LOANS

Loans as of September 30, 2018, and December 31, 2017, were as follows, in thousands:



	September 30, 2018			December 31, 2017
Loans receivable held to maturity:
Commercial	$	1,962,222		$	1,646,606
Commercial real estate	3,648,731			3,163,269
Agricultural and agricultural real estate	574,048			511,588
Residential real estate	676,941			624,279
Consumer	506,181			447,484
Gross loans receivable held to maturity	7,368,123			6,393,226
Unearned discount	(1,340		)	(556		)
Deferred loan fees	(1,290		)	(1,206		)
Total net loans receivable held to maturity	7,365,493			6,391,464
Allowance for loan losses	(61,221		)	(55,686		)
Loans receivable, net	$	7,304,272		$	6,335,778

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.

Diversification in the loan portfolio is also a means of managing risk associated with fluctuations in economic conditions. 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. Heartland's consumer finance subsidiaries, Citizens Finance Co. and Citizens Finance of Illinois Co., typically lend to borrowers with past credit problems or limited credit histories, which comprises approximately 14% of Heartland's total consumer loan portfolio.

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 September 30, 2018, and December 31, 2017, 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 2018.



	Allowance For Loan Losses						Gross Loans Receivable Held to Maturity
	Ending Balance Under ASC 310-10-35		Ending Balance Under ASC 450-20		Total		Ending Balance Evaluated for Impairment Under ASC 310-10-35		Ending Balance Evaluated for Impairment Under ASC 450-20		Total
September 30, 2018
Commercial	$	4,165	$	17,904	$	22,069	$	23,414	$	1,938,808	$	1,962,222
Commercial real estate	214		23,476		23,690		14,415		3,634,316		3,648,731
Agricultural and agricultural real estate	260		4,306		4,566		17,522		556,526		574,048
Residential real estate	279		1,571		1,850		23,647		653,294		676,941
Consumer	1,085		7,961		9,046		8,671		497,510		506,181
Total	$	6,003	$	55,218	$	61,221	$	87,669	$	7,280,454	$	7,368,123
December 31, 2017
Commercial	$	1,613	$	16,485	$	18,098	$	7,415	$	1,639,191	$	1,646,606
Commercial real estate	766		21,184		21,950		23,705		3,139,564		3,163,269
Agricultural and agricultural real estate	546		3,712		4,258		13,304		498,284		511,588
Residential real estate	430		1,794		2,224		27,141		597,138		624,279
Consumer	1,400		7,756		9,156		6,903		440,581		447,484
Total	$	4,755	$	50,931	$	55,686	$	78,468	$	6,314,758	$	6,393,226

The following table presents nonaccrual loans, accruing loans past due 90 days or more and performing troubled debt restructured loans at September 30, 2018, and December 31, 2017, in thousands:



	September 30, 2018		December 31, 2017
Nonaccrual loans	$	68,528	$	58,272
Nonaccrual troubled debt restructured loans	4,532		4,309
Total nonaccrual loans	$	73,060	$	62,581
Accruing loans past due 90 days or more	$	154	$	830
Performing troubled debt restructured loans	$	4,180	$	6,617

The following tables provide information on troubled debt restructured loans that were modified during the three- and nine-month periods ended September 30, 2018, and September 30, 2017, dollars in thousands:



	Three Months Ended September 30,
	2018					2017
	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	1	92		94		8	1,174		1,174
Consumer	—	—		—		—	—		—
Total	1	$	92	$	94	8	$	1,174	$	1,174



	Nine Months Ended September 30,
	2018					2017
	Number of Loans	Pre- Modification Recorded Investment		Post- Modification Recorded Investment		Number of Loans	Pre- Modification Recorded Investment		Post- Modification Recorded Investment
Commercial	—	$	—	$	—	3	$	131	$	131
Commercial real estate	—	—		—		—	—		—
Total commercial and commercial real estate	—	—		—		3	131		131
Agricultural and agricultural real estate	—	—		—		—	—		—
Residential real estate	11	2,098		1,808		22	2,977		2,977
Consumer	—	—		—		—	—		—
Total	11	$	2,098	$	1,808	25	$	3,108	$	3,108

The pre-modification and post-modification recorded investment represents amounts as of the date of loan modification. The change related to the pre-modification investment and post-modification investment amounts on Heartland's residential real estate trouble debt restructured loans for the nine-months ended September 30, 2018, is due to $356,000 of principal deferment collected from government guarantees and $66,000 of capitalized interest and escrow. At September 30, 2018, 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- and nine- month periods ended September 30, 2018, and September 30, 2017, that had been modified during the twelve-month period prior to default, in thousands:



	With Payment Defaults During the
	Three Months Ended September 30,
	2018			2017
	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Commercial	—	$	—	—	$	—
Commercial real estate	—	—		—	—
Total commercial and commercial real estate	—	—		—	—
Agricultural and agricultural real estate	—	—		—	—
Residential real estate	4	418		5	1,221
Consumer	—	—		—	—
Total	4	$	418	5	$	1,221



	With Payment Defaults During the
	Nine Months Ended September 30,
	2018			2017
	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Commercial	—	$	—	—	$	—
Commercial real estate	—	—		—	—
Total commercial and commercial real estate	—	—		—	—
Agricultural and agricultural real estate	—	—		—	—
Residential real estate	10	1,598		8	1,480
Consumer	—	—		—	—
Total	10	$	1,598	8	$	1,480

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 no loans classified as loss or doubtful as of September 30, 2018. 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 September 30, 2018, and December 31, 2017, in thousands:



	Pass		Nonpass		Total
September 30, 2018
Commercial	$	1,825,692	$	136,530	$	1,962,222
Commercial real estate	3,467,522		181,209		3,648,731
Total commercial and commercial real estate	5,293,214		317,739		5,610,953
Agricultural and agricultural real estate	476,261		97,787		574,048
Residential real estate	644,592		32,349		676,941
Consumer	491,092		15,089		506,181
Total gross loans receivable held to maturity	$	6,905,159	$	462,964	$	7,368,123
December 31, 2017
Commercial	$	1,552,783	$	93,823	$	1,646,606
Commercial real estate	2,985,501		177,768		3,163,269
Total commercial and commercial real estate	4,538,284		271,591		4,809,875
Agricultural and agricultural real estate	451,539		60,049		511,588
Residential real estate	586,623		37,656		624,279
Consumer	432,936		14,548		447,484
Total gross loans receivable held to maturity	$	6,009,382	$	383,844	$	6,393,226

The nonpass category in the table above is comprised of approximately 53% special mention loans and 47% substandard loans as of September 30, 2018. The percent of nonpass loans on nonaccrual status as of September 30, 2018, was 16%. As of December 31, 2017, 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, 2017, was 16%. Loans delinquent 30 to 89 days as a percent of total loans were 0.62% at September 30, 2018, compared to 0.27% at December 31, 2017. Changes in credit risk are monitored on a regular basis and changes in risk ratings are made when identified. All impaired loans are reviewed at least annually.

As of September 30, 2018, Heartland had $3.1 million of loans secured by residential real estate property that were in the process of foreclosure.

The following table sets forth information regarding Heartland's accruing and nonaccrual loans at September 30, 2018, and December 31, 2017, in thousands:



	Accruing Loans
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Nonaccrual		Total Loans
September 30, 2018
Commercial	$	10,558	$	3,521	$	61	$	14,140	$	1,924,173	$	23,909	$	1,962,222
Commercial real estate	11,495		9,036		58		20,589		3,616,737		11,405		3,648,731
Total commercial and commercial real estate	22,053		12,557		119		34,729		5,540,910		35,314		5,610,953
Agricultural and agricultural real estate	1,294		1,146		35		2,475		554,055		17,518		574,048
Residential real estate	2,893		192		—		3,085		659,662		14,194		676,941
Consumer	4,493		811		—		5,304		494,843		6,034		506,181
Total gross loans receivable held to maturity	$	30,733	$	14,706	$	154	$	45,593	$	7,249,470	$	73,060	$	7,368,123
December 31, 2017
Commercial	$	1,246	$	259	$	100	$	1,605	$	1,637,773	$	7,228	$	1,646,606
Commercial real estate	4,769		2,326		—		7,095		3,139,576		16,598		3,163,269
Total commercial and commercial real estate	6,015		2,585		100		8,700		4,777,349		23,826		4,809,875
Agricultural and agricultural real estate	604		134		—		738		497,546		13,304		511,588
Residential real estate	2,022		270		—		2,292		601,120		20,867		624,279
Consumer	4,734		943		730		6,407		436,493		4,584		447,484
Total gross loans receivable held to maturity	$	13,375	$	3,932	$	830	$	18,137	$	6,312,508	$	62,581	$	6,393,226

The majority of Heartland's impaired loans are on nonaccrual or have had their terms restructured in a troubled debt restructuring. The following tables present, by category of loan, impaired loans, the unpaid contractual loan balances at September 30, 2018, and December 31, 2017; the outstanding loan balances recorded on the consolidated balance sheets at September 30, 2018, and December 31, 2017; any related allowance recorded for those loans as of September 30, 2018, and December 31, 2017; the average outstanding loan balances recorded on the consolidated balance sheets during the three- and nine-months ended September 30, 2018, and year ended December 31, 2017; and the interest income recognized on the impaired loans during the three- and nine-month periods ended September 30, 2018, and year ended December 31, 2017, in thousands:



	Unpaid Contractual 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, 2018
Impaired loans with a related allowance:
Commercial	$	6,768	$	6,768	$	4,165	$	5,173	$	16	$	3,593	$	52
Commercial real estate	748		748		214		889		4		5,635		20
Total commercial and commercial real estate	7,516		7,516		4,379		6,062		20		9,228		72
Agricultural and agricultural real estate	2,043		2,043		260		3,000		2		2,369		2
Residential real estate	869		869		279		1,006		4		1,278		10
Consumer	3,028		3,028		1,085		3,146		9		3,069		29
Total impaired loans with a related allowance	$	13,456	$	13,456	$	6,003	$	13,214	$	35	$	15,944	$	113
Impaired loans without a related allowance:
Commercial	$	18,003	$	16,646	$	—	$	13,113	$	182	$	9,307	$	277
Commercial real estate	13,765		13,667		—		11,850		80		12,847		201
Total commercial and commercial real estate	31,768		30,313		—		24,963		262		22,154		478
Agricultural and agricultural real estate	18,002		15,479		—		15,837		1		14,726		4
Residential real estate	22,778		22,778		—		22,779		121		24,780		320
Consumer	5,643		5,643		—		5,522		22		4,930		78
Total impaired loans without a related allowance	$	78,191	$	74,213	$	—	$	69,101	$	406	$	66,590	$	880
Total impaired loans held to maturity:
Commercial	$	24,771	$	23,414	$	4,165	$	18,286	$	198	$	12,900	$	329
Commercial real estate	14,513		14,415		214		12,739		84		18,482		221
Total commercial and commercial real estate	39,284		37,829		4,379		31,025		282		31,382		550
Agricultural and agricultural real estate	20,045		17,522		260		18,837		3		17,095		6
Residential real estate	23,647		23,647		279		23,785		125		26,058		330
Consumer	8,671		8,671		1,085		8,668		31		7,999		107
Total impaired loans held to maturity	$	91,647	$	87,669	$	6,003	$	82,315	$	441	$	82,534	$	993



	Unpaid Contractual Balance		Loan Balance		Related Allowance Recorded		Year-to- Date Avg. Loan Balance		Year-to- Date Interest Income Recognized
December 31, 2017
Impaired loans with a related allowance:
Commercial	$	2,292	$	2,292	$	1,613	$	3,607	$	39
Commercial real estate	11,925		10,068		766		11,479		34
Total commercial and commercial real estate	14,217		12,360		2,379		15,086		73
Agricultural and agricultural real estate	1,539		1,539		546		3,437		—
Residential real estate	1,568		1,568		430		2,056		15
Consumer	2,634		2,634		1,400		2,370		41
Total impaired loans with a related allowance	$	19,958	$	18,101	$	4,755	$	22,949	$	129
Impaired loans without a related allowance:
Commercial	$	6,243	$	5,123	$	—	$	2,586	$	165
Commercial real estate	14,243		13,637		—		20,148		514
Total commercial and commercial real estate	20,486		18,760		—		22,734		679
Agricultural and agricultural real estate	13,793		11,765		—		9,654		—
Residential real estate	25,573		25,573		—		26,024		277
Consumer	4,269		4,269		—		3,884		73
Total impaired loans without a related allowance	$	64,121	$	60,367	$	—	$	62,296	$	1,029
Total impaired loans held to maturity:
Commercial	$	8,535	$	7,415	$	1,613	$	6,193	$	204
Commercial real estate	26,168		23,705		766		31,627		548
Total commercial and commercial real estate	34,703		31,120		2,379		37,820		752
Agricultural and agricultural real estate	15,332		13,304		546		13,091		—
Residential real estate	27,141		27,141		430		28,080		292
Consumer	6,903		6,903		1,400		6,254		114
Total impaired loans held to maturity	$	84,079	$	78,468	$	4,755	$	85,245	$	1,158

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. Included in loans acquired from Signature Bank was a lease portfolio with a fair value of $16.0 million on the acquisition date. The lease portfolio is included with the commercial loan category for disclosure purposes.

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 September 30, 2018, and December 31, 2017, the carrying amount of loans acquired since 2015 consist of purchased impaired and nonimpaired loans as summarized in the following table, in thousands:



	September 30, 2018						December 31, 2017
	Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans		Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans
Commercial	$	9,078	$	300,261	$	309,339	$	952	$	187,375	$	188,327
Commercial real estate	302		1,202,537		1,202,839		2,572		1,052,469		1,055,041
Agricultural and agricultural real estate	—		32,357		32,357		—		1,242		1,242
Residential real estate	220		204,414		204,634		214		173,909		174,123
Consumer loans	—		89,061		89,061		—		51,292		51,292
Total loans	$	9,600	$	1,828,630	$	1,838,230	$	3,738	$	1,466,287	$	1,470,025

Changes in accretable yield on acquired loans with evidence of credit deterioration at the date of acquisition for the three- and nine-month periods ended September 30, 2018, and September 30, 2017, were as follows, in thousands:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Balance at beginning of period	$	463		$	101		$	57		$	182
Original yield discount, net, at date of acquisition	—			—			508			—
Accretion	(93		)	(700		)	(943		)	(1,074		)
Reclassification from nonaccretable difference⁽¹⁾	186			654			934			947
Balance at period end	$	556		$	55		$	556		$	55

(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 million, and the estimated fair value of these loans was $21.8 million. At September 30, 2018, 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 September 30, 2018, there was $675,000 of allowance recorded and $139,000 of allowance recorded at December 31, 2017, related to these ASC 310-30 loans. Provision expense of $675,000 and $5,000 was recorded for the nine-month periods ended September 30, 2018, and 2017, 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 billion, and the estimated fair value of the loans was $3.59 billion.