UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended March 31, 20162017

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For transition period __________ to __________

Commission File Number: 001-15393

HEARTLAND FINANCIAL USA, INC.
(Exact name of Registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

42-1405748
(I.R.S. employer identification number)

1398 Central Avenue, Dubuque, Iowa  52001
(Address of principal executive offices)(Zip Code)

(563) 589-2000
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o

     Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o
   
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “accelerated filer,” “large accelerated filer” and, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ¨x
 
Accelerated Filer x¨
 
 
Non-accelerated filer ¨
(Do not check if a smaller reporting company)
 
Smaller reporting company ¨
 
Emerging growth company ¨
 
(Do not check if a smaller reporting company)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No x

Indicate the number of shares outstanding of each of the classes of Registrant's common stock as of the latest practicable date:  As of May 5, 2016,3, 2017, the Registrant had outstanding 24,521,74726,674,871 shares of common stock, $1.00 par value per share.



HEARTLAND FINANCIAL USA, INC.
Form 10-Q Quarterly Report
Table of Contents

Part I
Part II
 
 
 
 
 
 
 101 Financial statements formatted in Extensible Business Reporting Language: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Changes in Equity, and (vi) the Notes to Consolidated Financial Statements.




PART I

ITEM 1. FINANCIAL STATEMENTS

HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
      
March 31, 2016
(Unaudited)
 December 31, 2015March 31, 2017 (Unaudited) December 31, 2016
ASSETS      
Cash and due from banks$124,060
 $237,841
$129,386
 $151,290
Federal funds sold and other short-term investments9,168
 20,958
Interest bearing deposits with the Federal Reserve Bank and other banks and other short-term investments43,765
 7,434
Cash and cash equivalents133,228
 258,799
173,151
 158,724
Time deposits in other financial institutions2,355
 2,355
41,539
 2,105
Securities:  
  
Available for sale, at fair value (cost of $1,680,299 at March 31, 2016, and $1,584,703 at December 31, 2015)1,690,516
 1,578,434
Held to maturity, at cost (fair value of $289,446 at March 31, 2016, and $294,513 at December 31, 2015)271,300
 279,117
Available for sale, at fair value (cost of $1,938,457 at March 31, 2017, and $1,893,947 at December 31, 2016)1,893,528
 1,845,864
Held to maturity, at cost (fair value of $272,797 at March 31, 2017, and $274,799 at December 31, 2016)260,616
 263,662
Other investments, at cost22,325
 21,443
21,557
 21,560
Loans held for sale76,565
 74,783
49,009
 61,261
Loans and leases receivable:  
Loans receivable:  
Held to maturity5,503,005
 5,001,486
5,361,604
 5,351,719
Allowance for loan and lease losses(49,738) (48,685)
Loans and leases receivable, net5,453,267
 4,952,801
Allowance for loan losses(54,999) (54,324)
Loans receivable, net5,306,605
 5,297,395
Premises, furniture and equipment, net160,899
 146,259
164,183
 163,614
Premises, furniture and equipment held for sale3,889
 3,889
1,242
 414
Other real estate, net11,338
 11,524
11,188
 9,744
Goodwill127,699
 97,852
141,461
 127,699
Other intangible assets, net61,420
 56,945
Core deposit intangibles and customer relationship intangibles, net24,068
 22,775
Servicing rights, net35,441
 35,778
Cash surrender value on life insurance110,834
 110,297
117,613
 112,615
Other assets128,144
 100,256
120,644
 123,869
TOTAL ASSETS$8,253,779
 $7,694,754
$8,361,845
 $8,247,079
LIABILITIES AND EQUITY      
LIABILITIES:      
Deposits:      
Demand$2,079,521
 $1,914,141
$2,319,256
 $2,202,036
Savings3,702,431
 3,367,479
3,940,146
 3,788,089
Time1,142,368
 1,124,203
830,459
 857,286
Total deposits6,924,320
 6,405,823
7,089,861
 6,847,411
Short-term borrowings325,741
 293,898
155,025
 306,459
Other borrowings265,760
 263,214
282,051
 288,534
Accrued expenses and other liabilities68,415
 68,646
53,596
 63,759
TOTAL LIABILITIES7,584,236
 7,031,581
7,580,533
 7,506,163
STOCKHOLDERS' EQUITY:      
Series C Senior Non-Cumulative Perpetual Preferred Stock (par value $1 per share; 0 shares and 81,698 shares outstanding at March 31, 2016 and December 31, 2015, respectively)
 81,698
Series D Senior Non-Cumulative Perpetual Convertible Preferred Stock (par value $1 per share; authorized, issued and outstanding 3,000 shares at March 31, 2016, and 0 shares authorized, issued and outstanding at December 31, 2015)3,777
 
Common stock (par value $1 per share; 30,000,000 shares authorized at both March 31, 2016, and December 31, 2015; issued 24,519,928 shares at March 31, 2016, and 22,435,693 shares at December 31, 2015)24,520
 22,436
Preferred stock (par value $1 per share; authorize 17,604 shares; none issued or outstanding at both March 31, 2017, and December 31, 2016)
 
Series A Junior Participating preferred stock (par value $1 per share; authorized 16,000 shares; none issued or outstanding at both March 31, 2017, and December 31, 2016)
 
Series C Senior Non-Cumulative Perpetual Preferred Stock (par value $1 per share; 81,698 shares authorized at both March 31, 2017, and December 31, 2016, none issued or outstanding at both March 31, 2017, and December 31, 2016)
 
Series D Senior Non-Cumulative Perpetual Convertible Preferred Stock (par value $1 per share; 3,000 shares authorized at both March 31, 2017, and December 31, 2016; 745 shares issued and outstanding at March 31, 2017, and 1,078 shares issued and outstanding at December 31, 2016)938
 1,357
Common stock (par value $1 per share; 30,000,000 shares authorized at both March 31, 2017, and December 31, 2016; issued 26,674,121 shares at March 31, 2017, and 26,119,929 shares at December 31, 2016)26,674
 26,120
Capital surplus273,310
 216,436
351,423
 328,376
Retained earnings366,014
 348,630
431,219
 416,109
Accumulated other comprehensive income (loss)1,924
 (6,027)(28,942) (31,046)
Treasury stock at cost (65 shares at March 31, 2016, and 0 shares at December 31, 2015)(2) 
Treasury stock at cost (0 shares at both March 31, 2017, and December 31, 2016)
 
TOTAL STOCKHOLDERS' EQUITY669,543
 663,173
781,312
 740,916
TOTAL LIABILITIES AND EQUITY$8,253,779
 $7,694,754
$8,361,845
 $8,247,079
      
See accompanying notes to consolidated financial statements.      







HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share data)
      
Three Months Ended
March 31,
Three Months Ended
March 31,
2016 20152017 2016
INTEREST INCOME:      
Interest and fees on loans and leases$68,425
 $53,049
Interest and fees on loans$66,898
 $68,425
Interest on securities:      
Taxable8,735
 7,132
8,253
 8,644
Nontaxable3,510
 2,916
5,191
 3,510
Interest on federal funds sold10
 1

 10
Interest on interest bearing deposits in other financial institutions4
 4
209
 95
TOTAL INTEREST INCOME80,684

63,102
80,551

80,684
INTEREST EXPENSE:      
Interest on deposits4,173
 4,172
3,730
 4,173
Interest on short-term borrowings329
 198
137
 329
Interest on other borrowings (includes $506 and $564 of interest expense related to derivatives reclassified from accumulated other comprehensive income (loss) for the three months ended March 31, 2016 and 2015, respectively)3,475
 4,802
Interest on other borrowings (includes $397 and $506 of interest expense related to derivatives reclassified from accumulated other comprehensive income for the three months ended March 31, 2017 and 2016, respectively)3,656
 3,475
TOTAL INTEREST EXPENSE7,977

9,172
7,523

7,977
NET INTEREST INCOME72,707

53,930
73,028

72,707
Provision for loan and lease losses2,067
 1,671
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES70,640

52,259
Provision for loan losses3,641
 2,067
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES69,387

70,640
NONINTEREST INCOME:      
Service charges and fees7,162
 5,404
9,457
 7,162
Loan servicing income1,268
 1,041
1,724
 1,268
Trust fees3,813
 3,631
3,631
 3,813
Brokerage and insurance commissions1,022
 1,087
1,036
 1,022
Securities gains, net (includes $3,756 and $4,353 of net security gains reclassified from accumulated other comprehensive income for the three months ended March 31, 2016 and 2015, respectively)3,526
 4,353
Securities gains, net (includes $2,482 and $3,756 of net security gains reclassified from accumulated other comprehensive income for the three months ended March 31, 2017 and 2016, respectively)2,482
 3,526
Net gains on sale of loans held for sale11,065
 13,742
6,147
 11,065
Valuation allowance on commercial servicing rights5
 
Income on bank owned life insurance522
 524
617
 522
Other noninterest income1,200
 881
794
 1,200
TOTAL NONINTEREST INCOME29,578

30,663
25,893

29,578
NONINTEREST EXPENSES:      
Salaries and employee benefits41,714
 36,638
41,767
 41,714
Occupancy5,003
 4,259
5,073
 5,003
Furniture and equipment2,113
 2,106
2,501
 2,113
Professional fees7,010
 6,044
8,309
 7,010
FDIC insurance assessments1,168
 956
807
 1,168
Advertising1,284
 1,181
2,424
 1,284
Intangible assets amortization1,895
 631
Core deposit intangibles and customer relationship intangibles amortization1,171
 1,895
Other real estate and loan collection expenses572
 465
828
 572
Loss on sales/valuations of assets, net313
 353
412
 313
Other noninterest expenses9,237
 6,981
8,448
 9,237
TOTAL NONINTEREST EXPENSES70,309

59,614
71,740

70,309
INCOME BEFORE INCOME TAXES29,909

23,308
23,540

29,909
Income taxes (includes $1,212 and $1,413 of income tax expense reclassified from accumulated other comprehensive income for the three months ended March 31, 2016 and 2015, respectively)9,900
 7,599
Income taxes (includes $778 and $1,212 of income tax expense reclassified from accumulated other comprehensive income for the three months ended March 31, 2017 and 2016, respectively)5,530
 9,900
NET INCOME20,009

15,709
18,010

20,009
Preferred dividends(168) (204)(19) (168)
Interest expense on convertible preferred debt5
 
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS$19,841

$15,505
$17,996

$19,841
EARNINGS PER COMMON SHARE - BASIC$0.84
 $0.77
$0.68
 $0.84
EARNINGS PER COMMON SHARE - DILUTED$0.82
 $0.76
$0.68
 $0.82
CASH DIVIDENDS DECLARED PER COMMON SHARE$0.10
 $0.10
$0.11
 $0.10
      
See accompanying notes to consolidated financial statements.      



HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
Three Months Ended
March 31,
Three Months Ended
March 31,
2016 20152017 2016
NET INCOME$20,009
 $15,709
$18,010
 $20,009
OTHER COMPREHENSIVE INCOME      
Securities:      
Net change in unrealized gain on securities20,067
 11,478
5,379
 20,067
Reclassification adjustment for net gains realized in net income(3,756) (4,353)(2,482) (3,756)
Net change in non-credit related other than temporary impairment7
 24

 7
Income taxes(6,524) (2,859)(1,111) (6,524)
Other comprehensive income on securities9,794
 4,290
1,786
 9,794
Derivatives used in cash flow hedging relationships:      
Net change in unrealized loss on derivatives(3,423) (1,454)
Reclassification adjustment for net loss on derivatives realized in net income506
 564
Net change in unrealized gain (loss) on derivatives136
 (3,423)
Reclassification adjustment for net losses on derivatives realized in net income397
 506
Income taxes1,074
 327
(215) 1,074
Other comprehensive loss on cash flow hedges(1,843) (563)
Other comprehensive income (loss) on cash flow hedges318
 (1,843)
Other comprehensive income7,951
 3,727
2,104
 7,951
TOTAL COMPREHENSIVE INCOME$27,960
 $19,436
$20,114
 $27,960
      
See accompanying notes to consolidated financial statements.      



HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
  
Three Months Ended March 31,Three Months Ended March 31,
2016 20152017 2016
CASH FLOWS FROM OPERATING ACTIVITIES:      
Net income$20,009
 $15,709
$18,010
 $20,009
Adjustments to reconcile net income to net cash provided (used) by operating activities:   
Adjustments to reconcile net income to net cash provided by operating activities:   
Depreciation and amortization7,713
 5,747
7,023
 7,713
Provision for loan and lease losses2,067
 1,671
Provision for loan losses3,641
 2,067
Net amortization of premium on securities7,846
 6,949
7,226
 7,846
Securities gains, net(3,526) (4,353)(2,482) (3,526)
Stock based compensation1,087
 1,139
1,782
 1,087
Write downs and losses on repossessed assets, net313
 353
Write downs and losses on sales of assets, net412
 313
Loans originated for sale(227,823) (311,140)(164,324) (227,823)
Proceeds on sales of loans held for sale234,516
 287,768
180,404
 234,516
Net gains on sale of loans held for sale(8,475) (11,056)(3,828) (8,475)
Decrease in accrued interest receivable787
 3,234
93
 787
(Increase) decrease in prepaid expenses598
 (513)
Decrease in prepaid expenses84
 598
Increase in accrued interest payable637
 627
825
 637
Capitalization of servicing rights(2,590) (2,818)(2,226) (2,590)
Valuation allowance on commercial servicing rights(5) 
Net excess tax benefit from stock based compensation888
 1,100
Other, net(9,855) (11,472)(13,767) (9,855)
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES23,304
 (18,155)
NET CASH PROVIDED BY OPERATING ACTIVITIES33,756
 24,404
CASH FLOWS FROM INVESTING ACTIVITIES:      
Proceeds from the sale of securities available for sale303,448
 289,466
221,637
 303,448
Proceeds from the sale of securities held to maturity4,057
 

 4,057
Proceeds from the sale of other investments2,830
 5,489

 2,830
Proceeds from the redemption of time deposits in other financial institutions5,867
 
Proceeds from the maturity of and principal paydowns on securities available for sale35,379
 37,479
47,515
 35,379
Proceeds from the maturity of and principal paydowns on securities held to maturity3,254
 208
2,823
 3,254
Proceeds from the maturity of and principal paydowns on time deposits in other financial institutions3,185
 
Proceeds from the maturity of and principal paydowns on other investments1,521
 
Purchase of securities available for sale(362,764) (232,422)(312,769) (362,764)
Purchase of other investments(226) (2,004)(968) (226)
Net increase in loans and leases78,502
 25,684
Net decrease in loans80,916
 78,502
Capital expenditures(898) (2,919)(3,588) (898)
Net cash and cash equivalents received in acquisition8,084
 7,103
Net cash and cash equivalents received in acquisitions33,698
 8,084
Proceeds from the sale of equipment
 13
3
 
Proceeds on sale of OREO and other repossessed assets2,384
 2,312
585
 2,384
NET CASH PROVIDED BY INVESTING ACTIVITIES74,050
 130,409
$80,425
 $74,050
      



HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (Unaudited)
(Dollars in thousands)
      
Three Months Ended March 31,Three Months Ended March 31,
2016 20152017 2016
CASH FLOWS FROM FINANCING ACTIVITIES:      
Net increase in demand deposits and savings accounts1,759
 90,075
Net increase in demand deposits22,799
 1,098
Net increase in savings deposits88,767
 661
Net decrease in time deposit accounts(131,373) (25,618)(50,612) (131,373)
Net increase (decrease) in short-term borrowings1,077
 (31,765)(131,068) 1,077
Proceeds from short term FHLB advances5,000
 60,000
60,939
 5,000
Repayments of short term FHLB advances(10,000) (124,000)(81,305) (10,000)
Proceeds from other borrowings
 4,000
Repayments of other borrowings(5,501) (44,488)(6,432) (5,501)
Redemption of preferred stock(81,698) 

 (81,698)
Purchase of treasury stock(1,227) (1,780)(160) (1,227)
Proceeds from issuance of common stock563
 832
218
 563
Excess tax benefits on exercised stock options1,100
 612
Dividends paid(2,625) (2,261)(2,900) (2,625)
NET CASH USED BY FINANCING ACTIVITIES(222,925) (74,393)(99,754) (224,025)
Net increase (decrease) in cash and cash equivalents(125,571) 37,861
14,427
 (125,571)
Cash and cash equivalents at beginning of year258,799
 73,871
158,724
 258,799
CASH AND CASH EQUIVALENTS AT END OF PERIOD$133,228
 $111,732
$173,151
 $133,228
Supplemental disclosures:      
Cash paid for income/franchise taxes$2,305
 $840
$5
 $2,305
Cash paid for interest$7,340
 $8,545
$6,698
 $7,340
Loans transferred to OREO$442
 $2,371
$2,680
 $442
Purchases of securities available for sale, accrued, not paid$
 $5,149
$3,654
 $
Sales of securities available for sale, accrued, not settled$17,189
 $
$
 $17,189
Stock consideration granted for acquisition$57,433
 $53,052
Conversion of convertible debt to common stock$167
 $
Conversion of Series D preferred stock to common stock$419
 $
Stock consideration granted for acquisitions$22,589
 $57,433
      
See accompanying notes to consolidated financial statements.



HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Unaudited)
(Dollars in thousands, except per share data)
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Unaudited)
(Dollars in thousands, except per share data)
 
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Unaudited)
(Dollars in thousands, except per share data)
 
Heartland Financial USA, Inc. Stockholders' Equity  Heartland Financial USA, Inc. Stockholders' Equity 
Preferred
 Stock
 
Common
 Stock
 
Capital
 Surplus
 
Retained
 Earnings
 Accumulated Other Comprehensive Income (Loss) 
Treasury
Stock
 
Total
 Equity
Preferred
 Stock
 
Common
 Stock
 
Capital
 Surplus
 
Retained
 Earnings
 Accumulated Other Comprehensive Income (Loss) 
Treasury
Stock
 
Total
 Equity
Balance at January 1, 2015$81,698
 $18,511
 $95,816
 $298,764
 $1,528
 $
 $496,317
Comprehensive income

 





15,709
 3,727




19,436
Cash dividends declared:

 

 

 

 

 

  
Series C Preferred, $2.50 per share

 





(204) 





(204)
Common, $0.10 per share

 





(2,057) 





(2,057)
Purchase of 24,886 shares of common stock

 







 


(1,780)
(1,780)
Issuance of 2,098,833 shares of common stock

 2,075

50,687



 


1,734

54,496
Stock based compensation

 


1,139



 





1,139
Balance at March 31, 2015$81,698
 $20,586
 $147,642
 $312,212
 $5,255
 $(46) $567,347
Balance at January 1, 2016$81,698
 $22,436
 $216,436
 $348,630
 $(6,027) $
 $663,173
$81,698
 $22,436
 $216,436
 $348,630
 $(6,027) $
 $663,173
Comprehensive income      20,009
 7,951
 

 27,960


 





20,009
 7,951




27,960
Cash dividends declared:        

 

  


 

 

 

 

 

  
Series C Preferred, $2.50 per share   
 
(168) 





(168)

 





(168) 





(168)
Common, $0.10 per share   
 
(2,457) 





(2,457)

 





(2,457) 





(2,457)
Redemption of Series C preferred stock(81,698)           (81,698)
Issuance of Series D preferred stock3,777
           3,777
Redemption of Series C Preferred Stock(81,698)           (81,698)
Issuance of Series D Preferred Stock3,777
           3,777
Purchase of 20,070 shares of common stock   
 


 


(1,227)
(1,227)

 







 


(1,227)
(1,227)
Issuance of 2,104,305 shares of common stock  2,084

55,787
 

 


1,225

59,096


 2,084

55,787



 


1,225

59,096
Stock based compensation   
1,087



 





1,087


 


1,087



 





1,087
Balance at March 31, 2016$3,777
 $24,520
 $273,310
 $366,014
 $1,924
 $(2) $669,543
$3,777
 $24,520
 $273,310
 $366,014
 $1,924
 $(2) $669,543
Balance at January 1, 2017$1,357
 $26,120
 $328,376
 $416,109
 $(31,046) $
 $740,916
Comprehensive income      18,010
 2,104
 

 20,114
Cash dividends declared:        

 

  
Series D Preferred, $17.50 per share      (19)     (19)
Common, $0.11 per share   
 
(2,881) 





(2,881)
Conversion of Series D preferred stock(419)           (419)
Purchase of 3,338 shares of common stock   
 


 


(160)
(160)
Issuance of 557,530 shares of common stock  554

21,265
 

 


160

21,979
Stock based compensation   
1,782



 





1,782
Balance at March 31, 2017$938
 $26,674
 $351,423
 $431,219
 $(28,942) $
 $781,312
                          
See accompanying notes to consolidated financial statements.See accompanying notes to consolidated financial statements.        See accompanying notes to consolidated financial statements.        




HEARTLAND FINANCIAL USA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: BASIS OF PRESENTATION

The interim unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and accompanying notes to the consolidated financial statements for the fiscal year ended December 31, 2015,2016, included in the Form 10-K of Heartland Financial USA, Inc. ("Heartland") filed with the Securities and Exchange Commission ("SEC") on March 11, 20161, 2017. Accordingly, footnote disclosures which would substantially duplicate the disclosure contained in the audited consolidated financial statements have been omitted.

The financial information of Heartland included herein has been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments), that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of the interim period ended March 31, 2016,2017, are not necessarily indicative of the results expected for the year ending December 31, 2016.2017.

Earnings Per Share

Basic earnings per share is determined using net income available to common stockholders and weighted average common shares outstanding. Diluted earnings per share is computed by dividing net income available to common stockholders by the weighted average common shares and assumed incremental common shares issued. Amounts used in the determination of basic and diluted earnings per share for the three monthsthree-month periods ended March 31, 20162017 and 2015,2016, are shown in the table below:
Three Months Ended
March 31, 2016
Three Months Ended
March 31,
(Dollars and number of shares in thousands, except per share data)2016 20152017 2016
Net income attributable to Heartland$20,009
 $15,709
$18,010
 $20,009
Preferred dividends(168) (204)(19) (168)
Interest expense on convertible preferred debt5
 
Net income available to common stockholders$19,841
 $15,505
$17,996
 $19,841
Weighted average common shares outstanding for basic earnings per share23,657
 20,215
26,335
 23,657
Assumed incremental common shares issued upon exercise of stock options and non-vested restricted stock units460
 278
293
 460
Weighted average common shares for diluted earnings per share24,117
 20,493
26,628
 24,117
Earnings per common share — basic$0.84
 $0.77
$0.68
 $0.84
Earnings per common share — diluted$0.82
 $0.76
$0.68
 $0.82
Number of antidilutive common stock equivalents excluded from diluted earnings per share computation57
 

 57

Stock-Based Compensation

Heartland may grant, through its Nominating and Compensation Committee (the "Compensation Committee"), non-qualified and incentive stock options, stock appreciation rights, stock awards, restricted stock, restricted stock units and cash incentive awards, under its 2012 Long-Term Incentive Plan (the "Plan"). The Plan which was originally approved by stockholders in May 2012 and replaced Heartland's 2005 Long-Term Incentive Plan with respectwas amended effective March 8, 2016, to grants after such approval, reserved 162,868increase the number of shares of common stock atauthorized for issuance and make certain other changes to the Plan. As of March 31, 2016,2017, 507,226 shares of common stock were available for issuance under future awards that may be granted under the Plan to employees and directors of, and service providers to, Heartland or its subsidiaries.

Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 718, "Compensation-Stock Compensation" requires the measurement of the cost of employee services received in exchange for an award of equity instruments based upon the fair value of the award on the grant date. The cost of the award is based upon its fair value estimated on the date of grant and recognized in the consolidated statements of income over the vesting period of the award. The fair market value of restricted stock and restricted stock units is based on the fair value of the underlying shares of common stock on the date of grant. The fair value of stock options is estimated on the date of grant using the Black-Scholes model.




The amount of tax benefit related to the exercise, vesting and forfeiture of equity-based awards reflected as a tax benefit in additional paid-in-capital, not taxes payable,Heartland's income tax expense was $1.1 million and $612,000$888,000 during the three months ended March 31, 20162017. Prior to the adoption of ASU 2016-09 on January 1, 2017, $1.1 million of tax benefit related to the exercise, vesting and 2015, respectively.forfeiture of equity based awards was reflected in additional paid-in-capital during the three months ended March 31, 2016.

Restricted Stock Units

The Plan permits the Compensation Committee to grant restricted stock units ("RSUs"). In the first quarter of 2017, the Compensation Committee granted time-based RSUs with respect to 55,665 shares of common stock, and in the first quarter of 2016, the Compensation Committee granted time-based RSUs with respect to 72,644 shares of common stock, and in the first quarter of 2015, the Compensation Committee granted time-based RSUs with respect to 78,220 shares of common stock to selected officers. The time-based RSUs represent the right, without payment, to receive shares of Heartland common stock at a specified date in the future. TheThese time-based RSUs granted in 2016 vest over three years in equal installments on the first, second and third anniversaries of the grant date. The time-based RSUs granted in 2015 vest over five years in equal installments on the third, fourth, and fifth anniversaries of the grant date. The time-based RSUs will be settled in common stock upon vesting, and will not be entitled to dividends until vested. The time-based RSUs may also vest upon death or disability, upon a change in control or upon a "qualified retirement" (as defined in the RSU agreement). The retiree is required to sign a non-solicitation and non-compete agreement as a condition to vesting.

In addition to the time-based RSUs referenced in the preceding paragraph, the Compensation Committee granted performance-based RSUs with respect to 27,570 shares of common stock in the first quarter of 2017, and 35,516 shares of common stock in the first quarter of 2016, and 39,075 shares of common stock in the first quarter of 2015.2016. These performance-based RSUs are earned based on satisfaction of performance targets for the fiscal years ended December 31, 2016,2017, and December 31, 2015,2016, respectively, and then fully vest two years after the end of the performance period. For the grants awarded in 2017, the portion of the RSUs earned based on performance vests on December 31, 2019, and for the grants awarded in 2016, the portion of the RSUs earned based on performance vests on December 31, 2018, and for the grants awarded in 2015, the portion of the RSUs earned based on performance vests on December 31, 2017, subject to employment on the respective vesting dates. The performance-based RSUs vest to the extent that they are earned upon death or disability, upon a change in control or upon a "qualified retirement."

The Compensation Committee also granted three-year performance-based RSUs with respect to 9,032 shares of common stock in the first quarter of 2017, and 11,408 shares of common stock in the first quarter of 2016. These performance-based RSUs will be earned based on satisfaction of performance targets for the three-year performance period ended December 31, 2018.2019 and December 31, 2018, respectively. These performance-based RSUs will vest in 2020 and 2019, respectively, after measurement of performance in relation to the performance targets. The

Upon death, disability, or a "qualified retirement," all performance-based RSUs vest to the extent that theygranted in 2016 remain outstanding and are earned upon deathbased on actual performance at the end of each performance period. All RSUs granted on or disability,after March 8, 2016, become fully vested upon a change in control if (1) they are not assumed by the successor corporation or (2) upon a "qualified retirement."an involuntary termination of the participant's employment within two years after the change in control.

The Compensation Committee also grants RSUs under the Plan to directors as part of their compensation, to new management level employees at commencement of employment, and to other employees and service providers as incentives. During the three months ended March 31, 2016,2017, and March 31, 2015,2016, 0 and 150 and 300 RSUs, respectively, were granted to directors and new employees.

A summary of the RSUs outstanding as of March 31, 20162017 and 2015,2016, and changes during the three months ended March 31, 20162017 and 2015,2016, follows:
2016 20152017 2016
Shares 
Weighted-Average Grant Date
Fair Value
 Shares 
Weighted-Average Grant Date
Fair Value
Shares 
Weighted-Average Grant Date
Fair Value
 Shares 
Weighted-Average Grant Date
Fair Value
Outstanding at January 1353,195
 $25.53
 396,555
 $21.48
346,817
 $27.61
 353,195
 $25.53
Granted119,718
 29.05
 117,595
 27.87
92,267
 47.50
 119,718
 29.05
Vested(83,982) 20.79
 (126,847) 16.66
(103,897) 24.74
 (83,982) 20.79
Forfeited(2,078) 27.17
 (2,531) 23.82
(7,765) 31.03
 (2,078) 27.17
Outstanding at March 31386,853
 $27.53
 384,772
 $25.00
327,422
 $34.04
 386,853
 $27.53

Total compensation costs recorded for RSUs were $1.7 million and $1.1 million for both three monththe three-month periods ended March 31, 20162017 and 2015.2016. As of March 31, 2016,2017, there were $5.2$5.4 million of total unrecognized compensation costs related to the 2005 and 2012 Long-Term Incentive PlansPlan for RSUs whichthat are expected to be recognized through 2019.2020.




Options

Although the Plan provides authority to the Compensation Committee to grant stock options, no options were granted during the first three months of 20162017 and 2015.2016. Prior to 2009, options were typically granted annually with an expiration date ten years after the date of grant. Vesting was generally over a five-year service period with equal portions of a grant becoming exercisable at three years, four years, and five years after the date of grant. A summary of the stock options outstanding as of March 31, 20162017 and 2015,2016, and changes during the three months ended March 31, 20162017 and 2015,2016, follows:
2016 20152017 2016
Shares 
Weighted-Average
Exercise Price
 Shares 
Weighted-Average
Exercise Price
Shares 
Weighted-Average
Exercise Price
 Shares 
Weighted-Average
Exercise Price
Outstanding at January 1125,950
 $24.08
 215,851
 $23.85
26,400
 $18.60
 125,950
 $24.08
Granted
 
 
 

 
 
 
Exercised(19,750) 21.60
 (32,400) 20.85
(5,500) 18.60
 (19,750) 21.60
Forfeited(1,250) 21.60
 (1,500) 21.00

 
 (1,250) 21.60
Outstanding at March 31104,950
 $24.58
 181,951
 $24.37
20,900
 $18.60
 104,950
 $24.58
Options exercisable at March 31104,950
 $24.58
 181,951
 $24.37
20,900
 $18.60
 104,950
 $24.58

At March 31, 2016,2017, the vested options totaled 104,95020,900 shares with a weighted average exercise price of $24.58$18.60 per share and a weighted average remaining contractual life of 1.150.82 years. The intrinsic value (the difference between the market price and the aggregate exercise price) for the vested options as of March 31, 2016,2017, was $652,000.$655,000. The intrinsic value for the total of all options exercised during the three months ended March 31, 2016,2017, was $155,000.$161,000.

The exercise price of stock options granted is established by the Compensation Committee, but the exercise price for the stock options may not be less than the fair market value of the shares on the date that the option is granted or, if greater, the par value of a share of stock. Each option granted is exercisable in full at any time or from time to time, subject to vesting provisions, as determined by the Compensation Committee and as provided in the option agreement, but such time may not exceed ten years from the grant date. Cash received from options exercised was $102,000 for the three months ended March 31, 2017, and $427,000 for the three months ended March 31, 2016, and $676,000 for the three months ended March 31, 2015.2016.

Total compensation costs recorded for options were $0 for both three month periods ended March 31, 20162017 and 2015.2016. There are no unrecorded compensation costs related to options at March 31, 2016.2017. No stock options vested during the three-month periods ended March 31, 20162017 and 2015.2016.

Subsequent Events

- Heartland had nohas evaluated subsequent events that may require recognition or disclosure through the filing date of this quarterly reportQuarterly Report on Form 10-Q with the SEC. Based on this evaluation, Heartland has determined that none of these events were required to be recognized or disclosed in the consolidated financial statements and related notes.

Effect of New Financial Accounting Standards

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with CustomersCustomers." ." The amendment clarifies the principles for recognizing revenue and develops a common revenue standard. The amendment outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” In applying the revenue model to contracts within its scope, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The amendment appliesnew guidance does not apply to allcertain contracts with customers except those that are within the scope of other topicsASC Topics, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantees other than product or service warranties and nonmonetary exchanges between entities in the FASB Codification. The standard also requires significantly expanded disclosures about revenue recognition. The amendment is effective for annual reporting periods beginning after December 15, 2017 (including interim reporting periods within those periods). Early application is not permitted.same line of business to facilitate sales to customers. Heartland intends to adopt the accounting standard during the first quarter ofin 2018, as required, and is currently evaluating the impact on its results of operations, financial position, and liquidity.

In November 2014, the FASB issued ASU 2014-16, "Derivatives and Hedging (Topic 815): Determining Whetherwhich may require a Host Contract in a Hybrid Financial Instrument Issuedchange in the Formrecognition of a Share is More Akin to Debt or to Equity." The amendment clarifies how



current guidance should be interpreted in evaluating the characteristicscertain recurring revenue streams within trust and risks of a host contract in a hybrid financial instrument issued in the form of a share. One criterion requires evaluating whether the nature of the host contract is more akin to debt or to equity and whether the economic characteristics and risks of the embedded derivative feature are "clearly and closely related" to the host contract. In making that evaluation, an issuer or investor must consider all terms and features in a hybrid financial instrument including the embedded derivative feature that is being evaluated for separate accounting or may consider all terms and features in the hybrid financial instrument except for the embedded derivative feature that is being evaluated for separate accounting. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, with early adoption permitted. Heartland adopted this standard on January 1, 2016, andinvestment management fees; however, the adoption of this standard didthese amendments are not expected to have a material impactsignificant effect on its results of operations, financial position, and liquidity.

In January 2015, the FASB issued ASU 2015-01, "Income Statement-Extraordinary and Unusual Items." The amendment eliminates from U.S. GAAP the concept of extraordinary items. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. This amended guidance will prohibit separate disclosure of extraordinary items in the income statement. This amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Entities may apply the amendment prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. Heartland adopted this standard on January 1, 2016, and the adoption of this standard did not have a material impact on the results of operations, financial position, and liquidity.

In April 2015, the FASB issued ASU 2015-05, "Intangibles-Goodwill and Other-Internal-Use Software." The amendment intends to provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance will not change GAAP for a customer's accounting for service contracts. As a result, all software licenses within the scope of this guidance will be accounted for consistently with other licenses of intangible assets. This amendment is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Entities can elect to adopt the standard either retrospectively or prospectively to all cloud computing arrangements entered into or materially modified after the adoption date. Early adoption is permitted. Heartland adopted this standard on January 1, 2016 and the adoption did not have a material impact on the results of operations, financial position, and liquidity.

In September 2015, the FASB issued ASU 2015-16, "Simplifying the Accounting for Measurement-Period Adjustments." The amendment eliminates the requirement of Topic 805, Business Combinations, to retrospectively adjust the financial statements for measurement-period adjustments that occur in periods after a business combination is consummated. Measurement-period adjustments are calculated as if they were known at the acquisition date, but are recognized in the reporting period in which they are determined. Prior period information is not revised. Additional disclosures are required about the impact on current period income statement line items of adjustments that would have been recognized in prior periods if prior period information had been revised. This amendment is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted if financial statements have not been issued. Heartland adopted this standard effective September 30, 2015. The adoption of this standard did not have a material impact on the results of operations, financial position and liquidity.

In January 2016, the FASB issued guidance ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities." The amendments in ASU 2016-01 to Subtopic 825-10, Financial Instruments, contain the following elements: (1) requiresrequire equity investments to be measured at fair value with changes in fair value recognized in net income; (2) simplifiessimplify the



impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (3) eliminates the requirement for public entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (4) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (5) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or accompanying notes to the financial statements; (7) clarifies that the entity should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale securities in combination with the entity's other deferred tax assets. The amendments are effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. Except for the early application of the



amendment noted in item (5) above, early adoption of the amendments in this update is not permitted. Heartland intends to adopt the accounting standard in 2018, as required, and is currently evaluating the potential impact of this guidance on its results of operations, financial position and liquidity.

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." Topic 842 requires a lessee to recognize a lease liability and a right of use asset for each lease, with the exception of short term leases at the commencement date of the leaseon-balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the leasing arrangement. Accounting requirements applied by lessors is largely unchanged.balance sheet for all leases with a term longer than 12 months. Leases will be classified as financing or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The amendment is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and will be applied on a modified retrospective basis. Heartland leases certain properties and equipment under operating leases that will result in recognition of lease assets and lease liabilities on the consolidated balance sheets under the ASU; however the majority of Heartland's properties and equipment are owned, not leased. Heartland intends to adopt the accounting standard in 2019 as required, and is currently evaluating the impact on its results of operations, financial position, and liquidity.required.

In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718)." The amendments in this ASU simplify several aspects of the accounting for share-based payments, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The amendments in this ASU are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any interim or annual period prior to the effective date. An entity that elects early adoption must adopt all of the amendments in the same period. Heartland adopted this ASU on January 1, 2017, as required, using a prospective transition method. The requirement to report the excess tax benefit or shortfall related to settlements of share-based payment awards in earnings as an increase or decrease to tax expense has been applied to settlements occurring on or after January 1, 2017, and the impact of applying that guidance reduced reported income tax expense by $888,000.

ASU 2016-09 also requires that all income tax-related cash flows resulting from share-based payments be reported as an operating activity in the consolidated statements of cash flow. Previously income tax benefits resulting from the settlement of a share-based payment award were reported as a reduction of operating cash flows and an increase to financing cash flows to the extent that those benefits exceeded the income tax benefits reported in earnings during period in which the share-based payment awards vested. Heartland elected to adopt the change in cash flow classification on a retrospective basis, which resulted in a $1.1 million increase to net cash from operating activities and a corresponding decrease to net cash from financing activities in the accompanying consolidated statement of cash flows for the three months ended March 31, 2016. Heartland has elected to account for forfeitures as they occur.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326)." The amendments in this ASU require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The amendments in this ASU indicate that an entity should not use the length of time a security has been in an unrealized loss position to avoid recording a credit loss. In addition, in determining whether a credit loss exists, the amendments in this ASU also remove the requirements to consider the historical and implied volatility of the fair value of a security and recoveries or declines in fair value after the balance sheet date. The amendment is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. An entity may adopt the amendments earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Heartland intends to adopt the accounting standard in 2020, as required, and is currently evaluating the potential impact of this guidance on its results of operations, financial position and liquidity.

In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments." The amendments in this update address eight specific cash flow issues with the objective of reducing the



existing diversity in practice. The amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes the interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments in this update should be applied using a retrospective transition method to each period presented. Heartland intends to adopt this ASU in 2017,2018, as required, and believesis currently evaluating the potential impact on its results of operations, financial position, and liquidity.

In January 2017, the FASB issued ASU 2017-4, "Intangibles - Goodwill and Other (Topic 350)." This amendment is to simplify the subsequent measurement of goodwill by eliminating step two from the goodwill impairment test. Instead, an entity will perform only step one of its quantitative goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and then recognizing the impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity will still have the option to perform a qualitative assessment for a reporting unit to determine if the quantitative step one impairment test is necessary. This amendment is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019, and should be applied prospectively. Early adoption willis permitted, including in an interim period for impairment tests performed after January 1, 2017. Heartland intends to adopt this ASU in the third quarter of 2020, consistent with the annual impairment test as of September 30 each year, and is currently evaluating the potential impact of this guidance on its results of operations, financial position and liquidity.

In March 2017, the FASB issued ASU 2017-08, "Receivables - Nonrefundable Fee and Other Costs (Subtopic 310-20)." These amendments shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not haverequire an accounting change for securities held at a discount. Discounts continue to be amortized to maturity. These amendments are effective for public business entities for fiscal years and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If any entity early adopts in an interim period, any adjustments should be reflected as to the beginning of the fiscal year that includes the interim period. The amendments should be applied on a modified retrospective basis, with a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Heartland intends to adopt this ASU in 2019, as required, and is currently evaluating the potential impact on its results of operations, financial position, and liquidity.

NOTE 2: ACQUISITIONS

Citywide Banks of Colorado, Inc.
On February 13, 2017, Heartland entered into a definitive merger agreement with Citywide Banks of Colorado, Inc., parent company of Citywide Banks, headquartered in Aurora, Colorado. Under the terms of the definitive merger agreement, Heartland will acquire Citywide Banks of Colorado Inc., in a transaction valued at approximately $203.0 million as of the announcement date, subject to certain adjustments. Citywide Banks of Colorado, Inc. common shareholders will receive a combination of Heartland common stock and cash. The transaction is subject to customary closing conditions, including approval by shareholders of Citywide Banks of Colorado, Inc., and bank regulatory authorities. The transaction is also subject to Heartland stockholders approving an increase in the number of authorized shares of Heartland common stock at the 2017 annual meeting of stockholders. The transaction is expected to close in the third quarter of 2017, and simultaneous with the closing, Citywide Banks will merge into Heartland's Centennial Bank and Trust subsidiary. The combined entity will operate as Citywide Banks. As of March 31, 2017, Citywide Banks had total assets of $1.35 billion, including $982.0 million in net loans outstanding, and $1.17 billion of deposits.
Founders Bancorp
On February 28, 2017, Heartland acquired Founders Bancorp, parent company of Founders Community Bank, based in San Luis Obispo, California. The purchase price was approximately $31.0 million, which was paid by delivery of 455,877 shares of Heartland common stock and cash of $8.4 million. The transaction included, at fair value, total assets of $213.9 million, loans of $96.4 million, and deposits of $181.5 million on the acquisition date. The transaction also included one bank building with a fair value of $576,000 that Heartland intends to sell and is part of the balance of premises, furniture and equipment held for sale on the consolidated balance sheet. Simultaneous with the closing of the transaction, Founders Community Bank merged into Heartland's Premier Valley Bank subsidiary. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of Founders Bancorp.

CIC Bancshares, Inc.
On February 5, 2016, Heartland completed the acquisition of CIC Bancshares, Inc., parent company of Centennial Bank, headquartered in Denver, Colorado. The purchase price was approximately $76.9 million, which was paid by delivery of 2,003,235 shares of Heartland common stock and cash of $15.7 million. In addition, Heartland issued a new series of convertible preferred



stock with a fair value of $3.8 million and assumed convertible notes and subordinated debt totaling approximately $7.9 million. Simultaneous with the closing of the transaction, Centennial Bank merged into Heartland's Summit Bank & Trust, with the resulting institution operating under the name, Centennial Bank and Trust. As of the close date, the transaction included, at fair value, total assets of $772.6 million, total loans of $581.5 million, and total deposits of $648.1 million. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of CIC Bancshares, Inc.




The assets and liabilities of CIC Bancshares, Inc. were recorded on the consolidated balance sheet at estimated fair value on the acquisition date. The following table represents, in thousands, the amounts recorded on the consolidated balance sheet as of February 5, 2016:
 As of February 5, 2016
Fair value of consideration paid: 
Common Stock (2,003,235 shares)$57,433
Preferred Stock (3,000 shares)3,777
Cash15,672
Total consideration paid76,882
Fair value of assets acquired: 
Cash and due from banks23,756
Securities:
Securities available for sale92,831
Other securities3,486
Loans held to maturity581,477
Premises, furniture and equipment, net16,450
Other real estate, net1,934
Other intangible assets, net6,576
Other assets16,276
Total assets742,786
Fair value of liabilities assumed: 
Deposits648,111
Short term borrowings35,766
Other borrowings7,924
Other liabilities3,951
Total liabilities assumed695,752
Fair value of net assets acquired47,034
Goodwill resulting from acquisition$29,848

Heartland recognized $29.8 million of goodwill in conjunction with the acquisition of CIC Bancshares, Inc., which is calculated as the excess of both the consideration exchanged and the liabilities assumed as compared to the fair value of identifiable assets acquired. Goodwill resulted from the expected operational synergies, enhanced market area, cross-selling opportunities and expanded business lines. See Note 6 for further information on goodwill.

Pro Forma Information (unaudited): The following pro forma information presents the results of operations for the years ended December 31, 2015, and December 31, 2014, as if the CIC Bancshares, Inc. acquisition occurred on January 1, 2014:
(Dollars in thousands, except per share data), unauditedFor the Years Ended
 December 31, 2015 December 31, 2014
Net interest income$259,531
 $221,808
Net income available to common shareholders$59,491
 $41,004
Basic earnings per share$2.63
 $2.00
Diluted earnings per share$2.58
 $1.96

The above pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the merged companies that would have been achieved had the acquisition occurred at January 1, 2014, nor are they intended to represent or be indicative of future results of operations. The pro forma results do not include expected operating cost savings as a result of the acquisition. These pro forma results require significant estimates and judgments particularly with respect to valuation and accretion of income associated with the acquired loans.




Heartland incurred $551,000 of pre-tax merger related expenses in 2016 associated with the Centennial Bank acquisition. The merger expenses are reflected on the consolidated statements of income for the applicable period and are reported primarily in the categories of professional fees and other noninterest expenses.

Acquired loans were preliminarily recorded at fair value based on a discounted cash flow valuation methodology that considers, among other things, projected default rates, loss given defaults and recovery rates. No allowance for credit losses was carried over from the acquisition. The balance of nonaccrual loans on the acquisition date was $1.6 million.

Premier Valley Bank
On November 30, 2015, Heartland completed the purchase of Premier Valley Bank in Fresno, California. The purchase price was approximately $95.5 million, which was paid by delivery of 1,758,543 shares of Heartland common stock and cash of $28.5 million. The transaction included, at fair value, total assets of $692.7 million, loans of $389.8 million, and deposits of $622.7 million. Premier Valley Bank continues to operate under its current name and management team as Heartland's tenth, wholly-owned state-chartered bank. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of Premier Valley Bank.
Heartland recognized $41.0 million of goodwill in conjunction with the acquisition of Premier Valley Bank, which is calculated as the excess of both the consideration exchanged and the liabilities assumed as compared to the fair value of identifiable assets acquired. Goodwill resulted from the expected operational synergies, enhanced market area, cross-selling opportunities and expanded business lines. See Note 6 for further information on goodwill.
First Scottsdale Bank, N.A.
On September 11, 2015, Heartland completed the purchase of First Scottsdale Bank, N.A., in Scottsdale, Arizona, in an all cash transaction valued at approximately $17.7 million. Simultaneous with the closing of the transaction, First Scottsdale Bank, N.A., merged into Heartland's Arizona Bank & Trust subsidiary. The transaction included, at fair value, total assets of $81.2 million, loans of $54.7 million, and deposits of $65.9 million on the acquisition date.

Community Bancorporation of New Mexico, Inc.
On August 21, 2015, Heartland acquired Community Bancorporation of New Mexico, Inc., parent company of Community Bank in Santa Fe, New Mexico, in an all cash transaction valued at approximately $11.1 million. Simultaneous with the closing of the transaction, Community Bank merged into Heartland's New Mexico Bank & Trust subsidiary. The transaction included, at fair value, total assets of $166.3 million, loans of $99.5 million, and deposits of $147.4 million on the acquisition date. Also included in this transaction is one bank building with a fair value of $3.4 million that Heartland intends to sell. The bank building is part of the balance of premises, furniture and equipment held for sale on the consolidated balance sheet.

Community Banc-Corp of Sheboygan, Inc.
On January 16, 2015, Heartland completed the acquisition of Community Banc-Corp of Sheboygan, Inc., parent company of Community Bank & Trust in Sheboygan, Wisconsin. Under the terms of the merger agreement for this transaction, the aggregate purchase price was based upon 155% of the December 31, 2014, adjusted tangible book value, as defined in the merger agreement, of Community Banc-Corp of Sheboygan, Inc. The purchase price was approximately $53.1 million, which was paid by delivery of 1,970,720 shares of Heartland common stock. The transaction included, at fair value, total assets of $506.8 million, including loans of $395.0 million, and deposits of $433.9 million. Simultaneous with the close of the transaction, Community Bank & Trust merged into Heartland’s Wisconsin Bank & Trust subsidiary. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of Community Banc-Corp of Sheboygan, Inc.
Heartland recognized goodwill of $18.6 million in conjunction with the acquisition of Community Banc-Corp of Sheboygan, Inc., which is calculated as the excess of both the consideration exchanged and the liabilities assumed as compared to the fair value of identifiable assets acquired. See Note 6 for further information on goodwill.




NOTE 3: SECURITIES

The amortized cost, gross unrealized gains and losses, and estimated fair values of securities available for sale as of March 31, 2016,2017, and December 31, 2015,2016, are summarized in the table below, in thousands:
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
March 31, 2016       
March 31, 2017       
U.S. government corporations and agencies$6,479
 $140
 $
 $6,619
$15,027
 $71
 $(31) $15,067
Mortgage-backed securities1,386,707
 14,448
 (12,468) 1,388,687
1,319,662
 3,859
 (34,994) 1,288,527
Obligations of states and political subdivisions273,147
 8,008
 (152) 281,003
588,559
 2,997
 (16,963) 574,593
Corporate debt securities816
 15
 (1) 830
Total debt securities1,667,149
 22,611
 (12,621) 1,677,139
1,923,248
 6,927
 (51,988) 1,878,187
Equity securities13,150
 227
 
 13,377
15,209
 132
 
 15,341
Total$1,680,299
 $22,838
 $(12,621) $1,690,516
$1,938,457
 $7,059
 $(51,988) $1,893,528
December 31, 2015       
December 31, 2016       
U.S. government corporations and agencies$25,847
 $22
 $(103) $25,766
$4,716
 $16
 $(32) $4,700
Mortgage-backed securities1,254,452
 9,134
 (20,884) 1,242,702
1,321,760
 7,026
 (38,286) 1,290,500
Obligations of states and political subdivisions290,522
 6,547
 (1,087) 295,982
553,020
 2,436
 (19,312) 536,144
Corporate debt securities740
 106
 
 846
Total debt securities1,571,561

15,809

(22,074)
1,565,296
1,879,496

9,478

(57,630)
1,831,344
Equity securities13,142
 40
 (44) 13,138
14,451
 69
 
 14,520
Total$1,584,703
 $15,849
 $(22,118) $1,578,434
$1,893,947
 $9,547
 $(57,630) $1,845,864

At March 31, 2016, and December 31, 2015, the amortized cost of the available for sale securities is net of $0 and $237,000 of credit related other-than-temporary impairment ("OTTI"), respectively.

The amortized cost, gross unrealized gains and losses and estimated fair values of held to maturity securities as of March 31, 2016,2017, and December 31, 2015,2016, are summarized in the table below, in thousands:
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
March 31, 2016       
Mortgage-backed securities$
 $
 $
 $
March 31, 2017       
Obligations of states and political subdivisions271,300
 18,492
 (346) 289,446
260,616
 13,176
 (995) 272,797
Total$271,300
 $18,492
 $(346) $289,446
$260,616
 $13,176
 $(995) $272,797
December 31, 2015       
Mortgage-backed securities$4,369
 $306
 $
 $4,675
December 31, 2016       
Obligations of states and political subdivisions274,748
 15,595
 (505) 289,838
263,662
 12,282
 (1,145) 274,799
Total$279,117
 $15,901
 $(505) $294,513
$263,662
 $12,282
 $(1,145) $274,799

At March 31, 2016, the amortized cost of the held to maturity securities is net of $0 of credit related OTTI and $0 of non-credit related OTTI. At December 31, 2015, the amortized cost of the held to maturity securities was net of $1.5 million of credit related OTTI and $40,000 of non-credit related OTTI.

Approximately 79%2017, approximately 77% of Heartland's mortgage-backed securities are issuances of government-sponsored enterprises.




The amortized cost and estimated fair value of debt securities available for sale at March 31, 2016,2017, by contractual maturity are as follows, in thousands. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties.
March 31, 2017
Amortized Cost Estimated Fair ValueAmortized Cost Estimated Fair Value
Due in 1 year or less$1,265
 $1,273
$380
 $380
Due in 1 to 5 years12,836
 13,115
47,478
 47,375
Due in 5 to 10 years67,214
 69,250
96,785
 94,282
Due after 10 years199,127
 204,814
458,943
 447,623
Total debt securities280,442
 288,452
603,586
 589,660
Mortgage-backed securities1,386,707
 1,388,687
1,319,662
 1,288,527
Equity securities13,150
 13,377
15,209
 15,341
Total investment securities$1,680,299
 $1,690,516
$1,938,457
 $1,893,528

The amortized cost and estimated fair value of debt securities held to maturity at March 31, 2016,2017, by contractual maturity are as follows, in thousands. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties.
March 31, 2017
Amortized Cost Estimated Fair ValueAmortized Cost Estimated Fair Value
Due in 1 year or less$4,266
 $4,336
$1,993
 $2,022
Due in 1 to 5 years13,714
 14,499
19,307
 20,246
Due in 5 to 10 years68,786
 73,224
89,388
 92,873
Due after 10 years184,534
 197,387
149,928
 157,656
Total debt securities271,300
 289,446
Mortgage-backed securities
 
Total investment securities$271,300
 $289,446
$260,616
 $272,797

As of March 31, 20162017, and December 31, 2015,2016, securities with a fair value of $811.7$714.5 million and $855.8$810.6 million, respectively, were pledged to secure public and trust deposits, short-term borrowings and for other purposes as required and permitted by law.

Gross gains and losses realized related to the sales of securities available for sale for the three-month periodperiods ended March 31, 20162017 and 2015,2016, are summarized as follows, in thousands:
Three Months Ended
March 31,
Three Months Ended
March 31,
2016 20152017 2016
Proceeds from sales$303,448
 $289,466
$221,637
 $303,448
Gross security gains4,558
 4,622
3,830
 4,558
Gross security losses682
 269
1,339
 682

The following tables summarize, in thousands, the amount of unrealized losses, defined as the amount by which cost or amortized cost exceeds fair value, and the related fair value of investments with unrealized losses in Heartland's securities portfolio as of March 31, 2016,2017, and December 31, 2015.2016. The investments were segregated into two categories: those that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months. The reference point for determining how long an investment was in an unrealized loss position was March 31, 2015,2016, and December 31, 20142015, respectively. Securities for which Heartland has taken credit-related OTTIother-than-temporary impairment ("OTTI") write-downs are categorized as being "less than 12 months" or "12 months or longer" in a continuous loss position based on the point in time that the fair value declined to below the cost basis and not the period of time since the credit-related OTTI write-down.



Securities available for saleLess than 12 months 12 months or longer TotalLess than 12 months 12 months or longer Total
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
March 31, 2016           
March 31, 2017           
U.S. government corporations and agencies$
 $
 $
 $
 $
 $
$4,071
 $(31) $
 $
 $4,071
 $(31)
Mortgage-backed securities517,907
 (8,323) 130,640
 (4,145) 648,547
 (12,468)696,073
 (17,851) 316,686
 (17,143) 1,012,759
 (34,994)
Obligations of states and political subdivisions10,003
 (82) 6,619
 (70) 16,622
 (152)454,072
 (16,960) 250
 (3) 454,322
 (16,963)
Corporate debt securities500
 (1) 
 
 500
 (1)
Total debt securities528,410
 (8,406) 137,259
 (4,215) 665,669
 (12,621)1,154,216
 (34,842) 316,936
 (17,146) 1,471,152
 (51,988)
Equity securities
 
 
 
 
 

 
 
 
 
 
Total temporarily impaired securities$528,410
 $(8,406) $137,259
 $(4,215) $665,669
 $(12,621)$1,154,216
 $(34,842) $316,936
 $(17,146) $1,471,152
 $(51,988)
December 31, 2015
December 31, 2016December 31, 2016
U.S. government corporations and agencies$22,359
 $(103) $
 $
 $22,359
 $(103)$4,185
 $(32) $
 $
 $4,185
 $(32)
Mortgage-backed securities724,330
 (15,523) 139,562
 (5,361) 863,892
 (20,884)744,202
 (23,527) 272,449
 (14,759) 1,016,651
 (38,286)
Obligations of states and political subdivisions68,482
 (896) 7,460
 (191) 75,942
 (1,087)414,151
 (19,309) 251
 (3) 414,402
 (19,312)
Corporate debt securities
 
 
 
 
 
Total debt securities815,171
 (16,522) 147,022
 (5,552) 962,193
 (22,074)1,162,538
 (42,868) 272,700
 (14,762) 1,435,238
 (57,630)
Equity securities6,566
 (44) 
 
 6,566
 (44)
 
 
 
 
 
Total temporarily impaired securities$821,737
 $(16,566) $147,022
 $(5,552) $968,759
 $(22,118)$1,162,538
 $(42,868) $272,700
 $(14,762) $1,435,238
 $(57,630)

Securities held to maturityLess than 12 months 12 months or longer TotalLess than 12 months 12 months or longer Total
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
March 31, 2016           
Mortgage-backed securities$
 $
 $
 $
 $
 $
March 31, 2017           
Obligations of states and political subdivisions1,363
 (18) 5,717
 (328) 7,080
 (346)24,248
 (752) 2,024
 (243) 26,272
 (995)
Total temporarily impaired securities$1,363
 $(18) $5,717
 $(328) $7,080
 $(346)$24,248
 $(752) $2,024
 $(243) $26,272
 $(995)
December 31, 2015           
Mortgage-backed securities$
 $
 $
 $
 $
 $
December 31, 2016December 31, 2016
Obligations of states and political subdivisions3,646
 (12) 18,033
 (493) 21,679
 (505)31,479
 (884) 2,017
 (261) 33,496
 (1,145)
Total temporarily impaired securities$3,646
 $(12) $18,033
 $(493) $21,679
 $(505)$31,479
 $(884) $2,017
 $(261) $33,496
 $(1,145)

Heartland reviews the investment securities portfolio on a quarterly basis to monitor its exposure to OTTI. A determination as to whether a security's decline in fair value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Some factors Heartland may consider in the OTTI analysis include the length of time the security has been in an unrealized loss position, changes in security ratings, financial condition of the issuer, as well as security and industry specific economic conditions. In addition, with regard to debt securities, Heartland may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds and the value of any underlying collateral. For certain debt securities in unrealized loss positions, Heartland prepares cash flow analyses to compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

Heartland previously recorded $981,000 of OTTI on three private label mortgage-backed securities in March 2012. The other-than-temporary credit-related losses were $797,000 in the held to maturity category and $184,000 in the available for sale category. During 2015, Heartland recorded additional credit-related OTTI on two of the private label mortgage-backed securities that previously had OTTI credit losses. The underlying collateral on these securities experienced an increased level of defaults and a slowing of voluntary prepayments causing the present value of the forward expected cash flows, using prepayment and default vectors, to be below the amortized cost basis of the securities. Based on Heartland's evaluation, a $769,000 OTTI attributable to credit-related losses was recorded in December 2015. The credit-related OTTI was $716,000, of which $200,000 was reclassified



from previous non-credit related OTTI in the held to maturity category. Credit-related OTTI was $53,000 in the available for sale category.

In the first quarter of 2016, Heartland sold the mortgage-backed securities in the held to maturity portfolio because the credit quality of the securities showed further deterioration, and it was unlikely Heartland would recover the remaining basis of the securities prior to maturity. The significant deterioration of the credit quality of these securities was inconsistent with Heartland's original intent upon purchase and classification of these held to maturity securities. The carrying value of these securities was $4.4 million, and the associated realized gross gains were $89,000, and the realized gross losses were $439,000.

The remaining unrealized losses on Heartland's mortgage-backed securities are the result of changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities. The losses are not related to concerns regarding the underlying credit of the issuers or the underlying collateral. It is expected that the securities will not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because Heartland has the intent and ability to hold these investments until a market



price recovery or to maturity and does not believe it will be required to sell the securities before maturity, these investments are not considered other-than-temporarily impaired.

UnrealizedThe remaining unrealized losses on Heartland's obligations of states and political subdivisions are the result of changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities. Management monitors the published credit ratings of these securities and the stability of the underlying municipalities. Because the decline in fair value is attributable to changes in interest rates or widening market spreads due to insurance company downgrades and not underlying credit quality, and because Heartland has the intent and ability to hold these investments until a market price recovery or to maturity and does not believe it will be required to sell the securities before maturity, these investments are not considered other-than-temporarily impaired.

There were no gross realized gains and no gross realized losses on the sale of available for sale securities with OTTI write-downs for the period ended March 31, 2017. Additionally, there were no gross realized gains and no gross realized losses on the sale of held to maturity securities with OTTI write-downs for the period ended March 31, 2017. There were no gross realized gains and $85,000 of gross realized losses on the sale of available for sale securities with OTTI write-downswritedowns for the period ended March 31, 2016. Additionally, there were no gross realized gains and $439,000 of gross realized losses on the sale of held to maturity securities with OTTI write-downs for the period ended March 31, 2016. There were no gross realized gains or losses on the sale of available for sale or held to maturity securities with OTTI write-downs for the period ended March 31, 2015.
    
The following table shows the detail of OTTI write-downs on debt securities included in earnings and the related changes in other accumulated comprehensive income ("AOCI") for the same securities, in thousands:
Three Months Ended
March 31,
Three Months Ended
March 31,
2016 20152017 2016
Recorded as part of gross realized losses:      
Credit related OTTI$
 $
$
 $
Intent to sell OTTI
 

 
Total recorded as part of gross realized losses
 

 
Recorded directly to AOCI for non-credit related impairment:      
Residential mortgage backed securities
 

 
Reduction of non-credit related impairment related to security sales(120) 

 (120)
Accretion of non-credit related impairment(7) (24)
 (7)
Total changes to AOCI for non-credit related impairment(127) (24)
 (127)
Total OTTI losses (accretion) recorded on debt securities, net$(127) $(24)$
 $(127)

Included in other securities at March 31, 2016,2017, and December 31, 2015,2016, were shares of stock in each Federal Home Loan Bank (the "FHLB") of Des Moines, Chicago, Dallas, San Francisco and Topeka, both at an amortized cost of $15.7 million and $14.3 million, respectively.$14.4 million.

The Heartland banks are required to maintain FHLB stock as members of the various FHLBs as required by these institutions. These equity securities are "restricted" in that they can only be sold back to the respective institutions or another member institution at par. Therefore, they are less liquid than other marketable equity securities and their fair value approximates amortized cost. Heartland considers its FHLB stock as a long-term investment that provides access to competitive products and liquidity. Heartland evaluates impairment in these investments based on the ultimate recoverability of the par value and at March 31, 2017, did not consider the investments to be other than temporarily impaired.



NOTE 4: LOANS AND LEASES

Loans and leases as of March 31, 2016,2017, and December 31, 2015,2016, were as follows, in thousands:
March 31, 2016 December 31, 2015March 31, 2017 December 31, 2016
Loans and leases receivable held to maturity:   
Loans receivable held to maturity:   
Commercial$1,295,504
 $1,279,214
$1,314,393
 $1,287,265
Commercial real estate2,555,268
 2,326,360
2,535,355
 2,538,582
Agricultural and agricultural real estate471,271
 471,870
481,125
 489,318
Residential real estate753,666
 539,555
604,902
 617,924
Consumer430,699
 386,867
427,962
 420,613
Gross loans and leases receivable held to maturity5,506,408
 5,003,866
Gross loans receivable held to maturity5,363,737
 5,353,702
Unearned discount(640) (488)(668) (699)
Deferred loan fees(2,763) (1,892)(1,465) (1,284)
Total net loans and leases receivable held to maturity5,503,005
 5,001,486
Allowance for loan and lease losses(49,738) (48,685)
Loans and leases receivable, net$5,453,267
 $4,952,801
Total net loans receivable held to maturity5,361,604
 5,351,719
Allowance for loan losses(54,999) (54,324)
Loans receivable, net$5,306,605
 $5,297,395

Heartland has certain lending policies and procedures in place that are designed to provide for an acceptable level of credit risk. The board of directors reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the board with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies, nonperforming loans and potential problem loans. Diversification in the loan portfolio is also a means of managing risk associated with fluctuations in economic conditions.

The commercial and commercial real estate loan portfolio includes a wide range of business loans, including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment and real estate. Although most loans are made on a secured basis, loans may be made on an unsecured basis where warranted by the overall financial condition of the borrower. Terms of commercial business loans generally range from one to five years. Commercial loans and leases are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The collateral that Heartland requires for most of these loans and leases is based upon the discounted market value of the collateral. The primary repayment risks of commercial loans and leases are that the cash flow of the borrowers may be unpredictable, and the collateral securing these loans may fluctuate in value. Heartland seeks to minimize these risks in a variety of ways. The underwriting analysis includes credit verification, analysis of global cash flows, appraisals and a review of the financial condition of the borrower. Personal guarantees are frequently required as a tertiary form of repayment. In addition, when underwriting loans for commercial real estate, careful consideration is given to the property's operating history, future operating projections, current and projected occupancy, location and physical condition. Heartland also utilizes government guaranteed lending through the U.S. Small Business Administration and the U.S. Department of Agriculture's Rural Development Business and Industry Program to assist customers with longer-term funding and to reduce risk.

Agricultural loans, many of which are secured by crops, machinery and real estate, are provided to finance capital improvements and farm operations as well as acquisitions of livestock and machinery. Agricultural loans present unique credit risks relating to adverse weather conditions, loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations. The ultimate repayment of agricultural loans is dependent upon the profitable operation or management of the agricultural entity. In underwriting agricultural loans, lending personnel work closely with their customers to review budgets and cash flow projections for the ensuing crop year. These budgets and cash flow projections are monitored closely during the year and reviewed with the customers at least annually. Lending personnel also work closely with governmental agencies, including the Farm Service Agency, to help agricultural customers obtain credit enhancement products such as loan guarantees or interest assistance.

Heartland originates first-lien, adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a single family residential property. These loans are principally collateralized by owner-occupied properties and are amortized over 10 to 30 years. Heartland typically sells longer-term, low-rate, residential mortgage loans in the secondary market with servicing rights retained. This practice allows Heartland to better manage interest rate risk and liquidity risk. The Heartland bank subsidiaries participate in lending programs sponsored by U.S. government agencies such as Veterans Administration and Federal Home Administration when justified by market conditions. As of March 31, 2016,2017, Heartland had $2.2$2.6 million of loans secured by residential real estate property that were in the process of foreclosure.




Consumer lending includes motor vehicle, home improvement, home equity and small personal credit lines. Consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than one-to-four-family residential mortgage loans. Consumer loan collections are dependent on the borrower's continuing financial stability, and are therefore more likely to be affected by adverse personal circumstances. Risk is reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition, and personal cash flows. A security interest, with title insurance when necessary, is taken in the underlying real estate. Heartland's consumer finance subsidiaries, Citizens Finance Co. and Citizens Finance of Illinois Co., typically lend to borrowers with past credit problems or limited credit histories, and these loans comprise approximately 19%18% of Heartland's total consumer loan portfolio.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Heartland’s policy is to discontinue the accrual of interest income on any loan or lease when, in the opinion of management, there is a reasonable doubt as to the timely collection of the interest and principal, normally when a loan or lease is 90 days past due. When interest accruals are deemed uncollectible, interest credited to income in the current year is reversed and interest accrued in prior years is charged to the allowance for loan and lease losses. Nonaccrual loans and leases are returned to an accrual status when, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the timely payment of interest and principal.

Under Heartland’s credit practices, a loan is impaired when, based on current information and events, it is probable that Heartland will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loan impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except where more practical, impairment is measured at the observable market price of the loan or the fair value of the collateral if the loan is collateral dependent.

The following table shows the balance in the allowance for loan and lease losses at March 31, 2016,2017, and December 31, 2015,2016, and the related loan balances, disaggregated on the basis of impairment methodology, in thousands. Loans evaluated under ASC 310-10-35 include loans on nonaccrual status and troubled debt restructurings, which are individually evaluated for impairment, and other impaired loans deemed to have similar risk characteristics. All other loans are collectively evaluated for impairment under ASC 450-20. Heartland has made no significant changes to the accounting for the allowance for loan and lease losses policy during 2016.2017.
Allowance For Loan and Lease Losses Gross Loans and Leases Receivable Held to MaturityAllowance For Loan Losses Gross Loans Receivable Held to Maturity
Ending Balance
Under ASC
310-10-35
 
Ending Balance
Under ASC
450-20
 Total 
Ending Balance Evaluated for Impairment
Under ASC
310-10-35
 
Ending Balance Evaluated for Impairment
Under ASC
450-20
  Total
Ending Balance
Under ASC
310-10-35
 
Ending Balance
Under ASC
450-20
 Total 
Ending Balance Evaluated for Impairment
Under ASC
310-10-35
 
Ending Balance Evaluated for Impairment
Under ASC
450-20
  Total
March 31, 2016           
March 31, 2017           
Commercial$984
 $15,390
 $16,374
 $11,018
 $1,284,486
 $1,295,504
$1,763
 $14,417
 $16,180
 $3,989
 $1,310,404
 $1,314,393
Commercial real estate1,252
 19,243
 20,495
 44,082
 2,511,186
 2,555,268
2,666
 21,131
 23,797
 34,549
 2,500,806
 2,535,355
Agricultural and agricultural real estate
 4,028
 4,028
 13,593
 457,678
 471,271
41
 3,942
 3,983
 13,243
 467,882
 481,125
Residential real estate311
 1,540
 1,851
 19,345
 734,321
 753,666
496
 1,687
 2,183
 26,978
 577,924
 604,902
Consumer1,247
 5,743
 6,990
 5,963
 424,736
 430,699
1,397
 7,459
 8,856
 6,149
 421,813
 427,962
Total$3,794
 $45,944
 $49,738
 $94,001
 $5,412,407
 $5,506,408
$6,363
 $48,636
 $54,999
 $84,908
 $5,278,829
 $5,363,737
December 31, 2015           
December 31, 2016           
Commercial$471
 $15,624
 $16,095
 $6,919
 $1,272,295
 $1,279,214
$1,318
 $13,447
 $14,765
 $3,712
 $1,283,553
 $1,287,265
Commercial real estate698
 18,834
 19,532
 45,442
 2,280,918
 2,326,360
2,671
 21,648
 24,319
 45,217
 2,493,365
 2,538,582
Agricultural and agricultural real estate
 3,887
 3,887
 4,612
 467,258
 471,870
816
 3,394
 4,210
 16,730
 472,588
 489,318
Residential real estate393
 1,541
 1,934
 17,790
 521,765
 539,555
497
 1,766
 2,263
 25,726
 592,198
 617,924
Consumer1,206
 6,031
 7,237
 5,458
 381,409
 386,867
1,451
 7,316
 8,767
 5,988
 414,625
 420,613
Total$2,768
 $45,917
 $48,685
 $80,221
 $4,923,645
 $5,003,866
$6,753
 $47,571
 $54,324
 $97,373
 $5,256,329
 $5,353,702




The following table presents nonaccrual loans, accruing loans past due 90 days or more and troubled debt restructured loans at March 31, 2016,2017, and December 31, 2015,2016, in thousands. There were no nonaccrual leases, accruing leases past due 90 days or more or restructured leases at March 31, 2016, and December 31, 2015.thousands:
March 31, 2016 December 31, 2015March 31, 2017 December 31, 2016
Nonaccrual loans$46,316
 $37,874
$61,789
 $62,591
Nonaccrual troubled debt restructured loans1,434
 1,781
1,079
 1,708
Total nonaccrual loans$47,750
 $39,655
$62,868
 $64,299
Accruing loans past due 90 days or more$639
 $
$872
 $86
Performing troubled debt restructured loans$10,711
 $11,075
$11,010
 $10,380

The following table providestables provide information on troubled debt restructured loans that were modified during the three monthsthree-month periods ended March 31, 2016,2017, and March 31, 2015,2016, dollars in thousands:
            
Three Months Ended
March 31,
Three Months Ended March 31,
2016 20152017 2016
Number
of Loans
 
Pre-
Modification
Recorded
Investment
 
Post-
Modification
Recorded
Investment
 
Number
of Loans
 
Pre-
Modification
Recorded
Investment
 
Post-
Modification
Recorded
Investment
Number
of Loans
 
Pre-
Modification
Recorded
Investment
 
Post-
Modification
Recorded
Investment
 
Number
of Loans
 
Pre-
Modification
Recorded
Investment
 
Post-
Modification
Recorded
Investment
Commercial
 $
 $
 
 $
 $

 $
 $
 
 $
 $
Commercial real estate
 
 
 1
 3,992
 3,992

 
 
 
 
 
Total commercial and commercial real estate
 
 
 1
 3,992
 3,992

 
 
 
 
 
Agricultural and agricultural real estate
 
 
 
 
 

 
 
 
 
 
Residential real estate
 
 
 
 
 
3
 348
 348
 
 
 
Consumer
 
 
 
 
 

 
 
 
 
 
Total
 $
 $
 1
 $3,992
 $3,992
3
 $348
 $348
 
 $
 $
           
The pre-modification and post-modification recorded investment represents amounts as of the date of loan modification. Since the modifications on these loans have been only interest rate concessions and term extensions, not principal reductions, the pre-modification and post-modification recorded investment amounts are the same. At March 31, 2016,2017, there were no commitments to extend credit to any of the borrowers with an existing troubled debt restructuring.

Heartland had no troubled debt restructured loans for which there was a payment default during the three monthsthree-month periods ended March 31, 2016,2017, and March 31, 2015,2016, that had been modified during the twelve-month period prior to default.default:
        
        
Heartland's internal rating system is a series of grades reflecting management's risk assessment, based on its analysis of the borrower's financial condition. The "pass" category consists of all loans that are not in the "nonpass" category, categorized into a range of loan grades that reflect increasing, though still acceptable, risk. Movement of risk through the various grade levels in the pass category is monitored for early identification of credit deterioration. The "nonpass" category consists of special mention, substandard, doubtful and loss loans. The "special mention" rating is attached to loans where the borrower exhibits negative financial trends due to borrower specific or systemic conditions that, if left uncorrected, threaten the borrower's capacity to meet its debt obligations. The borrower is believed to have sufficient financial flexibility to react to and resolve its negative financial situation. These credits are closely monitored for improvement or deterioration. The "substandard" rating is assigned to loans that are inadequately protected by the current sound net worth and paying capacity of the borrower and may be further at risk due to deterioration in the value of collateral pledged. Well-defined weaknesses jeopardize liquidation of the debt. These loans are still considered collectible; however, a distinct possibility exists that Heartland will sustain some loss if deficiencies are not corrected. Substandard loans may exhibit some or all of the following weaknesses: deteriorating trends, lack of earnings, inadequate debt service capacity, excessive debt and/or lack of liquidity. The "doubtful" rating is assigned to loans where identified weaknesses make collection or liquidation in full, on the basis of existing facts, conditions and values, highly questionable and improbable. These borrowers are usually in default, lack liquidity and capital, as well as resources necessary to remain an operating entity. Specific pending events, such as capital injections, liquidations or perfection of liens on additional collateral, may strengthen the credit, thus deferring classification of the loan as loss until the exact status can be determined. The "loss" rating is assigned to



loans considered uncollectible. As of March 31, 2016,2017, Heartland had $80,000 ofno loans classified as doubtful and no loans classified as loss. Loans are placed on "nonaccrual" when management does not expect to collect payments of principal and interest in full or



when principal or interest has been in default for a period of 90 days or more, unless the loan is both well secured and in the process of collection.

The following table presents loans and leases by credit quality indicator at March 31, 2016,2017, and December 31, 2015,2016, in thousands:
Pass Nonpass TotalPass Nonpass Total
March 31, 2016     
March 31, 2017     
Commercial$1,128,858
 $166,646
 $1,295,504
$1,216,550
 $97,843
 $1,314,393
Commercial real estate2,339,414
 215,854
 2,555,268
2,362,759
 172,596
 2,535,355
Total commercial and commercial real estate3,468,272
 382,500
 3,850,772
3,579,309
 270,439
 3,849,748
Agricultural and agricultural real estate426,929
 44,342
 471,271
415,716
 65,409
 481,125
Residential real estate725,773
 27,893
 753,666
569,322
 35,580
 604,902
Consumer420,267
 10,432
 430,699
416,515
 11,447
 427,962
Total gross loans and leases receivable held to maturity$5,041,241
 $465,167
 $5,506,408
December 31, 2015     
Total gross loans receivable held to maturity$4,980,862
 $382,875
 $5,363,737
December 31, 2016     
Commercial$1,106,276
 $172,938
 $1,279,214
$1,187,557
 $99,708
 $1,287,265
Commercial real estate2,107,474
 218,886
 2,326,360
2,379,632
 158,950
 2,538,582
Total commercial and commercial real estate3,213,750
 391,824
 3,605,574
3,567,189
 258,658
 3,825,847
Agricultural and agricultural real estate435,745
 36,125
 471,870
424,311
 65,007
 489,318
Residential real estate515,195
 24,360
 539,555
584,626
 33,298
 617,924
Consumer377,173
 9,694
 386,867
409,474
 11,139
 420,613
Total gross loans and leases receivable held to maturity$4,541,863
 $462,003
 $5,003,866
Total gross loans receivable held to maturity$4,985,600
 $368,102
 $5,353,702

The nonpass category in the table above is comprised of approximately 57%54% special mention loans and 43%46% substandard loans as of March 31, 2016.2017. The percent of nonpass loans on nonaccrual status as of March 31, 2016,2017, was 10%17%. As of December 31, 2015,2016, the nonpass category in the table above was comprised of approximately 68%47% special mention loans and 32%53% substandard loans. The percent of nonpass loans on nonaccrual status as of December 31, 2015,2016, was 8%17%. Loans delinquent 30 to 89 days as a percent of total loans were 0.45%0.44% at March 31, 2016,2017, compared to 0.31%0.37% at December 31, 2015.2016. Changes in credit risk are monitored on a continuous basis and changes in risk ratings are made when identified. All impaired loans are reviewed at least annually.




The following table sets forth information regarding Heartland's accruing and nonaccrual loans and leases at March 31, 2016,2017, and December 31, 2015,2016, in thousands:
Accruing Loans and Leases    Accruing Loans    
30-59 Days
Past Due
 60-89 Days
Past Due
 
90 Days or
More Past Due
 
Total
Past Due
 Current Nonaccrual 
Total Loans
and Leases
30-59 Days
Past Due
 60-89 Days
Past Due
 
90 Days or
More
Past Due
 
Total
Past Due
 Current Nonaccrual Total Loans
March 31, 2016             
March 31, 2017             
Commercial$1,565
 $396
 $
 $1,961
 $1,288,064
 $5,479
 $1,295,504
$11,940
 $2,421
 $291
 $14,652
 $1,296,900
 $2,841
 $1,314,393
Commercial real estate3,413
 212
 89
 3,714
 2,529,840
 21,714
 2,555,268
3,618
 310
 500
 4,428
 2,506,236
 24,691
 2,535,355
Total commercial and commercial real estate4,978
 608
 89
 5,675
 3,817,904
 27,193
 3,850,772
15,558
 2,731
 791
 19,080
 3,803,136
 27,532
 3,849,748
Agricultural and agricultural real estate12,600
 423
 
 13,023
 457,459
 789
 471,271
347
 
 61
 408
 469,918
 10,799
 481,125
Residential real estate1,753
 192
 550
 2,495
 734,977
 16,194
 753,666
2,141
 163
 
 2,304
 581,850
 20,748
 604,902
Consumer3,434
 544
 
 3,978
 423,147
 3,574
 430,699
2,014
 746
 20
 2,780
 421,393
 3,789
 427,962
Total gross loans and leases receivable held to maturity$22,765
 $1,767
 $639
 $25,171
 $5,433,487
 $47,750
 $5,506,408
December 31, 2015             
Total gross loans receivable held to maturity$20,060
 $3,640
 $872
 $24,572
 $5,276,297
 $62,868
 $5,363,737
December 31, 2016             
Commercial$2,005
 $608
 $
 $2,613
 $1,273,678
 $2,923
 $1,279,214
$1,127
 $219
 $77
 $1,423
 $1,281,241
 $4,601
 $1,287,265
Commercial real estate3,549
 2,077
 
 5,626
 2,302,052
 18,682
 2,326,360
886
 3,929
 
 4,815
 2,513,069
 20,698
 2,538,582
Total commercial and commercial real estate5,554
 2,685
 
 8,239
 3,575,730
 21,605
 3,605,574
2,013
 4,148
 77
 6,238
 3,794,310
 25,299
 3,825,847
Agricultural and agricultural real estate143
 54
 
 197
 470,455
 1,218
 471,870
199
 3,191
 
 3,390
 472,597
 13,331
 489,318
Residential real estate1,900
 115
 
 2,015
 523,915
 13,625
 539,555
4,986
 846
 
 5,832
 590,626
 21,466
 617,924
Consumer3,964
 933
 
 4,897
 378,763
 3,207
 386,867
3,455
 1,021
 9
 4,485
 411,925
 4,203
 420,613
Total gross loans and leases receivable held to maturity$11,561
 $3,787
 $
 $15,348
 $4,948,863
 $39,655
 $5,003,866
Total gross loans receivable held to maturity$10,653
 $9,206
 $86
 $19,945
 $5,269,458
 $64,299
 $5,353,702




The majority of Heartland's impaired loans are those that are nonaccrual or have had their terms restructured in a troubled debt restructuring. The following tables present, by category of loan, impaired loans, the unpaid contractual loan balances at March 31, 2016,2017, and December 31, 2015;2016; the outstanding loan balances recorded on the consolidated balance sheets at March 31, 2016,2017, and December 31, 2015;2016; any related allowance recorded for those loans as of March 31, 2016,2017, and December 31, 2015;2016; the average outstanding loan balances recorded on the consolidated balance sheets during the three months ended March 31, 2016,2017, and year ended December 31, 2015;2016; and the interest income recognized on the impaired loans during the three monthsthree-month period ended March 31, 2016,2017, and year ended December 31, 2015,2016, in thousands:
Unpaid
Contractual
Balance
 
Loan
Balance
 
Related
Allowance
Recorded
 
Year-to-
Date
Avg.
Loan
Balance
 
Year-to-
Date
Interest
Income
Recognized
Unpaid
Contractual
Balance
 
Loan
Balance
 
Related
Allowance
Recorded
 
Year-
to-
Date
Avg.
Loan
Balance
 
Year-
to-
Date
Interest
Income
Recognized
March 31, 2016         
March 31, 2017         
Impaired loans with a related allowance:                  
Commercial$4,766
 $4,766
 $984
 $2,137
 $35
$2,841
 $2,829
 $1,763
 $2,776
 $137
Commercial real estate4,297
 4,203
 1,252
 4,210
 25
12,423
 12,423
 2,666
 13,635
 4
Total commercial and commercial real estate9,063
 8,969
 2,236
 6,347
 60
15,264
 15,252
 4,429
 16,411
 141
Agricultural and agricultural real estate
 
 
 
 
575
 575
 41
 2,013
 5
Residential real estate2,868
 2,873
 311
 2,917
 4
2,464
 2,464
 496
 3,103
 10
Consumer3,258
 3,258
 1,247
 3,208
 9
2,473
 2,473
 1,397
 2,480
 11
Total impaired loans with a related allowance$15,189
 $15,100
 $3,794
 $12,472
 $73
$20,776
 $20,764
 $6,363
 $24,007
 $167
Impaired loans without a related allowance:                  
Commercial$6,277
 $6,252
 $
 $9,849
 $143
$1,201
 $1,160
 $
 $1,650
 $59
Commercial real estate43,157
 39,879
 
 46,872
 384
23,203
 22,126
 
 27,545
 196
Total commercial and commercial real estate49,434
 46,131
 
 56,721
 527
24,404
 23,286
 
 29,195
 255
Agricultural and agricultural real estate13,593
 13,593
 
 7,422
 251
12,668
 12,668
 
 13,512
 35
Residential real estate16,610
 16,472
 
 17,173
 32
24,518
 24,514
 
 24,061
 77
Consumer2,706
 2,705
 
 2,970
 9
3,676
 3,676
 
 3,755
 19
Total impaired loans without a related allowance$82,343
 $78,901
 $
 $84,286
 $819
$65,266
 $64,144
 $
 $70,523
 $386
Total impaired loans held to maturity:                  
Commercial$11,043
 $11,018
 $984
 $11,986
 $178
$4,042
 $3,989
 $1,763
 $4,426
 $196
Commercial real estate47,454
 44,082
 1,252
 51,082
 409
35,626
 34,549
 2,666
 41,180
 200
Total commercial and commercial real estate58,497
 55,100
 2,236
 63,068
 587
39,668
 38,538
 4,429
 45,606
 396
Agricultural and agricultural real estate13,593
 13,593
 
 7,422
 251
13,243
 13,243
 41
 15,525
 40
Residential real estate19,478
 19,345
 311
 20,090
 36
26,982
 26,978
 496
 27,164
 87
Consumer5,964
 5,963
 1,247
 6,178
 18
6,149
 6,149
 1,397
 6,235
 30
Total impaired loans held to maturity$97,532
 $94,001
 $3,794
 $96,758
 $892
$86,042
 $84,908
 $6,363
 $94,530
 $553




Unpaid
Contractual
Balance
 
Loan
Balance
 
Related
Allowance
Recorded
 
Year-to-
Date
Avg.
Loan
Balance
 
Year-to-
Date
Interest
Income
Recognized
Unpaid
Contractual
Balance
 
Loan
Balance
 
Related
Allowance
Recorded
 
Year-to-
Date
Avg.
Loan
Balance
 
Year-to-
Date
Interest
Income
Recognized
December 31, 2015         
December 31, 2016         
Impaired loans with a related allowance:                  
Commercial$1,192
 $1,160
 $471
 $524
 $12
$2,852
 $2,840
 $1,318
 $3,136
 $2
Commercial real estate2,697
 2,697
 698
 2,539
 19
14,221
 14,221
 2,671
 10,625
 21
Total commercial and commercial real estate3,889
 3,857
 1,169
 3,063
 31
17,073
 17,061
 3,989
 13,761
 23
Agricultural and agricultural real estate
 
 
 2,823
 
2,771
 2,771
 816
 912
 21
Residential real estate2,210
 2,125
 393
 2,524
 16
3,490
 3,490
 497
 3,371
 43
Consumer3,111
 3,111
 1,206
 2,877
 33
2,644
 2,644
 1,451
 3,082
 42
Total impaired loans with a related allowance$9,210
 $9,093
 $2,768
 $11,287
 $80
$25,978
 $25,966
 $6,753
 $21,126
 $129
Impaired loans without a related allowance:                  
Commercial$5,784
 $5,759
 $
 $7,511
 $515
$925
 $872
 $
 $5,329
 $251
Commercial real estate46,099
 42,745
 
 38,444
 1,395
31,875
 30,996
 
 39,632
 1,647
Total commercial and commercial real estate51,883
 48,504
 
 45,955
 1,910
32,800
 31,868
 
 44,961
 1,898
Agricultural and agricultural real estate4,612
 4,612
 
 2,287
 175
13,959
 13,959
 
 12,722
 157
Residential real estate15,802
 15,665
 
 10,186
 145
22,408
 22,236
 
 18,446
 202
Consumer2,347
 2,347
 
 2,403
 38
3,344
 3,344
 
 2,659
 68
Total impaired loans without a related allowance$74,644
 $71,128
 $
 $60,831
 $2,268
$72,511
 $71,407
 $
 $78,788
 $2,325
Total impaired loans held to maturity:                  
Commercial$6,976
 $6,919
 $471
 $8,035
 $527
$3,777
 $3,712
 $1,318
 $8,465
 $253
Commercial real estate48,796
 45,442
 698
 40,983
 1,414
46,096
 45,217
 2,671
 50,257
 1,668
Total commercial and commercial real estate55,772
 52,361
 1,169
 49,018
 1,941
49,873
 48,929
 3,989
 58,722
 1,921
Agricultural and agricultural real estate4,612
 4,612
 
 5,110
 175
16,730
 16,730
 816
 13,634
 178
Residential real estate18,012
 17,790
 393
 12,710
 161
25,898
 25,726
 497
 21,817
 245
Consumer5,458
 5,458
 1,206
 5,280
 71
5,988
 5,988
 1,451
 5,741
 110
Total impaired loans held to maturity$83,854
 $80,221
 $2,768
 $72,118
 $2,348
$98,489
 $97,373
 $6,753
 $99,914
 $2,454

On February 28, 2017, Heartland acquired Founders Bancorp, parent company of Founders Community Bank, based in San Luis Obispo, California. As of February 28, 2017, Founder Community Bank had gross loans of $98.9 million, and the estimated fair value of the loans acquired was $96.4 million.

On February 5, 2016, Heartland acquired CIC Bancshares, Inc., parent company of Centennial Bank, in Denver, Colorado. As of February 5, 2016, Centennial Bank had gross loans of $594.9 million, and the estimated fair value of the loans acquired was $581.5 million.

On November 30, 2015, Heartland acquired Premier Valley Bank in Fresno, California. As of November 30, 2015, Premier Valley Bank had loans of $400.5 million, and the estimated fair value of the loans acquired was $389.8 million.

On September 11, 2015, Heartland acquired First Scottsdale Bank, N.A. in Scottsdale, Arizona. As of September 11, 2015, First Scottsdale Bank, N.A. had loans of $56.5 million, and the estimated fair value of the loans acquired was $54.7 million.

On August 21, 2015, Heartland acquired Community Bancorporation of New Mexico, Inc., parent company of Community Bank of Santa Fe, New Mexico. As of August 21, 2015, Community Bank had loans of $103.7 million, and the estimated fair value of the loans acquired was $99.5 million.

On January 16, 2015, Heartland acquired Community Banc-Corp of Sheboygan, Inc., parent company of Community Bank & Trust in Sheboygan, Wisconsin. As of January 16, 2015, Community Bank & Trust had loans of $413.4 million, and the estimated fair value of the loans acquired was $395.0 million.

The acquisitions of Community Banc-Corp of Sheboygan, Inc., Community Bancorporation of New Mexico, Inc., First Scottsdale Bank, N.A., Premier Valley Bank and CIC Bancshares, Inc. were accounted for underuses the acquisition method of accounting in accordance with ASC 805, "Business Combinations." Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date, but the purchaser cannot carry over the related allowance for loan and lease losses. Purchased loans are accounted for under ASC 310-30, "Loans and Debt Securities with Deteriorated Credit Quality," when the loans have evidence of credit deterioration since origination, and when at the date of the acquisition, it is probable that Heartland will not



collect all contractually required principal and interest payments. Evidence of credit quality deterioration at the purchase date includeincludes statistics such as past due and nonaccrual status. Generally, acquired loans that meet Heartland’s definition for nonaccrual status fall within the scope of ASC 310-30. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference which is included in the carrying value of the loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan and lease losses. Subsequent increases in cash flows result in a reversal of the provision for loan and lease losses to the extent of prior charges, or a reclassification of the difference from nonaccretable to accretable with a positive impact on future interest income. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.




The carrying amount of the acquired loans at March 31, 20162017, and December 31, 2015,2016, consisted of purchased impaired and nonimpaired loans as summarized in the following table, in thousands:
March 31, 2016 December 31, 2015March 31, 2017 December 31, 2016
Impaired
Purchased
Loans
 Non Impaired
Purchased
Loans
 
Total
Purchased
Loans
 Impaired
Purchased
Loans
 Non Impaired
Purchased
Loans
 
Total
Purchased
Loans
Impaired
Purchased
Loans
 
Non
Impaired
Purchased
Loans
 
Total
Purchased
Loans
 Impaired
Purchased
Loans
 
Non
Impaired
Purchased
Loans
 
Total
Purchased
Loans
Commercial$2,545
 $184,963
 $187,508
 $
 $159,393
 $159,393
$1,962
 $94,339
 $96,301
 $2,198
 $99,082
 $101,280
Commercial real estate5,997
 723,390
 729,387
 7,716
 494,010
 501,726
2,294
 617,124
 619,418
 2,079
 622,117
 624,196
Agricultural and agricultural real estate
 1,296
 1,296
 
 2,985
 2,985

 1,339
 1,339
 
 181
 181
Residential real estate715
 293,176
 293,891
 
 85,549
 85,549
187
 147,389
 147,576
 186
 157,468
 157,654
Consumer loans
 69,837
 69,837
 
 33,644
 33,644

 49,023
 49,023
 
 47,368
 47,368
Total Loans$9,257
 $1,272,662
 $1,281,919
 $7,716
 $775,581
 $783,297
Total loans$4,443
 $909,214
 $913,657
 $4,463
 $926,216
 $930,679

Changes in accretable yield on acquired loans with evidence of credit deterioration at the date of acquisition for the three monthsthree-month periods ended March 31, 2016,2017, and March 31, 2015,2016, were as follows, in thousands:
Balance at December 31, 2015$557
Original yield discount, net, at date of acquisitions19
Accretion273
Reclassification from nonaccretable difference (1)
(2)
Balance at March 31, 2016$305
  
(1) Represents increases in estimated cash flows expected to be received, primarily due to lower estimated credit losses.
 For the Three Months Ended
 March 31, 2017 March 31, 2016
Balance at beginning of year$182
 $557
Original yield discount, net, at date of acquisitions
 19
Accretion(173) (273)
Reclassification from nonaccretable difference(1)
127
 2
Balance at end of period$136
 $305
    
(1) Represents increased in estimated cash flows expected to be received, primarily due to lower estimated credit losses.

Balance at December 31, 2014$
Original yield discount, net, at date of acquisitions352
Accretion
Reclassification from nonaccretable difference (1)

Balance at March 31, 2015$352
  
(1) Represents increases in estimated cash flows expected to be received, primarily due to lower estimated credit losses.

OnFor loans acquired since January 2015, on the acquisition dates the preliminary estimate of the contractually required payments receivable for all loans with evidence of credit deterioration since origination was $21.0 million, and the estimated fair value of the loans was $13.1 million. At March 31, 2016,2017, a majority of these loans were valued based upon the liquidation value of the underlying collateral, because the expected cash flows are primarily based on the liquidation of underlying collateral, and the timing and amount of the cash flows could not be reasonably estimated. At March 31, 2017, and December 31, 2016, there was an allowance for loan and lease losses of $205,000$589,000 and $588,000, respectively, related to these ASC 310-30 loans. Provision expense of $1,000 and $124,000 was recorded for the three-month periods ended March 31, 2017, and 2016, respectively.

OnFor loans acquired since January 2015, on the acquisition dates the preliminary estimate of the contractually required payments receivable for all nonimpaired loans acquired in the acquisitions was $1.55$1.65 billion, and the estimated fair value of the loans was $1.51$1.60 billion.




NOTE 5: ALLOWANCE FOR LOAN AND LEASE LOSSES

Changes in the allowance for loan and lease losses for the three monthsthree-month periods ended March 31, 2016,2017, and March 31, 2015,2016, were as follows, in thousands:
Commercial 
Commercial
Real Estate
 Agricultural 
Residential
Real Estate
 Consumer Unallocated TotalCommercial 
Commercial
Real Estate
 Agricultural 
Residential
Real Estate
 Consumer Total
Balance at December 31, 2015$16,095
 $19,532
 $3,887
 $1,934
 $7,237
 $
 $48,685
Balance at December 31, 2016$14,765
 $24,319
 $4,210
 $2,263
 $8,767
 $54,324
Charge-offs(98) (312) 
 (37) (1,158) 
 (1,605)(230) (608) (871) (265) (1,744) (3,718)
Recoveries176
 146
 3
 20
 246
 
 591
234
 212
 1
 2
 303
 752
Provision201
 1,129
 138
 (66) 665
 
 2,067
1,411
 (126) 643
 183
 1,530
 3,641
Balance at March 31, 2016$16,374
 $20,495
 $4,028
 $1,851
 $6,990
 $
 $49,738
Balance at March 31, 2017$16,180
 $23,797
 $3,983
 $2,183
 $8,856
 $54,999



Commercial 
Commercial
Real Estate
 Agricultural 
Residential
Real Estate
 Consumer Unallocated TotalCommercial 
Commercial
Real Estate
 Agricultural 
Residential
Real Estate
 Consumer Total
Balance at December 31, 2014$11,909
 $15,898
 $3,295
 $3,741
 $6,606
 $
 $41,449
Balance at December 31, 2015$16,095
 $19,532
 $3,887
 $1,934
 $7,237
 $48,685
Charge-offs(274) (333) (276) (58) (1,063) 
 (2,004)(98) (312) 
 (37) (1,158) (1,605)
Recoveries320
 126
 22
 37
 233
 
 738
176
 146
 3
 20
 246
 591
Provision(267) 944
 175
 25
 794
 
 1,671
201
 1,129
 138
 (66) 665
 2,067
Balance at March 31, 2015$11,688
 $16,635
 $3,216
 $3,745
 $6,570
 $
 $41,854
Balance at March 31, 2016$16,374
 $20,495
 $4,028
 $1,851
 $6,990
 $49,738

Management allocates the allowance for loan and lease losses by pools of risk within each loan portfolio. The allocation of the allowance for loan and lease losses by loan portfolio is made for analytical purposes and is not necessarily indicative of the trend of future loan and lease losses in any particular category. The total allowance for loan and lease losses is available to absorb losses from any segment of the loan portfolio.

NOTE 6: GOODWILL, CORE DEPOSIT PREMIUM AND OTHER INTANGIBLE ASSETS

Heartland had goodwill of $127.7$141.5 million at March 31, 2016,2017, and $97.9$127.7 million at December 31, 2015.2016. Heartland conducts its annual internal assessment of the goodwill both collectively and at its subsidiaries as of September 30. There was no goodwill impairment as of the most recent assessment.

Heartland recorded $13.8 million of goodwill in connection with the acquisition of Founders Bancorp, parent company of Founders Community Bank, based in San Luis Obispo, California on February 28, 2017. The goodwill associated with this transaction is not deductible for tax purposes. As part of this acquisition, Heartland recognized core deposit intangibles of $2.5 million that are expected to be amortized over a period of 10 years on an accelerated basis. The core deposit intangibles associated with this transaction are not deductible for tax purposes.

Heartland recorded $29.8 million of goodwill in connection with the acquisition of CIC Bancshares, Inc., parent company of Centennial Bank, based in Denver, Colorado on February 5, 2016. The goodwill associated with this transaction is not deductible for tax purposes. As part of this acquisition, Heartland recognized core deposit intangibles of $6.4 million that are expected to be amortized over a period of 10 years on an accelerated basis. The core deposit intangibles associated with this transaction are not deductible for tax purposes. In addition, Heartland recognized commercial servicing rights of $190,000.

Heartland recorded $41.0 million of goodwill in connection with the acquisition of Premier Valley Bank, based in Fresno, California on November 30, 2015. The goodwill associated with this transaction is not deductible for tax purposes. As part of this acquisition, Heartland recognized core deposit intangibles of $8.0 million that are expected to be amortized over a period of 10 years on an accelerated basis. The core deposit intangibles associated with this transaction are not deductible for tax purposes. In addition, Heartland recognized commercial servicing rights of $616,000.

Heartland recorded $2.5 million of goodwill in connection with the acquisition of First Scottsdale Bank, N.A., based in Scottsdale, Arizona on September 11, 2015. The goodwill associated with this transaction is not deductible for tax purposes. As part of this acquisition, Heartland also recognized core deposit intangibles of $357,000 that are expected to be amortized over a period of 10 years on an accelerated basis. The core deposit intangibles associated with this transaction are not deductible for tax purposes.




Heartland recorded $213,000 of goodwill in connection with the acquisition of Community Bancorporation of New Mexico, Inc., parent company of Community Bank in Santa Fe, New Mexico, based in Santa Fe, New Mexico on August 21, 2015. The goodwill associated with this transaction is not deductible for tax purposes. As part of this acquisition, Heartland also recognized core deposit intangibles of $1.7 million that are expected to be amortized over a period of 10 years on an accelerated basis. The core deposit intangibles associated with this transaction are not deductible for tax purposes.

Heartland recorded $18.6 million of goodwill in connection with the acquisition of Community Banc-Corp of Sheboygan, Inc., the parent company of Community Bank & Trust, based in Sheboygan, Wisconsin on January 16, 2015. The goodwill associated with this transaction is not deductible for tax purposes. As part of this acquisition, Heartland recognized core deposit intangibles of $6.0 million that are expected to be amortized over a period of 10 years on an accelerated basis. The core deposit intangibles associated with this transaction are not deductible for tax purposes. In addition, Heartland recognized commercial servicing rights of $4.3 million.

Goodwill related to the Founders Bancorp and CIC Bancshares, Inc., Premier Valley Bank, First Scottsdale Bank, N.A., Community Bancorporation of New Mexico, Inc. and Community Banc-Corp of Sheboygan, Inc., acquisitions resulted from expected operational synergies, increased market presence, cross-selling opportunities, and expanded business lines.

OtherHeartland's intangible assets consist of core deposit intangibles, mortgage servicing rights, customer relationship intangible, and commercial servicing rights. The gross carrying amount of otherthese intangible assets and the associated accumulated amortization at March 31, 2016,2017, and December 31, 2015,2016, are presented in the table below, in thousands:
March 31, 2016 December 31, 2015March 31, 2017 December 31, 2016
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Amortizing intangible assets:                      
Core deposit intangibles$43,504
 $17,345
 $26,159
 $37,118
 $15,460
 $21,658
$45,968
 $22,211
 $23,757
 $43,504
 $21,049
 $22,455
Mortgage servicing rights46,818
 16,368
 30,450
 45,744
 15,430
 30,314
51,302
 19,343
 31,959
 50,467
 18,379
 32,088
Customer relationship intangible1,176
 825
 351
 1,177
 815
 362
1,177
 866
 311
 1,177
 857
 320
Commercial servicing rights6,071
 1,611
 4,460
 5,685
 1,074
 4,611
6,597
 3,115
 3,482
 6,504
 2,814
 3,690
Total$97,569
 $36,149
 $61,420
 $89,724
 $32,779
 $56,945
$105,044
 $45,535
 $59,509
 $101,652
 $43,099
 $58,553




The following table shows the estimated future amortization expense for amortizable intangible assets, in thousands:
Core
Deposit
Intangibles
 
Mortgage
Servicing
Rights
 
Customer
Relationship
Intangible
 
Commercial
Servicing
Rights
 
 
 
Total
Core
Deposit
Intangibles
 
Mortgage
Servicing
Rights
 
Customer
Relationship
Intangible
 
Commercial
Servicing
Rights
 
 
 
Total
Nine months ending December 31, 2016$3,716
 $6,778
 $31
 $720
 $11,245
Nine months ending December 31, 2017$3,577
 $6,784
 $30
 $632
 $11,023
Year ending December 31,                  
20174,419
 5,918
 40
 931
 11,308
20183,909
 5,073
 39
 837
 9,858
4,261
 6,294
 39
 789
 11,383
20193,426
 4,227
 38
 638
 8,329
3,741
 5,395
 38
 638
 9,812
20202,982
 3,382
 36
 455
 6,855
3,264
 4,496
 37
 476
 8,273
20212,463
 2,536
 35
 392
 5,426
2,716
 3,596
 35
 408
 6,755
20221,876
 2,697
 34
 323
 4,930
Thereafter5,244
 2,536
 132
 487
 8,399
4,322
 2,697
 98
 216
 7,333
Total$26,159
 $30,450
 $351
 $4,460
 $61,420
$23,757
 $31,959
 $311
 $3,482
 $59,509

Projections of amortization expense for mortgage servicing rights are based on existing asset balances and the existing interest rate environment as of March 31, 2016.2017. Heartland's actual experience may be significantly different depending upon changes in mortgage interest rates and market conditions. Mortgage loans serviced for others were $4.11$4.34 billion and $4.06$4.31 billion as of March 31, 2016,2017, and December 31, 2015,2016, respectively. Custodial escrow balances maintained in connection with the mortgage loan servicing portfolio were approximately $25.0$27.3 million and $19.2$21.4 million as of March 31, 20162017, and December 31, 2015,2016, respectively. The fair value of Heartland's mortgage servicing rights was estimated at $38.947.6 million at March 31, 2016,2017, and $40.9$45.2 million at December 31, 2015.2016.




Heartland's mortgage servicing rights portfolio is comprised of loans serviced for the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association. The servicing rights portfolio is separated into 15- and 30-year tranches.tranches, and the servicing rights portfolio is an asset of one of Heartland's subsidiaries.

The fair value of mortgage servicing rights is calculated based upon a discounted cash flow analysis. Cash flow assumptions, including prepayment speeds, servicing costs and escrow earnings are considered in the calculation. The average constant prepayment rate was 12.09%9.39% and 10.65%9.63% for the March 31, 2016,2017, and December 31, 2015,2016, valuations, respectively. The discount rate was 9.26%9.25% and 9.25%9.26% for the March 31, 2016,2017, and December 31, 2015,2016, valuations, respectively. The average capitalization rate for the firstthreemonths of 20162017 ranged from88 100 to 135150 basis points compared to the range of 6588 to 138135 basis points for 2015.2016. Fees collected for the servicing of mortgage loans for others were $2.9$3.2 million and $2.5$2.9 million for the three months ended March 31, 2016,2017, and March 31, 2015,2016, respectively.

The following table summarizes, in thousands, the changes in capitalized mortgage servicing rights for the three months ended March 31, 2016,2017, and March 31, 2015:2016:
2016 20152017 2016
Balance at January 1$30,314
 $24,984
Balance at January 1,$32,088
 $30,314
Originations2,395
 2,686
2,132
 2,395
Amortization(2,259) (2,175)(2,261) (2,259)
Balance at March 31$30,450
 $25,495
Balance at March 31,$31,959
 $30,450
Fair value of mortgage servicing rights$38,944
 $34,492
$47,564
 $45,210
Mortgage servicing rights, net to servicing portfolio0.74% 0.71%0.74% 0.74%

Heartland's commercial servicing rights portfolio was initially acquired with the Community Banc-Corp of Sheboygan, Inc. transaction that closed on January 16, 2015. Heartland also acquired commercial servicing rights portfolios with the Premier Valley Bank transaction that closed on November 30, 2015, and the CIC Bancshares, Inc. transaction that closed on February 5, 2016. The commercial servicing portfolio is comprised of loans serviced forguaranteed by the Small Business Administration and United States Department of Agriculture that have been sold with servicing retained by Heartland, which totaled $189.9 million.$160.7 million at March 31, 2017. The commercial servicing rights portfolio is separated into two tranches, loans with a term of less than 20 years and loans with a term of more than 20 years, at each subsidiary. Fees collected for the servicing of commercial loans for others were $415,000 and $80,000 for the periodthree months ended March 31, 2016.2017, and March 31, 2016, respectively.

The fair value of each commercial servicing rights portfolio is calculated based upon a discounted cash flow analysis. Cash flow assumptions, including prepayment speeds and servicing costs, are considered in the calculation. The range of average constant prepayment rates for the portfolio valuations for the first three monthswas 6.72% to 8.07% as of 2016 was 7.14% to 8.10%March 31, 2017, compared to 7.33%6.96% to 8.10%7.88% as of December 31, 2015.2016. The discount rate range was 11.74%12.07% to 13.49%13.69% for the March 31, 2016,2017, valuations compared to 12.35%12.44% to 13.49%



13.88% for the December 31, 2015,2016, valuations. The capitalization rate for 20162017 ranged from 3.10310 to 4.45445 basis points compared to 1.80310 to 4.45445 basis points for 2015.2016. The total fair value of Heartland's commercial servicing rights was estimated at $4.9$4.0 million as of March 31, 2016.2017.

The following table summarizes, in thousands, the changes in capitalized commercial servicing rights for the three months ended March 31, 2016,2017, and March 31, 2015:2016:
2016 20152017 2016
Balance at January 1$4,611
 $
Balance at January 1,$3,690
 $4,611
Purchased commercial servicing rights190
 4,255

 190
Originations195
 132
93
 195
Amortization(536) (215)(306) (536)
Balance at March 31$4,460
 $4,172
Valuation allowance on commercial servicing rights5
 
Balance at March 31,$3,482
 $4,460
Fair value of commercial servicing rights$4,899
 $4,429
$4,040
 $4,899
Commercial servicing rights, net to servicing portfolio2.35% 2.87%2.17% 2.35%

Mortgage and commercial servicing rights are initially recorded at fair value in net gains on sale of loans held for sale when they are acquired through loan sales. Fair value is based on market prices for comparable servicing contracts, when available, or based on a valuation model that calculates the present value of estimated future net servicing income.

Mortgage and commercial servicing rights are subsequently measured using the amortization method, which requires the asset to be amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the



underlying loans. Servicing rights are evaluated for impairment at each Heartland subsidiary based upon the fair value of the assets as compared to the carrying amount. Impairment is recognized through a valuation allowance for specific tranches to the extent that fair value is less than carrying amount.amount at each Heartland subsidiary. At March 31, 2016, and December 31, 2015,2017, no valuation allowance was required foron commercial servicing rights less than 20 years and a $28,000 valuation allowance was required on commercial servicing rights greater than 20 years. At December 31, 2016, no valuation allowance was required on commercial servicing rights less than 20 years and a $33,000 valuation allowance was required on commercial servicing rights greater than 20 years.

The following table summarizes, in thousands, the book value, the fair value of each tranche of the commercial servicing rights and any of Heartland's servicing rights.recorded valuation allowance at each respective subsidiary at March 31, 2017, and December 31, 2016:
March 31, 2017
Book Value-
Less than
20 Years
 
Fair Value-
Less than
20 Years
 
Impairment-
Less than
20 Years
 
Book Value-
More than
20 Years
 
Fair Value-
More than
20 Years
 
Impairment-
More than
20 Years
Centennial Bank and Trust$17
 $18
 $
 $103
 $114
 $
Premier Valley Bank131
 161
 
 345
 317
 28
Wisconsin Bank & Trust748
 929
 
 2,166
 2,501
 
Total$896
 $1,108
 $
 $2,614
 $2,932
 $28
December 31, 2016           
Centennial Bank and Trust$19
 $23
 $
 $107
 $114
 $
Premier Valley Bank156
 180
 
 359
 326
 33
Wisconsin Bank & Trust833
 997
 
 2,249
 2,487
 
Total$1,008
 $1,200
 $
 $2,715
 $2,927
 $33

NOTE 7: DERIVATIVE FINANCIAL INSTRUMENTS

Heartland uses derivative financial instruments as part of its interest rate risk management strategy. As part of the strategy, Heartland considers the use of interest rate swaps, caps, floors, collars, and certain interest rate lock commitments and forward sales of securities related to mortgage banking activities. Heartland's current strategy includes the use of interest rate swaps, interest rate lock commitments and forward sales of mortgage securities. In addition, Heartland is facilitating back-to-back loan swaps to assist customers in managing interest rate risk. Heartland's objectives are to add stability to its net interest margin and to manage its exposure to movements in interest rates. The contract or notional amount of a derivative is used to determine, along with the other terms of the derivative, the amounts to be exchanged between the counterparties. Heartland is exposed to credit risk in the event



of nonperformance by counterparties to financial instruments. Heartland minimizes this risk by entering into derivative contracts with counterparties that meet Heartland’s credit standards, and the contracts contain collateral provisions protecting the at-risk party. Heartland has not experienced any losses from nonperformance by these counterparties. Heartland monitors counterparty risk in accordance with the provisions of ASC 815.

In addition, interest rate-related derivative instruments generally contain language outlining collateral pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits which are determined by credit ratings of each counterparty. Heartland was required to pledge $7.7$1.8 million and $5.3$2.2 million of cash as collateral at March 31, 2016,2017, and December 31, 2015,2016, respectively. Heartland's counterparties were required to pledge $0 at both March 31, 2016,2017 and $79,000 at December 31, 2015, respectively.2016.

Heartland's derivative and hedging instruments are recorded at fair value on the consolidated balance sheets. See Note 8, “Fair Value,” for additional fair value information and disclosures.

Cash Flow Hedges
Heartland has variable rate funding which creates exposure to variability in interest payments due to changes in interest rates. To manage the interest rate risk related to the variability of interest payments, Heartland has entered into various interest rate swap agreements. Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are received or made on Heartland's variable-rate liabilities. For the three months ended March 31, 2016,2017, the change in net unrealized losses on cash flow hedges reflects changes in the fair value of the swaps and reclassification from accumulated other comprehensive income to interest expense totaling $506,000.$397,000. For the next twelve months, Heartland estimates that cash payments and reclassification from accumulated other comprehensive income to interest expense will total $2.0$1.6 million.

Heartland executed an interest rate swap transaction on April 5, 2011, with an effective date of April 20, 2011, and an expiration date of April 20, 2016, to effectively convert $15.0 million of its newly issued variable rate amortizing debt to fixed rate debt. For accounting purposes, this swap transaction iswas designated as a cash flow hedge of the changes in cash flows attributable to changes in one-month LIBOR, the benchmark interest rate being hedged, associated with thehedged. This interest payments maderate swap transaction expired on an amount of Heartland's debt principal equal to the then-outstanding swap notional amount. At inception, Heartland asserted that the underlying principal balance would remain outstanding throughout the hedge transaction, making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swap.April 20, 2016.

Heartland entered into five forward starting interest rate swap transactions to effectively convert Heartland Financial Statutory Trust IV, V, and VII, which total $65.0 million, as well as Morrill Statutory Trust I and II, which total $20.0 million, from variable rate subordinated debentures to fixed rate debt. For accounting purposes, these five swap transactions are designated as cash flow hedges of the changes in cash flows attributable to changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on $85.0 million of Heartland's subordinated debentures that reset quarterly on a specified reset date. At inception, Heartland asserted that the underlying principal balance would remain outstanding throughout the hedge transaction, making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swaps.

During the first quarter of 2015, Heartland entered into two additional forward starting interest rate swaps. The first forward starting interest rate swap transaction relates to Heartland's $20.0 million Statutory Trust VI, which will convert from a fixed interest rate subordinated debenture to a variable interest rate subordinated debenture. The effective date of the interest rate swap transaction is June 15, 2017, and Heartland Statutory Trust VI will effectively remain at a fixed interest rate. The forward-starting



swap transaction expires on June 15, 2024. The second forward starting interest rate swap iswas effective on March 1, 2017, and will replacereplaced the current interest rate swap related to Heartland Statutory Trust VII upon its expiration on March 1, 2017.

Heartland entered into an interest rate swap transaction on May 10, 2016, to effectively convert $40.0 million of amortizing term debt from variable rate debt to fixed rate debt. For accounting purposes, this swap is designated as a cash flow hedge of the changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments on the amortizing term debt that resets monthly on a specified reset date. The swap expires on May 10, 2021.




The table below identifies the balance sheet category and fair values of Heartland's derivative instruments designated as cash flow hedges at March 31, 2016,2017, and December 31, 2015,2016, in thousands:
Notional
Amount
 
Fair
Value
 
Balance
Sheet
Category
 
Receive
Rate
 
Weighted
Average
Pay Rate
 Maturity
Notional
Amount
 
Fair
Value
 
Balance
Sheet
Category
 
Receive
Rate
 
Weighted
Average
Pay Rate
 Maturity
March 31, 2016           
March 31, 2017           
Interest rate swap$8,580
 $(14) Other Liabilities 3.182% 5.140% 04/20/2016$25,000
 $(346) Other liabilities 1.148% 2.255% 03/17/2021
Interest rate swap25,000
 (1,374) Other Liabilities 0.642% 2.255% 03/17/2021
 
 Other liabilities % 3.220% 03/01/2017
Interest rate swap20,000
 (507) Other Liabilities 0.635% 3.220% 03/01/201720,000
 (996) Other liabilities 1.009% 3.355% 01/07/2020
Interest rate swap20,000
 (1,891) Other Liabilities 0.617% 3.355% 01/07/202010,000
 (17) Other liabilities 1.153% 1.674% 03/26/2019
Interest rate swap10,000
 (223) Other Liabilities 0.630% 1.674% 03/26/201910,000
 (16) Other liabilities 1.148% 1.658% 03/18/2019
Interest rate swap10,000
 (219) Other Liabilities 0.642% 1.658% 03/18/201936,667
 633
 Other assets 3.358% 3.674% 05/10/2021
Interest rate swap (1)
20,000
 (1,044) Other Liabilities % 2.390% 06/15/202420,000
 (207) Other liabilities % 2.390% 06/15/2024
Interest rate swap (2)
20,000
 (1,085) Other Liabilities % 2.352% 03/01/2024
        
December 31, 2015        
Interest rate swap20,000
 (253) Other liabilities 1.055% 2.352% 03/01/2024
December 31, 2016        
Interest rate swap$8,947
 $(57) Other Liabilities 3.152% 5.140% 04/20/2016$25,000
 $(447) Other liabilities 0.993% 2.255% 03/17/2021
Interest rate swap25,000
 (713) Other Liabilities 0.526% 2.255% 03/17/202120,000
 (114) Other liabilities 0.931% 3.220% 03/01/2017
Interest rate swap20,000
 (600) Other Liabilities 0.414% 3.220% 03/01/201720,000
 (1,145) Other liabilities 0.868% 3.355% 01/07/2020
Interest rate swap20,000
 (1,582) Other Liabilities 0.323% 3.355% 01/07/202010,000
 (42) Other liabilities 0.997% 1.674% 03/26/2019
Interest rate swap10,000
 (83) Other Liabilities 0.603% 1.674% 03/26/201910,000
 (41) Other liabilities 0.993% 1.658% 03/18/2019
Interest rate swap10,000
 (83) Other Liabilities 0.526% 1.658% 03/18/201937,667
 530
 Other assets 3.164% 3.674% 05/10/2021
Interest rate swap (1)
20,000
 (146) Other Liabilities % 2.390% 06/15/202420,000
 (214) Other liabilities % 2.390% 06/15/2024
Interest rate swap (2)
20,000
 (176) Other Liabilities % 2.352% 03/01/202420,000
 (262) Other Liabilities % 2.352% 03/01/2024
(1) This swap is a forward starting swap with a weighted average pay rate of 2.390% beginning on June 15, 2017. No interest payments are required related to this swap until September 15, 2017.(2) This swap is a forward starting swap with a weighted average pay rate of 2.352% beginning on March 1, 2017. No interest payments are required on this swap until June 1, 2017.




The table below identifies the gains and losses recognized on Heartland's derivative instruments designated as cash flow hedges for the three monthsthree-month periods ended March 31, 2016,2017, and March 31, 2015,2016, in thousands:
 Effective Portion Ineffective Portion
 Recognized in OCI Reclassified from AOCI into Income Recognized in Income on Derivatives
 
Amount of
Gain (Loss)
 Category 
Amount of
Gain (Loss)
 Category 
Amount of
Gain (Loss)
Three Months Ended March 31, 2016         
Interest rate swap$43
 Interest Expense $(44) Other Income $
Interest rate swap(661) Interest Expense (109) Other Income 
Interest rate swap93
 Interest Expense (142) Other Income 
Interest rate swap(309) Interest Expense (155) Other Income 
Interest rate swap(140) Interest Expense (27) Other Income 
Interest rate swap(136) Interest Expense (29) Other Income 
Interest rate swap(898) Interest Expense 
 Other Income 
Interest rate swap(909) Interest Expense 
 Other Income 
Three Months Ended March 31, 2015         
Interest rate swap$39
 Interest Expense $(57) Other Income $
Interest rate swap(376) Interest Expense (126) Other Income 
Interest rate swap45
 Interest Expense (151) Other Income 
Interest rate swap(184) Interest Expense (160) Other Income 
Interest rate swap(108) Interest Expense (35) Other Income 
Interest rate swap(106) Interest Expense (35) Other Income 
Interest rate swap(93) Interest Expense 
 Other Income 
Interest rate swap(107) Interest Expense 
 Other Income 



 Effective Portion Ineffective Portion
 Recognized in OCI Reclassified from AOCI into Income Recognized in Income on Derivatives
 
Amount of
Gain (Loss)
 Category 
Amount of
Gain (Loss)
 Category 
Amount of
Gain (Loss)
Three Months Ended March 31, 2017         
Interest rate swaps$533
 Interest expense $(397) Other income $
Three Months Ended March 31, 2016         
Interest rate swaps$(2,917) Interest expense $(506) Other income $

Fair Value Hedge
Heartland uses interest rate swaps to convert certain long term fixed rate loans to floating rates to hedge interest rate risk exposure. Heartland uses hedge accounting in accordance with ASC 815, with the unrealized gains and losses, representing the change in fair value of the derivative and the change in fair value of the risk being hedged on the related loan, being recorded in the consolidated statements of income. The ineffective portions of the unrealized gains or losses, if any, are recorded in interest income and interest expense in the consolidated statements of income. Heartland uses statistical regression to assess hedge effectiveness, both at the inception of the hedge as well as on a continual basis. The regression analysis involves regressing the periodic change in fair value of the hedging instrument against the periodic changes in the fair value of the asset being hedged due to changes in the hedge risk.

During the second quarter of 2015, Heartland entered into an interest rate swap, paying a fixed interest rate of 3.40% to the counterparty and receiving a variable interest rate from the same counterparty based on one month LIBOR plus .88% calculated on a notional amount of $13.8 million. In the fourth quarter of 2015, Heartland acquired undesignated interest rate swaps with the Premier Valley Bank transaction. These swaps were classified as undesignated interest rate swaps at December 31, 2015. During the first quarter of 2016, Heartland was able to designate some of these interest rate swaps with long term fixed rate loans and now classifies these interest rate swaps as fair value hedges and uses hedge accounting in accordance with ASC 815. Heartland was required to pledge $6.5$5.0 million of cash and securities as collateral as offor these fair value hedges at both March 31, 2017, and December 31, 2016.




The table below identifies the notional amount, fair value and balance sheet category of Heartland's fair value hedges at March 31, 20162017, and December 31, 2015,2016, in thousands:
Notional
Amount
 
Fair
Value
 
Balance Sheet
Category
Notional Amount Fair Value Balance Sheet Category
March 31, 2016    
March 31, 2017    
Fair value hedges$41,391
 $(4,053) Other Liabilities$36,144
 $(1,432) Other liabilities
December 31, 2015    
December 31, 2016    
Fair value hedges$13,805
 $(621) Other Liabilities$40,807
 $(1,626) Other liabilities

The table below identifies the gains and losses recognized on Heartland's fair value hedges for the three monththree-month periods ended March 31, 2016,2017, and March 31, 2015,2016, in thousands:
 Amount of Gain (Loss) Category Amount of Gain (Loss) Income Statement Category
Three Months Ended March 31, 2017   
Fair value hedges $194
 Interest income
Three Months Ended March 31, 2016      
Fair value hedges $(1,222) Interest Income $(1,222) Interest income
Three Months Ended March 31, 2015   
Fair value hedges $
 Interest Income

Embedded Derivatives
Heartland acquiredhas fixed rate loans with embedded derivatives in the Premier Valley Bank transaction during the fourth quarter of 2015.derivatives. The loans contain terms that affect the cash flows or value of the loan similar to a derivative instrument, and therefore are considered to contain an embedded derivative. The embedded derivatives are bifurcated from the loans because the terms of the derivative instrument are not clearly and closely related to the loans. The embedded derivatives are recorded at fair value on the consolidated balance sheets as a part of other assets, and changes in the fair value are a component of noninterest income. The table below identifies the notional amount, fair value and balance sheet category of Heartland's embedded derivatives at March 31, 20162017, and December 31, 2015,2016, in thousands:
Notional
Amount
 
Fair
Value
 
Balance
Sheet
Category
 
Income
Statement
Category
 Year-to-Date
Gain (Loss)
Recognized
Notional Amount Fair Value Balance Sheet Category
March 31, 2016     
March 31, 2017    
Embedded derivatives$14,903
 $1,846
 Other assets Other noninterest income $272
$14,418
 $987
 Other assets
December 31, 2015     
December 31, 2016    
Embedded derivatives$15,020
 $1,574
 Other assets Other noninterest income $
$14,549
 $1,104
 Other assets

The table below identifies the gains and losses recognized on Heartland's embedded derivatives for the three-month periods ended March 31, 2017, and March 31, 2016, in thousands:
  Amount of Gain (Loss) Income Statement Category
Three Months Ended March 31, 2017    
Embedded derivatives $117
 Other noninterest income
Three Months Ended March 31, 2016    
Embedded derivatives $272
 Other noninterest income

In conjunction with the CIC Bancshares, Inc., transaction on February 5, 2016, Heartland acquired convertible subordinated debt. The subordinated debt has a face value of $2.0 million, and the embedded conversion option allows the holder to convert the debt



to common equity in any increment.increment and at the discretion of the holder. The conversion option is bifurcated from the debt because the terms of the conversion option are not clearly and closely related to the terms of the debt. The total number of shares to be issued upon conversion is 73,394.




At March 31, 2017, and December 31, 2016, the remaining shares to be issued upon conversion totaled 14,353 and 20,481, respectively. The embedded conversion option is reported at fair value on the consolidated balance sheets using the Black-Scholes model. The following table identifies, in thousands, the notional amount, fair value, balance sheet category and income statement category for the change in fair value of the convertible debtembedded conversion option as of March 31, 2017, and December 31, 2016:
Notional
Amount
 
Fair
Value
 
Balance
Sheet
Category
 
Income
Statement
Category
 Year-to-Date
Gain (Loss)
Recognized
Notional Amount Fair Value Balance Sheet Category
March 31, 2016     
March 31, 2017    
Embedded conversion option$2,000
 $(422) Other Liabilities Other noninterest income $(100)$391
 $(325) Other liabilities
December 31, 2016    
Embedded conversion option$558
 $(422) Other liabilities

The table below identifies the gains and losses recognized on Heartland's embedded conversion options for the three-month periods ended March 31, 2017, and March 31, 2016, in thousands:
  Amount of Gain (Loss) Income Statement Category
Three Months Ended March 31, 2017    
Embedded conversion option $97
 Other noninterest income
Three Months Ended March 31, 2016    
Embedded conversion option $(100) Other noninterest income

Back-To-Back Loan Swaps
During 2015, Heartland began entering intohas interest rate swap loan relationships with customers to meet their financing needs. Upon entering into these loan swaps, Heartland enters into offsetting positions with counterparties in order to minimize interest rate risk. These back-to-back loan swaps qualify as free standing financial derivatives with the fair values reported in other assets and other liabilities on the consolidated balance sheets. Heartland was required to post $780,000$997,000 and $0$1.8 million as of March 31, 20162017, and December 31, 2015,2016, respectively, as collateral related to these back-to-back swaps. Heartland's counterparties were required to pledge $768,000 at both March 31, 2017, and December 31, 2016. Any gains and losses on these back-to-back swaps are recorded in noninterest income on the consolidated statementstatements of income, and for the three months ended March 31, 2017 and March 31, 2016, no gain or loss was recognized. The table below identifies the balance sheet category and fair values of Heartland's derivative instruments designated as loan swaps at March 31, 20162017, and December 31, 2015,2016, in thousands:
  
Notional
Amount
 
Fair
Value
 
Balance Sheet
Category
 
Weighted
Average
Receive
Rate
 
Weighted
Average
Pay
Rate
March 31, 2016          
Receive fixed-pay floating interest rate swap $33,028
 $2,356
 Other Assets 4.97% 3.16%
Pay fixed-receive floating interest rate swap 33,028
 (2,356) Other Liabilities 3.16% 4.97%
December 31, 2015          
Receive fixed-pay floating interest rate swap 15,782
 663
 Other Assets 5.08% 3.07%
Pay fixed-receive floating interest rate swap 15,782
 (663) Other Liabilities 3.07% 5.08%

  
Notional
Amount
 
Fair
Value
 
Balance Sheet
Category
 
Weighted
Average
Receive
Rate
 
Weighted
Average
Pay
Rate
March 31, 2017          
Customer interest rate swaps $73,780
 $1,658
 Other assets 4.75% 3.74%
Customer interest rate swaps 73,780
 (1,658) Other liabilities 3.74% 4.75%
December 31, 2016          
Customer interest rate swaps $69,594
 $1,588
 Other assets 4.66% 3.47%
Customer interest rate swaps 69,594
 (1,588) Other liabilities 3.47% 4.66%

Other Free Standing Derivatives
Heartland has entered into interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans and mortgage backed securities that are considered derivative instruments. Heartland enters into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on the commitments to fund the loans as well as on residential mortgage loans available for sale. The fair value of these commitments is recorded on the consolidated balance sheets, with the changes in fair value recorded in the consolidated statements of income as a component of gains on sale of loans held for sale. These derivative contracts are designated as free standing derivative contracts and are not designated against specific assets and liabilities on the consolidated balance sheets or forecasted transactions and therefore do not qualify for hedge accounting treatment. Heartland was required to pledge $30,000 at March 31, 2017, and $0 at December 31, 2016. Heartland's counterparties were required to pledge $8,000 and $2.9 million at March 31, 2017, and December 31, 2016, respectively, as collateral for these forward commitments.




Heartland acquired undesignated interest rate swaps with the Premier Valley Bank transaction in the fourth quarter of 2015. These swaps were entered into primarily for the benefit of customers seeking to manage their interest rate risk and are not designated against specific assets or liabilities on the consolidated balance sheet or forecasted transactions and therefore do not qualify for hedge accounting in accordance with ASC 815. These swaps are carried at fair value on the consolidated balance sheets as a component of other liabilities, with changes in the fair value recorded as a component of other noninterest income.




The table below identifies the balance sheet category and fair values of Heartland's other free standing derivative instruments not designated as hedging instruments at March 31, 2016,2017, and December 31, 2015,2016, in thousands:
Balance Sheet
Category
 
Notional
Amount
 
Fair
Value
Balance Sheet
Category
 
Notional
Amount
 
Fair
Value
March 31, 2016     
March 31, 2017     
Interest rate lock commitments (mortgage)Other Assets $153,073
 $6,956
Other assets $92,528
 $3,745
Forward commitmentsOther Assets 61,000
 343
Other assets 48,392
 176
Forward commitmentsOther Liabilities 258,183
 (1,623)Other liabilities 123,944
 (634)
Undesignated interest rate swapsOther Liabilities 23,005
 (2,159)Other liabilities 14,418
 (987)
December 31, 2015 

 

December 31, 2016 

 

Interest rate lock commitments (mortgage)Other Assets $99,665
 $3,168
Other assets $80,465
 $2,790
Forward commitmentsOther Assets 118,378
 523
Other assets 142,750
 2,546
Forward commitmentsOther Liabilities 136,709
 (315)Other liabilities 59,276
 (266)
Undesignated interest rate swapsOther Liabilities 50,975
 (3,677)Other liabilities 15,564
 (1,126)

The table below identifies the income statement category of the gains and losses recognized in income on Heartland's other free standing derivative instruments not designated as hedging instruments for the three monthsthree-month periods ended March 31, 2016,2017, and March 31, 2015,2016, in thousands:
Income Statement Category Gain (Loss) RecognizedIncome Statement Category Gain (Loss) Recognized
Three Months Ended March 31, 2017  
Interest rate lock commitments (mortgage)Net gains on sale of loans held for sale $1,062
Forward commitmentsNet gains on sale of loans held for sale (2,739)
Undesignated interest rate swapsOther noninterest income 117
Three Months Ended March 31, 2016    
Interest rate lock commitments (mortgage)Gains on sale of loans held for sale $4,727
Net gains on sale of loans held for sale $4,727
Forward commitmentsGains on sale of loans held for sale (1,489)Net gains on sale of loans held for sale (1,489)
Undesignated interest rate swapsOther noninterest income (316)Other noninterest income (316)
Three Months Ended March 31, 2015  
Interest rate lock commitments (mortgage)Gains on sale of loans held for sale $5,544
Forward commitmentsGains on sale of loans held for sale (125)
Undesignated interest rate swapsOther noninterest income 

NOTE 8: FAIR VALUE

Heartland utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale, trading securities and derivatives are recorded in the consolidated balance sheets at fair value on a recurring basis. Additionally, from time to time, Heartland may be required to record at fair value other assets on a nonrecurring basis such as loans held for sale, loans held to maturity and certain other assets including, but not limited to, mortgage servicing rights, commercial servicing rights and other real estate owned. These nonrecurring fair value adjustments typically involve application of the lower of cost or fair value accounting or write-downs of individual assets.

Fair Value Hierarchy

Under ASC 820, assets and liabilities are grouped at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 — Valuation is based upon quoted prices for identical instruments in active markets.

Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, or similar instruments in markets that are not active, and model-based valuation techniques for all significant assumptions are observable in the market.




Level 3 — Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.




The following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a recurring or non-recurring basis.

Assets

Securities Available for Sale and Held to Maturity
Securities available for sale are recorded at fair value on a recurring basis. Securities held to maturity are generally recorded at cost and are recorded at fair value only to the extent a decline in fair value is determined to be other-than-temporary. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security's credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, as well as U.S. Treasury securities. Level 2 securities include U.S. government and agency securities, mortgage-backed securities and private collateralized mortgage obligations, municipal bonds and corporate debt securities. Level 3 securities consist primarily of Z-TRANCHE mortgage-backed securities and corporate debt securities. On a quarterly basis, a secondary independent pricing service is used for a sample of securities to validate the pricing from Heartland's primary pricing service.

Loans Held for Sale
Loans held for sale are carried at the lower of cost or fair value on an aggregate basis. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, Heartland classifies loans held for sale subjected to nonrecurring fair value adjustments as Level 2.

Loans Held to Maturity
Heartland does not record loans held to maturity at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC 310. The fair value of impaired loans is measured using one of the following impairment methods: 1) the present value of expected future cash flows discounted at the loan's effective interest rate or 2) the observable market price of the loan or 3) the fair value of the collateral if the loan is collateral dependent. In accordance with ASC 820, impaired loans measured at fair value are classified as nonrecurring Level 3 in the fair value hierarchy.

Premises, furnitureFurniture and equipment heldEquipment Held for saleSale
Heartland values premises, furniture and equipment held for sale based on third-party appraisals less estimated disposal costs. Heartland considers third party appraisals, as well as independent fair value assessments from realtorsRealtors or persons involved in selling bank premises, furniture and equipment, in determining the fair value of particular properties. Accordingly, the valuation of premises, furniture and equipment held for sale is subject to significant external and internal judgment. Heartland periodically reviews premises, furniture and equipment held for sale to determine if the fair value of the property, less disposal costs, has declined below its recorded book value and records any adjustments accordingly. Premises, furniture and equipment held for sale are classified as nonrecurring Level 3 in the fair value hierarchy.

Mortgage Servicing Rights
Mortgage servicing rights assets represent the value associated with servicing residential real estate loans that have been sold to outside investors with servicing retained. Heartland uses the amortization method (i.e., the lower of amortized cost or estimated fair value measured on a nonrecurring basis), not fair value measurement accounting, to determine the carrying value of its mortgage servicing rights. The fair value for servicing assets is determined through discounted cash flow analysis and utilizes discount rates, prepayment speeds and delinquency rate assumptions as inputs. All of these assumptions require a significant degree of management estimation and judgment. Mortgage servicing rights are subject to impairment testing. The carrying values of these rights are reviewed quarterly for impairment based upon the calculation of fair value as performed by an outside third party. For purposes of measuring impairment, the rights are stratified into certain risk characteristics including note type and note term. If the valuation model reflects a fair value less than the carrying value, mortgage servicing rights are adjusted to fair value through a valuation allowance. Heartland classifies mortgage servicing rights as nonrecurring with Level 3 measurement inputs.




Commercial Servicing Rights
Commercial servicing rights assets represent the value associated with servicing commercial loans that have been sold toguaranteed by the Small Business Administration and the United States Department of Agriculture that have been sold with servicing retained by Heartland. Heartland uses the amortization method (i.e., the lower of amortized cost or estimated fair value measured on a nonrecurring basis), not fair value measurement accounting, to determine the carrying value of its commercial servicing rights. The fair value for servicing assets is determined through market prices for comparable servicing contracts, when available, or through a valuation model that calculates the present value of estimated future net servicing income. Inputs utilized include discount rates, prepayment speeds and



delinquency rate assumptions as inputs. All of these assumptions require a significant degree of management estimation and judgment. Commercial servicing rights are subject to impairment testing, and the carrying values of these rights are reviewed quarterly for impairment based upon the calculation of fair value as performed by an outside third party. If the valuation model reflects a fair value less than the carrying value, commercial servicing rights are adjusted to fair value through a valuation allowance. Heartland classifies commercial servicing rights as nonrecurring with Level 3 measurement inputs.

Derivative Financial Instruments
Heartland's current interest rate risk strategy includes interest rate swaps. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. To comply with the provisions of ASC 820, Heartland incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty's nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, Heartland has considered the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

Although Heartland has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2016,2017, and December 31, 2015,2016, Heartland has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, Heartland has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

Interest rate lock commitments
Heartland uses an internal valuation model that relies on internally developed inputs to estimate the fair value of its interest rate lock commitments which is based on unobservable inputs that reflect management's assumptions and specific information about each borrower. Interest rate lock commitments are classified in Level 3 of the fair value hierarchy.

Forward commitments
The fair value of forward commitments are estimated using an internal valuation model, which includes current trade pricing for similar financial instruments in active markets that Heartland has the ability to access and are classified in Level 2 of the fair value hierarchy.

Other Real Estate Owned
Other real estate owned ("OREO") represents property acquired through foreclosures and settlements of loans. Property acquired is carried at the fair value of the property at the time of acquisition (representing the property's cost basis), plus any acquisition costs, or the estimated fair value of the property, less disposal costs. Heartland considers third party appraisals, as well as independent fair value assessments from realtors or persons involved in selling OREO, in determining the fair value of particular properties. Accordingly, the valuation of OREO is subject to significant external and internal judgment. Heartland periodically reviews OREO to determine if the fair value of the property, less disposal costs, has declined below its recorded book value and records any adjustments accordingly. OREO is classified as nonrecurring Level 3 of the fair value hierarchy.




The table below presents Heartland's assets and liabilities that are measured at fair value on a recurring basis as of March 31, 2016,2017, and December 31, 2015,2016, in thousands, aggregated by the level in the fair value hierarchy within which those measurements fall:
Total Fair Value Level 1 Level 2 Level 3Total Fair Value Level 1 Level 2 Level 3
March 31, 2016       
March 31, 2017       
Assets              
Securities available for sale              
U.S. government corporations and agencies$6,619
 $531
 $6,088
 $
$15,067
 $10,496
 $4,571
 $
Mortgage-backed securities1,388,687
 
 1,386,913
 1,774
1,288,527
 
 1,288,527
 
Obligations of states and political subdivisions281,003
 
 281,003
 
574,593
 
 574,593
 
Corporate debt securities830
 
 500
 330
Equity securities13,377
 
 13,377
 
15,341
 
 15,341
 
Derivative financial instruments(1)
4,202
 
 4,202
 
3,278
 
 3,278
 
Interest rate lock commitments6,956
 
 
 6,956
3,745
 
 
 3,745
Forward commitments343
 
 343
 
176
 
 176
 
Total assets at fair value$1,702,017
 $531
 $1,692,426
 $9,060
$1,900,727
 $10,496
 $1,886,486
 $3,745
Liabilities              
Derivative financial instruments(2)
$15,347
 $
 $15,347
 $
$6,237
 $
 $6,237
 $
Forward commitments1,623
 
 1,623
 
634
 
 634
 
Total liabilities at fair value$16,970
 $
 $16,970
 $
$6,871
 $
 $6,871
 $
December 31, 2015       
December 31, 2016       
Assets              
Securities available for sale              
U.S. government corporations and agencies$25,766
 $519
 $25,247
 $
$4,700
 $517
 $4,183
 $
Mortgage-backed securities1,242,702
 
 1,240,663
 2,039
1,290,500
 
 1,288,276
 2,224
Obligations of states and political subdivisions295,982
 
 295,982
 
536,144
 
 536,144
 
Corporate debt securities846
 
 
 846
Equity securities13,138
 
 13,138
 
14,520
 
 14,520
 
Derivative financial instruments(1)
2,237
 
 2,237
 
3,222
 
 3,222
 
Interest rate lock commitments3,168
 
 
 3,168
2,790
 
 
 2,790
Forward commitments523
 
 523
 
2,546
 
 2,546
 
Total assets at fair value$1,584,362
 $519
 $1,577,790
 $6,053
$1,854,422
 $517
 $1,848,891
 $5,014
Liabilities              
Derivative financial instruments(2)
$8,401
 $
 $8,401
 $
$7,027
 $
 $7,027
 $
Forward commitments315
 
 315
 
266
 
 266
 
Total liabilities at fair value$8,716
 $
 $8,716
 $
$7,293
 $
 $7,293
 $
              
(1) Includes embedded derivatives and loans swaps
(1) Includes cash flow hedges, embedded derivatives and loan swaps(1) Includes cash flow hedges, embedded derivatives and loan swaps
(2) Includes cash flow hedges, fair value hedges, loan swaps, embedded conversion options and free standing derivative instruments




The tables below present Heartland's assets that are measured at fair value on a nonrecurring basis, in thousands:
Fair Value Measurements at March 31, 2016Fair Value Measurements at March 31, 2017
Total 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
 
Year-to-
Date
Losses
Total 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
 
Year-to-
Date
Losses
Collateral dependent impaired loans:                  
Commercial$1,344
 $
 $
 $1,344
 $
$1,216
 $
 $
 $1,216
 $
Commercial real estate2,609
 
 
 2,609
 
1,490
 
 
 1,490
 375
Agricultural and agricultural real estate
 
 
 
 
534
 
 
 534
 
Residential real estate3,168
 
 
 3,168
 
2,097
 
 
 2,097
 
Consumer2,010
 
 
 2,010
 
1,076
 
 
 1,076
 
Total collateral dependent impaired loans$9,131
 $
 $
 $9,131
 $
$6,413
 $
 $
 $6,413
 $375
Other real estate owned$11,338
 $
 $
 $11,338
 $237
$11,188
 $
 $
 $11,188
 $274
Premises, furniture and equipment held for sale$3,889
 $
 $
 $3,889
 $
$1,242
 
 $
 $1,242
 $
Commercial servicing rights$317
 $
 $
 $317
 $

Fair Value Measurements at December 31, 2015Fair Value Measurements at December 31, 2016
Total 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
 
Year-to-
Date
Losses
Total 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
 
Year-to-
Date
Losses
Collateral dependent impaired loans:                  
Commercial$597
 $
 $
 $597
 $82
$1,683
 $
 $
 $1,683
 $41
Commercial real estate1,522
 
 
 1,522
 86
3,026
 
 
 3,026
 527
Agricultural and agricultural real estate
 
 
 
 
1,955
 
 
 1,955
 
Residential real estate2,330
 
 
 2,330
 104
3,565
 
 
 3,565
 85
Consumer1,905
 
 
 1,905
 
1,193
 
 
 1,193
 
Total collateral dependent impaired loans$6,354
 $
 $
 $6,354
 $272
$11,422
 $
 $

$11,422
 $653
Other real estate owned$11,524
 $
 $
 $11,524
 $5,520
$9,744
 $
 $
 $9,744
 $1,341
Premises, furniture and equipment held for sale$3,889
 $
 $
 $3,889
 $
$414
 $
 $
 $414
 $35
Commercial servicing rights$326
 $
 $
 $326
 $33



The following tables present additional quantitative information about assets measured at fair value and for which Heartland has utilized Level 3 inputs to determine fair value, in thousands:
Fair Value
at 3/31/16
 Valuation
Technique
 Unobservable
Input
 Range
(Weighted Average)
Fair Value at 3/31/17 Valuation Technique Unobservable Input Range (Weighted Average)
Z-TRANCHE Securities$1,774
 Discounted cash flows Pretax discount rate 7.50 - 9.50%$
 Discounted cash flows Pretax discount rate 
  Actual defaults 22.07 - 34.19% (31.03%)  Actual defaults 
  Actual deferrals 10.67 - 20.53% (13.21%)  Actual deferrals 
Corporate debt securities330
 Discounted cash flows Bank analysis 
(1) 
Interest rate lock commitments6,956
 Discounted cash flows Closing ratio 
(2) 
3,745
 Discounted cash flows Closing ratio 
0-99% (87%)(1)
Premises, furniture and equipment held for sale3,889
 Modified appraised value Third party appraisal 
(3) 
1,242
 Modified appraised value Third party appraisal (2)
  Appraisal discount 
(3) 
  Appraisal discount 
0-10%(4)
Commercial servicing rights317
 Discounted cash flows Third party valuation (3)
Other real estate owned11,338
 Modified appraised value Third party appraisal 
(3) 
11,188
 Modified appraised value Third party appraisal (2)
  Appraisal discount 
(3) 
  Appraisal discount 0-10%
Collateral dependent impaired loans:    
Commercial1,344
 Modified appraised value Third party appraisal 
(3) 
1,216
 Modified appraised value Third party appraisal (2)
  Appraisal discount 
(3) 
  Appraisal discount 
0-8%(4)
Commercial real estate2,609
 Modified appraised value Third party appraisal 
(3) 
1,490
 Modified appraised value Third party appraisal (2)
  Appraisal discount 
(3) 
  Appraisal discount 
0-11%(4)
Agricultural and agricultural real estate
 Modified appraised value Third party appraisal 
(3) 
534
 Modified appraised value Third party appraisal (2)
  Appraisal discount 
(3) 
  Appraisal discount 
0-10%(4)
Residential real estate3,168
 Modified appraised value Third party appraisal 
(3) 
2,097
 Modified appraised value Third party appraisal (2)
  Appraisal discount 
(3) 
  Appraisal discount 
0-10%(4)
Consumer2,010
 Modified appraised value Third party valuation 
(3) 
1,076
 Modified appraised value Third party valuation (2)
  Valuation discount 
(3) 
  Valuation discount 
0-12%(4)
    
(1) The unobservable input is the bank analysis market using Moody's Global Bank Rating Methodology. The analysis takes into consideration various performance metrics as well as yield on the debt securities and credit risk analysis.
(2) The significant unobservable input used in the fair value measurement is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. The closing ratio calculation takes into consideration historical data and loan-level data; therefore providing a range would not be meaningful. The weighted average closing ratio at March 31, 2016, was 88%.
(3) Third party appraisals are obtained as to the value of the underlying asset, but disclosure of this information would not provide meaningful information, as the range will vary widely from loan to loan. Types of discounts considered included age of the appraisal, local market conditions, current condition of the property, and estimated sales costs. These discounts will also vary from loan to loan, thus providing range would not be meaningful.
(1) The significant unobservable input used in the fair value measurement is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. The closing ratio calculation takes into consideration historical data and loan-level data.(1) The significant unobservable input used in the fair value measurement is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. The closing ratio calculation takes into consideration historical data and loan-level data.
(2) Third party appraisals are obtained and updated at least annually to establish the value of the underlying asset, but the disclosure of the unobservable inputs used by the appraisers would not be meaningful because the range will vary widely from appraisal to appraisal.(2) Third party appraisals are obtained and updated at least annually to establish the value of the underlying asset, but the disclosure of the unobservable inputs used by the appraisers would not be meaningful because the range will vary widely from appraisal to appraisal.
(3) The significant unobservable input used in the fair value measurement are the value indices, which are weighted-average spreads to LIBOR based on maturity groups.(3) The significant unobservable input used in the fair value measurement are the value indices, which are weighted-average spreads to LIBOR based on maturity groups.
(4) Discounts applied to the appraised values primarily include estimated sales costs, but also consider the age of the appraisal, changes in local market conditions and changes in the current condition of the collateral.(4) Discounts applied to the appraised values primarily include estimated sales costs, but also consider the age of the appraisal, changes in local market conditions and changes in the current condition of the collateral.




 
Fair Value
at 12/31/15
 
Valuation
Technique
 
Unobservable
Input
 
Range
(Weighted Average)
Z-TRANCHE Securities$2,039
 Discounted cash flows Pretax discount rate 7.50 - 9.50%
     Actual defaults 22.20 - 33.55% (30.60%)
     Actual deferrals   10.75 - 21.82% (13.36%)
Corporate debt securities846
 Discounted cash flows Bank analysis 
(1) 
Interest rate lock commitments3,168
 Discounted cash flows Closing ratio 
(2) 
Premises, furniture and equipment held for sale3,889
 Modified appraised value Third party appraisal 
(3) 
Other real estate owned11,524
 Modified appraised value Disposal costs 
(3) 
     Third party appraisal 
(3) 
     Appraisal discount 
(3) 
Collateral dependent impaired loans:       
Commercial597
 Modified appraised value Third party appraisal 
(3) 
     Appraisal discount 
(3) 
Commercial real estate1,522
 Modified appraised value Third party appraisal 
(3) 
     Appraisal discount 
(3) 
Agricultural and agricultural real estate
 Modified appraised value Third party appraisal 
(3) 
     Appraisal discount 
(3) 
Residential real estate2,330
 Modified appraised value Third party appraisal 
(3) 
     Appraisal discount 
(3) 
Consumer1,905
 Modified appraised value Third party valuation 
(3) 
     Valuation discount 
(3) 
        
(1) The unobservable input is the bank analysis market using Moody's Global Bank Rating Methodology. The analysis takes into consideration various performance metrics as well as yield on the debt securities and credit risk analysis.
(2) The significant unobservable input used in the fair value measurement is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. The closing ratio calculation takes into consideration historical data and loan-level data; therefore providing a range would not be meaningful. The weighted average closing ratio at December 31, 2015, was 86%.
(3) Third party appraisals are obtained as to the value of the underlying asset, but disclosure of this information would not provide meaningful information, as the range will vary widely from loan to loan. Types of discounts considered included age of the appraisal, local market conditions, current condition of the property, and estimated sales costs. These discounts will also vary from loan to loan, thus providing range would not be meaningful.



 Fair Value at 12/31/16 Valuation Technique Unobservable Input Range (Weighted Average)
Z-TRANCHE Securities$2,224
 Discounted cash flows Pretax discount rate 7.50 - 9.50%
     Actual defaults 21.77 - 37.62% (33.11%)
     Actual deferrals  10.44 - 26.29% (14.81%)
Interest rate lock commitments2,790
 Discounted cash flows Closing ratio 
0-99% (89%)(1)
Premises, furniture and equipment held for sale414
 Modified appraised value Third party appraisal 
(2)
0-8%(4)
Commercial servicing rights326
 Discounted cash flows Third party valuation (3)
Other real estate owned9,744
 Modified appraised value Third party appraisal (2)
     Appraisal discount 0-10%
Collateral dependent impaired loans:       
Commercial1,683
 Modified appraised value Third party appraisal (2)
     Appraisal discount 
0-8%(4)
Commercial real estate3,026
 Modified appraised value Third party appraisal (2)
     Appraisal discount 
0-7%(4)
Agricultural and agricultural real estate1,955
 Modified appraised value Third party appraisal (2)
     Appraisal discount 
0-10%(4)
Residential real estate3,565
 Modified appraised value Third party appraisal (2)
     Appraisal discount 
0-8%(4)
Consumer1,193
 Modified appraised value Third party valuation (2)
     Valuation discount 
0-11%(4)
        
(1) The significant unobservable input used in the fair value measurement is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. The closing ratio calculation takes into consideration historical data and loan-level data.
(2) Third party appraisals are obtained and updated at least annually to establish the value of the underlying asset, but the disclosure of the unobservable inputs used by the appraisers would not be meaningful because the range will vary widely from appraisal to appraisal.
(3) The significant unobservable input used in the fair value measurement are the value indices, which are weighted-average spreads to LIBOR based on maturity groups.
(4) Discounts applied to the appraised values primarily include estimated sales costs, but also consider the age of the appraisal, changes in local market conditions and changes in the current condition of the collateral.

The changes in fair value of the Z-TRANCHE asecurities, Level 3 asset,assets that isare measured on a recurring basis, are summarized in the following table, in thousands:
For the Three Months Ended
March 31, 2016
 For the Year Ended
December 31, 2015
For the Three Months Ended March 31, 2017 For the Year Ended December 31, 2016
Balance at January 1,$2,039
 $4,947
$2,224
 $2,039
Total gains (losses):  

  

Included in earnings
 (3,038)2,810
 
Included in other comprehensive income(265) 982
(2,166) 185
Purchases, sales and settlements:  
  
Purchases
 6

 
Sales
 (736)(2,868) 
Settlements
 (122)
 
Balance at period end$1,774
 $2,039
$
 $2,224

The changes in fair value of the corporate debt securities, Level 3 assets, that are measured on a recurring basis is summarized in the following table, in thousands:
 For the Three Months Ended
March 31, 2016
 For the Year Ended
December 31, 2015
Balance at January 1,$846
 $
Total gains (losses):

 

  Included in earnings121
 
  Included in other comprehensive income(91) 106
Purchases, acquired, sales and settlements:  
  Purchases
 
  Acquired
 740
  Sales(546) 
  Settlements
 
Balance at period end$330
 $846


The changes in fair value of the interest rate lock commitments, which are Level 3 financial instruments and are measured on a recurring basis, are summarized in the following table, in thousands:
For the Three Months Ended
March 31, 2016
 For the Year Ended
December 31, 2015
For the Three Months Ended March 31, 2017 For the Year Ended December 31, 2016
Balance at January 1,$3,168
 $2,496
$2,790
 $3,168
Total gains (losses) included in earnings4,727
 288
1,062
 (1,564)
Issuances138
 5,428
382
 5,373
Settlements(1,077) (5,044)(489) (4,187)
Balance at period end$6,956
 $3,168
$3,745
 $2,790

Gains included in gains (losses) on sale of loans held for sale attributable to interest rate lock commitments held at March 31, 2016,2017, and December 31, 2015,2016, were $7.0$3.7 million and $3.2$2.8 million, respectively.

The tables below summarize the estimated fair value of Heartland's financial instruments as defined by ASC 825 as of March 31, 2016,2017, and December 31, 2015,2016, in thousands. The carrying amounts in the following tables are recorded in the consolidated balance sheets under the indicated captions. In accordance with ASC 825, the assets and liabilities that are not financial instruments are not included in the disclosure, such as the value of the mortgage servicing rights, premises, furniture and equipment, premises, furniture and equipment held for sale, goodwill and other intangibles and other liabilities.

Heartland does not believe that the estimated information presented herein is representative of the earnings power or value of Heartland. The following analysis, which is inherently limited in depicting fair value, also does not consider any value associated with either existing customer relationships or the ability of Heartland to create value through loan origination, deposit gathering or fee generating activities. Many of the estimates presented herein are based upon the use of highly subjective information and



assumptions and, accordingly, the results may not be precise. Management believes that fair value estimates may not be comparable between financial institutions due to the wide range of permitted valuation techniques and numerous estimates which must be made. Furthermore, because the disclosed fair value amounts were estimated as of the balance sheet date, the amounts actually realized or paid upon maturity or settlement of the various financial instruments could be significantly different.



    
Fair Value Measurements at
March 31, 2016
    Fair Value Measurements at
March 31, 2017
Carrying
Amount
 
Estimated
Fair
Value
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
Carrying
Amount
 
Estimated
Fair
Value
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
Financial assets:                  
Cash and cash equivalents$133,228
 $133,228
 $133,228
 $
 $
$173,151
 $173,151
 $173,151
 $
 $
Time deposits in other financial institutions2,355
 2,355
 2,355
 
 
41,539
 41,539
 41,539
 
 
Securities:                  
Available for sale1,690,516
 1,690,516
 531
 1,687,881
 2,104
1,893,528
 1,893,528
 10,496
 1,883,032
 
Held to maturity271,300
 289,446
 
 289,446
 
260,616
 272,797
 
 272,797
 
Other investments22,325
 22,325
 
 22,090
 235
21,557
 21,557
 
 21,362
 195
Loans held for sale76,565
 76,565
 
 76,565
 
49,009
 49,009
 
 49,009
 
Loans, net:                  
Commercial1,278,343
 1,271,778
 
 1,270,434
 1,344
1,297,723
 1,271,354
 
 1,270,138
 1,216
Commercial real estate2,533,220
 2,533,017
 
 2,530,408
 2,609
2,510,614
 2,514,151
 
 2,512,661
 1,490
Agricultural and agricultural real estate467,844
 473,559
 
 473,559
 
477,867
 479,134
 
 478,600
 534
Residential real estate750,219
 749,749
 
 746,581
 3,168
601,314
 591,256
 
 589,159
 2,097
Consumer423,641
 428,805
 
 426,795
 2,010
419,087
 421,627
 
 420,551
 1,076
Total Loans, net5,453,267
 5,456,908
 
 5,447,777
 9,131
5,306,605
 5,277,522
 
 5,271,109
 6,413
Derivative financial instruments (1)
4,202
 4,202
 
 4,202
 
3,278
 3,278
 
 3,278
 
Interest rate lock commitments6,956
 6,956
 
 
 6,956
3,745
 3,745
 
 
 3,745
Forward commitments343
 343
 
 343
 
176
 176
 
 176
 
Financial liabilities:                  
Deposits                  
Demand deposits2,079,521
 2,079,521
 
 2,079,521
 
2,319,256
 2,319,256
 
 2,319,256
 
Savings deposits3,702,431
 3,702,431
 
 3,702,431
 
3,940,146
 3,940,146
 
 3,940,146
 
Time deposits1,142,368
 1,142,368
 
 1,142,368
 
830,459
 830,459
 
 830,459
 
Short term borrowings325,741
 325,741
 
 325,741
 
155,025
 155,025
 
 155,025
 
Other borrowings265,760
 267,812
 
 267,812
 
282,051
 282,346
 
 282,346
 
Derivative financial instruments (2)
15,347
 15,347
 
 15,347
 
6,237
 6,237
 
 6,237
 
Forward commitments1,623
 1,623
 
 1,623
 
634
 634
 
 634
 
(1) Includes embedded derivatives and loan swaps
(1) Includes cash flow hedges, embedded derivatives and loan swaps(1) Includes cash flow hedges, embedded derivatives and loan swaps
(2) Includes cash flow hedges, fair value hedges, loan swaps, embedded conversion options and free standing derivative instruments




    
Fair Value Measurements at
December 31, 2015
    Fair Value Measurements at
December 31, 2016
Carrying
Amount
 
Estimated
Fair
Value
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
Carrying
Amount
 
Estimated
Fair
Value
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
 Inputs
(Level 3)
Financial assets:                  
Cash and cash equivalents$258,799
 $258,799
 $258,799
 $
 $
$158,724
 $158,724
 $158,724
 $
 $
Time deposits in other financial institutions2,355
 2,355
 2,355
 
 
2,105
 2,105
 2,105
 
 
Securities:                  
Available for sale1,578,434
 1,578,434
 519
 1,575,030
 2,885
1,845,864
 1,845,864
 517
 1,843,123
 2,224
Held to maturity279,117
 294,513
 
 294,513
 
263,662
 274,799
 
 274,799
 
Other investments21,443
 21,443
 
 21,208
 235
21,560
 21,560
 
 21,365
 195
Loans held for sale74,783
 74,783
 
 74,783
 
61,261
 61,261
 
 61,261
 
Loans, net:                  
Commercial1,262,612
 1,257,355
 
 1,256,758
 597
1,272,089
 1,258,754
 
 1,257,071
 1,683
Commercial real estate2,305,908
 2,304,716
 
 2,303,194
 1,522
2,513,446
 2,506,858
 
 2,503,832
 3,026
Agricultural and agricultural real estate468,533
 469,485
 
 469,485
 
485,820
 487,001
 
 485,046
 1,955
Residential real estate536,190
 531,931
 
 529,601
 2,330
614,207
 604,233
 
 600,668
 3,565
Consumer379,558
 382,579
 
 380,674
 1,905
411,833
 414,266
 
 413,073
 1,193
Total Loans, net4,952,801
 4,946,066
 
 4,939,712
 6,354
5,297,395
 5,271,112
 
 5,259,690
 11,422
Derivative financial instruments (1)
2,237
 2,237
 
 2,237
 
3,222
 3,222
 
 3,222
 
Interest rate lock commitments3,168
 3,168
 
 
 3,168
2,790
 2,790
 
 
 2,790
Forward commitments523
 523
 
 523
 
2,546
 2,546
 
 2,546
 
Financial liabilities:                  
Deposits                  
Demand deposits1,914,141
 1,914,141
 
 1,914,141
 
2,202,036
 2,202,036
 
 2,202,036
 
Savings deposits3,367,479
 3,367,479
 
 3,367,479
 
3,788,089
 3,788,089
 
 3,788,089
 
Time deposits1,124,203
 1,124,203
 
 1,124,203
 
857,286
 857,286
 
 857,286
 
Short term borrowings293,898
 293,898
 
 293,898
 
306,459
 306,459
 
 306,459
 
Other borrowings263,214
 281,271
 
 281,271
 
288,534
 288,534
 
 288,534
 
Derivative financial instruments (2)
8,401
 8,401
 
 8,401
 
7,027
 7,027
 
 7,027
 
Forward commitments315
 315
 
 315
 
266
 266
 
 266
 
(1) Includes embedded derivatives and loan swaps
(2) Includes cash flow hedges, fair value hedges, loan swaps and free standing derivative instruments
(1) Includes cash flow hedges, embedded derivatives and loan swaps(1) Includes cash flow hedges, embedded derivatives and loan swaps
(2) Includes cash flow hedges, fair value hedges, loan swaps, embedded conversion options and free standing derivative instruments(2) Includes cash flow hedges, fair value hedges, loan swaps, embedded conversion options and free standing derivative instruments

Cash and Cash Equivalents — The carrying amount is a reasonable estimate of fair value due to the short-term nature of these instruments.

Time Deposits in Other Financial Institutions — The carrying amount is a reasonable estimate of fair value due to the short-term nature of these instruments.

Securities — For securities either held to maturity, available for sale or trading, fair value equals quoted market price if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. For Level 3 securities, Heartland utilizes independent pricing provided by third party vendors or brokers.




Other Investments — Fair value measurement of other investments, which consists primarily of FHLB stock, are based on their redeemable value, which is at cost due to the restrictions placed on their transferability. The market for these securities is restricted to the issuer of the stock and subject to impairment evaluation.

Loans and Leases — The fair value of loans is estimated using an entrance price concept by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of impaired loans is measured using the fair value of the underlying collateral. The fair value of loans held for sale is estimated using quoted market prices.

Interest Rate Lock Commitments — The fair value of interest rate lock commitments is estimated using an internal valuation model, which includes grouping the interest rate lock commitments by interest rate and terms, applying an estimated closing ratio based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment group.

Forward Commitments — The fair value of these instruments is estimated using an internal valuation model, which includes current trade pricing for similar financial instruments.

Derivative Financial Instruments — The fair value of all derivatives is estimated based on the amount that Heartland would pay or would be paid to terminate the contract or agreement, using current rates and prices, and, when appropriate, the current creditworthiness of the counter-party.

Deposits — The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. If the fair value of the fixed maturity certificates of deposit is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value.

Short-term and Other Borrowings Rates currently available to Heartland for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.

Commitments to Extend Credit, Unused Lines of Credit and Standby Letters of Credit — Based upon management's analysis of the off balance sheet financial instruments, there are no significant unrealized gains or losses associated with these financial instruments based upon review of the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.

NOTE 9: SEGMENT REPORTING

Heartland has identified two operating segments for purposes of financial reporting: community and other banking, and retail mortgage banking. These segments were determined based on the products and services provided or the type of customers served and are consistent with the information used by Heartland's key decision makers to make operating decisions and to assess Heartland's performance. The following tables present financial information from Heartland's operating segments for the three monthsthree-month periods ended March 31, 2016,2017, and March 31, 2015,2016, in thousands.thousands:
 
Three Months Ended
March 31,
 2016 2015
 
Community
and Other
Banking
 
Retail
Mortgage
Banking
 Total 
Community
and Other
Banking
 
Retail
Mortgage
Banking
 Total
Net interest income$71,583
 $1,124
 $72,707
 $52,889
 $1,041
 $53,930
Provision for loan losses2,067
 
 2,067
 1,671
 
 1,671
Total noninterest income18,537
 11,041
 29,578
 17,061
 13,602
 30,663
Total noninterest expense59,739
 10,570
 70,309
 47,459
 12,155
 59,614
Income before taxes$28,314
 $1,595
 $29,909
 $20,820
 $2,488
 $23,308
Average Loans, for the period$5,296,191
 $61,911
 $5,358,102
 $4,189,966
 $77,627
 $4,267,593
Segment Assets, at period end$8,141,960
 $111,819
 $8,253,779
 $6,365,682
 $140,594
 $6,506,276

 Three Months Ended March 31,
 2017 2016
 Community
and Other
Banking
 Retail
Mortgage
Banking
 Total Community
and Other
Banking
 Retail
Mortgage
Banking
 Total
Net interest income$72,183
 $845
 $73,028
 $71,583
 $1,124
 $72,707
Provision for loan losses3,641
 
 3,641
 2,067
 
 2,067
Total noninterest income19,034
 6,859
 25,893
 18,537
 11,041
 29,578
Total noninterest expense63,212
 8,528
 71,740
 59,739
 10,570
 70,309
Income (loss) before taxes$24,364
 $(824) $23,540
 $28,314
 $1,595
 $29,909
Average Loans, for the period$5,334,659
 $30,995
 $5,365,654
 $5,296,191
 $61,911
 $5,358,102
Segment Assets, at period end$8,291,723
 $70,122
 $8,361,845
 $8,141,960
 $111,819
 $8,253,779



ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SAFE HARBOR STATEMENT

This document (including any information incorporated herein by reference) contains, and future oral and written statements of Heartland and its management may contain, forward-looking statements within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the business, financial condition, results of operations, plans, objectives and future performance and business of Heartland. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of Heartland's management and on information currently available to management, are generally identifiable by the use of words such as "believe," "expect," "anticipate," "plan," "intend," "estimate," "may," "will," "would," "could," "should" or other similar expressions. Although Heartland has made these statements based on management's experience and best estimate of future events, there may be events or factors that management has not anticipated, and the accuracy and achievement of such forward-looking statements and estimates are subject to a number of risks, including those identified in our Annual Report on Form 10-K for the year ended December 31, 2015.2016. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and Heartland undertakes no obligation to update any statement in light of new information or future events.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, income and expenses. These estimates are based upon historical experience and on various other assumptions that management believes are reasonable under the circumstances. Among other things, the estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates and judgments that management believes have the most effect on Heartland's reported financial position and results of operations are described as critical accounting policies in Heartland's Annual Report on Form 10-K for the year ended December 31, 2015.2016. There have been no significant changes in the critical accounting policies or the assumptions and judgments utilized in applying these policies since the year ended December 31, 2015.2016.

OVERVIEW

Heartland's results of operations depend primarily on net interest income, which is the difference between interest income from interest earning assets and interest expense on interest bearing liabilities. Noninterest income, which includes service charges and fees, loan servicing income, trust income, brokerage and insurance commissions, securities gains, andnet gains on sale of loans held for sale, and valuation adjustment on commercial servicing rights also affects Heartland's results of operations. Heartland's principal operating expenses, aside from interest expense, consist of the provision for loan and lease losses, salaries and employee benefits, occupancy and equipment costs, professional fees, FDICFederal Deposit Insurance Corporation ("FDIC") insurance premiums, advertising and other real estate and loan collection expenses.

Net income available to common stockholders for the quarter ended March 31, 2016,2017, was $19.8$18.0 million, or $0.82$0.68 per diluted common share, compared to $15.5$19.8 million, or $0.76$0.82 per diluted common share, for the quarter ended March 31, 2015.2016. Return on average common equity was 12.68%9.71% and return on average assets was 0.99%0.89% for the first quarter of 2016,2017, compared to 13.58%12.68% and 0.97%0.99%, respectively, for the same quarter in 2015.2016.

Acquisitions were a significant contributing factor to the improved net income duringResults for the first quarter of 2016. Heartland's earning assets during2017 in comparison with the first quarter of 2016 were $7.28 billion in comparison with $5.86 billion during the first quarter of 2015,mixed. Heartland experienced strong non-time deposit growth, a $1.42 billion or 24% increase. This growth resulted in an increase of $18.8 million or 35% insolid net interest income,margin and an improved tangible common equity ratio; however, weakness in loan growth and lower mortgage loan activity led to earnings that were slightly below the effect of which was partially offset by a $10.7 million or 18% increase in noninterest expense.company's expectations.

On February 5, 2016,28, 2017, Heartland completed the acquisition of CIC Bancshares, Inc.,Founders Bancorp, parent company of CentennialFounders Community Bank, headquarteredbased in Denver, Colorado, in a transaction valued at approximately $76.9 million. Of this amount, approximately $15.7San Luis Obispo, California. Based on Heartland's closing common stock price of $49.55 per share as of February 28, 2017, the aggregate consideration was $31.0 million, waswith 30% of the consideration paid in cash and the remainder of the consideration was provided70% by the issuance of 2,003,235 sharesdelivery of Heartland common stock and 3,000 shares of newly issued Heartland Series D preferred stock. In addition, Heartland assumed convertible notes and subordinated debt totaling approximately $7.9 million. Simultaneous with the closing of the transaction, CentennialFounders Community Bank merged into Heartland’s SummitHeartland's Premier Valley Bank & Trust subsidiary, with the resulting institution operating under the name Centennial Bank and Trust.subsidiary. As of the closingclose date, CentennialFounders Community Bank had, at fair value, total assets of $772.6$213.3 million, total loans of $581.5$96.4 million and total deposits of $648.1$181.5 million. The systems conversion for this transaction is expected to occur duringoccurred two weeks after the second quarter of 2016.



closing.

On March 15, 2016,February 13, 2017, Heartland redeemed allentered into a definitive merger agreement with Citywide Banks of Colorado, Inc., parent company of Citywide Banks, headquartered in Aurora, Colorado. Under the terms of the 81,698definitive merger agreement, Heartland
will acquire Citywide Banks of Colorado Inc. in a transaction valued at approximately $203.0 million as of the announcement date, subject to certain adjustments. Citywide Banks of Colorado, Inc. common shareholders will receive a combination of Heartland common stock and cash. The transaction is subject to customary closing conditions, including approval by the shareholders of Citywide Banks of Colorado, Inc. and bank regulatory authorities. The transaction is also subject to Heartland stockholders approving an increase in the number of authorized shares of its Series C Preferred Stock issuedHeartland common stock at the 2017 annual meeting of stockholders. The transaction is expected to the U.S. Treasury as part of the Small Business Lending Fund program. The aggregate redemption price was approximately $81.9 million, including dividends accrued but unpaid through the redemption date, and was paid with available funds. The redemption terminated Heartland's participationclose in the Small Business Lending Fund program.third quarter of 2017, and simultaneous with the closing, Citywide Banks will merge into Heartland's Centennial Bank and Trust subsidiary. The combined entity will operate as Citywide Banks. As of March 31, 2017, Citywide Banks had total assets of $1.35 billion, including $982.0 million in net loans outstanding, and $1.17 billion of deposits.

Total assets of Heartland were $8.25$8.36 billion at March 31, 2016,2017, an increase of $559.0$114.8 million or 7%1% since year-end 2015.2016. Included in this increase, at fair value, were $772.6$213.9 million of assets acquired in the CIC Bancshares, Inc.Founders Bancorp transaction. Securities represented 24%26% of total assets at both March 31, 2016,2017 and December 31, 2015.2016.

Total loans and leases held to maturity were $5.50$5.36 billion at March 31, 2016,2017, compared to $5.00$5.35 billion at year-end 2015,2016, an increase of $501.5 million or 10%.$9.9 million. This increase includes $581.5$96.4 million of total loans and leases held to maturity, at fair value, acquired in the CIC Bancshares, Inc.Founders Bancorp transaction.

Total deposits were $6.92$7.09 billion as of March 31, 2016,2017, compared to $6.41$6.85 billion at year-end 2015,2016, an increase of $518.5$242.5 million or 8%4%. This increase includes $648.1$181.5 million of deposits, at fair value, acquired in the CIC Bancshares, Inc. transaction. Demand deposits totaled $2.08 billion at March 31, 2016, an increase of $165.4 million or 9% since year-end 2015, with $164.3 million of the increase attributable to the CIC Bancshares, Inc.Founders Bancorp transaction.

Common stockholders' equity was $665.8$780.4 million at March 31, 2016,2017, compared to $581.5$739.6 million at year-end 2015.2016. Book value per common share was $27.15$29.26 at March 31, 2016,2017, compared to $25.92$28.31 at year-end 2015.2016. Heartland's unrealized gainsloss on securities available for sale, and derivative instruments, net of applicable taxes, were $1.9was $28.4 million at March 31, 2016,2017, compared to a $6.0$30.2 million unrealized loss, net of applicable taxes, at December 31, 2015.2016.

FINANCIAL HIGHLIGHTS
(Dollars in thousands, except per share data)Three Months Ended
March 31,
 2017 2016
STATEMENT OF INCOME DATA   
Interest income$80,551
 $80,684
Interest expense7,523
 7,977
Net interest income73,028
 72,707
Provision for loan losses3,641
 2,067
Net interest income after provision for loan losses69,387
 70,640
Noninterest income25,893
 29,578
Noninterest expenses71,740
 70,309
Income taxes5,530
 9,900
Net income18,010
 20,009
Preferred dividends(19) (168)
Interest expense on convertible preferred debt5
 
Net income available to common stockholders$17,996
 $19,841
    
Key Performance Ratios   
Annualized return on average assets0.89% 0.99%
Annualized return on average common equity (GAAP)9.71% 12.68%
Annualized return on average common tangible equity (non-GAAP)(1)
12.25% 16.45%
Annualized ratio of net charge-offs to average loans0.22% 0.08%
Annualized net interest margin (GAAP)3.95% 4.02%
Annualized net interest margin, fully tax-equivalent (non-GAAP)(2)
4.16% 4.19%
Efficiency ratio, fully tax-equivalent(3)
69.95% 66.90%
    



(Dollars in thousands, except per share data)Three Months Ended
March 31,
 2017 2016
Reconciliation of Return on Average Common Tangible Equity (non-GAAP)(4)
   
Net income available to common shareholders (GAAP)$17,996
 $19,841
    
Average common stockholders' equity (GAAP)751,671
 629,294
    Less average goodwill132,440
 119,750
    Less average other intangibles, net23,225
 24,436
Average common tangible equity (non-GAAP)$596,006
 $485,108
Annualized return on average common equity (GAAP)9.71% 12.68%
Annualized return on average common tangible equity (non-GAAP)12.25% 16.45%
    
Reconciliation of Annualized Net Interest Margin, Fully Tax-Equivalent (non-GAAP)(5)
   
Net Interest Income (GAAP)$73,028
 $72,707
    Plus tax-equivalent adjustment(7)
3,860
 3,041
Net interest income - tax-equivalent (non-GAAP)
$76,888
 $75,748
    
Average earning assets$7,502,496
 $7,276,703
Net interest margin (GAAP)3.95% 4.02%
Net interest margin, fully tax-equivalent (non-GAAP)4.16% 4.19%
    
Reconciliation of Non-GAAP Measure-Efficiency Ratio(6)
   
Net Interest Income (GAAP)$73,028
 $72,707
    Plus tax-equivalent adjustment(7)
3,860
 3,041
Net interest income - tax-equivalent (non-GAAP)
76,888
 75,748
Noninterest income25,893
 29,578
Securities gains, net(2,482) (3,526)
Adjusted income$100,299
 $101,800
    
Total noninterest expenses$71,740
 $70,309
Less:   
Core deposit intangibles and customer relationship intangibles amortization1,171
 1,895
Partnership investment in historic rehabilitation tax credits
 
(Gain)/loss on sales/valuations of assets, net412
 313
Adjusted noninterest expenses$70,157
 $68,101
    
Efficiency ratio, fully tax-equivalent (non-GAAP)69.95% 66.90%
    
(1) Refer to the "Reconciliation of Return on Average Common Tangible Equity (non-GAAP)" table.
(2) Refer to the "Reconciliation of Annualized Net Interest Margin, Fully Tax-Equivalent (non-GAAP)" table.
(3) Refer to the "Reconciliation of Non-GAAP Measure-Efficiency Ratio" (non-GAAP)" table.
(4) Return on average common tangible equity is net income available to common stockholders divided by average common stockholders' equity less goodwill and core deposit intangibles and customer relationship intangibles, net. This financial measure is included as it is considered to be a critical metric to analyze and evaluate the financial condition and capital strength of Heartland. This measure should not be considered a substitute for operating results determined in accordance with GAAP.
(5) Annualized net interest margin, fully tax-equivalent is a non-GAAP measure, which adjusts net interest income for the tax-favored status of certain loans and securities. Management believes this measure enhances the comparability of net interest income arising from taxable and tax-exempt sources. This measure should not be considered a substitute for operating results determined in accordance with GAAP.
(6) Efficiency ratio, fully tax-equivalent, expresses noninterest expenses as a percentage of fully tax-equivalent net interest income and noninterest income. This efficiency ratio is presented on a tax-equivalent basis, which adjusts net interest income and noninterest expenses for the tax favored status of certain loans, securities and historic rehabilitation tax credits. Management believes the presentation of this non-GAAP measure provides supplemental useful information for proper understanding of the financial results of Heartland as it enhances the comparability of income and expenses arising from taxable and nontaxable sources and excludes specific items, as noted in the table. This measure should not be considered a substitute for operating results determined in accordance with GAAP.
(7) Computed on a tax-equivalent basis using an effective tax rate of 35%.



(Dollars in thousands, except per share data)For the Quarters Ended
 3/31/2017 12/31/2016 9/30/2016 6/30/2016 3/31/2016
BALANCE SHEET DATA         
Investments$2,175,701
 $2,131,086
 $1,943,080
 $1,859,695
 $1,984,141
Loans held for sale49,009
 61,261
 78,317
 82,538
 76,565
Total loans receivable(1)
5,361,604
 5,351,719
 5,438,715
 5,482,258
 5,503,005
Allowance for loan losses(54,999) (54,324) (54,653) (51,756) (49,738)
Total assets8,361,845
 8,247,079
 8,202,215
 8,204,401
 8,253,779
Total deposits7,089,861
 6,847,411
 6,912,693
 6,837,572
 6,924,320
Long-term obligations282,051
 288,534
 294,493
 296,895
 265,760
Preferred equity938
 1,357
 1,357
 3,777
 3,777
Common stockholders’ equity780,374
 739,559
 703,031
 684,186
 665,766
          
Common Share Data         
Book value per common share (GAAP)$29.26
 $28.31
 $28.48
 $27.88
 $27.15
Tangible book value per common share (non-GAAP)(2)
$23.05
 $22.55
 $22.34
 $21.65
 $20.86
ASC 320 effect on book value per common share$(1.06) $(1.15) $0.03
 $0.21
 $0.23
Common shares outstanding, net of treasury stock26,674,121
 26,119,929
 24,681,380
 24,543,376
 24,519,928
Tangible common equity ratio (non-GAAP)(3)
7.50% 7.28% 6.85% 6.60% 6.32%
          
Reconciliation of Tangible Book Value Per Common Share (non-GAAP)(4)
         
Common stockholders' equity (GAAP)$780,374
 $739,559
 $703,031
 $684,186
 $665,766
  Less goodwill141,461
 127,699
 127,699
 127,699
 127,699
  Less core deposit intangibles and customer relationship
intangibles, net
24,068
 22,775
 23,922
 25,213
 26,510
Tangible common stockholders' equity (non-GAAP)$614,845
 $589,085
 $551,410
 $531,274
 $511,557
      ��   
Common shares outstanding, net of treasury stock26,674,121
 26,119,929
 24,681,380
 24,543,376
 24,519,928
Common stockholders' equity (book value) per share (GAAP)$29.26
 $28.31
 $28.48
 $27.88
 $27.15
Tangible book value per common share (non-GAAP)$23.05
 $22.55
 $22.34
 $21.65
 $20.86
          
Reconciliation of Tangible Common Equity Ratio (non-GAAP)(5)
         
Total assets (GAAP)$8,361,845
 $8,247,079
 $8,202,215
 $8,204,401
 $8,253,779
    Less goodwill141,461
 127,699
 127,699
 127,699
 127,699
  Less core deposit intangibles and customer relationship
intangibles, net
24,068
 22,775
 23,922
 25,213
 26,510
Total tangible assets (non-GAAP)$8,196,316
 $8,096,605
 $8,050,594
 $8,051,489
 $8,099,570
Tangible common equity ratio (non-GAAP)7.50% 7.28% 6.85% 6.60% 6.32%
 
(1) Excludes loans held for sale.
(2) Refer to the "Reconciliation of Tangible Book Value Per Common Share (non-GAAP)" table.
(3) Refer to the "Reconciliation of Tangible Common Equity Ratio (non-GAAP)" table.
(4) Tangible book value per common share is total common stockholders' equity less goodwill and core deposit and customer relationship intangibles, net, divided by common shares outstanding, net of treasury. This amount is a non-GAAP financial measure but has been included as it is considered to be a critical metric with which to analyze and evaluate the financial condition and capital strength of Heartland. This measure should not be considered a substitute for operating results determined in accordance with GAAP.
(5) The tangible common equity ratio is total common stockholders' equity less goodwill and core deposit intangibles, net divided by total assets less goodwill and core deposit intangibles, net. This ratio is a non-GAAP financial measure but has been included as it is considered to be a critical metric with which to analyze and evaluate the financial condition and capital strength of Heartland. This measure should not be considered a substitute for operating results determined in accordance with GAAP.




RESULTS OF OPERATIONS

Net Interest Income

Net interest margin, expressed as a percentage of average earning assets, was 4.19%3.95% (4.16% on a fully tax-equivalent basis) during the first quarter of 2016,2017, compared to 3.99%3.96% (4.14% on a fully tax-equivalent basis) during the fourth quarter of 20152016 and 3.90%4.02% (4.19% on a fully tax-equivalent basis) during the first quarter of 2015.2016. Heartland's success in maintaining net interest margin at or near the 4.00% level ishas been the result of continuous loan and deposit pricing discipline and management's ability to shift dollars from the securities portfolio into the loan portfolio. ContributingAlso contributing to the improvedHeartland's ability to maintain its net interest margin during the most recent quarters has been the amortization of purchase accounting discounts associated with the acquisitions completed during the last halfby Heartland. See "Analysis of 2015Average Balances, Tax-Equivalent Yields and first quarterRates" for a description of 2016.our use of net interest income on a fully tax-equivalent basis, which is not defined by GAAP, and a reconciliation of annualized net interest margin on a fully tax-equivalent basis to GAAP.

Interest income for the first quarter of 20162017 was $80.7$80.6 million, an increasea decrease of $17.6 million$133,000 or 28%less than 1%, compared to the $63.1$80.7 million recorded in the first quarter of 2015.2016. The tax-equivalent adjustmentadjustments for income taxes saved on the interest earned on nontaxable securities and loans waswere $3.9 million for the first quarter of 2017 and $3.0 million for the first quarter of 2016 and $2.4 million for the first quarter of 2015.2016. With these adjustments, interest income on a tax-equivalent basis was $84.4 million for the first quarter of 2017, an increase of $686,000, compared to $83.7 million for the first quarter of 2016, an increase of $18.2 million or 28%, compared to $65.5 million for the first quarter of 2015.2016. The increase in interest income in the first quarter of 2016, as compared to the first quarter of 2015,on a tax-equivalent basis during 2017 was primarily due to an increaseincreases in average earning assets, which totaled $7.50 billion during the first quarter of 2017 compared to $7.28 billion during the first quarter of 2016, compared to $5.86 billion during the first quarter of 2015, a $1.42 billion$225.8 million or 24%3% increase. A majority of thisthe growth in average earning assets during both comparable periods was attributable to the three acquisitions completed during last half of 2015, in addition to the CIC Bancshares, Inc. acquisition completed inon February 2016.5, 2016, and the Founders Bancorp acquisition completed on February 28, 2017.

Interest expense for the first quarter of 20162017 was $8.0$7.5 million, a decrease of $1.2 million$454,000 or 13%6% from $9.2$8.0 million in the first quarter of 2015.2016. Average interest bearing liabilities increased $875.0decreased $82.2 million or 20%2% for the quarter ended March 31, 2016,2017, as compared to the same quarter in 2015, while2016. In addition, the average interest rate paid on Heartland's interest bearing deposits and borrowings declined 242 basis points from 0.85% in the first quarter of 2015 to 0.61% in the first quarter of 2016.2016 to 0.59% in the first quarter of 2017. The average interest rate paid on savings deposits was 0.21%0.22% during the first quarter of 20162017 compared to 0.26% during0.21% for the first quarter of 2015,2016, and the average interest rate paid on time deposits was 0.79% during the first quarter of 2017 compared to 0.80% during the first quarter of 2016 compared to 1.09% during the first quarter of 2015.2016.

Net interest income increased $18.8$321,000 or less than 1% to $73.0 million or 35% toin the first quarter of 2017 from $72.7 million in the first quarter of 2016 from $53.9 million in2016. After the first quarter of 2015. Nettax-equivalent adjustment discussed above, net interest income on a tax-equivalent basis totaled $76.9 million during the first quarter of 2017, an increase of $1.1 million or 2% from $75.7 million during the first quarter of 2016, an increase of $19.4 million or 34% from $56.3 million during the first quarter of 2015. Net interest income in dollars has increased steadily for each of the last fourteen quarters.2016.

Heartland attempts to manage its balance sheet to minimize the effect that a change in interest rates has on its net interest margin. Heartland plans to continue to work toward improving both its earning assets and funding mix through targeted organic growth



strategies, which management believes will result in additional net interest income. Heartland believes its net interest income simulations reflect a well-balanced and manageable interest rate position.posture. Approximately 33%38% of Heartland's commercial and agricultural loan portfolios consist of floating rate loans that reprice based upon changes in the national prime or LIBOR interest rate. Since nearly 41%Approximately 21% of these floating rate loans have interest rate floors that are currently in effect, so that an upward movement in the national prime interest rate or LIBOR would not have an immediate positive effect on Heartland's interest income. Item 3 of Part I of this Form 10-Q report contains additional information about the results of Heartland's most recent net interest income simulations. Note 7 to the quarterly consolidated financial statements included in this Quarterly Report on Form 10-Q contains a detailed discussion of the derivative instruments Heartland has utilized to manage its interest rate risk.

The following table sets forth certain information relating to Heartland's average consolidated balance sheets and reflects the yield on average earning assets and the cost of average interest bearing liabilities for the periods indicated, in thousands. DividingSuch yields and costs are calculated by dividing income or expense by the average balance of assets or liabilities derives such yields and costs.liabilities. Average balances are derived from daily balances, and nonaccrual loans and loans held for sale are included in each respective loan category. Assets withthat receive tax favorable treatment are evaluated on a tax-equivalent basis assuming a federal income tax rate of 35%. Tax favorable assets generally have lower contractual pre-tax yields than fully taxable assets. A tax-equivalent yield is calculated by adding the tax savings to the interest earned on tax favorable assets and dividing this amount by the average balance of the tax favorable assets.
 



ANALYSIS OF AVERAGE BALANCES, TAX-EQUIVALENT YIELDS AND RATES(1)
For the Three Months Ended March 31, 2016 and 2015
ANALYSIS OF AVERAGE BALANCES, TAX-EQUIVALENT YIELDS AND RATES(1)
For the Three Months Ended March 31, 2017 and 2016
ANALYSIS OF AVERAGE BALANCES, TAX-EQUIVALENT YIELDS AND RATES(1)
For the Three Months Ended March 31, 2017 and 2016
2016 20152017 2016

Average
Balance

Interest
Rate
Average
Balance

Interest
RateAverage
Balance
 Interest Rate Average
Balance
 Interest Rate
Earning Assets










           
Securities:










           
Taxable$1,508,432

$8,735

2.33%
$1,283,509

$7,132

2.25%$1,449,054
 $8,253
 2.31% $1,453,350
 $8,644
 2.39%
Nontaxable(1)
417,224

5,400

5.21

331,339

4,486

5.49
645,534
 7,986
 5.02
 417,224
 5,400
 5.21
Total securities1,925,656

14,135

2.95

1,614,848

11,618

2.92
2,094,588
 16,239
 3.14
 1,870,574
 14,044
 3.02
Interest bearing deposits11,634

4

0.14

9,194

4

0.18
Interest bearing deposits with the Federal Reserve Bank and other banks and other short-term investments96,270
 209
 0.88
 66,716
 95
 0.57
Federal funds sold31,126

10

0.13

7,617

1

0.05
314
 
 
 31,126
 10
 0.13
Loans and leases:(2)











Loans:(2)
           
Commercial and commercial real estate(1)
3,743,940

46,754

5.02

3,023,204

35,875

4.81
3,813,258
 45,913
 4.88
 3,743,940
 46,754
 5.02
Residential mortgage734,134

7,599

4.16

478,948

4,883

4.13
646,532
 6,683
 4.19
 734,134
 7,599
 4.16
Agricultural and agricultural real estate(1)
467,978

5,729

4.92

418,251

5,030

4.88
483,079
 5,554
 4.66
 467,978
 5,729
 4.92
Consumer412,050

7,923

7.73

347,190

6,888

8.05
422,785
 8,053
 7.72
 412,050
 7,923
 7.73
Fees on loans

1,571





1,196


  1,760
 
   1,571
 
Less: allowance for loan and lease losses(49,815)




(42,048)



Net loans and leases5,308,287

69,576

5.27

4,225,545

53,872

5.17
Less: allowance for loan losses(54,330) 
 
 (49,815) 
 
Net loans5,311,324
 67,963
 5.19
 5,308,287
 69,576
 5.27
Total earning assets7,276,703

83,725

4.63%
5,857,204

65,495

4.53%7,502,496
 84,411
 4.56% 7,276,703
 83,725
 4.63%
Nonearning Assets748,367





597,067




731,014
     748,367
    
Total Assets$8,025,070





$6,454,271




$8,233,510
     $8,025,070
    
Interest Bearing Liabilities










           
Savings$3,556,207

$1,894

0.21%
$2,830,961

$1,795

0.26%$3,838,001
 $2,105
 0.22% $3,556,207
 $1,894
 0.21%
Time, $100,000 and over498,620

871

0.70

344,360

838

0.99
348,782
 725
 0.84
 498,620
 871
 0.70
Other time deposits642,301

1,408

0.88

536,170

1,539

1.16
484,336
 900
 0.75
 642,301
 1,408
 0.88
Short-term borrowings311,161

329

0.43

294,756

198

0.27
235,432
 137
 0.24
 311,161
 329
 0.43
Other borrowings264,875

3,475

5.28

391,937

4,802

4.97
284,404
 3,656
 5.21
 264,875
 3,475
 5.28
Total interest bearing liabilities5,273,164

7,977

0.61%
4,398,184

9,172

0.85%5,190,955
 7,523
 0.59% 5,273,164
 7,977
 0.61%
Noninterest Bearing Liabilities










           
Noninterest bearing deposits1,981,882





1,450,291




2,225,702
     1,981,882
    
Accrued interest and other liabilities74,253





61,050




63,895
     74,253
    
Total noninterest bearing liabilities2,056,135





1,511,341




2,289,597
     2,056,135
    
Stockholders' Equity695,771





544,746




752,958
     695,771
    
Total Liabilities and Stockholders' Equity$8,025,070





$6,454,271




$8,233,510
     $8,025,070
    
Net interest income(1)


$75,748





$56,323


Net interest income, fully tax-equivalent (non-GAAP)(1)
  $76,888
     $75,748
  
Net interest spread(1)




4.02%




3.68%    3.97%     4.02%
Net interest income to total earning assets(1)




4.19%




3.90%
Net interest income, fully tax-equivalent (non-GAAP) to total earning assets(3)
    4.16%     4.19%
Interest bearing liabilities to earning assets72.47%




75.09%



69.19%     72.47%    












           
(1) Tax-equivalent basis is calculated using an effective tax rate of 35%.
(2) Nonaccrual loans are included in average loans outstanding.
Reconciliation of Annualized Net Interest Margin, Fully Tax-Equivalent (non-GAAP)(3)
           
           
Net interest income, fully tax-equivalent (non-GAAP)  $76,888
     $75,748
  
Adjustments for tax-equivalent interest(1)
  (3,860)     (3,041)  
Net interest income (GAAP)  $73,028
     $72,707
  
           
Average Earning Assets$7,502,496
     $7,276,703
    
Annualized net interest margin (GAAP)    3.95%     4.02%
Annualized net interest margin, fully tax-equivalent (non-GAAP)    4.16%     4.19%
           
(1) Computed on a tax-equivalent basis using an effective tax rate of 35%.
(1) Computed on a tax-equivalent basis using an effective tax rate of 35%.
(2) Nonaccrual loans are included in the average loans outstanding.(2) Nonaccrual loans are included in the average loans outstanding.
(3) Annualized net interest margin, fully tax-equivalent is a non-GAAP measure, which adjusts net interest income for the tax-favored status of certain loans and securities. Management believes this measure enhances the comparability of net interest income arising from taxable and tax-exempt sources. This measure should not be considered a substitute for operating results determined in accordance with GAAP.(3) Annualized net interest margin, fully tax-equivalent is a non-GAAP measure, which adjusts net interest income for the tax-favored status of certain loans and securities. Management believes this measure enhances the comparability of net interest income arising from taxable and tax-exempt sources. This measure should not be considered a substitute for operating results determined in accordance with GAAP.




Provision For Loan And Lease Losses

The allowance for loan and lease losses is established through a provision charged to expense to provide, in Heartland management's opinion, an appropriate allowance for loan and lease losses. The provision for loan losses was $3.6 million for the first quarter of 2017 compared to $2.1 million for the first quarter of 2016 compared to $1.7 million for the first quarter of 2015.

2016. In determining that the allowance for loan and lease losses is appropriate, management uses factors that include the overall composition of the loan portfolio, general economic conditions, types of loans, loan collateral values, past loss experience, loan



delinquencies, substandard credits, and doubtful credits. For additional details on the specific factors considered in establishing the allowance for loan losses, refer to the discussion of critical accounting policies set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Heartland's Annual Report on Form 10-K for the year ended December 31, 2015,2016, and the information under the caption "Allowance For Loan and Lease Losses" in Item 2 of this Quarterly Report on Form 10-Q report. and Note 5 to the consolidated financial statements included herein.

Given the size of Heartland's loan portfolio, the level of organic loan growth, acquired loans that move out of the purchase accounting pool, changes in credit quality and the variability that can occur in the factors considered when determining the appropriateness of the allowance for loan losses, Heartland's quarterly provision for loan losses will vary from quarter to quarter. During the first quarter of 2017, Heartland’s credit quality was stable as nonperforming and delinquent loan levels were largely unchanged. As a result, the $3.6 million provision in the first quarter of 2017 was primarily due to the movement of acquired loans out of the purchase accounting pool and minor fluctuations in the variables that management uses to determine the allowance.
Heartland believes the allowance for loan and lease losses as of March 31, 2016,2017, was at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions should become more unfavorable, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision for loan and lease losses.

Noninterest Income

The tablestable below showshows Heartland's noninterest income for the three monthsthree-month periods ended March 31, 20162017 and 2015,2016, in thousands:
 
Three Months Ended
March 31,
    Three Months Ended
March 31,
    
2016 2015 Change % Change2017 2016 Change % Change
Service charges and fees$7,162
 $5,404
 $1,758
 33 %$9,457
 $7,162
 $2,295
 32 %
Loan servicing income1,268
 1,041
 227
 22
1,724
 1,268
 456
 36
Trust fees3,813
 3,631
 182
 5
3,631
 3,813
 (182) (5)
Brokerage and insurance commissions1,022
 1,087
 (65) (6)1,036
 1,022
 14
 1
Securities gains, net3,526
 4,353
 (827) (19)2,482
 3,526
 (1,044) (30)
Net gains on sale of loans held for sale11,065
 13,742
 (2,677) (19)6,147
 11,065
 (4,918) (44)
Valuation adjustment on commercial servicing rights5
 
 5
 100
Income on bank owned life insurance522
 524
 (2) 
617
 522
 95
 18
Other noninterest income1,200
 881
 319
 36
794
 1,200
 (406) (34)
Total noninterest income$29,578
 $30,663
 $(1,085) (4)%$25,893
 $29,578
 $(3,685) (12)%

Noninterest income totaled $25.9 million during the first quarter of 2017 compared to $29.6 million during the first quarter of 2016, compared to $30.7 million during the first quarter of 2015, a decrease of $1.1$3.7 million or 4%12%. This decrease reflected lower securities gains and decreased net and gains on sale of loans held for sale, the effect of which was partially mitigatedoffset by in an increase in servicesincreased service charges and fees.

Service charges and fees totaled $7.2increased $2.3 million or 32% during the first quarter of 20162017 compared to $5.4 million during the first quarter of 2015, an increase of $1.8 million or 33%.2016. Service charges on checking and savings accounts recorded during the first quarter of 20162017 were $1.9$2.1 million compared to $1.5$1.9 million during the first quarter of 2015,2016, an increase of $424,000$234,000 or 29%12%. Overdraft fees were $2.2 million during the first quarter of 2017 compared to $2.0 million during the first quarter of 2016, compared to $1.6 million during the first quarter of 2015, an increase of $385,000$242,000 or 25%12%. Interchange revenue from activity on bank debit cards, along with surcharges on ATM activity, resulted in service charges and fees of $3.0 million during the first quarter of 2017 compared to $2.3 million during the first quarter of 2016, compared to $1.9 million during the first quarter of 2015, an increase of $458,000$687,000 or 24%29%. These increases were primarily attributable to a larger demand deposit customer base, a portion of which is attributable to the acquisitions completed during the last halffirst quarters of 20152016 and first quarter of 2016.2017. Fees associated with credit card services were $2.0 million during the first quarter of 2017 compared to $909,000 during the first quarter of 2016, compared to $365,000 during the first quarter of 2015, an increase of $544,000$1.1 million or 149%,124%. This increase resulted primarily as a result of



from efforts to increase the level of commercial credit card services provided at Heartland's subsidiary banks, during 2015.including at the newly acquired banks in California and Colorado. Heartland recently enhanced its card payment solutions for businesses with the rollout of a more robust expense management service that provides business customers the ability to more efficiently manage their card-based spending.

Loan servicing income includes the fees collected for the servicing of commercial, agricultural, and mortgage loans, which are dependent upon the aggregate outstanding balances of these loans, rather than quarterly production and sale of these loans. Loan servicing income totaled $1.7 million during the first quarter of 2017 compared to $1.3 million during the first quarter of 2016, compared to $1.0 million during the first quarteran increase of 2015.$456,000 or 36%. Loan servicing income related to the servicing of commercial and agricultural loans totaled $813,000 during the first quarter of 2017 compared to $597,000 during the first quarter of 2016, compared to $721,000 during the first quarteran increase of 2015, a decrease of $124,000$216,000 or 17%36%. Fees collected for the servicing of mortgage loans, primarily for government sponsored entities, were $3.2 million during the first quarter of 2017 compared to $2.9 million during the first quarter of 2016, compared to $2.5 million during the first quarter of 2015, an increase of $436,000$241,000 or 17%8%. Included in and offsetting loan servicing income is the amortization of capitalized servicing rights, which was $2.3 million during the first quarter of 2016 compared to $2.2 million during the first quarter of 2015, an increase of $84,000 or 4%.both 2017 and 2016. The portfolio of mortgage loans serviced primarily for government sponsored entities by Heartland totaled $4.34 billion at March 31, 2017, compared to $4.11 billion at March 31, 2016, compared to $3.58 billion at March 31, 2015.



2016.

The following table summarizes Heartland's residential mortgage loan activity during the most recent five quarters, in thousands:
As Of and For the Quarter EndedAs Of and For the Quarter Ended
3/31/2016 12/31/2015 9/30/2015 6/30/2015 3/31/20153/31/2017 12/31/2016 9/30/2016 6/30/2016 3/31/2016
Mortgage Servicing Fees$2,931
 $2,921
 $2,738
 $2,553
 $2,495
$3,172
 $3,116
 $3,111
 $2,989
 $2,931
Mortgage Servicing Rights Amortization(2,259) (2,154) (2,086) (2,186) (2,175)(2,261) (2,698) (2,968) (2,567) (2,259)
Total Residential Mortgage Loan Servicing Income$672
 $767
 $652
 $367
 $320
$911
 $418
 $143
 $422
 $672
Net Gains On Sale of Residential Mortgage Loans$10,368
 $6,789
 $8,489
 $14,121
 $13,602
$5,947
 $5,664
 $11,061
 $10,707
 $10,368
Total Residential Mortgage Loan Applications$406,999

$307,163

$443,294

$615,463

$647,487
$248,614
 $304,018
 $445,107
 $440,907
 $406,999
Residential Mortgage Loans Originated$238,266

$258,939

$370,956

$421,798

$319,581
$161,851
 $278,065
 $324,337
 $324,633
 $238,266
Residential Mortgage Loans Sold$220,381

$260,189

$360,172

$402,151

$268,786
$172,521
 $269,333
 $315,917
 $302,448
 $220,381
Residential Mortgage Loan Servicing Portfolio$4,112,519

$4,057,861

$3,963,677

$3,785,794

$3,578,409
$4,338,311
 $4,308,580
 $4,259,459
 $4,203,429
 $4,112,519

Net gains on sale of loans held for sale totaled $6.1 million during the first quarter of 2017 compared to $11.1 million during the first quarter of 2016, compared to $13.7 million during the first quarter of 2015, a decrease of $2.6$4.9 million or 19%44%. These gains result primarily from the gain or loss on sales of mortgage loans into the secondary market, related fees and fair value marks on the associated derivatives. Mortgage loan applications were $248.6 million in the first quarter of 2017 compared to $407.0 million in the first quarter of 2016, compared to $647.5 million in the first quarter of 2015, a decrease of $240.5$158.4 million or 37%39%. The volume of mortgage loans sold totaled $220.4$172.5 million during the first quarter of 2016,2017, a $48.4$47.9 million or 18%22% decrease from the $268.8$220.4 million sold during the first quarter of 2015. These decreases were attributable2016. Similar to trends in the decreasing interest rate environment duringmortgage loan market as a whole, Heartland experienced a dramatic decline in demand for mortgage loan refinancings in the last quarter of 2014 and first of quarter of 2015 compared to antwo quarters as interest rate environment that remained relatively flatrates increased during this period. In addition, the last quarter of 2015 and first quarter of 2016. Principally duethe year is seasonally slow for the home purchases market. These two factors led to a significant decline in Heartland's mortgage loan production during the changing interest rate environment, thefirst quarter of 2017. The percentage of residential mortgage loans that represented refinancings was 53%36% during the first quarter of 20152017 compared to 42% duringin the first quarter of 2016. Net gains on sale of loans held for sale also includes gains on the sale of commercial and agricultural loans, which totaled $200,000 during the first quarter of 2017 compared to $697,000 during the first quarter of 2016 compared to $140,000 during the first quarter of 2015. An area of emphasis for the Community Banc-Corp of Sheboygan, Inc. bank branches was the origination for sale of small business loans written under the United States Small Business Administration and United States Department of Agriculture Rural Development Business and Industry loan programs. This focus was the primary reason for the increased gains on sale of commercial and agricultural loans during first quarter of 2016.

Trust fees increased $182,000 or 5% during the first quarter of 2016 compared to the same quarter in 2015. A large portion of trust fees are based upon the market value of the trust assets under management, which was $2.22 billion at March 31, 2016, compared to $1.92 billion at December 31, 2015, and $2.06 billion at March 31, 2015. Those values fluctuate throughout the year as market conditions improve or decline.

Net securities gains totaled $3.5 million during the first quarter of 2016 compared to $4.4 million during the first quarter of 2015, a decrease of $827,000 or 19%.

Other noninterest income was $794,000 during the first quarter of 2017 compared to $1.2 million during the first quarter of 2016, compared to $881,000 during the first quartera decrease of 2015, an increase of $319,000$406,000 or 36%, which34%. The decrease was primarily attributable to the reimbursement received in the first quarter of 2016 from a customer for loan workout expenses that had been incurred and paid in prior years.




Noninterest Expenses

The tablestable below showshows Heartland's noninterest expenses for the three monththree-month periods ended March 31, 20162017 and 2015,2016, in thousands:
        
 Three Months Ended
March 31,
  
 2017 2016 Change % Change
Salaries and employee benefits$41,767
 $41,714
 $53
  %
Occupancy5,073
 5,003
 70
 1
Furniture and equipment2,501
 2,113
 388
 18
Professional fees8,309
 7,010
 1,299
 19
FDIC insurance assessments807
 1,168
 (361) (31)
Advertising2,424
 1,284
 1,140
 89
Core deposit intangibles and customer relationship intangibles amortization1,171
 1,895
 (724) (38)
Other real estate and loan collection expenses828
 572
 256
 45
Loss on sales/valuations of assets, net412
 313
 99
 32
Other noninterest expenses8,448
 9,237
 (789) (9)
Total noninterest expenses$71,740
 $70,309
 $1,431
 2 %
 
Three Months Ended
March 31,
  
 2016 2015 Change % Change
Salaries and employee benefits$41,714
 $36,638
 $5,076
 14 %
Occupancy5,003
 4,259
 744
 17
Furniture and equipment2,113
 2,106
 7
 
Professional fees7,010
 6,044
 966
 16
FDIC insurance assessments1,168
 956
 212
 22
Advertising1,284
 1,181
 103
 9
Intangible assets amortization1,895
 631
 1,264
 200
Other real estate and loan collection expenses572
 465
 107
 23
Loss on sales/valuations of assets, net313
 353
 (40) (11)
Other noninterest expenses9,237
 6,981
 2,256
 32
  Total Noninterest Expenses$70,309
 $59,614
 $10,695
 18 %
Efficiency ratio, fully taxable equivalent(1)
66.90% 70.95%    
        
(1) See the reconciliation of Non-GAAP measure below.
Reconciliation of Non-GAAP Measure-Efficiency Ratio
 
For the Three Months Ended
March 31,
 2016 2015
Net interest income$72,707
 $53,930
Taxable equivalent adjustment(1)
3,041
 2,393
Fully taxable equivalent net interest income75,748
 56,323
Noninterest income29,578
 30,663
Securities gains, net(3,526) (4,353)
Adjusted income$101,800
 $82,633
 

 

Total noninterest expenses$70,309
 $59,614
Less:

 
Intangible assets amortization1,895
 631
Partnership investment in historic rehabilitation tax credits
 
Loss on sales/valuations of assets, net313
 353
Adjusted noninterest expenses$68,101
 $58,630
    
Efficiency ratio, fully taxable equivalent(2)
66.90% 70.95%
    
(1) Computed on a tax equivalent basis using an effective tax rate of 35%.
(2) Efficiency ratio, fully taxable equivalent, expresses noninterest expenses as a percentage of fully taxable equivalent net interest income and noninterest income. This efficiency ratio is presented on a tax equivalent basis, which adjusts net interest income and noninterest expenses for the tax favored status of certain loans, securities and historic rehabilitation tax credits. Management believes the presentation of this non-GAAP measure provides supplemental useful information for proper understanding of the financial results as it enhances the comparability of income and expenses arising from taxable and nontaxable sources and excludes specific items, such as securities gains, net and losses on sales/valuations of assets, net. This measure should not be considered a substitute for operating results determined in accordance with GAAP.




For the first quarter of 2016,2017, noninterest expenses totaled $70.3$71.7 million compared to $59.6$70.3 million during the first quarter of 2015,2016, an increase of $10.7$1.4 million or 18%2%. The categories with the most significant increases were professional fees and advertising.

The largest component of noninterest expenses, salaries and employee benefits, professionalincreased $53,000 or less than 1% during the first quarter of 2017 as compared to the same quarter in 2016. Heartland had total full-time equivalent employees of 1,896 on March 31, 2017, compared to 1,907 on March 31, 2016.

Professional fees intangible assetsincreased $1.3 million or 19% during the first quarter of 2017 compared to the first quarter of 2016, primarily as a result of a higher level of services provided to Heartland by third-party advisors, including services performed in connection with mergers and acquisitions and cloud-based applications.

Advertising expenses were $2.4 million during the first quarter of 2017 compared to $1.3 million during the first quarter of 2016, an increase of $1.1 million or 89% during the first quarter of 2017 compared to the first quarter of 2016. This increase was primarily a result of costs associated with a deposit promotion campaign.

Core deposit intangibles and customer relationship intangibles amortization andwas $1.2 million during the first quarter of 2017 compared to $1.9 million during the first quarter of 2016, a decrease of $724,000 or 38%. During the first quarter of 2016, a $700,000 adjustment to the core deposit intangibles was recorded at Premier Valley Bank due to the loss of a significant deposit account relationship at Premier Valley Bank.

For the first quarter of 2017, other noninterest expenses. These increases were primarily attributable toexpenses decreased $789,000 or 9% over the recent acquisitions.first quarter of 2016, as Heartland replaced certain existing software applications and their associated maintenance costs with cloud-based applications.

One of Heartland's top priorities is to improve its efficiency ratio, on a fully tax-equivalent basis, by reducing it to a ratio of 65% by the end of 2016.or less. During the first quarter of 2016,2017, Heartland's efficiency ratio, was 66.90%on a fully tax-equivalent basis, increased to 69.95% in comparison with 68.53% during the fourth quarter of 2015 and 70.95%66.90% during the first quarter of 2015. During the second and third quarters of 2015, management announced the consolidation of two banking centers and the closing of seven under-performing loan production offices. During the first quarter of 2016, management announced the closing of one additional loan production office located outside of Heartland's geographic footprint. Heartland also expects2016. Contributing to improve its efficiency ratio by completing systems conversions of acquired banks as soon as possible after the closing dates. The Premier Valley Bank systems conversion was completed during the first quarter of 2016, and the systems conversion for Centennial Bank is scheduled for completion during the second quarter of 2016.

The largest component of noninterest expenses, salaries and employee benefits, increased $5.1 million or 15% during the first quarter of 2016 as compared to the same quarter in 2015. This increase was primarily attributable to the additional salaries and employee benefits for employees of Premier Valley Bank, which was acquired in the fourth quarter of 2015, and Centennial Bank, which was acquired in the first quarter of 2016. Full-time equivalent employees totaled 1,907 on March 31, 2016, compared to 1,776 on March 31, 2015. Included in the full-time equivalent employees on March 31, 2016, were approximately 90 at Premier Valley Bank and 105 at Centennial Bank. The closing of out-of-footprint mortgage loan production offices resulted in a reduction of approximately 45 full-time equivalent employees during the first quarter of 2016.

Occupancy expense increased $744,000 or 17% during the first quarter of 2016 compared to the first quarter of 2015. A majority of this increase was attributable to the acquisitions completed during the last half of 2015 and first quarter of 2016.

Professional fees increased $966,000 or 16% during the first quarter of 2016 compared to the first quarter of 2015,were reduced operating revenue, primarily a result of additional services provided to Heartland by third-party advisors, including services performed in connection with acquisitions.

Intangible assets amortization increased $1.3 million or 200% during the first quarter of 2016 compared to the first quarter of 2015 as a result of the acquisitions completed during the last half of 2015a reduction in mortgage loan originations and firstincreased expenses associated with merger and acquisition activity and promotional costs incurred for a deposit marketing campaign. Heartland's efficiency ratio will show variability from quarter of 2016.

For the firstto quarter of 2016, other noninterest expenses increased $2.3 million or 32% over the first quarter of 2015. These increases were primarilyas a result of additional investmentsacquisition activities and also from the seasonality and related revenue and expense timing differences that are inherent in technology and initial and ongoing costs associated with the acquisitions.residential mortgage business.

Income Taxes

Heartland's effective tax rate was 23.49% for the first quarter of 2017 compared to 33.10% for the first quarter of 2016 compared to 32.60% for the first quarter of 2015.2016. Federal low-income housing tax credits included in the determination ofreduced Heartland's income taxes totaledby $304,000 during the first quarter of 2016 compared to $145,000 during the first quarter of 2015.both 2017 and 2016. Heartland's effective tax rate was also affected by the level of tax-exempt interest income which, as a percentage of pre-tax income,



was 30.46% during the first quarter of 2017 compared to 18.88% during the first quarter of 2016 compared to 19.07%2016. As a result of the adoption of ASU 2016-09, "Compensation-Stock Compensation (Topic 718)" on January 1, 2017, Heartland's income taxes during the first quarter of 2015.2017 included a tax benefit of $888,000 upon the vesting of outstanding restricted stock unit awards. The majority of Heartland's restricted stock unit awards vest annually in the first quarter. Exclusive of this tax benefit, Heartland's effective tax rate for the first quarter of 2017 was 27.26%.

Segment Reporting

Heartland has two reportable segments: community and other banking and retail mortgage banking. Revenues from community and other banking operations consist primarily of interest earned on loans and investment securities, fees from deposit and ancillary services and net security gains. Retail mortgage banking operating revenues consist of interest earned on mortgage loans held for sale, gains on sale of mortgage loans into the secondary market, the servicing of mortgage loans for various investorsothers and loan origination fee income. See Note 9 to ourthe consolidated financial statements included in this Quarterly Report on Form 10-Q for further information regarding ourHeartland's segment reporting.

Income before taxes for the community and other banking segment for the first quarter of 20162017 was $28.3$24.4 million compared to $20.8$28.3 million for the first quarter of 2015,2016, a $7.5$4.0 million or 36% increase,14% decrease. This decrease resulted primarily as a result of increased net interest income andfrom increased noninterest income, the effect of which was partially offset by increased noninterest expenses.

Net interest income from the community and other banking segment improved by $18.7was $72.2 million or 35% forduring the first quarter of 2017 compared to $71.6 million during the first quarter of 2016, as compared to the first quarteran increase of 2015,$600,000 or 1%. This increase was primarily as a result of additional earning assets from the four acquisitions completed during 2015 and the CIC Bancshares, Inc. acquisition completed on February 5, 2016, and the Founders Bancorp acquisition completed on February 28, 2017.

Provision for loan losses allocable to the community and other banking segment was $3.6 million for the first quarter of 2017 compared to $2.1 million during the first quarter of 2016. Given the size of Heartland's loan portfolio, the movement of acquired loans out of the purchase accounting pool and the variability that can occur in the factors considered when determining the appropriateness of the allowance for loan losses, Heartland's quarterly provision for loan losses will vary from quarter to quarter. During the first quarter of 2017, Heartland’s credit quality was stable as nonperforming and delinquent loan levels were largely unchanged. As a result, the higher provision in the first quarter of 2017 in comparison with the first quarter of 2016 combined with strong loan growth experienced duringwas primarily due to the last halfmovement of 2015. acquired loans out of the purchase accounting pool and minor fluctuations in the variables that management uses to determine the allowance.

Noninterest income allocable to the community and other banking segment totaled $19.0 million during the first quarter of 2017 compared to $18.5 million during the first three monthsquarter of 2016, compared to $17.1 million during the first three months of 2015, an increase of $1.5 million



$497,000 or 9%,3%. The increase was primarily a result of increasedhigher service charges and fees. fees, which were offset by a $1.0 million decrease in security gains, net.

Noninterest expenses allocable to the community and other banking segment increased $12.3totaled $63.2 million or 26%during the first quarter of 2017 compared to $59.7 million during the first quarter of 2016, as compared toan increase of $3.5 million or 6%. The categories of noninterest expenses with the first quarter of 2015, which wasmost significant increases were professional fees and advertising. These increases were primarily a result of additional services provided to Heartland by third-party advisors, including services performed in connection with mergers and acquisitions and the acquisitions.replacement of software applications with cloud-based applications, and advertising costs associated with a deposit promotion campaign.

The retail mortgage banking segment recorded a loss before taxes of $824,000 for the first quarter of 2017 compared to income before taxes of $1.6 million for the first quarter of 2016, compared to income before taxes of $2.5 million for the first quarter of 2015, a decrease of $893,000$2.4 million or 36%152%. Noninterest income from the retail mortgage banking segment totaled $6.9 million during the first quarter of 2017 compared to $11.0 million during the first quarter of 2016, compared to $13.6 million during the first quarter of 2015, a $2.6$4.2 million or 19%38% decrease. Retail mortgage banking income results primarily from net gains on sale of mortgage loans into the secondary market, related fees and fair value marks on the associated derivatives. Mortgage loan applications were $248.6 million in the first quarter of 2017 compared to $407.0 million in the first quarter of 2016, compared to $647.5 million in the first quarter of 2015, a decrease of $240.5$158.4 million or 37%39%. The volume of mortgage loans sold totaled $220.4$172.5 million during the first quarter of 2016, an 18%2017, a $47.9 million or 22% decrease from the $268.8$220.4 million of mortgage loans sold during the first quarter of 2015. 2016. This decrease was attributable to the higher mortgage interest rates during the first quarter of 2017, which significantly reduced mortgage loan refinancing activity.

Noninterest expenses allocable to the retail mortgage banking segment were $8.5 million during the first quarter of 2017 compared to $10.6 million during the first quarter of 2016, compared to $12.2a decrease of $2.0 million or 19%. Lower expenses during the first quarter of 2015, a decrease of $1.6 million or 13%. During 2015, management refined its strategy2017 in comparison with respect to its retail mortgage banking business by emphasizing growth in this line of business in bank subsidiary locations instead of in out-of-footprint locations. To implement this strategy, seven under-performing mortgage loan production offices were closed during the second and third quarters of 2015, and an additional closure was announced during the first quarter of 2016. In addition2016 were partially attributable to reduced transaction-based compensation paid to mortgage banking personnel as a result of the lower volume of residential mortgage loans underwritten during the first quarter of 20162017. Additionally, in comparison with first quarter of 2015, the office closures also contributedreaction to the reduction in noninterest expenseslower volume of mortgage loan originations, a series of workforce reductions were



implemented during the first quarter of 2016 in comparison with2017. The impact of the first quarter of 2015.workforce reductions are expected to continue into the second quarter.

FINANCIAL CONDITION

Total assets were $8.25$8.36 billion at March 31, 2016,2017, an increase of $559.0$114.8 million or 7%1% since year-end 2015.2016. Included in this growth,increase, at fair value, was $772.6$213.9 million of assets acquired in the CIC Bancshares, Inc.Founders Bancorp transaction.

Lending Activities

Total net loans and leases held to maturity were $5.50$5.36 billion at March 31, 2016,2017, compared to $5.00$5.35 billion at year-end 2015,2016, an increase of $501.5$9.9 million or 10%less than 1%. This increase includes $581.5$96.4 million of total loans and leases held to maturity, at fair value, acquired in the CIC Bancshares, Inc.Founders Bancorp transaction. Exclusive of this transaction, total loans and leases held to maturity decreased $80.0$86.6 million or 2%. This downward trend began to reverseHistorically, Heartland has not experienced significant organic loan growth in the first quarter of the year. Three of the Heartland bank subsidiaries experienced a decline in loan balances during the monthquarter primarily as a result of March 2016 and thescheduled construction loan pipeline looks stronger for the second quarter of 2016. Management expects loan growth will fluctuate from quarter-to-quarter, but overall to average 1% to 2% per quarter.payoffs.

The table below presents the composition of the loan portfolio as of March 31, 2016,2017, and December 31, 2015,2016, in thousands:
LOAN PORTFOLIOMarch 31, 2016 December 31, 2015March 31, 2017 December 31, 2016
Amount Percent Amount PercentAmount Percent Amount Percent
Loans and leases receivable held to maturity:       
Loans receivable held to maturity:       
Commercial$1,295,504
 23.53% $1,279,214
 25.56%$1,314,393
 24.50% $1,287,265
 24.04%
Commercial real estate2,555,268
 46.40
 2,326,360
 46.50
2,535,355
 47.27
 2,538,582
 47.42%
Agricultural and agricultural real estate471,271
 8.56
 471,870
 9.43
481,125
 8.97
 489,318
 9.14
Residential mortgage753,666
 13.69
 539,555
 10.78
604,902
 11.28
 617,924
 11.54
Consumer430,699
 7.82
 386,867
 7.73
427,962
 7.98
 420,613
 7.86
Gross loans and leases receivable held to maturity5,506,408
 100.00% 5,003,866
 100.00%
Gross loans receivable held to maturity5,363,737
 100.00% 5,353,702
 100.00%
Unearned discount(640)   (488)  (668)   (699)  
Deferred loan fees(2,763)   (1,892)  (1,465)   (1,284)  
Total net loans and leases receivable held to maturity5,503,005
   5,001,486
  
Allowance for loan and lease losses(49,738)   (48,685)  
Loans and leases receivable, net$5,453,267
   $4,952,801
 

Total net loans receivable held to maturity5,361,604
   5,351,719
  
Allowance for loan losses(54,999)   (54,324)  
Loans receivable, net$5,306,605
   $5,297,395
 





Loans and leases secured by real estate, either fully or partially, totaled $3.75$3.55 billion or 68%66% of gross loans and leases at March 31, 2016.2017. Excluding purchase accounting valuations, 51% of the properties securing non-farm, nonresidential real estate loans 56% are owner occupied. The largest categories withinof Heartland's real estate secured loans at March 31, 2016,2017, and December 31, 2015,2016, are listed below, in thousands:
LOANS SECURED BY REAL ESTATE
March 31, 2016 December 31, 2015March 31, 2017 December 31, 2016
Residential real estate, excluding residential construction and residential lot loans$916,658
 $849,296
$995,797
 $1,030,190
Industrial, manufacturing, business and commercial488,426
 429,891
475,339
 474,632
Agriculture250,110
 255,345
247,585
 255,046
Retail303,464
 239,975
336,866
 332,009
Office311,258
 275,289
351,700
 347,334
Land development and lots121,294
 122,551
130,999
 127,700
Hotel, resort and hospitality121,205
 115,083
167,914
 151,571
Multi-family172,362
 179,243
188,219
 185,559
Food and beverage88,958
 90,339
100,989
 102,225
Warehousing105,482
 82,356
123,766
 120,471
Health services119,631
 101,961
143,793
 147,412
Residential construction102,645
 97,205
132,659
 143,962
All other163,257
 164,255
173,387
 172,617
Loans acquired in the quarter512,834
 318,797
Purchase accounting valuations(24,945) (20,994)(17,901) (17,559)
Total loans secured by real estate$3,752,639
 $3,300,592
$3,551,112
 $3,573,169

Allowance For Loan and Lease Losses

The process utilized by Heartland to determine the appropriateness of the allowance for loan and lease losses is considered a critical accounting practice for Heartland and has remained consistent over the past several years. The allowance for loan and lease losses represents management's estimate of identified and unidentified probable losses in the existing loan portfolio. For additional details on the specific factors considered in determining the allowance for loan and lease losses, refer to the critical accounting policies section of our Annual Report on Form 10-K for the year ended December 31, 2015.

The allowance for loan and lease losses at March 31, 2016, was 0.90% of loans and leases and 102.79% of nonperforming loans compared to 0.97% of loans and leases and 122.77% of nonperforming loans at December 31, 2015.2016.

Nonperforming loans were $48.4$63.7 million or 0.88%1.19% of total loans and leases at March 31, 2016,2017, compared to $39.7$64.4 million or 0.79%1.20% of total loans and leases at December 31, 2015, an increase of $8.7 million or 22%. Exclusive of $1.6 million of nonperforming loans acquired in the CIC Bancshares, Inc. transaction, nonperforming loans increased $7.2 million or 18% since year-end 2015. A majority of the new nonperforming loans were part of the loan portfolios acquired in the bank acquisitions completed during 2015, which had been identified as potential problem loans prior to the closing of the acquisitions. Heartland's special assets group continues to work with these borrowers to obtain an appropriate resolution of these nonperforming loans.2016. At March 31, 2016,2017, approximately $15.5$27.1 million or 32%42% of Heartland's nonperforming loans had individual loan balances exceeding $1.0 million and represented loans to an aggregate of eightfour borrowers. The portion of Heartland's nonperforming loans covered by government guarantees was $12.0$16.6 million at March 31, 2016,2017, and $8.9$17.3 million at December 31, 2015.2016, which includes $14.2 million and $14.3 million, respectively, of repurchased residential real estate loans.

The allowance for loan losses at March 31, 2017, was 1.03% of loans and 86.29% of nonperforming loans compared to 1.02% of loans and 84.37% of nonperforming loans at December 31, 2016. Excluding those loans covered by the purchase accounting adjustments, the ratio of the allowance for loan losses to outstanding loans was 1.22% at both March 31, 2017, and December 31, 2016. At March 31, 2017, valuation reserves totaled $25.2 million and covered $938.9 million of acquired loans. At December 31, 2016, valuation reserves totaled $25.3 million and covered $956.0 million of acquired loans.

Loans delinquent 30 to 89 days as a percent of total loans increased to 0.45%was 0.44% at March 31, 2016,2017, in comparison with 0.31%0.37% at December 31, 2015, primarily due agricultural loans made to a borrower experiencing financial difficulties.2016.




The tablestable below presentpresents the changes in the allowance for loan and lease losses during the three monthsthree-month periods ended March 31, 20162017 and 2015,2016, in thousands:
ANALYSIS OF ALLOWANCE FOR LOAN AND LEASE LOSSES
Three Months Ended
March 31,
 2016 2015
Balance at beginning of period$48,685
 $41,449
Provision for loan and lease losses2,067
 1,671
Recoveries on loans and leases previously charged off591
 738
Charge-offs on loans and leases(1,605) (2,004)
Balance at end of period$49,738
 $41,854
Annualized ratio of net charge offs to average loans and leases0.08% 0.12%
ANALYSIS OF ALLOWANCE FOR LOAN LOSSESThree Months Ended
March 31,
 2017 2016
Balance at beginning of period$54,324
 $48,685
Provision for loan losses3,641
 2,067
Recoveries on loans previously charged off752
 591
Charge-offs on loans(3,718) (1,605)
Balance at end of period$54,999
 $49,738
Annualized ratio of net charge offs to average loans0.22% 0.08%

The table below presents the amounts of nonperforming loans and leases and other nonperforming assets on the dates indicated, in thousands:
NONPERFORMING ASSETSMarch 31, December 31,
 2016 2015 2015 2014
Not covered under loss share agreements:       
Nonaccrual loans and leases$47,750
 $27,023
 $39,655
 $25,070
Loan and leases contractually past due 90 days or more639
 9
 
 
Total nonperforming loans and leases48,389
 27,032
 39,655
 25,070
Other real estate11,338
 19,097
 11,524
 19,016
Other repossessed assets426
 404
 485
 445
Total nonperforming assets not covered under loss share agreements$60,153
 $46,533
 $51,664
 $44,531
Covered under loss share agreements:       
Nonaccrual loans and leases$
 $
 $
 $278
Other real estate
 
 
 
Total nonperforming assets covered under loss share agreements$
 $
 $
 $278
Performing troubled debt restructured loans(1)
$10,711
 $10,904
 $11,075
 $12,133
Nonperforming loans and leases not covered under loss share agreements to total loans and leases0.88% 0.64% 0.79% 0.63%
Nonperforming assets not covered under loss share agreements to total loans and leases plus repossessed property1.09% 1.09% 1.03% 1.14%
Nonperforming assets not covered under loss share agreements to total assets0.73% 0.72% 0.67% 0.74%
        
(1) Represents accruing troubled debt restructured loans performing according to their restructured terms.



NONPERFORMING ASSETSMarch 31, December 31,
 2017 2016 2016 2015
Nonaccrual loans$62,868
 $47,750
 $64,299
 $39,655
Loans contractually past due 90 days or more872
 639
 86
 
Total nonperforming loans63,740
 48,389
 64,385
 39,655
Other real estate11,188
 11,338
 9,744
 11,524
Other repossessed assets739
 426
 663
 485
Total nonperforming assets$75,667
 $60,153
 $74,792
 $51,664
Performing troubled debt restructured loans(1)
$11,010
 $10,711
 $10,380
 $11,075
Nonperforming loans to total loans1.19% 0.88% 1.20% 0.79%
Nonperforming assets to total loans plus repossessed property1.41% 1.09% 1.39% 1.03%
Nonperforming assets to total assets0.90% 0.73% 0.91% 0.67%
        
(1) Represents accruing troubled debt restructured loans performing according to their restructured terms.

The scheduleschedules below summarizessummarize the changes in Heartland's nonperforming assets including those covered by loss share agreements, during the first three months of 2016,2017, in thousands:
 
Nonperforming
Loans
 
Other
Real Estate
Owned
 
Other
Repossessed
Assets
 
Total
Nonperforming
Assets
December 31, 2015$39,655
 $11,524
 $485
 $51,664
Loan foreclosures(442) 436
 6
 
Net loan charge-offs(1,014) 
 
 (1,014)
Acquired nonperforming assets1,582
 1,934
 
 3,516
New nonperforming loans12,171
 
 
 12,171
Reduction of nonperforming loans(1)
(3,563) 
 
 (3,563)
OREO/Repossessed assets sales proceeds
 (2,345) (66) (2,411)
OREO/Repossessed assets writedowns, net
 (211) 29
 (182)
Net activity at Citizens Finance Co.
 
 (28) (28)
March 31, 2016$48,389
 $11,338
 $426
 $60,153
        
(1) Includes principal reductions and transfers to performing status.
 
Nonperforming
Loans
 
Other
Real Estate
Owned
 
Other
Repossessed
Assets
 
Total
Nonperforming
Assets
December 31, 2016$64,385
 $9,744
 $663
 $74,792
Loan foreclosures(2,461) 2,263
 198
 
Net loan charge-offs(2,966) 
 
 (2,966)
Acquired nonperforming assets
 
 
 
New nonperforming loans14,819
 
 
 14,819
Reduction of nonperforming loans(1)
(10,037) 
 
 (10,037)
OREO/Repossessed assets sales proceeds
 (545) (170) (715)
OREO/Repossessed assets writedowns, net
 (274) (5) (279)
Net activity at Citizens Finance Co.
 
 53
 53
March 31, 2017$63,740
 $11,188
 $739
 $75,667
        
(1) Includes principal reductions and transfers to performing status.

Securities

The composition of Heartland's securities portfolio is managed to maximize the return on the portfolio while considering the impact it has on Heartland's asset/liability position and liquidity needs. Securities represented 24%26% of total assets at both March 31, 2016,



2017, and December 31, 2015.2016. Total available for sale securities as of March 31, 2016,2017, were $1.69$1.89 billion, an increase of $112.1$47.7 million or 7%3% from $1.58$1.85 billion at December 31, 2015.2016.

The table below presents the composition of the securities portfolio, including trading, available for sale, and held to maturity securities and other, by major category, as of March 31, 2016,2017, and December 31, 2015,2016, in thousands:
SECURITIES PORTFOLIO COMPOSITIONMarch 31, 2016 December 31, 2015March 31, 2017 December 31, 2016
Amount Percent Amount PercentAmount Percent Amount Percent
U.S. government corporations and agencies$6,619
 0.33% $25,766
 1.37%$15,067
 0.69% $4,700
 0.22%
Mortgage-backed securities1,388,687
 69.99
 1,247,071
 66.37
1,288,527
 59.22
 1,290,500
 60.56
Obligation of states and political subdivisions552,303
 27.84
 570,730
 30.37
835,209
 38.39
 799,806
 37.53
Corporate debt securities830
 0.04
 846
 0.05
Equity securities13,377
 0.67
 13,138
 0.70
15,341
 0.71
 14,520
 0.68
Other securities22,325
 1.13
 21,443
 1.14
21,557
 0.99
 21,560
 1.01
Total securities$1,984,141
 100.00% $1,878,994
 100.00%$2,175,701
 100.00% $2,131,086
 100.00%

The percentage of Heartland's securities portfolio comprised of mortgage-backed securities was 70%59% at March 31, 2016, compared to 66%2017, and 61% at December 31, 2015.2016. Approximately 79%77% of Heartland's mortgage-backed securities were issued by government-sponsored enterprises at March 31, 2016.2017. Heartland's securities portfolio had an expected modified duration of 4.14.15 years as of March 31, 2016,2017, compared to 3.94.34 years at year-end 2015.2016.

The Volcker Rule, which is scheduled to be fully implemented ineffective July 21, 2017, prohibits insured depository institutions and their holding companies from engaging in proprietary trading except in limited circumstances,of securities, derivatives and certain other financial instruments for the entity's own account, and prohibits them from owning equitycertain interests in, excess of 3% of Tier 1 Capital inor relationships with, a hedge fund or private equity and hedge funds. Thefund. Heartland does not believe that it engages in any significant amount of proprietary trading, as defined in the Volcker Rule, willand believes that any impact of the Volcker Rule on Heartland's business activities and investment portfolio would be minimal. Heartland has reviewed its investment portfolio to determine if any investments meet the Volcker Rule's definition of covered funds. Based on the review, Heartland believes that any impact related to investments considered to be covered funds would not have a material impactsignificant effect on Heartland’s investment securities portfolio.its financial condition or results of operations.

At March 31, 2016,2017, Heartland had $22.3$21.6 million of other securities, including capital stock in each Federal Home Loan Bank ("FHLB") of which each of its bank subsidiaries is a member. All of these securities were classified as other securities held at cost.

Deposits And Borrowed Funds

Total deposits were $6.92$7.09 billion as of March 31, 2016,2017, compared to $6.41$6.85 billion at year-end 2015,2016, an increase of $518.5$242.5 million or 8%4%. This increase includes $648.1included $181.5 million of deposits, at fair value, acquired in the CIC Bancshares, Inc.Founders Bancorp transaction. Exclusive of this transaction, total deposits increased $61.0 million or 1% during the first quarter of 2017.


The table below presents, in thousands, the composition of Heartland's deposits by category as of March 31, 2017, and December 31, 2016:
DEPOSITSMarch 31, 2017 December 31, 2016
 Amount Percent Amount Percent
Demand$2,319,256
 32.71% $2,202,036
 32.16%
Savings3,940,146
 55.58
 3,788,089
 55.32
Time830,459
 11.71
 857,286
 12.52
Total$7,089,861
 100.00% $6,847,411
 100.00%

Demand deposits totaled $2.32 billion at March 31, 2017, an increase of $117.2 million or 5% since year-end 2016, with $94.4 million of the increase attributable to the Founders Bancorp transaction. Excluding demand deposits acquired in this acquisition,transaction, demand deposits increased $22.8 million or 1%. Deposit composition continued to reflect a favorable mix with demand deposits at 33% of total deposits, decreased $129.6 million or 2%. This entire decrease was attributablesavings deposits at 55% and time deposits at 12% at March 31, 2017, compared to reduceddemand deposits at 32% of total deposits, savings deposits at 55% and time deposits at 13% of total deposits at December 31, 2016. Contributing to the improvement in deposit mix were decreases in the level of time deposits, which decreased $131.4$50.6 million or 12%during the first quarter of 2017 when excluding the $149.5$23.8 million of time deposits acquired in the CIC Bancshares, Inc.Founders Bancorp transaction. This trend of reduced time deposits is expected to continue during the second quarterpartially a result of 2016 as management remains focusedmanagement's focus on building its demand and savings deposit customer base. Heartland



does not plan to offer highly competitive interest rates on time deposits, except to customers with which it has significantother banking relationships. DemandSavings deposits totaled $2.08$3.94 billion at March 31, 2016,2017, an increase of $165.4$152.1 million or 9%4% since year-end 2015,2016, with $164.3$63.3 million of the increase attributable to the CIC Bancshares, Inc.Founders Bancorp transaction. Deposit composition continued to reflect a favorable mix with demand deposits at 30% of total deposits,Excluding savings deposits at 53% and timeacquired in this transaction, savings deposits at 17% at bothincreased $88.8 million or 2%.

Short-Term Borrowings

Short-term borrowings, which Heartland defines as borrowings with an original maturity of one year or less, were as follows as of March 31, 2016,2017, and December 31, 2015.2016, in thousands:
 March 31, 2017 December 31, 2016
Securities sold under agreement to repurchase$135,748
 $229,555
Federal funds purchased3,680
 40,200
Advances from the FHLB10,000
 30,367
Other short-term borrowings5,597
 6,337
Total$155,025

$306,459

Short-term borrowings generally include federal funds purchased, securities sold under agreements to repurchase, short-term FHLB advances and discount window borrowings from the Federal Reserve Bank. These funding alternatives are utilized in varying degrees depending on their pricing and availability. All of Heartland's bank subsidiaries own FHLB stock in eitherone of the Chicago, Dallas, Des Moines, San Francisco or Topeka FHLBs, enabling them to borrow funds from their respective FHLB for short- or long-term purposes under a variety of programs. The amount of short-term borrowings of Heartland was $325.7$155.0 million at March 31, 2016,2017, compared to $293.9$306.5 million at year-end 2015. Short-term FHLB advances2016, a decrease of $32.7$151.4 million were included in short-term borrowings at March 31, 2016, in comparison with $11.1 million at December 31, 2015.or 49%.

All of the Heartland bank subsidiaries provide retail repurchase agreements to their customers as a cash management tool, sweepingwhich sweep excess funds from demand deposit accounts into these agreements. This source of funding does not increase the bank's reserve requirements. Although the aggregate balance of these retail repurchase agreements is subject to variation, the account relationships represented by these balances are principally local. The balances of retail repurchase agreements were $207.2$135.7 million at March 31, 2016,2017, compared to $253.7$229.6 million at December 31, 2015.2016, a decrease of $93.8 million or 41%. In addition to seasonal fluctuations, these balances declined as a result of Heartland's focus on reducing the volume of retail repurchase agreement activity so that the securities pledged under these repurchase agreements would be unencumbered. The treasury management teams at the Heartland bank subsidiaries introduced other value-added cash management tools and loss prevention services to these customers to further enhance their cash management alternatives.

Short-term FHLB advances of $10.0 million were included in short-term borrowings at March 31, 2017, in comparison with $30.4 million at December 31, 2016.

Also included in short-term borrowings is a $20.0 million revolving credit line Heartland has with an unaffiliated bank, primarily to provide liquidity to Heartland. ANo balance of $15.0 million was outstanding on this line at both March 31, 2016,2017, and December 31, 2015.2016.




Other Borrowings

The outstanding balances of other borrowings, which Heartland entered intodefines as borrowings with an additional non-revolving credit facility withoriginal maturity date of more than one year, are shown in the same unaffiliated bank on December 15, 2015, which provides borrowing capacity not to exceed $50.0 million when combined with the outstanding balance on its existing amortizing term loan with the same unaffiliated bank described below. Attable below, net of discount and issuance costs amortization, in thousands, as of March 31, 2016, a $40.0 million balance was outstanding on this non-revolving credit line compared to no balance outstanding at2017, and December 31, 2015. Any outstanding balance on the non-revolving credit line is due on November 30, 2016.2016:
 March 31, 2017 December 31, 2016
Advances from the FHLB$6,907
 $6,975
Wholesale repurchase agreements30,000
 30,000
Trust preferred securities115,321
 115,232
Senior notes11,000
 16,000
Note payable to unaffiliated bank36,667
 37,667
Contracts payable for purchase of real estate and other assets1,973
 2,339
Subordinated notes73,893
 73,857
Other borrowings6,290
 6,464
Total$282,051

$288,534

Other borrowings include all debt arrangements Heartland and its subsidiaries have entered into with original maturities that extend beyond one year, including long-term FHLB borrowings, term borrowings under term notes, subordinated notes and senior notes, convertible debt, and obligations under trust preferred capital securities. As of March 31, 2016,2017, the amount of other borrowings was $265.8$282.1 million, an increasea decrease of $2.5$6.5 million or 1%2% since year-end 2015.2016.

Long-term FHLB borrowings with an original term of more than one year totaled $12.2$6.9 million at March 31, 2016,2017, compared to $17.2$7.0 million at December 31, 2015, a decrease of $5.1 million or 30%.2016. Total long-term FHLB borrowings at March 31, 2016,2017, had an average rate of 2.29%3.27% and an average maturity of 3.2 years. Structured46 months.

Heartland's structured wholesale repurchase agreements totaled $30.0 million at both March 31, 20162017, and December 31, 2015.

In 2008, Heartland entered into various wholesale repurchase agreements, which had balances totaling $30.0 million at both March 31, 2016, and December 31, 2015.2016. These wholesale repurchase agreements mature in 2018.

In April 2011, Heartland obtainedhas a $15.0 million amortizing term loan fromnon-revolving credit facility with an unaffiliated bank, withwhich provides a maturity dateborrowing capacity of April 20,up to $75.0 million. At March 31, 2017, $36.7 million was outstanding on this non-revolving credit line compared to $37.7 million outstanding at December 31, 2016. TheAny outstanding balance on this amortizing term loan was $8.6 million atnon-revolving credit line is due in April 2021. At March 31, 2016, compared to $8.92017, Heartland had $27.1 million at December 31, 2015. At maturity,available on this amortizing term loan was repaid with an advance on Heartland's non-revolving credit line.facility.

Heartland also had senior notes totaling $11.0 million outstanding at March 31, 2017, and $16.0 million outstanding at December 31, 2016, and subordinated notes totaling $73.9 million outstanding at both March 31, 2016,2017, and December 31, 2015, and subordinated notes totaling $82.1 million outstanding at March 31, 2016, and $74.1 million at December 31, 2015. Included in2016. During the subordinated notes at March 31, 2016, werefirst quarter of 2017, $167,000 of the $2.0 million of subordinated convertible notes and $5.9 millionwere converted into 6,128 shares of subordinated debentures assumed in the CIC Bancshares, Inc. transaction.Heartland common stock.




A schedule of Heartland's trust preferred securities outstanding as of March 31, 2016,2017, is as follows, in thousands:
Amount
Issued
 
Issuance
Date
 
Interest
Rate
 
Interest
Rate as of
3/31/16(1)
 
Maturity
Date
 
Callable
Date
Amount
Issued
 
Issuance
Date
 
Interest
Rate
 
Interest
Rate as of
3/31/17(1)
 
Maturity
Date
 
Callable
Date
Heartland Financial Statutory Trust IV25,774
 03/17/2004 2.75% over LIBOR 
3.39%(2)
 03/17/2034 06/17/2016$25,774
 03/17/2004 2.75% over LIBOR 
3.90%(2)
 03/17/2034 06/17/2017
Heartland Financial Statutory Trust V20,619
 01/27/2006 1.33% over LIBOR 
1.95%(3)
 04/07/2036 07/07/201620,619
 01/27/2006 1.33% over LIBOR 
2.35%(3)
 04/07/2036 07/07/2017
Heartland Financial Statutory Trust VI20,619
 06/21/2007 6.75% 
6.75%(4)
 09/15/2037 06/15/201620,619
 06/21/2007 6.75% 
6.75%(4)
 09/15/2037 06/15/2017
Heartland Financial Statutory Trust VII20,619
 06/26/2007 1.48% over LIBOR 
2.12%(5)
 09/01/2037 06/01/201620,619
 06/26/2007 1.48% over LIBOR 
2.53%(5)
 09/01/2037 06/01/2017
Morrill Statutory Trust I8,735
 12/19/2002 3.25% over LIBOR 
3.88%(6)
 12/26/2032 06/26/20168,829
 12/19/2002 3.25% over LIBOR 
4.40%(6)
 12/26/2032 06/26/2017
Morrill Statutory Trust II8,337
 12/17/2003 2.85% over LIBOR 
3.49%(7)
 12/17/2033 06/17/20168,448
 12/17/2003 2.85% over LIBOR 
4.00%(7)
 12/17/2033 06/17/2017
Sheboygan Statutory Trust I6,199
 9/17/2003 2.95% over LIBOR 3.59% 09/17/2033 06/17/20166,287
 9/17/2003 2.95% over LIBOR 4.10% 09/17/2033 06/17/2017
CBNM Capital Trust I4,222
 9/10/2004 3.25% over LIBOR 3.88% 12/15/2034 06/15/20164,272
 9/10/2004 3.25% over LIBOR 4.38% 12/15/2034 06/15/2017
$115,124
          $115,467
          
    
(1) Effective weighted average interest rate as of March 31, 2016, was 4.97% due to interest rate swap transactions on the variable rate securities as discussed in Note 7 to Heartland's consolidated financial statements.
(2) Effective interest rate as of March 31, 2016, was 5.01% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements.
(3) Effective interest rate as of March 31, 2016, was 4.69% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements.
(1) Effective weighted average interest rate as of March 31, 2017, was 4.83% due to interest rate swap transactions on the variable rate securities as discussed in Note 7 to Heartland's consolidated financial statements included herein.(1) Effective weighted average interest rate as of March 31, 2017, was 4.83% due to interest rate swap transactions on the variable rate securities as discussed in Note 7 to Heartland's consolidated financial statements included herein.
(2) Effective interest rate as of March 31, 2017, was 5.01% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.(2) Effective interest rate as of March 31, 2017, was 5.01% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.
(3) Effective interest rate as of March 31, 2017, was 4.69% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.(3) Effective interest rate as of March 31, 2017, was 4.69% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.
(4) Interest rate is fixed at 6.75% through June 15, 2017, then resets to 1.48% over LIBOR for the remainder of the term.
(5) Effective interest rate as of March 31, 2016, was 4.70% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements.
(6) Effective interest rate as of March 31, 2016, was 4.92% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements.
(7) Effective interest rate as of March 31, 2016, was 4.51% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements.
(5) Effective interest rate as of March 31, 2017, was 3.83% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.(5) Effective interest rate as of March 31, 2017, was 3.83% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.
(6) Effective interest rate as of March 31, 2017, was 4.92% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.(6) Effective interest rate as of March 31, 2017, was 4.92% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.
(7) Effective interest rate as of March 31, 2017, was 4.51% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.(7) Effective interest rate as of March 31, 2017, was 4.51% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.


During 2015, Heartland entered into two additional forward starting interest rate swaps. The first forward starting interest rate swap transaction relates to Heartland's $20.0 million Statutory Trust VI, which will convert from a fixed interest rate subordinated debenture to a variable interest rate subordinated debenture. The effective date of the interest rate swap transaction is June 15, 2017, and Heartland Statutory Trust VI will effectively remain at a fixed interest rate. The forward-starting swap transaction expires on June 15, 2024. The second forward starting interest rate swap was effective on March 1, 2017, and replaced the current interest rate swap related to Heartland Statutory Trust VII that expired on March 1, 2017.


CAPITAL REQUIREMENTS

Bank regulatory agencies have adopted capital standards by which all bank holding companies are evaluated, including requirements to maintain certain core capital amounts included as Tier 1 capital at minimum levels relative to total assets (the "Tier 1 Leverage Capital Ratio") and at minimum levels relative to "risk-weighted assets"assets," which are calculated by assigning value to assets, and off balance sheet commitments, based on their risk characteristics (the "Tier 1 Risk-Based Capital Ratio"), and. Bank holding companies also are required to maintain total capital at minimum levels relative to risk-weighted assets (the "Total Risk-Based Capital Ratio"). Starting in 2015, bank holding companies became subject to a new Common Equity Tier 1 Capital Ratio, an increased Tier 1 Leverage Capital Ratio and an increased Tier 1 Risk-Based Capital Ratio under the Basel III rules andrules. They are required to include in Common Equity Tier 1 capital the effects of other comprehensive income adjustments, such as gains and losses on securities held to maturity, that were previously excluded from the definition of Tier 1 capital, butcapital. However, bank holding companies were allowed to make a one-time election not to include those effects. Heartland and its bank subsidiaries have been, and will continue to be, managed so they meet the well-capitalized requirements under the regulatory framework for prompt corrective actionaction. Heartland and haveits bank subsidiaries made the one-time election to exclude the effects of other comprehensive income adjustments on their Tier 1 capital.

Under the Basel III rules, the requirements to be categorized as well-capitalized was established at 6.5% for the Common Equity Tier 1 Capital Ratio, changed from 4% to 5% for the Tier 1 Leverage Capital Ratio, changed from 6% to 8% for the Tier 1 Risk-Based Capital Ratio and remained at 10% for the Total Risk-Based Capital Ratio. The most recent notification from the Federal Deposit Insurance CorporationFDIC categorized Heartland and each of its bank subsidiaries as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed each institution's category.the categorization of any of these entities.

Heartland's capital ratios are calculated in accordance with Federal Reserve Board instructions and are required regulatory financial measures. Heartland's capital ratios were as follows for the dates indicated, in thousands:
CAPITAL RATIOSMarch 31, 2016 December 31, 2015March 31, 2017 December 31, 2016
Amount Ratio Amount RatioAmount Ratio Amount Ratio
Risk-Based Capital Ratios:       
Risk-Based Capital Ratio       
Tier 1 capital$648,796
 9.98% $683,706
 11.56%$777,802
 12.40% $756,056
 11.93%
Tier 1 capital minimum requirement389,880
 6.00% 354,980
 6.00%376,277
 6.00% 380,148
 6.00%
Excess$258,916
 3.98% $328,726
 5.56%$401,525
 6.40% $375,908
 5.93%
              
Common equity Tier 1$530,053
 8.16% $487,132
 8.23%
Common equity Tier 1 minimum requirement292,410
 4.50% 266,324
 4.50%
Common Equity Tier 1 capital$661,543
 10.55% $639,467
 10.09%
Common Equity Tier 1 minimum requirement282,208
 4.50% 285,111
 4.50%
Excess$237,643
 3.66% $220,808
 3.73%$379,335
 6.05% $354,356
 5.59%
              
Total capital$778,834
 11.99% $812,568
 13.74%$907,922
 14.48% $887,607
 14.01%
Total capital minimum requirement519,840
 8.00% 473,282
 8.00%501,703
 8.00% 506,865
 8.00%
Excess$258,994
 3.99% $339,286
 5.74%$406,219
 6.48% $380,742
 6.01%
Total risk-adjusted assets$6,497,996
   $5,916,027
  
Total risk-weighted assets$6,271,289
   $6,335,807
  
              
Leverage Capital Ratios(1)
     
  
Leverage Ratio     
  
Tier 1 capital$648,796
 8.22% $683,706
 9.58%$777,802
 9.62% $756,056
 9.28%
Tier 1 capital minimum requirement(2)
315,621
 4.00% 285,606
 4.00%
Tier 1 capital minimum requirement323,357
 4.00% 325,894
 4.00%
Excess$333,175
 4.22% $398,100
 5.58%$454,445
 5.62% $430,162
 5.28%
Average adjusted assets (less goodwill and other intangible assets)$7,890,530
   $7,140,152
  $8,083,932
   $8,147,357
  
       
(1) The leverage ratio is defined as the ratio of Tier 1 capital to average total assets.

(2) Heartland has established a minimum target leverage ratio of 4.00%. Based on Federal Reserve Bank guidelines, a bank holding company generally is required to maintain a leverage ratio of 3.00% plus an additional cushion of at least 100 basis points.

On July 29, 2016, Heartland filed a universal shelf registration statement with the Securities and Exchange Commission on August 28, 2013, which became effective on September 9, 2013,SEC to register up to $75.0 million indebt or equity securities. TheThis shelf registration statement, which was effective immediately, provides Heartland with the ability to raise capital, subject to Securitiesmarket conditions and Exchange CommissionSEC rules and limitations, if Heartland’sHeartland's board of directors decides to do so. At March 31,This registration statement will permit Heartland, from time to time, in one or more public offerings, to offer debt securities, subordinated notes, common stock, preferred stock, rights or any combination of these securities. The amount of securities that may be offered is not specified in the registration statement, and the terms of any future offerings will be established at the time of the offering. In November 2016, $75.0 million was availableHeartland offered and sold 1,379,690 shares of its common stock pursuant to be issued under the universal shelfthis registration statement.




On February 5, 2016,28, 2017, Heartland completed the acquisition of CIC Bancshares, Inc.,Founders Bancorp, parent company of CentennialFounders Community Bank, headquarteredbased in Denver, Colorado, in a transaction valued atSan Luis Obispo, California. Based on Heartland's closing common stock price of $49.55 per share on February 28, 2017, the aggregate consideration was approximately $76.9 million. Of this amount, approximately $15.7$31.0 million, which was paid in cash and the remainder was provided by the issuancedelivery of 2,003,235455,877 shares of Heartland common stock and 3,000cash of $8.4 million.

During the first quarter of 2017, 333 shares of newly issuedthe Heartland Series D convertible preferred stock. In addition,stock issued in the CIC Bancshares, Inc. acquisition were converted into 13,283 shares of Heartland assumedcommon stock, and $167,000 of the convertible notes and subordinated debt totaling approximately $7.9 million. Simultaneous with closingassumed in the acquisition were converted into 6,128 shares of the transaction, Centennial Bank merged into Heartland’s Summit Bank & Trust subsidiary, with the resulting institution operating under the name Centennial Bank and Trust.Heartland common stock.

Common stockholders' equity was $665.8$780.4 million at March 31, 2016,2017, compared to $581.5$739.6 million at December 31, 2015.2016. Book value per common share was $27.15$29.26 at March 31, 2016,2017, compared to $25.92$28.31 at year-end 2015.2016. Changes in common stockholders' equity and book value per common share are the result of earnings, dividends paid, stock transactions and mark-to-market adjustment for unrealized gains and losses on securities available for sale and derivative instruments. Heartland had unrealized gainslosses on securities available for sale, and derivative instruments, net of applicable taxes, of $1.9$28.4 million at March 31, 2016,2017, compared to unrealized losses of $4.1$30.2 million at December 31, 2015.2016.

COMMITMENTS AND CONTRACTUAL OBLIGATIONS

Commitments and Contractual Obligations
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Heartland's bank subsidiaries evaluate the creditworthiness of customers to which they extend a credit commitment on a case-by-case basis and may require collateral to secure any credit extended. The amount of collateral obtained is based upon management's credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. Standby letters of



credit and financial guarantees are conditional commitments issued by Heartland's bank subsidiaries to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. At March 31, 2016,2017, and December 31, 2015,2016, commitments to extend credit aggregated $1.77$1.58 billion and $1.56$1.57 billion, and standbyrespectively. Standby letters of credit aggregated $51.8$45.9 million at March 31, 2017 and $55.4$46.1 million respectively.at December 31, 2016.

Contractual obligations and other commitments were disclosed in Heartland's Annual Report on Form 10-K for the year ended December 31, 2015. As part of the CIC Bancshares, Inc. transaction completed on February 5, 2016, Heartland assumed $2.0 million of subordinated convertible notes and $5.9 million of subordinated debentures.2016. Except for the commitments with respect to the CIC Bancshares,Citywide Banks of Colorado, Inc. acquisition described below, there have been no material changes in Heartland's contractual obligations and other commitments since that report was filed.

On February 13, 2017, Heartland entered into a definitive merger agreement with Citywide Banks of Colorado, Inc., parent company of Citywide Banks, headquartered in Aurora, Colorado. Under the terms of the definitive merger agreement, Heartland will acquire Citywide Banks of Colorado Inc., in a transaction valued at approximately $203.0 million as of the announcement date, subject to certain adjustments. Citywide Banks of Colorado, Inc. common shareholders will receive a combination of Heartland common stock and cash. The transaction is subject to customary closing conditions, including approval by shareholders of Citywide Banks of Colorado, Inc., and bank regulatory authorities. The transaction is also subject to Heartland stockholders approving an increase in the number of authorized shares of Heartland common stock at the 2017 annual meeting of stockholders. The transaction is expected to close in the third quarter of 2017, and simultaneous with the closing, Citywide Banks will merge into Heartland's Centennial Bank and Trust subsidiary. The combined entity will operate as Citywide Banks.

On a consolidated basis, Heartland maintains a large balance of short-term securities that, when combined with cash from operations, Heartland believes are adequate to meet its funding obligations.

At the parent company level, routine funding requirements consist primarily of dividends paid to stockholders, debt service on revolving credit arrangements and trust preferred securities issuances, debt repayment requirements under other debt obligations and payments for acquisitions. The parent company obtains the funding to meet these obligations from dividends collected frompaid by its bank subsidiaries and the issuance of debt and equity securities. At March 31, 2016,2017, Heartland’s revolving credit agreement with an unaffiliated bank provided a maximum borrowing capacity of $20.0 million, of which $15.0 millionno balance was outstanding. Heartland also has a non-revolving credit line with the same unaffiliated bank that provides borrowing capacity not to exceed $50.0 million when combined with the outstanding balance on Heartland's existing amortizing term loan with the same unaffiliated bank. At March 31, 2016, $40.02017, $27.1 million was outstandingavailable on this non-revolving credit line and an additional borrowing capacity of $1.4 million was available.line. These credit agreements containscontain specific financial covenants, all of which Heartland was in compliance with as of March 31, 2016.2017.

The ability of Heartland to pay dividends to its stockholders is dependent upon dividends paid by its subsidiaries. The bank subsidiaries are subject to statutory and regulatory restrictions on the amount they may pay in dividends. To maintain acceptable capital ratios in Heartland's bank subsidiaries, certain portions of their retained earnings are not available for the payment of dividends.

Heartland continues to explore opportunities to expand its footprint of independent community banks. GivenIn the current issues in the banking industry environment, Heartland has changed its strategicseeks these opportunities for growth initiatives from establishing de novo banks and branching tothrough acquisitions. Heartland is primarily focused on possible acquisitions in the markets it currently serves, in which there would be an opportunity to growincrease market share, achieve efficiencies and provide greater convenience for current customers. Future expenditures relating to expansion efforts, in addition to those identified above, cannot be estimated at this time.


Derivative Financial Instruments

Heartland enters into mortgage banking derivatives, which are classified as free standing derivatives. These derivatives include interest rate lock commitments provided to customers to fund certain mortgage loans to be sold into the secondary market and forward commitments for the future delivery of such loans. We enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future interest rate changes on the commitments to fund these loans and on the residential mortgage loans held as available for sale. See Note 7 to the consolidated financial statements include in this Quarterly Report on Form 10-Q for additional information on our derivative financial instruments.

LIQUIDITY

Liquidity refers to Heartland's ability to maintain cash flow that is adequate to meet maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund operations and to provide for customers' credit needs. The liquidity of Heartland principally depends on cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and its ability to borrow funds in the money or capital markets.




Operating activities provided $22.9cash of $33.8 million during the first three months of 2017 compared to providing cash of $24.4 million of cash during the first three months of 2016. In contrast, operating activities used $18.2 million of cash during the first three months of 2015. The largest factor in this change was the activity in loans originated for sale and the proceeds on sales of loans held for sale, which provided cash of $12.3 million during the first three months of 2017 compared to the use of $1.8 million in cash during the first three months of 2016.

Investing activities provided cash of $80.4 million during the first three months of 2017 compared to providing cash of $74.1 million during the first three months of 2016. The proceeds from securities sales, paydowns and maturities were $273.5 million during the first three months of 2017 compared to $349.0 million during the first three months of 2016. Cash used for the purchase of securities totaled $313.7 million during the first three months of 2017 compared to $363.0 million during the first three months of 2016. A net change in loans provided cash of $80.9 million during the first three months of 2017 compared to providing cash of $78.5 million during the first three months of 2016. Also contributing to cash provided by investing activities was net cash and cash equivalents received in acquisitions, which totaled $33.7 million during the first three months of 2017 compared to $8.1 million during the first three months of 2016.

Financing activities used cash of $99.8 million during the first three months of 2017 compared to using cash of $224.0 million during the first three months of 2016. A net increase in demand and savings deposits provided cash of $111.6 million during the firstthree months of 2017 compared to providing cash of $1.8 million during the first three months of 2016 compared to $34.42016. A net decrease in time deposits used cash of $50.6 million during the first three months of 2015.

Investing activities provided cash of $74.4 million during the first three months of 20162017 compared to $130.4 million during the first three months of 2015. The proceeds from securities sales, paydowns and maturities were $349.0 million during the first three months of 2016 compared to $332.6 million during the first three months of 2015. Cash used for the purchase of securities totaled $363.0 million during the first three months of 2016 compared to $234.4 million during the first three months of 2015. A net change in loans and leases provided $78.5 million of cash during the first three months of 2016 compared to $25.7 million during the first three months of 2015.

Financing activities used cash of $222.9 million during the first three months of 2016 compared to $74.4 million during the first three months of 2015. The net increase in demand and savings deposits provided cash of $1.8 million during the first three months of 2016 compared to providing $90.1 million during the first three months of 2015, while the net decrease in time deposits usedusing cash of $131.4 million during the first three months of 2016 compared to $25.62016. Short-term borrowings activity, including short-term FHLB activity, used cash of $151.4 million during the first three months of 2015. Short-term borrowings activity used2017 compared to using cash of $3.9 million during the first three months of 2016 compared to using $95.82016. Other borrowing activity used cash of $6.4 million of cash during the first three months of 2015. Other borrowing activity used2017 compared to using cash of $5.5 million during the first three months of 2016 compared to $40.5 million during the first three months of 2015. Also included2016. Included in the use of cash during the first three months of 2016 was thecash of $81.7 million of cash used for the redemption of Heartland's Series C Preferred Stock issued to the U.S. Treasury under the Small Business Lending Fund.Fund program.

Management of investing and financing activities, and market conditions, determine the level and the stability of net interest cash flows. Management attempts to mitigate the impact of changes in market interest rates to the extent possible, so that balance sheet growth is the principal determinant of increases in net interest cash flows.

Heartland's short-term borrowing balances are dependent on commercial cash management and smaller correspondent bank relationships, and, as a result, short-term borrowing balances will normally fluctuate. Management believes these balances, on average, to be stable sources of funds; however, management intends to rely more heavily on deposit growth and additional FHLB borrowings in the future.

In the event of short-term liquidity needs, Heartland's bank subsidiaries may purchase federal funds from each other or from correspondent banks, and may also borrow from the Federal Reserve Bank. Additionally, the bank subsidiaries’ FHLB memberships give them the ability to borrow funds for short- and long-term purposes under a variety of programs.

Heartland's revolving credit agreement with an unaffiliated bank provides a maximum borrowing capacity of $20.0 million, of with $15.0 millionwhich no balance had been drawn down at March 31, 2016.2017. Heartland also has a non-revolving credit line with the same unaffiliated bank, under which $40.0 was outstandinghad $27.1 million of borrowing capacity at March 31, 2016. The non-revolving credit line provided an additional borrowing capacity of $1.4 million at March 31, 2016.2017.





ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss arising from adverse changes in market prices and rates. Heartland's market risk is comprised primarily of interest rate risk resulting from its core banking activities of lending and deposit gathering.accepting deposits. Interest rate risk measures the impact on earnings from changes in interest rates and the effect on the current fair market values of Heartland's assets, liabilities and off-balance sheet contracts. TheHeartland's objective is to measure this risk and manage theits balance sheet to avoid unacceptable potential for economic loss.

Management continually develops and applies strategies to mitigate market risk. Exposure to market risk is reviewed on a regular basis by the asset/liability committees of the banksHeartland's bank subsidiaries and, on a consolidated basis, by Heartland's executive management and board of directors. Darling Consulting Group, Inc. has been engaged to provide asset/liability management position assessment and



strategy formulation services to Heartland and its bank subsidiaries. At least quarterly, a detailed review of the balance sheet risk profile is performed for Heartland and each of its bank subsidiaries. Included in these reviews are interest rate sensitivity analyses, which simulate changes in net interest income in response to various interest rate scenarios. These analyses consider current portfolio rates, existing maturities, repricing opportunities and market interest rates, in addition to prepayments and growth under different interest rate assumptions. Selected strategies are modeled prior to implementation to determine their effect on Heartland's interest rate risk profile and net interest income. Heartland believes its primary market risk exposures did not change significantly in the first three months of 2016.2017.

The core interest rate risk analysis utilized by Heartland examines the balance sheet under increasing and decreasing interest rate scenarios that are neither too modest nor too extreme. All rate changes are ramped over a 12-month horizon based upon a parallel shift in the yield curve and then maintained at those levels over the remainder of the simulation horizon. Using this approach, management is able to see the effect that both a gradual change of rates (year 1) and a rate shock (year 2 and beyond) could have on Heartland's net interest income. Starting balances in the model reflect actual balances on the “as of” date, adjusted for material and significant transactions. Pro-forma balances remain static. This methodology enables interest rate risk embedded within the existing balance sheet structure to be isolated from the interest rate risk often caused by growth in assets and liabilities. Due to the low interest rate environment, the simulations under a decreasing interest rate scenario were prepared using a 100 basis point shift in rates. The most recent reviews at March 31, 2016,2017, and March 31, 2015,2016, provided the following results, in thousands:
2016 20152017 2016
Net Interest
Margin
 
% Change
From Base
 
Net Interest
Margin
 
% Change
From Base
Net Interest
Margin
 
% Change
From Base
 
Net Interest
Margin
 
% Change
From Base
Year 1              
Down 100 Basis Points$277,416
 (2.76)% $202,855
 (2.37)%$288,697
 (2.40)% $277,416
 (2.76)%
Base$285,293
   $207,778
  $295,788
   $285,293
  
Up 200 Basis Points$281,351
 (1.38)% $202,708
 (2.44)%$299,112
 1.12 % $281,351
 (1.38)%
Year 2       
       
Down 100 Basis Points$266,563
 (6.57)% $193,859
 (6.70)%$270,796
 (8.45)% $266,563
 (6.57)%
Base$287,656
 0.83 % $207,469
 (0.15)%$293,625
 (0.73)% $287,656
 0.83 %
Up 200 Basis Points$289,691
 1.54 % $207,638
 (0.07)%$310,771
 5.07 % $289,691
 1.54 %

Heartland uses derivative financial instruments to manage the impact of changes in interest rates on its future interest income or interest expense. Heartland is exposed to credit-related losses in the event of nonperformance by the counterparties to these derivative instruments, but believes it has minimized the risk of these losses by entering into the contracts with large, stable financial institutions. The estimated fair market values of these derivative instruments are presented in Note 7 to the consolidated financial statements.statements included in this Quarterly Report on Form 10-Q.

Heartland enters into financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend funds to a customer as long as there is no violation of any condition established in the contract relating to the commitment. Commitments generally have fixed expiration dates and may require collateral from the borrower. Standby letters of credit are conditional commitments issued by Heartland to guarantee the performance of a customer to a third party up to a stated amount and subject to specified terms and conditions. These commitments to extend credit and standby letters of credit are not recorded on the balance sheet until the loan is made or the letter or credit is issued.




Heartland periodically holds a securities trading portfolio that would also be subject to elements of market risk. These securities are carried on the balance sheet at fair value. At both March 31, 2016,2017, and December 31, 2015,2016, Heartland held no securities in its securities trading portfolio.

ITEM 4. CONTROLS AND PROCEDURES

UnderBased on an evaluation, as of the directionend of ourthe period covered by this quarterly report on Form 10-Q, under the supervision and with the participation of Heartland's management, including its Chief Executive Officer and Chief Financial Officer, wethe Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of ourconcluded that Heartland's disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as ofwere effective. During the quarter ended March 31, 2016. Based on that evaluation, our management, including the Chief Executive Officer2017, there have been no changes in Heartland's internal controls over financial reporting (as defined in Rules 13a-15(f) and Chief Financial Officer, concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit15d-15(f) under the Securities Exchange Act



of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, in a manner that allows timely decisions regarding required disclosure.

There were no significant changes to Heartland's disclosure controls or internal controls over financial reporting during the quarter ended March 31, 2016,amended) that have materially affected, or are reasonably likely to materially affect, Heartland's internal control over financial reporting.



PART II

ITEM 1. LEGAL PROCEEDINGS

There are no material pending legal proceedings to which Heartland or its subsidiaries are a party other than ordinary routine litigation incidental to their respective businesses. While the ultimate outcome of current legal proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these legal actions should not have a material effect on Heartland's consolidated financial position or results of operations.

ITEM 1A. RISK FACTORS

There have been no material changes in the risk factors applicable to Heartland from those disclosed in Part I, Item 1A. “Risk Factors” in Heartland's 20152016 Annual Report on Form 10-K. Please refer to that section of Heartland's Form 10-K report for disclosures regarding the risks and uncertainties related to Heartland's business.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Heartland's board of directors has authorized management to acquire and hold up to 500,000 shares of common stock as treasury shares at any one time. Heartland and its affiliated purchasers made no purchases of its common stock during the three months ended March 31, 2016.2017.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

ITEM 5. OTHER INFORMATION

None.None




ITEM 6. EXHIBITS

Exhibits

10.1
(1)(2) 
10.2
(1)(2)
10.210.3
(1)(2) 
10.3
(1) (2)Plan
Form of Time-Based Restricted Stock Unit Award Agreement under the Heartland Financial USA, Inc. 2012 Long-Term Incentive Plan.
31.1
(2) 
31.2
(2) 
32.1
(2) 
32.2
(2) 
101
(2)
Financial statement formatted in Extensible Business Reporting Language: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Changes in Equity, and (vi) the Notes to Consolidated Financial Statements.
 
(1) Management contracts or compensatory plans or agreements.
(2) Filed herewith

(1) Management contracts or compensatory plans or arrangements.
(2) Filed herewith.



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.



HEARTLAND FINANCIAL USA, INC.
(Registrant)
 
 
/s/ Lynn B. Fuller
By: Lynn B. Fuller
Chairman and Chief Executive Officer
(Principal Executive Officer and Duly Authorized Officer)
 
 
/s/ Bryan R. McKeag
By: Bryan R. McKeag
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Duly Authorized Officer)
 
 
/s/ Janet M. Quick
By: Janet M. Quick
Executive Vice President and Deputy Chief Financial Officer
(Principal Accounting Officer and Duly Authorized Officer)
 
Dated: May 6, 20165, 2017