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Heartland Financial USA 10-Q 2009

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
form10q093009.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended September 30, 2009

 
                                                                 x TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For transition period __________ to __________

Commission File Number: 0-24724

HEARTLAND FINANCIAL USA, INC.
(Exact name of Registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

42-1405748
(I.R.S. employer identification number)

1398 Central Avenue, Dubuque, Iowa  52001
(Address of principal executive offices)(Zip Code)

(563) 589-2100
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ  No  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x   No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Act.
Large accelerated filer ¨                                                                   Accelerated filer þ                                        Non-accelerated filer ¨ Smaller reporting company ¨
(Do not check if a smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Securities Exchange Act of 1934).  Yes  ¨  No  þ

Indicate the number of shares outstanding of each of the classes of Registrant's common stock as of the latest practicable date:  As of November 5, 2009, the Registrant had outstanding 16,323,453 shares of common stock, $1.00 par value per share.

 
 

 


 
HEARTLAND FINANCIAL USA, INC.
Form 10-Q Quarterly Report
 

 
Part I
     
Item 1.
 
Financial Statements
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
 
Controls and Procedures
     
Part II
     
Item 1.
 
Legal Proceedings
Item 1A.
 
Risk Factors
Item 2.
 
Unregistered Sales of Issuer Securities and Use of Proceeds
Item 3.
 
Defaults Upon Senior Securities
Item 4.
 
Submission of Matters to a Vote of Security Holders
Item 5.
 
Other Information
Item 6.
 
Exhibits
     
   
Form 10-Q Signature Page

 
 

 

PART I
ITEM 1. FINANCIAL STATEMENTS

HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
   
September 30, 2009
 
December 31, 2008
   
(Unaudited)
   
ASSETS
               
Cash and due from banks
 
$
77,231
   
$
48,977
 
Federal funds sold and other short-term investments
   
5,277
     
2,326
 
Cash and cash equivalents
   
82,508
     
51,303
 
Securities:
               
Trading, at fair value
   
756
     
1,694
 
Available for sale, at fair value (cost of $1,061,562 at September 30, 2009, and $875,143 at December 31, 2008)
   
1,077,628
     
871,686
 
Held to maturity, at cost (fair value of $25,725 at September 30, 2009, and $26,326 at December 31, 2008)
   
27,360
     
30,325
 
Loans held for sale
   
19,923
     
19,695
 
Loans and leases:
               
Held to maturity
   
2,367,871
     
2,405,001
 
Loans covered by loss share agreements
   
36,175
     
-
 
Allowance for loan and lease losses
   
(42,260
)
   
(35,651
)
Loans and leases, net
   
2,361,786
     
2,369,350
 
Premises, furniture and equipment, net
   
117,140
     
120,500
 
Other real estate, net
   
33,342
     
11,750
 
Goodwill, net
   
40,207
     
40,207
 
Other intangible assets, net
   
12,101
     
8,079
 
Cash surrender value on life insurance
   
55,141
     
54,431
 
FDIC indemnification asset
   
4,393
     
-
 
Other assets
   
47,328
     
51,248
 
TOTAL ASSETS
 
$
3,879,613
   
$
3,630,268
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
LIABILITIES:
               
Deposits:
               
Demand
 
$
451,645
   
$
383,061
 
Savings
   
1,386,059
     
1,128,312
 
Time
   
1,106,710
     
1,128,859
 
Total deposits
   
2,944,414
     
2,640,232
 
Short-term borrowings
   
111,346
     
210,184
 
Other borrowings
   
457,444
     
437,833
 
Accrued expenses and other liabilities
   
38,044
     
33,396
 
TOTAL LIABILITIES
   
3,551,248
     
3,321,645
 
EQUITY:
               
Preferred stock (par value $1 per share; authorized and undesignated 102,302 shares; none issued or outstanding)
   
-
     
-
 
Series A Junior Participating preferred stock (par value $1 per share; authorized 16,000 shares; none issued or outstanding)
   
-
     
-
 
Series B Fixed Rate Cumulative Perpetual preferred stock (par value $1 per share; authorized 81,698 shares;  issued, 81,698 shares)
   
76,909
     
75,578
 
Common stock (par value $1 per share; authorized 25,000,000 shares at September 30, 2009, and 20,000,000 shares at December 31, 2008; issued 16,611,671 shares)
   
 
16,612
     
 
16,612
 
Capital surplus
   
44,221
     
43,827
 
Retained earnings
   
183,280
     
177,753
 
Accumulated other comprehensive income (loss)
   
10,397
     
(1,341
)
Treasury stock at cost (289,718 shares at September 30, 2009, and 337,181 shares at December 31, 2008)
   
(5,927
)
   
(6,826
)
TOTAL STOCKHOLDERS’ EQUITY
   
325,492
     
305,603
 
Noncontrolling interest
   
2,873
     
3,020
 
TOTAL EQUITY
   
328,365
     
308,623
 
TOTAL LIABILITIES AND EQUITY
 
$
3,879,613
   
$
3,630,268
 
 
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
 
Nine Months Ended
   
Sept. 30, 2009
 
Sept. 30, 2008
 
Sept. 30, 2009
 
Sept. 30, 2008
INTEREST INCOME:
                               
Interest and fees on loans and leases
 
$
38,790
   
$
40,990
   
$
116,696
   
$
124,444
 
Interest on securities and other:
                               
Taxable
   
10,809
     
8,228
     
29,269
     
22,728
 
Nontaxable
   
2,231
     
1,670
     
6,139
     
4,996
 
Interest on federal funds sold and other short-term investments
   
-
     
85
     
1
     
267
 
Interest on interest bearing deposits in other financial institutions
   
17
     
3
     
18
     
10
 
TOTAL INTEREST INCOME
   
51,847
     
50,976
     
152,123
     
152,445
 
INTEREST EXPENSE:
                               
Interest on deposits
   
13,046
     
15,622
     
40,744
     
48,375
 
Interest on short-term borrowings
   
154
     
776
     
539
     
4,049
 
Interest on other borrowings
   
4,065
     
4,692
     
12,803
     
13,562
 
TOTAL INTEREST EXPENSE
   
17,265
     
21,090
     
54,086
     
65,986
 
NET INTEREST INCOME
   
34,582
     
29,886
     
98,037
     
86,459
 
Provision for loan and lease losses
   
11,896
     
7,083
     
28,602
     
14,213
 
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES
   
22,686
     
22,803
     
69,435
     
72,246
 
NONINTEREST INCOME:
                               
Service charges and fees
   
3,288
     
3,125
     
9,284
     
8,620
 
Loan servicing income
   
1,756
     
1,094
     
7,853
     
3,585
 
Trust fees
   
1,949
     
2,070
     
5,617
     
6,159
 
Brokerage and insurance commissions
   
824
     
942
     
2,420
     
2,717
 
Securities gains, net
   
1,291
     
5
     
6,462
     
1,015
 
Gain (loss) on trading account securities
   
210
     
(33
)
   
272
     
(467
)
Impairment loss on securities
   
-
     
(4,688
)
   
-
     
(4,804
)
Gains on sale of loans
   
877
     
295
     
4,916
     
1,279
 
Income (loss) on bank owned life insurance
   
297
     
(247
)
   
640
     
596
 
Gain on acquisition
   
998
     
-
     
998
     
-
 
Gain on sale of merchant services
   
-
     
5,200
     
-
     
5,200
 
Other noninterest income
   
418
     
117
     
872
     
772
 
TOTAL NONINTEREST INCOME
   
11,908
     
7,880
     
39,334
     
24,672
 
NONINTEREST EXPENSES
                               
Salaries and employee benefits
   
14,661
     
15,000
     
46,046
     
44,459
 
Occupancy
   
2,221
     
2,262
     
6,772
     
6,799
 
Furniture and equipment
   
1,594
     
1,662
     
4,936
     
5,201
 
Professional fees
   
2,706
     
2,712
     
7,027
     
7,299
 
FDIC assessments
   
1,393
     
384
     
5,258
     
955
 
Advertising
   
740
     
1,012
     
2,272
     
2,853
 
Intangible assets amortization
   
199
     
236
     
668
     
708
 
Net loss on repossessed assets
   
3,680
     
327
     
6,832
     
517
 
Other noninterest expenses
   
3,129
     
3,142
     
9,275
     
9,290
 
TOTAL NONINTEREST EXPENSES
   
30,323
     
26,737
     
89,086
     
78,081
 
INCOME BEFORE INCOME TAXES
   
4,271
     
3,946
     
19,683
     
18,837
 
Income taxes
   
803
     
1,018
     
5,434
     
5,081
 
NET INCOME
   
3,468
     
2,928
     
14,249
     
13,756
 
Net income attributable to noncontrolling interest, net of tax
   
44
     
77
     
147
     
219
 
NET INCOME ATTRIBUTABLE TO HEARTLAND
   
3,512
     
3,005
     
14,396
     
13,975
 
Preferred dividends and discount
   
(1,336
)
   
-
     
(4,008
)
   
-
 
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
 
$
2,176
   
$
3,005
   
$
10,388
   
$
13,975
 
                                 
EARNINGS PER COMMON SHARE – BASIC
 
$
.13
   
$
.18
   
$
0.64
   
$
0.86
 
EARNINGS PER COMMON SHARE – DILUTED
 
$
.13
   
$
.18
   
$
0.64
   
$
0.85
 
CASH DIVIDENDS DECLARED PER COMMON SHARE
 
$
.10
   
$
.10
   
$
0.30
   
$
0.30
 
                                 
See accompanying notes to consolidated financial statements.
               
 
             


HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands, except per share data)
 
   
Nine Months Ended
   
Sept. 30, 2009
 
Sept. 30, 2008
CASH FLOWS FROM OPERATING ACTIVITIES:
               
Net income
 
$
14,249
   
$
13,756
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
6,832
     
7,028
 
Provision for loan and lease losses
   
28,602
     
14,213
 
Net amortization of premium on securities
   
2,043
     
(330
)
Securities gains, net
   
(6,462
)
   
(1,015
)
(Increase) decrease in trading account securities
   
734
     
(74
)
Loss on impairment of securities
   
-
     
4,804
 
Gain on acquisition
   
(998
)
   
-
 
Stock-based compensation
   
715
     
876
 
Loans originated for sale
   
(667,294
)
   
(203,758
)
Proceeds on sales of loans
   
672,438
     
207,904
 
Net gains on sales of loans
   
(4,916
)
   
(1,279
)
(Increase) decrease in accrued interest receivable
   
(1,658
)
   
1,538
 
Decrease in accrued interest payable
   
(2,109
)
   
(3,626
)
Other, net
   
2,795
     
(12,628
)
NET CASH PROVIDED BY OPERATING ACTIVITIES
   
44,971
     
27,409
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from the sale of securities available for sale
   
224,521
     
131,482
 
Proceeds from the sale of securities held to maturity
   
1,659
     
-
 
Proceeds from the maturity of and principal paydowns on securities available for sale
   
138,617
     
133,869
 
Proceeds from the maturity of and principal paydowns on securities held to maturity
   
2,243
     
121
 
Purchase of securities available for sale
   
(538,456
)
   
(337,576
)
Purchase of securities held to maturity
   
(895
)
   
(18,782
)
Net increase in loans and leases
   
(21,685
)
   
(92,645
)
Capital expenditures
   
(2,957
)
   
(6,544
)
Net cash and cash equivalents received in acquisition
   
7,193
     
-
 
Proceeds on sale of OREO and other repossessed assets
   
13,545
     
1,349
 
NET CASH USED BY INVESTING ACTIVITIES
   
(176,215
)
   
(188,726
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in demand deposits and savings accounts
   
298,403
     
179,022
 
Net increase (decrease) in time deposit accounts
   
(43,868
)
   
12,586
 
Net decrease in short-term borrowings
   
(104,666
)
   
(177,603
)
Proceeds from other borrowings
   
55,146
     
221,972
 
Repayments of other borrowings
   
(35,535
)
   
(45,433
)
Purchase of treasury stock
   
(74
)
   
(6,126
)
Proceeds from issuance of common stock
   
579
     
1,723
 
Excess tax benefits on exercised stock options
   
2
     
266
 
Common and preferred dividends paid
   
(7,538
)
   
(4,848
)
NET CASH PROVIDED BY FINANCING ACTIVITIES
   
162,449
     
181,559
 
Net increase in cash and cash equivalents
   
31,205
     
20,242
 
Cash and cash equivalents at beginning of year
   
51,303
     
46,832
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
82,508
   
$
67,074
 
Supplemental disclosures:
               
Cash paid for income/franchise taxes
 
$
5,314
   
$
7,646
 
Cash paid for interest
 
$
56,195
   
$
69,612
 
Securities transferred to available for sale from trading
 
$
204
   
$
-
 
Securities transferred to trading from available for sale
 
$
-
   
$
541
 
Loans transferred to OREO
 
$
37,607
   
$
8,553
 
Acquisition:
               
Net assets acquired
 
$
5,625
   
$
-
 
Cash received from FDIC in acquisition
 
$
3,995
   
$
-
 
Cash acquired in acquisition
   
3,198
     
-
 
Net cash received in acquisition of subsidiary
 
$
7,193
   
$
-
 
                 
See accompanying notes to consolidated financial statements.
               

 
 

 


HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY AND COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands, except per share data)
                                 
   
Heartland Financial USA, Inc. Stockholders’ Equity
       
   
 
Preferred
Stock
 
 
Common
Stock
 
 
Capital
Surplus
 
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
 
Treasury
Stock
 
Non-controlling
Interest
 
 
Total
Equity
Balance at January 1, 2008
 
$
-
   
$
16,612
   
$
37,269
   
$
173,100
   
$
6,506
   
$
(3,678
)
 
$
-
   
$
229,809
 
Net income
                           
13,975
                     
(219
)
   
13,756
 
Unrealized loss on securities available for sale arising during the period
                                   
 
(21,096
 
)
                   
 
(21,096
 
)
Unrealized gain on derivatives arising during the period
                                   
 
563
                     
563
 
Reclassification adjustment for net security losses realized in net income
                                   
 
3,789
                     
 
3,789
 
Reclassification adjustment for net derivatives gains realized in net income
                                   
 
 
(136
 
 
)
                   
 
 
(136
 
 
)
Income taxes
                                   
6,331
                     
6,331
 
Comprehensive income
                                                           
3,207
 
Cash dividends declared:
                                                               
Common, $0.30 per share
                           
(4,848
)
                           
(4,848
)
Purchase of 306,864 shares of common stock
                                           
 
(6,126
 
)
           
 
(6,126
 
)
Issuance of 132,739 shares of common stock
                   
 
(444
 
)
                   
 
2,619
             
 
2,175
 
Commitments to issue common stock
                   
876
                                     
876
 
Initial capital investment
                                                   
3,300
     
3,300
 
Balance at September 30, 2008
 
$
-
   
$
16,612
   
$
37,701
   
$
182,227
   
$
(4,043
)
 
$
(7,185
)
 
$
3,081
   
$
228,393
 
                                                                 
Balance at January 1, 2009
 
$
75,578
   
$
16,612
   
$
43,827
   
$
177,753
   
$
(1,341
)
 
$
(6,826
)
 
$
3,020
   
$
308,623
 
Net income
                           
14,396
                     
(147
)
   
14,249
 
Unrealized gain on securities available for sale arising during the period
                                   
 
25,985
                     
 
25,985
 
Unrealized loss on derivatives arising during the period
                                   
 
(813
 
)
                   
 
(813
 
)
Reclassification adjustment for net security gains realized in net income
                                   
 
(6,462
 
)
                   
 
(6,462
 
)
Reclassification adjustment for net derivatives gains realized in net income
                                   
 
 
(33
 
 
)
                   
 
 
(33
 
 
)
Income taxes
                                   
(6,939
)
                   
(6,939
)
Comprehensive income
                                                           
25,987
 
Cumulative preferred dividends accrued and discount accretion
   
 
1,331
                     
 
(1,331
 
)
                           
 
-
 
Cash dividends declared:
                                                               
Preferred, $37.50 per share
                           
(2,677
)
                           
(2,677
)
Common, $0.30 per share
                           
(4,861
)
                           
(4,861
)
Purchase of 4,557 shares of common stock
                                           
(74
)
           
(74
)
Issuance of 52,020 shares of common stock
                   
 
(321
 
)
                   
 
973
             
 
652
 
Commitments to issue common stock
                   
715
                                     
715
 
Balance at September 30, 2009
 
$
76,909
   
$
16,612
   
$
44,221
   
$
183,280
   
$
10,397
   
$
(5,927
)
 
$
2,873
   
$
328,365
 
                                                                 
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 consolidated financial statements for the fiscal year ended December 31, 2008, included in Heartland Financial USA, Inc.’s ("Heartland") Form 10-K filed with the Securities and Exchange Commission on March 16, 2009. Accordingly, footnote disclosures, which would substantially duplicate the disclosure contained in the audited consolidated financial statements, have been omitted.

The financial information of Heartland included herein has been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments), that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of the interim period ended September 30, 2009, are not necessarily indicative of the results expected for the year ending
December 31, 2009.

Earnings Per Share

Basic earnings per share is determined using net income available to common stockholders and weighted average common shares outstanding. Diluted earnings per share is computed by dividing net income available to common stockholders 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 and nine-month periods ended September 30, 2009 and 2008, are shown in the tables below:

   
Three Months Ended
(Dollars and numbers in thousands, except per share data)
 
September 30, 2009
 
September 30, 2008
Net income attributable to Heartland
 
$
3,512
   
$
3,005
 
Preferred dividends and discount
   
(1,336
)
   
-
 
Net income available to common stockholders
 
$
2,176
   
$
3,005
 
Weighted average common shares outstanding for basic earnings per share
 
$
16,311
   
$
16,264
 
Assumed incremental common shares issued upon exercise of stock options
   
29
     
91
 
Weighted average common shares for diluted earnings per share
 
$
16,340
   
$
16,355
 
Earnings per common share – basic
 
$
0.13
   
$
0.18
 
Earnings per common share – diluted
 
$
0.13
   
$
0.18
 
Number of antidilutive stock options excluded from diluted earnings per share computations
   
161
     
31
 

   
Nine Months Ended
(Dollars and numbers in thousands, except per share data)
 
September 30, 2009
 
September 30, 2008
Net income attributable to Heartland
 
$
14,396
   
$
13,975
 
Preferred dividends and discount
   
(4,008
)
   
-
 
Net income available to common stockholders
 
$
10,388
   
$
13,975
 
Weighted average common shares outstanding for basic earnings per share
 
$
16,296
   
$
16,315
 
Assumed incremental common shares issued upon exercise of stock options
   
24
     
77
 
Weighted average common shares for diluted earnings per share
 
$
16,320
   
$
16,392
 
Earnings per common share – basic
 
$
0.64
   
$
0.86
 
Earnings per common share – diluted
 
$
0.64
   
$
0.85
 
Number of antidilutive stock options excluded from diluted earnings per share computations
   
191
     
40
 


 
 

 


Stock-Based Compensation

Options are typically granted annually with an expiration date ten years after the date of grant. Vesting is generally over a five-year service period with portions of a grant becoming exercisable at three years, four years and five years after the date of grant. A summary of the status of the stock options as of September 30, 2009 and 2008, and changes during the nine months ended September 30, 2009 and 2008, follows:

   
2009
 
2008
   
Shares
 
Weighted-Average Exercise Price
 
Shares
 
Weighted-Average Exercise Price
Outstanding at January 1
   
743,363
   
$
19.79
     
733,012
   
$
18.61
 
Granted
   
-
     
-
     
164,400
     
18.60
 
Exercised
   
(4,125
)
   
11.13
     
(98,549
)
   
11.56
 
Forfeited
   
(16,292
)
   
20.43
     
(16,000
)
   
24.96
 
Outstanding at September 30
   
722,946
   
$
19.83
     
782,863
   
$
19.36
 
Options exercisable at September 30
   
327,879
   
$
16.04
     
277,713
   
$
13.60
 
Weighted-average fair value of options granted during the nine-month periods ended September 30
 
 
$
 
-
           
 
$
 
4.81
         

At September 30, 2009, the vested options totaled 327,879 shares with a weighted average exercise price of $16.04 per share and a weighted average remaining contractual life of 3.86 years. The intrinsic value for the vested options as of September 30, 2009, was $590 thousand. The intrinsic value for the total of all options exercised during the nine months ended September 30, 2009, was $15 thousand, and the total fair value of shares vested during the nine months ended September 30, 2009, was $715 thousand. At September 30, 2009, shares available for issuance under the 2005 Long-Term Incentive Plan totaled 481,102.

No options were granted during the first nine months of 2009. The fair value of the stock options granted during 2008 was estimated utilizing the Black Scholes valuation model. The fair value of a share of common stock on the grant date of the 2008 options was $18.60. Significant assumptions include:

         
2008
Risk-free interest rate
       
3.10%
Expected option life
       
6.4 years
Expected volatility
       
26.96%
Expected dividend yield
       
1.99%

The option term of each award granted was based upon Heartland’s historical experience of employees’ exercise behavior. Expected volatility was based upon historical volatility levels and future expected volatility of Heartland’s common stock. Expected dividend yield was based on a set dividend rate. Risk free interest rate reflects the average of the yields on the 5-year and 7-year zero coupon U.S. Treasury bond. Cash received from options exercised for the nine months ended September 30, 2009, was $46 thousand, with a related tax benefit of $2 thousand. Cash received from options exercised for the nine months ended September 30, 2008, was $1.1 million, with a related tax benefit of $266 thousand.

Total compensation costs recorded were $715 thousand and $876 thousand for the nine months ended September 30, 2009 and 2008, respectively, for stock options, restricted stock awards and shares to be issued under the 2006 Employee Stock Purchase Plan. As of September 30, 2009, there was $1.7 million of total unrecognized compensation costs related to the 2005 Long-Term Incentive Plan for stock options and restricted stock awards which is expected to be recognized through 2012.

Fair Value Measurements

On January 1, 2008, the Financial Accounting Standards Board (“FASB”) issued an accounting standard related to fair value measurements. This accounting standard defines fair value, establishes a framework for measuring fair value under U.S. generally accepted accounting principles, and expands disclosures about fair value measurements. This accounting standard applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances. Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This accounting standard clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. This accounting standard requires fair value measurements to be separately disclosed by level within the fair value hierarchy. Under this accounting standard, Heartland bases fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For assets and liabilities recorded at fair value, it is Heartland’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in this standard.

Fair value measurements for assets and liabilities where there exists limited or no observable market data, and therefore, are based primarily upon estimates, are often calculated based upon current pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other such factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Additional information regarding disclosures of fair value is presented in Note 7.

Heartland now applies the fair value measurement and disclosure provisions of this standard effective January 1, 2009, to nonfinancial assets and nonfinancial liabilities measured on a nonrecurring basis. Heartland measures the fair value of the following on a nonrecurring basis: (1) long-lived assets, (2) foreclosed assets, (3) goodwill and other intangibles and (4) indefinite-lived assets.

Effect of New Financial Accounting Standards

Effective for interim and annual periods ending after September 15, 2009, the FASB Accounting Standards Codification (“Codification” or “ASC”) is the single source of authoritative literature recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”). The Codification does not change current GAAP, but is intended to simplify user access to all authoritative GAAP by providing all of the authoritative literature related to a particular topic in one place. The Codification supersedes all pre-existing accounting and reporting standards, excluding separate rules and other interpretive guidance released by the Securities and Exchange Commission. New accounting guidance is now issued in the form of Accounting Standards Updates, which update the Codification. All guidance contained in the Codification carries an equal level of authority. Heartland has adopted the Codification in the period ending September 30, 2009, and as a result has replaced references to standards that were issued prior to the Codification with a description of the applicable accounting guidance. The adoption of this accounting standard did not have any impact on Heartland’s consolidated financial statements.

 In December 2007, the FASB issued ASC 805, “Business Combinations”, which requires significant changes in the accounting and reporting for business acquisitions. Among many changes under this accounting standard, an acquirer will record 100 percent  of all assets and liabilities at fair value at the acquisition date with changes possibly recognized in earnings, and acquisition related costs will be expensed rather than capitalized. ASC 805 applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. Heartland adopted this accounting standard on January 1, 2009, and, in the third quarter of 2009, applied its provisions to the assets acquired and liabilities assumed related to the acquisition of The Elizabeth State Bank. For a description of this acquisition, see Note 2.

In December 2007, the FASB issued ASC 810, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 5”, which establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary. Key changes under this accounting standard are that noncontrolling interests in a subsidiary are to be reported as part of equity, losses allocated to a noncontrolling interest can result in a deficit balance, and changes in ownership interests that do not result in a change of control are accounted for as equity transactions and upon a loss of control, the resultant gain or loss is recognized and the remaining interest is remeasured at fair value on the date control is lost. Effective January 1, 2009, this accounting standard requires retroactive adoption of the presentation and disclosure requirements for existing consolidated minority interests and prospective application for any new minority interests. The presentation and disclosure requirements of ASC 810 have been applied for the current period and retrospectively for prior periods on Heartland’s accompanying consolidated financial statements.

In March 2008, the FASB issued ASC 815, “Disclosures about Derivative Instruments and Hedging Activities”, which changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. ASC 815 is effective for all financial statements issued for fiscal years and interim periods beginning after November 15, 2008. For further detail on Heartland’s derivative instruments and hedging activities, see Note 6.

In January 2009, the FASB issued ASC 325, “Amendments to the Impairment and Interest Income Measurement Guidance of EITF issue No. 99-20”. ASC 325 amends the impairment guidance previously issued in order to achieve more consistent determination of whether an other-than-temporary impairment (“OTTI”) has occurred. This ASC amended previous guidance to more closely align the OTTI guidance therein in ASC 320. Retrospective application to a prior interim or annual period is prohibited. The implementation of ASC 325 in 2009 did not have a material impact on Heartland’s consolidated financial statements.

In April 2009, the FASB issued an accounting standard which amended OTTI guidance in GAAP for debt securities. This accounting standard revises the guidance for determining whether an impairment is other than temporary for debt securities, requires bifurcation of any other than temporary impairment between the amount representing credit loss and the amount related to all other factors and requires additional disclosures on other than temporary impairment of debt and equity securities. This accounting standard was effective for interim and annual reporting periods ending after June 15, 2009. Heartland adopted this accounting standard for the period ended June 30, 2009. See Note 2 for the disclosures required under this accounting standard, which was subsequently codified into ASC 320, “Investments-Debt and Equity Securities”.

In April 2009, the FASB issued an accounting standard related to disclosure about the fair value of financial instruments in interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. Heartland adopted this standard for the period ended June 30, 2009. As this accounting standard amended only the disclosure requirements about the fair value of financial statements in interim periods, the adoption had no impact on Heartland’s consolidated financial statements. See Note 7 for the disclosures required under this accounting standard, which was subsequently codified into ASC Topic 825, “Financial Instruments”.

In April 2009, the FASB issued an accounting standard which provides additional guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability, provides guidance on circumstances that may indicate that a transaction is not orderly and requires additional disclosures about fair value measurements in annual and interim reporting periods. Heartland adopted this accounting standard for the period ended June 30, 2009. The provisions in this accounting standard were applied prospectively and did not result in significant changes to Heartland’s valuation techniques. Furthermore, the adoption of this accounting standard, which was subsequently codified into ASC Topic 820, “Fair Value Measurements and Disclosures, did not have a material impact on Heartland’s consolidated financial statements.

In May 2009, the FASB issued an accounting standard on reporting of subsequent events. The objective of this standard is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this accounting standard sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This accounting standard was subsequently codified into ASC Topic 855, “Subsequent Events”. This accounting standard was effective for financial statements issued for interim and annual periods ending after June 15, 2009, and did not have any impact on Heartland’s consolidated financial statements. Heartland evaluated subsequent events through the filing date of its quarterly 10-Q with the SEC on November 9, 2009.

In June 2009, the FASB issued an accounting standard which amends current GAAP related to the accounting for transfers and servicing of financial assets and extinguishments of liabilities, including the removal of the concept of a qualifying special-purpose entity from GAAP. This new accounting standard also clarifies that a transferor must evaluate whether it has maintained effective control of a financial asset by considering its continuing direct or indirect involvement with the transferred financial asset. This accounting standard is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter and is not anticipated to have any material impact on Heartland’s consolidated financial statements.
 
 In June 2009, the FASB issued an accounting standard which will require a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity for consolidation purposes. This accounting standard requires an enterprise to perform an analysis and ongoing reassessments to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity and amends certain guidance for determining whether an entity is a variable interest entity. It also requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. This accounting standard is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and for all interim reporting periods after that and is not anticipated to have any material impact on Heartland’s consolidated financial statements.
 
NOTE 2: ACQUISITION

On July 2, 2009, Heartland acquired all deposits of The Elizabeth State Bank in Elizabeth, Illinois through its subsidiary Galena State Bank based in Galena, Illinois in a whole bank loss sharing transaction facilitated by the FDIC. Bank branches previously owned and operated by The Elizabeth State Bank reopened on Monday, July 6, 2009, as Galena State Bank branches. As of July 2, 2009, The Elizabeth State Bank had loans of $42.7 million and deposits of $49.3 million. Galena State Bank paid a premium of 1.0 percent to acquire all of the deposits of the failed bank. In addition to assuming all of the deposits of the failed bank, Galena State Bank agreed to purchase $52.3 million of assets. The FDIC retained the remaining assets for later disposition.

The acquired loans and other real estate owned are covered by two loss share agreements between the FDIC and Galena State Bank, which affords Galena State Bank significant loss protection. Under the loss share agreements, the FDIC will cover 80 percent of the covered loan and other real estate owned losses (referred to as covered assets) up to $10 million and 95 percent of losses in excess of that amount. The term for loss sharing on non-residential real estate losses is five years with respect to losses and eight years with respect to recoveries, while the term for loss sharing on residential real estate loans is ten years with respect to losses and recoveries. The reimbursable losses from the FDIC are based on the book value of the relevant loan as determined by the FDIC at the date of the transaction. New loans made after that date are not covered by the loss share agreements.

Galena State Bank received a $2.5 million discount on the assets acquired and paid a 1.0 percent deposit premium. The expected reimbursements under the loss share agreements were recorded as an indemnification asset at the estimated fair value of $4.4 million at the acquisition date. The estimated fair value of the loans acquired was $37.8 million and the estimated fair value of the deposits assumed was $49.5 million. In addition, a core deposit intangible of $200 thousand was recorded. An acquisition gain totaling $998 thousand resulted from the acquisition and is included as a component of noninterest income on the statement of income. The amount of the gain is equal to the amount by which the fair value of the liabilities assumed exceeded the fair value of the assets purchased.

The Elizabeth State Bank acquisition was accounted for under the acquisition method of accounting in accordance with ASC 805, “Business Combinations”. Purchased loans acquired in a business combination, which include loans purchased in The Elizabeth State Bank acquisition, are recorded at estimated fair value on their purchase date, but the purchaser can not carryover the related allowance for loan and lease losses. Purchased loans are accounted for under ASC 310-30, “Loans and Debt Securities with Deteriorated Credit Quality”, when the loans have evidence of credit deterioration since origination and it is probable at the date of the acquisition that Heartland will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration at the purchase date included statistics such as past due and nonaccrual status. Generally, acquired loans that meet Heartland’s definition for nonaccrual status fall within the scope of ASC 310-30. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference which is included in the carrying value of the loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan and lease losses. Subsequent increases in cash flows result in a reversal of the provision for loan and lease losses to the extent of prior charges, or a reclassification of the difference from nonaccretable to accretable with a positive impact on interest income. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.

The carrying amount of the covered loans at September 30, 2009, consisted of impaired and nonimpaired loans purchased and are summarized in the following table:

(Dollars in thousands)
     
   
Impaired Purchased Loans
   
Non Impaired Purchased Loans
   
Total Covered Loans
 
Commercial and commercial real estate
 
$
6,329
   
$
7,664
   
$
13,993
 
Residential mortgage
   
560
     
11,778
     
12,338
 
Agricultural and agricultural real estate
   
600
     
5,334
     
5,934
 
Consumer loans
   
1,238
     
2,672
     
3,910
 
Total Covered Loans
 
$
8,727
   
$
27,448
   
$
36,175
 

On the acquisition date, the preliminary estimate of the contractually required payments receivable for all ASC 310-30 loans acquired in the acquisition was $13.8 million and  the estimated fair value of the loans were $9.0 million. At September 30, 2009, a majority of these loans were valued based upon the liquidation value of the underlying collateral, because the expected cash flows are primarily based on the liquidation of underlying collateral and the timing and amount of the cash flows could not be reasonably estimated. There was no allowance for loan and lease losses related to these ASC 310-30 loans at September 30, 2009.

On the acquisition date, the preliminary estimate of the contractually required payments receivable for all non ASC 310-30 loans acquired in the acquisition was $28.9 million and the estimated fair value of the loans was $28.7 million.


NOTE 3: SECURITIES

The amortized cost, gross unrealized gains and losses and estimated fair values of available for sale securities as of September 30, 2009 and December 31, 2008 are summarized in the tables below, in thousands:
 
   
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
September 30, 2009
                               
Securities available for sale:
                               
U.S. government corporations and agencies
 
$
277,269
   
$
2,698
   
$
(149
)
 
$
279,818
 
Mortgage-backed securities
   
565,253
     
11,761
     
(7,698
)
   
569,316
 
Obligations of states and political subdivisions
   
183,966
     
9,106
     
(176
)
   
192,896
 
Corporate debt securities
   
4,430
     
40
     
(4
)
   
4,466
 
Total debt securities
   
1,030,918
     
23,605
     
(8,027
)
   
1,046,496
 
Equity securities
   
30,644
     
540
     
(52
)
   
31,132
 
Total
 
$
1,061,562
   
$
24,145
   
$
(8,079
)
 
$
             1,077,628
 


   
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
December 31, 2008
                               
Securities available for sale:
                               
U.S. government corporations and agencies
 
$
190,599
   
$
4,832
   
$
(75
)
 
$
195,356
 
Mortgage-backed securities
   
505,711
     
4,688
     
(16,409
)
   
493,990
 
Obligations of states and political subdivisions
   
145,534
     
4,230
     
(981
)
   
148,783
 
Corporate debt securities
   
4,479
     
185
     
-
     
4,664
 
Total debt securities
   
846,323
     
13,935
     
(17,465
)
   
842,793
 
Equity securities
   
28,820
     
73
     
-
     
28,893
 
Total
 
$
875,143
   
$
14,008
   
$
(17,465
)
 
$
871,686
 

The amortized cost, gross unrealized gains and losses and estimated fair values of held to maturity securities as of September 30, 2009 and December 31, 2008 are summarized in the tables below, in thousands:

   
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
September 30, 2009
                               
Securities held to maturity:
                               
Mortgage-backed securities
 
$
12,316
   
$
40
   
$
(1,659
)
 
$
10,697
 
Obligations of states and political subdivisions
   
15,044
     
-
     
(16
)
   
15,028
 
Total
 
$
27,360
   
$
40
   
$
(1,675
)