SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended September 30, 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 November 13, 2002, the Registrant had outstanding
9,805,382 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
Item 4. Controls and Procedures
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)
9/30/02 12/31/01
(Unaudited)
----------- ----------
ASSETS
Cash and due from banks $ 53,439 $ 45,738
Federal funds sold and other short-
term investments 4,455 47,812
---------- ----------
Cash and cash equivalents 57,894 93,550
Time deposits in other
financial institutions 1,660 564
Securities:
Trading, at fair value 763 1,528
Available for sale, at fair value
(cost of $369,388 for 2002 and
$318,342 for 2001) 379,448 323,689
Loans and leases:
Held for sale 21,954 26,967
Held to maturity 1,142,432 1,078,238
Allowance for loan and lease losses (15,565) (14,660)
---------- ----------
Loans and leases, net 1,148,821 1,090,545
Assets under operating leases 30,724 35,427
Premises, furniture and equipment, net 33,590 31,482
Other real estate, net 424 130
Goodwill, net 16,050 16,050
Core deposit premium and other
intangibles, net 4,260 4,655
Other assets 46,607 46,444
---------- ----------
TOTAL ASSETS $1,720,241 $1,644,064
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $ 171,794 $ 160,742
Savings 487,660 493,374
Time 630,919 551,043
---------- ----------
Total deposits 1,290,373 1,205,159
Short-term borrowings 147,326 160,703
Other borrowings 130,219 143,789
Accrued expenses and other liabilities 32,735 27,323
---------- ----------
TOTAL LIABILITIES 1,600,653 1,536,974
---------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock (par value $1 per
share; authorized, 184,000 shares,
none issued or outstanding) - -
Series A Junior Participating preferred
stock (par value $1 per share;
authorized, 16,000 shares, none
issued or outstanding) - -
Common stock (par value $1 per share;
authorized, 16,000,000 shares and
12,000,000 at September 30, 2002, and
December 31, 2001, respectively;
issued 9,905,783 shares at September
30, 2002, and December 31, 2001) 9,906 9,906
Capital surplus 16,791 18,116
Retained earnings 88,922 79,107
Accumulated other comprehensive income 5,282 3,565
Treasury stock at cost
(94,372 shares at September 30, 2002,
and 226,031 shares at December 31,
2001) (1,313) (3,604)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 119,588 107,090
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,720,241 $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 Nine Months Ended
9/30/02 9/30/01 9/30/02 9/30/01
------- ------- ------- -------
INTEREST INCOME:
Interest and fees on
loans and leases $ 21,683 $ 23,131 $ 63,790 $ 69,926
Interest on securities:
Taxable 3,425 3,626 9,807 10,346
Nontaxable 777 437 1,921 1,381
Interest on federal
funds sold 88 551 260 1,808
Interest on interest
bearing deposits in
other financial
institutions 54 29 194 120
-------- -------- -------- --------
TOTAL INTEREST INCOME 26,027 27,774 75,972 83,581
-------- -------- -------- --------
INTEREST EXPENSE:
Interest on deposits 8,064 11,503 24,477 36,138
Interest on short-term
borrowings 683 1,283 2,058 4,908
Interest on other
borrowings 2,039 2,122 6,344 6,276
-------- -------- -------- --------
TOTAL INTEREST EXPENSE 10,786 14,908 32,879 47,322
-------- -------- -------- --------
NET INTEREST INCOME 15,241 12,866 43,093 36,259
Provision for loan and
lease losses 177 1,197 1,778 3,041
-------- -------- -------- --------
NET INTEREST INCOME
AFTER PROVISION FOR
LOAN AND LEASE LOSSES 15,064 11,669 41,315 33,218
-------- -------- -------- --------
NONINTEREST INCOME:
Service charges and fees 2,188 1,702 6,338 4,717
Trust fees 871 767 2,607 2,311
Brokerage commissions 122 181 452 474
Insurance commissions 158 161 535 590
Securities gains, net 573 552 729 1,476
Gain (loss) on trading
account securities (450) (331) (692) (510)
Rental income on
operating leases 3,583 3,842 11,113 11,491
Gain on sale of loans 1,049 584 2,578 1,500
Valuation adjustment on
mortgage servicing rights (503) - (829) -
Impairment loss on equity
securities (267) (455) (267) (455)
Other noninterest income 190 164 728 561
-------- -------- -------- --------
TOTAL NONINTEREST INCOME 7,514 7,167 23,292 22,155
-------- -------- -------- --------
NONINTEREST EXPENSES:
Salaries and employee
benefits 7,180 6,381 21,088 18,919
Occupancy 799 758 2,353 2,365
Furniture and equipment 792 765 2,441 2,349
Depreciation on equipment
under operating leases 2,845 2,947 8,754 8,739
Outside services 1,054 901 3,051 2,525
FDIC deposit insurance
assessment 51 52 157 155
Advertising 406 394 1,245 1,180
Goodwill amortization - 264 - 793
Core deposit and other
intangibles amortization 124 154 371 461
Other noninterest expenses 2,375 2,136 6,687 6,052
-------- -------- -------- --------
TOTAL NONINTEREST
EXPENSES 15,626 14,752 46,147 43,538
-------- -------- -------- --------
INCOME BEFORE INCOME
TAXES 6,952 4,084 18,460 11,835
Income taxes 2,175 1,422 5,699 3,903
-------- -------- -------- --------
NET INCOME $ 4,777 $ 2,662 $ 12,761 $ 7,932
======== ======== ======== ========
EARNINGS PER COMMON
SHARE-BASIC $ 0.49 $ 0.28 $ 1.30 $ 0.83
EARNINGS PER COMMON
SHARE-DILUTED $ 0.48 $ 0.27 $ 1.30 $ 0.82
CASH DIVIDENDS DECLARED
PER COMMON SHARE $ 0.10 $ 0.09 $ 0.30 $ 0.27
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 - - 7,932
Unrealized gain on securities
available for sale - - -
Reclassification adjustment for
gains realized in net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.27 per share - - (2,591)
Purchase of 45,716 treasury
shares - - -
------- ------- --------
Balance at September 30, 2001 $ 9,906 $18,812 $ 76,594
======= ======= ========
Balance at January 1, 2002 $ 9,906 $18,116 $ 79,107
Net income - - 12,761
Unrealized gain on securities
available for sale - - -
Unrealized loss on derivatives
arising during the period - - -
Reclassification adjustment for
gains realized in net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.30 per share - - (2,946)
Purchase of 87,933 treasury
shares - - -
Issuance of 219,592 treasury
shares - (1,325) -
------- ------- --------
Balance at September 30, 2002 $ 9,906 $16,791 $ 88,922
======= ======= ========
Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock Total
------------- -------- --------
Balance at January 1, 2001 $ 1,301 $(5,126) $ 96,146
Net income - - 7,932
Unrealized gain on securities
available for sale 5,136 - 5,136
Reclassification adjustment for
gains realized in net income (1,021) - (1,021)
Income taxes (1,399) - (1,399)
--------
Comprehensive income 10,648
Cash dividends declared:
Common, $.27 per share - - (2,591)
Purchase of 45,716 treasury
shares - (585) (585)
------- ------- --------
Balance at September 30, 2001 $ 4,017 $(5,711) $103,618
======= ======= ========
Balance at January 1, 2002 $ 3,565 $(3,604) $107,090
Net income - - 12,761
Unrealized gain on securities
available for sale 5,050 - 5,050
Unrealized loss on derivatives
arising during the period (1,987) - (1,987)
Reclassification adjustment for
gains realized in net income (462) - (462)
Income taxes (884) - (884)
--------
Comprehensive income 14,478
Cash dividends declared:
Common, $.30 per share - - (2,946)
Purchase of 87,933 treasury
shares - (1,229) (1,229)
Issuance of 219,592 treasury
shares - 3,520 2,195
------- ------- --------
Balance at September 30, 2002 $ 5,282 $(1,313) $119,588
======= ======= ========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Nine Months Ended
9/30/02 9/30/01
-------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 12,761 $ 7,932
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 11,471 12,333
Provision for loan and lease losses 1,778 3,041
Provision for income taxes in excess
of payments 1,557 3,387
Net amortization of premium on
securities 3,392 457
Securities gains, net (729) (1,476)
Decrease (increase) in trading account
securities 765 (1,440)
Loss on impairment of equity
securities 267 455
Loans originated for sale (142,423) (81,197)
Proceeds on sales of loans 150,014 88,877
Net gain on sales of loans (2,578) (1,500)
Decrease (increase) in accrued
interest receivable (1,188) 106
Decrease in accrued interest payable (427) (1)
Other, net 912 796
--------- ---------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 35,572 31,770
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of time deposits in other
financial institutions (1,068) -
Proceeds on maturities of time
deposits in other financial
institutions 3 959
Proceeds from the sale of
securities available for sale 42,912 59,461
Proceeds from the maturity of and
principal paydowns on securities
available for sale 113,785 61,840
Purchase of securities available
for sale (209,726) (223,200)
Net increase in loans and leases (65,030) (47,135)
Purchase of bank-owned life insurance
policies - (8,568)
Increase in assets under operating
leases (4,051) (9,316)
Capital expenditures (4,522) (3,615)
Proceeds on sale of OREO and other
repossessed assets 495 610
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (127,202) (168,964)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits and
savings accounts 5,338 60,354
Net increase in time deposit accounts 79,876 25,002
Net increase (decrease) in short-term
borrowings (13,377) 3,672
Proceeds from other borrowings 7,840 37,881
Repayments of other borrowings (21,410) (17,695)
Purchase of treasury stock (1,229) (585)
Proceeds from issuance of treasury
stock 1,882 -
Dividends (2,946) (2,591)
--------- ---------
NET CASH PROVIDED BY FINANCING
ACTIVITIES 55,974 106,038
--------- ---------
Net decrease in cash and cash
equivalents (35,656) (31,156)
Cash and cash equivalents at
beginning of year 93,550 84,687
--------- ---------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 57,894 $ 53,531
========= =========
Supplemental disclosures:
Cash paid for income/franchise taxes $ 3,741 $ 717
========= =========
Cash paid for interest $ 33,306 $ 47,323
========= =========
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 disclosures, which would
substantially duplicate the disclosure contained in the audited
consolidated financial statements, have 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 periods ended
September 30, 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 and six month periods ended September 30,
2002 and 2001, are shown in the tables below:
Three Months Ended
9/30/02 9/30/01
------- -------
Net Income (000's) $ 4,777 $ 2,662
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,819 9,584
Assumed incremental common shares issued
upon exercise of stock options (000's) 76 109
------- -------
Weighted average common shares for
diluted earnings per share (000's) 9,895 9,693
======= =======
Nine Months Ended
9/30/02 9/30/01
------- -------
Net Income (000's) $12,761 $ 7,932
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,785 9,594
Assumed incremental common shares issued
upon exercise of stock options (000's) 65 102
------- -------
Weighted average common shares for
diluted earnings per share (000's) 9,850 9,696
======= =======
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 completed its initial goodwill
impairment assessment and did not have 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.
Effective September 30, 2002, the Company elected early adoption
of FAS No. 147, "Acquisitions of Certain Financial Institutions".
Financial institutions meeting conditions outlined in FAS No. 147
are required to restate previously issued financial statements.
The objective of that restatement is to present the balance sheet
and income statement as if the amount accounted for under FAS No.
72, "Accounting for Certain Acquisitions of Banking or Thrift
Institutions", as an unidentifiable intangible asset had been
reclassified to goodwill as of the date FAS No. 142 was initially
adopted. The effect of early adoption of FAS No. 147 on the
Company's balance sheet was the reclassification of $6.543
million excess purchase price of acquired branch net assets over
their fair value from other intangibles to goodwill. The effect
of early adoption of FAS No. 147 on the Company's income
statement was the reversal of $260 thousand other intangibles
amortization expense that had been recorded during the first six
months of the year.
Core deposit intangibles are amortized over ten years on an
accelerated basis. 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 AND FAS NO. 147
TRANSITIONAL DISCLOSURE
The table below reconciles reported earnings for the three and
nine-month periods ended September 30, 2001, to "adjusted"
earnings, which exclude goodwill amortization.
Three
Months
Ended
Sept. 30,
2002 Three Months Ended Sept. 30, 2001
--------- ---------------------------------
Reported Reported Goodwill "Adjusted"
Earnings Earnings Amort. Earnings
--------- -------- -------- -----------
Income before income
taxes (000's) $ 6,952 $ 4,084 $ 264 $ 4,348
Income taxes (000's) 2,175 1,422 - 1,422
--------- -------- -------- -----------
Net income (000's) $ 4,777 $ 2,662 $ 264 $ 2,926
========= ======== ======== ===========
Earnings per common
share - basic $ .49 $ .28 $ .03 $ .31
========= ======== ======== ===========
Earnings per common
share - diluted $ .48 $ .27 $ .03 $ .30
========= ======== ======== ===========
Nine
Months
Ended
Sept. 30,
2002 Nine Months Ended Sept. 30, 2001
--------- --------------------------------
Reported Reported Goodwill "Adjusted"
Earnings Earnings Amort. Earnings
--------- -------- -------- -----------
Income before income
taxes (000's) $ 18,460 $ 11,835 $ 793 $ 12,628
Income taxes (000's) 5,699 3,903 - 3,903
--------- -------- -------- -----------
Net income (000's) $ 12,761 $ 7,932 $ 793 $ 8,725
========= ======== ======== ===========
Earnings per common
share - basic $ 1.30 $ .83 $ .08 $ .91
========= ======== ======== ===========
Earnings per common
share - diluted $ 1.30 $ .82 $ .08 $ .90
========= ======== ======== ===========
NOTE 4: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated
accumulated amortization at September 30, 2002, is presented in
the table below.
September 30, 2002
-------------------------
Gross
Carrying Accumulated
Amount Amortization
-------- ------------
Intangible assets:
Core deposit premium (000's) $4,492 $ 1,932
Mortgage servicing rights (000's) 2,965 1,265
-------- -------
Total (000's) $7,457 $ 3,197
======== =======
Unamortized intangible assets (000's) $ 4,260
=======
Projections of amortization expense for mortgage servicing rights
are based on existing asset balances and the existing interest
rate environment as of September 30, 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 Total
--------- -------- ---------
Three months ended
December 31, 2002
(000's) $ 124 $ 462 $ 586
Year Ended December 31,
2003 (000's) $ 404 $ 354 $ 758
2004 (000's) 353 294 647
2005 (000's) 353 235 588
2006 (000's) 353 177 530
2007 (000's) 353 118 471
NOTE 5: OTHER BORROWINGS
On June 27, 2002, the Company completed an offering of $5.0
million of variable rate cumulative capital securities
representing undivided beneficial interests in Heartland
Financial Capital Trust II. The proceeds from the offering were
used by the trust to purchase junior subordinated debentures from
the Company. The proceeds are being used for general corporate
purposes. Interest is payable quarterly on March 30, June 30,
September 30 and December 30 of each year. The debentures will
mature and the capital securities must be redeemed on June 30,
2032. The Company has the option to shorten the maturity date to
a date not earlier than June 30, 2007. The Company may 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. Deferred issuance
costs related to this offering will be included in other assets
and amortized on a straight-line basis over the life of the
debentures.
NOTE 6: STOCKHOLDERS' RIGHTS PLAN
On June 7, 2002, the Company adopted a stockholders' rights plan
(the "Rights Plan"). Under the terms of the Rights Plan, on June
26, 2002, the Board of Directors distributed one purchase right
for each share of common stock outstanding as of June 24, 2002.
Upon becoming exercisable, each right entitles the registered
holder thereof, under certain limited circumstances, to purchase
one-thousandth of a share of Series A Junior Participating
preferred stock at an exercise price of $85.00. Rights do not
become exercisable until ten business days after any person or
group has acquired, commenced, or announced its intention to
commence a tender or exchange offer to acquire 15% or more of the
Company's common stock. If the rights become exercisable, holders
of each right, other than the acquiror, upon payment of the
exercise price, will have the right to purchase the Company's
common stock (in lieu of preferred shares) having a value equal
to two times the exercise price. If the Company is acquired in a
merger, share exchange or other business combination or 50% or
more of its consolidated assets or earning power are sold, rights
holders, other than the acquiring or adverse person or group,
will be entitled to purchase the acquiror's shares at a similar
discount. If the rights become exercisable, the Company may also
exchange rights, other than those held by the acquiring or
adverse person or group, in whole or in part, at an exchange
ratio of one share of the Company's common stock per right held.
Rights are redeemable by the Company at any time until they are
exercisable at the exchange rate of $.01 per right. Issuance of
the rights has no immediate dilutive effect, does not currently
affect reported earnings per share, is not taxable to the Company
or its shareholders, and will not change the way in which the
Company's shares are traded. The rights expire on June 7, 2012.
In connection with the Rights Plan, the Company designated 16,000
shares, par value $1.00 per share, of Series A Junior
Participating preferred stock. These shares, if issued, will be
entitled to receive quarterly dividends and a liquidation
preference. There are no shares issued and outstanding and the
Company does not anticipate issuing any shares of Series A Junior
Participating preferred stock except as may be required under the
Rights Plan.
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 any terrorist 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 third quarter of 2002 improved by $2.1 million
or 79% over the same quarter the previous year. Net income
totaled $4.8 million, or $.48 on a diluted earnings per common
share basis, compared to $2.7 million, or $.27 on a diluted
earnings per common share basis, during the same quarter in 2001.
Return on common equity was 16.20% and return on assets was 1.13%
for the third quarter of 2002. For the same period in 2001,
return on equity was 10.38% and return on assets was .67%.
Contributing to the improved earnings during the third quarter of
2002 was the $2.5 million or 19% growth in net interest income
due primarily to growth in earning assets. Average earning assets
went from $1.4 billion during the third quarter of 2001 to $1.5
billion during the same quarter in 2002, a change of $90.6
million or 6%. Also contributing to the increased earnings during
the third quarter was the $1.0 million or 85% decrease in
provision for loan and lease losses. Additionally, noninterest
income experienced a $760 thousand or 10% increase, exclusive of
a valuation adjustment on mortgage servicing rights and
securities gains and losses, including trading account securities
gains and losses and impairment losses on equity securities.
Noninterest expense was held to an $874 thousand or 6% increase.
Heartland's adoption of the provisions of Statement of Financial
Accounting Standards ("FAS") No. 142, "Goodwill and Other
Intangible Assets", on January 1, 2002, discontinued the
amortization of $9.5 million in unamortized goodwill. The
Company's adoption of the provisions of FAS No. 147,
"Acquisitions of Certain Financial Institutions", on September
30, 2002, discontinued the amortization of $6.5 million in
unamortized other intangibles retroactively to January 1, 2002.
The amount of amortization expense recorded during the third
quarter of 2001 on this goodwill and other intangibles was $264
thousand ($.03 on a diluted per common share basis). For the nine-
month period ended on September 30, 2001, amortization expense on
this goodwill and other intangibles was $793 thousand ($.08 on a
diluted per common share basis).
For the nine-month period ended on September 30, 2002, net income
increased $4.8 million or 61% when compared to the same period in
2001. Net income totaled $12.8 million, or $1.30 on a diluted per
common share basis, compared to $7.9 million, or $.82 on a
diluted per common share basis, during the same period in 2001.
Return on common equity was 15.14% and return on assets was 1.03%
for the nine-month period in 2002 compared to 10.65% and .69%,
respectively, for the same period in 2001.
Again, the largest contributor to the improved earnings during
the first nine months of 2002 was the $7.1 million or 19% growth
in net interest income. Average earning assets went from $1.4
billion during the first nine months of 2001 to $1.5 billion
during the same period in 2002, a change of $101.3 million or 7%.
The $1.3 million or 42% decrease in provision for loan and lease
losses also contributed to the improved earnings for the first
nine months of 2002. Additionally, noninterest income experienced
a $2.7 million or 13% increase, exclusive of securities gains and
losses, including impairment losses on equity securities and
trading account securities gains and losses, and valuation
adjustments on mortgage servicing rights. In addition to gains on
sale of loans, the other noninterest income category to reflect
significant improvement was service charges and fees. Noninterest
expense was held to a $2.6 million or 6% increase.
A majority of the $76.2 million or 5% growth in total assets
since year-end 2001 occurred during the third quarter. Loans and
leases were $1.2 billion and deposits were $1.3 billion at the
end of the third quarter, an increase of 5% and 7%, respectively,
since year-end 2001. Commercial and agricultural loan growth was
$79.8 million or 12% and $12.4 million or 9%, respectively,
during the first nine months of 2002. A portion of this growth
was offset by the $24.7 million or 15% decrease in the mortgage
loan portfolio due to paydowns experienced as customers continued
to refinance their mortgage loans into fifteen- and thirty-year
fixed rate loans, which Heartland usually sells into the
secondary market.
NET INTEREST INCOME
Net interest margin, expressed as a percentage of average earning
assets, was 4.12% for the third quarter of 2002 compared to 4.02%
during the second quarter of 2002 and 3.67% for the third quarter
of 2001. Heartland manages its balance sheet to minimize the
effect a change in interest rates has on its net interest margin.
The utilization of floors on Heartland's commercial loan
portfolio has had a positive impact on the net interest margin as
the affect of downward rates was minimized. 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. To offset the impact of these floors on the
net interest margin if rates move upward, funding in the three-
to five-year maturities has been locked in. During the last half
of 2001, Heartland elected to obtain additional Federal Home Loan
Bank advances to lock in historically low rates in anticipation
of fixed-rate commercial loan growth and the replacement of
maturing advances during the first half of 2002.
On a tax-equivalent basis, interest income as a percentage of
average earning assets went from 7.83% during the third quarter
of 2001 to 6.95% during the third quarter of 2002, a decline of
88 basis points. Interest expense as a percentage of average
earning assets went from 4.16% during the third quarter of 2001
to 2.83% for the same quarter in 2002, a decline of 133 basis
points.
For the three and nine month periods ended September 30, 2002,
interest income decreased $1.7 million or 6% and $7.6 million or
9%, respectively, when compared to the same periods in 2001.
These decreases were primarily attributable to the dramatic
decline in rates. During 2001, national prime decreased from
9.50% to 8.00% during the first quarter, from 8.00% to 6.75%
during the second quarter and from 6.75% to 6.00% during the
third quarter. During the first, second and third quarters 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 and nine month periods ended September 30, 2002,
interest expense decreased $4.1 million or 28% and $14.4 million
or 31%, respectively, when compared to the same periods 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.
On November 6, 2002, the Federal Reserve policy makers lowered
their benchmark interest rate 50 basis points, resulting in the
lowest target interest rate on overnight loans between banks
since 1961. Correspondingly, national prime decreased 50 basis
points to 4.25%. This most recent rate reduction may have a
negative impact on Heartland's net interest margin. Even though a
majority of Heartland's floating rate commercial loan portfolio
has floors in place, at these historical low interest rate
levels, there will be pressure to lower these floors or refinance
to fixed rate products. Additionally, the rates paid on deposit
products have been driven to significantly low levels during the
past year and, in many cases, there is little room to lower these
rates another 50 basis points.
PROVISION FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses is established through a
provision charged to expense. The $177 thousand provision for
loan losses made during the third quarter of 2002, a decrease of
$1.0 million or 85% when compared to the same quarter in 2001,
resulted primarily from a $685 thousand recovery on a prior-year
charge-off. On a nine-month comparative basis, the $1.8 million
provision for loan losses during the first nine months of 2002
was a decrease of $1.3 million or 42% when compared to the same
period in 2001. In addition to the recovery recorded during the
third quarter, this decrease was also reflective of a decrease in
nonperforming loans. 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 $347 thousand or 5% during the
quarter ended on September 30, 2002, compared to the same period
in 2001. Exclusive of securities gains and losses, including
trading account securities gains and losses and impairment losses
on equity securities, and a valuation adjustment on mortgage
servicing rights, noninterest income experienced a $760 thousand
or 10% increase. The noninterest categories reflecting
significant improvement during the quarter were gains on sale of
loans and service charges and fees.
On a year-to-date comparison, total noninterest income grew $1.1
million or 5%. Again, exclusive of securities gains and losses,
including trading account securities gains and losses and
impairment losses on equity securities, and valuation adjustments
on mortgage servicing rights, noninterest income experienced a
$2.7 million or 13% increase. In addition to gains on sale of
loans, the other noninterest income category to reflect
significant improvement during the first nine months of the year
was service charges and fees.
Service charges and fees increased $486 thousand or 29% during
the quarters under comparison and $1.6 million or 34% during the
nine-month period under comparison. The addition of an overdraft
privilege feature to our checking account product line, along
with growth in these account balances, resulted in the generation
of additional service charge revenue related to activity fees
charged to these accounts. Additionally, service fees collected
on the mortgage loans Heartland sold into the secondary market,
while retaining servicing, increased. Heartland's servicing
portfolio grew from $183.9 million at year-end 2000 and $268.6
million at year-end 2001 to $346.1 million at September 30, 2002.
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 $465 thousand or 80% for the
quarters under comparison. For the nine-month periods under
comparison, gains on sale of loans increased by $1.1 million or
72%. The volume of mortgage loans sold into the secondary market
during the first and third quarters of 2002 was greater than
those sold during the same periods in 2001, primarily as a result
of the low rate environment during 2002 compared to the same
quarters in 2001. During low rate environments, customers
frequently elect to take fifteen- and thirty-year, fixed-rate
mortgage loans, which Heartland usually elects to sell into the
secondary market.
During the third quarter of 2002, securities gains were $21
thousand or 4% above the amount recorded during the same period
in 2001. For the nine-month period ended on September 30, 2002,
securities gains were $747 thousand or 51% 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.
Heartland elected to begin classifying some of its new equity
securities purchases as trading during the first quarter of 2001.
Losses on this portfolio totaled $450 thousand during the third
quarter of 2002 compared to losses of $331 thousand during the
same quarter in 2001. On a nine-month comparison, losses totaled
$692 thousand during 2002 and $510 thousand during 2001. The
increased losses primarily resulted from the decline in the stock
market.
Impairment losses on equity securities totaled $267 thousand
during the third quarter of 2002. These losses were related to
the decline in market value on the common stock of three
companies held in Heartland's available for sale equity
securities portfolio. The carrying value of these stocks on
Heartland's balance sheet at September 30, 2002, was $206
thousand. During the third quarter of 2001, an impairment loss on
equity securities totaling $455 thousand was recorded. Heartland
was a limited partner in an investment partnership that had a
portion of its funds invested in a company that filed bankruptcy
under chapter 11. The impairment loss recorded reflected
Heartland's ownership percentage of 26%. During 2002, Heartland
began the process of divesting its interest in this partnership.
The fair value of the remaining portion of Heartland's investment
in this partnership at September 30, 2002, was $10 thousand.
During the second and third quarters of 2002, a $326 and $503
thousand loss was recorded, respectively, as a valuation
adjustment on mortgage servicing rights. The valuation of
Heartland's mortgage servicing rights declined since year-end as
a result of the further drop in mortgage loan interest rates.
Heartland utilizes the services of an independent third-party to
perform a valuation analysis of its servicing portfolio each
quarter.
NONINTEREST EXPENSE
Total noninterest expense was held to an increase of $874
thousand or 6% during the third quarter of 2002 when compared to
the same quarter in 2001. For the nine-month period ended on
September 30, 2002, noninterest expense increased $2.6 million or
6%. Growth in some of these expenses tapered off as Heartland
began 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 $799 thousand or 13% for the
quarters under comparison. On a year-to-date basis, salaries and
employee benefits grew $2.2 million or 11%. This category made
up more than 80% of the total increase in noninterest expense for
both time periods. In addition to normal merit increases, these
increases were also attributable to expansion efforts, primarily
in New Mexico Bank & Trust's Albuquerque market. The number of
full-time equivalent employees employed by Heartland increased
from 568 at September 30, 2001, to 576 at September 30, 2002.
Fees for outside services increased by $153 thousand or 17% for
the quarters under comparison and $526 thousand or 21% for the
nine-month periods under comparison. Contributing to these
increases were the following:
- A consultant was engaged last fall to assist in the
implementation of an overdraft privilege feature on
Heartland's checking account products. The fee
associated with these services is payable monthly
throughout all of 2002 based upon the additional fees
generated.
- Beginning this year, Heartland elected to engage
Darling Consulting Group to provide balance sheet
management advisory services. Included in these
services are quarterly asset/liability management
position assessments and strategy formulation.
- As on-line banking has grown in popularity, Heartland
has incurred additional costs to provide this service
to its customers.
- Legal fees related to actions brought by Heartland to
recover losses realized in an investment fund
partnership, in which Heartland was a limited partner,
and to resolve a dispute on the enforceability of a
guarantee on a nonperforming commercial loan.
Other noninterest expense increased $239 thousand or 11% for the
quarters under comparison and $635 thousand or 10% for the nine-
month periods under comparison. These increases were the result
of additional processing fees related to the increased activity
in the merchant credit card processing area, additional minority
interest related to the improved earnings at New Mexico Bank &
Trust and a fraud loss related to a kiting scheme at Wisconsin
Community Bank.
Heartland's adoption of the provisions of FAS No. 142 on January
1, 2002, and FAS No. 147 on September 30, 2002, discontinued the
amortization of $10.0 million in unamortized goodwill. The amount
of amortization expense recorded during the third quarter of 2001
on this goodwill was $264 thousand. For the nine-month period
ended on September 30, 2001, amortization expense on this
goodwill was $793 thousand.
INCOME TAX EXPENSE
Income tax expense for the third quarter of 2002 increased $753
thousand or 53% when compared to the same period in 2001. On a
nine-month comparative basis, income tax expense increased $1.8
million or 46%. These increases reflected the continued growth in
pre-tax earnings.
Heartland's effective tax rate decreased to 31.29% during the
third quarter of 2002 compared to 34.82% for the third quarter of
2001. For the nine-month periods ended September 30, 2002 and
2001, the effective tax rate was 30.87% and 32.98%, respectively.
In April of 2002, Dubuque Bank and Trust acquired a 99.9%
ownership in a limited liability company that owns a certified
historic structure for which historic rehabilitation tax credits
apply to the 2002 tax year. The reduction in Heartland's
effective tax rate was minimized as a result of a decrease in the
amount of tax-exempt interest income recorded during 2002. Tax-
exempt interest income was 12% of pre-tax income during the first
nine months of 2002 compared to 14% for the same period in 2001.
FINANCIAL CONDITION
LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Total loans and leases increased $58.3 million, an increase of 5%
since year-end 2001. This increase, attributable to growth in the
commercial and agricultural loan portfolios, would have been more
significant had the mortgage and consumer loan portfolios not
experienced declines.
The commercial and commercial real estate loan portfolio grew
$79.8 million or 12% during the first nine months of 2002. Most
of this growth occurred at New Mexico Bank & Trust, Wisconsin
Community Bank, Riverside Community Bank and Dubuque Bank and
Trust, principally as a result of continued calling efforts.
Agricultural and agricultural real estate loans grew $12.4
million or 9% during the first nine months of 2002. The majority
of this growth occurred at Dubuque Bank and Trust Company,
Heartland's flagship bank in Dubuque, Iowa.
The residential mortgage loan portfolio experienced a decline of
$24.7 million or 15% 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 $268.6 million at year-end
2001 and $346.1 million at September 30, 2002.
Consumer loan outstandings declined $6.9 million or 5% during the
first nine months of 2002, as the economy continued to weaken and
consumers were provided other sources of financing, e.g., zero
percent automobile financing through dealerships.
The table below presents the composition of the loan portfolio as
of September 30, 2002, and December 31, 2001.
LOAN PORTFOLIO
(Dollars in thousands)
September 30, December 31,
2002 2001
Amount Percent Amount Percent
---------- ------- ---------- -------
Commercial and commercial
real estate $ 731,294 62.63% $ 651,479 58.73%
Residential mortgage 144,221 12.35 168,912 15.23
Agricultural and
agricultural real estate 157,830 13.52 145,460 13.11
Consumer 121,020 10.36 127,874 11.53
Lease financing, net 13,266 1.14 15,570 1.40
---------- ------- ---------- -------
Gross loans and leases $1,167,631 100.00% $1,109,295 100.00%
======= =======
Unearned discount (2,447) (3,457)
Deferred loan fees (798) (633)
---------- ----------
Total loans and leases 1,164,386 1,105,205
Allowance for loan and
lease losses (15,565) (14,660)
---------- ----------
Loans and leases, net $1,148,821 $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:
- Heartland has continued to experience growth in more-
complex commercial loans as compared to relatively lower-
risk residential real estate loans.
- The nation has continued in a period of economic
slowdown.
- 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 September 30, 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 outlook of the
economy during the remainder of 2002. Even though there have been
various signs of emerging strength, it is not certain that this
strength will be sustainable. Consumer confidence plunged to a
nine-year low in October. 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.
The allowance for loan and lease losses increased by $905
thousand or 6% during the first nine months of 2002. The
allowance for loan and lease losses at September 30, 2002, was
1.34% of loans and 253% of nonperforming loans, compared to 1.33%
of loans and 180% of nonperforming loans, at year-end 2001.
Nonperforming loans decreased to .53% of total loans and leases
at September 30, 2002, compared to .73% of total loans and leases
at December 31, 2001. A portion of this decrease was the result
of one large credit that was partially repaid.
During the first nine months of 2002, Heartland recorded net
charge offs of $873 thousand compared to $1.4 million for the
same period in 2001. The decrease in net charge-offs during 2002
was primarily the result of a large recovery on a prior year
charge-off. Citizens Finance Co., Heartland's consumer finance
subsidiary, experienced net charge-offs of $762 thousand or 87%
of total net charge-offs during the first nine months of 2002
compared to $590 thousand or 42% 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. Net losses as a
percentage of average gross loans at Citizens were 4.39% for the
first nine months of 2002 compared to 3.32% for the same period
of 2001. Loans with payments past due for more than thirty days
at Citizens have increased from 5.30% of gross loans at December
31, 2001, to 7.73% at September 30, 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 September
30, 2002, as compared to 20% at December 31, 2001. As loan growth
continued to lag deposit growth during the first nine months of
2002, the amount of securities held in Heartland's portfolio was
increased.
During the first nine months 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. Management purchased some longer-term municipal
securities to take advantage of the unusually steep slope in the
yield curve and the spread of the tax-equivalent yield on
municipal securities over the yield on agency securities with the
same maturities. 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 available for
sale securities portfolio by major category as of September 30,
2002, and December 31, 2001.
AVAILABLE FOR SALE SECURITIES PORTFOLIO
(Dollars in thousands)
September 30, December 31,
2002 2001
Amount Percent Amount Percent
-------- ------- -------- -------
U.S. Treasury securities $ 496 .13% $ 498 .15%
U.S. government agencies 107,264 28.27 78,736 24.33
Mortgage-backed securities 173,889 45.83 183,661 56.74
States and political
subdivisions 69,190 18.23 30,948 9.56
Other securities 28,609 7.54 29,846 9.22
-------- ------- -------- -------
Total available for sale
securities $379,448 100.00% $323,689 100.00%
======== ======= ======== =======
DEPOSITS AND BORROWED FUNDS
Total deposits experienced an increase of $85.2 million or 7%
during the first nine months of 2002. Increases in total deposits
occurred at all the bank subsidiaries except for First Community
Bank. The savings deposit category experienced a decrease during
the nine-month period, while demand and certificate of deposit
account balances increased. Demand deposit account balances
increased $11.1 million or 7%. The Heartland bank subsidiaries
that experienced substantial increases were Dubuque Bank and
Trust, Galena State Bank and Riverside Community Bank. Savings
deposit account balances declined by $5.7 million or 1% while
certificate of deposit account balances grew by $79.9 million or
15% during the first nine months of 2002. With the continued
instability in the equity markets and low interest rates on
savings deposit accounts, many customers have elected to keep
funds on deposit in financial institutions and shift balances to
certificates of deposit to earn a higher rate. Additionally, as
long-term rates have continued at all-time lows, efforts were
focused at attracting customers into certificates of deposit with
a maturity exceeding two years. A portion of the growth in
certificate of deposit account balances was also attributable to
the implementation of a balance sheet management strategy that
included the acquisition of $27.9 million in brokered deposits.
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 nine month period ended September 30, 2002, the amount
of short-term borrowings decreased $13.4 million or 8%. 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. Repurchase agreement
balances declined $27.8 million or 26% since year-end 2001 as
interest rates continued at all-time low levels and 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 September 30, 2002, $25.0 million was outstanding as compared
to $29.2 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 $130.2 million on
September 30, 2002, compared to $143.8 million on December 31,
2001. The change in these account balances primarily resulted
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 September 30, 2002, and
December 31, 2001, were $73.5 million and $86.5 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 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 and bears
interest at the rate of 3.60% per annum over the three-month
LIBOR rate, as calculated each quarter. An additional private
placement offering for $5.0 million was completed in June of
2002. This additional variable rate issuance matures on June 30,
2032 and bears interest at the rate of 3.65% per annum over the
three-month LIBOR rate, as calculated each quarter.
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, December 31,
2002 2001
Amount Ratio Amount Ratio
------ ----- ------ -----
Risk-Based Capital Ratios:(1)
Tier 1 capital $ 136,382 10.45% $ 121,112 9.71%
Tier 1 capital minimum
requirement 52,186 4.00% 49,891 4.00%
---------- ------ ---------- ------
Excess $ 84,196 6.45% $ 71,221 5.71%
========== ====== ========== ======
Total capital $ 151,947 11.65% $ 135,770 10.89%
Total capital minimum
requirement 104,372 8.00% 99,782 8.00%
---------- ------ ---------- ------
Excess $ 47,575 3.65% $ 35,988 2.89%
========== ====== ========== ======
Total risk-adjusted
assets $1,304,648 $1,247,274
========== ==========
Leverage Capital Ratios:(2)
Tier 1 capital $ 136,382 8.24% $ 121,112 7.53%
Tier 1 capital minimum
requirement(3) 66,514 4.00% 64,336 4.00%
---------- ------ ---------- ------
Excess $ 69,868 4.24% $ 56,776 3.53%
========== ====== ========== ======
Average adjusted assets
(less goodwill) $1,662,853 $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 September 30, 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
$3.6 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 June 27, 2002, Heartland completed a private placement
offering of $5.0 million of variable rate cumulative capital
securities representing undivided beneficial interests in
Heartland Financial Capital 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 30, June 30, September 30 and December
30 of each year. The debentures will mature and the capital
securities must be redeemed on June 30, 2032. Heartland has the
option to shorten the maturity date to a date not earlier than
June 30, 2007. 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 September 30, 2002.
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 September 30, 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 Financial 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. Interest is payable quarterly on March 31,
June 30, September 30 and December 31 of each year. The
debentures will mature and the capital securities must be
redeemed by September 30, 2029. Heartland has the option to
shorten the maturity date to a date not earlier than December 18,
2006.Heartland has the option to shorten the maturity date to a
date not earlier than September 30, 2004. 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 continued to qualify as Tier 1 capital for regulatory
purposes as of September 30, 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. Wisconsin Community
Bank's share of the construction costs on this project is
estimated at $2.5 million. This project is underway with
completion targeted for March of 2003.
Plans for the renovation and 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 has begun with
completion anticipated next winter. 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.
RECENT DEVELOPMENTS
On October 11, 2002, Wisconsin Community Bank entered into a
purchase and assumption agreement to sell its branch facility in
Eau Claire, Wisconsin to S&C Bank, a Wisconsin state-chartered
bank. The branch has approximately $33 million in loans, of which
approximately $4 million will be participated back to Wisconsin
Community Bank due to loan relationships that exceed S&C's
lending limit. Additionally, S&C will assume deposit liabilities
of approximately $7 million. The transaction is subject to
regulatory approval and is expected to close prior to year-end
2002.
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.
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 provide a maximum
borrowing capacity of $50.0 million. As of September 30, 2002,
these credit agreements provided an additional borrowing capacity
of $25.0 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 September 30, 2002, Heartland was in
compliance with the covenants contained in these credit
agreements.
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.
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 September 30, 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 recorded as a
liability in the amount of $1.6 million on of September 30, 2002.
CONTROLS AND PROCEDURES
Based upon an evaluation within the 90 days prior to the filing
date of this report, the Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective. There have been no
significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's
internal controls subsequent to the date of the evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
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
10.1 Fifth Amendment and Waiver to Second Amended and Restated
Credit Agreement between Heartland Financial USA, Inc.
and The Northern Trust Company dated as of October 30,
2002.
10.2 See Exhibit 10.1 for substantially the same form of a
Fifth Amendment and Waiver to Credit Agreement between
Heartland Financial USA, Inc. and Harris Trust and
Savings Bank dated as of October 30, 2002.
99.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002, by the Company's Chief Executive Officer.
99.2 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002, by the Company's Chief Financial Officer.
Reports on Form 8-K
On October 17, 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 September 30,
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: November 14, 2002
I, Lynn B. Fuller, Principal Executive Officer of the Company,
certify that:
I have reviewed this quarterly report on Form 10-Q of Heartland
Financial USA, Inc.;
Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
Based on my knowledge, the financial statements, and other
financial information included in the Report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
- designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
- evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
- presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
- all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
- any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
The registrant's other certifying officers and I have indicated
in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to date of
their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
Principal Executive Officer
/s/ Lynn B. Fuller
-----------------------
By: Lynn B. Fuller
President and Chief Executive
Officer
I, John K. Schmidt, Principal Accounting Officer of the Company,
certify that:
I have reviewed this quarterly report on Form 10-Q of Heartland
Financial USA, Inc.;
Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
Based on my knowledge, the financial statements, and other
financial information included in the Report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
- designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
- evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
- presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
- all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
- any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
The registrant's other certifying officers and I have indicated
in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to date of
their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
Principal Financial and
Accounting Officer
/s/ John K. Schmidt
-----------------------
By: John K. Schmidt
Executive Vice President
and Chief Financial Officer