Heartland Financial USA, Inc.

Moat: 1/5

Understandability: 2/5

Balance Sheet Health: 4/5

Heartland Financial USA, Inc. (HTLF) is a regional bank holding company, operating through community bank branches in states across the Midwestern and Southwestern United States, providing a range of commercial and retail banking services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Moat Assessment: 1/5 HTLF’s moat is rated at 1 out of 5, indicating the company has little to no discernible sustainable competitive advantage compared to its peers. The business model is relatively commoditized. Banks in general struggle to build moats due to the nature of their services being easily replicated. Here are the key reasons why:

Lack of Pricing Power: The banking industry is highly competitive, making it challenging for most players to achieve a superior pricing power. HTLF operates in a fragmented regional market where interest rates are largely determined by macro factors and regulations rather than the bank’s unique advantages. There are many comparable banks offering similar services, and price competition is rife.
Undifferentiated Products & Services: The banking products offered by HTLF are mainly generic, such as savings accounts, loans, checking accounts, credit cards and payment solutions, which do not come with major unique characteristics, making it very easy for customers to switch banks.
Low Switching Costs: For the average consumer, the cost of switching banks is rather low compared to other industries. The customer will usually prioritize convenience, low fees, and proximity when deciding on a bank, instead of loyalty.
Limited Barriers to Entry: Setting up a bank is relatively difficult from the regulatory perspective, and requires substantial capital and regulatory approvals, but does not create an insurmountable competitive advantage because there are so many incumbents in the regional and national level.
Absence of Network Effects or Intangible Assets: There is no direct network effect for banks. Moreover, although some banks might develop strong local reputations, those brands are mostly geographically constrained and do not allow them to charge a significant premium or expand without limit.

In short, HTLF’s business is characterized by strong competition from other regional and national players offering similar commoditized services. It is an industry that will rely mostly on pricing and macroeconomic trends, rather than moats.

Risks to the Moat and Business Resilience Several risks could harm HTLF’s operations and overall business resilience:

Interest Rate Risk: Interest rates have a large impact on the company’s income and profitability. Since HTLF relies heavily on net interest income, fluctuations on interest rates could lead to large profits or losses, which can severely affect the bank’s financial situation.
Credit Risk: The biggest threat to banking is the loans not being repaid, which could lead to large losses. These risks are further amplified by the concentration risk in the real estate market. If real estate prices decline or the economy has a severe downturn, many borrowers may have difficulties in repaying their loans. * Liquidity risk: Because banks rely on deposits from various places, a substantial reduction in those deposits could cause great harm to the bank by reducing its capacity to operate, especially in bad times.
Regulatory and Legal Risk: Banks operate in a highly regulated environment. Thus, they are exposed to compliance and changes in law. These may affect the operations, financial reporting and business opportunities. * Competition: There is severe competition within the industry, increasing in the digital space with neobanks and other financial companies joining in, all trying to take away the market share from HTLF.
Regional Economic Risks: Because HTLF is a regional bank, it is highly dependent on the geographical region and its local economy. Thus a downturn in the economy of its operating regions would severely harm the company.
Acquisition Risk: Many companies pursue growth by acquisitions, and the failure to properly integrate them can destroy significant value. Such a situation can happen for HTLF also, with some of its competitors having had poor results in previous acquisition attempts. Despite these risks, HTLF has shown it can navigate these challenges successfully and maintain profits over long periods.

Overall, HTLF’s ability to sustain its operations during financial and macroeconomic downturns has shown its business resilience, allowing it to have satisfactory results and remain operational for long periods.

Business Description Heartland Financial USA, Inc. operates as a multi-bank holding company providing a diverse array of banking and financial services across multiple states in the US Midwest and Southwest. Its primary offerings include:

Commercial Banking: This segment primarily serves small and medium-sized businesses and corporations with commercial loans, working capital solutions, cash management, and other treasury services.

A large percentage of the banks net loans are in real estate, with commercial real estate comprising a higher portion of total loans.
Retail Banking: This segment serves individual consumers through branches and online services offering deposits, loans, and other personal financial products.

The bank has put an increased emphasis in growing core deposits. This is mainly to decrease funding costs by attracting customers that require fewer interest payments.

Most of the loans in the retail banking segment are in mortgages and home equity lines of credit (HELOCs).
Wealth Management: Investment advice and planning, wealth and trust management, and related services are also offered.
Mortgage Banking: Home mortgage lending.

Financial Analysis The performance of HTLF is reviewed based on the recent earnings calls and annual reports. Here are some of the important points:

Income Statement: As a bank, HTLF is very reliant on net interest income, the difference between what a bank earns on loans and pays on deposits. In the latest quarter the net interest income saw a considerable increase from $152.2M in the previous year to $175.9M, which is a very promising sign. On the other hand, the non-interest income has decreased year-over-year, going from $80.8M to $66.2M, and it is driven by lower gains on the sale of loans, reduction in mortgage banking revenue and increased trading losses. So, HTLF should focus on developing the interest-generating side of the business. As with other banks, expenses are divided into operating and non-operating, with a large percentage of those expenses belonging to salaries and benefits, then followed by data processing and communications, which are both necessary in the modern day, while other expenses do not have a large impact. The net income available for common stockholders for 2023 has been $393.2 million, a 2.6% increase compared to 2022.

The performance in the most recent earnings has been largely driven by net interest income.
Balance Sheet: Most of HTLF’s assets consists of loans, followed by securities and cash. As of September 2023, its total assets were $20.3 billion. Liabilities include mainly deposits and borrowed funds, and it is very important to monitor both deposits and debt in the future. Equity amounted to $2.8B, which is adequate for a bank of its size.

HTLF’s balance sheet is characterized by a larger proportion of commercial real estate loans, which may be vulnerable to changes in economy and interest rates.
ROIC: Return on invested capital has been consistently high for the company.

Although high ROIC indicates a healthy business, we do not know about its sustainability because of high competition and commoditization in the banking industry.
Capital Structure: The company’s capital structure is stable, and it is managed well in line with regulatory requirements. This involves closely monitoring the tier 1 ratio.

Understandability: 2/5 HTLF’s business model is rated at 2 out of 5 in terms of understandability.

Banking Complexity: Banks in general have complex business models that require careful analysis of financial statements. The number of unique metrics and formulas that one needs to understand in order to properly understand a bank’s business is quite large.
Regulation and Accounting: The regulated banking industry is subject to lots of regulations that affect the ways they operate and present financial statements, adding an additional layer of complexity. The need to consider both GAAP and IFRS reports can make the situation even more confusing. Moreover, factors affecting financial performance are not always intuitive, further complicating its understandability for the average investor.
Economic and Macro-economic Influence: Financial performance is heavily influenced by external economic and macroeconomic factors, such as interest rates, economic growth, inflation, etc. Analyzing its impact can be complex.
Regional Diversification: The company’s revenue diversification is spread across multiple regions, which makes the process of forecasting and valuing the company more complex than a single geographic area company.

Balance Sheet Health: 4/5 HTLF is rated 4 out of 5 in terms of balance sheet health, meaning its balance sheet is healthy and well managed.

Adequate Capitalization: The company’s total equity seems sufficient to absorb the risks of the underlying business and to comply with regulatory requirements.
Good Leverage Management: HTLF manages its debts well. Although the debt has seen a recent increase, the bank still has plenty of space to issue more debt if necessary.
Diverse Funding Base: The funding sources come mainly from customer deposits. The management has also stated its intention in acquiring more core deposits, which in turn further increases the banks stability.

* While HTLF is in a good financial state, close monitoring of credit risk is essential, and should be carefully monitored in the upcoming periods.

Other Relevant Factors:

Focus on Core Business: HTLF is trying to enhance its business by concentrating efforts on what makes profits for the company, which is mainly net interest income by increasing core deposits and lending. This should theoretically reduce costs and expenses and increase profitability. However, it is something that the other banks are also trying to focus on.

A clear strategic vision is a good sign, because companies with clear strategies tend to have better results in the long run. However, HTLF needs to execute this strategy well, otherwise, they could face tough times ahead.
Recent Acquisitions: In the last couple of years HTLF has also been involved in acquisitions. This is good, because it will help to fuel expansion and increase profitability, but it will also carry potential risks with integration. So HTLF must focus on a proper integration methodology.

Recent Concerns / Controversies and Problems:

Net Interest Income: There is some pressure in net interest income as the costs of deposits remain elevated. The management aims to improve by increasing interest rate on loans, while maintaining a high level of deposits by increasing interest on savings accounts. Also, there is some uncertainty on the direction of interest rates.
Non-Interest Income: The non-interest income has seen a decline in recent times and it is due to lower revenues generated from secondary sources such as mortgage banking, which may persist in the coming periods.
Economic Outlook: The overall economic outlook is uncertain and that can cause the bank’s operations to be unpredictable. As of recent, the company expects a light economic recession, although they have stated that the bank is well placed to weather the storm.

In conclusion, HTLF is a well managed bank but has little to no competitive advantage. It is dependent on macroeconomic factors and its own ability to efficiently manage its operations. It has a good balance sheet with some credit risk and the management has a clear strategic approach to value creation.