Heartland Financial USA Inc (HTLF) 2010 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the Heartland Financial USA fourth-quarter 2010 conference call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions).

At this time, I would like to turn the conference over to Leslie Loyet with Financial Relations Board.

Please go ahead, Ma'am.

Thank you and good afternoon, everyone. Again, thank you for joining us for the Heartland Financial USA's conference call to discuss fourth-quarter and year-end 2010 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.

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 year and then we'll open the call up to your questions.

Before we begin the presentation, I'd 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 the any statements made through 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.

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

Thank you, Leslie, and good afternoon. And thanks to each of you for joining us today as we review Heartland's performance for the fourth-quarter and full year of 2010.

For the next few minutes, I will touch on the highlights for 2010. I will then turn the call over to John Schmidt, our Chief Operating Officer and CFO, who will provide detail on Heartland's quarterly and annual financial results. Then Ken Erickson, our Executive Vice President and Chief Credit Officer, will offer insights on the status of our nonperforming assets and credit quality issues.

Well, I am very pleased to begin today's call with the news that Heartland reported net income for the fourth-quarter 2010 of $6.5 million and as compared to a loss of $7.9 million for the same quarter last year. On a per share base, Heartland earned $0.31 per diluted common share in the fourth quarter compared to a negative $0.56 in the same quarter of 2009.

For the year 2010, Heartland reported significant earnings improvement with net income of $23.8 million compared to $6.4 million for all of 2009. Income available to common shareholders for 2010 was $18.6 million or $1.13 per diluted common share compared to $1.2 million or $0.07 per diluted common share for 2009.

In comparison to previous years, 2010 was excellent in many respects and reflects the concerted effort of our team in weathering the storm that has battered the economy and the banking industry worldwide. For the year, our pre-provision, pretax earnings were exceptional at $66.1 million compared to $52.9 million in 2009. Our results continue to be driven by an excellent net interest margin north of 4% and enviable deposit mix and solid non-interest income.

With most aspects of our business clicking on all cylinders, we continue to be hindered by nonperforming assets which remain at an elevated level. Nonperforming loans to total loans ended the year at 3.87%. While still under 4%, and better than similarly sized peers, reduction of nonperforming assets is still our number one priority. I can assure you that our special assets and OREO officers are taking aggressive actions toward the reduction of nonperforming loans and other real estate.

With our allowance for loan losses at 1.82% of total loans, we believe we are properly reserved at this point. In a few minutes, Ken Erickson will address credit administration topics of interest.

2010 results were positively influenced by solid performers in a number of our operating units. And in fact, of our 11 subsidiaries, nine were profitable. Specifically, Dubuque Bank & Trust, Galena State Bank and Trust, New Mexico Bank & Trust, and Wisconsin Community Bank all had record years. Our Citizens Finance subsidiary also recorded its best year with a $1.9 million contribution to Company earnings.

A continuing bright spot in our operations is our net interest margin, which was 4.12% for the year and 4.05% for the fourth quarter. You might note that margins slipped in the fourth quarter as asset yields have followed market rates down.

Moving on to the balance sheet, our total assets are now just under $4 billion, which is essentially unchanged compared with last year. We continue to focus on improving the mix on both sides of the balance sheet. And as a result, other than for acquisitions we don't anticipate significant asset growth in the near term. Our balance sheet is extremely liquid, securities representing 32% of total assets. So we are well-positioned, as you can see, to make every good loan we can find.

As green shoots begin to emerge in our local economies, quality loan growth is now our second highest priority as we seek to convert cash flow from our securities portfolio in the quality loans. With our special assets staff concentrating on the loan workouts and real estate sales, our business bankers and business development officers are able to focus all of their efforts on loan growth.

One area where we see expanded lending opportunities is in government guaranteed lending. We continue to leverage the expertise of our Heartland business bank personnel in Wisconsin to provide clients attractive financing structures by utilizing the various USDA and SBA programs.

Well, even though deposits leveled off during 2010, we continue to enjoy improved deposit mix. Demand deposits grew by 26%. Savings and money market balances increased slightly and, by design, time deposits dropped by 14% along with the decrease in broker deposits and other borrowings. At year end, demand deposits and savings balances represented over 70% of our total deposits.

In terms of capital, our tangible common equity ratio ended the year at 5.6%, which was a significant improvement from where we started the year at 5.14%. Additionally, we are assessing the benefits of and completing an application for conversion of TARP to the Small Business Loan Fund and John Schmidt will elaborate on this development in his comments.

Incidentally, I am pleased to say that during the fourth quarter, Heartland completed a $24.5 million term private debt placement. With these low-cost fixed rate borrowings providing additional cash resources for an extended period of time, we really don't anticipate the need for a capital raise. The exception might be a large, very accretive M&A transaction.

Noninterest income for the fourth quarter grew significantly as record low interest rates fueled another wave of residential refinancing activity. We were also pleased that service charge income held its own compared to previous quarters, despite implementation of the Fed's new Reg. E rule, requiring debit card and ATM users to opt in for overdraft protection. Also showing nice improvement over 2009 were our Wealth Management Group and Investment Services lines of business.

In reference to noninterest income, you may recall my comments from previous quarters related to Heartland's intent to expand its residential lending activities. Recent legislative changes in this area opened the door for new opportunities in mortgage lending. As nonbank competitors in this space are beginning to disappear, we see significant opportunity for expanding residential loan origination as a gateway retail product and a strategic line of business.

In November, Heartland announced a significant addition to its residential mortgage lending capabilities with a high earning of a mortgage banking team of professionals and executives in the Phoenix, Arizona market. Our new unit is now fully operational and offering mortgage lending services at Heartland's Arizona Bank & Trust subsidiary with planned expansion into Heartland's largest metro markets and non-Heartland markets throughout 2011. Administrative and back-office support will be organized within a division of the Company's flagship bank, Dubuque Bank & Trust.

As with all Heartland credit products, this business line will focus on traditional mortgage banking based on sound lending principles.

On the subject of efficiency, you may be aware that Heartland announced late in 2010 its intent to combine the charters of its two Iowa-based banks -- First Community Bank located in Keokuk, Iowa and our flagship subsidiary bank, Dubuque Bank & Trust. We believe the change will be largely transparent to our customers as it's primarily a change in the legal status of the bank.

At the same time, we see several benefits for our customers. First Community Bank will continue to operate with the same people, the same name and the same great service for our customers. At the present time, we are not contemplating more near-term consolidations. We prefer instead to focus on numerous opportunities for both direct or assisted acquisitions that exist in all of our markets.

Given the ever-increasing attention to capital, however, we are taking every selective -- very, excuse me -- we are taking a very selective posture of pursuing only the most profitable growth opportunities.

In concluding my comments today, I am pleased to report that at its January meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share payable on March 11, 2011. I am proud to say that for every year since Heartland's inception in 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 John will then introduce Ken Erickson, who will provide commentary on credit quality and real estate exposure. John?

Thanks, Lynn, and good afternoon. Given the expansion of the content in the press release, I will limit my comments to provide an additional color on the most significant areas of change in the balance sheet and income statement. My comments will be primarily directed to comparing the past quarter, 12/31/2010 versus 9/30/2010.

Let's start with the balance sheet. I'd like to initially focus on the investment portfolio as Heartland has experienced an exceptional year relative to the portfolio's performance. As of 9/30/2010, the investment portfolio ranked in the 92nd percentile of all IDC reporting banks.

Obviously, maintaining this type of return in this rate environment will be challenging as we have $289 million of investments maturing in the next year.

Moving onto loans, forecasting loan growth has proven as challenging as actually making loans in this environment. I had indicated in the third-quarter call that we felt that $25 million of fourth-quarter loan growth was achievable. You will note that loan was actually decreased by $18 million.

This decrease was driven by the continued charge-off of problem credits and transition of problem credits to other real estate, seasonal paydowns in our agricultural portfolio, and refinances of portfolio real estate and home equity lines of credit into the secondary market. As I mentioned, we remain focused on growing loans and continue to look for the proper mix of personnel to do that. With this continued emphasis, we still feel comfortable forecasting $100 million of loan growth for 2011.

Net charge-offs for the fourth quarter totaled $10.9 million as compared to $8.4 million in the third quarter of 2010. With the provision of $8.9 million, our allowance as a percentage of loans decreased to 1.82%. This doesn't reflect a conscious effort to release reserve. Rather, as Ken Erickson will explain further, we are charging off credits as soon as an impairment is [identified] on loans in the process of foreclosure.

Additionally, in a couple of instances, we actually saw an improvement in the underlying collateral valuation on impaired loans. While other real estate was essentially flat for the quarter, this balance is reflective of the $7.3 million of net loss in other real estate owned. Included in this total is a $2.8 million write-down on land development in Montana.

The fourth quarter was somewhat unusual for us as a disproportionate amount of the larger properties were reappraised during the quarter. Lynn mentioned that the tangible common equity remained essentially flat at 5.6% despite the fact that our FAS 115 adjustment was reduced by 50%, consistent with the bond market sell off.

Again, our targeted range for tangible common equity is between 5% and 6%. We feel even more comfortable with this range, given the augment and liquidity position provided by the $24.5 million private placement.

Lynn also mentioned we are considering participating in the Small Business Lending Program. Based on our initial analysis it would appear that we have already grown qualifying loans by 2.8% since the measurement date, which would drop our weighted rate to 4.65% under the program. We are also evaluating the repurchase of the warrants associated with the initial TARP investment.

Let's move on to the income statement. Net income totaled $6.5 million for the fourth quarter while net income available to common stockholders totaled $5.2 million or $0.31 per share. As Lynn mentioned, we feel very good about our net interest margin which is 4.05% for the quarter. This is in line with our expectations.

Given the repricing of the investment portfolio we mentioned previously, we do see challenges maintaining the margin in excess of 4% without a substantial amount of loan growth. Thus assuming reasonable loan growth in 2011, we would suggest a margin of 3.90% to 3.95% range.

Relative to non-interest income, non-interest income totaled $18.3 million for the quarter which included several unusual items again this quarter. Items of note included a continued expansion of loan servicing income, which increased by $461,000. While this expansion was certainly driven by the refi boon, the addition of national residential will have a positive impact on this line item on a go-forward basis.

Trust and brokerage fees were also a bright spot as they increased by $370,000 for the quarter. We continue to focus on these areas and believe there is considerable upside. We recorded security gains of $2.2 million for the quarter as we continue to look to optimize the performance of the portfolio.

We feel there is some additional opportunities to harvest gains in 2011, albeit at a reduced level. The refi boon also contributed significantly significantly to the gains in sale of loans which totaled $3.8 million for the quarter, the highest ever recorded for the Company. With the addition of National Residential, we would anticipate this line item to minimally equate this total on an annualized basis as production personnel are added.

While the run-up in rates negatively impacted the bond portfolio, it had the opposite effect on the valuation adjustment on the mortgage servicing portfolio as we reversed the $1.2 million expense adjustment we recorded in the third quarter.

Finally, other non-interest income included life insurance, death benefit proceeds, of $502,000 on a retired employee. This quarterly total also included $324,000 of increased payouts from the FDIC, relative to our assisted transaction in July of 2009. It is important to note that a similar amount is included in our provision.

Focusing on non-interest expense. Total non-interest expense for the fourth quarter increased by $3.9 million as compared to the third quarter of 2010. Major changes in the fourth quarter included a $1.4 million increase in salaries and employee benefits, $444,000 increase in professional fees, and a $3.1 million increase in net loss and [repo those assets] we previously discussed.

The increase in salaries and employee benefits was driven in part by commissions on mortgage, trust, and brokerage production. Also contributing to this increase were the 24 additional employees associated with the National Residential expansion.

The addition of National Residential will materially impact this line item in 2011 as commissions increase consistent with mortgage production. We would expect that this initiative will be bottom-line neutral in 2011.

The $444,000 increase in professional fees was driven in large part by legal fees associated with the cleanup of problem loans. Additionally, we have engaged consultants to assist us in the expansion of our trust area and the re-evaluation of goodwill impairment at our bank in Montana.

The effective tax rate for the quarter was 18% and was driven by the receipt of a [cash] credit of $336,000 on a senior housing project. A change in our approach to filing state returns provided a $300,000 benefit, which will be an ongoing benefit. And finally, the aforementioned $500,000 life insurance proceeds were nontax -- were nontaxable.

For 2011, we would anticipate a tax rate in the 28% range.

In closing, while certainly a noisy quarter, I think there are several positive takeaways including the sustained margin, the improved parent company liquidity, and solid non-interest income.

With that, I 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'll begin by discussing the change in nonperforming loans in the fourth quarter. As already mentioned, our nonperforming loans increased in the fourth quarter, increasing by $5.4 million. 15 new credits exceeding $300,000 on an individual basis were added to nonperforming loans this quarter for a total of $22.1 million. $7.8 million of this was originated by New Mexico Bank & Trust, $5.2 million by Arizona Bank & Trust, $3.4 million by Wisconsin Community Bank and $3.2 million by Summit Bank & Trust.

21 credits exceeding $300,00 on an individual basis representing $18.6 million were removed or had significant reductions in their nonperforming balances during the fourth quarter. $7.2 million was transferred to other real estate, $6.5 million was charged off, while the remainder was resolved through payment, restoration to accrual status or sale of the collateral.

The three largest credits added to nonperforming this quarter were in the amount of $4.6 million, $3.2 million, and $3 million.

Please note the addition of a new table within the press release that reconciles the changes in nonperforming assets for the quarter.

I will now turn the discussion to total nonperforming loans. As stated in our earnings release, $56 million of the $91 million of nonperforming loans resides in 25 credits where individual exposures are greater than $1 million, the released details of the markets that originated these credits.

The industries for these credits are also detailed within the release. The largest concentrations of these nonperforming loans are in lessors of real estate, $13.1 million, and lot and land development, $11.6 million. $3.7 million of our nonperforming loans are covered by government guarantees through rural development, FDA or FFA.

$17.3 million or 18% of our nonperforming loans are not delinquent. Once a satisfactory payment history has been achieved, many of these will be returned to performing loan status.

Next, I will comment on charge-off and provision expense. Charge-offs in the fourth quarter were from loans originated primarily by our banks in the West and Southwest. Specifically $2 million were from loans originated by Arizona Bank & Trust; $1.9 million by Rocky Mountain Bank; $1.7 million by Summit Bank & Trust; and $1.6 million by New Mexico Bank. Out of the $10 million in losses incurred by our member banks in the fourth quarter of 2010, the majority was incurred in the following loan categories.

Construction, land development and other land loans in the amount of $2.8 million; first mortgage one-to-four family, $1.9 million; C&I, $1.7 million; and nonfarm, nonresidential owner occupied, $1.5 million. Losses in all other individual loan categories did not exceed $800,000.

In the fourth quarter of 2010, Heartland recorded a provision expense of $8.9 million. With net losses of $10.9 million the allowance decreased by $2 million. The allowance as a percent of loans was decreased from 1.89% at September 30, to 1.82% as of December 31. The current allowance of 1.82% is slightly above the allowance of 1.8% as of December 31, 2009.

During the first two quarters of 2010, additional loss exposure was identified and was recorded as specific reserves against impaired loans. Some of the charge-offs recorded in the third and fourth quarter was the result of charging off the impaired amount reducing the allowance. The fourth-quarter increased provision was primarily the result of updating impairment calculations as new collateral values were obtained. Several of these increased impairments were immediately charged off as they were on loans in the process of foreclosure.

Even with this quarter's increase in nonperforming loans, the overall portfolio condition still appears to be stable to improving. Delinquencies in each of the portfolio segments have been well managed and no significant adverse trends are identified.

The trend of 30- to 89-day delinquencies for the last six quarter ends beginning with September of 2009 is 1.39%, 1.22%, 1.22%. 0.61%, 1.65% last quarter, and 0.67% at year-end. Even with the slight increase in nonperforming loans, total delinquencies decreased this quarter from 5.37% to 4.63%.

Regarding expected resolution of the nonperforming loans, I can state that our collection efforts in the fourth quarter of 2010 did not result in the expected reduction, due to some delays in foreclosure processes. These delays were only temporary and will increase our estimate of first-quarter resolution.

Collection efforts in the first quarter are expected to result in a reduction of $32 million of the nonperforming loans recorded at December 31. Of this amount, $29 million is expected to be moved to other real estate. $2.3 million has been resolved already this month with an additional $9.2 million expected to be resolved by the end of January. During 2010, we modified our approach in managing special assets.

We believe that reassigning customers from their relationship managers to special asset officers will benefit both the customer and the bank. The special assets officers through their specific skill sets should be able to better negotiate, empathize, manage the interested parties and establish a sense of urgency. At the same time, this frees up our business bankers so that they can utilize their time and talents to target loan growth.

Relative to other real estate, as shown in the table in the press release, other real estate decreased by $406,000 to $32 million in the fourth quarter. Total owned residential real estate, including all properties intended to be used as one-to-four family residences is $12 million while owned commercial or agricultural real estate is $20 million.

During the fourth quarter, $8.7 million was moved into real estate while sales resulted in the reduction of $3 million and the reductions in other real estate balances of $6.2 million was recorded upon the receipt of the new appraisals or the sale of the properties. The reductions were primarily related to three properties with remaining book values of $9.8 million as of 12/31.

$3.4 million of these three properties have been contracted for sale since the end of the year with closings expected in the first quarter. This included $2.4 million sold via an online auction. We had entered six properties with a book balance of $3.8 million into an online auction. Bids in the amount of $3.1 million were expected on three of the six properties, resulting in gross sales proceeds at $86,000 above book value.

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 costs on these properties.

In the fourth quarter, we also added two other real estate facilitators. One for the Midwest and one for the West/Southwest. These individuals have experienced in both property management and sales. They are charged with the management and sale of these properties.

Regarding portfolio diversification, we remain well diversified in our loan portfolios. $1.7 billion or 72% of our loans are either fully or partially secured by real estate. Of the $823 million of loans, categorized as nonfarm, nonresidential, 59% or $489 million is owner-occupied.

A review of the $333 million commercial real estate nonowner-occupied portfolio at December 31 shows that $25.3 million or 7.6% of that portfolio is classified as nonperforming. A total of $4.1 million or 1.2% of these loans are 30 to 89 days past due.

Our exposure to nonowner-occupied properties decreased by $10.4 million or 3.03% in the past quarter. $95.4 million or 28.7% of this portfolio segment is in our hotel/motel portfolio segment. 7.49% of these hospitality credits are nonperforming. This segment is well diversified, though, with loans to 52 different relationships.

We have a total of $131.2 million in construction, land, and land development loans. This is down $15.3 million or 10.5% from last quarter. 12% of this portfolio segment is on nonaccrual and is considered impaired. The expected losses on these loans have already been recorded by a charge to the allowance.

My final comments will be directed at our retail portfolios. Our retail portfolios continue to perform quite well. Losses in the fourth quarter for residential real estate loans were 3.08% of outstanding, increasing the year-to-date losses to 1.58%. Half of the loss for the quarter and a third of the loss for the year related to a single condo project. Foreclosures on six residential properties for $714,000 were completed in the fourth quarter. 39 foreclosures on $3 million worth 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 fourth quarter. Net loan outstandings are at $49 million. Net charge-offs were 3.35% for the year 2010. Delinquencies were 4.39% as of December 31 with only 1.04% being over 90 days past due.

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

It's time we open the call for your questions.

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

Thanks. Good afternoon. Ken, as long as you are front and center, a couple for you. What do you attribute the decline in delinquencies to. I know it may be back to where it was in Q2, but is there anything you would attribute that decline to?

I think overall, we are seeing a leveling out of problem credits. The totals don't seem to be coming down yet as we had some delays in foreclosure processes and in court actions. I think the third quarter was more of a bump up from a couple of specific things that we could see.

I just feel like we've reached the end of the credits continuing to spiral down and looking at a plateauing of credit quality now looking for improvements from there.

Okay. And then this is maybe either for you or Lynn, but a couple of quarters ago I asked you this, Ken. Just in terms of are you seeing the gap close at all in terms of where you are holding some of your OREO property? Or where you have your nonperformers marked versus where the market is at?

And you know one of -- it sounds like you are very serious about this, but the new hires and I know it is a top priority, but I look at the OREO balances potentially creeping up next quarter. It's good that you have possession of the credit.

But I'm just curious how aggressive are you willing to be and what you are seeing in terms of the market versus where you have these assets held.

I guess I'll answer and look to Lynn to go from there. Like you said, we are planning to liquidate these ourselves. We have on a continuous basis [look] at what the market will provide and we are finding those discounts are still beyond what we think is reasonable.

In the fourth quarter, we did see the sale of some properties like I mentioned. We even went to an online auction and realized the majority in dollars that we had put out there. We ended up selling at what we had it booked at.

We will see a significant increase in other real estate in the first quarter, as I mentioned. But we've already gone through impairment calcs and we update those on a very serious basis on a -- every quarter. So I don't expect that we are going to move those properties into other real estate and then within the first six months see that the bottom is falling out from under those.

So will we see further ROE write downs next year? I would say certainly in some markets and some properties. But we are -- we are not seeing that death spiral of values that we saw in the Southwest during the end of 2009 and into 2010.

I would agree with that last comment that Ken made that I think we finally kind of started to form a bottom on this stuff. And I've said on past calls, you start out at 100 cents to the $1.00, you get it down to about $0.20 to $0.25 on the dollar. At some point, there isn't a lot more to write off.

I was very encouraged by that auction. I mean, we sold those properties at the marks or a little bit above. We've got a little bit of cost in the auction, but that was very encouraging. And then we learned, I think it was just yesterday, that we sold another property for $1.4 million in the Denver area and that was above our mark.

So I think we've got a pretty good handle on the marks and I think we are getting help now that we are at a level where things will start to move. So you know, knock on wood, hopefully we are pretty much there.

And maybe just one additional punctuation point on that. Relative to significant discounts, I think we are still -- we are seeing significant discounts on bulk sales, but on an individual basis, maybe this auction being representative over that, we are seeing generally speaking in our marks.

The other thing that we continue to think about is that what the $24.5 million of private placement -- it probably gives us some additional latitude. Now we know the cost to carry and we can certainly identify that at 5%. We have -- with that cash there, we have an ability to again look at each property and see if what's the better alternative are relative to the carrier taking a loss in the short term.

So each one has its own decision point and we are going to continue to do so. But I don't think we will look at the bulk sale at this point.

And then just one more housekeeping for you, John. Do you have the unrealized gain loss, gain or loss in the securities portfolio?

Okay, just that was at $0.60, it adds $0.60 I believe to our book value. About $15 million, but bear with me just a second here.

You know what? I see it here in your release.

I will find it here. Yes, it's about $15 million.

Okay, good. All right, thank you.

Stephen Geyen. Stifel Nicolaus.

Good afternoon. I guess with the modest growth in loans, I'm just wondering if you anticipate being able to fully take advantage of the rate reduction in the capital costs or through the SBA capital program?

I will just take the first part of that. Right now we're, thus far based on the initial measurement date, we've already grown 2 -- almost 2.8% or $28 million is really what the -- $28 million, $29 million. And then again if I had -- but and I can understand historically I mean the last two years has been a challenge, but we do feel that $100 million of growth is realistic this year.

We are looking at a lot of different alternatives obviously to grow those loans. But I don't think given the time frames available to us underneath the program, given the emphasis we have on growing loans, I think it is achievable.

It -- the [bogeys], Stephen, $100 million prox, okay? And so at $28 million we are 28% there and ag counts in this measurement and that is an area that we have a pretty good focus in some of our markets. And we have been steering away from the real estate reducing our concentration in nonowner-occupied real estate, moving more towards the C&I. So even though our loans have been a bit flat, we have been improving the mix.

And I think it is going to be achievable. So we think it is a heck of an opportunity.

In any case we won't do any worse from a cost in the period through June of 2013. The opportunity is only for the rate to go down. It can't go above 5%, and then thereafter, we still have an opportunity for improvement. The worst case is, if we don't grow at all, we go backwards. We go up to 7%, but by November of '13, we go to 9% if we don't pay it off. So it kind of looks like a no-brainer to us.

Okay, good. And with the backup in rates in fourth quarter, do you think the $3.8 million -- you talked about that with mortgage banking -- is that kind of a good run rate or do you think it might take some time to kind of work up to that level?

I think it would take some time to work up to that. Probably wasn't as clear as it could've been, but at $3.8 million, if you look on an annualized basis, we think it's achievable. It certainly is going to take some time to build to that level. So at the end of the year, it could be maybe $5 million, but I think on an annualized basis $16 million just short of that, $15 million to $16 million should be achievable if we hit our marks. And the other -- the mix will certainly shift from refi to purchase, but that is part of the analysis we've gone through and then we can -- we will continue to focus on.

And just kind of the last question, if you could provide just a kind of -- maybe Ken, provide your thoughts on charge-offs and certainly you feel -- you certainly sound more positive than you have been in quite a few quarters. Do you think that -- just kind of the trends that you are seeing out there are going to be reflected in charge-offs sooner rather than later?

Yes. But I will hinge that back a lot on the economy. I don't think that we need to see people get back to work to see businesses really get healthy and move forward. And without that, there are still going to be businesses that fail in the coming year.

So our portfolio from the inside out looks a lot better than it did a year ago and 18 months ago. But we've still got some problems in there to be resolved. And time will tell, but we need a stronger economy to see them move out of that.

(inaudible) just said weaker economy, just lends itself to credits and haven't been able to carry a challenge loan for, say, three years. They been able to make the payments, they had resources to make the payments but at some point they just run out of gas. I mean I think we saw a little bit of that in the fourth quarter. So back to Ken's point, if we seek a pickup in the economy, we can avoid those situations where the individual runs out of gas.

I just add that those sectors that everyone sees is improving, i.e. manufacturing, etc. Those sectors that nationally are doing better, we are seeing improvement in our credits in those sectors as well.

And as I mentioned in my comments to our exposure to those, that you would expect to be the highest risk such as land and land development. Those continue to decrease in there. So we have less exposure in those areas that were proven to be the higher loss areas over the last couple of years.

Okay, thank you.

Steve Scinicariello with Macquarie.

Just a couple of quick ones for you. Given the outlook that you have for putting on some of that loan growth for 2011, do you still think that we could see net balance sheet growth? Or would that -- would you still say we end up neutral, even down a little bit on a total asset basis for 2011?

We are still looking at some overall balance sheet growth for the year just not -- will not be significant, but as Lynn alluded to in his comments, it will be a shift, primarily a shift from investments into loans. I think that's our biggest opportunity at this point, again, saving acquisitions.

But the biggest opportunity again we have is to shifting from investments to loans and picking up the ensuing margin.

We used to experience anywhere from $200 million to $250 million in organic growth per year. We are not expecting that kind of organic growth because it is more of a continued shift in an improvement in the balance sheet. So we'll probably have some growth overall. Unless we'd end up with an acquisition then, we would certainly have that acquired growth. But we are really focusing on continuing to improve our deposit mix, continuing to use liquidity out of our investment portfolio to go into quality loans.

Makes sense. And I'm just wondering approximately how much would that quarterly cash flow coming from the securities maybe on a quarterly basis be just approximately?

Q1 is about $80 million overall. It is about $280 million.

Okay, got you. And then in terms of the provision, it seems to be moving around a little bit with the charge-offs there. You gave some good color on charge-offs and whatnot, but how should we maybe think about that in terms of correlating that to the charge-offs as you look into 2011?

Again, with the economy the way it is, we will have charge-offs greater than they were in 2006. We should see them being significantly less than they were for 2009 and 2010. It just depends on how fast and how solid the economy begins to grow in 2011.

Got you.

(inaudible) [3,006] for 11 basis points. So.

So that's what I said -- higher (laughter).

Great, great. And then one last one. I know what the private placement -- I think the original amount that I saw on the disclosure was up to like $50 million. So you did the $24.5 million. Would you say you are going to try and do more or are you tapped out now?

I think right now we are going to take a wait-and-see approach. We are also looking at some additional bank lines so -- if needed. And we are also again looking at the Small Business Funding Program and see what that brings. So I think for the time being we'll probably take a little bit of a wait and see approach.

Great. Thanks very much.

(Operator Instructions). John Rowan. Sidoti & Company.

Good evening. John, did I hear you right, did you say kind of the annual run rate for the mortgage bank is going to be $15 million to $16 million?

I think that's fair if we suddenly hit our marks again that we are anticipating with the additional -- addition of National Residential.

And I guess I'm just trying to gauge here. What is the direction of the net loss and repossessed assets? Is that down along with the outlook for reduced charge-off activity in 2010? I mean do those you know tend to correlate with one another?

Or I know you guys also said, too, that some of that charge in the fourth quarter was based on reviewing some large properties in the portfolio. How much of that specifically is related to the large increase in that expense for the quarter?

We had, what'd I say, how many dollars in those three properties. We had $2.8 million in one -- .

Almost $6 million on the total in those three properties.

Yes. And of that there's only $9.8 million of remaining book value on those three properties of which 1/3 of it is contracted for sale at book here in the first quarter. (multiple speakers).

$6 million of the $7.3 million expense for loss and repossessed assets was for three properties?

Yes. Pretty good, just short of that. Yes.

So I mean realistically, the trend in that number is going to be down in the first quarter?

Absolutely in the first and I would expect it to be down for the year. The big write-down came, we got properties in at the end of the year in the previous years here so we got updated appraisals in the fourth quarter, which leads to the fourth-quarter adjustment here. So those properties are now down to a book value of $9.8 million, those specific three. And of that 1/3 of those are contracted to sell and be gone in the first quarter at their book values.

And again, John, just to reinforce [for us this year], you look at intensity we put into our FAS 114 analysis, you would hope that we are recognizing that potential loss on sale currently versus via the 114 analysis versus at the disposition of the property. And that that would be the theory, and I think that's what we are trying to adhere to.

Are there any other valuations that can come up in early 2011 that can see that number stay high or not fall by $6 million?

I don't think there's anything that we are looking at right now that we haven't already recorded.

All right. Thank you.

Chris McGratty with KBW.

John, a quick question on the small business, the accounting. Now when does that --? When is that going to take affect for you guys?

When would it take affect?

Yes. When would it take affect? (multiple speakers).

Program, Chris, we would go in on 4/1. Potentially, if we are accepted into the program.

And then, John, on the way the accounting works, assuming you hit the certain growth rates that are laid out in the document, the -- basically this is just converting TARP into another Tier 1 instrument. So would it be still below the line or would it [be] closer to the margin? How would the economics work?

It'd still maintain the same character it is right now. And again, it is 100% moved. Where we go into the program it's 100% movement of the [81.7] we currently have in the program over into the Small Business Lending Program.

Okay --

The awards may or may -- you know, the elective on whether the awards (technical difficulty).

But this would essentially eliminate the need to raise capital for prepaid TARP, that's the [arbitrage there]?

That would be the thought if we drop it down to 1%. It is probably one of the most effective or cost effective mechanisms we would have.

It pushes the date for payoff out two years. So instead of paying that off -- we still may choose to pay it off, don't get me wrong, but instead of paying it off under TARP, which was our plan by November of 2013, and this would push it out into late 2015 (multiple speakers).

YOU have time to build capital. Okay. But the net impact on TC there would be no impact. Is that correct?

That's correct. Tangible common, there would be no impact.

Okay. The other question, John, your tax rate was -- was that an [FTE] number, the 28%?

I'm sorry.

The tax rate guidance you gave before, the 28% range. That was FTE adjusted, right?

Yes it's tax equivalent. Yes that is -- yes. 28%. I may just if you look on the face of the income statement right now, tax is again -- taxable income is around 18% is in Q4, around 28% in 2011 as we look at it right now.

Okay. Thanks a lot.

(Operator Instructions). Brad Milsaps with Sandler O'Neill.

Good evening. John, just one more question, the mortgage banking. The guidance that you gave, is that exclusive of loan servicing income? That would be a separate number above and beyond the $15 million to $16 million?

It would be, yes.

I was just going to say, how do we think about the personnel line item, as it relates to that -- the mortgage banking guidance? Is it typically $1.00 of revenue, $0.50 of expenses? Is that you know historically I've kind of thought about mortgage banking, but just curious what you guys are thinking on the expense front?

I think it is going to be in that range, but I also would suggest and I was trying to allude to in my comments, this year it is going to be probably a push relative to the bottom-line impact of this addition of National Residential as we certainly are a small profit as we look to expand the operation. So we have a lot of the infrastructure in place relative to the executive personnel.

Now we need to put in the loan production offices and augment as Lynn indicated our existing franchises, as well as actually some additional loan production offices in the western United States.

The first half of the year, it is going to be a drag on earnings. And the second half of the year, we hope to make that loss back up to get to the breakeven. I think that's a good perspective as well.

But again we all acknowledge the refi bin has probably run its course. But we also think there's opportunity out there, again, as Lynn alluded to in his comments, to seize market share given the turmoil of the marketplace. And the producers are the people within that National Residential that came over have a history of doing this and we are confident they can do it again.

Brad, the reason we hadn't pursued this in the past is that in our largest metro markets which would be Phoenix, Albuquerque, Denver, and the Twin Cities, where we really have little or no production of residential real estate, we hadn't pursued it before because those markets were controlled by the brokers. And now that that competition is going to away along with some of the mortgage banking operations, it's really opened those markets up.

And this group is capable and it has been in those markets and has been very successful attracting the people that originate the mortgages. So it's a huge opportunity for us to get into markets that have a lot of volume and production that we just had not been able to penetrate before. So we really think it is an opportunity where, even though the refi boom isn't going to be fedding us in 2011, we think we can pick up substantial purchase volume.

So back to your question again, I would suggest that again as you model 2011 it's probably about a push relative to your -- salary impact relative to the overall topline growth in mortgage activity. But go forward, your $0.50 is probably a reasonable estimate.

Okay. Any other expense levers out there, John, that you guys are looking at? I know you've got the one small charter consolidation, but you guys talked about pressure on the margin, loan demand is somewhat weak. Obviously you are looking for some nice credit leverage but on the expense side, you guys have done a nice job over the last few quarters of keeping it fairly stable.

So just curious. What else are you seeing out there?

As far as overall expense leverage -- and I think it is certainly the salary and benefits line item will be [channeled] in 2011. Again primarily driven by the ad -- addition of commissions associated with the loan fees.

Beyond that, I don't think there is anything that is that unusual in the overall expansion of the noninterest expense that I would look at that would be out of line.

Great. Thank you.

John Rowan with Sidoti & Company.

I just forgot to ask. What were the regulatory capital levels? I know you probably don't have a calculator, but are they still roughly double? What they need to be.

I think that would be right in that range.

And we don't have them yet, but by and large they would be right in that range.

All right. Thank you.

Thank you. Mr. Fuller, I am showing no further questions, sir. Please go ahead with any closing remarks.

Very good. Thank you. In closing, then, 2010 was Heartland's best earnings year in the last three years. Our net interest margin of 4.12% is producing exceptional pre-tax and pre-provision earnings. Our noninterest income and strong and noninterest expense is well controlled. Our balance sheet is very liquid and well-positioned for both loan growth and, also, actually for rising interest rates. And our deposit mix has really never been better than it is right now.

We are also well positioned and eager to pursue end market acquisitions that are accretive to earnings and meet and/or exceed our M&A criteria. So in short, I feel very good about the earnings power of our Company and continue to be seeing 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 is scheduled for April 25, 2011. Thanks, again, and have a good evening, everyone.

Thank you, sir. Ladies and gentlemen, this concludes the Heartland Financial USA fourth-quarter 2010 conference call. Thank you for your participation. You may now disconnect.