Attached files
file | filename |
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EX-31.1 - EX31.1 - HEARTLAND FINANCIAL USA INC | ex311.htm |
EX-31.2 - EX31.2 - HEARTLAND FINANCIAL USA INC | ex312.htm |
EX-32.2 - EX32.2 - HEARTLAND FINANCIAL USA INC | ex322.htm |
EX-32.1 - EX32.1 - HEARTLAND FINANCIAL USA INC | ex321.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
x QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
For
quarterly period ended September 30, 2009
x TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
transition period __________ to __________
Commission
File Number: 0-24724
HEARTLAND
FINANCIAL USA, INC.
(Exact
name of Registrant as specified in its charter)
Delaware
(State or
other jurisdiction of incorporation or organization)
42-1405748
(I.R.S.
employer identification number)
1398
Central Avenue, Dubuque, Iowa 52001
(Address
of principal executive offices)(Zip Code)
(563)
589-2100
(Registrant's
telephone number, including area code)
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 þ No ¨
Indicate by check mark whether the
Registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such files). Yes x No ¨
Indicate by check mark whether the
Registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of “accelerated
filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Act.
Large
accelerated filer ¨ Accelerated
filer þ Non-accelerated
filer ¨ Smaller reporting
company ¨
(Do not check if a smaller reporting
company)
Indicate
by check mark whether the Registrant is a shell company (as defined by Rule
12b-2 of the Securities Exchange Act of 1934). Yes ¨ No þ
Indicate
the number of shares outstanding of each of the classes of Registrant's common
stock as of the latest practicable date: As of November 5, 2009, the
Registrant had outstanding 16,323,453 shares of common stock, $1.00 par value
per share.
HEARTLAND
FINANCIAL USA, INC.
Form
10-Q Quarterly Report
Part
I
|
|||
Item
1.
|
Financial
Statements
|
||
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
||
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
||
Item
4.
|
Controls
and Procedures
|
||
Part
II
|
|||
Item
1.
|
Legal
Proceedings
|
||
Item
1A.
|
Risk
Factors
|
||
Item
2.
|
Unregistered
Sales of Issuer Securities and Use of Proceeds
|
||
Item
3.
|
Defaults
Upon Senior Securities
|
||
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
||
Item
5.
|
Other
Information
|
||
Item
6.
|
Exhibits
|
||
Form
10-Q Signature Page
|
PART
I
ITEM
1. FINANCIAL STATEMENTS
HEARTLAND
FINANCIAL USA, INC.
CONSOLIDATED
BALANCE SHEETS
(Dollars
in thousands, except per share data)
|
||||||||
September
30, 2009
|
December
31, 2008
|
|||||||
(Unaudited)
|
||||||||
ASSETS
|
||||||||
Cash
and due from banks
|
$
|
77,231
|
$
|
48,977
|
||||
Federal
funds sold and other short-term investments
|
5,277
|
2,326
|
||||||
Cash
and cash equivalents
|
82,508
|
51,303
|
||||||
Securities:
|
||||||||
Trading, at fair
value
|
756
|
1,694
|
||||||
Available for sale, at fair
value (cost of $1,061,562 at September 30, 2009, and $875,143 at December
31, 2008)
|
1,077,628
|
871,686
|
||||||
Held to maturity, at cost (fair
value of $25,725 at September 30, 2009, and $26,326 at December 31,
2008)
|
27,360
|
30,325
|
||||||
Loans
held for sale
|
19,923
|
19,695
|
||||||
Loans
and leases:
|
||||||||
Held to maturity
|
2,367,871
|
2,405,001
|
||||||
Loans covered by loss share
agreements
|
36,175
|
-
|
||||||
Allowance for loan and lease
losses
|
(42,260
|
)
|
(35,651
|
)
|
||||
Loans
and leases, net
|
2,361,786
|
2,369,350
|
||||||
Premises,
furniture and equipment, net
|
117,140
|
120,500
|
||||||
Other
real estate, net
|
33,342
|
11,750
|
||||||
Goodwill,
net
|
40,207
|
40,207
|
||||||
Other
intangible assets, net
|
12,101
|
8,079
|
||||||
Cash
surrender value on life insurance
|
55,141
|
54,431
|
||||||
FDIC
indemnification asset
|
4,393
|
-
|
||||||
Other
assets
|
47,328
|
51,248
|
||||||
TOTAL
ASSETS
|
$
|
3,879,613
|
$
|
3,630,268
|
||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
LIABILITIES:
|
||||||||
Deposits:
|
||||||||
Demand
|
$
|
451,645
|
$
|
383,061
|
||||
Savings
|
1,386,059
|
1,128,312
|
||||||
Time
|
1,106,710
|
1,128,859
|
||||||
Total
deposits
|
2,944,414
|
2,640,232
|
||||||
Short-term
borrowings
|
111,346
|
210,184
|
||||||
Other
borrowings
|
457,444
|
437,833
|
||||||
Accrued
expenses and other liabilities
|
38,044
|
33,396
|
||||||
TOTAL
LIABILITIES
|
3,551,248
|
3,321,645
|
||||||
EQUITY:
|
||||||||
Preferred
stock (par value $1 per share; authorized and undesignated 102,302 shares;
none issued or outstanding)
|
-
|
-
|
||||||
Series
A Junior Participating preferred stock (par value $1 per share; authorized
16,000 shares; none issued or outstanding)
|
-
|
-
|
||||||
Series
B Fixed Rate Cumulative Perpetual preferred stock (par value $1 per share;
authorized 81,698 shares; issued, 81,698
shares)
|
76,909
|
75,578
|
||||||
Common
stock (par value $1 per share; authorized 25,000,000 shares at September
30, 2009, and 20,000,000 shares at December 31, 2008; issued 16,611,671
shares)
|
16,612
|
16,612
|
||||||
Capital
surplus
|
44,221
|
43,827
|
||||||
Retained
earnings
|
183,280
|
177,753
|
||||||
Accumulated
other comprehensive income (loss)
|
10,397
|
(1,341
|
)
|
|||||
Treasury
stock at cost (289,718 shares at September 30, 2009, and 337,181 shares at
December 31, 2008)
|
(5,927
|
)
|
(6,826
|
)
|
||||
TOTAL
STOCKHOLDERS’ EQUITY
|
325,492
|
305,603
|
||||||
Noncontrolling
interest
|
2,873
|
3,020
|
||||||
TOTAL
EQUITY
|
328,365
|
308,623
|
||||||
TOTAL
LIABILITIES AND EQUITY
|
$
|
3,879,613
|
$
|
3,630,268
|
||||
See
accompanying notes to consolidated financial
statements.
|
HEARTLAND
FINANCIAL USA, INC.
|
||||||||||||||||
CONSOLIDATED
STATEMENTS OF INCOME (Unaudited)
|
||||||||||||||||
(Dollars
in thousands, except per share data)
|
||||||||||||||||
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||||||
Sept.
30, 2009
|
Sept.
30, 2008
|
Sept.
30, 2009
|
Sept.
30, 2008
|
|||||||||||||
INTEREST
INCOME:
|
||||||||||||||||
Interest
and fees on loans and leases
|
$
|
38,790
|
$
|
40,990
|
$
|
116,696
|
$
|
124,444
|
||||||||
Interest
on securities and other:
|
||||||||||||||||
Taxable
|
10,809
|
8,228
|
29,269
|
22,728
|
||||||||||||
Nontaxable
|
2,231
|
1,670
|
6,139
|
4,996
|
||||||||||||
Interest
on federal funds sold and other short-term investments
|
-
|
85
|
1
|
267
|
||||||||||||
Interest
on interest bearing deposits in other financial
institutions
|
17
|
3
|
18
|
10
|
||||||||||||
TOTAL
INTEREST INCOME
|
51,847
|
50,976
|
152,123
|
152,445
|
||||||||||||
INTEREST
EXPENSE:
|
||||||||||||||||
Interest
on deposits
|
13,046
|
15,622
|
40,744
|
48,375
|
||||||||||||
Interest
on short-term borrowings
|
154
|
776
|
539
|
4,049
|
||||||||||||
Interest
on other borrowings
|
4,065
|
4,692
|
12,803
|
13,562
|
||||||||||||
TOTAL
INTEREST EXPENSE
|
17,265
|
21,090
|
54,086
|
65,986
|
||||||||||||
NET
INTEREST INCOME
|
34,582
|
29,886
|
98,037
|
86,459
|
||||||||||||
Provision
for loan and lease losses
|
11,896
|
7,083
|
28,602
|
14,213
|
||||||||||||
NET
INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES
|
22,686
|
22,803
|
69,435
|
72,246
|
||||||||||||
NONINTEREST
INCOME:
|
||||||||||||||||
Service
charges and fees
|
3,288
|
3,125
|
9,284
|
8,620
|
||||||||||||
Loan
servicing income
|
1,756
|
1,094
|
7,853
|
3,585
|
||||||||||||
Trust
fees
|
1,949
|
2,070
|
5,617
|
6,159
|
||||||||||||
Brokerage
and insurance commissions
|
824
|
942
|
2,420
|
2,717
|
||||||||||||
Securities
gains, net
|
1,291
|
5
|
6,462
|
1,015
|
||||||||||||
Gain
(loss) on trading account securities
|
210
|
(33
|
)
|
272
|
(467
|
)
|
||||||||||
Impairment
loss on securities
|
-
|
(4,688
|
)
|
-
|
(4,804
|
)
|
||||||||||
Gains
on sale of loans
|
877
|
295
|
4,916
|
1,279
|
||||||||||||
Income
(loss) on bank owned life insurance
|
297
|
(247
|
)
|
640
|
596
|
|||||||||||
Gain
on acquisition
|
998
|
-
|
998
|
-
|
||||||||||||
Gain
on sale of merchant services
|
-
|
5,200
|
-
|
5,200
|
||||||||||||
Other
noninterest income
|
418
|
117
|
872
|
772
|
||||||||||||
TOTAL
NONINTEREST INCOME
|
11,908
|
7,880
|
39,334
|
24,672
|
||||||||||||
NONINTEREST
EXPENSES
|
||||||||||||||||
Salaries
and employee benefits
|
14,661
|
15,000
|
46,046
|
44,459
|
||||||||||||
Occupancy
|
2,221
|
2,262
|
6,772
|
6,799
|
||||||||||||
Furniture
and equipment
|
1,594
|
1,662
|
4,936
|
5,201
|
||||||||||||
Professional
fees
|
2,706
|
2,712
|
7,027
|
7,299
|
||||||||||||
FDIC
assessments
|
1,393
|
384
|
5,258
|
955
|
||||||||||||
Advertising
|
740
|
1,012
|
2,272
|
2,853
|
||||||||||||
Intangible
assets amortization
|
199
|
236
|
668
|
708
|
||||||||||||
Net
loss on repossessed assets
|
3,680
|
327
|
6,832
|
517
|
||||||||||||
Other
noninterest expenses
|
3,129
|
3,142
|
9,275
|
9,290
|
||||||||||||
TOTAL
NONINTEREST EXPENSES
|
30,323
|
26,737
|
89,086
|
78,081
|
||||||||||||
INCOME
BEFORE INCOME TAXES
|
4,271
|
3,946
|
19,683
|
18,837
|
||||||||||||
Income
taxes
|
803
|
1,018
|
5,434
|
5,081
|
||||||||||||
NET
INCOME
|
3,468
|
2,928
|
14,249
|
13,756
|
||||||||||||
Net
income attributable to noncontrolling interest, net of tax
|
44
|
77
|
147
|
219
|
||||||||||||
NET
INCOME ATTRIBUTABLE TO HEARTLAND
|
3,512
|
3,005
|
14,396
|
13,975
|
||||||||||||
Preferred
dividends and discount
|
(1,336
|
)
|
-
|
(4,008
|
)
|
-
|
||||||||||
NET
INCOME AVAILABLE TO COMMON STOCKHOLDERS
|
$
|
2,176
|
$
|
3,005
|
$
|
10,388
|
$
|
13,975
|
||||||||
EARNINGS
PER COMMON SHARE – BASIC
|
$
|
.13
|
$
|
.18
|
$
|
0.64
|
$
|
0.86
|
||||||||
EARNINGS
PER COMMON SHARE – DILUTED
|
$
|
.13
|
$
|
.18
|
$
|
0.64
|
$
|
0.85
|
||||||||
CASH
DIVIDENDS DECLARED PER COMMON SHARE
|
$
|
.10
|
$
|
.10
|
$
|
0.30
|
$
|
0.30
|
||||||||
See
accompanying notes to consolidated financial statements.
|
|
HEARTLAND
FINANCIAL USA, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars
in thousands, except per share data)
|
||||||||
Nine
Months Ended
|
||||||||
Sept.
30, 2009
|
Sept.
30, 2008
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
income
|
$
|
14,249
|
$
|
13,756
|
||||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
Depreciation and
amortization
|
6,832
|
7,028
|
||||||
Provision for loan and lease
losses
|
28,602
|
14,213
|
||||||
Net amortization of premium on
securities
|
2,043
|
(330
|
)
|
|||||
Securities gains,
net
|
(6,462
|
)
|
(1,015
|
)
|
||||
(Increase) decrease in trading
account securities
|
734
|
(74
|
)
|
|||||
Loss on impairment of
securities
|
-
|
4,804
|
||||||
Gain on
acquisition
|
(998
|
)
|
-
|
|||||
Stock-based
compensation
|
715
|
876
|
||||||
Loans originated for
sale
|
(667,294
|
)
|
(203,758
|
)
|
||||
Proceeds on sales of
loans
|
672,438
|
207,904
|
||||||
Net gains on sales of
loans
|
(4,916
|
)
|
(1,279
|
)
|
||||
(Increase) decrease in accrued
interest receivable
|
(1,658
|
)
|
1,538
|
|||||
Decrease in accrued interest
payable
|
(2,109
|
)
|
(3,626
|
)
|
||||
Other, net
|
2,795
|
(12,628
|
)
|
|||||
NET
CASH PROVIDED BY OPERATING ACTIVITIES
|
44,971
|
27,409
|
||||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Proceeds
from the sale of securities available for sale
|
224,521
|
131,482
|
||||||
Proceeds
from the sale of securities held to maturity
|
1,659
|
-
|
||||||
Proceeds
from the maturity of and principal paydowns on securities available for
sale
|
138,617
|
133,869
|
||||||
Proceeds
from the maturity of and principal paydowns on securities held to
maturity
|
2,243
|
121
|
||||||
Purchase
of securities available for sale
|
(538,456
|
)
|
(337,576
|
)
|
||||
Purchase
of securities held to maturity
|
(895
|
)
|
(18,782
|
)
|
||||
Net
increase in loans and leases
|
(21,685
|
)
|
(92,645
|
)
|
||||
Capital
expenditures
|
(2,957
|
)
|
(6,544
|
)
|
||||
Net
cash and cash equivalents received in acquisition
|
7,193
|
-
|
||||||
Proceeds
on sale of OREO and other repossessed assets
|
13,545
|
1,349
|
||||||
NET
CASH USED BY INVESTING ACTIVITIES
|
(176,215
|
)
|
(188,726
|
)
|
||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Net
increase in demand deposits and savings accounts
|
298,403
|
179,022
|
||||||
Net
increase (decrease) in time deposit accounts
|
(43,868
|
)
|
12,586
|
|||||
Net
decrease in short-term borrowings
|
(104,666
|
)
|
(177,603
|
)
|
||||
Proceeds
from other borrowings
|
55,146
|
221,972
|
||||||
Repayments
of other borrowings
|
(35,535
|
)
|
(45,433
|
)
|
||||
Purchase
of treasury stock
|
(74
|
)
|
(6,126
|
)
|
||||
Proceeds
from issuance of common stock
|
579
|
1,723
|
||||||
Excess
tax benefits on exercised stock options
|
2
|
266
|
||||||
Common
and preferred dividends paid
|
(7,538
|
)
|
(4,848
|
)
|
||||
NET
CASH PROVIDED BY FINANCING ACTIVITIES
|
162,449
|
181,559
|
||||||
Net
increase in cash and cash equivalents
|
31,205
|
20,242
|
||||||
Cash
and cash equivalents at beginning of year
|
51,303
|
46,832
|
||||||
CASH
AND CASH EQUIVALENTS AT END OF PERIOD
|
$
|
82,508
|
$
|
67,074
|
||||
Supplemental
disclosures:
|
||||||||
Cash paid for income/franchise
taxes
|
$
|
5,314
|
$
|
7,646
|
||||
Cash paid for
interest
|
$
|
56,195
|
$
|
69,612
|
||||
Securities transferred to
available for sale from trading
|
$
|
204
|
$
|
-
|
||||
Securities transferred to
trading from available for sale
|
$
|
-
|
$
|
541
|
||||
Loans transferred to
OREO
|
$
|
37,607
|
$
|
8,553
|
||||
Acquisition:
|
||||||||
Net assets
acquired
|
$
|
5,625
|
$
|
-
|
||||
Cash received from FDIC in
acquisition
|
$
|
3,995
|
$
|
-
|
||||
Cash acquired in
acquisition
|
3,198
|
-
|
||||||
Net cash received in acquisition
of subsidiary
|
$
|
7,193
|
$
|
-
|
||||
See
accompanying notes to consolidated financial statements.
|
HEARTLAND
FINANCIAL USA, INC.
|
||||||||||||||||||||||||||||||||
CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY AND COMPREHENSIVE INCOME
(Unaudited)
|
||||||||||||||||||||||||||||||||
(Dollars
in thousands, except per share data)
|
||||||||||||||||||||||||||||||||
Heartland
Financial USA, Inc. Stockholders’ Equity
|
||||||||||||||||||||||||||||||||
Preferred
Stock
|
Common
Stock
|
Capital
Surplus
|
Retained
Earnings
|
Accumulated
Other
Comprehensive
Income
(Loss)
|
Treasury
Stock
|
Non-controlling
Interest
|
Total
Equity
|
|||||||||||||||||||||||||
Balance
at January 1, 2008
|
$
|
-
|
$
|
16,612
|
$
|
37,269
|
$
|
173,100
|
$
|
6,506
|
$
|
(3,678
|
)
|
$
|
-
|
$
|
229,809
|
|||||||||||||||
Net
income
|
13,975
|
(219
|
)
|
13,756
|
||||||||||||||||||||||||||||
Unrealized
loss on securities available for sale arising during the
period
|
(21,096
|
)
|
(21,096
|
)
|
||||||||||||||||||||||||||||
Unrealized
gain on derivatives arising during the period
|
563
|
563
|
||||||||||||||||||||||||||||||
Reclassification
adjustment for net security losses realized in net income
|
3,789
|
3,789
|
||||||||||||||||||||||||||||||
Reclassification
adjustment for net derivatives gains realized in net
income
|
(136
|
)
|
(136
|
)
|
||||||||||||||||||||||||||||
Income
taxes
|
6,331
|
6,331
|
||||||||||||||||||||||||||||||
Comprehensive
income
|
3,207
|
|||||||||||||||||||||||||||||||
Cash
dividends declared:
|
||||||||||||||||||||||||||||||||
Common, $0.30 per
share
|
(4,848
|
)
|
(4,848
|
)
|
||||||||||||||||||||||||||||
Purchase
of 306,864 shares of common stock
|
(6,126
|
)
|
(6,126
|
)
|
||||||||||||||||||||||||||||
Issuance
of 132,739 shares of common stock
|
(444
|
)
|
2,619
|
2,175
|
||||||||||||||||||||||||||||
Commitments
to issue common stock
|
876
|
876
|
||||||||||||||||||||||||||||||
Initial
capital investment
|
3,300
|
3,300
|
||||||||||||||||||||||||||||||
Balance
at September 30, 2008
|
$
|
-
|
$
|
16,612
|
$
|
37,701
|
$
|
182,227
|
$
|
(4,043
|
)
|
$
|
(7,185
|
)
|
$
|
3,081
|
$
|
228,393
|
||||||||||||||
Balance
at January 1, 2009
|
$
|
75,578
|
$
|
16,612
|
$
|
43,827
|
$
|
177,753
|
$
|
(1,341
|
)
|
$
|
(6,826
|
)
|
$
|
3,020
|
$
|
308,623
|
||||||||||||||
Net
income
|
14,396
|
(147
|
)
|
14,249
|
||||||||||||||||||||||||||||
Unrealized
gain on securities available for sale arising during the
period
|
25,985
|
25,985
|
||||||||||||||||||||||||||||||
Unrealized
loss on derivatives arising during the period
|
(813
|
)
|
(813
|
)
|
||||||||||||||||||||||||||||
Reclassification
adjustment for net security gains realized in net income
|
(6,462
|
)
|
(6,462
|
)
|
||||||||||||||||||||||||||||
Reclassification
adjustment for net derivatives gains realized in net
income
|
(33
|
)
|
(33
|
)
|
||||||||||||||||||||||||||||
Income
taxes
|
(6,939
|
)
|
(6,939
|
)
|
||||||||||||||||||||||||||||
Comprehensive
income
|
25,987
|
|||||||||||||||||||||||||||||||
Cumulative
preferred dividends accrued and discount accretion
|
1,331
|
(1,331
|
)
|
-
|
||||||||||||||||||||||||||||
Cash
dividends declared:
|
||||||||||||||||||||||||||||||||
Preferred, $37.50 per
share
|
(2,677
|
)
|
(2,677
|
)
|
||||||||||||||||||||||||||||
Common, $0.30 per
share
|
(4,861
|
)
|
(4,861
|
)
|
||||||||||||||||||||||||||||
Purchase
of 4,557 shares of common stock
|
(74
|
)
|
(74
|
)
|
||||||||||||||||||||||||||||
Issuance
of 52,020 shares of common stock
|
(321
|
)
|
973
|
652
|
||||||||||||||||||||||||||||
Commitments
to issue common stock
|
715
|
715
|
||||||||||||||||||||||||||||||
Balance
at September 30, 2009
|
$
|
76,909
|
$
|
16,612
|
$
|
44,221
|
$
|
183,280
|
$
|
10,397
|
$
|
(5,927
|
)
|
$
|
2,873
|
$
|
328,365
|
|||||||||||||||
See
accompanying notes to consolidated financial
statements.
|
HEARTLAND
FINANCIAL USA, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1: BASIS OF PRESENTATION
The
interim unaudited consolidated financial statements contained herein should be
read in conjunction with the audited consolidated financial statements and
accompanying notes to the consolidated financial statements for the fiscal year
ended December 31, 2008, included in Heartland Financial USA, Inc.’s
("Heartland") Form 10-K filed with the Securities and Exchange Commission on
March 16, 2009. Accordingly, footnote disclosures, which would substantially
duplicate the disclosure contained in the audited consolidated financial
statements, have been omitted.
The
financial information of Heartland included herein has been prepared in
accordance with U.S. generally accepted accounting principles for interim
financial reporting and has been prepared pursuant to the rules and regulations
for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information
reflects all adjustments (consisting of normal recurring adjustments), that are,
in the opinion of management, necessary for a fair presentation of the financial
position and results of operations for the periods presented. The results of the
interim period ended September 30, 2009, are not necessarily indicative of the
results expected for the year ending
December
31, 2009.
Earnings
Per Share
Basic
earnings per share is determined using net income available to common
stockholders and weighted average common shares outstanding. Diluted earnings
per share is computed by dividing net income available to common stockholders by
the weighted average common shares and assumed incremental common shares issued.
Amounts used in the determination of basic and diluted earnings per share for
the three-month and nine-month periods ended September 30, 2009 and 2008, are
shown in the tables below:
Three
Months Ended
|
||||||||
(Dollars
and numbers in thousands, except per share data)
|
September
30, 2009
|
September
30, 2008
|
||||||
Net
income attributable to Heartland
|
$
|
3,512
|
$
|
3,005
|
||||
Preferred
dividends and discount
|
(1,336
|
)
|
-
|
|||||
Net
income available to common stockholders
|
$
|
2,176
|
$
|
3,005
|
||||
Weighted
average common shares outstanding for basic earnings per
share
|
$
|
16,311
|
$
|
16,264
|
||||
Assumed
incremental common shares issued upon exercise of stock
options
|
29
|
91
|
||||||
Weighted
average common shares for diluted earnings per share
|
$
|
16,340
|
$
|
16,355
|
||||
Earnings
per common share – basic
|
$
|
0.13
|
$
|
0.18
|
||||
Earnings
per common share – diluted
|
$
|
0.13
|
$
|
0.18
|
||||
Number
of antidilutive stock options excluded from diluted earnings per share
computations
|
161
|
31
|
Nine
Months Ended
|
||||||||
(Dollars
and numbers in thousands, except per share data)
|
September
30, 2009
|
September
30, 2008
|
||||||
Net
income attributable to Heartland
|
$
|
14,396
|
$
|
13,975
|
||||
Preferred
dividends and discount
|
(4,008
|
)
|
-
|
|||||
Net
income available to common stockholders
|
$
|
10,388
|
$
|
13,975
|
||||
Weighted
average common shares outstanding for basic earnings per
share
|
$
|
16,296
|
$
|
16,315
|
||||
Assumed
incremental common shares issued upon exercise of stock
options
|
24
|
77
|
||||||
Weighted
average common shares for diluted earnings per share
|
$
|
16,320
|
$
|
16,392
|
||||
Earnings
per common share – basic
|
$
|
0.64
|
$
|
0.86
|
||||
Earnings
per common share – diluted
|
$
|
0.64
|
$
|
0.85
|
||||
Number
of antidilutive stock options excluded from diluted earnings per share
computations
|
191
|
40
|
Stock-Based
Compensation
Options
are typically granted annually with an expiration date ten years after the date
of grant. Vesting is generally over a five-year service period with portions of
a grant becoming exercisable at three years, four years and five years after the
date of grant. A summary of the status of the stock options as of September 30,
2009 and 2008, and changes during the nine months ended September 30, 2009 and
2008, follows:
2009
|
2008
|
|||||||||||||||
Shares
|
Weighted-Average
Exercise Price
|
Shares
|
Weighted-Average
Exercise Price
|
|||||||||||||
Outstanding
at January 1
|
743,363
|
$
|
19.79
|
733,012
|
$
|
18.61
|
||||||||||
Granted
|
-
|
-
|
164,400
|
18.60
|
||||||||||||
Exercised
|
(4,125
|
)
|
11.13
|
(98,549
|
)
|
11.56
|
||||||||||
Forfeited
|
(16,292
|
)
|
20.43
|
(16,000
|
)
|
24.96
|
||||||||||
Outstanding
at September 30
|
722,946
|
$
|
19.83
|
782,863
|
$
|
19.36
|
||||||||||
Options
exercisable at September 30
|
327,879
|
$
|
16.04
|
277,713
|
$
|
13.60
|
||||||||||
Weighted-average
fair value of options granted during the nine-month periods ended
September 30
|
$
|
-
|
$
|
4.81
|
At
September 30, 2009, the vested options totaled 327,879 shares with a weighted
average exercise price of $16.04 per share and a weighted average remaining
contractual life of 3.86 years. The intrinsic value for the vested options as of
September 30, 2009, was $590 thousand. The intrinsic value for the total of all
options exercised during the nine months ended September 30, 2009, was $15
thousand, and the total fair value of shares vested during the nine months ended
September 30, 2009, was $715 thousand. At September 30, 2009, shares available
for issuance under the 2005 Long-Term Incentive Plan totaled
481,102.
No
options were granted during the first nine months of 2009. The fair value of the
stock options granted during 2008 was estimated utilizing the Black Scholes
valuation model. The fair value of a share of common stock on the grant date of
the 2008 options was $18.60. Significant assumptions include:
2008
|
|||||
Risk-free
interest rate
|
3.10%
|
||||
Expected
option life
|
6.4
years
|
||||
Expected
volatility
|
26.96%
|
||||
Expected
dividend yield
|
1.99%
|
The
option term of each award granted was based upon Heartland’s historical
experience of employees’ exercise behavior. Expected volatility was based upon
historical volatility levels and future expected volatility of Heartland’s
common stock. Expected dividend yield was based on a set dividend rate. Risk
free interest rate reflects the average of the yields on the 5-year and 7-year
zero coupon U.S. Treasury bond. Cash received from options exercised for the
nine months ended September 30, 2009, was $46 thousand, with a related tax
benefit of $2 thousand. Cash received from options exercised for the nine months
ended September 30, 2008, was $1.1 million, with a related tax benefit of $266
thousand.
Total
compensation costs recorded were $715 thousand and $876 thousand for the nine
months ended September 30, 2009 and 2008, respectively, for stock options,
restricted stock awards and shares to be issued under the 2006 Employee Stock
Purchase Plan. As of September 30, 2009, there was $1.7 million of total
unrecognized compensation costs related to the 2005 Long-Term Incentive Plan for
stock options and restricted stock awards which is expected to be recognized
through 2012.
Fair
Value Measurements
On
January 1, 2008, the Financial Accounting Standards Board (“FASB”) issued an
accounting standard related to fair value measurements. This accounting standard
defines fair value, establishes a framework for measuring fair value under U.S.
generally accepted accounting principles, and expands disclosures about fair
value measurements. This accounting standard applies to reported balances that
are required or permitted to be measured at fair value under existing accounting
pronouncements; accordingly, the standard does not require any new fair value
measurements of reported balances. Fair value is defined as the exchange price
that would be received to sell an asset or paid to transfer a liability in the
principal or most advantageous market for the asset or liability in an orderly
transaction between market participants on the measurement date. This accounting
standard clarifies that fair value should be based on the assumptions market
participants would use when pricing an asset or liability and establishes a fair
value hierarchy that prioritizes the information used to develop those
assumptions. The fair value hierarchy gives the highest priority to quoted
prices in active markets and the lowest priority to unobservable data. This
accounting standard requires fair value measurements to be separately disclosed
by level within the fair value hierarchy. Under this accounting standard,
Heartland bases fair values on the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. For assets and liabilities recorded at
fair value, it is Heartland’s policy to maximize the use of observable inputs
and minimize the use of unobservable inputs when developing fair value
measurements, in accordance with the fair value hierarchy in this
standard.
Fair
value measurements for assets and liabilities where there exists limited or no
observable market data, and therefore, are based primarily upon estimates, are
often calculated based upon current pricing policy, the economic and competitive
environment, the characteristics of the asset or liability and other such
factors. Therefore, the results cannot be determined with precision and may not
be realized in an actual sale or immediate settlement of the asset or liability.
Additionally, there may be inherent weaknesses in any calculation technique, and
changes in the underlying assumptions used, including discount rates and
estimates of future cash flows, could significantly affect the results of
current or future values. Additional information regarding disclosures of fair
value is presented in Note 7.
Heartland
now applies the fair value measurement and disclosure provisions of this
standard effective January 1, 2009, to nonfinancial assets and nonfinancial
liabilities measured on a nonrecurring basis. Heartland measures the fair value
of the following on a nonrecurring basis: (1) long-lived assets, (2) foreclosed
assets, (3) goodwill and other intangibles and (4) indefinite-lived
assets.
Effect
of New Financial Accounting Standards
Effective
for interim and annual periods ending after September 15, 2009, the FASB
Accounting Standards Codification (“Codification” or “ASC”) is the single source
of authoritative literature recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
accordance with U.S. generally accepted accounting principles (“GAAP”). The
Codification does not change current GAAP, but is intended to simplify user
access to all authoritative GAAP by providing all of the authoritative
literature related to a particular topic in one place. The Codification
supersedes all pre-existing accounting and reporting standards, excluding
separate rules and other interpretive guidance released by the Securities and
Exchange Commission. New accounting guidance is now issued in the form of
Accounting Standards Updates, which update the Codification. All guidance
contained in the Codification carries an equal level of authority. Heartland has
adopted the Codification in the period ending September 30, 2009, and as a
result has replaced references to standards that were issued prior to the
Codification with a description of the applicable accounting guidance. The
adoption of this accounting standard did not have any impact on Heartland’s
consolidated financial statements.
In
December 2007, the FASB issued ASC 805, “Business Combinations”, which
requires significant changes in the accounting and reporting for business
acquisitions. Among many changes under this accounting standard, an acquirer
will record 100 percent of all assets and liabilities at fair value at the
acquisition date with changes possibly recognized in earnings, and acquisition
related costs will be expensed rather than capitalized. ASC 805 applies
prospectively to business combinations for which the acquisition date is on or
after January 1, 2009. Heartland adopted this accounting standard on January 1,
2009, and, in the third quarter of 2009, applied its provisions to the assets
acquired and liabilities assumed related to the acquisition of The Elizabeth
State Bank. For a description of this acquisition, see Note 2.
In
December 2007, the FASB issued ASC 810, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 5”, which
establishes new accounting and reporting standards for the noncontrolling
interest in a subsidiary. Key changes under this accounting standard are that
noncontrolling interests in a subsidiary are to be reported as part of equity,
losses allocated to a noncontrolling interest can result in a deficit balance,
and changes in ownership interests that do not result in a change of control are
accounted for as equity transactions and upon a loss of control, the resultant
gain or loss is recognized and the remaining interest is remeasured at fair
value on the date control is lost. Effective January 1, 2009, this accounting
standard requires retroactive adoption of the presentation and disclosure
requirements for existing consolidated minority interests and prospective
application for any new minority interests. The presentation and disclosure
requirements of ASC 810 have been applied for the current period and
retrospectively for prior periods on Heartland’s accompanying consolidated
financial statements.
In March
2008, the FASB issued ASC 815, “Disclosures about Derivative
Instruments and Hedging Activities”, which changes the disclosure
requirements for derivative instruments and hedging activities. Entities are
required to provide enhanced disclosures about (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged items
are accounted for, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance and cash flows. ASC
815 is effective for all financial statements issued for fiscal years and
interim periods beginning after November 15, 2008. For further detail on
Heartland’s derivative instruments and hedging activities, see Note
6.
In
January 2009, the FASB issued ASC 325, “Amendments to the Impairment and
Interest Income Measurement Guidance of EITF issue No. 99-20”. ASC 325
amends the impairment guidance previously issued in order to achieve more
consistent determination of whether an other-than-temporary impairment (“OTTI”)
has occurred. This ASC amended previous guidance to more closely align the OTTI
guidance therein in ASC 320. Retrospective application to a prior interim or
annual period is prohibited. The implementation of ASC 325 in 2009 did not have
a material impact on Heartland’s consolidated financial statements.
In April
2009, the FASB issued an accounting standard which amended OTTI guidance in GAAP
for debt securities. This accounting standard revises the guidance for
determining whether an impairment is other than temporary for debt securities,
requires bifurcation of any other than temporary impairment between the amount
representing credit loss and the amount related to all other factors and
requires additional disclosures on other than temporary impairment of debt and
equity securities. This accounting standard was effective for interim and annual
reporting periods ending after June 15, 2009. Heartland adopted this accounting
standard for the period ended June 30, 2009. See Note 2 for the disclosures
required under this accounting standard, which was subsequently codified into
ASC 320, “Investments-Debt and
Equity Securities”.
In April
2009, the FASB issued an accounting standard related to disclosure about the
fair value of financial instruments in interim reporting periods of publicly
traded companies that were previously only required to be disclosed in annual
financial statements. Heartland adopted this standard for the period ended June
30, 2009. As this accounting standard amended only the disclosure requirements
about the fair value of financial statements in interim periods, the adoption
had no impact on Heartland’s consolidated financial statements. See Note 7 for
the disclosures required under this accounting standard, which was subsequently
codified into ASC Topic 825, “Financial
Instruments”.
In April
2009, the FASB issued an accounting standard which provides additional guidance
on estimating fair value when the volume and level of activity for an asset or
liability have significantly decreased in relation to normal market activity for
the asset or liability, provides guidance on circumstances that may indicate
that a transaction is not orderly and requires additional disclosures about fair
value measurements in annual and interim reporting periods. Heartland adopted
this accounting standard for the period ended June 30, 2009. The provisions in
this accounting standard were applied prospectively and did not result in
significant changes to Heartland’s valuation techniques. Furthermore, the
adoption of this accounting standard, which was subsequently codified into ASC
Topic 820, “Fair Value
Measurements and Disclosures”, did not have a material
impact on Heartland’s consolidated financial statements.
In May
2009, the FASB issued an accounting standard on reporting of subsequent events.
The objective of this standard is to establish general standards of accounting
for and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. In particular,
this accounting standard sets forth the period after the balance sheet date
during which management of a reporting entity should evaluate events or
transactions that may occur for potential recognition or disclosure in the
financial statements, the circumstances under which an entity should recognize
events or transactions occurring after the balance sheet date in its financial
statements and the disclosures that an entity should make about events or
transactions that occurred after the balance sheet date. This accounting
standard was subsequently codified into ASC Topic 855, “Subsequent Events”. This
accounting standard was effective for financial statements issued for interim
and annual periods ending after June 15, 2009, and did not have any impact on
Heartland’s consolidated financial statements. Heartland evaluated subsequent
events through the filing date of its quarterly 10-Q with the SEC on November 9,
2009.
In June
2009, the FASB issued an accounting standard which amends current GAAP related
to the accounting for transfers and servicing of financial assets and
extinguishments of liabilities, including the removal of the concept of a
qualifying special-purpose entity from GAAP. This new accounting standard also
clarifies that a transferor must evaluate whether it has maintained effective
control of a financial asset by considering its continuing direct or indirect
involvement with the transferred financial asset. This accounting standard is
effective as of the beginning of each reporting entity’s first annual reporting
period that begins after November 15, 2009, for interim periods within that
first annual reporting period and for interim and annual reporting periods
thereafter and is not anticipated to have any material impact on Heartland’s
consolidated financial statements.
In June 2009, the FASB issued an accounting standard which will require a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity for consolidation purposes. This accounting standard requires an enterprise to perform an analysis and ongoing reassessments to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity and amends certain guidance for determining whether an entity is a variable interest entity. It also requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. This accounting standard is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and for all interim reporting periods after that and is not anticipated to have any material impact on Heartland’s consolidated financial statements.
NOTE
2: ACQUISITION
On July
2, 2009, Heartland acquired all deposits of The Elizabeth State Bank in
Elizabeth, Illinois through its subsidiary Galena State Bank based in Galena,
Illinois in a whole bank loss sharing transaction facilitated by the FDIC. Bank
branches previously owned and operated by The Elizabeth State Bank reopened on
Monday, July 6, 2009, as Galena State Bank branches. As of July 2, 2009, The
Elizabeth State Bank had loans of $42.7 million and deposits of $49.3 million.
Galena State Bank paid a premium of 1.0 percent to acquire all of the deposits
of the failed bank. In addition to assuming all of the deposits of the failed
bank, Galena State Bank agreed to purchase $52.3 million of assets. The FDIC
retained the remaining assets for later disposition.
The
acquired loans and other real estate owned are covered by two loss share
agreements between the FDIC and Galena State Bank, which affords Galena State
Bank significant loss protection. Under the loss share agreements, the FDIC will
cover 80 percent of the covered loan and other real estate owned losses
(referred to as covered assets) up to $10 million and 95 percent of losses in
excess of that amount. The term for loss sharing on non-residential real estate
losses is five years with respect to losses and eight years with respect to
recoveries, while the term for loss sharing on residential real estate loans is
ten years with respect to losses and recoveries. The reimbursable losses from
the FDIC are based on the book value of the relevant loan as determined by the
FDIC at the date of the transaction. New loans made after that date are not
covered by the loss share agreements.
Galena
State Bank received a $2.5 million discount on the assets acquired and paid a
1.0 percent deposit premium. The expected reimbursements under the loss share
agreements were recorded as an indemnification asset at the estimated fair value
of $4.4 million at the acquisition date. The estimated fair value of the loans
acquired was $37.8 million and the estimated fair value of the deposits assumed
was $49.5 million. In addition, a core deposit intangible of $200 thousand was
recorded. An acquisition gain totaling $998 thousand resulted from the
acquisition and is included as a component of noninterest income on the
statement of income. The amount of the gain is equal to the amount by which the
fair value of the liabilities assumed exceeded the fair value of the assets
purchased.
The
Elizabeth State Bank acquisition was accounted for under the acquisition method
of accounting in accordance with ASC 805, “Business Combinations”.
Purchased loans acquired in a business combination, which include loans
purchased in The Elizabeth State Bank acquisition, are recorded at estimated
fair value on their purchase date, but the purchaser can not carryover the
related allowance for loan and lease losses. Purchased loans are accounted for
under ASC 310-30, “Loans and
Debt Securities with Deteriorated Credit Quality”, when the loans have
evidence of credit deterioration since origination and it is probable at the
date of the acquisition that Heartland will not collect all contractually
required principal and interest payments. Evidence of credit quality
deterioration at the purchase date included statistics such as past due and
nonaccrual status. Generally, acquired loans that meet Heartland’s definition
for nonaccrual status fall within the scope of ASC 310-30. The difference
between contractually required payments at acquisition and the cash flows
expected to be collected at acquisition is referred to as the nonaccretable
difference which is included in the carrying value of the loans. Subsequent
decreases to the expected cash flows will generally result in a provision for
loan and lease losses. Subsequent increases in cash flows result in a reversal
of the provision for loan and lease losses to the extent of prior charges, or a
reclassification of the difference from nonaccretable to accretable with a
positive impact on interest income. Further, any excess of cash flows expected
at acquisition over the estimated fair value is referred to as the accretable
yield and is recognized into interest income over the remaining life of the loan
when there is a reasonable expectation about the amount and timing of such cash
flows.
The
carrying amount of the covered loans at September 30, 2009, consisted of
impaired and nonimpaired loans purchased and are summarized in the following
table:
(Dollars
in thousands)
|
||||||||||||
Impaired
Purchased Loans
|
Non
Impaired Purchased Loans
|
Total
Covered Loans
|
||||||||||
Commercial
and commercial real estate
|
$
|
6,329
|
$
|
7,664
|
$
|
13,993
|
||||||
Residential
mortgage
|
560
|
11,778
|
12,338
|
|||||||||
Agricultural
and agricultural real estate
|
600
|
5,334
|
5,934
|
|||||||||
Consumer
loans
|
1,238
|
2,672
|
3,910
|
|||||||||
Total
Covered Loans
|
$
|
8,727
|
$
|
27,448
|
$
|
36,175
|
On the
acquisition date, the preliminary estimate of the contractually required
payments receivable for all ASC 310-30 loans acquired in the acquisition was
$13.8 million and the estimated fair value of the loans were $9.0
million. At September 30, 2009, a majority of these loans were valued based upon
the liquidation value of the underlying collateral, because the expected cash
flows are primarily based on the liquidation of underlying collateral and the
timing and amount of the cash flows could not be reasonably estimated. There was
no allowance for loan and lease losses related to these ASC 310-30 loans at
September 30, 2009.
On the
acquisition date, the preliminary estimate of the contractually required
payments receivable for all non ASC 310-30 loans acquired in the acquisition was
$28.9 million and the estimated fair value of the loans was $28.7
million.
NOTE
3: SECURITIES
The
amortized cost, gross unrealized gains and losses and estimated fair values of
available for sale securities as of September 30, 2009 and December 31, 2008 are
summarized in the tables below, in thousands:
Amortized
Cost
|
Gross
Unrealized Gains
|
Gross
Unrealized Losses
|
Estimated
Fair Value
|
|||||||||||||
September
30, 2009
|
||||||||||||||||
Securities
available for sale:
|
||||||||||||||||
U.S.
government corporations and agencies
|
$
|
277,269
|
$
|
2,698
|
$
|
(149
|
)
|
$
|
279,818
|
|||||||
Mortgage-backed
securities
|
565,253
|
11,761
|
(7,698
|
)
|
569,316
|
|||||||||||
Obligations
of states and political subdivisions
|
183,966
|
9,106
|
(176
|
)
|
192,896
|
|||||||||||
Corporate
debt securities
|
4,430
|
40
|
(4
|
)
|
4,466
|
|||||||||||
Total
debt securities
|
1,030,918
|
23,605
|
(8,027
|
)
|
1,046,496
|
|||||||||||
Equity
securities
|
30,644
|
540
|
(52
|
)
|
31,132
|
|||||||||||
Total
|
$
|
1,061,562
|
$
|
24,145
|
$
|
(8,079
|
)
|
$
|
1,077,628
|
Amortized
Cost
|
Gross
Unrealized Gains
|
Gross
Unrealized Losses
|
Estimated
Fair Value
|
|||||||||||||
December
31, 2008
|
||||||||||||||||
Securities
available for sale:
|
||||||||||||||||
U.S.
government corporations and agencies
|
$
|
190,599
|
$
|
4,832
|
$
|
(75
|
)
|
$
|
195,356
|
|||||||
Mortgage-backed
securities
|
505,711
|
4,688
|
(16,409
|
)
|
493,990
|
|||||||||||
Obligations
of states and political subdivisions
|
145,534
|
4,230
|
(981
|
)
|
148,783
|
|||||||||||
Corporate
debt securities
|
4,479
|
185
|
-
|
4,664
|
||||||||||||
Total
debt securities
|
846,323
|
13,935
|
(17,465
|
)
|
842,793
|
|||||||||||
Equity
securities
|
28,820
|
73
|
-
|
28,893
|
||||||||||||
Total
|
$
|
875,143
|
$
|
14,008
|
$
|
(17,465
|
)
|
$
|
871,686
|
The
amortized cost, gross unrealized gains and losses and estimated fair values of
held to maturity securities as of September 30, 2009 and December 31, 2008 are
summarized in the tables below, in thousands:
Amortized
Cost
|
Gross
Unrealized Gains
|
Gross
Unrealized Losses
|
Estimated
Fair Value
|
||||||||||||||
September
30, 2009
|
|||||||||||||||||
Securities
held to maturity:
|
|||||||||||||||||
Mortgage-backed
securities
|
$
|
12,316
|
$
|
40
|
$
|
(1,659
|
)
|
$
|
10,697
|
||||||||
Obligations
of states and political subdivisions
|
15,044
|
-
|
(16
|
)
|
15,028
|
||||||||||||
Total
|
$
|
27,360
|
$
|
40
|
$
|
(1,675
|
)
|
$
|
25,725
|
Amortized
Cost
|
Gross
Unrealized Gains
|
Gross
Unrealized Losses
|
Estimated
Fair Value
|
||||||||||||||
December
31, 2008
|
|||||||||||||||||
Securities
held to maturity:
|
|||||||||||||||||
Mortgage-backed
securities
|
$
|
15,511
|
$
|
57
|
$
|
(4,108
|
)
|
$
|
11,460
|
||||||||
Obligations
of states and political subdivisions
|
14,814
|
60
|
(8
|
)
|
14,866
|
||||||||||||
Total
|
$
|
30,325
|
$
|
117
|
$
|
(4,116
|
)
|
$
|
26,326
|
More than
75 percent of Heartland’s mortgage-backed securities are issuances of
government-sponsored enterprises.
The
following tables summarize, in thousands, the amount of unrealized losses,
defined as the amount by which cost or amortized cost exceeds fair value, and
the related fair value of investments with unrealized losses in Heartland’s
securities portfolio as of September 30, 2009 and December 31, 2008. The
investments were segregated into two categories: those that have been in a
continuous unrealized loss position for less than 12 months and those that have
been in a continuous unrealized loss position for 12 or more months. The
reference point for determining how long an investment was in an unrealized loss
position was September 30, 2008 and December 31, 2007,
respectively.
Unrealized
Losses on Securities Available for Sale
September
30, 2009
|
|||||||||||||||||||||
Less
than 12 months
|
12
months or longer
|
Total
|
|||||||||||||||||||
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
||||||||||||||||
U.S.
government corporations and agencies
|
$
|
23,615
|
$
|
(149
|
)
|
$
|
-
|
$
|
-
|
$
|
23,615
|
$
|
(149
|
)
|
|||||||
Mortgage-backed
securities
|
88,473
|
(1,788
|
)
|
44,276
|
(5,910
|
)
|
132,749
|
(7,698
|
)
|
||||||||||||
Obligations
of states and political subdivisions
|
4,818
|
(105
|
)
|
3,193
|
(71
|
)
|
8,011
|
(176
|
)
|
||||||||||||
Corporate
debt securities
|
1,937
|
(4
|
)
|
-
|
-
|
1,937
|
(4
|
)
|
|||||||||||||
Total
debt securities
|
118,843
|
(2,046
|
)
|
47,469
|
(5,981
|
)
|
166,312
|
(8,027
|
)
|
||||||||||||
Equity
securities
|
998
|
(52
|
)
|
-
|
-
|
998
|
(52
|
)
|
|||||||||||||
Total
temporarily impaired securities
|
$
|
119,841
|
$
|
(2,098
|
)
|
$
|
47,469
|
$
|
(5,981
|
)
|
$
|
167,310
|
$
|
(8,079
|
)
|
Unrealized
Losses on Securities Available for Sale
December
31, 2008
|
|||||||||||||||||||||
Less
than 12 months
|
12
months or longer
|
Total
|
|||||||||||||||||||
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
||||||||||||||||
U.S.
government corporations and agencies
|
$
|
18,022
|
$
|
(75
|
)
|
$
|
-
|
$
|
-
|
$
|
18,022
|
$
|
(75
|
)
|
|||||||
Mortgage-backed
securities
|
231,056
|
(8,820
|
)
|
31,366
|
(7,589
|
)
|
262,422
|
(16,409
|
)
|
||||||||||||
Obligations
of states and political subdivisions
|
32,280
|
(981
|
)
|
-
|
-
|
32,280
|
(981
|
)
|
|||||||||||||
Corporate
debt securities
|
-
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||||
Total
debt securities
|
281,358
|
(9,876
|
)
|
31,366
|
(7,589
|
)
|
312,724
|
(17,465
|
)
|
||||||||||||
Equity
securities
|
-
|
-
|
-
|
-
|
-
|
-
|
|||||||||||||||
Total
temporarily impaired securities
|
$
|
281,358
|
$
|
(9,876
|
)
|
$
|
31,366
|
$
|
(7,589
|
)
|
$
|
312,724
|
$
|
(17,465
|
)
|
A
majority of the unrealized losses on Heartland’s mortgage-backed securities are
the result of changes in market interest rates or widening of market spreads
subsequent to the initial purchase of the securities and not related to concerns
regarding the underlying credit of the issuers or the underlying collateral. It
is expected that the securities will not be settled at a price less than the
amortized cost of the investment. Because the decline in fair value is
attributable to changes in interest rates or widening market spreads and not
credit quality, and because Heartland has the ability to hold these investments
until a market price recovery or to maturity, the unrealized losses on these
investments are not considered other-than-temporarily impaired. Heartland does
not intend to sell, nor does it anticipate that it will be required to sell, any
of its mortgage-backed securities in an unrealized loss position.
A
majority of the unrealized losses on Heartland’s obligations of states and
political subdivisions are the result of changes in market interest rates or
widening of market spreads subsequent to the initial purchase of the securities.
Management monitors the published credit ratings of these securities and has
noted credit rating reductions in a number of these securities, primarily due to
the downgrade in the credit ratings of the insurance companies providing credit
enhancement to that of the issuing municipalities. In nearly all cases, the
municipalities themselves have not experienced adverse ratings changes since the
date of purchase. Because the decline in fair value is attributable to changes
in interest rates or widening market spreads and not underlying credit quality,
and because Heartland has the ability to hold these investments until a market
price recovery or to maturity, the unrealized losses on these investments are
not considered other-than-temporarily impaired. Heartland does not intend to
sell, nor does it anticipate that it will be required to sell, any of its
municipal securities in an unrealized loss position.
NOTE
4: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS
The gross
carrying amount of intangible assets and the associated accumulated amortization
at September 30, 2009, and December 31, 2008, are presented in the table below,
in thousands:
September
30, 2009
|
December
31, 2008
|
|||||||||||||||
Gross
Carrying Amount
|
Accumulated
Amortization
|
Gross
Carrying Amount
|
Accumulated
Amortization
|
|||||||||||||
Amortized
intangible assets:
|
||||||||||||||||
Core deposit
intangibles
|
$
|
9,957
|
$
|
7,683
|
$
|
9,757
|
$
|
7,092
|
||||||||
Mortgage servicing
rights
|
12,268
|
3,213
|
7,799
|
3,233
|
||||||||||||
Customer relationship
intangible
|
1,177
|
405
|
1,177
|
329
|
||||||||||||
Total
|
$
|
23,402
|
$
|
11,301
|
$
|
18,733
|
$
|
10,654
|
||||||||
Unamortized
intangible assets
|
$
|
12,101
|
$
|
8,079
|
Projections
of amortization expense for mortgage servicing rights are based on existing
asset balances and the existing interest rate environment as of September 30,
2009. Heartland’s actual experience may be significantly different depending
upon changes in mortgage interest rates and market conditions. There was no
valuation allowance on mortgage servicing rights at September 30, 2009, or
December 31, 2008. The fair value of Heartland’s mortgage servicing rights was
estimated at $11.2 million and $6.2 million at September 30, 2009, and December
31, 2008, respectively.
The
following table shows the estimated future amortization expense for amortized
intangible assets, in thousands:
Core
Deposit
Intangibles
|
Mortgage
Servicing
Rights
|
Customer
Relationship
Intangible
|
Total
|
|||||||||||||
Three
months ending December 31, 2009
|
$
|
190
|
$
|
554
|
$
|
25
|
$
|
769
|
||||||||
Year
ending December 31,
|
||||||||||||||||
2010
|
518
|
2,429
|
101
|
3,048
|
||||||||||||
2011
|
493
|
2,024
|
99
|
2,616
|
||||||||||||
2012
|
456
|
1,619
|
55
|
2,130
|
||||||||||||
2013
|
429
|
1,214
|
45
|
1,688
|
||||||||||||
2014
|
188
|
810
|
43
|
1,041
|
||||||||||||
Thereafter
|
-
|
405
|
404
|
809
|
The
following table summarizes, in thousands, the changes in capitalized mortgage
servicing rights:
2009
|
2008
|
|||||||
Balance
at January 1
|
$
|
4,566
|
$
|
3,912
|
||||
Originations
|
7,454
|
1,976
|
||||||
Amortization
|
(2,965
|
)
|
(1,305
|
)
|
||||
Balance
at September 30
|
$
|
9,055
|
$
|
4,583
|
NOTE
5: SHORT-TERM BORROWINGS
On
September 28, 2009, Heartland established a $15.0 million revolving credit line
with an unaffiliated bank primarily to provide working capital to Heartland.
This credit line may also be used to fund the operations of Heartland Community
Development, Inc., a wholly-owned subsidiary of Heartland. At September
30, 2009, $5.0 million was outstanding on this revolving credit line. The
agreement on this credit line contains specific financial covenants described
below, all of which Heartland was in compliance with as of September 30,
2009:
*
|
Heartland
will maintain regulatory capital at well capitalized levels and Citizens
Finance Co. will maintain a tangible net worth to total assets ratio of 14
percent, measured quarterly.
|
*
|
Citizens
Finance Co. will maintain a net charge-off ratio not to exceed 5.00
percent based upon the trailing four quarters, measured
quarterly.
|
*
|
Heartland
will inform the lender of any material regulatory non-compliance or
written agreement concerning Heartland or any of its
subsidiaries.
|
*
|
Within
thirty days after the end of each quarter, Heartland will provide a
certificate signed by the chief financial officer certifying compliance
with the covenants established under the credit
agreement.
|
NOTE 6: DERIVATIVE FINANCIAL INSTRUMENTS
On
occasion, Heartland uses derivative financial instruments as part of its
interest rate risk management, including interest rate swaps, caps, floors and
collars. Heartland’s objectives in using derivatives are to add stability to its
net interest margin and to manage its exposure to movements in interest
rates.
To reduce
the potentially negative impact a downward movement in interest rates would have
on its interest income, Heartland entered into the following two transactions.
On April 4, 2006, Heartland entered into a three-year interest rate collar
transaction with a notional amount of $50.0 million. The collar was effective on
April 4, 2006, and matured on April 4, 2009. Heartland was the payer on prime at
a cap strike rate of 8.95% and the counterparty was the payer on prime at a
floor strike rate of 7.00%. As of December 31, 2008, the fair market value of
this collar transaction was recorded as an asset of $636 thousand.
On
September 19, 2005, Heartland entered into a five-year interest rate collar
transaction on a notional amount of $50.0 million. The collar has an effective
date of September 21, 2005, and a maturity date of September 21, 2010. Heartland
is the payer on prime at a cap strike rate of 9.00% and the counterparty is the
payer on prime at a floor strike rate of 6.00%. As of September 30, 2009, and
December 31, 2008, the fair market value of this collar transaction was recorded
as an asset of $1.3 million and $2.1 million, respectively.
For
accounting purposes, the two collar transactions above are designated as cash
flow hedges of the overall changes in the cash flows above and below the collar
strike rates associated with interest payments on certain of Heartland’s
prime-based loans that reset whenever prime changes. The hedged transactions for
the two hedging relationships are designated as the first prime-based interest
payments received by Heartland each calendar month during the term of the collar
that, in aggregate for each period, are interest payments on principal from
specified portfolios equal to the notional amount of the collar.
Prepayments
in the hedged loan portfolios are treated in a manner consistent with the
guidance in SFAS 133 Implementation Issue No. G25, Cash Flow Hedges: Using the
First-Payments-Received Technique in Hedging the Variable Interest Payments on a
Group of Non-Benchmark-Rate-Based Loans, which allows the designated forecasted
transactions to be the variable, prime-rate-based interest payments on a rolling
portfolio of prepayable interest-bearing loans using the first-payments-received
technique, thereby allowing interest payments from loans that prepay to be
replaced with interest payments from new loan originations. Based on Heartland’s
assessments, both at inception and throughout the life of the hedging
relationship, it is probable that sufficient prime-based interest receipts will
exist through the maturity dates of the collars.
To reduce
the potentially negative impact an upward movement in interest rates would have
on its net interest income, Heartland entered into the following four cap
transactions. For accounting purposes, these four cap transactions were
designated as cash flow hedges of the changes in cash flows attributable to
changes in LIBOR, the benchmark interest rate being hedged, above the cap strike
rate associated with the interest payments made on $65.0 million of Heartland’s
subordinated debentures (issued in connection with the trust preferred
securities of Heartland Financial Statutory Trust IV, V and VII) that reset
quarterly on a specified reset date. At inception, Heartland asserted that the
underlying principal balance will remain outstanding throughout the hedge
transaction making it probable that sufficient LIBOR-based interest payments
will exist through the maturity date of the caps.
The first
transaction executed was a twenty-three month interest rate cap transaction on a
notional amount of $20.0 million. The cap had an effective date of February 1,
2007, and matured on January 7, 2009. Should 3-month LIBOR have exceeded 5.5% on
a reset date, the counterparty would have paid Heartland the amount of interest
that exceeded the amount owed on the debt at the cap LIBOR rate of 5.5%. The
floating-rate subordinated debentures contained an interest deferral feature
that was mirrored in the cap transaction. As of December 31, 2008, this cap
transaction had no fair value.
The
second transaction executed on February 1, 2007, was a twenty-five month
interest rate cap transaction on a notional amount of $25.0 million to reduce
the potentially negative impact an upward movement in interest rates would have
on its net interest income. The cap had an effective date of February 1, 2007,
and matured on March 17, 2009. Should 3-month LIBOR have exceeded 5.5% on a
reset date, the counterparty would have paid Heartland the amount of interest
that exceeded the amount owed on the debt at the cap LIBOR rate of 5.5%. The
floating-rate subordinated debentures contained an interest rate deferral
feature that was mirrored in the cap transaction. As of December 31, 2008, this
cap transaction had no fair value.
The third
transaction executed on January 15, 2008, was a fifty-five month interest rate
cap transaction on a notional amount of $20.0 million to reduce the potentially
negative impact an upward movement in interest rates would have on its net
interest income. The cap has an effective date of January 15, 2008, and a
maturity date of September 1, 2012. Should 3-month LIBOR exceed 5.12% on a reset
date, the counterparty will pay Heartland the amount of interest that exceeds
the amount owed on the debt at the cap LIBOR rate of 5.12%. The floating-rate
subordinated debentures contain an interest rate deferral feature that is
mirrored in the cap transaction. As of September 30, 2009, and December 31,
2008, the fair market value of this cap transaction was recorded as an asset of
$98 thousand and $46 thousand, respectively. Upon the execution of the second
swap transaction discussed below, this cap transaction was converted to a mark
to market hedge. During the first nine months of 2009, the mark to market
adjustment on this cap transaction was recorded as a gain of $52
thousand.
The
fourth transaction executed on March 27, 2008, was a twenty-eight month interest
rate cap transaction on a notional amount of $20.0 million to reduce the
potentially negative impact an upward movement in interest rates would have on
its net interest income. The cap has an effective date of January 7, 2009, and a
maturity date of April 7, 2011. Should 3-month LIBOR exceed 5.5% on a reset
date, the counterparty will pay Heartland the amount of interest that exceeds
the amount owed on the debt at the cap LIBOR rate of 5.5%. The floating-rate
subordinated debentures contain an interest rate deferral feature that is
mirrored in the cap transaction. As of September 30, 2009, and December 31,
2008, the fair market value of this cap transaction was recorded as an asset of
$9 thousand and $8 thousand, respectively. Upon the execution of the third swap
transaction discussed below, this cap transaction was converted to a mark to
market hedge. During the first nine months of 2009, the mark to market
adjustment on this cap transaction was recorded as a gain of $1
thousand.
In
addition to the four cap transactions, Heartland entered into the following
three forward-starting interest rate swap transactions to effectively convert
$65.0 million of its variable interest rate subordinated debentures (issued in
connection with the trust preferred securities of Heartland Financial Statutory
Trust IV, V and VII) to fixed interest rate debt. For accounting purposes, these
three swap transactions are designated as cash flow hedges of the changes in
cash flows attributable to changes in LIBOR, the benchmark interest rate being
hedged, associated with the interest payments made on $65.0 million of
Heartland’s subordinated debentures (issued in connection with the trust
preferred securities of Heartland Financial Statutory Trust IV, V and VII) that
reset quarterly on a specified reset date. At inception, Heartland asserted that
the underlying principal balance will remain outstanding throughout the hedge
transaction making it probable that sufficient LIBOR-based interest payments
will exist through the maturity date of the swaps.
The first
swap transaction was executed on January 28, 2009, on a notional amount of $25.0
million with an effective date of March 17, 2010, and an expiration date of
March 17, 2014. Under this interest rate swap contract, Heartland will pay a
fixed interest rate of 2.58% and receive a variable interest rate equal to
3-month LIBOR. As of September 30, 2009, the fair value of this swap transaction
was recorded as an asset of $89 thousand.
The
second swap transaction was executed on February 4, 2009, on a notional amount
of $20.0 million with an effective date of January 7, 2010, and an expiration
date of January 7, 2020. Under this interest rate swap contract, Heartland will
pay a fixed interest rate of 3.35% and receive a variable interest rate equal to
3-month LIBOR. As of September 30, 2009, the fair value of this swap transaction
was recorded as an asset of $207 thousand.
The third
swap transaction was executed on February 4, 2009, on a notional amount of $20.0
million with an effective date of March 1, 2010, and an expiration date of March
1, 2017. Under this interest rate swap contract, Heartland will pay a fixed
interest rate of 3.22% and receive a variable interest rate equal to 3-month
LIBOR. As of September 30, 2009, the fair value of this swap transaction was
recorded as an asset of $44 thousand.
For the
collar, cap and swap transactions described above, the effective portion of
changes in the fair values of the derivatives is initially reported in other
comprehensive income (outside of earnings) and subsequently reclassified to
earnings (interest income on loans or interest expense on borrowings) when the
hedged transactions affect earnings. Ineffectiveness resulting from the hedging
relationship, if any, is recorded as a gain or loss in earnings as part of
noninterest income. Heartland uses the “Hypothetical Derivative Method”
described in SFAS 133 Implementation Issue No. G20, Cash Flow Hedges: Assessing
and Measuring the Effectiveness of a Purchased Option Used in a Cash Flow Hedge,
for its quarterly prospective and retrospective assessments of hedge
effectiveness, as well as for measurements of hedge ineffectiveness. All
components of the derivative instruments’ change in fair value were included in
the assessment of hedge effectiveness. No ineffectiveness was recognized for the
cash flow hedge transactions for the nine months ended September 30, 2008 and
2009.
At the
inception of the September 19, 2005 collar transaction, Heartland designated
separate proportions of the $50.0 million collar in qualifying cash flow hedging
relationships. Designation of a proportion of a derivative instrument is
discussed in paragraph 18 of SFAS No. 133 (as amended), Accounting for
Derivative Instruments and Hedging Activities, which states that “Either all or
a proportion of a derivative may be designated as the hedging instrument. The
proportion must be expressed as a percentage of the entire derivative so that
the profile of risk exposures in the hedging portion of the derivative is the
same as that in the entire derivative.” Consistent with that guidance, Heartland
identified four different proportions of the $50.0 million collar and documented
four separate hedging relationships based on those proportions. Although only
one collar was executed with an external party, Heartland established four
distinct hedging relationships for various proportions of the collar and
designated them against hedged transactions specifically identified at each of
four different subsidiary banks. Because each proportion of the collar was
designated against hedged transactions specified at different subsidiary banks,
the hedging relationship for one proportion of the collar could fail hedge
accounting (or have hedge ineffectiveness), without affecting the separate
hedging relationships established for other proportions of the collar that were
designated against hedged transactions at other subsidiary banks. Effectiveness
of each hedging relationship is assessed and measured independently of the other
hedging relationships.
A portion
of the September 19, 2005 collar transaction did not meet the retrospective
hedge effectiveness test at March 31, 2008. The failure was on a portion of the
$50.0 million notional amount. That portion, $14.3 million, was designated as a
cash flow hedge of the overall changes in the cash flows above and below the
collar strike rates associated with interest payments on certain of Dubuque Bank
and Trust Company’s prime-based loans. The failure of this hedge relationship
was caused by paydowns, which reduced the designated loan pool from $14.3
million to $9.6 million. This hedge failure resulted in the recognition of a
gain of $198 thousand during the quarter ended March 31, 2008, which consists of
the mark to market gain on this portion of the collar transaction of $212
thousand and a reclass of unrealized losses out of other comprehensive income to
earnings of $14 thousand. During the second quarter of 2008, the mark to market
adjustment on this portion of the collar transaction was recorded as a loss of
$18 thousand. During the first nine months of 2009, the mark to market
adjustment on this portion of the collar transaction was recorded as a loss of
$213 thousand.
A portion
of the September 19, 2005 collar transaction also did not meet the retrospective
hedge effectiveness test at June 30, 2007. The failure was on a portion of the
$50.0 million notional amount. That portion, $14.3 million, was designated as a
cash flow hedge of the overall changes in the cash flows above and below the
collar strike rates associated with interest payments on certain of Rocky
Mountain Bank’s prime-based loans. The failure of this hedge relationship was
caused by the sale of its Broadus branch, which reduced the designated loan pool
from $14.3 million to $7.5 million. On August 17, 2007, the $14.3 million
portion of the September 19, 2005, collar transaction was redesignated and met
the requirements for hedge accounting treatment. The fair value of this portion
of the collar transaction was zero on the redesignation date. The redesignated
collar transaction did not meet the retrospective hedge effectiveness test at
December 31, 2008. The failure of the redesignated hedge was caused by paydowns,
which reduced the redesignated loan pool from $14.3 million to $10.4 million.
During the first nine months of 2009, the mark to market adjustment on this
portion of the collar transaction was recorded as a loss of $215
thousand.
An
additional portion of the September 19, 2005 collar transaction did not meet the
retrospective hedge effectiveness test at March 31, 2009. The failure was on a
portion of the $50.0 million notional amount. That portion, $14.3 million, was
designated as a cash flow hedge of the overall changes in the cash flows above
and below the collar strike rates associated with interest payments on certain
of New Mexico Bank & Trust’s prime-based loans. The failure of this hedge
relationship was caused by paydowns, which reduced the designated loan pool from
$14.3 million to $11.6 million. This hedge failure resulted in the recognition
of a gain of $68 thousand during the first quarter of 2009, which consists of
the mark to market loss on this portion of the collar transaction of $64
thousand and a reclass of unrealized gains out of other comprehensive income to
earnings of $132 thousand. During the second and third quarters of 2009, the
mark to market adjustment on this collar transaction was recorded as a loss of
$149 thousand.
The final
portion of the September 19, 2005 collar transaction did not meet the
retrospective hedge effectiveness test at June 30, 2009. The failure was on a
portion of the $50.0 million notional amount. That portion, $7.2 million, was
designated as a cash flow hedge of the overall changes in the cash flows above
and below the collar strike rates associated with interest payments on certain
of Wisconsin Community Bank’s prime-based loans. The failure of this hedge
relationship was caused by paydowns, which reduced the designated loan pool from
$7.2 million to $4.8 million. This hedge failure resulted in the recognition of
a loss of $68 thousand during the second quarter of 2009, which consists of the
mark to market loss on this portion of the collar transaction of $41 thousand
and a reclass of unrealized losses out of other comprehensive income to earnings
of $27 thousand. During the third quarter of 2009, the mark to market adjustment
on this collar transaction was recorded as a loss of $30 thousand.
For the
nine months ended September 30, 2009, the change in net unrealized losses of
$813 thousand for derivatives designated as cash flow hedges is separately
disclosed in the statement of changes in stockholders’ equity, before income
taxes of $308 thousand. For the nine months ended September 30, 2008, the change
in net unrealized gains of $563 thousand for derivatives designated as cash flow
hedges is separately disclosed in the statement of changes in shareholders’
equity, before income taxes of $203 thousand.
Amounts
reported in accumulated other comprehensive income related to derivatives will
be reclassified to interest income or expense as interest payments are received
or made on Heartland’s variable-rate assets and liabilities. For the nine months
ended September 30, 2009, the change in net unrealized gains on cash flow hedges
reflects a reclassification of $108 thousand of net unrealized losses from
accumulated other comprehensive income to interest income or interest expense.
For the next twelve months, Heartland estimates that an additional $65 thousand
will be reclassified from accumulated other comprehensive income to interest
income.
Cash
payments received on the two collar transactions totaled $886 thousand during
the first nine months of 2008 and $1.7 million during the first nine months of
2009.
By using
derivatives, Heartland is exposed to credit risk if counterparties to derivative
instruments do not perform as expected. Heartland minimizes this risk by
entering into derivative contracts with large, stable financial institutions and
Heartland has not experienced any losses from counterparty nonperformance on
derivative instruments. Furthermore, Heartland also periodically monitors
counterparty credit risk in accordance with the provisions of SFAS
133.
NOTE
7: FAIR VALUE
Heartland
utilizes fair value measurements to record fair value adjustments to certain
assets and liabilities and to determine fair value disclosures. Securities
available for sale, trading securities and derivatives are recorded at fair
value on a recurring basis. Additionally, from time to time, Heartland may be
required to record at fair value other assets on a non-recurring basis such as
loans held for sale, loans held to maturity and certain other assets including,
but not limited to, mortgage servicing rights. These nonrecurring fair value
adjustments typically involve application of lower of cost or market accounting
or write-downs of individual assets.
Fair
Value Hierarchy
Under ASC
820, assets and liabilities are grouped at fair value in three levels, based on
the markets in which the assets and liabilities are traded and the reliability
of the assumptions used to determine fair value. These levels are:
Level 1 -
Valuation is based upon quoted prices for identical instruments in active
markets.
Level 2 -
Valuation is based upon quoted prices for similar instruments in active markets,
or similar instruments in markets that are not active, and model-based valuation
techniques for all significant assumptions are observable in the
market.
Level 3 -
Valuation is generated from model-based techniques that use at least one
significant assumption not observable in the market. These unobservable
assumptions reflect estimates of assumptions that market participants would use
in pricing the asset or liability. Valuation techniques include use of option
pricing models, discounted cash flow models and similar techniques.
The
following is a description of valuation methodologies used for assets recorded
at fair value and for estimation of fair value for financial instruments not
recorded at fair value.
Assets
Securities
Available for Sale
Securities
available for sale are recorded at fair value on a recurring basis. Fair value
measurement is based upon quoted prices, if available. If quoted prices are not
available, fair values are measured using independent pricing models or other
model-based valuation techniques such as the present value of future cash flows,
adjusted for the security’s credit rating, prepayment assumptions and other
factors such as credit loss assumptions. Level 1 securities include those traded
on an active exchange, such as the New York Stock Exchange, as well as U.S.
Treasury and other U.S. government and agency securities that are traded by
dealers or brokers in active over-the-counter markets. Level 2 securities
include agency mortgage-backed securities and private collateralized mortgage
obligations, municipal bonds and corporate debt securities. The Level 3
securities consist primarily of $2.6 million of Z tranche assets.
Trading
Assets
Trading
assets are recorded at fair value and consist of securities held for trading
purposes. The valuation method for trading securities is the same as the
methodology used for securities classified as available for sale.
Loans
Held for Sale
Loans
held for sale are carried at the lower of cost or fair value. The fair value of
loans held for sale is based on what secondary markets are currently offering
for portfolios with similar characteristics. As such, Heartland classifies loans
held for sale subjected to nonrecurring fair value adjustments as Level
2.
Loans
Held to Maturity
Heartland
does not record loans at fair value on a recurring basis. However, from time to
time, a loan is considered impaired and an allowance for loan losses is
established. Loans for which it is probable that payment of interest and
principal will not be made in accordance with the contractual terms of the loan
agreement are considered impaired. Under Heartland’s credit policies, all
nonaccrual loans are defined as impaired loans. Once a loan is identified as
individually impaired, management measures impairment in accordance with ASC
310, Accounting by Creditors
for Impairment of a Loan. Loan impairment is measured based on the
present value of expected future cash flows discounted at the loan’s effective
interest rate, except where more practical, at the observable market price of
the loan or the fair value of the collateral if the loan is collateral
dependent. Heartland’s allowance methodology requires specific reserves for all
impaired loans. At September 30, 2009, substantially all of the total impaired
loans were based on the fair value of the collateral. In accordance with ASC
820, impaired loans where an allowance is established based on the fair value of
collateral require classification in the fair value hierarchy. When the fair
value of the collateral is based on an observable market price or a current
appraised value, Heartland records the impaired loan as nonrecurring Level 2.
When an appraised value is not available or management determines the fair value
of the collateral is further impaired below the appraised value and there is no
observable market price, Heartland records the impaired loan as nonrecurring
Level 3.
Derivative
Financial Instruments
Currently,
Heartland uses interest rate caps, floors, collars and swaps to manage its
interest rate risk. The valuation of these instruments is determined using
widely accepted valuation techniques including discounted cash flow analysis on
the expected cash flows of each derivative. This analysis reflects the
contractual terms of the derivatives, including the period to maturity, and uses
observable market-based inputs, including interest rate curves and implied
volatilities. The fair values of interest rate options are determined using the
market standard methodology of discounting the future expected cash
receipts that would occur if variable interest rates fell below (rise above) the
strike rate of the floors (caps). The variable interest rates used in the
calculation of projected receipts on the floor (cap) are based on an expectation
of future interest rates derived from observable market interest rate curves and
volatilities. To comply with the provisions of ASC 820, Heartland
incorporates credit valuation adjustments to appropriately reflect both its own
nonperformance risk and the respective counterparty’s nonperformance risk in the
fair value measurements. In adjusting the fair value of its derivative contracts
for the effect of nonperformance risk, Heartland has considered the impact of
netting any applicable credit enhancements, such as collateral postings,
thresholds, mutual puts, and guarantees.
Although
Heartland has determined that the majority of the inputs used to value its
derivatives fall within Level 2 of the fair value hierarchy, the credit
valuation adjustments associated with its derivatives utilize Level 3 inputs,
such as estimates of current credit spreads to evaluate the likelihood of
default by itself and its counterparties. However, as of September 30, 2009,
Heartland has assessed the significance of the impact of the credit valuation
adjustments on the overall valuation of its derivative positions and has
determined that the credit valuation adjustments are not significant to the
overall valuation of its derivatives. As a result, Heartland has determined that
its derivative valuations in their entirety are classified in Level 2 of the
fair value hierarchy.
Mortgage
Servicing Rights
Mortgage
servicing rights are subject to impairment testing. The carrying values of these
rights are reviewed quarterly for impairment based upon the calculation of fair
value as performed by an outside third party. For purposes of measuring
impairment, the rights are stratified into certain risk characteristics
including note type, note rate, prepayment trends and external market factors.
If the valuation model reflects a value less than the carrying value, mortgage
servicing rights are adjusted to fair value through a valuation allowance. As
such, Heartland classifies mortgage servicing rights subjected to nonrecurring
fair value adjustments as Level 2.
Other
Real Estate Owned
Other
real estate represents property acquired through foreclosures and settlements of
loans. Property acquired is carried at the lower of the principal amount of the
loan outstanding at the time of acquisition, plus any acquisition costs, or the
estimated fair value of the property, less disposal costs. Heartland considers
third party appraisals as well as independent fair value assessments from
Realtors or persons involved in selling OREO in determining the fair value of
particular properties. Accordingly, the valuation of OREO is subject to
significant external and internal judgment. Heartland also periodically reviews
OREO to determine whether the property continues to be carried at the lower of
its recorded book value or fair value of the property, less disposal costs. As
such, Heartland classifies OREO subjected to nonrecurring fair value adjustments
as Level 3.
The table
below presents, in thousands, Heartland’s assets and liabilities that are
measured at fair value on a recurring basis as of September 30, 2009, aggregated
by the level in the fair value hierarchy within which those measurements
fall:
Total
Fair Value
September
30, 2009
|
Level
1
|
Level
2
|
Level
3
|
|||||||||||||
Trading
securities
|
$
|
756
|
$
|
756
|
$
|
-
|
$
|
-
|
||||||||
Available-for-sale
securities
|
1,077,628
|
279,818
|
794,990
|
2,820
|
||||||||||||
Derivative
assets
|
1,759
|
-
|
1,759
|
-
|
||||||||||||
Total
assets at fair value
|
$
|
1,080,143
|
$
|
280,574
|
$
|
796,749
|
$
|
2,820
|
||||||||
The
changes in Level 3 assets that are measured at fair value on a recurring basis
are summarized in the following table, in thousands:
Fair
Value
|
|||
Balance
at January 1, 2009
|
$
|
120
|
|
Purchases
|
2,579
|
||
Assets
acquired through acquisition
|
141
|
||
Redemptions
|
(20
|
)
|
|
Balance
at September 30, 2009
|
$
|
2,820
|
The table
below presents Heartland’s assets measured at fair value on a nonrecurring
basis, in thousands:
Carrying
Value at September 30, 2009
|
Nine
Months Ended September 30, 2009
|
||||||||||||||||||
Total
|
Level
1
|
Level
2
|
Level
3
|
Total
Losses
|
|||||||||||||||
Impaired
loans
|
$
|
26,440
|
$
|
-
|
$
|
-
|
$
|
26,440
|
$
|
4,697
|
|||||||||
OREO
|
33,342
|
-
|
-
|
33,342
|
4,948
|
The table
below is a summary, in thousands, of the estimated fair value of Heartland’s
financial instruments as of September 30, 2009 and December 31, 2008 as defined
by ASC 825, “Disclosures about
Fair Value of Financial Instruments”. The carrying amounts in the
following table are recorded in the balance sheet under the indicated captions.
In accordance with ASC 825, the assets and liabilities that are not financial
instruments are not included in the disclosure, such as the value of the
mortgage servicing rights, premises, furniture and equipment, goodwill and other
intangibles and other liabilities.
Heartland
does not believe that the estimated information presented below is
representative of its earnings power or value. The following analysis, which is
inherently limited in depicting fair value, also does not consider any value
associated with existing customer relationships or the ability of Heartland to
create value through loan origination, deposit gathering or fee generating
activities. Many of the estimates presented below are based upon the use of
highly subjective information and assumptions and, accordingly, the results may
not be precise. Management believes that fair value estimates may not be
comparable between financial institutions due to the wide range of permitted
valuation techniques and numerous estimates which must be made. Furthermore,
because the disclosed fair value amounts were estimated as of the balance sheet
date, the amounts actually realized or paid upon maturity or settlement of the
various financial instruments could be significantly different.
September
30, 2009
|
December
31, 2008
|
|||||||||||
Carrying
Amount
|
Fair
Value
|
Carrying
Amount
|
Fair
Value
|
|||||||||
Financial
Assets:
|
||||||||||||
Cash
and cash equivalents
|
$
|
82,508
|
$
|
82,508
|
$
|
51,303
|
$
|
51,303
|
||||
Trading
securities
|
756
|
756
|
1,694
|
1,694
|
||||||||
Securities
available for sale
|
1,077,628
|
1,077,628
|
871,686
|
871,686
|
||||||||
Securities
held to maturity
|
27,360
|
25,575
|
30,325
|
26,326
|
||||||||
Loans
and leases, net of unearned
|
2,423,969
|
2,548,887
|
2,424,696
|
2,559,564
|
||||||||
Derivative
assets
|
1,759
|
1,759
|
2,698
|
2,698
|
||||||||
Financial
Liabilities:
|
||||||||||||
Demand
deposits
|
$
|
451,645
|
$
|
451,645
|
$
|
383,061
|
$
|
383,061
|
||||
Savings
deposits
|
1,386,059
|
1,386,059
|
1,128,312
|
1,128,312
|
||||||||
Time
deposits
|
1,106,710
|
1,110,935
|
1,128,859
|
1,136,933
|
||||||||
Short-term
borrowings
|
111,346
|
111,346
|
210,184
|
210,184
|
||||||||
Other
borrowings
|
457,444
|
462,242
|
437,833
|
448,037
|
||||||||
Cash and
Cash Equivalents – The carrying amount is a reasonable estimate of fair value
due to the short-term nature of these instruments.
Securities
- For securities either
held to maturity, available for sale or trading, fair value equals quoted market
price if available. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loans and
Leases - The fair value
of loans, including those covered by loss share agreements, is estimated by
discounting the future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities. The fair value of loans held for sale is estimated using
quoted market prices.
Deposits
- The fair value of demand deposits, savings accounts and certain money market
deposits is the amount payable on demand at the reporting date. The fair value
of fixed maturity certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities. If the fair value of the
fixed maturity certificates of deposits is calculated at less than the carrying
amount, the carrying value of these deposits is reported as the fair
value.
Short-term
and Other Borrowings -
Rates currently available to Heartland for debt with similar terms and
remaining maturities are used to estimate fair value of existing
debt.
Commitments
to Extend Credit, Unused Lines of Credit and Standby Letters of Credit - Based
upon management’s analysis of the off balance sheet financial instruments, there
are no significant unrealized gains or losses associated with these financial
instruments based upon our review of the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the present creditworthiness of the counterparties.
Derivatives
– The fair value of all derivatives was estimated based on the amount that
Heartland would pay or would be paid to terminate the contract or agreement,
using current rates and, when appropriate, the current creditworthiness of the
counter-party.
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
SAFE HARBOR
STATEMENT
This
document (including information incorporated by reference) contains, and future
oral and written statements of Heartland and its management may contain,
forward-looking statements, within the meaning of such term in the Private
Securities Litigation Reform Act of 1995, with respect to the financial
condition, results of operations, plans, objectives, future performance and
business of Heartland. Forward-looking statements, which may be based upon
beliefs, expectations and assumptions of Heartland’s management and on
information currently available to management, are generally identifiable by the
use of words such as "believe", "expect", "anticipate", "plan", "intend",
"estimate", "may", "will", "would", "could", "should" or other similar
expressions. Additionally, all statements in this document, including
forward-looking statements, speak only as of the date they are made, and
Heartland undertakes no obligation to update any statement in light of new
information or future events.
Heartland’s
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. The factors which could have a material adverse effect on
the operations and future prospects of Heartland and its subsidiaries are
detailed in the “Risk Factors” section included under Item 1A. of Part I of
Heartland’s 2008 Form 10-K filed with the Securities and Exchange Commission on
March 16, 2009. These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be placed on such
statements.
CRITICAL
ACCOUNTING POLICIES
The
process utilized by Heartland to estimate the adequacy of the allowance for loan
and lease losses is considered a critical accounting policy for Heartland. The
allowance for loan and lease losses represents management’s estimate of
identified and unidentified probable losses in the existing loan portfolio.
Thus, the accuracy of this estimate could have a material impact on Heartland’s
earnings. The adequacy of the allowance for loan and lease losses is determined
using factors that include the overall composition of the loan portfolio,
general economic conditions, types of loans, loan collateral values, past loss
experience, loan delinquencies, and potential losses from identified substandard
and doubtful credits. Nonperforming loans and large non-homogeneous loans are
specifically reviewed for impairment and the allowance is allocated on a
loan-by-loan basis as deemed necessary. Homogeneous loans and loans not
specifically evaluated are grouped into pools to which a loss percentage, based
on historical experience, is allocated. The adequacy of the allowance for loan
and lease losses is monitored on an ongoing basis by the loan review staff,
senior management and the boards of directors of each subsidiary bank. Specific
factors considered by management in establishing the allowance included the
following:
*
|
Heartland
has experienced an increase in net charge-offs and nonperforming loans
during recent quarters.
|
*
|
During
the last several years, Heartland has entered new geographical markets in
which it had little or no previous lending experience.
|
*
|
Heartland
has continued to experience growth in more complex commercial loans as
compared to relatively lower-risk residential real estate
loans.
|
There can
be no assurances that the allowance for loan and lease losses will be adequate
to cover all loan losses, but management believes that the allowance for loan
and lease losses was adequate at September 30, 2009. While management uses
available information to provide for loan and lease losses, the ultimate
collectability of a substantial portion of the loan portfolio and the need for
future additions to the allowance will be based on changes in economic
conditions. Should the economic climate continue to deteriorate, borrowers may
experience difficulty, and the level of nonperforming loans, charge-offs, and
delinquencies could rise and require further increases in the provision for loan
and lease losses. In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the allowance for loan and
lease losses carried by the Heartland subsidiaries. Such agencies may require
Heartland to make additional provisions to the allowance based upon their
judgment about information available to them at the time of their
examinations.
GENERAL
Heartland’s
results of operations depend primarily on net interest income, which is the
difference between interest income from interest earning assets and interest
expense on interest bearing liabilities. Noninterest income, which includes
service charges and fees, trust income, brokerage and insurance commissions and
gains on sale of loans, also affects Heartland’s results of operations.
Heartland’s principal operating expenses, aside from interest expense, consist
of compensation and employee benefits, occupancy and equipment costs and the
provision for loan and lease losses.
Net
income was $3.5 million for the quarter ended September 30, 2009, compared to
net income of $2.9 million earned during the third quarter of 2008. Net income
available to common stockholders was $2.2 million, or $0.13 per diluted common
share, for the quarter ended September 30, 2009, compared to $3.0 million, or
$0.18 per diluted common share, earned during the third quarter of 2008. Return
on average common equity was 3.54 percent and return on average assets was 0.22
percent for the third quarter of 2009, compared to 5.26 percent and 0.35
percent, respectively, for the same quarter in 2008.
On July
2, 2009, Heartland acquired all deposits of The Elizabeth State Bank in
Elizabeth, Illinois through its subsidiary Galena State Bank based in Galena,
Illinois in a whole bank loss sharing transaction facilitated by the FDIC. Bank
branches previously owned and operated by The Elizabeth State Bank reopened on
Monday, July 6, 2009, as Galena State Bank branches. As of July 2, 2009, The
Elizabeth State Bank had loans of $42.7 million and deposits of $49.3 million.
Galena State Bank paid a premium of 1.0 percent to acquire all of the deposits
of the failed bank. In addition to assuming all of the deposits of the failed
bank, Galena State Bank agreed to purchase $52.3 million of assets. The FDIC
retained the remaining assets for later disposition.
The
acquired loans and other real estate owned are covered by two loss share
agreements between the FDIC and Galena State Bank, which affords Galena State
Bank significant loss protection. Under the loss share agreements, the FDIC will
cover 80 percent of the covered loan and other real estate owned losses
(referred to as covered assets) up to $10 million and 95 percent of losses in
excess of that amount. The term for loss sharing on non-residential real estate
losses is five years with respect to losses and eight years with respect to
recoveries, while the term for loss sharing on residential real estate loans is
ten years with respect to losses and recoveries. The reimbursable losses from
the FDIC are based on the book value of the relevant loan as determined by the
FDIC at the date of the transaction. New loans made after that date are not
covered by the loss share agreements.
Galena
State Bank received a $2.5 million discount on the assets acquired and paid a
1.0 percent deposit premium. The expected reimbursements under the loss share
agreements were recorded as an indemnification asset at the estimated fair value
of $4.4 million at the acquisition date. The estimated fair value of the loans
acquired was $37.8 million and the estimated fair value of the deposits assumed
was $49.5 million. In addition, a core deposit intangible was recorded of $200
thousand. An acquisition gain totaling $998 thousand resulted from the
acquisition and is included as a component of noninterest income on the
statement of income. The amount of the gain is equal to the amount by which the
fair value of the liabilities assumed exceeded the fair value of the assets
purchased.
Earnings
for the third quarter of 2009 were positively affected by increased net interest
income, loan servicing income, securities gains, gains on sale of loans, income
on bank owned life insurance and the gain on The Elizabeth State Bank
acquisition. The growth in these areas was partially offset by an increase in
the loan loss provision, which was $11.9 million during the third quarter of
2009 compared to $7.1 million during the third quarter of 2008. Also negatively
affecting earnings during the third quarter of 2009 were increased FDIC
assessments and expenses associated with other real estate owned. Net interest
margin, expressed as a percentage of average earning assets, was 4.06 percent
during the third quarter of 2009 compared to 3.96 percent for the third quarter
of 2008.
During
the third quarter of 2009, net interest income on a tax-equivalent basis
increased $4.9 million or 16 percent compared to the same quarter in 2008.
Average earning assets increased $396.4 million or 13 percent during the
comparable quarterly periods. Noninterest income was $11.9 million during the
third quarter of 2009 compared to $7.9 million during the third quarter of 2008,
an increase of $4.0 million or 51 percent. Included in noninterest income during
the third quarter of 2009 was the $998 thousand gain on The Elizabeth State Bank
acquisition. Included in the third quarter 2008 noninterest income was a $5.2
million gain on the sale of Heartland’s merchant bankcard processing services
and a $4.6 million impairment loss recorded on Heartland’s investment in
perpetual preferred securities issued by Fannie Mae. Also contributing to the
increase in 2009 noninterest income was a $1.3 million increase in securities
gains, $662 thousand increase in loan servicing income, $582 thousand increase
in gains on sale of loans and $544 thousand increase in income on bank owned
life insurance. For the third quarter of 2009, noninterest expense totaled $30.3
million, an increase of $3.6 million or 13 percent from the $26.7 million
recorded during the same quarter in 2008. The noninterest expense categories to
experience significant increases during the quarters under comparison were net
losses on repossessed assets, which increased $3.4 million, and FDIC
assessments, which increased $1.0 million.
Net
income recorded for the first nine months of 2009 was $14.2 million, compared to
$13.8 million recorded during the first nine months of 2008. Net income
available to common stockholders was $10.4 million, or $0.64 per diluted common
share, for the nine months ended September 30, 2009, compared to $14.0 million,
or $0.85 per diluted common share, earned during the first nine months of 2008.
Return on average common equity was 5.81 percent and return on average assets
was 0.37 percent for the first nine months of 2009, compared to 8.04 percent and
0.56 percent, respectively, for the same period in 2008.
Earnings
for the nine months ended September 30, 2009, were positively affected by
increased net interest income, loan servicing income, securities gains, gains on
sale of loans and the gain on The Elizabeth State Bank acquisition. The growth
in these areas was partially offset by an increase in the loan loss provision,
which was $28.6 million during 2009 compared to $14.2 million during 2008. Also
negatively affecting earnings during the first nine months of 2009 were
increased FDIC assessments and expenses associated with other real estate owned.
Net interest margin, expressed as a percentage of average earning assets, was
3.98 percent during the first nine months of 2009 compared to 3.92 percent for
the first nine months of 2008.
During
the first nine months of 2009, net interest income on a tax-equivalent basis
increased $12.0 million or 13 percent compared to the same nine months in 2008.
Average earning assets increased $364.8 million or 12 percent during the
comparable nine-month periods. Noninterest income was $39.3 million during the
first nine months of 2009 compared to $24.7 million during the first nine months
of 2008, an increase of $14.6 million or 59 percent. In addition to the third
quarter nonrecurring items noted above, contributors to the growth in
noninterest income was a $4.3 million increase in loan servicing income, $3.6
million increase in gains on sale of loans and $5.4 million increase in
securities gains. For the first nine months of 2009, noninterest expense totaled
$89.1 million, an increase of $11.0 million or 14 percent from the $78.1 million
recorded during the same period in 2008. The largest component of noninterest
expense, salaries and employee benefits, increased $1.6 million or 4 percent
during the first nine months of 2009 compared to the first nine months of 2008.
The other noninterest expense categories to experience significant increases
during the nine-month periods under comparison were FDIC assessments, which
increased $4.3 million, and net losses on repossessed assets, which increased
$6.3 million.
At
September 30, 2009, total assets had increased $249.3 million or 9 percent
annualized since year-end 2008. Total loans and leases, exclusive of those
covered by the FDIC loss share agreements, were $2.37 billion at September 30,
2009, compared to $2.41 billion at year-end 2008, a decrease of $37.1 million or
2 percent annualized. In order to provide the investing community with a
perspective on how the growth in both loans and deposits during the first nine
months of the year equates to performance on an annualized basis, the growth
rates on these two categories have been reflected as an annualized percentage
throughout this report. These annualized numbers were calculated by multiplying
the growth percentage for the first nine months of the year by 1.33. The only
loan category to experience growth during the first nine months of 2009 was
agricultural and agricultural real estate loans.
Total
deposits grew to $2.94 billion at September 30, 2009, an increase of $304.2
million or 15 percent annualized since year-end 2008. The Elizabeth State Bank
acquisition accounted for $49.5 million of this growth. Nearly 55 percent of the
growth occurred in Heartland’s Western markets. Demand deposits increased $68.6
million or 24 percent annualized since year-end 2008 with $6.9 million coming
from The Elizabeth State Bank acquisition. Savings deposit balances experienced
an increase of $257.7 million or 30 percent annualized since year-end 2008 with
$21.0 million coming from The Elizabeth State Bank acquisition. Time deposits,
exclusive of brokered deposits, experienced a decrease of $14.1 million or 2
percent annualized since year-end 2008 despite the $21.6 million assumed in The
Elizabeth State Bank acquisition.
NET
INTEREST INCOME
Net
interest margin, expressed as a percentage of average earning assets, was 4.06
percent during the third quarter of 2009 compared to 3.96 percent during the
third quarter of 2008. For the nine-month periods ended September 30, net
interest margin, expressed as a percentage of average earning assets, was 3.98
percent during 2009 and 3.92 percent during 2008. Success at growing net
interest margin during the quarter was a direct result of disciplined pricing.
Management is committed to maintaining margin near the 4 percent level and will
not compete for loans or deposits strictly for the sake of growth.
Net
interest income on a tax-equivalent basis totaled $35.8 million during the third
quarter of 2009, an increase of $4.9 million or 16 percent from the $30.9
million recorded during the third quarter of 2008. For the nine-month period
during 2009, net interest income on a tax-equivalent basis was $101.4 million,
an increase of $12.0 million or 13 percent from the $89.4 million recorded
during the first nine months of 2008. These increases occurred as Heartland’s
interest bearing liabilities repriced downward more quickly than its interest
bearing assets. Also contributing to these increases was the $396.4 million or
13 percent growth in average earning assets during the third quarter of 2009
compared to the same quarter in 2008 and the $364.8 million or 12 percent growth
in average earning assets during the first nine months of 2009 compared to the
same nine months of 2008.
On a
tax-equivalent basis, interest income in the third quarter of 2009 totaled $53.1
million compared to $52.0 million in the third quarter of 2008, an increase of
$1.1 million or 2 percent. For the first nine months of 2009, interest income on
a tax-equivalent basis remained consistent at $155.4 million compared to $155.3
million for the same period in 2008. The increases in average earnings assets
were almost equally offset by a decrease in the average interest rate earned on
these assets of 67 basis points during the quarter and 62 basis points during
the nine months ended September 30, 2009, as compared to the same periods in
2008. Nearly half of Heartland’s commercial and agricultural loan portfolios
consist of floating rate loans that reprice immediately upon a change in the
national prime interest rate, thus changes in the national prime rate impact
interest income more quickly than if there were more fixed rate loans. The
national prime interest rate was 3.25 percent for the first nine months of 2009.
During the first nine months of 2008, the national prime interest rate decreased
from 7.25 percent on January 1, 2008, to 5.00 percent at September 30, 2008. A
large portion of Heartland’s floating rate loans that reprice immediately with a
change in national prime have interest rate floors that are currently in effect.
Additionally, Heartland had two $50.0 million derivative transactions on the
loan portfolio that were at their floor interest rates. One of these derivative
transactions matured on April 4, 2009.
Interest
expense for the third quarter of 2009 was $17.3 million compared to $21.1
million in the third quarter of 2008, a decrease of $3.8 million or 18 percent.
On a nine-month comparative basis, interest expense decreased $11.9 million or
18 percent. Despite increases in average interest bearing liabilities of 18
percent during the quarter and 10 percent during the nine months ended September
30, 2009, as compared to the same periods in 2008, the average interest rates
paid on Heartland’s deposits and borrowings declined 80 basis points in the
quarter and 75 basis points in the nine months ended September 30, 2009,
compared to the same periods in 2008. Approximately 40 percent of Heartland’s
certificate of deposit accounts will mature within the next six months at a
weighted average rate of 2.23 percent.
Heartland
attempts to manage its balance sheet to minimize the effect that a change in
interest rates has on its net interest margin. Heartland plans to continue to
work toward improving both its earning asset and funding mix through targeted
growth strategies that emphasize conservative pricing of deposits and careful
underwriting of loans, which management believes will result in additional net
interest margin. Heartland’s net interest income simulations reflect a
well-balanced and manageable interest rate posture. Management supports a
pricing discipline in which the focus is less on price and more on the unique
value provided to business and retail clients. Item 3 of this Form 10-Q contains
additional information about the results of Heartland’s most recent net interest
income simulations. Note 6 to the quarterly financial statements contains a
detailed discussion of the derivative instruments Heartland has utilized to
manage its interest rate risk.
The table
below 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 periods indicated.
Dividing income or expense by the average balance of assets or liabilities
derives such yields and costs. Average balances are derived from daily balances.
Nonaccrual loans and loans held for sale are included in each respective loan
category.
ANALYSIS
OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES1
For
the quarters ended September 30, 2009 and 2008
(Dollars
in thousands)
|
||||||||||||||||||||||
2009
|
2008
|
|||||||||||||||||||||
Average
Balance
|
Interest
|
Rate
|
Average
Balance
|
Interest
|
Rate
|
|||||||||||||||||
EARNING
ASSETS
|
||||||||||||||||||||||
Securities:
|
||||||||||||||||||||||
Taxable
|
$
|
904,721
|
$
|
10,810
|
4.74
|
%
|
$
|
622,376
|
$
|
8,228
|
5.26
|
%
|
||||||||||
Nontaxable1
|
194,621
|
3,246
|
6.62
|
153,996
|
2,441
|
6.31
|
||||||||||||||||
Total securities
|
1,099,342
|
14,056
|
5.07
|
776,372
|
10,669
|
5.47
|
||||||||||||||||
Interest
bearing deposits
|
4,845
|
15
|
1.23
|
654
|
3
|
1.82
|
||||||||||||||||
Federal
funds sold
|
179
|
-
|
-
|
18,419
|
85
|
1.84
|
||||||||||||||||
Loans
and leases:
|
||||||||||||||||||||||
Commercial and commercial real
estate1
|
1,716,855
|
25,399
|
5.87
|
1,651,002
|
26,910
|
6.48
|
||||||||||||||||
Residential
mortgage
|
213,799
|
3,056
|
5.67
|
223,267
|
3,570
|
6.36
|
||||||||||||||||
Agricultural and agricultural
real estate1
|
262,241
|
4,231
|
6.40
|
241,541
|
4,191
|
6.90
|
||||||||||||||||
Consumer
|
233,905
|
5,134
|
8.71
|
216,651
|
5,081
|
9.33
|
||||||||||||||||
Direct financing leases,
net
|
3,361
|
48
|
5.67
|
7,078
|
105
|
5.90
|
||||||||||||||||
Fees on loans
|
-
|
1,128
|
-
|
-
|
1,356
|
-
|
||||||||||||||||
Less: allowance for loan and
lease losses
|
(37,920
|
)
|
-
|
-
|
(34,776
|
)
|
-
|
-
|
||||||||||||||
Net loans and
leases
|
2,392,241
|
38,996
|
6.47
|
2,304,763
|
41,213
|
7.11
|
||||||||||||||||
Total earning
assets
|
3,496,607
|
$
|
53,067
|
6.02
|
%
|
3,100,208
|
$
|
51,970
|
6.67
|
%
|
||||||||||||
NONEARNING
ASSETS
|
357,051
|
298,991
|
||||||||||||||||||||
TOTAL
ASSETS
|
$
|
3,853,658
|
$
|
3,399,199
|
||||||||||||||||||
INTEREST
BEARING LIABILITIES
|
||||||||||||||||||||||
Interest
bearing deposits
|
||||||||||||||||||||||
Savings
|
$
|
1,329,415
|
$
|
4,690
|
1.40
|
%
|
$
|
981,108
|
$
|
4,777
|
1.94
|
%
|
||||||||||
Time, $100,000 and
over
|
366,573
|
2,655
|
2.87
|
374,170
|
3,527
|
3.75
|
||||||||||||||||
Other time
deposits
|
760,816
|
5,701
|
2.97
|
759,999
|
7,318
|
3.83
|
||||||||||||||||
Short-term
borrowings
|
125,863
|
154
|
0.49
|
184,800
|
776
|
1.67
|
||||||||||||||||
Other
borrowings
|
458,835
|
4,065
|
3.51
|
449,927
|
4,692
|
4.15
|
||||||||||||||||
Total interest bearing
liabilities
|
3,041,502
|
17,265
|
2.25
|
%
|
2,750,004
|
21,090
|
3.05
|
%
|
||||||||||||||
NONINTEREST
BEARING LIABILITIES
|
||||||||||||||||||||||
Noninterest
bearing deposits
|
455,521
|
384,711
|
||||||||||||||||||||
Accrued
interest and other liabilities
|
33,595
|
37,373
|
||||||||||||||||||||
Total noninterest bearing
liabilities
|
489,116
|
422,084
|
||||||||||||||||||||
STOCKHOLDERS’
EQUITY
|
323,040
|
227,111
|
||||||||||||||||||||
TOTAL
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
$
|
3,853,658
|
$
|
3,399,199
|
||||||||||||||||||
Net
interest income1
|
$
|
35,802
|
$
|
30,880
|
||||||||||||||||||
Net
interest spread1
|
3.77
|
%
|
3.62
|
%
|
||||||||||||||||||
Net
interest income to total earning assets1
|
4.06
|
%
|
3.96
|
%
|
||||||||||||||||||
Interest
bearing liabilities to earning assets
|
86.98
|
%
|
88.70
|
%
|
||||||||||||||||||
1
Tax equivalent basis is calculated using an effective tax rate of
35%.
|
ANALYSIS
OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES1
For
the nine months ended September 30, 2009 and 2008
(Dollars
in thousands)
|
||||||||||||||||||||||
2009
|
2008
|
|||||||||||||||||||||
Average
Balance
|
Interest
|
Rate
|
Average
Balance
|
Interest
|
Rate
|
|||||||||||||||||
EARNING
ASSETS
|
||||||||||||||||||||||
Securities:
|
||||||||||||||||||||||
Taxable
|
$
|
852,192
|
$
|
29,269
|
4.59
|
%
|
$
|
607,082
|
$
|
22,728
|
5.00
|
%
|
||||||||||
Nontaxable1
|
177,734
|
8,845
|
6.65
|
150,803
|
7,330
|
6.49
|
||||||||||||||||
Total securities
|
1,029,926
|
38,114
|
4.95
|
757,885
|
30,058
|
5.30
|
||||||||||||||||
Interest
bearing deposits
|
2,402
|
18
|
1.00
|
494
|
10
|
2.70
|
||||||||||||||||
Federal
funds sold
|
368
|
1
|
0.36
|
15,579
|
267
|
2.29
|
||||||||||||||||
Loans
and leases:
|
||||||||||||||||||||||
Commercial and commercial real
estate1
|
1,695,755
|
76,633
|
6.04
|
1,629,584
|
82,133
|
6.73
|
||||||||||||||||
Residential
mortgage
|
222,577
|
9,730
|
5.84
|
222,359
|
10,779
|
6.48
|
||||||||||||||||
Agricultural and agricultural
real estate1
|
258,528
|
12,547
|
6.49
|
236,537
|
12,855
|
7.26
|
||||||||||||||||
Consumer
|
231,510
|
15,145
|
8.75
|
207,116
|
14,909
|
9.62
|
||||||||||||||||
Direct financing leases,
net
|
4,408
|
176
|
5.34
|
7,926
|
353
|
5.95
|
||||||||||||||||
Fees on loans
|
-
|
3,085
|
-
|
-
|
3,966
|
-
|
||||||||||||||||
Less: allowance for loan and
lease losses
|
(36,676
|
)
|
-
|
-
|
(33,504
|
)
|
-
|
-
|
||||||||||||||
Net loans and
leases
|
2,376,102
|
117,316
|
6.60
|
2,270,018
|
124,995
|
7.36
|
||||||||||||||||
Total earning
assets
|
3,408,798
|
$
|
155,449
|
6.10
|
%
|
3,043,976
|
$
|
155,330
|
6.82
|
%
|
||||||||||||
NONEARNING
ASSETS
|
349,824
|
297,229
|
||||||||||||||||||||
TOTAL
ASSETS
|
$
|
3,758,622
|
$
|
3,341,205
|
||||||||||||||||||
INTEREST
BEARING LIABILITIES
|
||||||||||||||||||||||
Interest
bearing deposits
|
||||||||||||||||||||||
Savings
|
$
|
1,219,645
|
$
|
13,782
|
1.51
|
%
|
$
|
895,057
|
$
|
12,575
|
1.88
|
%
|
||||||||||
Time, $100,000 and
over
|
383,783
|
8,858
|
3.09
|
326,038
|
10,091
|
4.13
|
||||||||||||||||
Other time
deposits
|
764,558
|
18,104
|
3.17
|
821,894
|
25,709
|
4.18
|
||||||||||||||||
Short-term
borrowings
|
146,430
|
539
|
0.49
|
246,735
|
4,049
|
2.19
|
||||||||||||||||
Other
borrowings
|
467,307
|
12,803
|
3.66
|
410,427
|
13,562
|
4.41
|
||||||||||||||||
Total interest bearing
liabilities
|
2,981,723
|
54,086
|
2.43
|
%
|
2,700,151
|
65,986
|
3.26
|
%
|
||||||||||||||
NONINTEREST
BEARING LIABILITIES
|
||||||||||||||||||||||
Noninterest
bearing deposits
|
424,336
|
368,873
|
||||||||||||||||||||
Accrued
interest and other liabilities
|
34,202
|
40,094
|
||||||||||||||||||||
Total noninterest bearing
liabilities
|
458,538
|
408,967
|
||||||||||||||||||||
STOCKHOLDERS’
EQUITY
|
318,361
|
232,087
|
||||||||||||||||||||
TOTAL
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
$
|
3,758,622
|
$
|
3,341,205
|
||||||||||||||||||
Net
interest income1
|
$
|
101,363
|
$
|
89,344
|
||||||||||||||||||
Net
interest spread1
|
3.67
|
%
|
3.55
|
%
|
||||||||||||||||||
Net
interest income to total earning assets1
|
3.98
|
%
|
3.92
|
%
|
||||||||||||||||||
Interest
bearing liabilities to earning assets
|
87.47
|
%
|
88.70
|
%
|
||||||||||||||||||
1
Tax equivalent basis is calculated using an effective tax rate of
35%.
|
PROVISION
FOR LOAN AND LEASE LOSSES
The
allowance for loan and lease losses is established through a provision charged
to expense to provide, in Heartland management’s opinion, an adequate allowance
for loan and lease losses. During the third quarter of 2009, the provision for
loan losses was $11.9 million, an increase of $4.8 million or 68 percent over
the provision for loan losses of $7.1 million recorded during the same period in
2008. For the nine-month comparative period, the provision for loan losses was
$28.6 million during 2009 compared to $14.2 million during 2008, an increase of
$14.4 million or 101 percent. Additions to the allowance for loan and lease
losses during the first nine months of 2009 were driven by a variety of factors
including deterioration of economic conditions, downgrades in internal risk
ratings, reductions in appraised values and higher levels of charge-offs,
primarily in Heartland’s Western markets of Arizona, Montana and
Colorado.
The
adequacy of the allowance for loan and lease losses is determined by management
using factors that include the overall composition of the loan portfolio,
general economic conditions, types of loans, loan collateral values, past loss
experience, loan delinquencies, substandard credits, and doubtful credits. For
additional details on the specific factors considered, refer to the critical
accounting policies and allowance for loan and lease losses sections of this
report. Heartland believes the allowance for loan and lease losses as of
September 30, 2009, was at a level commensurate with the overall risk exposure
of the loan portfolio. However, if economic conditions should become more
unfavorable, certain borrowers may experience difficulty and the level of
nonperforming loans, charge-offs and delinquencies could rise and require
further increases in the provision for loan and lease losses.
NONINTEREST
INCOME
The table
below shows Heartland’s noninterest income for the quarters
indicated.
(Dollars
in thousands)
Three
Months Ended
|
||||||||||||||||
Sept.
30, 2009
|
Sept.
30, 2008
|
Change
|
%
Change
|
|||||||||||||
NONINTEREST
INCOME:
|
||||||||||||||||
Service
charges and fees, net
|
$
|
3,288
|
$
|
3,125
|
$
|
163
|
5
|
%
|
||||||||
Loan
servicing income
|
1,756
|
1,094
|
662
|
61
|
||||||||||||
Trust
fees
|
1,949
|
2,070
|
(121
|
)
|
(6
|
)
|
||||||||||
Brokerage
and insurance commissions
|
824
|
942
|
(118
|
)
|
(13
|
)
|
||||||||||
Securities
gains, net
|
1,291
|
5
|
1,286
|
25,720
|
||||||||||||
Gain
(loss) on trading account securities, net
|
210
|
(33
|
)
|
243
|
736
|
|||||||||||
Impairment
loss on securities
|
-
|
(4,688
|
)
|
4,688
|
100
|
|||||||||||
Gains
on sale of loans
|
877
|
295
|
582
|
197
|
||||||||||||
Income
(loss) on bank owned life insurance
|
297
|
(247
|
)
|
544
|
220
|
|||||||||||
Gain
on acquisition
|
998
|
-
|
998
|
100
|
||||||||||||
Gain
on sale of merchant services
|
-
|
5,200
|
(5,200
|
)
|
(100
|
)
|
||||||||||
Other
noninterest income
|
418
|
117
|
301
|
257
|
||||||||||||
TOTAL
NONINTEREST INCOME
|
$
|
11,908
|
$
|
7,880
|
$
|
4,028
|
51
|
%
|
(Dollars
in thousands)
Nine
Months Ended
|
||||||||||||||||
Sept.
30, 2009
|
Sept.
30, 2008
|
Change
|
%
Change
|
|||||||||||||
NONINTEREST
INCOME:
|
||||||||||||||||
Service
charges and fees, net
|
$
|
9,284
|
$
|
8,620
|
$
|
664
|
8
|
%
|
||||||||
Loan
servicing income
|
7,853
|
3,585
|
4,268
|
119
|
||||||||||||
Trust
fees
|
5,617
|
6,159
|
(542
|
)
|
(9
|
)
|
||||||||||
Brokerage
and insurance commissions
|
2,420
|
2,717
|
(297
|
)
|
(11
|
)
|
||||||||||
Securities
gains, net
|
6,462
|
1,015
|
5,447
|
537
|
||||||||||||
Gain
(loss) on trading account securities, net
|
272
|
(467
|
)
|
739
|
158
|
|||||||||||
Impairment
loss on securities
|
-
|
(4,804
|
)
|
4,804
|
100
|
|||||||||||
Gains
on sale of loans
|
4,916
|
1,279
|
3,637
|
284
|
||||||||||||
Income
on bank owned life insurance
|
640
|
596
|
44
|
7
|
||||||||||||
Gain
on acquisition
|
998
|
-
|
998
|
100
|
||||||||||||
Gain
on sale of merchant services
|
-
|
5,200
|
(5,200
|
)
|
(100
|
)
|
||||||||||
Other
noninterest income
|
872
|
772
|
100
|
13
|
||||||||||||
TOTAL
NONINTEREST INCOME
|
$
|
39,334
|
$
|
24,672
|
$
|
14,662
|
59
|
%
|
Noninterest
income was $11.9 million during the third quarter of 2009 compared to $7.9
million during the third quarter of 2008, an increase of $4.0 million or 51
percent. Included in noninterest income during the third quarter of 2009 was the
$998 thousand gain on The Elizabeth State Bank acquisition. Included in the
third quarter 2008 noninterest income was a $5.2 million gain on the sale of
Heartland’s merchant bankcard processing services and a $4.6 million impairment
loss recorded on Heartland’s investment in perpetual preferred securities issued
by Fannie Mae. For the first nine months of 2009, noninterest income was $39.3
million compared to $24.7 million during the first nine months of 2008, an
increase of $14.7 million or 59 percent. Exclusive of the above noted
nonrecurring items, the categories experiencing the largest increases for both
comparative periods were loan servicing income, securities gains and gains on
sale of loans.
Loan
servicing income increased $662 thousand or 61 percent for the quarter and $4.3
million or 119 percent for the nine-month periods under comparison, due to an
increase in the number of residential real estate loans that Heartland services.
Mortgage servicing rights income totaled $1.1 million during the third quarter
of 2009 compared to $480 thousand during the same quarter in 2008. For the
nine-month periods ended on September 30, mortgage servicing rights income
totaled $7.5 million and $2.0 million, respectively. Amortization of mortgage
servicing rights was $576 thousand during the third quarter of 2009 compared to
$347 thousand during the same quarter of 2008. On a nine-month comparative
basis, the amortization of mortgage servicing rights was $3.0 million in 2009
compared to $1.3 million during 2008. Note 4 to the quarterly financial
statements contains a discussion about Heartland’s mortgage servicing rights.
The portfolio of mortgage loans serviced for others by Heartland totaled $1.08
billion at September 30, 2009, compared to $1.03 billion at June 30, 2009, and
$703.3 million at September 30, 2008. We expect loan servicing income to
continue to increase for the remainder of the year, but at a more moderate pace,
as fixed rate loan originations have moderated.
As
long-term mortgage loan rates fell below 5.00 percent during the first half of
2009, refinancing activity significantly increased on 15- and 30-year,
fixed-rate mortgage loans. During the first nine months of 2009, Heartland banks
originated $696.9 million in new and refinanced mortgage loans to 3,810
borrowers. Heartland normally elects to sell these types of loans into the
secondary market and retains the servicing on these loans. Gains on sale of
loans totaled $877 thousand during the third quarter of 2009 compared to $295
thousand during the third quarter of 2008. For the first nine months of 2009,
gains on sale of loans totaled $4.9 million compared to $1.3 million for the
first nine months of 2008. Additionally, Heartland has assisted over 260
customers with modifications to their existing mortgage loans to help them stay
in their homes and avoid foreclosure during this time of financial
stress.
Securities
gains totaled $1.3 million during the third quarter of 2009 compared to $5
thousand during the third quarter of 2008. For the nine-month comparative
period, securities gains totaled $6.5 million during 2009 compared to $1.0
million during 2008. Securities designed to outperform in a declining rate
environment were sold during the first nine months of 2009 and replaced with
securities that are expected to outperform as rates rise.
NONINTEREST
EXPENSES
The table
below shows Heartland’s noninterest expense for the quarters
indicated.
(Dollars
in thousands)
Three
Months Ended
|
||||||||||||||||
Sept.
30, 2009
|
Sept.
30, 2008
|
Change
|
%
Change
|
|||||||||||||
NONINTEREST
EXPENSES:
|
||||||||||||||||
Salaries
and employee benefits
|
$
|
14,661
|
$
|
15,000
|
$
|
(339
|
)
|
(2
|
)%
|
|||||||
Occupancy
|
2,221
|
2,262
|
(41
|
)
|
(2
|
)
|
||||||||||
Furniture
and equipment
|
1,594
|
1,662
|
(68
|
)
|
(4
|
)
|
||||||||||
Professional
fees
|
2,706
|
2,712
|
(6
|
)
|
-
|
|||||||||||
FDIC
assessments
|
1,393
|
384
|
1,009
|
263
|
||||||||||||
Advertising
|
740
|
1,012
|
(272
|
)
|
(27
|
)
|
||||||||||
Intangible
assets amortization
|
199
|
236
|
(37
|
)
|
(16
|
)
|
||||||||||
Net
loss on repossessed assets
|
3,680
|
327
|
3,353
|
1,025
|
||||||||||||
Other
noninterest expenses
|
3,129
|
3,142
|
(13
|
)
|
-
|
|||||||||||
TOTAL
NONINTEREST EXPENSES
|
$
|
30,323
|
$
|
26,737
|
$
|
3,586
|
13
|
%
|
(Dollars
in thousands)
Nine
Months Ended
|
||||||||||||||||
Sept.
30, 2009
|
Sept
30, 2008
|
Change
|
%
Change
|
|||||||||||||
NONINTEREST
EXPENSES:
|
||||||||||||||||
Salaries
and employee benefits
|
$
|
46,046
|
$
|
44,459
|
$
|
1,587
|
4
|
%
|
||||||||
Occupancy
|
6,772
|
6,799
|
(27
|
)
|
-
|
|||||||||||
Furniture
and equipment
|
4,936
|
5,201
|
(265
|
)
|
(5
|
)
|
||||||||||
Professional
fees
|
7,027
|
7,299
|
(272
|
)
|
(4
|
)
|
||||||||||
FDIC
assessments
|
5,258
|
955
|
4,303
|
451
|
||||||||||||
Advertising
|
2,272
|
2,853
|
(581
|
)
|
(20
|
)
|
||||||||||
Intangible
assets amortization
|
668
|
708
|
(40
|
)
|
(6
|
)
|
||||||||||
Net
loss on repossessed assets
|
6,832
|
517
|
6,315
|
1,221
|
||||||||||||
Other
noninterest expenses
|
9,275
|
9,290
|
(15
|
)
|
-
|
|||||||||||
TOTAL
NONINTEREST EXPENSES
|
$
|
89,086
|
$
|
78,081
|
$
|
11,005
|
14
|
%
|
For the
third quarter of 2009, noninterest expense totaled $30.3 million, an increase of
$3.6 million or 13 percent from the same period in 2008. For the
nine-month periods ended September 30, 2009, noninterest expense totaled $89.1
million, an increase of $11.0 million or 14 percent when compared to the same
nine-month period in 2008. The increases in both periods under comparison were
primarily attributable to higher FDIC assessments and net losses on repossessed
assets.
The
largest component of noninterest expense, salaries and employee benefits,
decreased $339 thousand or 2 percent during the third quarter of 2009 compared
to the third quarter of 2008, primarily related to an accrual adjustment
for lower employee incentive payouts. For the nine-month comparative period,
salaries and employee benefits increased $1.6 million or 4 percent, primarily
due to: the opening of Minnesota Bank & Trust in April 2008; additional
staffing at Summit Bank & Trust and New Mexico Bank & Trust to grow
their customer base; additional staffing at Heartland’s operations center to
provide support services to the bank subsidiaries; and the employees Galena
State Bank acquired as a result of The Elizabeth State Bank acquisition. Total
full-time equivalent employees averaged 1,029 during the first nine months of
2009, compared to 1,002 during the first nine months of 2008.
FDIC
assessments totaled $1.4 million during the third quarter of 2009 compared to
$384 thousand during the third quarter of 2008, an increase of $1.0 million or
263 percent. For the nine-month period ended September 30, 2009, FDIC
assessments were $5.3 million compared to $955 thousand during the first nine
months of 2008, an increase of $4.3 million or 451 percent. Included in the FDIC
assessments recorded during the second quarter of 2009 was $1.7 million for the
emergency special assessment.
Net
losses on repossessed assets totaled $3.7 million during the third quarter of
2009 compared to $327 thousand during the third quarter of 2008. For the first
nine months of 2009, net losses on repossessed assets totaled $6.8 million
compared to $517 thousand for the first nine months of 2008. The third quarter
of 2009 net loss on repossessed assets included $2.9 million in valuation
adjustments and the second quarter of 2009 net loss on repossessed assets
included valuation adjustments of $1.9 million.
INCOME
TAX EXPENSE
Heartland’s
effective tax rate was 18.80 percent for the third quarter of 2009 compared to
25.80 percent for the third quarter of 2008. On a nine-month comparative basis,
Heartland’s effective tax rate was 27.61 percent for the first nine months of
2009 compared to 26.97 percent for the first nine months of 2008. Heartland’s
effective tax rate during the first nine months of 2009 did not include any
federal rehabilitation tax credits, whereas Heartland’s effective tax rate
during the first nine months of 2008 included $247 thousand in federal
rehabilitation tax credits associated with Dubuque Bank and Trust Company’s
ownership interests in limited liability companies that own certified historic
structures. Tax-exempt interest income as a percentage of pre-tax income was
53.03 percent during the third quarter of 2009 compared to 46.79 percent during
the same quarter of 2008. For the nine-month periods ended September 30, 2009
and 2008, tax-exempt income as a percentage of pre-tax income was 31.38 percent
and 28.44 percent, respectively. The tax-equivalent adjustment for this
tax-exempt interest income was $1.2 million during the third quarter of 2009
compared to $994 thousand during the same quarter in 2008. For the nine-month
comparative period, the tax-equivalent adjustment for tax-exempt interest income
was $3.3 million for 2009 and $2.9 million for 2008.
FINANCIAL
CONDITION
At
September 30, 2009, total assets were $3.88 billion, an increase of $249.3
million or 9 percent annualized since year-end 2008.
LOANS
AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Total
loans and leases, exclusive of those covered by the FDIC loss share agreements,
were $2.37 billion at September 30, 2009, compared to $2.41 billion at year-end
2008, a decrease of $37.1 million or 2 percent annualized. The only loan
category to experience growth during the first nine months of 2009 was
agricultural and agricultural real estate loans. Nearly all of this growth
occurred at Dubuque Bank and Trust Company. Total loans and leases, exclusive of
those covered by the FDIC loss share agreements, decreased $7.2 million during
the third quarter of 2009 compared to an increase of $18.6 million during the
second quarter of 2009 and a decrease of $48.6 million during the first quarter
of 2009.
The table
below presents the composition of the loan portfolio as of September 30, 2009,
and December 31, 2008.
LOAN
PORTFOLIO
(Dollars
in thousands)
|
||||||||||||||
September
30, 2009
|
December
31, 2008
|
|||||||||||||
Amount
|
Percent
|
Amount
|
Percent
|
|||||||||||
Loans
and leases held to maturity:
|
||||||||||||||
Commercial
and commercial real estate
|
$
|
1,694,589
|
71.42
|
%
|
$
|
1,718,071
|
71.30
|
%
|
||||||
Residential
mortgage
|
184,292
|
7.77
|
203,921
|
8.46
|
||||||||||
Agricultural
and agricultural real estate
|
257,738
|
10.86
|
247,664
|
10.28
|
||||||||||
Consumer
|
233,259
|
9.83
|
234,061
|
9.72
|
||||||||||
Lease
financing, net
|
2,882
|
0.12
|
5,829
|
0.24
|
||||||||||
Gross
loans and leases held to maturity
|
2,372,760
|
100.00
|
%
|
2,409,546
|
100.00
|
%
|
||||||||
Unearned
discount
|
(2,522
|
)
|
(2,443
|
)
|
||||||||||
Deferred
loan fees
|
(2,367
|
)
|
(2,102
|
)
|
||||||||||
Total
loans and leases held to maturity
|
2,367,871
|
2,405,001
|
||||||||||||
Loans
covered under loss share agreements:
|
||||||||||||||
Commercial
and commercial real estate
|
13,993
|
38.68
|
%
|
-
|
-
|
%
|
||||||||
Residential
mortgage
|
12,338
|
34.11
|
-
|
-
|
||||||||||
Agricultural
and agricultural real estate
|
5,934
|
16.40
|
-
|
-
|
||||||||||
Consumer
|
3,910
|
10.81
|
-
|
-
|
||||||||||
Total
loans covered under loss share agreements
|
36,175
|
100.00
|
%
|
-
|
-
|
%
|
||||||||
Allowance
for loan and lease losses
|
(42,260
|
)
|
(35,651
|
)
|
||||||||||
Loans
and leases, net
|
$
|
2,361,786
|
$
|
2,369,350
|
Loans and
leases secured by real estate, either fully or partially, totaled $1.8
billion or 76 percent of total loans and leases at September 30, 2009. More than
61 percent of the non-farm, nonresidential loans are owner occupied. The largest
categories within Heartland’s real estate secured loans are listed
below:
(Dollars
in thousands)
|
|||
Residential
real estate, excluding residential construction and residential lot
loans
|
$
|
417,268
|
|
Industrial,
manufacturing, business and commercial
|
252,122
|
||
Agriculture
|
198,126
|
||
Land
development and lots
|
174,907
|
||
Retail
|
154,933
|
||
Office
|
117,115
|
||
Hotel,
resort and hospitality
|
101,655
|
||
Warehousing
|
66,766
|
||
Food
and beverage
|
61,353
|
||
Residential
construction
|
56,853
|
The
process utilized by Heartland to determine the adequacy of the allowance for
loan and lease losses is considered a critical accounting practice for
Heartland. The allowance for loan and lease losses represents management’s
estimate of identified and unidentified probable losses in the existing loan
portfolio. For additional details on the specific factors considered, refer to
the critical accounting policies section of this report.
The
allowance for loan and lease losses at September 30, 2009, was 1.78 percent of
loans and leases and 50.31 percent of nonperforming loans, compared to 1.57
percent of loans and leases and 52.32 percent of nonperforming loans at June 30,
2009 and 1.48 percent of loans and leases and 45.73 percent of nonperforming
loans at December 31, 2008. Provision for loan losses during the first nine
months of 2009 was $28.6 million compared to $14.2 million during the first nine
months of 2008. Additions to the allowance for loan and lease losses during the
first nine months of 2009 were driven by a variety of factors including
deterioration of economic conditions, downgrades in internal risk ratings,
reductions in appraised values and higher levels of charge-offs, primarily in
Heartland’s Western markets of Arizona, Montana and Colorado.
Nonperforming
loans, exclusive of those covered under the loss share agreements, were $84.0
million or 3.55 percent of total loans and leases at September 30, 2009,
compared to $71.1 million or 3.00 percent of total loans and leases at June 30,
2009, and $78.0 million or 3.24 percent of total loans and leases at December
31, 2008. Approximately 65 percent, or $55.0 million, of Heartland’s
nonperforming loans are to 19 borrowers, with $14.7 million originated by
Arizona Bank & Trust, $11.7 million originated by Rocky Mountain Bank, $9.1
million originated by Summit Bank & Trust, $7.3 million originated by
Wisconsin Community Bank, $6.5 million originated by New Mexico Bank &
Trust, $3.3 million originated by Riverside Community Bank and $2.4 million
originated by Dubuque Bank and Trust. The portion of Heartland’s nonperforming
loans covered by government guarantees was $3.8 million at September 30, 2009.
The industry breakdown for these nonperforming loans was $16.7 million lots and
land development, $6.5 million real estate financing provider, $6.0 million
construction and development of commercial real estate, $5.8 million
transportation and $4.9 million lessors of real estate. The remaining $15.1
million was distributed among seven other industries. Based upon a review of the
loan portfolios, the economic conditions in the geographies and industries of
the borrowers, including current and historic rates of loan default in those
geographies and industries, and on stress testing of Heartland’s loan
portfolios, management believes that, although current levels of nonperforming
loans will continue to impact near-term credit trends, the level of
nonperforming loans should begin to moderate in the fourth quarter of 2009 or
early 2010 with an economic recovery from this adverse credit
cycle.
Other
real estate owned, exclusive of assets covered under the loss share agreements,
was $32.6 million at September 30, 2009, compared to $29.3 million at June 30,
2009, and $11.8 million at December 31, 2008. The majority of the increase
during 2009 occurred during the first quarter with $12.0 million attributable to
a residential lot development loan originated at Rocky Mountain Bank.
Liquidation strategies have been identified for all the assets held in other
real estate owned. Management plans to market these properties under an orderly
liquidation process instead of under a quick liquidation process which would
most likely result in discounts greater than the projected carrying
costs.
Net
charge-offs during the first nine months of 2009 were $22.0 million compared to
$12.4 million during the first nine months of 2008. A large portion of the net
charge-offs was related to commercial real estate development loans and
residential lot loans, primarily in the Phoenix, Arizona market.
The table
below presents the changes in the allowance for loan and lease losses during the
periods indicated:
ANALYSIS
OF ALLOWANCE FOR LOAN AND LEASE LOSSES
(Dollars
in thousands)
|
||||||||
Nine
Months Ended September 30,
|
||||||||
2009
|
2008
|
|||||||
Balance
at beginning of period
|
$
|
35,651
|
$
|
32,993
|
||||
Provision
for loan and lease losses
|
28,602
|
14,213
|
||||||
Recoveries
on loans and leases previously charged off
|
1,513
|
974
|
||||||
Loans
and leases charged off
|
(23,506
|
)
|
(13,335
|
)
|
||||
Balance
at end of period
|
$
|
42,260
|
$
|
34,845
|
||||
Annualized
net charge-offs to average loans and leases
|
1.22
|
%
|
0.72
|
%
|
The table
below presents the amounts of nonperforming loans and leases and other
nonperforming assets, exclusive of assets covered under loss share agreements,
on the dates indicated:
NONPERFORMING
ASSETS
(Dollars
in thousands)
|
||||||||||||||||
As
of September 30,
|
As
of December 31,
|
|||||||||||||||
2009
|
2008
|
2008
|
2007
|
|||||||||||||
Nonaccrual
loans and leases
|
$
|
78,940
|
$
|
43,523
|
$
|
76,953
|
$
|
30,694
|
||||||||
Loan
and leases contractually past due 90 days or more
|
5,063
|
347
|
1,005
|
1,134
|
||||||||||||
Total
nonperforming loans and leases
|
84,003
|
43,870
|
77,958
|
31,828
|
||||||||||||
Other
real estate
|
32,643
|
9,387
|
11,750
|
2,195
|
||||||||||||
Other
repossessed assets, net
|
565
|
520
|
1,484
|
438
|
||||||||||||
Total
nonperforming assets
|
$
|
117,211
|
$
|
53,777
|
$
|
91,192
|
$
|
34,461
|
||||||||
Nonperforming
loans and leases to total loans and leases
|
3.55
|
%
|
1.86
|
%
|
3.24
|
%
|
1.40
|
%
|
SECURITIES
The
composition of Heartland's securities portfolio is managed to maximize the
return on the portfolio while considering the impact it has on Heartland’s
asset/liability position and liquidity needs. Securities represented 29 percent
of total assets at September 30, 2009, and 25 percent at December 31, 2008.
Total available for sale securities as of September 30, 2009, were $1.08
billion, an increase of $205.9 million or 24 percent from December 31, 2008.
Additional securities were purchased during the first nine months of 2009 as
loan growth slowed.
The table
below presents the composition of the securities portfolio by major category as
of September 30, 2009, and December 31, 2008. More than 75 percent of
Heartland’s mortgage-backed securities are issuances of government-sponsored
enterprises as of September 30, 2009.
SECURITIES
PORTFOLIO COMPOSITION
(Dollars
in thousands)
|
||||||||||||||
September
30, 2009
|
December
31, 2008
|
|||||||||||||
Amount
|
Percent
|
Amount
|
Percent
|
|||||||||||
U.S.
government corporations and agencies
|
$
|
279,818
|
25.30
|
%
|
$
|
195,356
|
21.62
|
%
|
||||||
Mortgage-backed
securities
|
581,632
|
52.60
|
509,501
|
56.38
|
||||||||||
Obligation
of states and political subdivisions
|
207,940
|
18.81
|
163,597
|
18.10
|
||||||||||
Other
securities
|
36,354
|
3.29
|
35,251
|
3.90
|
||||||||||
Total
securities
|
$
|
1,105,744
|
100.00
|
%
|
$
|
903,705
|
100.00
|
%
|
DEPOSITS
AND BORROWED FUNDS
Total
deposits grew to $2.94 billion at September 30, 2009, an increase of $304.2
million or 15 percent annualized since year-end 2008. The Elizabeth State Bank
acquisition accounted for $49.5 million of this growth. With the exception of
First Community Bank, Wisconsin Community Bank and Rocky Mountain Bank, all
Heartland banks experienced a significant increase in deposits. This growth was
weighted more heavily in Heartland’s Western markets, which were responsible for
nearly 55 percent of the growth. Demand deposits increased $68.6 million or 24
percent annualized since year-end 2008 with $6.9 million coming from The
Elizabeth State Bank acquisition. Savings deposit balances experienced an
increase of $257.7 million or 30 percent annualized since year-end 2008 with
$21.0 million coming from The Elizabeth State Bank acquisition. Time deposits,
exclusive of brokered deposits, experienced a decrease of $14.1 million or 2
percent annualized since year-end 2008 despite the $21.6 million assumed in The
Elizabeth State Bank acquisition. At September 30, 2009, brokered time deposits
totaled $43.5 million or 1 percent of total deposits compared to $51.5 million
or 2 percent of total deposits at year-end 2008. Deposit growth, exclusive of
The Elizabeth State Bank acquisition, was $67.4 million during the third quarter
of 2009 compared to $38.8 million during the second quarter of 2009 and $148.5
million during the first quarter of 2009. Growth in non-maturity deposits is
attributable to an increased emphasis on non-maturity core deposit products over
higher-cost certificates of deposit. Additionally, commercial and retail
customers have continued to build cash reserves.
Short-term
borrowings generally include federal funds purchased, treasury tax and loan note
options, securities sold under agreement to repurchase, short-term Federal Home
Loan Bank ("FHLB") advances and discount window borrowings from the Federal
Reserve Bank. These funding alternatives are utilized in varying degrees
depending on their pricing and availability. As of September 30, 2009, the
amount of short-term borrowings was $111.3 million compared to $210.2 million at
year-end 2008, a decrease of $98.8 million or 47 percent, primarily due to
activity in retail repurchase agreements. All of the bank subsidiaries provide
retail repurchase agreements to their customers as a cash management tool,
sweeping excess funds from demand deposit accounts into these agreements. This
source of funding does not increase the bank’s reserve requirements, nor does it
create an expense relating to FDIC premiums on deposits. Although the aggregate
balance of these retail repurchase agreements is subject to variation, the
account relationships represented by these balances are principally local. These
balances were $91.8 million at September 30, 2009, compared to $170.5 million at
year-end 2008.
Also included in short-term borrowings is the revolving credit line
Heartland established with an unaffiliated bank on Septembe 28, 2009, primarily
to provide working capital to Heartland. This credit line may also be used
to fund the operations of Heartland Community Development, Inc., a wholly-owned
subsidiary of Heartland. Under this unsecured revolving credit line,
Heartland may borrow up to a $15.0 million at any one time. At September
30, 2009, $5.0 million was outstanding on this revolving credit line.
Other
borrowings include all debt arrangements Heartland and its subsidiaries have
entered into with original maturities that extend beyond one year. As of
September 30, 2009, the amount of other borrowings was $457.4 million, an
increase of $19.6 million or 4 percent since year-end 2008. Other borrowings
include structured wholesale repurchase agreements which totaled $135.0 million
at September 30, 2009, and $120.0 million at year-end 2008. The balances
outstanding on trust preferred capital securities issued by Heartland are also
included in other borrowings.
A
schedule of Heartland’s trust preferred offerings outstanding as of September
30, 2009, is as follows:
|
(Dollars
in thousands)
|
Amount
Issued
|
Issuance
Date
|
Interest
Rate
|
Interest Rate as of 9/30/09
|
Maturity
Date
|
Callable
Date
|
|
$
|
5,000
|
08/07/00
|
10.60%
|
10.60%
|
09/07/2030
|
09/07/2010
|
20,000
|
10/10/03
|
8.25%
|
8.25%
|
10/10/2033
|
12/30/2009
|
|
25,000
|
03/17/04
|
2.75%
over Libor
|
3.04%
|
03/17/2034
|
12/17/2009
|
|
20,000
|
01/31/06
|
1.33%
over Libor
|
1.84%
|
04/07/2036
|
04/07/2011
|
|
20,000
|
06/21/07
|
6.75%
|
6.75%
|
09/15/2037
|
06/15/2012
|
|
20,000
|
06/26/07
|
1.48%
over Libor
|
1.83%
|
09/01/2037
|
09/01/2012
|
|
$
|
110,000
|
Also in
other borrowings are the bank subsidiaries’ borrowings from the regional Federal
Home Loan Banks. All of the bank subsidiaries, except for Heartland’s most
recent de novo bank,
Minnesota Bank & Trust, own stock in the Federal Home Loan Bank of Chicago,
Dallas, Des Moines, Seattle, San Francisco or Topeka, enabling them to borrow
funds from their respective FHLB for short- or long-term purposes under a
variety of programs. FHLB borrowings at September 30, 2009, totaled $204.2
million, an increase of $4.6 million or 2 percent from the December 31, 2008,
FHLB borrowings of $199.5 million. Total FHLB borrowings at September 30, 2009,
had an average rate of 3.27 percent and an average maturity of 3.55 years. When
considering the earliest possible call date on these advances, the average
maturity is shortened to 2.02 years.
COMMITMENTS
AND CONTRACTUAL OBLIGATIONS
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Heartland banks evaluate each customer’s creditworthiness
on a case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Heartland banks upon extension of credit, is based upon management’s
credit evaluation of the counterparty. Collateral held varies but may include
accounts receivable, inventory, property, plant and equipment and
income-producing commercial properties. Standby letters of credit and financial
guarantees written are conditional commitments issued by the Heartland banks to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. At September 30, 2009,
and December 31, 2008, commitments to extend credit aggregated $570.0 million
and $529.1 million, and standby letters of credit aggregated $25.5 million and
$26.2 million, respectively.
Contractual
obligations and other commitments were presented in Heartland’s 2008 Annual
Report on Form 10-K. There have been no material changes in Heartland’s
contractual obligations and other commitments since that report was
filed.
CAPITAL
RESOURCES
Bank
regulatory agencies have adopted capital standards by which all bank holding
companies will be evaluated. Under the risk-based method of measurement, the
resulting ratio is dependent upon not only the level of capital and assets, but
also the composition of assets and capital and the amount of off-balance sheet
commitments. Heartland and its bank subsidiaries have been, and will continue to
be, managed so they meet the “well-capitalized” requirements under the
regulatory framework for prompt corrective action. To be categorized as
“well–capitalized” under the regulatory framework, bank holding companies and
banks must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios of 10%, 6% and 4%, respectively. The most recent notification
from the FDIC categorized Heartland and each of its bank subsidiaries as
“well–capitalized” under the regulatory framework for prompt corrective action.
There are no conditions or events since that notification that management
believes have changed each institution’s category.
Heartland's
capital ratios were as follows for the dates indicated:
CAPITAL
RATIOS
(Dollars
in thousands)
|
||||||||||||||
September
30, 2009
|
December
31, 2008
|
|||||||||||||
Amount
|
Ratio
|
Amount
|
Ratio
|
|||||||||||
Risk-Based
Capital Ratios1
|
||||||||||||||
Tier 1 capital
|
$
|
380,421
|
13.49
|
%
|
$
|
368,101
|
13.26
|
%
|
||||||
Tier 1 capital minimum
requirement
|
112,801
|
4.00
|
%
|
111,017
|
4.00
|
%
|
||||||||
Excess
|
$
|
267,620
|
9.49
|
%
|
$
|
257,084
|
9.26
|
%
|
||||||
Total
capital
|
$
|
424,324
|
15.05
|
%
|
$
|
413,913
|
14.91
|
%
|
||||||
Total
capital minimum requirement
|
225,601
|
8.00
|
%
|
222,035
|
8.00
|
%
|
||||||||
Excess
|
$
|
198,723
|
7.05
|
%
|
$
|
191,878
|
6.91
|
%
|
||||||
Total
risk-adjusted assets
|
$
|
2,820,016
|
$
|
2,775,436
|
||||||||||
Leverage
Capital Ratios2
|
||||||||||||||
Tier 1 capital
|
$
|
380,421
|
9.98
|
%
|
$
|
368,101
|
10.68
|
%
|
||||||
Tier 1 capital minimum
requirement3
|
152,443
|
4.00
|
%
|
137,917
|
4.00
|
%
|
||||||||
Excess
|
$
|
227,978
|
5.98
|
%
|
$
|
230,184
|
6.68
|
%
|
||||||
Average
adjusted assets (less goodwill and other intangible
assets)
|
$
|
3,811,079
|
$
|
3,447,927
|
(1)
|
Based
on the risk-based capital guidelines of the Federal Reserve, a bank
holding company is required to maintain a Tier 1 capital to risk-adjusted
assets ratio of 4.00% and total capital to risk-adjusted assets ratio of
8.00%.
|
(2)
|
The
leverage ratio is defined as the ratio of Tier 1 capital to average
adjusted assets.
|
(3)
|
Management
of Heartland has established a minimum target leverage ratio of
4.00%. Based on Federal Reserve guidelines, a bank holding
company generally is required to maintain a leverage ratio of 3.00% plus
additional capital of at least 100 basis
points.
|
Commitments
for capital expenditures are an important factor in evaluating capital adequacy.
During the second and third quarters of 2009, Heartland invested capital of
$23.0 million into Heartland Community Development Inc., a wholly-owned
subsidiary of Heartland. The primary purpose of Heartland Community Development
Inc. is to hold and manage certain nonperforming loans and assets to allow the
liquidation of such assets at a time that is more economically advantageous.
Heartland Community Development Inc. purchased other real estate with a fair
value of $23.0 million from certain Heartland bank subsidiaries during the
second and third quarters of 2009.
Summit
Bank & Trust began operations on November 1, 2006, in the Denver, Colorado
suburban community of Broomfield. The capital structure of this new bank is very
similar to that used when New Mexico Bank & Trust and Arizona Bank &
Trust were formed. Heartland’s initial investment was $12.0 million, or 80
percent, of the $15.0 million initial capital. All minority stockholders entered
into a stock transfer agreement that imposes certain restrictions on the sale,
transfer or other disposition of their shares in Summit Bank & Trust and
requires Heartland to repurchase the shares from investors five years from the
date of opening. The stock will be valued by an independent third party
appraiser with the required purchase by Heartland at the appraised value, not to
exceed 18x earnings, or a minimum return of 6 percent on the original investment
amount, whichever is greater. Through September 30, 2009, Heartland accrued the
amount due to the minority stockholders at 6 percent. The obligation to repay
the original investment is payable in cash or Heartland stock or a combination
of cash and stock at the option of the minority stockholders. The remainder of
the obligation to the minority stockholders is payable in cash or Heartland
stock or a combination of cash and stock at the option of
Heartland.
Minnesota
Bank & Trust, Heartland’s newest de novo, began operations on
April 15, 2008, in Edina, Minnesota, located in the Minneapolis, Minnesota
metropolitan area. Heartland’s initial investment was $13.2 million, or 80
percent, of the $16.5 million initial capital. All minority stockholders entered
into a stock transfer agreement that imposes certain restrictions on the sale,
transfer or other disposition of their shares in Minnesota Bank & Trust and
allows, but does not require, Heartland to repurchase the shares from
investors.
On
December 19, 2008, Heartland received $81.7 million through participation in the
U.S. Treasury’s Capital Purchase Program (CPP). The CPP was authorized by the
government’s Troubled Asset Relief Program (TARP) under the Emergency Economic
Stabilization Act of 2008. The TARP is designed to infuse capital into the
nation’s healthiest banks to increase the flow of financing to American
consumers and businesses. Funds received by Heartland were allocated to debt
reduction (including $34.0 million used to extinguish debt on Heartland’s credit
line), capital maintenance at its subsidiary banks and short-term investments.
Heartland continues to honor the intent of the CPP by seeking high quality
lending opportunities and the potential acquisition of banks in its existing
markets, such as The Elizabeth State Bank acquisition completed during the third
quarter of 2009.
Heartland
continues to explore opportunities to expand its footprint of independent
community banks. Given the current issues in the banking industry and the
availability of capital via the TARP, Heartland has changed its strategic growth
initiatives from de
novo banks and branching to acquisitions. Attention will be focused on
markets Heartland currently serves, where there would be an opportunity to grow
market share, achieve efficiencies and provide greater convenience for current
customers. Additionally, management has asked regulators to notify them when
troubled institutions surface in Heartland’s existing markets. Future
expenditures relating to expansion efforts, in addition to those identified
above, are not estimable at this time.
LIQUIDITY
Liquidity
refers to Heartland’s ability to maintain a cash flow that is adequate to meet
maturing obligations and existing commitments, to withstand fluctuations in
deposit levels, to fund operations and to provide for customers’ credit needs.
The liquidity of Heartland principally depends on cash flows from operating
activities, investment in and maturity of assets, changes in balances of
deposits and borrowings and its ability to borrow funds in the money or capital
markets.
Total
cash provided by operating activities was $45.0 million during the first nine
months of 2009 compared to $27.4 million during the first nine months of
2008.
Investing
activities used cash of $176.2 million during the first nine months of 2009
compared to $188.7 million during the first nine months of 2008. The proceeds
from securities sales, paydowns and maturities was $367.0 million during the
first nine months of 2009 compared to $265.5 million during the first nine
months of 2008. Purchases of securities used cash of $539.4 million during the
first nine months of 2009 while $356.4 million was used for securities purchases
during the first nine months of 2008. Cash used to fund loans and leases was
$21.7 million during the first nine months of 2009 compared to $92.6 million
during the first nine months of 2008.
Financing
activities provided cash of $162.4 million during the first nine months of 2009
compared to $181.6 million during the first nine months of 2008. There was a net
increase in deposit accounts of $254.5 million during the first nine months of
2009 compared to $191.6 million during the same nine months of 2008. Activity in
short-term borrowings used cash of $104.7 million during the first nine months
of 2009 compared to $177.6 million during the first nine months of 2008. Cash
proceeds from other borrowings were $55.1 million during the first nine months
of 2009 compared to $222.0 million during the first nine months of 2008.
Repayment of other borrowings used cash of $35.5 million during the first nine
months of 2009 compared to $45.4 million during the first nine months of
2008.
Management
of investing and financing activities, and market conditions, determine the
level and the stability of net interest cash flows. Management attempts to
mitigate the impact of changes in market interest rates to the extent possible,
so that balance sheet growth is the principal determinant of growth in net
interest cash flows.
Heartland’s
short-term borrowing balances are dependent on commercial cash management and
smaller correspondent bank relationships and, as such, will normally fluctuate.
Heartland believes these balances, on average, to be stable sources of funds;
however, it intends to rely on deposit growth and additional FHLB borrowings in
the future.
In the
event of short-term liquidity needs, the bank subsidiaries may purchase federal
funds from each other or from correspondent banks and may also borrow from the
Federal Reserve Bank. Additionally, the subsidiary banks' FHLB memberships give
them the ability to borrow funds for short- and long-term purposes under a
variety of programs.
At September 30, 2009, Heartland's revolving credit agreement with an
unaffiliated bank provided a maximum borrowing capacity of $15.0 million, of
which $5.0 million had been borrowed. This credit agreement contains
specific covenants which are listed in Note 5 to the consolidated financial
statments. At September 30, 2009, Heartland was in compliance with these
covenants.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market
risk is the risk of loss arising from adverse changes in market prices and
rates. Heartland’s market risk is comprised primarily of interest rate risk
resulting from its core banking activities of lending and deposit gathering.
Interest rate risk measures the impact on earnings from changes in interest
rates and the effect on current fair market values of Heartland’s assets,
liabilities and off-balance sheet contracts. The objective is to measure this
risk and manage the balance sheet to avoid unacceptable potential for economic
loss.
Management
continually develops and applies strategies to mitigate market risk. Exposure to
market risk is reviewed on a regular basis by the asset/liability committees of
the banks and, on a consolidated basis, by Heartland’s executive management and
board of directors. Darling Consulting Group, Inc. has been engaged to provide
asset/liability management position assessment and strategy formulation services
to Heartland and its bank subsidiaries. At least quarterly, a detailed review of
the balance sheet risk profile is performed for Heartland and each of its
subsidiary banks. Included in these reviews are interest rate sensitivity
analyses, which simulate changes in net interest income in response to various
interest rate scenarios. This analysis considers current portfolio rates,
existing maturities, repricing opportunities and market interest rates, in
addition to prepayments and growth under different interest rate assumptions.
Selected strategies are modeled prior to implementation to determine their
effect on Heartland’s interest rate risk profile and net interest income.
Although Heartland has entered into derivative financial instruments to mitigate
the exposure of Heartland’s net interest income to a change in the rate
environment, management does not believe that Heartland’s primary market risk
exposures have changed significantly in 2009 when compared to 2008.
The core
interest rate risk analysis utilized by Heartland examines the balance sheet
under increasing and decreasing interest scenarios that are neither too modest
nor too extreme. All rate changes are ramped over a 12-month horizon based upon
a parallel shift in the yield curve and then maintained at those levels over the
remainder of the simulation horizon. Using this approach, management is able to
see the effect that both a gradual change of rates (year 1) and a rate shock
(year 2 and beyond) could have on Heartland’s net interest income. Starting
balances in the model reflect actual balances on the “as of” date, adjusted for
material and significant transactions. Pro-forma balances remain static. This
enables interest rate risk embedded within the existing balance sheet to be
isolated from the interest rate risk often caused by growth in assets and
liabilities. Due to the low interest rate environment, the simulations under a
decreasing interest rate scenario were prepared using a 100 basis point shift in
rates during the second quarters of 2009 and 2008 instead of the 200 basis point
shift typically used. The most recent reviews at September 30, 2009 and 2008,
provided the following results:
2009
|
2008
|
|||||||||||||||||
Net
Interest
Income
(in thousands)
|
%
Change
From
Base
|
Net
Interest
Income
(in thousands)
|
%
Change
From
Base
|
|||||||||||||||
Year 1
|
||||||||||||||||||
Down
100 Basis Points
|
$ | 137,541 | 0.34 | % | $ | 113,869 | (1.24 | ) | % | |||||||||
Base
|
$ | 137,080 | $ | 115,297 | ||||||||||||||
Up
200 Basis Points
|
$ | 133,469 | (2.63 | ) | % | $ | 114,851 | (0.39 | ) | % | ||||||||
Year 2
|
||||||||||||||||||
Down
100 Basis Points
|
$ | 134,178 | (2.12 | ) | % | $ | 106,549 | (7.59 | ) | % | ||||||||
Base
|
$ | 137,026 | (0.04 | ) | % | $ | 113,445 | (1.61 | ) | % | ||||||||
Up
200 Basis Points
|
$ | 137,239 | 0.12 | % | $ | 116,011 | 0.62 | % |
Heartland
uses derivative financial instruments to manage the impact of changes in
interest rates on its future interest income or interest expense. Heartland is
exposed to credit-related losses in the event of nonperformance by the
counterparties to these derivative instruments, but believes it has minimized
the risk of these losses by entering into the contracts with large, stable
financial institutions. The estimated fair market values of these derivative
instruments are presented in Note 6 to the consolidated financial
statements.
Heartland
enters into financial instruments with off balance sheet risk in the normal
course of business to meet the financing needs of its customers. These financial
instruments include commitments to extend credit and standby letters of credit.
These instruments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the consolidated balance sheets.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates and may require collateral from the
borrower. Standby letters of credit are conditional commitments issued by
Heartland to guarantee the performance of a customer to a third party up to a
stated amount and with specified terms and conditions. These commitments to
extend credit and standby letters of credit are not recorded on the balance
sheet until the instrument is exercised.
Heartland
holds a securities trading portfolio that would also be subject to elements of
market risk. These securities are carried on the balance sheet at fair value. As
of September 30, 2009, these securities had a carrying value of $756 thousand or
0.02 percent of total assets compared to $1.7 million or 0.05 percent of total
assets at year-end 2008.
ITEM
4. CONTROLS AND PROCEDURES
As
required by Rule 13a-15(b) under the Securities Exchange Act of 1934,
Heartland’s management, with the participation of the Chief Executive Officer
and Chief Financial Officer, has evaluated the effectiveness of Heartland’s
disclosure controls and procedures as of the end of the period covered by this
report. Based on this evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that Heartland’s disclosure controls and procedures
(as defined in Exchange Act Rule 13a-15(e)) were effective as of September 30,
2009, in ensuring that information required to be disclosed by Heartland in the
reports it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in applicable rules
and forms, and that such information is accumulated and communicated to its
management, including its Chief Executive Officer and Chief Financial Officer,
in a manner that allows for timely decisions regarding required
disclosure.
There
were no changes in Heartland’s internal control over financial reporting that
occurred during the quarter ended September 30, 2009, that have materially
affected, or are reasonably likely to materially affect, Heartland’s internal
control over financial reporting.
PART
II
ITEM
1. LEGAL PROCEEDINGS
There are
no material pending legal proceedings to which Heartland or its subsidiaries is
a party other than ordinary routine litigation incidental to their respective
businesses. While the ultimate outcome of current legal proceedings cannot be
predicted with certainty, it is the opinion of management that the resolution of
these legal actions should not have a material effect on Heartland's
consolidated financial position or results of operations.
ITEM
1A. RISK FACTORS
There
have been no material changes in the risk factors applicable to Heartland from
those disclosed in Part I, Item 1A. “Risk Factors”, in Heartland’s 2008 Annual
Report on Form 10-K. Please refer to that section of Heartland’s Form 10-K for
disclosures regarding the risks and uncertainties related to Heartland’s
business.
ITEM
2. UNREGISTERED SALES OF ISSUER SECURITIES AND USE OF PROCEEDS
The
following table provides information about purchases by Heartland and its
affiliated purchasers during the quarter ended September 30, 2009, of its common
stock:
Period
|
(a)
Total
Number of Shares Purchased
|
(b)
Average
Price Paid per Share
|
(c)
Total
Number of Shares Purchased as Part of Publicly Announced Plans or
Programs(1)
|
(d)
Approximate
Dollar Value of Shares that May Yet Be Purchased Under the Plans or
Programs(2)
|
07/01/09-
07/31/09
|
1,449
|
$16.06
|
1,449
|
$3,329,352
|
08/01/09-
08/31/09
|
1,151
|
$16.53
|
1,551
|
$2,987,323
|
09/01/09-
09/30/09
|
-
|
-
|
-
|
$3,101,660
|
Total:
|
2,600
|
$16.27
|
2,600
|
N/A
|
(1)
|
The
amounts listed represent solely repurchases made under Heartland’s
Dividend Reinvestment Plan.
|
(2)
|
Although
Heartland’s board of directors authorized management to acquire and hold
up to 500,000 shares of common stock as treasury shares at any one time,
Heartland is prohibited from any repurchase, redemption, or acquisition of
its common stock, except for certain repurchases to the extent of
increases in shares outstanding because of issuances under existing
benefit plans, under the terms of the Securities Purchase Agreement
pursuant to which Heartland issued preferred stock to the Treasury under
the Capital Purchase Program.
|
ITEM
3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM
5. OTHER INFORMATION
None
ITEM
6. EXHIBITS
Exhibits
31.1
|
Certification
of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a).
|
31.2
|
Certification
of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a).
|
32.1
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
32.2
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned there unto
duly authorized.
HEARTLAND
FINANCIAL USA, INC.
(Registrant)
Principal Executive
Officer
/s/ Lynn B. Fuller
-----------------------
By: Lynn B. Fuller
President and Chief Executive
Officer
Principal Financial and
Accounting Officer
/s/ John
K. Schmidt
-----------------------
By: John K. Schmidt
Executive Vice President
and Chief Financial
Officer
Dated: November 9, 2009