Lynn Fuller - Chairman and Chief Executive Officer Bruce Lee - President Bryan McKeag - Executive Vice President and Chief Financial Officer Andrew Townsend - Executive Vice President and Chief Credit Officer.

Aaron Deer - Sandler O'Neill Jeff Rulis - D.A. Davidson Steve Moss - FBR Damon DelMonte - KBW Nathan Race - Piper Jaffray Daniel Cardenas - Raymond James.

Greetings and welcome to the Heartland Financial USA, Inc. Fourth Quarter 2016 Conference Call. This afternoon, Heartland distributed its fourth quarter press release and hopefully, you have had a chance to review the results. If there is anyone on this call who did not receive a copy, you may access it at Heartland’s website at www.htlf.com.

With us today from management are Lynn Fuller, Chairman and Chief Executive Officer; Bruce Lee, President; Bryan McKeag, Executive Vice President and Chief Financial Officer; and Andrew Townsend, Executive Vice President and Chief Credit Officer.

Management will provide a brief summary of the quarter and then we will open up the call to questions from analysts.

Before we begin the presentation, I would like to remind everyone that some of the information management will be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission.

As part of these guidelines, I must point out that any statements made during this presentation concerning the company’s hopes, beliefs, expectations and predictions of the future are forward-looking statements and actual results could differ materially from those projected.

Additional information on these factors is included from time-to-time in the company’s 10-K and 10-Q filings, which maybe obtained on the company’s website or the SEC’s website. [Operator Instructions] As a reminder, this conference is being recorded. At this time, I will now turn the call over to Mr. Lynn Fuller at Heartland. Please go ahead, sir..

Thank you, Darren, good afternoon. We appreciate everyone joining us today as we discuss Heartland’s performance for 2016. For the next few minutes, I will touch on the highlights for the year and the fourth quarter. I will then turn the call over to Heartland’s President, Bruce Lee, who will cover progress on our key operating strategies.

Then Bryan McKeag, our Executive Vice President and CFO, will provide additional color on Heartland’s quarterly results, followed by Drew Townsend, our Executive Vice President and Chief Credit Officer, who will offer insights on credit-related topics.

Well, I am certainly pleased to begin this afternoon’s call with news that Heartland has just completed its best year on record, with net income available to common shareholders of $80.1 million, which represents a 35% increase over 2015.

Now on a per share basis, Heartland earned $3.22 per diluted common share for 2016 and that’s a 14% increase over 2015. For the fourth quarter, net income available to common shareholders of $19.1 million represents a 33% increase over the fourth quarter of 2015 and on a per share basis that’s $0.74 compared to $0.67 for the fourth quarter of 2015.

Return on average assets for the quarter and year-to-date were 0.92% and 0.98% respectively. Return on average common equity for the quarter and year-to-date were 10.48% and 11.8%, respectively. And finally, return on average tangible common equity for the quarter and year-to-date were 13.24% and 15.15% respectively.

Heartland’s tangible common equity ratio fuelled by solid earnings and our recent common stock offering improved by 43 basis points during the quarter to 7.28%. Book value and tangible book value per common share continued to increase ending the quarter at $28.31 and $22.55 respectively.

Net interest margin on a fully taxed equivalent basis remained steady for the quarter at 4.14%, benefitting from lower funding cost and improved assets yields. Net interest income in dollars has increased each quarter for over four straight years.

Now, looking at the balance sheet, total assets held steady at $8.2 billion during the quarter and increased by $552 million for the year, largely the result of the CIC bank shares acquisition, and in a few minutes Bruce Lee will discuss loans, deposits, and fee income initiatives in more detail.

Heartland’s securities portfolio currently represents 26% of assets. With our target at 20%, we still have room to convert cash flow from our securities portfolio and the loans. Currently our portfolio duration is 3.5 to 4 years, with the portfolio yield approaching 3%.

Overall, credit quality remains sound, although we did experience a modest increase in non-performing assets for the quarter. That said, delinquencies decreased, net charge-offs were modest, and provision expense remained low. In a few minutes, Drew Townsend will provide more detail on these and other credit-related topics.

With respect to Heartland’s efficiency ratio, we’ve made significant progress ending the year at 66.25% that represents a 291 basis point improvement year-over-year. We continue to implement process improvements and buildout scalable systems in our ongoing efforts to bring lease ratios down further.

We are also taking steps to rationalize underperforming branch locations with two offices planned for consolidation early this year. As these reductions occur, we continue to invest in Heartland’s online banking channels converting more and more customers to our digital channels.

Following Bruce Lee’s comments, Bryan McKeag will address non-interest expense in more detail. Now, moving on to M&A, expansion of our banking franchise through mergers and acquisitions remains a high priority for Heartland.

Our proposed merger with Founders Bancorp, parent company of Founders Community Bank, headquartered in San Luis Obispo, California, is moving forward with Federal Regulatory Approval in place and state approval expected any day now.

Subject to the founders shareholders vote in February, the transaction is expected to close later in the month with the system conversion planned for March. At closing, Founder Community Bank will be merged into our Premier Valley Bank subsidiary, with the Founders Banking offices continuing to operate under the Founders brand.

Heartland’s presence in the Central Valley and Central Coast of California will grow to 9 locations with assets exceeding $800 million. Following the merger, Heartland will grow to 112 full service banking locations operating across 12 states. Now looking into 2017, we continue to evaluate several attractive opportunities.

Our common stock offering last fall combined with the surge in Heartland share price increases the likelihood of more M&A announcements to come. We remain committed to achieving our goal to reach $1 billion or more in assets in each state where Heartland operates.

Building on our M&A experience, Heartland is in a great position for additional accretive acquisitions. Well with respect to our dividend, I am very pleased to report that in December, the Heartland Board declared a special dividend of $0.10 per common share in recognition of the company’s record financial performance for 2016.

And at this month’s January meeting, the board approved an increase in the regular quarterly dividend to $0.11 per common share payable on March 03, 2017. In closing my portion of today’s call, I want to note that Heartland’s strong financial performance has not gone unnoticed.

We recently learned that Heartland has received recognition from Forbes magazine as we were rated as one of the best banks in America. Based on 10 metrics related to growth, profitability, capital adequacy and asset quality, Heartland ranked 44th on their list of the 100 largest U.S. banks.

I will now turn the call over to Bruce Lee, Heartland’s President, who will provide an overview of the company’s strategic initiatives.

Bruce?.

Thank you, Lynn. Good afternoon. I am pleased to comment today on the collective results at the Heartland Banks in revenue producing business lines as we pursue profitable and sustainable growth. I will begin my remarks with lending, where on a composite basis; total loans were down in the fourth quarter.

At the member bank level, the results vary as four banks increased loan balances, two were flat, and three experienced decreases.

We continue to see a trend at member banks that have completed recent acquisitions for declining balances as CRE exposure is brought into balance and challenged credits are resolved as we de-risk the balance sheet of those banks. Outside of these transitioning markets, loan growth is positive.

On the deposit side, our focus has been on growing non-time deposits. During 2016, non-time deposits grew over $700 million or 13.4%. For the fourth quarter, growth was mixed with retail non-time balance; non-time deposits growing $80 million, however, commercial and other balances declined a similar amount.

Although balances were flat, we were pleased to see a nice increase in the number of accounts this quarter with all three business lines retail, small business and commercial showing positive account growth.

With the emphasis in growth in non-time deposits during 2016, our deposit mix has experienced a favourable shift with non-time deposits increasing from 83% to 87% of total deposits. For the fourth quarter total deposit interest expense improved by two basis points to 21 basis points.

Moving now to residential real estate, originations were down 14% from the previous quarter as interest rates picked up along with the seasonal slowdown.

Compared to the year ago quarter, however originations are up over 7% with the prospect of lower volumes in the short term, we have implemented reductions in our workforce and continuing our efforts to improve profitability.

These efforts are meeting with success despite a $206 million decrease in loan volume year-over-year our pre-tax profit increased by $700,000. Additionally, margin in our mortgage business segment is up 26 basis points this year.

With the new management team in place, and our efforts to improve efficiency, we are optimistic our mortgage unit will have a solid year in 2017 as we focus our efforts on the purchase market which represents 60% of our volume.

We remain committed to the mortgage business and to that end are expanding our presence in current footprint locations in California and Arizona.

Heartland’s mortgage servicing portfolio continues to grow exceeding $4.3 billion on December 31, we show $32.1 million of MSRs on our books which have a fair value of approximately $45 million or $13 million more than book value.

We are also enthusiastic about the progress in some of our fee producing business lines, namely commercial card payment solutions which more than doubled the card related revenue in 2016 over the previous year. Gross revenues increased from $1.8 million in 2015 to $3.9 million in 2016, an increase of 119%.

Given the growth potential of this business line, we are adding additional resources to capture this opportunity. It’s another example of how Heartland’s size and business model gives us an advantage in this space.

We have identified an underserved market dominated by large regional and national competitors that have overlooked the small and medium sized businesses we serve in our community banking niche.

Our strategy is to approach these clients with a holistic solution that streamlines our business payments processes and adds value beyond reward points and rebase.

Likewise our treasury management teams are taking the same strategic approach by offering clients our expertise with process improvements that reduce fraud losses and enhance cash management.

We have selectively added experienced staff to our treasury management teams especially in our newly acquired banks in expanding markets, to bring enhanced treasury services to our customers who had limited availability previously. These actions are showing very good results as commercial deposit account service revenue increased by 35% in 2016.

Finally, as we begin a New Year we are pleased that all Heartland banks are profitable for each quarter of 2016 and excited by the prospects for each of the banks and the many opportunities to grow our franchises by adding value to our clients in 2017.

With that, I will now turn the call over to Bryan McKeag for more detail on our quarterly financial results..

Thanks Bruce and good afternoon. I will begin my comments today with the tangible common equity ratio, which showed good improvement again this quarter increasing 43 basis points over the last quarter to 7.28%. The increase was the result of the $50 million stock issuance in November which added approximately 57 basis points to the TCE ratio.

However, a good portion of that increase was offset by the decline in market value of our investment portfolio which reduced the ratio by about 30 basis points with the remaining 16 basis point increase coming from retained earnings.

Moving on to the income statement, net interest income continued to grow, reaching $75.2 million this quarter, up $1.5 million from the prior quarter. Net interest margin on a tax equivalent basis remained strong at 4.14%, which was unchanged from last quarter.

Yields on loans and investments increased by 5 basis point and 11 basis points, respectively and interest cost on deposits and borrowings decreased 3 basis point compared to last quarter.

This quarter, the net interest margin includes the positive impact of 15 basis points from the amortization of purchase accounting discounts, which is comparable to the prior quarter. Non-interest income totaled $24.5 million for the quarter, down $4 million from last quarter.

Gain on sale of securities was relatively unchanged at $1.6 million and gain on sale of loans for the quarter was down $5.6 million compared to the last quarter, primarily due to lower mortgage loan application activity which was down 30% from last quarter.

Switching to non-interest expense, total non-interest expenses were $69.9 million this quarter, an increase of $1.5 million from the prior quarter. Our largest expense category, salary and benefits decreased $1.6 million as compared to last quarter largely due to lower commissions and reductions in incentive and benefit accruals.

Professional fees were up $1.2 million from last quarter’s levels as consulting and other costs related to systems enhancements were higher during the fourth quarter. Advertising costs were also up $1 million from last quarter primarily due to a Heartland wide fourth quarter deposit campaign.

And finally other non-interest expense was also up $2 million over the last quarter as this quarter included $1 million of additional write-downs and partnerships investments in tax credit related projects. In addition there were several smaller year accruals that accounted for the bulk of the remaining increase in the line item.

For the quarter, our efficiency ratio was 66.29% up from 63.88% last quarter as core operating revenues decreased $2.4 million while core operating expenses increased $1 million compared to the prior quarter. For the full year 2016 the efficiency ratio was 66.25% down almost three percentage points from last year.

To wrap up, I want to add a couple of comments regarding our 2017 expectations. First, loan and deposits are budgeted to grow on a percentage basis in the mid single digits.

Net interest margin on a tax equivalent basis is expected to remain fairly stable but pull backed just a bit into the 4.05% to 4.10% range, as the impact from existing purchase accounting diminished obviously this could be offset by additional rate increases should they materialize in 2017.

Mortgage production is expected to be down modestly over last year’s levels due to anticipated slowdown in mortgage refi volumes. In contrast to the refi market we expect the purchase volumes to increase slightly as we view the purchase market as more stable and expect to see increased volumes in our newer and recently expanded markets.

Mortgage gain on sale margins are expected to be improved over the last year as we saw our margin expand over 30 basis points during the last half of 2016 and we expect that higher level to carry throughout 2017.

Other fee income areas are also expected to show continued improvement with deposit and service fee related growth on a percentage basis in the low to mid teens and private client services fees that’s trust, brokerage and insurance to grow in the mid single digits as we increase the penetration of products and services into our expanding customer bases.

Core expenses in total should remain well controlled as we work to improve the efficiency in each of our lines of business and in particular mortgage banking. However, these efficiency gains will be offset by investments in people and technology that are necessary as we continue our growth by $10 billion.

In addition, the core expenses it’s likely that we’ll see an increase in professional fees for M&A activities as we continue to work to find good, suitable M&A opportunities during 2017.

And finally, the Founders Bank core transaction is expected to be closed and converted in the first quarter of 2017, as a result shares outstanding will increase by approximately 450,000. Loans will increase by approximately 100 million and deposits will increase by approximately 180 million next quarter.

And with that, I will turn the call over to Drew Townsend, our Executive Vice President and Chief Credit Officer..

Thank you, Bryan. Good afternoon, this afternoon, I will begin my credit related remarks by discussing the changes in Heartland’s non-performing loans during the fourth quarter. During the quarter, non-performing loans showed a modest net increase of $6.5 million, which resulted in a 14 basis points change from 1.06% to 1.2% of total loans.

New non-performing loans identified during the fourth quarter equalled $23 million with $21.5 million generated from the Heartland member banks and $1.5 million from the Citizens Finance, Heartland’s consumer finance company. Within the member bank total, 95% of the $21.5 million increase was originated from the legacy bank portfolios.

The new non-performing loans by loan type included $14.1 million or 66% attributed to the commercial loan portfolio and $7.4 million or 34% from the retail portfolios. There were no new non-accrual agricultural loans identified during the quarter.

Within the $14.1 million increase in commercial non-accrual loans, it is noted that one large relationship of $10.9 million represents 75% of the total commercial increases. This relationship is Iowa based and was originated by Dubuque Bank.

This loan was previously deemed impaired during the second quarter of 2016 with total impairment reported for this loan of $1.7 million as of the fourth quarter of 2016.

When reviewing the total non-performing loans in greater detail, it is noted that Heartland wide commercial and ag loans equalled $38.6 million or 61% of the total and the retail portfolios accounted for $24.8 million or 39%.

Within the commercial total there are two large relationships, one ag business and one commercial which totalled $20.7 million and account for 33% of all non-performing loans. At this time both loans are adequately reserved and are in the process of collection.

Given the current complexicity of the circumstances with these relationships, it is anticipated it may take several quarters before these credits are brought to resolution. In the retail portfolios, $14.3 million or 22% of the total non-performing loans are repurchased residential, real estate loans from our service loans portfolio.

These loans are either FHA, VA or USDA guaranteed, in which our loss exposure is considered minimal. On a more positive note, I am very pleased to report that $13.7 million of non-performing loans in all categories were resolved during the fourth quarter of 2016.

When reviewing Heartlands overall loan quality metrics, the company’s positive trend with respect to total subrated loans those risk rated either watch or substandard continued during the fourth quarter with the combined total decreasing by $29.3 million.

These decreases were the result of either risk rating upgrades, desired paydowns or planned exits of credits with a minimal amount of decrease attributed to charge-offs. For the year, Heartland sub-rated loans were reduced in total by $93.9 million and as a percent of total loans equalled 6.9%.

This level of non pass credits compares favourably to any quarter at the company over the past several years. As it relates to delinquency totals, the 30 to 89 days delinquency ratio is down slightly from 40 basis points to 37 basis points from the third quarter to the fourth.

As a follow up to comments, I have made in prior quarters with respect to Heartlands exposure to the agricultural sector, Heartland banks have identified only a limited number of borrowers who have been downgraded to a non pass rating.

Due to the elevated risks exhibited by the agricultural industry, Heartland will continue to closely monitor the quality of this portfolio. Other real estate owned totals continued to show improvement during the fourth quarter to $9.7 million or the limited number of additions of new properties.

In total, non-performing assets as a percent of total assets increased from 0.85% as of September 30 to 0.91% as of December 31. Based on current information, it would be our expectation that some improvement should be realized during the first quarter of 2017 with continued limited credit losses.

With respect to the allowance for losses it is noted that provision expense was $2.2 million during the fourth quarter a decrease of $3.1 million from the $5.3 million level reported during the third quarter and in line with the first two quarters of 2016.

Provision expense was positively impacted during the quarter and the year due to a continued reduction in subrated credits, non-performing assets demonstrating limited impairments, very modest net charge-off experience and a lack of non-acquisition based loan growth.

It remains noteworthy that $956 million of loans from our acquisition still reside in the purchased accounting pool and are covered by the valuation PCI reserves. As credit decisions are made on these loans in future quarters a provision expense will be necessary to establish the associated allowance for these acquired loans.

As shown in the earnings release, our coverage ratio of allowance for loan losses as a percent of nonperforming loans was 84.37% in the fourth quarter, down slightly from 94.39% in the third quarter. The allowance for loan losses as a percent of total loans remained relatively unchanged, increasing only slightly from 1% to 1.02% this quarter.

Valuation reserves totaling $25.3 million are recorded for the aforementioned loans obtained from acquisitions. Excluding those loans covered by the valuation reserves would result in allowance to loan ratio of 1.22%, which compares to 1.23% at September 30.

In summary, although nonperforming assets increased modestly during the fourth quarter the cause, as previously stated is primarily attributed to one large commercial credit and in repurchased government guaranteed residential mortgages.

Beyond those specific items the trends for various other asset quality metrics including delinquency levels, net charge-offs, total sub-rated loans and total other real estate owned either remains stable or demonstrating improvement. That concludes my remarks. And I'll turn the call back to Lynn and remain available for questions..

Thank you, Drew. We can now open the phone lines for questions from our analysts..

Hi. Good afternoon, guys. It’s actually Aaron Deer on for Andrew..

Hi, Aaron..

Hi, Aaron..

First congratulations on a very solid year. I guess I’d like to start with question I guess for Lynn or Bruce.

As you kind of look out over the year ahead, particularly I guess some of the slight decline in some of the loan books heading into year-end., where do you see the best growth opportunities both I guess by categories as well as by geography?.

Yes. This is Bruce, Aaron. First of all, we think that most of the decreases particularly in real estate, couple of our newly acquired markets, that’s sort of behind us, so we would expect that the markets out west in particular will show the best opportunity for growth.

The Midwest is still little muted, particularly the manufacturing space, and I'll let Drew maybe address where he thinks Ag is going to go. But we do expect as Bryan mentioned kind of the mid-single-digit growth going forward, but I would say most of the growth opportunity we believe is in our Western franchises..

This is Drew. As relative to the Ag, I think we’re going to see another pretty flat year probably I think we all recognized some additional headwinds at least in the Midwest with respect to commodities prices. And so, if we would grow in that area we would be taking quality credit away from other banks.

Our Western portfolios tend to be a little less than more specialized in terms of commodity, and there's little more upside in those portfolios, but overall I would think Ag will be kind of hold your own type of year..

Okay. That’s great. And Drew, maybe continuing with you, generally speaking I know the credit trends are pretty favourable, just curious on the two kind of larger NPLs that you highlighted, are those both to two separate borrowers, and where did – I want to confirm that, and also if there’s industry correlation between the two.

And then also, can you give us what the specific reserve is against those credits?.

First answer is, it is two separate borrowers; one is an agribusiness, one is an assisted living industry. The reserve for the one with impairment is $1.7 million. The other one, we feel very good about our collateral position, so at this point there is no reserve attached to that one..

Okay. And then one last question for Bryan on the expense side, I know you gave the number, but I've missed it.

Can you give what the tax credits accrual amount was for the fourth quarter as well as maybe what it was in third quarter just to see what the variance was? And then what the kind of one-off items were in the fourth quarter?.

Yes. In terms of tax write-offs, we had about a $1 million write-off in the third quarter. I don't see there were any in the third quarter, so four quarter’s $1 million, none in the third quarter, so that that would be running through other expenses. The rest, we had at the end of the year a lot of accrual adjustments in the salary and related areas.

I think when you put it all together and maybe where your questions going is, what's her run rate going forward. Quite frankly I’ve looked at that a couple different ways.

I think we’re probably going to see the expense run rate hang in there at about this level plus or minus maybe given quarter million dollars, but I think we’re working to keep those expenses relatively flat to maybe slightly down is we’re working on efficiency within the company..

Okay. That's great. Thank you for taking my questions..

Our next question comes from Jeff Rulis with D.A. Davidson. Please proceed with your question..

Thanks. Good afternoon..

Good afternoon, Jeff..

Question on the mortgage side, particularly on the gain on sale maybe for Bryan, obviously that’s a number that was almost half of the previous quarter, and you discussed kind of the outlook, I guess specific to the gain on sale for the full year, what is that expectation I guess a quarterly, we’ve got a pretty wide range in the quarterly basis, but for the bulk of 2017, what are your thoughts on that line item?.

Yes. I think it's going to have its same seasonality, I mean, most of our business in 2017 is going to be purchased-related, so that has the seasonality to it. And we’ll see the first and fourth quarters will be the lowest and then the middle of the year should show a pretty good tick up.

The reason that fourth quarter was low is, we actually came into the third quarter with a pretty good size pipeline and we had a mark adjustment that kind of catches up right at the end of the year when the pipeline shrinks and the loans get sold in the secondary market.

So, I think that that accounting tends to cause things to shift a little bit quarter-to-quarter. I think on the full-year basis, you know probably flat in total, but slightly down, volume might be down a little bit.

We’re hoping to make up some of that volume difference and better margins that we saw towards the end of the year as we worked on margin management. So, we will see -- it really depends on the volumes that the purchased market gives to us..

Sure. Okay. That’s helpful. Thank you.

And then I guess that the tax rate going forward, I think it’s 31.5 in the in the range of your expectation?.

I would say, if you were to ask, I’d say between 31% and 32%, so I think 31.5% is a right smack in the middle..

Okay. And then maybe one last one, maybe for Bruce, just on the -- you talk about M&A and it sounds like there is additional opportunities out there, I guess, given the capital level, well, I guess two-part.

One, would you go back and consider additional stock offerings; and two, just a little more detail on those conversations on the M&A side if you could? Thanks. .

Yes. As you know in the past for acquisitions of any size we've done a good portion of those in stock, and so it's not uncommon to do 20% cash, 80% stock or 30% cash, 70% stock. So the deals that we've been working on would have a good portion of stock to be issued.

So, we really haven't to look at anything at this point as far as new issuances other than some of the acquisitions. I really kind of thought we'd have another announcement yet in 2016, but what we've been working on get pushed out into 2017, so you can expect that that we’ll be coming in with some announcements.

So, we’ll just have see -- you know our earnings have been strong, that $50 million really help to push our rate up as far as our PCE. We know that as we approached $10 billion, we need to start operating in that closer to 8%, but we really have no intention of going over $10 billion in 2017.

We kind of thought that that could happen potentially in 2018, so we’ll just had to play it by year..

Okay. Thank you..

[Operator Instructions] Our next question comes from Steve Moss with FBR. Please proceed with your question..

Good morning..

Hi, Steve..

Hi.

I was wondering if there's been any pickup in the loan pipeline here over the past couple months post the election?.

I’m not sure if that was related to the election or not, but we have seen a pickup in the loan pipeline as we head into the first quarter of this year over the fourth quarter and typically the first quarter is a little softer, so we feel optimistic about the level of the pipeline right now..

Okay.

And then with regard to the net interest margin guidance, what are the rate expectations build into that?.

As we budget, we typically don't build in a rising rate scenario, we budget a flat scenario, and we would not have picked up because it was so late year the last 25 basis points, so there may be 25 basis points of opportunity that we don't have in our budget, that wouldn't be in that guidance, so the 4.05 to 4.10 that I gave you.

I think a 25 basis point move though, is probably four to six basis points depending upon what happens with positive pricing when that move, so we’ll move a little bit but not materially..

Okay. Thank you. That’s helpful.

And then one more thing with regard to just on the expense side on the deposit campaign is that going to carry over into the New Year or is that completed?.

I think there could be a – I think most of its done, there could be just a little bleed over but most of that should be done..

Okay. Thank you very much..

Our next question comes from Damon DelMonte with KBW. Please proceed with your question..

Hey, good afternoon guys.

How is it going today?.

Pretty good..

Great. So my first question, just want to talk little about, the Wisconsin banking trust subsidiary, I think loans have steadily declined since if you look on a year-over-year basis they went from around 800 million down to 650.

Could you just talk a little bit about some of the de-risking that's going on there? And do you think it’s kind of reached an inflection point, or would expect additional runoff from that portfolio?.

Yes. Damon, this is Bruce. I’ll take the beginning of that. Then I’ll let Drew maybe follow up. Most of that runoff especially what occurred in the last half of this year was directly related to de-risking that portfolio, it had a significant portion of its portfolio was substandard. We knew it and we work very hard at working those relationships out.

We also did have one significant relationship where we were paid off which was unexpected, it was a little over $20 million. But I think Drew has the numbers that where we decreased the substandard portfolio year-over-year. You want to mention those….

Yes. Just as a follow-up to Bruce’s comments there. At the end of 2015 the total of sub-rated credit at WBT was $161 million as we conclude the 2016, we’re down to 92, so that’s about a $60 – so almost $70 million of the decrease was associated substandard credits that we worked out..

Got you. Okay..

And maybe just to finish, our numbers coming into the acquisition now are very much in line with portfolios considerably bigger and so I think to Bruce’s point we should be – so, we are the feeling inflections, yes, that, that portfolio is now to the point where it should turn, I mean there's clearly we’d like to workouts more of the substandard, however that is not the focus that the team in Wisconsin has which they did have in 2016..

Damon, this is Lynn Fuller. The only one I would add is that when we model that we had a very, very large mark on the loans. We knew going in that we tended to be a bit of a lender of last resort, so it was it was modeled appropriately, so that we knew that this was coming..

Got you.

So was all planned and anticipated on your end then?.

Yes..

Okay, great. And then, maybe for Bryan, on the other non-interesting income line, I think it was like 2.6 million this quarter. I miss that if you said it before.

What were some the components to that, because that was up from $1 million last quarter and $750,000 a quarter before?.

Yes. So this quarter and the fourth quarter there were two items. One we had a recovery on a credit out in California, that charge-off was actually taken before we acquired the bank out there, so that ran through other incomes because we couldn’t run at through a normal, as a normal recovery. Not it’s about a $0.5 million.

And then our tax partnerships, we did actually have a distribution from those that was income did not run through taxes, it ran through just other income, now its about mainly power..

How about [Indiscernible] Okay..

Well that’s the $1.5 million [ph] change..

Okay, great. And then I guess just lastly as we you look at the provision I know you guy touch on this little bit, but third quarter was abnormally high versus the other three quarters from this year.

So kind of look to back to the other first, second and fourth quarter levels, does that a reasonable expectation going forward?.

Yes. I guess I would – I thought a lot about this. I think when you look at this year in total, Damon I would say we probably would be -- it's reasonable to expect that it will be slightly higher than what we ramp through this year.

This year was a pretty good year in total in terms of – as Drew mentioned, our underlying credit quality actually got better. Didn’t have a lot of loan growth.

We didn’t have lot of charge-offs, and so I think with some loan growth and everything else still remaining in pretty good shape which we expect, I think you could see that go up to you know maybe run rate of somewhere in the 3.5 million per quarter something like that..

Okay. All right. That's helpful. Thanks a lot guys. I appreciate it..

Thanks.

Our next question comes from the Nathan Race with Piper Jaffray, Please proceed with your question..

Hi, guys. Good evening..

Hi, Nate..

Question just on the securities portfolio at this point, even there kind of up-tick in rates that we’ve seen over the last couple months, can you just update us on your strategy deploying some excess liquidity going forward?.

We’ve got -- as I mentioned we got a lot of cash flow coming off of the investment portfolio. We’ve got close to 200 million in principal alone coming off of the investment portfolio in 2017, so what we’d like to see happen obviously is that 200 million go out of the portfolio in the loans pick up, the increase in return as the plan.

We’ll see if we can get the loan growth. The portfolio structure hasn't really changed a lot. On the short end its SBA floaters and very short mortgage-backed, some of those actually increase in yield if rates increase. And on the long end, it’s munis.

Now, we’re not really buying more munis now, not knowing what's going to happen with the federal tax rate. We kind of stayed away from any additions in that long into the portfolio.

The average yield on those munis has somewhere in the 5%, so it's a good return, but obviously the federal tax rate was down to 20%, that taxable equivalent yields to become off. So we’re staying pretty short with the investment portfolio and we think we can hold in that 3% return range with a short duration..

And I think as rates go up if we can't reinvest those in the more – if we have more cash flow then we can go in the loans. We’re going to be reinvesting those at higher rates, so we get a little up-tick on that as if you don’t get the loans..

Okay. That’s helpful. And then just, heading into 2016, organic deposit growth was the top priority and the success there is fairly evident.

Just curious kind of what the top priorities are as we head into 2017?.

Well, we still have deposit growth and specifically non-time deposit, so that non-interest-bearing DDA and low cost savings still is very high priority. But you’d have to put loan growth right up with that. Those are still the two highest priorities.

I followed that with continual improvement in our efficiency ratio and integration of M&A transactions because we expect this year to be a busy year for M&A integration..

Nate, this is Bruce. Just follow up on Lynn’s comments. One of the major focus is for us on both the deposit and loan side and even our fee businesses is all about new customer acquisition. That's what really will drive us forward in 2017, bringing new relationships into the bank.

So that's why we were so pleased on the deposit front in the fourth quarter. We brought in 3000 new relationships to the bank during the fourth quarter and that will continue to be our focus in 2017 which should result in increased fees, increase loans and increased non-time deposits/.

Got it. I appreciate all that color. And with just going back to your previous point about M&A, expecting some acceleration this year.

Can you remind us kind of where your comfort level is in terms of bringing additional assets and what they would do on a pro forma basis for your capital levels in terms of where you guys would be operating if you were able to do some large acquisitions this year?.

Well, you can put a cap on it by just saying that we’re not going to go over 10 billion in 2017, so that will give you an idea on how many dollars of acquisitions we can do it. If you have a larger acquisition that of course takes more work, so we’re probably going to be limited to one or two for 2017.

If there’s smaller-- we've done as many as four a year that pushes the envelope pretty hard, we’re really more comfortable with the maximum of three. But again, we would be looking at acquisitions, but we can do a large portion of the purchase price in Heartland stock and it makes sense for us to use our currency given where its trading..

Well, I guess I was just curious if you had a kind of target capital level that you wouldn’t go below on either TCE or regulatory basis?.

We’re not going to go below seven and we want to continue to move toward eight..

Got it. I appreciate all the color. Thanks guys..

Thanks, Nate.

Your next question comes from Daniel Cardenas with Raymond James. Please proceed with your question..

Good afternoon, guys..

Hi, Dan..

Just a couple of quick questions. I apologize if you guys went through this on the call already I’ve been jumping in and out. But the sequential quarter loan decline.

What was that attributable to?.

Dan, this is Bruce. Majority of that was attributable to de-risking in three of our member banks, reducing CRE exposure as well as challenge credit. I think we gave a fair amount of color on Wisconsin Bank and Trust, which was – when you look both quarter-over-quarter, as well as year-over-year, the largest decline of balances.

And that was again planned as we work through substandard credit..

Except for the one bigger credits that was left, that was 20 million [ph] to 27 million [ph]..

And is all the de-risking been completed or is there still some additional de-risking there we can see in 2017?.

We feel on the real estate side, we’re very comfortable with all of our member bank, commercial real estate portfolios. So I think we’re kind of done with that. And we feel pretty comfortable that Wisconsin has done a great job for cleaning up their loan portfolio and now it's time for them to turn the corner..

And Dan. This is Drew. Just as to follow-up to Bruce’s CRE comment, I just did see for the first time that they are 100, 300 report, and as far as commercial real estate concentration we have all the banks that are well within the 300% level now. So there is room..

Okay. Good. All right. And then just a quick question on the Ag portfolio, I imagine you going through renewal season rate now, were there any trends, didn’t sound like it in your earlier comments, were there any trends emerging that are giving pause for concern right now..

There’s obviously some stress in the commodity of the Midwest here, but our borrowers tend to come into these situations with good balance sheets. We’ve tended to keep ourselves pretty restrained about loaning into higher land values.

And so they have capacity to work their way through, and then to answer this question specifically no not yet, we haven’t seen anything and obviously another difficult year in 2017 will put further stress but I think we are going to see our way through this year in pretty good shape.

Dairy is an example is actually going the right direction for the most part, so there is some bright spots..

I think I’ve said this in the past Dan that most of our ag would be with clients that take their crops and feed it through their live stock. So, you know we’re not like you would see down in Central and Southern Illinois where they are just playing crop farmers and dependant on the price of corn and beans.

So, I think we tend to do a little better and as Bruce said; our ag credits tend to be the larger credits in their low leverage.

So they are not making a lot of money, I think that’s pretty clear, but ag has always been a cyclical business and as long as you keep the leverage low on these guys and you don’t get levered up on expansive land they will have years where they don’t make any money but they are not going bust..

Okay, good.

And one last question on the margin Bryan, have you built in any additional rate increases for 2017?.

We have not..

Okay, perfect. Allright, great. Thanks guys..

Thanks, Dan..

There are no further questions at this time. I would like to turn the floor back over to Mr. Fuller for closing comments..

Thank you, Darren. In closing, we are obviously very pleased with our excellent performance for 2016 and the fourth quarter and I’ll recap very quickly. Heartland completed its best year on record in 2016 with net income available to common shareholders of 80.1 million representing a 35% increase over 2015.

And over the past three years now, just over the past three years, Heartland’s net income has more than doubled growing by 118% [ph] and assets have increased by nearly 40%.

Heartlands net interest margin on a fully tax equivalent basis remains at an enviable level of 4.14% and as a result our earnings are strong with full year earnings per share at $3.22 and that’s a 14% increase over last year.

The Company continues to produce double digit recurrence on average common equity and average common tangible equity and our efficiency ratio has improved by 291 basis points this year with ongoing efforts for further reductions.

And finally, our pipeline of acquisition opportunities remained strong and through both organic and acquired growth, we are moving closer to our goal of 1 billion of assets in each state where we operate. So in summary, we begin the New Year poised for strong financial performance as we work toward another record year.

I’d like to thank everyone for joining us today and hope you can join us again for our next quarterly conference call which is on April 24th 2017. Have a good evening everyone..

This concludes todays teleconference. You may disconnect your lines at this time. Thank you for your participation..