Heartland Financial USA Inc (HTLF) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Heartland Financial USA third-quarter conference call. During today's presentation, all parties will be placed in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions).

This conference is being recorded today, Monday, October 25th of 2010. And I would now like to turn the conference over to Scott Eckstein of Financial Relations Board. Please go ahead, sir.

Thank you, Operator. Good afternoon, everyone. Thank you for joining us on Heartland Financial USA's conference call to discuss third-quarter 2010 results.

This afternoon we distributed a copy of the press release and hopefully you've had a chance to review the results. If there is anyone on the line who did not receive a copy, you may access it at Heartland's website at www.HTLF.com. Or you may 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, and John Schmidt, Chief Operating Officer and Chief Financial Officer, Ken Erickson, Executive Vice President and Chief Credit Officer. Management will provide a brief summary of the quarter and then open up the call to your questions.

Before we begin the presentation, I would like to remind everyone that some of the information that management will be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, I must point out that any statements made during this presentation concerning 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 included from time to time in the Company's 10k and 10-Q filings, which can be obtained on the Company's website or the SEC's website.

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

Thank you, Scott, and good afternoon, everyone. We certainly appreciate everyone joining us this afternoon as we review Heartland's performance for the third quarter of 2010.

For the next few minutes, I will touch on the highlights for the quarter and will then turn the call over to John Schmidt, our Chief Operating Officer and CFO, who will further provide detail on Heartland's quarterly results. And then Ken Erickson, our Executive Vice President and Chief Credit Officer, will offer insights on the status of our nonperforming assets and credit quality issues.

I am pleased to open my remarks this afternoon on a very positive note with Heartland reporting net income for the quarter of $6.9 million, easily outdistancing our $3.5 million in earnings for the same period last year, and by far the best quarter since this Great Recession.

On a per share basis, Heartland earned $0.34 per diluted common share compared to $0.13 per diluted common share in the third quarter of 2009 and $0.23 for Q2 of this year. As a result of our strong third quarter, year-to-date income came in at $17.3 million or $0.81 per common share compared to $14.2 million or $0.64 per common share for the first nine months of 2009.

Our year-to-date, pre-provisioned, pretax earnings of $49.3 million were exceptional. Our results continue to be driven by a strong net interest margin, which increased to 4.18% for the quarter. That represents an improvement of 9 basis points over last quarter.

Well, with margin management as one of Heartland's top priorities, I am pleased to report that our NIM has remained above 4% over the last five quarters. And with nearly 30% of our assets in high-quality securities, our balance sheet has never been stronger.

As I have discussed in the past, reduction of nonperforming loans and other real estate is Heartland's number one priority and we continue to believe that we are in a stable to improving credit environment. With nonperformers holding steady in the $117 million range, we are optimistic that the worst is behind us. With NPAs to total assets just under 3%, I can assure you that we remain externally focused on improvement in this area and have snapped up and strengthened our special assets team.

With our allowance for loan loss at 1.89% of total loans, we believe we are properly reserved at this point. And in a few minutes, Ken Erickson will address the specifics related to credit administration topics.

Now moving on to the balance sheet. Our total assets are just over $4 billion, which is relatively unchanged over the last six months and other than for acquisitions, we don't really anticipate significant asset growth in the near term. With our securities portfolio representing nearly 30% of our assets, our balance sheet is extremely liquid.

Additionally, with our current loan to deposit ratio at 77%, we are eager to make every good loan we can find, converting cash flow from our securities portfolio into quality loans.

In response to the softness in loan demand, we are developing specific marketing and sales strategies for our business bankers and business development officers to generate new quality loan growth. With our special assets staff focused on loan workouts and collections, our business bankers are able to concentrate on growing their loan portfolios.

We continue to see opportunities in government-guaranteed lending, especially with the new SBA stimulus program that allows up to $5 million per borrower with no fees. We are leveraging the expertise developed by our Heartland Business Bank personnel in Wisconsin to benefit all of the Heartland Banks, especially with USDA and SBA 504 programs.

Our second-highest priority is the continued improvement in deposit mix through the growth of non-timed deposits. We are especially delighted with the continued growth in noninterest demand deposits, which are up 29% year over year, and savings deposits, which are up 13% over the previous year. At the same time, we are seeing higher costs non-core funding run off, further benefiting our margin.

We continue to focus on targeting and attracting solid deposit relationships first, and then make every quality loan that comes with the relationship. Remarkably, demand deposits and savings deposits now represent just over 70% of total deposits with timed deposits at just under 30%. Outstanding broker deposits have become insignificant as a result of the robust organic deposit growth, which we have enjoyed over the last year.

Well, in terms of capital, we saw marked improvement in our tangible capital ratio this quarter, PCE, increase to 5.63% for the quarter and is moving closer to the higher end of our range, which is between 5 and 6%. As a result, we will continue to be very selective in pursuing only the most profitable growth opportunities in the future in an effort to preserve capital and maximize the return on same.

In terms of regulatory capital, risk-based capital, Tier 1 capital ratios continue at nearly double the required levels. And as I mentioned last quarter, the cost of our trust preferreds is fixed for three to 10 years at rates averaging around 6%.

Noninterest income for the quarter returned to levels we saw last year as record low interest rates spurred another wave of residential refinancing activity. We were also pleased that service charge income improved over the second quarter, despite implementation of the Fed's new Reg E rule requiring debit card and ATM users to opt in for overdraft protection. And noninterest expense was essentially the same as last year other than for a $1.6 million goodwill impairment charge and $4.2 million of write-downs and expenses associated with repossessed assets.

In terms of the expansion, we see numerous opportunities in all of our markets, and in terms of how and where we invest our capital, we are taking a very selective posture of pursuing only the most profitable growth opportunities. Outside of acquisitions, organic growth opportunities exist in all of our markets where competitors, both large and small, are struggling.

As a result we are actively pursuing and successfully acquiring high-quality deposits and loan relationships from these troubled competitors.

I'm also pleased to comment on the excellent progress that we are making with our consumer finance subsidiary, Citizens Finance. With assets now at nearly $50 million Citizens' year-to-date earnings were $1.5 million and that is 55% over 2009 year-to-date earnings.

At the same time, Citizens is experiencing delinquencies and net charge-offs well below last year's level. As part of Citizen's expansion plan, they will be opening their ninth branch location later this year.

Finally, I think it's important to note that regulatory examinations were recently completed at all of our member banks with an examination date of June 30.

And in concluding my comments today, I am pleased to report that at its October meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share payable on December 10, 2010. I'm proud to say that since Heartland's inception since 1981, our dividend has either increased or remained stable.

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 exposures. John?

Thanks, Lynn, and good afternoon. Again today, I intend to provide additional background on a variety of issues relating to Heartland's balance sheet and income statement in the past quarter 9/30/2010 versus 6/30/2010.

Starting with the balance sheet, you will note that the overall size of the balance sheet increased by $55 million, driven in large part by the continued growth in demand in savings deposits, which I will discuss in greater detail shortly. Loan growth and the forecasting thereof continues to be very challenging, as loans held to maturity decreased by $24 million. This reduction was driven in part by payoffs of some large credits in addition to charge-offs, which Ken Erickson will discuss in greater detail.

As Lynn mentioned, we continue to aggressively pursue loans including developing unique yet prudent strategies to expand our loan portfolio. We would estimate our fourth-quarter loan growth to be $25 million.

Net charge-offs for the third quarter totaled $8.4 million as compared to $8 million in the second quarter of 2010. With the provision of $4.8 million, our allowance decreased to 1.89%. This is primarily driven by a reduction in the impairment amount on two credits in Dubuque and in New Mexico.

While we have tried to include significant color in the press release on the activity in the allowance, Ken Erickson will provide additional detail on this as well.

Finally in this area, we have just completed our exam cycle for all banks and focused additional attention on our processes around the FAS 114 impairment calculation. At the same time, we continue to focus our efforts on growing non-timed core deposits and decreasing wholesale funding where possible. We are very pleased with the current mix of deposits as demand and savings products now comprise 70% of total deposits in comparison with 66% at 12/31/09. Demand deposits have increased by $44 million since 6/30/2010, some of which include large increases in existing relationships but also continued an excellent trend in the granular growth in accounts and deposit balances. Savings balances showed similar growth, expanding by $20 million in the third quarter.

We certainly acknowledge that as the economy improves, these balances could decrease. However, we continue to solidify relationships by diligently working to cross-sell each of the accounts.

Moving on to the income statement, net income totaled $6.9 million for the third quarter while net income, available to common stockholders totaled $5.6 million or $0.34 per share. As Lynn mentioned, we feel very good about our managed margin, which was 4.18% for the quarter.

The margin has held up better than anticipated, as we were able to move more aggressively down our non-maturity and maturity deposit rates. In fact, our total cost of funds across the system now stands at just over 1%.

Again this quarter, we will focus on reducing our rates where possible and feel there are still some cuttings that can take place. That being said, we have over $75 million of investments maturing or paying down in the coming quarter with current reinvestment rates in the 2% range. As a result, I'd suggest that our margin will decrease to around 4.1% by year-end.

Noninterest income was $12.6 million for the quarter, which includes several unusual items. Focusing first on service charges, you'll note that we increased this line item by $171,000. What is important is that we were able to grow this category, despite the implementation of the revision to Reg E. In fact, during this process, we were able to add over 7,000 new accounts to the overdraft checking product.

You'll note that we continued to prudently manage the bond portfolio in this environment as we realized $2.3 million in gains on those securities which we felt had fully appreciated. We would anticipate additional bond gains in the coming quarter, [albeit] at a reduced level.

Consistent with the unprecedented low rates in the mortgage area, a gain on sales of loans increased by 1.2 million. Also consistent with the unprecedented low rates, we recorded $1.2 million valuation adjustments in our mortgage servicing portfolio.

We would expect a similar amount of gain on sale of loans in the fourth quarter, based from what we currently have in the pipeline and the overall level of rates. Total noninterest expense for the third quarter increased by $3.9 million as compared to the second quarter of 2010.

Expenses were very consistent quarter over quarter with the exception of the $1.6 million goodwill impairment charge and the $4.2 million net loss from repossessed assets. As noted in the release, the additional impairment charge in goodwill represents the correction of an error in the external [appraisal] received at 12/31/2009.

The $4.2 million in losses associated with repossessed assets included $3.2 million in additional write-downs on known property while the remaining $1 million primarily represents costs associated with owning the properties. We would expect our tax rate to remain in the 30% range for the remainder of 2010.

In closing, while certainly a noisy quarter, I think there were several positive takeaways including the sustained margin, strong deposit growth, solid noninterest income and generally well-controlled overhead. With that, I would turn it over to Ken Erickson, our Executive Vice President and Chief Credit Officer. Ken?

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 third quarter. As already mentioned, our nonperforming loans increased in the third quarter, increasing by $265,000. 12 new credits exceeding $300,000 on an individual basis were added to nonperforming loans this quarter for a total of $9.6 million.

$2.6 million of this was originated by our Wisconsin Community Bank. Arizona Bank & Trust originated $2.1 million of nonperforming loans while our Colorado location originated $1.5 million.

16 credits representing $10.1 million were removed from nonperforming status during the third quarter. $3.8 million was transferred to other real estate. $3.1 million was charged off while the remainder was resolved through payment restoration to accrual status or sale of the collateral.

The largest of the additions to nonperforming loans is a credit for $2.1 million. Two other credits added to non-performing this quarter were $1.5 million each.

I will now turn the discussion to total nonperforming loans. As stated in our earnings release, $55 million of the $85 million of nonperforming loans resides in 23 credits where individual exposures are greater than $1 million. The release detailed the markets that originated these credits.

80% or $43.9 million of these larger nonperforming loans are in the following four industries. Lot and land development, $15.2 million; less source of real estate, $14.2 million; other activities related to real estate, $7.6 million; and construction and development, $6.9 million. $3.7 million of our nonperforming loans are covered by government guarantees through [rural] development, FDA or FSA.

Next, I'll comment on charge-offs and provision expense. $4.5 million of our losses in the third quarter were from loans originated by Arizona Bank & Trust, $839,000 by Riverside Community Bank, and $775,000 by in Mexico Bank & Trust. Out of the $7.8 million in losses incurred by our member banks in the third quarter of 2010, the majority was incurred in one loan category -- construction, land development, and other land loans in the amount of $5.1 million. Losses in all other individual loan categories did not exceed $700,000.

In the third quarter of 2010, Heartland recorded a provision expense of $4.8 million. With net losses of $8.4 million, the allowance decreased by $3.6 million. The allowance as a percent of loans was decreased from 2.03% at June 30th to 1.89% as of September 30th. The current allowance of 1.89% is still greater than the allowance of 1.8% as of December 31st, 2009.

During the first two quarters of 2010, additional loss exposure was identified and was recorded as specific reserves against impaired loans. As we have progressed through the collection cycle of some of these loans, the actual loss has been taken, which had the result of reducing the allowance previously established for these specific credits.

In two other cases involving borrowers whose loans had become undercollateralized due to decreases and values of our collateral, additional collateral was pledged in the third quarter, reducing the amount of the impairment shown on these loans.

The overall portfolio condition appears to be stable to improving. Delinquencies on each of the portfolio segments have been well managed with no significance to adverse trends identified. Our trend of 30 to 89 day delinquencies for the last six quarter ends, beginning with June of 2009 are 1.14%, 1.39%, 1.22%, again -- 1.22%, 0.61%, and this quarter 1.65%.

With nonperforming loans remaining relatively constant, total delinquencies increased from 4.28% to 5.37%. The majority of this increase is attributed to six credits that became over 30 days delinquent as of September 30th. Since then, half are back to a current status. And at this point it appears that only one credit or $2.4 million may become a longer term collection.

Regarding expected resolution of nonperforming loans, I can state that our collection efforts in the fourth quarter of 2010 are expected to result in a reduction of $24 million of the nonperforming loans recorded as of September 30th. Of this amount, $18 million is expected to be moved to other real estate.

Relative to other real estate, it's decreased by $425,000 to $32.1 million in the third quarter. Total owned residential real estate properties is at $7.2 million while owned commercial and ag real estate is at $24.9 million.

During the third quarter, $4.7 million was moved to other real estate while sales resulted in the reduction of $1.8 million, and reductions in other real estate balances of $3.3 million was recorded upon the receipt of new appraisals or the sale of the properties. 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 discount in value that exceeds the projected carrying cost of these properties.

With that said, we have entered six properties with a book balance of $4.9 million into an online auction. Marketing and advertising will occur over the remainder of this quarter with sealed bids due in mid January. We will assess this marketing effort for the smaller sampling of our [OREO] portfolio to determine if additional properties should be marketed in this fashion in the future.

Regarding portfolio diversification, we remain well diversified in our loan portfolio. $1.7 billion or 72% of our loans are either fully or partially secured by real estate. Of the $829 million of loans categorized as nonfarm, nonresidential, 58% or $485 million is owner-occupied.

A review of the $344 million commercial real estate nonowner-occupied portfolio at September 30th shows that only $10.8 million or 3.13% of that portfolio is classified as nonperforming. A total of $6.6 million or 1.92% of these loans are 30 to 89 days past due.

$96.7 million or 28.1% of this portfolio segment is in our hotel and motel portfolio segment. Only 2.2% of our hospitality credits are nonperforming. This segment continues to be well diversified with loans to 52 different relationships.

We have a total of $147.6 million in construction, land, and land development loans. 10% of this portfolio is on nonaccrual and is considered impaired. The expected loss on these loans have already been recorded by a charge to be the allowance.

My final comments will be directed to our retail portfolio. They continue to perform quite well. Losses in the third quarter for residential real estate loans were 0.32% of outstanding, decreasing the year-to-date losses for the first nine months to 0.53%.

Foreclosures on eight residential properties or $659,000 were completed in the third quarter. 33 foreclosures on $3 million of loans are currently in process. Historically, several of these get resolved prior to final action.

Citizens Finance, our consumer finance company, performed well in the third quarter. Net loan outstandings are at $49 million. Net charge-offs were $507,000 or 4.28% on an annualized basis and at 2.98%, for the first nine months. Delinquencies were 4.19% at September 30th, down from 4.54% at June 30.

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

Very good. Thanks, Ken. We will now open the phone lines for questions.

(Operator Instructions). Stephen Geyen with Stifel Nicolaus.

Good afternoon. Couple of questions, mostly related to credit. Just curious as you mentioned stable to improved credit. So are you seeing -- is that including the West? Are you seeing the number of credits going bad, kind of stabilizing or dropping off significantly and also the appraisals, are they kind of where they are [for] the last few quarters as well?

I would say yes to both questions, Stephen. The third quarter was slow and seeing loans move through the foreclosure process so we didn't have a lot that we resolved to the collection activity there. But even with that, we didn't have an increase in NPAs that are relatively stable at $117 million.

We do see longer time periods between problem credits, the appraisals that we have seen, particularly in the Southwest. A couple of recent ones have shown slight increases in values since the last appraisals that we saw in the spring, April time frame.

And the write-downs on OREO, certainly it remains elevated. Just curious, is it the credits, the appraisals --? Can you give us some idea about the credits in the portfolio and how many had new appraisals recently completed?

Going to go from memory here, Stephen. We had updated valuations. We have one larger property that has a current book value of $7.5 million that we will have on appraisal on this quarter.

Other than that, most of our property have already had appraisals in this calendar year. So there's not too many that we would still update in this calendar year.

Your question on breakdown, are you looking by region? Or --?

Released [similar] to the type of credits.

The type of credit, like I said we've got 7 -- slightly over $7 million are residential property. Some of those are specific. I know we have one larger one that is a condo in Tempe. There is some single-family or duplex Section 8, but they fall into the residential. So the commercial properties, we still have lot and land development of in the range of $10 million, about 1/3 of our ORE portfolio plus or minus would be in lot and land development.

And then residential, like I said, makes up about 1/3.

Okay and I think, I guess this is just the last question. You mentioned two credits that had increased collateral provided. Can you give us an idea about how much the specific reserve was reduced for those credits?

The one in Dubuque was about just under $2 million and the one in New Mexico was just over $1 million.

Okay. Thank you.

Jon Arfstrom with RBC Capital Markets.

Thanks. Good afternoon. Ken, as long as you have the mic, I'll just ask you one more question. The $18 million you talked about that would drop into OREO potentially in Q4. Can you talk a little bit about the profile of those credits?

Give me one second here. There is about a 0.25 million that is or -- I'm sorry, $1.5 million that will be in lot and land development in the New Mexico area. It is in different credits. It is not an individual credit.

And then we have two commercial properties in Summit, one for $5 million that's rental real estate. It is underoccupied, but it is not vacant. And then we have another one of them approximately $1.5 million that is a condo property that is fully leased out. And then, we've got a couple million in convenience store operations that we would expect that will come into ORE.

There's a handful of other smaller ones in there. I guess I see one other one of about $1.5 million or slightly less that is commercial land, mostly commercial land. There's this small commercial building on it in the Arizona market.

Okay.

That makes up the majority of those.

And are those credits where you will go through a new appraisal process or something we think --? I guess the question is, does it happen immediately or does that take some time to occur?

We will make that happen before we take ownership. We have got a relatively recent appraisal. We make sure that we have updated ourselves on valuation on all impaired loans on no less than a quarterly basis. We will update those valuations again through an external third party before we take ownership, so that we will take it into ORE at the most current market value that we can obtain.

Maybe a question for John or Lynn, but the loan growth number you talked about, you know, it's an improvement from what you did this quarter and that's good. And I was wondering if you could just talk a little bit about where and what you think will drive that growth?

You know, I think, a couple of things. One, Lynn mentioned the fact that we are focusing heavy on the new SBA programs that are out there as well as USDA. So I think that is certainly an avenue for us.

I think Wisconsin continues to remain a source of loan growth as well as Dubuque. That's also a potential.

So I think it will be, in some respects, spread throughout the organization. But I think those will be some likely candidates for growth right now.

There's one other piece to this strategy and that is that we are really poised for rates up. So we have a fair amount of capacity to take on a little bit longer term loans. So we are looking at booking some jumbo loans in the portfolio. Those would be balloon loans. We have a demand from some of our better clients to do that.

We've set a goal for both conventional short-term loans, either 15 years fixed or balloon loans. No more than $[50] million across the entire company. That is one of the strategies.

But more so than that, it's just doing a better job of target marketing our weak competitors and making sure we've got our lenders out aggressively calling on quality credits that are in the markets that we serve.

And then near the back of the release, you had some tables on the individual banks. And I noticed that the Arizona Bank was profitable this quarter and I know it's not your largest bank, but it's been one of the largest drags on the earnings of the Company and I'm just wondering if there is anything happening there? Has that bank turned the corner? Is there just something specific in this quarter that made it profitable?

I think what we've seen is certainly some slowing in the provision, but it's -- the core operations are improving, the margin is improving, it is virtually in line with budget right now. I think we have constrained the cost very well down there at this point as far as some overhead issues.

So when I say it has turned the corner, I think it's too early to say that relative to profitability. I just -- I think more probably more appropriately, it is certainly trending in the right direction.

All right. Thanks.

Chris McGratty with KBW.

Hello. John, on capital, what was Tier 1 count for the quarter? Do you have that number?

I don't think we have that calc yet.

Okay. I guess maybe a broader picture -- broader question on credit, or on capital. What are your updated thoughts on TARP repayment?

I think we're holding pretty steady to that. We have looked to repay at all by the end of the year 5 which is November 2013. You know that that I think is -- you know, I think our opportunity we look to do it from cash flow and some debt issuance. But the combination of those two things, I think, certainly allows us based on our projection right now to do it by 2013.

Okay. Moving on to the income statement on the service charges. Can you give any color on any kind of -- you had some cautionary, sounds like some cautionary tone of text. Do you expect an impact from Reg E and on the revenue line next quarter?

I think we were trying, in our comments we were trying to spell that a little bit. I think we've, by and large, we saw an increase in service charges. Reg. E alone, I think we saw a small decrease year over year if you can compare September to September. But I think we are still, that really is a combination of Reg E plus the Durbin Amendment I think we are focused on there.

But again, I think, relative to service charges, I mentioned that we put on 7,000 additional -- well, we were able to put 7,000 additional accounts into the overdraft checking program. So even with those, the impact of that Reg E, I think we feel that we should -- at a minimum -- be able to sustain our revenue there.

Add to it the emphasis we had for certainly the last year to year and a half in treasury management products and the growth thereof. I really think that that line item is pretty solid for us.

So that 36, 37 line is, that has Reg E in it and you kind of expect flat to up revenues going forward. Is that fair? (Multiple Speakers). Okay.

And the OREO costs? Obviously they are elevated this quarter. What -- John, what's your outlook kind of, maybe I missed it -- you know, what's the reasonable kind of forecast for this next few quarters?

Well, Ken alluded to it in his one of the first questions that we have an appraisal coming up on a property, a relatively large property in Q4. I think $7 million plus that will certainly be -- at least has potential in this environment to have an impact. We don't know at this juncture, the appraisal has not been -- it generally hasn't been received.

So that has potential. The ongoing costs, which was about $1 million, that probably -- that potential exists as well. So I think that one credit or one property and other real estate plus the ongoing costs. I would hope it would be less, but who knows at this juncture?

That's helpful. And last on the reserve, maybe you could talk to us about, given the improvement in credit where you are comfortable kind of running the reserve at the bank?

You know, I think we -- what we do -- we've done is look at our methodology very -- like probably most banking organizations we really take a hard look at our raw allowance processes. You know the FAS 5 114 qualitative analysis. At [189], we feel we were appropriately reserved at 9/30. We will go through the same thing at 12/31. I think it is a function of those three components and we are going to adhere to that very diligently.

Okay. And again last thing for me, last question for Ken. But where are you guys carrying your nonperformers? Maybe I missed it in OREO. Where is that being carried? Approximately? Just relative to original base?

Wait, you mean the --.

How much write-down did we take -- (Multiple Speakers).

Yes. I'm just trying to gauge where you're carrying that stuff.

Oh, a more reasonable guess would be probably about 70% or --.

Okay.

I would say that's -- I think that's in the ballpark. Yes, I don't think it would be any deeper discount than that.

The deepest discounts, Chris, would be down Southwest, out West. Not nearly as deep a discounts (sic) in the Midwest.

Great. Thanks a lot.

(Operator Instructions). [Stephenson Aquilo] with Macquarie Capital.

Quick question on the reserve methodology for you. Specifically I know that the FAS 114, you know, leases and the specific reserve for leases kind of skewed results this quarter. But is it fair to assume maybe from, here barring more of those, that the provisions will attract charge-offs a little more closely as we look out down the road?

I would say for the next quarter or two, very likely. But our allowance as John mentioned is made up of three components. FAS 5 114 and them the qualitative factors. And today it sits real close to about 1/3, 1/3, 1/3 in those.

And as we continue to move through the economic cycle and see credit improvement, we will be carrying less loans than a FAS 114 bucket, I would expect. So while the other two may maintain the dollar levels that they have, I would expect the amount we are carrying against impaired loans will reduce, which, in time will see us fall back off of this 189 allowance.

How quickly that happens, it is going to be a couple, three quarters before we see anything significant in that, I would expect.

Makes sense.

(Multiple Speakers). I guess, just, you would think about we had two credits that we were able to bring $3 million respectively back into income, if you will. And then we had one large charge-off in Arizona that we also took that was a little bit of an aberration too.

So we had customers that are working with us and have loads that are currently paying, but had become undercollateralized. And in working with them, and they both came forward and pledged additional collateral to reduce those impairment amounts.

So we, really, if you look it's almost -- the first two quarters were maybe a little bit of an aberration on the provision side because as you indicated we funded this in Q1 and Q2 and were able to reverse them in Q3.

Brad Milsaps from Sandler O'Neill.

Good afternoon. John, you mentioned in your comments that you expected about $75 million coming off, out of the investment portfolio in the fourth quarter, if my notes are correct.

That's correct.

Curious if you could provide maybe some additional color as to what you expect in 2011, you know, that could be obviously subject to a lower reinvestment rate and sort of square that with, you know, what you have maturing on the other side of the balance sheet. You know your CD costs are still up around 2.6%, just wanted to get a sense kind of how the margin amount react absent any loan growth, in a major way in 2011?

Again, I think that run rate on the investment portfolio probably could, in fact, carry over to 2011. We -- I think again we would have some roll off of CDs as you are alluding to. If we forecast, maybe the best way to think about it, if we forecast a stable rate environment, I think we show about a 2% to 3% decrease in margin year one. Then that assumes no loan growth. So --.

So you're saying assume about 75% -- or $75 million and sort of quarterly runoffs in the investment portfolio?

Yes. Yes and we probably have 50% of these CDs rolling off in the next year at a 1.8%.

50% of --.

Rolling off in the next year at 1.8%.

Okay and where are you currently -- you know, 12 months (Multiple Speakers)?

Where we'd be on it somewhere book as far as the reprice on those CDs. They are rolling off at 1.8%.

Right.

It depends on where they go obviously in the curve, but they are maybe 50 bips are or as much as maybe not, maybe -- call it 30 bips.

So only 30 bips coming out of the CDs? Okay.

I think that's. Yes, okay just thought process here, probably 50 to 75 based on where they are going into the curve or slight 30.

Okay.

There is -- I think there is some movement down also on savings and then if we get a [shift], what's happening is as you know with most things is that when the CD rates get as low as they get, it you know the dollar just kind of starts to drip into savings. And I think there's room for us to push savings rates down as well.

Yes, and just coming back to our modeling, Brad, and as we look at it the next year, year one in a flat rate environment we showed 2% to 3% attrition in margin assuming that no loan growth. And again I know you want to do your own modeling, but that is where our models currently come out.

Again, that was very helpful. Thank you very much.

Thank you. (Operator Instructions). At this time, we're showing no further questions in the queue. I'd like to turn the conference back over to Mr. Fuller for closing comments.

Thank you. In conclusion, I would wrap everything up and just say that the third quarter highlighted Heartland's best earnings in three years. Our superb net interest margin as we talked about at 4.18% is producing exceptional pre-tax and pre-provision earnings with noninterest income strong and noninterest expense well under control.

We continue to improve the composition of our balance sheet with high-quality securities and an excellent mix on core deposits.

And finally, I think we're well positioned and eager to pursue end market acquisitions that are accretive, both to earnings and meet or exceed other M&A criteria. In short I feel good about the earnings power of our Company and continue to see excellent opportunities ahead for Heartland.

I'd like to thank everyone for joining us today and hope you can join us again for our next quarterly conference call which will take place next year on January 24th, 2011. Have a good evening, everyone.

Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 1-800-406-7325 with an access code of 437-1599 pound. We thank you for your participation and, at this time, you may now disconnect.