LOANS

Loans as of December 31, 2017, and December 31, 2016, were as follows, in thousands:



	December 31, 2017			December 31, 2016
Loans receivable held to maturity:
Commercial	$	1,646,606		$	1,287,265
Commercial real estate	3,163,269			2,538,582
Agricultural and agricultural real estate	511,588			489,318
Residential real estate	624,279			617,924
Consumer	447,484			420,613
Gross loans receivable held to maturity	6,393,226			5,353,702
Unearned discount	(556		)	(699		)
Deferred loan fees	(1,206		)	(1,284		)
Total net loans receivable held to maturity	6,391,464			5,351,719
Allowance for loan losses	(55,686		)	(54,324		)
Loans receivable, net	$	6,335,778		$	5,297,395

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. See Note 1 for Heartland's accounting policy for loans.

Diversification in the loan portfolio is also a means of managing risk associated with fluctuations in economic conditions. Heartland originates commercial and commercial real estate loans for a wide variety of business purposes, including lines of credit for capital and operating purposes and term loans for real estate and equipment purchases. Agricultural loans provide financing for capital improvements and farm operations, as well as livestock and machinery purchases. Residential mortgage loans are originated for the construction, purchase or refinancing of single family residential properties. Consumer loans include loans for motor vehicles, home improvement, home equity and personal lines of credit. 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 16% of Heartland's total consumer loan portfolio.

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, 2017, and December 31, 2016, 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 2017 or 2016.



	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, 2017
Commercial	$	1,613	$	16,485	$	18,098	$	7,415	$	1,639,191	$	1,646,606
Commercial real estate	766		21,184		21,950		23,705		3,139,564		3,163,269
Agricultural and agricultural real estate	546		3,712		4,258		13,304		498,284		511,588
Residential real estate	430		1,794		2,224		27,141		597,138		624,279
Consumer	1,400		7,756		9,156		6,903		440,581		447,484
Total	$	4,755	$	50,931	$	55,686	$	78,468	$	6,314,758	$	6,393,226
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

The following table presents nonaccrual loans, accruing loans past due 90 days or more and troubled debt restructured loans at December 31, 2017, and December 31, 2016, in thousands.



	December 31, 2017		December 31, 2016
Nonaccrual loans	$	58,272	$	62,591
Nonaccrual troubled debt restructured loans	4,309		1,708
Total nonaccrual loans	$	62,581	$	64,299
Accruing loans past due 90 days or more	$	830	$	86
Performing troubled debt restructured loans	$	6,617	$	10,380

Heartland had $10.9 million of troubled debt restructured loans at December 31, 2017, of which $4.3 million were classified as nonaccrual and $6.6 million were accruing according to the restructured terms. 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. At December 31, 2017, $4.6 million of the residential real estate troubled debt restructured loans were repurchased loans under various GNMA insured or guaranteed loan programs.

The following table provides information on troubled debt restructured loans that were modified during the years ended December 31, 2017, and December 31, 2016, in thousands:



	For the Years Ended
	December 31, 2017					December 31, 2016
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial	3	$	124	$	124	1	$	95	$	95
Commercial real estate	—	—		—		2	641		641
Total commercial and commercial real estate	3	124		124		3	736		736
Agricultural and agricultural real estate	—	—		—		—	—		—
Residential real estate	29	4,126		3,794		8	1,597		1,597
Consumer	—	—		—		—	—		—
Total	32	$	4,250	$	3,918	11	$	2,333	$	2,333

The pre-modification and post-modification recorded investment represents amounts as of the date of loan modification. The change in 2017 related to the pre-modification investment and post-modification investment amounts on Heartland’s residential real estate troubled debt restructured loans is due to $503,000 of principal deferment collected from government guarantees and $170,000 of capitalized interest and escrow. At December 31, 2017, 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, 2017, and December 31, 2016, 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, 2017			December 31, 2016
	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	16	2,435		2	264
Consumer	—	—		—	—
Total	16	$	2,435	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, 2017, 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, 2017, and December 31, 2016, in thousands:



	Pass		Nonpass		Total
December 31, 2017
Commercial	$	1,552,783	$	93,823	$	1,646,606
Commercial real estate	2,985,501		177,768		3,163,269
Total commercial and commercial real estate	4,538,284		271,591		4,809,875
Agricultural and agricultural real estate	451,539		60,049		511,588
Residential real estate	586,623		37,656		624,279
Consumer	432,936		14,548		447,484
Total gross loans receivable held to maturity	$	6,009,382	$	383,844	$	6,393,226
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

The nonpass category in the table above is comprised of approximately 52% special mention and 48% substandard as of December 31, 2017. The percentage of nonpass loans on nonaccrual status as of December 31, 2017, was 16%. As of December 31, 2016, the nonpass category in the table above was comprised of approximately 47% special mention and 53% substandard. The percentage of nonpass loans on nonaccrual status as of December 31, 2016, was 17%. Loans delinquent 30-89 days as a percentage of total loans were 0.27% at December 31, 2017, and 0.37% at December 31, 2016. 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.

As of December 31, 2017, Heartland had $3.1 million of loans secured by residential real estate property that were in the process of foreclosure.

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.

The following table sets forth information regarding Heartland's accruing and nonaccrual loans at December 31, 2017, and December 31, 2016, 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, 2017
Commercial	$	1,246	$	259	$	100	$	1,605	$	1,637,773	$	7,228	$	1,646,606
Commercial real estate	4,769		2,326		—		7,095		3,139,576		16,598		3,163,269
Total commercial and commercial real estate	6,015		2,585		100		8,700		4,777,349		23,826		4,809,875
Agricultural and agricultural real estate	604		134		—		738		497,546		13,304		511,588
Residential real estate	2,022		270		—		2,292		601,120		20,867		624,279
Consumer	4,734		943		730		6,407		436,493		4,584		447,484
Total gross loans receivable held to maturity	$	13,375	$	3,932	$	830	$	18,137	$	6,312,508	$	62,581	$	6,393,226
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

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, 2017, and December 31, 2016, the outstanding loan balance recorded on the consolidated balance sheets at December 31, 2017, and December 31, 2016, any related allowance recorded for those loans as of December 31, 2017, and December 31, 2016, the average outstanding loan balance recorded on the consolidated balance sheets during the years ended December 31, 2017, and December 31, 2016, and the interest income recognized on the impaired loans during the year ended December 31, 2017, and year ended December 31, 2016, in thousands:



	Unpaid Principal Balance		Loan Balance		Related Allowance Recorded		Year-to-Date Avg. Loan Balance		Year-to-Date Interest Income Recognized
December 31, 2017
Impaired loans with a related allowance:
Commercial	$	2,292	$	2,292	$	1,613	$	3,607	$	39
Commercial real estate	11,925		10,068		766		11,479		34
Total commercial and commercial real estate	14,217		12,360		2,379		15,086		73
Agricultural and agricultural real estate	1,539		1,539		546		3,437		—
Residential real estate	1,568		1,568		430		2,056		15
Consumer	2,634		2,634		1,400		2,370		41
Total loans held to maturity	$	19,958	$	18,101	$	4,755	$	22,949	$	129
Impaired loans without a related allowance:
Commercial	$	6,243	$	5,123	$	—	$	2,586	$	165
Commercial real estate	14,243		13,637		—		20,148		514
Total commercial and commercial real estate	20,486		18,760		—		22,734		679
Agricultural and agricultural real estate	13,793		11,765		—		9,654		—
Residential real estate	25,573		25,573		—		26,024		277
Consumer	4,269		4,269		—		3,884		73
Total loans held to maturity	$	64,121	$	60,367	$	—	$	62,296	$	1,029
Total impaired loans held to maturity:
Commercial	$	8,535	$	7,415	$	1,613	$	6,193	$	204
Commercial real estate	26,168		23,705		766		31,627		548
Total commercial and commercial real estate	34,703		31,120		2,379		37,820		752
Agricultural and agricultural real estate	15,332		13,304		546		13,091		—
Residential real estate	27,141		27,141		430		28,080		292
Consumer	6,903		6,903		1,400		6,254		114
Total impaired loans held to maturity	$	84,079	$	78,468	$	4,755	$	85,245	$	1,158



	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

On July 7, 2017, Heartland acquired Citywide Banks of Colorado, Inc., parent company of Citywide Banks, based in Denver, Colorado. As of July 7, 2017, Citywide Banks had gross loans of $1.00 billion, and the estimated fair value of the loans acquired was $985.4 million.

On February 28, 2017, Heartland acquired Founders Bancorp, parent company of Founders Community Bank, based in San Luis Obispo, California. As of February 28, 2017, Founders Community Bank had gross loans of $98.9 million, and the estimated fair value of the loans acquired was $96.4 million.

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.

Heartland uses the acquisition method of accounting for purchased loans in accordance with ASC 805, "Business Combinations." Purchased loans acquired in a business combination are recorded at estimated fair value on their 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 when at the date of the acquisition, it is probable that Heartland will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration at the purchase date includes 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 of the loan 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, 2017, and December 31, 2016, consisted of purchased impaired and nonimpaired purchased loans as summarized in the following table, in thousands:



	December 31, 2017						December 31, 2016
	Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans		Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans
Commercial	$	952	$	187,375	$	188,327	$	2,198	$	99,082	$	101,280
Commercial real estate	2,572		1,052,469		1,055,041		2,079		622,117		624,196
Agricultural and agricultural real estate	—		1,242		1,242		—		181		181
Residential real estate	214		173,909		174,123		186		157,468		157,654
Consumer loans	—		51,292		51,292		—		47,368		47,368
Total Covered Loans	$	3,738	$	1,466,287	$	1,470,025	$	4,463	$	926,216	$	930,679

Changes in accretable yield on acquired loans with evidence of credit deterioration at the date of acquisition for the years ended December 31, 2017, and December 31, 2016, are presented in the table below, in thousands:



	For the Years Ended
	December 31, 2017			December 31, 2016
Balance at beginning of year	$	182		$	557
Original yield discount, net, at date of acquisitions	—			19
Accretion	(1,591		)	(1,018		)
Reclassification from nonaccretable difference⁽¹⁾	1,466			624
Balance at end of year	$	57		$	182

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

For loans acquired since January 2015, on the acquisition dates the preliminary estimate of the contractually required payments receivable for all loans with evidence of credit deterioration since origination was $21.0 million and the estimated fair value of the loans was $13.1 million. At December 31, 2017, 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 $139,000 and $588,000, at December 31, 2017, and December 31, 2016, respectively, related to these ASC 310-30 loans. Provision expense of $12,000 and $507,000 was recorded for the years ended December 31, 2017, and 2016, respectively, related to these ASC 310-30 loans.

For loans acquired since January 2015, the preliminary estimate on the acquisition dates of the contractually required payments receivable for all nonimpaired loans acquired was $2.66 billion and the estimated fair value of the loans was $2.59 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, 2017 and 2016, were as follows, in thousands:



	2017			2016
Balance at beginning of year	$	114,305		$	141,465
Advances	56,652			57,165
Repayments	(55,284		)	(84,325		)
Balance at end of year	$	115,673		$	114,305