LOANS

6 Months Ended

Jun. 30, 2019

Loans as of June 30, 2019, and December 31, 2018, were as follows, in thousands:



	June 30, 2019			December 31, 2018
Loans receivable held to maturity:
Commercial	$	2,238,453		$	2,020,231
Commercial real estate	3,991,919			3,711,481
Agricultural and agricultural real estate	549,404			565,408
Residential real estate	613,707			673,603
Consumer	461,802			440,158
Gross loans receivable held to maturity	7,855,285			7,410,881
Unearned discount	(942		)	(1,624		)
Deferred loan fees	(1,292		)	(1,560		)
Total net loans receivable held to maturity	7,853,051			7,407,697
Allowance for loan losses	(63,850		)	(61,963		)
Loans receivable, net	$	7,789,201		$	7,345,734

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.

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.

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, impairment is measured 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 June 30, 2019, and December 31, 2018, 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 losses during the quarter ended March 31, 2019.



	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
June 30, 2019
Commercial	$	5,685	$	18,397	$	24,082	$	26,881	$	2,211,572	$	2,238,453
Commercial real estate	377		26,923		27,300		22,141		3,969,778		3,991,919
Agricultural and agricultural real estate	1,557		4,492		6,049		21,729		527,675		549,404
Residential real estate	197		1,375		1,572		18,556		595,151		613,707
Consumer	546		4,301		4,847		5,411		456,391		461,802
Total	$	8,362	$	55,488	$	63,850	$	94,718	$	7,760,567	$	7,855,285
December 31, 2018
Commercial	$	5,733	$	18,772	$	24,505	$	24,202	$	1,996,029	$	2,020,231
Commercial real estate	218		25,320		25,538		14,388		3,697,093		3,711,481
Agricultural and agricultural real estate	686		4,267		4,953		15,951		549,457		565,408
Residential real estate	168		1,617		1,785		20,251		653,352		673,603
Consumer	749		4,433		5,182		7,004		433,154		440,158
Total	$	7,554	$	54,409	$	61,963	$	81,796	$	7,329,085	$	7,410,881

The following table presents nonaccrual loans, accruing loans past due 90 days or more and performing troubled debt restructured loans at June 30, 2019, and December 31, 2018, in thousands:



	June 30, 2019		December 31, 2018
Nonaccrual loans	$	74,963	$	67,833
Nonaccrual troubled debt restructured loans	4,656		4,110
Total nonaccrual loans	$	79,619	$	71,943
Accruing loans past due 90 days or more	$	285	$	726
Performing troubled debt restructured loans	$	3,539	$	4,026

The following tables provide information on troubled debt restructured loans that were modified during the three- and six-month periods ended June 30, 2019, and June 30, 2018, dollars in thousands:



	Three Months Ended June 30,
	2019					2018
	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	—	—		—		—	—		—
Total commercial and commercial real estate	—	—		—		—	—		—
Agricultural and agricultural real estate	—	—		—		—	—		—
Residential real estate	3	240		246		6	1,292		1,125
Consumer	—	—		—		—	—		—
Total	3	$	240	$	246	6	$	1,292	$	1,125



	Six Months Ended June 30,
	2019					2018
	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	—	—		—		—	—		—
Total commercial and commercial real estate	—	—		—		—	—		—
Agricultural and agricultural real estate	—	—		—		—	—		—
Residential real estate	4	276		288		11	2,169		1,877
Consumer	—	—		—		—	—		—
Total	4	$	276	$	288	11	$	2,169	$	1,877

The pre-modification and post-modification recorded investment represents amounts as of the date of loan modification. The difference between the pre-modification investment and post-modification investment amounts on Heartland's residential real estate troubled debt restructured loans for the three- and six-months ended June 30, 2019, is due to principal deferment collected from government guarantees and capitalized interest and escrow. At June 30, 2019, there were no commitments to extend credit to any of the borrowers with an existing troubled debt restructured loan.

The following table shows troubled debt restructured loans for which there was a payment default during the three- and six-month periods ended June 30, 2019, and June 30, 2018, that had been modified during the twelve-month period prior to default, in thousands:



	With Payment Defaults During the Three Months Ended June 30,
	2019			2018
	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Commercial	—	$	—	—	$	—
Commercial real estate	—	—		—	—
Total commercial and commercial real estate	—	—		—	—
Agricultural and agricultural real estate	—	—		—	—
Residential real estate	1	61		3	667
Consumer	—	—		—	—
Total	1	$	61	3	$	667



	With Payment Defaults During the Six Months Ended June 30,
	2019			2018
	Number of Loans	Recorded Investment		Number of Loans	Recorded Investment
Commercial	—	$	—	—	$	—
Commercial real estate	—	—		—	—
Total commercial and commercial real estate	—	—		—	—
Agricultural and agricultural real estate	—	—		—	—
Residential real estate	3	253		6	1,184
Consumer	—	—		—	—
Total	3	$	253	6	$	1,184

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 trends in financial circumstances due to borrower specific or systemic conditions that, if left uncorrected, threaten the borrower's 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 net worth and paying capacity of the borrower and that 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 financial 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 in the borrowers' ability to repay the loan 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 as an operating entity. Specific pending events, such as capital injections, liquidations or perfection of liens on additional collateral, may strengthen the credit, thus deferring the rating of the loan as "loss" until the exact status of the loan can be determined. The loss rating is assigned to loans considered uncollectible. Heartland had no loans classified as loss or doubtful as of June 30, 2019. 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 June 30, 2019, and December 31, 2018, in thousands:



	Pass		Nonpass		Total
June 30, 2019
Commercial	$	2,095,930	$	142,523	$	2,238,453
Commercial real estate	3,755,285		236,634		3,991,919
Total commercial and commercial real estate	5,851,215		379,157		6,230,372
Agricultural and agricultural real estate	441,598		107,806		549,404
Residential real estate	586,121		27,586		613,707
Consumer	446,569		15,233		461,802
Total gross loans receivable held to maturity	$	7,325,503	$	529,782	$	7,855,285
December 31, 2018
Commercial	$	1,880,579	$	139,652	$	2,020,231
Commercial real estate	3,524,344		187,137		3,711,481
Total commercial and commercial real estate	5,404,923		326,789		5,731,712
Agricultural and agricultural real estate	471,642		93,766		565,408
Residential real estate	645,478		28,125		673,603
Consumer	425,451		14,707		440,158
Total gross loans receivable held to maturity	$	6,947,494	$	463,387	$	7,410,881

The nonpass category in the table above is comprised of approximately 57% special mention loans and 43% substandard loans as of June 30, 2019. The percent of nonpass loans on nonaccrual status as of June 30, 2019, was 15%. As of December 31, 2018, the nonpass category in the table above was comprised of approximately 52% special mention loans and 48% substandard loans. The percent of nonpass loans on nonaccrual status as of December 31, 2018, was 16%. Loans delinquent 30 to 89 days as a percent of total loans were 0.31% at June 30, 2019, compared to 0.21% at December 31, 2018. 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 June 30, 2019, 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. A loan can be restored to accrual status if the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments on the loan, and (1) all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within a reasonable period of time, and (2) that there is a sustained period of repayment performance (generally a minimum of six months) by the borrower in accordance with the scheduled contractual terms.

The following table sets forth information regarding Heartland's accruing and nonaccrual loans at June 30, 2019, and December 31, 2018, 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
June 30, 2019
Commercial	$	6,030	$	1,281	$	—	$	7,311	$	2,205,913	$	25,229	$	2,238,453
Commercial real estate	4,931		1,006		—		5,937		3,969,426		16,556		3,991,919
Total commercial and commercial real estate	10,961		2,287		—		13,248		6,175,339		41,785		6,230,372
Agricultural and agricultural real estate	2,664		386		285		3,335		524,655		21,414		549,404
Residential real estate	2,744		653		—		3,397		598,120		12,190		613,707
Consumer	3,850		578		—		4,428		453,144		4,230		461,802
Total gross loans receivable held to maturity	$	20,219	$	3,904	$	285	$	24,408	$	7,751,258	$	79,619	$	7,855,285
December 31, 2018
Commercial	$	2,574	$	205	$	—	$	2,779	$	1,991,525	$	25,927	$	2,020,231
Commercial real estate	4,819		—		726		5,545		3,694,259		11,677		3,711,481
Total commercial and commercial real estate	7,393		205		726		8,324		5,685,784		37,604		5,731,712
Agricultural and agricultural real estate	99		—		—		99		549,376		15,933		565,408
Residential real estate	5,147		49		—		5,196		655,329		13,078		673,603
Consumer	2,724		307		—		3,031		431,799		5,328		440,158
Total gross loans receivable held to maturity	$	15,363	$	561	$	726	$	16,650	$	7,322,288	$	71,943	$	7,410,881

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 June 30, 2019, and December 31, 2018, the outstanding loan balance recorded on the consolidated balance sheets at June 30, 2019, and December 31, 2018, any related allowance recorded for those loans as of June 30, 2019, and December 31, 2018, the average outstanding loan balances recorded on the consolidated balance sheets during the three- and six- months ended June 30, 2019, and year ended December 31, 2018, and the interest income recognized on the impaired loans during the three- and six-month period ended June 30, 2019, and year ended December 31, 2018, in thousands:



	Unpaid Principal Balance		Loan Balance		Related Allowance Recorded		Quarter- to- Date Avg. Loan Balance		Quarter- to- Date Interest Income Recognized		Year- to- Date Avg. Loan Balance		Year- to- Date Interest Income Recognized
June 30, 2019
Impaired loans with a related allowance:
Commercial	$	11,152	$	11,142	$	5,685	$	11,442	$	9	$	11,747	$	16
Commercial real estate	1,541		1,541		377		1,357		5		1,280		11
Total commercial and commercial real estate	12,693		12,683		6,062		12,799		14		13,027		27
Agricultural and agricultural real estate	3,916		3,916		1,557		3,314		—		2,772		—
Residential real estate	1,273		1,273		197		1,378		—		1,194		—
Consumer	1,175		1,173		546		1,200		1		1,237		7
Total loans held to maturity	$	19,057	$	19,045	$	8,362	$	18,691	$	15	$	18,230	$	34
Impaired loans without a related allowance:
Commercial	$	20,542	$	15,739	$	—	$	13,519	$	111	$	12,726	$	441
Commercial real estate	20,680		20,600		—		17,785		73		15,900		127
Total commercial and commercial real estate	41,222		36,339		—		31,304		184		28,626		568
Agricultural and agricultural real estate	20,220		17,813		—		17,739		17		16,056		33
Residential real estate	17,283		17,283		—		17,198		121		17,566		151
Consumer	4,238		4,238		—		4,222		18		4,522		43
Total loans held to maturity	$	82,963	$	75,673	$	—	$	70,463	$	340	$	66,770	$	795
Total impaired loans held to maturity:
Commercial	$	31,694	$	26,881	$	5,685	$	24,961	$	120	$	24,473	$	457
Commercial real estate	22,221		22,141		377		19,142		78		17,180		138
Total commercial and commercial real estate	53,915		49,022		6,062		44,103		198		41,653		595
Agricultural and agricultural real estate	24,136		21,729		1,557		21,053		17		18,828		33
Residential real estate	18,556		18,556		197		18,576		121		18,760		151
Consumer	5,413		5,411		546		5,422		19		5,759		50
Total impaired loans held to maturity	$	102,020	$	94,718	$	8,362	$	89,154	$	355	$	85,000	$	829



	Unpaid Principal Balance		Loan Balance		Related Allowance Recorded		Year-to- Date Avg. Loan Balance		Year-to- Date Interest Income Recognized
December 31, 2018
Impaired loans with a related allowance:
Commercial	$	12,376	$	12,366	$	5,733	$	4,741	$	33
Commercial real estate	891		891		218		4,421		25
Total commercial and commercial real estate	13,267		13,257		5,951		9,162		58
Agricultural and agricultural real estate	1,718		1,718		686		2,165		2
Residential real estate	647		647		168		1,138		12
Consumer	1,373		1,373		749		2,934		29
Total loans held to maturity	$	17,005	$	16,995	$	7,554	$	15,399	$	101
Impaired loans without a related allowance:
Commercial	$	13,616	$	11,836	$	—	$	10,052	$	299
Commercial real estate	13,578		13,497		—		13,000		249
Total commercial and commercial real estate	27,194		25,333		—		23,052		548
Agricultural and agricultural real estate	16,836		14,233		—		14,781		5
Residential real estate	19,604		19,604		—		23,950		308
Consumer	5,631		5,631		—		5,117		97
Total loans held to maturity	$	69,265	$	64,801	$	—	$	66,900	$	958
Total impaired loans held to maturity:
Commercial	$	25,992	$	24,202	$	5,733	$	14,793	$	332
Commercial real estate	14,469		14,388		218		17,421		274
Total commercial and commercial real estate	40,461		38,590		5,951		32,214		606
Agricultural and agricultural real estate	18,554		15,951		686		16,946		7
Residential real estate	20,251		20,251		168		25,088		320
Consumer	7,004		7,004		749		8,051		126
Total impaired loans held to maturity	$	86,270	$	81,796	$	7,554	$	82,299	$	1,059

On May 10, 2019, Heartland completed the acquisition of Blue Valley Ban Corp., parent company of Bank of Blue Valley, headquartered in Overland Park, Kansas. As of May 10, 2019, Blue Valley Ban Corp. had gross loans of $558.4 million, and the estimated fair value of the loans acquired was $542.3 million.

On May 18, 2018, Heartland completed the acquisition of First Bank Lubbock Bancshares, Inc., parent company of First Bank & Trust, headquartered in Lubbock, Texas. As of May 18, 2018, First Bank Lubbock Bancshares, Inc. had gross loans of $696.9 million, and the estimated fair value of the loans acquired was $681.1 million.

On February 23, 2018, Heartland acquired Signature Bancshares, Inc., parent company of Signature Bank, based in Minnetonka, Minnesota. As of February 23, 2018, Signature Bancshares, Inc. had gross loans of $335.1 million and the estimated fair value of the loans acquired was $324.5 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.

At June 30, 2019, and December 31, 2018, the carrying amount of loans acquired since 2015 consist of purchased impaired and nonimpaired purchased loans as summarized in the following table, in thousands:



	June 30, 2019						December 31, 2018
	Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans		Impaired Purchased Loans		Non Impaired Purchased Loans		Total Purchased Loans
Commercial	$	7,109	$	336,256	$	343,365	$	3,801	$	243,693	$	247,494
Commercial real estate	3,337		1,169,970		1,173,307		158		1,098,171		1,098,329
Agricultural and agricultural real estate	—		10,054		10,054		—		27,115		27,115
Residential real estate	—		171,327		171,327		231		184,389		184,620
Consumer loans	—		97,824		97,824		—		75,773		75,773
Total covered loans	$	10,446	$	1,785,431	$	1,795,877	$	4,190	$	1,629,141	$	1,633,331

Changes in accretable yield on acquired loans with evidence of credit deterioration at the date of acquisition for the three- and six-month periods ended June 30, 2019, and June 30, 2018, were as follows, in thousands:



	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Balance at beginning of period	$	188		$	—		$	227		$	57
Original yield discount, net, at date of acquisition	27			564			27			508
Accretion	(851		)	(651		)	(1,108		)	(850		)
Reclassification from nonaccretable difference⁽¹⁾	452			550			670			748
Balance at period end	$	(184	)	$	463		$	(184	)	$	463

(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 $44.6 million, and the estimated fair value of these loans was $28.2 million. At June 30, 2019, 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 such collateral, and the timing and amount of the cash flows could not be reasonably estimated. At June 30, 2019, there was $0 of allowance recorded and $57,000 of allowance recorded at December 31, 2018, related to these ASC 310-30 loans. Provision benefit of $64,000 and provision expense of $672,000 was recorded for the six-month periods ended June 30, 2019, and 2018, respectively.

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 $4.22 billion, and the estimated fair value of the loans was $4.12 billion.