Heartland Financial USA Inc (HTLF) 2008 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Heartland Financial USA fourth-quarter 2008 conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions). This conference is being recorded today, Monday, January 26 of 2009. I would now like to turn the conference over to Leslie Loyet for Financial Relations Board.

Good afternoon, everyone. Thank you for joining us for Heartland Financial USA's conference call to discuss fourth quarter and year end 2008 results. This morning we distributed a copy of the press release, and hopefully you have all had a chance to review the results. If there is anyone online who did not receive a copy, you may access it Heartland's web site at www.HTLF.com, or you can call [Hon Hoy] at 312-640-6688, and she will send you a copy immediately.

With us today from management are Lynn B. Fuller, President and Chief Executive Officer; John K. Schmidt, Chief Operating Officer and Chief Financial Officer; and Ken Erickson, EVP and Chief Credit Officer. Management will provide a brief summary of the quarter and year end and then open the call up 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 at the Company's web site or the SEC's website.

With that said, I would now like to turn the call over to Lynn Fuller. Please go ahead.

Thank you, Leslie, and good afternoon, everyone. We appreciate everyone joining us today as we review Heartland's performance for the fourth quarter and full year of 2008. For the next few minutes I will touch on the highlights for 2008 as well as our focus for 2009. I will then turn the call over to John Schmidt, our Chief Operating Officer and CFO, who will provide detail on Heartland's quarterly and annual financial results. Then, Ken Erickson, our EVP and Chief Credit Officer, will offer insights on the status of our nonperforming loans and credit quality.

In today's earnings release, Heartland reported income from continuing operations for 2008 of $11.3 million. That compares with $24 million in the previous year. On a per-share basis Heartland earned $0.68 per diluted share from continuing operations compared to earnings of $1.44 per diluted share from continuing operations in 2007.

Well, it goes without saying that 2008 was a disappointing year for us, primarily as a result of provision expense, which totaled $29.3 million for the year, over half of which occurred in Q4. This compared with $10 million in provision expense for the previous year as a result of the Company reporting a net loss of $2.7 million for the fourth quarter of '08 compared with earnings of $6.8 million from continuing operations for the same period last year. On a per-share basis, Heartland lost $0.18 per diluted share in the fourth quarter compared to earnings of $0.41 per diluted share for the same quarter a year ago.

I know that you are all keenly aware of the challenges facing the banking industry in the current economic environment, and I can assure you that Heartland and all of its subsidiaries are intensifying their efforts towards resolving the growing credit challenges and taking aggressive actions to better position the Company for the future. Achieving a substantial reduction in nonperforming loans continues as Heartland's top objective for 2009.

Throughout 2008, I consistently communicated and continually reinforced with our entire staff that we must focus on those things that we can control, such as reducing nonperforming assets, expense management, sales and service and pricing. Fortunately, we did see the results of this focus with solid performance in a number of our core operating units. Our two largest banks had excellent performance for 2008. Specifically, Dubuque Bank and Trust, our flagship bank, experienced its best year ever. Our second-largest bank, New Mexico Bank and Trust, had its second-best year. Our consumer finance company, Citizens Finance, also had its best year ever. Of our 11 subsidiaries, eight were profitable and three lost money.

Two of the three banks that lost money are still in de novo status, and the third is located in Phoenix, Arizona. And of all the markets that we are in, Phoenix has been the hardest hit by the recent recession.

Another bright spot in 2008 was maintenance of our net interest margin at just under 4%. Our margin slipped in the fourth quarter due to high non-accruals and a short-term deposit promotion. However, a continued focus on core deposit growth, disciplined loan and deposit pricing and a reduction of nonperforming assets will favorably impact margin going forward. As you will hear in a few minutes, margin maintenance continues as one of our top priorities for this year.

We were pleased that loans increased by $125 million or 5% during 2008 with $41 million of that growth in the fourth quarter. As loan demand continues to be fairly strong in a number of our markets, we continue to target and book high-quality credits with attractive deposit relationships. We were extremely pleased with our double-digit deposit growth. Thanks to new products and successful promotions, deposits grew by $264 million, or 11%, in 2008.

One of our new products introduced early last year was Cash Rewards Checking, which continues to be met with tremendous success, attracting over 6500 new accounts. Growth in core, non-maturity deposits was an area of primary focus last year and continues to be a high priority for 2009.

One of the strongest investment attributes of Heartland is our geographic diversity. We believe our footprint protects us by spreading risk across several regions. As a case in point, our weaker markets of Phoenix, Denver and Bozeman have been historically high growth areas with rapid price appreciation. Bozeman is proving to be somewhat of an isolated case since the rest of our Montana markets remain relatively stable.

Billings, for example, ranks among the lowest unemployment cities in the nation with a jobless rate of only 3.3%. Two of our strongest markets are Dubuque, Iowa and Albuquerque, New Mexico, which are well diversified and also have very low unemployment rates. And here in Dubuque, we're celebrating the announcement of IBM establishing a new division in our community, which will bring 1300 new jobs to the Dubuque market within the next 12 months.

Well, as I've stated before, capital is king in tough economic times, and Heartland's capital levels are strong. On September 30, 2008, before opting into the Treasury's Capital Purchase Program, our risk-based capital level was 12.32%. Now, with $81.7 million in TARP capital, it approaches 15%. Additionally, our total capital ratio now stands at 8.42%, and our tangible common equity ratio of 5.19% stands right between our benchmark range of 5% to 6%.

Following receipt of the TARP funding, which occurred on December 19, we paid off our credit line and invested the balance. Our expanded loan base of $41 million in the fourth quarter speaks to Heartland's intent to honor the spirit of the program. At this point we're evaluating the next steps in deploying this capital, including potential acquisitions.

Recapping last year's expansion efforts, Heartland opened its newest de novo charter, Minnesota Bank & Trust, in April. This new bank is located in Minneapolis suburb of Edina and by year end had produced new loans in excess of $13 million and deposits in excess of $10 million. Additionally, in October of last year we opened a new banking office in Albuquerque for New Mexico Bank & Trust, which brought our total number of New Mexico locations to 17. I might add that this new office has already attracted over $7 million in deposits, a pace significantly ahead of our annual de novo branch goal of $10 million per year.

With respect to M&A, we're finding more and more acquisition opportunities all the time. We like the markets that we are currently in and we'll focus our attention on fill-in acquisitions where we can grow market share, achieve efficiencies and provide greater convenience to our current clients. Additionally, we have asked our regulators to notify us when troubled institutions surface in our current markets.

So, looking ahead to this year, there are six critical areas on which we will focus our resources, and these are in the order of importance. Number one and most important, reduce nonperforming assets and minimize losses; number two, acquire and grow non-time core deposits; number three, reduce overhead; number four, manage net interest margin; number five, a continued emphasis on training so that we can the best we can possibly be and a leadership discipline which holds management accountable for achievement of our plans and budgets.

Finally, I'm pleased to report that at this month's Board meeting we elected to maintain our dividend at $0.10 per common share, payable on March 13, 2009.

That concludes my comments. I will now turn the call over to John Schmidt for more detail on our fourth-quarter and the full-year financial results. John?

Thanks, Lynn, and good afternoon. In my comments this afternoon I will provide additional color on the most substantial changes to Heartland's balance sheet and, in particular, the income statement in the past quarter, 12-31-08 versus 9-30-08.

Looking first at the balance sheet, total loan balances increased by $41 million in the fourth quarter. Year to date growth of $125 million on loans exceeded our forecasted growth of $100 million. For 2009, while not our top priority, we are looking to add $100 million in additional loans. As we add these credits, certainly the focus continues to be threefold -- one, booking quality credits; two, being paid appropriately on these credits; and, three, adding customers with attractive deposit potential.

We have been encouraged by our core deposit growth that excludes brokered CDs, which increased by $102.7 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 $85.9 million from the third quarter. The majority of this growth reflects the introduction of a new money market account that featured a teaser rate until 12-31-2008. While this product negatively impacted our margin by approximately 3 basis points in the fourth quarter, over 60% of the growth in this product was new money. Thus far, we've maintained nearly 80% of the dollars deposited into the product.

Time deposits continued last quarter's trend by increasing by $6.9 million. Finally, as Lynn mentioned, with the receipt of TARP, we paid off our $34 million credit facility. Relative to TARP or, more appropriately, the capital purchase program, we will accrue an annual preferred dividend amounting to $4.1 million in addition to recording the accretion of a discount at $1.3 million on the preferred stock.

Moving onto the income statement, for the quarter the Company recorded a net loss of $2.7 million or $0.18 per basic and diluted share. As we discussed in our pre-release, the most significant event this quarter was the $8 million increase in provision for loan loss, which totaled $15.1 million for the quarter.

At the same time, net charge-offs for the fourth quarter totaled $14.3 million as compared to a total of $12.4 million for the first three quarters of 2008. Net charge-offs for the year expressed as a percentage of average loans and leases totaled 115 basis points.

Ken Erickson, our Chief Credit Officer, will provide additional detail on the increase in provision, charge-offs and nonperforming loans. While Heartland experienced a decrease in margin for the quarter both in terms of actual dollars and as a percentage of average assets, we feel the margin remains a true strength in the Company. Despite the increase in non-performing loans including interest reversals on these loans and the negative impact of our deposit special, the margin was still a respectable 3.79% for the quarter.

As we mentioned last quarter, we feel that with the exception of the already instituted repricing on the promotional money market account, we're approaching an effective floor on the liability side. At the same time we feel we have the ability to see enhanced pricing and terms on the loan side for the foreseeable future. We also feel we have done a good job of instituting and adhering to floors on loans. As a result, as compared to the fourth quarter, we see a relative stabilization in margin in 2009. This could certainly be impacted by our ability to grow loans, [full] floors on loans and the level of non-performing loans.

Non-interest income decreased by $2.4 million in the fourth quarter, driven in large part by a loss on the cash surrender value of life insurance. In general, this loss was caused by the underlying mortgage-backed portfolios experiencing market declines in excess of the stable value wrap. We received the last notice in early December of these write-downs; and, with the rally in the mortgage-backed market, it would appear that we are fairly well insulated from future losses.

Non-interest expense for the fourth quarter decreased by $2.6 million or 9.6% from the third-quarter levels. Salaries and employee benefits decreased by $2.7 million from the third quarter as bonuses were reduced by $1.3 million and a $1.1 million adjustment was made to the discretionary portion of the retirement plan.

As we look to 2009, a salary freeze has been instituted for a significant portion of the officer base. Additionally, we will be accruing the retirement plan at 4.25% of salaries, which is consistent with 2008. In 2007 we contributed 6.25% to the plan.

Finally, while we intend to hire some key additional corporate personnel, including a chief risk officer, staffing will be tightly controlled with additions expected to be very limited in 2009. FDIC insurance expense, which is reflected in outside services, totaled $1.4 million for 2008. For modeling purposes total charges are expected to be $3.5 million in 2009. Tax benefit recorded for the fourth quarter was 39.7%. The crediting rate for the quarter was positively impacted by the recognition of a $220,000 tax credit at Dubuque Bank & Trust. We would expect our tax rate to be in the 29% range for 2009.

In closing, obviously the fourth quarter was very challenging for Heartland. At the same time, I think it's important to note that the majority of our problems remain isolated to a relatively small number of our subsidiaries. Accordingly, despite the increase in nonperforming loans, the core earning capacity of Heartland remains very much intact.

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

Thank you, John, and good afternoon. I will begin by discussing the increase to non-performing assets in the fourth quarter. As already mentioned, our non-performing assets increased significantly in the fourth quarter. This increase is primarily due to the addition of eight new credits to non-performing status. These credits were originated by Rocky Mountain Bank, $16.5 million; Summit Bank & trust, $7.7 million; Arizona Bank & Trust, $4.9 million and Riverside Community Bank, $3.1 million, for a total of $32.2 million.

These eight credits are all real estate-related in the following areas. Land and lot development represents $16.3 million; high-end residential, $11 million; and construction and development of commercial real estate, $4.9 million. These loans have recently deteriorated due to the continued softness in the commercial and residential real estate markets. Two of these loans were less than 60 days past due as of December 31st, but are considered impaired due to the borrower's inability to continue to service the debt from outside sources of cash flow.

The largest of these additions is the credit I discussed during the third quarter earnings call, an $11 million land development loan in Bozeman, Montana. The owners of this property were no longer able to support the carrying costs during the delayed absorption period for the residential lots of this subdivision. We have agreed to accept deed in lieu to this property and expect to move it to other real estate by the end of this month.

I will now turn the discussion to total non-performing loans. Of the $78 million in non-performing loans, $57 million resides in 18 credits where individual exposures are greater than $1 million each. The majority of these loans were originated by Rocky Mountain Bank, $21.3 million; Arizona Bank & Trust; $15.3 million; Summit Bank, $7.7 million; Wisconsin Community Bank, $7.1 million and Riverside Community Bank, $3.1 million. This totals $54.5 million of the $57 million.

The industry breakdown for these loans is lot and land development, $16.3 million; high-end residential, $11 million; construction and development of commercial real estate, $8.7 million; real estate credit providers, $6.5 million; construction of multifamily and condos for residential, $4 million and seven other industries make up the remaining $10.5 million.

In regards to charge-offs, as stated last quarter, Heartland had generally recognized the charge-off on a loan when the loan was resolved, sold or transferred to other real estate. However, in the third quarter Heartland began to recognize charge-offs on certain collateral-dependent loans by writing down the loan balance to an estimated net realizable value based upon the anticipated disposition value. That practice continued into the fourth quarter as we recognized losses on impaired loans.

While the continued slowdown in the economy collateral values were no longer sufficient to cover our loan balance on several real estate-related loans, we took charge-off on these impaired loans to bring those balances down to the estimated liquidation value of our collateral. The increase in expected absorption periods drove the majority of the discounts for these properties.

Since many of our loans are participated across our member banks, I have also analyzed our losses as if they had been recognized by the bank originating the loan. If so, our primary losses for 2008 would have been shown as Arizona Bank & Trust, $9.8 million; Rocky Mountain Bank, $7.1 million; Wisconsin Community Bank, $3.2 million and Summit Bank & Trust, $2 million. Our 2008 and fourth-quarter charge-offs were concentrated in a few larger credits. Eight credits represented $13.8 million or 52% of the annual loan loss. Those same credits represented $8.5 million or 59% of the loss taken in the fourth quarter.

$10.2 million of the fourth-quarter charge-offs were taken against the $57 million non-performing loan that represents the 18 largest non-performing loans with exposure greater than $1 million each. These recorded charge-offs recognize the expected loss in these credits as of December 31st. Our losses in 2008 were incurred in the following loan categories -- construction, land development and other land loans, $15.2 million, 5.3% of their respective loan outstanding; commercial and industrial loans, $6.6 million, 1.6% of their respective loan outstanding; loans to individuals, $2.3 million, 2.6% of their respective outstanding.

Without the influence of the losses taken by our consumer finance company, this is 0.72% for loans to individuals; junior liens on one-to-four-family residential, $1 million for 0.6% of the respective loan outstanding; and first lien on one-to-four-family residential, $400,000, 0.2% of their respective loan outstanding.

Regarding the loss exposure and expected resolution of the non-performing loans, I can state that, despite the fourth-quarter increase in non-performing loans, significant progress is being made. Collection efforts in the first quarter of 2009 are expected to result in a reduction of $22 million of the nonperforming loans recorded at year end. Of this amount, $20 million is expected to be moved to other real estate.

As the expected loss has already been recognized for the remaining $56 million of non-performing loans, the existing collateral appears to be adequate based upon recent appraisals.

Other real estate increased from $9.4 million to $11.8 million in the fourth quarter. The first quarter of 2009 is expected to see a significant increase in ORE. Now that we have completed this phase of the collection process on several of the non-performing loans, increased emphasis will now be placed on the prudent liquidation of the assets held in ORE.

While the economy remains unsettled, it is difficult to predict how many more loans within our portfolios may result in non-performing assets. I believe our recent actions are in concert with our history to quickly recognize problems and losses within our portfolio and to resolve them as quickly and as prudent as possible. I also continue to believe that our portfolios are well-managed, existing risks have been properly recognized and our allowance for loan and lease losses is adequately funded for the risks in the portfolio.

Again, keep in mind that with our immediate recognition of charge-offs on impaired loans, instead of creating a specific reserve for the potential loss, it had the impact of reducing both the allowance as a percent of total loans and the allowance as a percent of non-performing loans.

In regards to portfolio diversification, Heartland remains well diversified in its loan portfolio. $1.9 billion or 78% of its loans are either fully or partially secured by real estate. The largest categories within our real estate-secured loans are residential real estate excluding residential construction and residential lot loans, is $400 million; industrial, manufacturing, business and commercial, $387 million; agriculture, $190 million; land development and lots, $148 million; retail, $121 million; residential construction, $112 million; office, $99 million; hotel, resort and hospitality, $98 million.

Of the $900 million of loans categorized as non-farm, non-residential, 63% is owner occupied.

Loan demand resulted in a loan increase of $125 million in 2008. We continued to see reasonable demand for new quality credits.

The first quarter of 2009 should bring to completion of the installation of a software package acquired from Inmatrix. A key feature of this software was the design of a dual risk rating system measuring probability of default and loss given default. It is also designed to allow the user to perform various stress-testing scenarios on defined segments of our portfolios. We expect this software to assist us with enhanced portfolio of management and allowance methodology.

With that, I will turn the call back to you, Lynn, and remain available for questions.

Thank you, Ken, for the update; and at this time, Leslie, I'd open the call up for questions.

(Operator instructions) Jon Arfstrom, RBC Capital Markets.

I guess a question for you, Ken. I was writing fast and furiously when you were talking, but did you touch on the Watch List at all and what those trends look like?

I did not, but I can share with you -- I'll give you quarter two, quarter three, quarter four results. We had total delinquencies of $83 million, quarter two; $100.8 million, quarter three; $99.5 million in quarter four, so a slight decrease. We saw an increase in non-performings from quarter three to quarter four, as you saw, of $30 million-some, so we saw a reduction of about $8 million in those loans 60 to 89 days past due and a reduction by about $28 million of loans that are 30 to 59 days past due.

I guess I addressed your question on delinquencies versus Watch List. Those totals are approximately the same.

Okay, that's helpful. Lynn, maybe you or Ken, Lynn, you talked about some of the critical, six critical things that you would be focusing on this year and you talked about a decline in the non-performers and losses. I guess my question is, with the prospect of the real estate-owned balances increasing, how aggressive do you plan on being in moving those credits off the balance sheet? Is this something where you feel you can be patient, or would you rather just move them off the balance sheet and move forward?

At this point, we're in the process, Jon, of categorizing those. We didn't have a lot of OREO midyear or third quarter, so this has become a new effort, and we are identifying those properties that we would like to move immediately and those properties that we feel we would just assume be a bit patient with. We are projecting that out for all of '09 to try to get a better handle on where OREO should be, given the effort of liquidating some and holding others.

So that's underway right now. We're forecasting all of that out, along with forecasted non-performers, as Ken talked about shocking the portfolios to see what potentially could end up going into additional non-performers if the economy continues to weaken.

Ken, in terms of the secondary market for those credits, that's the type of valuation that you use or that you plan on using when you value these credits?

When we immediately move them to ORE, we do get a current liquidation market value appraisal and move it into ORE at, typically, 90% of that, allowing for a 10% marketing cost. As Lynn mentioned, my first step on this ORE, I sent something out to the banks within the last week of my forecast of the timing by quarter and asking them on each of these, with their perspective from their markets, the marketing efforts and the success that they would have marketing under normal conditions.

From there, we'll gather that information and decide whether or not we wish to become more aggressive or change our approach on the liquidation of those.

And then maybe one other question. In terms of your, I believe, John, you talked about $100 million in loan growth as the goal. Maybe John, you or Lynn, if you could maybe talk a little bit about where and what you would prefer that growth to come from?

We certainly still look to see Dubuque Bank & Trust grow their portfolio, Jon, and they have been very successful in growing portfolio. As you have seen, their portfolio has been relatively clean and there's more good news coming down the pike, as Lynn alluded to, relative to the new jobs in this economy. So that's one of the markets we certainly look to grow loans in.

I would say that the loans, by and large, are spread throughout the organization, though. Again, under the criteria we have already alliterated, I think we'll take those loans in the markets that we have discovered them, if you will, as long as they fit that criteria as we develop them versus discover them.

I might add to that, we have established target markets. We use our marketing group to identify those prospects in the individual markets. Our highest priority is to target deposit-rich type of companies, companies that tend to be more mature. In many cases they are individually owned by people that have been in business for some time and demonstrated the ability to work through these kinds of downturns in the economy.

So we really are looking for deposit-rich type of customers that also have some borrowing needs and have a great track record. We are looking at professional groups as another target market, and non-for-profits. So in those markets where we have been heavier in real estate, that's really not our top priority at this time. I think we've got plenty of real estate to deal with.

(Operator instructions) Brad Milsaps, Sandler O'Neill.

Ken, I just wanted to follow up on some of the data you were running through. The 18 credits that you said totaled about $57 million -- I think you mentioned that you had taken about $10.2 million in charges against those loans. Would that be the total amount of charges you've taken? That would equate to about a 15% reduction in the value there.

That's right. Of those 18 loans, in the fourth quarter we charged off $10.1 million, and the remaining balance is now $57 million.

Okay, so that 15% reduction, coming back to Jon's question, is kind of -- obviously, there could be some loans in there that are more than that or less. But on average, that's what you are looking at?

Yes. And then some of those loans did not have any specific charge-down in the fourth quarter, as we felt we were -- did have adequate collateral. But we had a couple of those that were larger amounts with the recent developments in the fourth quarter.

Sure.

Brad, the largest credit, though, that we took would have about a -- call it a 25% reduction.

That would be that high-end residential project?

Right.

Okay. And then you guys gave great detail in some of the sub-bank data. I know the loan portfolios don't necessarily reflect maybe where the loans were originated from, rather kind of loans that are participated throughout your system. I was going to see, Ken, if you could give me a sense of your three most problematic markets -- Montana, Arizona and Colorado -- what the actual exposures to those markets versus what you show here in the sub-bank data.

I guess I would turn back to the summary I made of the $78 million in non-performing loans. If I bring those back to the bank of origin, Rocky Mountain Bank is sitting on $21.3 million of that. Of that, $16 million, $17 million is made up of the two recent credits that went in in the fourth quarter, of which half of that is expected to move to ORE at the end of this month.

Maybe let me ask you a different way. You've got about $325 million of loans at Rocky Mountain Bank. Does that accurately reflect your exposure in Montana? Or would that number be much higher due to loan participations throughout your system?

I'm not sure I fully follow the question, Brad.

Let's follow up off-line, then. And then maybe just another follow-question for John. Can you go back over some of the operating expense kind of run rate in '09, specifically the FDIC insurance premiums and what you're looking for in terms of personnel expense?

The thing that we noted, Brad, was the fact that the FDIC charge, which was $1.4 million for 2008, we look to jump to $3.5 million for 2009.

Alright.

Reflected in the Q4, as I said, was a $1.1 million adjustment to the discretionary portion of the retirement plan. We look to keep the run rate of that as -- for 2008; we will roll that over to 2009. In essence, we booked 4.25% of salaries in 2008. You'll see the same thing in 2009.

Okay.

And bonuses -- we did reduce them by $1.3 million in the fourth quarter. Certainly, that will be dependent upon performance in 2009.

And I think we've proven in our past actions, certainly we are willing to respond either way. If we see enhances performance, we will increase bonuses, but if we see performances at this level, we will respond accordingly.

Since we are in that vein, maybe a question for Lynn as well. How do you think about acquisitions versus maintaining the dividend, thinking about a lot of focus on the tangible common equity number? Obviously, your hope is that the earnings can improve and that number gets moving in the right directions. But I'm just curious how you are thinking about the dividend weighed against potential acquisitions that might be out there.

If we did any acquisition of size greater than somewhere in the $100 million range, we would probably use part TARP and part new common.

Yes, if we did any acquisition of any size.

Okay, great, thank you.

Another thing I might just add, Brad, is that I don't want there to be confusion on what we think the devaluation of assets that we've taken into OREO is. If we look back at the lower of cost or appraisal of these loans, back when they were originated, we are seeing discounts from 50% to 60%. Do you understand what I'm saying?

Yes, absolutely.

The discounts are pretty big. Now, our loan-to-value on those was reasonable when we made those loans, but even that, we are getting current appraisals where John talked about as much as 25% additional write-down. So it has been significant. I have been amazed at how they've beat down these valuations.

You asked a question of Ken. I'm wondering if that was back to participations as far as Rocky Mountain, have they been a net recipient or have they participated loans out?

In other words -- I don't want to dwell on this too much -- but what is your exposure in Arizona? Is it more than $140 million that you show? Because doesn't Arizona participate in loans to New Mexico and potentially Dubuque? I'm just curious what your actual exposure is in some of these states versus what it says in terms of some of the sub-bank data.

Thanks for clarifying that. Arizona is a net seller of participations. They have just under $30 million that they have sold out. They've sold out $40 million of loans and have purchased from other affiliates $10 million.

Rocky Mountain Bank -- they have purchased $37 million and have sold out $27 million. And Summit, the other one that we have seen some larger exposures recently, is a net seller of loans of $24 million. So $24 million above the loans shown outstanding on their books, there would be another $24 million of their loans residing on other banks' books.

Brian Martin, Howe Barnes.

Brad just asked one of my questions, on the capital. But I guess, John maybe just the -- how low are you comfortable letting tangible common get at this point? You talked about a range of being 5 to 6; you are at the low end of range. So does it go below 5 and then it becomes a concern you look more at the dividend?

What we have committed to our Board is that if we should drop below the 5 range that we would come back with a plan how to get back up into our range of 5 to 6.

And then, just the only other question I have is, and it's small, but the other fee income this quarter, John, on a linked-quarter basis, it was a decent differential. Was there anything unusual in that line item or just smaller things that -- not to worry about?

Are you talking about other?

Yes, the other fee income line.

The 543 is what you are referring to, Brian?

Yes.

There is some of the ineffectiveness of a hedge that has gone to that line item, both in Dubuque and Rocky Mountain, so we saw some of that flow through. That would certainly account for that differential.

(Operator instructions) John Rowan, Sidoti & Company.

The loan growth figure that you gave us for '09 -- that doesn't include any potential acquisitions; correct?

Absolutely none.

Stephen Geyen, Stifel Nicolaus.

The impairment loss on the security for the quarter -- what was that from?

We had an investment in a hedge fund that has been -- it was a relatively small investment that had appreciated over time. But we saw some -- obviously, with the overall market, we saw the negative implications of that, Stephen, and thought at this time it was appropriate to take that.

There are no further questions at this time. I would like to turn it back to management for any closing comments.

Well, given the current economic environment and the challenges facing the financial industry, I think it's appropriate that I close with a brief recap on Heartland's history. As a company, times like this are not foreign to us, and historically, we have always emerged stronger out of hard times. In fact, our flagship bank, Dubuque Bank & Trust, was born out of the Great Depression of 1935. And our holding company was chartered following the worst recession since the depression of 1981, a period when Dubuque's unemployment rate was the highest in the nation at 26%. Let's hope we don't go there again.

Well, 2009 will certainly test the strength of our management teams across the Company as we navigate through these challenging times. However, I am confident that our leadership will continue to evaluate the challenges that lie before us, make the necessary changes and adjustments and lead Heartland's return to high performance, just as we always have in the past. Without question, we're all looking for better times ahead.

I'd like to thank everybody for joining us today and hope you can join us again for our next quarterly conference call, which is scheduled for April 27th. Have a good evening, everybody, thanks again.

Ladies and gentlemen, this concludes the Heartland Financial USA fourth quarter 2008 conference call. If you'd like to listen to a replay of today's conference, please dial 303-590-3000. Or, you can dial 1-800-405-2236 and enter access code 11124950 followed by the pound sign. AT&T would like to thank you for your participation. You may now disconnect.