10-Q 1 f10q301.txt 10-Q FOR 03/31/2001 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarterly period ended March 31, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For transition period __________ to __________ Commission File Number: 0-24724 HEARTLAND FINANCIAL USA, INC. (Exact name of Registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 42-1405748 (I.R.S. employer identification number) 1398 Central Avenue, Dubuque, Iowa 52001 (Address of principal executive offices Zip Code) (319)589-2100 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the classes of Registrant's common stock as of the latest practicable date: As of May 9, 2001, the Registrant had outstanding 9,597,776 shares of common stock, $1.00 par value per share. HEARTLAND FINANCIAL USA, INC. Form 10-Q Quarterly Report Table of Contents Part I Item 1. Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Part II Item 1. Legal Proceedings Item 2. Changes in Securities Item 3. Defaults Upon Senior Securities Item 4. Submission of Matters to a Vote of Security Holders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K Form 10-Q Signature Page HEARTLAND FINANCIAL USA, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share data) 3/31/01 12/31/00 (Unaudited) ----------- ---------- ASSETS Cash and due from banks $ 38,924 $ 38,387 Federal funds sold 44,400 46,300 ----------- ----------- Cash and cash equivalents 83,324 84,687 Time deposits in other financial institutions 1,121 1,504 Securities: Trading 871 - Available for sale-at fair value (cost of $257,118 for 2001 and $223,892 for 2000) 261,731 225,954 Held to maturity-at cost (approximate fair value of $2,154 for 2000) - 2,111 Loans and leases: Held for sale 18,471 18,127 Held to maturity 1,039,317 1,023,969 Allowance for loan and lease losses (14,100) (13,592) ----------- ----------- Loans and leases, net 1,043,688 1,028,504 Assets under operating leases 34,680 35,285 Premises, furniture and equipment, net 29,895 30,155 Other real estate, net 402 583 Goodwill and core deposit premium, net 20,245 20,661 Other assets 36,093 36,943 ----------- ----------- TOTAL ASSETS $1,512,050 $1,466,387 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Deposits: Demand $ 123,688 $ 136,066 Savings 389,682 406,712 Time 591,733 558,535 ----------- ----------- Total deposits 1,105,103 1,101,313 Short-term borrowings 198,057 175,084 Other borrowings 82,357 67,681 Accrued expenses and other liabilities 27,189 26,163 ----------- ----------- TOTAL LIABILITIES 1,412,706 1,370,241 ----------- ----------- STOCKHOLDERS' EQUITY: Preferred stock (par value $1 per Share; authorized, 200,000 shares) - - Common stock (par value $1 per share; authorized, 12,000,000 shares; issued 9,905,783 shares at March 31, 2001, and December 31, 2000) 9,906 9,906 Capital surplus 18,812 18,812 Retained earnings 72,843 71,253 Accumulated other comprehensive income 2,909 1,301 Treasury stock at cost (287,573 shares at March 31, 2001, and December 31, 2000) (5,126) (5,126) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 99,344 96,146 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,512,050 $1,466,387 =========== =========== See accompanying notes to consolidated financial statements. HEARTLAND FINANCIAL USA, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in thousands, except per share data) Three Months Ended 3/31/01 3/31/00 -------- -------- INTEREST INCOME: Interest and fees on loans and leases $ 23,412 $ 20,184 Interest on securities: Taxable 3,120 3,114 Nontaxable 471 425 Interest on federal funds sold 689 49 Interest on interest bearing deposits in other financial institutions 48 101 -------- -------- TOTAL INTEREST INCOME 27,740 23,873 -------- -------- INTEREST EXPENSE: Interest on deposits 12,476 9,565 Interest on short-term borrowings 2,552 2,138 Interest on other borrowings 1,450 1,461 -------- -------- TOTAL INTEREST EXPENSE 16,478 13,164 -------- -------- NET INTEREST INCOME 11,262 10,709 Provision for loan and lease losses 721 819 -------- -------- NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES 10,541 9,890 -------- -------- OTHER INCOME: Service charges and fees 1,461 1,155 Trust fees 766 714 Brokerage commissions 126 245 Insurance commissions 251 192 Securities gains, net 572 243 Loss on trading account securities (225) - Rental income on operating leases 3,854 3,652 Gain on sale of loans 393 40 Other noninterest income 228 212 -------- -------- TOTAL OTHER INCOME 7,426 6,453 -------- -------- OTHER EXPENSES: Salaries and employee benefits 6,210 5,916 Occupancy 825 756 Furniture and equipment 806 726 Depreciation on equipment under operating leases 2,918 2,738 Outside services 753 761 FDIC deposit insurance assessment 51 68 Advertising 379 359 Goodwill and core deposit intangibles amortization 418 454 Other operating expenses 1,913 1,732 -------- -------- TOTAL OTHER EXPENSES 14,273 13,510 -------- -------- INCOME BEFORE INCOME TAXES 3,694 2,833 Income taxes 1,238 789 -------- -------- NET INCOME $ 2,456 $ 2,044 ======== ======== EARNINGS PER COMMON SHARE-BASIC $ 0.26 $ 0.21 EARNINGS PER COMMON SHARE-DILUTED 0.25 0.21 CASH DIVIDENDS DECLARED PER COMMON SHARE 0.09 0.09 See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (Unaudited) (Dollars in thousands, except per share data) Common Capital Retained Stock Surplus Earnings ------- ------- -------- Balance at January 1, 2000 $ 9,707 $15,339 $65,132 Net Income - - 2,044 Unrealized loss on securities available for sale - - - Reclassification adjustment for gains realized in income - - - Income taxes - - - Comprehensive income Cash dividends declared: Common, $.09 per share - - (868) Issue of 198,531 shares of common stock 199 3,396 Purchase of 278,318 shares of common stock - - - Sale of 120,478 shares of common stock - 84 - ------- ------- ------- Balance at March 31, 2000 $ 9,906 $18,819 $66,308 ======= ======= ======= Balance at January 1, 2001 $ 9,906 $18,812 $71,253 Net Income - - 2,456 Unrealized gain on securities available for sale - - - Reclassification adjustment for gains realized in income - - - Income taxes - - - Comprehensive income Cash dividends declared: Common, $.09 per share - - (866) ------- ------- ------- Balance at March 31, 2001 $ 9,906 $18,812 $72,843 ======= ======= ======= Accumulated Other Comprehensive Treasury Income (Loss) Stock Total ------------- -------- ----- Balance at January 1, 2000 $(1,511) $(2,094) $86,573 Net Income - - 2,044 Unrealized loss on securities available for sale (711) - (711) Reclassification adjustment for gains realized in income (243) - (243) Income taxes 324 - 324 ------- Comprehensive income 1,414 Cash dividends declared: Common, $.09 per share - - (868) Issue of 198,531 shares of common stock - - 3,595 Purchase of 278,318 shares of common stock - (5,002) (5,002) Sale of 120,478 shares of common stock - 2,094 2,178 ------- ------- ------- Balance at March 31, 2000 $(2,141) $(5,002) $87,890 ======= ======= ======= Balance at January 1, 2001 $ 1,301 $(5,126) $96,146 Net Income - - 2,456 Unrealized gain on securities available for sale 1,864 - 1,864 Reclassification adjustment for gains realized in income 572 - 572 Income taxes (828) - (828) ------- Comprehensive income 4,064 Cash dividends declared: Common, $.09 per share - - (866) ------- ------- ------- Balance at March 31, 2001 $ 2,909 $(5,126) $99,344 ======= ======= ======= See accompanying notes to consolidated financial statements. HEARTLAND FINANCIAL USA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) Three Months Ended 3/31/01 3/31/00 ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,456 $ 2,044 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,131 4,034 Provision for loan and lease losses 721 819 Provision for income taxes 951 128 Net amortization/(accretion) of premium/(discount) on securities (29) (10) Securities gains, net (572) (243) Loss on trading account securities 225 - Loans originated for sale (27,352) (7,168) Proceeds on sales of loans 22,599 3,369 Net gain on sales of loans (393) (40) Decrease (increase) in accrued interest receivable 883 (917) Increase (decrease) in accrued interest payable 45 (135) Other, net 303 1,248 --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 3,968 3,129 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds on maturities of time deposits in other financial institutions 383 993 Proceeds from the sale of securities available for sale 25,574 23,748 Proceeds from the maturity of and principal paydowns on securities held to maturity - 975 Proceeds from the maturity of and principal paydowns on securities available for sale 6,025 14,626 Purchase of securities available for sale (62,114) (37,585) Purchase of trading account securities (1,095) - Net increase in loans and leases (10,651) (44,541) Increase in assets under operating leases (3,523) (3,188) Capital expenditures (503) (1,150) Net cash and cash equivalents received in acquisition of subsidiaries - 18,603 --------- --------- NET CASH USED BY INVESTING ACTIVITIES (45,904) (27,519) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in demand deposits and savings accounts (29,408) (11,306) Net increase in time deposit accounts 33,198 26,625 Proceeds from other borrowings 20,532 4,906 Net increase in short-term borrowings 17,117 15,291 Purchase of treasury stock - (5,002) Dividends (866) (868) --------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES 40,573 29,646 --------- --------- Net increase (decrease) in cash and cash equivalents (1,363) 5,256 Cash and cash equivalents at beginning of year 84,687 35,953 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 83,324 $ 41,209 ========= ========= Supplemental disclosures: Cash paid for income/franchise taxes $ 199 $ 106 ========= ========= Cash paid for interest $ 16,523 $ 12,963 ========= ========= Securities held to maturity transferred to securities available for sale $ 2,111 $ - ========= ========= Other borrowings transferred to short-term borrowings $ 5,856 $ 2,439 ========= ========= Acquisitions: Assets acquired $ - $119,858 ========= ========= Cash paid for purchase of stock $ - $(14,364) Cash acquired - 32,967 --------- --------- Net cash received in acquisitions $ - $ 18,603 ========= ========= See accompanying notes to consolidated financial statements. HEARTLAND FINANCIAL USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BASIS OF PRESENTATION The interim unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and accompanying notes to the financial statements for the fiscal year ended December 31, 2000, included in Heartland Financial USA, Inc.'s (the "Company") Form 10-K filed with the Securities and Exchange Commission on March 30, 2001. Accordingly, footnote disclosure which would substantially duplicate the disclosure contained in the audited consolidated financial statements has been omitted. The financial information of the Company included herein is prepared pursuant to the rules and regulations for reporting on Form 10-Q. Such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of results for the interim periods. The results of the interim period ended March 31, 2001, are not necessarily indicative of the results expected for the year ending December 31, 2001. Basic earnings per share is determined using net income and weighted average common shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted average common shares and assumed incremental common shares issued. Amounts used in the determination of basic and diluted earnings per share for the three month periods ended March 31, 2001 and 2000, are shown in the tables below: Three Months Ended 3/31/01 3/31/00 ------- ------- Net Income (000's) $ 2,456 $ 2,044 ======= ======= Weighted average common shares outstanding for basic earnings per share (000's) 9,618 9,634 Assumed incremental common shares issued upon exercise of stock options (000's) 107 155 ------- ------- Weighted average common shares for diluted earnings per share (000's) 9,725 9,789 ======= ======= Trading Account Securities - Trading securities represent those securities Heartland intends to actively trade and are stated at fair value with changes in market value reflected in other income. During the first quarter of 2001, Heartland began purchasing securities, on a limited basis, with the intent of actively trading those securities. 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 No. 137, Deferring Statement 133's Effective Date, which defers the effective date for implementation of FAS NO. 133 by one year, making FAS No. 133 effective no later than January 1, 2001, for Heartland's financial statements. In June 2000, the FASB issued FAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of FAS No. 133. Heartland implemented FAS No. 133 on January 1, 2001, and reclassified, at that date, all investments previously included in its held to maturity investment portfolio to the available for sale investment portfolio. There was no material impact on the consolidated financial statements as a result of the implementation. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SAFE HARBOR STATEMENT 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 laws, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, accounting principles, policies and guidelines, 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, Heartland's ability to develop and maintain secure and reliable electronic systems and implement new technologies. 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. GENERAL Heartland's results of operations depend primarily on net interest income, which is the difference between interest income from interest earning assets and interest expense on interest bearing liabilities. Noninterest income includes service charges, fees and gains on loans, rental income on operating leases and trust income. Heartland's principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy and equipment costs, depreciation on equipment under operating leases and provision for loan and lease losses. Earnings for the year were off to a good start as first quarter net income increased $412 thousand or 20%. Net income totaled $2.456 million, or $.26 on a basic per common share basis, for the first quarter of 2001 compared to $2.044 million, or $.21 on a basic per common share basis, during the same quarter in 2000. Return on common equity was 10.24% and return on assets was .67% for the first quarter of 2001. For the same period in 2000, return on equity was 9.41% and return on assets was .63%. The expansion of Heartland's franchise and the diversification of its earnings stream continue to provide the payoffs anticipated as reflected in the double-digit growth in earnings. Despite some signs of a weakening economy, Heartland's management team remains enthused about the future and focused on expanding the customer base in all the markets it serves. Contributing to the improved earnings during the first quarter of 2001 was the $973 thousand or 15% increase in other income while the increase in other expense was held to $763 thousand or 6%. The other income categories reflecting significant improvement were service charges and fees, rental income on operating leases and gains on sale of loans. Also contributing to the improved earnings was the $553 thousand or 5% growth in net interest income due primarily to growth in earning assets. Average earning assets went from $1.150 billion during the first quarter of 2000 to $1.321 billion during the same quarter in 2001, a change of $171 million or 15%. NET INTEREST INCOME Net interest margin, expressed as a percentage of average earning assets, was 3.54% during the first quarter of 2001 compared to 3.84% for the same period in 2000. During the first quarter of 2000, national prime increased from 8.50% to 9.00%. Conversely, during the first quarter of 2001, national prime decreased from 9.50% to 8.00%. In spite of the rapid change in the rate environment during the first quarter of 2001, the net interest margin was held to a slight decline when compared to the 3.61% recorded during the fourth quarter of 2000. For the three month period ended March 31, 2001, interest income increased $3.9 million or 16% when compared to the same period in 2000. This increase was primarily attributable to the growth in earning assets. For the three month period ended March 31, 2001, interest expense increased $3.3 million or 25% when compared to the same period in 2000. The growth in interest expense outpaced the growth in interest income as Heartland was not able to reprice its deposit products as quickly as market rates declined. Management continues to focus efforts on improving the mix of its funding sources to minimize its interest costs. PROVISION FOR LOAN AND LEASE LOSSES The provision for loan losses decreased $98 thousand or 12% during the first quarter of 2001 when compared to the same period in 2000. This decrease was primarily reflective of a change in the amount of growth experienced in the loan portfolio during the two quarters under comparison. During the first quarter of 2001, loan growth was slower than the first quarter of the previous year due to paydowns experienced in the mortgage portfolio and reduced demand in the commercial portfolio. Management feels that opportunities for growth within the commercial portfolio will expand during the remaining months of 2001. The adequacy of the allowance for loan and lease losses is determined by management using factors that include the overall composition of the loan portfolio, general economic conditions, types of loans, past loss experience, loan delinquencies, and potential substandard and doubtful credits. For additional details on the specific factors considered during this quarter refer to the loans and allowance for loan and lease losses section of this report. OTHER INCOME Total other income increased $973 thousand or 15% during the quarter ended on March 31, 2001, compared to the same period in 2000. The other income categories reflecting significant improvement were service charges and fees, rental income on operating leases and gains on sale of loans. Service charges and fees increased $306 thousand or 26% during the quarters under comparison. The $14.1 million or 13% growth in checking accounts for the twelve-month period ended on March 31, 2001, resulted in the generation of additional service charge revenue related to activity fees charged to these accounts. Also contributing to the increase in service charges and fees was the growth in fees collected for the processing of merchant credit card activity. Gains on sale of loans increased by $353 thousand or 882% for the periods under comparison. The volume of mortgage loans sold into the secondary market during the first quarter of 2001 was significantly greater than those sold during the same period in 2000. As rates moved downward, customers frequently elected to take fifteen- and thirty-year, fixed-rate mortgage loans, which Heartland usually elects to sell into the secondary market. Rental income on operating leases increased $202 thousand or 6% during the first quarter of 2001. This increase resulted from the normal replacement of vehicles under lease at our vehicle leasing and fleet management subsidiary, ULTEA. As vehicles within a fleet are replaced every three or four years, rent levels rise correspondingly to the increase in the cost of new vehicles. During the first quarter of 2001, securities gains were $329 thousand or 135% above the amount recorded during the same period in 2000. During the first quarter of 2000, gains on the equity portfolio were partially offset by losses realized when short- term agency securities were sold and replaced with longer-term agency securities to enhance the future total return of the portfolio. These trades were made because Heartland's interest rate forecast called for declining rates during 2000. During the first quarter of 2001, Heartland's interest rate forecast changed to a rising rate bias on the long end of the yield curve, and therefore, longer-term agency securities were sold at a gain to shorten the portfolio. The proceeds were invested in well- seasoned mortgage-backed securities that were projected to outperform the agency securities in a rising rate environment. A loss of $225 thousand on trading account securities was recorded during the first quarter of 2001. To take advantage of market opportunities, Heartland elected to begin classifying a portion of its securities portfolio as trading during the first quarter of 2001. The only other income category to experience a decrease during the quarters under comparison was brokerage commissions, which declined $119 thousand or 49%. Due to volatility in the stock market, brokerage transactions were significantly below those normally occurring as customers elected to defer active trading. OTHER EXPENSE Total other expense was held to an increase of $763 thousand or 6% during the first quarter of 2001 when compared to the same quarter in 2000. The categories making up $655 thousand or 86% of this change were salaries and employee benefits, depreciation on equipment under operating leases and other operating expenses. Salaries and employee benefits, the largest component of other expense, increased $294 thousand or 5% for the quarters under comparison. In addition to normal merit increases, this increase was also attributable to expansion efforts at New Mexico Bank & Trust. The number of full-time equivalent employees employed by Heartland increased from 535 at March 31, 2000, to 551 at March 31, 2001. Consistent with the vehicle replacement activity occurring at ULTEA, the depreciation on equipment under operating leases grew $180 thousand or 7% for the first quarter of 2001. Other operating expenses increased $181 thousand or 10% for the quarters under comparison. Over half of this increase was the result of additional processing fees related to the increased activity in the merchant credit card processing area. INCOME TAX EXPENSE Income tax expense for the first quarter of 2001 increased $449 thousand or 57% when compared to the same period in 2000. This increase was primarily the result of a corresponding increase in pre-tax earnings. Heartland's effective tax rate increased to 33.51% during the first quarter of 2001 compared to 27.85% for the first quarter of 2000, in part, as a result of a decrease in the amount of tax-exempt income recorded during 2001. Tax-exempt income was 15% of pre-tax income during the first quarter of 2001 compared to 19% for the same quarter in 2000. FINANCIAL CONDITION LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES Total loans and leases increased slightly during the first three months of 2001. Loan growth was slower than the first quarter of 2000 due to paydowns experienced in the mortgage loan portfolio and reduced demand in the commercial loan portfolio. Management feels that opportunities for growth within the commercial portfolio will expand during the remaining months of 2001. Commercial and commercial real estate loans increased by $28.3 million or 5% during the first three months of 2001. All the bank subsidiaries, except for First Community Bank in Keokuk, Iowa, experienced growth in this loan category as a result of continued calling efforts. The Dubuque, Iowa and Albuquerque, New Mexico markets were responsible for $17.6 million or 62% of this growth. During the first quarter of 2001, the residential mortgage loan portfolio experienced a decline of $11.9 million or 5%. As long- term rates decreased, customers decided to refinance their mortgage loans into fifteen- and thirty-year fixed rate loans, which Heartland usually sells into the secondary market. Servicing is retained on a majority of these loans so that the Heartland bank subsidiaries have an opportunity to continue providing their customers the excellent service they expect. The table below presents the composition of the loan portfolio as of March 31, 2001, and December 31, 2000. LOAN PORTFOLIO (Dollars in thousands) March 31, December 31, 2001 2000 Amount Percent Amount Percent ------ ------- ------ ------- Commercial and commercial real estate $ 578,633 54.50% $ 550,366 52.62% Residential mortgage 203,703 19.19 215,638 20.62 Agricultural and agricultural real estate 135,034 12.72 133,614 12.78 Consumer 127,109 11.97 128,685 12.30 Lease financing, net 17,249 1.62 17,590 1.68 ---------- ------- ---------- ------- Gross loans and leases $1,061,728 100.00% $1,045,893 100.00% ======= ======= Unearned discount (3,365) (3,397) Deferred loan fees (575) (400) ---------- ---------- Total loans and leases 1,057,788 1,042,096 Allowance for loan and lease losses (14,100) (13,592) ---------- ---------- Loans and leases, net $1,043,688 $1,028,504 ========== ========== 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 the loan review committee included the following: - Heartland has continued to experience growth in more- complex commercial loans as compared to relatively lower-risk residential real estate loans. - Heartland has entered new markets in which it had little or no previous lending experience. - The amount of nonperforming loans has trended upward during the past year. - The nation appears to be entering a period of economic slowdown. There can be no assurances that the allowance for loan and lease losses will be adequate to cover all losses, but management believes that the allowance for loan and lease losses was adequate at March 31, 2001. While management uses available information to provide for loan and lease losses, the ultimate collectibility of a substantial portion of the loan portfolio and the need for future additions to the allowance will be based on changes in economic conditions. Along with other financial institutions, management shares a concern for the possible continued softening of the economy in 2001. Should the economic climate continue to deteriorate, borrowers may experience difficulty, and the level of non-performing loans, charge-offs, and delinquencies could rise and require further increases in the provision. The allowance for loan and lease losses increased by $508 thousand or 4% during the first three months of 2001. At March 31, 2001, the allowance for loan and lease losses was 1.33% of loans and 249% of nonperforming loans, compared to 1.30% of loans and 202% of nonperforming loans, at year-end 2000. Nonperforming loans decreased to .54% of total loans and leases at March 31, 2001, compared to .65% of total loans and leases at December 31, 2000. This decrease was primarily the result of a pay down on one large credit. During the first quarter of 2001, Heartland recorded net charge offs of $213 thousand compared to $310 thousand for the same period in 2000. The acquisition of First National Bank of Clovis in New Mexico was responsible for $299 thousand or 96% of the net charge-offs during the first quarter of 2000. Heartland's loan review area, along with management at New Mexico Bank & Trust, have spent considerable time aggressively managing the exposure within the loan portfolio in this newest market for Heartland. Comprising 79% of the net charge-offs during the first quarter of 2001 were losses at Citizens Finance, Heartland's consumer finance subsidiary. Increased losses at Citizens Finance relate directly to the rapid growth it experienced over the past two years with expansion into the Appleton, Wisconsin and Rockford, Illinois markets. Due to the newness of a large portion of the portfolio, the identification of problem loans in the portfolio had not occurred until the portfolio began to mature. Losses as a percentage of gross loans at Citizens was 2.89% for the first quarter of 2001 compared to 2.87% for the year ended on December 31, 2000. Loans with payments past due for more than thirty days decreased from 4.67% of gross loans at December 31, 2000, to 3.94% at March 31, 2001. These ratios compare favorably to the consumer finance industry. SECURITIES The composition of Heartland's securities portfolio is managed to maximize the return on the portfolio while considering the impact it has on Heartland's asset/liability position and liquidity needs. Securities represented 17% of total assets at March 31, 2001, as compared to 16% at December 31, 2000. During 2000, management elected to replace paydowns received on mortgage-backed securities with U.S. government agency securities to lengthen the portfolio. U.S. government agency securities offer a better total return in a declining interest rate environment, which was Heartland's forecast at the time. The state tax-exempt nature of selected U.S. government agency securities also made them attractive purchases for Heartland's Illinois bank subsidiaries. As Heartland's interest rate forecast changed to one of rising rates, except for the short end of the yield curve, management elected to shift a portion of its securities portfolio into mortgage-backed securities from U.S. government agencies during the first quarter of 2001. Tightly structured tranches in well-seasoned mortgage-backed securities were purchased to enhance the performance of the portfolio given a rise in interest rates. Because of the well-seasoned nature of the mortgage-backed securities purchased, management anticipates that risk of prepayment within Heartland's securities portfolio has been minimized. The table below presents the composition of the securities portfolio by major category as of March 31, 2001, and December 31, 2000. SECURITIES PORTFOLIO (Dollars in thousands) March 31, December 31, 2001 2000 Amount Percent Amount Percent ------ ------- ------ ------- U.S. Treasury securities $ 496 .19% $ - -% U.S. government agencies 107,108 40.79 118,897 52.13 Mortgage-backed securities 108,245 41.22 53,407 23.42 States and political subdivisions 34,917 13.29 34,044 14.93 Other securities 11,836 4.51 21,717 9.52 -------- ------- -------- ------- Total securities $262,602 100.00% $228,065 100.00% ======== ======= ======== ======= DEPOSITS AND BORROWED FUNDS Total deposits remained flat during the first three months of 2001. The demand and savings deposit categories experienced a decrease during the quarter while certificate of deposit account balances increased. The $12.3 million or 9% decline in demand deposit balances was due primarily to normal seasonal fluctuations that many banks experience during the first quarter of the year. A shift from savings to certificate of deposit accounts continued into the first quarter of 2001 as deposit customers became more interested in certificate of deposit products and less interested in savings products. Also, with the volatility in the stock market, customers elected to keep a larger portion of their funds invested in certificates of deposit. Short-term borrowings generally include federal funds purchased, treasury tax and loan note options, securities sold under agreement to repurchase and short-term Federal Home Loan Bank ("FHLB") advances. These funding alternatives are utilized in varying degrees depending on their pricing and availability. Over the three month period ended March 31, 2001, the amount of short-term borrowings had increased $23.0 million or 13%. Nearly half this growth was the result of growth in repurchase agreement balances. Also included in short-term borrowings are the credit lines Heartland entered into with two unaffiliated banks. Under the unsecured credit lines, Heartland may borrow up to $50.0 million. At March 31, 2001, $42.0 million was outstanding as compared to $39.3 million at December 31, 2000. Other borrowings increased $14.7 million or 22% during the first three months of 2001. Included in these borrowings are long-term FHLB advances, which totaled $40.6 million on March 31, 2001, with a weighted average remaining term of 4.0 years and a weighted average rate of 5.61%. As rates moved downward during the first quarter of 2001, Heartland obtained additional long- term FHLB advances. On December 31, 2000, long-term FHLB advances totaled $25.1 million. CAPITAL RESOURCES Bank regulatory agencies have adopted capital standards by which all bank holding companies will be evaluated. Under the risk- based method of measurement, the resulting ratio is dependent upon not only the level of capital and assets, but the composition of assets and capital and the amount of off-balance sheet commitments. Heartland's capital ratios were as follows for the dates indicated: CAPITAL RATIOS (Dollars in thousands) March 31, December 31, 2000 2000 Amount Ratio Amount Ratio ------ ----- ------ ----- Risk-Based Capital Ratios:(1) Tier 1 capital $ 104,268 8.84% $ 102,443 8.74% Tier 1 capital minimum requirement 47,155 4.00% 46,878 4.00% ---------- ------ ---------- ------ Excess $ 57,113 4.84% $ 55,565 4.74% ========== ====== ========== ====== Total capital $ 118,368 10.04% $ 116,034 9.90% Total capital minimum requirement 94,309 8.00% 93,756 8.00% ---------- ------ ---------- ------ Excess $ 24,059 2.04% $ 22,278 1.90% ========== ====== ========== ====== Total risk-adjusted assets $1,178,863 $1,171,951 ========== ========== Leverage Capital Ratios:(2) Tier 1 capital $ 104,268 7.16% $ 102,443 7.25% Tier 1 capital minimum requirement(3) 58,256 4.00% 56,492 4.00% ---------- ------ ---------- ------ Excess $ 46,012 3.16% $ 45,951 3.25% ========== ====== ========== ====== Average adjusted assets (less goodwill) $1,456,399 $1,412,301 ========== ========== (1)Based on the risk-based capital guidelines of the Federal Reserve, a bank holding company is required to maintain a Tier 1 capital to risk-adjusted assets ratio of 4.00% and total capital to risk-adjusted assets ratio of 8.00%. (2)The leverage ratio is defined as the ratio of Tier 1 capital to average adjusted assets. (3)Management of Heartland has established a minimum target leverage ratio of 4.00%. Based on Federal Reserve guidelines, a bank holding company generally is required to maintain a leverage ratio of 3.00% plus additional capital of at least 100 basis points. Commitments for capital expenditures are an important factor in evaluating capital adequacy. The acquisition and merger of Lease Associates Group into ULTEA in July of 1998 included an agreement to make three equal remaining cash payments to the previous principal stockholder of $643 thousand, plus interest at 7.50%, with the final payment due in 2001. On January 1, 2000, Heartland completed its acquisition of National Bancshares, Inc., the one-bank holding company of First National Bank of Clovis. At the discretion of the stockholders, a portion of the purchase price was made in notes payable over three or five years, bearing interest at 7.00%. The remaining requisite cash payments under these notes payable total $855 thousand in 2002, and $637 thousand in 2003 and 2004, plus interest. In October of 1999, Heartland completed an offering of $25 million of 9.60% cumulative capital securities. All of the securities qualified as Tier 1 capital for regulatory purposes as of March 31, 2001. Subsequent acquisitions accounted for under the purchase method of accounting could cause a portion of these securities to not qualify 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. These securities are classified as other borrowings on Heartland's financial statements. 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. LIQUIDITY Liquidity measures the ability of Heartland to meet maturing obligations and its existing commitments, to withstand fluctuations in deposit levels, to fund its operations and to provide for customers' credit needs. The liquidity of Heartland principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings and its ability to borrow funds in the money or capital markets. Net cash outflows from investing activities increased $18.4 million during the first three months of 2001 compared to the same period in 2000. The acquisition of First National Bank of Clovis provided net cash and cash equivalents of $18.6 million during the first quarter of 2000. The net increase in loans and leases was $10.6 million during the first three months of 2000 compared to $44.5 million during the same period in 200, a $33.9 million change. During the first three months of 2001, proceeds from the sale and maturity of securities decreased $7.8 million compared to the same period in 2000. Conversely, the purchases of securities increased $25.6 million for the periods under comparison. As loan growth was below the levels experienced during the first quarter of 2000, additional securities purchases were made to enhance the net interest margin. Financing activities provided net cash of $40.6 million during the first three months of 2001 compared to $29.6 million during the same period in 2000. A net increase in deposit accounts provided cash of $3.8 million during the first three months of 2001 compared to $15.3 million during the same period in 2000. Offsetting the decline in growth in deposits for the periods under comparison, other borrowings provided cash of $20.5 million in 2001 compared to $4.9 million in 2000. Total cash inflows from operating activities increased $839 thousand for the first three months of 2001 compared to the same period in 2000. Management of investing and financing activities, and market conditions, determine the level and the stability of net interest cash flows. Management attempts to mitigate the impact of changes in market interest rates to the extent possible, so that balance sheet growth is the principal determinant of growth in net interest cash flows. In the event of short-term liquidity needs, the bank subsidiaries may purchase federal funds from each other or from correspondent banks and may also borrow from the Federal Reserve Bank. Additionally, the subsidiary banks' FHLB memberships give them the ability to borrow funds for short- and long-term purposes under a variety of programs. Heartland's revolving credit agreements, as of March 31, 2001, provided an additional borrowing capacity of $8.0 million. These agreements contain specific covenants which, among other things, limit dividend payments and restrict the sale of assets by Heartland under certain circumstances. Also contained within the agreements are certain financial covenants, including the maintenance by Heartland of a maximum nonperforming assets to total loans ratio, minimum return on average assets ratio and maximum funded debt to total equity capital ratio. In addition, Heartland and each of its bank subsidiaries must remain well capitalized, as defined from time to time by the federal banking regulators. At March 31, 2001, Heartland was in compliance with the covenants contained in these credit agreements. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Dollars in thousands) Market risk is the risk of loss arising from adverse changes in market prices and rates. Heartland's market risk is comprised primarily of interest rate risk resulting from its core banking activities of lending and deposit gathering. Interest rate risk measures the impact on earnings from changes in interest rates and the effect on current fair market values of Heartland's assets, liabilities and off-balance sheet contracts. The objective is to measure this risk and manage the balance sheet to avoid unacceptable potential for economic loss. Management continually develops and applies strategies to mitigate market risk. Exposure to market risk is reviewed on a regular basis by the asset/liability committees at the banks and, on a consolidated basis, by the Heartland board of directors. Management does not believe that Heartland's primary market risk exposures and how those exposures have been managed to-date in 2001 changed significantly when compared to 2000. PART II ITEM 1. LEGAL PROCEEDINGS There are no material pending legal proceedings to which the Company or its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses. ITEM 2. CHANGES IN SECURITIES None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K Exhibits None Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized. HEARTLAND FINANCIAL USA, INC. (Registrant) Principal Executive Officer /s/ Lynn B. Fuller ----------------------- By: Lynn B. Fuller President Principal Financial and Accounting Officer /s/ John K. Schmidt ----------------------- By: John K. Schmidt Executive Vice President and Chief Financial Officer Dated: May 14, 2001