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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 June 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 August 13, 2002, the Registrant had outstanding
9,819,470 shares of common stock, $1.00 par value per share.
HEARTLAND FINANCIAL USA, INC.
Form 10-Q Quarterly Report
Table of Contents
Part I
Item 1. Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About
Market Risk
Part II
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of
Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Form 10-Q Signature Page
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
6/30/02 12/31/01
(Unaudited)
----------- ----------
ASSETS
Cash and due from banks $ 39,336 $ 45,738
Federal funds sold and other short-
term investments 35,551 47,812
---------- ----------
Cash and cash equivalents 74,887 93,550
Time deposits in other
financial institutions 1,642 564
Securities:
Trading, at fair value 1,230 1,528
Available for sale, at fair value
(cost of $337,899 for 2002 and
$318,342 for 2001) 345,177 323,689
Loans and leases:
Held for sale 15,450 26,967
Held to maturity 1,099,589 1,078,238
Allowance for loan and lease losses (15,409) (14,660)
---------- ----------
Loans and leases, net 1,099,630 1,090,545
Assets under operating leases 32,057 35,427
Premises, furniture and equipment, net 33,176 31,482
Other real estate, net 108 130
Goodwill, net 9,507 9,507
Core deposit premium and other
intangibles, net 10,986 11,198
Other assets 43,838 46,444
---------- ----------
TOTAL ASSETS $1,652,238 $1,644,064
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $ 153,791 $ 160,742
Savings 496,862 493,374
Time 577,424 551,043
---------- ----------
Total deposits 1,228,077 1,205,159
Short-term borrowings 143,890 160,703
Other borrowings 136,321 143,789
Accrued expenses and other liabilities 29,226 27,323
---------- ----------
TOTAL LIABILITIES 1,537,514 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 June 30, 2002, and
December 31, 2001, respectively;
issued 9,905,783 shares at June 30,
2002, and December 31, 2001) 9,906 9,906
Capital surplus 16,784 18,116
Retained earnings 84,866 79,107
Accumulated other comprehensive income 4,364 3,565
Treasury stock at cost
(85,107 shares at June 30, 2002, and
226,031 shares at December 31, 2001) (1,196) (3,604)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 114,724 107,090
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,652,238 $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 Six Months Ended
6/30/02 6/30/01 6/30/02 6/30/01
------- ------- ------- -------
INTEREST INCOME:
Interest and fees on
loans and leases $ 21,134 $ 23,383 $ 42,107 $ 46,795
Interest on securities:
Taxable 3,188 3,600 6,382 6,720
Nontaxable 672 473 1,144 944
Interest on federal
funds sold 67 568 172 1,257
Interest on interest
bearing deposits in
other financial
institutions 37 43 140 91
-------- -------- -------- --------
TOTAL INTEREST INCOME 25,098 28,067 49,945 55,807
-------- -------- -------- --------
INTEREST EXPENSE:
Interest on deposits 8,024 12,159 16,413 24,635
Interest on short-term
borrowings 695 1,677 1,375 3,625
Interest on other
borrowings 2,096 2,100 4,305 4,154
-------- -------- -------- --------
TOTAL INTEREST EXPENSE 10,815 15,936 22,093 32,414
-------- -------- -------- --------
NET INTEREST INCOME 14,283 12,131 27,852 23,393
Provision for loan and
lease losses 616 1,123 1,601 1,844
-------- -------- -------- --------
NET INTEREST INCOME
AFTER PROVISION FOR
LOAN AND LEASE LOSSES 13,667 11,008 26,251 21,549
-------- -------- -------- --------
NONINTEREST INCOME:
Service charges and fees 2,217 1,554 4,150 3,015
Trust fees 904 778 1,736 1,544
Brokerage commissions 203 167 330 293
Insurance commissions 160 178 377 429
Securities gains, net 75 352 156 924
Gain (loss) on trading
account securities (214) 46 (242) (179)
Rental income on
operating leases 3,674 3,795 7,530 7,649
Gain on sale of loans 522 523 1,529 916
Impairment loss on mortgage
servicing rights (326) - (326) -
Other noninterest income 91 169 538 397
-------- -------- -------- --------
TOTAL NONINTEREST INCOME 7,306 7,562 15,778 14,988
-------- -------- -------- --------
NONINTEREST EXPENSES:
Salaries and employee
benefits 6,923 6,328 13,908 12,538
Occupancy 777 782 1,554 1,607
Furniture and equipment 831 778 1,649 1,584
Depreciation on equipment
under operating leases 2,879 2,874 5,909 5,792
Outside services 1,116 871 1,997 1,624
FDIC deposit insurance
assessment 53 52 106 103
Advertising 387 407 839 786
Goodwill amortization - 135 - 270
Core deposit and other
intangibles amortization 253 283 507 566
Other noninterst expenses 2,204 2,003 4,312 3,916
-------- -------- -------- --------
TOTAL NONINTEREST
EXPENSES 15,423 14,513 30,781 28,786
-------- -------- -------- --------
INCOME BEFORE INCOME
TAXES 5,550 4,057 11,248 7,751
Income taxes 1,639 1,243 3,524 2,481
-------- -------- -------- --------
NET INCOME $ 3,911 $ 2,814 $ 7,724 $ 5,270
======== ======== ======== ========
EARNINGS PER COMMON
SHARE-BASIC $ 0.40 $ 0.29 $ 0.79 $ 0.55
EARNINGS PER COMMON
SHARE-DILUTED $ 0.40 $ 0.29 $ 0.79 $ 0.54
CASH DIVIDENDS DECLARED
PER COMMON SHARE $ 0.10 $ 0.09 $ 0.20 $ 0.18
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 - - 5,270
Unrealized gain (loss) on
securities available for sale - - -
Reclassification adjustment for
gains realized in net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.18 per share - - (1,729)
Purchase of 26,634 treasury
shares - - -
------- ------- --------
Balance at June 30, 2001 $ 9,906 $18,812 $ 74,794
======= ======= ========
Balance at January 1, 2002 $ 9,906 $18,116 $ 79,107
Net income - - 7,724
Unrealized gain (loss) on
securities available for sale - - -
Unrealized gain (loss) on
derivatives arising during the
period - - -
Reclassification adjustment for
gains realized in net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.20 per share - - (1,965)
Purchase of 76,705 treasury
shares - - -
Issuance of 217,629 treasury
shares - (1,332) -
------- ------- --------
Balance at June 30, 2002 $ 9,906 $16,784 $ 84,866
======= ======= ========
Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock Total
------------- -------- -----
Balance at January 1, 2001 $ 1,301 $(5,126) $ 96,146
Net income - - 5,270
Unrealized gain (loss) on
securities available for sale 2,025 - 2,025
Reclassification adjustment for
gains realized in net income 924 - 924
Income taxes (1,003) - (1,003)
--------
Comprehensive income 7,216
Cash dividends declared:
Common, $.18 per share - - (1,729)
Purchase of 26,634 treasury
shares - (331) (331)
------- ------- --------
Balance at June 30, 2001 $ 3,247 $(5,457) $101,302
======= ======= ========
Balance at January 1, 2002 $ 3,565 $(3,604) $107,090
Net income - - 7,724
Unrealized gain (loss) on
securities available for sale 1,939 - 1,939
Unrealized gain (loss) on
derivatives arising during the
period (572) - (572)
Reclassification adjustment for
gains realized in net income (156) - (156)
Income taxes (412) - (412)
--------
Comprehensive income 8,523
Cash dividends declared:
Common, $.20 per share - - (1,965)
Purchase of 76,705 treasury
shares - (1,060) (1,060)
Issuance of 217,629 treasury
shares - 3,468 2,136
------- ------- --------
Balance at June 30, 2002 $ 4,364 $(1,196) $114,724
======= ======= ========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Six Months Ended
6/30/02 6/30/01
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,724 $ 5,270
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 8,021 8,214
Provision for loan and lease losses 1,601 1,844
Provision for income taxes in excess
of payments 2,971 1,889
Net amortization of premium on
securities 2,543 87
Securities gains, net (156) (924)
Decrease (increase) in trading account
securities 298 (1,475)
Loans originated for sale (70,779) (78,126)
Proceeds on sales of loans 83,825 52,418
Net gain on sales of loans (1,529) (916)
Decrease (increase) in accrued
interest receivable (708) 414
Increase in accrued interest payable 120 570
Other, net (530) (446)
--------- ---------
NET CASH PROVIDED (USED) BY OPERATING
ACTIVITIES 33,401 (11,181)
--------- ---------
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 4 959
Proceeds from the sale of
securities available for sale 20,889 29,090
Proceeds from the maturity of and
principal paydowns on securities
available for sale 84,178 25,894
Purchase of securities available
for sale (126,362) (99,382)
Net increase in loans and leases (21,567) (14,447)
Increase in assets under operating
leases (2,539) (6,241)
Capital expenditures (3,307) (2,555)
Proceeds on sale of OREO and other
repossessed assets 273 420
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (49,499) (66,262)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand
deposits and savings accounts (3,463) 33,379
Net increase in time deposit accounts 26,381 33,968
Net increase (decrease) in short-term
borrowings (16,813) 12,759
Proceeds from other borrowings 7,683 30,880
Repayments of other borrowings (15,151) (14,379)
Purchase of treasury stock (1,060) (331)
Proceeds from issuance of treasury
stock 1,823 -
Dividends (1,965) (1,729)
--------- ---------
NET CASH PROVIDED (USED) BY FINANCING
ACTIVITIES (2,565) 94,547
--------- ---------
Net decrease in cash and cash
equivalents (18,663) 17,104
Cash and cash equivalents at
beginning of year 93,550 84,687
--------- ---------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 74,887 $101,791
========= =========
Supplemental disclosures:
Cash paid for income/franchise taxes $ 332 $ 605
========= =========
Cash paid for interest $ 21,973 $ 31,844
========= =========
Securities held to maturity
transferred to securities available
for sale $ - $ 2,154
========= =========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The interim unaudited consolidated financial statements contained
herein should be read in conjunction with the audited
consolidated financial statements and accompanying notes to the
financial statements for the fiscal year ended December 31, 2001,
included in Heartland Financial USA, Inc.'s (the "Company") Form
10-K filed with the Securities and Exchange Commission on March
29, 2002. Accordingly, footnote disclosure which would
substantially duplicate the disclosure contained in the audited
consolidated financial statements has been omitted.
The financial information of the Company included herein is
prepared pursuant to the rules and regulations for reporting on
Form 10-Q. Such information reflects all adjustments (consisting
of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair presentation of results for the
interim periods. The results of the interim periods ended June
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 June 30, 2002
and 2001, are shown in the tables below:
Three Months Ended
6/30/02 6/30/01
------- -------
Net Income (000's) $ 3,911 $ 2,814
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,809 9,601
Assumed incremental common shares issued
upon exercise of stock options (000's) 64 94
------- -------
Weighted average common shares for
diluted earnings per share (000's) 9,873 9,695
======= =======
Six Months Ended
6/30/02 6/30/01
------- -------
Net Income (000's) $ 7,724 $ 5,270
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,770 9,601
Assumed incremental common shares issued
upon exercise of stock options (000's) 62 99
------- -------
Weighted average common shares for
diluted earnings per share (000's) 9,832 9,700
======= =======
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.
Core deposit intangibles are amortized over ten years on an
accelerated basis. Other intangible assets consist of the excess
purchase price of acquired branch net assets over their fair
value that will continue to be amortized over 15 years on the
straight-line basis in accordance with the provisions of FAS No.
72, "Accounting for Certain Acquisitions of Banking or Thrift
Institutions".
The Company reviews intangible assets whenever events or changes
in circumstances indicate that their carrying amounts may not be
recoverable. If impairment is indicated through an analysis of
undiscounted cash flows, the asset is written down to the extent
that the carrying value exceeds its fair value.
NOTE 3: "ADJUSTED" EARNINGS - FAS NO. 142 TRANSITIONAL DISCLOSURE
The table below reconciles reported earnings for the three and
six months periods ended June 30, 2001, to "adjusted" earnings,
which exclude goodwill amortization.
Three
Months
Ended
June 30,
2002 Three Months Ended June 30, 2001
--------- --------------------------------
Reported Reported Goodwill "Adjusted"
Earnings Earnings Amort. Earnings
--------- -------- -------- -----------
Income before income
taxes (000's) $ 5,550 $ 4,057 $ 135 $ 4,192
Income taxes (000's) 1,639 1,243 - 1,243
--------- -------- -------- -----------
Net income (000's) $ 3,911 $ 2,814 $ 135 $ 2,949
========= ======== ======== ===========
Earnings per common
share - basic $ .40 $ .29 $ .01 $ .31
========= ======== ======== ===========
Earnings per common
share - diluted $ .40 $ .29 $ .01 $ .30
========= ======== ======== ===========
Six
Months
Ended
June 30,
2002 Six Months Ended June 30, 2001
--------- --------------------------------
Reported Reported Goodwill "Adjusted"
Earnings Earnings Amort. Earnings
--------- -------- -------- -----------
Income before income
taxes (000's) $ 11,248 $ 7,751 $ 269 $ 8,020
Income taxes (000's) 3,524 2,481 - 2,481
--------- -------- -------- -----------
Net income (000's) $ 7,724 $ 5,270 $ 269 $ 5,539
========= ======== ======== ===========
Earnings per common
share - basic $ .79 $ .55 $ .03 $ .58
========= ======== ======== ===========
Earnings per common
share - diluted $ .79 $ .54 $ .03 $ .57
========= ======== ======== ===========
NOTE 4: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated
accumulated amortization at June 30, 2002, is presented in the
table below.
June 30, 2002
----------------------
Gross
Carrying Accumulated
Amount Amortization
-------- ------------
Intangible assets:
Core deposit premium (000's) $ 4,492 $ 1,808
Mortgage servicing rights (000's) 2,733 713
Other intangible assets (000's) 7,799 1,517
------- -------
Total (000's) $15,024 $ 4,038
======= =======
Unamortized intangible assets (000's) $10,986
=======
Projections of amortization expense for mortgage servicing rights
are based on existing asset balances and the existing interest
rate environment as of June 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 Other Total
--------- -------- ------- ---------
Six months ended
December 31, 2002
(000's) $ 247 $ 317 $ 260 $ 824
Year Ended December 31,
2003 (000's) $ 404 $ 486 $ 520 $ 1,410
2004 (000's) 353 405 520 1,278
2005 (000's) 353 324 520 1,197
2006 (000's) 353 243 520 1,116
2007 (000's) 353 162 520 1,035
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 the terrorist attacks that
occurred on September 11th, as well as any future threats
and attacks, and the response of the United States to any
such threats and attacks.
- The effects of, and changes in, federal, state and local
laws, regulations and policies affecting banking,
securities, insurance and monetary and financial matters.
- The effects of changes in interest rates (including the
effects of changes in the rate of prepayments of
Heartland's assets) and the policies of the Board of
Governors of the Federal Reserve System.
- The ability of Heartland to compete with other financial
institutions as effectively as Heartland currently
intends due to increases in competitive pressures in the
financial services sector.
- The inability of Heartland to obtain new customers and to
retain existing customers.
- The timely development and acceptance of products and
services, including products and services offered through
alternative delivery channels such as the Internet.
- Technological changes implemented by Heartland and by
other parties, including third party vendors, which may
be more difficult or more expensive than anticipated or
which may have unforeseen consequences to Heartland and
its customers.
- The ability of Heartland to develop and maintain secure
and reliable electronic systems.
- The ability of Heartland to retain key executives and
employees and the difficulty that Heartland may
experience in replacing key executives and employees in
an effective manner.
- Consumer spending and saving habits which may change in a
manner that affects Heartland's business adversely.
- Business combinations and the integration of acquired
businesses may be more difficult or expensive than
expected.
- The costs, effects and outcomes of existing or future
litigation.
- Changes in accounting policies and practices, as may be
adopted by state and federal regulatory agencies and the
Financial Accounting Standards Board.
- The ability of Heartland to manage the risks associated
with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be
placed on such statements. Additional information concerning
Heartland and its business, including other factors that could
materially affect Heartland's financial results, is included in
Heartland's filings with the Securities and Exchange Commission.
GENERAL
Heartland's results of operations depend primarily on net
interest income, which is the difference between interest income
from interest earning assets and interest expense on interest
bearing liabilities. Noninterest income, which includes service
charges, fees and gains on loans, rental income on operating
leases and trust income, also affects Heartland's results of
operations. Heartland's principal operating expenses, aside from
interest expense, consist of compensation and employee benefits,
occupancy and equipment costs, depreciation on equipment under
operating leases and provision for loan and lease losses.
Earnings for the second quarter of 2002 improved by $1.097
million or 39% over the same quarter the previous year, despite a
challenging economy. Net income totaled $3.911 million, or $.40
on a diluted earnings per common share basis, compared to $2.814
million, or $.29 on a diluted earnings per common share basis,
during the same quarter in 2001. Return on common equity was
13.98% and return on assets was .96% for the second quarter of
2002. For the same period in 2001, return on equity was 11.32%
and return on assets was .73%.
Contributing to the improved earnings during the second quarter
of 2002 was the $2.152 million or 18% growth in net interest
income due primarily to growth in earning assets. Average earning
assets went from $1.385 billion during the second quarter of 2001
to $1.462 billion during the same quarter in 2002, a change of
$77 million or 6%. Exclusive of securities gains and losses,
including trading account securities gains and losses, and a
valuation adjustment on mortgage servicing rights, noninterest
income experienced a $607 thousand or 8% 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 $9.507 million in unamortized goodwill. The
amount of amortization expense recorded during the second quarter
of 2001 on this goodwill was $135 thousand ($.01 on a diluted per
common share basis). For the six-month period ended on June 30,
2001, amortization expense on this goodwill was $269 thousand
($.03 on a diluted per common share basis).
For the six-month period ended on June 30, 2002, net income
increased $2.454 million or 47% when compared to the same period
in 2001. Net income totaled $7.724 million, or $.79 on a diluted
per common share basis, compared to $5.270 million, or $.54 on a
diluted per common share basis, during the same period in 2001.
Return on common equity was 14.08% and return on assets was .95%
for the six-month period in 2002 compared to 10.79% and .70%,
respectively, for the same period in 2001.
Again, the largest contributor to the improved earnings during
the first six months of 2002 was the $4.459 million or 19% growth
in net interest income. Average earning assets went from $1.353
billion during the first six months of 2001 to $1.460 billion
during the same period in 2002, a change of $107 million or 8%.
Exclusive of securities gains and losses, including trading
account securities gains and losses, and a valuation adjustment
on mortgage servicing rights, noninterest income experienced a
$1.947 million or 14% increase. 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 $1.995 million or 7% increase.
Total assets remained stable at June 30, 2002, increasing by less
than 1% since year-end 2001. Loans and leases were $1.115 billion
and deposits were $1.228 billion at the end of the second
quarter, an increase of 1% and 2%, respectively, since year-end
2001. Loan growth was slowed due to paydowns experienced in the
mortgage loan portfolio as customers continued to refinance their
mortgage loans into fifteen- and thirty-year fixed rate loans,
which Heartland usually sells into the secondary market. Some of
this slowed growth was offset by an increase in the commercial
loan portfolio, which grew $41.612 million or 6% during the first
six months.
NET INTEREST INCOME
Net interest margin, expressed as a percentage of average
earning assets, was 4.02% during the second quarter of 2002
compared to 3.86% for the first quarter of 2002 and 3.60%
for the second 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 8.21% during the second
quarter of 2001 to 6.99% during the second quarter of 2002,
a decline of 122 basis points. Interest expense as a
percentage of average earning assets went from 4.62% during
the second quarter of 2001 to 2.97% for the same quarter in
2002, a decline of 164 basis points.
For the three and six month periods ended June 30, 2002, interest
income decreased $3.0 million or 11% and $5.9 million or 11%,
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 and from 8.00% to 6.75% during the
second quarter. During the first and second 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 six month periods ended June 30, 2002, interest
expense decreased $5.1 million or 32% and $10.3 million or 32%,
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.
PROVISION FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses is established through a
provision charged to expense. The $616 thousand provision for
loan losses made during the second quarter of 2002, a decrease of
$507 thousand or 45% when compared to the same quarter in 2001,
was less than the previous year primarily in response to a
decline in nonperforming loans. On a six-month comparative basis,
the $1.6 million provision for loan losses during the first half
of 2002 was a decrease of $243 thousand or 13% when compared to
the same period in 2001. 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 decreased $256 thousand or 3% during the
quarter ended on June 30, 2002, compared to the same period in
2001. Exclusive of securities gains and losses, including trading
account securities gains and losses, and a valuation adjustment
on mortgage servicing rights, noninterest income experienced a
$607 thousand or 8% increase. The noninterest category reflecting
significant improvement during the quarter was service charges
and fees.
On a year-to-date comparison, total noninterest income grew $790
thousand or 5%. Exclusive of securities gains and losses,
including trading account securities gains and losses, and a
valuation adjustment on mortgage servicing rights, noninterest
income experienced a $1.9 million or 14% increase. In addition to
gains on sale of loans, the other noninterest income category to
reflect significant improvement during the first half of the year
was service charges and fees.
Service charges and fees increased $663 thousand or 43% during
the quarters under comparison and $1.1 million or 38% during the
six-month period under comparison. The addition of an overdraft
privilege feature to our checking account product line, along
with growth in these account balances, has 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 has sold into the
secondary market while retaining servicing has increased.
Heartland's servicing portfolio was $183.9 million at year-end
2000, $268.6 million at year-end 2001 and $327.7 million at June
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 remained constant at $522 thousand for the
quarters under comparison. For the six-month periods under
comparison, gains on sale of loans increased by $613 thousand or
67%. The volume of mortgage loans sold into the secondary market
during the first quarter of 2002 was greater than those sold
during the same period in 2001, primarily as a result of the low
rate environment during the first quarter of 2002 compared to the
same quarter 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 second quarter of 2002, securities gains were $277
thousand or 79% below the amount recorded during the same period
in 2001. The gains during the second quarter of 2001 resulted
primarily from sales within the equity securities portfolio. For
the six-month period ended on June 30, 2002, securities gains
were $768 thousand or 83% 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 $214 thousand during the second
quarter of 2002 compared to gains of $46 thousand during the same
quarter in 2001. On a six-month comparison, losses totaled $242
thousand during 2002 and $179 thousand during 2001. The increased
losses primarily resulted from the decline in the stock market.
During the second quarter of 2002, an impairment loss on mortgage
servicing rights was recorded in the amount of $326 thousand. The
valuation of Heartland's mortgage servicing rights declined since
year-end as a result of the further drop in mortgage loan
interest rates.
NONINTEREST EXPENSE
Total noninterest expense was held to an increase of $910
thousand or 6% during the second quarter of 2002 when compared to
the same quarter in 2001. For the six-month period ended on June
30, 2002, noninterest expense increased $2.0 million or 7%.
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 $595 thousand or 9% for the
quarters under comparison. On a year-to-date basis, salaries and
employee benefits grew $1.4 million or 11%. This category made
up more than 65% 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 571 at June 30, 2001, to 584 at June 30, 2002.
Fees for outside services increased by $245 thousand or 28% for
the quarters under comparison and $373 thousand or 23% for the
six-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 $201 thousand or 10% for the
quarters under comparison and $396 thousand or 10% for the six-
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 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 amount
of amortization expense recorded during the second quarter of
2001 on this goodwill was $135 thousand. For the six-month period
ended on June 30, 2001, amortization expense on this goodwill was
$269 thousand.
INCOME TAX EXPENSE
Income tax expense for the second quarter of 2002 increased $396
thousand or 32% when compared to the same period in 2001. On a
six-month comparative basis, income tax expense increased $1.0
million or 42%. These increases reflected the continued growth in
pre-tax earnings.
Heartland's effective tax rate decreased to 29.53% during the
second quarter of 2002 compared to 30.64% for the second quarter
of 2001. For the six-month periods ended June 30, 2002 and 2001,
the effective tax rate was 31.33% and 32.01%, 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 six 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 $9.1 million, an increase of 1%
since year-end 2001. Loan growth was slowed due to paydowns
experienced in the mortgage loan portfolio. The residential
mortgage loan portfolio experienced a decline of $30.7 million or
18% 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 $327.7 million at June
30, 2002.
The decline in the mortgage loan portfolio was partially offset
by an increase in the commercial and commercial real estate loan
portfolio, which grew $41.6 million or 6% during the first half
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.
The table below presents the composition of the loan portfolio as
of June 30, 2002, and December 31, 2001.
LOAN PORTFOLIO
(Dollars in thousands)
June 30, December 31,
2002 2001
Amount Percent Amount Percent
------ ------- ------ -------
Commercial and commercial
real estate $ 693,091 61.97% $ 651,479 58.73%
Residential mortgage 138,198 12.36 168,912 15.23
Agricultural and
agricultural real estate 150,136 13.42 145,460 13.11
Consumer 123,098 11.00 127,874 11.53
Lease financing, net 13,958 1.25 15,570 1.40
---------- ------- ---------- -------
Gross loans and leases $1,118,481 100.00% $1,109,295 100.00%
======= =======
Unearned discount (2,702) (3,457)
Deferred loan fees (740) (633)
---------- ----------
Total loans and leases 1,115,039 1,105,205
Allowance for loan and
lease losses (15,409) (14,660)
---------- ----------
Loans and leases, net $1,099,630 $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 June 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 are
various signs of emerging strength, it is not certain that this
strength will be sustainable. Additionally, the recent decline in
equity prices may negatively impact consumer confidence. 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 $749
thousand or 5% during the first six months of 2002. The allowance
for loan and lease losses at June 30, 2002, was 1.38% of loans
and 202% of nonperforming loans, compared to 1.33% of loans and
180% of nonperforming loans, at year-end 2001. Nonperforming
loans decreased to .69% of total loans and leases at June 30,
2002, compared to .73% of total loans and leases at December 31,
2001. This decrease was primarily the result of one large credit
that was partially paid-off, which brought the remaining balance
to a serviceable level.
During the first half of 2002, Heartland recorded net charge offs
of $852 thousand compared to $761 thousand for the same period in
2001. Citizens Finance Co., Heartland's consumer finance
subsidiary, was responsible for $493 thousand or 58% of the net
charge-offs during the first six months of 2002 and $373 thousand
or 49% 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 4.23% for the first half of 2002 compared
to 3.19% for the first half of 2001. Loans with payments past due
for more than thirty days decreased from 5.30% of gross loans at
December 31, 2001, to 5.28% at June 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 21% of total assets at June 30,
2002, as compared to 20% at December 31, 2001. The amount of
securities held in Heartland's portfolio was increased during the
first half of 2002 as deposit growth outpaced growth in the loan
portfolio.
During the first half 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. During the first half of 2002, 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 securities portfolio by
major category as of June 30, 2002, and December 31, 2001.
SECURITIES PORTFOLIO
(Dollars in thousands)
June 30, December 31,
2002 2001
Amount Percent Amount Percent
------ ------- ------ -------
U.S. Treasury securities $ 498 .14% $ 498 .15%
U.S. government agencies 116,975 33.89 78,736 24.33
Mortgage-backed securities 139,687 40.47 183,661 56.74
States and political
subdivisions 58,721 17.01 30,948 9.56
Other securities 29,296 8.49 29,846 9.22
-------- ------- -------- -------
Total securities $345,177 100.00% $323,689 100.00%
======== ======= ======== =======
DEPOSITS AND BORROWED FUNDS
Total deposits experienced an increase of $22.9 million or 2%
during the first half of 2002. Increases in total deposits
occurred at Galena State Bank, Riverside Community Bank and
Wisconsin Community Bank. The demand deposit category experienced
a decrease during the six months while savings and certificate of
deposit account balances increased. Demand deposit accounts
balances declined $7.0 million or 4% as all the Heartland bank
subsidiaries experienced a decrease in these balances since year-
end except for Galena State Bank and Riverside Community Bank.
With the volatility in the stock market, customers have elected
to keep a larger portion of their funds invested in savings and
certificate of deposit products at banks. Savings deposit account
balances grew by $3.5 million or 1% while certificate of deposit
account balances grew by $26.4 million or 5% during the first six
months of 2002.
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 six month period ended June 30, 2002, the amount of
short-term borrowings had decreased $16.8 million or 10%.
Repurchase agreement balances made up $6.5 million or 39% of this
change and treasury tax and loan note options made up $4.0
million or 24% of this change. All of the bank subsidiaries
provide repurchase agreements to their customers as a cash
management tool, sweeping excess funds from demand deposit
accounts into these agreements. This source of funding does not
increase the bank's reserve requirements, nor does it create an
expense relating to FDIC premiums on deposits. Although the
aggregate balance of repurchase agreements is subject to
variation, the account relationships represented by these
balances are principally local. With the continued decline in
interest rates during the last half of 2001, some of these
repurchase agreement customers elected to invest a portion of
their excess funds in higher-yielding products.
Also included in short-term borrowings are the credit lines
Heartland entered into with two unaffiliated banks. Under the
unsecured credit lines, Heartland may borrow up to $50.0 million.
At June 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 $136.3 million on
June 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 June 30, 2002, and December
31, 2001, were $77.0 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. 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.
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. As of
March 31, 2002, 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)
June 30, December 31,
2002 2001
Amount Ratio Amount Ratio
------ ----- ------ -----
Risk-Based Capital Ratios:(1)
Tier 1 capital $ 133,075 10.50% $ 121,112 9.71%
Tier 1 capital minimum
requirement 50,694 4.00% 49,891 4.00%
---------- ------ ---------- ------
Excess $ 82,381 6.50% $ 71,221 5.71%
========== ====== ========== ======
Total capital $ 148,483 11.72% $ 135,770 10.89%
Total capital minimum
requirement 101,388 8.00% 99,782 8.00%
---------- ------ ---------- ------
Excess $ 47,095 3.72% $ 35,988 2.89%
========== ====== ========== ======
Total risk-adjusted
assets $1,267,352 $1,247,274
========== ==========
Leverage Capital Ratios:(2)
Tier 1 capital $ 133,075 8.24% $ 121,112 7.53%
Tier 1 capital minimum
requirement(3) 64,601 4.00% 64,336 4.00%
---------- ------ ---------- ------
Excess $ 68,474 4.24% $ 56,776 3.53%
========== ====== ========== ======
Average adjusted assets
(less goodwill) $1,615,032 $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 June 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
$3.8 million to be made no later than February 29, 2004, to those
who remain employed with the subsidiary on December 31, 2003.
Additionally, each employee is bound by a confidentiality and non-
competition agreement. One-third of the payment will be made in
cash and the remaining two-thirds in shares of Heartland's common
stock. The obligation is being accrued over the performance
period.
On 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 June 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 June 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. All of these securities continued to qualify
as Tier 1 capital for regulatory purposes as of June 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 January 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 fall. A reduction in overall costs on
this project will result from tax credits and other incentives
made available on the project as it includes the rehabilitation
of two historical structures and the creation of new jobs.
Heartland continues to explore other opportunities to expand its
umbrella of independent community banks through mergers and
acquisitions as well as de novo and branching opportunities. As
evidenced by the expansion into New Mexico, Heartland is seeking
to operate in high growth areas, even if they are outside of its
traditional Midwest market areas. Future expenditures relating to
these efforts are not estimable at this time.
LIQUIDITY
Liquidity measures the ability of Heartland to meet maturing
obligations and its existing commitments, to withstand
fluctuations in deposit levels, to fund its operations and to
provide for customers' credit needs. The liquidity of Heartland
principally depends on cash flows from operating activities,
investment in and maturity of assets, changes in balances of
deposits and borrowings and its ability to borrow funds in the
money or capital markets.
Net cash outflows from investing activities decreased $16.8
million during the first six months of 2002 compared to the same
period in 2001. The cash used by a net increase in loans and
leases was $21.6 million during the first six months of 2002
compared to $14.4 million during the same period in 2001, a $7.1
million change, driven primarily by the growth in the commercial
loans portfolio. During the first six months of 2002, proceeds
from the sale of securities decreased $8.2 million compared to
the same period in 2001. During the first half of 2001,
management elected to shift a portion of its securities portfolio
into mortgage-backed securities from U.S. government agencies.
Proceeds from the maturity of and principal paydowns on
securities increased $58.3 million during the first half of 2002
when compared to the same period in 2001, primarily as a result
of increased paydowns on mortgage-backed securities. The
increased paydowns within the securities portfolio resulted in
additional purchases of securities. Purchases of securities
increased $27.0 million for the periods under comparison.
Financing activities used net cash of $2.6 million during the first
six months of 2002. Conversely, during the first six months of
2001, financing activities provided net cash of $94.5 million. A
net increase in deposit accounts provided cash of $22.9 million
during the first six months of 2002 compared to $67.3 million
during the same period in 2001. Short-term borrowings used cash of
$16.8 million in 2002 and provided cash of $12.8 million in 2001.
As deposit balances increased and loan growth slowed, Heartland did
not find it necessary to increase its other borrowings as much
during the first half of 2002 as it had during the same period in
2001. The proceeds from other borrowings had declined $23.2
million.
Total cash inflows from operating activities increased $44.6
million for the first six months of 2002 compared to the same
period in 2001. A large portion of this change resulted from real
estate mortgage loan activity as customers continued to refinance
their mortgage loans into fifteen- and thirty-year fixed rate
loans, which Heartland usually sells into the secondary market.
Loan sales activity provided cash of $11.5 million during 2002
compared to using cash of $26.6 million during the same period in
2001. Management of investing and financing activities, and
market conditions, determine the level and the stability of net
interest cash flows. Management attempts to mitigate the impact
of changes in market interest rates to the extent possible, so
that balance sheet growth is the principal determinant of growth
in net interest cash flows.
In the event of short-term liquidity needs, the bank subsidiaries
may purchase federal funds from each other or from correspondent
banks and may also borrow from the Federal Reserve Bank.
Additionally, the subsidiary banks' FHLB memberships give them
the ability to borrow funds for short- and long-term purposes
under a variety of programs.
Heartland's revolving credit agreements, as of June 30, 2002,
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 June 30, 2002, Heartland was in compliance with
the covenants contained in these credit agreements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
(Dollars in thousands)
Market risk is the risk of loss arising from adverse changes in
market prices and rates. Heartland's market risk is comprised
primarily of interest rate risk resulting from its core banking
activities of lending and deposit gathering. Interest rate risk
measures the impact on earnings from changes in interest rates
and the effect on current fair market values of Heartland's
assets, liabilities and off-balance sheet contracts. The
objective is to measure this risk and manage the balance sheet to
avoid unacceptable potential for economic loss. Management
continually develops and applies strategies to mitigate market
risk. Exposure to market risk is reviewed on a regular basis by
the asset/liability committees at the banks and, on a
consolidated basis, by the Heartland board of directors.
Management does not believe that Heartland's primary market risk
exposures and how those exposures have been managed to-date in
2002 changed significantly when compared to 2001.
Derivative financial instruments include futures, forwards,
interest rate swaps, option contracts and other financial
instruments with similar characteristics. Heartland's use of
derivative financial instruments relates to the management of the
risk that changes in interest rates will affect its future
interest payments. Heartland utilizes an interest rate swap
contract to effectively convert a portion of its variable rate
interest rate debt to fixed interest rate debt. Under the
interest rate swap contract, Heartland agrees to pay an amount
equal to a fixed rate of interest times a notional principal
amount, and to receive in return an amount equal to a specified
variable rate of interest times the same notional principal
amount. The notional amounts are not exchanged and payments under
the interest rate swap contract are made monthly. Heartland is
exposed to credit-related losses in the event of nonperformance
by the counterparty to the swap contract, which has been
minimized by entering into the contract with a large, stable
financial institution. As of June 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 $321 thousand on of June 30, 2002.
PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Company or its subsidiaries is a party other than ordinary
routine litigation incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of stockholders was held on May 22,
2002. At the meeting, James F. Conlan and Thomas L. Flynn were
elected to serve as Class III directors (term expires in 2005).
Continuing as Class I director (term expires in 2003) is Lynn B.
Fuller. Continuing as Class II directors (term expires in 2002)
are Mark C. Falb, John K. Schmidt and Robert Woodward. The
stockholders approved the appointment of KPMG LLP as the
Company's independent public accountants for the year ending
December 31, 2002.
There were 9,828,333 issued and outstanding shares of common
stock entitled to vote at the annual meeting. The voting results
on the above described items were as follows:
For Withheld
--- --------
Election of Directors
James F. Conlan 8,418,819 165,641
Thomas L. Flynn 8,418,719 165,741
Broker
For Against Abstain Non-Votes
--- ------- ------- ---------
Appointment of
KPMG LLP 8,523,924 50,793 9,743 0
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 Wells Fargo Bank, National Association, dated as of
June 27, 2002.
10.2 Fourth Amendment to Second Amended and Restated Credit
Agreement between Heartland Financial USA, Inc. and The
Northern Trust Company dated as of June 29, 2002.
10.3 See Exhibit 10.2 for substantially the same form of a
Fourth Amendment to Credit Agreement between Heartland
Financial USA, Inc. and Harris Trust and Savings Bank
dated as of June 29, 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 June 11, 2002, the Company filed a report on Form 8-K stating
under Item 5 that the Company declared a dividend of one
preferred share purchase right for each outstanding share of
common stock of the Company payable on June 26, 2002, to the
stockholders of record on June 24, 2002.
On July 19, 2002, the Company filed a report on Form 8-K stating
under Item 5 that the Company issued a press release announcing
its earnings for the quarter ended on June 30, 2002.
On July 30, 2002, the Company filed a report on Form 8-K stating
under Item 5 that the Company authorized management to acquire
and hold in treasury up to $4,000,000 of the Company's common
stock, par value $1.00 per share.
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: August 14, 2002