Heartland Financial USA Inc (HTLF) 2011 Q3 法說會逐字稿

Good day ladies and gentlemen. Thank you for standing by. Welcome to the Heartland Financial USA third quarter conference call. During today's presentation all parties will be 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 Mr. Scott Eckstein, please go ahead sir.

Thank you operator and good afternoon everyone. Thank you for joining us on Heartland Financial USA's conference call to discuss the third quarter 2011 results. This afternoon we distributed a copy of the press release and hopefully you've had a chance to review the results. If there is anyone 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 then we will open the call up to your questions.

Before we begin the presentation I would like to remind everyone that some of the information that management will be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines I must point out that any statements made during this presentation bearing the company's hopes, believes, 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 10K and 10-Q filings which can be obtained on the company's website or the SEC's website. At this time I would like to turn the call over to Lynn Fuller. Please go ahead.

Thank you Scott and good afternoon everyone. We certainly appreciate everyone joining us this afternoon as we review Heartland's performance for the third quarter of 2011. For the next few minutes I will touch on the highlights for the quarter and will then turn the call over to John Schmidt, our Chief Operating Officer and CFO, who will provide further detail on Heartland's quarterly results. Then Ken Erickson, our EVP and Chief Credit Officer will address the credit side. I am pleased to open my remarks this afternoon with news that Heartland reported a solid third quarter with net income of $7.4 million compared to $6.9 million for the same quarter last year. Year to date net income of $21.8 million or $0.92 per common share compared favorably with $17.3 million or $0.81 per common share for the first 9 months of 2010.

This was a unique a quarter for Heartland given our approval and participation in the Treasury's Small Business Lending Fund and the subsequent payoff of TARP and related common share warrants. I think it is important to note that the redemption of TARP created a one-time adjustment of $2.6 million, which equals $0.16 per diluted common share. And as a result, Heartland earned $0.20 per common diluted share for the third quarter. Our year-to-date pretax, pre-provision earnings remained very strong at $52 million compared to $49 million for the first 9 months of 2010. Heartland's results continue to be driven by a strong net interest margin of 4.14% for the quarter.

Now this marks 9 consecutive quarters with margins exceeding 4%. We continue to concentrate on margin management, turing deposit interest rates in step with national markets and local competitors while we benefit from significant growth in non-interest-bearing demand deposits. During the quarter, we experienced a slight uptick in nonperforming loans. And as I have said in prior calls, reduction of NPAs remains Heartland's number 1 priority.

We continue to believe that we are in a stable to improving credit environment with nonperforming loans decreasing by over 20% from their peak at year-end 2010. Compared to the high watermark set earlier this year, all of our asset quality majors continue to move in a favorable direction. With the allowance for loan losses at 1.86% of total loans, we believe we are properly reserved. In a few minutes, Ken Erickson will address the specifics related to credit administration topics.

Now moving onto the balance sheet. Total assets ended the quarter at just over $4.1 billion, reflecting a small increase over the last 4 quarters. Loan demand picked up during the third quarter with loans increasing at a 4% annualized rate. We believe this is the beginning of a very positive trend toward achievement of our second-highest priority which is quality loan growth. With our securities portfolio at 32% of total assets, we are extremely focused on converting cash flow from our securities portfolio into quality loans. I might add that the Small Business Lending Fund provides an added incentive for the Heartland member banks to originate small-business loans, which we would expect to increase employment and in turn sustain economic recovery. Additionally we continue to see opportunities in government guaranteed lending, especially with the SBA stimulus program that allows up to $5 million per borrower. We are leveraging the SBA and USDA expertise of our Heartland business bank personnel in Wisconsin to benefit all of our Heartland member banks.

While our third-highest priority is the continued improvement in deposit mix through the growth of non-timed deposits, we are especially delighted with the continued growth in non-interest-bearing demand deposits which are up 19% year-over-year. The increase in demand deposits was effectively matched with a corresponding decrease in timed deposits, the result is an improving mix of total deposits. With demand deposits representing 22%, savings representing 52%, and timed deposits represent the only 26% of total deposits. Well in terms of capital, our tangible capital ratio remained steady at 5.9% for the quarter. Risk-based capital and tier 1 capital ratios continue at nearly double the required levels. And as I mentioned last quarter, the cost of our non-common equity funding is fixed anywhere from 3 to 10 years at an after-tax average cost of 4.1%.

Non-interest income year-to-date strong at $41 million compared to $34 million last year. We are seeing increased revenue from service charges, trust fees, investment services, security gains, and gains on sale of loans. Another wave of residential refinancing activity combined with the expansion of our mortgage unit resulted in a 38% increase in gain on sale of loans compared to the first 9 months of 2010. After only 9 months of operation, our new Heartland Mortgage and National Residential Unit has transformed our mortgage origination business. As our group expands both within and outside of the Heartland footprint, we are optimistic that we will see continued significant increases in mortgage banking revenue.

Non-interest expense shows a year-over-year increase largely as a result of the human resource expenses associated with the expansion of our Heartland Mortgage and National Residential Unit. In addition to establishing mortgage loan origination at all of the Heartland member banks, we now have loan production offices in San Diego, California, Austin, Texas, and Reno, Nevada. Our mortgage team is actively pursuing additional locations in Midwestern and Western cities, where we can combine top talent with a healthy and growing real estate market. While expansion of our banking franchise continues to be a high priority, with opportunities appearing in almost all of our markets, in terms of how and where we invest our capital, we are taking a very selective posture of pursuing only the most profitable growth opportunities.

I am also pleased to comment on the excellent progress of our consumer finance subsidiary, Citizens Finance. With assets now exceeding $55 million, Citizens' year-to-date earnings were $1.8 million, that is a 21% increase over 2010. As part of Citizens' expansion plan, they opened their tenth branch location in Peoria, Illinois last month. In concluding my comments today, I am pleased to report that at its October meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share, payable on December 9, 2011. I am proud to say that 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. John will then introduce Ken Erickson will provide commentary on credit quality and real estate exposure. John?

Thanks Lynn and good afternoon. I will again keep my comments to the most significant areas of change in the balance sheet and income statement for the past quarter, September 30, 2011 versus June 30, 2011. Starting with the balance sheet. For the past several quarters we have discussed the stellar performance of the investment portfolio. And I'm pleased to report that this performance continued into the third quarter. During the quarter, $2.1 million of gains were realized, appreciation in the portfolio increased to $32.3 million up from the $22.5 million at the end of the second quarter. The portfolio yield did decrease by 31 basis points.

Again, this quarter it is important to note that the gains reflected in the third quarter do not include gains on the sale of Zetron Securities included in the first quarter results. The impact of our reduced portfolio yield on the margin is certainly a focus for the Company as we look to shift out of investments and into loans. Relative to the loan portfolio, we forecasted $100 million in loan growth in 2011. This quarters increase in outstandings certainly solidified the likelihood of Heartland reaching the short-term goal as loans increased $43 million for the quarter. We include loans held for sale in this total as our mortgage pipeline continues to grow. While the current pipeline is certainly reflective of refinance activity, balance sheet outstandings will continue as a disproportionate amount of loans being refinanced are replaced with purchase activity. To reiterate, we feel very comfortable that we will have $100 million in loan growth by the end of the fourth quarter.

We had previously discussed that with the transition to the SBLF, we had originated approximately one-third of the $100 million of loans required to reduce our rate to 1%. Further analysis would suggest that a disproportionate amount of loans originated in the last 12 months were non-qualifying loans. As a result, we believe that $100 million in qualifying loan growth is still required to allow us to reduce the dividend rate to 1%. Growth in deposits was excellent again this quarter increasing by $93 million or 12% on an annualized basis. Certainly a portion of these dollars is reflective of corporations parking money. But by the same token, we are doing everything we can to ensure that these are core deposits.

Moving on to the income statement. Much as we predicted last quarter, our margin decreased to 4.14% in the third quarter. Excluding the reversal of $351,000 of interest income on a problem credit, the margin would have been 4.17%. While we look for loan growth to at least partially offset investment maturities, we were still forecast the margin pushing closer to 4% by year end. Ken Erickson will provide additional background of the $3.9 million increase in provision for the quarter. At the same time I think it is important to note that examinations were completed at all 9 banks this quarter, resulting in a no material surprises.

Relative to non-interest income, non-interest income totaled $13.3 million for the third quarter. Excluding security gains, non-interest income increased $1.3 million quarter-over-quarter. The largest contributor to this with the $1.9 million increase in gain on sale of loans. This increase had 2 primary drivers, refinance activity in our legacy markets and the expansion into new markets such as San Diego. Much as I indicated in my, comments in the loan growth area, while current production is certainly driven by the refi activity, alternately we see 70% of total production reflecting purchase activity. Given the current expansion, we would also see total originations exceeding $1 billion next year. Income derived from our investment in bank owned life insurance continues to experience a decline driven by the overall reduced level of portfolio returns as well as 1 acquired policy tied to stock market returns. The recovery of a previously charged off credit is shown as the reduction in non-interest income reflected in the acquired payment to the FDIC. Excluding this other non-interest income would have been $216,000 for the quarter.

Focusing on non-interest expense. Total non-interest expense for the third quarter decreased by $480,000 as compared to the second quarter of 2011. Major changes in the third quarter included a $256,000 increase in salaries and employee benefits and $1.1 million decrease in net loss and repossessed assets. Much as we had forecast the last quarter, the increase in salaries and employee benefits primarily reflected increased commission expense associated with the expanded mortgage activity. As mentioned previously, we fully expect mortgage production to increase in the fourth quarter along with the associated increase in commission expense.

Finally, consistent with the payoff of TARP, an additional $2.6 billion was recorded to reflect the acceleration of the discounted amortization associated with the preferred shares. Without this one-time event, earnings per share would have been $0.36 per share. Additionally, as we had previously discussed, we also negotiated with treasury to purchase the warrants associated with TARP for $1.8 million. This payment is reflected as a charge against equity. With that I will turn it over to Ken Erickson, our Executive Vice President and Chief Credit Officer.

Thank you John and good afternoon. All of my comments this afternoon, unless otherwise stated, will be exclusive of those assets covered under the loss share agreement. I will begin by discussing the change in nonperforming loans in the third quarter. As already mentioned, Heartland experienced a $4.5 million increase in nonperforming loans in the third quarter. New credits added to nonperforming loans totaled $19.1 million of which $14.9 million or 78% was related to 3 credits. 2 of these credits totaling $8.3 million were originated by Arizona Bank and Trust, and 1 in the amount of $6.6 million was originated by Summit Bank and Trust.

We were able to remove $15.2 million from nonperforming during the quarter, $7.5 million or 49% was resolved through foreclosures, $4.1 million or 27% was charged off. While the remaining $3.6 million or 24% was resolved through payment, restoration to accrual status, or sales of collateral. Please refer to the table within the press release that reconciles these changes in nonperforming assets for the quarter.

I will now turn the discussion to total nonperforming loans. As stated in our earnings release, $44.8 million of the $72.6 million of nonperforming loans resides in 18 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 up $6.7 million from last quarter. The industries for these credits were also detailed in the release. The largest concentration within these nonperforming loans is in lot and land development which represents 36.8% or $44.8 million. $3.1 million of our nonperforming loans are covered by government guarantees through rural development FCA or FSA.

Next I'll comment on charge-offs and provision expense. The majority of the charge-offs in the third quarter were attributed to loans originated by the following banks. $1.6 million by Arizona Bank and Trust, $1.4 million by New Mexico Bank and Trust, and $1.1 million by Rocky Mountain Bank. Out of the $4.1 million in losses incurred by our member banks in the third quarter, the majority was incurred in the following loan categories. Construction, land development and other land loans, $1.8 million, non-farm, nonresidential, owner occupied, $838,000, farmland, $632,000, and no other individual category exceeded $600,000. In the third quarter of 2011, Heartland recorded a provision expense of $7.7 million. With net losses of $4.1 million the allowance increased by $3.6 million. This is primarily attributed to an impairment recorded for a loan that has shown recent weaknesses. 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 five quarter ends beginning with September of 2010 was detailed in the earnings release.

Regarding expected resolution of the nonperforming loans, I can state that our collection efforts in the fourth quarter are expected to result in a reduction of $28.7 million of the nonperforming loans recorded at September 30. Of this amount, $22.6 million is expected to be moved to other real estate and $6 million to be either paid down or restored to accrual status. Relative to other real estate, including those assets covered under loss share, shown in the table inserted in the press release, other real estate remained flat between the second and third quarters. Total owned residential real estate, including all properties intended to be used as 1 to 4 family residences is $10.3 million, while owned commercial or agricultural real estate is at $28.9 million. During the third quarter $7.3 million was moved into other real estate. Sales resulted in $6.5 million while ORE write-downs were in the amount of $754,000.

Since the end of the third quarter, $3.4 million of other real estate has already been sold or contracted for sale with closing expected in the fourth quarter. 5 properties with an aggregate book value of $4.7 million have been entered into an online auction. The bid deadline is November 17 for those properties. Regarding our portfolio diversification, we remain well diversified. $1.7 billion or 71% of our loans are either fully or partially secured by real estate. Over the $815 million in loans categorized as non-farm, nonresidential, 60% or $488 million is owner occupied.

A review of the $327 million commercial real estate non-owner occupied portfolio at the end of the third quarter shows that $19 million or 6% of that portfolio is classified as nonperfoming. As of September 30, these loans carry an impairment reserve of $291,000. Our exposure to non-owner occupied properties increased by $11 million in the past quarter. We have got a total of $125 million in construction land and land development loans. $12 million or 10% of this portfolio is on nonaccrual. 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. Our retail portfolios continued to perform quite well. Losses in the third quarter for residential real estate loans were 0.28%. Foreclosures on 5 residential properties, for a total of $215,000 were completed in the third quarter. 32 foreclosures on $3.6 million of loans are currently in process. As stated previously, several of these get resolved prior to final action.

Citizens, our consumer finance company, performed well in the third quarter. Net loan outstandings are at $56.2 million. Net charge-offs year to date stand at 2.51%. And delinquencies are 4.51% at September 30 with only 1.23% being 90 days past due. Year-to-date earnings were $1.8 million.

In conclusion, while being dissatisfied with the increase in the provision and nonperforming loans during the quarter, I remain optimistic regarding the positive trends we are seeing in the portfolio. As mentioned earlier, we expect a significant reduction in nonperforming loans in the fourth quarter as we gain control over the assets and move into ORE. Our 30 to 89 day delinquencies rest at only 0.54% and the problem loans within our most problematic loan categories of construction land and land development, have been significantly reduced. This should set us up for a solid finish to 2011 and a much stronger 2012. With that, I will turn the call back to you Lynn and remain available for questions.

Thank you, Ken. And I will open the phone lines for your questions.

Thank you Sir. Ladies and gentlemen. We will now begin the question-and-answer session.

(Operator Instructions)

Chris McGratty, KBW. Please go ahead.

John in terms of securities, maybe I missed it in your commentary, how should we think about the size? You guys are getting a little bit more optimistic on loan growth it seems. Is it likely to be funded through reductions in the securities book, or how do you envision the --

That is our overall thought Chris. 32% to 33% of the overall balance sheet is where we are at. And ideally we would like to be closer to 20% of the overall balance sheet in securities. So certainly for the foreseeable future, the funding for the loan portfolio will come out of the securities portfolio.

Okay. On the dividend. How should we think about kind of a 2012 preferred dividend from SBLF, what's the--

Where are we going to hit for the $100 million?

Yes. Or just do kind of a ballpark.

Again, just to reiterate, how that is calculated because there is a little bit of confusion. If, for instance, we are able to grow loans by $25 million, that $25 million goes from 5% down to 4%. Leaving it so the melded overall return on the SBLF is about 4.65%. So where we are going to be relative to the overall $100 million of loan growth? It is pretty tough to forecast at this point. We have aggressive growth goals in mind. I would like to see us certainly down closer to 3% or less by year end certainly. I don't think we will be able to realize the entire $100 million, but we are working very diligently towards that ultimate goal.

Okay. The tax rate. It seems like there was a recovery from prior returns. What should I be using kind of looking forward for a tax rate?

I think we are still probably, should call it 28% is a pretty fair rate for the.

That is FTE.

For the foreseeable future. Excuse me.

Okay so if I'm adding it up, the last question then I'll jump back If I'm looking at your numbers, you reported 20, there's a $0.16 really adjustment for the dividend, and there were securities gains and the tax benefits. So I'm doing my math right, it's like a $0.26 run rate. Was there adjustment for the MSR?

No. I mean we saw a somewhat reduced rate this quarter, but not a great MSR. I don't know if I'd get down to, what did you have $0.22 Chris?

$0.26, $0.20 plus $0.16 less $0.08 and then back up the tax rate.

Yes. Assuming the overall security gain, understand you'd pull those out, although we have seen a nice trend of recurring gains on the portfolio, we don't expect it to fall out completely. And I understand your direction.

Yes, I'm just had to make sure that I'm capturing all the adjustments, that's all I'm after.

Chris, this is Lynn. I would echo John's comment that if we are successful in growing loans, we are going to be moving out of securities, where we have a pretty significant appreciation. So I mean I think as we budget out next year, we generally don't budget in security gains. But that is something that we would expect as long as loan growth is there for that to continue. Because we are not going to probably see a whole lot of balance sheet growth. We're just going to see a difference in mix on the asset side. And hopefully a continued improvement of mix on the liability side.

And to add to that though too, I think we're just starting to leverage the investment we made in the mortgage side. Again, a lot of that is coming through in the form of refi activity and we see the refi activity being strong through the fourth quarter. Even within is in the pipeline right now. But that will shift as I indicated to more of a purchase portfolio, or purchase production rather. And we see that next year being a really significant, very additive to the overall income of this company.

Okay. That's helpful. Thanks a lot.

One last point too Chris. Remember that there will be no amortization of the warrants on a go forward basis. Which is $333,000.

A quarter.

A quarter.

Brad Milsaps, Sandler O'Neil Asset Management. Please go ahead.

John I just wanted to see if you could maybe talk a little bit more about the margin. I'm sorry if I missed this. But can you go over again what you have maturing in terms of CDs over the next say 3 to 6 months?

I think last quarter we indicated probably about half the book was maturing in the CD book, of which we are rolling off at about 170 overall rate. The portfolio is still short Brad. The overall CD book is still short. So you know, it is probably not quite half, but it's somewhere, call it 40% maturing, coming off as an estimate 150 and in the next 6 months, being priced at 70 BPs. So there's some opportunity relative to the margin. As I indicated in my comments, we still see it trending closer to 4%. By year-end, and probably won't be all the way there, but some of that is a function of loan growth, which as I pointed out last year, or last quarter rather. If we're able to achieve the loan growth, it could still hang above 410. Without any of the loan growth, which again we're working diligently to get there, it could trend closer to 4%.

Is there anything rolling off in that other borrowings category? Kind of the longer-term borrowings category that, I know you have some of that stuff swapped, but just kind of curious what kind of -- any kind of repricing characteristics there?

Really to a great extent no. I think that most of the, not a lot of FHOV coming off.

The Small Business Loan Fund would be the one that we potentially if we are successful, should be able to be reduced over the next 12 to 18 months.

And in the form of a dividend. But yes, absolutely the overall cost of the company. I think that we have 1 cusp preferred out there for a small piece that we acquired that is at 1065. We could think of our, but we are still evaluating that as well. So really we don't see a lot of opportunity there.

Okay and the final question on the taxable investment portfolio. It looked like the yield there was down maybe about 41 basis points on a lean quarter basis. Can you just talk about, kind of obviously with rates lower that's not a surprise, but just curious, how much of that was sort of accelerated premium amortization expense versus just regular reinvestment of runoff of the cash flows?

You know I think, it is pretty tough at this point Brad to get through all the way to that detail. I would say it's probably, as an estimate, 50-50. That would be a pure estimate at this point.

Okay. Great thank you.

Thank you. Stephen Geyen, Stifel Nicholas. Please go ahead.

Good afternoon guys. Maybe just a handful of questions. Maybe first off, just curious, you talk about the loan growth. Maybe what is driving your costs that you can grow loans, is it the small-business, is it agricultural, or maybe some geography thoughts as well?

I will certainly take a first shot at it Stephen. I think that each of our markets are seeing opportunity given some of -- driven by several things. One is personnel that have come to our organization. So it is market opportunities, people bringing books of business with him for one thing. We have certainly had a lot of discussion with our banks and planning sessions et cetera where we have talked about the need for loan growth, and they, not that they haven't heard it before, but they clearly get it. There is, obviously the SBLF adds another clear accelerant for us to focus on loans and pursue them. I mean it is a nice opportunity for us to reduce the overall rate for the company.

Again, I think it is just a variety of things coming to fruition at this point. And another thing would be, as much as indicated in my comments, the mortgage pipeline. Which is again, it is a constantly evolving or revolving portfolio. But given what we anticipated in increases production, that will add to the overall outstandings on our balance sheet.

Stephen, from a competitive standpoint, I have said this I think in past calls, that in almost every market that we operate in, we have major competitors who are stressed or have failed as an example, M&I Bank hits us in the Midwest. It hits us also in Arizona, Amcor in Illinois and Wisconsin. First State was our major competitor in Albuquerque. And then just a whole host of smaller banks that have failed in the markets that we're in. And the large banks that move their target up higher, where you know, they pay attention to the larger credits and do a nice job of that but in the smaller credits, where we tend to operate, they are not giving as much attention to those folks. So I think the competitive opportunities are significant, granted that in a slow GDP, 1% or 2% GDP growth market, we are not going to get a lot of requests from existing customers. So we are going to have to take it from competitors or hire their better people away. And we are having some success in doing both of those.

Okay. That's helpful.

You mentioned ag and small business. Those are 2 target markets that we're looking to expand our ag lenders staff. We have done a good job in that area. It has generally provided better returns to us and very little in the way of losses.

Okay. And in the press release you mentioned pressure on credit spreads. Is that something that you are seeing an increased intensity?

We are seeing some of that. You know, it's kind of different based upon what market we are in. But we are seeing that other banks that we compete with are becoming a little more aggressive on pricing. So for the very, very highest of quality credits, we are seeing reduced spread. We're still trying to maintain our fours. Whereas we used to maintain those fours and the fives. We are now in the fours.

Okay.

And that pressure in the current spread is when we're bringing credits over though too, Stephen, it's not like we're giving up a lot, but we will give up some for very quality credits to bring them across when they bring a full relationship with them.

Got it. Okay. And maybe a question for Ken. Just curious on the adjustments, the non-accruals and the watch list. The provisions that you had for the quarter. Maybe some additional thoughts there. Where do the provisions go? Was it evaluation adjustments in the nonaccrual watch list credits or just kind of across-the-board?

Yes, the largest as we hinted at in the earnings release was one credit which we are still in the payment current situation, but, and one that we are not sure that the customer can continue the cash flow long-term. It's in the construction industry, so we know values have decreased significantly from just booking throughout our portfolio for the last 18 months. So we thought it was best to move that to a FAS 114 and look at it from an impaired standpoint and there was a significant value adjustment in that. So we thought it was appropriate to move that and recognize an impairment in this quarter. We'll continue to work and to see where that customer goes. But that is the largest, most a significant portion of the provision expense for this quarter.

In regards to the other movement or lack of movement in nonperformings this quarter, I kind of looked at it like the first quarter of this year where we went into the quarter thinking we would see some reductions. And when you're in the collection mode on loans, there can always be delays in court that push it back another month or 2 for sheriff sale or a piece of other real estate that gets delayed in selling. And I think that we had a relatively flat quarter between the fourth quarter and first quarter last year. We kind of feel the same way here. We had a lot of things moving towards resolution and we just ran out of days in the third quarter.

I mentioned some pretty large dollars that $20 some million of loans that are in nonperforming at the end of the third quarter, that should move, the majority of them have the real estate in the fourth quarter. But then at least put those in our hands for sale. So I don't see it as moving backwards as much as just a few delays in getting credits moved through the pipeline. And it looks like today that the fourth quarter should show some very quick results like the second quarter did, the quarter before.

Okay. Thank you.

Stephen you hadn't asked the question, but a question that came up earlier relative to the overall taxable securities portfolio. And to answer that, 75% of the reduction is attributable to cash flow reinvest.

Thank you. Jon Arfstrom, RBC Capital Markets.

Hi guys, this is Andy Hedberg, in for Jon. A question on the Heartland Mortgage and the ramp-up there. John, you commented that you're expecting $1 billion in mortgage originations in 2012.

Right.

Wondering if you could help quantify what the associated mortgage -- banking revenue increase is? And then expenses along with that?

I think our peak was about $813 million or thereabouts in 2009. Last year I think we were at just -- call it less than that. So I think last year we did about $15 million in total revenue from the mortgage activity. So $1 billion relative to that, I think $600 million -- let me back up. We had $600 million of production in 2010. I think that translated to $50 million of revenue. Some from there it would be fairly close. Or maybe another way to think about it, we were thinking that on $1 billion we should be able to generate anywhere from about 220 basis point on that overall production. Maybe that is the best way to think about it.

Okay. That's helpful.

-- answer.

And then Ken this one is probably for you. Can you give us an update on your ORE disposition trends and maybe the prices that you are seeing in resolving the assets?

I think I was looking in the earnings release here, the table there shows how we started the year with $32 million and we had 27 new that we brought in this year. We have reduced that with sales to 16. We have said for some time that we have looked at some sales of notes and more rapid discounts of ORE. But in both cases over the last year to 2 years, we have seen the discounts we need to take are much greater than we think the carrying value is to a normal and prudent marketing of that. You can see of the write-downs we have had in the first 9 months we're $3.9 million, so what's that represent, about a 12% reduction from the beginning of the year on those book values. Plus or minus close to that. So those reductions are a must less than what we have experienced when we have gotten prices from the outside market to try to market those.

So we feel that we are near the bottom with the new appraisals that we have gotten in recently. There has not been significant push down from the last valuation. Like I said, we have got about $3 million already contracted for sale this quarter. It looks closer to maybe $6.5 million of those that we think will most likely close before the end of the quarter. And that is at or near the mark. And then we have got just under $5 million that we have put in an online auction. We sold some, quotes on them in the first quarter of this year that we used an turn online auction service. So we decided to go back to them and attempt to sell some lot and land development properties, all in Arizona, that had been slow to move.

So we're looking to see if we can generate activity in those. We will be able to tell you next quarter end whether or not we were successful in doing so. The last time that we moved through the properties, we did sell them at auction. It came in very close to what we have for book value.

Okay thanks guys.

Just one last point. Trying to maybe better quantify for you the mortgage activity. If you think about, I think that 220 basis point of origination fees is a fairly accurate or fairly reasonable approach to the overall $1 billion or $22 million. Additionally, given the cost that we anticipated, associated with the mortgage production, you know I think that we anticipate about a 1% net from that $1 billion. Further, that does not reflect an increase in the overall mortgage servicing book, which we are retaining servicing on, the majority of our portfolio, or the majority of the production. So that will build along as well as we, again, we put -- we originate these mortgages and put them into the servicing book. Right now we have not seen a real increase in that, again it's $1.5 billion, primarily because we have been refi-ing a lot of loans at this point. But, go forward, as I mentioned in my comments, the majority of production will be purchases which will accelerate the increasing overall mortgage servicing book.

Thank you.

(Operator Instructions)

Brad Milsaps. Please go ahead.

Sorry for the follow-up. Just curious if you had the level of TDRs at the end of the quarter.

I just happen to have that in front of me. $37 million total in TDRs. $12 million of those are on nonaccruals, so already showing up in the nonperforming. $24.8 million of that are restructured loans but in performing loan status.

Okay great. Thank you very much.

Hey Brad did you get the other response your question? 75% of the overall decline is attributable to cash flow reinvest?

Yes Sir. Thank you.

Great.

Thank you. We have another follow-up question from the line of Chris McGratty Please go ahead.

Just a quick follow-up John. For next year, the tax rate was 28? Or does that go up as you make more money? For 2012 or 2013?

I think given what we see right now, Chris, I would still model 28.

Okay thanks.

Thank you. And I'm showing no further questions at this time. I would now like to turn the call back over to management for closing remarks.

Thank you, and in conclusion, the third quarter of 2011 highlighted solid earnings with most performance measures moving in a positive direction. Our superb net interest margin continues to produce exceptional pretax pre-provision earnings. Non-interest income is strong and will continue to grow and non-interest expense is controlled. We continue to see marked improvement in deposit mix and the beginning of what we believe is a positive trend for loan growth. Finally, we are well-positioned and eager to pursue acquisitions that are accretive to earnings and meet or exceed our M&A criteria. In short, I feel good about the earnings power of our company and continue to see excellent opportunities ahead for Heartland. I would like to thank everybody for joining us today. And I hope that you can join us again for our next quarterly conference call which will take place next year on January 23, 2012. Thanks everybody and have a good evening.

Ladies and gentlemen. This concludes the Heartland Financial USA third quarter conference call. You may now disconnect. Thank you for using ATT conferencing.