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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 June 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For transition period __________ to __________
Commission File Number: 0-24724
HEARTLAND FINANCIAL USA, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
42-1405748
(I.R.S. employer identification number)
1398 Central Avenue, Dubuque, Iowa 52001
(Address of principal executive offices)(Zip Code)
(563) 589-2100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark whether the Registrant is an
accelerated filer (as defined by Rule 12b-2 of the Securities
Exchange Act of 1934). Yes X No
Indicate the number of shares outstanding of each of the
classes of Registrant's common stock as of the latest practicable
date: As of August 13, 2003, the Registrant had outstanding
10,122,504 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)
6/30/03 12/31/02
(Unaudited)
----------- ----------
ASSETS
Cash and due from banks $ 56,645 $ 61,106
Federal funds sold and other short-
term investments 29,941 39,886
---------- ----------
Cash and cash equivalents 86,586 100,992
Time deposits in other
financial institutions 1,205 1,677
Securities:
Trading, at fair value 1,030 915
Available for sale, at fair value
(cost of $359,689 for 2003 and
$381,398 for 2002) 371,037 389,900
Loans and leases:
Held for sale 32,054 23,167
Held to maturity 1,223,364 1,152,069
Allowance for loan and lease losses (17,600) (16,091)
---------- ----------
Loans and leases, net 1,237,818 1,159,145
Assets under operating leases 31,172 30,367
Premises, furniture and equipment, net 43,315 35,591
Other real estate, net 489 452
Goodwill, net 20,167 16,050
Core deposit premium and mortgage
servicing rights 3,821 4,879
Other assets 58,595 46,011
---------- ----------
TOTAL ASSETS $1,855,235 $1,785,979
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Demand $ 208,608 $ 197,516
Savings 517,545 511,979
Time 677,081 628,490
---------- ----------
Total deposits 1,403,234 1,337,985
Short-term borrowings 136,872 161,379
Other borrowings 146,206 126,299
Accrued expenses and other liabilities 31,971 36,275
---------- ----------
TOTAL LIABILITIES 1,718,283 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
June 30, 2003, and December 31, 2002;
issued 10,174,476 shares at June 30,
2003, and 9,905,783 shares at
December 31, 2002) 10,174 9,906
Capital surplus 20,532 16,725
Retained earnings 100,803 94,048
Accumulated other comprehensive income 5,820 4,230
Treasury stock at cost
(15,483 shares at June 30, 2003,
and 59,369 shares at December 31,
2002) (377) (868)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 136,952 124,041
---------- ----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,855,235 $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 Six Months Ended
6/30/03 6/30/02 6/30/03 6/30/02
------- ------- ------- -------
INTEREST INCOME:
Interest and fees on
loans and leases $ 21,606 $ 20,632 $ 42,742 $ 41,069
Interest on securities:
Taxable 2,064 3,188 5,231 6,382
Nontaxable 986 672 1,911 1,144
Interest on federal
funds sold 116 67 130 172
Interest on interest
bearing deposits in
other financial
institutions 48 37 97 140
-------- -------- -------- --------
TOTAL INTEREST INCOME 24,820 24,596 50,111 48,907
-------- -------- -------- --------
INTEREST EXPENSE:
Interest on deposits 7,072 7,994 14,105 16,358
Interest on short-term
borrowings 545 517 1,178 987
Interest on other
borrowings 1,996 2,096 3,862 4,305
-------- -------- -------- --------
TOTAL INTEREST EXPENSE 9,613 10,607 19,145 21,650
-------- -------- -------- --------
NET INTEREST INCOME 15,207 13,989 30,966 27,257
Provision for loan and
lease losses 922 630 2,226 1,611
-------- -------- -------- --------
NET INTEREST INCOME
AFTER PROVISION FOR
LOAN AND LEASE LOSSES 14,285 13,359 28,740 25,646
-------- -------- -------- --------
NONINTEREST INCOME:
Service charges and fees 1,449 1,697 2,756 3,144
Trust fees 858 904 1,810 1,736
Brokerage commissions 216 203 363 330
Insurance commissions 166 160 416 377
Securities gains, net 478 75 1,158 156
Gain (loss) on trading
account securities 277 (214) 249 (242)
Impairment loss on equity
securities (22) - (170) -
Rental income on
operating leases 3,477 3,674 6,895 7,530
Gain on sale of loans 1,689 522 3,221 1,529
Valuation adjustment on
mortgage servicing
rights (694) (326) (992) (326)
Other noninterest income 517 91 1,180 538
-------- -------- -------- --------
TOTAL NONINTEREST INCOME 8,411 6,786 16,886 14,772
-------- -------- -------- --------
NONINTEREST EXPENSES:
Salaries and employee
benefits 8,075 6,841 15,835 13,746
Occupancy 939 763 1,856 1,526
Furniture and equipment 973 814 1,848 1,618
Depreciation on equipment
under operating leases 2,825 2,879 5,612 5,909
Outside services 1,162 1,107 2,272 1,981
FDIC deposit insurance
assessment 54 53 107 106
Advertising 613 383 1,086 834
Core deposit and other
intangibles amortization 101 123 202 247
Other noninterst expenses 1,833 1,704 3,814 3,346
-------- -------- -------- --------
TOTAL NONINTEREST
EXPENSES 16,575 14,667 32,632 29,313
-------- -------- -------- --------
INCOME BEFORE INCOME
TAXES 6,121 5,478 12,994 11,105
Income taxes 1,914 1,560 4,263 3,366
-------- -------- -------- --------
INCOME FROM CONTINUING
OPERATIONS 4,207 3,918 8,731 7,739
Discontinued operations:
Income from operation of
discontinued branch - 202 - 403
Income taxes - 79 - 158
-------- -------- -------- --------
Income from discontinued
operations - 123 - 245
-------- -------- -------- --------
NET INCOME $ 4,207 $ 4,041 $ 8,731 $ 7,984
======== ======== ======== ========
EARNINGS PER COMMON
SHARE-BASIC $ 0.43 $ 0.41 $ 0.88 $ 0.82
EARNINGS PER COMMON
SHARE-DILUTED $ 0.42 $ 0.41 $ 0.87 $ 0.81
CASH DIVIDENDS DECLARED
PER COMMON SHARE $ 0.10 $ 0.10 $ 0.20 $ 0.20
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 - - 7,984
Unrealized gain (loss) on
securities available for sale - - -
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $213 - - -
Reclassification adjustment for
net security gains realized in
net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.20 per share - - (1,965)
Purchase of 76,705 shares of
common stock - - -
Sale of 217,629 shares of
common stock - (1,332) -
------- -------- --------
Balance at June 30, 2002 $ 9,906 $16,784 $ 85,126
======= ======= ========
Balance at January 1, 2003 $ 9,906 $16,725 $ 94,048
Net income - - 8,731
Unrealized gain (loss) on
securities available for sale - - -
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $117 - - -
Reclassification adjustment for
net security gains realized in
net income - - -
Income taxes - - -
Comprehensive income
Cash dividends declared:
Common, $.20 per share - - (1,976)
Purchase of 195,411 shares of
common stock - - -
Issuance of 268,693 shares of
common stock 268 3,805 -
Sale of 136,042 shares of
common stock - 2 -
------- ------- --------
Balance at June 30, 2003 $10,174 $20,532 $100,803
======= ======= ========
Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock Total
------------- -------- --------
Balance at January 1, 2002 $ 3,565 $(3,604) $107,090
Net income - - 7,984
Unrealized gain (loss) on
securities available for sale 1,939 - 1,939
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $213 (572) - (572)
Reclassification adjustment for
net security gains realized in
net income (156) - (156)
Income taxes (412) - (412)
--------
Comprehensive income 8,783
Cash dividends declared:
Common, $.20 per share - - (1,965)
Purchase of 76,705 shares of
common stock - (1,060) (1,060)
Sale of 217,629 shares of
common stock - 3,468 2,136
------- ------- --------
Balance at June 30, 2002 $ 4,364 $(1,196) $114,984
======= ======= ========
Balance at January 1, 2003 $ 4,230 $ (868) $124,041
Net income - - 8,731
Unrealized gain (loss) on
securities available for sale 3,595 - 3,595
Unrealized gain (loss) on
derivatives arising during the
period, net of reclassification
of $117 (198) - (198)
Reclassification adjustment for
net security gains realized in
net income (988) - (988)
Income taxes (819) - (819)
--------
Comprehensive income 10,321
Cash dividends declared:
Common, $.20 per share - - (1,976)
Purchase of 195,411 shares of
common stock - (5,469) (5,469)
Issuance of 268,693 shares of
common stock - 4,612 8,685
Sale of 136,042 shares of
common stock - 1,348 1,350
------- ------- --------
Balance at June 30, 2003 $ 5,820 $ (377) $136,952
======= ======= ========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Six Months Ended
6/30/03 6/30/02
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 8,731 $ 7,984
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 7,550 8,021
Provision for loan and lease losses 2,226 1,601
Provision for income taxes less than
payments 1,811 2,971
Net amortization of premium on
securities 3,480 2,543
Securities gains, net (1,158) (156)
(Increase) decrease in trading
account securities (115) 298
Loss on impairment of equity
securities 170 -
Loans originated for sale (219,507) (70,779)
Proceeds on sales of loans 214,392 83,825
Net gain on sales of loans (3,221) (1,529)
Decrease (increase) in accrued
interest receivable 50 (708)
(Decrease) increase in accrued
interest payable (38) 120
Other, net (1,218) (790)
-------- --------
NET CASH PROVIDED BY OPERATING
ACTIVITIES 13,153 33,401
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of time deposits in other
financial institutions - (1,068)
Proceeds on maturities of time
deposits in other financial
institutions 128 4
Proceeds from the sale of
securities available for sale 37,078 20,889
Proceeds from the maturity of and
principal paydowns on securities
available for sale 96,409 84,178
Purchase of securities available
for sale (113,385) (126,362)
Net increase in loans and leases (72,643) (21,567)
Purchase of bank-owned life
insurance policies (15,000) -
Increase in assets under operating
leases (6,417) (2,539)
Capital expenditures (9,110) (3,307)
Proceeds on sale of OREO and other
repossessed assets 899 273
-------- --------
NET CASH USED BY INVESTING ACTIVITIES (82,041) (49,499)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand
deposits and savings accounts 16,658 (3,463)
Net increase in time deposit accounts 48,591 26,381
Net decrease in short-term borrowings (24,507) (16,813)
Proceeds from other borrowings 25,750 7,683
Repayments of other borrowings (5,843) (15,151)
Purchase of treasury stock (5,469) (1,060)
Proceeds from sale of common stock 1,278 1,823
Dividends (1,976) (1,965)
-------- --------
NET CASH PROVIDED (USED) BY FINANCING
ACTIVITIES 54,482 (2,565)
-------- --------
Net decrease in cash and cash
equivalents (14,406) (18,663)
Cash and cash equivalents at
beginning of year 100,992 93,550
-------- --------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 86,586 $ 74,887
======== ========
Supplemental disclosures:
Cash paid for income/franchise taxes $ 2,623 $ 332
======== ========
Cash paid for interest $ 20,141 $ 21,973
======== ========
See accompanying notes to consolidated financial statements.
HEARTLAND FINANCIAL USA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The interim unaudited consolidated financial statements contained
herein should be read in conjunction with the audited
consolidated financial statements and accompanying notes to the
financial statements for the fiscal year ended December 31, 2002,
included in Heartland Financial USA, Inc.'s ("Heartland") Form 10-
K filed with the Securities and Exchange Commission on March 26,
2003. Accordingly, footnote disclosures, which would
substantially duplicate the disclosure contained in the audited
consolidated financial statements, have been omitted.
The financial information of Heartland included herein is
prepared pursuant to the rules and regulations for reporting on
Form 10-Q. Such information reflects all adjustments (consisting
of normal recurring adjustments), which are, in the opinion of
management, necessary for a fair presentation of results for the
interim periods. The results of the interim periods ended June
30, 2003, are not necessarily indicative of the results expected
for the year ending December 31, 2003.
Basic earnings per share is determined using net income and
weighted average common shares outstanding. Diluted earnings per
share is computed by dividing net income by the weighted average
common shares and assumed incremental common shares issued.
Amounts used in the determination of basic and diluted earnings
per share for the three- and six-month periods ended June 30,
2003 and 2002, are shown in the tables below:
Three Months Ended
(Dollars in thousands) 6/30/03 6/30/02
------- -------
Income from continuing operations $ 4,207 $ 3,918
Discontinued operations:
Income from operation of discontinued
branch - 202
Income taxes - 79
------- -------
Income from discontinued operation - 123
------- -------
Net income $ 4,207 $ 4,041
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,874 9,809
Assumed incremental common shares issued
upon exercise of stock options (000's) 185 64
------- -------
Weighted average common shares for
diluted earnings per share (000's) 10,059 9,873
======= =======
Earnings per common share - basic $ .43 $ .41
Earnings per common share - diluted .42 .41
Earnings per common share from
continuing operations - basic(1) .43 .40
Earnings per common share from
continuing operations - diluted(1) .42 .40
(1) Excludes the discontinued operations of our Eau Claire
branch.
Six Months Ended
(Dollars in thousands) 6/30/03 6/30/02
------- -------
Income from continuing operations $ 8,731 $ 7,739
Discontinued operations:
Income from operation of discontinued
branch - 403
Income taxes - 158
------- -------
Income from discontinued operation - 245
------- -------
Net income $ 8,731 $ 7,984
======= =======
Weighted average common shares
outstanding for basic earnings per
share (000's) 9,883 9,770
Assumed incremental common shares issued
upon exercise of stock options (000's) 188 62
------- -------
Weighted average common shares for
diluted earnings per share (000's) 10,071 9,832
======= =======
Earnings per common share - basic $ .88 $ .82
Earnings per common share - diluted .87 .81
Earnings per common share from
continuing operations - basic(1) .88 .79
Earnings per common share from
continuing operations - diluted(1) .87 .79
(1) Excludes the discontinued operations of our Eau Claire
branch.
Heartland applies APB Opinion No. 25 in accounting for its Stock
Option Plan and, accordingly, no compensation cost for its stock
options has been recognized in the financial statements. Had
Heartland determined compensation cost based on the fair value at
the grant date for its stock options under FAS No. 123,
Heartland's net income would have been reduced to the pro forma
amounts indicated below:
Three Months Six Months
(Dollars in thousands, Ended Ended
except per share data) 6/30/03 6/30/02 6/30/03 6/30/02
------- ------- ------- -------
Net income as reported $ 4,207 $ 4,041 $ 8,731 $ 7,984
Pro forma 4,207 4,041 8,515 7,736
Earnings per share-basic
as reported $ .43 $ .41 $ .88 $ .82
Pro forma .43 .41 .86 .79
Earnings per share-diluted
as reported $ .42 $ .41 $ .87 $ .79
Pro forma .42 .41 .85 .79
Pro forma net income only reflects options granted from 1996
through 2003. Therefore, the full impact of calculating
compensation cost for stock options under FAS 123 is not
reflected in the pro forma net income amounts presented above
because compensation is reflected over the options' vesting
period, and compensation cost for options granted prior to
January 1, 1996, is not considered.
Effect of New Financial Accounting Standards-In January 2003, the
Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 (FIN 46), "Consolidation of Variable
Interest Entities." FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to certain variable interest entities in which
equity investors do not have the characteristics of a controlling
interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated
financial support from other parties. The recognition and
measurement provisions of this Interpretation are effective for
newly created variable interest entities formed after January 31,
2003, and for existing variable interest entities on the first
interim or annual reporting period beginning after June 15, 2003.
Heartland adopted the disclosure provisions of FIN 46 effective
December 31, 2002, and the provisions of FIN 46 for newly formed
variable interest entities effective January 31, 2003. Heartland
has no newly formed variable interest entity subject to the
provisions of FIN 46. Heartland is in the process of determining
whether consolidation of various affordable housing tax credit
project partnerships will be necessary in the third quarter of
2003 to reflect the July 1, 2003 effective date. Consolidation of
these entities, if required, is not expected to have a material
effect on the consolidated financial statements of Heartland.
In April 2003, the FASB issued SFAS No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities."
This statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." In addition, SFAS
No. 149 requires that contract with comparable characteristics be
accounted for similarly. This statement is effective
prospectively for contracts entered into or modified after June
30, 2003, except for those provisions of the Statement that
relate to Statement 133 Implementation Issues that have been
effective for fiscal quarters that began prior to June 15, 2003,
which should continue to be applied in accordance with the
respective effective dates. The impact of adopting SFAS No. 149
on Heartland's financial condition and results of operation is
not expected to be material.
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity." This Statement establishes standards for
how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that
is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously
classified as equity. This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003, except for mandatory
redeemable financial instruments of nonpublic entities. The
impact of adopting SFAS No. 150 on Heartland's financial
condition and results of operation is not expected to be
material.
NOTE 2: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS
The gross carrying amount of intangible assets and the associated
accumulated amortization at June 30, 2003, is presented in the
table below.
June 30, 2003
------------------------
Gross
Carrying Accumulated
(Dollars in thousands) Amount Amortization
-------- ------------
Intangible assets:
Core deposit premium $ 4,492 $ 2,258
Mortgage servicing rights 3,522 1,935
------- -------
Total $ 8,014 $ 4,193
======= =======
Unamortized intangible assets $ 3,821
=======
Projections of amortization expense for mortgage servicing rights
are based on existing asset balances and the existing interest
rate environment as of June 30, 2003. What Heartland actually
experiences may be significantly different depending upon changes
in mortgage interest rates and market conditions. The following
table shows the estimated future amortization expense for
amortized intangible assets:
Core Mortgage
Deposit Servicing
(Dollars in thousands) Premium Rights Total
--------- --------- ---------
Six months ended
December 31, 2003 $ 202 $ 1,379 $ 1,581
Year Ended December 31,
2004 $ 353 $ 59 $ 412
2005 353 49 402
2006 353 39 392
2007 353 29 382
2008 353 20 373
NOTE 3: ACQUISITIONS
On June 30, 2003, Heartland completed the buyout of all minority
stockholders of New Mexico Bank & Trust as agreed upon during its
formation in 1998. The repurchase price was determined by an
appraisal of the stock of New Mexico Bank & Trust. In exchange
for their shares of New Mexico Bank & Trust stock, the minority
stockholders received a total of 383,574 shares of Heartland
common stock.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SAFE HARBOR STATEMENT
This report contains, and future oral and written statements of
Heartland and its management may contain, forward-looking
statements, within the meaning of such term in the Private
Securities Litigation Reform Act of 1995, with respect to the
financial condition, results of operations, plans, objectives,
future performance and business of Heartland. Forward-looking
statements, which may be based upon beliefs, expectations and
assumptions of Heartland's management and on information
currently available to management, are generally identifiable by
the use of words such as "believe", "expect", "anticipate",
"plan", "intend", "estimate", "may", "will", "would", "could",
"should" or other similar expressions. Additionally, all
statements in this document, including forward-looking
statements, speak only as of the date they are made, and
Heartland undertakes no obligation to update any statement in
light of new information or future events.
Heartland's ability to predict results or the actual effect of
future plans or strategies is inherently uncertain. Factors which
could have a material adverse effect on the operations and future
prospects of Heartland and its subsidiaries include, but are not
limited to, the following:
- The strength of the United States economy in general and
the strength of the local economies in which Heartland
conducts its operations which may be less favorable than
expected and may result in, among other things, a
deterioration in the credit quality and value of
Heartland's assets.
- The economic impact of past and any future terrorist
threats and attacks, acts of war or threats thereof, and
the response of the United States to any such threats and
attacks.
- The effects of, and changes in, federal, state and local
laws, regulations and policies affecting banking,
securities, insurance and monetary and financial matters.
- The effects of changes in interest rates (including the
effects of changes in the rate of prepayments of Heartland's
assets) and the policies of the Board of Governors of the Federal
Reserve System.
- The ability of Heartland to compete with other financial
institutions as effectively as Heartland currently
intends due to increases in competitive pressures in the
financial services sector.
- The inability of Heartland to obtain new customers and to
retain existing customers.
- The timely development and acceptance of products and
services, including products and services offered through
alternative delivery channels such as the Internet.
- Technological changes implemented by Heartland and by other
parties, including third party vendors, which may be more
difficult or more expensive than anticipated or which may have
unforeseen consequences to Heartland and its customers.
- The ability of Heartland to develop and maintain secure
and reliable electronic systems.
- The ability of Heartland to retain key executives and
employees and the difficulty that Heartland may
experience in replacing key executives and employees in
an effective manner.
- Consumer spending and saving habits which may change in a
manner that affects Heartland's business adversely.
- Business combinations and the integration of acquired
businesses may be more difficult or expensive than
expected.
- The costs, effects and outcomes of existing or future
litigation.
- Changes in accounting policies and practices, as may be
adopted by state and federal regulatory agencies and the
Financial Accounting Standards Board.
- The ability of Heartland to manage the risks associated
with the foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be
placed on such statements. Additional information concerning
Heartland and its business, including other factors that could
materially affect Heartland's financial results, is included in
Heartland's filings with the Securities and Exchange Commission.
GENERAL
Heartland's results of operations depend primarily on net
interest income, which is the difference between interest income
from interest earning assets and interest expense on interest
bearing liabilities. Noninterest income, which includes service
charges, 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 second quarter of 2003 was $4.2 million,
or $.42 on a diluted earnings per common share basis, compared to
$4.0 million, or $.41 on a diluted earnings per common share
basis, during the same quarter in 2002, a $166 thousand or 4%
increase. On an annualized basis, return on average common equity
was 13.15% and return on average assets was .92% for the second
quarter of 2003. For the same period in 2002, annualized return
on average equity was 14.44% and annualized return on average
assets was .99%. These results are particularly gratifying in
light of continued softness in the economy and Heartland's
continued investment in the growth of its franchise.
Earnings from continuing operations for the second quarter of
2003 increased $289 thousand or 7%. Net income from continuing
operations totaled $4.2 million, or $.42 on a diluted earnings
per common share basis, for the second quarter of 2003 compared
to $3.9 million, or $.40 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 second quarter of 2002 was a
gain of $123 thousand, or $.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 second quarter
of 2003 was the $1.2 million or 9% growth in net interest income
due primarily to growth in earning assets. Average earning assets
went from $1.46 billion during the second quarter of 2002 to
$1.65 billion during the same quarter in 2003, a change of $190.9
million or 13%. Gains on sale of loans and activities within the
available for sale and trading portfolios contributed to a $1.6
million or 24% increase in noninterest income. These improvements
in noninterest income were partially offset by a valuation
adjustment on mortgage servicing rights and an increase in
amortization on these mortgage servicing rights as a result of
prepayments experienced within Heartland's mortgage servicing
portfolio. Noninterest expense increased $l.9 million or 13%, a
portion of which was attributable to the implementation of
imaging technology across all the bank subsidiaries, the addition
of HTLF Capital Corp. and expansion into the Santa Fe, New Mexico
and Phoenix, Arizona markets.
For the six-month period ended June 30, 2003, total net income
increased 9% to $8.7 million, or $.87 per diluted share, compared
to total net income of $8.0 million, or $0.81 per diluted share
in the same period in 2002. Return on average equity was 13.84%,
and return on average assets was .98% for the six-month period in
2003 compared to 14.56% and .99%, respectively, for the same
period in 2002.
The improved earnings during the first six months of 2003 was
largely due to the $3.7 million or 14% growth in net interest
income as a result of the growth in earning assets. Average
earning assets went from $1.46 billion during the first half of
2002 to $1.62 billion during the same period in 2003, an increase
of $159.5 million or 11%. Noninterest income increased $2.1
million or 14%, primarily as a result of gains on sale of loans
and activities within the available for sale and trading
portfolios and would have been more significant had it not been
for the valuation adjustment on mortgage servicing rights
recorded during the second quarter of 2003 and the increased
amortization on mortgage servicing rights as a result of
prepayments experienced in the mortgage servicing portfolio.
Noninterest expense increased $3.3 million or 11%, due primarily
to the implementation of imaging technology and the expansion
efforts mentioned previously. Management remains focused on
expanding the customer base in the markets served and continues
to look for opportunities to enter new markets. New Mexico Bank &
Trust's branch in Santa Fe attracted deposits in excess of $10
million during its first six months of operations. Plans for
additional branch locations in this market are underway. Arizona
Bank & Trust, Heartland's de novo bank in Mesa, Arizona, is
scheduled to open on August 18, 2003. While expansion efforts can
initially be a drag on current earnings, they will provide a firm
foundation for future success.
Total assets at June 30, 2003, increased by 12% since June 30,
2002, and by 4% since December 31, 2002. Total loans and leases
grew 13% to $1.26 billion compared to June 30, 2002, and deposits
increased 14% to $1.40 billion over the same period. In the
first six months of 2003, total loans and leases and total
deposits increased by 7% and 5%, respectively. Commercial and
commercial real estate loan volume alone grew by over $50 million
since year-end and $100 million since last June. Deposits showed
strong increases in the latest six month and twelve month
periods, demonstrating continued strong customer response to
Heartland's products despite the very low interest rate
environment.
CRITICAL ACCOUNTING POLICIES
The process utilized by Heartland to estimate the adequacy of the
allowance for loan and lease losses is considered a critical
accounting practice for Heartland. The allowance for loan and
lease losses represents management's estimate of identified and
unidentified losses in the existing loan portfolio. Thus, the
accuracy of this estimate could have a material impact on
Heartland's earnings. The adequacy of the allowance for loan and
lease losses is determined using factors that include the overall
composition of the loan portfolio, general economic conditions,
types of loans, past loss experience, loan delinquencies, and
potential substandard and doubtful credits. The adequacy of the
allowance for loan and lease losses is monitored on an ongoing
basis by the loan review staff, senior management and the 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 June 30, 2003. While management uses available
information to provide for loan and lease losses, the ultimate
collectibility of a substantial portion of the loan portfolio and
the need for future additions to the allowance will be based on
changes in economic conditions. Along with other financial
institutions, management shares a concern for the outlook of the
economy during the remainder of 2003. Even though there have been
various signs of emerging strength, it is not certain that this
strength will be sustainable. Consumer confidence plunged to a
nine-year low during 2002. Should this economic climate continue,
borrowers may experience difficulty, and the level of
nonperforming loans, charge-offs, and delinquencies could rise
and require further increases in the provision for loan and lease
losses. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the
allowance for loan and lease losses carried by the Heartland
subsidiaries. Such agencies may require Heartland to make
additional provisions to the allowance based upon their judgment
about information available to them at the time of their
examinations.
NET INTEREST INCOME
Net interest margin, expressed as a percentage of average earning
assets, was 3.82% during the second quarter of 2003 compared to
3.94% for the same period in 2002 and 4.12% for the first quarter
of 2003. For the first six months of 2003, net interest margin
was 3.99%, compared to 3.86% in the same period one year ago.
A flat yield curve led to further compression of Heartland's net
interest margin, but management believes its disciplined approach
to asset and liability pricing has served to mitigate the effects
of margin pressure to a significant degree. Management has been
successful in the utilization of floors on its commercial loan
portfolio to minimize the effect downward rates have on
Heartland's interest income. If rates begin to edge upward,
Heartland will not see a corresponding increase in its interest
income until rates have moved above the floors in place on these
loans. On a tax-equivalent basis, interest income as a percentage
of average earning assets was 6.37% during the first six months
of 2003 compared to 6.85% during the first six months of 2002, a
decline of 48 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 2.38% during the first half of 2003
compared to 2.99% during the first half of 2002, a decline of 61
basis points.
For the three-month period ended June 30, 2003, interest income
increased $224 thousand or 1% when compared to the same period in
2002. This increase was attributable to the growth in earning
assets. Average earning assets were $1.65 billion during the
second quarter of 2003 compared to $1.46 billion during the
second quarter of 2002. For the six-month period ended June 30,
2003, interest income increased $1.2 million or 2% when compared
to the same period in 2002. This increase was attributable to the
growth in earning assets. Average earning assets were $1.62
billion during the second half of 2003 compared to $1.46 billion
during the second half of 2002. This growth in earning assets
offset the effect of a further decline in the national prime
rate. During the second quarter of 2003, the national prime rate
was further reduced from 4.25% to 4.00% compared to 4.75% during
the first half of 2002.
For the three-month period ended June 30, 2003, interest expense
decreased $1.0 million or 9% when compared to the same period in
2002. For the six-month period ended June 30, 2003, interest
expense decreased $2.5 million or 12% when compared to the same
period in 2002. The decline in interest expense outpaced the
decline in interest income, primarily as a result of the decline
in rates and the maturity of higher-rate certificate of deposit
accounts. Management continues to focus efforts on improving the
mix of its funding sources to minimize its interest costs.
On June 25, 2003, the Federal Open Market Committee decided to
lower its target for the federal funds rate by 25 basis points to
1.00%, the lowest target interest rate on overnight loans between
banks since 1961. Correspondingly, national prime declined to
4.00%. The continuation of these historically low interest rates
may have a negative impact on Heartland's net interest margin.
Even though a majority of Heartland's floating rate commercial
loan portfolio has floors in place, at these historically low
interest rate levels, there will be pressure to lower these
floors or refinance to fixed rate products. Additionally, the
rates paid on deposit products have been driven to significantly
low levels during the past year and, in many cases, there is
little room to lower these rates 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 provision
for loan losses during the second quarter of 2003 was $922
thousand, an increase of $292 thousand or 46% when compared to
the same quarter in 2002. During the first six months of 2003,
the provision for loan losses was $2.2 million, an increase of
$615 thousand or 38% when compared to the same period in 2002.
These increases resulted primarily from the 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 $1.6 million or 24% during the
second quarter of 2003 when compared to the same quarter in 2002.
On a year-to-date comparative basis, total noninterest income
increased $2.1 million or 14%. The noninterest income categories
reflecting significant improvement during the quarter and six
months were securities gains and gains on sale of loans.
Service charges and fees decreased $248 thousand or 15% during
the quarters under comparison and $388 thousand or 12% during the
six-month periods under comparison. Included in this category are
service fees collected on the mortgage loans Heartland sold into
the secondary market, while retaining servicing. Even though
Heartland's servicing portfolio grew to $464.0 million at June
30, 2003, from $395.1 million at year-end 2002, the amortization
on the mortgage servicing rights associated with the servicing
portfolio increased $519 thousand for the quarters and $929
thousand for the six months under comparison, as a result of
increased prepayments in the portfolio. Offsetting a portion of
these increases was an additional $144 thousand in service
charges on checking accounts during the first six months of 2003,
a 7% increase. The addition of an overdraft privilege feature to
our checking account product line in late 2001, along with growth
in the number of checking accounts, resulted in the generation of
additional service charge revenue related to activity fees
charged to these accounts. Checking account balances grew from
$153.8 million at June 30, 2002, to $208.6 million at June 30,
2003, a $54.8 million or 36% increase. Also contributing to the
increase in service charges and fees was the $93 thousand or 18%
growth in fees collected for the processing of activity on our
automated teller machines during the first six months of 2003.
Beginning in the summer of 2002, the state of Iowa began to allow
financial institutions to charge a fee for the use of automated
teller machines.
Gains on sale of loans increased by $1.2 million or 224% for the
quarters and $1.7 million or 111% for the six months under
comparison. The volume of mortgage loans sold into the secondary
market during the first half of 2003 was greater than those sold
during the same period in 2002, primarily as a result of the
historically low rate environment during 2003. During low rate
environments, customers frequently elect to take fifteen- and
thirty-year, fixed-rate mortgage loans, which Heartland usually
elects to sell into the secondary market. Mortgage rates began to
move upward recently and if that trend continues, the present
level of gains on sale of loans will not continue throughout the
balance of the year.
During the second quarter of 2003, securities gains were $478
thousand compared to $75 thousand during the second quarter of
2002. During the first six months of 2003, securities gains were
$1.2 million compared to $156 thousand during the first six
months 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. This
portfolio recorded gains of $277 thousand during the second
quarter of 2003 compared to losses of $214 thousand during the
same quarter in 2002. This improvement is indicative of the
overall rise in the stock markets.
Impairment losses on equity securities deemed to be other than
temporary totaled $22 thousand during the second quarter of 2003
and $170 thousand for the first six months of 2003. A majority of
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 June 30, 2003, was $42
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 second quarter of 2003, a $694 thousand loss was
recorded as a valuation adjustment on mortgage servicing rights
compared to a $326 thousand loss during the same quarter in 2002.
For the six-month period ended on June 30, the loss totaled $992
thousand during 2003 and $326 thousand during 2002. 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 $197 thousand or 5%
during the second quarter of 2003 and $635 thousand or 8% during
the first half of 2003. These decreases resulted from a decline
in the number of vehicles being replaced at our vehicle leasing
and fleet management subsidiary, ULTEA. As the economy weakened,
many companies elected to continue operations with their current
fleet of vehicles instead of the replacement of three or four
year old vehicles, as had typically been the norm.
Total other noninterest income was $517 thousand during the
second quarter of 2003 compared to $91 thousand during the same
quarter in 2002. For the six-month period ended on June 30, total
other noninterest income was $1.2 million in 2003 and $538
thousand in 2002. Contributing to the increases during 2003 were
the following:
- During the second quarter of 2003, Heartland purchased
an additional $15 million in bank-owned life insurance
policies and the corresponding increase in cash
surrender value on these policies was $100 thousand.
- During the first quarter of 2003, a $178 thousand gain
was realized on the sale of one parcel of repossessed
real estate.
- In April of 2002, Dubuque Bank and Trust acquired a
99.9% ownership in a limited liability company that
owns a certified historic structure for which historic
rehabilitation tax credits applied to the 2002 tax
year. Amortization of the investment in this limited
liability company recorded during the first six months
of 2002 was $178 thousand.
NONINTEREST EXPENSE
Total noninterest expense increased $1.9 million or 13% during
the second quarter of 2003 when compared to the same quarter in
2002. On a six-month comparative basis, total noninterest expense
increased $3.3 million or 11%. A large portion of this increase
was attributable to expansion efforts, as well as, to the
implementation of imaging technology across all of Heartland's
bank subsidiaries.
Salaries and employee benefits, the largest component of
noninterest expense, increased $1.2 million or 18% for the
quarters under comparison and $2.1 million or 15% for the six
months 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, the formation of HTLF Capital Corp. and preparations
for the opening of a de novo bank in Phoenix, Arizona. The number
of full-time equivalent employees employed by Heartland increased
from 584 at June 30, 2002, to 642 at June 30, 2003.
The noninterest expense categories experiencing increases during
the quarters and six-month periods under review due to the
expansion efforts mentioned above were occupancy, furniture and
equipment, outside services, advertising and other noninterest
expense. These expenses in aggregate grew by $749 thousand or 16%
during the quarters under comparison and $1.6 million or 17% for
the six-month periods under comparison. The implementation of
imaging technology across all the Heartland bank subsidiaries
also contributed to the increases in these categories.
Consistent with the lack of vehicle replacement activity
occurring at ULTEA, the depreciation on equipment under operating
leases decreased $54 thousand or 2% during second three months of
2003 and $297 thousand or 5% during the first six months of 2003.
INCOME TAX EXPENSE
Income tax expense for the second quarter of 2003 increased $275
thousand or 17% when compared to the same period in 2002. On a
six-month comparative basis, income tax expense increased $739
thousand or 21%. These increases reflected the continued growth
in pre-tax earnings.
Heartland's effective tax rate increased to 31.27% during the
second quarter of 2003 compared to 28.86% for the second quarter
of 2002. For the six-month periods ended June 30, 2003 and 2002,
the effective tax rate was 32.81% and 30.62%, respectively.
Historic rehabilitation tax credits were applied to the 2002 tax
year as a result of the previously mentioned ownership in a
limited liability company that owns a certified historic
structure. Tax-exempt interest income was 16% of pre-tax income
during the first six months of 2003 compared to 12% for the same
period in 2002.
FINANCIAL CONDITION
LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Total loans and leases increased $80.2 million, an increase of 7%
since year-end 2002. A majority of this growth occurred in the
commercial and commercial real estate category, which grew $53.8
million or 7%. All of the banks experienced growth in this
category, principally as a result of continued calling efforts.
Agricultural and agricultural real estate loans grew $6.0 million
or 4% during the first half of 2003. Nearly all this growth
occurred at Dubuque Bank and Trust Company, Heartland's flagship
bank in Dubuque, Iowa.
Residential mortgage loans experienced an increase of $19.7
million or 14%, nearly half of which occurred in the loans held
for sale. The remaining increase was primarily due to
management's election to retain a portion of the fifteen-year
fixed rate loans in its own portfolio. Customers have continued
to refinance their mortgage loans into fifteen- and thirty-year
fixed rate loans, which Heartland usually sells into the
secondary market. Servicing is retained on a majority of these
loans so that the Heartland bank subsidiaries have an opportunity
to continue providing their customers the excellent service they
expect. Heartland's servicing portfolio was $395.1 million at
year-end 2002 and $464.0 million at June 30, 2003.
Consumer loans increased $2.4 million or 2% during the first half
of 2003, primarily in home equity lines of credit at Riverside
Community Bank.
The table below presents the composition of the loan portfolio as
of June 30, 2003, and December 31, 2002.
LOAN PORTFOLIO
(Dollars in thousands)
June 30, December 31,
2003 2002
Amount Percent Amount Percent
---------- ------- ---------- -------
Commercial and commercial
real estate $ 797,282 63.37% $ 743,520 63.10%
Residential mortgage 165,647 13.17 145,931 12.39
Agricultural and
agricultural real estate 161,551 12.84 155,596 13.21
Consumer 123,226 9.80 120,853 10.26
Lease financing, net 10,365 .82 12,308 1.04
---------- ------- ---------- -------
Gross loans and leases 1,258,071 100.00% 1,178,208 100.00%
======= =======
Unearned discount (1,944) (2,161)
Deferred loan fees (709) (811)
---------- ----------
Total loans and leases 1,255,418 1,175,236
Allowance for loan and
lease losses (17,600) (16,091)
---------- ----------
Loans and leases, net $1,237,818 $1,159,145
========== ==========
The process utilized by Heartland to estimate the adequacy of the
allowance for loan and lease losses is considered a critical
accounting practice for Heartland. The allowance for loan and
lease losses represents management's estimate of identified and
unidentified losses in the existing loan portfolio. For
additional details on the specific factors considered, refer to
the critical accounting policies section of this report.
The allowance for loan and lease losses increased by $1.5 million
or 9% during the first six months of 2003. The allowance for loan
and lease losses at June 30, 2003, was 1.40% of loans and 327% of
nonperforming loans, compared to 1.37% of loans and 359% of
nonperforming loans, at year-end 2002. Nonperforming loans
increased slightly to .43% of total loans and leases compared to
..38% of total loans and leases at year-end 2002.
During the first six months of 2003, Heartland recorded net
charge offs of $717 thousand compared to $852 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 six months of 2003, Citizens recorded net
charge-offs of $310 thousand or 43% of total net charge-offs
compared to $493 thousand or 58% 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)
Six Months
Ended June 30,
2003 2002
------- -------
Balance at beginning of period $16,091 $14,660
Provision for loan and lease losses from
continuing operations 2,226 1,611
Provision for loan and lease losses from
discontinued operations - (10)
Recoveries on loans and leases previously
charged off 323 415
Loans and leases charged off (1,040) (1,267)
------- -------
Balance at end of period $17,600 $15,409
======= =======
Net charge offs to average loans and leases 0.06% 0.08%
The table below presents the amounts of nonperforming loans and
leases and other nonperforming assets on the dates indicated:
NONPERFORMING ASSETS
(Dollars in thousands)
As Of As Of
June 30, December 31,
2003 2002 2002 2001
------------------------------
Nonaccrual loans and leases $4,727 $6,918 $3,944
$7,269
Loan and leases contractually
past due 90 days or more 649 728 541 500
Restructured loans and leases - - - 354
------ ------ ------ ------
Total nonperforming loans and
leases 5,376 7,646 4,485 8,123
Other real estate 488 108 452 130
Other repossessed assets 287 241 279 343
------ ------ ------ ------
Total nonperforming assets $6,151 $7,995 $5,216 $8,596
====== ====== ====== ======
Nonperforming loans and leases
to total loans and leases 0.43% 0.69% 0.38% 0.73%
Nonperforming assets to total
assets 0.33% 0.48% 0.29% 0.52%
SECURITIES
The composition of Heartland's securities portfolio is managed to
maximize the return on the portfolio while considering the impact
it has on Heartland's asset/liability position and liquidity
needs. Securities represented 20% of total assets at June 30,
2003, and 22% of total assets at December 31, 2002. A portion of
the proceeds from the maturity and principal paydowns of
securities was used to fund the loan growth experienced thus far
in 2003.
During the first six 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 June 30, 2003,
and December 31, 2002.
AVAILABLE FOR SALE SECURITIES PORTFOLIO
(Dollars in thousands)
June 30, December 31,
2003 2002
Amount Percent Amount Percent
-------- ------- -------- -------
U.S. Treasury securities $ 499 .14% $ 498 .13%
U.S. government agencies 71,670 19.32 100,841 25.86
Mortgage-backed securities 178,187 48.02 187,318 48.04
States and political
subdivisions 89,916 24.23 71,391 18.31
Other securities 30,765 8.29 29,852 7.66
-------- ------- -------- -------
Total available for sale
securities $371,037 100.00% $389,900 100.00%
======== ======= ======== =======
DEPOSITS AND BORROWED FUNDS
Total deposits experienced an increase of $65.2 million or 5%
during the first six months of 2003. Increases in total deposits
occurred at all the bank subsidiaries except for First Community
Bank. All the deposit categories experienced an increase during
the six-month period. Demand deposit balances grew $11.1 million
or 6% with the most significant occurring in the Riverside
Community Bank and Wisconsin Community Bank markets. Savings
deposit account balances grew by $5.6 million or 1%, primarily in
the money market products offered by all the bank subsidiaries.
Certificate of deposit account balances grew by $48.6 million or
8% during the first six 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 six-month period ended June 30, 2003, the amount of
short-term borrowings decreased $24.5 million or 15%. 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 $2.8 million or 3% since year-end 2002.
Also included in short-term borrowings are the credit lines
Heartland entered into with two unaffiliated banks. Under the
unsecured credit lines, Heartland may borrow up to $50.0 million.
At June 30, 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 $146.2 million on
June 30, 2003, compared to $126.3 million on December 31, 2002.
The change in these account balances primarily resulted from
activity in the bank subsidiaries' borrowings from the FHLB. All
of the Heartland banks own stock in the FHLB of Des Moines,
Chicago or Dallas, enabling them to borrow funds from their
respective FHLB for short- or long-term purposes under a variety
of programs. Total FHLB borrowings at June 30, 2003, had
increased to $94.5 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)
June 30, December 31,
2003 2002
Amount Ratio Amount Ratio
------ ----- ------ -----
Risk-Based Capital Ratios:(1)
Tier 1 capital $ 145,001 10.17% $ 141,918 10.65%
Tier 1 capital minimum
requirement 57,028 4.00% 53,298 4.00%
---------- ------ ---------- ------
Excess $ 87,973 6.17% $ 88,620 6.65%
========== ====== ========== ======
Total capital $ 162,600 11.40% $ 158,010 11.86%
Total capital minimum
requirement 114,057 8.00% 106,596 8.00%
---------- ------ ---------- ------
Excess $ 48,543 3.40% $ 51,414 3.86%
========== ====== ========== ======
Total risk-adjusted
assets $1,425,708 $1,332,451
========== ==========
Leverage Capital Ratios:(2)
Tier 1 capital $ 145,001 7.97% $ 141,918 8.24%
Tier 1 capital minimum
requirement(3) 72,764 4.00% 68,883 4.00%
---------- ------ ---------- ------
Excess $ 72,237 3.97% $ 73,035 4.24%
========== ====== ========== ======
Average adjusted assets
(less goodwill and other
intangible assets) $1,819,088 $1,722,077
========== ==========
(1) Based on the risk-based capital guidelines of the Federal
Reserve, a bank holding company is required to maintain a
Tier 1 capital to risk-adjusted assets ratio of 4.00% and
total capital to risk-adjusted assets ratio of 8.00%.
(2) The leverage ratio is defined as the ratio of Tier 1 capital
to average adjusted assets.
(3) Management of Heartland has established a minimum target
leverage ratio of 4.00%. Based on Federal Reserve
guidelines, a bank holding company generally is required to
maintain a leverage ratio of 3.00% plus additional capital of
at least 100 basis points.
Commitments for capital expenditures are an important factor in
evaluating capital adequacy. In April of 2003, HTLF Capital
Corp., an investment banking subsidiary of Heartland was formed.
This advisory firm specializes in taxable and tax-exempt
municipal leasing, hospital financing, college and university
financing, project financing and 501(c)3 private-activity
funding. The firm also prides itself on being one of the few in
the country prepared to do Indian tribal private placements.
Heartland's initial investment in this subsidiary was $500
thousand.
In February of 2003, Heartland entered into an agreement with a
group of Arizona business leaders to establish a new bank in
Mesa. The new bank is expected to begin operations on August 18,
2003. Heartland's portion of the $15.0 million initial capital
investment is $12.0 million, of which $3.0 million 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. on
January 1, 2000, the one-bank holding company of First National
Bank of Clovis, remaining requisite cash payments under the notes
payable total $637 thousand in 2004, plus interest at 7.00%.
Immediately following the closing of the acquisition, the bank
was merged into New Mexico Bank & Trust.
On June 30, 2003, Heartland completed the buyout of all minority
stockholders of New Mexico Bank & Trust as agreed upon during its
formation in 1998. In exchange for their shares of New Mexico
Bank & Trust stock, the minority stockholders received a total of
383,574 shares of Heartland common stock.
Heartland has an incentive compensation agreement with certain
employees of one of the bank subsidiaries, none of whom is an
executive officer of Heartland, that requires a total payment of
$3.6 million to be made no later than February 29, 2004, to those
who remain employed with the subsidiary on December 31, 2003.
Additionally, each employee is bound by a confidentiality and non-
competition agreement. One-third of the payment will be made in
cash and the remaining two-thirds in shares of Heartland's common
stock. The obligation is being accrued over the performance
period.
On 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 June
30, 2003.
On December 18, 2001, Heartland completed a private placement
offering of $8.0 million of variable rate cumulative capital
securities representing undivided beneficial interests in
Heartland Financial Statutory Trust II, a special purpose trust
subsidiary formed for the sole purpose of this offering. The
proceeds from the offering were used by the trust to purchase
junior subordinated debentures from Heartland. The proceeds were
used by Heartland for general corporate purposes. The debentures
will mature and the capital securities must be redeemed on
December 18, 2031. Heartland has the option to shorten the
maturity date to a date not earlier than December 18, 2006. All
of these securities qualified as Tier 1 capital for regulatory
purposes as of June 30, 2003.
In October of 1999, Heartland completed an offering of $25.0
million of 9.60% cumulative capital securities representing
undivided beneficial interests in Heartland Capital Trust I, a
special purpose trust subsidiary formed for the sole purpose of
this offering. The proceeds from the offering were used by the
trust to purchase junior subordinated debentures from Heartland.
The proceeds were used by Heartland for general corporate
purposes. The debentures will mature and the capital securities
must be redeemed on September 30, 2029. Heartland has the option
to shorten the maturity date to a date not earlier than September
30, 2004. All of these securities continued to qualify as Tier 1
capital for regulatory purposes as of June 30, 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 in the spring of 2004. A reduction in
overall costs on this project will result from tax credits and
other incentives made available on the project as it includes the
rehabilitation of two historical structures and the creation of
new jobs.
Heartland continues to explore opportunities to expand its
umbrella of independent community banks through mergers and
acquisitions as well as de novo and branching opportunities.
Future expenditures relating to these efforts are not estimable
at this time.
LIQUIDITY
Liquidity measures the ability of Heartland to meet maturing
obligations and its existing commitments, to withstand
fluctuations in deposit levels, to fund its operations and to
provide for customers' credit needs. The liquidity of Heartland
principally depends on cash flows from operating activities,
investment in and maturity of assets, changes in balances of
deposits and borrowings and its ability to borrow funds in the
money or capital markets.
Management of investing and financing activities, and market
conditions, determine the level and the stability of net interest
cash flows. Management attempts to mitigate the impact of changes
in market interest rates to the extent possible, so that balance
sheet growth is the principal determinant of growth in net
interest cash flows.
In the event of short-term liquidity needs, the bank subsidiaries
may purchase federal funds from each other or from correspondent
banks and may also borrow from the Federal Reserve Bank.
Additionally, the subsidiary banks' FHLB memberships give them
the ability to borrow funds for short- and long-term purposes
under a variety of programs.
Heartland's revolving credit agreements provide a maximum
borrowing capacity of $50.0 million. As of June 30, 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 June 30, 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
interest rate debt to fixed interest rate debt. Under the
interest rate swap contract, Heartland agrees to pay an amount
equal to a fixed rate of interest times a notional principal
amount, and to receive in return an amount equal to a specified
variable rate of interest times the same notional principal
amount. The notional amounts are not exchanged and payments under
the interest rate swap contract are made monthly. Heartland is
exposed to credit-related losses in the event of nonperformance
by the counterparty to the swap contract, which has been
minimized by entering into the contract with a large, stable
financial institution. As of June 30, 2003, Heartland had an
interest rate swap contract to pay a fixed rate of interest and
receive a variable rate of interest on $25.0 million of
indebtedness. This contract expires on November 1, 2006. The fair
market value of the interest rate swap contract was recorded as a
liability in the amount of $2.1 million on June 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of Heartland's management, including the Chief
Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of Heartland's
disclosure controls and procedures (as defined in Rule 13a-15(e)
promulgated under the Securities and Exchange Act of 1934, as
amended) as of June 30, 2003. Based on that evaluation,
Heartland's management, including the Chief Executive Officer and
Chief Financial Officer, concluded that Heartland's disclosure
controls and procedures were effective. There have been no
significant changes in Heartland's internal controls or in other
factors that could significantly affect internal controls.
PART II
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the
Registrant or its subsidiaries is a party other than ordinary
routine litigation incidental to their respective businesses.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of stockholders was held on May 21,
2003. At the meeting, Lynn B. Fuller and John W. Cox, Jr. were
elected to serve as Class I directors (term expires in 2006).
Continuing as Class II directors (term expires in 2004) are Mark
C. Falb, John K. Schmidt and Robert Woodward. Continuing as Class
III directors (term expires in 2005) are James F. Conlan and
Thomas L. Flynn. The stockholders approved the adoption of the
Heartland Financial USA, Inc. 2003 Stock Option Plan and the
appointment of KPMG LLP as the Company's independent public
accountants for the year ending December 31, 2003.
There were 9,927,755 issued and outstanding shares of common
stock entitled to vote at the annual meeting. The voting results
on the above described items were as follows:
For Withheld
--- --------
Election of Directors
Lynn B. Fuller 8,331,158 151,612
John W. Cox, Jr. 8,428,251 54,519
Broker
For Against Abstain Non-Votes
--- ------- ------- ---------
Adoption of the 2003
Stock Option Plan 7,458,091 367,909 656,770 0
Appointment of KPMG
LLP 8,415,141 51,393 16,236 0
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
10.1 Change of Control Agreements including Golden Parachute
Payment Adjustments and Restrictive Covenants between
Heartland Financial USA, Inc. and Executive Officers
dated January 1, 2003.
10.2 Change of Control Agreements between Heartland Financial
USA, Inc. and Executive Officers dated January 1, 2003.
10.3 Sixth Amendment to Second Amended and Restated Credit
Agreement between Heartland Financial USA, Inc. and The
Northern Trust Company dates as of April 17, 2003.
10.4 See Exhibit 10.3 for substantially the same form of a
Sixth Amendment to Credit Agreement between Heartland
Financial USA, Inc. and Harris Trust and Savings Bank
dated as of April 17, 2003.
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a).
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a).
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
Reports on Form 8-K
On 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.
On May 15, 2003, the Registrant filed a report on Form 8-K
pursuant to Item 5 that a press release announcing that its
common shares would begin trading on the Nasdaq Market System
effective May 15, 2003.
On July 18, 2003, the Registrant filed a report on Form 8-K
pursuant to Item 12 that a press release announcing earnings for
the quarter ended on June 30, 2003, was issued.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned there unto duly authorized.
HEARTLAND FINANCIAL USA, INC.
(Registrant)
Principal Executive Officer
/s/ Lynn B. Fuller
-----------------------
By: Lynn B. Fuller
President
Principal Financial and
Accounting Officer
/s/ John K. Schmidt
-----------------------
By: John K. Schmidt
Executive Vice President
and Chief Financial Officer
Dated: August 14, 2003