Edgar Filing: HEARTLAND FINANCIAL USA INC

form10q063009.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended June 30, 2009

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For transition period __________ to __________

Commission File Number: 0-24724

HEARTLAND FINANCIAL USA, INC.

(Exact name of Registrant as specified in its charter)

Delaware

(State or other jurisdiction of incorporation or organization)

42-1405748

(I.R.S. employer identification number)

1398 Central Avenue, Dubuque, Iowa 52001

(Address of principal executive offices)(Zip Code)

(563) 589-2100

(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Act.

Large accelerated filer ¨ Accelerated filer þ Non-accelerated filer ¨ Smaller reporting company ¨

(Do not check if a smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Securities Exchange Act of 1934). Yes ¨ No þ

Indicate the number of shares outstanding of each of the classes of Registrant's common stock as of the latest practicable date: As of August 7, 2009, the Registrant had outstanding 16,309,376 shares of common stock, $1.00 par value per share.

HEARTLAND FINANCIAL USA, INC.

Form 10-Q Quarterly Report

Part I

Item 1.			Financial Statements
Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.			Quantitative and Qualitative Disclosures About Market Risk
Item 4.			Controls and Procedures

Part II

Item 1.			Legal Proceedings
Item 1A.			Risk Factors
Item 2.			Unregistered Sales of Issuer Securities and Use of Proceeds
Item 3.			Defaults Upon Senior Securities
Item 4.			Submission of Matters to a Vote of Security Holders
Item 5.			Other Information
Item 6.			Exhibits

			Form 10-Q Signature Page

PART I

ITEM 1. FINANCIAL STATEMENTS

HEARTLAND FINANCIAL USA, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share data)

	June 30, 2009			December 31, 2008
	(Unaudited)
ASSETS
Cash and due from banks	$	35,415		$	48,977
Federal funds sold and other short-term investments		4,546			2,326
Cash and cash equivalents		39,961			51,303
Securities:
Trading, at fair value		1,890			1,694
Available for sale, at fair value (cost of $1,030,521 at June 30, 2009, and $875,143 at December 31, 2008)		1,030,020			871,686
Held to maturity, at cost (fair value of $26,837 at June 30, 2009, and $26,326 at December 31, 2008)		29,301			30,325
Loans held for sale		24,339			19,695
Loans and leases:
Held to maturity		2,375,027			2,405,001
Allowance for loan and lease losses		(37,234	)		(35,651	)
Loans and leases, net		2,337,793			2,369,350
Premises, furniture and equipment, net		117,914			120,500
Other real estate, net		29,311			11,750
Goodwill, net		40,207			40,207
Other intangible assets, net		11,591			8,079
Cash surrender value on life insurance		54,817			54,431
Other assets		49,587			51,248
TOTAL ASSETS	$	3,766,731		$	3,630,268
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Demand	$	436,985		$	383,061
Savings		1,259,861			1,128,312
Time		1,130,657			1,128,859
Total deposits		2,827,503			2,640,232
Short-term borrowings		132,301			210,184
Other borrowings		457,508			437,833
Accrued expenses and other liabilities		31,459			33,396
TOTAL LIABILITIES		3,448,771			3,321,645
EQUITY:
Preferred stock (par value $1 per share; authorized and undesignated 102,302 shares; none issued or outstanding)		-			-
Series A Junior Participating preferred stock (par value $1 per share; authorized 16,000 shares; none issued or outstanding)		-			-
Series B Fixed Rate Cumulative Perpetual preferred stock (par value $1 per share; authorized 81,698 shares; issued, 81,698 shares)		76,594			75,578
Common stock (par value $1 per share; authorized 25,000,000 shares at June 30, 2009, and 20,000,000 shares at December 31, 2008; issued 16,611,671 shares)		16,612			16,612
Capital surplus		44,047			43,827
Retained earnings		182,726			177,753
Accumulated other comprehensive income (loss)		1,213			(1,341	)
Treasury stock at cost (300,846 shares at June 30, 2009, and 337,181 shares at December 31, 2008)		(6,149	)		(6,826	)
TOTAL STOCKHOLDERS’ EQUITY		315,043			305,603
Noncontrolling interest		2,917			3,020
TOTAL EQUITY		317,960			308,623
TOTAL LIABILITIES AND EQUITY	$	3,766,731		$	3,630,268

See accompanying notes to consolidated financial statements.

HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share data)

	Three Months Ended						Six Months Ended
	June 30, 2009			June 30, 2008			June 30, 2009			June 30, 2008
INTEREST INCOME:
Interest and fees on loans and leases	$	38,423		$	40,555		$	77,906		$	83,454
Interest on securities and other:
Taxable		10,039			7,885			18,460			14,500
Nontaxable		2,025			1,679			3,908			3,326
Interest on federal funds sold and other short-term investments		-			51			1			182
Interest on interest bearing deposits in other financial institutions		-			2			1			7
TOTAL INTEREST INCOME		50,487			50,172			100,276			101,469
INTEREST EXPENSE:
Interest on deposits		13,576			15,657			27,698			32,753
Interest on short-term borrowings		173			1,087			385			3,273
Interest on other borrowings		4,360			4,593			8,738			8,870
TOTAL INTEREST EXPENSE		18,109			21,337			36,821			44,896
NET INTEREST INCOME		32,378			28,835			63,455			56,573
Provision for loan and lease losses		10,041			5,369			16,706			7,130
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES		22,337			23,466			46,749			49,443
NONINTEREST INCOME:
Service charges and fees		3,109			2,880			5,996			5,495
Loan servicing income		3,311			1,195			6,097			2,491
Trust fees		1,971			2,068			3,668			4,089
Brokerage and insurance commissions		715			883			1,596			1,775
Securities gains, net		2,206			648			5,171			1,010
Gain (loss) on trading account securities		348			(227	)		62			(434	)
Impairment loss on securities		-			(30	)		-			(116	)
Gains on sale of loans		2,231			480			4,039			984
Income on bank owned life insurance		213			380			343			843
Other noninterest income		560			41			454			655
TOTAL NONINTEREST INCOME		14,664			8,318			27,426			16,792
NONINTEREST EXPENSES
Salaries and employee benefits		14,952			14,666			31,385			29,459
Occupancy		2,176			2,193			4,551			4,537
Furniture and equipment		1,695			1,771			3,342			3,539
Professional fees		2,151			2,382			4,321			4,587
FDIC assessments		2,818			266			3,865			571
Advertising		949			1,046			1,532			1,841
Intangible assets amortization		234			236			469			472
Net loss on repossessed assets		2,532			42			3,152			190
Other noninterest expenses		2,970			2,978			6,146			6,148
TOTAL NONINTEREST EXPENSES		30,477			25,580			58,763			51,344
INCOME BEFORE INCOME TAXES		6,524			6,204			15,412			14,891
Income taxes		1,812			1,643			4,631			4,063
NET INCOME		4,712			4,561			10,781			10,828
Net income attributable to noncontrolling interest, net of tax		44			142			103			142
NET INCOME ATTRIBUTABLE TO HEARTLAND		4,756			4,703			10,884			10,970
Preferred dividends and discount		(1,336	)		-			(2,672	)		-
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS	$	3,420		$	4,703		$	8,212		$	10,970

EARNINGS PER COMMON SHARE – BASIC	$	.21		$	.29		$	0.50		$	0.67
EARNINGS PER COMMON SHARE – DILUTED	$	.21		$	.29		$	0.50		$	0.67
CASH DIVIDENDS DECLARED PER COMMON SHARE	$	.10		$	.10		$	0.20		$	0.20

See accompanying notes to consolidated financial statements.

HEARTLAND FINANCIAL USA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands, except per share data)

	Six Months Ended
	June 30, 2009			June 30, 2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	10,781		$	10,828
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,620			4,603
Provision for loan and lease losses		16,706			7,130
Net amortization of premium on securities		2,011			(246	)
Securities gains, net		(5,171	)		(1,010	)
(Increase) decrease in trading account securities		(196	)		328
Loss on impairment of securities		-			(116	)
Stock-based compensation		477			589
Loans originated for sale		(556,129	)		(153,029	)
Proceeds on sales of loans		564,812			155,255
Net gains on sales of loans		(4,039	)		(984	)
Decrease in accrued interest receivable		1,066			1,517
Decrease in accrued interest payable		(788	)		(2,222	)
Other, net		(2,928	)		(7,639	)
NET CASH PROVIDED BY OPERATING ACTIVITIES		31,222			15,004

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the sale of securities available for sale		138,040			70,080
Proceeds from the maturity of and principal paydowns on securities available for sale		80,303			116,846
Proceeds from the maturity of and principal paydowns on securities held to maturity		1,247			19
Purchase of securities available for sale		(370,784	)		(300,579	)
Purchase of securities held to maturity		-			(2,700	)
Net increase in loans and leases		(24,062	)		(18,525	)
Capital expenditures		(1,892	)		(2,106	)
Proceeds on sale of OREO and other repossessed assets		10,067			1,410
NET CASH USED BY INVESTING ACTIVITIES		(167,081	)		(135,555	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits and savings accounts		185,473			40,675
Net increase (decrease) in time deposit accounts		1,798			(8,089	)
Net decrease in short-term borrowings		(77,883	)		(91,009	)
Proceeds from other borrowings		55,098			201,905
Repayments of other borrowings		(35,423	)		(21,506	)
Purchase of treasury stock		(32	)		(5,375	)
Proceeds from issuance of common stock		379			1,421
Excess tax benefits on exercised stock options		2			225
Common and preferred dividends paid		(4,895	)		(3,236	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		124,517			115,011
Net decrease in cash and cash equivalents		(11,342	)		(5,540	)
Cash and cash equivalents at beginning of year		51,303			46,832
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	39,961		$	41,292
Supplemental disclosures:
Cash paid for income/franchise taxes	$	5,003		$	7,163
Cash paid for interest	$	37,609		$	47,118
Loans transferred to OREO	$	29,400		$	3,286

See accompanying notes to consolidated financial statements.

HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY AND COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands, except per share data)

	Heartland Financial USA, Inc. Stockholders’ Equity
	Preferred Stock		Common Stock		Capital Surplus			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Non-controlling Interest			Total Equity
Balance at January 1, 2008	$	-	$	16,612	$	37,269		$	173,100		$	6,506		$	(3,678	)	$	-		$	229,809
Net income									10,970									(142	)		10,828
Unrealized loss on securities available for sale arising during the period												(10,693	)								(10,693	)
Unrealized gain on derivatives arising during the period												611									611
Reclassification adjustment for net security gains realized in net income												(894	)								(894	)
Reclassification adjustment for net derivatives gains realized in net income												(103	)								(103	)
Income taxes												4,189									4,189
Comprehensive income																					3,938
Cash dividends declared:
Common, $0.20 per share									(3,236	)											(3,236	)
Purchase of 269,356 shares of common stock															(5,375	)					(5,375	)
Issuance of 113,212 shares of common stock						(497	)								2,328						1,831
Commitments to issue common stock						589															589
Initial capital investment																		3,300			3,300
Balance at June 30, 2008	$	-	$	16,612	$	37,361		$	180,834		$	(384	)	$	(6,725	)	$	3,158		$	230,856

Balance at January 1, 2009	$	75,578	$	16,612	$	43,827		$	177,753		$	(1,341	)	$	(6,826	)	$	3,020		$	308,623
Net income									10,884									(103	)		10,781
Unrealized gain on securities available for sale arising during the period												8,127									8,127
Unrealized gain on derivatives arising during the period												1,011									1,011
Reclassification adjustment for net security gains realized in net income												(5,171	)								(5,171	)
Reclassification adjustment for net derivatives gains realized in net income												(100	)								(100	)
Income taxes												(1,313	)								(1,313	)
Comprehensive income																					13,335
Cumulative preferred dividends accrued and discount accretion		1,016							(1,016	)											-
Cash dividends declared:
Preferred, $25.00 per share									(1,656	)											(1,656	)
Common, $0.20 per share									(3,239	)											(3,239	)
Purchase of 1,957 shares of common stock															(32	)					(32	)
Issuance of 27,251 shares of common stock						(257	)								709						452
Commitments to issue common stock						477															477
Balance at June 30, 2009	$	76,594	$	16,612	$	44,047		$	182,726		$	1,213		$	(6,149	)	$	2,917		$	317,960

See accompanying notes to consolidated financial statements.

HEARTLAND FINANCIAL USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: BASIS OF PRESENTATION

The interim unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and accompanying notes to the consolidated financial statements for the fiscal year ended December 31, 2008, included in Heartland Financial USA, Inc.’s ("Heartland") Form 10-K filed with the Securities and Exchange Commission on March 16, 2009. Accordingly, footnote disclosures, which would substantially duplicate the disclosure contained in the audited consolidated financial statements, have been omitted.

The financial information of Heartland included herein has been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments), that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of the interim period ended June 30, 2009, are not necessarily indicative of the results expected for the year ending

December 31, 2009.

Earnings Per Share

Basic earnings per share is determined using net income available to common stockholders and weighted average common shares outstanding. Diluted earnings per share is computed by dividing net income available to common stockholders by the weighted average common shares and assumed incremental common shares issued. Amounts used in the determination of basic and diluted earnings per share for the three-month and six-month periods ended June 30, 2009 and 2008, are shown in the tables below:

	Three Months Ended
(Dollars and numbers in thousands, except per share data)	June 30, 2009			June 30, 2008
Net income attributable to Heartland		4,756			4,703
Preferred dividends and discount		(1,336	)		-
Net income available to common stockholders	$	3,420			4,703
Weighted average common shares outstanding for basic earnings per share		16,298			16,317
Assumed incremental common shares issued upon exercise of stock options		26			72
Weighted average common shares for diluted earnings per share		16,324			16,389
Earnings per common share – basic	$	0.21		$	0.29
Earnings per common share – diluted	$	0.21		$	0.29
Number of antidilutive stock options excluded from diluted earnings per share computations		212			36

	Six Months Ended
(Dollars and numbers in thousands, except per share data)	June 30, 2009			June 30, 2008
Net income attributable to Heartland		10,884			10,970
Preferred dividends and discount		(2,672	)		-
Net income available to common stockholders	$	8,212			10,970
Weighted average common shares outstanding for basic earnings per share		16,287			16,347
Assumed incremental common shares issued upon exercise of stock options		23			66
Weighted average common shares for diluted earnings per share		16,310			16,413
Earnings per common share – basic	$	0.50		$	0.67
Earnings per common share – diluted	$	0.50		$	0.67
Number of antidilutive stock options excluded from diluted earnings per share computations		230			48

Stock-Based Compensation

Options are typically granted annually with an expiration date ten years after the date of grant. Vesting is generally over a five-year service period with portions of a grant becoming exercisable at three years, four years and five years after the date of grant. A summary of the status of the stock options as of June 30, 2009 and 2008, and changes during the six months ended June 30, 2009 and 2008, follows:

	2009					2008
	Shares			Weighted-Average Exercise Price		Shares			Weighted-Average Exercise Price
Outstanding at January 1		743,363		$	19.79		733,012		$	18.61
Granted		-			-		164,400			18.60
Exercised		(1,125	)		8.80		(88,299	)		11.72
Forfeited		(1,000	)		24.13		(10,750	)		25.40
Outstanding at June 30		741,238		$	19.81		798,363		$	19.27
Options exercisable at June 30		338,088		$	16.03		288,046		$	13.48
Weighted-average fair value of options granted during the six-month periods ended June 30	$	-				$	4.81

At June 30, 2009, the vested options totaled 338,088 shares with a weighted average exercise price of $16.03 per share and a weighted average remaining contractual life of 4.09 years. The intrinsic value for the vested options as of June 30, 2009, was $535 thousand. The intrinsic value for the total of all options exercised during the six months ended June 30, 2009, was $6 thousand, and the total fair value of shares vested during the six months ended June 30, 2009, was $477 thousand. At June 30, 2009, shares available for issuance under the 2005 Long-Term Incentive Plan totaled 465,810.

No options were granted during the first six months of 2009. The fair value of the 2008 stock options granted was estimated utilizing the Black Scholes valuation model. The fair value of a share of common stock on the grant date of the 2008 options was $18.60. Significant assumptions include:

					2008
Risk-free interest rate					3.10%
Expected option life					6.4 years
Expected volatility					26.96%
Expected dividends					1.99%

The option term of each award granted was based upon Heartland’s historical experience of employees’ exercise behavior. Expected volatility was based upon historical volatility levels and future expected volatility of Heartland’s common stock. Expected dividend yield was based on a set dividend rate. Risk free interest rate reflects the average of the yields on the 5 year and 7 year zero coupon U.S. Treasury bond. Cash received from options exercised for the six months ended June 30, 2009, was $10 thousand, with a related tax benefit of $2 thousand. Cash received from options exercised for the six months ended June 30, 2008, was $1.0 million, with a related tax benefit of $225 thousand.

Total compensation costs recorded were $477 thousand and $589 thousand for the six months ended June 30, 2009 and 2008, respectively, for stock options, restricted stock awards and shares to be issued under the 2006 Employee Stock Purchase Plan. As of June 30, 2009, there was $1.9 million of total unrecognized compensation costs related to the 2005 Long-Term Incentive Plan for stock options and restricted stock awards which is expected to be recognized through 2012.

Fair Value Measurements

On January 1, 2008, Heartland adopted Statement of Financial Accounting Standards No. 157 (“FAS 157”), Fair Value Measurements. FAS 157 defines fair value, establishes a framework for measuring fair value under U.S. generally accepted accounting principles, and expands disclosures about fair value measurements. FAS 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances. Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FAS 157 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. FAS 157 requires fair value measurements to be separately disclosed by level within the fair value hierarchy. Under FAS 157, Heartland bases fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For assets and liabilities recorded at fair value, it is Heartland’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FAS 157.

Fair value measurements for assets and liabilities where there exists limited or no observable market data, and therefore, are based primarily upon estimates, are often calculated based upon current pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other such factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Additional information regarding disclosures of fair value is presented in Note 5.

Heartland now applies the fair value measurement and disclosure provisions of FAS 157 effective January 1, 2009, to nonfinancial assets and nonfinancial liabilities measured on a nonrecurring basis. Heartland measures the fair value of the following on a nonrecurring basis: (1) long-lived assets, (2) foreclosed assets, (3) goodwill and other intangibles and (4) indefinite-lived assets.

Effect of New Financial Accounting Standards

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (Revised 2007) Business Combinations (“FAS 141R”), which requires significant changes in the accounting and reporting for business acquisitions. Among many changes under FAS 141R, an acquirer will record 100% of all assets and liabilities at fair value at the acquisition date with changes possibly recognized in earnings, and acquisition related costs will be expensed rather than capitalized. FAS 141R applies prospectively to business combinations for which the acquisition date is on or after January 1, 2009. The adoption of FAS 141R by Heartland on January 1, 2009, had no effect on Heartland’s accompanying consolidated financial statements. Subsequent to June 30, 2009, Heartland did complete an acquisition for which the provisions of FAS 141R will be applied. For a description of this acquisition, see the Other Events section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included with this report.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“FAS 160”), which establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary. Key changes under FAS 160 are that noncontrolling interests in a subsidiary are to be reported as part of equity, losses allocated to a noncontrolling interest can result in a deficit balance, and changes in ownership interests that do not result in a change of control are accounted for as equity transactions and upon a loss of control, the resultant gain or loss is recognized and the remaining interest is remeasured at fair value on the date control is lost. Effective January 1, 2009, FAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing consolidated minority interests and prospective application for any new minority interests. The presentation and disclosure requirements of FAS 160 have been applied for the current period and retrospectively for prior periods on Heartland’s accompanying consolidated financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161 (“FAS 161”), Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, which changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. FAS 161 is effective for all financial statements issued for fiscal years and interim periods beginning after November 15, 2008. For further detail on Heartland’s derivative instruments and hedging activities, see Note 4.

In April 2009, the FASB issued Staff Position FAS 107-1 (“FAS 107-1”), Interim Disclosures About Fair Value of Financial Instruments, which extends the disclosure requirements of Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments, to interim financial statements of publicly traded companies. FAS 107-1 is effective for interim periods ending after June 15, 2009. Heartland adopted FAS 107-1 for the period ended June 30, 2009. For further detail on the fair value of Heartland’s financial instruments, see Note 5.

In April 2009, the FASB issued Staff Position FAS 115-2 (“FAS 115-2”), Recognition and Presentation of Other-Than-Temporary Impairments, which revises the guidance for determining whether an impairment is other than temporary for debt securities, requires bifurcation of any other than temporary impairment between the amount representing credit loss and the amount related to all other factors and requires additional disclosures on other than temporary impairment of debt and equity securities. FAS 115-2 is effective for interim and annual reporting periods ending after June 15, 2009. Heartland adopted FAS 115-2 for the period ended June 30, 2009. For further detail on Heartland’s securities, see Note 2.

In April 2009, the FASB issued Staff Position FAS 157-4 (“FAS 157-4”), Determining Fair Value When the Volume and Level of Activity for the Asset or Liability have Significantly Decreased and Identifying Transactions that are not Orderly , which provides additional guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability, provides guidance on circumstances that may indicate that a transaction is not orderly and requires additional disclosures about fair value measurements in annual and interim reporting periods. FAS 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. Heartland adopted FAS 157-4 for the period ended June 30, 2009, and the adoption did not have a material impact on its consolidated financial statements.

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165 (“FAS 165”), Subsequent Events . The objective of FAS 165 is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, FAS 165 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. FAS 165 is effective for financial statements issued for interim and annual periods ending after June 15, 2009, and did not have any impact on Heartland’s consolidated financial statements. Heartland evaluated subsequent events through the filing date of its quarterly 10-Q with the SEC on August 10, 2009.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166 (“FAS 166”), Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140. FAS 166 amends SFAS 140 and removes the concept of a qualifying special-purpose entity from Statement 140 and removes the exception from applying FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, on qualifying special-purpose entities. FAS 166 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter and is not anticipated to have any material impact on Heartland’s consolidated financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167 (“FAS 167”), Amendments to FASB Interpretation No. 46(R). FAS 167 amends FASB 46(R) to require an enterprise to perform an analysis and ongoing reassessments to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity and amends certain guidance for determining whether an entity is a variable interest entity. It also requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. FAS 167 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and for all interim reporting periods after that and is not anticipated to have any material impact on Heartland’s consolidated financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168 (“FAS 168”), The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles. FAS 168 establishes the Codification as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. Following FAS 168, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standard Updates that will serve only to update the Codification. FAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009, and is not anticipated to have any impact on Heartland’s consolidated financial statements.

NOTE 2: SECURITIES

The amortized cost, gross unrealized gains and losses and estimated fair values of available for sale securities as of June 30, 2009 and December 31, 2008 are summarized in the tables below, in thousands:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
June 30, 2009
Securities available for sale:
U.S. government corporations and agencies	$	295,502	$	2,811	$	(960	)	$	297,353
Mortgage-backed securities		526,759		5,801		(9,909	)		522,651
Obligations of states and political subdivisions		173,917		2,972		(1,673	)		175,216
Corporate debt securities		4,429		19		-			4,448
Total debt securities		1,000,607		11,603		(12,542	)		999,668
Equity securities		29,914		438		-			30,352
Total	$	1,030,521	$	12,041	$	(12,542	)	$	1,030,021

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
December 31, 2008
Securities available for sale:
U.S. government corporations and agencies	$	190,599	$	4,832	$	(75	)	$	195,356
Mortgage-backed securities		505,711		4,688		(16,409	)		493,990
Obligations of states and political subdivisions		145,534		4,230		(981	)		148,783
Corporate debt securities		4,479		185		-			4,664
Total debt securities		846,323		13,935		(17,465	)		842,793
Equity securities		28,820		73		-			28,893
Total	$	875,143	$	14,008	$	(17,465	)	$	871,686

The amortized cost, gross unrealized gains and losses and estimated fair values of held to maturity securities as of June 30, 2009 and December 31, 2008 are summarized in the tables below, in thousands:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
June 30, 2009
Securities held to maturity:
Mortgage-backed securities	$	14,680	$	35	$	(2,482	)	$	12,233
Obligations of states and political subdivisions		14,621		-		(17	)		14,604
Total	$	29,301	$	35	$	(2,499	)	$	26,837

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
December 31, 2008
Securities held to maturity:
Mortgage-backed securities	$	15,511	$	57	$	(4,108	)	$	11,460
Obligations of states and political subdivisions		14,814		60		(8	)		14,866
Total	$	30,325	$	117	$	(4,116	)	$	26,326

More than 75% of our mortgage-backed securities are issuances of government-sponsored enterprises.

The following tables summarize, in thousands, the amount of unrealized losses, defined as the amount by which cost or amortized cost exceeds fair value, and the related fair value of investments with unrealized losses in Heartland’s securities portfolio as of June 30, 2009 and December 31, 2008. The investments were segregated into two categories: those that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months. The reference point for determining how long an investment was in an unrealized loss position was June 30, 2008 and December 31, 2007, respectively.

Unrealized Losses on Securities Available for Sale

June 30, 2009

	Less than 12 months					12 months or longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. government corporations and agencies	$	93,402	$	(960	)	$	-	$	-		$	93,402	$	(960	)
Mortgage-backed securities		82,004		(4,549	)		41,521		(5,360	)		123,525		(9,909	)
Obligations of states and political subdivisions		45,515		(1,443	)		4,724		(230	)		50,239		(1,673	)
Corporate debt securities		-		-			-		-			-		-
Total debt securities		220,921		(6,952	)		46,245		(5,590	)		267,166		(12,542	)
Equity securities		-		-			-		-			-		-
Total temporarily impaired securities	$	220,921	$	(6,952	)	$	46,245	$	(5,590	)	$	267,166	$	(12,542	)

Unrealized Losses on Securities Available for Sale

December 31, 2008

	Less than 12 months					12 months or longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. government corporations and agencies	$	18,022	$	(75	)	$	-	$	-		$	18,022	$	(75	)
Mortgage-backed securities		231,056		(8,820	)		31,366		(7,589	)		262,422		(16,409	)
Obligations of states and political subdivisions		32,280		(981	)		-		-			32,280		(981	)
Corporate debt securities		-		-			-		-			-		-
Total debt securities		281,358		(9,876	)		31,366		(7,589	)		312,724		(17,465	)
Equity securities		-		-			-		-			-		-
Total temporarily impaired securities	$	281,358	$	(9,876	)	$	31,366	$	(7,589	)	$	312,724	$	(17,465	)

A majority of the unrealized losses on Heartland’s mortgage-backed securities are the result of changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities and not related to concerns regarding the underlying credit of the issuers or the underlying collateral. It is expected that the securities will not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because Heartland has the ability to hold these investments until a market price recovery or to maturity, the unrealized losses on these investments are not considered other-than-temporarily impaired.

A majority of the unrealized losses on Heartland’s obligations of states and political subdivisions are the result of changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities. Management monitors the published credit ratings of these securities and has noted credit rating reductions in a number of these securities, primarily due to the downgrade in the credit ratings of the insurance companies providing credit enhancement to that of the issuing municipalities. In nearly all cases, the municipalities themselves have not experienced adverse ratings changes since the date of purchase. Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not underlying credit quality, and because Heartland has the ability to hold these investments until a market price recovery or to maturity, the unrealized losses on these investments are not considered other-than-temporarily impaired.

NOTE 3: CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS

The gross carrying amount of intangible assets and the associated accumulated amortization at June 30, 2009, and December 31, 2008, are presented in the table below, in thousands:

	June 30, 2009				December 31, 2008
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Amortized intangible assets:
Core deposit intangibles	$	9,757	$	7,510	$	9,757	$	7,092
Mortgage servicing rights		11,505		2,958		7,799		3,233
Customer relationship intangible		1,177		380		1,177		329
Total	$	22,439	$	10,848	$	18,733	$	10,654
Unamortized intangible assets			$	11,591			$	8,079

Projections of amortization expense for mortgage servicing rights are based on existing asset balances and the existing interest rate environment as of June 30, 2009. Heartland’s actual experience may be significantly different depending upon changes in mortgage interest rates and market conditions. There was no valuation allowance on mortgage servicing rights at June 30, 2009, or December 31, 2008. The fair value of Heartland’s mortgage servicing rights was estimated at $9.9 million and $6.2 million at June 30, 2009, and December 31, 2008, respectively.

The following table shows the estimated future amortization expense for amortized intangible assets, in thousands:

	Core Deposit Intangibles		Mortgage Servicing Rights		Customer Relationship Intangible		Total

Six months ending December 31, 2009	$	335	$	1,834	$	51	$	2,220

Year ending December 31,
2010		466		1,918		100		2,484
2011		450		1,598		99		2,147
2012		422		1,279		55		1,756
2013		405		959		45		1,409
2014		169		639		43		851
Thereafter		-		320		404		724

The following table summarizes, in thousands, the changes in capitalized mortgage servicing rights:

	2009			2008
Balance at January 1	$	4,566		$	3,912
Originations		6,370			1,496
Amortization		(2,389	)		(959	)
Balance at June 30	$	8,547		$	4,449

NOTE 4: DERIVATIVE FINANCIAL INSTRUMENTS

On occasion, Heartland uses derivative financial instruments as part of its interest rate risk management, including interest rate swaps, caps, floors and collars. Heartland’s objectives in using derivatives are to add stability to its net interest margin and to manage its exposure to movements in interest rates.

To reduce the potentially negative impact a downward movement in interest rates would have on its interest income, Heartland entered into the following two transactions. On April 4, 2006, Heartland entered into a three-year interest rate collar transaction with a notional amount of $50.0 million. The collar was effective on April 4, 2006, and matured on April 4, 2009. Heartland was the payer on prime at a cap strike rate of 8.95% and the counterparty was the payer on prime at a floor strike rate of 7.00%. As of December 31, 2008, the fair market value of this collar transaction was recorded as an asset of $636 thousand.

On September 19, 2005, Heartland entered into a five-year interest rate collar transaction on a notional amount of $50.0 million. The collar has an effective date of September 21, 2005, and a maturity date of September 21, 2010. Heartland is the payer on prime at a cap strike rate of 9.00% and the counterparty is the payer on prime at a floor strike rate of 6.00%. As of June 30, 2009, and December 31, 2008, the fair market value of this collar transaction was recorded as an asset of $1.5 million and $2.1 million, respectively.

For accounting purposes, the two collar transactions above are designated as cash flow hedges of the overall changes in the cash flows above and below the collar strike rates associated with interest payments on certain of Heartland’s prime-based loans that reset whenever prime changes. The hedged transactions for the two hedging relationships are designated as the first prime-based interest payments received by Heartland each calendar month during the term of the collar that, in aggregate for each period, are interest payments on principal from specified portfolios equal to the notional amount of the collar.

Prepayments in the hedged loan portfolios are treated in a manner consistent with the guidance in SFAS 133 Implementation Issue No. G25, Cash Flow Hedges: Using the First-Payments-Received Technique in Hedging the Variable Interest Payments on a Group of Non-Benchmark-Rate-Based Loans, which allows the designated forecasted transactions to be the variable, prime-rate-based interest payments on a rolling portfolio of prepayable interest-bearing loans using the first-payments-received technique, thereby allowing interest payments from loans that prepay to be replaced with interest payments from new loan originations. Based on Heartland’s assessments, both at inception and throughout the life of the hedging relationship, it is probable that sufficient prime-based interest receipts will exist through the maturity dates of the collars.

To reduce the potentially negative impact an upward movement in interest rates would have on its net interest income, Heartland entered into the following four cap transactions. For accounting purposes, these four cap transactions were designated as cash flow hedges of the changes in cash flows attributable to changes in LIBOR, the benchmark interest rate being hedged, above the cap strike rate associated with the interest payments made on $65.0 million of Heartland’s subordinated debentures (issued in connection with the trust preferred securities of Heartland Financial Statutory Trust IV, V and VII) that reset quarterly on a specified reset date. At inception, Heartland asserted that the underlying principal balance will remain outstanding throughout the hedge transaction making it probable that sufficient LIBOR-based interest payments will exist through the maturity date of the caps.

The first transaction executed was a twenty-three month interest rate cap transaction on a notional amount of $20.0 million. The cap had an effective date of February 1, 2007, and matured on January 7, 2009. Should 3-month LIBOR have exceeded 5.5% on a reset date, the counterparty would have paid Heartland the amount of interest that exceeded the amount owed on the debt at the cap LIBOR rate of 5.5%. The floating-rate subordinated debentures contained an interest deferral feature that was mirrored in the cap transaction. As of December 31, 2008, this cap transaction had no fair value.

The second transaction executed on February 1, 2007, was a twenty-five month interest rate cap transaction on a notional amount of $25.0 million to reduce the potentially negative impact an upward movement in interest rates would have on its net interest income. The cap had an effective date of February 1, 2007, and matured on March 17, 2009. Should 3-month LIBOR have exceeded 5.5% on a reset date, the counterparty would have paid Heartland the amount of interest that exceeded the amount owed on the debt at the cap LIBOR rate of 5.5%. The floating-rate subordinated debentures contained an interest rate deferral feature that was mirrored in the cap transaction. As of December 31, 2008, this cap transaction had no fair value.

The third transaction executed on January 15, 2008, was a fifty-five month interest rate cap transaction on a notional amount of $20.0 million to reduce the potentially negative impact an upward movement in interest rates would have on its net interest income. The cap has an effective date of January 15, 2008, and a maturity date of September 1, 2012. Should 3-month LIBOR exceed 5.12% on a reset date, the counterparty will pay Heartland the amount of interest that exceeds the amount owed on the debt at the cap LIBOR rate of 5.12%. The floating-rate subordinated debentures contain an interest rate deferral feature that is mirrored in the cap transaction. As of June 30, 2009, and December 31, 2008, the fair market value of this cap transaction was recorded as an asset of $109 thousand and $46 thousand, respectively. Upon the execution of the second swap transaction discussed below, this cap transaction was converted to a mark to market hedge. During the first six months of 2009, the mark to market adjustment on this cap transaction was recorded as a gain of $62 thousand.

The fourth transaction executed on March 27, 2008, was a twenty-eight month interest rate cap transaction on a notional amount of $20.0 million to reduce the potentially negative impact an upward movement in interest rates would have on its net interest income. The cap has an effective date of January 7, 2009, and a maturity date of April 7, 2011. Should 3-month LIBOR exceed 5.5% on a reset date, the counterparty will pay Heartland the amount of interest that exceeds the amount owed on the debt at the cap LIBOR rate of 5.5%. The floating-rate subordinated debentures contain an interest rate deferral feature that is mirrored in the cap transaction. As of June 30, 2009, and December 31, 2008, the fair market value of this cap transaction was recorded as an asset of $11 thousand and $8 thousand, respectively. Upon the execution of the third swap transaction discussed below, this cap transaction was converted to a mark to market hedge. During the first six months of 2009, the mark to market adjustment on this cap transaction was recorded as a gain of $3 thousand.

In addition to the four cap transactions, Heartland entered into the following three forward-starting interest rate swap transactions to effectively convert $65.0 million of its variable interest rate subordinated debentures (issued in connection with the trust preferred securities of Heartland Financial Statutory Trust IV, V and VII) to fixed interest rate debt. For accounting purposes, these three swap transactions are designated as cash flow hedges of the changes in cash flows attributable to changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on $65.0 million of Heartland’s subordinated debentures (issued in connection with the trust preferred securities of Heartland Financial Statutory Trust IV, V and VII) that reset quarterly on a specified reset date. At inception, Heartland asserted that the underlying principal balance will remain outstanding throughout the hedge transaction making it probable that sufficient LIBOR-based interest payments will exist through the maturity date of the swaps.

The first swap transaction was executed on January 28, 2009, on a notional amount of $25.0 million with an effective date of March 17, 2010, and an expiration date of March 17, 2014. Under this interest rate swap contract, Heartland will pay a fixed interest rate of 2.58% and receive a variable interest rate equal to 3-month LIBOR. As of June 30, 2009, the fair value of this swap transaction was recorded as an asset of $573 thousand.

The second swap transaction was executed on February 4, 2009, on a notional amount of $20.0 million with an effective date of January 7, 2010, and an expiration date of January 7, 2020. Under this interest rate swap contract, Heartland will pay a fixed interest rate of 3.35% and receive a variable interest rate equal to 3-month LIBOR. As of June 30, 2009, the fair value of this swap transaction was recorded as an asset of $858 thousand.

The third swap transaction was executed on February 4, 2009, on a notional amount of $20.0 million with an effective date of March 1, 2010, and an expiration date of March 1, 2017. Under this interest rate swap contract, Heartland will pay a fixed interest rate of 3.22% and receive a variable interest rate equal to 3-month LIBOR. As of June 30, 2009, the fair value of this swap transaction was recorded as an asset of $592 thousand.

For the collar, cap and swap transactions described above, the effective portion of changes in the fair values of the derivatives is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings (interest income on loans or interest expense on borrowings) when the hedged transactions affect earnings. Ineffectiveness resulting from the hedging relationship, if any, is recorded as a gain or loss in earnings as part of noninterest income. Heartland uses the “Hypothetical Derivative Method” described in SFAS 133 Implementation Issue No. G20, Cash Flow Hedges: Assessing and Measuring the Effectiveness of a Purchased Option Used in a Cash Flow Hedge, for its quarterly prospective and retrospective assessments of hedge effectiveness, as well as for measurements of hedge ineffectiveness. All components of the derivative instruments’ change in fair value were included in the assessment of hedge effectiveness. No ineffectiveness was recognized for the cash flow hedge transactions for the six months ended June 30, 2008 and 2009.

At the inception of the September 19, 2005 collar transaction, Heartland designated separate proportions of the $50.0 million collar in qualifying cash flow hedging relationships. Designation of a proportion of a derivative instrument is discussed in paragraph 18 of SFAS No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities, which states that “Either all or a proportion of a derivative may be designated as the hedging instrument. The proportion must be expressed as a percentage of the entire derivative so that the profile of risk exposures in the hedging portion of the derivative is the same as that in the entire derivative.” Consistent with that guidance, Heartland identified four different proportions of the $50.0 million collar and documented four separate hedging relationships based on those proportions. Although only one collar was executed with an external party, Heartland established four distinct hedging relationships for various proportions of the collar and designated them against hedged transactions specifically identified at each of four different subsidiary banks. Because each proportion of the collar was designated against hedged transactions specified at different subsidiary banks, the hedging relationship for one proportion of the collar could fail hedge accounting (or have hedge ineffectiveness), without affecting the separate hedging relationships established for other proportions of the collar that were designated against hedged transactions at other subsidiary banks. Effectiveness of each hedging relationship is assessed and measured independently of the other hedging relationships.

A portion of the September 19, 2005 collar transaction did not meet the retrospective hedge effectiveness test at March 31, 2008. The failure was on a portion of the $50.0 million notional amount. That portion, $14.3 million, was designated as a cash flow hedge of the overall changes in the cash flows above and below the collar strike rates associated with interest payments on certain of Dubuque Bank and Trust Company’s prime-based loans. The failure of this hedge relationship was caused by paydowns, which reduced the designated loan pool from $14.3 million to $9.6 million. This hedge failure resulted in the recognition of a gain of $198 thousand during the quarter ended March 31, 2008, which consists of the mark to market gain on this portion of the collar transaction of $212 thousand and a reclass of unrealized losses out of other comprehensive income to earnings of $14 thousand. During the second quarter of 2008, the mark to market adjustment on this portion of the collar transaction was recorded as a loss of $18 thousand. During the first six months of 2009, the mark to market adjustment on this portion of the collar transaction was recorded as a loss of $78 thousand.

A portion of the September 19, 2005 collar transaction also did not meet the retrospective hedge effectiveness test at June 30, 2007. The failure was on a portion of the $50.0 million notional amount. That portion, $14.3 million, was designated as a cash flow hedge of the overall changes in the cash flows above and below the collar strike rates associated with interest payments on certain of Rocky Mountain Bank’s prime-based loans. The failure of this hedge relationship was caused by the sale of its Broadus branch, which reduced the designated loan pool from $14.3 million to $7.5 million. On August 17, 2007, the $14.3 million portion of the September 19, 2005, collar transaction was redesignated and met the requirements for hedge accounting treatment. The fair value of this portion of the collar transaction was zero on the redesignation date. The redesignated collar transaction did not meet the retrospective hedge effectiveness test at December 31, 2008. The failure of the redesignated hedge was caused by paydowns, which reduced the redesignated loan pool from $14.3 million to $10.4 million. During the first six months of 2009, the mark to market adjustment on this portion of the collar transaction was recorded as a loss of $155 thousand.

An additional portion of the September 19, 2005 collar transaction did not meet the retrospective hedge effectiveness test at March 31, 2009. The failure was on a portion of the $50.0 million notional amount. That portion, $14.3 million, was designated as a cash flow hedge of the overall changes in the cash flows above and below the collar strike rates associated with interest payments on certain of New Mexico Bank & Trust’s prime-based loans. The failure of this hedge relationship was caused by paydowns, which reduced the designated loan pool from $14.3 million to $11.6 million. This hedge failure resulted in the recognition of a gain of $68 thousand during the first quarter of 2009, which consists of the mark to market loss on this portion of the collar transaction of $64 thousand and a reclass of unrealized gains out of other comprehensive income to earnings of $132 thousand. During the second quarter of 2009, the mark to market adjustment on this collar transaction was recorded as a loss of $89 thousand.

For the six months ended June 30, 2009, the change in net unrealized gains of $1.0 million for derivatives designated as cash flow hedges is separately disclosed in the statement of changes in stockholders’ equity, before income taxes of $383 thousand. For the six months ended June 30, 2008, the change in net unrealized gains of $611 thousand for derivatives designated as cash flow hedges is separately disclosed in the statement of changes in shareholders’ equity, before income taxes of $232 thousand.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest income or expense as interest payments are received or made on Heartland’s variable-rate assets and liabilities. For the six months ended June 30, 2009, the change in net unrealized gains on cash flow hedges reflects a reclassification of $106 thousand of net unrealized losses from accumulated other comprehensive income to interest income or interest expense. For the next twelve months, Heartland estimates that an additional $69 thousand will be reclassified from accumulated other comprehensive income to interest income.

Cash payments received on the two collar transactions totaled $375 thousand during the first six months of 2008 and $1.3 million during the first six months of 2009.

By using derivatives, Heartland is exposed to credit risk if counterparties to derivative instruments do not perform as expected. Heartland minimizes this risk by entering into derivative contracts with large, stable financial institutions and Heartland has not experienced any losses from counterparty nonperformance on derivative instruments. Furthermore, Heartland also periodically monitors counterparty credit risk in accordance with the provisions of SFAS 133.

NOTE 5: FAIR VALUE

Heartland utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale, trading securities and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, Heartland may be required to record at fair value other assets on a non-recurring basis such as loans held for sale, loans held to maturity and certain other assets including, but not limited to, mortgage servicing rights. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy

Under FAS 157, assets and liabilities are grouped at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 - Valuation is based upon quoted prices for identical instruments in active markets.

Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, or similar instruments in markets that are not active, and model-based valuation techniques for all significant assumptions are observable in the market.

Level 3 - Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The following is a description of valuation methodologies used for assets recorded at fair value and for estimation of fair value for financial instruments not recorded at fair value.

Assets

Securities Available for Sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, as well as U.S. Treasury and other U.S. government and agency securities that are traded by dealers or brokers in active over-the-counter markets. Level 2 securities include agency mortgage-backed securities and private collateralized mortgage obligations, municipal bonds and corporate debt securities. The Level 3 securities of $120 thousand are related to an investment in a partnership.

Trading Assets

Trading assets are recorded at fair value and consist of securities held for trading purposes. The valuation method for trading securities is the same as the methodology used for securities classified as available for sale.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, Heartland classifies loans held for sale subjected to nonrecurring fair value adjustments as Level 2.

Loans Held to Maturity

Heartland does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Under Heartland’s credit policies, all nonaccrual loans are defined as impaired loans. Once a loan is identified as individually impaired, management measures impairment in accordance with FAS 114, Accounting by Creditors for Impairment of a Loan. Loan impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except where more practical, at the observable market price of the loan or the fair value of the collateral if the loan is collateral dependent. Heartland’s allowance methodology requires specific reserves for all impaired loans. At June 30, 2009, substantially all of the total impaired loans were based on the fair value of the collateral. In accordance with FAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, Heartland records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, Heartland records the impaired loan as nonrecurring Level 3.

Derivative Financial Instruments

Currently, Heartland uses interest rate caps, floors, collars and swaps to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate options are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates fell below (rise above) the strike rate of the floors (caps). The variable interest rates used in the calculation of projected receipts on the floor (cap) are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities. To comply with the provisions of FAS No. 157, Heartland incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, Heartland has considered the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

Although Heartland has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of June 30, 2009, Heartland has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, Heartland has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

Mortgage Servicing Rights

Mortgage servicing rights are subject to impairment testing. The carrying values of these rights are reviewed quarterly for impairment based upon the calculation of fair value as performed by an outside third party. For purposes of measuring impairment, the rights are stratified into certain risk characteristics including note type, note rate, prepayment trends and external market factors. If the valuation model reflects a value less than the carrying value, mortgage servicing rights are adjusted to fair value through a valuation allowance. As such, Heartland classifies mortgage servicing rights subjected to nonrecurring fair value adjustments as Level 2.

Other Real Estate Owned

Other real estate represents property acquired through foreclosures and settlements of loans. Property acquired is carried at the lower of the principal amount of the loan outstanding at the time of acquisition, plus any acquisition costs, or the estimated fair value of the property, less disposal costs. Heartland considers third party appraisals as well as independent fair value assessments from realtors or persons involved in selling OREO in determining the fair value of particular properties. Accordingly, the valuation of OREO is subject to significant external and internal judgment. Heartland also periodically reviews OREO to determine whether the property continues to be carried at the lower of its recorded book value or fair value of the property, less disposal costs.

The table below presents, in thousands, Heartland’s assets and liabilities that are measured at fair value on a recurring basis as of June 30, 2009, aggregated by the level in the fair value hierarchy within which those measurements fall:

	Total Fair Value June 30, 2009		Level 1		Level 2		Level 3

Trading securities	$	1,890	$	1,890	$	-	$	-
Available-for-sale securities		1,030,020		297,353		732,547		120
Derivative assets		3,672		-		3,672		-
Total assets at fair value	$	1,035,582	$	299,243	$	736,219	$	120

The changes in Level 3 assets that are measured at fair value on a recurring basis are summarized in the following table, in thousands:

		Fair Value
Balance at January 1, 2009	$	120
Purchases		-
Redemptions		-
Balance at June 30, 2009	$	120

The table below presents Heartland’s assets measured at fair value on a nonrecurring basis, in thousands:

	Carrying Value at June 30, 2009									Six Months Ended June 30, 2009
		Total		Level 1		Level 2		Level 3		Total Losses

Impaired loans	$	24,192	$	-	$	-	$	24,192	$	4,318
OREO		29,311		-		-		29,311		2,004

The table below is a summary, in thousands, of the estimated fair value of Heartland’s financial instruments as of June 30, 2009 and December 31, 2008 as defined by Statement of Financial Accounting Standards No. 107 (“FAS 107”), Disclosures about Fair Value of Financial Instruments. The carrying amounts in the following table are recorded in the balance sheet under the indicated captions. In accordance with FAS 107, the assets and liabilities that are not financial instruments are not included in the disclosure, such as the value of the mortgage servicing rights, premises, furniture and equipment, goodwill and other intangibles and other liabilities.

Heartland does not believe that the estimated information presented below is representative of the earnings power or value of Heartland. The following analysis, which is inherently limited in depicting fair value, also does not consider any value associated with existing customer relationships or the ability of Heartland to create value through loan origination, deposit gathering or fee generating activities. Many of the estimates presented below are based upon the use of highly subjective information and assumptions and, accordingly, the results may not be precise. Management believes that fair value estimates may not be comparable between financial institutions due to the wide range of permitted valuation techniques and numerous estimates which must be made. Furthermore, because the disclosed fair value amounts were estimated as of the balance sheet date, the amounts actually realized or paid upon maturity or settlement of the various financial instruments could be significantly different.

	June 30, 2009				December 31, 2008
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Assets:
Cash and cash equivalents	$	39,961	$	39,961	$	51,303	$	51,303
Trading securities		1,890		1,890		1,694		1,694
Securities available for sale		1,030,020		1,030,020		871,686		871,686
Securities held to maturity		29,301		26,837		30,325		26,326
Loans and leases, net of unearned		2,399,366		2,508,403		2,424,696		2,559,564
Derivatives		3,672		3,672		2,698		2,698

Financial Liabilities:
Demand deposits	$	436,985	$	436,985	$	383,061	$	383,061
Savings deposits		1,259,861		1,259,861		1,128,312		1,128,312
Time deposits		1,130,657		1,135,528		1,128,859		1,136,933
Short-term borrowings		132,301		132,301		210,184		210,184
Other borrowings		457,508		463,950		437,833		448,037

Cash and Cash Equivalents – The carrying amount is a reasonable estimate of fair value due to the short-term nature of these instruments.

Securities - For securities either held to maturity, available for sale or trading, fair value equals quoted market price if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans and Leases - The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of loans held for sale is estimated using quoted market prices.

Deposits - The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. If the fair value of the fixed maturity certificates of deposits is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value.

Short-term and Other Borrowings - Rates currently available to Heartland for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.

Commitments to Extend Credit, Unused Lines of Credit and Standby Letters of Credit - Based upon management’s analysis of the off balance sheet financial instruments, there are no significant unrealized gains or losses associated with these financial instruments based upon our review of the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.

Derivatives – The fair value of all derivatives was estimated based on the amount that Heartland would pay or would be paid to terminate the contract or agreement, using current rates and, when appropriate, the current creditworthiness of the counter-party.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SAFE HARBOR STATEMENT

This document (including information incorporated by reference) contains, and future oral and written statements of Heartland and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of Heartland. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of Heartland’s management and on information currently available to management, are generally identifiable by the use of words such as "believe", "expect", "anticipate", "plan", "intend", "estimate", "may", "will", "would", "could", "should" or other similar expressions. Additionally, all statements in this document, 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.

Heartland’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors which could have a material adverse effect on the operations and future prospects of Heartland and its subsidiaries are detailed in the “Risk Factors” section included under Item 1A. of Part I of Heartland’s 2008 Form 10-K filed with the Securities and Exchange Commission on March 16, 2009. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

CRITICAL ACCOUNTING POLICIES

The process utilized by Heartland to estimate the adequacy of the allowance for loan and lease losses is considered a critical accounting policy for Heartland. The allowance for loan and lease losses represents management’s estimate of identified and unidentified probable losses in the existing loan portfolio. Thus, the accuracy of this estimate could have a material impact on Heartland’s earnings. The adequacy of the allowance for loan and lease losses is determined using factors that include the overall composition of the loan portfolio, general economic conditions, types of loans, loan collateral values, past loss experience, loan delinquencies, and potential losses from identified substandard and doubtful credits. Nonperforming loans and large non-homogeneous loans are specifically reviewed for impairment and the allowance is allocated on a loan-by-loan basis as deemed necessary. Homogeneous loans and loans not specifically evaluated are grouped into pools to which a loss percentage, based on historical experience, is allocated. The adequacy of the allowance for loan and lease losses is monitored on an ongoing basis by the loan review staff, senior management and the boards of directors of each subsidiary bank. Specific factors considered by management in establishing the allowance included the following:

*	Heartland has experienced an increase in net charge-offs and nonperforming loans during the most recent quarters.

*	Heartland has continued to experience growth in more complex commercial loans as compared to relatively lower-risk residential real estate loans.

*	During the last several years, Heartland has entered new geographical markets in which it had little or no previous lending experience.

There can be no assurances that the allowance for loan and lease losses will be adequate to cover all loan losses, but management believes that the allowance for loan and lease losses was adequate at June 30, 2009. While management uses available information to provide for loan and lease losses, the ultimate collectability of a substantial portion of the loan portfolio and the need for future additions to the allowance will be based on changes in economic conditions. Should the economic climate continue to deteriorate, borrowers may experience difficulty, and the level of nonperforming loans, charge-offs, and delinquencies could rise and require further increases in the provision for loan and lease losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan and lease losses carried by the Heartland subsidiaries. Such agencies may require Heartland to make additional provisions to the allowance based upon their judgment about information available to them at the time of their examinations.

GENERAL

Heartland’s results of operations depend primarily on net interest income, which is the difference between interest income from interest earning assets and interest expense on interest bearing liabilities. Noninterest income, which includes service charges and fees, trust income, brokerage and insurance commissions and gains on sale of loans, also affects Heartland’s results of operations. Heartland’s principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy and equipment costs and the provision for loan and lease losses.

Net income was $4.7 million for the quarter ended June 30, 2009, compared to $4.6 million earned during the second quarter of 2008. Net income available to common stockholders was $3.4 million, or $0.21 per diluted common share, for the quarter ended June 30, 2009, compared to $4.7 million, or $0.29 per diluted common share, earned during the second quarter of 2008. Return on average common equity was 5.74 percent and return on average assets was 0.36 percent for the second quarter of 2009, compared to 8.08 percent and 0.56 percent, respectively, for the same quarter in 2008.

Earnings for the second quarter of 2009 were positively affected by increased net interest income, loan servicing income, securities gains and gains on sale of loans. The growth in these areas was partially offset by an increase in the loan loss provision, which was $10.0 million during the second quarter of 2009 compared to $5.4 million during the second quarter of 2008. Also negatively affecting earnings during the second quarter of 2009 were increased FDIC assessments and expenses associated with other real estate owned. Net interest margin, expressed as a percentage of average earning assets, was 3.92 percent during the second quarter of 2009 compared to 3.92 percent for the second quarter of 2008 and 3.94 percent for the first quarter of 2009.

During the second quarter of 2009, net interest income on a tax-equivalent basis increased $3.7 million or 12 percent compared to the same quarter in 2008. Average earning assets increased $362.7 million or 12 percent during the comparable quarterly periods. Noninterest income was $14.7 million during the second quarter of 2009 compared to $8.3 million during the second quarter of 2008, an increase of $6.4 million or 76 percent. Contributing to this increase was a $2.1 million increase in loan servicing income, $1.8 million increase in gains on sale of loans and $1.6 million increase in securities gains. For the second quarter of 2009, noninterest expense totaled $30.5 million, an increase of $4.9 million or 19 percent from the $25.6 million recorded during the same quarter in 2008. The other noninterest expense categories to experience significant increases during the quarters under comparison were FDIC assessments, which increased $2.6 million, and net losses on repossessed assets, which increased $2.5 million.

Net income recorded for the first six months of 2009 was $10.8 million, compared to $10.8 million recorded during the first six months of 2008. Net income available to common stockholders was $8.2 million, or $0.50 per diluted common share, for the six months ended June 30, 2009, compared to $11.0 million, or $0.67 per diluted common share, earned during the first six months of 2008. Return on average common equity was 6.99 percent and return on average assets was 0.45 percent for the first six months of 2009, compared to 9.40 percent and 0.67 percent, respectively, for the same period in 2008.

Earnings for the six months ended June 30, 2009, were positively affected by increased net interest income, loan servicing income, securities gains and gains on sale of loans. The growth in these areas was partially offset by an increase in the loan loss provision, which was $16.7 million during 2009 compared to $7.1 million during 2008. Also negatively affecting earnings during the first six months of 2009 were increased FDIC assessments and expenses associated with other real estate owned. Net interest margin, expressed as a percentage of average earning assets, was 3.93 percent during the first six months of 2009 compared to 3.90 percent for the first six months of 2008.

During the first six months of 2009, net interest income on a tax-equivalent basis increased $7.1 million or 12 percent compared to the same six months in 2008. Average earning assets increased $349.0 million or 12 percent during the comparable six-month periods. Noninterest income was $27.4 million during the first half of 2009 compared to $16.8 million during the first half of 2008, an increase of $10.6 million or 63 percent. Contributing to this increase was a $3.6 million increase in loan servicing income, $3.1 million increase in gains on sale of loans and $4.2 million increase in securities gains. For the first half of 2009, noninterest expense totaled $58.8 million, an increase of $7.5 million or 14 percent from the $51.3 million recorded during the same period in 2008. The largest component of noninterest expense, salaries and employee benefits, increased $1.9 million or 7 percent during the first half of 2009 compared to the first half of 2008. The other noninterest expense categories to experience significant increases during the six-month periods under comparison were FDIC assessments, which increased $3.3 million, and net losses on repossessed assets, which increased $3.0 million.

At June 30, 2009, total assets had increased $136.5 million or 8 percent annualized since year-end 2008. Total loans and leases were $2.38 billion at June 30, 2009, compared to $2.41 billion at year-end 2008, a decrease of $30.0 million or 2 percent annualized. In order to provide the investing community with a perspective on how the growth in both loans and deposits during the first six months of the year equates to performance on an annualized basis, the growth rates on these two categories have been reflected as an annualized percentage throughout this report. These annualized numbers were calculated by multiplying the growth percentage for the first six months of the year by two. The only loan category to experience growth during the first six months of 2009 was agricultural and agricultural real estate loans.

Total deposits grew to $2.83 billion at June 30, 2009, an increase of $187.3 million or 14 percent annualized since year-end 2008. This growth was weighted more heavily in Heartland’s Western markets, which were responsible for nearly 56 percent of the growth. Demand deposits increased $53.9 million or 28 percent annualized since year-end 2008. Savings deposit balances experienced an increase of $131.5 million or 23 percent annualized since year-end 2008 and time deposits, exclusive of brokered deposits, experienced an increase of $8.0 million or 1 percent annualized since year-end 2008.

NET INTEREST INCOME

Net interest margin, expressed as a percentage of average earning assets, was 3.92 percent during the second quarter of 2009 and the second quarter of 2008. For the six-month periods ended June 30, net interest margin, expressed as a percentage of average earning assets, was 3.93 percent during 2009 and 3.90 percent during 2008. Success at growing net interest margin during the quarter was a direct result of disciplined pricing. Management is committed to maintaining margin near the 4 percent level and will not compete for loans or deposits strictly for the sake of growth.

Net interest income on a tax-equivalent basis totaled $33.4 million during the second quarter of 2009, an increase of $3.6 million or 12 percent from the $29.8 million recorded during the second quarter of 2008. For the six-month period during 2009, net interest income on a tax-equivalent basis was $65.6 million, an increase of $7.1 million or 12 percent from the $58.5 million recorded during the first six months of 2008. These increases occurred as Heartland’s interest bearing liabilities repriced downward more quickly than its interest bearing assets. Also contributing to these increases was the $362.7 million or 12 percent growth in average earning assets during the second quarter of 2009 compared to the same quarter in 2008 and the $349.0 million or 12 percent growth in average earning assets during the first six months of 2009 compared to the same six months of 2008.

On a tax-equivalent basis, interest income in the second quarter of 2009 totaled $51.5 million compared to $51.1 million in the second quarter of 2008, an increase of $429 thousand or 1 percent. For the first six months of 2009, interest income on a tax-equivalent basis decreased $978 thousand or 1 percent over the same period in 2008. Nearly half of Heartland’s commercial and agricultural loan portfolios consist of floating rate loans that reprice immediately upon a change in the national prime interest rate, thus changes in the national prime rate impact interest income more quickly than if there were more fixed rate loans. The national prime interest rate was 3.25 percent for the first six months of 2009. During the first six months of 2008, the national prime interest rate decreased from 7.25 percent on January 1, 2008, to 5.00 percent at June 30, 2008. A large portion of Heartland’s floating rate loans that reprice immediately with a change in national prime have interest rate floors that are currently in effect. Additionally, Heartland had two $50.0 million derivative transactions on the loan portfolio that were at their floor interest rates. One of these derivative transactions matured on April 4, 2009.

Interest expense for the second quarter of 2009 was $18.1 million compared to $21.3 million in the second quarter of 2008, a decrease of $3.2 million or 15 percent. On a six-month comparative basis, interest expense decreased $8.1 million or 18 percent. Interest rates paid on Heartland’s deposits and borrowings were significantly lower during the first six months of 2009 compared to the first six months of 2008. Approximately 46 percent of Heartland’s certificate of deposit accounts will mature within the next six months at a weighted average rate of 2.55 percent.

Heartland attempts to manage its balance sheet to minimize the effect that a change in interest rates has on its net interest margin. Heartland plans to continue to work toward improving both its earning asset and funding mix through targeted growth strategies that emphasize conservative pricing of deposits and careful underwriting of loans, which management believes will result in additional net interest margin. Heartland’s net interest income simulations reflect a well-balanced and manageable interest rate posture. Management supports a pricing discipline in which the focus is less on price and more on the unique value provided to business and retail clients. Item 3 of this Form 10-Q contains additional information about the results of Heartland’s most recent net interest income simulations. Note 4 to the quarterly financial statements contains a detailed discussion of the derivative instruments Heartland has utilized to manage its interest rate risk.

The table below sets forth certain information relating to Heartland’s average consolidated balance sheets and reflects the yield on average earning assets and the cost of average interest bearing liabilities for the periods indicated. Dividing income or expense by the average balance of assets or liabilities derives such yields and costs. Average balances are derived from daily balances. Nonaccrual loans and loans held for sale are included in each respective loan category.

ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES1 For the quarters ended June 30, 2009 and 2008 (Dollars in thousands)
	2009							2008
	Average Balance			Interest		Rate		Average Balance			Interest		Rate
EARNING ASSETS
Securities:
Taxable	$	891,873		$	10,038	4.51	%	$	642,011		$	7,885	4.94	%
Nontaxable1		178,433			2,879	6.47			152,470			2,468	6.51
Total securities		1,070,306			12,917	4.84			794,481			10,353	5.24
Interest bearing deposits		1,727			2	0.46			395			2	2.04
Federal funds sold		139			-	-			9,313			51	2.20
Loans and leases:
Commercial and commercial real estate1		1,676,614			25,092	6.00			1,614,240			26,626	6.63
Residential mortgage		217,054			3,225	5.96			218,908			3,508	6.45
Agricultural and agricultural real estate1		257,283			4,224	6.59			239,105			4,340	7.30
Consumer		229,298			5,038	8.81			206,227			4,897	9.55
Direct financing leases, net		4,319			60	5.57			7,912			115	5.85
Fees on loans		-			991	-			-			1,228	-
Less: allowance for loan and lease losses		(36,507	)		-	-			(33,076	)		-	-
Net loans and leases		2,348,061			38,630	6.60			2,253,316			40,714	7.27
Total earning assets		3,420,233		$	51,549	6.05	%		3,057,505		$	51,120	6.72	%
NONEARNING ASSETS		342,770							297,375
TOTAL ASSETS	$	3,763,003						$	3,354,880
INTEREST BEARING LIABILITIES
Interest bearing deposits
Savings	$	1,213,206		$	4,568	1.51	%	$	876,075		$	3,763	1.73	%
Time, $100,000 and over		389,827			2,965	3.05			295,184			3,017	4.11
Other time deposits		763,416			6,043	3.17			860,375			8,877	4.15
Short-term borrowings		142,600			173	0.49			253,789			1,087	1.72
Other borrowings		475,854			4,360	3.68			427,064			4,593	4.33
Total interest bearing liabilities		2,984,903			18,109	2.43	%		2,712,487			21,337	3.16	%
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits		423,873							365,329
Accrued interest and other liabilities		36,150							43,059
Total noninterest bearing liabilities		460,023							408,388
STOCKHOLDERS’ EQUITY		318,077							234,005
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	3,763,003						$	3,354,880
Net interest income1				$	33,440						$	29,783
Net interest spread1						3.61	%						3.56	%
Net interest income to total earning assets1						3.92	%						3.92	%
Interest bearing liabilities to earning assets		87.27	%						88.72	%

1 Tax equivalent basis is calculated using an effective tax rate of 35%.

ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES1 For the six months ended June 30, 2009 and 2008 (Dollars in thousands)
	2009							2008
	Average Balance			Interest		Rate		Average Balance			Interest		Rate
EARNING ASSETS
Securities:
Taxable	$	825,928		$	18,459	4.51	%	$	599,435		$	14,500	4.86	%
Nontaxable1		169,290			5,599	6.67			149,206			4,889	6.59
Total securities		995,218			24,058	4.87			748,641			19,389	5.21
Interest bearing deposits		1,181			3	0.51			414			7	3.40
Federal funds sold		462			1	0.44			14,159			182	2.58
Loans and leases:
Commercial and commercial real estate1		1,685,205			51,234	6.13			1,618,875			55,223	6.86
Residential mortgage		226,966			6,674	5.93			221,905			7,209	6.53
Agricultural and agricultural real estate1		256,671			8,316	6.53			234,035			8,664	7.44
Consumer		230,313			10,011	8.77			202,348			9,828	9.77
Direct financing leases, net		4,932			128	5.23			8,350			248	5.97
Fees on loans		-			1,957	-			-			2,610	-
Less: allowance for loan and lease losses		(36,054	)		-	-			(32,867	)		-	-
Net loans and leases		2,368,033			78,320	6.67			2,252,646			83,782	7.48
Total earning assets		3,364,894		$	102,382	6.14	%		3,015,860		$	103,360	6.89	%
NONEARNING ASSETS		346,210							296,347
TOTAL ASSETS	$	3,711,104						$	3,312,207
INTEREST BEARING LIABILITIES
Interest bearing deposits
Savings	$	1,164,760		$	9,092	1.57	%	$	852,032		$	7,798	1.84	%
Time, $100,000 and over		392,387			6,203	3.19			301,972			6,564	4.37
Other time deposits		766,430			12,403	3.26			852,841			18,391	4.34
Short-term borrowings		156,713			385	0.50			277,703			3,273	2.37
Other borrowings		471,543			8,738	3.74			390,676			8,870	4.57
Total interest bearing liabilities		2,951,833			36,821	2.52	%		2,675,224			44,896	3.37	%
NONINTEREST BEARING LIABILITIES
Noninterest bearing deposits		408,744							360,954
Accrued interest and other liabilities		34,505							41,455
Total noninterest bearing liabilities		443,249							402,409
STOCKHOLDERS’ EQUITY		316,022							234,574
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	3,711,104						$	3,312,207
Net interest income1				$	65,561						$	58,464
Net interest spread1						3.62	%						3.52	%
Net interest income to total earning assets1						3.93	%						3.90	%
Interest bearing liabilities to earning assets		87.72	%						88.71	%

1 Tax equivalent basis is calculated using an effective tax rate of 35%.

PROVISION FOR LOAN AND LEASE LOSSES

The allowance for loan and lease losses is established through a provision charged to expense to provide, in Heartland management’s opinion, an adequate allowance for loan and lease losses. During the second quarter of 2009, the provision for loan losses was $10.0 million, an increase of $4.6 million or 87% over the provision for loan losses of $5.4 million recorded during the same period in 2008. For the six-month comparative period, the provision for loan losses was $16.7 million during 2009 compared to $7.1 million during 2008, an increase of $9.6 million or 134%. Additions to the allowance for loan and lease losses during the first half of 2009 were driven by a variety of factors including deterioration of economic conditions, downgrades in internal risk ratings, reductions in appraised values and higher levels of charge-offs, primarily in Heartland’s Western markets of Arizona, Montana and Colorado.

The adequacy of the allowance for loan and lease losses is determined by management using factors that include the overall composition of the loan portfolio, general economic conditions, types of loans, loan collateral values, past loss experience, loan delinquencies, substandard credits, and doubtful credits. For additional details on the specific factors considered, refer to the critical accounting policies and allowance for loan and lease losses sections of this report. Heartland believes the allowance for loan and lease losses as of June 30, 2009, was at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions should become more unfavorable, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision for loan and lease losses.

NONINTEREST INCOME

The table below shows Heartland’s noninterest income for the quarters indicated.

(Dollars in thousands)

	Three Months Ended
	June 30, 2009		June 30, 2008			Change			% Change
NONINTEREST INCOME:
Service charges and fees, net	$	3,109	$	2,880		$	229			8	%
Loan servicing income		3,311		1,195			2,116			177
Trust fees		1,971		2,068			(97	)		(5	)
Brokerage and insurance commissions		715		883			(168	)		(19	)
Securities gains, net		2,206		648			1,558			240
Gain (loss) on trading account securities, net		348		(227	)		575			253
Impairment loss on securities		-		(30	)		30			100
Gains on sale of loans		2,231		480			1,751			365
Income on bank owned life insurance		213		380			(167	)		(44	)
Other noninterest income		560		41			519			1266
TOTAL NONINTEREST INCOME	$	14,664	$	8,318		$	6,346			76	%

(Dollars in thousands)

	Six Months Ended
	June 30, 2009		June 30, 2008			Change			% Change
NONINTEREST INCOME:
Service charges and fees, net	$	5,996	$	5,495		$	501			9	%
Loan servicing income		6,097		2,491			3,606			145
Trust fees		3,668		4,089			(421	)		(10	)
Brokerage and insurance commissions		1,596		1,775			(179	)		(10	)
Securities gains, net		5,171		1,010			4,161			412
Gain (loss) on trading account securities, net		62		(434	)		496			114
Impairment loss on securities		-		(116	)		116			100
Gains on sale of loans		4,039		984			3,055			310
Income on bank owned life insurance		343		843			(500	)		(59	)
Other noninterest income		454		655			(201	)		(31	)
TOTAL NONINTEREST INCOME	$	27,426	$	16,792		$	10,634			63	%

Noninterest income was $14.7 million during the second quarter of 2009 compared to $8.3 million during the second quarter of 2008, an increase of $6.4 million or 76 percent. For the first six months of 2009, noninterest income was $27.4 million compared to $16.8 million during the first six months of 2008, an increase of $10.6 million or 63 percent. The categories experiencing the largest increases for both comparative periods were loan servicing income, securities gains and gains on sale of loans.

Loan servicing income increased $2.1 million or 177 percent for the quarter and $3.6 million or 145 percent for the six-month periods under comparison, due to an increase in the number of residential real estate loans that Heartland services. Mortgage servicing rights income totaled $3.2 million during the second quarter of 2009 compared to $663 thousand during the same quarter in 2008. For the six-month periods ended on June 30, mortgage servicing rights income totaled $6.4 million and $1.5 million, respectively. Amortization of mortgage servicing rights was $1.0 million during the second quarter of 2009 compared to $409 thousand during the same quarter of 2008. On a six-month comparative basis, the amortization of mortgage servicing rights was $2.4 million in 2009 compared to $959 thousand during 2008. Note 3 to the quarterly financial statements contains a discussion about Heartland’s mortgage servicing rights. The portfolio of mortgage loans serviced for others by Heartland totaled $1.02 billion at June 30, 2009, compared to $681.5 million at June 30, 2008.

As long-term mortgage loan rates fell below 5.00 percent during the first half of 2009, refinancing activity significantly increased on 15- and 30-year, fixed-rate mortgage loans. During the first half of 2009, Heartland banks originated $581.6 million in new and refinanced mortgage loans to 3,148 borrowers. Heartland normally elects to sell these types of loans into the secondary market and retains the servicing on these loans. Gains on sale of loans totaled $2.2 million during the second quarter of 2009 compared to $480 thousand during the second quarter of 2008. For the first six months of 2009, gains on sale of loans totaled $4.0 million compared to $984 thousand for the first six months of 2008. Additionally, Heartland assisted over 260 customers with modifications to their existing mortgage loans to help them stay in their homes and avoid foreclosure during this time of financial stress.

Securities gains totaled $2.2 million during the second quarter of 2009 compared to $648 thousand during the second quarter of 2008. For the six-month comparative period, securities gains totaled $5.2 million during 2009 compared to $1.0 million during 2008. Securities designed to outperform in a declining rate environment were sold during the first half of 2009 and replaced with securities that are expected to outperform as rates rise.

NONINTEREST EXPENSES

The table below shows Heartland’s noninterest expense for the quarters indicated.

(Dollars in thousands)

	Three Months Ended
	June 30, 2009		June 30, 2008		Change			% Change
NONINTEREST EXPENSES:
Salaries and employee benefits	$	14,952	$	14,666	$	286			2	%
Occupancy		2,176		2,193		(17	)		(1	)
Furniture and equipment		1,695		1,771		(76	)		(4	)
Professional fees		2,151		2,382		(231	)		(10	)
FDIC assessments		2,818		266		2,552			959
Advertising		949		1,046		(97	)		(9	)
Intangible assets amortization		234		236		(2	)		(1	)
Net loss on repossessed assets		2,532		42		2,490			5,929
Other noninterest expenses		2,970		2,978		(8	)		-
TOTAL NONINTEREST EXPENSES	$	30,477	$	25,580	$	4,897			19	%

(Dollars in thousands)

	Six Months Ended
	June 30, 2009		June 30, 2008		Change			% Change
NONINTEREST EXPENSES:
Salaries and employee benefits	$	31,385	$	29,459	$	1,926			7	%
Occupancy		4,551		4,537		14			-
Furniture and equipment		3,342		3,539		(197	)		(6	)
Professional fees		4,321		4,587		(266	)		(6	)
FDIC assessments		3,865		571		3,294			577
Advertising		1,532		1,841		(309	)		(17	)
Intangible assets amortization		469		472		(3	)		(1	)
Net loss on repossessed assets		3,152		190		2,962			1,559
Other noninterest expenses		6,146		6,148		(2	)		-
TOTAL NONINTEREST EXPENSES	$	58,763	$	51,344	$	7,419			14	%

For the second quarter of 2009, noninterest expense totaled $30.5 million, an increase of $4.9 million or 19 percent from the same period in 2008. This increase was primarily attributable to higher FDIC assessments and net losses on repossessed assets. For the six-month period ended June 30, 2009, noninterest expense totaled $58.8 million, an increase of $7.4 million or 14 percent when compared to the same six-month period in 2008. The largest contributors to the increase for the six-month comparative periods were salaries and employee benefits, FDIC assessments and net losses on repossessed assets.

The largest component of noninterest expense, salaries and employee benefits, increased $286 thousand or 2 percent during the second quarter of 2009 compared to the second quarter of 2008 and $1.9 million or 7 percent during the six-month comparative period. Merit increases for all salaried employees are made on January 1 of each year. Also contributing to these increases, primarily during the first quarter of 2009, was the opening of Minnesota Bank & Trust in April 2008 and additional staffing at Summit Bank & Trust and New Mexico Bank & Trust to grow its customer base and at Heartland’s operations center to provide support services to the bank subsidiaries. Total full-time equivalent employees were 1,020 at June 30, 2009, compared to 1,002 at June 30, 2008.

FDIC assessments totaled $2.8 million during the second quarter of 2009 compared to $266 thousand during the second quarter of 2008, an increase of $2.6 million or 959 percent. Included in the FDIC assessments recorded during the second quarter of 2009 was $1.7 million for the emergency special assessment. For the six-month period ended June 30, 2009, FDIC assessments were $3.9 million compared to $571 thousand during the first six months of 2008, an increase of $3.3 million or 577 percent.

Net losses on repossessed assets totaled $2.5 million during the second quarter of 2009 compared to $42 thousand during the second quarter of 2008. For the first six months of 2009, net losses on repossessed assets totaled $3.2 million compared to $190 thousand for the first six months of 2008. Included in the second quarter of 2009 net losses on repossessed assets was $1.9 million in valuation adjustments.

INCOME TAX EXPENSE

Heartland’s effective tax rate was 27.78 percent for the second quarter of 2009 compared to 26.48 percent for the second quarter of 2008. On a six-month comparative basis, Heartland’s effective tax rate was 30.05 percent for the first half of 2009 compared to 27.28 percent for 2008. Heartland’s effective tax rate during the first six months of 2009 did not include any federal rehabilitation tax credits, whereas Heartland’s effective tax rate during the first six months of 2008 included $247 thousand in federal rehabilitation tax credits associated with Dubuque Bank and Trust Company’s ownership interests in limited liability companies that own certified historic structures. Tax-exempt interest income as a percentage of pre-tax income was 30.23 percent during the second quarter of 2009 compared to 28.37 percent during the same quarter of 2008. For the six-month periods ended June 30, 2009 and 2008, tax-exempt income as a percentage of pre-tax income was 25.38 percent and 23.58 percent, respectively. The tax-equivalent adjustment for this tax-exempt interest income was $1.1 million during the second quarter of 2009 compared to $947 thousand during the same quarter in 2008. For the six-month comparative period, the tax-equivalent adjustment for tax-exempt interest income was $2.1 million for 2009 and $1.9 million for 2008.

FINANCIAL CONDITION

At June 30, 2009, total assets had increased $136.5 million or 8 percent annualized since year-end 2008.

LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES

Total loans and leases were $2.38 billion at June 30, 2009, compared to $2.41 billion at year-end 2008, a decrease of $30.0 million or 2 percent annualized. The only loan category to experience growth during the first six months of 2009 was agricultural and agricultural real estate loans. Nearly all of this growth occurred at Dubuque Bank and Trust Company. Loan demand improved during the second quarter of 2009. Growth in total loans and leases was $18.6 million during the second quarter of 2009 compared to a decrease of $48.6 million during the first quarter of 2009. This growth was driven primarily by activity in commercial and commercial real estate loans, which increased by $28.1 million, nearly all of which occurred at Dubuque Bank and Trust Company.

The table below presents the composition of the loan portfolio as of June 30, 2009, and December 31, 2008.

LOAN PORTFOLIO (Dollars in thousands)
	June 30, 2009							December 31, 2008
	Amount			Percent			Amount			Percent
Commercial and commercial real estate	$	1,701,933			71.51	%	$	1,718,071			71.30	%
Residential mortgage		187,016			7.86			203,921			8.46
Agricultural and agricultural real estate		255,340			10.73			247,664			10.28
Consumer		231,986			9.75			234,061			9.72
Lease financing, net		3,615			0.15			5,829			0.24
Gross loans and leases		2,379,890			100.00	%		2,409,546			100.00	%
Unearned discount		(2,574	)					(2,443	)
Deferred loan fees		(2,289	)					(2,102	)
Total loans and leases		2,375,027						2,405,001
Allowance for loan and lease losses		(37,234	)					(35,651	)
Loans and leases, net	$	2,337,793					$	2,369,350

Loans and leases secured by real estate, either fully or partially, totaled $1.8 billion or 77% of total loans and leases at June 30, 2009. More than 62% of the non-farm, nonresidential loans are owner occupied. The largest categories within Heartland’s real estate secured loans are listed below:

(Dollars in thousands)

Residential real estate, excluding residential construction and residential lot loans	$	429,885
Industrial, manufacturing, business and commercial		256,979
Agriculture		198,146
Land development and lots		183,372
Retail		156,780
Office		118,443
Hotel, resort and hospitality		97,275
Warehousing		65,744
Residential construction		55,569

The process utilized by Heartland to determine the adequacy of the allowance for loan and lease losses is considered a critical accounting practice for Heartland. The allowance for loan and lease losses represents management’s estimate of identified and unidentified probable losses in the existing loan portfolio. For additional details on the specific factors considered, refer to the critical accounting policies section of this report.

The allowance for loan and lease losses at June 30, 2009, was 1.57 percent of loans and leases and 52.32 percent of nonperforming loans, compared to 1.48 percent of loans and leases and 45.73 percent of nonperforming loans at December 31, 2008. Additions to the allowance for loan and lease losses during the first six months of 2009 were driven by a variety of factors including deterioration of economic conditions, downgrades in internal risk ratings, reductions in appraised values and higher levels of charge-offs, primarily in Heartland’s Western markets of Arizona, Montana and Colorado.

Nonperforming loans were $71.1 million or 3.00 percent of total loans and leases at June 30, 2009, compared to $78.0 million or 3.24 percent of total loans and leases at December 31, 2008, and $67.1 million or 2.85% of total loans and leases at March 31, 2009. The portion of Heartland’s nonperforming loans covered by government guarantees was $3.3 million at June 30, 2009. Approximately 65 percent, or $46.1 million, of Heartland’s nonperforming loans are to 15 borrowers, with $14.3 million originated by Rocky Mountain Bank, $9.5 million originated by Arizona Bank & Trust, $8.6 million originated by Wisconsin Community Bank, $6.8 million originated by Summit Bank & Trust, $3.3 million originated by Riverside Community Bank, $2.0 million originated by Dubuque Bank and Trust Company and $1.6 million originated by New Mexico Bank & Trust. The industry breakdown for these nonperforming loans was $14.9 million land development and lots, $10.9 million construction and development of commercial real estate, $7.2 million transportation and $5.6 million real estate financing provider. The remaining $7.5 million was distributed among four other industries.

Other real estate owned was $29.3 million at June 30, 2009, compared to $11.8 million at December 31, 2008, an increase of $17.6 million. All of this increase occurred during the first quarter of 2009 with $12.0 million attributable to a residential lot development loan originated at Rocky Mountain Bank. Liquidation strategies have been identified for all the assets held in other real estate owned. Management plans to market these properties under an orderly liquidation process rather than under a quick liquidation process that could result in discounts greater than the projected carrying costs.

Net charge-offs during the first six months of 2009 were $15.1 million compared to $5.2 million during the first six months of 2008. A large portion of the net charge-offs was related to commercial real estate development loans and residential lot loans, primarily in the Phoenix, Arizona market. Previously, Heartland generally recognized the charge-off on a loan when the loan was resolved, sold or transferred to other real estate owned. However, in the third quarter of 2008, Heartland began to recognize charge-offs on loans it considered impaired by writing down the loan balance to an estimated net realizable value based on the anticipated disposition value.

The table below presents the changes in the allowance for loan and lease losses during the periods indicated:

ANALYSIS OF ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in thousands)
	Six Months Ended June 30,
	2009			2008
Balance at beginning of period	$	35,651			$	32,993
Provision for loan and lease losses		16,706				7,130
Recoveries on loans and leases previously charged off		918				684
Loans and leases charged off		(16,041	)			(5,876	)
Balance at end of period	$	37,234			$	34,931
Annualized net charge-offs to average loans and leases		1.28	%			0.46	%

The table below presents the amounts of nonperforming loans and leases and other nonperforming assets on the dates indicated:

NONPERFORMING ASSETS (Dollars in thousands)
	As of June 30,						As of December 31,
	2009			2008			2008			2007
Nonaccrual loans and leases	$	71,116		$	42,857		$	76,953		$	30,694
Loan and leases contractually past due 90 days or more		54			51			1,005			1,134
Total nonperforming loans and leases		71,170			42,908			77,958			31,828
Other real estate		29,311			4,196			11,750			2,195
Other repossessed assets, net		1,477			419			1,484			438
Total nonperforming assets	$	101,958		$	47,523		$	91,192		$	34,461
Nonperforming loans and leases to total loans and leases		3.00	%		1.87	%		3.24	%		1.40	%

SECURITIES

The composition of Heartland's securities portfolio is managed to maximize the return on the portfolio while considering the impact it has on Heartland’s asset/liability position and liquidity needs. Securities represented 28 percent of total assets at June 30, 2009, and 25 percent at December 31, 2008. Total available for sale securities as of June 30, 2009, were $1.03 billion, an increase of $158.3 million or 18 percent from December 31, 2008. Additional securities were purchased during the first half of 2009 as loan growth slowed.

The table below presents the composition of the securities portfolio by major category as of June 30, 2009, and December 31, 2008. More than 75 percent of Heartland’s mortgage-backed securities are issuances of government-sponsored enterprises as of June 30, 2009.

SECURITIES PORTFOLIO COMPOSITION (Dollars in thousands)
	June 30, 2009						December 31, 2008
	Amount		Percent			Amount		Percent
U.S. government corporations and agencies	$	297,353		28.02	%	$	195,356		21.62	%
Mortgage-backed securities		537,331		50.63			509,501		56.38
Obligation of states and political subdivisions		189,837		17.89			163,597		18.10
Other securities		36,690		3.46			35,251		3.90
Total securities	$	1,061,211		100.00	%	$	903,705		100.00	%

DEPOSITS AND BORROWED FUNDS

Total deposits grew to $2.83 billion at June 30, 2009, an increase of $187.3 million or 14 percent annualized since year-end 2008. With the exception of First Community Bank, Wisconsin Community Bank and Rocky Mountain Bank, all Heartland banks experienced a significant increase in deposits. This growth was weighted more heavily in Heartland’s Western markets, which were responsible for nearly 56 percent of the growth. Demand deposits increased $53.9 million or 28 percent annualized since year-end 2008. Savings deposit balances experienced an increase of $131.5 million or 23 percent annualized since year-end 2008 and time deposits, exclusive of brokered deposits, experienced an increase of $8.0 million or 1 percent annualized since year-end 2008. At June 30, 2009, brokered time deposits totaled $45.3 million or 2 percent of total deposits compared to $51.5 million or 2 percent of total deposits at year-end 2008. Growth in non-maturity deposits is attributable to an increased emphasis on non-maturity core deposit products over higher-cost certificates of deposit. Additionally, commercial and retail customers have continued to build cash reserves.

Short-term borrowings generally include federal funds purchased, treasury tax and loan note options, securities sold under agreement to repurchase, short-term Federal Home Loan Bank ("FHLB") advances and discount window borrowings from the Federal Reserve Bank. These funding alternatives are utilized in varying degrees depending on their pricing and availability. As of June 30, 2009, the amount of short-term borrowings was $132.3 million compared to $210.2 million at year-end 2008, a decrease of $77.9 million or 37 percent, primarily due to activity in retail repurchase agreements. All of the bank subsidiaries provide retail repurchase agreements to their customers as a cash management tool, sweeping excess funds from demand deposit accounts into these agreements. This source of funding does not increase the bank’s reserve requirements, nor does it create an expense relating to FDIC premiums on deposits. Although the aggregate balance of these retail repurchase agreements is subject to variation, the account relationships represented by these balances are principally local. These balances were $117.9 million at June 30, 2009, compared to $170.5 million at year-end 2008.

Other borrowings include all debt arrangements Heartland and its subsidiaries have entered into with original maturities that extend beyond one year. As of June 30, 2009, the amount of other borrowings was $457.5 million, an increase of $19.7 million or 4 percent since year-end 2008. Other borrowings include structured wholesale repurchase agreements which totaled $135.0 million at June 30, 2009, and $120.0 million at year-end 2008. The balances outstanding on trust preferred capital securities issued by Heartland are also included in other borrowings.

A schedule of Heartland’s trust preferred offerings outstanding as of June 30, 2009, is as follows:

(Dollars in thousands)

Amount Issued		Issuance Date	Interest Rate	Interest Rate as of 6/30/09	Maturity Date	Callable Date

$	5,000	08/07/00	10.60%	10.60%	09/07/2030	09/07/2010
	20,000	10/10/03	8.25%	8.25%	10/10/2033	09/30/2009
	25,000	03/17/04	2.75% over Libor	3.36%	03/17/2034	09/17/2009
	20,000	01/31/06	1.33% over Libor	2.46%	04/07/2036	04/07/2011
	20,000	06/21/07	6.75%	6.75%	09/15/2037	06/15/2012
	20,000	06/26/07	1.48% over Libor	2.15%	09/01/2037	09/01/2012
$	110,000

Also in other borrowings are the bank subsidiaries’ borrowings from the regional Federal Home Loan Banks. All of the bank subsidiaries, except for Heartland’s most recent de novo bank, Minnesota Bank & Trust, own stock in the Federal Home Loan Bank of Chicago, Dallas, Des Moines, Seattle, San Francisco or Topeka, enabling them to borrow funds from their respective FHLB for short- or long-term purposes under a variety of programs. FHLB borrowings at June 30, 2009, totaled $204.3 million, an increase of $4.8 million or 2 percent from the December 31, 2008, FHLB borrowings of $199.5 million. Total FHLB borrowings at June 30, 2009, had an average rate of 3.27 percent and an average maturity of 3.80 years. When considering the earliest possible call date on these advances, the average maturity is shortened to 2.27 years.

COMMITMENTS AND CONTRACTUAL OBLIGATIONS

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Heartland banks evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Heartland banks upon extension of credit, is based upon management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. Standby letters of credit and financial guarantees written are conditional commitments issued by the Heartland banks to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. At June 30, 2009, and December 31, 2008, commitments to extend credit aggregated $506.3 million and $529.1 million, and standby letters of credit aggregated $25.4 million and $26.2 million, respectively.

Contractual obligations and other commitments were presented in Heartland’s 2008 Annual Report on Form 10-K. There have been no material changes in Heartland’s contractual obligations and other commitments since that report was filed.

CAPITAL RESOURCES

Bank regulatory agencies have adopted capital standards by which all bank holding companies will be evaluated. Under the risk-based method of measurement, the resulting ratio is dependent upon not only the level of capital and assets, but also the composition of assets and capital and the amount of off-balance sheet commitments. Heartland and its bank subsidiaries have been, and will continue to be, managed so they meet the “well-capitalized” requirements under the regulatory framework for prompt corrective action. To be categorized as “well–capitalized” under the regulatory framework, bank holding companies and banks must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios of 10%, 6% and 4%, respectively. The most recent notification from the FDIC categorized Heartland and each of its bank subsidiaries as “well–capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed each institution’s category.

Heartland's capital ratios were as follows for the dates indicated:

CAPITAL RATIOS (Dollars in thousands)
	June 30, 2009						December 31, 2008
	Amount		Ratio			Amount		Ratio
Risk-Based Capital Ratios1
Tier 1 capital	$	377,249		13.44	%	$	368,101		13.26	%
Tier 1 capital minimum requirement		112,260		4.00	%		111,017		4.00	%
Excess	$	264,989		9.44	%	$	257,084		9.26	%
Total capital	$	421,354		15.01	%	$	413,913		14.91	%
Total capital minimum requirement		224,520		8.00	%		222,035		8.00	%
Excess	$	196,834		7.01	%	$	191,878		6.91	%
Total risk-adjusted assets	$	2,806,503				$	2,775,436
Leverage Capital Ratios2
Tier 1 capital	$	377,249		10.14	%	$	368,101		10.68	%
Tier 1 capital minimum requirement3		148,756		4.00	%		137,917		4.00	%
Excess	$	228,493		6.14	%	$	230,184		6.68	%
Average adjusted assets (less goodwill and other intangible assets)	$	3,718,898				$	3,447,927

(1)	Based on the risk-based capital guidelines of the Federal Reserve, a bank holding company is required to maintain a Tier 1 capital to risk-adjusted assets ratio of 4.00% and total capital to risk-adjusted assets ratio of 8.00%.

(2)	The leverage ratio is defined as the ratio of Tier 1 capital to average adjusted assets.

(3)	Management of Heartland has established a minimum target leverage ratio of 4.00%. Based on Federal Reserve guidelines, a bank holding company generally is required to maintain a leverage ratio of 3.00% plus additional capital of at least 100 basis points.

Commitments for capital expenditures are an important factor in evaluating capital adequacy. On June 30, 2009, Heartland invested capital of $15.3 million into Heartland Community Development Inc., a wholly-owned subsidiary of Heartland. The primary purpose of Heartland Community Development Inc. is to hold and manage certain nonperforming loans and assets to allow the liquidation of such assets at a time that is more economically advantageous. Heartland Community Development Inc. used the initial capital investment to purchase other real estate with a fair value of $15.3 million from certain Heartland bank subsidiaries on June 30, 2009.

Summit Bank & Trust began operations on November 1, 2006, in the Denver, Colorado suburban community of Broomfield. The capital structure of this new bank is very similar to that used when New Mexico Bank & Trust and Arizona Bank & Trust were formed. Heartland’s initial investment was $12.0 million, or 80%, of the $15.0 million initial capital. All minority stockholders entered into a stock transfer agreement that imposes certain restrictions on the sale, transfer or other disposition of their shares in Summit Bank & Trust and requires Heartland to repurchase the shares from investors five years from the date of opening. The stock will be valued by an independent third party appraiser with the required purchase by Heartland at the appraised value, not to exceed 18x earnings, or a minimum return of 6 percent on the original investment amount, whichever is greater. Through June 30, 2009, Heartland accrued the amount due to the minority stockholders at 6 percent. The obligation to repay the original investment is payable in cash or Heartland stock or a combination of cash and stock at the option of the minority stockholders. The remainder of the obligation to the minority stockholders is payable in cash or Heartland stock or a combination of cash and stock at the option of Heartland.

Minnesota Bank & Trust, Heartland’s newest de novo, began operations on April 15, 2008, in Edina, Minnesota, located in the Minneapolis, Minnesota metropolitan area. Heartland’s initial investment was $13.2 million, or 80 percent, of the $16.5 million initial capital. All minority stockholders entered into a stock transfer agreement that imposes certain restrictions on the sale, transfer or other disposition of their shares in Minnesota Bank & Trust and allows, but does not require, Heartland to repurchase the shares from investors.

On December 19, 2008, Heartland received $81.7 million through participation in the U.S. Treasury’s Capital Purchase Program (CPP). The CPP was authorized by the government’s Troubled Asset Relief Program (TARP) under the Emergency Economic Stabilization Act of 2008. The TARP is designed to infuse capital into the nation’s healthiest banks to increase the flow of financing to American consumers and businesses. Funds received by Heartland were allocated to debt reduction (including $34.0 million used to extinguish debt on Heartland’s credit line), capital maintenance at its subsidiary banks and short-term investments. Heartland continues to honor the intent of the CPP by seeking high quality lending opportunities and the potential acquisition of banks in its existing markets.

Heartland continues to explore opportunities to expand its footprint of independent community banks. Given the current issues in the banking industry and the availability of capital via the TARP, Heartland has changed its strategic growth initiatives from de novo banks and branching to acquisitions. Attention will be focused on markets Heartland currently serves, where there would be an opportunity to grow market share, achieve efficiencies and provide greater convenience for current customers. Additionally, management has asked regulators to notify them when troubled institutions surface in Heartland’s existing markets. Future expenditures relating to expansion efforts, in addition to those identified above, are not estimable at this time.

RECENT EVENTS

On July 2, 2009, Galena State Bank, Heartland’s subsidiary bank based in Galena, Illinois, acquired all of the deposits and substantially all of the financial obligations and financial assets, including loans, of Elizabeth State Bank in Elizabeth, Illinois from the FDIC as receiver. The two bank branches previously owned and operated by Elizabeth State Bank, one in Elizabeth and the other in Galena, reopened on Monday, July 6, 2009, as Galena State Bank branches. Liabilities, including deposits, assumed were approximately $55.4 million and assets acquired were approximately $53.5 million. Galena State Bank paid a premium of 1.0 percent to acquire all of the deposits of the failed bank, but also received a discount of $2.5 million on the assets, resulting in a net payment to Galena State Bank from the FDIC of approximately $4.0 million at closing. The loans acquired are subject to a loss-sharing arrangement with the FDIC. The Elizabeth State Bank acquisition strengthens Heartland’s Galena State Bank subsidiary through increased market share and adds more convenience for existing customers.

LIQUIDITY

Liquidity refers to Heartland’s ability to maintain a cash flow that is adequate to meet maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund operations and to provide for customers’ credit needs. The liquidity of Heartland principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings and its ability to borrow funds in the money or capital markets.

Total cash provided by operating activities was $31.2 million during the first six months of 2009 compared to $15.0 million during the first six months of 2008. A portion of this change was the result of proceeds on sales of loans in excess of cash used for the origination of loans for sale.

Investing activities used cash of $167.1 million during the first six months of 2009 compared to $135.6 million during the first six months of 2008. The proceeds from securities sales, paydowns and maturities was $219.6 million during the first six months of 2009 compared to $186.9 million during the first six months of 2008. Purchases of securities used cash of $370.8 million during the first six months of 2009 while $303.3 million was used for securities purchases during the first six months of 2008. Cash used to fund loans and leases was $24.1 million during the first six months of 2009 compared to $18.5 million during the first six months of 2008.

Financing activities provided cash of $124.5 million during the first six months of 2009 compared to $115.0 million during the first six months of 2008. There was a net increase in deposit accounts of $187.3 million during the first six months of 2009 compared to $32.6 million during the same six months of 2008. Activity in short-term borrowings used cash of $77.9 million during the first six months of 2009 compared to $91.0 million during the first six months of 2008. Cash proceeds from other borrowings were $55.1 million during the first six months of 2009 compared to $201.9 million during the first six months of 2008. Repayment of other borrowings used cash of $35.4 million during the first six months of 2009 compared to $21.5 million during the first six months of 2008.

Management of investing and financing activities, and market conditions, determine the level and the stability of net interest cash flows. Management attempts to mitigate the impact of changes in market interest rates to the extent possible, so that balance sheet growth is the principal determinant of growth in net interest cash flows.

Heartland’s short-term borrowing balances are dependent on commercial cash management and smaller correspondent bank relationships and, as such, will normally fluctuate. Heartland believes these balances, on average, to be stable sources of funds; however, it intends to rely on deposit growth and additional FHLB borrowings in the future.

In the event of short-term liquidity needs, the bank subsidiaries may purchase federal funds from each other or from correspondent banks and may also borrow from the Federal Reserve Bank. Additionally, the subsidiary banks' FHLB memberships give them the ability to borrow funds for short- and long-term purposes under a variety of programs.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in market prices and rates. Heartland’s market risk is comprised primarily of interest rate risk resulting from its core banking activities of lending and deposit gathering. Interest rate risk measures the impact on earnings from changes in interest rates and the effect on current fair market values of Heartland’s assets, liabilities and off-balance sheet contracts. The objective is to measure this risk and manage the balance sheet to avoid unacceptable potential for economic loss.

Management continually develops and applies strategies to mitigate market risk. Exposure to market risk is reviewed on a regular basis by the asset/liability committees of the banks and, on a consolidated basis, by Heartland’s executive management and board of directors. Darling Consulting Group, Inc. has been engaged to provide asset/liability management position assessment and strategy formulation services to Heartland and its bank subsidiaries. At least quarterly, a detailed review of the balance sheet risk profile is performed for Heartland and each of its subsidiary banks. Included in these reviews are interest rate sensitivity analyses, which simulate changes in net interest income in response to various interest rate scenarios. This analysis considers current portfolio rates, existing maturities, repricing opportunities and market interest rates, in addition to prepayments and growth under different interest rate assumptions. Selected strategies are modeled prior to implementation to determine their effect on Heartland’s interest rate risk profile and net interest income. Although Heartland has entered into derivative financial instruments to mitigate the exposure of Heartland’s net interest income to a change in the rate environment, management does not believe that Heartland’s primary market risk exposures have changed significantly in 2009 when compared to 2008.

The core interest rate risk analysis utilized by Heartland examines the balance sheet under increasing and decreasing interest scenarios that are neither too modest nor too extreme. All rate changes are ramped over a 12-month horizon based upon a parallel shift in the yield curve and then maintained at those levels over the remainder of the simulation horizon. Using this approach, management is able to see the effect that both a gradual change of rates (year 1) and a rate shock (year 2 and beyond) could have on Heartland’s net interest income. Starting balances in the model reflect actual balances on the “as of” date, adjusted for material and significant transactions. Pro-forma balances remain static. This enables interest rate risk embedded within the existing balance sheet to be isolated from the interest rate risk often caused by growth in assets and liabilities. Due to the low interest rate environment, the simulations under a decreasing interest rate scenario were prepared using a 100 basis point shift in rates during the second quarters of 2009 and 2008 instead of the 200 basis point shift typically used. The most recent reviews at June 30, 2009 and 2008, provided the following results:

	2009						2008
	Net Interest Income (in thousands)		% Change From Base				Net Interest Income (in thousands)		% Change From Base

Year 1
Down 100 Basis Points	$	131,826		0.39		%	$	113,838		(0.59	)	%
Base	$	131,313					$	114,518
Up 200 Basis Points	$	126,444		(3.71	)	%	$	112,843		(1.46	)	%

Year 2
Down 100 Basis Points	$	130,304		(0.77	)	%	$	109,814		(4.11	)	%
Base	$	132,327		0.77		%	$	115,117		0.52		%
Up 200 Basis Points	$	129,979		(1.02	)	%	$	114,979		0.40		%

Heartland uses derivative financial instruments to manage the impact of changes in interest rates on its future interest income or interest expense. Heartland is exposed to credit-related losses in the event of nonperformance by the counterparties to these derivative instruments, but believes it has minimized the risk of these losses by entering into the contracts with large, stable financial institutions. The estimated fair market values of these derivative instruments are presented in Note 4 to the consolidated financial statements.

Heartland enters into financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and may require collateral from the borrower. Standby letters of credit are conditional commitments issued by Heartland to guarantee the performance of a customer to a third party up to a stated amount and with specified terms and conditions. These commitments to extend credit and standby letters of credit are not recorded on the balance sheet until the instrument is exercised.

Heartland holds a securities trading portfolio that would also be subject to elements of market risk. These securities are carried on the balance sheet at fair value. As of June 30, 2009, these securities had a carrying value of $1.9 million or 0.05% of total assets compared to $1.7 million or 0.05% of total assets at year-end 2008.

ITEM 4. CONTROLS AND PROCEDURES

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, Heartland’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Heartland’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Heartland’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) were effective as of June 30, 2009, in ensuring that information required to be disclosed by Heartland in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms, and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, in a manner that allows for timely decisions regarding required disclosure.

There were no changes in Heartland’s internal control over financial reporting that occurred during the quarter ended June 30, 2009, that have materially affected, or are reasonably likely to materially affect, Heartland’s internal control over financial reporting.

PART II

ITEM 1. LEGAL PROCEEDINGS

There are no material pending legal proceedings to which Heartland or its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses. While the ultimate outcome of current legal proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these legal actions should not have a material effect on Heartland's consolidated financial position or results of operations.

ITEM 1A. RISK FACTORS

There have been no material changes in the risk factors applicable to Heartland from those disclosed in Part I, Item 1A. “Risk Factors”, in Heartland’s 2008 Annual Report on Form 10-K. Please refer to that section of Heartland’s Form 10-K for disclosures regarding the risks and uncertainties related to Heartland’s business.

ITEM 2. UNREGISTERED SALES OF ISSUER SECURITIES AND USE OF PROCEEDS

The following table provides information about purchases by Heartland and its affiliated purchasers during the quarter ended June 30, 2009, of its common stock:

Period	(a) Total Number of Shares Purchased		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1)		(d) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(2)
04/01/09- 04/30/09		-		-		-	$	2,707,060
05/01/09- 05/31/09		43	$	14.52		43	$	2,844,284
06/01/09- 06/30/09		1	$	13.76		1	$	2,843,919
Total:		44	$	14.50		44		N/A

(1)	The amounts listed represent solely repurchases made under Heartland’s Dividend Reinvestment Plan.

(2)

Although Heartland’s board of directors authorized management to acquire and hold up to 500,000 shares of common stock as treasury shares at any one time, Heartland is prohibited from any repurchase, redemption, or acquisition of its common stock, except for certain repurchases to the extent of increases in shares outstanding because of issuances under existing benefit plans, under the terms of the Securities Purchase Agreement pursuant to which Heartland issued preferred stock to the Treasury under the Capital Purchase Program.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Heartland’s annual meeting of stockholders was held on May 20, 2009. At the meeting, John W. Cox, Jr. and Lynn B. Fuller were elected to serve as Class I directors (term expires in 2012). Continuing as Class II directors (term expires in 2010) are Mark C. Falb, James R. Hill and John K. Schmidt. Continuing as Class III directors (term expires in 2011) are James F. Conlan and Thomas L. Flynn. Additionally, the stockholders ratified the appointment of KPMG LLP as Heartland's independent registered public accounting firm for the year ending December 31, 2009, amended the Certificate of Incorporation to increase the authorized shares of common stock from 20,000,000 shares to 25,000,000 shares and approved, by a non-binding advisory vote, the compensation of Heartland’s executive officers as described in the 2009 proxy statement. As recommended by Heartland’s board of directors, a stockholder proposal urging declassification of the Board of Directors was not approved.

There were 16,273,695.342 issued and outstanding shares of common stock entitled to vote at the annual meeting. The voting results on the above described items were as follows:

Election of Directors
		For	Withheld
	John W. Cox, Jr.	13,832,024.330	93,342.528
	Lynn B. Fuller	13,826,849.256	98,517.602

		For		Against		Abstain		Broker Non-Votes
Appointment of KPMG LLP		13,861,088.231		20,850.351		43,428.276		2,348,328.484

		For		Against		Abstain		Broker Non-Votes
Amendment of Certificate of Incorporation to increase authorized shares		13,037,761.859		742,248.831		145,356.168		2,348,328.484

		For		Against		Abstain		Broker Non-Votes
Approve compensation of executives		13,067,387.206		548,060.159		309,919.493		2,348,328.484

		For		Against		Abstain		Broker Non-Votes
Proposal urging declassification of Board of Directors		1,979,877.878		9,765,748.974		473,639.006		4,054,429.484

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

Exhibits

3.1	Amendment to Certificate of Incorporation.
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a).
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a).
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.

HEARTLAND FINANCIAL USA, INC.

(Registrant)

Principal Executive Officer

/s/ Lynn B. Fuller

-----------------------

By: Lynn B. Fuller

President and Chief Executive Officer

Principal Financial and

Accounting Officer

/s/ John K. Schmidt

-----------------------

By: John K. Schmidt

Executive Vice President

and Chief Financial Officer

Dated: August 10, 2009