SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

131 MAIN STREET, HILLS, Iowa 52235

Telephone number: (319) 679-2291



Title of each class	Trading Symbol(s)	Name of each exchange on which registered

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	☐	Accelerated Filer	☑
Non-accelerated filer	☐	Small Reporting Company	☐
Emerging Growth Company	☐

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☑ No

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


				SHARES OUTSTANDING
CLASS				July 31, 2020

Common Stock			No par value	9,365,231

				~~SHARES OUTSTANDING~~
~~CLASS~~		~~October 31, 2019~~

~~Common Stock~~	~~No par value~~	~~9,350,658~~

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

September 30, 2019 December 31, 2018
ASSETS (Unaudited)
Cash and cash equivalents $ 315,134
$ 43,305
Investment securities available for sale at fair value (amortized cost September 30, 2019 $319,037 December 31, 2018 $321,660) 323,377
318,926
Stock of Federal Home Loan Bank 12,265
12,172
Loans held for sale 24,857
1,984
Loans, net of allowance for loan losses (September 30, 2019 $35,570; December 31, 2018 $37,810) 2,603,311
2,591,085
Property and equipment, net 36,146
37,051
Tax credit real estate investment 8,416
9,193
Accrued interest receivable 13,502
11,784
Deferred income taxes, net 8,890
10,869
Goodwill 2,500
2,500
Other assets 9,334
3,595
Total Assets $ 3,357,732
$ 3,042,464

LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities

Noninterest-bearing deposits $ 372,020
$ 372,152
Interest-bearing deposits 2,328,938
2,048,972
Total deposits $ 2,700,958
$ 2,421,124
Federal Home Loan Bank borrowings 215,000
215,000
Accrued interest payable 2,591
1,812
Other liabilities 24,046
20,776
Total Liabilities $ 2,942,595
$ 2,658,712

Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP) $ 51,302
$ 48,870

STOCKHOLDERS' EQUITY

Common stock, no par value; authorized 20,000,000 shares; issued September 30, 2019 10,325,757 shares; December 31, 2018 10,325,191 shares $ —
$ —
Paid in capital 55,836
52,122
Retained earnings 397,896
371,848
Accumulated other comprehensive income (loss) 1,248
(3,250 )
Treasury stock at cost (September 30, 2019 984,397 shares; December 31, 2018 988,750 shares) (39,843 ) (36,968 )
Total Stockholders' Equity $ 415,137
$ 383,752
Less maximum cash obligation related to ESOP shares 51,302
48,870
Total Stockholders' Equity Less Maximum Cash Obligation Related to ESOP Shares $ 363,835
$ 334,882
Total Liabilities & Stockholders' Equity $ 3,357,732
$ 3,042,464

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Amounts In Thousands, Except Per Share Amounts)

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited) (Amounts In Thousands)

Three Months Ended September 30, Nine Months Ended
September 30,
2019 2018 2019 2018
Net income $ 11,282
$ 10,050
$ 33,705
$ 30,971

Other comprehensive income (loss)

Securities:

Net change in unrealized income (loss) on securities available for sale $ 495
$ (1,321 ) $ 7,046
$ (3,849 )
Reclassification adjustment for net (gains) losses realized in net income (24 ) —
28
—
Income taxes (118 ) 330
(1,765 ) 960
Other comprehensive income (loss) on securities available for sale $ 353
$ (991 ) $ 5,309
$ (2,889 )
Derivatives used in cash flow hedging relationships:

Net change in unrealized (loss) income on derivatives $ (103 ) $ 361
$ (1,081 ) $ 1,887
Income taxes 26
(90 ) 270
(470 )
Other comprehensive (loss) income on cash flow hedges $ (77 ) $ 271
$ (811 ) $ 1,417

Other comprehensive income (loss), net of tax $ 276
$ (720 ) $ 4,498
$ (1,472 )

Comprehensive income $ 11,558
$ 9,330
$ 38,203
$ 29,499


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Net income	$	11,711	$	11,220	$	18,786	$	22,423

Other comprehensive (loss) income
Securities:
Net change in unrealized income on securities available for sale	$	7,740	$	3,258	$	8,304	$	6,551
Reclassification adjustment for net loss (gains) realized in net income	—		52		(10)		52
Income taxes	(1,931)		(826)		(2,070)		(1,647)
Other comprehensive income on securities available for sale	$	5,809	$	2,484	$	6,224	$	4,956
Derivatives used in cash flow hedging relationships:
Net change in unrealized gain (loss) on derivatives	$	8	$	(680)	$	(1,090)	$	(978)
Income taxes	(2)		169		272		244
Other comprehensive income (loss) on cash flow hedges	$	6	$	(511)	$	(818)	$	(734)

Other comprehensive income, net of tax	$	5,815	$	1,973	$	5,406	$	4,222

Comprehensive income	$	17,526	$	13,193	$	24,192	$	26,645

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited) (Amounts In Thousands, Except Share Amounts)


Three Months Ended June 30, 2020 and 2019
	Paid In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Maximum Cash Obligation Related To ESOP Shares		Total
Balance, March 31, 2019	$	55,295	$	375,394	$	(1,001)	$	(39,057)	$	(49,851)	$	340,780
Issuance of 2,327 shares of common stock	84		—		—		61		—		145
Issuance of 2,106 shares of common stock under the employee stock purchase plan	118		—		—		—		—		118
Unearned restricted stock compensation	237		—		—		—		—		237
Forfeiture of 4,418 shares of common stock	(220)		—		—		—		—		(220)
Share-based compensation	1		—		—		—		—		1
Change related to ESOP shares	—		—		—		—		(374)		(374)
Net income	—		11,220		—		—		—		11,220


Purchase of 5,626 shares of common stock	—		—		—		(356)		—		(356)
Other comprehensive income	—		—		1,973		—		—		1,973
Balance, June 30, 2019	$	55,515	$	386,614	$	972	$	(39,352)	$	(50,225)	$	353,524

Balance, March 31, 2020	$	59,733	$	408,259	$	1,006	$	(41,939)	$	(50,249)	$	376,810
Issuance of 1,148 shares of common stock	43		—		—		30		—		73
Issuance of 1,857 shares of common stock under the employee stock purchase plan	99		—		—		—		—		99
Unearned restricted stock compensation	191		—		—		—		—		191
Forfeiture of 580 shares of common stock	(29)		—		—		—		—		(29)
Share-based compensation	6		—		—		—		—		6

Change related to ESOP shares	—		—		—		—		4,920		4,920
Net income	—		11,711		—		—		—		11,711


Purchase of 13,719 shares of common stock	—		—		—		(878)		—		(878)
Other comprehensive income	—		—		5,815		—		—		5,815
Balance, June 30, 2020	$	60,043	$	419,970	$	6,821	$	(42,787)	$	(45,329)	$	398,718

~~HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited) (Amounts In Thousands, Except Share Amounts)~~

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

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

Note 1.Summary of Significant Accounting Policies

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 1 business segment, a commercial bank.

Operating results for the ~~nine~~six month period ended ~~September~~June 30, ~~2019~~2020 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, ~~2019.~~2020. 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, ~~2018~~2019 filed with the Securities Exchange Commission on March ~~5, 2019.~~6, 2020. The consolidated balance sheet as of December 31, ~~2018,~~2019, 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.

The majority of the Company’s revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans, letters of credit and investment securities as these activities are not subject to the requirements of ASC 606. Interest income on loans and investment securities is recognized on the accrual method in accordance with written contracts.

Descriptions of the Company’s revenue-generating activities that are within the scope of ASC 606 are the following: Service charges and fees on deposit accounts represent general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue which includes interchange income, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when the Company’s performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied. Trust income represents monthly fees due from wealth management customers as consideration for managing the customers' assets. Wealth management and trust services include custody of assets, investment management, fees for trust services and similar fiduciary activities. Revenue is recognized when our performance obligation is completed each month, which is generally the time that payment is received.

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity's obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. As of ~~September~~June 30, ~~2019,~~2020, the Company did not have any significant contract balances.

An entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company has not incurred or capitalized any contract acquisition costs as of ~~September~~June 30, ~~2019.~~2020.

~~HILLS BANCORPORATION~~

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

Effect of New Financial Accounting Standards:

~~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. ASU 2014-09 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The adoption of ASU 2014-09 by the Company did not have a material impact on the recognition of revenue though did require additional disclosures on our material noninterest income streams discussed in revenue recognition above.

~~In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10),~~ ~~Recognition and Measurement of Financial Assets and Financial Liabilities.~~ ~~ASU 2016-01 created Subtopic 321-10,~~ ~~Investments-Equity Securities~~ which is applicable to all entities except those in industries that account for substantially all investments at fair value through earnings or the change in net assets. Under this new subtopic, equity securities are generally required to be measured at fair value with unrealized holding gains and losses reflected in net income. ASU 2016-01 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The Company adopted ASU 2016-01 for the period ending March 31, 2018. There was no material impact on the financial statements however it required a change in disclosure and related methodology located in Note 7 Fair Value Measurements.

~~In March 2016, the FASB issued ASU No. 2016-04, Liabilities - Extinguishments of Liabilities (Subtopic 405-20),~~ ~~Recognition of Breakage for Certain Prepaid Stored-Value Products~~. ASU 2016-04 applies to all entities that offer certain prepaid stored - value products. The ASU provides guidance for the derecognition of financial liabilities related to the issuance of these products and aligns the recognition of breakage to current authoritative guidance. For public companies, ASU 2016-04 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company adopted ASU 2016-04 for the period ending March 31, 2018. There was no material impact on the financial statements.

~~Index~~

~~HILLS BANCORPORATION~~

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

~~(Unaudited)~~

our allowance. For public companies, ASU 2016-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, early adoption is permitted for the fiscal year beginning after December 15, 2018. With the passage of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the option to delay CECL was provided until the earlier of the national health emergency being declared over or December 31, 2020. The Company elected to delay implementing CECL and continued to use the incurred loss method to calculate the allowance for loan losses as of and for the period ending June 30, 2020.

•An initial forecast period of one year for all portfolio segments and off-balance-sheet credit exposures. This period reflects management’s expectation of losses based on forward-looking economic scenarios over that time.

•A historical loss forecast period covering the remaining contractual life, adjusted for prepayments, by portfolio segment based on the change in key historical economic variables.

•A reversion period of up to 3 years connecting the initial loss forecast to the historical loss forecast based on economic conditions at the measurement date.

•We will primarily utilize discounted cash flow (DCF) methods to estimate credit losses by portfolio segment. The DCF methods ~~would~~ obtain estimated life-time credit losses using the conceptual components described above.

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

~~Index~~

~~HILLS BANCORPORATION~~

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

~~(Unaudited)~~

~~In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220),~~ ~~Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.~~ This ASU allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. ASU 2018-02 is effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company adopted ASU 2018-02 for the period ending March 31, 2018 and elected the specific identification method accounting policy. There was a $0.53 million reclassification recorded in stockholders' equity for the period ending March 31, 2018.

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted upon issuance of this ASU. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The ~~adoption of~~Company adopted ASU 2018-13 byfor the ~~Company is not expected to have a~~period ending March 31, 2020. There was no material ~~impact.~~impact on the financial statements.

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.

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,
2019 2018 2019 2018
Common shares outstanding at the beginning of the period 9,346,449
9,373,666
9,336,441
9,335,154
Weighted average number of net shares (redeemed) issued (160 ) (22,223 ) 21,712
40,123
Weighted average shares outstanding (basic) 9,346,289
9,351,443
9,358,153
9,375,277
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method 4,284
4,245
4,146
4,067
Weighted average number of shares (diluted) 9,350,573
9,355,688
9,362,299
9,379,344
Net income (In thousands) $ 11,282
$ 10,050
$ 33,705
$ 30,971
Earnings per share:

Basic $ 1.21
$ 1.07
$ 3.61
$ 3.30
Diluted $ 1.21
$ 1.07
$ 3.61
$ 3.30


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Common shares outstanding at the beginning of the period	9,375,356		9,352,060		9,351,694		9,336,441
Weighted average number of net shares issued (redeemed)	(5,496)		(1,419)		39,905		27,644
Weighted average shares outstanding (basic)	9,369,860		9,350,641		9,391,599		9,364,085
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method	3,785		4,191		3,721		4,083
Weighted average number of shares (diluted)	9,373,645		9,354,832		9,395,320		9,368,168
Net income (In thousands)	$	11,711	$	11,220	$	18,786	$	22,423
Earnings per share:
Basic	$	1.25	$	1.20	$	2.00	$	2.40
Diluted	$	1.25	$	1.20	$	2.00	$	2.40

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 3.Other Comprehensive Income

The following table summarizes the balances of each component of accumulated other comprehensive income (AOCI), included in stockholders’ equity, at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018:~~2019:

September 30,
2019
December 31, 2018
(amounts in thousands)
Net unrealized income (loss) on available-for-sale securities $ 4,340
$ (2,734 )
Net unrealized loss on derivatives used for cash flow hedges (2,677 ) (1,596 )
Tax effect $ (415 ) $ 1,080
Net-of-tax amount $ 1,248
$ (3,250 )

The carrying values of investment securities at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 are summarized in the following table (dollars in thousands):

September 30, 2019 December 31, 2018
Amount Percent Amount Percent
Securities available for sale
U.S. Treasury $ 115,949
35.86 % $ 83,155
26.07 %
Other securities (FHLB, FHLMC and FNMA) 20,198
6.24
34,871
10.93
State and political subdivisions 187,230
57.90
200,900
63.00
Total securities available for sale $ 323,377
100.00 % $ 318,926
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~~June 30, ~~2019~~2020 or December 31, ~~2018.~~2019. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 (in thousands):

Amortized Cost
Gross
Unrealized
Gains

Gross
Unrealized
(Losses)

Estimated Fair
Value
September 30, 2019
U.S. Treasury $ 114,153
$ 1,843
$ (47 ) $ 115,949
Other securities (FHLB, FHLMC and FNMA) 20,306
—
(108 ) 20,198
State and political subdivisions 184,578
2,806
(154 ) 187,230
Total $ 319,037
$ 4,649
$ (309 ) $ 323,377
December 31, 2018:

U.S. Treasury $ 83,839
$ 124
$ (808 ) $ 83,155
Other securities (FHLB, FHLMC and FNMA) 35,371
—
(500 ) 34,871
State and political subdivisions 202,450
278
(1,828 ) 200,900
Total $ 321,660
$ 402
$ (3,136 ) $ 318,926

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at ~~September~~June 30, ~~2019,~~2020, were as follows (in thousands):

Amortized
Cost
Fair Value
Due in one year or less $ 49,028
$ 48,979
Due after one year through five years 180,354
182,558
Due after five years through ten years 83,351
85,521
Due over ten years 6,304
6,319
Total $ 319,037
$ 323,377

As of ~~September~~June 30, ~~2019~~2020 investment securities with a carrying value of ~~$12.92~~$13.79 million were pledged to collateralize derivative financial instruments and other borrowings.

September 30, 2019 September 30, 2018
Sales proceeds $ 12,467
$ —
Gross realized gains 24
—
Gross realized losses 52
—


	June 30, 2020		June 30, 2019
Sales proceeds	$	313	$	4,881
Gross realized gains	10		—
Gross realized losses	—		52

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~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 (in thousands):

Page 17

Less than 12 months 12 months or more Total
September 30, 2019
Description of Securities # Fair Value
Unrealized
Loss
% # Fair Value
Unrealized
Loss
% # Fair Value
Unrealized
Loss
%
U.S. Treasury 6
$ 15,168
$ (38 ) 0.25 % 2
$ 4,985
$ (9 ) 0.18 % 8
$ 20,153
$ (47 ) 0.23 %

Other securities (FHLB, FHLMC and FNMA) —
—
—
—
8
20,198
(108 ) 0.53
8
20,198
(108 ) 0.53

State and political subdivisions 98
25,496
(127 ) 0.50
20
3,817
(27 ) 0.71
118
29,313
(154 ) 0.53

Total temporarily impaired securities 104
$ 40,664
$ (165 ) 0.41 % 30
$ 29,000
$ (144 ) 0.50 % 134
$ 69,664
$ (309 ) 0.44 %

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)


	Less than 12 months												12 months or more									Total
December 31, 2019 Description of Securities	#	Fair Value		Unrealized Loss		%		#	Fair Value		Unrealized Loss		%		#	Fair Value		Unrealized Loss		%
U.S. Treasury	11	$	27,932	$	(136)	0.49	%	1	$	2,495	$	(1)	0.04	%	12	$	30,427	$	(137)	0.45	%

Other securities (FHLB, FHLMC and FNMA)	—	—		—		—		6	15,229		(58)		0.38		6	15,229		(58)		0.38

State and political subdivisions	66	17,881		(119)		0.67		20	3,825		(16)		0.42		86	21,706		(135)		0.62

Total temporarily impaired securities	77	$	45,813	$	(255)	0.56	%	27	$	21,549	$	(75)	0.35	%	104	$	67,362	$	(330)	0.49	%

Less than 12 months 12 months or more Total
December 31, 2018
Description of Securities # Fair Value
Unrealized
Loss
% # Fair Value
Unrealized
Loss
% # Fair Value
Unrealized
Loss
%
U.S. Treasury 6
$ 14,644
$ (49 ) 0.33 % 19
$ 46,443
$ (759 ) 1.63 % 25
$ 61,087
$ (808 ) 1.32 %

Other securities (FHLB, FHLMC and FNMA) —
—
—
—
14
34,871
(500 ) 1.43
14
34,871
(500 ) 1.43

State and political subdivisions 113
31,022
(162 ) 0.52
325
77,921
(1,666 ) 2.14
438
108,943
(1,828 ) 1.68

Total temporarily impaired securities 119
$ 45,666
$ (211 ) 0.46 % 358
$ 159,235
$ (2,925 ) 1.84 % 477
$ 204,901
$ (3,136 ) 1.53 %

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.


~~Note 5.~~	~~Loans~~

Note 5.Loans

Classes of loans are as follows:

September 30,
2019 December 31,
2018
(Amounts In Thousands)
Agricultural $ 91,621
$ 92,673
Commercial and financial 219,362
229,501
Real estate:
Construction, 1 to 4 family residential 80,969
72,279
Construction, land development and commercial 108,662
113,807
Mortgage, farmland 237,513
236,454
Mortgage, 1 to 4 family first liens 913,206
912,059
Mortgage, 1 to 4 family junior liens 149,969
152,625
Mortgage, multi-family 350,378
352,434
Mortgage, commercial 401,615
383,314
Loans to individuals 32,613
30,072
Obligations of state and political subdivisions 52,030
52,725
$ 2,637,938
$ 2,627,943
Net unamortized fees and costs 943
952
$ 2,638,881
$ 2,628,895
Less allowance for loan losses 35,570
37,810
$ 2,603,311
$ 2,591,085


	June 30, 2020		December 31, 2019
	(Amounts In Thousands)
Agricultural	$	94,101	$	91,317
Commercial and financial	335,784		221,323
Real estate:
Construction, 1 to 4 family residential	78,727		80,209
Construction, land development and commercial	109,456		108,410
Mortgage, farmland	246,781		242,730
Mortgage, 1 to 4 family first liens	894,013		910,742
Mortgage, 1 to 4 family junior liens	135,863		149,227
Mortgage, multi-family	361,206		350,761
Mortgage, commercial	411,116		402,181
Loans to individuals	30,139		32,308
Obligations of state and political subdivisions	55,705		49,896
	$	2,752,891	$	2,639,104
Net unamortized fees and costs	970		933
	$	2,753,861	$	2,640,037
Less allowance for loan losses	37,620		33,760
	$	2,716,241	$	2,606,277

As of June 30, 2020, the Company has provided $125.65 million of Paycheck Protection Program (PPP) loans recorded with commercial and financial loans above and has $4.28 million of deferred PPP loan fees recorded net of commercial and financial loans. For the six months ended June 30, 2020, the Company has recognized $0.61 million of fees in interest income.

Page 18

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~~six months ended ~~September~~June 30, ~~2019~~2020 were as follows:


	Three Months Ended June 30, 2020
	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	$	2,760��	$	6,680	$	2,621	$	4,096	$	11,752	$	9,063	$	1,368	$	38,340
Charge-offs	(31)		(760)		(43)		(1)		(231)		(78)		(23)		(1,167)
Recoveries	8		101		53		—		247		9		21		439
Provision	(190)		(244)		(198)		(6)		514		179		(47)		8

Ending balance	$	2,547	$	5,777	$	2,433	$	4,089	$	12,282	$	9,173	$	1,319	$	37,620


	Six Months Ended June 30, 2020
	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	$	2,400	$	4,988	$	2,599	$	3,950	$	10,638	$	7,859	$	1,326	$	33,760
Charge-offs	(35)		(775)		(43)		(1)		(460)		(80)		(213)		(1,607)
Recoveries	19		209		54		—		434		23		71		810
Provision	163		1,355		(177)		140		1,670		1,371		135		4,657

Ending balance	$	2,547	$	5,777	$	2,433	$	4,089	$	12,282	$	9,173	$	1,319	$	37,620

Ending balance, individually evaluated for impairment	$	94	$	747	$	6	$	3	$	140	$	1	$	—	$	991

Ending balance, collectively evaluated for impairment	$	2,453	$	5,030	$	2,427	$	4,086	$	12,142	$	9,172	$	1,319	$	36,629

Loans:

Ending balance	$	94,101	$	335,784	$	188,183	$	246,781	$	1,029,876	$	772,322	$	85,844	$	2,752,891

Ending balance, individually evaluated for impairment	$	2,035	$	2,575	$	1,614	$	2,948	$	8,263	$	3,866	$	—	$	21,301

Ending balance, collectively evaluated for impairment	$	92,066	$	333,209	$	186,569	$	243,833	$	1,021,613	$	768,456	$	85,844	$	2,731,590

Page 19

Three Months Ended September 30, 2019
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 $ 2,535
$ 5,603
$ 2,646
$ 3,891
$ 11,384
$ 8,194
$ 1,397
$ 35,650
Charge-offs (135 ) (177 ) —
—
(332 ) —
(92 ) (736 )
Recoveries 18
128
2
—
317
12
35
512
Provision 288
(143 ) 240
96
(166 ) (110 ) (61 ) 144

Ending balance $ 2,706
$ 5,411
$ 2,888
$ 3,987
$ 11,203
$ 8,096
$ 1,279
$ 35,570

Nine Months Ended September 30, 2019
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 $ 2,789
$ 5,826
$ 3,292
$ 3,972
$ 12,516
$ 8,165
$ 1,250
$ 37,810
Charge-offs (135 ) (641 ) (9 ) —
(711 ) (133 ) (326 ) (1,955 )
Recoveries 87
451
6
5
576
100
132
1,357
Provision (35 ) (225 ) (401 ) 10
(1,178 ) (36 ) 223
(1,642 )

Ending balance $ 2,706
$ 5,411
$ 2,888
$ 3,987
$ 11,203
$ 8,096
$ 1,279
$ 35,570

Ending balance, individually evaluated for impairment $ 341
$ 1,008
$ —
$ —
$ 65
$ 1
$ 2
$ 1,417

Ending balance, collectively evaluated for impairment $ 2,365
$ 4,403
$ 2,888
$ 3,987
$ 11,138
$ 8,095
$ 1,277
$ 34,153

Loans:

Ending balance $ 91,621
$ 219,362
$ 189,631
$ 237,513
$ 1,063,175
$ 751,993
$ 84,643
$ 2,637,938

Ending balance, individually evaluated for impairment $ 1,865
$ 3,176
$ 456
$ 4,117
$ 7,729
$ 2,043
$ 2
$ 19,388

Ending balance, collectively evaluated for impairment $ 89,756
$ 216,186
$ 189,175
$ 233,396
$ 1,055,446
$ 749,950
$ 84,641
$ 2,618,550

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Changes in the allowance for loan losses for the three and ~~nine~~six months ended ~~September~~June 30, ~~2018~~2019 were as follows:

Three Months Ended September 30, 2018
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 $ 2,071
$ 5,040
$ 3,054
$ 3,475
$ 8,902
$ 5,697
$ 1,271
$ 29,510
Charge-offs (68 ) (241 ) —
—
(280 ) (107 ) (197 ) (893 )
Recoveries 74
415
2
10
187
80
32
800
Provision (47 ) (133 ) (188 ) 50
1,756
193
(38 ) 1,593

Ending balance $ 2,030
$ 5,081
$ 2,868
$ 3,535
$ 10,565
$ 5,863
$ 1,068
$ 31,010

Nine Months Ended September 30, 2018
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 $ 2,294
$ 4,837
$ 2,989
$ 3,669
$ 8,668
$ 5,700
$ 1,243
$ 29,400
Charge-offs (72 ) (447 ) —
—
(607 ) (161 ) (420 ) (1,707 )
Recoveries 102
856
147
29
433
97
114
1,778
Provision (294 ) (165 ) (268 ) (163 ) 2,071
227
131
1,539

Ending balance $ 2,030
$ 5,081
$ 2,868
$ 3,535
$ 10,565
$ 5,863
$ 1,068
$ 31,010

Ending balance, individually evaluated for impairment $ 118
$ 1,165
$ 3
$ —
$ 91
$ 40
$ 48
$ 1,465

Ending balance, collectively evaluated for impairment $ 1,912
$ 3,916
$ 2,865
$ 3,535
$ 10,474
$ 5,823
$ 1,020
$ 29,545

Loans:

Ending balance $ 79,155
$ 214,681
$ 171,944
$ 230,032
$ 1,049,249
$ 729,626
$ 81,095
$ 2,555,782

Ending balance, individually evaluated for impairment $ 2,342
$ 3,288
$ 927
$ 3,729
$ 6,728
$ 8,217
$ 48
$ 25,279

Ending balance, collectively evaluated for impairment $ 76,813
$ 211,393
$ 171,017
$ 226,303
$ 1,042,521
$ 721,409
$ 81,047
$ 2,530,503


	Three Months Ended June 30, 2019
	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	$	2,541	$	6,004	$	2,928	$	3,871	$	11,630	$	8,223	$	1,323	$	36,520
Charge-offs	—		(284)		(1)		—		(202)		(129)		(126)		(742)
Recoveries	59		139		2		—		149		2		61		412
Provision	(65)		(256)		(283)		20		(193)		98		139		(540)

Ending balance	$	2,535	$	5,603	$	2,646	$	3,891	$	11,384	$	8,194	$	1,397	$	35,650


	Six Months Ended June 30, 2019
	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	$	2,789	$	5,826	$	3,292	$	3,972	$	12,516	$	8,165	$	1,250	$	37,810
Charge-offs	—		(464)		(9)		—		(379)		(133)		(234)		(1,219)
Recoveries	69		323		4		5		259		88		97		845
Provision	(323)		(82)		(641)		(86)		(1,012)		74		284		(1,786)

Ending balance	$	2,535	$	5,603	$	2,646	$	3,891	$	11,384	$	8,194	$	1,397	$	35,650

Ending balance, individually evaluated for impairment	$	213	$	1,059	$	—	$	—	$	70	$	1	$	40	$	1,383

Ending balance, collectively evaluated for impairment	$	2,322	$	4,544	$	2,646	$	3,891	$	11,314	$	8,193	$	1,357	$	34,267

Loans:

Ending balance	$	91,215	$	225,990	$	172,740	$	238,779	$	1,069,126	$	756,869	$	83,898	$	2,638,617

Ending balance, individually evaluated for impairment	$	1,930	$	4,213	$	458	$	4,170	$	6,956	$	2,084	$	40	$	19,851

Ending balance, collectively evaluated for impairment	$	89,285	$	221,777	$	172,282	$	234,609	$	1,062,170	$	754,785	$	83,858	$	2,618,766

Page 20

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~~June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively (amounts in thousands):


	Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial
June 30, 2020
Grade:
Excellent	$	3,017	$	15,179	$	2	$	237
Good	13,532		61,937		7,672		15,516
Satisfactory	42,587		188,587		51,897		56,622
Monitor	26,947		55,891		17,706		29,124
Special Mention	5,421		9,206		884		7,171
Substandard	2,597		4,984		566		786
Total	$	94,101	$	335,784	$	78,727	$	109,456

Agricultural
Commercial and
Financial

Real Estate:
Construction, 1 to 4
family residential

Real Estate:
Construction, land
development and
commercial
September 30, 2019
Grade:
Excellent $ 3,484
$ 3,078
$ —
$ 194
Good 12,754
40,411
8,071
24,959
Satisfactory 42,257
120,698
55,490
41,622
Monitor 26,226
44,518
14,856
33,714
Special Mention 2,700
7,069
2,552
7,539
Substandard 4,200
3,588
—
634
Total $ 91,621
$ 219,362
$ 80,969
$ 108,662


	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
June 30, 2020
Grade:
Excellent	$	6,704	$	2,479	$	261	$	17,974
Good	43,153		34,744		3,531		52,676
Satisfactory	132,937		723,717		123,921		194,594
Monitor	54,652		105,212		4,868		64,038
Special Mention	5,928		12,014		1,442		13,458
Substandard	3,407		15,847		1,840		18,466
Total	$	246,781	$	894,013	$	135,863	$	361,206

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, 2019
Grade:
Excellent $ 6,268
$ 1,859
$ 607
$ 21,016
Good 40,387
33,034
4,014
49,684
Satisfactory 131,790
752,092
136,188
187,940
Monitor 48,244
100,469
6,070
57,945
Special Mention 3,056
9,111
1,455
27,729
Substandard 7,768
16,641
1,635
6,064
Total $ 237,513
$ 913,206
$ 149,969
$ 350,378


										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, 2019
June 30, 2020									June 30, 2020
Grade:									Grade:
Excellent	$	34,016	$	—	$	7,652	$	78,174	Excellent	$	28,228	$	—	$	7,142	$	81,223
Good	81,831		224		16,438		311,807		Good	79,123		176		14,092		326,152
Satisfactory	193,035		31,635		20,128		1,712,875		Satisfactory	207,053		29,358		26,385		1,777,658
Monitor	82,657		560		7,416		422,675		Monitor	75,112		384		7,936		441,870
Special Mention	6,122		172		396		67,901		Special Mention	17,600		151		150		73,425
Substandard	3,954		22		—		44,506		Substandard	4,000		70		—		52,563
Total	$	401,615	$	32,613	$	52,030	$	2,637,938	Total	$	411,116	$	30,139	$	55,705	$	2,752,891

Page 21

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
December 31, 2019
Grade:
Excellent	$	3,594	$	3,461	$	260	$	190
Good	12,380		47,843		8,868		23,217
Satisfactory	43,308		117,114		51,093		47,987
Monitor	24,857		44,543		17,505		29,009
Special Mention	3,110		5,157		2,483		7,428
Substandard	4,068		3,205		—		579
Total	$	91,317	$	221,323	$	80,209	$	108,410

Agricultural
Commercial and
Financial

Real Estate:
Construction, 1 to 4
family residential

Real Estate:
Construction, land
development and
commercial
December 31, 2018
Grade:
Excellent $ 3,667
$ 3,322
$ —
$ 209
Good 15,342
51,562
13,029
16,667
Satisfactory 39,897
121,759
42,043
68,123
Monitor 27,510
35,897
15,045
19,888
Special Mention 647
11,418
1,767
7,635
Substandard 5,610
5,543
395
1,285
Total $ 92,673
$ 229,501
$ 72,279
$ 113,807

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, 2018
Grade:
Excellent $ 5,619
$ 2,715
$ 520
$ 22,058
Good 52,364
33,134
4,569
60,047
Satisfactory 126,706
752,473
138,533
187,641
Monitor 41,486
96,187
6,242
60,398
Special Mention 1,055
10,439
1,130
16,065
Substandard 9,224
17,111
1,631
6,225
Total $ 236,454
$ 912,059
$ 152,625
$ 352,434

Real Estate:
Mortgage,
commercial

Loans to
individuals

Obligations of state and
political subdivisions
Total
December 31, 2018
Grade:
Excellent $ 34,096
$ —
$ 8,117
$ 80,323
Good 86,453
315
15,652
349,134
Satisfactory 177,271
28,797
20,685
1,703,928
Monitor 74,990
647
8,271
386,561
Special Mention 3,228
217
—
53,601
Substandard 7,276
96
—
54,396
Total $ 383,314
$ 30,072
$ 52,725
$ 2,627,943


	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, 2019
Grade:
Excellent	$	3,630	$	3,209	$	261	$	18,955
Good	40,118		32,474		4,233		47,871
Satisfactory	134,738		751,215		136,079		189,391
Monitor	53,147		96,353		5,473		60,965
Special Mention	3,033		11,167		1,469		27,559
Substandard	8,064		16,324		1,712		6,020
Total	$	242,730	$	910,742	$	149,227	$	350,761


	Real Estate: Mortgage, commercial		Loans to individuals		Obligations of state and political subdivisions		Total
December 31, 2019
Grade:
Excellent	$	27,017	$	—	$	7,444	$	68,021
Good	79,467		221		14,465		311,157
Satisfactory	206,196		31,385		20,274		1,728,780
Monitor	81,381		437		7,323		420,993
Special Mention	4,802		212		390		66,810
Substandard	3,318		53		—		43,343
Total	$	402,181	$	32,308	$	49,896	$	2,639,104

Page 22

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The below are descriptions of the credit quality indicators:

Excellent – 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 sources and timely and accurate financial information.

Satisfactory – Satisfactory rated loans are 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 the primary source of repayment is seen to be clear and adequate.

Monitor – Monitor rated loans are identified by management as warranting special attention for a variety of reasons that may bear on ultimate collectability. This may be due to adverse trends, a 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 are marginally 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.

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 23

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Past due loans as of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 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
(Amounts In Thousands)
September 30, 2019
Agricultural $ 1,438
$ 246
$ —
$ 1,684
$ 89,937
$ 91,621
$ —
Commercial and financial 271
200
103
574
218,788
219,362
102
Real estate:
Construction, 1 to 4 family residential 1,109
438
—
1,547
79,422
80,969
—
Construction, land development and commercial 1,041
—
33
1,074
107,588
108,662
—
Mortgage, farmland 964
406
—
1,370
236,143
237,513
—
Mortgage, 1 to 4 family first liens 973
2,874
3,276
7,123
906,083
913,206
641
Mortgage, 1 to 4 family junior liens 430
133
61
624
149,345
149,969
61
Mortgage, multi-family —
101
—
101
350,277
350,378
—
Mortgage, commercial 598
276
182
1,056
400,559
401,615
—
Loans to individuals 144
30
3
177
32,436
32,613
—
Obligations of state and political subdivisions —
—
—
—
52,030
52,030
—
$ 6,968
$ 4,704
$ 3,658
$ 15,330
$ 2,622,608
$ 2,637,938
$ 804

December 31, 2018

Agricultural $ 1,026
$ —
$ 135
$ 1,161
$ 91,512
$ 92,673
$ —
Commercial and financial 988
459
225
1,672
227,829
229,501
—
Real estate:

Construction, 1 to 4 family residential —
—
212
212
72,067
72,279
212
Construction, land development and commercial 233
202
—
435
113,372
113,807
—
Mortgage, farmland 193
388
—
581
235,873
236,454
—
Mortgage, 1 to 4 family first liens 3,972
833
3,234
8,039
904,020
912,059
158
Mortgage, 1 to 4 family junior liens 199
36
—
235
152,390
152,625
—
Mortgage, multi-family —
—
—
—
352,434
352,434
—
Mortgage, commercial 733
344
—
1,077
382,237
383,314
—
Loans to individuals 195
—
22
217
29,855
30,072
—
Obligations of state and political subdivisions —
—
—
—
52,725
52,725
—
$ 7,539
$ 2,262
$ 3,828
$ 13,629
$ 2,614,314
$ 2,627,943
$ 370


	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)
June 30, 2020
Agricultural	$	112	$	—	$	572	$	684	$	93,417	$	94,101	$	329
Commercial and financial	1,016		473		84		1,573		334,211		335,784		4
Real estate:
Construction, 1 to 4 family residential	2,427		10		424		2,861		75,866		78,727		424
Construction, land development and commercial	45		214		566		825		108,631		109,456		—
Mortgage, farmland	270		134		965		1,369		245,412		246,781		298
Mortgage, 1 to 4 family first liens	628		1,216		3,569		5,413		888,600		894,013		1
Mortgage, 1 to 4 family junior liens	168		100		275		543		135,320		135,863		113
Mortgage, multi-family	—		—		91		91		361,115		361,206		—
Mortgage, commercial	679		486		351		1,516		409,600		411,116		—
Loans to individuals	99		65		4		168		29,971		30,139		—
Obligations of state and political subdivisions	—		—		—		—		55,705		55,705		—
	$	5,444	$	2,698	$	6,901	$	15,043	$	2,737,848	$	2,752,891	$	1,169

December 31, 2019
Agricultural	$	163	$	275	$	122	$	560	$	90,757	$	91,317	$	48
Commercial and financial	1,076		229		101		1,406		219,917		221,323		65
Real estate:
Construction, 1 to 4 family residential	635		—		—		635		79,574		80,209		—
Construction, land development and commercial	215		101		—		316		108,094		108,410		—
Mortgage, farmland	736		—		610		1,346		241,384		242,730		—
Mortgage, 1 to 4 family first liens	5,026		3,100		4,149		12,275		898,467		910,742		354
Mortgage, 1 to 4 family junior liens	813		126		233		1,172		148,055		149,227		139
Mortgage, multi-family	—		97		—		97		350,664		350,761		—
Mortgage, commercial	321		489		—		810		401,371		402,181		—
Loans to individuals	226		55		15		296		32,012		32,308		—
Obligations of state and political subdivisions	—		—		—		—		49,896		49,896		—
	$	9,211	$	4,472	$	5,230	$	18,913	$	2,620,191	$	2,639,104	$	606

Page 24

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The Company does not have a 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~~June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, was as follows:


	June 30, 2020										December 31, 2019
	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)
Agricultural	$	1,270	$	329	$	132	$	1,192	$	48	$	404
Commercial and financial	786		4		1,260		679		65		1,934
Real estate:
Construction, 1 to 4 family residential	566		424		—		—		—		—
Construction, land development and commercial	209		—		317		—		—		320
Mortgage, farmland	1,143		298		1,507		1,369		—		2,712
Mortgage, 1 to 4 family first liens	6,392		1		1,604		6,558		354		1,626
Mortgage, 1 to 4 family junior liens	250		113		—		94		139		—
Mortgage, multi-family	91		—		1,707		97		—		1,719
Mortgage, commercial	1,560		—		509		779		—		593
	$	12,267	$	1,169	$	7,036	$	10,768	$	606	$	9,308

September 30, 2019 December 31, 2018

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)
Agricultural $ 1,114
$ —
$ 543
$ 1,338
$ —
$ 120
Commercial and financial 820
102
2,053
1,476
—
2,686
Real estate:

Construction, 1 to 4 family residential —
—
—
—
212
—
Construction, land development and commercial 33
—
323
—
—
328
Mortgage, farmland 986
—
3,131
1,062
—
3,301
Mortgage, 1 to 4 family first liens 6,093
641
1,011
5,799
158
1,143
Mortgage, 1 to 4 family junior liens —
61
24
—
—
24
Mortgage, multi-family 101
—
—
145
—
—
Mortgage, commercial 1,039
—
903
1,009
—
937
$ 10,186
$ 804
$ 7,988
$ 10,829
$ 370
$ 8,539

(1)There were $4.40 million and $4.34 million of TDR loans included within nonaccrual loans as of June 30, 2020 and December 31, 2019, respectively.


~~(1)~~	~~There were $4.03 million and $4.84 million of TDR loans included within nonaccrual loans as of September 30, 2019 and December 31, 2018, respectively.~~

Loans 90 days or more past due that are still accruing interest increased ~~$0.43~~$0.56 million from December 31, ~~2018~~2019 to ~~September~~June 30, ~~2019~~2020 due to an increase in the number of accruing loans past due 90 days or more. As of ~~September~~June 30, ~~2019~~2020 there were 910 accruing loans past due 90 days or more. The average accruing loans past due as of ~~September~~June 30, ~~2019 are $0.09~~2020 was $0.12 million. There were 28 accruing loans past due 90 days or more as of December 31, ~~2018~~2019 and the average loan balance was ~~$0.19~~$0.08 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 25

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Below is a summary of information for TDR loans as of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	June 30, 2020								December 31, 2019
	Number of contracts	Recorded investment		Commitments outstanding		Number of contracts	Recorded investment		Commitments outstanding
		(Amounts In Thousands)							(Amounts In Thousands)
Agricultural	8	$	1,381	$	42	9	$	1,552	$	3
Commercial and financial	17	1,940		85		16	2,641		95
Real estate:
Construction, 1 to 4 family residential	—	—		—		—	—		—
Construction, land development and commercial	2	317		—		2	320		—
Mortgage, farmland	7	2,705		—		8	4,021		—
Mortgage, 1 to 4 family first liens	19	2,005		—		16	2,083		—
Mortgage, 1 to 4 family junior liens	—	—		—		—	—		—
Mortgage, multi-family	2	1,707		—		2	1,719		—
Mortgage, commercial	7	1,717		—		7	1,373		—
Loans to individuals	—	—		—		—	—		—
	62	$	11,772	$	127	60	$	13,709	$	98

September 30, 2019 December 31, 2018

Number
of
contracts

Recorded
investment

Commitments
outstanding

Number
of
contracts

Recorded
investment

Commitments
outstanding
(Amounts In Thousands) (Amounts In Thousands)
Agricultural 9
$ 1,657
$ 3
5
$ 1,316
$ 91
Commercial and financial 15
2,703
95
13
3,867
75
Real estate:
Construction, 1 to 4 family residential —
—
—
—
—
—
Construction, land development and commercial 2
323
—
2
328
—
Mortgage, farmland 8
4,049
—
8
4,291
—
Mortgage, 1 to 4 family first liens 14
1,535
—
16
1,710
—
Mortgage, 1 to 4 family junior liens 1
24
—
1
24
—
Mortgage, multi-family —
—
—
—
—
—
Mortgage, commercial 8
1,724
—
9
1,839
—
Loans to individuals —
—
—
—
—
—
57
$ 12,015
$ 98
54
$ 13,375
$ 166

The following is a summary of TDR loans that were modified during the three and ~~nine~~six months ended ~~September~~June 30, ~~2019:~~2020:


	Three Months Ended June 30, 2020								Six Months Ended June 30, 2020
	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)
Agricultural	—	$	—	$	—	2	$	93	$	93
Commercial and financial	1	19		19		2	218		218
Real estate:
Construction, 1 to 4 family residential	—	—		—		—	—		—
Construction, land development and commercial	—	—		—		—	—		—
Mortgage, farmland	—	—		—		—	—		—
Mortgage, 1 to 4 family first lien	5	104		104		5	104		104
Mortgage, 1 to 4 family junior liens	—	—		—		—	—		—
Mortgage, multi-family	—	—		—		—	—		—
Mortgage, commercial	—	—		—		1	513		513
	6	$	123	$	123	10	$	928	$	928

Three Months Ended September 30, 2019 Nine Months Ended September 30, 2019

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)
Agricultural —
$ —
$ —
4
$ 574
$ 574
Commercial and financial —
—
—
3
303
303
Real estate:

Construction, 1 to 4 family residential —
—
—
—
—
—
Construction, land development and commercial —
—
—
—
—
—
Mortgage, farmland —
—
—
1
620
620
Mortgage, 1 to 4 family first lien —
—
—
—
—
—
Mortgage, 1 to 4 family junior liens —
—
—
—
—
—
Mortgage, multi-family —
—
—
—
—
—
Mortgage, commercial —
—
—
—
—
—
—
$ —
$ —
8
$ 1,497
$ 1,497

Page 26

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The Company had commitments to lend $0.13 million in additional borrowings to restructured loan customers as of June 30, 2020. The Company had commitments to lend $0.10 million in additional borrowings to restructured loan customers as of ~~September 30, 2019. The Company had commitments to lend $0.17 million in additional borrowings to restructured loan customers as of~~ December 31, ~~2018.~~2019. These commitments were in the normal course of business. The additional borrowings were not used to facilitate payments on these loans.

There were 02 TDR loans that were in payment default (defined as past due 90 days or more) totaling $0.33 million during the period ended ~~September~~June 30, ~~2019~~2020 and ~~0ne for~~1 totaling $0.065 million modified during the year ended December 31, ~~2018.~~2019.

Page 27

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Information regarding impaired loans as of and for the three and ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 is as follows:


	September 30, 2019						Three Months Ended September 30, 2019				Nine Months Ended September 30, 2019					June 30, 2020												Three Months Ended June 30, 2020			Six Months Ended June 30, 2020
	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)														With no related allowance recorded:	(Amounts In Thousands)
Agricultural	$	1,524	$	2,007	$	—	$	1,535	$	1	$	1,611	$	4	Agricultural	$	1,624	$	2,265	$	—	$	1,778	$	5	$	1,754		$	10
Commercial and financial	1,541		2,702		—		1,875		15		2,151		51		Commercial and financial	1,514		3,069		—		2,396		26		1,992			43
Real estate:															Real estate:
Construction, 1 to 4 family residential	101		144		—		101		—		106		—		Construction, 1 to 4 family residential	664		710		—		736		—		700			—
Construction, land development and commercial	355		379		—		356		4		362		13		Construction, land development and commercial	526		542		—		530		4		528			9
Mortgage, farmland	4,117		4,633		—		4,144		40		4,162		118		Mortgage, farmland	2,762		3,283		—		4,052		39		3,420			64
Mortgage, 1 to 4 family first liens	6,052		7,955		—		6,108		8		6,124		22		Mortgage, 1 to 4 family first liens	6,949		8,815		—		7,175		18		7,091			34
Mortgage, 1 to 4 family junior liens	—		248		—		—		—		—		—		Mortgage, 1 to 4 family junior liens	95		340		—		94		—		94			—
Mortgage, multi-family	101		213		—		103		—		123		—		Mortgage, multi-family	1,798		1,917		—		1,810		20		1,807			40
Mortgage, commercial	1,871		2,702		—		1,888		10		1,980		29		Mortgage, commercial	2,000		2,693		—		2,158		5		2,084			10
Loans to individuals	—		14		—		—		—		—		—		Loans to individuals	—		14		—		—		—		—			—
	$	15,662	$	20,997	$	—	$	16,110	$	78	$	16,619	$	237		$	17,932	$	23,648	$	—	$	20,729	$	117	$	19,470		$	210

With an allowance recorded:															With an allowance recorded:
Agricultural	$	341	$	341	$	341	$	464	$	7	$	491	$	21	Agricultural	$	411	$	411	$	94	$	438	$	5	$	436		$	11
Commercial and financial	1,635		1,670		1,008		1,607		21		1,715		67		Commercial and financial	1,061		1,235		747		1,040		7		992			14
Real estate:															Real estate:
Construction, 1 to 4 family residential	—		—		—		—		—		—		—		Construction, 1 to 4 family residential	424		424		6		421		5		421			10
Construction, land development and commercial	—		—		—		—		—		—		—		Construction, land development and commercial	—		—		—		—		—		—			—
Mortgage, farmland	—		—		—		—		—		—		—		Mortgage, farmland	186		186		3		187		2		187			4
Mortgage, 1 to 4 family first liens	1,593		1,700		62		1,613		12		1,529		36		Mortgage, 1 to 4 family first liens	951		1,152		80		1,212		6		1,096			8
Mortgage, 1 to 4 family junior liens	84		84		3		86		1		89		3		Mortgage, 1 to 4 family junior liens	268		273		60		272		1		271			3
Mortgage, multi-family	—		—		—		—		—		—		—		Mortgage, multi-family	—		—		—		—		—		—			—
Mortgage, commercial	71		71		1		72		1		73		3		Mortgage, commercial	68		68		1		70		1		69			2
Loans to individuals	2		2		2		2		—		2		—		Loans to individuals	—		—		—		—		—		—			—
	$	3,726	$	3,868	$	1,417	$	3,844	$	42	$	3,899	$	130		$	3,369	$	3,749	$	991	$	3,640	$	27	$	3,472		$	52

Total:															Total:
Agricultural	$	1,865	$	2,348	$	341	$	1,999	$	8	$	2,102	$	25	Agricultural	$	2,035	$	2,676	$	94	$	2,216	$	10	$	2,190		$	21
Commercial and financial	3,176		4,372		1,008		3,482		36		3,866		118		Commercial and financial	2,575		4,304		747		3,436		33		2,984			57
Real estate:															Real estate:
Construction, 1 to 4 family residential	101		144		—		101		—		106		—		Construction, 1 to 4 family residential	1,088		1,134		6		1,157		5		1,121			10
Construction, land development and commercial	355		379		—		356		4		362		13		Construction, land development and commercial	526		542		—		530		4		528			9
Mortgage, farmland	4,117		4,633		—		4,144		40		4,162		118		Mortgage, farmland	2,948		3,469		3		4,239		41		3,607			68
Mortgage, 1 to 4 family first liens	7,645		9,655		62		7,721		20		7,653		58		Mortgage, 1 to 4 family first liens	7,900		9,967		80		8,387		24		8,187			42
Mortgage, 1 to 4 family junior liens	84		332		3		86		1		89		3		Mortgage, 1 to 4 family junior liens	363		613		60		366		1		365			3
Mortgage, multi-family	101		213		—		103		—		123		—		Mortgage, multi-family	1,798		1,917		—		1,810		20		1,807			40
Mortgage, commercial	1,942		2,773		1		1,960		11		2,053		32		Mortgage, commercial	2,068		2,761		1		2,228		6		2,153			12
Loans to individuals	2		16		2		2		—		2		—		Loans to individuals	—		14		—		—		—		—			—
	$	19,388	$	24,865	$	1,417	$	19,954	$	120	$	20,518	$	367		$	21,301	$	27,397	$	991	$	24,369	$	144	$	22,942		$	262

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Information regarding impaired loans as of December 31, ~~2018~~2019 is as follows:

Recorded
Investment

Unpaid Principal
Balance

Related
Allowance
With no related allowance recorded: (Amounts In Thousands)
Agricultural $ 1,395
$ 1,663
$ —
Commercial and financial 1,650
2,503
—
Real estate:

Construction, 1 to 4 family residential 111
148
—
Construction, land development and commercial 328
344
—
Mortgage, farmland 3,612
4,071
—
Mortgage, 1 to 4 family first liens 6,089
7,819
—
Mortgage, 1 to 4 family junior liens —
254
—
Mortgage, multi-family 145
213
—
Mortgage, commercial 1,871
2,486
—
Loans to individuals —
14
—
$ 15,201
$ 19,515
$ —

With an allowance recorded:

Agricultural $ 1,065
$ 1,229
$ 479
Commercial and financial 2,512
2,512
1,189
Real estate:

Construction, 1 to 4 family residential 698
698
4
Construction, land development and commercial —
—
—
Mortgage, farmland —
—
—
Mortgage, 1 to 4 family first liens 899
974
70
Mortgage, 1 to 4 family junior liens 24
24
2
Mortgage, multi-family 7,447
7,447
305
Mortgage, commercial 75
75
1
Loans to individuals 64
64
64
$ 12,784
$ 13,023
$ 2,114

Total:

Agricultural $ 2,460
$ 2,892
$ 479
Commercial and financial 4,162
5,015
1,189
Real estate:

Construction, 1 to 4 family residential 809
846
4
Construction, land development and commercial 328
344
—
Mortgage, farmland 3,612
4,071
—
Mortgage, 1 to 4 family first liens 6,988
8,793
70
Mortgage, 1 to 4 family junior liens 24
278
2
Mortgage, multi-family 7,592
7,660
305
Mortgage, commercial 1,946
2,561
1
Loans to individuals 64
78
64
$ 27,985
$ 32,538
$ 2,114

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Impaired loans ~~decreased $8.60~~increased $0.38 million from December 31, ~~2018~~2019 to ~~September~~June 30, ~~2019.~~2020. 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 ~~0.73%~~0.77% of loans held for investment as of ~~September~~June 30, ~~2019~~2020 and ~~1.06%~~0.79% as of December 31, ~~2018.~~2019. The ~~decrease~~increase in impaired loans is due to ~~a decrease~~an increase of ~~$7.83~~$0.43 million in loans with a specific reserve, ~~a decrease in TDR loans of $0.55 million, a decrease~~an increase in nonaccrual loans of ~~$0.64~~$1.50 million and ~~is offset by a $0.43 million~~an increase in 90 days or more accruing loans of $0.56 million and is offset by a decrease in TDR loans of $2.27 million from December 31, ~~2018~~2019 to ~~September~~June 30, ~~2019.~~2020.

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 may recognize a charge off or record a specific allowance 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.

The Bank leases branch offices, parking facilities and certain equipment under operating leases. The leases have remaining lease terms of 1 year to 1615 years, some of which include options to extend the leases for up to 10 years, and some of which include options to terminate the leases within 1 year. As the options are reasonably certain to be exercised, they are recognized as part of the right-of-use assets and lease liabilities.

For the ~~nine~~six months ended ~~September~~June 30, 2020 and 2019, total operating lease expense was ~~$0.47~~$0.28 million and $0.32 million, respectively, and is included in occupancy expenses in the consolidated ~~statement~~statements of income. Included in this for the six months ended June 30, 2020 and 2019 were ~~$0.40~~$0.23 million and $0.27 million of operating lease costs, respectively, $0.02 million and $0.02 million of short term lease costs, respectively, and ~~$0.05~~$0.03 million and $0.03 million of variable lease ~~costs.~~costs, respectively.

For the ~~nine~~six months ended ~~September~~June 30, 2020 and 2019, cash paid for amounts included in the measurement of operating lease liabilities was ~~$0.40~~$0.23 million and $0.27 million, respectively, and right-of-use assets obtained in exchange for lease obligations was $0.00 million and $3.58 ~~million.~~million, respectively.

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

As of ~~September~~June 30, 2020 and December 31, 2019, operating lease right-of-use assets included in other assets was ~~$3.30~~$3.00 million and $3.20 million, respectively. Operating lease liabilities ~~was $3.32 million. The~~were $3.04 million and $3.23 million as of June 30, 2020 and December 31, 2019. As of June 30, 2020 and December 31, 2019, the weighted average remaining lease term for operating leases was ~~10.99~~11.13 years and 10.86 years, respectively, and the weighted average discount rate for operating leases was ~~3.45%.~~3.47% and 3.46%, respectively. Discount rates used were determined from FHLB borrowing rates for comparable terms.

As of ~~September~~June 30, ~~2019,~~2020, maturities of lease liabilities were as follows:


Year ending December 31:	(Amounts In Thousands)
2020	$	234
2021	456
2022	448
2023	301
2024	250
Thereafter	2,009
Total lease payments	3,698
Less imputed interest	(657)
Total operating lease liabilities	$	3,041

Year ending December 31: (Amounts In Thousands)
2019 $ 117
2020 470
2021 456
2022 447
2023 301
Thereafter 2,259
Total lease payments 4,050
Less imputed interest (734 )
Total operating lease liabilities $ 3,316

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 7.Fair Value Measurements

The carrying value and estimated fair values of the Company's financial instruments as of ~~September~~June 30, ~~2019~~2020 are as follows:

(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.

September 30, 2019

Carrying
Amount

Estimated Fair
Value

Readily
Available
Market
Prices(1)

Observable
Market
Prices(2)

Company
Determined
Market
Prices(3)
(Amounts In Thousands)
Financial instrument assets:
Cash and cash equivalents $ 315,134
$ 315,134
$ 315,134
$ —
$ —
Investment securities 335,642
335,642
115,949
219,693
—
Loans held for sale 24,857
24,857
—
24,857
—
Loans

Agricultural 88,915
91,215
—
—
91,215
Commercial and financial 213,951
218,564
—
—
218,564
Real estate:

Construction, 1 to 4 family residential 79,640
81,500
—
—
81,500
Construction, land development and commercial 107,103
108,135
—
—
108,135
Mortgage, farmland 233,526
233,940
—
—
233,940
Mortgage, 1 to 4 family first liens 904,581
903,249
—
—
903,249
Mortgage, 1 to 4 family junior liens 148,334
144,653
—
—
144,653
Mortgage, multi-family 346,532
350,285
—
—
350,285
Mortgage, commercial 397,365
395,913
—
—
395,913
Loans to individuals 31,854
33,164
—
—
33,164
Obligations of state and political subdivisions 51,510
51,620
—
—
51,620
Accrued interest receivable 13,502
13,502
—
13,502
—
Total financial instrument assets $ 3,292,446
$ 3,301,373
$ 431,083
$ 258,052
$ 2,612,238
Financial instrument liabilities

Deposits

Noninterest-bearing deposits $ 372,020
$ 372,020
$ —
$ 372,020
$ —
Interest-bearing deposits 2,328,938
2,342,313
—
2,342,313
—
Federal Home Loan Bank borrowings 215,000
208,682
—
208,682
—
Interest rate swaps 2,677
2,677
—
2,677
—
Accrued interest payable 2,591
2,591
—
2,591
—
Total financial instrument liabilities $ 2,921,226
$ 2,928,283
$ —
$ 2,928,283
$ —

Face Amount

Financial instrument with off-balance sheet risk:

Loan commitments $ 452,367
$ —
$ —
$ —
$ —
Letters of credit 7,725
—
—
—
—
Total financial instrument liabilities with off-balance-sheet risk $ 460,092
$ —
$ —
$ —
$ —

Index


~~(1)~~	~~Considered Level 1 under Accounting Standards Codification (“ASC”) Topic 820,~~ ~~Fair Value Measurements and Disclosures (“ASC 820”).~~ HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited)


~~(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.~~

The carrying value and estimated fair values of the Company's financial instruments as of December 31, ~~2018~~2019 are as follows:


	December 31, 2019
	Carrying Amount		Estimated Fair Value		Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)
	(Amounts In Thousands)
Financial instrument assets:
Cash and cash equivalents	$	241,965	$	241,965	$	241,965	$	—	$	—
Investment securities	366,368		366,368		128,585		237,783		—
Loans held for sale	8,400		8,400		—		8,400		—
Loans
Agricultural	88,917		90,118		—		—		90,118
Commercial and financial	216,335		217,640		—		—		217,640
Real estate:
Construction, 1 to 4 family residential	79,096		79,954		—		—		79,954
Construction, land development and commercial	106,924		107,276		—		—		107,276
Mortgage, farmland	238,780		239,521		—		—		239,521
Mortgage, 1 to 4 family first liens	902,630		896,676		—		—		896,676
Mortgage, 1 to 4 family junior liens	147,634		143,261		—		—		143,261
Mortgage, multi-family	346,938		349,663		—		—		349,663
Mortgage, commercial	398,145		395,838		—		—		395,838
Loans to individuals	31,455		32,722		—		—		32,722
Obligations of state and political subdivisions	49,423		50,564		—		—		50,564
Accrued interest receivable	12,442		12,442		—		12,442		—
Total financial instrument assets	$	3,235,452	$	3,232,408	$	370,550	$	258,625	$	2,603,233
Financial instrument liabilities:
Deposits
Noninterest-bearing deposits	$	387,612	$	387,612	$	—	$	387,612	$	—
Interest-bearing deposits	2,273,752		2,292,332		—		2,292,332		—

Federal Home Loan Bank borrowings	185,000		186,091		—		186,091		—
Interest rate swaps	2,349		2,349				2,349
Accrued interest payable	2,474		2,474		—		2,474		—
Total financial instrument liabilities	$	2,851,187	$	2,870,858	$	—	$	2,870,858	$	—

	Face Amount
Financial instrument with off-balance sheet risk:
Loan commitments	$	424,165	$	—	$	—	$	—	$	—
Letters of credit	8,569		—		—		—		—
Total financial instrument liabilities with off-balance-sheet risk	$	432,734	$	—	$	—	$	—	$	—

(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 33

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

December 31, 2018

Carrying
Amount

Estimated Fair
Value

Readily
Available
Market
Prices(1)

Observable
Market
Prices(2)

Company
Determined
Market
Prices(3)
(Amounts In Thousands)
Financial instrument assets:
Cash and cash equivalents $ 43,305
$ 43,305
$ 43,305
$ —
$ —
Investment securities 331,098
331,098
83,155
247,943
—
Loans held for sale 1,984
1,984
—
1,984
—
Loans

Agricultural 89,884
93,736
—
—
93,736
Commercial and financial 223,675
227,774
—
—
227,774
Real estate:

Construction, 1 to 4 family residential 70,982
72,419
—
—
72,419
Construction, land development and commercial 111,812
112,960
—
—
112,960
Mortgage, farmland 232,482
235,771
—
—
235,771
Mortgage, 1 to 4 family first liens 902,261
882,908
—
—
882,908
Mortgage, 1 to 4 family junior liens 150,859
148,128
—
—
148,128
Mortgage, multi-family 348,351
342,099
—
—
342,099
Mortgage, commercial 379,232
376,257
—
—
376,257
Loans to individuals 29,349
29,962
—
—
29,962
Obligations of state and political subdivisions 52,198
51,945
—
—
51,945
Accrued interest receivable 11,784
11,784
—
11,784
—
Total financial instrument assets $ 2,979,256
$ 2,962,130
$ 126,460
$ 261,711
$ 2,573,959
Financial instrument liabilities:

Deposits

Noninterest-bearing deposits $ 372,152
$ 372,152
$ —
$ 372,152
$ —
Interest-bearing deposits 2,048,972
2,059,336
—
2,059,336
—
Federal Home Loan Bank borrowings 215,000
207,948
—
207,948
—
Interest rate swaps 1,596
1,596
1,596

Accrued interest payable 1,812
1,812
—
1,812
—
Total financial instrument liabilities $ 2,639,532
$ 2,642,844
$ —
$ 2,642,844
$ —

Face Amount

Financial instrument with off-balance sheet risk:

Loan commitments $ 375,940
$ —
$ —
$ —
$ —
Letters of credit 9,033
—
—
—
—
Total financial instrument liabilities with off-balance-sheet risk $ 384,973
$ —
$ —
$ —
$ —


~~(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.~~

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

~~Index~~

~~HILLS BANCORPORATION~~

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

~~(Unaudited)~~

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.

ASSETS

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. U.S. Treasury securities are considered Level 1 with the remaining securities considered Level 2.

The pricing for investment securities is obtained from an independent source. There are no 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~~six months ended ~~September~~June 30, ~~2019.~~2020. 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 and Loans: ASU 2016-01, Financial Instruments -Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. ~~Therefore, the fair value presented herein may not be comparable to prior periods.~~ Methodologies utilized for this financial statement period are as follows:

•Income Approach: Fair value is determined based on a discounted cash flow analysis. The discounted cash flow analysis was based on the contractual maturity of the loan and market indications of rates, prepayment speeds, defaults and credit risk.

•Asset Approach: Fair value is determined based on the estimated values of the underlying collateral or individual analysis of receipts. This provides a better indication of value than the contractual income streams as these loans are not performing or exhibit strong signs indicative of non-performance.

Fair value has been estimated in accordance with ASC 820, Fair Value Measurements and Disclosures, and is intended to represent the price that would be received in an orderly transaction between market participants as of the measurement date. In

Page 34

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, at least one significant assumption not observable in the market was utilized. These unobservable assumptions reflect estimates that market participants would use in pricing the asset or liability. Inputs to these valuation techniques are subjective in nature, involve uncertainties and

~~Index~~

~~HILLS BANCORPORATION~~

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

~~(Unaudited)~~

require significant judgment and therefore cannot be determined with precision. Accordingly, the fair value estimates presented are not necessarily indicative of the amounts to be realized in a current market exchange. Loans are classified as Level 3.

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.

Impaired loans: A loan is considered to be impaired when it is probable that all of the principal and interest due may not be collected according to its contractual terms. Generally, when a loan is considered impaired, the amount of reserve required under ASC 310, Receivables, is measured based on the fair value of the underlying collateral. The Company makes such measurements on all material loans deemed impaired using the fair value of the collateral for collateral dependent loans or based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or the fair value of the loan if determinable. The fair value of collateral used by the Company is determined by obtaining an observable market price or by obtaining an appraised value from an independent, licensed or certified appraiser, using observable market data. This data includes information such as selling price of similar properties and capitalization rates of similar properties sold within the market, expected future cash flows or earnings of the subject property based on current market expectations, and other relevant factors. All appraised values are adjusted for market-related trends based on the Company's experience in sales and other appraisals of similar property types as well as estimated selling costs. Each quarter management reviews all collateral dependent impaired loans on a loan-by-loan basis to determine whether updated appraisals are necessary based on loan performance, collateral type and guarantor support. At times, the Company measures the fair value of collateral dependent impaired loans using appraisals with dates prior to one year from the date of review. These appraisals are discounted by applying current, observable market data about similar property types such as sales contracts, estimations of value by individuals familiar with the market, other appraisals, sales or collateral assessments based on current market activity until updated appraisals are obtained. Depending on the length of time since an appraisal was performed, the data provided through reviews and estimated selling costs, collateral values are typically discounted by 0-35%. 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).

LIABILITIES

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).

Page 35

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:


	June 30, 2020
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value
Securities available for sale	(Amounts In Thousands)
U.S. Treasury	$	159,742	$	—	$	—	$	159,742
State and political subdivisions	—		193,781		—		193,781
Other securities (FHLB, FHLMC and FNMA)	—		12,929		—		12,929
Derivative Financial Instruments
Interest rate swaps	$	—	(3,439)		$	—	(3,439)
Total	$	159,742	$	203,271	$	—	$	363,013

September 30, 2019

Readily
Available
Market
Prices(1)

Observable
Market Prices(2)

Company
Determined
Market
Prices(3)

Total at Fair
Value
Securities available for sale (Amounts In Thousands)
U.S. Treasury $ 115,949
$ —
$ —
$ 115,949
State and political subdivisions —
187,230
—
187,230
Other securities (FHLB, FHLMC and FNMA) —
20,198
—
20,198
Derivative Financial Instruments
Interest rate swaps $ —
(2,677 ) $ —
(2,677 )
Total $ 115,949
$ 204,751
$ —
$ 320,700


	December 31, 2018											December 31, 2019
	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
Securities available for sale	(Amounts In Thousands)										Securities available for sale	(Amounts In Thousands)
U.S. Treasury	$	83,155	$	—		$	—	$	83,155		U.S. Treasury	$	128,585	$	—	$	—	$	128,585
State and political subdivisions	—		200,900			—		200,900			State and political subdivisions	—		211,489		—		211,489
Other securities (FHLB, FHLMC and FNMA)	—		34,871			—		34,871			Other securities (FHLB, FHLMC and FNMA)	—		15,229		—		15,229
Derivative Financial Instruments											Derivative Financial Instruments
Interest rate swaps	—		(1,596		)	—		(1,596		)	Interest rate swaps	—		(2,349)		—		(2,349)
Total	$	83,155	$	234,175		$	—	$	317,330		Total	$	128,585	$	224,369	$	—	$	352,954

(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~~six months ended ~~September~~June 30, ~~2019~~2020 and the year ended December 31, ~~2018.~~2019.

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.

(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.

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

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


	December 31, 2019										Year Ended December 31, 2019
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Total Losses
	(Amounts in Thousands)
Loans (4)
Agricultural	$	—	$	—	$	1,272	$	1,272	$	36
Commercial and financial	—		—		1,803		1,803		499
Real Estate:
Construction, 1 to 4 family residential	—		—		—		—		—
Construction, land development and commercial	—		—		215		215		8
Mortgage, farmland	—		—		3,576		3,576		—
Mortgage, 1 to 4 family first liens	—		—		7,986		7,986		370
Mortgage, 1 to 4 family junior liens	—		—		49		49		—
Mortgage, multi-family	—		—		1,816		1,816		—
Mortgage, commercial	—		—		1,237		1,237		125
Loans to individuals	—		—		—		—		—
Foreclosed assets (5)	—		—		—		—		—
Total	$	—	$	—	$	17,954	$	17,954	$	1,038

(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.

December 31, 2018 Year Ended December 31, 2018

Readily
Available
Market
Prices(1)

Observable
Market
Prices(2)

Company
Determined
Market
Prices(3)

Total at Fair
Value
Total Losses
(Amounts in Thousands)
Loans (4)
Agricultural $ —
$ —
$ 1,160
$ 1,160
$ 63
Commercial and financial —
—
2,882
2,882
122
Real Estate:
Construction, 1 to 4 family residential —
—
—
—
—
Construction, land development and commercial —
—
703
703
—
Mortgage, farmland —
—
3,848
3,848
—
Mortgage, 1 to 4 family first liens —
—
6,729
6,729
520
Mortgage, 1 to 4 family junior liens —
—
22
22
60
Mortgage, multi-family —
—
7,286
7,286
—
Mortgage, commercial —
—
1,458
1,458
349
Loans to individuals —
—
—
—
—
Foreclosed assets (5) —
—
—
—
—
Total $ —
$ —
$ 24,088
$ 24,088
$ 1,114

Note 8.Stock Repurchase Program

On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of 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, 2020. 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 ~~1,210,485~~1,298,603 shares of its common stock in privately negotiated transactions from August 1, 2005 through ~~September~~June 30, ~~2019.~~2020. Of these ~~1,210,485~~1,298,603 shares, ~~8,209~~13,719 shares were purchased during the quarter ended ~~September~~June 30, ~~2019,~~2020, at an average price per share of ~~$64.49.~~

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 9. Commitments and Contingencies

On April 10, 2019, Hills Bank was sued in a class action ~~lawsuit.~~lawsuit in the Iowa District Court for Johnson County. The lawsuit seeks class action status for customers who had paid overdraft fees on debit card transactions that were authorized into a positive account, but settled into a negative account. Plaintiff contends that these overdraft fees breached the terms of Hills Bank’s account documents. Plaintiff seeks compensatory and punitive damages for breach of contract. The Bank disputes the merits of Plaintiff’s ~~claims~~claims. The parties are negotiating a class-wide settlement and ~~filed~~expect to reach a ~~motion to dismiss the case,~~final agreement in 2020 upon which the ~~Court denied.~~settlement will be recorded in the Company's financial statements. At this stage of the proceedings, ~~it is not possible for~~ management of the Bank ~~to determine the probability of an~~does not believe that any adverse outcome or ~~reasonably estimate~~potential loss will have a material impact on the ~~amount~~Company's financial statements when taken as a whole.

The outbreak of ~~any potential loss.~~Coronavirus Disease 2019 (“COVID-19”) has and will continue to adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. The World Health Organization has declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections.

The spread of the outbreak has caused significant disruptions in the U.S. economy and is highly likely to disrupt banking and other financial activity in the areas in which the Company operates and could also potentially create widespread business continuity issues for the Company. The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to contain COVID-19 escalates or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows.

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.

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

A summary of the Bank’s commitments at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 is as follows:

September 30, 2019 December 31, 2018
(Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:
Home equity loans $ 67,224
$ 59,330
Credit cards 55,879
52,802
Commercial, real estate and home construction 119,866
89,171
Commercial lines and real estate purchase loans 209,398
174,637
Outstanding letters of credit 7,725
9,033

Note 10.Income Taxes

Federal income tax expense for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018~~2019 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, 2019, 2018 ~~2017,~~ and ~~2016~~2017 remain subject to examination by the Internal Revenue Service. For state tax purposes, the tax years ended December 31, 2019, 2018 ~~2017,~~ and ~~2016~~2017 remain open for examination. There were no material unrecognized tax benefits at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 and therefore no interest or penalties on unrecognized tax benefits has been recorded. As of ~~September~~June 30, ~~2019,~~2020, the Company does not anticipate any significant increase in unrecognized tax benefits during the twelve-month period ending ~~September~~June 30, ~~2020.~~2021. Income taxes as a percentage of income before taxes were ~~22.02%~~22.16% for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~20.05%~~21.70% for the same period in ~~2018.~~2019.

~~Index~~

~~HILLS BANCORPORATION~~

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

~~(Unaudited)~~

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cut and Jobs Act (the “Tax Act”). The Tax Act established new tax laws that reduced the U.S. federal corporate income tax rate from 35% to 21% in 2018.

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 ~~$2.68~~$3.44 million of collateral as of ~~September~~June 30, ~~2019.~~2020.

The Bank executed 2 forward-starting interest rate swap transactions on November 7, 2013. NaN of the interest rate swap transactions had an effective date of November 9, 2015, and an expiration date of November 9, 2020, effectively converting $25.00 million of variable rate debt to fixed rate debt. The other interest rate swap transaction had an effective date of November 7, 2016 and an expiration date of November 7, 2023, effectively converting $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.

Index

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

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~~June 30, ~~2019~~2020 and December 31, ~~2018:~~2019:

Notional
Amount

Fair
Value

Balance
Sheet
Category
Maturity
(Amounts in Thousands)
September 30, 2019
Interest rate swap $ 25,000
$ (326 ) Other Liabilities 11/9/2020
Interest rate swap 25,000
(2,351 ) Other Liabilities 11/7/2023

December 31, 2018

Interest rate swap $ 25,000
$ (120 ) Other Liabilities 11/9/2020
Interest rate swap 25,000
(1,476 ) Other Liabilities 11/7/2023

~~Index~~

~~HILLS BANCORPORATION~~

~~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 for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and year ended December 31, ~~2018:~~2019:

Recognized
in OCI

Reclassified from AOCI into
Income

Recognized in Income on
Derivatives

Amount of
Gain (Loss)
Category
Amount
of Gain
(Loss)
Category
Amount
of Gain
(Loss)
(Amounts in Thousands)
September 30, 2019
Interest rate swap $ (155 ) Interest Expense $ —
Other Income $ —
Interest rate swap (656 ) Interest Expense —
Other Income —

December 31, 2018

Interest rate swap $ 347
Interest Expense $ —
Other Income $ —
Interest rate swap 571
Interest Expense —
Other Income —

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.

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.

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HILLS BANCORPORATION

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.

~~Index~~•

~~HILLS BANCORPORATION~~

•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.

•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, diseases and/or pandemics, 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.

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HILLS BANCORPORATION

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.

Index

~~Index~~

HILLS BANCORPORATION

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~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 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.

With the passage of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the option to delay CECL was provided until the earlier of the national health emergency being declared over or December 31, 2020. The Company elected to delay implementing CECL and continued to use the incurred loss method to calculate the allowance for loan losses as of and for the period ending June 30, 2020.

COVID-19: What the Company knows and what steps we have taken.

The outbreak of Coronavirus Disease 2019 (“COVID-19”) has and will continue to adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. The World Health Organization has declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections.

Shareholders

Dividend declaration

The Company expects to continue to maintain the payment of its annual dividend consistent with its past practices.

Communities

Offices

With the health of our employees and customers being our top concern, as of March 17, 2020, the Bank temporarily suspended branch lobby hours to the public for walk-in transactions. The Bank has since reopened all branch lobbies with the following changes:

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HILLS BANCORPORATION

• Plexiglass windows on our teller stations and reception areas

•A limit on the number of people who can be in the lobby at one time

•Transaction areas and reusable items will be frequently wiped down

•Hand sanitizing stations located at each entrance

•Floor stickers to guide social distancing while waiting in line

•Require all customers and non-customers entering lobbies to wear face masks.

Drive-thru services remain available as well as all ATM’s to complete needed transactions. Customers are also able to directly contact our bankers through the HERE by Hills Bank app and Hills Bank Online is available 24/7.

Consumers

Home Loans

With theFederal Reserve rate drops of 150 basis points in March (100 basis points of which was directly related to the effects of the virus on the economy), a surge in home loan activity has occurred, a significant portion of which is refinance related. The Bank sells most of its home loans into the secondary market and has seen a significant increase in the net gain on the sale of these loans.

The Bank is working with customers who request forbearance agreements, though this has not been a significant number or dollar amount of agreements as of June 30, 2020. The Bank has also provided short-term modifications for customers primarily through deferrals of principal only payments for three or four months. Commercial related modifications including commercial and financial and multifamily and commercial real estate mortgages were provided for 512 loans totaling $318.79 million. 1 to 4 family and consumer related modifications were provided for 626 loans totaling $74.27 million and agricultural related modifications were provided for 12 loans totaling $3.30 million.

The Bank continues to assist our customers through this difficult time in the best manner possible by providing $125.65 million of Paycheck Protection Program (PPP) loans as of June 30, 2020.

Employees

The Bank continues to promote social distancing by encouraging employees who can work remotely to do so and in other cases, departments have been dispersed to keep the team separated.

Financial - Exposures

Given the timing of the outbreak in the United States of the COVID-19 pandemic, the Company’s first quarter performance was not significantly impacted with the exception of the provision for loan losses. In the second quarter, the Company provided a significant number of PPP loans to customers as well as short-term loan modifications deferring principal and interest or principal only for three to four months. The COVID-19 pandemic represents an unprecedented challenge to the global economy in general and the financial services sector in particular. However, there is still significant uncertainty regarding the overall length of the pandemic and the aggregate impact that it will have on global and regional economies, including uncertainties regarding the potential positive effects of governmental actions taken in response to the pandemic during the first half of 2020. With so much uncertainty, it is impossible for the Bank to accurately predict the impact that the pandemic will have on the Company’s primary markets and the overall extent to which it will affect the Company’s financial condition and results of operations during the remainder of the current fiscal year. At a minimum, the actions taken by the Company to assist its customers experiencing challenges from the pandemic will likely have a material impact on the Company’s performance in 2020. Nonetheless, management believes that the Company’s current regulatory capital position is adequate to face the coming challenges.

To account for potential exposures resulting from the pandemic, the Bank has increased its allowance for loan losses for the six months ended June 30, 2020 by approximately $3.9 million. The Bank is fully prepared to make additional provisions as warranted by the COVID-19 situation.

Our credit administration is closely monitoring and analyzing the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. Based on the Company’s capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, we currently expect to be able to manage the economic risks and uncertainties associated with the pandemic and remain adequately capitalized.

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HILLS BANCORPORATION

Government Response

Congress, the FRB and the other U.S. state and federal financial regulatory agencies have taken actions to mitigate disruptions to economic activity and financial stability resulting from the COVID-19 pandemic. The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers and passed measures to provide relief from reporting loan classifications due to modifications related to the COVID-19 outbreak. The descriptions below summarize additional significant government actions taken in response to the COVID-19 pandemic. The descriptions are qualified in their entirety by reference to the particular statutory or regulatory provisions or government programs summarized.

The CARES Act

The Coronavirus Aid, Relief and Economic Security (CARES) Act was signed into law on March 27, 2020. Among other provisions, the CARES Act includes funding for the SBA to expand lending, relief from certain U.S. GAAP requirements to allow COVID-19-related loan modifications to not be categorized as troubled debt restructurings and a range of incentives to encourage deferment, forbearance or modification of consumer credit and mortgage contracts. One of the key CARES Act programs is the Paycheck Protection Program, which temporarily expands the SBA’s business loan guarantee program through August 8, 2020. Paycheck Protection Program loans are available to a broader range of entities than ordinary SBA loans, and the loan may be forgiven in an amount equal to payroll costs and certain other expenses during either an eight-week or twenty-four week “covered period.” The Bank is participating in this program as described above.

The CARES Act contains additional protections for homeowners and renters of properties with federally-backed mortgages, including a 60-day moratorium on the initiation of foreclosure proceedings beginning on March 18, 2020 and a 120-day moratorium on initiating eviction proceedings effective March 27, 2020. Borrowers of federally-backed mortgages have the right under the CARES Act to request up to 360 days of forbearance on their mortgage payments if they experience financial hardship directly or indirectly due to the coronavirus-related public health emergency.

Also pursuant to the CARES Act, the U.S. Treasury has the authority to provide loans, guarantees and other investments in support of eligible businesses, states and municipalities affected by the economic effects of COVID-19. Some of these funds have been used to support several FRB programs and facilities described below or additional programs or facilities that are established by its authority under Section 13(3) of the Federal Reserve Act and meeting certain criteria.

FRB Actions

The FRB has taken a range of actions to support the flow of credit to households and businesses. For example, on March 15, 2020, the FRB reduced the target range for the federal funds rate to 0 to 0.25% and announced that it would increase its holdings of U.S. Treasury securities and agency mortgage-backed securities and begin purchasing agency commercial mortgage-backed securities. The FRB has also encouraged depository institutions to borrow from the discount window and has lowered the primary credit rate for such borrowing by 150 basis points while extending the term of such loans up to 90 days. Reserve requirements have been reduced to zero as of March 26, 2020.

In addition, the FRB has established, or has taken steps to establish, a range of facilities and programs to support the U.S. economy and U.S. marketplace participants in response to economic disruptions associated with COVID-19. Through these facilities and programs, the FRB, relying on its authority under Section 13(3) of the Federal Reserve Act, has taken steps to directly or indirectly purchase assets from, or make loans to, U.S. companies, financial institutions, municipalities and other market participants.

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HILLS BANCORPORATION

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 Washington, Iowa. At ~~September~~June 30, ~~2019,~~2020, the Bank has nineteen full-service locations.

Net income for the ~~nine~~six month period ended ~~September~~June 30, ~~2019~~2020 was ~~$33.71~~$18.79 million compared to ~~$30.97~~$22.42 million for the same ~~nine~~six months of ~~2018, an increase~~2019, a decrease of ~~8.83%~~16.22%. The ~~$2.73~~$3.64 million ~~increase~~decrease in net income was caused by a number of factors. The principal factors in the ~~increase~~decrease in net income for the first ~~nine~~six months of ~~2019~~2020 are an increase in the provision for loan losses of $6.44 million, primarily due to the uncertainty created by the COVID-19 pandemic, and an increase in noninterest expenses of $1.69 million. This change was offset by an increase in net interest income of ~~$4.22~~$2.03 million, an increase in noninterest income of $1.60 million and a decrease in ~~the provision for loan losses of $3.18 million. These changes were offset by a decrease in noninterest income of $0.79 million, an increase in~~ income tax expense of ~~$1.75 million and an increase in noninterest expenses of $2.12~~$0.87 million.

The Company achieved a return on average assets of 1.25% and a return on average equity of ~~11.38%~~11.30% for the twelve months ended ~~September~~June 30, ~~2019,~~2020, compared to the twelve months ended ~~September~~June 30, ~~2018,~~2019, which were ~~1.20%~~1.24% and ~~11.12%~~11.48%, respectively. Dividends of ~~$0.82~~$0.89 per share were paid in January ~~2019~~2020 to ~~2,481~~2,644 shareholders. The ~~2018~~2019 dividend was ~~$0.75~~$0.82 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 ~~3.20%~~3.13% for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 compared to ~~3.24%~~3.23% for the same ~~nine~~six months of ~~2018.~~2019. Average earning assets were ~~$3.108~~$3.282 billion year to date in ~~2019~~2020 and ~~$2.891~~$3.065 billion in ~~2018.~~2019.

~~Index~~

~~HILLS BANCORPORATION~~

Highlights noted on the balance sheet as of ~~September~~June 30, ~~2019~~2020 for the Company included the following:

•Total assets were ~~$3.358~~$3.577 billion, an increase of ~~$315.27~~$276.41 million since December 31, ~~2018.~~2019.

•Cash and cash equivalents were ~~$315.13~~$368.83 million, an increase of ~~$271.83~~$126.86 million since December 31, ~~2018. Cash and cash equivalents growth included approximately $122 million of certificates of deposit and approximately $5.56 million of brokered deposits.~~2019.

•Net loans were ~~$2.628~~$2.757 billion, an increase of ~~$35.10~~$142.09 million since December 31, ~~2018.~~2019. The increase was primarily due to PPP loans provided to customers totaling $125.65 million. Loans held for sale increased ~~$22.87~~$32.12 million since December 31, ~~2018.~~2019.

•Deposits increased ~~$279.83~~$262.89 million since December 31, ~~2018.~~2019.

Reference is made to Note 7 for a discussion of fair value measurements which relate to methods used by the Company in recording assets and liabilities on its financial statements.

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Financial Condition

~~Loan demand is expected to remain steady throughout the year ending December 31, 2019 and into 2020.~~ As indicated in the table below, growth isin the loan portfolio since year end was primarily in ~~1 to 4 family residential construction~~commercial and financial, multi-family and commercial real estate loans. The significant increase in commercial and financial is due to PPP loans totaling $125.65 million being provided to customers.

The COVID-19 pandemic has created significant uncertainty regarding projecting loan demand throughout the remainder of 2020 and into 2021.

The following table sets forth the composition of the loan portfolio as of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	June 30, 2020						December 31, 2019
	Amount		Percent		Amount		Percent
	(Amounts In Thousands)						(Amounts In Thousands)
Agricultural	$	94,101	3.42	%	$	91,317	3.46	%
Commercial and financial	335,784		12.20		221,323		8.39
Real estate:
Construction, 1 to 4 family residential	78,727		2.86		80,209		3.04
Construction, land development and commercial	109,456		3.98		108,410		4.11
Mortgage, farmland	246,781		8.96		242,730		9.20
Mortgage, 1 to 4 family first liens	894,013		32.48		910,742		34.51
Mortgage, 1 to 4 family junior liens	135,863		4.94		149,227		5.65
Mortgage, multi-family	361,206		13.12		350,761		13.29
Mortgage, commercial	411,116		14.93		402,181		15.24
Loans to individuals	30,139		1.09		32,308		1.22
Obligations of state and political subdivisions	55,705		2.02		49,896		1.89
	$	2,752,891	100.00	%	$	2,639,104	100.00	%
Net unamortized fees and costs	970				933
	$	2,753,861			$	2,640,037
Less allowance for loan losses	37,620				33,760
	$	2,716,241			$	2,606,277

Page 48

September 30, 2019 December 31, 2018
Amount Percent Amount Percent
(Amounts In Thousands) (Amounts In Thousands)
Agricultural $ 91,621
3.47 % $ 92,673
3.53 %
Commercial and financial 219,362
8.32
229,501
8.73
Real estate:

Construction, 1 to 4 family residential 80,969
3.07
72,279
2.75
Construction, land development and commercial 108,662
4.12
113,807
4.33
Mortgage, farmland 237,513
9.00
236,454
9.00
Mortgage, 1 to 4 family first liens 913,206
34.62
912,059
34.71
Mortgage, 1 to 4 family junior liens 149,969
5.69
152,625
5.81
Mortgage, multi-family 350,378
13.28
352,434
13.41
Mortgage, commercial 401,615
15.22
383,314
14.58
Loans to individuals 32,613
1.24
30,072
1.14
Obligations of state and political subdivisions 52,030
1.97
52,725
2.01
$ 2,637,938
100.00 % $ 2,627,943
100.00 %
Net unamortized fees and costs 943

952

$ 2,638,881

$ 2,628,895

Less allowance for loan losses 35,570

37,810

$ 2,603,311

$ 2,591,085

Index

~~Index~~

HILLS BANCORPORATION

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 may be downgraded and the uncollectible amount charged-off or recorded as a specific allowance for losses. 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.

Page 49

Index

HILLS BANCORPORATION

The following table presents the allowance for loan losses on loans by loan category, the percentage of the allowance for each category to the total allowance, and the percentage of all loans in each category to total loans as of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018:~~2019:


	June 30, 2020										December 31, 2019
	Amount		% of Total Allowance		% of Loans to Total Loans		Amount		% of Total Allowance		% of Loans to Total Loans
	(In Thousands)						(In Thousands)
Agricultural	$	2,547	6.77	%	3.42	%	$	2,400	7.11	%	3.46	%
Commercial and financial	5,777		15.36		12.20		4,988		14.77		8.39
Real estate:
Construction, 1 to 4 family residential	1,028		2.73		2.86		1,113		3.30		3.04
Construction, land development and commercial	1,405		3.73		3.98		1,486		4.40		4.11
Mortgage, farmland	4,089		10.87		8.96		3,950		11.70		9.20
Mortgage, 1 to 4 family first liens	10,690		28.42		32.48		9,045		26.79		34.51
Mortgage, 1 to 4 family junior liens	1,592		4.23		4.94		1,593		4.72		5.65
Mortgage, multi-family	4,251		11.30		13.12		3,823		11.32		13.29
Mortgage, commercial	4,922		13.08		14.93		4,036		11.95		15.24
Loans to individuals	688		1.83		1.09		853		2.53		1.22
Obligations of state and political subdivisions	631		1.68		2.02		473		1.41		1.89
	$	37,620	100.00	%	100.00	%	$	33,760	100.00	%	100.00	%

September 30, 2019 December 31, 2018
Amount
% of Total
Allowance

% of Loans to
Total Loans
Amount
% of Total
Allowance

% of Loans to
Total Loans
(In Thousands) (In Thousands)
Agricultural $ 2,706
7.61 % 3.47 % $ 2,789
7.38 % 3.53 %
Commercial and financial 5,411
15.21
8.32
5,826
15.41
8.73
Real estate:

Construction, 1 to 4 family residential 1,329
3.74
3.07
1,297
3.43
2.75
Construction, land development and commercial 1,559
4.38
4.12
1,995
5.28
4.33
Mortgage, farmland 3,987
11.21
9.00
3,972
10.51
9.00
Mortgage, 1 to 4 family first liens 9,568
26.90
34.62
10,750
28.43
34.71
Mortgage, 1 to 4 family junior liens 1,635
4.60
5.69
1,766
4.67
5.81
Mortgage, multi-family 3,846
10.81
13.28
4,083
10.80
13.41
Mortgage, commercial 4,250
11.95
15.22
4,082
10.80
14.58
Loans to individuals 759
2.13
1.24
723
1.91
1.14
Obligations of state and political subdivisions 520
1.46
1.97
527
1.38
2.01
$ 35,570
100.00 % 100.00 % $ 37,810
100.00 % 100.00 %

The allowance for loan losses totaled ~~$35.57~~$37.62 million at ~~September~~June 30, ~~2019~~2020 compared to ~~$37.81~~$33.76 million at December 31, ~~2018.~~2019. The percentage of the allowance to outstanding loans was ~~1.35%~~1.37% and ~~1.44%~~1.28% at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, 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 ~~2019~~2020 is ~~the result of change in the composition and allocation of loans within credit quality ratings, improvements~~due to anticipated declines in the credit quality of the Bank's loan portfolio ~~decreases~~primarily due to the significant uncertainty created by the COVID-19 pandemic and increases in ~~specific allowances on loans~~qualitative factors primarily in the areas of 1 to 4 family mortgages, commercial and ~~improving qualitative factors.~~financial, multi-family and commercial mortgages also primarily due to COVID-19.

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~~June 30, ~~2019,~~2020, 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.

Page 50

Index

HILLS BANCORPORATION

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.

Investment securities available for sale held by the Company increased by ~~$4.45~~$11.15 million from December 31, ~~2018~~2019 to ~~September~~June 30, ~~2019.~~2020. The fair value of securities available for sale was ~~$4.34~~$12.53 million more than the amortized cost of such securities as of ~~September~~June 30, ~~2019.~~2020. At December 31, ~~2018,~~2019, the fair value of the securities available for sale was ~~$2.73~~$4.23 million ~~less~~more than the amortized cost of such securities.

Deposits increased ~~$279.83~~$262.89 million in the first ~~nine~~six months of ~~2019~~2020 primarily due to ~~broker deposits and rate specials on certificate~~the disbursement of ~~deposits.~~Paycheck Protection Program (PPP) funds to customers' accounts. A portion of the increase can also be attributed to the current negative economic environment. 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 ~~$138.03~~$69.13 million as of ~~September~~June 30, ~~2019~~2020 with an average rate of ~~2.22%~~0.34%. Brokered deposits were ~~$132.46~~$109.29 million as of December 31, ~~2018~~2019 with an average interest rate of ~~2.46%~~1.65%. As of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, brokered deposits were ~~5.11%~~2.36% and ~~5.47%~~4.11% of total deposits, respectively.

Federal Home Loan Bank (FHLB) borrowings were ~~$215~~$185 million as of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018.~~2019. It is expected that the FHLB funding source will be considered in the future if loan growth continues to exceed core deposit increases and the interest rates on funds borrowed from the FHLB are favorable compared to other funding alternatives.

Dividends and Equity

In January ~~2019,~~2020, Hills Bancorporation paid a dividend of ~~$7.66~~$8.32 million or ~~$0.82~~$0.89 per share. The dividend was ~~$0.75~~$0.82 per share in January ~~2018.~~2019. After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of ~~September~~June 30, ~~2019~~2020 totaled ~~$363.84~~$398.72 million. On January 1, 2015, the final rules of the Federal Reserve Board went into effect implementing in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision. The final rule also adopted changes to the agencies’ regulatory capital requirements that meet the requirements of section 171 and section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Under the BASEL III rules, the minimum capital ratios are 4% for Tier 1 Leverage Capital Ratio, 4.5% for the Common Equity Tier 1 Capital Ratio, 6% for the Tier 1 Risk-Based Capital Ratio and 8% for the Total Risk-Based Capital Ratio. ~~A new capital conservation buffer~~As of March 31, 2020, the Bank elected to use the Community Bank Leverage Ratio (CBLR) framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act. Under the CBLR framework, the Bank is ~~being phased~~required to maintain a CBLR of greater than 9%. The CARES Act reduced the minimum ratio to 8% beginning in the 2nd quarter of 2020 through December 31, 2020, increasing to 8.5% for 2021 and returning to 9% beginning January 1, ~~2016, at 0.625% of risk-weighted assets and increased each subsequent year by an additional 0.625% until reaching 2.5% on January 1, 2019.~~2022. As of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, the Company had regulatory capital in excess of the Federal Reserve’s minimum and well-capitalized definition requirements. The actual amounts and capital ratios as of ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018~~2019 are presented below (amounts in thousands):


	Actual					For Capital Adequacy Purposes	To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Ratio	Ratio
As of June 30, 2020:
Company:



Community Bank Leverage ratio	$	434,725	12.46	%	8.000	11.000
Bank:



Community Bank Leverage ratio	435,447		12.48		8.000	11.000

Page 51

Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount Ratio Ratio Ratio
As of September 30, 2019:
Company:
Total risk-based capital $ 442,360
17.89 % 8.000 % 10.000 %
Tier 1 risk-based capital 411,389
16.63
6.000
8.000
Tier 1 common equity 411,389
16.63
4.500
6.500
Leverage ratio 411,389
12.46
4.000
5.000
Bank:

Total risk-based capital 443,870
17.96
8.000
10.000
Tier 1 risk-based capital 412,915
16.71
6.000
8.000
Tier 1 common equity 412,915
16.71
4.500
6.500
Leverage ratio 412,915
12.51
4.000
5.000

Index

~~Index~~

HILLS BANCORPORATION


	Actual						For Capital Adequacy Purposes		To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Ratio		Ratio
As of December 31, 2019
Company:
Total risk-based capital	$	454,452	18.15	%	8.00	%	10.00	%
Tier 1 risk-based capital	423,122		16.90		6.00		8.00
Tier 1 common equity	423,122		16.90		4.50		6.50
Leverage ratio	423,122		12.77		4.00		5.00
Bank:
Total risk-based capital	455,440		18.20		8.00		10.00
Tier 1 risk-based capital	424,127		16.95		6.00		8.00
Tier 1 common equity	424,127		16.95		4.50		6.50
Leverage ratio	424,127		12.81		4.00		5.00

Page 52

Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount Ratio Ratio Ratio
As of December 31, 2018:
Company:
Total risk-based capital $ 414,772
17.18 % 8.00 % 10.00 %
Tier 1 risk-based capital 384,502
15.93
6.00
8.00
Tier 1 common equity 384,502
15.93
4.50
6.50
Leverage ratio 384,502
12.68
4.00
5.00
Bank:

Total risk-based capital 416,198
17.25
8.00
10.00
Tier 1 risk-based capital 385,943
16.00
6.00
8.00
Tier 1 common equity 385,943
16.00
4.50
6.50
Leverage ratio 385,943
12.73
4.00
5.00

Index

~~Index~~

HILLS BANCORPORATION

Discussion of operations for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018~~2019

Net Income Overview

Net income ~~increased $2.73~~decreased $3.64 million for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 compared to the first ~~nine~~six months of ~~2018.~~2019. Total net income was ~~$33.71~~$18.79 million in ~~2019~~2020 and ~~$30.97~~$22.42 million in the comparable period in ~~2018, an increase~~2019, a decrease of ~~8.83%~~16.22%. The changes in net income in ~~2019~~2020 from the first ~~nine~~six months of ~~2018~~2019 were primarily the result of the following:

•Net interest income increased by ~~$4.22~~$2.03 million, before provision expense. Total interest income increased by $11.55 million as a result of growth in the volume of earning assets and rising interest rates. Total interest expense increased by $7.33 million primarily due to rising interest rates increasing the costs of funding.

•The provision for loan losses ~~decreased~~increased by ~~$3.18~~$6.44 million.

•Noninterest income ~~decreased~~increased by ~~$0.79~~$1.60 million.

•Noninterest expenses increased by ~~$2.12~~$1.69 million.

•Income tax expense ~~increased~~decreased by ~~$1.75~~$0.87 million.

For the ~~nine~~six month period ended ~~September~~June 30, ~~2019~~2020 and ~~September~~June 30, ~~2018~~2019 basic earnings per share was ~~$3.61~~$2.00 and ~~$3.30,~~$2.40, respectively. Diluted earnings per share was ~~$3.61~~$2.00 for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 compared to ~~$3.30~~$2.40 for the same period in ~~2018.~~2019.

The Company’s net income is 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 $72.86 million for the first nine months of 2019 was derived from the Company’s $3.108 billion of average earning assets during that period and its tax-equivalent net interest margin of 3.20%. Average earning assets in the nine months ended September 30, 2018 were $2.891 billion and the tax-equivalent net interest margin was 3.24%. 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 $2.33 million change in income before income taxes in the nine month period ended September 30, 2019. Net interest income for the Company increased primarily as a result of growth in the volume of earning assets. The Company expects net interest compression to impact earnings for the foreseeable future with increased costs of funding in the short-term due to competition for deposits combined with the potential future interest rate decreases by the Federal Reserve Board. 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 ~~$2.628~~$2.757 billion at ~~September~~June 30, ~~2019~~.2020. 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 $4.66 million in 2020 compared to a reduction of expense of ~~$1.64 million in 2019 compared to an expense of $1.54~~$1.79 million in ~~2018.~~2019. The ~~reduction~~increase is primarily attributable to ~~a decrease in specific reserves on loans and decreases~~increases in qualitative factors ~~related~~due to ~~land development and commercial construction, multi-family real estate, commercial real estate and 1 to 4 family first lien mortgages.~~the COVID-19 pandemic's economic impact. The Company believes that the provision for loan losses may increase for the foreseeable future resulting from projected increases in the size of the Company’s loan ~~portfolio.~~portfolio and further deterioration in credit quality due to COVID-19.

The second 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 $50.19 million for the first six months of 2020 was derived from the Company’s $3.282 billion of average earning assets during that period and its tax-equivalent net interest margin of 3.13%. Average earning assets in the six months ended June 30, 2019 were $3.065 billion and the tax-equivalent net interest margin was 3.23%. 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 $1.64 million change in income before income taxes in the six month period ended June 30, 2020. Net interest income for the Company increased primarily as a result of growth in the volume of earning assets and the continued low interest rates on interest bearing deposits resulting in decreased interest expense. The Company expects net interest compression to impact earnings for the foreseeable future with increased costs of funding in the short-term due to competition for deposits combined with the interest rate decreases by the Federal Reserve Board. The Company believes growth in net interest income will be contingent on the growth of the Company’s earnings assets.

The third ~~significant~~important factor affecting the Company’s net income is ~~income tax expense. Federal and state income tax expenses were $9.52~~net gain on the sale of loans. The net gain on the sale of loans was $2.56 million and ~~$7.77~~$0.86 million for the ~~nine~~six months ended ~~September~~June 30, 2020 and 2019, ~~and 2018, respectively. Income taxes as a percentage~~respectively, an increase of ~~income before taxes were 22.02%~~196.18% for the six months ended June 30, 2020 compared to the same period in 2019. Loans originated for sale in the first sixmonths of 2020 totaled $237.42 million compared to $63.38 million in the same period in 2019, ~~and 20.05%~~an increase of 274.58%. The amount of the net gain on sale of secondary market mortgage loans in ~~2018.~~each year can vary significantly. The ~~increase~~volume of activity in ~~income taxes as a percentage~~these types of ~~income before taxes~~loans is ~~due to tax credits~~directly related to ~~investments in tax credit real estate being fully utilized. On December 22, 2017,~~ the ~~U.S. government enacted comprehensive tax legislation commonly referred~~level of interest rates and has been significantly impacted by the Federal Reserve Board's reduction of the federal funds rate to ~~as the Tax Cut and Jobs Act (the “Tax Act”)~~0.25%. The Tax Act established new tax laws that reduced the U.S. federal corporate income tax rate from 35% to 21% in 2018. The quarter ended March 31, 2019 was the first with all comparable periods on a Post-Tax Act basis, therefore the Company expects income taxes as a percentage of income before taxes to be more comparable in current and future periods than it was over the previous fiscal year.

Page 53

Index

HILLS BANCORPORATION

Discussion of operations for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018~~2019

Net Interest Income

Net interest income increased for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 compared to the comparable period in ~~2018.~~2019. The increase was as a result of growth in the average volume of earning ~~assets.~~assets and the continued low interest rates on interest bearing deposits resulting in decreased interest expense. 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~~six months of ~~2019~~2020 was ~~3.20%~~3.13% compared to ~~3.24%~~3.23% in ~~2018~~2019 for the same period. Interest expense ~~increased $7.33~~decreased $2.42 million for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 compared to the ~~nine~~six months ended ~~September~~June 30, ~~2018~~2019 primarily due to ~~increasing~~decreasing interest rates on deposits. The measure is shown on a tax-equivalent basis using a tax rate of 21% 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~~six months ended in ~~2019~~2020 compared to the comparable period in ~~2018~~2019 are shown in the following table:


					Increase (Decrease) in Net Interest Income
	Change in Average Balance		Change in Average Rate		Volume Changes		Rate Changes		Net Change
	(Amounts in Thousands)
Interest income:
Loans, net	$	68,506	(0.13)	%	$	2,801	$	(2,539)	$	262
Taxable securities	33,818		(0.20)		453		(236)		217
Nontaxable securities	6,123		(0.05)		84		(47)		37
Federal funds sold	108,521		(1.82)		1,319		(2,206)		(887)
	$	216,968			$	4,657	$	(5,028)	$	(371)

Interest expense:
Interest-bearing demand deposits	$	127,269	(0.24)	%	$	(564)	$	982	$	418
Savings deposits	(24,592)		(0.57)		536		1,941		2,477
Time deposits	56,293		0.08		(625)		(291)		(916)
FHLB borrowings	(30,000)		(0.01)		427		9		436
Interest-bearing other liabilities	(4)		(1.44)		—		—		—
	$	128,966			$	(226)	$	2,641	$	2,415
Change in net interest income					$	4,431	$	(2,387)	$	2,044

Increase (Decrease) in Net Interest Income

Change in
Average Balance

Change in
Average Rate
Volume Changes Rate Changes Net Change
(Amounts in Thousands)
Interest income:
Loans, net $ 147,468
0.24 % $ 4,993
$ 4,565
$ 9,558
Taxable securities 10,767
0.19
197
175
372
Nontaxable securities 9,418
0.14
183
195
378
Federal funds sold 49,762
0.53
659
685
1,344
$ 217,415

$ 6,032
$ 5,620
$ 11,652

Interest expense:

Interest-bearing demand deposits $ 61,508
0.30 % $ (266 ) $ (1,589 ) $ (1,855 )
Savings deposits 24,334
0.27
(150 ) (1,736 ) (1,886 )
Time deposits 124,502
0.51
(1,539 ) (2,450 ) (3,989 )
FHLB borrowings (17,422 ) (0.01 ) 388
16
404
Interest-bearing other liabilities (2 ) 0.76
—
—
—
$ 192,920

$ (1,567 ) $ (5,759 ) $ (7,326 )
Change in net interest income

$ 4,465
$ (139 ) $ 4,326

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)	2020		2019
Yield on average interest-earning assets	4.01	%	4.34	%
Rate on average interest-bearing liabilities	1.15		1.42
Net interest spread	2.86	%	2.92	%
Effect of noninterest-bearing funds	0.27		0.31
Net interest margin (tax equivalent interest income divided by average interest-earning assets)	3.13	%	3.23	%

Page 54

(Tax Equivalent Basis) 2019 2018
Yield on average interest-earning assets 4.32 % 4.11 %
Rate on average interest-bearing liabilities 1.44
1.12
Net interest spread 2.88 % 2.99 %
Effect of noninterest-bearing funds 0.32
0.25
Net interest margin (tax equivalent interest income divided by average interest-earning assets) 3.20 % 3.24 %

Index

~~Index~~

HILLS BANCORPORATION

Discussion of operations for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018~~2019

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 ~~six~~five times during the first ~~nine~~six months of ~~2019.~~2020. The target rate decreased to ~~2.00%~~0.25% as of ~~September~~June 30, ~~2019.~~2020. 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~~June 30, ~~2019,~~2020, the rate indexes for the one, three and five year indexes were ~~1.75%~~0.16%, ~~1.56%~~0.18% and ~~1.55%~~0.29%, respectively. The one year index decreased ~~32.43%~~92.67% from ~~2.59%~~1.92% at ~~September~~June 30, ~~2018,~~2019, the three year index decreased ~~45.83%~~89.47% and the five year index decreased ~~42.28%~~83.52%. The three year index was ~~2.88%~~1.71% and the five year index was ~~2.94%~~1.76% at ~~September~~June 30, ~~2018.~~2019. The targeted federal funds rate was ~~2.00%~~0.25% and ~~2.25%~~2.50% at ~~September~~June 30, ~~2019~~2020 and ~~2018,~~2019, respectively. The Company anticipates short term and long term rates in the indexes to remain consistent for ~~2019.~~2020.

Provision for Loan Losses

The provision for loan losses was an expense of $4.66 million for the six months ended June 30, 2020 compared to a reduction of expense of ~~$1.64 million for the nine months ended September 30, 2019 compared to an expense of $1.54~~$1.79 million in ~~2018, a reduction~~2019, an increase of expense of ~~$3.18 million.~~$6.44 million, which resulted in an overall increase to the allowance of $3.86 million since year end. In the first six months of 2020, there was an increase of $3.62 million due to changes in average balances, composition of loans outstanding and changes in qualitative factors and a $0.24 million increase in the amount allocated to the allowance due to changes in credit quality. 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 historically higher credit risks. The ~~decrease~~increase in expense in ~~2019~~2020 is primarily attributable to significant uncertainties with respect to the ~~result of a change in~~qualitative factors considered by management due to the ~~composition and allocation of loans within credit quality ratings~~COVID-19 pandemic's economic impact as compared to ~~September~~June 30, ~~2018 and improvements in the credit quality of the Bank's loan portfolio.~~2019.

The allowance for loan losses decreased $2.24 million during the first nine months of 2019 as compared to December 31, 2018. In the first nine months of 2019, there was a decrease of $1.44 million due to changes in average balances and composition of loans outstanding and a $0.80 million decrease in the amount allocated to the allowance due to improvements in credit quality.

The allowance for loan losses balance is affected by charge-offs, net of recoveries, for the periods presented. For the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018,~~2019, recoveries were ~~$1.36~~$0.81 million and ~~$1.78~~$0.85 million, respectively; and charge-offs were ~~$1.96~~$1.61 million in ~~2019~~2020 and ~~$1.71~~$1.22 million in ~~2018.~~2019. The allowance for loan losses totaled ~~$35.57~~$37.62 million at ~~September~~June 30, ~~2019~~2020 compared to ~~$37.81~~$33.76 million at December 31, ~~2018.~~2019. The allowance represented ~~1.35%~~1.37% and ~~1.44%~~1.28% of loans held for investment at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018.~~2019.

Noninterest Income

The following table sets forth the various categories of noninterest income for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018.~~2019.

Nine Months Ended September 30,
2019 2018 $ Change % Change
(Amounts in thousands)
Net gain on sale of loans $ 2,060
$ 1,227
$ 833
67.89 %
Trust fees 7,107
7,753
(646 ) (8.33 )
Service charges and fees 7,618
7,475
143
1.91
Other noninterest income 982
2,075
(1,093 ) (52.67 )
Loss on sale of investment securities (28 ) —
(28 ) —
$ 17,739
$ 18,530
$ (791 ) (4.27 )


	Six Months Ended June 30,
	2020		2019		$ Change		% Change
	(Amounts in thousands)
Net gain on sale of loans	$	2,556	$	863	$	1,693	196.18	%
Trust fees	4,956		4,680		276		5.90
Service charges and fees	4,791		4,923		(132)		(2.68)
Other noninterest income	385		687		(302)		(43.96)
Gain (loss) on sale of investment securities	10		(52)		62		119.23
	$	12,698	$	11,101	$	1,597	14.39

Loans originated for sale in the first ~~nine~~six months of ~~2019~~2020 totaled ~~$201.51~~$237.42 million compared to ~~$110.69~~$63.38 million in the same period in ~~2018,~~2019, an increase of ~~82.05%~~274.58%. In the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018,~~2019, the net gain on sale of loans was ~~$2.06~~$2.56 million and ~~$1.23~~$0.86 million, respectively. The amount of the net gain on sale of secondary market mortgage loans in each year can

~~Index~~

~~HILLS BANCORPORATION~~

vary significantly. The volume of activity in these types of loans is directly related to the level of interest ~~rates.~~rates and has been significantly impacted by the Federal Reserve Board's reduction of the federal funds rate to 0.25%. 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.

Page 55

Index

~~Other noninterest income decreased $1.09 million in~~

HILLS BANCORPORATION

Discussion of operations for the ~~nine~~six months ended ~~September~~June 30, 2020 and 2019 ~~compared to September 30, 2018 primarily due to the sale of the insurance department in August 2018 for a gain of $885,000.~~

Other noninterest income categories experienced marginal period-to-period fluctuations for the ~~nine~~six months ended ~~September~~June 30, ~~2019.~~

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~~HILLS BANCORPORATION~~

2020.

~~Discussion of operations for the nine months ended September 30, 2019 and 2018~~

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018.~~2019.


	Six Months Ended June 30,
	2020		2019		$ Change		% Change
	(Amounts in thousands)
Salaries and employee benefits	$	19,710	$	18,052	$	1,658	9.18	%
Occupancy	2,181		2,288		(107)		(4.68)
Furniture and equipment	3,750		3,337		413		12.38
Office supplies and postage	908		901		7		0.78
Advertising and business development	1,139		1,193		(54)		(4.53)
Outside services	5,202		5,095		107		2.10
FDIC insurance assessment	394		404		(10)		(2.48)
Other noninterest expense	815		1,139		(324)		(28.45)
	$	34,099	$	32,409	$	1,690	5.21

Nine Months Ended September 30,
2019 2018 $ Change % Change
(Amounts in thousands)
Salaries and employee benefits $ 27,310
$ 25,718
$ 1,592
6.19 %
Occupancy 3,274
3,331
(57 ) (1.71 )
Furniture and equipment 5,036
4,657
379
8.14
Office supplies and postage 1,370
1,327
43
3.24
Advertising and business development 1,800
1,821
(21 ) (1.15 )
Outside services 7,824
7,692
132
1.72
FDIC insurance assessment 612
657
(45 ) (6.85 )
Other noninterest expense 1,787
1,688
99
5.86
$ 49,013
$ 46,891
$ 2,122
4.53

In the ~~nine~~six months ended ~~September~~June 30, ~~2019~~2020 and ~~2018,~~2019, salaries and employee benefits expense increased ~~$1.59~~$1.66 million. The increase is primarily the result of annual salary adjustments and hiring of additional employees to staff growth.

Other noninterest expense categories experienced marginal period-to-period fluctuations for the ~~nine~~six months ended ~~September~~June 30, ~~2019.~~

2020.

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HILLS BANCORPORATION

Discussion of operations for the three months ended ~~September~~June 30, ~~2019~~2020 and ~~2018~~2019

Net Income Overview

Net income increased ~~$1.23~~$0.49 million for the three months ended ~~September~~June 30, ~~2019~~2020 compared to the same period in ~~2018.~~2019. Total net income was ~~$11.28~~$11.71 million in ~~2019~~2020 and ~~$10.05~~$11.22 million in the comparable period in ~~2018,~~2019, an increase of ~~12.26%~~4.38%. For the three month period ended ~~September~~June 30, ~~2019~~2020 and ~~September~~June 30, ~~2018~~2019 basic earnings per share was ~~$1.21~~$1.25 and ~~$1.07,~~$1.20, respectively. Diluted earnings per share was ~~$1.21~~$1.25 for the three months ended ~~September~~June 30, ~~2019~~2020 compared to ~~$1.07~~$1.20 for the same period in ~~2018.~~

~~Index~~

~~HILLS BANCORPORATION~~

2019.

~~Discussion of operations for the three months ended September 30, 2019 and 2018~~

Net Interest Income

Net interest income increased for the three months ended ~~September~~June 30, ~~2019~~2020 compared to the comparable period in ~~2018.~~2019. The increase was primarily the result of growth in the volume of earning ~~assets.~~assets and the continued low interest rates on interest bearing deposits resulting in decreased interest expense. 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. Interest expense ~~increased $2.38~~decreased $2.20 million for the three months ended ~~September~~June 30, ~~2019~~2020 compared to the three months ended ~~September~~June 30, ~~2018~~2019 primarily due to ~~increasing~~decreasing interest rates on ~~deposits.The~~deposits. 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~~June 30, ~~2019~~2020 was ~~3.13%~~3.10% compared to ~~3.27%~~3.20% in ~~2018~~2019 for the same period. The measure is shown on a tax-equivalent basis using a tax rate of 21% 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 ~~2019~~2020 compared to the comparable period in ~~2018~~2019 are shown in the following table:


					Increase (Decrease) in Net Interest Income
	Change in Average Balance		Change in Average Rate		Volume Changes		Rate Changes		Net Change
	(Amounts in Thousands)
Interest income:
Loans, net	$	118,104	(0.21)	%	$	2,119	$	(2,180)	$	(61)
Taxable securities	39,856		(0.31)		256		(162)		94
Nontaxable securities	6,202		(0.05)		42		(26)		16
Federal funds sold	96,841		(2.31)		586		(1,620)		(1,034)
	$	261,003			$	3,003	$	(3,988)	$	(985)

Interest expense:
Interest-bearing demand deposits	$	150,573	(0.40)	%	$	(333)	$	845	$	512
Savings deposits	(25,978)		(0.75)		361		1,294		1,655
Time deposits	42,366		(0.02)		(226)		31		(195)
FHLB borrowings	(30,000)		(0.02)		222		9		231
Interest-bearing other liabilities	(4)		(2.34)		—		—		—
	$	136,957			$	24	$	2,179	$	2,203
Change in net interest income					$	3,027	$	(1,809)	$	1,218

Increase (Decrease) in Net Interest Income

Change in
Average Balance

Change in
Average Rate
Volume Changes Rate Changes Net Change
(Amounts in Thousands)
Interest income:
Loans, net $ 116,080
0.20 % $ 1,388
$ 1,201
$ 2,589
Taxable securities 10,355
0.03
78
(11 ) 67
Nontaxable securities 5,315
0.08
36
37
73
Federal funds sold 148,587
0.18
747
111
858
$ 280,337

$ 2,249
$ 1,338
$ 3,587

Interest expense:

Interest-bearing demand deposits $ 114,140
0.27 % $ (185 ) $ (492 ) $ (677 )
Savings deposits 2,919
0.12
11
(273 ) (262 )
Time deposits 134,439
0.48
(604 ) (835 ) (1,439 )
FHLB borrowings 3
0.01
—
(5 ) (5 )
Interest-bearing other liabilities (3 ) (0.09 ) —
—
—
$ 251,498
$ (778 ) $ (1,605 ) $ (2,383 )
Change in net interest income

$ 1,471
$ (267 ) $ 1,204

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HILLS BANCORPORATION

Discussion of operations for the three months ended June 30, 2020 and 2019

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


(Tax Equivalent Basis)	2020		2019
Yield on average interest-earning assets	3.89	%	4.34	%
Rate on average interest-bearing liabilities	1.03		1.45
Net interest spread	2.86	%	2.89	%
Effect of noninterest-bearing funds	0.24		0.31
Net interest margin (tax equivalent interest income divided by average interest-earning assets)	3.10	%	3.20	%

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(Tax Equivalent Basis) 2019 2018
Yield on average interest-earning assets 4.28 % 4.20 %
Rate on average interest-bearing liabilities 1.47
1.21
Net interest spread 2.81 % 2.99 %
Effect of noninterest-bearing funds 0.32
0.28
Net interest margin (tax equivalent interest income divided by average interest-earning assets) 3.13 % 3.27 %

Index

~~Index~~

HILLS BANCORPORATION

Discussion of operations for the three months ended ~~September~~June 30, ~~2019~~2020 and ~~2018~~2019

Provision for Loan Losses

The provision for loan losses was an expense of ~~$0.14~~$0.01 million for the three months ended ~~September~~June 30, ~~2019~~2020 compared to a reduction of expense of $0.54 million in 2019, an expense increase of ~~$1.59 million in 2018, an expense decrease of $1.45~~$0.55 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 ~~2019~~2020 is the result of changes in the composition and allocation of loans within credit quality ratings as compared to ~~September~~June 30, ~~2018~~2019 and a reduction in specific reserves as of ~~September~~June 30, ~~2019~~2020 as compared to ~~September~~June 30, ~~2018.~~2019.

The allowance for loan losses decreased ~~$0.08~~$0.72 million during the three months ended ~~September~~June 30, ~~2019~~2020 compared to ~~September 30, 2018.~~March 31, 2020. In the three months ended ~~September~~June 30, ~~2019,~~2020, there was a ~~$0.08~~$0.68 million decrease in the amount allocated to the allowance due to credit quality and ~~no material change~~a $0.04 decrease due to the composition of loans outstanding.

The allowance for loan losses balance is affected by charge-offs, net of recoveries, for the periods presented. For the three months ended ~~September~~June 30, ~~2019~~2020 and ~~2018,~~2019, recoveries were ~~$0.51~~$0.44 million and ~~$0.80~~$0.41 million, respectively; and charge-offs were $1.17 million in 2020 and $0.74 million in ~~2019 and $0.89 million in 2018.~~2019. The allowance for loan losses totaled ~~$35.57~~$37.62 million at ~~September~~June 30, ~~2019~~2020 compared to ~~$37.81~~$33.76 million at December 31, ~~2018.~~2019. The allowance represented ~~1.35%~~1.37% and ~~1.44%~~1.28% of loans held for investment at ~~September~~June 30, ~~2019~~2020 and December 31, ~~2018,~~2019, respectively.

Noninterest Income

The following table sets forth the various categories of noninterest income for the three months ended ~~September~~June 30, ~~2019~~2020 and ~~2018.~~2019.

Three Months Ended September 30,
2019 2018 $ Change % Change
(Amounts in thousands)
Net gain on sale of loans $ 1,197
$ 453
$ 744
164.24 %
Trust fees 2,427
2,105
322
15.30
Service charges and fees 2,695
2,839
(144 ) (5.07 )
Other noninterest income 295
1,271
(976 ) (76.79 )
Gain on sale of investment securities 24
—
24
—
$ 6,638
$ 6,668
$ (30 ) (0.45 )


	Three Months Ended June 30,
	2020		2019		$ Change		% Change
	(Amounts in thousands)
Net gain on sale of loans	$	1,898	$	577	$	1,321	228.94	%
Trust fees	2,386		2,428		(42)		(1.73)
Service charges and fees	2,262		2,648		(386)		(14.58)
Other noninterest income	(15)		250		(265)		(106.00)
(Loss) on sale of investment securities	—		(52)		52		—
	$	6,531	$	5,851	$	680	11.62

In the three months ended ~~September~~June 30, ~~2019~~2020 and ~~2018,~~2019, the net gain on sale of loans was ~~$1.20~~$1.90 million and ~~$0.45~~$0.58 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.~~rates and has been significantly impacted by the Federal Reserve Board's reduction of the federal funds rate to 0.25%.. 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.

Other noninterest income decreased $0.98 million in the three months ended September 30, 2019 compared to September 30, 2018 primarily due to the sale of the insurance department in August 2018 for a gain of $885,000.

Other noninterest income categories experienced marginal period-to-period fluctuations for the three months ended ~~September~~June 30, ~~2019.~~2020.

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HILLS BANCORPORATION

Discussion of operations for the three months ended ~~September~~June 30, ~~2019~~2020 and ~~2018~~2019

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the three months ended ~~September~~June 30, ~~2019~~2020 and ~~2018.~~2019.

Three Months Ended
September 30,
2019 2018 $ Change % Change
(Amounts in thousands)
Salaries and employee benefits $ 9,258
$ 8,611
$ 647
7.51 %
Occupancy 986
1,208
(222 ) (18.38 )
Furniture and equipment 1,699
1,693
6
0.35
Office supplies and postage 469
432
37
8.56
Advertising and business development 607
584
23
3.94
Outside services 2,729
2,767
(38 ) (1.37 )
FDIC insurance assessment 208
226
(18 ) (7.96 )
Other noninterest expense 648
434
214
49.31
$ 16,604
$ 15,955
$ 649
4.07


	Three Months Ended June 30,
	2020		2019		$ Change		% Change
	(Amounts in thousands)
Salaries and employee benefits	$	10,126	$	9,330	$	796	8.53	%
Occupancy	1,029		1,102		(73)		(6.62)
Furniture and equipment	1,969		1,664		305		18.33
Office supplies and postage	405		442		(37)		(8.37)
Advertising and business development	380		555		(175)		(31.53)
Outside services	2,517		2,523		(6)		(0.24)
FDIC insurance assessment	214		195		19		9.74
Other noninterest expense	232		549		(317)		(57.74)
	$	16,872	$	16,360	$	512	3.13

In the three months ended ~~September~~June 30, ~~2019~~2020 and ~~2018,~~2019, salaries and employee benefits expense increased ~~$0.65~~$0.80 million. The increase is primarily the result of annual salary adjustments and hiring of additional employees to staff branch growth.

Other noninterest expense categories experienced marginal period-to-period fluctuations for the three months ended ~~September~~June 30, ~~2019.~~2020.

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HILLS BANCORPORATION

Income Taxes

Federal and state income tax expenses were ~~$3.30~~$5.35 million and ~~$2.59~~$6.22 million for the ~~three~~six months ended ~~September~~June 30, 2020 and 2019, ~~and 2018,~~ respectively. The decrease in income taxes compared to 2019 is a result of lower net income primarily attributable to the increase in the provision for loan losses for the six months ended June 30, 2020. Income taxes as a percentage of income before taxes were ~~22.65%~~22.16% in ~~2019~~2020 and ~~20.49%~~21.70% in 2018. On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cut and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that affects 2017, including, but not limited to, accelerated depreciation that will allow for full expensing of qualified property. The Tax Act also established new tax laws that reduced the U.S. federal corporate income tax rate from 35% to 21% in 2018. The quarter ended March 31, 2019 was the first with all comparable periods on a Post-Tax Act basis, therefore the Company expects income taxes as a percentage of income before taxes to be more comparable in current and future periods than it was over the previous fiscal year.

2019.

~~Index~~

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HILLS BANCORPORATION

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 ~~9.63%~~10.24% of the Company’s total assets at ~~September~~June 30, ~~2019~~2020 compared to ~~10.48%~~10.76% at December 31, ~~2018.~~2019.

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~~June 30, ~~2019,~~2020, the Company had borrowed ~~$215.00~~$185.00 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 ~~$693.89~~$716.06 million at ~~September~~June 30, ~~2019.~~2020.

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 ~~$472.91~~$495.45 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~~June 30, ~~2019.~~2020.

As of ~~September~~June 30, ~~2019,~~2020, investment securities with a carrying value of ~~$12.92~~$13.79 million were pledged to collateralize public and trust deposits, derivative financial instruments, and other borrowings. As of December 31, ~~2018,~~2019, investment securities with a carrying value of ~~$9.78~~$12.93 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, ~~2018.~~2019.



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 indicates the amount of 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.

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.

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HILLS BANCORPORATION

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.

The Bank's interest rate risk, as monitored by management, has ~~not changed materially~~increased from December 31, ~~2018.~~2019 due to the significant Federal Reserve rate cuts in the first quarter of 2020.



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~~six months ended ~~September~~June 30, ~~2019~~2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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 conditions, or results of operations.

On April 10, 2019, Hills Bank was sued in a class action ~~lawsuit.~~lawsuit in the Iowa District Court for Johnson County. The lawsuit seeks class action status for customers who had paid overdraft fees on debit card transactions that were authorized into a positive account, but settled into a negative account. Plaintiff contends that these overdraft fees breached the terms of Hills Bank’s account documents. Plaintiff seeks compensatory and punitive damages for breach of contract. The Bank disputes the merits of Plaintiff’s ~~claims~~claims. The parties are negotiating a class-wide settlement and ~~filed~~expect to reach a ~~motion to dismiss the case,~~final agreement in 2020 upon which the ~~Court denied.~~settlement will be recorded in the Company's financial statements. At this stage of the proceedings, ~~it is not possible for~~ management of the Bank ~~to determine the probability of an~~does not believe that any adverse outcome or ~~reasonably estimate~~potential loss will have a material impact on the ~~amount of any potential loss.~~Company's financial statement when taken as a whole.



Item 1A.			Risk Factors

~~There~~Except as otherwise provided below, there have been no material changes from the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, ~~2018.~~2019.

The ongoing COVID-19 pandemic and measures intended to prevent its spread could have a material adverse effect on our business, results of operations and financial condition, and such effects will depend on future developments, which are highly uncertain and are difficult to predict.

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In December 2019, a novel coronavirus (COVID-19) was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. On March 12, 2020, the President of the United States declared the COVID-19 outbreak in the United States a national emergency. The COVID-19 pandemic has caused significant economic dislocation in the United States as many state and local governments ordered non-essential businesses to close and residents to shelter in place at home. This has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. Since the COVID-19 outbreak, more than 48 million people have filed claims for unemployment, and stock markets have declined in value and, in particular, bank stocks have significantly declined in value. In response to the COVID-19 outbreak, the Federal Reserve Board has reduced the benchmark fed funds rate to a target range of 0% to 0.25%, and the yields on 10 and 30-year treasury notes have declined to historic lows. The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers and recently passed legislation to provide relief from reporting loan classifications due to modifications related to the COVID-19 outbreak.

Finally, the spread of the coronavirus has caused the Company to modify its business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. The Company may take further actions as may be required by government authorities or that it determines are in the best interests of employees, customers and business partners.There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus or will otherwise be satisfactory to government authorities. In addition, the success of the Company’s operations substantially depends on the management skills of its executive officers and directors, many of whom have held officer and director positions with the Company for many years. The unanticipated loss or unavailability of key employees due to the outbreak could harm our ability to operate our business or execute our business strategy.

Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 outbreak on our business.The United States government has taken steps to attempt to mitigate some of the more severe anticipated economic effects of the virus, including the passage of the CARES Act, but there can be no assurance that such steps will be effective or achieve their desired results in a timely fashion. The extent of such impact from the COVID-19 outbreak and related mitigation efforts will depend on future developments, which are highly uncertain, including but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. As the result, the Company could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

•demand for our products and services may decline, making it difficult to grow assets and income;

•if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;

•collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;

•our allowance for loan losses may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;

•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;

•as the result of the decline in the Federal Reserve Board’s target federal funds rate, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;

•a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of our quarterly cash dividend;

•we rely on third party vendors for certain services and the unavailability of a critical service due to the COVID-19 outbreak could have an adverse effect on us; and

•Federal Deposit Insurance Corporation premiums may increase if the agency experiences additional resolution costs.

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Any one or a combination of the factors identified above could negatively impact our business, financial condition and results of operations and prospects. Even after the COVID-19 outbreak has subsided, the Company may continue to experience materially adverse impacts to our business as a result of the virus’s global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future.

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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~~six months ended ~~September~~June 30, ~~2019:~~2020:

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)
July 1 to July 31 55
$ 63.50
55
297,669
August 1 to August 31 1,430
64.49
1,430
296,239
September 1 to September 30 6,724
64.50
6,724
289,515
Total 8,209
$ 64.49
8,209
289,515


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)
April 1 to April 30	5,523	$	66.00	5,523	209,593
May 1 to May 31	3,696	65.98		3,696	205,897
June 1 to June 30	4,500	60.00		4,500	201,397
Total	13,719	$	64.03	13,719	201,397

(1) On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to 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, ~~2020.~~2021. 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.

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Item 3.			Defaults upon Senior Securities

Hills Bancorporation has no senior securities.



Item 4.			Mine Safety Disclosure

Not applicable.



Item 5.			Other Information

None.

~~Index~~

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Item 6.			Exhibits



3.1			Restated Articles of Incorporation, incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q Filed with the Commission on May 6, 2015.
3.2			Amended and Restated Bylaws of Hills Bancorporation, incorporated by reference to Exhibit 3.2 to the Company's Form 10-Q Filed with the Commission on May 6, 2019.
314.1			Description of Registered Securities, incorporated by reference to Exhibit 4.1 to the Company's Form 10-K filed with the Commission on March 6, 2020.
10.1			Stock Option and Incentive Plan incorporate d by reference to Exhibit 10.1 to the Company's Form 10-Q filed with the Commis sion on May 4, 2020 .
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), (2)
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.


~~(2)~~	~~The instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document.~~

(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.

(2)The instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document.

~~Index~~

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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 4 2019~~August 5, 2020	By: /s/ Dwight O. Seegmiller
		Dwight O. Seegmiller, Director, President and Chief Executive Officer

Date:	~~November 4 2019~~August 5, 2020	By: /s/ Shari DeMaris
		Shari DeMaris, Secretary, Treasurer and Chief Accounting Officer

~~Index~~Page 69

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HILLS BANCORPORATION

QUARTERLY REPORT OF FORM 10-Q FOR THE

QUARTER ENDED ~~SEPTEMBER~~JUNE 30, ~~2019~~2020


Exhibit Number	Description	Page Number In The Sequential Numbering System June 30, 2020 Form 10-Q

31	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002	71-72

32	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002	73

Exhibit
Number
Description
Page Number In The Sequential
Numbering System
September 30, 2019 Form 10-Q

31
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
63-64

32
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002
65

Page 6270



(State or other jurisdiction of incorporation or organization)			I.R.S. Employer Identification No.
Iowa			42-1208067



		Page
		Number

Item 1.	Financial Statements

	Consolidated balance sheets, ~~September 30, 2019~~June 3 0 , 2020 (unaudited) and December 31, ~~2018~~2019	4
	Consolidated statements of income (unaudited) for three and ~~nine~~six months ended ~~September~~June 30 , 2020 and 2019 ~~and 2018~~	5
	Consolidated statements of comprehensive income (unaudited) for three and ~~nine~~six months ended ~~September~~June 30 , 2020 and 2019 ~~and 2018~~	6
	Consolidated statements of stockholders' equity (unaudited) for three and ~~nine~~six months ended ~~September~~June 30 , 2020 and 2019 ~~and 2018~~	7
	Consolidated statements of cash flows (unaudited) for ~~nine~~six months ended ~~September~~June 30 , 2020 and 2019 ~~and 2018~~	9
	Notes to consolidated financial statements (condensed)	11

Item 2.	Management Discussion and Analysis of Financial Condition and Results of Operations	41

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	5762

Item 4.	Controls and Procedures	5863

	Part II
	OTHER INFORMATION

Item 1.	Legal proceedings	5863

Item 1A.	Risk factors	5863

Item 2.	Unregistered sales of equity securities and use of proceeds	5966

Item 3.	Defaults upon senior securities	5967

Item 4.	Mine safety disclosures	5967

Item 5.	Other information	5967

Item 6.	Exhibits	6068

	Signatures	6169

	Exhibits Index	6270


	Nine Months Ended September 30,							Six Months Ended June 30,
	2019			2018				2020		2019
Cash Flows from Operating Activities							Cash Flows from Operating Activities
Net income	$	33,705		$	30,971		Net income	$	18,786	$	22,423
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Adjustments to reconcile net income to net cash and cash equivalents (used in) provided by operating activities:							Adjustments to reconcile net income to net cash and cash equivalents (used in) provided by operating activities:
Depreciation	2,542			2,463			Depreciation	1,749		1,695
Provision for loan losses	(1,642		)	1,539			Provision for loan losses	4,657		(1,786)
Net loss on sale of investment securities available for sale	28			—
Net (gain) loss on sale of investment securities available for sale							Net (gain) loss on sale of investment securities available for sale	(10)		52
Forfeiture of common stock	(262		)	(140		)	Forfeiture of common stock	(52)		(254)
Share-based compensation	7			—			Share-based compensation	12		1
Compensation expensed through issuance of common stock	348			387			Compensation expensed through issuance of common stock	162		253
Provision for deferred income taxes	484			(379		)	Provision for deferred income taxes	(996)		454
Net (gain) loss on sale of other real estate owned and other repossessed assets	(11		)	3
Net gain on sale of other real estate owned and other repossessed assets							Net gain on sale of other real estate owned and other repossessed assets	—		(11)
Increase in accrued interest receivable	(1,718		)	(1,938		)	Increase in accrued interest receivable	(155)		(1,333)
Amortization of premium on investment securities, net	303			370			Amortization of premium on investment securities, net	372		194
Increase in other assets	(1,763		)	(2,120		)
Decrease (increase) in other assets							Decrease (increase) in other assets	1,705		(303)
Amortization of operating lease right-of-use assets	265			—			Amortization of operating lease right-of-use assets	102		177
Decrease in accrued interest payable and other liabilities	(40		)	(1,358		)	Decrease in accrued interest payable and other liabilities	(4,180)		(1,140)

Loans originated for sale	(201,514		)	(110,694		)	Loans originated for sale	(237,416)		(63,382)
Proceeds on sales of loans	180,701			113,680			Proceeds on sales of loans	207,850		53,602
Net gain on sales of loans	(2,060		)	(1,227		)	Net gain on sales of loans	(2,556)		(863)
Net cash and cash equivalents provided by operating activities	$	9,373		$	31,557
Net cash and cash equivalents (used in) provided by operating activities							Net cash and cash equivalents (used in) provided by operating activities	$	(9,970)	$	9,779

Cash Flows from Investing Activities							Cash Flows from Investing Activities
Proceeds from maturities of investment securities available for sale	$	51,275		$	51,224		Proceeds from maturities of investment securities available for sale	$	48,980	$	48,028
Proceeds from sales of investment securities available for sale	12,467			—			Proceeds from sales of investment securities available for sale	313		4,881
Purchases of investment securities available for sale	(61,544		)	(59,757		)	Purchases of investment securities available for sale	(52,843)		(35,771)
Loans made to customers, net of collections	(11,296		)	(96,159		)	Loans made to customers, net of collections	(114,621)		(11,095)
Proceeds on sale of other real estate owned and other repossessed assets	63			59			Proceeds on sale of other real estate owned and other repossessed assets	—		62
Purchases of property and equipment	(1,637		)	(2,088		)	Purchases of property and equipment	(919)		(802)
Net changes from tax credit real estate investment	777			912			Net changes from tax credit real estate investment	732		515
Net cash and cash equivalents used in investing activities	$	(9,895	)	$	(105,809	)
Net cash and cash equivalents (used in) provided by investing activities							Net cash and cash equivalents (used in) provided by investing activities	$	(118,358)	$	5,818

Cash Flows from Financing Activities							Cash Flows from Financing Activities
Net increase in deposits	$	279,834		$	200,187		Net increase in deposits	$	262,885	$	198,077
Net decrease in FHLB borrowings	—			(80,000		)

Issuance of common stock, net of costs	5,026			4,713			Issuance of common stock, net of costs	5,844		5,026

Purchase of treasury stock	(5,177		)	(5,589		)	Purchase of treasury stock	(5,416)		(4,647)
Proceeds from the issuance of common stock through the employee stock purchase plan	325			313			Proceeds from the issuance of common stock through the employee stock purchase plan	200		223
Dividends paid	(7,657		)	(7,002		)	Dividends paid	(8,325)		(7,657)
Net cash and cash equivalents provided by financing activities	$	272,351		$	112,622		Net cash and cash equivalents provided by financing activities	$	255,188	$	191,022

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

	Nine Months Ended September 30,					Six Months Ended June 30,
	2019		2018			2020		2019
Increase in cash and cash equivalents	$	271,829	$	38,370	Increase in cash and cash equivalents	$	126,860	$	206,619
Cash and cash equivalents:					Cash and cash equivalents:
Beginning of period	43,305		154,353		Beginning of period	241,965		43,305
End of period	$	315,134	$	192,723	End of period	$	368,825	$	249,924

Supplemental Disclosures					Supplemental Disclosures
Cash payments for:					Cash payments for:
Interest paid to depositors	$	20,639	$	13,270	Interest paid to depositors	$	12,058	$	13,275
Interest paid on other obligations	4,778		5,182		Interest paid on other obligations	2,730		3,166
Income taxes paid	8,044		7,188		Income taxes paid	4,275		4,909

Noncash activities:					Noncash activities:
Increase in maximum cash obligation related to ESOP shares	$	2,432	$	4,285
(Decrease)/increase in maximum cash obligation related to ESOP shares					(Decrease)/increase in maximum cash obligation related to ESOP shares	$	(6,497)	$	1,355
Transfers to other real estate owned	712		65		Transfers to other real estate owned	—		51

Right-of-use assets obtained in exchange for operating lease obligations	3,581		—		Right-of-use assets obtained in exchange for operating lease obligations	—		3,581


	Amortized Cost		Fair Value
Due in one year or less	$	49,005	$	49,249
Due after one year through five years	213,618		221,496
Due after five years through ten years	76,762		80,824
Due over ten years	14,539		14,883
Total	$	353,924	$	366,452


	Three Months Ended September 30,				Nine Months Ended September 30,						Three Months Ended June 30,						Six Months Ended June 30,
	2019		2018		2019			2018			2020		2019		2020		2019
Interest income:										Interest income:
Loans, including fees	$	30,857	$	28,280	$	90,825		$	81,276	Loans, including fees	$	30,332	$	30,395	$	60,225	$	59,968
Investment securities:										Investment securities:
Taxable	825		758		2,375			2,003		Taxable	883		792		1,767		1,550
Nontaxable	918		862		2,898			2,617		Nontaxable	971		955		2,008		1,980
Federal funds sold	1,369		511		2,954			1,610		Federal funds sold	60		1,094		698		1,585
Total interest income	$	33,969	$	30,411	$	99,052		$	87,506	Total interest income	$	32,246	$	33,236	$	64,698	$	65,083
Interest expense:										Interest expense:
Deposits	$	7,662	$	5,284	$	21,418		$	13,688	Deposits	$	5,285	$	7,257	$	11,777	$	13,756
FHLB borrowings	1,612		1,607		4,778			5,182		FHLB borrowings	1,360		1,591		2,730		3,166
Total interest expense	$	9,274	$	6,891	$	26,196		$	18,870	Total interest expense	$	6,645	$	8,848	$	14,507	$	16,922
Net interest income	$	24,695	$	23,520	$	72,856		$	68,636	Net interest income	$	25,601	$	24,388	$	50,191	$	48,161
Provision for loan losses	144		1,593		(1,642		)	1,539		Provision for loan losses	8		(540)		4,657		(1,786)
Net interest income after provision for loan losses	$	24,551	$	21,927	$	74,498		$	67,097	Net interest income after provision for loan losses	$	25,593	$	24,928	$	45,534	$	49,947
Noninterest income:										Noninterest income:
Net gain on sale of loans	$	1,197	$	453	$	2,060		$	1,227	Net gain on sale of loans	$	1,898	$	577	$	2,556	$	863
Trust fees	2,427		2,105		7,107			7,753		Trust fees	2,386		2,428		4,956		4,680
Service charges and fees	2,695		2,839		7,618			7,475		Service charges and fees	2,262		2,648		4,791		4,923
Other noninterest income	295		1,271		982			2,075		Other noninterest income	(15)		250		385		687
Gain (loss) on sale of investment securities	24		—		(28		)	—		Gain (loss) on sale of investment securities	—		(52)		10		(52)
	$	6,638	$	6,668	$	17,739		$	18,530		$	6,531	$	5,851	$	12,698	$	11,101

Noninterest expenses:										Noninterest expenses:
Salaries and employee benefits	$	9,258	$	8,611	$	27,310		$	25,718	Salaries and employee benefits	$	10,126	$	9,330	$	19,710	$	18,052
Occupancy	986		1,208		3,274			3,331		Occupancy	1,029		1,102		2,181		2,288
Furniture and equipment	1,699		1,693		5,036			4,657		Furniture and equipment	1,969		1,664		3,750		3,337
Office supplies and postage	469		432		1,370			1,327		Office supplies and postage	405		442		908		901
Advertising and business development	607		584		1,800			1,821		Advertising and business development	380		555		1,139		1,193
Outside services	2,729		2,767		7,824			7,692		Outside services	2,517		2,523		5,202		5,095
FDIC insurance assessment	208		226		612			657		FDIC insurance assessment	214		195		394		404
Other noninterest expense	648		434		1,787			1,688		Other noninterest expense	232		549		815		1,139
	$	16,604	$	15,955	$	49,013		$	46,891		$	16,872	$	16,360	$	34,099	$	32,409
Income before income taxes	$	14,585	$	12,640	$	43,224		$	38,736	Income before income taxes	$	15,252	$	14,419	$	24,133	$	28,639
Income taxes	3,303		2,590		9,519			7,765		Income taxes	3,541		3,199		5,347		6,216
Net income	$	11,282	$	10,050	$	33,705		$	30,971	Net income	$	11,711	$	11,220	$	18,786	$	22,423

Earnings per share:										Earnings per share:
Basic	$	1.21	$	1.07	$	3.61		$	3.30	Basic	$	1.25	$	1.20	$	2.00	$	2.40
Diluted	$	1.21	$	1.07	$	3.61		$	3.30	Diluted	$	1.25	$	1.20	$	2.00	$	2.40



Three Months Ended September 30, 2019 and 2018
	Paid In Capital			Retained Earnings		Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Maximum Cash Obligation Related To ESOP Shares			Total
Balance, June 30, 2018	$	51,899		$	356,003	$	(3,724	)	$	(33,886	)	$	(46,144	)	$	324,148
Issuance of 843 shares of common stock	27			—		—			21			—			48
Issuance of 1,866 shares of common stock under the employee stock purchase plan	99			—		—			—			—			99
Unearned restricted stock compensation	207			—		—			—			—			207
Forfeiture of 234 shares of common stock	(9		)	—		—			—			—			(9		)
Change related to ESOP shares	—			—		—			—			(1,449		)	(1,449		)
Net income	—			10,050		—			—			—			10,050
Purchase of 40,818 shares of common stock	—			—		—			(2,390		)	—			(2,390		)
Other comprehensive loss	—			—		(720		)	—			—			(720		)
Balance, September 30, 2018	$	52,223		$	366,053	$	(4,444	)	$	(36,255	)	$	(47,593	)	$	329,984

Balance, June 30, 2019	55,515			386,614		972			(39,352		)	(50,225		)	353,524
Issuance of 1,468 shares of common stock	56			—		—			39			—			95
Issuance of 1,786 shares of common stock under the employee stock purchase plan	102			—		—			—			—			102
Unearned restricted stock compensation	165			—		—			—			—			165
Forfeiture of 134 shares of common stock	(8		)	—		—			—			—			(8		)
Share-based compensation	6			—		—			—			—			6
Change related to ESOP shares	—			—		—			—			(1,077		)	(1,077		)
Net income	—			11,282		—			—			—			11,282
Purchase of 8,209 shares of common stock	—			—		—			(530		)	—			(530		)
Other comprehensive income	—			—		276			—			—			276
Balance, September 30, 2019	$	55,836		$	397,896	$	1,248		$	(39,843	)	$	(51,302	)	$	363,835



Nine Months Ended September 30, 2019 and 2018
	Paid In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Maximum Cash Obligation Related To ESOP Shares			Total
Balance, December 31, 2017	$	48,930		$	341,558		$	(2,446	)	$	(33,018	)	$	(43,308	)	$	311,716
Issuance of 94,097 shares of common stock	2,748			—			—			2,352			—			5,100
Issuance of 6,149 shares of common stock under the employee stock purchase plan	313			—			—			—			—			313
Unearned restricted stock compensation	372			—			—			—			—			372
Forfeiture of 2,996 shares of common stock	(140		)													(140		)
Change related to ESOP shares	—			—			—			—			(4,285		)	(4,285		)
Net income	—			30,971			—			—			—			30,971
Cash dividends ($0.75 per share)	—			(7,002		)	—			—			—			(7,002		)
Reclassification of stranded tax effects due to the Tax Cuts and Jobs Act				526			(526		)							—
Purchase of 97,081 shares of common stock	—			—			—			(5,589		)	—			(5,589		)
Other comprehensive loss	—			—			(1,472		)	—			—			(1,472		)
Balance, September 30, 2018	$	52,223		$	366,053		$	(4,444	)	$	(36,255	)	$	(47,593	)	$	329,984

Balance, December 31, 2018	52,122			371,848			(3,250		)	(36,968		)	(48,870		)	334,882
Issuance of 87,959 shares of common stock	3,072			—			—			2,302			—			5,374
Issuance of 5,821 shares of common stock under the employee stock purchase plan	325			—			—			—			—			325
Unearned restricted stock compensation	572			—			—			—			—			572
Forfeiture of 5,255 shares of common stock	(262		)	—			—			—			—			(262		)
Share-based compensation	7			—			—			—			—			7
Change related to ESOP shares	—			—			—			—			(2,432		)	(2,432		)
Net income	—			33,705			—			—			—			33,705
Cash dividends ($0.82 per share)	—			(7,657		)	—			—			—			(7,657		)
Purchase of 83,606 shares of common stock	—			—			—			(5,177		)	—			(5,177		)
Other comprehensive income	—			—			4,498			—			—			4,498
Balance, September 30, 2019	$	55,836		$	397,896		$	1,248		$	(39,843	)	$	(51,302	)	$	363,835


Six Months Ended June 30, 2020 and 2019
	Paid In Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Maximum Cash Obligation Related To ESOP Shares		Total
Balance, December 31, 2018	$	52,122	$	371,848	$	(3,250)	$	(36,968)	$	(48,870)	$	334,882
Issuance of 86,491 shares of common stock	3,016		—		—		2,263		—		5,279
Issuance of 4,035 shares of common stock under the employee stock purchase plan	223		—		—		—		—		223
Unearned restricted stock compensation	407		—		—		—		—		407
Forfeiture of 5,121 shares of common stock	(254)		—		—		—		—		(254)
Share-based compensation	1		—		—		—		—		1
Change related to ESOP shares	—		—		—		—		(1,355)		(1,355)
Net income	—		22,423		—		—		—		22,423
Cash dividends ($0.82 per share)	—		(7,657)		—		—		—		(7,657)

Purchase of 75,397 shares of common stock	—		—		—		(4,647)		—		(4,647)
Other comprehensive income	—		—		4,222		—		—		4,222
Balance, June 30, 2019	$	55,515	$	386,614	$	972	$	(39,352)	$	(50,225)	$	353,524

Balance, December 31, 2019	$	55,943	$	409,509	$	1,415	$	(39,830)	$	(51,826)	$	375,211
Issuance of 92,422 shares of common stock	3,547		—		—		2,459		—		6,006
Issuance of 3,569 shares of common stock under the employee stock purchase plan	200		—		—		—		—		200
Unearned restricted stock compensation	393		—		—		—		—		393
Forfeiture of 1,023 shares of common stock	(52)		—		—		—		—		(52)
Share-based compensation	12		—		—		—		—		12

Change related to ESOP shares	—		—		—		—		6,497		6,497
Net income	—		18,786		—		—		—		18,786
Cash dividends ($0.89 per share)	—		(8,325)		—		—		—		(8,325)

Purchase of 82,600 shares of common stock	—		—		—		(5,416)		—		(5,416)
Other comprehensive income	—		—		5,406		—		—		5,406
Balance, June 30, 2020	$	60,043	$	419,970	$	6,821	$	(42,787)	$	(45,329)	$	398,718



	September 30, 2019			December 31, 2018
	(amounts in thousands)
Net unrealized income (loss) on available-for-sale securities	$	4,340		$	(2,734	)
Net unrealized loss on derivatives used for cash flow hedges	(2,677		)	(1,596		)
Tax effect	$	(415	)	$	1,080
Net-of-tax amount	$	1,248		$	(3,250	)



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
September 30, 2019
U.S. Treasury	$	114,153	$	1,843	$	(47	)	$	115,949
Other securities (FHLB, FHLMC and FNMA)	20,306		—		(108		)	20,198
State and political subdivisions	184,578		2,806		(154		)	187,230
Total	$	319,037	$	4,649	$	(309	)	$	323,377
December 31, 2018:
U.S. Treasury	$	83,839	$	124	$	(808	)	$	83,155
Other securities (FHLB, FHLMC and FNMA)	35,371		—		(500		)	34,871
State and political subdivisions	202,450		278		(1,828		)	200,900
Total	$	321,660	$	402	$	(3,136	)	$	318,926



	September 30, 2019		September 30, 2018
Sales proceeds	$	12,467	$	—
Gross realized gains	24		—
Gross realized losses	52		—



	September 30, 2019		December 31, 2018
	(Amounts In Thousands)
Agricultural	$	91,621	$	92,673
Commercial and financial	219,362		229,501
Real estate:
Construction, 1 to 4 family residential	80,969		72,279
Construction, land development and commercial	108,662		113,807
Mortgage, farmland	237,513		236,454
Mortgage, 1 to 4 family first liens	913,206		912,059
Mortgage, 1 to 4 family junior liens	149,969		152,625
Mortgage, multi-family	350,378		352,434
Mortgage, commercial	401,615		383,314
Loans to individuals	32,613		30,072
Obligations of state and political subdivisions	52,030		52,725
	$	2,637,938	$	2,627,943
Net unamortized fees and costs	943		952
	$	2,638,881	$	2,628,895
Less allowance for loan losses	35,570		37,810
	$	2,603,311	$	2,591,085



	Three Months Ended September 30, 2019
	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	$	2,535		$	5,603		$	2,646	$	3,891	$	11,384		$	8,194		$	1,397		$	35,650
Charge-offs	(135		)	(177		)	—		—		(332		)	—			(92		)	(736		)
Recoveries	18			128			2		—		317			12			35			512
Provision	288			(143		)	240		96		(166		)	(110		)	(61		)	144

Ending balance	$	2,706		$	5,411		$	2,888	$	3,987	$	11,203		$	8,096		$	1,279		$	35,570



	Three Months Ended September 30, 2018
	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	$	2,071		$	5,040		$	3,054		$	3,475	$	8,902		$	5,697		$	1,271		$	29,510
Charge-offs	(68		)	(241		)	—			—		(280		)	(107		)	(197		)	(893		)
Recoveries	74			415			2			10		187			80			32			800
Provision	(47		)	(133		)	(188		)	50		1,756			193			(38		)	1,593

Ending balance	$	2,030		$	5,081		$	2,868		$	3,535	$	10,565		$	5,863		$	1,068		$	31,010


~~Note 1.~~	~~Summary of Significant Accounting Policies~~


~~Note 2.~~	~~Earnings Per Share~~


~~Note 4.~~	~~Securities~~



	Nine Months Ended September 30, 2018
	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	$	2,294		$	4,837		$	2,989		$	3,669		$	8,668		$	5,700		$	1,243		$	29,400
Charge-offs	(72		)	(447		)	—			—			(607		)	(161		)	(420		)	(1,707		)
Recoveries	102			856			147			29			433			97			114			1,778
Provision	(294		)	(165		)	(268		)	(163		)	2,071			227			131			1,539

Ending balance	$	2,030		$	5,081		$	2,868		$	3,535		$	10,565		$	5,863		$	1,068		$	31,010

Ending balance, individually evaluated for impairment	$	118		$	1,165		$	3		$	—		$	91		$	40		$	48		$	1,465

Ending balance, collectively evaluated for impairment	$	1,912		$	3,916		$	2,865		$	3,535		$	10,474		$	5,823		$	1,020		$	29,545

Loans:

Ending balance	$	79,155		$	214,681		$	171,944		$	230,032		$	1,049,249		$	729,626		$	81,095		$	2,555,782

Ending balance, individually evaluated for impairment	$	2,342		$	3,288		$	927		$	3,729		$	6,728		$	8,217		$	48		$	25,279

Ending balance, collectively evaluated for impairment	$	76,813		$	211,393		$	171,017		$	226,303		$	1,042,521		$	721,409		$	81,047		$	2,530,503



	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:	(Amounts In Thousands)
Agricultural	$	1,395	$	1,663	$	—
Commercial and financial	1,650		2,503		—
Real estate:
Construction, 1 to 4 family residential	111		148		—
Construction, land development and commercial	328		344		—
Mortgage, farmland	3,612		4,071		—
Mortgage, 1 to 4 family first liens	6,089		7,819		—
Mortgage, 1 to 4 family junior liens	—		254		—
Mortgage, multi-family	145		213		—
Mortgage, commercial	1,871		2,486		—
Loans to individuals	—		14		—
	$	15,201	$	19,515	$	—

With an allowance recorded:
Agricultural	$	1,065	$	1,229	$	479
Commercial and financial	2,512		2,512		1,189
Real estate:
Construction, 1 to 4 family residential	698		698		4
Construction, land development and commercial	—		—		—
Mortgage, farmland	—		—		—
Mortgage, 1 to 4 family first liens	899		974		70
Mortgage, 1 to 4 family junior liens	24		24		2
Mortgage, multi-family	7,447		7,447		305
Mortgage, commercial	75		75		1
Loans to individuals	64		64		64
	$	12,784	$	13,023	$	2,114

Total:
Agricultural	$	2,460	$	2,892	$	479
Commercial and financial	4,162		5,015		1,189
Real estate:
Construction, 1 to 4 family residential	809		846		4
Construction, land development and commercial	328		344		—
Mortgage, farmland	3,612		4,071		—
Mortgage, 1 to 4 family first liens	6,988		8,793		70
Mortgage, 1 to 4 family junior liens	24		278		2
Mortgage, multi-family	7,592		7,660		305
Mortgage, commercial	1,946		2,561		1
Loans to individuals	64		78		64
	$	27,985	$	32,538	$	2,114


~~(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.~~



	December 31, 2018								Year Ended December 31, 2018
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Total Losses
	(Amounts in Thousands)
Loans (4)
Agricultural	$	—	$	—	$	1,160	$	1,160	$	63
Commercial and financial	—		—		2,882		2,882		122
Real Estate:
Construction, 1 to 4 family residential	—		—		—		—		—
Construction, land development and commercial	—		—		703		703		—
Mortgage, farmland	—		—		3,848		3,848		—
Mortgage, 1 to 4 family first liens	—		—		6,729		6,729		520
Mortgage, 1 to 4 family junior liens	—		—		22		22		60
Mortgage, multi-family	—		—		7,286		7,286		—
Mortgage, commercial	—		—		1,458		1,458		349
Loans to individuals	—		—		—		—		—
Foreclosed assets (5)	—		—		—		—		—
Total	$	—	$	—	$	24,088	$	24,088	$	1,114



	Notional Amount		Fair Value			Balance Sheet Category	Maturity
	(Amounts in Thousands)
September 30, 2019
Interest rate swap	$	25,000	$	(326	)	Other Liabilities	11/9/2020
Interest rate swap	25,000		(2,351		)	Other Liabilities	11/7/2023

December 31, 2018
Interest rate swap	$	25,000	$	(120	)	Other Liabilities	11/9/2020
Interest rate swap	25,000		(1,476		)	Other Liabilities	11/7/2023




	Recognized in OCI			Reclassified from AOCI into Income			Recognized in Income on Derivatives
	Amount of Gain (Loss)			Category	Amount of Gain (Loss)		Category	Amount of Gain (Loss)
	(Amounts in Thousands)
September 30, 2019
Interest rate swap	$	(155	)	Interest Expense	$	—	Other Income	$	—
Interest rate swap	(656		)	Interest Expense	—		Other Income	—

December 31, 2018
Interest rate swap	$	347		Interest Expense	$	—	Other Income	$	—
Interest rate swap	571			Interest Expense	—		Other Income	—



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



	Nine Months Ended September 30,
	2019			2018		$ Change			% Change
	(Amounts in thousands)
Net gain on sale of loans	$	2,060		$	1,227	$	833		67.89	%
Trust fees	7,107			7,753		(646		)	(8.33	)
Service charges and fees	7,618			7,475		143			1.91
Other noninterest income	982			2,075		(1,093		)	(52.67	)
Loss on sale of investment securities	(28		)	—		(28		)	—
	$	17,739		$	18,530	$	(791	)	(4.27	)



	Three Months Ended September 30,
	2019		2018		$ Change			% Change
	(Amounts in thousands)
Salaries and employee benefits	$	9,258	$	8,611	$	647		7.51	%
Occupancy	986		1,208		(222		)	(18.38	)
Furniture and equipment	1,699		1,693		6			0.35
Office supplies and postage	469		432		37			8.56
Advertising and business development	607		584		23			3.94
Outside services	2,729		2,767		(38		)	(1.37	)
FDIC insurance assessment	208		226		(18		)	(7.96	)
Other noninterest expense	648		434		214			49.31
	$	16,604	$	15,955	$	649		4.07