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, 2013, included in the Form 10-K of Heartland Financial USA, Inc. ("Heartland") filed with the Securities and Exchange Commission ("SEC") on March 14, 2014. Accordingly, footnote disclosures which would substantially duplicate the disclosure contained in the audited consolidated financial statements have been omitted.

The financial information of Heartland included herein has been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments), that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of the interim period ended September 30, 2014, are not necessarily indicative of the results expected for the year ending December 31, 2014.

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 month and nine months ended September 30, 2014 and 2013, are shown in the table below:



	Three Months Ended September 30,
(Dollars and number of shares in thousands, except per share data)	2014			2013
Net income attributable to Heartland	$	11,973		$	6,810
Preferred dividends and discount	(205		)	(276		)
Net income available to common stockholders	$	11,768		$	6,534
Weighted average common shares outstanding for basic earnings per share	18,469			16,936
Assumed incremental common shares issued for common stock equivalents	284			285
Weighted average common shares for diluted earnings per share	18,753			17,221
Earnings per common share — basic	$	0.64		$	0.39
Earnings per common share — diluted	$	0.63		$	0.38
Number of antidilutive common stock equivalents excluded from diluted earnings per share computation	94			105



	Nine Months Ended September 30,
(Dollars and number of shares in thousands, except per share data)	2014			2013
Net income attributable to Heartland	$	29,637		$	28,854
Preferred dividends and discount	(613		)	(889		)
Net income available to common stockholders	$	29,024		$	27,965
Weighted average common shares outstanding for basic earnings per share	18,456			16,904
Assumed incremental common shares issued for common stock equivalents	287			279
Weighted average common shares for diluted earnings per share	18,743			17,183
Earnings per common share — basic	$	1.57		$	1.65
Earnings per common share — diluted	$	1.55		$	1.63
Number of antidilutive common stock equivalents excluded from diluted earnings per share computation	94			105

Stock-Based Compensation

Heartland may grant, through its Nominating and Compensation Committee (the "Compensation Committee"), non-qualified and incentive stock options, stock appreciation rights, stock awards, restricted stock, restricted stock units and cash incentive awards, under its 2012 Long-Term Incentive Plan (the "Plan"). The Plan, which was approved by stockholders in May 2012 and replaced Heartland's 2005 Long-Term Incentive Plan with respect to grants after such approval, reserved 368,026 shares of common stock at September 30, 2014, for issuance under future awards that may be granted under the Plan to employees and directors of, and service providers to, Heartland or its subsidiaries.

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

The amount of tax benefit related to the exercise, vesting, and forfeiture of equity-based awards reflected in additional paid-in-capital, not taxes payable, was $119,000 and $68,000 during the nine months ended September 30, 2014, and 2013, respectively.

Restricted Stock Units

The Plan permits the Compensation Committee to grant restricted stock units ("RSUs"). On March 11, 2014, the Compensation Committee granted time-based RSUs with respect to 67,190 shares of common stock and on January 22, 2013, granted time-based RSUs with respect to 72,595 shares of common stock, to selected officers. The time-based RSUs, which represent the right, without payment, to receive shares of Heartland common stock at a specified date in the future based on specific vesting conditions, vest over five years in three equal installments on the third, fourth and fifth anniversaries of the grant date, will be settled in common stock upon vesting, and will not be entitled to dividends until vested. The time-based RSUs granted in 2014 vest upon a "qualified retirement" (as defined in the RSU agreement) while the RSUs granted in 2013 allow the Compensation Committee to exercise its discretion to provide for vesting upon retirement. In both cases, the retiree is required to sign a non-solicitation and non-compete agreement as a condition to vesting.

In addition to the time-based RSUs referenced in the preceding paragraph, the Compensation Committee granted performance-based RSUs with respect to 32,645 shares of common stock on March 11, 2014, and performance-based RSUs with respect to 40,990 shares of common stock on January 22, 2013, to Heartland executives and subsidiary presidents. These performance-based RSUs vest based first on performance measures tied to Heartland's earnings and loans on December 31, 2014, for the 2014 RSUs, and earnings and assets on December 31, 2013, for the 2013 RSUs, and then on time-based vesting conditions. For the grants awarded in 2014, the portion of the RSUs earned based on performance vest on December 31, 2016, if the executive remains employed on that date, and for the grants awarded in 2013, the portion of the RSUs earned based on performance vest on December 31, 2015, subject to employment on that date.

The Compensation Committee also grants RSUs under the Plan to directors as part of their compensation, to new management level employees at commencement of employment, and to other employees and service providers as incentives. During the nine months ended September 30, 2014, and 2013, 33,304 and 13,100 RSUs, respectively, were granted to directors and new employees.

A summary of the status of the RSUs as of September 30, 2014 and 2013, and changes during the nine months ended September 30, 2014 and 2013, follows:



	2014				2013
	Shares		Weighted-Average Grant Date Fair Value		Shares		Weighted-Average Grant Date Fair Value
Outstanding at January 1	353,070		$	18.62	348,897		$	15.75
Granted	133,139		26.65		126,685		26.92
Vested	(74,521	)	16.95		(43,388	)	17.00
Forfeited	(7,483	)	20.22		(57,982	)	19.08
Outstanding at September 30	404,205		$	21.44	374,212		$	19.02

Total compensation costs recorded for RSUs were $2.7 million and $1.5 million for the nine months ended September 30, 2014, and 2013, respectively. As of September 30, 2014, there were $3.6 million of total unrecognized compensation costs related to the 2005 and 2012 Long-Term Incentive Plans for RSUs which are expected to be recognized through 2019.

Options

Although the Plan provides authority to the Compensation Committee to grant stock options, no options were granted during the first nine months of 2014 and 2013. Prior to 2009, options were typically granted annually with an expiration date ten years after the date of grant. Vesting was generally over a five-year service period with portions of a grant becoming exercisable at three years, four years, and five years after the date of grant. A summary of the status of the stock options as of September 30, 2014 and 2013, and changes during the nine months ended September 30, 2014 and 2013, follows:



	2014				2013
	Shares		Weighted-Average Exercise Price		Shares		Weighted-Average Exercise Price
Outstanding at January 1	261,936		$	23.60	377,907		$	22.62
Granted	—		—		—		—
Exercised	(9,750	)	19.67		(68,586	)	19.54
Forfeited	(7,000	)	26.62		(1,800	)	26.68
Outstanding at September 30	245,186		$	23.67	307,521		$	23.28
Options exercisable at September 30	245,186		$	23.67	307,521		$	23.28

At September 30, 2014, the vested options totaled 245,186 shares with a weighted average exercise price of $23.67 per share and a weighted average remaining contractual life of 2.25 years. The intrinsic value (the difference between the market price and the aggregate exercise price) for the vested options as of September 30, 2014, was $594,000. The intrinsic value for the total of all options exercised during the nine months ended September 30, 2014, was $41,000.

The exercise price of stock options granted is established by the Compensation Committee, but the exercise price for the stock options may not be less than the fair market value of the shares on the date that the option is granted or, if greater, the par value of a share of stock. Each option granted is exercisable in full at any time or from time to time, subject to vesting provisions, as determined by the Compensation Committee and as provided in the option agreement, but such time may not exceed ten years from the grant date. Cash received from options exercised was $192,000 for the nine months ended September 30, 2014, and $1.3 million for the nine months ended September 30, 2013.

Total compensation costs recorded for options were $0 and $10,000 for the nine months ended September 30, 2014, and 2013, respectively. There are no unrecorded compensation costs related to options at September 30, 2014.

Subsequent Events

On October 22, 2014, Heartland entered into a merger agreement with Community Banc-Corp of Sheboygan, Inc., parent company of Community Bank & Trust in Sheboygan, Wisconsin. As of September 30, 2014, Community Bank & Trust had assets of approximately $525.0 million, including loans of $410.0 million. Under the merger agreement, and subject to shareholder and regulatory approval, Community Banc-Corp of Sheboygan, Inc. will merge into Heartland, and the shareholders of Community Banc-Corp of Sheboygan, Inc. will receive Heartland common stock. The aggregate purchase price will be based upon 155% of adjusted tangible book value, as defined in the merger agreement, of Community Banc-Corp of Sheboygan, Inc. prior to closing. Heartland estimates the purchase price at approximately $52.0 million. The merger agreement also provides that Community Bank & Trust will simultaneously merge into Heartland’s Wisconsin Bank & Trust subsidiary. The transaction, expected to close in the first quarter of 2015, is intended to be a tax-free reorganization with respect to the stock consideration received by the stockholders of Community Banc-Corp of Sheboygan, Inc.

Heartland has entered into an agreement to sell one branch of its Morrill & Janes Bank and Trust Company subsidiary. The branch sale is expected to close on November 7, 2014. The branch had loans of approximately $9.0 million and deposits of $28.0 million at September 30, 2014. The anticipated premium on the branch sale is 2% of average deposits.

Effect of New Financial Accounting Standards

In July 2013, the FASB issued ASU No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists," to eliminate the diversity in practice and to increase the comparability of financial statements among companies. The guidance requires that a reporting entity generally must show an unrecognized tax benefit, or a portion of an unrecognized tax benefit, for a net operating loss carryforward, similar tax loss or a tax credit carryforward as a reduction of a deferred tax asset. However, the entity should present the unrecognized tax benefit as a liability and not as a reduction of a deferred tax asset if the carryforward or tax loss is not available on the financial statement date to settle any additional income tax liability that would result from the disallowance of the tax position under the applicable tax law, or the applicable tax law does not require the company to use, and the company does not intend to use, the carryforward or tax loss to settle additional income taxes resulting from the disallowance of the tax position. The guidance does not require any new recurring disclosures because it does not affect the recognition or measurement of uncertain tax positions. Heartland adopted this standard on January 1, 2014, and the adoption did not have a material impact on the results of operations, financial position, and liquidity.

In January 2014, the FASB issued ASU 2014-01, "Accounting for Investments in Qualified Affordable Housing Projects." The amendments in ASU 2014-01 to Topic 323, "Equity Investments and Joint Ventures," provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The amendments permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments are effective for fiscal years, and interim periods within those years, beginning after December 31, 2014, and should be applied retrospectively to all periods presented. Early adoption is permitted. Heartland is in the process of evaluating the impact that adoption of this guidance will have on the results of operations, financial position, and liquidity.

In January 2014, the FASB issued ASU 2014-04, "Receivables-Troubled Debt Restructurings by Creditors: Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure." The amendments in ASU 2014-04 clarify that an in-substance foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (i) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (ii) the borrower conveying all interest in the residential real estate property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure or similar legal agreement. ASU 2014-04 also requires disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in loans collateralized by residential real estate property that are in the process of foreclosure. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2014, with early adoption permitted. Once adopted, an entity can elect either (i) a modified retrospective transition method or (ii) a prospective transition method. The modified retrospective transition method is applied by means of a cumulative-effect adjustment to residential mortgage loans and foreclosed residential real estate properties existing as of the beginning of the period for which the amendments of ASU 2014-04 are effective, with real estate reclassified to loans measured at the carrying value of the real estate at the date of adoption and loans reclassified to real estate measured at the lower of net carrying value of the loan or the fair value of the real estate less costs to sell at the date of adoption. The prospective transition method is applied by means of applying the amendments of ASU 2014-04 to all instances of receiving physical possession of residential real estate properties that occur after the date of adoption. Heartland does not expect the adoption of this standard to have a material impact on the results of operations, financial position, and liquidity.

In August 2014, the FASB issued ASU 2014-14, "Receivables-Troubled Debt Restructurings by Creditors: Classification of Certain Government-Guaranteed Mortgage Loans Upon Foreclosure." The amendment clarifies how creditors are to classify certain government-guaranteed mortgage loans upon foreclosure. The amendment requires that a mortgage loan be derecognized and a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separate from the loan before foreclosure, and (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under the claim, and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured on the amount of the loan balance (principal and interest) expected to be recovered for the guarantor. This amendment is effective for annual reporting periods, and interim reporting periods within those years, beginning after December 15, 2014, with early adoption permitted. Heartland does not expect the adoption of this standard to have a material impact on the results of operations, financial position, and liquidity.

Reclassifications

In the first quarter of 2014, Heartland revised the classification of mortgage servicing rights income from loan servicing income to gain on sale of loans held for sale. The reclassification is presented in both the current and prior reporting periods. For the three and nine months ended September 30, 2013, $3.4 million and $10.6 million, respectively, were reclassified from loan servicing income to gain on sale of loans held for sale.

During the first quarter of 2014, Heartland revised the classification of loss on sales/valuations of other real estate and repossessed assets, net, from other real estate and loan collection expenses to a specific noninterest income classification. This reclassification is presented in both the current and prior reporting periods. For the three and nine months ended September 30, 2013, losses of $339,000 and $2.4 million were reclassified from other real estate and loan collection expenses to loss on sales/valuations of other real estate and repossessed assets, net. This reclassification results in other real estate and loan collection expenses for the three and nine months ended September 30, 2013, decreasing from $1.1 million and $4.9 million as previously reported to $730,000 and $2.4 million, respectively.

These reclassifications do not have a material impact on Heartland's financial statements and do not affect the financial results. Heartland believes these reclassifications are more consistent with industry reporting practices.