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Derivative Financial Instruments
3 Months Ended
Mar. 31, 2014
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments
DERIVATIVE FINANCIAL INSTRUMENTS

Heartland uses derivative financial instruments as part of its interest rate risk management strategy. As part of the strategy, Heartland considers the use of interest rate swaps, caps, floors and collars and certain interest rate lock commitments and forward sales of securities related to mortgage banking activities. Heartland's current strategy includes the use of interest rate swaps, interest rate lock commitments, and forward sales of mortgage securities. Heartland'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. Heartland is exposed to credit risk in the event of nonperformance by counterparties to financial instruments. Heartland minimizes this risk by entering into derivative contracts with large, stable financial institutions. Heartland has not experienced any losses from nonperformance by these counterparties. Heartland monitors counterparty risk in accordance with the provisions of ASC 815. In addition, interest rate-related derivative instruments generally contain language outlining collateral pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits which are determined by credit ratings of each counterparty. Heartland was required to pledge $4.0 million and $5.4 million of cash as collateral at March 31, 2014, and December 31, 2013, respectively. Heartland's counterparties were required to pledge $0 and $540,000 at March 31, 2014, and December 31, 2013, respectively.

Heartland'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

Heartland has variable rate funding which creates exposure to variability in interest payments due to changes in interest rates. To manage the interest rate risk related to the variability of interest payments, Heartland has entered into various interest rate swap agreements. Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are received or made on Heartland's variable-rate liabilities. For the three months ended March 31, 2014, the change in net unrealized losses on cash flow hedges reflects changes in the fair value of the swaps and reclassification from accumulated other comprehensive income (loss) to interest expense totaling $521,000. For the next twelve months, Heartland estimates that cash payments and reclassification from accumulated other comprehensive income (loss) to interest expense will total $2.1 million.

Heartland executed an interest rate swap transaction on April 5, 2011, with an effective date of April 20, 2011, and an expiration date of April 20, 2016, to effectively convert $15.0 million of its newly issued variable rate amortizing debt to fixed rate debt. For accounting purposes, this swap transaction is designated as a cash flow hedge of the changes in cash flows attributable to changes in one-month LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on an amount of Heartland's debt principal equal to the then-outstanding swap notional amount. At inception, Heartland asserted that the underlying principal balance would remain outstanding throughout the hedge transaction making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swap.

Heartland entered into three forward-starting interest rate swap transactions during 2009 to effectively convert Heartland Financial Statutory Trust IV, V and VII, which are variable interest rate subordinated debentures, to fixed interest rate debt. During the first quarter of 2014, the interest rate swap transaction on Heartland Financial Statutory Trust IV expired. Prior to the expiration of the swap, Heartland entered into a new forward-starting interest rate swap to replace the expiring swap. In addition, Heartland added two new forward starting interest rate swap transactions to effectively convert Morrill Statutory Trust I and Morrill Statutory Trust II, which total $16.6 million, from variable interest rate subordinated debentures to fixed interest rate debt. For accounting purposes, these five swap transactions are designated as cash flow hedges of the changes in cash flows attributable to changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on $85.0 million of Heartland's subordinated debentures that reset quarterly on a specified reset date. At inception, Heartland asserted that the underlying principal balance would remain outstanding throughout the hedge transaction making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swaps.

The table below identifies the balance sheet category and fair values of Heartland's derivative instruments designated as cash flow hedges at March 31, 2014, and December 31, 2013, in thousands:
 
Notional
Amount
 
Fair
Value
 
Balance
Sheet
Category
 
Receive
Rate
 
Weighted
Average
Pay Rate
 
Maturity
March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap
$
11,388

 
$
(406
)
 
Other Liabilities
 
2.910
%
 
5.140
%
 
04/20/2016
Interest rate swap
25,000

 
62

 
Other Assets
 
0.233
%
 
2.255
%
 
03/17/2021
Interest rate swap
20,000

 
(1,393
)
 
Other Liabilities
 
0.236
%
 
3.220
%
 
03/01/2017
Interest rate swap
20,000

 
(1,668
)
 
Other Liabilities
 
0.240
%
 
3.355
%
 
01/07/2020
Interest rate swap
10,000

 
45

 
Other Assets
 
0.235
%
 
1.674
%
 
03/26/2019
Interest rate swap
10,000

 
45

 
Other Assets
 
0.233
%
 
1.658
%
 
03/18/2019
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap
$
11,719

 
$
(457
)
 
Other Liabilities
 
2.917
%
 
5.140
%
 
04/20/2016
Interest rate swap
25,000

 
(146
)
 
Other Liabilities
 
0.244
%
 
2.580
%
 
03/17/2014
Interest rate swap
20,000

 
(1,507
)
 
Other Liabilities
 
0.239
%
 
3.220
%
 
03/01/2017
Interest rate swap
20,000

 
(1,587
)
 
Other Liabilities
 
0.243
%
 
3.355
%
 
01/07/2020


The table below identifies the gains and losses recognized on Heartland's derivative instruments designated as cash flow hedges for the three months ended March 31, 2014, and March 31, 2013, in thousands:
 
Effective Portion
 
Ineffective Portion
 
Recognized in OCI
 
Reclassified from AOCI into Income
 
Recognized in Income on Derivatives
 
Amount of Gain (Loss)
 
Category
 
Amount of Gain (Loss)
 
Category
 
Amount of Gain (Loss)
March 31, 2014
 
 
 
 
 
 
 
 
 
Interest rate swap
$
51

 
Interest Expense
 
$
(65
)
 
Other Income
 
$

Interest rate swap
146

 
Interest Expense
 
(146
)
 
Other Income
 

Interest rate swap
62

 
Interest Expense
 

 
Other Income
 

Interest rate swap
114

 
Interest Expense
 
(151
)
 
Other Income
 

Interest rate swap
(81
)
 
Interest Expense
 
(159
)
 
Other Income
 

Interest rate swap
45

 
Interest Expense
 

 
Other Income
 

Interest rate swap
45

 
Interest Expense
 

 
Other Income
 

March 31, 2013
 
 
 
 
 
 
 
 
 
Interest rate swap
$
66

 
Interest Expense
 
$
(71
)
 
Other Income
 
$

Interest rate swap
143

 
Interest Expense
 
(142
)
 
Other Income
 

Interest rate swap
131

 
Interest Expense
 
(142
)
 
Other Income
 

Interest rate swap
247

 
Interest Expense
 
(150
)
 
Other Income
 



Mortgage Derivatives

Heartland also 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. 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.

The table below identifies the balance sheet category and fair values of Heartland's derivative instruments not designated as hedging instruments at March 31, 2014, and December 31, 2013, in thousands:
 
Balance Sheet Category
 
Notional
Amount
 
Fair
Value
March 31, 2014
 
 
 
 
 
Interest rate lock commitments (mortgage)
Other Assets
 
$
92,583

 
$
2,993

Forward commitments
Other Assets
 
108,333

 
238

Forward commitments
Other Liabilities
 
98,823

 
(307
)
December 31, 2013
 
 


 


Interest rate lock commitments (mortgage)
Other Assets
 
$
63,370

 
$
1,809

Forward commitments
Other Assets
 
117,637

 
1,206

Forward commitments
Other Liabilities
 
53,277

 
(133
)

The table below identifies the income statement category of the gains and losses recognized in income on Heartland's derivative instruments not designated as hedging instruments for the three months ended March 31, 2014, and March 31, 2013, in thousands:
 
Income Statement Category
 
Year-to-Date
Gain (Loss) Recognized
March 31, 2014
 
 
 
Interest rate lock commitments (mortgage)
Gains on sale of loans held for sale
 
$
1,882

Forward commitments
Gains on sale of loans held for sale
 
(1,142
)
March 31, 2013
 
 
 
Interest rate lock commitments (mortgage)
Gains on sale of loans held for sale
 
$
(3,161
)
Forward commitments
Gains on sale of loans held for sale
 
372