An M&A Deal That May Have Settled a Score

Heartland Financial USA's (HTLF) acquisition of Freedom Bank in Sterling, Ill., seemed unusual from the start.

Heartland, based in Dubuque, Iowa, announced the transaction late on Friday afternoon, Nov. 22, describing it as a "negotiated transfer of ownership." It withheld how much it paid for the much smaller Freedom Bank and said regulators had already approved the deal.

Executives of Heartland have remained vague about their reason for the acquisition, but followers of the company say it has all the earmarks of a trade-off. River Valley Bancorp in Davenport, Iowa, the former owner of Freedom, may have used it as payment of a debt to Heartland, says Brad Milsaps, an analyst at Sandler O'Neill who follows Heartland.

Indeed, Heartland previously disclosed that it had moved a $13 million loan to an unspecified bank holding company into nonaccrual status in the third quarter. Heartland executives said during their quarterly conference call that they didn't believe Heartland had any other problematic loans to bank holding companies.

"We believe the [deal and the loan] may be related," Milsaps wrote in a research note.

River Valley officials didn't return a call for comment about whether it was the borrower in question. It has two bank units that are currently under consent orders with the Federal Deposit Insurance Corp.; Freedom was freed from a consent order in September 2012.

Heartland executives confirmed that River Valley is a customer, but did not answer the question whether it had acquired Freedom to collect on a debt.

"We do have a relationship with the parent with some correspondent banking," says Lynn B. Fuller, the chief executive of Heartland. He declined to provide further details on the structure of the deal to be "respectful of that business."

Loans to fellow bank holding companies were once a common practice. Along with pooled trust-preferred securities, such loans were a staple in the capital structure for community banks before the economic collapse of 2008.

For many, the interconnectivity turned out to be a compounded exposure — not only did the lenders suffer from their own real estate loans, they also felt the effects of problem loans at other banks. Illinois was a hotbed for such problems, with several banks essentially failing because of their exposure to other banks' problems.

There are several examples in the last few years of either holding companies offering up banks as payment or lenders seizing the collateral — the bank — in loans gone bad.

In 2009, Mercantile Bancorp transferred HNB National Bank in Hannibal, Mo., to the owner of a banking company in Illinois in exchange for forgiveness of a $28 million debt. And in 2011, National Bancorp Holdings was able to buy Generations Bank in Overland Park, Kan., after its owners defaulted on a loan from a third party.

If Heartland in fact took a bank as payment, observers say it may have lucked out because it was dealing with a multibank holding company and doesn't appear to be fighting for claims with other stakeholders like the Treasury Department or the holders of trust-preferred securities.

 "It can be an easy way to resolve a debt," says Walt Moeling, a partner at Bryan Cave in Atlanta. "But when you are dealing with a one-bank holding company, that is all there is, so there is not a lot of room to negotiate. … This also sounds like a cleaner situation — when you throw in Tarp or trups and try to strike a three- or four-way settlement, oh my God, it gets difficult."

The acquisition has some strategic value to Heartland, too. It has assets of $4.9 billion and a goal of reaching $1 billion of assets in each of its markets. The addition of the $67 million-asset Freedom brings it to "not quite $900 million in Illinois," Fuller says.

"It is a little opportunistic," Fuller says. "We typically don't hunt for banks less than $150 million to $200 million. …. When we find smaller operations that fit in somewhere, those still kind of make sense."

Freedom's headquarters in Sterling, Ill., is well-situated between Heartland's two other Illinois banks, Galena State Bank & Trust and Riverside Community Bank. Sterling is about 75 miles southeast of Galena and about 55 miles southwest of Riverside's base is Rockford.

Heartland has been looking to make inroads in agriculture lending in the Sterling area, including the hiring of a lender in that region last year, and Freedom will help feed that business.

"This is not a huge needle-mover for them, but it is still consistent with trying to get to a billion in assets in each market," says Jeff Rulis, an analyst at D.A. Davidson. "It still somewhat satisfies some goals."