UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, ~~2014~~2015

Commission file number: 0-12668

Hills Bancorporation



Incorporated in Iowa	I.R.S. Employer Identification
	No. 42-1208067

131 MAIN STREET, HILLS, IOWA 52235

Telephone number: (319) 679-2291

Indicate by checkmark 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.

þ Yes o No

Indicate by checkmark whether the Registrant has submitted electronically and posted on its corporate website, 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).

þ Yes o No

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer o	Accelerated Filer þ
Non-accelerated filer o	Small Reporting Company o

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes þ No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date.

Index



	SHARES OUTSTANDING
CLASS	October 31, ~~2014~~2015

Common Stock, no par value	~~4,694,840~~9,335,704

Index

HILLS BANCORPORATION

Index to Form 10-Q

Part I

FINANCIAL INFORMATION



		Page
		Number

Item 1.	Financial Statements

	Consolidated balance sheets, September 30, ~~2014~~2015 (unaudited) and December 31, ~~2013~~2014	34
	Consolidated statements of income (unaudited) for three and nine months ended September 30, ~~2014~~2015 and ~~2013~~2014	45
	Consolidated statements of comprehensive income (unaudited) for three and nine months ended September 30, ~~2014~~2015 and ~~2013~~2014	56
	Consolidated statements of stockholders' equity (unaudited) for nine months ended September 30, ~~2014~~2015 and ~~2013~~2014	67
	Consolidated statements of cash flows (unaudited) for nine months ended September 30, ~~2014~~2015 and ~~2013~~2014	78
	Notes to consolidated financial statements (condensed)	910

Item 2.	Management Discussion and Analysis of Financial Condition and Results of Operations	3736

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	52

Item 4.	Controls and Procedures	53

	Part II
	OTHER INFORMATION

Item 1.	Legal proceedings	54

Item 1A.	Risk factors	54

Item 2.	Unregistered sales of equity securities and use of proceeds	55

Item 3.	Defaults upon senior securities	55

Item 4.	Mine safety disclosures	55

Item 5.	Other information	55

Item 6.	Exhibits	56

	Signatures	57

	Exhibits Index	58

Page 23

Index

HILLS BANCORPORATION CONSOLIDATED BALANCE SHEETS (Amounts In Thousands, Except Share Amounts)


	September 30, 2014			December 31, 2013			September 30, 2015			December 31, 2014
ASSETS	(Unaudited)			December 31, 2013			(Unaudited)			December 31, 2014
Cash and cash equivalents	$	68,864		$	43,702		$	33,985		$	29,174
Investment securities available for sale at fair value (amortized cost September 30, 2014 $241,159; December 31, 2013 $236,702)	243,818			238,510
Investment securities available for sale at fair value (amortized cost September 30, 2015 $244,975; December 31, 2014 $256,920)							247,485			258,992
Stock of Federal Home Loan Bank	7,651			7,579			9,641			8,248
Loans held for sale	2,484			4,927			4,395			4,476
Loans, net of allowance for loan losses (September 30, 2014 $24,500; December 31, 2013 $25,550)	1,914,139			1,801,247
Loans, net of allowance for loan losses (September 30, 2015 $25,480; December 31, 2014 $24,020)							2,051,349			1,961,369
Property and equipment, net	28,623			29,836			33,694			29,071
Tax credit real estate	17,498			18,180			16,593			17,259
Accrued interest receivable	8,980			7,676			9,700			8,276
Deferred income taxes, net	9,090			8,605			11,527			9,938
Other real estate	1,084			541			573			1,213
Goodwill	2,500			2,500			2,500			2,500
Other assets	3,550			4,492			3,563			3,802
Total Assets	$	2,308,281		$	2,167,795		$	2,425,005		$	2,334,318

LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities
Noninterest-bearing deposits	$	270,139		$	256,788		$	297,676		$	288,718
Interest-bearing deposits	1,569,357			1,453,089			1,591,300			1,546,351
Total deposits	$	1,839,496		$	1,709,877		$	1,888,976		$	1,835,069
Short-term borrowings	36,033			42,016
Other borrowings							36,124			47,499
Federal Home Loan Bank borrowings	125,000			125,000			170,000			140,000
Accrued interest payable	906			1,102			750			902
Other liabilities	20,877			16,437			25,098			20,749
Total Liabilities	$	2,022,312		$	1,894,432		$	2,120,948		$	2,044,219

Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)	$	32,500		$	29,574		$	35,930		$	34,571

STOCKHOLDERS' EQUITY
Common stock, no par value; authorized 10,000,000 shares; issued September 30, 2014 5,081,004 shares; December 31, 2013 5,074,894 shares	$	—		$	—
Common stock, no par value; authorized 20,000,000 shares; issued September 30, 2015 10,184,227 shares; December 31, 2014 10,177,854 shares							$	—		$	—
Paid in capital	42,660			42,194			43,395			42,925
Retained earnings	266,774			250,370			288,604			271,924
Accumulated other comprehensive income	748			1,591
Accumulated other comprehensive loss							(1,343		)	(448		)
Unearned ESOP shares	(1,008		)	(1,008		)	(504		)	(504		)
Treasury stock at cost (September 30, 2014 391,351 shares; December 31, 2013 347,269 shares)	(23,205		)	(19,784		)
Treasury stock at cost (September 30, 2015 851,132 shares; December 31, 2014 797,422 shares)							(26,095		)	(23,798		)
Total Stockholders' Equity	$	285,969		$	273,363		$	304,057		$	290,099
Less maximum cash obligation related to ESOP shares	32,500			29,574			35,930			34,571
Total Stockholders' Equity Less Maximum Cash Obligations Related to ESOP Shares	$	253,469		$	243,789		$	268,127		$	255,528
Total Liabilities & Stockholders' Equity	$	2,308,281		$	2,167,795		$	2,425,005		$	2,334,318

See Notes to Consolidated Financial Statements.

Page 34

Index

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Amounts In Thousands, Except Per Share Amounts)

Three Months Ended
September 30, Nine Months Ended
September 30,
2014 2013 2014 2013
Interest income:
Loans, including fees $ 20,676
$ 19,886
$ 60,775
$ 59,353
Investment securities:

Taxable 275
303
815
957
Nontaxable 840
823
2,513
2,497
Federal funds sold 3
11
29
57
Total interest income $ 21,794
$ 21,023
$ 64,132
$ 62,864
Interest expense:

Deposits $ 2,245
$ 2,684
$ 7,036
$ 8,488
Short-term borrowings 50
41
97
102
FHLB borrowings 1,409
1,409
4,181
4,181
Total interest expense $ 3,704
$ 4,134
$ 11,314
$ 12,771
Net interest income $ 18,090
$ 16,889
$ 52,818
$ 50,093
Provision for loan losses (1,008 ) 112
(1,209 ) (309 )
Net interest income after provision for loan losses $ 19,098
$ 16,777
$ 54,027
$ 50,402
Noninterest income:

Net gain on sale of loans $ 338
$ 531
$ 638
$ 1,793
Trust fees 1,595
1,185
4,494
3,740
Service charges and fees 2,152
2,240
6,001
6,616
Rental revenue on tax credit real estate 377
398
1,112
1,114
Net gain on sale of other real estate owned and other repossessed assets 186
18
426
168
Other noninterest income 599
591
1,944
1,939
$ 5,247
$ 4,963
$ 14,615
$ 15,370

Noninterest expenses:

Salaries and employee benefits $ 6,400
$ 6,158
$ 19,042
$ 18,312
Occupancy 947
907
2,900
2,780
Furniture and equipment 1,212
1,183
3,685
3,650
Office supplies and postage 390
445
1,157
1,163
Advertising and business development 775
624
2,216
1,895
Outside services 1,773
1,819
4,981
5,437
Rental expenses on tax credit real estate 552
614
1,635
1,571
FDIC insurance assessment 282
229
823
760
Other noninterest expense 490
432
1,177
1,298
$ 12,821
$ 12,411
$ 37,616
$ 36,866
Income before income taxes $ 11,524
$ 9,329
$ 31,026
$ 28,906
Income taxes 3,625
2,705
9,202
8,558
Net income $ 7,899
$ 6,624
$ 21,824
$ 20,348

Earnings per share:

Basic $ 1.69
$ 1.41
$ 4.65
$ 4.32
Diluted $ 1.68
$ 1.40
$ 4.64
$ 4.31

~~See Notes to Consolidated Financial Statements.~~

~~Page 4~~

~~Index~~

~~HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME~~

~~(Unaudited) (Amounts In Thousands)~~

Three Months Ended
September 30, Nine Months Ended
September 30,
2014 2013 2014 2013
Net income $ 7,899
$ 6,624
$ 21,824
$ 20,348

Other comprehensive loss

Securities:

Net change in unrealized gain (loss) on securities available for sale $ 26
$ (1,084 ) $ 851
$ (4,236 )
Reclassification adjustment for net gains realized in net income —
—
—
(17 )
Income taxes (10 ) 414
(325 ) 1,627
Other comprehensive income (loss) on securities available for sale $ 16
$ (670 ) $ 526
$ (2,626 )
Derivatives used in cash flow hedging relationships:

Unrealized loss on derivatives $ (37 ) $ —
$ (2,216 ) $ —
Income taxes 14
—
847
—
Other comprehensive loss on cash flow hedges $ (23 ) $ —
$ (1,369 ) $ —

Other comprehensive loss, net of tax $ (7 ) $ (670 ) $ (843 ) $ (2,626 )

Comprehensive income $ 7,892
$ 5,954
$ 20,981
$ 17,722



	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015		2014
Interest income:
Loans, including fees	$	22,159		$	20,676		$	65,139	$	60,775
Investment securities:
Taxable	321			275			907		815
Nontaxable	813			840			2,473		2,513
Federal funds sold	2			3			17		29
Total interest income	$	23,295		$	21,794		$	68,536	$	64,132
Interest expense:
Deposits	$	1,973		$	2,245		$	6,247	$	7,036
Short-term borrowings	55			50			114		97
FHLB borrowings	1,686			1,409			4,647		4,181
Total interest expense	$	3,714		$	3,704		$	11,008	$	11,314
Net interest income	$	19,581		$	18,090		$	57,528	$	52,818
Provision for loan losses	(95		)	(1,008		)	360		(1,209		)
Net interest income after provision for loan losses	$	19,676		$	19,098		$	57,168	$	54,027
Noninterest income:
Net gain on sale of loans	$	396		$	338		$	1,144	$	638
Trust fees	1,672			1,595			4,920		4,494
Service charges and fees	2,124			2,152			6,151		6,001
Rental revenue on tax credit real estate	392			377			1,296		1,112
Net gain on sale of other real estate owned and other repossessed assets	22			186			139		426
Other noninterest income	612			599			2,064		1,944
	$	5,218		$	5,247		$	15,714	$	14,615

Noninterest expenses:
Salaries and employee benefits	$	7,125		$	6,400		$	20,700	$	19,042
Occupancy	919			947			2,887		2,900
Furniture and equipment	1,304			1,212			3,911		3,685
Office supplies and postage	457			390			1,311		1,157
Advertising and business development	854			775			2,547		2,216
Outside services	1,770			1,773			5,203		4,981
Rental expenses on tax credit real estate	558			552			1,719		1,635
FDIC insurance assessment	293			282			866		823
Other noninterest expense	392			490			1,231		1,177
	$	13,672		$	12,821		$	40,375	$	37,616
Income before income taxes	$	11,222		$	11,524		$	32,507	$	31,026
Income taxes	3,537			3,625			9,972		9,202
Net income	$	7,685		$	7,899		$	22,535	$	21,824

Earnings per share:
Basic	$	0.82		$	0.85		$	2.41	$	2.33
Diluted	$	0.82		$	0.84		$	2.41	$	2.32

See Notes to Consolidated Financial Statements.

Page 5

Index

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF ~~STOCKHOLDERS' EQUITY~~ COMPREHENSIVE INCOME

(Unaudited) (Amounts In ~~Thousands, Except Share Amounts)~~Thousands)

Paid In Capital Retained Earnings
Accumulated Other
Comprehensive
Income (Loss)

Unearned ESOP
Shares
Treasury Stock
Maximum Cash
Obligation Related
To ESOP Shares
Total
Balance, December 31, 2012 $ 42,241
$ 229,625
$ 3,955
$ (1,513 ) $ (18,397 ) $ (30,715 ) $ 225,196
Issuance of 6,180 shares of common stock 240
—
—
—
—
—
240
Issuance of 1,592 shares of common stock under the employee stock purchase plan 111
—
—
—
—
—
111
Unearned restricted stock compensation (660 ) —
—
—
—
—
(660 )
Forfeiture of 375 shares of common stock (25 ) —
—
—
—
—
(25 )
Share-based compensation 21
—
—
—
—
—
21
Income tax benefit related to share-based compensation 85
—
—
—
—
—
85
Change related to ESOP shares —
—
—
—
—
2,575
2,575
Net income —
20,348
—
—
—
—
20,348
Cash dividends ($1.10 per share) —
(5,186 ) —
—
—
—
(5,186 )
Purchase of 13,601 shares of common stock —
—
—
—
(976 ) —
(976 )
Other comprehensive loss —
—
(2,626 ) —
—
—
(2,626 )
Balance, September 30, 2013 $ 42,013
$ 244,787
$ 1,329
$ (1,513 ) $ (19,373 ) $ (28,140 ) $ 239,103

Balance, December 31, 2013 $ 42,194
$ 250,370
$ 1,591
$ (1,008 ) $ (19,784 ) $ (29,574 ) $ 243,789
Issuance of 5,064 shares of common stock 266
—
—
—
—
—
266
Issuance of 1,617 shares of common stock under the employee stock purchase plan 121
—
—
—
—
—
121
Unearned restricted stock compensation 48
—
—
—
—
—
48
Forfeiture of 571 shares of common stock (40 ) —
—
—
—
—
(40 )
Share-based compensation 21
—
—
—
—
—
21
Income tax benefit related to share-based compensation 50
—
—
—
—
—
50
Change related to ESOP shares —
—
—
—
—
(2,926 ) (2,926 )
Net income —
21,824
—
—
—
—
21,824
Cash dividends ($1.15 per share) —
(5,420 ) —
—
—
—
(5,420 )
Purchase of 44,082 shares of common stock —
—
—
—
(3,421 ) —
(3,421 )
Other comprehensive loss —
—
(843 ) —
—
—
(843 )
Balance, September 30, 2014 $ 42,660
$ 266,774
$ 748
$ (1,008 ) $ (23,205 ) $ (32,500 ) $ 253,469



	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Net income	$	7,685		$	7,899		$	22,535		$	21,824

Other comprehensive income (loss)
Securities:
Net change in unrealized gain on securities available for sale	$	1,026		$	26		$	438		$	851
Reclassification adjustment for net gains realized in net income	—			—			—			—
Income taxes	(392		)	(10		)	(167		)	(325		)
Other comprehensive income on securities available for sale	$	634		$	16		$	271		$	526
Derivatives used in cash flow hedging relationships:
Net change in unrealized loss on derivatives	$	(1,637	)	$	(37	)	$	(1,889	)	$	(2,216	)
Income taxes	626			14			723			847
Other comprehensive loss on cash flow hedges	$	(1,011	)	$	(23	)	$	(1,166	)	$	(1,369	)

Other comprehensive loss, net of tax	$	(377	)	$	(7	)	$	(895	)	$	(843	)

Comprehensive income	$	7,308		$	7,892		$	21,640		$	20,981

See Notes to Consolidated Financial Statements.

Page 6

Index

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF ~~CASH FLOWS~~STOCKHOLDERS' EQUITY (Unaudited) (Amounts In ~~Thousands)~~

Thousands, Except Share Amounts)

Nine Months Ended
September 30,
2014 2013
Cash Flows from Operating Activities
Net income $ 21,824
$ 20,348
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:

Depreciation 1,916
2,176
Provision for loan losses (1,209 ) (309 )
Net gain on sale of investment securities —
(17 )
Share-based compensation 21
21
Forfeiture of common stock (40 ) (25 )
Compensation expensed through issuance of common stock 286
176
Excess tax benefits from share-based compensation (50 ) (85 )
Provision for deferred income taxes 37
(103 )
Net gain on sale of other real estate owned and other repossessed assets (426 ) (168 )
Increase in accrued interest receivable (1,304 ) (609 )
Amortization of discount on investment securities, net 654
834
Decrease in prepaid FDIC insurance —
2,957
Decrease in other assets 222
3,175
Increase in accrued interest payable and other liabilities 2,845
1,287
Loans originated for sale (80,798 ) (178,872 )
Proceeds on sales of loans 83,879
206,110
Net gain on sales of loans (638 ) (1,793 )
Net cash and cash equivalents provided by operating activities $ 27,219
$ 55,103

Cash Flows from Investing Activities

Proceeds from maturities of investment securities available for sale $ 46,252
$ 21,070
Proceeds from sales of investment securities available for sale —
566
Purchases of investment securities available for sale (51,434 ) (27,721 )
Loans made to customers, net of collections (113,409 ) (71,241 )
Proceeds on sale of other real estate owned and other repossessed assets 1,609
1,275
Purchases of property and equipment (703 ) (1,428 )
Income from tax credit real estate, net 682
478
Net cash and cash equivalents used in investing activities $ (117,003 ) $ (77,001 )

Cash Flows from Financing Activities

Net increase in deposits $ 129,619
$ 30,761
Net decrease in short-term borrowings (5,983 ) (9,620 )
Stock options exercised 101
175
Excess tax benefits related to share-based compensation 50
85
Purchase of treasury stock (3,421 ) (976 )
Dividends paid (5,420 ) (5,186 )
Net cash and cash equivalents provided by financing activities $ 114,946
$ 15,239



	Paid In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Unearned ESOP Shares			Treasury Stock			Maximum Cash Obligation Related To ESOP Shares			Total
Balance, December 31, 2013	$	42,194		$	250,370		$	1,591		$	(1,008	)	$	(19,784	)	$	(29,574	)	$	243,789
Issuance of 10,128 shares of common stock	266			—			—			—			—			—			266
Issuance of 3,234 shares of common stock under the employee stock purchase plan	121			—			—			—			—			—			121
Unearned restricted stock compensation	48			—			—			—			—			—			48
Forfeiture of 1,142 shares of common stock	(40		)	—			—			—			—			—			(40		)
Share-based compensation	21			—			—			—			—			—			21
Income tax benefit related to share-based compensation	50			—			—			—			—			—			50
Change related to ESOP shares	—			—			—			—			—			(2,926		)	(2,926		)
Net income	—			21,824			—			—			—			—			21,824
Cash dividends ($0.575 per share)	—			(5,420		)	—			—			—			—			(5,420		)
Purchase of 88,164 shares of common stock	—			—			—			—			(3,421		)	—			(3,421		)
Other comprehensive loss	—			—			(843		)	—			—			—			(843		)
Balance, September 30, 2014	$	42,660		$	266,774		$	748		$	(1,008	)	$	(23,205	)	$	(32,500	)	$	253,469

Balance, December 31, 2014	$	42,925		$	271,924		$	(448	)	$	(504	)	$	(23,798	)	$	(34,571	)	$	255,528
Issuance of 3,260 shares of common stock	136			—			—			—			—			—			136
Issuance of 4,155 shares of common stock under the employee stock purchase plan	172			—			—			—			—			—			172
Unearned restricted stock compensation	171			—			—			—			—			—			171
Forfeiture of 1,042 shares of common stock	(37		)	—			—			—			—			—			(37		)
Share-based compensation	21			—			—			—			—			—			21
Income tax benefit related to share-based compensation	7			—			—			—			—			—			7
Change related to ESOP shares	—			—			—			—			—			(1,359		)	(1,359		)
Net income	—			22,535			—			—			—			—			22,535
Cash dividends ($0.625 per share)	—			(5,855		)	—			—			—			—			(5,855		)
Purchase of 53,710 shares of common stock	—			—			—			—			(2,297		)	—			(2,297		)
Other comprehensive loss	—			—			(895		)	—			—			—			(895		)
Balance, September 30, 2015	$	43,395		$	288,604		$	(1,343	)	$	(504	)	$	(26,095	)	$	(35,930	)	$	268,127

~~(Continued)~~

See Notes to Consolidated Financial Statements.

Page 7

Index

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Amounts In Thousands)

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) (Amounts In Thousands)
Nine Months Ended
September 30,
2014 2013
Increase (decrease) in cash and cash equivalents $ 25,162
$ (6,659 )
Cash and cash equivalents:

Beginning of year 43,702
63,582
End of period $ 68,864
$ 56,923

Supplemental Disclosures

Cash payments for:

Interest paid to depositors $ 7,232
$ 8,757
Interest paid on other obligations 4,278
4,283
Income taxes paid 8,072
6,800

Noncash activities:

Increase (decrease) in maximum cash obligation related to ESOP shares $ 2,926
$ (2,575 )
Transfers to other real estate owned 1,726
949



	Nine Months Ended September 30,
	2015			2014
Cash Flows from Operating Activities
Net income	$	22,535		$	21,824
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation	2,055			1,916
Provision for loan losses	360			(1,209		)
Share-based compensation	21			21
Forfeiture of common stock	(37		)	(40		)
Compensation expensed through issuance of common stock	308			286
Excess tax benefits from share-based compensation	(7		)	(50		)
Provision for deferred income taxes	(1,033		)	37
Net gain on sale of other real estate owned and other repossessed assets	(139		)	(426		)
Increase in accrued interest receivable	(1,424		)	(1,304		)
Amortization of discount on investment securities, net	498			654
Decrease in other assets	246			222
Increase in accrued interest payable and other liabilities	2,479			2,845
Loans originated for sale	(133,522		)	(80,798		)
Proceeds on sales of loans	134,747			83,879
Net gain on sales of loans	(1,144		)	(638		)
Net cash and cash equivalents provided by operating activities	$	25,943		$	27,219

Cash Flows from Investing Activities
Proceeds from maturities of investment securities available for sale	$	45,901		$	46,252
Purchases of investment securities available for sale	(35,847		)	(51,434		)
Loans made to customers, net of collections	(90,695		)	(113,409		)
Proceeds on sale of other real estate owned and other repossessed assets	1,134			1,609
Purchases of property and equipment	(6,678		)	(703		)
Income from tax credit real estate, net	666			682
Net cash and cash equivalents used in investing activities	$	(85,519	)	$	(117,003	)

Cash Flows from Financing Activities
Net increase in deposits	$	53,907		$	129,619
Net decrease in other borrowings	(11,375		)	(5,983		)
Net increase in FHLB borrowings	30,000			—
Borrowings from FRB	4			—
Payments on FRB borrowings	(4		)	—
Stock options exercised	—			101
Excess tax benefits related to share-based compensation	7			50
Purchase of treasury stock	(2,297		)	(3,421		)
Dividends paid	(5,855		)	(5,420		)
Net cash and cash equivalents provided by financing activities	$	64,387		$	114,946

(Continued)

Page 8

Index

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) (Amounts In Thousands)

	Nine Months Ended September 30,
	2015		2014
Increase in cash and cash equivalents	$	4,811	$	25,162
Cash and cash equivalents:
Beginning of year	29,174		43,702
End of period	$	33,985	$	68,864

Supplemental Disclosures
Cash payments for:
Interest paid to depositors	$	6,399	$	7,232
Interest paid on other obligations	4,761		4,278
Income taxes paid	10,072		8,072

Noncash activities:
Increase in maximum cash obligation related to ESOP shares	$	1,359	$	2,926
Transfers to other real estate owned	355		1,726
Sale and financing of other real estate owned	452		242

See Notes to Consolidated Financial Statements.

Page 89

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


Note 1.	Summary of Significant Accounting Policies

Basis of Presentation:

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and with instructions for Form 10-Q and Regulation S-X. These financial statements include all adjustments (consisting of normal recurring accruals) which in the opinion of management are considered necessary for the fair presentation of the financial position and results of operations for the periods shown. Certain prior year amounts have been reclassified to conform to the current year presentation. The Company considers that it operates as one business segment, a commercial bank.

Operating results for the nine month period ended September 30, ~~2014~~2015 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2014. For further information, refer to the consolidated financial statements and footnotes thereto included in the Form 10-K Annual Report of Hills Bancorporation and subsidiary (the “Company”) for the year ended December 31, ~~2013~~2014 filed with the Securities Exchange Commission on March 11, ~~2014.~~2015. The consolidated balance sheet as of December 31, ~~2013,~~2014, has been derived from the audited consolidated financial statements for that period.

The Company evaluated subsequent events through the filing date of its quarterly report on Form 10-Q with the SEC.

Effect of New Financial Accounting Standards:

~~In January 2014, the FASB issued ASU No. 2014-01,~~ ~~Accounting for Investments in Qualified Affordable Housing Projects",~~ ~~to amend FASB ASC Topic 323,~~ ~~Investments – Equity Method and Joint Ventures~~. The objective of this standard is to provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The amendments in the standard permit, but do not require, reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The standard will be effective for the Company beginning January 1, 2015; however, early adoption is permitted. The Company does have significant investments in such qualified affordable housing projects and is currently reviewing the provisions of this standard to determine what, if any, impacts it may have on the Company’s financial position or results of operations.

~~In January 2014, the FASB issued ASU No. 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40):~~ ~~Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.~~ ASU 2014-4 clarifies that an in substance foreclosure repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either the creditor obtaining legal title to the residential real estate property upon foreclosure or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additional disclosures are required. ASU 2014-4 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2014. The adoption of ASU 2014-4 by the Company is not expected to have a material impact.

In May 2014, The FASB and International Accounting Standards Board (IASB) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of ASU 2014-09 is that a company should recognize revenue to depict the transfer of promised good or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. For financial institutions, significant changes are not expected given that most financial instruments are not in the scope of the accounting standard update. ASU 2014-09 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. ~~Early adoption~~In August 2015, FASB issued ASU 2015-14 deferring the effective date for annual periods and interim periods within those annual periods after December 15, 2017. Earlier application is ~~not permitted.~~permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is currently reviewing the provisions of this standard to determine the application to financial institutions.

In February 2015, the FASB issued ASU No. 2015-02 (Topic 810), Consolidation. The ASU modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIE) or voting interest entities (VOE). The standard relaxes existing criteria for determining when fees paid to a decision maker or service provider do not represent a variable interest by focusing on whether those fees are "at market". The ASU eliminates both the consolidation model specific to limited partnerships and the current presumption that a general partner controls a limited partnership. For public companies, ASU 2015-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The Company is currently reviewing the provisions of this standard to determine the impact on the Company's financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. For public companies, ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The Company has determined that the adoption of ASU 2015-03 will not have a material impact on the Company's financial statements.

In April 2015, the FASB issued ASU No. 2015-05, Intangibles – Goodwill and Other Internal-Use Software (Subtopic 350-40), Customer's Accounting for Fees Paid in a Cloud Computing Arrangement. ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. The adoption of ASU ~~2014-09~~2015-05 by the Company is not expected to have a material impact.

Page 910

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)


Note 2.	Earnings Per Share

Basic earnings per share is computed using the weighted average number of actual common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that would occur from the exercise of common stock options outstanding. ESOP shares are considered outstanding for this calculation unless unearned.

On March 24, 2015, the Company declared a payment of a 2-for-1 stock split of each issued and unissued share of the Company's common stock outstanding as of April 27, 2015. The additional shares were issued as a result of the stock split and were mailed to the shareholders as of May 4, 2015. All shares and earnings per share numbers have been restated for the stock split.

The computation of basic and diluted earnings per share for the periods presented is as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,						Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013			2015			2014			2015			2014
Common shares outstanding at the beginning of the period	4,696,591			4,708,910			4,711,995			4,712,328			9,351,859			9,393,182			9,365,176			9,423,990
Weighted average number of net shares redeemed	(10,673		)	(720		)	(12,490		)	(364		)	(10,342		)	(21,346		)	(11,936		)	(24,980		)
Weighted average shares outstanding (basic)	4,685,918			4,708,190			4,699,505			4,711,964			9,341,517			9,371,836			9,353,240			9,399,010
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method	2,139			3,220			2,365			3,755			5,590			4,278			5,285			4,730
Weighted average number of shares (diluted)	4,688,057			4,711,410			4,701,870			4,715,719			9,347,107			9,376,114			9,358,525			9,403,740
Net income (In thousands)	$	7,899		$	6,624		$	21,824		$	20,348		$	7,685		$	7,899		$	22,535		$	21,824
Earnings per share:
Basic	$	1.69		$	1.41		$	4.65		$	4.32		$	0.82		$	0.85		$	2.41		$	2.33
Diluted	$	1.68		$	1.40		$	4.64		$	4.31		$	0.82		$	0.84		$	2.41		$	2.32

~~Page 10~~

~~Index~~

~~HILLS BANCORPORATION~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

~~(Unaudited)~~


Note 3.	Other Comprehensive Income (Loss)

The following table summarizes the balances of each component of accumulated other comprehensive income (AOCI), included in stockholders’ equity, at September 30, ~~2014~~2015 and December 31, ~~2013:~~2014:


	September 30, 2014			December 31, 2013			September 30, 2015			December 31, 2014
	(amounts in thousands)						(amounts in thousands)
Net unrealized gain on available-for-sale securities	$	2,659		$	1,808		$	2,510		$	2,072
Net unrealized (loss) gain on derivatives used for cash flow hedges	(1,447		)	769
Net unrealized loss on derivatives used for cash flow hedges							(4,685		)	(2,796		)
Tax effect	(464		)	(986		)	832			276
Net-of-tax amount	$	748		$	1,591		$	(1,343	)	$	(448	)

~~Amounts reclassified from AOCI and the affected line items in the statement of income during the three and nine months ended September 30, 2014 and 2013, were as follows:~~

Amounts reclassifed from AOCI
Three Months Ended September 30,
2014 2013 Affected Line Item in the Statements of Income
(amounts in thousands)
Unrealized gains on available-for-sale securities $ —
$ —
Other noninterest income
Tax effect —
—
Tax (expense) benefit
Total reclassification out of AOCI $ —
$ —

Nine Months Ended
September 30,
2014 2013 Affected Line Item in the Statements of Income
(amounts in thousands)
Unrealized gains on available-for-sale securities $ —
$ 17
Other noninterest income
Tax effect —
(7 ) Tax (expense) benefit
Total reclassification out of AOCI $ —
$ 10

Page 11

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)


Note 4.	Securities

The carrying values of investment securities at September 30, ~~2014~~2015 and December 31, ~~2013~~2014 are summarized in the following table (dollars in thousands):


	September 30, 2014				December 31, 2013				September 30, 2015				December 31, 2014
	Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent
Securities available for sale
U.S. Treasury	$	19,794	8.12	%	$	—	—	%	$	22,643	9.15	%	$	22,333	8.62	%
Other securities (FHLB, FHLMC and FNMA)									67,419		27.24		67,691		26.14
State and political subdivisions	154,198		63.24		151,366		63.46		157,423		63.61		168,968		65.24
Other securities (FHLB, FHLMC and FNMA)	69,826		28.64		87,144		36.54
Total securities available for sale	$	243,818	100.00	%	$	238,510	100.00	%	$	247,485	100.00	%	$	258,992	100.00	%

Investment securities have been classified in the consolidated balance sheets according to management’s intent. Available-for-sale securities consist of debt securities not classified as trading or held to maturity. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity. There were no trading or held to maturity securities as of September 30, ~~2014~~2015 or December 31, ~~2013.~~2014. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of September 30, ~~2014~~2015 and December 31, ~~2013~~2014 (in thousands):


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
September 30, 2014:
September 30, 2015:
U.S. Treasury	$	19,828	$	6	$	(40	)	$	19,794	$	22,385	$	258	$	—		$	22,643
Other securities (FHLB, FHLMC and FNMA)										67,095		335		(11		)	67,419
State and political subdivisions	151,632		2,969		(403		)	154,198		155,495		2,210		(282		)	157,423
Total										$	244,975	$	2,803	$	(293	)	$	247,485
December 31, 2014:
U.S. Treasury										$	22,351	$	18	$	(36	)	$	22,333
Other securities (FHLB, FHLMC and FNMA)	69,699		191		(64		)	69,826		67,644		147		(100		)	67,691
State and political subdivisions										166,925		2,499		(456		)	168,968
Total	$	241,159	$	3,166	$	(507	)	$	243,818	$	256,920	$	2,664	$	(592	)	$	258,992
December 31, 2013:
U.S. Treasury	$	—	$	—	$	—		$	—
State and political subdivisions	149,704		3,182		(1,520		)	151,366
Other securities (FHLB, FHLMC and FNMA)	86,998		316		(170		)	87,144
Total	$	236,702	$	3,498	$	(1,690	)	$	238,510

The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at September 30, ~~2014,~~2015, were as follows (in thousands):


	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	35,464	$	35,621	$	31,404	$	31,517
Due after one year through five years	136,084		138,213		144,620		146,563
Due after five years through ten years	69,611		69,984		67,597		68,048
Due over ten years	—		—		1,354		1,357
Total	$	241,159	$	243,818	$	244,975	$	247,485

As of September 30, ~~2014~~2015 investment securities with a carrying value of ~~$36.03~~$36.12 million were pledged to collateralize ~~short-term~~repurchase agreements, derivative financial instruments, and other borrowings.

Page 12

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The following table shows the fair value, gross unrealized losses and the percentage of fair value represented by gross unrealized losses of applicable investment securities owned by the Company, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, ~~2014~~2015 and December 31, ~~2013~~2014 (in thousands):


	Less than 12 months								12 months or more								Total								Less than 12 months								12 months or more								Total
September 30, 2014 Description of Securities	#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%
September 30, 2015 Description of Securities																									#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%
U.S. Treasury	4	$	9,876	$	(40	)	0.41	%	—	$	—	$	—		—	%	4	$	9,876	$	(40	)	0.41	%	—	$	—	$	—		—	%	—	$	—	$	—		—	%	—	$	—	$	—		—	%

Other securities (FHLB, FHLMC and FNMA)																									4	9,416		(11		)	0.12		—	—		—			—		4	9,416		(11		)	0.12

State and political subdivisions	57	14,490		(76		)	0.52	%	95	19,873		(327		)	1.65	%	152	34,363		(403		)	1.17	%	105	23,698		(178		)	0.75		27	5,861		(104		)	1.77		132	29,559		(282		)	0.95

Other securities (FHLB, FHLMC and FNMA)	5	10,505		(46		)	0.44	%	2	4,359		(18		)	0.41	%	7	14,864		(64		)	0.43	%

Total temporarily impaired securities	66	$	34,871	$	(162	)	0.46	%	97	$	24,232	$	(345	)	1.42	%	163	$	59,103	$	(507	)	0.86	%	109	$	33,114	$	(189	)	0.57	%	27	$	5,861	$	(104	)	1.77	%	136	$	38,975	$	(293	)	0.75	%


	Less than 12 months								12 months or more								Total								Less than 12 months								12 months or more								Total
December 31, 2013 Description of Securities	#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%
December 31, 2014 Description of Securities																									#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%
U.S. Treasury	—	$	—	$	—		—	%	—	$	—	$	—		—	%	—	$	—	$	—		—	%	5	$	12,396	$	(36	)	0.29	%	—	$	—	$	—		—	%	5	$	12,396	$	(36	)	0.29	%

Other securities (FHLB, FHLMC and FNMA)																									10	24,382		(100		)	0.41		—	—		—			—		10	24,382		(100		)	0.41

State and political subdivisions	164	36,212		(1,259		)	3.48	%	25	5,565		(261		)	4.69	%	189	41,777		(1,520		)	3.64	%	91	21,724		(124		)	0.57		78	16,154		(332		)	2.06		169	37,878		(456		)	1.20

Other securities (FHLB, FHLMC and FNMA)	10	21,810		(149		)	0.68	%	1	2,557		(21		)	0.82	%	11	24,367		(170		)	0.70	%

Total temporarily impaired securities	174	$	58,022	$	(1,408	)	2.43	%	26	$	8,122	$	(282	)	3.47	%	200	$	66,144	$	(1,690	)	2.56	%	106	$	58,502	$	(260	)	0.44	%	78	$	16,154	$	(332	)	2.06	%	184	$	74,656	$	(592	)	0.79	%

The Company considered the following information in reaching the conclusion that the impairments disclosed in the table above are temporary and not other-than-temporary impairments. None of the unrealized losses in the above table was due to the deterioration in the credit quality of any of the issues that might result in the non-collection of contractual principal and interest. The unrealized losses are due to changes in interest rates. The Company has not recognized any unrealized loss in income because management does not have the intent to sell the securities included in the previous table. Management has concluded that it is more likely than not that the Company will not be required to sell these securities prior to recovery of the amortized cost basis.

Page 13

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)


Note 5.	Loans

Classes of loans are as follows:


	September 30, 2014		December 31, 2013		September 30, 2015		December 31, 2014
	(Amounts In Thousands)				(Amounts In Thousands)
Agricultural	$	86,243	$	82,138	$	93,533	$	97,645
Commercial and financial	179,872		166,102		173,029		174,738
Real estate:
Construction, 1 to 4 family residential	39,551		30,309		54,706		45,949
Construction, land development and commercial	80,273		69,182		91,742		77,020
Mortgage, farmland	145,070		142,685		179,981		162,503
Mortgage, 1 to 4 family first liens	658,766		605,687		715,575		672,674
Mortgage, 1 to 4 family junior liens	107,443		105,785		115,657		110,284
Mortgage, multi-family	241,768		244,090		251,512		245,213
Mortgage, commercial	322,714		315,187		323,454		321,601
Loans to individuals	20,324		19,824		22,960		21,342
Obligations of state and political subdivisions	55,940		45,167		53,930		55,729
	$	1,937,964	$	1,826,156	$	2,076,079	$	1,984,698
Net unamortized fees and costs	675		641		750		691
	$	1,938,639	$	1,826,797	$	2,076,829	$	1,985,389
Less allowance for loan losses	24,500		25,550		25,480		24,020
	$	1,914,139	$	1,801,247	$	2,051,349	$	1,961,369

Page 14

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Changes in the allowance for loan losses, the allowance for loan losses applicable to impaired loans and the related loan balance of impaired loans for the three and nine months ended September 30, ~~2014~~2015 were as follows:


	Three Months Ended September 30, 2014																								Three Months Ended September 30, 2015
	Agricultural			Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland			Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total			Agricultural			Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)																								(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	3,036		$	4,832		$	3,431		$	2,749		$	6,831		$	3,739		$	732		$	25,350		$	2,783		$	4,698		$	3,025		$	2,825	$	7,396		$	4,111		$	962		$	25,800
Charge-offs	—			(60		)	—			—			(471		)	—			(50		)	(581		)	(69		)	(18		)	(100		)	—		(135		)	(305		)	(137		)	(764		)
Recoveries	60			258			37			—			244			99			41			739			32			318			40			—		92			4			53			539
Provision	(402		)	(328		)	(483		)	(173		)	497			(98		)	(21		)	(1,008		)	117			(303		)	(379		)	107		70			320			(27		)	(95		)

Ending balance	$	2,694		$	4,702		$	2,985		$	2,576		$	7,101		$	3,740		$	702		$	24,500		$	2,863		$	4,695		$	2,586		$	2,932	$	7,423		$	4,130		$	851		$	25,480


	Nine Months Ended September 30, 2014																							Nine Months Ended September 30, 2015
	Agricultural			Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total			Agricultural			Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)																							(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	2,852		$	4,733		$	2,918		$	2,557	$	7,064		$	4,787		$	639		$	25,550		$	2,515		$	4,231		$	2,241		$	2,672	$	7,419		$	4,195		$	747		$	24,020
Charge-offs	(125		)	(515		)	(247		)	—		(963		)	(48		)	(255		)	(2,153		)	(325		)	(334		)	(247		)	—		(803		)	(486		)	(287		)	(2,482		)
Recoveries	65			867			311			—		696			259			114			2,312			115			1,053			343			6		652			1,274			139			3,582
Provision	(98		)	(383		)	3			19		304			(1,258		)	204			(1,209		)	558			(255		)	249			254		155			(853		)	252			360

Ending balance	$	2,694		$	4,702		$	2,985		$	2,576	$	7,101		$	3,740		$	702		$	24,500		$	2,863		$	4,695		$	2,586		$	2,932	$	7,423		$	4,130		$	851		$	25,480

Ending balance, individually evaluated for impairment	$	2		$	10		$	28		$	21	$	73		$	11		$	—		$	145		$	2		$	471		$	12		$	—	$	102		$	50		$	26		$	663

Ending balance, collectively evaluated for impairment	$	2,692		$	4,692		$	2,957		$	2,555	$	7,028		$	3,729		$	702		$	24,355		$	2,861		$	4,224		$	2,574		$	2,932	$	7,321		$	4,080		$	825		$	24,817

Loans:

Ending balance	$	86,243		$	179,872		$	119,824		$	145,070	$	766,209		$	564,482		$	76,264		$	1,937,964		$	93,533		$	173,029		$	146,448		$	179,981	$	831,232		$	574,966		$	76,890		$	2,076,079

Ending balance, individually evaluated for impairment	$	1,772		$	2,737		$	475		$	2,267	$	5,117		$	17,847		$	—		$	30,215		$	1,611		$	2,364		$	1,231		$	2,298	$	4,259		$	3,069		$	26		$	14,858

Ending balance, collectively evaluated for impairment	$	84,471		$	177,135		$	119,349		$	142,803	$	761,092		$	546,635		$	76,264		$	1,907,749		$	91,922		$	170,665		$	145,217		$	177,683	$	826,973		$	571,897		$	76,864		$	2,061,221

Page 15

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Changes in the allowance for loan losses for the three and nine months ended September 30, ~~2013~~2014 were as follows:

Three Months Ended September 30, 2013
Agricultural Commercial and
Financial Real Estate:
Construction and
land development Real Estate:
Mortgage,
farmland Real Estate:
Mortgage, 1 to 4
family Real Estate:
Mortgage, multi-
family and
commercial Other Total
(Amounts In Thousands)
Allowance for loan losses:
Beginning balance $ 2,379
$ 4,878
$ 2,988
$ 2,150
$ 6,984
$ 4,370
$ 651
$ 24,400
Charge-offs —
(283 ) —
—
(103 ) (44 ) (19 ) (449 )
Recoveries 12
220
76
—
85
258
36
687
Provision 150
58
(258 ) 139
105
(12 ) (70 ) 112

Ending balance $ 2,541
$ 4,873
$ 2,806
$ 2,289
$ 7,071
$ 4,572
$ 598
$ 24,750


	Nine Months Ended September 30, 2013																						Three Months Ended September 30, 2014
	Agricultural		Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total			Agricultural			Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland			Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)																						(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	1,653	$	4,573		$	3,175		$	1,746	$	8,088		$	5,104		$	821		$	25,160		$	3,036		$	4,832		$	3,431		$	2,749		$	6,831		$	3,739		$	732		$	25,350
Charge-offs	—		(778		)	(220		)	—		(651		)	(327		)	(143		)	$	(2,119	)	—			(60		)	—			—			(471		)	—			(50		)	(581		)
Recoveries	30		772			242			—		434			414			126			$	2,018		60			258			37			—			244			99			41			739
Provision	858		306			(391		)	543		(800		)	(619		)	(206		)	$	(309	)	(402		)	(328		)	(483		)	(173		)	497			(98		)	(21		)	(1,008		)

Ending balance	$	2,541	$	4,873		$	2,806		$	2,289	$	7,071		$	4,572		$	598		$	24,750		$	2,694		$	4,702		$	2,985		$	2,576		$	7,101		$	3,740		$	702		$	24,500

Ending balance, individually evaluated for impairment	$	3	$	13		$	—		$	4	$	69		$	218		$	1		$	308

Ending balance, collectively evaluated for impairment	$	2,538	$	4,860		$	2,806		$	2,285	$	7,002		$	4,354		$	597		$	24,442

Loans:

Ending balance	$	82,740	$	166,175		$	99,154		$	131,105	$	700,116		$	550,642		$	61,795		$	1,791,727

Ending balance, individually evaluated for impairment	$	123	$	1,868		$	1,722		$	459	$	4,519		$	17,912		$	12		$	26,615

Ending balance, collectively evaluated for impairment	$	82,617	$	164,307		$	97,432		$	130,646	$	695,597		$	532,730		$	61,783		$	1,765,112



	Nine Months Ended September 30, 2014
	Agricultural			Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	2,852		$	4,733		$	2,918		$	2,557	$	7,064		$	4,787		$	639		$	25,550
Charge-offs	(125		)	(515		)	(247		)	—		(963		)	(48		)	(255		)	$	(2,153	)
Recoveries	65			867			311			—		696			259			114			$	2,312
Provision	(98		)	(383		)	3			19		304			(1,258		)	204			$	(1,209	)

Ending balance	$	2,694		$	4,702		$	2,985		$	2,576	$	7,101		$	3,740		$	702		$	24,500

Ending balance, individually evaluated for impairment	$	2		$	10		$	28		$	21	$	73		$	11		$	—		$	145

Ending balance, collectively evaluated for impairment	$	2,692		$	4,692		$	2,957		$	2,555	$	7,028		$	3,729		$	702		$	24,355

Loans:

Ending balance	$	86,243		$	179,872		$	119,824		$	145,070	$	766,209		$	564,482		$	76,264		$	1,937,964

Ending balance, individually evaluated for impairment	$	1,772		$	2,737		$	475		$	2,267	$	5,117		$	17,847		$	—		$	30,215

Ending balance, collectively evaluated for impairment	$	84,471		$	177,135		$	119,349		$	142,803	$	761,092		$	546,635		$	76,264		$	1,907,749

Page 16

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The following table presents the credit quality indicators by type of loans in each category as of September 30, ~~2014~~2015 and December 31, ~~2013,~~2014, respectively (amounts in thousands):


	Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial		Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial
September 30, 2014
September 30, 2015
Grade:
Pass	$	62,482	$	141,198	$	32,670	$	66,560
Excellent									$	1,803	$	2,742	$	—	$	263
Good									11,212		33,727		2,810		10,841
Satisfactory									36,958		100,810		34,963		65,205
Monitor	14,386		18,511		3,881		4,289		14,695		20,543		10,777		2,721
Special Mention	6,159		13,010		2,625		8,983		26,050		10,846		5,331		10,179
Substandard	3,216		7,153		375		441		2,815		4,361		825		2,533
Total	$	86,243	$	179,872	$	39,551	$	80,273	$	93,533	$	173,029	$	54,706	$	91,742


	Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family first liens		Real Estate: Mortgage, 1 to 4 family junior liens		Real Estate: Mortgage, multi- family		Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family first liens		Real Estate: Mortgage, 1 to 4 family junior liens		Real Estate: Mortgage, multi- family
September 30, 2014
September 30, 2015
Grade:
Pass	$	124,813	$	580,005	$	100,191	$	187,591
Excellent									$	2,783	$	439	$	—	$	6,747
Good									31,664		16,872		3,012		69,168
Satisfactory									106,512		616,904		104,706		144,510
Monitor	12,834		41,707		2,783		36,089		27,079		48,408		4,570		25,419
Special Mention	2,115		17,718		2,404		17,715		8,627		16,314		1,811		5,122
Substandard	5,308		19,336		2,065		373		3,316		16,638		1,558		546
Total	$	145,070	$	658,766	$	107,443	$	241,768	$	179,981	$	715,575	$	115,657	$	251,512


	Real Estate: Mortgage, commercial		Loans to individuals		Obligations of state and political subdivisions		Total		Real Estate: Mortgage, commercial		Loans to individuals		Obligations of state and political subdivisions		Total
September 30, 2014
September 30, 2015
Grade:
Pass	$	274,011	$	19,682	$	54,913	$	1,644,116
Excellent									$	12,733	$	—	$	2,385	$	29,895
Good									83,272		77		40,960		303,615
Satisfactory									187,838		22,228		10,049		1,430,683
Monitor	33,471		210		1,027		169,188		27,690		286		518		182,706
Special Mention	8,835		324		—		79,888		7,910		195		18		92,403
Substandard	6,397		108		—		44,772		4,011		174		—		36,777
Total	$	322,714	$	20,324	$	55,940	$	1,937,964	$	323,454	$	22,960	$	53,930	$	2,076,079

Page 17

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)


	Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial		Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial
December 31, 2013
December 31, 2014
Grade:
Pass	$	71,370	$	134,605	$	26,519	$	56,555
Excellent									$	1,375	$	4,820	$	—	$	276
Good									13,214		37,941		6,893		13,875
Satisfactory									51,107		94,158		27,738		47,852
Monitor	3,579		12,469		758		3,963		15,243		20,445		8,435		2,811
Special Mention	1,076		12,971		2,242		6,854		13,070		11,031		1,881		11,870
Substandard	6,113		6,057		790		1,810		3,636		6,343		1,002		336
Total	$	82,138	$	166,102	$	30,309	$	69,182	$	97,645	$	174,738	$	45,949	$	77,020


	Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family first liens		Real Estate: Mortgage, 1 to 4 family junior liens		Real Estate: Mortgage, multi- family		Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family first liens		Real Estate: Mortgage, 1 to 4 family junior liens		Real Estate: Mortgage, multi- family
December 31, 2013
December 31, 2014
Grade:
Pass	$	132,988	$	532,921	$	98,142	$	196,616
Excellent									$	2,867	$	474	$	—	$	7,011
Good									36,680		22,094		2,875		73,852
Satisfactory									103,552		571,546		99,095		111,650
Monitor	5,413		30,454		2,273		28,438		11,754		41,805		3,377		35,812
Special Mention	1,795		22,097		3,187		18,161		4,721		18,428		2,520		16,611
Substandard	2,489		20,215		2,183		875		2,929		18,327		2,417		277
Total	$	142,685	$	605,687	$	105,785	$	244,090	$	162,503	$	672,674	$	110,284	$	245,213


	Real Estate: Mortgage, commercial		Loans to individuals		Obligations of state and political subdivisions		Total		Real Estate: Mortgage, commercial		Loans to individuals		Obligations of state and political subdivisions		Total
December 31, 2013
December 31, 2014
Grade:
Pass	$	262,252	$	19,263	$	43,047	$	1,574,278
Excellent									$	15,416	$	87	$	2,440	$	34,766
Good									87,612		94		43,108		338,238
Satisfactory									178,069		20,465		10,181		1,315,413
Monitor	30,140		117		1,061		118,665		25,165		251		—		165,098
Special Mention	14,749		316		1,059		84,507		9,371		353		—		89,856
Substandard	8,046		128		—		48,706		5,968		92		—		41,327
Total	$	315,187	$	19,824	$	45,167	$	1,826,156	$	321,601	$	21,342	$	55,729	$	1,984,698

Page 18

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The below are descriptions of the credit quality indicators:

~~Pass~~Excellent – ~~Pass~~Excellent rated loans are prime quality loans covered by highly liquid collateral with generous margins or supported by superior current financial conditions reflecting substantial net worth, relative to total credit extended, and based on assets of a stable and non-speculative nature whose values can be readily verified. Identified repayment source or cash flow is abundant and assured.

Good – Good rated loans are adequately secured by readily marketable collateral or good financial condition characterized by liquidity, flexibility and sound net worth. Loans are supported by sound primary and secondary payment ~~capacity,~~sources and timely and accurate financial information.

Satisfactory – Satisfactory rated loans are ~~adequately collateralized~~loans to borrowers of average financial means not especially vulnerable to changes in economic or other circumstances, where the major support for the extension is sufficient collateral of a marketable nature, and ~~have no apparent weaknesses that would affect~~ the ~~full~~primary source of repayment ~~of the loan under the established terms~~is seen to be clear and ~~conditions.~~adequate.

Monitor – Monitor rated loans are ~~supported~~identified by ~~adequate payment capacity, are adequately collateralized and are performing according to the established terms and conditions. However, the loan requires more than average monitoring~~management as warranting special attention for a variety of reasons that may bear on ultimate collectability. This may be due to adverse trends, a potential weakness. The monitor indicator assists the Company in identifying and monitoring loans for which credit quality could deteriorate. This grade was labeled potential watch in previous reports; the Company changed the label only and has not changed the overall description of the credit quality indicator.particular industry, loan structure, or repayment that is dependent on projections, or a one-time occurrence.

Special Mention – Special mention rated loans are supported by a marginal payment capacity and ~~may be~~are marginally ~~collateralized.~~protected by collateral. There are identified weaknesses that if not monitored and corrected may adversely affect the Company’s credit position. A special mention credit would typically have a weakness in one of the general categories (cash flow, collateral position or payment history) but not in all categories. ~~This grade was labeled watch in previous reports; the Company changed the label only and has not changed the overall description of the credit quality indicator~~

Substandard – Substandard loans are not adequately supported by the paying capacity of the borrower and may be inadequately collateralized. These loans have a well-defined weakness or weaknesses. For these loans, it is more probable than not that the Company could sustain some loss if the deficiency(ies) is not corrected.

Page 19

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Past due loans as of September 30, ~~2014~~2015 and December 31, ~~2013~~2014 were as follows:


	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable		Accruing Loans Past Due 90 Days or More		30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable		Accruing Loans Past Due 90 Days or More
	(Amounts In Thousands)														(Amounts In Thousands)
September 30, 2014
September 30, 2015
Agricultural	$	—	$	43	$	—	$	43	$	86,200	$	86,243	$	—	$	263	$	326	$	—	$	589	$	92,944	$	93,533	$	—
Commercial and financial	988		98		951		2,037		177,835		179,872		—		688		1,182		172		2,042		170,987		173,029		—
Real estate:
Construction, 1 to 4 family residential	—		—		—		—		39,551		39,551		—		192		214		—		406		54,300		54,706		42
Construction, land development and commercial	265		—		132		397		79,876		80,273		—		—		123		79		202		91,540		91,742		79
Mortgage, farmland	289		—		—		289		144,781		145,070		—		420		—		—		420		179,561		179,981		—
Mortgage, 1 to 4 family first liens	347		1,437		1,947		3,731		655,035		658,766		996		655		841		1,322		2,818		712,757		715,575		305
Mortgage, 1 to 4 family junior liens	247		82		492		821		106,622		107,443		103		205		68		140		413		115,244		115,657		105
Mortgage, multi-family	23		—		—		23		241,745		241,768		—		51		—		—		51		251,461		251,512		—
Mortgage, commercial	1,020		622		197		1,839		320,875		322,714		—		190		541		105		836		322,618		323,454		—
Loans to individuals	8		1		—		9		20,315		20,324		—		102		68		—		170		22,790		22,960		—
Obligations of state and political subdivisions	—		—		—		—		55,940		55,940		—		—		—		—		—		53,930		53,930		—
	$	3,187	$	2,283	$	3,719	$	9,189	$	1,928,775	$	1,937,964	$	1,099	$	2,766	$	3,363	$	1,818	$	7,947	$	2,068,132	$	2,076,079	$	531

December 31, 2013:
December 31, 2014
Agricultural	$	8	$	10	$	—	$	18	$	82,120	$	82,138	$	—	$	310	$	99	$	—	$	409	$	97,236	$	97,645	$	—
Commercial and financial	526		177		951		1,654		164,448		166,102		—		397		14		1,048		1,459		173,279		174,738		—
Real estate:
Construction, 1 to 4 family residential	—		—		—		—		30,309		30,309		—		—		—		—		—		45,949		45,949		—
Construction, land development and commercial	276		144		731		1,151		68,031		69,182		—		937		—		—		937		$	76,083	77,020		—
Mortgage, farmland	108		—		—		108		142,577		142,685		—		753		—		—		753		161,750		162,503		—
Mortgage, 1 to 4 family first liens	4,418		1,649		2,223		8,290		597,397		605,687		959		3,594		1,656		1,582		6,832		$	665,842	672,674		348
Mortgage, 1 to 4 family junior liens	835		43		29		907		104,878		105,785		—		181		12		244		437		109,847		110,284		—
Mortgage, multi-family	—		150		—		150		243,940		244,090		—		—		21		—		21		$	245,192	245,213		—
Mortgage, commercial	1,350		—		493		1,843		313,344		315,187		—		359		557		34		950		320,651		321,601		—
Loans to individuals	7		4		—		11		19,813		19,824		—		27		—		—		27		$	21,315	21,342		—
Obligations of state and political subdivisions	14		—		—		14		45,153		45,167		—		—		—		—		—		55,729		55,729		—
	$	7,542	$	2,177	$	4,427	$	14,146	$	1,812,010	$	1,826,156	$	959	$	6,558	$	2,359	$	2,908	$	11,825	$	1,972,873	$	1,984,698	$	348

Page 20

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The Company does not have a ~~significant~~material amount of loans that are past due less than 90 days where there are serious doubts as to the ability of the borrowers to comply with the loan repayment terms.

Certain impaired loan information by loan type at September 30, ~~2014~~2015 and December 31, ~~2013,~~2014, was as follows:


	September 30, 2014						December 31, 2013						September 30, 2015						December 31, 2014
	Non-accrual loans (1)		Accruing loans past due 90 days or more (2)		TDR loans		Non- accrual loans (1)		Accruing loans past due 90 days or more (2)		TDR loans		Non-accrual loans (1)		Accruing loans past due 90 days or more		TDR loans		Non- accrual loans (1)		Accruing loans past due 90 days or more		TDR loans
	(Amounts In Thousands)						(Amounts In Thousands)						(Amounts In Thousands)						(Amounts In Thousands)
Agricultural	$	—	$	—	$	1,772	$	—	$	—	$	120	$	—	$	—	$	1,611	$	—	$	—	$	1,942
Commercial and financial	1,170		—		1,567		1,462		—		945		1,717		—		647		1,343		—		1,366
Real estate:
Construction, 1 to 4 family residential	—		—		170		—		—		—		173		42		468		—		—		431
Construction, land development and commercial	132		—		173		1,319		—		—		—		79		469		127		—		—
Mortgage, farmland	—		—		2,267		—		—		284		—		—		2,298		—		—		2,220
Mortgage, 1 to 4 family first liens	2,025		996		1,604		2,209		959		1,272		2,349		305		1,318		1,912		348		1,199
Mortgage, 1 to 4 family junior liens	389		103		—		178		—		—		155		105		27		369		—		—
Mortgage, multi-family	58		—		5,932		456		—		5,608		242		—		—		55		—		5,470
Mortgage, commercial	1,884		—		9,973		1,568		—		10,146		1,174		—		1,653		2,275		—		1,712
Loans to individuals	—		—		—		—		—		—		—		—		—		—		—		—
	$	5,658	$	1,099	$	23,458	$	7,192	$	959	$	18,375	$	5,810	$	531	$	8,491	$	6,081	$	348	$	14,340


(1)	There were ~~$2.03~~$2.72 million and ~~$2.72~~$2.14 million of TDR loans included within nonaccrual loans as of September 30, ~~2014~~2015 and December 31, ~~2013, respectively.~~


~~(2)~~	~~There were no TDR loans within accruing loans past due 90 days or more as of September 30,~~ 2014, ~~and December 31, 2013,~~ respectively.

Loans 90 days or more past due that are still accruing interest increased ~~$0.14~~$0.02 million from December 31, ~~2013~~2014 to September 30, ~~2014~~2015 due to an increase in the number of loans past due greater than 90 days. As of September 30, 2015 there were 8 accruing loans past due 90 days or more. The average accruing loans past due as of September 30, 2015 are $0.07 million. The average accruing loans past due 90 days or more ~~balance was $0.08 million as of September 30, 2014 and $0.08 million~~ as of December 31, ~~2013.~~2014 was $0.07 million. The accruing loans past due 90 days or more balances are believed to be adequately collateralized and the Company expects to collect all principal and interest as contractually due under these loans.

The Company may modify the terms of a loan to maximize the collection of amounts due. Such a modification is considered a troubled debt restructuring (“TDR”). In most cases, the modification is either a reduction in interest rate, conversion to interest only payments or an extension of the maturity date. The borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term, so a concessionary modification is granted to the borrower that would otherwise not be considered. TDR loans accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles.

Page 21

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Below is a summary of information for TDR loans as of September 30, ~~2014~~2015 and December 31, ~~2013:~~2014:


	September 30, 2014					December 31, 2013					September 30, 2015					December 31, 2014
	Number of contracts	Recorded investment		Commitments outstanding		Number of contracts	Recorded investment		Commitments outstanding		Number of contracts	Recorded investment		Commitments outstanding		Number of contracts	Recorded investment		Commitments outstanding
		(Amounts In Thousands)					(Amounts In Thousands)					(Amounts In Thousands)					(Amounts In Thousands)
Agricultural	9	$	1,772	$	13	1	$	120	$	4	6	$	1,610	$	118	9	$	1,942	$	272
Commercial and financial	15	2,408		157		12	2,214		101		10	2,072		290		13	2,202		53
Real estate:
Construction, 1 to 4 family residential	1	170		—		—	—		—		3	641		18		3	431		111
Construction, land development and commercial	1	173		—		1	13		—		2	469		4		1	127		—
Mortgage, farmland	4	2,267		—		1	284		—		5	2,298		—		4	2,220		—
Mortgage, 1 to 4 family first liens	15	1,881		—		12	1,697		—		13	1,536		—		11	1,467		—
Mortgage, 1 to 4 family junior liens	1	225		45		—	—		177		2	38		—		1	225		65
Mortgage, multi-family	4	5,932		—		3	6,000		—		1	71		—		2	5,470		—
Mortgage, commercial	10	10,659		—		9	10,766		10		10	2,473		—		8	2,398		—
Loans to individuals	—	—		—		—	—		—		—	—		—		—	—		—
	60	$	25,487	$	215	39	$	21,094	$	292	52	$	11,208	$	430	52	$	16,482	$	501

The following is a summary of TDR loans that were modified during the three and nine months ended September 30, ~~2014:~~2015:


	Three Months Ended September 30, 2014					Nine Months Ended September 30, 2014					Three Months Ended September 30, 2015					Nine Months Ended September 30, 2015
	Number of contracts	Pre-modification recorded investment		Post-modification recorded investment		Number of contracts	Pre-modification recorded investment		Post-modification recorded investment		Number of contracts	Pre-modification recorded investment		Post-modification recorded investment		Number of contracts	Pre-modification recorded investment		Post-modification recorded investment
		(Amounts In Thousands)										(Amounts In Thousands)					(Amounts In Thousands)
Agricultural	6	$	1,874	$	1,874	9	$	2,033	$	2,033	—	$	—	$	—	5	$	394	$	278
Commercial and financial	1	85		85		8	882		882		1	486		486		2	677		663
Real estate:
Construction, 1 to 4 family residential	—	—		—		1	170		170		1	276		276		—	276		276
Construction, land development and commercial	—	—		—		1	184		173		1	350		350		—	350		350
Mortgage, farmland	3	2,007		2,007		3	2,007		2,007		—	—		—		3	644		531
Mortgage, 1 to 4 family first lien	2	333		333		5	514		514		—	—		—		4	264		264
Mortgage, 1 to 4 family junior liens	—	—		—		1	225		225		—	—		—		2	42		42
Mortgage, multi-family	—	—		—		1	89		89		—	—		—		1	71		71
Mortgage, commercial	—	—		—		2	269		269		—	—		—		2	222		190
	12	$	4,299	$	4,299	31	$	6,373	$	6,362	3	$	1,112	$	1,112	19	$	2,940	$	2,665

Page 22

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The Company had commitments to lend ~~$0.22~~$0.43 million in additional borrowings to restructured loan customers as of September 30, ~~2014.~~2015. The Company had commitments to lend ~~$0.29~~$0.50 million in additional borrowings to restructured loan customers as of December 31, ~~2013.~~2014. These commitments were in the normal course of business. The additional borrowings were not used to facilitate payments on these loans.

There were ~~$1.23~~$0.00 million and $0.00 million of TDR loans that were in payment default (defined as past due 90 days or more) as of September 30, ~~2014~~2015 and December 31, 2013, respectively. As of September 30, 2014, TDR loans in payment default consisted of a $0.09 million 1 to 4 family first lien mortgage loan, a $0.22 million 1 to 4 family junior lien loan, a $0.16 million commercial mortgage loan and a commercial and financial loan totaling $0.76 million.2014.

Page 23

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Information regarding impaired loans as of and for the three and nine months ended September 30, ~~2014~~2015 is as follows:


	September 30, 2014						Three Months Ended September 30, 2014				Nine Months Ended September 30, 2014				September 30, 2015						Three Months Ended September 30, 2015				Nine Months Ended September 30, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:	(Amounts In Thousands)														(Amounts In Thousands)
Agricultural	$	1,659	$	1,756	$	—	$	1,812	$	22	$	1,674	$	60	$	1,507	$	1,669	$	—	$	1,462	$	18	$	1,569	$	58
Commercial and financial	2,068		3,655		—		1,839		9		1,832		25		1,353		2,003		—		1,371		1		1,472		4
Real estate:
Construction, 1 to 4 family residential	—		—		—		—		—		—		—		192		192		—		190		2		140		2
Construction, land development and commercial	132		222		—		138		—		144		—		469		563		—		296		3		298		7
Mortgage, farmland	977		977		—		977		12		1,047		37		2,298		2,412		—		2,306		28		2,338		83
Mortgage, 1 to 4 family first liens	3,470		4,672		—		3,450		16		3,515		47		3,123		3,846		—		3,145		12		3,291		38
Mortgage, 1 to 4 family junior liens	389		682		—		392		—		396		—		120		414		—		122		—		132		—
Mortgage, multi-family	5,990		6,643		—		6,020		66		6,071		201		171		230		—		175		—		182		—
Mortgage, commercial	10,996		13,745		—		11,069		103		11,245		311		2,105		3,326		—		2,129		12		2,158		36
Loans to individuals	—		20		—		—		—		—		—		—		20		—		—		—		—		—
	$	25,681	$	32,372	$	—	$	25,697	$	228	$	25,924	$	681	$	11,338	$	14,675	$	—	$	11,196	$	76	$	11,580	$	228

With an allowance recorded:
Agricultural	$	113	$	113	$	2	$	114	$	1	$	117	$	4	$	104	$	104	$	2	$	105	$	1	$	107	$	3
Commercial and financial	669		669		10		683		9		712		28		1,011		1,011		471		1,044		7		1,072		23
Real estate:
Construction, 1 to 4 family residential	170		170		20		170		2		170		6		491		502		11		491		4		480		7
Construction, land development and commercial	173		184		8		173		2		178		7		79		79		1		79		1		77		3
Mortgage, farmland	1,290		1,290		21		1,271		15		994		36		—		—		—		—		—		—		—
Mortgage, 1 to 4 family first liens	1,155		1,347		69		1,195		13		1,216		38		849		879		93		854		7		856		21
Mortgage, 1 to 4 family junior liens	103		158		4		105		1		105		3		167		167		9		167		1		149		4
Mortgage, multi-family	—		—		—		—		—		—		—		71		109		7		71		—		91		—
Mortgage, commercial	861		875		11		864		9		873		28		722		722		43		726		9		734		27
Loans to individuals	—		—		—		—		—		—		—		26		26		26		20		1		14		1
	$	4,534	$	4,806	$	145	$	4,575	$	52	$	4,365	$	150	$	3,520	$	3,599	$	663	$	3,557	$	31	$	3,580	$	89

Total:
Agricultural	$	1,772	$	1,869	$	2	$	1,926	$	23	$	1,791	$	64	$	1,611	$	1,773	$	2	$	1,567	$	19	$	1,676	$	61
Commercial and financial	2,737		4,324		10		2,522		18		2,544		53		2,364		3,014		471		2,415		8		2,544		27
Real estate:
Construction, 1 to 4 family residential	170		170		20		170		2		170		6		683		694		11		681		6		620		9
Construction, land development and commercial	305		406		8		311		2		322		7		548		642		1		375		4		375		10
Mortgage, farmland	2,267		2,267		21		2,248		27		2,041		73		2,298		2,412		—		2,306		28		2,338		83
Mortgage, 1 to 4 family first liens	4,625		6,019		69		4,645		29		4,731		85		3,972		4,725		93		3,999		19		4,147		59
Mortgage, 1 to 4 family junior liens	492		840		4		497		1		501		3		287		581		9		289		1		281		4
Mortgage, multi-family	5,990		6,643		—		6,020		66		6,071		201		242		339		7		246		—		273		—
Mortgage, commercial	11,857		14,620		11		11,933		112		12,118		339		2,827		4,048		43		2,855		21		2,892		63
Loans to individuals	—		20		—		—		—		—		—		26		46		26		20		1		14		1
	$	30,215	$	37,178	$	145	$	30,272	$	280	$	30,289	$	831	$	14,858	$	18,274	$	663	$	14,753	$	107	$	15,160	$	317

Page 24

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Information regarding impaired loans as of December 31, ~~2013~~2014 is as follows:


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:	(Amounts In Thousands)						(Amounts In Thousands)
Agricultural	$	—	$	—	$	—	$	1,634	$	1,696	$	—
Commercial and financial	1,602		3,140		—		2,076		3,695		—
Real estate:
Construction, 1 to 4 family residential	1,270		2,974		—		89		89		—
Construction, land development and commercial	140		140		—		128		220		—
Mortgage, farmland	—		—		—		2,040		2,040		—
Mortgage, 1 to 4 family first liens	2,597		3,542		—		2,951		3,705		—
Mortgage, 1 to 4 family junior liens	177		451		—		369		673		—
Mortgage, multi-family	456		1,068		—		5,525		5,632		—
Mortgage, commercial	2,494		5,303		—		3,290		4,588		—
Loans to individuals	—		20		—		—		20		—
	$	8,736	$	16,638	$	—	$	18,102	$	22,358	$	—

With an allowance recorded:
Agricultural	$	120	$	120	$	3	$	210	$	247	$	44
Commercial and financial	805		838		16		633		633		9
Real estate:
Construction, 1 to 4 family residential	—		—		—		343		354		28
Construction, land development and commercial	—		—		—		—		—		—
Mortgage, farmland	284		284		14		278		278		12
Mortgage, 1 to 4 family first liens	1,768		1,897		66		506		596		52
Mortgage, 1 to 4 family junior liens	—		—		—		—		—		—
Mortgage, multi-family	5,608		5,608		188		—		—		—
Mortgage, commercial	9,205		9,205		17		697		697		9
Loans to individuals	—		—		—		—		—		—
	$	17,790	$	17,952	$	304	$	2,667	$	2,805	$	154

Total:
Agricultural	$	120	$	120	$	3	$	1,844	$	1,943	$	44
Commercial and financial	2,407		3,978		16		2,709		4,328		9
Real estate:
Construction, 1 to 4 family residential	1,270		2,974		—		432		443		28
Construction, land development and commercial	140		140		—		128		220		—
Mortgage, farmland	284		284		14		2,318		2,318		12
Mortgage, 1 to 4 family first liens	4,365		5,439		66		3,457		4,301		52
Mortgage, 1 to 4 family junior liens	177		451		—		369		673		—
Mortgage, multi-family	6,064		6,676		188		5,525		5,632		—
Mortgage, commercial	11,699		14,508		17		3,987		5,285		9
Loans to individuals	—		20		—		—		20		—
	$	26,526	$	34,590	$	304	$	20,769	$	25,163	$	154

Page 25

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Impaired loans ~~increased $3.52~~decreased $5.94 million from December 31, ~~2013~~2014 to September 30, ~~2014.~~2015. Impaired loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and TDR loans. Impaired loans also include loans that, based on management’s evaluation of current information and events, the Company expects to be unable to collect in full according to the contractual terms of the original loan agreement. Impaired loans were ~~1.56%~~0.71% of loans held for investment as of September 30, ~~2014~~2015 and ~~1.45%~~1.05% as of December 31, ~~2013.~~2014. The ~~increase~~decrease in impaired loans is due mainly to ~~an increase~~a decrease in nonaccrual loans of $0.27 million and a decrease in TDR loans of ~~$5.08~~$5.85 million from December 31, ~~2013~~2014 to September 30, ~~2014.~~2015.

The Company regularly reviews a substantial portion of the loans in the portfolio and assesses whether the loans are impaired in accordance with ASC 310. If the loans are impaired, the Company determines if a specific allowance is appropriate. In addition, the Company's management also reviews and, where determined necessary, provides allowances for particular loans based upon (1) reviews of specific borrowers and (2) management’s assessment of areas that management considers are of higher credit risk, including loans that have been restructured. Loans that are determined not to be impaired and for which there are no specific allowances are classified into one or more risk categories. Based upon the risk category assigned, the Company allocates a percentage, as determined by management, for a required allowance needed. The determination of the appropriate percentage begins with historical loss experience factors, which are then adjusted for levels and trends in past due loans, levels and trends in charged-off and recovered loans, trends in volume growth, trends in problem and watch loans, trends in restructured loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates.

Specific allowances for losses on impaired loans are established if the loan balances exceed the net present value of the relevant future cash flows or the fair value of the relevant collateral based on updated appraisals and/or updated collateral analysis for the properties if the loan is collateral dependent. The Company recognizes a charge off related to an impaired loan if there is a collateral shortfall or it is unlikely the borrower can make all principal and interest payments as contractually due.

For loans that are collateral dependent, losses are evaluated based on the portion of a loan that exceeds the fair market value of the collateral. In general, this is the amount that the carrying value of the loan exceeds the related appraised value less estimated costs to sell the collateral. Generally, it is the Company’s policy not to rely on appraisals that are older than one year prior to the date the impairment is being measured. The most recent appraisal values may be adjusted if, in the Company’s judgment, experience and other market data indicate that the property’s value, use, condition, exit market or other variable affecting its value may have changed since the appraisal was performed, consistent with the December 2006 joint interagency guidance on the allowance for loan losses. The charge off or loss adjustment supported by an appraisal is considered the minimum charge off. Any adjustments made to the appraised value are to provide an additional charge off or specific reserve based on the applicable facts and circumstances. In instances where there is an estimated decline in value, a specific reserve may be provided or a charge off taken pending confirmation of the amount of the loss from an updated appraisal. Upon receipt of the new appraisals, an additional specific reserve may be provided or charge off taken based on the appraised value of the collateral. On average, appraisals are obtained within one month of order.

Page 26

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)


Note 6.	Fair Value Measurements

The carrying value and estimated fair values of the Company's financial instruments as of September 30, ~~2014~~2015 are as follows:


	September 30, 2014										September 30, 2015
	Carrying Amount		Estimated Fair Value		Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Carrying Amount		Estimated Fair Value		Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)
	(Amounts In Thousands)										(Amounts In Thousands)
Financial instrument assets:
Cash and cash equivalents	$	68,864	$	68,864	$	68,864	$	—	$	—	$	33,985	$	33,985	$	33,985	$	—	$	—
Investment securities	251,469		251,469		—		251,469		—		257,126		257,126		—		257,126		—
Loans held for sale	2,484		2,484				2,484				4,395		4,395		—		4,395		—
Loans
Agricultural	83,549		83,530		—		—		83,530		90,670		90,740		—		—		90,740
Commercial and financial	175,170		176,122		—		—		176,122		168,334		168,794		—		—		168,794
Real estate:
Construction, 1 to 4 family residential	38,471		38,311		—		—		38,311		53,746		53,722		—		—		53,722
Construction, land development and commercial	78,368		78,338		—		—		78,338		90,116		90,077		—		—		90,077
Mortgage, farmland	142,494		142,785		—		—		142,785		177,049		177,168		—		—		177,168
Mortgage, 1 to 4 family first liens	652,582		655,991		—		—		655,991		709,309		708,961		—		—		708,961
Mortgage, 1 to 4 family junior liens	106,526		110,723		—		—		110,723		114,500		119,346		—		—		119,346
Mortgage, multi-family	240,235		243,133		—		—		243,133		249,974		252,792		—		—		252,792
Mortgage, commercial	320,507		319,958		—		—		319,958		320,862		320,030		—		—		320,030
Loans to individuals	19,974		19,922		—		—		19,922		22,514		22,491		—		—		22,491
Obligations of state and political subdivisions	55,588		54,717		—		—		54,717		53,525		53,313		—		—		53,313
Accrued interest receivable	8,980		8,980		—		8,980		—		9,700		9,700		—		9,700		—
Total financial instrument assets	$	2,245,261	$	2,255,327	$	68,864	$	262,933	$	1,923,530	$	2,355,805	$	2,362,640	$	33,985	$	271,221	$	2,057,434
Financial instrument liabilities
Deposits
Noninterest-bearing deposits	$	270,139	$	270,139	$	—	$	270,139	$	—	$	297,676	$	297,676	$	—	$	297,676	$	—
Interest-bearing deposits	1,569,357		1,573,833		—		1,573,833		—		1,591,300		1,592,144		—		1,592,144		—
Short-term borrowings	36,033		36,033		—		36,033		—
Other borrowings											36,124		36,124		—		36,124		—
Federal Home Loan Bank borrowings	125,000		130,785		—		130,785		—		170,000		174,864		—		174,864		—
Interest rate swaps											4,685		4,685		—		4,685		—
Accrued interest payable	906		906		—		906		—		750		750		—		750		—
Total financial instrument liabilities	$	2,001,435	$	2,011,696	$	—	$	2,011,696	$	—	$	2,100,535	$	2,106,243	$	—	$	2,106,243	$	—

	Face Amount										Face Amount
Financial instrument with off-balance sheet risk:
Loan commitments	$	380,570	$	—	$	—	$	—	$	—	$	375,418	$	—	$	—	$	—	$	—
Letters of credit	14,131		—		—		—		—		8,959		—		—		—		—
Total financial instrument liabilities with off-balance-sheet risk	$	394,701	$	—	$	—	$	—	$	—	$	384,377	$	—	$	—	$	—	$	—


(1)	Considered Level 1 under Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”).


(2)	Considered Level 2 under ASC 820.


(3)	Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.

Page 27

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The carrying value and estimated fair values of the Company's financial instruments as of December 31, ~~2013~~2014 are as follows:


	December 31, 2013										December 31, 2014
	Carrying Amount		Estimated Fair Value		Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Carrying Amount		Estimated Fair Value		Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)
	(Amounts In Thousands)										(Amounts In Thousands)
Financial instrument assets:
Cash and cash equivalents	$	43,702	$	43,702	$	43,702	$	—	$	—	$	29,174	$	29,174	$	29,174	$	—	$	—
Investment securities	246,089		246,089		—		246,089		—		267,240		267,240		—		267,240		—
Loans held for sale	4,927		4,927		—		4,927		—		4,476		4,476		—		4,476		—
Loans
Agricultural	79,286		86,137		—		—		86,137		95,130		95,126		—		—		95,126
Commercial and financial	161,369		176,385		—		—		176,385		170,507		171,081		—		—		171,081
Real estate:
Construction, 1 to 4 family residential	29,298		28,364		—		—		28,364		45,139		45,159		—		—		45,159
Construction, land development and commercial	67,275		65,544		—		—		65,544		75,589		75,623		—		—		75,623
Mortgage, farmland	140,128		137,938		—		—		137,938		159,831		159,623		—		—		159,623
Mortgage, 1 to 4 family first liens	599,586		595,054		—		—		595,054		666,406		665,428		—		—		665,428
Mortgage, 1 to 4 family junior liens	104,822		104,133		—		—		104,133		109,133		115,726		—		—		115,726
Mortgage, multi-family	242,026		240,595		—		—		240,595		243,723		246,191		—		—		246,191
Mortgage, commercial	312,464		310,558		—		—		310,558		318,896		318,211		—		—		318,211
Loans to individuals	19,554		19,710		—		—		19,710		21,043		21,016		—		—		21,016
Obligations of state and political subdivisions	44,798		45,184		—		—		45,184		55,281		54,800		—		—		54,800
Accrued interest receivable	7,676		7,676		—		7,676		—		8,276		8,276		—		8,276		—
Total financial instrument assets	$	2,103,000	$	2,111,996	$	43,702	$	258,692	$	1,809,602	$	2,269,844	$	2,277,150	$	29,174	$	279,992	$	1,967,984
Financial instrument liabilities:
Deposits
Noninterest-bearing deposits	$	256,788	$	256,788	$	—	$	256,788	$	—	$	288,718	$	288,718	$	—	$	288,718	$	—
Interest-bearing deposits	1,453,089		1,461,454		—		1,461,454		—		1,546,351		1,550,974		—		1,550,974		—
Short-term borrowings	42,016		42,016		—		42,016		—
Other borrowings											47,499		47,499		—		47,499		—
Federal Home Loan Bank borrowings	125,000		132,469		—		132,469		—		140,000		145,210		—		145,210		—
Interest rate swaps											2,796		2,796		—		2,796		—
Accrued interest payable	1,102		1,102		—		1,102		—		902		902		—		902		—
Total financial instrument liabilities	$	1,877,995	$	1,893,829	$	—	$	1,893,829	$	—	$	2,026,266	$	2,036,099	$	—	$	2,036,099	$	—

	Face Amount										Face Amount
Financial instrument with off-balance sheet risk:
Loan commitments	$	360,945	$	—	$	—	$	—	$	—	$	334,100	$	—	$	—	$	—	$	—
Letters of credit	11,019		—		—		—		—		12,437		—		—		—		—
Total financial instrument liabilities with off-balance-sheet risk	$	371,964	$	—	$	—	$	—	$	—	$	346,537	$	—	$	—	$	—	$	—


(1)	Considered Level 1 under ASC 820.


(2)	Considered Level 2 under ASC 820.


(3)	Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.

Page 28

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Fair value of financial instruments: FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) provides a single definition for fair value, a framework for measuring fair value and expanded disclosures concerning fair value. Fair value is defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

The Company determines the fair market value of its financial instruments based on the fair value hierarchy established in ASC 820. There are three levels of inputs that may be used to measure fair value as follows:



	Level 1	Quoted prices in active markets for identical assets or liabilities.



	Level 2	Observable inputs other than quoted prices included within Level 1. Observable inputs include the quoted prices for similar assets or liabilities in markets that are not active and inputs other than quoted prices that are observable for the asset or liability.



	Level 3	Unobservable inputs supported by little or no market activity for financial instruments. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

It is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. The Company is required to use observable inputs, to the extent available, in the fair value estimation process unless that data results from forced liquidations or distressed sales.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for assets or liabilities not recorded at fair value.

ASSETS

Cash and cash equivalents: The carrying amounts reported in the consolidated balance sheets for cash and short-term instruments approximate their fair values (Level 1).

Investment securities available for sale: Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If a quoted price is not available, the fair value is obtained from benchmarking the security against similar securities. All of the Company’s securities are considered Level 2.

The pricing for investment securities is obtained from an independent source. There are no level 1 or level 3 investment securities owned by the Company. The Company obtains an understanding of the independent source’s valuation methodologies used to determine fair value by level of security. The Company validates assigned fair values on a sample basis using an additional third-party provider pricing service to determine if the fair value measurement is reasonable. Due to the nature of our investment portfolio, we do not expect significant and unusual fluctuations as fair value changes primarily relate to interest rate changes. No unusual fluctuations were identified during the nine months ended September 30, ~~2014.~~2015. If a fluctuation requiring investigation was identified, the Company would research the change with the independent source or other available information.

Loans held for sale: Loans held for sale are carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the short time between origination of the loan and its sale on the secondary market (Level 2). The market is active for these loans and as a result prices for similar assets are available.

Page 29

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Loans: The Company does not record loans at fair value on a recurring basis. For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values (Level 3). The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality utilizing an entrance price concept (Level 3). The Company does record nonrecurring fair value adjustments to loans to reflect (1) partial write-downs that are based on the observable market price or appraised value of the collateral or ~~(2 )the~~(2) the full charge-off of the loan carrying value (Level 3). These loans are considered Level 3 as the instruments used to determine fair market value require significant management judgment and estimation.

Foreclosed assets: The Company does not record foreclosed assets at fair value on a recurring basis. Foreclosed assets consist mainly of other real estate owned but may include other types of assets repossessed by the Company. Foreclosed assets are adjusted to the lower of carrying value or fair value less the cost of disposal. Fair value is generally based upon independent market prices or appraised values of the collateral, and may include a marketability discount as deemed necessary by management based on its experience with similar types of real estate. The value of foreclosed assets is evaluated periodically as a nonrecurring fair value adjustment. Foreclosed assets are classified as Level 3.

Off-balance sheet instruments: Fair values for outstanding letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of the outstanding letters of credit is not significant. Unfunded loan commitments are not valued since the loans are generally priced at market at the time of funding (Level 2).

Accrued interest receivable: The fair value of accrued interest receivable equals the amount receivable due to the current nature of the amounts receivable (Level 2).

Non-marketable equity investments: Non-marketable equity investments are recorded under the cost or equity method of accounting. There are generally restrictions on the sale and/or liquidation of these investments, including stock of the Federal Home Loan Bank. The carrying value of stock of the Federal Home Loan Bank approximates fair value (Level 2).

LIABILITIES

Deposit liabilities: Deposit liabilities are carried at historical cost. The fair value of demand deposits, savings accounts and certain money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. If the fair value of the fixed maturity certificates of deposit is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value (Level 2). Deposit liabilities are classified as Level 2 due to available prices for similar liabilities in the market.

~~Short-term~~Other borrowings: ~~Short-term~~Other borrowings are carried at historical cost and include federal funds purchased and securities sold under agreements to repurchase. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the liability and its expected realization (Level 2). ~~Short-term~~Other borrowings are classified as Level 2 due to available prices for similar liabilities in the market.

Federal Home Loan Bank borrowings: Federal Home Loan Bank borrowings are recorded at historical cost. The fair values of the Company’s Federal Home Loan Bank borrowings are estimated using discounted cash flow ~~analyses,~~analysis, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements (Level 2). Federal Home Loan Bank borrowings are classified as Level 2 due to available prices for similar liabilities in the market.

Interest Rate Swap Agreements: The fair value is estimated using forward-looking interest rate curves and is calculated using discounted cash flows that are observable or that can be corroborated by observable market data (Level 2).

Accrued interest payable: The fair value of accrued interest payable equals the amount payable due to the current nature of the amounts payable (Level 2).

Page 30

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below represents the balances of assets and liabilities measured at fair value on a recurring basis:


	September 30, 2014								September 30, 2015
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Readily Available Market Prices(1)		Observable Market Prices(2)			Company Determined Market Prices(3)		Total at Fair Value
	(Amounts In Thousands)
Securities available for sale									(Amounts In Thousands)
U.S. Treasury	$	—	$	19,794	$	—	$	19,794	$	—	$	22,643		$	—	$	22,643
State and political subdivisions	—		154,198		—		154,198		—		157,423			—		157,423
Other securities (FHLB, FHLMC and FNMA)	—		69,826		—		69,826		—		67,419			—		67,419
Derivative Financial Instruments
Interest rate swaps									$	—	(4,685		)	$	—	(4,685		)
Total	$	—	$	243,818	$	—	$	243,818	$	—	$	242,800		$	—	$	242,800


	December 31, 2013								December 31, 2014
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Readily Available Market Prices(1)		Observable Market Prices(2)			Company Determined Market Prices(3)		Total at Fair Value
	(Amounts In Thousands)
Securities available for sale									(Amounts In Thousands)
U.S. Treasury	$	—	$	—	$	—	$	—	$	—	$	22,333		$	—	$	22,333
State and political subdivisions	—		151,366		—		151,366		—		168,968			—		168,968
Other securities (FHLB, FHLMC and FNMA)	—		87,144		—		87,144		—		67,691			—		67,691
Derivative Financial Instruments
Interest rate swaps									—		(2,796		)	—		(2,796		)
Total	$	—	$	238,510	$	—	$	238,510	$	—	$	256,196		$	—	$	256,196


(1)	Considered Level 1 under ASC 820.


(2)	Considered Level 2 under ASC 820.


(3)	Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.

There were no transfers between Levels 1, 2 or 3 during the nine months ended September 30, ~~2014~~2015 and the year ended December 31, ~~2013.~~2014.

Page 31

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company is required to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The valuation methodologies used to measure these fair value adjustments are described above. The following tables present the Company’s assets that are measured at fair value on a nonrecurring basis.


	September 30, 2014								Three Months Ended September 30, 2014		Nine Months Ended September 30, 2014		September 30, 2015								Three Months Ended September 30, 2015		Nine Months Ended September 30, 2015
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Total Losses		Total Losses		Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Total Losses		Total Losses
	(Amounts in Thousands)												(Amounts in Thousands)
Loans (4)
Agricultural	$	—	$	—	$	1,770	$	1,770	$	—	$	25	$	—	$	—	$	1,409	$	1,409	$	—	$	116
Commercial and financial	—		—		2,727		2,727		50		110		—		—		1,251		1,251		11		39
Real Estate:
Construction, 1 to 4 family residential	—		—		150		150		—		—		—		—		440		440		100		161
Construction, land development and commercial	—		—		297		297		—		—		—		—		345		345		—		—
Mortgage, farmland	—		—		2,246		2,246		—		—		—		—		2,298		2,298		—		—
Mortgage, 1 to 4 family first liens	—		—		4,556		4,556		310		408		—		—		3,036		3,036		106		441
Mortgage, 1 to 4 family junior liens	—		—		488		488		—		24		—		—		175		175		3		152
Mortgage, multi-family	—		—		5,990		5,990		—		—		—		—		236		236		—		38
Mortgage, commercial	—		—		11,846		11,846		—		140		—		—		997		997		—		140
Loans to individuals	—		—		—		—		—		—		—		—		—		—		—		—
Foreclosed assets (5)	—		—		38		38		54		77		—		—		303		303		19		59
Total	$	—	$	—	$	30,108	$	30,108	$	414	$	784	$	—	$	—	$	10,490	$	10,490	$	239	$	1,146


(1)	Considered Level 1 under ASC 820.


(2)	Considered Level 2 under ASC 820.


(3)	Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.


(4)	Represents carrying value and related write-downs of loans for which adjustments are based on the value of the collateral. The carrying value of loans fully-charged off is zero.


(5)	Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

Page 32

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis (continued)


	December 31, 2013								Year Ended December 31, 2013		December 31, 2014								Year Ended December 31, 2014
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Total Losses		Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Total Losses
	(Amounts in Thousands)										(Amounts in Thousands)
Loans (4)
Agricultural	$	—	$	—	$	117	$	117	$	—	$	—	$	—	$	1,679	$	1,679	$	25
Commercial and financial	—		—		2,391		2,391		53		—		—		1,709		1,709		206
Real Estate:
Construction, 1 to 4 family residential	—		—		1,270		1,270		—		—		—		315		315		—
Construction, land development and commercial	—		—		140		140		—		—		—		—		—		—
Mortgage, farmland	—		—		270		270		—		—		—		2,040		2,040		—
Mortgage, 1 to 4 family first liens	—		—		4,299		4,299		424		—		—		2,500		2,500		576
Mortgage, 1 to 4 family junior liens	—		—		177		177		59		—		—		369		369		24
Mortgage, multi-family	—		—		5,876		5,876		69		—		—		5,525		5,525		—
Mortgage, commercial	—		—		11,682		11,682		229		—		—		1,918		1,918		328
Loans to individuals	—		—		—		—		—		—		—		—		—		—
Foreclosed assets (5)	—		—		427		427		68		—		—		301		301		210
Total	$	—	$	—	$	26,649	$	26,649	$	902	$	—	$	—	$	16,356	$	16,356	$	1,369


(1)	Considered Level 1 under ASC 820.


(2)	Considered Level 2 under ASC 820.


(3)	Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.


(4)	Represents carrying value and related write-downs of loans for which adjustments are based on the value of the collateral. The carrying value of loans fully-charged off is zero.


(5)	Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.


Note 7.	Stock Repurchase Program

On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of ~~750,000~~1,500,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”). The Company’s Board of Directors has authorized the 2005 Stock Repurchase Program through December 31, ~~2015.~~2016. The Company expects the purchases pursuant to the 2005 Stock Repurchase Program to be made from time to time in private transactions at a price equal to the most recent quarterly independent appraisal of the shares of the Company’s common stock and with the Board reviewing the overall results of the 2005 Stock Repurchase Program on a quarterly basis. All purchases made pursuant to the 2005 Stock Repurchase Program since its inception have been made on that basis. The amount and timing of stock repurchases will be based on various factors, such as the Board’s assessment of the Company’s capital structure and liquidity, the amount of interest shown by shareholders in selling shares of stock to the Company at their appraised value, and applicable regulatory, legal and accounting factors. The Company has purchased ~~391,351~~851,132 shares of its common stock in privately negotiated transactions from August 1, 2005 through September 30, ~~2014.~~2015. Of these ~~391,351~~851,132 shares, ~~23,853~~33,679 shares were purchased during the quarter ended September 30, ~~2014,~~2015, at an average price per share of ~~$78.78.~~

$43.32.

Page 33

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~~HILLS BANCORPORATION~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)~~

~~(Unaudited)~~


Note 8.	Commitments and Contingencies

Concentrations of credit risk: The Bank’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Bank's market area. Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately ~~$70.62~~$76.29 million. The concentrations of credit by type of loan are set forth in Note 5 to the Consolidated Financial Statements. Outstanding letters of credit were granted primarily to commercial borrowers. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson, Linn and Washington Counties, Iowa.

Contingencies: In the normal course of business, the Company and Bank are involved in various legal proceedings. While the ultimate outcome of such legal proceedings cannot be predicted with certainty, after reviewing pending and threatened litigation with counsel, management believes at this time that the outcome of such litigation will not have a material adverse effect on the Company's business, financial condition or results of operations.

Financial instruments with off-balance sheet risk: The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, credit card participations and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank’s commitments at September 30, ~~2014~~2015 and December 31, ~~2013~~2014 is as follows:


	September 30, 2014		December 31, 2013		September 30, 2015		December 31, 2014
	(Amounts In Thousands)				(Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:
Home equity loans	$	40,553	$	38,243	$	42,856	$	40,484
Credit cards	46,452		44,326		40,984		46,573
Commercial, real estate and home construction	113,481		106,241		103,993		81,613
Commercial lines and real estate purchase loans	180,084		172,135		187,585		165,430
Outstanding letters of credit	14,131		11,019		8,959		12,437


Note 9.	Income Taxes

Federal income tax expense for the nine months ended September 30, ~~2014~~2015 and ~~2013~~2014 was computed using the consolidated effective federal tax rate. The Company also recognized income tax expense pertaining to state franchise taxes payable individually by the subsidiary bank. The Company files a consolidated tax return for federal purposes and separate tax returns for State of Iowa purposes. The tax years ended December 31, 2014, 2013, ~~2012,~~ and ~~2011~~2012 remain subject to examination by the Internal Revenue Service. For state tax purposes, the tax years ended December 31, 2014, 2013, ~~2012,~~ and ~~2011~~2012 remain open for examination. There were no material unrecognized tax benefits at September 30, ~~2014~~2015 and December 31, ~~2013~~2014 and therefore no interest or penalties on unrecognized tax benefits has been recorded. As of September 30, ~~2014,~~2015, the Company does not anticipate any significant increase in unrecognized tax benefits during the twelve-month period ending ~~September 30, 2015.~~March 31, 2016.

Income taxes as a percentage of income before taxes were ~~29.66%~~30.68% for the nine months ended September 30, ~~2014~~2015 and ~~29.61%~~29.66% for the same period in ~~2013.~~2014. The ~~slight~~ increase in the effective tax rate is due to a decrease in the amount of low-income housing tax credits earned by the Company in ~~2014.~~2015.

Page 34

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)


Note 10.	Derivative Financial Instruments

In the normal course of business, the Bank may use derivative financial instruments to manage its interest rate risk. These instruments carry varying degrees of credit, interest rate and market or liquidity risks. Derivative instruments are recognized as either assets or liabilities in the accompanying financial statement and are measured at fair value. The Bank’s objectives are to add stability to its net interest margin and to manage its exposure to movements in interest rates. The contract or notional amount of a derivative is used to determine, along with the other terms of the derivative, the amount to be exchanged between the counterparties. The Bank is exposed to credit risk in the event of nonperformance by counterparties to financial instruments. The Bank minimizes this risk by entering into derivative contracts with large, stable financial institutions. The Bank has not experienced any losses from nonperformance by counterparties. The Bank monitors counterparty risk in accordance with the provisions of ASC 815. In addition, the Bank’s interest rate-related derivative instruments contain language outlining collateral pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits which are determined by credit ratings of each counterparty. The Bank was required to pledge ~~$1.50~~$4.69 million of collateral as of September 30, ~~2014.~~2015.

Cash Flow Hedges:

The Bank executed two forward-starting interest rate swap transactions on November 7, 2013. One of the interest rate swap transactions has an effective date of November 9, 2015, and an expiration date of November 9, 2020, to effectively convert $25.00 million of variable rate debt to fixed rate debt. The other interest rate swap transaction has an effective date of November 7, 2016 and an expiration date of November 7, 2023, also to effectively convert $25.00 million of variable rate debt to fixed rate debt. For accounting purposes, these swap transactions are designated as a cash flow hedge of the changes in cash flows attributable to changes in three-month LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on an amount of the Bank’s debt principal equal to the then-outstanding swap notional amount. At inception, the Bank asserted that the underlying principal balance would remain outstanding throughout the hedge transaction making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swaps.

The table below identifies the balance sheet category and fair values of the Bank’s derivative instruments designated as cash flow hedges as of September 30, ~~2014~~2015 and December 31, ~~2013:~~2014:


	Notional Amount		Fair Value			Balance Sheet Category	Maturity	Notional Amount		Fair Value			Balance Sheet Category	Maturity
	(Amounts in Thousands)							(Amounts in Thousands)
September 30, 2014
September 30, 2015
Interest rate swap	$	25,000	$	(372	)	Other Liabilities	11/9/2020	$	25,000	$	(1,781	)	Other Liabilities	11/9/2020
Interest rate swap	25,000		(1,075		)	Other Liabilities	11/7/2023	25,000		(2,905		)	Other Liabilities	11/7/2023

December 31, 2013
December 31, 2014
Interest rate swap	$	25,000	$	357		Other Assets	11/9/2020	$	25,000	$	(864	)	Other Liabilities	11/9/2020
Interest rate swap	25,000		412			Other Assets	11/7/2023	25,000		(1,932		)	Other Liabilities	11/7/2023

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The table below identifies the gains and losses recognized on the Bank’s derivative instruments designated as cash flow hedges as of September 30, ~~2014~~2015 and December 31, ~~2013:~~2014:


	Effective Portion						Ineffective Portion			Effective Portion						Ineffective Portion
	Recognized in OCI			Reclassifed from AOCI into Income			Recognized in Income on Derivatives			Recognized in OCI			Reclassifed from AOCI into Income			Recognized in Income on Derivatives
	Amount of Gain (Loss)			Category	Amount of Gain (Loss)		Category	Amount of Gain (Loss)		Amount of Gain (Loss)			Category	Amount of Gain (Loss)		Category	Amount of Gain (Loss)
	(Amounts in Thousands)									(Amounts in Thousands)
September 30, 2014
September 30, 2015
Interest rate swap	$	(450	)	Interest Expense	$	—	Other Income	$	—	$	(566	)	Interest Expense	$	—	Other Income	$	—
Interest rate swap	(919		)	Interest Expense	—		Other Income	—		(600		)	Interest Expense	—		Other Income	—

December 31, 2013
December 31, 2014
Interest rate swap	$	220		Interest Expense	$	—	Other Income	$	—	$	(754	)	Interest Expense	$	—	Other Income	$	—
Interest rate swap	255			Interest Expense	—		Other Income	—		(1,448		)	Interest Expense	—		Other Income	—

~~Note 11. Subsequent Events~~

On October 29, 2014, a potential commercial and financial loan impairment was brought to the Company’s attention related to one of the Company's borrowing relationships. The Company is in the early stages of determining what, if any, loss might exist within that relationship. The Company is in the process of working with the borrower to verify and gather collateral to mitigate any potential loss. The borrower relationship consists of 7 loans totaling $1.97 million. At this time, the Company does not anticipate that the total outstanding loan balance will be a loss but cannot reasonably estimate the amount of any loss as of the date of this filing. If, after management's review of the overall lending relationship, including the fair value of the collateral and consideration of other payment sources, the Company does not believe the loans will be fully repaid, additional specific reserves may be necessary in the future.

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Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion and analysis of the financial condition of Hills Bancorporation (“Hills Bancorporation” or “the Company”) and its banking subsidiary Hills Bank and Trust Company (“the Bank”) for the dates and periods indicated. The discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying footnotes.

Special Note Regarding Forward Looking Statements

This report contains, and future oral and written statements of the Company and its management may contain, forward-looking statements within the meaning of such term in the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Actual results may differ materially from those included in the forward-looking statements. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, the following:

The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets.

The effects of recent financial market disruptions, and monetary and other governmental actions designed to address such disruptions.

The financial strength of the counterparties with which the Company or the Company’s customers do business and as to which the Company has investment or financial exposure.

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The credit quality and credit agency ratings of the securities in the Company’s investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the affected securities and the recognition of an impairment loss.

The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company.

The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System.

The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.

The ability of the Company to obtain new customers and to retain existing customers.

The timely development and acceptance of products and services, including products and services offered through alternative electronic delivery channels.

Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers.

The ability of the Company to develop and maintain secure and reliable electronic systems.

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~~HILLS BANCORPORATION~~

The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.

Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely.

The economic impact of natural disasters, terrorist attacks and military actions.

Business combinations and the integration of acquired businesses and assets which may be more difficult or expensive than expected.

The costs, effects and outcomes of existing or future litigation.

Changes in accounting policies and practices that may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.

The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

These risks and uncertainties should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission.

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Critical Accounting Policies

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these financial statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policies to be those which are related to the allowance for loan losses. The Company's allowance for loan losses methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan losses that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in impaired loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include the general economic environment in the Company's markets, including

economic conditions throughout the Midwest and the state of certain industries. Determinations relating to the possible level of future loan losses are based in part on subjective judgments by management. Future loan losses in excess of current estimates, could materially adversely affect our results of operations or financial position. Size and complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. As the Company adds new products and increases the complexity of its loan portfolio, it will enhance its methodology accordingly. This discussion of the Company’s critical accounting policies should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes presented elsewhere herein, as well as other relevant portions of Management’s Discussion and Analysis of Financial Condition and Results of Operations. Although management believes the levels of the allowance as of September 30, ~~2014~~2015 and December 31, ~~2013~~2014 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.

Overview

This overview highlights selected information and may not contain all of the information that is important to you in understanding our performance during the period. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates, you should carefully read this entire report.

The Company is a holding company engaged in the business of commercial banking. The Company’s subsidiary is Hills Bank and Trust Company, Hills, Iowa (the “Bank”), which is wholly-owned. The Bank was formed in Hills, Iowa in 1904. The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona, Wellman, Cedar Rapids, Marion, and ~~Marion,~~Washington, Iowa. At September 30, ~~2014,~~2015, the Bank has ~~seventeen~~eighteen full-service locations.

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~~HILLS BANCORPORATION~~

Net income for the nine month period ended September 30, ~~2014~~2015 was ~~$21.82~~$22.54 million compared to ~~$20.35~~$21.82 million for the same nine months of ~~2013,~~2014, an increase of ~~7.25%~~3.26%. The ~~$1.48~~$0.71 million increase in net income was caused by a number of factors. The principal factors in the increase in net income for the first nine months of ~~2014~~2015 are an increase in net interest income of ~~$2.73~~$4.71 million and ~~a decrease~~an increase in ~~the provision for loan losses~~noninterest income of ~~$0.90~~$1.10 million. These changes were offset by an increase in income tax expense of ~~$0.64~~$0.77 million, ~~a decrease in noninterest income of $0.76 million and~~ an increase in noninterest expenses of ~~$0.75~~$2.76 million, and an increase in the provision for loan losses of $1.57 million.

The Company achieved a return on average assets of ~~1.26%~~1.19% and a return on average equity of ~~11.58%~~10.73% for the twelve months ended September 30, ~~2014,~~2015, compared to the twelve months ended September 30, ~~2013,~~2014, which were ~~1.23%~~1.26% and ~~11.36%~~11.22%, respectively. Dividends of ~~$1.15~~$0.625 per share were paid in January ~~2014~~2015 to ~~2,204~~2,284 shareholders. The ~~2013~~2014 dividend was ~~$1.10~~$0.575 per share.

The Company’s net interest income is the largest component of revenue and it is primarily a function of the average earning assets and the net interest margin percentage. The Company achieved a net interest margin on a tax-equivalent basis of ~~3.49%~~3.53% for the nine months ended September 30, ~~2014~~2015 compared to ~~3.51%~~3.49% for the same nine months of ~~2013.~~2014. Average earning assets were $2.260 billion year to date in 2015 and $2.106 billion in ~~2014 and $1.985 billion in 2013.~~2014.

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Highlights noted on the balance sheet as of September 30, ~~2014~~2015 for the Company included the following:

Total assets were ~~$2.308~~$2.425 billion, an increase of ~~$140.49~~$90.69 million since December 31, ~~2013.~~2014.

Cash and cash equivalents were ~~$68.86~~$33.99 million, an increase of ~~$25.16~~$4.81 million since December 31, ~~2013.~~2014.

Net loans were ~~$1.917~~$2.056 billion, an increase of ~~$110.45~~$89.90 million since December 31, ~~2013.~~2014. Loans held for sale decreased ~~$2.44~~$0.08 million since December 31, ~~2013.~~2014.

~~Deposit growth of $129.62~~Deposits increased $53.91 million since December 31, ~~2013.~~2014. Deposit growth included ~~$58.36~~approximately $75.00 million of temporary public funds.

Federal Home Loan Bank borrowings increased $30.00 million since December 31, 2014.

Reference is made to Note 6 for a discussion of fair value measurements which relate to methods used by the Company in recording assets and liabilities on its financial statements.

Financial Condition

The following table sets forth the composition of the loan portfolio as of September 30, ~~2014~~2015 and December 31, ~~2013:~~2014:


	September 30, 2014				December 31, 2013				September 30, 2015				December 31, 2014
	Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent
	(Amounts In Thousands)				(Amounts In Thousands)				(Amounts In Thousands)				(Amounts In Thousands)
Agricultural	$	86,243	4.45	%	$	82,138	4.50	%	$	93,533	4.51	%	$	97,645	4.92	%
Commercial and financial	179,872		9.28		166,102		9.10		173,029		8.33		174,738		8.80
Real estate:
Construction, 1 to 4 family residential	39,551		2.04		30,309		1.66		54,706		2.64		45,949		2.32
Construction, land development and commercial	80,273		4.14		69,182		3.79		91,742		4.42		77,020		3.88
Mortgage, farmland	145,070		7.49		142,685		7.81		179,981		8.67		162,503		8.19
Mortgage, 1 to 4 family first liens	658,766		33.99		605,687		33.16		715,575		34.46		672,674		33.88
Mortgage, 1 to 4 family junior liens	107,443		5.54		105,785		5.79		115,657		5.57		110,284		5.56
Mortgage, multi-family	241,768		12.48		244,090		13.37		251,512		12.11		245,213		12.36
Mortgage, commercial	322,714		16.65		315,187		17.26		323,454		15.58		321,601		16.20
Loans to individuals	20,324		1.05		19,824		1.09		22,960		1.11		21,342		1.08
Obligations of state and political subdivisions	55,940		2.89		45,167		2.47		53,930		2.60		55,729		2.81
	$	1,937,964	100.00	%	$	1,826,156	100.00	%	$	2,076,079	100.00	%	$	1,984,698	100.00	%
Net unamortized fees and costs	675				641				750				691
	$	1,938,639			$	1,826,797			$	2,076,829			$	1,985,389
Less allowance for loan losses	24,500				25,550				25,480				24,020
	$	1,914,139			$	1,801,247			$	2,051,349			$	1,961,369

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Loan demand has been steady and is expected to remain steady or increase throughout the year ending December 31, ~~2014~~2015 and into ~~2015.~~2016. As indicated in the table above growth in the ~~commercial~~construction, farmland and ~~financial, construction,~~ 1 to 4 family real estate loans ~~obligation of state and political subdivisions loan portfolios as well as real estate loans secured by commercial property~~ have been primarily responsible for the increase in total loans. Management expects overall portfolio loan growth to increase as a result of general improvement in market conditions resulting in increased loan demand.

The Bank has an established formal loan origination policy. In general, the loan origination policy attempts to reduce the risk of credit loss to the Bank by requiring, among other things, maintenance of minimum loan to value ratios, evidence of appropriate levels of insurance carried by borrowers and documentation of appropriate types and amounts of collateral and sources of expected payment. The collateral relied upon in the loan origination policy is generally the property being financed by the Bank. The source of expected payment is generally the income produced from the property being financed. Personal guarantees are required of individuals owning or controlling at least 20% of the ownership of an entity. Limited or proportional guarantees may be accepted in circumstances if approved by the Company’s Board of Directors. Financial information provided by the borrower is verified as considered necessary by reference to tax returns, or audited, reviewed or compiled financial statements. The Bank does not originate subprime loans. In order to modify, restructure or otherwise change the terms of a loan, the Bank’s policy is to evaluate each borrower situation individually. Modifications, restructures, extensions and other changes are done to improve the Bank’s position and to protect the Bank’s capital. If a borrower is not current with its payments, any additional loans to such borrowers are evaluated on an individual borrower basis.

The Company has not experienced any significant time lapses in recognizing the required provisions for collateral dependent loans, nor has the Company delayed appropriate charge offs. When an updated appraisal value has been obtained, the Company has used the appraisal amount in determining the appropriate charge off or required reserve. The Company also evaluates any changes in the financial condition of the borrower and guarantors (if applicable), economic conditions, and the Company’s loss experience with the type of property in question. Any information utilized in addition to the appraisal is intended to identify additional charge offs or provisions, not to override the appraised value.

In accordance with Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues, the Company determines and assigns ratings to loans using factors that include the following: an assessment of the financial condition of the borrower; a realistic determination of the value and adequacy of underlying collateral; the condition of the local economy and the condition of the specific industry of the borrower; an analysis of the levels and trends of loan categories; and a review of delinquent and classified loans.

Through the credit risk rating process, loans are reviewed to determine if they are performing in accordance with the original contractual terms. If the borrower has failed to comply with the original contractual terms, further action may be required by the Company, including a downgrade in the credit risk rating, movement to non-accrual status, a charge-off or the establishment of a specific impairment reserve. In the event a collateral shortfall is identified during the credit review process, the Company will work with the borrower for a principal reduction and/or a pledge of additional collateral and/or additional guarantees. In the event that these options are not available, the loan may be subject to a downgrade of the credit risk rating. If the Company determines a loan amount or portion thereof is uncollectible, the loan’s credit risk rating is immediately downgraded and the uncollectible amount is charged-off. The Bank’s credit and legal departments undertake a thorough and ongoing analysis to determine if additional impairment and/or charge-offs are appropriate and to begin a workout plan for the loan to minimize actual losses.

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The following table presents the allowance for loan losses on loans by ~~type~~loan category, the percentage of ~~loans~~the allowance for each category to the total allowance, and the percentage of all loans in each category to total loans as of September 30, ~~2014~~2015 and December 31, ~~2013:~~2014:


	September 30, 2014						December 31, 2013						September 30, 2015						December 31, 2014
	Amount		% of Total Allowance		% of Loans to Total Loans		Amount		% of Total Allowance		% of Loans to Total Loans		Amount		% of Total Allowance		% of Loans to Total Loans		Amount		% of Total Allowance		% of Loans to Total Loans
	(In Thousands)						(In Thousands)						(In Thousands)						(In Thousands)
Agricultural	$	2,694	11.00	%	4.45	%	$	2,852	11.17	%	4.50	%	$	2,863	11.24	%	4.51	%	$	2,515	10.47	%	4.92	%
Commercial and financial	4,702		19.19		9.28		4,733		18.52		9.10		4,695		18.43		8.33		4,231		17.61		8.80
Real estate:
Construction, 1 to 4 family residential	1,080		4.41		2.04		1,011		3.96		1.66		960		3.77		2.64		810		3.37		2.32
Construction, land development and commercial	1,905		7.77		4.14		1,907		7.46		3.79		1,626		6.38		4.42		1,431		5.96		3.88
Mortgage, farmland	2,576		10.51		7.49		2,557		10.01		7.81		2,932		11.51		8.67		2,672		11.12		8.19
Mortgage, 1 to 4 family first liens	6,184		25.24		33.99		6,101		23.87		33.16		6,266		24.59		34.46		6,268		26.11		33.88
Mortgage, 1 to 4 family junior liens	917		3.74		5.54		963		3.77		5.79		1,157		4.54		5.57		1,151		4.79		5.56
Mortgage, multi-family	1,533		6.26		12.48		2,064		8.08		13.37		1,538		6.03		12.11		1,490		6.20		12.36
Mortgage, commercial	2,207		9.01		16.65		2,723		10.66		17.26		2,592		10.17		15.58		2,705		11.26		16.20
Loans to individuals	352		1.44		1.05		369		1.44		1.09		446		1.75		1.11		299		1.24		1.08
Obligations of state and political subdivisions	350		1.43		2.89		270		1.06		2.47		405		1.59		2.60		448		1.87		2.81
	$	24,500	100.00	%	100.00	%	$	25,550	100.00	%	100.00	%	$	25,480	100.00	%	100.00	%	$	24,020	100.00	%	100.00	%

The allowance for loan losses totaled ~~$24.50~~$25.48 million at September 30, ~~2014~~2015 compared to ~~$25.55~~$24.02 million at December 31, ~~2013.~~2014. The percentage of the allowance to outstanding loans was ~~1.26%~~1.23% and ~~1.40%~~1.21% at September 30, ~~2014~~2015 and December 31, ~~2013,~~2014, respectively. The allowance was based on management’s consideration of a number of factors, including composition of the loan portfolio, loans with higher credit risks and the overall amount of loans outstanding. The ~~decrease~~increase in the allowance in ~~2014~~2015 is the result of an increase in net loans and a change in the composition and allocation of loans within credit quality ratings.

The adequacy of the allowance is reviewed quarterly and adjusted as appropriate after consideration has been given to the impact of economic conditions on the borrowers’ ability to repay, loan collateral values, past collection experience, the risk characteristics of the loan portfolio and such other factors that deserve current recognition. The growth of the loan portfolio and the trends in problem and watch loans are significant elements in the determination of the provision for loan losses. Quantitative factors include the Company’s historical loss experience, which is then adjusted for levels and trends in past due, levels and trends in charged-off and recovered loans, trends in volume growth, trends in problem and watch loans, trends in restructured loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates.

Management has determined that the allowance for loan losses was appropriate at September 30, ~~2014,~~2015, and that the loan portfolio is diversified and secured, without undue concentration in any specific risk area. This process involves a high degree of management judgment; however, the allowance for loan losses is based on a comprehensive, well documented, and consistently applied analysis of the Company’s loan portfolio. This analysis takes into consideration all available information existing as of the financial statement date, including environmental factors such as economic, industry, geographical and political factors. The relative level of allowance for loan losses is reviewed and compared to industry data. This review encompasses levels of total impaired loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs.

Residential real estate loan products that include features such as loan-to-values in excess of 100% or interest only payments, which expose a borrower to payment increases in excess of changes in the market interest rate, increase the credit risk of a loan. The Bank has not offered and does not intend to offer this type of loan product.

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Investment securities available for sale held by the Company ~~increased~~decreased by ~~$5.31~~$11.51 million from December 31, ~~2013~~2014 to September 30, ~~2014.~~2015. The fair value of securities available for sale was ~~$2.66~~$2.51 million more than the amortized cost of such securities as of September 30, ~~2014.~~2015. At December 31, ~~2013,~~2014, the fair value of the securities available for sale was ~~$1.81~~$2.07 million more than the amortized cost of such securities.

~~Deposit growth was $129.62~~Deposits increased $53.91 million in the first nine months of ~~2014.~~2015. Deposit growth included approximately $75.00 million of temporary public funds. Repurchase agreements decreased ~~$5.98~~$11.38 million and Federal Home Loan Bank borrowings increased $30.00 million since December 31, 2014. In the opinion of the Company’s management, the Company continues to have sufficient liquidity resources available to fund expected additional loan growth.

Brokered deposits are included in total deposits and totaled ~~$59.18~~$58.37 million as of September 30, ~~2014~~2015 with an average rate of ~~0.39%~~0.40%. Brokered deposits were ~~$57.77~~$64.49 million as of December 31, ~~2013~~2014 with an average interest rate of ~~0.44%~~0.39%. As of September 30, ~~2014~~2015 and December 31, ~~2013,~~2014, brokered deposits were ~~3.22%~~3.09% and ~~3.38%~~3.51% of total deposits, respectively.

Dividends and Equity

In January ~~2014,~~2015, Hills Bancorporation paid a dividend of ~~$5.42~~$5.85 million or ~~$1.15~~$0.625 per share. The dividend was ~~$1.10~~$0.575 per share in January ~~2013.~~2014. After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of September 30, ~~2014~~2015 totaled ~~$253.47~~$268.13 million. ~~Under risk-based capital~~On January 1, 2015, the final rules the total amount of Tier 1 risk-based capital was 16.22% and 16.19% as of September 30, 2014 and December 31, 2013, respectively. The Tier 1 risk-based capital was in excess of the required minimum of 8.00%. Risk-based capital was 17.47% and 17.44% as of September 30, 2014 and December 31, 2013, respectively. As of September 30, 2014, the most recent notifications from the Federal Reserve System categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company’s category.

~~In July 2013, the Officer of the Comptroller of the Currency and Board of Governors~~ of the Federal Reserve ~~System adopted a final rule~~Board went into effect implementing ~~agreements reached by~~in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision ~~in “Basel III: A Global Regulatory Framework for More Resilient Banks~~ and ~~Banking Systems”(BASEL III). The final rule also adopts~~certain changes ~~to the agencies’ regulatory capital requirements that meet the requirements of section 171 and section 939A of~~required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Under the final rule, minimum requirements increased for both the quality and quantity of capital held by banking organizations. The rule ~~implements a revised definition of regulatory capital,~~requires a new ~~4.50%~~minimum ratio of common equity tier 1 ~~minimum~~ capital ~~requirement,~~to risk-weighted assets of 4.50% and a ~~6.00%~~common equity tier 1 capital ~~requirement, and a~~conservation buffer of 2.50% of risk-weighted assets that will apply to all supervised financial institutions. The rule also raises the minimum ratio of tier 1 ~~risk-based~~ capital to risk-weighted assets from 4.00% to 6.00% and includes a minimum leverage ratio of ~~8.00%. The Bank expects to remain categorized as well capitalized under the final rule when it becomes effective on January 1, 2015.~~4.00% for all banking organizations.

The Company continues to be well-capitalized in accordance with Federal regulatory capital requirements as the capital ratios below show:



	September 30, 2015
Common equity tier 1 capital ratio	14.59	%
Tier 1 capital ratio	14.59	%
Total capital ratio	15.81	%
Leverage ratio	12.66	%

Page 42

Index

HILLS BANCORPORATION

Discussion of operations for the nine months ended September 30, ~~2014~~2015 and ~~2013~~2014

Net Income Overview

Net income increased ~~$1.48~~$0.71 million for the nine months ended September 30, ~~2014~~2015 compared to the first nine months of ~~2013.~~2014. Total net income was ~~$21.82~~$22.54 million in ~~2014~~2015 and ~~$20.35~~$21.82 million in the comparable period in ~~2013,~~2014, an increase of ~~7.25%~~3.26%. The changes in net income in ~~2014~~2015 from the first nine months of ~~2013~~2014 were primarily the result of the following:

Net interest income increased by ~~$2.73~~$4.71 million, before provision expense, as a result of growth in the volume of earning assets and reductions in interest expense.

The provision for loan losses ~~decreased~~increased by ~~$0.90~~$1.57 million.

Noninterest income ~~decreased~~increased by ~~$0.76~~$1.10 million.

Noninterest expenses increased by ~~$0.75~~$2.76 million.

Income tax expense increased by ~~$0.64~~$0.77 million.

For the nine month period ended September 30, ~~2014~~2015 and September 30, ~~2013~~2014 basic earning per share was ~~$4.65~~$2.41 and ~~$4.32,~~$2.33, respectively. Diluted earnings per share was ~~$4.64~~$2.41 for the nine months ended September 30, ~~2014~~2015 compared to ~~$4.31~~$2.32 for the same period in ~~2013.~~2014.

~~Page 42~~

~~Index~~

~~HILLS BANCORPORATION~~

~~Discussion of operations for the nine months ended September 30, 2014 and 2013~~

The Company’s net income continues to be driven primarily by three important factors. The first important factor is the interaction between changes in net interest margin and changes in average volumes of the Bank's earnings assets. Net interest income of ~~$52.82~~$57.53 million for the first nine months of ~~2014~~2015 was derived from the Company’s ~~$2.106~~$2.260 billion of average earning assets during that period and its tax-equivalent net interest margin of ~~3.49%~~3.53%. Average earning assets in the nine months ended September 30, ~~2013~~2014 were ~~$1.985~~$2.106 billion and the tax-equivalent net interest margin was ~~3.55%~~3.49%. The importance of net interest margin is illustrated by the fact that an increase or decrease in the net interest margin of 10 basis points would have resulted approximately in a ~~$1.58~~$1.70 million change in income before income taxes in the nine month period ended September 30, ~~2014 .~~2015. Net interest income for the Company increased as a result of growth in the volume of earning assets and a decrease in net interest expense due to the mix of interest bearing liabilities of the Company as well as a reduction in dollar amount and rate on time deposits. The Company expects ~~continued~~ net interest compression to continue to impact earnings for the foreseeable future. The Company believes growth in net interest income will be contingent on the growth of the Company’s earnings assets.

The second significant factor affecting the Company’s net income is the provision for loan losses. The majority of the Company’s interest-earning assets are in loans outstanding, which amounted to more than ~~$1.917~~$2.056 billion at September 30, ~~2014~~2015. The provision is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio. The provision reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more. In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historically higher credit risk. The provision for loan losses was an expense of $0.36 million in 2015 compared to a reduction of expense of $1.21 million in ~~2014 compared to a reduction of expense of $0.31 million in 2013.~~2014. The Company believes that the provision for loan losses will ~~remain stable~~steadily increase for the foreseeable future resulting from projected increases in the size of the Company’s loan ~~portfolio offset by continued improvement in credit quality subject to the circumstances discussed in Note 11.~~portfolio.

The third significant factor affecting the Company’s net income is income tax expense. Federal and state income tax expenses were ~~$9.20~~$9.97 million and ~~$8.56~~$9.20 million for the nine months ended September 30, ~~2014~~2015 and ~~2013,~~2014, respectively. Income taxes as a percentage of income before taxes were 30.68% in 2015 and 29.66% in ~~2014 and 29.61% in 2013.~~2014.

Page 43

Index

HILLS BANCORPORATION

Discussion of operations for the nine months ended September 30, ~~2014~~2015 and ~~2013~~2014

Net Interest Income

Net interest income increased for the nine months ended September 30, ~~2014~~2015 compared to the comparable period in ~~2013.~~2014. The increase was as a result of growth in the volume of earning assets and a decrease in net interest expense due to the mix of interest bearing liabilities of the Company as well as a reduction in dollar amount and rate on time deposits. Net interest income is the excess of the interest and fees earned on interest-earning bearing assets over the interest expense of the interest-bearing liabilities. The factors that have the greatest impact on net interest income are the average volume of earning assets for the period and the net interest margin. The net interest margin for the first nine months of ~~2014~~2015 was ~~3.49%~~3.53% compared to ~~3.51%~~3.49% in ~~2013~~2014 for the same period. The measure is shown on a tax-equivalent basis using a tax rate of 35% to make the interest earned on taxable and non-taxable assets more comparable. The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the nine months ended in ~~2014~~2015 compared to the comparable period in ~~2013~~2014 are shown in the following table:


						Increase (Decrease) in Net Interest Income														Increase (Decrease) in Net Interest Income
	Change in Average Balance			Change in Average Rate		Volume Changes			Rate Changes			Net Change			Change in Average Balance			Change in Average Rate		Volume Changes			Rate Changes			Net Change
	(Amounts in Thousands)														(Amounts in Thousands)
Interest income:
Loans, net	$	121,405		(0.20	)%	$	4,199		$	(2,689	)	$	1,510		$	146,868		(0.03	)%	$	7,164		$	(2,763	)	$	4,401
Taxable securities	(4,471		)	(0.14	)	(33		)	(109		)	(142		)	3,655			0.08		72			20			92
Nontaxable securities	18,514			(0.47	)	547			(521		)	26			10,049			(0.27	)	261			(322		)	(61		)
Federal funds sold	(14,697		)	—		(28		)	—			(28		)	(6,702		)	—		(12		)	—			(12		)
	$	120,751				$	4,685		$	(3,319	)	$	1,366		$	153,870				$	7,485		$	(3,065	)	$	4,420

Interest expense:
Interest-bearing demand deposits	$	33,512		(0.06	)%	$	(52	)	$	177		$	125		$	57,245		—	%	$	(65	)	$	9		$	(56	)
Savings deposits	90,144			(0.03	)	(154		)	111			(43		)	38,017			(0.01	)	(54		)	36			(18		)
Time deposits	(49,830		)	(0.19	)	625			745			1,370			(26,164		)	(0.16	)	290			572			862
Short-term borrowings	10,015			(0.01	)	(27		)	8			(19		)
Other borrowings															7,547			(0.01	)	(24		)	11			(13		)
FHLB borrowings	—			—		—			—			—			22,554			(0.26	)	(754		)	288			(466		)
Interest-bearing other liabilities	(53		)	(1.16	)	—			24			24			(48		)	0.23		—			(4		)	(4		)
	$	83,788				$	392		$	1,065		$	1,457		$	99,151				$	(607	)	$	912		$	305
Change in net interest income						$	5,077		$	(2,254	)	$	2,823							$	6,878		$	(2,153	)	$	4,725

Rate/volume variances are allocated on a consistent basis using the absolute values of changes in volume compared to the absolute values of the changes in rates. Loan fees included in interest income are not material. Interest on nontaxable securities and loans is shown on a tax-equivalent basis.

A summary of the net interest spread and margin is as follows:


(Tax Equivalent Basis)	2014		2013		2015		2014
Yield on average interest-earning assets	4.20	%	4.36	%	4.18	%	4.20	%
Rate on average interest-bearing liabilities	0.91		1.08		0.83		0.91
Net interest spread	3.29	%	3.28	%	3.35	%	3.29	%
Effect of noninterest-bearing funds	0.20		0.23		0.18		0.20
Net interest margin (tax equivalent interest income divided by average interest-earning assets)	3.49	%	3.51	%	3.53	%	3.49	%

Page 44

Index

HILLS BANCORPORATION

Discussion of operations for the nine months ended September 30, ~~2014~~2015 and ~~2013~~2014

In pricing loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates. The Federal Open Market Committee met ~~seven~~six times during the first nine months of ~~2014.~~2015. The target rate remains unchanged since December 31, 2008 at 0.25%. Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally increase or decrease when the Federal Reserve Board raises or lowers the federal funds rate. As of September 30, ~~2014,~~2015, the rate indexes for the one, three and five year indexes were ~~0.10%~~0.34%, ~~1.06%~~0.99% and ~~1.79%~~1.47%, respectively. The one year index ~~decreased 9.09%~~increased 240.00% from ~~0.11%~~0.10% at September 30, ~~2013,~~2014, the three year index ~~increased 45.21%~~decreased 6.60% and the five year index ~~increased 16.23%~~decreased 17.88%. The three year index was ~~0.73%~~1.06% and the five year index was ~~1.54%~~1.79% at September 30, ~~2013.~~2014. The targeted federal funds rate was 0.25% at September 30, ~~2014~~2015 and ~~2013.~~2014. The Company anticipates nopossible increases in short term ~~rates~~ and ~~possible increases in~~ long term rates in the indexes for ~~2014.~~2015.

Provision for Loan Losses

The provision for loan losses was an expense of $0.36 million for the nine months ended September 30, 2015 compared to a reduction of expense of $1.21 million in 2014, ~~compared to a reduction of expense of $0.31 million in 2013,~~ an expense ~~reduction~~increase of ~~$0.90~~$1.57 million. The loan loss provision is the amount necessary to adjust the allowance for loan losses to the level considered by management to appropriately account for the estimated impairment to the Bank's loan portfolio. The provision expense taken to fund the allowance for loan losses is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio. The provision reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact on the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more. In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historical higher credit risks. The ~~decrease~~increase in expense in ~~2014~~2015 is the result of an increase in net loans and a change in the composition and allocation of loans within credit quality ratings.

The allowance for loan losses ~~decreased $1.05~~increased $1.46 million during the first nine months of ~~2014.~~2015. In the first nine months of ~~2014,~~2015, there was an increase of ~~$0.05~~$0.18 million due to the volume and composition of loans outstanding and a ~~$1.10~~$1.28 million ~~decrease~~increase in the amount allocated to the allowance due to ~~a combination of~~ credit ~~quality improvements.~~quality.

The allowance for loan losses balance is affected by charge-offs, net of recoveries, for the periods presented. For the nine months ended September 30, ~~2014~~2015 and ~~2013,~~2014, recoveries were ~~$2.31~~$3.58 million and ~~$2.02~~$1.57 million, respectively; and charge-offs were ~~$2.15~~$2.48 million in ~~2014~~2015 and ~~$2.12~~$1.57 million in ~~2013.~~2014. The allowance for loan losses totaled ~~$24.50~~$25.48 million at September 30, ~~2014~~2015 compared to ~~$25.55~~$24.02 million at December 31, ~~2013.~~2014. The allowance represented ~~1.26%~~1.23% and ~~1.40%~~1.21% of loans held for investment at September 30, ~~2014~~2015 and December 31, ~~2013, respectively.~~2014.

Page 45

Index

HILLS BANCORPORATION

Discussion of operations for the nine months ended September 30, ~~2014~~2015 and ~~2013~~2014

Noninterest Income

The following table sets forth the various categories of noninterest income for the nine months ended September 30, ~~2014~~2015 and ~~2013.~~2014.


	Nine Months Ended September 30,									Nine Months Ended September 30,
	2014		2013		$ Change			% Change		2015		2014		$ Change			% Change
	(Amounts in thousands)									(Amounts in thousands)
Net gain on sale of loans	$	638	$	1,793	$	(1,155	)	(64.42	)%	$	1,144	$	638	$	506		79.31	%
Trust fees	4,494		3,740		754			20.16		4,920		4,494		426			9.48
Service charges and fees	6,001		6,616		(615		)	(9.30	)	6,151		6,001		150			2.50
Rental revenue on tax credit real estate	1,112		1,114		(2		)	(0.18	)	1,296		1,112		184			16.55
Net gain on sale of other real estate owned and other reposessed assets	426		168		258			153.57
Net gain on sale of other real estate owned and other repossessed assets										139		426		(287		)	(67.37	)
Other noninterest income	1,944		1,939		5			0.26		2,064		1,944		120			6.17
	$	14,615	$	15,370	$	(755	)	(4.91	)	$	15,714	$	14,615	$	1,099		7.52

Loans originated for sale in the first nine months of ~~2014~~2015 totaled ~~$80.80~~$133.52 million compared to ~~$178.87~~$80.80 million in the same period in ~~2013, a decrease~~2014, an increase of ~~54.83%~~65.25%. In the nine months ended September 30, ~~2014~~2015 and ~~2013,~~2014, the net gain on sale of loans was ~~$0.64~~$$1.14 million and ~~$1.79~~$0.64 million, respectively. The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly. The volume of activity in these types of loans is directly related to the level of interest rates. The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income. The Company believes residential mortgage interest rates will continue to rise for the foreseeable future resulting in decreased net gain on sale of loan income.

Trust fees increased $0.75 million in the first nine months of 2014 as a result of assets under management increasing to $1.251 billion as of September 30, 2014 from $1.126 billion as of September 30, 2013 due to market conditions and new trust relationships.

Service charges and fees decreased $0.62 million in the first nine months of 2014 from their level for the comparable period in 2013. Credit card merchant fees are included in service charges and fees, and that component decreased during the same period by $0.98 million due to a change to an agent program utilized by the Bank. This decrease was offset by an increase of $0.32 million in credit card, debit card and POS Pin interchange income due to increased volume in transactions during the period.

The net gain on sale of other real estate owned and other repossessed assets ~~increased $0.26~~decreased $0.29 million to a net gain of ~~$0.43~~$0.14 million for the nine months ended September 30, ~~2014.~~2015. The total net gain on sale of other real estate owned for the nine months ended consisted of a $0.20 million net gain on the sale of 13 properties offset by a $0.06 million fair market value adjustment on 4 properties. During the same period in 2014, the gain consisted of a $0.50 million net gain on ~~the~~ sale of 13 properties offset by a $0.07 million fair market value adjustment on one property. ~~During~~

Trust fees increased $0.43 million in the ~~same period in 2013, the gain consisted of a $0.19 million net gain on sale of 11 properties offset by a $0.02 million fair market value adjustment on one property.~~nine months ended September 30, 2015 compared to September 30, 2014 due to new trust relationships.

Page 46

Index

HILLS BANCORPORATION

Discussion of operations for the nine months ended September 30, ~~2014~~2015 and ~~2013~~2014

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the nine months ended September 30, ~~2014~~2015 and ~~2013.~~2014.


	Nine Months Ended September 30,									Nine Months Ended September 30,
	2014		2013		$ Change			% Change		2015		2014		$ Change			% Change
	(Amounts in thousands)									(Amounts in thousands)
Salaries and employee benefits	$	19,042	$	18,312	$	730		3.99	%	$	20,700	$	19,042	$	1,658		8.71	%
Occupancy	2,900		2,780		120			4.32		2,887		2,900		(13		)	(0.45	)
Furniture and equipment	3,685		3,650		35			0.96		3,911		3,685		226			6.13
Office supplies and postage	1,157		1,163		(6		)	(1	)	1,311		1,157		154			13.31
Advertising and business development	2,216		1,895		321			16.94		2,547		2,216		331			14.94
Outside services	4,981		5,437		(456		)	(8.39	)	5,203		4,981		222			4.46
Rental expenses on tax credit real estate	1,635		1,571		64			4.07		1,719		1,635		84			5.14
FDIC insurance assessment	823		760		63			8.29		866		823		43			5.22
Other noninterest expense	1,177		1,298		(121		)	(9.32	)	1,231		1,177		54			4.59
	$	37,616	$	36,866	$	750		2.03		$	40,375	$	37,616	$	2,759		7.33

In the nine months ended September 30, 2015 and 2014, salaries and employee benefits expense increased $1.66 million. The increase is primarily the result of annual salary adjustments and additional employees.

Advertising and business development expense increased ~~$0.32~~$0.33 million in the first nine months of ~~2014~~2015 compared to ~~2013~~2014 as a result of ~~$0.07~~$0.37 million increase in ~~mail processing expense, $0.12 million in~~ business ~~promotions~~ and $0.08 million in charitable contributions. Outside services expenses decreased $0.46 million in the first nine months of 2014 from their level for the comparable period in 2013. Merchant card processing charges are included in outside services expense, and that component decreased during the same period by $0.91 million due to a change to an agent program utilized by the Bank. Most otherproduct promotions. Other noninterest expense categories experienced marginal period-to-period fluctuations for the nine months ended September 30, ~~2014.~~2015.

Page 47

Index

HILLS BANCORPORATION

Discussion of operations for the three months ended September 30, ~~2014~~2015 and ~~2013~~2014

Net Income Overview

Net income ~~increased $1.28~~decreased $0.21 million for the three months ended September 30, ~~2014~~2015 compared to the same period in ~~2013.~~2014. Total net income was ~~$7.90~~$7.69 million in ~~2014~~2015 and ~~$6.62~~$7.90 million in the comparable period in ~~2013, an increase~~2014, a decrease of ~~19.25%~~2.71%. For the three month period ended September 30, ~~2014~~2015 and September 30, ~~2013~~2014 basic earning per share was ~~$1.69~~$0.82 and ~~$1.41,~~$0.85, respectively. Diluted earnings per share was ~~$1.68~~$0.82 for the three months ended September 30, ~~2014~~2015 compared to ~~$1.40~~$0.84 for the same period in ~~2013.~~2014.

Net Interest Income

Net interest income increased for the three months ended September 30, ~~2014~~2015 compared to the comparable period in ~~2013.~~2014. The increase was primarily the result of growth in the volume of earning assets and a decrease in net interest expense due to the mix of interest bearing liabilities of the Company as well as a reduction in dollar amount and rate on time deposits Net interest income is the excess of the interest and fees earned on interest-earning bearing assets over the interest expense of the interest-bearing liabilities. The factors that have the greatest impact on net interest income are the volume of average earning assets and the net interest margin. The net interest margin for the three months ended September 30, 2015 was 3.52% compared to 3.49% in 2014 ~~was 3.49%, which remained unchanged from~~for the same ~~period for 2013.~~period. The measure is shown on a tax-equivalent basis using a tax rate of 35% to make the interest earned on taxable and non-taxable assets more comparable. The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the three months ended in ~~2014~~2015 compared to the comparable period in ~~2013~~2014 are shown in the following table:


						Increase (Decrease) in Net Interest Income														Increase (Decrease) in Net Interest Income
	Change in Average Balance			Change in Average Rate		Volume Changes			Rate Changes			Net Change			Change in Average Balance			Change in Average Rate		Volume Changes			Rate Changes			Net Change
	(Amounts in Thousands)														(Amounts in Thousands)
Interest income:
Loans, net	$	139,727		(0.17	)%	$	1,643		$	(810	)	$	833		$	144,980		(0.02	)%	$	2,462		$	(982	)	$	1,480
Taxable securities	(4,431		)	(0.06	)	(3		)	(25		)	(28		)	6,690			0.11		29			17			46
Nontaxable securities	19,043			(0.42	)	185			(157		)	28			3,175			(0.18	)	27			(69		)	(42		)
Federal funds sold	(11,796		)	—		(8		)	—			(8		)	(2,940		)	0.01		(1		)	—			(1		)
	$	142,543				$	1,817		$	(992	)	$	825		$	151,905				$	2,517		$	(1,034	)	$	1,483

Interest expense:
Interest-bearing demand deposits	$	28,825		(0.06	)%	$	(14	)	$	64		$	50		$	60,705		—	%	$	(21	)	$	(10	)	$	(31	)
Savings deposits	91,902			(0.04	)	(53		)	57			4			28,175			0.01		(11		)	(11		)	(22		)
Time deposits	(40,929		)	(0.17	)	165			220			385			(36,890		)	(0.16	)	133			192			325
Short-term borrowings	20,935			—		(9		)	(6		)	(15		)	10,725			0.01		(10		)	2			(8		)
FHLB borrowings	—			—		—			—			—			38,226			(0.37	)	(431		)	154			(277		)
Interest-bearing other liabilities	(57		)	(0.86	)	—			6			6			(47		)	(0.52	)	—			3			3
	$	100,676				$	89		$	341		$	430		$	100,894				$	(340	)	$	330		$	(10	)
Change in net interest income						$	1,906		$	(651	)	$	1,255							$	2,177		$	(704	)	$	1,473

Page 48

Index

HILLS BANCORPORATION

Discussion of operations for the three months ended September 30, ~~2014~~2015 and ~~2013~~2014

A summary of the net interest spread and margin is as follows:


(Tax Equivalent Basis)	2014		2013		2015		2014
Yield on average interest-earning assets	4.18	%	4.31	%	4.16	%	4.18	%
Rate on average interest-bearing liabilities	0.88		1.04		0.83		0.88
Net interest spread	3.30	%	3.27	%	3.33	%	3.30	%
Effect of noninterest-bearing funds	0.19		0.22		0.19		0.19
Net interest margin (tax equivalent interest income divided by average interest-earning assets)	3.49	%	3.49	%	3.52	%	3.49	%

Provision for Loan Losses

The provision for loan losses was a reduction of expense of $0.10 million for the three months ended September 30, 2015 compared to a reduction of expense of $1.01 million in 2014, ~~compared to~~ an expense increase of ~~$0.11 million in 2013, an expense reduction of $1.12~~$0.91 million. The loan loss provision is the amount necessary to adjust the allowance for loan losses to the level considered by management to appropriately account for the estimated impairment to the Bank's loan portfolio. The provision expense taken to fund the allowance for loan losses is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio. The provision reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact on the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more. In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historical higher credit risks.

The allowance for loan losses decreased ~~$0.85~~$0.32 million during the three months ended September 30, ~~2014.~~2015. In the three months ended September 30, ~~2014,~~2015, there was a decrease of ~~$0.02~~$0.28 million due to the ~~volume and~~ composition of loans outstanding and a ~~$0.83~~$0.04 million decrease in the amount allocated to the allowance due to ~~an improvement in~~ credit quality.

The allowance for loan losses balance is affected by charge-offs, net of recoveries, for the periods presented. For the three months ended September 30, ~~2014~~2015 and ~~2013,~~2014, recoveries were ~~$0.74~~$0.54 million and ~~$0.69~~$0.74 million, respectively; and charge-offs were $0.76 million in 2015 and $0.58 million in ~~2014 and $0.45 million in 2013.~~2014. The allowance for loan losses totaled ~~$24.50~~$25.48 million at September 30, ~~2014~~2015 compared to ~~$25.55~~$24.02 million at December 31, ~~2013.~~2014. The allowance represented ~~1.26%~~1.23% and ~~1.40%~~1.21% of loans held for investment at September 30, ~~2014~~2015 and December 31, ~~2013,~~2014, respectively.

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HILLS BANCORPORATION

Discussion of operations for the three months ended September 30, ~~2014~~2015 and ~~2013~~2014

Noninterest Income

The following table sets forth the various categories of noninterest income for the three months ended September 30, ~~2014~~2015 and ~~2013.~~2014.


	Three Months Ended September 30, 2014									Three Months Ended September 30,
	2014		2013		$ Change			% Change		2015		2014		$ Change			% Change
	(Amounts in thousands)									(Amounts in thousands)
Net gain on sale of loans	$	338	$	531	$	(193	)	(36.35	)%	$	396	$	338	$	58		17.16	%
Trust fees	1,595		1,185		410			34.60		1,672		1,595		77			4.83
Service charges and fees	2,152		2,240		(88		)	(3.93	)	2,124		2,152		(28		)	(1.30	)
Rental revenue on tax credit real estate	377		398		(21		)	(5.28	)	392		377		15			3.98
Net gain on sale of other real estate owned and other reposessed assets	186		18		168			933.33
Net gain on sale of other real estate owned and other repossessed assets										22		186		(164		)	(88.17	)
Other noninterest income	599		591		8			1.35		612		599		13			2.17
	$	5,247	$	4,963	$	284		5.72		$	5,218	$	5,247	$	(29	)	(0.55	)

In the three months ended September 30, ~~2014~~2015 and ~~2013,~~2014, the net gain on sale of loans was ~~$0.34~~$0.40 million and ~~$0.53~~$0.34 million, respectively. The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly. The volume of activity in these types of loans is directly related to the level of interest rates. The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income. The Company believes residential mortgage interest rates will continue to rise for the foreseeable future resulting in decreased net gain on sale of loan income.

Trust fees increased ~~$0.41~~$0.08 million in the three months ended September 30, ~~2014 as a result of assets under management increasing~~2015 compared to ~~$1.251 billion as of~~ September 30, 2014 ~~from $1.126 billion as of September 30, 2013~~ due to ~~market conditions and~~ new trust relationships.

The net gain on sale of other real estate owned and other repossessed assets increased $0.17 million to a net gain of $0.19 million for the three months ended September 30, 2014. The total net gain on sale of other real estate owned for the three months ended September 30, 2014 consisted of a $0.24 million net gain on the sale of 4 properties and a $0.05 million fair market value adjustment on three properties. During the same period in 2013, the gain consisted of a $0.04 net gain on sale of 3 properties and a $0.02 million fair market value adjustment on one property.

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HILLS BANCORPORATION

~~Discussion of operations for the three months ended September 30, 2014 and 2013~~

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the three months ended September 30, ~~2014~~2015 and ~~2013.~~2014.


	Three Months Ended September 30,									Three Months Ended September 30,
	2014		2013		$ Change			% Change		2015		2014		$ Change			% Change
	(Amounts in thousands)									(Amounts in thousands)
Salaries and employee benefits	$	6,400	$	6,158	$	242		3.93	%	$	7,125	$	6,400	$	725		11.33	%
Occupancy	947		907		40			4.41		919		947		(28		)	(2.96	)
Furniture and equipment	1,212		1,183		29			2.45		1,304		1,212		92			7.59
Office supplies and postage	390		445		(55		)	(12	)	457		390		67			17
Advertising and business development	775		624		151			24.20		854		775		79			10.19
Outside services	1,773		1,819		(46		)	(2.53	)	1,770		1,773		(3		)	(0.17	)
Rental expenses on tax credit real estate	552		614		(62		)	(10.10	)	558		552		6			1.09
FDIC insurance assessment	282		229		53			23.14		293		282		11			3.90
Other noninterest expense	490		432		58			13.43		392		490		(98		)	(20.00	)
	$	12,821	$	12,411	$	410		3.30		$	13,672	$	12,821	$	851		6.64

In the three months ended September 30, 2015 and 2014, salaries and employee benefits expense increased $0.73 million. The increase is primarily the result of annual salary adjustments and additional employees.

Advertising and business development expenses increased ~~$0.15~~$0.08 million in the three months ended September 30, ~~2014~~2015 from their level for the comparable period in ~~2013~~2014 as a result of a ~~$0.07~~ increase ~~in mail processing expense and $0.11~~of $0.06 in business and product promotions. ~~Most other~~Other noninterest expense categories experienced marginal period-to-period increases for the three months ended September 30, ~~2014.~~2015.

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HILLS BANCORPORATION

Income Taxes

Federal and state income tax expenses were ~~$3.63~~$3.54 million and ~~$2.71~~$3.63 million for the three months ended September 30, ~~2014~~2015 and ~~2013,~~2014, respectively. Income taxes as a percentage of income before taxes were 31.52% in 2015 and 31.46% in ~~2014 and 29.00% in 2013.~~2014.

Liquidity

The Company actively monitors and manages its liquidity position with the objective of maintaining sufficient cash flows to fund operations, meet client commitments, take advantage of market opportunities and provide a margin against unforeseeable liquidity needs. Federal funds sold and investment securities available for sale are readily marketable assets. Maturities of all investment securities are managed to meet the Company’s normal liquidity needs, to respond to market changes or to adjust the Company’s interest rate risk position. Investment securities available for sale comprised ~~10.56%~~10.21% of the Company’s total assets at September 30, ~~2014~~2015 compared to ~~11.00%~~11.09% at December 31, ~~2013.~~2014.

The Company has historically maintained a stable deposit base and a relatively low level of large deposits, which has mitigated the volatility in the Company’s liquidity position. As of September 30, ~~2014,~~2015, the Company had borrowed ~~$125.00~~$170.00 million from the Federal Home Loan Bank (“FHLB”) of Des Moines. Advances are used as a means of providing both long and short-term, fixed-rate funding for certain assets and for managing interest rate risk. The Company had additional borrowing capacity available from the FHLB of approximately ~~$478.73~~$463.98 million at September 30, ~~2014.~~2015.

As additional sources of liquidity, the Company has the ability to borrow up to $10.00 million from the Federal Reserve Bank of Chicago, and has lines of credit with three banks totaling ~~$216.65~~$227.78 million. The borrowings under these credit lines would be secured by the Bank’s investment securities. The combination of high levels of potentially liquid assets, low dependence on volatile liabilities and additional borrowing capacity provided sources of liquidity for the Company which management considered sufficient at September 30, ~~2014.~~2015.

~~Page 51~~

~~Index~~

~~HILLS BANCORPORATION~~

As of September 30, ~~2014,~~2015, investment securities with a carrying value of ~~$36.03~~$62.38 million were pledged to collateralize public and trust deposits, ~~short-term borrowings~~repurchase agreements, derivative financial instruments, and ~~for~~ other ~~purposes, as permitted by law.~~borrowings. As of December 31, ~~2013,~~2014, investment securities with a carrying value of ~~$42.02~~$68.12 million were pledged.

Contractual Obligations

There have been no material changes with regard to contractual obligations disclosed in the Company’s Form 10-K for the year ended December 31, ~~2013.~~2014.



Item 3.	Quantitative and Qualitative Disclosures about Market Risk

The Company's primary market risk exposure is to changes in interest rates. Interest rate risk is the risk to current or anticipated earnings or capital arising from movements in interest rates. Interest rate risk arises from repricing risk, basis risk, yield curve risk and options risk. Repricing risk is the difference between the timing of rate changes and the timing of cash flows. Basis risk is the difference from changing rate relationships among different yield curve affecting Bank activities. Yield curve risk is the difference from changing rate relationships across the spectrum of maturities. Option risk is the difference resulting from interest-related options imbedded in Bank products. The Bank’s primary source of interest rate risk exposure arises from repricing risk. To measure this risk the Bank uses a static gap measurement system that identifies the repricing gaps across the full maturity spectrum of the Bank’s assets and liabilities and an earnings simulation approach. The gap schedule is known as the interest rate sensitivity report. The report reflects the repricing characteristics of the Bank’s assets and liabilities. The report details the calculation of the gap ratio. This ratio ~~indicated~~indicates the amount if interest-earning assets repricing within a given period in comparison to the amount of interest-bearing liabilities repricing within the same period of time. A gap ratio of 1.0 indicates a matched position, in which case the effect on net interest income due to interest rate movements will be minimal. A gap ratio of less than 1.0 indicates that more liabilities than assets reprice within the time period, and a ratio greater than 1.0 indicates that more assets reprice than liabilities.

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HILLS BANCORPORATION

The Company's asset/liability management, or its management of interest rate risk, is focused primarily on evaluating and managing net interest income given various risk criteria. Factors beyond the Company's control, such as market interest rates and competition, may also have an impact on the Company's interest income and interest expense. In the absence of other factors, the Company's overall yield on interest-earning assets will increase as will its cost of funds on its interest-bearing liabilities when market interest rates increase over an extended period of time. Inversely, the Company's yields and cost of funds will decrease when market rates decline. The Company is able to manage these swings to some extent by attempting to control the maturity or rate adjustments of its interest-earning assets and interest-bearing liabilities over given periods of time.

The Bank maintains an Asset/Liability Committee, which meets at least quarterly to review the interest rate sensitivity position and to review and develop various strategies for managing interest rate risk within the context of the following factors: 1) capital adequacy, 2) asset/liability mix, 3) economic outlook, 4) market characteristics and 5) the interest rate forecast. In addition, the Bank uses a simulation model to review various assumptions relating to interest rate movement. The model attempts to limit rate risk even if it appears the Bank’s asset and liability maturities are perfectly matched and a favorable interest margin is present. The Bank’s policy is to generally maintain a balance between profitability and interest rate risk.

In order to minimize the potential effects of adverse material and prolonged increases or decreases in market interest rates on the Company's operations, management has implemented an asset/liability program designed to mitigate the Company's interest rate sensitivity. The program emphasizes the origination of adjustable rate loans, which are held in the portfolio, the investment of excess cash in short or intermediate term interest-earning assets, and the solicitation of transaction deposit accounts, which are less sensitive to changes in interest rates and can be re-priced rapidly.

~~Page 52~~

~~Index~~The Bank's interest rate risk, as monitored by management, has not changed materially from December 31, 2014.

~~HILLS BANCORPORATION~~



Item 4.	Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, as of the end of the period covered by this report, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports it files with the Securities and Exchange Commission. There have been no changes in the Company’s internal controls over financial reporting during the nine months ended September 30, ~~2014~~2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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HILLS BANCORPORATION

PART II - OTHER INFORMATION



Item 1.	Legal Proceedings

In the normal course of business, the Company and its subsidiaries are subject to pending and threatened legal actions, some of which seek substantial relief or damages. While the ultimate outcome of such legal proceedings cannot be predicted with certainty, after reviewing pending and threatened litigation with counsel, management believes at this time that the outcome of such litigation will not have a material adverse effect on the Company’s business, financial condition or results of operations.

On April 24, 2014, a suit was filed against the Bank in the Iowa District Court for Johnson County by a customer alleging that the fees associated with the Bank’s automated overdraft program in connection with its debit and ATM cards constitute unlawful interest in violation of Iowa’s usury laws and that the collection of such interest violates the Iowa Debt Collection Practices Act. The suit seeks class-action status for Bank customers who have paid overdraft fees arising from debit or ATM card transactions on their consumer accounts. The Bank filed a motion to dismiss the case, which the Court denied. The Bank ~~is appealing the District Court's ruling on the motion to dismiss through the filing of~~filed an application for interlocutory appeal to the Iowa Supreme ~~Court.~~Court, which the Court denied. The parties and District Court have put the case on hold pending a ruling by the Iowa Supreme Court in an appeal filed by West Bank on a similar issue under dispute in the Hills Bank case. At this stage of the proceedings, it is not possible for management of the Bank to determine the probability of a material adverse outcome or reasonably estimate the amount of any potential loss.



Item 1A.	Risk Factors

There have been no material changes from the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, ~~2013.~~2014.

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Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth information about the Company’s stock purchases, all of which were made pursuant to the 2005 Stock Repurchase Program, for the three months ended September 30, ~~2014:~~2015:


Period	Total number of shares purchased	Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs	Maximum number of shares that may yet be purchased under the plans or programs (1)	Total number of shares purchased	Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs	Maximum number of shares that may yet be purchased under the plans or programs (1)
July 1 to July 31	7,480	$	77.50	374,978	375,022	1,035	$	42.50	818,488	681,512
August 1 to August 31	7,159	78.83		382,137	367,863	7,143	42.80		825,631	674,369
September 1 to September 30	9,214	80.00		391,351	358,649	25,501	43.50		851,132	648,868
Total	23,853	$	78.78	391,351	358,649	33,679	$	43.32	851,132	648,868

(1) On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to ~~750,000~~1,500,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”). The Company’s Board of Directors authorized the 2005 Stock Repurchase Program through December 31, ~~2015.~~2016. The Company expects the purchases pursuant to the 2005 Stock Repurchase Program to be made from time to time in private transactions at a price equal to the most recent quarterly independent appraisal of the shares of the Company’s common stock. All purchases made pursuant to the 2005 Stock Repurchase Program since its inception have been made on that basis. The amount and timing of stock repurchases will be based on various factors, such as the Board’s assessment of the Company’s capital structure and liquidity, the amount of interest shown by shareholders in selling shares of stock to the Company at their appraised value, and applicable regulatory, legal and accounting factors. The Board reviews the overall results of the 2005 Stock Repurchase Program on a quarterly basis.

During the first nine months of ~~2014,~~2015, the Company issued ~~2,124~~3,260 shares of restricted stock under the 2010 Stock Option and Incentive ~~Plan, 831 shares of which were issued in the third quarter.~~Plan. The restricted shares were issued to officers of the company for no cash consideration and will vest over a five-year period from the date of grant. The issuance of these shares was exempt from the registration requirements of the SEC pursuant to Section 4(2) of the Securities Act of 1933.



Item 3.	Defaults upon Senior Securities

Hills Bancorporation has no senior securities.



Item 4.	Mine Safety Disclosure

Not applicable.



Item 5.	Other Information

None

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Item 6.	Exhibits



3.1	Restated Articles of Incorporation of Hills Bancorporation, as amended, incorporated by reference to Exhibit 3.1 to the ~~Company’s~~Company's Form ~~S-3 filed~~10-Q files with the Commission on May ~~12, 2011.~~6, 2015.
3.2	Amended and Restated By-laws of Hills Bancorporation, incorporated by reference to Exhibit 3.2 to the Company’s Form ~~S-3~~10-K filed with the Commission on ~~May 12, 2011.~~March 11, 2015.
31	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
32	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document (1)
101.SCH	XBRL Taxonomy Extension Schema Document (1)
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document (1)
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document (1)
101.LAB	XBRL Taxonomy Extension Label Linkbase Document (1)
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document (1)


(1)	Users of this data are advised that, pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and are otherwise not subject to liability under these sections.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		HILLS BANCORPORATION

Date:	November ~~6, 2014~~4, 2015	By: /s/ Dwight O. Seegmiller
		Dwight O. Seegmiller, Director, President and Chief Executive Officer

Date:	November ~~6, 2014~~4, 2015	By: /s/ Shari DeMaris
		Shari DeMaris, Secretary, Treasurer and Chief Accounting Officer

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HILLS BANCORPORATION

QUARTERLY REPORT OF FORM 10-Q FOR THE

QUARTER ENDED SEPTEMBER 30, ~~2014~~2015


Exhibit Number	Description	Page Number In The Sequential Numbering System September 30, 2014 Form 10-Q	Description	Page Number In The Sequential Numbering System September 30, 2015 Form 10-Q

31	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002	60-61	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002	59-60

32	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002	62	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002	61

Page 58



	Amounts reclassifed from AOCI
	Three Months Ended September 30,
	2014		2013			Affected Line Item in the Statements of Income
	(amounts in thousands)
Unrealized gains on available-for-sale securities	$	—	$	—		Other noninterest income
Tax effect	—		—			Tax (expense) benefit
Total reclassification out of AOCI	$	—	$	—

	Nine Months Ended September 30,
	2014		2013			Affected Line Item in the Statements of Income
	(amounts in thousands)
Unrealized gains on available-for-sale securities	$	—	$	17		Other noninterest income
Tax effect	—		(7		)	Tax (expense) benefit
Total reclassification out of AOCI	$	—	$	10



	Three Months Ended September 30, 2013
	Agricultural		Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	2,379	$	4,878		$	2,988		$	2,150	$	6,984		$	4,370		$	651		$	24,400
Charge-offs	—		(283		)	—			—		(103		)	(44		)	(19		)	(449		)
Recoveries	12		220			76			—		85			258			36			687
Provision	150		58			(258		)	139		105			(12		)	(70		)	112

Ending balance	$	2,541	$	4,873		$	2,806		$	2,289	$	7,071		$	4,572		$	598		$	24,750