FAIR VALUE

Heartland utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale, trading securities and derivatives are recorded 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 and other real estate owned. These nonrecurring fair value adjustments typically involve application of 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

Securities available for sale are recorded at fair value on a recurring basis. 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 and other U.S. government and agency securities that are traded by dealers or brokers in active over-the-counter markets. Level 2 securities include agency mortgage-backed securities and private collateralized mortgage obligations, municipal bonds and corporate debt securities. The Level 3 securities consist primarily of Z tranche mortgage-backed securities. On a quarterly basis, a secondary independent pricing service is used for a sample of securities to validate the pricing from our primary pricing service.

Trading Assets

Trading assets are recorded at fair value and consist of securities held for trading purposes. The valuation method for trading securities is the same as the methodology used for securities classified as available for sale.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value. 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. 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. At March 31, 2012, all impaired loans were measured based on the fair value of the collateral. In accordance with ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. Heartland classifies impaired loans as nonrecurring Level 3.

Derivative Financial Instruments

Currently, Heartland uses interest rate swaps, caps, floors, collars and certain interest rate lock commitments and forward sales of securities related to mortgage banking activities to manage its interest rate risk. 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. The fair values of interest rate options are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates fell below (rise above) the strike rate of the floors (caps). The variable interest rates used in the calculation of projected receipts on the floor (cap) are based on an expectation of future interest rates derived from observable market interest rate curves and 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, 2012, and December 31, 2011, 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.

Other Real Estate Owned

Other real estate owned ("OREO") represents property acquired through foreclosures and settlements of loans. Property acquired is carried at the lower of the principal amount of the loan outstanding at the time of acquisition, 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 also 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.

The table below presents Heartland's assets and liabilities that are measured at fair value on a recurring basis as of March 31, 2012, and December 31, 2011, in thousands, aggregated by the level in the fair value hierarchy within which those measurements fall:



	Total Fair Value		Level 1		Level 2		Level 3
March 31, 2012
Trading securities	$	330	$	330	$	—	$	—
Securities available for sale	1,165,108		48,116		1,113,607		3,385
Derivative assets	5,278		—		5,278		—
Total assets at fair value	$	1,170,716	$	48,446	$	1,118,885	$	3,385
Derivative liabilities	$	5,984	$	—	$	5,984	$	—
Total liabilities at fair value	$	5,984	$	—	$	5,984	$	—
December 31, 2011
Trading securities	$	333	$	333	$	—	$	—
Securities available for sale	1,267,999		107,147		1,157,609		3,243
Derivative assets	2,828		—		2,828		—
Total assets at fair value	$	1,271,160	$	107,480	$	1,160,437	$	3,243
Derivative liabilities	$	6,405	$	—	$	6,405	$	—
Total liabilities at fair value	$	6,405	$	—	$	6,405	$	—

There were no transfers between Levels 1, 2 or 3 during the three-month period ended March 31, 2012, or the year ended December 31, 2011.

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, 2012
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Losses
Assets:
Collateral dependent impaired loans:
Commercial	$	6,831	$	—	$	—	$	6,831	$	502
Commercial real estate	57,105		—		—		57,105		286
Agricultural and agricultural real estate	14,228		—		—		14,228		63
Residential real estate	5,584		—		—		5,584		—
Consumer	3,535		—		—		3,535		757
Total collateral dependent impaired loans	$	87,283	$	—	$	—	$	87,283	$	1,608
Other real estate owned	$	38,934	$	—	$	—	$	38,934	$	2,063



	Fair Value Measurements at December 31, 2011
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Losses
Assets:
Collateral dependent impaired loans	$	94,961	$	—	$	—	$	94,961	$	32,640
Other real estate owned	$	44,387	$	—	$	—	$	44,387	$	7,079



	Quantitative Information About Level 3 Fair Value Measurements
	Fair Value at 3/31/12		Valuation Technique	Unobservable Input	Range (Weighted Average)
Z-Tranche Securities	$	3,385	Discounted cash flows	Pretax discount rate	15.00%
				Actual defaults	13.94-20.94% (15.52%)
				Actual deferrals	6.30-23.71% (11.32%)
Collateral dependent impaired loans:
Commercial real estate	$	57,105	Modified appraised value	Third party appraisal	NM*
				Appraisal discount	NM*
Commercial	$	6,831	Modified appraised value	Third party appraisal	NM*
				Appraisal discount	NM*
Agricultural and agricultural real estate	$	14,228	Modified appraised value	Third party appraisal	NM*
				Appraisal discount	NM*
Residential real estate	$	5,584	Modified appraised value	Third party appraisal	NM*
				Appraisal discount	NM*
Consumer	$	3,535	Modified appraised value	Third party appraisal	NM*
				Appraisal discount	NM*
Other real estate owned	$	38,934	Modified appraised value	Disposal costs	NM*

* Not Meaningful. Third party appraisals are obtained as to the value of the underlying asset, but disclosure of this information would not provide meaningful information, as the range will vary widely from loan to loan. Types of discounts considered included age of the appraisal, local market conditions, current condition of the property, and estimated sales costs. These discounts will also vary from loan to loan, thus providing range would not be meaningful.

The changes in Level 3 assets that are measured at fair value on a recurring basis are summarized in the following table, in thousands:



	For the Three Months Ended			For the Year Ended
	March 31, 2012			December 31, 2011
	Fair Value			Fair Value
Balance at January 1,	$	3,243		$	4,676
Total gains:
Included in earnings	—			(1,424		)
Included in other comprehensive income	156			12
Purchases, issuances, sales and settlements:
Sales	—			(11		)
Settlements	(14		)	(10		)
Balance at period end,	$	3,385		$	3,243

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, 2012, and December 31, 2011, in thousands. The carrying amounts in the following table are recorded in the balance sheet under the indicated captions. In accordance with ASC 825, the assets and liabilities that are not financial instruments are not included in the disclosure, such as the value of the mortgage servicing rights, premises, furniture and equipment, 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 Measurement at March 31, 2012						December 31, 2011
(in thousands)	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
Financial assets:
Cash and cash equivalents	$	150,122	$	150,122	$	150,122	$	—	$	—	$	129,834	$	129,834
Securities:
Trading	330		330		330		—		—		333		333
Available for sale	1,165,108		1,165,108		48,116		1,113,607		3,385		1,267,999		1,267,999
Held to maturity	56,471		57,441		—		57,441		—		58,260		57,486
Total securities	1,221,579		1,222,549		48,116		1,171,048		3,385		1,326,259		1,325,485
Loans held for sale	103,460		103,490		—		103,490		—		53,528		53,999
Loans, net:
Commercial	635,828		635,474		—		—		635,474
Commercial real estate	1,209,628		1,217,094		—		—		1,217,094
Agricultural and agricultural real estate	271,556		274,282		—		—		274,282
Residential real estate	205,077		200,343		—		—		200,343
Consumer	221,367		224,564		—		—		224,564
Total Loans, net	2,543,456		2,551,757		—		—		2,551,757		2,494,631		2,488,881
Mortgage derivatives	$	5,278	$	5,278	$	—	$	5,278	$	—	$	2,828	$	2,828
Financial liabilities
Deposits
Demand deposits	771,421		771,421		—		—		771,421		737,323		737,323
Savings deposits	1,731,399		1,731,399		—		—		1,731,399		1,678,154		1,678,154
Time deposits	772,939		772,939		—		—		772,939		794,636		794,636
Short term borrowings	229,533		229,533		—		—		229,533		270,081		270,081
Other borrowings	377,362		367,405		—		—		367,405		372,820		352,847
Derivatives	5,984		5,984		—		5,984		—		6,405		6,405

Cash and Cash Equivalents — The carrying amount is a reasonable estimate of fair value due to the short-term nature of these instruments.

Securities — For 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.

Loans and Leases — The fair value of loans is estimated using a historical or replacement cost basis concept (i.e., an entrance price concept). The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of loans held for sale is estimated using quoted market prices.

Derivatives — 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, when appropriate, the current creditworthiness of the counter-party.

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.

Short-term and Other Borrowings — Rates 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.