Heartland Financial USA, Inc. Reports Second Quarter 2013 Results

Heartland Financial USA, Inc. Reports Second Quarter 2013 Results

Quarterly Highlights

• Net income of $9.6 million or diluted earnings per common share of $0.54

• Return on average common equity of 11.28%

• Net interest margin of 3.71%

• Provision for loan and lease losses decreased $1.1 million or 38% over second quarter 2012

• Loan growth of $42.5 million or 6% annualized since March 31, 2013

• Announced merger agreement with Morrill Bancshares, Inc.

• Completed repurchase of minority shares in Minnesota Bank & Trust

DUBUQUE, Iowa--(BUSINESS WIRE)-- Heartland Financial USA, Inc.:

Heartland Financial USA, Inc. (Nasdaq: HTLF) today reported net income of $9.6 million for the quarter ended June 30, 2013, which was a decrease from the $14.0 million recorded for the second quarter of 2012. Net income available to common stockholders was $9.4 million, or $0.54 per diluted common share, for the quarter ended June 30, 2013, compared to $12.9 million, or $0.77 per diluted common share, for the second quarter of 2012. Return on average common equity was 11.28% and return on average assets was 0.76% for the second quarter of 2013, compared to 18.28% and 1.20%, respectively, for the same quarter in 2012.

Earnings for the second quarter of 2013 were below Heartland's quarterly earnings record set in the second quarter of 2012, primarily as a result of a $3.6 million decrease in gains on sale of loans and a $2.9 million decrease in securities gains, coupled with a $4.1 million increase in salaries and employee benefits. Positively affecting earnings for the second quarter of 2013, in comparison to the second quarter of 2012, were an increase in net interest income, a reduction in provision for loan and lease losses and an increase in loan servicing income. Loan growth picked up during the second quarter of 2013.

Commenting on Heartland's second quarter results, Lynn B. Fuller, Heartland's chairman, president and chief executive officer said, "Heartland reported a good second quarter of 2013 with earnings of $9.6 million. We were pleased to see new loan demand in the quarter and our net interest margin held up reasonably well. While mortgage loan originations increased over the same period of 2012, the recent rise in long-term interest rates negatively impacted the gains on sale of residential mortgage loans."

Net income recorded for the first six months of 2013 was $22.1 million, compared to $26.8 million recorded during the first six months of 2012. Net income available to common stockholders was $21.4 million, or $1.25 per diluted common share, for the six months ended June 30, 2013, compared to $24.8 million, or $1.48 per diluted common share, earned during the first six months of 2012. Return on average common equity was 13.19% and return on average assets was 0.88% for the first six months of 2013, compared to 17.78% and 1.16%, respectively, for the same period in 2012.

Earnings for the first six months of 2013, in comparison to the first six months of 2012, were positively affected by an increase in net interest income, a lower provision for loan and lease losses and an increase in loan servicing income. The first quarter of 2012 noninterest income included $2.0 million in equity earnings from the sale of two low-income housing projects within partnerships in which Dubuque Bank and Trust Company was a member. In addition to the absence of comparable other noninterest income during the first half of 2013, reduced securities gains and significant increases in salaries and employee benefits, occupancy and furniture and equipment expenses offset the improvements discussed above.

Net Interest Margin Percentage Remains Stable; Increases in Dollars

Net interest margin, expressed as a percentage of average earning assets, was 3.71% during the second quarter of 2013 compared to 3.77% during the first quarter of 2013 and 4.05% for the second quarter of 2012. For the six-month periods ended June 30, net interest margin was 3.74% during 2013 and 4.14% during 2012.

Fuller said, "We are pleased to see net interest margin hold relatively steady at 3.71% in the second quarter compared to the previous quarter. Going forward, we expect margin to stay in its current range as some opportunity remains in reducing deposit cost while an increase in loan volume will benefit interest income."

On a tax-equivalent basis, interest income in the second quarter of 2013 was $50.2 million compared to $48.8 million in the second quarter of 2012, an increase of $1.4 million or 3%. For the first six months of 2013, interest income on a tax-equivalent basis was $100.2 million compared to $98.7 million during the same period in 2012, an increase of $1.5 million or 1%. Average earning assets increased $591.6 million or 15% during the second quarter of 2013 compared to the second quarter of 2012 and $605.6 million or 16% during the first six months of 2013 compared to the same period in 2012, with approximately $225.0 million of the growth in both periods attributable to the three acquisitions completed during the second half of 2012. The average interest rate earned on total average earning assets was 4.51% during the second quarter of 2013 compared to 5.07% during the second quarter of 2012. For the first six months of the year, the average interest rate earned on these assets was 4.56% during 2013 compared to 5.19% during 2012.

Interest expense for the second quarter of 2013 was $8.9 million, a decrease of $1.0 million or 10% from $9.9 million in the second quarter of 2012. On a six-month comparative basis, interest expense decreased $2.0 million or 10%. Even though average interest bearing liabilities increased $293.6 million or 9% for the quarter ended June 30, 2013, as compared to the same quarter in 2012, and $312.5 million or 10% for the six-month period ended on June 30, 2013, as compared to the same six-month period in 2012, the average interest rate paid on Heartland's deposits and borrowings declined 22 basis points during the quarterly period under comparison and 24 basis points during the six-month period under comparison. Contributing to this improvement in interest expense was a continued change in the mix of deposits. Average savings balances, the lowest cost interest bearing deposits, as a percentage of total average interest bearing deposits, were 70% during both the second quarter and first six-month periods of 2013 compared to 69% for both the second quarter and first six-month periods of 2012. Additionally, the average interest rate paid on savings deposits was 0.30% during the second quarter and 0.32% during the first six months of 2013 compared to 0.40% during both the second quarter and first six months of 2012.

Net interest income on a tax-equivalent basis totaled $41.3 million during the second quarter of 2013, an increase of $2.3 million or 6% from the $39.0 million recorded during the second quarter of 2012. For the first six months of 2013, net interest income on a tax-equivalent basis was $82.3 million, an increase of $3.5 million or 4% from the $78.8 million recorded during the first six months of 2012.

Decrease in Noninterest Income; Increase in Noninterest Expenses

Noninterest income was $24.9 million during the second quarter of 2013 compared to $28.3 million during the second quarter of 2012, a decrease of $3.4 million or 12%. For the six-month period ended June 30, noninterest income was $51.3 million in 2013 compared to $51.7 million in 2012, a decrease of $340,000 or 1%. Although noninterest income was negatively affected by decreased securities gains and gains on sale of loans in both the quarterly and six-month comparative periods, these decreases were partially offset by increases in loan servicing income and other fee income categories. Gains on sale of loans totaled $9.1 million during the second quarter of 2013 compared to $12.7 million during the second quarter of 2012, a decrease of $3.6 million or 28%. During the first six months of 2013, gains on sale of loans totaled $19.0 million compared to $21.2 million during the first six months of 2012, a $2.2 million or 10% decrease. Gains on sale of loans result primarily from the gain or loss on sales of mortgage loans into the secondary market, related fees and fair value marks on the associated derivatives. The volume of residential mortgage loans sold totaled $445.5 million during the second quarter of 2013 compared to $360.7 million during the second quarter of 2012, and totaled $870.4 million during the first six months of 2013 compared to $604.6 million during the first six months of 2012. Securities gains totaled $2.1 million during the second quarter of 2013 compared to $5.0 million during the second quarter of 2012, and totaled $5.5 million during the first six months of 2013 compared to $8.9 million during the first six months of 2012. Offsetting, in part, the securities gains during the first six months of 2012 was an impairment loss on securities totaling $981,000 recorded during the first quarter of 2012. Other noninterest income totaled $1.4 million during the first six months of 2013 compared to $2.7 million during the first six months of 2012. Included in other noninterest income during the first quarter of 2012 was $2.0 million in equity earnings which resulted from the sale of two low-income housing projects within partnerships in which Dubuque Bank and Trust Company was a member.

Loan servicing income increased $1.0 million or 34% for the second quarter of 2013 as compared to the second quarter of 2012 as mortgage servicing rights income, which is influenced by market interest rates for home mortgage loans and the level of residential loans Heartland originates and sells into the secondary market, increased significantly. For the first six months of 2013 compared to the first six months of 2012, loan servicing income increased $2.7 million or 55%. Loan servicing income also includes the fees collected for the servicing of mortgage loans for others, which is dependent upon the aggregate outstanding balance of these loans, rather than quarterly production and sale of mortgage loans. Fees collected for the servicing of mortgage loans for others were $1.6 million during the second quarter of 2013 compared to $1.0 million during the second quarter of 2012, and $3.0 million during the first six months of 2013 compared to $2.0 million during the first six months of 2012. The portfolio of mortgage loans serviced for others by Heartland totaled $2.70 billion at June 30, 2013, compared to $1.78 billion at June 30, 2012.

As reflected in the table below, on a sequential quarterly basis, residential mortgage loan originations and the gains on sale of residential mortgage loans and the mortgage servicing rights income they create, decreased in the first two quarters of 2013 as compared to the last two quarters of 2012. These decreases resulted primarily from the seasonality typically experienced in mortgage loan activity during the first quarter of the year, coupled with an increase in residential mortgage loan interest rates. Heartland believes long term success in the mortgage banking business depends on its ability to shift toward the origination of loans for the purchase of new homes versus the refinance of mortgages on existing homes. For the second quarter of 2013, refinancing activity represented 50% of total mortgage loan originations compared to 70% during the first quarter of 2013, 71% during the fourth quarter of 2012, 64% during the third quarter of 2012 and 58% during the second quarter of 2012.

The following table summarizes Heartland's residential mortgage loan activity during the most recent five quarters, in thousands:

For the second quarter of 2013, noninterest expense totaled $48.8 million, an increase of $7.3 million or 18% from the same quarter of 2012. For the six-month period ended June 30, noninterest expense totaled $95.5 million in 2013 compared to $81.6 million in 2012, a $13.9 million or 17% increase. Contributing to these increases in noninterest expense were a $4.1 million or 16% increase in salaries and employee benefits for the quarter and a $9.9 million or 20% increase for the six-month period, a large portion of which resulted from the expansion of Heartland's residential loan origination operations, with a smaller portion attributable to the additional employees joining Heartland through the acquisitions completed during the last two quarters of 2012. Full-time equivalent employees totaled 1,550 on June 30, 2013, compared to 1,321 on June 30, 2012. Also contributing to the increases in noninterest expense were additional occupancy, furniture and equipment, professional fees and other noninterest expenses.

Fuller commented, "Our Heartland Mortgage unit continues to produce solid revenue for our banks, though at a somewhat slower pace than last year. Our mortgage origination focus is shifting toward a stronger purchase market as the refinancing wave begins to slow. As a result, we are seeing a positive shift in loan servicing income."

Heartland's effective tax rate was 28.46% for the first six months of 2013 compared to 33.19% for the first six months of 2012. Federal low-income housing tax credits included in Heartland's effective tax rate totaled $399,000 during the first six months of both 2013 and 2012. Heartland's effective tax rate is also affected by the level of tax-exempt interest income which, as a percentage of pre-tax income, was 28.02% during the first six months of 2013 compared to 15.87% during the first six months of 2012. The tax-equivalent adjustment for this tax-exempt interest income was $4.7 million during the first six months of 2013 compared to $3.4 million during the first six months of 2012.

Slight Increase in Loans; Slight Decrease in Deposits, With Improved Mix

Total assets were $4.96 billion at June 30, 2013, a decrease of $30.8 million since December 31, 2012. Securities represented 32% of total assets at June 30, 2013, compared to 31% at year-end 2012.

Total loans and leases held to maturity were $2.83 billion at June 30, 2013, compared to $2.82 billion at year-end 2012, an increase of $10.8 million or 1% annualized. Loan demand picked up during the second quarter of 2013, resulting in growth of $42.5 million or 6% annualized. Commercial and commercial real estate loans, which totaled $2.00 billion at June 30, 2013, increased $3.4 million or less than 1% annualized since year-end 2012, with $14.1 million occurring during the second quarter. Residential mortgage loans, which totaled $248.6 million at June 30, 2013, decreased $1.1 million or 1% annualized since year-end 2012, with growth of $8.2 million occurring during the second quarter. Agricultural and agricultural real estate loans, which totaled $327.5 million at June 30, 2013, decreased $821,000 or 1% annualized since year-end 2012, with growth of $12.9 million occurring during the second quarter. Consumer loans, which totaled $254.8 million at June 30, 2013, increased $9.1 million or 7% annualized since year-end 2012, with $7.8 million occurring during the second quarter.

"After a slow first quarter, loan demand resumed in the second quarter, resulting in year-to-date net growth of $11 million. We continue to focus on loan growth as our primary strategy to achieve increased earnings." added Fuller.

Fuller also noted, "Our participation in the Small Business Lending Fund provides added incentive for the Heartland member banks to originate small business loans. As a result of our success in growing qualifying loans, the cost on our $81.7 million of SBLF preferred stock is now 1%. Consistent with our business purpose, the SBLF allows Heartland to provide affordable credit to small commercial and agricultural clients, which in turn helps to increase employment and assist the economic recovery in the communities we serve."

Total deposits were $3.84 billion at June 30, 2013, compared to $3.85 billion at year-end 2012, a decrease of $4.5 million or less than 1% annualized. Demand deposits totaled $1.03 billion at June 30, 2013, an increase of $55.6 million or 11% annualized since year-end 2012. Savings deposits decreased $25.5 million or 3% annualized since year-end 2012 and certificates of deposit decreased $34.6 million or 8% annualized. The composition of Heartland's deposits continued its positive trend as no-cost demand deposits as a percentage of total deposits was 27% at June 30, 2013, compared to 25% at both March 31, 2013, and December 31, 2012, while higher-cost certificates of deposit as a percentage of total deposits was 22% at both June 30, 2013, and March 31, 2013, compared to 23% at December 31, 2012.

Fuller said, "While deposit growth has slowed this year, we continue to see a very favorable shift in our deposit mix through the growth of demand deposits which now represent 27% of our deposits."

Common stockholders' equity was $313.4 million at June 30, 2013, compared to $320.1 million at year-end 2012. Book value per common share was $18.51 at June 30, 2013, compared to $19.02 at year-end 2012. Changes in common stockholders' equity and book value per common share are the result of earnings, dividends paid, stock transactions and mark-to-market adjustment for unrealized gains and losses on securities available for sale. As a result of increases in market interest rates on many debt securities during the second quarter of 2013, Heartland's unrealized gains and losses on securities available for sale, net of applicable taxes, were at an unrealized loss of $7.5 million at June 30, 2013, compared to an unrealized gain of $17.4 million at March 31, 2013, and $20.5 million at December 31, 2012.

Decrease in Provision for Loan Losses; Increase in Nonperforming Loans During the Quarter

The allowance for loan and lease losses at June 30, 2013, was 1.33% of loans and leases and 91.74% of nonperforming loans compared to 1.37% of loans and leases and 89.71% of nonperforming loans at December 31, 2012, and 1.58% of loans and leases and 92.40% of nonperforming loans at June 30, 2012. The provision for loan losses was $1.9 million for the second quarter of 2013 compared to $3.0 million for the second quarter of 2012, a decrease of $1.1 million or 38%, primarily as a result of reduced charge-offs and reductions in the level of nonperforming and substandard loans. For the first six months of 2013, provision for loan losses was $2.5 million compared to $5.4 million for the first six months of 2012, a $2.9 million or 53% reduction. As historic losses have continued to trend downward and overall economic conditions have improved, the required allowance for loan and lease losses has continued to decrease resulting in the related provision expense being reduced.

Nonperforming loans, exclusive of those covered under loss sharing agreements, were $41.0 million or 1.45% of total loans and leases at June 30, 2013, compared to $32.8 million or 1.18% of total loans and leases at March 31, 2013, $43.2 million or 1.53% of total loans and leases at December 31, 2012, and $44.8 million or 1.71% of total loans and leases at June 30, 2012. Approximately 58%, or $23.7 million, of Heartland's nonperforming loans have individual loan balances exceeding $1.0 million. These nonperforming loans, to an aggregate of 6 borrowers, are evenly distributed between the Western and Midwestern states, with $7.1 million originated by Wisconsin Bank & Trust, $4.7 million originated by Dubuque Bank and Trust Company, $4.4 million originated by New Mexico Bank & Trust, $4.0 million originated by Rocky Mountain Bank and $3.4 million originated by Summit Bank & Trust. The portion of Heartland's nonperforming loans covered by government guarantees was $414,000 at June 30, 2013. The industry breakdown for nonperforming loans with individual balances exceeding $1.0 million, as identified using the North American Industry Classification System (NAICS), was $8.4 million for lot and land development and $7.1 million for grain/cattle operation. The remaining $8.2 million was distributed among two other industry categories.

Delinquencies in each of the loan portfolios continue to be well-managed and no significant adverse trends were identified during the second quarter of 2013. Loans delinquent 30 to 89 days as a percent of total loans were 0.29% at June 30, 2013, compared to 0.48% at March 31, 2013, 0.32% at December 31, 2012, 0.53% at September 30, 2012, and 0.46% at June 30, 2012.

Other real estate owned was $34.8 million at June 30, 2013, compared to $36.7 million at March 31, 2013, and $35.8 million at December 31, 2012. Liquidation strategies have been identified for all the assets held in other real estate owned. Management continues to market these properties through an orderly liquidation process instead of a quick liquidation process in order to avoid discounts greater than the projected carrying costs. During 2013, $5.3 million of other real estate owned was sold during the second quarter and $8.6 million during the first six months.

The schedules below summarize the changes in Heartland's nonperforming assets, including those covered by loss share agreements, during the second quarter of 2013 and the first six months of 2013, in thousands: