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Section 1: 10-Q (10-Q 2018 Q2)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended June 30, 2018

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For transition period from __________ to __________

Commission File Number: 001-15393

HEARTLAND FINANCIAL USA, INC.
(Exact name of Registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

42-1405748
(I.R.S. employer identification number)

1398 Central Avenue, Dubuque, Iowa  52001
(Address of principal executive offices)(Zip Code)

(563) 589-2100
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o

     Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o
   
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “accelerated filer,” “large accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer x
 
Accelerated Filer ¨
 
 
Non-accelerated filer ¨
(Do not check if a smaller reporting company)
 
Smaller reporting company ¨
 
Emerging growth company ¨
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No x

Indicate the number of shares outstanding of each of the classes of Registrant's common stock as of the latest practicable date:  As of August 6, 2018, the Registrant had outstanding 34,440,416 shares of common stock, $1.00 par value per share.





HEARTLAND FINANCIAL USA, INC.
Form 10-Q Quarterly Report
Table of Contents

Part I
Part II
 
 
 
 
 
 
 
 
101 Financial statements formatted in Extensible Business Reporting Language: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Changes in Equity, and (vi) the Notes to Consolidated Financial Statements.






PART I

ITEM 1. FINANCIAL STATEMENTS
HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
 
 
 
June 30, 2018 (Unaudited)
 
December 31, 2017
ASSETS
 
 
 
Cash and due from banks
$
193,069

 
$
168,723

Interest bearing deposits with the Federal Reserve Bank and other banks and other short-term investments
194,937

 
27,280

Cash and cash equivalents
388,006

 
196,003

Time deposits in other financial institutions
6,803

 
9,820

Securities:
 
 

Carried at fair value (cost of $2,258,048 at June 30, 2018, and $2,248,181 at December 31, 2017)
2,197,117

 
2,216,753

Held to maturity, at cost (fair value of $253,153 at June 30, 2018, and $265,494 at December 31, 2017)
244,271

 
253,550

Other investments, at cost
26,725

 
22,563

Loans held for sale
55,684

 
44,560

Loans receivable:
 
 

Held to maturity
7,477,697

 
6,391,464

Allowance for loan and lease losses
(61,324
)
 
(55,686
)
Loans receivable, net
7,416,373

 
6,335,778

Premises, furniture and equipment, net
195,981

 
172,324

Premises, furniture and equipment held for sale
3,978

 
1,977

Other real estate, net
11,074

 
10,777

Goodwill
391,668

 
236,615

Core deposit intangibles and customer relationship intangibles, net
52,698

 
35,203

Servicing rights, net
31,996

 
25,857

Cash surrender value on life insurance
159,302

 
142,818

Other assets
120,244

 
106,141

TOTAL ASSETS
$
11,301,920

 
$
9,810,739

LIABILITIES AND EQUITY
 
 
 
LIABILITIES:
 
 
 
Deposits:
 
 
 
Demand
$
3,399,598

 
$
2,983,128

Savings
4,864,773

 
4,240,328

Time
1,224,773

 
923,453

Total deposits
9,489,144

 
8,146,909

Short-term borrowings
229,890

 
324,691

Other borrowings
258,708

 
285,011

Accrued expenses and other liabilities
68,431

 
62,671

TOTAL LIABILITIES
10,046,173

 
8,819,282

STOCKHOLDERS' EQUITY:
 
 
 
Preferred stock (par value $1 per share; authorized 17,604 shares; none issued or outstanding at both June 30, 2018, and December 31, 2017)

 

Series A Junior Participating preferred stock (par value $1 per share; authorized 16,000 shares; none issued or outstanding at both June 30, 2018, and December 31, 2017)

 

Series C Senior Non-Cumulative Perpetual Preferred Stock (par value $1 per share; 81,698 shares authorized at both June 30, 2018, and December 31, 2017, none issued or outstanding at both June 30, 2018, and December 31, 2017)

 

Series D Senior Non-Cumulative Perpetual Convertible Preferred Stock (par value $1 per share; 3,000 shares authorized at both June 30, 2018, and December 31, 2017; 745 shares issued and outstanding at both June 30, 2018, and December 31, 2017)
938

 
938

Common stock (par value $1 per share; 40,000,000 shares authorized at both June 30, 2018, and December 31, 2017; issued 34,438,445 shares at June 30, 2018, and 29,953,356 shares at December 31, 2017)
34,438

 
29,953

Capital surplus
740,128

 
503,709

Retained earnings
524,786

 
481,331

Accumulated other comprehensive loss
(44,543
)
 
(24,474
)
Treasury stock at cost (0 shares at both June 30, 2018, and December 31, 2017)

 

TOTAL STOCKHOLDERS' EQUITY
1,255,747

 
991,457

TOTAL LIABILITIES AND EQUITY
$
11,301,920

 
$
9,810,739

 
 
 
 
See accompanying notes to consolidated financial statements.
 
 
 





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share data)
 
 
 
 
 
 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
INTEREST INCOME:
 
 
 
 
 
 
 
Interest and fees on loans
$
96,787

 
$
68,094

 
$
182,438

 
$
134,992

Interest on securities:
 
 
 
 
 
 
 
Taxable
12,270

 
8,599

 
23,847

 
16,852

Nontaxable
3,584

 
5,020

 
7,163

 
10,211

Interest on federal funds sold

 
3

 

 
3

Interest on interest bearing deposits in other financial institutions
768

 
345

 
1,175

 
554

TOTAL INTEREST INCOME
113,409

 
82,061

 
214,623


162,612

INTEREST EXPENSE:
 
 
 
 
 
 
 
Interest on deposits
7,983

 
4,163

 
13,749

 
7,893

Interest on short-term borrowings
547

 
90

 
815

 
227

Interest on other borrowings (includes $30 and $300 of interest expense related to derivatives reclassified from accumulated other comprehensive income for the three months ended June 30, 2018 and 2017, respectively, and $227 and $697 of interest expense related to derivatives reclassified from accumulated other comprehensive income for the six months ended June 30, 2018 and 2017, respectively)
3,470

 
3,228

 
7,066

 
6,884

TOTAL INTEREST EXPENSE
12,000

 
7,481

 
21,630


15,004

NET INTEREST INCOME
101,409

 
74,580

 
192,993


147,608

Provision for loan losses
4,831

 
889

 
9,094

 
4,530

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
96,578

 
73,691

 
183,899


143,078

NONINTEREST INCOME:
 
 
 
 
 
 
 
Service charges and fees
12,072

 
9,696

 
22,151

 
19,153

Loan servicing income
1,807

 
1,351

 
3,561

 
3,075

Trust fees
4,615

 
3,979

 
9,295

 
7,610

Brokerage and insurance commissions
877

 
976

 
1,784

 
2,012

Securities gains/(losses), net (includes $259 of net security losses and $1,392 of net security gains reclassified from accumulated other comprehensive income for the three months ended June 30, 2018 and 2017, respectively, and $1,182 and $3,874 of net security gains reclassified from accumulated other comprehensive income for the six months ended June 30, 2018 and 2017, respectively)
(259
)
 
1,392

 
1,182

 
3,874

Unrealized gain on equity securities, net
71

 

 
43

 

Net gains on sale of loans held for sale
6,800

 
6,817

 
10,851

 
12,964

Valuation allowance on servicing rights
(216
)
 
19

 
(218
)
 
24

Income on bank owned life insurance
700

 
656

 
1,314

 
1,273

Other noninterest income
1,167

 
738

 
2,387

 
1,532

TOTAL NONINTEREST INCOME
27,634

 
25,624

 
52,350


51,517

NONINTEREST EXPENSES:
 
 
 
 
 
 
 
Salaries and employee benefits
50,758

 
41,126

 
99,468

 
82,893

Occupancy
6,315

 
5,056

 
12,358

 
10,129

Furniture and equipment
3,184

 
2,586

 
5,933

 
5,087

Professional fees
9,948

 
7,583

 
18,407

 
15,892

FDIC insurance assessments
684

 
909

 
1,673

 
1,716

Advertising
2,145

 
1,359

 
4,085

 
3,783

Core deposit intangibles and customer relationship intangibles amortization
2,274

 
1,218

 
4,137

 
2,389

Other real estate and loan collection expenses
948

 
365

 
1,680

 
1,193

(Gain)/loss on sales/valuations of assets, net
1,528

 
(112
)
 
1,331

 
300

Restructuring expenses



 
2,564

 

Other noninterest expenses
11,098

 
9,208

 
20,892

 
17,656

TOTAL NONINTEREST EXPENSES
88,882

 
69,298

 
172,528


141,038

INCOME BEFORE INCOME TAXES
35,330

 
30,017

 
63,721


53,557

Income taxes (includes $(61) and $407 of income tax expense/(benefit) reclassified from accumulated other comprehensive income for the three months ended June 30, 2018 and 2017, respectively, and $201 and $1,185 of income tax expense reclassified from accumulated other comprehensive income for the six months ended June 30, 2018 and 2017, respectively)
7,451

 
8,059

 
12,574

 
13,589

NET INCOME
27,879

 
21,958

 
51,147


39,968

Preferred dividends
(13
)
 
(13
)
 
(26
)
 
(32
)
Interest expense on convertible preferred debt

 
4

 

 
9

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
$
27,866

 
$
21,949

 
$
51,121


$
39,945

EARNINGS PER COMMON SHARE - BASIC
$
0.85

 
$
0.82

 
$
1.62

 
$
1.51

EARNINGS PER COMMON SHARE - DILUTED
$
0.85

 
$
0.81

 
$
1.61

 
$
1.49

CASH DIVIDENDS DECLARED PER COMMON SHARE
$
0.13

 
$
0.11

 
$
0.26

 
$
0.22

 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.
 
 
 
 
 
 
 





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
NET INCOME
$
27,879

 
$
21,958

 
$
51,147

 
$
39,968

OTHER COMPREHENSIVE INCOME (LOSS)
 
 
 
 
 
 
 
Securities:
 
 
 
 
 
 
 
Net change in unrealized gain (loss) on securities
(8,501
)
 
9,683

 
(28,335
)
 
15,062

Reclassification adjustment for net (gains)/losses realized in net income
259

 
(1,392
)
 
(1,182
)
 
(3,874
)
Income taxes
2,117

 
(3,238
)
 
7,508

 
(4,349
)
Other comprehensive income (loss) on securities
(6,125
)
 
5,053

 
(22,009
)
 
6,839

Derivatives used in cash flow hedging relationships:
 
 
 
 
 
 
 
Net change in unrealized gain (loss) on derivatives
897

 
(809
)
 
2,596

 
(673
)
Reclassification adjustment for net losses on derivatives realized in net income
30

 
300

 
227

 
697

Income taxes
105

 
1

 
(603
)
 
(214
)
Other comprehensive income (loss) on cash flow hedges
1,032

 
(508
)
 
2,220

 
(190
)
Other comprehensive income (loss)
(5,093
)
 
4,545

 
(19,789
)
 
6,649

TOTAL COMPREHENSIVE INCOME
$
22,786

 
$
26,503

 
$
31,358

 
$
46,617

 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.
 
 
 
 
 
 
 





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
 
 
Six Months Ended
June 30,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
51,147

 
$
39,968

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
14,273

 
14,566

Provision for loan losses
9,094

 
4,530

Net amortization of premium on securities
12,587

 
13,997

Securities gains, net
(1,182
)
 
(3,874
)
Unrealized gain on equity securities, net
(43
)
 

Stock based compensation
2,770

 
2,763

Loans originated for sale
(317,979
)
 
(369,579
)
Proceeds on sales of loans held for sale
346,083

 
390,683

Net gains on sale of loans held for sale
(8,178
)
 
(8,691
)
(Increase) decrease in accrued interest receivable
(35
)
 
1,876

Decrease in prepaid expenses
2,263

 
936

Decrease in accrued interest payable
(25
)
 
(130
)
Capitalization of servicing rights
(2,694
)
 
(4,406
)
Valuation allowance on servicing rights
218

 
(24
)
Loss on sales/valuations of assets, net
1,331

 
300

Net excess tax benefit from stock based compensation
660

 
989

Other, net
(16,605
)
 
(11,989
)
NET CASH PROVIDED BY OPERATING ACTIVITIES
93,685

 
71,915

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of time deposits in other financial institutions
(1,000
)
 

Proceeds from the sale of securities available for sale
635,735

 
624,008

Proceeds from the redemption of time deposits in other financial institutions
8,767

 
5,867

Proceeds from the maturity of and principal paydowns on securities available for sale
112,166

 
102,506

Proceeds from the maturity of and principal paydowns on securities held to maturity
8,897

 
3,655

Proceeds from the maturity of and principal paydowns on time deposits in other financial institutions
4,862

 
14,483

Proceeds from the maturity of and principal paydowns on other investments
1,400

 
2,017

Purchase of securities available for sale
(733,030
)
 
(666,588
)
Purchase of other investments
(1,842
)
 
(1,001
)
Net (increase) decrease in loans
(86,466
)
 
113,369

Purchase of bank owned life insurance policies

 
(2,000
)
Capital expenditures
(9,788
)
 
(5,683
)
Net cash and cash equivalents received in acquisitions
212,197

 
33,698

Proceeds from the sale of equipment
622

 
1,692

Proceeds on sale of OREO and other repossessed assets
2,091

 
4,352

NET CASH PROVIDED BY INVESTING ACTIVITIES
$
154,611

 
$
230,375

 
 
 
 





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (Unaudited)
(Dollars in thousands)
 
 
 
 
Six Months Ended
June 30,
 
2018
 
2017
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net increase in demand deposits
$
117,456

 
$
58,953

Net increase (decrease) in savings deposits
5,408

 
(146,800
)
Net decrease in time deposit accounts
(31,789
)
 
(10,891
)
Proceeds on short-term revolving credit line
25,000

 

Net decrease in short-term borrowings
(155,403
)
 
(161,963
)
Proceeds from short term FHLB advances
302,102

 
86,139

Repayments of short term FHLB advances
(266,500
)
 
(91,505
)
Repayments of other borrowings
(44,654
)
 
(7,503
)
Purchase of treasury stock
(97
)
 
(217
)
Proceeds from issuance of common stock
156

 
398

Dividends paid
(7,972
)
 
(5,849
)
NET CASH USED BY FINANCING ACTIVITIES
(56,293
)
 
(279,238
)
Net increase in cash and cash equivalents
192,003

 
23,052

Cash and cash equivalents at beginning of year
196,003

 
158,724

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
388,006

 
$
181,776

Supplemental disclosures:
 
 
 
Cash paid for income/franchise taxes
$
8,254

 
$
5,860

Cash paid for interest
$
21,655

 
$
15,134

Loans transferred to OREO
$
2,264

 
$
4,302

Transfer of premises from premises, furniture and equipment, net, to premises, furniture and equipment held for sale
$
2,501

 
$

Purchases of securities available for sale, accrued, not settled
$

 
$

Sales of securities available for sale, accrued, not settled
$

 
$

Conversion of convertible debt to common stock
$

 
$
167

Conversion of Series D preferred stock to common stock
$

 
$
419

Stock consideration granted for acquisitions
$
238,075

 
$
22,589

 
 
 
 
See accompanying notes to consolidated financial statements.





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Unaudited)
(Dollars in thousands, except per share data)
 
 
Heartland Financial USA, Inc. Stockholders' Equity
 
 
Preferred
 Stock
 
Common
 Stock
 
Capital
 Surplus
 
Retained
 Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Treasury
Stock
 
Total
 Equity
Balance at January 1, 2017
$
1,357

 
$
26,120

 
$
328,376

 
$
416,109

 
$
(31,046
)
 
$

 
$
740,916

Comprehensive income


 






39,968

 
6,649





46,617

Cash dividends declared:


 


 


 


 


 


 
 
Series D Preferred, $35.00 per share
 
 
 
 
 
 
(32
)
 
 
 
 
 
(32
)
Common, $0.22 per share


 






(5,817
)
 






(5,817
)
Conversion of Series D Preferred Stock
(419
)
 
 
 
 
 
 
 
 
 
 
 
(419
)
Purchase of 4,611 shares of common stock


 








 



(217
)

(217
)
Issuance of 585,908 shares of common stock


 
581


21,361




 



217


22,159

Stock based compensation


 



2,763




 






2,763

Balance at June 30, 2017
$
938

 
$
26,701

 
$
352,500

 
$
450,228

 
$
(24,397
)
 
$

 
$
805,970

Balance at January 1, 2018
$
938

 
$
29,953

 
$
503,709

 
$
481,331

 
$
(24,474
)
 
$

 
$
991,457

Comprehensive income
 
 
 
 
 
 
51,147

 
(19,789
)
 


 
31,358

Reclassification of unrealized net gain on equity securities

 
 
 
 
 
 
280

 
(280
)
 
 
 

Cash dividends declared:
 
 
 
 
 
 
 
 


 


 

Series D Preferred, $35.00 per share
 
 
 
 
 
 
(26
)
 
 
 
 
 
(26
)
Common, $0.26 per share
 
 
 

 

(7,946
)
 






(7,946
)
Purchase of 1,761 shares of common stock
 
 
 

 



 



(97
)

(97
)
Issuance of 4,486,850 shares of common stock
 
 
4,485


233,649

 


 



97


238,231

Stock based compensation
 
 
 

2,770




 






2,770

Balance at June 30, 2018
$
938

 
$
34,438

 
$
740,128

 
$
524,786

 
$
(44,543
)
 
$

 
$
1,255,747

 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.
 
 
 
 
 
 
 
 






HEARTLAND FINANCIAL USA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: BASIS OF PRESENTATION

The interim unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and accompanying notes to the consolidated financial statements for the fiscal year ended December 31, 2017, included in the Form 10-K of Heartland Financial USA, Inc. ("Heartland") filed with the Securities and Exchange Commission ("SEC") on February 28, 2018. Footnote disclosures to the interim unaudited consolidated financial statements which would substantially duplicate the disclosure contained in the footnotes to the audited consolidated financial statements have been omitted.

The financial information of Heartland included herein has been prepared in accordance with U.S. generally accepted accounting principles for interim financial reporting and has been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Rule 10-01 of Regulation S-X. Such information reflects all adjustments (consisting of normal recurring adjustments), that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of the interim period ended June 30, 2018, are not necessarily indicative of the results expected for the year ending December 31, 2018.

In the Annual Report on Form 10-K for the year ended December 31, 2017, Heartland reported the results of operations through two business segments: Community and Other Banking and Mortgage Banking. Effective January 1, 2018, the recently restructured mortgage banking segment is no longer a reportable segment due to the significant reduction in infrastructure and the reporting structure of the mortgage sales staff, who currently report directly to the bank president in each market. Accordingly, Heartland is no longer reporting results of operations by segment.






Earnings Per Share

Basic earnings per share is determined using net income available to common stockholders and weighted average common shares outstanding. Diluted earnings per share is computed by dividing net income available to common stockholders by the weighted average common shares and assumed incremental common shares issued. Amounts used in the determination of basic and diluted earnings per share for the three- and six-month periods ended June 30, 2018, and 2017, are shown in the table below:
 
Three Months Ended
June 30,
(Dollars and number of shares in thousands, except per share data)
2018
 
2017
Net income
$
27,879

 
$
21,958

Preferred dividends
(13
)
 
(13
)
Interest expense on convertible preferred debt

 
4

Net income available to common stockholders
$
27,866

 
$
21,949

Weighted average common shares outstanding for basic earnings per share
32,621

 
26,687

Assumed incremental common shares issued upon exercise of stock options and non-vested restricted stock units
210

 
286

Weighted average common shares for diluted earnings per share
32,831

 
26,973

Earnings per common share — basic
$
0.85

 
$
0.82

Earnings per common share — diluted
$
0.85

 
$
0.81

Number of antidilutive common stock equivalents excluded from diluted earnings per share computation

 

 
 
 
 
 
Six Months Ended
June 30,
(Dollars and number of shares in thousands, except per share data)
2018
 
2017
Net income
$
51,147

 
$
39,968

Preferred dividends
(26
)
 
(32
)
Interest expense on convertible preferred debt

 
9

Net income available to common stockholders
$
51,121

 
$
39,945

Weighted average common shares outstanding for basic earnings per share
31,537

 
26,512

Assumed incremental common shares issued upon non-vested restricted stock units
209

 
286

Weighted average common shares for diluted earnings per share
31,746

 
26,798

Earnings per common share — basic
$
1.62

 
$
1.51

Earnings per common share — diluted
$
1.61

 
$
1.49

Number of antidilutive common stock equivalents excluded from diluted earnings per share computation

 


Stock-Based Compensation

Heartland may grant, through its Nominating and Compensation Committee (the "Compensation Committee"), non-qualified and incentive stock options, stock appreciation rights, stock awards, restricted stock, restricted stock units and cash incentive awards, under its 2012 Long-Term Incentive Plan (the "Plan"). The Plan was originally approved by stockholders in May 2012 and was amended effective March 8, 2016, to increase the number of shares of common stock authorized for issuance and make certain other changes to the Plan. As of June 30, 2018, 440,844 shares of common stock were available for issuance under future awards that may be granted under the Plan to employees and directors of, and service providers to, Heartland or its subsidiaries.

Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 718, "Compensation-Stock Compensation" requires the measurement of the cost of employee services received in exchange for an award of equity instruments based upon the fair value of the award on the grant date. The cost of the award is based upon its fair value estimated on the date of grant and recognized in the consolidated statements of income over the vesting period of the award. The fair market value of restricted stock and restricted stock units is based on the fair value of the underlying shares of common stock on the date of grant. The fair value of stock options is estimated on the date of grant using the Black-Scholes model. Forfeitures are accounted for as they occur.

The amount of tax benefit related to the exercise, vesting and forfeiture of equity-based awards reflected as a tax benefit in Heartland's income tax expense was $660,000 and $989,000 during the six months ended June 30, 2018 and 2017, respectively.






Restricted Stock Units
The Plan permits the Compensation Committee to grant restricted stock units ("RSUs"). In the first quarter of 2018, the Compensation Committee granted time-based RSUs with respect to 52,153 shares of common stock, and in the first quarter of 2017, the Compensation Committee granted time-based RSUs with respect to 55,665 shares of common stock to selected officers and employees. The time-based RSUs represent the right, without payment, to receive shares of Heartland common stock on a specified date in the future. The time-based RSUs granted in 2018 vest over three years in equal installments on March 6 of each of the three years following the year of the grant, while the 2017 time-based RSUs vest in equal installments on January 19 of each of the three years following the year of the grant. The time-based RSUs may also vest upon death or disability, upon a change in control or upon a "qualified retirement" (as defined in the RSU agreement). The retiree is required to sign a non-solicitation agreement as a condition to vesting.

In addition to the time-based RSUs referenced in the preceding paragraph, the Compensation Committee granted one-year performance-based RSUs with respect to 18,988 shares of common stock in the first quarter of 2018, and 27,570 shares of common stock in the first quarter of 2017. These performance-based RSUs are earned based on satisfaction of performance targets for the fiscal years ended December 31, 2018, and December 31, 2017, respectively, and then fully vest on a specified date in the third calendar year following the year of the initial grant.

The Compensation Committee also granted three-year performance-based RSUs with respect to 16,108 shares and 9,032 shares of common stock in the first quarter of 2018 and 2017, respectively. These performance-based RSUs will be earned based on satisfaction of performance targets for the three-year performance period ended December 31, 2020, and December 31, 2019, respectively. These performance-based RSUs or a portion thereof may vest in 2021 and 2020, respectively, after measurement of performance in relation to the performance targets.

The one-year and three-year performance-based RSUs vest to the extent that they are earned upon death or disability or upon a "qualified retirement." Upon a change in control, performance-based RSUs shall become vested at 100% of target if the RSU obligations are not assumed by the successor company. If the successor company does assume the RSU obligations, the 2017 and 2018 performance-based RSUs will vest at 100% of target upon a "Termination of Service" within the period beginning six months prior to a change in control and ending twenty-four months after a change in control.

All of Heartland's RSUs will be settled in common stock upon vesting and are not entitled to dividends until vested.

The Compensation Committee may grant RSUs under the Plan to directors as part of their compensation, to new management level employees at commencement of employment, and to other employees and service providers as incentives. During the six months ended June 30, 2018, and June 30, 2017, 26,489 and 15,978 time-based RSUs, respectively, were granted to directors and new employees.

A summary of the RSUs outstanding as of June 30, 2018 and 2017, and changes during the six months ended June 30, 2018 and 2017, follows:
 
2018
 
2017
 
Shares
 
Weighted-Average Grant Date
Fair Value
 
Shares
 
Weighted-Average Grant Date
Fair Value
Outstanding at January 1
301,578

 
$
34.74

 
346,817

 
$
27.61

Granted
113,738

 
55.16

 
108,245

 
47.21

Vested
(124,764
)
 
32.64

 
(125,840
)
 
26.32

Forfeited
(25,011
)
 
45.50

 
(10,563
)
 
31.78

Outstanding at June 30
265,541

 
$
43.49

 
318,659

 
$
34.64


Total compensation costs recorded for RSUs were $2.8 million and $2.8 million for the six-month periods ended June 30, 2018 and 2017. As of June 30, 2018, there were $6.2 million of total unrecognized compensation costs related to the Plan for RSUs that are expected to be recognized through 2021.






Options
Although the Plan provides authority to the Compensation Committee to grant stock options, no options were granted during the first six months of 2018 and 2017. Prior to 2009, options were typically granted annually with an expiration date ten years after the date of grant. Vesting was generally over a five-year service period with equal portions of a grant becoming exercisable at three years, four years, and five years after the date of grant. A summary of the stock options outstanding as of June 30, 2018 and 2017, and changes during the six months ended June 30, 2018 and 2017, follows:
 
2018
 
2017
 
Shares
 
Weighted-Average
Exercise Price
 
Shares
 
Weighted-Average
Exercise Price
Outstanding at January 1
6,500

 
$
18.60

 
26,400

 
$
18.60

Granted

 

 

 

Exercised
(6,500
)
 
18.60

 
(8,250
)
 
18.60

Forfeited

 

 
(500
)
 
18.60

Outstanding at June 30

 
$

 
17,650

 
$
18.60

Options exercisable at June 30

 
$

 
17,650

 
$
18.60


The intrinsic value for the total of all options exercised during the six months ended June 30, 2018, was $231,000. Cash received from options exercised was $121,000 for the six months ended June 30, 2018, and $153,000 for the six months ended June 30, 2017.

No compensation costs were recorded for options during the six month periods ended June 30, 2018 and 2017. There are no unrecorded compensation costs related to options at June 30, 2018. No stock options vested during the six-month periods ended June 30, 2018 and 2017.

Subsequent Events - Heartland has evaluated subsequent events that may require recognition or disclosure through the filing date of this Quarterly Report on Form 10-Q with the SEC.

Effect of New Financial Accounting Standards

In May 2014, the FASB issued Accounting Standards Update ("ASU") 2014-09, "Revenue from Contracts with Customers." The amendment clarifies the principles for recognizing revenue and develops a common revenue standard. The amendment outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that "an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services." In applying the revenue model to contracts within its scope, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance does not apply to certain contracts within the scope of other ASC Topics, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantees other than product or service warranties and nonmonetary exchanges between entities in the same line of business to facilitate sales to customers. Heartland evaluates noninterest income contracts affected by the new guidance by analyzing contracts and current accounting practices to determine if a change is appropriate. The amendment is largely consistent with existing guidance and current practices. Heartland adopted the accounting standard effective January 1, 2018, as required, using a modified retrospective approach. However, the adoption of these amendments did not have a significant effect on Heartland's results of operations, financial position and liquidity other than expanded disclosure requirements. See Note 9, "Revenue," for further details regarding Heartland's revenue.

In January 2016, the FASB issued guidance ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities." The amendments in ASU 2016-01 to Subtopic 825-10, Financial Instruments, contain the following elements: (1) require equity investments to be measured at fair value with changes in fair value recognized in net income; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (3) eliminates the requirement for public entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (4) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (5) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability





at fair value in accordance with the fair value option for financial instruments; (6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or accompanying notes to the financial statements; and (7) clarifies that the entity should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale securities in combination with the entity's other deferred tax assets. The amendments are effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. Except for the early application of the amendment noted in item (5) above, early adoption of the amendments in this update is not permitted. Entities are required to and Heartland applied the amendment by means of a cumulative-effect adjustment as of the beginning of the fiscal year of adoption, with the exception of the amendment related to equity securities without readily determinable fair values, which are to be applied prospectively to equity investments that exist as of the adoption date. Heartland adopted the accounting standard on January 1, 2018, as required, and the adoption of these amendments did not have a material impact on its results of operations, financial position and liquidity. Heartland reclassified $280,000 from accumulated other comprehensive income to retained earnings on January 1, 2018, related to the fair value of its equity investments.

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." Topic 842 requires a lessee to recognize leases on-balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as financing or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The amendment is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and will be applied on a modified retrospective basis. Heartland leases certain properties and equipment under operating leases that will result in recognition of lease assets and lease liabilities on the consolidated balance sheets under the ASU; however the majority of Heartland's properties and equipment are owned, not leased. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset. Early adoption is permitted. In January 2018, the FASB issued an amendment to provide entities with the optional practical expedient to not evaluate existing or expired land easements that were previously not accounted for as leases under Topic 840. Heartland intends to adopt the accounting standard in 2019, as required, and does not expect the adoption of this standard to have a significant impact on its results of operations, financial position and liquidity. Heartland has signed an agreement with a cloud-based lease software provider, and implementation of the software started in the first quarter of 2018.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326)." The amendments in this ASU require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The amendments in this ASU indicate that an entity should not use the length of time a security has been in an unrealized loss position to avoid recording a credit loss. In addition, in determining whether a credit loss exists, the amendments in this ASU also remove the requirements to consider the historical and implied volatility of the fair value of a security and recoveries or declines in fair value after the balance sheet date. The amendment is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. An entity may adopt the amendments earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Heartland intends to adopt the accounting standard in 2020, as required, and is currently evaluating the potential impact of this guidance on its results of operations, financial position and liquidity. Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective. Heartland has formed an internal committee to assess and implement the standard, and Heartland has entered into an agreement with a third party vendor to evaluate potential methodologies and data.

In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments." The amendments in this update address eight specific cash flow issues with the objective of reducing the existing diversity in practice. The amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes the interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments in this update should be applied using a retrospective transition method to each period presented. Heartland adopted this ASU on January 1, 2018, as required, and the adoption of these amendments did not have a material impact on Heartland's results of operations, financial position and liquidity.

In October 2016, the FASB issued ASU 2016-16, "Income Taxes (Topic 740) - Intra-Entity Transfer of Assets Other Than Inventory." The amendment requires an entity to recognize income tax consequences on an intra-entity transfer of an asset other than inventory at the time the transaction occurs. The amendment is effective for fiscal years beginning after December 15, 2017, including





interim periods within those fiscal years. The amendments must be applied and Heartland applied these amendments using a modified retrospective basis. Heartland adopted this ASU on January 1, 2018, as required, and the adoption of this amendment did not have a material impact on Heartland's results of operations, financial position and liquidity.

In January 2017, the FASB issued ASU No. 2017-01, "Business Combinations (Topic 805): Clarifying the Definition of a Business," which narrows the definition of a business and provides a framework that gives entities a basis for making reasonable judgments about whether a transaction involves an asset or a business. ASU 2017-01 is effective for public business entities in annual periods beginning after December 15, 2017, including interim periods therein. Heartland adopted ASU 2017-01 on January 1, 2018, as required, and the adoption did not have a material impact on Heartland's results of operations, financial position, and liquidity.

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350)." This amendment is to simplify the subsequent measurement of goodwill by eliminating step two from the goodwill impairment test. Instead, an entity will perform only step one of its quantitative goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and then recognizing the impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized cannot exceed the total amount of goodwill allocated to that reporting unit. An entity will still have the option to perform a qualitative assessment for a reporting unit to determine if the quantitative step one impairment test is necessary. This amendment is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019, and should be applied prospectively. Early adoption is permitted, including in an interim period for impairment tests performed after January 1, 2017. Heartland intends to adopt this ASU in the third quarter of 2020, consistent with the annual impairment test as of September 30, 2020, and is currently evaluating the potential impact of this guidance on its results of operations, financial position and liquidity.

In March 2017, the FASB issued ASU 2017-08, "Receivables - Nonrefundable Fee and Other Costs (Subtopic 310-20)." These amendments shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount. Discounts continue to be amortized to maturity. These amendments are effective for public business entities for fiscal years and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If any entity early adopts the amendments in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes the interim period. The amendments must be applied and Heartland intends to apply these amendments on a modified retrospective basis, with a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Heartland intends to adopt this ASU in 2019, as required, and is currently evaluating the potential impact on its results of operations, financial position and liquidity.

In May 2017, the FASB issued ASU 2017-09, "Compensation - Stock Compensation (Topic 718)." The amendments provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. An entity should account for the effects of a modification unless all the following are met: (1) the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification; (2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and (3) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The amendments are effective for annual periods and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim periods for public business entities for reporting periods for which financial statements have not yet been issued. The amendments should be applied and Heartland applied these amendments prospectively to an award modified on or after the adoption date. Heartland adopted this ASU on January 1, 2018, as required, and the adoption did not have a material impact to its results of operations, financial position and liquidity because Heartland has not typically modified share-based payment awards after the original award has been granted.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities." The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. ASU 2017-12 is effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. ASU 2017-12 requires a modified retrospective transition method in which Heartland will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the consolidated balance sheet as of the date of adoption. Heartland intends to adopt this ASU in 2019, as required, and does not believe there will be a material impact to its results of operations, financial position and liquidity.






In February 2018, the FASB issued ASU 2018-02, "Income Statement-Reporting Comprehensive Income (Topic 220)." This ASU allows for the option to reclassify from accumulated other comprehensive income ("AOCI") to retained earnings for stranded tax effects resulting from the newly enacted federal corporate income tax rate in the Tax Cuts and Jobs Act of 2017, which was enacted on December 22, 2017. The legislation included a reduction to the corporate income tax rate from 35 percent to 21 percent effective January 1, 2018. The amount of the reclassification would be the difference between the historical corporate income tax rate and the newly enacted 21 percent corporate income tax rate. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for public businesses for reporting periods for which financial statements have not yet been issued. Heartland adopted the guidance as of December 31, 2017. The adoption of this ASU was accounted for as a cumulative-effect adjustment to the balance sheet resulting in a $4.5 million increase to retained earnings and a corresponding decrease to AOCI on December 31, 2017.

NOTE 2: ACQUISITIONS

First Bank Lubbock Bancshares, Inc.
On May 18, 2018, Heartland completed the acquisition of Lubbock, Texas based First Bank Lubbock Bancshares, Inc. ("FBLB"), parent company of First Bank & Trust, and PrimeWest Mortgage Corporation, which is a wholly-owned subsidiary of First Bank & Trust. Under the terms of the definitive merger agreement, Heartland acquired FBLB in a transaction valued at approximately $189.9 million, of which $5.5 million was cash, and the remainder was settled by delivery of 3,350,664 shares of Heartland common stock. On the closing date, in addition to this merger consideration, Heartland provided FBLB the funds necessary to repay outstanding debt of $3.9 million, and Heartland assumed $8.2 million of trust preferred securities at fair value. Immediately after the close of the transaction, Heartland paid $13.3 million to the holders of FBLB's stock appreciation rights. The transaction included, at fair value, total assets of $1.12 billion, including $681.1 million of gross loans held to maturity, and deposits of $893.8 million. Upon closing of the transaction, First Bank & Trust became a wholly-owned subsidiary of Heartland and continues to operate under its current name and management team as Heartland's eleventh state-chartered bank. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of FBLB.





The assets and liabilities of FBLB were recorded on the consolidated balance sheet at the estimated fair value on the acquisition date. The following table represents, in thousands, the amounts recorded on the consolidated balance sheet as of May 18, 2018:
 
As of May 18, 2018
Fair value of consideration paid:
 
Common stock (3,350,664 shares)
$
184,454

Cash
5,451

Total consideration paid
189,905

Fair value of assets acquired
 
Cash and cash equivalents
212,105

Securities:
 
Carried at fair value
1,788

Other securities
3,268

Loans held for sale
31,050

Loans held to maturity
681,080

Premises, furniture and equipment, net
23,271

Other real estate, net
379

Mortgage servicing rights
6,995

Core deposit intangibles and customer relationships, net
13,908

Cash surrender value on life insurance
14,997

Other assets
7,185

Total assets
996,026

Fair value of liabilities assumed
 
Deposits
893,827

Other borrowings
12,077

Other liabilities
21,580

Total liabilities assumed
927,484

Fair value of net assets acquired
68,542

Goodwill resulting from acquisition
$
121,363

Heartland recognized $121.4 million of goodwill in conjunction with the acquisition of FBLB, which is calculated as the excess of both the consideration exchanged and the liabilities assumed as compared to the fair value of identifiable assets acquired. Goodwill resulted from the expected operational synergies, enhanced market area, cross-selling opportunities and expanded business lines. See Note 6 for further information on goodwill.

Pro Forma Information (unaudited): The following pro forma information represents the results of operations for the six-month
periods ended June 30, 2018, and 2017, as if the FBLB acquisition occurred on January 1, 2018, and January 1, 2017, respectively:
(Dollars in thousands, except per share data), unaudited
For the Six Months Ended
 
June 30, 2018
 
June 30, 2017
Net interest income
$
207,168

 
$
163,837

Net income available to common stockholders
$
35,378

 
$
48,817

Basic earnings per share
$
1.04

 
$
1.63

Diluted earnings per share
$
1.03

 
$
1.62


The above pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the merged companies that would have been achieved had the acquisition occurred on January 1, 2018, and January 1, 2017, respectively, nor are they intended to represent or be indicative of future results of operations. The pro forma results do not include expected operating cost savings as a result of the acquisition or adjustments for $6.0 million of transaction costs or $13.3 million of stock appreciation rights expense recorded by FBLB in 2018 prior to the acquisition. The pro forma





results also do not include adjustment for income taxes. These pro forma results require significant estimates and judgments particularly with respect to valuation and accretion of income associated with the acquired loans.

Heartland incurred $1.1 million of pre-tax merger related expenses in the six months ended June 30, 2018, associated with the FBLB acquisition. The merger expenses are reflected on the consolidated statements of income for the applicable period and are reported primarily in the categories of professional fees and other noninterest expenses.

Acquired loans were preliminarily recorded at fair value based on a discounted cash flow valuation methodology that considers, among other things, projected default rates, loss given defaults and recovery rates. No allowance for credit losses was carried over from the acquisition. The balance of nonaccrual loans on the acquisition date was $7.6 million.

Signature Bancshares, Inc.
On February 23, 2018, Heartland completed the acquisition of Signature Bancshares, Inc., parent company of Signature Bank, headquartered in Minnetonka, Minnesota. Under the terms of the definitive merger agreement, Heartland acquired Signature Bancshares, Inc. in a transaction valued at approximately $61.4 million, of which $7.8 million was cash, and the remainder was settled by delivery of 1,000,843 shares of Heartland common stock. Simultaneous with the close, Signature Bank merged into Heartland's wholly-owned Minnesota Bank & Trust subsidiary, and the combined entity operates under the Minnesota Bank & Trust brand name. The transaction included, at fair value, total assets of $427.1 million, including $324.5 million of gross loans held to maturity, and deposits of $357.3 million. On the closing date, Heartland provided Signature Bancshares, Inc. the funds necessary to repay outstanding subordinated debt of $5.9 million. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of Signature Bancshares, Inc.

Citywide Banks of Colorado, Inc.
On July 7, 2017, Heartland acquired Citywide Banks of Colorado, Inc., parent company of Citywide Banks, headquartered in Aurora, Colorado. The transaction consideration was approximately $211.2 million, of which $58.6 million was cash, and the remainder was settled by delivery of 3,216,161 shares of Heartland common stock. Simultaneous with the close, Citywide Banks merged into Heartland's Centennial Bank and Trust subsidiary, and the combined entity operates as Citywide Banks. The transaction included, at fair value, total assets of $1.49 billion, including $985.4 million of net loans outstanding, and $1.21 billion of deposits on the acquisition date. Included in this transaction was one bank building with a fair value of $1.4 million that Heartland intends to sell and is classified as premises, furniture and equipment held for sale on the consolidated balance sheets. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of Citywide Banks of Colorado, Inc.
Founders Bancorp
On February 28, 2017, Heartland acquired Founders Bancorp, parent company of Founders Community Bank, based in San Luis Obispo, California. The purchase price was approximately $31.0 million, which was paid by delivery of 455,877 shares of Heartland common stock and cash of $8.4 million. The transaction included, at fair value, total assets of $213.9 million, loans of $96.4 million, and deposits of $181.5 million on the acquisition date. The transaction also included one bank building with a fair value of $576,000 that Heartland sold during the second quarter of 2017. Simultaneous with the closing of the transaction, Founders Community Bank merged into Heartland's Premier Valley Bank subsidiary. The transaction was a tax-free reorganization with respect to the stock consideration received by the stockholders of Founders Bancorp.






NOTE 3: SECURITIES

The amortized cost, gross unrealized gains and losses, and estimated fair values of debt securities available for sale and equity securities with a readily determinable that are carried at fair value as of June 30, 2018, and December 31, 2017, are summarized in the table below, in thousands:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
June 30, 2018
 
 
 
 
 
 
 
U.S. government corporations and agencies
$
20,273

 
$
1

 
$
(86
)
 
$
20,188

Mortgage and asset-backed securities
1,834,569

 
1,916

 
(52,754
)
 
1,783,731

Obligations of states and political subdivisions
386,272

 
781

 
(10,789
)
 
376,264

Total debt securities
2,241,114

 
2,698

 
(63,629
)
 
2,180,183

Equity securities with a readily determinable fair value
16,934

 

 

 
16,934

Total
$
2,258,048

 
$
2,698

 
$
(63,629
)
 
$
2,197,117

December 31, 2017
 
 
 
 
 
 
 
U.S. government corporations and agencies
$
5,358

 
$
8

 
$
(38
)
 
$
5,328

Mortgage and asset-backed securities
1,785,467

 
5,856

 
(37,587
)
 
1,753,736

Obligations of states and political subdivisions
441,060

 
4,669

 
(4,714
)
 
441,015

Total debt securities
2,231,885


10,533


(42,339
)

2,200,079

Equity securities
16,296

 
378

 

 
16,674

Total
$
2,248,181

 
$
10,911

 
$
(42,339
)
 
$
2,216,753

Investment securities as shown in this report reflect categories as required by Heartland’s adoption of ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities", on January 1, 2018. That new guidance refined the definition of equity securities and required their segregation from available for sale debt securities.
While changes in the fair value of available for sale debt securities continue to be recorded in the equity category of accumulated other comprehensive income, the new guidance requires changes in the fair value of equity securities to be recorded in current earnings. As required by the new guidance, the unrealized gain in fair value on equity securities (recorded in accumulated other comprehensive income at December 31, 2017) was reclassified to retained earnings on January 1, 2018. The amount of the reclassification was $280,000, net of tax.
Equity securities include money market accounts that totaled $16.9 million at cost and $16.9 million at fair value at June 30, 2018. The portion of unrealized net gains on equity securities recognized in current earnings during the first six months of 2018, which related to securities still held at June 30, 2018, totaled $43,000.
The amortized cost, gross unrealized gains and losses and estimated fair values of held to maturity securities as of June 30, 2018, and December 31, 2017, are summarized in the table below, in thousands:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
June 30, 2018
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
244,271

 
$
9,669

 
$
(787
)
 
$
253,153

Total
$
244,271

 
$
9,669

 
$
(787
)
 
$
253,153

December 31, 2017
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
253,550

 
$
12,460

 
$
(516
)
 
$
265,494

Total
$
253,550

 
$
12,460

 
$
(516
)
 
$
265,494


At June 30, 2018, approximately 66% of Heartland's mortgage and asset-backed securities were issued by government-sponsored enterprises.






The amortized cost and estimated fair value of debt securities carried at fair value at June 30, 2018, by contractual maturity, are as follows, in thousands. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties.
 
June 30, 2018
 
Amortized Cost
 
Estimated Fair Value
Due in 1 year or less
$
18,467

 
$
18,422

Due in 1 to 5 years
56,798

 
56,473

Due in 5 to 10 years
123,063

 
118,857

Due after 10 years
208,217

 
202,700

Total debt securities
406,545

 
396,452

Mortgage and asset-backed securities
1,834,569

 
1,783,731

Total investment securities
$
2,241,114

 
$
2,180,183


The amortized cost and estimated fair value of debt securities held to maturity at June 30, 2018, by contractual maturity, are as follows, in thousands. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties.
 
June 30, 2018
 
Amortized Cost
 
Estimated Fair Value
Due in 1 year or less
$
1,359

 
$
1,383

Due in 1 to 5 years
27,074

 
27,651

Due in 5 to 10 years
104,305

 
106,680

Due after 10 years
111,533

 
117,439

Total investment securities
$
244,271

 
$
253,153


As of June 30, 2018, and December 31, 2017, securities with a fair value of $572.5 million and $670.3 million, respectively, were pledged to secure public and trust deposits, short-term borrowings and for other purposes as required or permitted by law.

Gross gains and losses realized related to the sales of securities carried at fair value for the three- and six-month periods ended June 30, 2018 and 2017, are summarized as follows, in thousands:
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Proceeds from sales
$
243,489

 
$
402,371

 
$
635,735

 
$
624,008

Gross security gains
457

 
2,667

 
3,470

 
6,497

Gross security losses
716

 
1,275

 
2,288

 
2,614


The following tables summarize, in thousands, the amount of unrealized losses, defined as the amount by which cost or amortized cost exceeds fair value, and the related fair value of investments with unrealized losses in Heartland's securities portfolio as of June 30, 2018, and December 31, 2017. The investments were segregated into two categories: those that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or more. The reference point for determining how long an investment was in an unrealized loss position was June 30, 2017, and December 31, 2016, respectively. Securities for which Heartland has taken credit-related other-than-temporary impairment ("OTTI") write-downs are categorized as being "less than 12 months" or "12 months or longer" in a continuous loss position based on the point in time that the fair value declined to below the cost basis and not the period of time since the credit-related OTTI write-down.





Debt securities available for sale
Less than 12 months
 
12 months or longer
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. government corporations and agencies
$
19,687

 
$
(86
)
 
$

 
$

 
$
19,687

 
$
(86
)
Mortgage and asset-backed securities
1,142,205

 
(20,824
)
 
430,160

 
(31,930
)
 
1,572,365

 
(52,754
)
Obligations of states and political subdivisions
198,005

 
(3,696
)
 
131,780

 
(7,093
)
 
329,785

 
(10,789
)
Total temporarily impaired securities
$
1,359,897

 
$
(24,606
)
 
$
561,940

 
$
(39,023
)
 
$
1,921,837

 
$
(63,629
)
December 31, 2017
U.S. government corporations and agencies
$
4,819

 
$
(38
)
 
$

 
$

 
$
4,819

 
$
(38
)
Mortgage and asset-backed securities
851,070

 
(11,533
)
 
399,978

 
(26,054
)
 
1,251,048

 
(37,587
)
Obligations of states and political subdivisions
93,040

 
(667
)
 
159,180

 
(4,047
)
 
252,220

 
(4,714
)
Total temporarily impaired securities
$
948,929

 
$
(12,238
)
 
$
559,158

 
$
(30,101
)
 
$
1,508,087

 
$
(42,339
)

Securities held to maturity
Less than 12 months
 
12 months or longer
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
26,942

 
$
(261
)
 
$
7,889

 
$
(526
)
 
$
34,831

 
$
(787
)
Total temporarily impaired securities
$
26,942

 
$
(261
)
 
$
7,889

 
$
(526
)
 
$
34,831

 
$
(787
)
December 31, 2017
Obligations of states and political subdivisions
$
8,512

 
$
(49
)
 
$
8,989

 
$
(467
)
 
$
17,501

 
$
(516
)
Total temporarily impaired securities
$
8,512

 
$
(49
)
 
$
8,989

 
$
(467
)
 
$
17,501

 
$
(516
)

Heartland reviews the investment securities portfolio on a quarterly basis to monitor its exposure to OTTI. A determination as to whether a security's decline in fair value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Some factors Heartland may consider in the OTTI analysis include the length of time the security has been in an unrealized loss position, changes in security ratings, financial condition of the issuer, as well as security and industry specific economic conditions. In addition, with regard to debt securities, Heartland may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds and the value of any underlying collateral. For certain debt securities in unrealized loss positions, Heartland prepares cash flow analyses to compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

The remaining unrealized losses on Heartland's mortgage and asset-backed securities are the result of changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities. The losses are not related to concerns regarding the underlying credit of the issuers or the underlying collateral. It is expected that the securities will not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because Heartland has the intent and ability to hold these investments until a market price recovery or to maturity and does not believe it will be required to sell the securities before maturity, these investments are not considered other-than-temporarily impaired.

The remaining unrealized losses on Heartland's obligations of states and political subdivisions are the result of changes in market interest rates or widening of market spreads subsequent to the initial purchase of the securities. Management monitors the published credit ratings of these securities and the stability of the underlying municipalities. Because the decline in fair value is attributable to changes in interest rates or widening market spreads due to insurance company downgrades and not underlying credit quality, and because Heartland has the intent and ability to hold these investments until a market price recovery or to maturity and does not believe it will be required to sell the securities before maturity, these investments are not considered other-than-temporarily impaired.






There were no gross realized gains or losses on the sale of securities carried at fair value or held to maturity securities with OTTI write-downs for the six-month periods ended June 30, 2018, and June 30, 2017, respectively.

Other investments, at cost, include equity securities without a readily determinable fair value. Equity securities without a readily determinable fair value totaled $22.4 million and $18.6 million at June 30, 2018, and December 31, 2017, respectively. At June 30, 2018, and December 31, 2017, other investments at cost included shares of stock in the Federal Home Loan Banks (the "FHLBs") of Des Moines, Chicago, Dallas, San Francisco and Topeka at an amortized cost of $15.5 million and $14.0 million, respectively.

The Heartland banks are required by federal law to maintain FHLB stock as members of the various FHLBs. These equity securities are "restricted" in that they can only be sold back to the respective institutions from which they were acquired or another member institution at par. Therefore, the FHLB stock is less liquid than other marketable equity securities, and the fair value approximates amortized cost. Heartland considers its FHLB stock as a long-term investment that provides access to competitive products and liquidity. Heartland evaluates impairment in these investments based on the ultimate recoverability of the par value and, at June 30, 2018, did not consider the investments to be other than temporarily impaired.

NOTE 4: LOANS

Loans as of June 30, 2018, and December 31, 2017, were as follows, in thousands:
 
June 30, 2018
 
December 31, 2017
Loans receivable held to maturity:
 
 
 
Commercial
$
2,034,240

 
$
1,646,606

Commercial real estate
3,686,898

 
3,163,269

Agricultural and agricultural real estate
562,353

 
511,588

Residential real estate
683,051

 
624,279

Consumer
512,899

 
447,484

Gross loans receivable held to maturity
7,479,441

 
6,393,226

Unearned discount
(1,420
)
 
(556
)
Deferred loan fees
(324
)
 
(1,206
)
Total net loans receivable held to maturity
7,477,697

 
6,391,464

Allowance for loan losses
(61,324
)
 
(55,686
)
Loans receivable, net
$
7,416,373

 
$
6,335,778


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. 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 14% 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, 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, 2018, and December 31, 2017, 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 2018.
 
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, 2018
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
2,821

 
$
17,888

 
$
20,709

 
$
14,072

 
$
2,020,168

 
$
2,034,240

Commercial real estate
212

 
23,515

 
23,727

 
13,164

 
3,673,734

 
3,686,898

Agricultural and agricultural real estate
1,648

 
4,061

 
5,709

 
20,887

 
541,466

 
562,353

Residential real estate
310

 
1,547

 
1,857

 
25,481

 
657,570

 
683,051

Consumer
1,445

 
7,877

 
9,322

 
8,857

 
504,042

 
512,899

Total
$
6,436

 
$
54,888

 
$
61,324

 
$
82,461

 
$
7,396,980

 
$
7,479,441

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


The following table presents nonaccrual loans, accruing loans past due 90 days or more and performing troubled debt restructured loans at June 30, 2018, and December 31, 2017, in thousands:
 
June 30, 2018
 
December 31, 2017
Nonaccrual loans
$
64,980

 
$
58,272

Nonaccrual troubled debt restructured loans
4,396

 
4,309

Total nonaccrual loans
$
69,376

 
$
62,581

Accruing loans past due 90 days or more
$
54

 
$
830

Performing troubled debt restructured loans
$
4,012

 
$
6,617







The following tables provide information on troubled debt restructured loans that were modified during the three- and six-month periods ended June 30, 2018, and June 30, 2017, dollars in thousands:
 
Three Months Ended
June 30,
 
2018
 
2017
 
Number
of Loans
 
Pre-
Modification
Recorded
Investment
 
Post-
Modification
Recorded
Investment
 
Number
of Loans
 
Pre-
Modification
Recorded
Investment
 
Post-
Modification
Recorded
Investment
Commercial

 
$

 
$

 
3

 
$
131

 
$
131

Commercial real estate

 

 

 

 

 

Total commercial and commercial real estate

 

 

 
3


131

 
131

Agricultural and agricultural real estate

 

 

 

 

 

Residential real estate
6

 
1,292

 
1,125

 
11

 
1,455

 
1,455

Consumer

 

 

 

 

 

Total
6

 
$
1,292

 
$
1,125

 
14


$
1,586

 
$
1,586

 
Six Months Ended
June 30,
 
2018
 
2017
 
Number
of Loans
 
Pre-
Modification
Recorded
Investment
 
Post-
Modification
Recorded
Investment
 
Number
of Loans
 
Pre-
Modification
Recorded
Investment
 
Post-
Modification
Recorded
Investment
Commercial

 
$

 
$

 
3

 
$
131

 
$
131

Commercial real estate

 

 

 

 

 

Total commercial and commercial real estate

 

 

 
3

 
131

 
131

Agricultural and agricultural real estate

 

 

 

 

 

Residential real estate
11

 
2,169

 
1,877

 
14

 
1,803

 
1,803

Consumer

 

 

 

 

 

Total
11

 
$
2,169

 
$