DERIVATIVE FINANCIAL INSTRUMENTS

3 Months Ended

Mar. 31, 2023

Derivative Instruments and Hedging Activities Disclosure [Abstract]

HTLF uses derivative financial instruments as part of its interest rate risk management strategy. As part of the strategy, HTLF considers the use of interest rate swaps, risk participation agreements, caps, floors, collars, and certain interest rate lock commitments and forward sales of securities related to mortgage banking activities. HTLF's current strategy includes the use of interest rate swaps, interest rate lock commitments and forward sales of mortgage securities. In addition, HTLF is facilitating back-to-back loan swaps to assist customers in managing their interest rate risk while executing offsetting interest rate swaps with dealer counterparties. HTLF'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. HTLF is exposed to credit risk in the event of nonperformance by counterparties to financial instruments. HTLF minimizes this risk by entering into derivative contracts with counterparties that meet HTLF’s credit standards, and the contracts contain collateral provisions protecting the at-risk party. HTLF has not experienced any losses from nonperformance by these counterparties. HTLF monitors counterparty risk in accordance with the provisions of ASC 815.

HTLF's derivative and hedging instruments are recorded at fair value on the consolidated balance sheets. See Note 7, "Fair Value," for additional fair value information and disclosures.

Cash Flow Hedges

In 2021, two interest rate swap transactions were terminated, and the debt was converted to variable rate subordinated debentures. For the next twelve months, HTLF estimates cash payments and reclassification from accumulated other comprehensive income (loss) to interest expense related to the terminated swaps will total $704,000.

In the first quarter of 2023, HTLF terminated its interest rate swap agreement, which effectively converted $500.0 million of variable rate loans to fixed rate loans. For the next twelve months, Heartland estimates cash payments and reclassification from accumulated other comprehensive income (loss) to interest expense will total $985,000.

The table below identifies the balance sheet category and fair value of HTLF's derivative instrument designated as a cash flow hedges at March 31, 2023 and December 31, 2022, in thousands:


	Notional Amount		Fair Value		Balance Sheet Category
March 31, 2023
Interest rate swap	$	—	$	—	Other Assets
December 31, 2022
Interest rate swap	$	500,000	$	13	Other Assets

The table below identifies the gains recognized on HTLF's derivative instrument designated as a cash flow hedge for the three months ended March 31, 2023, and March 31, 2022, in thousands:



	Recognized in OCI		Reclassified from AOCI into Income
	Amount of Gain (Loss)		Category	Amount of Gain (Loss)
March 31, 2023
Interest rate swap	$	1,952	Interest income	$	591
March 31, 2022
Interest rate swap	$	—	Interest income	$	—

Fair Value Hedges

HTLF uses interest rate swaps to convert certain long term fixed rate loans to floating rates to hedge interest rate risk exposure. HTLF 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. HTLF 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.

HTLF was required to pledge $481,000 and $481,000 of cash as collateral for these fair value hedges at March 31, 2023, and December 31, 2022, respectively.

The table below identifies the notional amount, fair value and balance sheet category of HTLF's fair value hedges at March 31, 2023, and December 31, 2022, in thousands:


	Notional Amount		Fair Value		Balance Sheet Category
March 31, 2023

Fair value hedges	$	1,132	$	39	Other assets
December 31, 2022

Fair value hedges	$	1,185	$	54	Other assets

The table below identifies the gains and losses recognized on HTLF's fair value hedges for the three months ended March 31, 2023, and March 31, 2022, in thousands:


	Three Months Ended March 31,
		2023		2022
Gain (loss) recognized in interest income on fair value hedges		$	(15)	$	1,183

Embedded Derivatives

HTLF has fixed rate loans with embedded derivatives. These 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 the embedded derivatives at March 31, 2023, and December 31, 2022, in thousands:


	Notional Amount		Fair Value		Balance Sheet Category
March 31, 2023
Embedded derivatives	$	5,935	$	98	Other assets

December 31, 2022
Embedded derivatives	$	6,028	$	135	Other assets

The table below identifies the gains and losses recognized on HTLF's embedded derivatives for the three months ended March 31, 2023, and March 31, 2022, in thousands:


	Three Months Ended March 31,
		2023		2022
Gain (loss) recognized in other noninterest income on embedded derivatives		$	(37)	$	225

Back-to-Back Loan Swaps

HTLF has interest rate swap loan relationships with customers to assist them in managing their interest rate risk. Upon entering into these loan swaps, HTLF 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. HTLF was required to post $103,000 of collateral at March 31, 2023, compared to $312,000 as of December 31, 2022, related to these back-to-back swaps. HTLF's counterparties were required to pledge $33.8 million at March 31, 2023, compared to $45.1 million at December 31, 2022. Any gains and losses on these back-to-back swaps are recorded in noninterest income on the consolidated statements of income, and for the three months ended March 31, 2023, and March 31, 2022, no gain or loss was recognized. The table below identifies the balance sheet category and fair values of the derivative instruments designated as loan swaps at March 31, 2023, and December 31, 2022, in thousands:


	Notional Amount		Fair Value		Balance Sheet Category	Weighted Average Receive Rate		Weighted Average Pay Rate
March 31, 2023
Customer interest rate swaps	$	1,017,539	$	27,805	Other assets	4.14	%	6.97	%
Customer interest rate swaps	1,017,539		(27,805)		Other liabilities	6.97		4.14
December 31, 2022
Customer interest rate swaps	$	819,662	$	46,091	Other assets	4.23	%	6.76	%
Customer interest rate swaps	819,662		(46,091)		Other liabilities	6.76		4.23

Other Free Standing Derivatives

HTLF 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. HTLF enters into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into and 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. HTLF was required to pledge no collateral at both March 31, 2023, and December 31, 2022. HTLF's counterparties were required to pledge no collateral at both March 31, 2023, and December 31, 2022, as collateral for these forward commitments.

HTLF 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 sheets 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 HTLF's other free standing derivative instruments not designated as hedging instruments at March 31, 2023, and December 31, 2022, in thousands:


	Balance Sheet Category	Notional Amount		Fair Value
March 31, 2023
Interest rate lock commitments (mortgage)	Other assets	$	15,717	$	449

Forward commitments	Other assets	21,000		241
Forward commitments	Other liabilities	4,150		(21)
Undesignated interest rate swaps	Other liabilities	5,935		(98)

December 31, 2022
Interest rate lock commitments (mortgage)	Other assets	$	9,340	$	174

Forward commitments	Other assets	6,400		47
Forward commitments	Other liabilities	5,750		(99)
Undesignated interest rate swaps	Other liabilities	6,028		(135)

HTLF recognizes gains and losses on other free standing derivatives in two separate income statement categories. Interest rate lock commitments and forward commitments are recognized in net gains on sale of loans held for sale and undesignated interest rate swaps are recognized in other noninterest income. The table below identifies the gains and losses recognized in income on HTLF's other free standing derivative instruments not designated as hedging instruments for the three months ended March 31, 2023, and March 31, 2022, in thousands:


	Three Months Ended March 31,
		2023		2022
Interest rate lock commitments (mortgage)		$	410	$	(1,195)

Forward commitments		272		1,036
Undesignated interest rate swaps		37		(225)