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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission File Number: 0-24724
HEARTLAND FINANCIAL USA, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
42-1405748
(I.R.S. Employer identification number)
1398 Central Avenue, Dubuque, Iowa 52001
(Address of principal executive offices) (Zip Code)
(563) 589-2100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Trust Preferred Securities
(issued by Heartland Financial Capital Trust I)
(Title of Exchange Class)
American Stock Exchange
(Name of Each Exchange on which Registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $1.00 par value
Preferred Share Purchase Rights
(Title of Class)
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 X No
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of Registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
The index to exhibits follows the signature page.
As of June 28, 2002, the Registrant had issued and outstanding
9,820,676 shares of the Registrant's common stock. Indicate by
check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
The aggregate market value of the voting and non-voting common
equity held by non-affiliates of the Registrant, based on the
last sales price quoted on the over-the-counter market bulletin
board on June 28, 2002, the last business day of the registrant's
most recently completed second fiscal quarter, was approximately
$107,405,670.* Such figures include 1,742,015 shares of the
Registrant's Common Stock held in a fiduciary capacity by the
Trust Department of the Dubuque Bank and Trust Company, a wholly-
owned subsidiary of the Registrant.
* Based on the last sales price of the Registrant's common stock
on June 28, 2002, and reports of beneficial ownership filed by
directors and executive officers of Registrant and by beneficial
owners of more than 5% of the outstanding shares of common stock
of Registrant; however, such determination of shares owned by
affiliates does not constitute an admission of affiliate status
or beneficial interest in shares of Registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2003 Annual Meeting of
Stockholders are incorporated by reference into Part III.
HEARTLAND FINANCIAL USA, INC.
Form 10-K Annual Report
Table of Contents
Part I
Item 1. Business
A. General Description
B. Market Areas
C. Competition
D. Employees
E. Internet Access
F. Accounting Standards
G. Supervision and Regulation
H. Governmental Monetary Policy and Economic Conditions
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of
Security Holders
Part II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure
Part III
Item 10. Directors and Executive Officers of the
Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners
and Management
Item 13. Certain Relationships and Related Transactions
Item 14. Controls and Procedures
Part IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K
PART I.
ITEM 1.
BUSINESS
A. GENERAL DESCRIPTION
Heartland Financial USA, Inc. ("Heartland"), reincorporated in
the state of Delaware in 1993, is a multi-bank holding company
registered under the Bank Holding Company Act of 1956, as amended
("BHCA"). Heartland has six bank subsidiaries in the states of
Iowa, Wisconsin, Illinois and New Mexico (collectively, the "Bank
Subsidiaries"). All six Bank Subsidiaries are members of the
Federal Deposit Insurance Corporation ("FDIC"). Dubuque Bank and
Trust Company, Dubuque, Iowa, and First Community Bank, Keokuk,
Iowa are chartered under the laws of the State of Iowa. Dubuque
Bank and Trust Company has two wholly-owned subsidiaries: DB&T
Insurance, Inc., a multi-line insurance agency and DB&T Community
Development Corp., majority owner of a senior housing project.
Galena State Bank and Trust Company, Galena, Illinois, and
Riverside Community Bank, Rockford, Illinois, are chartered under
the laws of the State of Illinois. Wisconsin Community Bank,
Cottage Grove, Wisconsin, is chartered under the laws of the
State of Wisconsin and has one subsidiary, DBT Investment
Corporation, an investment management company. New Mexico Bank &
Trust, Albuquerque, New Mexico, is chartered under the laws of
the state of New Mexico. The Bank Subsidiaries operate 34 banking
locations in Iowa, Illinois, Wisconsin and New Mexico. Heartland
has six non-bank subsidiaries. Citizens Finance Co. is a consumer
finance company. ULTEA, Inc. is a fleet leasing company
headquartered in Madison, Wisconsin. Heartland Capital Trust I,
Heartland Statutory Trust II and Heartland Capital Trust II are
special purpose trust subsidiaries of Heartland formed for the
purpose of the offering of cumulative capital securities. All of
Heartland's subsidiaries are wholly-owned, except for New Mexico
Bank & Trust, of which Heartland owned 86% of the capital stock
on December 31, 2002.
The Bank Subsidiaries provide full service retail banking within
Dubuque and Lee Counties in Iowa; within Jo Daviess, Hancock and
Winnebago Counties in Illinois; within Dane, Green, Sheboygan and
Brown Counties in Wisconsin; and Bernalillo, Curry and Santa Fe
Counties in New Mexico. Deposit products include checking and
other demand deposit accounts, NOW accounts, savings accounts,
money market accounts, certificates of deposit, individual
retirement accounts and other time deposits. The deposits in the
Bank Subsidiaries are insured by the FDIC to the full extent
permitted by law. Loans include commercial and industrial,
agricultural, real estate mortgage, consumer, home equity, credit
cards and lines of credit. Other products and services include
VISA debit cards, automatic teller machines, safe deposit boxes
and trust services. The principal service of the Bank
Subsidiaries consists of making loans to businesses and
individuals. These loans are made at the offices of the Bank
Subsidiaries. The Bank Subsidiaries also engage in activities
that are closely related to banking, including investment
brokerage.
Operating Strategy
Heartland's primary operating strategy is to differentiate the
company as a growing consortium of strong community banks through
community involvement, active boards of directors, local
presidents and local decision-making. As part of the operating
strategy, all directors, officers and employees are encouraged to
maintain a strong ownership interest in Heartland. As of December
31, 2002, these individuals owned approximately 45% of
Heartland's outstanding common stock.
Management believes that the personal and professional service
that is offered to customers provides an appealing alternative to
the "megabanks" that have resulted from the recent mergers and
acquisitions in the financial services industry. While Heartland
employs a community banking philosophy, management believes that
Heartland's size, combined with the full line of financial
products and services, is sufficient to effectively compete in
the respective market areas. At the same time, management
realizes that to remain price competitive Heartland must manage
expense levels by centralizing the back office support functions
to gain economies of scale. Each of the subsidiaries of Heartland
operates under the direction of its own board of directors,
although Heartland has standard operating policies regarding
asset/liability management, liquidity management, investment
management, lending policies and deposit structure management.
In order to accomplish these strategic objectives, management has
focused on improving the performance of the existing subsidiaries
while simultaneously pursuing an acquisition and expansion
strategy. With respect to the existing subsidiaries, Heartland
has primarily focused on the following strategies:
- Improving the bank subsidiaries' funding costs by
reducing the levels of higher-cost certificates of
deposit, increasing the percentage of lower-cost
transaction accounts such as checking, savings and money
market accounts, emphasizing relationship banking and
capitalizing on cross-selling opportunities;
- Emphasizing the expansion of non-traditional sources of
income, including trust and investment services, consumer
finance and vehicle leasing and fleet management;
- Centralizing back office support functions to enable the
Bank Subsidiaries to operate as efficiently as possible;
and
- Continually evaluating new technology and acquiring it
when the expected return justifies the cost.
Acquisition and Expansion Strategy
Heartland's strategy is to diversify both its market area and
asset base while increasing profitability through acquisitions
and through expansion of its current subsidiaries. The goal is to
expand through the acquisition of established financial services
organizations, primarily commercial banks or thrifts, when
suitable candidates can be identified and acceptable business
terms negotiated. Heartland has also formed de novo banking
institutions in market areas where management has identified
market potential and management with banking expertise and
philosophy similar to Heartland's. In evaluating expansion and
acquisition opportunities, Heartland has focused on geographic
areas in the Midwest or Southwest with growth potential. In this
regard, Heartland and a group of investors recently announced
that they intend to file an application with the Arizona
Department of Banking to charter a new bank to be headquartered
in the East Valley of Phoenix.
Heartland continually seeks and evaluates opportunities to
establish branches, loan production offices or other business
facilities as a means of expanding its presence in current or new
market areas. Heartland also looks for opportunities beyond the
Midwest and beyond the categories of community banks and thrifts
when the Heartland board of directors and management believes
that the opportunity will provide a desirable strategic fit
without posing undue risk. Heartland does not currently have any
other definitive understandings or agreements for any
acquisitions material to Heartland. However, Heartland will
continue to look for further expansion opportunities.
Lending Activities
General
The Bank Subsidiaries provide a range of commercial and retail
lending services to corporations, partnerships and individuals.
These credit activities include agricultural, commercial,
residential real estate and installment loans, as well as loan
participations and lines of credit.
The Bank Subsidiaries aggressively market their services to
qualified lending customers. Lending officers actively solicit
the business of new companies entering their market areas as well
as long-standing members of the Bank Subsidiaries' respective
business communities. Through professional service and
competitive pricing, the Bank Subsidiaries have been successful
in attracting new lending customers. Heartland also actively
pursues consumer lending opportunities. With convenient
locations, advertising and customer communications, the Bank
Subsidiaries have been successful in capitalizing on the credit
needs of their market areas.
Commercial Loans
The Bank Subsidiaries have a strong commercial loan base and
Dubuque Bank and Trust Company, in particular, continues to be a
premier commercial lender in the tri-state area of northeast
Iowa, northwest Illinois and southwest Wisconsin. The Bank
Subsidiaries' areas of emphasis include, but are not limited to,
loans to wholesalers, hotel and real estate developers,
manufacturers, building contractors, business services companies
and retailers. The Bank Subsidiaries provide a wide range of
business loans, including lines of credit for working capital and
operational purposes and term loans for the acquisition of
equipment and real estate. Loans may be made on an unsecured
basis where warranted by the overall financial condition of the
borrower. Terms of commercial business loans generally range from
one to five years.
Dubuque Bank and Trust Company and Wisconsin Community Bank have
also generated loans that are guaranteed by the U.S. Small
Business Administration, and these entities have been certified
as Preferred Lenders by the agency. Management believes that
making these guaranteed loans helps its local communities as well
as provides Heartland with a source of income and solid future
lending relationships as such businesses grow and prosper.
Dubuque Bank and Trust Company is also currently one of the state
of Iowa's top lenders in the "Linked Investment for Tomorrow"
program. This state-sponsored program offers interest rate
reductions to businesses opened by minorities and those in rural
areas.
The primary repayment risk for commercial real estate loans is
the failure of the business due to economic events or
governmental regulations outside of the control of the borrower
or lender that negatively impact the future cash flow and market
values of the affected properties. In most cases, the Bank
Subsidiaries have collateralized these loans and/or taken
personal guarantees to help assure repayment.
The Bank Subsidiaries' commercial loans and leases are primarily
made based on the identified cash flow of the borrower and
secondarily on the underlying collateral provided by the
borrower. Credit support provided by the borrower for most of
these loans and leases and the probability of repayment is based
on the liquidation of the pledged collateral and enforcement of a
personal guarantee, if any exists. The primary repayment risks of
commercial loans and leases are that the cash flows of the
borrower may be unpredictable, and the collateral securing these
loans may fluctuate in value.
As the credit portfolios of the Bank Subsidiaries have continued
to grow, several changes have been made in their lending
departments resulting in an overall increase in these
departments' skill levels. Commercial lenders interact with their
respective Boards of Directors each month. Heartland also
utilizes an internal loan review function to analyze credits of
the Bank Subsidiaries and to provide periodic reports to the
respective boards of directors. Management has attempted to
identify problem loans at an early date and to aggressively seek
a resolution of these situations.
Agricultural Loans
Agricultural loans are emphasized by Dubuque Bank and Trust
Company, Wisconsin Community Bank's Monroe banking center and New
Mexico Bank and Trust's Clovis banking offices due to their
concentration of customers in rural markets. Dubuque Bank and
Trust Company maintains its status as one of the largest
agricultural lenders in the state of Iowa. Agricultural loans
remain balanced, however, in proportion to the rest of
Heartland's loan portfolio, constituting approximately 13% of the
total loan portfolio at December 31, 2002. In connection with
their agricultural lending, all of the Bank Subsidiaries have
remained close to their traditional geographic market areas. The
majority of the outstanding agricultural operating and real
estate loans are within 60 miles of their main or branch offices.
Agricultural loans, many of which are secured by crops, machinery
and real estate, are provided to finance capital improvements and
farm operations as well as acquisitions of livestock and
machinery. The ability of the borrower to repay may be affected
by many factors outside of the borrower's control including
adverse weather conditions, loss of livestock due to disease or
other factors, declines in market prices for agricultural
products and the impact of government regulations. Payments on
agricultural loans are ultimately dependent on the profitable
operation or management of the farm property securing the loan.
The agricultural loan departments work closely with all of their
customers, including companies and individual farmers, and review
the preparation of budgets and cash flow projections for the
ensuing crop year. These budgets and cash flow projections are
monitored closely during the year and reviewed with the customers
at least once a year. In addition, the Bank Subsidiaries work
closely with governmental agencies, including the Farmers Home
Administration, to assist agricultural customers in obtaining
credit enhancement products such as loan guarantees.
Real Estate Mortgage Loans
Mortgage lending has been a focal point of the Bank Subsidiaries
as each of them continues to build real estate lending business.
As long-term rates decreased during 2002 and 2001, customers
refinanced their mortgage loans into fifteen- and thirty-year
fixed rate loans, which Heartland usually sells into the
secondary market. Conversely, during 2000, customers elected to
take adjustable-rate mortgage loans, which Heartland elected to
retain in its loan portfolio, during this period of increasing
long-term rates. Management believes that the retention of
mortgage servicing provides the Bank Subsidiaries with a
relatively steady source of fee income as compared to fees
generated solely from mortgage origination operations. Moreover,
the retention of such servicing rights allows each of the Bank
Subsidiaries to continue to have regular contact with mortgage
customers.
Consumer Lending
The Bank Subsidiaries' consumer lending departments provide all
types of consumer loans including motor vehicle, home
improvement, home equity, student loans, credit cards, signature
loans and small personal credit lines. Consumer loans typically
have shorter terms and lower balances with higher yields as
compared to one- to four-family residential mortgage loans, but
generally carry higher risks of default. Consumer loan
collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be affected by adverse
personal circumstances.
Consumer loan demand is also serviced through Citizens Finance
Co., which currently serves the consumer credit needs of almost
5,300 customers in the three state area of Iowa, Illinois and
Wisconsin from its Dubuque, Iowa, Madison and Appleton,
Wisconsin, and Loves Park, Illinois offices. Citizens Finance Co.
typically lends to borrowers with past credit problems or limited
credit histories. Heartland expects to incur a higher level of
credit losses on Citizens Finance Co. loans as compared to other
consumer loans.
Trust Departments
The trust departments for Dubuque Bank and Trust Company, Galena
State Bank and Trust Company, First Community Bank and Wisconsin
Community Bank have been providing trust services to their
respective communities for many years. Trust personnel from
Dubuque Bank and Trust also work with Riverside Community Bank
and New Mexico Bank & Trust personnel to provide trust services
to all Bank Subsidiaries. Currently, the Bank Subsidiaries have
over $651 million of consolidated assets under management and
provide a full complement of trust and investment services for
individuals and corporations.
The trust department of Dubuque Bank and Trust Company is
nationally recognized as a leading provider of socially
responsible investment services and manages investment portfolios
for religious and other non-profit organizations located
throughout the United States. The Bank Subsidiaries' trust
departments are also active in the management of employee benefit
and retirement plans in their market areas. The Bank Subsidiaries
have targeted their trust departments as primary areas for future
growth.
Brokerage and Other Services
Heartland contracts with a third-party vendor, Invest Financial
Corporation, to operate independent securities offices at Dubuque
Bank and Trust Company, Galena State Bank and Trust Company,
Riverside Community Bank and First Community Bank. Invest
Financial Corporation offers full-service stock and bond trading,
direct investments, annuities and mutual funds.
DB&T Insurance has continued to grow its personal insurance lines
and the number of independent insurance companies it represents.
DB&T Insurance is a multi-line insurance agency in the Dubuque
area and offers a complete array of vehicle, property and
casualty, life and disability insurance and tax-free annuities.
B. MARKET AREAS
Dubuque Bank and Trust Company is located in Dubuque County,
Iowa, which encompasses the city of Dubuque and a number of
surrounding rural communities. The city of Dubuque is located in
northeastern Iowa, on the Mississippi River, approximately 175
miles west of Chicago, Illinois, and approximately 200 miles
northeast of Des Moines, Iowa. It is strategically situated at
the intersection of the state borders of Iowa, Illinois and
Wisconsin. Based upon the results of the 2000 census, the city of
Dubuque had a total population of approximately 58,000.
In addition to its main banking office, Dubuque Bank and Trust
Company has seven branch offices, all of which are located in the
Dubuque County area. As a subsidiary of Dubuque Bank and Trust
Company, DB&T Insurance has substantially the same market area as
the parent organization. Citizens Finance Co. also operates
within this market area, and, in addition, offices were opened in
Madison, Wisconsin, during June, 1996, Appleton, Wisconsin,
during August, 1998 and Loves Park, Illinois during February,
1999.
Galena State Bank and Trust Company is located in Galena,
Illinois, which is less than five miles from the Mississippi
River, approximately 20 miles east of Dubuque and 155 miles west
of Chicago. Galena State Bank and Trust Company also has an
office in Stockton, Illinois, and as such, services customers in
Jo Daviess County, Illinois. Based on the 2000 census, the county
had a population of approximately 22,000.
First Community Bank's main office is in Keokuk, Iowa, which is
located in the southeast corner of Iowa near the borders of Iowa,
Missouri and Illinois. Due to its location, First Community Bank
serves customers in the tri-county region of Lee County, Iowa,
Hancock County, Illinois and Clark County, Missouri. Lee, Hancock
and Clark Counties have populations of approximately 38,000,
20,000 and 7,400, respectively. First Community Bank has one
branch office in Keokuk and another branch in the city of
Carthage in Hancock County, Illinois. Keokuk is an industrial
community with a population of approximately 11,000.
Riverside Community Bank is located on the northeast edge of
Rockford, Illinois, which is approximately 75 miles west of
Chicago in Winnebago County. In addition to its main banking
office, Riverside Community Bank has two branch offices, all of
which are located in the Winnebago County area. Based on the
2000 census, the county had a population of 278,000 and the city
of Rockford had a population of 150,000.
Wisconsin Community Bank operates one office from its location in
Cottage Grove, Wisconsin, which is approximately 10 miles east of
Madison in Dane County. A branch office was opened in Middleton,
a suburb of Madison, in February, 1998. Another branch was opened
in Fitchburg, a suburb of Madison, in March, 2003. According to
the 2000 census, the county had a population of 427,000, and the
village of Cottage Grove had a population of 3,800. Wisconsin
Business Bank, a branch of Wisconsin Community Bank, opened three
offices in Sheboygan, DePere and Eau Claire, Wisconsin during
1999. The Eau Claire office was subsequently sold in the fourth
quarter of 2002. The Sheboygan and Depere facilities are located
in the northeastern Wisconsin counties of Sheboygan and Brown
with populations of 113,000 and 227,000, respectively, according
to the 2000 census. Wisconsin Community Bank also acquired the
Bank One Monroe Wisconsin banking center in July of 1999. The
city of Monroe, which is approximately 50 miles southwest of
Madison, is located in Green County in south central Wisconsin.
According to the 2000 census, Monroe had a population of 11,000,
and Green County had a population of 34,000.
New Mexico Bank & Trust operates six offices within Albuquerque,
New Mexico in Bernalillo County. Based upon the 2000 census, the
county had a population of 557,000, and the city had a population
of 449,000. New Mexico Bank & Trust also operates five locations
in the New Mexico communities of Clovis, Portales and Melrose,
all located in Curry County. Clovis is located in east central
New Mexico, approximately 220 miles from Albuquerque, 100 miles
northwest of Lubbock, Texas and 105 miles southwest of Amarillo,
Texas. Clovis had a population of approximately 33,000 according
to the 2000 census, and Curry County had a population of 45,000.
In January, 2003, a branch was opened in Santa Fe, in Santa Fe
County. Santa Fe had of a population of approximately 62,000
according to the 2000 census, and Santa Fe County had a
population of approximately 129,000 according to the 2000 census.
C. COMPETITION
Heartland encounters competition in all areas of its business
pursuits. In order to compete effectively, to develop its market
base, to maintain flexibility and to move in pace with changing
economic and social conditions, Heartland continuously refines
and develops its products and services. The principal methods of
competition in the financial services industry are price, service
and convenience.
The Bank Subsidiaries' combined market area is highly
competitive. Many financial institutions based in the communities
surrounding the Bank Subsidiaries actively compete for customers
within Heartland's market area. The Bank Subsidiaries also face
competition from finance companies, insurance companies, mortgage
companies, securities brokerage firms, money market funds, loan
production offices and other providers of financial services.
Under the Gramm-Leach-Bliley Act, effective in March 2000,
securities firms and insurance companies that elect to become
financial holding companies may acquire banks and other financial
institutions. The Gramm-Leach-Bliley Act may significantly change
the competitive environment in which Heartland and the Bank
Subsidiaries conduct business. The financial services industry is
also likely to become more competitive as further technological
advances enable more companies to provide financial services.
These technological advances may diminish the importance of
depository institutions and other financial intermediaries in the
transfer of funds between parties.
Heartland competes for loans principally through the range and
quality of the services it provides, interest rates and loan
fees. Heartland believes that its long-standing presence in the
community and personal service philosophy enhance its ability to
compete favorably in attracting and retaining individual and
business customers. Heartland actively solicits deposit-oriented
clients and competes for deposits by offering customer's personal
attention, professional service and competitive interest rates.
D. EMPLOYEES
At December 31, 2002, Heartland employed 606 full-time equivalent
employees. Heartland places a high priority on staff development,
which involves extensive training, including customer service
training. New employees are selected on the basis of both
technical skills and customer service capabilities. None of
Heartland's employees are covered by a collective bargaining
agreement. Heartland offers a variety of employee benefits and
management considers its employee relations to be excellent.
E. Internet Access
Heartland maintains an Internet site at www.htlf.com. Heartland
makes available free of charge on this site its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and other reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act as soon as reasonably
practicable after it electronically files such material with, or
furnishes it to, the Securities and Exchange Commission.
F. ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB")
issued Statement No. 143 (FAS 143), "Accounting for Asset
Retirement Obligations," which addresses the recognition and
measurement of obligations with the retirement of tangible long-
lived assets. FAS 143 is effective January 1, 2003, with early
adoption permitted. Heartland adopted FAS 143 effective January
1, 2003,and the adoption of the Statement did not have a material
effect on the financial statements.
In July 2001, the FASB issued Statement No. 141, "Business
Combinations," (FAS 141) and Statement No. 142, "Goodwill and
Other Intangible Assets" (FAS 142). FAS 141 requires that the
purchase method of accounting be used for all business
combinations initiated after June 30, 2001, as well as all
purchase method business combinations completed after June 30,
2001. FAS 141 also specifies criteria that intangible assets
acquired in a purchase method business combination must meet to
be recognized and reported apart from goodwill. FAS 142 requires
that goodwill and intangible assets with indefinite useful lives
no longer be amortized, but instead tested for impairment at
least annually in accordance with the provisions of FAS 142. FAS
142 also requires that intangible assets with definite useful
lives be amortized over their respective estimated useful lives
to their estimated residual values, and reviewed for impairment.
Heartland adopted the provisions of FAS 141 immediately, and FAS
142 effective January 1, 2002. Goodwill and intangible assets
acquired in business combinations completed before July 1, 2001,
continued to be amortized and tested for impairment in accordance
with the appropriate pre-FAS 142 accounting requirements prior to
adoption of FAS 142.
In October 2002, the FASB issued Statement No. 147 (FAS 147),
"Acquisitions of Certain Financial Institutions," which amends
Statement No. 72 (FAS 72), "Accounting for Certain Acquisitions
of Banking or Thrift Institutions," and no longer requires the
separate recognition and subsequent amortization of goodwill.
FAS 147 also amends Statement No. 144 (FAS 144), "Accounting for
the Impairment or Disposal of Long-Lived Assets," to include in
its scope core deposit intangibles. Heartland adopted FAS 147 on
September 30, 2002. As of December 31, 2002, Heartland had
unamortized goodwill in the amount of $16.1 million and
unamortized core deposit premiums in the amount of $2.4 million.
Amortization expense related to goodwill was $1.1 million for the
years ended December 31, 2001 and 2000. Amortization expense
related to core deposit intangible assets was $495, $615 and $757
thousand for the years ended December 31, 2002, 2001 and 2000,
respectively.
The table below reconciles reported earnings for the years ended
December 31, 2002, 2001 and 2000, to "adjusted" earnings, which
exclude goodwill amortization.
(Dollars in thousands, except earnings per share data)
Year
Ended
Dec. 31,
2002 Year Ended Dec. 31, 2001
--------- --------------------------------
Reported Reported Goodwill "Adjusted"
Earnings Earnings Amort. Earnings
--------- -------- -------- -----------
Income from
continuing
operations before
taxes $ 24,113 $ 16,659 $ 1,057 $ 17,716
Income taxes 7,523 5,530 - 5,530
--------- -------- -------- -----------
Income from
continuing
operations $ 16,590 $ 11,129 $ 1,057 $ 12,186
========= ======== ======== ===========
Net income $ 18,867 $ 11,414 $ 1,057 $ 12,471
========= ======== ======== ===========
Earnings from
continuing
operations per
share - basic $ 1.69 $ 1.16 $ .11 $ 1.27
========= ======== ======== ===========
Earnings from
continuing
operations
per common
share - diluted $ 1.68 $ 1.15 $ .11 $ 1.26
=========== ======= ======== ===========
Earnings per
share - basic $ 1.93 $ 1.19 $ .11 $ 1.30
========= ======== ======== ===========
Earnings per
share - diluted $ 1.91 $ 1.18 $ .11 $ 1.28
========= ======== ======== ===========
Year Ended Dec. 31, 2000
-------------------------------
Reported Goodwill "Adjusted"
Earnings Amort. Earnings
-------- -------- -----------
Income from
continuing
operations before
taxes $ 13,790 $ 1,057 $ 14,847
Income taxes 4,211 - 4,211
-------- -------- -----------
Income from
continuing
operations $ 9,579 $ 1,057 $ 10,636
======== ======== ===========
Net income $ 9,586 $ 1,057 $ 10,643
======== ======== ===========
Earnings from
continuing
operations per
share - basic $ .99 $ .11 $ 1.11
======== ======== ===========
Earnings from
continuing
operations
per common
share - diluted $ .98 $ .11 $ 1.09
======== ======== ===========
Earnings per
share - basic $ 1.00 $ .11 $ 1.10
======== ======== ===========
Earnings per
share - diluted $ .98 $ .11 $ 1.09
======== ======== ===========
In August 2001, the FASB issued Statement No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which
supersedes both Statement No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," and the accounting and reporting provisions of Accounting
Principles Bulletin (APB) Opinion No. 30, "Reporting the Results
of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a
business (as previously defined in that Opinion.) FAS 144 retains
the fundamental provisions in FAS 121 for recognizing and
measuring impairment losses on long-lived assets held for use and
long-lived assets to be disposed of by sale, while also resolving
significant implementation issues associated with FAS 121. For
example, FAS 144 provides guidance on how a long-lived asset that
is used as part of a group should be evaluated for impairment,
establishes criteria for when a long-lived asset is held for
sale, and prescribes the accounting for a long-lived asset that
will be disposed of other than by sale. FAS 144 retains the
basic provisions of Opinion No. 30 on how to present discontinued
operations in the income statement but broadens that presentation
to include a component of an entity (rather than a segment of a
business.) Unlike FAS 121, an impairment assessment under FAS
144 will never result in a write-down of goodwill. Rather,
goodwill is evaluated for impairment under FAS 142. Heartland
adopted FAS 144 effective January 1, 2002, and applied FAS 144 to
the sale of Wisconsin Community Bank's branch in Eau Claire,
Wisconsin.
In June 2002, the FASB issued Statement 146 (FAS 146),
"Accounting for Costs Associated with Exit or Disposal
Activities," which addresses financial accounting and reporting
of costs associated with exit or disposal activities. Under FAS
146, such costs will be recognized when the liability is
incurred, rather than at the date of the commitment to an exit
plan. FAS 146 is effective for exit or disposal activities that
are initiated after December 31, 2002, with early adoption
permitted. Heartland adopted FAS 146 on January 1, 2003 and the
adoption of the Statement did not have a material effect on the
financial statements.
In November of 2002, the FASB issued Interpretation No. 45 (FIN
45), Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others. This Interpretation describes the disclosures to be made
by a guarantor in interim and annual financial statements about
obligations under certain guarantees the guarantor has issued. It
also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of FIN 45 are applicable
on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 will not have a
material effect on Heartland's financial statements. Heartland
adopted the disclosure provisions of FIN 45 effective
December 31, 2002.
In December 2002, the FASB issued Statement No. 148 (FAS 148),
Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment to FASB Statement 123. FAS 148 provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, FAS 148 amends the disclosure
requirements of FAS 123 to require more prominent disclosures in
both annual and interim financial statements about the method
used on reported results. FAS 148 is effective for financial
statements for fiscal years ending after December 15, 2002.
Heartland has adopted the disclosure provisions of FAS 148.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities." FIN 46 clarifies
the application of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," to certain entities in which
equity investors do not have the characteristics of a controlling
interest. The recognition and measurement provisions of this
Interpretation are effective for newly created variable interest
entities formed after January 31, 2003, and for existing variable
interest entities, on the first interim or annual reporting
period beginning after June 15, 2003. Heartland adopted the
disclosure provisions of FIN 46 effective December 31, 2002 and
will adopt the provisions of FIN 46 for newly formed variable
interest entities effective January 31, 2003, which will not have
a material effect on Heartland's financial statements. Heartland
has three existing variable interest entities related to low
income housing partnerships and will adopt the provisions of FIN
46 for those entities on July 1, 2003. The total amount of
assets in these entities at December 31, 2002 was approximately
$4.5 million.
G. SUPERVISION AND REGULATION
General
Financial institutions, their holding companies and their
affiliates are extensively regulated under federal and state law.
As a result, the growth and earnings performance of Heartland may
be affected not only by management decisions and general economic
conditions, but also by the requirements of federal and state
statutes and by the regulations and policies of various bank
regulatory authorities, including the Iowa Superintendent of
Banking (the "Superintendent"), the Illinois Commissioner of
Banks and Real Estate (the "Commissioner"), the Division of
Banking of the Wisconsin Department of Financial Institutions
(the "Wisconsin DFI"), the New Mexico Financial Institutions
Division (the "New Mexico FID"), the Board of Governors of the
Federal Reserve System (the "Federal Reserve") and the Federal
Deposit Insurance Corporation (the "FDIC"). Furthermore,
taxation laws administered by the Internal Revenue Service and
state taxing authorities and securities laws administered by the
Securities and Exchange Commission (the "SEC") and state
securities authorities have an impact on the business of
Heartland. The effect of these statutes, regulations and
regulatory policies may be significant, and cannot be predicted
with a high degree of certainty.
Federal and state laws and regulations generally applicable to
financial institutions regulate, among other things, the scope of
business, the kinds and amounts of investments, reserve
requirements, capital levels relative to operations, the nature
and amount of collateral for loans, the establishment of
branches, mergers and consolidations and the payment of
dividends. This system of supervision and regulation establishes
a comprehensive framework for the respective operations of
Heartland and its subsidiaries and is intended primarily for the
protection of the FDIC insured deposits and depositors of the
Bank Subsidiaries, rather than shareholders.
The following is a summary of the material elements of the
regulatory framework that applies to Heartland and its
subsidiaries. It does not describe all of the statutes,
regulations and regulatory policies that apply, nor does it
restate all of the requirements of those that are described. As
such, the following is qualified in its entirety by reference to
applicable law. Any change in statutes, regulations or
regulatory policies may have a material effect on the business of
Heartland and its subsidiaries.
Heartland
General
Heartland as the sole shareholder of Dubuque Bank and Trust
Company, Galena State Bank and Trust Company, Riverside Community
Bank, First Community Bank, Wisconsin Community Bank and the
controlling shareholder of New Mexico Bank & Trust, is a bank
holding company. As a bank holding company, Heartland is
registered with, and is subject to regulation by, the Federal
Reserve under the Bank Holding Company Act of 1956, as amended
(the "BHCA"). In accordance with Federal Reserve policy,
Heartland is expected to act as a source of financial strength to
the Bank Subsidiaries and to commit resources to support the Bank
Subsidiaries in circumstances where Heartland might not otherwise
do so. Under the BHCA, Heartland is subject to periodic
examination by the Federal Reserve. Heartland is also required
to file with the Federal Reserve periodic reports of Heartland's
operations and such additional information regarding Heartland
and its subsidiaries as the Federal Reserve may require.
Acquisitions, Activities and Change in Control
The primary purpose of a bank holding company is to control and
manage banks. The BHCA generally requires the prior approval of
the Federal Reserve for any merger involving a bank holding
company or any acquisition by a bank holding company of another
bank or bank holding company. Subject to certain conditions
(including certain deposit concentration limits established by
the BHCA), the Federal Reserve may allow a bank holding company
to acquire banks located in any state of the United States. In
approving interstate acquisitions, the Federal Reserve is
required to give effect to applicable state law limitations on
the aggregate amount of deposits that may be held by the
acquiring bank holding company and its insured depository
institution affiliates in the state in which the target bank is
located (provided that those limits do not discriminate against
out-of-state depository institutions or their holding companies)
and state laws that require that the target bank have been in
existence for a minimum period of time (not to exceed five years)
before being acquired by an out-of-state bank holding company.
The BHCA generally prohibits Heartland from acquiring direct or
indirect ownership or control of more than 5% of the voting
shares of any company that is not a bank and from engaging in any
business other than that of banking, managing and controlling
banks or furnishing services to banks and their subsidiaries.
This general prohibition is subject to a number of exceptions.
The principal exception allows bank holding companies to engage
in, and to own shares of companies engaged in, certain businesses
found by the Federal Reserve to be "so closely related to banking
.... as to be a proper incident thereto." This authority would
permit Heartland to engage in a variety of banking-related
businesses, including the operation of a thrift, consumer
finance, equipment leasing, the operation of a computer service
bureau (including software development), and mortgage banking and
brokerage. The BHCA generally does not place territorial
restrictions on the domestic activities of non-bank subsidiaries
of bank holding companies.
Additionally, bank holding companies that meet certain
eligibility requirements prescribed by the BHCA and elect to
operate as financial holding companies may engage in, or own
shares in companies engaged in, a wider range of nonbanking
activities, including securities and insurance underwriting and
sales, merchant banking and any other activity that the Federal
Reserve, in consultation with the Secretary of the Treasury,
determines by regulation or order is financial in nature,
incidental to any such financial activity or complementary to any
such financial activity and does not pose a substantial risk to
the safety or soundness of depository institutions or the
financial system generally. As of the date of this filing,
Heartland has neither applied for nor received approval to
operate as a financial holding company.
Federal law also prohibits any person or company from acquiring
"control" of an FDIC-insured depository institution or its
holding company without prior notice to the appropriate federal
bank regulator. "Control" is conclusively presumed to exist upon
the acquisition of 25% or more of the outstanding voting
securities of a bank or bank holding company, but may arise under
certain circumstances at 10% ownership.
Capital Requirements
Bank holding companies are required to maintain minimum levels of
capital in accordance with Federal Reserve capital adequacy
guidelines. If capital levels fall below the minimum required
levels, a bank holding company, among other things, may be denied
approval to acquire or establish additional banks or non-bank
businesses.
The Federal Reserve's capital guidelines establish the following
minimum regulatory capital requirements for bank holding
companies: (i) a risk-based requirement expressed as a
percentage of total assets weighted according to risk; and (ii) a
leverage requirement expressed as a percentage of total assets.
The risk-based requirement consists of a minimum ratio of total
capital to total risk-weighted assets of 8%, and a minimum ratio
of Tier 1 capital to total risk-weighted assets of 4%. The
leverage requirement consists of a minimum ratio of Tier 1
capital to total assets of 3% for the most highly rated
companies, with a minimum requirement of 4% for all others. For
purposes of these capital standards, Tier 1 capital consists
primarily of permanent stockholders' equity less intangible
assets (other than certain loan servicing rights and purchased
credit card relationships). Total capital consists primarily of
Tier 1 capital plus certain other debt and equity instruments
that do not qualify as Tier 1 capital and a portion of the
company's allowance for loan and lease losses.
The risk-based and leverage standards described above are minimum
requirements. Higher capital levels will be required if warranted
by the particular circumstances or risk profiles of individual
banking organizations. For example, the Federal Reserve's capital
guidelines contemplate that additional capital may be required to
take adequate account of, among other things, interest rate risk,
or the risks posed by concentrations of credit, nontraditional
activities or securities trading activities. Further, any
banking organization experiencing or anticipating significant
growth would be expected to maintain capital ratios, including
tangible capital positions (i.e., Tier 1 capital less all
intangible assets), well above the minimum levels. As of
December 31, 2002, Heartland had regulatory capital in excess of
the Federal Reserve's minimum requirements.
Dividend Payments
Heartland's ability to pay dividends to its shareholders may be
affected by both general corporate law considerations and
policies of the Federal Reserve applicable to bank holding
companies. As a Delaware corporation, Heartland is subject to
the limitations of the Delaware General Corporation Law
(the "DGCL"), which allows Heartland to pay dividends only out of
its surplus (as defined and computed in accordance with the
provisions of the DGCL) or if Heartland has no such surplus, out
of its net profits for the fiscal year in which the dividend is
declared and/or the preceding fiscal year. Additionally, policies
of the Federal Reserve caution that a bank holding company should
not pay cash dividends that exceed its net income or that can
only be funded in ways that weaken the bank holding company's
financial health, such as by borrowing. The Federal Reserve also
possesses enforcement powers over bank holding companies and
their non-bank subsidiaries to prevent or remedy actions that
represent unsafe or unsound practices or violations of applicable
statutes and regulations. Among these powers is the ability to
proscribe the payment of dividends by banks and bank holding
companies.
Federal Securities Regulation
Heartland's common stock is registered with the SEC under the
Securities Act of 1933, as amended, and the Securities Exchange
Act of 1934, as amended (the "Exchange Act"). Consequently,
Heartland is subject to the information, proxy solicitation,
insider trading and other restrictions and requirements of the
SEC under the Exchange Act.
The Bank Subsidiaries
General
Dubuque Bank and Trust Company and First Community Bank are Iowa-
chartered banks, the deposit accounts of which are insured by the
FDIC's Bank Insurance Fund ("BIF"). As Iowa-chartered banks,
Dubuque Bank and Trust Company and First Community Bank are
subject to the examination, supervision, reporting and
enforcement requirements of the Superintendent, the chartering
authority for Iowa banks, and the FDIC, designated by federal law
as the primary federal regulator of state-chartered FDIC-insured
banks that, like Dubuque Bank and Trust Company and First
Community Bank, are not members of the Federal Reserve System
("non-member banks").
Galena State Bank and Trust Company and Riverside Community Bank
are Illinois-chartered banks, the deposit accounts of which are
insured by the BIF. As Illinois-chartered banks, Galena State
Bank and Trust Company and Riverside Community Bank are subject
to the examination, supervision, reporting and enforcement
requirements of the Commissioner, the chartering authority for
Illinois banks, and the FDIC, as the primary federal regulator of
state-chartered FDIC-insured non-member banks.
Wisconsin Community Bank is a Wisconsin-chartered bank, the
deposit accounts of which are insured by the BIF. As a Wisconsin-
chartered bank, Wisconsin Community Bank is subject to the
examination, supervision, reporting and enforcement requirements
of the Wisconsin DFI, the chartering authority for Wisconsin
banks, and the FDIC, as the primary federal regulator of state-
chartered FDIC-insured non-member banks.
New Mexico Bank & Trust is a New Mexico-chartered bank, the
deposit accounts of which are insured by the BIF. As a New
Mexico-chartered bank, New Mexico Bank & Trust is subject to the
examination, supervision, reporting and enforcement requirements
of the New Mexico FID, the chartering authority for New Mexico
banks, and the FDIC, as the primary federal regulator of state-
chartered FDIC-insured non-member banks.
Deposit Insurance
As FDIC-insured institutions, the Bank Subsidiaries are required
to pay deposit insurance premium assessments to the FDIC. The
FDIC has adopted a risk-based assessment system under which all
insured depository institutions are placed into one of nine
categories and assessed insurance premiums based upon their
respective levels of capital and results of supervisory
evaluations. Institutions classified as well-capitalized (as
defined by the FDIC) and considered healthy pay the lowest
premium while institutions that are less than adequately
capitalized (as defined by the FDIC) and considered of
substantial supervisory concern pay the highest premium. Risk
classification of all insured institutions is made by the FDIC
for each semi-annual assessment period.
During the year ended December 31, 2002, BIF assessments ranged
from 0% of deposits to 0.27% of deposits. For the semi-annual
assessment period beginning January 1, 2003, BIF assessment rates
will continue to range from 0% of deposits to 0.27% of deposits.
FICO Assessments
Since 1987, a portion of the deposit insurance assessments paid
by members of the FDIC's Savings Association Insurance Fund
("SAIF") has been used to cover interest payments due on the
outstanding obligations of the Financing Corporation ("FICO").
FICO was created in 1987 to finance the recapitalization of the
Federal Savings and Loan Insurance Corporation, the SAIF's
predecessor insurance fund. As a result of federal legislation
enacted in 1996, beginning as of January 1, 1997, both SAIF
members and BIF members became subject to assessments to cover
the interest payments on outstanding FICO obligations until the
final maturity of such obligations in 2019. These FICO
assessments are in addition to amounts assessed by the FDIC for
deposit insurance. During the year ended December 31, 2002, the
FICO assessment rate for BIF and SAIF members was approximately
0.02% of deposits.
Supervisory Assessments
All Iowa banks, Illinois banks, Wisconsin banks and New Mexico
banks are required to pay supervisory assessments to their
respective state banking regulators to fund the operations of
those agencies. In general, the amount of the assessment is
calculated on the basis of each institution's total assets.
During the year ended December 31, 2002, the Bank Subsidiaries
paid supervisory assessments totaling $231 thousand.
Capital Requirements
Banks are generally required to maintain capital levels in excess
of other businesses. The FDIC has established the following
minimum capital standards for state-chartered insured non-member
banks, such as the Bank Subsidiaries: (i) a leverage requirement
consisting of a minimum ratio of Tier 1 capital to total assets
of 3% for the most highly-rated banks with a minimum requirement
of at least 4% for all others; and (ii) a risk-based capital
requirement consisting of a minimum ratio of total capital to
total risk-weighted assets of 8%, and a minimum ratio of Tier 1
capital to total risk-weighted assets of 4%. For purposes of
these capital standards, the components of Tier 1 capital and
total capital are the same as those for bank holding companies
discussed above.
The capital requirements described above are minimum
requirements. Higher capital levels will be required if
warranted by the particular circumstances or risk profiles of
individual institutions. For example, regulations of the FDIC
provide that additional capital may be required to take adequate
account of, among other things, interest rate risk or the risks
posed by concentrations of credit, nontraditional activities or
securities trading activities.
Further, federal law and regulations provide various incentives
for financial institutions to maintain regulatory capital at
levels in excess of minimum regulatory requirements. For example,
a financial institution that is "well-capitalized" may qualify
for exemptions from prior notice or application requirements
otherwise applicable to certain types of activities and may
qualify for expedited processing of other required notices or
applications. Additionally, one of the criteria that determines a
bank holding company's eligibility to operate as a financial
holding company is a requirement that all of its financial
institution subsidiaries be "well capitalized." Under the
regulations of the FDIC, in order to be "well-capitalized" a
financial institution must maintain a ratio of total capital to
total risk-weighted assets of 10% or greater, a ratio of Tier 1
capital to total risk-weighted assets of 6% or greater and a
ratio of Tier 1 capital to total assets of 5% or greater.
Federal law also provides the federal banking regulators with
broad power to take prompt corrective action to resolve the
problems of undercapitalized institutions. The extent of the
regulators' powers depends on whether the institution in question
is "adequately capitalized," "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized," in each case
as defined by regulation. Depending upon the capital category to
which an institution is assigned, the regulators' corrective
powers include: (i) requiring the institution to submit a
capital restoration plan; (ii) limiting the institution's asset
growth and restricting its activities; (iii) requiring the
institution to issue additional capital stock (including
additional voting stock) or to be acquired; (iv) restricting
transactions between the institution and its affiliates; (v)
restricting the interest rate the institution may pay on
deposits; (vi) ordering a new election of directors of the
institution; (vii) requiring that senior executive officers or
directors be dismissed; (viii) prohibiting the institution from
accepting deposits from correspondent banks; (ix) requiring the
institution to divest certain subsidiaries; (x) prohibiting the
payment of principal or interest on subordinated debt; and (xi)
ultimately, appointing a receiver for the institution.
As of December 31, 2002: (i) none of the Bank Subsidiaries was
subject to a directive from the FDIC to increase its capital to
an amount in excess of the minimum regulatory capital
requirements; (ii) each of the Bank Subsidiaries exceeded its
minimum regulatory capital requirements under FDIC capital
adequacy guidelines; and (iii) each of the Bank Subsidiaries was
"well-capitalized," as defined by FDIC regulations.
Liability of Commonly Controlled Institutions
Institutions insured by the FDIC may be liable for any loss
incurred by, or reasonably expected to be incurred by, the FDIC
in connection with the default of commonly controlled FDIC-
insured depository institutions or any assistance provided by the
FDIC to commonly controlled FDIC insured depository institutions
in danger of default. Because Heartland controls each of the Bank
Subsidiaries, the Bank Subsidiaries are commonly controlled.
Dividend Payments
The primary source of funds for Heartland is dividends from the
Bank Subsidiaries. In general, under applicable law, none of the
Bank Subsidiaries may pay dividends in excess of its respective
undivided profits.
The payment of dividends by any financial institution or its
holding company is affected by the requirement to maintain
adequate capital pursuant to applicable capital adequacy
guidelines and regulations, and a financial institution generally
is prohibited from paying any dividends if, following payment
thereof, the institution would be undercapitalized. As described
above, each of the Bank Subsidiaries exceeded its minimum capital
requirements under applicable guidelines as of December 31, 2002.
As of December 31, 2002, approximately $45.9 million was
available to be paid as dividends by the Bank Subsidiaries.
Notwithstanding the availability of funds for dividends, however,
the FDIC may prohibit the payment of any dividends by the Bank
Subsidiaries if the FDIC determines such payment would constitute
an unsafe or unsound practice.
Insider Transactions
The Bank Subsidiaries are subject to certain restrictions imposed
by federal law on extensions of credit to Heartland and its
subsidiaries, on investments in the stock or other securities of
Heartland and its subsidiaries and the acceptance of the stock or
other securities of Heartland or its subsidiaries as collateral
for loans made by the Bank Subsidiaries. Certain limitations and
reporting requirements are also placed on extensions of credit by
the Bank to its directors and officers, to directors and officers
of Heartland and its subsidiaries, to principal shareholders of
Heartland and to "related interests" of such directors, officers
and principal shareholders. In addition, federal law and
regulations may affect the terms upon which any person who is a
director or officer of Heartland or any of its subsidiaries or a
principal shareholder of Heartland may obtain credit from banks
with which the Bank Subsidiaries maintain correspondent
relationships.
Safety and Soundness Standards
The federal banking agencies have adopted guidelines that
establish operational and managerial standards to promote the
safety and soundness of federally insured depository
institutions. The guidelines set forth standards for internal
controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset
growth, compensation, fees and benefits, asset quality and
earnings.
In general, the safety and soundness guidelines prescribe the
goals to be achieved in each area, and each institution is
responsible for establishing its own procedures to achieve those
goals. If an institution fails to comply with any of the
standards set forth in the guidelines, the institution's primary
federal regulator may require the institution to submit a plan
for achieving and maintaining compliance. If an institution fails
to submit an acceptable compliance plan, or fails in any material
respect to implement a compliance plan that has been accepted by
its primary federal regulator, the regulator is required to issue
an order directing the institution to cure the deficiency. Until
the deficiency cited in the regulator's order is cured, the
regulator may restrict the institution's rate of growth, require
the institution to increase its capital, restrict the rates the
institution pays on deposits or require the institution to take
any action the regulator deems appropriate under the
circumstances. Noncompliance with the standards established by
the safety and soundness guidelines may also constitute grounds
for other enforcement action by the federal banking regulators,
including cease and desist orders and civil money penalty
assessments.
Branching Authority
Until 2001, an Iowa-chartered bank, such as Dubuque Bank and
Trust or First Community Bank, could only establish a branch
office within the boundaries of the counties contiguous to, or
cornering upon, the county in which the principal place of
business of the bank was located. Further, Iowa law prohibited an
Iowa bank from establishing new branches in a municipality other
than the municipality in which the bank's principal place of
business was located, if another bank already operated one or
more offices in the municipality in which the branch was to be
located. In 2001, the Iowa Banking Act was amended to allow Iowa-
chartered banks to establish up to three branches at any location
in Iowa, subject to regulatory approval, in addition to any
branches established under the branching rules described above.
Beginning July 1, 2004, Iowa-chartered banks will be permitted to
establish any number of branches at any location in Iowa, subject
to regulatory approval.
Illinois banks, such as Galena State Bank and Trust Company and
Riverside Community Bank, have the authority under Illinois law
to establish branches anywhere in the State of Illinois, subject
to receipt of all required regulatory approvals. Likewise, under
the laws of Wisconsin and New Mexico, Wisconsin banks (such as
Wisconsin Community Bank) and New Mexico banks (such as New
Mexico Bank & Trust), respectively, have statewide branching
authority, subject to regulatory approval.
State and national banks are allowed to establish interstate
branch networks through acquisitions of other banks, subject to
certain conditions, including certain limitations on the
aggregate amount of deposits that may be held by the surviving
bank and all of its insured depository institution affiliates.
The establishment of new interstate branches or the acquisition
of individual branches of a bank in another state (rather than
the acquisition of an out-of-state bank in its entirety) is
allowed only if specifically authorized by state law. The laws
of Iowa, Illinois, Wisconsin and New Mexico permit interstate
mergers subject to certain conditions, including a condition
requiring an Iowa, Illinois, Wisconsin or New Mexico bank,
respectively, involved in an interstate merger to have been in
existence and continuous operation for more than five years.
State Bank Investments and Activities
Each of the Bank Subsidiaries generally is permitted to make
investments and engage in activities directly or through
subsidiaries as authorized by the laws of the state under which
it is chartered. However, under federal law and FDIC regulations,
FDIC insured state banks are prohibited, subject to certain
exceptions, from making or retaining equity investments of a
type, or in an amount, that are not permissible for a national
bank. Federal law and FDIC regulations also prohibit FDIC
insured state banks and their subsidiaries, subject to certain
exceptions, from engaging as principal in any activity that is
not permitted for a national bank unless the bank meets, and
continues to meet, its minimum regulatory capital requirements
and the FDIC determines the activity would not pose a significant
risk to the deposit insurance fund of which the bank is a member.
These restrictions have not had, and are not currently expected
to have, a material impact on the operations of the Bank
Subsidiaries.
Federal Reserve System
Federal Reserve regulations, as presently in effect, require
depository institutions to maintain non-interest earning reserves
against their transaction accounts (primarily NOW and regular
checking accounts), as follows: for transaction accounts
aggregating $42.1 million or less, the reserve requirement is 3%
of total transaction accounts; and for transaction accounts
aggregating in excess of $42.1 million, the reserve requirement
is $1.083 million plus 10% of the aggregate amount of total
transaction accounts in excess of $42.1 million. The first $6.0
million of otherwise reservable balances are exempted from the
reserve requirements. These reserve requirements are subject to
annual adjustment by the Federal Reserve. The Bank Subsidiaries
are in compliance with the foregoing requirements.
H. GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS
The earnings of Heartland are affected by the policies of
regulatory authorities, including the Federal Reserve System
whose monetary policies have had a significant effect on the
operating results of commercial banks in the past and are
expected to continue to do so in the future. Because of changing
conditions in the economy and in the money markets, as a result
of actions by monetary and fiscal authorities, interest rates,
credit availability and deposit levels may change due to
circumstances beyond the control of Heartland. Future policies of
the Federal Reserve System and other authorities cannot be
predicted, nor can their effect on future earnings be predicted.
ITEM 2.
PROPERTIES
The following table is a listing of the principal operating
facilities of Heartland:
Main Main
Facility Facility Number
Name and Main Square Owned or of
Facility Address Footage Leased Locations
- ---------------- -------- -------- ---------
Banking Subsidiary
Dubuque Bank and
Trust Company
1398 Central Avenue 59,500 Owned 8
Dubuque, IA 52001
Galena State Bank and
Trust Company
971 Gear Street 18,000 Owned 3
Galena, IL 61036
Riverside Community Bank
6855 E. Riverside Blvd. 8,000 Owned 3
Rockford, IL 60114
First Community Bank
320 Concert Street 6,000 Owned 3
Keokuk, IA 52632
Wisconsin Community Bank
580 North Main Street
Cottage Grove, WI 53527 6,000 Owned 6
New Mexico Bank & Trust
320 Gold NW
Albuquerque, NM 87102 11,400 Lease term 11
through 2006
Main
Facility Number
Name and Main Owned or of
Facility Address Leased Locations
- ---------------- -------- ---------
Nonbanking Subsidiaries
Citizens Finance Co.
1275 Main Street Leased
Dubuque, IA 52001 from DB&T 4
ULTEA, Inc.
2976 Triverton Pike
Madison, WI 53711 Leased 1
The principal offices of Heartland are located in DB&T's main
office.
ITEM 3.
LEGAL PROCEEDINGS
There are no pending legal proceedings, other than ordinary
routine litigation incidental to the business of banking, to
which Heartland or any of its subsidiaries is a party or of which
any of their property is the subject. While the ultimate outcome
of current legal proceedings cannot be predicted with certainty,
it is the opinion of management that the resolution of these
legal actions should not have a material effect on Heartland's
consolidated financial position or results of operations.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 2002 to a
vote of security holders.
PART II
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Heartland's common stock was held by approximately 960
stockholders of record as of March 12, 2003, and is traded in the
over-the-counter market. The common stock has been approved for
listing on the Nasdaq National Market System and it is
anticipated that it will officially be listed in the beginning of
April, 2003.
The following table shows, for the periods indicated, the range
of reported prices per share of Heartland's common stock in the
over-the-counter market. These quotations represent inter-dealer
prices without retail markups, markdowns or commissions and do
not necessarily represent actual transactions.
Heartland Common Stock
Calendar Quarter High Low
---- ---
2001:
First $14 1/4 $12 1/2
Second 14 10 1/4
Third 13 13/16 13 5/32
Fourth 13 1/2 12 25/32
2002:
First $14 $12 13/16
Second 15 13 19/32
Third 15 9/32 14 13/32
Fourth 17 22/32 15
Cash dividends have been declared by Heartland quarterly during
the past two years ending December 31, 2002. The following table
sets forth the cash dividends per share paid on Heartland's
common stock for the past two years:
Calendar Quarter
2002 2001
---- ----
First $.10 $.09
Second .10 .09
Third .10 .09
Fourth .10 .10
Heartland has paid dividends as set forth in the table above.
Heartland's ability to pay dividends to shareholders is largely
dependent upon the dividends it receives from the bank
subsidiaries, and the banks are subject to regulatory limitations
on the amount of cash dividends they may pay. See "Business -
Supervision and Regulation - Heartland - Dividend Payments" and
"Business - Supervision and Regulation- The Bank Subsidiaries -
Dividend Payments" for a more detailed description of these
limitations.
ITEM 6.
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
For the Years Ended December 31,
2002 2001 2000
----------------------------------
STATEMENT OF INCOME DATA
Interest income $ 100,012 $ 107,609 $ 102,535
Interest expense 42,332 58,620 58,678
---------- ---------- ----------
Net interest income 57,680 48,989 43,857
Provision for loan and
lease losses 3,553 4,258 2,976
---------- ---------- ----------
Net interest income after
provision for loan and
lease losses 54,127 44,731 40,881
Noninterest income 32,757 30,261 26,979
Noninterest expense 62,771 58,333 54,070
Income taxes 7,523 5,530 4,211
---------- ---------- ----------
Income from continuing
operations $ 16,590 $ 11,129 $ 9,579
Discontinued operations:
Income (loss) from
operations of discontinued
branch (including gain on
sale of $2,602) 3,751 469 12
Income taxes 1,474 184 5
---------- ---------- ----------
Income (loss) on
discontinued operations 2,277 285 7
---------- ---------- ----------
Net income $ 18,867 $ 11,414 $ 9,586
========== ========== ==========
PER COMMON SHARE DATA
Net income - diluted $ 1.91 $ 1.18 $ 0.98
Income from continuing
operations - diluted(1) 1.68 1.15 0.98
Adjusted net income -
diluted(2) 1.91 1.28 1.09
Adjusted income from
continuing operations -
diluted(3) 1.68 1.26 1.09
Cash dividends 0.40 0.37 0.36
Dividend payout ratio 20.81% 31.19%
36.15%
Book value $ 12.60 $ 11.06 $ 10.00
Weighted average shares
outstanding 9,791,549 9,602,520 9,628,038
BALANCE SHEET DATA
Investments and federal
funds sold $ 424,514 $ 349,417 $ 274,365
Total loans and leases,
net of unearned 1,175,236 1,105,205 1,042,096
Allowance for loan and
lease losses 16,091 14,660 13,592
Total assets 1,785,979 1,644,064 1,466,387
Total deposits 1,337,985 1,205,159 1,101,313
Long-term obligations 161,379 143,789 102,856
Stockholders' equity 124,041 107,090 96,146
EARNINGS PERFORMANCE DATA
Return on average total assets 1.13% 0.72% 0.70%
Return on average stockholders'
equity 16.44 11.32 10.69
Net interest margin ratio(1)(4) 4.04 3.67 3.74
Earnings to fixed charges:
Excluding interest on deposits 3.28x 2.27x 1.87x
Including interest on deposits 1.57 1.28 1.23
ASSET QUALITY RATIOS
Nonperforming assets to total
assets 0.29% 0.52% 0.51%
Nonperforming loans and leases
to total loans and leases 0.38 0.73 0.65
Net loan and lease charge-offs
to average loans and leases 0.16 0.30 0.17
Allowance for loan and lease
losses to total loans and
leases 1.37 1.33 1.30
Allowance for loan and lease
losses to nonperforming
loans and leases 358.77 180.47 201.60
CAPITAL RATIOS
Average equity to average
assets 6.86% 6.47% 6.54%
Total capital to risk-adjusted
assets 11.86 10.89 9.90
Tier 1 leverage 8.24 7.53 7.25
(1) Excludes the discontinued operations of our Eau Claire
branch and the related gain on sale in the fourth quarter of
2002.
(2) Excludes goodwill amortization discontinued with the
adoption of FAS 142 on January 1, 2002, and the adoption of
FAS 147 on September 30, 2002.
(3) Excludes goodwill amortization discontinued with the
adoption of FAS 142 on January 1, 2002, and the adoption of
FAS 147 on September 30, 2002, and the discontinued
operations of our Eau Claire branch and the related gain on
sale in the fourth quarter of 2002.
(4) Tax equivalent using a 34% tax rate.
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
For the Years Ended
December 31,
1999 1998
-----------------------
STATEMENT OF INCOME DATA
Interest income $ 74,119 $ 64,517
Interest expense 40,830 36,304
---------- ----------
Net interest income 33,289 28,213
Provision for loan and lease losses 2,550 951
---------- ----------
Net interest income after provision
for loan and lease losses 30,739 27,262
Noninterest income 25,423 17,297
Noninterest expense 44,571 31,781
Income taxes 3,239 3,757
---------- ----------
Income from continuing operations 8,352 9,021
Discontinued operations:
Income (loss) from operations of
discontinued branch (including
gain on sale of $2,602) (210) -
Income taxes (83) -
---------- ----------
Income (loss) on discontinued
operations (127) -
---------- ----------
Net income $ 8,225 $ 9,021
========== ==========
PER COMMON SHARE DATA
Net income - diluted $ 0.84 $ 0.94
Income from continuing operations -
diluted(1) 0.86 0.94
Adjusted net income - diluted(2) 0.89 0.96
Adjusted income from continuing
operations - diluted(3) 0.91 0.96
Cash dividends 0.34 0.31
Dividend payout ratio 39.47% 32.48%
Book value $ 9.03 $ 8.84
Weighted average shares
outstanding 9,555,194 9,463,313
BALANCE SHEET DATA
Investments and federal funds sold $ 213,452 $ 259,964
Total loans and leases, net of unearned 835,146 590,133
Allowance for loan and lease losses 10,844 7,945
Total assets 1,184,147 953,785
Total deposits 869,659 717,877
Long-term obligations 105,737 80,016
Stockholders' equity 86,573 84,270
EARNINGS PERFORMANCE DATA
Return on average total assets 0.78% 1.01%
Return on average stockholders' equity 9.61 11.26
Net interest margin ratio(1)(4) 3.64 3.58
Earnings to fixed charges:
Excluding interest on deposits 2.18x 2.65x
Including interest on deposits 1.28 1.35
ASSET QUALITY RATIOS
Nonperforming assets to total assets 0.19% 0.28%
Nonperforming loans and leases
to total loans and leases 0.20 0.30
Net loan and lease charge-offs
to average loans and leases 0.06 0.07
Allowance for loan and lease losses
to total loans and leases 1.30 1.35
Allowance for loan and lease losses
to nonperforming loans and leases 657.49 453.74
CAPITAL RATIOS
Average equity to average assets 8.12% 9.01%
Total capital to risk-adjusted assets 11.68 12.13
Tier 1 leverage 8.85 8.58
(1) Excludes the discontinued operations of our Eau Claire
branch and the related gain on sale in the fourth quarter of
2002.
(2) Excludes goodwill amortization discontinued with the
adoption of FAS No. 142 on January 1, 2002, and the adoption
of FAS No. 147 on September 30, 2002.
(3) Excludes goodwill amortization discontinued with the
adoption of FAS No. 142 on January 1, 2002, and the adoption
of FAS No. 147 on September 30, 2002, and the discontinued
operations of our Eau Claire branch and the related gain on
sale in the fourth quarter of 2002.
(4) Tax equivalent using a 34% tax rate.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following presents management's discussion and analysis of
the consolidated financial condition and results of operations of
Heartland Financial USA, Inc. ("Heartland") as of the dates and
for the periods indicated. This discussion should be read in
conjunction with the Selected Financial Data, Heartland's
Consolidated Financial Statements and the Notes thereto and other
financial data appearing elsewhere in this report. The
consolidated financial statements include the accounts of
Heartland and its subsidiaries. All of Heartland's subsidiaries
are wholly-owned except for New Mexico Bank & Trust, of which
Heartland owned 86% of its capital stock on December 31, 2002.
SAFE HARBOR STATEMENT
This report (including information incorporated by reference)
contains, and future oral and written statements of Heartland and
its management may contain, forward-looking statements, within
the meaning of such term in the Private Securities Litigation
Reform Act of 1995, with respect to the financial condition,
results of operations, plans, objectives, future performance and
business of Heartland. Forward-looking statements, which may be
based upon beliefs, expectations and assumptions of Heartland's
management and on information currently available to management,
are generally identifiable by the use of words such as "believe",
"expect", "anticipate", "plan", "intend", "estimate", "may",
"will", "would", "could", "should" or other similar expressions.
Additionally, all statements in this document, including forward-
looking statements, speak only as of the date they are made, and
Heartland undertakes no obligation to update any statement in
light of new information or future events.
Heartland's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which
could have a material adverse effect on the operations and future
prospects of Heartland and its subsidiaries include, but are not
limited to, the following:
- The strength of the United States economy in general and
the strength of the local economies in which Heartland
conducts its operations which may be less favorable than
expected and may result in, among other things, a
deterioration in the credit quality and value of
Heartland's assets.
- The economic impact of past and any future terrorist
threats and attacks, acts of war or threats thereof, and
the response of the United States to any such threats and
attacks.
- The effects of, and changes in, federal, state and local
laws, regulations and policies affecting banking,
securities, insurance and monetary and financial matters.
- The effects of changes in interest rates (including the
effects of changes in the rate of prepayments of
Heartland's assets) and the policies of the Board of
Governors of the Federal Reserve System.
- The ability of Heartland to compete with other financial
institutions as effectively as Heartland currently
intends due to increases in competitive pressures in the
financial services sector.
- The inability of Heartland to obtain new customers and to
retain existing customers.
- The timely development and acceptance of products and
services, including products and services offered through
alternative delivery channels such as the Internet.
- Technological changes implemented by Heartland and by
other parties, including third party vendors, which may
be more difficult or more expensive than anticipated or
which may have unforeseen consequences to Heartland and
its customers.
- The ability of Heartland to develop and maintain secure
and reliable electronic systems.
- The ability of Heartland to retain key executives and
employees and the difficulty that Heartland may
experience in replacing key executives and employees in
an effective manner.
- Consumer spending and saving habits which may change in a
manner that affects Heartland's business adversely.
- Business combinations and the integration of acquired
businesses may be more difficult or expensive than
expected.
- The costs, effects and outcomes of existing or future
litigation.
- Changes in accounting policies and practices, as may be
adopted by state and federal regulatory agencies and the
Financial Accounting Standards Board.
- The ability of Heartland to manage the risks associated
with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be
placed on such statements. Additional information concerning
Heartland and its business, including other factors that could
materially affect Heartland's financial results, is included in
Heartland's filings with the Securities and Exchange Commission.
OVERVIEW
Heartland is a diversified financial services holding company
providing full-service community banking through six banking
subsidiaries with a total of 33 banking locations in Iowa,
Illinois, Wisconsin and New Mexico. In addition, Heartland has
separate subsidiaries in the consumer finance, vehicle
leasing/fleet management, insurance agency and investment
management businesses. Heartland's primary strategy is to balance
its focus on increasing profitability with asset growth and
diversification through acquisitions, de novo bank formations,
branch openings and expansion into non-bank subsidiary
activities.
Heartland's results of operations depend primarily on net
interest income, which is the difference between interest income
from interest earning assets and interest expense on interest
bearing liabilities. Noninterest income, which includes service
charges, fees and gains on loans, rental income on operating
leases and trust income, also affects Heartland's results of
operations. Heartland's principal operating expenses, aside from
interest expense, consist of compensation and employee benefits,
occupancy and equipment costs, depreciation on equipment under
operating leases and provision for loan and lease losses.
The year 2002 was the third consecutive year Heartland was able
to record double-digit growth in earnings. Net income increased
$7.5 million or 65% when compared to 2001. Return on common
equity was 16.44% and return on assets was 1.13%. The Eau Claire
branch of Wisconsin Community Bank, a bank subsidiary of
Heartland, was sold effective December 15, 2002. This
discontinued operation contributed net income of $2.3 million, or
$.23 on a diluted earnings per common share basis, during 2002,
which includes a $1.6 million gain on disposal, net of taxes.
Exclusive of the Eau Claire branch, income from continuing
operations totaled $16.6 million, or $1.68 on a diluted per
common share basis, compared to $11.1 million, or $1.15 on a
diluted per common share basis, during 2001, an increase of $5.5
million or 49%. The 2002 results reinforce and encourage our
community banking approach.
The largest contributor to the improved earnings during 2002 was
net interest income, which grew $8.7 million or 18%. Average
earning assets from continuing operations rose from $1.363
billion during 2001 to $1.467 billion during 2002, a change of
$103.2 million or 8%. The $705 thousand or 17% decrease in
provision for loan and lease losses also contributed to the
improved earnings for 2002. Additionally, noninterest income
experienced a $3.3 million or 11% increase, exclusive of
securities gains and losses, including impairment losses on
equity securities and trading account securities gains and
losses, and valuation adjustments on mortgage servicing rights.
In addition to gains on sale of loans, the other noninterest
income category to reflect significant improvement was service
charges and fees. Noninterest expense was held to a $4.4 million
or 8% increase.
Heartland's adoption of the provisions of Statement of Financial
Accounting Standards ("FAS") No. 142, "Goodwill and Other
Intangible Assets," on January 1, 2002, discontinued the
amortization of $9.5 million in unamortized goodwill. Heartland's
adoption of the provisions of FAS No. 147, "Acquisitions of
Certain Financial Institutions," on September 30, 2002,
discontinued the amortization of $6.6 million in unamortized
other intangibles retroactively to January 1, 2002. The amount of
amortization expense recorded during 2001 on this goodwill and
other intangibles was $1.1 million, or $.11 on a diluted per
common share basis.
A majority of the $142 million or 9% growth in total assets since
year-end 2001 occurred during the last half of the year. Loans
and leases were $1.175 billion and deposits were $1.338 billion
at the end of 2002, an increase of 6% and 11%, respectively,
since year-end 2001. Commercial and agricultural loan growth was
$92 million or 14% and $10 million or 7%, respectively, during
2002. A portion of this growth was offset by the $23 million or
14% decrease in the mortgage loan portfolio due to paydowns
experienced as customers continued to refinance their mortgage
loans into fifteen- and thirty-year fixed rate loans, which
Heartland usually sells into the secondary market.
For the year ended December 31, 2001, income from continuing
operations totaled $11.1 million, an increase of $1.6 million or
16% when compared to the net income of $9.6 million recorded in
2000. Diluted earnings per common share grew to $1.15 from the
$.98 recorded during 2000. Return on common equity was 11.32% and
return on assets was .72% for 2001, compared to 10.69% and .70%,
respectively, for 2000. Contributing to the increased earnings
during 2001 was the $5.1 million or 12% increase in net interest
income from continuing operations, due in large part to growth in
average earning assets. Noninterest income experienced a $3.3
million or 12% increase, primarily due to additional gains on
sale of loans and service charges and fees. As interest rates
moved downward throughout 2001, customers frequently elected to
refinance into fifteen- and thirty-year, fixed-rate mortgage
loans, which Heartland usually elects to sell into the secondary
market while retaining servicing.
Total assets reached $1.644 billion at year-end 2001, an increase
of $178 million or 12% over year-end 2000. Even though the
economy weakened throughout 2001, Heartland was able to grow its
loan portfolio by $63 million or 6% and its deposit account
balances by $104 million or 9% in 2001.
CRITICAL ACCOUNTING POLICIES
The process utilized by Heartland to estimate the adequacy of the
allowance for loan and lease losses is considered a critical
accounting practice for Heartland. The allowance for loan and
lease losses represents management's estimate of identified and
unidentified losses in the existing loan portfolio. Thus, the
accuracy of this estimate could have a material impact on
Heartland's earnings. The adequacy of the allowance for loan and
lease losses is determined using factors that include the overall
composition of the loan portfolio, general economic conditions,
types of loans, past loss experience, loan delinquencies, and
potential substandard and doubtful credits. The adequacy of the
allowance for loan and lease losses is monitored on an ongoing
basis by the loan review staff, senior management and the board
of directors. Factors considered by the loan review committee
included the following:
- Heartland has continued to experience growth in more-
complex commercial loans as compared to relatively lower-
risk residential real estate loans.
- The nation has continued in a period of economic
slowdown.
- During the last several years, Heartland has entered new
markets in which it had little or no previous lending
experience.
There can be no assurances that the allowance for loan and lease
losses will be adequate to cover all losses, but management
believes that the allowance for loan and lease losses was
adequate at December 31, 2002. While management uses available
information to provide for loan and lease losses, the ultimate
collectibility of a substantial portion of the loan portfolio and
the need for future additions to the allowance will be based on
changes in economic conditions. Along with other financial
institutions, management shares a concern for the outlook of the
economy during 2003. Even though there have been various signs of
emerging strength, it is not certain that this strength will be
sustainable. Consumer confidence plunged to a nine-year low
during 2002. Should the economic climate continue to deteriorate,
borrowers may experience difficulty, and the level of
nonperforming loans, charge-offs, and delinquencies could rise
and require further increases in the provision for loan and lease
losses. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the
allowance for loan and lease losses carried by the Heartland
subsidiaries. Such agencies may require Heartland to make
additional provisions to the allowance based upon their judgment
about information available to them at the time of their
examinations.
The table below estimates the theoretical range of the 2002
allowance outcomes and related changes in provision expense
assuming either a reasonably possible deterioration in loan
credit quality or a reasonably possible improvement in loan
credit quality.
THEORETICAL RANGE OF ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars
in thousands)
Allowance for loan and lease losses at
December 31, 2002 $16,091
=======
Assuming deterioration in credit quality:
Addition to provision 1,649
-------
Resultant allowance for loan and lease losses $17,740
=======
Assuming improvement in credit quality:
Reduction in provision (1,154)
-------
Resultant allowance for loan and lease losses $14,937
=======
The assumptions underlying this sensitivity analysis represent an
attempt to quantify theoretical changes that could occur in the
total allowance for loan and lease losses given various economic
assumptions that could impact inherent loss in the loan and lease
portfolio as currently configured. It further assumes that the
general composition of the allowance for loans and lease losses
determined through Heartland's existing process and methodology
remains relatively unchanged. It does not attempt to encompass
extreme and/or prolonged economic downturns, systemic
contractions to specific industries, or systemic shocks to the
financial services sector. A downward/upward migration of the
balances from the current loan grade to the next lower/higher
loan grade was assumed based upon Heartland's experiences during
previous periods of economic movement.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the difference between interest income
earned on earning assets and interest expense paid on interest
bearing liabilities. As such, net interest income is affected by
changes in the volume and yields on earning assets and the volume
and rates paid on interest bearing liabilities. Net interest
margin is the ratio of tax equivalent net interest income to
average earning assets.
Net interest margin from continuing operations, expressed as a
percentage of average earning assets, was 4.04% for the year 2002
compared to 3.67% for the year 2001. Heartland has been
successful in the utilization of floors on its commercial loan
portfolio to minimize the effect downward rates have on its
interest income. If rates begin to edge upward, Heartland will
not see a corresponding increase in its interest income until
rates have moved above the floors in place on these loans.
Interest income as a percentage of average earning assets went
from 7.97% during 2001 to 6.93% during 2002, a decline of 104
basis points. Additionally, on the liability side of the balance
sheet, Heartland has locked in some funding in the three- to five-
year maturities as rates were at historical low levels. Interest
expense as a percentage of average earning assets went from 4.30%
during 2001 to 2.89% for 2002, a decline of 141 basis points.
Net interest margin from continuing operations, expressed as a
percentage of average earning assets, decreased from 3.74% during
2000 to 3.67% during 2001. During 2000, the national prime rate
increased from 8.50% at the beginning of the year to 9.50% at the
end of the year. Conversely, during 2001, the national prime rate
decreased from 9.50% to 4.75%. Management elected to remain
competitive in the market areas it serves and not reprice its
deposit products as quickly. In addition to the delay in
repricing of deposit products, also negatively impacting the net
interest margin was the change in the composition of the balance
sheet, as the percentage of average loans to total average
earning assets decreased from 80% in 2000 to 75% in 2001. Loan
growth slowed due to paydowns experienced in the mortgage loan
portfolio and reduced demand in the commercial loan portfolio.
Net interest income from continuing operations, on a fully tax
equivalent basis, was $59.3 million, $50.1 million and $45.0
million for 2002, 2001 and 2000, respectively, an increase of 18%
for 2002 and 11% for 2001. These increases were the largest
contributors to the double-digit growth in earnings experienced
during both years and were primarily attributable to the growth
in earning assets and the ability to keep the increase in
interest expense below the growth in interest income. Average
earning assets from continuing operations grew $103 million or 8%
and $162 million or 13% during 2002 and 2001, respectively.
Heartland continues to manage its balance sheet on a proactive
basis. The following table sets forth certain information
relating to Heartland's average consolidated balance sheets and
reflects the yield on average earning assets and the cost of
average interest bearing liabilities for the years indicated.
Dividing income or expense by the average balance of assets or
liabilities derives such yields and costs. Average balances are
derived from daily balances, and nonaccrual loans are included in
each respective loan category.
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES(1)
(Dollars in thousands)
For the Year Ended
December 31, 2002
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $ 305,315 $ 13,132 4.30%
Nontaxable(1) 52,756 4,177 7.92
---------- ----------
Total securities 358,071 17,309 4.83
---------- ----------
Interest bearing deposits 10,535 248 2.35
Federal funds sold 20,835 322 1.55
---------- ----------
Loans and leases:
Commercial and commercial
real estate(1) 665,431 45,480 6.83
Residential mortgage 142,469 10,518 7.38
Agricultural and agricultural
real estate(1) 150,485 10,941 7.27
Consumer 120,561 12,036 9.98
Direct financing leases, net 13,626 1,037 7.61
Fees on loans - 3,694 -
Less: allowance for loan
and lease losses (15,309) - -
---------- ----------
Net loans and leases 1,077,263 83,706 7.77
---------- ----------
Total earning assets 1,466,704 101,585 6.93
---------- ----------
NONEARNING ASSETS
Assets of discontinued operation 31,525 - -
Total nonearning assets 173,385 - -
---------- ----------
TOTAL ASSETS $1,671,614 $ 101,585 6.08%
========== ========== ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
Savings accounts $ 477,484 $ 6,530 1.37%
Time, $100 and over 124,063 4,505 3.63
Other time deposits 459,638 20,360 4.43
Short-term borrowings 134,949 2,643 1.96
Other borrowings 135,365 8,294 6.13
---------- ----------
Total interest bearing
liabilities 1,331,499 42,332 3.18
---------- ----------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 162,638 - -
Liabilities of discontinued
operation 31,525 - -
Accrued interest and other
liabilities 31,212 - -
---------- ----------
Total noninterest bearing
liabilities 225,375 - -
---------- ----------
Stockholders' Equity 114,740 - -
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,671,614 $ 42,332 2.53%
========== ========== ======
Net interest income(1) $ 59,253
==========
Net interest income
to total earning assets(1) 4.04%
======
Interest bearing liabilities
to earning assets 90.78%
==========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES(1)
(Dollars in thousands)
For the Year Ended
December 31, 2001
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $ 253,290 $ 14,143 5.58%
Nontaxable(1) 30,909 2,712 8.77
---------- ----------
Total securities 284,199 16,855 5.93
---------- ----------
Interest bearing deposits 7,320 243 3.32
Federal funds sold 49,126 1,981 4.03
---------- ----------
Loans and leases:
Commercial and commercial
real estate(1) 564,261 44,773 7.93
Residential mortgage 191,081 15,364 8.04
Agricultural and agricultural
real estate(1) 139,421 11,767 8.44
Consumer 126,027 13,278 10.54
Direct financing leases, net 16,574 1,242 7.49
Fees on loans - 3,197 -
Less: allowance for loan
and lease losses (14,528) - -
---------- ----------
Net loans and leases 1,022,836 89,621 8.76
---------- ----------
Total earning assets 1,363,481 108,700 7.97
---------- ----------
NONEARNING ASSETS
Assets of discontinued operation 31,951 - -
Total nonearning assets 162,900 - -
---------- ----------
TOTAL ASSETS $1,558,332 $ 108,700 6.98%
========== ========== ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
Savings accounts $ 425,258 $ 11,858 2.79%
Time, $100 and over 143,315 8,220 5.74
Other time deposits 441,325 25,705 5.82
Short-term borrowings 141,532 5,598 3.96
Other borrowings 106,267 7,239 6.81
---------- ----------
Total interest bearing
liabilities 1,257,697 58,620 4.66
---------- ----------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 138,694 - -
Liabilities of discontinued
operation 31,951 - -
Accrued interest and other
liabilities 29,154 - -
---------- ----------
Total noninterest bearing
liabilities 199,799 - -
---------- ----------
Stockholders' Equity 100,836 - -
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,558,332 $ 58,620 3.76%
========== ========== ======
Net interest income(1) $ 50,080
==========
Net interest income
to total earning assets(1) 3.67%
======
Interest bearing liabilities
to earning assets 92.24%
==========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES(1)
(Dollars in thousands)
For the Year Ended
December 31, 2000
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $ 189,610 $ 11,824 6.24%
Nontaxable(1) 31,026 2,748 8.86
---------- ----------
Total securities 220,636 14,572 6.60
---------- ----------
Interest bearing deposits 5,796 333 5.75
Federal funds sold 16,874 911 5.40
---------- ----------
Loans and leases:
Commercial and commercial
real estate(1) 502,040 43,531 8.67
Residential mortgage 202,429 16,376 8.09
Agricultural and agricultural
real estate(1) 133,043 11,848 8.91
Consumer 118,455 12,625 10.66
Direct financing leases, net 15,027 1,056 7.03
Fees on loans - 2,400 -
Less: allowance for loan
and lease losses (12,984) - -
---------- ----------
Net loans and leases 958,010 87,836 9.17
---------- ----------
Total earning assets 1,201,316 103,652 8.63
---------- ----------
NONEARNING ASSETS
Assets of discontinued operation 18,777 - -
Total nonearning assets 150,305 - -
---------- ----------
TOTAL ASSETS $1,370,398 $ 103,652 7.56%
========== ========== ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
Savings accounts $ 382,365 $ 13,866 3.63%
Time, $100 and over 99,272 6,001 6.05
Other time deposits 399,952 23,274 5.82
Short-term borrowings 120,561 6,986 5.79
Other borrowings 113,706 8,551 7.52
---------- ----------
Total interest bearing
liabilities 1,115,856 58,678 5.26
---------- ----------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 123,411 - -
Liabilities of discontinued
operation 18,777 -
Accrued interest and other
liabilities 22,681 -
---------- ----------
Total noninterest bearing
liabilities 164,869 - -
---------- ----------
Stockholders' Equity 89,673 - -
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,370,398 $ 58,678 4.28%
========== ========== ======
Net interest income(1) $ 44,974
==========
Net interest income
to total earning assets(1) 3.74%
======
Interest bearing liabilities
to earning assets 92.89%
==========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
The following table allocates the changes in net interest income
to differences in either average balances or average rates for
earning assets and interest bearing liabilities. The changes have
been allocated proportionately to the change due to volume and
change due to rate. Interest income is measured on a tax
equivalent basis using a 34% tax rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in thousands)
For the Year Ended
December 31,
2002 Compared to 2001
Change Due to
Volume Rate Net
---------------------------
EARNING ASSETS/INTEREST INCOME
Securities
Taxable $ 2,905 $(3,916) $(1,011)
Nontaxable 1,917 (452) 1,465
Interest bearing deposits 107 (102) 5
Federal funds sold (1,141) (518) (1,659)
Loans and leases 4,769 (10,684) (5,915)
------- ------- -------
TOTAL EARNING ASSETS 8,557 (15,672) (7,115)
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
Savings accounts 1,456 (6,784) (5,328)
Time, $100 and over (1,104) (2,611) (3,715)
Other time deposits 1,067 (6,412) (5,345)
Short-term borrowings (260) (2,695) (2,955)
Other borrowings 1,982 (927) 1,055
------- ------- -------
TOTAL INTEREST BEARING
LIABILITIES 3,141 (19,429) (16,288)
------- ------- -------
NET INTEREST INCOME $ 5,416 $ 3,757 $ 9,173
======= ======= =======
ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in thousands)
For the Year Ended
December 31,
2001 Compared to 2000
Change Due to
Volume Rate Net
---------------------------
EARNING ASSETS/INTEREST INCOME
Securities
Taxable $ 3,971 $(1,652) $ 2,319
Nontaxable (10) (26) (36)
Interest bearing deposits 88 (178) (90)
Federal funds sold 1,741 (671) 1,070
Loans and leases 5,944 (4,159) 1,785
------- ------- -------
TOTAL EARNING ASSETS 11,734 (6,686) 5,048
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
Savings accounts 1,555 (3,563) (2,008)
Time, $100 and over 2,662 (443) 2,219
Other time deposits 2,408 23 2,431
Short-term borrowings 1,215 (2,603) (1,388)
Other borrowings (559) (753) (1,312)
------- ------- -------
TOTAL INTEREST BEARING
LIABILITIES 7,281 (7,339) (58)
------- ------- -------
NET INTEREST INCOME $ 4,453 $ 653 $ 5,106
======= ======= =======
PROVISION FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses is established through a
provision charged to expense to provide, in Heartland's opinion,
an adequate allowance for loan and lease losses. The $3.6 million
provision for loan losses made during 2002, a decrease of $705
thousand or 17% when compared to 2001, resulted primarily from a
large recovery on a prior-year charge-off and a decrease in
nonperforming loans. The provision for loan losses made during
2001 was $4.3 million, an increase of $1.3 million or 43% when
compared to the $3.0 million provision made during 2000. Much of
this increase was recorded in response to loan growth experienced
and an increase in nonperforming loans. The adequacy of the
allowance for loan and lease losses is determined by management
using factors that include the overall composition of the loan
portfolio, general economic conditions, ty