Heartland Financial USA Inc (HTLF) 2009 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Heartland Financial USA second-quarter 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, July 27, 2009.

I will now turn the conference over to our host, Leslie Loyet of Financial Relations Board. Please go ahead, ma'am.

Thank you and good afternoon, everyone. Thank you for joining us for Heartland Financial USA's conference call to discuss second-quarter 2009 results.

This afternoon, we distributed a copy of the press release and hopefully you've all 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 can call Han Huie at 312-640-6688 and she will send you a copy immediately.

With us today from management are Lynn Fuller, President and Chief Executive Officer; John 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 then we will 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 SEC. 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 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, Leslie, and good afternoon, everyone. We certainly appreciate everyone joining us this afternoon as we review Heartland's performance for the second quarter of 2009. For the next few minutes, I will touch on the highlights for the quarter, and we will then turn the call over to John Schmidt, our Chief Operating Officer and CFO, who will provide further detail on Heartland's quarterly results. Then Ken Erickson, our EVP and Chief Credit Officer, will offer insights on the status of our nonperforming assets and credit quality.

Well, I am certainly pleased to open my remarks this afternoon on a positive note with Heartland reporting its second profitable quarter this year. Net income for the quarter was $4.7 million, slightly ahead of the $4.6 million reported for the same quarter last year. On a per-share basis, Heartland earned $0.21 per diluted common share, compared to $0.29 per diluted share in the second quarter of 2008, with the primary difference being our preferred dividend on TARP.

Pretax earnings were aided by a sustained, solid net interest margin at just under 4%. Additionally, we benefited from $5.9 million in mortgage banking activities and $2.2 million in security gains. These benefits were, to some extent, offset by FDIC assessments of $2.8 million, $2.5 million of write-downs and expenses related to OREO, and provision expense of $10 million for the quarter.

Well, with nonperforming assets up slightly from $98 million to $102 million, reduction of nonperforming assets obviously continues to be our number one priority.

On a positive note, we are experiencing a declining rate of increase or an apparent leveling off of nonperforming assets at this time. Solid core earnings and a sustained margin at just under 4% have allowed us to carry our nonperforming assets while we seek opportunities to maximize proceeds from the sale of our collateral. In a few minutes, Ken Erickson will provide more detail on credit administration topics.

While we continue to operate in an adverse economic environment, the favorable trends that we see in our balance sheet composition and income statement provide reasons for optimism. For example, in terms of total assets, we've experienced excellent year-over-year growth of $388 million with $137 million so far in 2009. The growth rate is slowing by design as we focus on improving the composition of our balance sheet and exiting lower-quality credits.

Loans are up $77 million or 3.4% over the second quarter of 2008 and increased marginally in this year's second quarter but still trailing year-end 2008 by $30 million. In contrast, investments are up $265 million, or 33% over the second quarter of 2008, and up $157 million year-to-date. As stated in our first-quarter earnings call, if economic conditions stabilize, annual loan growth of $70 million could be attainable for the year 2009.

Another real positive is our continued strong organic deposit growth. Compared to one year ago, deposits increased 17% with a 14% increase in non-interest-bearing demand and a 41% increase in savings and money market deposits. Total time deposits were virtually flat.

I am extremely pleased with our continued success in executing on our second-highest strategic initiative, which is to emphasize non-maturity core deposit growth versus higher-cost certificates of deposit. We attribute much of our deposit growth to a loyal customer base that places confidence in our strength.

Net interest margin continues to be a bright spot in Heartland's performance. Still holding at 3.92%, we've maintained margin near 4% for the past eight quarters. We remain committed to disciplined loan pricing and controlling our deposit costs.

Helping to offset the higher provision expense, noninterest income was a major contributor to Heartland's second-quarter results, increasing 76% over last year's second quarter. Results are comparable to our six-month totals with exceptional increases in mortgage-related revenue and security gains. While low interest rates have been fueling stronger residential mortgage loan activity, we have also booked security gains and repositioned our portfolio for a rates-up scenario, improving yields while maintaining a two to three-year portfolio duration.

After two profitable quarters, our capital ratios continue to improve. The tangible capital ratio moved up to 5.24% and remains within our benchmark range of 5% to 6%.

Although our balance sheet has grown, the $157 million increase in our securities portfolio since year-end results in both greater liquidity and less overall risk on our balance sheet. With our allowance for loan losses at 1.57% of total loans, we believe we are properly reserved at this point. We continue to closely monitor the loan portfolios of our most economically challenged markets, which would be Phoenix, Denver, and Bozeman, Montana.

With respect to M&A, you are likely aware that Heartland, through its Galena State Bank subsidiary, recently announced its first FDIC-assisted transaction, purchasing approximately $50 million in assets of the former Elizabeth State Bank in Elizabeth, Illinois. We continue to maintain contact with the FDIC to identify opportunities that make sense. Like the Elizabeth purchase, we are seeking fill-in acquisitions where we can grow market share, achieve efficiencies, and provide greater convenience to our current clients.

In concluding my comments today, I am pleased to report that, at its July board meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share, payable on September 11, 2009.

I will now turn the call over to John Schmidt for more detail on our quarterly results. John will then introduce Ken Erickson, who will provide commentary on credit quality and real estate exposure. John?

Thanks, Lynn, and good afternoon. In my comments this afternoon, I will provide additional detail on Heartland's performance in the past quarter, 6-30-09 versus 3-31-09.

Starting with the balance sheet, the first thing I bring your attention to is a $55 million increase in investment balances as funding continued to outpace loan growth. I think it's important to note that a portion of this increase went into private-label CMOs which now represent 11% of our investment portfolio. While these investments require additional evaluation prior to purchase, as well as more intense monitoring, we are comfortable with our current ownership position. Investments now comprise over 28% of the assets on our balance sheet, which suggests a lower risk profile for the Company.

For the quarter, loans and leases held to maturity increased by $18.6 million. We would reiterate our forecast of $70 million of loan growth for the entire year. The majority of this growth is expected to occur in our New Mexico, Minnesota, and Rockford, Illinois markets.

Net charge offs for the quarter totaled $10.1 million as compared to $5 million in the first quarter of 2009. With a $10 million provision taken in the second quarter, the allowance remained essentially flat, ending the quarter at 1.57% of outstanding loans.

Deposit growth was significant again in the second quarter as we saw core deposits -- meaning excluding brokerage CDs -- increase by $38 million from a quarter-over-quarter perspective. While the growth rate has slowed from $155 million recorded in the first quarter, we are still very comfortable with our progress. This is particularly true as you examine the mix of deposit growth, as demand and savings products grew by $101 million during the second quarter.

As I mentioned last quarter, we remain focused on optimizing both sides of the balance sheet. Accordingly, we continue in our efforts to book solid credit and replace CD funding with demand and savings deposits.

As Lynn mentioned, tangible common equity ended the quarter at 5.24%, up slightly from the 5.23% recorded at 3-31-09. Again, I believe this level of tangible common equity should be viewed within the context of investments which comprise over 28% of our balance sheet.

Moving onto the income statement, net income totaled $4.7 million for the second quarter, while net income available to common stockholders totaled $3.4 million or $0.21 per share. As Lynn mentioned, we feel very good about our ability to sustain our net interest margin, which was 3.92% for the second quarter. For the remainder of the year, with our continued focus on optimizing our balance sheet composition, we are comfortable that the margin will continue in this range.

There continued to be a lot of noise in the noninterest income area in the second quarter. The refi boom again provided welcome assistance, including a $525,000 increase in the loan servicing income.

Our mortgage servicing portfolio increased from $868 million in the first quarter to over $1 billion at the end of this quarter. Gains on the sale of loans increased by $423,000 from the quarter ended 3-31-09, again reflecting the benefits of refi activity.

While security gains decreased by $759,000 from the first quarter, we were still pleased with the $2.2 million result. During the quarter, we continued to sell lower-rate securities in favor of higher-coupon offerings. In doing this, we feel that we have positioned ourselves for an increasing rate environment.

I would like to remind you that this quarter, like last, we were able to monetize these gains while maintaining current yields with a similar duration.

We would also suggest that, as the majority of this portfolio has now been repositioned, future material gains are unlikely.

While total noninterest expense increased for the quarter, we experienced a $1.5 million reduction in its largest component, salary and employee benefits. The most significant component of this decrease was an $800,000 reduction in the Company's bonus accrual. The second quarter of 2009 continued to be impacted by higher commission and overtime levels associated with mortgage production. We expect to see that level off in the third and fourth quarters. Unfortunately, we expect the revenue in the mortgage area to level off as well. On a go-forward basis, we would forecast a run rate for salaries and employee benefits to be closer to $15 million per quarter.

As I'm sure you noted in the release, we provided a separate category for FDIC costs which increased by $1.8 million. Additionally, we thought it appropriate to separately breakout the $2.5 million net loss on repossessed property. This line item reflects write-downs and other carrying expenses on foreclosed property. The majority of the costs incurred in the second quarter were on lot loans and one land development in Arizona.

We would expect our tax rate to be in the 30% range for the remainder of 2009.

Relative to Heartland's FDIC-assisted acquisition of the Elizabeth State Bank, we would expect the transaction to be at least $0.03 accretive to earnings. We continue to work through the mechanics of the transaction with the FDIC and the integration into our Galena State Bank subsidiary.

In closing, while the size of this quarter's provisions is disconcerting, the majority of the Company's other metrics are very positive and speak very effectively to the true earnings capacity of the Company, particularly as the economy improves.

With that, I 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 change in nonperforming loans in the second quarter.

As already mentioned, our nonperforming loans increased in the second quarter by $4 million. Although we saw a significant reduction in the loans that were nonperforming at the end of the first quarter, those reductions were offset by new credits moving to nonperforming status during the second quarter.

14 credits that represented $23.4 million were removed from nonperforming status during the second quarter. $7 million of that was transferred to ORE, $5.1 million was charged off, while the remainder was resolved through payments restoration to accrual status, or sale of collateral.

19 new credits which exceeded $300,000 on an individual basis were added to nonperforming loans this quarter for a total of $29.1 million. Five of these loans were originated by our Montana bank and represent $8.1 million or 27% of the addition. The Arizona and Colorado markets added $6.3 million and $5.3 million of nonperforming loans, respectively.

The industries of the largest of these 19 new credits are land development, $10.8 million; construction and development, $5.3 million; aluminum die casting, $2 million; and healthcare and social assistance, $1.6 million.

I will now turn the discussion to total nonperforming loans. Of the $71 million in nonperforming loans, $46 million resides in 15 credits where individual exposures are greater than $1 million. The majority of these loans were originated by Rocky Mountain Bank, $14.3 million; Arizona Bank and Trust, $9.5 million; Wisconsin Community Bank, $8.6 million; Summit Bank & Trust, $6.7 million; and Riverside Community Bank, $3.3 million. These five banks originated $42.5 million of the $46.1 million in these 15 large credits.

The industry breakdown then for these 15 loans are lot and land development, $14.9 million; construction and development, $10.9 million; transportation, $7.2 million; lessors of real estate, $5.6 million; and four other industries remake make up the remaining $7.5 million.

Next, I would like to comment on our charge-off and provision expense. As stated in the past three quarters, Heartland has generally recognized a charge-off on a loan when the loan was resolved, sold, or transferred to other real estate. However, in the third quarter of 2008, Heartland began to recognize charge-offs on loans it considers impaired by writing down the loan balance to an estimated net realizable value based upon the anticipated disposition value. That practice continues as we recognize our losses on impaired loans.

Since many of our loans are participated across our member banks, I also analyze our losses as if they had been recognized by the banks that originated the loan. If so, $4.8 million of our losses in the first half of 2009 would have been shown at Arizona Bank and Trust, and $2 million at both Riverside Community Bank and Summit Bank and Trust.

The majority of the losses for the second quarter of 2009 were incurred in three loan categories, the first being construction, land development and other land loans -- $3.4 million, which is 4.2% annualized loss; commercial and industrial loans, $2.6 million or 2.5% annualized of their respective loan outstanding; and nonfarm, non-residential real estate, $2.6 million or a 1.2% annualized loss. No other category accounted for more than $600,000 of losses.

In the second quarter of 2009, Heartland recorded provision expense of $10 million. This expense covered the net losses recorded of $10 million. The allowance as a percent of loans was reduced from 1.58% at March 31, to 1.57% as of June 30.

Uncertainties still exist in the financial market. Although it appears we may reaching or have reached the bottom of this adverse credit cycle, there undoubtedly will be a continued impact until economic recovery begins to be felt by individual businesses.

Regarding expected resolution of the nonperforming loans, I can state that collection efforts in the third quarter of 2009 are expected to result in a reduction of $11 million of the nonperforming loans recorded as of June 30. Of this amount, the majority is expected to be moved to other real estate.

In regards to other real estate, it stayed at $29.3 million, the same balance as of the end of the first quarter. Total owned residential real estate is $5 million, while owned commercial real estate is $24.3 million.

Two residential subdivision properties comprise $16 million or 55% of the total ORE. Carrying values were reduced by $1.4 million in the second quarter upon receipt of new appraisals. Liquidation strategies have been put in place for all the assets held in ORE. It is our plan to continue to carry and market these properties in an orderly liquidation. It is our opinion that the current market for quick liquidation requires a discount in value that exceeds the projected carrying cost of these properties.

Regarding our portfolio diversification, we remain well diversified in our loan portfolio. $1.8 billion or 77% of our loans are either fully or partially secured by real estate. Of the $848 million of loans categorized as nonfarm nonresidential, 62% or $529 million is owner occupied.

My final comments will be directed at our retail portfolios. Our retail portfolios continue to perform quite well. Losses in the first six months for residential real estate loans were only 0.29% of outstanding. Foreclosures have only been required on $2 million of our portfolio loans year-to-date with another $1.8 million currently in the process of foreclosure. Consumer loans have resulted in $1 million in net charge-offs for the first six months of the year, or 1.1% of net outstanding spirit.

Citizens Finance, our consumer finance company, continues to perform quite well. Net loan outstandings are now at $46 million. Year-to-date, we have experienced 3.27% in net charge-offs, which compares favorably to their budgeted losses of 3.65%.

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

Thank you, Ken, John. Now we will open it up for questions.

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions). John Rowan, Sidoti & Co.

Good afternoon. John, just a couple of quick questions on the compensation line -- you said that there wasn't any bonus accrual in this quarter. Is that something that is expected to go forward? I am trying to get a run rate for the compensation line.

I would use that $15 million number I spoke to, John, for the quarter-over-quarter compensation line item.

Okay. I think, in the press release, it said there was going to be a termination of a derivative contract next quarter, or I guess soon. Is that going to result in any kind of gain or loss next quarter?

I would say, by and large, there will be no change between this quarter and next quarter relative to the derivative contracts. (multiple speakers) probably the short answer.

Okay. Maybe just a couple of questions for Ken. Maybe he can just go over 30 to 89-day trends, watch list trends and also just comment. The $11 million that is getting transferred from NPL to obviously OREO, I just want to make sure that there is no further charges that are going to be taken on that.

I will address that last question first, John. On all of those that we consider to be impaired within that group, the charge-off has already been recognized. But as we get to within 30 days of obtaining deed, we do get an updated valuation. So if there is a reduction in the value seen from our current appraisal to that date, there could be a further charge-down. But as of today, we don't expect any additional charge-offs in that $11 million.

Regarding the trends in delinquencies, I believe that was your question.

Yes.

It seems to be relatively stable for this six months. As I mentioned, we have replaced, unfortunately, the loans that we have collected with new loans that have tipped over. But we seem to be on the pace of remedying those at the same pace that we are having new ones come aboard. So the delinquencies do not seem to be increasing in any specific category.

Okay, thank you.

(Operator Instructions). Jeff Davis, FTN Equity Capital.

Lynn, could you just give any updated thoughts on paying back TARP?

Well, as I said last time, Jeff, we've talked about paying it off sooner versus later, but that is going to be probably in the next 18 to 24 months, depending upon which direction the economy goes because, as I said, that is the primary difference between our earnings per common share, between the second quarter of '08 and the second quarter of '09.

Okay, that's fine. I just thought I would ask.

Yes.

Chris McGratty, KBW.

John, on the loan-servicing number this quarter, did you, in your prepared remarks, kind of give your expectations for a run rate? I know you indicated they would be lower I guess next quarter. But any color there would be helpful.

I think the loan-servicing income -- I think the gains alone will certainly decrease as we go into this quarter, Chris. I mean that's probably what my comments were directed to, by and large.

Loan-servicing income, I mean there could be some mark-to-market implications relative to the mortgage servicing rights. I would see it -- it's going to be in this relative range, I think it's still fair, as far as the loan-servicing income.

On the gain on sale -- I'm sorry, that's probably what I was alluding to.

Yes, the gain on sale, I mean that is pretty hard to assess at this juncture -- again, how early we are in the quarter. I think we're still, what we are seeing is a reduction in refi activity. Purchases are starting to come around, though, which is kind of good news in many respects, I guess. I would say it is probably too early for us to tell what that decrease will be.

I don't think we can quantify the decrease. I think what we've identified is that chances are we are going to see reduced volume but we will also have an offset with reduced commission and overtime. So we've got a little bit of an offset going against some reduced production in that area.

Okay. Then secondarily, on the margin, it sounds like you are expecting a pretty stable margin. I was wondering, on the acquisition, how are you thinking about a potential benefit on the liability side?

Well, I think we had a reasonable deposit mix, Chris. I think you've seen the NOI numbers there. It is such a relatively small entity, I don't see a movement, significant movement one way or another on it. Again, my comment was overall it is probably going to be $0.03 accretive, but it's still a fairly small entity overall, so I don't see a big swing relative to the margin or in particular the liability side.

Okay, thanks.

There is, Chris, there is a benefit that we are continuing to accrue that is positive. That is, each month, we've got anywhere from $80 million to $100 million in CDs maturing. We continue to see a reduction in the cost of those dollars, in the 1% range. So that is helping as we go forward.

Yes, I think, as we pointed out in the press release, there 46% of the CDs maturing within the next six months at an average rate of 2.55, and there's some movement there.

Stephen Geyen, Stifel Nicholas.

I think you partially answered my question, but I will ask it again. I'm just wondering what the balance sheet might look like going forward with the increase in the investment portfolio this quarter and what the run-up might be in the CD portfolio, if we might expect a little bit of a decline. (multiple speakers)

I think that's a good question, Stephen. I would say we may see some of that CD move out. Again maybe what we saw this quarter in particular is a decrease -- the first quarter was $155 million deposit growth, this quarter $38 million. Is it probable that we see a relatively flat quarter in deposit growth? That's not unreasonable, but you also do need to add in the deposits from Elizabeth State Bank relative to the overall size of our balance sheet. So, on balance, we could be up probably similar to what we were up this quarter.

Our continued focus throughout the remainder of the year, though, is going to be on generating non-interest-bearing demand and savings deposits and de-emphasis on high-priced [time/money].

Sure, thank you.

Thank you. At this time, there are no further questions. I will turn the call back to Mr. Fuller for any closing remarks.

Very good. Thank you.

In conclusion, we are seeing several favorable trends in Heartland's performance that both John and I mentioned. Our stable net interest margin, in combination with solid noninterest income, is providing earnings sufficient to cover provision expense, increased FDIC assessments, and pay both common and preferred dividends while at the same time adding to our capital base.

During the second quarter, we saw a noticeable slowing in the growth of nonperforming assets, which was positive. We continue to improve the composition of our balance sheet with high-quality securities and a better mix on our core deposits.

In short, I feel very good about the earnings power of our company and continue to see excellent opportunities ahead for Heartland.

I would like to thank everyone for joining us today and hope you can all join us again for our next quarterly conference call, which is scheduled for October 26, 2009. Have a good evening, everyone.

Thank you. Ladies and gentlemen, this concludes the Heartland Financial USA second-quarter conference call. If you would like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030 with the access code of 4110374.

We would like to thank you for your participation. You may now disconnect.