Heartland Financial USA Inc : Heartland Financial USA, Inc. Reports Fourth Quarter 2013 Results

Heartland Financial USA, Inc. (NASDAQ: HTLF):

Heartland Financial USA, Inc. (NASDAQ: HTLF) today reported net income available to common stockholders of $7.7 million, or $0.42 per diluted common share, for the quarter ended December 31, 2013, compared to $9.0 million, or $0.54 per diluted common share, for the fourth quarter of 2012. Return on average common equity was 8.79% and return on average assets was 0.55% for the fourth quarter of 2013, compared to 11.33% and 0.76%, respectively, for the same quarter in 2012.

Net income for the fourth quarter of 2013 was $1.6 million lower than the fourth quarter of 2012, primarily as a result of an $11.1 million decrease in gains on sale of loans, offset by an $8.4 million increase in net interest income and a$1.3 million decrease in the provision for loan and lease losses. Loan growth, exclusive of acquisitions, was $178.6 million or 6% during the fourth quarter of 2013.

Commenting on Heartland's results for 2013, Lynn B. Fuller, Heartland's chairman, president and chief executive officer said, "We are pleased to report that 2013 was Heartland's second best in its 33-year history. Though the company fell short of matching the exceptional year experienced in 2012, Heartland's net income of $35.7 million and return on average equity of 10.87% demonstrate the excellent potential in the company's core operations."

Net income available to common stockholders was $35.7 million, or $2.04 per diluted common share, for the year ended December 31, 2013, compared to $46.4 million, or $2.77 per diluted common share, earned during the prior year. Return on average common equity was 10.87% and return on average assets was 0.70% for 2013, compared to 15.78% and 1.04%, respectively, for 2012.

Earnings for 2013, in comparison to 2012, were most positively affected by increases in net interest income, loan servicing income and service charges and fees, combined with decreases in net loss on repossessed assets and other noninterest expenses. In addition to a decline in gains on sale of loans during 2013, reduced securities gains and significant increases in salaries and employee benefits, occupancy and furniture and equipment expenses more than offset the improvements discussed above.

On October 18, 2013, Heartland completed a merger transaction with Morrill Bancshares, Inc., the holding company for Morrill & Janes Bank and Trust Company, based in Merriam, Kansas. On the date of merger, Morrill & Janes Bank and Trust Company had total loans valued at $383.1 million and total deposits valued at $664.8 million. After the merger, Morrill & Janes Bank and Trust Company became Heartland's tenth independent, state-chartered, bank subsidiary and continues to operate under its current name and management team. The aggregate purchase price, which was based on the tangible book value of Morrill Bancshares, Inc., was approximately $55.4 million, $16.6 million or 30% of which was paid in cash, and $38.8 million or 70% of which was paid by delivery of 1,402,431 shares of Heartland common stock.

On November 22, 2013, Heartland acquired Freedom Bank in Sterling, Illinois, from its parent company, River Valley Bancorp, Inc., a Davenport, Iowa-based bank holding company. The acquisition of Freedom Bank was arranged through a negotiated transfer of ownership with Heartland's flagship bank, Dubuque Bank and Trust Company. On the date of acquisition, Freedom Bank had total loans valued at $38.9 million and total deposits valued at $54.1 million. Freedom Bank will operate independently as a subsidiary of Dubuque Bank and Trust Company under its current name, staff and systems until at least the first quarter of 2014 when Heartland intends to consolidate Freedom with Riverside Community Bank, Heartland's Rockford, Illinois-based bank.

Net Interest Margin Percentage Remains Stable; Net Interest Income Increases

Net interest margin, expressed as a percentage of average earning assets, was 3.82% during the fourth quarter of 2013 compared to 3.81% during the third quarter of 2013 and 3.81% for the fourth quarter of 2012. For the full year of 2013, net interest margin was 3.78% compared to 3.98% during 2012.

Fuller said, "Compared to the previous quarter, we are pleased to see net interest margin increase slightly to 3.82% in the fourth quarter. Margin has been maintained through loan growth, a slowing in the decrease in asset yields and some improvement in our funding cost."

On a tax-equivalent basis, interest income was $58.0 million in the fourth quarter of 2013 compared to $49.5 million in the fourth quarter of 2012, an increase of $8.5 million or 17%. For the full year of 2013, interest income on a tax-equivalent basis was $209.0 million compared to $196.7 million during 2012, an increase of $12.3 million or 6%. Average earning assets increased $890.3 million or 21% during the fourth quarter of 2013 compared to the fourth quarter of 2012, with approximately $680.1 million of the growth attributable to the acquisitions completed during the fourth quarter of 2013. For the full year, average earning assets increased $620.0 million or 16% during 2013 compared to 2012, with approximately $171.4 million of the growth attributable to the acquisitions completed during the fourth quarter of 2013. The average interest rate earned on total average earning assets was 4.55% during the fourth quarter of 2013 compared to 4.72% during the fourth quarter of 2012. For the full year, the average interest rate earned on these assets was 4.56% during 2013 compared to 4.97% during 2012.

Interest expense was $9.3 million for the fourth quarter of 2013, a decrease of $270,000 or 3% from $9.5 million in the fourth quarter of 2012. On an annual comparative basis, interest expense decreased $3.5 million or 9%. Even though average interest bearing liabilities increased $591.7 million or 18% for the quarter ended December 31, 2013, as compared to the same quarter in 2012, and $348.5 million or 11% for the full year of 2013, as compared to the full year of 2012, the average interest rate paid on Heartland's deposits and borrowings declined 20 basis points during the comparable quarterly period and 22 basis points during the comparable yearly period. Contributing to this improvement in interest expense was a continued change in the mix of deposits. Average savings balances, the lowest cost interest bearing deposits, as a percentage of total average interest bearing deposits, were 74% during the fourth quarter of 2013 and 71% during the full year of 2013 compared to 69% for both the fourth quarter and full year of 2012. Additionally, the average interest rate paid on savings deposits was 0.33% during the fourth quarter of 2013 and 0.32% during the full year of 2013 compared to 0.35% during the fourth quarter of 2012 and 0.38% during the full year of 2012.

Net interest income on a tax-equivalent basis totaled $48.8 million during the fourth quarter of 2013, an increase of $8.8 million or 22% from the $40.0 million recorded during the fourth quarter of 2012. For the full year of 2013, net interest income on a tax-equivalent basis was $173.3 million, an increase of $15.7 million or 10% from the $157.6 million recorded during the full year of 2012.

Decrease in Noninterest Income; Decrease in Noninterest Expenses Over Fourth Quarter 2012

Noninterest income was $17.6 million during the fourth quarter of 2013 compared to $27.2 million during the fourth quarter of 2012, a decrease of $9.6 million or 35%. For the full year, noninterest income was $89.6 million in 2013 compared to $108.7 million in 2012, a decrease of $19.1 million or 18%. Although noninterest income was negatively affected by decreased gains on sale of loans in both the quarterly and yearly comparative periods, these decreases were partially offset by increases in other fee income categories. In particular, Heartland experienced solid growth in service charges and fees, which increased $883,000 or 22% for the quarter and $2.4 million or 16% for the full year; trust fees, which increased $406,000 or 16% for the quarter and $1.2 million or 12% for the full year; and brokerage and insurance commissions, which increased $301,000 or 32% for the quarter and $859,000 or 23% for the full year. Also negatively affecting noninterest income for the yearly comparative period were securities gains which totaled $7.1 million during 2013 compared to $14.0 million during 2012.

The following table summarizes Heartland's residential mortgage loan activity during the most recent five quarters, in thousands:

As reflected in the table above, on a sequential quarterly basis, residential mortgage loan originations and the gains on sale of residential mortgage loans and the mortgage servicing rights income they create, decreased during 2013. Gains on sale of loans totaled $3.2 million during the fourth quarter of 2013 compared to $14.3 million during the fourth quarter of 2012, a decrease of $11.1 million or 78%. During the full year of 2013, gains on sale of loans totaled $27.4 million compared to $49.2 million during the full year of 2012, a $21.8 million or 44% decrease. Gains on sale of loans result primarily from the gain or loss on sales of mortgage loans into the secondary market, related fees and fair value marks on the associated derivatives. The volume of residential mortgage loans sold totaled $214.3 million during the fourth quarter of 2013 compared to $478.3 million during the fourth quarter of 2012, and totaled $1.42 billion during the full year of 2013 compared to $1.53 billion during the full year of 2012. For the fourth quarter of 2013, refinancing activity represented 35% of total mortgage loan originations compared to 34% during the third quarter of 2013 and 71% during the fourth quarter of 2012.

Loan servicing income decreased $516,000 or 15% for the fourth quarter of 2013 as compared to the fourth quarter of 2012. On an annual comparative basis, loan servicing income increased $3.1 million or 28% for 2013 as compared to 2012. Included in loan servicing income are the fees collected for the servicing of mortgage loans for others, which are dependent upon the aggregate outstanding balance of these loans, rather than quarterly production and sale of mortgage loans. Fees collected for the servicing of mortgage loans for others were $2.0 million during the fourth quarter of 2013 compared to $1.3 million during the fourth quarter of 2012, an increase of $647,000 or 50%. For the year, fees collected for the servicing of mortgage loans for others was $6.9 million for 2013 compared to $4.4 million during 2012, an increase of $2.5 million or 56%. The portfolio of mortgage loans serviced for others by Heartland totaled $3.05 billion at December 31, 2013, compared to $2.20 billion at December 31, 2012.

Fuller commented, "The mortgage business changed considerably during 2013, creating challenges to our goals. Originations of $1.5 billion in 2013 came close to matching the previous year's production of $1.6 billion. We remain committed to this business line and continue to look for opportunities to expand into markets with strong residential growth potential."

For the fourth quarter of 2013, noninterest expense totaled $53.9 million compared to $54.6 million during the fourth quarter of 2012, a decrease of $722,000 or 1%. For the full year, noninterest expense totaled $196.6 million in 2013 compared to $183.4 million in 2012, a $13.2 million or 7% increase. Included in other noninterest expenses during the fourth quarter of both years were writedowns on investments in commercial and residential real estate projects which qualified for historic rehabilitation tax credits. These writedowns were $596,000 in 2013 and $5.3 million in 2012. The largest component of noninterest expense, salaries and employee benefits, increased $838,000 or 3% during the fourth quarter of 2013 as compared to the same quarter in 2012, and $12.5 million or 12% for the full year of 2013 as compared to the full year of 2012. Full-time equivalent employees totaled 1,676 on December 31, 2013, compared to 1,498 on December 31, 2012. The acquisitions completed in the fourth quarter of 2013 added 133 full-time equivalent employees representing 75% of this increase.

Heartland's effective tax rate was 21.90% for 2013 compared to 25.86% for 2012. Heartland's income taxes included federal historic rehabilitation tax credits totaling $914,000 for 2013 and $5.8 million in 2012. Federal low-income housing tax credits included in Heartland's income taxes totaled $798,000 during both 2013 and 2012. Heartland's effective tax rate is also affected by the level of tax-exempt interest income which, as a percentage of pre-tax income, was 37.26% during 2013 compared to 20.43% during 2012. The tax-equivalent adjustment for this tax-exempt interest income was $9.5 million during 2013 compared to $7.4 million during 2012.

Solid Growth in Loans; Increase in Demand Deposits

Total assets were $5.92 billion at December 31, 2013, an increase of $927.5 million or 19% since December 31, 2012. Total assets at acquisition date were $809.2 million for the Morrill & Janes merger and $67.1 million for the Freedom acquisition. Securities represented 32% of Heartland's total assets at December 31, 2013, compared to 31% at year-end 2012.

Total loans and leases held to maturity were $3.50 billion at December 31, 2013, compared to $2.82 billion at year-end 2012, an increase of $675.4 million or 24%, with $595.2 million occurring during the fourth quarter. Included in the loan growth for the fourth quarter of 2013 were $377.4 million acquired in the Morrill & Janes merger and $39.3 million acquired in the Freedom acquisition. Excluding these acquisitions, loan growth totaled $178.9 million or 6% for the fourth quarter of 2013 and $258.7 million or 9% for the full year of 2013. Commercial and commercial real estate loans, which totaled $2.48 billion at December 31, 2013, increased $478.6 million or 24% since year-end 2012, with $295.6 million attributable to the acquisitions. Residential mortgage loans, which totaled $349.3 million at December 31, 2013, increased $99.7 million or 40% since year-end 2012, with $56.6 million attributable to the acquisitions. Agricultural and agricultural real estate loans, which totaled $376.7 million at December 31, 2013, increased $48.4 million or 15% since year-end 2012, with $49.4 million attributable to the acquisitions. Consumer loans, which totaled $294.1 million at December 31, 2013, increased $48.5 million or 20% since year-end 2012, with $15.0 million attributable to the acquisitions.

"After a slow start in early 2013, Heartland experienced excellent loan growth in the second, third and fourth quarters of the year. Adjusting for acquisitions, total loans grew by 9%, balanced nicely among commercial and consumer business lines," added Fuller.

Total deposits were $4.67 billion at December 31, 2013, compared to $3.85 billion at year-end 2012, an increase of $820.8 million or 21%, with $665.3 million attributable to the Morrill & Janes merger and $54.1 million attributable to the Freedom acquisition. Demand deposits totaled $1.24 billion at December 31, 2013, an increase of $264.3 million or 27% since year-end 2012, with $91.6 million attributable to the acquisitions. Exclusive of $543.6 million acquired, savings deposits decreased $12.8 million or 1% since year-end 2012. Certificates of deposit decreased $58.5 million or 7% when excluding $84.2 million in acquired certificates of deposit. The composition of Heartland's deposits continued its positive trend as no-cost demand deposits as a percentage of total deposits were 27% at December 31, 2013, compared to 25% at December 31, 2012, while higher-cost certificates of deposit as a percentage of total deposits were 19% at December 31, 2013, compared to 23% at December 31, 2012.

Fuller said, "Adjusting for acquisitions, deposits increased by 3% in 2013. We continue to experience a very favorable shift in deposit mix, with demand deposits growing at an 18% rate."

Common stockholders' equity was $357.8 million at December 31, 2013, compared to $314.9 million at September 30, 2013, and $320.1 million at year-end 2012. Book value per common share was $19.44 at December 31, 2013, compared to $18.58 at September 30, 2013, and $19.02 at year-end 2012. Changes in common stockholders' equity and book value per common share are the result of earnings, dividends paid, stock transactions and mark-to-market adjustment for unrealized gains and losses on securities available for sale. As a result of increases in market interest rates on many debt securities during the last three quarters of 2013, Heartland's unrealized gains and losses on securities available for sale, net of applicable taxes, were at an unrealized loss of $15.1 million at December 31, 2013, and $11.2 million at September 30, 2013, compared to an unrealized gain of $20.5 million at December 31, 2012.

Decrease in Provision for Loan Losses For the Year; Decrease in Nonperforming Loans During the Quarter

The allowance for loan and lease losses at December 31, 2013, was 1.19% of loans and leases and 98.27% of nonperforming loans compared to 1.37% of loans and leases and 89.71% of nonperforming loans at December 31, 2012. The provision for loan losses was $2.0 million for the fourth quarter of 2013 compared to $3.4 million for the fourth quarter of 2012. For the full year of 2013, provision for loan losses was $9.7 million compared to $8.2 million for 2012.

Nonperforming loans, exclusive of those covered under loss sharing agreements, were $42.4 million or 1.21% of total loans and leases at December 31, 2013, compared to $47.1 million or 1.62% of total loans and leases at September 30, 2013, and $43.2 million or 1.53% of total loans and leases at December 31, 2012. Approximately 63%, or $27.3 million, of Heartland's nonperforming loans have individual loan balances exceeding $1.0 million, the largest of which is $6.8 million. These nonperforming loans, to an aggregate of 8 borrowers, are primarily located in the Midwestern states and are spread over 6 different industry classifications.

Delinquencies in each of the loan portfolios continue to be well-managed. Loans delinquent 30 to 89 days as a percent of total loans were 0.29% at December 31, 2013, compared to 0.67% at September 30, 2013, and 0.32% at December 31, 2012. The increase in delinquencies during the third quarter of 2013 was primarily associated with a single credit that was renewed after quarter end. Had this renewal occurred prior to quarter end, loans delinquent 30 to 89 days would have been at 0.37% at September 30, 2013.

Other real estate owned was $29.9 million at December 31, 2013, compared to $33.0 million at September 30, 2013, and $35.8 million at December 31, 2012. Liquidation strategies have been identified for all the assets held in other real estate owned. Management continues to market these properties through an orderly liquidation process instead of a quick liquidation process in order to avoid discounts greater than the projected carrying costs. During 2013, $6.0 million of other real estate owned was sold during the fourth quarter, $2.7 million during the third quarter, $5.3 million during the second quarter and $3.3 million during the first quarter.

The schedules below summarize the changes in Heartland's nonperforming assets, including those covered by loss share agreements, during the fourth quarter of 2013 and the year, in thousands:

Net charge-offs on loans during the fourth quarter of 2013 were $1.7 million compared to $5.0 during the fourth quarter of 2012. For the full year, net charge-offs were $6.7 million during 2013 compared to $6.3 million during 2012.

"For both the fourth quarter and the year 2013, we made excellent progress in the reduction of nonperforming loans. Total nonperforming loans ended the quarter at 1.21% of total loans, a decrease from 1.62% for the third quarter of 2013 and from 1.53% at year-end 2012. Maintaining excellent quality in our loan portfolio will always be one of our highest priorities," Fuller concluded.

Conference Call Details

Heartland will host a conference call for investors at 5:00 p.m. EDT today. To participate, dial 877-407-0781 at least five minutes before start time. To listen to the live webcast, log on to www.htlf.com at least 15 minutes before start time. If you are unable to participate on the call, a replay will be available until January 26, 2015, by logging on to www.htlf.com.

About Heartland Financial USA, Inc.

Heartland Financial USA, Inc. is a $5.9 billion diversified financial services company providing banking, mortgage, wealth management, investment, insurance and consumer finance services to individuals and businesses. Heartland currently has 80 banking locations in 60 communities in Iowa, Illinois, Wisconsin, New Mexico, Arizona, Montana, Colorado, Minnesota, Kansas and Missouri and loan production offices in California, Nevada, Wyoming, Idaho, North Dakota, Oregon, Washington and Nebraska. Additional information about Heartland Financial USA, Inc. is available at www.htlf.com.

Safe Harbor Statement

This release, and future oral and written statements of Heartland and its management, may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 about Heartland's financial condition, results of operations, plans, objectives, future performance and business. Although these forward-looking statements are based upon the beliefs, expectations and assumptions of Heartland's management, there are a number of factors, many of which are beyond the ability of management to control or predict, that could cause actual results to differ materially from those in its forward-looking statements. These factors, which are detailed in the risk factors included in Heartland's Annual Report on Form 10-K filed with the Securities and Exchange Commission, include, among others: (i) the strength of the local and national economy; (ii) the economic impact of past and any future terrorist threats and attacks and any acts of war, (iii) changes in state and federal laws, regulations and governmental policies concerning the Company's general business; (iv) changes in interest rates and prepayment rates of the Company's assets; (v) increased competition in the financial services sector and the inability to attract new customers; (vi) changes in technology and the ability to develop and maintain secure and reliable electronic systems; (vii) the potential impact of acquisitions, (viii) the loss of key executives or employees; (ix) changes in consumer spending; (x) unexpected outcomes of existing or new litigation involving the Company; and (xii) changes in accounting policies and practices. All statements in this release, including forward-looking statements, speak only as of the date they are made, and Heartland undertakes no obligation to update any statement in light of new information or future events.