SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended March 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For transition period __________ to __________
Commission File Number: 0-24724
HEARTLAND FINANCIAL USA, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
42-1405748
(I.R.S. employer identification number)
1398 Central Avenue, Dubuque, Iowa 52001
(Address of principal executive offices)(Zip Code)
(563) 589-2100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the
classes of Registrant's common stock as of the latest practicable
date: As of May 14, 2002, the Registrant had outstanding
9,792,333 shares of common stock, $1.00 par value per share.
HEARTLAND FINANCIAL USA, INC.
Form 10-Q Quarterly Report
Table of Contents
Part I
Item 1. Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About
Market Risk
Part II
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of
Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Form 10-Q Signature Page
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
3/31/02 12/31/01
(Unaudited)
----------- ----------
ASSETS
Cash and due from banks $ 37,042 $ 45,738
Federal funds sold and other short-
term investments 21,963 47,812
---------- ----------
Cash and cash equivalents 59,005 93,550
Time deposits in other
financial institutions 568 564
Securities:
Trading, at fair value 1,548 1,528
Available for sale, at fair value
(cost of $355,398 for 2002 and
$318,342 for 2001) 359,579 323,689
Loans and leases:
Held for sale 14,027 26,967
Held to maturity 1,079,778 1,078,238
Allowance for loan and lease losses (15,075) (14,660)
---------- ----------
Loans and leases, net 1,078,730 1,090,545
Assets under operating leases 33,264 35,427
Premises, furniture and equipment, net 33,303 31,482
Other real estate, net 245 130
Goodwill, net 9,507 9,507
Core deposit premium and other
intangibles, net 11,405 11,198
Other assets 44,283 46,444
---------- ----------
TOTAL ASSETS $1,631,437 $1,644,064
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $ 154,553 $ 160,742
Savings 474,132 493,374
Time 588,514 551,043
---------- ----------
Total deposits 1,217,199 1,205,159
Short-term borrowings 137,753 160,703
Other borrowings 140,483 143,789
Accrued expenses and other liabilities 25,591 27,323
---------- ----------
TOTAL LIABILITIES 1,521,026 1,536,974
---------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock (par value $1 per
share; authorized, 200,000 shares) - -
Common stock (par value $1 per share;
authorized, 16,000,000 shares and
12,000,000 at March 31, 2002, and
December 31, 2001, respectively;
issued 9,905,783 shares at March 31,
2002, and December 31, 2001) 9,906 9,906
Capital surplus 16,639 18,116
Retained earnings 81,938 79,107
Accumulated other comprehensive income 2,982 3,565
Treasury stock at cost
(79,450 shares at March 31, 2002, and
226,031 shares at December 31, 2001) (1,054) (3,604)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 110,411 107,090
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,631,437 $1,644,064
========== ==========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share data)
Three Months Ended
3/31/02 3/31/01
-------- --------
INTEREST INCOME:
Interest and fees on loans and leases $ 20,973 $ 23,412
Interest on securities:
Taxable 3,194 3,120
Nontaxable 472 471
Interest on federal funds sold 105 689
Interest on interest bearing deposits
in other financial institutions 103 48
-------- --------
TOTAL INTEREST INCOME 24,847 27,740
-------- --------
INTEREST EXPENSE:
Interest on deposits 8,389 12,476
Interest on short-term borrowings 680 1,948
Interest on other borrowings 2,209 2,054
-------- --------
TOTAL INTEREST EXPENSE 11,278 16,478
-------- --------
NET INTEREST INCOME 13,569 11,262
Provision for loan and lease losses 985 721
-------- --------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN AND LEASE LOSSES 12,584 10,541
-------- --------
NONINTEREST INCOME:
Service charges and fees 1,933 1,461
Trust fees 832 766
Brokerage commissions 127 126
Insurance commissions 217 251
Securities gains, net 81 572
Loss on trading account securities (28) (225)
Rental income on operating leases 3,856 3,854
Gain on sale of loans 1,007 393
Other noninterest income 447 228
-------- --------
TOTAL NONINTEREST INCOME 8,472 7,426
-------- --------
NONINTEREST EXPENSES:
Salaries and employee benefits 6,985 6,210
Occupancy 777 825
Furniture and equipment 818 806
Depreciation on equipment under
operating leases 3,030 2,918
Outside services 881 753
FDIC deposit insurance assessment 53 51
Advertising 452 379
Goodwill amortization - 135
Core deposit and other intangibles
amortization 254 283
Other noninterest expenses 2,108 1,913
-------- --------
TOTAL OTHER NONINTEREST EXPENSES 15,358 14,273
-------- --------
INCOME BEFORE INCOME TAXES 5,698 3,694
Income taxes 1,885 1,238
-------- --------
NET INCOME $ 3,813 $ 2,456
======== ========
EARNINGS PER COMMON SHARE-BASIC $ 0.39 $ 0.26
EARNINGS PER COMMON SHARE-DILUTED 0.39 0.25
CASH DIVIDENDS DECLARED
PER COMMON SHARE 0.10 0.09
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands, except per share data)
Common Capital Retained
Stock Surplus Earnings
------- ------- ---------
Balance at January 1, 2001 $ 9,906 $18,812 $ 71,253
Net Income - - 2,456
Unrealized gain (loss) on
securities available for sale - - -
Reclassification adjustment for
gains realized in net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.09 per share - - (866)
------- ------- --------
Balance at March 31, 2001 $ 9,906 $18,812 $ 72,843
======= ======= ========
Balance at January 1, 2002 $ 9,906 $18,116 $ 79,107
Net Income - - 3,813
Unrealized gain (loss) on
securities available for sale - - -
Unrealized gain (loss) on
derivatives arising during the
period - - -
Reclassification adjustment for
gains realized in net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.10 per share - - (982)
Purchase of 22,705 treasury
shares - - -
Issuance of 169,286 treasury
shares - (1,477) -
------- ------- --------
Balance at March 31, 2002 $ 9,906 $16,639 $ 81,938
======= ======= ========
Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock Total
------------- -------- -----
Balance at January 1, 2001 $ 1,301 $(5,126) $ 96,146
Net Income - - 2,456
Unrealized gain (loss) on
securities available for sale 1,864 - 1,864
Reclassification adjustment for
gains realized in net income 572 - 572
Income taxes (828) - (828)
--------
Comprehensive income 4,064
Cash dividends declared:
Common, $.09 per share - - (866)
------- ------- --------
Balance at March 31, 2001 $ 2,909 $(5,126) $ 99,344
======= ======= ========
Balance at January 1, 2002 $ 3,565 $(3,604) $107,090
Net Income - - 3,813
Unrealized gain (loss) on
securities available for sale (1,025) - (1,025)
Unrealized gain (loss) on
derivatives arising during the
period 222 - 222
Reclassification adjustment for
gains realized in net income (81) - (81)
Income taxes 301 - 301
--------
Comprehensive income 3,320
Cash dividends declared:
Common, $.10 per share - - (983)
Purchase of 22,705 treasury
shares - (305) (305)
Issuance of 169,286 treasury
shares - 2,855 1,378
------- ------- --------
Balance at March 31, 2002 $ 2,982 $(1,054) $110,410
======= ======= ========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Three Months Ended
3/31/02 3/31/01
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,813 $ 2,456
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 4,079 4,131
Provision for loan and lease losses 985 721
Provision for income taxes in excess
of payments 1,709 951
Net amortization (accretion) of
Premium (discount) on securities 1,337 (29)
Securities gains, net (81) (572)
Increase in trading account securities (20) (871)
Loans originated for sale (38,533) (27,352)
Proceeds on sales of loans 52,480 22,599
Net gain on sales of loans (1,007) (393)
Decrease (increase) in accrued
interest receivable (778) 883
Increase (decrease) in accrued
interest payable (466) (45)
Other, net (934) 394
--------- ---------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 22,584 2,873
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds on maturities of time
deposits in other financial
institutions 4 383
Proceeds from the sale of
securities available for sale 902 25,574
Proceeds from the maturity of and
principal paydowns on securities
available for sale 42,206 6,025
Purchase of securities available
for sale (81,168) (62,114)
Net increase in loans and leases (1,778) (10,651)
Increase in assets under operating
leases (867) (3,523)
Capital expenditures (2,459) (503)
Proceeds on sale of OREO and other
repossessed assets 156 -
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (43,004) (44,809)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in demand deposits and
savings accounts (25,431) (29,408)
Net increase in time deposit accounts 37,471 33,198
Net increase (decrease) in short-term
borrowings (22,950) 21,040
Proceeds from other borrowings 2,840 20,547
Repayments of other borrowings (6,146) (3,938)
Purchase of treasury stock (305) -
Proceeds from issuance of treasury
stock 1,378 -
Dividends (982) (866)
--------- ---------
NET CASH PROVIDED (USED) BY FINANCING
ACTIVITIES (14,125) 40,573
--------- ---------
Net decrease in cash and cash
equivalents (34,545) (1,363)
Cash and cash equivalents at
beginning of year 93,550 84,687
--------- ---------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 59,005 $ 83,324
========= =========
Supplemental disclosures:
Cash paid for income/franchise taxes $ 117 $ 199
========= =========
Cash paid for interest $ 11,744 $ 16,523
========= =========
Securities held to maturity
transferred to securities available
for sale $ - $ 2,154
========= =========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The interim unaudited consolidated financial statements contained
herein should be read in conjunction with the audited
consolidated financial statements and accompanying notes to the
financial statements for the fiscal year ended December 31, 2001,
included in Heartland Financial USA, Inc.'s (the "Company") Form
10-K filed with the Securities and Exchange Commission on March
29, 2002. Accordingly, footnote disclosure which would
substantially duplicate the disclosure contained in the audited
consolidated financial statements has been omitted.
The financial information of the Company included herein is
prepared pursuant to the rules and regulations for reporting on
Form 10-Q. Such information reflects all adjustments (consisting
of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair presentation of results for the
interim periods. The results of the interim period ended March
31, 2002, are not necessarily indicative of the results expected
for the year ending December 31, 2002.
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 periods ended March 31, 2002 and
2001, are shown in the tables below:
Three Months Ended
3/31/02 3/31/01
------- -------
Net Income (000's) $ 3,813 $ 2,456
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,729 9,618
Assumed incremental common shares issued
upon exercise of stock options (000's) 64 107
------- -------
Weighted average common shares for
diluted earnings per share (000's) 9,794 9,725
======= =======
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Goodwill and Other Intangible Assets - Goodwill represents the
excess of the purchase price of acquired subsidiaries' net assets
over their fair value. On July 1, 2001, the Company adopted FASB
Statement ("FAS") No. 142, Goodwill and Other Intangible Assets.
During the transition period from July 1, 2001, through December
31, 2001, substantially all the Company's goodwill associated
with business combinations completed prior to July 1, 2001,
continued to be amortized over periods of 15 to 25 years on the
straight-line basis. Effective January 1, 2002, all goodwill
amortization was discontinued.
Effective January 1, 2002, goodwill will be assessed at least
annually for impairment by applying a fair-value-based test using
discounted cash flows. The Company will complete its initial
goodwill impairment assessment during the second quarter and does
not anticipate any transitional impairment charge. Subsequent
assessments will be performed in the fourth quarter of each year
and any resulting impairment will be recognized as a charge to
noninterest expense unless related to discontinued operations.
Core deposit intangibles are amortized over ten years on an
accelerated basis. Other intangible assets consist of the excess
purchase price of acquired branch net assets over their fair
value that will continue to be amortized over 15 years on the
straight-line basis in accordance with the provisions of FAS No.
72, Accounting for Certain Acquisitions of Banking or Thrift
Institutions.
The Company reviews intangible assets whenever events or changes
in circumstances indicate that their carrying amounts may not be
recoverable. If impairment is indicated through an analysis of
undiscounted cash flows, the asset is written down to the extent
that the carrying value exceeds its fair value.
NOTE 3: "ADJUSTED" EARNINGS - FAS NO. 142 TRANSITIONAL DISCLOSURE
The table below reconciles reported earnings for the first
quarter of 2001 to "adjusted" earnings, which exclude goodwill
amortization.
Quarter Quarter
Ended Ended
March 31, March 31,
2002 2001
--------- -------------------------------
Reported Reported Goodwill "Adjusted"
Earnings Earnings Amort. Earnings
--------- -------- -------- -----------
Income before income
taxes (000's) $ 5,698 $ 3,694 $ 135 $ 3,829
Income taxes (000's) 1,885 1,238 - 1,238
--------- -------- -------- -----------
Net income (000's) $ 3,813 $ 2,456 $ 135 $ 2,591
========= ======== ======== ===========
Earnings per common
share - basic $ .39 $ .26 $ .01 $ .27
========= ======== ======== ===========
Earnings per common
share - diluted $ .39 $ .25 $ .01 $ .27
========= ======== ======== ===========
NOTE 4: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated
accumulated amortization at March 31, 2002, is presented in the
table below.
March 31, 2002
------------------------
Gross
Carrying Accumulated
Amount Amortization
-------- ------------
Intangible assets:
Core deposit premium (000's) $ 4,491 $ 1,684
Mortgage servicing rights (000's) 2,492 306
Other intangible assets (000's) 7,799 1,387
------- -------
Total (000's) $14,782 $ 3,378
======= =======
Unamortized intangible assets (000's) $11,405
=======
Projections of amortization expense for mortgage servicing rights
are based on existing asset balances and the existing interest
rate environment as of March 31, 2002. What the Company actually
experiences may be significantly different depending upon changes
in mortgage interest rates and market conditions. The following
table shows the estimated future amortization expense for
amortized intangibles assets:
Core Mortgage
Deposit Servicing
Premium Rights Other Total
--------- -------- ------- ---------
Nine months ended
December 31, 2002
(000's) $ 371 $ 413 $ 390 $ 1,174
Year Ended December 31,
2003 (000's) $ 404 $ 624 $ 520 $ 1,548
2004 (000's) 353 520 520 1,393
2005 (000's) 353 416 520 1,289
2006 (000's) 353 312 520 1,185
2007 (000's) 353 208 520 1,081
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SAFE HARBOR STATEMENT
This report (including information incorporated by reference)
contains, and future oral and written statements of Heartland and
its management may contain, forward-looking statements, within
the meaning of such term in the Private Securities Litigation
Reform Act of 1995, with respect to the financial condition,
results of operations, plans, objectives, future performance and
business of Heartland. Forward-looking statements, which may be
based upon beliefs, expectations and assumptions of Heartland's
management and on information currently available to management,
are generally identifiable by the use of words such as "believe",
"expect", "anticipate", "plan", "intend", "estimate", "may",
"will", "would", "could", "should" or other similar expressions.
Additionally, all statements in this document, including forward-
looking statements, speak only as of the date they are made, and
Heartland undertakes no obligation to update any statement in
light of new information or future events.
Heartland's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which
could have a material adverse effect on the operations and future
prospects of Heartland and its subsidiaries include, but are not
limited to, the following:
- The strength of the United States economy in general and
the strength of the local economies in which Heartland
conducts its operations which may be less favorable than
expected and may result in, among other things, a
deterioration in the credit quality and value of
Heartland's assets.
- The economic impact of the terrorist attacks that
occurred on September 11th, as well as any future threats
and attacks, and the response of the United States to any
such threats and attacks.
- The effects of, and changes in, federal, state and local
laws, regulations and policies affecting banking,
securities, insurance and monetary and financial matters.
- The effects of changes in interest rates (including the
effects of changes in the rate of prepayments of
Heartland's assets) and the policies of the Board of
Governors of the Federal Reserve System.
- The ability of Heartland to compete with other financial
institutions as effectively as Heartland currently
intends due to increases in competitive pressures in the
financial services sector.
- The inability of Heartland to obtain new customers and to
retain existing customers.
- The timely development and acceptance of products and
services, including products and services offered through
alternative delivery channels such as the Internet.
- Technological changes implemented by Heartland and by
other parties, including third party vendors, which may
be more difficult or more expensive than anticipated or
which may have unforeseen consequences to Heartland and
its customers.
- The ability of Heartland to develop and maintain secure
and reliable electronic systems.
- The ability of Heartland to retain key executives and
employees and the difficulty that Heartland may
experience in replacing key executives and employees in
an effective manner.
- Consumer spending and saving habits which may change in a
manner that affects Heartland's business adversely.
- Business combinations and the integration of acquired
businesses may be more difficult or expensive than
expected.
- The costs, effects and outcomes of existing or future
litigation.
- Changes in accounting policies and practices, as may be
adopted by state and federal regulatory agencies and the
Financial Accounting Standards Board.
- The ability of Heartland to manage the risks associated
with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be
placed on such statements. Additional information concerning
Heartland and its business, including other factors that could
materially affect Heartland's financial results, is included in
Heartland's filings with the Securities and Exchange Commission.
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, fees and gains on loans, rental income on operating
leases and trust income, also affects Heartland's results of
operations. Heartland's principal operating expenses, aside from
interest expense, consist of compensation and employee benefits,
occupancy and equipment costs, depreciation on equipment under
operating leases and provision for loan and lease losses.
Earnings for the year were off to a good start as first quarter
net income increased $1.357 million or 55% over last year's first
quarter results. Net income totaled $3.813 million, or $.39 on a
diluted earnings per common share basis, for the first quarter of
2002 compared to $2.456 million, or $.25 on a diluted earnings
per common share basis, during the same quarter in 2001. Return
on common equity was 14.19% and return on assets was .95% for the
first quarter of 2002. For the same period in 2001, return on
equity was 10.24% and return on assets was .67%. Our performance
this quarter provides excellent evidence of the benefits derived
from the expansion and diversification efforts embarked upon in
the late 1990's.
Heartland's adoption of the provision of Statement of Financial
Accounting Standards ("FAS") No. 142, Goodwill and Other
Intangible Assets, on January 1, 2002, discontinued the
amortization of $9.507 million in unamortized goodwill. The
amount of amortization expense recorded during the first quarter
of 2001 on this goodwill was $135 thousand ($.01 on a diluted per
common share basis).
Contributing to the improved earnings during the first quarter of
2002 was the $2.309 million or 20% growth in net interest income
on a fully tax equivalent basis, due primarily to growth in
earning assets. Average earning assets went from $1.321 billion
during the first quarter of 2001 to $1.457 billion during the
same quarter in 2002, a change of $136 million or 10%. Also
contributing to the improved earnings was the $1.046 million or
14% increase in noninterest income while the increase in
noninterest expense was held to $1.085 million or 8%. In addition
to gains on sale of loans, the other noninterest income category
to reflect significant improvement was service charges and fees.
Exclusive of securities gains and losses, including trading
account securities gains and losses, noninterest income
experienced a $1.340 million or 19% increase.
Total assets remained stable at March 31, 2002, declining by less
than 1% since year-end 2001. Loans and leases were $1.094 billion
and deposits were $1.217 billion at the end of the first quarter,
a decrease of 1% and an increase of 1%, respectively, since year-
end 2001. Historically, Heartland has not experienced significant
growth in its core business during the first quarter of the year.
Loan growth was slowed due to paydowns experienced in the
mortgage loan portfolio as customers continued to refinance their
mortgage loans into fifteen- and thirty-year fixed rate loans,
which the Company usually sells into the secondary market. Some
of this slowed growth was offset by an increase in the commercial
loan portfolio, which grew $21.606 million or 3% during the first
quarter. Management feels that opportunities for growth within
the commercial loan portfolio will continue to expand during the
remaining quarters of 2002.
NET INTEREST INCOME
Net interest margin, expressed as a percentage of average earning
assets, was 3.86% during the first quarter of 2002 compared to
3.54% for the same period in 2001 and 3.79% for the fourth
quarter of 2001. Heartland manages its balance sheet to minimize
the effect a change in interest rates has on its net interest
margin. Heartland has been successful in the utilization of
floors on its commercial loan portfolio to minimize the affect
downward rates have on its interest income. If rates begin to
edge upward, Heartland will not see a corresponding increase in
its interest income until rates have moved above the floors in
place on these loans. Interest income as a percentage of average
earning assets went from 8.60% during the first quarter of 2001
to 7.00% during the first quarter of 2002, a decline of 160 basis
points. Additionally, on the liability side of the balance sheet,
Heartland has locked in some funding in the three- to five-year
maturities as rates were at historical low levels. During the
last half of 2001, Heartland elected to obtain additional Federal
Home Loan Bank advances to lock in these low rates in
anticipation of fixed-rate commercial loan growth and the
replacement of maturing advances during the first half of 2002.
Interest expense as a percentage of average earning assets went
from 5.06% during the first quarter of 2001 to 3.14% for the same
quarter in 2002, a decline of 192 basis points.
For the three-month period ended March 31, 2002, interest income
decreased $2.893 million or 10% when compared to the same period
in 2001. This decrease was primarily attributable to the dramatic
decline in rates. During the first quarter of 2001, national
prime decreased from 9.50% to 8.00%. During the first quarter of
2002, national prime remained unchanged at 4.75%. Additionally,
the significant amount of refinance activity experienced on
mortgage loans during the fourth quarter of 2001 reduced the
amount of interest income realized in Heartland's mortgage-backed
securities portfolio.
For the three-month period ended March 31, 2002, interest expense
decreased $5.200 million or 32% when compared to the same period
in 2001. The decline in interest expense outpaced the decline in
interest income primarily as a result of the decline in rates and
the maturity of higher-rate certificates of deposit accounts.
Management continues to focus efforts on improving the mix of its
funding sources to minimize its interest costs.
PROVISION FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses is established through a
provision charged to expense. The $985 thousand provision for
loan losses made during the first quarter of 2002, an increase of
$264 thousand or 37% when compared to the same period in 2001,
resulted primarily from an increase in nonperforming loans and
growth experienced in the commercial loan portfolio. 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,
past loss experience, loan delinquencies, and potential
substandard and doubtful credits. For additional details on the
specific factors considered during this quarter, refer to the
loans and allowance for loan and lease losses section of this
report.
NONINTEREST INCOME
Total noninterest income increased $1.046 million or 14% during
the quarter ended on March 31, 2002, compared to the same period
in 2001. The noninterest income categories reflecting significant
improvement were service charges and fees and gains on sale of
loans.
Service charges and fees increased $472 thousand or 32% during
the quarters under comparison. The $30.865 million or 25% growth
in checking accounts for the twelve-month period ended on March
31, 2002, resulted in the generation of additional service charge
revenue related to activity fees charged to these accounts. Also
contributing to the increase in service charges and fees was the
growth in fees collected for the processing of merchant credit
card activity.
Gains on sale of loans increased by $614 thousand or 156% for the
periods under comparison. The volume of mortgage loans sold into
the secondary market during the first quarter of 2002 was greater
than those sold during the same period in 2001. As rates moved
downward during the second half of 2001, customers frequently
elected to take fifteen- and thirty-year, fixed-rate mortgage
loans, which Heartland usually elects to sell into the secondary
market.
During the first quarter of 2002, securities gains were $491
thousand or 86% below the amount recorded during the same period
in 2001. During the first quarter of 2001, Heartland's interest
rate forecast changed to a rising rate bias on the long end of
the yield curve, and therefore, longer-term agency securities
were sold at a gain to shorten the portfolio. The proceeds were
invested in well-seasoned mortgage-backed securities that were
projected to outperform the agency securities in a rising rate
environment.
During the first quarter of 2001, Heartland elected to begin
classifying some of its new equity securities purchases as
trading. Losses on this portfolio totaled $28 thousand during the
first quarter of 2002 and $225 thousand during the first quarter
of 2001, primarily as a result of the decline in the stock
market.
Other noninterest income experienced an increase of $219 thousand
or 96% during the quarters under comparison. A majority of this
increase was attributable to growth in the cash surrender value
of life insurance policies owned by Heartland. An additional
purchase of $8.5 million was made during 2001.
NONINTEREST EXPENSE
Total noninterest expense was held to an increase of $1.085
million or 8% during the first quarter of 2002 when compared to
the same quarter in 2001. Growth in some of these expenses has
tapered off as Heartland has begun to realize the full
utilization of the resources it expended during the early stages
of its growth initiatives.
Salaries and employee benefits, the largest component of
noninterest expense, increased $775 thousand or 12% for the
quarters under comparison. This increase made up 71% of the total
increase in noninterest expense. In addition to normal merit
increases, this increase was also attributable to expansion
efforts, primarily at New Mexico Bank & Trust. The number of full-
time equivalent employees employed by Heartland increased from
551 at March 31, 2001, to 571 at March 31, 2002.
Other noninterest expense increased $195 thousand or 10% for the
quarters under comparison. Over half of this increase was the
result of additional processing fees related to the increased
activity in the merchant credit card processing area.
INCOME TAX EXPENSE
Income tax expense for the first quarter of 2002 increased $647
thousand or 52% when compared to the same period in 2001. This
increase was primarily the result of a corresponding increase in
pre-tax earnings. Heartland's effective tax rate was 33.08%
during the first quarter of 2002 and 33.51% for the first quarter
of 2001.
FINANCIAL CONDITION
LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Total loans and leases decreased slightly to $1.094 billion at
the end of the first quarter of 2002, a decrease of 1% since year-
end 2001. Loan growth was slowed due to paydowns experienced in
the mortgage loan portfolio. The residential mortgage loan
portfolio experienced a decline of $26.208 million or 16% as
customers continued to refinance their mortgage loans into
fifteen- and thirty-year fixed rate loans, which Heartland
usually sells into the secondary market. Servicing is retained on
a majority of these loans so that the Heartland bank subsidiaries
have an opportunity to continue providing their customers the
excellent service they expect. Heartland's servicing portfolio
was $183.880 million at year-end 2000, $268.625 million at year-
end 2001 and $309.805 at March 31, 2002.
The decline in the mortgage loan portfolio was partially offset
by an increase in the commercial and commercial real estate loan
portfolio, which grew $21.606 million or 3% during the first
quarter of 2002. Most of this growth occurred at New Mexico Bank
& Trust, Wisconsin Community Bank and Riverside Community Bank,
principally as a result of continued calling efforts. Management
feels that opportunities for growth within the commercial loan
portfolio will continue to expand during the remaining quarters
of 2002.
The table below presents the composition of the loan portfolio as
of March 31, 2002, and December 31, 2001.
LOAN PORTFOLIO
(Dollars in thousands)
March 31, December 31,
2002 2001
Amount Percent Amount Percent
------ ------- ------ -------
Commercial and commercial
real estate $ 673,085 54.50% $ 651,479 58.73%
Residential mortgage 142,704 19.19 168,912 15.23
Agricultural and
agricultural real estate 143,887 12.72 145,460 13.11
Consumer 124,045 11.97 127,874 11.53
Lease financing, net 13,793 1.62 15,570 1.40
---------- ------- ---------- -------
Gross loans and leases $1,097,514 100.00% $1,109,295 100.00%
======= =======
Unearned discount (2,954) (3,457)
Deferred loan fees (755) (633)
---------- ----------
Total loans and leases 1,093,805 1,105,205
Allowance for loan and
lease losses (15,075) (14,660)
---------- ----------
Loans and leases, net $1,078,730 $1,090,545
========== ==========
The process utilized by Heartland to estimate the adequacy of the
allowance for loan and lease losses is considered a critical
accounting practice for Heartland. The allowance for loan and
lease losses represents management's estimate of identified and
unidentified losses in the existing loan portfolio. Thus, the
accuracy of this estimate could have a material impact on
Heartland's earnings. The adequacy of the allowance for loan and
lease losses is determined using factors that include the overall
composition of the loan portfolio, general economic conditions,
types of loans, past loss experience, loan delinquencies, and
potential substandard and doubtful credits. The adequacy of the
allowance for loan and lease losses is monitored on an ongoing
basis by the loan review staff, senior management and the board
of directors. Factors considered by the loan review committee
included the following:
- The amount of Heartland's nonperforming loans has trended
upward.
- The nation has been in a period of economic slowdown.
- 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
markets in which it had little or no previous lending
experience.
There can be no assurances that the allowance for loan and lease
losses will be adequate to cover all losses, but management
believes that the allowance for loan and lease losses was
adequate at March 31, 2002. While management uses available
information to provide for loan and lease losses, the ultimate
collectibility of a substantial portion of the loan portfolio and
the need for future additions to the allowance will be based on
changes in economic conditions. Along with other financial
institutions, management shares a concern for the possible
continued softening of the economy. Should the economic climate
continue to deteriorate, borrowers may experience difficulty, and
the level of non-performing loans, charge-offs, and delinquencies
could rise and require further increases in the provision for
loan and lease losses. In addition, various regulatory agencies,
as an integral part of their examination process, periodically
review the allowance for loan and lease losses carried by the
Heartland subsidiaries. Such agencies may require Heartland to
make additional provisions to the allowance based upon their
judgment about information available to them at the time of their
examinations.
The allowance for loan and lease losses increased by $415
thousand or 3% during the first three months of 2002. The
allowance for loan and lease losses at March 31, 2002, was 1.38%
of loans and 177% of nonperforming loans, compared to 1.33% of
loans and 180% of nonperforming loans, at year-end 2001.
Nonperforming loans increased to .78% of total loans and leases
at March 31, 2002, compared to .73% of total loans and leases at
December 31, 2001. This increase was primarily the result of one
agricultural credit at New Mexico Bank and Trust for which a
workout plan is in process.
During the first quarter of 2002, Heartland recorded net charge
offs of $570 thousand compared to $213 thousand for the same
period in 2001. Citizens Finance Co., Heartland's consumer
finance subsidiary, was responsible for $327 thousand or 57% of
the net charge-offs during the first three months of 2002 and
$213 thousand or 79% during the same period in 2001. Increased
losses at Citizens relate directly to the rapid growth it
experienced during the previous two years with expansion into the
Rockford, Illinois, market. Identification of problem loans in a
portfolio begin to occur as the portfolio matures. Additionally,
the weakened economy has affected the ability of borrowers to
repay their consumer loans. Losses as a percentage of gross loans
at Citizens were 5.60% for the first quarter of 2002 compared to
2.89% for the first quarter of 2001. Loans with payments past due
for more than thirty days decreased from 5.30% of gross loans at
December 31, 2001, to 4.75% at March 31, 2002.
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% of total assets at March 31,
2002, as compared to 20% at December 31, 2001. The amount of
securities held in Heartland's portfolio was increased during the
first quarter of 2002 as deposit growth outpaced growth in the
loan portfolio.
During the first quarter of 2002, management changed the
composition of the securities portfolio. Additional paydowns
received on mortgage-backed securities were replaced with short-
term U.S. treasury and government agency securities and municipal
securities. A continuation of increasing interest rates along the
yield curve, except on the short end, resulted in an unusually
steep yield curve during the first quarter of 2002. Management
purchased some longer-term municipal securities to take advantage
of the slope in the municipal yield curve, as Heartland's rate
forecast called for a flattening of the yield curve.
Additionally, to improve net interest margin, management elected
to reduce its fed funds and money market instruments position and
invest in short-term U.S. treasury and government agency
securities. The table below presents the composition of the
securities portfolio by major category as of March 31, 2002, and
December 31, 2001.
SECURITIES PORTFOLIO
(Dollars in thousands)
March 31, December 31,
2002 2001
Amount Percent Amount Percent
------ ------- ------ -------
U.S. Treasury securities $ 20,471 5.69% $ 498 .15%
U.S. government agencies 97,671 27.16 78,736 24.33
Mortgage-backed securities 161,774 44.99 183,661 56.74
States and political
subdivisions 45,233 12.58 30,948 9.56
Other securities 34,430 9.58 29,846 9.22
-------- ------- -------- -------
Total securities $359,579 100.00% $323,689 100.00%
======== ======= ======== =======
DEPOSITS AND BORROWED FUNDS
Total deposits remained flat during the first three months of
2002. The demand and savings deposit categories experienced a
decrease during the quarter while certificate of deposit account
balances increased. The $6.189 million or 4% decline in demand
deposit balances was due primarily to normal seasonal
fluctuations that many banks experience during the first quarter
of the year. A shift from savings to certificate of deposit
accounts continued into the first quarter of 2002 as deposit
customers became more interested in certificate of deposit
products and less interested in savings products. Also, with the
volatility in the stock market, customers elected to keep a
larger portion of their funds invested in certificates of
deposit. Savings deposits declined $19.242 million or 4% while
certificates of deposit grew $37.471 million or 7% during the
first quarter.
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.
Over the three month period ended March 31, 2002, the amount of
short-term borrowings had decreased $22.950 million or 14%.
Treasury tax and loan note options made up $8.199 million or 36%
of this change and repurchase agreement balances made up $12.427
million or 54% of this change. 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 repurchase agreements is subject to
variation, the account relationships represented by these
balances are principally local. With the continued decline in
interest rates during the last half of 2001, some of these
repurchase agreement customers elected to invest a portion of
their excess funds in higher-yielding products.
Also included in short-term borrowings are the credit lines
Heartland entered into with two unaffiliated banks. Under the
unsecured credit lines, Heartland may borrow up to $50.0 million.
At March 31, 2002, $26.425 million was outstanding as compared to
$29.225 million at December 31, 2001.
Other borrowings include all debt arrangements Heartland and its
subsidiaries have entered into with original maturities that
extend beyond one year. These borrowings were $140.483 million on
March 31, 2002, compared to $143.789 million on December 31,
2001. The change in these account balances primarily results from
activity in the bank subsidiaries' borrowings from the FHLB. All
of the Heartland banks own stock in the FHLB of Des Moines,
Chicago or Dallas, enabling them to borrow funds from their
respective FHLB for short- or long-term purposes under a variety
of programs. Total FHLB borrowings at March 31, 2002, and
December 31, 2001, were $83.985 million and $86.486 million,
respectively. Substantially all of these borrowings are fixed-
rate advances for original terms between three and five years.
Additionally, balances outstanding on capital securities issued
by Heartland in 1999 and 2001 are included in total other
borrowings. The issuance in October of 1999 for $25.0 million
bears an annual rate of 9.60% and matures on September 30, 2029.
A private placement offering for $8.0 million was completed in
December of 2001. This variable rate issuance matures on December
18, 2031.
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 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. As of
December 31, 2001, 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)
March 31, December 31,
2002 2001
Amount Ratio Amount Ratio
------ ----- ------ -----
Risk-Based Capital Ratios:(1)
Tier 1 capital $ 125,380 10.02% $ 121,112 9.71%
Tier 1 capital minimum
requirement 50,048 4.00% 49,891 4.00%
---------- ------ ---------- ------
Excess $ 75,332 6.02% $ 71,221 5.71%
========== ====== ========== ======
Total capital $ 140,454 11.23% $ 135,770 10.89%
Total capital minimum
requirement 100,095 8.00% 99,782 8.00%
---------- ------ ---------- ------
Excess $ 40,359 3.23% $ 35,988 2.89%
========== ====== ========== ======
Total risk-adjusted
assets $1,251,192 $1,247,274
========== ==========
Leverage Capital Ratios:(2)
Tier 1 capital $ 125,380 7.78% $ 121,112 7.53%
Tier 1 capital minimum
requirement(3) 64,455 4.00% 64,336 4.00%
---------- ------ ---------- ------
Excess $ 60,925 3.78% $ 56,776 3.53%
========== ====== ========== ======
Average adjusted assets
(less goodwill) $1,611,366 $1,608,402
========== ==========
(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. As a result of the acquisition of
National Bancshares, Inc., the one-bank holding company of First
National Bank of Clovis, remaining requisite cash payments under
the notes payable total $637 thousand in 2003 and 2004, plus
interest at 7.00%. Immediately following the closing of the
acquisition, the bank was merged into New Mexico Bank & Trust. As
a result of this affiliate bank merger, Heartland's ownership in
New Mexico Bank & Trust increased to approximately 88%.
In June of 2000, Heartland offered a portion of its shares of New
Mexico Bank & Trust's common stock to interested investors. In no
case would Heartland's interest be allowed to fall below 80%. All
minority stockholders, including the initial investors, entered
into a stock transfer agreement before shares were issued to
them. This stock transfer agreement imposes certain restrictions
on the investor's sale, transfer or other disposition of their
shares and requires Heartland to repurchase the shares from the
investor on April 9, 2003. As of March 31, 2002, Heartland's
ownership in New Mexico Bank & Trust was 86%.
Heartland has an incentive compensation agreement with certain
employees of one of the bank subsidiaries, none of whom is an
executive officer of Heartland, that requires a total payment of
$3.8 million to be made no later than February 29, 2004, to those
who remain employed with the subsidiary on December 31, 2003.
Additionally, each employee is bound by a confidentiality and non-
competition agreement. One-third of the payment will be made in
cash and the remaining two-thirds in shares of Heartland's common
stock. The obligation is being accrued over the performance
period.
On December 18, 2001, Heartland completed a private placement
offering of $8.0 million of variable rate cumulative capital
securities representing undivided beneficial interests in
Heartland Financial Statutory Trust II, a special purpose trust
subsidiary formed for the sole purpose of this offering. The
proceeds from the offering were used by the trust to purchase
junior subordinated debentures from Heartland. The proceeds were
used by Heartland for general corporate purposes. Interest is
payable quarterly on March 18, June 18, September 18 and December
18 of each year. The debentures will mature and the capital
securities must be redeemed on December 18, 2031. Heartland has
the option to shorten the maturity date to a date not earlier
than December 18, 2006. Heartland will not shorten the maturity
date without prior approval of the Board of Governors of the
Federal Reserve System, if required. Prior redemption is
permitted under certain circumstances, such as changes in tax or
regulatory capital rules. All of these securities qualified as
Tier 1 capital for regulatory purposes as of March 31, 2002.
In October of 1999, Heartland completed an offering of $25.0
million of 9.60% cumulative capital securities representing
undivided beneficial interests in Heartland Capital Trust I, a
special purpose trust subsidiary formed for the sole purpose of
this offering. The proceeds from the offering were used by the
trust to purchase junior subordinated debentures from Heartland.
The proceeds were used by Heartland for general corporate
purposes. All of these securities continued to qualify as Tier 1
capital for regulatory purposes as of March 31, 2002.
Expansion efforts are underway at Wisconsin Community Bank, as it
committed to the construction of a 3-story, 20,000 square foot
building in Fitchburg, a suburb southwest of Madison. The bank
will occupy the first floor and financially related companies or
law offices will occupy the top two floors. Construction of this
$2.5 million facility is scheduled to begin this May with
completion targeted for this November.
Plans for the construction of a 50,000 square foot facility to
accommodate the operations and support functions of Heartland are
underway. Property in downtown Dubuque, Iowa, across the street
from Dubuque Bank and Trust's main facility, has been purchased.
The $4.5 million project will begin this summer with completion
anticipated early next summer. A reduction in overall costs on
this project will result from tax credits and other incentives
made available on the project as it includes the rehabilitation
of two historical structures and the creation of new jobs.
Heartland continues to explore other opportunities to expand its
umbrella of independent community banks through mergers and
acquisitions as well as de novo and branching opportunities. As
evidenced by the expansion into New Mexico, Heartland is seeking
to operate in high growth areas, even if they are outside of its
traditional Midwest market areas. Future expenditures relating to
these efforts are not estimable at this time.
LIQUIDITY
Liquidity measures the ability of Heartland to meet maturing
obligations and its existing commitments, to withstand
fluctuations in deposit levels, to fund its 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.
Net cash outflows from investing activities decreased $1.8
million during the first three months of 2002 compared to the
same period in 2001. The net increase in loans and leases was
$1.8 million during the first three months of 2002 compared to
$10.7 million during the same period in 2001, an $8.9 million
change, driven primarily by the paydowns experienced in the
mortgage loan portfolio. During the first three months of 2002,
proceeds from the sale of securities decreased $24.7 million
compared to the same period in 2001. During the first quarter of
2001, management elected to shift a portion of its securities
portfolio into mortgage-backed securities from U.S. government
agencies. Proceeds from the maturity of and principal paydowns on
securities increased $36.2 million during the first quarter of
2002 when compared to the same period in 2001, primarily as a
result of increased paydowns on mortgage-backed securities. The
increased paydowns within the securities and loan portfolio
resulted in additional purchases of securities. Purchases of
securities increased $19.1 million for the periods under
comparison.
Financing activities used net cash of $14.1 million during the
first quarter of 2002. Conversely, during the first quarter of
2001, financing activities provided net cash of $40.6 million. A
net increase in deposit accounts provided cash of $12.0 million
during the first three months of 2002 compared to $3.8 million
during the same period in 2001. Short-term borrowings used cash of
$22.9 million in 2002 and provided cash of $21.0 million in 2001.
This change in the cash provided by short-term borrowings was
partially the result of repurchase agreement customers electing to
invest a portion of their excess funds in higher-yielding products.
As deposit balances increased and loan growth slowed, Heartland did
not find it necessary to increase its other borrowings as much
during the first quarter of 2002 as it had during the same quarter
in 2001. The proceeds from other borrowings had declined $17.7
million.
Total cash inflows from operating activities increased $19.7
million for the first three months of 2002 compared to the same
period in 2001. A large portion of this change resulted from real
estate mortgage loan activity as customers continued to refinance
their mortgage loans into fifteen- and thirty-year fixed rate
loans, which Heartland usually sells into the secondary market.
Loan sales activity provided cash of $12.9 million during 2002
compared to using cash of $5.1 million during the same period in
2001. 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.
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.
Heartland's revolving credit agreements, as of March 31, 2002,
provided an additional borrowing capacity of $23.575 million.
These agreements contain specific covenants which, among other
things, limit dividend payments and restrict the sale of assets
by Heartland under certain circumstances. Also contained within
the agreements 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 March 31, 2002, Heartland was in compliance with
the covenants contained in these credit agreements.
RECENT REGULATORY DEVELOPMENTS
On October 26, 2001, President Bush signed into law the
Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 (the
"USA PATRIOT Act"). Among its other provisions, the USA PATRIOT
Act requires each financial institution: (i) to establish an anti-
money laundering program; (ii) to establish due diligence
policies, procedures and controls with respect to its private
banking accounts and correspondent banking accounts involving
foreign individuals and certain foreign banks; and (iii) to avoid
establishing, maintaining, administering, or managing
correspondent accounts in the United States for, or on behalf of,
foreign banks that do not have a physical presence in any
country. The USA PATRIOT Act also requires the Secretary of the
Treasury to prescribe, by regulations to be issued jointly with
the federal banking regulators and certain other agencies,
minimum standards that financial institutions must follow to
verify the identity of customers, both foreign and domestic, when
a customer opens an account. In addition, the USA PATRIOT Act
contains a provision encouraging cooperation among financial
institutions, regulatory authorities and law enforcement
authorities with respect to individuals, entities and
organizations suspected of engaging in terrorist acts or money
laundering activities.
During the first quarter of 2002, the Financial Crimes
Enforcement Network (FinCEN), a bureau of the Department of the
Treasury, issued proposed and interim regulations as mandated by
the USA PATRIOT Act that would: (i) prohibit certain financial
institutions from providing correspondent accounts to foreign
shell banks; (ii) require such financial institutions to take
reasonable steps to ensure that correspondent accounts provided
to foreign banks are not being used to indirectly provide banking
services to foreign shell banks; (iii) require certain financial
institutions that provide correspondent accounts to foreign banks
to maintain records of the ownership of such foreign banks and
their agents in the United States; (iv) require the termination
of correspondent accounts of foreign banks that fail to turn over
their account records in response to a lawful request from the
Secretary of the Treasury or the Attorney General; and (v)
encourage information sharing among financial institutions and
federal law enforcement agencies to identify, prevent, deter and
report money laundering and terrorist activity. To date, it has
not been possible to predict the impact the USA PATRIOT ACT and
its implementing regulations may have on Heartland or its bank
subsidiaries in the future.
On April 11, 2002, the Office of Thrift Supervision (the "OTS")
announced the implementation of a restructuring plan designed to
achieve greater operating efficiencies and consistency of
regulation for the thrift industry. Under the plan, the OTS
consolidated and realigned its regional structure into four
supervisory regions by eliminating the Central Region (formerly
located in Chicago, Illinois) and apportioning supervisory
responsibilities for the institutions in the states that made up
that region among other regions. Although the OTS will continue
to maintain a Chicago office with a substantial supervisory
presence, under the realignment, the Southeast Region (located in
Atlanta, Georgia) assumed oversight of thrifts in Michigan,
Illinois, Indiana and Kentucky, the Midwest Region (located in
Dallas, Texas) assumed oversight of thrifts in Wisconsin and
Tennessee and Ohio became part of the Northeast Region (located
in Jersey City, New Jersey). In addition, North and South Dakota,
Colorado and New Mexico were transferred to the West Region
(located in San Francisco, California) from the Midwest Region.
First Community Bank, Heartland's only thrift, will continue to
be supervised by the Midwest Region office located in Dallas,
Texas.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
(Dollars in thousands)
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.
Management does not believe that Heartland's primary market risk
exposures and how those exposures have been managed to-date in
2002 changed significantly when compared to 2001.
Derivative financial instruments include futures, forwards,
interest rate swaps, option contracts and other financial
instruments with similar characteristics. Heartland's use of
derivative financial instruments relates to the management of the
risk that changes in interest rates will affect its future
interest payments. Heartland utilizes an interest rate swap
contract to effectively convert a portion of its variable rate
interest rate debt to fixed interest rate debt. Under the
interest rate swap contract, Heartland agrees to pay an amount
equal to a fixed rate of interest times a notional principal
amount, and to receive in return an amount equal to a specified
variable rate of interest times the same notional principal
amount. The notional amounts are not exchanged and payments under
the interest rate swap contract are made monthly. Heartland is
exposed to credit-related losses in the event of nonperformance
by the counterparty to the swap contract, which has been
minimized by entering into the contract with a large, stable
financial institution. As of March 31, 2002, Heartland had an
interest rate swap contract to pay a fixed rate of interest and
receive a variable rate of interest on $25.0 million of
indebtedness. This contract expires on November 1, 2006. The fair
market value of the interest rate swap contract was $572 thousand
as of March 31, 2002.
PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Company or its subsidiaries is a party other than ordinary
routine litigation incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES
None
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 AND REPORTS ON FORM 8-K
Exhibits
None
Reports on Form 8-K
On January 22, 2002, the Company filed a report on Form 8-K
stating under Item 5 that the Company issued a press release
announcing its earnings for the quarter ended on December 31,
2001. Also reported on this same report under Item 5 was the
appointment of Thomas L. Flynn as a director of the Company and
the resignation of Gregory R. Miller as a director of the
Company.
On April 19, 2002, the Company filed a report on Form 8-K stating
under Item 5 that the Company issued a press release announcing
its earnings for the quarter ended on March 31, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned there unto duly authorized.
HEARTLAND FINANCIAL USA, INC.
(Registrant)
Principal Executive Officer
/s/ Lynn B. Fuller
-----------------------
By: Lynn B. Fuller
President
Principal Financial and
Accounting Officer
/s/ John K. Schmidt
-----------------------
By: John K. Schmidt
Executive Vice President
and Chief Financial Officer
Dated: May 15, 2002