UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended September 30, 2003
[ ] 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 by check mark whether the Registrant is an
accelerated filer (as defined by Rule 12b-2 of the Securities
Exchange Act of 1934). 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 12, 2003, the Registrant had outstanding
10,073,999 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 and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of
Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Form 10-Q Signature Page
PART I
ITEM 1. FINANCIAL STATEMENTS
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
9/30/03 12/31/02
(Unaudited)
----------- ----------
ASSETS
Cash and due from banks $ 58,752 $ 61,106
Federal funds sold and other short-
term investments 90,264 39,886
---------- ----------
Cash and cash equivalents 149,016 100,992
Time deposits in other
financial institutions 1,216 1,677
Securities:
Trading, at fair value 948 915
Available for sale, at fair value
(cost of $388,644 for 2003 and
$381,398 for 2002) 381,665 389,900
Loans and leases:
Held for sale 19,477 23,167
Held to maturity 1,249,096 1,152,069
Allowance for loan and lease losses (18,041) (16,091)
---------- ----------
Loans and leases, net 1,250,532 1,159,145
Assets under operating leases 31,000 30,367
Premises, furniture and equipment, net 47,230 35,591
Other real estate, net 1,082 452
Goodwill, net 20,167 16,050
Core deposit premium and mortgage
servicing rights 5,133 4,879
Other assets 59,917 46,011
---------- ----------
TOTAL ASSETS $1,947,906 $1,785,979
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $ 218,822 $ 197,516
Savings 559,582 511,979
Time 678,761 628,490
---------- ----------
Total deposits 1,457,165 1,337,985
Short-term borrowings 167,567 161,379
Other borrowings 153,194 126,299
Accrued expenses and other liabilities 32,858 36,275
---------- ----------
TOTAL LIABILITIES 1,810,784 1,661,938
---------- ----------
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 at
September 30, 2003, and December 31,
2002; issued 10,174,476 shares at
September 30, 2003, and 9,905,783
shares at December 31, 2002) 10,174 9,906
Capital surplus 20,528 16,725
Retained earnings 105,056 94,048
Accumulated other comprehensive income 3,918 4,230
Treasury stock at cost
(89,327 shares at September 30, 2003,
and 59,369 shares at December 31,
2002) (2,554) (868)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 137,122 124,041
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,947,906 $1,785,979
========== ==========
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
9/30/03 9/30/02 9/30/03 9/30/02
------- ------- ------- -------
INTEREST INCOME:
Interest and fees on
loans and leases $ 21,527 $ 21,151 $ 64,269 $ 62,220
Interest on securities:
Taxable 1,497 3,425 6,728 9,807
Nontaxable 998 777 2,909 1,921
Interest on federal
funds sold 149 88 279 260
Interest on interest
bearing deposits in
other financial
institutions 38 54 135 194
-------- -------- -------- --------
TOTAL INTEREST INCOME 24,209 25,495 74,320 74,402
-------- -------- -------- --------
INTEREST EXPENSE:
Interest on deposits 6,866 8,034 20,971 24,392
Interest on short-term
borrowings 581 516 1,759 1,503
Interest on other
borrowings 1,953 2,039 5,815 6,344
-------- -------- -------- --------
TOTAL INTEREST EXPENSE 9,400 10,589 28,545 32,239
-------- -------- -------- --------
NET INTEREST INCOME 14,809 14,906 45,775 42,163
Provision for loan and
lease losses 950 167 3,176 1,778
-------- -------- -------- --------
NET INTEREST INCOME
AFTER PROVISION FOR
LOAN AND LEASE LOSSES 13,859 14,739 42,599 40,385
-------- -------- -------- --------
NONINTEREST INCOME:
Service charges and fees 1,452 1,585 4,208 4,729
Trust fees 951 871 2,761 2,607
Brokerage commissions 236 122 599 452
Insurance commissions 141 158 557 535
Securities gains, net 527 573 1,685 729
Gain (loss) on trading
account securities 80 (450) 329 (692)
Impairment loss on equity
securities (69) (267) (239) (267)
Rental income on
operating leases 3,447 3,583 10,342 11,113
Gain on sale of loans 2,446 1,049 5,667 2,578
Valuation adjustment on
mortgage servicing
rights 1,360 (503) 368 (829)
Other noninterest income 631 190 1,811 728
-------- -------- -------- --------
TOTAL NONINTEREST INCOME 11,202 6,911 28,088 21,683
-------- -------- -------- --------
NONINTEREST EXPENSES:
Salaries and employee
benefits 8,579 7,109 24,414 20,855
Occupancy 1,021 785 2,877 2,311
Furniture and equipment 1,064 777 2,912 2,395
Depreciation on equipment
under operating leases 2,859 2,845 8,471 8,754
Outside services 1,286 1,037 3,558 3,018
FDIC deposit insurance
assessment 54 51 161 157
Advertising 679 405 1,765 1,239
Core deposit and other
intangibles amortization 101 124 303 371
Other noninterst expenses 1,763 1,789 5,577 5,135
-------- -------- -------- --------
TOTAL NONINTEREST
EXPENSES 17,406 14,922 50,038 44,235
-------- -------- -------- --------
INCOME BEFORE INCOME
TAXES 7,655 6,728 20,649 17,833
Income taxes 2,391 2,087 6,654 5,453
-------- -------- -------- --------
INCOME FROM CONTINUING
OPERATIONS 5,264 4,641 13,995 12,380
Discontinued operations:
Income from operation of
discontinued branch - 224 - 627
Income taxes - 88 - 246
-------- -------- -------- --------
Income from discontinued
operations - 136 - 381
-------- -------- -------- --------
NET INCOME $ 5,264 $ 4,777 $ 13,995 $ 12,761
======== ======== ======== ========
EARNINGS PER COMMON
SHARE-BASIC $ 0.52 $ 0.49 $ 1.41 $ 1.30
EARNINGS PER COMMON
SHARE-DILUTED $ 0.51 $ 0.48 $ 1.38 $ 1.30
CASH DIVIDENDS DECLARED
PER COMMON SHARE $ 0.10 $ 0.10 $ 0.30 $ 0.30
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, 2002 $ 9,906 $18,116 $ 79,107
Net income - - 12,761
Unrealized gain (loss) on
securities available for sale - - -
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $1,182 - - -
Reclassification adjustment for
net security gains realized in
net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.30 per share - - (2,946)
Purchase of 87,933 shares of
common stock - - -
Sale of 219,592 shares of
common stock - (1,325) -
------- -------- --------
Balance at September 30, 2002 $ 9,906 $16,791 $ 88,922
======= ======= ========
Balance at January 1, 2003 $ 9,906 $16,725 $ 94,048
Net income - - 13,995
Unrealized gain (loss) on
securities available for sale - - -
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $12 - - -
Reclassification adjustment for
net security gains realized in
net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.30 per share - - (2,987)
Purchase of 273,745 shares of
common stock - - -
Issuance of 512,480 shares of
common stock 268 3,803 -
------- ------- --------
Balance at September 30, 2003 $10,174 $20,528 $105,056
======= ======= ========
Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock Total
------------- -------- --------
Balance at January 1, 2002 $ 3,565 $(3,604) $107,090
Net income - - 12,761
Unrealized gain (loss) on
securities available for sale 5,050 - 5,050
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $1,182 (1,987) - (1,987)
Reclassification adjustment for
net security 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 shares of
common stock - (1,229) (1,229)
Sale of 219,592 shares of
common stock - 3,520 2,195
------- ------- --------
Balance at September 30, 2002 $ 5,282 $(1,313) $119,588
======= ======= ========
Balance at January 1, 2003 $ 4,230 $ (868) $124,041
Net income - - 13,995
Unrealized gain (loss) on
securities available for sale 953 - 953
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $12 20 - 20
Reclassification adjustment for
net security gains realized in
net income (1,446) - (1,446)
Income taxes 161 - 161
--------
Comprehensive income 13,683
Cash dividends declared:
Common, $.30 per share - - (2,987)
Purchase of 273,745 shares of
common stock - (7,687) (7,687)
Issuance of 512,480 shares of
common stock - 6,001 10,072
------- ------- --------
Balance at September 30, 2003 $ 3,918 $(2,554) $137,122
======= ======= ========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Nine Months Ended
9/30/03 9/30/02
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 13,995 $ 12,761
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 11,455 11,471
Provision for loan and lease losses 3,176 1,778
Provision for income taxes less than
payments 1,152 1,557
Net amortization of premium on
securities 5,810 3,392
Securities gains, net (1,685) (729)
(Increase) decrease in trading
account securities (33) 765
Loss on impairment of equity
securities 239 267
Loans originated for sale (382,521) (142,423)
Proceeds on sales of loans 391,622 150,014
Net gain on sales of loans (5,667) (2,578)
Increase in accrued interest
receivable (336) (1,188)
Decrease in accrued interest payable (367) (427)
Other, net (651) 912
-------- --------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 36,189 35,572
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of time deposits in other
financial institutions (95) (1,068)
Proceeds on maturities of time
deposits in other financial
institutions 600 3
Proceeds from the sale of
securities available for sale 56,393 42,912
Proceeds from the maturity of and
principal paydowns on securities
available for sale 145,277 113,785
Purchase of securities available
for sale (197,078) (209,726)
Net increase in loans and leases (98,464) (65,030)
Purchase of bank-owned life
insurance policies (15,000) -
Increase in assets under operating
leases (9,104) (4,051)
Capital expenditures (14,011) (4,522)
Proceeds on sale of OREO and other
repossessed assets 414 495
-------- --------
NET CASH USED BY INVESTING ACTIVITIES (131,068) (127,202)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits and
savings accounts 68,909 5,338
Net increase in time deposit accounts 50,271 79,876
Net increase (decrease) in short-term
borrowings 6,188 (13,377)
Proceeds from other borrowings 32,750 7,840
Repayments of other borrowings (5,855) (21,410)
Purchase of treasury stock (7,687) (1,229)
Proceeds from sale of common stock 1,314 1,882
Dividends (2,987) (2,946)
-------- --------
NET CASH PROVIDED BY FINANCING
ACTIVITIES 142,903 55,974
-------- --------
Net increase (decrease) in cash and
cash equivalents 48,024 (35,656)
Cash and cash equivalents at
beginning of year 100,992 93,550
-------- --------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $149,016 $ 57,894
======== ========
Supplemental disclosures:
Cash paid for income/franchise taxes $ 5,647 $ 3,741
======== ========
Cash paid for interest $ 28,912 $ 33,306
======== ========
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, 2002,
included in Heartland Financial USA, Inc.'s ("Heartland") Form 10-
K filed with the Securities and Exchange Commission on March 26,
2003. Accordingly, footnote disclosures, which would
substantially duplicate the disclosure contained in the audited
consolidated financial statements, have been omitted.
The financial information of Heartland included herein 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, 2003, are not necessarily indicative of the results
expected for the year ending December 31, 2003.
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 nine-month periods ended September
30, 2003 and 2002, are shown in the tables below:
Three Months Ended
(Dollars in thousands) 9/30/03 9/30/02
------- -------
Income from continuing operations $ 5,264 $ 4,641
Discontinued operations:
Income from operation of discontinued
branch - 224
Income taxes - 88
------- -------
Income from discontinued operation - 136
------- -------
Net income $ 5,264 $ 4,777
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 10,142 9,819
Assumed incremental common shares issued
upon exercise of stock options (000's) 178 76
------- -------
Weighted average common shares for
diluted earnings per share (000's) 10,320 9,895
======= =======
Earnings per common share - basic $ .52 $ .49
Earnings per common share - diluted .51 .48
Earnings per common share from
continuing operations - basic(1) .52 .47
Earnings per common share from
continuing operations - diluted(1) .51 .47
(1) Excludes the discontinued operations of our Eau Claire
branch.
Nine Months Ended
(Dollars in thousands) 9/30/03 9/30/02
------- -------
Income from continuing operations $13,995 $12,380
Discontinued operations:
Income from operation of discontinued
branch - 627
Income taxes - 246
------- -------
Income from discontinued operation - 381
------- -------
Net income $13,995 $12,761
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,960 9,785
Assumed incremental common shares issued
upon exercise of stock options (000's) 185 65
------- -------
Weighted average common shares for
diluted earnings per share (000's) 10,145 9,850
======= =======
Earnings per common share - basic $ 1.41 $ 1.30
Earnings per common share - diluted 1.38 1.30
Earnings per common share from
continuing operations - basic(1) 1.41 1.27
Earnings per common share from
continuing operations - diluted(1) 1.38 1.26
(1) Excludes the discontinued operations of our Eau Claire
branch.
Heartland applies APB Opinion No. 25 in accounting for its Stock
Option Plan and, accordingly, no compensation cost for its stock
options has been recognized in the financial statements. Had
Heartland determined compensation cost based on the fair value at
the grant date for its stock options under FAS No. 123,
Heartland's net income would have been reduced to the pro forma
amounts indicated below:
Three Months Nine Months
(Dollars in thousands, Ended Ended
except per share data) 9/30/03 9/30/02 9/30/03 9/30/02
------- ------- ------- -------
Net income as reported $ 5,264 $ 4,777 $13,995 $12,761
Pro forma 5,264 4,777 13,779 12,513
Earnings per share-basic
as reported $ .52 $ .49 $ 1.41 $ 1.30
Pro forma .52 .49 1.38 1.28
Earnings per share-diluted
as reported $ .51 $ .48 $ 1.38 $ 1.30
Pro forma .51 .48 1.36 1.27
Pro forma net income only reflects options granted from 1996
through 2003. Therefore, the full impact of calculating
compensation cost for stock options under FAS 123 is not
reflected in the pro forma net income amounts presented above
because compensation is reflected over the options' vesting
period, and compensation cost for options granted prior to
January 1, 1996, is not considered.
Effect of New Financial Accounting Standards-In January 2003, the
Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 (FIN 46), "Consolidation of Variable
Interest Entities." FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to certain variable interest entities in which
equity investors do not have the characteristics of a controlling
interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated
financial support from other parties. The recognition and
measurement provisions of this Interpretation are effective for
newly created variable interest entities formed after January 31,
2003, and for existing variable interest entities on the first
interim or annual reporting period beginning after December 15,
2003. Heartland adopted the disclosure provisions of FIN 46
effective December 31, 2002, and the provisions of FIN 46 for
newly formed variable interest entities effective January 31,
2003. Heartland has no newly formed variable interest entity
subject to the provisions of FIN 46. Heartland is in the process
of determining whether consolidation of various affordable
housing tax credit project partnerships will be necessary in the
fourth quarter of 2003 to reflect the January 1, 2004 effective
date. Consolidation of these entities, if required, is not
expected to have a material effect on the consolidated financial
statements of Heartland.
In April 2003, the FASB issued SFAS No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities."
This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." In addition, SFAS
No. 149 requires that contracts with comparable characteristics
be accounted for similarly. This Statement is effective
prospectively for contracts entered into or modified after June
30, 2003, except for those provisions of the Statement that
relate to Statement 133 Implementation Issues that have been
effective for fiscal quarters that began prior to June 15, 2003,
which should continue to be applied in accordance with the
respective effective dates. The impact of adopting SFAS No. 149
on Heartland's financial condition and results of operation was
not material.
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity." This Statement establishes standards for
how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that
is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously
classified as equity. This Statement was effective for financial
instruments entered into or modified after May 31, 2003, and
otherwise effective at the beginning of the first interim period
beginning after June 15, 2003, except for mandatory redeemable
financial instruments of nonpublic entities. On October 29,
2003, the FASB voted to defer for an indefinite period the
application of the guidance in SFAS No. 150, to non-controlling
interests that are classified as equity in the financial
statements of a subsidiary but would be classified as a liability
on the parent's financial statements. The adoption of the
sections of this Statement that have not been deferred did not
have a significant impact on Heartland's financial condition or
results of operations. The section noted above that has been
deferred indefinitely is not expected to have a significant
impact on Heartland's financial condition or results of
operations.
NOTE 2: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated
accumulated amortization at September 30, 2003, is presented in
the table below.
September 30, 2003
-------------------------
Gross
Carrying Accumulated
(Dollars in thousands) Amount Amortization
-------- ------------
Intangible assets:
Core deposit premium $ 4,492 $ 2,359
Mortgage servicing rights 3,558 558
------- -------
Total $ 8,050 $ 2,917
======= =======
Unamortized intangible assets $ 5,133
=======
Projections of amortization expense for mortgage servicing rights
are based on existing asset balances and the existing interest
rate environment as of September 30, 2003. What Heartland
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 intangible assets:
Core Mortgage
Deposit Servicing
(Dollars in thousands) Premium Rights Total
--------- --------- ---------
Three months ended
December 31, 2003 $ 101 $ 523 $ 624
Year Ended December 31,
2004 $ 353 $ 577 $ 930
2005 353 481 834
2006 353 384 737
2007 353 288 641
2008 353 192 545
NOTE 3: ACQUISITIONS
On June 30, 2003, Heartland completed the buyout of all minority
stockholders of New Mexico Bank & Trust as agreed upon during its
formation in 1998. The repurchase price was determined by an
appraisal of the stock of New Mexico Bank & Trust. In exchange
for their shares of New Mexico Bank & Trust stock, the minority
stockholders received a total of 383,574 shares of Heartland
common stock. This transaction resulted in a $4.1 million
increase in goodwill.
NOTE 4: SUBSEQUENT EVENT - OTHER BORROWINGS
On October 10, 2003, Heartland completed an offering of $20.0
million of 8.25% cumulative capital securities representing
undivided beneficial interests in Heartland Financial Statutory
Trust III, 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 are being used 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 on October 10,
2033. Heartland has the option to shorten the maturity date to a
date not earlier than October 10, 2008. Heartland 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SAFE HARBOR STATEMENT
This report 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 past and any future terrorist
threats and attacks, acts of war or threats thereof, 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 and fees, gains on sale of 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.
Total net income for the third quarter of 2003 was $5.3 million,
or $.51 on a diluted earnings per common share basis, compared to
$4.8 million, or $.48 on a diluted earnings per common share
basis, during the same quarter in 2002, a $487 thousand or 10%
increase. Annualized return on average equity for the third
quarter of 2003 was 15.52% compared to 16.20% in the third
quarter of 2002 and 13.15% in the second quarter of 2003.
Annualized return on average assets was 1.10% compared to 1.13%
in the third quarter of 2002 and 0.92% in the second quarter of
2003. These results are particularly gratifying in light of
continued softness in the economy and Heartland's continued
investment in the growth of its franchise.
Earnings from continuing operations for the third quarter of 2003
increased $623 thousand or 13%. Net income from continuing
operations totaled $5.3 million, or $.51 on a diluted earnings
per common share basis, for the third quarter of 2003 compared to
$4.6 million, or $.47 on a diluted earnings per common share
basis, during the same quarter in 2002. The Eau Claire branch of
Wisconsin Community Bank, a bank subsidiary of Heartland, was
sold effective December 15, 2002. The effect of this discontinued
operation on net income during the third quarter of 2002 was a
gain of $136 thousand, or $.01 on a diluted earnings per common
share basis. This branch sale allowed Heartland to redirect
assets to markets where the assets were more productively and
profitably employed.
Contributing to the improved earnings during the third quarter of
2003 was the $4.3 million or 62% increase in noninterest income,
driven primarily by a $1.4 million valuation adjustment on
mortgage servicing rights as well as gains on sales of loans
totaling $2.4 million. Net interest income remained flat even
though average earning assets increased during the quarter due in
large part to accelerated prepayments in the mortgage-backed
securities portfolio. Noninterest expense increased $2.5 million
or 17% during the third quarter, reflecting increased costs
related to the opening of offices in the last twelve months in
Santa Fe, New Mexico; Fitchburg, Wisconsin; and Mesa, Arizona as
well as the formation of HTLF Capital Corp., an investment
banking subsidiary.
For the nine-month period ended September 30, 2003, total net
income increased 10% to $14.0 million, or $1.38 per diluted
share, compared to total net income of $12.8 million, or $1.30
per diluted share, in the same period in 2002. Return on average
equity was 14.43% and return on average assets was 1.02% for the
nine-month period in 2003 compared to 15.14% and 1.03%,
respectively, for the same period in 2002.
The improved earnings during the first nine months of 2003 was
largely due to the $6.4 million or 30% increase in noninterest
income, primarily as a result of gains on sales of loans and
activities within the available for sale and trading account
securities portfolios. Additionally, the cumulative valuation
adjustments on mortgage servicing rights have been positive thus
far in 2003 compared to losses during 2002. The $3.6 million or
9% growth in net interest income also contributed to the improved
earnings through the third quarter of 2003 as average earning
assets went from $1.48 billion during the first nine months of
2002 to $1.64 billion during the same period in 2003, an increase
of $164.3 million or 11%. Noninterest expense increased $5.8
million or 13%, due primarily to the implementation of imaging
technology across all the bank subsidiaries and the expansion
efforts mentioned previously. Management remains focused on
expanding the customer base in the markets served and continues
to look for opportunities to enter new markets. New Mexico Bank &
Trust's new branches in Santa Fe attracted deposits in excess of
$13 million during their first nine months of operations. Since
its opening on August 18, 2003, Arizona Bank & Trust, Heartland's
de novo bank in Mesa, Arizona, attracted deposits in excess of $7
million. While expansion efforts generally are initially a drag
on current earnings because of the necessary overhead
expenditures, they should provide a firm foundation for future
income.
Total assets reached $1.95 billion on September 30, 2003, an
increase of $161.9 million or 9% since year-end 2002. In the
first nine months of 2003, total loans and leases increased $91.4
million or 8% and total deposits increased $119.2 million or 9%.
Commercial and commercial real estate loan volume alone grew by
over $66 million since year-end. Deposits have shown strong
increases in the latest nine-month period, demonstrating
continued strong customer response to Heartland's products
despite the very low interest rate environment.
CRITICAL ACCOUNTING POLICIES
The process utilized by Heartland to estimate the adequacy of the
allowance for loan and lease losses is considered a critical
accounting 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 banks'
boards of directors. Factors considered by the allowance
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, 2003. 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 2003 and beyond. 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 during 2002. Should this
economic climate continue, 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.
NET INTEREST INCOME
Net interest margin, expressed as a percentage of average earning
assets, was 3.62% during the third quarter of 2003 compared to
4.03% for the same period in 2002 and 3.82% for the second
quarter of 2003. Even though average earning assets increased 12%
during the quarter, net interest margin was adversely affected by
accelerated prepayments in the mortgage-backed securities
portfolio.
For the first nine months of 2003, net interest margin as a
percentage of average earnings assets was 3.86%, compared to
3.92% in the same period one year ago. A steep yield curve and
relatively low interest rates led to further compression of
Heartland's net interest margin, but management believes its
disciplined approach to asset and liability pricing has served to
mitigate the effects of margin pressure to a significant degree.
The $164.3 million or 11% growth in average earning assets has
contributed to the sustenance of net interest margin. Management
has been successful in the utilization of floors on its
commercial loan portfolio to minimize the effect downward rates
have on Heartland's 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. On the liability side of the balance sheet,
management has continued to look for opportunities to lock in
some funding in three- to five-year maturities as rates have been
at historical low levels.
Net interest income was $14.8 million during the third quarter of
2003 compared to $14.9 million during the same quarter of 2002.
On a year-to-date basis, net interest income was $45.8 million
during 2003 compared to $42.2 million during 2002. As the
interest rate environment continued at historical low levels,
reinvestment rates on early payments and maturities of securities
negatively affected interest income. During the quarter,
accelerated prepayments in the mortgage-backed securities
portfolio were more significant than earlier quarters of the
year. Interest income in the third quarter of 2003 totaled $24.2
million compared to $25.5 million in the third quarter of 2002, a
decrease of $1.3 million or 5%. For the nine-month period ended
September 30, 2003, interest income decreased $82 thousand or
less than 1% when compared to the same period in 2002. If it had
not been for the growth in loans during this period, interest
income would have declined further as the national prime rate was
reduced from 4.25% to 4.00% during the second and third quarters
of 2003, compared to 4.75% during the first half of 2002.
For the three-month period ended September 30, 2003, interest
expense decreased $1.2 million or 11% when compared to the same
period in 2002. For the nine-month period ended September 30,
2003, interest expense decreased $3.7 million or 11% when
compared to the same period in 2002. 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
certificate of deposit accounts. Management continues to focus
efforts on improving the mix of its funding sources to minimize
its interest costs.
On October 28, 2003, the Federal Open Market Committee decided to
keep its target for the federal funds rate at 1.00%, the lowest
target interest rate on overnight loans between banks since 1961.
Correspondingly, national prime remained at 4.00%. The
continuation of these historically low interest rates 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 historically 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 further.
PROVISION FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses is established through a
provision charged to expense to provide, in Heartland's opinion,
an adequate allowance for loan and lease losses. The provision
for loan losses during the third quarter of 2003 was $950
thousand compared to $167 thousand in the same period one year
ago. The reduced provision in 2002 resulted primarily from a $685
thousand recovery on a prior-year charge-off. During the first
nine months of 2003, the provision for loan losses was $3.1
million compared to $1.8 million in the same period in 2002.
Exclusive of the third quarter recovery in 2002, provision for
loan losses increased $713 thousand or 29% during the nine-month
periods under comparison. This increase resulted primarily from
an increase in watch and problem loan exposure and the growth
experienced in the 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. A weak economy will inevitably result in
increased problem loans, but Heartland expects the problems to be
manageable and of a lesser scope for Heartland than for the
industry as a whole. For additional details on the specific
factors considered, refer to the critical accounting policies and
allowance for loan and lease losses sections of this report.
NONINTEREST INCOME
Total noninterest income increased $4.3 million or 62% during the
third quarter of 2003 when compared to the same quarter in 2002.
On a year-to-date comparative basis, total noninterest income
increased $6.4 million or 30%. The noninterest income categories
reflecting significant improvement during the quarter and nine
months were securities gains, gains on sale of loans and
valuation adjustment on mortgage servicing rights.
Service charges and fees decreased $133 thousand or 8% during the
quarters under comparison and $521 thousand or 11% during the
nine-month periods under comparison. Included in this category
are service fees collected on the mortgage loans Heartland sold
into the secondary market, while retaining servicing. Even though
Heartland's servicing portfolio grew to $521.1 million at
September 30, 2003, from $395.1 million at year-end 2002, the
amortization on the mortgage servicing rights associated with the
servicing portfolio increased $470 thousand for the quarters and
$1.4 million for the nine months under comparison, as a result of
increased prepayments in the portfolio. Offsetting a portion of
these increases was an additional $207 thousand in service
charges on checking accounts during the first nine months of
2003, a 7% increase. The addition of an overdraft privilege
feature to our checking account product line in late 2001, along
with growth in the number of checking accounts, resulted in the
generation of additional service charge revenue related to
activity fees charged to these accounts. Checking account
balances grew from $171.8 million at September 30, 2002, to
$218.8 million at September 30, 2003, a $47.0 million or 27%
increase. Also contributing to the increase in service charges
and fees was the $157 thousand or 19% growth in fees collected
for the processing of activity on our automated teller machines
during the first nine months of 2003. Beginning in the summer of
2002, the state of Iowa began to allow financial institutions to
charge a fee for the use of automated teller machines.
Gains on sale of loans increased by $1.4 million or 133% for the
quarters and $3.1 million or 120% for the nine months under
comparison. The volume of mortgage loans sold into the secondary
market during the first nine months of 2003 was greater than
those sold during the same period in 2002, primarily as a result
of the historically low rate environment during 2003. 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. Mortgage rates
began to move upward recently and even if that trend does not
continue, the present level of gains on sale of loans will not
continue throughout the balance of the year as many refinancings
have already occurred.
During the third quarter of 2003, securities gains were $527
thousand compared to $573 thousand during the third quarter of
2002. Because of the steepness of the yield curve during the
third quarter of 2003 and the protection afforded, longer-term
bullet agency securities were purchased with the proceeds on the
sale of shorter-term agency securities. During the first nine
months of 2003, securities gains were $1.7 million compared to
$729 thousand during the first nine months of 2002. Heartland's
interest rate forecast changed to a rising rate bias on the long
end of the yield curve during the first quarter of 2003, and
therefore, longer-term agency securities were sold at a gain to
shorten the portfolio. The proceeds were invested in mortgage-
backed securities that were projected to outperform the agency
securities in a rising rate environment.
Heartland began classifying some of its new equity securities
purchases as trading during the first quarter of 2001. This
portfolio recorded gains of $80 thousand during the third quarter
of 2003 compared to losses of $450 thousand during the same
quarter in 2002. On a year-to-date comparative basis, gains of
$329 thousand were recorded in 2003 compared to losses of $692
thousand in 2002. This improvement was reflective of the overall
rise in the stock markets.
Impairment losses on equity securities deemed to be other than
temporary totaled $69 thousand during the third quarter of 2003
and $239 thousand for the first nine months of 2003. A majority
of these losses were related to the decline in market value on
the common stock of four companies held in Heartland's available
for sale equity securities portfolio. Three of those stocks were
subsequently sold during the third quarter of 2003. The carrying
value of the one remaining stock on Heartland's balance sheet at
September 30, 2003, was $74 thousand. Additionally, during the
first quarter of 2003, an impairment loss on equity securities
totaling $20 thousand was recorded on Heartland's investment in a
limited partnership. The fair value of the remaining portion of
Heartland's investment in this partnership at quarter-end was $80
thousand.
During the third quarter of 2003, a $1.4 million gain was
recorded as a valuation adjustment on mortgage servicing rights
compared to a $503 thousand loss during the same quarter in 2002.
For the nine-month period ended on September 30, the valuation
adjustment totaled $368 thousand during 2003 compared to a loss
of $829 thousand during 2002. The valuation of Heartland's
mortgage servicing rights improved since last quarter as a result
of the upward movement 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. At
September 30, 2003, the remaining valuation adjustment totaled
$101 thousand.
Rental income on operating leases decreased $136 thousand or 4%
during the third quarter of 2003 and $771 thousand or 7% during
the first nine months of 2003. These decreases resulted from a
decline in the number of vehicles being replaced at our vehicle
leasing and fleet management subsidiary, ULTEA. As the economy
weakened, many companies elected to continue operations with
their current fleet of vehicles instead of the replacement of
three or four year old vehicles, as had been the norm.
Total other noninterest income was $631 thousand during the third
quarter of 2003 compared to $190 thousand during the same quarter
in 2002. For the nine-month period ended on September 30, total
other noninterest income was $1.8 million in 2003 and $728
thousand in 2002. Contributing to the increases during 2003 were
the following:
- During the second quarter of 2003, Heartland purchased
an additional $15 million in bank-owned life insurance
policies and the corresponding increase in cash
surrender value on these policies since purchase has
been $209 thousand.
- During the first quarter of 2003, a $178 thousand gain
was realized on the sale of one parcel of repossessed
real estate.
- 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 applied to the 2002 tax
year. Amortization of the investment in this limited
liability company recorded during the first nine months
of 2002 was $355 thousand.
NONINTEREST EXPENSE
Total noninterest expense increased $2.5 million or 17% during
the third quarter of 2003 when compared to the same quarter in
2002. On a nine-month comparative basis, total noninterest
expense increased $5.8 million or 13%. A large portion of this
increase was attributable to expansion efforts discussed
previously, as well as, to the implementation of imaging
technology across all of Heartland's bank subsidiaries.
Salaries and employee benefits, the largest component of
noninterest expense, increased $1.5 million or 21% for the
quarters under comparison and $3.6 million or 17% for the nine
months under comparison. This category made up more than half the
total increase in noninterest expense. In addition to normal
merit increases, these increases were also attributable to the
opening of new branches in Santa Fe, New Mexico and Fitchburg,
Wisconsin, the formation of HTLF Capital Corp. and the opening of
Arizona Bank & Trust, our de novo bank in Phoenix, Arizona. The
number of full-time equivalent employees employed by Heartland
increased from 576 at September 30, 2002, to 667 at September 30,
2003.
The noninterest expense categories experiencing increases during
the quarters and nine-month periods under review due to the
expansion efforts mentioned above were occupancy, furniture and
equipment, outside services, advertising and other noninterest
expense. These expenses in aggregate grew by $1.0 million or 21%
during the quarters under comparison and $2.6 million or 18% for
the nine-month periods under comparison. The implementation of
imaging technology across all the Heartland bank subsidiaries
also contributed to the increases in these categories.
Consistent with the lack of vehicle replacement activity
occurring at ULTEA, the depreciation on equipment under operating
leases decreased $283 thousand or 3% during the first nine months
of 2003.
INCOME TAX EXPENSE
Income tax expense for the third quarter of 2003 increased $216
thousand or 10% when compared to the same period in 2002. On a
nine-month comparative basis, income tax expense increased $955
thousand or 17%. These increases reflected the continued growth
in pre-tax earnings.
Heartland's effective tax rate remained consistent at 31.23%
during the third quarter of 2003 compared to 31.29% for the third
quarter of 2002. For the nine-month periods ended September 30,
2003 and 2002, the effective tax rate was 32.22% and 30.87%,
respectively. Historic rehabilitation tax credits were applied to
the 2002 tax year as a result of the previously mentioned
ownership in a limited liability company that owns a certified
historic structure. Tax-exempt interest income was 15% of pre-tax
income during the first nine months of 2003 compared to 12% for
the same period in 2002.
FINANCIAL CONDITION
LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Total loans and leases increased $93.3 million, an increase of 8%
since year-end 2002. A majority of this growth occurred in the
commercial and commercial real estate category, which grew $66.1
million or 9%. All Heartland's banks experienced growth in this
category, principally as a result of continued calling efforts.
Agricultural and agricultural real estate loans grew $13.3
million or 9% during the first nine months of 2003. Nearly all
this growth occurred at Dubuque Bank and Trust Company,
Heartland's flagship bank in Dubuque, Iowa.
Residential mortgage loans experienced an increase of $4.4
million or 3% since year-end 2002. This increase was primarily
due to management's election to retain a portion of the fifteen-
year fixed rate loans in its own portfolio. Customers have
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 grew to
$521.1 million at September 30, 2003, from $395.1 million at year-
end 2002.
Consumer loans increased $11.8 million or 10% during the first
nine months of 2003, primarily in home equity lines of credit at
all the Heartland bank subsidiaries except First Community Bank.
This product line was enhanced to build new customer
relationships.
The table below presents the composition of the loan portfolio as
of September 30, 2003, and December 31, 2002.
LOAN PORTFOLIO
(Dollars in thousands)
September 30, December 31,
2003 2002
Amount Percent Amount Percent
---------- ------- ---------- -------
Commercial and commercial
real estate $ 809,596 63.69% $ 743,520 63.10%
Residential mortgage 150,338 11.83 145,931 12.39
Agricultural and
agricultural real estate 168,923 13.29 155,596 13.21
Consumer 132,679 10.44 120,853 10.26
Lease financing, net 9,595 .75 12,308 1.04
---------- ------- ---------- -------
Gross loans and leases 1,271,131 100.00% 1,178,208 100.00%
======= =======
Unearned discount (1,816) (2,161)
Deferred loan fees (742) (811)
---------- ----------
Total loans and leases 1,268,573 1,175,236
Allowance for loan and
lease losses (18,041) (16,091)
---------- ----------
Loans and leases, net $1,250,532 $1,159,145
========== ==========
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. For
additional details on the specific factors considered, refer to
the critical accounting policies section of this report.
The allowance for loan and lease losses increased by $1.9 million
or 12% during the first nine months of 2003. The allowance for
loan and lease losses at September 30, 2003, was 1.42% of loans
and 330% of nonperforming loans, compared to 1.37% of loans and
359% of nonperforming loans, at year-end 2002. Nonperforming
loans increased slightly to .43% of total loans and leases at the
end of the third quarter of 2003 compared to .38% of total loans
and leases at year-end 2002.
During the first nine months of 2003, Heartland recorded net
charge offs of $1.2 million compared to $873 thousand for the
same period in 2002. During the third quarter of 2002, there was
a $685 thousand recovery on one large credit. Citizens Finance
Co., Heartland's consumer finance subsidiary, experienced an
improvement in net charge-offs. For the first nine months of
2003, Citizens recorded net charge-offs of $532 thousand or 43%
of total net charge-offs compared to $762 thousand or 49% of
total net charge-offs during the same period in 2002, exclusive
of the one significant recovery in 2002 mentioned above.
The table below presents the changes in the allowance for loan
and lease losses during the periods indicated:
ANALYSIS OF ALLOWANCE FOR LOAN AND LEASE LOSSES
(Dollars in thousands)
Nine Months
Ended Sept. 30,
2003 2002
------- -------
Balance at beginning of period $16,091 $14,660
Provision for loan and lease losses from
continuing operations 3,176 1,778
Recoveries on loans and leases previously
charged off 488 1,250
Loans and leases charged off (1,714) (2,123)
------- -------
Balance at end of period $18,041 $15,565
======= =======
Net charge offs to average loans and leases 0.10% 0.08%
The table below presents the amounts of nonperforming loans and
leases and other nonperforming assets on the dates indicated:
NONPERFORMING ASSETS
(Dollars in thousands)
As Of As Of
September 30, December 31,
2003 2002 2002 2001
------------------------------
Nonaccrual loans and leases $4,612 $5,296 $3,944
$7,269
Loan and leases contractually
past due 90 days or more 862 861 541 500
Restructured loans and leases - - - 354
------ ------ ------ ------
Total nonperforming loans and
leases 5,474 6,157 4,485 8,123
Other real estate 1,082 322 452 130
Other repossessed assets 346 424 279 343
------ ------ ------ ------
Total nonperforming assets $6,902 $6,903 $5,216 $8,596
====== ====== ====== ======
Nonperforming loans and leases
to total loans and leases 0.43% 0.53% 0.38% 0.73%
Nonperforming assets to total
assets 0.35% 0.40% 0.29% 0.52%
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 20% of total assets at September
30, 2003, and 22% of total assets at December 31, 2002. A portion
of the proceeds from the maturity and principal paydowns of
securities was used to fund the loan growth experienced thus far
in 2003.
During the first nine months of 2003, management purchased 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.
The table below presents the composition of the available for
sale securities portfolio by major category as of September 30,
2003, and December 31, 2002.
AVAILABLE FOR SALE SECURITIES PORTFOLIO
(Dollars in thousands)
September 30, December 31,
2003 2002
Amount Percent Amount Percent
-------- ------- -------- -------
U.S. Treasury securities $ 498 .13% $ 498 .13%
U.S. government agencies 89,287 23.39 100,841 25.86
Mortgage-backed securities 171,181 44.85 187,318 48.04
States and political
subdivisions 88,775 23.26 71,391 18.31
Other securities 31,924 8.37 29,852 7.66
-------- ------- -------- -------
Total available for sale
securities $381,665 100.00% $389,900 100.00%
======== ======= ======== =======
DEPOSITS AND BORROWED FUNDS
Total deposits experienced an increase of $119.2 million or 9%
during the first nine months of 2003. Increases in total deposits
occurred at all the bank subsidiaries except for First Community
Bank. All the deposit categories experienced an increase during
the nine-month period. Demand deposit balances grew $21.3 million
or 11% with the most significant occurring in the Riverside
Community Bank, Wisconsin Community Bank and New Mexico Bank &
Trust markets. Savings deposit account balances grew by $47.6
million or 9%, primarily in the money market products offered by
all the bank subsidiaries. Certificate of deposit account
balances grew by $50.3 million or 8% during the first nine months
of 2003. With the continued instability in the equity markets,
many customers have elected to keep funds on deposit in financial
institutions. 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.
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, 2003, the amount
of short-term borrowings increased $6.2 million or 4%. 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 increased $12.4 million or 13% since year-end 2002.
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, 2003, and December 31, 2002, a total of $28.0
million and $25.0 million, respectively, was outstanding on these
credit lines.
Other borrowings include all debt arrangements Heartland and its
subsidiaries have entered into with original maturities that
extend beyond one year. These borrowings were $153.2 million on
September 30, 2003, compared to $126.3 million on December 31,
2002. 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, 2003, had
increased to $101.5 million from $72.5 million at December 31,
2002. Substantially all of these borrowings are fixed-rate
advances for original terms between three and five years. To fund
a portion of the fixed-rate commercial and residential loan
growth experienced, Heartland entered into three-, five- and
seven-year FHLB advances.
Additionally, balances outstanding on trust preferred 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,
2003 2002
Amount Ratio Amount Ratio
------ ----- ------ -----
Risk-Based Capital Ratios:(1)
Tier 1 capital $ 149,241 10.20% $ 141,918 10.65%
Tier 1 capital minimum
requirement 58,504 4.00% 53,298 4.00%
---------- ------ ---------- ------
Excess $ 90,737 6.20% $ 88,620 6.65%
========== ====== ========== ======
Total capital $ 167,283 11.44% $ 158,010 11.86%
Total capital minimum
requirement 117,007 8.00% 106,596 8.00%
---------- ------ ---------- ------
Excess $ 50,576 3.44% $ 51,414 3.86%
========== ====== ========== ======
Total risk-adjusted
assets $1,462,592 $1,332,451
========== ==========
Leverage Capital Ratios:(2)
Tier 1 capital $ 149,241 7.95% $ 141,918 8.24%
Tier 1 capital minimum
requirement(3) 75,077 4.00% 68,883 4.00%
---------- ------ ---------- ------
Excess $ 74,164 3.95% $ 73,035 4.24%
========== ====== ========== ======
Average adjusted assets
(less goodwill and other
intangible assets) $1,876,923 $1,722,077
========== ==========
(1) Based on the risk-based capital guidelines of the Federal
Reserve, a bank holding company is required to maintain a
Tier 1 capital to risk-adjusted assets ratio of 4.00% and
total capital to risk-adjusted assets ratio of 8.00%.
(2) The leverage ratio is defined as the ratio of Tier 1 capital
to average adjusted assets.
(3) Management of Heartland has established a minimum target
leverage ratio of 4.00%. Based on Federal Reserve
guidelines, a bank holding company generally is required to
maintain a leverage ratio of 3.00% plus additional capital of
at least 100 basis points.
Commitments for capital expenditures are an important factor in
evaluating capital adequacy. In April of 2003, HTLF Capital
Corp., an investment banking subsidiary of Heartland was formed.
This advisory firm specializes in taxable and tax-exempt
municipal leasing, hospital financing, college and university
financing, project financing and 501(c)3 private-activity
funding. The firm also prides itself on being one of the few in
the country prepared to do Indian tribal private placements.
Heartland's initial investment in this subsidiary was $500
thousand.
In February of 2003, Heartland entered into an agreement with a
group of Arizona business leaders to establish a new bank in
Mesa. The new bank began operations on August 18, 2003.
Heartland's investment in Arizona Bank & Trust was $12.0 million,
which currently reflects an ownership percentage of 86%. A
portion of Arizona Bank & Trust's common stock is still available
to interested local investors. In no case will Heartland's
ownership interest be allowed to fall below 80%. All minority
stockholders, both initial and subsequent, have or will enter
into a stock transfer agreement that 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 in 2008.
As a result of the acquisition of National Bancshares, Inc. on
January 1, 2000, the one-bank holding company of First National
Bank of Clovis, remaining requisite cash payments under the notes
payable total $637 thousand in 2004, plus interest at 7.00%.
Immediately following the closing of the acquisition, the bank
was merged into New Mexico Bank & Trust.
On June 30, 2003, Heartland completed the buyout of all minority
stockholders of New Mexico Bank & Trust as agreed upon during its
formation in 1998. In exchange for their shares of New Mexico
Bank & Trust stock, the minority stockholders received a total of
383,574 shares of Heartland common stock.
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 October 10, 2003, Heartland completed an offering of $20.0
million of 8.25% cumulative capital securities representing
undivided beneficial interests in Heartland Financial Statutory
Trust III, 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 are being used 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 on October 10,
2033. Heartland has the option to shorten the maturity date to a
date not earlier than October 10, 2008. It is anticipated that
all of these securities will qualify as Tier 1 capital for
regulatory purposes.
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. 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. All of these securities
qualified as Tier 1 capital for regulatory purposes as of
September 30, 2003.
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. 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. All
of these securities qualified as Tier 1 capital for regulatory
purposes as of September 30, 2003.
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. The debentures will mature and the capital securities
must be redeemed on September 30, 2029. Heartland has the option
to shorten the maturity date to a date not earlier than September
30, 2004. All of these securities continued to qualify as Tier 1
capital for regulatory purposes as of September 30, 2003.
The renovation and construction of a 50,000 square foot facility
to accommodate the operations and support functions of Heartland
are underway on property in downtown Dubuque, Iowa, across the
street from Dubuque Bank and Trust's main facility. Completion of
this project is anticipated in the spring of 2004. 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. Final net costs are estimated to be $4.5 million.
Heartland continues to explore opportunities to expand its
umbrella of independent community banks through mergers and
acquisitions as well as de novo and branching opportunities.
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.
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, 2003,
these credit agreements provided an additional borrowing capacity
of $22.0 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, 2003, Heartland was in
compliance with the covenants contained in these credit
agreements. At the present time, Heartland is in the process of
extending the credit agreements and reviewing the terms to
consider expanding the credit line amount and adding new
participants.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Market risk is the risk of loss arising from adverse changes in
market prices and rates. Heartland's market risk is comprised
primarily of interest rate risk resulting from its core banking
activities of lending and deposit gathering. Interest rate risk
measures the impact on earnings from changes in interest rates
and the effect on current fair market values of Heartland's
assets, liabilities and off-balance sheet contracts. The
objective is to measure this risk and manage the balance sheet to
avoid unacceptable potential for economic loss. Management
continually develops and applies strategies to mitigate market
risk. Exposure to market risk is reviewed on a regular basis by
the asset/liability committees at the banks and, on a
consolidated basis, by the Heartland board of directors.
Management does not believe that Heartland's primary market risk
exposures and how those exposures have been managed to-date in
2003 changed significantly when compared to 2002.
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
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, 2003, 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 $2.1 million on September 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of Heartland's management, including the Chief
Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of Heartland's
disclosure controls and procedures (as defined in Rule 13a-15(e)
promulgated under the Securities and Exchange Act of 1934, as
amended) as of September 30, 2003. Based on that evaluation,
Heartland's management, including the Chief Executive Officer and
Chief Financial Officer, concluded that Heartland's disclosure
controls and procedures were effective. There have been no
significant changes in Heartland's internal controls or in other
factors that could significantly affect internal controls.
PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Registrant or its subsidiaries is a party other than ordinary
routine litigation incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
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 Indenture by and between Heartland Financial USA, Inc.
and U.S. Bank National Association, dated as of October
10, 2003.
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a).
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a).
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
Reports on Form 8-K
On July 18, 2003, the Registrant filed a report on Form 8-K
pursuant to Item 12 that a press release announcing earnings for
the quarter ended on June 30, 2003, was issued.
On October 24, 2003, the Registrant filed a report on Form 8-K
pursuant to Item 12 that a press release announcing earnings for
the quarter ended on September 30, 2003, was issued.
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 13, 2003