Heartland Financial USA Inc (HTLF) 2008 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you so much for standing by. Welcome to the Heartland Financial USA third quarter 2008 conference call. During (Operator Instructions). As a reminder, this conference is being recorded today, on Monday, the 27th of October, 2008.

I will now turn the conference over to Mr. Scott Eckstein of the Financial Relations Board. Please go ahead.

Thank you, operator. Good afternoon, everyone. Thank you for joining us on Heartland Financial USA's conference call to discuss third quarter's 2008 results.

This morning we distributed a copy of the press release, and hopefully, you have had a chance to review the results. If there is anyone online who did not receive a copy, you may access it at Heartland's website at www.HTLF.com, or you may call [Hon Hoy] at 312-640-6688, and she will send you a copy immediately.

With this today from Management are Lynn B. Fuller, President and Chief Executive Officer; John K. Schmidt, Chief Operating Officer and Chief Financial Officer; Ken Erickson, Executive Vice President and Chief Credit Officer. Management will provide a brief summary of the quarter and then open up the call to your questions.

Before we begin the presentation, I would like to remind everyone that some of the information that Management will be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, I must point out that any statements made during this presentation regarding the Company's hopes, beliefs, expectations, or predictions of the future are forward-looking statements, and actual results could differ materially from those projected. Additional information on these factors is included from time to time in the Company's 10-K and 10-Q filings, which can be obtained on the Company's website or the SEC's website.

At this time, I would like to turn the call over to Lynn Fuller. Please go ahead.

Thank you, Scott, and good afternoon everyone. We certainly appreciate everyone joining us today as we review Heartland's performance for the third quarter of 2008. I hope you've all have an opportunity to review Heartland's earnings release that we issued this morning.

For the next few minutes, I will touch on the highlights of our quarterly performance and the opportunities we see in the present financial environment, and then turn the call over to John Schmidt, our Chief Operating Officer and CFO; and Ken Erickson, our Executive Vice President and Chief Credit Officer, who will provide additional detail on Heartland's third-quarter and year-to-date financial results.

In today's earnings release, Heartland reported net income for the third quarter of $3 million, or $0.18 per diluted share, compared with net income of $6.9 million, or $0.42 per diluted share, for the third quarter last year. Year-to-date income from continuing operations was $14 million, or $0.85 per diluted share, compared with $17.2 million, or $1.04 per diluted share last year.

For the first time in several years, these results fell short of prior comparable periods and certainly short of our expectations. However, as I've said in the past, we tend to take a longer-term focus versus a quarter-over-quarter approach.

Given this quarter's provision expense, we're pleased to report solid core earnings with our net interest margin increasing to $2.7 million, or 10%, over third quarter 2007. Heartland's margin has now remained steady at just under 4% for the past five quarters.

Obviously, our shortfall in bottom-line income, both for the quarter and year-to-date, stems from our loan loss provision expense of $7 million and $14 million, respectively. We continue to believe we're adequately reserved. However, these are indeed unprecedented times for the banking industry, given the continued decline in real estate valuations.

The big question everyone is asking is, where's the bottom and how far out is the recovery? In a few minutes, Ken Erickson, our Executive Vice President and Chief Credit Officer, will provide more detail on the credit side, including provision expense and nonperformers.

Outside of the credit issues, there are a number of positive developments that point to our company's underlying strength and potential. As I mentioned, most notably is Heartland's positive trend in net interest margin. Our margin, now just below 4%, has increased in each of the past four quarters. We continue to achieve favorable progress through strict pricing discipline and emphasis on growing non-maturity deposits. Our stated goal this year is to maintain margin at or above the 2007 year-end mark of 3.87%.

Another bright spot this year is growth in deposits, increasing at an annualized rate of 11%. By design, much of this growth is in the non-maturity categories of money market deposit accounts and interest-bearing checking. As a case in point, the introduction of our new transaction account, Cash rewards Checking, has resulted in growth of over 5,000 net new checking accounts in 2008, a substantial increase over last year. 50% of these accounts are new customers to our banks, with which we intend to build even deeper relationships.

Heartland's stated goal is to have eight products and services per household, and at present a number of our member banks average five or greater products and services per household. Additionally, as a member of the Cedars network, we have attracted new accounts at many of our banks as depositors have come to us seeking additional safety for their deposits.

As you know from previous calls, collection of nonperforming loans is this year's highest priority. Even though we have not shown a substantial reduction in nonperformers this quarter, we are hopeful that progress will be made over the next two quarters. With respect to loan growth, we are first and foremost focused on quality; second, on profitability; and last, on volume. That being said, total loan outstandings have still increased by 5% on a year-to-date annualized basis. Some of our member banks are reporting opportunities to attract high-quality credits from other financial institutions that have restricted the availability of credit.

In times such as these, capital is king, and Heartland is very well positioned in this regard with risk-based capital remaining in excess of 12%. Heartland, and each of our member banks, remains well capitalized by all regulatory measures.

Liquidity is another highly favorable element among our key performance indicators. Our liquidity position continues to increase as a result of attractive deposit product offerings and depositor confidence, with the growth in deposits, outpacing the growth in loans.

The quarter's income statement reflects a couple of special items. First, is the other-than-temporary impairment charge of $4.6 million pretax, taken on Fannie Mae preferred shares held in our investment portfolio. Offsetting this charge was the sale of our merchant credit card processing service to TransFirst for $5.2 million pretax. Shortly, John Schmidt will provide more detail on the treatment of these non-recurring events.

In terms of Heartland's expansion plans, we have intentionally slowed the pace of new branch office openings. This year, we've opened two new banking offices and are contemplating the same number for 2009, with an office in Santa Fe, New Mexico, and a possible office to support our new de novo Bank in Minneapolis, Minnesota.

At present, we believe our resources are best focused on ramping up the 13 offices which we have opened over the last three years. These offices represent nearly a quarter of our total offices.

Heartland's current branch network, comprised of 60 offices across eight states, continues to enjoy solid growth, with average earning assets increasing to $209 million, or 7%, over third quarter 2007. As we discussed in last quarter's conference call, instead of aggressive branch expansion, greater opportunities for growth are emerging as acquisition candidates surface.

At this point, Heartland is reviewing the advantages associated with the Treasury's TARP program. Bank regulators are encouraging strong banks such as ourselves to consider the advantages of the TARP, even though our capital levels are well in excess of the required regulatory levels. If we choose to take advantage of the Treasury's offer, the additional capital could be used to further stimulate our local economies through increased lending. Also, the TARP proceeds may be helpful as we pursue our stated strategic focus on acquisitions, which are additive to earnings.

As a growing number of banks announce dividend cuts and eliminations this quarter, I believe it's important to share with you that at this month's meeting, the Heartland Board held our dividend unchanged at $0.10 per common share, payable on December 12, 2008.

Well, that concludes my comments. I will now turn the call over to John Schmidt for more details on the third-quarter and year-to-date financial results. John will then introduce Ken Erickson, who will provide additional color on credit quality and real estate exposures in our major markets. John?

Thanks, Lynn, and good afternoon. My comments will again focus on the most substantial changes to Heartland's balance sheet and income statement in the past quarter, 09-30-08 versus 06-30-08. Ahead of that, as Lynn indicated, these are very challenging times, and while our provisioning is certainly higher than we would like, we are still encouraged by the strong underlying operating characteristics of the Company.

Looking first at balance sheet, total loan balances increased by $69 million in the third quarter with our year-to-date growth now totaling $84 million. We feel comfortable in reaffirming our forecasted growth of $100 million in loan growth. Our focus for the coming quarters is twofold -- one, to book quality credits; two, to be paid appropriately on these credits.

Net charge-offs for the third quarter totaled $7.2 million, as compared to the total of $5.2 million for the first two quarters of 2008. (inaudible) originated in Arizona account for over 50% of charge-offs incurred by the Company in 2008. Net charge-offs for the nine months expressed as a percentage of average loans and leases totaled 54 basis points.

Our core deposits, meaning excluding brokered CDs, increased by 50 -- $156.6 million from a quarter-over-quarter perspective. Again, this quarter, we saw substantial growth in our savings and interest-bearing checking products, which increased by $148.3 million since the second quarter. Approximately 55% of this growth reflects the introduction of a new money market account that featured a 5% teaser rate until 12-31-08. This account, 52% of which is new money, will negatively impact our margin in the fourth quarter. At the same time, were comfortable that we'll be able to retain a substantial amount of these deposits. We're also pleased to see the $18.3 million growth in time deposits, which reversed a trend in the second quarter.

Moving to the income statement. Net income totaled $3 million, or $0.18 per basic and diluted share, probably of most significant in this is the fact that we again increased our margin to 3.96% for the third quarter. We were able to accomplish this by aggressively moving our certificate of deposit rates down. Especially encouraging is the fact that we were able to achieve this growth in margin even with the current levels of nonperforming loans.

We feel that we've reached an effective floor on the liability side. Additionally, as I previously mentioned, the introduction of the money -- the new money market account will negatively impact margin in the fourth quarter. At the same time, we feel we have the ability to see enhanced pricing on the loan side for the foreseeable future. Accordingly, we would suggest that our margin will fall to around 3.9% for the fourth quarter, but then rebound to at least the current level in 2009. Since our balance sheet remains asset sensitive, this could certainly be impacted by additional Fed rate cuts, our ability to grow loans, and the level of nonperforming loans.

While noninterest income was essentially flat for the quarter, there was certainly a lot of noise in the individual components. Like many institutions, we are forced to write down our $5.1 million holdings in Fannie Mae by $4.6 million, with the remaining balance placed into a trading account. Additionally, we incurred a net loss of $247,000 for the quarter in our bank-owned life insurance as depreciation and securities held in a separate account fell below the underlying stable value wrap guarantee.

Finally, on a positive note, we were able to bring the sale of our merchant card portfolio to fruition in the third quarter. This six-month effort to sell the portfolio will immaterially affect our ongoing revenue, given the negotiated fee sharing arrangements.

Total noninterest expense for the second quarter increased by $1.2 million, or 4.8%, for the second-quarter levels -- from the second-quarter levels. Salaries and benefits increased from the second quarter, as we brought out additional staff in Minnesota Bank & Trust.

Outside services increased by $448,000, primarily related to legal costs associated with the collection of our nonperforming loans and increased FDIC premiums. We are continuing our advertising promotions focusing primarily on core deposit generation and the opening of Minnesota Bank & Trust.

The tax rate for the quarter was 25.3% and 26.66% for the nine months, reflecting the recognition of tax credits in Dubuque and a higher level of tax-exempt income. We would expect our tax rate to be in the 27% range for the remainder of 2008.

In closing, we are pleased with several aspects of the third-quarter performance, including margin maintenance and deposit growth. At the same time, we realize that job one remains the reduction of nonperforming loans.

With that, I turn it over to Ken Erickson, our Executive Vice President and Chief Credit Officer.

Thank you, John, and good afternoon everyone. Nonperforming loans ended the quarter at $43.9 million. While it is far from encouraging to see nonperforming loans at this level, it is somewhat encouraging to see that the amount of nonperforming loans is approximately the same as it was at the end of the prior quarter. $3.4 million of our nonperforming loans is made up of the guaranteed portion of government guaranteed loans.

Our press release stated that 64%, or $28 million, of these nonperforming loans are to eight borrowers. The largest of these is a $6.4 million Arizona credit that was added to nonperforming assets this quarter. This loan is supported by a recent appraisal of nearly $12 million. The developable property is being actively marketed. No loss is anticipated for this loan.

The remaining seven credits can be summarized in the following way. By location -- in Wisconsin, $6.8 million; Arizona, $6 million; Montana, $4.8 million; Iowa, $2.3 million; and Colorado, $1.6 million. By industry type -- the largest is residential condos at $6.8 million; followed by transportation, $6 million; commercial real estate, $4.8 million; construction; $1.7 million; food industry, $1.3 million; and senior housing, $1 million. And the expected resolution of these seven credits -- the fourth quarter of 2008 I expect a reduction of $8.8 million, with the remaining $12.9 million in 2009 or even potentially later.

We recorded $7.2 million in net charge-offs in the third quarter, which $6.6 million was recorded at the banks. Of the $6.6 million, $4.0 million had previously been taken as a provision expense and had been established as a specific reserve for those credits.

The unanticipated losses in this quarter were primarily concentrated in three credits. Approximately half of this was attributed to one loan in Arizona, in which an expected settlement with the guarantors did not materialize. The other half was about equally split between a Wisconsin and a Colorado customer, and both related to reduced real estate values.

Also mentioned in our press release, we have generally recognized the charge-off on a loan when the loan was resolved, sold, or transferred to other real estate. In the third quarter we recognized charge-offs on certain collateral-dependent loans by writing down the loan balance to an estimated net realizable value based on the anticipated disposition value. Due to these unprecedented times in the banking industry and the continued questions regarding sustainable real estate values, we feel this is more prudent.

Last quarter, I commented that I expected resolution of $9 million of nonperforming loans in the third quarter. We exceeded that by $3 million as six smaller credits were either paid off or paid down.

The increases in nonperforming loans in the third quarter were primarily driven by the following credits -- a $6.4 million Arizona credit I mentioned earlier, $1.6 million in Colorado condos, $1.3 million in the Iowa meat industry, $1 million in an Iowa senior housing credit, and $1.1 million made up of four different lot loans in Arizona.

Also in the second-quarter call, I commented that the fourth quarter should see the reduction of an additional $11.4 million of existing nonperforming loans. I now expect that number to come closer to $16 million as we obtain ownership of our collateral. That being said, improvement in nonperforming loans in the fourth quarter hinges on the continued performance of a $15 million credit. Although still a performing real estate loan, the borrower and we are still addressing their plans related to this credit. It is believed the borrower still sees there is equity in the project and will take appropriate actions to protect their investment.

Other real estate owned increased from $4.2 million to $9.4 million during the third quarter. This increase is primarily the result of that Arizona lot development loan that we took to OREO in the amount of $4.6 million. Expected foreclosures in the fourth quarter could see this increase by another $12 million.

Citizens Finance, our consumer finance company, continues to show solid performance for the year. Loan growth for the year is $3.4 million, or 8.5%. Net outstandings now sit at $43 million. Annualized net losses for this company are 4.09% year-to-date, approximate -- appropriate for the risk and yield within that portfolio.

With that, Lynn, I will return to call to you.

Thank you, Ken. At this time, we'd open to call of for questions.

(Operator Instructions). Jon Arfstrom, RBC Capital Markets.

A couple of questions here. Ken, you talked a little bit about the three credits that drove charge-offs during the quarter. I guess -- I'm not sure if you want to get into the nitty-gritty on each of these, but can you talk about maybe what percentage of the charge-offs were attributable to those three?

Like I'd said, we had about $2.5 million of charge-offs that were above what we had previously identified through specific reserves. $1.3 million of that came in the one credit, where we had anticipated settlement with a guarantor. And the other $1.3 million was split just about 50/50 between the Wisconsin business, where we took a further write-down on a commercial real estate project where we see continued decreases in value, and the other half was to a Colorado customer.

And the expected settlement with the guarantor, is that something that is not likely to happen in the fourth quarter or the first quarter?

Not voluntarily. We're pursuing legal action on the two guarantors that we have on that credit.

Okay. And then I was writing quickly when you were talking about your $16 million expected decline in nonperforming loans in the fourth quarter. And then you talked about a $15 million credit that you were watching carefully. Did I get those two numbers right?

Yes, it is correct. Of the existing loans in there at the end of the third quarter, we should have resolution to approximately $16 million as we see it today. $12 million of that resolution is taking ownership of property and transferring it to other real estate.

Yes. Okay. That was the $12 million you talked about?

That is the $12 million. And then on the potential side, that would swing back as we still have questions on one credit of $15 million that I mentioned, that is performing at this point in time. But I do view it as a higher-risk credit.

But other than that, you don't see any -- at this point, you don't see any major issues?

Nothing of major dollar size. That's the largest one that we have that could be a potential problem.

Okay. Just changing gears here, John, maybe for you, and in terms of your money market product, what kind of books do you put in the client that opens up an account with a 5% rate of interest? Is it a --? I understand it's a money market type account. But can you do anything like direct deposit or bill pay or any other obligations that a client might have?

Right now, Jon, our efforts are to redouble our efforts, if you will, to go back and really solidify the entire relationship. That's done through direct calling, obviously, as well as some additional incentive to the producers to retain those deposits. Experience has been that we can retain as much as 80% of these type of accounts based on efforts such as these. In other circumstances on some other offerings, we certainly have tied in checking accounts, tied in ACH deposits. We do not do that in this case.

Okay. And is this primarily consumer, or is this commercial, as well?

Primarily consumer.

And then, in your text in the release you talked about Western market deposit growth. Any idea as to why it would be in the West and maybe not so much in the Midwestern market?

I think, certainly, we still see that one of the reasons that ultimately drew us to the West is the population out there. We still are viewed as a very attractive alternative in the West. The markets are still very large, and our brands out there are very viable, so that I think that's why we see that in the West.

That doesn't diminish what we've been able to do in the Midwest. It just says that's probably been less consolidated. And certainly the activity may be not as great as far as overall population growth. I think it's just a function of the market demographics still, Jon.

Then, Lynn, maybe a question for you. You touched a bit on potential M&A opportunities. What makes sense for Heartland? You've typically been a de novo Company, but just curious in your mind, what makes sense from your Company's point of view?

Yes, Jon. The reason that we switched this year in our -- well actually, for '08 we switched our strategy from de novo to acquisition strategy, because we just felt the environment was right for acquisitions that we could make some sense out of. There hasn't been a lot of activity to date, but we're anticipating that that activity will pick up, given the TARP program and just the ongoing consolidation of the industry.

During a period of time when we were seeing acquisitions at 2.5 to 3.0 times book, in the mid-20s to high 20s even on multiples of earnings, we just couldn't make any sense out of those. And we've always committed to our shareholders that we would not do acquisitions unless they were additive to shareholder earnings per share. So we just couldn't make any sense out of acquisitions at those lofty levels.

So we did de novos during that period of time. We knew the markets that we wanted to be in. The only way we felt we could access them and make sense out of them and still make sure that our shareholders continued to see increases in EPS was to do it via de novo.

That's no longer the case. We think that we're going to see multiples on acquisitions come down considerably. You are seeing banks trading at tangible book -- tangible book values lower than I've ever seen it, quite obviously. Back in the '70s we used to see transactions at book value, but I've never seen them at sub-book. So this is really a pretty interesting period of time, and we think we're going to see some consolidation in the industry. And with the advent of the TARP program, we think it's going to accelerate.

I think to add to that, Jon, too, I think the attractive deposit base is one of the key drivers we are looking for now. Strong non-maturity deposits -- I think that's the key to today's world, and that's something we'll be focusing very hard on as far as potential acquisitions.

In last month's conference call, I talked about the markets that we're interested in. They are primarily the ones that we're already in, where we could get some cost takeouts, economies of scale, and build market share with a good solid deposit base. Those would be the highest priority partners that we would seek out.

Stephen Geyen, Stifel Nicolaus.

Just a couple of questions. Just wondering what you're seeing in the migration of like substandard loans or loans in lower rated credits? You know, across the footprint by geography?

I'm thinking of that, Stephen. I don't think we've seen much shift bank by bank. Lynn had mentioned on his call, the majority of the losses year-to-date -- or possibly this was John -- that have come from the Arizona market, roughly half of the losses we've had to date. I would say the nonperforming assets are still heavily concentrated, from a Company standpoint, in that market, as well as Wisconsin, as well as Rocky Mountain Bank, pretty much the same as it has been for the last couple of quarters.

I can't find it now in the release, but you gave a -- the pricing of CDs currently, what's going to roll over over the next few quarters. Just wondering what you see right now in the market as far as a potential for reducing those costs going forward, or at least over the next -- given the current market environment, what could you expect?

I can take the first part of that, and then have John respond, as well. But we continue to see anywhere between 85 basis points and a 1% reduction in the CDs that are coming due. And we're showing, on average, about $100 million in maturing CDs every month. We are still able to add to CD outstandings and get that kind of reduction.

I would anticipate that that may come off a little bit going forward. But yet the same time, it depends on what market you are in. We are seeing some FIs paying as much as 5% out five years for a CD. I think it's still hard to attract money out that far. Most of the CDs are rolling over, 30 months or less. So most of our customers tend to be staying a bit more short term. John, did you have something to add to that?

Yes. I think, Stephen, that what we had talked about is that we're probably seeing probably at least a diminishment in our ability to reprice our CD book to some extent. So we're getting maybe to a floor in some respects, and certainly that's going to be driven in part by what is going to go on in the market relative to liquidity needs, etc. So we're keeping a close eye on that. Again, on the flip side, what I'd suggest is, I think we're going to see some opportunity on the asset side for enhanced pricing, which certainly would at least balance those two out.

If the Fed continues to ease and markets start to free up, we may see rates kind of settling in this range.

That's true.

And if that in fact happens, that could be helpful. But who knows what's going to happen with the financial markets, whether they will start to settle out or not.

Sure. Last question. There was an adjustment to BOLI in the quarter. Just wondering if there's any impact going forward.

We see probably one more impact, Stephen, of probably a lesser -- to a lesser extent in Q4. It's called immaterial at this point, but we're certainly keeping our eye on that.

John Rowan, Sidoti & Company.

Lynn, my first question is for you. In terms of the TARP money, I know you talked about it. But I would assume based off of what you discussed that your primary use of receiving TARP money would be acquisitions. Is that correct?

That would be the principal. And although I would say that because we don't have any specific negotiations going on at this point in time -- we have talked to a lot of banks obviously throughout the years, but we don't have anything that we can report on right now that's in process.

But we are growing at a rate of somewhere around $200 million per year in assets. And when we looked at this, if we took down -- as an example. I'm not saying we will or we won't. But if we took down call it $40 million in preferred, we would only have to leverage that two to one, or $80 million, in additional assets, for it not to be dilutive to our shareholders' earnings per share.

So to me, it doesn't look like much of a hurdle from an EPS dilution standpoint. But clearly, if we are able to find partners in the markets that we're currently operating in that make sense for our shareholders, those proceeds would come in very handy for an acquisition.

John, I guess just to keep within the spirit of the TARP, as well, certainly we'd look for additional lending opportunities, but again, as we indicated, we grew our loans by $69 million in this quarter, so it's not like we haven't been at the party relative to making loans.

Okay. But to stay on TARP for a second, if you guys do take TARP money -- and have you said how much you've been prequalified for or no?

We know that our maximum potential would be just short of $79 million.

$79 million. And even if you did lever two to one, it is positive to earnings. But even relative to your return on assets on that money, I would assume even at that point on a two-to-one leverage, it would in fact be dilutive to your current ROA. Do you -- if you can't find the acquisitions to make, and you do take TARP money, do you have the demand to lever out that further than two to one?

Do we have the potential loan demand?

Yes.

Clearly, that's going to be a function of the economy, John. We have a lot of assets in place, if you will. We've talked about that for a long time. In fact, we talked about that on the call today. We have three de novos, or effective de novos, in place that are still growing. So that suggests we have a lot of engine that's just starting to warm up, if the economy starts to return to a normal phase. So I think that's a potential.

But again, as Lynn indicated, we are very focused on acquisitions. We always have been. A third of our growth has historically come from acquisitions. So that's still a play for us, as well.

Just one last thing on the TARP program. Would you consider buying deposits from a failed institution?

Absolutely.

Yes.

Absolutely.

I -- we had -- you know, if it's out in Timbuktu, probably not. But we would want it to be additive to our current footprint and in a market that would be attractive to us. But just to buy deposits for the sake of buying deposits wouldn't make much sense.

But as John said in his comments, when we look at acquisitions, we're looking very much at the deposit franchise and the value of those deposits, because we really see that as the franchise value of our institution.

And just one more before I get to Ken. John, the FDIC insurance premiums, you said they are going up. Can you say what they were this quarter and what you see them going to on a quarterly run rate?

I can tell you that we're looking to see it about $2.8 million on an annualized basis in '09.

But you don't know what it was this quarter?

Tell you, I think it was about $1.7 million -- run about $1.7 million for the year -- $1.4 million rather. About $490,000.

Of an increase?

No. That's total.

Oh, okay. For the quarter?

Yes.

And then, Ken -- just wanted to touch base on the $16 million that you expect to clear out of NPL and liquidate down through REO. You guys talked about taking charge-offs before you move things into REO. And I just want to find out, of that $16 million, what have your already taken charges on -- potential you took in the third quarter? And what your collateral is backing that $16 million -- the potential for charge-offs in the fourth quarter.

That charge-offs, John. Did you say $16 million in charge-offs?

No. $16 million coming out of NPL.

Into REO. (multiple speakers)

Into OREO. But I want to know if you guys had charged off any -- charged any of those -- that $16 million down already.

Let me scan all the names. Say it's $750,000 on one. That's all that jumps out at me. When I look at this, it's three, five, nine, 11, 14, 16, 18, 20. There's a total of 25 credits involved in that, and as I scan the names there, I only see $750,000 that we took as a charge-off in the third quarter.

Okay. So realistically, could we be looking at a significantly higher charge-off in the fourth quarter?

No, not on those credits.

Jeff Davis, Wolf River Capital.

Two part question, unrelated. First, does the recent drop in commodity prices impact the ag portfolio? I'm going to preface by assuming not this year, but maybe thoughts on next year?

And then secondly, Lynn and John, in terms of TARP, and the -- maybe for the focus for those who don't get TARP money or are offered TARP money, which you're clearly not going to be in that camp, is -- what are you hearing from the regulators informally? Is the MO, then will be like what we read about [Mat City] where [Dugan] told Peter to go find an M&A partner quickly so that some of these more challenged institutions are cleared out quickly? Or are they going to have more of a regulatory forbearance, where they're allowed to linger for a year or so?

I don't leave, Jeff -- this is Lynn. I don't believe they've really shared that with us. They have said that they'd like strong institutions to be able to acquire the weaker ones so that the FDIC doesn't have to take them out and end up liquidating them. So I think that's clearly one of the motivations. But your other question -- I don't know the answer to that. (multiple speakers)

I think that's at a higher level than we've been at, Jeff, maybe. But --

Yes. I was just asking you to speculate. That's okay.

Yes. Oh, I understand. I am sure some of that's going on. We haven't seen all -- a lot of that, but (multiple speakers)

My guess is that they would be reluctant to share that with us. Whether some of the money will be politically driven or not to the institutions, I don't know. I would guess those institutions that are three rated, that are kind of on the bubble, they'll have to make a decision as to whether they help save them or they let them join with somebody else.

But again, that certainly would be -- as we think about acquisitions, Jeff, that certainly would be part of our targeting, as well.

Yes. Okay. And then (multiple speakers)

Commodity -- the question on commodity prices. We've been watching that. With corn coming from $8 a bushel down to $4, we're going to be watching that very closely with our ag clients, although I will say that our ag customers tend to be very well capitalized. They've not over leveraged on farmland like they did back years ago in the '80s.

We've seen land sell for as high as $6500 an acre for good, productive land, but most of our clients have not participated in purchasing a those levels. If they have, it's been a neighboring farm where they've been able to meld the cost of that into the rest of their land. We've always cross collateralized with all the land of our farmers and cross collateralized with their operating lines.

But we've got a pretty savvy group of ag clients, and my guess is they will be very careful to hedge their inputs and their outputs as they have in the past. And fuel prices keep coming down. That's certainly going to help.

I was going to say, it puts -- they should see some relief from their inputs, as well.

That's the key. The concern was, if corn comes down to $4 an acre, and oil stayed up at the price that it was, that that was going to be a real squeeze. But it looks like both are easing. So I would guess that it will be a manageable situation for those ag producers that are well capitalized and have good management.

Correct me if I'm wrong, but I think you've only got, what, one relatively small situation that's ethanol related. But how does the drop in commodity and drop in oils flow through for those financial institutions that have been making loans for ethanol plants and the like?

We've only got two, and they are extremely profitable. They are very well capitalized. We've had a cash flow recapture on our loans, where any additional cash flow that they were receiving over and above the payments was going to prepay their debt. So I feel pretty comfortable with what we've got.

I think there may be some challenges out there for people that were aggressive in that industry. We set early on, a limit on the amount of dollars we wanted to have loaned to ethanol plants, because we've just never been overly comfortable with where that whole thing was going.

That being said, though, the ones that we've done I think have performed very well, and they're with good management.

I'd echo that too, Jeff. And in the commodity prices, the high corn prices and the high soybean prices that came over the summer really came when there also wasn't a lot of commodities available to trade there.

I know that our ag lenders have been very active in working with their borrowers to say these last couple of years that have been very profitable in all segments of the ag markets, whether it's been in meats or dairy or row crops, that they use the cash that they can build over that time to help build a stronger financial position, because other than fuel recently coming down, other input costs appear to be going up from the fertilizer and seed side.

But as Lynn had mentioned, most of our ag borrowers are fairly well sophisticated, are good business people and are positioning themselves for those potential increased prices.

Brad Millsaps. Sandler O'Neill.

John or Lynn, I was wondering if you could talk maybe specifically about the loss at Summit Bank & Trust this quarter. Just curious, is that mostly related to credit? And then secondly, maybe talk a little bit about what you're seeing in New Mexico and Montana.

Let me take New Mexico first, because it's kind of amazing to me, both New Mexico and here in Iowa, in this region, the tri-state area, it's hard to tell that we've got a recession going on. It's hard to tell that we've got the kind of problems in the financial industry across the world that we're seeing today.

But in Arizona, clearly, as I said before, it's the most challenged market that we're in. And Montana is seeing a slowdown, as well. So I think Denver is soft, but it's not terrible. It's nowhere near as tough as Arizona. Wisconsin is soft, but yet again, hasn't seen the huge declines in property values that we see in Arizona.

Ken can address the credits in Denver. We had a couple real estate transactions that are slow. They are still servicing the debt, but they are slow. And Ken, do you want to expand on those at all?

Yes. The one I had already commented on that we took, it was about $650,000 that we took a charge-off on in expecting lower real estate values. Another one we took a reduction on was some retail condos in the Denver market that we took a few hundred thousand dollar charge-off, as we feel that we may be getting that property back, and we took it down to what we felt was realizable value. The losses there have come from reduced real estate values in that market.

Okay. So the loss this quarter of about $1.2 million, that's -- you're saying most -- that that's mostly all credit related, even though -- if I'm looking -- if I have my subsidiary data correct here, you only have about $1.5 million of nonperforming loans at that location?

Right. I mean the provision expense in the month of September only was $1.2 million at Summit.

Including growth [of loans], too, Brad, that also would be in the equation.

And on Summit's situation, I would expect some recoveries on those loans.

And Ken, how much sort of land and development construction exposure do you have at the -- at your Montana subsidiary?

Give me just a second here. I can tell you that. Montana, in the construction land development we have a total of $36 million. I will tell you that that is the dollars outstanding on the books of Rocky Mountain. Naturally, we participate loans out to our other member banks. So that one $15 million credit I mentioned before, that is not all on the books of Rocky Mountain. They would have approximately $4.5 million to $5 million of that, and the remainder would be participated to our other Heartland banks.

(Operator Instructions). Brian Martin, Howe Barnes Hoefer & Arnett.

Ken, I think you maybe just answered this, but that -- the $15 million credit that's still performing, I just kind of want to get a sense for what market that was in, and the collateral, and if you guys have had an appraisal on that recently?

Brian, it is in the Montana market. We haven't a recent appraisal, and I guess for the sake of not disclosing any more about the customer -- I always try to be close to the vest of not disclosing enough about any particular credit that we can tie it back there or to the market. So I guess I wouldn't go farther on that answer.

As far as appraisals in '08 (multiple speakers)

We had one a year ago at the beginning of the year. We haven't had one since December of last year.

How about just two last things. On the loan side, the -- maybe you can just talk a little bit about the loan pricing you're seeing that will help a little going forward, and just kind of the growth in the consumer portfolio this quarter, just what was driving that.

I think -- general statement on pricing -- we're seeing all of our banks realizing that there is an opportunity to get increased margin with the changes going on in the banking environment. So I believe I would tell you that they're -- we do see that marked up just within the last 30 days by most of our commercial lenders. In the deals they're doing, we are seeing some better spreads than what we've seen previously.

Maybe more appropriate pricing is one way to think about it.

How about more equity? Are you getting more equity in these deals? Or is it just better pricing?

I think we framed it in our discussions, Brian, that we're looking really for [quali-fits] -- solid credits first, and better pricing second, and then volume third.

How about just the growth in consumer in the quarter?

I'm trying to think. We had -- that was -- do you have it? In the core we had $1 million at Citizens, and then $2 million in New Mexico Bank & Trust, and then another $1.5 million at Dubuque Bank and Trust.

I was looking at year-end '07, so my bad on that one. Sorry, guys. That's all I had.

And Management, there are no further questions at this time. Please continue with any closing comments.

Thank you. In closing, Heartland's core financial performance remains solid. And to that point, two of our largest banks are having their best year on record, that's New Mexico Bank & Trust and Dubuque Bank and Trust.

However, like our peers, regional problems in the real estate area have resulted in increased levels of nonperforming loans, provision expense, and charge-offs that Ken Erickson referred to. We have allocated additional resources and focused our energies on those markets that are most challenged. We believe that we are properly reserved and are hopeful, as Ken said, that an improving trend will be evident within the next two quarters.

We continue to operate with an attractive net interest margin of just under 4%. Risk-based capital is in excess of 12%. We have ample liquidity and a growing loan and deposit base. With a dedicated and capable staff, and the potential of accessing capital via the TARP program, we are poised to take advantage of acquisition opportunities which are likely to surface in our industry over the next few quarters and over the next 18 months.

I would like to thank everyone for joining us today, and hope that you can join us again for our next quarterly conference call, which will be January 26, 2009.

Thanks again, everyone, and have a great evening.

All right. Thank you, ladies and gentlemen. This does conclude the Heartland Financial USA third quarter 2008 conference call. If you would like to listen to a replay of today's conference, please dial 1-800-405-2236 or 303-590-3000, input the access code 11120596. Again, (Operator Instructions).

HT would like to thank you very much for your participation today. You may now disconnect. Have a very pleasant rest of your day.