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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, 1998
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 22, 1999, the Registrant had issued and outstanding
9,518,805 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 22, 1999, was $108,576,625.* Such figures
include 733,908 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 March 22, 1999, and reports of
beneficial ownership filed by directors and executive officers of
Registrant and by beneficial owners of more than 5% of the
outstanding shares of Common Stock of Registrant; however, such
determination of shares owned by affiliates does not constitute
an admission of affiliate status or beneficial interest in shares
of Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1999 Annual Meeting of
Stockholders are incorporated by reference into Part III.
HEARTLAND FINANCIAL USA, INC.
Form 10-K Annual Report
Table of Contents
Part I
Item 1. Business
A. General Description
B. 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 five bank subsidiaries which are located
in Dubuque, Iowa, Cottage Grove, Wisconsin, Galena and Rockford,
Illinois and Albuquerque, New Mexico and one federal savings bank
subsidiary which is located in Keokuk, Iowa (collectively, the
"Bank Subsidiaries"). All six 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 two wholly-owned subsidiaries: DB&T
Insurance, Inc. ("DB&T Insurance"), a multi-line insurance agency
and DB&T Community Development Corp. ("DB&T Development"),
majority owner of a senior housing project. Galena State Bank
and Trust Company, Galena, Illinois, ("GSB") and Riverside
Community Bank, Rockford,Illinois, ("RCB") are chartered under
the laws of the State of Illinois. First Community Bank, FSB
("FCB")is a federal savings association organized under the laws
of the United States. FCB has one subsidiary, KFS Services, Inc.
Wisconsin Community Bank, previously Cottage Grove State Bank,
("WCB") is chartered under the laws of the State of Wisconsin and
has one subsidiary, DBT Investment Corporation ("DBT
Investment"), an investment management company. New Mexico Bank &
Trust ("NMB") is chartered under the laws of the state of New
Mexico. The Bank Subsidiaries operate 19 banking locations in
Iowa, Illinois, Wisconsin and New Mexico. Heartland has three non-
bank subsidiaries. Citizens Finance Co. ("Citizens") is a
consumer finance company. ULTEA, Inc. ("ULTEA") is a fleet
leasing company headquartered in Madison, Wisconsin. Keokuk
Bancshares, Inc. ("Keokuk") is an investment management company.
All subsidiaries are wholly-owned with the exception of NMB, of
which Heartland is the 80% owner.
The Bank Subsidiaries provide full service retail banking within
Dubuque and Lee Counties in Iowa, within Jo Daviess, Hancock and
Winnebago Counties in Illinois, within Dane County in Wisconsin
and Bernalillo County in New Mexico. Deposit products include
checking and other demand deposit accounts, NOW accounts, savings
accounts, money market accounts, certificates of deposit,
individual retirement accounts and other time deposits. The
deposits in the Bank Subsidiaries are insured by the FDIC to the
full extent permitted by law. Loans include commercial and
industrial, agricultural, real estate mortgage, consumer, home
equity, credit cards and lines of credit. Other products and
services include VISA debit cards, automatic teller machines,
safe deposit boxes and trust services. The principal service of
the Bank Subsidiaries consists of making loans to businesses and
individuals. These loans are made at the offices of the Bank
Subsidiaries. The Bank Subsidiaries also engage in activities
that are closely related to banking, including investment
brokerage.
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 converted to the Fiserv Comprehensive
Banking System program, 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 has focused primarily on
traditional community banks and thrifts located in stable and
growing areas of Iowa, Wisconsin, Minnesota and Illinois.
Heartland intends to look beyond these geographic areas for
acquisition opportunities as evidenced by the de novo bank in
Albuquerque, New Mexico. 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 GSB 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 declining rate environment along with expanded production
capabilities combined to increase the number of loan originations
as compared to 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 on over
one-half of these sales. 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 2,500
customers in the three state area of Iowa, Illinois and Wisconsin
from its Dubuque, Iowa, Madison and Appleton, Wisconsin, and
Loves Park, Illinois offices.
Trust Departments
The trust departments for DB&T, GSB and FCB have been providing
trust services to their respective communities for many years.
Trust personnel from DB&T also work with RCB and WCB personnel to
provide trust services to all bank subsidiaries. Currently, the
Bank Subsidiaries have over $496 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
DB&T contracts with a third-party vendor, Focused Investments
LLC, an affiliate of Wayne Hummer & Co., to operate independent
securities offices within DB&T's main office, Grandview and
Kennedy Mall branch offices and GSB's main office. DB&T's Farley
office also schedules 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 Dubuque County,Iowa, which encompasses the
city of Dubuque and a number of surrounding rural communities.
The city of Dubuque is located in northeastern Iowa, on the
Mississippi River, approximately 175 miles west of Chicago,
Illinois, and approximately 200 miles northeast of Des Moines,
Iowa. It is strategically situated at the intersection of the
state borders of Iowa, Illinois and Wisconsin. Based upon the
results of the 1990 census, the city of Dubuque had a total
population of approximately 61,000.
In addition to its main banking office, DB&T has seven 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, offices were opened in
Madison, Wisconsin, during June, 1996, Appleton, Wisconsin,
during August, 1998 and Loves Park, Illinois during February,
1999.
GSB 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. GSB 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.
FCB'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, FCB 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. FCB has one branch office in Keokuk and another
branch in the city of Carthage in Hancock County, Illinois.
Keokuk is an industrial community with a population of
approximately 13,500.
RCB 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.
WCB operates one office from its location in Cottage Grove,
Wisconsin, which is approximately 10 miles east of Madison in
Dane County. A branch office was opened in Middleton, a suburb of
Madison, in February, 1998. According to the 1990 census, the
county had a population of 390,000, and the village of Cottage
Grove had a population of 1,100.
NMB operates one office in the northeast section of Albuquerque,
New Mexico in Bernalillo County. Based upon the 1990 census, the
county had a population of 480,000 and the city had a population
of 385,000.
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, Rockford, Cottage Grove, Keokuk and
Albuquerque 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, 1998, Heartland employed 396 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
Effect of New Financial Accounting Standards -Heartland adopted
SFAS No. 130,"Reporting Comprehensive Income,"on January 1, 1998.
SFAS No. 130 establishes standards for the reporting and display
of comprehensive income in the financial statements.
Comprehensive income consists of net income and certain amounts
reported directly in stockholders' equity, such as the net
unrealized gains or losses on available for sale securities. The
statement requires only additional disclosures in the
consolidated financial statements; it does not affect Heartland's
financial position or results of operations. Prior year
financial statements have been reclassified to conform to the
requirements of SFAS No. 130.
SFAS No. 131,"Disclosure About Segments of an Enterprise and
Related Information," was effective for Heartland for the year
beginning January 1, 1998, and established disclosure
requirements for segment operations. The adoption had no effect
on Heartland's financial statement disclosures.
SFAS No. 132,"Employers' Disclosures About Pensions and Other
Postretirement Benefits," was effective for Heartland for the
year beginning January 1, 1998, and revises the disclosure
requirements for pension and other postretirement benefit plans.
The adoption had no effect on Heartland's financial statement
disclosures.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," will be effective for Heartland for the year
beginning January 1, 2000. Heartland expects to adopt SFAS No.
133 when required. Management does not believe the adoption of
SFAS No. 133 will have a material impact on the consolidated
financial statements.
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 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 the Board of Governors of the
Federal Reserve System (the "Federal Reserve"), the FDIC, the
OTS, the Iowa Superintendent of Banking (the "Iowa
Superintendent"), the Illinois Commissioner of Banks and Real
Estate (the "Illinois Commissioner"), the Division of Banking of
the Wisconsin Department of Financial Institutions (the
"Wisconsin DFI"), the New Mexico Financial Institutions Division
(the "New Mexico Division"), the Internal Revenue Service and
state taxing authorities and the Securities and Exchange
Commission (the "SEC"). The effect of applicable statutes,
regulations and regulatory 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 its 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 its
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 is a summary of the material elements of the
regulatory framework that applies to Heartland and its
subsidiaries. It does not describe all of the statutes,
regulations and regulatory policies that apply to Heartland and
its subsidiaries, nor does it restate all of the requirements of
the statutes, regulations and regulatory policies that are
described. As such, the following is qualified in its entirety by
reference to the applicable statutes, regulations and regulatory
policies. Any change in applicable law, regulations or
regulatory policies may have a material effect on the business of
Heartland and its subsidiaries.
Recent Regulatory Developments
Pending Legislation
Legislation has been introduced in the Congress that would allow
bank holding companies to engage in a wider range of nonbanking
activities, including greater authority to engage in securities
and insurance activities. The expanded powers generally would be
available to a bank holding company only if the bank holding
company and its bank subsidiaries remain well-capitalized and
well-managed. Unlike prior financial modernization bills
considered by the Congress, the pending legislation does not
include provisions eliminating the federal savings association
charter and requiring all federal savings associations to convert
to banks. At this time, Heartland is unable to predict whether
the proposed legislation will be enacted and, therefore, is
unable to predict the impact such legislation may have on
Heartland and the Bank Subsidiaries.
Heartland
General
Heartland, as the sole shareholder of DB&T, GSB, RCB and WCB and
the controlling shareholder of NMB, is a bank holding company.
As a bank holding company, Heartland is registered with, and is
subject to regulation by, the Federal Reserve under the Bank
Holding Company Act, as amended (the "BHCA"). In accordance with
Federal Reserve policy, Heartland is expected to act as a source
of financial strength to the Bank Subsidiaries and to commit
resources to support the Bank Subsidiaries in circumstances where
Heartland might not otherwise do so. Under the BHCA, Heartland
is subject to periodic examination by the Federal Reserve.
Heartland is also required to file with the Federal Reserve
periodic reports of Heartland's operations and such additional
information regarding Heartland and its subsidiaries as the
Federal Reserve may require.
Heartland's ownership of FCB makes Heartland a savings and loan
holding company, as defined in the HOLA. Although savings and
loan holding companies generally are subject to supervision and
regulation by the OTS, companies that, like Heartland, are both
bank holding companies and savings and loan holding companies are
generally exempt from OTS supervision. Federal law, however,
requires the Federal Reserve to consult with the OTS, as
appropriate, in establishing the scope of a Federal Reserve
examination of any such holding company, to provide the OTS, upon
request, with copies of Federal Reserve examination reports and
other supervisory information concerning any such holding
company, and to cooperate with the OTS in any enforcement action
against any such holding company if the conduct at issue involves
the company's savings association subsidiary.
Investments and Activities
Under the BHCA, a bank holding company must obtain Federal
Reserve approval before: (i) acquiring, directly or indirectly,
ownership or control of any voting shares of another bank or bank
holding company if, after the acquisition, it would own or
control more than 5% of the shares of the other bank or bank
holding company (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 Federal Reserve 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 Federal Reserve
is required to give effect to applicable state law limitations on
the aggregate amount of deposits that may be held by the
acquiring bank holding company and its insured depository
institution affiliates in the state in which the target bank is
located (provided that those limits do not discriminate against
out-of-state depository institutions or their holding companies)
and state laws 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 generally prohibits 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.
This general prohibition is subject to a number of exceptions.
The principal exception allows bank holding companies to engage
in, and to own shares of companies engaged in, certain businesses
found by the Federal Reserve to be "so closely related to banking
... as to be a proper incident thereto." Under current
regulations of the Federal Reserve, Heartland and its non-bank
subsidiaries are permitted to engage in a variety of banking-
related businesses, including 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 domestic activities of non-
bank subsidiaries of bank holding companies.
Federal law also prohibits any person or company from acquiring
"control" of an FDIC-insured depository institution or its
holding company without prior notice to the appropriate federal
bank regulator. "Control" is defined in certain cases as the
acquisition of 10% of the outstanding shares of an institution or
holding company.
Capital Requirements
Bank holding companies are required to maintain minimum levels of
capital in accordance with Federal Reserve 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 Federal Reserve'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%, at least one-half of which 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 a minimum requirement of 4% for all others. For
purposes of these capital standards, Tier 1 capital consists
primarily of permanent stockholders' equity less intangible
assets (other than certain mortgage servicing rights and
purchased credit card relationships). Total capital consists
primarily of 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. Higher capital levels will be required if warranted
by the particular circumstances or risk profiles of individual
banking organizations. For example, the Federal Reserve's capital
guidelines contemplate that additional capital may be required to
take adequate account of, among other things, interest rate risk,
or the risks posed by concentrations of credit, nontraditional
activities or securities trading activities. Further, any
banking organization experiencing or anticipating significant
growth would be expected to maintain capital ratios, including
tangible capital positions (i.e., Tier 1 capital less all
intangible assets), well above the minimum levels.
As of December 31, 1998, Heartland had regulatory capital in
excess of the Federal Reserve's minimum requirements, with a risk-
based capital ratio of 12.13% and a leverage ratio of 8.58%.
Dividends
The Delaware General Corporation Law (the "DGCL") allows
Heartland to pay dividends only out of its surplus (as defined
and computed in accordance with the provisions of the DGCL) or if
Heartland has no such surplus, out of its net profits for the
fiscal year in which the dividend is declared and/or the
preceding fiscal year. Additionally, the Federal Reserve has
issued a policy statement with regard to the payment of cash
dividends by bank holding companies. The policy statement
provides that a bank holding company should not pay cash
dividends which exceed its net income or which can only be funded
in ways that weaken the bank holding company's financial health,
such as by borrowing. The Federal Reserve also possesses
enforcement powers over bank holding companies and their non-bank
subsidiaries to prevent or remedy actions that represent unsafe
or unsound practices or violations of applicable statutes and
regulations. Among these powers is the ability to proscribe the
payment of dividends by banks and bank holding companies.
Federal Securities Regulation
Heartland's common stock is registered with the SEC under the
Securities 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, the deposit accounts of which are
insured by the FDIC's Bank Insurance Fund ("BIF"). As a BIF-
insured, Iowa-chartered bank, DB&T is subject to the examination,
supervision, reporting and enforcement requirements of the Iowa
Superintendent, as the chartering authority for Iowa banks, and
the FDIC, as administrator of the BIF.
GSB and RCB are Illinois-chartered banks, the deposit accounts of
which are insured by the BIF of the FDIC. As BIF-insured,
Illinois-chartered banks, GSB and RCB are subject to the
examination, supervision, reporting and enforcement requirements
of the Illinois Commissioner, as the chartering authority for
Illinois banks, and the FDIC, as administrator of the BIF.
WCB is a Wisconsin-chartered bank, the deposit accounts of which
are insured by the BIF of the FDIC. As a BIF-insured, Wisconsin-
chartered bank, WCB is subject to the examination, supervision,
reporting and enforcement requirements of the Wisconsin DFI, as
the chartering authority for Wisconsin banks, and the FDIC, as
administrator of the BIF.
NMB is a New Mexico-chartered bank, the deposit accounts of which
are insured by the BIF of the FDIC. As a BIF-insured, New Mexico-
chartered bank, NMB is subject to the examination, supervision,
reporting and enforcement requirements of the New Mexico
Division, as the chartering authority for New Mexico banks, and
the FDIC, as administrator of the BIF.
FCB is a federally chartered savings association, the deposits of
which are insured by the FDIC's Savings Association Insurance
Fund ("SAIF"). As a SAIF-insured, federally chartered savings
association, FCB 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.
Deposit Insurance
As FDIC-insured institutions, the Bank Subsidiaries are required
to pay deposit insurance premium assessments to the FDIC. The
FDIC has adopted a risk-based assessment system under which all
insured depository institutions are placed into one of nine
categories and assessed insurance premiums based upon their
respective levels of capital and results of supervisory
evaluations. Institutions classified as well-capitalized (as
defined by the FDIC) and considered healthy pay the lowest
premium while institutions that are less than adequately
capitalized (as defined by the FDIC) and considered of
substantial supervisory concern pay the highest premium. Risk
classification of all insured institutions is made by the FDIC
for each semi-annual assessment period.
During the year ended December 31, 1998, both BIF and SAIF
assessments ranged from 0% of deposits to 0.27% of deposits. For
the semi-annual assessment period beginning January 1, 1999, both
BIF and SAIF assessment rates will continue to range from 0% of
deposits to 0.27% of deposits.
The FDIC may terminate the deposit insurance of any insured
depository institution if the FDIC determines, after a hearing,
that the institution (i) has engaged or is engaging in unsafe or
unsound practices, (ii) is in an unsafe or unsound condition to
continue operations or (iii) 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 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 Financing Corporation
("FICO"). FICO was created in 1987 to finance the
recapitalization of the Federal Savings and Loan Insurance
Corporation, the SAIF's predecessor insurance fund. As a result
of federal legislation enacted in 1996, beginning as of January
1, 1997, both SAIF members and BIF members became subject to
assessments to cover the interest payments on outstanding FICO
obligations. These FICO assessments are 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. Between January 1, 2000 and the final 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. During the year ended December 31, 1998, the
FICO assessment rate for SAIF members ranged between
approximately 0.061% of deposits and approximately 0.063% of
deposits, while the FICO assessment rate for BIF members ranged
between approximately 0.012% of deposits and approximately 0.013%
of deposits. During the year ended December 31, 1998, the Bank
Subsidiaries paid FICO assessments totaling $118.
Supervisory Assessments
All Iowa banks, Illinois banks, Wisconsin banks, New Mexico banks
and federal savings associations are required to pay supervisory
assessments to the Iowa Superintendent, the Illinois
Commissioner, the Wisconsin DFI, the New Mexico Division and the
OTS, respectively, to fund the operations of such agencies. In
general, the amount of such supervisory assessments is based upon
each institution's total assets. During the year ended December
31, 1998, the Bank Subsidiaries paid supervisory assessments
totaling $42.
Capital Requirements
The FDIC has established the following minimum capital standards
for state-chartered insured non-member banks, such as DB&T, GSB,
RCB, WCB and NMB: a leverage requirement consisting of a minimum
ratio of Tier 1 capital to total assets of 3% for the most highly-
rated banks with a minimum requirement of at least 4% for all
others, and 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 Federal Reserve's capital
guidelines for bank holding companies (see "--Heartland--Capital
Requirements").
Pursuant to the HOLA and OTS regulations, savings associations,
such as FCB, are subject to the following minimum capital
requirements: 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. Core capital consists primarily of
permanent stockholders' equity less (i) intangible assets other
than certain supervisory goodwill, certain mortgage servicing
rights and certain purchased credit card relationships and (ii)
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. Total capital
consists primarily of core capital plus certain debt and equity
instruments that do not qualify as core capital and a portion of
the Bank's allowances for loan and leases 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, among other things, interest rate risk or
the risks posed by concentrations of credit or nontraditional
activities.
During the year ended December 31, 1998, 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 requirement. As of December 31, 1998, each of the
Bank Subsidiaries exceeded its minimum regulatory capital
requirements, as follows:
Total
Risk-Based Leverage Tangible
Capital Capital Capital
Ratio Ratio Ratio
--------- --------- ---------
DB&T 10.10 7.38 N/A
GSB 13.66 7.76 N/A
RCB 11.23 7.03 N/A
WCB 13.60 9.14 N/A
NMB 45.85 40.62 N/A
FCB 13.53 8.36 8.25
The OTS has proposed to amend its regulations to establish a
minimum core capital requirement of 3% of total assets for any
savings association assigned a composite rating of 1 as of the
association's most recent OTS examination, with a minimum core
capital requirement of 4% of total assets for all other savings
associations. It is not anticipated that the adoption of this
proposal would affect FCB's ability to comply with the OTS
capital requirements.
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," in each case as defined by regulation.
Depending upon the capital category to which an institution is
assigned, the regulators' corrective powers include: requiring
the institution to submit a capital restoration plan; limiting
the institution's asset growth and restricting its activities;
requiring the institution to issue additional capital stock
(including additional voting stock) or to be acquired;
restricting transactions between the institution and its
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. As of
December 31, 1998, each of the Bank Subsidiaries was "well
capitalized," as defined by applicable regulations.
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. Because Heartland owns more
than 25% of the outstanding stock of each of the Bank
Subsidiaries, the Bank Subsidiaries are deemed to be commonly
controlled.
Dividends
In general, under applicable state law, DB&T, GSB, RCB, WCB and
NMB may not pay dividends in excess of their undivided profits.
OTS regulations impose limitations upon all capital distributions
by savings associations, including cash dividends. Under the OTS
rule that is presently in effect, an institution that exceeds all
applicable capital requirements both before and after the
proposed capital distribution (a "Tier 1 Institution") may,
after prior notice to, but without the approval of, the OTS, make
capital distributions during a calendar year in an aggregate
amount 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 amounts of its
capital in excess of its 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 OTS approval. As of December
31, 1998, FCB was a Tier 1 Institution.
The OTS has amended its regulations governing capital
distributions (including cash dividends) by savings associations.
The amended rule, which takes effect April 1, 1999, will require
prior OTS approval for any capital distribution by a savings
association that is not eligible for expedited processing under
the OTS's application processing regulations. In order to
qualify for expedited processing, a savings association must:
(i) have a composite examination rating of 1 or 2; (ii) have a
Community Reinvestment Act rating of satisfactory or better;
(iii) have a compliance rating of 1 or 2; (iv) meet all
applicable regulatory capital requirements; and (v) not have been
notified by the OTS that it is a problem association or an
association in troubled condition. Savings associations that
qualify for expedited processing will be required to obtain OTS
approval prior to making a capital distribution if: (a) the
amount of the proposed capital distribution, when aggregated with
all other capital distributions during the same calendar year,
will exceed an amount equal to the association's year-to-date net
income plus its retained net income for the preceding two years;
(b) after giving effect to the distribution, the association will
not be at least "adequately capitalized" (as defined by OTS
regulation); or (c) the distribution would violate a prohibition
contained in an applicable statute, regulation or agreement with
the OTS or the FDIC or violate a condition imposed in connection
with an OTS-approved application or notice. The amended
regulation will continue to require that the OTS be given prior
notice of certain types of capital distributions, including any
capital distribution by a savings association that, like FCB, is
a subsidiary of a holding company, or by a savings association
that, after giving effect to the distribution, would not be "well-
capitalized" (as defined by OTS regulation).
The payment of dividends by any financial institution or its
holding company is affected by the requirement to maintain
adequate capital pursuant to applicable capital adequacy
guidelines and regulations, and a financial institution generally
is prohibited from paying any dividends if, following payment
thereof, the institution would be undercapitalized. As described
above, each of the Bank Subsidiaries exceeded its minimum capital
requirements under applicable guidelines as of December 31, 1998.
Further, under applicable regulations of the OTS, FCB may not pay
dividends in an amount which would reduce its capital below the
amount required for the liquidation account established in
connection with FCB's conversion from the mutual to the stock
form of ownership in 1991. As of December 31, 1998,
approximately $33 million was available to be paid as dividends
to Heartland by the Bank Subsidiaries. Notwithstanding the
availability of funds for dividends, however, the banking
regulators may prohibit the payment of any dividends by the Bank
Subsidiaries if such payment is deemed to constitute an unsafe or
unsound practice.
Insider Transactions
The Bank Subsidiaries are subject to certain restrictions imposed
by federal law on extensions of credit to Heartland and its
subsidiaries, on investments in the stock or other securities of
Heartland and its subsidiaries and the acceptance of the stock or
other securities of Heartland or its subsidiaries as collateral
for loans. 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,
federal law 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 one of the Bank Subsidiaries
maintains a correspondent relationship.
Safety and Soundness Standards
The federal banking agencies have adopted guidelines which
establish operational and managerial standards to promote the
safety and soundness of federally insured depository
institutions. The guidelines set forth standards for internal
controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset
growth, compensation, fees and benefits, asset quality and
earnings. In addition, in October 1998, the federal banking
regulators issued safety and soundness standards for achieving
Year 2000 compliance, including standards for developing and
managing Year 2000 project plans, testing remediation efforts and
planning for contingencies.
In general, the safety and soundness guidelines prescribe the
goals to be achieved in each area, and each institution is
responsible for establishing its own procedures to achieve those
goals. If an institution fails to comply with any of the
standards set forth in the guidelines, the institution's primary
federal regulator may require the institution to submit a plan
for achieving and maintaining compliance. If an institution fails
to submit an acceptable compliance plan, or fails in any material
respect to implement a compliance plan that has been accepted by
its primary federal regulator, the regulator is required to issue
an order directing the institution to cure the deficiency. Until
the deficiency cited in the regulator's order is cured, the
regulator may restrict the institution's rate of growth, require
the institution to increase its capital, restrict the rates the
institution pays on deposits or require the institution to take
any action the regulator deems appropriate under the
circumstances. Noncompliance with the standards established by
the safety and soundness guidelines may also constitute grounds
for other enforcement action by the federal banking regulators,
including cease and desist orders and civil money penalty
assessments.
Branching Authority
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 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 GSB and RCB, have authority under
Illinois law to establish branches anywhere in the State of
Illinois, subject to receipt of all required regulatory
approvals. Likewise, under the laws of Wisconsin and New Mexico,
Wisconsin banks and New Mexico banks, respectively, have
statewide branching authority, subject to regulatory approval.
Under the Riegle-Neal Interstate Banking and Branching Efficiency
Act of 1994 (the "Riegle-Neal Act"), both state and national
banks are allowed to establish interstate branch networks through
acquisitions of other banks, subject to certain conditions,
including certain limitations on the aggregate amount of deposits
that may be held by the surviving bank and all of its insured
depository institution affiliates. The establishment of new
interstate branches or the acquisition of individual branches of
a bank in another state (rather than the acquisition of an out-of-
state bank in its entirety) is allowed by the Riegle-Neal Act
only if specifically authorized by state law. The legislation
allowed individual states to "opt-out" of certain provisions of
the Riegle-Neal Act by enacting appropriate legislation prior to
June 1, 1997. The laws of Iowa, Illinois, Wisconsin and New
Mexico permit interstate bank mergers, subject to certain
conditions, including a prohibition against interstate mergers
involving an Iowa, Illinois, Wisconsin or New Mexico bank,
respectively, that has been in existence and continuous operation
for fewer than five years.
Federally chartered savings associations 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 -- Qualified Thrift Lender Test") have the
authority, subject to receipt of OTS approval, to establish or
acquire branch offices anywhere in the United States. If a
federal savings association fails to qualify as a "domestic
building and loan association," as defined in the Internal
Revenue Code, and fails to meet the qualified thrift lender test
the association may branch only to the extent permitted for
national banks located in the savings association's home state.
As of December 31, 1998, 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.
These restrictions have not had, and are not currently expected
to have, a material impact on the operations of DB&T, GSB, RCB,
WCB or NMB.
Qualified Thrift Lender Test
The HOLA requires every savings association to satisfy a
"qualified thrift lender" ("QTL") test. Under the HOLA, a
savings association will be deemed to meet the QTL test if it
either (i) maintains at least 65% of its "portfolio assets" in
"qualified thrift investments" on a monthly basis in nine out of
every 12 months or (ii) qualifies as a "domestic building and
loan association," as defined in the Internal Revenue Code. For
purposes of the QTL test, "qualified thrift investments" consist
of mortgage loans, mortgage-backed securities, education loans,
small business loans, credit card loans and certain other housing
and consumer-related loans and investments. "Portfolio assets"
consist of a savings association's total assets less goodwill and
other intangible assets, the association's business properties
and a limited amount of the liquid assets maintained by the
association pursuant to the liquidity requirements of the HOLA
and OTS regulations (see "--The Bank--Liquidity Requirements").
A savings association that fails to meet the QTL test must either
convert to a bank charter or operate under certain restrictions
on its operations and activities. Additionally, within one year
following the loss of QTL status, the holding company for the
savings association will be required to register as, and will be
deemed to be, a bank holding company. A savings association that
fails the QTL test may requalify as a QTL but it may do so only
once. As of December 31, 1998, FCB satisfied the QTL test, with
a ratio of qualified thrift investments to portfolio assets of
83.87%, 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 quarter, 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 4% of either (i)
its liquidity base (i.e., its net withdrawable accounts plus
borrowings repayable in 12 months or less) as of the end of the
preceding calendar quarter or (ii) the average daily balance of
its liquidity base during the preceding calendar quarter. This
liquidity requirement may be changed from time to time by the OTS
to an amount within a range of 4% to 10% of the liquidity base,
depending upon economic conditions and the deposit flows of
savings associations. The OTS may also require a savings
association to maintain a higher level of liquidity than the
minimum 4% requirement if the OTS deems necessary to ensure the
safe and sound operation of the association. Penalties may be
imposed for failure to meet liquidity ratio requirements. At
December 31, 1998, FCB was in compliance with OTS liquidity
requirements, with a liquidity ratio of 10.43%.
Federal Reserve System
Federal Reserve regulations, as presently in effect, require
depository institutions to maintain non-interest earning reserves
against their transaction accounts (primarily NOW and regular
checking accounts), as follows: for transaction accounts
aggregating $46.5 million or less, the reserve requirement is 3%
of total transaction accounts; and for transaction accounts
aggregating in excess of $46.5 million, the reserve requirement
is $1.395 million plus 10% of the aggregate amount of total
transaction accounts in excess of $46.5 million. The first $4.9
million of otherwise reservable balances are exempted from the
reserve requirements. These reserve requirements are subject to
annual adjustment by the Federal Reserve. The Bank Subsidiaries
are in compliance with the foregoing requirements. The balances
used to meet the reserve requirements imposed by the Federal
Reserve may be used to satisfy the liquidity requirements to
which FCB is subject under the HOLA and OTS regulations.
G. GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS
The earnings of Heartland are affected by the policies of
regulatory authorities, including the Federal Reserve System
whose monetary policies have had a significant effect on the
operating results of commercial banks in the past and are
expected to continue to do so in the future. Because of changing
conditions in the economy and in the money markets, as a result
of actions by monetary and fiscal authorities, interest rates,
credit availability and deposit levels may change due to
circumstances beyond the control of Heartland. Future policies of
the Federal Reserve System and other authorities cannot be
predicted, nor can their effect on future earnings be predicted.
ITEM 2.
PROPERTIES
The 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.
DB&T has a total of seven 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 the Main Street Office
location of DB&T. The Madison office for Citizens is located in
a leased building at 1771 Thierer Road, Madison, Wisconsin 53707,
and the Appleton office is located in a leased building at 740
West Northland Avenue, Appleton, Wisconsin 54914. The Loves Park
office is located in a leased building at 6345 North Second
Street, Loves Park, Illinois 61132.
GSB'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 main office of FCB is located at 4th and Concert Street,
Keokuk, Iowa 52632. The property was purchased by FCB 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 FCB. During 1996, FCB opened a 2,100 square foot
branch on the northwest side of Keokuk. FCB 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 FCB. Each of these
offices are owned without material encumbrances.
RCB operates from an 8,000 square foot one-story brick building
located at 6700 East Riverside Boulevard, Rockford, Illinois
61114.
The main office of WCB is located at 580 N. Main Street, Cottage
Grove, Wisconsin 53527. The property was constructed by WCB in
1972 and consists of a one-story stucco building. This building
comprises approximately 6,000 square feet, all of which is
occupied by WCB. A branch facility was purchased in Middleton,
Wisconsin in 1997. This branch facility is a one-story wood
building totaling 2,500 square feet, all of which is occupied by
WCB and is owned without material encumbrances.
NMB operates from its leased facility, an 8,665 square foot
facility at Suite 100, 6501 Americas Parkway NE, Albuquerque, New
Mexico 87110.
ULTEA leases a 1900 square foot facility at 2976 Triverton Pike,
Madison, Wisconsin 53711. During 1998, Heartland acquired all of
the assets and assumed certain liabilities of Arrow Motors, Inc.,
a Wisconsin corporation, doing business as Lease Associates Group
("LAG"). With the purchase of LAG, ULTEA operates a second leased
facility of 3000 square feet at 1433 West Silver Springs Drive,
Milwaukee, Wisconsin 53209.
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 1998 to a
vote of security holders.
PART II
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Heartland's Common Stock was held by approximately 800
shareholders of record as of March 22, 1999, 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
1997:
First $12 $13 3/16
Second 12 5/8 13 21/32
Third 12 1/2 15 1/4
Fourth 13 15
1998:
First $14 5/16 $16
Second 14 16 7/8
Third 15 3/4 19
Fourth 16 3/4 19
Cash dividends have been declared by Heartland quarterly during
the past two years ending December 31, 1998. The following table
sets forth the cash dividends per share paid on Heartland's
Common Stock for the past two years:
Calendar Quarter
1998 1997
First $.075 $.065
Second .075 .065
Third .08 .065
Fourth .08 .065
ITEM 6.
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
For the Years Ended December 31,
1998 1997 1996
--------------------------------
STATEMENT OF INCOME DATA
Interest income $ 64,517 $ 59,261 $ 51,886
Interest expense 36,304 31,767 27,644
-------- -------- --------
Net interest income 28,213 24,494 24,242
Provision for loan and
lease losses 951 1,179 1,408
-------- -------- --------
Net interest income after
provision for loan and
lease losses 27,262 26,215 22,834
Noninterest income 17,297 8,565 7,364
Noninterest expense 31,781 22,927 19,507
Provision for income taxes 3,757 3,338 2,685
-------- -------- --------
Net income $ 9,021 $ 8,515 $ 8,006
======== ======== ========
PER COMMON SHARE DATA (1)
Net income-basic $ 0.95 $ 0.90 $ 0.85
Net income-diluted 0.94 $ 0.89 0.84
Cash dividends 0.31 .26 .20
Dividend payout ratio 32.48% 28.96% 23.53%
Book value $ 8.84 $ 8.19 $ 7.42
Weighted average shares
outstanding 9,463,313 9,476,342 9,430,018
BALANCE SHEET DATA
Investments and federal
funds sold $259,964 $234,666 $183,966
Total loans and leases,
net of unearned 590,133 556,406 484,085
Allowance for loan and lease
losses 7,945 7,362 6,191
Total assets 953,785 852,060 736,552
Total deposits 717,877 623,532 558,343
Long-term obligations 57,623 43,023 42,506
Stockholders' equity 84,270 77,772 70,259
EARNINGS PERFORMANCE DATA
Return on average total assets 1.01% 1.09% 1.16%
Return on average stockholders'
equity 11.26 11.59 12.00
Net interest margin ratio (2) 3.58 3.89 3.98
ASSET QUALITY RATIOS
Nonperforming assets to total
assets 0.28% 0.34% 0.34%
Nonperforming loans and leases
to total loans and leases 0.30 0.37 0.41
Net loan and lease charge-offs
to average loans and leases 0.07 0.08 0.17
Allowance for loan and lease
losses to total loans and
leases 1.35 1.32 1.28
Allowance for loan and lease
losses to nonperforming
loans and leases 453.74 362.30 313.63
CAPITAL RATIOS
Average equity to average
assets 9.01% 9.39% 9.66%
Total capital to risk-adjusted
assets 12.13 12.71 14.28
Tier 1 leverage 8.58 8.76 9.54
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
For the Years Ended
December 31,
1995 1994
--------------------
STATEMENT OF INCOME DATA
Interest income $49,149 $ 43,373
Interest expense 25,529 20,128
-------- --------
Net interest income 23,620 23,245
Provision for loan and lease losses 820 811
-------- --------
Net interest income after provision
for loan and lease losses 22,800 22,434
Noninterest income 4,981 4,965
Noninterest expense 17,323 17,244
Provision for income taxes 2,884 3,015
-------- ---------
Net income $ 7,574 $ 7,140
======== ========
PER COMMON SHARE DATA (1)
Net income-basic $ 0.79 $ 0.74
Net income-diluted 0.78 0.74
Cash dividends .15 .13
Dividend payout ratio 19.03% 17.99%
Book value $ 6.88 $ 5.88
Weighted average shares
outstanding 9,610,368 9,691,296
BALANCE SHEET DATA
Investments and federal funds sold $171,726 $162,968
Total loans and leases, net of unearned 454,905 422,216
Allowance for loan and lease losses 5,580 5,124
Total assets 677,313 626,490
Total deposits 534,587 513,239
Long-term obligations 45,400 23,562
Stockholders' equity 64,506 56,930
EARNINGS PERFORMANCE DATA
Return on average total assets 1.18% 1.18%
Return on average stockholders' equity 12.28 12.82
Net interest margin ratio (2) 4.13 4.32
ASSET QUALITY RATIOS
Nonperforming assets to total assets 0.28% 0.17%
Nonperforming loans and leases
to total loans and leases 0.26 0.21
Net loan and lease charge-offs
to average loans and leases
Allowance for loan and lease losses 0.08 0.03
to total loans and leases 1.23 1.21
Allowance for loan and lease losses
to nonperforming loans and leases 463.84 580.95
CAPITAL RATIOS
Average equity to average assets 9.59% 9.22%
Total capital to risk-adjusted assets 14.46 15.04
Tier 1 leverage 9.47 9.32
(1) Per share data has been restated to reflect the two-for-one
stock split effected in the form of a stock dividend on June 30,
1998.
(2) Tax equivalent using a 34% tax rate.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands)
The following presents management's discussion and analysis of
the consolidated financial condition and results of operations of
Heartland Financial USA, Inc. ("Heartland") as of the dates and
for the periods indicated. This discussion should be read in
conjunction with the Selected Financial Data, Heartland's
Consolidated Financial Statements and the Notes thereto and other
financial data appearing elsewhere in this report.
The consolidated financial statements include the accounts of
Heartland and its subsidiaries: Dubuque Bank and Trust Company
("DB&T"); Galena State Bank and Trust Company ("GSB"); Riverside
Community Bank ("RCB"); Wisconsin Community Bank ("WCB"); New
Mexico Bank & Trust ("NMB"); First Community Bank, FSB ("FCB");
Citizens Finance Co. ("Citizens"); ULTEA, Inc. ("ULTEA"); DB&T
Insurance, Inc.; DB&T Community Development Corp.; DBT Investment
Corporation and Keokuk Bancshares, Inc. (dba KBS Investment
Corp.). All of Heartland's subsidiaries are wholly-owned except
for NMB, of which Heartland is an 80% owner.
This report 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 recorded its eighth consecutive year of increased
annual earnings during 1998, up $506 or 5.94% from 1997. On a
basic per common share basis, the 1998 earnings increased 5.56%.
Return on common equity was 11.26% and return on assets was 1.01%
for 1998 compared to 11.59% and 1.09% for 1997, respectively. Net
income increased $509 or 6.36% in 1997 from 1996. On a basic per
common share basis, 1997 net income increased 5.88% from 1996.
Return on common equity was 11.59% and return on assets was 1.09%
for 1997 compared to 12.00% and 1.16%, respectively, for 1996.
These sustained increases in earnings are particularly gratifying
given the additional overhead expended to develop the growth
initiatives which Heartland had underway during the previous two
years. Total assets grew $101,725 or 11.94% to $953,785 at
December 31, 1998, and $115,508 or 15.68% to $852,060 at December
31, 1997. At the same time, total deposits increased $94,345 or
15.13% during 1998 and $65,189 or 11.68% during 1997. Loans and
leases were up $33,727 or 6.06% at December 31, 1998, and $72,321
or 14.94% at December 31, 1997. The initiatives undertaken to
generate this growth and sustain earnings included:
The spring 1998 de novo expansion into Albuquerque, New Mexico
with NMB.
Expansion into the vehicle leasing and fleet management
business with the purchase of ULTEA in late 1996 and Lease
Associates Group ("LAG") in the summer of 1998.
The 1997 acquisition of WCB and its early 1998 opening of a
branch facility in Middleton, Wisconsin.
The conversion of all Heartland banks to new banking software
in early 1997.
Enhancement of banking operations at RCB, Heartland's 1995 de
novo banking operation in Rockford, Illinois.
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 $28,999,
$28,280 and $25,476 for 1998, 1997 and 1996, respectively, an
increase of 2.54% for 1998 and 11.01% for 1997. Expressed as a
percentage of average earning assets, Heartland's net interest
margin decreased to 3.58% in 1998 and 3.89% in 1997, compared to
3.98% in 1996. These decreases occurred for several reasons:
As a result of the acquisitions of ULTEA and LAG, additional
interest expense was incurred on debt utilized to fund the
vehicles under operating leases while the income derived from
these leases is recorded as noninterest income.
A decline and flattening of the yield curve resulted in an
acceleration of paydowns in the mortgage-backed securities and
loan portfolio and pressure from loan customers to lower rates
charged on their balances.
The return on Heartland's securities portfolio declined as
several higher-yielding securities matured or were called and
the average life of the portfolio was reduced as prepayments
accelerated on the mortgage-backed securities portfolio.
Growth in noninterest bearing deposits remained relatively
flat during 1997.
Heartland continues to manage its balance sheet on a proactive
basis. The following table sets forth certain information
relating to Heartland's average consolidated balance sheets and
reflects the yield on average earning assets and the cost of
average interest bearing liabilities for the years indicated.
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)
For the Year Ended
December 31, 1998
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $196,206 $ 11,515 5.87%
Nontaxable (1) 20,507 1,716 8.37
--------- --------- ------
Total securities 216,713 13,231 6.11
--------- --------- ------
Interest bearing deposits 8,313 386 4.64
Federal funds sold 29,830 1,582 5.30
--------- --------- ------
Loans and leases:
Commercial and commercial
real estate (1) 249,326 21,523 8.63
Residential mortgage 162,545 12,854 7.91
Agricultural and agricultural
real estate (1) 75,685 6,751 8.92
Consumer 66,138 6,702 10.13
Direct financing leases, net 8,367 625 7.47
Fees on loans - 1,649 -
Less: allowance for loan
and lease losses (7,944) - -
--------- --------- ------
Net loans and leases 554,117 50,104 9.04
--------- --------- ------
Total earning assets 808,973 65,303 8.07
--------- --------- ------
NONEARNING ASSETS
Total nonearning assets 80,317 - -
--------- --------- ------
TOTAL ASSETS $889,290 $ 65,303 7.34%
========= ========= ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
Savings accounts $266,282 $ 9,512 3.57%
Time, $100,000 and over 51,283 2,905 5.66
Other time deposits 282,142 16,228 5.75
Short-term borrowings 78,484 4,076 5.19
Other borrowings 56,137 3,583 6.38
--------- --------- ------
Total interest bearing
liabilities 734,328 36,304 4.94
--------- --------- ------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 60,514 - -
Accrued interest and other
liabilities 14,343 - -
--------- --------- ------
Total noninterest bearing
liabilities 74,857 - -
--------- --------- ------
Stockholders' Equity 80,105 - -
--------- --------- ------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $889,290 $ 36,304 4.08%
========= ========= ======
Net interest income (1) $ 28,999
=========
Net interest income
to total earning assets (1) 3.58%
======
Interest bearing liabilities
to earning assets 90.77%
=========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1)
For the Year Ended
December 31, 1997
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $169,086 $ 10,393 6.15%
Nontaxable (1) 19,700 1,773 9.00
--------- --------- ------
Total securities 188,786 12,166 6.44
--------- --------- ------
Interest bearing deposits 2,972 98 3.30
Federal funds sold 12,570 681 5.42
--------- --------- ------
Loans and leases:
Commercial and commercial
real estate (1) 222,157 19,683 8.86
Residential mortgage 178,362 14,083 7.90
Agricultural and agricultural
real estate (1) 66,294 6,037 9.11
Consumer 55,218 5,672 10.27
Direct financing leases, net 6,739 501 7.43
Fees on loans - 1,126 -
Less: allowance for loan
and lease losses (6,998) - -
--------- --------- ------
Net loans and leases 521,772 47,102 9.03
--------- --------- ------
Total earning assets 726,100 60,047 8.27
--------- --------- ------
NONEARNING ASSETS
Total nonearning assets 56,596 - -
--------- --------- ------
TOTAL ASSETS $782,696 $ 60,047 7.67%
========= ========= ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
Savings accounts $237,730 $ 8,317 3.50%
Time, $100,000 and over 34,913 1,961 5.62
Other time deposits 268,201 15,487 5.77
Short-term borrowings 70,313 3,740 5.32
Other borrowings 36,406 2,262 6.21
--------- --------- ------
Total interest bearing
liabilities 647,563 31,767 4.91
--------- --------- ------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 51,770 - -
Accrued interest and other
liabilities 9,906 - -
--------- --------- ------
Total noninterest bearing
liabilities 61,676 - -
--------- --------- ------
Stockholders' Equity 73,457 - -
--------- --------- ------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $782,696 $ 31,767 4.06%
========= ========= ======
Net interest income (1) $ 28,280
=========
Net interest income
to total earning assets (1) 3.89%
======
Interest bearing liabilities
to earning assets 89.18%
=========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1)
For the Year Ended
December 31, 1996
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $136,107 $ 8,392 6.17%
Nontaxable (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 12,637 7.87
Agricultural and agricultural
real estate (1) 58,975 5,377 9.12
Consumer 41,302 4,250 10.29
Direct financing leases, net 7,502 549 7.32
Fees on loans - 976 -
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:
Savings accounts $214,401 $ 7,474 3.49%
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%
=========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
The following table allocates the changes in net interest income
to differences in either average balances or average rates for
earning assets and interest bearing liabilities. The changes have
been allocated proportionately to the change due to volume and
change due to rate. Interest income is measured on a tax
equivalent basis using a 34% tax rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
For the Year Ended
December 31,
1998 Compared to 1997
Change Due to
Volume Rate Net
-----------------------
EARNING ASSETS/INTEREST INCOME
Securities
Taxable $1,668 $ (546) $1,122
Nontaxable 72 (129) (57)
Interest bearing deposits 176 112 288
Federal funds sold 935 (34) 901
Loans and leases 2,920 82 3,002
------- ------- -------
TOTAL EARNING ASSETS 5,771 (515) 5,256
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
Savings accounts 999 196 1,195
Time, $100,000 and over 919 25 944
Other time deposits 805 (64) 741
Short-term borrowings 435 (99) 336
Other borrowings 1,226 95 1,321
------- ------- -------
TOTAL INTEREST BEARING
LIABILITIES 4,384 153 4,537
------- ------- -------
NET INTEREST INCOME $1,387 $ (668) $ 719
======= ======= =======
ANALYSIS OF CHANGES IN NET INTEREST INCOME
For the Year Ended
December 31,
1997 Compared to 1996
Change Due to
Volume Rate Net
-----------------------
EARNING ASSETS/INTEREST INCOME
Securities
Taxable $2,033 $ (32) $2,001
Nontaxable (1,133) (202) (1,335)
Interest bearing deposits (51) (14) (65)
Federal funds sold 55 16 71
Loans and leases 5,725 530 6,255
------- ------- -------
TOTAL EARNING ASSETS 6,629 298 6,927
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
Savings accounts 813 30 843
Time, $100,000 and over (163) (7) (170)
Other time deposits 1,641 261 1,902
Short-term borrowings 1,739 58 1,797
Other borrowings (331) 82 (249)
------- ------- -------
TOTAL INTEREST BEARING
LIABILITIES 3,699 424 4,123
------- ------- -------
NET INTEREST INCOME $2,930 $ (126) $2,804
======= ======= =======
ANALYSIS OF CHANGES IN NET INTEREST INCOME
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
Nontaxable 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
Savings accounts 286 (150) 136
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 2,175 (60) 2,115
------- ------- -------
NET INTEREST INCOME $1,092 $(337) $ 755
======= ======= =======
PROVISION FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses decreased $328 or 25.65%
during 1998 and $129 or 9.16% during 1997. During 1996,
additional provision resulted from a $469 writedown in the
commercial loan portfolio at FCB on a pool of leases purchased
from the Bennett Funding Group. During 1998, provision was
reduced as a result of a $357 recovery on this same pool of
leases. The allowance for loan and lease losses as a percentage
of total loans and leases increased to 1.35% at December 31,
1998, from 1.32% at December 31, 1997 and 1.28% at December 31,
1996.
NONINTEREST INCOME
For the Years Ended
December 31,
1998 1997 1996
------------------------
Service charges and fees $ 3,013 $ 2,723 $ 2,437
Trust fees 2,284 2,009 1,810
Brokerage commissions 413 324 212
Insurance commissions 751 563 650
Securities gains, net 1,897 1,446 1,889
Rental income on operating leases 7,428 811 -
Gains on sale of loans 1,212 373 131
Other noninterest income 299 316 235
-------- -------- --------
Total noninterest income $17,297 $ 8,565 $ 7,364
======== ======== ========
The above table shows Heartland's noninterest income for the
years indicated. Total noninterest income increased $8,732 or
101.95% during 1998, as compared to an increase of $1,201 or
16.31% during 1997.
Expansion into the vehicle leasing and fleet management business
was responsible for the significant growth in noninterest income
during both years. Rental income on operating leases accounted
for 75.78% and 67.53% of the change in 1998 and 1997,
respectively. ULTEA's first full year of operation as a
Heartland subsidiary occurred in 1997. During the third quarter
of 1998, LAG was acquired and subsequently merged into ULTEA.
Gains on sale of loans increased $839 or 224.93% during 1998 and
$242 or 184.73% during 1997. Heartland experienced refinancing
activity in its real estate mortgage loan portfolio, especially
during 1998, as a result of decreasing interest rates. The
majority of these new fixed rate 15- and 30-year real estate
loans were sold into the secondary market.
Securities gains increased $451 or 31.19% during 1998 compared to
1997 and were attributable to the strong performance of
Heartland's equity portfolio. During 1997, securities gains
decreased $443 or 23.45% compared to 1996. A gain of $1,174 on
the sale of Federal Home Loan Mortgage Corporation common stock
held in the investment portfolio at FCB was recorded in 1996.
Heartland was able to sustain a portion of those gains during
1997 due to its equity portfolio performance.
Emphasis during the past several years on enhancing revenues from
services provided to customers has influenced the growth of fee
income. Service charges, trust fees and brokerage commissions
all increased by more than 10% during each of the past two years.
NONINTEREST EXPENSE
For the Years Ended
December 31,
1998 1997 1996
------------------------
Salaries and employee
benefits $15,218 $13,070 $11,035
Occupancy, net 1,695 1,354 1,268
Furniture and equipment 1,998 1,537 1,236
Outside services 1,416 1,439 1,155
FDIC deposit insurance
assessment 118 116 746
Advertising 1,150 826 996
Depreciation on equipment under
operating leases 5,296 584 -
Other noninterest expense 4,890 4,001 3,071
-------- -------- --------
Total noninterest expense $31,781 $22,927 $19,507
======== ======== ========
Efficiency ratio (1) 71.58% 64.77% 63.03%
======== ======== ========
(1) Noninterest expense divided by the sum of net interest
income and noninterest income less securities gains.
The above table shows Heartland's noninterest expense for the
years indicated. Noninterest expense increased $8,854 or 38.62%
in 1998 as compared to 1997. Total 1997 noninterest expense
represented an increase of $3,420 or 17.53% from the 1996 total.
The largest component of the increase in noninterest expense
during 1998 was related to the addition of LAG to the ULTEA
operations, as depreciation on equipment under operating leases
increased $4,712 or 806.85%. During 1997, the depreciation on
equipment under operating leases accounted for $584 of the change
in noninterest expense. Exclusive of depreciation on equipment
under operating leases, the change in noninterest expense during
1998 was $4,142 or 18.54%.
Salaries and employee benefits expense continued to experience
increases during both 1998 and 1997, growing $2,148 or 16.43% and
$2,035 or 18.44%, respectively. In addition to the normal merit
and cost of living raises, these increases were attributable to
Heartland's continued expansion efforts, particularly the
additions of NMB, WCB and ULTEA.
In addition to the increases experienced in salaries and employee
benefits, the expansion efforts underway during the past two
years have resulted in additional occupancy, furniture and
equipment and advertising/public relations costs. These expenses
increased $1,126 or 30.29% during 1998 and $217 or 6.20% during
1997. Exclusive of a one-time contribution of stock from FCB's
securities portfolio to a public charitable trust at a cost basis
of $220 during 1996, these costs increased $437 or 13.32% during
1997.
Other noninterest expenses grew $889 or 22.22% during 1998
compared to an increase of $930 or 30.28% during 1997.
Amortization and maintenance expense on software have contributed
to this increase primarily due to the conversion of the bank
subsidiaries to Fiserv's Comprehensive Banking Systems during the
spring of 1997.
Federal Deposit Insurance Corporation ("FDIC") premium expense
decreased $630 (84.45%) during 1997 compared to 1996. The one-
time special assessment on all savings associations to capitalize
the Savings Association Insurance Fund ("SAIF") amounted to $545
at FCB and was recorded during 1996. Also contributing to this
change was the reduction in FDIC premium expense on January 1,
1997, at FCB when the assessment for SAIF members dropped from
.23% to .065% of deposits.
INCOME TAXES
Income tax expense increased $419 or 12.55% for 1998 and $653 or
24.32% for 1997. The effective tax rate increased from 25.11% in
1996, to 28.16% in 1997 and 29.40% in 1998. Reductions in tax-
exempt income contributed to these increases.
FINANCIAL CONDITION
LENDING ACTIVITIES
Heartland's major source of income is interest on loans and
leases. The table below presents the composition of Heartland's
loan portfolio at the end of the years indicated.
LOAN PORTFOLIO
December 31,
1998 1997
Amount Percent Amount Percent
------ ------- ------ -------
Commercial and commercial
real estate $277,765 46.88% $242,868 43.46%
Residential mortgage 156,415 26.40 175,268 31.37
Agricultural and
agricultural real estate 77,211 13.03 69,302 12.40
Consumer 72,642 12.26 64,223 11.49
Lease financing, net 8,508 1.43 7,171 1.28
-------- ------- -------- -------
Gross loans and leases 592,541 100.00% 558,832 100.00%
======= =======
Unearned discount (2,136) (2,077)
Deferred loan fees (272) (349)
--------- ---------
Total loans and leases 590,133 556,406
Allowance for loan and
lease losses (7,945) (7,362)
--------- ---------
Loans and leases, net $582,188 $549,044
========= =========
LOAN PORTFOLIO
December 31,
1996 1995
Amount Percent Amount Percent
------ ------- ------ -------
Commercial and commercial
real estate $206,523 42.46% $191,866 42.00%
Residential mortgage 166,999 34.33 158,324 34.66
Agricultural and
agricultural real estate 57,526 11.83 59,089 12.94
Consumer 48,361 9.94 38,988 8.54
Lease financing, net 7,042 1.44 8,530 1.86
-------- ------- -------- -------
Gross loans and leases 486,451 100.00% 456,797 100.00%
======= =======
Unearned discount (1,962) (1,510)
Deferred loan fees (404) (382)
--------- ---------
Total loans and leases 484,085 454,905
Allowance for loan and
lease losses (6,191) (5,580)
--------- ---------
Loans and leases, net $477,894 $449,325
========= =========
LOAN PORTFOLIO
December 31,
1994
Amount Percent
------ -------
Commercial and commercial
real estate $170,998 40.32%
Residential mortgage 150,147 35.41
Agricultural and
agricultural real estate 56,736 13.38
Consumer 36,068 8.51
Lease financing, net 10,076 2.38
-------- -------
Gross loans and leases 424,025 100.00%
=======
Unearned discount (1,438)
Deferred loan fees (371)
---------
Total loans and leases 422,216
Allowance for loan and
lease losses (5,124)
---------
Loans and leases, net $417,092
=========
The table below sets forth the remaining maturities by loan and
lease category.
MATURITY AND RATE SENSITIVITY OF LOANS AND LEASES (1)
December 31, 1998
Over 1 Year
Through 5 Years
One Year Fixed Floating
or less Rate Rate
------------------------------
Commercial and commercial
real estate $115,214 $102,354 $ 29,232
Residential mortgage 62,947 22,622 28,761
Agricultural and
agricultural real estate 35,278 28,707 6,163
Consumer 18,618 35,961 7,514
Lease financing, net 2,571 5,737 -
-------- -------- --------
Total $234,628 $195,381 $ 71,670
======== ======== ========
Over 5 Years
Fixed Floating
Rate Rate Total
-------------------------------
Commercial and commercial
real estate $ 7,838 $ 23,127 $277,765
Residential mortgage 12,891 29,194 156,415
Agricultural and
agricultural real estate 2,279 4,784 77,211
Consumer 3,706 6,843 72,642
Lease financing, net 200 - 8,508
-------- -------- --------
Total $ 26,914 $ 63,948 $592,541
======== ======== ========
(1) Maturities based upon contractual dates.
Net loans and leases grew $33,144 or 6.04% from December 31,
1997, to December 31, 1998, compared to $71,150 or 14.89% from
December 31, 1996, to December 31, 1997. The opening of NMB
accounted for $28,829 or 86.98% of the growth during 1998 while
the WCB acquisition accounted for $22,906 or 32.19% of the growth
during 1997.
During both years, the largest dollar growth occurred in
commercial and commercial real estate loans, which increased
$34,897 or 14.37% during 1998 and $36,345 or 17.60% during 1997.
NMB made up $22,860 or 65.51% of the 1998 growth while WCB
accounted for $10,789 or 29.68% of the 1997 growth in this loan
category.
Consumer loan outstandings grew $8,419 or 13.11% during 1998.
Loans at NMB made up $2,721 or 32.32% of this change. Exclusive
of the WCB loan portfolio, consumer loan outstandings grew
$11,474 or 23.73% during 1997. These increases were attributed
to significant growth in consumer lines of credit and dealer
paper.
Agricultural and agricultural real estate loans experienced
$7,909 or 11.41% growth during 1998. This same loan category,
exclusive of WCB, grew $10,569 or 18.37% during 1997. These
increases reflected the solid reputation and expertise DB&T has
developed in agricultural lending, combined with continued
calling efforts.
Residential mortgage loan outstandings, the only loan category to
experience a decrease during 1998, declined $18,853 or 10.76%.
This decrease occurred as customers chose fixed rate 15- and 30-
year mortgages which the subsidiary banks elected to sell into
the secondary market. In 1997, exclusive of WCB, Heartland's
total outstanding residential mortgage loans increased $1,406 or
.84%.
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, if
appropriate, guaranteed by government agencies and that insurance
coverage is adequate.
NONPERFORMING LOANS AND LEASES AND OTHER NONPERFORMING ASSETS
The table below sets forth the amounts of nonperforming loans and
leases and other nonperforming assets on the dates indicated.
NONPERFORMING ASSETS
December 31,
1998 1997 1996 1995 1994
----------------------------------
Nonaccrual loans and
leases $1,324 $1,819 $1,697 $ 977 $ 748
Loan and leases
contractually past
due 90 days or more 426 187 247 226 134
Restructured loans
and leases - 26 30 - -