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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended March 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For transition period __________ to __________
Commission File Number: 0-24724
HEARTLAND FINANCIAL USA, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
42-1405748
(I.R.S. employer identification number)
1398 Central Avenue, Dubuque, Iowa 52001
(Address of principal executive offices)(Zip Code)
(563) 589-2100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark whether the Registrant is an
accelerated filer (as defined by Rule 12b-2 of the Securities
Exchange Act of 1934). Yes X No
Indicate the number of shares outstanding of each of the
classes of Registrant's common stock as of the latest practicable
date: As of May 13, 2003, the Registrant had outstanding
9,907,451 shares of common stock, $1.00 par value per share.
HEARTLAND FINANCIAL USA, INC.
Form 10-Q Quarterly Report
Table of Contents
Part I
Item 1. Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About
Market Risk
Item 4. Controls and Procedures
Part II
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of
Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Form 10-Q Signature Page
PART I
ITEM 1. FINANCIAL STATEMENTS
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
3/31/03 12/31/02
(Unaudited)
----------- ----------
ASSETS
Cash and due from banks $ 52,698 $ 61,106
Federal funds sold and other short-
term investments 4,059 39,886
---------- ----------
Cash and cash equivalents 56,757 100,992
Time deposits in other
financial institutions 1,694 1,677
Securities:
Trading, at fair value 963 915
Available for sale, at fair value
(cost of $382,089 for 2003 and
$381,398 for 2002) 389,893 389,900
Loans and leases:
Held for sale 22,108 23,167
Held to maturity 1,211,428 1,152,069
Allowance for loan and lease losses (17,054) (16,091)
---------- ----------
Loans and leases, net 1,216,482 1,159,145
Assets under operating leases 30,498 30,367
Premises, furniture and equipment, net 38,767 35,591
Other real estate, net 117 452
Goodwill, net 16,050 16,050
Core deposit premium and mortgage
servicing rights 4,670 4,879
Other assets 46,224 46,011
---------- ----------
TOTAL ASSETS $1,802,115 $1,785,979
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $ 184,233 $ 197,516
Savings 526,542 511,979
Time 656,216 628,490
---------- ----------
Total deposits 1,366,991 1,337,985
Short-term borrowings 132,238 161,379
Other borrowings 140,582 126,299
Accrued expenses and other liabilities 34,600 36,275
---------- ----------
TOTAL LIABILITIES 1,674,411 1,661,938
---------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock (par value $1 per
share; authorized, 184,000 shares;
none issued or outstanding) - -
Series A Junior Participating preferred
stock (par value $1 per share;
authorized, 16,000 shares; none
issued or outstanding) - -
Common stock (par value $1 per share;
authorized, 16,000,000 shares at
March 31, 2003, and December 31, 2002;
issued 9,952,152 shares at March 31,
2003, and 9,905,783 shares at
December 31, 2002) 9,952 9,906
Capital surplus 16,945 16,725
Retained earnings 97,577 94,048
Accumulated other comprehensive income 3,774 4,230
Treasury stock at cost
(24,397 shares at March 31, 2003,
and 59,369 shares at December 31,
2002) (544) (868)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 127,704 124,041
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,802,115 $1,785,979
========== ==========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share data)
Three Months Ended
3/31/03 3/31/02
------- -------
INTEREST INCOME:
Interest and fees on loans and leases $ 21,136 $ 20,437
Interest on securities:
Taxable 3,167 3,194
Nontaxable 925 472
Interest on federal funds sold 14 105
Interest on interest bearing deposits in
other financial institutions 49 103
-------- --------
TOTAL INTEREST INCOME 25,291 24,311
-------- --------
INTEREST EXPENSE:
Interest on deposits 7,033 8,364
Interest on short-term borrowings 633 470
Interest on other borrowings 1,866 2,209
-------- --------
TOTAL INTEREST EXPENSE 9,532 11,043
-------- --------
NET INTEREST INCOME 15,759 13,268
Provision for loan and lease losses 1,304 981
-------- --------
NET INTEREST INCOME AFTER PROVISION FOR
LOAN AND LEASE LOSSES 14,455 12,287
-------- --------
NONINTEREST INCOME:
Service charges and fees 1,307 1,447
Trust fees 952 832
Brokerage commissions 147 127
Insurance commissions 250 217
Securities gains, net 680 81
Loss on trading account securities (28) (28)
Impairment loss on equity securities (148) -
Rental income on operating leases 3,418 3,856
Gain on sale of loans 1,532 1,007
Valuation adjustment on mortgage servicing
rights (298) -
Other noninterest income 663 447
-------- --------
TOTAL NONINTEREST INCOME 8,475 7,986
-------- --------
NONINTEREST EXPENSES:
Salaries and employee benefits 7,760 6,905
Occupancy 917 763
Furniture and equipment 875 804
Depreciation on equipment under operating
leases 2,787 3,030
Outside services 1,110 874
FDIC deposit insurance assessment 53 53
Advertising 473 451
Core deposit premium amortization 101 124
Other noninterest expenses 1,981 1,642
-------- --------
TOTAL NONINTEREST EXPENSES 16,057 14,646
-------- --------
INCOME BEFORE INCOME TAXES 6,873 5,627
Income taxes 2,349 1,806
-------- --------
INCOME FROM CONTINUING OPERATIONS 4,524 3,821
Discontinued operations:
Income from operation of discontinued
branch - 201
Income taxes - 79
-------- --------
Income from discontinued operation - 122
-------- --------
NET INCOME $ 4,524 $ 3,943
======== ========
EARNINGS PER COMMON SHARE-BASIC $ 0.46 $ 0.41
EARNINGS PER COMMON SHARE-DILUTED $ 0.45 $ 0.40
CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.10 $ 0.10
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands, except per share data)
Common Capital Retained
Stock Surplus Earnings
------- ------- ---------
Balance at January 1, 2002 $ 9,906 $18,116 $79,107
Net income - - 3,943
Unrealized loss on securities
available for sale - - -
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $75 - - -
Reclassification adjustment for
net security gains realized in
net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.10 per share - - (983)
Purchase of 22,705 shares of
common stock - - -
Sale of 169,286 shares of
common stock - (1,477) -
------- ------- -------
Balance at March 31, 2002 $ 9,906 $16,639 $82,067
======= ======= =======
Balance at January 1, 2003 $ 9,906 $16,725 $94,048
Net income - - 4,524
Unrealized loss on securities
available for sale - - -
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $15 - - -
Reclassification adjustment for
net security gains realized in
net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.10 per share - - (995)
Purchase of 26,119 shares of
common stock - - -
Sale of 107,460 shares of
common stock 46 220 -
------- ------- -------
Balance at March 31, 2003 $ 9,952 $16,945 $97,577
======= ======= =======
Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock Total
------------- -------- -----
Balance at January 1, 2002 $ 3,565 $(3,604) $107,090
Net income - - 3,943
Unrealized loss on securities
available for sale (1,025) - (1,025)
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $75 222 - 222
Reclassification adjustment for
net security gains realized in
net income (81) - (81)
Income taxes 301 - 301
--------
Comprehensive income 3,360
Cash dividends declared:
Common, $.10 per share - - (983)
Purchase of 22,705 shares of
common stock - (305) (305)
Sale of 169,286 shares of
common stock - 2,855 1,378
------- ------- --------
Balance at March 31, 2002 $ 2,982 $(1,054) $110,540
======= ======= ========
Balance at January 1, 2003 $ 4,230 $ (868) $124,041
Net income - - 4,524
Unrealized loss on securities
available for sale (134) - (134)
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $15 (25) - (25)
Reclassification adjustment for
net security gains realized in
net income (532) - (532)
Income taxes 235 - 235
--------
Comprehensive income 4,068
Cash dividends declared:
Common, $.10 per share - - (995)
Purchase of 26,119 shares of
common stock - (579) (579)
Sale of 107,460 shares of
common stock - 903 1,169
------- ------- --------
Balance at March 31, 2003 $ 3,774 $ (544) $127,704
======= ======= ========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Three Months Ended
3/31/03 3/31/02
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,524 $ 3,943
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 3,716 3,949
Provision for loan and lease losses 1,304 985
Provision for income taxes less than
payments 1,545 1,709
Net amortization of premium on
securities 1,478 1,337
Securities gains, net (680) (81)
Increase in trading account
securities (48) (20)
Loss on impairment of equity
securities 148 -
Loans originated for sale (86,407) (38,533)
Proceeds on sales of loans 89,508 52,480
Net gain on sales of loans (1,532) (1,007)
Increase in accrued interest
receivable (185) (778)
Decrease in accrued interest payable (996) (466)
Other, net (2,890) (933)
-------- --------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 9,485 22,585
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds on maturities of time
deposits in other financial
institutions 17 4
Proceeds from the sale of
securities available for sale 14,892 902
Proceeds from the maturity of and
principal paydowns on securities
available for sale 47,944 42,206
Purchase of securities available
for sale (63,976) (81,168)
Net increase in loans and leases (60,034) (1,778)
Increase in assets under operating
leases (2,918) (867)
Capital expenditures (3,948) (2,459)
Proceeds on sale of OREO and other
repossessed assets 661 156
-------- --------
NET CASH USED BY INVESTING ACTIVITIES (67,362) (43,004)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand
deposits and savings accounts 1,280 (25,431)
Net increase in time deposit accounts 27,726 37,471
Net decrease in short-term borrowings (29,141) (22,950)
Proceeds from other borrowings 20,000 2,840
Repayments of other borrowings (5,717) (6,146)
Purchase of treasury stock (579) (305)
Proceeds from sale of common stock 1,068 1,378
Dividends (995) (983)
-------- --------
NET CASH PROVIDED (USED) BY FINANCING
ACTIVITIES 13,642 (14,126)
-------- --------
Net decrease in cash and cash
equivalents (44,235) (34,545)
Cash and cash equivalents at
beginning of year 100,992 93,550
-------- --------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 56,757 $ 59,005
======== ========
Supplemental disclosures:
Cash paid for income/franchise taxes $ 1,127 $ 17
======== ========
Cash paid for interest $ 10,528 $ 11,744
======== ========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The interim unaudited consolidated financial statements contained
herein should be read in conjunction with the audited
consolidated financial statements and accompanying notes to the
financial statements for the fiscal year ended December 31, 2002,
included in Heartland Financial USA, Inc.'s ("Heartland") Form 10-
K filed with the Securities and Exchange Commission on March 26,
2003. Accordingly, footnote disclosures, which would
substantially duplicate the disclosure contained in the audited
consolidated financial statements, have been omitted.
The financial information of Heartland included herein is
prepared pursuant to the rules and regulations for reporting on
Form 10-Q. Such information reflects all adjustments (consisting
of normal recurring adjustments), which are, in the opinion of
management, necessary for a fair presentation of results for the
interim periods. The results of the interim period ended March
31, 2003, are not necessarily indicative of the results expected
for the year ending December 31, 2003.
Basic earnings per share is determined using net income and
weighted average common shares outstanding. Diluted earnings per
share is computed by dividing net income by the weighted average
common shares and assumed incremental common shares issued.
Amounts used in the determination of basic and diluted earnings
per share for the three-month periods ended March 31, 2003 and
2002, are shown in the tables below:
Three Months Ended
(Dollars in thousands) 3/31/03 3/31/02
------- -------
Income from continuing operations $ 4,524 $ 3,821
Discontinued operations:
Income from operation of discontinued
branch - 201
Income taxes - 79
------- -------
Income from discontinued operation - 122
------- -------
Net income $ 4,524 $ 3,943
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,891 9,729
Assumed incremental common shares issued
upon exercise of stock options (000's) 116 65
------- -------
Weighted average common shares for
diluted earnings per share (000's) 10,007 9,794
======= =======
Earnings per common share - basic $ .46 $ .41
Earnings per common share - diluted .45 .40
Earnings per common share from
continuing operations - basic(1) .46 .39
Earnings per common share from
continuing operations - diluted (1) .45 .39
(1) Excludes the discontinued operations of our Eau Claire
branch.
Heartland applies APB Opinion No. 25 in accounting for its Stock
Option Plan and, accordingly, no compensation cost for its stock
options has been recognized in the financial statements. Had
Heartland determined compensation cost based on the fair value at
the grant date for its stock options under FAS No. 123,
Heartland's net income would have been reduced to the pro forma
amounts indicated below:
(Dollars in thousands, except per share Three Months Ended
data) 3/31/03 3/31/02
------- -------
Net income as reported $ 4,524 $ 3,943
Pro forma 4,308 3,695
Earnings per share-basic
as reported $ .46 $ .41
Pro forma .44 .38
Earnings per share-diluted
as reported $ .45 $ .40
Pro forma .43 .38
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.
NOTE 2: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated
accumulated amortization at March 31, 2003, is presented in the
table below.
March 31, 2003
------------------------
Gross
Carrying Accumulated
Amount Amortization
-------- ------------
Intangible assets:
Core deposit premium (000's) $ 4,492 $ 2,157
Mortgage servicing rights (000's) 3,102 767
------- -------
Total (000's) $ 7,594 $ 2,924
======= =======
Unamortized intangible assets (000's) $ 4,670
=======
Projections of amortization expense for mortgage servicing rights
are based on existing asset balances and the existing interest
rate environment as of March 31, 2003. What Heartland actually
experiences may be significantly different depending upon changes
in mortgage interest rates and market conditions. The following
table shows the estimated future amortization expense for
amortized intangible assets:
Core Mortgage
Deposit Servicing
Premium Rights Total
--------- -------- ---------
Nine months ended
December 31, 2003
(000's) $ 303 $1,611 $ 1,914
Year Ended December 31,
2004 (000's) $ 353 $ 207 $ 560
2005 (000's) 353 172 525
2006 (000's) 353 138 491
2007 (000's) 353 103 456
2008 (000's) 353 69 422
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SAFE HARBOR STATEMENT
This report (including information incorporated by reference)
contains, and future oral and written statements of Heartland and
its management may contain, forward-looking statements, within
the meaning of such term in the Private Securities Litigation
Reform Act of 1995, with respect to the financial condition,
results of operations, plans, objectives, future performance and
business of Heartland. Forward-looking statements, which may be
based upon beliefs, expectations and assumptions of Heartland's
management and on information currently available to management,
are generally identifiable by the use of words such as "believe",
"expect", "anticipate", "plan", "intend", "estimate", "may",
"will", "would", "could", "should" or other similar expressions.
Additionally, all statements in this document, including forward-
looking statements, speak only as of the date they are made, and
Heartland undertakes no obligation to update any statement in
light of new information or future events.
Heartland's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which
could have a material adverse effect on the operations and future
prospects of Heartland and its subsidiaries include, but are not
limited to, the following:
- The strength of the United States economy in general and
the strength of the local economies in which Heartland
conducts its operations which may be less favorable than
expected and may result in, among other things, a
deterioration in the credit quality and value of
Heartland's assets.
- The economic impact of past and any future terrorist
threats and attacks, acts of war or threats thereof, and
the response of the United States to any such threats and
attacks.
- The effects of, and changes in, federal, state and local
laws, regulations and policies affecting banking,
securities, insurance and monetary and financial matters.
- The effects of changes in interest rates (including the
effects of changes in the rate of prepayments of Heartland's
assets) and the policies of the Board of Governors of the Federal
Reserve System.
- The ability of Heartland to compete with other financial
institutions as effectively as Heartland currently
intends due to increases in competitive pressures in the
financial services sector.
- The inability of Heartland to obtain new customers and to
retain existing customers.
- The timely development and acceptance of products and
services, including products and services offered through
alternative delivery channels such as the Internet.
- Technological changes implemented by Heartland and by other
parties, including third party vendors, which may be more
difficult or more expensive than anticipated or which may have
unforeseen consequences to Heartland and its customers.
- The ability of Heartland to develop and maintain secure
and reliable electronic systems.
- The ability of Heartland to retain key executives and
employees and the difficulty that Heartland may
experience in replacing key executives and employees in
an effective manner.
- Consumer spending and saving habits which may change in a
manner that affects Heartland's business adversely.
- Business combinations and the integration of acquired
businesses may be more difficult or expensive than
expected.
- The costs, effects and outcomes of existing or future
litigation.
- Changes in accounting policies and practices, as may be
adopted by state and federal regulatory agencies and the
Financial Accounting Standards Board.
- The ability of Heartland to manage the risks associated
with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be
placed on such statements. Additional information concerning
Heartland and its business, including other factors that could
materially affect Heartland's financial results, is included in
Heartland's filings with the Securities and Exchange Commission.
GENERAL
Heartland's results of operations depend primarily on net
interest income, which is the difference between interest income
from interest earning assets and interest expense on interest
bearing liabilities. Noninterest income, which includes service
charges, 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.
Total net income for the first quarter of 2003 was $4.5 million,
or $.45 on a diluted earnings per common share basis, compared to
$3.9 million, or $.40 on a diluted earnings per common share
basis, during the same quarter in 2002, a $581 thousand or 15%
increase. On an annualized basis, return on average common equity
was 14.56% and return on average assets was 1.04% for the first
quarter of 2003. For the same period in 2002, annualized return
on average equity was 14.68% and annualized return on average
assets was .98%. These results continue to provide excellent
evidence of the benefits derived from the expansion and
diversification efforts embarked upon in the late 1990's.
Management remains focused on expanding the customer base in the
markets served and continues to look for opportunities to enter
new markets. New Mexico Bank & Trust's branch in Santa Fe
attracted deposits of nearly $5 million during its first three
months of operations. Plans for additional branch locations in
this market are underway. Later this summer, we hope to begin
operation of a de novo bank in Phoenix, Arizona, as Heartland has
joined a group of experienced, local bankers in that area to
bring true community banking to the East Valley of Phoenix. While
expansion efforts can initially be a drag on current earnings, we
are confident they will provide a firm foundation for future
success.
Earnings from continuing operations for the first quarter of 2003
increased $703 thousand or an 18% increase. Net income from
continuing operations totaled $4.5 million, or $.45 on a diluted
earnings per common share basis, for the first quarter of 2003
compared to $3.8 million, or $.39 on a diluted earnings per
common share basis, during the same quarter in 2002. The Eau
Claire branch of Wisconsin Community Bank, a bank subsidiary of
Heartland, was sold effective December 15, 2002. The effect of
this discontinued operation on net income during the first
quarter of 2002 was a gain of $122 thousand, or less than $.01 on
a diluted earnings per common share basis. This branch sale
allowed Heartland to redirect assets to markets where the assets
can be more productively and profitably employed.
Contributing to the improved earnings during the first quarter of
2003 was the $2.6 million or 19% growth in net interest income
due primarily to growth in earning assets. Average earning assets
went from $1.46 billion during the first quarter of 2002 to $1.59
billion during the same quarter in 2003, a change of $128.0
million or 9%. Noninterest income increased $489 thousand or 6%
while noninterest expense increased $1.4 million or 10%. Gains on
sale of loans and activities within the available for sale and
trading portfolios contributed to the additional noninterest
income. These improvements in noninterest income were offset by a
valuation adjustment on mortgage servicing rights and an increase
in amortization on these mortgage servicing rights as prepayments
were experienced in our servicing portfolio. A portion of the
increase in noninterest expense was attributable to the
implementation of imaging technology across all the bank
subsidiaries and to expansion into the Santa Fe, New Mexico and
Phoenix, Arizona markets.
Total assets at March 31, 2003, had increased $16.136 million or
nearly 1% since year-end 2002. Loans and leases were $1.23
billion and deposits were $1.37 billion at the end of the first
quarter, an increase of 5% and 2%, respectively, since year-end
2002. Nearly two-thirds of the growth in the loan portfolio was
commercial and commercial real estate.
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.
- Heartland has continued to experience an increase in watch
and problem loan exposure.
There can be no assurances that the allowance for loan and lease
losses will be adequate to cover all losses, but management
believes that the allowance for loan and lease losses was
adequate at March 31, 2003. While management uses available
information to provide for loan and lease losses, the ultimate
collectibility of a substantial portion of the loan portfolio and
the need for future additions to the allowance will be based on
changes in economic conditions. Along with other financial
institutions, management shares a concern for the outlook of the
economy during the remainder of 2003. 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.
NET INTEREST INCOME
Net interest margin, expressed as a percentage of average earning
assets, was 4.12% during the first quarter of 2003 compared to
3.77% for the same period in 2002 and 4.06% for the fourth
quarter of 2002. Heartland manages its balance sheet to minimize
the effect a change in interest rates has on its net interest
margin. Management has been successful in the utilization of
floors on its commercial loan portfolio to minimize the affect
downward rates have on Heartland's interest income. If rates
begin to edge upward, Heartland will not see a corresponding
increase in its interest income until rates have moved above the
floors in place on these loans. On a tax-equivalent basis,
interest income as a percentage of average earning assets was
6.56% during the first quarter of 2003 compared to 6.85% during
the first quarter of 2002, a decline of 29 basis points. On the
liability side of the balance sheet, management has continued to
look for opportunities to lock in some funding in three- to five-
year maturities as rates have been at historical low levels.
Interest expense as a percentage of average earning assets was
2.44% during the first quarter of 2003 compared to 3.07% during
the first quarter of 2002, a decline of 63 basis points.
For the three-month period ended March 31, 2003, interest income
increased $980 thousand or 4% when compared to the same period in
2002. This increase was attributable to the growth in earning
assets. Average earning assets were $1.59 billion during the
first quarter of 2003 compared to $1.46 billion during the first
quarter of 2002. This growth in earning assets offset the effect
of a further decline in the national prime rate. During the first
quarter of 2003, the national prime rate was 4.25% compared to
4.75% during the first quarter of 2002.
For the three-month period ended March 31, 2003, interest expense
decreased $1.5 million or 14% when compared to the same period in
2002. The decline in interest expense outpaced the decline in
interest income primarily as a result of the decline in rates and
the maturity of higher-rate certificates of deposit accounts.
Management continues to focus efforts on improving the mix of its
funding sources to minimize its interest costs.
On May 6, 2003, the Federal Reserve policy makers decided to keep
their target for the federal funds interest rate unchanged at
1.25%, the lowest target interest rate on overnight loans between
banks since 1961. Correspondingly, national prime remained
unchanged at 4.25%. The continuation of these historically low
interest rates may have a negative impact on Heartland's net
interest margin. Even though a majority of Heartland's floating
rate commercial loan portfolio has floors in place, at these
historically low interest rate levels, there will be pressure to
lower these floors or refinance to fixed rate products.
Additionally, the rates paid on deposit products have been driven
to significantly low levels during the past year and, in many
cases, there is little room to lower these rates another 50 basis
points.
PROVISION FOR LOAN AND LEASE LOSSES
The allowance for loan and lease losses is established through a
provision charged to expense to provide, in Heartland's opinion,
an adequate allowance for loan and lease losses. The $1.3 million
provision for loan losses made during the first quarter of 2003,
an increase of $323 thousand or 33% when compared to the same
quarter in 2002, resulted primarily from growth experienced in
the loan portfolio and an increase in watch and problem loan
exposure. The adequacy of the allowance for loan and lease losses
is determined by management using factors that include the
overall composition of the loan portfolio, general economic
conditions, types of loans, past loss experience, loan
delinquencies, and potential substandard and doubtful credits. A
weak economy will inevitably result in increased problem loans,
but Heartland expects the problems to be manageable and of a
lesser scope for Heartland than for the industry as a whole. For
additional details on the specific factors considered, refer to
the critical accounting policies and allowance for loan and lease
losses sections of this report.
NONINTEREST INCOME
Total noninterest income increased $489 thousand or 6% during the
first quarter of 2003 when compared to the same quarter in 2002.
The noninterest categories reflecting significant improvement
during the quarter were securities gains and gains on sale of
loans.
Service charges and fees decreased $140 thousand or 9% during the
quarters under comparison. Included in this category are service
fees collected on the mortgage loans Heartland sold into the
secondary market, while retaining servicing. Even though
Heartland's servicing portfolio grew to $428.1 million at March
31, 2003, from $395.1 million at year-end 2002, the amortization
on the mortgage servicing rights associated with the servicing
portfolio increased $410 thousand for the quarters under
comparison as more prepayments were experienced in the portfolio.
Offsetting a portion of this increase was an additional $75
thousand, a 7% increase, in service charges on checking accounts.
The addition of an overdraft privilege feature to our checking
account product line in late 2001, along with growth in checking
account balances, resulted in the generation of additional
service charge revenue related to activity fees charged to these
accounts. Checking account balances grew from $154.6 million at
March 31, 2002, to $181.2 million at March 31, 2003, a $26.6
million or 17% increase. Also contributing to the increase in
service charges and fees was the $65 thousand or 33% growth in
fees collected for the processing of activity on our automated
teller machines. Beginning in the summer of 2002, the state of
Iowa began to allow financial institutions to charge a fee for
the use of automated teller machines. Iowa was only one of a few
states that had not been allowing surcharges on automated teller
machines.
Gains on sale of loans increased by $525 thousand or 52% for the
quarters under comparison. The volume of mortgage loans sold into
the secondary market during the first quarter of 2003 was greater
than those sold during the same period in 2002, primarily as a
result of the low rate environment during 2003 compared to the
same quarter in 2002. During low rate environments, customers
frequently elect to take fifteen- and thirty-year, fixed-rate
mortgage loans, which Heartland usually elects to sell into the
secondary market.
During the first quarter of 2003, securities gains were $680
thousand compared to $81 thousand during the first quarter of
2002. During the first quarter of 2003, Heartland's interest rate
forecast changed to a rising rate bias on the long end of the
yield curve, and therefore, longer-term agency securities were
sold at a gain to shorten the portfolio. The proceeds were
invested in well-seasoned mortgage-backed securities that were
projected to outperform the agency securities in a rising rate
environment.
Heartland began classifying some of its new equity securities
purchases as trading during the first quarter of 2001. Losses on
this portfolio totaled $28 thousand during the first quarters of
both years under comparison.
Impairment losses on equity securities deemed to be other than
temporary totaled $148 thousand during the first quarter of 2003.
A majority of these losses were related to the decline in market
value on the common stock of two companies held in Heartland's
available for sale equity securities portfolio. The carrying
value of these stocks on Heartland's balance sheet at March 31,
2003, was $63 thousand. Additionally, during the first quarter of
2003, an impairment loss on equity securities totaling $20
thousand was recorded on Heartland's investment in a limited
partnership. The fair value of the remaining portion of
Heartland's investment in this partnership at quarter-end was $80
thousand.
During the first quarter of 2003, a $298 thousand loss was
recorded as a valuation adjustment on mortgage servicing rights.
The valuation of Heartland's mortgage servicing rights declined
since year-end as a result of the further drop in mortgage loan
interest rates. Heartland utilizes the services of an independent
third-party to perform a valuation analysis of its servicing
portfolio each quarter.
Rental income on operating leases decreased $438 thousand or 11%
during the first three months of 2003. This decrease resulted
from a decline in the number of vehicles being replaced at our
vehicle leasing and fleet management subsidiary, ULTEA. As the
economy weakened, many companies elected to continue operations
with their current fleet of vehicles instead of the replacement
of three or four year old vehicles, as had typically been the
norm.
Total other noninterest income increased $216 thousand or 48%
during the quarters under comparison. Nearly all this increase
was attributable to a gain on the sale of repossessed real
estate.
NONINTEREST EXPENSE
Total noninterest expense increased $1.4 million or 10% during
the first quarter of 2003 when compared to the same quarter in
2002. A large portion of this increase was attributable to
expansion efforts, as well as, to the implementation of imaging
technology across all Heartland's bank subsidiaries.
Salaries and employee benefits, the largest component of
noninterest expense, increased $855 thousand or 12% for the
quarters under comparison. This category made up more than 60% of
the total increase in noninterest expense. In addition to normal
merit increases, these increases were also attributable to the
opening of new branches in Santa Fe, New Mexico and Fitchburg,
Wisconsin and plans to open a de novo bank in Phoenix, Arizona.
The number of full-time equivalent employees employed by
Heartland increased from 572 at March 31, 2002, to 626 at March
31, 2003.
Fees for outside services increased by $236 thousand or 27% for
the quarters under comparison. Contributing to these increases
were the following:
- Early in 2003, Heartland embarked upon the
implementation of imaging technology across all its
bank subsidiaries.
- As on-line banking has grown in popularity, Heartland
has incurred additional costs to provide this service
to its customers.
- Legal and professional fees related to Heartland's
continuing expansion through branch and de novo bank
formations, in addition to the exploration of potential
acquisitions, increased during 2003.
Consistent with the lack of vehicle replacement activity
occurring at ULTEA, the depreciation on equipment under operating
leases decreased $243 thousand or 8% during first three months of
2003.
Other noninterest expense increased $339 thousand or 21% for the
quarters under comparison. This increase was primarily the result
of the implementation of imaging technology and the opening of
branches in the new markets of Santa Fe and Fitchburg. Some of
the expenses included within other noninterest expense that
experienced growth as a result of these efforts were advertising,
office supplies, postage and telephone. Additionally, settlement
on an action brought by Heartland to recover losses on an
investment fund partnership, in which Heartland was a limited
partner, was paid during the first quarter of 2003.
INCOME TAX EXPENSE
Income tax expense for the first quarter of 2003 increased $464
thousand or 25% when compared to the same period in 2002,
primarily as a result of growth in pre-tax earnings. Heartland's
effective tax rate increased to 34.18% during the first quarter
of 2003 compared to 32.34% for the first quarter of 2002.
FINANCIAL CONDITION
LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Total loans and leases increased $58.3 million, an increase of 5%
since year-end 2002. Growth was experienced in all the loan
portfolios except consumer.
The commercial and commercial real estate loan portfolio grew
$37.2 million or 5% during the first three months of 2003. Most
of this growth occurred at Dubuque Bank and Trust and Riverside
Community Bank, principally as a result of continued calling
efforts.
Agricultural and agricultural real estate loans grew $10.9
million or 7% during the first three months of 2003. The majority
of this growth occurred at Dubuque Bank and Trust Company,
Heartland's flagship bank in Dubuque, Iowa.
The residential mortgage loan portfolio experienced an increase
of $13.0 million or 9% as management elected to retain a portion
of the fifteen-year fixed rate loans. Customers have continued to
refinance their mortgage loans into fifteen- and thirty-year
fixed rate loans, which Heartland usually sells into the
secondary market. Servicing is retained on a majority of these
loans so that the Heartland bank subsidiaries have an opportunity
to continue providing their customers the excellent service they
expect. Heartland's servicing portfolio was $395.1 million at
year-end 2002 and $418.1 million at March 31, 2003.
Consumer loan outstandings declined $2.1 million or 2% during the
first three months of 2003, as the economy continued to weaken
and consumers were provided other sources of financing, e.g.,
zero percent automobile financing through dealerships.
The table below presents the composition of the loan portfolio as
of March 31, 2003, and December 31, 2002.
LOAN PORTFOLIO
(Dollars in thousands)
March 31, December 31,
2003 2002
Amount Percent Amount Percent
---------- ------- ---------- -------
Commercial and commercial
real estate $ 780,742 63.15% $ 743,520 63.10%
Residential mortgage 158,895 12.85 145,931 12.39
Agricultural and
agricultural real estate 166,520 13.47 155,596 13.21
Consumer 118,799 9.61 120,853 10.26
Lease financing, net 11,360 .92 12,308 1.04
---------- ------- ---------- -------
Gross loans and leases 1,236,316 100.00% 1,178,208 100.00%
======= =======
Unearned discount (2,039) (2,161)
Deferred loan fees (741) (811)
---------- ----------
Total loans and leases 1,233,536 1,175,236
Allowance for loan and
lease losses (17,054) (16,091)
---------- ----------
Loans and leases, net $1,216,482 $1,159,145
========== ==========
The process utilized by Heartland to estimate the adequacy of the
allowance for loan and lease losses is considered a critical
accounting practice for Heartland. The allowance for loan and
lease losses represents management's estimate of identified and
unidentified losses in the existing loan portfolio. For
additional details on the specific factors considered, refer to
the critical accounting policies section of this report.
The allowance for loan and lease losses increased by $963
thousand or 6% during the first three months of 2003. The
allowance for loan and lease losses at March 31, 2003, was 1.38%
of loans and 337% of nonperforming loans, compared to 1.37% of
loans and 359% of nonperforming loans, at year-end 2002.
Nonperforming loans increased slightly to .41% of total loans and
leases compared to .38% of total loans and leases at year-end
2002.
During the first three months of 2003, Heartland recorded net
charge offs of $341 thousand compared to $570 thousand for the
same period in 2002. Citizens Finance Co., Heartland's consumer
finance subsidiary, experienced an improvement in net charge-
offs. For the first three months of 2003, Citizens recorded net
charge-offs of $139 thousand or 41% of total net charge-offs
compared to $327 thousand or 57% of total net charge-offs during
the same period in 2002.
The table below presents the changes in the allowance for loan
and lease losses during the periods indicated:
ANALYSIS OF ALLOWANCE FOR LOAN AND LEASE LOSSES
(Dollars in thousands)
Three Months
Ended March 31,
2003 2002
------- -------
Balance at beginning of period $16,091 $14,660
Provision for loan and lease losses from
continuing operations 1,304 981
Provision for loan and lease losses from
discontinued operations - 4
Recoveries on loans and leases previously
charged off 153 267
Loans and leases charged off (494) (837)
------- -------
Balance at end of period $17,054 $15,075
======= =======
Net charge offs to average loans and leases 0.03% 0.05%
The table below presents the amounts of nonperforming loans and
leases and other nonperforming assets on the dates indicated:
NONPERFORMING ASSETS
(Dollars in thousands)
As Of As Of
March 31, December 31,
2003 2002 2002 2001
------------------------------
Nonaccrual loans and leases $4,426 $7,071 $3,944 $7,269
Loan and leases contractually
past due 90 days or more 632 1,069 541 500
Restructured loans and leases - 354 - 354
------ ------ ------ ------
Total nonperforming loans and
leases 5,058 8,494 4,485 8,123
Other real estate 117 245 452 130
Other repossessed assets 291 291 279 343
------ ------ ------ ------
Total nonperforming assets $5,466 $9,030 $5,216 $8,596
====== ====== ====== ======
Nonperforming loans and leases
to total loans and leases 0.41% 0.78% 0.38% 0.73%
Nonperforming assets to total
assets 0.30% 0.55% 0.29% 0.52%
SECURITIES
The composition of Heartland's securities portfolio is managed to
maximize the return on the portfolio while considering the impact
it has on Heartland's asset/liability position and liquidity
needs. Securities represented 22% of total assets at March 31,
2003, and December 31, 2002.
During the first three months of 2003, management elected to
shift a portion of the 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. Additionally, 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.
The table below presents the composition of the available for
sale securities portfolio by major category as of March 31, 2003,
and December 31, 2002.
AVAILABLE FOR SALE SECURITIES PORTFOLIO
(Dollars in thousands)
March 31, December 31,
2003 2002
Amount Percent Amount Percent
-------- ------- -------- -------
U.S. Treasury securities $ 498 .13% $ 498 .13%
U.S. government agencies 74,061 19.00 100,841 25.86
Mortgage-backed securities 201,469 51.67 187,318 48.04
States and political
subdivisions 83,560 21.43 71,391 18.31
Other securities 30,305 7.77 29,852 7.66
-------- ------- -------- -------
Total available for sale
securities $389,893 100.00% $389,900 100.00%
======== ======= ======== =======
DEPOSITS AND BORROWED FUNDS
Total deposits experienced an increase of $29.0 million or 2%
during the first three months of 2003. Increases in total
deposits occurred at all the bank subsidiaries except for First
Community Bank. The demand deposit category experienced a
decrease during the three-month period, while savings and
certificate of deposit account balances increased. The $13.3
million or 7% decline in demand deposit balances appeared to be
due primarily to normal seasonal fluctuations that many banks
experience during the first quarter of the year. Savings deposit
account balances grew by $14.6 million or 3% and certificate of
deposit account balances grew by $27.7 million or 4% during the
first three months of 2003. With the continued instability in the
equity markets, many customers have elected to keep funds on
deposit in financial institutions. Additionally, as long-term
rates have continued at all-time lows, efforts were focused at
attracting customers into certificates of deposit with a maturity
exceeding two years.
Short-term borrowings generally include federal funds purchased,
treasury tax and loan note options, securities sold under
agreement to repurchase and short-term Federal Home Loan Bank
("FHLB") advances. These funding alternatives are utilized in
varying degrees depending on their pricing and availability.
Over the three-month period ended March 31, 2003, the amount of
short-term borrowings decreased $29.1 million or 18%. All of the
bank subsidiaries provide repurchase agreements to their
customers as a cash management tool, sweeping excess funds from
demand deposit accounts into these agreements. This source of
funding does not increase the bank's reserve requirements, nor
does it create an expense relating to FDIC premiums on deposits.
Although the aggregate balance of repurchase agreements is
subject to variation, the account relationships represented by
these balances are principally local. Repurchase agreement
balances declined $14.0 million or 14% since year-end 2002 as
interest rates continued at all-time low levels and some of these
repurchase agreement customers elected to invest a portion of
their excess funds in higher-yielding products.
Also included in short-term borrowings are the credit lines
Heartland entered into with two unaffiliated banks. Under the
unsecured credit lines, Heartland may borrow up to $50.0 million.
At March 31, 2003, and December 31, 2002, a total of $25.0
million was outstanding on these credit lines.
Other borrowings include all debt arrangements Heartland and its
subsidiaries have entered into with original maturities that
extend beyond one year. These borrowings were $140.6 million on
March 31, 2003, compared to $126.3 million on December 31, 2002.
The change in these account balances primarily resulted from
activity in the bank subsidiaries' borrowings from the FHLB. All
of the Heartland banks own stock in the FHLB of Des Moines,
Chicago or Dallas, enabling them to borrow funds from their
respective FHLB for short- or long-term purposes under a variety
of programs. Total FHLB borrowings at March 31, 2003, had
increased to $90.5 million from $72.5 million at December 31,
2002. Substantially all of these borrowings are fixed-rate
advances for original terms between three and five years. To fund
a portion of the fixed-rate commercial and residential loan
growth experienced, Heartland entered into three-, five- and
seven-year FHLB advances.
Additionally, balances outstanding on capital securities issued
by Heartland are included in total other borrowings. The issuance
in October of 1999 for $25.0 million bears an annual rate of
9.60% and matures on September 30, 2029. A private placement
offering for $8.0 million was completed in December of 2001. This
variable rate issuance matures on December 18, 2031 and bears
interest at the rate of 3.60% per annum over the three-month
LIBOR rate, as calculated each quarter. An additional private
placement offering for $5.0 million was completed in June of
2002. This additional variable rate issuance matures on June 30,
2032 and bears interest at the rate of 3.65% per annum over the
three-month LIBOR rate, as calculated each quarter.
CAPITAL RESOURCES
Bank regulatory agencies have adopted capital standards by which
all bank holding companies will be evaluated. Under the risk-
based method of measurement, the resulting ratio is dependent
upon not only the level of capital and assets, but also the
composition of assets and capital and the amount of off-balance
sheet commitments. Heartland and its bank subsidiaries have been,
and will continue to be, managed so they meet the well-
capitalized requirements under the regulatory framework for
prompt corrective action. To be categorized as well capitalized
under the regulatory framework, bank holding companies and banks
must maintain minimum total risk-based, Tier 1 risk-based and
Tier 1 leverage ratios of 10%, 6% and 4%, respectively. The most
recent notification from the FDIC categorized Heartland and each
of its bank subsidiaries as well capitalized under the regulatory
framework for prompt corrective action. There are no conditions
or events since that notification that management believes have
changed each institution's category.
Heartland's capital ratios were as follows for the dates
indicated:
CAPITAL RATIOS
(Dollars in thousands)
March 31, December 31,
2003 2002
Amount Ratio Amount Ratio
------ ----- ------ -----
Risk-Based Capital Ratios:(1)
Tier 1 capital $ 146,222 10.54% $ 141,918 10.65%
Tier 1 capital minimum
requirement 55,499 4.00% 53,298 4.00%
---------- ------ ---------- ------
Excess $ 90,723 6.54% $ 88,620 6.65%
========== ====== ========== ======
Total capital $ 163,277 11.77% $ 158,010 11.86%
Total capital minimum
requirement 110,997 8.00% 106,596 8.00%
---------- ------ ---------- ------
Excess $ 52,280 3.77% $ 51,414 3.86%
========== ====== ========== ======
Total risk-adjusted
assets $1,387,468 $1,332,451
========== ==========
Leverage Capital Ratios:(2)
Tier 1 capital $ 146,222 8.36% $ 141,918 8.24%
Tier 1 capital minimum
requirement(3) 69,975 4.00% 68,883 4.00%
---------- ------ ---------- ------
Excess $ 76,247 4.36% $ 73,035 4.24%
========== ====== ========== ======
Average adjusted assets
(less goodwill and other
intangible assets) $1,749,378 $1,722,077
========== ==========
(1) Based on the risk-based capital guidelines of the Federal
Reserve, a bank holding company is required to maintain a
Tier 1 capital to risk-adjusted assets ratio of 4.00% and
total capital to risk-adjusted assets ratio of 8.00%.
(2) The leverage ratio is defined as the ratio of Tier 1 capital
to average adjusted assets.
(3) Management of Heartland has established a minimum target
leverage ratio of 4.00%. Based on Federal Reserve
guidelines, a bank holding company generally is required to
maintain a leverage ratio of 3.00% plus additional capital of
at least 100 basis points.
Commitments for capital expenditures are an important factor in
evaluating capital adequacy. In April of 2003, HTLF Capital
Corp., an investment banking subsidiary of Heartland was formed.
This entity will specialize in purchasing direct taxable and tax-
exempt investments including: municipal leasing, hospital
financing, college and university financing, project financing
and 501c(3) private activity financing. Heartland's initial
investment in this subsidiary was $500 thousand.
In February of 2003, Heartland entered into an agreement with a
group of Arizona business leaders to establish a new bank in
Mesa. 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.
Late in 2002, Heartland entered into an agreement to purchase a
49% ownership interest in an airplane. This airplane will replace
Heartland's current ownership in an airplane purchased in 1998.
Delivery of the new airplane is scheduled to occur at the end of
May. Heartland's net investment in this airplane will be
approximately $2.1 million, of which a $233 thousand down payment
was made in December of 2002.
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 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 in May of 2003. Alex Sheshunoff Management Services,
Inc. has been engaged to perform an appraisal of the stock of New
Mexico Bank & Trust, upon which appraisal the repurchase price
will be determined. As of March 31, 2003, 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 March
31, 2003.
On December 18, 2001, Heartland completed a private placement
offering of $8.0 million of variable rate cumulative capital
securities representing undivided beneficial interests in
Heartland Financial Statutory Trust II, a special purpose trust
subsidiary formed for the sole purpose of this offering. The
proceeds from the offering were used by the trust to purchase
junior subordinated debentures from Heartland. The proceeds were
used by Heartland for general corporate purposes. The debentures
will mature and the capital securities must be redeemed on
December 18, 2031. Heartland has the option to shorten the
maturity date to a date not earlier than December 18, 2006. All
of these securities qualified as Tier 1 capital for regulatory
purposes as of March 31, 2003.
In October of 1999, Heartland completed an offering of $25.0
million of 9.60% cumulative capital securities representing
undivided beneficial interests in Heartland Capital Trust I, a
special purpose trust subsidiary formed for the sole purpose of
this offering. The proceeds from the offering were used by the
trust to purchase junior subordinated debentures from Heartland.
The proceeds were used by Heartland for general corporate
purposes. The debentures will mature and the capital securities
must be redeemed on September 30, 2029. Heartland has the option
to shorten the maturity date to a date not earlier than September
30, 2004. All of these securities continued to qualify as Tier 1
capital for regulatory purposes as of March 31, 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 this 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.
LIQUIDITY
Liquidity measures the ability of Heartland to meet maturing
obligations and its existing commitments, to withstand
fluctuations in deposit levels, to fund its operations and to
provide for customers' credit needs. The liquidity of Heartland
principally depends on cash flows from operating activities,
investment in and maturity of assets, changes in balances of
deposits and borrowings and its ability to borrow funds in the
money or capital markets.
Management of investing and financing activities, and market
conditions, determine the level and the stability of net interest
cash flows. Management attempts to mitigate the impact of changes
in market interest rates to the extent possible, so that balance
sheet growth is the principal determinant of growth in net
interest cash flows.
In the event of short-term liquidity needs, the bank subsidiaries
may purchase federal funds from each other or from correspondent
banks and may also borrow from the Federal Reserve Bank.
Additionally, the subsidiary banks' FHLB memberships give them
the ability to borrow funds for short- and long-term purposes
under a variety of programs.
Heartland's revolving credit agreements provide a maximum
borrowing capacity of $50.0 million. As of March 31, 2003, 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 March 31, 2003, Heartland was in
compliance with the covenants contained in these credit
agreements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Market risk is the risk of loss arising from adverse changes in
market prices and rates. Heartland's market risk is comprised
primarily of interest rate risk resulting from its core banking
activities of lending and deposit gathering. Interest rate risk
measures the impact on earnings from changes in interest rates
and the effect on current fair market values of Heartland's
assets, liabilities and off-balance sheet contracts. The
objective is to measure this risk and manage the balance sheet to
avoid unacceptable potential for economic loss. Management
continually develops and applies strategies to mitigate market
risk. Exposure to market risk is reviewed on a regular basis by
the asset/liability committees at the banks and, on a
consolidated basis, by the Heartland board of directors.
Management does not believe that Heartland's primary market risk
exposures and how those exposures have been managed to-date in
2003 changed significantly when compared to 2002.
Derivative financial instruments include futures, forwards,
interest rate swaps, option contracts and other financial
instruments with similar characteristics. Heartland's use of
derivative financial instruments relates to the management of the
risk that changes in interest rates will affect its future
interest payments. Heartland utilizes an interest rate swap
contract to effectively convert a portion of its variable rate
interest rate debt to fixed interest rate debt. Under the
interest rate swap contract, Heartland agrees to pay an amount
equal to a fixed rate of interest times a notional principal
amount, and to receive in return an amount equal to a specified
variable rate of interest times the same notional principal
amount. The notional amounts are not exchanged and payments under
the interest rate swap contract are made monthly. Heartland is
exposed to credit-related losses in the event of nonperformance
by the counterparty to the swap contract, which has been
minimized by entering into the contract with a large, stable
financial institution. As of March 31, 2003, Heartland had an
interest rate swap contract to pay a fixed rate of interest and
receive a variable rate of interest on $25.0 million of
indebtedness. This contract expires on November 1, 2006. The fair
market value of the interest rate swap contract was recorded as a
liability in the amount of $1.8 million on March 31, 2003.
ITEM 4. 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 II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Registrant or its subsidiaries is a party other than ordinary
routine litigation incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
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 Registrant'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 Registrant's Chief Financial Officer.
Reports on Form 8-K
On April 17, 2003, the Registrant filed a report on Form 8-K
pursuant to Item 12 that a press release announcing earnings for
the quarter ended on March 31, 2003, was issued.
On May 12, 2003, the Registrant filed a report on Form 8-K
pursuant to Item 12 that its quarterly newsletter to shareholders
was mailed on or about May 12, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned there unto duly authorized.
HEARTLAND FINANCIAL USA, INC.
(Registrant)
Principal Executive Officer
/s/ Lynn B. Fuller
-----------------------
By: Lynn B. Fuller
President
Principal Financial and
Accounting Officer
/s/ John K. Schmidt
-----------------------
By: John K. Schmidt
Executive Vice President
and Chief Financial Officer
Dated: May 14, 2003
I, Lynn B. Fuller, Principal Executive Officer of the Registrant,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Heartland Financial USA, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in the Report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for,
the periods presented in this quarterly report;
4. The Registrant's other certifying officer 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:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90
days prior to the filing date of this quarterly report
(the "Evaluation Date"); and
c) 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;
5. The Registrant's other certifying officer 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):
a) 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
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The Registrant's other certifying officer and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to date of their evaluation, including any corrective actions
with regard to significant deficiencies and material
weaknesses.
Date: May 14, 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
Registrant, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Heartland Financial USA, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in the Report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for,
the periods presented in this quarterly report;
4. The Registrant's other certifying officer 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:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90
days prior to the filing date of this quarterly report
(the "Evaluation Date"); and
c) 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;
5. The Registrant's other certifying officer 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):
a) 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
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The Registrant's other certifying officer and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to date of their evaluation, including any corrective actions
with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
Principal Financial and
Accounting Officer
/s/ John K. Schmidt
-------------------------------
By: John K. Schmidt
Executive Vice President
and Chief Financial Officer