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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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)
Securities registered pursuant to Section 12(b) of the Act:
Trust Preferred Securities
(issued by Heartland Financial Capital Trust I)
(Title of Exchange Class)
American Stock Exchange
(Name of Each Exchange on which Registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $1.00 par value
Preferred Share Purchase Rights
(Title of Class)
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 if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of Registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
The index to exhibits follows the signature page.
As of June 28, 2002, the Registrant had issued and outstanding
9,820,676 shares of the Registrant's common stock. Indicate by
check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
The aggregate market value of the voting and non-voting common
equity held by non-affiliates of the Registrant, based on the
last sales price quoted on the over-the-counter market bulletin
board on June 28, 2002, the last business day of the registrant's
most recently completed second fiscal quarter, was approximately
$107,405,670.* Such figures include 1,742,015 shares of the
Registrant's Common Stock held in a fiduciary capacity by the
Trust Department of the Dubuque Bank and Trust Company, a wholly-
owned subsidiary of the Registrant.
* Based on the last sales price of the Registrant's common stock
on June 28, 2002, and reports of beneficial ownership filed by
directors and executive officers of Registrant and by beneficial
owners of more than 5% of the outstanding shares of common stock
of Registrant; however, such determination of shares owned by
affiliates does not constitute an admission of affiliate status
or beneficial interest in shares of Registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2003 Annual Meeting of
Stockholders are incorporated by reference into Part III.
HEARTLAND FINANCIAL USA, INC.
Form 10-K Annual Report
Table of Contents
Part I
Item 1. Business
A. General Description
B. Market Areas
C. Competition
D. Employees
E. Internet Access
F. Accounting Standards
G. Supervision and Regulation
H. Governmental Monetary Policy and Economic Conditions
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of
Security Holders
Part II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure
Part III
Item 10. Directors and Executive Officers of the
Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners
and Management
Item 13. Certain Relationships and Related Transactions
Item 14. Controls and Procedures
Part IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K
PART I.
ITEM 1.
BUSINESS
A. GENERAL DESCRIPTION
Heartland Financial USA, Inc. ("Heartland"), reincorporated in
the state of Delaware in 1993, is a multi-bank holding company
registered under the Bank Holding Company Act of 1956, as amended
("BHCA"). Heartland has six bank subsidiaries in the states of
Iowa, Wisconsin, Illinois and New Mexico (collectively, the "Bank
Subsidiaries"). All six Bank Subsidiaries are members of the
Federal Deposit Insurance Corporation ("FDIC"). Dubuque Bank and
Trust Company, Dubuque, Iowa, and First Community Bank, Keokuk,
Iowa are chartered under the laws of the State of Iowa. Dubuque
Bank and Trust Company has two wholly-owned subsidiaries: DB&T
Insurance, Inc., a multi-line insurance agency and DB&T Community
Development Corp., majority owner of a senior housing project.
Galena State Bank and Trust Company, Galena, Illinois, and
Riverside Community Bank, Rockford, Illinois, are chartered under
the laws of the State of Illinois. Wisconsin Community Bank,
Cottage Grove, Wisconsin, is chartered under the laws of the
State of Wisconsin and has one subsidiary, DBT Investment
Corporation, an investment management company. New Mexico Bank &
Trust, Albuquerque, New Mexico, is chartered under the laws of
the state of New Mexico. The Bank Subsidiaries operate 34 banking
locations in Iowa, Illinois, Wisconsin and New Mexico. Heartland
has six non-bank subsidiaries. Citizens Finance Co. is a consumer
finance company. ULTEA, Inc. is a fleet leasing company
headquartered in Madison, Wisconsin. Heartland Capital Trust I,
Heartland Statutory Trust II and Heartland Capital Trust II are
special purpose trust subsidiaries of Heartland formed for the
purpose of the offering of cumulative capital securities. All of
Heartland's subsidiaries are wholly-owned, except for New Mexico
Bank & Trust, of which Heartland owned 86% of the capital stock
on December 31, 2002.
The Bank Subsidiaries provide full service retail banking within
Dubuque and Lee Counties in Iowa; within Jo Daviess, Hancock and
Winnebago Counties in Illinois; within Dane, Green, Sheboygan and
Brown Counties in Wisconsin; and Bernalillo, Curry and Santa Fe
Counties in New Mexico. Deposit products include checking and
other demand deposit accounts, NOW accounts, savings accounts,
money market accounts, certificates of deposit, individual
retirement accounts and other time deposits. The deposits in the
Bank Subsidiaries are insured by the FDIC to the full extent
permitted by law. Loans include commercial and industrial,
agricultural, real estate mortgage, consumer, home equity, credit
cards and lines of credit. Other products and services include
VISA debit cards, automatic teller machines, safe deposit boxes
and trust services. The principal service of the Bank
Subsidiaries consists of making loans to businesses and
individuals. These loans are made at the offices of the Bank
Subsidiaries. The Bank Subsidiaries also engage in activities
that are closely related to banking, including investment
brokerage.
Operating Strategy
Heartland's primary operating strategy is to differentiate the
company as a growing consortium of strong community banks through
community involvement, active boards of directors, local
presidents and local decision-making. As part of the operating
strategy, all directors, officers and employees are encouraged to
maintain a strong ownership interest in Heartland. As of December
31, 2002, these individuals owned approximately 45% of
Heartland's outstanding common stock.
Management believes that the personal and professional service
that is offered to customers provides an appealing alternative to
the "megabanks" that have resulted from the recent mergers and
acquisitions in the financial services industry. While Heartland
employs a community banking philosophy, management believes that
Heartland's size, combined with the full line of financial
products and services, is sufficient to effectively compete in
the respective market areas. At the same time, management
realizes that to remain price competitive Heartland must manage
expense levels by centralizing the back office support functions
to gain economies of scale. Each of the subsidiaries of Heartland
operates under the direction of its own board of directors,
although Heartland has standard operating policies regarding
asset/liability management, liquidity management, investment
management, lending policies and deposit structure management.
In order to accomplish these strategic objectives, management has
focused on improving the performance of the existing subsidiaries
while simultaneously pursuing an acquisition and expansion
strategy. With respect to the existing subsidiaries, Heartland
has primarily focused on the following strategies:
- Improving the bank subsidiaries' funding costs by
reducing the levels of higher-cost certificates of
deposit, increasing the percentage of lower-cost
transaction accounts such as checking, savings and money
market accounts, emphasizing relationship banking and
capitalizing on cross-selling opportunities;
- Emphasizing the expansion of non-traditional sources of
income, including trust and investment services, consumer
finance and vehicle leasing and fleet management;
- Centralizing back office support functions to enable the
Bank Subsidiaries to operate as efficiently as possible;
and
- Continually evaluating new technology and acquiring it
when the expected return justifies the cost.
Acquisition and Expansion Strategy
Heartland's strategy is to diversify both its market area and
asset base while increasing profitability through acquisitions
and through expansion of its current subsidiaries. The goal is to
expand through the acquisition of established financial services
organizations, primarily commercial banks or thrifts, when
suitable candidates can be identified and acceptable business
terms negotiated. Heartland has also formed de novo banking
institutions in market areas where management has identified
market potential and management with banking expertise and
philosophy similar to Heartland's. In evaluating expansion and
acquisition opportunities, Heartland has focused on geographic
areas in the Midwest or Southwest with growth potential. In this
regard, Heartland and a group of investors recently announced
that they intend to file an application with the Arizona
Department of Banking to charter a new bank to be headquartered
in the East Valley of Phoenix.
Heartland continually seeks and evaluates opportunities to
establish branches, loan production offices or other business
facilities as a means of expanding its presence in current or new
market areas. Heartland also looks for opportunities beyond the
Midwest and beyond the categories of community banks and thrifts
when the Heartland board of directors and management believes
that the opportunity will provide a desirable strategic fit
without posing undue risk. Heartland does not currently have any
other definitive understandings or agreements for any
acquisitions material to Heartland. However, Heartland will
continue to look for further expansion opportunities.
Lending Activities
General
The Bank Subsidiaries provide a range of commercial and retail
lending services to corporations, partnerships and individuals.
These credit activities include agricultural, commercial,
residential real estate and installment loans, as well as loan
participations and lines of credit.
The Bank Subsidiaries aggressively market their services to
qualified lending customers. Lending officers actively solicit
the business of new companies entering their market areas as well
as long-standing members of the Bank Subsidiaries' respective
business communities. Through professional service and
competitive pricing, the Bank Subsidiaries have been successful
in attracting new lending customers. Heartland also actively
pursues consumer lending opportunities. With convenient
locations, advertising and customer communications, the Bank
Subsidiaries have been successful in capitalizing on the credit
needs of their market areas.
Commercial Loans
The Bank Subsidiaries have a strong commercial loan base and
Dubuque Bank and Trust Company, in particular, continues to be a
premier commercial lender in the tri-state area of northeast
Iowa, northwest Illinois and southwest Wisconsin. The Bank
Subsidiaries' areas of emphasis include, but are not limited to,
loans to wholesalers, hotel and real estate developers,
manufacturers, building contractors, business services companies
and retailers. The Bank Subsidiaries provide a wide range of
business loans, including lines of credit for working capital and
operational purposes and term loans for the acquisition of
equipment and real estate. Loans may be made on an unsecured
basis where warranted by the overall financial condition of the
borrower. Terms of commercial business loans generally range from
one to five years.
Dubuque Bank and Trust Company and Wisconsin Community Bank have
also generated loans that are guaranteed by the U.S. Small
Business Administration, and these entities have been certified
as Preferred Lenders by the agency. Management believes that
making these guaranteed loans helps its local communities as well
as provides Heartland with a source of income and solid future
lending relationships as such businesses grow and prosper.
Dubuque Bank and Trust Company is also currently one of the state
of Iowa's top lenders in the "Linked Investment for Tomorrow"
program. This state-sponsored program offers interest rate
reductions to businesses opened by minorities and those in rural
areas.
The primary repayment risk for commercial real estate loans is
the failure of the business due to economic events or
governmental regulations outside of the control of the borrower
or lender that negatively impact the future cash flow and market
values of the affected properties. In most cases, the Bank
Subsidiaries have collateralized these loans and/or taken
personal guarantees to help assure repayment.
The Bank Subsidiaries' commercial loans and leases are primarily
made based on the identified cash flow of the borrower and
secondarily on the underlying collateral provided by the
borrower. Credit support provided by the borrower for most of
these loans and leases and the probability of repayment is based
on the liquidation of the pledged collateral and enforcement of a
personal guarantee, if any exists. The primary repayment risks of
commercial loans and leases are that the cash flows of the
borrower may be unpredictable, and the collateral securing these
loans may fluctuate in value.
As the credit portfolios of the Bank Subsidiaries have continued
to grow, several changes have been made in their lending
departments resulting in an overall increase in these
departments' skill levels. Commercial lenders interact with their
respective Boards of Directors each month. Heartland also
utilizes an internal loan review function to analyze credits of
the Bank Subsidiaries and to provide periodic reports to the
respective boards of directors. Management has attempted to
identify problem loans at an early date and to aggressively seek
a resolution of these situations.
Agricultural Loans
Agricultural loans are emphasized by Dubuque Bank and Trust
Company, Wisconsin Community Bank's Monroe banking center and New
Mexico Bank and Trust's Clovis banking offices due to their
concentration of customers in rural markets. Dubuque Bank and
Trust Company maintains its status as one of the largest
agricultural lenders in the state of Iowa. Agricultural loans
remain balanced, however, in proportion to the rest of
Heartland's loan portfolio, constituting approximately 13% of the
total loan portfolio at December 31, 2002. In connection with
their agricultural lending, all of the Bank Subsidiaries have
remained close to their traditional geographic market areas. The
majority of the outstanding agricultural operating and real
estate loans are within 60 miles of their main or branch offices.
Agricultural loans, many of which are secured by crops, machinery
and real estate, are provided to finance capital improvements and
farm operations as well as acquisitions of livestock and
machinery. The ability of the borrower to repay may be affected
by many factors outside of the borrower's control including
adverse weather conditions, loss of livestock due to disease or
other factors, declines in market prices for agricultural
products and the impact of government regulations. Payments on
agricultural loans are ultimately dependent on the profitable
operation or management of the farm property securing the loan.
The agricultural loan departments work closely with all of their
customers, including companies and individual farmers, and review
the preparation of budgets and cash flow projections for the
ensuing crop year. These budgets and cash flow projections are
monitored closely during the year and reviewed with the customers
at least once a year. In addition, the Bank Subsidiaries work
closely with governmental agencies, including the Farmers Home
Administration, to assist agricultural customers in obtaining
credit enhancement products such as loan guarantees.
Real Estate Mortgage Loans
Mortgage lending has been a focal point of the Bank Subsidiaries
as each of them continues to build real estate lending business.
As long-term rates decreased during 2002 and 2001, customers
refinanced their mortgage loans into fifteen- and thirty-year
fixed rate loans, which Heartland usually sells into the
secondary market. Conversely, during 2000, customers elected to
take adjustable-rate mortgage loans, which Heartland elected to
retain in its loan portfolio, during this period of increasing
long-term rates. Management believes that the retention of
mortgage servicing provides the Bank Subsidiaries with a
relatively steady source of fee income as compared to fees
generated solely from mortgage origination operations. Moreover,
the retention of such servicing rights allows each of the Bank
Subsidiaries to continue to have regular contact with mortgage
customers.
Consumer Lending
The Bank Subsidiaries' consumer lending departments provide all
types of consumer loans including motor vehicle, home
improvement, home equity, student loans, credit cards, signature
loans and small personal credit lines. Consumer loans typically
have shorter terms and lower balances with higher yields as
compared to one- to four-family residential mortgage loans, but
generally carry higher risks of default. Consumer loan
collections are dependent on the borrower's continuing financial
stability, and thus are more likely to be affected by adverse
personal circumstances.
Consumer loan demand is also serviced through Citizens Finance
Co., which currently serves the consumer credit needs of almost
5,300 customers in the three state area of Iowa, Illinois and
Wisconsin from its Dubuque, Iowa, Madison and Appleton,
Wisconsin, and Loves Park, Illinois offices. Citizens Finance Co.
typically lends to borrowers with past credit problems or limited
credit histories. Heartland expects to incur a higher level of
credit losses on Citizens Finance Co. loans as compared to other
consumer loans.
Trust Departments
The trust departments for Dubuque Bank and Trust Company, Galena
State Bank and Trust Company, First Community Bank and Wisconsin
Community Bank have been providing trust services to their
respective communities for many years. Trust personnel from
Dubuque Bank and Trust also work with Riverside Community Bank
and New Mexico Bank & Trust personnel to provide trust services
to all Bank Subsidiaries. Currently, the Bank Subsidiaries have
over $651 million of consolidated assets under management and
provide a full complement of trust and investment services for
individuals and corporations.
The trust department of Dubuque Bank and Trust Company is
nationally recognized as a leading provider of socially
responsible investment services and manages investment portfolios
for religious and other non-profit organizations located
throughout the United States. The Bank Subsidiaries' trust
departments are also active in the management of employee benefit
and retirement plans in their market areas. The Bank Subsidiaries
have targeted their trust departments as primary areas for future
growth.
Brokerage and Other Services
Heartland contracts with a third-party vendor, Invest Financial
Corporation, to operate independent securities offices at Dubuque
Bank and Trust Company, Galena State Bank and Trust Company,
Riverside Community Bank and First Community Bank. Invest
Financial Corporation offers full-service stock and bond trading,
direct investments, annuities and mutual funds.
DB&T Insurance has continued to grow its personal insurance lines
and the number of independent insurance companies it represents.
DB&T Insurance is a multi-line insurance agency in the Dubuque
area and offers a complete array of vehicle, property and
casualty, life and disability insurance and tax-free annuities.
B. MARKET AREAS
Dubuque Bank and Trust Company is located in Dubuque County,
Iowa, which encompasses the city of Dubuque and a number of
surrounding rural communities. The city of Dubuque is located in
northeastern Iowa, on the Mississippi River, approximately 175
miles west of Chicago, Illinois, and approximately 200 miles
northeast of Des Moines, Iowa. It is strategically situated at
the intersection of the state borders of Iowa, Illinois and
Wisconsin. Based upon the results of the 2000 census, the city of
Dubuque had a total population of approximately 58,000.
In addition to its main banking office, Dubuque Bank and Trust
Company has seven branch offices, all of which are located in the
Dubuque County area. As a subsidiary of Dubuque Bank and Trust
Company, DB&T Insurance has substantially the same market area as
the parent organization. Citizens Finance Co. also operates
within this market area, and, in addition, offices were opened in
Madison, Wisconsin, during June, 1996, Appleton, Wisconsin,
during August, 1998 and Loves Park, Illinois during February,
1999.
Galena State Bank and Trust Company is located in Galena,
Illinois, which is less than five miles from the Mississippi
River, approximately 20 miles east of Dubuque and 155 miles west
of Chicago. Galena State Bank and Trust Company also has an
office in Stockton, Illinois, and as such, services customers in
Jo Daviess County, Illinois. Based on the 2000 census, the county
had a population of approximately 22,000.
First Community Bank's main office is in Keokuk, Iowa, which is
located in the southeast corner of Iowa near the borders of Iowa,
Missouri and Illinois. Due to its location, First Community Bank
serves customers in the tri-county region of Lee County, Iowa,
Hancock County, Illinois and Clark County, Missouri. Lee, Hancock
and Clark Counties have populations of approximately 38,000,
20,000 and 7,400, respectively. First Community Bank has one
branch office in Keokuk and another branch in the city of
Carthage in Hancock County, Illinois. Keokuk is an industrial
community with a population of approximately 11,000.
Riverside Community Bank is located on the northeast edge of
Rockford, Illinois, which is approximately 75 miles west of
Chicago in Winnebago County. In addition to its main banking
office, Riverside Community Bank has two branch offices, all of
which are located in the Winnebago County area. Based on the
2000 census, the county had a population of 278,000 and the city
of Rockford had a population of 150,000.
Wisconsin Community Bank operates one office from its location in
Cottage Grove, Wisconsin, which is approximately 10 miles east of
Madison in Dane County. A branch office was opened in Middleton,
a suburb of Madison, in February, 1998. Another branch was opened
in Fitchburg, a suburb of Madison, in March, 2003. According to
the 2000 census, the county had a population of 427,000, and the
village of Cottage Grove had a population of 3,800. Wisconsin
Business Bank, a branch of Wisconsin Community Bank, opened three
offices in Sheboygan, DePere and Eau Claire, Wisconsin during
1999. The Eau Claire office was subsequently sold in the fourth
quarter of 2002. The Sheboygan and Depere facilities are located
in the northeastern Wisconsin counties of Sheboygan and Brown
with populations of 113,000 and 227,000, respectively, according
to the 2000 census. Wisconsin Community Bank also acquired the
Bank One Monroe Wisconsin banking center in July of 1999. The
city of Monroe, which is approximately 50 miles southwest of
Madison, is located in Green County in south central Wisconsin.
According to the 2000 census, Monroe had a population of 11,000,
and Green County had a population of 34,000.
New Mexico Bank & Trust operates six offices within Albuquerque,
New Mexico in Bernalillo County. Based upon the 2000 census, the
county had a population of 557,000, and the city had a population
of 449,000. New Mexico Bank & Trust also operates five locations
in the New Mexico communities of Clovis, Portales and Melrose,
all located in Curry County. Clovis is located in east central
New Mexico, approximately 220 miles from Albuquerque, 100 miles
northwest of Lubbock, Texas and 105 miles southwest of Amarillo,
Texas. Clovis had a population of approximately 33,000 according
to the 2000 census, and Curry County had a population of 45,000.
In January, 2003, a branch was opened in Santa Fe, in Santa Fe
County. Santa Fe had of a population of approximately 62,000
according to the 2000 census, and Santa Fe County had a
population of approximately 129,000 according to the 2000 census.
C. COMPETITION
Heartland encounters competition in all areas of its business
pursuits. In order to compete effectively, to develop its market
base, to maintain flexibility and to move in pace with changing
economic and social conditions, Heartland continuously refines
and develops its products and services. The principal methods of
competition in the financial services industry are price, service
and convenience.
The Bank Subsidiaries' combined market area is highly
competitive. Many financial institutions based in the communities
surrounding the Bank Subsidiaries actively compete for customers
within Heartland's market area. The Bank Subsidiaries also face
competition from finance companies, insurance companies, mortgage
companies, securities brokerage firms, money market funds, loan
production offices and other providers of financial services.
Under the Gramm-Leach-Bliley Act, effective in March 2000,
securities firms and insurance companies that elect to become
financial holding companies may acquire banks and other financial
institutions. The Gramm-Leach-Bliley Act may significantly change
the competitive environment in which Heartland and the Bank
Subsidiaries conduct business. The financial services industry is
also likely to become more competitive as further technological
advances enable more companies to provide financial services.
These technological advances may diminish the importance of
depository institutions and other financial intermediaries in the
transfer of funds between parties.
Heartland competes for loans principally through the range and
quality of the services it provides, interest rates and loan
fees. Heartland believes that its long-standing presence in the
community and personal service philosophy enhance its ability to
compete favorably in attracting and retaining individual and
business customers. Heartland actively solicits deposit-oriented
clients and competes for deposits by offering customer's personal
attention, professional service and competitive interest rates.
D. EMPLOYEES
At December 31, 2002, Heartland employed 606 full-time equivalent
employees. Heartland places a high priority on staff development,
which involves extensive training, including customer service
training. New employees are selected on the basis of both
technical skills and customer service capabilities. None of
Heartland's employees are covered by a collective bargaining
agreement. Heartland offers a variety of employee benefits and
management considers its employee relations to be excellent.
E. Internet Access
Heartland maintains an Internet site at www.htlf.com. Heartland
makes available free of charge on this site its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and other reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act as soon as reasonably
practicable after it electronically files such material with, or
furnishes it to, the Securities and Exchange Commission.
F. ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB")
issued Statement No. 143 (FAS 143), "Accounting for Asset
Retirement Obligations," which addresses the recognition and
measurement of obligations with the retirement of tangible long-
lived assets. FAS 143 is effective January 1, 2003, with early
adoption permitted. Heartland adopted FAS 143 effective January
1, 2003,and the adoption of the Statement did not have a material
effect on the financial statements.
In July 2001, the FASB issued Statement No. 141, "Business
Combinations," (FAS 141) and Statement No. 142, "Goodwill and
Other Intangible Assets" (FAS 142). FAS 141 requires that the
purchase method of accounting be used for all business
combinations initiated after June 30, 2001, as well as all
purchase method business combinations completed after June 30,
2001. FAS 141 also specifies criteria that intangible assets
acquired in a purchase method business combination must meet to
be recognized and reported apart from goodwill. FAS 142 requires
that goodwill and intangible assets with indefinite useful lives
no longer be amortized, but instead tested for impairment at
least annually in accordance with the provisions of FAS 142. FAS
142 also requires that intangible assets with definite useful
lives be amortized over their respective estimated useful lives
to their estimated residual values, and reviewed for impairment.
Heartland adopted the provisions of FAS 141 immediately, and FAS
142 effective January 1, 2002. Goodwill and intangible assets
acquired in business combinations completed before July 1, 2001,
continued to be amortized and tested for impairment in accordance
with the appropriate pre-FAS 142 accounting requirements prior to
adoption of FAS 142.
In October 2002, the FASB issued Statement No. 147 (FAS 147),
"Acquisitions of Certain Financial Institutions," which amends
Statement No. 72 (FAS 72), "Accounting for Certain Acquisitions
of Banking or Thrift Institutions," and no longer requires the
separate recognition and subsequent amortization of goodwill.
FAS 147 also amends Statement No. 144 (FAS 144), "Accounting for
the Impairment or Disposal of Long-Lived Assets," to include in
its scope core deposit intangibles. Heartland adopted FAS 147 on
September 30, 2002. As of December 31, 2002, Heartland had
unamortized goodwill in the amount of $16.1 million and
unamortized core deposit premiums in the amount of $2.4 million.
Amortization expense related to goodwill was $1.1 million for the
years ended December 31, 2001 and 2000. Amortization expense
related to core deposit intangible assets was $495, $615 and $757
thousand for the years ended December 31, 2002, 2001 and 2000,
respectively.
The table below reconciles reported earnings for the years ended
December 31, 2002, 2001 and 2000, to "adjusted" earnings, which
exclude goodwill amortization.
(Dollars in thousands, except earnings per share data)
Year
Ended
Dec. 31,
2002 Year Ended Dec. 31, 2001
--------- --------------------------------
Reported Reported Goodwill "Adjusted"
Earnings Earnings Amort. Earnings
--------- -------- -------- -----------
Income from
continuing
operations before
taxes $ 24,113 $ 16,659 $ 1,057 $ 17,716
Income taxes 7,523 5,530 - 5,530
--------- -------- -------- -----------
Income from
continuing
operations $ 16,590 $ 11,129 $ 1,057 $ 12,186
========= ======== ======== ===========
Net income $ 18,867 $ 11,414 $ 1,057 $ 12,471
========= ======== ======== ===========
Earnings from
continuing
operations per
share - basic $ 1.69 $ 1.16 $ .11 $ 1.27
========= ======== ======== ===========
Earnings from
continuing
operations
per common
share - diluted $ 1.68 $ 1.15 $ .11 $ 1.26
=========== ======= ======== ===========
Earnings per
share - basic $ 1.93 $ 1.19 $ .11 $ 1.30
========= ======== ======== ===========
Earnings per
share - diluted $ 1.91 $ 1.18 $ .11 $ 1.28
========= ======== ======== ===========
Year Ended Dec. 31, 2000
-------------------------------
Reported Goodwill "Adjusted"
Earnings Amort. Earnings
-------- -------- -----------
Income from
continuing
operations before
taxes $ 13,790 $ 1,057 $ 14,847
Income taxes 4,211 - 4,211
-------- -------- -----------
Income from
continuing
operations $ 9,579 $ 1,057 $ 10,636
======== ======== ===========
Net income $ 9,586 $ 1,057 $ 10,643
======== ======== ===========
Earnings from
continuing
operations per
share - basic $ .99 $ .11 $ 1.11
======== ======== ===========
Earnings from
continuing
operations
per common
share - diluted $ .98 $ .11 $ 1.09
======== ======== ===========
Earnings per
share - basic $ 1.00 $ .11 $ 1.10
======== ======== ===========
Earnings per
share - diluted $ .98 $ .11 $ 1.09
======== ======== ===========
In August 2001, the FASB issued Statement No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which
supersedes both Statement No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," and the accounting and reporting provisions of Accounting
Principles Bulletin (APB) Opinion No. 30, "Reporting the Results
of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a
business (as previously defined in that Opinion.) FAS 144 retains
the fundamental provisions in FAS 121 for recognizing and
measuring impairment losses on long-lived assets held for use and
long-lived assets to be disposed of by sale, while also resolving
significant implementation issues associated with FAS 121. For
example, FAS 144 provides guidance on how a long-lived asset that
is used as part of a group should be evaluated for impairment,
establishes criteria for when a long-lived asset is held for
sale, and prescribes the accounting for a long-lived asset that
will be disposed of other than by sale. FAS 144 retains the
basic provisions of Opinion No. 30 on how to present discontinued
operations in the income statement but broadens that presentation
to include a component of an entity (rather than a segment of a
business.) Unlike FAS 121, an impairment assessment under FAS
144 will never result in a write-down of goodwill. Rather,
goodwill is evaluated for impairment under FAS 142. Heartland
adopted FAS 144 effective January 1, 2002, and applied FAS 144 to
the sale of Wisconsin Community Bank's branch in Eau Claire,
Wisconsin.
In June 2002, the FASB issued Statement 146 (FAS 146),
"Accounting for Costs Associated with Exit or Disposal
Activities," which addresses financial accounting and reporting
of costs associated with exit or disposal activities. Under FAS
146, such costs will be recognized when the liability is
incurred, rather than at the date of the commitment to an exit
plan. FAS 146 is effective for exit or disposal activities that
are initiated after December 31, 2002, with early adoption
permitted. Heartland adopted FAS 146 on January 1, 2003 and the
adoption of the Statement did not have a material effect on the
financial statements.
In November of 2002, the FASB issued Interpretation No. 45 (FIN
45), Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others. This Interpretation describes the disclosures to be made
by a guarantor in interim and annual financial statements about
obligations under certain guarantees the guarantor has issued. It
also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of FIN 45 are applicable
on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 will not have a
material effect on Heartland's financial statements. Heartland
adopted the disclosure provisions of FIN 45 effective
December 31, 2002.
In December 2002, the FASB issued Statement No. 148 (FAS 148),
Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment to FASB Statement 123. FAS 148 provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, FAS 148 amends the disclosure
requirements of FAS 123 to require more prominent disclosures in
both annual and interim financial statements about the method
used on reported results. FAS 148 is effective for financial
statements for fiscal years ending after December 15, 2002.
Heartland has adopted the disclosure provisions of FAS 148.
In January 2003, the 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 entities in which
equity investors do not have the characteristics of a controlling
interest. 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 June 15, 2003. Heartland adopted the
disclosure provisions of FIN 46 effective December 31, 2002 and
will adopt the provisions of FIN 46 for newly formed variable
interest entities effective January 31, 2003, which will not have
a material effect on Heartland's financial statements. Heartland
has three existing variable interest entities related to low
income housing partnerships and will adopt the provisions of FIN
46 for those entities on July 1, 2003. The total amount of
assets in these entities at December 31, 2002 was approximately
$4.5 million.
G. SUPERVISION AND REGULATION
General
Financial institutions, their holding companies and their
affiliates are extensively regulated under federal and state law.
As a result, the growth and earnings performance of Heartland may
be affected not only by management decisions and general economic
conditions, but also by the requirements of federal and state
statutes and by the regulations and policies of various bank
regulatory authorities, including the Iowa Superintendent of
Banking (the "Superintendent"), the Illinois Commissioner of
Banks and Real Estate (the "Commissioner"), the Division of
Banking of the Wisconsin Department of Financial Institutions
(the "Wisconsin DFI"), the New Mexico Financial Institutions
Division (the "New Mexico FID"), the Board of Governors of the
Federal Reserve System (the "Federal Reserve") and the Federal
Deposit Insurance Corporation (the "FDIC"). Furthermore,
taxation laws administered by the Internal Revenue Service and
state taxing authorities and securities laws administered by the
Securities and Exchange Commission (the "SEC") and state
securities authorities have an impact on the business of
Heartland. The effect of these statutes, regulations and
regulatory policies may be significant, and cannot be predicted
with a high degree of certainty.
Federal and state laws and regulations generally applicable to
financial institutions regulate, among other things, the scope of
business, the kinds and amounts of investments, reserve
requirements, capital levels relative to operations, the nature
and amount of collateral for loans, the establishment of
branches, mergers and consolidations and the payment of
dividends. This system of supervision and regulation establishes
a comprehensive framework for the respective operations of
Heartland and its subsidiaries and is intended primarily for the
protection of the FDIC insured deposits and depositors of the
Bank Subsidiaries, rather than shareholders.
The following is a summary of the material elements of the
regulatory framework that applies to Heartland and its
subsidiaries. It does not describe all of the statutes,
regulations and regulatory policies that apply, nor does it
restate all of the requirements of those that are described. As
such, the following is qualified in its entirety by reference to
applicable law. Any change in statutes, regulations or
regulatory policies may have a material effect on the business of
Heartland and its subsidiaries.
Heartland
General
Heartland as the sole shareholder of Dubuque Bank and Trust
Company, Galena State Bank and Trust Company, Riverside Community
Bank, First Community Bank, Wisconsin Community Bank and the
controlling shareholder of New Mexico Bank & Trust, is a bank
holding company. As a bank holding company, Heartland is
registered with, and is subject to regulation by, the Federal
Reserve under the Bank Holding Company Act of 1956, as amended
(the "BHCA"). In accordance with Federal Reserve policy,
Heartland is expected to act as a source of financial strength to
the Bank Subsidiaries and to commit resources to support the Bank
Subsidiaries in circumstances where Heartland might not otherwise
do so. Under the BHCA, Heartland is subject to periodic
examination by the Federal Reserve. Heartland is also required
to file with the Federal Reserve periodic reports of Heartland's
operations and such additional information regarding Heartland
and its subsidiaries as the Federal Reserve may require.
Acquisitions, Activities and Change in Control
The primary purpose of a bank holding company is to control and
manage banks. The BHCA generally requires the prior approval of
the Federal Reserve for any merger involving a bank holding
company or any acquisition by a bank holding company of another
bank or bank holding company. Subject to certain conditions
(including certain deposit concentration limits established by
the BHCA), the Federal Reserve may allow a bank holding company
to acquire banks located in any state of the United States. In
approving interstate acquisitions, the Federal Reserve is
required to give effect to applicable state law limitations on
the aggregate amount of deposits that may be held by the
acquiring bank holding company and its insured depository
institution affiliates in the state in which the target bank is
located (provided that those limits do not discriminate against
out-of-state depository institutions or their holding companies)
and state laws that require that the target bank have been in
existence for a minimum period of time (not to exceed five years)
before being acquired by an out-of-state bank holding company.
The BHCA generally prohibits Heartland from acquiring direct or
indirect ownership or control of more than 5% of the voting
shares of any company that is not a bank and from engaging in any
business other than that of banking, managing and controlling
banks or furnishing services to banks and their subsidiaries.
This general prohibition is subject to a number of exceptions.
The principal exception allows bank holding companies to engage
in, and to own shares of companies engaged in, certain businesses
found by the Federal Reserve to be "so closely related to banking
.... as to be a proper incident thereto." This authority would
permit Heartland to engage in a variety of banking-related
businesses, including the operation of a thrift, consumer
finance, equipment leasing, the operation of a computer service
bureau (including software development), and mortgage banking and
brokerage. The BHCA generally does not place territorial
restrictions on the domestic activities of non-bank subsidiaries
of bank holding companies.
Additionally, bank holding companies that meet certain
eligibility requirements prescribed by the BHCA and elect to
operate as financial holding companies may engage in, or own
shares in companies engaged in, a wider range of nonbanking
activities, including securities and insurance underwriting and
sales, merchant banking and any other activity that the Federal
Reserve, in consultation with the Secretary of the Treasury,
determines by regulation or order is financial in nature,
incidental to any such financial activity or complementary to any
such financial activity and does not pose a substantial risk to
the safety or soundness of depository institutions or the
financial system generally. As of the date of this filing,
Heartland has neither applied for nor received approval to
operate as a financial holding company.
Federal law also prohibits any person or company from acquiring
"control" of an FDIC-insured depository institution or its
holding company without prior notice to the appropriate federal
bank regulator. "Control" is conclusively presumed to exist upon
the acquisition of 25% or more of the outstanding voting
securities of a bank or bank holding company, but may arise under
certain circumstances at 10% ownership.
Capital Requirements
Bank holding companies are required to maintain minimum levels of
capital in accordance with Federal Reserve capital adequacy
guidelines. If capital levels fall below the minimum required
levels, a bank holding company, among other things, may be denied
approval to acquire or establish additional banks or non-bank
businesses.
The Federal Reserve's capital guidelines establish the following
minimum regulatory capital requirements for bank holding
companies: (i) a risk-based requirement expressed as a
percentage of total assets weighted according to risk; and (ii) a
leverage requirement expressed as a percentage of total assets.
The risk-based requirement consists of a minimum ratio of total
capital to total risk-weighted assets of 8%, and a minimum ratio
of Tier 1 capital to total risk-weighted assets of 4%. The
leverage requirement consists of a minimum ratio of Tier 1
capital to total assets of 3% for the most highly rated
companies, with a minimum requirement of 4% for all others. For
purposes of these capital standards, Tier 1 capital consists
primarily of permanent stockholders' equity less intangible
assets (other than certain loan servicing rights and purchased
credit card relationships). Total capital consists primarily of
Tier 1 capital plus certain other debt and equity instruments
that do not qualify as Tier 1 capital and a portion of the
company's allowance for loan and lease losses.
The risk-based and leverage standards described above are minimum
requirements. Higher capital levels will be required if warranted
by the particular circumstances or risk profiles of individual
banking organizations. For example, the Federal Reserve's capital
guidelines contemplate that additional capital may be required to
take adequate account of, among other things, interest rate risk,
or the risks posed by concentrations of credit, nontraditional
activities or securities trading activities. Further, any
banking organization experiencing or anticipating significant
growth would be expected to maintain capital ratios, including
tangible capital positions (i.e., Tier 1 capital less all
intangible assets), well above the minimum levels. As of
December 31, 2002, Heartland had regulatory capital in excess of
the Federal Reserve's minimum requirements.
Dividend Payments
Heartland's ability to pay dividends to its shareholders may be
affected by both general corporate law considerations and
policies of the Federal Reserve applicable to bank holding
companies. As a Delaware corporation, Heartland is subject to
the limitations of the Delaware General Corporation Law
(the "DGCL"), which allows Heartland to pay dividends only out of
its surplus (as defined and computed in accordance with the
provisions of the DGCL) or if Heartland has no such surplus, out
of its net profits for the fiscal year in which the dividend is
declared and/or the preceding fiscal year. Additionally, policies
of the Federal Reserve caution that a bank holding company should
not pay cash dividends that exceed its net income or that can
only be funded in ways that weaken the bank holding company's
financial health, such as by borrowing. The Federal Reserve also
possesses enforcement powers over bank holding companies and
their non-bank subsidiaries to prevent or remedy actions that
represent unsafe or unsound practices or violations of applicable
statutes and regulations. Among these powers is the ability to
proscribe the payment of dividends by banks and bank holding
companies.
Federal Securities Regulation
Heartland's common stock is registered with the SEC under the
Securities Act of 1933, as amended, and the Securities Exchange
Act of 1934, as amended (the "Exchange Act"). Consequently,
Heartland is subject to the information, proxy solicitation,
insider trading and other restrictions and requirements of the
SEC under the Exchange Act.
The Bank Subsidiaries
General
Dubuque Bank and Trust Company and First Community Bank are Iowa-
chartered banks, the deposit accounts of which are insured by the
FDIC's Bank Insurance Fund ("BIF"). As Iowa-chartered banks,
Dubuque Bank and Trust Company and First Community Bank are
subject to the examination, supervision, reporting and
enforcement requirements of the Superintendent, the chartering
authority for Iowa banks, and the FDIC, designated by federal law
as the primary federal regulator of state-chartered FDIC-insured
banks that, like Dubuque Bank and Trust Company and First
Community Bank, are not members of the Federal Reserve System
("non-member banks").
Galena State Bank and Trust Company and Riverside Community Bank
are Illinois-chartered banks, the deposit accounts of which are
insured by the BIF. As Illinois-chartered banks, Galena State
Bank and Trust Company and Riverside Community Bank are subject
to the examination, supervision, reporting and enforcement
requirements of the Commissioner, the chartering authority for
Illinois banks, and the FDIC, as the primary federal regulator of
state-chartered FDIC-insured non-member banks.
Wisconsin Community Bank is a Wisconsin-chartered bank, the
deposit accounts of which are insured by the BIF. As a Wisconsin-
chartered bank, Wisconsin Community Bank is subject to the
examination, supervision, reporting and enforcement requirements
of the Wisconsin DFI, the chartering authority for Wisconsin
banks, and the FDIC, as the primary federal regulator of state-
chartered FDIC-insured non-member banks.
New Mexico Bank & Trust is a New Mexico-chartered bank, the
deposit accounts of which are insured by the BIF. As a New
Mexico-chartered bank, New Mexico Bank & Trust is subject to the
examination, supervision, reporting and enforcement requirements
of the New Mexico FID, the chartering authority for New Mexico
banks, and the FDIC, as the primary federal regulator of state-
chartered FDIC-insured non-member banks.
Deposit Insurance
As FDIC-insured institutions, the Bank Subsidiaries are required
to pay deposit insurance premium assessments to the FDIC. The
FDIC has adopted a risk-based assessment system under which all
insured depository institutions are placed into one of nine
categories and assessed insurance premiums based upon their
respective levels of capital and results of supervisory
evaluations. Institutions classified as well-capitalized (as
defined by the FDIC) and considered healthy pay the lowest
premium while institutions that are less than adequately
capitalized (as defined by the FDIC) and considered of
substantial supervisory concern pay the highest premium. Risk
classification of all insured institutions is made by the FDIC
for each semi-annual assessment period.
During the year ended December 31, 2002, BIF assessments ranged
from 0% of deposits to 0.27% of deposits. For the semi-annual
assessment period beginning January 1, 2003, BIF assessment rates
will continue to range from 0% of deposits to 0.27% of deposits.
FICO Assessments
Since 1987, a portion of the deposit insurance assessments paid
by members of the FDIC's Savings Association Insurance Fund
("SAIF") has been used to cover interest payments due on the
outstanding obligations of the Financing Corporation ("FICO").
FICO was created in 1987 to finance the recapitalization of the
Federal Savings and Loan Insurance Corporation, the SAIF's
predecessor insurance fund. As a result of federal legislation
enacted in 1996, beginning as of January 1, 1997, both SAIF
members and BIF members became subject to assessments to cover
the interest payments on outstanding FICO obligations until the
final maturity of such obligations in 2019. These FICO
assessments are in addition to amounts assessed by the FDIC for
deposit insurance. During the year ended December 31, 2002, the
FICO assessment rate for BIF and SAIF members was approximately
0.02% of deposits.
Supervisory Assessments
All Iowa banks, Illinois banks, Wisconsin banks and New Mexico
banks are required to pay supervisory assessments to their
respective state banking regulators to fund the operations of
those agencies. In general, the amount of the assessment is
calculated on the basis of each institution's total assets.
During the year ended December 31, 2002, the Bank Subsidiaries
paid supervisory assessments totaling $231 thousand.
Capital Requirements
Banks are generally required to maintain capital levels in excess
of other businesses. The FDIC has established the following
minimum capital standards for state-chartered insured non-member
banks, such as the Bank Subsidiaries: (i) a leverage requirement
consisting of a minimum ratio of Tier 1 capital to total assets
of 3% for the most highly-rated banks with a minimum requirement
of at least 4% for all others; and (ii) a risk-based capital
requirement consisting of a minimum ratio of total capital to
total risk-weighted assets of 8%, and a minimum ratio of Tier 1
capital to total risk-weighted assets of 4%. For purposes of
these capital standards, the components of Tier 1 capital and
total capital are the same as those for bank holding companies
discussed above.
The capital requirements described above are minimum
requirements. Higher capital levels will be required if
warranted by the particular circumstances or risk profiles of
individual institutions. For example, regulations of the FDIC
provide that additional capital may be required to take adequate
account of, among other things, interest rate risk or the risks
posed by concentrations of credit, nontraditional activities or
securities trading activities.
Further, federal law and regulations provide various incentives
for financial institutions to maintain regulatory capital at
levels in excess of minimum regulatory requirements. For example,
a financial institution that is "well-capitalized" may qualify
for exemptions from prior notice or application requirements
otherwise applicable to certain types of activities and may
qualify for expedited processing of other required notices or
applications. Additionally, one of the criteria that determines a
bank holding company's eligibility to operate as a financial
holding company is a requirement that all of its financial
institution subsidiaries be "well capitalized." Under the
regulations of the FDIC, in order to be "well-capitalized" a
financial institution must maintain a ratio of total capital to
total risk-weighted assets of 10% or greater, a ratio of Tier 1
capital to total risk-weighted assets of 6% or greater and a
ratio of Tier 1 capital to total assets of 5% or greater.
Federal law also provides the federal banking regulators with
broad power to take prompt corrective action to resolve the
problems of undercapitalized institutions. The extent of the
regulators' powers depends on whether the institution in question
is "adequately capitalized," "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized," in each case
as defined by regulation. Depending upon the capital category to
which an institution is assigned, the regulators' corrective
powers include: (i) requiring the institution to submit a
capital restoration plan; (ii) limiting the institution's asset
growth and restricting its activities; (iii) requiring the
institution to issue additional capital stock (including
additional voting stock) or to be acquired; (iv) restricting
transactions between the institution and its affiliates; (v)
restricting the interest rate the institution may pay on
deposits; (vi) ordering a new election of directors of the
institution; (vii) requiring that senior executive officers or
directors be dismissed; (viii) prohibiting the institution from
accepting deposits from correspondent banks; (ix) requiring the
institution to divest certain subsidiaries; (x) prohibiting the
payment of principal or interest on subordinated debt; and (xi)
ultimately, appointing a receiver for the institution.
As of December 31, 2002: (i) none of the Bank Subsidiaries was
subject to a directive from the FDIC to increase its capital to
an amount in excess of the minimum regulatory capital
requirements; (ii) each of the Bank Subsidiaries exceeded its
minimum regulatory capital requirements under FDIC capital
adequacy guidelines; and (iii) each of the Bank Subsidiaries was
"well-capitalized," as defined by FDIC regulations.
Liability of Commonly Controlled Institutions
Institutions insured by the FDIC may be liable for any loss
incurred by, or reasonably expected to be incurred by, the FDIC
in connection with the default of commonly controlled FDIC-
insured depository institutions or any assistance provided by the
FDIC to commonly controlled FDIC insured depository institutions
in danger of default. Because Heartland controls each of the Bank
Subsidiaries, the Bank Subsidiaries are commonly controlled.
Dividend Payments
The primary source of funds for Heartland is dividends from the
Bank Subsidiaries. In general, under applicable law, none of the
Bank Subsidiaries may pay dividends in excess of its respective
undivided profits.
The payment of dividends by any financial institution or its
holding company is affected by the requirement to maintain
adequate capital pursuant to applicable capital adequacy
guidelines and regulations, and a financial institution generally
is prohibited from paying any dividends if, following payment
thereof, the institution would be undercapitalized. As described
above, each of the Bank Subsidiaries exceeded its minimum capital
requirements under applicable guidelines as of December 31, 2002.
As of December 31, 2002, approximately $45.9 million was
available to be paid as dividends by the Bank Subsidiaries.
Notwithstanding the availability of funds for dividends, however,
the FDIC may prohibit the payment of any dividends by the Bank
Subsidiaries if the FDIC determines such payment would constitute
an unsafe or unsound practice.
Insider Transactions
The Bank Subsidiaries are subject to certain restrictions imposed
by federal law on extensions of credit to Heartland and its
subsidiaries, on investments in the stock or other securities of
Heartland and its subsidiaries and the acceptance of the stock or
other securities of Heartland or its subsidiaries as collateral
for loans made by the Bank Subsidiaries. Certain limitations and
reporting requirements are also placed on extensions of credit by
the Bank to its directors and officers, to directors and officers
of Heartland and its subsidiaries, to principal shareholders of
Heartland and to "related interests" of such directors, officers
and principal shareholders. In addition, federal law and
regulations may affect the terms upon which any person who is a
director or officer of Heartland or any of its subsidiaries or a
principal shareholder of Heartland may obtain credit from banks
with which the Bank Subsidiaries maintain correspondent
relationships.
Safety and Soundness Standards
The federal banking agencies have adopted guidelines that
establish operational and managerial standards to promote the
safety and soundness of federally insured depository
institutions. The guidelines set forth standards for internal
controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset
growth, compensation, fees and benefits, asset quality and
earnings.
In general, the safety and soundness guidelines prescribe the
goals to be achieved in each area, and each institution is
responsible for establishing its own procedures to achieve those
goals. If an institution fails to comply with any of the
standards set forth in the guidelines, the institution's primary
federal regulator may require the institution to submit a plan
for achieving and maintaining compliance. If an institution fails
to submit an acceptable compliance plan, or fails in any material
respect to implement a compliance plan that has been accepted by
its primary federal regulator, the regulator is required to issue
an order directing the institution to cure the deficiency. Until
the deficiency cited in the regulator's order is cured, the
regulator may restrict the institution's rate of growth, require
the institution to increase its capital, restrict the rates the
institution pays on deposits or require the institution to take
any action the regulator deems appropriate under the
circumstances. Noncompliance with the standards established by
the safety and soundness guidelines may also constitute grounds
for other enforcement action by the federal banking regulators,
including cease and desist orders and civil money penalty
assessments.
Branching Authority
Until 2001, an Iowa-chartered bank, such as Dubuque Bank and
Trust or First Community Bank, could only establish a branch
office within the boundaries of the counties contiguous to, or
cornering upon, the county in which the principal place of
business of the bank was located. Further, Iowa law prohibited an
Iowa bank from establishing new branches in a municipality other
than the municipality in which the bank's principal place of
business was located, if another bank already operated one or
more offices in the municipality in which the branch was to be
located. In 2001, the Iowa Banking Act was amended to allow Iowa-
chartered banks to establish up to three branches at any location
in Iowa, subject to regulatory approval, in addition to any
branches established under the branching rules described above.
Beginning July 1, 2004, Iowa-chartered banks will be permitted to
establish any number of branches at any location in Iowa, subject
to regulatory approval.
Illinois banks, such as Galena State Bank and Trust Company and
Riverside Community Bank, have the authority under Illinois law
to establish branches anywhere in the State of Illinois, subject
to receipt of all required regulatory approvals. Likewise, under
the laws of Wisconsin and New Mexico, Wisconsin banks (such as
Wisconsin Community Bank) and New Mexico banks (such as New
Mexico Bank & Trust), respectively, have statewide branching
authority, subject to regulatory approval.
State and national banks are allowed to establish interstate
branch networks through acquisitions of other banks, subject to
certain conditions, including certain limitations on the
aggregate amount of deposits that may be held by the surviving
bank and all of its insured depository institution affiliates.
The establishment of new interstate branches or the acquisition
of individual branches of a bank in another state (rather than
the acquisition of an out-of-state bank in its entirety) is
allowed only if specifically authorized by state law. The laws
of Iowa, Illinois, Wisconsin and New Mexico permit interstate
mergers subject to certain conditions, including a condition
requiring an Iowa, Illinois, Wisconsin or New Mexico bank,
respectively, involved in an interstate merger to have been in
existence and continuous operation for more than five years.
State Bank Investments and Activities
Each of the Bank Subsidiaries generally is permitted to make
investments and engage in activities directly or through
subsidiaries as authorized by the laws of the state under which
it is chartered. However, under federal law and FDIC regulations,
FDIC insured state banks are prohibited, subject to certain
exceptions, from making or retaining equity investments of a
type, or in an amount, that are not permissible for a national
bank. Federal law and FDIC regulations also prohibit FDIC
insured state banks and their subsidiaries, subject to certain
exceptions, from engaging as principal in any activity that is
not permitted for a national bank unless the bank meets, and
continues to meet, its minimum regulatory capital requirements
and the FDIC determines the activity would not pose a significant
risk to the deposit insurance fund of which the bank is a member.
These restrictions have not had, and are not currently expected
to have, a material impact on the operations of the Bank
Subsidiaries.
Federal Reserve System
Federal Reserve regulations, as presently in effect, require
depository institutions to maintain non-interest earning reserves
against their transaction accounts (primarily NOW and regular
checking accounts), as follows: for transaction accounts
aggregating $42.1 million or less, the reserve requirement is 3%
of total transaction accounts; and for transaction accounts
aggregating in excess of $42.1 million, the reserve requirement
is $1.083 million plus 10% of the aggregate amount of total
transaction accounts in excess of $42.1 million. The first $6.0
million of otherwise reservable balances are exempted from the
reserve requirements. These reserve requirements are subject to
annual adjustment by the Federal Reserve. The Bank Subsidiaries
are in compliance with the foregoing requirements.
H. GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS
The earnings of Heartland are affected by the policies of
regulatory authorities, including the Federal Reserve System
whose monetary policies have had a significant effect on the
operating results of commercial banks in the past and are
expected to continue to do so in the future. Because of changing
conditions in the economy and in the money markets, as a result
of actions by monetary and fiscal authorities, interest rates,
credit availability and deposit levels may change due to
circumstances beyond the control of Heartland. Future policies of
the Federal Reserve System and other authorities cannot be
predicted, nor can their effect on future earnings be predicted.
ITEM 2.
PROPERTIES
The following table is a listing of the principal operating
facilities of Heartland:
Main Main
Facility Facility Number
Name and Main Square Owned or of
Facility Address Footage Leased Locations
- ---------------- -------- -------- ---------
Banking Subsidiary
Dubuque Bank and
Trust Company
1398 Central Avenue 59,500 Owned 8
Dubuque, IA 52001
Galena State Bank and
Trust Company
971 Gear Street 18,000 Owned 3
Galena, IL 61036
Riverside Community Bank
6855 E. Riverside Blvd. 8,000 Owned 3
Rockford, IL 60114
First Community Bank
320 Concert Street 6,000 Owned 3
Keokuk, IA 52632
Wisconsin Community Bank
580 North Main Street
Cottage Grove, WI 53527 6,000 Owned 6
New Mexico Bank & Trust
320 Gold NW
Albuquerque, NM 87102 11,400 Lease term 11
through 2006
Main
Facility Number
Name and Main Owned or of
Facility Address Leased Locations
- ---------------- -------- ---------
Nonbanking Subsidiaries
Citizens Finance Co.
1275 Main Street Leased
Dubuque, IA 52001 from DB&T 4
ULTEA, Inc.
2976 Triverton Pike
Madison, WI 53711 Leased 1
The principal offices of Heartland are located in DB&T's main
office.
ITEM 3.
LEGAL PROCEEDINGS
There are no pending legal proceedings, other than ordinary
routine litigation incidental to the business of banking, to
which Heartland or any of its subsidiaries is a party or of which
any of their property is the subject. While the ultimate outcome
of current legal proceedings cannot be predicted with certainty,
it is the opinion of management that the resolution of these
legal actions should not have a material effect on Heartland's
consolidated financial position or results of operations.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 2002 to a
vote of security holders.
PART II
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Heartland's common stock was held by approximately 960
stockholders of record as of March 12, 2003, and is traded in the
over-the-counter market. The common stock has been approved for
listing on the Nasdaq National Market System and it is
anticipated that it will officially be listed in the beginning of
April, 2003.
The following table shows, for the periods indicated, the range
of reported prices per share of Heartland's common stock in the
over-the-counter market. These quotations represent inter-dealer
prices without retail markups, markdowns or commissions and do
not necessarily represent actual transactions.
Heartland Common Stock
Calendar Quarter High Low
---- ---
2001:
First $14 1/4 $12 1/2
Second 14 10 1/4
Third 13 13/16 13 5/32
Fourth 13 1/2 12 25/32
2002:
First $14 $12 13/16
Second 15 13 19/32
Third 15 9/32 14 13/32
Fourth 17 22/32 15
Cash dividends have been declared by Heartland quarterly during
the past two years ending December 31, 2002. The following table
sets forth the cash dividends per share paid on Heartland's
common stock for the past two years:
Calendar Quarter
2002 2001
---- ----
First $.10 $.09
Second .10 .09
Third .10 .09
Fourth .10 .10
Heartland has paid dividends as set forth in the table above.
Heartland's ability to pay dividends to shareholders is largely
dependent upon the dividends it receives from the bank
subsidiaries, and the banks are subject to regulatory limitations
on the amount of cash dividends they may pay. See "Business -
Supervision and Regulation - Heartland - Dividend Payments" and
"Business - Supervision and Regulation- The Bank Subsidiaries -
Dividend Payments" for a more detailed description of these
limitations.
ITEM 6.
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
For the Years Ended December 31,
2002 2001 2000
----------------------------------
STATEMENT OF INCOME DATA
Interest income $ 100,012 $ 107,609 $ 102,535
Interest expense 42,332 58,620 58,678
---------- ---------- ----------
Net interest income 57,680 48,989 43,857
Provision for loan and
lease losses 3,553 4,258 2,976
---------- ---------- ----------
Net interest income after
provision for loan and
lease losses 54,127 44,731 40,881
Noninterest income 32,757 30,261 26,979
Noninterest expense 62,771 58,333 54,070
Income taxes 7,523 5,530 4,211
---------- ---------- ----------
Income from continuing
operations $ 16,590 $ 11,129 $ 9,579
Discontinued operations:
Income (loss) from
operations of discontinued
branch (including gain on
sale of $2,602) 3,751 469 12
Income taxes 1,474 184 5
---------- ---------- ----------
Income (loss) on
discontinued operations 2,277 285 7
---------- ---------- ----------
Net income $ 18,867 $ 11,414 $ 9,586
========== ========== ==========
PER COMMON SHARE DATA
Net income - diluted $ 1.91 $ 1.18 $ 0.98
Income from continuing
operations - diluted(1) 1.68 1.15 0.98
Adjusted net income -
diluted(2) 1.91 1.28 1.09
Adjusted income from
continuing operations -
diluted(3) 1.68 1.26 1.09
Cash dividends 0.40 0.37 0.36
Dividend payout ratio 20.81% 31.19%
36.15%
Book value $ 12.60 $ 11.06 $ 10.00
Weighted average shares
outstanding 9,791,549 9,602,520 9,628,038
BALANCE SHEET DATA
Investments and federal
funds sold $ 424,514 $ 349,417 $ 274,365
Total loans and leases,
net of unearned 1,175,236 1,105,205 1,042,096
Allowance for loan and
lease losses 16,091 14,660 13,592
Total assets 1,785,979 1,644,064 1,466,387
Total deposits 1,337,985 1,205,159 1,101,313
Long-term obligations 161,379 143,789 102,856
Stockholders' equity 124,041 107,090 96,146
EARNINGS PERFORMANCE DATA
Return on average total assets 1.13% 0.72% 0.70%
Return on average stockholders'
equity 16.44 11.32 10.69
Net interest margin ratio(1)(4) 4.04 3.67 3.74
Earnings to fixed charges:
Excluding interest on deposits 3.28x 2.27x 1.87x
Including interest on deposits 1.57 1.28 1.23
ASSET QUALITY RATIOS
Nonperforming assets to total
assets 0.29% 0.52% 0.51%
Nonperforming loans and leases
to total loans and leases 0.38 0.73 0.65
Net loan and lease charge-offs
to average loans and leases 0.16 0.30 0.17
Allowance for loan and lease
losses to total loans and
leases 1.37 1.33 1.30
Allowance for loan and lease
losses to nonperforming
loans and leases 358.77 180.47 201.60
CAPITAL RATIOS
Average equity to average
assets 6.86% 6.47% 6.54%
Total capital to risk-adjusted
assets 11.86 10.89 9.90
Tier 1 leverage 8.24 7.53 7.25
(1) Excludes the discontinued operations of our Eau Claire
branch and the related gain on sale in the fourth quarter of
2002.
(2) Excludes goodwill amortization discontinued with the
adoption of FAS 142 on January 1, 2002, and the adoption of
FAS 147 on September 30, 2002.
(3) Excludes goodwill amortization discontinued with the
adoption of FAS 142 on January 1, 2002, and the adoption of
FAS 147 on September 30, 2002, and the discontinued
operations of our Eau Claire branch and the related gain on
sale in the fourth quarter of 2002.
(4) Tax equivalent using a 34% tax rate.
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
For the Years Ended
December 31,
1999 1998
-----------------------
STATEMENT OF INCOME DATA
Interest income $ 74,119 $ 64,517
Interest expense 40,830 36,304
---------- ----------
Net interest income 33,289 28,213
Provision for loan and lease losses 2,550 951
---------- ----------
Net interest income after provision
for loan and lease losses 30,739 27,262
Noninterest income 25,423 17,297
Noninterest expense 44,571 31,781
Income taxes 3,239 3,757
---------- ----------
Income from continuing operations 8,352 9,021
Discontinued operations:
Income (loss) from operations of
discontinued branch (including
gain on sale of $2,602) (210) -
Income taxes (83) -
---------- ----------
Income (loss) on discontinued
operations (127) -
---------- ----------
Net income $ 8,225 $ 9,021
========== ==========
PER COMMON SHARE DATA
Net income - diluted $ 0.84 $ 0.94
Income from continuing operations -
diluted(1) 0.86 0.94
Adjusted net income - diluted(2) 0.89 0.96
Adjusted income from continuing
operations - diluted(3) 0.91 0.96
Cash dividends 0.34 0.31
Dividend payout ratio 39.47% 32.48%
Book value $ 9.03 $ 8.84
Weighted average shares
outstanding 9,555,194 9,463,313
BALANCE SHEET DATA
Investments and federal funds sold $ 213,452 $ 259,964
Total loans and leases, net of unearned 835,146 590,133
Allowance for loan and lease losses 10,844 7,945
Total assets 1,184,147 953,785
Total deposits 869,659 717,877
Long-term obligations 105,737 80,016
Stockholders' equity 86,573 84,270
EARNINGS PERFORMANCE DATA
Return on average total assets 0.78% 1.01%
Return on average stockholders' equity 9.61 11.26
Net interest margin ratio(1)(4) 3.64 3.58
Earnings to fixed charges:
Excluding interest on deposits 2.18x 2.65x
Including interest on deposits 1.28 1.35
ASSET QUALITY RATIOS
Nonperforming assets to total assets 0.19% 0.28%
Nonperforming loans and leases
to total loans and leases 0.20 0.30
Net loan and lease charge-offs
to average loans and leases 0.06 0.07
Allowance for loan and lease losses
to total loans and leases 1.30 1.35
Allowance for loan and lease losses
to nonperforming loans and leases 657.49 453.74
CAPITAL RATIOS
Average equity to average assets 8.12% 9.01%
Total capital to risk-adjusted assets 11.68 12.13
Tier 1 leverage 8.85 8.58
(1) Excludes the discontinued operations of our Eau Claire
branch and the related gain on sale in the fourth quarter of
2002.
(2) Excludes goodwill amortization discontinued with the
adoption of FAS No. 142 on January 1, 2002, and the adoption
of FAS No. 147 on September 30, 2002.
(3) Excludes goodwill amortization discontinued with the
adoption of FAS No. 142 on January 1, 2002, and the adoption
of FAS No. 147 on September 30, 2002, and the discontinued
operations of our Eau Claire branch and the related gain on
sale in the fourth quarter of 2002.
(4) Tax equivalent using a 34% tax rate.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following presents management's discussion and analysis of
the consolidated financial condition and results of operations of
Heartland Financial USA, Inc. ("Heartland") as of the dates and
for the periods indicated. This discussion should be read in
conjunction with the Selected Financial Data, Heartland's
Consolidated Financial Statements and the Notes thereto and other
financial data appearing elsewhere in this report. The
consolidated financial statements include the accounts of
Heartland and its subsidiaries. All of Heartland's subsidiaries
are wholly-owned except for New Mexico Bank & Trust, of which
Heartland owned 86% of its capital stock on December 31, 2002.
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 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.
OVERVIEW
Heartland is a diversified financial services holding company
providing full-service community banking through six banking
subsidiaries with a total of 33 banking locations in Iowa,
Illinois, Wisconsin and New Mexico. In addition, Heartland has
separate subsidiaries in the consumer finance, vehicle
leasing/fleet management, insurance agency and investment
management businesses. Heartland's primary strategy is to balance
its focus on increasing profitability with asset growth and
diversification through acquisitions, de novo bank formations,
branch openings and expansion into non-bank subsidiary
activities.
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.
The year 2002 was the third consecutive year Heartland was able
to record double-digit growth in earnings. Net income increased
$7.5 million or 65% when compared to 2001. Return on common
equity was 16.44% and return on assets was 1.13%. The Eau Claire
branch of Wisconsin Community Bank, a bank subsidiary of
Heartland, was sold effective December 15, 2002. This
discontinued operation contributed net income of $2.3 million, or
$.23 on a diluted earnings per common share basis, during 2002,
which includes a $1.6 million gain on disposal, net of taxes.
Exclusive of the Eau Claire branch, income from continuing
operations totaled $16.6 million, or $1.68 on a diluted per
common share basis, compared to $11.1 million, or $1.15 on a
diluted per common share basis, during 2001, an increase of $5.5
million or 49%. The 2002 results reinforce and encourage our
community banking approach.
The largest contributor to the improved earnings during 2002 was
net interest income, which grew $8.7 million or 18%. Average
earning assets from continuing operations rose from $1.363
billion during 2001 to $1.467 billion during 2002, a change of
$103.2 million or 8%. The $705 thousand or 17% decrease in
provision for loan and lease losses also contributed to the
improved earnings for 2002. Additionally, noninterest income
experienced a $3.3 million or 11% increase, exclusive of
securities gains and losses, including impairment losses on
equity securities and trading account securities gains and
losses, and valuation adjustments on mortgage servicing rights.
In addition to gains on sale of loans, the other noninterest
income category to reflect significant improvement was service
charges and fees. Noninterest expense was held to a $4.4 million
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 $9.5 million in unamortized goodwill. Heartland's
adoption of the provisions of FAS No. 147, "Acquisitions of
Certain Financial Institutions," on September 30, 2002,
discontinued the amortization of $6.6 million in unamortized
other intangibles retroactively to January 1, 2002. The amount of
amortization expense recorded during 2001 on this goodwill and
other intangibles was $1.1 million, or $.11 on a diluted per
common share basis.
A majority of the $142 million or 9% growth in total assets since
year-end 2001 occurred during the last half of the year. Loans
and leases were $1.175 billion and deposits were $1.338 billion
at the end of 2002, an increase of 6% and 11%, respectively,
since year-end 2001. Commercial and agricultural loan growth was
$92 million or 14% and $10 million or 7%, respectively, during
2002. A portion of this growth was offset by the $23 million or
14% decrease in the mortgage loan portfolio due to paydowns
experienced as customers continued to refinance their mortgage
loans into fifteen- and thirty-year fixed rate loans, which
Heartland usually sells into the secondary market.
For the year ended December 31, 2001, income from continuing
operations totaled $11.1 million, an increase of $1.6 million or
16% when compared to the net income of $9.6 million recorded in
2000. Diluted earnings per common share grew to $1.15 from the
$.98 recorded during 2000. Return on common equity was 11.32% and
return on assets was .72% for 2001, compared to 10.69% and .70%,
respectively, for 2000. Contributing to the increased earnings
during 2001 was the $5.1 million or 12% increase in net interest
income from continuing operations, due in large part to growth in
average earning assets. Noninterest income experienced a $3.3
million or 12% increase, primarily due to additional gains on
sale of loans and service charges and fees. As interest rates
moved downward throughout 2001, customers frequently elected to
refinance into fifteen- and thirty-year, fixed-rate mortgage
loans, which Heartland usually elects to sell into the secondary
market while retaining servicing.
Total assets reached $1.644 billion at year-end 2001, an increase
of $178 million or 12% over year-end 2000. Even though the
economy weakened throughout 2001, Heartland was able to grow its
loan portfolio by $63 million or 6% and its deposit account
balances by $104 million or 9% in 2001.
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 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 December 31, 2002. While management uses available
information to provide for loan and lease losses, the ultimate
collectibility of a substantial portion of the loan portfolio and
the need for future additions to the allowance will be based on
changes in economic conditions. Along with other financial
institutions, management shares a concern for the outlook of the
economy during 2003. 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 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 table below estimates the theoretical range of the 2002
allowance outcomes and related changes in provision expense
assuming either a reasonably possible deterioration in loan
credit quality or a reasonably possible improvement in loan
credit quality.
THEORETICAL RANGE OF ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars
in thousands)
Allowance for loan and lease losses at
December 31, 2002 $16,091
=======
Assuming deterioration in credit quality:
Addition to provision 1,649
-------
Resultant allowance for loan and lease losses $17,740
=======
Assuming improvement in credit quality:
Reduction in provision (1,154)
-------
Resultant allowance for loan and lease losses $14,937
=======
The assumptions underlying this sensitivity analysis represent an
attempt to quantify theoretical changes that could occur in the
total allowance for loan and lease losses given various economic
assumptions that could impact inherent loss in the loan and lease
portfolio as currently configured. It further assumes that the
general composition of the allowance for loans and lease losses
determined through Heartland's existing process and methodology
remains relatively unchanged. It does not attempt to encompass
extreme and/or prolonged economic downturns, systemic
contractions to specific industries, or systemic shocks to the
financial services sector. A downward/upward migration of the
balances from the current loan grade to the next lower/higher
loan grade was assumed based upon Heartland's experiences during
previous periods of economic movement.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the difference between interest income
earned on earning assets and interest expense paid on interest
bearing liabilities. As such, net interest income is affected by
changes in the volume and yields on earning assets and the volume
and rates paid on interest bearing liabilities. Net interest
margin is the ratio of tax equivalent net interest income to
average earning assets.
Net interest margin from continuing operations, expressed as a
percentage of average earning assets, was 4.04% for the year 2002
compared to 3.67% for the year 2001. Heartland has been
successful in the utilization of floors on its commercial loan
portfolio to minimize the effect downward rates have on its
interest income. If rates begin to edge upward, Heartland will
not see a corresponding increase in its interest income until
rates have moved above the floors in place on these loans.
Interest income as a percentage of average earning assets went
from 7.97% during 2001 to 6.93% during 2002, a decline of 104
basis points. Additionally, on the liability side of the balance
sheet, Heartland has locked in some funding in the three- to five-
year maturities as rates were at historical low levels. Interest
expense as a percentage of average earning assets went from 4.30%
during 2001 to 2.89% for 2002, a decline of 141 basis points.
Net interest margin from continuing operations, expressed as a
percentage of average earning assets, decreased from 3.74% during
2000 to 3.67% during 2001. During 2000, the national prime rate
increased from 8.50% at the beginning of the year to 9.50% at the
end of the year. Conversely, during 2001, the national prime rate
decreased from 9.50% to 4.75%. Management elected to remain
competitive in the market areas it serves and not reprice its
deposit products as quickly. In addition to the delay in
repricing of deposit products, also negatively impacting the net
interest margin was the change in the composition of the balance
sheet, as the percentage of average loans to total average
earning assets decreased from 80% in 2000 to 75% in 2001. Loan
growth slowed due to paydowns experienced in the mortgage loan
portfolio and reduced demand in the commercial loan portfolio.
Net interest income from continuing operations, on a fully tax
equivalent basis, was $59.3 million, $50.1 million and $45.0
million for 2002, 2001 and 2000, respectively, an increase of 18%
for 2002 and 11% for 2001. These increases were the largest
contributors to the double-digit growth in earnings experienced
during both years and were primarily attributable to the growth
in earning assets and the ability to keep the increase in
interest expense below the growth in interest income. Average
earning assets from continuing operations grew $103 million or 8%
and $162 million or 13% during 2002 and 2001, respectively.
Heartland continues to manage its balance sheet on a proactive
basis. The following table sets forth certain information
relating to Heartland's average consolidated balance sheets and
reflects the yield on average earning assets and the cost of
average interest bearing liabilities for the years indicated.
Dividing income or expense by the average balance of assets or
liabilities derives such yields and costs. Average balances are
derived from daily balances, and nonaccrual loans are included in
each respective loan category.
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES(1)
(Dollars in thousands)
For the Year Ended
December 31, 2002
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $ 305,315 $ 13,132 4.30%
Nontaxable(1) 52,756 4,177 7.92
---------- ----------
Total securities 358,071 17,309 4.83
---------- ----------
Interest bearing deposits 10,535 248 2.35
Federal funds sold 20,835 322 1.55
---------- ----------
Loans and leases:
Commercial and commercial
real estate(1) 665,431 45,480 6.83
Residential mortgage 142,469 10,518 7.38
Agricultural and agricultural
real estate(1) 150,485 10,941 7.27
Consumer 120,561 12,036 9.98
Direct financing leases, net 13,626 1,037 7.61
Fees on loans - 3,694 -
Less: allowance for loan
and lease losses (15,309) - -
---------- ----------
Net loans and leases 1,077,263 83,706 7.77
---------- ----------
Total earning assets 1,466,704 101,585 6.93
---------- ----------
NONEARNING ASSETS
Assets of discontinued operation 31,525 - -
Total nonearning assets 173,385 - -
---------- ----------
TOTAL ASSETS $1,671,614 $ 101,585 6.08%
========== ========== ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
Savings accounts $ 477,484 $ 6,530 1.37%
Time, $100 and over 124,063 4,505 3.63
Other time deposits 459,638 20,360 4.43
Short-term borrowings 134,949 2,643 1.96
Other borrowings 135,365 8,294 6.13
---------- ----------
Total interest bearing
liabilities 1,331,499 42,332 3.18
---------- ----------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 162,638 - -
Liabilities of discontinued
operation 31,525 - -
Accrued interest and other
liabilities 31,212 - -
---------- ----------
Total noninterest bearing
liabilities 225,375 - -
---------- ----------
Stockholders' Equity 114,740 - -
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,671,614 $ 42,332 2.53%
========== ========== ======
Net interest income(1) $ 59,253
==========
Net interest income
to total earning assets(1) 4.04%
======
Interest bearing liabilities
to earning assets 90.78%
==========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES(1)
(Dollars in thousands)
For the Year Ended
December 31, 2001
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $ 253,290 $ 14,143 5.58%
Nontaxable(1) 30,909 2,712 8.77
---------- ----------
Total securities 284,199 16,855 5.93
---------- ----------
Interest bearing deposits 7,320 243 3.32
Federal funds sold 49,126 1,981 4.03
---------- ----------
Loans and leases:
Commercial and commercial
real estate(1) 564,261 44,773 7.93
Residential mortgage 191,081 15,364 8.04
Agricultural and agricultural
real estate(1) 139,421 11,767 8.44
Consumer 126,027 13,278 10.54
Direct financing leases, net 16,574 1,242 7.49
Fees on loans - 3,197 -
Less: allowance for loan
and lease losses (14,528) - -
---------- ----------
Net loans and leases 1,022,836 89,621 8.76
---------- ----------
Total earning assets 1,363,481 108,700 7.97
---------- ----------
NONEARNING ASSETS
Assets of discontinued operation 31,951 - -
Total nonearning assets 162,900 - -
---------- ----------
TOTAL ASSETS $1,558,332 $ 108,700 6.98%
========== ========== ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
Savings accounts $ 425,258 $ 11,858 2.79%
Time, $100 and over 143,315 8,220 5.74
Other time deposits 441,325 25,705 5.82
Short-term borrowings 141,532 5,598 3.96
Other borrowings 106,267 7,239 6.81
---------- ----------
Total interest bearing
liabilities 1,257,697 58,620 4.66
---------- ----------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 138,694 - -
Liabilities of discontinued
operation 31,951 - -
Accrued interest and other
liabilities 29,154 - -
---------- ----------
Total noninterest bearing
liabilities 199,799 - -
---------- ----------
Stockholders' Equity 100,836 - -
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,558,332 $ 58,620 3.76%
========== ========== ======
Net interest income(1) $ 50,080
==========
Net interest income
to total earning assets(1) 3.67%
======
Interest bearing liabilities
to earning assets 92.24%
==========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES(1)
(Dollars in thousands)
For the Year Ended
December 31, 2000
Average
Balance Interest Rate
------- -------- ----
EARNING ASSETS
Securities:
Taxable $ 189,610 $ 11,824 6.24%
Nontaxable(1) 31,026 2,748 8.86
---------- ----------
Total securities 220,636 14,572 6.60
---------- ----------
Interest bearing deposits 5,796 333 5.75
Federal funds sold 16,874 911 5.40
---------- ----------
Loans and leases:
Commercial and commercial
real estate(1) 502,040 43,531 8.67
Residential mortgage 202,429 16,376 8.09
Agricultural and agricultural
real estate(1) 133,043 11,848 8.91
Consumer 118,455 12,625 10.66
Direct financing leases, net 15,027 1,056 7.03
Fees on loans - 2,400 -
Less: allowance for loan
and lease losses (12,984) - -
---------- ----------
Net loans and leases 958,010 87,836 9.17
---------- ----------
Total earning assets 1,201,316 103,652 8.63
---------- ----------
NONEARNING ASSETS
Assets of discontinued operation 18,777 - -
Total nonearning assets 150,305 - -
---------- ----------
TOTAL ASSETS $1,370,398 $ 103,652 7.56%
========== ========== ======
INTEREST BEARING LIABILITIES
Interest bearing deposits:
Savings accounts $ 382,365 $ 13,866 3.63%
Time, $100 and over 99,272 6,001 6.05
Other time deposits 399,952 23,274 5.82
Short-term borrowings 120,561 6,986 5.79
Other borrowings 113,706 8,551 7.52
---------- ----------
Total interest bearing
liabilities 1,115,856 58,678 5.26
---------- ----------
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits 123,411 - -
Liabilities of discontinued
operation 18,777 -
Accrued interest and other
liabilities 22,681 -
---------- ----------
Total noninterest bearing
liabilities 164,869 - -
---------- ----------
Stockholders' Equity 89,673 - -
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,370,398 $ 58,678 4.28%
========== ========== ======
Net interest income(1) $ 44,974
==========
Net interest income
to total earning assets(1) 3.74%
======
Interest bearing liabilities
to earning assets 92.89%
==========
(1) Tax equivalent basis is calculated using an effective tax
rate of 34%.
The following table allocates the changes in net interest income
to differences in either average balances or average rates for
earning assets and interest bearing liabilities. The changes have
been allocated proportionately to the change due to volume and
change due to rate. Interest income is measured on a tax
equivalent basis using a 34% tax rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in thousands)
For the Year Ended
December 31,
2002 Compared to 2001
Change Due to
Volume Rate Net
---------------------------
EARNING ASSETS/INTEREST INCOME
Securities
Taxable $ 2,905 $(3,916) $(1,011)
Nontaxable 1,917 (452) 1,465
Interest bearing deposits 107 (102) 5
Federal funds sold (1,141) (518) (1,659)
Loans and leases 4,769 (10,684) (5,915)
------- ------- -------
TOTAL EARNING ASSETS 8,557 (15,672) (7,115)
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
Savings accounts 1,456 (6,784) (5,328)
Time, $100 and over (1,104) (2,611) (3,715)
Other time deposits 1,067 (6,412) (5,345)
Short-term borrowings (260) (2,695) (2,955)
Other borrowings 1,982 (927) 1,055
------- ------- -------
TOTAL INTEREST BEARING
LIABILITIES 3,141 (19,429) (16,288)
------- ------- -------
NET INTEREST INCOME $ 5,416 $ 3,757 $ 9,173
======= ======= =======
ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in thousands)
For the Year Ended
December 31,
2001 Compared to 2000
Change Due to
Volume Rate Net
---------------------------
EARNING ASSETS/INTEREST INCOME
Securities
Taxable $ 3,971 $(1,652) $ 2,319
Nontaxable (10) (26) (36)
Interest bearing deposits 88 (178) (90)
Federal funds sold 1,741 (671) 1,070
Loans and leases 5,944 (4,159) 1,785
------- ------- -------
TOTAL EARNING ASSETS 11,734 (6,686) 5,048
LIABILITIES/INTEREST EXPENSE
Interest bearing deposits
Savings accounts 1,555 (3,563) (2,008)
Time, $100 and over 2,662 (443) 2,219
Other time deposits 2,408 23 2,431
Short-term borrowings 1,215 (2,603) (1,388)
Other borrowings (559) (753) (1,312)
------- ------- -------
TOTAL INTEREST BEARING
LIABILITIES 7,281 (7,339) (58)
------- ------- -------
NET INTEREST INCOME $ 4,453 $ 653 $ 5,106
======= ======= =======
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 $3.6 million
provision for loan losses made during 2002, a decrease of $705
thousand or 17% when compared to 2001, resulted primarily from a
large recovery on a prior-year charge-off and a decrease in
nonperforming loans. The provision for loan losses made during
2001 was $4.3 million, an increase of $1.3 million or 43% when
compared to the $3.0 million provision made during 2000. Much of
this increase was recorded in response to loan growth experienced
and an increase 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 probable 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 (Dollars in thousands)
For the Years Ended
December 31,
2002 2001 2000
---------------------------
Service charges and fees $ 8,089 $ 6,308 $ 5,357
Trust fees 3,407 3,148 3,088
Brokerage commissions 658 615 846
Insurance commissions 765 807 862
Securities gains, net 790 1,489 501
Loss on trading account securities (598) (417) -
Impairment loss on equity
securities (267) (773) (244)
Valuation adjustment on mortgage
servicing rights (469) - -
Rental income on operating leases 14,602 15,446 14,918
Gains on sale of loans 4,656 2,738 521
Other noninterest income 1,124 900 1,130
------- ------- -------
Total noninterest income $32,757 $30,261 $26,979
======= ======= =======
The table shows Heartland's noninterest income for the years
indicated. Total noninterest income from continuing operations
increased $2.5 million or 8% during 2002 and $3.3 million or 12%
during 2001. Exclusive of valuation adjustments on mortgage
servicing rights and securities gains and losses, including
trading account securities losses and impairment losses on equity
securities, noninterest income experienced a $3.3 million or 11%
increase in 2002 and a $3.2 million or 12% increase in 2001.
During both periods, the noninterest income categories reflecting
significant improvement were gains on sale of loans and service
charges and fees.
Emphasis during the past several years on enhancing revenues from
services provided to customers has resulted in significant growth
in service charges and fees. These fees increased $1.8 million or
28% during 2002 and $951 thousand or 18% during 2001. Average
noninterest bearing checking account balances increased $23.9
million or 17% during 2002 and $15.8 million or 12% during 2001.
The addition of an overdraft privilege feature to our checking
account product line during the fall of 2001, along with growth
in these noninterest bearing checking account balances, resulted
in the generation of additional service charge revenue related to
activity fees charged to these accounts. Service fees are also
collected on the mortgage loans Heartland has sold into the
secondary market while retaining servicing. Heartland's servicing
portfolio grew from $183.9 million at year-end 2000 and $268.6
million at year-end 2001 to $395.1 million at December 31, 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 totaled $4.7 million during 2002, $2.7
million during 2001 and $521 thousand during 2000. 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. The lower
volume of mortgage loans sold into the secondary market during
2000 was reflective of a higher rate environment in which
customers elected to take three- and five-year adjustable rate
mortgage loans, which Heartland elected to retain in its loan
portfolio.
Securities gains were $790 thousand, $1.5 million and $501
thousand during 2002, 2001 and 2000, respectively. The continual
decline of interest rates during 2001 provided an opportunity for
Heartland to realize securities gains in its bond portfolio. As
rates declined in 2001, Heartland's interest rate forecast
changed to an upward bias and therefore, longer-term agency
securities were sold at a gain to shorten the portfolio. In order
to reduce the interest rate risk of rising interest rates, the
proceeds were invested in well-seasoned premium mortgage backed
securities that were projected to outperform the agency
securities in a rising interest 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 $598 thousand during 2002
compared to losses of $417 thousand during 2001. The losses
primarily resulted from the decline in the stock market.
Impairment losses on equity securities totaled $267 thousand
during 2002. These losses were related to the decline in market
value on the common stock of three companies held in Heartland's
available for sale equity securities portfolio. The carrying
value of these stocks on Heartland's balance sheet at December
31, 2002, was $206 thousand. During 2001, impairment losses on
equity securities totaled $773 thousand. Heartland was a limited
partner in an investment partnership that had a portion of its
funds invested in a company that filed bankruptcy under Chapter
11 in 2001. The impairment loss recorded on this investment
totaled $700 thousand and reflected Heartland's 30% ownership.
During 2002, Heartland began the process of divesting its
interest in this partnership. The fair value of the remaining
portion of Heartland's investment in this partnership at December
31, 2002, was $10 thousand. The remaining $73 thousand of
impairment losses recorded during 2001 related to common stock
held in the available for sale equity securities portfolio, all
of which stock was sold during 2002. Similarly, during 2000, an
impairment loss on equity securities of $244 thousand was
recorded. This loss resulted from the announcement that Safety
Kleen Corp. had filed bankruptcy under Chapter 11. Heartland
held 20,000 shares of Safety Kleen's common stock in its equity
portfolio, which stock was sold during 2002.
Valuation adjustments on mortgage servicing rights totaled a $469
thousand loss during 2002. The valuation of Heartland's mortgage
servicing rights declined since year-end 2001 as a result of the
further drop in mortgage loan interest rates. Heartland utilizes
the services of an independent third-party to perform a valuation
analysis of its servicing portfolio each quarter.
NONINTEREST EXPENSE (Dollars in thousands)
For the Years Ended
December 31,
2002 2001 2000
---------------------------
Salaries and employee
benefits $28,571 $25,182 $23,645
Occupancy 3,178 3,014 2,876
Furniture and equipment 3,273 3,144 2,989
Depreciation on equipment under
operating leases 11,555 11,805 11,199
Outside services 4,318 3,433 2,634
FDIC deposit insurance
assessment 209 208 228
Advertising 1,917 1,588 1,482
Goodwill amortization - 1,057 1,057
Core deposit premium amortization 495 615 757
Other noninterest expenses 9,255 8,287 7,203
------- ------- -------
Total noninterest expense $62,771 $58,333 $54,070
======= ======= =======
Efficiency ratio(1) 68.81% 73.98% 75.67%
======= ======= =======
(1) Noninterest expense divided by the sum of net interest
income and noninterest income less securities gains.
The table shows Heartland's noninterest expense for the years
indicated. Noninterest expense from continuing operations
increased $4.4 million or 8% in 2002 and $4.3 million or 8% in
2001. Growth in some of these expenses began to taper off in 2001
as Heartland began to realize the full utilization of the
resources it expended during the early stages of its 1999 and
2000 growth initiatives.
Salaries and employee benefits expense, the largest component of
noninterest expense, experienced increases of $3.4 million or 13%
and $1.5 million or 7% during 2002 and 2001, respectively. In
addition to normal merit increases, these increases were also
attributable to expansion efforts, primarily at New Mexico Bank &
Trust. The number of full-time equivalent employees increased
from 544 at December 31, 2000 to 581 at December 31, 2001, and
606 at December 31, 2002.
Fees for outside services increased $885 thousand or 26% during
2002 and $799 thousand or 30% during 2001. Contributing to these
increases were the following:
- A consultant was engaged to assist in the
implementation of an overdraft privilege feature on
Heartland's checking account products during 2001. The
fee associated with these services was accrued and
payable monthly during the last quarter of 2001 and
throughout all of 2002 based upon the additional fees
generated.
- Beginning in 2002, 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.
- During 2002, legal fees were paid 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. Legal and professional fees related to
Heartland's continuing exploration of potential
acquisitions also were paid during 2001.
- Beginning in 2001, Heartland elected to outsource its
internal audit function instead of fully staffing an
internal audit department.
- As a result of enhancing the fleet card program at
ULTEA, additional conversion costs were incurred during
2001.
During 2002, advertising/public relations expense increased $329
thousand or 21%. Dubuque Bank and Trust deposited $200 thousand
into its charitable trust fund during 2002. This fund provides a
source for future charitable giving.
Other noninterest expenses increased $968 thousand or 12% during
2002 and $1.1 million or 15% during 2001. A large portion of the
2002 increase was the result of additional processing fees
related to increased activity in the merchant credit card
processing area and additional minority interest related to the
improved earnings at New Mexico Bank & Trust. During 2001, a
large portion of the increase was also the result of additional
processing fees related to increased activity in the merchant
credit card processing area and growth in amortization and
maintenance expense on software.
Heartland's adoption of the provisions of FAS 142 on January 1,
2002, and FAS 147 on September 30, 2002, discontinued the
amortization of $16.1 million in unamortized goodwill. The amount
of amortization expense recorded during both 2001 and 2000 on
this goodwill was $1.1 million.
INCOME TAXES
Income tax expense increased $3.3 million or 57% for 2002 and
$1.5 million or 36% for 2001, primarily as a result of increased
pre-tax earnings. The discontinued operations and related gain on
sale of our Eau Claire branch was responsible for $1.5 million or
45% of the 2002 increase in income taxes. Heartland's effective
tax rate was 32.3% for 2002, 33.4% for 2001 and 30.5% for 2000.
The effective tax rate grew in 2001, in part, as a result of the
amount of additional merger-related goodwill and other
intangibles amortization expense recorded that was not deductible
for federal income tax purposes. These expenses grew as a
percentage of pre-tax income from 4.26% in 2000 to 5.71% in 2001.
Tax-exempt interest income on securities and loans as a
percentage of pre-tax income has varied over the past several
years. Tax-exempt interest income was 10% of pre-tax income
during 2002 and 2001 compared to 13% for 2000. 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.
FINANCIAL CONDITION
LENDING ACTIVITIES
Heartland's major source of income is interest on loans and
leases. The table below presents the composition of Heartland's
loan portfolio at the end of the years indicated.
LOAN PORTFOLIO (Dollars in thousands)
December 31,
2002 2001
Amount Percent Amount Percent
---------- ------- ---------- -------
Commercial and commercial
real estate $ 743,520 63.10% $ 651,479 58.73%
Residential mortgage 145,931 12.39 168,912 15.23
Agricultural and
agricultural real estate 155,596 13.21 145,460 13.11
Consumer 120,853 10.26 127,874 11.53
Lease financing, net 12,308 1.04 15,570 1.40
---------- ------- ---------- -------
Gross loans and leases 1,178,208 100.00% 1,109,295 100.00%
======= =======
Unearned discount (2,161) (3,457)
Deferred loan fees (811) (633)
---------- ----------
Total loans and leases 1,175,236 1,105,205
Allowance for loan and
lease losses (16,091) (14,660)
---------- ----------
Loans and leases, net $1,159,145 $1,090,545
========== ==========
LOAN PORTFOLIO (Dollars in thousands)
December 31,
2000 1999
Amount Percent Amount Percent
---------- ------- ---------- -------
Commercial and commercial
real estate $ 550,366 52.62% $ 448,991 53.53%
Residential mortgage 215,638 20.62 180,347 21.50
Agricultural and
agricultural real estate 133,614 12.78 92,936 11.08
Consumer 128,685 12.30 103,608 12.35
Lease financing, net 17,590 1.68 12,886 1.54
---------- ------- ---------- -------
Gross loans and leases 1,045,893 100.00% 838,768 100.00%
======= =======
Unearned discount (3,397) (3,169)
Deferred loan fees (400) (453)
---------- ----------
Total loans and leases 1,042,096 835,146
Allowance for loan and
lease losses (13,592) (10,844)
---------- ----------
Loans and leases, net $1,028,504 $ 824,302
========== ==========
LOAN PORTFOLIO (Dollars in thousands)
December 31,
1998
Amount Percent
-------- -------
Commercial and commercial
real estate $277,765 46.88%
Residential mortgage 156,415 26.40
Agricultural and
agricultural real estate 77,211 13.03
Consumer 72,642 12.26
Lease financing, net 8,508 1.43
-------- -------
Gross loans and leases 592,541 100.00%
=======
Unearned discount (2,136)
Deferred loan fees (272)
--------
Total loans and leases 590,133
Allowance for loan and
lease losses (7,945)
--------
Loans and leases, net $582,188
========
The table below sets forth the remaining maturities by loan and
lease category.
MATURITY AND RATE SENSITIVITY OF LOANS AND LEASES(1)
December 31, 2002 (Dollars in thousands)
Over 1 Year
Through 5 Years
One Year Fixed Floating
or less Rate Rate
----------------------------------
Commercial and commercial
real estate $ 261,341 $ 244,846 $ 154,777
Residential mortgage 62,087 19,492 20,760
Agricultural and
agricultural real estate 73,565 39,231 25,708
Consumer 33,319 48,762 13,075
Lease financing, net 3,876 8,142 -
---------- ---------- ----------
Total $ 434,188 $ 360,473 $ 214,320
========== ========== ==========
Over 5 Years
Fixed Floating
Rate Rate Total
----------------------------------
Commercial and commercial
real estate $ 30,146 $ 52,410 $ 743,520
Residential mortgage 13,235 30,357 145,931
Agricultural and
agricultural real estate 5,970 11,122 155,596
Consumer 4,973 20,724 120,853
Lease financing, net 290 - 12,308
---------- ---------- ----------
Total $ 54,614 $ 114,613 $1,178,208
========== ========== ==========
(1) Maturities based upon contractual dates.
Heartland experienced growth in net loans and leases during both
2002 and 2001. This growth was $68.6 million or 6% in 2002 and
$62.0 million or 6% in 2001. Exclusive of the $30.0 million loans
included in the sale of the Eau Claire branch, net loans and
leases grew by $98.6 million or 9% during 2002. This increase was
attributable to growth in the commercial and agricultural loan
portfolios and would have been more significant had the mortgage
and consumer loan portfolios not experienced declines. Loan
growth during 2001 was slower than during 2000 due to paydowns
experienced in the mortgage loan portfolio and reduced demand in
the commercial loan portfolio, particularly during the first half
of the year. Growth in the commercial loan portfolio increased
during the remaining half of 2001 and continued into 2002.
The largest growth occurred in commercial and commercial real
estate loans, which increased $92.0 million or 14% during 2002
and $101.1 million or 18% during 2001. All the loans included in
the Eau Claire branch sale were classified as commercial and
commercial real estate. Exclusive of those loans, this category
of the loan portfolio grew $122.0 million or 20%. All the bank
subsidiaries, except for First Community Bank, experienced growth
in this loan category, principally as a result of continued
calling efforts.
Agricultural and agricultural real estate loans outstanding
experienced an increase of $10.1 million or 7% during 2002. Over
75% of this growth occurred at Dubuque Bank and Trust Company,
Heartland's flagship bank in Dubuque, Iowa. During 2001,
agricultural and agricultural real estate loans outstanding grew
$11.8 million or 9%, the majority of which occurred at New Mexico
Bank & Trust's office in Clovis and at Dubuque Bank and Trust
Company.
The residential mortgage loan portfolio experienced a decline of
$23.0 million or 14% during 2002 and $46.7 million or 22% during
2001, as customers refinanced 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 $395.1 million at December 31, 2002.
During both years, long-term rates were at all-time lows and many
customers were anxious to lock in these low rates for a longer
period of time on their mortgage loans.
Consumer loan outstandings declined $7.0 million or 5% during
2002, as the economy continued to weaken and consumers were
provided other sources of financing, e.g., zero percent
automobile financing through dealerships. During 2001, consumer
loan outstandings remained relatively flat, as the economy began
to weaken and consumers were provided other sources of financing.
Although the risk of nonpayment for any reason exists with
respect to all loans, specific risks are associated with each
type of loan. The primary risks associated with commercial and
agricultural loans are the quality of the borrower's management
and the impact of national and regional economic factors.
Additionally, risks associated with commercial and agricultural
real estate loans include fluctuating property values and
concentrations of loans in a specific type of real estate.
Repayment on loans to individuals, including those on residential
real estate, are dependent on the borrower's continuing financial
stability, and thus are more likely to be affected by adverse
personal circumstances and deteriorating economic conditions.
Heartland monitors its loan concentrations and does not believe
it has concentrations in any specific industry.
Heartland's strategy with respect to the management of these
types of risks, whether loan demand is weak or strong, is to
encourage the Heartland banks to follow tested and prudent loan
policies and underwriting practices which include: (i) granting
loans on a sound and collectible basis; (ii) ensuring that
primary and secondary sources of repayment are adequate in
relation to the amount of the loan; (iii) administering loan
policies through a board of directors and an officers' loan
committee; (iv) developing and maintaining adequate
diversification of the loan portfolio as a whole and of the loans
within each loan category; and (v) ensuring that each loan is
properly documented and, if appropriate, guaranteed by government
agencies and that insurance coverage is adequate.
NONPERFORMING LOANS AND LEASES AND OTHER NONPERFORMING ASSETS
The table below sets forth the amounts of nonperforming loans and
leases and other nonperforming assets on the dates indicated.
NONPERFORMING ASSETS (Dollars in thousands)
December 31,
2002 2001 2000 1999 1998
------------------------------------
Nonaccrual loans and
leases $3,944 $7,269 $5,860 $1,414 $1,324
Loan and leases
contractually past
due 90 days or more 541 500 523 236 426
Restructured loans
and leases - 354 357 - -
------ ------ ------ ------ ------
Total nonperforming
loans and leases 4,485 8,123 6,740 1,650 1,750
Other real estate 452 130 489 514 832
Other repossessed assets 279 343 219 138 102
------ ------ ------ ------ ------
Total nonperforming assets $5,216 $8,596 $7,448 $2,302 $2,684
====== ====== ====== ====== ======
Nonperforming loans and
leases to total loans
and leases 0.38% 0.73% 0.65% 0.20% 0.30%
Nonperforming assets
to total loans and
leases plus repossessed
property 0.44% 0.78% 0.71% 0.28% 0.45%
Nonperforming assets to
total assets 0.29% 0.52% 0.51% 0.19% 0.28%
Under Heartland's internal loan review program, a loan review
officer is responsible for reviewing existing loans and leases,
identifying potential problem loans and leases and monitoring the
adequacy of the allowance for loan and lease losses at the
Heartland banks.
Heartland constantly monitors and continues to develop systems to
oversee the quality of its loan portfolio. One integral part is a
loan rating system, which assigns a rating on each loan and lease
within the portfolio based on the borrower's financial position,
repayment ability, collateral position and repayment history.
This emphasis on quality is reflected in Heartland's credit
quality figures, which compare favorably to peer data in the Bank
Holding Company Performance Reports published by the Federal
Reserve Board for bank holding companies with total assets of $1
to $3 billion. In this report, the peer group reported
nonperforming assets to total assets of 0.63% and 0.59% for
September 30, 2002, and December 31, 2001, respectively.
Heartland's ratios at December 31, 2002 and 2001, were 0.29% and
0.52%, respectively.
Nonperforming loans, defined as nonaccrual loans, restructured
loans and loans past due ninety days or more, decreased to .38%
of total loans and leases at December 31, 2002, compared to .73%
of total loans and leases at December 31, 2001. A portion of this
decrease was the result of one large credit that was partially
paid off. Nonperforming loans increased to 0.73% of total loans
and leases at December 31, 2001, compared to 0.65% of total loans
and leases at December 31, 2000. Contributing to this increase in
nonperforming loans at year-end 2001 were a $1.4 million and $1.5
million increase at Wisconsin Community Bank and New Mexico Bank
& Trust, respectively. These increases were attributable to a few
large credits and not felt to be an indication of a trend in
either of these newer markets for Heartland. These increases were
offset by a $2.3 million reduction in nonperforming loans at
Dubuque Bank and Trust Company, as payments totaling $1.5 million
were received during the first quarter of 2001 and a $900
thousand charge-off was recorded during the last quarter of 2001
on the same credit. Workout plans are in process on a majority of
Heartland's nonperforming loans and, because of the net
realizable value of collateral, guarantees and other factors,
anticipated losses on these credits are expected to be minimal. 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.
ALLOWANCE FOR LOAN AND LEASE LOSSES
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 $1.4 million
or 10% during 2002 and $1.1 million or 8% during 2001. The
allowance for loan and lease losses at December 31, 2002, was
1.37% of loans and 359% of nonperforming loans, compared to 1.33%
of loans and 180% of nonperforming loans, at year-end 2001. A
portion of the growth in the allowance for loan and lease losses
occurred as a result of the expansion of the loan portfolio
during both years.
During 2002, Heartland recorded net charge offs of $1.8 million
compared to $3.2 million in 2001. The decrease in net charge-offs
during 2002 was primarily the result of a large recovery on a
prior year charge-off. Citizens Finance Co., Heartland's consumer
finance subsidiary, experienced net charge-offs of $1.2 million
or 66% of total net charge-offs during 2002 compared to $1.0
million or 32% during 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 5.17% for 2002 compared to 4.37% for 2001. Loans with
payments past due for more than thirty days at Citizens remained
constant at 5.30% of gross loans at December 31, 2001 and 5.27%
at December 31, 2002.
The table below summarizes activity in the allowance for loan and
lease losses for the years indicated, including amounts of loans
and leases charged off, amounts of recoveries, additions to the
allowance charged to income and the ratio of net charge-offs to
average loans and leases outstanding.
ANALYSIS OF ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in
thousands)
For the years ended
December 31,
2002 2001 2000 1999 1998
------------------------------------------
Allowance at
beginning of year $14,660 $13,592 $10,844 $ 7,945 $7,362
Charge-offs:
Commercial and
commercial real
estate 795 1,477 407 81 289
Residential mortgage 38 32 54 - 20
Agricultural and
agricultural real
estate 279 463 580 8 41
Consumer 2,085 1,785 1,239 546 473
Lease financing 6 - - - -
------- ------- ------- ------ ------
Total charge-offs 3,203 3,757 2,280 635 823
------- ------- ------- ------ ------
Recoveries:
Commercial and
commercial
real estate 836 79 97 74 372
Residential mortgage 8 - 4 12 -
Agricultural and
agricultural
real estate 177 108 176 6 1
Consumer 389 355 308 151 82
Lease financing - - - - -
------- ------- ------- ------ ------
Total recoveries 1,410 542 585 243 455
------- ------- ------- ------ ------
Net charge-offs(1) 1,793 3,215 1,695 392 368
Provision for loan
and lease losses
from continuing
operations 3,553 4,258 2,976 2,550 951
Provision for loan
and lease losses
from discontinued
operations (329) 25 325 76 -
Additions related
to acquisitions - - 1,142 665 -
------- ------- ------- ------ ------
Allowance at end
of year $16,091 $14,660 $13,592 $10,844 $7,945
======= ======= ======= ====== ======
Net charge-offs to
average loans and
leases 0.16% 0.30% 0.17% 0.06% 0.07%
======= ======= ======= ====== ======
(1) Includes net charge-offs at Citizens Finance, Heartland's
consumer finance company, of $1,182 for 2002 $1,043 for
2001, $614 for 2000, $256 for 1999,and $278 for 1998.
The table below shows Heartland's allocation of the allowance for
loan and lease losses by types of loans and leases and the amount
of unallocated reserves. The amount of unallocated reserves has
decreased over the past two years as Heartland has enhanced its
allowance adequacy methodology to identify a specific allowance
for each credit.
ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in
thousands)
As of December 31,
2002 2001
---------------------------------------
Loan/ Loan/
Lease Lease
Category Category
to Gross to Gross
Loans & Loans &
Amount Leases Amount Leases
------ -------- ------ --------
Commercial and
commercial real
estate $ 8,408 63.10% $ 7,534 58.73%
Residential
mortgage 1,328 12.39 1,192 15.23
Agricultural and
agricultural real
estate 2,239 13.21 2,214 13.11
Consumer 2,083 10.26 2,009 11.53
Lease financing 140 1.04 162 1.40
Unallocated 1,893 - 1,549 -
------- ------- ------- -------
$16,091 100.00% $14,660 100.00%
======= ======= ======= =======
ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in
thousands)
As of December 31,
2000 1999
---------------------------------------
Loan/ Loan/
Lease Lease
Category Category
to Gross to Gross
Loans & Loans &
Amount Leases Amount Leases
------- ------- ------ -------
Commercial and
commercial real
estate $ 7,324 52.62% $ 6,108 53.53%
Residential
mortgage 1,004 20.62 756 21.50
Agricultural and
agricultural real
estate 2,377 12.78 1,016 11.08
Consumer 1,743 12.30 1,917 12.35
Lease financing 106 1.68 91 1.54
Unallocated 1,038 - 956 -
------- ------- ------- -------
$13,592 100.00% $10,844 100.00%
======= ======= ======= =======
ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in
thousands)
As of December 31, 1998
--------------------------
Loan/
Lease
Category
to Gross
Loans &
Amount Leases
------ -------
Commercial and commercial
real estate $2,180 46.88%
Residential mortgage 697 26.40
Agricultural and agricultural
real estate 583 13.03
Consumer 1,096 12.26
Lease financing(1) 44 1.43
Unallocated 3,345 -
------ -------
$7,945 100.00%
====== =======
SECURITIES
The composition of Heartland's securities portfolio is managed to
maximize the return on the portfolio while considering the impact
it has on Heartland's asset/liability position and liquidity
needs. Securities represented 22% of total assets at December 31,
2002, as compared to 20% at December 31, 2001. As loan growth
lagged deposit growth during the first half of 2002, the amount
of securities held in Heartland's portfolio was increased.
Additionally, Heartland increased its securities portfolio as
opposed to holding excess liquidity in lower-yielding federal
funds sold.
During 2002, management changed the composition of the securities
portfolio. Additional paydowns received on mortgage-backed
securities were replaced with short-term U.S. government agency
securities and municipal securities. Management purchased some
longer-term municipal securities to take advantage of the
unusually steep slope in the yield curve and the spread of the
tax-equivalent yield on municipal securities over the yield on
agency securities with the same maturities. Also 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.
During 2001, as Heartland's interest rate forecast changed to one
of rising rates, except for the short end of the yield curve,
management elected to shift a portion of its securities portfolio
into mortgage-backed securities from U.S. government agencies.
Tightly structured tranches in well-seasoned mortgage-backed
securities were purchased to enhance the performance of the
portfolio given a rise in interest rates.
Heartland implemented Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging
Activities," on January 1, 2001. At that date, all investments
previously included in Heartland's held to maturity investment
portfolio were reclassified to the available for sale investment
portfolio. The tables below present the composition and
maturities of the securities portfolio by major category.
SECURITIES PORTFOLIO COMPOSITION (Dollars in thousands)
Total
% of
December 31, 2002 Amount Portfolio
-------------------
U.S. government corporations
and agencies and treasuries $101,339 25.99%
Mortgage-backed securities 187,318 48.04
States and political
subdivisions 71,391 18.31
Other securities 29,852 7.66
-------- -------
Total $389,900 100.00%
======== =======
SECURITIES PORTFOLIO COMPOSITION (Dollars in thousands)
Total
% of
December 31, 2001 Amount Portfolio
-------------------
U.S. government corporations and
agencies and treasuries $ 79,234 24.48%
Mortgage-backed securities 183,661 56.74
States and political
subdivisions 30,948 9.56
Other securities 29,846 9.22
-------- -------
Total $323,689 100.00%
======== =======
SECURITIES PORTFOLIO COMPOSITION (Dollars in thousands)
Held to Maturity Available for Sale
% of % of
December 31, 2000 Amount Portfolio Amount Portfolio
---------------------------------------
U.S. government
corporations and
agencies and treasuries $ - -% $118,897 52.13%
Mortgage-backed
securities - - 53,407 23.42
States and political
subdivisions 2,111 0.93 31,933 14.00
Other securities - - 21,717 9.52
------ ------- -------- -------
Total $2,111 0.93% $225,954 99.07%
====== ======= ======== =======
SECURITIES PORTFOLIO COMPOSITION (Dollars in thousands)
Total
% of
December 31, 2000 Amount Portfolio
-------------------
U.S. government corporations
and agencies and treasuries $118,897 52.13%
Mortgage-backed securities 53,407 23.42
States and political
subdivisions 34,044 14.93
Other securities 21,717 9.52
-------- -------
Total $228,065 100.00%
======== =======
SECURITIES PORTFOLIO MATURITIES (Dollars in thousands)
After One But
Within One Year Within Five Years
--------------- -----------------
December 31, 2002 Amount Yield Amount Yield
------------------------------------
U.S. government
corporations and
agencies and
treasuries $45,879 5.84% $ 49,881 4.77%
Mortgage-backed
securities 52,093 4.83 117,709 4.58
States and political
subdivisions(1) 460 2.93 7,006 6.42
------- --------
Total $98,432 5.29% $174,596 4.71%
======= ====== ======== =======
SECURITIES PORTFOLIO MATURITIES (Dollars in thousands)
After Five But
Within Ten Years After Ten Years
---------------- -----------------
December 31, 2002 Amount Yield Amount Yield
------------------------------------
U.S. government
corporations and
agencies and
treasuries $ 5,579 3.25% $ - -%
Mortgage-backed
securities 8,999 5.85 8,517 6.42
States and political
subdivisions(1) 27,105 7.13 36,820 7.53
------- -------
Total $41,683 6.34% $45,337 7.32%
======= ======= ======= ======
SECURITIES PORTFOLIO MATURITIES (Dollars in thousands)
Total
December 31, 2002 Amount Yield
-------------------
U.S. government corporations
and agencies and treasuries $101,339 5.17%
Mortgage-backed securities 187,318 4.79
States and political
subdivisions(1) 71,391 7.24
--------
Total $360,048 5.39%
======== ======
(1) Rates on obligations of states and political subdivisions
have been adjusted to tax equivalent yields using a 34%
income tax rate.
DEPOSITS AND BORROWED FUNDS
Total average deposits experienced an increase of $99.4 million
or 9% during 2002 compared to an increase of $144.2 million or
14% during 2001. Total average deposits were $1.252 billion
during 2002, $1.153 billion during 2001 and $1.009 billion during
2000. The Eau Claire branch sale included deposits of $6.7
million. Exclusive of those deposits, growth in average deposits
was $106.1 million or 9% during 2002. Increases in total deposits
occurred at all of the bank subsidiaries except for First
Community Bank.
All deposit categories, except for time deposits over $100,000,
experienced growth during 2002. Average demand deposit account
balances increased $24.4 million or 17%. All the Heartland bank
subsidiaries experienced double-digit growth in these balances
except for First Community Bank. Average savings deposit account
balances increased by $60.8 million or 14% and average time
deposits under $100,000 grew by $33.3 million or 8% during 2002.
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. A
portion of the growth in certificate of deposit account balances
was also attributable to the implementation of a balance sheet
management strategy that included the acquisition of brokered
deposits. Average balances in time deposits over $100,000
decreased during 2002 by $19.1 million or 13%. These accounts are
typically obtained via a bidding process and Heartland management
elected to not aggressively pursue these deposits.
During 2001, the demand and savings deposit categories
experienced growth in excess of 10% and most of this growth was
reflective of increased marketing efforts and customers' election
to keep funds on deposit in a financial institution as the
volatility in the stock market continued. Half of the $15.8
million or 13% growth in average demand deposits occurred at New
Mexico Bank & Trust in Albuquerque, New Mexico. The $42.9 million
or 11% growth in average savings deposits resulted from growth in
all of the markets served by the Heartland banks. The money
market product line was enhanced during 2000 and much of the
growth in savings was attributable to marketing efforts focused
on attracting new customers into this product line, as well as,
customers' election to keep funds on deposit in a financial
institution as the volatility in the stock market continued.
Average time deposits grew by $85.5 million or 17%. Again, all
the Heartland banks experienced growth in this deposit category.
As long-term rates moved downward during 2001, efforts were
initiated to attract customers into certificates of deposit with
a maturity exceeding two years.
The table below sets forth the distribution of Heartland's
average deposit account balances and the average interest rates
paid on each category of deposits for the years indicated.
AVERAGE DEPOSITS (Dollars in thousands)
For the year ended December 31, 2002
Percent
Average of
Balance Deposits Rate
--------------------------
Demand deposits $ 164,280 13.12% -%
Savings accounts 488,756 39.03 1.37
Time deposits less than $100 474,817 37.92 4.41
Time deposits of $100 or more 124,321 9.93 3.62
---------- -------
Total deposits $1,252,174 100.00%
========== =======
AVERAGE DEPOSITS (Dollars in thousands)
For the year ended December 31, 2001
Percent
Average of
Balance Deposits Rate
--------------------------
Demand deposits $ 139,870 12.13% -%
Savings accounts 427,953 37.13 2.80
Time deposits less than $100 441,505 38.30 5.82
Time deposits of $100 or more 143,429 12.44 5.74
---------- -------
Total deposits $1,152,757 100.00%
========== =======
AVERAGE DEPOSITS (Dollars in thousands)
For the year ended December 31, 2000
Percent
Average of
Balance Deposits Rate
--------------------------
Demand deposits $ 124,117 12.30% -%
Savings accounts 385,047 38.18 3.61
Time deposits less than $100 400,096 39.67 5.82
Time deposits of $100 or more 99,322 9.85 6.04
---------- -------
Total deposits $1,008,582 100.00%
========== =======
The following table sets forth the amount and maturities of time
deposits of $100,000 or more at December 31, 2002.
Time Deposits $100,000 and Over (Dollars in thousands)
December 31,
2002
------------
3 months or less $ 44,805
Over 3 months through 6 months 26,221
Over 6 months through 12 months 25,284
Over 12 months 29,918
--------
$126,228
========
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. At
year-end 2002, the $161.4 million of short-term borrowings was
consistent with the $160.7 million outstanding at year-end 2001.
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. These balances declined
$9.6 million since year-end 2001 as interest rates continued at
all-time low levels and some of these repurchase agreement
customers elected to invest a portion of their excess funds in
higher-yielding products. From year-end 2000 to year-end 2001,
these balances grew from $93.0 million to $108.6 million,
principally as a result of the entry into new markets.
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 December 31, 2002, $25.0 million was outstanding as compared
to $29.2 million at December 31, 2001.
The following table reflects short-term borrowings, which in the
aggregate have average balances during the period greater than
30% of stockholders' equity at the end of the period.
SHORT-TERM BORROWINGS (Dollars in thousands)
At or for the
Year Ended December 31,
2002 2001 2000
----------------------------
Balance at end of period $161,379 $160,703 $139,909
Maximum month-end amount
outstanding 161,379 162,744 144,604
Average month-end amount
outstanding 140,282 151,139 122,777
Weighted average interest
rate at year-end 1.59% 1.39% 5.60%
Weighted average interest
rate for the year 1.96% 3.96% 5.79%
Other borrowings include all debt arrangements Heartland and its
subsidiaries have entered into with original maturities that
extend beyond one year. These borrowings were $126.3 million on
December 31, 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 December 31, 2002, and
December 31, 2001, were $72.5 million and $86.5 million,
respectively. Substantially all of these borrowings are fixed-
rate advances for original terms between three and five years.
As advance rates moved downward during 2001 to historically low
levels, Heartland elected to obtain additional advances to lock
in funding for anticipated fixed-rate commercial loan growth and
replace the maturity of advances during the first half of 2002.
Additionally, balances outstanding on capital securities issued
by Heartland are included in total other borrowings. The issuance
in October of 1999 for $25.0 million bears an annual rate of
9.60% and matures on September 30, 2029. A private placement
offering for $8.0 million was completed in December of 2001. This
variable rate issuance matures on December 18, 2031, and bears
interest at the rate of 3.60% per annum over the three-month
LIBOR rate, as calculated each quarter. An additional private
placement offering for $5.0 million was completed in June of
2002. This additional variable rate issuance matures on June 30,
2032, and bears interest at the rate of 3.65% per annum over the
three-month LIBOR rate, as calculated each quarter.
The following table summarizes significant contractual
obligations and other commitments as of December 31, 2002:
Payments Due By Period
----------------------------------
Less More
Than One- Three- Than
One Three Five Five
Total Year Years Years Years
Contractual
Obligations:
Long-term debt
obligations $126,299 $ 10,157 $ 46,824 $ 20,578 $ 48,740
Operating lease
obligations 3,277 536 1,258 772 711
Purchase
obligations 4,469 3,845 624 - -
Other long-term
liabilities 4,359 - 3,610 - 749
-------- -------- -------- -------- --------
Total contractual
obligations $138,404 $ 14,538 $ 52,316 $ 21,350 $ 50,200
======== ======== ======== ======== ========
Other
commitments:
Lines of credit $391,144 $237,849 $ 57,398 $ 17,433 $ 78,464
Standby letters
of credit 11,803 9,543 307 55 1,898
Other
commitments 21,418 21,418 - - -
-------- -------- -------- -------- --------
Total other
commitments $424,365 $268,810 $ 57,705 $ 17,488 $ 80,362
======== ======== ======== ======== ========
Since many of these commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily
represent future cash flow requirements.
CAPITAL RESOURCES
Heartland's risk-based capital ratios, which take into account
the different credit risks among banks' assets, met all capital
adequacy requirements over the past three years. Tier 1 and total
risk-based capital ratios were 10.65% and 11.86%, respectively,
on December 31, 2002, compared with 9.71% and 10.89%,
respectively, on December 31, 2001, and 8.74% and 9.90%,
respectively, on December 31, 2000. At December 31, 2002,
Heartland's leverage ratio, the ratio of Tier 1 capital to total
average assets, was 8.24% compared to 7.53% and 7.25% at December
31, 2001 and 2000, respectively. 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.
Commitments for capital expenditures are an important factor in
evaluating capital adequacy. In February of 2003, Heartland
entered into an agreement with a group of Arizona business
leaders to establish a new bank in Mesa. Pending regulatory
approval, the new bank is expected to begin operations in the
summer of 2003. Heartland's portion of the $15.0 million initial
capital investment is $12.0 million, of which $500 thousand has
already been advanced. Heartland intends to fund this transaction
through its revolving credit line.
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 December 31, 2002, Heartland's
ownership in New Mexico Bank & Trust was 86%.
Heartland has an incentive compensation agreement with certain
employees of one of the bank subsidiaries, none of whom is an
executive officer of Heartland, that requires a total payment of
$3.6 million to be made no later than February 29, 2004, to those
who remain employed with the subsidiary on December 31, 2003.
Additionally, each employee is bound by a confidentiality and non-
competition agreement. One-third of the payment will be made in
cash and the remaining two-thirds in shares of Heartland's common
stock. The obligation is being accrued over the performance
period.
On June 27, 2002, Heartland completed a private placement
offering of $5.0 million of variable rate cumulative capital
securities representing undivided beneficial interests in
Heartland Financial Capital Trust II, a special purpose trust
subsidiary formed for the sole purpose of this offering. The
proceeds from the offering were used by the trust to purchase
junior subordinated debentures from Heartland. The proceeds were
used by Heartland for general corporate purposes. 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
December 31, 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. 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 December 31, 2002.
In October of 1999, Heartland completed an offering of $25.0
million of 9.60% cumulative capital securities representing
undivided beneficial interests in Heartland Capital Trust I, a
special purpose trust subsidiary formed for the sole purpose of
this offering. The proceeds from the offering were used by the
trust to purchase junior subordinated debentures from Heartland.
The proceeds were used by Heartland for general corporate
purposes. 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 December 31, 2002.
Expansion efforts are underway at Wisconsin Community Bank, as it
committed to the construction of a 3-story, 20,000 square foot
building in Fitchburg, a suburb southwest of Madison. The bank
will occupy the first floor and financially related companies or
law offices will occupy the top two floors. Wisconsin Community
Bank's share of the construction costs on this project is
estimated at $2.5 million. This project is well underway with
completion targeted for March of 2003.
Plans for the renovation and construction of a 50,000 square foot
facility to accommodate the operations and support functions of
Heartland are underway. Property in downtown Dubuque, Iowa,
across the street from Dubuque Bank and Trust's main facility,
has been purchased. The $4.5 million project has begun with
completion anticipated next winter. A reduction in overall costs
on this project will result from tax credits and other incentives
made available on the project as it includes the rehabilitation
of two historical structures and the creation of new jobs.
Heartland continues to explore opportunities to expand its
umbrella of independent community banks through mergers and
acquisitions as well as de novo and branching opportunities.
Representative of this was the entrance into a new market at the
beginning of 2003 by our bank subsidiary in New Mexico with the
opening of a branch in Santa Fe. Future expenditures relating to
these efforts are not estimable at this time.
Heartland's capital ratios are detailed in the table below.
RISK-BASED CAPITAL RATIOS(1) (Dollars in thousands)
December 31,
2002 2001
Amount Ratio Amount Ratio
--------------------------------------
Capital Ratios:
Tier 1 capital $ 141,918 10.65% $ 121,112 9.71%
Tier 1 capital
minimum
requirement 53,298 4.00 49,891 4.00
---------- ------ ---------- ------
Excess $ 88,620 6.65% $ 71,221 5.71%
========== ====== ========== ======
Total capital $ 158,010 11.86% $ 135,770 10.89%
Total capital
minimum
requirement 106,596 8.00 99,782 8.00
---------- ------ ---------- ------
Excess $ 51,414 3.86% $ 35,988 2.89%
========== ====== ========== ======
Total risk-
adjusted
assets $1,332,451 $1,247,274
========== ==========
RISK-BASED CAPITAL RATIOS(1) (Dollars in thousands)
December
2000
Amount Ratio
------------------
Capital Ratios:
Tier 1 capital $ 102,443 8.74%
Tier 1 capital
minimum
requirement 46,878 4.00
---------- ------
Excess $ 55,565 4.74%
========== ======
Total capital $ 116,034 9.90%
Total capital
minimum
requirement 93,756 8.00
---------- ------
Excess $ 22,278 1.90%
========== ======
Total risk-
adjusted
assets $1,171,951
==========
(1) Based on the risk-based capital guidelines of the Federal
Reserve, a bank holding company is required to maintain a
Tier 1 to risk-adjusted assets ratio of 4.00% and total
capital to risk-adjusted assets ratio of 8.00%.
LEVERAGE RATIOS(1) (Dollars in thousands)
December 31,
2002 2001
Amount Ratio Amount Ratio
--------------------------------------
Capital Ratios:
Tier 1 capital $ 141,918 8.24% $ 121,112 7.53%
Tier 1 capital
minimum
requirement(2) 68,883 4.00 64,336 4.00
---------- ----- ---------- -----
Excess $ 73,035 4.24% $ 56,776 3.53%
========== ===== ========== =====
Average adjusted
assets $1,722,077 $1,608,402
========== ==========
LEVERAGE RATIOS(1) (Dollars in thousands)
December
2000
Amount Ratio
------------------
Capital Ratios:
Tier 1 capital $ 102,443 7.25%
Tier 1 capital
minimum
requirement(2) 56,492 4.00
---------- ------
Excess $ 45,951 3.25%
========== ======
Average adjusted
assets $1,412,304
==========
(1) The leverage ratio is defined as the ratio of Tier 1 capital
to average total assets.
(2) 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 an additional cushion
of at least 100 basis points.
OTHER DEVELOPMENTS
At its regular board meeting held on January 21, 2003, Heartland
appointed John W. Cox Jr. as a director. Mr. Cox is a partner
with the law firm of Cox and Ward, P.C. in Galena, Illinois, and
a former Member of the U.S. House of Representatives from
Illinois' 16th District. He serves on the board of directors of
Galena State Bank and Trust, a Heartland bank subsidiary. Mr.
Cox's appointment fills the vacancy created last January by the
resignation of Gregory R. Miller. At Heartland's annual
stockholders meeting in May, Mr. Cox will stand for election to a
full term.
LIQUIDITY
Liquidity refers to Heartland's ability to maintain a cash flow,
which is adequate to meet maturing obligations and existing
commitments, to withstand fluctuations in deposit levels, to fund
operations and to provide for customers' credit needs.
The liquidity of Heartland principally depends on cash flows from
operating activities, investment in and maturity of assets,
changes in balances of deposits and borrowings and its ability to
borrow funds in the money or capital markets.
Management of investing and financing activities, and market
conditions, determine the level and the stability of net interest
cash flows. Management attempts to mitigate the impact of changes
in market interest rates to the extent possible, so that balance
sheet growth is the principal determinant of growth in net
interest cash flows.
Heartland's short-term borrowing balances are dependent on
commercial cash management and smaller correspondent bank
relationships and, as such, will normally fluctuate. Heartland
believes these balances, on average, to be stable sources of
funds; however, it intends to rely on deposit growth and
additional FHLB borrowings in the future.
In the event of short-term liquidity needs, the bank subsidiaries
may purchase federal funds from each other or from correspondent
banks and may also borrow from the Federal Reserve Bank.
Additionally, the subsidiary banks' FHLB memberships give them
the ability to borrow funds for short- and long-term purposes
under a variety of programs.
Heartland's revolving credit agreements provide a maximum
borrowing capacity of $50.0 million. As of December 31, 2002,
these credit agreements provided an additional borrowing capacity
of $25.0 million. These agreements contain specific covenants
which, among other things, limit dividend payments and restrict
the sale of assets by Heartland under certain circumstances. Also
contained within the agreements are certain financial covenants,
including the maintenance by Heartland of a maximum nonperforming
assets to total loans ratio, minimum return on average assets
ratio and maximum funded debt to total equity capital ratio. In
addition, Heartland and each of its bank subsidiaries must remain
well capitalized, as defined from time to time by the federal
banking regulators. At December 31, 2002, Heartland was in
compliance with the covenants contained in these credit
agreements.
MARKET RISK MANAGEMENT
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.
Heartland 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 management team and
board of directors. Darling Consulting Group, Inc. has been
engaged to provide asset/liability management position assessment
and strategy formulation services to Heartland and its bank
subsidiaries. At least quarterly, a detailed review of
Heartland's and each of the bank subsidiaries' balance sheet risk
profile is performed. Included in these reviews are interest rate
sensitivity analyses, which simulate changes in net interest
income in response to various interest rate scenarios. This
analysis considers current portfolio rates, existing maturities,
repricing opportunities and market interest rates, in addition to
prepayments and growth under different interest rate assumptions.
Selected strategies are modeled prior to implementation to
determine their effect on Heartland's interest rate risk profile
and net interest income. Through the use of these tools,
Heartland has determined that the balance sheet is structured
such that changes in net interest margin in response to changes
in interest rates would be minimal, all other factors being held
constant. Management does not believe that Heartland's primary
market risk exposures and how those exposures were managed in
2002 have materially changed 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 December 31, 2002, Heartland had an
interest rate swap contract to pay a fixed rate of interest and
receive a variable rate of interest on $25.0 million of
indebtedness. This contract expires on November 1, 2006. The fair
market value of the interest rate swap contract was recorded as a
liability in the amount of $1.7 million as of December 31, 2002.
Heartland does enter into financial instruments with off balance
sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include
commitments to extend credit and standby letters of credit. These
instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the
consolidated balance sheets. Commitments to extend credit are
agreements to lend to a customer as long as there is no violation
of any condition established in the contract. Commitments
generally have fixed expiration dates and may require collateral
from the borrower. Standby letters of credit are conditional
commitments issued by Heartland to guarantee the performance of a
customer to a third party up to a stated amount and with
specified terms and conditions. These commitments to extend
credit and standby letters of credit are not recorded on the
balance sheet until the instrument is exercised.
The table below summarizes the scheduled maturities of market
risk sensitive assets and liabilities as of December 31, 2002.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
TABLE OF MARKET RISK-SENSITIVE INSTRUMENTS (Dollars in thousands)
December 31, 2002
MATURING IN: 2003 2004 2005 2006
--------------------------------------
ASSETS
Federal funds sold and
other short-term
investments $ 39,886 $ - $ - $ -
Time deposits in other
financial institutions 587 - 1,090 -
Trading securities - - - -
Securities available
for sale 98,432 76,167 64,109 27,059
Loans and leases:
Fixed rate loans 198,504 128,673 120,320 60,390
Variable rate loans 232,712 71,125 59,118 34,711
---------- -------- -------- --------
Loans and leases, net 431,216 199,798 179,438 95,101
---------- -------- -------- --------
Total Market Risk-
Sensitive Assets $ 570,121 $275,965 $244,637 $122,160
========== ======== ======== ========
LIABILITIES
Savings $ 511,979 $ - $ - $ -
Time deposits:
Fixed rate time
certificates less
than $100 208,531 86,806 76,889 25,343
Variable rate time
certificates less
than $100 8,389 4,227 5 2
---------- -------- -------- --------
Time deposits less
than $100 216,920 91,033 76,894 25,345
Time deposits of
$100 or more 96,310 12,741 6,656 1,936
Federal funds purchased,
securities sold
under repurchase
agreements and
other short-term
borrowings 161,379 - - -
Other borrowings:
Fixed rate borrowings 10,157 22,659 24,165 20,538
Variable rate borrowings - - - -
---------- -------- -------- --------
Other borrowings 10,157 22,659 24,165 20,538
---------- ------- -------- --------
Total Market Risk-
Sensitive Liabilities $ 996,745 $126,433 $107,715 $ 47,819
========== ======== ======== ========
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
TABLE OF MARKET RISK-SENSITIVE INSTRUMENTS (Dollars in thousands)
December 31, 2002
Average Estimated
Interest Fair
MATURING IN: 2007 Thereafter Total Rate Value
----------------------------------------------
ASSETS
Federal funds sold
and other short-
term investments $ - $ - $ 39,886 1.09% $ 39,886
Time deposits in
other financial
institutions - - 1,677 6.14 1,677
Trading securities - 915 915 1.22
915
Securities
available for
sale 7,261 116,872 389,900 5.39 389,900
Loans and leases:
Fixed rate loans 51,090 54,614 613,591 7.58 656,755
Variable rate
loans 49,366 114,613 561,645 5.99 568.657
-------- -------- ---------- ----------
Loans and leases,
net 100,456 169,227 1,175,236 1,225,412
-------- -------- ---------- ----------
Total Market Risk-
Sensitive Assets $107,717 $287,014 $1,607,614 $1,657,790
======== ======== ========== ==========
LIABILITIES
Savings $ - $ - $ 511,979 1.04% $ 511,979
Time deposits:
Fixed rate time
certificates
less than $100 91,636 434 489,639 3.93 521,024
Variable rate
time
certificates
less than $100 - - 12,623 3.62 12,623
-------- -------- ---------- ----------
Time deposits less
than $100 91,636 434 502,262 533,647
Time deposits of
$100 or more 8,585 - 126,228 3.10 129,603
Federal funds
purchased,
securities sold
under repurchase
agreements and
other short-term
borrowings - - 161,379 1.39 161,379
Other borrowings:
Fixed rate
borrowings 40 35,740 113,299 6.10 152,133
Variable rate
borrowings - 13,000 13,000 5.02 13,000
-------- -------- ---------- ----------
Other borrowings 40 48,740 126,299 165,133
-------- -------- ---------- ----------
Total Market Risk-
Sensitive
Liabilities $100,261 $ 49,174 $1,428,147 $1,501,741
======== ======== ========== ==========
EFFECTS OF INFLATION
Consolidated financial data included in this report has been
prepared in accordance with generally accepted accounting
principles. Presently, these principles require reporting of
financial position and operating results in terms of historical
dollars, except for available for sale securities, trading
securities and derivative instruments, which require reporting at
fair value. Changes in the relative value of money due to
inflation or recession are generally not considered.
In management's opinion, changes in interest rates affect the
financial condition of a financial institution to a far greater
degree than changes in the inflation rate. While interest rates
are greatly influenced by changes in the inflation rate, they do
not change at the same rate or in the same magnitude as the
inflation rate. Rather, interest rate volatility is based on
changes in the expected rate of inflation, as well as on changes
in monetary and fiscal policies. A financial institution's
ability to be relatively unaffected by changes in interest rates
is a good indicator of its capability to perform in today's
volatile economic environment. Heartland seeks to insulate itself
from interest rate volatility by ensuring that rate-sensitive
assets and rate-sensitive liabilities respond to changes in
interest rates in a similar time frame and to a similar degree.
CONTROLS AND PROCEDURES
Based upon an evaluation within the 90 days prior to the filing
date of this report, Heartland's Chief Executive Officer and
Chief Financial Officer concluded that Heartland's disclosure
controls and procedures are effective. There have been no
significant changes in Heartland's internal controls or in other
factors that could significantly affect Heartland's internal
controls subsequent to the date of the evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
(Dollars in thousands, except per share data)
Notes 2002 2001
----- ---------- ----------
ASSETS
Cash and due from banks 4 $ 61,106 $ 45,738
Federal funds sold and other
short-term investments 39,886 47,812
---------- ----------
Cash and cash equivalents 100,992 93,550
Time deposits in other
financial institutions 1,677 564
Securities: 5
Trading, at fair value 915 1,528
Available for sale-at fair
value (cost of $381,398 for
2002 and $318,342 for 2001) 389,900 323,689
Loans and leases: 6
Held for sale 23,167 26,967
Held to maturity 1,152,069 1,078,238
Allowance for loan and
lease losses 7 (16,091) (14,660)
---------- ----------
Loans and leases, net 1,159,145 1,090,545
Assets under operating leases 30,367 35,427
Premises, furniture and
equipment, net 8 35,591 31,482
Other real estate, net 452 130
Goodwill 16,050 16,050
Core deposit premium
and mortgage servicing rights 9 4,879 4,655
Other assets 46,011 46,444
---------- ----------
TOTAL ASSETS $1,785,979 $1,644,064
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits: 10
Demand $ 197,516 $ 160,742
Savings 511,979 493,374
Time 628,490 551,043
---------- ----------
Total deposits 1,337,985 1,205,159
Short-term borrowings 11 161,379 160,703
Other borrowings 12 126,299 143,789
Accrued expenses and other
liabilities 36,275 27,323
---------- ----------
TOTAL LIABILITIES 1,661,938 1,536,974
----------- ----------
STOCKHOLDERS' EQUITY: 16,17,18,19
Preferred stock
(par value $1 per
share; authorized,
184,000 shares and
200,000 shares at
December 31, 2002, and
December 31, 2001,
respectively; none issued
or outstanding) - -
Series A Junior Participating
preferred stock (par value
$1 per share; authorized,
16,000 shares at December 31,
2002; none issued or
outstanding) - -
Common stock
(par value $1 per share;
authorized, 16,000,000 shares
and 12,000,000 shares at December
31, 2002, and December 31,
2001, respectively; issued,
9,905,783 shares at December 31,
2002, and December 31, 2001) 9,906 9,906
Capital surplus 16,725 18,116
Retained earnings 94,048 79,107
Accumulated other
comprehensive income 4,230 3,565
Treasury stock at cost
(59,369 shares at December
31, 2002, and 226,031 shares
at December 31, 2001,
respectively) (868) (3,604)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 124,041 107,090
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,785,979 $1,644,064
========== ==========
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31, 2002, 2001 and 2000
(Dollars in thousands, except per share data)
Notes 2002 2001 2000
----- -------- -------- --------
INTEREST INCOME:
Interest and fees on
loans and leases 6 $ 83,553 $ 89,452 $ 87,653
Interest on securities:
Taxable 13,132 14,143 11,824
Nontaxable 2,757 1,790 1,814
Interest on federal funds sold 322 1,981 911
Interest on interest bearing
deposits in other financial
institutions 248 243 333
--------- -------- --------
TOTAL INTEREST INCOME 100,012 107,609 102,535
--------- -------- --------
INTEREST EXPENSE:
Interest on deposits 10 31,395 45,783 43,141
Interest on short-term
borrowings 2,643 4,515 6,986
Interest on other borrowings 8,294 8,322 8,551
--------- -------- --------
TOTAL INTEREST EXPENSE 42,332 58,620 58,678
--------- -------- --------
NET INTEREST INCOME 57,680 48,989 43,857
Provision for loan and
lease losses 7 3,553 4,258 2,976
--------- -------- --------
Net interest income after
provision for loan and
lease losses 54,127 44,731 40,881
--------- -------- --------
NONINTEREST INCOME:
Service charges and fees 8,089 6,308 5,357
Trust fees 3,407 3,148 3,088
Brokerage commissions 658 615 846
Insurance commissions 765 807 862
Securities gains, net 790 1,489 501
Loss on trading account
securities (598) (417) -
Impairment loss on equity
securities (267) (773) (244)
Rental income on operating
leases 14,602 15,446 14,918
Gains on sale of loans 4,656 2,738 521
Valuation adjustment on
mortgage servicing rights (469) - -
Other noninterest income 1,124 900 1,130
--------- -------- -------
TOTAL NONINTEREST INCOME 32,757 30,261 26,979
--------- -------- -------
NONINTEREST EXPENSES:
Salaries and employee
benefits 15 28,571 25,182 23,645
Occupancy 16 3,178 3,014 2,876
Furniture and equipment 3,273 3,144 2,989
Depreciation on equipment
under operating leases 11,555 11,805 11,199
Outside services 4,318 3,433 2,634
FDIC deposit insurance
assessment 209 208 228
Advertising 1,917 1,588 1,482
Goodwill amortization - 1,057 1,057
Core deposit premium
amortization 495 615 757
Other noninterest expenses 9,255 8,287 7,203
--------- -------- --------
TOTAL NONINTEREST EXPENSES 62,771 58,333 54,070
--------- -------- --------
Income before income taxes 24,113 16,659 13,790
Income taxes 14 7,523 5,530 4,211
--------- -------- --------
INCOME FROM CONTINUING
OPERATIONS 16,590 11,129 9,579
Discontinued operations:
Income from operation of
discontinued branch
(including gain on sale
of $2,602) 3,751 469 12
Income taxes 1,474 184 5
-------- -------- --------
Income on discontinued
operation 2,277 285 7
-------- -------- --------
NET INCOME $ 18,867 $ 11,414 $ 9,586
======== ======== ========
EARNINGS PER COMMON SHARE-BASIC $ 1.93 $ 1.19 $ 1.00
========= ======== ========
EARNINGS PER COMMON SHARE-
DILUTED $ 1.91 $ 1.18 $ 0.98
======== ======== ========
CASH DIVIDENDS DECLARED PER
COMMON SHARE $ 0.40 $ 0.37 $ 0.36
======== ======== ========
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
For the years ended December 31, 2002, 2001 and 2000
(Dollars in thousands, except per share data)
Common Capital Retained
Stock Surplus Earnings
------- ------- --------
Balance at January 1, 2000 $ 9,707 $15,339 $65,132
Net Income - 2000 9,586
Unrealized gain (loss) on
securities available for sale
Reclassification adjustment for
net gains realized in
net income
Income taxes
Comprehensive income
Cash dividends declared:
Common, $0.36 per share (3,465)
Purchase of 291,501 shares
of common stock
Sale of 322,937 shares
of common stock 199 3,473
------- ------- -------
Balance at December 31, 2000 $ 9,906 $18,812 $71,253
Net Income - 2001 11,414
Unrealized gain (loss) on
securities available for sale
Unrealized gain (loss) on
derivatives arising during
the period, net of
reclassification of $46
Reclassification adjustment for
net security gains realized in
net income
Income taxes
Comprehensive income
Cash dividends declared:
Common, $0.37 per share (3,560)
Purchase of 79,256 shares
of common stock
Sale of 140,798 shares
of common stock (696)
------- ------- -------
Balance at December 31, 2001 $ 9,906 $18,116 $79,107
Net Income - 2002 18,867
Unrealized gain (loss) on
securities available for sale
Unrealized gain (loss) on
derivatives arising during
the period, net of
reclassification of $667
Reclassification adjustment for
net security gains realized in
net income
Income taxes
Comprehensive income
Cash dividends declared:
Common, $0.40 per share (3,926)
Purchase of 95,543 shares of
common stock
Sale of 262,205 shares of
common stock (1,391)
------- ------- -------
BALANCE AT DECEMBER 31, 2002 $ 9,906 $16,725 $94,048
======= ======= =======
Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock Total
------------- -------- -----
Balance at January 1, 2000 $(1,511) $(2,094)
$ 86,573
Net Income - 2000 9,586
Unrealized gain (loss) on
securities available for sale 4,003 4,003
Reclassification adjustment for
net gains realized in
net income 257 257
Income taxes (1,448) (1,448)
--------
Comprehensive income 12,398
Cash dividends declared:
Common, $0.36 per share (3,465)
Purchase of 291,501 shares
of common stock (5,197) (5,197)
Sale of 322,937 shares
of common stock 2,165 5,837
------- ------- --------
Balance at December 31, 2000 $ 1,301 $(5,126) $ 96,146
Net Income - 2001 11,414
Unrealized gain (loss) on
securities available for sale 3,796 3,796
Unrealized gain (loss)on
derivatives arising during
the period, net of
reclassification of $46 350 350
Reclassification adjustment for
net security gains realized in
net income (716) (716)
Income taxes (1,166) (1,166)
--------
Comprehensive income 13,678
Cash dividends declared:
Common, $0.37 per share (3,560)
Purchase of 79,256 shares
of common stock (1,026) (1,026)
Sale of 140,798 shares of
common stock 2,548 1,852
------- ------- --------
Balance at December 31, 2001 $ 3,565 $(3,604) $107,090
Net Income - 2002 18,867
Unrealized gain (loss) on
securities available for sale 3,630 3,630
Unrealized gain (loss) on
derivatives arising during
the period, net of
reclassification of $667 (2,100) (2,100)
Reclassification adjustment for
net security gains realized in
net income (523) (523)
Income taxes (342) (342)
--------
Comprehensive income 19,532
Cash dividends declared:
Common, $0.40 per share (3,926)
Purchase of 95,543 shares
of common stock (1,348) (1,348)
Sale of 262,205 shares
of common stock 4,084 2,693
------- ------- --------
BALANCE AT DECEMBER 31, 2002 $ 4,230 $ (868) $124,041
======= ======= ========
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2002, 2001 and 2000
(Dollars in thousands)
2002 2001 2000
-------- -------- --------
Cash Flows from Operating
Activities:
Net income $ 18,867 $ 11,414 $ 9,586
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 15,203 16,616 16,167
Provision for loan and
lease losses 3,553 4,283 3,301
Provision for income taxes
less than (in excess of)
payments 1,996 (635) 41
Net amortization (accretion)
of premium (discount)
on securities 4,420 1,285 (39)
Securities gains, net (790) (1,489) (501)
(Increase) decrease in
trading account securities 613 (1,528) -
Loss on impairment of equity
securities 267 773 244
Loans originated for sale (278,650) (207,332) (42,991)
Proceeds on sales of loans 287,106 201,565 36,273
Net gain on sales of loans (4,656) (2,738) (521)
Decrease (increase) in accrued
interest receivable 235 1,603 (4,091)
Increase (decrease) in accrued
interest payable 491 (1,597) 2,641
Other, net 199 (4,923) (4,119)
-------- -------- --------
Net cash provided by operating
activities 48,854 17,297 15,991
-------- -------- --------
Cash Flows from Investing
Activities:
Purchase of time deposits (1,068) - (600)
Proceeds on maturities of time
deposits 3 959 5,180
Proceeds from the sale of
securities available for sale 47,086 65,010 34,442
Proceeds from the maturity of
and principal paydowns on
securities held to maturity - - 6,353
Proceeds from the maturity of
and principal paydowns on
securities available for sale 151,099 109,436 48,260
Purchase of securities
available for sale (263,566) (267,354) (81,918)
Net increase in loans and
leases (109,282) (55,118) (132,761)
Purchase of bank-owned
life insurance policies - (8,568) -
Increase in assets under
operating leases (6,495) (11,663) (11,409)
Capital expenditures (7,398) (4,602) (3,647)
Cash and cash equivalents
received for sale of
operation 30,469 - -
Net cash and cash equivalents
received in acquisition
of subsidiaries - - 18,603
Net cash received from minority
interest stockholders - - 780
Proceeds on sale of OREO and
other repossessed assets 1,192 790 815
-------- -------- --------
Net cash used by investing
activities (157,960) (171,110) (115,902)
Cash Flows from Financing
Activities:
Net increase in demand
deposits and savings accounts 58,758 111,338 26,090
Net increase (decrease) in
time deposit accounts 77,802 (7,492) 111,248
Net increase in
short-term borrowings 676 20,794 25,795
Proceeds from other
borrowings 7,840 69,381 26,463
Repayments of other
borrowings (25,330) (28,448) (32,308)
Purchase of treasury stock (1,348) (1,026) (5,197)
Proceeds from sale of
common stock 2,076 1,689 19
Dividends (3,926) (3,560) (3,465)
-------- -------- --------
Net cash provided by
financing activities 116,548 162,676 148,645
-------- -------- --------
Net increase in cash and
cash equivalents 7,442 8,863 48,734
Cash and cash equivalents at
beginning of year 93,550 84,687 35,953
-------- -------- --------
Cash and cash equivalents at
end of period $100,992 $ 93,550 $ 84,687
======== ======== ========
Supplemental disclosures:
Cash paid for income/
franchise taxes $ 6,648 $ 6,365 $ 3,890
Cash paid for interest $ 41,841 $ 61,790 $ 57,068
Securities held to maturity
transferred to securities
available for sale $ - $ 2,154 $ -
Acquisitions:
Assets acquired $ - $ - $119,837
Cash paid for purchase of
stock $ - $ - $(14,364)
Cash acquired - - 32,967
-------- -------- --------
Net cash received for
acquisitions $ - $ - $ 18,603
Notes issued for acquisition $ - $ - $ 3,820
Common stock issued for
acquisition $ - $ - $ 5,773
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ONE
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations-Heartland Financial USA, Inc. ("Heartland")
is a multi-bank holding company primarily operating full-service
retail banking offices in Dubuque and Lee Counties in Iowa; Jo
Daviess, Hancock and Winnebago Counties in Illinois; Dane, Green,
Sheboygan and Brown Counties in Wisconsin; and Bernalillo, Curry
and Santa Fe Counties in New Mexico, serving communities in and
around those counties. The principal services of Heartland,
through its subsidiaries, are FDIC-insured deposit accounts and
related services, and loans to businesses and individuals. The
loans consist primarily of commercial and commercial real estate
and residential real estate.
Principles of Presentation-The consolidated financial statements
include the accounts of Heartland and its subsidiaries: Dubuque
Bank and Trust Company; Galena State Bank and Trust Company;
Riverside Community Bank; Wisconsin Community Bank; New Mexico
Bank & Trust; First Community Bank; Citizens Finance Co.; ULTEA,
Inc.; DB&T Insurance, Inc.; DB&T Community Development Corp.; DBT
Investment Corporation; Heartland Capital Trust I; Heartland
Capital Trust II and Heartland Financial Statutory Trust II. All
of Heartland's subsidiaries are wholly-owned except for New
Mexico Bank & Trust, of which Heartland was an 86.47% owner on
December 31, 2002. All significant intercompany balances and
transactions have been eliminated in consolidation.
The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the
United States of America and prevailing practices within the
banking industry. In preparing such financial statements,
management is required to make estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of
the balance sheet and revenues and expenses for the period.
Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to
significant change relate to the determination of the allowance
for loan and lease losses.
Trading Account Securities - Trading securities represent those
securities Heartland intends to actively trade and are stated at
fair value with changes in fair value reflected in noninterest
income. During the first quarter of 2001, Heartland began
purchasing securities, on a limited basis, with the intent of
actively trading those securities.
Securities Available for Sale-Available for sale securities
consist of those securities not classified as held to maturity or
trading, which management intends to hold for indefinite periods
of time or that may be sold in response to changes in interest
rates, prepayments or other similar factors. Such securities are
stated at fair value with any unrealized gain or loss, net of
applicable income tax, reported as a separate component of
stockholders' equity. Security premiums and discounts are
amortized/accreted using the interest method over the period from
the purchase date to the maturity or call date of the related
security. Gains or losses from the sale of available for sale
securities are determined based upon the adjusted cost of the
specific security sold. Unrealized losses judged to be other
than temporary are charged to operations for both securities
available for sale and securities held to maturity.
Securities Held to Maturity-Securities which Heartland has the
ability and positive intent to hold to maturity are classified as
held to maturity. Such securities are stated at amortized cost,
adjusted for premiums and discounts that are amortized/accreted
using the interest method over the period from the purchase date
to the maturity date of the related security.
Loans and Leases-Interest on loans is accrued and credited to
income based primarily on the principal balance outstanding.
Income from leases is recorded in decreasing amounts over the
term of the contract resulting in a level rate of return on the
lease investment. The policy of Heartland is to discontinue the
accrual of interest income on any loan or lease when, in the
opinion of management, there is a reasonable doubt as to the
timely collection of the interest and principal. When interest
accruals are deemed uncollectible, interest credited to income in
the current year is reversed and interest accrued in prior years
is charged to the allowance for loan and lease losses. Nonaccrual
loans and leases are returned to an accrual status when, in the
opinion of management, the financial position of the borrower
indicates that there is no longer any reasonable doubt as to the
timely payment of interest and principal.
Under Heartland's credit policies, all nonaccrual and
restructured loans are defined as impaired loans. Loan
impairment is measured based on the present value of expected
future cash flows discounted at the loan's effective interest
rate, except where more practical, at the observable market price
of the loan or the fair value of the collateral if the loan is
collateral dependent.
Net nonrefundable loan and lease origination fees and certain
direct costs associated with the lending process are deferred and
recognized as a yield adjustment over the life of the related
loan or lease.
Loans held for sale are stated at the lower of aggregate cost or
estimated fair value. Loans are sold on a nonrecourse basis with
either servicing released or retained, and gains and losses are
recognized based on the difference between sales proceeds and the
carrying value of the loan.
Allowance for Loan and Lease Losses - The allowance for loan and
lease losses is maintained at a level estimated by management to
provide for known and inherent risks in the loan and lease
portfolios. The allowance is based upon a continuing review of
past loan and lease loss experience, current economic conditions,
volume growth, the underlying collateral value of the loans and
leases and other relevant factors. Loans and leases which are
deemed uncollectible are charged off and deducted from the
allowance. Provisions for loan and lease losses and recoveries on
previously charged-off loans and leases are added to the
allowance.
Premises, Furniture and Equipment - Premises, furniture and
equipment are stated at cost less accumulated depreciation. The
provision for depreciation of premises, furniture and equipment
is determined by straight-line and accelerated methods over the
estimated useful lives of 18 to 39 years for buildings, 15 years
for land improvements and 3 to 7 years for furniture and
equipment.
Other Real Estate - Other real estate represents property
acquired through foreclosures and settlements of loans. Property
acquired is carried at the lower of the principal amount of the
loan outstanding at the time of acquisition, plus any acquisition
costs, or the estimated fair value of the property, less disposal
costs. The excess, if any, of such costs at the time acquired
over the fair value is charged against the allowance for loan and
lease losses. Subsequent write downs estimated on the basis of
later evaluations, gains or losses on sales and net expenses
incurred in maintaining such properties are charged to
operations.
Intangible Assets - Intangible assets consist of goodwill, core
deposit premiums and mortgage servicing rights. Goodwill
represents the excess of the purchase price of acquired
subsidiaries' net assets over their fair value. On July 1, 2001,
Heartland adopted Financial Accounting Standards Board Statement
No. 142 (FAS 142), "Goodwill and Other Intangible Assets." FAS
142 eliminates amortization of goodwill associated with business
combinations completed after June 30, 2001. Effective January 1,
2002, all goodwill amortization was discontinued. Heartland
assesses goodwill for impairment annually, and more frequently in
the presence of certain circumstances. Impairment exists when the
carrying amount of the goodwill exceeds its implied fair value.
Core deposit premiums are amortized over ten years on an
accelerated basis. Periodically, Heartland reviews the intangible
assets for events or circumstances that may indicate a change in
the recoverability of the underlying basis, except mortgage
servicing rights which are reviewed quarterly.
Mortgage servicing rights associated with loans originated and
sold, where servicing is retained, are capitalized. The values of
these capitalized servicing rights are amortized in relation to
the servicing revenue expected to be earned. The carrying values
of these rights are periodically reviewed for impairment. For
purposes of measuring impairment, the rights are stratified into
certain risk characteristics including loan type, note rate,
prepayment trends and external market factors. A valuation
allowance of $469 thousand was required as of December 31, 2002,
and no valuation allowance was required as of December 31, 2001.
The following table summarizes the changes in capitalized
mortgage loan servicing rights:
(Dollars in thousands)
2002 2001
---------- ----------
Balance, beginning of year $ 1,174 $ 556
Originations 2,499 1,626
Amortization (761) (1,008)
Valuation allowance (469) -
---------- ----------
Balance, end of year $ 2,443 $ 1,174
========== ==========
Mortgage loans serviced for others were $395.1 million and $268.6
million as of December 31, 2002 and 2001, respectively. Custodial
escrow balances maintained in connection with the loan servicing
portfolio were approximately $1.8 million and $1.2 million as of
December 31, 2002 and 2001, respectively.
Income Taxes - Heartland and its subsidiaries file a consolidated
federal income tax return. Heartland and its subsidiaries file
separate income or franchise tax returns as required by the
various states.
Heartland has a tax allocation agreement which provides that each
subsidiary of the consolidated group pay a tax liability to, or
receive a tax refund from Heartland, computed as if the
subsidiary had filed a separate return.
Heartland recognizes certain income and expenses in different
time periods for financial reporting and income tax purposes. The
provision for deferred income taxes is based on an asset and
liability approach and represents the change in deferred income
tax accounts during the year, including the effect of enacted tax
rate changes. Deferred tax assets are recognized if their
expected realization is "more likely than not."
Treasury Stock - Treasury stock is accounted for by the cost
method, whereby shares of common stock reacquired are recorded at
their purchase price.
Trust Department Assets - Property held for customers in
fiduciary or agency capacities is not included in the
accompanying consolidated balance sheets, as such items are not
assets of the Heartland banks.
Earnings Per Share - Amounts used in the determination of basic
and diluted earnings per share for the years ended December 31,
2002, 2001 and 2000 are shown in the table below:
(Dollars in thousands)
2002 2001 2000
------- ------- -------
Income from continuing operations $16,590 $11,129 $ 9,579
Discontinued operations:
Income from operations of
discontinued branch (including
gain on sale of $2,602) 3,751 469 12
Income taxes 1,474 184 5
------- ------- -------
Income from discontinued operations 2,277 285 7
------- ------- -------
Net income $18,867 $11,414 $ 9,586
======= ======= =======
Weighted average common shares
outstanding for basic earnings
per share (1) 9,792 9,602 9,628
Assumed incremental common shares
issued upon exercise of stock
options (1) 64 103 130
------- ------- -------
Weighted average common shares
for diluted earnings per share (1) 9,856 9,705 9,758
======= ======= =======
Earnings per common share-basic $ 1.93 $ 1.19 $ 1.00
Earnings per common share-diluted 1.91 1.18 .98
Adjusted earnings per share from
continuing operations-basic (2) 1.69 1.16 .99
Adjusted earnings per share from
continuing operations-diluted (2) 1.68 1.15 .98
Earnings per common share-basic (3) 1.93 1.30 1.11
Earnings per common share-diluted
diluted -(3) 1.91 1.28 1.09
Adjusted earnings per share from
continuing operations - basic (4) 1.69 1.27 1.10
Adjusted earnings per share from
continuing operations -
diluted (4) 1.68 1.26 1.09
(1) In thousands.
(2) Excludes the discontinued operations of our Eau Claire
branch and the related gain on sale in the fourth quarter
of 2002.
(3) Excludes goodwill amortization discontinued with the
adoption of FAS 142 on January 1, 2002, and the adoption
of FAS 147 on September 30, 2002.
(4) Excludes goodwill amortization discontinued with the
adoption of FAS 142 on January 1, 2002, and the adoption
of FAS 147 on September 30, 2002, and the discontinued
operations of our Eau Claire branch and the related gain
on sale in the fourth quarter of 2002.
Cash Flows - For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks, federal
funds sold and other short-term investments. Generally, federal
funds are purchased and sold for one-day periods.
Effect of New Financial Accounting Standards-In June 2001, the
Financial Accounting Standards Board ("FASB") issued Statement
No. 143 (FAS 143), "Accounting for Asset Retirement Obligations,"
which addresses the recognition and measurement of obligations
with the retirement of tangible long-lived assets. FAS 143 is
effective January 1, 2003, with early adoption permitted.
Heartland adopted FAS 143 effective January 1, 2003,and the
adoption of the Statement did not have a material effect on the
financial statements.
In July 2001, the FASB issued Statement No. 141, "Business
Combinations," (FAS 141) and Statement No. 142, "Goodwill and
Other Intangible Assets" (FAS 142). FAS 141 requires that the
purchase method of accounting be used for all business
combinations initiated after June 30, 2001, as well as all
purchase method business combinations completed after June 30,
2001. FAS 141 also specifies criteria that intangible assets
acquired in a purchase method business combination must meet to
be recognized and reported apart from goodwill. FAS 142 requires
that goodwill and intangible assets with indefinite useful lives
no longer be amortized, but instead tested for impairment at
least annually in accordance with the provisions of FAS 142. FAS
142 also requires that intangible assets with definite useful
lives be amortized over their respective estimated useful lives
to their estimated residual values, and reviewed for impairment.
Heartland adopted the provisions of FAS 141 immediately, and FAS
142 effective January 1, 2002. Goodwill and intangible assets
acquired in business combinations completed before July 1, 2001,
continued to be amortized and tested for impairment in accordance
with the appropriate pre-FAS 142 accounting requirements prior to
adoption of FAS 142.
In October 2002, the FASB issued Statement No. 147 (FAS 147),
"Acquisitions of Certain Financial Institutions," which amends
Statement No. 72 (FAS 72), "Accounting for Certain Acquisitions
of Banking or Thrift Institutions," and no longer requires the
separate recognition and subsequent amortization of goodwill.
FAS 147 also amends Statement No. 144 (FAS 144), "Accounting for
the Impairment or Disposal of Long-Lived Assets," to include in
its scope core deposit intangibles. Heartland adopted FAS 147 on
September 30, 2002. As of December 31, 2002, Heartland had
unamortized goodwill in the amount of $16.1 million and
unamortized core deposit premiums in the amount of $2.4 million.
Amortization expense related to goodwill was $1.1 million for the
years ended December 31, 2001 and 2000. Amortization expense
related to core deposit intangible assets was $495, $615 and $757
thousand for the years ended December 31, 2002, 2001 and 2000,
respectively.
The table below reconciles reported earnings for the years ended
December 31, 2002, 2001 and 2000, to "adjusted" earnings, which
exclude goodwill amortization.
(Dollars in thousands, except earnings per share data)
Year
Ended
Dec. 31,
2002 Year Ended Dec. 31, 2001
--------- --------------------------------
Reported Reported Goodwill "Adjusted"
Earnings Earnings Amort. Earnings
--------- -------- -------- -----------
Income from
continuing
operations before
taxes $ 24,113 $ 16,659 $ 1,057 $ 17,716
Income taxes 7,523 5,530 - 5,530
--------- -------- -------- -----------
Income from
continuing
operations $ 16,590 $ 11,129 $ 1,057 $ 12,186
========= ======== ======== ===========
Net income $ 18,867 $ 11,414 $ 1,057 $ 12,471
========= ======== ======== ===========
Earnings from
continuing
operations per
share - basic $ 1.69 $ 1.16 $ .11 $ 1.27
========= ======== ======== ===========
Earnings from
continuing
operations
per common
share - diluted $ 1.68 $ 1.15 $ .11 $ 1.26
========= ======== ======== ===========
Earnings per
share - basic $ 1.93 $ 1.19 $ .11 $ 1.30
========= ======== ======== ===========
Earnings per
share - diluted $ 1.91 $ 1.18 $ .11 $ 1.28
========= ======== ======== ===========
Year Ended Dec. 31, 2000
-------------------------------
Reported Goodwill "Adjusted"
Earnings Amort. Earnings
-------- -------- -----------
Income from
continuing
operations before
taxes $ 13,790 $ 1,057 $ 14,847
Income taxes 4,211 - 4,211
-------- -------- -----------
Income from
continuing
operations $ 9,579 $ 1,057 $ 10,636
======== ======== ===========
Net income $ 9,586 $ 1,057 $ 10,643
======== ======== ===========
Earnings from
continuing
operations per
share - basic $ .99 $ .11 $ 1.11
======== ======== ===========
Earnings from
continuing
operations
per common
share - diluted $ .98 $ .11 $ 1.09
======== ======== ===========
Earnings per
share - basic $ 1.00 $ .11 $ 1.10
======== ======== ===========
Earnings per
share - diluted $ .98 $ .11 $ 1.09
======== ======== ===========
In August 2001, the FASB issued Statement No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which
supersedes both Statement No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," and the accounting and reporting provisions of Accounting
Principles Bulletin (APB) Opinion No. 30, "Reporting the Results
of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a
business (as previously defined in that Opinion.) FAS 144 retains
the fundamental provisions in FAS 121 for recognizing and
measuring impairment losses on long-lived assets held for use and
long-lived assets to be disposed of by sale, while also resolving
significant implementation issues associated with FAS 121. For
example, FAS 144 provides guidance on how a long-lived asset that
is used as part of a group should be evaluated for impairment,
establishes criteria for when a long-lived asset is held for
sale, and prescribes the accounting for a long-lived asset that
will be disposed of other than by sale. FAS 144 retains the
basic provisions of Opinion No. 30 on how to present discontinued
operations in the income statement but broadens that presentation
to include a component of an entity (rather than a segment of a
business.) Unlike FAS 121, an impairment assessment under FAS
144 will never result in a write-down of goodwill. Rather,
goodwill is evaluated for impairment under FAS 142. Heartland
adopted FAS 144 effective January 1, 2002, and applied FAS 144 to
the sale of Wisconsin Community Bank's branch in Eau Claire,
Wisconsin.
In June 2002, the FASB issued Statement 146 (FAS 146),
"Accounting for Costs Associated with Exit or Disposal
Activities," which addresses financial accounting and reporting
of costs associated with exit or disposal activities. Under FAS
146, such costs will be recognized when the liability is
incurred, rather than at the date of the commitment to an exit
plan. FAS 146 is effective for exit or disposal activities that
are initiated after December 31, 2002, with early adoption
permitted. Heartland adopted FAS 146 on January 1, 2003 and the
adoption of the Statement did not have a material effect on the
financial statements.
In November of 2002, the FASB issued Interpretation No. 45 (FIN
45), Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others. This Interpretation describes the disclosures to be made
by a guarantor in interim and annual financial statements about
obligations under certain guarantees the guarantor has issued. It
also clarifies that a guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of FIN 45 are applicable
on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 will not have a
material effect on Heartland's financial statements. Heartland
adopted the disclosure provisions of FIN 45 effective
December 31, 2002.
In December 2002, the FASB issued Statement No. 148 (FAS 148),
Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment to FASB Statement 123. FAS 148 provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, FAS 148 amends the disclosure
requirements of FAS 123 to require more prominent disclosures in
both annual and interim financial statements about the method
used on reported results. FAS 148 is effective for financial
statements for fiscal years ending after December 15, 2002.
Heartland has adopted the disclosure provisions of FAS 148.
In January 2003, the 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 entities in which
equity investors do not have the characteristics of a controlling
interest. 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 June 15, 2003. Heartland adopted the
disclosure provisions of FIN 46 effective December 31, 2002 and
will adopt the provisions of FIN 46 for newly formed variable
interest entities effective January 31, 2003, which will not have
a material effect on Heartland's financial statements. Heartland
has three existing variable interest entities related to low
income housing partnerships and will adopt the provisions of FIN
46 for those entities on July 1, 2003. The total amount of
assets in these entities at December 31, 2002 was approximately
$4.5 million.
Stock-Based Compensation - 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. 148, Heartland's net income would have been
reduced to the pro forma amounts indicated below:
(Dollars in thousands, except earnings per share data)
2002 2001 2000
------- ------- -------
Net income as reported $18,867 $11,414 $ 9,586
Pro forma 18,619 11,112 9,231
Earnings per share-basic
as reported $ 1.93 $ 1.19 $ 1.00
Pro forma 1.90 1.16 .96
Earnings per share-diluted
as reported $ 1.91 $ 1.18 $ .98
Pro forma 1.89 1.14 .95
Pro forma net income only reflects options granted in 2002, 2001,
2000, 1999, 1998, 1997 and 1996. 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.
Reclassifications-Certain reclassifications have been made to
prior periods' consolidated financial statements to place them on
a basis comparable with the current period's consolidated
financial statements.
TWO
DISCONTINUED OPERATIONS
On December 15, 2002, Heartland sold the assets and liabilities
of its Eau Claire, Wisconsin branch of Wisconsin Community Bank
due to the fact that the branch did not achieve critical mass in
the marketplace. The sale allows Heartland to redirect assets to
markets where they can be more productively and profitably
employed. Loans sold totaled $34.3 million and deposits assumed
by the buyer totaled $6.7 million. As part of the sale agreement,
Wisconsin Community Bank subsequently purchased loans of $4.3
million from the buyer. Prior to the application of the direct
costs of $133 thousand, the transaction resulted in a gain on
sale of $1.6 million, net of tax. These amounts are included in
the line item "Income from operation of discontinued branch." The
branch's pretax profit or loss, for the periods presented, is
also reflected in this line item. Additionally, included in this
line item are the following amounts of net interest income for
the branch for the years ended December 31, 2002, 2001 and 2000,
respectively: $1.2 million, $906 thousand and $684 thousand.
THREE
ACQUISITIONS
Heartland regularly explores opportunities for acquisitions of
financial institutions and related businesses. Generally,
management does not make a public announcement about an
acquisition opportunity until a definitive agreement has been
signed.
In February of 2003, Heartland entered into an agreement with a
group of Arizona business leaders to establish a new bank in
Mesa. Pending regulatory approval, the new bank is expected to
begin operations in the summer of 2003. Heartland's portion of
the $15.0 million initial capital investment is $12.0 million.
Heartland intends to fund this transaction through its revolving
credit line.
On January 1, 2000, Heartland completed its acquisition of
National Bancshares, Inc., the one-bank holding company of First
National Bank of Clovis in New Mexico. First National Bank of
Clovis had four locations in the New Mexico communities of Clovis
and Melrose, with $120.1 million in assets and $97.5 million in
deposits at December 31, 1999. The total purchase price for
National Bancshares Inc. was $23.1 million, of which $5.8 million
was paid in common stock of Heartland to National Bancshares
Inc.'s Employee Stock Ownership Plan and $3.8 million in notes
payable over three or five years, at the stockholders'
discretion, bearing interest at 7.00%. As provided in the merger
agreement, participants in the Employee Stock Ownership Plan
elected to receive a cash payment totaling $4.6 million for
255,180 of the 319,009 shares of Heartland's common stock
originally issued to them. Heartland merged First National Bank
of Clovis into its New Mexico bank subsidiary New Mexico Bank &
Trust immediately after the closing of the National Bancshares
Inc. acquisition. As a result of this affiliate bank merger,
Heartland's ownership in New Mexico Bank & Trust increased from
its initial 80% to approximately 88%. The acquisition of
National Bancshares Inc. has been accounted for as a purchase;
accordingly, the results of operations of First National Bank of
Clovis are included in the consolidated financial statements from
the acquisition date. The resultant acquired deposit base
intangible of $2.0 million is being amortized over a period of 10
years.
FOUR
CASH AND DUE FROM BANKS
The Heartland banks are required to maintain certain average cash
reserve balances as a member of the Federal Reserve System. The
reserve balance requirements at December 31, 2002 and 2001 were
$5.2 and $3.3 million respectively.
FIVE
SECURITIES
The amortized cost, gross unrealized gains and losses and
estimated fair values of available for sale securities as of
December 31, 2002 and 2001, are summarized as follows:
(Dollars in thousands)
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- --------- --------- ---------
2002
Securities available
for sale:
U.S. government
corporations and
agencies and
treasuries $ 98,088 $ 3,251 $ - $101,339
Mortgage-backed
securities 185,216 2,353 (251) 187,318
Obligations of states
and political
subdivisions 67,810 3,648 (67) 71,391
-------- -------- -------- --------
Total debt
securities 351,114 9,252 (318) 360,048
Equity securities 30,284 157 (589) 29,852
-------- -------- -------- --------
Total $381,398 $ 9,409 $ (907) $389,900
======== ======== ======== ========
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- -------- --------- --------
2001
Securities available
for sale:
U.S. government
corporations and
agencies and treasuries $ 76,797 $ 2,543 $ (106) $ 79,234
Mortgage-backed
securities 182,179 1,764 (282) 183,661
Obligations of states
and political
subdivisions 29,493 1,575 (120) 30,948
Corporate debt
securities 521 2 - 523
-------- -------- -------- --------
Total debt
securities 288,990 5,884 (508) 294,366
Equity securities 29,352 262 (291) 29,323
-------- -------- -------- --------
Total $318,342 $ 6,146 $ (799) $323,689
======== ======== ======== ========
The amortized cost and estimated fair value of debt securities
available for sale at December 31, 2002, by estimated maturity,
are as follows. Expected maturities will differ from contractual
maturities because issuers may have the right to call or prepay
obligations with or without penalties.
(Dollars in thousands)
Estimated
Amortized Fair
Cost Value
--------- ---------
Securities available for sale:
Due in 1 year or less $ 97,242 $ 98,432
Due in 1 to 5 years 170,371 174,596
Due in 5 to 10 years 40,143 41,683
Due after 10 years 43,358 45,337
-------- --------
Total $351,114 $360,048
======== ========
As of December 31, 2002, securities with a fair value of $200.3
million were pledged to secure public and trust deposits, short-
term borrowings and for other purposes as required by law.
Gross gains and losses related to sales of securities for the
years ended December 31, 2002, 2001 and 2000, are summarized as
follows:
(Dollars in thousands)
2002 2001 2000
-------- -------- --------
Securities sold:
Proceeds from sales $46,796 $65,010 $34,442
Gross security gains 941 2,233 1,084
Gross security losses 151 744 583
During the years ended December 31, 2002 and 2001, Heartland
incurred other than temporary impairment losses of $267 and $773
thousand on equity securities available for sale.
SIX
LOANS AND LEASES
Loans and leases as of December 31, 2002 and 2001, were as
follows:
(Dollars in thousands)
2002 2001
---------- ----------
Loans:
Commercial and commercial
real estate $ 743,520 $ 651,479
Residential mortgage 145,931 168,912
Agricultural and agricultural
real estate 155,596 145,460
Consumer 120,853 127,874
---------- ----------
Loans, gross 1,165,900 1,093,725
Unearned discount (2,161) (3,457)
Deferred loan fees (811) (633)
---------- ----------
Loans, net 1,162,928 1,089,635
---------- ----------
Direct financing leases:
Gross rents receivable 9,765 13,129
Estimated residual value 4,336 4,921
Unearned income (1,793) (2,480)
---------- ----------
Direct financing leases, net 12,308 15,570
---------- ----------
Allowance for loan and
lease losses (16,091) (14,660)
---------- ----------
Loans and leases, net $1,159,145 $1,090,545
========== ==========
Direct financing leases receivable are generally short-term
equipment leases. Future minimum lease payments as of December
31, 2002, were as follows: $4.4 million for 2003, $4.0 million
for 2004, $3.2 million for 2005, $1.2 million for 2006, $924
thousand for 2007 and $353 thousand thereafter.
As Dubuque Bank and Trust Company is the largest subsidiary of
Heartland, the majority of the loan portfolio is concentrated in
northeast Iowa, northwest Illinois and southwest Wisconsin.
Loans and leases on a nonaccrual status amounted to $3.9 and $7.3
million at December 31, 2002 and 2001, respectively. The
allowance for loan and lease losses related to these nonaccrual
loans was $774 thousand and $2.0 million, respectively. All loans
were subject to a related allowance at December 31, 2002, and
December 31, 2001, as Heartland's allowance adequacy methodology
identifies a specific allocation for each credit. The average
balances of nonaccrual loans for the years ended December 31,
2002, 2001 and 2000 were $6.3, $7.0 and $3.2 million,
respectively. For the years ended December 31, 2002, 2001 and
2000, interest income which would have been recorded under the
original terms of these loans and leases amounted to
approximately $272, $557 and $323 thousand respectively, and
interest income actually recorded amounted to approximately $57,
$188 and $107 thousand, respectively.
Loans and leases on a restructured status amounted to $0 and $354
thousand at December 31, 2002 and 2001, respectively. The
allowance for loan and lease losses related to these nonaccrual
loans was $0 and $150 thousand for the same periods. All loans
were subject to a related allowance at December 31, 2002 and 2001
as Heartland's allowance adequacy methodology identifies a
specific allocation for each credit. The average balances of
restructured loans for the years ended December 31, 2002, 2001
and 2000 were $119, $355 and $367 thousand, respectively. For
the years ended December 31, 2002, 2001 and 2000, interest income
which would have been recorded under the original terms of these
loans and leases amounted to approximately $9, $32 and $28
thousand, respectively, and interest income actually recorded
amounted to approximately $9, $9 and $28 thousand, respectively.
Loans are made in the normal course of business to directors,
officers and principal holders of equity securities of Heartland.
The terms of these loans, including interest rates and
collateral, are similar to those prevailing for comparable
transactions and do not involve more than a normal risk of
collectibility. Changes in such loans during the year ended
December 31, 2002 and 2001 were as follows:
(Dollars in thousands)
2002 2001
-------- --------
Balance at beginning of year $ 26,912 $ 24,433
Advances 24,357 46,935
Repayments (19,328) (44,456)
-------- --------
Balance at end of year $ 31,941 $ 26,912
======== ========
SEVEN
ALLOWANCE FOR
LOAN AND LEASE LOSSES
Changes in the allowance for loan and lease losses for the years
ended December 31, 2002, 2001 and 2000, were as follows:
(Dollars in thousands)
2002 2001 2000
------- ------- -------
Balance at beginning of year $14,660 $13,592 $10,844
Provision for loan and
lease losses from continuing
operations 3,553 4,258 2,976
Provision for loan and lease
losses from discontinued
operations (329) 25 325
Recoveries on loans and leases
previously charged off 1,410 542 585
Loans and leases charged off (3,203) (3,757) (2,280)
Additions related to acquisitions - - 1,142
------- ------- -------
Balance at end of year $16,091 $14,660 $13,592
======= ======= =======
EIGHT
PREMISES, FURNITURE AND EQUIPMENT
Premises, furniture and equipment as of December 31, 2002 and
2001, were as follows:
(Dollars in thousands)
2002 2001
------- -------
Land and land improvements $ 6,610 $ 5,279
Buildings and building improvements 29,899 26,144
Furniture and equipment 20,960 19,428
------- -------
Total 57,469 50,851
Less accumulated depreciation (21,878) (19,369)
------- -------
Premises, furniture and equipment, net $35,591 $31,482
======= =======
Depreciation expense on premises, furniture and equipment was
$2.8 million for 2002, $2.7 million for 2001 and $2.7 million for
2000.
NINE
INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated
accumulated amortization at December 31, 2002 and 2001 are
presented in the tables below.
(Dollars in thousands)
December 31, 2002
------------------------
Gross
Carrying Accumulated
Amount Amortization
-------- ------------
Intangible assets:
Core deposit premium $4,492 $ 2,056
Mortgage servicing rights 3,346 903
-------- -------
Total $7,838 $ 2,959
======== =======
Unamortized intangible assets $ 4,879
=======
(Dollars in thousands)
December 31, 2001
------------------------
Gross
Carrying Accumulated
Amount Amortization
-------- ------------
Intangible assets:
Core deposit premium $4,492 $ 1,561
Mortgage servicing rights 1,963 239
-------- -------
Total $6,455 $ 1,800
======== =======
Unamortized intangible assets $ 4,655
=======
Projections of amortization expense for mortgage servicing rights
are based on existing asset balances and the existing interest
rate environment as of December 31, 2002. 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
amortizable intangibles assets:
(Dollars in thousands)
Core Mortgage
Deposit Servicing
Premium Rights Total
--------- -------- ---------
Year Ended December 31,
2003 $ 404 $ 698 $1,102
2004 353 582 935
2005 353 465 818
2006 353 349 702
2007 353 232 585
TEN
DEPOSITS
The aggregate amount of time certificates of deposit in
denominations of one hundred thousand dollars or more as of
December 31, 2002 and 2001, were $126.2 and $111.5 million,
respectively. At December 31, 2002, the scheduled maturities of
time certificates of deposit were as follows:
(Dollars in thousands)
2002
---------
2003 $ 313,230
2004 103,774
2005 83,550
2006 27,281
2007 100,221
Thereafter 434
---------
Total $ 628,490
=========
Interest expense on deposits for the years ended December 31,
2002, 2001 and 2000, was as follows:
(Dollars in thousands)
2002 2001 2000
------- ------- -------
Savings and money
market accounts $ 6,530 $11,858 $13,866
Time certificates of deposit in
denominations of $100,000 or more 4,505 8,220 6,001
Other time deposits 20,360 25,705 23,274
------- ------- -------
Interest expense on deposits $31,395 $45,783 $43,141
======= ======= =======
ELEVEN
SHORT-TERM BORROWINGS
Short-term borrowings as of December 31, 2002 and 2001, were as
follows:
(Dollars in thousands)
2002 2001
-------- --------
Securities sold under
agreements to repurchase $ 99,004 $108,592
Federal funds purchased 28,325 10,175
U.S. Treasury demand note 6,550 10,211
Citizens short-term notes 2,500 2,500
Notes payable to unaffiliated banks 25,000 29,225
-------- --------
Total $161,379 $160,703
======== ========
On September 28, 2000, Heartland entered into a credit agreement
with two unaffiliated banks to replace an existing term credit
line, as well as to increase availability under a revolving
credit line. Under the new unsecured revolving credit lines,
Heartland may borrow up to $50.0 million at any one time. At
December 31, 2002 and December 31, 2001, $25.0 and $29.2 million,
respectively, was outstanding on the revolving credit lines. The
additional credit line was established primarily to provide
additional working capital to the nonbanking subsidiaries and to
meet general corporate commitments.
All repurchase agreements as of December 31, 2002 and 2001, were
due within six months.
Average and maximum balances and rates on aggregate short-term
borrowings outstanding during the years ended December 31, 2002,
2001 and 2000, were as follows:
(Dollars in thousands)
2002 2001 2000
-------- -------- --------
Maximum month-end balance $161,379 $162,744 $144,604
Average month-end balance 140,282 151,139 122,777
Weighted average interest
rate for the year 1.96% 3.96% 5.79%
Weighted average interest
rate at year-end 1.59 1.39 5.60
TWELVE
OTHER BORROWINGS
Other borrowings at December 31, 2002 and 2001, were
as follows:
(Dollars in thousands)
2002 2001
-------- --------
Advances from the FHLB;
weighted average maturity dates at
December 31, 2002 and 2001, were
February 2005 and May 2004,
respectively; and weighted average
interest rates were 5.04% and 5.37%,
respectively $ 72,481 $ 86,486
Notes payable on leased assets with
interest rates varying from 3.17 to
9.50% 14,245 22,193
Trust preferred securities 38,000 33,000
Contracts payable to previous stock-
holders of National Bancshares, Inc.
for acquisition due over a three-or
five-year schedule at 7.00%
through January 2004 1,255 2,110
Contracts payable for purchase of
real estate 318 -
-------- --------
Total $126,299 $143,789
======== ========
The Heartland banks are members of the Federal Home Loan Bank
("FHLB") of Des Moines, Chicago, or Dallas. The advances from the
FHLB are collateralized by the banks' investment in FHLB stock of
$26.7 and $25.6 million at December 31, 2002 and 2001,
respectively. Additional collateral is provided by the banks' one-
to-four unit residential mortgages, commercial and agricultural
mortgages and securities pledged totaling $195.8 million at
December 31, 2002 and $123.8 million at December 31, 2001.
On June 27, 2002, Heartland 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 Heartland. 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. Heartland
has the option to shorten the maturity date to a date not earlier
than June 30, 2007. 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. In connection with this offering, the balance of
deferred issuance costs included in other assets was $163
thousand as of December 31, 2002. These deferred costs are
amortized on a straight-line basis over the life of the
debentures.
On December 18, 2001, Heartland completed an offering of $8.0
million of variable rate cumulative capital securities
representing undivided beneficial interests in Heartland
Statutory Trust II. The proceeds from the offering were used by
Heartland Statutory Trust II to purchase junior subordinated
debentures from Heartland. The proceeds are being used for
general corporate purposes, including the repayment of $8.0
million of indebtedness on the revolving credit lines. 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 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. In connection with
this offering, the balance of deferred issuance costs included in
other assets was $237 thousand as of December 31, 2002. These
deferred costs are amortized on a straight-line basis over the
life of the debentures.
On October 21, 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 of Heartland formed for the sole
purpose of this offering. The proceeds from the offering were
used by Heartland Capital Trust I to purchase junior subordinated
debentures from Heartland. 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 September 30, 2029. Heartland has the option to
shorten the maturity date to a date not earlier than September
30, 2004. 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. In connection with this offering, the balance of deferred
issuance costs included in other assets was $1.0 million as of
December 31, 2002. The deferred costs are amortized on a
straight-line basis over the life of the debentures.
All of the capital securities qualified as Tier 1 capital for
regulatory purposes as of December 31, 2002 and 2001.
Future payments at December 31, 2002, for all other borrowings
were as follows:
(Dollars in thousands)
2003 $ 10,157
2004 22,659
2005 24,165
2006 20,538
2007 40
Thereafter 48,740
--------
Total $126,299
========
THIRTEEN
DERIVATIVE FINANCIAL INSTRUMENTS
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
the 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. This
risk is minimized by entering into the contract with a large,
stable financial institution.
As of December 31, 2002, Heartland had an interest rate swap
contract to pay a fixed interest rate of 4.35% and receive a
variable interest rate of 1.52% based 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 of $1.7 million as of December 31, 2002.
There was no ineffectiveness recognized on this interest rate
swap during the year. All components of the derivative
instrument's gain or loss were included in the assessment of
hedge effectiveness. For the period ended December 31, 2002,
there were no cash flow hedges discontinued related to forecasted
transactions that are probable of not occurring.
As of December 31, 2002, $1.1 million of deferred net expense on
derivative instruments included in other comprehensive income are
expected to be reclassified to net income during the next twelve
months.
FOURTEEN
INCOME TAXES
Income taxes for the years ended December 31, 2002, 2001 and
2000, were as follows:
(Dollars in thousands)
Current Deferred Total
------- -------- ------
2002:
Federal $6,591 $ 967 $7,558
State 1,156 283 1,439
------ ------ ------
Total $7,747 $1,250 $8,997
====== ====== ======
2001:
Federal $5,310 $ (540) $4,770
State 1,037 (93) 944
------ ------ ------
Total $6,347 $ (633) $5,714
====== ====== ======
2000:
Federal $3,504 $ (86) $3,418
State 850 (52) 798
------ ------ ------
Total $4,354 $ (138) $4,216
====== ====== ======
Temporary differences between the amounts reported in the
financial statements and the tax basis of assets and liabilities
result in deferred taxes. No valuation allowance was required
for deferred tax assets. Based upon Heartland's level of
historical taxable income and anticipated future taxable income
over the periods in which the deferred tax assets are deductible,
management believes it is more likely than not that Heartland
will realize the benefits of these deductible differences.
Deferred tax assets and liabilities for the years ended December
31, 2002 and 2001, were as follows:
(Dollars in thousands)
2002 2001
-------- --------
Deferred tax assets:
Tax effect of net unrealized loss on
derivatives reflected in stockholders'
equity $ 653 $ -
Securities 112 240
Allowance for loan and lease losses 5,798 5,635
Deferred compensation 1,427 789
Organization and acquisitions costs 265 244
Net operating loss carryforwards 608 708
Other 52 140
-------- --------
Gross deferred tax assets $ 8,915 $ 7,756
-------- --------
Deferred tax liabilities:
Tax effect of net unrealized gain on
securities available for sale reflected
in stockholders' equity $ (3,175) $ (2,001)
Tax effect of net unrealized gain on
derivatives reflected in stockholders'
equity - (131)
Premises, furniture and equipment (6,085) (4,452)
Lease financing (2,627) (2,791)
Tax bad debt reserves (549) (580)
Purchase accounting (954) (895)
Prepaid expenses (309) (272)
Mortgage servicing rights (911) (643)
Other (130) (176)
-------- --------
Gross deferred tax liabilities $(14,740) $(11,941)
-------- --------
Net deferred tax asset(liability) $ (5,825) $ (4,185)
======== ========
The actual income tax expense differs from the expected amounts
(computed by applying the U.S. federal corporate tax rate of 35%
for 2002, 2001 and 2000, to income before income taxes) as
follows:
(Dollars in thousands)
2002 2001 2000
--------------------------
Computed "expected" amount $9,752 $5,995 $4,831
Increase (decrease) resulting from:
Nontaxable interest income (944) (610) (624)
State income taxes, net of federal
tax benefit 935 614 520
Goodwill and other intangibles not
deductible 78 270 291
Graduated income tax rates - (36) (100)
Tax credits (792) (440) (440)
Other (32) (79) (262)
------- ------- -------
Income taxes $8,997 $5,714 $4,216
======= ======= =======
Effective tax rates 32.3% 33.4% 30.5%
======= ======= =======
Heartland has investments in certain low-income housing projects
totaling $4.5 million and $4.7 million as of December 31, 2002
and 2001, respectively, which are included in other assets in the
consolidated financial statements. These investments are
expected to generate federal income tax credits of approximately
$440 thousand per year through 2005. In April of 2002, a 99.9%
ownership in a limited liability company was acquired that
provided approximately $352 thousand historic rehabilitation
credits for the 2002 tax year.
FIFTEEN
EMPLOYEE BENEFIT PLANS
Heartland sponsors a retirement plan covering substantially all
employees. Contributions to this plan are subject to approval by
the Heartland Board of Directors. The Heartland subsidiaries fund
and record as an expense all approved contributions. Costs
charged to operating expenses were $1.7 million for 2002, $761
thousand for 2001 and $692 thousand for 2000. This plan includes
an employee savings program, under which the Heartland
subsidiaries make matching contributions of up to 2% of the
participants' wages. Costs charged to operating expenses with
respect to the matching contributions were $294 thousand for
2002, $275 thousand for 2001 and $262 thousand for 2000.
On January 1, 2002, Heartland merged its non-contributory,
defined contribution pension plan into the retirement plan
covering substantially all employees. Annual contributions were
based upon 5% of qualified compensation as defined in the plan.
Costs charged to operating expense were $761 thousand for 2001
and $692 thousand for 2000.
SIXTEEN
COMMITMENTS AND CONTINGENT LIABILITIES
Heartland leases certain land and facilities under operating
leases. Minimum future rental commitments at December 31, 2002,
for all non-cancelable leases were as follows:
(Dollars in thousands)
2003 $ 536
2004 672
2005 586
2006 465
2007 307
Thereafter 711
------
Total $3,277
======
Rental expense for premises and equipment leased under operating
leases was $700 thousand for 2002, $707 thousand for 2001 and
$687 thousand for 2000.
In the normal course of business, the Heartland banks make
various commitments and incur certain contingent liabilities that
are not presented in the accompanying consolidated financial
statements. The commitments and contingent liabilities include
various guarantees, commitments to extend credit and standby
letters of credit.
Commitments to extend credit are agreements to lend to a customer
as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Heartland banks evaluate
each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the
Heartland banks upon extension of credit, is based upon
management's credit evaluation of the counterparty. Collateral
held varies but may include accounts receivable, inventory,
property, plant and equipment and income-producing commercial
properties. Standby letters of credit and financial guarantees
written are conditional commitments issued by the Heartland banks
to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and
private borrowing arrangements. The credit risk involved in
issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. At December
31, 2002 and 2001, commitments to extend credit aggregated $391.1
and $325.3 million and standby letters of credit aggregated $11.8
and $11.6 million, respectively. Heartland enters into
commitments to sell mortgage loans to reduce interest rate risk
on certain mortgage loans held for sale and loan commitments. At
December 31, 2002 and 2001, Heartland had commitments to sell
residential real estate loans totaling $56.7 and $30.8 million,
respectively. Heartland does not anticipate any material loss as
a result of the commitments and contingent liabilities.
SEVENTEEN
STOCK PLANS
Heartland's Stock Option Plan is administered by the Compensation
Committee of the Board of Directors whose members determine to
whom options will be granted and the terms of each option. Under
the Stock Option Plan, 1,200,000 common shares have been reserved
for issuance. Directors and key policy-making employees are
eligible for participation in the Stock Option Plan. Options may
be granted that are either intended to be "incentive stock
options" as defined under Section 422 of the Internal Revenue
Code or not intended to be incentive stock options ("non-
qualified stock options"). The exercise price of stock options
granted will be established by the Compensation Committee, but
the exercise price for the incentive stock options may not be
less than the fair market value of the shares on the date that
the option is granted. Each option granted is exercisable in full
at any time or from time to time, subject to vesting provisions,
as determined by the Compensation Committee and as provided in
the option agreement, but such time may not exceed ten years from
the grant date. At December 31, 2002 and 2001, respectively,
there were 59,369 and 201,717 shares available for issuance under
the Stock Option Plan.
Under the Stock Option Plan, stock appreciation rights ("SARS")
may also be granted alone or in tandem with or with reference to
a related stock option, in which event the grantee, at the
exercise date, has the option to exercise the option or the SARS,
but not both. SARS entitle the holder to receive in cash or
stock, as determined by the Compensation Committee, an amount per
share equal to the excess of the fair market value of the stock
on the date of exercise over the fair market value at the date
the SARS or related options were granted. SARS may be exercisable
for up to ten years after the date of grant. No SARS have been
granted under the Stock Option Plan.
A summary of the status of the Stock Option Plan as of December
31, 2002, 2001 and 2000, and changes during the years ended
follows:
2002 2001 2000
Weighted- Weighted- Weighted-
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
(000) Price (000) Price (000) Price
------ -------- ------ -------- ------ ---------
Outstanding
at beginning
of year 842 $12 798 $12 760 $11
Granted 48 13 45 13 40 18
Exercised (230) 8 - - - -
Forfeited (48) 9 (1) 18 (2) 16
--- --- ---
Outstanding at
end of year 612 $13 842 $12 798 $12
=== === ===
Options
exercisable
at end of year 366 $12 522 $ 9 389 $ 9
Weighted-average
fair value of
options
granted during
the year $2.57 $3.00 $4.41
As of December 31, 2002 and 2001, options outstanding had
exercise prices ranging from $8 to $18 per share and a weighted-
average remaining contractual life of 5.22 and 4.28 years,
respectively.
The fair value of stock options granted was determined utilizing
the Black Scholes Valuation model. Significant assumptions
include:
2002 2001 2000
------ ------ ------
Risk-free interest rate 4.88% 5.36% 5.00%
Expected option life 10 Years 10 Years 10 Years
Expected volatility 15.35% 16.03% 13.04%
Expected dividends 3.03% 2.77% 2.00%
In 2001, Heartland adopted a Director Short-Term Incentive Plan.
Under the Director Short-Term Incentive Plan, the aggregate
number of shares that could be obtained by the directors was set
at 150,000. The exercise price of stock options granted was
established by the Compensation Committee at the fair market
value of the shares on the date that the options were granted.
Each director was eligible to receive non-qualified options to
acquire up to no more than 7,500 shares. Under the Director
Short-Term Incentive Plan, 127,065 shares were issued, and under
the terms of the Director Short-Term Incentive Plan, all
remaining shares were considered to be forfeited at December 31,
2001.
In 1996, Heartland adopted the Heartland Employee Stock Purchase
Plan ("ESPP"), which permits all eligible employees to purchase
shares of Heartland common stock at a price of not less than 85%
of the fair market value on the determination date (as determined
by the Committee). A maximum of 400,000 shares is available for
sale under the ESPP. For the years ended December 31, 2002 and
2001, Heartland approved a price of 100% of fair market value at
December 31, 2001 and 2000, respectively. At December 31, 2002
and 2001, respectively, 23,751 and 12,355 shares were purchased
under the ESPP at no charge to Heartland's earnings.
During each of the years ended December 31, 2002, 2001 and 2000,
Heartland acquired shares for use in the Stock Option Plan and
the ESPP. Shares acquired totaled 95,543, 79,256 and 291,501 for
2002, 2001 and 2000, respectively.
EIGHTEEN
STOCKHOLDER RIGHTS PLAN
On June 7, 2002, Heartland 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
Heartland'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 Heartland's
common stock (in lieu of preferred shares) having a value equal
to two times the exercise price. If Heartland 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, Heartland 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 Heartland's common stock per right held.
Rights are redeemable by Heartland 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 Heartland
or its shareholders, and will not change the way in which
Heartland's shares are traded. The rights expire on June 7, 2012.
In connection with the Rights Plan, Heartland 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
Heartland does not anticipate issuing any shares of Series A
Junior Participating preferred stock except as may be required
under the Rights Plan.
NINETEEN
REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS ON SUBSIDIARY
DIVIDENDS
The Heartland banks are subject to various regulatory capital
requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain
mandatory, and possibly additional discretionary, actions by
regulators that, if undertaken, could have a direct material
effect on the Heartland banks' financial statements. The
regulations prescribe specific capital adequacy guidelines that
involve quantitative measures of a bank's assets, liabilities and
certain off balance sheet items as calculated under regulatory
accounting practices. Capital classification is also subject to
qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Heartland banks to maintain minimum amounts
and ratios (set forth in the table below) of total and Tier 1
capital (as defined in the regulations) to risk-weighted assets
(as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31,
2002 and 2001, that the Heartland banks met all capital adequacy
requirements to which they were subject.
As of December 31, 2002, the most recent notification from the
FDIC categorized each of the Heartland banks as well capitalized
under the regulatory framework for prompt corrective action. To
be categorized as well capitalized, the Heartland banks must
maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the following table. There are
no conditions or events since that notification that management
believes have changed each institution's category.
The Heartland banks' actual capital amounts and ratios are also
presented in the table below.
(Dollars in thousands)
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
-------------- -------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
As of December 31, 2002
Total Capital (to Risk-
Weighted Assets)
Consolidated $158,010 11.86% $106,596 8.0% NA -
DB&T 58,288 11.02 42,304 8.0 $ 52,880 10.0%
GSB 15,919 12.27 10,380 8.0 12,975 10.0
FCB 9,278 12.53 5,922 8.0 7,403 10.0
RCB 11,680 11.58 8,072 8.0 10,090 10.0
WCB 24,783 13.28 14,929 8.0 18,662 10.0
NMB 28,676 10.87 21,103 8.0 26,379 10.0
Tier 1 Capital (to Risk-
Weighted Assets)
Consolidated $141,918 10.65% $ 53,298 4.0% NA -
DB&T 52,450 9.92 21,152 4.0 $ 31,728 6.0%
GSB 14,487 11.17 5,190 4.0 7,785 6.0
FCB 8,352 11.28 2,961 4.0 4,442 6.0
RCB 10,591 10.50 4,036 4.0 6,054 6.0
WCB 22,449 12.03 7,465 4.0 11,197 6.0
NMB 25,378 9.62 10,551 4.0 15,827 6.0
Tier 1 Capital
(to Average Assets)
Consolidated $141,918 8.24% $ 68,883 4.0% NA -
DB&T 52,450 8.03 26,118 4.0 $ 32,648 5.0%
GSB 14,487 7.61 7,613 4.0 9,516 5.0
FCB 8,352 7.67 4,355 4.0 5,443 5.0
RCB 10,591 7.01 6,045 4.0 7,556 5.0
WCB 22,449 8.41 10,676 4.0 13,345 5.0
NMB 25,378 8.13 12,491 4.0 15,614 5.0
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
-------------- -------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -----
As of December 31, 2001
Total Capital
(to Risk-Weighted Assets)
Consolidated $135,770 10.89% $100,099 8.0% N/A -
DB&T 54,802 10.35 42,363 8.0 $ 52,954 10.0%
GSB 13,996 11.91 9,402 8.0 11,753 10.0
FCB 9,230 11.47 6,440 8.0 8,050 10.0
RCB 9,651 10.80 7,150 8.0 8,938 10.0
WCB 20,001 11.52 13,892 8.0 17,366 10.0
NMB 24,997 10.48 19,073 8.0 23,841 10.0
Tier 1 Capital
(to Risk-Weighted Assets)
Consolidated $121,112 9.71% $ 50,049 4.0% N/A -
DB&T 49,334 9.32 21,182 4.0 $ 31,773 6.0%
GSB 12,700 10.81 4,701 4.0 7,052 6.0
FCB 8,223 10.21 3,220 4.0 4,830 6.0
RCB 8,787 9.83 3,575 4.0 5,363 6.0
WCB 17,829 10.27 6,946 4.0 10,419 6.0
NMB 22,177 9.30 9,536 4.0 14,305 6.0
Tier 1 Capital
(to Average Assets)
Consolidated $121,112 7.53% $ 64,336 4.0% N/A -
DB&T 49,334 7.45 26,502 4.0 $ 33,128 5.0%
GSB 12,700 7.21 7,044 4.0 8,805 5.0
FCB 8,223 7.04 4,674 4.0 5,843 5.0
RCB 8,787 6.92 5,082 4.0 6,352 5.0
WCB 17,829 8.14 8,756 4.0 10,945 5.0
NMB 22,177 7.83 11,323 4.0 14,153 5.0
For purposes of the above table, Heartland subsidiary banks are
abbreviated as follows:
Dubuque Bank and Trust Company DB&T
Galena State Bank and Trust Company GSB
First Community Bank FCB
Riverside Community Bank RCB
Wisconsin Community Bank WCB
New Mexico Bank & Trust NMB
The ability of Heartland to pay dividends to its stockholders is
dependent upon dividends paid by its subsidiaries. The Heartland
banks are subject to certain statutory and regulatory
restrictions on the amount they may pay in dividends. To maintain
acceptable capital ratios in the Heartland banks, certain
portions of their retained earnings are not available for the
payment of dividends. Retained earnings that could be available
for the payment of dividends to Heartland totaled approximately
$45.9 million as of December 31, 2002, under the most restrictive
minimum capital requirements.
TWENTY
FAIR VALUE OF FINANCIAL INSTRUMENTS
Following are disclosures of the estimated fair value of
Heartland's financial instruments. The estimated fair value
amounts have been determined using available market information
and appropriate valuation methodologies. However, considerable
judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts
Heartland could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts.
(Dollars in thousands)
December 31,
2002
-------------------------
Carrying Fair
Amount Value
-------------------------
Financial Assets:
Cash and cash equivalents $ 100,992 $ 100,992
Time deposits in other financial
institutions 1,677 1,677
Trading securities 915 915
Securities available for sale 389,900 389,900
Loans and leases, net of
unearned 1,175,236 1,225,412
Financial Liabilities:
Demand deposits $ 197,516 $ 197,516
Savings deposits 511,979 511,979
Time deposits 628,490 663,250
Short-term borrowings 161,379 161,379
Other borrowings 126,299 165,133
December 31,
2001
-------------------------
Carrying Fair
Amount Value
-------------------------
Financial Assets:
Cash and cash equivalents $ 93,550 $ 93,550
Time deposits in other financial
institutions 564 564
Trading securities 1,528 1,528
Securities available for sale 323,689 323,689
Loans and leases, net of
unearned 1,105,205 1,126,512
Financial Liabilities:
Demand deposits $ 160,742 $ 160,742
Savings deposits 493,374 493,374
Time deposits 551,043 564,043
Short-term borrowings 160,703 160,703
Other borrowings 143,789 156,930
Cash and Cash Equivalents and Time Deposits in Other Financial
Institutions - The carrying amount is a reasonable estimate of
fair value.
Securities - For securities either available for sale or trading,
fair value equals quoted market price if available. If a quoted
market price is not available, fair value is estimated using
quoted market prices for similar securities.
Loans and Leases - The fair value of loans is estimated by
discounting the future cash flows using the current rates at
which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities. The fair
value of loans held for sale is estimated using quoted market
prices.
Deposits - The fair value of demand deposits, savings accounts
and certain money market deposits is the amount payable on demand
at the reporting date. The fair value of fixed maturity
certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities.
Short-term and Other Borrowings - Rates currently available to
Heartland for debt with similar terms and remaining maturities
are used to estimate fair value of existing debt.
Commitments to Extend Credit, Unused Lines of Credit and Standby
Letters of Credit - Based upon management's analysis of the off
balance sheet financial instruments, there are no significant
unrealized gains or losses associated with these financial
instruments based upon our review of the fees currently charged
to enter into similar agreements, taking into account the
remaining terms of the agreements and the present
creditworthiness of the counterparties.
TWENTY-ONE
PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed financial information for Heartland Financial USA, Inc.
is as follows:
(Dollars in thousands)
Balance Sheets
December 31, 2002 2001
-------- --------
Assets:
Cash and interest bearing deposits $ 1,985 $ 323
Trading securities 915 1,528
Securities available for sale 3,003 3,666
Investment in subsidiaries 166,061 148,966
Other assets 5,480 4,375
Due from subsidiaries 17,250 15,500
-------- --------
Total $194,694 $174,358
======== ========
Liabilities
and stockholders' equity:
Liabilities:
Short-term borrowings $ 25,000 $ 29,225
Other borrowings 40,438 36,138
Accrued expenses and other liabilities 5,215 1,905
-------- --------
Total liabilities 70,653 67,268
-------- --------
Stockholders' equity:
Common stock 9,906 9,906
Capital surplus 16,725 18,116
Retained earnings 94,048 79,107
Accumulated other comprehensive
income 4,230 3,565
Treasury stock (868) (3,604)
-------- --------
Total stockholders' equity 124,041 107,090
-------- --------
Total $194,694 $174,358
======== ========
Income Statements for the
Years Ended December 31, 2002 2001 2000
------- ------- -------
Operating revenues:
Dividends from subsidiaries $ 9,890 $15,452 $21,768
Security gains (losses), (net) 95 (246) -
Loss on trading account
securities (598) (192) -
Impairment loss on equity
securities (267) (773) -
Other 1,016 1,047 769
------- ------- -------
Total operating revenues 10,136 15,288 22,537
------- ------- -------
Operating expenses:
Interest 4,592 4,807 4,934
Salaries and benefits 1,973 1,039 958
Outside services 572 456 198
Other operating expenses 367 262 246
Minority interest expense 403 207 237
------- ------- -------
Total operating expenses 7,907 6,771 6,573
------- ------- -------
Equity in undistributed earnings 14,509 659 (8,322)
------- ------- -------
Income before income tax benefit 16,738 9,176 7,642
Income tax benefit 2,129 2,238 1,944
------- ------- -------
Net income $18,867 $11,414 $ 9,586
======= ======= =======
Statements of Cash Flows For
the Years Ended December 31, 2002 2001 2000
------- ------- -------
Cash flows from operating
activities:
Net income $18,867 $11,414 $ 9,586
Adjustments to reconcile net
income to net cash provided by
operating activities:
Undistributed earnings of
subsidiaries (14,509) (659) 8,322
(Increase) decrease in due
from subsidiaries (1,750) 1,250 (9,200)
Increase in other
liabilities 3,310 601 1,183
Increase in other assets (1,105) (1,531) (410)
(Increase) decrease in trading
account securities 613 (657) -
Noncash dividend from subsidiary - (5,149) -
Other (33) 1,282 88
------- ------- -------
Net cash provided
by operating activities 5,393 6,551 9,569
------- ------- -------
Cash flows from investing
activities:
Capital injections for
subsidiaries (600) (1,248) (4,150)
Receipts for sale of
minority interest - - 780
Payments for purchase of
subsidiaries - - (13,509)
Purchases of available for sale
securities (1,774) (1,377) -
Sales of available for sale
securities 1,766 1,917 -
------- ------- -------
Net cash used by
investing activities (608) (708) (16,879)
------- ------- -------
Cash flows from financing
activities:
Net increase (decrease) in
short-term borrowings (4,225) (10,075) 14,300
Proceeds from other borrowings 5,155 8,248 -
Payments on other borrowings (855) (1,438) (1,449)
Cash dividends paid (3,926) (3,560) (3,465)
Purchase of treasury stock (1,348) (1,026) (5,197)
Sale of treasury stock 2,076 1,689 19
------- ------- -------
Net cash provided (used) by
financing activities (3,123) (6,162) 4,208
------- ------- -------
Net increase (decrease) in cash
and cash equivalents 1,662 (319) (3,102)
Cash and cash equivalents at
beginning of year 323 642 3,744
------- ------- -------
Cash and cash equivalents at
end of year $ 1,985 $ 323 $ 642
======= ======= =======
TWENTY-TWO
SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(Dollars in thousands, except per share data)
2002 December 31 September 30
----------- ------------
Net interest income $ 15,517 $ 14,906
Provision for loan and lease losses 1,775 167
Net interest income after provision
for loan and lease losses 13,742 14,739
Noninterest income 9,553 7,489
Noninterest expense 17,015 15,500
Income taxes 2,070 2,087
Income from continuing operations 4,210 4,641
Gain from operations of discontinued
operations (including gain on
disposal of $2,602) 3,124 224
Income tax expense 1,228 88
Gain on discontinued operation 1,896 136
Net income $ 6,106 $ 4,777
Per share:
Earnings per share-basic $ .62 $ .49
Earnings per share-diluted .62 .48
Earnings per common share from
continuing operations-basic (1) .43 .47
Earning per common share from
continuing operations-diluted (1) .43 .47
Adjusted earnings per common share
-basic (2) .62 .49
Adjusted earnings per common share
-diluted (2) .62 .48
Adjusted earnings per common share
from continuing operations-basic (3) .43 .47
Adjusted earnings per common share
from continuing operations-
diluted (3) .43 .47
Cash dividends declared on
common stock .10 .10
Book value per common share 12.60 12.19
Market price - high 17.70 15.30
low 15.00 14.40
Weighted average common shares
outstanding 9,811,168 9,819,148
Weighted average diluted common
shares outstanding 9,890,267 9,894,883
Ratios:
Return on average assets 1.39% 1.13%
Return on average equity 20.06 16.20
Net interest margin 4.06 4.12
Efficiency ratio 66.78 69.08
SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2002 June 30 March 31
----------- ------------
Net interest income $ 13,989 $ 13,268
Provision for loan and lease losses 630 981
Net interest income after provision
for loan and lease losses 13,359 12,287
Noninterest income 7,274 8,441
Noninterest expense 15,155 15,101
Income taxes 1,560 1,806
Income from continuing operations 3,918 3,821
Gain from operations of discontinued
operations (including gain on
disposal of $2,602) 202 201
Income tax expense 79 79
Gain on discontinued operation 123 122
Net income $ 4,041 $ 3,943
Per share:
Earnings per share-basic $ .41 $ .41
Earnings per share-diluted .41 .40
Earnings per common share from
continuing operations-basic (1) .40 .39
Earning per common share from
continuing operations-diluted (1) .40 .39
Adjusted earnings per common share
-basic (2) .41 .41
Adjusted earnings per common share
-diluted (2) .41 .40
Adjusted earnings per common share
from continuing operations-basic (3) .40 .39
Adjusted earnings per common share
from continuing operations-
diluted (3) .40 .39
Cash dividends declared on
common stock .10 .10
Book value per common share 11.68 11.24
Market price - high 15.00 14.00
low 13.60 12.80
Weighted average common shares
outstanding 9,808,922 9,729,332
Weighted average diluted common
shares outstanding 9,872,842 9,793,766
Ratios:
Return on average assets .96% .95%
Return on average equity 13.98 14.19
Net interest margin 4.02 3.86
Efficiency ratio 70.43 69.04
SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2001 December 31 September 30
----------- ------------
Net interest income $ 13,433 $ 12,635
Provision for loan and lease losses 1,196 1,230
Net interest income after provision
for loan and lease losses 12,237 11,405
Noninterest income 8,156 7,150
Noninterest expense 15,134 14,652
Income taxes 1,798 1,351
Income from continuing operations 3,461 2,552
Gain from operations of discontinued
operations 34 181
Income tax expense 13 71
Gain on discontinued operation 21 110
Net income $ 3,482 $ 2,662
Per share:
Earnings per share-basic $ .36 $ .28
Earnings per share-diluted .36 .27
Earnings per common share from
continuing operations-basic (1) .36 .27
Earning per common share from
continuing operations-diluted (1) .36 .26
Adjusted earnings per common share
-basic (2) .39 .31
Adjusted earnings per common share
-diluted (2) .38 .30
Adjusted earnings per common share
from continuing operations-basic (3) .39 .29
Adjusted earnings per common share
from continuing operations-
diluted (3) .38 .29
Cash dividends declared on
common stock 0.10 0.09
Book value per common share 11.06 10.82
Market price - high 13.50 13.80
low 12.78 13.15
Weighted average common shares
outstanding 9,581,389 9,584,400
Weighted average diluted common
shares outstanding 9,689,376 9,692,878
Ratios:
Return on average assets 0.85% 0.67%
Return on average equity 13.20 10.38
Net interest margin 3.79 3.67
Efficiency ratio 69.28 74.69
SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2001 June 30 March 31
---------- ------------
Net interest income $ 11,877 $ 11,044
Provision for loan and lease losses 1,131 701
Net interest income after provision
for loan and lease losses 10,746 10,343
Noninterest income 7,546 7,409
Noninterest expense 14,395 14,152
Income taxes 1,180 1,201
Income from continuing operations 2,717 2,399
Gain from operations of discontinued
operations 160 94
Income tax expense 63 37
Gain on discontinued operation 97 57
Net income $ 2,814 $ 2,456
Per share:
Earnings per share-basic $ .29 $ .26
Earnings per share-diluted .29 .25
Earnings per common share from
continuing operations-basic (1) .28 .25
Earning per common share from
continuing operations-diluted (1) .28 .25
Adjusted earnings per common share
-basic (2) .32 .28
Adjusted earnings per common share
-diluted (2) .32 .28
Adjusted earnings per common share
from continuing operations-basic (3) .31 .28
Adjusted earnings per common share
from continuing operations-
diluted (3) .31 .27
Cash dividends declared on
common stock 0.09 0.09
Book value per common share 10.56 10.33
Market price - high 14.00 14.25
low 10.25 12.50
Weighted average common shares
outstanding 9,600,801 9,618,210
Weighted average diluted common
shares outstanding 9,695,351 9,724,761
Ratios:
Return on average assets 0.73% 0.67%
Return on average equity 11.32 10.24
Net interest margin 3.60 3.54
Efficiency ratio 73.95 77.58
(1) Excludes the discontinued operations for the sale of our Eau
Claire branch in the fourth quarter of 2002 and the related gain
on sale.
(2) Excludes goodwill amortization discontinued with the
adoption of FAS 142 on January 1, 2002, and the adoption
of FAS 147 on September 30, 2002.
(3) Excludes the goodwill amortization discontinued with the
adoption of FAS 142 on January 2, 2002, and the adoption
of FAS 147 on September 30, 2002, and the discontinued
operations for the sale of our Eau Claire branch in the
fourth quarter of 2002 and the related gain on sale.
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Heartland Financial USA, Inc.:
We have audited the accompanying consolidated balance sheets of
Heartland Financial USA, Inc. and subsidiaries as of December 31,
2002 and 2001, and the related consolidated statements of income,
changes in stockholders' equity and comprehensive income, and
cash flows for each of the years in the three-year period ended
December 31, 2002. These consolidated financial statements are
the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial
position of Heartland Financial USA, Inc. and subsidiaries as of
December 31, 2002 and 2001, and the results of their operations
and their cash flows for each the years in the three-year period
ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America. As discussed
in note one to the consolidated financial statements, the Company
changed its method of accounting for goodwill in 2002.
KPMG LLP
Des Moines, Iowa
January 17, 2003
Representations of Management
Management is responsible for the contents of the consolidated
financial statements and other information contained in other
sections of this annual report. The consolidated financial
statements have been prepared in conformity with accounting
principles generally accepted in the United States of America
appropriate to reflect, in all material respects, the substance
of events and transactions that should be included. The
consolidated financial statements reflect management's judgments
and estimates as to the effects of events and transactions that
are accounted for or disclosed. The company maintains accounting
and reporting systems, supported by an internal accounting
control system, which are adequate to provide reasonable
assurance that transactions are authorized, assets are
safeguarded, and reliable consolidated financial statements are
prepared, recognizing the cost and expected benefits of internal
accounting controls. A staff of internal auditors conducts
ongoing reviews of accounting practices and internal accounting
controls.
The consolidated financial statements as of December 31, 2002,
2001 and 2000, of Heartland Financial USA, Inc. and its
subsidiaries: Dubuque Bank and Trust Company; Galena State Bank
and Trust Company; Riverside Community Bank; Wisconsin Community
Bank; New Mexico Bank & Trust; First Community Bank; DB&T
Insurance, Inc.; DB&T Community Development Corp.; Citizens
Finance Co.; ULTEA, Inc.; DBT Investment Corporation; Heartland
Capital Trust I; Heartland Statutory Trust II; and Heartland
Capital Trust II were audited by independent certified public
accountants. Their role is to render independent professional
opinions of the fairness of the consolidated financial statements
based upon performance of procedures they deem appropriate under
generally accepted auditing standards.
The Audit Committees of the Boards of Directors of member banks
meet periodically with the internal auditors to review matters
relating to internal accounting controls and the nature, extent
and results of audit efforts. The internal auditors and
independent certified public accountants have free access to the
Audit Committees.
/s/ Lynn B. Fuller
- -----------------------------
Lynn B. Fuller
President and CEO, Heartland Financial USA, Inc.
/s/ John K. Schmidt
- ------------------------------
John K. Schmidt
Executive Vice President and CFO, Heartland Financial USA, Inc.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS
The information in the Heartland Proxy Statement for the 2003
annual meeting of stockholders dated April 9, 2003 (the "2003
Proxy Statement") under the caption "Election of Directors" and
under the caption, "Security Ownership of Directors and Executive
Officers and Certain Beneficial Owners" is incorporated by
reference. The information regarding executive officers is
included pursuant to Instruction 3 to Item 401 (b) and (c) of
Regulation S-K and is noted below.
EXECUTIVE OFFICERS
The term of office for the executive officers of Heartland is
from the date of election until the next annual organizational
meeting of the board of directors. The names and ages of the
executive officers of Heartland as of December 31, 2002, offices
held by these officers on that date and other positions held with
Heartland and its subsidiaries are set forth below.
Position with Heartland
and Subsidiaries
Name Age and Principal Occupation
Lynn B. Fuller 53 Chairman, President and Chief
Executive Officer of
Heartland; Vice Chairman of
Dubuque Bank and Trust
Company; Director of Galena
State Bank and Trust Company,
First Community Bank,
Riverside Community Bank,
Wisconsin Community Bank, New
Mexico Bank & Trust, and
Citizens Finance Co.; Director
and President of Citizens
Finance Co.; Chairman and
Director of ULTEA, Inc.
John K. Schmidt 43 Executive Vice President,
Chief Financial Officer and
Treasurer of Heartland;
Director, President and Chief
Executive Officer of Dubuque
Bank and Trust Company;
Treasurer of Citizens Finance
Co.; Treasurer of ULTEA, Inc.
Kenneth J. Erickson 51 Executive Vice President,
Credit Administration, of
Heartland; Executive Vice
President, Lending of Dubuque
Bank and Trust Company; Senior
Vice President of Citizens
Finance Co.; Director of
ULTEA, Inc.
Edward H. Everts 51 Senior Vice President,
Heartland, Operations and
Retail Banking; Senior Vice
President of Operations and
Retail Banking of Dubuque Bank
and Trust Company
Douglas J. Horstmann 49 Senior Vice President,
Lending of Heartland;
Executive Vice President, Head
of Lending of Dubuque Bank and
Trust Company
Paul J. Peckosh 57 Senior Vice President, Trust
of Heartland; Executive Vice
President, Trust, of Dubuque
Bank and Trust Company
Mr. Lynn B. Fuller is the brother-in-law of Mr. James F. Conlan,
who is a director of Heartland. There are no other family
relationships among any of the directors or executive officers of
Heartland.
Lynn B. Fuller has been a director of Heartland and of Dubuque
Bank and Trust Company since 1984 and has been President of
Heartland since 1987. He has been a director of Galena State Bank
and Trust Company since its acquisition by Heartland in 1992 and
First Community Bank since the merger in 1994. Mr. Fuller joined
Dubuque Bank and Trust Company in 1971 as a consumer loan officer
and was named Dubuque Bank and Trust Company's Executive Vice
President and Chief Executive Officer in 1985. He was named
Director of Riverside Community Bank in conjunction with the
opening of the de novo operation in 1995, Director of Wisconsin
Community Bank in conjunction with the purchase of Cottage Grove
State Bank in 1997 and Director of New Mexico Bank & Trust in
conjunction with the opening of the de novo bank in 1998. Mr.
Fuller was President of Dubuque Bank and Trust Company from 1987
until 1999 at which time he was named Chief Executive Officer of
Heartland.
John K. Schmidt has been Heartland's Executive Vice President and
Chief Financial Officer since 1991. He has been employed by
Dubuque Bank and Trust Company since September, 1984 and became
Dubuque Bank and Trust Company's Vice President, Finance in 1986,
Senior Vice President and Chief Financial Officer in January,
1991 and President and Chief Executive Officer in 1999. Mr.
Schmidt is a certified public accountant and worked at KPMG LLP
in Des Moines, Iowa, from 1982 until joining Dubuque Bank and
Trust Company. Mr. Schmidt has been a director of Heartland since
February, 2001.
Kenneth J. Erickson was named Executive Vice President, Credit
Administration, of Heartland in 1999 and has served as Executive
Vice President since 2000, Senior Vice President since 1992 and
Senior Vice President, Lending of Dubuque Bank and Trust Company
since 1989. Mr. Erickson joined Dubuque Bank and Trust Company in
1975 and was appointed Vice President, Commercial Loans in 1985.
Edward H. Everts was appointed as Senior Vice President of
Heartland in 1996. Mr. Everts joined Dubuque Bank and Trust
Company as Senior Vice President, Operations and Retail Banking
in 1992. Prior to his service with Dubuque Bank and Trust
Company, Mr. Everts was Vice President and Lead Retail Banking
Manager of First Bank, Duluth, Minnesota.
Douglas J. Horstmann was named as Senior Vice President of
Heartland in 1999, and has been Executive Vice President, Lending
since 2000 and Senior Vice President, Lending, of Dubuque Bank
and Trust Company since 1989. Mr. Horstmann joined Dubuque Bank &
Trust Company in 1980 and was appointed Vice President,
Commercial Loans in 1985. Prior to joining Dubuque Bank and
Trust Company, Mr. Horstmann was an examiner for the Iowa
Division of Banking.
Paul J. Peckosh was appointed Senior Vice President of Heartland
in 1999, and has been Executive Vice President, Trust, since 2000
and Senior Vice President, Trust, of Dubuque Bank and Trust
Company since 1991. Mr. Peckosh joined Dubuque Bank and Trust
Company in 1975 as Assistant Vice President, Trust and was
appointed Vice President, Trust in 1980. Mr. Peckosh is an
attorney and graduated from the Marquette University of Law
School in 1970.
ITEM 11.
EXECUTIVE COMPENSATION
The information in the 2003 Proxy Statement, under the caption
"Executive Compensation" is incorporated by reference, except for
the information contained under the heading "Compensation
Committee Report on Executive Compensation" and "Stockholder
Return Performance Presentation."
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the 2003 Proxy Statement, under the caption
"Security Ownership of Certain Beneficial Owners and Management"
is incorporated by reference.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in the 2003 Proxy Statement under the caption
"Transactions with Management" is incorporated by reference.
The table below sets forth the following information as of
December 31, 2002 for (i) all compensation plans previously
approved by Heartland's shareholders and (ii) all compensation
plans not previously approved by Heartland's shareholders:
(a) the number of securities to be issued upon the exercise
of outstanding options, warrants and rights;
(b) the weighted-average exercise price of such outstanding
options, warrants and rights;
(c) other than securities to be issued upon the exercise of
such outstanding options, warrants and rights, the number of
securities remaining available for future issuance under the
plans.
EQUITY COMPENSATION PLAN INFORMATION
Number of
securities Weighted-
to be average Number of
issued upon exercise securities
exercise of price of available
outstanding outstanding for future
options options issuance
----------- ----------- ----------
Equity compensation
plans approved by
security holders 612,000 $13.30 357,234
Equity compensation
plans not approved
by security holders - - -
------- ------ -------
Total 612,000 $13.30 357,234(1)
======= ====== =======
(1) Includes 59,369 shares available for use under the Heartland
Stock Option Plan and 297,865 shares available for use under
the Heartland Employee Stock Purchase Plan.
ITEM 14.
CONTROLS AND PROCEDURES
Based upon an evaluation within the 90 days prior to the filing
date of this report, Heartland's Chief Executive Officer and
Chief Financial Officer concluded that Heartland's disclosure
controls and procedures are effective. There have been no
significant changes in Heartland's internal controls or in other
factors that could significantly affect Heartland's internal
controls subsequent to the date of the evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
PART IV
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The documents filed as a part of this report are listed
below:
3. Exhibits
The exhibits required by Item 601 of Regulation S-K are
included along with this Form 10-K and are listed on the "Index
of Exhibits" immediately following the signature page.
(b) Reports of Form 8-K:
On January 22, 2003, Heartland filed a report on Form 8-K
stating under Item 5 that Heartland issued a press release
announcing the election of a new director to its board of
directors.
On January 23, 2003, Heartland filed a report on Form 8-K
stating under Item 5 that Heartland issued a press release
announcing its earnings for the quarter ended on December 31,
2002.
On February 21, 2003, Heartland issued a report on Form 8-K
stating under Itme 5 that Heartland issued a press release
announcing that Heartland and a group of investors intend to file
application with the Arizona State Department of Banking to
charter a new bank.
On February 26, 2003, Heartland issued a report on Form 8-K
stating under Item 5 that Heartland issued a press release
announcing that an application has been filed with the Nasdaq
Stock Market, Inc. to make its common stock eligible for
quotation on the Nasdaq National Market System.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities
Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly
authorized on March 26, 2003.
Heartland Financial USA, Inc.
By: /s/ Lynn B. Fuller /s/ John K. Schmidt
------------------------ ------------------------
Lynn B. Fuller John K. Schmidt
Principal Executive Officer Executive Vice President
and Principal Financial
and Accounting Officer
Date: March 26, 2003
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the Registrant and in the capacities indicated on
March 26, 2003.
/s/ Lynn B. Fuller /s/ John K. Schmidt
- ----------------------------- -----------------------------
Lynn B. Fuller John K. Schmidt
President, CEO, Chairman Executive Vice President, CFO
and Director and Director
/s/ James F. Conlan /s/ Mark C. Falb
- ----------------------------- -----------------------------
James F. Conlan Mark C. Falb
Director Director
/s/ Thomas L. Flynn /s/ John W. Cox, Jr.
- ----------------------------- -----------------------------
Thomas L. Flynn John W. Cox, Jr.
Director Director
I, Lynn B. Fuller, Principal Executive Officer of the Company,
certify that:
I have reviewed this annual report on Form 10-K of Heartland
Financial USA, Inc.;
Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
Based on my knowledge, the financial statements, and other
financial information included in the Report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;
The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
- designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
- evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
- presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
- all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
- any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
The registrant's other certifying officers and I have indicated
in this annual report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to date of
their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 26, 2003
Principal Executive Officer
/s/ Lynn B. Fuller
-----------------------
By: Lynn B. Fuller
President and Chief Executive
Officer
I, John K. Schmidt, Principal Accounting Officer of the Company,
certify that:
I have reviewed this annual report on Form 10-K of Heartland
Financial USA, Inc.;
Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
Based on my knowledge, the financial statements, and other
financial information included in the Report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;
The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
- designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
- evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
- presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
- all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
- any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
The registrant's other certifying officers and I have indicated
in this annual report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to date of
their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 26, 2003
Principal Financial and
Accounting Officer
/s/ John K. Schmidt
-----------------------
By: John K. Schmidt
Executive Vice President
and Chief Financial Officer
3. Exhibits
3.1 Certificate of Incorporation of Heartland Financial USA,
Inc. (Filed as Exhibit 3.1 to Registrant's Form S-4 for
the fiscal year ended December 31, 1993, and incorporated
by reference herein.)
3.2 Bylaws of Heartland Financial USA, Inc. (Filed as Exhibit
3.2 to Registrant's Form S-4 for the fiscal year ended
December 31, 1993, and incorporated by reference herein.)
4.1 Specimen Stock Certificate of Heartland Financial USA,
Inc. (Exhibit 4.1 to the Registration Statement on Form S-
4 filed with the Commission May 4, 1994, as amended (SEC
File No. 33-76228)
10.1 Heartland Financial USA, Inc. 1993 Stock Option Plan
(Filed as Exhibit 10.1 to Registrant's Form S-4 for the
fiscal year ended December 31, 1993, and incorporated by
reference herein.)
10.2 Dubuque Bank and Trust Management Incentive Compensation
Plan (Filed as Exhibit 10.3 to Registrant's Form S-4 for
the fiscal year ended December 31, 1993, and incorporated
by reference herein.)
10.3 Heartland Financial Defined Contribution Master Plan and
Trust Agreement dated January 1, 1995. (Filed as Exhibit
10.21 to Registrant's Form 10-K for the fiscal year ended
December 31, 1995, and incorporated by reference herein.)
10.4 Form of Split-Dollar Life Insurance Plan effective
November 13, 2001, between the Heartland subsidiaries and
their selected officers who have met the three years of
service requirement. These plans are in place at Dubuque
Bank and Trust Company, Galena State Bank and Trust
Company, First Community Bank, Riverside Community Bank,
Wisconsin Community Bank, New Mexico Bank & Trust and
ULTEA, Inc.
10.5 Heartland Financial USA, Inc. Employee Stock Purchase
Plan effective January 1, 1996. (Filed in conjunction
with Form S-8 on June 18, 1996, and incorporated by
reference herein.)
10.6 License and Service Agreement, Software License
Agreement, and Professional Services Agreement between
Fiserv and Heartland Financial USA, Inc. dated June 21,
1996. (Filed as Exhibit 10.43 to Registrant's form 10Q
for the quarter ended June 30, 1996, and incorporated by
reference herein.)
10.7 Stockholder Agreement between Heartland Financial USA,
Inc. and Investors in the Proposed New Mexico Bank dated
November 5, 1997. (Filed as Exhibit 10.23 to Registrant's
Form 10K for the fiscal year ended December 31, 1997, and
incorporated by reference herein.)
10.8 Heartland Financial USA, Inc. Health Care Plan dated
January 1, 1999. (Filed as Exhibit 10.13 to Registrant's
Form 10K for the fiscal year ended December 31, 1998, and
incorporated by reference herein.)
10.9 Second Amended and Restated Credit Agreement between
Heartland Financial USA, Inc. and The Northern Trust
Company dated September 28, 2000. (Filed as Exhibit 10.19
to Registrant's Form 10Q for the nine months ended
September 30, 2000, and incorporated by reference
herein.)
10.10 See Exhibit 10.9 for substantially the same form of a
Credit Agreement between Heartland Financial USA, Inc.
and Harris Trust and Savings Bank dated September 28,
2000, except that the lender is Harris Trust and Savings
Bank and the commitment is $20 million. (Filed as Exhibit
10.20 to Registrant's Form 10Q for the nine months ended
September 30, 2000, and incorporated by reference
herein.)
10.11 Change of Control Agreements including Golden Parachute
Payment Adjustments and Restrictive Covenants between
Heartland Financial USA, Inc. and Executive Officers
dated January 1, 2002. (Filed as Exhibit 10.12 to
Registrant's Form 10K for the year ended December 31,
2001, and incorporated by reference herein.)
10.12 Change of Control Agreements between Heartland Financial
USA, Inc. and Executive Officers dated January 1, 2002.
(Filed as Exhibit 10.13 to Registrant's Form 10K for the
year ended December 31, 2001, and incorporated by
reference herein.)
10.13 Third Amendment to Second Amended and Restated Credit
Agreement between Heartland Financial USA, Inc. and The
Northern Trust Company dated as of December 13, 2001.
(Filed as Exhibit 10.14 to Registrant's Form 10K for the
year ended December 31, 2001, and incorporated by
reference herein.)
10.14 See Exhibit 10.14 for substantially the same form of a
Third Amendment to Credit Agreement between Heartland
Financial USA, Inc. and Harris Trust and Savings Bank
dated as of December 13, 2001, except that the lender is
Harris Trust and Savings Bank and the commitment is $20
million (Filed as Exhibit 10.15 to Registrant's Form 10K
for the year ended December 31, 2001, and incorporated by
reference herein.)
10.15 Indenture between Heartland Financial USA, Inc. and First
Union Trust Company, National Association, dated as of
October 21, 1999 (filed as Exhibit 4.1 to Form S-3 dated
September 16, 1999, and incorporated by reference
herein.)
10.16 Indenture between Heartland Financial USA, Inc. and State
Street Bank and Trust Company of Connecticut, National
Association, dated as of December 18, 2001. (Filed as
Exhibit 10.17 to Registrant's Form 10K for the year ended
December 31, 2001, and incorporated by reference herein.)
10.17 Indenture between Heartland Financial USA, Inc. and Wells
Fargo Bank, National Association, dated as of June 27,
2002. (Filed as Exhibit 10.1 to the Registrant's 10Q for
the six months ended June 30, 2002, and incorporated by
reference herein.)
10.18 Fourth Amendment to Second Amended and Restated Credit
Agreement between Heartland Financial USA, Inc. and The
Northern Trust Company dated as of December 13, 2001.
(Filed as Exhibit 10.2 to Registrant's Form 10Q for the
six months ended June 30, 2002, and incorporated by
reference herein.)
10.19 See Exhibit 10.18 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 December 13, 2001, except that the lender is
Harris Trust and Savings Bank and the commitment is $20
million (Filed as Exhibit 10.2 to Registrant's Form 10Q
for the six months ended June 30, 2002, and incorporated
by reference herein.)
10.20 Fifth Amendment to Second Amended and Restated Credit
Agreement between Heartland Financial USA, Inc. and The
Northern Trust Company dated as of December 13, 2001.
(Filed as Exhibit 10.1 to Registrant's Form 10Q for the
nine months ended September 30, 2002, and incorporated by
reference herein.)
10.21 See Exhibit 10.20 for substantially the same form of a
Fifth Amendment to Credit Agreement between Heartland
Financial USA, Inc. and Harris Trust and Savings Bank
dated as of December 13, 2001, except that the lender is
Harris Trust and Savings Bank and the commitment is $20
million (Filed as Exhibit 10.2 to Registrant's Form 10Q
for the nine months ended September 30, 2002, and
incorporated by reference herein.)
10.22 Dividend Reinvestment Plan dated as of January 24, 2002.
(Filed as Form S-3D on January 25, 2002, and incorporated
by reference herein.)
10.23 Stockholder Rights Agreement between Heartland Financial
USA, Inc., and Dubuque Bank and Trust Company, as Rights
Agent, dated as of June 7, 2002. (Filed as Form 8-K on
June 11, 2002, and incorporated by reference herein.)
10.24 Agreement to Organize and Stockholder Agreement between
Heartland Financial USA, Inc. and Investors in the
Proposed Arizona Bank dated February 1, 2003
10.25 Supplemental Initial Investor Agreement between Heartland
Financial USA, Inc. and Initial Investors in the Proposed
Arizona Bank dated February 1, 2003
11. Statement re Computation of Per Share Earnings
21.1 Subsidiaries of the Registrant
23.1 Consent of KPMG LLP
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.