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Heartland Financial USA, Inc. (NASDAQ:HTLF)

Q4 2013 Earnings Conference Call

January 27, 2014; 05:00 p.m. ET

Executives

Lynn Fuller - Chairman, President & Chief Executive Officer

Bryan McKeag - Chief Financial Officer

Kenneth Erickson - Executive Vice President & Chief Credit Officer

Analysts

Chris McGratty - KBW

Jeff Rulis - D.A. Davidson

John Rowan - Sidoti & Company

Jon Arfstrom - RBC

Operator

Greetings, and welcome to the Heartland Financial USA Inc., fourth quarter 2013 conference call. This afternoon Heartland distributed its fourth quarter press release and hopefully you've had a chance to review the results. If there is anyone on this call 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, Chairman, President and Chief Executive Officer; Bryan McKeag, 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 up the call to your questions.

Before we begin the presentation, I would like to remind everyone that some of the information 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 concerning the company's hopes, beliefs, expectations and predictions of the future are forward-looking statements, and actual results could differ materially from those projected. Additional information on these factors is included from time-to-time in the company's 10-K and 10-Q filings, which may be obtained on the company's website or the SEC's website.

At this time all participants are in a listen-only mode. (Operator Instructions). As a reminder, this conference is being recorded.

At this time I will now turn the call over to Mr. Lynn Fuller at Heartland. Please go ahead, sir.

Lynn Fuller

Thank you Manny and good afternoon everyone. We certainly appreciate everyone joining us this afternoon as we review Heartland's performance for the fourth quarter and full year of 2013. For the next few minutes I'll touch on the highlights for the quarter and the year and we'll then turn the call over to Bryan McKeag, our Executive Vice President and Chief Financial Officer, who will provide further detail on Heartland's quarterly financial results. And then Ken Erickson, our EVP and Chief Credit Officer, will offer insights on credit-related topics.

I’ll open my remarks this afternoon with news that Heartland recorded solid fourth quarter net income of $7.9 million or $0.42 per diluted common share. 2013 was Heartland’s second best year in its 33-year history, with earnings of $36.9 million or $2.04 per diluted common share, albeit short of the spectacular 2012 all time record year of $2.77 per share.

Well we have good reason to be encouraged by several aspects of Heartland’s performance. Return on average equity and return on average common tangible equity were 10.87% and 12.16% respectively. Our net interest margin remained stable and we experienced strong loan growth with improved credit quality; let me elaborate on these.

Net interest margin increase to 3.82%, a small gain over the previous quarter, but significant given the pressure on asset yields. Our 2013 annual margin was 3.78%. Margin improvement was a result of a combination of loan growth, improved yields on securities and some reduction in our funding cost.

After a slow start early in the year, we were very pleased to see solid loan growth during the second, third and fourth quarter. Adjusting for acquisitions, total loans grew by $259 million or 9%, well balanced among commercial and consumer business lines.

Quality loan growth remains our highest priorities, thus we continue to invest in sales training programs to enhance our business development efforts. As we stated in previous calls, our strategy remains to shift dollars out of securities into quality loans. Securities now represent 32% of total assets, so we can grow loans significantly without increasing the size of our balance sheet.

Another encouraging trend is the continued reduction in non-performing loans. Non-performing loans ended the year at 1.21% of total loans and we see even more opportunity to reduce this percentage going forward. Our allowance as a percentage of non-performing loans to total loans now stands at 98%.

Provision expense increased slightly in 2013 to $9.7 million compared to $8.2 million for the previous year; much of the provision is related to loan growth with net charge-offs at only 22 bips. In a few minutes Ken Erickson will provide more detail on credit related topics.

We are moving on to deposits. For 2013 deposits increased by 3% net of acquisitions. More importantly, non-interest demand deposits grew at an impressive rate of 18%. As a result we continue to experience a very favorable shift in deposit mix. At year-end, non-interest demand deposits represented 27% of total deposits, with savings in money markets representing 54% and CDs now representing only 19% of total deposits.

Well in terms of capital, our tangible capital ratio slipped to 5.29% for the quarter, largely as a result of our two acquisitions. Our book value and tangible book value per share ended the quarter at $19.44 and $16.90 respectively.

Moving on to the income statement, non-interest income of $89.6 million for 2013 is down from the previous year as a result of the slow down in mortgage originations. Like the industry, we’ve had to pair back overhead. Originations of $1.5 billion came close to matching the previous year’s production on $1.6 billion. Other fee income areas such as service charges, loan-servicing income, trust fees and brokerage saw double digit increases.

Our mortgage production continues to shift away from refi's towards purchase originations, with purchase originations at 65% for the fourth quarter and 50% for the full year. Responding to the slowdown in residential refi activity, our Heartland Mortgage unit continues to increase its production capabilities, both within and outside our current footprint.

We recently opened new loan production office in Omaha, Nebraska; Sacramental, California; Seattle, Washington and Portland, Oregon. In the near future we will be originating loans in Las Vegas, Nevada and Kansas City, Kansas.

Expansion of our banking franchise through M&A remains a high priority for Heartland. In the fourth quarter we completed the purchase of Kansas-based Morrill Bancshares, and welcomed our new associates from Morrill & Janes Bank and Trust Company into the Heartland organization. Additionally we acquired Freedom Bank of Sterling, Illinois through our Dubuque Bank and Trust flagship bank.

In March Freedom Bank will become part of our Rockford, Illinois-based Riverside Community Bank, bringing our total assets in Illinois to nearly $800 million. Our goal remains to achieve a minimum of $1 billion in assets in each state where Heartland has its subsidiary.

Also during the fourth quarter Citizens Finance, our consumer finance subsidiary opened its 12th branch in Milwaukee, Wisconsin. Heartland now operates out of 10 states with new branches from acquisitions and one branch closure, we now have 80 banking locations and assets just shy of $6 billion. With mortgage loan production offices in eight additional states, it takes Heartland’s footprint into 18 states, both Midwest and West.

Our new retail division continues to generate strong consumer loan growth, while at the same time improving efficiencies. Our five year goal is to have 80% of our branches at $50 million or greater in depositions and/or profitable.

Well, I’m pleased to report that in January the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share payable on March 7, 2014. Proud to say that since Heartlands inception in 1981, our regular quarterly dividend has either increased or remained stable.

Well, now I’ll turn the call over to Bryan McKeag for more details on our quarterly results and then Bryan will introduce Ken Erickson, who will provide commentary on credit topics. Go ahead Bryan.

Bryan McKeag

Thanks Lynn and good afternoon. Over the next few minutes I'll share some details on the main performance drivers of our fourth quarter results and provide updates on some of our key operating metrics.

I'll start with the balance sheet. The investment portfolio increased $448 million, which includes $479 million from acquired institutions, ending the quarter at just under $1.9 billion.

The tax equivalent yield on the portfolio increased 12 basis points during the quarter to 2.81%, reflecting both the impact of lower-yielding portfolio run-offs and lower premium amortization, due to slowing prepayment speeds on our mortgage-backed securities. These slowing prepayment speeds have also caused the duration of the portfolio to increase slightly to 4.5 years, up from 4.3 years at the end of 2012.

Moving to the loan portfolio, loans held for maturity grew $595 million this quarter, ending the quarter at $3.5 billion. Excluding the 470 million of loans added from acquisitions, core growth was very strong at $197 million for quarter. This brings the full years growth to approximately $260 million or 9%, excluding acquisitions.

Shifting to the income statement, net interest margin remained flat at 3.82% for the fourth quarter, compared to 3.81% in the prior quarter. This increase reflects the previously mentioned 12 basis-point pickup in investment yield, our reduction in liability interest cost of five basis points, offset by a nine basis-point decline in loan yields.

More importantly, net interest income continued to growth in the fourth quarter, increasing to $46.4 million from $39.9 million in the third quarter. This is the seventh consecutive quarter of increasing net interest income, and is a trend, which we believe should continue inline with our ability to increase loan balances.

As I stated, we continue to make progress in reducing our interest costs, which declined another five basis points this quarter. Our greatest opportunity continues to be in time deposits, with about $100 million maturing per quarter over the next several quarters, at average rates of around 1.3%. We have been experiencing a 75 to 100 basis-point reduction in cost as these certificates mature. Ken Erickson will provide additional information on the provision for loan and lease losses, which totaled $2 million for the quarter.

Non-interest income totaled $17.6 million for the fourth quarter, down $3.1 million compared to the prior quarter. The decrease is attributable to a $3.4 million or 38% decline in mortgage banking income, which correlates to the lower volume of mortgage loans sold, which totaled $214 million for the quarter, down 36% from the prior quarter.

Shifting to non-interest expense. The fourth quarter was a relatively noisy quarter for expenses, which increased $6.8 million over the prior quarter. Salaries and benefits costs increased $1.3 million quarter-over-quarter, primarily as a result of acquired acquisitions completed during the quarter.

Increases and decreases in all the components within this category largely offset each other, as lower commissions and salaries associated with the decline in mortgage production where offset by changes in benefits and incentive approvals.

Professional fees increased $800,000 quarter-over-quarter due to higher than normal recruiting and acquisition related cost. Other expenses increased $2.4 million over the prior quarter, due to approximately $1.8 million of one-time costs related to tax credit investments, losses on fixed assets in conjunction with branch closures and other year end adjustments. The remaining $600,000 increase relates to run-rate increases from our new acquisitions. Ken Erickson will also provide some detail regarding $1.3 million increase in loses on repossessed assets in his comments.

Increases in all of the remaining expense categories that I’ve not mentioned together totaled approximately $1 million, which primarily reflect run-rate increases related to our new acquisitions.

In regards to income taxes, during the quarter we recorded $1.3 million of tax credit adjustments, resulting in net tax expense of only $46,000 for the quarter. Without these items our effective tax rate would have been consistent with 18% in the prior quarter.

In summary I would provide the following relative to anticipated performance as we head into 2014. Loan growth for 2014 is expected to be similar to 2013. Of course this is highly dependent on the level of economy activity in the markets where we operate.

Also similar to 2013 the quarterly growth will be choppy, with the first quarterly likely to be lower due to the historically weaker loan demand generally experienced since quarter one. We plan to continue to fund with the large portion of our loan growth with the investment portfolio cash flow.

Net interest income should continue to increase slowing in line with loan growth, with the net interest margin remaining fairly stable over the next quarter, with some deterioration as we move through the year assuming interest rates remain low, which will continue to put pressure on asset yields.

Gain on sales of loans will be lower in the first of 2014 as loan production is expected to be lower in the first quarter of 2014 and this quarter and then should begin to increase modestly. We feel it’s appropriate to expect the tax rate to return to the 27% to 28% range going forward for 2014.

With that I’ll turn the call over Ken Erickson, Executive Vice President and Chief Credit Officer.

Kenneth Erickson

Thank you Bryan and good afternoon. I will begin by discussing the change in non-performing loans and other real estate owned. We acquired two banks in the fourth quarter, which increased our non-performing loans by $1.7 million and all the real estate owned by $2.9 million. Including those assets covered by a law share agreement and those acquired in the acquisitions, our non-performing loans decreased by $4.7 million in the fourth quarter.

Excluding the effect of acquisitions, the non-performing loans declined by $6.1 million. Other real estate owned and other repossessed assets were reduced by $3.2 million for the fourth quarter. Excluding the effect of acquisition, all the real estate loans decreased by $6.4 million.

As of December 31 our ratio of non-performing loans to total loans is at 1.21%, which compares favorably to the 1.62% as of September 30 and the 1.53% as of December 31, 2012. Our ratio of non-performing assets to total assets is at 1.23% and also compares favorably to the 1.63% at the end of the third quarter and 1.59% at the end of last year.

These reductions are the result of continued collection effort of our non-performing assets, as well as the fact that the loan portfolio of the Morrill & Janes Bank acquired in the fourth quarter is exceptionally clean.

Provision expense was reduced in the fourth quarter to $2 million. $1.1 million of this provision relates to our consumer finance company, Citizens Finance. The remaining provision expense was mainly a result of the allowance needed for the new loan growth.

30 to 89 day delinquencies decreased from 67 basis points at the end of the third quarter to 29 basis points at December 31, which is more consistent with our expectations and performance over the past several years.

The increase in the third quarter was related to a single borrower who its notes were reviewed after quarter end. Other real estate owned continues to sell at or near book value. The net loss on repossessed assets was $2.4 million. $2 million of this is collection, ORE and repo expense. The remainder was associated with property value adjustments during the quarter.

This appears elevated, but a significant portion of this expense is offset by other real estate income on an income property that was sold in the fourth quarter. $6.8 million in sales were recorded in the fourth quarter, which represented 21% of the other real estate owned as of September 30.

Our existing portfolio is made up of 19 residential properties, aggregating to $2 million and 85 commercial properties that aggregate to $27.8 million. Of these 85 properties, 32 are individual lots and 19 are land loans combined comprising $14.9 million of our other real estate owned.

As shown in the earnings release, our coverage ratio of allowance for loan and lease losses as a percent of non-performing loans and lease was 98.27%, up from 87.73% as shown at the end of the third quarter. Excluding the non-performing loans obtained in the acquisition, that will be covered by the valuation reserve this ratio would be 105.7%.

The allowance for loan and lease losses as a percent of loans and leases decreased from 1.42% to 1.19% this quarter. This is primarily the result of the loans acquired in the fourth quarter. A valuation reserve of $9 million is recorded for those loans obtained in the acquisition.

Excluding those loans from the allowance for loan and lease losses as a percent of loans and leases calculation, would result in a ratio of a 1.38% for December 31, which would compare to 1.47% at September 30, 1.38% for June 30 and 1.41% for March 31. As mentioned by both Lynn and Bryan, we had good loan growth in 2013. Excluding acquisitions we had organic growth of $259 million or 9.17%.

In February and March we launched our Small Business banking platform across all of our banks with two primary objectives. The first was to bring banking services to what we believe to be an underserved market. We feel successful in meeting the first objective and that we obtained a 15% loan growth in this segment since March 31.

The second objective was to make our commercial bankers more productive and allow them more time for sales activity by moving the management responsibilities of the Small Business customers from them to dedicated business bankers. We feel we also saw significant lift in the productivity of the commercial bankers meeting our second objectives.

182 million of our organic growth in 2013 came in our commercial and agricultural portfolio. Growth occurred primarily in C&I. The majority of the growth came in three of our markets, the Dubuque, Iowa, Rockford, Illinois and Phoenix, Arizona. Strong performance was also shown at Minnesota Bank and Trust, as well as the Mexico Bank and Trust.

A new CRM system and app was installed in 2013. The ability to manage sales activity has begun to show its impact. Our bank sales activity and active pipelines are showing growth nearly every month. We know this will be critical to our success since in this economy multiple loan growth will need to be obtained from outperforming our competitors for their existing customers versus new loan growth.

Credit quality continues to be of utmost importance. We have not and will not loosen credit standards to obtain loan growth. Our underwriting process and policy guidelines remain relatively unchanged. Our weighted average risk rating has improved over the past year. When I compare those loans that were booked in 2013 to the entire portfolio, I also see that the weighted average risk rating on the 2013 production is better than the portfolio as a whole. This analysis gives me confidence that credit quality has not been sacrificed to obtain growth.

Growth within the consumer sector was also strong in 2013 with 14% growth in loans. This was primarily shown in two product categories, home equity lines of credit and automobile loans. The implementation of our retail banking division continues to take hold as evidenced by this loan growth.

With that I will turn the call back to you Lynn and remain available for questions.

Lynn Fuller

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is from Chris McGratty of KBW. Please go ahead.

Chris McGratty - KBW

Hey, good afternoon guys.

Lynn Fuller

Hi Chris.

Chris McGratty - KBW

Lynn, you talked about the growth momentum that’s changing the year and it sounds – like if I heard you correctly, the organic growth was called $260 million. That’s kind of the target for this year. My first question is, should we assume the majority of this comes from a reduction in the securities portfolio, which is $1.750 billion or will…

Lynn Fuller

Yes.

Chris McGratty - KBW

Okay, good. Its…

Lynn Fuller

Yes, that’s our intent. We saw that happen to a fair extent during ’13. We will continue to see that during ’14. I mean we would more typically run out of banks and the company at about a 20% investment to assets versus the 32% right now.

Chris McGratty - KBW

That helps address my second question. Your capital ratios with the deal fell a little bit and you guys are always drawing a little bit more levered on the tangible. But I guess I’ll be interested in your comments about how you balance future portfolio growth, maybe against the need to eventually raise some growth capital down the road.

Bryan McKeag

Yes, we really don’t worry about the other capital ratios, because they are – I didn’t quote those today, but they are extremely strong relative to the regulatory guidelines; you know not quite double, but they are out there. So the shift out of securities into loan assets doesn’t really cause as a concern for risk based capital and those are all in good shape.

The asset side, as I said you’re not going to see a lot of growth just from our organic activities. If you see a lot of growth, its most likely going to be from acquisitions and our pipeline for the most part has banks that are looking for partners and they are looking for our stock versus cash.

We do have a preference to do stock transactions versus cash transactions knowing that these M&A transactions will have some small portion of cash associated and you know that we have a $75 million shelf out there if we should need common stock, but again, as we shift out of securities into loans, we are not going to see a lot of organic asset growth.

Chris McGratty - KBW

Okay, so your comfortable running the tangible with this?

Bryan McKeag

Well, our forecast shows us getting back up to that 6% to 7%. We used to think that 5% to 6% was a decent range for TCE. We really think we’d be better at the 6% to 7%, but it’s going to take earnings to get us back up to that level.

Chris McGratty - KBW

Okay. Just a couple of housekeeping items. The intangible amortization, that’s 470,000, Bryan, that’s a good run rate going forward in terms of the expense?

Bryan McKeag

Yes, I think it might go up just a little bit, because we only had M&J on for about two-thirds of the quarter, so it could puck-up just a little bit. If you put that number and probably added a third to it, you should be pretty close.

Chris McGratty - KBW

Okay, and then maybe a little bit of help Bryan on the expense run rate. It sounds like they are only in need of one time expenses and there was an offset to the tax line. Its sounds like those are the [most watched] (ph), but the outlook would be given the moderation in the mortgage business, how quickly are the expenses incremental in 2014.

Lynn Fuller

Yes, I mean it gets a little tricky with our new acquisition and we’ve got several things going on. I think for this quarter a place to start would be somewhere around plus or minus $51 million. It’s probably a more normalized expense rate for this quarter and you can look at it several ways. Really that’s about last quarter plus our acquisition and I think that’s probably a less volatile, more normal run rate. However we’ve got things going on. Coming up we’re going to do – here in May we’re going to convert M&J; that will change and bring some cost saves.

The mortgage origination, we dropped some capacity already in 2013. We’re going to drop a little more excess capacity here in January as we go forward and we still need to keep looking at that volume to see what we need to do on the back office side, so that’s going to be moving and we’ve got our retail vision, which is going to – you know its aimed at our branch network as well. Try and bring some efficiency and improve some cost training in the branches etcetera, so a lot of moving parts.

In Q1 we have merit increases that go in. So I think you kind of start it with $51 million and put what you might think is the normal growth rate on that; that’s probably the place to start.

Chris McGratty - KBW

That was helpful. Thanks Bryan.

Operator

Thank you. Our next question is from Jeff Rulis of D.A. Davidson. Please go ahead.

Jeff Rulis - D.A. Davidson

Thanks. Good afternoon. Hi. Bryan, just a quick follow-up. So one time a merger related cost in Q1. Are you anticipating any more next quarter?

Bryan McKeag

Yes, there shouldn’t be a lot of one-time merger related costs related to our two acquisitions. So I think most of that is set and they’ll be running their systems until we convert them and at that time you should get some space after conversion.

Jeff Rulis - D.A. Davidson

And both convert around the same time?

Bryan McKeag

I think we got one in March and then one in May.

Jeff Rulis - D.A. Davidson

Okay. And then I wanted to – Ken, you kind of went over the, I guess the annual loan growth and some of the segments. I guess I’m having a tough time kind of triangulating. This quarter alone was a pretty robust quarter from a production standpoint, you know I guess kind of which on the – for the quarter why was it so strong and in what categories and what geography. If you could provide a little more color just on a sequential basis what was going on in the quarter.

Kenneth Erickson

I did mention it came in the Dubuque Bank and Trust; it came in Rockford, Illinois, Riverside Community Bank and Phoenix, Arizona. The calling efforts have been quite robust for a number of months and it just happened that that transaction that they’ve been working on finally closed in the fourth quarter. There’s always some end of the year pressure probably by us and by borrowers to get transactions closed. There was a lot of deals that closed, there was a couple of larger deals that were part of that as well, but I think in looking at the pipeline, this certainly took a small chunk out of that, but they are quite robust when I look at what the pipelines have been month over month.

Jeff Rulis - D.A. Davidson

Okay, and by category it’s the same stuff that you indicated. I thought there was sort of an annual kind of context in that, not so much the quarter.

Kenneth Erickson

All of the growth that we had that increased that, it all increased C&I. There is a little bit of commercial real estate in that Arizona number, but all in all the total came in the C&I business.

Jeff Rulis - D.A. Davidson

Great, thanks for clearing it out. That’s it from me. Thanks.

Kenneth Erickson

Jeff, just one last point on that. If you remember the first quarter of ’13, we went backwards by some $40 million, so we kind of dug a hole for ourselves. We had some substantial payoffs and we didn’t have very good production in the first quarter. We made all of that backup, plus some in the second quarter. The third quarter was pretty strong at $60 million plus and we had a great fourth quarter. The current pipeline still is pretty down. So hopefully we talked to our banks and said lets not go backwards in the first quarter again. It makes it hard to get a good year for loan growth.

Jeff Rulis - D.A. Davidson

All right, thanks guys.

Operator

Thank you. (Operator Instructions). And the next question is from John Rowan of Sidoti & Company. Please go ahead.

John Rowan - Sidoti & Company

Good afternoon guys.

Lynn Fuller

Hi John.

John Rowan - Sidoti & Company

Bryan, I missed it in the prepared remarks, but can you just go over the one-time items in the non-interest expense and the tax line again. I know you mentioned them, but I missed them.

Bryan McKeag

Yes, I think the one-time items are really predominantly in the professional fees. Those are up about $800,000 and that’s some recruiting and some acquisition related expenses for professionals and then in the other expense line, that was up $2.4 million. About $1.8 million of that is what I would call one-time items that relate to the tax credits. We closed the branch and wrote down some assets there and I think the rest are just kind of year-end adjustments, people bringing their T&E’s etcetera. It just seemed to be higher than normal, so.

John Rowan - Sidoti & Company

Okay, and then what was the tax adjustment?

Bryan McKeag

We booked tax adjustments of $1.3 million and the expense on that is slightly higher or slightly less than that because we make a little bit of money on our investments. So there’s around $1 million I think probably going through that line on related tax investments.

John Rowan - Sidoti & Company

Okay. Thank you very much.

Operator

Thank you. The next question is from Chris McGratty of KBW. Please go ahead.

Chris McGratty - KBW

Yes, just a quick follow-up, thanks. For both, Ken or Bryan, do you have the amount of the proportion of your loans that are fixed versus floating and then maybe account on how you would expect the margin to perform with a short rate that’s potentially low.

Bryan McKeag

Yes, I think Ken can add to some of that, give us materials. Ken?

Kenneth Erickson

Yes, we’re a little over 50% fixed versus variable and that has maintained relatively stable there. Yes, and the balance of your question Chris was…

John Rowan - Sidoti & Company

Yes, can you give expectations for how the margin performed in an operational…

Kenneth Erickson

Yes, from an asset liability standpoint Chris we’re still very asset sensitive and we’ve shocked the balance sheet for movement of deposits out of non-interest bearing DDA and savings into tying money and we still did reasonably well even with that kind of a shock. But our worst scenario is rates down; it’s still our worst scenario. If we see rates stay at these very, very low levels or go down from here, that’s the most challenging, because we’re just not able to get much of a return in the investment portfolio as you go and it continues to put pressure on keeping those loan rates low.

Bryan McKeag

Yes, our best scenario is a relatively modest increase, not big jumps going forward, but if we get modest increases going forward, that’s probably the best for us.

John Rowan - Sidoti & Company

Okay, thank you.

Operator

Thank you. The next question is from Jon Arfstrom of RBC. Please go ahead.

Jon Arfstrom – RBC

Thanks. Good afternoon guys.

Lynn Fuller

Hi Jon.

Jon Arfstrom – RBC

A question for you Lynn on mortgage production; you mentioned a couple of more offices coming online in 2014 and I’m just curious, how are you thinking about that business in terms of the outlook? Are you still looking to add new offices? Is there something where maybe you need to take a pause and wait for a little bit more origination volume to pick up before you step forward again with more offices. But just help us think through what you’re thinking on the business going forward.

Lynn Fuller

Yes, that’s a good point Jon. The offices that I mentioned are really the only offices we’re looking to add and you’re right, we’re going to be taking a pause. If you think about the metro centers that we’re opening new offices in, they have a pretty good churn of population and population growth and a fair amount of starts and originations versus refi’s. We’re just not expecting a lot out of the REFI business, but we need to be in markets that have enough population influx, where we can get a fair share of origination business.

Its very challenging with smaller communities like a Dubuque or like a Morrill, some of the smaller communities just don’t have that much population inflow. As a result they don’t have a lot of origination business and new starts. So that’s why we went into these other markets like Seattle and Portland and Sacramental and assuming that we can get good producers onboard, we should be able to get our volume up a bit this year. But we are going to monitor that very closely and as you heard from Bryan, we reduced staffing in the backroom in 2013. We are reducing staffing again this month in January and we got another staffing that we’ll be looking at. If things don’t pick up there’ll be another reduction.

Jon Arfstrom – RBC

Okay. Just to clarify something, when you talk about taking production up, you obviously have some pretty tough comps. I’m assuming your talking about from current levels. Is that the right way to look at it?

Lynn Fuller

Yes, I would look at that. One of the benefits we will have is, Kansas City is another very good market and of course we have our banking operations there with Morrill & Janes Bank and Trust, so that should be a good market for us as well and there wasn’t a lot of mortgage production in the Kansas City area from our bank, but we’ve got people identified to bring onboard and really try to ramp that up.

Bryan McKeag

Right. I think Jon the first quarter is still going to be a little bit tough. We’re coming off of a very slow fourth quarter, a slowing fourth quarter and so I think the first quarter is still going to be at or could be below what we did last quarter and then it should start to pick up as spring gets here and hopefully the markets will charge up a little bit.

Jon Arfstrom – RBC

Okay, that’s helpful. And then maybe this is for you Ken, but you talked about on the long growth front, share gain versus maybe existing customers becoming more active and kind of going back on the question on the big growth in the quarter; is that share gain, is that new customers coming on or is there a different way to think about that?

Kenneth Erickson

Hey, it was new to us. I was trying to think of how much of that was actually new borrowings in the economy. I would say about half of it and we probably picked up half from competitors where we were successful in moving business to us.

Jon Arfstrom – RBC

Okay. All right, thank you. That helps.

Operator

(Operator Instructions). Okay, it appears we have no further questions at this time. I would like to turn the call back over to management for any additional remarks.

Lynn Fuller

Thank you Manny. In conclusion, Heartland's earnings performance for 2013 as I said was our second best year in our 33-year history and we believe that offers several areas of promise. They would include, first an improved net interest margin; second, continued improvement in deposit mix; third, a continued positive trend for loan growth and a last double-digit return on the equity.

We continue to be well positioned and eager to pursue acquisitions that are accretive to our earnings and meet or exceed our M&A criteria. So in short, I feel very good about the earnings power of the company and continue to see excellent opportunities ahead in 2014.

I'd like to thank everyone for joining us today and hope you can join us again for our next quarterly conference call, which will take place on Monday, April 28, 2014. So thanks again and have a good evening everyone.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.

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