LOANS AND LEASES

Loans and leases as of March 31, 2015, and December 31, 2014, were as follows, in thousands:



	March 31, 2015			December 31, 2014
Loans and leases receivable held to maturity:
Commercial	$	1,134,614		$	1,036,080
Commercial real estate	1,932,701			1,707,060
Agricultural and agricultural real estate	411,732			423,827
Residential real estate	413,938			380,341
Consumer	351,981			330,555
Gross loans and leases receivable held to maturity	4,244,966			3,877,863
Unearned discount	(85		)	(90		)
Deferred loan fees	(1,192		)	(1,028		)
Total net loans and leases receivable held to maturity	4,243,689			3,876,745
Loans covered under loss share agreements:
Commercial and commercial real estate	—			54
Agricultural and agricultural real estate	—			—
Residential real estate	—			1,204
Consumer	—			—
Total loans covered under loss share agreements	—			1,258
Allowance for loan and lease losses	(41,854		)	(41,449		)
Loans and leases receivable, net	$	4,201,835		$	3,836,554

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.

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 that Heartland requires for most of these loans and leases is based upon the discounted market value of the collateral. 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, including the Farm Service Agency, 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. 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 comprise approximately 21% of Heartland's total consumer loan portfolio.

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 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, 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 March 31, 2015, and December 31, 2014, 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 and lease losses policy during 2015.



	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
March 31, 2015
Commercial	$	205	$	11,483	$	11,688	$	3,566	$	1,131,048	$	1,134,614
Commercial real estate	466		16,169		16,635		35,872		1,896,829		1,932,701
Agricultural and agricultural real estate	49		3,167		3,216		4,989		406,743		411,732
Residential real estate	491		3,254		3,745		10,401		403,537		413,938
Consumer	723		5,847		6,570		4,713		347,268		351,981
Total	$	1,934	$	39,920	$	41,854	$	59,541	$	4,185,425	$	4,244,966
December 31, 2014
Commercial	$	754	$	11,155	$	11,909	$	4,526	$	1,031,554	$	1,036,080
Commercial real estate	636		15,262		15,898		35,771		1,671,289		1,707,060
Agricultural and agricultural real estate	52		3,243		3,295		5,049		418,778		423,827
Residential real estate	442		3,299		3,741		10,235		370,106		380,341
Consumer	813		5,793		6,606		6,143		324,412		330,555
Total	$	2,697	$	38,752	$	41,449	$	61,724	$	3,816,139	$	3,877,863

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 March 31, 2015, and December 31, 2014, in thousands. There were no nonaccrual leases, accruing leases past due 90 days or more or restructured leases at March 31, 2015, and December 31, 2014.



	March 31, 2015		December 31, 2014
Nonaccrual loans	$	26,501	$	24,205
Nonaccrual troubled debt restructured loans	522		865
Total nonaccrual loans	$	27,023	$	25,070
Accruing loans past due 90 days or more	$	9	$	—
Performing troubled debt restructured loans	$	10,904	$	12,133

The following table provides information on troubled debt restructured loans that were modified during the three months ended March 31, 2015, and March 31, 2014, dollars in thousands:



	Three Months Ended March 31,
	2015					2014
	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	1	3,992		3,992		1	368		368
Total commercial and commercial real estate	1	3,992		3,992		1	368		368
Agricultural and agricultural real estate	—	—		—		—	—		—
Residential real estate	—	—		—		—	—		—
Consumer	—	—		—		—	—		—
Total	1	$	3,992	$	3,992	1	$	368	$	368

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. At March 31, 2015, there were no commitments to extend credit to any of the borrowers with an existing troubled debt restructuring.

There were no troubled debt restructured loans for which there was a payment default during the three months ended March 31, 2015, and March 31, 2014, that had been modified during the twelve month period prior to the default.

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 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 March 31, 2015, Heartland had one loan classified as doubtful and no loans classified as 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 March 31, 2015, and December 31, 2014, in thousands:



	Pass		Nonpass		Total
March 31, 2015
Commercial	$	1,025,159	$	109,455	$	1,134,614
Commercial real estate	1,774,036		158,665		1,932,701
Total commercial and commercial real estate	2,799,195		268,120		3,067,315
Agricultural and agricultural real estate	389,296		22,436		411,732
Residential real estate	394,534		19,404		413,938
Consumer	343,674		8,307		351,981
Total gross loans and leases receivable held to maturity	$	3,926,699	$	318,267	$	4,244,966
December 31, 2014
Commercial	$	939,717	$	96,363	$	1,036,080
Commercial real estate	1,567,711		139,349		1,707,060
Total commercial and commercial real estate	2,507,428		235,712		2,743,140
Agricultural and agricultural real estate	402,883		20,944		423,827
Residential real estate	361,325		19,016		380,341
Consumer	321,114		9,441		330,555
Total gross loans and leases receivable held to maturity	$	3,592,750	$	285,113	$	3,877,863

The nonpass category in the table above is comprised of approximately 68% special mention, 32% substandard and less than 1% doubtful as of March 31, 2015. The percent of nonpass loans on nonaccrual status as of March 31, 2015, was 8%. As of December 31, 2014, the nonpass category in the table above was comprised of approximately 66% special mention and 34% substandard. The percent of nonpass loans on nonaccrual status as of December 31, 2014, was 9%. Loans delinquent 30 to 89 days as a percent of total loans were 0.42% at March 31, 2015, compared to 0.21% at December 31, 2014. 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 March 31, 2015, and December 31, 2014, 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
March 31, 2015
Commercial	$	1,485	$	729	$	—	$	2,214	$	1,131,303	$	1,097	$	1,134,614
Commercial real estate	9,336		1,177		—		10,513		1,907,619		14,569		1,932,701
Total commercial and commercial real estate	10,821		1,906		—		12,727		3,038,922		15,666		3,067,315
Agricultural and agricultural real estate	569		129		9		707		409,658		1,367		411,732
Residential real estate	1,483		139		—		1,622		404,861		7,455		413,938
Consumer	2,246		502		—		2,748		346,698		2,535		351,981
Total gross loans and leases receivable held to maturity	$	15,119	$	2,676	$	9	$	17,804	$	4,200,139	$	27,023	$	4,244,966
December 31, 2014
Commercial	$	980	$	48	$	—	$	1,028	$	1,032,707	$	2,345	$	1,036,080
Commercial real estate	1,788		111		—		1,899		1,693,554		11,607		1,707,060
Total commercial and commercial real estate	2,768		159		—		2,927		2,726,261		13,952		2,743,140
Agricultural and agricultural real estate	119		50		—		169		422,219		1,439		423,827
Residential real estate	1,037		445		—		1,482		371,982		6,877		380,341
Consumer	2,382		1,366		—		3,748		324,005		2,802		330,555
Total gross loans and leases receivable held to maturity	$	6,306	$	2,020	$	—	$	8,326	$	3,844,467	$	25,070	$	3,877,863

The majority of Heartland's impaired loans are those that are nonaccrual or have had their terms restructured in a troubled debt restructuring. The following tables present, for impaired loans not covered by loss share agreements and by category of loan, the unpaid contractual balance at March 31, 2015, and December 31, 2014; the outstanding loan balance recorded on the consolidated balance sheets at March 31, 2015, and December 31, 2014; any related allowance recorded for those loans as of March 31, 2015, and December 31, 2014; the average outstanding loan balance recorded on the consolidated balance sheets during the three months ended March 31, 2015, and year ended December 31, 2014; and the interest income recognized on the impaired loans during the three months ended March 31, 2015, and year ended December 31, 2014, in thousands:



	Unpaid Contractual Balance		Loan Balance		Related Allowance Recorded		Year-to- Date Avg. Loan Balance		Year-to- Date Interest Income Recognized
March 31, 2015
Impaired loans with a related allowance:
Commercial	$	307	$	273	$	205	$	520	$	3
Commercial real estate	1,973		1,484		466		3,279		6
Total commercial and commercial real estate	2,280		1,757		671		3,799		9
Agricultural and agricultural real estate	3,276		3,276		49		3,291		41
Residential real estate	2,749		2,581		491		2,674		4
Consumer	2,483		2,483		723		2,620		5
Total loans held to maturity	$	10,788	$	10,097	$	1,934	$	12,384	$	59
Impaired loans without a related allowance:
Commercial	$	4,022	$	3,293	$	—	$	3,584	$	33
Commercial real estate	42,421		34,388		—		23,997		292
Total commercial and commercial real estate	46,443		37,681		—		27,581		325
Agricultural and agricultural real estate	3,692		1,713		—		1,588		3
Residential real estate	7,861		7,820		—		7,726		58
Consumer	2,237		2,230		—		3,011		11
Total loans held to maturity	$	60,233	$	49,444	$	—	$	39,906	$	397
Total impaired loans held to maturity:
Commercial	$	4,329	$	3,566	$	205	$	4,104	$	36
Commercial real estate	44,394		35,872		466		27,276		298
Total commercial and commercial real estate	48,723		39,438		671		31,380		334
Agricultural and agricultural real estate	6,968		4,989		49		4,879		44
Residential real estate	10,610		10,401		491		10,400		62
Consumer	4,720		4,713		723		5,631		16
Total impaired loans held to maturity	$	71,021	$	59,541	$	1,934	$	52,290	$	456



	Unpaid Contractual Balance		Loan Balance		Related Allowance Recorded		Year-to- Date Avg. Loan Balance		Year-to- Date Interest Income Recognized
December 31, 2014
Impaired loans with a related allowance:
Commercial	$	780	$	780	$	754	$	5,594	$	19
Commercial real estate	7,356		7,322		636		5,931		303
Total commercial and commercial real estate	8,136		8,102		1,390		11,525		322
Agricultural and agricultural real estate	3,317		3,317		52		3,966		104
Residential real estate	2,412		2,244		442		3,398		12
Consumer	2,799		2,799		813		4,053		19
Total loans held to maturity	$	16,664	$	16,462	$	2,697	$	22,942	$	457
Impaired loans without a related allowance:
Commercial	$	4,913	$	3,746	$	—	$	3,499	$	101
Commercial real estate	32,708		28,449		—		24,522		1,172
Total commercial and commercial real estate	37,621		32,195		—		28,021		1,273
Agricultural and agricultural real estate	3,961		1,732		—		3,308		13
Residential real estate	8,200		7,991		—		6,267		110
Consumer	3,350		3,344		—		1,870		127
Total loans held to maturity	$	53,132	$	45,262	$	—	$	39,466	$	1,523
Total impaired loans held to maturity:
Commercial	$	5,693	$	4,526	$	754	$	9,093	$	120
Commercial real estate	40,064		35,771		636		30,453		1,475
Total commercial and commercial real estate	45,757		40,297		1,390		39,546		1,595
Agricultural and agricultural real estate	7,278		5,049		52		7,274		117
Residential real estate	10,612		10,235		442		9,665		122
Consumer	6,149		6,143		813		5,923		146
Total impaired loans held to maturity	$	69,796	$	61,724	$	2,697	$	62,408	$	1,980

On January 16, 2015, Heartland acquired Community Banc-Corp of Sheboygan, Inc., parent company of Community Bank & Trust in Sheboygan, Wisconsin. As of January 16, 2015, Community Bank & Trust had loans of $413.4 million, and the estimated fair value of the loans acquired was $395.0 million.

The Community Banc-Corp of Sheboygan, Inc. acquisition was accounted for under the acquisition method of accounting in accordance with ASC 805, “Business Combinations.” Purchased loans acquired in a business combination, which include loans purchased in the Community Bank & Trust acquisition, are recorded at estimated fair value on their purchase date, but the purchaser cannot carry over the related allowance for loan and lease 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 it is probable at the date of the acquisition that Heartland will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration at the purchase date included 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 will generally result in a provision for loan and lease losses. Subsequent increases in cash flows result in a reversal of the provision for loan and lease 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.

The carrying amount of the loans acquired with the acquisition of Community Bank & Trust at March 31, 2015 consisted of purchased impaired and nonimpaired loans as summarized in the following table, in thousands:



	March 31, 2015
	Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans
Commercial	$	—	$	123,442	$	123,442
Commercial real estate	8,055		191,297		199,352
Agricultural and agricultural real estate	—		3,124		3,124
Residential real estate	—		24,299		24,299
Consumer loans	—		21,125		21,125
Total Loans	$	8,055	$	363,287	$	371,342

On the acquisition date, the preliminary estimate of the contractually required payments receivable for all loans with evidence of credit deterioration since origination acquired in the acquisition was $12.9 million and the estimated fair value of the loans was $8.2 million. At March 31, 2015, 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 underlying collateral and the timing and amount of the cash flows could not be reasonably estimated. There was no allowance for loan and lease losses related to these ASC 310-30 loans at March 31, 2015.

On the acquisition date, the preliminary estimate of the contractually required payments receivable for all nonimpaired loans acquired in the acquisition was $400.0 million and the estimated fair value of the loans was $386.8 million.

On July 2, 2009, Heartland acquired all deposits of The Elizabeth State Bank in Elizabeth, Illinois through its subsidiary Galena State Bank & Trust Co. based in Galena, Illinois, in a whole bank loss sharing transaction facilitated by the FDIC. As of July 2, 2009, The Elizabeth State Bank had loans of $42.7 million. The estimated fair value of the loans acquired was $37.8 million. The FDIC approved the transfer of the loss share agreements to Illinois Bank & Trust as part of the merger of Galena State Bank & Trust Co. into Illinois Bank & Trust.

At the date of acquisition, the acquired loans and other real estate owned were covered by a loss share agreement for non-residential loans and a loss share agreement for residential real estate. Effective October 1, 2014, loans subject to the non-residential loss sharing agreement with the FDIC were no longer covered by loss sharing agreements. The remaining residential real estate loans covered under the loss share agreement are not material at March 31, 2015.