-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AGUOmQsUES7kayTeKpGqNdIZCQTSzZffDTipgJ2+RxPp6aLyDjMDD5gM9dLZ2vnr S7xnrXy9ZSaxe8nhIlA2Ww== 0000920112-00-000006.txt : 20000331 0000920112-00-000006.hdr.sgml : 20000331 ACCESSION NUMBER: 0000920112-00-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HEARTLAND FINANCIAL USA INC CENTRAL INDEX KEY: 0000920112 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 421405748 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-15393 FILM NUMBER: 585058 BUSINESS ADDRESS: STREET 1: 1398 CENTRAL AVE CITY: DUBUQUE STATE: IA ZIP: 52001 BUSINESS PHONE: 3195892000 MAIL ADDRESS: STREET 1: 1398 CENTRAL AVE CITY: DUBUQUE STATE: IA ZIP: 52001 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 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) (319) 589-2100 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(g) of the Act: None (Title of Exchange Class) None (Name of Each Exchange on which Registered) Common Stock $1.00 par value (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X) The index to exhibits follows the signature page. As of March 23, 2000, the Registrant had issued and outstanding 9,627,465 shares of the Registrant's Common Stock. The aggregate market value of the voting stock held by non-affiliates of the Registrant as of March 23, 2000, was $88,521,510. * Such figures include 735,460 shares of the Registrant's Common Stock held in a fiduciary capacity by the Trust Department of the Dubuque Bank & Trust Company, a wholly-owned subsidiary of the Registrant. *Based on the last reported price of an actual transaction in Registrant's Common Stock on March 23, 2000, and reports of beneficial ownership filed by directors and executive officers of Registrant and by beneficial owners of more than 5% of the outstanding shares of Common Stock of Registrant; however, such determination of shares owned by affiliates does not constitute an admission of affiliate status or beneficial interest in shares of Registrant's Common Stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the 2000 Annual Meeting of Stockholders are incorporated by reference into Part III. HEARTLAND FINANCIAL USA, INC. Form 10-K Annual Report Table of Contents Part I Item 1. Business A. General Description B. Market Areas C. Competition D. Employees E. Accounting Standards F. Supervision and Regulation G. Governmental Monetary Policy and Economic Conditions Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Part III Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management Item 13. Certain Relationships and Related Transactions Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K PART I. ITEM 1. BUSINESS A. GENERAL DESCRIPTION Heartland Financial USA, Inc. ("Heartland"), reincorporated in the state of Delaware in 1993, is a multi-bank holding company registered under the Bank Holding Company Act of 1956, as amended ("BHCA"). Heartland has five bank subsidiaries in the states of Iowa, Wisconsin, Illinois and New Mexico and one federal savings bank subsidiary in Iowa (collectively, the "Bank Subsidiaries"). All six Bank Subsidiaries are members of the Federal Deposit Insurance Corporation ("FDIC"). Dubuque Bank and Trust Company, Dubuque, Iowa, ("DB&T") is chartered under the laws of the State of Iowa and has two wholly-owned subsidiaries: DB&T Insurance, Inc. ("DB&T Insurance"), a multi-line insurance agency and DB&T Community Development Corp. ("DB&T Development"), majority owner of a senior housing project. Galena State Bank and Trust Company, Galena, Illinois, ("GSB") and Riverside Community Bank, Rockford, Illinois, ("RCB") are chartered under the laws of the State of Illinois. First Community Bank, FSB, Keokuk, Iowa, ("FCB") is a federal savings association organized under the laws of the United States. Wisconsin Community Bank, Cottage Grove, Wisconsin, ("WCB") is chartered under the laws of the State of Wisconsin and has one subsidiary, DBT Investment Corporation ("DBT Investment"), an investment management company. New Mexico Bank & Trust, Albuquerque, New Mexico, ("NMB") is chartered under the laws of the state of New Mexico. The Bank Subsidiaries operate 29 banking locations in Iowa, Illinois, Wisconsin and New Mexico. Heartland has four non-bank subsidiaries. Citizens Finance Co. ("Citizens") is a consumer finance company. ULTEA, Inc. ("ULTEA") is a fleet leasing company headquartered in Madison, Wisconsin. Keokuk Bancshares, Inc. ("Keokuk") is an investment management company. Heartland Capital Trust I is a special purpose trust subsidiary of Heartland formed for the purpose of the offering of cumulative capital securities in October, 1999. All of Heartland's subsidiaries are wholly-owned, except for NMB, of which Heartland was an 80% owner on December 31, 1999. On January 1, 2000, Heartland completed the acquisition of National Bancshares, Inc. ("NBI") the one-bank holding company of First National Bank of Clovis ("FNB") in New Mexico. Heartland merged FNB into its NMB subsidiary immediately after the closing of the NBI acquisition. As a result of this affiliate bank merger, Heartland's ownership in NMB increased to approximately 88%. The Bank Subsidiaries provide full service retail banking within Dubuque and Lee Counties in Iowa; within Jo Daviess, Hancock and Winnebago Counties in Illinois; within Dane, Green, Sheboygan, Brown, and Eau Claire Counties in Wisconsin; and Bernalillo and Curry Counties in New Mexico. Deposit products include checking and other demand deposit accounts, NOW accounts, savings accounts, money market accounts, certificates of deposit, individual retirement accounts and other time deposits. The deposits in the Bank Subsidiaries are insured by the FDIC to the full extent permitted by law. Loans include commercial and industrial, agricultural, real estate mortgage, consumer, home equity, credit cards and lines of credit. Other products and services include VISA debit cards, automatic teller machines, safe deposit boxes and trust services. The principal service of the Bank Subsidiaries consists of making loans to businesses and individuals. These loans are made at the offices of the Bank Subsidiaries. The Bank Subsidiaries also engage in activities that are closely related to banking, including investment brokerage. Operating Strategy Heartland's primary operating strategy is to differentiate the company as a growing consortium of strong community banks through community involvement, active boards of directors, local presidents and local decision-making. As part of the operating strategy, all directors, officers and employees are encouraged to maintain a strong ownership interest in Heartland. As of December 31, 1999, these individuals owned approximately 50% of Heartland's outstanding common stock. Management believes that the personal and professional service that is offered to customers provides an appealing alternative to the "megabanks" that have resulted from the recent mergers and acquisitions in the financial services industry. While Heartland employs a community banking philosophy, management believes that Heartland's size, combined with the full line of financial products and services, is sufficient to effectively compete in the respective market areas. At the same time, management realizes that to remain price competitive Heartland must manage expense levels by centralizing the back office support functions to gain economies of scale. Each of the subsidiaries of Heartland operates under the direction of its own board of directors, although Heartland has standard operating policies regarding asset/liability management, liquidity management, investment management, lending policies and deposit structure management. In order to accomplish these strategic objectives, management has focused on improving the performance of the existing subsidiaries while simultaneously pursuing an acquisition and expansion strategy. With respect to the existing subsidiaries, Heartland has primarily focused on the following strategies: - Improving the bank subsidiaries' funding costs by reducing the levels of higher-cost certificates of deposit, increasing the percentage of lower-cost transaction accounts such as checking, savings and money market accounts, emphasizing relationship banking and capitalizing on cross-selling opportunities; - Emphasizing the expansion of non-traditional sources of income, including trust and investment services, consumer finance and vehicle leasing and fleet management; - Centralizing back office support functions to enable the Bank Subsidiaries to operate as efficiently as possible; and - Continually evaluating new technology and acquiring it when the expected return justifies the cost. Acquisition and Expansion Strategy Heartland's strategy is to diversify both its market area and asset base while increasing profitability through acquisitions and through expansion of its current subsidiaries. The goal is to expand through the acquisition of established financial services organizations, primarily commercial banks or thrifts, when suitable candidates can be identified and acceptable business terms negotiated. Heartland has also formed de novo banking institutions in market areas where management has identified market potential and management with banking expertise and philosophy similar to Heartland's. In evaluating expansion and acquisition opportunities, Heartland has focused on geographic areas in the Midwest or Southwest with growth potential. Heartland continually seeks and evaluates opportunities to establish branches, loan production offices or other business facilities as a means of expanding its presence in current or new market areas. Heartland also looks for opportunities beyond the Midwest and beyond the categories of community banks and thrifts when the Heartland board of directors and management believes that the opportunity will provide a desirable strategic fit without posing undue risk. Heartland does not currently have any definitive understandings or agreements for any acquisitions material to Heartland. However, Heartland will continue to look for further expansion opportunities. Lending Activities General The Bank Subsidiaries provide a range of commercial and retail lending services to corporations, partnerships and individuals. These credit activities include agricultural, commercial, residential real estate and installment loans, as well as loan participations and lines of credit. The Bank Subsidiaries aggressively market their services to qualified lending customers. Lending officers actively solicit the business of new companies entering their market areas as well as long-standing members of the Bank Subsidiaries' respective business communities. Through professional service and competitive pricing, the Bank Subsidiaries have been successful in attracting new lending customers. Heartland also actively pursues consumer lending opportunities. With convenient locations, advertising and customer communications, the Bank Subsidiaries have been successful in capitalizing on the credit needs of their market areas. Commercial Loans The Bank Subsidiaries have a strong commercial loan base and DB&T, in particular, continues to be a premier commercial lender in the tri-state area of northeast Iowa, northwest Illinois and southwest Wisconsin. The Bank Subsidiaries' areas of emphasis include, but are not limited to, loans to wholesalers, hotel and real estate developers, manufacturers, building contractors, business services companies and retailers. The Bank Subsidiaries provide a wide range of business loans, including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment and real estate. Loans may be made on an unsecured basis where warranted by the overall financial condition of the borrower. Terms of commercial business loans generally range from one to five years. DB&T and WCB have also generated loans that are guaranteed by the U.S. Small Business Administration, and DB&T has been certified as one of that agency's Preferred Lenders. Management believes that making these guaranteed loans helps its local communities as well as provides Heartland with a source of income and solid future lending relationships as such businesses grow and prosper. DB&T is also currently one of the state of Iowa's top lenders in the "Linked Investment for Tomorrow" program. This state- sponsored program offers interest rate reductions to businesses opened by minorities and those in rural areas. The primary repayment risk for commercial real estate loans is the failure of the business due to economic events or governmental regulations outside of the control of the borrower or lender that negatively impact the future cash flow and market values of the affected properties. In most cases, the Bank Subsidiaries have collateralized these loans and/or taken personal guarantees to help assure repayment. The Bank Subsidiaries' commercial loans and leases are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Credit support provided by the borrower for most of these loans and leases and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists. The primary repayment risks of commercial loans and leases are that the cash flows of the borrower may be unpredictable, and the collateral securing these loans may fluctuate in value. As the credit portfolios of the Bank Subsidiaries have continued to grow, several changes have been made in their lending departments resulting in an overall increase in these departments' skill levels. Commercial lenders interact with their respective Boards of Directors each month. Heartland also utilizes an internal loan review function to analyze credits of the Bank Subsidiaries and to provide periodic reports to the respective boards of directors. Management has attempted to identify problem loans at an early date and to aggressively seek a resolution of these situations. The result has been a significantly below average level of problem loans compared to the Heartland Banks' industry peer groups in recent years. Agricultural Loans Agricultural loans are emphasized by DB&T, WCB's Monroe banking center and NMB's Clovis banking offices due to their concentration of customers in rural markets. DB&T maintains its status as one of the largest agricultural lenders in the state of Iowa. Agricultural loans remain balanced, however, in proportion to the rest of Heartland's loan portfolio, constituting approximately 11% of the total loan portfolio at December 31, 1999. In connection with their agricultural lending, all of the Bank Subsidiaries have remained close to their traditional geographic market areas. The majority of the outstanding agricultural operating and real estate loans are within 60 miles of their main or branch offices. Agricultural loans, many of which are secured by crops, machinery and real estate, are provided to finance capital improvements and farm operations as well as acquisitions of livestock and machinery. The ability of the borrower to repay may be affected by many factors outside of the borrower's control including adverse weather conditions, loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations. Payments on agricultural loans are ultimately dependent on the profitable operation or management of the farm property securing the loan. The agricultural loan departments work closely with all of their customers, including companies and individual farmers, and review the preparation of budgets and cash flow projections for the ensuing crop year. These budgets and cash flow projections are monitored closely during the year and reviewed with the customers at least once a year. In addition, the Bank Subsidiaries work closely with governmental agencies, including the Farmers Home Administration, to assist agricultural customers in obtaining credit enhancement products such as loan guarantees. Real Estate Mortgage Loans Mortgage lending has been a focal point of the Bank Subsidiaries as each of them continues to build real estate lending business. As interest rates rose during 1999, residential mortgage outstandings grew as customers elected to take three-, five- and seven-year adjustable rate mortgage loans, which were retained in the loan portfolios. During prior years, the majority of home loans generated by the Bank Subsidiaries were sold to government agencies in the secondary mortgage market with servicing rights retained. Management believes that the retention of mortgage servicing provides the Bank Subsidiaries with a relatively steady source of fee income as compared to fees generated solely from mortgage origination operations. Moreover, the retention of such servicing rights allows each of the Bank Subsidiaries to continue to have regular contact with mortgage customers. Consumer Lending The Bank Subsidiaries' consumer lending departments provide all types of consumer loans including motor vehicle, home improvement, home equity, student loans, credit cards, signature loans and small personal credit lines. Consumer loans typically have shorter terms and lower balances with higher yields as compared to one- to four-family residential mortgage loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Consumer loan demand is also serviced through Citizens, which currently serves the consumer credit needs of over 3,900 customers in the three state area of Iowa, Illinois and Wisconsin from its Dubuque, Iowa, Madison and Appleton, Wisconsin, and Loves Park, Illinois offices. Citizens typically lends to borrowers with past credit problems or limited credit histories. Heartland expects to incur a higher level of credit losses on Citizens loans as compared to other consumer loans. Trust Departments The trust departments for DB&T, GSB and FCB have been providing trust services to their respective communities for many years. Trust personnel from DB&T also work with RCB, WCB and NMB personnel to provide trust services to all Bank Subsidiaries. Currently, the Bank Subsidiaries have over $600 million of consolidated assets under management and provide a full complement of trust and investment services for individuals and corporations. The trust department of DB&T is nationally recognized as a leading provider of socially responsible investment services and manages investment portfolios for religious and other non-profit organizations located throughout the United States. The Bank Subsidiaries' trust departments are also active in the management of employee benefit and retirement plans in their market areas. The Bank Subsidiaries have targeted their trust departments as primary areas for future growth. Brokerage and Other Services DB&T contracts with a third-party vendor, Focused Investments LLC, an affiliate of Wayne Hummer & Co., to operate independent securities offices at DB&T, GSB and FCB. Focused Investments LLC offers full-service stock and bond trading, direct investments, annuities and mutual funds. RCB also contracts with Invest Financial Corporation to operate an independent securities office at the main facility. DB&T Insurance has continued to grow its personal and commercial insurance lines and the number of independent insurance companies it represents. DB&T Insurance is a multi-line insurance agency in the Dubuque area and offers a complete array of vehicle, property and casualty, life and disability insurance, as well as commercial lines and tax-free annuities. B. MARKET AREAS DB&T is located in Dubuque County, Iowa, which encompasses the city of Dubuque and a number of surrounding rural communities. The city of Dubuque is located in northeastern Iowa, on the Mississippi River, approximately 175 miles west of Chicago, Illinois, and approximately 200 miles northeast of Des Moines, Iowa. It is strategically situated at the intersection of the state borders of Iowa, Illinois and Wisconsin. Based upon the results of the 1990 census, the city of Dubuque had a total population of approximately 61,000. In addition to its main banking office, DB&T has seven branch offices, all of which are located in the Dubuque County area. As a subsidiary of DB&T, DB&T Insurance has substantially the same market area as the parent organization. Citizens also operates within this market area, and, in addition, offices were opened in Madison, Wisconsin, during June, 1996, Appleton, Wisconsin, during August, 1998 and Loves Park, Illinois during February, 1999. GSB is located in Galena, Illinois, which is less than five miles from the Mississippi River, approximately 20 miles east of Dubuque and 155 miles west of Chicago. GSB also has an office in Stockton, Illinois, and as such, services customers in Jo Daviess County, Illinois. Based on the 1990 census, the county had a population of approximately 22,000 people. FCB's main office is in Keokuk, Iowa, which is located in the southeast corner of Iowa near the borders of Iowa, Missouri and Illinois. Due to its location, FCB serves customers in the tri- county region of Lee County, Iowa, Hancock County, Illinois and Clark County, Missouri. Lee, Hancock and Clark Counties have populations of approximately 43,100, 23,900 and 8,500, respectively. FCB has one branch office in Keokuk and another branch in the city of Carthage in Hancock County, Illinois. Keokuk is an industrial community with a population of approximately 13,500. RCB is located on the northeast edge of Rockford, Illinois, which is approximately 75 miles west of Chicago in Winnebago County. Based on the 1990 census, the county had a population of 284,000 and the city of Rockford had a population of 140,000. WCB operates one office from its location in Cottage Grove, Wisconsin, which is approximately 10 miles east of Madison in Dane County. A branch office was opened in Middleton, a suburb of Madison, in February, 1998. According to the 1990 census, the county had a population of 390,000, and the village of Cottage Grove had a population of 1,100. Wisconsin Business Bank, a branch of WCB, opened three offices in Sheboygan, DePere and Eau Claire, Wisconsin during 1999. These three facilities are located in the northeastern Wisconsin counties of Sheboygan and Brown and the west central Wisconsin county of Eau Claire with populations of 104,000, 195,000 and 85,000, respectively, according to the 1990 census. WCB also acquired the Bank One Monroe Wisconsin banking center in July of 1999. The city of Monroe, which is approximately 50 miles southwest of Madison, is located in Green County in south central Wisconsin. According to the 1990 census, Monroe had a population of 13,700, and Green County had a population of 30,000. NMB operates four offices within Albuquerque, New Mexico in Bernalillo County. Based upon the 1990 census, the county had a population of 480,000 and the city had a population of 385,000. NMB also operates two locations in the New Mexico communities of Clovis and Melrose, both located in Curry County. Clovis is located in east central New Mexico, approximately 220 miles from Albuquerque, 100 miles northwest of Lubbock, Texas and 105 miles southwest of Amarillo, Texas. Clovis had a population of approximately 31,000, and Curry County had a population of 42,000 according to the 1990 census. C. COMPETITION Heartland encounters competition in all areas of its business pursuits. In order to compete effectively, to develop its market base, to maintain flexibility and to move in pace with changing economic and social conditions, Heartland continuously refines and develops its products and services. The principal methods of competition in the financial services industry are price, service and convenience. The Bank Subsidiaries' combined market area is highly competitive. Many financial institutions based in the communities surrounding the Bank Subsidiaries actively compete for customers within Heartland's market area. The Bank Subsidiaries also face competition from finance companies, insurance companies, mortgage companies, securities brokerage firms, money market funds, loan production offices and other providers of financial services. Under the Gramm-Leach-Bliley Act of 1999, effective March 11, 2000, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. The Gramm-Leach-Bliley Act may significantly change the competitive environment in which Heartland and the Bank Subsidiaries conduct business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties. Heartland competes for loans principally through the range and quality of the services it provides, interest rates and loan fees. Heartland believes that its long-standing presence in the community and personal service philosophy enhance its ability to compete favorably in attracting and retaining individual and business customers. Heartland actively solicits deposit-oriented clients and competes for deposits by offering customers personal attention, professional service and competitive interest rates. D. EMPLOYEES At December 31, 1999, Heartland employed 484 full-time equivalent employees. Heartland places a high priority on staff development, which involves extensive training, including customer service training. New employees are selected on the basis of both technical skills and customer service capabilities. None of Heartland's employees are covered by a collective bargaining agreement. Heartland offers a variety of employee benefits and management considers its employee relations to be excellent. E. ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("FAS") No. 133, Accounting for Derivative Instruments and Hedging Activities. In July 1999, the FASB issued FAS 137, Deferring Statement 133's Effective Date, which defers the effective date for implementation of FAS 133 by one year, making FAS 133 effective no later than January 1, 2001 for Heartland's financial statements. Management does not believe the adoption of FAS 133 will have a material impact on the consolidated financial statements. F. SUPERVISION AND REGULATION (dollars in thousands) General Financial institutions and their holding companies are extensively regulated under federal and state law. As a result, the growth and earnings performance of Heartland can be affected not only by management decisions and general economic conditions, but also by the requirements of applicable state and federal statutes and regulations and the policies of various governmental regulatory authorities, including the Iowa Superintendent of Banking (the "Iowa Superintendent"), the Illinois Commissioner of Banks and Real Estate (the "Illinois Commissioner"), the Division of Banking of the Wisconsin Department of Financial Institutions (the "Wisconsin DFI"), the New Mexico Financial Institutions Division (the "New Mexico Division"), the Office of Thrift Supervision (the "OTS"), the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the Federal Deposit Insurance Corporation (the "FDIC"), the Internal Revenue Service and state taxing authorities and the Securities and Exchange Commission (the "SEC"). The effect of applicable statutes, regulations and regulatory policies can be significant, and cannot be predicted with a high degree of certainty. Federal and state laws and regulations generally applicable to financial institutions, such as Heartland and its subsidiaries, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to Heartland and its subsidiaries establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC's deposit insurance funds and the depositors, rather than the shareholders, of financial institutions. The following is a summary of the material elements of the regulatory framework that applies to Heartland and its subsidiaries. It does not describe all of the statutes, regulations and regulatory policies that apply to Heartland and its subsidiaries, nor does it restate all of the requirements of the statutes, regulations and regulatory policies that are described. As such, the following is qualified in its entirety by reference to the applicable statutes, regulations and regulatory policies. Any change in applicable law, regulations or regulatory policies may have a material effect on the business of Heartland and its subsidiaries. Recent Regulatory Developments On November 12, 1999, President Clinton signed legislation that will allow bank holding companies to engage in a wider range of nonbanking activities, including greater authority to engage in securities and insurance activities. Under the Gramm-Leach- Bliley Act (the "Act"), a bank holding company that elects to become a financial holding company may engage in any activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is (i) financial in nature, (ii) incidental to any such financial activity, or (iii) complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. The Act specifies certain activities that are deemed to be financial in nature, including lending, exchanging, transferring, investing for others, or safeguarding money or securities; underwriting and selling insurance; providing financial, investment, or economic advisory services; underwriting, dealing in or making a market in, securities; and any activity currently permitted for bank holding companies by the Federal Reserve under section 4(c)(8) of the Bank Holding Company Act. A bank holding company may elect to be treated as a financial holding company only if all depository institution subsidiaries of the holding company are well-capitalized, well-managed and have at least a satisfactory rating under the Community Reinvestment Act. National banks are also authorized by the Act to engage, through "financial subsidiaries," in any activity that is permissible for a financial holding company (as described above) and any activity that the Secretary of the Treasury, in consultation with the Federal Reserve, determines is financial in nature or incidental to any such financial activity, except (i) insurance underwriting, (ii) real estate development or real estate investment activities (unless otherwise permitted by law), (iii) insurance company portfolio investments and (iv) merchant banking. The authority of a national bank to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank must be well-managed and well-capitalized (after deducting from capital the bank's outstanding investments in financial subsidiaries). The Act provides that state banks may invest in financial subsidiaries (assuming they have the requisite investment authority under applicable state law) subject to the same conditions that apply to national bank investments in financial subsidiaries. At this time, it is not possible to predict the impact the Act may have on Heartland. Various bank regulatory agencies have just begun issuing regulations as mandated by the Act. The Federal Reserve has issued an interim rule that sets forth procedures by which bank holding companies may become financial holding companies, the criteria necessary for such a conversion, and the Federal Reserve's enforcement powers should a holding company fail to maintain compliance with the criteria. The Office of the Comptroller of the Currency has issued a final rule discussing the procedures by which national banks may establish financial subsidiaries as well as the qualifications and safeguards that will be required. In addition, in February, 2000, all federal bank regulatory agencies jointly issued a proposed rule that would implement the financial privacy provisions of the Act. Heartland General Heartland, as the sole shareholder of DB&T, GSB, RCB and WCB and the controlling shareholder of NMB, is a bank holding company. As a bank holding company, Heartland is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the "BHCA"). In accordance with Federal Reserve policy, Heartland is expected to act as a source of financial strength to the Bank Subsidiaries and to commit resources to support the Bank Subsidiaries in circumstances where Heartland might not otherwise do so. Under the BHCA, Heartland is subject to periodic examination by the Federal Reserve. Heartland is also required to file with the Federal Reserve periodic reports of Heartland's operations and such additional information regarding Heartland and its subsidiaries as the Federal Reserve may require. Heartland's ownership of FCB makes Heartland a savings and loan holding company, as defined in the Home Owners' Loan Act (the "HOLA"). Although savings and loan holding companies generally are subject to supervision and regulation by the OTS, companies that, like Heartland, are both bank holding companies and savings and loan holding companies are generally exempt from OTS supervision. Federal law, however, requires the Federal Reserve to consult with the OTS, as appropriate, in establishing the scope of a Federal Reserve examination of such holding company, to provide the OTS, upon request, with copies of Federal Reserve examination reports and other supervisory information concerning any such holding company, and to cooperate with the OTS in any enforcement action against any such holding company if the conduct at issue involves Heartland's savings association subsidiary. Investments and Activities Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the shares of the other bank or bank holding company (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank; or (iii) merging or consolidating with another bank holding company. Subject to certain conditions (including certain deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. In approving interstate acquisitions, however, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws which require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. The BHCA also generally prohibits Heartland from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be "so closely related to banking ... as to be a proper incident thereto." Under current regulations of the Federal Reserve, Heartland and its non-bank subsidiaries are permitted to engage in a variety of banking- related businesses, including the operation of a thrift, sales and consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non- bank subsidiaries of bank holding companies. Federal law also prohibits any person or company from acquiring "control" of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. "Control" is defined in certain cases as the acquisition of 10% of the outstanding shares of an institution or holding company. Capital Requirements Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The Federal Reserve's capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk- weighted assets of 8%, at least one-half of which must be Tier 1 capital. The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others. For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders' equity less intangible assets (other than certain mortgage servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments which do not qualify as Tier 1 capital and a portion of the company's allowance for loan and lease losses. The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve's capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels. As of December 31, 1999, Heartland had regulatory capital in excess of the Federal Reserve's minimum requirements, with a risk- based capital ratio of 11.68% and a leverage ratio of 8.85%. Dividends The Delaware General Corporation Law (the "DGCL") allows Heartland to pay dividends only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or if Heartland has no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Additionally, the Federal Reserve has issued a policy statement with regard to the payment of cash dividends by bank holding companies. The policy statement provides that a bank holding company should not pay cash dividends which exceed its net income or which can only be funded in ways that weaken the bank holding company's financial health, such as by borrowing. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies. Federal Securities Regulation Heartland's common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act. The Bank Subsidiaries General DB&T is an Iowa-chartered bank, the deposit accounts of which are insured by the FDIC's Bank Insurance Fund ("BIF"). As a BIF- insured, Iowa-chartered bank, DB&T is subject to the examination, supervision, reporting and enforcement requirements of the Iowa Superintendent, as the chartering authority for Iowa banks, and the FDIC, as administrator of the BIF. GSB and RCB are Illinois-chartered banks, the deposit accounts of which are insured by the BIF of the FDIC. As BIF-insured, Illinois-chartered banks, GSB and RCB are subject to the examination, supervision, reporting and enforcement requirements of the Illinois Commissioner, as the chartering authority for Illinois banks, and the FDIC, as administrator of the BIF. WCB is a Wisconsin-chartered bank, the deposit accounts of which are insured by the BIF of the FDIC. As a BIF-insured, Wisconsin- chartered bank, WCB is subject to the examination, supervision, reporting and enforcement requirements of the Wisconsin DFI, as the chartering authority for Wisconsin banks, and the FDIC, as administrator of the BIF. NMB is a New Mexico-chartered bank, the deposit accounts of which are insured by the BIF of the FDIC. As a BIF-insured, New Mexico- chartered bank, NMB is subject to the examination, supervision, reporting and enforcement requirements of the New Mexico Division, as the chartering authority for New Mexico banks, and the FDIC, as administrator of the BIF. FCB is a federally chartered savings association, the deposits of which are insured by the FDIC's Savings Association Insurance Fund ("SAIF"). As a SAIF-insured, federally chartered savings association, FCB is subject to the examination, supervision, reporting and enforcement requirements of the OTS, as the chartering authority for federal savings associations, and the FDIC, as administrator of the SAIF. Deposit Insurance As FDIC-insured institutions, the Bank Subsidiaries are required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their respective levels of capital and results of supervisory evaluations. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. During the year ended December 31, 1999, both BIF and SAIF assessments ranged from 0% of deposits to 0.27% of deposits. For the semi-annual assessment period beginning January 1, 2000, both BIF and SAIF assessment rates will continue to range from 0% of deposits to 0.27% of deposits. The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution (i) has engaged or is engaging in unsafe or unsound practices, (ii) is in an unsafe or unsound condition to continue operations or (iii) has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Management of Heartland is not aware of any activity or condition that could result in termination of the deposit insurance of the Bank Subsidiaries. FICO Assessments Since 1987, a portion of the deposit insurance assessments paid by SAIF members has been used to cover interest payments due on the outstanding obligations of the Financing Corporation ("FICO"). FICO was created in 1987 to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the SAIF's predecessor insurance fund. As a result of federal legislation enacted in 1996, beginning as of January 1, 1997, both SAIF members and BIF members became subject to assessments to cover the interest payments on outstanding FICO obligations. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. Between January 1, 2000 and the final maturity of the outstanding FICO obligations in 2019, BIF members and SAIF members will share the cost of the interest on the FICO bonds on a pro rata basis. During the year ended December 31, 1999, the FICO assessment rate for SAIF members ranged between approximately 0.058% of deposits and approximately 0.061% of deposits, while the FICO assessment rate for BIF members ranged between approximately 0.0116% of deposits and approximately 0.0122% of deposits. During the year ended December 31, 1999, the Bank Subsidiaries paid FICO assessments totaling $121. Supervisory Assessments All Iowa banks, Illinois banks, Wisconsin banks, New Mexico banks and federal savings associations are required to pay supervisory assessments to the Iowa Superintendent, the Illinois Commissioner, the Wisconsin DFI, the New Mexico Division and the OTS, respectively, to fund the operations of such agencies. In general, the amount of such supervisory assessments is based upon each institution's total assets. During the year ended December 31, 1999, the Bank Subsidiaries paid supervisory assessments totaling $152. Capital Requirements The FDIC has established the following minimum capital standards for state-chartered insured non-member banks, such as DB&T, GSB, RCB, WCB and NMB: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly- rated banks with a minimum requirement of at least 4% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. For purposes of these capital standards, Tier 1 capital and total capital consist of substantially the same components as Tier 1 capital and total capital under the Federal Reserve's capital guidelines for bank holding companies (see "--Heartland--Capital Requirements"). Pursuant to the HOLA and OTS regulations, savings associations, such as FCB, are subject to the following minimum capital requirements: a core capital requirement, consisting of a minimum ratio of core capital to total assets of 3% for savings associations assigned a composite rating of 1 as of the association's most recent OTS examination, with a minimum core capital requirement of 4% of total assets for all other savings associations; a tangible capital requirement, consisting of a minimum ratio of tangible capital to total assets of 1.5%; and a risk-based capital requirement, consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one- half of which must consist of core capital. Core capital consists primarily of permanent stockholders' equity less (i) intangible assets other than certain supervisory goodwill, certain mortgage servicing rights and certain purchased credit card relationships and (ii) investments in subsidiaries engaged in activities not permitted for national banks. Tangible capital is substantially the same as core capital except that all intangible assets other than certain mortgage servicing rights must be deducted. Total capital consists primarily of core capital plus certain debt and equity instruments that do not qualify as core capital and a portion of FCB's allowances for loan and leases losses. The capital requirements described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, the regulations of the FDIC and the OTS provide that additional capital may be required to take adequate account of, among other things, interest rate risk or the risks posed by concentrations of credit or nontraditional activities. During the year ended December 31, 1999, none of the Bank Subsidiaries was required by its primary federal regulator to increase its capital to an amount in excess of the minimum regulatory requirement. As of December 31, 1999, each of the Bank Subsidiaries exceeded its minimum regulatory capital requirements, as follows: Risk-Based Leverage Tangible Capital Capital Capital Ratio Ratio Ratio --------- --------- --------- DB&T 10.75 7.94 N/A GSB 12.16 7.68 N/A RCB 11.57 8.23 N/A WCB 10.99 8.43 N/A NMB 19.02 18.00 N/A FCB 12.01 8.08 8.04 Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators' powers depends on whether the institution in question is "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized," in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators' corrective powers include: requiring the institution to submit a capital restoration plan; limiting the institution's asset growth and restricting its activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions between the institution and its affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution. As of December 31, 1999, each of the Bank Subsidiaries was well capitalized, as defined by applicable regulations. Additionally, institutions insured by the FDIC may be liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of commonly controlled FDIC insured depository institutions or any assistance provided by the FDIC to commonly controlled FDIC insured depository institutions in danger of default. Because Heartland owns more than 25% of the outstanding stock of each of the Bank Subsidiaries, the Bank Subsidiaries are deemed to be commonly controlled. Dividends In general, under applicable state law, DB&T, GSB, RCB, WCB and NMB may not pay dividends in excess of their undivided profits. OTS regulations require prior OTS approval for any capital distribution by a savings association that is not eligible for expedited processing under the OTS's application processing regulations. In order to qualify for expedited processing, a savings association must: (i) have a composite examination rating of 1 or 2; (ii) have a Community Reinvestment Act rating of satisfactory or better; (iii) have a compliance rating of 1 or 2; (iv) meet all applicable regulatory capital requirements; and (v) not have been notified by the OTS that it is a problem association or an association in troubled condition. Savings associations that qualify for expedited processing are not required to obtain OTS approval prior to making a capital distribution unless: (a) the amount of the proposed capital distribution, when aggregated with all other capital distributions during the same calendar year, will exceed an amount equal to the association's year-to-date net income plus its retained net income for the preceding two years; (b) after giving effect to the distribution, the association will not be at least "adequately capitalized" (as defined by OTS regulation); or (c) the distribution would violate a prohibition contained in an applicable statute, regulation or agreement with the OTS or the FDIC or violate a condition imposed in connection with an OTS- approved application or notice. The OTS must be given prior notice of certain types of capital distributions, including any capital distribution by a savings association that, like FCB, is a subsidiary of a holding company, or by a savings association that, after giving effect to the distribution, would not be "well- capitalized" (as defined by OTS regulation). The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, each of the Bank Subsidiaries exceeded its minimum capital requirements under applicable guidelines as of December 31, 1999. Further, under applicable regulations of the OTS, the FCB may not pay dividends in an amount, which would reduce its capital below the amount required for the liquidation account established in connection with the FCB's conversion from the mutual to the stock form of ownership in 1991. As of December 31, 1999, approximately $35,210 was available to be paid as dividends to Heartland by the Bank Subsidiaries. Notwithstanding the availability of funds for dividends, however, the banking regulators may prohibit the payment of any dividends by the Bank Subsidiaries if such payment is deemed to constitute an unsafe or unsound practice. Insider Transactions The Bank Subsidiaries are subject to certain restrictions imposed by federal law on extensions of credit to Heartland and its subsidiaries, on investments in the stock or other securities of Heartland and its subsidiaries and the acceptance of the stock or other securities of Heartland or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank Subsidiaries to their respective directors and officers, to directors and officers of Heartland and its subsidiaries, to principal stockholders of Heartland, and to "related interests" of such directors, officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of Heartland or one of its subsidiaries or a principal stockholder of Heartland may obtain credit from banks with which one of the Bank Subsidiaries maintains a correspondent relationship. Safety and Soundness Standards The federal banking agencies have adopted guidelines, which establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings. Since the fourth quarter of 1998, and through the first quarter of 2000, the federal banking regulators have issued safety and soundness standards for achieving Year 2000 compliance, including standards for developing and managing Year 2000 project plans, testing remediation efforts and planning for contingencies. In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution's primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator's order is cured, the regulator may restrict the institution's rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments. Branching Authority Iowa law strictly regulates the establishment of bank offices. Under the Iowa Banking Act, an Iowa state bank, such as DB&T, may not establish a bank office outside the boundaries of the counties contiguous to or cornering upon the county in which the principal place of business of the bank is located. Further, Iowa law prohibits an Iowa bank from establishing de novo branches in a municipality other than the municipality in which the bank's principal place of business is located, if another bank already operates one or more offices in the municipality in which the de novo branch is to be located. Illinois banks, such as GSB and RCB, have authority under Illinois law to establish branches anywhere in the State of Illinois, subject to receipt of all required regulatory approvals. Likewise, under the laws of Wisconsin and New Mexico, Wisconsin banks and New Mexico banks, respectively, have statewide branching authority, subject to regulatory approval. Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), both state and national banks are allowed to establish interstate branch networks through acquisitions of other banks, subject to certain conditions, including certain limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of- state bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state law. The legislation allowed individual states to "opt-out" of certain provisions of the Riegle-Neal Act by enacting appropriate legislation prior to June 1, 1997. The laws of Iowa, Illinois, Wisconsin and New Mexico permit interstate bank mergers, subject to certain conditions, including a prohibition against interstate mergers involving an Iowa, Illinois, Wisconsin or New Mexico bank, respectively, that have been in existence and continuous operation for fewer than five years. Federally chartered savings associations which qualify as "domestic building and loan associations," as defined in the Internal Revenue Code, or meet the qualified thrift lender test (see "-The Bank Subsidiaries -- Qualified Thrift Lender Test") have the authority, subject to receipt of OTS approval, to establish or acquire branch offices anywhere in the United States. If a federal savings association fails to qualify as a "domestic building and loan association," as defined in the Internal Revenue Code, and fails to meet the qualified thrift lender test, the association may branch only to the extent permitted for national banks located in the savings association's home state. As of December 31, 1999, FCB qualified as a "domestic building and loan association," as defined in the Internal Revenue Code and met the qualified thrift lender test. State Bank Activities Under federal law and FDIC regulations, FDIC insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. These restrictions have not had, and are not currently expected to have, a material impact on the operations of DB&T, GSB, RCB, WCB or NMB. Qualified Thrift Lender Test The HOLA requires every savings association to satisfy a "qualified thrift lender" ("QTL") test. Under the HOLA, a savings association will be deemed to meet the QTL test if it either (i) maintains at least 65% of its "portfolio assets" in "qualified thrift investments" on a monthly basis in nine out of every 12 months or (ii) qualifies as a "domestic building and loan association," as defined in the Internal Revenue Code. For purposes of the QTL test, "qualified thrift investments" consist of mortgage loans, mortgage-backed securities, education loans, small business loans, credit card loans and certain other housing and consumer-related loans and investments. "Portfolio assets" consist of a savings association's total assets less goodwill and other intangible assets, the association's business properties and a limited amount of the liquid assets maintained by the association pursuant to the liquidity requirements of the HOLA and OTS regulations (see "--The Bank Subsidiaries--Liquidity Requirements"). A savings association that fails to meet the QTL test must either convert to a bank charter or operate under certain restrictions on its operations and activities. Additionally, within one year following the loss of QTL status, the holding company for the savings association will be required to register as, and will be deemed to be, a bank holding company. A savings association that fails the QTL test may requalify as a QTL but it may do so only once. As of December 31, 1999, FCB satisfied the QTL test, with a ratio of qualified thrift investments to portfolio assets of 79.03%, and qualified as a "domestic building and loan association," as defined in the Internal Revenue Code. Liquidity Requirements OTS regulations currently require each savings association to maintain, for each calendar quarter, an average daily balance of liquid assets (including cash, certain time deposits, bankers' acceptances, and specified United States Government, state or federal agency obligations) equal to at least 4% of either (i) its liquidity base (i.e., its net withdrawable accounts plus borrowings repayable in 12 months or less) as of the end of the preceding calendar quarter or (ii) the average daily balance of its liquidity base during the preceding calendar quarter. This liquidity requirement may be changed from time to time by the OTS to an amount within a range of 4% to 10% of the liquidity base, depending upon economic conditions and the deposit flows of savings associations. The OTS may also require a savings association to maintain a higher level of liquidity than the minimum 4% requirement if the OTS deems necessary to ensure the safe and sound operation of the association. Penalties may be imposed for failure to meet liquidity ratio requirements. At December 31, 1999, FCB was in compliance with OTS liquidity requirements, with a liquidity ratio of 8.73%. Federal Reserve System Federal Reserve regulations, as presently in effect, require depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $44,300 or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $44,300, the reserve requirement is $1,329 plus 10% of the aggregate amount of total transaction accounts in excess of $44,300. The first $5,000 of otherwise reservable balances is exempted from the reserve requirements. These reserve requirements are subject to annual adjustment by the Federal Reserve. The Bank Subsidiaries are in compliance with the foregoing requirements. The balances used to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements to which FCB is subject under the HOLA and OTS regulations. G. GOVERNMENTAL MONETARY POLICY AND ECONOMIC CONDITIONS The earnings of Heartland are affected by the policies of regulatory authorities, including the Federal Reserve System whose monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Because of changing conditions in the economy and in the money markets, as a result of actions by monetary and fiscal authorities, interest rates, credit availability and deposit levels may change due to circumstances beyond the control of Heartland. Future policies of the Federal Reserve System and other authorities cannot be predicted, nor can their effect on future earnings be predicted. ITEM 2. PROPERTIES The following table is a listing of the principal operating facilities of Heartland: Main Main Facility Facility Number Name and Main Square Owned or of Facility Address Footage Leased Locations - ---------------- -------- -------- --------- Banking Subsidiary DB&T 1398 Central Avenue 59,500 Owned 8 Dubuque, IA 52001 GSB 971 Gear Street 18,000 Owned 3 Galena, IL 61036 RCB 6855 E. Riverside Blvd. 8,000 Owned 3 Rockford, IL 60114 FCB 320 Concert Street 6,000 Owned 3 Keokuk, IA 52632 WCB 580 North Main Street Cottage Grove, WI 53527 6,000 Owned 6 NMB 320 Gold NW Albuquerque, NM 87102 11,400 Lease term 6 through 2006 Main Facility Number Name and Main Owned or of Facility Address Leased Locations - ---------------- -------- --------- Nonbanking Subsidiaries Citizens 1275 Main Street Leased Dubuque, IA 52001 from DB&T 4 ULTEA 2976 Triverton Pike Madison, WI 53711 Leased 2 The principal offices of Heartland are located in DB&T's main office. ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which Heartland or any of its subsidiaries is a party or of which any of their property is the subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of 1999 to a vote of security holders. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Heartland's common stock was held by approximately 870 shareholders of record as of March 23, 2000, and is traded in the over-the-counter market. The following table shows, for the periods indicated, the range of reported prices per share of Heartland's common stock in the over-the-counter market. These quotations represent inter-dealer prices without retail markups, markdowns or commissions and do not necessarily represent actual transactions. Heartland Common Stock Calendar Quarter High Low ---- --- 1998: First $14 5/16 $16 Second 14 16 7/8 Third 15 3/4 19 Fourth 16 3/4 19 1999: First $19 1/2 $17 7/8 Second 19 3/4 18 1/4 Third 20 1/2 18 7/8 Fourth 19 3/8 16 Cash dividends have been declared by Heartland quarterly during the past two years ending December 31, 1999. The following table sets forth the cash dividends per share paid on Heartland's common stock for the past two years: Calendar Quarter 1999 1998 ---- ---- First $.08 $.075 Second .08 .075 Third .09 .08 Fourth .09 .08 ITEM 6. SELECTED FINANCIAL DATA (Dollars in thousands, except per share data) For the Years Ended December 31, 1999 1998 1997 -------------------------------- STATEMENT OF INCOME DATA Interest income $ 74,154 $ 64,517 $ 59,261 Interest expense 40,849 36,304 31,767 -------- -------- -------- Net interest income 33,305 28,213 27,494 Provision for loan and lease losses 2,626 951 1,279 -------- -------- -------- Net interest income after provision for loan and lease losses 30,679 27,262 26,215 Noninterest income 25,424 17,297 8,565 Noninterest expense 44,722 31,781 22,927 Provision for income taxes 3,156 3,757 3,338 -------- -------- -------- Net income $ 8,225 $ 9,021 $ 8,515 ======== ======== ======== PER COMMON SHARE DATA Net income-basic $ 0.86 $ 0.95 $ 0.90 Net income-diluted 0.84 0.94 0.89 Cash dividends 0.34 .31 .26 Dividend payout ratio 39.47% 32.48% 28.96% Book value $ 9.03 $ 8.84 $ 8.19 Weighted average shares outstanding 9,555,194 9,463,313 9,476,342 BALANCE SHEET DATA Investments and federal funds sold $213,452 $259,964 $234,666 Total loans and leases, net of unearned 835,146 590,133 556,406 Allowance for loan and lease losses 10,844 7,945 7,362 Total assets 1,184,147 953,785 852,060 Total deposits 869,659 717,877 623,532 Long-term obligations 76,657 57,623 43,023 Stockholders' equity 86,573 84,270 77,772 EARNINGS PERFORMANCE DATA Return on average total assets 0.78% 1.01% 1.09% Return on average stockholders' equity 9.61 11.26 11.59 Net interest margin ratio (1) 3.64 3.58 3.89 Earnings to fixed charges: Excluding interest on deposits 2.15x 2.65x 2.97x Including interest on deposits 1.28 1.35 1.37 ASSET QUALITY RATIOS Nonperforming assets to total assets 0.19% 0.28% 0.34% Nonperforming loans and leases to total loans and leases 0.20 0.30 0.37 Net loan and lease charge-offs to average loans and leases 0.06 0.07 0.08 Allowance for loan and lease losses to total loans and leases 1.30 1.35 1.32 Allowance for loan and lease losses to nonperforming loans and leases 657.49 453.74 362.30 CAPITAL RATIOS Average equity to average assets 8.12% 9.01% 9.39% Total capital to risk-adjusted assets 11.68 12.13 12.71 Tier 1 leverage 8.85 8.58 8.76 SELECTED FINANCIAL DATA (Dollars in thousands, except per share data) For the Years Ended December 31, 1996 1995 ------------------- STATEMENT OF INCOME DATA Interest income $51,886 $ 49,149 Interest expense 27,644 25,529 -------- -------- Net interest income 24,242 23,620 Provision for loan and lease losses 1,408 820 -------- -------- Net interest income after provision for loan and lease losses 22,834 22,800 Noninterest income 7,364 4,981 Noninterest expense 19,507 17,323 Provision for income taxes 2,685 2,884 -------- --------- Net income $ 8,006 $ 7,574 ======== ======== PER COMMON SHARE DATA Net income-basic $ 0.85 $ 0.79 Net income-diluted 0.84 0.78 Cash dividends .20 .15 Dividend payout ratio 23.53% 19.03% Book value $ 7.42 $ 6.88 Weighted average shares outstanding 9,430,018 9,610,368 BALANCE SHEET DATA Investments and federal funds sold $183,966 $171,726 Total loans and leases, net of unearned 484,085 454,905 Allowance for loan and lease losses 6,191 5,580 Total assets 736,552 677,313 Total deposits 558,343 534,587 Long-term obligations 42,506 45,400 Stockholders' equity 70,259 64,506 EARNINGS PERFORMANCE DATA Return on average total assets 1.16% 1.18% Return on average stockholders' equity 12.00 12.28 Net interest margin ratio (1) 3.98 4.13 Earnings to fixed charges: Excluding interest on deposits 3.38x 3.97x Including interest on deposits 1.39 1.41 ASSET QUALITY RATIOS Nonperforming assets to total assets 0.34% 0.28% Nonperforming loans and leases to total loans and leases 0.41 0.26 Net loan and lease charge-offs to average loans and leases 0.17 0.08 Allowance for loan and lease losses to total loans and leases 1.28 1.23 Allowance for loan and lease losses to nonperforming loans and leases 313.63 463.84 CAPITAL RATIOS Average equity to average assets 9.66% 9.59% Total capital to risk-adjusted assets 14.28 14.46 Tier 1 leverage 9.54 9.47 (1) Tax equivalent using a 34% tax rate. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands) The following presents management's discussion and analysis of the consolidated financial condition and results of operations of Heartland Financial USA, Inc. ("Heartland") as of the dates and for the periods indicated. This discussion should be read in conjunction with the Selected Financial Data, Heartland's Consolidated Financial Statements and the Notes thereto and other financial data appearing elsewhere in this report. The consolidated financial statements include the accounts of Heartland and its subsidiaries: Dubuque Bank and Trust Company ("DB&T"); Galena State Bank and Trust Company ("GSB"); Riverside Community Bank ("RCB"); Wisconsin Community Bank ("WCB"); New Mexico Bank & Trust ("NMB"); First Community Bank, FSB ("FCB"); Citizens Finance Co. ("Citizens"); ULTEA, Inc. ("ULTEA"); DB&T Insurance, Inc.; DB&T Community Development Corp.; DBT Investment Corporation; Keokuk Bancshares, Inc. (dba KBS Investment Corp.), and Heartland Capital Trust I ("Trust I"). All of Heartland's subsidiaries are wholly-owned except for NMB, of which Heartland was an 80% owner on December 31, 1999. This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Heartland intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of Heartland are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" or similar expressions. 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 affect on the operations and future prospects of Heartland and the subsidiaries include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in Heartland's market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning Heartland and its business, including additional factors that could materially affect Heartland's financial results, is included in Heartland's filings with the Securities and Exchange Commission. OVERVIEW 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. Heartland crossed the one billion dollar mark during 1999, as total assets reached $1,184,147 at year-end, an increase of $230,362 or 24.15% since year-end 1998 and the largest percentage increase since 1992. Particularly gratifying was the significant growth experienced in the loan portfolio, which grew to $835,146 at December 31, 1999, an increase of $245,013 or 41.52% since December 31, 1998. Net income recorded during 1999 totaled $8,225 or $.86 on a basic per common share basis. During 1998, annual earnings were $9,021 or $.95 on a basic per common share basis. Return on common equity was 9.61% and return on assets was .78% for 1999, compared to 11.26% and 1.01% for 1998, respectively. Earnings declined during the year, as compared to 1998, primarily as a result of an increased loan loss provision associated with the strong loan growth experienced. Additionally, earnings were affected by expenses incurred to pursue growth initiatives in new and existing markets, combined with a reduction in the amount of securities gains realized. During 1998, Heartland was able to sustain an increase in earnings even though additional overhead was expended on growth initiatives. Earnings increased $506 or 5.94% during 1998 when compared to the $8,515 or $.90 per basic common share recorded during 1997. Return on common equity was 11.59% and return on assets was 1.09% for 1997. Heartland's total assets grew $101,725 or 11.94% from year-end 1997. Loans and leases were up $33,727 or 6.06% at December 31, 1998. The initiatives undertaken in these years to position Heartland for future increased earnings included: NMB was established in Albuquerque, New Mexico in May of 1998 and subsequently opened three additional branches during the second and third quarters of 1999. Total assets at NMB reached $101,164 at December 31, 1999. The acquisition and subsequent merger of First National Bank of Clovis into NMB was completed on January 1, 2000, nearly doubling NMB's asset size. WCB was acquired in March of 1997 and subsequently opened a branch office in Middleton, Wisconsin in early 1998. Additional offices were opened during 1999 in Sheboygan, Green Bay and Eau Claire, Wisconsin and the acquisition of Bank One Wisconsin's Monroe branch was completed in July of 1999. Total assets at this entity went from $54,031 at year- end 1998 to $185,837 on December 31, 1999. RCB, Heartland's 1995 de novo bank in Rockford, Illinois, opened an additional branch location in July of 1999. ULTEA acquired Arrow Motors Inc., a Wisconsin corporation doing business as Lease Associates Group ("LAG"), in July of 1998 and, as a result, became the largest fleet management company based in Wisconsin. Citizens, a consumer finance company, opened offices in Appleton, Wisconsin and Rockford, Illinois during 1998. RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income is the difference between interest income earned on earning assets and interest expense paid on interest bearing liabilities. As such, net interest income is affected by changes in the volume and yields on earning assets and the volume and rates paid on interest bearing liabilities. Net interest margin is the ratio of tax equivalent net interest income to average earning assets. Net interest income on a fully tax equivalent basis was $34,125, $28,999 and $28,280 for 1999, 1998 and 1997, respectively, an increase of $5,126 or 17.68% for 1999 and $719 or 2.54% for 1998. These increases were primarily attributable to the significant growth in loans and the ability to keep the increase in interest expense below the growth in interest income. Expressed as a percentage of average earning assets, Heartland's net interest margin was 3.64% in 1999, 3.58% in 1998 and 3.89% in 1997. The 1999 increase was primarily the result of a shift in the asset mix on the balance sheet as gross loans went from 61.87% of total assets at December 31, 1998, to 70.53% at December 31, 1999. The decrease in net interest margin during 1998 occurred for several reasons: The operations of ULTEA resulted in additional interest expense associated with debt utilized to fund the vehicles under operating leases while the income derived from these leases is recorded as noninterest income. A decline and flattening of the yield curve resulted in an acceleration of paydowns in the mortgage-backed securities and loan portfolio and pressure from loan customers to lower rates charged on their balances. The return on Heartland's securities portfolio declined as several higher-yielding securities matured or were called and the average life of the portfolio was reduced as prepayments accelerated on the mortgage-backed securities portfolio. Heartland continues to manage its balance sheet on a proactive basis. The following table sets forth certain information relating to Heartland's average consolidated balance sheets and reflects the yield on average earning assets and the cost of average interest bearing liabilities for the years indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities. Average balances are derived from daily balances, and nonaccrual loans are included in each respective loan category. ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1) For the Year Ended December 31, 1999 Average Balance Interest Rate ---------- -------- ------ EARNING ASSETS Securities: Taxable $ 200,559 $11,113 5.54% Nontaxable (1) 21,010 1,842 8.77 ---------- ------- ------ Total securities 221,569 12,955 5.85 ----- ---- ------- ------ Interest bearing deposits 8,176 468 5.72 Federal funds sold 7,741 410 5.30 ---------- ------- ------ Loans and leases: Commercial and commercial real estate (1) 365,199 29,790 8.16 Residential mortgage 162,878 12,773 7.84 Agricultural and agricultural real estate (1) 86,505 7,382 8.53 Consumer 86,132 8,683 10.08 Direct financing leases, net 9,401 659 7.01 Fees on loans - 1,854 - Less: allowance for loan and lease losses (9,336) - - ---------- ------- ------ Net loans and leases 700,779 61,141 8.72 ---------- ------- ------ Total earning assets 938,265 74,974 7.99 ---------- ------- ------ NONEARNING ASSETS Total nonearning assets 115,757 - - ---------- ------- ------ TOTAL ASSETS $1,054,022 $74,974 7.11% ========== ======= ====== INTEREST BEARING LIABILITIES Interest bearing deposits: Savings accounts $ 324,476 $10,789 3.33% Time, $100,000 and over 59,822 3,222 5.39 Other time deposits 312,051 17,169 5.50 Short-term borrowings 111,853 5,630 5.03 Other borrowings 60,490 4,039 6.68 ---------- ------- ------ Total interest bearing liabilities 868,692 40,849 4.70 ---------- ------- ------ NONINTEREST BEARING LIABILITIES Noninterest bearing deposits 81,511 - - Accrued interest and other liabilities 18,254 - - ---------- ------- ------ Total noninterest bearing liabilities 99,765 - - ---------- ------- ------ Stockholders' Equity 85,565 - - ---------- ------- ------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,054,022 $40,849 3.88% ========== ======= ====== Net interest income (1) $34,125 ======= Net interest income to total earning assets (1) 3.64% ====== Interest bearing liabilities to earning assets 92.58% ========== (1) Tax equivalent basis is calculated using an effective tax rate of 34%. ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1) For the Year Ended December 31, 1998 Average Balance Interest Rate -------- -------- ------ EARNING ASSETS Securities: Taxable $196,206 $11,515 5.87% Nontaxable (1) 20,507 1,716 8.37 -------- ------- ------ Total securities 216,713 13,231 6.11 -------- ------- ------ Interest bearing deposits 8,313 386 4.64 Federal funds sold 29,830 1,582 5.30 -------- ------- ------ Loans and leases: Commercial and commercial real estate (1) 249,326 21,523 8.63 Residential mortgage 162,545 12,854 7.91 Agricultural and agricultural real estate (1) 75,685 6,751 8.92 Consumer 66,138 6,702 10.13 Direct financing leases, net 8,367 625 7.47 Fees on loans - 1,649 - Less: allowance for loan and lease losses (7,944) - - -------- ------- ------ Net loans and leases 554,117 50,104 9.04 -------- ------- ------ Total earning assets 808,973 65,303 8.07 -------- ------- ------ NONEARNING ASSETS Total nonearning assets 80,317 - - -------- ------- ------ TOTAL ASSETS $889,290 $65,303 7.34% ======== ======= ====== INTEREST BEARING LIABILITIES Interest bearing deposits: Savings accounts $266,282 $ 9,512 3.57% Time, $100,000 and over 51,283 2,905 5.66 Other time deposits 282,142 16,228 5.75 Short-term borrowings 78,484 4,076 5.19 Other borrowings 56,137 3,583 6.38 -------- ------- ------ Total interest bearing liabilities 734,328 36,304 4.94 -------- ------- ------ NONINTEREST BEARING LIABILITIES Noninterest bearing deposits 60,514 - - Accrued interest and other liabilities 14,343 - - -------- ------- ------ Total noninterest bearing liabilities 74,857 - - -------- ------- ------ Stockholders' Equity 80,105 - - -------- ------- ------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $889,290 $36,304 4.08% ======== ======= ====== Net interest income (1) $28,999 ======= Net interest income to total earning assets (1) 3.58% ====== Interest bearing liabilities to earning assets 90.77% ======== (1) Tax equivalent basis is calculated using an effective tax rate of 34%. ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1) For the Year Ended December 31, 1997 Average Balance Interest Rate -------- -------- ------ EARNING ASSETS Securities: Taxable $169,086 $10,393 6.15% Nontaxable (1) 19,700 1,773 9.00 -------- ------- ------ Total securities 188,786 12,166 6.44 -------- ------- ------ Interest bearing deposits 2,972 98 3.30 Federal funds sold 12,570 681 5.42 -------- ------- ------ Loans and leases: Commercial and commercial real estate (1) 222,157 19,683 8.86 Residential mortgage 178,362 14,083 7.90 Agricultural and agricultural real estate (1) 66,294 6,037 9.11 Consumer 55,218 5,672 10.27 Direct financing leases, net 6,739 501 7.43 Fees on loans - 1,126 - Less: allowance for loan and lease losses (6,998) - - -------- ------- ------ Net loans and leases 521,772 47,102 9.03 -------- ------- ------ Total earning assets 726,100 60,047 8.27 -------- ------- ------ NONEARNING ASSETS Total nonearning assets 56,596 - - -------- ------- ------ TOTAL ASSETS $782,696 $60,047 7.67% ======== ======= ====== INTEREST BEARING LIABILITIES Interest bearing deposits: Savings accounts $237,730 $ 8,317 3.50% Time, $100,000 and over 34,913 1,961 5.62 Other time deposits 268,201 15,487 5.77 Short-term borrowings 70,313 3,740 5.32 Other borrowings 36,406 2,262 6.21 -------- ------- ------ Total interest bearing liabilities 647,563 31,767 4.91 -------- ------- ------ NONINTEREST BEARING LIABILITIES Noninterest bearing deposits 51,770 - - Accrued interest and other liabilities 9,906 - - -------- ------- ------ Total noninterest bearing liabilities 61,676 - - -------- ------- ------ Stockholders' Equity 73,457 - - -------- ------- ------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $782,696 $31,767 4.06% ======== ======= ====== Net interest income (1) $28,280 ======= Net interest income to total earning assets (1) 3.89% ====== Interest bearing liabilities to earning assets 89.18% ======== (1) Tax equivalent basis is calculated using an effective tax rate of 34%. The following table allocates the changes in net interest income to differences in either average balances or average rates for earning assets and interest bearing liabilities. The changes have been allocated proportionately to the change due to volume and change due to rate. Interest income is measured on a tax equivalent basis using a 34% tax rate. ANALYSIS OF CHANGES IN NET INTEREST INCOME For the Year Ended December 31, 1999 Compared to 1998 Change Due to Volume Rate Net -------------------------- EARNING ASSETS/INTEREST INCOME Securities Taxable $ 255 $ (657) $ (402) Nontaxable 42 84 126 Interest bearing deposits (6) 88 82 Federal funds sold (1,171) (1) (1,172) Loans and leases 13,261 (2,224) 11,037 ------- ------ ------- TOTAL EARNING ASSETS 12,381 (2,710) 9,671 LIABILITIES/INTEREST EXPENSE Interest bearing deposits Savings accounts 2,079 (802) 1,277 Time, $100,000 and over 484 (167) 317 Other time deposits 1,720 (779) 941 Short-term borrowings 1,733 (179) 1,554 Other borrowings 278 178 456 ------- ------- ------- TOTAL INTEREST BEARING LIABILITIES 6,294 (1,749) 4,545 ------- ------- ------- NET INTEREST INCOME $ 6,087 $ (961) $ 5,126 ======= ======= ======= ANALYSIS OF CHANGES IN NET INTEREST INCOME For the Year Ended December 31, 1998 Compared to 1997 Change Due to Volume Rate Net ------------------------- EARNING ASSETS/INTEREST INCOME Securities Taxable $1,668 $(546) $1,122 Nontaxable 72 (129) (57) Interest bearing deposits 176 112 288 Federal funds sold 935 (34) 901 Loans and leases 2,920 82 3,002 ------ ----- ------ TOTAL EARNING ASSETS 5,771 (515) 5,256 LIABILITIES/INTEREST EXPENSE Interest bearing deposits Savings accounts 999 196 1,195 Time, $100,000 and over 919 25 944 Other time deposits 805 (64) 741 Short-term borrowings 435 (99) 336 Other borrowings 1,226 95 1,321 ------ ----- ------ TOTAL INTEREST BEARING LIABILITIES 4,384 153 4,537 ------ ----- ------ NET INTEREST INCOME $1,387 $(668) $ 719 ====== ===== ====== ANALYSIS OF CHANGES IN NET INTEREST INCOME For the Year Ended December 31, 1997 Compared to 1996 Change Due to Volume Rate Net ------------------------- EARNING ASSETS/INTEREST INCOME Securities Taxable $2,033 $ (32) $2,001 Nontaxable (1,133) (202) (1,335) Interest bearing deposits (51) (14) (65) Federal funds sold 55 16 71 Loans and leases 5,725 530 6,255 ------ ----- ------ TOTAL EARNING ASSETS 6,629 298 6,927 LIABILITIES/INTEREST EXPENSE Interest bearing deposits Savings accounts 813 30 843 Time, $100,000 and over (163) (7) (170) Other time deposits 1,641 261 1,902 Short-term borrowings 1,739 58 1,797 Other borrowings (331) 82 (249) ------ ----- ------ TOTAL INTEREST BEARING LIABILITIES 3,699 424 4,123 ------ ----- ------ NET INTEREST INCOME $2,930 $(126) $2,804 ====== ===== ====== PROVISION FOR LOAN AND LEASE LOSSES The provision for loan and lease losses increased $1,675 or 176.13% during 1999 when compared to 1998. This increase was primarily in response to the significant loan growth experienced and was made to provide, in management's opinion, an adequate allowance for loan and lease losses. During 1998, the provision for loan and lease losses decreased $328 or 25.65% when compared to 1997. This reduction was primarily the result of a $357 recovery on a pool of leases written down during 1996. NONINTEREST INCOME For the Years Ended December 31, 1999 1998 1997 -------------------------- Service charges and fees $ 3,906 $ 3,013 $2,723 Trust fees 2,662 2,284 2,009 Brokerage commissions 655 413 324 Insurance commissions 803 751 563 Securities gains, net 713 1,897 1,446 Rental income on operating leases 14,718 7,428 811 Gains on sale of loans 1,028 1,212 373 Other noninterest income 939 299 316 ------- ------- ------ Total noninterest income $25,424 $17,297 $8,565 ======= ======= ====== The above table shows Heartland's noninterest income for the years indicated. Total noninterest income increased $8,127 or 46.99% during 1999, as compared to an increase of $8,732 or 101.95% during 1998. Expansion into vehicle leasing and fleet management was responsible for the significant growth in noninterest income during both years. Rental income on operating leases accounted for 89.70% and 75.78% of the change in 1999 and 1998, respectively. ULTEA's first full year of operation as a Heartland subsidiary occurred in 1997. During the third quarter of 1998, ULTEA acquired LAG and, as a result, more than doubled in asset size going from $15 million to $35 million. Gains on sale of loans decreased $184 or 15.18% during 1999. The volume of mortgage loans sold into the secondary market declined during 1999 as rates moved upward and customers elected to take three- and five-year adjustable rate mortgage loans, which Heartland elected to retain in its loan portfolio. Conversely, during 1998, gains on sale of loans increased $839 or 224.93% as Heartland experienced refinancing activity in its real estate mortgage loan portfolio as a result of decreasing interest rates. The majority of these new fixed rate 15- and 30-year real estate loans were sold into the secondary market. Securities gains decreased $1,184 or 62.41% during 1999 compared to 1998. During 1998, securities gains increased $451 or 31.19% compared to 1997 and were attributable to the strong performance of Heartland's equity portfolio. Emphasis during the past several years on enhancing revenues from services provided to customers has contributed to the growth of fee income. Service charges, trust fees and brokerage commissions all increased by more than 10% during each of the past two years. Other noninterest income increased $640 or 214.05% during 1999 primarily due to gains on the disposal of leased assets at ULTEA. NONINTEREST EXPENSE For the Years Ended December 31, 1999 1998 1997 --------------------------- Salaries and employee benefits $18,945 $15,218 $13,070 Occupancy, net 2,076 1,695 1,354 Furniture and equipment 2,416 1,998 1,537 Outside services 2,239 1,416 1,439 FDIC deposit insurance assessment 121 118 116 Advertising 1,376 1,150 826 Depreciation on equipment under operating leases 10,844 5,296 584 Other noninterest expense 6,705 4,890 4,001 ------- ------- ------- Total noninterest expense $44,722 $31,781 $22,927 ======= ======= ======= Efficiency ratio (1) 76.01% 71.58% 64.77% ======= ======= ======= (1) Noninterest expense divided by the sum of net interest income and noninterest income less securities gains. The above table shows Heartland's noninterest expense for the years indicated. Noninterest expense increased $12,941 or 40.72% in 1999 when compared to 1998. Total 1998 noninterest expense represented an increase of $8,854 or 38.62% from the 1997 total. The largest component of the increase in noninterest expense during both 1999 and 1998 was related to the operations of ULTEA, as depreciation on equipment under operating leases increased $5,548 or 104.76% in 1999 and $4,712 or 806.85% in 1998. Salaries and employee benefits expense continued to experience increases during both 1999 and 1998, growing $3,727 or 24.49% and $2,148 or 16.43%, respectively. In addition to the normal merit and cost of living raises, these increases were attributable to Heartland's continued expansion efforts, particularly the additions at NMB and WCB. The number of full-time equivalent employees increased from 396 at December 31, 1998, to 484 at December 31, 1999. In addition to the increases experienced in salaries and employee benefits, the expansion efforts underway during the past two years have resulted in additional occupancy, furniture and equipment and advertising/public relations costs. These expenses increased $1,025 or 21.16% during 1999 and $1,126 or 30.29% during 1998. Fees for outside services increased $823 or 58.12% during 1999 when compared to 1998. In addition to fees relating to expansion efforts, this increase resulted from consulting fees paid for a net interest margin and earnings improvement study. This engagement was focused on identifying specific strategies to increase earnings with an emphasis on reaching and expanding the bank subsidiaries' core customers more effectively and efficiently. The study was completed during the third quarter of 1999 and implementation of the recommendations is scheduled to be completed by the second quarter of 2000. Other noninterest expenses increased $1,815 or 37.12% during 1999 due primarily to the growth initiatives underway. Some of the expenses included within this category that experienced significant growth during 1999 as a result of the expansion efforts were goodwill and core deposit intangibles amortization, office supplies, telephone charges and fees relating to the processing of credit cards for merchants. During 1998, other noninterest expenses grew $889 or 22.22%. Amortization and maintenance expense on software contributed to this increase, primarily due to the conversion of the bank subsidiaries to Fiserv's Comprehensive Banking Systems during the spring of 1997. INCOME TAXES Income tax expense decreased $601 or 16.00% for 1999 primarily as a result of a reduction in pre-tax earnings. During 1998, income tax expense increased $419 or 12.55% as a result of additional pre-tax earnings. The effective tax rate was 27.73% in 1999, 29.40% in 1998 and 28.16% in 1997. FINANCIAL CONDITION LENDING ACTIVITIES Heartland's major source of income is interest on loans and leases. The table below presents the composition of Heartland's loan portfolio at the end of the years indicated. LOAN PORTFOLIO December 31, 1999 1998 Amount Percent Amount Percent -------- ------- -------- ------- Commercial and commercial real estate $448,991 53.53% $277,765 46.88% Residential mortgage 180,347 21.50 156,415 26.40 Agricultural and agricultural real estate 92,936 11.08 77,211 13.03 Consumer 103,608 12.35 72,642 12.26 Lease financing, net 12,886 1.54 8,508 1.43 -------- ------- -------- ------- Gross loans and leases 838,768 100.00% 592,541 100.00% ======= ======= Unearned discount (3,169) (2,136) Deferred loan fees (453) (272) -------- -------- Total loans and leases 835,146 590,133 Allowance for loan and lease losses (10,844) (7,945) -------- -------- Loans and leases, net $824,302 $582,188 ======== ======== LOAN PORTFOLIO December 31, 1997 1996 Amount Percent Amount Percent -------- ------- -------- ------- Commercial and commercial real estate $242,868 43.46% $206,523 42.46% Residential mortgage 175,268 31.37 166,999 34.33 Agricultural and agricultural real estate 69,302 12.40 57,526 11.83 Consumer 64,223 11.49 48,361 9.94 Lease financing, net 7,171 1.28 7,042 1.44 -------- ------- -------- ------- Gross loans and leases 558,832 100.00% 486,451 100.00% ======= ======= Unearned discount (2,077) (1,962) Deferred loan fees (349) (404) -------- -------- Total loans and leases 556,406 484,085 Allowance for loan and lease losses (7,362) (6,191) -------- -------- Loans and leases, net $549,044 $477,894 ======== ======== LOAN PORTFOLIO December 31, 1995 Amount Percent -------- ------- Commercial and commercial real estate $191,866 42.00% Residential mortgage 158,324 34.66 Agricultural and agricultural real estate 59,089 12.94 Consumer 38,988 8.54 Lease financing, net 8,530 1.86 -------- ------- Gross loans and leases 456,797 100.00% ======= Unearned discount (1,510) Deferred loan fees (382) -------- Total loans and leases 454,905 Allowance for loan and lease losses (5,580) -------- Loans and leases, net $449,325 ======== The table below sets forth the remaining maturities by loan and lease category. MATURITY AND RATE SENSITIVITY OF LOANS AND LEASES (1) December 31, 1999 Over 1 Year Through 5 Years One Year Fixed Floating or less Rate Rate ------------------------------ Commercial and commercial real estate $149,798 $201,105 $ 41,020 Residential mortgage 35,437 37,483 12,432 Agricultural and agricultural real estate 35,699 40,240 5,657 Consumer 26,835 51,142 10,557 Lease financing, net 3,108 8,988 - -------- -------- -------- Total $250,877 $338,958 $ 69,666 ======== ======== ======== Over 5 Years Fixed Floating Rate Rate Total ------------------------------- Commercial and commercial real estate $ 25,816 $ 31,252 $448,991 Residential mortgage 11,828 83,167 180,347 Agricultural and agricultural real estate 5,268 6,072 92,936 Consumer 6,223 8,851 103,608 Lease financing, net 790 - 12,886 -------- -------- -------- Total $ 49,925 $129,342 $838,768 ======== ======== ======== (1) Maturities based upon contractual dates. Net loans and leases grew $242,114 or 41.59% from December 31, 1998, to December 31, 1999, compared to $33,144 or 6.04% from December 31, 1997, to December 31, 1998. Expansion at WCB accounted for $106,951 or 44.17% of the growth during 1999, with the acquisition of the Monroe banking office making up $37,916 of this increase. Also contributing to the 1999 growth was the $54,499 increase in the loan portfolio at DB&T, Heartland's lead bank, which comprised 22.51% of the growth. NMB accounted for $28,829 or 86.98% of the growth during 1998 and $36,328 or 15.00% during 1999. During both years, the largest dollar growth occurred in commercial and commercial real estate loans, which increased $171,226 or 61.64% during 1999 and $34,897 or 14.37% during 1998. This growth was the result of aggressive calling efforts combined with the expansion into new markets. During 1999, the majority of the growth occurred at three of the subsidiary banks. WCB was responsible for $72,617 or 42.41% of this increase with the Monroe acquisition contributing $26,420. DB&T accounted for $42,025 or 24.54% of the growth and NMB contributed $30,129 or 17.60%. During 1998, NMB made up $22,860 or 65.51% of the increase in this loan category. The other loan category to experience significant growth during 1999, consumer loans, grew $29,960 or 41.24%, exclusive of the Monroe acquisition. Indirect paper, primarily on new automobiles, at DB&T and Citizens, Heartland's consumer finance subsidiary, were responsible for the majority of this growth. During 1998, consumer loan outstandings grew $8,419 or 13.11% with loans at NMB comprising $2,721 or 32.32% of this change. Exclusive of the Monroe acquisition, agricultural and agricultural real estate loans experienced a $4,570 or 5.92% growth during 1999. This same loan category grew $7,909 or 11.41% during 1998. These increases reflected the solid reputation and expertise DB&T has developed in agricultural lending, combined with continued calling efforts. Residential mortgage loan outstandings grew $23,932 or 15.30% during 1999. Nearly all the growth was recorded at WCB as Heartland's full real estate loan product line was introduced to this market. This same loan category was the only one to experience a decrease during 1998, declining $18,853 or 10.76%. This decrease occurred as customers chose fixed rate 15- and 30- year mortgages which the subsidiary banks elected to sell into the secondary market. Although the risk of nonpayment for any reason exists with respect to all loans, specific risks are associated with each type of loan. The primary risks associated with commercial and agricultural loans are the quality of the borrower's management and the impact of national and regional economic factors. Additionally, risks associated with commercial and agricultural real estate loans include fluctuating property values and concentrations of loans in a specific type of real estate. Repayment on consumer loans, including those on residential real estate, are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances and deteriorating economic conditions. Heartland monitors its loan concentrations and does not believe it has concentrations in any specific industry. Heartland's strategy with respect to the management of these types of risks, whether loan demand is weak or strong, is to encourage the Heartland banks to follow tested and prudent loan policies and underwriting practices which include: (i) granting loans on a sound and collectible basis; (ii) ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan; (iii) administering loan policies through a Board of Directors and an officers' loan committee; (iv) developing and maintaining adequate diversification of the loan portfolio as a whole and of the loans within each loan category; and (v) ensuring that each loan is properly documented and, if appropriate, guaranteed by government agencies and that insurance coverage is adequate. NONPERFORMING LOANS AND LEASES AND OTHER NONPERFORMING ASSETS The table below sets forth the amounts of nonperforming loans and leases and other nonperforming assets on the dates indicated. NONPERFORMING ASSETS December 31, 1999 1998 1997 1996 1995 ------------------------------------ Nonaccrual loans and leases $1,414 $1,324 $1,819 $1,697 $ 977 Loan and leases contractually past due 90 days or more 236 426 187 247 226 Restructured loans and leases - - 26 30 - ------ ------ ------ ------ ------ Total nonperforming loans and leases 1,650 1,750 2,032 1,974 1,203 Other real estate 585 857 774 532 640 Other repossessed assets 67 77 124 21 51 ------ ------ ------ ------ ------ Total nonperforming assets $2,302 $2,684 $2,930 $2,527 $1,894 ====== ====== ====== ====== ====== Nonperforming loans and leases to total loans and leases 0.20% 0.30% 0.37% 0.41% 0.26% Nonperforming assets to total loans and leases plus repossessed property 0.28% 0.45% 0.53% 0.52% 0.42% Nonperforming assets to total assets 0.19% 0.28% 0.34% 0.34% 0.28% Under Heartland's internal loan review program, a loan review officer is responsible for reviewing existing loans and leases, identifying potential problem loans and leases and monitoring the adequacy of the allowance for loan and lease losses at the Heartland banks. Heartland constantly monitors and continues to develop systems to oversee the quality of its loan portfolio. One integral part is a loan rating system, which assigns a rating on each loan and lease within the portfolio based on the borrower's financial position, repayment ability, collateral position and repayment history. This emphasis on quality is reflected in Heartland's credit quality figures, which compare very favorably to peer data in the Bank Holding Company Performance Reports published by the Federal Reserve Board for bank holding companies with total assets of $1 to $3 billion. In this report, the peer group reported nonperforming assets to total assets of .53% and .58% for September 30, 1999, and December 31, 1998, respectively. Heartland's ratios at December 31, 1999 and 1998, were .19% and .28%, respectively. ALLOWANCE FOR LOAN AND LEASE LOSSES 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. 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 Heartland's loan review committee included the following: i) a continued increase in higher-risk consumer and more-complex commercial loans as compared to relatively lower-risk residential real estate loans; ii) the entrance into new markets in which Heartland had little or no previous lending experience; iii) uncertainties within the agricultural markets; and iv) the economies of Heartland's primary market areas have been stable for some time and the allowance is intended to anticipate the cyclical nature of most economies. The allowance for loan and lease losses increased by $2,899 or 36.49% during 1999, primarily as a result of the significant growth experienced in the loan portfolio. Additionally, the Monroe branch acquisition accounted for $665 or 22.94% of the increase in the allowance for loan and lease losses during 1999. As a percentage of total loans and leases, the allowance for loan and lease losses was 1.30% at December 31, 1999, 1.35% at December 31, 1998 and 1.32% at December 31, 1997. There can be no assurances that the allowance for loan and lease losses will be adequate to cover all probable losses, but management believes that the allowance for loan and lease losses was adequate at December 31, 1999. 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. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan and lease losses carried by the Heartland subsidiaries. Such agencies may require Heartland to make additional provisions to the allowance based upon their judgment about information available to them at the time of their examinations. The table below summarizes activity in the allowance for loan and lease losses for the years indicated, including amounts of loans and leases charged off, amounts of recoveries, additions to the allowance charged to income and the ratio of net charge-offs to average loans and leases outstanding. ANALYSIS OF ALLOWANCE FOR LOAN AND LEASE LOSSES December 31, 1999 1998 1997 1996 1995 ----------------------------------------- Allowance at beginning of year $ 7,945 $7,362 $6,191 $5,580 $5,124 Charge-offs: Commercial and commercial real estate 81 289 93 578 108 Residential mortgage - 20 21 23 6 Agricultural and agricultural real estate 8 41 21 2 - Consumer 546 473 449 323 381 Lease financing - - - - ------- ------ ------ ------ ------ Total charge-offs 635 823 584 926 495 ------- ------ ------ ------ ------ Recoveries: Commercial and commercial real estate 74 372 36 16 22 Residential mortgage 12 - 8 1 15 Agricultural and agricultural real estate 6 1 2 45 8 Consumer 151 82 99 67 86 Lease financing - - - - - ------- ------ ------ ------ ------ Total recoveries 243 455 145 129 131 ------- ------ ------ ------ ------ Net charge-offs (1) 392 368 439 797 364 Provision for loan and lease losses 2,626 951 1,279 1,408 820 Additions related to acquisitions 665 - 331 - - ------- ------ ------ ------ ------ Allowance at end of period $10,844 $7,945 $7,362 $6,191 $5,580 ======= ====== ====== ====== ====== Net charge-offs to average loans and leases 0.06% 0.07% 0.08% 0.17% 0.08% ======= ====== ====== ====== ====== (1) Includes net charge-offs at Citizens, Heartland's consumer finance company, of $256 for 1999, $278 for 1998, $256 for 1997, $173 for 1996 and $153 for 1995. The table below shows Heartland's allocation of the allowance for loan and lease losses by types of loans and leases and the amount of unallocated reserves. ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES As of December 31, 1999 1998 --------------------------------------- Loan/ Loan/ Lease Lease Category Category to Gross to Gross Loans & Loans & Amount Leases Amount Leases ------- -------- ------ -------- Commercial and commercial real estate $ 6,108 53.53% $2,180 46.88% Residential mortgage 756 21.50 397 26.40 Agricultural and agricultural real estate 1,016 11.08 583 13.03 Consumer 1,917 12.35 1,096 12.26 Lease financing(1) 91 1.54 44 1.43 Unallocated 956 - 3,345 - ------- ------- ------ ------- $10,844 100.00% $7,362 100.00% ======= ======= ====== ======= ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES As of December 31, 1997 1996 --------------------------------------- Loan/ Loan/ Lease Lease Category Category to Gross to Gross Loans & Loans & Amount Leases Amount Leases ------ -------- ------ -------- Commercial and commercial real estate $1,889 43.46% $1,568 42.46% Residential mortgage 725 31.37 590 34.33 Agricultural and agricultural real estate 577 12.40 480 11.83 Consumer 1,044 11.49 818 9.94 Lease financing(1) 30 1.28 28 1.44 Unallocated 3,097 - 2,707 - ------ ------- ------ ------- $7,362 100.00% $6,191 100.00% ====== ======= ====== ======= ALLOCATION OF ALLOWANCE FOR LOAN AND LEASE LOSSES As of December 31, 1995 -------------------------- Loan/ Lease Category to Gross Loans & Amount Leases ------ -------- Commercial and commercial real estate $1,430 42.00% Residential mortgage 500 34.66 Agricultural and agricultural real estate 518 12.94 Consumer 618 8.54 Lease financing(1) 34 1.86 Unallocated 2,480 - ------ ------- $5,580 100.00% ====== ======= SECURITIES The primary objective of the securities portfolio continues to be to provide the Heartland bank subsidiaries with a source of liquidity given their high loan-to-deposit ratios. Securities represented 17.87% of total assets at December 31, 1999, as compared to 25.42% at December 31, 1998 and 23.68% at December 31, 1997. The reduction in 1999 was representative of a shift in the asset mix of Heartland, as growth in the loan portfolio outpaced deposit growth. The composition of the portfolio is managed to maximize the return on the portfolio while considering the impact it has on the Heartland's asset/liability position and liquidity needs. During 1999, management elected to replace paydowns received on mortgage-backed securities with less volatile U.S. government agency securities, as the spreads on mortgage-backed securities compared to comparable U.S. treasury securities with the same maturities narrowed. The state tax-exempt nature of selected U.S. government agency securities also made them attractive purchases for Heartland's Illinois bank subsidiaries. During 1998, purchases were made in U.S. government agencies and fixed- rate collateralized mortgage obligations ("CMO's"). Management purchased tightly structured tranches in well-seasoned CMO's to reduce its exposure to prepayments. These investments closely resemble treasury securities in their repayment predictability and accordingly are less volatile to interest rate fluctuations, while still providing an increased spread when compared to U.S. treasuries with similar maturities. The tables below present the composition and maturities of the securities portfolio by major category. SECURITIES PORTFOLIO COMPOSITION Held to Maturity Available for Sale % of % of December 31, 1999 Amount Portfolio Amount Portfolio --------------------------------------- U.S. Treasury securities $ - -% $ - -% U.S. government agencies - - 90,536 42.79 Mortgage-backed securities - - 75,637 35.75 States and political subdivisions 2,196 1.04 23,708 11.20 Other securities - - 19,500 9.22 ------ ------- -------- ------- Total $2,196 1.04% $209,381 98.96% ====== ======= ======== ======= SECURITIES PORTFOLIO COMPOSITION Total % of December 31, 1999 Amount Portfolio ------------------- U.S. Treasury securities $ - -% U.S. government agencies 90,536 42.79 Mortgage-backed securities 75,637 35.75 States and political subdivisions 25,904 12.24 Other securities 19,500 9.22 -------- ------- Total $211,577 100.00% ======== ======= SECURITIES PORTFOLIO COMPOSITION Held to Maturity Available for Sale % of % of December 31, 1998 Amount Portfolio Amount Portfolio --------------------------------------- U.S. Treasury securities $ - -% $ 1,709 0.71% U.S. government agencies - - 77,361 31.90 Mortgage-backed securities - - 128,317 52.92 States and political subdivisions 2,718 1.12 18,818 7.76 Other securities - - 13,565 5.59 ------ ------ -------- ------- Total $2,718 1.12% $239,770 98.88% ====== ====== ======== ======= SECURITIES PORTFOLIO COMPOSITION Total % of December 31, 1998 Amount Portfolio ------------------- U.S. Treasury securities $ 1,709 0.71% U.S. government agencies 77,361 31.90 Mortgage-backed securities 128,317 52.92 States and political subdivisions 21,536 8.88 Other securities 13,565 5.59 -------- ------- Total $242,488 100.00% ======== ======= SECURITIES PORTFOLIO COMPOSITION Held to Maturity Available for Sale % of % of December 31, 1997 Amount Portfolio Amount Portfolio --------------------------------------- U.S. Treasury securities $ - -% $ 13,342 6.62% U.S. government agencies 598 .30 63,762 31.60 Mortgage-backed securities 325 .16 86,690 42.97 States and political subdivisions 2,956 1.46 17,746 8.80 Other securities - - 16,329 8.09 ------ ------- -------- ------- Total $3,879 1.92% $197,869 98.08% ====== ====== ======== ======= SECURITIES PORTFOLIO COMPOSITION Total % of December 31, 1997 Amount Portfolio ------------------- U.S. Treasury securities $ 13,342 6.62% U.S. government agencies 64,360 31.90 Mortgage-backed securities 87,015 43.13 States and political subdivisions 20,702 10.26 Other securities 16,329 8.09 -------- ------- Total $201,748 100.00% ======== ======= SECURITIES PORTFOLIO MATURITIES After One But Within One Year Within Five Years --------------- ----------------- December 31, 1999 Amount Yield Amount Yield ------------------------------------ U.S. Treasury securities $ - -% $ - -% U.S. government agencies 15,280 5.59 75,248 5.96 Mortgage-backed securities 30,872 5.76 27,700 6.13 States and political subdivisions (1) 1,138 10.99 4,678 8.80 Other securities 8,504 5.61 1,755 5.83 ------- ------ ------- ------- Total $55,794 5.80% $109,381 6.10% ======= ====== ======== ======= SECURITIES PORTFOLIO MATURITIES After Five But Within Ten Years After Ten Years ---------------- ----------------- Amount Yield Amount Yield ------------------------------------ U.S. Treasury securities $ - -% $ - -% U.S. government agencies 8 10.25 - - Mortgage-backed securities 4,835 5.43 12,230 6.40 States and political subdivisions (1) 6,090 8.23 13,998 8.05 Other securities - - 1,040 5.62 ------- ------- ------- ------ Total $10,933 7.00% $27,268 7.22% ======= ======= ======= ====== SECURITIES PORTFOLIO MATURITIES Total Amount Yield -------------------- U.S. Treasury securities $ - -% U.S. government agencies 90,536 5.89 Mortgage-backed securities 75,637 5.98 States and political subdivisions (1) 25,904 8.36 Other securities 11,299 5.64 -------- ------ Total $203,376 6.22% ======== ====== (1) Rates on obligations of states and political subdivisions have been adjusted to tax equivalent yields using a 34% income tax rate. DEPOSITS AND BORROWED FUNDS Total average deposits experienced an increase of $117,639 or 17.82% during 1999 compared to an increase of $67,607 or 11.41% during 1998. The Monroe acquisition accounted for $40,121 or 34.11% of the growth in average deposits during 1999. Without the acquisition, growth during 1999 was $77,518 or 11.74%. All of the subsidiary banks, with the exception of FCB, were able to grow average deposits by more than seven percent during both years. The de novo community banks of RCB and NMB made up $36,568 or 47.17% of the 1999 growth and $22,335 or 33.04% of the 1998 growth. The mix of individual account balances to total deposits has been shifting from the time deposit category to the demand and savings deposit categories over the past two years. Consumer interest in traditional time deposits has diminished over time as they are drawn to alternative investment products. In order to attract additional deposit customers, the subsidiary banks have continued to enhance their checking and money market deposit product lines. The table below sets forth the distribution of Heartland's average deposit account balances and the average interest rates paid on each category of deposits for the years indicated. AVERAGE DEPOSITS For the year ended December 31, 1999 Percent Average of Balance Deposits Rate ------------------------ Demand deposits $ 81,511 10.48% 0.00% Savings accounts 324,476 41.71 3.33 Time deposits less than $100,000 312,051 40.12 5.50 Time deposits of $100,000 or more 59,822 7.69 5.39 -------- ------- Total deposits $777,860 100.00% ======== ======= AVERAGE DEPOSITS For the year ended December 31, 1998 Percent Average of Balance Deposits Rate ------------------------ Demand deposits $ 60,514 9.17% 0.00% Savings accounts 266,282 40.33 3.57 Time deposits less than $100,000 282,142 42.73 5.75 Time deposits of $100,000 or more 51,283 7.77 5.66 -------- ------- Total deposits $660,221 100.00% ======== ======= AVERAGE DEPOSITS For the year ended December 31, 1997 Percent Average of Balance Deposits Rate ------------------------ Demand deposits $ 51,770 8.74% 0.00% Savings accounts 237,730 40.12 3.50 Time deposits less than $100,000 268,201 45.25 5.77 Time deposits of $100,000 or more 34,913 5.89 5.62 -------- ------- Total deposits $592,614 100.00% ======== ======= The following table sets forth the amount and maturities of time deposits of $100,000 or more at December 31, 1999. Time Deposits $100,000 and Over December 31, 1999 ------------ 3 months or less $21,255 Over 3 months through 6 months 7,412 Over 6 months through 12 months 19,264 Over 12 months 9,521 ------- $57,452 ======= All of the Heartland banks, except for NMB, own stock in the Federal Home Loan Bank ("FHLB") of Des Moines or of Chicago, enabling them to borrow funds from their respective FHLB for short- or long-term purposes under a variety of programs. Total FHLB borrowings at December 31, 1999 and 1998, were $33,613 and $40,618, respectively. Heartland also utilizes securities sold under agreements to repurchase as a source of funds. All of the bank subsidiaries provide repurchase agreements to their customers as a cash management tool, sweeping excess funds from demand deposit accounts into these agreements. This source of funding does not increase the bank's reserve requirements, nor does it create an expense relating to FDIC premiums on deposits. Although the aggregate balance of repurchase agreements is subject to variation, the account relationships represented by these balances are principally local. With the entry into new markets, these balances have grown from $36,716 at December 31, 1998, to $66,839 at December 31, 1999. On July 23, 1999, Heartland amended its credit agreement with an unaffiliated bank increasing Heartland's unsecured credit line from $20,000 to $40,000. The additional credit line provided the $18,000 capital investment required at WCB to complete the Monroe acquisition. Under the terms of this agreement, Heartland has a term loan of $25,000 and a revolving credit loan of up to $15,000 with a reduction to $5,000 at December 31, 1999. Heartland had no balance outstanding on the revolving credit loan at December 31, 1999. The term loan is payable quarterly in $1,000 installments beginning March 31, 2000, with the final payment of $10,000 payable on December 31, 2003. This credit line was established to provide working capital to the nonbanking subsidiaries and to meet general corporate commitments. The following table reflects short-term borrowings, which in the aggregate have average balances during the period greater than 30% of stockholders equity at the end of the period. SHORT-TERM BORROWINGS At or for the Year Ended December 31, 1999 1998 1997 --------------------------- Balance at end of period $132,300 $ 75,920 $96,239 Maximum month-end amount Outstanding 140,992 102,313 96,239 Average month-end amount Outstanding 116,252 80,277 73,170 Weighted average interest rate at year-end 4.80% 5.00% 5.49% Weighted average interest rate for the year ended 5.03% 5.19% 5.32% CAPITAL RESOURCES Heartland's risk-based capital ratios, which take into account the different credit risks among banks' assets, have remained strong over the past three years. Tier 1 and total risk-based capital ratios were 10.56% and 11.68%, respectively, on December 31, 1999, compared with 11.05% and 12.13% at December 31, 1998, and 11.54% and 12.71% for December 31, 1997. At December 31, 1999, Heartland's leverage ratio, the ratio of Tier 1 capital to total average assets, was 8.85% compared to 8.58% and 8.76% at December 31, 1998 and 1997, respectively. Commitments for capital expenditures are an important factor in evaluating capital adequacy. As a result of the acquisition of WCB in March of 1997, remaining cash payments to previous stockholders total $594 in 2000 and $584 in 2001, plus interest at rates of 7.00% to 7.50%. The acquisition and merger of LAG into ULTEA in July of 1998 included an agreement to make three equal remaining cash payments to the previous principal stockholder of $643 in 2000 and 2001, plus interest at 7.50%. In July of 1999, WCB completed its acquisition of Bank One Wisconsin's Monroe banking center. As part of this transaction, Heartland infused an additional capital investment at WCB of $18,000. On January 1, 2000, Heartland completed its acquisition of National Bancshares, Inc. ("NBI"), the one-bank holding company of First National Bank of Clovis ("FNB") in New Mexico. FNB has four locations in the New Mexico communities of Clovis and Melrose, with $120,113 in assets and $97,533 in deposits at December 31, 1999. The total purchase price for NBI was $23,103, of which $5,774 was paid in common stock of Heartland to NBI's Employee Stock Ownership Plan (the "ESOP") and $3,820 in notes payable over three or five years, at the stockholders' discretion, bearing interest at 7.00%. The requisite cash payments under these notes payable, including interest, total $855 in 2000, $1,062 in 2001, $1003 in 2002, $731 in 2003 and $687 in 2004. As provided in the merger agreement, participants in the ESOP elected to receive a cash payment totaling $4,619 for 255,180 of the 319,009 shares of Heartland common stock originally issued to them. Immediately following the closing of the NBI acquisition, FNB was merged into NMB. As a result of this affiliate bank merger, Heartland's ownership in NMB increased to approximately 88%. In October of 1999, Heartland completed an offering of $25,000 of 9.60% cumulative capital securities representing undivided beneficial interests in Trust I, a special purpose trust subsidiary formed for the sole purpose of this offering. The proceeds from the offering were used by Trust I to purchase junior subordinated debentures from Heartland. The proceeds are being used for general corporate purposes, including the repayment of $15,000 of indebtedness on the revolving credit loan and the financing of acquisitions. All of the securities qualified as Tier 1 capital for regulatory purposes as of December 31, 1999. Subsequent to the acquisition of NBI, approximately $22,970 of the securities qualified as Tier 1 capital, as regulations do not allow the amount of these securities included in Tier 1 capital to exceed 25% of total Tier 1 capital. When including the acquisition of NBI, total capital would have been approximately $105,861 or 10.27% of total risk- adjusted assets on December 31, 1999. Tier 1 capital, adjusted for the NBI acquisition, would have been approximately $99,880 or 8.91% of total risk-adjusted assets on December 31, 1999. 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. As evidenced by the recent expansion into New Mexico, Heartland is seeking to operate in high growth areas, even if they are outside of its traditional Midwest market areas. Future expenditures relating to these efforts are not estimable at this time. Heartland's capital ratios are detailed in the table below. RISK-BASED CAPITAL RATIOS(1) December 31, 1999 1998 1997 Amount Ratio Amount Ratio Amount Ratio ------------------------------------------------- Capital Ratios: Tier 1 capital $101,665 10.56% $ 81,149 11.05% $ 71,713 11.54% Tier 1 capital minimum requirement 38,517 4.00 29,379 4.00 24,854 4.00 -------- ------ -------- ------ -------- ------ Excess $ 63,148 6.56% $ 51,770 7.05% $ 46,859 7.54% ======== ====== ======== ====== ======== ====== Total capital $112,508 11.68% $ 89,093 12.13% $ 78,995 12.71% Total capital minimum requirement 77,035 8.00 58,757 8.00 49,707 8.00 -------- ------ -------- ------ -------- ------ Excess $ 35,473 3.68% $ 30,336 4.13% $ 29,288 4.71% ======== ====== ======== ====== ======== ====== Total risk- adjusted assets $962,933 $734,463 $621,338 ======== ======== ======== (1) Based on the risk-based capital guidelines of the Federal Reserve, a bank holding company is required to maintain a Tier 1 to risk-adjusted assets ratio of 4.00% and total to risk-adjusted assets ratio of 8.00%. LEVERAGE RATIOS(1) December 31, 1999 1998 1997 Amount Ratio Amount Ratio Amount Ratio -------------------------------------------------- Capital Ratios: Tier 1 capital $ 101,665 8.85% $ 81,149 8.58% $ 71,713 8.76% Tier 1 capital minimum requirement(2) 45,965 4.00 37,810 4.00 32,729 4.00 ---------- ----- -------- ------ -------- ------ Excess $ 55,700 4.85% $ 43,339 4.58% $ 38,984 4.76% ========== ===== ======== ====== ======== ====== Average adjusted assets $1,149,125 $945,242 $818,232 ========== ======== ======== (1) The leverage ratio is defined as the ratio of Tier 1 capital to average total assets. (2) Management of Heartland has established a minimum target leverage ratio of 4.00%. Based on Federal Reserve guidelines, a bank holding company generally is required to maintain a leverage ratio of 3.00% plus an additional cushion of at least 100 basis points. LIQUIDITY Liquidity refers to Heartland's ability to maintain a cash flow, which is adequate to meet maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund operations and to provide for customers' credit needs. Heartland's usual and primary sources of funding have been deposits, loan and mortgage-backed security principal repayments, sales of loans, cash flow generated from operations and FHLB borrowings. Heartland's short-term borrowing balances are dependent on commercial cash management and smaller correspondent bank relationships and, as such, will normally fluctuate. Heartland believes these balances, on average, to be stable sources of funds; however, it intends to rely on deposit growth and additional FHLB borrowings in the future. In the event of short-term liquidity needs, the bank subsidiaries may purchase federal funds from each other or from correspondent banks. The bank subsidiaries may also borrow funds from the Federal Reserve Bank, but have not done so during the periods covered in this report. Also, 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 agreement, as of December 31, 1999, provided an additional borrowing capacity of $5,000. This agreement contains specific covenants which, among other things, limit dividend payments and restrict the sale of assets by the Heartland under certain circumstances. Also contained within the agreement are certain financial covenants, including the maintenance by Heartland of a maximum nonperforming assets to total loans ratio, minimum return on average assets ratio, maximum funded debt to total equity capital ratio, and requires that each of the bank subsidiaries remain well capitalized, as defined from time to time by the federal banking regulators. At December 31, 1999, Heartland was in compliance with all the covenants contained in this credit agreement. MARKET RISK MANAGEMENT Market risk is the risk of loss arising from adverse changes in market prices and rates. Heartland's market risk is comprised primarily of interest rate risk resulting from its core banking activities of lending and deposit gathering. Interest rate risk measures the impact on earnings from changes in interest rates and the effect on current fair market values of Heartland's assets, liabilities and off-balance sheet contracts. The objective is to measure this risk and manage the balance sheet to avoid unacceptable potential for economic loss. Heartland management continually develops and applies strategies to mitigate market risk. Exposure to market risk is reviewed on a regular basis by the asset/liability committees at the banks and, on a consolidated basis, by the Heartland board of directors. Monthly, management utilizes both the standard balance sheet GAP report and an independently developed income statement GAP report to analyze the effect of changes in interest rates on net interest income and to manage interest rate risk. Also utilized periodically during the year is an interest rate sensitivity analysis, which simulates changes in net interest income in response to various interest rate scenarios. This analysis considers current portfolio rates, existing maturities, repricing opportunities and market interest rates, in addition to prepayments and growth under different interest rate assumptions. Through the use of these tools, Heartland has determined that the balance sheet is structured such that changes in net interest margin in response to changes in interest rates would be minimal, all other factors being held constant. Management does not believe that Heartland's primary market risk exposures and how those exposures were managed in 1999 have materially changed when compared to 1998. Derivative financial instruments include futures, forwards, interest rate swaps, option contracts and other financial instruments with similar characteristics. Heartland was not a party to these types of derivatives at December 31, 1999. However, Heartland does enter into financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require collateral from the borrower. Standby letters of credit are conditional commitments issued by Heartland to guarantee the performance of a customer to a third party up to a stated amount and with specified terms and conditions. These commitments to extend credit and standby letters of credit are not recorded on the balance sheet until the instrument is exercised. The table below summarizes the scheduled maturities of market risk sensitive assets and liabilities as of December 31, 1999. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK TABLE OF MARKET RISK-SENSITIVE INSTRUMENTS December 31, 1999 MATURING IN: 2000 2001 2002 2003 ------------------------------------ ASSETS Federal funds sold $ 1,875 $ - $ - $ - Time deposits in other financial institutions 5,093 913 2 - Securities 55,794 39,263 22,967 42,073 Loans and leases: Fixed rate loans 158,024 114,065 120,417 52,692 Variable rate loans 101,937 47,957 31,978 16,804 -------- -------- -------- -------- Loans and leases, net 259,961 162,022 152,395 69,496 -------- -------- -------- -------- Total Market Risk- Sensitive Assets $322,723 $202,198 $175,364 $111,569 ======== ======== ======== ======== LIABILITIES Savings $367,413 $ - $ - $ - Time deposits: Fixed rate time certificates less than $100,000 201,119 83,135 29,792 18,991 Variable rate time certificates less than $100,000 5,072 2,822 - - -------- -------- -------- -------- Time deposits less than $100,000 206,191 85,957 29,792 18,991 Time deposits of $100,000 or more 47,931 7,109 1,455 857 Federal funds purchased, securities sold under repurchase agreements and other short-term borrowings 132,300 - - - Other borrowings: Fixed rate borrowings - 10,570 11,987 1,505 Variable rate borrowings - 4,000 4,000 13,000 -------- -------- -------- -------- Other borrowings - 14,570 15,987 14,505 -------- -------- -------- -------- Total Market Risk- Sensitive Liabilities $753,835 $107,636 $ 47,234 $ 34,353 ======== ======== ======== ======== Average Estimated Interest Fair MATURING IN: 2004 Thereafter Total Rate Value ------------------------------------------------- ASSETS Federal funds sold $ - $ - $ 1,875 2.88% $ 1,875 Time deposits in other financial institutions - 76 6,084 5.44 6,084 Securities 5,078 46,402 211,577 6.19 211,645 Loans and leases: Fixed rate loans 51,784 49,925 546,907 8.40 542,077 Variable rate loans 11,565 77,998 288,239 8.32 287,854 -------- -------- ---------- ---------- Loans and leases, net 63,349 127,923 835,146 829,931 -------- -------- ---------- ---------- Total Market Risk- Sensitive Assets $ 68,427 $174,401 $1,054,682 $1,049,536 ======== ======== ========== ========== LIABILITIES Savings $ - $ - $ 367,413 3.48% $ 367,413 Time deposits Fixed rate time certificates less than $100,000 10,167 2,305 345,509 5.51 343,043 Variable rate time certificates less than $100,000 - - 7,894 5.32 7,893 -------- -------- ---------- ---------- Time deposits less than $100,000 10,167 2,305 353,403 350,936 Time deposits of $100,000 or more 100 - 57,452 5.62 57,377 Federal funds purchased, securities sold under repurchase agreements and other short-term borrowings - - 132,300 4.80 132,300 Other borrowings: Fixed rate borrowings 5 31,590 55,657 8.03 63,796 Variable rate borrowings - - 21,000 5.76 21,000 -------- -------- ---------- ---------- Other borrowings 5 31,590 76,657 84,796 -------- -------- ---------- ---------- Total Market Risk Sensitive Liabilities $ 10,272 $ 33,895 $ 987,225 $ 992,822 ======== ======== ========== ========== EFFECTS OF INFLATION Consolidated financial data included in this report has been prepared in accordance with generally accepted accounting principles. Presently, these principles require reporting of financial position and operating results in terms of historical dollars. Changes in the relative value of money due to inflation or recession are generally not considered. In management's opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not change at the same rate or in the same magnitude as the inflation rate. Rather, interest rate volatility is based on changes in the expected rate of inflation, as well as on changes in monetary and fiscal policies. A financial institution's ability to be relatively unaffected by changes in interest rates is a good indicator of its capability to perform in today's volatile economic environment. Heartland seeks to insulate itself from interest rate volatility by ensuring that rate-sensitive assets and rate-sensitive liabilities respond to changes in interest rates in a similar time frame and to a similar degree. YEAR 2000 The Year 2000 posed a unique set of challenges to those industries, such as financial institutions, that are reliant on information technology. Heartland began to identify and react to issues related to the Year 2000 in 1996. A project team, comprised of individuals from key areas throughout Heartland, identified issues and took steps necessary to eliminate any adverse effects on Heartland's operations. The total out-of-pocket expenditures required to bring Heartland's systems into compliance for the Year 2000 were approximately $330. These required expenditures did not have a material impact on operations, cash flow or financial condition. This amount included costs for upgrading equipment specifically for the purpose of Year 2000 compliance and staff expense for testing and contingency development. Although management feels confident that all necessary upgrades have been identified, no assurance can be made that Year 2000 compliance has been achieved without additional unanticipated expenditures. As a result of the efforts of Heartland's Year 2000 project team, Heartland and its subsidiaries experienced an uneventful transition from 1999 to 2000. There was no disruption of services to customers or with internal operations. Among the benefits derived from the time, effort and costs related to Year 2000 was a complete review and update of Heartland's disaster recovery and contingency plans. As a result, Heartland is now better prepared to deal with technical or natural disasters that could threaten its operations. As it is too soon to conclude that there will not be any problems arising from the century date change, management continues to monitor its information systems, vendors and customers to assure that Year 2000 problems, should they arise, are resolved promptly. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED BALANCE SHEETS December 31, 1999 and 1998 (Dollars in thousands, except per share data) Notes 1999 1998 ----- -------- -------- ASSETS Cash and due from banks 3 $ 34,078 $ 25,355 Federal funds sold 1,875 17,476 -------- -------- Cash and cash equivalents 35,953 42,831 Time deposits in other financial institutions 6,084 6,127 Securities: 4 Available for sale-at market (cost of $211,782 for 1999 and $236,417 for 1998) 209,381 239,770 Held to maturity-at cost (approximate market value of $2,264 for 1999 and $2,871 for 1998) 2,196 2,718 Loans and leases: 5 Held for sale 16,636 10,985 Held to maturity 818,510 579,148 Allowance for loan and lease losses 6 (10,844) (7,945) -------- -------- Loans and leases, net 824,302 582,188 Assets under operating leases 35,495 34,622 Premises, furniture and equipment, net 7 26,995 19,780 Other real estate, net 585 857 Goodwill and core deposit premium, net 13,997 3,841 Other assets 29,159 21,051 -------- -------- TOTAL ASSETS $1,184,147 $953,785 ========== ======== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Deposits: 8 Demand $ 91,391 $ 70,871 Savings 367,413 292,852 Time 410,855 354,154 -------- -------- Total deposits 869,659 717,877 Short-term borrowings 9 132,300 75,920 Accrued expenses and other liabilities 18,958 18,095 Other borrowings 11 76,657 57,623 -------- -------- TOTAL LIABILITIES 1,097,574 869,515 --------- -------- STOCKHOLDERS' EQUITY: 13,14,16 Preferred stock (par value $1 per share; authorized 200,000 shares) - - Common stock (par value $1 per share; authorized, 12,000,000 shares; issued, 9,707,252 shares at December 31, 1999, and 1998) 9,707 9,707 Capital surplus 15,339 14,984 Retained earnings 65,132 60,154 Accumulated other comprehensive income (1,511) 2,107 Treasury stock at cost (120,478 and 172,173 shares at December 31, 1999, and December 31, 1998, respectively) (2,094) (2,682) -------- -------- TOTAL STOCKHOLDERS' EQUITY 86,573 84,270 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,184,147 $953,785 ========== ======== See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) Notes 1999 1998 1997 ----- -------- -------- -------- INTEREST INCOME: Interest and fees on loans and leases 5 $60,947 $49,901 $46,919 Interest on securities: Taxable 11,113 11,515 10,393 Nontaxable 1,216 1,133 1,170 Interest on federal funds sold 410 1,582 681 Interest on interest bearing deposits in other financial institutions 468 386 98 -------- -------- -------- TOTAL INTEREST INCOME 74,154 64,517 59,261 -------- -------- -------- INTEREST EXPENSE: Interest on deposits 8 31,180 28,645 25,765 Interest on short-term borrowings 5,630 4,076 3,740 Interest on other borrowings 4,039 3,583 2,262 -------- -------- -------- TOTAL INTEREST EXPENSE 40,849 36,304 31,767 -------- -------- -------- NET INTEREST INCOME 33,305 28,213 27,494 Provision for loan and lease losses 6 2,626 951 1,279 -------- -------- -------- Net interest income after provision for loan and lease losses 30,679 27,262 26,215 -------- -------- -------- OTHER INCOME: Service charges and fees 3,906 3,013 2,723 Trust fees 2,662 2,284 2,009 Brokerage commissions 655 413 324 Insurance commissions 803 751 563 Securities gains, net 713 1,897 1,446 Rental income on operating leases 14,718 7,428 811 Gains on sale of loans 1,028 1,212 373 Other noninterest income 939 299 316 -------- -------- -------- TOTAL OTHER INCOME 25,424 17,297 8,565 -------- -------- -------- OTHER EXPENSES: Salaries and employee benefits 12 18,945 15,218 13,070 Occupancy 13 2,076 1,695 1,354 Furniture and equipment 2,416 1,998 1,537 Depreciation on equipment under operating leases 10,844 5,296 584 Outside services 2,239 1,416 1,439 FDIC deposit insurance assessment 121 118 116 Advertising 1,376 1,150 826 Other operating expenses 6,705 4,890 4,001 -------- -------- -------- TOTAL OTHER EXPENSES 44,722 31,781 22,927 -------- -------- -------- Income before income taxes 11,381 12,778 11,853 Income taxes 10 3,156 3,757 3,338 -------- -------- -------- NET INCOME $ 8,225 $ 9,021 $ 8,515 ======== ======== ======== EARNINGS PER COMMON SHARE-BASIC $ 0.86 $ 0.95 $ 0.90 ======== ======== ======== EARNINGS PER COMMON SHARE- DILUTED 1 $ 0.84 $ 0.94 $ 0.89 ======== ======== ======== CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.34 $ 0.31 $ 0.26 ======== ======== ======== See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME For the years ended December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) Common Capital Retained Stock Surplus Earnings ------- ------- -------- Balance at January 1, 1997 $ 4,854 $13,366 $52,864 Net Income - 1997 8,515 Unrealized gain on securities available for sale Reclassification adjustment for gains realized in income Income taxes Comprehensive income Cash dividends declared: Common, $.26 per share (2,465) Purchase of 32,835 shares of common stock Sale of 44,650 shares of common stock 340 ------- ------- ------- Balance at December 31, 1997 $ 4,854 $13,706 $58,914 Net Income - 1998 9,021 Unrealized gain on securities available for sale Reclassification adjustment for gains realized in income Income taxes Comprehensive income Cash dividends declared: Common, $.31 per share (2,928) Two-for-one stock split 4,853 (4,853) Purchase of 166,970 shares of common stock Sale of 328,857 shares of common stock 1,278 ------- ------- ------- Balance at December 31, 1998 $ 9,707 $14,984 $60,154 Net Income - 1999 8,225 Unrealized loss on securities available for sale Reclassification adjustment for gains realized in income Income taxes Comprehensive income Cash dividends declared: Common, $.34 per share (3,247) Purchase of 44,907 shares of common stock Sale of 96,602 shares of common stock 355 ------- ------- ------- BALANCE AT DECEMBER 31, 1999 $ 9,707 $15,339 $65,132 ======= ======= ======= Accumulated Other Comprehensive Treasury Income Stock Total ------------- -------- ----- Balance at January 1, 1997 $ 1,327 $(2,152) $70,259 Net Income - 1997 8,515 Unrealized gain on securities available for sale 3,291 3,291 Reclassification adjustment for gains realized in income (1,446) (1,446) Income taxes (627) (627) ------- Comprehensive income 9,733 Cash dividends declared: Common, $.26 per share (2,465) Purchase of 32,835 shares of common stock (865) (865) Sale of 44,650 shares of common stock 770 1,110 ------- ------- ------- Balance at December 31, 1997 $ 2,545 $(2,247) $77,772 Net Income - 1998 9,021 Unrealized gain on securities available for sale 1,233 1,233 Reclassification adjustment for gains realized in income (1,897) (1,897) Income taxes 226 226 ------- Comprehensive income 8,583 Cash dividends declared: Common, $.31 per share (2,928) Two-for-one stock split Purchase of 166,970 shares of common stock (4,431) (4,431) Sale of 328,857 shares of common stock 3,996 5,274 ------- ------- ------- Balance at December 31, 1998 $ 2,107 $(2,682) $84,270 Net Income - 1999 8,225 Unrealized loss on securities available for sale (4,769) (4,769) Reclassification adjustment for gains realized in income (713) (713) Income taxes 1,864 1,864 ------- Comprehensive income 4,607 Cash dividends declared: Common, $.34 per share (3,247) Purchase of 44,907 shares of common stock (837) (837) Sale of 96,602 shares of common stock 1,425 1,780 ------- ------- ------- BALANCE AT DECEMBER 31, 1999 $(1,511) $(2,094) $86,573 ======= ======= ======= See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data) 1999 1998 1997 ------- ------- ------- Cash Flows from Operating Activities: Net income $ 8,225 $ 9,021 $ 8,515 Adjustments to reconcile net income to net cash provided by operating activities net of acquisitions: Depreciation and amortization 14,294 7,856 2,635 Provision for loan and lease losses 2,626 951 1,279 Provision for income taxes (348) (488) 114 Net amortization/(accretion) of premium/(discount) on securities 1,417 875 (292) Securities gains, net (713) (1,897) (1,446) Loans originated for sale (80,804) (139,554) (44,035) Proceeds on sales of loans 75,351 142,328 49,563 Net gain on sales of loans (1,028) (1,212) (373) Increase in accrued interest receivable (826) (620) (354) Increase in accrued interest payable 353 623 449 Other, net (5,613) 468 (2,265) ------- ------- ------- Net cash provided by operating activities 12,934 18,351 13,790 ------- ------- ------- Cash Flows from Investing Activities: Purchase of time deposits - (5,934) (33) Proceeds on maturities of time deposits 43 - 201 Proceeds from the sale of securities available for sale 22,454 27,928 20,053 Proceeds from the sale of mortgage-backed securities available for sale - 2,276 3,980 Proceeds from the maturity of and principal paydowns on securities held to maturity 520 837 2,732 Proceeds from the maturity of and principal paydowns on securities available for sale 26,139 41,902 13,647 Proceeds from the maturity of and principal paydowns on mortgage-backed securities held to maturity - 343 - Proceeds from the maturity of and principal paydowns on mortgage-backed securities available for sale 68,931 53,040 13,175 Purchase of securities available for sale (71,354) (70,211) (24,485) Purchase of mortgage-backed securities available for sale (21,257) (96,543) (30,612) Net increase in loans and leases (201,186) (36,262) (55,546) Increase in assets under operating leases (11,716) (12,161) (3,259) Capital expenditures (7,802) (4,365) (2,522) Net cash and cash equivalents received in acquisition of subsidiaries 43,682 2,730 670 Net cash received from minority interest stockholders 58 2,950 - Net cash and cash equivalents paid in acquisition of trust assets (528) - - Proceeds on sale of OREO and other repossessed assets 1,086 831 7 Proceeds on sale of fixed assets 4 8 1 ------- ------- ------- Net cash used by investing activities (150,926) (92,631) (61,991) Cash Flows from Financing Activities: Net increase in demand deposits and savings accounts 42,217 50,481 17,137 Net increase in time deposit accounts 18,165 43,864 15,182 Net increase in other borrowings 34,633 15,250 23,886 Net increase (decrease) in short-term borrowings 38,403 (42,979) 11,483 Purchase of treasury stock (837) (4,431) (865) Proceeds from sale of treasury stock 1,780 669 948 Dividends (3,247) (2,928) (2,465) ------- ------- ------- Net cash provided by financing activities 131,114 59,926 65,306 ------- ------- ------- Net increase (decrease) in cash and cash equivalents (6,878) (14,354) 17,105 Cash and cash equivalents at beginning of year 42,831 57,185 40,080 ------- ------- ------- Cash and cash equivalents at end of period $35,953 $42,831 $57,185 ======= ======= ======= Supplemental disclosures: Cash paid for income/franchise taxes $ 3,596 $ 3,303 $ 3,090 Cash paid for interest $40,496 $35,681 $31,318 Other borrowings transferred to short-term borrowings $15,599 $15,323 $25,500 See accompanying notes to consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share data) ONE SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations-Heartland Financial USA, Inc. ("Heartland") is a multi-bank holding company primarily operating full-service retail banking offices in Dubuque and Lee Counties in Iowa; Jo Daviess, Hancock and Winnebago Counties in Illinois; Dane, Green, Sheboygan, Brown and Eau Claire Counties in Wisconsin; and Bernalillo and Curry Counties in New Mexico, serving communities in and around those counties. The principal services of Heartland, through its subsidiaries, are FDIC-insured deposit accounts and related services, and loans to businesses and individuals. The loans consist primarily of commercial and commercial real estate and residential real estate. Principles of Presentation-The consolidated financial statements include the accounts of Heartland and its subsidiaries: Dubuque Bank and Trust Company ("DB&T"); Galena State Bank and Trust Company ("GSB"); Riverside Community Bank ("RCB"); Wisconsin Community Bank ("WCB"); New Mexico Bank & Trust ("NMB"); First Community Bank, FSB ("FCB"); Citizens Finance Co.("Citizens"); ULTEA, Inc. ("ULTEA"); DB&T Insurance, Inc.; DB&T Community Development Corp.; DBT Investment Corporation; and Keokuk Bancshares, Inc. (dba KBS Investment Corp.); and Heartland Capital Trust I ("Trust I"). All of Heartland's subsidiaries are wholly-owned except for NMB, of which Heartland was an 80% owner on December 31, 1999. All significant intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and with general practice within the banking industry. In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for possible loan and lease losses. Securities Available for Sale-Available for sale securities consist of those securities not classified as held to maturity or trading, which management intends to hold for indefinite periods of time or that may be sold in response to changes in interest rates, prepayments or other similar factors. Such securities are stated at fair value with any unrealized gain or loss, net of applicable income tax, reported as a separate component of stockholders' equity. Security premiums and discounts are amortized/accreted using the interest method over the period from the purchase date to the maturity or call date of the related security. Gains or losses from the sale of available for sale securities are determined based upon the adjusted cost of the specific security sold. Securities Held to Maturity-Securities which Heartland has the ability and positive intent to hold to maturity are classified as held to maturity. Such securities are stated at amortized cost, adjusted for premiums and discounts that are amortized/accreted using the interest method over the period from the purchase date to the maturity date of the related security. Loans and Leases-Interest on loans is accrued and credited to income based primarily on the principal balance outstanding. Income from leases is recorded in decreasing amounts over the term of the contract resulting in a level rate of return on the lease investment. The policy of Heartland is to discontinue the accrual of interest income on any loan or lease when, in the opinion of management, there is a reasonable doubt as to the timely collection of the interest and principal. When interest accruals are deemed uncollectible, interest credited to income in the current year is reversed and interest accrued in prior years is charged to the allowance for loan and lease losses. Nonaccrual loans and leases are returned to an accrual status when, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the timely payment of interest and principal. Under Heartland's credit policies, all nonaccrual and restructured loans are defined as impaired loans. Loan impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, except where more practical, at the observable market price of the loan or the fair value of the collateral if the loan is collateral dependent. Net nonrefundable loan and lease origination fees and certain direct costs associated with the lending process are deferred and recognized as a yield adjustment over the life of the related loan or lease. Loans held for sale are stated at the lower of individual cost or estimated fair value. Loans are sold on a nonrecourse basis with either servicing released or retained, and gains and losses are recognized based on the difference between sales proceeds and the carrying value of the loan. Mortgage servicing rights associated with loans originated and sold, where servicing is retained, are capitalized and included in other assets in the balance sheet. The value of these capitalized servicing rights are amortized in relation to the servicing revenue expected to be earned. The carrying values of these rights are periodically reviewed for impairment. For purposes of measuring impairment, the rights are stratified into certain risk characteristics including loan type, note rate, prepayment trends, and external market factors. There was no valuation allowance required as of December 31, 1999. Mortgage loans serviced for others were $188,258 and $154,089 as of December 31, 1999 and 1998, respectively. Custodial escrow balances maintained in connection with the loan servicing portfolio were approximately $1,112 and $894 as of December 31, 1999 and 1998, respectively. Allowance for Loan and Lease Losses - The allowance for loan and lease losses is maintained at a level estimated by management to provide for known and inherent risks in the loan and lease portfolios. The allowance is based upon a continuing review of past loan and lease loss experience, current economic conditions, volume growth, the underlying collateral value of the loans and leases and other relevant factors. Loans and leases which are deemed uncollectible are charged off and deducted from the allowance. Provisions for loan and lease losses and recoveries on previously charged-off loans and leases are added to the allowance. Premises, Furniture and Equipment - Premises, furniture and equipment are stated at cost less accumulated depreciation. The provision for depreciation of premises, furniture and equipment is determined by straight-line and accelerated methods over the estimated useful lives of 18 to 39 years for buildings, 15 years for land improvements and 3 to 7 years for furniture and equipment. Other Real Estate - Other real estate represents property acquired through foreclosures and settlements of loans. Property acquired is carried at the lower of the principal amount of the loan outstanding at the time of acquisition, plus any acquisition costs, or the estimated fair value of the property, less disposal costs. The excess, if any, of such costs at the time acquired over the fair value is charged against the allowance for loan and lease losses. Subsequent write downs estimated on the basis of later evaluations, gains or losses on sales and net expenses incurred in maintaining such properties are charged to operations. Intangible Assets - Intangible assets consist of goodwill and core deposit premiums. Goodwill represents the excess of the purchase price of acquired subsidiaries' net assets over their fair value. Goodwill is amortized over periods of 15 to 25 years on the straight-line basis. Core deposit premiums are amortized over ten years on an accelerated basis. Periodically, Heartland reviews the intangible assets for events or circumstances that may indicate a change in the recoverability of the underlying basis. Income Taxes - Heartland and its subsidiaries file a consolidated federal income tax return. For state tax purposes, DB&T, GSB, RCB, FCB, WCB and NMB ("Banks") file income or franchise tax returns as required. The other entities file corporate income or franchise tax returns as required by the various states. Heartland has a tax allocation agreement which provides that each subsidiary of the consolidated group pay a tax liability to, or receive a tax refund from Heartland, computed as if the subsidiary had filed a separate return. Heartland recognizes certain income and expenses in different time periods for financial reporting and income tax purposes. The provision for deferred income taxes is based on an asset and liability approach and represents the change in deferred income tax accounts during the year, including the effect of enacted tax rate changes. Deferred tax assets are recognized if their expected realization is "more likely than not". Treasury Stock - Treasury stock is accounted for by the cost method, whereby shares of common stock reacquired are recorded at their purchase price. Trust Department Assets - Property held for customers in fiduciary or agency capacities is not included in the accompanying consolidated balance sheets, as such items are not assets of the Banks. Earnings Per Share - Amounts used in the determination of basic and diluted earnings per share for the years ended December 31, 1999, 1998 and 1997 are shown in the table below. 1999 1998 1997 ------ ------ ------ Net income $8,225 $9,021 $8,515 ====== ====== ====== Weighted average common shares outstanding for basic earnings per share 9,555 9,463 9,476 Assumed incremental common shares issued upon exercise of stock options 196 148 143 ------ ------ ------ Weighted average common shares for diluted earnings per share 9,751 9,611 9,619 ====== ====== ====== Cash Flows - For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. Effect of New Financial Accounting Standards - In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("FAS") No. 133, Accounting for Derivative Instruments and Hedging Activities. In July 1999, the FASB issued FAS 137, Deferring Statement 133's Effective Date, which defers the effective date for implementation of FAS 133 by one year, making FAS 133 effective no later than January 1, 2001 for Heartland's financial statements. Management does not believe the adoption of FAS 133 will have a material impact on the consolidated financial statements. TWO ACQUISITIONS Heartland regularly explores opportunities for acquisitions of financial institutions and related businesses. Generally, management does not make a public announcement about an acquisition opportunity until a definitive agreement has been signed. On January 1, 2000, Heartland completed its acquisition of National Bancshares, Inc. ("NBI"), the one-bank holding company of First National Bank of Clovis ("FNB") in New Mexico. FNB has four locations in the New Mexico communities of Clovis and Melrose, with $120,113 in assets and $97,533 in deposits at December 31, 1999. The total purchase price for NBI was $23,103, of which $5,774 was paid in common stock of Heartland to NBI's Employee Stock Ownership Plan (the "ESOP") and $3,820 in notes payable over three or five years, at the stockholders' discretion, bearing interest at 7.00%. As provided in the merger agreement, participants in the ESOP elected to receive a cash payment totaling $4,619 for 255,180 of the 319,009 shares of Heartland common stock originally issued to them. Heartland merged FNB into its NMB subsidiary immediately after the closing of the NBI acquisition. As a result of this affiliate bank merger, Heartland's ownership in NMB increased to approximately 88%. The acquisition of NBI will be accounted for as a purchase; accordingly, the results of operations of FNB will be included in the financial statements from the acquisition date. The resultant acquired deposit base intangible and goodwill of approximately $8,911 will be amortized over a period of 10 to 15 years. The pro forma effect of the acquisition was not material to the financial statements. On July 23, 1999, WCB completed its acquisition of Bank One Wisconsin's branch in Monroe, Wisconsin. Included in the acquisition were deposits of $93,780 and loans of $38,581. Trust assets of the Monroe branch were also acquired by WCB. The acquisition was accounted for as a purchase; accordingly, the results of operations of the Monroe banking center have been included in the financial statements from the acquisition date. The resultant acquired deposit base intangible of $2,505 is being amortized over a period of 10 years and the remaining excess purchase price over the fair value of assets acquired of $8,327 is being amortized over a period of 15 years. The pro forma effect of the acquisition was not material to the financial statements. On July 17, 1998, Heartland acquired all of the assets and assumed certain liabilities of Arrow Motors, Inc., a Wisconsin corporation doing business as Lease Associates Group ("LAG") in Milwaukee. With $28,000 in total assets, LAG was merged into ULTEA, Heartland's fleet leasing subsidiary. The stockholders of LAG, at the acquisition date, received 287,644 shares of Heartland common stock and the remaining balance of $1,929 in a promissory note payable over three years bearing a rate of 7.50%. The excess of the purchase price over the fair value of net assets acquired was $632 and is being amortized over 25 years using the straight-line method. The transaction was accounted for as a purchase transaction, and accordingly, the results of operations are included in the consolidated financial statements from the acquisition date. The pro forma effect of the acquisition was not material to the financial statements. During 1997, Heartland entered into an agreement with a group of New Mexico business leaders to establish a new bank in Albuquerque. NMB opened on May 4, 1998, and Heartland's portion of the $15,000 investment was $12,000. On March 1, 1997, Heartland acquired Cottage Grove State Bank (subsequently named WCB), a $39,287 Wisconsin state bank located in Cottage Grove, Wisconsin, at a cost of $7,890. The stockholders of Cottage Grove State Bank, at the date of acquisition, received cash of $4,892 and the remaining balance in contracts payable over two, three or four years, at their discretion, bearing rates of 7.00% and 7.50%. The purchase price paid in excess of the fair value of net assets acquired was $2,465 and is being amortized over 25 years using the straight- line method. This transaction was accounted for as a purchase; accordingly, WCB's results of operations were included in the consolidated financial statements from the acquisition date. THREE CASH AND DUE FROM BANKS The Banks are required to maintain certain average cash reserve balances as a member of the Federal Reserve System. The reserve balance requirements at December 31, 1999 and 1998 were $1,443 and $1,257 respectively. FOUR Securities The amortized cost, gross unrealized gains and losses and estimated fair values of held to maturity and available for sale securities as of December 31, 1999 and 1998, are summarized as follows: Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- -------- 1999 Securities held to maturity: Obligations of states and political subdivisions $ 2,196 $ 69 $ (1) $ 2,264 -------- -------- -------- -------- Total $ 2,196 $ 69 $ (1) $ 2,264 ======== ======== ======== ======== Securities available for sale: U.S. government corporations and agencies $ 92,234 $ 3 $ (1,701) $ 90,536 Mortgage-backed securities 75,959 212 (534) 75,637 Obligations of states and political subdivisions 23,583 683 (558) 23,708 Corporate debt securities 11,415 - (116) 11,299 -------- -------- -------- -------- Total debt securities 203,191 898 (2,909) 201,180 Equity securities 8,591 128 (518) 8,201 -------- -------- -------- -------- Total $211,782 $ 1,026 $ (3,427) $209,381 ======== ======== ======== ======== Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- -------- 1998 Securities held to maturity: Obligations of states and political subdivisions $ 2,718 $ 153 $ - $ 2,871 -------- -------- -------- -------- Total $ 2,718 $ 153 $ - $ 2,871 ======== ======== ======== ======== Securities available for sale: U.S. Treasury securities $ 1,701 $ 8 $ - $ 1,709 U.S. government corporations and agencies 76,471 1,005 (115) 77,361 Mortgage-backed securities 127,732 817 (232) 128,317 Obligations of states and political subdivisions 17,281 1,542 (5) 18,818 Corporate debt securities 2,454 40 (1) 2,493 -------- -------- -------- -------- Total debt securities 225,639 3,412 (353) 228,698 Equity securities 10,778 647 (353) 11,072 -------- -------- -------- -------- Total $236,417 $ 4,059 $ (706) $239,770 ======== ======== ======== ======== The amortized cost and estimated fair value of debt securities held to maturity and available for sale at December 31, 1999, by estimated maturity, are as follows. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties. Estimated Amortized Fair Cost Value --------- --------- Securities held to maturity: Due in 1 year or less $ 203 $ 204 Due in 1 to 5 years 981 996 Due in 5 to 10 years 1,012 1,064 Due after 10 years - - -------- -------- Total $ 2,196 $ 2,264 ======== ======== Securities available for sale: Due in 1 year or less $ 55,704 $ 55,591 Due in 1 to 5 years 110,294 108,400 Due in 5 to 10 years 9,989 9,921 Due after 10 years 27,204 27,268 -------- -------- Total $203,191 $201,180 ======== ======== As of December 31, 1999, securities with a market value of $141,836 were pledged to secure public and trust deposits, short- term borrowings and for other purposes as required by law. Gross gains and losses related to sales of securities for the years ended December 31, 1999, 1998 and 1997, are summarized as follows: 1999 1998 1997 ------- ------- ------- Securities sold: Proceeds from sales $22,454 $30,204 $24,033 Gross security gains 1,007 1,945 1,526 Gross security losses 294 48 80 FIVE LOANS AND LEASES Loans and leases as of December 31, 1999 and 1998, were as follows: 1999 1998 -------- -------- Loans: Commercial and commercial real estate $448,991 $277,765 Residential mortgage 180,347 156,415 Agricultural and agricultural real estate 92,936 77,211 Consumer 103,608 72,642 -------- -------- Loans, gross 825,882 584,033 Unearned discount (3,169) (2,136) Deferred loan fees (453) (272) -------- -------- Loans, net 822,260 581,625 -------- -------- Direct financing leases: Gross rents receivable 11,929 7,281 Estimated residual value 3,100 2,514 Unearned income (2,143) (1,287) -------- -------- Direct financing leases, net 12,886 8,508 -------- -------- Allowance for loan and lease losses (10,844) (7,945) -------- -------- Loans and leases, net $824,302 $582,188 ======== ======== Direct financing leases receivable are generally short-term equipment leases. Future minimum lease payments as of December 31, 1999, were as follows: $3,723 for 2000, $3,443 for 2001, $2,941 for 2002, $2,143 for 2003, $1,922 for 2004 and $857 thereafter. As DB&T is the largest subsidiary of Heartland, the majority of the loan portfolio is concentrated in northeast Iowa, northwest Illinois and southwest Wisconsin. Loans and leases on a nonaccrual status amounted to $1,414 and $1,324 at December 31, 1999 and 1998, respectively. The allowance for loan and lease losses related to these nonaccrual loans was $104 and $176, respectively. Nonaccrual loans of $953 and $314 were not subject to a related allowance for loan and lease losses at December 31, 1999 and 1998, respectively, because of the net realizable value of loan collateral, guarantees and other factors. The average balances of nonaccrual loans for the years ended December 31, 1999, 1998 and 1997 were $1,367, $1,437 and $1,585, respectively. For the years ended December 31, 1999, 1998 and 1997, interest income which would have been recorded under the original terms of these loans and leases amounted to approximately $63, $59, and $87, respectively, and interest income actually recorded amounted to approximately $16, $10, and $9, respectively. Loans are made in the normal course of business to directors, officers and principal holders of equity securities of Heartland. The terms of these loans, including interest rates and collateral, are similar to those prevailing for comparable transactions and do not involve more than a normal risk of collectibility. Changes in such loans during the year ended December 31, 1999, were as follows: 1999 -------- Balance at beginning of year $ 12,477 New loans 14,196 Repayments (3,955) -------- Balance at end of year $ 22,718 ======== SIX ALLOWANCE FOR LOAN AND LEASE LOSSES Changes in the allowance for loan and lease losses for the years ended December 31, 1999, 1998 and 1997, were as follows: 1999 1998 1997 ------- ------- ------- Balance at beginning of year $ 7,945 $ 7,362 $ 6,191 Provision for loan and lease losses 2,626 951 1,279 Recoveries on loans and leases previously charged off 243 455 145 Loans and leases charged off (635) (823) (584) Additions related to acquisitions 665 - 331 ------- ------- ------- Balance at end of year $10,844 $ 7,945 $ 7,362 ======= ======= ======= SEVEN PREMISES, FURNITURE AND EQUIPMENT Premises, furniture and equipment as of December 31, 1999 and 1998, were as follows: 1999 1998 ------- ------- Land and land improvements $ 4,204 $ 3,366 Buildings and building improvements 21,630 15,787 Furniture and equipment 14,632 12,349 ------- ------- Total 40,466 31,502 Less accumulated depreciation (13,471) (11,722) ------- ------- Premises, furniture and equipment, net $26,995 $19,780 ======= ======= Depreciation expense on premises, furniture and equipment was $2,095 for 1999, $1,730 for 1998, and $1,443 for 1997. EIGHT DEPOSITS The aggregate amount of time certificates of deposit in denominations of one hundred thousand dollars or more as of December 31, 1999 and 1998, were $57,452 and $62,293, respectively. At December 31, 1999, the scheduled maturities of time certificates of deposit were as follows: 1999 --------- 2000 $ 254,122 2001 93,067 2002 31,246 2003 19,848 2004 thereafter 12,572 --------- Total $ 410,855 ========= Interest expense on deposits for the years ended December 31, 1999, 1998 and 1997, was as follows: 1999 1998 1997 ------- ------- ------- Savings and insured money market accounts $10,789 $ 9,512 $ 8,317 Time certificates of deposit in denominations of $100 or more 3,222 2,905 1,961 Other time deposits 17,169 16,228 15,487 ------- ------- ------- Interest expense on deposits $31,180 $28,645 $25,765 ======= ======= ======= NINE SHORT-TERM BORROWINGS Short-term borrowings as of December 31, 1999 and 1998, were as follows: 1999 1998 -------- -------- Securities sold under agreements to repurchase $ 66,839 $ 36,716 Federal funds purchased 28,600 13,175 Federal Home Loan Bank ("FHLB") advances 17,504 14,504 U.S. Treasury demand note 7,781 3,636 Notes payable on leased assets 6,339 6,423 Contracts payable to previous owners of LAG for acquisition 643 643 Contracts payable to previous stockholders of WCB for acquisition 594 823 Note payable to unaffiliated bank 4,000 - -------- -------- Total $132,300 $ 75,920 ======== ======== See Note 11 related to the note payable to an unaffiliated bank and collateral pledged for FHLB advances. All repurchase agreements as of December 31, 1999 and 1998, were due within six months. Average and maximum balances and rates on aggregate short-term borrowings outstanding during the years ended December 31, 1999, 1998 and 1997, were as follows: 1999 1998 1997 -------- -------- ------- Maximum month-end balance $140,992 $102,313 $96,239 Average month-end balance 116,252 80,277 73,170 Weighted average interest rate for the year 5.03% 5.19% 5.32% Weighted average interest rate at year-end 4.80 5.00 5.49 TEN INCOME TAXES Income taxes for the years ended December 31, 1999, 1998 and 1997, were as follows: Current Deferred Total -------------------------- 1999: Federal $2,790 $ 14 $2,804 State 504 (152) 352 ------ ------ ------ Total $3,294 $ (138) $3,156 ====== ====== ====== 1998: Federal $2,900 $ 300 $3,200 State 577 (20) 557 ------ ------ ------ Total $3,477 $ 280 $3,757 ====== ====== ====== 1997: Federal $2,977 $ (47) $2,930 State 428 (20) 408 ------ ------ ------ Total $3,405 $ (67) $3,338 ====== ====== ====== Temporary differences between the amounts reported in the financial statements and the tax basis of assets and liabilities result in deferred taxes. No valuation allowance was required for deferred tax assets. Based upon Heartland's level of historical taxable income and anticipated future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that Heartland will realize the benefits of these deductible differences. Deferred tax liabilities and assets for the years ended December 31, 1999 and 1998, were as follows: 1999 1998 ------- ------- Deferred tax assets: Unrealized loss on Securities available for sale $ 889 $ - Allowance for loan and lease losses 4,020 2,997 Deferred compensation 280 244 Securities 30 136 Net operating loss 600 468 ------- ------- Gross deferred tax assets $ 5,819 $ 3,845 ------- ------- Deferred tax liabilities: Unrealized gain on securities available for sale $ - $(1,246) Fixed assets (4,580) (4,470) Leases (1,800) (1,360) Tax bad debt reserves (670) (697) Discount on loans (220) - Prepaid expenses (165) (165) Other (49) (30) Mortgage servicing rights (185) - ------- ------- Gross deferred tax liabilities $(7,669) $(7,968) ------- ------- Net deferred tax (liability) $(1,850) $(4,123) ======= ======= The actual income taxes differ from the expected amounts (computed by applying the U.S. federal corporate tax rate of 35% for 1999, 1998 and 1997, to income before income taxes) as follows: 1999 1998 1997 -------------------------- Computed "expected" amount $3,983 $4,472 $4,149 Increase (decrease) resulting from: Nontaxable interest income (515) (511) (510) State income taxes, net of federal tax benefit 230 360 260 Graduated income tax rates (100) (100) (100) Tax credits (440) (440) (440) Other (2) (24) (21) ------ ------ ------ Income taxes $3,156 $3,757 $3,338 ====== ====== ====== Effective tax rates 27.7% 29.4% 28.2% ====== ====== ====== Heartland has investments in certain low-income housing projects totaling $5,100 and $5,400 as of December 31, 1999 and 1998, respectively, which are included in other assets in the consolidated financial statements. These investments are expected to generate federal income tax credits of approximately $440 per year through 2005. ELEVEN OTHER BORROWINGS Other borrowings at December 31, 1999 and 1998, were as follows: 1999 1998 ------- ------- Advances from the FHLB; weighted average maturity dates at December 31, 1999 and 1998, were July, 2005 and July, 2002, respectively; and weighted average interest rates were 6.03% and 6.12%, respectively $16,109 $26,114 Notes payable on leased assets with interest rates varying from 5.39% to 9.75% 13,322 12,845 Note payable with unaffiliated bank 21,000 16,200 Trust preferred securities 25,000 - Contracts payable to previous stock- holders of LAG for acquisition due over a three-year schedule at 7.50% through July, 2001 643 1,286 Contracts payable to previous stock- holders of WCB for acquisition due in annual payments over two-, three- or four-year schedules at interest rates of 7.00% to 7.50% through March, 2001 583 1,178 ------- ------ Total $76,657 $57,623 ======= ======= DB&T, GSB, FCB, RCB and WCB are members of the FHLB of Des Moines or of Chicago. The advances from the FHLB are collateralized by the Banks' investment in FHLB stock of $3,756 and $3,659 at December 31, 1999 and 1998, respectively. Additional collateral is provided by the Banks' one-to-four unit residential mortgages totaling $113,133 at December 31, 1999, and $116,520 at December 31, 1998. On July 23, 1999, Heartland entered into an Amended and Restated Loan Agreement with an unaffiliated bank to establish a term credit line as well as to increase the availability under an existing revolving credit line. The unsecured credit line was increased from $20,000 to $40,000. Under the terms of this agreement at December 31,1999, Heartland has a term loan of $25,000 and a revolving credit loan of up to $5,000. The term loan is payable quarterly in $1,000 installments beginning March 31, 2000, with the final payment of $10,000 payable on December 31, 2003. At December 31, 1999, $25,000 was outstanding on the term loan with $21,000 classified as other borrowings and the subsequent year's payments of $4,000 classified as short-term borrowings. The additional credit line was established primarily to provide the $18,000 capital investment required at WCB upon its acquisition of the Monroe branch. Under the terms of this agreement, Heartland must maintain a minimum return on average assets, maximum non-performing assets to total loans ratio, maximum funded debt to total equity capital ratio and each of Heartland's banking subsidiaries must remain well capitalized. On October 21, 1999, Heartland completed an offering of $25,000 of 9.60% cumulative capital securities representing undivided beneficial interests in Trust I, a special purpose trust subsidiary of Heartland formed for the sole purpose of this offering. The proceeds from the offering were used by Trust I to purchase junior subordinated debentures from Heartland. The proceeds are being used for general corporate purposes, including the repayment of $15,000 of indebtedness on the revolving credit loan and the financing of acquisitions. All of the securities qualified as Tier 1 capital for regulatory purposes as of December 31, 1999. Subsequent to the acquisition of NBI on January 1, 2000, approximately $22,970 of the securities qualified as Tier 1 capital, as the amount of securities may not exceed more than 25% of Heartland's total Tier 1 capital. Interest is payable quarterly on March 31, June 30, September 30 and December 31 of each year. The debentures will mature and the capital securities must be redeemed on September 30, 2029. Heartland has the option to shorten the maturity date to a date not earlier than September 30, 2004. Heartland will not shorten the maturity date without prior approval of the Board of Governors of the Federal Reserve System, if required. Prior redemption is permitted under certain circumstances such as changes in tax or regulatory capital rules. In connection with this offering, $1,137 of deferred issuance costs was recorded in other assets. Future payments at December 31, 1999, for all other borrowings were as follows: 2001 $ 14,570 2002 15,987 2003 14,505 2004 6 Thereafter 31,589 -------- Total $ 76,657 ======== TWELVE EMPLOYEE BENEFIT PLANS Heartland sponsors a retirement plan covering substantially all employees. Contributions to this plan are subject to approval by the Heartland Board of Directors. The Heartland subsidiaries fund and record as an expense all approved contributions. Costs charged to operating expenses were $530 for 1999, $435 for 1998 and $418 for 1997. This plan includes an employee savings program, under which the Heartland subsidiaries make matching contributions of up to 2% of the participants' wages. Costs charged to operating expenses were $183 for 1999, $161 for 1998 and $150 for 1997. Heartland also has a non-contributory, defined contribution pension plan covering substantially all employees. Annual contributions are based upon 5% of qualified compensation as defined in the plan. Costs charged to operating expense were $530 for 1999, $435 for 1998 and $418 for 1997. THIRTEEN COMMITMENTS AND CONTINGENT LIABILITIES Heartland leases certain land and facilities under operating leases. Minimum future rental commitments at December 31, 1999, for all non-cancelable leases were as follows: 2000 $ 476 2001 484 2002 433 2003 393 2004 413 Thereafter 691 ------ Total $2,890 ====== Rental expense for premises and equipment leased under operating leases was $521 for 1999, $268 for 1998 and $78 for 1997. In the normal course of business, the Banks make various commitments and incur certain contingent liabilities that are not presented in the accompanying consolidated financial statements. The commitments and contingent liabilities include various guarantees, commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit, is based upon management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. Standby letters of credit and financial guarantees written are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. At December 31, 1999 and 1998, commitments to extend credit aggregated $274,406 and $229,332 and standby letters of credit aggregated $9,564 and $6,230, respectively. Heartland does not anticipate any material loss as a result of the commitments and contingent liabilities. FOURTEEN STOCK PLANS Heartland's Stock Option Plan ("Plan") is administered by the Compensation Committee ("Committee") of the Board of Directors whose members determine to whom options will be granted and the terms of each option. Under the Plan, 1,200,000 common shares have been reserved for issuance. Directors and key policy-making employees are eligible for participation in the Plan. Options may be granted that are either intended to be "incentive stock options" as defined under Section 422 of the Internal Revenue Code or not intended to be incentive stock options ("non- qualified stock options"). The exercise price of stock options granted will be established by the Committee, but the exercise price for the incentive stock options may not be less than the fair market value of the shares on the date that the option is granted. Each option granted is exercisable in full at any time or from time to time, subject to vesting provisions, as determined by the Committee and as provided in the option agreement, but such time may not exceed ten years from the grant date. At December 31, 1999 and 1998 respectively, there were 283,467 and 468,519 shares available for issuance under the Plan. Under the Plan, stock appreciation rights ("SARS") may also be granted alone or in tandem with or with reference to a related stock option, in which event the grantee, at the exercise date, has the option to exercise the option or the SARS, but not both. SARS entitle the holder to receive in cash or stock, as determined by the Committee, an amount per share equal to the excess of the fair market value of the stock on the date of exercise over the fair market value at the date the SARS or related options were granted. SARS may be exercisable for up to ten years after the date of grant. No SARS have been granted under the Plan. A summary of the status of the Plan as of December 31, 1999, 1998 and 1997, and changes during the years ended follows: 1999 1998 1997 Weighted- Weighted- Weighted- Average Average Average Shares Exercise Shares Exercise Shares Exercise (000) Price (000) Price (000) Price ------ --------- ------ --------- ------ --------- Outstanding at beginning of year 654 $10 522 $ 9 392 $ 8 Granted 274 18 196 15 146 12 Exercised (79) 19 (28) 15 (4) 13 Forfeited (89) 19 (36) 16 (12) 13 --- --- --- Outstanding at end of year 760 $11 654 $10 522 $ 9 === === === Options exercisable at end of year 6 $12 6 $12 6 $12 Weighted-average fair value of options granted during the year $1.96 $3.65 $3.83 As of December 31, 1999 and 1998, options outstanding had exercise prices ranging from $8 to $18 per share and a weighted- average remaining contractual life of 6.77 and 7.40 years, respectively. The fair value of stock options granted was determined utilizing the Black Scholes Valuation model. Significant assumptions include: 1999 1998 1997 -------- -------- --------- Risk-free interest rate 6.28% 5.75% 6.30% Expected option life 10 Years 10 Years 10 Years Expected volatility 13.04% 24.27% 24.27% Expected dividends 1.94% 1.76% 2.17% Heartland applies APB Opinion No. 25 in accounting for its 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 "Accounting for Stock-Based Compensation", Heartland's net income would have been reduced to the pro forma amounts indicated below: 1999 1998 1997 ------ ------ ------ Net income as reported $8,225 $9,021 $8,515 Pro forma 7,890 8,745 8,317 Earnings per share-basic as reported $ .86 $ .95 $ .90 Pro forma .83 .92 .88 Earnings per share-diluted as reported $ .84 $ .94 $ .89 Pro forma .81 .91 .86 Pro forma net income reflects only options granted in 1999, 1998, 1997, 1996 and 1995. Therefore, the full impact of calculating compensation cost for stock options under FAS No. 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, 1995, is not considered. In 1996, Heartland adopted the Heartland Employee Stock Purchase Plan ("ESPP"), which permits all eligible employees to purchase shares of Heartland common stock at a price of not less than 85% of the fair market value on the determination date (as determined by the Committee). A maximum of 400,000 shares is available for sale under the ESPP. For the years ended December 31, 1999 and 1998, Heartland approved a price of 100% of fair market value at December 31, 1998 and December 31, 1997, respectively. At December 31, 1999 and 1998, respectively, 16,481 and 15,333 shares were purchased under the ESPP at no charge to Heartland's earnings. In 1991, Heartland adopted a stock purchase plan which provides executive officers of Heartland and the Banks the opportunity to purchase up to a cumulative total of 400,000 common shares of Heartland stock. Under this plan, Heartland may issue treasury shares at a price equal to the price paid when acquired as treasury shares. Cumulative shares sold through December 31, 1997 under the plan were 399,800. Total compensation expense associated with this plan was $267 for 1997. No additional shares are anticipated to be issued under this plan. A summary of the activity in the executive restricted stock purchase plan for the year ended December 31, 1997 follows: 1997 ------- Granted 55,268 Exercised 55,068 Forfeited 200 Average Offering Price $ 8.10 During each of the years ended December 31, 1999, 1998 and 1997, Heartland acquired shares for use in the executive stock purchase plan, the Plan and the ESPP. Shares acquired totaled 44,907, 290,924 and 65,670 for 1999, 1998 and 1997, respectively. FIFTEEN FAIR VALUE OF FINANCIAL INSTRUMENTS Following are disclosures of the estimated fair value of Heartland's financial instruments. The estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts Heartland could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. December 31, December 31, 1999 1998 ------------------------------------ Carrying Fair Carrying Fair Amount Value Amount Value ------------------------------------- Financial Assets: Cash and cash equivalents $ 35,953 $ 35,953 $ 42,831 $ 42,831 Time deposits in other banks 6,084 6,084 6,127 6,127 Securities available for sale 209,381 209,381 239,770 239,770 Securities held to maturity 2,196 2,264 2,718 2,871 Loans and leases, net of unearned 835,146 829,931 590,133 594,185 Financial Liabilities: Demand deposits $ 91,391 $ 91,391 $ 70,871 $ 70,871 Savings deposits 367,413 367,413 292,852 292,852 Time deposits 410,855 408,313 354,154 358,044 Short-term borrowings 132,300 132,300 75,920 75,920 Other borrowings 76,657 84,796 57,623 58,872 Cash and Cash Equivalents and Time Deposits in Other Banks - The carrying amount is a reasonable estimate of fair value. Securities - For securities either held to maturity or available for sale, fair value equals quoted market price if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loans and Leases - The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of loans held for sale is estimated using quoted market prices. Deposits - The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. Short-term and Other Borrowings - Rates currently available to the Banks for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. Commitments to Extend Credit, Unused Lines of Credit and Standby Letters of Credit - Based upon management's analysis of the off balance sheet financial instruments, there are no significant unrealized gains or losses associated with these financial instruments based upon our review of the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. SIXTEEN REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS ON SUBSIDIARY DIVIDENDS The Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Banks' financial statements. The regulations prescribe specific capital adequacy guidelines that involve quantitative measures of a bank's assets, liabilities and certain off balance sheet items as calculated under regulatory accounting practices. Capital classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 1999 and 1998, that the Banks met all capital adequacy requirements to which they were subject. As of December 31, 1999, the most recent notification from the FDIC categorized each of the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution's category. The Banks' actual capital amounts and ratios are also presented in the table below. To Be Well Capitalized Under Prompt For Capital Corrective Adequacy Action Actual Purposes Provisions -------------- -------------- ------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------- ----- ------- ----- As of December 31, 1999 Total Capital (to Risk- Weighted Assets) Consolidated $112,508 11.68% $ 77,035 >8.0% $ N/A - DB&T 51,041 10.75 37,980 >8.0 47,475 >10.0% GSB 11,604 12.16 7,635 >8.0 9,544 >10.0 FCB 9,033 12.01 6,016 >8.0 7,520 >10.0 RCB 6,555 11.57 4,534 >8.0 5,667 >10.0 WCB 15,704 10.99 11,430 >8.0 14,287 >10.0 NMB 15,306 19.02 6,438 >8.0 8,048 >10.0 Tier 1 Capital (to Risk- Weighted Assets) Consolidated $101,665 10.56% $ 38,517 >4.0% $ N/A - DB&T 46,049 9.70 18,990 >4.0 28,485 >6.0 GSB 10,411 10.91 3,818 >4.0 5,726 >6.0 FCB 8,092 10.76 3,008 >4.0 4,512 >6.0 RCB 5,969 10.53 2,267 >4.0 3,400 >6.0 WCB 14,012 9.81 5,715 >4.0 8,572 >6.0 NMB 14,556 18.09 3,219 >4.0 4,829 >6.0 Tier 1 Capital (to Average Assets) Consolidated $101,665 8.85% $ 45,965 >4.0% $ N/A - DB&T 46,049 7.94 23,212 >4.0 29,015 >5.0 GSB 10,411 7.68 5,424 >4.0 6,780 >5.0 FCB 8,092 8.08 4,007 >4.0 5,009 >5.0 RCB 5,969 8.23 2,900 >4.0 3,625 >5.0 WCB 14,012 8.43 6,648 >4.0 8,310 >5.0 NMB 14,556 18.00 3,235 >4.0 4,044 >5.0 To Be Well Capitalized Under Prompt For Capital Corrective Adequacy Action Actual Purposes Provisions -------------- -------------- ------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------- ----- ------- ----- As of December 31, 1998 Total Capital (to Risk- Weighted Assets) Consolidated $89,093 12.13% $58,757 >8.0% N/A DB&T 44,380 10.10 35,144 >8.0 $43,930 >10.0% GSB 10,850 13.66 6,353 >8.0 7,941 >10.0 FCB 9,385 13.53 5,551 >8.0 6,939 >10.0 RCB 4,818 11.23 3,431 >8.0 4,288 >10.0 WCB 4,774 13.60 2,809 >8.0 3,511 >10.0 NMB 14,901 45.85 2,600 >8.0 3,250 >10.0 Tier 1 Capital (to Risk- Weighted Assets) Consolidated $81,149 11.05% $29,379 >4.0% N/A DB&T 39,960 9.10 17,572 >4.0 $26,358 >6.0% GSB 9,857 12.41 3,177 >4.0 4,765 >6.0 FCB 8,516 12.27 2,776 >4.0 4,163 >6.0 RCB 4,398 10.26 1,715 >4.0 2,573 >6.0 WCB 4,358 12.41 1,405 >4.0 2,107 >6.0 NMB 14,535 44.72 1,300 >4.0 1,950 >6.0 Tier 1 Capital (to Average Assets) Consolidated $81,149 8.58% $37,810 >4.0% N/A DB&T 39,960 7.38 21,670 >4.0 $27,088 >5.0% GSB 9,857 7.76 5,082 >4.0 6,353 >5.0 FCB 8,516 8.36 4,073 >4.0 5,092 >5.0 RCB 4,398 7.03 2,502 >4.0 3,127 >5.0 WCB 4,358 9.14 1,908 >4.0 2,385 >5.0 NMB 14,535 40.62 1,431 >4.0 1,789 >5.0 The ability of Heartland to pay dividends to its stockholders is dependent upon dividends paid by its subsidiaries. The Banks are subject to certain statutory and regulatory restrictions on the amount they may pay in dividends. To maintain acceptable capital ratios in the Banks, certain portions of their retained earnings are not available for the payment of dividends. Retained earnings which could be available for the payment of dividends to Heartland totaled approximately $35,210 as of December 31, 1999, under the most restrictive minimum capital requirements. SEVENTEEN PARENT COMPANY ONLY FINANCIAL INFORMATION Condensed financial information for Heartland Financial USA, Inc. is as follows: Balance Sheets December 31, 1999 1998 -------- -------- Assets: Cash and interest bearing deposits $ 3,744 $ 695 Investment in subsidiaries 124,924 100,585 Other assets 2,434 1,442 Due from subsidiaries 7,550 - -------- -------- Total $138,652 $102,722 ======== ======== Liabilities and stockholders' equity: Liabilities: Short-term borrowings $ 4,594 $ 823 Other borrowings 47,364 17,378 Accrued expenses and other liabilities 121 251 -------- -------- Total liabilities 52,079 18,452 -------- -------- Stockholders' equity: Common stock 9,707 9,707 Capital surplus 15,339 14,984 Retained earnings 65,132 60,154 Accumulated other comprehensive income (1,511) 2,107 Treasury stock (2,094) (2,682) -------- -------- Total stockholders' equity 86,573 84,270 -------- -------- Total $138,652 $102,722 ======== ======== Income Statements for the Years Ended December 31, 1999 1998 1997 ------ ------ ------ Operating revenues: Dividends from subsidiaries $8,515 $7,413 $2,621 Other 201 173 10 ------ ------ ------ Total operating revenues 8,716 7,586 2,631 ------ ------ ------ Operating expenses: Interest 2,087 1,115 208 Outside services 172 151 219 Other operating expenses 450 442 350 ------ ------ ------ Total operating expenses 2,709 1,708 777 ------ ------ ------ Equity in undistributed earnings 1,430 2,684 6,398 ------ ------ ------ Income before income tax benefit 7,437 8,562 8,252 Income tax benefit 788 459 263 ------ ------ ------ Net income $8,225 $9,021 $8,515 ====== ====== ====== Statements of Cash Flows For the Years Ended December 31, 1999 1998 1997 ------- ------- ------- Cash flows from operating activities: Net income $ 8,225 $ 9,021 $ 8,515 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed earnings of subsidiaries (1,430) (2,684) (6,398) (Increase) decrease in due from subsidiaries (7,550) 1,350 (1,135) Increase (decrease) in other liabilities (130) (6) 167 (Increase) decrease in other assets (992) 261 (1,499) ------- ------- ------- Net cash provided (used) by operating activities (1,877) 7,942 (350) ------- ------- ------- Cash flows from investing activities: Capital injections for subsidiaries (26,580) (13,152) (2,855) Receipts for sale of minority interest 58 - - Payments for purchase of subsidiaries - - (7,890) Retirement of subsidiary stock - - 4,500 Other (5) 2 - ------- ------- ------- Net cash used by investing activities (26,527) (13,150) (6,245) ------- ------- ------- Cash flows from financing activities: Payments on other borrowings (15,823) (7,018) (1,042) Proceeds from other borrowings 49,580 18,895 7,365 Cash dividends paid (3,247) (2,928) (2,465) Purchase of treasury stock (837) (4,431) (865) Sale of treasury stock 1,780 669 1,110 ------- ------- ------- Net cash provided by financing activities 31,453 5,187 4,103 ------- ------- ------- Net increase (decrease) in cash and cash equivalents 3,049 (21) (2,492) Cash and cash equivalents at beginning of year 695 716 3,208 ------- ------- ------- Cash and cash equivalents at end of year $ 3,744 $ 695 $ 716 ======= ======= ======= INDEPENDENT AUDITORS' REPORT The Board of Directors Heartland Financial USA, Inc.: We have audited the accompanying consolidated balance sheets of Heartland Financial USA, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Heartland Financial USA, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles. KPMG LLP Des Moines, Iowa January 20, 2000 Representations of Management Management is responsible for the contents of the consolidated financial statements and other information contained in other sections of this annual report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles appropriate to reflect, in all material respects, the substance of events and transactions that should be included. The consolidated financial statements reflect management's judgments and estimates as to the effects of events and transactions that are accounted for or disclosed. The company maintains accounting and reporting systems, supported by an internal accounting control system, which are adequate to provide reasonable assurance that transactions are authorized, assets are safeguarded, and reliable consolidated financial statements are prepared, recognizing the cost and expected benefits of internal accounting controls. A staff of internal auditors conducts ongoing reviews of accounting practices and internal accounting controls. The consolidated financial statements as of December 31, 1999, 1998 and 1997, of Heartland Financial USA, Inc. and its subsidiaries: Dubuque Bank and Trust Company; Galena State Bank and Trust Company; Riverside Community Bank; Wisconsin Community Bank; New Mexico Bank & Trust; First Community Bank, FSB; DB&T Insurance, Inc.; DB&T Community Development Corp.; Citizens Finance Co.; ULTEA, Inc.; Keokuk Bancshares, Inc. (dba KBS Investment Corp); DBT Investment Corporation; and Heartland Capital Trust I were audited by independent certified public accountants. Their role is to render independent professional opinions of the fairness of the consolidated financial statements based upon performance of procedures they deem appropriate under generally accepted auditing standards. The Audit Committees of the Boards of Directors of member banks meet periodically with the internal auditors to review matters relating to internal accounting controls and the nature, extent and results of audit efforts. The internal auditors and independent certified public accountants have free access to the Audit Committees. /s/ Lynn B. Fuller - ------------------------------ Lynn B. Fuller President and CEO, Heartland Financial USA, Inc. /s/ John K. Schmidt - ------------------------------ John K. Schmidt Executive Vice President and CFO, Heartland Financial USA, Inc. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The information in the Heartland Proxy Statement for the 2000 annual meeting of stockholders dated April 5, 2000 (the "2000 Proxy Statement") under the caption "Election of Directors" and under the caption, "Security Ownership of Directors and Executive Officers and Certain Beneficial Owners" is incorporated by reference. The information regarding executive officers is included pursuant to Instruction 3 to Item 401 (b) and (c) of Regulation S-K and is noted below. EXECUTIVE OFFICERS The term of office for the executive officers of Heartland is from the date of election until the next annual organizational meeting of the board of directors. The names and ages of the executive officers of Heartland as of December 31, 1999, offices held by these officers on that date and other positions held with Heartland and its subsidiaries are set forth below. Position with Heartland and Subsidiaries Name Age and Principal Occupation Lynn B. Fuller 50 Director, President and Chief Executive Officer of Heartland; Director of DBT, GSB, FCB, WCB, NMB, Keokuk, DB&T Insurance, Citizens, DBT Investment and DB&T Development; President of DB&T Insurance, DB&T Development and Citizens; Chairman and Director of RCB; Chairman and Director of ULTEA. Lynn S. Fuller 75 Chairman of the Board of Heartland; Director and Vice Chairman of the Board of DB&T; Director of DB&T Insurance, Citizens and DB&T Development James A. Schmid 76 Vice Chairman of the Board of Heartland; Chairman of the Board of DB&T; Director of DB&T Insurance, Citizens and DB&T Development John K. Schmidt 40 Executive Vice President and Chief Financial Officer of Heartland; President and Chief Executive Officer of DB&T; Treasurer of DB&T Insurance and Citizens; Director of DBT Investment; Vice President and Assistant Secretary of ULTEA Kenneth J. Erickson 48 Executive Vice President of Heartland; Senior Vice President, Lending of DB&T; Senior Vice President of Cit- izens; Director of ULTEA Edward H. Everts 48 Senior Vice President, Heartland; Senior Vice President of Operations and Retail Banking of DB&T Douglas J. Horstmann 46 Senior Vice President, Lending of Heartland; Senior Vice President, Lending of DB&T; Executive Vice President of DB&T Development Paul J. Peckosh 54 Senior Vice President, Trust of Heartland; Senior Vice President of DB&T Mr. Lynn B. Fuller is the son of Mr. Lynn S. Fuller. There are no other family relationships among any of the directors or executive officers of Heartland. Lynn B. Fuller has been a director of Heartland and of DB&T since 1984 and has been President of Heartland since 1987. He has been a director of GSB since its acquisition by Heartland in 1992 and of Keokuk and FCB since the merger in 1994. Mr. Fuller joined DB&T in 1971 as a consumer loan officer and was named DB&T's Executive Vice President and Chief Executive Officer in 1985. He was named Chairman and Director of RCB in conjunction with the opening of the de novo operation in 1995, Director of WCB in conjunction with the purchase of Cottage Grove State Bank in 1997 and Director of NMB in conjunction with the opening of the de novo bank in 1998. Mr. Fuller was President of DB&T from 1987 until 1999 at which time he was named Chief Executive Officer of Heartland. Lynn S. Fuller has been a director of Heartland since its formation in 1981 and of DB&T since 1964. Mr. Fuller began his banking career in 1946 in Minnesota, and he returned to Iowa in 1949 to serve as Executive Vice President and Cashier of Jackson State Savings Bank in Maquoketa. Mr. Fuller joined DB&T in 1964. He was later named President of DB&T and held this position until 1987 and was Chief Executive Officer until 1999. Mr. Fuller remains as the Chairman of the Board of Heartland. James A. Schmid has been a director of Heartland since its formation in 1981 and of DB&T since 1966. Mr. Schmid also currently serves as the Vice Chairman of Heartland and as the Chairman of the Board of DB&T. John K. Schmidt has been Heartland's Executive Vice President and Chief Financial Officer since 1991. He has been employed by DB&T since September, 1984 and became DB&T's Vice President, Finance in 1986, Senior Vice President and Chief Financial Officer in January, 1991 and President and Chief Executive Officer in 1999. Mr. Schmidt is a certified public accountant and worked at KPMG LLP in Des Moines, Iowa, from 1982 until joining DB&T. Kenneth J. Erickson was named Executive Vice President of Heartland in 1999 and has served as Senior Vice President since 1992 and Senior Vice President, Lending of DB&T since 1989. Mr. Erickson joined DB&T in 1975 and was appointed Vice President, Commercial Loans in 1985. Edward H. Everts was appointed as Senior Vice President of Heartland in 1996. Mr. Everts joined DB&T as Senior Vice President, Operations and Retail Banking in 1992. Prior to his service with DB&T, Mr. Everts was Vice President and Lead Retail Banking Manager of First Bank, Duluth, Minnesota. Douglas J. Horstmann was named as Senior Vice President of Heartland in 1999 and has been Senior Vice President, Lending, of DB&T since 1989. Mr. Horstmann joined DB&T in 1980 and was appointed Vice President, Commercial Loans in 1985. Prior to joining DB&T, Mr. Horstmann was an examiner for the Iowa Division of Banking. Paul J. Peckosh was appointed Senior Vice President of Heartland in 1999 and has been Senior Vice President, Trust, of DB&T since 1991. Mr. Peckosh joined DB&T in 1975 as Assistant Vice President, Trust and was appointed Vice President, Trust in 1980. Mr. Peckosh is an attorney and graduated from the Marquette University of Law School in 1970. ITEM 11. EXECUTIVE COMPENSATION The information in the 2000 Proxy Statement, under the caption "Executive Compensation" is incorporated by reference, except for the information contained under the heading "Compensation Committee Report on Executive Compensation" and "Stockholder Return Performance Presentation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information in the 2000 Proxy Statement, under the caption "Security Ownership of Certain Beneficial Owners and Management" is incorporated by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information in the 2000 Proxy Statement under the caption "Transactions with Management" is incorporated by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The documents filed as a part of this report are listed below: 3. Exhibits The exhibits required by Item 601 of Regulation S-K are included along with this Form 10-K and are listed on the "Index of Exhibits" immediately following the signature page. (b) Reports of Form 8-K: There were no reports on Form 8-K filed during the last quarter of the period covered by this report. SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 22, 2000. Heartland Financial USA, Inc. By:/s/ Lynn S. Fuller /s/ John K. Schmidt ------------------------ ------------------------ Lynn S. Fuller John K. Schmidt Chairman and Executive Vice President Principal Executive Officer and Principal Financial and Accounting Officer Date: March 22, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 22, 2000. /s/ Lynn B. Fuller /s/ Lynn S. Fuller - ----------------------------- ----------------------------- Lynn B. Fuller Lynn S. Fuller President and Director Chairman, CEO and Director /s/ James A. Schmid /s/ Mark C. Falb - ----------------------------- ----------------------------- James A. Schmid Mark C. Falb Vice Chairman and Director Director /s/ Gregory R. Miller /s/ Evangeline K. Jansen - ----------------------------- ----------------------------- Gregory R. Miller Evangeline K. Jansen Director and Director Executive Vice President /s/ Robert Woodward - ----------------------------- Robert Woodward Director 3. Exhibits 3.1 Certificate of Incorporation of Heartland Finan- cial USA, Inc. (Filed as Exhibit 3.1 to Registrant's Form S-4 for the fiscal year ended December 31, 1993, and incorporated by reference herein.) 3.2 Bylaws of Heartland Financial USA, Inc. (Filed as Exhibit 3.2 to Registrant's Form S-4 for the fiscal year ended December 31, 1993, and incorporated by ref- erence herein.) 4.1 Specimen Stock Certificate of Heartland Financial USA, Inc. (Exhibit 4.1 to the Registration Statement on Form S-4 filed with the Commission May 4, 1994, as amended (SEC File No. 33-76228) 10.1 Heartland Financial USA, Inc. 1993 Stock Option Plan (Filed as Exhibit 10.1 to Registrant's Form S-4 for the fiscal year ended December 31, 1993, and incorporated by reference herein.) 10.2 Heartland Financial USA, Inc. Executive Restricted Stock Purchase Plan (Filed as Exhibit 10.2 to Registrant's Form S-4 for the fiscal year ended December 31, 1993, and in- corporated by reference herein.) 10.3 Dubuque Bank and Trust Management Incentive Compensation Plan (Filed as Exhibit 10.3 to Registrant's Form S-4 for the fiscal year ended December 31, 1993, and incorporated by reference herein.) 10.4 Heartland Financial Money Purchase Pension Plan and Defined Contribution Master Plan and Trust Agreement dated January 1, 1995. (Filed as Exhibit 10.21 to Registrant's Form 10-K for the fiscal year ended December 31, 1995, and incorporated by reference herein.) 10.5 Dubuque Bank and Trust Company Executive Death Benefit Program Plan Revisions, Enrollment Booklet, and Universal Life Split-Dollar Agreement effective December 1, 1995, and similar agreements are in place at Galena State Bank and Trust Company, First Community Bank, FSB, Riverside Community Bank, Wisconsin Community Bank, New Mexico Bank & Trust and ULTEA. (Filed as Exhibit 10.25 to Registrant's Form 10-K for the fiscal year ended December 31, 1995, and incorporated by reference herein.) 10.6 Investment Center Agreement between Focused Investment LLC and Heartland Financial USA, Inc. dated August 1, 1995. (Filed as Exhibit 10.30 to Registrant's Form 10-K for the fiscal year ended December 31, 1995, and incorporated by reference herein.) 10.7 Heartland Financial USA, Inc. Employee Stock Purchase Plan effective January 1, 1996. (Filed in conjunction with Form S-8 on June 18, 1996, and incorporated by reference herein.) 10.8 License and Service Agreement, Software License Agreement, and Professional Services Agreement between Fiserv and Heartland Financial USA, Inc. dated June 21, 1996. (Filed as Exhibit 10.43 to Registrant's form 10Q for the quarter ended June 30, 1996, and incorporated by reference herein.) 10.9 The Stock Purchase Agreement between Heartland Financial USA, Inc. and the stockholders of Cottage Grove State Bank dated November 8, 1996. (Filed as Exhibit 10.36 to Regis- trant's Form 10K for the fiscal year ended December 31, 1996, and incorporated by reference herein.) 10.10 Stockholder Agreement between Heartland Financial USA, Inc. and Investors in the Proposed New Mexico Bank dated November 5, 1997. (Filed as Exhibit 10.23 to Registrant's Form 10K for the fiscal year ended December 31, 1997, and incorporated by reference herein.) 10.11 Change of Control Agreements including Golden Parachute Payment Adjustments and Restrictive Covenants between Heartland Financial USA, Inc. and Executive Officers dated January 1, 1999. (Filed as Exhibit 10.11 to Registrant's Form 10K for the fiscal year ended December 31, 1998, and incorporated by reference herein.) 10.12 Change of Control Agreements between Heartland Financial USA, Inc. and Executive Officers dated January 1, 1999. (Filed as Exhibit 10.12 to Registrant's Form 10K for the fiscal year ended December 31, 1998, and incorporated by reference herein.) 10.13 Heartland Financial USA, Inc. Health Care Plan dated January 1, 1999. (Filed as Exhibit 10.13 to Registrant's Form 10K for the fiscal year ended December 31, 1998, and incorporated by reference herein.) 10.14 Letter Agreement between Wisconsin Community Bank and Bank One Wisconsin dated February 9, 1999. (Filed as Exhibit 10.14 to Registrant's Form 10K for the fiscal year ended December 31, 1998, and incorporated by reference herein.) 10.15 Office Purchase and Assumption Agreement by and between Bank One Wisconsin and Wisconsin Community Bank dated February 9, 1999, excluding Schedules A through S. (Filed as Exhibit 10.15 to Registrant's Form 10K for the fiscal year ended December 31, 1998, and incorporated by reference herein.) 10.16 Amended and Restated Credit Agreement between Heartland Financial USA, Inc. and The Northern Trust Company dated July 23, 1999 (Filed as Exhibit 10.16 to Registrant's Form 10Q for the six months ended June 30, 1999, and incorporated by reference herein.) 10.17 Agreement and Plan of Merger, dated as of August 17, 1999, by and among Heartland Financial USA, Inc., National Bancshares, Inc. and NBI Acquisition Corporation. (Filed as Exhibit 2.1 to Registrant's Form 8K dated August 25, 1999, and incorporated by reference herein.) 10.18 Amendment Agreement, dated as of November 1, 1999, between Heartland Financial USA, Inc. and the Northern Trust Company 11. Statement re Computation of Per Share Earnings 21.1 Subsidiaries of the Registrant 23.1 Consent of KPMG LLP 27.1 Financial Data Schedule 99.1 2000 Proxy Statement (only such parts as are incorporated by reference into this Form 10-K) EX-10 2 AMENDMENT TO LOAN AGREEMENT Exhibit 10.18 AMENDMENT, DATED AS OF NOVEMBER 1, 1999 THIS AMENDMENT AGREEMENT, dated as of November 1, 1999, is entered into between HEARTLAND FINANCIAL USA, INC., a Delaware corporation (the "BORROWER"), and THE NORTHERN TRUST COMPANY, an Illinois banking corporation having its principal office at 50 South LaSalle Street, Chicago, Illinois 60675 (the "BANK"). RECITALS: A. The Borrower and the Bank have entered into an Amended and Restated Credit Agreement, dated as of July 23, 1999, (said Agreement, as amended, shall hereinafter be referred to as "THE AGREEMENT"). Terms defined in the Agreement and not otherwise defined herein shall be used herein as in the Agreement. B. The Borrower and the Bank wish to amend the Agreements to change the definition of "Tangible Net Worth" by executing this Amendment. C. Therefore, the parties hereto agree as follows: 1. AMENDMENTS TO THE AGREEMENT. 1.1 SECTION 8.1(K) OF THE AGREEMENT. SECTION 8.1(K) of the Agreement is hereby amended and restated in its entirety as of the date hereof as follows. "(k) The term "Tangible Net Worth" shall mean at any date Borrower's Tier 1 Capital, as defined herein." 2. WARRANTIES. To induce the Bank to enter into this Amendment, the Borrower warrants that: 2.1 AUTHORIZATION. The Borrower is duly authorized to execute and deliver this Amendment and is and will continue to be duly authorized to borrow monies under the Notes, and to perform its obligations under the Agreement, as amended hereby, and under the Notes. 2.2 NO CONFLICTS. The execution and delivery of this Amendment, and the performance by the Borrower of its obligations under the Agreement, as amended hereby, and under the Notes, do not and will not conflict with any provision of law or of the charter or by-laws of the Borrower or of any agreement binding upon the Borrower. 2.3 VALIDITY AND BINDING EFFECT. The Agreement, as amended hereby, is, and when duly executed and delivered will be legal, valid and binding obligation of the Borrower, enforceable against the Borrower in accordance with its terms, except as enforceability may be limited by bankruptcy, insolvency or other similar laws of general application affecting the enforcement of creditors' rights or by general principles of equity limiting the availability of equitable remedies. 3. CONDITIONS PRECEDENT TO AMENDMENT. The amendment contemplated by SECTION 1 hereof is subject to the satisfaction of each of the following conditions precedent: 3.1 DOCUMENTATION. The Borrower shall have delivered to the Bank all of the following, each duly executed and dated the closing date hereof, in form and substance satisfactory to the Bank: (a) AMENDMENT. This Amendment. (b) INCUMBENCY CERTIFICATE. A certificate of the secretary or an assistant secretary of the Borrower certifying the names of the Borrower's officers authorized to sign this Amendment and all other documents or certificates to be delivered hereunder, together with the true signatures of such officers. (c) CERTIFICATE. A certificate of the president or chief financial officer of the Borrower as to the matters set out in SECTION 3.2 and 3.3 hereof. (d) GUARANTORS' ACKNOWLEDGMENT. The acknowledgment and consent of each Guarantor to this Amendment as evidenced by its signed acknowledgment of this Amendment on the signature page hereof. (e) OTHER. Such other documents as the Bank may reasonably request. 3.2 NO DEFAULT. As of the closing date hereof, no Event of Default or Unmatured Event of Default under the Agreements shall have occurred and be continuing. 3.3 WARRANTIES. As of the closing date hereof, the warranties in the Agreement and in SECTION 2 of this Amendment shall be true and correct as though made on such date, except for such changes as are specifically permitted under the Agreement. 4. GENERAL. 4.1 EXPENSES. The Borrower agrees to pay the Bank upon demand for all reasonable expenses, including reasonable attorneys' and legal assistants' fees (which attorneys and legal assistants may be employees of the Bank), incurred by the Bank in connection with the preparation, negotiation and execution of this Amendment and any document required to be furnished herewith or therewith. 4.2 LAW. THIS AMENDMENT SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE INTERNAL LAWS OF THE STATE OF ILLINOIS. 4.3 SUCCESSORS. This Amendment shall be binding upon the Borrower and the Bank and their respective successors and assigns, and shall inure to the benefit of the Borrower and the Bank and the successors and assigns of the Bank. 4.4 CONFIRMATION OF THE AGREEMENT. The Agreement, as amended hereby, shall remain in full force and effect and is hereby ratified and confirmed in all respects. 4.5 REFERENCES TO THE AGREEMENT. Each reference in the Agreement to "this Agreement," "hereunder," "hereof," or words of similar import in instruments or documents provided for in such Agreement or delivered or to be delivered there- under or in connection therewith, shall, except where the context otherwise requires, be deemed a reference to such Agreement as amended hereby. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed at Chicago, Illinois by their respective officers thereunto duly authorized as of the date first written above. HEARTLAND FINANCIAL USA, INC. By: -------------------------- Title ------------------------ THE NORTHERN TRUST COMPANY By: -------------------------- Title ------------------------ GUARANTOR ACKNOWLEDGMENT Each of the undersigned Guarantors hereby acknowledges and consents to Borrower's execution of this Amendment. CITIZENS FINANCE CO., as Guarantor ULTEA, INC., as Guarantor By: By: ----------------------------- --------------------------- Title Title --------------------------- ------------------------- The Northern Trust Company 50 South LaSalle Street Chicago, Illinois 60675 Re: Amendment, dated as of November 1, 1999 (the "AMENDMENT"), between Heartland Financial USA, Inc. (the "BORROWER") and The Northern Trust Company (the "BANK") Ladies and Gentlemen: This certificate is being delivered to the Bank pursuant to SECTION 4.1(C) of the Amendment. Terms used in this certificate which are defined in the Amendment shall have the same meaning herein as therein. In connection with Borrower's execution of the Amendment, the undersigned officer of the Borrower hereby certifies as follows: 1. No Event of Default or Unmatured Event of Default under the Agreement or Notes has occurred and is continuing. 2. The warranties in the Agreement and in SECTION 2 of the Amendment are true and correct as of the date hereof as though made on the date hereof, except for such changes as are specifically permitted under the Agreement. Very truly yours, Dated November 1, 1999 HEARTLAND FINANCIAL USA, INC. By: ------------------------- Title: ---------------------- EX-11 3 EARNINGS PER SHARE Exhibit 11 EARNINGS PER SHARE Net income for the year ended December 31, 1999 $8,225,000 ========== Weighted average common shares outstanding 9,555,194 Assumed incremental common shares issued upon exercise of stock options 196,280 ---------- Weighted average common shares for diluted earnings per share 9,751,474 ========== Earnings per common share - basic $ .86 ===== Earnings per common share - diluted $ .84 ===== EX-21 4 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT 1. Galena State Bank and Trust Company, an Illinois state bank with its main office located in Galena, Illinois 2. Dubuque Bank and Trust Company, an Iowa state bank with its main office located in Dubuque, Iowa 2.a. DB&T Insurance, Inc. 2.b. DB&T Community Development Corp. 3. Keokuk Bancshares, Inc. (dba KBS Investment Corp.) 4. First Community Bank, FSB, a federal savings bank with its main office located in Keokuk, Iowa 4.a. KFS Services, Inc. 5. Riverside Community Bank, an Illinois state bank with its main office located in Rockford, Illinois 6. Citizens Finance Co. 7. ULTEA 7.a. Autorent Wisconsin, Inc. 7.b. Econo Lease, Inc. 8. Wisconsin Community Bank, a Wisconsin bank with its main office located in Cottage Grove, Wisconsin 8.a. DBT Investment Corporation 9. New Mexico Bank & Trust, a New Mexico state bank with its main office located in Albuquerque, New Mexico EX-23 5 AUDITOR'S CONSENT EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT The Board of Directors and Stockholders Heartland Financial USA, Inc.: We consent to incorporation by reference in the Registration Statement on Form S-8 for the 1993 Stock Option Plan of Heartland Financial USA, Inc. of our report dated on January 20, 2000, relating to the consolidated balance sheets of Heartland Financial USA, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 1999 which report appears in the December 31, 1999 annual report on Form 10-K of Heartland Financial USA, Inc. and subsidiaries. KPMG LLP Des Moines, Iowa March 27, 2000 EX-27 6 FDS SCHEDULE FOR 12-99 10K
9 0000920112 HEARTLAND FINANCIAL USA, INC. 1,000 12-MOS DEC-31-1999 DEC-31-1999 33,084 7,078 1,875 000 209,381 2,196 2,264 835,146 (10,844) 1,184,147 869,659 132,300 18,958 76,657 000 000 9,707 76,866 1,184,147 60,947 12,329 878 74,154 31,180 40,849 33,305 2,626 713 44,722 11,381 8,225 000 000 8,225 .86 .84 3.64 1,414 236 000 000 7,945 (635) 243 10,884 9,888 000 956
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