Heartland Financial USA Inc (HTLF) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, thank you for standing by. Welcome to the Heartland Financial USA second-quarter conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions.

(Operator Instructions)

I would now like to turn the conference over to Ms. Leslie Loreto of the Financial Relations Board. Please go ahead.

Good afternoon, everyone, and thank you for joining us on the Heartland Financial USA's conference call to discuss second-quarter 2011 results. This afternoon we distributed a copy of the press release and hopefully you've all had a chance to review it. 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 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 statements -- any statements made during this presentation regarding the Company's hopes, beliefs, expectations, or predictions of the future are forward-looking statements, and actual results could differ materially from those projected. Additional information on these factors is included from time to time in the Company's 10-K and 10-Q filings which can be obtained on the Company's website or the SEC's website. At this time, I would like to turn the call over to Lynn Fuller. Please go ahead.

Thank you, Leslie, and good afternoon, everyone. We certainly thank everyone for joining us this summer afternoon as we review Heartland's performance for the second quarter of 2011. For the next few minutes I will touch on the highlights for the quarter. I will then turn the call over to John Schmidt, our Chief Operating Officer and CFO, who will provide further detail on Heartland's quarterly results; then Ken Erickson, our Executive Vice President and Chief Credit Officer, will offer insights on the status of our nonperforming assets and credit quality. Well, I'm pleased to open my remarks this afternoon on a very positive note with Heartland reporting its best quarter ever.

In today's earnings release, Heartland announced record net income of $10.2 million, doubling last year's second-quarter earnings of $5.1 million. Annualized return on average common equity for the 6 months was 9.28%. The Company's exceptional performance is a result of continued improvement in our net interest margin, a sharp drop in provision for loan losses, and 4.8 million in security gains. I think it's important to note that we were able to realize these gains while generally maintaining both portfolio yield and duration.

On a per share basis, Heartland earned $0.54 per diluted common share compared to $0.23 per diluted common share in the second quarter 2010 and $0.18 in the first quarter this year. Year to date, net income was solid at $14.4 million, or $0.71 per common share compared to $10.4 million, or $0.47 per common share for the first half of 2010. Net interest margin expanded again in the second quarter, thanks to improvement on both sides of the balance sheet. Margin reached 4.23%, up 4 basis points over Q1.

We've now maintained our margin above 4% for 8 consecutive quarters. For those of you that follow Heartland, you know that reduction of nonperforming assets has been our number one priority for several quarters. During the second quarter, we saw marked improvement in this measure as a number of problem credits were resolved and other real estate was sold, which resulted in a $19 million reduction in nonperformers, or a 15% drop compared to the linked quarter. With this reduction, nonperforming assets now represents 2.67% of total assets. As a result, even with an allowance for loan loss reduction of $3 million during the quarter, our allowance as a percent of nonperforming loans has increased to 60%. While we're far from satisfied, we're very pleased to see the significant improvement.

At this time, we're not identifying a lot of new problem credits, and 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 $4.8 million of OREO, and since the end of the quarter, we've contracted for sale or sold an additional $3.9 million. Ken Erickson will give you more detail in his comments.

While looking at the balance sheet, total assets remained unchanged at $4 billion. Year to date, loans have been pretty flat, primarily due to portfolio reductions from credits which have been either collected or moved out and large payoffs. As a result, loan growth during the first half of the year was difficult. However, we are beginning to see pipelines improve in most of our markets.

The Midwest markets are stronger than the Western markets at this time, although we do see improvement out West. Securities still represent 30% of total assets and, for the next several quarters, we intend to shift the mix from securities toward loans. In pursuit of our second-highest priority, quality loan growth, we are intensifying our calling efforts and reaching out to potential borrowers in every Heartland market. As we mentioned in previous calls, Heartland has submitted its application to participate in the US Treasury Small Business Lending Fund. We are hopeful that news on Heartland's application will be forthcoming soon. If approval is received and the decision is made to participate, we would hope to reduce the cost of our noncommon equity funding -- that's TruPS, TARP and other debt, most of which is currently fixed at 4.1% on an after-tax basis.

Shifting now to deposits, Heartland's margin continues to benefit from favorable changes in deposit mix. Deposits grew by over $46 million since year end with demand deposits growing by nearly $70 million. Compared to last year, demand deposits are up 21%, and time deposits are actually down 6%. At June 30, demand deposits represented over 21% of total deposits compared with 18% a year ago. Time deposits now represent only 28% of total deposits compared to 31% last year.

In terms of capital, our tangible capital ratio increased appreciably in the quarter to 5.92%, near the upper end of our target range of 5% to 6%. The 31-basis-point increase over Q1 can be attributed to our healthy earnings, our unrealized gain position in our investment portfolio, and our stable asset size. At present, we're sitting on approximately $30 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 our branch balance sheet and income statement in his comments momentarily.

Our mortgage loan origination strategy continues to ramp up with the opening of a lending office in Austin, Texas, during the quarter. Our team is actively pursuing additional locations in Midwestern and Western cities, where we can combine top talent with a healthy and growing market. In every location outside of the Heartland footprint, we are operating under the name of National Residential Mortgage. Our consumer finance subsidiary, Citizens Finance Company, continued at an impressive pace in the second quarter. Citizens earned $622,000 in Q2, bringing its year-to-date earnings contribution to $1.223 million. At the same time, Citizens' delinquency rates continued to decline, both year to date and year over year, currently at 3.82% year to date. With its newest branch office in Aurora, Illinois, it brings our total locations to 9; with the plan to add an office in Peoria, Illinois this year, we will have 10 locations, all in the Midwest.

In concluding my comments today, I'm pleased to report that, at its July Board meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share, payable on September 9, 2011. I will now turn the call over to John Schmidt for more detail on our quarterly results; and then John will introduce Ken Erickson, who will provide commentary on credit quality and real estate exposure. John?

Thanks, Lynn, and good afternoon. I will focus my comments on the most significant areas of change in the balance sheet and income statement for the past quarter, 6/30/2011 versus 3/31/2011. Before proceeding, I would certainly like to reiterate Lynn's suggestion that, by almost every metric, the second quarter was a very good quarter for Heartland.

Starting with the balance sheet, last quarter I discussed the stellar performance of the investment portfolio, which, in retrospect, was really a precursor of the second quarter. During the quarter, $4.8 million of gains were realized, appreciation in the portfolio increased to $22.5 million, while the portfolio yield decreased by just 8 basis points. I think it's important to note that the gains reflected in the second quarter do not include any of the [Zetron] securities I mentioned last quarter.

As a final point on the securities portfolio, $65 million of 4- to 5-year agencies were sold in the latter part of June in anticipation of reinvesting in 10-year treasuries and short-term CMOs. The subsequent reinvestment was completed early in July, thereby reducing our cash position and moving our securities to total assets back to the 32% level. This swap, which only modestly impacted the duration of the portfolio, was a fresh way to reduce the exposure the Company might have in a flat-yield curve environment.

Moving on to loans, Lynn mentioned that loans decreased by $8.8 million, which included a payoff of a $40 million credit. Additionally, considering the combination of charge-offs and the movement of loans into ORE which totaled $17.5 million, loans would increase by $58 million during the quarter. While loan production is still somewhat spotty, we are feeling more confident. Our internal estimate currently indicates production in excess of $100 million by year-end 2011. As discussed last quarter, we still expect the majority of our loan growth will be centered in the Midwest.

Moving on to the income statement, the margin for the quarter of 4.23% reflects the second highest ever recorded by the Company and has held up even better than we had anticipated, especially considering the lack of loan growth. I would suggest that the margin will be in the 4.15% range in the third quarter, still trending closer to 4% by year end. Relative to noninterest income, noninterest income totaled $14.7 million for the second quarter. Excluding security gains in both quarters, noninterest income decreased $600,000 quarter over quarter. This decrease had 2 primary components -- mortgage production, or the lack thereof; and the collection of a previously charged-off covered credit relative to Elizabeth State Bank, FDIC-assisted transaction. Relative to the mortgage production, loan servicing income and gains and sale loans decreased by $345,000 in total.

I mentioned last quarter that we've seen the refi boom fade in our legacy markets, while the developmental efforts in the national residential markets are still ramping up. This continues and now has impacted the loan servicing income as we've seen mortgages pay down or pay off faster than we've been able to replace them. We anticipate a 50% increase in production in this area for the last 6 months of the year, which suggests a total of $450 million for all of 2011. While certainly below last year's total of $694 million, we are very satisfied with the infrastructure that has been built in the last 7 months. And, as a result, we feel very comfortable that 2012 will reflect substantially enhanced production. The recovery of the previously charged-off covered credits is shown as a reduction in other noninterest income reflecting the payment to the FDIC. Excluding this, other noninterest income would have been $309,000 for the quarter.

Focusing on noninterest expense, total noninterest expense for the second quarter decreased by $500,000 as compared to the first quarter of 2011. Major changes in the second quarter included a $700,000 decrease in salaries and employee benefits, a $600,000 decrease in FDIC insurance costs, and a $900,000 increase in the net loss and repossessed assets. The decrease in salaries and employee benefits was driven by the reduction of expenses associated with annual executive life premiums, life expenses, and employment taxes experienced in the first quarter. As mentioned previously, we fully expect mortgage production to increase in the second half of the year, along with the associated increase in commission expense.

Relative to the increase in net loss from repossessed assets, the second quarter included write-downs on properties in our Rocky Mountain, New Mexico, and Riverside markets. The efficiency ratio for the quarter was 67.53%, which would seem somewhat high. However, on a normalized basis, excluding the net loss in repossessed assets, this ratio decreases to 62.9%. Additionally, the net loss associated with the 2 de novos Heartland is currently carrying, along with the start-up cost of National Residential, reduces this ratio to slightly under 60%.

Given the high level of income before tax, the effective tax rate increased this quarter as the amount of tax exempt income as a percent of total income decreased. Additionally, the first quarter included realization of some tax credits. We would still expect our tax rate to be around 30% for the remainder of the year.

In closing, the second quarter was the best quarter Heartland has experienced on a gross basis and one of the best when buying gains and TARP payments are excluded. We feel that the sustained margin, potential for loan growth and reduction in nonperforming loans bodes well for the Company. With that, I would like to turn it over to Ken Erickson, our Executive Vice President and Chief Credit Officer.

Thank you, John, and good afternoon. Except for a summer cold, all else appears to be going as planned. All of my comments this afternoon, unless otherwise stated, will be exclusive of those assets covered under the loss share agreement. I will begin by discussing the change in nonperforming loans in the second quarter.

As already mentioned, Heartland achieved a $23 million reduction in nonperforming loans in the second quarter. 6 new credits that exceeded $300,000 on an individual basis were added to nonperforming loans this quarter for a total of $6.7 million. Out of those 6 -- 2 credits totaling $2.7 million were originated by New Mexico Bank and Trust; 2 credits totaling $2.1 million were originated by Rocky Mountain Bank; and 1 credit in the amount of $1.4 million by Arizona Bank & Trust. 19 credits exceeding $300,000 on an individual basis representing $20.2 million were removed or had significant reductions in their nonperforming balances during the second quarter. $10.3 million was transferred to other real estate, $3.9 million was charged off, while the remaining $5.2 million was resolved through payment restoration to accrual status or sale of collateral. Please refer to the 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, $38.1 million of the $68.1 million of nonperforming loans resides in 21 credits where individual exposures are greater than $1 million. The release details the markets that originated these credits. The nonperforming loans greater than $1 million are down $14.9 million from last quarter. The industry for these credits were also detailed within the release. The largest concentration within these nonperforming loans is in lot and land development, which represents 25.2% of the $38.1 million. $3.5 million of our nonperforming loans are covered by government guarantees through a rural involvement FDA or FFA.

Next I'll comment on charge-offs and provision expense. The majority of the charge-offs in the second quarter were attributed to loans originated by the following banks -- $2.5 million by New Mexico Bank & Trust; $1.2 million by Arizona Bank; and $1.2 million by Rocky Mountain Bank. Out of the $6.7 million in losses incurred by our member banks, in the second quarter of 2011, the majority was incurred in the following loan categories -- construction, land development and other land loans, $2.9 million; nonfarm, nonresidential owner-occupied, $932,000. No other categories exceeded $600,000.

In the second quarter of 2011, Heartland recorded a provision expense of $3.8 million; with net losses of $6.5 million, the allowance decreased by $2.7 million. This is primarily attributed to a $2.1 million charge-off of an impairment for a specific loan that had been established in the fourth quarter of last year. Delinquencies in each of the portfolio segments have been well managed, with no significant adverse trends identified. The trend of 30- to 89-day delinquencies for the last 6 quarter ends, beginning with March of 2010, was detailed in the earnings release. Regarding expected resolution of the nonperforming loans, I can state that our collection efforts in the third quarter are expected to result in a reduction of $13.8 million of the nonperforming loans recorded at June 30. Of this amount, $9 million is expected to be moved to other real estate, and $4.9 million to be paid down or restored to accrual status.

Relative to other real estate, including those assets under loss share agreement, as shown in the table inserted into the press release, other real-estate increased by $4 million to $39 million in the second quarter. Total owned residential real estate, including all properties intended to be used as 1- to 4-family residences, is $10.8 million, while owned commercial or agricultural real estate is $28.2 million.

During the second quarter, $10.9 million was moved into other real estate. Sales resulted in $4.8 million while ORE write-downs were in the amount of $2.1 million. Since the end of the second quarter, $3.9 million of other real estate has already been sold or contracted for sale with closing expected in the third quarter. Regarding our portfolio diversification, we do remain well diversified, $1.7 billion of our -- or 70% of our loans are either full or partially secured by real estate. Of the $806 million in loans categorized as nonfarm/nonresidential, 61%, or $491 million, is owner occupied.

A review of the $316 million commercial real estate nonowner-occupied portfolio at June 30 shows that $14 million of this portfolio was classified as nonperfoming. As of June 30, these loans carry an impairment of $999,000. Our exposure to nonowner-occupied properties decreased by $8.4 million in the past quarter. We have a total of $123 million in construction, land and land development loans. $10 million of this portfolio segment is on nonaccrual. Staying 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 will be directed at our retail portfolio and future initiatives. Our retail portfolios continued to perform quite well. Losses in the second quarter for residential real estate were at 0.9%. Foreclosures on 6 residential properties, totaling $842,000, were completed in the second quarter. 33 foreclosures on $2.1 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 second quarter. Net loan outstandings are now at $53.4 million. Net charge-offs year to date are 2.19%. Delinquencies were 3.7% at June 30, with only 1.08% being over 90 days past due. Citizens' year-to-date earnings were $1.2 million.

As we continue to work towards improved credit quality, we are also looking to the future in assessing how we can improve efficiencies and our customers' experience. We are in the process of adding a small business underwriting unit to our credit administration department so as to better serve this attractive business segment. To provide our bankers with more time for outside calling, we are also taking steps to reposition work flows and remove redundant and clerical tasks from their daily routine. Our business bankers will continue to dedicate themselves to a value-added consultative role to their customers. With that, I'll turn the call back to you, Lynn, and remain available for questions.

Thank you, Ken. Now we'll open the phone lines for your questions.

Thank you, sir. (Operator Instructions) And our first question is from the line of Jeff Arfstrom with RBC Capital Markets.

It's Jon Arfstrom.

Hi, Jon.

Nice job this quarter.

Thank you.

Question, Ken and Lynn, you both referred to Midwestern growth being the strongest in terms of the lending outlook, but you also talked a little bit about some signs of life in the west, and I'm wondering if you could specifically talk about what you're seeing in the west.

Well, I guess I talked about it first, and Ken can follow up. But clearly, in the first half of the year, we were seeing more production out of the Midwest banks, and they continue to see a little better economic environments than our western banks, although in talking with our Presidents out west in Montana, Denver, Colorado, New Mexico, and Arizona, they are starting to see some things pick up.

Part of that is, the economies out there tend to be recovering a bit. They're not strong, but they are recovering a bit, and we really picked up our calling efforts. We've had some new hires in those banks that are pretty skilled commercial bankers, and they're spending most of their time on the Street calling on prospects that we've targeted.

Jon -- go ahead, Ken.

And I don't think I have anything to add to that. It's increased calling efforts, some additional personnel added in a couple of those locations.

And still, the majority Jon, we're anticipating a majority of production still to be in the Midwest versus the West.

Right, right, okay. The other thing I guess I wanted to talk about, maybe Ken, the -- you talked a little bit about some of the OREO dispositions, and I think those are pretty good trends you're talking about. Obviously, we'd like to see things move out of nonperforming loans into OREO. But wondered if you could reflect and talk to us about, what is the OREO disposition like in terms of pricing today versus maybe what we saw a year ago? That would be part one, and then part two is it looks like the OREO balances might be up against next quarter. I'm curious how aggressive you might be starting to work these down.

Okay. I would say overall we've seen ORE prices in the market now compared to a year ago, they've got to be down, but not as much as they were in the 12 months prior to that. So, as Lynn mentioned, the sales that we've seen over the last three to four months have been very close to what our marks are. There was one ORE write-down that accounted for about 50% of what we had, but that wasn't upon a sale. That was upon some updated valuation on a partially completed property that we got back. So, it was kind of an aberration on there.

As far as ORE pickup in the third quarter, I too think that we might end the third quarter with a higher balance than we are entering into it. We've got about $4 million sold, but I expect $8 million to $9 million to move in there this quarter. Naturally we've got another couple of quarter -- couple of months to still see some properties sold out of there. So, will we see the full $4 million to $5 million increase? Hopefully not.

As far as getting aggressive, we have talked internally of utilizing that online auction service that we had employed last year in the fourth quarter. We're looking, should we move some of our properties into that and attempt to move some properties out in the fourth quarter selectively? So, that's still a question we have on the table internally. We'll review that when we get into mid-August probably, and if we make that decision, we'll move those properties forward here at the end of the third quarter so they're ready to be marketed and sold during the fourth quarter.

And I'd just add that we are pricing the property to move. These appraisals that have come in over the last 12 months quarter by quarter have been pretty severe, and so you feel like you're giving this stuff away. Some of it is marked down to 30% of its original value or even less in some cases. So, we are aggressively looking to move the stuff, and we're having success over the last couple quarters.

All that being said, I don't think we want to have a fire sale, either. We have the capacity to carry it. We're selling it at our current marks. And we've thought about it. A lot of these investors are looking to get a 20% to 30% internal rate of return, and we feel that our shareholders should be able to see some of that as well.

We're seeing some gains, too. We're moving some of this stuff at prices that are better than what recent appraisals came in at, so.

You think about the logic of the appraisals, many times the appraisals may have a 10-year absorption period whereas we're selling them currently. So, that's obviously resulting in the gain.

And finding good comps is not always the easiest, either. So, that's in part what some of these appraisals are coming in so low, because they just don't have good comps.

Okay, great, makes sense. Thanks, guys.

Thank you. And our next question is from the line of Chris McGratty with KBW. Please go ahead. Sir, your line is open. Our next question is from the line of Jeff Davis with Guggenheim Partners.

Good afternoon. Couple of questions. The -- this quarter, eight of the nine banks made money. Is it -- are we -- it safe to say that for maybe Arizona and perhaps Rocky Mountain that the corner's been turned? And if not on a quarterly basis, then on an annual basis where these banks will be solidly in the black going forward?

I think we're getting to that inflection point, Jeff. Rocky Mountain, I think certainly. That's obviously an established bank. They've gone through some challenging times, but we're seeing the credit quality pick up there pretty significantly. Arizona, I think the core of operations are improving and will continue to improve.

As Lynn mentioned the market has been stabilized out there to a great extent. So, I think that has certainly -- has helped and I think will improve the overall performance of (inaudible) going forward. I think we have -- well, we feel to very capable management there, as Lynn also indicated, we're bringing on additional talent in Arizona. So, hopefully we're at that inflection point.

I think as we look back a couple years where the de novos and Arizona were dragging heavily on us, printing a lot of red ink, we just don't see that going forward. We may have small losses, given a quarter here and there, but we're certainly not going to have to be carrying heavy losses at those banks.

Yes, and that's what I was trying to get at, Lynn. Okay. And--?

Hey, Jeff, one additional point too on those banks. There was some security gains in those banks as well that was picked up that certainly helped for the quarter. But I think my comments still hold on both Rocky Mountain and on Arizona.

Right, okay. And same true for Summit? I realize, it's not as big, but.

Yes. Summit isn't as big, and I think we're still in the ramp-up period. It's really only that the -- almost through the five-year ramp-up on Summit, and we've had some challenges in that market, but it's still in some respects in that de novo status.

Minnesota is very, very close to having positive earnings on a monthly basis, but I would say in the case of Minnesota, Summit Bank in Denver and in Arizona, we just need scale in all three of those banks. So, we've been looking at M&A activity in those markets. If we can get scale and get to a reasonable loan to deposit ratio, we should be able to start showing positive numbers, because I think most of the credit issues are behind us. Minnesota never really had significant credit issues. They just need scale.

Minnesota has been very choosey in the credit they're bringing on and have done a nice job of that.

And then a second unrelated question, what are you guys thinking in terms of amount of SBLF you take down, and how does that with the $80 million, $82 million you owe under TARP, how does that play in with the $30 million of cash that you have at the holding company right now?

Right now our thought is, Jeff, that we would just pay off the TARP with the -- we've applied for the similar amount or would apply -- apply for the $81.7 million, if we choose to take it, we would pay out the TARP. So, it would be really an exchange of (inaudible). So, really the cash position wouldn't be impacted. We have some lines available, et cetera, yet that we could further draw on to augment that cash position.

Thank you very much.

Thank you. And our next question is from the line of Stephen Geyen with Stifel Nicolaus. Please go ahead.

Good afternoon, guys. Just curious, the favorable rate that -- of the SBL, kind of depends on the specific types of loan growth. I'm wondering if you can comment on the potential growth in those loans. Is there more demand in the -- I guess the small business, ag versus some other types of loans?

Well, as we've looked at in the past, it really kind of hits us in our sweet spot. That's the type of lending that we really do a lot of. And I think the last time I looked, we were about a third of the way to the required amount to get the full benefit. So, if our projections are correct for the next six months, I think at one time we felt that within 12 months we could have full benefit of that, so.

I think just to augment what Lynn said, Stephen, our internal pipeline would suggest $100 million production, and our core primary credits are less than a $10 million threshold and certainly a lot of ag as well. So, I think the program fits us, as Lynn said, very well, and we should be able to hopefully see that -- the requisite growth, which is just over $100 million total growth for us to be able to reduce our rate down to that 1%.

Given the TARP right now, the after-tax is costing us 5%, so to the extent that we could be effective booking somewhere close to $100 million in qualifying loans, that takes $81 million from 5 down to 1. And of course, the loan growth also helps the margin. Our second highest priority is to move dollars of cash flow out of the investment portfolio into quality loans. So, we're heavily focused on that.

And really, right now, I mentioned in my comments we thought that the margin would trend towards 4%, but with substantial loan growth, I think we can sustain it higher than that 4% level.

Okay, and just the last question, in the press release there's one line that has additions to the nonaccruals and looks to be down pretty significantly from the last quarter or last few quarters. Just curious to maybe your thoughts, is this a good metric for us to look at for maybe future credit trends? And wondering if you have some -- maybe some insight into what new nonaccruals look like so far this quarter.

I'd like to say I hope so. That has been something I've been saying for the last few quarters is that I was cautiously optimistic that we were seeing quality improve. We've been fixing problems at the rate of about $20 million or $25 million per quarter that we've gotten to the tail end inflection process and getting it collected and moved to ORE. The last few quarters, though, we've had like dollars that have come in right behind it and replaced those.

So, this is the first quarter where we've really got ahead of the game and didn't see the further deterioration of a handful of credits in there. Like I mentioned, there was only six credits over $300,000 that became nonperforming. We've gotten most of the year end financial statements in, so we're well into having all of those spread and identifying if there's any more weakness out there. We certainly will have some, as every bank will. But I really believe that the problems have been identified in the portfolio. It's just now an issue of seeing people get reemployed in this country and those businesses with cash on the sidelines starting to invest, so.

And again, the 30 to 89 days being another barometer that--.

Our delinquencies, other than nonperformings, have been below 67 basis points for the last three-quarters running. I think it was 67, 61 and 60. So, it's been a very strong credit excepting those that we have already identified and have moved out into nonperforming status.

Okay, thank you.

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

Good afternoon, guys.

Hi, Dan.

For your nonperformers, the nonaccrual number, does that include renegotiated loans?

No, it does not.

And what is the -- your renegotiated amount as of June 30?

$37 million? (multiple speakers)

$36 million, $37 million. Just a couple million increase over March.

All right. And then you had mentioned that you were looking to start up a small business unit. Is that tied to the SBLF, or was that something you were going to do regardless if you get SBLF funds?

No, it's not tied to the SBLF, and again, the small business loan fund backs loans up to $10 million in note amount. So, as Lynn mentioned, I think that really hits us in a sweet spot because when we look at our large borrowers, when we pull up the top 20, we're already down to a $14 million relationship size. So, the loans that will qualify into that fund really fit our sweet spot. What we're looking at is trying to help the turnaround time in normal underwriting and documenting of loans for those smaller loan relationships out at all of our member banks. So, that's just an ancillary benefit of trying to assist the banks in the underwriting and turn around of the loans out there.

Okay, okay.

I think, while not a direct thought, Dan, I think that certainly realizes that if we are into the program, we'll need additional production. This initiative certainly could help us facilitate that production.

And back to the TDR question, we have a total of $37 million, but $31 of those are on accrual. So only $6 million of those are in a nonperforming category.

Okay, thank you. And then if you could talk a little bit about talent additions you've made during the quarter, how many folks have you added, which markets have you been concentrating in.

Well, most of the staff additions have been in Heartland mortgage and nat res. That's probably had the greatest number of FTE increases.

We've also added talent in Rockford, Illinois, we've added it in Minnesota, Minneapolis.

In Montana, we've added a couple new adds in Montana in both Billings and Bozeman.

Arizona.

We've added in Arizona.

And Denver.

And Denver. No new adds at this point in New Mexico although we are looking.

And then last, you had mentioned that you were looking at M&A as a possible way to grow Minnesota and some of the other portions of your footprint. What are some of your expectations like right now? Have they improved?

(Laughter) That's across the board, Dan. We're still thinking that some of the smaller banks that are not FDIC candidates for sale but just kind of tired, we're thinking somewhere in the range of a discount to book to tangible book. I know that sellers, probably expectations would be book and a quarter, book and a half. But it's got to be a very, very clean bank with a lot of up side potential and significant cost savings to get much of a premium, in our mind. Now, talk to the sellers and they may tell you something different.

And I think really, Dan, from what we see, the majority of the banks thus far that we see, and we are seeing a lot of them right now, have some challenges or some significant challenges. What we're seeing now maybe is the next generation of that where we're seeing banks that aren't troubled. Their clean shop is starting to come forward, and I don't think we're quite there yet. But I think we're going to start to see some blending of the expectations, hopefully in the next 6 months.

If you're asking us what are we going to end up paying for a bank, first of all, it's going to have to be accretive to our shareholders. We've committed that through the years, that we're not going to do dilutive transactions to earnings per share. And second of all, my guess is it's going to be very difficult to pay much of a premium unless our stock starts trading at where we think it should trade. Book and a quarter, maybe book and three-eighths would be the high, I would think, for a quality bank that provides good accretion to earnings. But time will tell where it ends up.

It's going to be a function of our currency and where the internal rate of return comes through as well and as Lynn said, creative transactions.

Great. All right, thank you.

Thank you. And our next question is from the line of John Barber with KBW. Please go ahead.

Good afternoon.

Hi, John.

Just so you know, I work with Chris McGratty. I think he was having some connection issues, so I'll ask a few questions on his behalf.

Great.

How are you thinking about your reserves to loan ratio longer term? Where do you think they normalize, and when do you think that happens?

I think I'd mentioned last quarter, maybe the quarter before, that our allowance was split just about a third, a third, a third between our FAS 5 calcs, our FAS 114s for impaired, and then the qualitative factors we assess to the portfolio. In this quarter, I think about 20 basis points came out of the FAS 114 with that $2 million charge-off. So, I think about 65 basis points or so sits in FAS 5. About the same with qualitative and 40 some basis points in 114. I would expect the 114 calcs will continue to trend down over the next couple of quarters. Long term will160 get down into 130, 125 range, how soon, I don't know, but it will certainly continue to go that way as we move through our impaired loans.

Okay, thanks. That's very helpful. I guess my last question was somewhat related. What do you think is normalized level of net charge-offs?

If I look back three years, it was 10 basis points. We've always prided ourselves on solid underwriting and good collection efforts. I think we will look at ourselves as performing better than peer in that, so we'll continue to say that about ourselves as we go forward. Whatever is happening to the economy and making banks suffer as businesses suffer, we'll certainly have charge-offs, but we wouldn't expect our level of losses to be as high as what the peer group.

Great, thank you very much.

Thank you. (Operator Instructions) Our next question is from the line of Brad Milsaps with Sandler O'Neill. Please go ahead.

Hey, good afternoon, guys.

Brad.

Hey, just a quick question on the margin guidance. I think, John, you mentioned close to the 4% by the end of the year. Please correct me if I've heard that incorrectly, but just wanted to right-size that with what your expectations are for loan growth. And then also, it looked like the loan yields in themselves were up quite a bit on a linked quarter basis. Could you talk about that a little bit, how you've been able to get a little better pricing there?

A couple of thoughts. One, I did say 4%, Brad. I think we can sustain that if we do see the loan growth that we're suggesting. So, in some respects that 4% is anticipating minimal growth. So, if we can do better at minimal growth, we can in fact hit the $100 million. I think there's potential to sustain it over 4%. The question that you've asked historically, we do have, in maturing CDs about $305 million of CDs maturing in the next six months at 161. They were priced at 70 basis points -- in their range of 70 basis points, now that's what we've seen for the last couple months. So, understanding that, that has the ability to help sustain the margin.

Obviously we're going to see investment roll off, et cetera, that's going to impact that but might trend towards 4% would anticipate somewhat minimal loan growth. So, there's a potential to sustain that higher if we hit the loan growth. Relative to the higher performance in loan yield, one factor in that would certainly be the fact that we -- the nonperforming loans coming off and that fact that $20 million or thereabouts of nonperforming loans came off helped shift that return up. The growth in Citizens certainly helps impact that loan yield. Those are the things that come to mind initially on that. I think we still could do a decent job of pricing loans.

Great, John, thanks for the additional color.

There are no further questions at this time. I would now like to turn the call over to Mr. Fuller for closing remarks.

Thank you. In closing, we're very, very pleased with the positive financial performance trends that we've been able to share with you today. As I've said in the past, I feel very confident about the earnings power of our Company and see excellent opportunities ahead. Our margin remains solid at just under 4.25%, and we remain intensely focused on our highest priorities, which are, and I will share those with you, first and foremost the continued reduction of NPAs. Second, the growth of quality loans. Third, the growth of nontimed core deposits, that's checking and savings. Fourth, the focus on training and technology and last, holding ourselves accountable for execution of both our plans and our budgets. I would like to thank everybody for joining us today and hope you can join us again for our next quarterly conference call which is scheduled on October 24, 2011. Have a good evening, everybody.

Ladies and gentlemen, this concludes the Heartland Financial USA second quarter conference call. You may now disconnect. Thank you for using ACT conferencing.