Heartland uses derivative financial instruments as part of its interest rate risk management strategy. As part of the strategy, Heartland considers the use of interest rate swaps, caps, floors, collars, and certain interest rate lock commitments and forward sales of securities related to mortgage banking activities. Heartland's current strategy includes the use of interest rate swaps, interest rate lock commitments and forward sales of mortgage securities. In addition, Heartland is facilitating back-to-back loan swaps to assist customers in managing interest rate risk. Heartland's objectives are to add stability to its net interest margin and to manage its exposure to movements in interest rates. The contract or notional amount of a derivative is used to determine, along with the other terms of the derivative, the amounts to be exchanged between the counterparties. Heartland is exposed to credit risk in the event of nonperformance by counterparties to financial instruments. Heartland minimizes this risk by entering into derivative contracts with counterparties that meet Heartland’s credit standards, and the contracts contain collateral provisions protecting the at-risk party. Heartland has not experienced any losses from nonperformance by these counterparties. Heartland monitors counterparty risk in accordance with the provisions of ASC 815.

In addition, interest rate-related derivative instruments generally contain language outlining collateral pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits which are determined by credit ratings of each counterparty. Heartland was required to pledge $4.2 million of cash as collateral at September 30, 2020 compared to $1.9 million at December 31, 2019. At both September 30, 2020 and December 31, 2019, no collateral was required to be pledged by Heartland's counterparties.

Heartland has variable rate funding which creates exposure to variability in interest payments due to changes in interest rates. To manage the interest rate risk related to the variability of interest payments, Heartland has entered into various interest rate swap agreements. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are received or made on Heartland's variable-rate liabilities. For the nine months ended September 30, 2020, the change in net unrealized losses on cash flow hedges reflects changes in the fair value of the swaps and reclassification from accumulated other comprehensive income to interest expense totaling $1.2 million. For the next twelve months, Heartland estimates that cash payments and reclassification from accumulated other comprehensive income to interest expense will total $2.4 million.

Heartland entered into four forward starting interest rate swap transactions to effectively convert Heartland Financial Statutory Trust IV, V, VI, and VII, which total $85.0 million, from variable rate subordinated debentures to fixed rate debt. For accounting purposes, these four swap transactions are designated as cash flow hedges of the changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on $85.0 million of Heartland's subordinated debentures that reset quarterly on a specified reset date. At inception, Heartland asserted that the underlying principal balance would remain outstanding throughout the hedge transaction, making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swaps. During the first quarter of 2020, the interest rate swap transaction associated with Heartland Financial Statutory Trust VI, totaling $20.0 million, matured and the fixed rate debt has been converted to a variable rate subordinated debenture.

On May 18, 2018, Heartland acquired cash flow hedges related to OCGI Statutory Trust III and OCGI Capital Trust IV with notional amounts of $3.0 million and $6.0 million, respectively, in the First Bank Lubbock Bancshares, Inc. transaction. The cash flow hedges effectively convert OCGI Statutory Trust III and OGCI Capital Trust IV from variable rate subordinated debentures to fixed rate debt. These swaps are designated as cash flow hedges of the changes in LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on $9.0 million of Heartland's subordinated debentures that reset quarterly on a specified reset date.


	Notional Amount		Fair Value		Balance Sheet Category	Receive Rate		Weighted Average Pay Rate		Maturity
September 30, 2020

Interest rate swap	$	25,000	$	(253)	Other liabilities	0.246	%	2.255	%	03/17/2021




Interest rate swap	22,667		(147)		Other liabilities	2.656		3.674		05/10/2021
Interest rate swap	23,500		(2,449)		Other liabilities	2.651		5.425		07/24/2028
Interest rate swap	20,000		(1,592)		Other liabilities	0.250		2.390		06/15/2024
Interest rate swap	20,000		(1,488)		Other liabilities	0.246		2.352		03/01/2024
Interest rate swap	6,000		(74)		Other liabilities	0.250		1.866		06/15/2021
Interest rate swap	3,000		(38)		Other liabilities	0.275		1.878		06/30/2021
December 31, 2019
Interest rate swap	$	25,000	$	(167)	Other liabilities	1.900	%	2.255	%	03/17/2021
Interest rate swap	20,000		(67)		Other liabilities	2.043		3.355		01/07/2020
Interest rate swap	25,667		135		Other assets	4.215		3.674		05/10/2021
Interest rate swap	25,750		(1,384)		Other liabilities	4.280		5.425		07/24/2028
Interest rate swap	20,000		(614)		Other liabilities	1.894		2.390		06/15/2024
Interest rate swap	20,000		(561)		Other liabilities	1.907		2.352		03/01/2024
Interest rate swap	6,000		(15)		Other liabilities	1.894		1.866		06/15/2021
Interest rate swap	3,000		(9)		Other liabilities	1.831		1.878		06/30/2021


	Effective Portion					Ineffective Portion
	Recognized in OCI		Reclassified from AOCI into Income			Recognized in Income on Derivatives
	Amount of Gain (Loss)		Category	Amount of Gain (Loss)		Category	Amount of Gain (Loss)
Three Months Ended September 30, 2020












Interest rate swaps	$	(604)	Interest expense	$	595	Other income	$	—
Nine Months Ended September 30, 2020












Interest rate swaps	$	(3,359)	Interest expense	$	1,195	Other income	$	—
Three Months Ended September 30, 2019










Interest rate swaps	$	(766)	Interest expense	$	(31)	Other income	$	—
Nine Months Ended September 30, 2019










Interest rate swaps	$	(4,269)	Interest expense	$	(296)	Other income	$	—

Heartland uses interest rate swaps to convert certain long term fixed rate loans to floating rates to hedge interest rate risk exposure. Heartland uses hedge accounting in accordance with ASC 815, with the unrealized gains and losses, representing the change in fair value of the derivative and the change in fair value of the risk being hedged on the related loan, being recorded in the consolidated statements of income. The ineffective portions of the unrealized gains or losses, if any, are recorded in interest income and interest expense in the consolidated statements of income. Heartland uses statistical regression to assess hedge effectiveness, both at the inception of the hedge as well as on a continual basis. The regression analysis involves regressing the periodic change in the fair value of the hedging instrument against the periodic changes in the fair value of the asset being hedged due to changes in the hedge risk.

Amount of Gain (Loss)

Income Statement Category

Three Months Ended September 30, 2020

Fair value hedges

Interest income

Nine Months Ended September 30, 2020

Fair value hedges

(1,647)

Interest income

Three Months Ended September 30, 2019

Fair value hedges

(263)

Interest income

Nine Months Ended September 30, 2019

Fair value hedges

(1,553)

Interest income

Heartland has fixed rate loans with embedded derivatives. The loans contain terms that affect the cash flows or value of the loan similar to a derivative instrument, and therefore are considered to contain an embedded derivative. The embedded derivatives are bifurcated from the loans because the terms of the derivative instrument are not clearly and closely related to the loans. The embedded derivatives are recorded at fair value on the consolidated balance sheets as a part of other assets, and changes in the fair value are a component of noninterest income. The table below identifies the notional amount, fair value and balance sheet category of Heartland's embedded derivatives at September 30, 2020, and December 31, 2019, in thousands:

Amount of Gain (Loss)

Income Statement Category

Three Months Ended September 30, 2020

Embedded derivatives

(69)

Other noninterest income

Nine Months Ended September 30, 2020

Embedded derivatives

293

Other noninterest income

Three Months Ended September 30, 2019

Embedded derivatives

1,389

Other noninterest income

Nine Months Ended September 30, 2019

Embedded derivatives

318

Other noninterest income

Heartland has interest rate swap loan relationships with customers to meet their financing needs. Upon entering into these loan swaps, Heartland enters into offsetting positions with counterparties in order to minimize interest rate risk. These back-to-back loan swaps qualify as free standing financial derivatives with the fair values reported in other assets and other liabilities on the consolidated balance sheets. Heartland was required to post $53.2 million and $20.2 million as of September 30, 2020, and December 31, 2019, respectively, as collateral related to these back-to-back swaps. Heartland's counterparties were required to pledge $0 at September 30, 2020, and $0 at December 31, 2019. Any gains and losses on these back-to-back swaps are recorded in noninterest income on the consolidated statements of income, and for the three- and nine months ended September 30, 2020 and September 30, 2019, no gain or loss was recognized. The table below identifies the balance sheet category and fair values of Heartland's derivative instruments designated as loan swaps at September 30, 2020, and December 31, 2019, in thousands:


	Notional Amount		Fair Value		Balance Sheet Category	Weighted Average Receive Rate		Weighted Average Pay Rate
September 30, 2020
Customer interest rate swaps	$	443,856	$	49,629	Other assets	4.46	%	2.45	%
Customer interest rate swaps	443,856		(49,629)		Other liabilities	2.45		4.46
December 31, 2019
Customer interest rate swaps	$	374,191	$	16,927	Other assets	4.68	%	4.05	%
Customer interest rate swaps	374,191		(16,927)		Other liabilities	4.05		4.68

Heartland has entered into interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans and mortgage backed securities that are considered derivative instruments. Heartland enters into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on the commitments to fund the loans as well as on residential mortgage loans available for sale. The fair value of these commitments is recorded on the consolidated balance sheets, with the changes in fair value recorded in the consolidated statements of income as a component of gains on sale of loans held for sale. These derivative contracts are designated as free standing derivative contracts and are not designated against specific assets and liabilities on the consolidated balance sheets or forecasted transactions and therefore do not qualify for hedge accounting treatment. Heartland was required to pledge no collateral at both September 30, 2020, and December 31, 2019. Heartland's counterparties were required to pledge no collateral at both September 30, 2020 and December 31, 2019, as collateral for these forward commitments.

Heartland acquired undesignated interest rate swaps in 2015. These swaps were entered into primarily for the benefit of customers seeking to manage their interest rate risk and are not designated against specific assets or liabilities on the consolidated balance sheet or forecasted transactions and therefore do not qualify for hedge accounting in accordance with ASC 815. These swaps are carried at fair value on the consolidated balance sheets as a component of other liabilities, with changes in the fair value recorded as a component of other noninterest income.


	Balance Sheet Category	Notional Amount		Fair Value
September 30, 2020
Interest rate lock commitments (mortgage)	Other assets	$	51,579	$	2,255

Forward commitments	Other assets	24,500		27
Forward commitments	Other liabilities	72,500		(352)
Undesignated interest rate swaps	Other liabilities	9,308		(758)

December 31, 2019
Interest rate lock commitments (mortgage)	Other assets	$	20,356	$	681

Forward commitments	Other assets	16,000		15
Forward commitments	Other liabilities	36,500		(113)
Undesignated interest rate swaps	Other liabilities	9,627		(465)

The table below identifies the income statement category of the gains and losses recognized in income on Heartland's other free standing derivative instruments not designated as hedging instruments for the three- and nine-month periods ended September 30, 2020, and September 30, 2019, in thousands:


	Income Statement Category	Gain (Loss) Recognized
Three Months Ended September 30, 2020
Interest rate lock commitments (mortgage)	Net gains on sale of loans held for sale	$	249
Forward commitments	Net gains on sale of loans held for sale	(44)
Undesignated interest rate swaps	Other noninterest income	69
Nine Months Ended September 30, 2020
Interest rate lock commitments (mortgage)	Net gains on sale of loans held for sale	$	3,243
Forward commitments	Net gains on sale of loans held for sale	(228)
Undesignated interest rate swaps	Other noninterest income	(293)
Three Months Ended September 30, 2019
Interest rate lock commitments (mortgage)	Net gains on sale of loans held for sale	$	(255)
Forward commitments	Net gains on sale of loans held for sale	283
Undesignated interest rate swaps	Other noninterest income	(1,389)
Nine Months Ended September 30, 2019
Interest rate lock commitments (mortgage)	Net gains on sale of loans held for sale	$	561

Forward commitments	Net gains on sale of loans held for sale	255
Undesignated interest rate swaps	Other noninterest income	(318)