HILLS BANCORPORATION - Quarter Report: 2009 March (Form 10-Q)

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

FORM 10-Q

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

For the quarterly period ended March 31, 2009

Commission file number: 0-12668

Hills Bancorporation


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

131 MAIN STREET, HILLS, IOWA 52235

Telephone number: (319) 679-2291

Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes o No

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


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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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


	CLASS	SHARES OUTSTANDING At April 30, 2009


Common Stock, no par value		4,597,687

Page 1 of 34

HILLS BANCORPORATION
Index to Form 10-Q

Part I
FINANCIAL INFORMATION


		Page Number


Item 1.	Financial Statements

	Consolidated balance sheets, March 31, 2009 (unaudited) and December 31, 2008		3
	Consolidated statements of income, (unaudited) for three months ended March 31, 2009 and 2008		4
	Consolidated statements of comprehensive income, (unaudited) for three months ended March 31, 2009 and 2008		5
	Consolidated statements of stockholders’ equity, (unaudited) for three months ended March 31, 2009 and 2008		6
	Consolidated statements of cash flows (unaudited) for three months ended March 31, 2009 and 2008		7 - 8
	Notes to consolidated financial statements		9 - 14

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15 - 26

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		27

Item 4.	Controls and Procedures		28

	Part II
	OTHER INFORMATION

Item 1.	Legal proceedings		29

Item 1A.	Risk factors		29

Item 2.	Unregistered sales of equity securities and use of proceeds		29

Item 3.	Defaults upon senior securities		29

Item 4.	Submission of matters to a vote of security holders		29

Item 5.	Other information		29

Item 6.	Exhibits		29

Signatures			30

Exhibits Index			31

Page 2 of 34

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



ASSETS	March 31, 2009 (Unaudited)			December 31, 2008


Cash and due from banks	$	24,655		$	22,575
Federal funds sold		76,150			—

Total cash and cash equivalents	$	100,805		$	22,575
Investment securities available for sale at fair value (amortized cost March 31, 2009 $195,196; December 31, 2008 $194,402)		201,102			200,312
Stock of Federal Home Loan Bank		14,247			14,247
Loans held for sale		3,373			8,490
Loans, net of allowance for loan losses (March 31, 2009 $28,600; December 31, 2008 $27,660)		1,468,050			1,469,840
Property and equipment, net		23,953			23,606
Tax credit real estate		11,518			12,065
Accrued interest receivable		10,627			10,437
Deferred income taxes, net		8,878			8,959
Other real estate		1,578			5,155
Goodwill		2,500			2,500
Other assets		2,726			2,607

	$	1,849,357		$	1,780,793


LIABILITIES AND STOCKHOLDERS’ EQUITY


Liabilities
Noninterest-bearing deposits	$	162,199		$	169,299
Interest-bearing deposits		1,207,323			1,068,587

Total deposits	$	1,369,522		$	1,237,886
Short-term borrowings		36,039			99,937
Federal Home Loan Bank borrowings		265,000			265,000
Accrued interest payable		2,886			2,914
Other liabilities		13,343			11,879

	$	1,686,790		$	1,617,616


Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)	$	23,815		$	23,815


STOCKHOLDERS’ EQUITY
Capital stock, no par value; authorized 10,000,000 shares; issued March 31, 2009 4,597,877 shares; December 31, 2008 4,597,427 shares	$	—		$	—
Paid in capital		13,476			13,447
Retained earnings		154,124			154,176
Accumulated other comprehensive income		3,647			3,649
Treasury stock at cost (March 31, 2009 167,512 shares; December 31, 2008 156,882 shares)		(8,680	)		(8,095	)

	$	162,567		$	163,177
Less maximum cash obligation related to ESOP shares		23,815			23,815

	$	138,752		$	139,362

	$	1,849,357		$	1,780,793

See Notes to Consolidated Financial Statements.

Page 3 of 34

HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Amounts In Thousands, Except Per Share Amounts)


	Three Months Ended March 31,

	2009		2008

Interest income:
Loans, including fees	$	22,057	$	22,482
Investment securities:
Taxable		954		1,250
Nontaxable		853		841
Federal funds sold		4		—

Total interest income	$	23,868	$	24,573

Interest expense:
Deposits	$	6,562	$	8,304
Short-term borrowings		223		548
FHLB borrowings		3,173		3,218

Total interest expense	$	9,958	$	12,070

Net interest income	$	13,910	$	12,503
Provision for loan losses		2,436		587

Net interest income after provision for loan losses	$	11,474	$	11,916

Other income:
Net gain on sale of loans	$	1,180	$	324
Trust fees		830		1,011
Service charges and fees		1,816		1,894
Rental revenue on tax credit real estate		308		278
Other noninterest income		592		803

	$	4,726	$	4,310

Other expenses:
Salaries and employee benefits	$	5,201	$	5,006
Occupancy		773		618
Furniture and equipment		929		914
Office supplies and postage		340		328
Advertising and business development		451		361
Outside services		1,457		1,269
Rental expenses on tax credit real estate		413		305
FDIC insurance assessment		525		179
Other noninterest expense		755		273

	$	10,844	$	9,253

Income before income taxes	$	5,356	$	6,973
Income taxes		1,367		2,184

Net income	$	3,989	$	4,789


Earnings per share:
Basic	$	0.90	$	1.07
Diluted		0.90		1.06

See Notes to Consolidated Financial Statements.

Page 4 of 34

HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Amounts In Thousands)


	Three Months Ended March 31,

	2009			2008


Net income	$	3,989		$	4,789

Other comprehensive income (loss):
Unrealized holding gains (losses) arising during the period, net of income taxes, 2009 ($2); 2008 $1,481		(2	)		2,392


Comprehensive income	$	3,987		$	7,181

See Notes to Consolidated Financial Statements.

Page 5 of 34

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


	Paid In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Maximum Cash Obligation Related To ESOP Shares			Treasury Stock			Total


Balance, December 31, 2007	$	12,823		$	144,122		$	647		$	(22,205	)	$	(4,697	)	$	130,690
Issuance of 1,597 shares of common stock		85			—			—			—			—			85
Forfeiture of 169 shares of common stock		(6	)		—			—			—			—			(6	)
Share-based compensation		5			—			—			—			—			5
Net income		—			4,789			—			—			—			4,789
Cash dividends ($.91 per share)		—			(4,086	)		—			—			—			(4,086	)
Purchase of 5,600 shares of common stock		—			—			—			—			(297	)		(297	)
Other comprehensive income		—			—			2,392			—			—			2,392

Balance, March 31, 2008	$	12,907		$	144,825		$	3,039		$	(22,205	)	$	(4,994	)	$	133,572


Balance, December 31, 2008	$	13,447		$	154,176		$	3,649		$	(23,815	)	$	(8,095	)	$	139,362
Issuance of 607 shares of common stock		33			—			—			—			—			33
Forfeiture of 157 shares of common stock		(8	)		—			—			—			—			(8	)
Share-based compensation		4			—			—			—			—			4
Net income		—			3,989			—			—			—			3,989
Cash dividends ($.91 per share)		—			(4,041	)		—			—			—			(4,041	)
Purchase of 10,630 shares of common stock		—			—			—			—			(585	)		(585	)
Other comprehensive loss		—			—			(2	)		—			—			(2	)

Balance, March 31, 2009	$	13,476		$	154,124		$	3,647		$	(23,815	)	$	(8,680	)	$	138,752

See Notes to Consolidated Financial Statements.

Page 6 of 34

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


	Three Months Ended March 31,

	2009			2008

Cash Flows from Operating Activities
Net income	$	3,989		$	4,789
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation		602			563
Provision for loan losses		2,436			587
Share-based compensation		4			5
Forfeiture of common stock		(8	)		(6	)
Compensation expensed through issuance of common stock		33			85
Provision for deferred income taxes		83			(160	)
Net loss on sale of other real estate owned and other repossessed assets		464			18
Increase in accrued interest receivable		(190	)		(402	)
Amortization of discount on investment securities, net		147			83
(Increase) decrease in other assets		(119	)		317
Increase in accrued interest payable and other liabilities		1,436			2,337
Loans originated for sale		(88,232	)		(42,348	)
Proceeds on sales of loans		94,529			39,714
Net gain on sales of loans		(1,180	)		(324	)

Net cash and cash equivalents provided by operating activities	$	13,994		$	5,258


Cash Flows from Investing Activities
Proceeds from maturities of investment securities available for sale	$	10,770		$	12,892
Purchases of investment securities available for sale		(11,711	)		(10,822	)
Loans made to customers, net of collections		(1,305	)		(17,772	)
Proceeds on sale of other real estate owned and other repossessed assets		3,772			259
Purchases of property and equipment		(949	)		(1,392	)
Investment in tax credit real estate, net		547			54

Net cash provided by (used in) investing activities	$	1,124		$	(16,781	)


Cash Flows from Financing Activities
Net increase in deposits	$	131,636		$	47,192
Net decrease in short-term borrowings		(63,898	)		(23,485	)
Payments on FHLB borrowings		—			(10,001	)
Borrowings from FRB		—			2,000
Payments on FRB borrowings		—			(2,000	)
Purchase of treasury stock		(585	)		(297	)
Dividends paid		(4,041	)		(4,086	)

Net cash provided by financing activities	$	63,112		$	9,323

(Continued)

Page 7 of 34

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


	Three Months Ended March 31,

	2009		2008


Increase (decrease) in cash and cash equivalents	$	78,230	$	(2,200	)

Cash and cash equivalents:
Beginning of year		22,575		32,383

End of period	$	100,805	$	30,183


Supplemental Disclosures
Cash payments for:
Interest paid to depositors	$	6,590	$	8,283
Interest paid on other obligations		3,396		3,766
Income taxes		1,079		456

Noncash financing activities:
Transfers to other real estate owned	$	659	$	304

See Notes to Consolidated Financial Statements.

Page 8 of 34

HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Note 1.	Basis of Presentation

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

Operating results for the three-month period ended March 31, 2009 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2009. 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, 2008 filed with the Securities Exchange Commission on March 11, 2009.

The allowance for loan losses in an estimate, and as such, events may occur in the future which affect its accuracy. Actual default and loss rates may differ materially from levels assumed by the Company. Management will continue to closely monitor its portfolio.


Note 2.	Earnings Per Share

Basic earnings per share amounts are computed by dividing net income (the numerator) by the weighted average number of common shares outstanding (the denominator) during the period. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock equivalents unless the effect is to reduce the loss or increase the income per common share from continuing operations.

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


	Three months ended March 31,

	2009			2008


Common shares outstanding at the beginning of the period		4,440,545			4,490,107
Weighted average number of net shares redeemed		(2,673	)		(2,806	)

Weighted average shares outstanding (basic)		4,437,872			4,487,301
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method		15,457			19,778

Weighted average number of shares (diluted)		4,453,329			4,507,079


Net income (In Thousands)	$	3,989		$	4,789


Earnings per share:
Basic	$	0.90		$	1.07

Diluted	$	0.90		$	1.06

Page 9 of 34

HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


Note 3.	Recent Accounting Pronouncements

As of January 1, 2009, the Company adopted FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (“FAS 161”). The standard requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk related contingent features in derivative agreements. The adoption of FAS 161 did not have a significant effect on the Company’s consolidated financial statements.

In April 2009, the FASB issued FASB Staff Position FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS 157-4”). FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. FSP FAS 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is effective for financial statements issued after June 15, 2009. Early adoption is permitted for periods ending after March 15, 2009. The adoption of FSP FAS 157-4 will not have a significant effect on the Company’s consolidated financial statements.

In April 2009, the FASB issued FASB Staff Position FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS 115-2 and FAS 124-2”). FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS 115-2 and FAS 124-2 does not amend existing recognition and measurement guidance related to other-than-temporary impairment of equity securities. FSP FAS 115-2 and FAS 124-2 is effective for financial statements issued after June 15, 2009. Early adoption is permitted for periods ending after March 15, 2009. The adoption of FSP FAS 115-2 and FAS 124-2 will not have a significant effect on the Company’s consolidated financial statements.

In April 2009, the FASB issued FASB Staff Position FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. FSP FAS 107-1 and APB 28-1 also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. FSP FAS 107-1 and APB 28-1 is effective for financial statements issued after June 15, 2009. Early adoption is permitted for periods ending after March 15, 2009. The adoption of FSP FAS 107-1 and APB 28-1 will not have a significant effect on the Company’s consolidated financial statements.


Note 4.	Fair Value Measurements

The Company adopted FASB Statement No. 157, Fair Value Measurements (“FAS 157”), in its entirety on January 1, 2008. FAS 157 provides a single definition for fair value, a framework for measuring fair value and expanded disclosures concerning fair value. Fair value is defined under FAS 157 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.

Page 10 of 34

HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


Note 4.	Fair Value Measurements (continued)

The Company determines the fair market value of its financial instruments based on the fair value hierarchy established in FAS 157. There are three levels of inputs that may be used to measure fair value as follows:


Level 1	Valuations for assets and liabilities traded in active markets for identical assets or liabilities. Level 1 includes securities purchased from the Federal Home Loan Bank (“FHLB”), Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”) that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2	Valuations for assets and liabilities traded in less active dealer or broker markets. Level 2 includes securities issued by state and political subdivisions. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities.

Level 3	Valuations for assets and liabilities that are derived from other valuation methodologies, including discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets and liabilities. 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. The Company does not have any Level 3 assets or liabilities.

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. Recent market conditions have led to diminished, and in some cases, non-existent trading in certain of the financial asset classes. 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. Despite the Company’s best efforts to maximize the use of relevant observable inputs, the current market environment has diminished the observability of trades and assumptions that have historically been available.

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

ASSETS

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. Level 1 securities include securities from the FHLB, FHLMC and FNMA. Level 2 securities include securities issued by state or political subdivisions.

Loans held for sale: Loans held for sale are carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the short time between origination of the loan and its sale on the secondary market.

Loans: The Company does not record loans at fair value on a recurring basis. The Company does record nonrecurring fair value adjustments to loans to reflect (1) partial write-downs that are based on the observable market price or appraised value of the collateral or (2) the full charge-off of the loan carrying value.

Page 11 of 34

HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


Note 4.	Fair Value Measurements (continued)

Foreclosed assets: 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 upon transfer of the loans to foreclosed assets. Fair value is generally based upon independent market prices or appraised values of the collateral. The value of foreclosed assets is evaluated periodically. Foreclosed assets are classified as Level 2.

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

LIABILITIES

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

Short-term borrowings: Short-term borrowings are carried at historical cost and include federal funds purchased and securities sold under agreements to repurchase. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the liability and its expected realization.

Long-term borrowings: Long-term borrowings are recorded at historical cost. The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Valuation methodologies have not changed during the quarter ended March 31, 2009.

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:


	March 31, 2009

	Level 1		Level 2		Level 3		Total

	(Amounts in Thousands)

Investment securities available for sale	$	98,457	$	102,645	$	—	$	201,102


Total	$	98,457	$	102,645	$	—	$	201,102

All securities from the FHLB, FHLMC and FNMA are included in Level 1.

Page 12 of 34

HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


Note 4.	Fair Value Measurements (continued)

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. For assets measured at fair value on a nonrecurring basis in 2009 that were still held on the balance sheet at March 31, 2009, the following table provides the level of valuation assumptions used to determine the adjustment and the carrying value of the related individual assets at quarter end.


	March 31, 2009								Quarter Ended March 31, 2009

	Level 1		Level 2		Level 3		Total		Total Losses

	(Amounts in Thousands)

Loans (1)	$	—	$	4,742	$	—	$	4,742	$	376


Total	$	—	$	4,742	$	—	$	4,742	$	376


(1)	Represents carrying value after 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.


Note 5.	Stock Repurchase Program

In July of 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of 750,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”). This authorization was previously set to expire on December 31, 2009. At its January 2009 meeting, the Company’s Board of Directors extended the expiration date of the 2005 Stock Repurchase Program to December 31, 2013. 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. 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 167,512 shares of its common stock in privately negotiated transactions from August 1, 2005 through March 31, 2009. Of these 167,512 shares, 10,630 shares were purchased during the quarter ended March 31, 2009, at an average price per share of $55.00.

Page 13 of 34

HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


Note 6.	Commitments and Contingencies

The Company’s subsidiary, Hills Bank and Trust (the “Bank”) is a party to financial instruments with off-balance–sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, credit card participations and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank’s commitments at March 31, 2009 and December 31, 2008 is as follows:


	March 31, 2009		December 31, 2008

	(Amounts In Thousands)

Firm loan commitments and unused portion of lines of credit:
Home equity loans	$	39,477	$	38,519
Credit cards		41,096		35,407
Commercial, real estate and home construction		72,664		86,073
Commercial lines and real estate purchase loans		158,983		149,306
Outstanding letters of credit		11,135		12,365


Note 7.	Income Taxes

Federal income tax expense for the three months ended March 31, 2009 and 2008 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. On January 1, 2007, the Company adopted FIN 48, Accounting for Uncertainty in Income Taxes. The evaluation was performed for those tax years which remain open to audit. 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, 2008, 2007 and 2006, remain subject to examination by the Internal Revenue Service. For state tax purposes, the tax years ended December 31, 2008, 2007 and 2006, remain open for examination. As a result of the implementation of FIN 48, the Company did not recognize any increase or decrease for unrecognized tax benefits. There were no material unrecognized tax benefits on December 31, 2008 and March 31, 2009. No interest or penalties on these unrecognized tax benefits has been recorded. As of March 31, 2009, the Company does not anticipate any significant increase or decrease in unrecognized tax benefits during the twelve-month period ending March 31, 2010.

Income taxes as a percentage of income before taxes were 25.52% in 2009 and 31.32% in 2008. The decrease in the effective tax rate is due to tax-exempt interest income and income tax credits and the relationship to total income before income taxes. For the first three months of 2008, tax-exempt interest income was $841,000, or 12.06% of income before income taxes resulting in a 4.22% decrease in the effective tax rate. For the first three months of 2009, tax-exempt interest income was $853,000, or 15.93% of income before income taxes. This decreased the effective tax rate an additional 1.35% for a total reduction in the effective tax rate of 5.57% in 2009. Also, tax credits increased $183,000 for the three months ended March 31, 2009 as compared to the same period in 2008, reducing the 2009 effective tax rate an additional 4.18% compared to 2008. Tax credits totaled $360,000 for the three months ended March 31, 2009 and resulted in a reduction in the effective tax rate of 6.72% compared to a reduction of 2.54% in the comparable period in 2008.

Page 14 of 34

HILLS BANCORPORATION


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

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

Special Note Regarding Forward Looking Statements

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

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


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

•	The effects of recent financial market disruptions and the current global economic recession, and monetary and other governmental actions designed to address such disruptions and recession.

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

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

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

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

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

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

•	The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.

Page 15 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)


•	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, 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, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.

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

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

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these 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 loss 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 non-performing 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 in particular, the state of certain industries. Size and complexity of individual loans 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 and analysis 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 March 31, 2009 and December 31, 2008 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.

Page 16 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

Overview

This overview highlights selected information and may not contain all of the information that is important to you in understanding the Company’s 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, Mount Vernon, Kalona, Wellman, Cedar Rapids and Marion, Iowa. At March 31, 2009, the Bank has fourteen full service locations and a trust and wealth management location.

Net income for the period ended March 31, 2009 was $3.99 million compared to $4.79 million for the first quarter of 2008, a decrease of 16.70%. The $800,000 decline in net income was caused by a number of factors. The principal factors were increases of $1,849,000 in the provision for loan losses, $346,000 in FDIC insurance assessments and $482,000 in other noninterest expense. The increase in these and some other expenses was partially offset by items including a $1,407,000 increase in net interest income and an increase of $856,000 in net gain on sale of loans. Return on average equity was 11.32% for the three months ended March 31, 2009, compared to 14.32% for the same period in 2008. Return on average assets was 0.89% in 2009 compared to 1.16% in 2008. Return on average assets and return on average equity are calculated based on annualized first quarter results for both periods presented. Dividends of $.91 per share were paid in January 2009 to 1,635 shareholders. The 2009 dividend was the same dividend per share as paid in January 2008.

The Bank’s net interest income is the largest component of revenue and it is a function of the average earnings assets and the net interest margin percentage. For the period ended March 31, 2009, the Bank achieved a net interest margin on a tax-equivalent basis of 3.45% compared to 3.34% in 2008. Average earning assets were $1.698 billion in 2009 and $1.572 billion in 2008.

Highlights noted on the balance sheet as of March 31, 2009 for the Company included the following:


•	Total assets are $1.849 billion, an increase of $68.56 million since December 31, 2008.

•	Cash and cash equivalents are $100.81 million, an increase of $78.23 million since December 31, 2008.

•	Net loans are $1.471 billion, a decrease of $6.91 million since December 31, 2008.

•	Deposit growth of $131.64 million since December 31, 2008.

•	Short-term borrowings decreased $63.90 million since December 31, 2008.

Reference is made to Note 4 for a discussion of fair value measurements which relate to methods used by the Company in recording assets and liabilities on its financial statements.

A detailed discussion of the financial position and results of operations follows this overview.

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 twice during the first quarter of 2009. The target rate remains unchanged since December 31, 2008 at 0.25%. Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally increase or decrease when the Federal Reserve Board raises or lowers the federal funds rate. As of March 31, 2009, the average rate indexes for the one, three and five year indexes were 0.57%, 1.15% and 1.67%, respectively. The one year index decreased 63.23% from 1.55% at March 31, 2008, the three year index decreased 35.75% and the five year index decreased 32.11%. The three year index was 1.79% and the five year index was 2.46% at March 31, 2008. During this same period, the average federal funds rate decreased from 2.25% in 2008 to 0.25% in 2009.

Page 17 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

Financial Position

The tables below set forth the composition of the loan portfolio as of March 31, 2009 and December 31, 2008 (dollars in thousands), along with changes in the allowance for loan losses and non-performing loan information:


	March 31, 2009					December 31, 2008

	Amount		Percent			Amount		Percent

	(Amounts In Thousands)					(Amounts In Thousands)

Agricultural	$	61,075		4.08	%	$	64,198		4.29	%
Commercial and financial		162,655		10.87			162,170		10.83
Real estate:
Construction		138,862		9.28			140,349		9.37
Mortgage		1,101,044		73.56			1,095,742		73.17
Loans to individuals		33,014		2.21			35,041		2.34

	$	1,496,650		100.00	%	$	1,497,500		100.00	%

Less allowance for loan losses		28,600					27,660

	$	1,468,050				$	1,469,840

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 that, 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.

Changes in the allowance for loan losses for the periods shown in the following table were as follows:


	Three Months Ended March 31,

	2009			2008

	(Amounts In Thousands)

Balance, beginning	$	27,660		$	19,710
Provision charged to expenses		2,436			587
Recoveries		225			170
Loans charged off		(1,721	)		(677	)

Balance, ending	$	28,600		$	19,790

Page 18 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

Non-performing loan information at March 31, 2009 and December 31, 2008, was as follows:


	March 31, 2009			December 31, 2008

	(Amounts in thousands)

Non-accrual loans	$	3,084		$	2,535
Accruing loans past due ninety days or more		11,202			5,049
Restructured loans		4,465			4,478
Non-performing loans (includes non-accrual and restructured loans)		69,454			52,186
Loans held for investment		1,496,650			1,497,500
Ratio of allowance for loan losses to loans held for investment		1.91	%		1.85	%
Ratio of allowance for loan losses to non-performing loans		41.18			53.00

Non-performing loans increased $17.3 million from December 31, 2008 to March 31, 2009. Non-performing loans include any loan that has been placed on non-accrual status and restructured loans. Non-performing loans also include loans that based on management’s evaluation of current information and events, the Bank expects to be unable to collect in full according to the contractual terms of the original loan agreement. These loans are also considered impaired loans. Non-performing loans were 4.64% of loans held for investment as of March 31, 2009 and 3.48% as of December 31, 2008. The increase in non-performing loans is due to the deterioration of credit quality related to multiple borrowers including one large agricultural production operation with an aggregate loan balance of $4.4 million as of March 31, 2009, one commercial real estate borrower with an aggregate balance of $1.7 million, one land development borrower with an aggregate balance of $1.7 million, and three unrelated borrowers with multi-family real estate loans with an aggregate balance of $4.2 million. The remainder of the increase in non-performing loans is related to borrower relationships of less than $1.0 million and the continued deterioration in economic conditions. Non-performing loans includes $16.6 million of loans related to the June 2008 floods in the Bank’s trade area. Most of the non-performing loans are secured by real estate and are believed to be adequately collateralized.

Loans 90 days past due that are still accruing interest increased $6.2 million in the first quarter of 2009. This increase is due mainly to three loans to one borrower with an aggregate balance of $4.6 million as of March 31, 2009. These three loans are secured by commercial real estate and are believed to be adequately collateralized.

The Company believes that the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions continue to deteriorate, certain borrowers may experience difficulty and the level of nonperforming loans, chargeoffs and delinquencies could continue to rise and require increases in the provision for loan losses. The Company will continue to monitor the adequacy of the allowance on a quarterly basis and will consider 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.

Overall credit quality may continue to deteriorate in 2009. Such a deterioration could cause increases in nonperforming loans, allowance for loan loss provision expense and net chargeoffs. Management will monitor changing market conditions as a part of its allowance for loan loss methodology.

Page 19 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

The Bank restructured loans totaling $4.5 million during 2008. These loans related to two customers. The first customer relationship consisted of six loans totaling $1.2 million and are flood related. The Bank would have recorded $16,000 in interest income during the first quarter of 2009 related to these loans if the loans had been current in accordance with their original terms. For the first customer relationship, no interest income related to the restructured loans was included in net income for the first quarter of 2009 as the loans are currently on non-accrual status. The Bank loaned an additional $164,000 to the borrower after the completion of the restructuring of the loans. In addition, the Bank has committed to lend an additional $243,000 to the customer. The second restructured customer relationship consisted of four loans totaling $3.3 million. This restructure was completed as of the end of 2008. The Bank would have recorded $44,000 in interest income during the first quarter of 2009 related to these loans if the loans had been current in accordance with their original terms. Instead, the Bank recorded $35,000 of interest for the three months ended March 31, 2009, a loss of interest income of $9,000 due to the restructure of the second borrower relationship. The Bank loaned an additional $34,000 to the borrower after the completion of the restructuring of the loans. One of the restructured loans related to the second borrower is a line of credit for $1.4 million. Currently, the borrower could advance an additional $640,000 on the line of credit. The Bank does not have any other commitments to lend the customer additional funds.

Investment securities available for sale held by the Company increased by $0.8 million from December 31, 2008 to March 31, 2009. The fair value of securities available for sale was $5.9 million more than the amortized cost of such securities as of March 31, 2009. The fair value of the securities in excess of amortized cost is unchanged from December 31, 2008. The carrying values of investment securities at March 31, 2009 and December 31, 2008 are summarized in the following table (dollars in thousands):


	March 31, 2009					December 31, 2008

	Amount		Percent			Amount		Percent

Securities available for sale

State and political subdivisions	$	102,645		51.04	%	$	100,463		50.15	%

Other securities (FHLB, FHLMC and FNMA)		98,457		48.96			99,849		49.85


Total securities available for sale	$	201,102		100.00	%	$	200,312		100.00	%

Deposit growth was $131.6 million in the first quarter of 2009 and included a $44.0 million increase in public funds that are temporary deposits. This large increase due to public funds is consistent with the first quarter of 2008 when they increased $31.5 million. As a result of this deposit growth, federal funds purchased included in short-term borrowings at December 31, 2008 were reduced $53.4 million to zero. In the opinion of the Company’s management, the Company and the Bank continue to have sufficient liquidity resources available to fund the Bank’s expected loan growth.

Brokered deposits totaled $37.5 million as of March 31, 2009 with an average rate of 1.86%. Brokered deposits were $10.4 million as of December 31, 2008 with an average rate of 3.28%.

Page 20 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

Dividends and Equity

In January 2009, Hills Bancorporation paid a dividend of $4,041,000 or $.91 per share. The dividend was also $.91 per share in January 2008. After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of March 31, 2009 totaled $138.8 million. Under risk-based capital rules, the total amount of risk-based capital as of March 31, 2009, was 12.26% of risk-adjusted assets, and is in excess of the required minimum of 8.00%. Risk-based capital was 12.93% and 12.64% as of March 31, 2008 and December 31, 2008, respectively. As of March 31, 2009, the most recent notifications from the Federal Reserve System categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company’s category.

In 2008, the Bank opted to participate in both programs under the FDIC’s Temporary Liquidity Guarantee Program (“TLGP”). The first program was the Transaction Account Guarantee Program under which, through December 31, 2009, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount of the account. Coverage under the Transaction Account Guarantee Program is in addition to and separate from the coverage available under the FDIC’s general deposit insurance rules. The second TLGP program in which the Bank elected to participate was the Debt Guarantee Program. The Debt Guarantee Program guarantees certain newly issued senior, unsecured debt of participating financial institutions. Under the FDIC’s Final Rule adopted on November 21, 2008, certain senior, unsecured debt issued before June 30, 2009, with a maturity of greater than 30 days that matures on or prior to June 30, 2012, is automatically included in the program. The fees associated with this program range from 50 to 100 basis points on an annualized basis and vary according to the maturity of the debt issuance. On February 10, 2009, it was announced that, for an additional premium, the FDIC will extend the Debt Guarantee Program through October 2009. The Company did not have any senior unsecured debt as of March 31, 2009.

In response to the financial crisis affecting the banking system, financial markets, investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the United States Department of the Treasury (the “Treasury”) has the authority to, among other things, make equity investments in certain financial institutions and purchase mortgage-backed and other securities from financial institutions for an aggregate amount of up to $700 billion. The Treasury exercised its authority to make such equity investments by developing the Capital Purchase Program. Under the terms of the Capital Purchase Program as they relate to companies other than S corporations, the Treasury may purchase preferred shares and warrants issued by such companies. Additional preferred shares are issued to the Treasury upon exercise of the Warrants. An investment by the Treasury subjects participants to a number of restrictions, including the need to obtain the Treasury’s consent to increase common stock dividends or repurchase common stock. The Company elected not to apply for the capital available under the Treasury’s Capital Purchase Program. The Company and the Bank are well capitalized with capital ratios that exceed regulatory requirements.

Net Income Overview

Net income decreased $800,000 or 16.70% for the quarter ended March 31, 2009 compared to the first quarter of 2008. Total net income was $3,989,000 in the 2009 quarter and $4,789,000 in the comparable 2008 quarter. The changes from the first quarter in 2008 were principally the result of the following:


•	Net interest income increased $1,407,000.

•	The provision for loan losses increased $1,849,000.

•	Other income increased $416,000.

•	Other expenses increased $1,591,000.

•	Income taxes decreased $817,000.

Page 21 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

For the three-month periods ended March 31, 2009 and 2008, basic earnings per share were $0.90 and $1.07, respectively. Diluted earnings per share were $0.90 for the three months ended March 31, 2009 compared to $1.06 for the same period in 2008.

Quarterly fluctuations in the Company’s net income continue to be driven primarily by three important factors. The first important factor is the interaction between changes in net interest margin and changes in average earning assets. Net interest income of $13.9 million for the first three months of 2009 was derived from the Company’s $1.698 billion of average earning assets and its net interest margin of 3.45%. Average earning assets in 2008 were $1.572 billion and the net interest margin was 3.34%. The importance of net interest margin is illustrated by the fact that a decrease in the net interest margin of 10 basis points to 3.35% would have resulted approximately in a $419,000 decrease in income before income taxes for the three-month period ended March 31, 2009. Similarly, an increase in the net interest margin of 10 basis points to 3.55% would have resulted approximately in a $419,000 increase in interest income before taxes. Net interest income for the Company increased due to the increase in average earning assets over the similar three-month period in 2008 and the increase in the net interest margin of 11 basis points.

The second significant factor affecting the Company’s net income is the provision for loan losses. The majority of the Company’s interest-earning assets are in loans outstanding, which amounted to more than $1.471 billion at March 31, 2009. 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, loan concentrations, the level of non-performing loans (which includes non-accrual loans) and loans past due 90 days or more. The provision for loan losses was $2,436,000 in 2009 compared to $587,000 in 2008. The $1,849,000 increase in the provision is due to the deterioration of overall credit quality of the Company’s loans outstanding.

The amount of mortgage loans sold on the secondary market is the third factor that can cause fluctuations in net income. Loans originated in the first three months of 2009 totaled $88.2 million compared to $42.3 million in the same period in 2008, an increase of 109%. In the three months ended March 31, 2009 and 2008, the net gain on sale of loans was $1,180,000 and $324,000, respectively. The sale of loans is influenced by the real estate market and interest rates. 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. During the three months ended March 31, 2009, secondary market rates were favorable resulting in the increase in the volume of loans sold. 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 22 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

Net Interest Income

Net interest income is the excess of the interest and fees received on interest-earning bearing assets over the interest expense of the interest-bearing liabilities. The factors that have the greatest impact on net interest income are the volume of average earning assets and the net interest margin. The net interest margin for the first three months of 2009 was 3.45% compared to 3.34% in 2008 for the same period. The measure is shown on a tax-equivalent basis using a tax rate of 35% to make the interest earned on taxable and non-taxable assets more comparable. The change in average balances and average rates between years and the effect on the net interest income on a tax equivalent basis for the three months ended March 31, 2009 compared to the comparable period in 2008 are shown in the following table:


	Change in Average Balance			Change in Average Rate			Increase (Decrease) in Net Interest Income

							Volume Changes			Rate Changes			Net Change


	(Amounts in Thousands)

Interest income:
Loans, net	$	113,102			(0.58	)%	$	1,684		$	(2,109	)	$	(425	)
Taxable securitities		(7,711	)		(0.78	)		(83	)		(213	)		(296	)
Nontaxable securities		5,043			(0.20	)		68			(50	)		18
Federal funds sold		15,614			(5.24	)		4			—			4

	$	126,048					$	1,673		$	(2,372	)	$	(699	)


Interest expense:
Interest-bearing demand deposits	$	29,286			(0.44	)	$	(74	)	$	217		$	143
Savings deposits		27,470			(0.60	)		(164	)		504			340
Time deposits		54,641			(1.16	)		(564	)		1,823			1,259
Short-term borrowings		(11,700	)		(1.56	)		93			232			325
FHLB borrowings		5,868			(0.12	)		(36	)		81			45

	$	105,565					$	(745	)	$	2,857		$	2,112

Change in net interest income							$	928		$	485		$	1,413

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. Loans 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)	2009			2008


Yield on average interest-earning assets		5.81	%		6.41	%
Rate on average interest-bearing liabilities		2.78			3.60

Net interest spread		3.03	%		2.81	%
Effect of noninterest-bearing funds		0.42			0.53

Net interest margin (tax equivalent interest income divided by average interest-earning assets)		3.45	%		3.34	%

Page 23 of 34

HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

Provision for Loan Losses

The provision for loan losses was $2,436,000 in 2009 compared to $587,000 in 2008, an increase of $1,849,000. The loan loss provision is the amount necessary to adjust the allowance to the level considered appropriate by management. The provision adjustment 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, loan concentrations, the impact on the borrowers’ ability to repay, 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 (primarily agricultural and spec real estate construction loans).

In the first quarter of 2009, problem and watch loans decreased $1.4 million while there was an increase of $11.5 million in substandard loans in the same period. These asset quality changes increased the provision $1.6 million. In the first quarter of 2008, problem and watch loans increased $1.0 million and substandard loans decreased $2.0 million. The 2008 asset quality changes increased the provision expense by $0.5 million. In addition, loan growth was $19.8 million in the first quarter of 2008, increasing the provision for loan losses by $0.4 million. In the first quarter of 2009, loan balances declined $6.9 million which decreased the provision for loan losses by $0.6 million

The allowance for loan losses balance is also affected by the charge-offs, net of recoveries, for the periods presented. For the quarters ended March 31, 2009 and 2008, recoveries were $225,000 and $170,000, respectively; and charge-offs were $1,721,000 in 2009 and $677,000 in 2008. The allowance for loan losses totaled $28,600,000 at March 31, 2009 compared to $27,660,000 at December 31, 2008. The allowance represented 1.91% and 1.85% of loans held for investment at March 31, 2009 and December 31, 2008, respectively. The allowance was based on management’s consideration of a number of factors, including loan concentrations, loans with higher credit risks (primarily agriculture loans and spec real estate construction) and overall increases in net loans outstanding. As of March 31, 2009, the allowance includes $4,200,000 in flood-related provisions. The methodology used in 2009 is consistent with 2008.

Net Gain on Sale of Loans

Net gain on sale of loans for the three months ended March 31, 2009 was $1,180,000 compared to $324,000 for the comparable period ended March 31, 2008. Loans originated in the first three months of 2009 totaled $88.2 million compared to $42.3 million in the same period in 2008, an increase of 109%. 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. During the three months ended March 31, 2009, secondary market rates were favorable resulting in the increase in the volume of loans sold. 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 Income

Other income, other than the net gain on sale of loans discussed above, decreased by $440,000 for the three months ended March 31, 2009. Trust fees decreased $181,000 as a result of assets under management decreasing from $904.8 million as of March 31, 2008 to $760.2 million as of March 31, 2009. Service charges and fees decreased $78,000 in the 2009 quarter from their level in the 2008 quarter. The principal reason for this decrease was a reduction of $138,000 in service fees on deposit accounts as a result of diminished results from fee income strategies. Debit card and point of sale (POS) pin interchange fees are also included in service charges and fees, and that component increased during the same period by $67,000 due to volume of activity.

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HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

Other noninterest income was $592,000 for the quarter ended March 31, 2009, a $211,000 decrease from the first quarter of 2008. Included in the 2008 first quarter other noninterest income were amounts related to Visa, Inc. (“Visa”). The Company received $114,000 in proceeds from the redemption of shares as a part of the Visa IPO. In conjunction with the IPO, Visa created a litigation escrow which is to be used to pay the litigation settlement payments. As a result, the Company recorded a receivable equal to the $50,000 reserve during the first quarter of 2008. This receivable was recorded as a contra-liability to the reserve. Both the liability and receivable are reflected in other liabilities on the Company’s consolidated financial statements. The economic benefit of the receivable was recorded in other noninterest income in 2008. In addition, rental income decreased $78,000 in the first quarter of 2009 compared to the same period in 2008. The decrease is due to the expiration of an ATM rental contract which was not renewed in late 2008. The monthly rental income is recorded in 2008 but was not received in 2009.

Other Expenses

Other expenses increased $1,591,000 in 2009 to $10,844,000 from the same period in 2008. This increase of 17.19% included an increase of $195,000 in salaries and benefits. Direct salary expense increased $234,000, or 6.23%, due to annual salary adjustments and an increase in the number of employees.

Occupancy expenses increased $155,000 in 2009 due mainly to increases related to operating two additional locations in 2009. The Company leases an additional location at a cost of $6,600 per month. Building depreciation has increased due to the addition of certain leasehold improvements at the new leased location which are being depreciated over the term of the four-year term of the lease. The Company also opened a modular temporary office on the site of its fourteenth location. Rents for the temporary office are $1,700 a month. Rent expense for the Company’s ATM locations is also included in occupancy expense. ATM rent expense increased $39,000 in the first quarter of 2009 compared to the same period in 2008. This increase is related to placement of additional ATMs in the Company’s trade area.

Advertising and business development expense were $451,000 for the quarter ended March 31, 2009, a $90,000 increase over the same period in 2008. The increase is related to the timing of office promotions expenses incurred in 2009 when compared to the prior year.

Outside services expense increased $188,000 for the quarter ended March 31, 2009 compared to March 31, 2008. Outside services include professional fees, courier services and ATM fees, and processing charges for the merchant credit card program, retail credit cards and other data processing services. Credit card, debit card and merchant card processing expenses increased $25,000 due to an increase in the volume of transactions in 2009 compared to 2008. Professional fees were $463,000 for the three months ended March 31, 2009, an increase of $96,000 over the same period in 2008. This increase includes $95,000 in attorney fees and is due to credit-related matters.

Rental expenses on tax credit real estate were $413,000 in 2009, an increase of $108,000 from the first quarter of 2008. This increase is due mainly to the addition of a fifth tax credit property late in 2008.

FDIC insurance assessment expense was $525,000 for the three-months ended March 31, 2009. This is an increase of $346,000 when compared to the same period in 2008. This increase is due in part to an additional 10 basis point assessment related to Transaction Account Guarantee Program. This Program increased insurance coverage for non-interest bearing deposit accounts in excess of $250,000. In addition, the FDIC has raised assessment rates for all banks as part of its restoration plan for the deposit insurance fund.

Other noninterest expense increased $482,000 in the first quarter of 2009 to $755,000. The majority of this increase is due to the loss on repossessed real estate property, which increased $446,000 in the first three months of 2009 when compared the same period in 2008. During the quarter ended March 31, 2008, three properties were sold at a loss of approximately $18,000. The nine properties sold in 2009 were sold at a loss of $464,000.

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HILLS BANCORPORATION


Item 2.	Management’s Discussion and Analysis of Financial Condition And Results of Operations (continued)

Income Taxes

Federal and state income tax expenses were $1,367,000 and $2,184,000 for the three months ended March 31, 2009 and 2008, respectively. Income taxes as a percentage of income before taxes were 25.52% in 2009 and 31.32% in 2008.

The decrease in the effective tax rate is due to an increase in the percentage of income before income taxes represented by tax-exempt interest income and an increase in tax credits. For the first three months of 2008, tax-exempt interest income was $841,000, or 12.06% of income before income taxes resulting in a 4.22% decrease in the effective tax rate. For the first three months of 2009, tax-exempt interest income increased to $853,000, or 15.93% of income before income taxes, which decreased the effective tax rate an additional 1.35% as compared to the same period in 2008, for a total reduction in the effective tax rate that was attributable to the increase in tax-exempt income of 5.57% in 2009. Also, tax credits increased $183,000 to $360,000 for the three months ended March 31, 2009 as compared to $177,000 the same period in 2008, reducing the 2009 effective tax rate an additional 4.18% compared to 2008. The additional tax credits that were available in 2009 resulted in a reduction in the effective tax rate of 6.72% compared to a reduction of 2.54% in the comparable period in 2008.

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. Federal funds sold and investment securities available for sale comprised 14.99% of the Company’s total assets at March 31, 2009, compared to 11.25% at December 31, 2008.

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 March 31, 2009, the Company had borrowed $265.0 million from the Federal Home Loan Bank (“FHLB”) of Des Moines. There have been no new borrowings from the FHLB in 2009. 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 $131.9 million at March 31, 2009.

As additional sources of liquidity, the Company has the ability to borrow up to $10 million from the Federal Reserve Bank of Chicago, and has lines of credit with two banks totaling $142.2 million. Those two lines of credit require the pledging of investment securities when drawn upon. 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 March 31, 2009.

As of March 31, 2009, investment securities with a carrying value of $36,039,000 were pledged to collateralize public and trust deposits, short-term borrowings and for other purposes, as permitted by law. As of December 31, 2008, investment securities with a carrying value of $99,937,000 were pledged.

Contractual Obligations

The Company will be constructing its fourteenth office location during 2009. The Company signed a contract for the construction of the office in April 2009 with costs of construction not to exceed $3.0 million.

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HILLS BANCORPORATION


Item 3.	Quantitative and Qualitative Disclosures About Market Risk

Market Risk Management

The Company’s primary market risk exposure is to changes in interest rates. 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. Conversely, 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.

Asset/Liability Management

The Bank maintains an asset/liability committee, which meets at least quarterly to review the Bank’s interest rate sensitivity position and to review various strategies as to interest rate risk management. 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.

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 savings or transaction deposit accounts, which are less sensitive to changes in interest rates and can be re-priced rapidly.

Net interest income should decline as interest rates increase, while net interest income should increase as interest rates decline. Generally, during periods of increasing interest rates, the Company’s interest rate sensitive liabilities would re-price faster than its interest rate sensitive assets causing a decline in the Company’s interest rate spread and margin. This would tend to reduce net interest income because the resulting increase in the Company’s cost of funds would not be immediately offset by an increase in its yield on earning assets. In times of decreasing interest rates, fixed rate assets could increase in value and the lag in re-pricing of interest rate sensitive assets could be expected to have a positive effect on the Company’s net interest income.

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HILLS BANCORPORATION


Item 4.	Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in the Securities Exchange Act of 1934 Rule 13a-15(f). 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 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 first quarter of 2009 that have materially affected, or are reasonably likely to affect materially, the Company’s internal controls over financial reporting.

Page 28 of 34

HILLS BANCORPORATION
PART II - OTHER INFORMATION


Item 1.	Legal Proceedings

No material legal proceedings are pending.


Item 1A.	Risk Factors

There have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.


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

The following table sets forth information about the Company’s stock purchases, all of which were made pursuant to the 2005 Stock Repurchase Program, for the three months ended March 31, 2009:


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)

January 1 to January 31		765	$	55.00		157,647		592,353

February 1 to February 28		2,300		55.00		159,947		590,053

March 1 to March 31		7,565		55.00		167,512		582,488

Total		10,630	$	55.00		167,512		582,488

(1) On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to 750,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”). This authorization was previously set to expire on December 31, 2009. At its January 2009 meeting, the Company’s Board of Directors extended the expiration date of the 2005 Stock Repurchase Program to December 31, 2013. 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.


Item 3.	Defaults upon Senior Securities

Hills Bancorporation has no senior securities.


Item 4.	Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the quarter ended March 31, 2009.


Item 5.	Other Information

None


Item 6.	Exhibits


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

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

Page 29 of 34

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: May 8, 2009		By: /s/ Dwight O. Seegmiller

		Dwight O. Seegmiller, Director, President and Chief Executive Officer

Date: May 8, 2009		By: /s/ James G. Pratt

		James G. Pratt, Secretary, Treasurer and Chief Accounting Officer

Page 30 of 34

HILLS BANCORPORATION
QUARTERLY REPORT OF FORM 10-Q FOR THE
QUARTER ENDED MARCH 31, 2009


Exhibit Number	Description	Page Number In The Sequential Numbering System March 31, 2009 Form 10-Q


31	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002	32 - 33 of 34

32	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002	34 of 34

Page 31 of 34