Heartland Financial USA, Inc.
Q1 2008 Earnings Call Transcript

Published: 29 Apr 2008

[Operator:]

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Heartland Financial USA first quarter 2008 conference call. (Operator Instructions) I would now like to turn the call over to Leslie Loyet, with the Financial Relations Board. Please go ahead, ma'am.

[Leslie Loyet:]

Thank you. Good afternoon, everyone. Thank you for joining us on Heartland Financial USA's conference call to discuss first quarter 2008 results. This morning we distributed a copy of the press release and hopefully you've all had a chance to review the results. If there is anyone on line who did not receive a copy, you may either access it at Heartland's website at www.htlf.com or you may call Han Huie at 312-640-6688, and she will send you a copy immediately. With us today from management are Lynn B. Fuller, President and Chief Executive Officer, John K. Schmidt, Chief Operating Officer and Chief Financial Officer, and Ken Erickson, EVP and Chief Credit Officer. Management will provide a brief summary of the quarter, and then we'll open the call up to your questions. Before we begin the presentation I would like to remind everyone that some of the information that management will be providing today falls under 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 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 10K and 10Q filings, which can be obtained on the company's website or the SEC's website. At this time I'd like to turn the call over to Lynn Fuller. Please go ahead.

[Lynn B. Fuller:]

Thank you, Leslie, and good afternoon, everyone. We certainly appreciate all of you joining us here today to review Heartland's performance for the first quarter of 2008. I hope you all have had an opportunity to review Heartland's earnings release that was distributed this morning. For the next few minutes I will discuss quarterly highlights and the ongoing implementation of our growth strategy. I am joined today by John Schmidt, our Chief Operating Officer and CFO, and Ken Erickson, our Executive Vice President and Chief Credit Officer, both of whom will have additional details on Heartland's first quarter results. Today Heartland reported earnings of $6.3 million, a 9% increase compared to last year's first quarter earnings of $5.8 million. Earnings on a per diluted share basis from continuing operations grew to $0.38, an increase of 12%, compared to $0.34 per share for the first quarter of 2007. Also with respect to balance sheet growth, average earning assets increased $184 million or 7% over the first quarter 2007. In addition to earnings and asset growth, we maintained our net interest margin at or near 3.88% for three consecutive quarters. I feel we've done a remarkable job maintaining margin in light of the current environment. We've endured a rapid downward movement in rates and intense competition, including irrational pricing of loans and deposits by some competitors, all of which have caused significant margin compression among many of our peers. For the remainder of the year, margin maintenance will be aided on the deposit side as we continue to benefit from reduced rates on maturing CDs. On average, we are renewing $100 million in CDs per month, with as much as a 1% reduction in rates paid. On the loan side, we should be able to maintain returns with a continued discipline for appropriately pricing risk return as well as establishing interest rate floors backed up by prepayment fees. This, combined with improved returns on our investment portfolio and various sound asset, liability, and hedging strategies, should continue to serve the company well. In time, we will need to move our margin back up over 4%, however near-term non-accrual loans will continue to be a drag on our margin. While we are pleased with the first quarter results, we recognize there is room for improvement, especially in terms of our nonperforming loans. Like most banks of all sizes, we have seen nonperformers grow in recent quarters. As I shared with you last quarter, reduction of nonperforming loans is this year's number on priority. You may recall my mentioning in January that we hired a seasoned workout specialist charged with the responsibility of assisting our member banks in substantially reducing our problem loans by year end. We have scheduled out by quarter our best estimate of when we will gain control of our collateral, begin liquidation, and return dollars to earning assets. At this time we anticipated marked improvement in the third and fourth quarter of this year. Obviously, we are dissatisfied with nonperforming loans at this level as they are much higher than our historical levels, however we believe we are well collateralized in these loans and adequately reserved, with reserves at 1.48% of total loans and leases. Among Heartland's first quarter highlights we saw a solid increase of 11% in noninterest income compared to last year. This is an area of ongoing emphasis and annually each of our member banks are required to review the pricing of every service line to assure a fair return to the company while remaining competitively priced in each of their respective markets. Managing non-interest expense ranks number three in our top corporate objectives for this year. At the beginning of the year we initiated an internal effort to identify cost savings in every area of our operation. Each subsidiary and corporate departments have identified opportunities, many of which are being implemented right now. Combined with our ongoing efforts to implement workplace lean processes, we expect to see notable improvement in noninterest expense by year end. In terms of expansion, our plans for 2008 anticipate a somewhat slower pace, with one additional office in Albuquerque, New Mexico, and a main office location in Edina, Minnesota for Heartland's newest de novo and tenth bank charter. Our bank president, Kate Kelly, has assembled a talented team of experienced bankers who will cater to businesses and affluent individuals. We believe now is an excellent time to open a new bank in the Twin Cities market, and we are looking forward to Minnesota Bank & Trust's grand opening on May 22. Now with 60 banking offices in Heartland's footprint and 25% of our locations under three years old, we recognize the near-term negative impact on our efficiency ratio. However, as these office mature, we appreciate significant opportunity for future earnings growth. As a result, the generation of [more] non-time deposits is our second highest priority, and to that end, we are channeling resources into promotional efforts, introducing attractive new products for both business and retail markets, and investing in ongoing sales training for our staff. We believe the current stressful banking environment will eventually lead to some attractive acquisition opportunities for Heartland. Our current strategy is to seek out other community banking organizations within our existing markets. We are well positioned for these opportunities, with a solid capital base, nominal goodwill, and deep internal experience with M&A. We will continue our commitment to pursue only those transactions which are additive to our current shareholders' earnings per share. That concludes my comments. I will now turn the call over to John Schmidt for more detail on our first quarter and year-to-date financial results, and then John will introduce Ken Erickson, who will share his comments on the credit side. John?

[John K. Schmidt:]

Thanks, Lynn, and good afternoon. My comments will again focus on the most substantial changes to Heartland's balance sheet and income statement in the past quarter, in this case, 3/31/08 versus 12/31/07. Looking first at the balance sheet, total loan balances decreased by $8.5 million in the first quarter. This decrease was partially attributable to the payoff of a $24 million commercial credit that was refinanced into the secondary market. Saying that, we are seeing reduced loan demand and at the same time our first priority for our lenders is to clean up our nonperforming loans. For the remainder of 2008, with Minnesota Bank & Trust coming online, we would forecast loan production to be in the $100 million range. Net charge-offs for the quarter totaled $1.1 million. Net charge-offs to date expressed as a percentage of average loans and leases totaled 5 basis points or 19 basis points on an annualized basis. For the quarter, charge-offs at Citizens Finance, our finance subsidiary, represented 33% of the net losses. At the conclusion of my remarks, Ken Erickson - our Chief Credit Officer - will provide additional detail on our loan portfolio. Core deposits in this case excluding brokered CDs increased by $24.2 million from a quarter-over-quarter perspective. Competition for deposits continues to be keen and, as a result, we've found the Federal Home Loan Bank to be a lower-cost funding alternative, with balances increasing by $92 million in the past quarter. At the same time, our expectations of our lenders has always been to develop deposits, and given the slowing loan demand, we have asked them to redouble their efforts in this area. As Lynn mentioned, net income totaled $0.38 per basic diluted share in the quarter. Most significant in this is the fact that we're able to maintain our margin at 3.88% for the quarter. By and large, we are able to accomplish this by aggressively moving down rates in light of the Federal Reserve cuts. Going forward, 77% of our CD portfolio re-price in the next year at rates as much as 100 basis points below the average current rate of 4.3%. As a result, we would still model our margin in the lower 3.8% range for the remainder of 2008. Since our balance sheet remains asset sensitive, this will certainly be impacted by additional Fed rate cuts, our ability to grow loans, and the level of nonperforming assets. Non-interest income was up $300,000 on a linked core income basis. This analysis excludes the first quarter 2008 gain of $446,000 related to the Visa IPO as well as the fourth quarter 2007 $1 million gain on the sale of our credit card portfolio. It also excludes $838,000 amortization of investments made in limited liability companies that provided offsetting tax credits which were recognized in the fourth quarter. Total non-interest expense increased by $2.2 million or 9.5% comparing Q4 of 2007 versus Q1 2008. From a macro perspective, the opening of Minnesota Bank & Trust has had a significant impact in this area as we incurred $294,000 of expense in 2007 and $444,000 thus far in 2008. As we've indicated in the past, our de novos typically lose between $1 million and $1.5 million on an after-tax basis in the first year of operation. As we discussed last quarter, salaries and employee benefits experienced a $2.4 million decrease in the fourth quarter of 2007 as we reduced our incentive compensation and profit sharing payouts. For the purposes of this line item, a more reflective comparison would be with the third quarter of 2007. In this comparison, salaries and employee benefits increased by $492,000 or 3.5%. Consistent with previous years, we expect to see relatively modest increases in this area for the remainder of the year. Of the remaining categories in non-interest expense, occupancy experienced the largest increase of $383,000 or 20%. This increase is primarily attributable to the opening of branches in Arizona and Colorado. On a go forward basis, we don't forecast a significant increase in this area given the moderation in branch openings that Lynn mentioned. The tax rate for the quarter was 27.86% reflecting the recognition of tax credits at Dubuque Bank & Trust. On a go forward basis, we still feel that our tax rate will be in the 30% range for the remainder of 2008. In closing, I would reiterate some of Lynn's comments in that we are very pleased with many aspects of the first quarter performance, including income, margin maintenance, and general cost control. At the same time, we realize that we have a lot of work to do in terms of nonperforming loans. With that, I'll turn it over to Ken Erickson, our Chief Credit Officer.

[Ken Erickson:]

Thanks, John. Good afternoon. As already mentioned, for the quarter ended March 31, our nonperforming loans had increased by $7 million. This is almost entirely attributed to one credit in the Arizona market which is in the process of collection. Foreclosure on this property is anticipated to be completed prior to the end of the year. Our nonperforming loans are still concentrated within a small number of credits. Six nonperforming credit relationships individually exceed $1 million for an aggregate of $23.7 million or 61% of the nonaccrual loans. Four of these relationships are in housing related industries, representing $15.9 million, with $8.8 million of these in Wisconsin and the remaining $7 million in Arizona. While material losses are not anticipated in any of these credits, we do understand the softness in recent real estate values, especially in Arizona, which may further increase our loss exposure if our estimated collateral values decrease. Although this quarter still shows an increase in nonperforming assets, I am encouraged by the progress shown on several of these loans. Collection efforts continue, and reductions should be seen throughout the balance of this year on the existing nonperforming loans. Several of these will be resolved through foreclosure, which will increase other real estate owned. With only $2.7 million currently in OREO, this increase will not put a significant strain on our financial performance, but we will make concerted efforts to liquidate the additions as soon as possible and return these dollars to income-producing assets. Our retail loans continue to perform quite well. Our bank consumer loans over 30 days delinquency is 1.53%. Approximately one-half of our bank consumer loans are home equity lines of credit. The over 30 day delinquencies of [inaudible] is 1.47%. Our residential real estate loans have a delinquency of 1.05%. Excluding the serviced loans, the $218 million held in portfolio have a delinquency of 2.05%. Foreclosures also remain relatively low in all of our markets. Only 12 of our residential real estate loans held in portfolio - with an addition of 10 more within the serviced loans - are in foreclosure. At the end of March, this represents only 0.35% of the balances and 0.24% of the number of residential real estate loans and 0.75% of the balances of those held in portfolio. Citizens Finance, our consumer finance company, has also shown solid performance in the first quarter. Delinquency is 4.68% at the end of the quarter, which is down from an average of 5.69% for 2007. Net losses were 3.51% as compared to 4.14% for the year 2007. With that, I'll return the call back to Lynn.

[Lynn B. Fuller:]

Thank you, Ken. Thank you, John, for your comments as well. At this time we'd like to open it up for questions.

[Operator:]

Thank you, sir. (Operator Instructions) Our first question comes from Jon Arfstrom with RBC Capital Markets. Please go ahead.

[Jon Arfstrom:]

Thanks. Good afternoon.

[Lynn B. Fuller:]

Good afternoon, Jon.

[Jon Arfstrom:]

A couple of questions for you. The $100 million you talked about in -- the loan growth target for '08.

[John K. Schmidt:]

Right.

[Jon Arfstrom:]

What markets do you think will drive that growth?

[John K. Schmidt:]

Currently we do look, John, to Minneapolis. As I mentioned, that bank comes online. It opened on April 15. And so we would anticipate, with the staffing that Kate Kelly, our President, has in place at this point, that certainly would be number one on the list. I would add to that, then, [Summit] Bank in Denver, Colorado, our second-newest de novo, if you will. And we still see loan growth to be pretty solid in Dubuque - Dubuque Bank & Trust.

[Jon Arfstrom:]

Okay.

[Lynn B. Fuller:]

You might add - this is Lynn - you might add New Mexico, John, to that and possibly Montana. We have some credits that we're moving out in both of those markets, but they still could show us some pretty positive growth. I would say the strongest market from an economic standpoint that we're in is probably New Mexico and Iowa, believe it or not. I think the economies are pretty stable in the Madison area, although things are slow in Wisconsin. Denver seems to be stable, and Minnesota seems to be stable. Arizona is by far the weakest market that we're in at present.

[Jon Arfstrom:]

Okay. And just a question on the agriculture portfolio. You know, I know you've seen a lot of variation in commodity prices through the years, but it looks like you had a pretty good quarter in that business and obviously one of the stronger sectors of the economy. I'm just curious how you balance some of the risks and opportunities in that business and what kind of an appetite you have for expanding that business further.

[Lynn B. Fuller:]

We are probably one of the premiere ag lenders in the state as far as the bank. Dubuque Bank & Trust has a very solid portfolio of ag loans and our historic losses in that portfolio have been very, very low. We tend to deal with the large ag relationships, the larger operations, where you have - the young people have come back from graduating from ag school at Ames or the like. They clearly are running the family farm like a business. These are larger operations that are well managed. They hedge their inputs and their outputs. We've always been very careful not to lend at too high a levels of loan to value where you see land values escalating from $5,000 an acre to $6,000 an acre for productive land. So we're pretty careful not to get caught up in loaning out at too high loan to values with land at these levels.

[Ken Erickson:]

Jon, it's Ken. I would just add to that, we certainly look - especially when some ag land has shot up in value significantly in the last 12 months - we do keep in mind the production value versus the recent sales price when we're underwriting any credit. And then within our ag portfolio we do have a fair amount of diversification in there between those in the livestock industry - between cattle, hogs and dairy - as well as those in row crop production. So behind the numbers of ag loans there's a fairly good diversification within the ag sector. And as far as the states that we're in, the biggest portfolios would be Iowa - out of Dubuque Bank & Trust  followed by probably Wisconsin - Monroe, Wisconsin and the surrounding areas south of Madison. We have a small amount  a very small amount - of ag in Illinois, but we do have ag in Montana as well as down in Clovis and Portales, New Mexico, which is on the border of Texas and New Mexico.

[Jon Arfstrom:]

Okay. All right. That's helpful. And then, John, just one question. Do you have the dollar amount of your floating rate loans that are at floor?

[John K. Schmidt:]

Jon, I don't have that in front of me right now.

[Jon Arfstrom:]

I'll just follow up later on that.

[John K. Schmidt:]

All right, if you would.

[Jon Arfstrom:]

Yep. Thanks, guys.

[Lynn B. Fuller:]

Thank you, Jon.

[Operator:]

(Operator Instructions) Our next question come from Brad Milsaps with Sandler O'Neill. Please go ahead.

[Brad Milsaps:]

Hey, good afternoon.

[Lynn B. Fuller:]

Hey, Brad.

[Ken Erickson:]

Hi, Brad.

[Brad Milsaps:]

Hi. Just curious - any charges this quarter related to the large Arizona one? Did you write that down at all? Is that part of the $1.1 million in net charge-offs this quarter?

[John K. Schmidt:]

There was no direct charge-off on that credit yet. We do have a specific reserve against that as well as many other credits within our portfolio, but none of the $1.1 charge-offs was related to that credit.

[Lynn B. Fuller:]

We did have some real estate, though, in Arizona that we had written down - we're bringing into OREO. Is that correct, Ken?

[Ken Erickson:]

Okay, that's in the following.

[Lynn B. Fuller:]

Okay.

[Brad Milsaps:]

So did I understand correctly that you expect some resolution to that - to that $7 million credit  this quarter?

[John K. Schmidt:]

No. It will happen this year. We have begun legal process. It will most likely go through foreclosure, and that will be completed prior to year end.

[Brad Milsaps:]

Okay. And then, guys, just maybe a little bit more color on the $24 million loan that paid off this quarter. Just curious - did that relationship have any significant deposits attached to it? Which bank did that come out of? And then would you consider that one of your larger loans on the books and, you know, any others that might fit in that category?

[Ken Erickson:]

Brad, that is one of the larger loans we do have on our books. It was really - participated out through all of our banks. The originating bank was Galena State Bank. All the deposit balances did remain with us and will remain with us on a go forward basis.

[Brad Milsaps:]

Okay. And then final question. John, could you just talk a little bit about maybe the margin and kind of what you're doing on the balance sheet in terms of maybe duration of some of the wholesale borrowings that you're using at this point? And then maybe what else you're buying in the investment portfolio?

[John K. Schmidt:]

As far as the duration on the balance sheet, we're still keeping that relatively short overall. The funding sources - again, as I indicated in my comments, Brad - you are seeing the FHLB, although they've [tightened] up a little bit recently. We saw that as a tremendous opportunity in the first quarter, and we did seize that opportunity. Not to say that we departed any of the local markets, but certainly that was one of our key funding sources throughout the quarter. So we drove down our costs there. We drove it down in terms of repurchase agreements as well, most of which are tied to fed funds. I think all that was very positive from our perspective - the [inaudible] from the margin perspective. Relative to the investment side, we are shifting more of our portfolio to mortgage backs now. We're moving out of agencies into mortgage backs. We feel there's tremendous value there versus historical spreads, so that's been our focus, really, for the last probably six to seven months.

[Lynn B. Fuller:]

We're buying mortgage backs, Brad, that perform better in a rates up environment. Our concern is that the next 12 to 18 months we could start to see rates move up the other direction, so even if we get some short-term drop by the Fed, we're repositioning some of the investment dollars to help us out as rates increase. The other thing, with FHLB, we bought a number of maturities that we could lock in very low cost of funding. These were five, seven and 10-year total maturities with no call for two, three and four years. So we got a lock on those dollars for the next two, three and four years, and it was much cheaper than what we could actually buy two, three and four-year money in our local markets in CDs.

[Brad Milsaps:]

Okay, great. Thank you very much.

[Operator:]

Our next question comes from John Rowan with Sidoti & Company. Please go ahead.

[John Rowan:]

Good afternoon.

[Lynn B. Fuller:]

John.

[John Rowan:]

Hey, John, can you just discuss - again on the margin issue - can you just discuss your deposits and kind of where you're going to get some compression on the liability side if you see further rate cuts?

[John K. Schmidt:]

Well, you know, certainly on the savings product we're going to see some impact there, both the regular savings and IBCA. We are reaching the effective 4 in those. Maybe [inaudible] a little bit. We introduced a product which we call Cash Reward Checking that we've been paying 6% on, the cost of which is offset by debits that are required - the customer is required to put through each month - in order to obtain that rate. It's a $20,000 maximum balance that we'll pay that 6% on. We do see an opportunity ultimately to push that down. We have in one bank committed to - all through I believe the end of '09, but the remaining balance in that account we can start to look at reducing that cost probably at the year end in that account. I think total balances in that right now are approximately $7 million, so it's not huge right now but we do see an opportunity to grow that. But that's one way we can actually start to reduce our costs at the same time.

[Lynn B. Fuller:]

John, I - this isn't your question but it was a question asked before about the floors, and I don't have the dollar amount either, but most of the floors that we're implementing on our floating rate loans are between 5% and 6%. So many of those have started to kick in.

[John Rowan:]

Okay. Thank you very much.

[Lynn B. Fuller:]

Did I address your question, John?

[John Rowan:]

Sure.

[Operator:]

(Operator Instructions) And our next question comes from Brian Martin with Howe Barnes. Please go ahead.

[Brian Martin:]

Hi, guys.

[Ken Erickson:]

Hi, Brian.

[Lynn B. Fuller:]

Afternoon, Brian.

[Brian Martin:]

Hey, I just wanted - you talked about some of the resolution and the liquidation of the credit issues. Ken, can you just give a little bit more color as far as what your expectations are in that area - you talked about the second half of the year.

[Ken Erickson:]

I think Lynn mentioned it, too. We have scheduled those out, the existing nonperforming, and I'm looking at the sheet here. With the existing nonperformings we have, I expect those to be a third of what they are today. That bars any new nonperformings sliding into that group, which certainly could occur. But from the ones that we see today, we see those down to approximately a third of what we have. As I mentioned, a good part of those will go through foreclosure and will end up in other real estate. But then we'll be through the process of the problem loan and be in control of the underlying asset so we can liquidate it.

[Brian Martin:]

Okay. And you talked about just some of the loss content being pretty minimal and, I guess, have you done - you know, I guess, what have you done, reappraisals on these properties or what are the current timing of those reappraisals? Have they been done or are you in the process of that?

[Ken Erickson:]

The most recent one that I mentioned - the $7 million in Arizona - we have an appraisal ordered on that. It will several months before we get to conclusion of a foreclosure process, but we have an appraisal that's been ordered so we can begin assessment of that at this time.

[Brian Martin:]

Okay.

[Lynn B. Fuller:]

Brian, there are other credits beyond that, though, that we do have current appraisals within the last 90 days.

[Brian Martin:]

Okay. Okay.

[Lynn B. Fuller:]

Ken was just referring to that individual credit.

[Brian Martin:]

Right. Exactly. Okay. Yeah, I think that's all I've got. Thanks, guys.

[Lynn B. Fuller:]

Thanks, Brian.

[Operator:]

Our next question comes from Stephen Geyen with Stifel Nicolaus. Please go ahead.

[Stephen Geyen:]

Yeah, I was wondering if you could quantify the improvement in non-interest expense that you expect by the year end?

[John K. Schmidt:]

The overall improvement, Stephen, in non-interest expense, did you say?

[Stephen Geyen:]

Yes, please.

[John K. Schmidt:]

I think the biggest thing we saw is really the plateauing of salaries and employee benefits. As I indicated, we're up modestly in that line item when you compare 9/30 versus 3/31. The other item by and large look to be fairly stable across the board with the exception of occupancy, as I indicated, which, really, we're starting to see some of the cost associated with branches coming online. It impacts us there. Other than that, again, I see it relatively stable almost across the board quarter-over-quarter.

[Stephen Geyen:]

Okay. And Lynn, you'd mentioned the acquisitions, or the interest in acquisitions. Could you talk a little bit about location, size, asset [inaudible] that you might be interested in?

[Lynn B. Fuller:]

We're starting to hear of more community banks that are interested in looking at having Heartland as a partner. And we've heard of that in Minnesota, we've heard of it in Arizona - in Phoenix - in Denver, so I would say those are probably the ones that we have the most knowledge of at this point. We don’t have any in Iowa; none at this point in Wisconsin or Illinois, but we do have some interest in both Minnesota, Arizona, and - let's see - one in Montana  Montana, Minnesota, Denver and Arizona, those four states. The size? Anywhere from $100 to $300 million in size would be probably the most probable prospects, $100 to $300 would be the range.

[Stephen Geyen:]

Okay, thank you.

[Operator:]

Our next question comes from Jeff Davis with Ftn Financial. Please go ahead.

[Jeff Davis:]

Good afternoon. John, if you said it, I completely missed it - or Lynn, if you said it, or Ken, for that matter  in terms of loss rates, then, for the quarter, 19 bips annualized and a third or so for Citizens, is it fair to say, then, expectations for charge-offs this year will be somewhere between the - call it 20 bips - and the 30 or so you've had the last year or two?

[John K. Schmidt:]

That's a good question, Jeff, and I think Ken framed it pretty well in his comments that based on what we're seeing right now, yes, it is. It should hopefully be in that 20 basis point area. But we also understand that there is a softness in that Arizona market, and so as we take these properties into other real estate, that's going to be swing pick at this juncture.

[Jeff Davis:]

Okay. But nothing dramatic, at least as of today?

[John K. Schmidt:]

I would turn that question over to Ken.

[Ken Erickson:]

As of today, I don't see any major surprises that would show us losses that would be anywhere close to where we were last year. We still have to work through these issues. We've always been good at taking collateral, and we're faced in some markets where we've had some significant decline in collateral values. We still feel relatively well protected, but we need to get through this softness, especially in Arizona.

[Jeff Davis:]

And Ken, you made a reference to I guess problem or potential problem loans declining by a third, if I heard that right. Could you restate that again and the context?

[Ken Erickson:]

Yeah. Lynn started by making the comment that we have charted out the nonperforming assets, looking at those quarter by quarter on resolutions that we expect will come to fruition. And by the end of the year - by the end of the fourth quarter - I expect the existing nonperforming portfolio will a third of the size that it is today.

[Jeff Davis:]

Sorry, I'm not listening well. I'm not listening well, sorry. So Ken is it - then is, in terms of your watch list or just from a grading of your credits, has the migration of deterioration plateaued and now we're starting to see sevens become sixes and more sixes become fives?

[Ken Erickson:]

I would say we're seeing sevens becoming worked out and moving those to other real estate.

[Jeff Davis:]

Okay.

[Ken Erickson:]

And as I had mentioned before, nonaccrual loans I anticipate will be reduced by a third from our existing portfolio. I wish I could see into the future well enough to know if we have any more that are going to slip over. Today I feel fairly comfortable with our portfolio, and I expect those non-accrual loans to be a third of what they are today. But with that said, we'll have a significant pickup in other real estate, which then we'll have to market those properties and reduce - and return those into income-producing assets.

[Jeff Davis:]

Understood. Thank you.

[Operator:]

At this time I am showing no further questions. I'd like to turn the call back over to Mr. Fuller for any concluding remarks.

[Lynn B. Fuller:]

Great. Thank you, and thank you all for joining us today. Heartland continues to navigate through some very challenging times, but with a solid first quarter increase in earnings and increase in earnings per share and continued growth in non-interest income as well as continued growth in our earning assets. I thank you all again for joining us and hope you can join us at our next quarterly conference call, which is scheduled for July 28, 2008. Have a good evening, everybody.

[Operator:]

Ladies and gentlemen, this concludes the Heartland Financial USA first quarter 2008 conference call. You may now disconnect, and ACP would like to thank you for your participation. Have a pleasant day.