Heartland Financial USA Inc (HTLF) 2011 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Heartland Financial USA first quarter conference call. During today's presentation, all party will be in a listen-only mode, and following the presentation, the conference will be open for questions.

(Operator Instructions).

I would now like to turn the call over to Leslie Loyet of the Financial Relations Board. Please go ahead, ma'am.

Thank you. Good afternoon, everyone. Thank you for joining us for the Heartland Financial USA's conference call to discuss first quarter 2011 results.

This afternoon, we distributed a copy of the press release, and hopefully, you've had all 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, EVP and Chief Credit Officer. Management will provide a brief summary of the quarter, 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 that any statements made during this presentations 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'd like to turn the call over to Lynn Fuller. Please go ahead.

Thank you, Leslie, and good afternoon, everyone. I thank everybody for joining us this afternoon as we review Heartland's performance for the first quarter of 2011. For the next few minutes, I'll touch on the highlights for the quarter. I'll then turn the call over to John Schmidt, our Chief Operating Officer and CFO, who will provide further detail on Heartland's quarterly results. Then Ken Erickson, our Executive Vice President and Chief Credit Officer, will offer insights on the status of non-performing assets and credit quality issues.

In today's earnings release, Heartland reported net income of $4.2 million, which is below the $5.3 million reported for the same quarter last year. On a per share basis, that's $0.18 per diluted share, versus $0.24 per diluted share for the same quarter last year. This quarter's earnings clearly fell short of our expectations; however, on a positive note, our pre-tax, pre-provision earnings remain strong at $15.4 million. This quarter's earnings were negatively impacted by $10 million of provision expense, which resulted from lower appraised values on a handful of previously identified impaired loans. You may recall that during the prior quarter, lower appraised values caused the write-down on OREO.

At this time, we are not identifying a lot of new problem credits; however, we are discouraged by the extremely low appraised values on our underlying collateral. On the positive side, we now have our collateral written down to a level where it's selling and selling very close to our marks. During the quarter, we sold nearly $5.3 million of OREO, and since the end of the quarter, we've contracted for sale or sold an additional $3.6 million. Ken will address this in more detail in his comments. Fortunately, we continued to benefit from an exceptional net interest margin, which reached an annualized rate of 4.19% for the quarter. That's up five basis points over one year ago and the best margin we've seen in well over a decade. We've now maintained our margin above 4% for seven consecutive quarters.

Looking at the balance sheet, assets were unchanged at $4 billion. We remain well positioned for either a prolonged low-rate scenario or a rising-rate environment. Given our asset sensitivity, rising rates would have the most favorable impact. Securities continued to represent nearly one-third of total assets, and our loan-to-deposit ratio is 77%. So, we're eagerly seeking opportunities to lend.

Much of Heartland's margin improvement is a result of core deposit growth, which has resulted in favorable changes in our deposit mix. Deposits grew by nearly $50 million over year-end, with demand deposits accounting for all the growth. Compared to last year, demand deposits are up 30%, and time deposits are down over 10%. At this point in time, demand deposits represent nearly 21% of total deposits, compared to 16% a year ago. Comparatively, time deposits represent 28%, compared to 32% last year.

Unfortunately, loan demand is not keeping pace with deposit growth. Total loans increased by $17 million in the quarter. We continue to reach out to prospective borrowers with our consultative sales approach, providing full-service, value-added proposals. I'm cautiously optimistic, as our pipeline for loans to be funded is building, especially in the Midwest. Additionally, as the economy improves, we should experience some loan growth from current clients as they advance funds on their committed lines of credit. With our special assets staff concentrating on loan work-outs and real estate sales, our business bankers and business development officers can focus all their attention on loan growth, which is this year's second highest priority, right behind our number one priority of reducing NPAs.

Well, speaking of NPAs, non-performing assets experienced a slight uptick at $126 million or just over 3% of total assets. However, if we adjust for one $3 million credit that was 90 days past due and brought current immediately after quarter-end, our NPAs would be flat. With our allowance for loan losses representing 1.83% of total loans, we believe we are properly reserved. I would also expect that further funding of the allowance should begin to ease as the economy improves, and in a few minutes, Ken Erickson will provide more detail on credit administration topics.

Well, as I indicated in January, Heartland has submitted its application to participate in the US Treasury Small Business Lending Fund. Through this program, we're confident that we can achieve not only our objective for quality loan growth but also the government's goal of making more funding available for small businesses. Subject to Treasury approval, we will have 30 days to determine participation in the program. If the decision is made to participate, we would hope to reduce the cost of our non-common equity funding -- that's the cost of our drops, TARP, and other debt -- which is currently at a rate of 4.12% on an after-tax basis.

In terms of capital, our tangible capital ratio of 5.61% is steady and remains within our target range. At present, we are sitting on approximately $43 million in cash at the holding company, and, as a result, we continue to evaluate profitable growth opportunities in nearly all of our markets. Our regulatory capital ratios of risk-based capital and tier 1 capital continue well above required levels. John Schmidt will provide more detail on balance sheet and income statement in his comments, momentarily.

As reported in our January earnings report, Heartland significantly expanded its mortgage loan origination capabilities with the addition of a mortgage banking team in Phoenix, Arizona, last year. The new unit is now fully operational in our Arizona, New Mexico, Colorado, and Montana markets. Additionally, new lending offices are now staffed in the non-Heartland markets of Austin, Texas, and Danville, California, where we are operating under the name of National Residential Mortgage. As part of his comments, John Schmidt will cover the cost impacting the Company on this expansion.

We are extremely pleased with the progress experienced by our consumer finance subsidiary. After a record-breaking year in 2010, Citizens Finance Company continued its run, earning over $600,000 in the first quarter of 2011. At the same time, Citizens' delinquency rates continue to decline. With its newest branch office in Aurora, Illinois, it brings our total locations to nine, with a plan to add one more office this year, bringing the total to 10. In concluding my comments today, I'm pleased to report at its April board meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share, payable on June 10, 2011.

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

Thanks, Lynn, and good afternoon. I'll limit my comments this again this quarter to providing 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 March 31, 2011 versus December 31, 2010.

Focusing first on the balance sheet. I would like to initially focus on the investment portfolio, as its performance has been stellar over the past three years. Evidence of this is the fact that the portfolio is still ranked in the 95th percentile of all IDC reporting holding companies. This base performance, plus the restructuring which occurred in the first quarter, has certainly contributed to our outperformance in margin. During the quarter, we swapped $150 million of treasuries into short-term premium CMOs. As a result, we enhanced the yield on the portfolio, recognized $1.2 million in gains, while only extending the duration of the portfolio from 3.94 years to 4.20 years. During the quarter, we also sold a private label Z tranche, held at the holding company, with a book value of $10,000 for a $1.4 million gain. Seven of these bonds remain, with a book value of $150,000 and market appreciation of $4.4 million.

Moving on to loans, Lynn mentioned that we saw $17 million of growth in loans and leases held to maturity. While below our expectations, I agree with Lynn that the pipeline is growing. Generally speaking, the majority of our loan growth and forecasted growth is still centered in the Midwest. While we remain focused on growing C&I loans, we would not be adverse to incrementally expanding into well-structured CRE loans. I would re-emphasize that we feel that we can grow loans by $100 million by year-end 2011.

Our tangible common equity remained essentially flat at 5.61%. Again, our stated targeted range for tangible common equity is between 5% and 6%. As I suggested last quarter, we feel even more comfortable with this range, given the Company's enhanced liquidity. During the first quarter, we issued another $3 million of our senior notes to one additional accredited investor, bringing the total to $27.5 million. Additionally, in early April, we expanded our credit facilities by $5 million, such that we now have $25 million available. Finally, we moved $15 million of the $25 million into a five-year term facility, fixed at 5.14%.

Moving on to the income statement. The margin for the quarter was a very encouraging 4.19%. This expansion of the margin is fairly remarkable, given the relatively weak loan growth in the quarter. Relative to the outperformance, we would point to the following factors. One, our diligence in reducing deposit rates, and, as importantly, the shift in mix of deposits as we have less reliance on the longer-maturity deposits through the improved investment returns. This is attributable to the investment swap I mentioned earlier, combined with better performance of the underlying securities and through the improved loan yield.

We continue to focus on properly pricing our loans. However, during the quarter, we also recorded $392,000 of adjustments through interest income, the majority of which were interest collections of loans previously in non-accrual status. Without these adjustments, the margin would have been 4.09% for the quarter. I would suggest the margin will be in the 4.10% range in the second quarter, trending closer to 4% by year-end.

Relative to non-interest income, non-interest income totaled $12.6 million during the quarter. With the exception of security gains, which have been become, in some respects, core, there are very few unusual items. Income primarily related to mortgage activity reflected the most decreases during the quarter. Specifically, loan servicing income and gain on sale loans were both down significantly for the quarter. By and large, we've seen the re-fi boom fade in our legacy markets, while the developmental efforts in the National Residential markets are still ramping up. By year-end, we would expect that these categories would at least equal last year's totals.

Focusing on non-interest expense. Total non-interest expense for the first quarter decreased by $4.4 million, as compared to the fourth, first -- fourth quarter of 2010. Major changes in the first quarter included a $1.3 million increase in salary and employee benefits and a $5.7 million decrease in net loss and repossessed assets. The increase in salaries and employee benefits had two significant contributors. One, we experienced the first full quarter of compensation expense associated with National Residential expansion, which accounted for roughly a third of this increase. Secondarily, raises for all salaries employees, which averaged 3% going into effect at the first of the year.

As I mentioned in last year -- last quarter's call, the addition of National Residential will materially impact this line item in 2011, as commissions increase consistent with mortgage production. Again, we expect this initiative to be at or near bottom-line neutral in 2011. Relative to the decrease in net loss and repossessed assets, the fourth quarter included a large number of reappraisals of ORE, which didn't occur this quarter. We continue to feel that our ORE is appropriately valued. Anticipating the items' impact in the tax rate as outlined in the press release, we would still expect our tax rate to be in the 28% range for the year.

In closing, while certainly not our best quarter, I think there are several positive takeaways, including the sustained margin, potential for loan growth, and improved parent company liquidity. With that, I'd 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 law share agreement. I'll begin by discussing the change in non-performing loans in the first quarter. As already mentioned, our non-performing loans remained flat in the first quarter, non-performing loans to include both loans off accrual and loans 90-plus days past due. At quarter end, a single credit in the amount of $3 million represented the entire amount reported as over 90 days and still accruing. This delinquency was resolved on April 6.

Excluding that credit, 14 new credits exceeding $300,000 on an individual basis were added to non-performing loans this quarter for a total of $19.3 million. The three largest credits adding to non-performing this quarter were in the amounts of $4.1 million originated by New Mexico Bank & Trust, $4 million originated by Minnesota Bank & Trust, and $3 million originated by Wisconsin Community Bank. 19 credits exceeding $300,000 on an individual basis, representing $20.7 million, were removed or had significant reductions in their non-performing balances during the first quarter. $7.2 million was transferred to other real estate, $5.2 million was charged off, while the remaining $8.3 million was resolved through payment, restoration to accrual status, or sale of the collateral. Please refer to the table within the press release that reconciles the changes in non-performing assets for the quarter.

I'll now turn the discussion to total non-performing loans. As stated in our earnings release, $53 million of the $91 million of non-performing loans resides in 25 credits where individual exposures are greater than $1 million. The release details the markets that originated these credits. The industries for these credits were also detailed within the release. The largest concentrations of these non-performing loans remain in the two categories, lessors of real estate and lot and land development. $3.1 million of our non-performing loans are covered by government guarantees through Rural Development, SBA, or FSA.

Next, I'll comment on charge-offs and provision expense. The majority of the charge-offs in the first quarter were attributed to loans originated by the following banks. $3.3 million by New Mexico Bank & Trust; $1.6 million, Arizona Bank and Trust; and $1.4 million, Riverside Community Bank. Of the $9.2 million in losses incurred by our member banks in the first quarter, the majority was incurred in the following loan categories. Non-farm, non-residential, non-owner-occupied was $2.9 million; non-farm, non-residential, owner-occupied, $1.8 million, construction land development and other land loans, $1.7 million; and C&I, $1.3 million. In the first quarter of 2011, Heartland recorded a provision expense of $10 million. With net losses of $9.4 million, the allowance increased by $600,000.

Delinquencies in each of the portfolio segments have been well managed, with no significant adverse trends identified. Our trend for 30- to 89-day delinquencies for the last six quarter-ends, beginning with December 2009, is 1.22%, 1.22%, 0.61%, 1.65%, 0.67% and this quarter, 0.61%. Regarding expected resolution of non-performing loans, I can state that our collection efforts in the second quarter are expected to result in $22 million of non-performing loans, a reduction that was recorded of March 31. Of this amount, $16 million is expected to be moved to other real estate and $5.6 million to be paid down or restored to accrual status.

Relative to other real estate, including those assets covered under loss share agreements, as shown in the table in the press release, other real estate increased by $3 million to $35 million in total in the first quarter. Total owned residential real estate, including all properties intended to be used as one- to four-family residences, is $11 million, while owned commercial or agricultural real estate is at $24 million. During the first quarter, $8.9 million was moved into other real estate, and sales resulted in $5.3 million. As of today, six properties valued at $2.4 million have already been sold this quarter, with an additional seven properties valued at $1.2 million contracted for sale and expected to close in the very near future. In the fourth quarter, we added two other real estate facilitators, one for the Midwest and one for the West-Southwest. These individuals have experience in both property management and sales. They are charged with the management and sale of the other real estate properties.

Regarding portfolio diversification, we remain well diversified in our loan portfolio; $1.7 billion or 70% of our loans are either fully or partially secured by real estate. Of the $813 million in loans categorized as non-farm, non-residential, 60% or $489 million is owner-occupied. A review of the $324 million commercial real estate non-owner-occupied portfolio at March 31 shows that $23 million of that portfolio is classified as non-performing. The $23 million is net of $4.9 million in impairments that have already been recorded as charge-offs, $4 million in the first quarter and $1 million in the prior year. As of March 31, these loans carry an impairment of $990,000. Our exposure to non-owner-occupied properties decreased by $8.6 million in the past quarter.

We also have $124.7 million in construction land and land development loans. This is down $6.5 million from last quarter. $12.6 million of this portfolio is on non-accrual. Consistent with our allowance and impairment methodologies, the expected losses on these loans have already been recorded by a charge to the allowance.

My final comments are in regards to the retail portfolio. Our retail portfolios continue to perform quite well. Losses in the first quarter on residential real estate loans were 0.88%. Foreclosures on the 11 residential properties for $1 million were completed in the first quarter. 34 foreclosures for $2.6 million of loans are currently in process. But, historically, several of these get resolved prior to the final foreclosure action.

Citizens Finance, our consumer finance company, performed well in the first quarter. Net loan outstandings are now at $51 million. Net charge-offs were 2.05%. Delinquencies were 3.56% at March 31, with only 1.19% being over 90 days past due.

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

Thank you, Ken. We'll now open the phone lines for your questions.

Thank you. We will now begin the question and answer session. (Operator Instructions). And our first question comes from the line of Jon Arfstrom with RBC Capital Markets. Please go ahead.

Thanks. Good afternoon, guys.

Hi, Jon.

Jon.

Hi, Jon.

Couple questions for you. First of all, on loan demand, I appreciate you sticking with the guidance that you laid out last quarter. Just curious where you're the most optimistic in terms of maybe geography and type of loans?

I think we'd still look to the Midwest as our primary source of new loan growth, John. Certainly, the Dubuque Bank & Trust has the probably strongest pipeline at this point.

Wisconsin. I'd add Wisconsin in that mix as well.

Yes.

Yes. We will see a pay down in Dubuque of one large credit, but even despite that, we feel that we'll see solid loan growth in Dubuque, and as Lynn mentioned, Wisconsin as well.

Minnesota is starting to see some pretty decent loan growth. Most of the Midwest locations, maybe not as much as in Rockford because of the high unemployment in that market, but the West is still slow relative to loan growth.

Okay.

Maybe touch a little bit on the ag portfolio. Obviously, it's catching a lot of national attention in terms of crop prices and land prices and just curious, since it is a little over 10% of your loan book, how do you feel about it near term, longer term, and whether or not you have any limits on that portfolio.

That portfolio has been an extremely good portfolio, very low losses, and I would credit that to the underwriting in that area. We've been very, very careful not to follow land prices up. We have typically taken all the land and the chattel and tried to keep the debt per acre to somewhere in the 2,500 to 3,000 per acre. Most of the land acquisition we see are large farm credits that are acquiring a neighbor's property, and they are having to pay up for it. You can see pricing from $5,000 an acre up to $7,000 or even higher depending on, you know, the productivity of the land, but we're not lending up to those levels.

I would echo that. We've always looked at production value of the land versus the market value, knowing that it does take what they can produce to, to service the debt, so we've always kept lower levels of what we would advance on a per-acre basis.

John, a quick question for you on the Z tranches that you talked about --

Right.

Obviously, you had some unrealized gains there. Is there any reason to wait, or is this something that you feel you need to realize to take advantage of it sooner rather than later?

No, I think what we've seen since we bought those, Jon, it's been a continued improvement, the overall placing of those Z tranches. Mel Miller, who runs our portfolio, has been the one to guide us as to when they've -- he's seen the -- the appropriate time to sell those securities, and I think we'd still defer to him. But it's really been kind of a continuous march relative to the improvement in appreciation. So as long as that continues, I think we're still in the mind to hold them.

Okay.

Yes, I would just add, Jon, you know, I think Mel figures that he should maybe take a little bit off the table as we go forward, in case we would see values come back on those securities, so I think he's prudently taken a little bit off the table as we go along.

And I think that really has been his motivation to sell to this point. It's not that he thought there was an inflection point relative to those securities, but rather than keeping all your eggs in one basket, he thought it appropriate, as Lynn suggested, take some of that off the table. But again, I think we'd still defer to him as to when he'll be selling the majority of these securities.

If there's an adverse change, maybe just to complete that thought, if there's an adverse change in that, for whatever reason, he wouldn't be adverse to selling them all at one time, either.

That's a high-class problem. Good problem.

I wish we had a few more of those.

\And then, Ken, just one question for you, more general in nature on credit. Any change in the theme on the inflow of NTLs than what you were seeing a few quarters ago?

I would say that there is, Jon. We had a couple this quarter of larger dollar size, but they were on our radar. Just certain events caused them to come into non-performing in this quarter. But I think I said in the last couple of quarters, there seems to be more time in between, and usually they're smaller. I'd mentioned our two real estate portfolios specifically today, just to let you know that they continue to reduce in size. There's problems yet in both of those portfolios sitting in non-performing loans, but we recognize the losses that are visible in both of those at this time. So it does seem like it's getting better, but you're -- in this economy, you're still cautiously optimistic.

All right. Thanks a lot.

Thank you. And our next question comes from the line of John Rowan with Sidoti & Company. Please go ahead.

Good afternoon, guys.

Hi, John.

Lynn, I was kind of on and off before, but what were you saying about the cost of your cust preferreds going down?

Yes, I was referring to our non-common funding sources, which would be [trups] --TARPs and other debt, and that averages about 4.12% on an after-tax basis. And so to the extent that we would convert the $81 million in TARP over to the Small Business Loan Fund, you could see that cost continue to go down. We have put in swaps to fix the rate, as well as the debt that we took on as fixed -- a good portion is fixed for five years. So, we felt it was important to try to fix the cost on the non-equity funding piece, as long as the rates have been so darn low.

How much of a basis point pick up could you get going down?

Well, if the $81 million goes from an after-tax cost of -- call it 5% down to one, I haven't calculated that, but that would be pretty significant.

So, it can go down 400 basis points?

Well, yes. Under the, you know, we don't know yet if we're going to get approved for the Small Business Loan Fund program, and if we do get approved, if the rules are going to stay the same, you know, then we probably would participate. If they continue to fool around with it, that's still a question. But yes, you've got $81 million that you could potentially move from 5% down to 1%.

Okay. And --

40% of our total, John, could go down, thereabouts. If that goes down from 5% down to 1%, as soon as we hit that $100 million mark. You can do the math from there. That's where we'd trend down.

Again, that's -- you recall how that goes down. It's -- you don't get the full benefit until you get down to that $400 million growth to get to that 1%. I think last year -- last quarter, we suggested with our current growth we thought the rate would be somewhere around 4.56%.

Okay.

As it sits now.

As it sits right now.

Again, the qualifying -- the qualifying loans right now are about at $30 million to $35 million, and we've got to achieve $100 million to get all the way down to 1%. So -- and it's only those dollars that are in qualifying loans that get a reduction on the rate. So we can give you that effective cost -- you know, John can get that and get back to you on that.

Okay.

I was a little surprised to see the mortgage banking line as low as it was. Obviously, you guys had given in some guidance at the end of the last quarter that seems to be substantially higher. Was it a particular month that was weak, or how should we think about that line, going forward?

I think March was, as you might have guessed, John, was probably the weakest month. Again, you saw some carry over from 2010 into 2011. So the re-fi boom, as I mentioned, really has, to a great extent, come to a -- not a screeching halt, but certainly we've seen a lot of reduction in that.

So what we're anticipating is the transition from the re-fi activity into a purchase activity that really will be, in large part, driven by National Residential. We're still putting that entire framework into place. You heard the offices that are currently open, but that's taking some time to ramp up, as you might guess. There's been a lot of transition going on in the mortgage market in total, relative to overtime hours, relative to commission structure, et cetera, all of which we've fully anticipated. At the same time, we've instituted or implemented a lot of additional infrastructure, to include a new mortgage production system and also a hedging vehicle to the secondary market.

All that said, I think we really have some -- a very solid footing relative to additional mortgage production for the rest of the year. But again, it's going to be a switch from re-fi into purchase.

Okay. But you said -- did you say that the total for that line might be what it was in 2010, so implying around $8.1 million?

Yes, we do anticipate that, getting back to that. Again, a variety of factors in place, but that would be what we would still anticipate.

Okay, and just one last --

The implementation of National Residential is probably running a little behind, given all the factors I've talked about. But they're ramping up quickly now, and we're still -- still would guide towards that number of equalling last year's numbers.

Okay.

And just one last question. Where did the regulatory ratios finish the quarter? I know Lynn said that they remained strong. Were they still roughly double what they need to be, or --

Yes, they really haven't transitioned much, John, from where they were. All the numbers aren't finally in yet, but -- given the aggregation of all the charters. But right now, they would run really consistent with where they were last quarter.

Okay. All right. Thank you.

Thank you. And our next question comes from the line of Chris Mcgratty with KBW. Please go ahead.

Good afternoon, guys.

Hi, Chris.

John, can you -- maybe I missed it. What's the -- in the whole securities book, what's the unrealized gains or loss position in aggregate? I mean, how much more security gains could you rely on?

Overall, it's about -- just short of $13 million of appreciation in that portfolio, Chris.

Okay.

Again, you know, that's -- we're not necessarily in there for gains trading, but for a variety of reasons. It's -- we'd like to reposition the portfolio where appropriate, and what we had done this quarter was sell off $150 million of treasuries and moved into those, as I've said, the shorter-term CMOs. Just felt that was the appropriate play and recognized the gains at that point.

Sure.

The Z tranche really being a separate issue, and we've really been through that. So, where appropriate, we'll recognize the gains, but we're also, obviously, relying on that portfolio to enhance our margin on a go-forward basis.

Sure.

And on the, on the capital -- on the capital front, to the extent that the rules are changed on the SDLF, I guess maybe, [Jack], you talk your -- kind of your contingent capital plan if the lawmakers change the, change the plan.

Well, if the program goes by the wayside, which -- I don't know where it is right now. I think we hear a lot of discussion back and forth relative to potential amendments, et cetera, so that jury's still out at this juncture. If that doesn't come through, then I think we'd look back then to what we have talked about historically, is that we would still look to pay off TARP by 2013, when the rate goes from 5% to 9%. And that would be generally done through the -- really, the debt we have currently in place plus enhanced performance of Heartland on a go-forward basis.

Okay. So in the event that they change the rules, you still, you kind of -- you view that a capital raise wouldn't necessarily be necessary?

We don't see that right now. No, we don't, Chris.

Okay.

Again, the only -- what we've framed out, generally speaking, and very consistently, though, is that we look to a capital raise only when there's a very accretive acquisition that sits before us that we think we can -- would make sense to the Company as a whole, including our shareholders, obviously.

And then the TARP rate, could you do repayment in tranches, though, right? Or would you do it all in one swoop?

We -- absolutely. I mean, we could do in tranches, if we'd elected to do so.

Okay. And then on the --

I'm sorry. And then your question on the -- on your comment on the deals. What do you guys see in terms of flow from in the Midwest markets or maybe your Arizona markets?

I'd still say the activity is -- the overall, relatively remarkable as to the activity that's out there. It seems like a week doesn't go by that we aren't approached by at least one if not two potential acquisitions that we are studying very closely and then looking at the alternatives right now.

I would say not as much in Arizona. We see more probably in Minnesota, Colorado. Some in the Midwest as well.

And then in terms of size, what would be that kind of trip point for you guys to say, we need to raise capital --

Everything else being equal, think anything over $100 million, we'd have to raise -- we'd have do a capital raise.

Okay. That's helpful. Thanks a lot, guys.

Chris, one thing I might add to John's comment is that if we do convert out of TARP into the Small Business Loan Fund, then I think pre-payment of that is not likely, as long as we're able to achieve the required growth in qualifying small business loans. With the cost of that going down to 1%, it's just -- it doesn't seem to make a lot of sense to be issuing stock or pre-paying that.

And our next question comes from the line of Brad Milsaps with Sandler O'Neill & Partners. Please go ahead.

Hi, good afternoon.

Brad.

Hi, Brad.

John, I just wanted to go back to some comments you made regarding the margin. I think you mentioned there was about $392,000 of additional interest income this quarter that you recaptured. Is that the right number?

That's correct.

Okay.

And then, in regards to your guidance, you said, you know, maybe 4.1% in the second quarter, then 4% by the end of the year. And I've asked this previously, just curious on the CDs. They're flat on a link quarter basis -- actually, maybe the retail CDs were up a basis point. Just curious on what the repricing looks like there, and kind of how that fits with your margin guidance. You know, they're still up above 250 basis points. It just seems like you've got a tremendous amount of room there to bring those lower.

Yes, we have some room. The CD book in the next six months, I think there's $280-some million dollars of CDs coming off of 174. If -- everything else being equal, the reprice range would probably be in the 1% range. And again, we still match that up with, you know, maturing investment portfolio, et cetera, so that's why we'd probably guide again toward that relatively stable 4.1% in Q2, but still trending down towards 4%. We also have some additional carry on that fixed debt I mentioned, Brad. We took down $15 million of term debt, five years at that 5.14. So we went from $5 million of revolver we had out and moved that out to $15 million, so we have incrementally $10 million of additional debt at 5.14%. So those -- all those factors together suggest that we'll -- you know, the margin, I think will hold in fairly tight in Q2, trending down toward 4% by year-end.

Brad, what I've noticed over the last few months is that we're seeing somewhere around $40 million to $45 million in CDs maturing and renewing, and we're getting a cost savings of anywhere from 60 to 70 basis points on that.

And the other -- I think the point to be made too in this, Brad, it's hard to tell from the SEC reports, but by and large, I think our CD book has a longer maturity than most of our peer group, such that that does drive up the rates. And I think that's the general trend in the legacy markets, that they like the longer-term CD. They're probably reaching for yield, so that does push it out a little bit as far as the overall costs.

Okay.

And John, on the expense side, do you have some other levers that you kind of see right now that you could pull in case the revenue doesn't come through as you guys expect? I mean, I kind of look at your pre-credit cost earnings, you know, you're down, obviously, from the fourth quarter related to mortgage. But even year-over-year, I'm just curious kind of what your thoughts are on kind of making up for that, for that gap. You know, maybe as it relates to expenses.

I think, you know, you're still -- in many respects, we're still a growing franchise. And I think, obviously, that we're all looking at bottom line, but by the same token, we're building that top line and the infrastructure we're putting in place right now, as far as National Residential is -- it's a fairly large investment in that. So that's, that's certainly, you know, one thing to think about, and one thing we think about, but again, that's a longer term build. We need to build that top line, Brad, and that's what we're focused on.

You know, what's the longer-term solution? Certainly, we have a lot of investment in special assets and other real estate personnel. The costs associated with that, the legal costs, et cetera, that we're working through, that are concerning earnings in the short-term. That won't go on forever in the numbers that Ken, you know, indicated. Hopefully, we're starting to see that trend go down such that that tug will start to diminish as we go forward, as well.

At the same time, we evaluate our infrastructure all the time. We realize that the margin is -- has been very solid. We incurred the duration, that Lynn made in his comments, but by the same token, we realize that that's something that we -- whereas we would like to count on it, we also need to understand that there will be some talk on that at the same time. So we make sure that we have the best alignment of personnel that we can, and that's an ongoing analysis.

Okay.

And then just a final question for Ken. I was curious what the TDR balance was at March 31 and how you guys sort of feel about the new accounting treatment or some of the commentary out there regarding that. Kind of how you guys handle TDRs versus maybe the new way to look at those going forward?

I don't have that number in front of me, but it's roughly $30 million. It didn't change much over the previous quarter.

We're certainly glad that they backed off some from what their original discussion was and what could be a TDR. I think the transactions that we have seen were -- that would qualify -- need to be qualified as a TDR in the past, doesn't seem like they fit fixing the problems in our portfolio. We've been more to collect the amount rather than to restructure with the type of credit problems that we've had. Didn't seem to be the ones to fit mostly around debt restructure.

We are monitoring it very closely. We are, we've -- we're going to be very careful about putting anything in the TDR, so I guess we'll see that in the next quarter or two, but I don't see a huge increase in TDRs. I guess that's a long-winded answer, but I don't see that we'll have a big increase to that with the way that we approach credit.

It's still about 30 million bucks.

Right.

Okay. Great. Thank you.

Thank you. (Operator Instructions). And our next question comes from the line of Stephen Geyen with Stifel Nicolaus. Please go ahead.

Yes. Good afternoon, guys. How are you today?

Hi, Stephen.

Maybe just a question or two for Ken. Ken, if you could maybe give us some thoughts on kind of what your' re seeing in non-accrual loans in the commercial real estate and C&D (inaudible).

In those specific segments?

Yes.

I would say it's relatively flat. I mentioned early in my comments that we had some new credits that came into non-performing, about the same dollar amount that came out. Our highest concentrations are still in -- of problem loans are still in the same two categories that were the quarter before. I'm looking at my notes on those.

They're still in the land development, is part of it, but we are down to $124 million, I believe I said, in total in that category. We've looked at those on an individual basis every quarter and have reason to believe the majority of those are going to be performing loans, long-term. So I think we've -- as of the current period, we've flushed through the problems in there. If we have continued delays in growth in some of the markets, we will see some additional problems come up in there. But all in all, feel that we've got the problems in front of us today.

Okay. That answers my question. Thank you.

Thank you. (Operator Instructions). Our next question comes from the line of Daniel Cardenas with Raymond James. Please go ahead

Good afternoon, gentlemen.

Hi, Dan.

Dan.

Quick question on the FDA. Your insurance costs for the quarter -- wow should we be thinking about that going forward? Is there room for that number to come down?

Dan, we're having trouble hearing you. Could you repeat the question, please?

All right. Sorry about that. How about now, can you hear me?

It's better.

All right. How should we be thinking about your FDIC insurance costs going forward? Is there room for that number to come down?

Yes, I think we see that incrementally going down. It's not a huge number, but I think that will be trending down on a go-forward basis.

And then if you could just remind me on TDRs, your thoughts. Is it once a TDR, always a TDR, or is it 12 months of performance and then off? What's kind of your rule of thumb?

If the concession was a rate concession, it's on there until the note matures. If it was a non-rate concession, it comes off at the end of -- after the end of the calendar year.

Okay. Great. Thank you.

Dan, just to answer -- just relatively speaking on the FDIC, I think we'd see that trending down by about $1 million year-over-year.

Okay. Great. Thanks a lot.

Thank you. And Mr. Fuller, there are no further questions at this time.

And maybe I can make one more comment relative to Brad Milsap's comments. The other thing that occurs to me, relative to looking at costs, we certainly have looked at all our vendor costs and undertaken a very significant renegotiation on several contracts, which we feel will materially reduce some of the costs carried or originally materially by as much as $1 million a year, probably in aggregate now. So we -- again, coming back to the overall comment, we're looking at every category to see where we can, again, make sure we have an optimal configuration for this Company on a go-forward basis.

Great. Thank you, John.

In conclusion, I'll share my comments. Heartland continues to produce solid operating income, as we said, fueled by a very strong net interest margin of 4.19%. We continue to improve the composition of our balance sheet with high-quality short-term securities and low-cost core deposit growth. With $43 million in cash sitting at the holding company, we're looking at profitable growth opportunities in nearly all of our markets. As we manage down our non-performing assets, we're actively seeking to make new loans to credit-worthy borrowers, and I continue to feel very positive about the earnings power of our Company and continue to see excellent opportunities ahead.

I'd like to take this opportunity to invite our shareholders and analysts on this call to attend our annual meeting of shareholders, which will be held next month on Wednesday, May 18, 6.00 PM Central Time, at the Grand River Center in Dubuque. I hope we can see you there. Look forward to seeing all of you.

And then in closing, 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 on July 25, 2011. Thanks again, and have a good evening, everyone.

Ladies and gentlemen, this concludes the Heartland Financial USA first quarter conference call. You may now disconnect, and thank you for using AT&T conferencing.