Heartland Financial USA Inc (HTLF) 2009 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Heartland Financial USA fourth-quarter conference call. (Operator Instructions). This conference is being recorded Monday, January 25 of 2010. I will now turn the conference over to our host, Leslie Loyet of the Financial Relations Board.

Good afternoon everyone. Thank you for joining us for the Heartland Financial USA conference call to discuss fourth-quarter and year-end 2009 results. This afternoon 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 at Heartland's website at www.HTLF.com, or you can call Han Hoi 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, Executive Vice President and Chief Credit Officer. Management will provide a brief summary of the quarter and the year 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 Securities and Exchange Commission. As part of these guidelines, I must point out that the 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, Leslie, and good afternoon everyone. We appreciate everyone joining us this afternoon as we review Heartland's performance for the fourth quarter and for the full year of 2009. For the next few minutes I will touch on the highlights for 2009 and our focus for 2010. I will then turn the call over to John Schmidt, our Chief Operating officer and CFO, who will provide further details 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 assets and credit quality.

Let me start with earnings, which were far short of our expectations certainly, however, still positive for the year. I will say that our operating income has never been stronger, and we are optimistic that this trend will continue throughout 2010.

Two items make it challenging to compare current periods with prior periods. However, if you bear with me for a little bit I will try to walk you through them. The two items that I am referring to are, one, a full year of TARP dividends and discounts totaling $5.3 million for 2009 versus less than $200,000 for 2008. Number two, a fourth-quarter non-cash goodwill impairment charge of $12.7 million, which we reported in an 8-K over a week ago.

Before the year 2009 net income, and this is exclusive of both the goodwill impairment charge and TARP payments, was $19 million compared to $11 million for 2008. Net income for the quarter, again exclusive of both the goodwill impairment charge and the TARP payments, was $4.8 million compared to a loss of $2.7 million for the previous year's fourth quarter.

Net income for 2009 now exclusive of goodwill impairment, but after our TARP payment, was $13.9 million compared to $11.1 million for 2008. And viewed another way, net income for 2009 after the goodwill impairment charge, but before the TARP payment, was $6.4 million compared to $11 million for 2008. And remember there was very little TARP impact in 2008.

Finally, net income for the year after both the goodwill impairment charge and the TARP payments, $1.2 million or $0.07 per diluted common share compared to $11.1 million or $0.68 per diluted common share for 2008. Then the same for the fourth quarter, a net loss of $9.2 million compared with a loss of $2.9 million for the fourth quarter last year. As we have discussed, this quarter's loss was attributed to the non-cash goodwill impairment charge of $12.7 million.

Well, core earnings continued to be strong, fueled by an exceptional net interest margin of 4.04% for the quarter and 3.99% for the year. In addition to margin, 2009 earnings benefited from a 75% increase in noninterest income. We enjoyed substantial increases in mortgage banking related revenues, as well as exceptional security gains, and gains on the FDIC-assisted transaction of The Elizabeth State Bank. These benefits were offset by FDIC assessments of $6.6 million, which increased 355% over the previous year, $10.8 million of write-downs and related expenses on OREO, and provision expense of $39.4 million for the year.

With our allowance for loan losses at 1.8% of 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, Arizonia, Denver, Colorado and Bozeman, Montana.

As far as it relates to our loan loss provision, we see a continuing trend of nonperforming assets decreasing by $8 million from the previous quarter. The steady reduction of nonperforming assets continues as our number one priority. It seems to be going in the right direction. And 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 we see in our balance sheet composition and income statement provide reasons for optimism. Total assets, for example, increased by $383 million over the previous year. We continue to focus on improving the composition and quality of our balance sheet through exiting lower quality credits, reducing our loan to deposit ratio, and in general becoming much more liquid. We are pleased that Heartland has been able to accomplish this, while at the same time increasing net interest margin. As a result, the earnings power of this Company has never been greater.

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. Compared to one year ago deposits increased by $410 million or 15.5%, with all the growth occurring in noninterest-bearing demand, savings and money market deposits. Along with this we have seen substantial reduction in brokered funds and short-term borrowings. As a result, our loan to deposit ratio now stands at 77%, and loan to funding is 69%. We believe the Company is very well positioned to fund new loan requests when the economy finally turns around.

With respect to loans, loans decreased by $74 million compared to year-end 2008. At this point we don't see measurable loan growth in the immediate future. However, we continue to target deposit rich operating companies where we can develop full banking relationships.

Our securities portfolio is up $272 million or 30% over year-end 2008, adding greater liquidity and less risk to our balance sheet. This category represents nearly 30% of Heartland's assets, with a relatively short average duration of 3.2 years.

Well, that brings us to our third strategic initiative, which is net interest margin, which I would describe as being quite remarkable last year. Net interest margin, which ended the year at 4.04%, is a key component of Heartland's long-term earnings potential and a vital component of our value proposition.

Going back 10 years margin has been at or above 3.8%. And now despite the worst economic condition we have seen in nearly 30 years, our margin remains above 4%. We are continually developing strategies to maintain our margin at or near its present levels.

With the growth of our balance sheet, albeit almost entirely in cash and securities, our tangible capital ratio ended the year at 5.14%, down from 5.35% last quarter. It still remains within our benchmark range of 5% to 6%; however, at this level we will be very selective in pursuing only the most profitable growth opportunities.

Our regulatory capital ratio of risk-based capital and Tier 1 capital continue well above the required regulatory levels. John Schmidt will comment on the size of our balance sheet and some anticipated events that might lie ahead.

With respect to expansion, we have one branch replacement under construction in San Jose, New Mexico. This new office will replace our leased main office facility in Santa Fe, providing greater convenience to our customers at no additional cost to either the bank or Heartland.

We continue to keep in touch with the FDIC, seeking opportunities similar to the Elizabeth Illinois purchase. We are seeking fill-in acquisitions where we can grow marketshare, achieve efficiencies, and provide greater convenience to our current clients.

Well, looking forward our strategic initiatives for 2010 have not changed from 2009. We are carrying these forward and renewing our commitment to execution of the following. Number one, achieve a substantial reduction in nonperforming loans and nonperforming assets. We remain intensely focused on a disciplined approach to working with borrowers, yet taking affirmative collection action as each situation warrants.

Number two, grow core non-time deposits, that is checking and savings. Number three, maintain our net interest margin near or above 4%. Number four, manage our noninterest expense. Number five, a continued emphasis on training, especially for our salespeople and supervisors. We continue to invest heavily in our greatest asset, our people. And number six, a leadership discipline which holds management accountable for achievement of our plans and budgets.

In concluding my comments today, I am pleased to report that at its January Board meeting the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share payable on March 12, 2010.

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

Thanks, Lynn, and good afternoon. For my comments this afternoon I will provide additional perspective on Heartland's balance sheet and the income statement for the quarter ended 12/31/09 in comparison to the prior quarter.

Starting with the balance sheet. Total loans decreased by $41 million for the quarter, as loan demand continues to remain sluggish. For the year, despite the addition of $42 million of loans acquired in an FDIC-assisted transaction, in the third quarter loans decreased by $44 million, far short of our growth goal of $100 million of loan growth.

We attribute this decrease to our focus on moving weaker credits out of our banks and weak overall demand for credit from qualified borrowers. While it is difficult to forecast loan outstandings in this environment, we would still guide for loans to increase by $100 million in 2010.

Deposits increased by $106 million in the fourth quarter, with a remarkable $177 million growth in demand and savings deposit products. Certificates of deposit, including brokered, decreased by $71 million in the quarter. Throughout 2009 our efforts have been on -- have been focused on attracting core non-maturity accounts with less reliance on CD-only customers. We continue to experience growth in the savings products, even as we have reduced interest rates, as customers are focused on building cash reserves and on the safety of their deposits.

Finally, it is important to note that we typically see a run-up in deposits in the fourth quarter of the year, with a plateauing or decrease of deposits in the first quarter of the following year.

As Lynn mentioned, 2009 was a remarkable year in terms of deposit growth and in turn balance sheet expansion. Importantly, while we believe our balance sheet has less risk, best evidenced by our 77% loan to deposit ratio, part of our focus for 2010 is to maintain the same relative size of the balance sheet. We feel we can do this by replacing investments with loans, by allowing non-core funding, including FHLB advances and wholesale repurchase agreements to run off.

With this focus, combined with the strong pre-tax, pre-provision capacity of the Company, and the aforementioned balance sheet risk profile, we continue to feel that the Company and our banks are properly capitalized.

Moving onto the income statement. As noted in the earnings release, Heartland recorded a loss for the quarter of $7.9 million or $0.56 per common share. Without the goodwill impairment charge of $12.7 million, income for the quarter was $4.8 million or $0.21 per common share.

Beyond these headline issues there are -- there were several other significant components in the income statement, which I will detail. Starting with the net interest margin, which continues to be strong in terms of dollars, expressed as a percentage of average earning assets was 4.04% for the quarter.

Looking to 2010, without a material increase in loan outstandings we will likely see some margin deterioration. This is driven by the following factors. Spreads have tightened at most investments, including mortgage-backed securities, which has been our product of choice in 2009.

While we still have some room to decrease our liability pricing, we likely will reach an effective floor by midyear 2010. During 2009 we entered into forward started interest-rate swaps on $65 million of our trust preferred funding, shifting them from variable to fixed. In the short term this will increase our funding costs by $1.8 million in 2010, assuming no change in interest rates. Long-term these swaps will provide an excellent hedge against rising rates.

[Same as], and assuming we maintain the same relative sized balance sheet, we see our margin in the 3.95% to 4% range for the first half of 2010.

Moving to the provision for loan and lease losses. While decreasing for the third quarter, we aren't pleased with the overall level of provisioning in the fourth quarter. It is important to note that of the $10.8 million recorded, $1.3 million represents losses incurred on loans covered under loss share agreements with the FDIC. Ken Erickson will provide additional color on the losses incurred in the fourth quarter, as well as his perspective of where Heartland is in this credit cycle.

The $1.5 million increase in noninterest income in the fourth quarter had several moving parts, some of which will carry over into 2010. These include trustees experienced an increase of $207,000 or 11% increase in the fourth quarter. This area of the Company has experienced excellent growth in the past year, which should increase 2010 gross income in this area by $1 million from the 2009 total. While we experienced another strong quarter of security gains, we do not anticipate this level of gains continuing in 2010.

The fourth quarter also saw a $291,000 or 33% increase in the gain on sale of loans as refi activity increased. For 2010 we would be more comfortable modeling closer to the $900,000 level we experienced in the third quarter of 2009.

The $298,000 gain on acquisition reflects the final entry associated with the acquisition of Elizabeth State Bank. Finally, other noninterest income includes $1.1 million received from the FDIC, related to loans covered under loss share agreements. This is the offset to the $1.3 million provision recorded in the fourth quarter I mentioned earlier.

While noninterest expense increased by $13 million or 43% in the fourth quarter, not concerning the impact of the goodwill impairment, this total increased by $452,000 or 1.5%.

Beyond the goodwill impairment there were a few items of note, including salaries and employee benefits decreased by $242,000 from the third quarter, as bonus and the discretionary portion of the retirement plan contribution were adjusted downward as a result of the loss recorded in the fourth quarter.

As we look to 2010 salaries and employee benefits will likely average around $16 million per quarter. [Same as] much like we saw in 2009, total expense in this area will be scaled back throughout the year if the performance is below our expectation.

The other item of significant note in the fourth quarter was a $4 million expense and net loss on repossessed property. The largest component of this expense was a $3.2 million write-down on a Montana land development, which was previously carried on our books at $12 million.

Exclusive of the charge to goodwill, which is nondeductible, the tax rate for the quarter was 26.9%. We would expect our tax rate to be in the 29% range for 2010.

In closing, while we are still operating in a very challenging environment, I think we are positioned for a better 2010 then we experienced in 2009. This is dependent on several things, the foremost of which is credit quality. With that I will turn it over to Ken Erickson, Executive Vice President and Chief Credit Officer.

Thank you, John, and good afternoon. All of my comments this afternoon, unless otherwise stated, will be exclusive of those assets covered under the loss share agreement.

I will begin by discussing the change in nonperforming loans in the fourth quarter. As already mentioned, our nonperforming loans decreased in the fourth quarter by $5.9 million. 9 credits, representing $10.8 million, were removed from nonperforming status during the fourth quarter. $3.7 million was transferred to other real estate, $123,000 was charged off, while the remainder was resolved through payment, restoration to accrual status or sale of the collateral. 9 new credits, which exceeded $300,000 on an individual basis, were added to nonperforming loans this quarter for a total of $15.4 million.

$6.5 million of this was originated by our Colorado bank. The Montana and Arizona markets added $3.4 million and $2.8 million of nonperforming loans, respectively. The largest of the additions to nonperforming loans is a credit for $6.5 million. At the current time I expect this credit to be restored to accrual status in the first quarter of 2010.

The industries of the largest of these 9 new credits are other activities related to real estate, $8.4 million; construction and development, $4.2 million; hotels, $2 million.

I will now turn the discussion to total nonperforming loans. Of the $78 million in nonperforming loans, $50 million resides in 20 credits where individual exposures are greater than $1 million. The majority of these loans were originated by Rocky Mountain Bank at $15 million; Summit Bank & Trust, $13.7 million; Wisconsin Community Bank, $7.5 million; and Arizona Bank & Trust, $6.5 million. These four banks originated $42.7 million of the $50 million.

The industry breakdown for these 20 loans is other activities related to real estate, $12 million; lot and land development, $8 million; construction and development, $7.8 million; lessors of real estate, $4.5 million; real estate credit provider, $4.2 million; and seven other industries make up the remainder $13.6 million.

Next I will comment on charge-offs and provision expense. Since many of our loans are participated across our member banks, I analyze our losses as if they had been recognized by the bank originating the loan. $9.9 million of our losses in 2009 were from loans originated by Arizona Bank & Trust; $4.8 million by Rocky Mountain Bank; and $4.5 million by Summit Bank & Trust.

The majority of the losses in the fourth quarter of 2009 were incurred in three loan categories -- construction, land development and other land loans, $3.5 million; C&I loans, $2.9 million; first mortgage 1 to 4 family, $845,000. No other category accounted for more than $550,000 of losses.

In the fourth quarter of 2009 Heartland recorded provision expense of $10.8 million. With net losses of $11.2 million, of which $1.3 million were for loans covered by loss share agreements, the allowance decreased by $412,000, which was primarily due to the decrease in loan outstandings during the quarter.

The allowance as a percentage of loans was increased from 1.78% at September 30 to 1.8% as of December 31. For the year the allowance increased by $6.3 million from 1.48% to 1.80%.

The overall portfolio condition appears to be stable to improving. Delinquencies in each of the portfolio segments have been well-managed with no significant trends identified. The trend of 30 to 89 day delinquencies for the last five quarter end, beginning with December of 2008, is 1.01%, 1.5%, 1.14%, 1.39%, 1.22%.

A review of the $315 million non-owner occupied portfolio at December 31, shows that only $14.1 million of that portfolio is classified as nonperforming, with $6.5 million of that represented by the one credit discussed earlier that is anticipated to go back on accrual status in the first quarter.

Only three accounts are 30 to 89 days past due, for a total of $6.6 million. $96 million or 31% of this portfolio segment is in our hotel and motel portfolio segment. And this segment is well diversified with loans to 50 different relationships.

We will continue to closely monitor and manage our construction land and land development loans, which total $130 million. While we feel most of the issues within this portfolio segment have been identified, the portfolio will continue to be under stress until such time that we begin to see construction activity resume.

Regarding expected resolution of the nonperforming loans, I can state that collection efforts in the first quarter of 2010 are expected to result in a reduction of $15.8 million of the nonperforming loans recorded at December 31. Of this amount, $11.8 million is expected to be moved to other real estate.

Relative to other real estate, [OREs] decreased by $2.7 million to $30.6 million in the fourth quarter. Total owned residential real estate is $5.9 million, while owned commercial or ag real estate is $24.7 million.

During the fourth quarter 15 new properties are moved into other real estate, with a value of $4.9 million. 12 properties were sold, reducing other real estate by $3.4 million. And reductions in other real estate balances of $4.3 million were recorded upon the receipt of new appraisals or the sale of the property. The majority of this reduction was related to a residential subdivision property now valued at $8.9 million or 29% of the total other real estate.

On the positive side in the past few weeks accepted offers have been received for 13% of the lots in this subdivision. Some closings have already occurred, while others are not scheduled to close until the second quarter.

Liquidation strategies have been put in place for all of the assets held in other real estate. We continue to carry and market these properties in an orderly liquidation manner. It remains our opinion that the current market for quick liquidation requires a discounted value that exceeds the projected carrying costs of these properties.

Regarding portfolio diversification, we remain well diversified in our loan portfolio. $1.8 billion or 78% of our loan are either fully or partially secured by real estate. Of the $854 million of loans categorized as nonfarm, nonresidential, 63% or $539 million is owner occupied.

My final comments will be directed at our retail portfolio. Our retail portfolios continue to perform quite well. Losses in the 2009 for residential real estate loans were one-half of 1% of outstandings. Foreclosures on 13 properties for $2.1 million were required in 2009. 23 foreclosures on $3.6 million of loans are currently in process. Historically several of these get resolved prior to final action.

Consumer loans, excluding those held in our consumer finance company, have resulted in $2.55 million in net charge-offs for 2009, or 1.29% of net outstandings. Citizens Finance, our consumer finance company, continues to perform quite well. Net loan outstandings are at $46 million. In 2009 we experienced 4.27% in net charge-offs compared to net losses in 2008 of 4.83%.

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

Thank you, Ken. We will now open the phone lines for questions.

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

A couple of questions for you. John, can you talk a little bit about your approach on securities portfolio management? Typically when asked about it on the call, that it is a little larger part of your earning assets, and just curious how you are managing it, and what kind of expectations you have for rates on that portfolio in terms of what you're buying and what you are getting rid of?

I guess the first thing as we think about controlling the size of our balance sheet, what we -- as I mentioned, we do intend to look to move some of the non-core funding off the balance sheet -- or our matured, probably better said. As we do that we look to rollout those securities that are currently maturing or short term in nature off our balance sheet at the same time.

By and large we are trying to keep the portfolio shorter at this point as far as new additions, trying to keep that duration under 3%. Again, just trying to control the rate risk at this point -- interest rate risk.

We use a total return approach to investing. Our Chief Investment Officer, Mel Miller, has had a number of years of experience in this area. He used to run both our equity portfolio as well as our fixed income in the wealth management area. Now he spends almost all of his time just running our fixed income portfolios for our banks.

We are keeping the portfolio short. If you remember our prior quarterly releases, we talked about repositioning our mortgage backs for rates up. So we have already done some of that. Our municipal portfolio would be our longer portfolio. 10 years would be common there. So I think the way we are thinking about it is that we've got pretty good liquidity coming out of the portfolio in 2010. We will let that runoff. We will shrink back some of our higher cost non-core funding.

Maybe just addition to that, our orientation is still [primarily] to mortgage backs more than anything else. There are still some opportunities there, although spreads obviously have come in. We do look for some opportunities in munis as well, and that would be -- this would run a close 1, 2. Again, I think the focus now is on reducing the size of that overall investment portfolio.

I guess the other question would be on just the overall nonperforming asset trends. I know it is a priority for you, and I am just curious -- maybe Ken, this is a question for you. How aggressive do you plan to be in terms of trying to move out some of these properties? It looks like you had a little bit of loss on repossessed assets. And just curious what your -- you touched on it a bit in your comments, but curious what your tolerances for trying to move these things quickly under the theory that may be the first loss is the best loss, or how much holding capacity do you think you have to hang onto some of these assets?

John and I both mentioned the largest share of that write-down came in that subdivision we have out in Bozeman, Montana, a little over $3 million that we wrote-down. We continue to look at what liquidation values are to move those assets immediately. I think we collectively still feel that those discounts far surpass moving those properties in an orderly liquidation.

If we were in a different period, where we did not see an end to the increase of nonperforming loans, that may be a different answer. But as I mentioned, we have seen just since the end of the quarter, 13 of those -- 13% of those lots have been entered into a buy/sell agreement to close on those. They are the lower end lots, but they collectively will bring in, I think it is a little over $750,000.

So the best thing of that in our opinion is that it begins to show progress within that subdivision. We get some building going on and begin to show some activity. And hopefully we get out of the winter and into the spring, we'll see where construction activity take foot in there.

I think an important note to that too is that the lot sales were at or maybe above the most recent appraisal we had. So the values are holding up relative to their recent appraisal. And certainly the flipside, if we pursued a bulk sale, you know how that would go. That would be $0.30 on the $1 no matter where you are stating that analysis. So, again, when you get that close to the appraisal on the sales, I think we feel that is a more prudent strategy at this point.

I don't want to put words in your mouth, Ken, but is it -- can we draw some conclusions by that sale that we are starting to see some of the prices of the [REO] assets firm up?

I would say so. We had a fair amount of activity, if a fair amount is -- what did I mention, 10 or 12 properties sold out. That did not include any of these lots out of this subdivision. But there were some other properties across that whole portfolio. They were all close to what the current price was. There was no -- any significant write-down to the sales value as we accepted an offer.

I would say we are comfortable with the values they represent on each of the individual properties today. What will be another three or six months, well we will see if activity does begin to resume in each of those markets, as we're beginning to see reflected out there.

One last piece on that. We actually had a commercial property in Arizona that we sold at about a 20% gain off our books. It depends on the property, certainly. I wouldn't say that it's a trend. It just depends on the property and the situation, but it is not all gloom and doom.

All right. Thanks for the help.

John Rowan, Sidoti & Company.

John, you said the loan sales are going to average about $900. Is that per quarter?

Per quarter.

Per quarter, okay. And just to make sure I understood you correctly, compensation and benefits is going to go up to $16 million per quarter?

Per quarter.

Okay. And maybe --

Just one important note on that, just to reconfirm what I said, again as we did throughout 2009, if we aren't hard hitting our marks, we will scale back that compensation. But obviously we are accruing towards a result, and that is -- that $16 million per quarter is a good benchmark, much as it was when you look back to Q1 of 2009, that is about where we were as well.

How about the advertising expense, it seemed fairly high this quarter?

I think it did jump up a little bit. We had some anniversary specials going through, some additional -- the additional -- they had anniversary celebrations at Dubuque Bank & Trust, which is our largest bank and our oldest bank of 75 years. Also we had the cash rewards checking program, which is a significant initiative for us within the organization. Again, it provides a tickler rate. It has been a real product of choice for the consumer. And it is part of the overall initiative that Lynn mentioned as far as growing our core savings and DDA products.

It still is an initiative for us. We still see an opportunity to grow those products out there, so we don't want to be devoid of advertising in this environment.

Now as far as loan demand goes, is there any particular market that is stronger than another? And how -- at what point do you go back and raise some common equity?

I think -- Ken (inaudible).

I would say immediately loan demand is sitting here even stronger in the Midwest than West or Southwest. I know our Wisconsin bank had some loans that are committed and will fund in the near term. And, John, I will defer to you to the capital question.

New Mexico has been pretty good as well. It is driven to some extent by the competitors we face in those markets. With First State Bank struggling, we are seeing a fair amount of business coming our way, and decent credits and good deposits. With Amcore struggles in Rockford and Madison, we are seeing some opportunities there as well.

As far as capital raise, that would have to be an event driven situation, where we've got either an FDIC-assisted transaction or an acquisition that we felt we needed to fold into one of our existing properties and raise some capital to do so.

My comments were driven in some part towards that discussion. We're going to keep the balance sheet the same relative size. We have tremendous earnings capability. And I think that has been our focus throughout and has been our message throughout, that we think we can grow through this thing -- grow earnings through this to bring us back to that close to the 6% level.

Remember, each $100 million of balance sheet expansion adds or subtracts -- expansion, that deducts about 14 basis points of risk for tangible common equity. So as we keep it this same relative size, the earnings will, I think, ultimately catch up and push us closer towards 6%.

What I would ask you to think about is with our investment portfolio at its current size, I think there is an opportunity, since the returns on those securities are not as attractive as what we saw before, to run off expensive non-core funding as well as some of that investment portfolio. And hopefully that will be replaced by good core noninterest-bearing demand and good quality loans. So we may be able to just reshuffle the balance sheet without really adding asset size.

(Operator Instructions). Chris McGratty, KBW.

Just a quick question on the TARP, and just in the context of capital, how are you guys thinking about timing? How are you thinking about method of paying it back? And maybe any color on that would be helpful.

Probably the underlying question on all that is are we going to raise capital to pay back TARP, and I think we have been, at least internally, very focused on the statement that we don't want to raise capital to repay TARP. I think that is a disservice at this juncture to our stockholders. I think it gives us some flexibility. We understand all the other ramifications of it. But at this juncture we don't feel that is the n appropriate approach to raising capital to repay TARP.

Given our focus on earnings on a go forward basis, maintaining the Company's balance sheet at the same relative size, I think that we can certainly lay out a scenario where cash flow will be sufficient to pay off TARP.

Then in terms of the capital, the guidelines you gave of the 5% to 6%, assuming for what you're seeing the securities books declines and loan demand remains weak, how are you thinking about the dividend to get to the 6%? Can you get to 6% without cutting the dividend?

We think we can move up toward 6% without cutting the dividend, as well as we have set an internal goal be able to pay off our TARP through earnings by the time we reach the fifth anniversary. So that it has been our stated internal goal.

So get to 6% within five years to pay it off? Okay. Thanks.

(inaudible), if you will.

Adam Klauber, Macquarie Group.

Just a couple of questions around credit. You mentioned you are hoping that [MPAs] will come down throughout the year. Do you think inflows will start to -- will also down throughout the year?

You said you hoped that we see nonperforming assets come down, what was the balance of the question?

Sorry. Are you looking for [MPA] inflows to come down throughout the year?

Yes, I would say that is all the result of how we get to the reduction as we go through 2010. I think I made a statement internally here within the last couple of weeks, you want to be very cautiously optimistic, but it appears that the problems that we see arise that there is more days in between those since the last one. And when they do, they have got a few less zeros than those in the past.

So we still have some problem loans that will come up. I am sure that when we see first-quarter financial statements, we are going to identify some additional weakenings in some companies out there. But I think we have done a pretty good job of identifying those to date. And like I said, it just seems like the ones that are tipping over, becoming nonperforming now, are lesser in magnitude than the ones we had in the past.

That's great. Now obviously a lot of issues have come in the western territories. If you look at your midwestern territories, what are the one or two that you are worried about most?

For loan quality the first one would be our Riverside Community Bank. They are sitting in one of the highest unemployments in the country. So that naturally flows back to the whole quality issue within that whole bank environment over here. So they've got a fairly -- for the size of that bank, retail portfolio, as well as C&I business from a lot of smaller tool and dyes. So there is some strain in that portfolio.

The other one that I would look at depends upon the -- how long before we start to see any construction resume now would be in the New Mexico market. They've got -- I mentioned we've got $130 million in total in construction development and land loans. That is fairly well spread out between banks, but they would have the largest of any bank exposure in that. So if we don't see some construction activity come, we will continue to see some pressure in the quality of those customers.

Brad Milsaps, Sandler O'Neill.

John or -- just a little more clarity maybe on some of your margin guidance. I know -- I think if I've got all my notes right here, you mentioned most of the deposit repricing, you thought would be over with by the middle part of the year. It looks like your CD costs are still running maybe a little bit higher than peers. Does that more reflect maybe just a longer duration of most of your CD book?

The second question would be, how much loan growth -- and I apologize if I missed it -- are you assuming in that margin guidance, just as you talked about transforming the balance sheet a bit, swapping from investments to loans.

Your thought on the overall CD pricing is in fact driven in large part by the maturity. But I think, again we do have some opportunity to drive those costs down, as I mentioned in the release.

What I mentioned in my comment is about $100 million -- not about, but $100 million of loan growth in 2010 is called a best estimate at this point. Obviously, it is a challenging environment to produce loans as well as to predict loans, but that is where we would peg the 2010 growth.

Are you assuming any kind of lift in rates in the back half of the year?

As far as the overall curve, right now we budget flat. So no, we are not anticipating an increase in rates.

That doesn't mean that we don't think rates are going to rise. We do believe rates are going to rise. We just simply budget on a flat interest rate scenario, so we just don't end up complicating our budget. If rates should go the other direction, the budget would be way off.

Great, fair enough. Thank you.

Jeff Davis, FTN Equity Capital Markets.

John, when looking at the subs, some of the newer subs, Minnesota continues to lose money maybe consistently, about $200,000 a quarter. Summit has credit issues. Do any of the newer subs turn profitable this year?

Just a note on Minnesota, that sub is what -- a year and three quarters old, or just even short of that. They are on track with some of our initial projections, and actually I think they beat the budget this year. So in some respects that is good news. We haven't seen them produce the loans yet that we had anticipated in the initial budget, but again, it is a challenging environment.

As we budget towards 2010, we do look for those newer entities to come very close to breaking even.

Would that include Colorado?

Very close.

Colorado is real close to breakeven. Arizona turns profitable.

In our current projections.

Stephen Geyen, Stifel Nicolaus.

Just a real quick question on NSF fees. I am just wondering if you had an opportunity to chat some more about how you might replace that with other fees, or how you're thinking about that?

That is a challenge. We are looking for a decrease this year, probably like everyone else. On some of the offsets we do think about are the -- I mentioned the Wealth Management or trust fees going up. We are very focused on cash management. We hired someone last year to head that entire effort up for us, and I think we are starting to see some significant results as a result of that hiring, and a focus by the Company on that initiative.

So again, we see noninterest income as a key source of revenue for this Company. We realize the margin is always going to be tough to sustain at the current level, so we do intend to continue to focus on building that revenue stream and offsetting the attrition on NSF.

There are no further questions at this time. I will turn the call back to Mr. Fuller for any closing remarks you may have. Please go ahead, sir.

Thank you. In closing Hartland continues to produce solid operating income, fueled by an exceptional net interest margin, as we talked about, and currently in excess of 4%. Also, as we just talked about, strong noninterest income. This combination is generating earnings sufficient to cover our provision expense, increased FDIC assessments, and to pay both common and preferred dividends. Deposit growth is exceptional in the categories that we have targeted, which are checking and savings. And we have reduced higher cost deposits, short-term borrowing and brokered funds. And we continue to improve the composition of our balance sheet with high-quality loans and high-quality short-term investments.

So, in short, I feel very good about the earnings power of the Company, and continue to see excellent opportunities for us ahead. I would 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 26, 2010. Have a good evening everybody.

Thank you, sir. Ladies and gentlemen, this concludes the Heartland Financial USA fourth-quarter conference call. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 1-800-406-7325 and enter an access code 4199372. ACT wants to thank you for your participation, and you may now disconnect.