LOANS

Loans as of December 31, 2016, and December 31, 2015, were as follows, in thousands:



	December 31, 2016			December 31, 2015
Loans receivable held to maturity:
Commercial	$	1,287,265		$	1,279,214
Commercial real estate	2,538,582			2,326,360
Agricultural and agricultural real estate	489,318			471,870
Residential real estate	617,924			539,555
Consumer	420,613			386,867
Gross loans receivable held to maturity	5,353,702			5,003,866
Unearned discount	(699		)	(488		)
Deferred loan fees	(1,284		)	(1,892		)
Total net loans receivable held to maturity	5,351,719			5,001,486
Allowance for loan losses	(54,324		)	(48,685		)
Loans receivable, net	$	5,297,395		$	4,952,801

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 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 is based upon a discount from its market value. The primary repayment risks of commercial loans 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. As of December 31, 2016, Heartland had $4.6 million of loans secured by residential real estate property that were in the process of foreclosure.

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 first-lien 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 comprises approximately 19% 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 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 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 losses. Nonaccrual loans 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 losses at December 31, 2016, and December 31, 2015, 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 changes to the accounting for the allowance for loan losses policy during 2016 or 2015.



	Allowance For Loan Losses						Gross Loans 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
December 31, 2016
Commercial	$	1,318	$	13,447	$	14,765	$	3,712	$	1,283,553	$	1,287,265
Commercial real estate	2,671		21,648		24,319		45,217		2,493,365		2,538,582
Agricultural and agricultural real estate	816		3,394		4,210		16,730		472,588		489,318
Residential real estate	497		1,766		2,263		25,726		592,198		617,924
Consumer	1,451		7,316		8,767		5,988		414,625		420,613
Total	$	6,753	$	47,571	$	54,324	$	97,373	$	5,256,329	$	5,353,702
December 31, 2015
Commercial	$	471	$	15,624	$	16,095	$	6,919	$	1,272,295	$	1,279,214
Commercial real estate	698		18,834		19,532		45,442		2,280,918		2,326,360
Agricultural and agricultural real estate	—		3,887		3,887		4,612		467,258		471,870
Residential real estate	393		1,541		1,934		17,790		521,765		539,555
Consumer	1,206		6,031		7,237		5,458		381,409		386,867
Total	$	2,768	$	45,917	$	48,685	$	80,221	$	4,923,645	$	5,003,866

The following table presents nonaccrual loans, accruing loans past due 90 days or more and troubled debt restructured loans at December 31, 2016, and December 31, 2015, in thousands.



	December 31, 2016		December 31, 2015
Nonaccrual loans	$	62,591	$	37,874
Nonaccrual troubled debt restructured loans	1,708		1,781
Total nonaccrual loans	$	64,299	$	39,655
Accruing loans past due 90 days or more	86		—
Performing troubled debt restructured loans	$	10,380	$	11,075

Heartland had $12.1 million of troubled debt restructured loans at December 31, 2016, of which $1.7 million were classified as nonaccrual and $10.4 million were accruing according to the restructured terms. Heartland had $12.9 million of troubled debt restructured loans at December 31, 2015, of which $1.8 million were classified as nonaccrual and $11.1 million were accruing according to the restructured terms.

The following table provides information on troubled debt restructured loans that were modified during the years ended December 31, 2016, and December 31, 2015, in thousands:



	For the Years Ended
	December 31, 2016					December 31, 2015
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial	1	$	95	$	95	—	$	—	$	—
Commercial real estate	2	641		641		5	5,823		5,823
Total commercial and commercial real estate	3	736		736		5	5,823		5,823
Agricultural and agricultural real estate	—	—		—		1	311		311
Residential real estate	8	1,597		1,597		1	55		55
Consumer	—	—		—		—	—		—
Total	11	$	2,333	$	2,333	7	$	6,189	$	6,189

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 December 31, 2016, there were no commitments to extend credit to any of the borrowers with an existing TDR.

The following table provides information on troubled debt restructured loans for which there was a payment default during the years ended December 31, 2016, and December 31, 2015, in thousands, that had been modified during the 12-month period prior to the default:



	With Payment Defaults During the Following Periods
	For the Years Ended
	December 31, 2016			December 31, 2015
	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Commercial	1	$	95	—	$	—
Commercial real estate	—	—		—	—
Total commercial and commercial real estate	1	95		—	—
Agricultural and agricultural real estate	—	—		—	—
Residential real estate	2	264		—	—
Consumer	—	—		—	—
Total	3	$	359	—	$	—

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 December 31, 2016, Heartland had no loans 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 by credit quality indicator at December 31, 2016, and December 31, 2015, in thousands:



	Pass		Nonpass		Total
December 31, 2016
Commercial	$	1,187,557	$	99,708	$	1,287,265
Commercial real estate	2,379,632		158,950		2,538,582
Total commercial and commercial real estate	3,567,189		258,658		3,825,847
Agricultural and agricultural real estate	424,311		65,007		489,318
Residential real estate	584,626		33,298		617,924
Consumer	409,474		11,139		420,613
Total gross loans receivable held to maturity	$	4,985,600	$	368,102	$	5,353,702
December 31, 2015
Commercial	$	1,106,276	$	172,938	$	1,279,214
Commercial real estate	2,107,474		218,886		2,326,360
Total commercial and commercial real estate	3,213,750		391,824		3,605,574
Agricultural and agricultural real estate	435,745		36,125		471,870
Residential real estate	515,195		24,360		539,555
Consumer	377,173		9,694		386,867
Total gross loans receivable held to maturity	$	4,541,863	$	462,003	$	5,003,866

The nonpass category in the table above is comprised of approximately 47% special mention and 53% substandard as of December 31, 2016. The percentage of nonpass loans on nonaccrual status as of December 31, 2016, was 17%. As of December 31, 2015, the nonpass category in the table above was comprised of approximately 68% special mention and 32% substandard. The percentage of nonpass loans on nonaccrual status as of December 31, 2015, was 8%. Loans delinquent 30-89 days as a percentage of total loans were 0.37% at December 31, 2016, and 0.21% at December 31, 2015. 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 at December 31, 2016, and December 31, 2015, in thousands:



	Accruing Loans
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Nonaccrual		Total Loans
December 31, 2016
Commercial	$	1,127	$	219	$	77	$	1,423	$	1,281,241	$	4,601	$	1,287,265
Commercial real estate	886		3,929		—		4,815		2,513,069		20,698		2,538,582
Total commercial and commercial real estate	2,013		4,148		77		6,238		3,794,310		25,299		3,825,847
Agricultural and agricultural real estate	199		3,191		—		3,390		472,597		13,331		489,318
Residential real estate	4,986		846		—		5,832		590,626		21,466		617,924
Consumer	3,455		1,021		9		4,485		411,925		4,203		420,613
Total gross loans receivable held to maturity	$	10,653	$	9,206	$	86	$	19,945	$	5,269,458	$	64,299	$	5,353,702
December 31, 2015
Commercial	$	2,005	$	608	$	—	$	2,613	$	1,273,678	$	2,923	$	1,279,214
Commercial real estate	3,549		2,077		—		5,626		2,302,052		18,682		2,326,360
Total commercial and commercial real estate	5,554		2,685		—		8,239		3,575,730		21,605		3,605,574
Agricultural and agricultural real estate	143		54		—		197		470,455		1,218		471,870
Residential real estate	1,900		115		—		2,015		523,915		13,625		539,555
Consumer	3,964		933		—		4,897		378,763		3,207		386,867
Total gross loans receivable held to maturity	$	11,561	$	3,787	$	—	$	15,348	$	4,948,863	$	39,655	$	5,003,866

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 tables present the unpaid principal balance that was contractually due at December 31, 2016, and December 31, 2015, the outstanding loan balance recorded on the consolidated balance sheets at December 31, 2016, and December 31, 2015, any related allowance recorded for those loans as of December 31, 2016, and December 31, 2015, the average outstanding loan balance recorded on the consolidated balance sheets during the years ended December 31, 2016, and December 31, 2015, and the interest income recognized on the impaired loans during the year ended December 31, 2016, and year ended December 31, 2015, in thousands:



	Unpaid Principal Balance		Loan Balance		Related Allowance Recorded		Year-to-Date Avg. Loan Balance		Year-to-Date Interest Income Recognized
December 31, 2016
Impaired loans with a related allowance:
Commercial	$	2,852	$	2,840	$	1,318	$	3,136	$	2
Commercial real estate	14,221		14,221		2,671		10,625		21
Total commercial and commercial real estate	17,073		17,061		3,989		13,761		23
Agricultural and agricultural real estate	2,771		2,771		816		912		21
Residential real estate	3,490		3,490		497		3,371		43
Consumer	2,644		2,644		1,451		3,082		42
Total loans held to maturity	$	25,978	$	25,966	$	6,753	$	21,126	$	129
Impaired loans without a related allowance:
Commercial	$	925	$	872	$	—	$	5,329	$	251
Commercial real estate	31,875		30,996		—		39,632		1,647
Total commercial and commercial real estate	32,800		31,868		—		44,961		1,898
Agricultural and agricultural real estate	13,959		13,959		—		12,722		157
Residential real estate	22,408		22,236		—		18,446		202
Consumer	3,344		3,344		—		2,659		68
Total loans held to maturity	$	72,511	$	71,407	$	—	$	78,788	$	2,325
Total impaired loans held to maturity:
Commercial	$	3,777	$	3,712	$	1,318	$	8,465	$	253
Commercial real estate	46,096		45,217		2,671		50,257		1,668
Total commercial and commercial real estate	49,873		48,929		3,989		58,722		1,921
Agricultural and agricultural real estate	16,730		16,730		816		13,634		178
Residential real estate	25,898		25,726		497		21,817		245
Consumer	5,988		5,988		1,451		5,741		110
Total impaired loans held to maturity	$	98,489	$	97,373	$	6,753	$	99,914	$	2,454



	Unpaid Principal Balance		Loan Balance		Related Allowance Recorded		Year-to-Date Avg. Loan Balance		Year-to-Date Interest Income Recognized
December 31, 2015
Impaired loans with a related allowance:
Commercial	$	1,192	$	1,160	$	471	$	524	$	12
Commercial real estate	2,697		2,697		698		2,539		19
Total commercial and commercial real estate	3,889		3,857		1,169		3,063		31
Agricultural and agricultural real estate	—		—		—		2,823		—
Residential real estate	2,210		2,125		393		2,524		16
Consumer	3,111		3,111		1,206		2,877		33
Total loans held to maturity	$	9,210	$	9,093	$	2,768	$	11,287	$	80
Impaired loans without a related allowance:
Commercial	$	5,784	$	5,759	$	—	$	7,511	$	515
Commercial real estate	46,099		42,745		—		38,444		1,395
Total commercial and commercial real estate	51,883		48,504		—		45,955		1,910
Agricultural and agricultural real estate	4,612		4,612		—		2,287		175
Residential real estate	15,802		15,665		—		10,186		145
Consumer	2,347		2,347		—		2,403		38
Total loans held to maturity	$	74,644	$	71,128	$	—	$	60,831	$	2,268
Total impaired loans held to maturity:
Commercial	$	6,976	$	6,919	$	471	$	8,035	$	527
Commercial real estate	48,796		45,442		698		40,983		1,414
Total commercial and commercial real estate	55,772		52,361		1,169		49,018		1,941
Agricultural and agricultural real estate	4,612		4,612		—		5,110		175
Residential real estate	18,012		17,790		393		12,710		161
Consumer	5,458		5,458		1,206		5,280		71
Total impaired loans held to maturity	$	83,854	$	80,221	$	2,768	$	72,118	$	2,348

On February 5, 2016, Heartland acquired CIC Bancshares, Inc., parent company of Centennial Bank, in Denver, Colorado. As of February 5, 2016, Centennial Bank had loans of $594.9 million, and the estimated fair value of the loans acquired was $581.5 million.

On November 30, 2015, Heartland acquired Premier Valley Bank in Fresno, California. As of November 30, 2015, Premier Valley Bank had loans of $400.5 million, and the estimated fair value of the loans acquired was $389.8 million.

On September 11, 2015, Heartland acquired First Scottsdale Bank, N.A. in Scottsdale, Arizona. As of September 11, 2015, First Scottsdale Bank, N.A. had loans of $56.5 million, and the estimated fair value of the loans acquired was $54.7 million.

On August 21, 2015, Heartland acquired Community Bancorporation of New Mexico, Inc., parent company of Community Bank in Santa Fe, New Mexico. As of August 21, 2015, Community Bank had loans of $103.7 million, and the estimated fair value of the loans acquired was $99.5 million.

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 acquisitions of CIC Bancshares, Inc., Premier Valley Bank, First Scottsdale Bank, N.A., Community Bancorporation of New Mexico, Inc. and Community Banc-Corp of Sheboygan, Inc. were accounted for under the acquisition method of accounting in accordance with ASC 805, "Business Combinations." Purchased loans acquired in a business combination are recorded at estimated fair value on the purchase date, but the purchaser cannot carry over the related allowance for loan 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. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan 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 acquired loans at December 31, 2016, and December 31, 2015, consisted of purchased impaired and nonimpaired purchased loans as summarized in the following table, in thousands:



	December 31, 2016						December 31, 2015
	Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans		Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans
Commercial	$	2,198	$	99,082	$	101,280	$	—	$	159,393	$	159,393
Commercial real estate	2,079		622,117		624,196		7,716		494,010		501,726
Agricultural and agricultural real estate	—		181		181		—		2,985		2,985
Residential real estate	186		157,468		157,654		—		85,549		85,549
Consumer loans	—		47,368		47,368		—		33,644		33,644
Total Covered Loans	$	4,463	$	926,216	$	930,679	$	7,716	$	775,581	$	783,297

Changes in accretable yield on acquired loans with evidence of credit deterioration at the date of acquisition for the years ended December 31, 2016, and December 31, 2015, are presented in the table below, in thousands:



	For the Years Ended
	December 31, 2016			December 31, 2015
Balance at beginning of year	$	557		$	—
Original yield discount, net, at date of acquisitions	19			602
Accretion	(1,018		)	(196		)
Reclassification from nonaccretable difference⁽¹⁾	624			151
Balance at end of year	$	182		$	557

(1) Represents increases in estimated cash flows expected to be received, primarily due to lower estimated credit losses.

On the acquisition dates, the preliminary estimate of the contractually required payments receivable for all loans with evidence of credit deterioration since origination acquired was $21.0 million and the estimated fair value of the loans was $13.1 million. At December 31, 2016, 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 an allowance for loan losses of $588,000 and $81,000, at December 31, 2016, and December 31, 2015, respectively, related to these ASC 310-30 loans. Provision expense of $507,000 and $81,000 was recorded for the years ended December 31, 2016, and 2015, respectively, related to these ASC 310-30 loans.

On the acquisition dates, the preliminary estimate of the contractually required payments receivable for all nonimpaired loans acquired in the acquisitions was $1.55 billion and the estimated fair value of the loans was $1.51 billion.

Loans are made in the normal course of business to directors, officers and principal holders of equity securities of Heartland. The terms of these loans, including interest rates and collateral, are similar to those prevailing for comparable transactions and do not involve more than a normal risk of collectability. Changes in such loans during the years ended December 31, 2016 and 2015, were as follows, in thousands:



	2016			2015
Balance at beginning of year	$	141,465		$	135,599
Advances	57,165			54,197
Repayments	(84,325		)	(48,331		)
Balance at end of year	$	114,305		$	141,465