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Section 1: 10-Q (10-Q)

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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 September 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 every Interactive Data File required to be submitted 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 ¨
 
 
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 November 2, 2018, the Registrant had outstanding 34,473,352 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)
 
 
 
 
September 30, 2018 (Unaudited)
 
December 31, 2017
ASSETS
 
 
 
Cash and due from banks
$
196,847

 
$
168,723

Interest bearing deposits with the Federal Reserve Bank and other banks and other short-term investments
240,528

 
27,280

Cash and cash equivalents
437,375

 
196,003

Time deposits in other financial institutions
5,836

 
9,820

Securities:
 
 

Carried at fair value (cost of $2,342,977 at September 30, 2018, and $2,248,181 at December 31, 2017)
2,274,215

 
2,216,753

Held to maturity, at cost (fair value of $247,394 at September 30, 2018, and $265,494 at December 31, 2017)
239,908

 
253,550

Other investments, at cost
26,656

 
22,563

Loans held for sale
77,727

 
44,560

Loans receivable:
 
 

Held to maturity
7,365,493

 
6,391,464

Allowance for loan and lease losses
(61,221
)
 
(55,686
)
Loans receivable, net
7,304,272

 
6,335,778

Premises, furniture and equipment, net
193,802

 
172,324

Premises, furniture and equipment held for sale
4,422

 
1,977

Other real estate, net
11,908

 
10,777

Goodwill
391,668

 
236,615

Core deposit intangibles and customer relationship intangibles, net
50,071

 
35,203

Servicing rights, net
32,039

 
25,857

Cash surrender value on life insurance
162,216

 
142,818

Other assets
123,017

 
106,141

TOTAL ASSETS
$
11,335,132

 
$
9,810,739

LIABILITIES AND EQUITY
 
 
 
LIABILITIES:
 
 
 
Deposits:
 
 
 
Demand
$
3,427,819

 
$
2,983,128

Savings
4,958,430

 
4,240,328

Time
1,125,914

 
923,453

Total deposits
9,512,163

 
8,146,909

Deposits held for sale
50,312

 

Short-term borrowings
131,139

 
324,691

Other borrowings
277,563

 
285,011

Accrued expenses and other liabilities
83,562

 
62,671

TOTAL LIABILITIES
10,054,739

 
8,819,282

STOCKHOLDERS' EQUITY:
 
 
 
Preferred stock (par value $1 per share; authorized 17,604 shares; none issued or outstanding at both September 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 September 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 September 30, 2018, and December 31, 2017, none issued or outstanding at both September 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 September 30, 2018, and December 31, 2017; none issued or outstanding at September 30, 2018, and 745 shares issued and outstanding at December 31, 2017)

 
938

Common stock (par value $1 per share; 40,000,000 shares authorized at both September 30, 2018, and December 31, 2017; issued 34,473,029 shares at September 30, 2018, and 29,953,356 shares at December 31, 2017)
34,473

 
29,953

Capital surplus
742,080

 
503,709

Retained earnings
553,662

 
481,331

Accumulated other comprehensive loss
(49,822
)
 
(24,474
)
Treasury stock at cost (0 shares at both September 30, 2018, and December 31, 2017)

 

TOTAL STOCKHOLDERS' EQUITY
1,280,393

 
991,457

TOTAL LIABILITIES AND EQUITY
$
11,335,132

 
$
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
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
INTEREST INCOME:
 
 
 
 
 
 
 
Interest and fees on loans
$
105,733

 
$
82,906

 
$
288,171

 
$
217,898

Interest on securities:
 
 
 
 
 
 
 
Taxable
14,433

 
10,394

 
38,280

 
27,246

Nontaxable
3,490

 
5,086

 
10,653

 
15,297

Interest on federal funds sold

 
34

 

 
37

Interest on interest bearing deposits in other financial institutions
1,238

 
558

 
2,413

 
1,112

TOTAL INTEREST INCOME
124,894

 
98,978

 
339,517


261,590

INTEREST EXPENSE:
 
 
 
 
 
 
 
Interest on deposits
10,092

 
5,073

 
23,841

 
12,966

Interest on short-term borrowings
464

 
271

 
1,279

 
498

Interest on other borrowings (includes $242 and $308 of interest expense related to derivatives reclassified from accumulated other comprehensive income for the three months ended September 30, 2018 and 2017, respectively, and $469 and $1,005 of interest expense related to derivatives reclassified from accumulated other comprehensive income for the nine months ended September 30, 2018 and 2017, respectively)
3,660

 
3,790

 
10,726

 
10,674

TOTAL INTEREST EXPENSE
14,216

 
9,134

 
35,846


24,138

NET INTEREST INCOME
110,678

 
89,844

 
303,671


237,452

Provision for loan losses
5,238

 
5,705

 
14,332

 
10,235

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
105,440

 
84,139

 
289,339


227,217

NONINTEREST INCOME:
 
 
 
 
 
 
 
Service charges and fees
12,895

 
10,138

 
35,046

 
29,291

Loan servicing income
1,670

 
1,161

 
5,231

 
4,236

Trust fees
4,499

 
3,872

 
13,794

 
11,482

Brokerage and insurance commissions
1,111

 
950

 
2,895

 
2,962

Securities gains/(losses), net (includes $145 of net security losses and $1,679 of net security gains reclassified from accumulated other comprehensive income for the three months ended September 30, 2018 and 2017, respectively, and $1,037 and $5,553 of net security gains reclassified from accumulated other comprehensive income for the nine months ended September 30, 2018 and 2017, respectively)
(145
)
 
1,679

 
1,037

 
5,553

Unrealized gain on equity securities, net
54

 

 
97

 

Net gains on sale of loans held for sale
7,410

 
4,997

 
18,261

 
17,961

Valuation allowance on servicing rights
230

 
5

 
12

 
29

Income on bank owned life insurance
892

 
766

 
2,206

 
2,039

Other noninterest income
1,149

 
1,409

 
3,536

 
2,941

TOTAL NONINTEREST INCOME
29,765

 
24,977

 
82,115


76,494

NONINTEREST EXPENSES:
 
 
 
 
 
 
 
Salaries and employee benefits
49,921

 
45,225

 
149,389

 
128,118

Occupancy
6,348

 
6,223

 
18,706

 
16,352

Furniture and equipment
3,470

 
2,826

 
9,403

 
7,913

Professional fees
11,681

 
8,450

 
30,088

 
24,342

FDIC insurance assessments
1,119

 
894

 
2,792

 
2,610

Advertising
2,754

 
1,358

 
6,839

 
5,141

Core deposit intangibles and customer relationship intangibles amortization
2,626

 
1,863

 
6,763

 
4,252

Other real estate and loan collection expenses
784

 
581

 
2,464

 
1,774

Loss on sales/valuations of assets, net
912

 
1,342

 
2,243

 
1,642

Restructuring expenses

 

 
2,564

 

Other noninterest expenses
12,924

 
9,997

 
33,816

 
27,653

TOTAL NONINTEREST EXPENSES
92,539

 
78,759

 
265,067


219,797

INCOME BEFORE INCOME TAXES
42,666

 
30,357

 
106,387


83,914

Income taxes (includes $(26) and $511 of income tax expense/(benefit) reclassified from accumulated other comprehensive income for the three months ended September 30, 2018 and 2017, respectively, and $174 and $1,696 of income tax expense/(benefit) reclassified from accumulated other comprehensive income for the nine months ended September 30, 2018 and 2017, respectively)
8,956

 
8,725

 
21,530

 
22,314

NET INCOME
33,710

 
21,632

 
84,857


61,600

Preferred dividends
(13
)
 
(13
)
 
(39
)
 
(45
)
Interest expense on convertible preferred debt

 
3

 

 
12

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
$
33,697

 
$
21,622

 
$
84,818


$
61,567

EARNINGS PER COMMON SHARE - BASIC
$
0.98

 
$
0.73

 
$
2.61

 
$
2.23

EARNINGS PER COMMON SHARE - DILUTED
$
0.97

 
$
0.72

 
$
2.59

 
$
2.21

CASH DIVIDENDS DECLARED PER COMMON SHARE
$
0.14

 
$
0.11

 
$
0.40

 
$
0.33

 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.
 
 
 
 
 
 
 





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
NET INCOME
$
33,710

 
$
21,632

 
$
84,857

 
$
61,600

OTHER COMPREHENSIVE INCOME (LOSS)
 
 
 
 
 
 
 
Securities:
 
 
 
 
 
 
 
Net change in unrealized gain (loss) on securities
(8,060
)
 
6,940

 
(36,395
)
 
22,002

Reclassification adjustment for net (gains)/losses realized in net income
145

 
(1,679
)
 
(1,037
)
 
(5,553
)
Income taxes
2,078

 
(2,084
)
 
9,586

 
(6,433
)
Other comprehensive income (loss) on securities
(5,837
)
 
3,177

 
(27,846
)
 
10,016

Derivatives used in cash flow hedging relationships:
 
 
 
 
 
 
 
Net change in unrealized gain (loss) on derivatives
395

 
17

 
2,991

 
(656
)
Reclassification adjustment for net losses on derivatives realized in net income
242

 
308

 
469

 
1,005

Income taxes
(79
)
 
(123
)
 
(682
)
 
(337
)
Other comprehensive income on cash flow hedges
558

 
202

 
2,778

 
12

Other comprehensive income (loss)
(5,279
)
 
3,379

 
(25,068
)
 
10,028

TOTAL COMPREHENSIVE INCOME
$
28,431

 
$
25,011

 
$
59,789

 
$
71,628

 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.
 
 
 
 
 
 
 





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
 
 
Nine Months Ended
September 30,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
84,857

 
$
61,600

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
22,647

 
22,738

Provision for loan losses
14,332

 
10,235

Net amortization of premium on securities
18,958

 
20,186

Securities gains, net
(1,037
)
 
(5,553
)
Unrealized gain on equity securities, net
(97
)
 

Stock based compensation
3,689

 
3,588

Loans originated for sale
(551,328
)
 
(548,768
)
Proceeds on sales of loans held for sale
594,529

 
586,202

Net gains on sale of loans held for sale
(13,939
)
 
(11,968
)
Increase in accrued interest receivable
(5,422
)
 
(1,449
)
Decrease in prepaid expenses
2,243

 
838

Decrease in accrued interest payable
1,121

 
1,104

Capitalization of servicing rights
(4,404
)
 
(5,993
)
Valuation allowance on servicing rights
(12
)
 
(29
)
Loss on sales/valuations of assets, net
2,243

 
1,642

Net excess tax benefit from stock based compensation
672

 
1,121

Other, net
(1,979
)
 
(5,637
)
NET CASH PROVIDED BY OPERATING ACTIVITIES
167,073

 
129,857

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

Proceeds from the sale of securities available for sale
694,872

 
1,127,091

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

 
12,171

Proceeds from the maturity of and principal paydowns on securities available for sale
172,702

 
161,827

Proceeds from the maturity of and principal paydowns on securities held to maturity
13,169

 
6,645

Proceeds from the maturity of and principal paydowns on time deposits in other financial institutions
5,829

 
24,931

Proceeds from the maturity of and principal paydowns on other investments
2,038

 
2,574

Purchase of securities available for sale
(940,607
)
 
(1,299,492
)
Purchase of other investments
(2,411
)
 
(1,012
)
Net (increase) decrease in loans
(13,737
)
 
45,139

Purchase of bank owned life insurance policies
(2,000
)
 
(2,000
)
Proceeds from sale of mortgage servicing rights

 
5,137

Capital expenditures
(11,793
)
 
(6,876
)
Net cash and cash equivalents received in acquisitions
212,197

 
71,089

Proceeds from the sale of equipment
998

 
1,845

Proceeds on sale of OREO and other repossessed assets
3,128

 
7,578

NET CASH PROVIDED BY INVESTING ACTIVITIES
$
142,152

 
$
156,647

 
 
 
 





HEARTLAND FINANCIAL USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED (Unaudited)
(Dollars in thousands)
 
 
 
 
Nine Months Ended
September 30,
 
2018
 
2017
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net increase in demand deposits
$
156,497

 
$
181,206

Net increase (decrease) in savings deposits
130,704

 
(179,721
)
Net decrease in time deposit accounts
(122,795
)
 
(8,582
)
Proceeds on short-term revolving credit line
25,000

 
20,000

Repayments on short-term revolving credit line
(25,000
)
 
(15,000
)
Net decrease in short-term borrowings
(183,552
)
 
(168,667
)
Proceeds from short term FHLB advances
355,602

 
186,039

Repayments of short term FHLB advances
(365,602
)
 
(191,405
)
Proceeds from other borrowings
30,131

 

Repayments of other borrowings
(56,221
)
 
(8,573
)
Purchase of treasury stock
(97
)
 
(440
)
Proceeds from issuance of common stock
286

 
804

Dividends paid
(12,806
)
 
(9,153
)
NET CASH USED BY FINANCING ACTIVITIES
(67,853
)
 
(193,492
)
Net increase in cash and cash equivalents
241,372

 
93,012

Cash and cash equivalents at beginning of year
196,003

 
158,724

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
437,375

 
$
251,736

Supplemental disclosures:
 
 
 
Cash paid for income/franchise taxes
$
14,754

 
$
10,775

Cash paid for interest
$
34,725

 
$
23,034

Loans transferred to OREO
$
5,016

 
$
4,955

Transfer of premises from premises, furniture and equipment, net, to premises, furniture and equipment held for sale
$
3,415

 
$

Deposits transferred to held for sale
$
50,312

 
$

Loans transferred to held for sale
$
31,379

 
$

Purchases of securities available for sale, accrued, not settled
$
3,481

 
$
2,063

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

 
$
125

Conversion of convertible debt to common stock
$

 
$
558

Conversion of Series D preferred stock to common stock
$
938

 
$
419

Stock consideration granted for acquisitions
$
238,075

 
$
175,196

 
 
 
 
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


 






61,600

 
10,028





71,628

Cash dividends declared:


 


 


 


 


 


 
 
Series D Preferred, $52.50 per share
 
 
 
 
 
 
(45
)
 
 
 
 
 
(45
)
Common, $0.33 per share


 






(9,108
)
 






(9,108
)
Conversion of Series D Preferred Stock
(419
)
 
 
 
 
 
 
 
 
 
 
 
(419
)
Purchase of 9,392 shares of common stock


 








 



(440
)

(440
)
Issuance of 3,835,532 shares of common stock


 
3,826


171,298




 



440


175,564

Stock based compensation


 



3,588




 






3,588

Balance at September 30, 2017
$
938

 
$
29,946

 
$
503,262

 
$
468,556

 
$
(21,018
)
 
$

 
$
981,684

Balance at January 1, 2018
$
938

 
$
29,953

 
$
503,709

 
$
481,331

 
$
(24,474
)
 
$

 
$
991,457

Comprehensive income
 
 
 
 
 
 
84,857

 
(25,068
)
 


 
59,789

Reclassification of unrealized net gain on equity securities

 
 
 
 
 
 
280

 
(280
)
 
 
 

Cash dividends declared:
 
 
 
 
 
 
 
 


 


 


Series D Preferred, $52.50 per share
 
 
 
 
 
 
(39
)
 
 
 
 
 
(39
)
Common, $0.40 per share
 
 
 

 

(12,767
)
 






(12,767
)
Conversion of Series D preferred stock
(938
)
 
 
 
 
 
 
 
 
 
 
 
(938
)
Purchase of 1,761 shares of common stock
 
 
 

 



 



(97
)

(97
)
Issuance of 4,521,434 shares of common stock
 
 
4,520


234,682

 


 



97


239,299

Stock based compensation
 
 
 

3,689




 






3,689

Balance at September 30, 2018
$

 
$
34,473

 
$
742,080

 
$
553,662

 
$
(49,822
)
 
$

 
$
1,280,393

 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 September 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 nine-month periods ended September 30, 2018, and 2017, are shown in the table below:
 
Three Months Ended
September 30,
(Dollars and number of shares in thousands, except per share data)
2018
 
2017
Net income
$
33,710

 
$
21,632

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

 
3

Net income available to common stockholders
$
33,697

 
$
21,622

Weighted average common shares outstanding for basic earnings per share
34,452

 
29,648

Assumed incremental common shares issued upon vesting of outstanding restricted stock units
192

 
262

Weighted average common shares for diluted earnings per share
34,644

 
29,910

Earnings per common share — basic
$
0.98

 
$
0.73

Earnings per common share — diluted
$
0.97

 
$
0.72

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

 

 
 
 
 
 
Nine Months Ended
September 30,
(Dollars and number of shares in thousands, except per share data)
2018
 
2017
Net income
$
84,857

 
$
61,600

Preferred dividends
(39
)
 
(45
)
Interest expense on convertible preferred debt

 
12

Net income available to common stockholders
$
84,818

 
$
61,567

Weighted average common shares outstanding for basic earnings per share
32,520

 
27,569

Assumed incremental common shares issued upon vesting of outstanding restricted stock units
187

 
265

Weighted average common shares for diluted earnings per share
32,707

 
27,834

Earnings per common share — basic
$
2.61

 
$
2.23

Earnings per common share — diluted
$
2.59

 
$
2.21

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 September 30, 2018, 442,320 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 $672,000 and $1.1 million during the nine months ended September 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 nine months ended September 30, 2018, and September 30, 2017, 29,048 and 16,804 time-based RSUs, respectively, were granted to directors and new employees.

A summary of the RSUs outstanding as of September 30, 2018, and 2017, and changes during the nine months ended September 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
116,297

 
55.26

 
109,071

 
47.21

Vested
(127,429
)
 
32.70

 
(136,428
)
 
26.66

Forfeited
(27,678
)
 
45.58

 
(12,923
)
 
31.57

Outstanding at September 30
262,768

 
$
43.65

 
306,537

 
$
34.72


Total compensation costs recorded for RSUs were $3.7 million and $3.6 million for the nine-month periods ended September 30, 2018 and 2017. As of September 30, 2018, there were $5.3 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 nine 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 September 30, 2018 and 2017, and changes during the nine months ended September 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

 
(13,650
)
 
18.60

Forfeited

 

 
(500
)
 
18.60

Outstanding at September 30

 
$

 
12,250

 
$
18.60

Options exercisable at September 30

 
$

 
12,250

 
$
18.60


The intrinsic value for the total of all options exercised during the nine months ended September 30, 2018, was $231,000. Cash received from options exercised was $121,000 for the nine months ended September 30, 2018, and $254,000 for the nine months ended September 30, 2017.

No compensation costs were recorded for options during the nine month periods ended September 30, 2018 and 2017. There are no unrecorded compensation costs related to options at September 30, 2018. No stock options vested during the nine-month periods ended September 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 streams subject to the accounting standard.

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) eliminate 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) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (5) require 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) require 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) clarify 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 is 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. In July 2018, the FASB issued ASU 2018-11, "Leases - Targeted Improvements" to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, Specifically, under the amendments in ASU 2018-11, entities may elect not to recast the comparative periods presented when transitioning to the new leasing standard, and lessors may elect not to separate lease and non-lease components when certain conditions are met. The amendments have the same effective date as ASU 2016-02. Heartland intends to adopt the accounting standard on January 1, 2019, as required, and will not restate comparative periods. Heartland also expects to adopt certain optional practical expedients. Heartland signed an agreement with a cloud-based lease software provider, and the software implementation is nearly complete. Based on Heartland's current lease portfolio, management anticipates recognizing a right-of-use asset and lease liability on the consolidated balance sheet, with an immaterial impact to the consolidated statement of income. However, the ultimate impact of the standard will depend on the lease portfolio on January 1, 2019.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326)." The amendments in this ASU, also referred to as "CECL," 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 expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the results of operations, financial position and liquidity. Heartland has formed a cross-functional internal committee to assess and implement the standard, and the project plan calls for running a parallel CECL model during 2019 prior to adoption in 2020. Heartland has entered into an agreement with a third party software vendor, selected CECL-compliant methodologies, and started implementation of the software.

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.

In August 2018, the FASB issued ASU 2018-13, "Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement." This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019, and early adoption is permitted. Heartland intends to adopt this ASU in 2020, as required, and because the ASU only revises disclosure requirements, the adoption of this ASU will not have a material impact on results of operations, financial position and liquidity.

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 nine-month
periods ended September 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 Nine Months Ended
 
September 30, 2018
 
September 30, 2017
Net interest income
$
317,846

 
$
262,367

Net income available to common stockholders
$
69,075

 
$
76,698

Basic earnings per share
$
2.02

 
$
2.48

Diluted earnings per share
$
2.01

 
$
2.46


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 nine months ended September 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 September 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
September 30, 2018
 
 
 
 
 
 
 
U.S. government corporations and agencies
$
27,112

 
$

 
$
(115
)
 
$
26,997

Mortgage and asset-backed securities
1,926,803

 
1,341

 
(56,325
)
 
1,871,819

Obligations of states and political subdivisions
372,146

 
239

 
(13,902
)
 
358,483

Total debt securities
2,326,061

 
1,580

 
(70,342
)
 
2,257,299

Equity securities with a readily determinable fair value
16,916

 

 

 
16,916

Total
$
2,342,977

 
$
1,580

 
$
(70,342
)
 
$
2,274,215

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 September 30, 2018. The portion of unrealized net gains on equity securities recognized in current earnings during the first nine months of 2018, which related to securities still held at September 30, 2018, totaled $97,000.
The amortized cost, gross unrealized gains and losses and estimated fair values of held to maturity securities as of September 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
September 30, 2018
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
239,908

 
$
8,422

 
$
(936
)
 
$
247,394

Total
$
239,908

 
$
8,422

 
$
(936
)
 
$
247,394

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 September 30, 2018, approximately 70% of Heartland's mortgage and asset-backed securities were issued by government-sponsored enterprises.






The amortized cost and estimated fair value of investment securities carried at fair value at September 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.
 
September 30, 2018
 
Amortized Cost
 
Estimated Fair Value
Due in 1 year or less
$
23,216

 
$
23,161

Due in 1 to 5 years
50,520

 
49,592

Due in 5 to 10 years
131,431

 
125,824

Due after 10 years
194,091

 
186,903

Total debt securities
399,258

 
385,480

Mortgage and asset-backed securities
1,926,803

 
1,871,819

Equity securities with a readily determinable fair value
16,916

 
16,916

Total investment securities
$
2,342,977

 
$
2,274,215


The amortized cost and estimated fair value of debt securities held to maturity at September 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.
 
September 30, 2018
 
Amortized Cost
 
Estimated Fair Value
Due in 1 year or less
$
1,274

 
$
1,281

Due in 1 to 5 years
31,121

 
31,495

Due in 5 to 10 years
105,183

 
107,052

Due after 10 years
102,330

 
107,566

Total investment securities
$
239,908

 
$
247,394


As of September 30, 2018, and December 31, 2017, securities with a fair value of $551.3 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 nine-month periods ended September 30, 2018 and 2017, are summarized as follows, in thousands:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Proceeds from sales
$
59,137

 
$
503,083

 
$
694,872

 
$
1,127,091

Gross security gains
67

 
2,088

 
3,537

 
8,585

Gross security losses
212

 
409

 
2,500

 
3,023


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 September 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 September 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
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. government corporations and agencies
$
22,392

 
$
(39
)
 
$
4,605

 
$
(76
)
 
$
26,997

 
$
(115
)
Mortgage and asset-backed securities
1,007,078

 
(18,299
)
 
668,623

 
(38,026
)
 
1,675,701

 
(56,325
)
Obligations of states and political subdivisions
203,363

 
(5,552
)
 
139,394

 
(8,350
)
 
342,757

 
(13,902
)
Total temporarily impaired securities
$
1,232,833

 
$
(23,890
)
 
$
812,622

 
$
(46,452
)
 
$
2,045,455

 
$
(70,342
)
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
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
29,174

 
$
(209
)
 
$
13,160

 
$
(727
)
 
$
42,334

 
$
(936
)
Total temporarily impaired securities
$
29,174

 
$
(209
)
 
$
13,160

 
$
(727
)
 
$
42,334

 
$
(936
)
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 nine-month periods ended September 30, 2018, and September 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 September 30, 2018, and December 31, 2017, respectively. At September 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 $15.1 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 September 30, 2018, did not consider the investments to be other than temporarily impaired.

NOTE 4: LOANS

Loans as of September 30, 2018, and December 31, 2017, were as follows, in thousands:
 
September 30, 2018
 
December 31, 2017
Loans receivable held to maturity:
 
 
 
Commercial
$
1,962,222

 
$
1,646,606

Commercial real estate
3,648,731

 
3,163,269

Agricultural and agricultural real estate
574,048

 
511,588

Residential real estate
676,941

 
624,279

Consumer
506,181

 
447,484

Gross loans receivable held to maturity
7,368,123

 
6,393,226

Unearned discount
(1,340
)
 
(556
)
Deferred loan fees
(1,290
)
 
(1,206
)
Total net loans receivable held to maturity
7,365,493

 
6,391,464

Allowance for loan losses
(61,221
)
 
(55,686
)
Loans receivable, net
$
7,304,272

 
$
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 September 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
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
4,165

 
$
17,904

 
$
22,069

 
$
23,414

 
$
1,938,808

 
$
1,962,222

Commercial real estate
214

 
23,476

 
23,690

 
14,415

 
3,634,316

 
3,648,731

Agricultural and agricultural real estate
260

 
4,306

 
4,566

 
17,522

 
556,526

 
574,048

Residential real estate
279

 
1,571

 
1,850

 
23,647

 
653,294

 
676,941

Consumer
1,085

 
7,961

 
9,046

 
8,671

 
497,510

 
506,181

Total
$
6,003

 
$
55,218

 
$
61,221

 
$
87,669

 
$
7,280,454

 
$
7,368,123

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 September 30, 2018, and December 31, 2017, in thousands:
 
September 30, 2018
 
December 31, 2017
Nonaccrual loans
$
68,528

 
$
58,272

Nonaccrual troubled debt restructured loans
4,532

 
4,309

Total nonaccrual loans
$
73,060

 
$
62,581

Accruing loans past due 90 days or more
$
154

 
$
830

Performing troubled debt restructured loans
$
4,180

 
$
6,617







The following tables provide information on troubled debt restructured loans that were modified during the three- and nine-month periods ended September 30, 2018, and September 30, 2017, dollars in thousands:
 
Three Months Ended
September 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

 
$

 
$

 

 
$

 
$

Commercial real estate

 

 

 

 

 

Total commercial and commercial real estate

 

 

 



 

Agricultural and agricultural real estate

 

 

 

 

 

Residential real estate
1

 
92

 
94

 
8

 
1,174

 
1,174

Consumer

 

 

 

 

 

Total
1

 
$
92

 
$
94

 
8


$
1,174

 
$
1,174

 
Nine Months Ended
September 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