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,September 30, 2019
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For transition period from __________ 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) 589-2100
(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 every Interactive Data File required to be submitted 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, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filerx
Accelerated Filer¨
Non-accelerated filer¨
Smaller reporting company¨
Emerging growth 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 Exchange Act). Yes oNo x


Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common Stock, par value $1.00 per shareHTLFNasdaq Stock Market

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 6,November 4, 2019, the Registrant had outstanding 34,604,46236,698,445 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








PART I


ITEM 1. FINANCIAL STATEMENTS

HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 September 30, 2019 (Unaudited)December 31, 2018
ASSETS  
Cash and due from banks$243,395  $223,135  
Interest bearing deposits with other banks and other short-term investments204,372  50,495  
Cash and cash equivalents447,767  273,630  
Time deposits in other financial institutions3,711  4,672  
Securities: 
Carried at fair value (cost of $2,993,045 at September 30, 2019, and $2,492,620 at December 31, 2018)3,020,568  2,450,709  
Held to maturity, at cost (fair value of $97,905 at September 30, 2019, and $245,341 at December 31, 2018)87,965  236,283  
Other investments, at cost29,042  28,396  
Loans held for sale35,427  119,801  
Loans receivable: 
Held to maturity7,971,608  7,407,697  
Allowance for loan and lease losses(66,222) (61,963) 
Loans receivable, net7,905,386  7,345,734  
Premises, furniture and equipment, net195,984  187,418  
Premises, furniture and equipment held for sale3,251  7,258  
Other real estate, net6,425  6,153  
Goodwill427,097  391,668  
Core deposit intangibles and customer relationship intangibles, net49,819  47,479  
Servicing rights, net6,271  31,072  
Cash surrender value on life insurance171,471  162,892  
Other assets179,078  114,841  
TOTAL ASSETS$12,569,262  $11,408,006  
LIABILITIES AND EQUITY  
LIABILITIES:  
Deposits:  
Demand$3,581,127  $3,264,737  
Savings5,770,754  5,107,962  
Time1,117,975  1,023,730  
Total deposits10,469,856  9,396,429  
Deposits held for sale—  106,409  
Short-term borrowings107,853  227,010  
Other borrowings278,417  274,905  
Accrued expenses and other liabilities149,293  78,078  
TOTAL LIABILITIES11,005,419  10,082,831  
STOCKHOLDERS' EQUITY:  
Preferred stock (par value $1 per share; authorized 17,604 shares; 0ne issued or outstanding at both September 30, 2019, and December 31, 2018)—  —  
Series A Junior Participating preferred stock (par value $1 per share; authorized 16,000 shares; 0ne issued or outstanding at both September 30, 2019, and December 31, 2018)—  —  
Series C Senior Non-Cumulative Perpetual Preferred Stock (par value $1 per share; 81,698 shares authorized at both September 30, 2019, and December 31, 2018, 0ne issued or outstanding at both September 30, 2019, and December 31, 2018)—  —  
Series D Senior Non-Cumulative Perpetual Convertible Preferred Stock (par value $1 per share; 3,000 shares authorized at both September 30, 2019, and December 31, 2018; 0ne issued or outstanding at both September 30, 2019, and December 31, 2018)—  —  
Common stock (par value $1 per share; 60,000,000 shares authorized at September 30, 2019, and 40,000,000 shares authorized at December 31, 2018; issued 36,696,190 shares at September 30, 2019, and 34,477,499 shares at December 31, 2018)36,696  34,477  
Capital surplus838,543  743,095  
Retained earnings670,816  579,252  
Accumulated other comprehensive income/(loss)17,788  (31,649) 
TOTAL STOCKHOLDERS' EQUITY1,563,843  1,325,175  
TOTAL LIABILITIES AND EQUITY$12,569,262  $11,408,006  
See accompanying notes to consolidated financial statements.





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
   
 March 31, 2019 (Unaudited) December 31, 2018
ASSETS   
Cash and due from banks$174,198
 $223,135
Interest bearing deposits with other banks and other short-term investments318,303
 50,495
Cash and cash equivalents492,501
 273,630
Time deposits in other financial institutions4,675
 4,672
Securities:  
Carried at fair value (cost of $2,415,641 at March 31, 2019, and $2,492,620 at December 31, 2018)2,400,460
 2,450,709
Held to maturity, at cost (fair value of $95,240 at March 31, 2019, and $245,341 at December 31, 2018)88,089
 236,283
Other investments, at cost27,506
 28,396
Loans held for sale69,716
 119,801
Loans receivable:  
Held to maturity7,331,544
 7,407,697
Allowance for loan and lease losses(62,639) (61,963)
Loans receivable, net7,268,905
 7,345,734
Premises, furniture and equipment, net183,185
 187,418
Premises, furniture and equipment held for sale7,030
 7,258
Other real estate, net5,391
 6,153
Goodwill391,668
 391,668
Core deposit intangibles and customer relationship intangibles, net44,637
 47,479
Servicing rights, net28,968
 31,072
Cash surrender value on life insurance163,764
 162,892
Other assets136,000
 114,841
TOTAL ASSETS$11,312,495
 $11,408,006
LIABILITIES AND EQUITY   
LIABILITIES:   
Deposits:   
Demand$3,118,909
 $3,264,737
Savings5,145,929
 5,107,962
Time1,088,104
 1,023,730
Total deposits9,352,942
 9,396,429
Deposits held for sale118,564
 106,409
Short-term borrowings104,314
 227,010
Other borrowings268,312
 274,905
Accrued expenses and other liabilities96,261
 78,078
TOTAL LIABILITIES9,940,393
 10,082,831
STOCKHOLDERS' EQUITY:   
Preferred stock (par value $1 per share; authorized 17,604 shares; none issued or outstanding at both March 31, 2019, and December 31, 2018)
 
Series A Junior Participating preferred stock (par value $1 per share; authorized 16,000 shares; none issued or outstanding at both March 31, 2019, and December 31, 2018)
 
Series C Senior Non-Cumulative Perpetual Preferred Stock (par value $1 per share; 81,698 shares authorized at both March 31, 2019, and December 31, 2018, none issued or outstanding at both March 31, 2019, and December 31, 2018)
 
Series D Senior Non-Cumulative Perpetual Convertible Preferred Stock (par value $1 per share; 3,000 shares authorized at both March 31, 2019, and December 31, 2018; none issued or outstanding at both March 31, 2019, and December 31, 2018)
 
Common stock (par value $1 per share; 40,000,000 shares authorized at both March 31, 2019, and December 31, 2018; issued 34,603,611 shares at March 31, 2019, and 34,477,499 shares at December 31, 2018)34,604
 34,477
Capital surplus745,596
 743,095
Retained earnings603,506
 579,252
Accumulated other comprehensive loss(11,604) (31,649)
TOTAL STOCKHOLDERS' EQUITY1,372,102
 1,325,175
TOTAL LIABILITIES AND EQUITY$11,312,495
 $11,408,006
    
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
September 30,
Nine Months Ended
September 30,
 2019201820192018  
INTEREST INCOME:  
Interest and fees on loans$110,566  $105,733  $317,049  $288,171  
Interest on securities:
Taxable18,567  14,433  50,566  38,280  
Nontaxable2,119  3,490  7,766  10,653  
Interest on federal funds sold—  —   —  
Interest on interest bearing deposits in other financial institutions2,151  1,238  5,742  2,413  
TOTAL INTEREST INCOME133,403  124,894  381,127  339,517  
INTEREST EXPENSE: 
Interest on deposits17,982  10,092  47,333  23,841  
Interest on short-term borrowings250  464  1,477  1,279  
Interest on other borrowings (includes $24 and $242 of interest expense related to derivatives reclassified from accumulated other comprehensive income for the three months ended September 30, 2019 and 2018, respectively, and $276 and $469 of interest expense related to derivatives reclassified from accumulated other comprehensive income for the nine months ended September 30, 2019 and 2018, respectively)3,850  3,660  11,333  10,726  
TOTAL INTEREST EXPENSE22,082  14,216  60,143  35,846  
NET INTEREST INCOME111,321  110,678  320,984  303,671  
Provision for loan losses5,201  5,238  11,754  14,332  
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES106,120  105,440  309,230  289,339  
NONINTEREST INCOME: 
Service charges and fees12,366  12,895  39,789  35,046  
Loan servicing income821  1,670  3,888  5,231  
Trust fees4,959  4,499  14,258  13,794  
Brokerage and insurance commissions962  1,111  2,724  2,895  
Securities gains/(losses), net (includes $2,013 of net security gains and $(145) of net security losses reclassified from accumulated other comprehensive income for the three months ended September 30, 2019 and 2018, respectively and $7,168 and $1,037 of net security gains reclassified from accumulated other comprehensive income for the nine months ended September 30, 2019 and 2018, respectively)2,013  (145) 7,168  1,037  
Unrealized gain on equity securities, net144  54  514  97  
Net gains on sale of loans held for sale4,673  7,410  12,192  18,261  
Valuation allowance on servicing rights(626) 230  (1,579) 12  
Income on bank owned life insurance881  892  2,668  2,206  
Other noninterest income3,207  1,149  6,556  3,536  
TOTAL NONINTEREST INCOME29,400  29,765  88,178  82,115  
NONINTEREST EXPENSES: 
Salaries and employee benefits50,027  49,921  150,307  149,389  
Occupancy6,594  6,348  19,637  18,706  
Furniture and equipment2,858  3,470  8,770  9,403  
Professional fees12,131  12,800  38,478  32,880  
Advertising2,737  2,754  7,723  6,839  
Core deposit intangibles and customer relationship intangibles amortization2,899  2,626  9,054  6,763  
Other real estate and loan collection expenses(89) 784  774  2,464  
(Gain)/loss on sales/valuations of assets, net356  912  (20,934) 2,243  
Restructuring expenses—  —  3,227  2,564  
Other noninterest expenses15,454  12,924  39,259  33,816  
TOTAL NONINTEREST EXPENSES92,967  92,539  256,295  265,067  
INCOME BEFORE INCOME TAXES42,553  42,666  141,113  106,387  
Income taxes (includes $502 and $(26) of income tax expense/(benefit) reclassified from accumulated other comprehensive income for the three months ended September 30, 2019 and 2018, respectively and $1,740 and $174 of income tax expense reclassified from accumulated other comprehensive income for the nine months ended September 30, 2019 and 2018, respectively)7,941  8,956  29,835  21,530  
NET INCOME34,612  33,710  111,278  84,857  
Preferred dividends—  (13) —  (39) 
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS$34,612  $33,697  $111,278  $84,818  
EARNINGS PER COMMON SHARE - BASIC$0.94  $0.98  $3.12  $2.61  
EARNINGS PER COMMON SHARE - DILUTED$0.94  $0.97  $3.11  $2.59  
CASH DIVIDENDS DECLARED PER COMMON SHARE$0.18  $0.14  $0.50  $0.40  
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,
 2019 2018
INTEREST INCOME:   
Interest and fees on loans$100,456
 $85,651
Interest on securities:   
Taxable15,876
 11,577
Nontaxable3,093
 3,579
Interest on federal funds sold4
 
Interest on interest bearing deposits in other financial institutions1,292
 407
TOTAL INTEREST INCOME120,721

101,214
INTEREST EXPENSE:   
Interest on deposits13,213
 5,766
Interest on short-term borrowings889
 268
Interest on other borrowings (includes $165 and $197 of interest expense related to derivatives reclassified from accumulated other comprehensive income for the three months ended March 31, 2019 and 2018, respectively)3,664
 3,596
TOTAL INTEREST EXPENSE17,766

9,630
NET INTEREST INCOME102,955

91,584
Provision for loan losses1,635
 4,263
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES101,320

87,321
NONINTEREST INCOME:   
Service charges and fees12,794
 10,079
Loan servicing income1,729
 1,754
Trust fees4,474
 4,680
Brokerage and insurance commissions734
 907
Securities gains, net (includes $1,575 and $1,441 of net security gains reclassified from accumulated other comprehensive income for the three months ended March 31, 2019 and 2018, respectively)1,575
 1,441
Unrealized gain/(loss) on equity securities, net258
 (28)
Net gains on sale of loans held for sale3,176
 4,051
Valuation allowance on servicing rights(589) (2)
Income on bank owned life insurance899
 614
Other noninterest income1,667
 1,220
TOTAL NONINTEREST INCOME26,717

24,716
NONINTEREST EXPENSES:   
Salaries and employee benefits50,285
 48,710
Occupancy6,607
 6,043
Furniture and equipment2,692
 2,749
Professional fees11,379
 9,448
Advertising2,325
 1,940
Core deposit intangibles and customer relationship intangibles amortization2,842
 1,863
Other real estate and loan collection expenses701
 732
Gain on sales/valuations of assets, net(3,004) (197)
Restructuring expenses3,227
 2,564
Other noninterest expenses11,176
 9,794
TOTAL NONINTEREST EXPENSES88,230

83,646
INCOME BEFORE INCOME TAXES39,807

28,391
Income taxes (includes $358 and $261 of income tax expense reclassified from accumulated other comprehensive income for the three months ended March 31, 2019 and 2018, respectively)8,310
 5,123
NET INCOME31,497

23,268
Preferred dividends
 (13)
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS$31,497

$23,255
EARNINGS PER COMMON SHARE - BASIC$0.91
 $0.76
EARNINGS PER COMMON SHARE - DILUTED$0.91
 $0.76
CASH DIVIDENDS DECLARED PER COMMON SHARE$0.16
 $0.13
    
See accompanying notes to consolidated financial statements.   
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
Three Months Ended
September 30,
Nine Months Ended
September 30,
2019201820192018
NET INCOME$34,612  $33,710  $111,278  $84,857  
OTHER COMPREHENSIVE INCOME/(LOSS)
Securities:
Net change in unrealized gain/(loss) on securities19,851  (8,060) 78,238  (36,395) 
Reclassification adjustment for net (gains)/losses realized in net income(2,013) 145  (7,168) (1,037) 
Income taxes(4,577) 2,078  (18,241) 9,586  
Other comprehensive income/(loss) on securities13,261  (5,837) 52,829  (27,846) 
Derivatives used in cash flow hedging relationships:
Net change in unrealized gain/(loss) on derivatives(800) 395  (4,568) 2,991  
Reclassification adjustment for net losses on derivatives realized in net income27  242  279  469  
Income taxes161  (79) 897  (682) 
Other comprehensive income/(loss) on cash flow hedges(612) 558  (3,392) 2,778  
Other comprehensive income/(loss)12,649  (5,279) 49,437  (25,068) 
TOTAL COMPREHENSIVE INCOME$47,261  $28,431  $160,715  $59,789  
See accompanying notes to consolidated financial statements.








HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
 Three Months Ended
March 31,
 2019 2018
NET INCOME$31,497
 $23,268
OTHER COMPREHENSIVE INCOME/(LOSS)   
Securities:   
Net change in unrealized gain/(loss) on securities29,965
 (19,834)
Reclassification adjustment for net gains realized in net income(1,575) (1,441)
Income taxes(7,281) 5,391
Other comprehensive income/(loss) on securities21,109
 (15,884)
Derivatives used in cash flow hedging relationships:   
Net change in unrealized gain/(loss) on derivatives(1,505) 1,699
Reclassification adjustment for net losses on derivatives realized in net income158
 197
Income taxes283
 (708)
Other comprehensive income/(loss) on cash flow hedges(1,064) 1,188
Other comprehensive income/(loss)20,045
 (14,696)
TOTAL COMPREHENSIVE INCOME$51,542
 $8,572
    
See accompanying notes to consolidated financial statements.   



HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Nine Months Ended
September 30,
 20192018
CASH FLOWS FROM OPERATING ACTIVITIES: 
Net income$111,278  $84,857  
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization23,561  22,647  
Provision for loan losses11,754  14,332  
Net amortization of premium on securities15,959  18,958  
Securities gains, net(7,168) (1,037) 
Unrealized gain on equity securities, net(514) (97) 
Stock based compensation4,833  3,689  
Loans originated for sale(289,877) (551,328) 
Proceeds on sales of loans held for sale289,769  594,529  
Net gains on sale of loans held for sale(11,545) (13,939) 
(Increase) decrease in accrued interest receivable932  (5,422) 
(Increase) decrease in prepaid expenses(3,611) 2,243  
Increase in accrued interest payable1,905  1,121  
Gain on extinguishment of debt(375) —  
Capitalization of servicing rights(756) (4,404) 
Valuation allowance on servicing rights1,579  (12) 
(Gain)/loss on sales/valuations of assets, net(10,378) 2,243  
Net excess tax benefit from stock based compensation270  672  
Other, net(40,706) (1,979) 
NET CASH PROVIDED BY OPERATING ACTIVITIES96,910  167,073  
CASH FLOWS FROM INVESTING ACTIVITIES: 
Purchase of time deposits in other financial institutions(254) (1,000) 
Proceeds from the sale of securities available for sale1,485,773  694,872  
Proceeds from the redemption of time deposits in other financial institutions—  8,767  
Proceeds from the maturity of and principal paydowns on securities available for sale265,500  172,702  
Proceeds from the maturity of and principal paydowns on securities held to maturity2,938  13,169  
Proceeds from the maturity of and principal paydowns on time deposits in other financial institutions1,215  5,829  
Proceeds from the sale, maturity of and principal paydowns on other investments10,297  2,038  
Purchase of securities available for sale(1,984,228) (940,607) 
Purchase of other investments(4,957) (2,411) 
Net increase in loans(47,023) (13,737) 
Purchase of bank owned life insurance policies(16) (2,000) 
Proceeds from bank owned life insurance policies421  —  
Proceeds from sale of mortgage servicing rights33,823  —  
Capital expenditures(8,389) (11,793) 
Net cash and cash equivalents received in acquisitions38,650  212,197  
Proceeds from the sale of equipment1,277  998  
Net cash expended in divestitures(49,264) —  
Proceeds on sale of OREO and other repossessed assets6,907  3,128  
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES$(247,330) $142,152  



HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
 
 Three Months Ended
March 31,
 2019 2018
CASH FLOWS FROM OPERATING ACTIVITIES:   
Net income$31,497
 $23,268
Adjustments to reconcile net income to net cash provided by operating activities:   
Depreciation and amortization8,155
 6,802
Provision for loan losses1,635
 4,263
Net amortization of premium on securities5,692
 5,823
Securities gains, net(1,575) (1,441)
Unrealized (gain)/loss on equity securities, net(258) 28
Stock based compensation2,375
 1,858
Loans originated for sale(61,348) (112,433)
Proceeds on sales of loans held for sale64,941
 135,506
Net gains on sale of loans held for sale(2,978) (2,889)
Decrease in accrued interest receivable682
 3,239
(Increase) decrease in prepaid expenses(1,708) 194
Increase in accrued interest payable1,261
 1,029
Capitalization of servicing rights(266) (1,183)
Valuation allowance on servicing rights589
 2
(Gain)/loss on sales/valuations of assets, net1,512
 (197)
Net excess tax benefit from stock based compensation336
 611
Other, net(16,493) (5,441)
NET CASH PROVIDED BY OPERATING ACTIVITIES34,049
 59,039
CASH FLOWS FROM INVESTING ACTIVITIES:   
Purchase of time deposits in other financial institutions(248) 
Proceeds from the sale of securities available for sale434,154
 392,246
Proceeds from the redemption of time deposits in other financial institutions
 8,767
Proceeds from the maturity of and principal paydowns on securities available for sale86,727
 49,603
Proceeds from the maturity of and principal paydowns on securities held to maturity2,156
 3,570
Proceeds from the maturity of and principal paydowns on time deposits in other financial institutions245
 4,368
Proceeds from the sale, maturity of and principal paydowns on other investments2,730
 677
Purchase of securities available for sale(299,105) (244,289)
Purchase of other investments(1,779) (644)
Net (increase) decrease in loans43,925
 (32,314)
Purchase of bank owned life insurance policies(5) 
Capital expenditures(1,123) (2,356)
Net cash and cash equivalents received in acquisitions
 5,543
Proceeds from the sale of equipment117
 615
Net cash received in divestitures28,142
 
Proceeds on sale of OREO and other repossessed assets2,537
 668
NET CASH PROVIDED BY INVESTING ACTIVITIES$298,473
 $186,454
    
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (Unaudited)
(Dollars in thousands)
Nine Months Ended
September 30,
20192018
CASH FLOWS FROM FINANCING ACTIVITIES: 
Net increase in demand deposits$159,044  $156,497  
Net increase in savings deposits347,749  130,704  
Net decrease in time deposit accounts(397) (122,795) 
Proceeds on short-term revolving credit line—  25,000  
Repayments on short-term revolving credit line—  (25,000) 
Net decrease in short-term borrowings(43,733) (183,552) 
Proceeds from short term FHLB advances430,888  355,602  
Repayments of short term FHLB advances(531,725) (365,602) 
Proceeds from other borrowings50  30,131  
Repayments of other borrowings(17,769) (56,221) 
Payment for the redemption of debt(2,125) —  
Purchase of treasury stock—  (97) 
Proceeds from issuance of common stock576  286  
Dividends paid(18,001) (12,806) 
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES324,557  (67,853) 
Net increase in cash and cash equivalents174,137  241,372  
Cash and cash equivalents at beginning of year273,630  196,003  
CASH AND CASH EQUIVALENTS AT END OF PERIOD$447,767  $437,375  
Supplemental disclosures: 
Cash paid for income/franchise taxes$30,523  $14,754  
Cash paid for interest$58,297  $34,725  
Loans transferred to OREO$7,421  $5,016  
Transfer of premises from premises, furniture and equipment, net, to premises, furniture and equipment held for sale$2,568  $3,415  
Transfer of premises from premises, furniture and equipment held for sale to premises, furniture and equipment, net,$1,564  $—  
Deposits transferred to held for sale$76,968  $50,312  
Loans transferred to held for sale$32,111  $31,379  
Securities transferred from held to maturity to available for sale$148,030  $—  
Purchases of securities available for sale, accrued, not settled$22,879  $3,481  
Conversion of Series D preferred stock to common stock$—  $938  
Stock consideration granted for acquisitions$92,258  $238,075  
See accompanying notes to consolidated financial statements.








HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (Unaudited)
(Dollars in thousands)
   
 Three Months Ended
March 31,
 2019 2018
CASH FLOWS FROM FINANCING ACTIVITIES:   
Net increase/(decrease) in demand deposits$(131,876) $5,834
Net increase in savings deposits74,016
 100,608
Net (increase) decrease in time deposit accounts75,141
 (69,143)
Proceeds on short-term revolving credit line
 15,000
Net decrease in short-term borrowings(43,000) (168,451)
Proceeds from short term FHLB advances430,888
 220,000
Repayments of short term FHLB advances(506,725) (260,000)
Proceeds from other borrowings50
 
Repayments of other borrowings(6,868) (14,995)
Purchase of treasury stock
 (97)
Proceeds from issuance of common stock253
 14
Dividends paid(5,530) (3,920)
NET CASH USED BY FINANCING ACTIVITIES(113,651) (175,150)
Net increase in cash and cash equivalents218,871
 70,343
Cash and cash equivalents at beginning of year273,630
 196,003
CASH AND CASH EQUIVALENTS AT END OF PERIOD$492,501
 $266,346
Supplemental disclosures:   
Cash paid for income/franchise taxes$84
 $2
Cash paid for interest$16,537
 $8,601
Loans transferred to OREO$1,694
 $939
Transfer of premises from premises, furniture and equipment, net, to premises, furniture and equipment held for sale$654
 $
Deposits transferred to held for sale$76,968
 $
Loans transferred to held for sale$32,111
 $
Securities transferred from held to maturity to available for sale$148,030
 $
Purchases of securities available for sale, accrued, not settled$2,019
 $
Maturity of securities available for sale, accrued, not settled$1,000
 $
Stock consideration granted for acquisitions$
 $53,621
    
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. Stockholders' Equity
 Preferred
Stock
Common
Stock
Capital
Surplus
Retained
Earnings
Accumulated Other Comprehensive Income (Loss)Treasury
Stock
Total
Equity
Balance at June 30, 2018$938  $34,438  $740,128  $524,786  $(44,543) $—  $1,255,747  
Comprehensive income33,710  (5,279) 28,431  
Cash dividends declared:
Series D Preferred, $17.50 per share(13) (13) 
Common, $0.14 per share(4,821) (4,821) 
Conversion of Series D Preferred Stock(938) (938) 
Issuance of 34,584 shares of common stock35  1,033  1,068  
Stock based compensation919  919  
Balance at September 30, 2018$—  $34,473  $742,080  $553,662  $(49,822) $—  $1,280,393  
Balance at January 1, 2018$938  $29,953  $503,709  $481,331  $(24,474) $—  $991,457  
Comprehensive income84,857  (25,068) 59,789  
Reclassification of unrealized net gain on equity securities280  (280) —  
Cash dividends declared:
Series D Preferred, $52.50 per share(39) (39) 
Common, $0.40 per share(12,767) (12,767) 
Conversion of Series D Preferred Stock(938) (938) 
Purchase of 1,761 shares of common stock(97) (97) 
Issuance of 4,521,434 shares of common stock4,520  234,682  97  239,299  
Stock based compensation3,689  3,689  
Balance at September 30, 2018$—  $34,473  $742,080  $553,662  $(49,822) $—  $1,280,393  
Balance at June 30, 2019$—  $36,690  $837,150  $642,808  $5,139  $—  $1,521,787  
Comprehensive income$34,612  $12,649  47,261  
Cash dividends declared:
Common, $0.18 per share(6,604) (6,604) 
Issuance of 6,129 shares of common stock 162  168  
Stock based compensation1,231  1,231  
Balance at September 30, 2019$—  $36,696  $838,543  $670,816  $17,788  $—  $1,563,843  
Balance at January 1, 2019$—  $34,477  $743,095  $579,252  $(31,649) $—  $1,325,175  
Comprehensive income111,278  49,437  160,715  
Retained earnings adjustment for adoption of leasing standard(1,713) (1,713) 
Cash dividends declared:
Common, $0.50 per share(18,001) (18,001) 
Issuance of 2,218,691 shares of common stock2,219  90,615  92,834  
Stock based compensation4,833  4,833  
Balance at September 30, 2019$—  $36,696  $838,543  $670,816  $17,788  $—  $1,563,843  
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. Stockholders' Equity 
 
Preferred
 Stock
 
Common
 Stock
 
Capital
 Surplus
 
Retained
 Earnings
 Accumulated Other Comprehensive Income (Loss) 
Treasury
Stock
 
Total
 Equity
Balance at January 1, 2018$938
 $29,953
 $503,709
 $481,331
 $(24,474) $
 $991,457
Comprehensive income

 





23,268
 (14,696)



8,572
Reclassification of unrealized net gain on equity securities

 





280
 (280)




Cash dividends declared:

 

 

 

 

 

  
Series D Preferred, $17.50 per share      (13)     (13)
Common, $0.13 per share

 





(3,907) 





(3,907)
Purchase of 1,761 shares of common stock

 







 


(97)
(97)
Issuance of 1,116,644 shares of common stock

 1,115

52,423



 


97

53,635
Stock based compensation

 


1,858



 





1,858
Balance at March 31, 2018$938
 $31,068
 $557,990
 $500,959
 $(39,450) $
 $1,051,505
Balance at January 1, 2019$
 $34,477
 $743,095
 $579,252
 $(31,649) $
 $1,325,175
Comprehensive income      31,497
 20,045
 

 51,542
Retained earnings adjustment for adoption of leasing standard      (1,713)     (1,713)
Cash dividends declared:        

 

 

Common, $0.16 per share   
 
(5,530) 





(5,530)
Issuance of 126,112 shares of common stock  127

126
 

 





253
Stock based compensation   
2,375



 





2,375
Balance at March 31, 2019$
 $34,604
 $745,596
 $603,506
 $(11,604) $
 $1,372,102
              
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, 2018, included in the Form 10-K of Heartland Financial USA, Inc. ("Heartland") filed with the Securities and Exchange Commission ("SEC") on February 27, 2019. Footnote disclosures to the interim unaudited consolidated financial statements which would substantially duplicate the disclosure contained in the footnotes to 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,September 30, 2019, are not necessarily indicative of the results expected for the year ending December 31, 2019.


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-monththree- and nine-month periods ended March 31,September 30, 2019, and 2018, are shown in the table below:

Three Months Ended
September 30,
(Dollars and number of shares in thousands, except per share data)20192018
Net income$34,612  $33,710  
Preferred dividends—  (13) 
Net income available to common stockholders$34,612  $33,697  
Weighted average common shares outstanding for basic earnings per share36,692  34,452  
Assumed incremental common shares issued upon vesting of outstanding restricted stock units143  192  
Weighted average common shares for diluted earnings per share36,835  34,644  
Earnings per common share — basic$0.94  $0.98  
Earnings per common share — diluted$0.94  $0.97  
Number of antidilutive common stock equivalents excluded from diluted earnings per share computation —  
Nine Months Ended
September 30,
(Dollars and number of shares in thousands, except per share data)20192018
Net income$111,278  $84,857  
Preferred dividends—  (39) 
Net income available to common stockholders$111,278  $84,818  
Weighted average common shares outstanding for basic earnings per share35,675  32,520  
Assumed incremental common shares issued upon vesting of outstanding restricted stock units143  187  
Weighted average common shares for diluted earnings per share35,818  32,707  
Earnings per common share — basic$3.12  $2.61  
Earnings per common share — diluted$3.11  $2.59  
Number of antidilutive common stock equivalents excluded from diluted earnings per share computation —  




 Three Months Ended
March 31,
(Dollars and number of shares in thousands, except per share data)2019 2018
Net income$31,497
 $23,268
Preferred dividends
 (13)
Net income available to common stockholders$31,497
 $23,255
Weighted average common shares outstanding for basic earnings per share34,564
 30,442
Assumed incremental common shares issued upon vesting of outstanding restricted stock units136
 203
Weighted average common shares for diluted earnings per share34,700
 30,645
Earnings per common share — basic$0.91
 $0.76
Earnings per common share — diluted$0.91
 $0.76
Number of antidilutive common stock equivalents excluded from diluted earnings per share computation2
 

Subsequent Events - Heartland has evaluated subsequent events that may require recognition or disclosure through the filing date of this Quarterly Report on Form 10-Q with the SEC. On April 26, 2019, Heartland signed an agreement to sell the mortgage servicing rights portfolio of Dubuque Bank and Trust Company, and the transaction closed on April 30, 2019. See Note 6, "Goodwill, Core Deposit Premium and Other Intangible Assets," for further details on this transaction.


Effect of New Financial Accounting Standards


In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." Topic 842 requires a lessee to recognize leases on-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 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 is applied on a modified retrospective basis. Heartland leases certain properties and equipment under operating leases that will resultresulted 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. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase



the underlying asset. Early adoption is permitted. In January 2018, the FASB issued an amendment to provide entities with the optional practical expedient to not evaluate existing or expired land easements that were previously not accounted for as leases under Topic 840. In July 2018, the FASB issued ASU 2018-11, "Leases - Targeted Improvements" to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, Specifically, under the amendments in ASU 2018-11, entities may elect not to recast the comparative periods presented when transitioning to the new leasing standard, and lessors may elect not to separate lease and non-lease components when certain conditions are met. The amendments have the same effective date as ASU 2016-02. Heartland adopted the accounting standard on January 1, 2019, on a modified retrospective basis, as required, and willhas not restaterestated comparative periods. Heartland adopted the practical expedients, which allow for existing leases to be accounted for under previous guidance with the exception of balance sheet recognition for lessees. The adoption of the new standard resulted in the recording of ROU assets and lease liabilities of approximately $25.9 million and $27.6 million, respectively, on January 1, 2019. The difference between the lease assets and lease liabilities, which was $1.7 million, was recorded as an adjustment to retained earnings. The adoption of the standard did not impact Heartland's results of operations or liquidity. See Note 11, "Leases", for more information on Heartland's leases.


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. In April 2019, the FASB also issued ASU 2019-04, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments." As it relates to current expected credit losses, this guidance amends certain provisions contained in ASU 2016-13, particularly with regards to the inclusion of accrued interest in the definition of amortized cost, as well as clarifying the extension and renewal options that are not unconditionally cancelable by the entity that are included in the original or modified contract should be considered in the entity's determination of expected credit losses. Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective. Heartland has formed an internal committee to assess and implement the standard. During 2018, Heartland has entered into an agreement with a third party vendor to evaluate potential methodologiesfor consulting services and dataa technology solution. The technology solution implementation has been completed, and Heartland has started designing its financial modelsproduced two parallel runs for the first two quarters of 2019 excluding economic forecasting to estimate creditthe impact of this new guidance.

Prior to the end of 2019, management will continue to prepare parallel calculations to compare the existing allowance for loan losses in accordance with theto this new standard. Further development, testingguidance. Additionally, management expects to complete data validation and evaluationdocumentation of the models is requiredaccounting policies and internal controls related to determine the impact thatstandard. Heartland has also entered into an agreement to have its new model validated by a third party prior to January 1, 2020. Further review and refinement of the economic forecasting, as well as the model and methodologies, will continue in preparation for the adoption of thisthe standard will have on Heartland's results of operations, financial position and liquidity.January 1, 2020.





In January 2017, the FASB issued ASU 2017-04, "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 cannot 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 is 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, 2020, 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 require 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 the amendments in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes the interim period. The amendments must be applied and Heartland intends to apply these amendments on a modified retrospective basis, with a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Heartland adopted this ASU on January 1, 2019, as required, and the adoption did not have a material impact on its results of operations, financial position and liquidity.


In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging:Targeted Improvements to Accounting for Hedging Activities." The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. ASU 2017-12 is effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. For a closed portfolio of prepayable



financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, this ASU permits an entity to designate an amount that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows (the “last-of-layer”"last-of-layer" method). Under this designation, prepayment risk is not incorporated into the measurement of the hedged item. ASU 2017-12 requires a modified retrospective transition method in which Heartland will recognize the cumulative effect of the change on the opening balance of each affected component of equity on the balance sheet as of the date of adoption. Heartland adopted this ASU on January 1, 2019, as required, and as a result of the adoption, $148.0 million of held to maturity securities were reclassified to available for sale debt securities carried at fair value. See Note 3, "Securities," for further details. There was no impact to Heartland's results of operations, or liquidity as a result of the adoption of this amendment.


In August 2018, the FASB issued ASU 2018-13, "Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement." This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019, and early adoption is permitted. Heartland intends to adopt this ASU in 2020, as required, and because the ASU only revises disclosure requirements, the adoption of this ASU is not expected to have a material impact on results of operations, financial position and liquidity.


In August 2018, the FASB issued ASU 2018-15, "Intangible-Goodwill and Other-Internal Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract." The amendment aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments in this update require an entity in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. The amendments also require the entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The amendment is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, and the amendment can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption was permitted. Heartland early adopted this ASU using the prospective approach in the second quarter of 2019, and the adoption did not have a material impact on its results of operations, financial position and liquidity.




In October 2018, the FASB issued ASU 2018-16, "Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting."  In the United States, eligible benchmark interest rates under Topic 815 are interest rates on direct Treasury obligations of the U.S. government ("UST"), the London Interbank Offered Rate ("LIBOR") swap rate, and the Overnight Index Swap ("OIS") Rate based on the Fed Funds Effective Rate. When the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, in August 2017, it introduced the Securities Industry and Financial Markets Association ("SIFMA") Municipal Swap Rate as the fourth permissible U.S. benchmark rate. The new ASU adds the OIS rate based on the Secured Overnight Financing Rate ("SOFR") as a U.S. benchmark interest rate to facilitate the LIBOR to SOFR transition and provide sufficient lead time for entities to prepare for changes to interest rate risk hedging strategies for both risk management and hedge accounting purposes. The amendments in this update became effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years and the financial statement impact immediately upon adoption was immaterial.  The future financial statement impact will depend on any new contracts entered into using new benchmark rates, as well as any existing contracts that get migrated from LIBOR to new benchmark interest rates. Heartland is currently evaluating the impact of the transition from LIBOR as an interest rate benchmark to other potential alternative reference rates, including but not limited to the SOFR. Currently, Heartland has adjustable rate loans, several debt obligations and derivative instruments in place that reference LIBOR-based rates. The transition from LIBOR is estimated to take place at the end of 2021, and management will continue to actively assess the related opportunities and risks involved in this transition.



NOTE 2: ACQUISITIONS


Rockford Bank and Trust Company
On August 13, 2019, Heartland's Illinois Bank & Trust subsidiary entered into a purchase and assumption agreement to acquire substantially all of the assets and substantially all of the deposits and certain other liabilities of Rockford Bank and Trust Company ("RB&T"), headquartered in Rockford, Illinois. RB&T is a wholly-owned subsidiary of Moline, Illinois-based QCR Holdings, Inc. As of September 30, 2019, RB&T had total assets of $519.5 million, which included $417.3 million of gross loans held to maturity, and $451.5 million of deposits. RB&T serves the Rockford market from 2 full-service banking locations. The all-cash transaction is subject to regulatory approval and to customary closing conditions and is expected to close in the fourth quarter of 2019. The systems conversion is expected to occur in the first quarter of 2020.

Blue Valley Ban Corp.
On January 16,May 10, 2019, Heartland entered into a definitive merger agreement to acquirecompleted the acquisition of Blue Valley Ban Corp., ("BVBC") and its wholly-owned subsidiary, Bank of Blue Valley, headquartered in Overland Park, Kansas. AsBased on Heartland's closing common stock price of $44.78 per share on May 10, 2019, the announcement date, the transaction, inaggregate consideration paid to BVBC common shareholders was $92.3 million, which allwas paid by delivery of the issued and outstanding shares of Blue Valley Ban Corp. stock will be exchanged for2,060,258 shares of Heartland common stock, was valuedstock. On the closing date, in addition to this merger consideration, Heartland provided BVBC the funds necessary to repay outstanding debt of $6.9 million, and Heartland assumed $16.1 million of trust preferred securities at approximately $93.9 million. Simultaneous withfair value. Immediately following the closing of the transaction, Bank of Blue Valley will mergewas merged with and into Heartland's Kansas-basedwholly-owned Kansas subsidiary, Morrill & Janes Bank and Trust Company, and the combined entity will operate as Bank of Blue Valley. The amount ofoperates under the merger consideration is subject to fluctuations in the price of Heartland common stock and certain potential adjustments, and the transaction is subject to customary closing conditions. The transaction is expected to close in the second quarter of 2019 with a systems conversion planned for the third quarter of 2019. As of March 31, 2019, Bank of Blue Valley brand. As of the closing date, BVBC had, at fair value, total assets of approximately $711.6$766.2 million, which included approximately $564.1total loans held to maturity of $542.0 million, and total deposits of gross loans outstanding, and approximately $587.2 million$617.1 million. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of deposits.BVBC.


First Bank Lubbock Bancshares, Inc.
On May 18, 2018, Heartland completed the acquisition of Lubbock, Texas based First Bank Lubbock Bancshares, Inc. ("FBLB"), parent company of First Bank & Trust, and PrimeWest Mortgage Corporation, which is a wholly-owned subsidiary of First Bank & Trust. Under the terms of the definitive merger agreement, Heartland acquired FBLB in a transaction valued at approximately $189.9 million, of which $5.5 million was cash, and the remainder was settled by delivery of 3,350,664 shares of Heartland common stock. On the closing date, in addition to this merger consideration, Heartland provided FBLB the funds necessary to repay outstanding debt of $3.9 million, and Heartland assumed $8.2 million of trust preferred securities at fair value. Immediately after the close of the transaction, Heartland paid $13.3 million to the holders of FBLB's stock appreciation rights. The transaction included, at fair value, total assets of $1.12 billion, including $681.1 million of gross loans held to maturity, and deposits of $893.8 million. Upon closing of the transaction, First Bank & Trust became a wholly-owned subsidiary of Heartland and continues to operate under its current name and management team as Heartland's eleventh state-chartered bank. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of FBLB.
Signature Bancshares, Inc.
On February 23, 2018, Heartland completed the acquisition of Signature Bancshares, Inc., parent company of Signature Bank, headquartered in Minnetonka, Minnesota. Under the terms of the definitive merger agreement, Heartland acquired Signature Bancshares, Inc. in a transaction valued at approximately $61.4 million, of which $7.8 million was cash, and the remainder was settled by delivery of 1,000,843 shares of Heartland common stock. Simultaneous with the close, Signature Bank merged into Heartland's wholly-owned Minnesota Bank & Trust subsidiary, and the combined entity operates under the Minnesota Bank & Trust brand name. The transaction included, at fair value, total assets of $427.1 million, including $324.5 million of gross loans held to maturity, and deposits of $357.3 million. On the closing date, Heartland provided Signature Bancshares, Inc. the funds necessary to repay outstanding subordinated debt of $5.9 million. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of Signature Bancshares, Inc.








NOTE 3: SECURITIES


The amortized cost, gross unrealized gains and losses, and estimated fair values of debt securities available for sale and equity securities with a readily determinable fair value that are carried at fair value as of March 31,September 30, 2019, and December 31, 2018, 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, 2019       
September 30, 2019September 30, 2019    
U.S. government corporations and agencies$26,873
 $10
 $(115) $26,768
U.S. government corporations and agencies$8,900  $50  $—  $8,950  
Mortgage and asset-backed securities1,889,977
 6,476
 (25,055) 1,871,398
Mortgage and asset-backed securities2,465,561  28,381  (13,265) 2,480,677  
Obligations of states and political subdivisions481,452
 6,146
 (2,643) 484,955
Obligations of states and political subdivisions500,222  13,915  (1,558) 512,579  
Total debt securities2,398,302
 12,632
 (27,813) 2,383,121
Total debt securities2,974,683  42,346  (14,823) 3,002,206  
Equity securities with a readily determinable fair value17,339
 
 
 17,339
Equity securities with a readily determinable fair value18,362  —  —  18,362  
Total$2,415,641
 $12,632
 $(27,813) $2,400,460
Total$2,993,045  $42,346  $(14,823) $3,020,568  
December 31, 2018       December 31, 2018
U.S. government corporations and agencies$32,075
 $3
 $(127) $31,951
U.S. government corporations and agencies$32,075  $ $(127) $31,951  
Mortgage and asset-backed securities2,061,358
 3,740
 (38,400) 2,026,698
Mortgage and asset-backed securities2,061,358  3,740  (38,400) 2,026,698  
Obligations of states and political subdivisions382,101
 919
 (8,046) 374,974
Obligations of states and political subdivisions382,101  919  (8,046) 374,974  
Total debt securities2,475,534

4,662

(46,573)
2,433,623
Total debt securities2,475,534  4,662  (46,573) 2,433,623  
Equity securities with a readily determinable fair value17,086
 
 
 17,086
Equity securities with a readily determinable fair value17,086  —  —  17,086  
Total$2,492,620
 $4,662
 $(46,573) $2,450,709
Total$2,492,620  $4,662  $(46,573) $2,450,709  


On January 1, 2019, Heartland adopted ASU 2017-12, and as a result of the adoption, $148.0 million of held to maturity debt securities were transferred to debt securities available for sale. The securities were transferred at book value on the date of the transfer.


The amortized cost, gross unrealized gains and losses and estimated fair values of held to maturity securities as of March 31,September 30, 2019, and December 31, 2018, are summarized in the table below, in thousands:

Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair
Value
September 30, 2019    
Obligations of states and political subdivisions$87,965  $9,940  $—  $97,905  
Total$87,965  $9,940  $—  $97,905  
December 31, 2018
Obligations of states and political subdivisions$236,283  $9,554  $(496) $245,341  
Total$236,283  $9,554  $(496) $245,341  


 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
March 31, 2019       
Obligations of states and political subdivisions$88,089
 $7,151
 $
 $95,240
Total$88,089
 $7,151
 $
 $95,240
December 31, 2018       
Obligations of states and political subdivisions$236,283
 $9,554
 $(496) $245,341
Total$236,283
 $9,554
 $(496) $245,341




The amortized cost and estimated fair value of investment securities carried at fair value at March 31,September 30, 2019, 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, 2019September 30, 2019
Amortized Cost Estimated Fair ValueAmortized CostEstimated Fair Value
Due in 1 year or less$29,138
 $29,100
Due in 1 year or less$22,717  $22,750  
Due in 1 to 5 years51,367
 50,972
Due in 1 to 5 years23,369  23,725  
Due in 5 to 10 years123,062
 123,289
Due in 5 to 10 years76,723  79,411  
Due after 10 years304,758
 308,362
Due after 10 years386,313  395,643  
Total debt securities508,325
 511,723
Total debt securities509,122  521,529  
Mortgage and asset-backed securities1,889,977
 1,871,398
Mortgage and asset-backed securities2,465,561  2,480,677  
Equity securities with a readily determinable fair value17,339
 17,339
Equity securities with a readily determinable fair value18,362  18,362  
Total investment securities$2,415,641
 $2,400,460
Total investment securities$2,993,045  $3,020,568  


The amortized cost and estimated fair value of debt securities held to maturity at March 31,September 30, 2019, 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, 2019September 30, 2019
Amortized Cost Estimated Fair ValueAmortized CostEstimated Fair Value
Due in 1 year or less$6
 $6
Due in 1 year or less$2,403  $2,443  
Due in 1 to 5 years12,966
 13,200
Due in 1 to 5 years15,153  15,690  
Due in 5 to 10 years58,150
 61,138
Due in 5 to 10 years58,936  64,695  
Due after 10 years16,967
 20,896
Due after 10 years11,473  15,077  
Total investment securities$88,089
 $95,240
Total investment securities$87,965  $97,905  


As of March 31,September 30, 2019, and December 31, 2018, securities with a fair value of $455.6$431.5 million and $524.8 million, respectively, were pledged to secure public and trust deposits, short-term borrowings and for other purposes as required or permitted by law.


Gross gains and losses realized related to the sales of securities carried at fair value for the three-monththree- and nine-month periods ended March 31,September 30, 2019 and 2018, are summarized as follows, in thousands:

Three Months Ended
March 31,
Three Months Ended
September 30,
Nine Months Ended
September 30,
2019 20182019201820192018
Proceeds from sales$434,154
 $392,246
Proceeds from sales$290,877  $59,137  $1,485,773  $694,872  
Gross security gains2,408
 3,013
Gross security gains2,371  67  10,301  3,537  
Gross security losses833
 1,572
Gross security losses358  212  3,133  2,500  


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,September 30, 2019, and December 31, 2018. 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 months or more. The reference point for determining how long an investment was in an unrealized loss position was March 31,September 30, 2018, and December 31, 2017, respectively. Securities for which Heartland has taken credit-related other-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.






Debt securities available for saleLess than 12 months 12 months or longer TotalDebt securities available for saleLess than 12 months12 months or longerTotal
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, 2019           
September 30, 2019September 30, 2019
U.S. government corporations and agencies$18,742
 $(95) $4,541
 $(20) $23,283
 $(115)U.S. government corporations and agencies$—  $—  $—  $—  $—  $—  
Mortgage and asset-backed securities227,902
 (2,075) 926,176
 (22,980) 1,154,078
 (25,055)Mortgage and asset-backed securities976,443  (7,689) 255,827  (5,576) 1,232,270  (13,265) 
Obligations of states and political subdivisions26,161
 (98) 132,515
 (2,545) 158,676
 (2,643)Obligations of states and political subdivisions118,741  (1,525) 2,139  (33) 120,880  (1,558) 
Total temporarily impaired securities$272,805
 $(2,268) $1,063,232
 $(25,545) $1,336,037
 $(27,813)Total temporarily impaired securities$1,095,184  $(9,214) $257,966  $(5,609) $1,353,150  $(14,823) 
December 31, 2018December 31, 2018December 31, 2018
U.S. government corporations and agencies$24,902
 $(83) $4,577
 $(44) $29,479
 $(127)U.S. government corporations and agencies$24,902  $(83) $4,577  $(44) $29,479  $(127) 
Mortgage and asset-backed securities733,826
 (9,060) 805,089
 (29,340) 1,538,915
 (38,400)Mortgage and asset-backed securities733,826  (9,060) 805,089  (29,340) 1,538,915  (38,400) 
Obligations of states and political subdivisions34,990
 (390) 258,143
 (7,656) 293,133
 (8,046)Obligations of states and political subdivisions34,990  (390) 258,143  (7,656) 293,133  (8,046) 
Total temporarily impaired securities$793,718
 $(9,533) $1,067,809
 $(37,040) $1,861,527
 $(46,573)Total temporarily impaired securities$793,718  $(9,533) $1,067,809  $(37,040) $1,861,527  $(46,573) 


Securities held to maturityLess than 12 months12 months or longerTotal
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
September 30, 2019
Obligations of states and political subdivisions  $—  $—  $—  $—  $—  $—  
Total temporarily impaired securities  $—  $—  $—  $—  $—  $—  
December 31, 2018
Obligations of states and political subdivisions  $10,802  $(17) $19,508  $(479) $30,310  $(496) 
Total temporarily impaired securities  $10,802  $(17) $19,508  $(479) $30,310  $(496) 
Securities held to maturityLess than 12 months 12 months or longer Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
March 31, 2019           
Obligations of states and political subdivisions$
 $
 $
 $
 $
 $
Total temporarily impaired securities$
 $
 $
 $
 $
 $
December 31, 2018
Obligations of states and political subdivisions$10,802
 $(17) $19,508
 $(479) $30,310
 $(496)
Total temporarily impaired securities$10,802
 $(17) $19,508
 $(479) $30,310
 $(496)


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.


The remaining unrealized losses on Heartland's mortgage and asset-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.


The 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 no0 gross realized gains or losses on the sale of securities carried at fair value or held to maturity securities with OTTI write-downs for the three-monthnine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, respectively.


Other investments, at cost, include equity securities without a readily determinable fair value. Equity securities without a readily determinable fair value, which totaled $17.3$29.0 million and $17.1$28.4 million at March 31,September 30, 2019, and December 31, 2018, respectively. At March 31,September 30, 2019, and December 31, 2018, other investments at cost included shares of stock in the Federal Home Loan Banks (the "FHLBs") of Des Moines, Chicago, Dallas, San Francisco and Topeka at an amortized cost of $15.4$14.9 million and $16.6 million, respectively.


The Heartland banks are required by federal law to maintain FHLB stock as members of the various FHLBs. These equity securities are "restricted" in that they can only be sold back to the respective institutions from which they were acquired or another member institution at par. Therefore, the FHLB stock is less liquid than other marketable equity securities, and the 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,September 30, 2019, did not consider the investments to be other than temporarily impaired.





NOTE 4: LOANS


Loans as of March 31,September 30, 2019, and December 31, 2018, were as follows, in thousands:

March 31, 2019 December 31, 2018September 30, 2019December 31, 2018
Loans receivable held to maturity:   Loans receivable held to maturity:  
Commercial$2,042,594
 $2,020,231
Commercial$2,276,916  $2,020,231  
Commercial real estate3,702,457
 3,711,481
Commercial real estate4,116,680  3,711,481  
Agricultural and agricultural real estate544,805
 565,408
Agricultural and agricultural real estate545,006  565,408  
Residential real estate630,433
 673,603
Residential real estate589,793  673,603  
Consumer412,573
 440,158
Consumer447,718  440,158  
Gross loans receivable held to maturity7,332,862
 7,410,881
Gross loans receivable held to maturity7,976,113  7,410,881  
Unearned discount(288) (1,624)Unearned discount(833) (1,624) 
Deferred loan fees(1,030) (1,560)Deferred loan fees(3,672) (1,560) 
Total net loans receivable held to maturity7,331,544
 7,407,697
Total net loans receivable held to maturity7,971,608  7,407,697  
Allowance for loan losses(62,639) (61,963)Allowance for loan losses(66,222) (61,963) 
Loans receivable, net$7,268,905
 $7,345,734
Loans receivable, net$7,905,386  $7,345,734  


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 and nonperforming loans and potential problem loans.


Heartland originates commercial and commercial real estate loans for a wide variety of business purposes, including lines of credit for capital and operating purposes and term loans for real estate and equipment purchases. Agricultural loans provide financing for capital improvements and farm operations, as well as livestock and machinery purchases. Residential mortgage loans are originated for the construction, purchase or refinancing of single family residential properties. Consumer loans include loans for motor vehicles, home improvement, home equity and personal lines of credit.


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 losses at March 31,September 30, 2019, and December 31, 2018, 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 losses during the quarter ended March 31,September 30, 2019.

Allowance For
Loan Losses
Gross Loans Receivable
Held to Maturity
Allowance For
Loan Losses
 
Gross Loans Receivable
Held to Maturity
Ending Balance
Under ASC
310-10-35
Ending Balance
Under ASC
450-20
TotalEnding 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, 2019           
September 30, 2019September 30, 2019
Commercial$6,301
 $17,520
 $23,821
 $24,498
 $2,018,096
 $2,042,594
Commercial$6,124  $19,161  $25,285  $23,355  $2,253,561  $2,276,916  
Commercial real estate353
 26,434
 26,787
 18,150
 3,684,307
 3,702,457
Commercial real estate308  29,073  29,381  19,913  4,096,767  4,116,680  
Agricultural and agricultural real estate1,099
 4,499
 5,598
 20,475
 524,330
 544,805
Agricultural and agricultural real estate1,084  4,267  5,351  20,073  524,933  545,006  
Residential real estate153
 1,452
 1,605
 18,619
 611,814
 630,433
Residential real estate123  1,319  1,442  17,552  572,241  589,793  
Consumer653
 4,175
 4,828
 5,826
 406,747
 412,573
Consumer475  4,288  4,763  5,100  442,618  447,718  
Total$8,559
 $54,080
 $62,639
 $87,568
 $7,245,294
 $7,332,862
Total$8,114  $58,108  $66,222  $85,993  $7,890,120  $7,976,113  
December 31, 2018           December 31, 2018
Commercial$5,733
 $18,772
 $24,505
 $24,202
 $1,996,029
 $2,020,231
Commercial$5,733  $18,772  $24,505  $24,202  $1,996,029  $2,020,231  
Commercial real estate218
 25,320
 25,538
 14,388
 3,697,093
 3,711,481
Commercial real estate218  25,320  25,538  14,388  3,697,093  3,711,481  
Agricultural and agricultural real estate686
 4,267
 4,953
 15,951
 549,457
 565,408
Agricultural and agricultural real estate686  4,267  4,953  15,951  549,457  565,408  
Residential real estate168
 1,617
 1,785
 20,251
 653,352
 673,603
Residential real estate168  1,617  1,785  20,251  653,352  673,603  
Consumer749
 4,433
 5,182
 7,004
 433,154
 440,158
Consumer749  4,433  5,182  7,004  433,154  440,158  
Total$7,554
 $54,409
 $61,963
 $81,796
 $7,329,085
 $7,410,881
Total$7,554  $54,409  $61,963  $81,796  $7,329,085  $7,410,881  


The following table presents nonaccrual loans, accruing loans past due 90 days or more and performing troubled debt restructured loans at March 31,September 30, 2019, and December 31, 2018, in thousands:

September 30, 2019December 31, 2018
Nonaccrual loans$67,924  $67,833  
Nonaccrual troubled debt restructured loans4,284  4,110  
Total nonaccrual loans$72,208  $71,943  
Accruing loans past due 90 days or more$40  $726  
Performing troubled debt restructured loans$3,199  $4,026  



 March 31, 2019 December 31, 2018
Nonaccrual loans$72,670
 $67,833
Nonaccrual troubled debt restructured loans4,624
 4,110
Total nonaccrual loans$77,294
 $71,943
Accruing loans past due 90 days or more$1,706
 $726
Performing troubled debt restructured loans$3,460
 $4,026





The following tables provide information on troubled debt restructured loans that were modified during the three-monththree- and nine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, dollars in thousands:

Three Months Ended
March 31,
Three Months Ended
September 30,
2019 201820192018
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—  $—  $—  —  $—  $—  
Commercial real estate
 
 
 
 
 
Commercial real estate—  —  —  —  —  —  
Total commercial and commercial real estate
 
 
 
 
 
Total commercial and commercial real estate—  —  —  —  —  —  
Agricultural and agricultural real estate
 
 
 
 
 
Agricultural and agricultural real estate—  —  —  —  —  —  
Residential real estate1
 36
 42
 5
 877
 752
Residential real estate—  —  —   92  94  
Consumer
 
 
��
 
 
Consumer—  —  —  —  —  —  
Total1
 $36
 $42
 5
 $877
 $752
Total—  $—  $—   $92  $94  


Nine Months Ended
September 30,
20192018
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—  —  —  —  —  —  
Total commercial and commercial real estate—  —  —  —  —  —  
Agricultural and agricultural real estate—  —  —  —  —  —  
Residential real estate 276  288  11  2,098  1,808  
Consumer—  —  —  —  —  —  
Total $276  $288  11  $2,098  $1,808  

The pre-modification and post-modification recorded investment represents amounts as of the date of loan modification. The difference between the pre-modification investment and post-modification investment amounts on Heartland's residential real estate troubletroubled debt restructured loans for the three-monthsthree- and nine-months ended March 31,September 30, 2019, is due to principal deferment collected from government guarantees and capitalized interest and escrow. At March 31,September 30, 2019, there were no commitments to extend credit to any of the borrowers with an existing troubled debt restructured loan.





The following table shows troubled debt restructured loans for which there was a payment default during the three monththree- and nine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, that had been modified during the twelve-month period prior to default, in thousands:

With Payment Defaults During the
Three Months Ended
March 31,
With Payment Defaults During the
Three Months Ended
September 30,
2019 201820192018
Number of Loans Recorded Investment Number of Loans Recorded InvestmentNumber of LoansRecorded InvestmentNumber of LoansRecorded Investment
Commercial
 $



$
Commercial—  $—  —  $—  
Commercial real estate
 




Commercial real estate—  —  —  —  
Total commercial and commercial real estate
 
 
 
Total commercial and commercial real estate—  —  —  —  
Agricultural and agricultural real estate
 




Agricultural and agricultural real estate—  —  —  —  
Residential real estate1
 42

3

519
Residential real estate—   418  
Consumer
 




Consumer—  —  —  —  
Total1
 $42
 3
 $519
Total—  $—   $418  


With Payment Defaults During the
Nine Months Ended
September 30,
20192018
Number of LoansRecorded InvestmentNumber of LoansRecorded Investment
Commercial—  $—  —  $—  
Commercial real estate—  —  —  —  
  Total commercial and commercial real estate—  —  —  —  
Agricultural and agricultural real estate—  —  —  —  
Residential real estate 253  10  1,598  
Consumer—  —  —  —  
  Total $253  10  $1,598  

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 trends in financial circumstances 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 net worth and paying capacity of the borrower and that 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 financial 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 in the borrowers' ability to repay the loan 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 as an operating entity. Specific pending events, such as capital injections, liquidations or perfection of liens on additional collateral, may strengthen the credit, thus deferring the rating of the loan as "loss" until the exact status of the loan can be determined. The loss rating is assigned to loans considered uncollectible. Heartland had no0 loans classified as loss or doubtful as of March 31,September 30, 2019. 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 by credit quality indicator at March 31,September 30, 2019, and December 31, 2018, in thousands:

PassNonpassTotal
Pass Nonpass Total
March 31, 2019     
September 30, 2019September 30, 2019
Commercial$1,907,620
 $134,974
 $2,042,594
Commercial$2,125,500  $151,416  $2,276,916  
Commercial real estate3,510,161
 192,296
 3,702,457
Commercial real estate3,864,191  252,489  4,116,680  
Total commercial and commercial real estate5,417,781
 327,270
 5,745,051
Total commercial and commercial real estate5,989,691  403,905  6,393,596  
Agricultural and agricultural real estate440,927
 103,878
 544,805
Agricultural and agricultural real estate426,383  118,623  545,006  
Residential real estate603,647
 26,786
 630,433
Residential real estate563,603  26,190  589,793  
Consumer398,695
 13,878
 412,573
Consumer435,407  12,311  447,718  
Total gross loans receivable held to maturity$6,861,050
 $471,812
 $7,332,862
Total gross loans receivable held to maturity$7,415,084  $561,029  $7,976,113  
December 31, 2018     December 31, 2018
Commercial$1,880,579
 $139,652
 $2,020,231
Commercial$1,880,579  $139,652  $2,020,231  
Commercial real estate3,524,344
 187,137
 3,711,481
Commercial real estate3,524,344  187,137  3,711,481  
Total commercial and commercial real estate5,404,923
 326,789
 5,731,712
Total commercial and commercial real estate5,404,923  326,789  5,731,712  
Agricultural and agricultural real estate471,642
 93,766
 565,408
Agricultural and agricultural real estate471,642  93,766  565,408  
Residential real estate645,478
 28,125
 673,603
Residential real estate645,478  28,125  673,603  
Consumer425,451
 14,707
 440,158
Consumer425,451  14,707  440,158  
Total gross loans receivable held to maturity$6,947,494
 $463,387
 $7,410,881
Total gross loans receivable held to maturity$6,947,494  $463,387  $7,410,881  

The nonpass category in the table above is comprised of approximately 48%62% special mention loans and 52%38% substandard loans as of March 31,September 30, 2019. The percent of nonpass loans on nonaccrual status as of March 31,September 30, 2019, was 16%13%. As of December 31, 2018, the nonpass category in the table above was comprised of approximately 52% special mention loans and 48% substandard loans. The percent of nonpass loans on nonaccrual status as of December 31, 2018, was 16%. Loans delinquent 30 to 89 days as a percent of total loans were 0.47%0.28% at March 31,September 30, 2019, compared to 0.21% at December 31, 2018. 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.


As of March 31,September 30, 2019, Heartland had $2.8$3.3 million of loans secured by residential real estate property that were in the process of foreclosure.


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 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 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 losses. A loan can be restored to accrual status if the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments on the loan, and (1) all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within a reasonable period of time, and (2) that there is a sustained period of repayment performance (generally a minimum of six months) by the borrower in accordance with the scheduled contractual terms.










The following table sets forth information regarding Heartland's accruing and nonaccrual loans at March 31,September 30, 2019, and December 31, 2018, in thousands:

Accruing Loans
Accruing Loans    30-59 Days
Past Due
60-89 Days
Past Due
90 Days or
More
Past Due
Total
Past Due
CurrentNonaccrualTotal Loans
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, 2019             
September 30, 2019September 30, 2019
Commercial$8,253
 $2,859
 $325
 $11,437
 $2,006,358
 $24,799
 $2,042,594
Commercial$5,727  $3,376  $34  $9,137  $2,244,365  $23,414  $2,276,916  
Commercial real estate5,870
 4,942
 1,264
 12,076
 3,674,676
 15,705
 3,702,457
Commercial real estate4,824  1,257  —  6,081  4,097,311  13,288  4,116,680  
Total commercial and commercial real estate14,123
 7,801
 1,589
 23,513
 5,681,034
 40,504
 5,745,051
Total commercial and commercial real estate10,551  4,633  34  15,218  6,341,676  36,702  6,393,596  
Agricultural and agricultural real estate2,179
 800
 31
 3,010
 521,621
 20,174
 544,805
Agricultural and agricultural real estate3,144  24  —  3,168  521,910  19,928  545,006  
Residential real estate4,224
 110
 
 4,334
 613,667
 12,432
 630,433
Residential real estate1,993  185  —  2,178  576,365  11,250  589,793  
Consumer4,835
 536
 86
 5,457
 402,932
 4,184
 412,573
Consumer1,411  537   1,954  441,436  4,328  447,718  
Total gross loans receivable held to maturity$25,361
 $9,247
 $1,706
 $36,314
 $7,219,254
 $77,294
 $7,332,862
Total gross loans receivable held to maturity$17,099  $5,379  $40  $22,518  $7,881,387  $72,208  $7,976,113  
December 31, 2018             December 31, 2018
Commercial$2,574
 $205
 $
 $2,779
 $1,991,525
 $25,927
 $2,020,231
Commercial$2,574  $205  $—  $2,779  $1,991,525  $25,927  $2,020,231  
Commercial real estate4,819
 
 726
 5,545
 3,694,259
 11,677
 3,711,481
Commercial real estate4,819  —  726  5,545  3,694,259  11,677  3,711,481  
Total commercial and commercial real estate7,393
 205
 726
 8,324
 5,685,784
 37,604
 5,731,712
Total commercial and commercial real estate7,393  205  726  8,324  5,685,784  37,604  5,731,712  
Agricultural and agricultural real estate99
 
 
 99
 549,376
 15,933
 565,408
Agricultural and agricultural real estate99  —  —  99  549,376  15,933  565,408  
Residential real estate5,147
 49
 
 5,196
 655,329
 13,078
 673,603
Residential real estate5,147  49  —  5,196  655,329  13,078  673,603  
Consumer2,724
 307
 
 3,031
 431,799
 5,328
 440,158
Consumer2,724  307  —  3,031  431,799  5,328  440,158  
Total gross loans receivable held to maturity$15,363
 $561
 $726
 $16,650
 $7,322,288
 $71,943
 $7,410,881
Total gross loans receivable held to maturity$15,363  $561  $726  $16,650  $7,322,288  $71,943  $7,410,881  





The majority of Heartland's impaired loans are those that are nonaccrual, are past due 90 days or more and still accruing or have had their terms restructured in a troubled debt restructuring. The following tables present the unpaid principal balance that was contractually due at March 31,September 30, 2019, and December 31, 2018, the outstanding loan balance recorded on the consolidated balance sheets at March 31,September 30, 2019, and December 31, 2018, any related allowance recorded for those loans as of March 31,September 30, 2019, and December 31, 2018, the average outstanding loan balances recorded on the consolidated balance sheets during the threethree- and nine- months ended March 31,September 30, 2019, and year ended December 31, 2018, and the interest income recognized on



the impaired loans during the three-monththree- and nine-month period ended March 31,September 30, 2019, and year ended December 31, 2018, in thousands:

Unpaid
Principal
Balance
Loan
Balance
Related
Allowance
Recorded
Quarter-
to-
Date
Avg.
Loan
Balance
Quarter-
to-
Date
Interest
Income
Recognized
Year-
to-
Date
Avg.
Loan
Balance
Year-
to-
Date
Interest
Income
Recognized
September 30, 2019
Impaired loans with a related allowance:  
Commercial  $11,025  $11,015  $6,124  $11,399  $—  $11,630  $ 
Commercial real estate  1,751  1,751  308  1,596   1,386  17  
Total commercial and commercial real estate  12,776  12,766  6,432  12,995   13,016  26  
Agricultural and agricultural real estate  2,979  2,979  1,084  3,100  17  2,881  17  
Residential real estate  999  999  123  1,086   1,157   
Consumer  1,122  1,120  475  1,116   1,197   
Total loans held to maturity  $17,876  $17,864  $8,114  $18,297  $27  $18,251  $54  
Impaired loans without a related allowance:
Commercial  $14,752  $12,340  $—  $13,529  $186  $12,989  $627  
Commercial real estate  18,243  18,162  —  18,897  88  16,897  215  
Total commercial and commercial real estate  32,995  30,502  —  32,426  274  29,886  842  
Agricultural and agricultural real estate  20,137  17,094  —  16,958  12  16,243  45  
Residential real estate  16,578  16,553  —  16,612  69  17,362  220  
Consumer  3,979  3,980  —  3,897   4,314  46  
Total loans held to maturity  $73,689  $68,129  $—  $69,893  $358  $67,805  $1,153  
Total impaired loans held to maturity:
Commercial  $25,777  $23,355  $6,124  $24,928  $186  $24,619  $636  
Commercial real estate  19,994  19,913  308  20,493  94  18,283  232  
Total commercial and commercial real estate  45,771  43,268  6,432  45,421  280  42,902  868  
Agricultural and agricultural real estate  23,116  20,073  1,084  20,058  29  19,124  62  
Residential real estate  17,577  17,552  123  17,698  72  18,519  223  
Consumer  5,101  5,100  475  5,013   5,511  54  
Total impaired loans held to maturity  $91,565  $85,993  $8,114  $88,190  $385  $86,056  $1,207  




Unpaid
Principal
Balance
Loan
Balance
Related
Allowance
Recorded
Year-to-
Date
Avg.
Loan
Balance
Year-to-
Date
Interest
Income
Recognized
Unpaid
Principal
Balance
 
Loan
Balance
 
Related
Allowance
Recorded
 
Year-
to-
Date
Avg.
Loan
Balance
 
Year-
to-
Date
Interest
Income
Recognized
March 31, 2019         
December 31, 2018December 31, 2018
Impaired loans with a related allowance:         Impaired loans with a related allowance:
Commercial$12,107
 $12,096
 $6,301
 $12,046
 $7
Commercial$12,376  $12,366  $5,733  $4,741  $33  
Commercial real estate1,421
 1,421
 353
 1,201
 6
Commercial real estate891  891  218  4,421  25  
Total commercial and commercial real estate13,528
 13,517
 6,654
 13,247
 13
Total commercial and commercial real estate13,267  13,257  5,951  9,162  58  
Agricultural and agricultural real estate3,280
 3,280
 1,099
 2,225
 1
Agricultural and agricultural real estate1,718  1,718  686  2,165   
Residential real estate1,253
 1,253
 153
 1,012
 
Residential real estate647  647  168  1,138  12  
Consumer1,272
 1,270
 653
 1,275
 6
Consumer1,373  1,373  749  2,934  29  
Total loans held to maturity$19,333
 $19,320
 $8,559
 $17,759
 $20
Total loans held to maturity  $17,005  $16,995  $7,554  $15,399  $101  
Impaired loans without a related allowance:         Impaired loans without a related allowance:
Commercial$14,467
 $12,402
 $
 $11,928
 $330
Commercial$13,616  $11,836  $—  $10,052  $299  
Commercial real estate16,809
 16,729
 
 14,008
 54
Commercial real estate13,578  13,497  —  13,000  249  
Total commercial and commercial real estate31,276
 29,131
 
 25,936
 384
Total commercial and commercial real estate27,194  25,333  —  23,052  548  
Agricultural and agricultural real estate19,538
 17,195
 
 14,373
 16
Agricultural and agricultural real estate16,836  14,233  —  14,781   
Residential real estate17,370
 17,366
 
 17,933
 76
Residential real estate19,604  19,604  —  23,950  308  
Consumer4,620
 4,556
 
 4,820
 25
Consumer5,631  5,631  —  5,117  97  
Total loans held to maturity$72,804
 $68,248
 $
 $63,062
 $501
Total loans held to maturity  $69,265  $64,801  $—  $66,900  $958  
Total impaired loans held to maturity:         Total impaired loans held to maturity:
Commercial$26,574
 $24,498
 $6,301
 $23,974
 $337
Commercial$25,992  $24,202  $5,733  $14,793  $332  
Commercial real estate18,230
 18,150
 353
 15,209
 60
Commercial real estate14,469  14,388  218  17,421  274  
Total commercial and commercial real estate44,804
 42,648
 6,654
 39,183
 397
Total commercial and commercial real estate40,461  38,590  5,951  32,214  606  
Agricultural and agricultural real estate22,818
 20,475
 1,099
 16,598
 17
Agricultural and agricultural real estate18,554  15,951  686  16,946   
Residential real estate18,623
 18,619
 153
 18,945
 76
Residential real estate20,251  20,251  168  25,088  320  
Consumer5,892
 5,826
 653
 6,095
 31
Consumer7,004  7,004  749  8,051  126  
Total impaired loans held to maturity$92,137
 $87,568
 $8,559
 $80,821
 $521
Total impaired loans held to maturity$86,270  $81,796  $7,554  $82,299  $1,059  



On May 10, 2019, Heartland completed the acquisition of Blue Valley Ban Corp., parent company of Bank of Blue Valley, headquartered in Overland Park, Kansas. As of May 10, 2019, Blue Valley Ban Corp. had gross loans of $558.4 million, and the estimated fair value of the loans acquired was $542.3 million.


 
Unpaid
Principal
Balance
 
Loan
Balance
 
Related
Allowance
Recorded
 
Year-to-
Date
Avg.
Loan
Balance
 
Year-to-
Date
Interest
Income
Recognized
December 31, 2018         
Impaired loans with a related allowance:         
Commercial$12,376
 $12,366
 $5,733
 $4,741
 $33
Commercial real estate891
 891
 218
 4,421
 25
Total commercial and commercial real estate13,267
 13,257
 5,951
 9,162
 58
Agricultural and agricultural real estate1,718
 1,718
 686
 2,165
 2
Residential real estate647
 647
 168
 1,138
 12
Consumer1,373
 1,373
 749
 2,934
 29
Total loans held to maturity$17,005
 $16,995
 $7,554
 $15,399
 $101
Impaired loans without a related allowance:         
Commercial$13,616
 $11,836
 $
 $10,052
 $299
Commercial real estate13,578
 13,497
 
 13,000
 249
Total commercial and commercial real estate27,194
 25,333
 
 23,052
 548
Agricultural and agricultural real estate16,836
 14,233
 
 14,781
 5
Residential real estate19,604
 19,604
 
 23,950
 308
Consumer5,631
 5,631
 
 5,117
 97
Total loans held to maturity$69,265
 $64,801
 $
 $66,900
 $958
Total impaired loans held to maturity:         
Commercial$25,992
 $24,202
 $5,733
 $14,793
 $332
Commercial real estate14,469
 14,388
 218
 17,421
 274
Total commercial and commercial real estate40,461
 38,590
 5,951
 32,214
 606
Agricultural and agricultural real estate18,554
 15,951
 686
 16,946
 7
Residential real estate20,251
 20,251
 168
 25,088
 320
Consumer7,004
 7,004
 749
 8,051
 126
Total impaired loans held to maturity$86,270
 $81,796
 $7,554
 $82,299
 $1,059


On May 18, 2018, Heartland completed the acquisition of First Bank Lubbock Bancshares, Inc., parent company of First Bank & Trust, headquartered in Lubbock, Texas. As of May 18, 2018, First Bank Lubbock Bancshares, Inc. had gross loans of $696.9 million, and the estimated fair value of the loans acquired was $681.1 million.


On February 23, 2018, Heartland acquired Signature Bancshares, Inc., parent company of Signature Bank, based in Minnetonka, Minnesota. As of February 23, 2018, Signature Bancshares, Inc. had gross loans of $335.1 million and the estimated fair value of the loans acquired was $324.5 million.


Heartland uses the acquisition method of accounting for purchased loans 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 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 includes 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 of the loan will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan 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.





At March 31,September 30, 2019, and December 31, 2018, the carrying amount of loans acquired since 2015 consist of purchased impaired and nonimpaired purchased loans as summarized in the following table, in thousands:

March 31, 2019 December 31, 2018September 30, 2019December 31, 2018
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$3,804
 $197,958
 $201,762
 $3,801
 $243,693
 $247,494
Commercial$6,744  $260,192  $266,936  $3,801  $243,693  $247,494  
Commercial real estate156
 986,926
 987,082
 158
 1,098,171
 1,098,329
Commercial real estate3,260  1,086,336  1,089,596  158  1,098,171  1,098,329  
Agricultural and agricultural real estate
 14,942
 14,942
 
 27,115
 27,115
Agricultural and agricultural real estate—  9,827  9,827  —  27,115  27,115  
Residential real estate227
 168,167
 168,394
 231
 184,389
 184,620
Residential real estate—  157,575  157,575  231  184,389  184,620  
Consumer loans
 63,090
 63,090
 
 75,773
 75,773
Consumer loans—  85,918  85,918  —  75,773  75,773  
Total covered loans$4,187
 $1,431,083
 $1,435,270
 $4,190
 $1,629,141
 $1,633,331
Total covered loans$10,004  $1,599,848  $1,609,852  $4,190  $1,629,141  $1,633,331  


Changes in accretable yield on acquired loans with evidence of credit deterioration at the date of acquisition for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, were as follows, in thousands:

Three Months Ended
March 31,
Three Months Ended
September 30,
Nine Months Ended
September 30,
2019 20182019201820192018
Balance at beginning of period$227
 $57
Balance at beginning of period$(184) $463  $227  $57  
Original yield discount, net, at date of acquisition
 (56)Original yield discount, net, at date of acquisition—  —  27  508  
Accretion(257) (199)Accretion(1,438) (93) (2,546) (943) 
Reclassification from nonaccretable difference(1)
218
 198
Reclassification from nonaccretable difference(1)
1,687  186  2,357  934  
Balance at period end$188
 $
Balance at period end$65  $556  $65  $556  
   
(1) Represents increases in estimated cash flows expected to be received, primarily due to lower estimated credit losses.(1) Represents increases in estimated cash flows expected to be received, primarily due to lower estimated credit losses.(1) Represents increases in estimated cash flows expected to be received, primarily due to lower estimated credit losses.


For 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 $36.9$44.6 million, and the estimated fair value of these loans was $21.8$28.2 million. At March 31,September 30, 2019, 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 such collateral, and the timing and amount of the cash flows could not be reasonably estimated. At March 31,September 30, 2019, there was $64,000$103,000 of allowance recorded and $57,000 of allowance recorded at December 31, 2018, related to these ASC 310-30 loans. Provision expense of $7,000$39,000 and $0$675,000 was recorded for the three-monthnine-month periods ended March 31,September 30, 2019, and 2018, respectively.


For loans acquired since January 2015, the preliminary estimate on the acquisition dates of the contractually required payments receivable for all nonimpaired loans acquired was $3.67$4.22 billion, and the estimated fair value of the loans was $3.59$4.12 billion.





NOTE 5: ALLOWANCE FOR LOAN LOSSES


Changes in the allowance for loan losses for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, were as follows, in thousands:

CommercialCommercial
Real Estate
Agricultural and Agricultural Real EstateResidential
Real Estate
ConsumerTotal
Balance at June 30, 2019Balance at June 30, 2019$24,082  $27,300  $6,049  $1,572  $4,847  $63,850  
Charge-offsCharge-offs(2,175) (135) (1,670) (3) (859) (4,842) 
RecoveriesRecoveries1,273  204  198  25  313  2,013  
ProvisionProvision2,105  2,012  774  (152) 462  5,201  
Balance at September 30, 2019Balance at September 30, 2019$25,285  $29,381  $5,351  $1,442  $4,763  $66,222  
Commercial 
Commercial
Real Estate
 
Agricultural and Agricultural
Real Estate
 
Residential
Real Estate
 Consumer TotalCommercialCommercial
Real Estate
Agricultural and Agricultural
Real Estate
Residential
Real Estate
ConsumerTotal
Balance at December 31, 2018$24,505
 $25,538
 $4,953
 $1,785
 $5,182
 $61,963
Balance at December 31, 2018$24,505  $25,538  $4,953  $1,785  $5,182  $61,963  
Charge-offs(644) (39) (379) (163) (725) (1,950)Charge-offs(6,506) (295) (2,098) (316) (2,357) (11,572) 
Recoveries175
 151
 330
 13
 322
 991
Recoveries1,642  381  533  72  1,449  4,077  
Provision(215) 1,137
 694
 (30) 49
 1,635
Provision5,644  3,757  1,963  (99) 489  11,754  
Balance at March 31, 2019$23,821
 $26,787
 $5,598
 $1,605
 $4,828
 $62,639
Balance at September 30, 2019Balance at September 30, 2019$25,285  $29,381  $5,351  $1,442  $4,763  $66,222  



CommercialCommercial
Real Estate
Agricultural and Agricultural Real EstateResidential
Real Estate
ConsumerTotal
Balance at June 30, 2018$20,709  $23,727  $5,709  $1,857  $9,322  $61,324  
Charge-offs(2,945) (199) (1,145) —  (1,831) (6,120) 
Recoveries158  242  —   378  779  
Provision4,147  (80)  (8) 1,177  5,238  
Balance at September 30, 2018$22,069  $23,690  $4,566  $1,850  $9,046  $61,221  
Commercial  Commercial
Real Estate 
 Agricultural and Agricultural
Real Estate 
 Residential
Real Estate 
 Consumer  Total  
Balance at December 31, 2017$18,098  $21,950  $4,258  $2,224  $9,156  $55,686  
Charge-offs(4,717) (761) (1,357) (211) (4,462) (11,508) 
Recoveries562  1,013  14  77  1,045  2,711  
Provision8,126  1,488  1,651  (240) 3,307  14,332  
Balance at September 30, 2018$22,069  $23,690  $4,566  $1,850  $9,046  $61,221  

 Commercial 
Commercial
Real Estate
 
Agricultural and Agricultural
Real Estate
 
Residential
Real Estate
 Consumer Total
Balance at December 31, 2017$18,098
 $21,950
 $4,258
 $2,224
 $9,156
 $55,686
Charge-offs(794) (125) 
 (16) (1,289) (2,224)
Recoveries104
 448
 14
 75
 290
 931
Provision1,987
 1,196
 444
 (142) 778
 4,263
Balance at March 31, 2018$19,395
 $23,469
 $4,716
 $2,141
 $8,935
 $58,656


Management allocates the allowance for loan losses by pools of risk within each loan portfolio. The allocation of the allowance for loan losses by loan portfolio is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular category. The total allowance for loan 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 $427.1 million at September 30, 2019, and $391.7 million at both March 31, 2019, and December 31, 2018. Heartland conducts its annual internal assessment of the goodwill both at the consolidated level and at its subsidiaries as of September 30. There was no0 goodwill impairment as of the most recent assessment.





Heartland recorded $35.4 million of goodwill and $11.4 million of core deposit intangibles in connection with the acquisition of Blue Valley Ban Corp., parent company of Bank of Blue Valley, headquartered in Overland Park, Kansas on May 10, 2019.

Heartland recorded $121.4 million of goodwill and $13.9 million of core deposit intangibles in connection with the acquisition of First Bank Lubbock Bancshares, Inc., parent company of First Bank & Trust Company, headquartered in Lubbock, Texas on May 18, 2018.


Heartland recorded $33.7 million of goodwill and $7.7 million of core deposit intangibles in connection with the acquisition of Signature Bancshares, Inc., parent company of Signature Bank, headquartered in Minnetonka, Minnesota on February 23, 2018.


The core deposit intangibles recorded with the Blue Valley Ban Corp., First Bank Lubbock Bancshares, Inc. and Signature Bancshares, Inc. acquisitions are not deductible for tax purposes and are expected to be amortized over a period of 10 years on an accelerated basis.


Goodwill related to the Blue Valley Ban Corp., First Bank Lubbock Bancshares, Inc., and Signature Bancshares, Inc. acquisitions resulted from expected operational synergies, increased market presence, cross-selling opportunities, and expanded business lines and is not deductible for tax purposes.


Heartland's intangible assets consist of core deposit intangibles, mortgage servicing rights, customer relationship intangibles, and commercial servicing rights. The gross carrying amount of these intangible assets and the associated accumulated amortization at March 31,September 30, 2019, and December 31, 2018, are presented in the table below, in thousands:

March 31, 2019 December 31, 2018 September 30, 2019December 31, 2018
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:           Amortizing intangible assets:    
Core deposit intangibles$83,640
 $39,236
 $44,404
 $83,640
 $36,403
 $47,237
Core deposit intangibles$95,033  $45,428  $49,605  $83,640  $36,403  $47,237  
Customer relationship intangibles1,177
 944
 233
 1,177
 935
 242
Customer relationship intangibles1,177  963  214  1,177  935  242  
Mortgage servicing rights41,473
 14,001
 27,472
 42,228
 12,865
 29,363
Mortgage servicing rights7,584  2,562  5,022  42,228  12,865  29,363  
Commercial servicing rights6,902
 5,406
 1,496
 6,834
 5,125
 1,709
Commercial servicing rights6,936  5,687  1,249  6,834  5,125  1,709  
Total$133,192
 $59,587
 $73,605
 $133,879
 $55,328
 $78,551
Total$110,730  $54,640  $56,090  $133,879  $55,328  $78,551  


On April 26,30, 2019, Dubuque Bank and Trust Company signed an agreement to sellclosed on the sale of substantially all its servicing rights portfolio, which contained loans with an unpaid principal balance of $3.31 billion to PNC Bank, N.A., headquartered in Pittsburgh, Pennsylvania. The servicing portfolio had a book value of $21.0 million, and the portfolio contained approximately 20,300 serviced residential mortgage loans with unpaid principal balances of $3.35 billion as of March 31, 2019. The serviced loans are primarily owned by Fannie Mae and Freddie Mac. The transaction was approved by Fannie Mae and Freddie Mac and closed on April 30, 2019. Based upon the terms of the agreement, proceeds from the transaction were approximately $37.0 million. As part of the agreement, Dubuque Bank and Trust Company will subservice the loans until the transfer date in August 2019. The transaction qualified as a sale, and $21.0$20.6 million of mortgage servicing rights were de-recognized on the consolidated balance sheet as of AprilJune 30, 2019. Cash of approximately $34.8 million was received during the second quarter, and Heartland recorded an estimated gain on the sale of this portfolio of approximately $13.3 million. A payable of approximately $293,000 was recorded as of September 30, 2019, whendue to the transaction closed.timing of the servicing transfer per the terms of the sale agreement. In the agreement, which includes customary terms and conditions, Dubuque Bank and Trust Company provided interim servicing of the loans until the transfer date, which was August 1, 2019.








The following table shows the estimated future amortization expense for amortizable intangible assets, excluding the mortgage servicing rights portfolio for Dubuque Bank and Trust Company, in thousands:

Core
Deposit
Intangibles
Customer
Relationship
Intangibles
Mortgage
Servicing
Rights
Commercial
Servicing
Rights
 
 
Total
Core
Deposit
Intangibles
 
Customer
Relationship
Intangibles
 
Mortgage
Servicing
Rights
 
Commercial
Servicing
Rights
 
 
 
Total
Nine months ending December 31, 2019$6,949
 $28
 $736
 $310
 $8,023
Three months ending December 31, 2019Three months ending December 31, 2019$2,908  $ $472  $89  $3,478  
Year ending December 31,         Year ending December 31, 
20208,230
 36
 1,431
 331
 10,028
202010,159  36  1,137  311  11,643  
20217,036
 35
 1,226
 293
 8,590
20218,462  35  975  275  9,747  
20225,634
 35
 1,022
 246
 6,937
20226,898  35  813  240  7,986  
20234,933
 34
 818
 159
 5,944
20236,019  34  649  158  6,860  
20244,008
 33
 613
 86
 4,740
20244,945  33  488  86  5,552  
Thereafter7,614
 32
 613
 71
 8,330
Thereafter10,214  32  488  90  10,824  
Total$44,404
 $233
 $6,459
 $1,496
 $52,592
Total$49,605  $214  $5,022  $1,249  $56,090  


Projections of amortization expense for mortgage servicing rights are based on existing asset balances and the existing interest rate environment as of March 31,September 30, 2019. Heartland's actual experience may be significantly different depending upon changes in mortgage interest rates and market conditions. Mortgage loans serviced for others at First Bank & Trust were approximately $692.3$621.5 million at March 31,September 30, 2019 compared to $648.9 million at December 31, 2018. Mortgage loans serviced for others at Dubuque Bank and Trust Company were $3.35 billion and $3.45 billion at March 31, 2019 and December 31, 2018, respectively. Custodial escrow balances maintained in connection with the mortgage loan servicing portfolio for First Bank & Trust were approximately $8.7 million at March 31, 2019 and $5.9 million at December 31, 2018. Custodial escrow balances maintained in connection with the mortgage loan servicing portfolio forat First Bank & Trust were approximately $16.3 million at September 30, 2019 and $5.9 million at December 31, 2018.

Heartland transferred custodial escrow balances totaling $22.9 million to PNC Bank, N.A. in conjunction with the transfer of the mortgage servicing rights portfolio on August 1, 2019. Custodial escrow balances maintained in connection with the mortgage loan servicing portfolio at Dubuque Bank and Trust Company totaled $23.3 million at March 31, 2019 and $17.7 million at December 31, 2018.

At March 31,September 30, 2019, the fair value of First Bank and Trust'sthe mortgage servicing rights at First Bank & Trust was estimated at $6.5$5.0 million compared to $7.1 million at December 31, 2018. The fair value of Dubuque Bank and Trust Company's mortgage servicing rights at March 31, 2019 was estimated at $37.1 million compared to $41.5 million at December 31, 2018.


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 of First Bank & Trust's mortgage servicing rights are considered in the calculation. The average constant prepayment rate was 16.40% for the First Bank & TrustSeptember 30, 2019 valuation was 12.00% as of March 31, 2019 compared to 10.30% atfor the December 31, 2018.2018 valuation. The discount rate for the First Bank & Trust valuation was 9.03% atfor both March 31,September 30, 2019 and December 31, 2018.2018 valuations. The average capitalization rate for First Bank & Trust during the first threenine months of 2019 ranged from 92 80 to 98 basis points compared to a range of 93 to 117 basis points for 2018 since acquisition on May 18, 2018. Fees collected for the servicing of mortgage loans for others were $427,000$422,000 and $2.6 million for the three-monthsquarters ended March 31, 2019.September 30, 2019 and September 30, 2018, respectively, and $1.3 million and $7.3 million for the nine-months ended September 30, 2019 and September 30, 2018.


The following table summarizes, in thousands, the changes in capitalized mortgage servicing rights for the threenine months ended March 31,September 30, 2019, and March 31,September 30, 2018:
 2019 2018
Balance at January 1,$29,363
 $23,248
Originations198
 1,162
Amortization(1,500) (1,245)
Valuation adjustment(589) 
Balance at period end$27,472
 $23,165
Mortgage servicing rights, net to servicing portfolio0.68% 0.72%


 20192018
Balance at January 1,$29,363  $23,248  
Originations654  4,322  
Amortization(2,867) (4,394) 
Sale of mortgage servicing rights(20,556) —  
Acquired mortgage servicing rights—  6,995  
Valuation allowance(1,572) —  
Balance at period end$5,022  $30,171  
Mortgage servicing rights, net to servicing portfolio0.81 %0.73 %

Heartland's commercial servicing portfolio is comprised of loans guaranteed by the Small Business Administration and United States Department of Agriculture that have been sold with servicing retained by Heartland, which totaled $95.0$87.0 million at March 31,



September 30, 2019 and $107.4 million at December 31, 2018. The commercial servicing rights portfolio is separated into two tranches at the respective Heartland subsidiary, loans with a term of less than 20 years and loans with a term of more than 20 years. Fees collected for the servicing of commercial loans for others were $380,000$216,000 and $420,000$401,000 for the three-monthsquarter ended March 31,September 30, 2019 and March 31,September 30, 2018, respectively, and $826,000 and $1.2 million for the nine-months ended September 30, 2019, and September 30, 2018, 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 valuations was 11.37%13.11% to 14.44%16.60% as of March 31,September 30, 2019, compared to 11.01% to 13.50% as of December 31, 2018. The discount rate range was 12.71%9.77% to 16.13%14.41% for the March 31,September 30, 2019, valuations compared to 13.44% to 16.96% for the December 31, 2018, valuations. The capitalization rate for both 2019 and 2018 ranged from 310 to 445 basis points. The total fair value of Heartland's commercial servicing rights was estimated at $1.9$1.8 million as of March 31,September 30, 2019, and $2.1 million as of December 31, 2018.


The following table summarizes, in thousands, the changes in capitalized commercial servicing rights for the three-monthsnine-months ended March 31,September 30, 2019, and March 31,September 30, 2018:

2019 201820192018
Balance at January 1,$1,709
 $2,609
Balance at January 1,$1,709  $2,609  
Originations68
 21
Originations102  82  
Amortization(281) (322)Amortization(555) (835) 
Valuation allowance on commercial servicing rights
 (2)Valuation allowance on commercial servicing rights(7) 12  
Balance at period end$1,496
 $2,306
Balance at period end$1,249  $1,868  
Fair value of commercial servicing rights$1,926
 $2,781
Fair value of commercial servicing rights$1,827  $2,529  
Commercial servicing rights, net to servicing portfolio1.58% 1.84%Commercial servicing rights, net to servicing portfolio1.44 %1.63 %


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 at each Heartland subsidiary. At March 31,September 30, 2019, a $589,000$1.6 million valuation allowance was required on mortgage servicing rights and at December 31, 2018, a $58,000 valuation allowance was required on mortgage servicing rights. At March 31,September 30, 2019, noa $7,000 valuation allowance was required on commercial servicing rights with a term less than 20 years and no0 valuation allowance was required on commercial servicing rights with a term greater than 20 years. At December 31, 2018, no0 valuation allowance was required on commercial servicing rights with a term less than 20 years and no0 valuation allowance was required on commercial servicing rights with a term greater than 20 years.





The following table summarizes, in thousands, the book value, the fair value of each tranche of the mortgage servicing rights and any recorded valuation allowance at each respective subsidiary at March 31,September 30, 2019, and December 31, 2018:

March 31, 2019Book Value 15-Year Tranche Fair Value 15-Year Tranche Impairment 15-Year Tranche Book Value 30-Year Tranche Fair Value 30-Year Tranche Impairment 30-Year Tranche
September 30, 2019September 30, 2019Book Value 15-Year TrancheFair Value 15-Year TrancheImpairment 15-Year TrancheBook Value 30-Year TrancheFair Value 30-Year TrancheImpairment 30-Year Tranche
Dubuque Bank and Trust Company$1,982
 $4,648
 $
 $19,031
 $32,420
 $
Dubuque Bank and Trust Company$—  $—  $—  $—  $—  $—  
First Bank & Trust1,644
 1,519
 125
 5,462
 4,940
 522
First Bank & Trust1,511  1,267  244  5,140  3,755  1,385  
Total$3,626
 $6,167
 $125
 $24,493
 $37,360
 $522
Total$1,511  $1,267  $244  $5,140  $3,755  $1,385  
December 31, 2018           December 31, 2018
Dubuque Bank and Trust Company$2,195
 $4,636
 $
 $20,025
 $36,901
 $
Dubuque Bank and Trust Company$2,195  $4,636  $—  $20,025  $36,901  $—  
First Bank & Trust1,685
 1,665
 20
 5,516
 5,478
 38
First Bank & Trust1,685  1,665  20  5,516  5,478  38  
Total$3,880
 $6,301
 $20
 $25,541
 $42,379
 $38
Total$3,880  $6,301  $20  $25,541  $42,379  $38  





The following table summarizes, in thousands, the book value, the fair value of each tranche of the commercial servicing rights and any recorded valuation allowance at each respective subsidiary at March 31,September 30, 2019, and December 31, 2018:

September 30, 2019Book 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
Citywide Banks$—  $—  $—  $—  $—  $—  
Premier Valley Bank24  17   149  167  —  
Wisconsin Bank & Trust155  331  —  928  1,311  —  
Total$179  $348  $ $1,077  $1,478  $—  
December 31, 2018
Citywide Banks$ $ $—  $18  $20  $—  
Premier Valley Bank45  74  —  178  184  —  
Wisconsin Bank & Trust249  411  —  1,218  1,439  —  
Total$295  $491  $—  $1,414  $1,643  $—  

March 31, 2019
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
Citywide Banks$
 $
 $
 $
 $
 $
Premier Valley Bank37
 65
 
 168
 178
 
Wisconsin Bank & Trust212
 387
 
 1,079
 1,296
 
Total$249
 $452
 $
 $1,247
 $1,474
 $
December 31, 2018           
Citywide Banks$1
 $6
 $
 $18
 $20
 $
Premier Valley Bank45
 74
 
 178
 184
 
Wisconsin Bank & Trust249
 411
 
 1,218
 1,439
 
Total$295
 $491
 $
 $1,414
 $1,643
 $

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 $540,000$2.2 million cash as collateral at March 31,September 30, 2019 and no cashcompared to 0 collateral at December 31, 2018. At March 31,September 30, 2019, no0 collateral was required to be pledged by Heartland's counterparties, compared to $770,000 collateral at December 31, 2018.


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 related to derivatives will be reclassified to interest expense as interest payments are received or made on Heartland's variable-rate liabilities. For the threenine months ended March 31,September 30, 2019, 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 $165,000.$299,000. For the next twelve months, Heartland estimates that cash receipts and reclassification from accumulated other comprehensive income to reduce interest expense will total $660,000.$134,000.


Heartland entered into six6 forward starting interest rate swap transactions to effectively convert Heartland Financial Statutory Trust IV, V, VI, and VII, which total $85.0 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 six6 swap transactions are designated as cash flow hedges of the changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on $105.0 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 2019,



the interest rate swap transactions associated with Morrill Statutory Trust I and II, totaling $20.0 million, matured and the fixed rate debt has been converted to variable rate subordinated debentures.


On May 18, 2018, Heartland acquired cash flow hedges related to OCGI Statutory Trust III and OCGI Capital Trust IV with notional amounts of $3.0 million and $6.0 million, respectively, in the First Bank Lubbock Bancshares, Inc. transaction. The cash flow hedges effectively convert OCGI Statutory Trust III and OGCI Capital Trust IV from variable rate subordinated debentures to fixed rate debt. These swaps are designated as cash flow hedges of the changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on $9.0 million of Heartland's subordinated debentures that reset quarterly on a specified reset date.





The table below identifies the balance sheet category and fair values of Heartland's derivative instruments designated as cash flow hedges at March 31,September 30, 2019, and December 31, 2018, in thousands:

Notional
Amount
Fair
Value
Balance
Sheet
Category
Receive
Rate
Weighted
Average
Pay Rate
Maturity
September 30, 2019September 30, 2019
Notional
Amount
 
Fair
Value
 
Balance
Sheet
Category
 
Receive
Rate
 
Weighted
Average
Pay Rate
 Maturity
March 31, 2019           
Interest rate swap$25,000
 $50
 Other assets 2.615% 2.255% 03/17/2021Interest rate swap$25,000  $(202) Other liabilities  2.139 %2.255 %03/17/2021
Interest rate swap20,000
 (153) Other liabilities 2.795
 3.355
 01/07/2020Interest rate swap20,000  (119) Other liabilities  2.303  3.355  01/07/2020
Interest rate swap28,667
 563
 Other assets 4.993
 3.674
 05/10/2021Interest rate swap26,667  154  Other assets  4.549  3.674  05/10/2021
Interest rate swap28,000
 (897) Other liabilities 4.986
 5.425
 07/24/2028Interest rate swap26,500  (1,726) Other liabilities  4.537  5.425  07/24/2028
Interest rate swap20,000
 (141) Other liabilities 2.611
 2.390
 06/15/2024Interest rate swap20,000  (828) Other liabilities  2.119  2.390  06/15/2024
Interest rate swap20,000
 (99) Other liabilities 2.626
 2.352
 03/01/2024Interest rate swap20,000  (754) Other liabilities  2.138  2.352  03/01/2024
Interest rate swap6,000
 62
 Other assets 2.611
 1.866
 06/15/2021Interest rate swap6,000  (21) Other liabilities  2.119  1.866  06/15/2021
Interest rate swap3,000
 35
 Other assets 2.787
 1.878
 06/30/2021Interest rate swap3,000  (13) Other liabilities  2.303  1.878  06/30/2021
December 31, 2018        December 31, 2018
Interest rate swap$25,000
 $191
 Other assets 2.788% 2.255% 03/17/2021Interest rate swap$25,000  $191  Other assets  2.788 %2.255 %03/17/2021
Interest rate swap20,000
 (177) Other liabilities 2.408
 3.355
 01/07/2020Interest rate swap20,000  (177) Other liabilities  2.408  3.355  01/07/2020
Interest rate swap10,000
 29
 Other assets 2.822
 1.674
 03/26/2019Interest rate swap10,000  29  Other assets  2.822  1.674  03/26/2019
Interest rate swap10,000
 28
 Other assets 2.788
 1.658
 03/18/2019Interest rate swap10,000  28  Other assets  2.788  1.658  03/18/2019
Interest rate swap29,667
 763
 Other assets 4.887
 3.674
 05/10/2021Interest rate swap29,667  763  Other assets  4.887  3.674  05/10/2021
Interest rate swap28,750
 (572) Other liabilities 5.004
 5.425
 07/24/2028Interest rate swap28,750  (572) Other liabilities  5.004  5.425  07/24/2028
Interest rate swap20,000
 157
 Other assets 2.788
 2.390
 06/15/2024Interest rate swap20,000  157  Other assets  2.788  2.390  06/15/2024
Interest rate swap20,000
 185
 Other assets 2.738
 2.352
 03/01/2024Interest rate swap20,000  185  Other assets  2.738  2.352  03/01/2024
Interest rate swap6,000
 105
 Other Assets 2.788
 1.866
 06/15/2021Interest rate swap6,000  105  Other Assets  2.788  1.866  06/15/2021
Interest rate swap3,000
 51
 Other assets 2.787
 1.878
 06/30/2021Interest rate swap3,000  51  Other assets  2.787  1.878  06/30/2021


The table below identifies the gains and losses recognized on Heartland's derivative instruments designated as cash flow hedges for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, in thousands:

Effective PortionIneffective Portion
Recognized in OCIReclassified from AOCI into IncomeRecognized in Income on Derivatives
Amount of
Gain (Loss)
CategoryAmount of
Gain (Loss)
CategoryAmount of
Gain (Loss)
Three Months Ended September 30, 2019Three Months Ended September 30, 2019
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, 2019     
Interest rate swaps$(1,340) Interest expense $(165) Other income $
Interest rate swaps$(766) Interest expense  $(31) Other income  $—  
Three Months Ended March 31, 2018     
Nine Months Ended September 30, 2019Nine Months Ended September 30, 2019
Interest rate swaps$1,896
 Interest expense $(197) Other income $
Interest rate swaps$(4,269) Interest expense  $(296) Other income  $—  
Three Months Ended September 30, 2018Three Months Ended September 30, 2018
Interest rate swapsInterest rate swaps$375  Interest expense  $21  Other income  $—  
Nine Months Ended September 30, 2018Nine Months Ended September 30, 2018
Interest rate swapsInterest rate swaps$3,198  Interest expense  $(207) Other income  $—  


Fair Value Hedges
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 the 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.


Heartland was required to pledge $3.2$3.4 million and $2.5 million of cash as collateral for these fair value hedges at March 31,September 30, 2019, and December 31, 2018, respectively.


The table below identifies the notional amount, fair value and balance sheet category of Heartland's fair value hedges at March 31,September 30, 2019, and December 31, 2018, in thousands:

Notional AmountFair ValueBalance Sheet Category
Notional Amount Fair Value Balance Sheet Category
March 31, 2019    
September 30, 2019September 30, 2019
Fair value hedges$670
 $5
 Other assetsFair value hedges$—  $—  Other assets
Fair value hedges28,749
 (900) Other liabilitiesFair value hedges21,349  (1,818) Other liabilities
December 31, 2018    December 31, 2018
Fair value hedges$19,820
 $74
 Other assetsFair value hedges$19,820  $74  Other assets
Fair value hedges$15,064
 $(339) Other liabilitiesFair value hedges15,064  $(339) Other liabilities


The table below identifies the gains and losses recognized on Heartland's fair value hedges for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, in thousands:

  Amount of Gain (Loss) Income Statement Category
Three Months Ended March 31, 2019    
Fair value hedges $(630) Interest income
Three Months Ended March 31, 2018    
Fair value hedges $894
 Interest income
Amount of Gain (Loss)Income Statement Category
Three Months Ended September 30, 2019
Fair value hedges$(263)Interest income
Nine Months Ended September 30, 2019
Fair value hedges$(1,553)Interest income
Three Months Ended September 30, 2018
Fair value hedges$179 Interest income
Nine Months Ended September 30, 2018
Fair value hedges$1,423 Interest income


Embedded Derivatives
Heartland has fixed rate loans with embedded 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,September 30, 2019, and December 31, 2018, in thousands:

Notional AmountFair ValueBalance Sheet Category
September 30, 2019
Embedded derivatives$11,742  $717  Other assets
Embedded derivatives—  —  Other liabilities
December 31, 2018
Embedded derivatives$11,266  $453  Other assets
Embedded derivatives2,231  (54) Other liabilities



 Notional Amount Fair Value Balance Sheet Category
March 31, 2019     
Embedded derivatives$2,216
 $17
 Other assets
Embedded derivatives$9,785
 $(507) Other liabilities
December 31, 2018     
Embedded derivatives$11,266
 $453
 Other assets
Embedded derivatives$2,231
 $(54) Other liabilities





The table below identifies the gains and losses recognized on Heartland's embedded derivatives for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, in thousands:

  Amount of Gain (Loss) Income Statement Category
Three Months Ended March 31, 2019    
Embedded derivatives $889
 Other noninterest income
Three Months Ended March 31, 2018    
Embedded derivatives $277
 Other noninterest income
Amount of Gain (Loss)Income Statement Category
Three Months Ended September 30, 2019
Embedded derivatives$1,389 Other noninterest income
Nine Months Ended September 30, 2019
Embedded derivatives$318 Other noninterest income
Three Months Ended September 30, 2018
Embedded derivatives$108 Other noninterest income
Nine Months Ended September 30, 2018
Embedded derivatives$523 Other noninterest income


Back-to-Back Loan Swaps
Heartland has 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 $7.2$25.2 million and $2.0 million as of March 31,September 30, 2019, and December 31, 2018, respectively, as collateral related to these back-to-back swaps. Heartland's counterparties were required to pledge $140,000$0 at March 31,September 30, 2019, and $680,000 at December 31, 2018. Any gains and losses on these back-to-back swaps are recorded in noninterest income on the consolidated statements of income, and for the threenine months ended March 31,September 30, 2019 and March 31,September 30, 2018, no0 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,September 30, 2019, and December 31, 2018, in thousands:

Notional
Amount
Fair
Value
Balance Sheet
Category
Weighted
Average
Receive
Rate
Weighted
Average
Pay
Rate
 
Notional
Amount
 
Fair
Value
 
Balance Sheet
Category
 
Weighted
Average
Receive
Rate
 
Weighted
Average
Pay
Rate
March 31, 2019        
September 30, 2019September 30, 2019
Customer interest rate swaps $233,665
 $7,654
 Other assets 5.15% 5.05%Customer interest rate swaps$320,994  $21,281  Other assets4.72 %4.32 %
Customer interest rate swaps 233,665
 (7,654) Other liabilities 5.05
 5.15
Customer interest rate swaps320,994(21,281) Other liabilities4.32  4.72  
December 31, 2018        December 31, 2018
Customer interest rate swaps $211,246
 $4,449
 Other assets 5.10% 4.96%Customer interest rate swaps$211,246  $4,449  Other assets5.10 %4.96 %
Customer interest rate swaps 211,246
 (4,449) Other liabilities 4.96
 5.10
Customer interest rate swaps211,246  (4,449) Other liabilities4.96  5.10  


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 collateral of $0 at March 31,September 30, 2019, and $35,000 at December 31, 2018. Heartland's counterparties were required to pledge no0 collateral at both March 31,September 30, 2019 and December 31, 2018, as collateral for these forward commitments.


Heartland acquired undesignated interest rate swaps in 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,September 30, 2019, and December 31, 2018, in thousands:

Balance Sheet CategoryNotional AmountFair Value
September 30, 2019September 30, 2019
Interest rate lock commitments (mortgage)Interest rate lock commitments (mortgage)Other assets  $29,816  $970  
Balance Sheet
Category
 
Notional
Amount
 
Fair
Value
March 31, 2019     
Interest rate lock commitments (mortgage)Other assets $25,318
 $800
Forward commitmentsOther assets 1,000
 
Forward commitmentsOther assets  18,000  64  
Forward commitmentsOther liabilities 46,000
 (282)Forward commitmentsOther liabilities  48,500  (209) 
Undesignated interest rate swapsOther liabilities 9,785
 (507)Undesignated interest rate swapsOther liabilities  11,742  (717) 
Undesignated interest rate swapsOther assets 2,216
 17
Undesignated interest rate swapsOther assets  —  —  
December 31, 2018 

 

December 31, 2018
Interest rate lock commitments (mortgage)Other assets $22,451
 $725
Interest rate lock commitments (mortgage)Other assets  $22,451  $725  
Forward commitmentsOther assets 
 
Forward commitmentsOther assets  —  —  
Forward commitmentsOther liabilities 51,500
 (399)Forward commitmentsOther liabilities  51,500  (399) 
Undesignated interest rate swapsOther liabilities 11,266
 (453)Undesignated interest rate swapsOther liabilities  11,266  (453) 
Undesignated interest rate swapsOther assets 2,231
 54
Undesignated interest rate swapsOther assets  2,231  54  


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-monththree- and nine-month periods ended March 31,September 30, 2019, and March 31,September 30, 2018, in thousands:

 Income Statement Category Gain (Loss) Recognized
Three Months Ended March 31, 2019   
Interest rate lock commitments (mortgage)Net gains on sale of loans held for sale $264
Forward commitmentsNet gains on sale of loans held for sale 117
Undesignated interest rate swapsOther noninterest income 889
Three Months Ended March 31, 2018   
Interest rate lock commitments (mortgage)Net gains on sale of loans held for sale $17
Forward commitmentsNet gains on sale of loans held for sale 115
Undesignated interest rate swapsOther noninterest income 277
Income Statement CategoryGain (Loss) Recognized
Three Months Ended September 30, 2019
Interest rate lock commitments (mortgage)Net gains on sale of loans held for sale$(255)
Forward commitmentsNet gains on sale of loans held for sale283 
Undesignated interest rate swapsOther noninterest income(1,389)
Nine Months Ended September 30, 2019
Interest rate lock commitments (mortgage)Net gains on sale of loans held for sale$561 
Forward commitmentsNet gains on sale of loans held for sale255 
Undesignated interest rate swapsOther noninterest income(318)
Three Months Ended September 30, 2018
Interest rate lock commitments (mortgage)Net gains on sale of loans held for sale$(4,470)
Forward commitmentsNet gains on sale of loans held for sale644 
Undesignated interest rate swapsOther noninterest income108 
Nine Months Ended September 30, 2018
Interest rate lock commitments (mortgage)Net gains on sale of loans held for sale$(1,849)
Forward commitmentsNet gains on sale of loans held for sale352 
Undesignated interest rate swapsOther noninterest income523 


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 carried at fair value, which include available for sale, trading securities and equity securities with a readily determinable fair value, 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 and asset-backed securities and private collateralized mortgage obligations, municipal bonds and corporate debt securities. On a quarterly basis, a secondary independent pricing service is used for the securities portfolio to validate the pricing from Heartland's primary pricing service.


Equity Securities with a Readily Determinable Fair Value
Equity securities with a readily determinable fair value generally include Community Reinvestment Act mutual funds and are classified as Level 2 due to the infrequent trading of these securities. The fair value is based on the price per share.


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, Furniture and Equipment Held for Sale
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 Realtors 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. 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 the assumptions in the discounted cash flow analysis 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 guaranteed 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,September 30, 2019, and December 31, 2018, 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,September 30, 2019, and December 31, 2018, in thousands, aggregated by the level in the fair value hierarchy within which those measurements fall:

Total Fair ValueLevel 1Level 2Level 3
September 30, 2019
Assets
Securities available for sale
U.S. government corporations and agencies$8,950  $7,497  $1,453  $—  
Mortgage and asset-backed securities2,480,677  —  2,480,677  —  
Obligations of states and political subdivisions512,579  —  512,579  —  
Equity securities with a readily determinable fair value18,362  —  18,362  —  
Derivative financial instruments(1)
22,152  —  22,152  —  
Interest rate lock commitments970  —  —  970  
Forward commitments64  —  64  —  
Total assets at fair value$3,043,754  $7,497  $3,035,287  $970  
Liabilities
Derivative financial instruments(2)
$27,479  $—  $27,479  $—  
Forward commitments209  ���  209  —  
Total liabilities at fair value$27,688  $—  $27,688  $—  
December 31, 2018
Assets
Securities available for sale
U.S. government corporations and agencies$31,951  $25,414  $6,537  $—  
Mortgage and asset-backed securities2,026,698  —  2,026,698  —  
Obligations of states and political subdivisions374,974  —  374,974  —  
Equity securities17,086  —  17,086  —  
Derivative financial instruments(1)
6,539  —  6,539  —  
Interest rate lock commitments725  —  —  725  
Total assets at fair value$2,457,973  $25,414  $2,431,834  $725  
Liabilities
Derivative financial instruments(2)
$6,044  $—  $6,044  $—  
Forward commitments399  —  399  —  
Total liabilities at fair value$6,443  $—  $6,443  $—  
(1) Includes embedded derivatives, back-to-back loan swaps, fair value hedges, free standing derivative instruments and cash flow hedges.
(2) Includes cash flow hedges, fair value hedges, back-to-back loan swaps, embedded derivatives and free standing derivative instruments.



 Total Fair Value Level 1 Level 2 Level 3
March 31, 2019       
Assets       
Securities available for sale       
U.S. government corporations and agencies$26,768
 $20,458
 $6,310
 $
Mortgage and asset-backed securities1,871,398
 
 1,871,398
 
Obligations of states and political subdivisions484,955
 
 484,955
 
Equity securities with a readily determinable fair value17,339
 
 17,339
 
Derivative financial instruments(1)
8,403
 
 8,403
 
Interest rate lock commitments800
 
 
 800
Total assets at fair value$2,409,663
 $20,458
 $2,388,405
 $800
Liabilities       
Derivative financial instruments(2)
$10,858
 $
 $10,858
 $
Forward commitments282
 
 282
 
Total liabilities at fair value$11,140
 $
 $11,140
 $
December 31, 2018       
Assets       
Securities available for sale       
U.S. government corporations and agencies$31,951
 $25,414
 $6,537
 $
Mortgage and asset-backed securities2,026,698
 
 2,026,698
 
Obligations of states and political subdivisions374,974
 
 374,974
 
Equity securities17,086
 
 17,086
 
Derivative financial instruments(1)
6,539
 
 6,539
 
Interest rate lock commitments725
 
 
 725
Total assets at fair value$2,457,973
 $25,414
 $2,431,834
 $725
Liabilities       
Derivative financial instruments(2)
$6,044
 $
 $6,044
 $
Forward commitments399
 
 399
 
Total liabilities at fair value$6,443
 $
 $6,443
 $
        
(1) Includes embedded derivatives, back-to-back loan swaps, fair value hedges, free standing derivative instruments and cash flow hedges.
(2) Includes cash flow hedges, fair value hedges, back-to-back loan swaps, embedded derivatives 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, 2019
Fair Value Measurements at
September 30, 2019
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 (Gains)
Losses
TotalQuoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Year-to-
Date (Gains)
Losses
Collateral dependent impaired loans:         Collateral dependent impaired loans:
Commercial$9,998
 $
 $
 $9,998
 $285
Commercial$10,767  $—  $—  $10,767  $1,098  
Commercial real estate717
 
 
 717
 
Commercial real estate1,088  —  —  1,088  72  
Agricultural and agricultural real estate8,932
 
 
 8,932
 379
Agricultural and agricultural real estate11,536  —  —  11,536  1,015  
Residential real estate1,207
 
 
 1,207
 4
Residential real estate1,042  —  —  1,042  24  
Consumer633
 
 
 633
 
Consumer645  —  —  645  —  
Total collateral dependent impaired loans$21,487
 $
 $
 $21,487
 $668
Total collateral dependent impaired loans$25,078  $—  $—  $25,078  $2,209  
Loans held for sale$69,716
 $
 $69,716
 $
 $(1,107)Loans held for sale$35,427  $—  $35,427  $—  $(1,234) 
Other real estate owned$5,391
 $
 $
 $5,391
 $452
Other real estate owned$6,425  $—  $—  $6,425  $880  
Premises, furniture and equipment held for sale$7,030
 $
 $
 $7,030
 $
Premises, furniture and equipment held for sale$3,251  $—  $—  $3,251  $954  
Servicing rights$6,459
 $
 $
 $6,459
 $589
Servicing rights$5,039  $—  $—  $5,039  $1,579  


Fair Value Measurements at
December 31, 2018
TotalQuoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Year-to-
Date (Gains)
Losses
Collateral dependent impaired loans:
Commercial$12,932  $—  $—  $12,932  $660  
Commercial real estate405  —  —  405  72  
Agricultural and agricultural real estate11,070  —  —  11,070  575  
Residential real estate478  —  —  478  —  
Consumer624  —  —  624  —  
Total collateral dependent impaired loans$25,509  $—  $—  $25,509  $1,307  
Loans held for sale$119,801  $—  $52,577  $67,224  $(1,870) 
Other real estate owned$6,153  $—  $—  $6,153  $2,647  
Premises, furniture and equipment held for sale$7,258  $—  $—  $7,258  $59  
Servicing rights$7,143  $—  $—  $7,143  $58  


 
Fair Value Measurements at
December 31, 2018
 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 (Gains)
Losses
Collateral dependent impaired loans:         
Commercial$12,932
 $
 $
 $12,932
 $660
Commercial real estate405
 
 
 405
 72
Agricultural and agricultural real estate11,070
 
 
 11,070
 575
Residential real estate478
 
 
 478
 
Consumer624
 
 
 624
 
Total collateral dependent impaired loans$25,509
 $
 $

$25,509
 $1,307
Loans held for sale$119,801
 $
 $52,577
 $67,224
 $(1,870)
Other real estate owned$6,153
 $
 $
 $6,153
 $2,647
Premises, furniture and equipment held for sale$7,258
 $
 $
 $7,258
 $59
Servicing rights$7,143
 $
 $
 $7,143
 $58




The following tables present additional quantitative information about assets measured at fair value on a recurring and nonrecurring basis and for which Heartland has utilized Level 3 inputs to determine fair value, in thousands:

Fair Value at
9/30/2019
Valuation
Technique
Unobservable
Input
Range
(Weighted Average)
Interest rate lock commitments$970  Discounted cash flowsClosing ratio
0-99% (90%)(1)
Other real estate owned6,425  Modified appraised valueThird party appraisal(2) 
Appraisal discount
0-10%(3)
Servicing rights5,039  Discounted cash flowsThird party valuation(4) 
Premises, furniture and equipment held for sale3,251  Modified appraised valueThird party appraisal   
Appraisal discount
0-10%(3)
Collateral dependent impaired loans:
Commercial10,767  Modified appraised valueThird party appraisal(2)
Appraisal discount
0-15%(3)
Commercial real estate1,088  Modified appraised valueThird party appraisal(2)
Appraisal discount
0-10%(3)
Agricultural and agricultural real estate11,536  Modified appraised valueThird party appraisal(2)
Appraisal discount
0-15%(3)
Residential real estate1,042  Modified appraised valueThird party appraisal(2)
Appraisal discount
0-12%(3)
Consumer645  Modified appraised valueThird party valuation(2)
Valuation discount
0-10%(3)
(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. The weighted average closing ratio for PrimeWest Mortgage Corporation is 90%.
(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) 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) 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.



Fair Value at
12/31/2018
Valuation
Technique
Unobservable
Input
Range
(Weighted Average)
Fair Value at
3/31/2019
 Valuation
Technique
 Unobservable
Input
 Range
(Weighted Average)
Loans held for saleLoans held for sale$67,224  Discounted cash flowsSales contract
(1)
Interest rate lock commitments$800
 Discounted cash flows Closing ratio 
0-99% (89%)(1)
Interest rate lock commitments725  Discounted cash flowsClosing ratio
0-99% (91%)(2)
Other real estate owned5,391
 Modified appraised value Third party appraisal (2)Other real estate owned6,153  Modified appraised valueThird party appraisal(3) 
 Appraisal discount 
0-10%(3)
Appraisal discount
0-10%(4)
Servicing rights6,459
 Discounted cash flows Third party valuation (4)Servicing rights7,143  Discounted cash flowsThird party valuation
(5)
Premises, furniture and equipment held for sale7,030
 Modified appraised value Third party appraisal (2)Premises, furniture and equipment held for sale7,258  Modified appraised valueThird party appraisal(3)
 Appraisal discount 
0-10%(3)
Appraisal discount
0-10%(4)
Collateral dependent impaired loans:  Collateral dependent impaired loans:
Commercial9,998
 Modified appraised value Third party appraisal (2)Commercial12,932  Modified appraised valueThird party appraisal(3)
 Appraisal discount 
0-18%(3)
Appraisal discount
0-8%(4)
Commercial real estate717
 Modified appraised value Third party appraisal (2)Commercial real estate405  Modified appraised valueThird party appraisal(3)
 Appraisal discount 
0-9%(3)
Appraisal discount
0-19%(4)
Agricultural and agricultural real estate8,932
 Modified appraised value Third party appraisal (2)Agricultural and agricultural real estate11,070  Modified appraised valueThird party appraisal(3)
 Appraisal discount 
0-15%(3)
Appraisal discount
0-24%(4)
Residential real estate1,207
 Modified appraised value Third party appraisal (2)Residential real estate478  Modified appraised valueThird party appraisal(3)
 Appraisal discount 
0-12%(3)
Appraisal discount
0-24%(4)
Consumer633
 Modified appraised value Third party valuation (2)Consumer624  Modified appraised valueThird party valuation(3)
 Valuation discount 
0-9%(3)
Valuation discount
0-14%(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. The weighted average closing ratio for PrimeWest Mortgage Corporation is 89%.
(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) 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) 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.
(1) The significant unobservable input related to the loans held for sale was the third party sales contract Heartland entered into prior to December 31, 2018. The sale of these consumer loans closed on January 11, 2019.(1) The significant unobservable input related to the loans held for sale was the third party sales contract Heartland entered into prior to December 31, 2018. The sale of these consumer loans closed on January 11, 2019.
(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.(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.
(3) 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) 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.
(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.
(5) 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.(5) 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.




 
Fair Value at
12/31/2018
 
Valuation
Technique
 
Unobservable
Input
 
Range
(Weighted Average)
Loans held for sale$67,224
 Discounted cash flows Sales contract 
(1) 
Interest rate lock commitments725
 Discounted cash flows Closing ratio 
0-99% (91%)(2)
Other real estate owned6,153
 Modified appraised value Third party appraisal (3)
    Appraisal discount 
0-10%(4)
Servicing rights7,143
 Discounted cash flows Third party valuation 
(5) 
Premises, furniture and equipment held for sale7,258
 Modified appraised value Third party appraisal (3)
    Appraisal discount 
0-10%(4)
Other real estate owned6,153
 Modified appraised value Third party appraisal (3)
    Appraisal discount 
0-10%(4)
Collateral dependent impaired loans:       
Commercial12,932
 Modified appraised value Third party appraisal (3)
     Appraisal discount 
0-8%(4)
Commercial real estate405
 Modified appraised value Third party appraisal (3)
     Appraisal discount 
0-19%(4)
Agricultural and agricultural real estate11,070
 Modified appraised value Third party appraisal (3)
    Appraisal discount 
0-24%(4)
Residential real estate478
 Modified appraised value Third party appraisal (3)
    Appraisal discount 
0-24%(4)
Consumer624
 Modified appraised value Third party valuation (3)
    Valuation discount 
0-14%(4)
        
(1) The significant unobservable input related to the loans held for sale was the third party sales contract Heartland entered into prior to December 31, 2018. The sale of these consumer loans closed on January 11, 2019.
(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.
(3) 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.
(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.
(5) 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.


The changes in fair value of the interest rate lock commitments, which are Level 3 financial instruments measured on a recurring basis, are summarized in the following table, in thousands:

For the Three Months Ended
March 31, 2019
 
For the Year Ended
December 31, 2018
For the Nine Months Ended
September 30, 2019
For the Year Ended
December 31, 2018
Balance at January 1,$725
 $1,738
Balance at January 1,$725  $1,738  
Acquired interest rate lock commitments
 1,383
Acquired interest rate lock commitments—  1,383  
Total gains (losses) included in earnings264
 (3,269)Total gains (losses) included in earnings561  (3,269) 
Issuances2,081
 2,962
Issuances8,077  2,962  
Settlements(2,270) (2,089)Settlements(8,393) (2,089) 
Balance at period end$800
 $725
Balance at period end$970  $725  


Gains included in gains (losses) on sale of loans held for sale attributable to interest rate lock commitments held at March 31,September 30, 2019, and December 31, 2018, were $800,000$970,000 and $725,000, respectively.


The table below is a summary of the estimated fair value of Heartland's financial instruments (as defined by ASC 825) as of March 31,September 30, 2019, and December 31, 2018, 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, including the value of the commercial and mortgage servicing rights,



premises, furniture and equipment, premises, furniture and equipment held for sale, OREO, 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
September 30, 2019
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$447,767  $447,767  $447,767  $—  $—  
Time deposits in other financial institutions3,711  3,711  3,711  —  —  
Securities:
Carried at fair value3,020,568  3,020,568  7,497  3,013,071  —  
Held to maturity87,965  97,905  —  97,905  —  
Other investments29,042  29,042  —  29,042  —  
Loans held for sale35,427  35,427  —  35,427  —  
Loans, net:
Commercial2,250,134  2,187,799  —  2,177,032  10,767  
Commercial real estate4,084,592  4,057,687  —  4,056,599  1,088  
Agricultural and agricultural real estate540,406  532,650  —  521,114  11,536  
Residential real estate587,288  561,187  —  560,145  1,042  
Consumer442,966  440,984  —  440,339  645  
Total Loans, net7,905,386  7,780,307  —  7,755,229  25,078  
Cash surrender value on life insurance171,471  171,471  —  171,471  —  
Derivative financial instruments(1)
22,152  22,152  —  22,152  —  
Interest rate lock commitments970  970  —  —  970  
Forward commitments64  64  —  64  —  
Financial liabilities:
Deposits
Demand deposits3,581,127  3,581,127  —  3,581,127  —  
Savings deposits5,770,754  5,770,754  —  5,770,754  —  
Time deposits1,117,975  1,117,975  —  1,117,975  —  
Deposits held for sale—  —  —  —  —  
Short term borrowings107,853  107,853  —  107,853  —  
Other borrowings278,417  278,707  —  278,707  —  
Derivative financial instruments(1)
27,479  27,479  —  27,479  —  
Forward commitments209  209  —  209  —  
(1) Includes embedded derivatives, back-to-back loan swaps, fair value hedges, free standing derivative instruments and cash flow hedges.





    Fair Value Measurements at
March 31, 2019
Fair Value Measurements at
December 31, 2018
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:         Financial assets:
Cash and cash equivalents$492,501
 $492,501
 $492,501
 $
 $
Cash and cash equivalents$273,630  $273,630  $273,630  $—  $—  
Time deposits in other financial institutions4,675
 4,675
 4,675
 
 
Time deposits in other financial institutions4,672  4,672  4,672  —  —  
Securities:         Securities:
Carried at fair value2,400,460
 2,400,460
 20,458
 2,380,002
 
Carried at fair value2,450,709  2,450,709  25,414  2,425,295  —  
Held to maturity88,089
 95,240
 
 95,240
 
Held to maturity236,283  245,341  —  245,341  —  
Other investments27,506
 27,506
 
 27,506
 
Other investments28,396  28,396  —  28,396  —  
Loans held for sale69,716
 69,716
 
 69,716
 
Loans held for sale119,801  119,801  —  52,577  67,224  
Loans, net:         Loans, net:
Commercial2,018,438
 1,972,580
 
 1,962,582
 9,998
Commercial1,994,785  1,955,607  —  1,942,675  12,932  
Commercial real estate3,675,063
 3,644,142
 
 3,643,425
 717
Commercial real estate3,684,213  3,667,138  —  3,666,733  405  
Agricultural and agricultural real estate540,022
 531,817
 
 522,885
 8,932
Agricultural and agricultural real estate561,265  553,112  —  542,042  11,070  
Residential real estate627,619
 613,086
 
 611,879
 1,207
Residential real estate670,473  654,596  —  654,118  478  
Consumer407,763
 405,120
 
 404,487
 633
Consumer434,998  432,016  —  431,392  624  
Total Loans, net7,268,905
 7,166,745
 
 7,145,258
 21,487
Total Loans, net7,345,734  7,262,469  —  7,236,960  25,509  
Cash surrender value on life insurance163,764
 163,764
 
 163,764
 
Cash surrender value on life insurance162,892  162,892  —  162,892  —  
Derivative financial instruments(1)
8,403
 8,403
 
 8,403
 
Derivative financial instruments(1)
6,539  6,539  —  6,539  —  
Interest rate lock commitments800
 800
 
 
 800
Interest rate lock commitments725  725  —  —  725  
Financial liabilities:         Financial liabilities:
Deposits         Deposits
Demand deposits3,118,909
 3,118,909
 
 3,118,909
 
Demand deposits3,264,737  3,264,737  —  3,264,737  —  
Savings deposits5,145,929
 5,145,929
 
 5,145,929
 
Savings deposits5,107,962  5,107,962  —  5,107,962  —  
Time deposits1,008,104
 1,088,104
 
 1,088,104
 
Time deposits1,023,730  1,023,730  —  1,023,730  —  
Deposits held for sale118,564
 111,742
 
 111,742
 
Deposits held for sale106,409  100,241  —  —  100,241  
Short term borrowings104,314
 104,314
 
 104,314
 
Short term borrowings227,010  227,010  —  227,010  —  
Other borrowings268,312
 268,528
 
 268,528
 
Other borrowings274,905  276,966  —  276,966  —  
Derivative financial instruments(2)
10,858
 10,858
 
 10,858
 
Derivative financial instruments(1)
Derivative financial instruments(1)
6,044  6,044  —  6,044  —  
Forward commitments282
 282
 
 282
 
Forward commitments399  399  —  399  —  
(1) Includes embedded derivatives, back-to-back loan swaps, fair value hedges, free standing derivative instruments and cash flow hedges.(1) Includes embedded derivatives, back-to-back loan swaps, fair value hedges, free standing derivative instruments and cash flow hedges.(1) Includes embedded derivatives, back-to-back loan swaps, fair value hedges, free standing derivative instruments and cash flow hedges.
(2) Includes cash flow hedges, fair value hedges, back-to-back loan swaps, embedded derivatives and free standing derivative instruments.




     
Fair Value Measurements at
December 31, 2018
 
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$273,630
 $273,630
 $273,630
 $
 $
Time deposits in other financial institutions4,672
 4,672
 4,672
 
 
Securities:         
Carried at fair value2,450,709
 2,450,709
 25,414
 2,425,295
 
Held to maturity236,283
 245,341
 
 245,341
 
Other investments28,396
 28,396
 
 28,396
 
Loans held for sale119,801
 119,801
 
 52,577
 67,224
Loans, net:         
Commercial1,994,785
 1,955,607
 
 1,942,675
 12,932
Commercial real estate3,684,213
 3,667,138
 
 3,666,733
 405
Agricultural and agricultural real estate561,265
 553,112
 
 542,042
 11,070
Residential real estate670,473
 654,596
 
 654,118
 478
Consumer434,998
 432,016
 
 431,392
 624
Total Loans, net7,345,734
 7,262,469
 
 7,236,960
 25,509
Cash surrender value on life insurance162,892
 162,892
 
 162,892
 
Derivative financial instruments(1)
6,539
 6,539
 
 6,539
 
Interest rate lock commitments725
 725
 
 
 725
Financial liabilities:         
Deposits         
Demand deposits3,264,737
 3,264,737
 
 3,264,737
 
Savings deposits5,107,962
 5,107,962
 
 5,107,962
 
Time deposits1,023,730
 1,023,730
 
 1,023,730
 
Deposits held for sale106,409
 100,241
 
 
 100,241
Short term borrowings227,010
 227,010
 
 227,010
 
Other borrowings274,905
 276,966
 
 276,966
 
Derivative financial instruments(2)
6,044
 6,044
 
 6,044
 
Forward commitments399
 399
 
 399
 
 
(1) Includes embedded derivatives, back-to-back loan swaps, fair value hedges, free standing derivative instruments and cash flow hedges.
(2) Includes cash flow hedges, fair value hedges, back-to-back loan swaps, embedded derivatives 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 equity securities with a readily determinable fair value and debt 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 — The fair value of loans is determined using an exit price methodology as prescribed by ASU 2016-01, which was effective on January 1, 2018. The exit price estimation of fair value is based on the present value of the expected cash flows. The projected cash flows are based on the contractual terms of the loans, adjusted for prepayments and a discount rate based on the relative risk of the cash flows. Other considerations include the loan type, remaining life of the loan and credit risk.


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.


Cash surrender value on life insurance — Life insurance policies are held on certain officers. The carrying value of these policies approximates fair value as it is based on the cash surrender value adjusted for other charges or amounts due that are probable at settlement. As such, Heartland classifies the estimated fair value of the cash surrender value on life insurance as Level 2.


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.

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.

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.


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.


Deposits Held for Sale — As of September 30, 2019, Heartland had $0 of deposits held for sale. Prior to December 31, 2018, Heartland entered into agreements with third parties to sell the deposits of five5 branch locations, which totaled $118.6$106.4 million as of MarchDecember 31, 2019.2018. The estimated fair value in the table above iswas based on the carrying value of the deposits less the premium Heartland expectsexpected to receive in accordance with the sales contract when the transactions arewere completed which is expected to be in the first six months of 2019.


Short-term and Other BorrowingsRates 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: REVENUE


On January 1, 2018, Heartland adopted ASU 2014-09, "Revenue from Contracts with Customers" (Topic 606), and all subsequent ASUs that modified Topic 606.


Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with loan servicing income, bank owned life insurance, derivatives and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as service charges and fees, trust fees, and brokerage and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of Heartland's revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.





Service Charges and Fees
Service charges and fees consist of revenue generated from deposit account related service charges and fees, overdraft fees, customer service fees and other service charges, credit card fee income, debit card income and other service charges and fees.


Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders and other deposit account related fees. Heartland's performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees, including overdraft fees, are largely transactional based, and therefore, the performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.


Customer service fees and other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. Heartland's performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.


Credit card fee income and debit card income are comprised of interchange fees, ATM fees, and merchant services income. Credit card fee income and debit card income are earned whenever the banks' debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a bank cardholder uses an ATM that is not owned by one of Heartland's banks or a non-bank cardholder uses Heartland-owned ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees.


Trust Fees
Trust fees are primarily comprised of fees earned from the management and administration of trusts and other customer assets. Heartland's performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the average daily market value or month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days before or after month end through a direct charge to customers’ accounts. Heartland does not earn performance-based incentives. Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. Heartland's performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered.


Brokerage and Insurance Commissions
Brokerage commission primarily consist of commissions related to broker-dealer contracts. The contracts are between the customer and the broker-dealer, and Heartland satisfies its performance obligation and earns commission when the transactions are completed. The recognition of revenue is based on a defined fee schedule and does not require significant judgment. Payment is received shortly after services are rendered. Insurance commissions are related to commissions received directly from the insurance carrier. Heartland acts as an insurance agent between the customer and the insurance carrier. Heartland's performance obligations and associated fee and commission income are defined with each insurance product with the insurance company. When insurance payments are received from customers, a portion of the payment is recognized as commission revenue.








The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three-monthsthree- and nine-months ended March 31,September 30, 2019, and 2018, in thousands:

Three Months Ended
March 31,
Three Months Ended
September 30,
Nine Months Ended
September 30,
2019 20182019201820192018
In-scope of Topic 606   In-scope of Topic 606
Service charges and fees   Service charges and fees
Service charges and fees on deposit accounts$2,977
 $2,618
Service charges and fees on deposit accounts$3,221  $2,858  $9,383  $8,270  
Overdraft fees2,744
 2,208
Overdraft fees2,917  2,990  8,537  7,716  
Customer service fees81
 77
Customer service and other service feesCustomer service and other service fees104  102  270  268  
Credit card fee income3,349
 2,190
Credit card fee income3,936  3,062  11,555  8,443  
Debit card income3,642
 2,985
Debit card income2,188  3,883  10,044  10,349  
Other service charges1
 1
Total service charges and fees$12,794
 $10,079
Total service charges and fees$12,366  $12,895  $39,789  $35,046  
Trust fees4,474
 4,680
Trust fees4,959  4,499  14,258  13,794  
Brokerage and insurance commissions734
 907
Brokerage and insurance commissions962  1,111  2,724  2,895  
Total noninterest income in-scope of Topic 606$18,002
 $15,666
Total noninterest income in-scope of Topic 606$18,287  $18,505  $56,771  $51,735  
   
Out-of-scope of Topic 606   Out-of-scope of Topic 606
Loan servicing income$1,729
 $1,754
Loan servicing income$821  $1,670  $3,888  $5,231  
Securities gains/(losses), net1,575
 1,441
Securities gains/(losses), net2,013  (145) 7,168  1,037  
Unrealized gain/(loss) on equity securities, net258
 (28)
Unrealized gain on equity securities, netUnrealized gain on equity securities, net144  54  514  97  
Net gains on sale of loans held for sale3,176
 4,051
Net gains on sale of loans held for sale4,673  7,410  12,192  18,261  
Valuation adjustment on servicing rights(589) (2)Valuation adjustment on servicing rights(626) 230  (1,579) 12  
Income on bank owned life insurance899
 614
Income on bank owned life insurance881  892  2,668  2,206  
Other noninterest income1,667
 1,220
Other noninterest income3,207  1,149  6,556  3,536  
Total noninterest income out-of-scope of Topic 6068,715
 9,050
Total noninterest income out-of-scope of Topic 60611,113  11,260  31,407  30,380  
Total noninterest income$26,717
 $24,716
Total noninterest income$29,400  $29,765  $88,178  $82,115  


Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. Heartland's noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after Heartland satisfies its performance obligation and revenue is recognized. Heartland does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of March 31,September 30, 2019, and December 31, 2018, Heartland did not have any significant contract balances.


Contract Acquisition Costs
In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). Heartland utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, Heartland did not capitalize any contract acquisition costs.


NOTE 10: STOCK 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,






awards, under its 2012 Long-Term Incentive Plan (the "Plan"). The Plan was originally approved by stockholders in May 2012 and was amended effective March 8, 2016, to increase the number of shares of common stock authorized for issuance and make certain other changes to the Plan. As of March 31,September 30, 2019, 368,071350,412 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. Forfeitures are accounted for as they occur.


The amount of tax benefit related to the exercise, vesting and forfeiture of equity-based awards reflected as a tax benefit in Heartland's income tax expense was $336,000$270,000 and $611,000$672,000 during the threenine months ended March 31,September 30, 2019 and 2018, respectively.


Restricted Stock Units
The Plan permits the Compensation Committee to grant restricted stock units ("RSUs"). In the first quarter of 2019, the Compensation Committee granted time-based RSUs with respect to 90,073 shares of common stock, and in the first quarter of 2018, the Compensation Committee granted time-based RSUs with respect to 52,153 shares of common stock to selected officers and employees. The time-based RSUs represent the right, without payment, to receive shares of Heartland common stock on a specified date in the future. The time-based RSUs granted in 2019 and 2018 vest over three years in equal installments on March 6 of each of the three years following the year of the grant. 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 agreement as a condition to vesting.


The Compensation Committee also granted three-yearthree-year performance-based RSUs with respect to 34,848 shares and 16,108 shares of common stock in the first quarter of 2019 and 2018, respectively. These performance-based RSUs will be earned based on satisfaction of performance targets for the three-yearthree-year performance period ended December 31, 2021, and December 31, 2020, respectively. These performance-based RSUs or a portion thereof may vest in 2022 and 2021, respectively, after measurement of performance in relation to the performance targets.


The three-yearthree-year performance-based RSUs vest to the extent that they are earned upon death or disability or upon a "qualified retirement." Upon a change in control, performance-based RSUs shall become vested at 100% of target if the RSU obligations are not assumed by the successor company. If the successor company does assume the RSU obligations, the 2019 and 2018 performance-based RSUs will vest at 100% of target upon a "Termination of Service" within the period beginning six months prior to a change in control and ending twenty-four months after a change in control.


All of Heartland's RSUs will be settled in common stock upon vesting and are not entitled to dividends until vested.


The Compensation Committee may grant 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 threenine months ended March 31,September 30, 2019, and March 31,September 30, 2018, 1,04532,662 and 029,048 time-based RSUs, respectively, were granted to directors and new employees.





A summary of the RSUs outstanding as of March 31,September 30, 2019, and 2018, and changes during the threenine months ended March 31,September 30, 2019 and 2018, follows:

2019 201820192018
Shares Weighted-Average Grant Date
Fair Value
 Shares Weighted-Average Grant Date
Fair Value
SharesWeighted-Average Grant Date
Fair Value
SharesWeighted-Average Grant Date
Fair Value
Outstanding at January 1,266,995
 $43.89
 301,578
 $34.74
Outstanding at January 1,266,995  $43.89  301,578  $34.74  
Granted125,966
 45.77
 87,249
 55.25
Granted157,583  45.00  116,297  55.26  
Vested(117,122) 35.84
 (107,553) 30.79
Vested(142,023) 38.93  (127,429) 32.70  
Forfeited(13,364) 49.89
 (19,113) 43.62
Forfeited(26,136) 48.95  (27,678) 45.58  
Outstanding at March 31,262,475
 $48.07
 262,161
 $42.60
Outstanding at September 30,Outstanding at September 30,256,419  $46.96  262,768  $43.65  





Total compensation costs recorded for RSUs were $2.4$4.8 million and $1.9$3.7 million for the three-monthnine-month periods ended March 31,September 30, 2019 and 2018. As of March 31,September 30, 2019, there were $7.5$6.0 million of total unrecognized compensation costs related to the Plan for RSUs that are expected to be recognized through 2022.


NOTE 11: LEASES


A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, Heartland adopted ASU No. 2016-02 "Leases" (Topic 842) and all subsequent ASUs that modified Topic 842. For Heartland, Topic 842 primarily affected the accounting treatment for operating lease agreements in which Heartland is the lessee.


Lessee Accounting
Substantially all of the leases in which Heartland is the lessee are comprised of real estate property for branches, ATM locations, and office space with terms extending through 2034.2031. All of Heartland's leases are classified as operating leases, and therefore, were previously not recognized on the consolidated balance sheet. With the adoption of Topic 842, operating lease agreements are required to be recognized on the consolidated balance sheet as a right-of-use ("ROU") asset and a corresponding lease liability.


Heartland elected not to include short-term leases (i.e., leases with initial terms of twelve months or less), or equipment leases (deemed immaterial) on the consolidated balance sheet. The table below presents Heartland's ROU assets and lease liabilities as of March 31,September 30, 2019, (in thousands):in thousands:

Assets Classification March 31, 2019
Operating lease assets Other assets $24,664
Total lease right-of-use assets   $24,664
     
Liabilities    
Operating lease liabilities Accrued expenses and other liabilities $26,333
Total lease liabilities   $26,333
AssetsClassificationSeptember 30, 2019
Operating lease assetsOther assets$24,677 
Total lease right-of-use assets$24,677 
Liabilities
Operating lease liabilitiesAccrued expenses and other liabilities$26,403 
Total lease liabilities$26,403 


The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used to present value the minimum lease payments. Heartland’s lease agreements often include one or more options to renew at Heartland’s discretion. If at lease inception, Heartland considers the exercising of a renewal option to be reasonably certain, Heartland will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, Heartland utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used. The variable lease cost primarily represents variable payments such as common area maintenance and utilities. The table below presents the lease costs and supplemental information as of March 31,September 30, 2019, in thousands:



Three Months Ended March 31, 2019Income Statement CategoryThree Months Ended
September 30, 2019
Nine Months Ended
September 30, 2019
Lease Cost Lease Cost
Operating lease cost$1,405
Operating lease costOccupancy expense$1,681  $4,548  
Variable lease cost35
Variable lease costOccupancy expense42  109  
Total lease cost$1,440
Total lease cost$1,723  $4,657  
Supplemental Information Supplemental Information
Non-cash information on lease liabilities arising from obtaining ROU assets$1,209
Weighted-average remaining lease term (in years) 
Operating leases7.04
Weighted-average discount rate 
Operating leases3.00%
Noncash reduction of ROU assets arising from lease modificationsNoncash reduction of ROU assets arising from lease modificationsOccupancy expense$495  $2,959  
Noncash reduction lease liabilities arising from lease modificationsNoncash reduction lease liabilities arising from lease modificationsOccupancy expense284  2,771  
Supplemental balance sheet informationSupplemental balance sheet informationAs of September 30, 2019
Weighted-average remaining operating lease term (in years)Weighted-average remaining operating lease term (in years)6.5
Weighted-average discount rate for operating leasesWeighted-average discount rate for operating leases3.00 %





As defined by Topic 842, future minimum payments forA maturity analysis of operating leases with initial or remaining termslease liabilities and reconciliation of one year or more are presented in the table belowundiscounted cash flows to the total of operating lease liabilities as of March 31,September 30, 2019 is as follows, in thousands:

Nine months ending December 31, 2019$3,859
Three months ending December 31, 2019Three months ending December 31, 2019$1,503  
Year ending December 31, Year ending December 31,
20205,174
20205,931  
20214,855
20215,678  
20223,351
20224,346  
20231,947
20232,900  
Thereafter7,147
Thereafter8,751  
Total lease payments$26,333
Total lease payments$29,109  
Less interestLess interest(2,706) 
Present value of lease liabilitiesPresent value of lease liabilities$26,403  


As defined by Topic 840, Heartland's minimum future rental commitments at December 31, 2018, for all non-cancelable leases were as follows, in thousands:

2019$5,776  
20205,493  
20215,102  
20223,241  
20232,297  
Thereafter12,419  
$34,328  





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


SAFE HARBOR STATEMENT


This Quarterly Report on Form 10-Q (including any information incorporated herein by reference) contains, and future oral and written statements of Heartland Financial USA, Inc. ("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 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, 2018. 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, 2018. There have been no significant changes in the critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2018.


OVERVIEW


Heartland is a multi-bank holding company providing banking, mortgage, wealth management, investments and insurance services to individuals and businesses. As of the date of this Quarterly Report on Form 10-Q, Heartland has eleven banking subsidiaries with 114 locations in Iowa, Illinois, Wisconsin, New Mexico, Arizona, Montana, Colorado, Minnesota, Kansas, Missouri, Texas and California. Heartland's primary objectives are to increase profitability and diversify its market area and asset base by expanding through acquisitions and to grow organically by increasing its customer base in the markets it serves.


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, net gains on sale of loans held for sale, and income on bank owned life insurance also affects Heartland's results of operations. Heartland's principal operating expenses, aside from interest expense, consist of the provision for loan losses, salaries and employee benefits, occupancy and equipment costs, professional fees, advertising, core deposit and customer relationship intangibles amortization and other real estate and loan collection expenses.


Net income available to common stockholders for the quarter ended March 31,September 30, 2019, was $31.5$34.6 million, or $0.91$0.94 per diluted common share, compared to $23.3$33.7 million, or $0.76$0.97 per diluted common share, for the quarter ended March 31,September 30, 2018. Return on average common equity was 9.56%8.91% and return on average assets was 1.13%1.12% for the firstthird quarter of 2019, compared to 9.32%10.58% and 0.97%1.18%, respectively, for the same quarter in 2018.


Net income available to common stockholders for the nine months ended September 30, 2019, was $111.3 million or $3.11 per diluted common share, compared to $84.8 million or $2.59 per diluted common share for the nine months ended September 30, 2018. Return on average common equity was 10.33% and return on average assets was 1.27% for the first nine months of 2019, compared to 9.95% and 1.07% for the same period in 2018.

For the firstthird quarter of 2019, Heartland's net interest margin was 4.12% (4.18%3.98% (4.02% on a fully tax-equivalent basis) compared to 4.19% (4.26%4.32% (4.38% on a fully tax-equivalent basis) for the same quarter in 2018, and the efficiency ratio was 65.23%61.92% and 68.21%62.51% for the firstthird quarter of 2019 and 2018, respectively.

The financial impact of For the following transaction is included in the results of operations for the three-monthnine-month period ended March 31,September 30, 2019, but not in the results of operationsHeartland's net interest



margin was 4.05% (4.10% on a fully tax-equivalent basis) compared to 4.25% (4.32% on a fully tax-equivalent basis) for the same period ended March 31, 2018:

On May 18, 2018, Heartland completedin 2018. The efficiency ratio for the acquisitionfirst nine months of Lubbock, Texas based First Bank Lubbock Bancshares, Inc. ("FBLB"), parent company of First Bank & Trust, and PrimeWest Mortgage Corporation, which is a wholly-owned subsidiary of First Bank & Trust. Based on Heartland's closing common stock price of $55.05 per share on May 18, 2018,2019 was 63.95% compared to 65.03% for the aggregate consideration paid to FBLB common shareholders was $189.9 million, with approximately 3% of the consideration paidsame period in cash and 97% paid by delivery of Heartland common stock. As a result of the transaction, First Bank & Trust became a wholly-owned subsidiary of Heartland and its 11th state-chartered bank. First Bank & Trust and PrimeWest Mortgage Corporation continue to operate under their present brands and management teams. As of the closing date, FBLB had, at fair value, total assets of $1.12 billion, total loans held to maturity of $681.1 million and total deposits of $893.8 million. Heartland also assumed, at fair value, $8.2 million of trust preferred debt. The systems conversion for this transaction occurred on August 17, 2018.


Total assets of Heartland were $11.31$12.57 billion at March 31,September 30, 2019, a decreasean increase of $95.5 million$1.16 billion or 1%10% since year-end 2018. Securities represented 22%25% of total assets at March 31,September 30, 2019, and 24% of total assets at December 31, 2018.


Total loans held to maturity were $7.33$7.97 billion at March 31,September 30, 2019, compared to $7.41 billion at year-end 2018, a decreasean increase of $76.2$563.9 million or 1%8%. This change includes $542.0 million of total loans held to maturity acquired at fair value in the Blue Valley Ban Corp. ("BVBC") transaction. During the first quarter of 2019, the sale of two branches at Dubuque Bank and Trust Company was announced, which included $20.3Heartland classified $32.1 million of loans that were classified as held for sale at March 31, 2019. Heartland also reclassified commercialin conjunction with the branch sales described below in "Recent Developments". Excluding the reclassification of loans with balances of $11.8 million at March 31, 2019, to held for sale as part of a plan to exit a small lease portfolio. Exclusive of these transactions,and the BVBC transaction, total loans held to maturity decreased $44.0increased $54.0 million or less than 1% since year-endDecember 31, 2018.





Total deposits were $9.35$10.47 billion as of March 31,September 30, 2019, compared to $9.40 billion at year-end 2018, a decreasean increase of $43.5$1.07 billion or 11%. This increase includes $617.1 million or less than 1%. Theof deposits acquired at fair value in the BVBC transaction. During the first quarter of 2019, Heartland classified $77.0 million of deposits as held for sale in conjunction with the expected sale of two branches at Dubuque Bank and Trust Company totaled $77.0 million at March 31, 2019.branch sales. Exclusive of thisthe reclassification of deposits to held for sale and the deposits acquired at fair value in the BVBC transaction, total deposits increased $33.5$533.3 million or less than 1%6% since December 31, 2018.


Total equity was $1.37$1.56 billion at March 31,September 30, 2019, compared to $1.33 billion at year-end 2018. Book value per common share was $39.65$42.62 at March 31,September 30, 2019, compared to $38.44 at year-end 2018. Heartland's unrealized lossgain on securities available for sale, net of applicable taxes, was $11.4$20.3 million at March 31,September 30, 2019, compared to an unrealized loss of $32.5 million, net of applicable taxes, at December 31, 2018.


RECENT DEVELOPMENTS

Regulatory Developments

Enactment of the Economic Growth, Regulatory Relief, and Consumer Protection Act in May 2018 significantly altered several provisions of the Dodd-Frank Act, including how stress tests are run. Bank holding companies with assets of less than $100 billion, such as Heartland, are no longer subject to company-run stress testing requirements in accordance with the Dodd-Frank Act, which included publishing a summary of results. In response to the initial provisions of the Dodd-Frank Act, Heartland has added staff, enhanced risk management processes and invested in upgraded information systems and technology. In addition, management continues to run internal stress tests as a component of the comprehensive risk management and capital planning process.

Other provisions of the Dodd-Frank Act, such as the Durbin Amendment, which restricts interchange fees, remain in place. The Durbin Amendment, which will be effective for Heartland on July 1, 2019, restricts interchange fees to those which are "reasonable and proportionate" for certain debit card issuers and limits the ability of networks and issuers to restrict debit card transaction routing. In the final rules, interchange fees for debit card transactions were capped at $0.21 plus five basis points in order to be eligible for a safe harbor such that the fee is conclusively determined to be reasonable and proportionate. Based on calculations using 2018 debit card volume, the negative impact of the Durbin Amendment would be approximately $6.0 million annually to Heartland's noninterest income.


In keeping with its focus on core businesses and execution of strategic priorities, Heartland has announced or completed the following transactions since January 1, 2019:


Blue Valley Ban Corp. Merger AgreementAcquisition


On January 16,May 10, 2019, Heartland entered into a definitive merger agreement to acquire Blue Valley Ban Corp.,completed the acquisition of BVBC and its wholly-owned subsidiary, Bank of Blue Valley, headquartered in Overland Park, Kansas. AsBased on Heartland's closing common stock price of $44.78 per share on May 10, 2019, the announcement date, the transaction, inaggregate consideration paid to BVBC common shareholders was $92.3 million, which allwas paid by delivery of the issued and outstanding shares of Blue Valley Ban Corp. stock will be exchanged for2,060,258 shares of Heartland common stock, was valuedstock. On the closing date, in addition to this merger consideration, Heartland provided BVBC the funds necessary to repay outstanding debt of $6.9 million, and Heartland assumed $16.1 million of trust preferred securities at approximately $93.9 million. Simultaneous withfair value. Immediately following the closing of the transaction, Bank of Blue Valley will mergewas merged with and into Heartland's Kansas-basedwholly-owned Kansas subsidiary, Morrill & Janes Bank and Trust Company, and the combined entity will operate as Bank of Blue Valley. The amount ofoperates under the merger consideration is subject to fluctuations in the price of Heartland common stock and certain potential adjustments, and the transaction is subject to customary closing conditions. The transaction is expected to close in the second quarter of 2019 with a systems conversion planned for the third quarter of 2019. As of March 31, 2019, Bank of Blue Valley brand. As of the closing date, BVBC had, at fair value, total assets of approximately $711.6$766.2 million, which included approximately $564.1total loans held to maturity of $542.0 million, and total deposits of gross loans outstanding, and approximately $587.2 million$617.1 million. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of deposits.BVBC.


The foregoing descriptionfinancial impact of the definitive merger agreementBVBC acquisition is qualifiedincluded in its entirety by reference to the agreement, which is partresults of operations for the proxy statement/prospectus containedperiod ended September 30, 2019, but not in Heartland’s Registration Statement on Form S-4 (File No. 333-230060), which became effective on April 9, 2019.the results of operations for the same period ended September 30, 2018.


Branch Sales and Other Divestitures


On January 11, 2019, Heartland completed the sale of the loan portfolios of its consumer finance subsidiaries, Citizens Finance Co. and Citizens Finance of Illinois Co. (collectively, "Citizens"). The loan portfolios had a fair value of $67.2 million.
On January 23, 2019, Heartland announced the sale of two branch locations of Dubuque Bank and Trust Company, which operate as First Community Bank, in Keokuk, Iowa. The announcement of this resulted in $20.3 million of loans and $77.0 million of deposits classified as held for sale as of March 31, 2019. This transaction, along with two previously announced branch sales, is expected to close in the second quarter of 2019.



On February 22, 2019, Heartland completed the sale of two branch locations of Wisconsin Bank & Trust. The sale included loans of $11.7 million and deposits of $48.6 million. Heartland recorded a net gain of $3.2 million in the first quarter of 2019, which consisted of a gain of $3.5 million and write-off $379,000of $329,000 of core deposit intangibles.



On April 26,30, 2019, Dubuque Bank and Trust Company signed an agreement to sellclosed on the sale of substantially all its mortgage servicing rights portfolio, which contained loans with an unpaid principal balance of approximately $3.31 billion to PNC Bank, N.A., headquartered in Pittsburgh, Pennsylvania. The transaction qualified as a sale, and $20.6 million of mortgage servicing rights hadwere de-recognized on the consolidated balance sheet as of June 30, 2019. Cash of approximately $34.8 million was received during the second quarter, and Heartland recorded an estimated fair valuegain on the sale of $37.0 million and a book valuethis portfolio of $21.0 millionapproximately $13.3 million. A payable of approximately $293,000 was recorded as of March 31, 2019. The portfolio contained approximately 20,300 serviced residential mortgage loans with unpaid principal balancesSeptember 30, 2019, due to the timing of $3.35 billion asthe servicing transfer per the terms of March 31, 2019. The serviced loans are primarily owned by Fannie Mae and Freddie Mac. The transaction was approved by Fannie Mae and Freddie Mac and closed on April 30, 2019.the sale agreement. In the agreement, which includedincludes customary terms and conditions, Dubuque Bank and Trust Company will provideprovided interim servicing of the loans until the transfer date, which was August 1, 2019.
On May 3, 2019, Heartland completed the sale of two branches of Illinois Bank & Trust. The sale included loans of $1.2 million and deposits of $11.4 million. Heartland recorded a net gain of $340,000 in the second quarter of 2019, which consisted of a gain of $519,000 and write-off of $179,000 of core deposit intangibles.
On May 17, 2019, Heartland completed the sale of one branch of Citywide Banks. The sale included loans of $8.4 million and deposits of $24.4 million. Heartland recorded a net gain of $1.6 million in the second quarter of 2019, which consisted of a gain of $1.8 million and write-off of $174,000 of core deposit intangibles.
On May 31, 2019, Heartland completed the sale of two branch locations of Dubuque Bank and Trust Company, which operated as First Community Bank, in Keokuk, Iowa. The sale included loans of $17.5 million and deposits of $72.0 million. Heartland recorded a gain of $4.2 million in the second quarter of 2019.

Heartland has been working on company-wide strategic initiatives since the end of 2018. Management expects approximately $8 million to $10 million of the net gains on the sale of the branches and mortgage servicing rights previously discussed will be invested in talent, process improvement, and technology upgrades that management believes are necessary to support future organic and acquired growth, improve efficiency and ultimately provide a superior customer experience and enhance profitability.

Three of the most significant investments in technology and process improvement are:
a project called Operation Customer Compass, which is focused on streamlining and automating processes. This project is intended to create back-office capacity for growth and enhance the customer experience. Expense reductions of over $10 million annually are expected to be realized once the project is completed, which is anticipated to be the end of 2019;
an upgrade to the existing customer relationship management system to the Salesforce Platform, which is an industry leader for relationship management, and,
the implementation of nCino, a premiere commercial loan origination system.

The upgrade to Salesforce and the implementation of nCino is expected to significantly improve the sales management process and improve the effectiveness of the commercial sales teams. The integration between nCino and Salesforce is expected to improve back office efficiencies and shorten the sales cycle. These two projects are currently underway and will be ongoing into mid-2020.

Pending Acquisition-Rockford Bank and Trust Company
On August 13, 2019, Heartland's Illinois Bank & Trust subsidiary entered into a purchase and assumption agreement to acquire substantially all of the assets and substantially all of the deposits and certain other liabilities of Rockford Bank and Trust Company ("RB&T"), headquartered in AugustRockford, Illinois. RB&T is a wholly-owned subsidiary of Moline, Illinois-based QCR Holdings, Inc. As of September 30, 2019, RB&T had total assets of $519.5 million, which included $417.3 million of gross loans held to maturity, and $451.5 million of deposits. RB&T serves the Rockford market from two full-service banking locations. The all-cash transaction is subject to regulatory approval and to customary closing conditions and is expected to close in the fourth quarter of 2019. The systems conversion is expected to occur in the first quarter of 2020.





FINANCIAL HIGHLIGHTS   
(Dollars in thousands, except per share data)Three Months Ended
March 31,
 2019 2018
STATEMENT OF INCOME DATA   
Interest income$120,721
 $101,214
Interest expense17,766
 9,630
Net interest income102,955
 91,584
Provision for loan losses1,635
 4,263
Net interest income after provision for loan losses101,320
 87,321
Noninterest income26,717
 24,716
Noninterest expenses88,230
 83,646
Income taxes8,310
 5,123
Net income31,497
 23,268
Preferred dividends
 (13)
Net income available to common stockholders$31,497
 $23,255
    
Key Performance Ratios   
Annualized return on average assets1.13% 0.97%
Annualized return on average common equity (GAAP)9.56% 9.32%
Annualized return on average tangible common equity (non-GAAP)(1)
15.24% 13.85%
Annualized ratio of net charge-offs to average loans0.05% 0.08%
Annualized net interest margin (GAAP)4.12% 4.19%
Annualized net interest margin, fully tax-equivalent (non-GAAP)(1)
4.18% 4.26%
Efficiency ratio, fully tax-equivalent (non-GAAP)(1)
65.23% 68.21%
    



FINANCIAL HIGHLIGHTS
(Dollars in thousands, except per share data)Three Months Ended
September 30,
Nine Months Ended
September 30,
2019201820192018
STATEMENT OF INCOME DATA
Interest income$133,403  $124,894  $381,127  $339,517  
Interest expense22,082  14,216  60,143  35,846  
Net interest income111,321  110,678  320,984  303,671  
Provision for loan losses5,201  5,238  11,754  14,332  
Net interest income after provision for loan losses106,120  105,440  309,230  289,339  
Noninterest income29,400  29,765  88,178  82,115  
Noninterest expenses92,967  92,539  256,295  265,067  
Income taxes7,941  8,956  29,835  21,530  
Net income34,612  33,710  111,278  84,857  
Preferred dividends—  (13) —  (39) 
Net income available to common stockholders$34,612  $33,697  $111,278  $84,818  
Key Performance Ratios
Annualized return on average assets1.12 %1.18 %1.27 %1.07 %
Annualized return on average common equity (GAAP)8.91 %10.58 %10.33 %9.95 %
Annualized return on average tangible common equity (non-GAAP)(1)
13.78 %17.31 %16.13 %15.64 %
Annualized ratio of net charge-offs to average loans0.14 %0.28 %0.13 %0.17 %
Annualized net interest margin (GAAP)3.98 %4.32 %4.05 %4.25 %
Annualized net interest margin, fully tax-equivalent (non-GAAP)(1)
4.02 %4.38 %4.10 %4.32 %
Efficiency ratio, fully tax-equivalent (non-GAAP)(1)
61.92 %62.51 %63.95 %65.03 %
Reconciliation of Annualized Return on Average Tangible Common Equity (non-GAAP)
Net income available to common shareholders (GAAP)$34,612  $33,697  $111,278  $84,818  
Plus core deposit and customer relationship intangibles amortization, net of tax(2)
2,291  2,075  7,153  5,343  
Adjusted net income available to common shareholders (non-GAAP)$36,903  $35,772  $118,431  $90,161  
Average common stockholders' equity (GAAP)$1,541,369  $1,263,226  $1,440,754  $1,139,149  
    Less average goodwill427,097  391,668  409,932  323,058  
    Less average other intangibles, net51,704  51,592  49,373  45,207  
Average tangible common equity (non-GAAP)$1,062,568  $819,966  $981,449  $770,884  
Annualized return on average common equity (GAAP)8.91 %10.58 %10.33 %9.95 %
Annualized return on average tangible common equity (non-GAAP)13.78 %17.31 %16.13 %15.64 %
Reconciliation of Annualized Net Interest Margin, Fully Tax-Equivalent (non-GAAP)
Net Interest Income (GAAP)$111,321  $110,678  $320,984  $303,671  
    Plus tax-equivalent adjustment(2)
1,140  1,544  3,820  4,663  
Net interest income - tax-equivalent (non-GAAP)
$112,461  $112,222  $324,804  $308,334  
Average earning assets$11,102,581  $10,154,591  $10,598,465  $9,547,147  
Net interest margin (GAAP)3.98 %4.32 %4.05 %4.25 %
Net interest margin, fully tax-equivalent (non-GAAP)4.02 %4.38 %4.10 %4.32 %



FINANCIAL HIGHLIGHTS   
(Dollars in thousands, except per share data)Three Months Ended
March 31,
Reconciliation of Annualized Return on Average Tangible Common Equity (non-GAAP)   
Net income available to common shareholders (GAAP)$31,497
 $23,255
Plus core deposit and customer relationship intangibles amortization, net of tax(2)
2,245
 1,472
Adjusted net income available to common shareholders (non-GAAP)$33,742
 $24,727
    
Average common stockholders' equity (GAAP)$1,336,250
 $1,011,580
    Less average goodwill391,668
 250,172
    Less average other intangibles, net46,490
 37,510
Average tangible common equity (non-GAAP)$898,092
 $723,898
Annualized return on average common equity (GAAP)9.56% 9.32%
Annualized return on average tangible common equity (non-GAAP)15.24% 13.85%
    
Reconciliation of Annualized Net Interest Margin, Fully Tax-Equivalent (non-GAAP)   
Net Interest Income (GAAP)$102,955
 $91,584
    Plus tax-equivalent adjustment(2)
1,412
 1,544
Net interest income - tax-equivalent (non-GAAP)
$104,367
 $93,128
    
Average earning assets$10,129,957
 $8,857,801
Net interest margin (GAAP)4.12% 4.19%
Net interest margin, fully tax-equivalent (non-GAAP)4.18% 4.26%
    
Reconciliation of Efficiency Ratio (non-GAAP)   
Net interest income$102,955
 $91,584
    Plus tax-equivalent adjustment(2)
1,412
 1,544
Fully tax-equivalent net interest income104,367
 93,128
Noninterest income26,717
 24,716
Securities gains, net(1,575) (1,441)
Unrealized (gain)/loss on equity securities, net(258) 28
Valuation adjustment on servicing rights589
 2
Adjusted income$129,840
 $116,433
    
Total noninterest expenses$88,230
 $83,646
Less:   
Core deposit and customer relationship intangibles amortization2,842
 1,863
Partnership investment in tax credit projects475
 
Gain on sales/valuations of assets, net

(3,004) (197)
   Restructuring expenses3,227
 2,564
Adjusted noninterest expenses$84,690
 $79,416
    
Efficiency ratio, fully tax-equivalent (non-GAAP)65.23% 68.21%
    
(1) Refer to the "Non-GAAP Measures" section after these financial tables for additional information on the usage and presentation of these non-GAAP measures, and refer to these financial tables for the reconciliations to the most directly comparable GAAP measures.
(2) Computed on a tax-equivalent basis using an effective tax rate of 21%.
FINANCIAL HIGHLIGHTS
(Dollars in thousands, except per share data)Three Months Ended
September 30,
Nine Months Ended
September 30,
2019201820192018
Reconciliation of Efficiency Ratio (non-GAAP)
Net interest income (GAAP)$111,321  $110,678  $320,984  $303,671  
    Plus tax-equivalent adjustment(2)
1,140  1,544  3,820  4,663  
Fully tax-equivalent net interest income112,461  112,222  324,804  308,334  
Noninterest income29,400  29,765  88,178  82,115  
Securities (gains)/losses, net(2,013) 145  (7,168) (1,037) 
Unrealized gain on equity securities, net(144) (54) (514) (97) 
Gain on extinguishment of debt(375) —  (375) —  
Valuation adjustment on servicing rights626  (230) 1,579  (12) 
Adjusted income (non-GAAP)$139,955  $141,848  $406,504  $389,303  
Total noninterest expenses (GAAP)$92,967  $92,539  $256,295  $265,067  
Less:
Core deposit and customer relationship intangibles amortization2,899  2,626  9,054  6,763  
Partnership investment in tax credit projects3,052  338  4,992  338  
(Gain)/loss on sales/valuations of assets, net
356  912  (20,934) 2,243  
   Restructuring expenses—  —  3,227  2,564  
Adjusted noninterest expenses (non-GAAP)$86,660  $88,663  $259,956  $253,159  
Efficiency ratio, fully tax-equivalent (non-GAAP)61.92 %62.51 %63.95 %65.03 %
(1) Refer to the "Non-GAAP Financial Measures" section after these financial tables for additional information on the usage and presentation of these non-GAAP measures, and refer to these financial tables for the reconciliations to the most directly comparable GAAP measures.
(2) Computed on a tax-equivalent basis using an effective tax rate of 21%.

















FINANCIAL HIGHLIGHTS, continued
FINANCIAL HIGHLIGHTS
(Dollars in thousands, except per share data)As Of and For the Quarter Ended
9/30/20196/30/20193/31/201912/31/20189/30/2018
BALANCE SHEET DATA
Investments$3,137,575  $2,681,419  $2,516,055  $2,715,388  $2,540,779  
Loans held for sale35,427  34,575  69,716  119,801  77,727  
Total loans receivable(1)7,971,608  7,853,051  7,331,544  7,407,697  7,365,493  
Allowance for loan losses66,222  63,850  62,639  61,963  61,221  
Total assets12,569,262  12,160,290  11,312,495  11,408,006  11,335,132  
Total deposits(2)
10,469,856  10,108,557  9,352,942  9,396,429  9,512,163  
Long-term obligations278,417  282,863  268,312  274,905  277,563  
Common stockholders’ equity1,563,843  1,521,787  1,372,102  1,325,175  1,280,393  
Common Share Data
Book value per common share (GAAP)$42.62  $41.48  $39.65  $38.44  $37.14  
Tangible book value per common share (non-GAAP)(3)
$29.62  $28.40  $27.04  $25.70  $24.33  
Common shares outstanding, net of treasury stock36,696,190  36,690,061  34,603,611  34,477,499  34,473,029  
Tangible common equity ratio (non-GAAP)(3)
8.99 %8.92 %8.60 %8.08 %7.70 %



FINANCIAL HIGHLIGHTSFINANCIAL HIGHLIGHTS
(Dollars in thousands, except per share data)As Of and For the Quarter Ended(Dollars in thousands, except per share data)As Of and For the Quarter Ended
3/31/2019 12/31/2018 9/30/2018 6/30/2018 3/31/20189/30/20196/30/20193/31/201912/31/20189/30/2018
BALANCE SHEET DATA         
Investments$2,516,055
 $2,715,388
 $2,540,779
 $2,468,113
 $2,300,413
Loans held for sale69,716
 119,801
 77,727
 55,684
 24,376
Total loans receivable(1)
7,331,544
 7,407,697
 7,365,493
 7,477,697
 6,746,015
Allowance for loan losses62,639
 61,963
 61,221
 61,324
 58,656
Total assets11,312,495
 11,408,006
 11,335,132
 11,301,920
 10,055,863
Total deposits(2)
9,352,942
 9,396,429
 9,512,163
 9,489,144
 8,541,540
Long-term obligations268,312
 274,905
 277,563
 258,708
 276,118
Preferred equity
 
 
 938
 938
Common stockholders’ equity1,372,102
 1,325,175
 1,280,393
 1,254,809
 1,050,567
         
Common Share Data         
Book value per common share (GAAP)$39.65
 $38.44
 $37.14
 $36.44
 $33.81
Tangible book value per common share (non-GAAP)(3)
$27.04
 $25.70
 $24.33
 $23.53
 $23.79
Common shares outstanding, net of treasury stock34,603,611
 34,477,499
 34,473,029
 34,438,445
 31,068,239
Tangible common equity ratio (non-GAAP)(3)
8.60% 8.08% 7.70% 7.46% 7.59%
         
Reconciliation of Tangible Book Value Per Common Share (non-GAAP)         Reconciliation of Tangible Book Value Per Common Share (non-GAAP)
Common stockholders' equity (GAAP)$1,372,102
 $1,325,175
 $1,280,393
 $1,254,809
 $1,050,567
Common stockholders' equity (GAAP)$1,563,843  $1,521,787  $1,372,102  $1,325,175  $1,280,393  
Less goodwill391,668
 391,668
 391,668
 391,668
 270,305
Less goodwill427,097  427,097  391,668  391,668  391,668  
Less core deposit and customer relationship intangibles, net44,637
 47,479
 50,071
 52,698
 41,063
Less core deposit and customer relationship intangibles, net49,819  52,718  44,637  47,479  50,071  
Tangible common stockholders' equity (non-GAAP)$935,797
 $886,028
 $838,654
 $810,443
 $739,199
Tangible common stockholders' equity (non-GAAP)$1,086,927  $1,041,972  $935,797  $886,028  $838,654  
         
Common shares outstanding, net of treasury stock34,603,611
 34,477,499
 34,473,029
 34,438,445
 31,068,239
Common shares outstanding, net of treasury stock36,696,190  36,690,061  34,603,611  34,477,499  34,473,029  
Common stockholders' equity (book value) per share (GAAP)$39.65
 $38.44
 $37.14
 $36.44
 $33.81
Common stockholders' equity (book value) per share (GAAP)$42.62  $41.48  $39.65  $38.44  $37.14  
Tangible book value per common share (non-GAAP)$27.04
 $25.70
 $24.33
 $23.53
 $23.79
Tangible book value per common share (non-GAAP)$29.62  $28.40  $27.04  $25.70  $24.33  
         
Reconciliation of Tangible Common Equity Ratio (non-GAAP)         Reconciliation of Tangible Common Equity Ratio (non-GAAP)
Tangible common stockholders' equity (non-GAAP)$935,797
 $886,028
 $838,654
 $810,443
 $739,199
Tangible common stockholders' equity (non-GAAP)$1,086,927  $1,041,972  $935,797  $886,028  $838,654  
         
Total assets (GAAP)$11,312,495
 $11,408,006
 $11,335,132
 $11,301,920
 $10,055,863
Total assets (GAAP)$12,569,262  $12,160,290  $11,312,495  $11,408,006  $11,335,132  
Less goodwill391,668
 391,668
 391,668
 391,668
 270,305
Less goodwill427,097  427,097  391,668  391,668  391,668  
Less core deposit and customer relationship intangibles, net44,637
 47,479
 50,071
 52,698
 41,063
Less core deposit and customer relationship intangibles, net49,819  52,718  44,637  47,479  50,071  
Total tangible assets (non-GAAP)$10,876,190
 $10,968,859
 $10,893,393
 $10,857,554
 $9,744,495
Total tangible assets (non-GAAP)$12,092,346  $11,680,475  $10,876,190  $10,968,859  $10,893,393  
Tangible common equity ratio (non-GAAP)8.60% 8.08% 7.70% 7.46% 7.59%Tangible common equity ratio (non-GAAP)8.99 %8.92 %8.60 %8.08 %7.70 %
(1) Excludes loans held for sale.(1) Excludes loans held for sale.(1) Excludes loans held for sale.
(2) Excludes deposits held for sale.(2) Excludes deposits held for sale.(2) Excludes deposits held for sale.
(3) Refer to the "Non-GAAP Measures" section after these financial tables for additional information on the usage and presentation of these non-GAAP measures, and refer to these financial tables for the reconciliations to the most directly comparable GAAP measures.
(3) Refer to the "Non-GAAP Financial Measures" section after these financial tables for additional information on the usage and presentation of these non-GAAP measures, and refer to these financial tables for the reconciliations to the most directly comparable GAAP measures.(3) Refer to the "Non-GAAP Financial Measures" section after these financial tables for additional information on the usage and presentation of these non-GAAP measures, and refer to these financial tables for the reconciliations to the most directly comparable GAAP measures.


Non-GAAP Financial Measures


This Quarterly Report on Form 10-Q contains references to financial measures which are not defined by generally accepted accounting principles ("GAAP"). Management believes the non-GAAP measures are helpful for investors to analyze and evaluate Heartland's financial condition and operating results. However, these non-GAAP measures have inherent limitations and should not be considered a substitute for operating results determined in accordance with GAAP. Additionally, because non-GAAP measures are not standardized, it may not be possible to compare the non-GAAP measures presented in this section with other companies' non-GAAP measures. Reconciliations of each non-GAAP measure to the most directly comparable GAAP measure may be found in the financial tables above.




The non-GAAP measures presented in this Quarterly Report on Form 10-Q, management's reason for including each measure and the method of calculating each measure are presented below:


Annualized return on average tangible common tangible equity is net income available to common stockholders plus core deposit and customer relationship intangibles amortization, net of tax, divided by average common stockholders' equity less goodwill and core deposit and customer relationship intangibles, net. This measure is included as it is considered to be a critical metric to analyze and evaluate financial condition and capital strength.
Annualized net interest margin, fully tax-equivalent, 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.
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 tax credit projects. 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 as noted in reconciliation contained in this Quarterly Report on Form 10-Q.



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 measure is included as it is considered to be a critical metric to analyze and evaluate use of equity, financial condition and capital strength.
Tangible common equity ratio is total common stockholders' equity less goodwill and core deposit and customer relationship intangibles, net, divided by total assets less goodwill and core deposit and customer relationship intangibles, net. This measure is included as it is considered to be a critical metric to analyze and evaluate use of equity, financial condition and capital strength.


RESULTS OF OPERATIONS


Net Interest Margin and Net Interest Income

Net interest margin, expressed as a percentage of average earning assets, was 4.12% (4.18% on a fully tax-equivalent basis) during the first quarter of 2019, compared to 4.19% (4.26% on a fully tax-equivalent basis) during the first quarter of 2018. Heartland's success in maintaining itscompetitive net interest margin has been the result of an increase in average earning assets and a favorable deposit mix.mix for the quarters ended September 30, 2019 and 2018 and the nine-month periods ended September 30, 2019 and 2018. Also contributing to Heartland's ability to maintain its net interest margin has been the amortization of purchase accounting discounts associated with acquisitions completed by Heartland. ForGrowth in interest income on a tax-equivalent basis was largely due to the first quarter of 2019, Heartland's netincrease in average earning assets primarily from recent acquisitions. Increases in total interest margin included 16 basis points of purchase accounting discount amortization comparedexpense were primarily due to 22 basis pointsrecent increases in the same quarter of 2018.market interest rates and deposit growth from recent acquisitions. See "Analysis of Average Balances, Tax-Equivalent Yields and Rates" for information relating to Heartland's net interest income on a fully tax-equivalent basis, which is not defined by GAAP, and referGAAP. Refer to the financial tableshighlights above for a reconciliation of annualized net interest margin on a fully tax-equivalent basis to GAAP.


Growth inFor the Quarters ended September 30, 2019 and 2018
Net interest incomemargin, expressed as a percentage of average earning assets, was 3.98% (4.02% on a fully tax-equivalent basis) during the third quarter of 2019, compared to 4.32% (4.38% on a fully tax-equivalent basis) during the third quarter of 2018. For the third quarter of 2019, Heartland's net interest margin included 23 basis was primarily duepoints of purchase accounting discount amortization compared to recent increases25 basis points in market interest rates and the increase in average earning assets. same quarter of 2018.

Total interest income for the firstthird quarter of 2019 was $120.7$133.4 million, an increase of $19.5$8.5 million or 19%7%, compared to $101.2$124.9 million recorded in the firstthird quarter of 2018. The tax-equivalent adjustments for income taxes saved on the interest earned on nontaxable securities and loans were $1.4$1.1 million for the firstthird quarter of 2019 and $1.5 million for the firstthird quarter of 2018. With these adjustments, total interest income on a tax-equivalent basis was $122.1$134.5 million for the firstthird quarter of 2019, an increase of $19.4$8.1 million or 19%6%, compared to $102.8$126.4 million for the firstthird quarter of 2018.


Average earning assets increased $1.27$948.0 million or 9% to $11.10 billion or 14% from $10.15 billion in the firstthird quarter of 2018, which was primarily attributable to the acquisitions completed in 2018.recent acquisitions. The average interest rate on earning assets increased 19decreased 13 basis points to 4.89%4.81% for the third quarter of 2019 compared to 4.94% for the same quarter in 2018. In the first quarter of 2019, Heartland sold its higher yielding consumer loan portfolios, which decreased the average rate on earning assets by approximately 13 basis points for the third quarter of 2019 compared to 4.70% for the same quarter in 2018.


Increases in total interest expense were primarily due to recent increases in market interest rates and deposit growth from recent acquisitions. Total interest expense for the firstthird quarter of 2019 was $17.8$22.1 million, an increase of $8.1$7.9 million or 84%55% from $9.6$14.2 million in the firstthird quarter of 2018. The average interest rate paid on savings deposits was 0.80% duringHeartland's interest bearing liabilities increased to 1.22% for the firstthird quarter of 2019 compared to 0.35%0.86% for the firstthird quarter of 2018, which was primarily due to recent increases in market interest rates. The average interest rate paid on savings deposits was 0.94% during the third quarter of 2019 compared to 0.56% for the third quarter of 2018, and the average interest rate paid on time deposits was 1.23%1.62% for the firstthird quarter of 2019 compared to 0.88%1.03% for the firstthird quarter of 2018. The average interest rate paid on Heartland's borrowings was 3.96%4.26% for the firstthird quarter of 2019 compared to 3.66%3.91% in the firstthird quarter of 2018.


For the quarter ended March 31,September 30, 2019, average interest bearing liabilities were $6.62$7.17 billion, an increase of $927.8$630.0 million or 16%10%, from $5.69$6.54 billion for the quarter ended March 31,September 30, 2018. Average interest bearing deposits increased $889.5$666.8 million or 17%11% to $6.16$6.79 billion for the quarter ended March 31,September 30, 2019, from $5.27$6.13 billion in the same quarter in 2018. Average borrowings increased $38.3decreased $36.8 million or 9% to $466.2$382.2 million during the firstthird quarter of 2019 from $427.9$419.0 million during the same quarter in 2018. The increase in Heartland's average interest bearing liabilities is primarily attributable to recent acquisitions.


Net interest income increased $11.4 million$643,000 or 12%1% to $103.0$111.3 million in the firstthird quarter of 2019 from $91.6$110.7 million in the firstthird quarter of 2018. After the tax-equivalent adjustment discussed above, net interest income on a tax-equivalent basis totaled $104.4$112.5 million during the firstthird quarter of 2019, an increase of $11.2$239,000 or less than 1% from $112.2 million during the third quarter of 2018.




For the Nine Months Ended September 30, 2019 and 2018
Net interest margin, expressed as a percentage of average earning assets, was 4.05% (4.10% on a fully tax-equivalent basis) during the nine-month period ended September 30, 2019, compared to 4.25% (4.32% on a fully tax-equivalent basis) during the same period of 2018. For the nine months ended September 30, 2019, Heartland's net interest margin included 19 basis points of purchase accounting discount amortization compared to 21 basis points for the same period of 2018.

Total interest income for the first nine months of 2019 was $381.1 million, an increase of $41.6 million or 12%, compared to $339.5 million recorded in the first nine months of 2018. The tax-equivalent adjustments for income taxes saved on the interest earned on nontaxable securities and loans were $3.8 million for the first nine months of 2019 and $4.7 million for the same period of 2018. With these adjustments, total interest income on a tax-equivalent basis was $384.9 million for the first nine months of 2019, an increase of $40.8 million or 12%, compared to $344.2 million for the first nine months of 2018.

Average earning assets increased $1.05 billion or 11% to $10.60 billion for the first nine months of 2019 from $93.1$9.55 billion for the first nine months of 2018, which was primarily attributable to recent acquisitions. The average interest rate on earning assets increased 4 basis points to 4.86% for the first nine months of 2019 compared to 4.82% for the same period in 2018. In the first quarter of 2019, Heartland sold its higher yielding consumer loan portfolios, which decreased the average rate on earning assets by approximately 14 basis points for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018.

Total interest expense for the nine-month period ended September 30, 2019 was $60.1 million, an increase of $24.3 million or 68% from $35.8 million in the nine-month period ended September 30, 2018. The average interest rate paid on Heartland's interest bearing liabilities increased to 1.17% for the nine months ended September 30, 2019 compared to 0.78% for the same period of 2018, which was primarily due to recent increases in market interest rates. The average interest rate paid on savings deposits was 0.88%, and the average interest rate paid on time deposits was 1.45% during the first nine months of 2019 compared to 0.47% and 0.96%, respectively, for the first nine months of 2018. The average interest rate paid on Heartland's borrowings for the nine months ended September 30, 2019 and 2018, was 4.22% and 3.82%, respectively.

For the first nine months of 2019, average interest bearing liabilities were $6.89 billion, an increase of $740.6 million or 12%, from $6.15 billion for the same period of 2018. Average interest bearing deposits increased $755.7 million or 13% to $6.49 billion for the nine months ended September 30, 2019, from $5.73 billion in the first nine months of 2018. Average borrowings decreased $15.1 million or 4% to $405.6 million during the first quarternine months of 2019 from $420.7 million during the same period in 2018.

Net interest income increased $17.3 million or 6% to $321.0 million in the first nine months of 2019 from $303.7 million recorded in the first nine months of 2018. After the tax-equivalent adjustment discussed above, net interest income on a tax-equivalent basis totaled $324.8 million during the first nine months of 2019, an increase of $16.5 million or 5% from $308.3 million during the same period of 2018.


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 produces and reviews simulations of various interest rate scenarios to assist in monitoring its exposure to interest rate risk. Based on these simulations, it is management's opinion that Heartland maintains a well-balanced and manageable interest rate posture. Item 3 of Part I of this Quarterly Report on Form 10-Q contains additional information about the results of Heartland's most recent net interest income simulations. Note 7 to the 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 setstables set forth certain information relating to Heartland's average consolidated balance sheets and reflectsreflect the yield on average earning assets and the cost of average interest bearing liabilities for the periods indicated, in thousands. Such yields and costs are calculated by dividing income or expense by the average balance of assets or liabilities. Average balances are derived from daily balances, and nonaccrual loans and loans held for sale are included in each respective loan category. Assets that receive favorable tax treatment are evaluated on a tax-equivalent basis assuming a federal income tax rate of 21%. Tax-favored 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 favored assets and dividing this amount by the average balance of the tax favorable assets.










ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1)
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1)
ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1)
(DOLLARS IN THOUSANDS)(DOLLARS IN THOUSANDS)(DOLLARS IN THOUSANDS)
For the Quarter EndedFor the Quarter Ended
March 31, 2019 December 31, 2018 March 31, 2018September 30, 2019June 30, 2019September 30, 2018
Average
Balance
 Interest Rate Average Balance Interest Rate Average
Balance
 Interest RateAverage
Balance
InterestRateAverage BalanceInterestRateAverage
Balance
InterestRate
Earning Assets                 Earning Assets
Securities:                 Securities:
Taxable$2,169,016
 $15,876
 2.97% $2,184,096
 $15,851
 2.88% $1,827,611
 $11,577
 2.57%Taxable$2,658,107  $18,567  2.77 %$2,217,863  $16,123  2.92 %$2,066,071  $14,433  2.77 %
Nontaxable(1)
391,724
 3,915
 4.05
 427,332
 4,388
 4.07
 448,641
 4,530
 4.09
Nontaxable(1)
266,933  2,682  3.99  324,164  3,233  4.00  435,045  4,418  4.03  
Total securities2,560,740
 19,791
 3.13
 2,611,428
 20,239
 3.07
 2,276,252
 16,107
 2.87
Total securities2,925,040  21,249  2.88  2,542,027  19,356  3.05  2,501,116  18,851  2.99  
Interest on deposits with other banks and other short-term investments218,445
 1,292
 2.40
 238,087
 1,285
 2.14
 112,024
 407
 1.47
Interest on deposits with other banks and other short-term investments358,327  2,151  2.38  424,262  2,299  2.17  252,535  1,238  1.94  
Federal funds sold560
 4
 2.90
 309
 
 
 
 
 
Federal funds sold—  —  —  —  —  —  —  —  —  
Loans:(2)
                 
Loans:(2)
Commercial and commercial real estate(1)
5,745,180
 78,083
 5.51
 5,644,475
 77,822
 5.47
 4,910,797
 62,813
 5.19
Commercial and commercial real estate(1)
6,216,133  86,864  5.54  5,968,424  82,328  5.53  5,637,360  77,443  5.45  
Residential mortgage673,682
 7,179
 4.32
 704,012
 8,682
 4.89
 642,181
 6,851
 4.33
Residential mortgage662,663  7,979  4.78  676,465  8,238  4.88  736,875  8,952  4.82  
Agricultural and agricultural real estate(1)
554,506
 7,301
 5.34
 568,904
 7,752
 5.41
 513,780
 6,004
 4.74
Agricultural and agricultural real estate(1)
550,441  7,551  5.44  558,128  7,581  5.45  571,599  7,725  5.36  
Consumer439,487
 6,479
 5.98
 519,106
 9,355
 7.15
 458,795
 8,660
 7.66
Consumer454,441  6,697  5.85  445,545  6,517  5.87  516,342  10,043  7.72  
Fees on loans  2,004
 
 
 2,733
 
   1,916
 
Fees on loans2,052  —  1,952  —  2,186  —  
Less: allowance for loan losses(62,643) 
 
 (60,912) 
 
 (56,028) 
 
Less: allowance for loan losses(64,464) —  —  (62,685) —  —  (61,236) —  —  
Net loans7,350,212
 101,046
 5.58
 7,375,585
 106,344
 5.72
 6,469,525
 86,244
 5.41
Net loans7,819,214  111,143  5.64  7,585,877  106,616  5.64  7,400,940  106,349  5.70  
Total earning assets10,129,957
 122,133
 4.89% 10,225,409
 127,868
 4.96% 8,857,801
 102,758
 4.70%Total earning assets11,102,581  134,543  4.81 %10,552,166  128,271  4.88 %10,154,591  126,438  4.94 %
Nonearning Assets1,137,257
     1,145,838
 

   902,135
    Nonearning Assets1,190,751  1,156,372  1,136,698  
Total Assets$11,267,214
     $11,371,247
     $9,759,936
    Total Assets$12,293,332  $11,708,538  $11,291,289  
Interest Bearing Liabilities(3)
                 
Interest Bearing Liabilities(3)
Savings$5,121,179
 $10,083
 0.80% $5,071,573
 $8,817
 0.69% $4,358,508
 $3,791
 0.35%Savings$5,643,722  $13,301  0.94 %$5,360,355  $11,895  0.89 %$4,932,013  $6,980  0.56 %
Time deposits1,034,744
 3,130
 1.23
 1,088,122
 3,009
 1.10
 907,928
 1,975
 0.88
Time deposits1,149,064  4,681  1.62  1,142,842  4,243  1.49  1,193,971  3,112  1.03  
Short-term borrowings195,390
 889
 1.85
 121,053
 417
 1.37
 147,738
 268
 0.74
Short-term borrowings102,440  250  0.97  92,977  338  1.46  148,041  464  1.24  
Other borrowings270,836
 3,664
 5.49
 276,437
 3,777
 5.42
 280,163
 3,596
 5.21
Other borrowings279,718  3,850  5.46  276,275  3,819  5.54  270,924  3,660  5.36  
Total interest bearing liabilities6,622,149
 17,766
 1.09% 6,557,185
 16,020
 0.97% 5,694,337
 9,630
 0.69%Total interest bearing liabilities7,174,944  22,082  1.22 %6,872,449  20,295  1.18 %6,544,949  14,216  0.86 %
Noninterest Bearing Liabilities(3)
                 
Noninterest Bearing Liabilities(3)
Noninterest bearing deposits3,200,281
     3,437,112
     2,984,704
    Noninterest bearing deposits3,460,857  3,287,559  3,404,759  
Accrued interest and other liabilities108,534
     86,259
     68,377
    Accrued interest and other liabilities116,162  106,142  77,786  
Total noninterest bearing liabilities3,308,815
     3,523,371
     3,053,081
    Total noninterest bearing liabilities3,577,019  3,393,701  3,482,545  
Stockholders' Equity1,336,250
     1,290,691
     1,012,518
    Stockholders' Equity1,541,369  1,442,388  1,263,795  
Total Liabilities and Stockholders' Equity$11,267,214
     $11,371,247
     $9,759,936
    Total Liabilities and Stockholders' Equity$12,293,332  $11,708,538  $11,291,289  
Net interest income, fully tax-equivalent (non-GAAP)(1)
  $104,367
     $111,848
     $93,128
  
Net interest income, fully tax-equivalent (non-GAAP)(1)
$112,461  $107,976  $112,222  
Net interest spread(1)
    3.80%     3.99%     4.01%
Net interest spread(1)
3.59 %3.70 %4.08 %
Net interest income, fully tax-equivalent (non-GAAP) to total earning assets    4.18%     4.34%     4.26%Net interest income, fully tax-equivalent (non-GAAP) to total earning assets4.02 %4.10 %4.38 %
                 
(1) Computed on a tax-equivalent basis using an effective tax rate of 21%.(1) Computed on a tax-equivalent basis using an effective tax rate of 21%.(1) Computed on a tax-equivalent basis using an effective tax rate of 21%.
(2) Nonaccrual loans and loans held for sale are included in the average loans outstanding.(2) Nonaccrual loans and loans held for sale are included in the average loans outstanding.(2) Nonaccrual loans and loans held for sale are included in the average loans outstanding.
(3) Includes deposits held for sale.(3) Includes deposits held for sale.(3) Includes deposits held for sale.





ANALYSIS OF AVERAGE BALANCES, TAX EQUIVALENT YIELDS AND RATES (1)
DOLLARS IN THOUSANDS
For the Nine Months Ended
September 30, 2019September 30, 2018
Average
Balance
InterestRateAverage
Balance
InterestRate
Earning Assets
Securities:
Taxable$2,350,120  $50,566  2.88 %$1,937,053  $38,280  2.64 %
Nontaxable(1)
327,150  9,830  4.02 %444,127  13,485  4.06  
Total securities2,677,270  60,396  3.02  2,381,180  51,765  2.91  
Interest bearing deposits with other banks and other short-term investments334,191  5,742  2.30  183,905  2,413  1.75  
Federal funds sold185   2.89  471  —  —  
Loans:(2)
Commercial and commercial real estate(1)
5,978,304  247,275  5.53  5,319,862  211,557  5.32  
Residential mortgage670,896  23,396  4.66  688,367  23,365  4.54  
Agricultural and agricultural real estate(1)
554,344  22,433  5.41  542,755  20,579  5.07  
Consumer446,546  19,693  5.90  489,417  27,895  7.62  
Fees on loans6,008  —  6,606  —  
Less: allowance for loan losses(63,271) —  —  (58,810) —  —  
Net loans7,586,819  318,805  5.62  6,981,591  290,002  5.55  
Total earning assets10,598,465  384,947  4.86 %9,547,147  344,180  4.82 %
Nonearning Assets1,161,655  1,023,306  
Total Assets$11,760,120  $10,570,453  
Interest Bearing Liabilities(3)
Savings$5,376,999  $35,279  0.88 %$4,681,710  $16,306  0.47 %
Time deposits1,109,302  12,054  1.45  1,048,878  7,535  0.96  
Short-term borrowings129,928  1,477  1.52  149,453  1,279  1.14  
Other borrowings275,642  11,333  5.50  271,234  10,726  5.29  
Total interest bearing liabilities6,891,871  60,143  1.17 %6,151,275  35,846  0.78 %
Noninterest Bearing Liabilities(3)
Noninterest bearing deposits3,317,187  3,207,709  
Accrued interest and other liabilities110,308  71,506  
Total noninterest bearing liabilities3,427,495  3,279,215  
Stockholders' Equity1,440,754  1,139,963  
Total Liabilities and Stockholders' Equity$11,760,120  $10,570,453  
Net interest income, fully tax-equivalent (non-GAAP)(1)
$324,804  $308,334  
Net interest spread(1)
3.69 %4.04 %
Net interest income, fully tax-equivalent (non-GAAP) to total earning assets4.10 %4.32 %
(1) Computed on a tax-equivalent basis using an effective tax rate of 21%.
(2) Nonaccrual loans and loans held for sale are included in the average loans outstanding.
(3) Includes deposits held for sale.

Provision For Loan Losses


The allowance for loan losses is established through provision expense to provide, in Heartland management's opinion, an appropriate allowance for loan losses. The provision for loan losses decreased $2.6 million to $1.6was $5.2 million for the firstthird quarter of 2019 and 2018. For the nine months ended September 30, 2019, provision expense totaled $11.8 million compared to $4.3$14.3 million for the first quartersame period of 2018.

The impact of the closuresale of the Citizen's Finance offices in the first quarter of 2019loan portfolios resulted in net recoveries of $93,000 in$1,800 for the third quarter and $629,000 for the first quarternine months of 2019, compared to net charge-offs of $706,000$805,000 in the



third quarter of 2018 and $2.3 million for the first quarternine months of 2018. As a result of the sale of the Citizen's Finance loan portfolios, Heartland recorded



negative provision expense of $93,000$1,800 and $629,000 for the firstthird quarter of 2019 comparedand first nine months of 2019, respectively. Provision expense related to the Citizen's Finance loan portfolios of $769,000 and $2.3 million, respectively, was recorded for the same periods of 2018. This was a change to provision expense of $792,000 in$771,000 and $2.9 million for the same quarter of 2018, which was a decrease of $885,000.three- and nine-months ended September 30, 2019, respectively, for the Citizen's Finance loan portfolios.


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 provision for loan losses will vary from quarter to quarter. 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, 2018, and the information under the caption "Allowance For Loan Losses" in Item 2 of this Quarterly Report on Form 10-Q and Note 5 to the consolidated financial statements included herein.


Heartland believes the allowance for loan losses as of March 31,September 30, 2019, was at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions should deteriorate, 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 losses.


Noninterest Income
The tables below show Heartland's noninterest income for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and 2018, in thousands:

Three Months Ended
September 30,
 20192018Change% Change
Service charges and fees$12,366  $12,895  $(529) (4)%
Loan servicing income821  1,670  (849) (51) 
Trust fees4,959  4,499  460  10  
Brokerage and insurance commissions962  1,111  (149) (13) 
Securities gains/(losses), net2,013  (145) 2,158  1,488  
Unrealized gain on equity securities, net144  54  90  167  
Net gains on sale of loans held for sale4,673  7,410  (2,737) (37) 
Valuation adjustment on servicing rights(626) 230  (856) (372) 
Income on bank owned life insurance881  892  (11) (1) 
Other noninterest income3,207  1,149  2,058  179  
  Total noninterest income$29,400  $29,765  $(365) (1)%

Nine Months Ended
September 30, 
 
20192018Change  % Change  
Service charges and fees$39,789  $35,046  $4,743  14 %
Loan servicing income3,888  5,231  (1,343) (26) 
Trust fees14,258  13,794  464   
Brokerage and insurance commissions2,724  2,895  (171) (6) 
Securities gains, net7,168  1,037  6,131  591  
Unrealized gain on equity securities, net514  97  417  430  
Net gains on sale of loans held for sale12,192  18,261  (6,069) (33) 
Valuation adjustment on servicing rights(1,579) 12  (1,591) (13,258) 
Income on bank owned life insurance2,668  2,206  462  21  
Other noninterest income6,556  3,536  3,020  85  
  Total noninterest income$88,178  $82,115  $6,063  %



 Three Months Ended
March 31,
  
 2019 2018 Change % Change
Service charges and fees$12,794
 $10,079
 $2,715
 27 %
Loan servicing income1,729
 1,754
 (25) (1)
Trust fees4,474
 4,680
 (206) (4)
Brokerage and insurance commissions734
 907
 (173) (19)
Securities gains, net1,575
 1,441
 134
 9
Unrealized (gain)/loss on equity securities, net258
 (28) 286
 1,021
Net gains on sale of loans held for sale3,176
 4,051
 (875) (22)
Valuation adjustment on servicing rights(589) (2) (587) (29,350)
Income on bank owned life insurance899
 614
 285
 46
Other noninterest income1,667
 1,220
 447
 37
  Total noninterest income$26,717
 $24,716
 $2,001
 8 %


Total noninterest income totaled $26.7$29.4 million during the firstthird quarter of 2019 compared to $24.7$29.8 million during the firstthird quarter of 2018, a decrease of $365,000 or 1%. For the nine months ended September 30, 2019, total noninterest income totaled $88.2 million compared to $82.1 million for the first nine months of 2018, which was an increase of $2.0$6.1 million or 8%7%. This increase reflectedThe changes for the quarterly and nine month comparison were primarily the result of higher service charges and fees, net securities gains, and other noninterest income,net, which were partially offset by decreasedlower loan servicing income, net gains on sale of loans held for sale and an increased valuation adjustment on servicing rights. Also impacting the nine months ended September 30, 2019 compared to the same period in 2018 were higher service charges and fees.





Service Charges and Fees
The following tables summarize the changes in service charges and fees for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and 2018, in thousands:

Three Months Ended
March 31,
    Three Months Ended
September 30,
2019 2018 Change % Change20192018Change% Change
Service charges and fees on deposit accounts$2,977
 $2,618
 $359
 14%Service charges and fees on deposit accounts$3,221  $2,858  $363  13 %
Overdraft fees2,744
 2,208
 536
 24
Overdraft fees2,917  2,990  (73) (2) 
Customer service fees81
 77
 4
 5
Customer service and other service feesCustomer service and other service fees104  102    
Credit card fee income3,349
 2,190
 1,159
 53
Credit card fee income3,936  3,062  874  29  
Debit card income3,642
 2,985
 657
 22
Debit card income2,188  3,883  (1,695) (44) 
Other service charges1
 1
 
 
Total service charges and fees$12,794
 $10,079
 $2,715
 27%Total service charges and fees$12,366  $12,895  $(529) (4)%
Nine Months Ended
September 30,
20192018Change% Change
Service charges and fees on deposit accountsService charges and fees on deposit accounts$9,383  $8,270  $1,113  13 %
Overdraft feesOverdraft fees8,537  7,716  821  11  
Customer service and other service feesCustomer service and other service fees270  268    
Credit card fee incomeCredit card fee income11,555  8,443  3,112  37  
Debit card incomeDebit card income10,044  10,349  (305) (3) 
Total service charges and feesTotal service charges and fees$39,789  $35,046  $4,743  14 %


Total service charges and fees increased $2.7 milliondecreased $529,000 or 27%4% to $12.8$12.4 million during the firstthird quarter of 2019 compared to $10.1$12.9 million during the third quarter of 2018, as increases in credit card fee income and service charges and fees on deposit accounts were offset by a decrease in debit card income. Total service charges and fees increased $4.7 million or 14% to $39.8 million during the first quarternine months of 2018. 2019 compared to $35.0 million for the same period of 2018, which was primarily attributable to higher service charges and fees on deposit accounts and higher credit card fee income.

Service charges and fees on deposit accounts increased $359,000$363,000 or 14%13% to $3.2 million for the third quarter of 2019 compared to $2.9 million for the third quarter of 2018. For the first nine months of 2019, service charges and fees on deposit accounts totaled $9.4 million compared to $8.3 million for the first nine months of 2018, which was an increase of $1.1 million or 13%. Overdraft fees decreased $73,000 or 2% to $2.9 million for the third quarter of 2019 compared to $3.0 million for the firstthird quarter of 2018, and overdraft fees increased $821,000 or 11% during the first nine months of 2019 to $8.5 million compared to $2.6$7.7 million for the first quarternine months of 2018. OverdraftThe increases in service charges and fees increased $536,000 or 24% to $2.7 million for the first quarter of 2019 compared to $2.2 million for the first quarter of 2018. These increaseson deposit accounts and overdraft fees were primarily attributable to a larger demand deposit customer base, a portion of which is attributable to the acquisitions completed in 2018.2018 and the first half of 2019.


Fees associated with credit card services were $3.3$3.9 million during the firstthird quarter of 2019 compared to $2.2$3.1 million during the firstthird quarter of 2018, an increase of $1.2$874,000 or 29%. For the nine months ended September 30, 2019, credit card fee income totaled $11.6 million, which was an increase of $3.1 million or 53%.37% from $8.4 million recorded in the same period of 2018. These increases resulted primarily from efforts to increase the level of commercial credit card services provided at Heartland's subsidiary banks, including at the recently acquired banks. Heartland has focused on expanding its card payment solutions for



businesses. In particular, Heartland has introduced an expense management service that provides business customers the ability to more efficiently manage their card-based spending.


Debit card income increased $657,000decreased $1.7 million or 22%44% to $3.6$2.2 million for the firstthird quarter of 2019 compared to $3.0$3.9 million for the firstthird quarter of 2018. Based on estimated calculations using 2018For the nine months ended September 30, 2019, debit card income Heartland estimatesdecreased $305,000 or 3% to $10.0 million from $10.3 million for the nine months ended September 30, 2018. The decrease for the quarterly period was primarily attributable to the impact of the Durbin Amendment, which Heartland expectsrestricts interchange fees to be subjectthose which are "reasonable and proportionate" for certain debit card issuers and limits the ability of networks and issuers to restrict debit card transaction routing. The Durbin Amendment was effective for Heartland on July 1, 2019, will reduce debit card income by approximately $6.0 million on an annualized basis.2019.


Loan Servicing Income
The following tables show the changes in loan servicing income for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and 2018, in thousands:

Three Months Ended
September 30,
20192018Change% Change
Commercial and agricultural loan servicing fees(1)
Commercial and agricultural loan servicing fees(1)
$774  $702  $72  10 %
Residential mortgage servicing feesResidential mortgage servicing fees519  2,610  (2,091) (80) 
Mortgage servicing rights amortizationMortgage servicing rights amortization(472) (1,642) 1,170  71  
Total loan servicing incomeTotal loan servicing income$821  $1,670  $(849) (51)%
Three Months Ended
March 31,
    Nine Months Ended
September 30,
2019 2018 Change % Change20192018Change% Change
Commercial and agricultural loan servicing fees(1)
$683
 $749
 $(66) (9)%
Commercial and agricultural loan servicing fees(1)
$2,270  $2,375  $(105) (4)%
Residential mortgage servicing fees2,546
 2,250
 296
 13
Residential mortgage servicing fees4,484  7,250  (2,766) (38) 
Mortgage servicing rights amortization(1,500) (1,245) (255) (20)Mortgage servicing rights amortization(2,866) (4,394) 1,528  35  
Total loan servicing income$1,729
 $1,754
 $(25) (1)%Total loan servicing income$3,888  $5,231  $(1,343) (26)%
    
 
(1) Includes servicing fees for commercial, commercial real estate, agricultural and agricultural real estate loans.(1) Includes servicing fees for commercial, commercial real estate, agricultural and agricultural real estate loans.(1) Includes servicing fees for commercial, commercial real estate, agricultural and agricultural real estate loans.


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$821,000 during the firstthird quarter of 2019 compared to $1.8$1.7 million during the firstthird quarter of 2018, a decrease of $25,000$849,000 or 1%51%. DueFor the nine months ended September 30, 2019, loan servicing income totaled $3.9 million, which was a decrease of $1.3 million or 26% from $5.2 million recorded in the same period of 2018. The decrease for both the quarterly and year-to-date comparisons was primarily due to the sale of the mortgage servicing rights portfolio of Dubuque Bank and Trust Company, which occurred on April 30, 2019, net loan servicing income related to residential mortgage loans is expected to decrease by approximately $500,000 in the second quarter of 2019 and $800,000 in future quarters.2019. This transaction does not impact the residential mortgage servicing portfolio of Heartland's PrimeWest Mortgage Corporation subsidiary.





Securities Gains, Net
Securities gains, net, totaled $1.6$2.0 million for the firstthird quarter of 2019 compared to net securities gainslosses of $1.4 million$145,000 for the firstthird quarter of 2018, which was an increase of $134,000 or 9%.$2.2 million. Securities gains, net, totaled $7.2 million and $1.0 million for the nine months ended September 30, 2019 and 2018, respectively, which was an increase of $6.1 million. Heartland's net unrealized lossgain on securities available for sale totaled $15.2$27.5 million at March 31,September 30, 2019, compared to $52.8net unrealized losses of $68.8 million at March 31,September 30, 2018.


Net Gains on Sale of Loans Held for Sale
During the firstthird quarter of 2019, net gains on sale of loans held for sale totaled $3.2$4.7 million compared to $4.1$7.4 million during the same period in 2018, a decrease of $875,000$2.7 million or 22%,37%. For the nine months ended September 30, 2019, net gains on sales of loans held for sale totaled $12.2 million compared to $18.3 million for the nine months ended September 30, 2018, which was a decrease of $6.1 million or 33%. These decreases were primarily due to the outsourcing of Heartland's legacy residential mortgage lending operations in the fourth quarter of 2018.


Other Noninterest Income



Other noninterest income totaled $1.7$3.2 million and $1.2$1.1 million for the quarters ended March 31,September 30, 2019 and 2018, respectively. Therespectively, which was an increase of $447,000$2.1 million or 37%179%. Commercial swap fee income increased $1.3 million to $1.6 million for the third quarter of 2019 compared to $374,000 for the same quarter of 2018. Also included in other noninterest income for the third quarter of 2019 was a gain on the extinguishment of debt of $375,000. For the nine months ended September 30, 2019 and 2018, other noninterest income totaled $6.6 million and $3.5 million, respectively, which was an increase of $3.0 million or 85%. This increase was primarily attributable to a recovery of $266,000 on an acquired loan that was charged off prior to acquisition, $368,000 from the accrual on a death benefit on bank owned life insurance, inas well as the first quarter of 2019. Heartland expects to receiveitems impacting the proceeds in the secondthird quarter of 2019.


Noninterest Expense
The tables below show Heartland's noninterest expenses for the three-monththree- and nine-month periods ended March 31,September 30, 2019, and 2018, in thousands:

Three Months Ended
March 31,
  Three Months Ended
September 30,
2019 2018 Change % Change 20192018Change% Change
Salaries and employee benefits$50,285
 $48,710
 $1,575
 3 %Salaries and employee benefits$50,027  $49,921  $106  — %
Occupancy6,607
 6,043
 564
 9
Occupancy6,594  6,348  246   
Furniture and equipment2,692
 2,749
 (57) (2)Furniture and equipment2,858  3,470  (612) (18) 
Professional fees11,379
 9,448
 1,931
 20
Professional fees12,131  12,800  (669) (5) 
Advertising2,325
 1,940
 385
 20
Advertising2,737  2,754  (17) (1) 
Core deposit and customer relationship intangibles amortization2,842
 1,863
 979
 53
Core deposit and customer relationship intangibles amortization2,899  2,626  273  10  
Other real estate and loan collection expenses701
 732
 (31) (4)
Gain on sales/valuations of assets, net(3,004) (197) (2,807) (1,425)
Other real estate and loan collection expenses, netOther real estate and loan collection expenses, net(89) 784  (873) (111) 
(Gain)/loss on sales/valuations of assets, net(Gain)/loss on sales/valuations of assets, net356  912  (556) (61) 
Restructuring expenses3,227
 2,564
 663
 26
Restructuring expenses—  —  —  —  
Other noninterest expenses11,176
 9,794
 1,382
 14
Other noninterest expenses15,454  12,924  2,530  20  
Total noninterest expenses$88,230
 $83,646
 $4,584
 5 %Total noninterest expenses$92,967  $92,539  $428  — %

Nine Months Ended
September 30,
 20192018Change% Change
Salaries and employee benefits$150,307  $149,389  $918  %
Occupancy19,637  18,706  931   
Furniture and equipment8,770  9,403  (633) (7) 
Professional fees38,478  32,880  5,598  17  
Advertising7,723  6,839  884  13  
Core deposit and customer relationship intangibles amortization9,054  6,763  2,291  34  
Other real estate and loan collection expenses, net774  2,464  (1,690) (69) 
(Gain)/loss on sales/valuations of assets, net(20,934) 2,243  (23,177) (1,033) 
Restructuring expenses3,227  2,564  663  26  
Other noninterest expenses39,259  33,816  5,443  16  
Total noninterest expenses$256,295  $265,067  $(8,772) (3)%

For the firstthird quarter of 2019, noninterest expenses totaled $88.2$93.0 million compared to $83.6$92.5 million during the firstthird quarter of 2018, an increase of $4.6 million$428,000 or 5%less than 1%. The most significant increases were related to salaries and employee benefits, professional fees, core deposit and customer relationship intangibles amortization, gain on sales/valuations of assets, net, and restructuring expenses. The increases in occupancy, advertising and otherFor the nine months ended September 30, 2019, total noninterest expenses are primarily related to the acquisitions completed in 2018.

Salaries and Employee Benefits
The largest component of noninterest expenses, salaries and employee benefits, increased $1.6were $256.3 million or 3% during the first quarter of 2019 as compared to the same quarter in 2018. Base salary expense totaled $32.3 million and $31.2$265.1 million for the first quarter of 2019 and 2018, respectively, which was an increase of $1.1 million or 3%. This increase is primarily related to the acquisitions completed in 2018. Stock compensation expense for restricted stock units and employee stock purchase plan expense increased $398,000 or 24% to $2.1 million in the first quarter of 2019 compared to $1.9 million in the first quarter of 2018. Retirement plan and 401K expenses totaled $2.7 million in the first quarter of 2019 compared to $2.3 million in the first quartersame period of 2018, which was an increasea decrease of $409,000$8.8 million or 18%3%. Heartland had total full-time equivalent employees

Management has taken actions to streamline operations and reduce expenses, which included restructuring its mortgage lending operations, optimizing bank branch locations, and strategic initiative projects. Operation Customer Compass is anticipated to be complete by the end of 1,9762019, and this project is focused on March 31,streamlining and automating processes. Expense reductions of over $10 million annually are expected to be realized once the Operation Customer Compass project is completed. Other process improvement projects will continue into mid-2020. Additionally, systems conversions of newly acquired entities are completed



as soon as possible after the closing of the transaction in order to optimize cost savings. Notable changes in noninterest expense categories for the quarterly and nine-month periods ended September 30, 2019 compared to 2,022 on March 31, 2018.and 2018 are as follows:


Professional Fees
Professional fees for the firstthird quarter of 2019 totaled $11.4$12.1 million compared to $9.4$12.8 million for the same quarter of 2018, which was a decrease of $669,000 or 5%. For the nine months ended September 30, 2019, professional fees totaled $38.5 million compared to $32.9 million for the nine months ended September 30, 2018, which was an increase of $1.9$5.6 million or 20%17%. In the third quarter of 2019, Heartland's banks reversed the accrual for FDIC insurance assessments, which totaled $1.8 million, because the Deposit Insurance Fund ratio exceeded 1.38%, which is threshold required for assessment credits to be applied. This resulted in a benefit recorded in professional fees of $1.8 million for the third quarter of 2019 compared to expense of $1.1 million for the third quarter of 2018. Future FDIC insurance assessment expense may continue to be reduced by the assessment credits depending on the level of the Deposit Insurance Fund until the credits are fully utilized.

Professional fees related to Heartland's 2019 strategic initiative projects totaled $1.2 million for the third quarter and $4.3 million for the nine months ended September 30, 2019. The remainder of the increase isfor both the quarterly and year-to-date comparisons was primarily attributable to professional fees incurred at therecently acquired entities, acquired in 2018, model validation expenses, and increased advisory services associated with the higher level of regulation resulting from Heartland having assets over $10 billion.





Core Deposit and Customer Relationship Intangibles Amortization
Core deposit and customer relationship intangibles amortization was $2.8$2.9 million for the firstthird quarter of 2019 compared to $1.9$2.6 million for the same quarter of 2018, which was an increase of $979,000$273,000 or 53%10%. Included in this increase was a $379,000 write-off ofFor the nine months ended September 30, 2019, core deposit and customer relationship intangibles related to the branch sales at Wisconsin Bank & Trust during the first quarter of 2019. The remainder of the increaseamortization was due to acquisitions completed in 2018.

Gain on Sales/Valuations of Assets, Net
Gain on sales/valuations of assets, net, totaled $3.0$9.1 million during the first quarter of 2019 compared to $197,000$6.8 million for the first quartersame period of 2018, which was an increase of $2.8$2.3 million or 34%. The increase for the quarterly comparison was due to recent acquisitions. The increase for the nine-month comparison was due to recent acquisitions and write-offs totaling $682,000 related to the branch sales at Illinois Bank & Trust, Citywide Banks and Wisconsin Bank & Trust.

Gain/Loss on Sales/Valuations of Assets, Net
Net losses on sales/valuations of assets totaled $356,000 during the third quarter of 2019 compared to $912,000 for the third quarter of 2018, which was a decrease of $556,000 or 61%. For the nine months ended September 30, 2019, net gains on sales/valuations of assets totaled $20.9 million compared to net losses on sales/valuations of assets of $2.2 million, which was a change of $23.2 million. In the firstsecond quarter of 2019, gains of $19.8 million were recorded in conjunction with the branch sales at Illinois Bank & Trust, Citywide Banks, and Dubuque Bank and Trust Company, and the sale of Dubuque Bank and Trust Company's mortgage servicing rights portfolio. Additionally, a gain of $3.5 million was recorded related to the sale of two branches at Wisconsin Bank & Trust.

Restructuring Expenses
Restructuring expenses totaled $3.2 million and $2.6 million forTrust in the first quarter of 2019.
Other noninterest expenses
Other noninterest expenses totaled $15.5 million for the third quarter of 2019 compared to $12.9 million for the third quarter of 2018, which was an increase of $2.5 million or 20%. For the nine months ended September 30, 2019 and 2018, respectively. Inother noninterest expenses totaled $39.3 million and $33.8 million, respectively, which was an increase of $5.4 million or 16%. Write-downs on partnership investments which qualified for tax credits totaled $3.1 million and $5.0 million for the first quarter and the nine months ended September 30, 2019, respectively, compared to $338,000 for the same periods of 2019, the restructuring expenses consisted of severance and retention payments for legacy mortgage and Citizens' Finance Co. employees, software discontinuation fees and expected lease buyouts. In the first quarter of 2018, the restructuring expenses were primarily related to outsourcing the residential mortgage loan application processing, underwriting and loan closing functions. The restructuring expenses consisted of severance and retention costs related to the workforce reduction and contract buyouts associated with the discontinued use of several systems.2018.

Efficiency Ratio


One of Heartland's top priorities is to improve its efficiency ratio, on a fully tax-equivalent basis, by reducing it to the low 60% range.55-60% range over the next twelve to eighteen months. During the firstthird quarter of 2019, Heartland's efficiency ratio on a fully tax-equivalent basis decreased by 29859 basis points to 65.23%61.92% in comparison with 68.21%62.51% for the quarter ended March 31,September 30, 2018. Management has taken actions to improve its efficiency ratio, including restructuring its mortgage lending operations and optimizing bank branch locations. Additionally, systems conversions of newly acquired entities are completed as soon as possible afterFor the closing of the transaction in order to optimize cost savings.nine months ended September 30, 2019, Heartland's efficiency ratio will varywas 63.95%, which was an improvement of 108 basis points from quarter to quarter as a result65.03% for the same period of merger and acquisition activities.2018.


Income Taxes


Heartland's effective tax rate was 20.88%18.66% for the firstthird quarter of 2019 compared to 18.04%20.99% for the firstthird quarter of 2018. Included in Heartland's third quarter 2019 and 2018 tax calculations were solar energy tax credits of $2.0 million and $223,000, respectively. Federal low-income housing tax credits included in the determination of Heartland's income taxes totaled $281,000 for the firstthird quarter of 2019 compared to $307,000 for the firstthird quarter of 2018. Tax-exempt interest income as a percentage of pre-tax income declined to 10.08% during the third quarter of 2019 from 13.62% during the third quarter of 2018.




Heartland's effective tax rate was 21.14% and 20.24% for the nine months ended September 30, 2019 and 2018, respectively. Included in Heartland's first quarter 2019 tax calculation was afor the first nine months of 2019 and 2018 were solar energy tax credit totaling $314,000.credits of $3.2 million and $223,000, respectively. Federal low-income housing tax credits include in the determination of Heartland's income taxes were $843,000 and $921,000 for the nine months ended September 30, 2019 and 2018, respectively. The tax-exempt interest income as a percentage of pre-tax income declined to 13.35%10.19% during the first quarternine months of 2019 from 20.46%16.49% during the first quarternine months of 2018.


Heartland's income taxes included a tax benefit of $336,000$270,000 and $611,000$672,000 for the three-monthnine-month periods ended March 31,September 30, 2019, and 2018, respectively, resulting from the vesting of outstanding restricted stock unit awards and options. The majority of Heartland's restricted stock unit awards vest in the first quarter of each year.


FINANCIAL CONDITION


Total assets of Heartland were $11.31$12.57 billion at March 31,September 30, 2019, a decreasean increase of $95.5 million$1.16 billion or 1%10% since December 31, 2018. Excluding $766.2 million of assets acquired at fair value in the BVBC transaction, total assets increased $395.0 million or 3% since year-end 2018. Securities represented 22%25% and 24% of total assets at March 31,September 30, 2019, and December 31, 2018, respectively.


Lending Activities


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.


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 if warranted by the overall financial condition of the borrower. Terms of commercial business loans generally range from one to five years. Commercial loans 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 is based upon the discounted market value of the collateral. The primary repayment risks of commercial loans 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 reasons, 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 crop production for the ensuing 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.


During the fourth quarter of 2018, Heartland entered into arrangements with third parties to offer residential mortgage loans to customers in many of its markets. In addition, the acquisition in 2018 of First Bank & Trust in Lubbock, Texas, included its wholly owned mortgage subsidiary, PrimeWest Mortgage Corporation. PrimeWest Mortgage Corporation provides mortgage loans to customers in Texas and has expanded to also serve the mortgage needs of customers in several of Heartland's southwestern markets. PrimeWest Mortgage Corporation services the loans it sells into the secondary market.


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.


Total loans held to maturity were $7.33$7.97 billion at March 31,September 30, 2019, compared to $7.41 billion at December 31, 2018, a decreasean increase of $76.2$563.9 million or 1%8%. This change includes $542.0 million of total loans held to maturity acquired in the BVBC transaction. During the first quarter of 2019, the sale of two branches at Dubuque Bank and Trust Company was announced, which included $20.3Heartland classified $32.1 million of loans that were classified as held for sale at March 31, 2019. Heartland also reclassified commercialin conjunction with the branch sales. Excluding the reclassification of loans with balances of $11.8 million at March 31, 2019, to held for sale as part of a plan to exit a small lease portfolio. Exclusive of these transactions,and the BVBC transaction, total loans held to maturity decreased $44.0increased $54.0 million or less than 1% since December 31, 2018. Loan changes by category were:were


Commercial and commercial real estate loans totaled $5.75$6.39 billion at March 31,September 30, 2019, compared to $5.73 billion at December 31, 2018, which was an increase of $13.3$661.9 million or less than 1%12%. Excluding $14.9 million of commercial and commercial real estate loans classified as held for sale during the first quarter of 2019 and $480.1 million of loans acquired in the BVBC transaction, commercial and commercial real estate loans increased $28.2$196.6 million or less than 1%3% since year-end.
Agricultural and agricultural real estate loans totaled $544.8$545.0 million at March 31,September 30, 2019, compared to $565.4 million at year-end,December 31, 2018, which was a decrease of $20.6$20.4 million or 4%. Excluding $6.6 million of agricultural and agricultural real estate loans classified as held for sale during the first quarter of 2019 and $1.8 million of loans acquired in the BVBC transaction, agricultural and agricultural real estate loans decreased $14.0$15.6 million or 2%3% since December 31, 2018.year-end.
Residential mortgage loans decreased $43.2$83.8 million or 6%12% to $630.4$589.8 million at March 31,September 30, 2019, from $673.6 million at year-end.December 31, 2018. Excluding $2.0 million of residential mortgage loans classified as held for sale during the first quarter of 2019 and $17.2 million of loans acquired in the BVBC transaction, residential mortgage loans decreased $41.2$99.0 million or 6%15% since year-end.year-end, primarily as a result of customers refinancing loans due to the recent decreases in mortgage interest rates.
Consumer loans decreased $27.6increased $7.6 million or 6%2% to $412.6$447.7 million at March 31,September 30, 2019, compared to $440.2 million at December 31, 2018. Excluding $8.6 million of loans classified as held for sale during the first quarter of 2019 and $42.9 million of loans acquired in the BVBC transaction, consumer loans decreased $19.0$26.7 million or 4%6% since year-end.year-end, primarily as a result of customers refinancing loans due to the recent decreases in mortgage interest rates.





The table below presents the composition of the loan portfolio as of March 31,September 30, 2019, and December 31, 2018, in thousands:

LOAN PORTFOLIOSeptember 30, 2019December 31, 2018
 AmountPercentAmountPercent
Loans receivable held to maturity:
Commercial$2,276,916  28.56 %$2,020,231  27.26 %
Commercial real estate4,116,680  51.61  3,711,481  50.08  
Agricultural and agricultural real estate545,006  6.83  565,408  7.63  
Residential mortgage589,793  7.39  673,603  9.09  
Consumer447,718  5.61  440,158  5.94  
Gross loans receivable held to maturity7,976,113  100.00 %7,410,881  100.00 %
Unearned discount(833) (1,624) 
Deferred loan fees(3,672)  (1,560)  
Total net loans receivable held to maturity7,971,608   7,407,697   
Allowance for loan losses(66,222) (61,963)  
Loans receivable, net$7,905,386   $7,345,734  



LOAN PORTFOLIOMarch 31, 2019 December 31, 2018
 Amount Percent Amount Percent
Loans receivable held to maturity:       
Commercial$2,042,594
 27.86% $2,020,231
 27.26%
Commercial real estate3,702,457
 50.48
 3,711,481
 50.08
Agricultural and agricultural real estate544,805
 7.43
 565,408
 7.63
Residential mortgage630,433
 8.60
 673,603
 9.09
Consumer412,573
 5.63
 440,158
 5.94
Gross loans receivable held to maturity7,332,862
 100.00% 7,410,881
 100.00%
Unearned discount(288)   (1,624)  
Deferred loan fees(1,030)   (1,560)  
Total net loans receivable held to maturity7,331,544
   7,407,697
  
Allowance for loan losses(62,639)   (61,963)  
Loans receivable, net$7,268,905
   $7,345,734
 



Loans secured by real estate, either fully or partially, totaled $4.74$5.10 billion or 65%64% of gross loans at March 31,September 30, 2019. At March 31,Exclusive of purchase accounting valuations at September 30, 2019, approximately 52%49% of the properties securing non-farm, nonresidential real estate loans are owner occupied. The largest categories of Heartland's loans secured by real estate at March 31,September 30, 2019, and December 31, 2018, are listed below, in thousands:

LOANS SECURED BY REAL ESTATELOANS SECURED BY REAL ESTATELOANS SECURED BY REAL ESTATE
March 31, 2019 December 31, 2018September 30, 2019December 31, 2018
Residential real estate, excluding residential construction and residential lot loans$1,079,352
 $1,119,942
Residential real estate, excluding residential construction and residential lot loans$1,051,362  $1,119,942  
Industrial, manufacturing, business and commercial670,440
 805,265
Industrial, manufacturing, business and commercial630,781  805,265  
Agriculture266,010
 270,023
Agriculture281,143  270,023  
Retail479,469
 435,680
Retail465,184  435,680  
Office485,794
 485,262
Office681,065  485,262  
Land development and lots202,513
 216,665
Land development and lots228,997  216,665  
Hotel, resort and hospitality280,285
 233,735
Hotel, resort and hospitality316,795  233,735  
Multi-family324,198
 311,319
Multi-family346,381  311,319  
Food and beverage142,630
 130,981
Food and beverage134,721  130,981  
Warehousing169,721
 186,436
Warehousing203,697  186,436  
Health services204,410
 182,882
Health services262,696  182,882  
Residential construction161,116
 171,116
Residential construction188,639  171,116  
All other269,165
 255,145
All other309,949  255,145  
Total loans secured by real estate$4,735,103
 $4,804,451
Total loans secured by real estate$5,101,410  $4,804,451  


Allowance For Loan Losses


The process utilized by Heartland to determine the appropriateness of the allowance for loan losses is considered a critical accounting practice for Heartland and has remained consistent over the past several years. The allowance for loan 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 losses, refer to the critical accounting policies section of Heartland's Annual Report on Form 10-K for the year ended December 31, 2018.


Heartland's nonpass loans totaled 7.03% of total loans as of September 30, 2019 compared to 6.26% of total loans as of December 31, 2018. As of September 30, 2019, Heartland's nonpass loans consisted of approximately 62% special mention loans and 38% substandard loans. The percent of nonpass loans on nonaccrual status as of September 30, 2019, was 13%. As of December 31, 2018, Heartland's nonpass loans were comprised of approximately 52% special mention loans and 48% substandard loans. The percent of nonpass loans on nonaccrual status as of December 31, 2018, was 16%.

Nonperforming loans were $79.0$72.2 million or 1.08%0.91% of total loans at March 31,September 30, 2019, compared to $72.7 million or 0.98% of total loans at December 31, 2018. The increase was primarily related to two agribusiness relationships that were originated in Heartland's Midwestern markets. At March 31,September 30, 2019, approximately $42.4$38.2 million or 54%53% of Heartland's nonperforming loans had individual loan balances exceeding $1.0 million and represented loans to seventeenthirteen borrowers. At March 31,September 30, 2019, and December 31, 2018, Heartland had $7.9$6.5 million and $7.7 million, respectively, of nonperforming residential real estate loans that were repurchased under various Government National Mortgage Association ("GNMA") or other guaranteed loan programs. The portion of



Heartland's nonperforming nonresidential real estate loans covered by government guarantees totaled $12.7$12.4 million at March 31,September 30, 2019, compared to $7.7 million at December 31, 2018.
The allowance for loan losses was 0.85%0.83% and 0.84% of loans at March 31,September 30, 2019 and December 31, 2018, respectively, and 79.29%91.66% and 85.27% of nonperforming loans at March 31,September 30, 2019, and December 31, 2018, respectively. Excluding the acquired loans covered by the valuation reserves, the ratio of the allowance for loan losses to outstanding loans was 1.01%1.00% and 1.03% at March 31,September 30, 2019, and December 31, 2018, respectively. At March 31,September 30, 2019, valuation reserves totaled $36.7$42.1 million and covered $1.47$1.65 billion of acquired loans. At December 31, 2018, valuation reserves totaled $40.9 million and covered $1.63 billion of acquired loans. Loans delinquent 30-89 days as a percent of total loans was 0.47%0.28% at March 31,September 30, 2019, in comparison with 0.21% at December 31, 2018. The increase in loans delinquent 30-89 days was primarily attributable to recently acquired portfolios and one large credit resolved in the near term. Management believes the increase in delinquencies in the acquired portfolios is due to the implementation of Heartland's underwriting and closing processes at the new entities and is not indicative of the underlying credit quality.





The table below presents the changes in the allowance for loan losses during the three-monththree- and nine-month periods ended March 31,September 30, 2019 and 2018, in thousands:

ANALYSIS OF ALLOWANCE FOR LOAN LOSSESANALYSIS OF ALLOWANCE FOR LOAN LOSSESThree Months Ended
September 30,
20192018
Balance at beginning of periodBalance at beginning of period$63,850  $61,324  
Provision for loan lossesProvision for loan losses5,201  5,238  
Recoveries on loans previously charged offRecoveries on loans previously charged off2,013  779  
Charge-offs on loansCharge-offs on loans(4,842) (6,120) 
Balance at end of periodBalance at end of period$66,222  $61,221  
Annualized ratio of net charge offs to average loansAnnualized ratio of net charge offs to average loans0.14 %0.28 %
Three Months Ended
March 31,
Nine Months Ended
September 30,
2019 2018 20192018
Balance at beginning of period$61,963
 $55,686
Balance at beginning of period$61,963  $55,686  
Provision for loan losses1,635
 4,263
Provision for loan losses11,754  14,332  
Recoveries on loans previously charged off991
 931
Recoveries on loans previously charged off4,077  2,711  
Charge-offs on loans(1,950) (2,224)Charge-offs on loans(11,572) (11,508) 
Balance at end of period$62,639
 $58,656
Balance at end of period$66,222  $61,221  
Annualized ratio of net charge offs to average loans0.05% 0.08%Annualized ratio of net charge offs to average loans0.13 %0.17 %


The table below presents the amounts of nonperforming loans and other nonperforming assets on the dates indicated, in thousands:

NONPERFORMING ASSETSSeptember 30,December 31,
 2019201820182017
Nonaccrual loans$72,208  $73,060  $71,943  $62,581  
Loans contractually past due 90 days or more40  154  726  830  
Total nonperforming loans72,248  73,214  72,669  63,411  
Other real estate6,425  11,908  6,153  10,777  
Other repossessed assets13  495  459  411  
Total nonperforming assets$78,686  $85,617  $79,281  $74,599  
Performing troubled debt restructured loans(1)
$3,199  $4,180  $4,026  $6,617  
Nonperforming loans to total loans0.91 %0.99 %0.98 %0.99 %
Nonperforming assets to total loans plus repossessed property0.99 %1.16 %1.07 %1.17 %
Nonperforming assets to total assets0.63 %0.76 %0.69 %0.76 %
(1) Represents accruing troubled debt restructured loans performing according to their restructured terms.


NONPERFORMING ASSETSMarch 31, December 31,
 2019 2018 2018 2017
Nonaccrual loans$77,294
 $64,806
 $71,943
 $62,581
Loans contractually past due 90 days or more1,706
 22
 726
 830
Total nonperforming loans79,000
 64,828
 72,669
 63,411
Other real estate5,391
 11,801
 6,153
 10,777
Other repossessed assets8
 423
 459
 411
Total nonperforming assets$84,399
 $77,052
 $79,281
 $74,599
Performing troubled debt restructured loans(1)
$3,460
 $3,206
 $4,026
 $6,617
Nonperforming loans to total loans1.08% 0.96% 0.98% 0.99%
Nonperforming assets to total loans plus repossessed property1.15% 1.14% 1.07% 1.17%
Nonperforming assets to total assets0.75% 0.77% 0.69% 0.76%
        
(1) Represents accruing troubled debt restructured loans performing according to their restructured terms.





The schedules below summarize the changes in Heartland's nonperforming assets during the first three monthsthree- and nine-month periods of 2019, in thousands:
Nonperforming
Loans
Other
Real Estate
Owned
Other
Repossessed
Assets
Total
Nonperforming
Assets
June 30, 2019$79,904  $6,646  $39  $86,589  
Loan foreclosures(2,784) 2,766  18  —  
Net loan charge-offs(2,829) —  —  (2,829) 
Acquired nonperforming assets—  —  —  —  
New nonperforming loans6,818  —  —  6,818  
Reduction of nonperforming loans(1)
(8,861) —  —  (8,861) 
OREO/Repossessed assets sales proceeds—  (3,043) (22) (3,065) 
OREO/Repossessed assets writedowns, net—  56  (20) 36  
Net activity at Citizens Finance Co.—  —  (2) (2) 
September 30, 2019$72,248  $6,425  $13  $78,686  
(1) Includes principal reductions and transfers to performing status.
 
Nonperforming
Loans
 
Other
Real Estate
Owned
 
Other
Repossessed
Assets
 
Total
Nonperforming
Assets
December 31, 2018$72,669
 $6,153
 $459
 $79,281
Loan foreclosures(1,786) 1,694
 92
 
Net loan charge-offs(959) 
 
 (959)
New nonperforming loans15,314
 
 
 15,314
Reduction of nonperforming loans(1)
(6,238) 
 
 (6,238)
OREO/Repossessed assets sales proceeds
 (2,004) (88) (2,092)
OREO/Repossessed assets writedowns, net
 (452) (10) (462)
Net activity at Citizens Finance Co.
 
 (445) (445)
March 31, 2019$79,000
 $5,391
 $8
 $84,399
        
(1) Includes principal reductions and transfers to performing status.


Nonperforming
Loans
Other
Real Estate
Owned
Other
Repossessed
Assets
Total
Nonperforming
Assets
December 31, 2018$72,669  $6,153  $459  $79,281  
Loan foreclosures(7,631) 7,421  210  —  
Net loan charge-offs(7,495) —  —  (7,495) 
Acquired nonperforming assets230  —  —  230  
New nonperforming loans35,820  —  —  35,820  
Reduction of nonperforming loans(1)
(21,345) —  —  (21,345) 
OREO/Repossessed assets sales proceeds—  (6,268) (177) (6,445) 
OREO/Repossessed assets writedowns, net—  (881) (32) (913) 
Net activity at Citizens Finance Co.—  —  (447) (447) 
September 30, 2019$72,248  $6,425  $13  $78,686  
(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 22%25% and 24% of total assets at March 31,September 30, 2019, and December 31, 2018, respectively. Total securities carried at fair value as of March 31,September 30, 2019, were $2.40$3.02 billion, a decreasean increase of $50.2$569.9 million or 2%23% from $2.45 billion at December 31, 2018.


The table below presents the composition of the securities portfolio, including securities carried at fair value, held to maturity securities and other, by major category, as of March 31,September 30, 2019, and December 31, 2018, in thousands:

SECURITIES PORTFOLIO COMPOSITIONSeptember 30, 2019December 31, 2018
 AmountPercentAmountPercent
U.S. government corporations and agencies$8,950  0.29 %$31,951  1.18 %
Mortgage and asset-backed securities2,480,677  79.05  2,026,698  74.64  
Obligation of states and political subdivisions600,544  19.14  611,257  22.50  
Equity securities18,362  0.59  17,086  0.63  
Other securities29,042  0.93  28,396  1.05  
Total securities$3,137,575  100.00 %$2,715,388  100.00 %



SECURITIES PORTFOLIO COMPOSITIONMarch 31, 2019 December 31, 2018
 Amount Percent Amount Percent
U.S. government corporations and agencies$26,768
 1.06% $31,951
 1.18%
Mortgage and asset-backed securities1,871,398
 74.38
 2,026,698
 74.64
Obligation of states and political subdivisions573,044
 22.78
 611,257
 22.50
Equity securities17,339
 0.69
 17,086
 0.63
Other securities27,506
 1.09
 28,396
 1.05
Total securities$2,516,055
 100.00% $2,715,388
 100.00%


The percentage of Heartland's securities portfolio comprised of mortgage and asset-backed securities was 74%79% at March 31,September 30, 2019, compared to 75% at December 31, 2018. Heartland's securities portfolio had an expected modified duration of 4.345.63 years as of March 31,September 30, 2019, compared to 4.01 years as of year-end 2018.


At March 31,September 30, 2019, Heartland had $27.5$29.0 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


Total deposits were $9.35$10.47 billion as of March 31,September 30, 2019, compared to $9.40 billion at December 31, 2018, a decreasean increase of $43.5$1.07 billion or 11%. This increase includes $617.1 million or less than 1%. Theof deposits acquired at fair value in the BVBC transaction. During the first quarter of 2019, Heartland classified $77.0 million of deposits as held for sale in conjunction with the sale of two branches at Dubuque Bank and Trust Company totaled $77.0 million at March 31, 2019.branch sales. Exclusive of thisthe reclassification of deposits to held for sale and the deposits acquired at fair value in the BVBC transaction, total deposits increased $33.5$533.3 million or less than 1%6% since December 31, 2018. DepositsDeposit changes by typecategory were:


Demand deposits decreased $145.8increased $316.4 million or 4%10% to $3.12$3.58 billion at March 31,September 30, 2019, compared to $3.26 billion at December 31, 2018. Excluding $164.9 million of demand deposits acquired in the BVBC transaction and $17.3 million of demand deposits classified as held for sale duringin the first quarter of 2019, demand deposits decreased $128.6increased $168.8 million or 4%5% since year-end 2018.



Savings deposits increased $38.0$662.8 million or 1%13% to $5.15$5.77 billion at March 31,September 30, 2019, from $5.11 billion at December 31, 2018. Excluding savings deposits of $346.2 million acquired in the BVBC transaction and $47.8 million of savings deposits classified as held for sale duringin the first quarter of 2019, savings deposits increased $85.8$364.4 million or 2%7% since year-end 2018.
Time deposits increased $64.4$94.2 million or 6%9% to $1.09$1.12 billion at March 31,September 30, 2019 from $1.02 billion at December 31, 2018. Excluding time deposits of $106.0 million acquired in the BVBC transaction and $11.9 million of time deposits classified as held for sale duringin the first quarter of 2019, time deposits increased $76.2 million$100,000 or 7%less than 1% since year-end 2018.

The table below presents the composition of Heartland's deposits by category as of March 31,September 30, 2019, and December 31, 2018, in thousands:

DEPOSITSMarch 31, 2019 December 31, 2018DEPOSITSSeptember 30, 2019December 31, 2018
Amount Percent Amount PercentAmountPercentAmountPercent
Demand$3,118,909
 33.35% $3,264,737
 34.74%Demand$3,581,127  34.20 %$3,264,737  34.74 %
Savings5,145,929
 55.02
 5,107,962
 54.37
Savings5,770,754  55.12  5,107,962  54.37  
Time1,088,104
 11.63
 1,023,730
 10.89
Time1,117,975  10.68  1,023,730  10.89  
Total$9,352,942
 100.00% $9,396,429
 100.00%Total$10,469,856  100.00 %$9,396,429  100.00 %


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,September 30, 2019, and December 31, 2018, in thousands:

March 31, 2019 December 31, 2018September 30, 2019December 31, 2018
Securities sold under agreement to repurchase$65,696
 $80,124
Securities sold under agreement to repurchase$85,715  $80,124  
Federal funds purchased3,650
 35,400
Federal funds purchased5,850  35,400  
Advances from the FHLB25,000
 100,838
Advances from the FHLB—  100,838  
Other short-term borrowings9,968
 10,648
Other short-term borrowings16,288  10,648  
Total$104,314

$227,010
Total$107,853  $227,010  


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 one of the



Chicago, Dallas, Des Moines, San Francisco or Topeka FHLBs, enabling them to borrow funds from their respective FHLB for short-term or long-term purposes under a variety of programs. The amount of short-term borrowings of Heartland was $104.3$107.9 million at March 31,September 30, 2019, compared to $227.0 million at year-end 2018, a decrease of $122.7$119.2 million or 54%52%.


All of the Heartland bank subsidiaries provide retail repurchase agreements to their customers as a cash management tool, which sweep excess funds from demand deposit accounts into these agreements. 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 $65.7$85.7 million at March 31,September 30, 2019, compared to $80.1 million at December 31, 2018, a decreasean increase of $14.4$5.6 million or 18%7%.


Also included in short-term borrowings is aHeartland renewed its $30.0 million revolving credit line agreement Heartland has with an unaffiliated bank primarilyon June 14, 2019. This revolving credit line agreement is included in short-term borrowings, and the primary purpose of this credit line agreement is to provide liquidity to Heartland. TheHeartland had no advances on this line during the first nine months of 2019, and the outstanding balance was $0 at both March 31,September 30, 2019, and December 31, 2018.





Other Borrowings


The outstanding balances of other borrowings, which Heartland defines as borrowings with an original maturity date of more than one year, are shown in the table below, net of discount and issuance costs amortization as of March 31,September 30, 2019, and December 31, 2018, in thousands:

March 31, 2019 December 31, 2018September 30, 2019December 31, 2018
Advances from the FHLB$3,350
 $3,399
Advances from the FHLB$3,260  $3,399  
Trust preferred securities131,105
 130,913
Trust preferred securities145,098  130,913  
Senior notes
 5,000
Senior notes—  5,000  
Note payable to unaffiliated bank56,667
 58,417
Note payable to unaffiliated bank53,167  58,417  
Contracts payable for purchase of real estate and other assets1,932
 1,953
Contracts payable for purchase of real estate and other assets1,908  1,953  
Subordinated notes74,178
 74,143
Subordinated notes74,250  74,143  
Other borrowings1,080
 1,080
Other borrowings734  1,080  
Total$268,312

$274,905
Total$278,417  $274,905  


As of March 31,September 30, 2019, the amount of other borrowings was $268.3$278.4 million, a decreasean increase of $6.6$3.5 million or 2%1% since year-end 2018. The decrease since year-end 2018Heartland acquired $6.9 million of subordinated debt in the BVBC transaction that was due to scheduled principal payments in accordancesimultaneously paid off with the debt agreements.closing of the transaction. Trust preferred securities with a fair value of $16.1 million were also acquired in the BVBC transaction.
Heartland has a non-revolving credit facility with an unaffiliated bank, which provides a borrowing capacity of up to $70.0 million. At March 31,September 30, 2019, $56.7$53.2 million was outstanding on this non-revolving credit line compared to $58.4 million outstanding at December 31, 2018. At March 31,September 30, 2019, Heartland had $8.3$14.8 million available on this non-revolving credit facility, of which no balance was drawn.






A schedule of Heartland's trust preferred securities outstanding excluding deferred issuance costs, as of March 31,September 30, 2019, is as follows, in thousands:

Amount
Issued
 
Issuance
Date
 
Interest
Rate
 
Interest
Rate as of 3/31/19(1)
  
Maturity
Date
 
Callable
Date
Amount
Issued
Issuance
Date
Interest
Rate
Interest
Rate as of 9/30/19(1)
Maturity
Date
Callable
Date
Heartland Financial Statutory Trust IV$10,310
 03/17/2004 2.75% over LIBOR 5.36%
(2) 
 03/17/2034 06/17/2018Heartland Financial Statutory Trust IV  $10,310  03/17/20042.75% over LIBOR4.89%  
(2)
03/17/203412/17/2019
Heartland Financial Statutory Trust V20,619
 01/27/2006 1.33% over LIBOR 4.12%
(3) 
 04/07/2036 07/07/2019Heartland Financial Statutory Trust V  20,619  01/27/20061.33% over LIBOR3.63%  
(3)
04/07/203601/07/2020
Heartland Financial Statutory Trust VI20,619
 06/21/2007 1.48% over LIBOR 4.09%
(4) 
 09/15/2037 06/15/2019Heartland Financial Statutory Trust VI20,619  06/21/20071.48% over LIBOR3.60%  
(4)
09/15/203712/15/2019
Heartland Financial Statutory Trust VII20,619
 06/26/2007 1.48% over LIBOR 4.11%
(5) 
 09/01/2037 06/01/2019Heartland Financial Statutory Trust VII  18,042  06/26/20071.48% over LIBOR3.61%  
(5)
09/01/203712/01/2019
Morrill Statutory Trust I9,017
 12/19/2002 3.25% over LIBOR 5.86% 12/26/2032 06/26/2018Morrill Statutory Trust I  9,064  12/19/20023.25% over LIBOR5.36%  12/26/203212/26/2019
Morrill Statutory Trust II8,670
 12/17/2003 2.85% over LIBOR 5.46% 12/17/2033 06/17/2019Morrill Statutory Trust II  8,726  12/17/20032.85% over LIBOR4.99%  12/17/203312/17/2019
Sheboygan Statutory Trust I6,462
 09/17/2003 2.95% over LIBOR 5.56% 09/17/2033 06/17/2019Sheboygan Statutory Trust I  6,506  09/17/20032.95% over LIBOR5.09%  09/17/203312/17/2019
CBNM Capital Trust I4,371
 09/10/2004 3.25% over LIBOR 5.86% 12/15/2034 06/15/2019CBNM Capital Trust I  4,396  09/10/20043.25% over LIBOR5.37%  12/15/203412/15/2019
Citywide Capital Trust III6,398
 12/19/2003 2.80% over LIBOR 5.55% 12/19/2033 07/23/2019Citywide Capital Trust III  6,424  12/19/20032.80% over LIBOR5.07%  12/19/203301/23/2020
Citywide Capital Trust IV4,252
 09/30/2004 2.20% over LIBOR 4.85% 09/30/2034 05/23/2019Citywide Capital Trust IV  4,281  09/30/20042.20% over LIBOR4.35%  09/30/203411/23/2019
Citywide Capital Trust V11,579
 05/31/2006 1.54% over LIBOR 4.15% 07/25/2036 06/15/2019Citywide Capital Trust V  11,692  05/31/20061.54% over LIBOR3.66%  07/25/203612/15/2019
OCGI Statutory Trust III2,991
 06/27/2002 3.65% over LIBOR 6.25%
(6) 
 09/30/2032 06/30/2019OCGI Statutory Trust III  2,995  06/27/20023.65% over LIBOR5.95%  
(6)
09/30/203212/30/2019
OCGI Capital Trust IV5,300
 09/23/2004 2.50% over LIBOR 5.11%
(7) 
 12/15/2034 06/15/2019OCGI Capital Trust IV  5,328  09/23/20042.50% over LIBOR4.62%  
(7)
12/15/203412/15/2019
BVBC Capital Trust II BVBC Capital Trust II  7,187  04/10/20033.25% over LIBOR5.50%  04/24/203301/24/2020
BVBC Capital Trust III BVBC Capital Trust III  9,003  07/29/20051.60% over LIBOR3.70%  09/30/203512/30/2019
$131,207
          $145,192       
  
(1) Effective weighted average interest rate as of March 31, 2019, was 5.11% 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, 2019, 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, 2019, was 4.69% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.
(4) Effective interest rate as of March 31, 2019, was 3.87% 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, 2019, 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, 2019, was 5.53% 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, 2019, was 4.37% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.
(1) Effective weighted average interest rate as of September 30, 2019, was 4.94% 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 September 30, 2019, was 4.94% 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 September 30, 2019, 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 September 30, 2019, 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 September 30, 2019, 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 September 30, 2019, was 4.69% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.
(4) Effective interest rate as of September 30, 2019, was 3.87% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.(4) Effective interest rate as of September 30, 2019, was 3.87% 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 September 30, 2019, 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 September 30, 2019, 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 September 30, 2019, was 5.53% 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 September 30, 2019, was 5.53% 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 September 30, 2019, was 4.37% 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 September 30, 2019, was 4.37% due to an interest rate swap transaction as discussed in Note 7 to Heartland's consolidated financial statements included herein.


CAPITAL REQUIREMENTS


The Federal Reserve Board, which supervises bank holding companies, has adopted capital adequacy guidelines that are used to assess the adequacy of capital of a bank holding company. Under Basel III, Heartland must hold a conservation buffer above the adequately capitalized risk-based capital ratios; however, the transition provisions related to the conservation buffer have been extended indefinitely.


The most recent notification from the FDIC 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 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. The following table illustrates Heartland's capital ratios and the Federal Reserve Board's current capital adequacy guidelines for the dates indicated, in thousands. The table also indicates the fully-phased in capital conservation buffer, but the requirements to comply have been extended indefinitely.

Total
Capital
(to Risk-
Weighted
Assets)
Tier 1
Capital
(to Risk-
Weighted
Assets)
Common
Equity
Tier 1
(to Risk-
Weighted
Assets)
Tier 1
Capital
(to Average Assets)
Total
Capital
(to Risk-
Weighted
Assets)
 
Tier 1
Capital
(to Risk-
Weighted
Assets)
 
Common
Equity
Tier 1
(to Risk-
Weighted
Assets)
 
Tier 1
Capital
(to Average Assets)
March 31, 201914.37% 12.77% 11.24% 10.08%
September 30, 2019September 30, 201914.55 %13.04 %11.50 %10.39 %
Minimum capital requirement8.00% 6.00% 4.50% 4.00%Minimum capital requirement8.00 %6.00 %4.50 %4.00 %
Well capitalized requirement10.00% 8.00% 6.50% 5.00%Well capitalized requirement10.00 %8.00 %6.50 %5.00 %
Minimum capital requirement, including fully-phased in capital conservation buffer10.50% 8.50% 7.00% N/A
Minimum capital requirement, including fully-phased in capital conservation buffer10.50 %8.50 %7.00 %N/A
Risk-weighted assets$8,558,021
 $8,558,021
 $8,558,021
 N/A
Risk-weighted assets$9,418,827  $9,418,827  $9,418,827  N/A  
Average AssetsN/A
 N/A
 N/A
 $10,845,274
Average AssetsN/A  N/A  N/A  $11,830,836  
       
December 31, 201813.72% 12.16% 10.66% 9.73%December 31, 201813.72 %12.16 %10.66 %9.73 %
Minimum capital requirement8.00% 6.00% 4.50% 4.00%Minimum capital requirement8.00 %6.00 %4.50 %4.00 %
Well capitalized requirement10.00% 8.00% 6.50% 5.00%Well capitalized requirement10.00 %8.00 %6.50 %5.00 %
Minimum capital requirement, including fully-phased in capital conservation buffer (2019)10.50% 8.50% 7.00% N/A
Minimum capital requirement, including fully-phased in capital conservation buffer (2019)10.50 %8.50 %7.00 %N/A  
Risk-weighted assets$8,756,130
 $8,756,130
 $8,756,130
 N/A
Risk-weighted assets$8,756,130  $8,756,130  $8,756,130  N/A  
Average AssetsN/A
 N/A
 N/A
 $10,946,440
Average AssetsN/A  N/A  N/A  $10,946,440  


At September 30, 2019, and December 31, 2018, retained earnings that could be available for the payment of dividends to meet the minimum capital requirements totaled $555.2 million and $486.5 million, respectively. Retained earnings that could be available for the payment of dividends to Heartland from its banks totaled approximately $352.4$366.3 million and $311.3 million at March 31,September 30, 2019, and December 31, 2018, respectively, under the capital requirements to remain well capitalized. At March 31, 2019, and December 31, 2018, retained earnings that could be available for the payment of dividends under the most restrictive minimum capital requirements totaled $523.7 million and $486.5 million, respectively.


On July 29, 2016,August 8, 2019, Heartland filed a universal shelf registration statement with the SEC to register debt or equity securities. This shelf registration statement, which was effective immediately, providesprovided Heartland with the ability to raise capital, subject to market conditions and SEC rules and limitations, if Heartland's board of directors decidesdecided to do so. This registration statement will permitpermitted 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 behave been offered iswas not specified in the registration statement, and the terms of any future offerings willwere to be established at the time of the offering. In November 2016, Heartland offered and sold 1,379,690 shares of its common stock pursuant to this registration statement.


OFF-BALANCE SHEET ARRANGEMENTS


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. 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 interest rate changes on the commitments to fund the loans as well as on the residential mortgage loans available for sale. See Note 7, "Derivative Financial Instruments," to the consolidated financial statements for additional information on Heartland's derivative financial instruments.


Heartland also enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of customers. These financial instruments include commitments to extend credit and standby letters of credit.


Off-balance sheet arrangements were disclosed in Heartland's Annual Report on Form 10-K for the year ended December 31, 2018. There have been no material changes to Heartland's off-balance sheet arrangements since that report was filed.








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,September 30, 2019, and December 31, 2018, commitments to extend credit aggregated $2.33$2.66 billion and $2.47 billion, respectively. Standby letters of credit aggregated $72.9$77.2 million at March 31,September 30, 2019, and $71.9 million at December 31, 2018.


Contractual obligations and other commitments were disclosed in Heartland's Annual Report on Form 10-K for the year ended December 31, 2018. Except for the purchase and assumption agreement entered into by Heartland's Illinois Bank & Trust subsidiary to acquire Blue Valley Ban Corp.substantially all of the assets and substantially all of the deposits and certain other liabilities of Rockford Bank and Trust Company described below, there have been no material changes to Heartland's contractual obligations and other commitments since that report was filed.


On January 16,August 13, 2019, HeartlandHeartland's Illinois Bank & Trust subsidiary entered into a definitive mergerpurchase and assumption agreement to acquire Blue Valley Ban Corp., and its wholly-owned subsidiary, Bank of Blue Valley, headquartered in Overland Park, Kansas. As of the announcement date, the transaction, in whichsubstantially all of the issuedassets and outstanding shares of Blue Valley Ban Corp. stock will be exchanged for shares of Heartland common stock, was valued at approximately $93.9 million. Simultaneous with the closingsubstantially all of the transaction, Bankdeposits and certain other liabilities of Blue Valley will merge into Heartland's Kansas-based subsidiary, Morrill & JanesRockford Bank and Trust Company ("RB&T"), headquartered in Rockford, Illinois. RB&T is a wholly-owned subsidiary of Moline, Illinois-based QCR Holdings, Inc. As of September 30, 2019, RB&T had total assets of $519.5 million, which included $417.3 million of gross loans held to maturity, and $451.5 million of deposits. RB&T serves the combined entity will operate as Bank of Blue Valley.Rockford market from two full-service banking locations. The amount of the merger consideration is subject to fluctuations in the price of Heartland common stock and certain potential adjustments, and theall-cash transaction is subject to regulatory approval and to customary closing conditions. The transactionconditions and is expected to close in the second quarter of 2019 with a systems conversion planned for the thirdfourth quarter of 2019. AsThe systems conversion is expected to occur in the first quarter of March 31, 2019, Bank of Blue Valley had total assets of approximately $711.6 million, which included approximately $564.1 million of gross loans outstanding, and approximately $587.2 million of deposits.2020.


Heartland continues to explore opportunities to expand the size of its independent community banks. In the current banking industry environment, Heartland seeks these opportunities for growth through acquisitions. Heartland is primarily focused on possible acquisitions in the markets it currently serves, in which there would be an opportunity to increase market share, achieve efficiencies and provide greater convenience for current customers. However, Heartland may also pursue acquisitions in areas outside of its current geographic footprint. 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 these loans. 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 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 Heartland's derivative financial instruments.


LIQUIDITY


Liquidity refers to Heartland's ability to maintain a 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.


At March 31,September 30, 2019, Heartland had $492.5$447.8 million of cash and cash equivalents, time deposits in other financial institutions of $4.7$3.7 million and securities carried at fair value of $2.40$3.02 billion.








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 growth in net interest cash flows.


Heartland's diversified deposit base provides a sizable source of relatively stable and low-cost funding. Total deposits were $9.35 billion at March 31, 2019, compared to $9.40 billion at December 31, 2018. Heartland's short-term borrowing balances are, on average, another stable source of funds. These balances are dependent on commercial cash management and smaller correspondent bank relationships and, as a result, will normally fluctuate. Management believes these balances, on average, to be stable sources of funds; however, Heartland intends to rely on deposit growth and additional FHLB borrowings as needed in the future.


Additional funding is provided by long-term debt and short-term borrowings. In the event of short-term liquidity needs, Heartland's banks may purchase federal funds from each other or from correspondent banks and may also borrow from the Federal Reserve Bank. As of March 31,September 30, 2019, Heartland had $104.3$107.9 million of short-term borrowings outstanding. As of March 31,September 30, 2019, Heartland had $268.3$278.4 million of long-term debt outstanding, and it is an important funding source because of its multi-year borrowing structure. Additionally, the banks' FHLB memberships give them the ability to borrow funds for short-term and long-term purposes under a variety of programs. At March 31,September 30, 2019, Heartland had $1.44$1.55 billion of borrowing capacity under these programs.


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, repayment requirements under other debt obligations and payments for acquisitions. The parent company obtains the funding to meet these obligations from dividends paid by its bank subsidiaries and the issuance of debt and equity securities. Heartland has a revolving credit agreement and non-revolving credit line with an unaffiliated bank, which was renewed on June 14, 2019. Heartland's revolving credit agreement with an unaffiliated bank has $30.0 million of maximum borrowing capacity, of which none was outstanding at March 31,September 30, 2019. Heartland also has a non-revolving credit line with the same unaffiliated bank. At March 31,September 30, 2019, $8.3$14.8 million was available on thisthe non-revolving credit line. These credit agreements contain specific financial covenants, all of which Heartland complied with as of March 31,September 30, 2019.


The ability of Heartland to pay dividends to its stockholders is dependent upon dividends paid to Heartland 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 at Heartland's bank subsidiaries, certain portions of their retained earnings are not available for the payment of dividends.


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 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. Heartland's objective is to measure this risk and manage its 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 Heartland's bank subsidiaries and, on a consolidated basis, by Heartland's executive management and board of directors. 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 threenine months of 2019.





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 one) and a rate shock (year two 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 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,September 30, 2019, and March 31,September 30, 2018, provided the following results, in thousands:

2019 2018 20192018
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       Year 1    
Down 100 Basis Points$400,843
 (3.30)% $362,642
 (3.02)%Down 100 Basis Points$425,662  (3.37)%$442,187  (3.07)%
Base$414,540
   $373,953
  Base$440,498  — %$456,192  — %
Up 200 Basis Points$437,779
 5.61 % $377,453
 0.94 %Up 200 Basis Points$468,374  6.33 %$454,513  (0.37)%
Year 2       
Year 2      
Down 100 Basis Points$382,215
 (7.80)% $346,225
 (7.41)%Down 100 Basis Points$388,722  (11.75)%$423,766  (7.11)%
Base$416,785
 0.54 % $379,901
 1.59 %Base$426,489  (3.18)%$463,765  1.66 %
Up 200 Basis Points$464,301
 12.00 % $404,390
 8.14 %Up 200 Basis Points$485,463  10.21 %$474,816  4.08 %





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 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 consolidated balance sheet until the loan is made or the letter or credit is issued.


ITEM 4. CONTROLS AND PROCEDURES


Based on an evaluation, as of the end of the 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, the Chief Executive Officer and Chief Financial Officer have concluded that:
Heartland's disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended) were effective.
During the quarter ended March 31,September 30, 2019, there have been no changes in Heartland's internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as 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 2018 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 quarter ended March 31,September 30, 2019.


ITEM 3. DEFAULTS UPON SENIOR SECURITIES


None


ITEM 4. MINE SAFETY DISCLOSURES


Not applicable


ITEM 5. OTHER INFORMATION


None







ITEM 6. EXHIBITS


Exhibits

(1)(2)
(1)(2)
(2)
(2)
(2)
(2)
101Financial statement formatted in Inline 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.
104Cover page formatted in Inline Extensible Business Reporting Language
______________
(1) Management contracts or compensatory plans or arrangementsThe disclosure schedules to the Purchase and Assumption Agreement have been omitted pursuant to Item 601(b)(2)(ii) of Regulation S-K.
(2) Filed or furnished herewith.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)
HEARTLAND FINANCIAL USA, INC.
(Registrant)
/s/ Bruce K. Lee
By: Bruce K. Lee
President 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 7,November 6, 2019