LOANS AND LEASES

Loans and leases as of September 30, 2011, and December 31, 2010, were as follows, in thousands:



	September 30, 2011			December 31, 2010
Loans and leases receivable held to maturity:
Commercial	$	561,063		$	558,031
Commercial real estate	1,164,523			1,160,962
Residential real estate	179,628			163,726
Agricultural and agricultural real estate	256,857			250,943
Consumer	217,007			214,515
Gross loans receivable held to maturity	2,379,078			2,348,177
Net direct financing leases held to maturity	604			981
Gross loans and leases receivable held to maturity	2,379,682			2,349,158
Unearned discount	(2,466		)	(2,581		)
Deferred loan fees	(3,030		)	(2,590		)
Total net loans and leases receivable held to maturity	2,374,186			2,343,987
Loans covered under loss share agreements:
Commercial and commercial real estate	6,788			10,056
Residential real estate	4,410			5,792
Agricultural and agricultural real estate	2,139			2,723
Consumer	1,429			2,229
Total loans covered under loss share agreements	14,766			20,800
Allowance for loan and lease losses	(44,195		)	(42,693		)
Loans and leases receivable, net	$	2,344,757		$	2,322,094

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 non-performing loans and potential problem loans. Diversification in the loan portfolio is also a means of managing risk associated with fluctuations in economic conditions.

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

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

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

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.

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

Under Heartland’s credit policies, all nonaccrual and troubled debt restructured loans meeting the criteria of a troubled debt restructuring are defined as impaired loans. 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, at the observable market price of the loan or the fair value of the collateral if the loan is collateral dependent.

The following table shows the balance in the allowance for loan and lease losses at September 30, 2011, and December 31, 2010, 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, 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 changes to the accounting for the allowance for loan and lease losses policy during 2011.



	Allowance For Loan and Lease Losses						Gross Loans and Leases 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, 2011
Commercial	$	1,724	$	8,105	$	9,829	$	8,670	$	552,393	$	561,063
Commercial real estate	10,244		12,575		22,819		87,812		1,076,711		1,164,523
Agricultural and agricultural real estate	5		1,688		1,693		19,440		237,417		256,857
Residential real estate	493		2,261		2,754		6,041		173,587		179,628
Consumer	1,612		5,482		7,094		4,381		212,626		217,007
Lease financing	—		6		6		—		604		604
Unallocated	—		—		—		—		—		—
Total	$	14,078	$	30,117	$	44,195	$	126,344	$	2,253,338	$	2,379,682

December 31, 2010
Commercial	$	2,837	$	7,688	$	10,525	$	16,598	$	541,433	$	558,031
Commercial real estate	7,127		13,189		20,316		105,341		1,055,621		1,160,962
Agricultural and agricultural real estate	512		1,635		2,147		16,255		234,688		250,943
Residential real estate	659		1,722		2,381		5,450		158,276		163,726
Consumer	1,026		5,289		6,315		3,540		210,975		214,515
Lease financing	—		9		9		—		981		981
Unallocated	—		1,000		1,000		—		—		—
Total	$	12,161	$	30,532	$	42,693	$	147,184	$	2,201,974	$	2,349,158

The following table presents nonaccrual loans, accruing loans past due 90 days or more and troubled debt restructured loans not covered under loss share agreements at September 30, 2011, and December 31, 2010, in thousands. There were no nonaccrual leases, accruing leases past due 90 days or more or restructured leases at September 30, 2011, and December 31, 2010.



	September 30, 2011		December 31, 2010
Nonaccrual loans	$	60,088	$	77,875
Nonaccrual troubled debt restructured loans	12,541		12,637
Total nonaccrual loans	$	72,629	$	90,512
Accruing loans past due 90 days or more	—		85
Performing troubled debt restructured loans	$	24,853	$	23,719

Heartland had $37.4 million of troubled debt restructured loans at September 30, 2011, of which $12.5 million were classified as nonaccrual and $24.9 million were accruing according to the restructured terms. Heartland had $36.4 million of troubled debt restructured loans at December 31, 2010, of which $12.7 million were classified as nonaccrual and $23.7 million were accruing according to the restructured terms.

The following table provides information on troubled debt restructured loans that were modified during the three and nine months ended September 30, 2011:



(Dollars in thousands)	Three Months Ended Sept. 30, 2011					Nine Months Ended Sept. 30, 2011
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial	1	$	298	$	298	4	$	424	$	424
Commercial real estate	—	—		—		21	13,383		13,383
Total commercial and commercial real estate	1	298		298		25	13,807		13,807
Residential real estate	4	342		342		8	1,165		1,165
Agricultural and agricultural real estate	7	3,014		3,014		7	3,014		3,014
Consumer	1	41		41		1	41		41
Total	13	$	3,695	$	3,695	41	$	18,027	$	18,027

The pre-modification and post-modification recorded investment represents amounts as of the date of loan modification. Since the modifications on these loans have been only interest rate concessions and term extensions, not principal reductions, the pre-modification and post-modification recorded investment amounts are the same.

The following table provides information on troubled debt restructured loans for which there was a payment default during the three and nine months ended September 30, 2011, that had been modified during the 12-month period prior to the default:



(Dollars in thousands)	With Payment Defaults During the Following Periods
	Three Months Ended September 30, 2011			Nine Months Ended September 30, 2011
	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Commercial	—	$	—	—	$	—
Commercial real estate	1	6,605		1	6,605
Total commercial and commercial real estate	1	6,605		1	6,605
Residential real estate	—	—		3	295
Agricultural and agricultural real estate	—	—		—	—
Consumer	—	—		—	—
Total	1	$	6,605	4	$	6,900

The following table presents nonaccrual loans not covered by loss share agreements at September 30, 2011, and December 31, 2010, in thousands:



	September 30, 2011		December 31, 2010
Commercial	$	1,808	$	9,114
Commercial real estate	58,307		65,534
Total commercial and commercial real estate	60,115		74,648
Residential real estate	5,974		9,510
Agricultural and agricultural real estate	1,957		1,670
Consumer	4,583		4,684
Total nonaccrual loans held to maturity	$	72,629	$	90,512

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 a range of loan grades that reflect increasing, though still acceptable, risk. Movement of risk through the various grade levels in the pass category is monitored for early identification of credit deterioration. The "nonpass" category consists of special mention, substandard, doubtful and loss loans. The "special mention" rating is attached to loans where the borrower exhibits negative financial trends due to borrower specific or systemic conditions that, if left uncorrected, threaten its capacity to meet its debt obligations. The borrower is believed to have sufficient financial flexibility to react to and resolve its negative financial situation. These credits are closely monitored for improvement or deterioration. The "substandard" rating is assigned to loans that are inadequately protected by the current sound net worth and paying capacity of the borrower and may be further at risk due to deterioration in the value of collateral pledged. Well-defined weaknesses jeopardize liquidation of the debt. These loans are still considered collectible, however, a distinct possibility exists that Heartland will sustain some loss if deficiencies are not corrected. Substandard loans may exhibit some or all of the following weaknesses: deteriorating trends, lack of earnings, inadequate debt service capacity, excessive debt and/or lack of liquidity. The "doubtful" rating is assigned to loans where identified weaknesses make collection or liquidation in full, on the basis of existing facts, conditions and values, highly questionable and improbable. These borrowers are usually in default, lack liquidity and capital, as well as, resources necessary to remain an operating entity. Specific pending events, such as capital injections, liquidations or perfection of liens on additional collateral, may strengthen the credit, thus deferring classification of the loan as loss until exact status can be determined. The "loss" rating is assigned to loans considered uncollectible. As of September 30, 2011, Heartland had no loans classified as doubtful or loss. Loans are placed on "nonaccrual" when management does not expect to collect payments of principal and interest in full or when principal or interest has been in default for a period of 90 days or more, unless the loan is both well secured and in the process of collection.

The following table presents loans and leases not covered by loss share agreements by credit quality indicator at September 30, 2011, and December 31, 2010, in thousands:



	Pass		Nonpass		Total
September 30, 2011
Commercial	$	509,323	$	51,740	$	561,063
Commercial real estate	964,964		199,559		1,164,523
Total commercial and commercial real estate	1,474,287		251,299		1,725,586
Residential real estate	163,138		16,490		179,628
Agricultural and agricultural real estate	215,797		41,060		256,857
Consumer	207,244		9,763		217,007
Lease financing	604		—		604
Total gross loans and leases receivable held to maturity	$	2,061,070	$	318,612	$	2,379,682

December 31, 2010
Commercial	$	504,207	$	53,824	$	558,031
Commercial real estate	912,897		248,065		1,160,962
Total commercial and commercial real estate	1,417,104		301,889		1,718,993
Residential real estate	146,392		17,334		163,726
Agricultural and agricultural real estate	220,096		30,847		250,943
Consumer	202,533		11,982		214,515
Lease financing	981		—		981
Total gross loans and leases receivable held to maturity	$	1,987,106	$	362,052	$	2,349,158

The nonpass category in the table above is comprised of approximately 41% special mention and 59% substandard as of September 30, 2011. The percent of nonpass loans on nonaccrual status as of September 30, 2011, was 23%. As of December 31, 2010, the nonpass category in the table above was comprised of approximately 37% special mention and 63% substandard. The percent of nonpass loans on nonaccrual status as of December 31, 2010, was 25%. Changes in credit risk are monitored on a continuous basis and changes in risk ratings are made when identified. All impaired loans are reviewed at least annually.

The following table sets forth information regarding Heartland's accruing and nonaccrual loans and leases not covered by loss share agreements at September 30, 2011, and December 31, 2010, in thousands:



	Accruing Loans and Leases
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Nonaccrual		Total Loans and Leases
September 30, 2011
Commercial	$	1,097	$	54	$	—	$	1,151	$	558,104	$	1,808	$	561,063
Commercial real estate	5,107		1,253		—		6,360		1,099,856		58,307		1,164,523
Total commercial and commercial real estate	6,204		1,307		—		7,511		1,657,960		60,115		1,725,586
Residential real estate	1,204		—		—		1,204		172,450		5,974		179,628
Agricultural and agricultural real estate	169		655		—		824		254,076		1,957		256,857
Consumer	2,046		1,256		—		3,302		209,122		4,583		217,007
Lease financing	—		—		—		—		604		—		604
Total gross loans and leases receivable held to maturity	$	9,623	$	3,218	$	—	$	12,841	$	2,294,212	$	72,629	$	2,379,682

December 31, 2010
Commercial	$	895	$	282	$	—	$	1,177	$	547,740	$	9,114	$	558,031
Commercial real estate	5,328		2,940		85		8,353		1,087,075		65,534		1,160,962
Total commercial and commercial real estate	6,223		3,222		85		9,530		1,634,815		74,648		1,718,993
Residential real estate	2,482		—		—		2,482		151,734		9,510		163,726
Agricultural and agricultural real estate	283		292		—		575		248,698		1,670		250,943
Consumer	2,369		628		—		2,997		206,834		4,684		214,515
Lease financing	—		—		—		—		981		—		981
Total gross loans and leases receivable held to maturity	$	11,357	$	4,142	$	85	$	15,584	$	2,243,062	$	90,512	$	2,349,158

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 table presents data on impaired loans not covered by loss share agreements as of September 30, 2011, and December 31, 2010, in thousands:



	September 30, 2011		December 31, 2010
Impaired loans for which a valuation allowance has been provided	$	47,933	$	58,975
Impaired loans for which no valuation allowance has been provided	78,411		88,209
Total loans determined to be impaired	$	126,344	$	147,184
Allowance for loan losses related to impaired loans	$	14,078	$	12,161

The following tables present, for impaired loans not covered by loss share agreements and by category of loan, the unpaid balance that was contractually due at September 30, 2011, and December 31, 2010, the outstanding loan balance recorded on the consolidated balance sheet at September 30, 2011, and December 31, 2010, any related allowance recorded for those loans as of September 30, 2011, and December 31, 2010, the average outstanding loan balance recorded on the balance sheet during the nine months ended September 30, 2011, and year ended December 31, 2010, and the interest income recognized on the impaired loans during the nine months ended September 30, 2011, and year ended December 31, 2010, in thousands:



September 30, 2011	Unpaid Contractual Balance		Loan Balance		Related Allowance Recorded		Year-to-Date Avg. Loan Balance		Year-to-Date Interest Income Recognized
Impaired loans with a related allowance
Commercial	$	7,783	$	7,745	$	1,724	$	9,838	$	281
Commercial real estate	35,623		34,862		10,244		34,267		706
Total commercial and commercial real estate	43,406		42,607		11,968		44,105		987
Residential real estate	1,999		1,999		493		1,883		41
Agricultural and agricultural real estate	10		1		5		3,630		—
Consumer	3,326		3,326		1,612		2,524		31
Total loans held to maturity	$	48,741	$	47,933	$	14,078	$	52,142	$	1,059
Impaired loans without a related allowance
Commercial	$	1,436	$	925	$	—	$	2,635	$	3
Commercial real estate	73,748		52,950		—		55,260		396
Total commercial and commercial real estate	75,184		53,875		—		57,895		399
Residential real estate	4,564		4,042		—		4,330		38
Agricultural and agricultural real estate	19,555		19,439		—		13,119		629
Consumer	1,363		1,055		—		1,483		2
Total loans held to maturity	$	100,666	$	78,411	$	—	$	76,827	$	1,068
Total impaired loans held to maturity
Commercial	$	9,219	$	8,670	$	1,724	$	12,473	$	284
Commercial real estate	109,371		87,812		10,244		89,527		1,102
Total commercial and commercial real estate	118,590		96,482		11,968		102,000		1,386
Residential real estate	6,563		6,041		493		6,213		80
Agricultural and agricultural real estate	19,565		19,440		5		16,749		629
Consumer	4,689		4,381		1,612		4,007		33
Total impaired loans held to maturity	$	149,407	$	126,344	$	14,078	$	128,969	$	2,128



December 31, 2010	Unpaid Contractual Balance		Loan Balance		Related Allowance Recorded		Year-to-Date Avg. Loan Balance		Year-to-Date Interest Income Recognized
Impaired loans with a related allowance
Commercial	$	14,936	$	14,936	$	2,837	$	15,471	$	481
Commercial real estate	35,365		35,282		7,127		36,545		1,394
Total commercial and commercial real estate	50,301		50,218		9,964		52,016		1,875
Residential real estate	2,577		2,415		659		1,390		7
Agricultural and agricultural real estate	3,911		3,911		512		3,707		181
Consumer	2,445		2,431		1,026		1,740		70
Total loans held to maturity	$	59,234	$	58,975	$	12,161	$	58,853	$	2,133
Impaired loans without a related allowance
Commercial	$	4,378	$	1,662	$	—	$	1,722	$	1
Commercial real estate	92,979		70,059		—		72,567		1,026
Total commercial and commercial real estate	97,357		71,721		—		74,289		1,027
Residential real estate	3,515		3,035		—		1,748		47
Agricultural and agricultural real estate	12,401		12,344		—		11,701		391
Consumer	1,458		1,109		—		793		2
Total loans held to maturity	$	114,731	$	88,209	$	—	$	88,531	$	1,467
Total impaired loans held to maturity
Commercial	$	19,314	$	16,598	$	2,837	$	17,193	$	482
Commercial real estate	128,344		105,341		7,127		109,112		2,420
Total commercial and commercial real estate	147,658		121,939		9,964		126,305		2,902
Residential real estate	6,092		5,450		659		3,138		54
Agricultural and agricultural real estate	16,312		16,255		512		15,408		572
Consumer	3,903		3,540		1,026		2,533		72
Total impaired loans held to maturity	$	173,965	$	147,184	$	12,161	$	147,384	$	3,600