Lynn Fuller - Chairman & CEO Bryan McKeag - CFO Ken Erickson - EVP & CCO.

Jeff Rulis - D.A. Davidson & Co. Jon Arfstrom - RBC Capital Markets Andrew Liesch - Sandler O'Neill & Partners LP Damon DelMonte - Keefe, Bruyette & Woods Inc. Daniel Cardenas - Raymond James & Associates, Inc..

Greetings and welcome to the Heartland Financial USA Inc. Fourth Quarter 2015 Conference Call. This afternoon, Heartland distributed its fourth quarter press release, and hopefully you've had a chance to review the results. If there is anyone on this call who did not receive a copy, you may access it at Heartland's website at www.htfl.com.

With us today from management are Lynn Fuller, Chairman and Chief Executive Officer; Bryan McKeag, Chief Financial Officer; and Ken Erickson, Executive Vice President and Chief Credit Officer. Management will provide a brief summary of the quarter and then we will open up the call to your questions.

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

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

Additional information on these factors is included from time to time in the Company's 10-K and 10-Q filings, which may be obtained on the company's website or the SEC's website. [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, Darrin, and good afternoon, everyone. We sure appreciate everyone joining us today as we review Heartland's performance for the fourth quarter and full year of 2015.

For the next few minutes, I'll touch on the highlights for the quarter and will then turn the call over to Bryan McKeag, our Executive Vice President and Chief Financial Officer, who will provide further detail on Heartland's quarterly and annual operating results.

And then Ken Erickson, our Executive Vice President and Chief Credit Officer will offer insights on credit related topics. Well, I'm very pleased to begin this afternoon's call with news that Heartland has just completed its best year on record with net income of $60 million.

2015 net income available to common shareholders of $59.2 million represents a 44% increase over 2014. On a per share basis, Heartland earned $2.83 per diluted common share for 2015, compared to earnings per share of $2.19 per diluted common share for 2014 and that's a 29% increase.

For the fourth quarter, net income available to common stockholders of $14.4 million represents a 19% increase over the fourth quarter of 2014. And on a per share basis, Heartland earned $0.67 compared to $0.64 per share for the fourth quarter of 2014.

Well in light of our company's exceptional earnings report today, I'm compelled to point that our stock is trading near its book value and less than 10 times our trailing 12 months earnings of $2.83 per share and we can only you view this as an exceptional opportunity for buyers.

Onto book value and tangible book value per share, that continued to increase, ending the quarter at $25.92 and $20.60 respectively. Our tangible capital ratio is 6.1% for the quarter, reflecting the goodwill created through our acquisitions, but still within our target range of 6% to 7%.

Heartland's annualized return on average common equity year-to-date was 11.9%, so just under 12% and return on average tangible common equity was at 13.9%, so we just missed 14%. A continuing highlight of Heartland's strong performance is net interest margin, which held up well at 3.99% for the quarter and 3.97% for the year.

Net interest income in dollars was also up with a significant increase over last year's quarter and year-to-date periods. Now looking at the balance sheet, total assets increased 27% for 2015, ending the year at $7.7 billion.

Onto loans, after a very strong second quarter, loan demand moderated during the second half of the year and that said, organic loan growth at $186 million represents an increase of 5%, which is respectable. And for 2016, we remain cautiously optimistic as quality loan growth is our second highest priority.

Heartland's residential real estate division experienced a good year, with funded volume up 30% to $1.4 billion versus $1.1 billion in 2014. During the year, we successfully implemented a new strategy concentrating loan origination within our bank branch footprint and proven profitable loan production offices.

Specifically, we closed offices in Washington, Oregon, Southern California, Nebraska and North Dakota. We believe these and other cost savings initiatives will produce positive results in 2016. Heartland's mortgage servicing portfolio continues to grow, exceeding $4 billion at year end.

We show $30.3 million of MSRs on our books, which is approximately $10.6 million less than our valuation. Credit quality remains excellent. Non-performing assets to total assets at 67 basis points, and net charge-offs for the year at only 12 basis points are both exceptional.

In a few minutes, Ken Erickson will provide more detail on credit-related topics, including Heartland's lack of exposure to the oil and gas industry. Our securities portfolio now represents 24% of total assets compared to 28% just over one year ago. The tax equivalent yield on our securities portfolio increased by 11 basis points to two point.

As we've shared in the past, our goal was to convert securities into quality loans. Having achieved much of that goal, we've shifted our strategic priority to funding future loan growth. Deposit growth is our highest priority now with emphasis on non-reporting [ph] demand, savings and money market deposits.

Moving on to deposits, we experienced strong organic deposit growth of $368 million representing an increase of nearly 8% for the year, with the majority coming in the fourth quarter as we initiated a new deposit acquisition contest which produced a substantial amount of non-timed deposit dollars and new account relationships.

Deposit composition continues to reflect a very favorable mix, with non-interest demand deposits at 30%, savings and money market demand at 53%, and timed deposits at only 17% of total deposits. Well an area of significant focus for Heartland is non-interest expense.

We are implementing a variety of process improvement initiatives, efficiency projects and FTE reductions with a corporate goal of bringing our efficiency ratio to 65% by the end of 2016.

Having started this initiative when the ratio was in the mid-70s, we are pleased with our progress on this front, as the ratio reached 69% for the year and 68.5% for the fourth quarter. We continue to invest in technology and talent, building out scalable systems and processes, preparing Heartland for $10 billion in asset size and beyond.

In a moment, Bryan McKeag will address non-interest expenses in more detail. Now for an update on M&A activity, in October, Heartland announced a definitive merger agreement with CIC Bancshares Inc., parent company of Centennial Bank, headquartered in Denver, Colorado.

With regulatory approval now in place, we anticipate closing the transaction in February, with a systems integration planned for the second quarter of this year.

Upon closing, Centennial Bank will be merged into our Summit Bank & Trust subsidiary, adding 14 banking centers to our footprint and bringing our assets in Colorado to approximately $890 million with 17 locations.

The combined bank will operate under the name Centennial Bank and Trust, with Kevin Ahern, James Spacey and John Rhodes leading the Heartland team in Colorado. So in November, Heartland closed on our previously announced acquisition of Premier Valley Bank in Fresno, California.

Premier Valley Bank, which added assets of approximately $734 million, is our 10th independent state chartered bank subsidiary, and will continue to on operate under its current name and management team. We continue to prioritize in-footprint opportunities, with the goal of achieving $1 billion in assets or more for each of our member banks.

We currently have three banks over $1 billion, with the potential for two to three additional banks exceeding $1 billion in 2016. Finally, we remain committed to pursuing only those deals that will be accretive to our current shareholders' earnings per share and produce a minimum of 15% internal rates of return.

Well in concluding my comments today, I'm very pleased to report that in December, the Heartland Board of Directors in recognition of our outstanding record setting financial performance declared a special dividend of $0.05 per common share. With this paid in December 31, our total dividends in 2015 came to $0.45 per common share.

Additionally, at its January 16 Board meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share, payable on March 4, 2016. Certainly worth noting that Heartland has paid an increased or level dividend in every quarter since the company's inception in 1981.

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

Bryan?.

Thanks, Lynn, and good afternoon. I'll take the next few minutes to discuss the main performance drivers of our results, and provide updates on key operating metrics for the quarter. I'll start with the loan portfolio, where loans held to maturity grew $359 million this quarter, ending the quarter at $5 billion.

Excluding the $390 million in loans from our Premier Valley acquisition, loans showed a slight decrease of $31 million. Full year 2015, organic loan growth, however, was $186 million or 5%. Moving to deposits, which increased $899 million this quarter, ending the quarter at $6.4 billion.

The increase was comprised of $276 million of organic growth and $623 million from the acquisition this quarter. Demand deposits accounted for $282 million of this growth in the quarter, of which $13 million was organic, and savings account balances grew $431 million, of which $248 million was organic.

Shifting to the income statement, net interest income continued to grow, reaching a new high of $62.7 million this quarter, up $3 million or 5% from the prior quarter.

The net interest margin remained strong, declining just two basis points this quarter to 3.99%, as interest costs on deposits and borrowings declined five basis points and loan yields decreased four basis points compared to last quarter.

Non-interest income totaled $24.4 million for the quarter, down $600,000 from the prior quarter as investment security gains and impairments showed a net increase of $1.4 million and income from the sale and servicing of loans had a net decline of $2.4 million this quarter.

More specifically, gain on sale of loans was $7.1 million, down $2.7 million or 28% from the prior quarter primarily due to lower mortgage loan application activity, which was down 31% quarter-over-quarter. The decline in applications reflects the seasonally lower activity we expect to see in the fourth quarter.

The service loan portfolio continued to grow, adding $94 million this quarter, ending the quarter at just under $4.1 billion. The portfolio has grown $559 million or 16% over the past 12 months.

As a result of the growth in the service portfolio throughout the year, loan servicing income has grown steadily over the past three quarters, increasing $300,000 in the fourth quarter over the third quarter. Switching to non-interest expense, total expenses were $66 million, an increase of $4 million from the prior quarter.

Expenses this quarter included approximately $1 million in non-recurring costs related to our completed acquisitions, which about $300,000 higher than last quarter.

Several expense categories of note include salary and benefit expense, which decreased $3.5 million from the prior quarter, primarily due to lower commissions and lower incentive and profit-sharing accruals. Professional fees increased $1.3 million this quarter, as recruiting and merger-related costs increased over last quarter.

Loss on the sale or valuation of assets increased $3.5 million this quarter, primarily due to a $3.2 million write-down on a single property held in other real estate which was the results of an updated appraisal.

Other non-interest expense was up $1.8 million from last quarter, as this quarter included $1.4 million of costs for historical tax credits, compared with $800,000 of similar costs last quarter. In addition, travel related to data conversion and integration activities was also higher this quarter than the prior quarter.

For the quarter, our efficiency ratio improved to 68.53% from 69.85% last quarter as core expenses remained flat and core operating revenue increased compared to the prior quarter.

As I've stated before, on a go-forward basis, our efficiency ratio will show variability from quarter-to-quarter as we realize the benefits of scale and cost savings from our acquisitions offset by some lumpiness as the initial costs related to these acquisitions are recorded.

We will also experience some seasonal variability in this ratio from our mortgage business. Over the long haul, however, we are confident that our efficiency ratio will continue to trend downward during 2016 just as it did in 2015.

The effective tax rate was just under 23% for the quarter, which included $1.4 million of historic tax credits, that's down from last quarter's 25% rate, which also -- which included a lower level of store tax credits. Excluding the credits, the tax rate this quarter would have been in the 30% to 31% range.

To wrap-up, I would add the following comments about 2015 and I would note that these comments exclude the pending Centennial Bank acquisition, and reflect a cautiously optimistic view of the economy in 2016.

So first, loan growth for next year is expected to be similar to the 4% to 5% growth we saw in 2015 and will likely be lumpy from quarter-to-quarter. Our net interest margin is expected to remain between 3.95% and 4.05%. However, if a much flatter yield curve emerges, that margin could be pushed below the range.

Core non-interest income, excluding security gains and mortgage banking, is expected to show year-over-year growth on a percentage basis in the mid-teens reflecting the fee generation opportunities from our acquisition partners, which did not have meaningful mortgage banking, wealth, treasury management and card-based products and services prior to joining us.

In addition, we expect revenue growth within our existing markets and customer base from our continued investment in our fee-based businesses. Mortgage production is expected to approach 2015 levels, as production from our expanded footprint largely offsets the lost production from the seven out-of-footprint markets we exited.

In 2016, production is expected to follow normal seasonal mortgage trends.

Core expenses, that is excluding losses on OREO and the cost of tax credits, are expected to grow year-over-year on a percentage basis in the mid to upper single-digits reflecting the full-year impacts of our acquisitions late in 2015 and costs related to growing our fee businesses.

Finally, the Centennial Bank acquisition is expected to close in February 2016. As a result, we should see loans increase by approximately $550 million and deposits increase by approximately $650 million in the first quarter. Shares outstanding will increase as we anticipate issuing approximately 2.2 million shares in this transaction.

But remember, for EPS purposes, these shares will only be outstanding for about half the quarter. The net EPS impact up next quarter should be minor. However, we expect Centennial to be additive to earnings and accretive to EPS in the quarters thereafter; particularly after systems conversions are completed in the second quarter of 2016.

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

Thank you, Bryan, and good afternoon. I will begin by discussing the change in non-performing loans and other real estate owned. This quarter resulted in non-performing loans increasing from 0.73% to 0.79% of total loans. This occurred as a result of the acquisition of Premier Valley Bank and the addition of $5 million of acquired non-performing loans.

There are only six non-performing loans with individual loan balances exceeding $1 million. In aggregate, these six loans total $13.8 million or 34.9% of the total non-performing loans. Four of these loans totaling $10 million came with the acquisitions closed this year.

$16.1million or 40.7% of our non-performing loans are in our Bank's retail portfolios of consumer and residential real estate loans.

This is an increase of $4 million since September 30 and is tied to an increase in non-performing FHA, VA residential real estate loans from our serviced loan portfolio, which we report as non-performing while we conclude the collection activity on these loans. Those loans continue to be guaranteed, so our loss exposure is minimal.

30 to 89-day delinquencies decreased to 0.31%. The increasing trends of non-performing loans and delinquencies are both the result of these four bank acquisitions closed this year. Without the acquisitions, non-performing loans decreased by $809,000 or 3.2% compared to December 31, 2014.

The increases were identified in the due diligence for these acquisitions. Our special assets team has begun working with these borrowers to obtain an appropriate resolution. Other real estate owned decreased by $5.5 million in the fourth quarter to $11.5 million. Non-performing assets as a percent of total assets decreased from 0.76% to 0.67%.

Other real estate owned has also been impacted by acquisitions. Without the acquisitions, other real estate owned would have decreased by $9 million or 47.3% compared to December 31, 2014. Sale of other real estate owned resulted in a reduction of $3 million in the past quarter.

This quarter we took write-downs in the amount of $3.9 million on other real estate owned, of this, $3.2 million related to a single property. The recently received appraisal on this property showed significant changes in market values of similar properties in the area and limited sales activity.

We update the valuations on all of the properties held in other real estate on an annual basis and write the book values down to market value when the updated valuations indicate a decline in value.

Our existing portfolio of other real estate is made up of 11 residential properties aggregating to $1.6 million and 41 commercial properties that aggregate to $9.9 million. Provision expense was $2.2 million in the fourth quarter, a $1 million reduction from the third quarter.

$781 million of loans from our acquisitions still reside in purchased accounting pool and are covered by the valuation reserve. As credit decisions are made on these accounts in future quarters, a provision expense will be necessary to establish the associated allowance for those loans. Net charge-offs were $591,000 for the fourth quarter.

$931,000 of charge-offs were taken by our consumer finance company. Net recoveries at the banks in the fourth quarter were $340,000. As shown in the earnings release, our coverage ratio of allowance per loan and lease losses as a percent of non-performing loans and leases was 122.77%, down from 139.54% at the end of September.

This decrease is the result of the non-performing loans added through acquisitions.

Excluding the effect of future acquisitions, the coverage ratio should continue to increase in future quarters as non-performing loans are reduced and as loans currently covered by the valuation reserve migrate out of the purchased accounting pool and have an allowance established on them.

The allowance for loan and lease losses as a percent of loans and leases decreased from 1.01% to 0.97% this quarter. Valuation reserves totaling $27.8 million are recorded for those loans obtained in acquisition. Excluding those loans covered by the valuation reserves would result in a ratio of 1.15%, which would compare to 1.13% at September 30.

As mentioned by both Lynn and Bryan, our organic loan growth was $186 million for the year, but negative for the quarter. Our unscheduled pay-downs and payoffs this quarter in the amount of $137 million were much higher than the previous quarter of $84.9 million.

Included in these unscheduled pay-downs this quarter was a reduction in loans in the amount of $47.3 million from customers making seasonal reductions. $25.8 million in payoffs as customers sold their business or sold assets within their business, and $7.3 million of reductions as a result of collection activities on problem loans.

Within the commercial and the agricultural portfolios, new loan production, excluding acquisition, resulted in $491 million of increased outstanding in 2015 compared to $515 million in 2014. We attribute this slower organic growth to the sluggish economy.

We pride ourselves in being able to retain acquired loan customers and turn them into long-term relationships. Our organic growth should continue to exceed the peer growth percentage. We will continue to acquire new loan customers through bank acquisitions, while the market still supports these purchase activities.

In the first quarter, we will renew the majority of our annual agricultural lines of credit and obtain updated financial information in the process. We expect that 2015 farm income will be less than that shown in 2014. The last few years have shown unprecedented farm income.

Row crops, corn and soybeans have seen a significant price decline and are at or near breakeven based upon the operator's fixed overhead. Cattle prices have dropped significantly within the past four to five months. It is anticipated that the drop in feeder cattle prices will result in normalized earnings beginning in the second quarter of 2016.

Hog prices have declined to a level that we expect many operators to be at breakeven or even a small loss. And milk prices have seen significant decreases from their record highs last year and milk producers are approaching breakeven.

Short-term price fluctuations are the norm in the agricultural economy; even the best agricultural borrowers are not profitable every year. When profits are strong, there are new entrants into the market, and existing players add to their acres planted or livestock raised. This increases supply and negatively impacts prices and profitability.

These cycles are somewhat predictable and rectify themselves. The reduction in commodity prices thus have a positive impact by reducing feed costs and lower breakeven prices for the livestock segment. The expected decline in an agricultural borrower's profitability would be more serious if they were not coming off of record profits years.

Many have reduced debt and built equity over the past couple of years. We anticipate a few borrowers may need to term out operating lines. This is not unusual in agricultural lending in years where operating losses occur.

We also limit our exposure to fluctuating and inflated real estate values in agricultural lending by providing loans based upon production value as opposed to current market values of real estate. We expect limited downgrades and a few credit losses. We only have $3 million of indirect exposure to the oil and gas industry.

These loans are to 26 unique borrowers that support mining and extraction activities. With that, I'll turn the call back to you, Lynn, and remain available for questions..

Thanks, Ken. Before we open the phone lines, I'd like to take a moment to recognize and thank Ken Erickson for his 40 years of service to Heartland and our member banks as he will be retiring next week. Ken is an admired and respected leader across Heartland.

His business sense, and in particular his credit acumen, have served as a compass along Heartland's growth path and will certainly be missed. Ken navigated Heartland through numerous credit cycles with great skill and discipline, including the worst economic crisis of our time, the Great Recession.

As a result, Ken has helped us to the point where we have never experienced a loss year in our history. So, we owe Ken a great deal of gratitude for his many contributions to Heartland and wish him well in his retirement. Beginning with Heartland's next earnings call in April this year, we will welcome Andrew Townsend to the table.

Drew has been named Heartland's Executive Vice President and Chief Credit Officer, having worked alongside Ken as deputy Chief Credit Officer for the past three years. We're indeed fortunate to have Drew well prepared to lead our credit culture going forward.

Also participating in future calls will be Bruce K Lee, President of Heartland, who joined us just over one year ago from Fifth Third Bank, where he served in a variety of positions, most recently as Executive Vice President and Chief Credit Officer.

I can assure you that Heartland's credit culture will remain exceptionally strong well into the future. So with that, I'll now open the phone lines for your questions..

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Mr. Jeff Rulis with D.A. Davidson. Please proceed with your question..

Thanks. Good afternoon..

Hi, Jeff. .

Ken, could you repeat the payoff figures again? I missed jotting those down. .

Sure. This quarter was $137 million compared to last quarter of $84.9 million. And in that, $47.3 million was customers making seasonal reductions, $25.8 million is from customers that sold their business or sold assets in the business, and $7.3 million was from collection activity..

Great. Okay. Thank you. And then I guess Bryan, do you have a -- thanks for the loan-to-deposit numbers on the upcoming acquisition.

But do you have an anticipated goodwill and CDI figure?.

Probably, I think the goodwill number will range around $35 million. I don't have the deposit CDI number with me, but I think it will be around that number. It's always hard to pin down, because we haven't finalized all the purchase accounting. So, whatever the market values are on that date will impact that..

Okay, great. And then question on the mortgage process this quarter.

The TRID documentation, did that delay any booking of fees or loans into the portfolio? And is there any potential for a back loaded, those that were maybe be delayed maybe a catch-up at any point?.

I think there may be a little bit of that. I think that without question that that created more work for the mortgage unit and getting up-to-speed on that. So, there may be a little of that. I don't see a whole lot. I think they did a pretty good job adjusting to the new requirements.

So, again, there may be some adjustment, but I don't think it's real significant, Jeff..

Got it. Okay. And then maybe one quick last one on that.

On the SBLF, is Q1 the last -- is this the last quarter of the current coupon rate?.

That's right, Jeff. Yes, you're correct, Jeff. We've said that a number of times in past releases that our plan has been to pay that off in March..

Okay. Thank you..

Our next question comes from Jon Arfstrom with RBC Capital Markets. Please proceed with your question..

Thanks. Good afternoon, guys..

Hi Jon..

A few things here. Just back on the question on some of the pay-downs and reductions in balances at year end.

Ken, are you saying that maybe the activity was a little stronger than you expected in Q4?.

I'm saying it was stronger than it was in Q3 and I think Bryan's number was $31 million of actual reduction of loan outstanding from the organic side. So, we knew the production was not as solid in the second half of the year, but dropping back $31 million was because of the stronger pay-downs that we had..

Yeah. Okay..

Jon, I might add to that too that when you look at all the acquired loans and deposits we had to fold in and sorting through some of the credits that we wanted to purposely exit, I think that took a fair amount of work. So, our loan growth has never been just a straight line. It's always been a little bit lumpy.

And I think the M&A activity creates some of that lumpiness. But we're able to absorb an awful lot of acquired loan assets, and at the same time end up with what I would consider to be excellent credit quality..

Okay. That makes sense.

In terms of the footprint, maybe Lynn or Ken, which geographies in the footprint would you say are strongest and most challenging in terms of growth?.

You mean the greatest growth markets?.

Yes, both sides of it..

The greatest growth market that we have I would say it's still Denver, Colorado. That market seems to be pretty well diversified historically. It used to be heavily reliant upon oil and gas. But they're pretty well diversified. We just haven't ever lent into that sector.

So, I would I say Denver's probably the strongest, the twin cities remains reasonably strong. New Mexico, we've got a very strong management team there. So, even though the economy in New Mexico hasn't been that robust, they've generally done pretty darn good.

I mean you can look at the earnings of our individual banks, and you can see that most of them have really improved their earnings situation. I guess the more challenging one would still be Minnesota, because of its small size.

We clearly need to get that bank either through acquisition or organic growth up past that $0.5 billion mark and onto $1 billion. If you look at our banks, the three banks that are $1 billion in assets and greater, they tend to be the most profitable.

We should have two to three of additional banks going over that $1 billion asset mark, and as we get scale, we really tend to do pretty good. So, I mean we're still cautiously optimistic across the entire footprint. Wisconsin has been busy absorbing Community Bank of Cheboygan. We're doing well in Arizona. Arizona I think has a lot of upside potential.

So -- Phoenix had been weak in the past, but that's starting to come around now. So, I feel pretty optimistic across the entire footprint..

Okay, good. Couple more things here as long as I've got you guys.

Just on the deposit growth as the new highest priority, what changes there? What do you do differently, and how do you define success in that category?.

Well, we've always told our banks that their deposit franchise is really the value of the franchise. And we ran a deposit, new deposit, acquisition contest in the fourth quarter and really did well with that. So, I would anticipate that we'd look at something like that again in 2016.

But clearly the focus for over the last number of years has been on non-time, non-interest bearing DDA, savings and money market accounts. You can see that from our deposit mix. And the Western banks seem to do better than the Midwest banks as far as deposit mix. But I just think that if we can continue to grow deposits, two things will happen.

One, we'll be able to fund our loan growth. The other thing is we only have about 2.5%, 3% of non-core funding on our balance sheet across the system, we could certainly reduce the non-core funding. And we still have some room to convert our investment securities, which are about 24% of total assets.

We could bring that down to 20% and still be comfortable. So, you may not see a lot of core organic asset growth, but you'd see continued improvement in the mix on our balance sheet. And that will help us maintain our net interest margin. That's really the goal for 2016.

We want to try to hold that margin in that 4% range, I think Bryan talked to that point and that's clearly the goal..

Okay, good. And then, Bryan, just a couple of points of clarification from you. In terms of starting point on expenses, carve some of these items out and maybe we get to $245 million as the baseline from last year.

Is that the fair number?.

Yeah, I think that's a fair number for the base. I think this quarter when I kind of look at the expenses, if you start with that $66 million and you take out the tax, the $1.4 million and the $3.2 million of that one-time loss, you get in that $62 million range, which is where I thought the run rate would be when we talked last quarter.

But then if you add back a couple million for two months of Premier Valley being there and maybe a little bit for CIC in the next quarter, we're probably looking at $64 million point something next quarter as a core place to start..

Okay.

And in terms of fees, just under $100 million is probably the run rate?.

Yeah, probably. Fees -- what bounces around is the -- is mortgage..

Yeah..

If you--.

That includes mortgage, obviously, but--..

That does, yeah. I think it's probably -- for the full year, it's probably going to -- I'm just trying to pull something up here real quick. I think you're going to see -- with everything in it, the non-mortgage pieces of our fee business should be growing at pretty good clip as I mentioned in my comments.

And I think those are going to grow mid-teens type of percentage growth. And then you're going to see probably the mortgage and loan part of the business be somewhat flat, as I said, mortgage production should be similar to last year in 2016.

So, combine that all together, we should see probably an eight percentage increase off of the $100 million we have this year..

Okay..

Hey, Jon, the thing that I'm really excited about, when you think about the four banks that joined us last year and the two that are announced to join this year, none of those banks really were able to penetrate the fee-based services we provide. They didn't provide private client services, which is trust and 401-K plans and financial planning.

They didn't provide much in the way of treasury services or card services, for that matter. Mortgage wasn't part of their offering. So when you look at all those fee-based services, we've got a lot of additional customer base to sell fee-based services into, and really expand the services per household.

And that's clearly helping us retain that customer base and helping us grow fee income. That's one of the things that these acquisitions are really bringing us. They're also bringing us very low cost deposits, which is a real positive..

Okay, makes sense. Thanks for everything and Ken, best of luck..

Thanks..

[Operator Instructions] Our next question comes from Andrew Liesch with Sandler O'Neill. Please proceed with your question..

Hey, guys..

Hey, Andrew. .

Just circle back to the loan production in this quarter. So, it sounds like origination activity might have been a little bit less, but pay-downs as well were maybe more than you were looking for. Just kind of curious where these pay-downs came from.

Was it customers that from acquired deals that you didn't really want to keep, or was it customers that you were surprised that paid down their loans? Just kind of curious what was -- any more color on the driver behind that?.

The first part, the larger group of that, the $47 million, was just end of year normal seasonal pay-down. It was just a little larger than what we had in the previous quarter. We only had $7.3 million that was truly the special asset reduction collection activity. But well it's going to hit on another part.

I didn't measure in these numbers or try to quantify from those acquisitions that we've had, how many of those customers that have moved on that's been okay with us. I commented, we really look at the relationship and try to build relationships.

But in every acquisition, we're going to have ones that don't fit our culture or our credit parameters and they will move on. So, we have had a fair amount of bad activity that has paid off over the year as well..

Certainly. And then just looking at the back of the release, just the portfolio breakout by subsidiary type. It looks like Wisconsin had the biggest decline, so, I'm just curious what might have been going on there this quarter..

That would have tied into the reduction of loans in that Community Bank acquisition. That was a higher level of non-performing loans or classified loans coming into our portfolio and we have had the opportunity to work with them since January of this year. So, that portfolio has cleaned up significantly over this year..

Got you. Very helpful. And then if you could just comment on the M&A conversations that you've been having lately, frequency of them. And then your thoughts being with the stock where it is makes it a little bit tougher for deals to pencil out, so I'm just curious your thoughts there..

Well, you hit on something that we've talked a lot about. And so if you guys can get our price expectations up there, maybe we can be back in the market. As you can imagine, if our stock is trading at book and less than 10 times earnings, it's going to be tough to pencil these out.

We do have some discussions with individuals that still are interested, but if our stock doesn't recover a bit, it's going to be challenging. But we're not alone in that space. I mean the industry's been hit to a great extent much as we've been hit. So, what's going to happen is I'd ask you guys.

Are seller expectations going to come down to meet the current multiples of buyers? Or are we going to see stock prices start to recover a bit? I kind of think that the market has over reacted.

I mean we still think we've got better earnings to show our shareholders both in 2016 and 2017, but I know a lot of banks have reported that they're expecting lower earnings for the next couple years..

All right. Thank you for your insight..

Yeah. We'll see..

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

Hey, guys, good afternoon.

How you doing today?.

Good afternoon..

Great. My first question just relates to the repayment of the SBLF funds. Bryan, are you able to quantify what the impact is to your regulatory capital ratios? I think with the deal that closed this quarter and then folding in the Centennial in the first quarter.

Then you factor in another $80 million, $81.5 million or so, what does that do to your total risk-based capital ratio?.

I don't know if I have -- I have a lot of things with me. That wasn't one I brought. I can get you that. It would be something we could calculate pretty easy. We've been looking at lots of different things. I just don't have it with me..

We don't have the exact numbers, Dam. We did report to the Heartland Board that all of our capital ratios, our regulatory capital ratios, are still in good shape. And we certainly lose some of that margin, but we're not in danger of breaking through regulatory levels that would cause a concern. We're still good there.

But I would suggest, Bryan, that you get those back to Damon..

I'll get you those. We've been working on that, actually as part of our application to pay this off, we have to work through what that is. So, I have some things sitting on my desk that I could get those to you right away. I just don't have them with me..

Okay. That's great.

And then in the non-interest income categories, was there a BOLI gain this quarter?.

It went up, and the reason is Premier Valley has some BOLI. So when we brought them in, they had one month that caused that to pick up a little bit. But no doubt [Indiscernible] anything like that, nothing unusual..

Okay. That's helpful. And then I guess just lastly, when you think about the provision expense, any guidance as to what we could expect next year? This year you put up $12.7 million, I think it was, for the year.

Could we expect a little bit of an increase, especially as you guys start to comb through the ag portfolio?.

I think -- I'll jump first on that. I think I commented a little bit last quarter also that we don't expect a lot of losses in that ag group. We'll see a few go to the watch list or maybe classified, but just don't see much in loss there.

But what you do need to watch for provision expense is that $781 million of loans that currently sits in the purchased accounting pool. Over the next two to three years, those will move from that pool into the allowance. So, they will have a new allowance just as if they were a brand new loan to the organization.

And then you will have the loan growth, and I think Bryan or Lynn commented of maybe a 4% to 5% loan growth target for 2016..

Okay.

So what are you provisioning on new loans? Somewhere around 100, 125 basis points?.

I think you can target 1.25..

1.25, okay. That's all that I had for now. Thank you very much..

Hey, Damon, before you go. I did get -- somebody walked over to my desk and grab a piece of paper off there. It looks to me like our total risk-based capital will probably go down by 1.1% or thereabouts, and we'll take about a 1.5% to 1.75% decrease on our risk based Tier-1..

And then show the ending percentage then..

Yeah, well these are projections for the third quarter or for the first quarter. But they'll both be well above the required well capitalized..

That's what I remembered from the Board meeting..

Yeah..

So that probably puts you below 12% though on the total risk based capital?.

It would, yes..

It would, okay. And then do you guys have any thoughts on taking action to boost that and bolster that? Because it seems like if your total risk-based capital goes below 12% that may also constrict your ability to do additional deals until you rebuild that level..

Remember that our focus on acquisitions has been more on the end of giving stock versus cash. So, in effect, we are issuing stock when we do acquisitions..

Got you..

Again, if our price doesn't go up, you're not going to see a lot more of that activity and we'll start to just retaining earnings which will improve those ratios..

Right..

And at our level of earnings, we'll retain an awful lot of earnings. And of course the interest cost on that SBLF goes away. So, we'll be recapturing a lot of retained earnings..

Got it. Okay. Thank you very much..

[Operator Instructions] Our next question comes from Daniel Cardenas with Raymond James. Please proceed with your question..

Good afternoon, guys..

Hey, Dan..

Just a quick question on -- a follow-up question on that purchased accounting pool, that $781 million that you have in there.

Does that stream into the regular portfolio on a fairly consistent basis, or is it lumpier, or maybe heavily weighted towards years three than it would maybe year one?.

No, it would be more pro rata. It's when a credit decision is made on the credit, it will move from the purchased pool to the allowance calculation. And then it's also accreted through and pretty well matches up probably with the interest income that is shown that's written off as we increase the allowance in that same quarter..

Okay.

Then as I think about the tax rate for modeling purposes, what would be a good effective tax rate to assume for you guys in 2016?.

I would say probably around 30%, 31%, and then with -- at our current earnings rate, and then the add you'd have to use an incremental rate of about 36% or 37%. So, I don't know for next year, it probably blends to -- I think are too high -- it's probably 32% to 33% for next year..

All right. The rest of my questions have been answered. Thanks, guys..

Thanks, Dan. .

If there are no further questions, I would like to turn the floor back over to Mr. Fuller for closing comments..

Thank you, Darrin. In conclusion, we are very pleased with Heartland's excellent performance for 2015. And consistent with our master strategy of balanced profit and growth, both earnings and assets achieved new record highs. Net income reached $60 million and assets reached $7.7 billion.

And more specifically, net income to common shareholders grew by 44% over the previous year. And earnings per share increased by 29% over the previous year to $2.83. Assets increased by 27% or nearly $1.7 billion over the year and credit quality remained exceptional. We maintained our margin at 3.99%, with solid organic loan and deposit growth.

And double-digit returns on both average common and average common tangible equity for the year at 11.9% and 13.9% respectively. Continued reduction in our efficiency ratio in pursuit of our 65% goal by Q4 of 2016. And through both organic and acquired growth, we're moving closer to our goal of $1 billion of assets in each state where we operate.

In short, I feel very good about Heartland's performance and continue to see excellent opportunities ahead for our shareholders. I'd like to thank everyone for joining us today, and hope you can join us again at our next quarterly conference call which will take place on Monday, April 25th, 2016. Thanks again, and have a good evening, everybody.

Good night..

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