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, 2007, included in Heartland Financial USA, Inc.’s
("Heartland") Form 10-K filed with the Securities and Exchange Commission on
March 17, 2008. 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, 2008, are not necessarily indicative of the
results expected for the year ending December 31, 2008.
Earnings
Per Share
Basic
earnings per share is determined using net income and weighted average common
shares outstanding. Diluted earnings per share is computed by dividing net
income 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, 2008
and 2007, are shown in the tables below:
|
|
Three
Months Ended
|
(Dollars
and numbers in thousands, except per share data)
|
|
Sept.
30, 2008
|
|
Sept.
30, 2007
|
Net
income
|
|
$
|
3,005
|
|
|
$
|
6,925
|
|
Weighted
average common shares outstanding for basic earnings per
share
|
|
|
16,264
|
|
|
|
16,447
|
|
Assumed
incremental common shares issued upon exercise of stock
options
|
|
|
91
|
|
|
|
97
|
|
Weighted
average common shares for diluted earnings per share
|
|
|
16,355
|
|
|
|
16,544
|
|
Earnings
per common share – basic
|
|
$
|
0.18
|
|
|
$
|
0.42
|
|
Earnings
per common share – diluted
|
|
$
|
0.18
|
|
|
$
|
0.42
|
|
|
|
Nine
Months Ended
|
(Dollars
and numbers in thousands, except per share data)
|
|
Sept.
30, 2008
|
|
Sept.
30, 2007
|
Income
from continuing operations
|
|
$
|
13,975
|
|
|
$
|
17,210
|
|
Income
from discontinued operations
|
|
|
-
|
|
|
|
1,671
|
|
Net
income
|
|
$
|
13,975
|
|
|
$
|
18,881
|
|
Weighted
average common shares outstanding for basic earnings per
share
|
|
|
16,315
|
|
|
|
16,487
|
|
Assumed
incremental common shares issued upon exercise of stock
options
|
|
|
77
|
|
|
|
133
|
|
Weighted
average common shares for diluted earnings per share
|
|
|
16,392
|
|
|
|
16,620
|
|
Earnings
per common share – basic
|
|
$
|
0.86
|
|
|
$
|
1.15
|
|
Earnings
per common share – diluted
|
|
$
|
0.85
|
|
|
$
|
1.14
|
|
Earnings
per common share from continuing operations – basic
|
|
$
|
0.86
|
|
|
$
|
1.04
|
|
Earnings
per common share from continuing operations – diluted
|
|
$
|
0.85
|
|
|
$
|
1.04
|
|
Earnings
per common share from discontinued operations – basic
|
|
$
|
-
|
|
|
$
|
0.10
|
|
Earnings
per common share from discontinued operations – diluted
|
|
$
|
-
|
|
|
$
|
0.10
|
|
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. The 2008 standard stock option agreement provides that the
options become fully exercisable and expire if not exercised within six months
of the date of retirement at age 65 or later. Prior period stock option
agreements included early retirement provisions at age 55 provided that the
officer has provided ten years of service to Heartland. A summary of the status
of the stock options as of September 30, 2008 and 2007, and changes during the
nine months ended September 30, 2008 and 2007, follows:
|
|
2008
|
|
2007
|
|
|
Shares
|
|
Weighted-Average
Exercise Price
|
|
Shares
|
|
Weighted-Average
Exercise Price
|
Outstanding
at January 1
|
|
|
733,012
|
|
|
$
|
18.61
|
|
|
|
815,300
|
|
|
$
|
14.46
|
|
Granted
|
|
|
164,400
|
|
|
|
18.60
|
|
|
|
146,750
|
|
|
|
29.65
|
|
Exercised
|
|
|
(98,549
|
)
|
|
|
11.56
|
|
|
|
(194,788
|
)
|
|
|
9.86
|
|
Forfeited
|
|
|
(16,000
|
)
|
|
|
24.96
|
|
|
|
(14,500
|
)
|
|
|
25.24
|
|
Outstanding
at September 30
|
|
|
782,863
|
|
|
$
|
19.36
|
|
|
|
752,762
|
|
|
$
|
18.40
|
|
Options
exercisable at September 30
|
|
|
277,713
|
|
|
$
|
13.60
|
|
|
|
300,554
|
|
|
$
|
11.60
|
|
Weighted-average
fair value of options granted during the nine-month periods ended
September 30
|
|
$
|
4.81
|
|
|
|
|
|
|
$
|
7.69
|
|
|
|
|
|
At
September 30, 2008, the vested options totaled 277,713 shares with a weighted
average exercise price of $13.60 per share and a weighted average remaining
contractual life of 3.79 years. The intrinsic value for the vested options as of
September 30, 2008, was $3.2 million. The intrinsic value for the total of all
options exercised during the nine months ended September 30, 2008, was $1.3
million, and the total fair value of shares vested during the nine months ended
September 30, 2008, was $876 thousand. At September 30, 2008, shares available
for issuance under the 2005 Long-Term Incentive Plan totaled
474,810.
The fair
value of the 2008 and 2007 stock options granted 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. The fair value of a share of common
stock on the grant date of the 2007 options was $27.85. Significant assumptions
include:
|
|
2008
|
|
|
2007
|
|
Risk-free
interest rate
|
|
|
3.10
|
%
|
|
|
4.74
|
%
|
Expected
option life
|
|
6.4
years
|
|
|
6.2
years
|
|
Expected
volatility
|
|
|
26.96
|
%
|
|
|
24.20
|
%
|
Expected
dividends
|
|
|
1.99
|
%
|
|
|
1.25
|
%
|
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, 2008, was $1.1 million, with a related tax
benefit of $266 thousand. Cash received from options exercised for the nine
months ended September 30, 2007, was $1.9 million, with a related tax benefit of
$845 thousand.
Total
compensation costs recorded were $864 thousand and $1.2 million for the nine
months ended September 30, 2008 and 2007, respectively, for stock options,
restricted stock awards and shares to be issued under the 2006 Employee Stock
Purchase Plan. As of September 30, 2008, there was $2.8 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, Heartland adopted Statement of Financial Accounting Standards
No. 157 (“FAS 157”),
Fair
Value Measurements
. FAS 157 defines fair value, establishes a framework
for measuring fair value under U.S. generally accepted accounting principles,
and expands disclosures about fair value measurements. FAS 157
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. FAS 157 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.
FAS 157 requires fair value measurements to be separately disclosed by level
within the fair value hierarchy. Under FAS 157, 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 FAS 157.
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 5.
Heartland
will apply the fair value measurement and disclosure provisions of FAS 157
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
In
September 2006, the Emerging Issues Task Force Issue 06-4 (“EITF 06-4”),
Accounting for Deferred Compensation
and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements,
was ratified. EITF 06-4 addresses accounting for separate
agreements which split life insurance policy benefits between an employer and
employee and requires the employer to recognize a liability for future benefits
payable to the employee under these agreements. The effects of applying EITF
06-4 must be recognized through either a change in accounting principle through
an adjustment to equity or through the retrospective application to all prior
periods. For calendar year companies, EITF 06-4 is effective beginning January
1, 2008. Heartland adopted EITF 06-4 on January 1, 2008, which resulted in a
$791 thousand adjustment to Heartland’s equity on January 1, 2008.
In
February 2007, the FASB issued Statement of Financial Accounting Standards No.
159 (“FAS 159”),
The Fair
Value Option for Financial Assets and Financial Liabilities
, which allows
entities to voluntarily choose, at specified election dates, to measure many
financial assets and financial liabilities at fair value. The election is made
on an instrument-by-instrument basis and is irrevocable. If the fair value
option is elected for an instrument, FAS 159 specifies that all subsequent
changes in fair value for that instrument shall be reported in earnings. FAS 159
is effective for all financial statements issued for fiscal years beginning
after November 15, 2007. Heartland adopted FAS 159 on January 1, 2008, and the
adoption did not have an impact on its consolidated financial
statements.
In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141 (Revised 2007)
Business
Combinations
(“SFAS No. 141R”) and Statement of Financial Accounting
Standards No. 160,
Noncontrolling Interests in
Consolidated Financial Statements
, an amendment of ARB No. 51 (“SFAS No.
160”). SFAS No. 141R and SFAS No. 160 require significant changes in the
accounting and reporting for business acquisitions and the reporting of a
noncontrolling interest in a subsidiary. Among many changes under SFAS No. 141R,
an acquirer will record 100% 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. SFAS No. 160 establishes
new accounting and reporting standards for the noncontrolling interest in a
subsidiary. Key changes under the standard are that noncontrolling interests in
a subsidiary will 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, gain or loss is recognized
and the remaining interest is remeasured at fair value on the date control is
lost. SFAS No. 141R and SFAS No. 160 apply prospectively to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008. Early
adoption is not permitted. Heartland will adopt these statements on January 1,
2009.
In March
2008, the FASB issued Statement of Financial Accounting Standards No. 161 (“FAS
161”),
Disclosures about
Derivative Instruments and Hedging Activities
, an amendment of FASB
Statement No. 133, 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 under SFAS No.
133 and its related interpretations, and (c) how derivative instruments and
related hedged items affect an entity’s financial position, financial
performance and cash flows. FAS 161 is effective for all financial statements
issued for fiscal years and interim periods beginning after November 15, 2008.
Heartland is currently evaluating the impact of FAS 161 on its consolidated
financial statement disclosures.
In May
2008, the FASB issued Statement of Financial Accounting Standards No. 162 (“FAS
162”),
The Hierarchy of
Generally Accepted Accounting Principles
, which identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented inconformity with GAAP in the United States (the “U.S. GAAP
hierarchy”). The current U.S. GAAP hierarchy is set forth in the American
Institute of Certified Public Accountants Statement of Auditing Standard No. 69,
The Meaning of Present Fairly
in Conformity With Generally Accepted Accounting Principles.
The FASB has
concluded that the U.S. GAAP hierarchy should reside in the accounting
literature established by the FASB and issued FAS 162 to achieve that result.
FAS 162 is effective 60 days following the SEC’s approval of the Public Company
Accounting Oversight Board amendments to Interim Auditing Standards AU Section
411,
The Meaning of Present
Fairly in Conformity With Generally Accepted Accounting Principles.
Heartland does not expect the adoption of FAS 162 to have an impact on
its consolidated financial statements.
In June
2008, the FASB issued FASB Staff Position EITF 03-6-1 (“FSP EITF 03-6-1”),
Determining Whether Instruments
Granted In Share-Based Payment Transactions Are Participating Securities,
which clarified that all outstanding unvested share-based payment awards that
contain rights to nonforfeitable dividends participate in undistributed earnings
with common shareholders. Awards of this nature are considered participating
securities and the two-class method of computing basic and diluted earnings per
share must be applied. FSP EITF 03-6-1 is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those years. All prior-period EPS data presented shall be adjusted
retrospectively. Early application is not
permitted.
Heartland does not expect the adoption of FSP EITF 03-6-1 to have an impact on
its consolidated financial statements as none of its unvested restricted stock
participates with common shareholders in dividends declared and
paid.
In
October 2008, the FASB issued FASB Staff Position No. 157-3 (“FAS 157-3”),
Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active
, which
clarifies the application of FAS 157 in a market that is not active and provides
an example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. This FSP
was effective upon issuance, including prior periods for which financial
statements have not been issued. Heartland adopted this guidance effective
September 30, 2008, and the adoption did not have an impact on its consolidated
financial statements.
The SEC
released Staff Accounting Bulletin No. 109 (“SAB No. 109”) in November 2007. SAB
No. 109 provides guidance on written loan commitments that are accounted for at
fair value through earnings. SAB No. 109 supersedes SAB No. 105 which provided
guidance on derivative loan commitments pursuant to SFAS No. 133, “
Accounting for Derivative
Instruments and Hedging Activities
”. SAB No. 105 stated that in measuring
the fair value of a derivative loan commitment it would be inappropriate to
incorporate the expected net future cash flows related to the associated
servicing of the loan. SAB No. 109, consistent with the guidance in SFAS No. 156
and SFAS No. 159, requires that expected net future cash flows related to the
associated servicing of the loan be included in the measurement of all written
loan commitments that are accounted for at fair value through earnings. SAB No.
109 is effective for fiscal quarters beginning after December 15, 2007.
Heartland adopted SAB No. 109 on January 1, 2008, and the adoption of this issue
did not have a material impact on its consolidated financial
statements.
NOTE
2: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS
The gross
carrying amount of intangible assets and the associated accumulated amortization
at September 30, 2008, and December 31, 2007, are presented in the table below,
in thousands:
|
|
September
30, 2008
|
|
December
31, 2007
|
|
|
Gross
Carrying Amount
|
|
Accumulated
Amortization
|
|
Gross
Carrying Amount
|
|
Accumulated
Amortization
|
Amortized
intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Core deposit
intangibles
|
|
$
|
9,757
|
|
|
$
|
6,882
|
|
|
$
|
9,757
|
|
|
$
|
6,252
|
|
Mortgage servicing
rights
|
|
|
7,641
|
|
|
|
3,058
|
|
|
|
6,505
|
|
|
|
2,592
|
|
Customer relationship
intangible
|
|
|
1,177
|
|
|
|
303
|
|
|
|
1,177
|
|
|
|
226
|
|
Total
|
|
$
|
18,575
|
|
|
$
|
10,243
|
|
|
$
|
17,439
|
|
|
$
|
9,070
|
|
Unamortized
intangible assets
|
|
|
|
|
|
$
|
8,332
|
|
|
|
|
|
|
$
|
8,369
|
|
Projections
of amortization expense for mortgage servicing rights are based on existing
asset balances and the existing interest rate environment as of September 30,
2008. 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, 2008, or
December 31, 2007. The fair value of Heartland’s mortgage servicing rights was
estimated at $7.6 million and $6.4 million at September 30, 2008, and December
31, 2007, 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, 2008
|
|
$
|
216
|
|
|
$
|
339
|
|
|
$
|
26
|
|
|
$
|
581
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ending December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
748
|
|
|
|
1,212
|
|
|
|
102
|
|
|
|
2,062
|
|
2010
|
|
|
465
|
|
|
|
1,010
|
|
|
|
100
|
|
|
|
1,575
|
|
2011
|
|
|
450
|
|
|
|
808
|
|
|
|
99
|
|
|
|
1,357
|
|
2012
|
|
|
421
|
|
|
|
607
|
|
|
|
55
|
|
|
|
1,083
|
|
2013
|
|
|
405
|
|
|
|
404
|
|
|
|
45
|
|
|
|
854
|
|
Thereafter
|
|
|
170
|
|
|
|
203
|
|
|
|
447
|
|
|
|
820
|
|
NOTE
3: SHORT-TERM BORROWINGS
On April
28, 2008, Heartland’s credit agreement was renewed with two of the four
unaffiliated banks, which resulted in a reduction in the amount Heartland could
borrow at any one time under this unsecured revolving credit line from $60.0
million to $40.0 million. On June 30, 2008, an additional unaffiliated bank was
added to this credit agreement and thereby increased the amount Heartland may
borrow at any one time back to $60.0 million.
NOTE
4: 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 matures on April 4, 2009. Heartland is the payer
on prime at a cap strike rate of 8.95% and the counterparty is the payer on
prime at a floor strike rate of 7.00%. As of September 30, 2008, and December
31, 2007, the fair market value of this collar transaction was recorded as an
asset of $502 thousand and $391 thousand, respectively.
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, 2008, and
December 31, 2007, the fair market value of this collar transaction was recorded
as an asset of $741 thousand and $387 thousand, 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 are
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 has an effective date of February 1,
2007, and a maturity date of January 7, 2009. 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 deferral feature that
is mirrored in the cap transaction. As of September 30, 2008, and December 31,
2007, this cap transaction had no fair market 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 has an effective date of February 1, 2007,
and a maturity date of March 17, 2009. 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, 2008, and December
31, 2007, this cap transaction had no fair market 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, 2008, the fair market value
of this cap transaction was recorded as an asset of $230 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, 2008, the fair market value
of this cap transaction was recorded as an asset of $59 thousand.
For both
the collar and cap 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 the 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.
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 the collar transaction of $212 thousand and a
reclassification of unrealized losses out of other comprehensive income to
earnings of $14 thousand. During the quarter ended June 30, 2008, the mark to
market adjustment on this collar transaction was recorded as a loss of $173
thousand. During the quarter ended September 30, 2008, the mark to market
adjustment on this collar transaction was recorded as a gain of $63
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 stockholders’ equity, before income taxes of $203
thousand. For the nine months ended September 30, 2007, the change in
net unrealized losses of $235 thousand for derivatives designated as cash flow
hedges is separately disclosed in the statement of changes in shareholders’
equity, before income taxes of $87 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, 2008, the change in net unrealized losses on cash flow
hedges reflects a reclassification of $63 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 $84 thousand
will be reclassified from accumulated other comprehensive income to interest
income.
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
5: 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 FAS
157, 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. Level 3 securities
consist primarily of auction rate securities. Heartland has utilized auction
rate securities in previous periods as a higher-yielding alternative investment
for fed funds. Heartland purchased $10.7 million of auction rate securities in
February of 2008. This portfolio consisted of securities issued by various state
governmental entities and includes securities backed by student loans that are
guaranteed under the Federal Family Education Loan Program. Auction rate
securities are primarily debt instruments with long-term maturities for which
interest rates are reset periodically through an auction process, which
typically occurs every 28 days. The auction process results in the interest rate
being reset on the underlying securities until the next reset or auction date. A
failed auction occurs when there are insufficient bids for the number of
instruments being offered. Upon a failed auction, the then present holders of
the instruments continue to hold them and the instrument carries an interest
rate based upon certain predefined formulas. In February 2008, the market for
these securities began to show signs of illiquidity as auctions for several
securities failed on their scheduled auction dates. Shortly thereafter,
liquidity left the market causing the traditional auction process to fail. As a
result, Heartland was not able to access these funds until the securities were
redeemed by the issuer. Due to the illiquidity in the market for auction rate
securities, Heartland had classified these investments as Level 3 for purposes
of reporting under FAS 157. In April 2008, $1.0 million of the $10.7 million was
redeemed at par value and in September 2008, the remaining $9.7 million was
redeemed at par value. All of the related auction rate securities paid interest
as defined by the predetermined formula. The remaining $200 thousand of
securities classified as Level 3 is related to an investment in a
partnership.
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 FAS
114,
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, 2008, substantially all of the total impaired
loans were based on the fair value of the collateral. In accordance with FAS
157, 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 and collars 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 FAS No. 157, 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, 2008, 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.
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, 2008, aggregated
by the level in the fair value hierarchy within which those measurements
fall:
|
|
Total
Fair Value
Sept.
30, 2008
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading
securities
|
|
$
|
1,962
|
|
|
$
|
1,962
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Available-for-sale
securities
|
|
|
733,820
|
|
|
|
113,320
|
|
|
|
620,300
|
|
|
|
200
|
|
Derivative
assets
|
|
|
1,244
|
|
|
|
-
|
|
|
|
1,244
|
|
|
|
-
|
|
Total
assets at fair value
|
|
$
|
737,026
|
|
|
$
|
115,282
|
|
|
$
|
621,544
|
|
|
$
|
200
|
|
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, 2008
|
$
|
200
|
|
Purchases
|
|
10,700
|
|
Redemptions
|
|
(10,700
|
)
|
Balance
at September 30, 2008
|
$
|
200
|
|
The table
below presents Heartland’s assets measured at fair value on a nonrecurring
basis, in thousands:
|
|
Carrying
Value at September 30, 2008
|
|
|
Nine
Months Ended Sept. 30, 2008
|
|
|
|
Total
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired
loans
|
|
$
|
23,890
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
23,890
|
|
|
$
|
4,147
|
|
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 2007 Form 10-K filed with the Securities and Exchange Commission on
March 17, 2008. 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 banks’ boards of directors. Specific factors considered by
management in establishing the allowance included the following:
*
|
Heartland
has continued to experience growth in more complex commercial loans as
compared to relatively lower-risk residential real estate
loans.
|
|
|
*
|
During
the last several years, Heartland has entered new geographical markets in
which it had little or no previous lending experience.
|
|
|
*
|
Heartland
has experienced an increase in net charge-offs and nonperforming loans
during the most recent quarters.
|
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, 2008. While management uses
available information to provide for loan and lease losses, the ultimate
collectibility of a substantial portion of the loan portfolio and the need for
future additions to the allowance will be based on changes in economic
conditions. 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
provision for loan and lease losses.
Net
income was $3.0 million, or $0.18 per diluted share, for the quarter ended
September 30, 2008, compared to $6.9 million, or $0.42 per diluted share, earned
during the third quarter of 2007. Return on average equity was 5.26 percent and
return on average assets was 0.35 percent for the third quarter of 2008,
compared to 12.72 percent and 0.86 percent, respectively, for the same quarter
in 2007.
Earnings
for the third quarter of 2008 were significantly impacted by the provision for
loan losses, which was $7.1 million for the third quarter of 2008 compared to
$575 thousand for the third quarter of 2007. This increase in the loan loss
provision was due, in large part, to the continued softening of the economy and
reduced real estate values, particularly in the Phoenix market. Earnings in the
third quarter of 2008 were also negatively impacted by a $4.6 million impairment
loss on Fannie Mae preferred stock, which was offset by a $5.2 million gain on
the sale of Heartland’s merchant bankcard processing services.
Net
interest margin was 3.96 percent during the third quarter of 2008, the third
straight quarter that net interest margin improved. During the third quarter of
2008, net interest income on a tax-equivalent basis increased $2.7 million or 10
percent compared to the same quarter in 2007. Average earning assets increased
$209.4 million or 7 percent during the comparable quarterly periods. Noninterest
income remained at $7.9 million during both the third quarter of 2008 and 2007.
In addition to the $5.2 million gain on the sale of the merchant bankcard
processing services, the other category showing notable improvement during the
third quarter of 2008 was service charges and fees. The additional income in
these categories was partially offset by $4.7 million of impairment losses on
securities, decreased gains on sale of loans and a loss on the cash surrender
value of bank owned life insurance. For the third quarter of 2008, noninterest
expense increased $1.9 million or 8 percent from the same period in 2007. The
largest component of noninterest expense, salaries and employee benefits,
increased $699 thousand or 5 percent during the third quarter of 2008 compared
to the third quarter of 2007. Occupancy expense increased during the quarter,
primarily as a result of the opening of six new banking offices during 2007 and
the 2008 opening of Heartland’s 10
th
bank
subsidiary, Minnesota Bank & Trust. The other category of noninterest
expense that increased significantly during the third quarter of 2008 was
outside services, resulting primarily from additional legal fees related to
collection efforts on nonperforming loans and additional Federal Deposit
Insurance Corporation (“FDIC”) assessments as a majority of the FDIC credits at
Heartland’s bank subsidiaries were utilized during 2007.
Net
income recorded for the first nine months of 2008 was $14.0 million, or $0.85
per diluted share, compared to $18.9 million, or $1.14 per diluted share,
recorded during the first nine months of 2007. Return on average equity was 8.04
percent and return on average assets was 0.56 percent for the first nine months
of 2008, compared to 11.89 percent and 0.80 percent, respectively, for the same
period in 2007.
The 2007
results were impacted by the sale of Rocky Mountain Bank’s branch banking office
in Broadus, Montana, which was completed on June 22, 2007. The results of
operations of the branch are reflected on the income statement as discontinued
operations for the nine-month period ended on September 30, 2007, which included
a $2.4 million pre-tax gain recorded as a result of the sale. Income from
continuing operations during the first nine months of 2008 was $14.0 million, or
$0.85 per diluted share, a decrease of $3.2 million or 19 percent over the $17.2
million, or $1.04 per diluted share, earned during the same period in 2007. The
provision for loan losses for the nine-month comparative period was $14.2
million during 2008 compared to $6.8 million during 2007. The provision for loan
losses increased as a result of loan growth, an increase in nonperforming loans
and the impact historical losses have on the calculation of the adequacy of
Heartland’s allowance for loan and lease losses. The nine-month performance
during 2008 was positively affected by increased net interest income and growth
in noninterest income.
For the
nine-month period ended September 30, 2008, net interest income on a
tax-equivalent basis increased $4.7 million or 6 percent when compared to the
same period in 2007. During this same nine-month comparative period, Heartland’s
average earning assets increased $198.2 million or 7 percent. Noninterest income
increased $1.1 million or 4 percent over the same nine-month period in 2007. In
addition to the $5.2 million gain on the sale of merchant bankcard processing
services, noninterest income during the first nine months of 2008 was positively
affected by growth in service charges and fees, loan servicing income, brokerage
and insurance commissions and securities gains. The improvements in these
categories were partially offset by $4.8 million of impairment losses on
securities and increased losses on trading account securities, reduced gains on
sale of loans and a loss in the cash surrender value of bank owned life
insurance. For the nine-month comparative period in 2008, noninterest expense
increased $3.8 million or 5 percent when compared to the same nine-month period
in 2007. Again, the largest component of noninterest expense, salaries and
employee benefits, grew by $1.8 million or 4 percent during this nine-month
comparative period. Occupancy expense increased during the nine-month
comparative periods, primarily as a result of the aforementioned expansion
activities. The other category of noninterest expense that increased
significantly during the 2008 nine-month period was outside services, resulting
primarily from the aforementioned additional legal fees and FDIC
assessments.
At
September 30, 2008, total assets had increased $181.9 million or 7 percent
annualized since year-end 2007. For the same period, total loans and leases
increased $84.1 million or 5 percent annualized. This growth was primarily
distributed among the commercial, agricultural and consumer loan categories at
$39.8 million, $19.7 million and $25.0 million, respectively. 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.
Total
deposits had grown by $191.6 million or 11 percent annualized since year-end
2007. Growth in deposits was weighted more heavily in Heartland’s Western
markets. Demand deposits experienced a decrease of $8.3 million or 3 percent
annualized since year-end 2007. Savings deposit balances experienced an increase
of $187.3 million or 29 percent annualized since year-end 2007. Time deposits,
exclusive of brokered deposits, remained at $1.1 billion. At September 30, 2008,
brokered time deposits totaled $81.9 million or 3 percent of total deposits
compared to $69.0 million or 3 percent of total deposits at year-end 2007. A
large portion of the growth in savings deposits is attributable to the January
2008 introduction of a new retail interest-bearing checking account product, the
third quarter 2008 introduction of a premium money market account that featured
a teaser interest rate of 5 percent through year-end 2008 and the conversion of
several retail repurchase agreement sweep accounts to a new money market sweep
product initially rolled out to business depositors during the second quarter of
2008.
NET
INTEREST INCOME
Net
interest margin, expressed as a percentage of average earning assets, was 3.96
percent during the third quarter of 2008 compared to 3.87 percent for the third
quarter of 2007. For the nine-month periods ended on September 30, net interest
margin, expressed as a percentage of average earning assets, was 3.92 percent
during 2008 and 3.98 percent during 2007. Affecting the net interest margin
throughout the second half of 2007 and first nine months of 2008 was the impact
of foregone interest on Heartland’s nonperforming loans, which had balances of
$43.9 million at September 30, 2008, compared to $31.8 million at year-end 2007
and $30.4 million at September 30, 2007. Additionally, early in the third
quarter of 2007, a $20.5 million investment was made in bank owned life
insurance upon which interest expense associated with the funding of this
investment is reflected in net interest margin while the corresponding earnings
on this investment are recorded as noninterest income.
Net
interest income on a tax-equivalent basis totaled $30.9 million during the third
quarter of 2008, an increase of $2.7 million or 10 percent from the $28.2
million recorded during the third quarter of 2007. For the nine-month period
during 2008, net interest income on a tax-equivalent basis was $89.3 million, an
increase of $4.7 million or 6 percent from the $84.6 million recorded during the
first nine months of 2007. 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 $209.4 million or 7 percent
growth in average earning assets during the third quarter of 2008 compared to
the same quarter in 2007 and the $198.2 million or 7 percent growth in average
earning assets during the first nine months of 2008 compared to the same nine
months of 2007.
On a
tax-equivalent basis, interest income in the third quarter of 2008 totaled $52.0
million compared to $55.6 million in the third quarter of 2007, a decrease of
$3.6 million or 7 percent. For the first nine months of 2008, interest income on
a tax-equivalent basis decreased $8.9 million or 5 percent over the same period
in 2007. Nearly half of the loans in Heartland’s commercial and agricultural
loan portfolios are 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 8.25 percent for the first eight months of
2007. During the first nine months of 2008, the national prime interest rate
decreased 225 basis points, ranging from 7.25 percent on January 1, 2008, to
5.00 percent on September 30, 2008. A large portion of Heartland’s floating rate
loans that reprice immediately have a floor interest rate which they have now
met. Additionally, Heartland has two $50.0 million derivative transactions on
the loan portfolio that are at their floor interest rates. Accordingly,
management believes the negative impact of further reductions in the national
prime interest rate on Heartland’s interest income in future periods should be
softened.
Interest
expense for the third quarter of 2008 was $21.1 million compared to $27.4
million in the third quarter of 2007, a decrease of $6.3 million or 23 percent.
On a nine-month comparative basis, interest expense decreased $13.6 million or
17 percent. Interest rates paid on Heartland’s deposits and borrowings were
significantly lower during the first nine months of 2008 compared to the first
nine months of 2007. Through the third quarter, Heartland experienced a
reduction in funding costs as higher rate certificates of deposit rolled over at
lower rates. Management believes deposit costs will begin to level off as
competitor banks seeking to improve their liquidity positions push rates upward.
Approximately 51 percent of Heartland’s certificate of deposit accounts, at a
weighted average rate of 3.39 percent, will mature within the next six
months.
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
organic growth strategies, which management believes will result in additional
net interest income. 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.
In order
to reduce the potentially negative impact a downward movement in interest rates
would have on net interest income on the loan portfolio, Heartland has certain
derivative transactions currently open: a five-year collar transaction on a
notional $50.0 million entered into in September 2005 and a three-year collar
transaction on a notional $50.0 million entered into in April 2006.
Additionally, in August 2006, Heartland entered into a leverage structured
wholesale repurchase agreement transaction. This wholesale repurchase agreement
in the amount of $50.0 million initially had a variable interest rate that reset
quarterly to the 3-month LIBOR rate plus 29.375 basis points. Within this
contract was an interest floor option that resulted when the 3-month LIBOR rate
fell to 4.40 percent or lower. If that situation occurred, the rate paid would
have been decreased by two times the difference between the 3-month LIBOR rate
and 4.40 percent. In order to effectuate this wholesale repurchase agreement, a
$55.0 million government agency bond was acquired. On the date of the contract,
the interest rate on the securities was nearly equivalent to the interest rate
being paid on the repurchase agreement contract. As the general level of
interest rates declined during 2007, this transaction was restructured to reduce
the risk of rising rates in the future. The unrealized gains were utilized to
reduce the maximum rate to 3.06 percent until August 28, 2009, when it is
callable. If not called, the funding will remain in place until November 28,
2010. Within this contract is an interest rate cap option that will reduce the
interest rate being paid when the 3-month LIBOR rate exceeds 5.15
percent.
On
February 1, 2007, Heartland entered into two interest rate cap transactions on a
total notional amount of $45.0 million to reduce the potentially negative impact
an upward rate environment would have on net interest income. These two-year
contracts were acquired with the counterparty as the payer on 3-month LIBOR at a
cap strike rate of 5.50 percent and were designated as a cash flow hedge against
the LIBOR based variable-rate interest payments on Heartland’s subordinated
debentures associated with two of its trust preferred capital securities. On
January 15, 2008, Heartland entered into another interest rate cap transaction
on a notional amount of $20.0 million to further reduce the potentially negative
impact an upward rate environment would have on net interest income. This
fifty-five month contract was acquired with the counterparty as the payer on
3-month LIBOR at a cap strike rate of 5.12 percent and was designated as a cash
flow hedge against the LIBOR based variable-rate interest payments on
Heartland’s subordinated debentures associated with another of its trust
preferred capital securities. Additionally, on March 28, 2008, Heartland entered
into a twenty-eight month interest rate cap transaction on a notional amount of
$20.0 million to extend the maturity date on a portion of the February 2007
transactions. This cap has an effective date of January 7, 2009, and a maturity
date of April 7, 2011. Should 3-month LIBOR exceed 5.5 percent 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 percent. Note 4 to the
consolidated financial statements contains additional information about
Heartland’s derivative transactions.
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 RATES
1
For
the quarters ended September 30, 2008 and 2007
(Dollars
in thousands)
|
|
|
2008
|
|
2007
|
|
|
Average
Balance
|
|
Interest
|
|
Rate
|
|
Average
Balance
|
|
Interest
|
|
Rate
|
EARNING
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
$
|
622,376
|
|
|
$
|
8,228
|
|
|
5.26
|
%
|
|
$
|
474,366
|
|
|
$
|
5,446
|
|
|
4.55
|
%
|
Nontaxable
1
|
|
|
153,996
|
|
|
|
2,441
|
|
|
6.31
|
|
|
|
136,834
|
|
|
|
2,271
|
|
|
6.58
|
|
Total securities
|
|
|
776,372
|
|
|
|
10,669
|
|
|
5.47
|
|
|
|
611,200
|
|
|
|
7,717
|
|
|
5.01
|
|
Interest
bearing deposits
|
|
|
654
|
|
|
|
3
|
|
|
1.82
|
|
|
|
764
|
|
|
|
2
|
|
|
1.04
|
|
Federal
funds sold
|
|
|
18,419
|
|
|
|
85
|
|
|
1.84
|
|
|
|
24,180
|
|
|
|
310
|
|
|
5.09
|
|
Loans
and leases:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial and commercial real
estate
1
|
|
|
1,651,002
|
|
|
|
26,910
|
|
|
6.48
|
|
|
|
1,609,044
|
|
|
|
31,757
|
|
|
7.83
|
|
Residential
mortgage
|
|
|
223,267
|
|
|
|
3,570
|
|
|
6.36
|
|
|
|
239,447
|
|
|
|
4,069
|
|
|
6.74
|
|
Agricultural and agricultural
real estate
1
|
|
|
241,541
|
|
|
|
4,191
|
|
|
6.90
|
|
|
|
227,630
|
|
|
|
4,650
|
|
|
8.10
|
|
Consumer
|
|
|
216,651
|
|
|
|
5,081
|
|
|
9.33
|
|
|
|
199,823
|
|
|
|
5,351
|
|
|
10.62
|
|
Direct financing leases,
net
|
|
|
7,078
|
|
|
|
105
|
|
|
5.90
|
|
|
|
11,320
|
|
|
|
171
|
|
|
5.99
|
|
Fees on loans
|
|
|
-
|
|
|
|
1,356
|
|
|
-
|
|
|
|
-
|
|
|
|
1,589
|
|
|
-
|
|
Less: allowance for loan and
lease losses
|
|
|
(34,776
|
)
|
|
|
-
|
|
|
-
|
|
|
|
(32,647
|
)
|
|
|
-
|
|
|
-
|
|
Net loans and
leases
|
|
|
2,304,763
|
|
|
|
41,213
|
|
|
7.11
|
|
|
|
2,254,617
|
|
|
|
47,587
|
|
|
8.37
|
|
Total earning
assets
|
|
|
3,100,208
|
|
|
$
|
51,970
|
|
|
6.67
|
%
|
|
|
2,890,761
|
|
|
$
|
55,616
|
|
|
7.63
|
%
|
NONEARNING
ASSETS
|
|
|
298,991
|
|
|
|
|
|
|
|
|
|
|
285,954
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$
|
3,399,199
|
|
|
|
|
|
|
|
|
|
$
|
3,176,715
|
|
|
|
|
|
|
|
|
INTEREST
BEARING LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
bearing deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings
|
|
$
|
981,108
|
|
|
$
|
4,777
|
|
|
1.94
|
%
|
|
$
|
850,988
|
|
|
$
|
6,021
|
|
|
2.81
|
%
|
Time, $100,000 and
over
|
|
|
374,170
|
|
|
|
3,527
|
|
|
3.75
|
|
|
|
305,748
|
|
|
|
3,848
|
|
|
4.99
|
|
Other time
deposits
|
|
|
759,999
|
|
|
|
7,318
|
|
|
3.83
|
|
|
|
888,706
|
|
|
|
10,608
|
|
|
4.74
|
|
Short-term
borrowings
|
|
|
184,800
|
|
|
|
776
|
|
|
1.67
|
|
|
|
243,820
|
|
|
|
2,764
|
|
|
4.50
|
|
Other
borrowings
|
|
|
449,927
|
|
|
|
4,692
|
|
|
4.15
|
|
|
|
269,198
|
|
|
|
4,199
|
|
|
6.19
|
|
Total interest bearing
liabilities
|
|
|
2,750,004
|
|
|
|
21,090
|
|
|
3.05
|
%
|
|
|
2,558,460
|
|
|
|
27,440
|
|
|
4.26
|
%
|
NONINTEREST
BEARING LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest
bearing deposits
|
|
|
384,711
|
|
|
|
|
|
|
|
|
|
|
369,716
|
|
|
|
|
|
|
|
|
Accrued
interest and other liabilities
|
|
|
37,373
|
|
|
|
|
|
|
|
|
|
|
32,501
|
|
|
|
|
|
|
|
|
Total noninterest bearing
liabilities
|
|
|
422,084
|
|
|
|
|
|
|
|
|
|
|
402,217
|
|
|
|
|
|
|
|
|
STOCKHOLDERS’
EQUITY
|
|
|
227,111
|
|
|
|
|
|
|
|
|
|
|
216,038
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
$
|
3,399,199
|
|
|
|
|
|
|
|
|
|
$
|
3,176,715
|
|
|
|
|
|
|
|
|
Net
interest income
1
|
|
|
|
|
|
$
|
30,880
|
|
|
|
|
|
|
|
|
|
$
|
28,176
|
|
|
|
|
Net
interest spread
1
|
|
|
|
|
|
|
|
|
|
3.62
|
%
|
|
|
|
|
|
|
|
|
|
3.38
|
%
|
Net
interest income to total earning assets
1
|
|
|
|
|
|
|
|
|
|
3.96
|
%
|
|
|
|
|
|
|
|
|
|
3.87
|
%
|
Interest
bearing liabilities to earning assets
|
|
|
88.70
|
%
|
|
|
|
|
|
|
|
|
|
88.50
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
Tax equivalent basis is calculated using an effective tax rate of
35%.
|
ANALYSIS
OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES
1
For
the nine months ended September 30, 2008 and 2007
(Dollars
in thousands)
|
|
|
2008
|
|
2007
|
|
|
Average
Balance
|
|
Interest
|
|
Rate
|
|
Average
Balance
|
|
Interest
|
|
Rate
|
EARNING
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
$
|
607,082
|
|
|
$
|
22,728
|
|
|
5.00
|
%
|
|
$
|
468,616
|
|
|
$
|
16,010
|
|
|
4.57
|
%
|
Nontaxable
1
|
|
|
150,803
|
|
|
|
7,330
|
|
|
6.49
|
|
|
|
132,831
|
|
|
|
6,677
|
|
|
6.72
|
|
Total securities
|
|
|
757,885
|
|
|
|
30,058
|
|
|
5.30
|
|
|
|
601,447
|
|
|
|
22,687
|
|
|
5.04
|
|
Interest
bearing deposits
|
|
|
494
|
|
|
|
10
|
|
|
2.70
|
|
|
|
683
|
|
|
|
20
|
|
|
3.92
|
|
Federal
funds sold
|
|
|
15,579
|
|
|
|
267
|
|
|
2.29
|
|
|
|
7,490
|
|
|
|
310
|
|
|
5.53
|
|
Loans
and leases:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial and commercial real
estate
1
|
|
|
1,629,584
|
|
|
|
82,133
|
|
|
6.73
|
|
|
|
1,590,559
|
|
|
|
94,567
|
|
|
7.95
|
|
Residential
mortgage
|
|
|
222,359
|
|
|
|
10,779
|
|
|
6.48
|
|
|
|
243,299
|
|
|
|
12,399
|
|
|
6.81
|
|
Agricultural and agricultural
real estate
1
|
|
|
236,537
|
|
|
|
12,855
|
|
|
7.26
|
|
|
|
225,606
|
|
|
|
13,728
|
|
|
8.14
|
|
Consumer
|
|
|
207,116
|
|
|
|
14,909
|
|
|
9.62
|
|
|
|
196,110
|
|
|
|
15,482
|
|
|
10.55
|
|
Direct financing leases,
net
|
|
|
7,926
|
|
|
|
353
|
|
|
5.95
|
|
|
|
12,553
|
|
|
|
560
|
|
|
5.96
|
|
Fees on loans
|
|
|
-
|
|
|
|
3,966
|
|
|
-
|
|
|
|
-
|
|
|
|
4,500
|
|
|
-
|
|
Less: allowance for loan and
lease losses
|
|
|
(33,504
|
)
|
|
|
-
|
|
|
-
|
|
|
|
(32,012
|
)
|
|
|
-
|
|
|
-
|
|
Net loans and
leases
|
|
|
2,270,018
|
|
|
|
124,995
|
|
|
7.36
|
|
|
|
2,236,115
|
|
|
|
141,236
|
|
|
8.44
|
|
Total earning
assets
|
|
|
3,043,976
|
|
|
$
|
155,330
|
|
|
6.82
|
%
|
|
|
2,845,735
|
|
|
$
|
164,253
|
|
|
7.72
|
%
|
NONEARNING
ASSETS
|
|
|
297,229
|
|
|
|
|
|
|
|
|
|
|
290,299
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$
|
3,341,205
|
|
|
|
|
|
|
|
|
|
$
|
3,136,034
|
|
|
|
|
|
|
|
|
INTEREST
BEARING LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
bearing deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings
|
|
$
|
895,057
|
|
|
$
|
12,575
|
|
|
1.88
|
%
|
|
$
|
825,967
|
|
|
$
|
17,132
|
|
|
2.77
|
%
|
Time, $100,000 and
over
|
|
|
326,038
|
|
|
|
10,091
|
|
|
4.13
|
|
|
|
282,393
|
|
|
|
10,394
|
|
|
4.92
|
|
Other time
deposits
|
|
|
821,894
|
|
|
|
25,709
|
|
|
4.18
|
|
|
|
878,808
|
|
|
|
30,799
|
|
|
4.69
|
|
Short-term
borrowings
|
|
|
246,735
|
|
|
|
4,049
|
|
|
2.19
|
|
|
|
291,941
|
|
|
|
10,545
|
|
|
4.83
|
|
Other
borrowings
|
|
|
410,427
|
|
|
|
13,562
|
|
|
4.41
|
|
|
|
234,186
|
|
|
|
10,762
|
|
|
6.14
|
|
Total interest bearing
liabilities
|
|
|
2,700,151
|
|
|
|
65,986
|
|
|
3.26
|
%
|
|
|
2,513,295
|
|
|
|
79,632
|
|
|
4.24
|
%
|
NONINTEREST
BEARING LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest
bearing deposits
|
|
|
368,873
|
|
|
|
|
|
|
|
|
|
|
357,679
|
|
|
|
|
|
|
|
|
Accrued
interest and other liabilities
|
|
|
40,094
|
|
|
|
|
|
|
|
|
|
|
52,721
|
|
|
|
|
|
|
|
|
Total noninterest bearing
liabilities
|
|
|
408,967
|
|
|
|
|
|
|
|
|
|
|
410,400
|
|
|
|
|
|
|
|
|
STOCKHOLDERS’
EQUITY
|
|
|
232,087
|
|
|
|
|
|
|
|
|
|
|
212,339
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
$
|
3,341,205
|
|
|
|
|
|
|
|
|
|
$
|
3,136,034
|
|
|
|
|
|
|
|
|
Net
interest income
1
|
|
|
|
|
|
$
|
89,344
|
|
|
|
|
|
|
|
|
|
$
|
84,621
|
|
|
|
|
Net
interest spread
1
|
|
|
|
|
|
|
|
|
|
3.55
|
%
|
|
|
|
|
|
|
|
|
|
3.48
|
%
|
Net
interest income to total earning assets
1
|
|
|
|
|
|
|
|
|
|
3.92
|
%
|
|
|
|
|
|
|
|
|
|
3.98
|
%
|
Interest
bearing liabilities to earning assets
|
|
|
88.70
|
%
|
|
|
|
|
|
|
|
|
|
88.32
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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’s opinion, an adequate allowance for loan
and lease losses. During the third quarter of 2008, the provision for loan
losses was $7.1 million, a significant increase over the provision for loan
losses of $575 thousand recorded during the same quarter in 2007. The provision
for loan losses for the nine-month comparative period was $14.2 million during
2008 compared to $6.8 million during 2007. The provision for loan losses
increased during 2008 as a result of an increase in nonperforming loans, the
continuing softening of the economy and the impact historical losses have on the
calculation of the adequacy of Heartland’s allowance for loan and lease
losses.
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 believed the allowance for loan and lease losses as of
September 30, 2008, 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
(Dollars
in thousands)
|
|
Three
Months Ended
|
|
|
|
|
Sept.
30, 2008
|
|
Sept.
30, 2007
|
|
Change
|
|
%
Change
|
NONINTEREST
INCOME:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
charges and fees, net
|
|
$
|
3,125
|
|
|
$
|
2,861
|
|
|
$
|
264
|
|
|
|
9
|
%
|
Loan
servicing income
|
|
|
1,094
|
|
|
|
1,068
|
|
|
|
26
|
|
|
|
2
|
|
Trust
fees
|
|
|
2,070
|
|
|
|
2,089
|
|
|
|
(19
|
)
|
|
|
(1)
|
|
Brokerage
and insurance commissions
|
|
|
942
|
|
|
|
820
|
|
|
|
122
|
|
|
|
15
|
|
Securities
gains, net
|
|
|
5
|
|
|
|
31
|
|
|
|
(26
|
)
|
|
|
(84
|
)
|
Gain
(loss) on trading account securities, net
|
|
|
(33
|
)
|
|
|
(7
|
)
|
|
|
(26
|
)
|
|
|
(371
|
)
|
Impairment
loss on securities
|
|
|
(4,688
|
)
|
|
|
-
|
|
|
|
(4,688
|
)
|
|
|
(100
|
)
|
Gains
on sale of loans
|
|
|
295
|
|
|
|
604
|
|
|
|
(309
|
)
|
|
|
(51
|
)
|
Income
(loss) on bank owned life insurance
|
|
|
(247
|
)
|
|
|
595
|
|
|
|
(842
|
)
|
|
|
(142
|
)
|
Gain
on sale of merchant credit card services
|
|
|
5,200
|
|
|
|
-
|
|
|
|
5,200
|
|
|
|
100
|
|
Other
noninterest income
|
|
|
117
|
|
|
|
(145
|
)
|
|
|
262
|
|
|
|
181
|
|
TOTAL
NONINTEREST INCOME
|
|
$
|
7,880
|
|
|
$
|
7,916
|
|
|
$
|
(36
|
)
|
|
|
-
|
%
|
|
|
Nine
Months Ended
|
|
|
|
|
Sept.
30, 2008
|
|
Sept.
30, 2007
|
|
Change
|
|
%
Change
|
NONINTEREST
INCOME:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
charges and fees, net
|
|
$
|
8,620
|
|
|
$
|
8,287
|
|
|
$
|
333
|
|
|
|
4
|
%
|
Loan
servicing income
|
|
|
3,585
|
|
|
|
3,103
|
|
|
|
482
|
|
|
|
16
|
|
Trust
fees
|
|
|
6,159
|
|
|
|
6,265
|
|
|
|
(106
|
)
|
|
|
(2
|
)
|
Brokerage
and insurance commissions
|
|
|
2,717
|
|
|
|
2,158
|
|
|
|
559
|
|
|
|
26
|
|
Securities
gains, net
|
|
|
1,015
|
|
|
|
303
|
|
|
|
712
|
|
|
|
235
|
|
Gain
(loss) on trading account securities, net
|
|
|
(467
|
)
|
|
|
80
|
|
|
|
(547
|
)
|
|
|
(684
|
)
|
Impairment
loss on securities
|
|
|
(4,804
|
)
|
|
|
-
|
|
|
|
(4,804
|
)
|
|
|
(100
|
)
|
Gains
on sale of loans
|
|
|
1,279
|
|
|
|
2,051
|
|
|
|
(772
|
)
|
|
|
(38
|
)
|
Income
(loss) on bank owned life insurance
|
|
|
596
|
|
|
|
1,212
|
|
|
|
(616
|
)
|
|
|
(51
|
)
|
Gain
on sale of merchant credit card services
|
|
|
5,200
|
|
|
|
-
|
|
|
|
5,200
|
|
|
|
100
|
|
Other
noninterest income
|
|
|
772
|
|
|
|
161
|
|
|
|
611
|
|
|
|
380
|
|
TOTAL
NONINTEREST INCOME
|
|
$
|
24,672
|
|
|
$
|
23,620
|
|
|
$
|
1,052
|
|
|
|
4
|
%
|
Noninterest
income remained at $7.9 million during the third quarters of both 2008 and 2007.
A $5.2 million gain on the sale of Heartland’s merchant bankcard processing
services to TransFirst LLC was included in the third quarter 2008 noninterest
income. Also included in third quarter 2008 noninterest income was 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 2008,
noninterest income increased $1.1 million or 4 percent over the same period in
2007. In addition to the $5.2 million gain on the sale of merchant bankcard
processing services, noninterest income during the first nine months of 2008 was
positively affected by increased service charges and fees, loan servicing
income, brokerage and insurance commissions and securities gains. For both
comparative periods, the improvements in the aforementioned categories were
partially offset by $4.8 million of impairment losses on securities and
increased losses on trading account securities, reduced gains on sale of loans
and a reduction in the cash surrender value on bank owned life
insurance.
Service
charges and fees increased $264 thousand or 9 percent during the quarters under
comparison. On a nine-month comparative basis, service charges and fees
increased $333 thousand or 4 percent. Overdraft fees recorded during the third
quarter of 2008 were $1.6 million compared to $1.4 million during the third
quarter of 2007, an increase of $265 thousand or 19 percent. For the first nine
months of 2008, overdraft fees were $4.4 million compared to $4.0 million during
the same first nine months of 2007, an increase of $485 thousand or 12 percent.
Growth in the number of checking accounts resulted in the increased overdraft
fees. Interchange revenue from activity on bank debit cards, along with
surcharges on ATM activity, resulted in service charges and fees of $798
thousand during the third quarter of 2008 compared to $516 thousand during the
third quarter of 2007, an increase of $282 thousand or 55 percent. For the
nine-month comparative periods, these same revenues totaled $2.1 million during
2008 and $1.5 million during 2007, an increase of $640 thousand or 44
percent. Included in service charges and fees are the fees generated
from the issuance of bank credit cards. During the fourth quarter of 2007,
Heartland sold its credit card portfolio. As a result of this sale, revenue
resulting from activity on these credit cards decreased by $169 thousand or 83
percent during the third quarter of 2008 compared to the third quarter of 2007.
On a nine-month comparative basis, the fees recorded as a result of activity on
the bank-issued credit cards had decreased $526 thousand or 83
percent.
Loan
servicing income increased $26 thousand or 2 percent during the quarters under
comparison. On a nine-month comparative basis, loan servicing income increased
$482 thousand or 16 percent. These increases were largely due to an increase in
service fees collected on the mortgage loans Heartland sold into the secondary
market while retaining servicing. Heartland’s portfolio of mortgage loans
serviced for others totaled $703.3 million at September 30, 2008, compared to
$617.9 million at September 30, 2007.
Brokerage
and insurance commissions increased $122 thousand or 15 percent during the third
quarter of 2008 and $559 thousand or 26 percent during the first nine months of
2008 compared to the same periods of 2007. The larger increase for the nine
month comparative period was primarily a result of the March 2007 acquisition of
brokerage personnel and a book of business by Summit Bank & Trust and the
receipt by Dubuque Bank and Trust Company’s insurance agency of its annual
insurance contingency that exceeded the prior year’s payment.
Impairment
losses on securities deemed to be other than temporary totaled $4.7 million
during the third quarter of 2008. Nearly all of this loss was
attributable to Heartland’s investment in perpetual preferred securities issued
by Fannie Mae, which was included in securities available for sale at a cost of
$5.1 million. At September 30, 2008, these securities were written down to their
trading value of $541 thousand and transferred to the trading portfolio.
Heartland does not hold any common or any other equity securities issued by
Fannie Mae or Freddie Mac.
For the
nine-month period ended on September 30, securities gains totaled $1.0 million
during 2008 and $303 thousand during 2007. As the yield curve steepened and the
spreads on mortgage-backed securities in comparison to government agency
securities widened during the first six months of 2008, management elected to
sell a portion of its agency securities at gains and replace them with
mortgage-backed securities that provided enhanced yields.
Gains on
sale of loans decreased $309 thousand or 51 percent during the third quarter of
2008 compared to the third quarter of 2007. For the first nine months of 2008,
gains on sale of loans decreased $772 thousand or 38 percent compared to the
same nine months of 2007. Heartland’s gains on sale of loans generally results
from the sale of fifteen- and thirty-year, fixed-rate mortgage loans into the
secondary market. Customer demand for these types of loans has decreased during
2008 as economic conditions softened.
The
change in cash surrender value on bank owned life insurance resulted in a loss
of $247 thousand for the third quarter of 2008 compared to income of $595
thousand during the same quarter of 2007. On a nine-month comparative basis,
income on bank owned life insurance was $596 thousand in 2008 compared to $1.2
million in 2007. A large portion of Heartland’s bank owned life insurance is
held in a separate account product that experienced significant market value
declines during the third quarter of 2008.
Other
noninterest income increased $262 thousand or 181 percent during the third
quarter of 2008 compared to the third quarter of 2007. For the first nine months
of 2008, other noninterest income increased $611 thousand or 380 percent over
the same period in 2007. The initial public offering of Visa Inc., completed on
March 18, 2008, provided Heartland with a $246 thousand pre-tax gain, which was
recorded as other noninterest income during the first quarter of 2008. This gain
was attributable to restricted shares of Visa, Inc. held by Dubuque Bank and
Trust Company and Galena State Bank & Trust Co. that were redeemed in
connection with the initial public offering. Recorded in other noninterest
income during the first quarter of 2007 was a $250 thousand payment received in
the settlement of a dispute with two former employees at one of our bank
subsidiaries.
NONINTEREST
EXPENSES
(Dollars
in thousands)
|
|
Three
Months Ended
|
|
|
|
|
Sept.
30, 2008
|
|
Sept.
30, 2007
|
|
Change
|
|
%
Change
|
NONINTEREST
EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
$
|
15,000
|
|
|
$
|
14,301
|
|
|
$
|
699
|
|
|
|
5
|
%
|
Occupancy
|
|
|
2,262
|
|
|
|
2,004
|
|
|
|
258
|
|
|
|
13
|
|
Furniture
and equipment
|
|
|
1,662
|
|
|
|
1,669
|
|
|
|
(7
|
)
|
|
|
-
|
|
Outside
services
|
|
|
3,096
|
|
|
|
2,374
|
|
|
|
722
|
|
|
|
30
|
|
Advertising
|
|
|
1,012
|
|
|
|
886
|
|
|
|
126
|
|
|
|
14
|
|
Intangible
assets amortization
|
|
|
236
|
|
|
|
241
|
|
|
|
(5
|
)
|
|
|
(2
|
)
|
Other
noninterest expenses
|
|
|
3,392
|
|
|
|
3,272
|
|
|
|
120
|
|
|
|
4
|
|
TOTAL
NONINTEREST EXPENSES
|
|
$
|
26,660
|
|
|
$
|
24,747
|
|
|
$
|
1,913
|
|
|
|
8
|
%
|
|
|
Nine
Months Ended
|
|
|
|
|
Sept.
30, 2008
|
|
Sept.
30, 2007
|
|
Change
|
|
%
Change
|
NONINTEREST
EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
$
|
44,459
|
|
|
$
|
42,680
|
|
|
$
|
1,779
|
|
|
|
4
|
%
|
Occupancy
|
|
|
6,799
|
|
|
|
5,941
|
|
|
|
858
|
|
|
|
14
|
|
Furniture
and equipment
|
|
|
5,201
|
|
|
|
5,124
|
|
|
|
77
|
|
|
|
2
|
|
Outside
services
|
|
|
8,254
|
|
|
|
7,011
|
|
|
|
1,243
|
|
|
|
18
|
|
Advertising
|
|
|
2,853
|
|
|
|
2,694
|
|
|
|
159
|
|
|
|
6
|
|
Intangible
assets amortization
|
|
|
708
|
|
|
|
652
|
|
|
|
56
|
|
|
|
9
|
|
Other
noninterest expenses
|
|
|
9,588
|
|
|
|
9,970
|
|
|
|
(382
|
)
|
|
|
(4
|
)
|
TOTAL
NONINTEREST EXPENSES
|
|
$
|
77,862
|
|
|
$
|
74,072
|
|
|
$
|
3,790
|
|
|
|
5
|
%
|
For the
third quarter of 2008, noninterest expense increased $1.9 million or 8 percent
from the same period in 2007. For the nine-month period ended September 30,
2008, noninterest expense increased $3.8 million or 5 percent when compared to
the same nine-month period in 2007. The noninterest expense categories
experiencing the largest increases were salaries and employee benefits,
occupancy and outside services.
The
largest component of noninterest expense, salaries and employee benefits,
increased $699 thousand or 5 percent during the third quarter of 2008 compared
to the third quarter of 2007 and $1.8 million or 4 percent during the nine-month
comparative period. Total full-time equivalent employees were 1,011 at September
30, 2008, compared to 975 at September 30, 2007. A majority of the growth in
employees was attributable to Heartland’s newest
de novo
banks, Summit Bank
& Trust and Minnesota Bank & Trust.
Occupancy
expense increased $258 thousand or 13 percent and $858 thousand or 14 percent
during the quarter and nine-month comparative periods, respectively. These
increases were primarily a result of the opening of six new banking offices
during 2007 and the opening of Heartland’s 10
th
bank
subsidiary, Minnesota Bank & Trust, during 2008. In addition to the opening
of Minnesota Bank & Trust, Heartland’s plan for expansion during 2008 has
been much slower, with the addition of only one new location at New Mexico Bank
& Trust. Of Heartland’s 60 banking offices, fifteen offices, or 25 percent,
have been open less than three years. Of these, six have been open for
two-to-three years, an additional three have been open for one-to-two years and
six more have been open for one year or less. Management believes that it
generally takes approximately three years for new branch offices to become
profitable.
The other
category of noninterest expense that increased significantly during the 2008
quarter and nine-month period was outside services, which increased $722
thousand or 30 percent and $1.2 million or 18 percent, respectively. These
increases resulted primarily from additional legal fees related to collection
efforts on nonperforming loans and additional FDIC assessments as a majority of
the FDIC credits at Heartland’s bank subsidiaries were utilized during
2007.
For the
first quarter of 2007, other noninterest expenses included $202 thousand of
remaining unamortized issuance costs expensed due to the redemption of $8.0
million of floating rate trust preferred securities. Exclusive of this
nonrecurring item, other noninterest expenses decreased $180 thousand or 2
percent during the first nine months of 2008 compared to the same period in
2007. The following types of expenses are classified in the other noninterest
expenses category: supplies, telephone, software maintenance, software
amortization, seminars and other staff expense.
INCOME
TAX EXPENSE
Heartland’s
effective tax rate was 25.30 percent for the third quarter of 2008 compared to
29.56 percent for the third quarter of 2007. On a nine-month comparative basis,
Heartland’s effective tax rate was 26.66 percent for 2008 compared to 31.01
percent for 2007. Tax-exempt interest income as a percentage of income before
taxes was 45.89 percent during the third quarter of 2008 compared to 17.74
percent during the same quarter of 2007. For the nine-month periods ended
September 30, 2008 and 2007, tax-exempt interest income as a percentage of
income before taxes was 28.12 percent and 18.91 percent, respectively. The
tax-equivalent adjustment for this tax-exempt interest income was $994 thousand
during the third quarter of 2008 compared to $939 thousand during the same
quarter in 2007. For the nine-month comparative period, the tax-equivalent
adjustment for tax-exempt interest income was $2.9 million for 2008 and $2.8
million for 2007. Another factor contributing to the decrease in Heartland’s
effective tax rate during the first nine months of 2008 was $170 thousand in
federal rehabilitation tax credits associated with Dubuque Bank and Trust
Company’s ownership interest in a limited liability company that owns a
certified historic structure. Additionally, low-income housing tax credits were
projected to total $218 thousand for 2008 and $163 thousand for
2007.
FINANCIAL
CONDITION
At
September 30, 2008, total assets had increased $181.9 million or 7 percent
annualized since year-end 2007.
Contributing
to this growth was the $82.2 million growth in total loans and leases and the
$70.2 million growth in the securities portfolio since year-end
2007.
LOANS
AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Total
loans and leases were $2.36 billion at September 30, 2008, compared to $2.28
billion at year-end 2007, an increase of $84.1 million or 5 percent annualized.
This growth was primarily distributed among the commercial, agricultural and
consumer loan categories at $39.8 million, $19.7 million and $25.0 million,
respectively. Most of the loan growth in the commercial and commercial real
estate category occurred at Dubuque Bank and Trust Company, Riverside Community
Bank and Summit Bank & Trust. A majority of the increase in agricultural and
agricultural real estate loans occurred at Dubuque Bank and Trust Company. New
Mexico Bank & Trust, Rocky Mountain Bank, Summit Bank & Trust and
Citizens Finance Co. were responsible for most of the growth in the consumer
loan portfolio.
The table
below presents the composition of the loan portfolio as of September 30, 2008,
and December 31, 2007.
LOAN
PORTFOLIO
(Dollars
in thousands)
|
|
|
September
30, 2008
|
|
|
December
31, 2007
|
|
|
Amount
|
Percent
|
|
Amount
|
Percent
|
Commercial
and commercial real estate
|
|
$
|
1,672,372
|
|
|
70.61
|
%
|
|
$
|
1,632,597
|
|
|
71.48
|
%
|
Residential
mortgage
|
|
|
219,662
|
|
|
9.27
|
|
|
|
217,044
|
|
|
9.50
|
|
Agricultural
and agricultural real estate
|
|
|
245,355
|
|
|
10.36
|
|
|
|
225,663
|
|
|
9.88
|
|
Consumer
|
|
|
224,474
|
|
|
9.48
|
|
|
|
199,518
|
|
|
8.74
|
|
Lease
financing, net
|
|
|
6,689
|
|
|
0.28
|
|
|
|
9,158
|
|
|
0.40
|
|
Gross
loans and leases
|
|
|
2,368,552
|
|
|
100.00
|
%
|
|
|
2,283,980
|
|
|
100.00
|
%
|
Unearned
discount
|
|
|
(2,402
|
)
|
|
|
|
|
|
(2,107
|
)
|
|
|
|
Deferred
loan fees
|
|
|
(1,891
|
)
|
|
|
|
|
|
(1,706
|
)
|
|
|
|
Total
loans and leases
|
|
|
2,364,259
|
|
|
|
|
|
|
2,280,167
|
|
|
|
|
Allowance
for loan and lease losses
|
|
|
(34,845
|
)
|
|
|
|
|
|
(32,993
|
)
|
|
|
|
Loans
and leases, net
|
|
$
|
2,329,414
|
|
|
|
|
|
$
|
2,247,174
|
|
|
|
|
Total
loans and leases secured by real estate were $1.8 billion at September 30, 2008,
with $1.4 billion in the commercial category. Of these commercial real estate
loans, $389.8 million were secured by industrial manufacturing property.
Commercial loans to contractors of residential real estate totaled $69.4
million, with $46.7 million of this amount representing presold homes. The
amount extended in land development and lot loans to commercial borrowers
totaled $34.9 million. Loans to individuals for residential construction and for
the purchase of residential lots were $91.1 million.
Flooding
in Iowa and other Midwestern states in the second quarter of 2008 had a limited
impact on the performance of Heartland’s loan portfolio as Heartland does not
have banking establishments in the communities most heavily impacted by the
floods. Of the $245.4 million in agricultural loans, nearly 70 percent were
originated at Heartland’s Midwestern banks. The agricultural loan portfolio is
well diversified between grains, dairy, hogs and cattle, with approximately 30
percent being in grain production. Both flooding and delays in planting the
crops will impact this year's profits to be realized by the agricultural
customers this year. Agricultural profits, as a result of the flood, are
expected to be less than those realized in 2007, but are not expected to have
any significant negative impact on the industry or Heartland’s
portfolio.
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, 2008, was 1.47 percent of
loans and leases and 79.43 percent of nonperforming loans, compared to 1.45
percent of loans and leases and 103.66 percent of nonperforming loans at
December 31, 2007. Additions to the allowance for loan and lease losses were
primarily driven by the continued softening of the economy and reduced real
estate values, particularly in the Phoenix market. Nonperforming loans were
$43.9 million or 1.86 percent of total loans and leases at September 30, 2008,
compared to $31.8 million or 1.40 percent of total loans and leases at December
31, 2007. The majority of the $12.1 million increase in nonperforming loans from
December 31, 2007, resulted from two large credits originated by Arizona Bank
& Trust and Rocky Mountain Bank. Approximately 64 percent, or $28.1 million,
of Heartland’s nonperforming loans are to eight borrowers, with $12.5 million
originated by Arizona Bank & Trust, $8.1 million originated by Wisconsin
Community Bank, $4.8 million originated by Rocky Mountain Bank, $1.6 million
originated by Summit Bank & Trust and $1.1 million originated by Dubuque
Bank and Trust Company. The portion of Heartland’s nonperforming loans covered
by government guarantees was $3.4 million at September 30, 2008. Management
monitors the loan portfolio of each bank subsidiary and, at this point, believes
that the increase in nonperforming loans is most likely a result of the
continuing shift in the economy in some of Heartland’s markets.
During
the fourth quarter of 2008, management is hopeful that $16.0 million in existing
nonperforming loans will come to resolution, a large portion of which will
likely be transferred to other real estate owned. That being said, improvement
in nonperforming loans by year-end 2008 could be hindered by a $15.0 million
real estate development loan originated at Rocky Mountain Bank that management
continues to monitor closely.
Other
real estate owned increased to $9.4 million at September 30, 2008, compared to
$2.2 million at year-end 2007. As a result of continued collection activities,
it is likely that other real estate owned will rise by approximately $12.0
million by year-end 2008.
Net
charge-offs during the first nine months of 2008 were $12.4 million compared to
$5.2 million during the first nine months of 2007. Net charge-offs at Arizona
Bank & Trust comprised $6.4 million or 52 percent of the total net
charge-offs for the first nine months of 2008. Due to the untimely death of the
sole owner of a business in June of 2008 and the filing of Chapter 11 bankruptcy
shortly thereafter by the business, the $2.0 million outstanding on a line of
credit for working capital was charged-off. The remaining $4.4 million of net
charge-offs at Arizona Bank & Trust was primarily related to commercial real
estate development loans and residential lot loans. Heartland has generally
recognized the charge-off on a loan when the loan was resolved, sold or
transferred to other real estate owned. However, in the third quarter of 2008,
Heartland recognized charge-offs on certain collateral dependent loans by
writing down the loan balance to an estimated net realizable value based on the
anticipated disposition value.
Heartland’s
bank subsidiaries have not been active in the origination of subprime loans.
Consistent with Heartland’s community banking model, which includes meeting the
legitimate credit needs within the communities served, the bank subsidiaries may
make loans to borrowers possessing subprime characteristics if there are
mitigating factors present that reduce the potential default risk of the
loan.
Slightly
over half of the consumer loans originated by the Heartland banks, $97.1
million, are in home equity lines of credit (“HELOC’s”). Under Heartland’s
policy guidelines for the underwriting of these lines of credit, the customer
may receive advances of up to 90 percent of the value of the property securing
the line, provided the customer qualifies for Tier I classification, Heartland’s
internal ranking for customers considered to possess a high credit quality
profile. Additionally, to qualify for advances up to 90 percent of the value of
the property securing the line, the first mortgage must be held by Heartland and
the customer must escrow for both taxes and insurance. Otherwise, HELOC’s are
established at an 80 percent loan to value.
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,
|
|
|
2008
|
|
2007
|
Balance
at beginning of period
|
|
$
|
32,993
|
|
|
$
|
29,981
|
|
Provision
for loan and lease losses from continuing operations
|
|
|
14,213
|
|
|
|
6,769
|
|
Recoveries
on loans and leases previously charged off
|
|
|
974
|
|
|
|
1,362
|
|
Loans
and leases charged off
|
|
|
(13,335
|
)
|
|
|
(6,536
|
)
|
Reduction
related to discontinued operations
|
|
|
-
|
|
|
|
(138
|
)
|
Balance
at end of period
|
|
$
|
34,845
|
|
|
$
|
31,438
|
|
Net
charge offs to average loans and leases
|
|
|
0.54
|
%
|
|
|
0.23
|
%
|
The table
below presents the amounts of nonperforming loans and leases and other
nonperforming assets on the dates indicated:
NONPERFORMING
ASSETS
(Dollars
in thousands)
|
|
|
As
of September 30,
|
|
As
of December 31,
|
|
|
2008
|
|
2007
|
|
2007
|
|
2006
|
Nonaccrual
loans and leases
|
|
$
|
43,523
|
|
|
$
|
30,286
|
|
|
$
|
30,694
|
|
|
$
|
8,104
|
|
Loan
and leases contractually past due 90 days or more
|
|
|
347
|
|
|
|
69
|
|
|
|
1,134
|
|
|
|
315
|
|
Total
nonperforming loans and leases
|
|
|
43,870
|
|
|
|
30,355
|
|
|
|
31,828
|
|
|
|
8,419
|
|
Other
real estate
|
|
|
9,387
|
|
|
|
2,129
|
|
|
|
2,195
|
|
|
|
1,575
|
|
Other
repossessed assets, net
|
|
|
520
|
|
|
|
392
|
|
|
|
438
|
|
|
|
349
|
|
Total
nonperforming assets
|
|
$
|
53,777
|
|
|
$
|
32,876
|
|
|
$
|
34,461
|
|
|
$
|
10,343
|
|
Nonperforming
loans and leases to total loans and leases
|
|
|
1.86
|
%
|
|
|
1.33
|
%
|
|
|
1.40
|
%
|
|
|
0.39
|
%
|
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 22 percent
of total assets at September 30, 2008, and 21 percent at December 31, 2007.
Total available for sale securities as of September 30, 2008, were $733.8
million, an increase of $51.4 million or 8 percent from December 31,
2007.
The
composition of the securities portfolio shifted from an emphasis in U.S.
government corporations and agencies to mortgage-backed securities during the
first nine months of 2008 as the spread on mortgage-backed securities widened in
comparison to government agency securities. Additionally, during the second
quarter of 2008, management implemented a leverage transaction which included
the purchase of $50.0 million in mortgage-backed securities. This purchase was
funded with $35.0 million in long-term structured wholesale repurchase agreement
transactions and the remainder in short-term borrowings. The percentage of U.S.
government corporations and agencies securities was 37 percent at year-end 2007
compared to 15 percent at September 30, 2008. The table below presents the
composition of the securities portfolio by major category as of September 30,
2008, and December 31, 2007. All of Heartland’s U.S. government corporations and
agencies securities and more than 79 percent of its mortgage-backed securities
are issuances of government-sponsored enterprises.
SECURITIES
PORTFOLIO COMPOSITION
(Dollars
in thousands)
|
|
|
September
30, 2008
|
|
|
December
31, 2007
|
|
|
Amount
|
Percent
|
|
Amount
|
Percent
|
U.S.
government corporations and agencies
|
|
$
|
113,319
|
|
14.91
|
%
|
|
$
|
255,257
|
|
37.00
|
%
|
Mortgage-backed
securities
|
|
|
457,456
|
|
60.18
|
|
|
|
244,934
|
|
35.50
|
|
Obligation
of states and political subdivisions
|
|
|
153,419
|
|
20.18
|
|
|
|
147,398
|
|
21.36
|
|
Other
securities
|
|
|
35,949
|
|
4.73
|
|
|
|
42,360
|
|
6.14
|
|
Total
securities
|
|
$
|
760,143
|
|
100.00
|
%
|
|
$
|
689,949
|
|
100.00
|
%
|
Periodically,
Heartland has utilized auction rate securities as a higher-yielding alternative
investment for fed funds. As of September 30, 2008, and December 31, 2007,
Heartland’s securities portfolio held no auction rate securities. For a further
description of these securities refer to Note 5 to Heartland’s consolidated
financial statements.
DEPOSITS
AND BORROWED FUNDS
Total
deposits grew to $2.57 billion at September 30, 2008, an increase of $191.6
million or 11 percent annualized since year-end 2007. Growth in deposits was
weighted more heavily in Heartland’s Western markets. Demand deposits
experienced a decrease of $8.3 million or 3 percent annualized since year-end
2007. Savings deposit balances experienced an increase of $187.3 million or 29
percent annualized since year-end 2007. Time deposits, exclusive of brokered
deposits, remained at $1.1 billion. At September 30, 2008, brokered time
deposits totaled $81.9 million or 3 percent of total deposits compared to $69.0
million or 3 percent of total deposits at year-end 2007. A large portion of the
growth in savings deposits is attributable to the January 2008 introduction of a
new retail interest-bearing checking account product, the third quarter 2008
introduction of a premium money market account that featured a teaser interest
rate of 5 percent through year-end 2008 and the conversion of several retail
repurchase agreement sweep accounts to a new money market sweep product
initially rolled out to business depositors during the second quarter of
2008.
Short-term
borrowings generally include federal funds purchased, treasury tax and loan note
options, securities sold under agreement to repurchase and short-term Federal
Home Loan Bank ("FHLB") advances. These funding alternatives are utilized in
varying degrees depending on their pricing and availability. As of September 30,
2008, the amount of short-term borrowings was $176.5 million compared to $354.1
million at year-end 2007, a decrease of $177.6 million or 50 percent. Management
elected to utilize some additional long-term FHLB borrowings in the first nine
months of 2008 as the interest rates on these borrowings were at lower levels
than other funding alternatives, particularly brokered deposits.
All of
the bank subsidiaries provide 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 $132.9 million at September 30, 2008,
compared to $237.9 million at year-end 2007.
Also
included in short-term borrowings is the revolving credit line Heartland has
with third-party banks. At September 30, 2008, this unsecured revolving credit
line allowed Heartland to borrow up to $60.0 million at any one time. A total of
$32.0 million was outstanding on this credit line at September 30, 2008,
compared to $15.0 million at December 31, 2007.
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, 2008, the amount of other borrowings was $440.0 million, an
increase of $176.6 million or 67 percent since year-end 2007. Other borrowings
include structured wholesale repurchase agreements which totaled $120.0 million
at September 30, 2008, and $50.0 million at year-end 2007. 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, 2008, is as follows:
(Dollars
in thousands)
Amount
Issued
|
Issuance
Date
|
Interest
Rate
|
Interest Rate as of
9/30
/0
8
|
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
|
10/10/2008
|
|
25,000
|
03/17/04
|
2.75%
over Libor
|
5.57%
|
03/17/2034
|
03/18/2009
|
|
20,000
|
01/31/06
|
1.33%
over Libor
|
4.12%
|
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
|
4.29%
|
09/01/2037
|
09/01/2012
|
$
|
110,000
|
|
|
|
|
|
Also in
other borrowings are the bank subsidiaries’ borrowings from the FHLB. All of the
bank subsidiaries, except for Heartland’s most recent
de novo
bank, Minnesota Bank
& Trust, own FHLB stock in either 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, 2008, totaled $201.7 million, an increase of $108.2 million or 116
percent from the December 31, 2007, FHLB borrowings of $93.5 million. Included
in the FHLB borrowings at December 31, 2007, was $2.0 million classified as
short-term borrowings on Heartland’s consolidated balance sheet. Total FHLB
borrowings at September 30, 2008, had an average rate of 3.74 percent and an
average maturity of 3.96 years. When considering the earliest possible call date
on these advances, the average maturity is shortened to 2.28 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, 2008,
and December 31, 2007, commitments to extend credit aggregated $591.2 million
and $588.7 million, and standby letters of credit aggregated $33.5 million and
$36.0 million, respectively.
Contractual
obligations and other commitments were presented in Heartland’s 2007 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, 2008
|
|
|
December
31, 2007
|
|
|
Amount
|
Ratio
|
|
Amount
|
Ratio
|
Risk-Based
Capital Ratios
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier 1 capital
|
|
$
|
264,474
|
|
|
9.71
|
%
|
|
$
|
253,675
|
|
|
9.74
|
%
|
Tier 1 capital minimum
requirement
|
|
|
108,931
|
|
|
4.00
|
%
|
|
|
104,191
|
|
|
4.00
|
%
|
Excess
|
|
$
|
155,543
|
|
|
5.71
|
%
|
|
$
|
149,484
|
|
|
5.74
|
%
|
Total
capital
|
|
$
|
335,484
|
|
|
12.32
|
%
|
|
$
|
325,016
|
|
|
12.48
|
%
|
Total
capital minimum requirement
|
|
|
217,863
|
|
|
8.00
|
%
|
|
|
208,382
|
|
|
8.00
|
%
|
Excess
|
|
$
|
117,621
|
|
|
4.32
|
%
|
|
$
|
116,634
|
|
|
4.48
|
%
|
Total
risk-adjusted assets
|
|
$
|
2,723,286
|
|
|
|
|
|
$
|
2,604,771
|
|
|
|
|
Leverage
Capital Ratios
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier 1 capital
|
|
$
|
264,474
|
|
|
7.88
|
%
|
|
$
|
253,675
|
|
|
8.01
|
%
|
Tier 1 capital minimum
requirement
3
|
|
|
134,191
|
|
|
4.00
|
%
|
|
|
126,644
|
|
|
4.00
|
%
|
Excess
|
|
$
|
130,283
|
|
|
3.88
|
%
|
|
$
|
127,031
|
|
|
4.01
|
%
|
Average
adjusted assets (less goodwill and other intangible
assets)
|
|
$
|
3,354,785
|
|
|
|
|
|
$
|
3,166,102
|
|
|
|
|
(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.
In February of 2003, Heartland entered into an agreement with a group of Arizona
business leaders to establish a new bank in Mesa. The new bank began operations
on August 18, 2003, as Arizona Bank & Trust. Heartland’s initial investment
in Arizona Bank & Trust was $12.0 million, which reflected an ownership
percentage of 86 percent. After completion of the Bank of the Southwest
acquisition in 2006, Heartland’s ownership percentage had increased to 90
percent. All minority stockholders had entered into a stock transfer agreement
that imposed certain restrictions on the sale, transfer or other disposition of
their shares and required Heartland to repurchase the shares from the investors
five years from the date of opening with a minimum return of 6 percent on the
original investment amount. In August of 2008, Heartland paid $3.7 million in
cash to repurchase the shares held by these minority stockholders.
Summit
Bank & Trust began operations on November 1, 2006, in the Denver, Colorado
collar 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, 2008, Heartland accrued the
amount due to the minority shareholders 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 shareholder. The remainder of
the obligation to the minority shareholders is payable in cash or Heartland
stock or a combination of cash and stock at the option of
Heartland.
Minnesota
Bank & Trust, Heartland’s tenth
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.
Heartland
continues to explore opportunities to expand its footprint of independent
community banks. Given the current issues in the banking industry, 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.
The
Emergency Economic Stabilization Act of 2008 authorizes the United States
Treasury Department (“Treasury Department”) to use appropriated funds to restore
liquidity and stability to the U.S. financial system. As part of this authority,
the Treasury Department announced on October 14, 2008, a capital purchase
program designed to encourage U.S. financial institutions to build capital to
increase the flow of financing to U.S. businesses and consumers and to support
the U.S. economy. Under this program, eligible financial institutions, including
Heartland, may sell shares of their fixed rate cumulative perpetual preferred
stock, with accompanying warrants, to the Treasury Department for cash proceeds
of between one percent and three percent of the institution’s risk-weighted
assets, all of which may be included as Tier 1 capital for the institution. The
preferred stock issued under this program pays cumulative dividends at a rate of
5 percent per year for the first five years and 9 percent per year after five
years. The preferred stock may not be redeemed by the institution during the
first three years except with proceeds from a “qualifying equity offering”, and
is redeemable thereafter at its purchase price plus accumulated dividends. The
preferred stock is non-voting, except for rights to approve authorization for
securities that are on par with, or senior to, the preferred stock, changes in
the rights of the preferred stock and certain acquisitions that affect the
preferred stock. The Treasury Department also receives ten-year warrants to
purchase a number of shares of common stock of the issuing institution having a
market value equal to 15 percent of its investment. In order to facilitate
transfer, the issuing institution is required to file a registration statement
covering the Treasury Department’s resale of the preferred stock, warrants and
common stock issuable thereunder.
To
participate in this program, Heartland will be required to apply prior to
November 14, 2008, and is currently considering making application. Based on
current asset levels, Heartland estimates that it could, if approved, obtain
between $27 million and $81 million of additional capital under this program. If
it does participate, Heartland will be required to obtain the consent of the
Treasury Department to increase its common stock dividend or repurchase its
common stock or other equity or capital securities during the first three years
after the sale to the Treasury Department. Further, and although Heartland does
not believe these restrictions would have any significant impact on it based on
the level of current executive compensation, Heartland would be required to
agree to restrictions on executive compensation in order to participate.
Although this program is intended to support and enhance the capital position of
participating institutions, there are no restrictions on the use of capital
obtained through the program.
The FDIC has also
announced a program under which it will guarantee until June 2012 some senior
unsecured debt
issued by qualifying institutions between October 14,
2008, and June 30, 2009, in amounts up to 125 percent of the qualifying
debt for each entity under the terms of the plan. The FDIC charges a 75 basis
point fee for any new qualifying debt issued with the FDIC guarantee. Heartland
is currently considering participation in this program.
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.
Investing
activities from continuing operations used cash of $188.7 million during the
first nine months of 2008 compared to $187.1 million during the first nine
months of 2007. The proceeds from securities sales, paydowns and maturities was
$265.5 million during the first nine months of 2008 compared to $155.7 million
during the first nine months of 2007. Purchases of securities used cash of
$356.3 million during the first nine months of 2008 while $184.2 million was
used for securities purchases during the first nine months of 2007. A larger
portion of the proceeds from securities sales, paydowns and maturities was used
to fund loan growth during the first nine months of 2007. Net loans and leases
experienced an increase of $92.6 million during the first nine months of 2008
compared to an increase of $121.5 million during the first nine months of
2007.
Financing
activities from continuing operations provided cash of $181.6 million during the
first nine months of 2008 compared to $158.6 million during the first nine
months of 2007. There was a net increase in deposit accounts of $191.6 million
during the first nine months of 2008 compared to $140.3 million during the same
nine months of 2007. Activity in short-term borrowings used cash of $177.6
million during the first nine months of 2008 compared to $17.1 million during
the first nine months of 2007. Cash proceeds from other borrowings were $222.0
million during the first nine months of 2008 compared to $62.1 million during
the first nine months of 2007. Repayment of other borrowings used cash of $45.4
million during the first nine months of 2008 compared to $17.9 million during
the first nine months of 2007.
Total
cash provided by operating activities from continuing operations was $27.4
million during the first nine months of 2008 compared to $20.8 million during
the first nine months of 2007. Cash used for the payment of income taxes was
$7.6 million during the first nine months of 2008 compared to $16.7 million
during the first nine months of 2007. The larger payment in 2007 resulted from
the sale of Heartland’s fleet leasing subsidiary, ULTEA, Inc., during the fourth
quarter of 2006.
The
totals previously discussed did not include the cash flows related to the
discontinued operations at the Broadus branch. Net cash provided from investing
activities of discontinued operations of the Broadus branch was $22.6 million
during the first nine months of 2007. Financing activities from the discontinued
operations of the Broadus branch used cash of $32.5 million during the first
nine months of 2007. Relative to operating activities, cash provided from the
discontinued operations of the Broadus branch was $10 thousand during the first
nine months of 2007.
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, 2008, Heartland’s revolving credit agreement with third-party
banks provided a maximum borrowing capacity of $60.0 million, of which $32.0
million had been borrowed. The revolving credit agreement contains specific
covenants which, among other things, limit dividend payments and restrict the
sale of assets by Heartland under certain circumstances. Also contained within
the agreement are certain financial covenants, including the maintenance by
Heartland of a maximum nonperforming assets to total loans ratio, minimum return
on average assets ratio and maximum funded debt to total equity capital ratio.
In addition, Heartland and each of its bank subsidiaries must remain well
capitalized, as defined from time to time by the federal banking regulators. At
September 30, 2008, Heartland was in compliance with the covenants contained in
the credit agreement.
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 at
the banks and, on a consolidated basis, by the Heartland 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 Heartland’s
and each of its bank subsidiaries’ balance sheet risk profile is performed.
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 management has entered into derivative
financial instruments to mitigate the exposure Heartland’s net interest margin
has in a downward rate environment, it does not believe that Heartland’s primary
market risk exposures and how those exposures have been managed to-date in 2008
changed significantly when compared to 2007.
The core
interest rate risk analysis utilized by Heartland examines the balance sheet
under rates up/down scenarios that are neither too modest nor too extreme. All
rate changes are ramped over a 12-month horizon based upon a parallel yield
curve shift 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 margin. 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 structure to be
isolated as growth assumptions can make interest rate risk. The most recent
reviews at September 30, 2008 and 2007, provided the following
results:
|
|
2008
|
|
|
|
2007
|
|
|
|
|
Net
Interest
Margin
(in thousands
)
|
|
|
%
Change
From
Base
|
|
|
|
Net
Interest
Margin
(in thousands)
|
|
|
%
Change
From
Base
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year 1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Down
100 Basis Points
|
|
$
|
113,869
|
|
|
|
(1.24
|
)
|
%
|
|
$
|
100,545
|
|
|
|
(3.35
|
)
|
%
|
Base
|
|
$
|
115,297
|
|
|
|
|
|
|
|
$
|
104,032
|
|
|
|
|
|
|
Up
200 Basis Points
|
|
$
|
114,851
|
|
|
|
(0.39
|
)
|
%
|
|
$
|
103,814
|
|
|
|
(0.21
|
)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year 2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Down
100 Basis Points
|
|
$
|
106,549
|
|
|
|
(7.59
|
)
|
%
|
|
$
|
97,775
|
|
|
|
(6.01
|
)
|
%
|
Base
|
|
$
|
113,445
|
|
|
|
(1.61
|
)
|
%
|
|
$
|
106,693
|
|
|
|
2.56
|
|
%
|
Up
200 Basis Points
|
|
$
|
116,011
|
|
|
|
0.62
|
|
%
|
|
$
|
106,101
|
|
|
|
1.99
|
|
%
|
Heartland’s
use of derivative financial instruments relates to the management of the risk
that changes in interest rates will affect its future interest income or
interest expense. Heartland is exposed to credit-related losses in the event of
nonperformance by the counterparties to its derivative instruments, which has
been minimized by entering into the contracts with large, stable financial
institutions. The estimated fair market values of these derivative instruments
are presented in Note 4 to the consolidated financial statements.
ITEM
4. CONTROLS AND PROCEDURES
As
required by Rules 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,
2008, 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, 2008, 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 2007 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, 2008, 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
(1)
|
07/01/08-
07/31/08
|
21,474
|
$18.79
|
21,474
|
$2,858,330
|
08/01/08-
08/31/08
|
13,020
|
$21.62
|
13,020
|
$2,905,624
|
09/01/08-
09/30/08
|
3,014
|
$22.01
|
3,014
|
$3,538,973
|
Total:
|
37,508
|
$20.03
|
37,508
|
N/A
|
(1)
|
Effective
April 17, 2007, Heartland’s board of directors authorized management to
acquire and hold up to 250,000 shares of common stock as treasury shares
at any one time. Effective January 24, 2008, Heartland’s board of
directors authorized an expansion of the number of treasury shares at any
one time to 500,000. Effective September 30, 2008, until its expiration
date on April 28, 2009, Heartland’s credit agreement provides for a limit
of no more than an aggregate of 100,000 shares of common stock to be
purchased as treasury shares with no purchases to be made on the open
market.
|
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
3.1
|
Certificate
of Incorporation of Heartland Financial USA, Inc., as amended May 19,
2004, and the Certificate of Designation of Junior Participating Preferred
Stock of Heartland Financial USA, Inc.
|
10.1
|
Fourth
Amendment to Amended and Restated Credit Agreement among Heartland
Financial USA, Inc. and The Northern Trust Company, U.S. Bank National
Association and JPMorgan Chase Bank, N.A., dated as of September 30,
2008.
|
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
-----------------------
By: Lynn B. Fuller
President and Chief Executive
Officer
Principal Financial and
Accounting Officer
-----------------------
By: John K. Schmidt
Executive Vice President
and Chief Financial
Officer
Dated: November 7, 2008