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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, 1996
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)
319) 589-2100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of Exchange Class)
None
(Name of Each Exchange on which Registered)
Common Stock $1.00 par value
(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. (X)
The index to exhibits follows the signature page.
As of March 24, 1997, the Registrant had issued and outstanding
4,734,948 shares of the Registrant's Common Stock. The aggregate
market value of the voting stock held by non-affiliates of the
Registrant as of March 24, 1997, was $78,887,327.* Such figures
include 459,540 shares of the Registrant's Common Stock held in a
fiduciary capacity by the Trust Department of the Dubuque Bank &
Trust Company, a wholly-owned subsidiary of the Registrant.
*Based on the last reported price of an actual transaction in
Registrant's Common Stock on February 28, 1997, 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
None
HEARTLAND FINANCIAL USA, INC.
Form 10-K Annual Report
Table of Contents
Part I
Item 1. Business
A. General Description
B. Recent Developments
C. Market Areas
D. Competition
E. Employees
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
Part IV
Item 14. 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 four wholly-owned bank subsidiaries which
are located in Dubuque, Iowa, Cottage Grove, Wisconsin and Galena
and Rockford, Illinois and one wholly-owned federal savings bank
subsidiary which is located in Keokuk, Iowa (collectively, the
"Bank Subsidiaries"). All five Bank Subsidiaries are members of
the Federal Deposit Insurance Corporation ("FDIC"). Dubuque Bank
and Trust Company ("DB&T") is chartered under the laws of the
State of Iowa and has three wholly-owned subsidiaries: DB&T
Insurance, Inc. ("DB&T Insurance"), a multi-line insurance
agency; DBT Investment Corporation ("DBT Investment"), an
investment management company; and DB&T Community Development
Corp. ("DB&T Development"), majority owner of a senior housing
project. Galena State Bank and Trust Company, Galena, Illinois,
("Galena") and Riverside Community Bank, Rockford,Illinois,
("Riverside") are chartered under the laws of the State of
Illinois. Keokuk Bancshares, Inc. ("Keokuk") is a savings and
loan holding company within the meaning of the Home Owner's Loan
Act, as amended ("HOLA") with a wholly-owned federal savings bank
subsidiary, First Community Bank, FSB ("First Community"),
organized under the laws of the United States. First Community
has one wholly-owned subsidiary, KFS Services, Inc. Cottage Grove
State Bank is chartered under the laws of the State of Wisconsin.
The Bank Subsidiaries operate 17 banking locations in Iowa,
Illinois and Wisconsin. Heartland has two wholly-owned non-bank
subsidiaries. Citizens Finance Co. ("Citizens"), previously doing
business as Tri-State Community Credit Corp., is a consumer
finance company. Subsequent to year end 1996, Citizens was
dividended up to Heartland from DB&T. Heartland also acquired
the assets of ULTEA, LLC, a fleet leasing company headquartered
in Madison, Wisconsin, in December, 1996.
The Bank Subsidiaries provide full service retail banking within
Dubuque and Lee Counties in Iowa, within Jo Daviess, Hancock and
Winnebago Counties in Illinois and within Dane County in
Wisconsin. 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.
Although each of the subsidiaries of Heartland operates under the
direction of its own Board of Directors, Heartland has standard
operating policies regarding asset/liability management,
liquidity management, investment management, lending policies and
deposit structure management. Heartland has historically
centralized certain operations where economies of scale can be
achieved.
Operating Strategy
Corporate policy, strategy and goals are established by the Board
of Directors of Heartland (the "Heartland Board"). Pursuant to
Heartland's philosophy, operational and administrative policies
for the Bank Subsidiaries are also established by the Heartland
Board. Within this framework, each of the Bank Subsidiaries
focuses on providing personalized services and quality products
to its customers to meet the needs of the communities which it
serves.
Heartland operates its banking subsidiaries as traditional
community banks with conveniently located facilities and
professional, highly motivated staffs which are active in the
communities in which they are located. Heartland focuses on long-
term relationships with customers and provides individualized
quality service. In addition, within credit and rate of return
parameters, Heartland attempts to ensure that each of the Bank
Subsidiaries meets the credit needs of its communities and
invests in local municipal obligations.
Heartland uses a variety of marketing strategies to attract and
retain customers, with a particular emphasis on a strong sales
culture within the Bank Subsidiaries and an outside officer
calling program. Many of Heartland's sales employees work on a
salary plus commission basis, thus providing them with a strong
incentive to aggressively market Heartland's financial products.
Officers of each of the Bank Subsidiaries also regularly call on
customers and potential customers of the institutions to maintain
and develop deposit and other special service relationships,
including cash management, employee benefit plan administration,
and trust services.
Heartland has an internal data processing division and has
attempted to remain at the forefront of the banking industry in
new technological innovations. Heartland believes that retaining
control of its data processing leads to decreased operating costs
and more effective service to its customers. Accordingly, during
1997, all Bank Subsidiaries are scheduled to convert to the
Comprehensive Banking system program purchased from Fiserv, a
national leader in bank software technology. To provide a high
level of customer service and to manage effectively its growth,
acquisition and operating strategies, Heartland also focuses on
continued improvement of the internal operating systems of the
Bank Subsidiaries.
Acquisition and Expansion Strategy
Heartland seeks to diversify both its market area and asset base
while increasing profitability through acquisitions and
expansion. Heartland's goal is to expand through the acquisition
of established financial service organizations, primarily
commercial banks or thrifts, to the extent suitable candidates
can be identified and acceptable business terms negotiated.
Heartland's acquisition strategy is focused on traditional
community banks and thrifts located in stable and growing areas
of Iowa, Wisconsin, Minnesota and Illinois. It is possible that
as a result of consolidation within the banking industry
generally, as well as in Heartland's current market areas,
Heartland may in the future look beyond these geographic areas
for acquisition opportunities. In addition to price and terms,
other factors considered by Heartland in determining the
desirability of an acquisition candidate include financial
condition, earnings potential, quality of management, market area
and competitive environment.
The Heartland Board may in the future consider establishing
branches, loan production offices or other business facilities as
a means of expanding its presence in current or new market areas.
The Heartland Board may also investigate expansion into other
lines of business closely related to banking if it believes these
lines could be profitable without undue risk to Heartland and if
Heartland can be competitive. Heartland does not currently have
any 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
DB&T, 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. The majority of the Bank
Subsidiaries' commercial business loans have floating interest
rates or reprice within one year.
DB&T has also generated loans which are guaranteed by the U.S.
Small Business Administration and has been certified as one of
that agency's Preferred Lenders. 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. DB&T
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 loans is the failure of
the business due to economic or financial factors. In most cases,
the Bank Subsidiaries have collateralized these loans and/or
taken personal guarantees to help assure repayment.
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. Loan review personnel and 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. Management has
attempted to identify problem loans at an early date and to
aggressively seek a resolution of these situations. The result
has been a significantly below average level of problem loans
compared to the Heartland Banks' industry peer groups in recent
years.
Agricultural Loans
DB&T is one of the largest agricultural lenders in the state of
Iowa. Agricultural loans continue to be emphasized by both DB&T
and Galena due to their concentration of customers in rural
markets. Agricultural loans remain balanced, however, in
proportion to the rest of Heartland's consolidated loan
portfolio. 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 agricultural loan departments work closely with
all agricultural 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 agricultural 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.
A stable rate environment along with expanded production
capabilities at Riverside combined to increase the number of loan
originations as compared to prior years. Residential mortgage
outstandings grew as customers elected to take three-, five- and
seven-year mortgages which were retained in the loan portfolios.
During prior years, the majority of home loans generated by the
Bank Subsidiaries were sold to government agencies in the
secondary mortgage market with servicing rights retained.
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 loan demand is also serviced through Citizens which
currently serves the consumer credit needs of over 1,800
customers in the three state area of Iowa, Illinois and Wisconsin
from its Dubuque, Iowa, and Madison, Wisconsin, offices.
Trust Departments
The trust departments for DB&T and Galena have been providing
trust services to their respective communities for a number of
years. First Community received full trust powers from the Office
of Thrift Supervision (the "OTS") in February, 1995. Currently,
the Bank Subsidiaries have over $366 million of consolidated
assets under management and provide a full complement of trust
and investment services for individuals and corporations.
The trust department of DB&T 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
In 1995, DB&T contracted with a new third-party vendor, Focused
Investments LLC, an affiliate of Wayne Hummer & Co., to operate
an independent securities office within DB&T's main office and
Kennedy Mall branch office and Galena's main office. During 1996,
DB&T's Grandview branch office was added to the bank locations
offering brokerage services, and DB&T's Farley, Iowa office
scheduled regular hours for a broker to be available to meet with
customers. Focused Investments LLC offers full-service stock and
bond trading, direct investments, annuities and mutual funds.
DB&T Insurance has continued to grow its personal and commercial
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, as well as
commercial lines and tax-free annuities.
B. MARKET AREAS
DB&T is located in the Dubuque County, Iowa, area, 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 1990 census, the city of Dubuque had a total
population of approximately 61,000.
In addition to its main banking office, DB&T has eight branch
offices, all of which are located in the Dubuque County area. As
a subsidiary of DB&T, DB&T Insurance has substantially the same
market area as the parent organization. Citizens also operates
within this market area, and, in addition, an office was opened
in Madison, Wisconsin, during June, 1996.
Galena 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 also has an office
in Stockton, Illinois, and as such, services customers in Jo-
Daviess County, Illinois. Based on the 1990 census, the county
had a population of approximately 22,000 people.
First Community'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
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 43,100,
23,900 and 8,500, respectively. First Community has one branch
office in Keokuk and in the city of Carthage in Hancock County,
Illinois. Keokuk is an industrial community with a population of
approximately 13,500.
Riverside is located on the northeast edge of Rockford, Illinois,
which is approximately 75 miles west of Chicago in Winnebago
County. Based on the 1990 census, the county had a population of
284,000 and the city of Rockford had a population of 140,000.
Cottage Grove State Bank operates one office from its location in
Cottage Grove, Wisconsin, which is approximately 10 miles east of
Madison in Dane County. The county had a population of 390,000
and the village of Cottage Grove had a population of 1,100
according to the 1990 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 Dubuque, Galena, Riverside, Cottage Grove and Keokuk
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.
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 customers personal
attention, professional service and competitive interest rates.
D. EMPLOYEES
At December 31, 1996, Heartland employed 312 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 with Heartland. Heartland offers a variety of employee
benefits and management considers its employee relations to be
excellent.
E. ACCOUNTING STANDARDS
Statement of Financial Accounting Standards ("SFAS") No. 121
"Accounting for the Impairment of Long-Lived Assets to be
Disposed of" ("SFAS No. 121") was effective for Heartland for the
year beginning January 1, 1996, and requires that long-lived
assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset is not recoverable. SFAS No.
122 "Accounting for Mortgage Servicing Rights", an amendment of
SFAS No. 65 ("SFAS No. 122") was effective for Heartland for the
year beginning January 1, 1996, and required the allocation of
basis between a loan and the related servicing right when a loan
is sold with servicing retained. SFAS No. 123 "Accounting for
Stock-Based Compensation" ("SFAS No. 123") was effective for
Heartland for transactions entered into after December 15, 1995,
and for disclosure requirements beginning January 1, 1996. SFAS
No. 123 established a fair value based method of accounting for
stock-based compensation plans. The adoption of SFAS Nos. 121,
122 and 123 did not have a material effect on Heartland.
SFAS No. 125 "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities" ("SFAS No. 125") will
be effective for Heartland for transactions occurring after
December 31, 1996, and provides standards for accounting
recognition or derecognition of assets and liabilities. Heartland
expects to adopt SFAS No. 125 when required, and management
believes adoption will not have a material effect on Heartland's
financial position and results of operations, nor will adoption
require additional capital resources.
F. SUPERVISION AND REGULATION
General
Financial institutions and their holding companies are
extensively regulated under federal and state law. As a result,
the growth and earnings performance of Heartland and the Bank
Subsidiaries can be affected not only by management decisions and
general economic conditions, but also by the requirements of
applicable state and federal statutes and regulations and the
policies of various governmental regulatory authorities
including, but not limited to, the Board of Governors of the
Federal Reserve System (the "FRB"), the FDIC, the Office of
Thrift Supervision ("OTS"), the Iowa Superintendent of Banking
(the "Superintendent"), the Illinois Commissioner of Banks and
Real Estate (the "Commissioner"), the State of Wisconsin
Department of Financial Institutions, the Internal Revenue
Service and state taxing authorities and the Securities and
Exchange Commission (the "SEC"). The effect of such statutes,
regulations and policies can be significant, and cannot be
predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to
financial institutions, such as Heartland and the Bank
Subsidiaries, regulate, among other things, the scope of
business, investments, reserves against deposits, capital levels
relative to operations, the nature and amount of collateral for
loans, the establishment of branches, mergers, consolidations and
dividends. The system of supervision and regulation applicable to
Heartland and the Bank Subsidiaries establishes a comprehensive
framework for their respective operations and is intended
primarily for the protection of the FDIC's deposit insurance
funds and the depositors, rather than the shareholders, of
financial institutions.
The following references to material statutes and regulations
affecting Heartland and the Bank Subsidiaries are brief summaries
thereof and do not purport to be complete, and are qualified in
their entirety by reference to such statutes and regulations. Any
change in applicable law or regulations may have a material
effect on the business of Heartland and the Bank Subsidiaries.
The following discussion does not include references to Cottage
Grove State Bank, which was acquired in 1997.
Recent Regulatory Developments
On September 30, 1996, President Clinton signed into law the
"Economic Growth and Regulatory Paperwork Reduction Act of 1996"
(the "Regulatory Reduction Act"). Subtitle G of the Regulatory
Reduction Act consists of the "Deposit Insurance Funds Act of
1996" (the "DIFA"). The DIFA provides for a one-time special
assessment on each depository institution holding deposits
subject to assessment by the FDIC for the Savings Association
Insurance Fund (the "SAIF") in an amount which, in the aggregate,
will increase the designated reserve ratio of the SAIF (i.e., the
ratio of the insurance reserves of the SAIF to total SAIF-insured
deposits) to 1.25% on October 1, 1996. Subject to certain
exceptions, the special assessment was payable in full on
November 27, 1996. As a SAIF-member, First Community was subject
to the special assessment. DB&T, Galena and Riverside, however,
hold no SAIF-assessable deposits and, therefore, were not subject
to the special assessment.
Under the DIFA, the amount of the special assessment payable by
an institution was determined on the basis of the amount of SAIF-
assessable deposits held by the institution on March 31, 1995, or
acquired by the institution after March 31, 1995 from another
institution which held the deposits on March 31, 1995, but was no
longer in existence on November 27, 1996. The DIFA provides for a
20% discount in calculating the SAIF-assessable deposits of
certain "Oakar" banks (i.e., Bank Insurance Fund ("BIF") member
banks that hold deposits acquired from a SAIF member that remain
SAIF insured) and certain "Sasser" banks (i.e., institutions that
converted from thrift to bank charters but remain SAIF members).
The DIFA also exempts certain institutions from payment of the
special assessment (including institutions that are
undercapitalized or that would become undercapitalized as a
result of payment of the special assessment), and allows an
institution to pay the special assessment in two installments if
there is a significant risk that by paying the special assessment
in a lump sum, the institution or its holding company would be in
default under or in violation of terms or conditions of debt
obligations or preferred stock issued by the institution or its
holding company and outstanding on September 13, 1995.
On October 8, 1996, the FDIC adopted a final regulation
implementing the SAIF special assessment. In that regulation, the
FDIC set the special assessment rate at 0.657% of SAIF-assessable
deposits held on March 31, 1995. The amount of the special
assessment paid by First Community was $545,000, the full amount
of which was recorded as a charge against earnings for the
quarter ended September 30, 1996. As discussed below, however,
the recapitalization of the SAIF resulting from the special
assessment should significantly reduce First Community's ongoing
deposit insurance expense.
In light of the recapitalization of the SAIF pursuant to the
special assessment authorized by the DIFA, the FDIC, on December
11, 1996, took action to reduce regular semi-annual SAIF
assessments from the range of 0.23% - 0.31% of deposits to a
range of 0% - 0.27% of deposits. The new rates were effective
October 1, 1996, for Oakar and Sasser banks, but did not take
affect for other SAIF-assessable institutions until January 1,
1997. From October 1, 1996, through December 31, 1996,
assessments payable by SAIF-assessable institutions other than
Oakar and Sasser banks ranged from 0.18% to 0.27% of deposits,
which represents the amount the FDIC calculates as necessary to
cover the interest due for that period on outstanding obligations
of the Financing Corporation (the "FICO"), discussed below.
Because SAIF-assessable institutions were previously assessed at
higher rates (i.e., 0.23% - 0.31% of deposits) for the semi-
annual period ending December 31, 1996, the FDIC will refund or
credit back the amount collected from such institutions for the
period from October 1, 1996, through December 31, 1996, which
exceeds the amount due for that period under the reduced
assessment schedule. As a result of the FDIC's action, the
deposit insurance assessments payable by First Community have
been reduced significantly.
Prior to the enactment of the DIFA, a substantial amount of the
SAIF assessment revenue was used to pay the interest due on bonds
issued by the FICO, the entity created in 1987 to finance the
recapitalization of the Federal Savings and Loan Insurance
Corporation (the "FSLIC"), the SAIF's predecessor insurance fund.
Pursuant to the DIFA, the interest due on outstanding FICO bonds
will be covered by assessments against both SAIF and BIF member
institutions beginning January 1, 1997. Between January 1, 1997,
and December 31, 1999, FICO assessments against BIF-member
institutions cannot exceed 20% of the FICO assessments charged
SAIF-member institutions. From January 1, 2000, until the FICO
bonds mature in 2019, FICO assessments will be shared by all FDIC-
insured institutions on a pro rata basis. It has been estimated
that the FICO assessments for the period January 1, 1997, through
December 31, 1999, will be approximately 0.013% of deposits for
BIF members versus approximately 0.064% of deposits for SAIF
members, and will be less than 0.025% of deposits thereafter.
The DIFA also provides for a merger of the BIF and the SAIF on
January 1, 1999, provided there are no state or federally
chartered, FDIC-insured savings associations existing on that
date. To facilitate the merger of the BIF and the SAIF, the DIFA
directs the Treasury Department to conduct a study on the
development of a common charter and to submit a report, along
with appropriate legislative recommendations, to the Congress by
March 31, 1997.
In addition to the DIFA, the Regulatory Reduction Act includes a
number of statutory changes designed to eliminate duplicative,
redundant or unnecessary regulatory requirements. Among other
things, the Regulatory Reduction Act establishes streamlined
notice procedures for the commencement of new nonbanking
activities by bank holding companies, and generally exempts bank
holding companies that own one or more savings associations from
regulation by the OTS as savings and loan holding companies. The
Regulatory Reduction Act also removes the percentage of assets
limitations on the aggregate amount of credit card and education
loans that may be made by a savings association, such as First
Community; increases from 10% to 20% of total assets the
aggregate amount of commercial loans that a savings association
may make, provided that any amount in excess of 10% of total
assets represents small business loans; allows education, small
business and credit card loans to be counted in full in
determining a savings association's compliance with the qualified
thrift lender ("QTL") test; and provides that a savings
association may be deemed to meet the QTL test if it qualifies as
a domestic building and loan association under the Internal
Revenue Code. Finally, the Regulatory Reduction Act establishes
time frames within which the FDIC must act on applications by
state banks to engage in activities which, although permitted for
state banks under applicable state law, are not permissible
activities for national banks, excludes ATM closures and certain
branch office relocations from the requirements applicable to
branch closings and clarifies the liability of a financial
institution, when acting as a lender or in a fiduciary capacity,
under the federal environmental laws. Although the full impact of
the Regulatory Reduction Act on the operations of Heartland and
the Bank Subsidiaries cannot be determined at this time,
management believes that the legislation may reduce compliance
costs to some extent and allow Heartland and the Bank
Subsidiaries somewhat greater operating flexibility.
On August 10, 1996, President Clinton signed into law the Small
Business Job Protection Act of 1996 (the "Job Protection Act").
Among other things, the Job Protection Act eliminates the percent-
of-taxable-income ("PTI") method for computing additions to a
savings association's tax bad debt reserves for tax years
beginning after December 31, 1995, and requires all savings
associations that have used the PTI method to recapture, over a
six year period, all or a portion of their tax bad debt reserves
added since the last taxable year beginning before January 1,
1988. The Job Protection Act allows a savings association to
postpone the recapture of bad debt reserves for up to two years
if the institution meets a minimum level of mortgage lending
activity during those years. First Community believes that it
will engage in sufficient mortgage lending activity during 1996
and 1997 to be able to postpone any recapture of its bad debt
reserves until 1998. As a result of these provisions of the Job
Protection Act, First Community will determine additions to its
tax bad debt reserves using the same method as a commercial bank
of comparable size, and, if First Community were to decide to
convert to a commercial bank charter, the changes in the tax bad
debt recapture rules enacted in the Job Protection Act should
make such conversion less costly.
Heartland
General
Heartland, as the sole stockholder of DB&T, Galena and Riverside,
is a bank holding company. As a bank holding company, Heartland
is registered with, and is subject to regulation by, the FRB
under the BHCA. In accordance with FRB 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 do so
absent such policy. Under the BHCA, Heartland is subject to
periodic examination by the FRB and is required to file with the
FRB periodic reports of its operations and such additional
information as the FRB may require. Further as the sole
stockholder of Galena and Riverside, Heartland is subject to the
requirements of the Illinois Bank Holding Company Act, as
amended.
Heartland's ownership of First Community makes Heartland a
savings and loan holding company, as defined in the Home Owners'
Loan Act, as amended (the "HOLA"), and prior to September 30,
1996, Heartland was subject to OTS examination, supervision and
reporting requirements under the HOLA. Effective September 30,
1996, the Regulatory Reduction Act exempts companies, like
Heartland, that are both bank holding companies and savings and
loan holding companies from OTS regulation, but requires the FRB
and the OTS to cooperate in any enforcement actions taken against
such companies.
Investments and Activities
Under the BHCA, a bank holding company must obtain FRB approval
before: (i) acquiring, directly or indirectly, ownership or
control of any voting shares of another bank or bank holding
company if, after such acquisition, it would own or control more
than 5% of such shares (unless it already owns or controls the
majority of such shares); (ii) acquiring all or substantially all
of the assets of another bank; or (iii) merging or consolidating
with another bank holding company. Subject to certain conditions
(including certain deposit concentration limits established by
the BHCA), the FRB may allow a bank holding company to acquire
banks located in any state of the United States without regard to
whether the acquisition is prohibited by the law of the state in
which the target bank is located. In approving interstate
acquisitions, however, the FRB 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 or which 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 also prohibits, with certain exceptions, Heartland from
acquiring direct or indirect ownership or control of more than 5%
of the voting shares of any company which 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. The principal exception to this prohibition allows
bank holding companies to engage in, and own shares of companies
engaged in, certain businesses found by the FRB to be "so closely
related to banking ... as to be a proper incident thereto." Under
current regulations of the FRB, Heartland and its non-bank
subsidiaries are permitted to engage in, among other activities,
such banking-related businesses as the operation of a thrift,
sales and 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 activities of non-bank
subsidiaries of bank holding companies.
Federal legislation also prohibits acquisition of "control" of a
bank holding company, such as Heartland, without prior notice to
certain federal bank regulators. "Control" is defined in certain
cases as acquisition of 10% of the outstanding shares of a bank
holding company.
Capital Requirements
Bank holding companies are required to maintain minimum levels of
capital in accordance with FRB capital adequacy guidelines. If
capital falls below minimum guideline levels, a bank holding
company, among other things, may be denied approval to acquire or
establish additional banks or non-bank businesses.
The FRB's capital guidelines establish the following minimum
regulatory capital requirements for bank holding companies: a
risk-based requirement expressed as a percentage of total
risk-weighted assets, and 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%, of which at least one-half must be Tier 1 capital. The
leverage requirement consists of a minimum ratio of Tier 1
capital to total assets of 3% for the most highly rated
companies, with minimum requirements of 4% to 5% for all others.
For purposes of these capital standards, Tier 1 capital consists
primarily of permanent stockholders' equity less intangible
assets (other than certain mortgage servicing rights and
purchased credit card relationships) and total capital means Tier
1 capital plus certain other debt and equity instruments which 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, and higher capital levels will be required if
warranted by the particular circumstances or risk profiles of
individual banking organizations. 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, 1996, Heartland had regulatory capital in
excess of the FRB's minimum requirements, with a risk-based
capital ratio of 14.28% and a leverage ratio of 9.81%.
Dividends
The FRB has issued a policy statement with regard to the payment
of cash dividends by bank holding companies. In the policy
statement, the FRB expressed its view that a bank holding company
should not pay cash dividends exceeding its net income or which
can only be funded in ways that weaken the bank holding company's
financial health, such as by borrowing. Additionally, the FRB
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. In addition to the restrictions on dividends that may
be imposed by the FRB, the Delaware General Corporation Law would
allow Heartland to pay dividends only out of its surplus, 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.
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
DB&T is an Iowa-chartered bank and is subject to supervision and
regulation by the Superintendent, the chartering authority for
Iowa banks. Galena and Riverside are both Illinois-chartered
banks and are subject to supervision and regulation by the
Commissioner, the chartering authority for Illinois banks. The
deposit accounts of DB&T, Galena and Riverside are insured by the
BIF of the FDIC and, as BIF-insured institutions, DB&T, Galena
and Riverside are subject to the examination, supervision,
reporting and enforcement requirements of the FDIC, as
administrator of the BIF. First Community is a federally
chartered savings association, the deposits of which are insured
by the SAIF of the FDIC. As a SAIF-insured, federally chartered
savings association, First Community is subject to the
examination, supervision, reporting and enforcement requirements
of the OTS, as the chartering authority for federal savings
associations, and the FDIC as administrator of the SAIF.
DB&T, Galena and First Community are also members of the Federal
Home Loan Bank System, which provides a central credit facility
primarily for member institutions.
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 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, 1996, BIF assessments ranged
from 0% of deposits to 0.27% of deposits. The FDIC has announced
that for the semi-annual assessment period beginning January 1,
1997, BIF assessment rates will continue to range from 0% of
deposits to 0.27% of deposits. During the period January 1, 1996,
through September 30, 1996, SAIF assessment rates ranged from
0.23% of deposits to 0.31% of deposits. As a result of the
recapitalization of the SAIF on October 1, 1996, SAIF assessment
rates were reduced, effective October 1, 1996, to a range of
0.18% of deposits to 0.27% of deposits and were further reduced,
effective January 1, 1997, to a range of 0% of deposits to 0.27%
of deposits. See "--Recent Regulatory Developments."
The FDIC may terminate the deposit insurance of any insured
depository institution if the FDIC determines, after a hearing,
that the institution has engaged or is engaging in unsafe or
unsound practices, is in an unsafe or unsound condition to
continue operations or has violated any applicable law,
regulation, order, or any condition imposed in writing by, or
written agreement with, the FDIC. The FDIC may also suspend
deposit insurance temporarily during the hearing process for a
permanent termination of insurance if the institution has no
tangible capital. Management of Heartland is not aware of any
activity or condition that could result in termination of the
deposit insurance of any of the Bank Subsidiaries.
FICO Assessments
Since 1987, a portion of the deposit insurance assessments paid
by SAIF members has been used to cover interest payments due on
the outstanding obligations of the FICO, the entity created to
finance the recapitalization of the FSLIC, the SAIF's predecessor
insurance fund. Pursuant to federal legislation enacted September
30, 1996, commencing January 1, 1997, both SAIF members and BIF
members will be subject to assessments to cover the interest
payment on outstanding FICO obligations. Such FICO assessments
will be in addition to amounts assessed by the FDIC for deposit
insurance. Until January 1, 2000, the FICO assessments made
against BIF members may not exceed 20% of the amount of the FICO
assessments made against SAIF members. It is estimated that SAIF
members will pay FICO assessments equal to 0.064% of deposits
while BIF members will pay FICO assessments equal to 0.013% of
deposits. Between January 1, 2000 and the maturity of the
outstanding FICO obligations in 2019, BIF members and SAIF
members will share the cost of the interest on the FICO bonds on
a pro rata basis. It is estimated that FICO assessments during
this period will be less than 0.025% of deposits.
Capital Requirements
The FDIC has established the following minimum capital standards
for state-chartered insured non-member banks, such as DB&T,
Galena and Riverside: a leverage requirement consisting of a
minimum ratio of Tier 1 capital to total assets of 3% for the
most highly-rated banks with minimum requirements of 4% to 5% for
all others, and a risk-based capital requirement consisting of a
minimum ratio of total capital to total risk-weighted assets of
8%, at least one-half of which must be Tier 1 capital. For
purposes of these capital standards, Tier 1 capital and total
capital consist of substantially the same components as Tier 1
capital and total capital under the FRB's capital guidelines for
bank holding companies (see "--Heartland--Capital Requirements").
The OTS has established the following minimum capital standards
for savings associations, such as First Community: a core capital
requirement, consisting of a minimum ratio of core capital to
total assets of 3%; a tangible capital requirement consisting of
a minimum ratio of tangible capital to total assets of 1.5%; and
a risk-based capital requirement, consisting of a minimum ratio
of total capital to total risk-weighted assets of 8%, at least
one-half of which must consist of core capital. For purposes of
these capital standards, core capital consists primarily of
permanent stockholders' equity less intangible assets other than
certain supervisory goodwill, certain mortgage servicing rights
and certain purchased credit card relationships and less
investments in subsidiaries engaged in activities not permitted
for national banks; tangible capital is substantially the same as
core capital except that all intangible assets other than certain
mortgage servicing rights must be deducted; and total capital
means core capital plus certain debt and equity instruments that
do not qualify as core capital and a portion of First Community's
allowances for loan and lease losses.
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, the regulations of the FDIC and the
OTS provide that additional capital may be required to take
adequate account of interest rate risk or the risks posed by
concentrations of credit or nontraditional activities.
During the year ended December 31, 1996, none of the Bank
Subsidiaries was required by its primary federal regulator to
increase its capital to an amount in excess of the minimum
regulatory requirements. As of December 31, 1996, each of the
Bank Subsidiaries exceeded its minimum regulatory capital
requirements, as follows:
Total Risk- Leverage/ Tangible
Based Capital Core Capital Capital
Ratio Ratio Ratio
DB&T 12.67% 8.58% N/A
Galena 13.74% 7.63% N/A
Riverside 19.42% 20.45% N/A
First Community 15.17% 11.17% 6.00%
Federal law 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 "well
capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" or "critically
undercapitalized." Depending upon the capital category to which
an institution is assigned, the regulators' corrective powers
include: requiring the submission of a capital restoration plan;
placing limits on asset growth and restrictions on activities;
requiring the institution to issue additional capital stock
(including additional voting stock) or to be acquired;
restricting transactions with affiliates; restricting the
interest rate the institution may pay on deposits; ordering a new
election of directors of the institution; requiring that senior
executive officers or directors be dismissed; prohibiting the
institution from accepting deposits from correspondent banks;
requiring the institution to divest certain subsidiaries;
prohibiting the payment of principal or interest on subordinated
debt; and ultimately, appointing a receiver for the institution.
Additionally, 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.
Dividends
The Iowa Banking Act provides that an Iowa-chartered bank, such
as DB&T, may not pay dividends in an amount greater than its
accumulated undistributed net profits. Under the Illinois Banking
Act, Illinois-chartered banks, such as Galena and Riverside, are
subject to a substantially similar dividend restriction.
OTS regulations impose limitations upon all capital distributions
by savings associations, such as First Community, including cash
dividends. The rule establishes three tiers of institutions. An
institution that exceeds all fully phased-in capital requirements
before and after the proposed capital distribution (a "Tier 1
Institution") could, after prior notice to, but without the
approval of, the OTS, make capital distributions during a
calendar year of up to the higher of (i) 100% of its net income
to date during the calendar year plus the amount that would
reduce by one-half its "surplus capital ratio" (i.e., the excess
capital over its fully phased-in capital requirements) at the
beginning of the calendar year, or (ii) 75% of its net income
over the most recent preceding four quarter period. Any
additional capital distributions would require prior regulatory
approval. As of December 31, 1996, First Community was a Tier 1
Institution.
The payment of dividends by any financial institution 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, 1996. Further, under
applicable regulations of the OTS, First Community may not pay
dividends in an amount which would reduce its capital below the
amount required for the liquidation account established in
connection with First Community's conversion from the mutual to
the stock form of ownership in 1991. As of December 31, 1996,
approximately $28.1 million was available to be paid as dividends
to Heartland by the Bank Subsidiaries. Notwithstanding the
availability of funds for dividends, however, the federal banking
regulators may prohibit the payment of any dividends by the Bank
Subsidiaries if they determine such payment would constitute an
unsafe or unsound practice.
Insider Transactions
The Bank Subsidiaries are subject to certain restrictions imposed
by the Federal Reserve Act 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. Certain limitations and reporting
requirements are also placed on extensions of credit by the Bank
Subsidiaries to their respective directors and officers, to
directors and officers of Heartland and its subsidiaries, to
principal stockholders of Heartland, and to "related interests"
of such directors, officers and principal stockholders. In
addition, such legislation and regulations may affect the terms
upon which any person becoming a director or officer of Heartland
or one of its subsidiaries or a principal stockholder of
Heartland may obtain credit from banks with which any of the Bank
Subsidiaries maintains a correspondent relationship.
Safety and Soundness Standards
The FDIC and OTS have adopted guidelines which establish
operational and managerial standards to promote the safety and
soundness of state non-member banks and savings associations,
respectively. 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 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 agency may require the institution to
submit a plan for achieving and maintaining compliance. The
preamble to the guidelines states that the agencies expect to
require a compliance plan from an institution whose failure to
meet one or more of the guidelines is of such severity that it
could threaten the safety and soundness of the institution.
Failure to submit an acceptable plan, or failure to comply with a
plan that has been accepted by the agency, would constitute
grounds for further enforcement action.
Branching Authority
Iowa law strictly regulates the establishment of bank offices.
Under the Iowa Banking Act, an Iowa state bank, such as DB&T, may
not establish a bank office outside the boundaries of the
counties contiguous to or cornering upon the county in which the
principal place of business of the bank is located. Further, Iowa
law prohibits an Iowa bank from establishing de novo branches in
a municipality other than the municipality in which the bank's
principal place of business is located, if another bank already
operates one or more offices in the municipality in which the
proposed de novo branch is to be located. The number of offices
an Iowa bank may establish in a particular municipality is also
limited depending upon the municipality's population. Illinois
banks, such as Galena and Riverside, have the authority under
Illinois law to establish branches anywhere in the State of
Illinois, subject to receipt of all required regulatory
approvals.
Effective June 1, 1997, (or earlier if expressly authorized by
applicable state law), the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Riegle-Neal Act") allows
banks 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 de novo
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 by the Riegle-Neal Act
only if specifically authorized by state law. The legislation
allows individual states to "opt-out" of certain provisions of
the Riegle-Neal Act by enacting appropriate legislation prior to
June 1, 1997. Illinois and Iowa have both enacted legislation
permitting interstate mergers beginning on June 1, 1997, subject
to certain conditions.
Federally chartered savings associations, such as First
Community, which qualify as "domestic building and loan
associations," as defined in the Internal Revenue Code, or meet
the qualified thrift lender test (see "-The Bank Subsidiaries --
Qualified Thrift Lender Test") have the authority, subject to
receipt of OTS approval, to establish branch offices anywhere in
the United States, either de novo or through acquisitions of all
or part of another financial institution. If a federal savings
association fails to qualify as a "domestic building and loan
association," as defined in the Internal Revenue Code, or fails
to meet the qualified thrift lender test, the association
generally may establish a branch in a state other than the state
of its home office only to the extent authorized by the law of
the state in which the branch is to be located. As of December
31, 1996, First Community qualified as a "domestic building and
loan association," as defined in the Internal Revenue Code, and
met the qualified thrift lender test.
State Bank Activities
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 or its subsidiary, respectively, 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.
Impermissible investments and activities must be divested or
discontinued within certain time frames set by the FDIC. These
restrictions have not had, and are not currently expected to
have, a material impact on the operations of DB&T, Galena or
Riverside.
Qualified Thrift Lender Test
Under the QTL test in effect prior to September 30, 1996, First
Community generally was required to invest at least 65% of its
portfolio assets in "qualified thrift investments," as measured
on a monthly average basis in nine out of every 12 months.
Qualified thrift investments for purposes of the QTL test consist
principally of residential mortgage loans, mortgage-backed
securities and other housing and consumer-related investments.
The term "portfolio assets" is statutorily defined to mean a
savings association's total assets less goodwill and other
intangible assets, the association's business property and a
limited amount of its liquid assets. Under amendments to the HOLA
enacted September 30, 1996, First Community will be deemed to
satisfy the QTL test if it either holds qualified thrift
investments equaling 65% or more of its portfolio assets or
qualifies as a domestic building and loan association under the
Internal Revenue Code. The new legislation also expanded somewhat
the definition of qualified thrift investments. See "--Recent
Regulatory Developments." As of December 31, 1996, First
Community satisfied the QTL test, with a ratio of qualified
thrift investments to portfolio assets of 76.52% and qualified as
a "domestic building and loan association," as defined in the
Internal Revenue Code.
Liquidity Requirements
OTS regulations currently require each savings association to
maintain, for each calendar month, an average daily balance of
liquid assets (including cash, certain time deposits, bankers'
acceptances, and specified United States Government, state or
federal agency obligations) equal to at least 5% of the average
daily balance of its net withdrawable accounts plus short-term
borrowings (i.e., those repayable in 12 months or less) during
the preceding calendar month. This liquidity requirement may be
changed from time to time by the OTS to an amount within a range
of 4% to 10% of such accounts and borrowings, depending upon
economic conditions and the deposit flows of savings
associations. OTS regulations also require each savings
association to maintain, for each calendar month, an average
daily balance of short-term liquid assets (generally liquid
assets having maturities of 12 months or less) equal to at least
1% of the average daily balance of its net withdrawable accounts
plus short-term borrowings during the preceding calendar month.
Penalties may be imposed for failure to meet liquidity ratio
requirements. At December 31, 1996, First Community was in
compliance with OTS liquidity requirements, with an overall
liquidity ratio of 10.67% and a short-term liquidity ratio of
2.78%.
Federal Reserve System
FRB 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 $49.3
million or less, the reserve requirement is 3% of total
transaction accounts; and for transaction accounts aggregating in
excess of $49.3 million, the reserve requirement is $1.479
million plus 10% of the aggregate amount of total transaction
accounts in excess of $49.3 million. The first $4.4 million of
otherwise reservable balances are exempted from the reserve
requirements. These reserve requirements are subject to annual
adjustment by the FRB. Each of the Bank Subsidiaries is in
compliance with the foregoing requirements. The balances used to
meet the reserve requirements imposed by the FRB may be used to
satisfy liquidity requirements imposed on First Community by the
OTS.
G. GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS
The earnings of Heartland are affected by the policies of
regulatory authorities, including the Federal 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 principal offices of Heartland are located in DB&T's main
office at 1398 Central Avenue, Dubuque, Iowa 52001. This office
is owned by DB&T and consists of a three-story glazed terra cotta
building constructed in 1922. The main office building currently
comprises approximately 59,500 square feet, all of which is
occupied by DB&T and Heartland. Construction of a three-story
addition of approximately 32,000 square feet was completed in
1994. The cost of this new addition and remodeling of the
existing main office building was approximately $4.9 million.
DB&T has a total of eight branch offices in addition to its main
office. Five of these offices are located in the city of Dubuque,
and three branches are located in the surrounding Iowa
communities of Epworth, Farley and Holy Cross. DB&T owns all of
its branch offices without material encumbrances, except its
branch located at Kennedy Mall. DB&T owns the buildings but
leases the land under long term agreements at its Kennedy Mall
branch and Main Street office location. The DB&T subsidiaries,
operate out of the main office.
Citizens' Dubuque office is located in a leased building at 1477
Locust Street, Dubuque, Iowa 52001. The Madison office for
Citizens is located in a leased building at 1771 Thierer Road,
Madison, Wisconsin 53707.
Galena's main office is located at 971 Gear Street on the west
side of Galena, Illinois. Construction of this new 18,000 square
foot brick banking facility was completed in 1996. A drive-up
facility is also located in downtown Galena. One branch office is
located in Stockton, Illinois, which is located approximately 24
miles east of Galena. Each of these offices is owned without
material encumbrances.
The principal offices of Keokuk are located at the main office of
First Community at 4th and Concert Street, Keokuk, Iowa 52632.
The property was purchased by First Community in 1983 and
consists of a one-story brick building constructed in 1951. This
building comprises approximately 6,000 square feet, all of which
is occupied by First Community. During 1996, First Community
opened a 2,100 square foot branch on the northwest side of
Keokuk. First Community also has one branch office located in
Carthage, Illinois, which is located approximately 15 miles east
of Keokuk, Iowa. The one-story wooden frame building constructed
in 1976 comprises approximately 3,000 square feet, all of which
is occupied by First Community. Each of these offices are owned
without material encumbrances.
Riverside moved from its temporary facility to its permanent
facility in September, 1996. This 8,000 square foot one-story
brick building is located at 6700 East Riverside Boulevard,
Rockford, Illinois 61114.
ULTEA leases a facility at 2976 Triverton Pike, Madison,
Wisconsin 53711.
ITEM 3.
LEGAL PROCEEDINGS
There are no material pending legal proceedings, other than
ordinary routine litigation incidental to the business, to which
Heartland or any of its subsidiaries is a party or of which any
of their property is the subject.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 1996 to a
vote of security holders.
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Heartland's Common Stock was held by approximately 700
shareholders of record as of March 24, 1997, and is traded in the
over-the-counter market.
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 Actual
Calendar Quarter High Low
1995:
First $16 $14 19/32
Second 17 15 1/2
Third 17 1/4 17
Fourth 17 1/4 17 1/4
1996:
First 17 11/16 16 3/16
Second 20 17 1/4
Third 25 17 1/4
Fourth 24 3/4 24
Cash dividends have been declared by Heartland quarterly during
the past two years ending December 31, 1996, with a special
dividend having also been paid in the first quarter of 1995. The
following table sets forth the cash dividends per share paid on
Heartland's Common Stock for the past two years:
Calendar Quarter
1995:
First $ .19
Second .075
Third .075
Fourth .075
1996:
First $ .10
Second .10
Third .10
Fourth .10
ITEM 6.
SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
For the Years Ended December 31,
1996 1995 1994
--------------------------------
STATEMENT OF INCOME DATA
Interest income $ 51,886 $ 49,149 $ 43,373
Interest expense 27,644 25,529 20,128
-------- -------- --------
Net interest income 24,242 23,620 23,245
Provision for loan and
lease losses 1,408 820 811
-------- -------- --------
Net interest income after
provision for loan and
lease losses 22,834 22,800 22,434
Noninterest income 7,364 4,981 4,965
Noninterest expense 19,507 17,323 17,244
Provision for income taxes 2,685 2,884 3,015
-------- -------- --------
Net income 8,006 $ 7,574 $ 7,140
======== ======== ========
PER COMMON SHARE DATA (1)
Net income $ 1.70 $ 1.58 $ 1.47
Cash dividends .40 .30 0.26
Dividend payout ratio 23.53% 19.03% 17.99%
Book value $ 14.84 $ 13.76 $ 11.76
Weighted average shares
outstanding 4,715,009 4,805,184 4,845,648
BALANCE SHEET DATA
Investments and federal
funds sold $183,966 $171,726 $162,968
Total loans and leases,
net of unearned 484,085 454,905 422,216
Allowance for loan and lease
losses 6,191 5,580 5,124
Total assets 736,552 677,313 626,490
Total deposits 558,343 534,587 513,239
Long-term obligations 42,506 45,400 23,562
Redeemable preferred stock - - -
Stockholders' equity 70,259 64,506 56,930
EARNINGS PERFORMANCE DATA
Return on average total assets 1.16% 1.18% 1.18%
Return on average stockholders'
equity 12.00 12.28 12.82
Net interest margin ratio (2) 3.98 4.13 4.32
ASSET QUALITY RATIOS
Nonperforming assets to total
assets 0.34% 0.28% 0.17%
Nonperforming loans and leases
to total loans and leases 0.41 0.26 0.21
Net loan and lease charge-offs
to average loans and leases 0.17 0.08 0.03
Allowance for loan and lease
losses to total loans and
leases 1.28% 1.23% 1.21%
Allowance for loan and lease
losses to nonperforming
loans and leases 313.63 463.84 580.95
CAPITAL RATIOS
Average equity to average
assets 9.66% 9.59% 9.22%
Total capital to risk-adjusted
assets 14.28 14.46 15.04
Tier 1 leverage 9.81 9.47 9.32
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
For the Years Ended
December 31,
1993 1992
--------------------
STATEMENT OF INCOME DATA
Interest income $ 43,265 $ 43,432
Interest expense 21,126 24,575
-------- --------
Net interest income 22,139 18,857
Provision for loan and lease losses 1,014 630
-------- --------
Net interest income after provision
for loan and lease losses 21,125 18,227
Noninterest income 5,470 5,826
Noninterest expense 16,338 15,363
Provision for income taxes 3,251 2,558
-------- --------
Net income $ 7,006 $ 6,132
======== ========
PER COMMON SHARE DATA (1)
Net income $ 1.47 $ 1.28
Cash dividends .20 0.14
Dividend payout ratio 13.33% 10.84%
Book value $ 11.52 $ 9.55
Weighted average shares outstanding 4,774,718 4,788,524
BALANCE SHEET DATA
Investments and federal funds sold $211,394 $227,492
Total loans and leases, net of unearned 374,778 331,588
Allowance for loan and lease losses 4,433 3,406
Total assets 620,214 596,627
Total deposits 498,279 499,714
Long-term obligations 25,055 3,209
Redeemable preferred stock 67 68
Stockholders' equity 55,098 45,740
EARNINGS PERFORMANCE DATA
Return on average total assets 1.17% 1.10%
Return on average stockholders' equity 14.20 14.13
Net interest margin ratio (2) 4.11 3.83
ASSET QUALITY RATIOS
Nonperforming assets to total assets 0.30% 0.38%
Nonperforming loans and leases
to total loans and leases 0.32 0.47
Net loan and lease charge-offs
to average loans and leases 0.04 0.08
Allowance for loan and lease losses
to total loans and leases 1.18 1.03
Allowance for loan and lease losses
to nonperforming loans and leases 374.09 216.25
CAPITAL RATIOS
Average equity to average assets 8.23% 7.80%
Total capital to risk adjusted assets 14.37 13.24
Tier 1 leverage 8.49 8.01
(1) Per share data has been restated to reflect the two-for-one
stock split effected in the form of a stock dividend on
March 29, 1996 and the four-for-one stock conversion
effected as part of the reincorporation of Heartland in
Delaware on June 30, 1993.
(2) Tax equivalent using a 34% tax rate.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 wholly-owned subsidiaries: Dubuque Bank and
Trust Company ("DB&T"), DB&T Insurance, Inc., DB&T Community
Development Corp., Galena State Bank and Trust Company
("Galena"), Riverside Community Bank ("Riverside"), Keokuk
Bancshares, Inc. ("Keokuk"), First Community Bank, FSB ("FCB"),
Citizens Finance Co. ("Citizens", previously Tri-State Community
Credit Corp.) and ULTEA, Inc. ("ULTEA").
This report, including the Chairman's Report to Stockholders,
contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended.
Heartland intends such forward-looking statements to be covered
by the safe harbor provisions for forward-looking statements
contained in the Private Securities Reform Act of 1995, and is
including this statement for purposes of these safe harbor
provisions. Forward-looking statements, which are based on
certain assumptions and describe future plans, strategies and
expectations of Heartland are generally identifiable by use of
the words "believe," "expect," "intend," "anticipate,"
"estimate," "project" or similar expressions. 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 affect on the operations and future prospects
of Heartland and the subsidiaries include, but are not limited
to, changes in: interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of
the U.S. Government, including policies of the U.S. Treasury and
the Federal Reserve Board, the quality or composition of the loan
or investment portfolios, demand for loan products, deposit
flows, competition, demand for financial services in Heartland's
market area and accounting principles, policies and guidelines.
These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be
placed on such statements. Further information concerning
Heartland and its business, including additional factors that
could materially affect Heartland's financial results, is
included in Heartland's filings with the Securities and Exchange
Commission.
OVERVIEW
Heartland reported earnings for the year ended December 31, 1996,
of $8,006,000, an increase of $432,000 (5.70%) from the 1995
total of $7,574,000. On a per common share basis, 1996 net income
increased 7.73% to $1.70 from $1.58 earned in 1995. This
performance reflects significantly improved noninterest income,
partially mitigated by increased costs related to the first full
year of operation of Riverside and the one-time Savings
Association Insurance Fund ("SAIF") assessment at FCB.
Net income increased $434,000 (6.08%)in 1995 from the 1994 total
of $7,140,000. On a per common share basis, 1995 income
increased from $1.47 earned in 1994 to $1.58.
Heartland's strategy of joining independent community banks and
related services together under a common umbrella to become a
viable market competitor continues to evolve. Central to this
strategy is the continued development of Heartland's sales
culture, maintenance of strong asset quality and net interest
margins, and control of net overhead combined with the expansion
of alternative sources of noninterest income. Heartland believes
that continued concentration on these goals will lead to enhanced
returns for stockholders.
The success of Heartland's efforts to implement this strategy is
evidenced by the following:
Total loans and leases outstanding increased $29,180,000
during 1996, an increase of 6.41% from December 31, 1995.
Deposit growth experienced during 1996 was $23,756,000 or
4.44%.
Heartland announced the signing of a definitive agreement to
purchase Cottage Grove State Bank, a $40 million financial
institution located in Cottage Grove, Wisconsin.
The acquisition of ULTEA, LLC, a vehicle fleet leasing company
headquartered in Madison, Wisconsin, was completed in December
1996, expanding Heartland's sources of noninterest income.
Total noninterest income increased 47.84% during 1996. While
gains on sales of securities accounted for 61.94% of this
$2,383,000 change, there were substantial increases in core
noninterest income components. An example was the 22.96% growth
in trust revenues which increased $338,000 during 1996. The
majority of the increases were generated at DB&T.
Concurrent with Heartland's growth, noninterest expense increased
$2,184,000 (12.61%) in 1996, compared to 1995. The majority of
this increase is attributable to costs associated with
Heartland's Riverside subsidiary, the special one-time SAIF
assessment at FCB and a substantial charitable gift at FCB.
While management remains committed to the control of overhead, it
also realizes that resources must be committed to expansion of
the franchise.
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 income on a fully tax equivalent basis was
$25,476,000 and $24,721,000 for 1996 and 1995, respectively, an
increase of 3.05%. However, Heartland's net interest margin
expressed as a percentage of average earning assets decreased to
3.98% in 1996, compared to 4.13% in 1995. This decrease occurred
for several reasons:
Less than anticipated loan growth caused a shift from higher-
yielding loans into lower-yielding investments.
The additional investment of nearly $3 million in low-income
housing projects generated substantial tax credits, while
negatively impacting the net interest margin calculation.
One of the primary causes of this reduction was the reduced
return on Heartland's securities portfolio as several higher-
yielding securities matured or were called.
Heartland experienced increased funding costs as rates were
elevated to sustain deposit growth.
Average noninterest bearing deposits grew a modest $1,738,000
or 4.00% during 1996. While this represents an improvement
over the 1.59% growth experienced during 1995, noninterest
bearing deposits expressed as a percentage of average assets
dropped to 6.54% at December 31, 1996, compared to 6.76% at
December 31, 1995.
Heartland continues to manage its balance sheet on a proactive
basis. The quarter ended December 31, 1996, is representative of
this, as the net interest margin expressed as a percentage of
average earning assets increased to 4.17% as compared to 3.96%
for the same quarter during 1995.
The net interest margin expressed as a percentage of average
earning assets decreased to 4.13% for the year ending December
31, 1995, compared to 4.32% for 1994. The primary component of
the 1995 decrease was attributable to higher funding costs, as
the expense associated with total interest bearing liabilities
increased 19.60% from the December 31, 1994, total of 4.03%. One
of the primary components of this change was Heartland's
increased reliance on Federal Home Loan Bank ("FHLB") funding.
This funding source, which is typically more expensive than core
deposits, continued to be a critical component of Heartland's
funding as total average deposits increased by $20,220,000
(4.10%) during 1995, or $25,779,000 short of the $45,999,000
growth experienced in average net loans and leases.
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. Such yields and
costs are derived by dividing income or expense by the average
balance of assets or liabilities. 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, 1996
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $136,107 $ 8,392 6.17%
Tax-exempt (1) 31,005 3,108 10.02
--------- --------- ------
Total securities 167,112 11,500 6.88
--------- --------- ------
Interest bearing deposits 4,332 163 3.76
Federal funds sold 11,532 610 5.29
--------- --------- ------
Loans and leases:
Commercial and commercial
real estate (1) 195,372 17,058 8.73
Residential mortgage 160,511 12,834 8.00
Agricultural and agricultural
real estate (1) 58,975 5,377 9.12
Consumer 41,302 4,250 10.29
Lease financing 7,502 549 7.32
Fees on loans - 779 -
Less: allowance for loan
and lease losses (6,026) - -
--------- --------- ------
Net loans and leases 457,636 40,847 8.93
--------- --------- ------
Total earning assets 640,612 53,120 8.29
--------- --------- ------
NONEARNING ASSETS
Total nonearning assets 50,473 - -
--------- --------- ------
TOTAL ASSETS $691,085 $ 53,120 7.69%
========= ========= ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
NOW accounts $ 93,198 $ 3,129 3.36%
Money market accounts 45,956 1,867 4.06
Savings accounts 75,247 2,478 3.29
Time, $100,000 and over 37,806 2,131 5.64
Other time deposits 239,300 13,585 5.68
Short-term borrowings 37,100 1,943 5.24
Other borrowings 41,936 2,511 5.99
--------- --------- ------
Total interest bearing
liabilities 570,543 27,644 4.85
--------- --------- ------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 45,205 - -
Accrued interest and other
liabilities 8,606 - -
--------- --------- ------
Total noninterest bearing
liabilities 53,811 - -
--------- --------- ------
Stockholders' Equity 66,731 - -
--------- --------- ------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $691,085 $ 27,644 4.00%
========= ========= ======
Net interest income (1) $ 25,476
=========
Net interest income
to total earning assets (1) 3.98%
======
Interest bearing liabilities
to earning assets 89.06%
=========
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS & RATES (1)
(Dollars in thousands)
For the Year Ended
December 31, 1995
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $116,683 $ 7,562 6.48%
Tax-exempt (1) 25,518 2,671 10.47
-------- ------- ------
Total securities 142,201 10,233 7.20
-------- ------- ------
Interest bearing deposits 3,059 116 3.79
Federal funds sold 12,765 740 5.80
-------- -------- ------
Loans and leases:
Commercial and commercial
real estate (1) 186,062 16,403 8.82
Residential mortgage 155,208 12,211 7.87
Agricultural and agricultural
real estate (1) 60,171 5,422 9.01
Consumer 35,881 3,650 10.17
Lease financing 9,362 670 7.16
Fees on loans - 805 -
Less: allowance for loan
and lease losses (5,454) - -
--------- -------- ------
Net loans and leases 441,230 39,161 8.88
--------- -------- ------
Total earning assets 599,255 50,250 8.39
--------- -------- ------
NONEARNING ASSETS
Total nonearning assets 43,501 - -
--------- -------- ------
TOTAL ASSETS $642,756 $50,250 7.82%
========= ======== ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
NOW accounts $ 85,023 $ 2,842 3.34%
Money market accounts 41,208 1,723 4.18
Savings accounts 80,122 2,773 3.46
Time, $100,000 and over 30,091 1,658 5.51
Other time deposits 233,983 13,033 5.57
Short-term borrowings 21,665 1,236 5.71
Other borrowings 37,253 2,264 6.08
--------- -------- ------
Total interest bearing
liabilities 529,345 25,529 4.82
--------- -------- ------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 43,467 - -
Accrued interest and other
liabilities 8,281 - -
--------- -------- ------
Total noninterest bearing
liabilities 51,748 - -
--------- -------- ------
Stockholders' Equity 61,663 - -
--------- -------- ------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $642,756 $25,529 3.97%
========= ======== ======
Net interest income (1) $24,721
========
Net interest income 4.13%
to total earning assets (1) ======
Interest bearing liabilities
to earning assets 88.33%
=========
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS & RATES (1)
(Dollars in thousands)
For the Year Ended
December 31, 1994
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $137,865 $ 8,247 5.98%
Tax-exempt (1) 26,802 3,210 11.98
-------- ------- ------
Total securities 164,667 11,457 6.96
-------- ------- ------
Interest bearing deposits 2,621 72 2.75
Federal funds sold 4,416 192 4.35
Loans and leases:
Commercial and commercial
real estate (1) 166,241 13,327 8.02
Residential mortgage 134,101 10,305 7.68
Agricultural and agricultural
real estate (1) 57,526 4,703 8.18
Consumer 35,208 3,363 9.55
Lease financing 7,014 493 7.03
Fees on loans - 726 -
Less: allowance for loan
and lease losses (4,859) - -
--------- -------- ------
Net loans and leases 395,231 32,917 8.33
--------- -------- ------
Total earning assets 566,935 44,638 7.87
--------- -------- ------
NONEARNING ASSETS
Total nonearning assets 37,274 - -
--------- -------- ------
TOTAL ASSETS $604,209 $44,638 7.39%
========= ======== ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
NOW accounts $ 81,634 $ 2,064 2.53%
Money market accounts 42,738 1,314 3.07
Savings accounts 83,340 2,145 2.57
Time, $100,000 and over 22,118 1,020 4.61
Other time deposits 221,059 11,263 5.10
Short-term borrowings 24,508 960 3.92
Other borrowings 24,175 1,362 5.63
--------- -------- ------
Total interest bearing
liabilities 499,572 20,128 4.03
--------- -------- ------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 42,785 - -
Accrued interest and other
liabilities 6,158 - -
--------- -------- ------
Total noninterest bearing
liabilities 48,943 - -
--------- -------- ------
Stockholders' Equity 55,694 - -
--------- -------- ------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $604,209 $20,128 3.33%
========= ======== ======
Net interest income (1) $24,510
========
Net interest income 4.32%
to total earning assets (1) ======
Interest bearing liabilities
to earning assets 88.12%
=========
(1) Tax equivalent basis was 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,
1996 Compared to 1995
Change Due to
Volume Rate Net
-----------------------
EARNING ASSETS/
INTEREST INCOME
Securities
Taxable $1,260 $ (430) $ 830
Tax-exempt 574 (137) 437
Interest bearing deposits 48 (1) 47
Federal funds sold (71) (59) (130)
Loans and leases 1,456 230 1,686
------- ------- -------
TOTAL EARNING ASSETS 3,267 (397) 2,870
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
NOW accounts 273 14 287
Money market accounts 199 (55) 144
Savings accounts (169) (126) (295)
Time, $100,000 and over 425 48 473
Other time deposits 296 256 552
Short term borrowings 883 (176) 707
Other borrowings 285 (38) 247
------- ------- -------
TOTAL INTEREST BEARING
LIABILITIES 2,192 (77) 2,115
------- ------- -------
NET INTEREST INCOME $1,075 ($320) $ 755
======= ======= =======
For the Year Ended
December 31,
1995 Compared to 1994
Change Due to
Volume Rate Net
-----------------------
EARNING ASSETS/
INTEREST INCOME
Securities
Taxable ($1,267) $ 582 $ (685)
Tax-exempt (154) (385) (539)
Interest bearing deposits 12 32 44
Federal funds sold 363 185 548
Loans and leases 3,831 2,413 6,244
-------- ------- -------
TOTAL EARNING ASSETS 2,785 2,827 5,612
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
NOW accounts 86 692 778
Money market accounts (47) 456 409
Savings accounts (83) 711 628
Time, $100,000 and over 368 270 638
Other time deposits 658 1,112 1,770
Short term borrowings (111) 387 276
Other borrowings 737 165 902
-------- ------- -------
TOTAL INTEREST BEARING
LIABILITIES 1,608 3,793 5,401
------- ------- -------
NET INTEREST INCOME $ 1,177 ($ 966) $ 211
======= ======= =======
For the Year Ended
December 31,
1994 Compared to 1993
Change Due to
Volume Rate Net
-----------------------
EARNING ASSETS/
INTEREST INCOME
Securities
Taxable ($1,921) ($286) ($2,207)
Tax-exempt 316 321 637
Interest bearing deposits 30 (61) (31)
Federal funds sold (288) 59 (229)
Loans and leases 3,602 (1,370) 2,232
-------- -------- --------
TOTAL EARNING ASSETS 1,739 (1,337) 402
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
NOW accounts (190) (234) (424)
Money market accounts (496) 6 (490)
Savings accounts 88 (204) (116)
Time, $100,000 and over 50 84 134
Other time deposits 149 (962) (813)
Short term borrowings 60 155 215
Other borrowings 552 (56) 496
-------- -------- --------
TOTAL INTEREST BEARING
LIABILITIES 213 (1,211) (998)
-------- -------- --------
NET INTEREST INCOME $1,526 ($ 126) $ 1,400
======== ======== ========
PROVISION FOR LOAN AND LEASE LOSSES
The $433,000 (118.96%)increase in net charge-offs in 1996 was
primarily attributable to a $469,000 writedown on a pool of
leases purchased from the Bennett Funding Group. The $233,000
(177.86%) increase in net charge-offs in 1995, was in large part
because of charge-offs on consumer loans, including those at
Citizens, a consumer finance subsidiary. The allowance for loan
and lease losses as a percentage of total loans and leases was
1.28% at December 31, 1996, and 1.23% at December 31, 1995.
NONINTEREST INCOME
(Dollars in thousands)
For the Years Ended
December 31,
1996 1995 1994
------------------------
Service charges and fees $ 2,437 $ 2,106 $ 2,013
Trust income 1,810 1,472 1,436
Brokerage income 212 110 229
Insurance income 650 611 637
Securities gains, net 1,889 413 802
Trading securities losses, net - - (359)
Gains on sales of loans 131 73 63
Other noninterest income 235 196 144
-------- -------- --------
Total noninterest income $ 7,364 $ 4,981 $ 4,965
======== ======== ========
The above table shows Heartland's noninterest income for the
years indicated.
Total noninterest income increased $2,383,000 (47.84%) in 1996,
as compared to 1995. Total noninterest income during 1995
remained stable as compared to the prior year.
One of the most significant components of noninterest income is
service charges and fees which totaled $2,437,000 and $2,106,000
in 1996 and 1995, respectively. Increases expressed as a
percentage were 15.72% and 4.62% for those years. The relatively
strong growth experienced in 1996 reflects the addition of new
merchants in the credit card processing area, in addition to the
increased emphasis Heartland has placed on enhancing revenues
from services provided to customers.
Trust income increased 22.96% to $1,810,000 in 1996, as compared
to the prior year's total of $1,472,000. This strong performance
resulted from the increase in assets under management, ending
1996 at $366,000,000, an increase of $77,000,000 (26.64%) during
1996 and $41,000,000 (16.53%) during 1995. This growth reflects
especially strong equity and debt markets, combined with the
development of new trust relationships through aggressive calling
efforts. Minimal growth in assets under management in 1994
contributed to the less significant increase of 2.51% in gross
revenues during 1995 as compared to the prior year.
Brokerage income increased $102,000 (92.73%) in 1996, from the
previous year's total. Results for 1996 benefited from the
replacement of two sales personnel lost in 1995, combined with
the full integration of the brokerage area into the retail
division. Income in 1995 was $119,000 (51.97%) less than in 1994.
This significant decrease was primarily caused by the departure
of the two brokerage personnel, combined with the transition to a
new third party vendor.
Securities gains totaled $1,889,000, $413,000 and $443,000 in
1996, 1995 and 1994, respectively. The significant increase
experienced during 1996 resulted from the strong performance of
the equity portfolio at Keokuk which included a $1,174,000 gain
recognized on the sale of Federal Home Loan Mortgage Corporation
common stock. Included in 1994 was a $359,000 loss experienced in
the trading account at DB&T and is a direct result of the
significant downturn in the bond market during the first quarter.
DB&T's trading portfolio was liquidated during 1995.
NONINTEREST EXPENSE
(Dollars in thousands)
For the Years Ended
December 31,
1996 1995 1994
------------------------
Salaries and employee
benefits $11,035 $ 9,730 $ 9,481
Occupancy expense, net 1,268 1,059 976
Furniture and equipment
expense 1,336 1,315 1,209
Outside services 1,155 1,164 1,254
FDIC deposit insurance
assessment 746 681 1,117
Advertising 996 696 587
Other noninterest expense 2,971 2,678 2,620
-------- -------- --------
Total noninterest expense $19,507 $17,323 $17,244
======== ======== ========
Efficiency ratio (1) 63.03% 59.15% 59.29%
======== ======== ========
(1) Noninterest expense divided by the sum of net interest
income on a tax equivalent basis and noninterest income less
security gains.
The above table shows Heartland's noninterest expense for the
years indicated.
Noninterest expense increased $2,184,000 (12.61%) in 1996 as
compared to 1995. Total 1995 noninterest expense represented a
mere increase of $79,000 (.46%) from the 1994 total.
Salaries and employee benefit expense represented 56.57% of the
total 1996 noninterest expense, increasing $1,305,000 (13.41%)
from the total for 1995. This increase was attributable to merit
and cost of living raises and the addition of personnel at
Riverside. Heartland continues to closely monitor compensation
to ensure that employees are appropriately utilized and
adequately remunerated for their services.
The $209,000 (19.74%) increase in occupancy costs for 1996
represented additional depreciation and property tax costs
associated with the construction of new facilities at the
subsidiary banks.
The one-time special assessment on all savings associations to
capitalize the SAIF amounted to $545,000 at FCB and was recorded
during 1996. Exclusive of this one-time charge, FDIC premiums
decreased $480,000 (70.48%) in 1996 compared to 1995. During
1995, FDIC premium expense also experienced a reduction,
decreasing $436,000 (39.03%). The FDIC premium expense was
reduced when the premium charged to members of the Bank Insurance
Fund ("BIF") dropped from .23% to .04% of deposits and
subsequently to $2,000 per year for well capitalized banks. Three
of Heartland's four banks were affected by this reduction, which
took effect in September of 1995. FCB, as a SAIF member,
experienced a reduction in FDIC premium expense on January 1,
1997, when the assessment dropped from .23% to .065% of deposits.
Advertising and public relations expense experienced the largest
single percentage increase within the noninterest expense
category, rising $300,000 (43.10%) in 1996, compared to the 1995
total. The primary component of this increase was the
contribution of stock from FCB's securities portfolio to a public
charitable trust at a cost basis of $220,000 with an associated
market value of $820,000. The $109,000 (18.57%) increase during
1995 resulted primarily from efforts to publicize a new retail
delivery package and the building addition at DB&T, along with
the opening of Riverside.
The $293,000 (10.94%) increase in other noninterest expense
during 1996 was attributable to expenses incurred to grow the
merchant credit card processing area and the opening of
Riverside.
INCOME TAXES
The $199,000 (6.90%) decrease in total tax expense for 1996,
despite the increase in net income, was driven primarily by the
addition of $195,000 in tax credits associated with the
investment in low-income housing projects. The contribution of
appreciated property to a public charitable trust also aided in
this decrease. Income taxes for 1995 decreased $131,000 (4.34%)
from the 1994 total due to $247,000 of tax credits associated
with two of the low-income housing projects.
FINANCIAL CONDITION
LENDING ACTIVITIES
Heartland's major source of income is interest on loans and
leases. Heartland's loan and lease portfolio represents the
communities served by the Heartland banks and their continued
emphasis on commercial and agricultural lending. The table below
presents the composition of Heartland's loan portfolio at the end
of the years indicated.
With the exception of agricultural loans and lease financing, all
loan categories experienced growth during 1996. The largest
dollar growth occurred in commercial and commercial real estate
loans, which increased $14,657,000 (7.64%)compared to $20,868,000
(12.20%) during 1995. The reduced growth in 1996 reflects
softness in the local economies of the Heartland banks, primarily
at DB&T.
Heartland's residential mortgage loans consist of multi-family
and residential real estate mortgage loans. A stable rate
environment along with expanded production capabilities at
Riverside combined to increase the number of loan originations to
873 and 717 in 1996 and 1995, respectively. Residential mortgage
loans outstanding continued to grow as customers elected to take
three-, five- and seven-year mortgages which were retained in
inventory. In 1996 and 1995 Heartland's total outstanding
residential mortgage loans increased $8,675,000 (5.48%) and
$8,177,000 (5.45%), respectively.
While the Heartland banks continued to emphasize agricultural
loans and agricultural real estate loans, these loans experienced
a slight decrease of $1,563,000 (2.65%) from the December 31,
1995, total. While this decrease was minimal, it reflected the
consolidation occurring in the agricultural sector and strong
commodity prices. These loans increased $2,353,000 (4.15%) during
1995 from the December 31, 1994, total.
Consumer loan outstandings grew $9,373,000 (24.04%) during 1996
when compared to the December 31, 1995, total. This increase in
outstandings was attributed to significant growth in consumer
lines of credit and dealer paper, combined with the integration
of consumer loans into the retail delivery system and the
expansion of Citizens into Madison, Wisconsin. The 1995 figure
represents a $2,920,000 (8.10%) increase compared to the December
31, 1994, total. Citizen's loans reflected in these consolidated
totals were $8,937,000, $6,783,000 and $6,337,000 at December 31,
1996, 1995 and 1994, respectively.
Although the risk of nonpayment for any reason exists with
respect to all loans, specific risks are associated with each
type of loan. The primary risks associated with commercial and
agricultural loans are the quality of the borrower's management
and the impact of national and regional economic factors. Risks
associated with real estate loans include fluctuating land values
and concentrations of loans in a specific type of real estate.
Consumer loans also have risks associated with concentrations of
loans in a single type of loan and the risk of a borrower's
unemployment as a result of deteriorating economic conditions.
Heartland monitors its loan concentrations and does not believe
it has concentrations in any specific industry other than
agriculture.
Heartland's strategy with respect to the management of these
types of risks, whether loan demand is weak or strong, is to
encourage the Heartland banks to follow tested and prudent loan
policies and underwriting practices which include: (i) granting
loans on a sound and collectible basis; (ii) investing funds
profitably for the benefit of stockholders and the protection of
depositors; (iii) serving the needs of the community and each
bank's general market area while obtaining a balance between
maximum yield and minimum risk; (iv) ensuring that primary and
secondary sources of repayment are adequate in relation to the
amount of the loan; (v) administering loan policies through a
Board of Directors and an officers' loan committee; (vi)
developing and maintaining adequate diversification of the loan
portfolio as a whole and of the loans within each loan category;
and (vii) ensuring that each loan is properly documented and,