Heartland Financial USA Inc.'s first-quarter earnings results took a hit after it identified two instances of customer fraud, but the company remains optimistic about its asset quality.
After announcing its first-quarter results on April 25, Heartland Financial, or HTLF, identified two instances of customer fraud that resulted in material loan collateral deficiencies. The company subsequently updated its first-quarter results in a May 9 release to include a $9.2 million increase to its provision for credit losses. The increase lowered the company's net income available to common stockholders in the first quarter by 14.2% to $41.1 million and decreased its diluted earnings per share for the quarter by 13.4% to 97 cents.
"It's unfortunate that we've had two situations where fraud was involved," President and CEO Bruce Lee said in an interview with S&P Global Market Intelligence. "But the rest of the underlying trends remain positive."
One of the fraud situations involved a commercial loan with a customer that had a relationship with the bank for more than five years, Lee said. After discovering that "there was some fraud involved in the way certain collateral was presented," the company reserved $4 million against the loan and put the remaining relationship of about $5 million on nonaccrual, he said.
Lee did not disclose which industry the loan involved but said "the industry or the sector had nothing to do with this situation. It was just straight-up fraud."
The second loan was a consumer loan — more specifically, a private banking loan — with a customer that had about a one-year relationship with the bank. The company reserved $5 million against this loan after discovering that "there was fraud involved with not only our borrowers, but with a third party," Lee said.
At the time of discovering the fraud, both loans were current. While the fraud situations were similar, the two instances were unrelated and isolated, he said. The loans were made by two different banking subsidiaries under the HTLF brand.
HTLF has 11 different banking charters for its 11 bank subsidiaries, but the company is currently working to consolidate all 11 charters into one charter. While the main goals of the charter consolidation are to drive long-term efficiency, improve agility, reduce expenses and enhance scalability, the initiative could also help to prevent future fraud, Lee said.
"Part of what we will accomplish in charter consolidation is a fair amount of what I'll call standardization," he said. "So that situations like this won't just be left up to be managed by a single bank or to document alone. We will have, I think, improved controls."
Remaining upbeat
HTLF's credit quality metrics continued to improve during the first quarter despite the updates to its first-quarter results. Lee expects the trend of improving asset quality to continue.
Nonaccrual loans made up 0.63% of the company's total loans as of March 31, down from 0.91% in the year-ago period, according to S&P Global Market Intelligence data.
"The overall portfolio health continues to trend in the right direction," Lee said.
Analysts agreed that while the two instances of fraud were negative for HTLF, the overall outlook for the company remains positive.
"The news on net is not a positive, although our view on HTLF's credit quality is little changed and the highlights in the quarter of accelerating loan growth and a steadying NIM remain unchanged," D.A. Davidson analyst Jeff Rulis wrote in a May 10 note.
Keefe Bruyette & Woods analyst Damon DelMonte labeled the announcement a "blemish" on the company's first-quarter earnings results, but he does not expect any further financial impact from the two events, he wrote in a May 10 note.
"While these events are never viewed favorably, after speaking with management, we remain comfortable these are isolated events and not indicative of any broader concerns," DelMonte wrote.
