assessment area subject to the reporting requirements of CRA. These lenders extended 22,593 small business loans totaling approximately $488.0 million. 2 Reporting institutions represent only a portion of all institutions competing for small business lending in the assessment area. 3 Exhibits 4 and 5, on the following pages, present key demographic and business information used to help develop a performance context for the assessment area, based on the 2010 U.S. Census and 2013 and 2014 Dun and Bradstreet data. As indicated below, 30 percent of the assessment area s households live in low- or moderate-income areas, where the majority of housing is rented. A similar percentage of the assessment area s small businesses likewise operate in low- and moderate-income areas. 1 U.S. Census Bureau, American Community Survey 3-Yr Estimate, Selected Social Characteristics DPO2-DP03, 2013; available from: (accessed July 2, 2015). 2 Information based on 2013 aggregate data consisting of institutions required to file annual CRA data. 3 Those institutions required to collect and report small business loan information under the CRA for a given year were all those regulated by the Office of the Comptroller of the Currency, Federal Reserve System, or the Federal Deposit Insurance Corporation that met the asset size threshold. The asset size threshold for reporting 2013 data was $1.186 billion as of December 31 of each of the prior two calendar years; the asset size threshold for reporting 2014 data was $1.202 billion as of December 31 of each of the prior two calendar years. 10

13 Income Categories EXHIBIT 4 ASSESSMENT AREA DEMOGRAPHICS SANTA CLARA-SAN BENITO ASSESSMENT AREA 2010 CENSUS AND 2013 DUN AND BRADSTREET DATA Tract Distribution Families by Tract Income Families < Poverty Level as % of Families by Tract Families by Family Income # % # % # % # % Low-income , , , Moderate-income , , , Middle-income , , , Upper-income , , , Unknown-income Total AA , , , Income Categories Housing Units by Tract Housing Types by Tract Owner-Occupied Rental Vacant # % % # % # % Low-income 47,950 15, , , Moderate-income 154,057 68, , , Middle-income 249, , , , Upper-income 192, , , , Unknown-income Total AA 644, , , , Businesses by Tract & Revenue Size Total Businesses by Income Categories Tract Less Than or Equal Greater than $1 Revenue Not to $1 Million Million Reported # % # % # % # % Low-income 6, , Moderate-income 21, , , Middle-income 33, , , , Upper-income 32, , , Unknown-income Total AA 93, , , , % of Total Businesses Median Family Income 4 San Benito County Santa Clara County 2013 HUD Adjusted Median Family Income 6 San Benito County Santa Clara County $71,425 $103,983 $79,800 $101,300 December 2013 Median Housing Value 5 San Benito County Santa Clara County 2013 Unemployment Rate 7 San Benito County Santa Clara County $410,000 $769, % 6.5% 4 U.S. Census Bureau, American Community Survey 5-Yr Estimate, Median Family Income in the Past 12 Months (In 2013 Inflation-Adjusted Dollars) B19113, 2013; available from: (accessed August 5, 2015). 5 California Association of Realtors, Historical Housing Data, Median Prices of Existing Detached Homes; available from: (accessed August 5, 2015). 6 HUD Adjusted Median Family Income; available from: (accessed August 5, 2015). 7 U.S. Bureau of Labor Statistics. Labor Force Data by County, 2013 Annual Averages; available from: 11

14 Income Categories EXHIBIT 5 ASSESSMENT AREA DEMOGRAPHICS SANTA CLARA-SAN BENITO ASSESSMENT AREA 2010 CENSUS AND 2014 DUN AND BRADSTREET DATA Tract Distribution Families by Tract Income Families < Poverty Level as % of Families by Tract Families by Family Income # % # % # % # % Low-income , , , Moderate-income , , , Middle-income , , , Upper-income , , , Unknown-income Total AA , , , Income Categories Housing Units by Tract Housing Types by Tract Owner-Occupied Rental Vacant # % % # % # % Low-income 47,950 15, , , Moderate-income 154,057 68, , , Middle-income 249, , , , Upper-income 192, , , , Unknown-income Total AA 644, , , , Businesses by Tract & Revenue Size Total Businesses by Income Categories Tract Less Than or Equal Greater than $1 Revenue Not to $1 Million Million Reported # % # % # % # % Low-income 5, , Moderate-income 21, , , Middle-income 33, , , , Upper-income 33, , , Unknown-income Total AA 93, , , , % of Total Businesses Median Family Income 8 San Benito County Santa Clara County 2014 HUD Adjusted Median Family Income 10 San Benito County Santa Clara County $71,124 $106,401 $76,100 $101,900 December 2014 Median Housing Value 9 San Benito County Santa Clara County 2014 Unemployment Rate 11 San Benito County Santa Clara County $435,000 $846, % 5.2% 8 U.S. Census Bureau, American Community Survey 5-Yr Estimate, Median Family Income in the Past 12 Months (In 2014 Inflation-Adjusted Dollars) B19113, 2014; available from: (accessed March 23, 2016). 9 California Association of Realtors, Historical Housing Data, Median Prices of Existing Detached Homes; available from: (accessed August 5, 2015). 10 HUD Adjusted Median Family Income; available from: (accessed August 5, 2015). 11 U.S. Bureau of Labor Statistics. Labor Force Data by County, 2014 Annual Averages; available from: 12

15 Economic Conditions The Santa Clara-San Benito assessment area s economy is comprised of two distinct regions. Santa Clara County, which is located at the heart of Silicon Valley, hosts a thriving technology section that continues to play an integral role in the area s economy and bolsters numerous other ancillary sectors. In contrast, San Benito County is a largely residential community bordering Santa Clara County to the south, and has one of the highest rates of workers commuting to other counties. It is closely tied to Santa Clara County, where the majority of its commuter workforce is employed. In Santa Clara County, key data observed throughout the review period indicate a nuanced environment of modest, general economic growth across the assessment area with pockets of higher growth. During the review period, both startups and larger technology companies such as Oracle, Google, and Facebook expanded, whereby various factors contributed to sectoral wage growth well above national averages. The county s construction sector also witnessed strong growth due to the need for new office space demanded by technology firms and additional residential real estate to house an expanded workforce. 12 In 2014, residential permitting rose by more than 40 percent in the San Jose area, while it fell nearly 30 percent in nearby San Francisco. Santa Clara generally saw growth in each of its main industries in San Benito County likewise evidenced general growth over the review period. Home to a large agricultural sector with wide, open plots of land, over 80 percent of the county is devoted to farming or ranching and produced $330 million of agricultural commodities in The limestone-rich soil and moderate climate make the area extremely favorable for viticulture, and the county has experienced a growing tourism industry as travelers come to visit the region s dozens of winemakers. 15 As with Santa Clara County, every major industry in San Benito County either added additional jobs or maintained employment levels in Despite the wage and job growth noted above, numerous statistics indicate a continued but uneven recovery from recessionary contractions. While the overall economy continued to improve, small business loan data suggest that, although improved from Great Recession-level lows, lending levels remained significantly depressed. 17 As presented in Exhibit 5, approximately 82,922 small businesses operated in the assessment area in 2014, constituting 88.9 percent of area businesses; in the same year, they received only 45.6 percent of business loans made, well short of their relative presence. 18 National 12 Moody s Analytics, Précis Report, January 2015, San Jose. 13 Department of Transportation, Santa Clara County Economic Forecast, 2014; available from: (accessed June 27, 2015). 14 San Benito Crop Report 2013 (p. 6); available from: 15 Magazine calls San Benito County the area s best kept wine secret. June 19, Benito Link; available from: (accessed June 28, 2015). 16 Department of Transportation, San Benito County Economic Forecast, 2014; available from: (accessed June 27, 2015). 17 Aggregate CRA Small Business data reports; available from: 18 Aggregate CRA Small Business data reports, by MSA; available from: aggregate.aspx. 13

16 surveys suggest that depressed demand, uncertainty about the economy, and concerns for credit worthiness may help explain the lower levels of lending to small businesses. 19 Unemployment data offer additional evidence of ongoing but uneven recovery from the Great Recession. As shown in Exhibit 6 below, the unemployment rate declined throughout the assessment area. At the end of the review period, the unemployment rate in Santa Clara County was over 1.5 percent lower than the statewide average. San Benito County, which experienced large losses in farm and professional service employment in the recession, sustained unemployment rates significantly higher than the statewide average. 20 Unemployment rates in 2014 remained above prerecession figures for both counties, when average annual unemployment rates for Santa Clara County and San Benito County were 4.7 percent and 7.2 percent, respectively, in December ; Californiawide, the rate was 5.4 percent % 10.0% EXHIBIT 6 ANNUAL UNEMPLOYMENT RATES % 8.0% 6.0% 4.0% 8.0% 6.8% 6.5% 5.2% 9.3% 2.0% 0.0% CA Santa Clara San Benito Unevenness in growth across the assessment area is displayed clearly in the housing sector, as seen in Exhibit 7 on the following page. While home prices in the assessment area have risen since 2012, only in Santa Clara County have they recovered to pre-recession-era levels. In Santa Clara County, one of the most expensive housing markets in the state of California, the median home price reached a county record of $900,000 in May In comparison, home prices also increased in San Benito County, albeit at a slower rate, but they have not approached pre-recession levels. While the San Benito data sample 19 Wiersch, Anne Marie. Good News and Bad News on Small Business Lending in January 5, Available from: %20Briefs/Briefs/Good%20News%20and%20Bad%20News%20on%20Small%20Business%20Lending%20in% aspx (accessed March 25, 2015). 20 Bureau of Labor Statistics, Local Area Unemployment Statistics by County, annual average; available from: (accessed May 27, 2015). 21 National Bureau of Economic Research, US Business Cycle Expansions and Contractions; available from: (accessed July 30, 2015). 22 Bureau of Labor Statistics, Local Area Unemployment Statistics by County, annual average; available from: (accessed May 27, 2015). 14

17 is much smaller than Santa Clara County due to its smaller population (only 115 homes were on the market at the end of the review period), trends in the county are consistent with those statewide, which have shown modest, but consistent increases since 2012, recovering approximately half of the values lost in the Great Recession. 23 $1,000,000 $900,000 EXHIBIT 7 MEDIAN HOME PRICES JANUARY 2007-DECEMBER 2014 CA Santa Clara San Benito $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Against this backdrop of rising housing prices and uneven wage growth, home ownership and rental housing have become less accessible in both counties. According to the California Association of Realtors Traditional Affordability Index, the percentage of households that could afford to purchase the median-priced home in Santa Clara County dropped from 30 percent to 22 percent in the two-year span of 2013 to To highlight the relative tightness of the Santa Clara County housing market, statewide rates dropped from 44 percent to 31 percent in the same period. 24 A recent study by the California Housing Partnership Corporation noted that Santa Clara County has the fifth largest shortfall of homes affordable to low-income families in California. Despite the area s rebounding economy and sector-specific wage growth, wages have, for the most part, remained stagnant overall; while inflation-adjusted median rent increased by 10 percent from 2005 to 2012, inflation-adjusted income increased by just 1 percent during the same period. With a shortfall of over 50,000 homes in the county, the net effect is that almost 60 percent of very low-income households pay more than half their income on rent. 25 The Urban Institute, a nonprofit social and economic policy 23 California Association of Realtors, Sales and Median Prices for Existing Detached Homes; available from: (accessed April 23, 2015). 24 California Association of Realtors, Housing Affordability Index-Traditional; available from: (accessed May 29, 2015). 25 California Housing Partnership Corporation; available from: 15

18 research group, estimates that for every 100 very low-income renter households, there are only 24 available affordable units in Santa Clara County. 26 In San Benito County, where housing costs are comparatively lower, housing affordability constraints remain equally binding given lower median household income ($71,379 versus $103,443); there, the Urban Institute estimates there are even fewer (18) available affordable housing units for every 100 very low-income renter households. 27 San Benito County s relative proximity to economic opportunity in Santa Clara County, combined with that county s lack of affordable housing, has generated even stronger demand for such housing in San Benito. 28 Lastly, poverty and food stamp usage rates in the assessment area counties, shown below in Exhibit 8, likewise bear out the incompleteness of economic recovery. While rates of poverty in Santa Clara and San Benito counties stabilized or declined between 2010 and 2013 as statewide rates increased, they remained elevated, and the percentage of those utilizing food stamp benefits remained double that of pre-recession levels in both counties. Within the assessment area, economic conditions remained weaker in San Benito County, where unemployment, poverty and food stamp usage rates have historically been higher, reflecting an urban-rural divide. 29 EXHIBIT 8 POVERTY AND FOOD STAMP USAGE % 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% CA Santa Clara San Benito 16.4% 16.8% 11.8% 10.6% 11.0% 10.6% 11.4% 8.3% 8.8% 9.0% 5.0% 5.2% Poverty Food Stamp Usage Credit and Community Development Needs The economic data previously discussed, as well as feedback from community contacts with small business development agencies, suggest that small businesses in the assessment area need access to a 26 Urban Institute, Housing Assistance Matter Initiative; available from: (accessed January 6, 2015). 27 Urban Institute, Housing Assistance Matter Initiative; available from: (accessed January 6, 2015). 28 San Benito County Regional Housing Needs Allocation Plan (p. 5); available from: 29 U.S. Census Bureau, American Community Survey 3-Yr Estimate, Selected Social Characteristics DPO3, 2007 through 2013; available from: (accessed September 19, 2014). 16

19 variety of forms of credit. As previously mentioned, data reported by banks subject to the CRA within the assessment area indicates that small business lending levels in 2013 and 2014 remained depressed. A review of surveys of senior loan officers conducted by the Federal Reserve Board during the review period indicate that only a small percentage of banks had reported some easing of their lending standards to small firms with annual sales of less than $50.0 million. 30 The depressed lending levels and the limited easing of credit standards for small firms, which became more conservative during the Great Recession, suggest that small businesses face challenges in accessing credit. Information from community contacts suggests that demand for loans in smaller dollar amounts remains unmet, particularly in amounts of less than $250,000. The lack of housing affordability appears to be exacerbating this issue as small business owners, who rely on home equity as an important source of collateral for small business development, have been constrained by an increasingly less affordable housing market. Discussions with contacts also suggested that recovery from the Great Recession has not brought a resurgence of small business activity in the services sector, and high property rental prices driven by competition from the growth of larger technology companies have disproportionately displaced small businesses. In addition to the information from community contacts, a variety of other factors indicate that there is also a need for affordable housing development and financing within the assessment area. High housing costs combined with low rental affordability and availability highlight a need for products and services that support access to affordable housing, particularly as growing firms workforces expand. There are a number of resources in the area that are attempting to address these needs and that may provide an opportunity for participation by banks. As previously discussed, the recession took a toll on residents of the area. A 2013 study found that many Californians find it difficult to make ends meet and that the situation would be much worse without state, federal, and local safety net programs. 31 Many households are still struggling from the effects of the recession and those that withdrew funds from emergency accounts during the recession may find themselves doubly disadvantaged as they no longer have assets to draw upon. 32 At the same time, lower revenues resulting from decreased government support and difficulty attracting donations, among other factors have made it more difficult for local non-profits to meet the needs of an expanding clientele. 33 The prevalence of poverty and the need for social support services discussed earlier highlight the importance of community service organizations within the bank s communities. Due to the significant ongoing demand for community services, these organizations often find themselves in need of financial support and technical assistance. This creates potential community development service and investment opportunities for local financial institutions. 30 Federal Reserve Board, Senior Loan Officer Opinion Surveys; available from: 31 Holland, Gale L.A. County Leads California in Poverty Rate, New Analysis Shows. Los Angeles Times, September 30, 2013, available at (accessed August 2, 2014). 32 Rebalancing the American Dream: Forging Pathway to Financial Security. Community Investments. Federal Reserve of San Francisco. Summer/Fall (p. 4). 33 UCLA Center for Civil Society. Stressed and Stretched: The Recession, Poverty, and Human Services Nonprofits in Los Angeles, p. vii. Available at (accessed August 2, 2014). 17

20 CONCLUSIONS WITH RESPECT TO PERFORMANCE TESTS IN SANTA CLARA-SAN BENITO Lending Test HBC s performance under the lending test is good. This assessment is attributable to levels of lending that were responsive to area credit needs, an excellent geographic distribution of loans and a relatively high level of community development loans. Conversely, the bank s lending distributions by business revenue were poor. Tables 1 through 10 contain lending and demographic data used to assess HBC s performance under the lending test. Lending Activity Levels of lending within the assessment area are good and include a number of community development loans, as reflected in Table 1. In addition, lending levels compared reasonably relative to the deposits in this assessment area. Lending Distribution by Geography The geographic distribution of loans within the assessment area reflects excellent penetration of geographies of varying income levels throughout the assessment area, particularly among low- and moderate-income areas. As presented in Table 2, the bank s percentage of lending in low- and moderate-income geographies significantly and consistently exceeded the performance of other lenders in the market as well as the percentage of businesses in these geographies. Small business loans were generally concentrated near branch locations, and no conspicuous gaps in lending across the assessment area were identified. Lending Distribution by Business Revenue Overall, lending distributions within the assessment area by business revenue is poor. HBC s rate of lending to small businesses was consistently and significantly less than that of other CRA reporters active in the market, as presented in Table 7; it was also less than the relative frequency of small businesses in the area. The predominance of small businesses in the assessment area and information discussed in the performance context suggests there are opportunities to lend to this segment of the market consistent with the bank s focus on commercial lending. HBC did, however, extend a majority of its loans in amounts less than $250,000 and a good percentage of loans in amounts under $100,000, which responds to the need for smaller dollar loans also discussed in the performance context. Community Development Lending HBC made a relatively high level of community development loans within the assessment area, helping address the need for affordable housing and services to low- or moderate-income families. The bank funded a total of 31 community development loans, totaling $58.3 million. Of these loans, 19 supported the provision of services to low- and moderate-income individuals and an additional nine loans, totaling $4.4 million, supported affordable housing for low- and moderate-income individuals. Two loans, totaling $12.9 million, helped promote economic development by financing small businesses, consistent with HBC s overall commercial focus. 18

21 Highlights of community development loans in this assessment area are noted below. Two loans and two lines of credit, totaling $3.7 million, to an organization providing vocational training and job placement services to the unemployed who reside in Santa Clara County. Two lines of credit, totaling $2.0 million, were extended to an organization that provides affordable housing to low- and moderate-income individuals, particularly to seniors, singleparent families, and disabled individuals. One loan and one line of credit, totaling $1.9 million, to an organization providing health care services to low-income patients. Two lines of credit, totaling $1.5 million, for an organization providing free legal services to lowincome individuals. One line of credit, totaling $25.0 million, to a firm operating in an Enterprise Zone. While community development lending was limited to Santa Clara County, the relative lack of community development lending in San Benito County may be partially explained by the bank s short branch tenure in the county. Investment Test Overall, HBC s performance under the investment test in the Santa Clara-San Benito assessment area is adequate. Investments and grants demonstrated adequate responsiveness to area community development needs, particularly the need for affordable housing for low- and moderate-income individuals and for the revitalization and stabilization of low- and moderate-income geographies. HBC made one new investment in a mortgage-backed security totaling $3.2 million backed by loans that supported affordable housing for eleven low- and moderate-income households. The bank also provided roughly $279,000 in qualified community development grants to 45 different organizations. The majority of these consisted of grants and sponsorships to organizations providing educational, health, and social services to low- and moderate-income individuals. Seven grants totaling $20,000 were provided to four organizations involved in providing affordable housing to low- and moderateincome individuals. Service Test Performance under the service test within the Santa Clara-San Benito assessment area is good based on the accessibility of retail banking services and delivery systems and the relatively high level of community development services. HBC s relatively limited service hours in San Benito County is consistent with the company s limited tenure in this market. 19