HILLS BANCORPORATION - Annual Report: 2019 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)



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

For the fiscal year ended December 31, 2019



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

For the transition period from October 1, 2019 to December 31, 2019

Commission file number 0-12668

Hills Bancorporation

(Exact name of registrant as specified in its charter)



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

131 E. Main Street, PO Box 160	Hills	Iowa	52235
(Address of Principal Executive Offices)			(Zip Code)

(319) 679-2291

Registrant's telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act: None



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

Securities registered pursuant to section 12(g) of the Act:

_________________________________________________No par value common stock_______________________________________

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No o

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



Large accelerated filer	o	Accelerated filer	x
Non-accelerated filer	o	Smaller reporting company	☐
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2019, based on the most recent sale price of $63.50 per share, and 7,726,130 shares held was $490,609,255. Common stock held by non-affiliates excludes 1,620,319 shares held by directors, executive officers, and under the Registrant’s Employee Stock Ownership Plan.

The number of shares outstanding of the Registrant's common stock as of February 29, 2020 is 9,435,369 shares of no par value common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement dated March 20, 2020 for the Annual Meeting of the Shareholders of the Registrant to be held April 20, 2020 (the Proxy Statement) are incorporated by reference in Part III of this Form 10-K.

Table of Contents

HILLS BANCORPORATION

FORM 10-K

TABLE OF CONTENTS



	PART I
Item 1.	Business	Page 3
	General	Page 3
	Market Area	Page 7
	Competition	Page 7
	Supervision and Regulation	Page 8
Item 1A.	Risk Factors	Page 14
Item 1B.	Unresolved Staff Comments	Page 21
Item 2.	Properties	Page 21
Item 3.	Legal Proceedings	Page 22
Item 4.	Mine Safety Disclosures	Page 22

	PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	Page 22
Item 6.	Selected Financial Data	Page 25
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	Page 26
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	Page 49
Item 8.	Consolidated Financial Statements and Supplementary Data	Page 51
Item 9.	Changes In and Disagreements with Accountants on Accounting and Financial Disclosure	Page 106
Item 9A.	Controls and Procedures	Page 106
Item 9B.	Other Information	Page 107

	PART III
Item 10.	Directors, Executive Officers and Corporate Governance	Page 107
Item 11.	Executive Compensation	Page 108
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	Page 108
Item 13.	Certain Relationships and Related Transactions, and Director Independence	Page 108
Item 14.	Principal Accounting Fees and Services	Page 108

	PART IV
Item 15.	Exhibits, Consolidated Financial Statement Schedules	Page 109

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PART I

References in this report to “we,” “us,” “our,” “Bank,” or the “Company” or similar terms refer to Hills Bancorporation and its subsidiary.



Item 1.	Business

GENERAL

Hills Bancorporation (the "Company") is a holding company principally engaged, through its subsidiary bank, in the business of banking. The Company was incorporated December 12, 1982 and all operations are conducted within the state of Iowa. The Company became owner of 100% of the outstanding stock of Hills Bank and Trust Company, Hills, Iowa (“Hills Bank and Trust” or the “Bank”) as of January 23, 1984 when stockholders of Hills Bank and Trust exchanged their shares for shares of the Company. Effective July 1, 1996, the Company formed a new subsidiary, Hills Bank, which acquired for cash all the outstanding shares of a bank in Lisbon, Iowa. Subsequently an office of Hills Bank was opened in Mount Vernon, Iowa, a community that is contiguous to Lisbon. Effective November 17, 2000, Hills Bank was merged into the Bank. On September 20, 1996, another subsidiary, Hills Bank Kalona, acquired cash and other assets and assumed the deposits of the Kalona, Iowa office of Boatmen's Bank Iowa, N.A. Effective October 26, 2001, Hills Bank Kalona was merged into the Bank.

Through its internet website (www.hillsbank.com), the Company makes available the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, all amendments to those reports, and other filings with the Securities and Exchange Commission, as soon as reasonably practicable after they are filed or furnished.

The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers. The Bank is actively engaged in all areas of commercial banking, including acceptance of demand, savings and time deposits; making commercial, real estate, agricultural and consumer loans; maintaining night and safe deposit facilities; and performing collection, exchange and other banking services tailored for individual customers. The Bank administers estates, personal trusts, and pension plans and provides farm management, investment advisory and custodial services for individuals, corporations and nonprofit organizations. In addition, the Bank earns substantial fees from originating mortgages that are sold on the secondary residential real estate market without mortgage servicing rights being retained.

Lending Activities

Real Estate Loans

Real estate loans totaled $2.244 billion and comprised 85.03% of the Bank’s loan portfolio as of December 31, 2019. The Bank’s real estate loans include construction loans and mortgage loans.

Mortgage Loans. The Bank offers residential, commercial and agricultural real estate loans. As of December 31, 2019, mortgage loans totaled $2.056 billion and comprised 77.89% of the Bank’s loan portfolio.

Residential real estate loans totaled $1,059.97 million and were 40.16% of the Bank’s loan portfolio as of December 31, 2019. These loans include first and junior liens on 1 to 4 family residences. The Bank originates 1 to 4 family mortgage loans to individuals and businesses within its trade area. The Bank sells certain mortgage loans to third parties on the secondary market. For the loans sold on the secondary market, the Bank does not retain any percentage of ownership or servicing rights. Interest rates for residential real estate mortgages are determined by competitive pricing factors on the secondary market and within the Bank’s trade area. Collateral for residential real estate mortgages is generally the underlying property. Generally, repayment of these loans is from monthly principal and interest payments from the borrower’s personal cash flows and liquidity, and collateral values are a function of residential real estate values in the markets that the Bank serves.

Commercial real estate loans totaled $402.18 million and were 15.24% of the Bank’s loan portfolio at December 31, 2019. The Bank originates loans for commercial properties to individuals and businesses within its trade area. The primary source of repayment is the cash flow generated by the collateral underlying the loan. The secondary repayment source would be the liquidation of the collateral. Generally, terms for commercial real estate loans range from one to five years with an amortization period of 25 years or less. The Bank offers both fixed and variable rate loans for commercial real estate.

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Multi-family real estate loans totaled $350.76 million and were 13.29% of the Bank’s loan portfolio at December 31, 2019. Multi-family real estate loans are made to individuals and businesses in the Bank’s trade area. These loans are primarily secured by properties such as apartment complexes. The primary source of repayment is the cash flow generated by the collateral underlying the loan. The secondary repayment source would be the liquidation of the collateral. Generally, terms for commercial real estate loans range from one to five years with an amortization period of 25 years or less. Generally, interest rates for multi-family loans are fixed for the loan term.

Mortgage loans secured by farmland totaled $242.73 million and were 9.20% of the Bank’s loan portfolio at December 31, 2019. Loans for farmland are made to individuals and businesses within the Bank’s trade area. The primary source of repayment is the cash flow generated by the collateral underlying the loan. The secondary repayment source would be the liquidation of the collateral. Terms for real estate loans secured by farmland range from one to ten years with an amortization period of 25 years or less. Generally, interest rates are fixed for mortgage loans secured by farmland.

Construction Loans. The Bank offers loans both to individuals that are constructing personal residences and to real estate developers and building contractors for the acquisition of land for development and the construction of homes and commercial properties. The Bank makes these loans to established borrowers in the Bank’s trade area. Construction loans generally have a term of one year or less, with interest payable at maturity. Interest rate arrangements are variable for construction projects. Generally, collateral for construction loans is the underlying construction project.

As of December 31, 2019, construction loans for personal residences totaled $80.21 million and were 3.04% of the Bank’s loan portfolio. Construction loans for land development and commercial projects totaled $108.41 million and were 4.10% of the Bank’s loan portfolio. In total, construction loans totaled $188.62 million and were 7.14% of the Bank’s loan portfolio as of December 31, 2019.

Commercial and Financial Loans

The Bank’s commercial and financial loan portfolio totaled $221.32 million and comprised 8.39% of the total loan portfolio at December 31, 2019. The Bank’s commercial and financial loans include loans to contractors, retailers and other businesses. The Bank provides a wide range of business loans, including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment. Although most loans are made on a secured basis, loans may be made on an unsecured basis where warranted by the overall financial condition of the borrower. Terms of commercial and financial loans generally range from one to five years. Interest rates for commercial loans can be fixed or variable.

The Bank’s commercial and financial loans are primarily made based on the reported cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The collateral support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of personal guarantees, if applicable. The primary repayment risks of commercial loans are that the cash flows of the borrower may be unpredictable, and the collateral securing these loans may fluctuate in value.

Agricultural Loans

Agricultural loans include loans made to finance agricultural production and other loans to farmers and farming operations. These loans totaled $91.32 million and constituted 3.46% of the total loan portfolio at December 31, 2019. Agricultural loans, most of which are secured by crops and machinery, are provided to finance capital improvement and farm operations as well as acquisitions of livestock and machinery. The ability of the borrower to repay may be affected by many factors outside of the borrower’s control including adverse weather conditions, loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations. The ultimate repayment of agricultural loans is dependent upon the profitable operation or management of the agricultural entity. Agricultural loans generally have a term of one year and may have a fixed or variable rate.

Consumer Lending

The Bank offers consumer loans including personal loans and automobile loans. These consumer loans typically have shorter terms and lower balances. At December 31, 2019, consumer loans totaled $32.31 million and were 1.22% of the Bank’s total loan portfolio.

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Loans to State and Political Subdivisions

Loans to State and Political Subdivisions include only tax-exempt loans. These loans totaled $49.90 million and comprised 1.90% of the Bank’s total loan portfolio at December 31, 2019.

Deposit Activities

The Bank’s primary funding source for its loan portfolio and other investments consist of the acceptance of demand, savings and time deposits.

Average Daily Balances

The following table shows average balances of assets, liabilities and stockholders’ equity:

AVERAGE BALANCES

(Average Daily Basis)



	Years Ended December 31,
	2019		2018		2017
	(Amounts In Thousands)
ASSETS
Noninterest-bearing cash and cash equivalents	$	27,663	$	27,914	$	27,409
Interest-bearing cash and cash equivalents	190,205		105,609		37,024
Taxable securities	139,188		128,128		105,059
Nontaxable securities	189,739		180,912		168,877
Federal funds sold	79		46		71
Loans, net	2,611,546		2,487,736		2,340,606
Property and equipment, net	36,584		37,766		38,139
Other assets	44,631		32,178		39,175
	$	3,239,635	$	3,000,289	$	2,756,360
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits	$	366,682	$	364,916	$	342,640
Interest-bearing demand deposits	716,848		644,712		548,598
Savings deposits	851,503		832,772		748,862
Time deposits	661,548		537,575		451,208
Other borrowings	8		9		28,602
FHLB borrowings	213,468		228,066		268,411
Noninterest-bearing other liabilities	26,162		21,773		22,226
Redeemable common stock held by Employee Stock Ownership Plan	50,348		46,089		42,045
Stockholders' equity	353,068		324,377		303,768
	$	3,239,635	$	3,000,289	$	2,756,360

Other Information

The Bank’s business is not seasonal. As of December 31, 2019, the Company had no employees and the Bank had 432 full-time and 52 part-time employees.

For additional discussion of the impact of the economy on the financial condition and results of operations of the Company, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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Executive Officers of the Registrant

The executive officers of the Company and the Bank, along with their respective ages and positions held, are identified in the table below.



Name	Age	Position
Company
Dwight O. Seegmiller	67	Mr. Seegmiller, who joined the Company in 1975, has served as its President since 1986. Prior to 1986, Mr. Seegmiller was the Senior Vice President of Lending.

Shari J. DeMaris	50	Ms. DeMaris has held the position of Secretary, Treasurer and Principal Financial Officer since 2012.

Bank
Timothy D. Finer	58	Mr. Finer has held the position of Senior Vice President, Director of Real Estate Lending since 2005.

Steven R. Ropp	59	Mr. Ropp has held the position of Senior Vice President, Director of Commercial Banking since 2008.

Bradford C. Zuber	63	Mr. Zuber has held the position of Senior Vice President, Director of Trust Services since 1987.

Brian R. Globokar	46	Mr. Globokar has held the position of Senior Vice President, Trust Officer since 2015.

Joan M. Frieden	49	Ms. Frieden has held the position of Senior Vice President, Human Resource Director since 2005.

Kenneth W. Hinrichs	46	Mr. Hinrichs has held the position of Senior Vice President, Director of Operations and Digital Banking since 2019.

Kevin H. Sheehan	49	Mr. Sheehan has held the position of Senior Vice President, Director of Risk Management since 2019.

Lisa A. Shileny	43	Ms. Shileny has held the position of Senior Vice President, Director of Administration since 2019.

Neal T. Marple	50	Mr. Marple has held the position of Senior Vice President, Director of Information Services since 2019.

Nicole M. Slaubaugh	42	Ms. Slaubaugh has held the position of Senior Vice President, Director of Retail Banking since 2016.

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MARKET AREA

Johnson County

The Bank’s trade area includes the Johnson County communities of Iowa City, Coralville, Hills and North Liberty, located near Interstate 80 and Interstate 380 in Eastern Iowa. These communities have a combined population of approximately 120,400. Johnson County, Iowa has a population of approximately 154,600. The University of Iowa in Iowa City has approximately 32,500 students and 36,400 full and part-time employees, including 11,600 employees of The University of Iowa Hospitals and Clinics.

Linn County

The Bank operates offices in the Linn County, Iowa communities of Lisbon, Marion, Mount Vernon and Cedar Rapids, Iowa. Lisbon has a population of approximately 2,200 and Mount Vernon, located two miles from Lisbon, has a population of about 4,700. Both communities are within easy commuting distances to Cedar Rapids and Iowa City, Iowa. Cedar Rapids has a metropolitan population of approximately 174,600 including approximately 39,200 from adjoining Marion, Iowa and is located approximately 10 miles west of Lisbon, Iowa and 25 miles north of Iowa City on Interstate 380. The total population of Linn County is approximately 228,600. The largest employer in the Cedar Rapids area is Collins Aerospace, manufacturer of communications instruments, with approximately 9,400 employees.

Washington County

The Bank has offices located in Kalona, Washington and Wellman, Iowa, which are in Washington County. Kalona is located approximately 14 miles north of Washington. Wellman is located approximately 5 miles west of Kalona. Kalona has a population of approximately 2,900, Washington has a population of approximately 7,200 and Wellman has a population of about 1,400. The population of Washington County is approximately 22,100. Kalona, Washington and Wellman are primarily agricultural communities, but are located within easy driving distance for employment in Iowa City, Coralville and North Liberty.

COMPETITION

Competition among financial institutions in attracting and retaining deposits and making loans is intense. Traditionally, the Company’s most direct competition for deposits has come from commercial banks, savings institutions and credit unions doing business in its areas of operation. Increasingly, the Company has experienced competition for deposits from nonbanking sources, such as securities firms, insurance companies, money market mutual funds and financial services subsidiaries of commercial and manufacturing companies. Competition for loans comes primarily from other commercial banks, savings institutions, consumer finance companies, credit unions, mortgage banking companies, insurance companies and other institutional lenders. The Company competes primarily on the basis of products offered, customer service and price. A number of institutions with which the Company competes enjoy the benefits of fewer regulatory constraints and lower cost structures including favorable income tax treatments. Some have greater assets and capital than the Company does and, thus, are better able to compete on the basis of price than the Company. Technological advances, which may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties, could make it more difficult for the Company to compete in the future.

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The Bank is in direct competition for loans and deposits and financial services with a number of other banks and credit unions in Johnson, Linn and Washington County. A comparison of the number of office locations and deposits in the three counties as of June, 2019 (most recent date of available data from the FDIC and national credit union websites) is as follows:



	Johnson County			Linn County			Washington County
	Offices	Deposits (in millions)		Offices	Deposits (in millions)		Offices	Deposits (in millions)
Hills Bank and Trust Company	9	$	1,925	7	$	488	3	$	208
Branches of largest competing national bank	5	234		8	841		1	22
Largest competing independent bank	7	719		5	1,151		2	202
Largest competing credit union (1)	6	4,320		7	979		1	1
All other bank and credit union offices	22	956		81	3,384		8	211
Total Market in County	49	$	8,154	108	$	6,843	15	$	644


(1)	Deposit balance of the largest competing credit union in Johnson County and Linn County includes the credit union’s deposit balance for the entire institution. County specific deposit balances for the credit union are unavailable.

SUPERVISION AND REGULATION

Financial institutions and their holding companies are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions but also by the requirements of applicable state and federal statutes and regulations and the policies of various governmental regulatory authorities, including the Iowa Superintendent of Banking (the “Superintendent”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”), the Internal Revenue Service and state taxing authorities and the Securities and Exchange Commission (the “SEC”). The effect of applicable statutes, regulations and regulatory policies can be significant and cannot be predicted with a high degree of certainty.

Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and its subsidiary Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds and the depositors, rather than the stockholders, of financial institutions. The enforcement powers available to federal and state banking regulators are substantial and include, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions.

The following is a summary of the material elements of the regulatory framework applicable to the Company and its subsidiary Bank. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of the statutes, regulations and regulatory policies that are described. As such, the following is qualified in its entirety by reference to the applicable statutes, regulations and regulatory policies. Any change in applicable law, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiary Bank.

Regulation of the Company

General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the “BHCA”). According to Federal Reserve Board policy, bank/financial holding companies are expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each such subsidiary. This support may be required at times when a bank/financial holding company may not be able to provide support. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve. The Company is also required to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the Company and its subsidiary as the Federal Reserve may require.

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Investments and Activities. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the shares of the other bank or bank holding company (unless it already owns or controls the majority of such shares), (ii) acquiring all or substantially all of the assets of another bank or (iii) merging or consolidating with another bank holding company. Subject to certain conditions (including certain deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. On approving interstate acquisitions, however, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws which require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.

The BHCA also generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking as to be a proper incident thereto.” Under current regulations of the Federal Reserve, the Company either directly or through non-bank subsidiaries would be permitted to engage in a variety of banking-related businesses, including the operation of a thrift, sales and consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.

Federal law also prohibits any person from acquiring “control” of a bank holding company without prior notice to the appropriate federal bank regulator. “Control” is defined in certain cases as the acquisition of 10% or more of the outstanding shares of a bank or a bank holding company depending on the circumstances surrounding the acquisition.

Regulatory Capital Requirements. Bank holding companies are required to maintain minimum levels of capital in accordance with bank regulatory agencies' capital guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses. The guidelines include requirements to maintain certain core capital amounts included as Tier 1 capital at minimum levels relative to total assets (the "Tier 1 Leverage Capital Ratio") and at minimum levels relative to "risk-weighted assets" which is calculated by assigning value to assets, and off balance sheet commitments, based on their risk characteristics (the "Total Risk-Based Capital Ratio"), and to maintain total capital at minimum levels relative to risk-weighted assets (the "Total Risk-Based Capital Ratio").

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. The rule includes a new Common Equity Tier 1 Capital Ratio, an increased Tier 1 Leverage Capital Ratio and an increased Tier 1 Risk-Based Capital Ratio. Bank holding companies are required to include in Common Equity Tier 1 capital the effects of other comprehensive income adjustments, such as gains and losses on securities held to maturity, that are currently excluded from the definition of Tier 1 capital, but were allowed to make a one-time election not to include those effects. The Company and the Bank meet the well-capitalized requirements under the regulatory framework for prompt corrective action and have made the one-time election to exclude the effects of other comprehensive income adjustments on Tier 1 capital.

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 capital conservation buffer was phased in 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. As of December 31, 2019, the Company had regulatory capital in excess of the Federal Reserve’s minimum and well-capitalized definition requirements, with a Tier 1 Leverage Capital Ratio of 12.77%, with Common Equity Tier 1 Ratio of 16.90%, with Tier 1 Risk-Based Capital Ratio of 16.90% and Total Risk-Based Capital Ratio of 18.15%.

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Dividends. The ability of the Company to pay dividends to its shareholders is dependent upon the earnings and capital adequacy of its subsidiary Bank, which directly impact the ability of the Bank to pay dividends to the Company. The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends, which restrictions are discussed more thoroughly below. The Iowa Business Corporation Act (“IBCA”) allows the Company to make distributions, including cash dividends, to its shareholders unless, after giving effect to such distributions, either (i) the Company would not be able to pay its debts as they become due in the ordinary course of business or (ii) the Company’s total assets would be less than the sum of its total liabilities plus the amount that would be needed to satisfy preferential shareholder rights, if any, that are superior to the rights of those receiving the distribution. Additionally, the Federal Reserve has issued a policy statement with regard to the payment of cash dividends by bank holding companies. The policy statement provides that a bank holding company should not pay cash dividends which exceed its net income or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.

Federal Securities Regulation. The Company’s common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

Regulation of the Bank

General. The Bank is an Iowa-chartered bank, the deposit accounts of which are insured by the FDIC. As an Iowa-chartered, FDIC insured bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the Superintendent of Banking of the State of Iowa (the “Superintendent”), as the chartering authority for Iowa banks, and the FDIC, as the Bank’s primary federal regulator.

Deposit Insurance. The deposits of the Bank are insured up to regulatory limits set by the FDIC, and, accordingly in 2019, were subject to deposit insurance assessments based on the Federal Deposit Insurance Reform Act of 2005, as adopted and effective on April 21, 2006. The FDIC maintains the Deposit Insurance Fund (“DIF”) by assessing depository institutions an insurance premium (assessment). The amount assessed to each institution is based on the average total assets of the Company less average tangible equity as well as the degree of risk the institution poses to the DIF. The FDIC assesses higher rates to those institutions that pose greater risks to the insurance fund.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation (FICO), a mixed-ownership government corporation established in the 1980’s to recapitalize the Federal Savings and Loan Insurance Corporation. The current annualized assessment rate is 0.00 basis points due to the FICO bonds maturing in 2019.

Capital Requirements. The Bank is an insured state bank, incorporated under the laws of the state of Iowa. As such, the Bank is subject to regulation, supervision and periodic examination by the Superintendent. Among the requirements and restrictions imposed upon state banks by the Superintendent are the requirements to maintain reserves against deposits, restrictions on the nature and amount of loans, and restrictions relating to investments, opening of bank offices and other activities of state banks. Changes in the capital structure of state banks are also approved by the Superintendent. State banks must have a Tier 1 risk-based leverage ratio of 6.50% plus a fully-funded loan loss reserve. In certain instances, the Superintendent may mandate higher capital, but the Superintendent has not imposed such a requirement on the Bank. In determining the Tier 1 risk-based leverage ratio, the Superintendent uses total equity capital without unrealized securities gains and the allowance for loan losses less any intangible assets. At December 31, 2019, the Tier 1 risk-based leverage ratio of the Bank was 12.81% and exceeded the ratio required by the Superintendent.

Capital adequacy for banks took on an added dimension with the establishment of a formal system of prompt corrective action under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) which provides the federal banking regulators of the Bank with broad power to take prompt corrective action to resolve the problems of undercapitalized banking institutions. The extent of the regulators’ powers depends on whether the institution in question is “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Under prompt corrective action, banks that are inadequately capitalized face a variety of mandatory and discretionary supervisory actions. For example, “undercapitalized banks” must restrict asset growth, obtain prior approval for business expansion, and have an approved plan to restore capital. “Critically undercapitalized banks” must be placed in receivership or conservatorship within 90 days unless some other action would result in lower long-term costs to the deposit insurance fund.

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The actual amounts of risk-based capital and risk-based capital ratios as of December 31, 2019 and the minimum regulatory requirements for the Company and the Bank 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 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

Supervisory Assessments. All Iowa banks are required to pay supervisory assessments to the Superintendent to fund the Superintendent’s examination and supervision operations. The method of computation of the supervisory assessment is based on the assets of the bank, the expected hours needed to conduct examinations of that size bank and an additional amount if more work is required.

Community Investment and Consumer Protection Laws. The Community Reinvestment Act requires insured institutions to offer credit products and take other actions that respond to the credit needs of the community. Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Home Mortgage Disclosure Act.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) posed a significant impact on financial regulations. The Dodd-Frank Act created an independent regulatory body, the Bureau of Consumer Financial Protection (“Bureau”), with authority and responsibility to set rules and regulations for most consumer protection laws applicable to all banks – large and small - adds another regulator to scrutinize and police financial activities. The Bureau has responsibility for mortgage reform and enforcement, as well as broad new powers over consumer financial activities which could impact what consumer financial services would be available and how they are provided. The following consumer protection laws are the designated laws that fall under the Bureau’s rulemaking authority: the Alternative Mortgage Transactions Parity Act of 1928, the Consumer Leasing Act of 1976, the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Billing Act, the Fair Credit Reporting Act subject to certain exclusions, the Fair Debt Collection Practices Act, the Home Owners Protection Act, certain privacy provisions of the Gramm-Leach-Bliley Act, the Home Mortgage Disclosure Act (HMDA), the Home Ownership and Equity Protection Act of 1994, the Real Estate Settlement Procedures Act (RESPA), the S.A.F.E. Mortgage Licensing Act of 2008 (SAFE Act), and the Truth in Lending Act.

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Dividends. The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Bank. The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends. The Iowa Banking Act provides that an Iowa bank may not pay dividends in an amount greater than its undivided profits. The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2019. Notwithstanding the availability of funds for dividends, however, the Superintendent may prohibit the payment of any dividends by the Bank if the Superintendent determines such payment would constitute an unsafe or unsound practice. To maintain acceptable capital ratios in the Bank, certain of its retained earnings are not available for the payment of dividends. To maintain a ratio of total risk-based capital to assets of 8%, $223.92 million of the Bank’s Tier 1 capital of $424.13 million as of December 31, 2019, is available for the payment of dividends to the Company. Also, the capital conservation buffer discussed previously could limit the amount of payment of dividends if the Company fails to maintain required capital levels.

Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company, on investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiary, to principal stockholders of the Company, and to related interests of such directors, officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal stockholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.

Safety and Soundness Standards. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.

Branching Authority. Historically, Iowa’s intrastate branching statutes have been rather restrictive when compared with those of other states. Effective July 1, 2004, all limitations on bank office locations were repealed, which effectively allowed statewide branching. Since that date, banks have been allowed to establish an unlimited number of offices in any location in Iowa subject only to regulatory approval.

Under the Riegle-Neal Act, both state and national banks are allowed to establish interstate branch networks through acquisitions of other banks, subject to certain conditions including limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state law. Iowa permits interstate bank mergers, subject to certain restrictions, including a prohibition against interstate mergers involving an Iowa bank that has been in existence and continuous operation for fewer than five years.

State Bank Activities. Under federal law and FDIC regulations, FDIC insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the Bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the Bank is a member. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.

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Financial Privacy. In accordance with the Gramm-Leach-Bliley Financial Modernization Act of 1999 (the “GLB Act”), federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to non-affiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a non-affiliated third party. The privacy provisions of the GLB Act affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.

Anti-Money Laundering Initiatives and the USA Patriot Act. A major focus of governmental policy on financial institutions has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001 (the “USA Patriot Act”) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The U. S. Treasury Department has issued a number of regulations that apply various requirements of the USA Patriot Act to financial institutions such as the Bank. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.

Depositor Preference Statute. In the "liquidation or other resolution" of an institution by any receiver, U.S. federal legislation provides that deposits and certain claims for administrative expenses and employee compensation against the insured depository institution would be afforded a priority over general unsecured claims against that institution, including federal funds and letters of credit.

Government Monetary Policy. The earnings of the Company are affected primarily by general economic conditions and to a lesser extent by the fiscal and monetary policies of the federal government and its agencies, particularly the Federal Reserve. Its policies influence, to some degree, the volume of bank loans and deposits, and interest rates charged and paid thereon, and thus have an effect on the earnings of the Company's subsidiary Bank.

Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act was signed into law on July 21, 2010. The Dodd-Frank Act represents the most sweeping financial services industry reform since the 1930s. Generally, the Dodd-Frank Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the Dodd-Frank Act. The Dodd-Frank Act is expected to be fully phased in over twelve years. Among other things, the Dodd-Frank Act may result in added costs of doing business and regulatory compliance burdens and affect competition among financial services entities. Uncertainty exists as to the ultimate impact of many provisions of the Dodd-Frank Act, which could have a material adverse impact on the financial services industry as a whole and on the Company’s business, results of operations and financial condition. Additional information, including a summary of certain provisions of the Dodd-Frank Act, is available on the Federal Deposit Insurance Corporation website at www.fdic.gov/regulations/reform/initiatives.html.

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Item 1A.	Risk Factors

The performance of our Company is subject to various risks. We consider the risks described below to be the most significant risks we face, but such risks are not the only risk factors that could affect us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition or results of operations. For a discussion of the impact of risks on our financial condition and results of operations in recent years and on forward looking statements contained in this report, reference is made to Item 7 below.

We may be adversely affected by economic conditions in the local economies in which we conduct our operations, and in the United States in general.

Our primary market includes the Iowa counties of Johnson, Linn and Washington. Our market has been one of the strongest economic areas in Iowa exhibiting economic growth over the past ten years. The unemployment rate for our prime market area is favorable and the rate historically has been lower than the unemployment rates for both the United States and the State of Iowa. However, unfavorable or uncertain economic and market conditions may adversely affect our business and profitability. Our business faces various material risks, including credit risk, liquidity risk and the risk that the demand for our products and services will decrease. Consumer confidence, real estate values, interest rates and investment returns could make the types of loans we originate less profitable and could increase our credit risk and litigation expense. And, while the presence of the University of Iowa and its affiliated institutions has a significant favorable impact upon the regional economy, it is unclear what impact the State budget and funding models will have on the University of Iowa and the University of Iowa Hospitals and Clinics.

Changes in U.S. trade policies, such as the implementation of tariffs, and other factors beyond the Company’s control may adversely impact our business, financial condition and results of operations.

Throughout 2018 and 2019, the U.S. government implemented tariffs on certain products from countries or entities such as Mexico, Canada, China and the European Union. These countries have issued or continue to threaten retaliatory tariffs against products from the United States, including agricultural products. The United States and these countries may impose additional tariffs and retaliatory tariffs in the future. Tariffs, retaliatory tariffs or other trade restrictions on products and materials that our customers import or export, including agricultural products such as soybeans, could cause the prices of our customers’ products to increase which could reduce demand for such products, or reduce our customer margins, and adversely impact their revenues, financial results and ability to service debt. This could adversely affect our financial condition and results of operations. In addition, to the extent changes in the political environment have a negative impact on us or on the markets in which we operate, our business, results of operations and financial condition could be materially and adversely impacted in the future. In January 2020, passage of the United States-Mexico-Canada (USMCA) trade agreement helped to alleviate some of these risks. The USMCA updates trading rules to better reflect 21st century technology, regulates labor and environmental standards in Mexico, tightens the rules the auto industry must follow to trade vehicles duty free across the three countries and provides tariff-free trade in North America.

We may be adversely impacted by recent legislation and potential additional legislation and rulemaking.

The 2008-2009 recession produced a number of new laws that impact financial institutions including the Dodd-Frank Act. The Dodd-Frank Act established the Consumer Financial Protection Bureau (the “CFPB”) and granted it the broad authority to administer and enforce a new federal regulatory framework of consumer financial regulation. Any changes to state and federal banking laws and regulations may adversely impact our ability to expand services and to increase the value of our business. We are subject to extensive state and federal regulation, supervision, and legislation that govern almost all aspects of our operations. These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. In addition, our earnings are affected by the monetary policies of the Board of Governors of the Federal Reserve. These policies, which include regulating the national supply of bank reserves and bank credit, may have a major effect upon the source and cost of funds and the rates of return earned on loans and investments. The Federal Reserve influences the size and distribution of bank reserves through its open market operations and changes in cash reserve requirements against member bank deposits. We cannot predict what effect such act and any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, but such changes could be materially adverse to our financial performance.

Our profitability and liquidity may be adversely affected by deterioration in the credit quality of, or defaults by, third parties who owe us money or other assets.

We are exposed to the risk that third parties that owe us money or other assets will not fulfill their obligations. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Our rights against third parties may not be enforceable in all circumstances. In addition, deterioration in the credit quality of third parties whose securities

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or obligations we hold could result in losses and/or adversely affect our ability to use those securities or obligations for liquidity purposes.

Our financial condition has not been materially impacted by the deterioration in the credit quality of third parties except as related to borrower credit quality. Management believes that the allowance for loan losses is adequate to absorb probable losses on any existing loans that may become uncollectible but cannot predict loan losses with certainty and cannot assure that our allowance for loan losses will prove sufficient to cover actual losses in the future.

Changing interest rates may adversely affect our profits.

Our income and cash flows depend to a great extent on the difference between the interest rates earned by us on interest-earning assets such as loans and investment securities and the interest rates paid by us on interest-bearing liabilities such as deposits and borrowings. Our net interest margin will be affected by general economic conditions, fiscal and monetary policies of the federal government, and our ability to respond to changes in such rates. Our assets and liabilities are affected differently by a change in interest rates. An increase or decrease in rates, the length of loan terms or the mix of adjustable and fixed rate loans in our portfolio could have a positive or negative effect on our net income, capital and liquidity. We measure interest rate risk under various rate scenarios and using specific criteria and assumptions. A summary of this process is presented under the heading "Quantitative and Qualitative Disclosures about Market Risk" included under Item 7A of Part II of this Form 10-K. Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates may have an adverse effect on our business, financial condition and results of operations. Also, our interest rate risk modeling techniques and assumptions may not fully predict or capture the impact of actual interest rate changes on our financial condition and results of operations.

We experience intense competition for loans and deposits.

Competition in banking and financial services business in our market is highly competitive and is currently undergoing significant change. Our competitors include local commercial banks, local credit unions, online banks, mortgage companies, finance companies and other non-bank financial services providers. Increasingly, competitors are able to provide integrated financial services over a broad geographic area. Increased competition may result in a decrease in the amounts of loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are less favorable to us. Competition may also accelerate investments in technology or infrastructure. Any of these results could have a material adverse effect on our ability to grow and remain profitable.

If we do not continue to meet or exceed regulatory capital requirements and maintain our “well-capitalized” status, there could be an adverse effect on the manner in which we do business and on the confidence of our customers in us.

Under regulatory capital adequacy guidelines, we must meet guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items. Failure to meet minimum capital requirements could have a material effect on our financial condition and could subject us to a variety of enforcement actions, as well as certain restrictions on our business. Failure to maintain the status of “well-capitalized” under the regulatory framework could adversely affect the confidence that our customers have in us, which may lead to a decline in the demand for or a reduction in the prices that we are able to charge for our products and services. Failure to meet the guidelines could also limit our access to liquidity sources.

Our growth may require us to raise additional capital in the future, but that capital may not be available.

We may at some point need to raise additional capital to maintain our “well-capitalized” status. Any capital we obtain may result in the dilution of the interests of existing holders of our stock. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances of our ability to raise additional capital if needed, or if the terms will be acceptable to us.

Our allowance for loan losses may not be adequate to cover actual losses.

Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and non-performance. Our allowance for loan losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, current economic conditions and concentrations within the portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem

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loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed expectations, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses may result in a decrease in net income and capital, and may have a material adverse effect on our financial condition and results of operations.

In June 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments," which replaces the current "incurred loss" model for recognizing credit losses with an "expected loss" model referred to as the Current Expected Credit Loss model, or CECL. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the "incurred loss" model required under current GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our allowance for loan losses.

The Company is currently finalizing the CECL model and upon adoption of ASU 2016-13 (CECL) in the first quarter of 2020 anticipates an increase to the allowance for credit losses for loans of approximately $3 to $4 million and an unfunded commitment liability of approximately $1 to $2 million. See Note 1 for further discussion.

Our loan portfolio has a large concentration of real estate loans, which involve risks specific to real estate value.

Real estate loans, which constitute a large portion of our loan portfolio, include home equity, commercial, construction and residential loans, and such loans are concentrated in the Bank’s trade area. As of December 31, 2019, 85.03% of our loans had real estate as a primary component of collateral. The market value of real estate may fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Adverse developments affecting real estate values in our market could increase the credit risk associated with our loan portfolio. Also, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic events or governmental regulations outside of the control of the borrower could adversely impact the future cash flow and market values of the affected properties.

If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.

Our real estate loans also include construction loans, including land acquisition and development. Construction, land acquisition and development lending involves additional risks because funds are advanced based upon estimates of costs and the estimated value of the completed project. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. As a result, commercial construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project.

Commercial loans make up a significant portion of our loan portfolio.

Our commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Repayment of our commercial loans is often dependent on the cash flows of the borrower, which may be unpredictable. Most often, this collateral is accounts receivable, inventory, machinery and equipment. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The other types of collateral securing these loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

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There may be issues with environmental law compliance if we take possession of real property that secures a loan.

A significant portion of our loan portfolio is secured by real property. We may foreclose on and take title to certain real property. There is a risk that hazardous substances could be found on the property and we may be liable for remediation costs, personal injury and/or property damage. We may incur substantial expenses to comply with environmental laws which may materially reduce the property's value or limit our ability to dispose of the property. The remediation costs and any other financial liabilities associated with the property could have a material adverse effect on our financial condition and results of operations.

Our agricultural loans may involve a greater degree of risk than other loans, and the ability of the borrower to repay may be affected by many factors outside of the borrower’s control.

Payments on agricultural real estate loans are dependent on the profitable operation or management of the farm property securing the loan. The success of the farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, changes in market prices for agricultural products (both domestically and internationally) and the impact of government regulation (including changes in price supports, subsidies and environmental regulation). In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired. The primary crops in our market areas are corn and soybeans. Accordingly, adverse circumstances affecting these crops could have an adverse effect on our agricultural real estate loan portfolio.

We also originate agricultural operating loans. As with agricultural real estate loans, the repayment of operating loans is dependent on the successful operation or management of the farm property. Likewise, agricultural operating loans involve a greater degree of risk than lending on residential properties, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment or assets such as livestock or crops. The primary livestock in our market areas is hogs and turkeys. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.

We may be required to repurchase mortgage loans or reimburse investors and others as a result of breaches in contractual representations and warranties.

We sell residential mortgage loans to various parties that purchase mortgage loans for investment. The agreements under which we sell mortgage loans contain various representations and warranties regarding the origination and characteristics of the mortgage loans, including ownership of the loan, compliance with loan criteria set forth in the applicable agreement, validity of the lien securing the loan, absence of delinquent taxes or liens against the property securing the loan, and compliance with applicable origination laws. We may be required to repurchase mortgage loans, indemnify the investor, or reimburse the investor for credit losses incurred on loans in the event of a breach of contractual representations or warranties. The agreements under which we sell mortgage loans require us to deliver various documents to the investor, and we may be obligated to repurchase any mortgage loan as to which the required documents are not delivered or are defective.

We depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors and accountants if made available. If this information is inaccurate, we may be subject to regulatory action, reputational harm or other adverse effects with respect to the operation of our business, our financial condition and our results of operation.

Growth levels in local and national real estate markets may impact our operations and/or financial condition.

Change in growth in the national housing market as evidenced by reports of levels of new and existing home sales, inventories of houses on the market, property values, building permits, and the time houses remain on the market may indicate increased levels of credit risk. In past history of real estate growth, some lenders made many adjustable-rate mortgage loans, and lowered their credit standards with respect to mortgage loans and home equity loans. A subsequent slowdown in the national housing market created uncertainty and liquidity issues relating to the value of such mortgage loans, which caused disruption in credit markets. Management will continue to monitor that the Bank has maintained appropriate lending standards in times of real estate growth and decline. No assurance can be given that these conditions will not directly or indirectly affect our operations.

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If we are unable to continuously attract deposits and other short-term funding, our financial condition and our business prospects could be adversely affected.

In managing our liquidity, our primary source of short-term funding is customer deposits. Our ability to continue to attract these deposits, and other short-term funding sources, is subject to variability based upon a number of factors, including the relative interest rates we are prepared to pay for these liabilities and the perception of safety of those deposits or short-term obligations relative to alternative short-term investments. The availability and cost of credit in short-term markets depends upon market perceptions of our liquidity and creditworthiness. Our efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated changes in event-driven reductions in liquidity. In such events, our cost of funds may increase, thereby reducing our net interest revenue, or we may need to dispose of a portion of our investment portfolio, which, depending on market conditions, could result in our realizing a loss or experiencing other adverse consequences.

Conditions in the financial markets may limit our access to funding to meet our liquidity needs.

Liquidity is essential to our business, as we must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a substantial adverse effect on our liquidity. Our access to funding sources in the amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could adversely affect our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as severe disruption of the financial markets or adverse news and expectations about the prospects for the financial services industry as a whole.

As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources include brokered money markets and certificates of deposit, federal funds purchased, lines of credit and Federal Home Loan Bank advances. Negative operating results or changes in industry conditions could lead to an inability to replace these additional funding sources at maturity. Our financial flexibility could be constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our results of operations and financial condition would be adversely affected.

Reduction in the value, or impairment of our investment securities, may impact our earnings and stockholders' equity.

We maintained a balance of $366.37 million, or 11.10% of our assets, in investment securities at December 31, 2019. Changes in market interest rates may affect the value of these investment securities, with increasing interest rates generally resulting in a reduction of value. Although the reduction in value from temporary increases in market rates does not affect our income until the security is sold, it does result in an unrealized loss recorded in other comprehensive income that may reduce our stockholders' equity. Further, we periodically test our investment securities for other-than-temporary impairment in value. In assessing whether the impairment of investment securities is other-than-temporary, we consider the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability to retain our investment in the security for a period of time sufficient to allow for any anticipated recovery in fair value.

Our growth strategy relies heavily on our management team, and the unexpected loss of key managers and/or officers may adversely affect our operations.

Our success is dependent on experienced senior management with a strong local community network. Our ability to retain the current management team is key to the successful implementation of our growth strategy. It is equally important that we are able to continue to attract and retain quality and community-focused managers and officers. The unexpected loss of one of our key managers and/or officers or the inability to attract qualified personnel could have an adverse effect on our operations, financial condition and reputation.

We are subject to risks associated with technological changes and the resources needed to implement the changes.

Our industry is susceptible to significant technological changes as there continue to be a high level of new technology driven products and services introduced. Technological advancement aids us in providing customer service and increases efficiency. Our national competitors may have more resources to invest in technological changes. As a result they may be able to offer products and services that are more technologically advanced and that may put us at a competitive disadvantage. Our future may depend on our ability to analyze technological changes to determine the best course of action for our business, customers and shareholders.

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We rely heavily on our network security and any system failure or data breach could subject us to increased costs as well as reputational risk.

Our operations are dependent on our ability to process financial transactions in a secure manner. Failure in or breach of our operational or security systems or infrastructure, or those of our third-party vendors and other service providers, could disrupt our business or the businesses of our customers, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses. We must ensure that information is properly protected from a variety of threats such as cyber attacks, error, fraud, sabotage, terrorism, industrial espionage, privacy violation, service interruption, and natural disaster. These threats arise from numerous sources including human error, fraud on the part of employees or third parties, technological failure, telecommunication outages, and severe weather conditions. Information security risks for financial institutions like us have increased recently in part because of new technologies, the increased use of the internet and telecommunications technologies (including mobile devices and cloud computing) to conduct financial and other business transactions, political activism, and the increased sophistication and activities of organized crime. Although we employ detection and response mechanisms designed to contain and mitigate security incidents, early detection may be thwarted by persistent sophisticated attacks and malware designed to avoid detection.

While we have not been materially impacted by cyber incidents, we have been subject to other intentional cyber incidents from third parties over the last several years, including denial of service attacks which attempt to interrupt service to customers and malicious software attacks on computer systems which attempt to allow unauthorized entrance. We also face risks related to cyber attacks and other security breaches in connection with card transactions that typically involve the transmission of sensitive information regarding our customers through various third parties. Some of these parties have in the past been the target of security breaches and cyber attacks, and because the transactions involve third parties and environments that we do not control or secure, future security breaches or cyber attacks affecting any of these third parties could impact us through no fault of our own, and in some cases we may have exposure and suffer losses for breaches or attacks relating to them. We also rely on numerous other third party service providers to conduct other aspects of our business operations and face similar risks relating to them. While we conduct security assessments on our higher risk third party service providers, we cannot be sure that their information security protocols are sufficient to withstand a cyber attack or other security breach. There can be no assurance that cyber incidents will not occur and they could occur more frequently and on a more significant scale.

We devote significant resources to implement, maintain, monitor and regularly upgrade our systems and networks with measures such as intrusion detection and prevention and firewalls to safeguard critical business applications. The additional cost to the Company of our cyber security monitoring and protection systems and controls includes the cost of hardware and software, third party technology providers, consulting, and legal fees, in addition to the incremental cost of our personnel who focus a substantial portion of their responsibilities on cyber security. In addition, because cyber attacks can change frequently we may be unable to implement effective preventive or proactive measures in time. With the assistance of third-party service providers, we intend to continue to implement security technology and establish procedures to maintain network security, but there is no assurance that these measures will be successful. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.

Any activity that jeopardizes our network and the security of the information stored thereon may result in significant cost and have a significant adverse effect on our reputation. We maintain insurance coverage that may, subject to policy terms and conditions, cover certain aspects of cyber risks. Such insurance coverage may be insufficient to cover all losses.

Any successful cyber attack or other security breach involving the misappropriation or other unauthorized disclosure of confidential customer information or that compromises our ability to function could severely damage our reputation, erode confidence in the security of our systems, products and services, expose us to the risk of litigation and liability, disrupt our operations and have a material adverse effect on our business. Any successful cyber attack may also subject the Company to regulatory investigations, litigation or enforcement, or require the payment of regulatory fines or penalties or undertaking costly remediation efforts with respect to third parties affected by a cyber security incident, all or any of which could adversely affect the Company’s business, financial condition or results of operations and damage its reputation.

Loss of key third-party vendor relationships or failure of a vendor to protect information of our customers or employees could adversely affect our business or result in losses.

We rely on third-party vendors to provide key components of our business operations such as data processing, recording and monitoring transactions, online and mobile banking interfaces and services, internet connections and network access. While we have performed due diligence procedures in selecting vendors, we do not control their actions. In the event that one or more of our vendors suffers a bankruptcy or otherwise becomes unable to continue to provide products or services, or fails to protect non-

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public personal information of our customers or employees, we may suffer operational impairments, reputational damage and financial losses. Replacing these third-party vendors could create significant delay and expense. Accordingly, use of such third parties creates an inherent risk to our business operations.

The potential for business interruption exists throughout our organization.

Integral to our performance is the continued efficacy of our technical systems, operational infrastructure, relationships with third parties and the array of personnel involved with bank operations. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes, but is not limited to, operational or technical failures, ineffectiveness or exposure due to interruption in third-party support, as well as the loss of key individuals or failure on the part of key individuals to perform properly. These risks are heightened during data system changes or conversions. Although management has established policies and procedures to address such failures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Our risk management framework may not be effective in mitigating risk and loss.

We maintain an enterprise risk management program that is designed to identify, quantify, monitor, report and control the risks that we face. These include credit, liquidity, market, operational, reputational, compliance, strategic, information technology and security, and trust risks. While we assess this program on an ongoing basis, there can be no assurance that its approach and framework for risk management and related controls will effectively mitigate risk and limit losses in our business. If conditions or circumstances arise that expose flaws or gaps in the risk management program or if its controls break down, the performance and value of our business could be adversely affected.

Our internal controls may be ineffective.

We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well-designed and operated, is based in part on certain assumptions and may provide only reasonable, not absolute, assurances that the objectives of the controls are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, financial condition and results of operation.

We are subject to a variety of litigation or other proceedings, which could adversely affect our business.

We are involved from time to time in a variety of litigation or other proceedings arising out of business or operations. We establish reserves for claims when appropriate under accounting principles generally accepted in the United States of America, but costs often may be incurred in connection with a matter before any reserve has been created. In addition, the actual costs associated with resolving a claim may be substantially higher than amounts that we have reserved. Substantial legal claims could have a detrimental impact on our business, results of operations, and financial condition and may cause reputational harm.

New products and services are essential to remain competitive but may subject us to additional risks.

We consistently attempt to offer new products and services to our customers to remain competitive. There can be risks and uncertainties associated with these new products and services especially if they are newer to market products and services. We may spend significant time and resources in development of new products and services to market to customers. Through our development and implementation process we may incur risks associated with delivery timetables, pricing and profitability, compliance with regulations, effect on internal controls and shifting customer preferences. Failure to successfully manage these risks could have a material effect on our financial condition, result of operations, and business.

Our customers may decide to use non-bank competitors for financial transactions, which could result in loss of business.

Advancement in technology and other changes are increasing the ability for customers to complete financial transactions that have traditionally involved banks through non-bank competitors. Elimination of banks as intermediaries of financial transactions could result in the loss of customer deposits as well as fee income to us.

We are subject to risks associated with negative publicity.

Reputational risk arises from the potential that negative publicity regarding our business practices, whether true or not, could cause a decline in our customer base, costly litigation, or revenue reductions. In addition, our success in maintaining our reputation depends on the ability to adapt to a rapidly changing environment including increasing reliance on social media.

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We may be adversely affected by changes in U.S. tax laws and regulations.

The Tax Cuts and Jobs Act was signed into law in December 2017, reforming the U.S. tax code. The legislation includes lowering the federal corporate income tax rate to 21 percent beginning in 2018 from a maximum rate of 35 percent, modifying the U.S. taxation of income earned outside the U.S. and limiting or eliminating various deductions, tax credits and/or other tax preferences. The legislation could negatively impact our customers because it lowers the existing caps on mortgage interest deductions and limits the state and local tax deductions. These changes could make it more difficult for borrowers to make their loan payments and could also negatively impact the housing market, which could adversely affect our business and loan growth.

Our stock is thinly traded.

The average daily trading volume of our common stock is relatively small compared to many public companies. The desired market characteristics of depth, liquidity, and orderliness require the substantial presence of willing buyers and sellers in the marketplace at any given time. In our case, this presence depends on the individual decisions of a relatively small number of investors and general economic and market conditions over which we have no control. Due to the relatively small trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause the stock price to fall more than would be justified by the inherent worth of the Company. Conversely, attempts to purchase a significant amount of our stock could cause the market price to rise above the reasonable inherent worth of the Company.

The stock market can be volatile, and fluctuations in our operating results and other factors could cause our stock price to decline.

The stock market has experienced, and may continue to experience, fluctuations that significantly impact the market prices of securities issued by many companies. Market fluctuations could adversely affect our stock price. These fluctuations have often been unrelated or disproportionate to the operating performance of particular companies. These broad market fluctuations, as well as general economic, systemic, political and market conditions, such as recessions, loss of investor confidence, or interest rate changes, may negatively affect the market price of our common stock. Moreover, our operating results may fluctuate and vary from period to period due to the risk factors set forth herein. As a result, period-to-period comparisons should not be relied upon as an indication of future performance. Our stock price could fluctuate significantly in response to the impact these risk factors have on our operating results or financial position.

There can be no assurances concerning continuing dividend payments.

Our common stockholders are only entitled to receive the dividends declared by our Board of Directors. Although we have historically paid annual dividends on our common stock, there can be no assurances that we will be able to continue to pay regular annual dividends or that any dividends we do declare will be in any particular amount. The primary source of money to pay our dividends comes from dividends paid to the Company by Hills Bank and Trust. Hills Bank and Trust’s ability to pay dividends to the Company is subject to, among other things, its earnings, financial condition and applicable regulations, which in some instances limit the amount that may be paid as dividends.



Item 1B.	Unresolved Staff Comments

None.



Item 2.	Properties

The Company's office and the main office of the Bank are located at 131 E. Main Street, Hills, Iowa. This is a brick building containing approximately 45,000 square feet. A portion of the building was built in 1977, a two-story addition was completed in 1984, and a two-story brick addition was completed in February 2001. With the completion of the 2001 addition, the entire Bank’s operations and administrative functions were consolidated in Hills, Iowa. The Bank operates its business from its main office and its 18 full service branches in the Iowa counties of Johnson, Linn and Washington. The Bank owns its main office complex and 14 of its branch offices. Four of the Bank’s branches are leased.

All of the properties owned by the Bank are free and clear of any mortgages or other encumbrances of any type. See Note 15 to the Consolidated Financial Statements for minimum future rental commitments for leased properties.

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Item 3.	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 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 and filed a motion to dismiss the case, which the Court denied. At this stage of the proceedings, it is not possible for management of the Bank to determine the probability of an adverse outcome or reasonably estimate the amount of any potential loss.



Item 4.	Mine Safety Disclosures

Not applicable.

PART II



Item 5.	Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

As of January 31, 2020, the Company had 2,644 stockholders. There is no established trading market for the Company's common stock, and the Company's stock is not actively traded. Our common stock is not listed on the NASDAQ stock market or any other stock exchange. While there is no established public trading market for our common stock, our shares are currently quoted in the inter-dealer quotation, or “over-the-counter,” marketplace under the trading symbol “HBIA.” The principal over-the-counter market is operated by OTC Markets Group, Inc., which provides quotes for the Company on its OTC Pink tier.

The high and low bid information for the Company’s stock for each quarter of the two most recent fiscal years, as reported by OTC Market Groups, Inc., is provided below. The prices indicated reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.



	2019				2018
	High		Low		High		Low
1st quarter	$	65.00	$	60.60	$	57.00	$	54.75
2nd quarter	65.85		62.01		57.50		55.50
3rd quarter	66.00		63.80		59.50		58.00
4th quarter	71.00		65.00		62.99		59.00

In addition, based on the Company’s stock transfer records and information informally provided to the Company, stock trading transactions have been as follows:



Year	Number of Shares Traded	Number of Transactions	High Selling Price		Low Selling Price
2019	126,189	146	$	65.00	$	61.00	(1)
2018	157,749	168	$	61.00	$	54.00	(2)
2017	93,095	176	$	54.00	$	48.00	(3)


(1)	2019 transactions included repurchases by the Company of 89,124 shares of stock under the 2005 Stock Repurchase Program. 2019 transactions made under the 2005 Stock Repurchase Program were made at prices that ranged from $61.00 to $65.00 per share.

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(2)	2018 transactions included repurchases by the Company of 116,962 shares of stock under the 2005 Stock Repurchase Program. 2018 transactions made under the 2005 Stock Repurchase Program were made at prices that ranged from $54.00 to $61.00 per share.


(3)	2017 transactions included repurchases by the Company of 46,966 shares of stock under the 2005 Stock Repurchase Program. 2017 transactions made under the 2005 Stock Repurchase Program were made at prices that ranged from $48.00 to $54.00 per share.

All transactions under the 2005 Stock Repurchase Program were at a price equal to the most recent quarterly independent appraisal of the shares of the Company's common stock. The most recent independent current quarterly appraisal value of the stock is $66.00 a share. The closing bid for the Company's stock on February 14, 2020 was $65.35 a share as reported by the OTC Markets Group, Inc.

The Company currently pays an annual dividend on its common stock to stockholders, and it expects to continue to maintain its annual dividend for the foreseeable future periods.

The following performance graph provides information regarding cumulative, five-year shareholder returns on an indexed basis of the Company's Common Stock compared to the NASDAQ Market Index and the Regional-Southwest Banks Index prepared by MORNINGSTAR of Chicago, IL. The latter index reflects the performance of twenty-five bank holding companies operating principally in the Midwest as selected by MORNINGSTAR. The indexes assume the investment of $100 on December 31, 2014 in Company Common Stock, the NASDAQ Index and the Regional-Southwest Banks Index, with all dividends reinvested.



	2014		2015		2016		2017		2018		2019
HILLS BANCORPORATION	$	100.00	$	109.51	$	119.85	$	136.80	$	156.68	$	169.20
REGIONAL-SOUTHWEST BANKS	$	100.00	$	97.30	$	147.25	$	155.26	$	141.52	$	172.41
NASDAQ MARKET INDEX	$	100.00	$	106.96	$	116.45	$	150.96	$	146.67	$	200.49

Note regarding the performance graph: Cumulative five-year Shareholder returns on an indexed basis. The indexes assume the investment of $100 in year with all dividends reinvested.

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The following table sets forth the Company’s equity compensation plan information as of December 31, 2019, all of which relates to stock options issued under stock option plans approved by stockholders of the Company:



Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)	Weighted-average exercise price of outstanding options, warrants and rights (b)		Number of securities remaining available for future issuance under equity compensation plans [excluding securities reflected in column (a)] (c)
Equity compensation plans approved by security holders	13,025	$	45.92	19,853
Equity compensation plans not approved by security holders	—	—		—
Total	13,025	$	45.92	19,853

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, 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.

The following table sets forth information about the Company’s stock purchases pursuant to the 2005 Stock Repurchase Program for the quarter ended December 31, 2019:



Period in 2019	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
October 1 to October 31	2,556	$	64.50	2,556	286,959
November 1 to November 30	2,602	65.00		2,602	284,357
December 1 to December 31	360	65.00		360	283,997
Total	5,518	$	64.77	5,518	283,997

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Item 6.	Selected Financial Data

CONSOLIDATED FIVE-YEAR STATISTICAL SUMMARY

The following table sets forth certain of our financial and statistical information for each of the years in the five-year period ended December 31, 2019. This data should be read in conjunction with the consolidated financial statements and the accompanying notes thereto included or incorporated by reference elsewhere in this document.



	2019			2018			2017			2016			2015
YEAR-END TOTALS (Amounts in Thousands)
Total assets	$	3,300,887		$	3,042,464		$	2,963,360		$	2,655,770		$	2,493,607
Investment securities	366,368			331,098			300,160			279,950			276,069
Loans held for sale	8,400			1,984			5,162			9,806			5,554
Loans, net	2,606,277			2,591,085			2,431,165			2,251,445			2,099,174
Deposits	2,661,364			2,421,124			2,288,565			2,036,312			1,890,702
Federal Home Loan Bank borrowings	185,000			215,000			295,000			235,000			225,000
Redeemable common stock	51,826			48,870			43,308			40,781			37,562
Stockholders' equity	375,211			334,882			311,716			289,270			272,175

EARNINGS (Amounts in Thousands)
Interest income	$	132,332		$	118,797		$	105,952		$	97,677		$	92,167
Interest expense	34,873			26,323			17,972			16,087			14,967
Provision for loan losses	(2,880		)	8,497			1,688			(1,163		)	1,655
Other income	24,792			23,818			20,818			19,995			20,802
Other expenses	67,264			62,123			59,512			56,799			55,460
Income taxes	12,549			8,905			19,537			14,394			12,469
Net income	45,318			36,767			28,061			31,555			28,418
Net income before Tax Act (1)	NA			NA			32,770			NA			NA

PER SHARE
Net income:
Basic	$	4.85		$	3.93		$	3.01		$	3.40		$	3.04
Basic before Tax Act (1)	NA			NA			3.51			NA			NA
Diluted	4.85			3.92			3.01			3.40			3.04
Diluted before Tax Act (1)	NA			NA			3.51			NA			NA
Cash dividends	0.820			0.750			0.700			0.650			0.625
Book value as of December 31	40.12			35.87			33.39			31.22			29.20
Increase (decrease) in book value due to:
ESOP obligation	(5.54		)	(5.23		)	(4.64		)	(4.40		)	(4.03		)
Accumulated other comprehensive income	0.15			(0.35		)	(0.26		)	(0.36		)	(0.13		)

SELECTED RATIOS
Return on average assets	1.40		%	1.23		%	1.02		%	1.23		%	1.19		%
Return on average assets before Tax Act (1)	NA			NA			1.19			NA			NA
Return on average equity	11.23			9.92			9.24			11.26			10.79
Return on average equity before Tax Act (1)	NA			NA			10.79			NA			NA
Net interest margin	3.18			3.25			3.43			3.43			3.50
Average stockholders' equity to average total assets	12.45			12.35			11.02			10.94			11.03
Dividend payout ratio	16.90			19.05			23.11			19.20			20.60


(1)	Non-GAAP financial measurement. For further information, refer to the Non-GAAP Financial Measures section of this report in Item 7.

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Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operation

The following discussion by management is presented regarding the financial results for the Company for the dates and periods indicated. The discussion should be read in conjunction with the “Selected Consolidated Five-Year Statistical Summary” and the consolidated financial statements and the accompanying notes thereto included or incorporated by reference elsewhere in this document.

An overview of the year 2019 is presented following the section discussing a special note regarding forward looking statements.

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 financial market disruptions and/or an 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 has investment or financial exposure.


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


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


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


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


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


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


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


•	The ability of the Company to develop and maintain secure and reliable technology 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.

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


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


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


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

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

Non-GAAP Financial Measures

This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the Company's presentation of net income without the effect of the Tax Cut and Jobs Act enacted on December 22, 2017 (the "Tax Act"), and the presentation of earnings per share, return on assets and return on equity with the adjusted net income figure. Management believes these Non-GAAP financial measures provide useful information to both management and investors to analyze and evaluate the Company's financial performance. Limitations associated with non-GAAP financial measures include the risks that persons might disagree as to the appropriateness of items included in these measures. These non-GAAP disclosures should not be considered an alternative to the Company's GAAP results. The following table reconciles the non-GAAP financial measures to GAAP.



	Year Ended December 31, 2017
Reconciliation of net income before effect of Tax Act to net income (GAAP):
Net Income (GAAP)	$	28,061
Tax Act related tax expense	4,709
Net Income before Tax Act related expense	$	32,770

Reconciliation of earnings per share before effect of Tax Act to earnings per share (GAAP):
Non-GAAP net income reconciled above	$	32,770
Weighted average shares outstanding (basic)	9,330,003
Earnings Per Share (basic) before effect of Tax Act	$	3.51

Weighted average shares outstanding (diluted)	9,334,635
Earnings Per Share (diluted) before effect of Tax Act	$	3.51

Reconciliation of return on average assets before effect of Tax Act to return on average assets (GAAP):
Non-GAAP net income reconciled above	$	32,770
Average assets	2,756,360
Return on average assets before effect of Tax Act	1.19		%

Reconciliation of return on average equity after effect of Tax Act to return on average equity (GAAP):
Non-GAAP net income reconciled above	$	32,770
Average equity	303,768
Return on average equity before effect of Tax Act	10.79		%

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Overview

The Company is a bank holding company engaged, through its wholly-owned subsidiary bank, in the business of commercial banking. The Company’s subsidiary is Hills Bank and Trust Company, Hills, Iowa. 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.

The Company’s net income for 2019 was $45.32 million compared to $36.77 million in 2018 and $28.06 million in 2017. Before the effect of the Tax Act, the Company's net income for 2017 would have been $32.77 million. (1) Diluted earnings per share were $4.85, $3.92, and $3.01 for the years ended December 31, 2019, 2018 and 2017, respectively. Before the effect of the Tax Act, diluted earnings per share would have been $3.51 in 2017. (1) Without the effect of the Tax Act, management estimates the Company's net income for 2018 would have been $30.96 million.

The Tax Act resulted in an approximately $4.7 million charge against net income primarily due to the write down of its deferred tax assets as a result of the Tax Act’s reduction in the base corporate tax rate from 35% to 21%. While the Tax Act negatively impacted earnings for the Company's fiscal year ended December 31, 2017, the lower corporate rate is expected to be a significant ongoing benefit to the Company.

The Bank’s net interest income is the largest component of the Bank’s revenue, and is a function of the average earning assets and the net interest margin percentage. Net interest margin is the ratio of net interest income to average earning assets. For the years ended December 31, 2019 and 2018, the Bank achieved a net interest margin of 3.18% and 3.25%, respectively. For the year ended December 31, 2019, net interest income on a tax equivalent basis increased by $5.11 million. In 2019, net interest income increased $5.55 million due to growth of $229.77 million in the Bank's average earning assets and decreased $0.44 million due to interest rate changes.

Highlights with respect to items on the Company’s balance sheet as of December 31, 2019 included the following:


•	Loans, net of allowance for loan losses and unamortized fees and costs, totaling $2.615 billion.


•	Net loan growth in 2019 of $15.19 million.


•	Deposit growth of $240.24 million in 2019. Deposits increased to $2.661 billion and included $109.29 million of brokered deposits.


•	FHLB Borrowings decreased $30.00 million.


•	Stockholders’ equity increased $40.33 million to $375.21 million in 2019, with dividends having been paid in 2019 of $7.66 million.

Reference is made to Note 13 of the Company’s consolidated financial statements for a discussion of fair value measurements which relate to methods used by the Company in recording certain assets and liabilities on its consolidated financial statements.

The return on average equity was 11.23% in 2019 compared to 9.92% in 2018. The returns for the three previous years, 2017, 2016 and 2015, were 9.24%, 11.26% and 10.79%, respectively. Before the effect of the Tax Act, the Company's 2017 return on average equity would have been 10.79%. (1) The Company remains well-capitalized as of December 31, 2019 with total risk-based capital at 18.15% and Tier 1 risk-based capital at 16.90%. The minimum regulatory guidelines are 8% and 6% respectively. The Company paid a dividend per share of $0.820 in 2019, $0.750 in 2018 and $0.700 in the year ended December 31, 2017.

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

(1) Non-GAAP financial measurement. For further information, refer to the Non-GAAP Financial Measurement section of this report.

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Critical Accounting Policies

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these financial statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policies to be those which are related to the allowance for loan losses.

Allowance for Loan Losses

The Company separates its portfolio loans and leases into segments for determining the allowance for loan losses. The Company's portfolio segments includes agricultural, commercial and financial, real estate, loans to individuals and obligations of state and political subdivisions. The Company further separates its portfolio into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes within the real estate portfolio segment includes 1 to 4 family residential construction, land development and commercial construction, farmland, 1 to 4 family first liens, 1 to 4 family junior liens, multi-family and commercial. For an analysis of the Company's allowance for loan losses by portfolio segment and credit risk rating information by class, see Note 3 to the Company's Consolidated Financial Statements.

Loans that exhibit probable or observed credit weaknesses, as well as loans that have been modified in a troubled debt restructuring ("TDR loans"), are subject to individual review for impairment. When individual loans are reviewed for impairment, the Company determines allowances based on management's estimate of the borrower's ability to repay the loan given the availability of the collateral, other sources of cash flow, as well as evaluation of legal options available. Allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral.

Historical loss rates are applied to loans that are not individually reviewed for impairment. A 20 quarter migration analysis performed by management uses loan level attributes to track the movement of loans through the various credit risk rating categories in order to estimate the percentage of historical loss to apply to each specific credit risk rating in each loan category. The credit risk rating system currently utilized for allowance analysis purposes encompasses six categories.

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 impaired loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include changes in lending policies and procedures; changes in national and local economic and business conditions; changes in the nature and volume of the loan portfolio; changes in the experience, ability and depth of lending management and staff; changes in the quality of the Bank's loan review system; the existence and effect of concentrations of credit; and the effect of any other identified external factors.

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. 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 for loan losses as of December 31, 2019 and 2018 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.

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Financial Position



Year End Amounts	2019		2018		2017		2016		2015
	(Amounts In Thousands)
Total assets	$	3,300,887	$	3,042,464	$	2,963,360	$	2,655,770	$	2,493,607
Investment securities	366,368		331,098		300,160		279,950		276,069
Loans held for sale	8,400		1,984		5,162		9,806		5,554
Loans, net	2,606,277		2,591,085		2,431,165		2,251,445		2,099,174
Deposits	2,661,364		2,421,124		2,288,565		2,036,312		1,890,702
Federal Home Loan Bank borrowings	185,000		215,000		295,000		235,000		225,000
Redeemable common stock	51,826		48,870		43,308		40,781		37,562
Stockholders' equity	375,211		334,882		311,716		289,270		272,175

Total assets at December 31, 2019 increased $258.42 million, or 8.49%, from the prior year-end. Asset growth from 2017 to 2018 was $79.10 million and represented a 2.67% increase. The largest growth in assets in 2019 occurred in Cash and Cash Equivalents, which increased $198.66 million as of December 31, 2019 compared to December 31, 2018 and decreased $111.05 million as of December 31, 2018 compared to December 31, 2017. Net Loans increased $15.19 million and $159.92 million for the years ended December 31, 2019 and 2018, respectively. Loans held for sale to the secondary market increased $6.42 million and decreased $3.18 for the years ended December 31, 2019 and 2018, respectively. Loans held for investment represent the largest component of the Bank’s earning assets. Loans held for investment were $2.640 billion and $2.629 billion at December 31, 2019 and 2018, respectively.

The local economy that generated consistent demand for loans was a significant factor in the trend of increasing net loans in each of the last five years. The trend of increasing Net Loans did slow in 2019 and may not continue, and as a result, may not be indicative of future performance.

Loans secured by real estate represent the largest increase in loan growth. These loans increased $21.29 million in 2019 and increased $154.56 million in 2018. Loans secured by real estate include loans for 1 to 4 family residential properties, multi-family properties, agricultural real estate, commercial real estate and construction and development.

On a net basis, the Company originated $13.02 million and $168.57 million in loans to customers for the years ended December 31, 2019 and 2018, respectively. Net loan originations decreased 92.27% in 2019 compared to 2018. The decrease in net loan originations in 2019 as compared to 2018 is reflective of a decrease in loan demand in the local commercial lending environment. The Company does not engage in significant participation activity and does not purchase participations from outside its established trade area. The Company’s policy allows for the purchase or sale of participations related to existing customers or to participate in community development activity. The Company held participations purchased of $15.17, $14.03 and $14.94 million as of December 31, 2019, 2018 and 2017, respectively. The participations purchased were less than one percent of loans held for investment for each of the three years.

The Company did not experience a material change in the composition of its loans held for investment in 2019 or 2018. Residential real estate loans, including first and junior liens, were $1,059.97 million, $1,064.68 million and $975.79 million as of December 31, 2019, 2018 and 2017, respectively. The dollar total of residential real estate loans decreased 0.44% in 2019 and increased 9.11% in 2018. Residential real estate loans were 40.16% of the loan portfolio at December 31, 2019, 40.51% at December 31, 2018 and 39.67% at December 31, 2017. Commercial real estate loans totaled $402.18 million at December 31, 2019, a 4.92% increase over the December 31, 2018 total of $383.31 million. Commercial real estate loans increased 6.12% in 2018. Commercial real estate loans totaled $361.20 million at December 31, 2017. Commercial real estate loans represented 15.24%, 14.59% and 14.69% of the Company’s loan portfolio as of December 31, 2019, 2018 and 2017, respectively. The Company monitors its commercial real estate level so that it does not have a concentration in that category that exceeds 300% of its capital. Commercial real estate loan concentration was 167.37% of capital as of December 31, 2019.

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The following table shows the composition of loans (before deducting the allowance for loan losses) as of December 31 for each of the last five years. The table does not include loans held for sale to the secondary market.




	2019		2018		2017		2016		2015

Agricultural	$	91,317	$	92,673	$	88,580	$	92,871	$	101,588
Commercial and financial	221,323		229,501		218,632		192,995		184,199
Real estate:
Construction, 1 to 4 family residential	80,209		72,279		69,738		57,864		51,346
Construction, land development and commercial	108,410		113,807		109,595		121,561		83,121
Mortgage, farmland	242,730		236,454		215,286		202,340		187,856
Mortgage, 1 to 4 family first liens	910,742		912,059		831,591		767,469		727,160
Mortgage, 1 to 4 family junior liens	149,227		152,625		144,200		125,400		117,873
Mortgage, multi-family	350,761		352,434		336,810		302,831		271,974
Mortgage, commercial	402,181		383,314		361,196		334,198		323,409
Loans to individuals	32,308		30,072		26,417		25,157		24,019
Obligations of state and political subdivisions	49,896		52,725		57,626		54,462		52,371
	$	2,639,104	$	2,627,943	$	2,459,671	$	2,277,148	$	2,124,916
Net unamortized fees and costs	933		952		894		827		768
	$	2,640,037	$	2,628,895	$	2,460,565	$	2,277,975	$	2,125,684
Less allowance for loan losses	33,760		37,810		29,400		26,530		26,510
	$	2,606,277	$	2,591,085	$	2,431,165	$	2,251,445	$	2,099,174

There were no foreign loans outstanding for any of the years presented.

The following table shows the principal payments due on loans as of December 31, 2019:



	Amount Of Loans		Amounts Due in One Year Or Less (1)		Amounts Due in One To Five Years		Amounts Due in Over Five Years
	(Amounts In Thousands)
Commercial and Agricultural	$	1,496,931	$	460,985	$	958,184	$	77,762
Real Estate (2)	1,059,307		140,849		722,339		196,119
Other	82,866		6,521		25,215		51,130
Totals	$	2,639,104	$	608,355	$	1,705,738	$	325,011

The types of interest rates applicable to these principal payments are shown below:

Fixed rate	$	1,543,646	$	422,029	$	937,937	$	183,680
Variable rate	1,095,458		186,326		767,801		141,331
	$	2,639,104	$	608,355	$	1,705,738	$	325,011


(1)	A significant portion of the commercial loans are due in one year or less. A significant percentage of the loans will be re-evaluated prior to their maturity and are likely to be extended.


(2)	Commercial, multi-family, construction 1 to 4 family residential, construction land development and commercial, and agricultural real estate loans are reflected in the Commercial and Agricultural total.

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The overall economy in the Company’s trade area, Johnson, Linn and Washington Counties, remains in stable condition with levels of unemployment below national and state levels. The following table shows unemployment as of December 31, 2019, 2018 and 2017 and median income information as of December 31, 2018, 2017 and 2016, as December 31, 2019 information is not available as of the date of this report:



	Unemployment Rate %						Median Income
	2019		2018		2017		2018		2017		2016
United States	3.5	%	3.9	%	4.1	%	$	60,293	$	60,336	$	57,617
State of Iowa	2.7	%	2.5	%	2.8	%	58,580		58,570		56,247
Johnson County	2.2	%	1.7	%	2.0	%	61,640		59,965		56,808
Linn County	3.1	%	2.7	%	3.2	%	64,862		62,702		60,989
Washington County	2.5	%	2.2	%	2.4	%	61,769		59,157		56,864

Competition for quality loans and deposits may continue to be a challenge. The increased competition for both loans and deposits could result in a lower interest rate margin that could result in lower net interest income if the volume of loans and deposits does not increase to offset any such reduction in the interest margin.

Total deposits increased by $240.24 million in 2019. Deposits increased by $132.56 million in 2018. As of June 30, 2019 (latest data available from the FDIC), Johnson County total deposits were $8.154 billion and the Company’s deposits were $1.925 billion, which represent a 23.6% market share. The Company had nine office locations in Johnson County as of June 30, 2019. The total banking locations in Johnson County was 49 as of June 30, 2019. At June 30, 2018, the Company’s deposits were $1.772 billion or a 23.5% market share. As of June 30, 2019, Linn County total deposits were $6.843 billion and there were 108 total banking locations in the county. The seven Linn County offices of the Company had deposits of $488.05 million or a 7.1% share of the market. The Company’s Linn County deposits at June 30, 2018 were $438.41 million and represented a 6.9% market share. As of June 30, 2019, the Company’s three Washington County offices had deposits of $207.78 million which was 32.3% of the County’s total deposits of $643.61 million. Washington County had a total of 15 banking locations as of June 30, 2019. In 2018, the Company’s Washington County deposits were $187.30 million or a 31.1% market share.

The following tables show the amounts of the Company's average deposits and average rates paid on such deposits for the years ended December 31, 2019, 2018 and 2017 and the composition of the certificates of deposit issued in denominations in excess of $100,000 as of December 31, 2019, 2018 and 2017:



	December 31,
	2019		Rate		2018		Rate		2017		Rate
	(Amounts In Thousands)
Average noninterest-bearing deposits	$	366,682	—		$	364,916	—		$	342,640	—
Average interest-bearing demand deposits	716,848		0.87	%	644,712		0.63	%	548,598		0.21	%
Average savings deposits	851,503		0.92		832,772		0.75		748,862		0.34
Average time deposits	661,548		2.19		537,575		1.72		451,208		1.34
	$	2,596,581			$	2,379,975			$	2,091,308



Time certificates issued in amounts of $100,000 or more with maturity in:
	2019		Rate		2018		Rate		2017		Rate
	(Amounts In Thousands)
3 months or less	$	30,832	2.24	%	$	6,988	0.86	%	$	7,392	0.62	%
3 through 6 months	51,404		2.21		20,346		1.68		10,726		0.79
6 through 12 months	59,986		1.92		69,782		2.01		27,896		1.16
Over 12 months	150,760		3.67		131,435		2.29		128,149		1.90
	$	292,982			$	228,551			$	174,163

Investment securities increased $35.27 million in 2019. In 2018, investment securities increased by $30.94 million. The investment portfolio consists of $355.30 million of securities that are stated at fair value, with any unrealized gain or loss, net of income taxes,

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reported as a separate component of stockholders’ equity. The securities portfolio is used for liquidity and pledging purposes and to provide a rate of return that is acceptable to management.

The following tables show the carrying value of the investment securities held by the Bank, including stock of the Federal Home Loan Bank, as of December 31, 2019, 2018 and 2017 and the maturities and weighted average yields of the investment securities, computed on a tax-equivalent basis using a federal tax rate of 21%, as of December 31, 2019:



	December 31,
	2019		2018		2017
	(Amounts In Thousands)
Carrying value:
U.S. Treasury	$	128,585	$	83,155	$	54,318
Other securities (FHLB, FHLMC and FNMA)	15,229		34,871		43,959
Stock of the Federal Home Loan Bank	11,065		12,172		15,005
Obligations of state and political subdivisions	211,489		200,900		186,878
	$	366,368	$	331,098	$	300,160



	December 31, 2019
	Carrying Value		Weighted Average Yield
	(Amounts In Thousands)
U.S. Treasury
Within 1 year	$	12,493	1.98	%
From 1 to 5 years	116,092		2.11	%
	$	128,585
Other securities (FHLB, FHLMC and FNMA), maturities:
Within 1 year	$	12,743	1.21	%
From 1 to 5 years	2,486		1.33
From 5 to 10 years	—		—
	$	15,229

Stock of the Federal Home Loan Bank	$	11,065	2.92	%

Obligations of state and political subdivisions, maturities:
Within 1 year	$	37,953	1.79	%
From 1 to 5 years	79,981		1.90
From 5 to 10 years	84,025		2.18
Over 10 years	9,530		2.05
	$	211,489
Total	$	366,368

As of December 31, 2019, the Company held no investment securities exceeding 10% of stockholders’ equity, other than securities of the U.S. Government agencies and corporations. The Company does not hold any investments in FNMA preferred stock, any pooled trust preferred stocks or other preferred stock type investments. See Note 2 to the Company’s Consolidated Financial Statements.

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During 2019, the major funding source for the growth in loans and other assets was the $240.24 million increase in deposits. In 2018, the major source of funding for the growth in loans was deposit growth of $132.56 million. Brokered deposits totaled $109.29 million and $132.46 million as of December 31, 2019 and 2018, respectively. Total advances from the FHLB were $185.00 million at December 31, 2019 and $215.00 million in 2018. It is expected that the FHLB funding source and brokered deposits funding 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 and interest rates on brokered deposits are favorable compared to other funding alternatives.

Stockholders’ equity was $375.21 million at December 31, 2019 compared to $334.88 million at December 31, 2018. The Company’s capital resources are discussed in detail in the Liquidity and Capital Resources section. Over the last five years, the Company has realized cumulative earnings of $170.12 million and paid shareholders dividends of $33.06 million, or 19.43% of earnings, while maintaining capital ratios in excess of regulatory requirements.

The following table presents the return on average assets, return on average stockholders' equity, the dividend payout ratio and average stockholders’ equity to average assets ratio for the years ended December 31, 2019, 2018 and 2017:



	2019		2018		2017
Return on average assets	1.40	%	1.23	%	1.02	%
Return on average assets before Tax Act (1)	NA		NA		1.19
Return on average stockholders' equity	11.23		9.92		9.24
Return on average equity before Tax Act (1)	NA		NA		10.79
Dividend payout ratio	16.90		19.05		23.11
Average stockholders' equity to average assets ratio	12.45		12.35		11.02


(1)	Non-GAAP financial measurement. For further information, refer to the Non-GAAP Financial Measures section of this report in Item 7.

Net Income Overview

Net income and diluted earnings per share for the last five years are as presented below:



Year	Net Income		% (Decrease) Increase		Earnings Per Share - Diluted
	(In Thousands)
2019	$	45,318	23.26	%	$	4.85
2018	36,767		31.03		3.92
2017	28,061		(11.07	)	3.01
2017 (1)	32,770		3.85		3.51
2016	31,555		11.04		3.40
2015	28,418		5.35		3.04


(1)	Non-GAAP financial measurement. For further information, refer to the Non-GAAP Financial Measurement section of this report.

Net income for 2019 increased by $8.55 million or 23.26% and diluted earnings per share increased by 23.72%. In 2019, net interest income increased $5.55 million due to growth of $229.77 million in the Bank's average earning assets and decreased $0.44 million due to interest rate changes. Noninterest income increased by $0.97 million, the provision for loan losses decreased by $11.38 million and total noninterest expenses increased by $5.14 million.

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Annual fluctuations in the Company's net income continue to be driven primarily by three generally recurring important factors. The first important factor is net interest margin. Net interest income of $97.46 million in 2019 was derived from the Company's $3.133 billion of average earning assets and its net interest margin of 3.18%, compared to $2.903 billion of average earning assets and a 3.25% net interest margin in 2018. The importance of net interest margin is illustrated by the fact that a decrease or an increase in the net interest margin of 10 basis points would result in a $3.13 million decrease or increase in income before taxes. Net interest margin in 2017 was 3.43%. Based on the current interest rate environment, the Company expects continued net interest compression to impact earnings for the foreseeable future. The Company believes net interest margin in dollars will be contingent on the growth of the Company’s earnings assets and maintaining yield on loans. Net interest income was also impacted by the increase in interest expense of $8.55 million compared to 2018, primarily driven by interest rate increases which accounted for $6.28 million of the change.

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 $2.648 billion at the end of 2019. The Company’s allowance for loan losses was $33.76 million at December 31, 2019. The allowance in 2019 decreased in comparison to 2018 due to a decreased provision for loan losses of $11.38 million resulting from a combination of the composition of loan growth, historical loss rates, changes in the composition of loans among the credit risk ratings in 2019 including decrease in specific reserve on impaired loans and management's evaluation of qualitative factors given the current and expected national and local economic conditions. The loan loss provision, which is the amount necessary to adjust the allowance to the level considered appropriate by management, totaled a reduction of expense of $2.88 million for 2019, an expense of $8.5 million for 2018 and an expense of $1.69 million for 2017. Provision expense is expected to be dependent on the Company’s loan growth, local economic conditions, asset quality and the adoption of ASU 2016-13, or CECL, through the end of 2020. See Note 3 to the Company's Consolidated Financial Statements. A detailed discussion is included in the Provision for Loan Losses section below.

The third significant factor affecting the Company’s net income is income tax expense. Federal and state income tax expenses were $12.55 million, $8.91 million and $19.54 million for the years ended December 31, 2019, 2018 and 2017, respectively. Income taxes as a percentage of income before taxes were 21.69% in 2019, 19.50% in 2018 and 41.05% in 2017. 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. Without the effect of the Tax Act, management estimates the Company's net income for 2018 would have been $30.96 million.

Net income for 2018 was $36.77 million, or diluted earnings per share of $3.92. For 2018, diluted earnings per share increased by $0.91 per share compared to 2017. Net interest income increased $4.49 million for the year ended December 31, 2018 compared to 2017. This increase in net interest income was due to an increase in average earning assets of $251.20 million in 2018. Noninterest income increased 14.41% in 2018 to $23.82 million. Noninterest expense increased from $59.51 million in 2017 to $62.12 million in 2018, or 4.39%. Without the effect of the Tax Act, net income for 2017 would have increased by $1.22 million or 3.85%. In addition, diluted earnings per share would have increased 3.25%.(1)

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Net Interest Income

Net interest income is the excess of the interest and fees received on interest-earning assets over the interest paid on 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 volume of average earning assets has continued to grow each year, primarily due to net loan growth. The net interest margin was 3.18% in 2019, 3.25% in 2018, 3.43% in 2017, 3.43% in 2016, and 3.50% in 2015. The measure is shown on a tax-equivalent basis using a rate of 21% for 2019 and 2018 and 35% for 2017 to make the interest earned on taxable and nontaxable assets more comparable. Interest income and expense for 2019, 2018 and 2017 are indicated on the following table:



	Years Ended December 31,
	2019		2018		2017
	(Amounts In Thousands)
Income:
Loans (1)	$	121,862	$	111,172	$	101,564
Taxable securities	3,239		2,759		1,709
Nontaxable securities (1)	5,168		4,717		4,972
Interest-bearing cash and cash equivalents	3,980		1,939		433
Total interest income	$	134,249	$	120,587	$	108,678
Expense:
Interest-bearing demand deposits	6,232		4,056		1,172
Savings deposits	7,825		6,208		2,532
Time deposits	14,483		9,267		6,038
Other borrowings	—		—		184
FHLB borrowings	6,333		6,792		8,046
Interest-bearing other liabilities	—		—		—
Total interest expense	$	34,873	$	26,323	$	17,972
Net interest income	$	99,376	$	94,264	$	90,706

(1) Presented on a tax equivalent basis using a rate of 21% for 2019 and 2018 and 35% for 2017.

Net interest income on a tax-equivalent basis changed in 2019 as follows:



	Change In			Change In		Increase (Decrease)
	Average Balance			Average Rate		Volume Changes			Rate Changes			Net Change
	(Amounts In Thousands)
Interest income:
Loans, net	$	123,810		0.20	%	$	5,716		$	4,974		$	10,690
Taxable securities	11,060			0.15		325			155			480
Nontaxable securities	8,827			0.11		230			221			451
Interest-bearing cash and cash equivalents	84,596			0.26		1,553			488			2,041
Federal funds sold	33			1.13		—			—			—
	$	228,326				$	7,824		$	5,838		$	13,662
Interest expense:
Interest-bearing demand deposits	$	72,136		0.24	%	$	(454	)	$	(1,723	)	$	(2,177	)
Savings deposits	18,731			0.17		(119		)	(1,497		)	(1,616		)
Time deposits	123,973			0.47		(2,137		)	(3,079		)	(5,216		)
Other borrowings	(1		)	(0.07	)	—			—			—
FHLB borrowings	(14,598		)	(0.01	)	435			24			459
Interest-bearing other liabilities	—			—		—			—			—
	$	200,241				$	(2,275	)	$	(6,275	)	$	(8,550	)
Change in net interest income						$	5,549		$	(437	)	$	5,112

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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 at tax equivalent amounts.

Net interest income on a tax equivalent basis changed in 2018 as follows:



	Change In Average Balance			Change In Average Rate		Increase (Decrease)
	Change In Average Balance			Change In Average Rate		Volume Changes			Rate Changes			Net Change
	(Amounts In Thousands)
Interest income:
Loans, net	$	147,130		0.13	%	$	6,369		$	3,239		$	9,608
Taxable securities	23,069			0.50		374			676			1,050
Nontaxable securities	12,035			(0.33	)	354			(609		)	(255		)
Interest-bearing cash and cash equivalents	68,585			0.67		801			705			1,506
Federal funds sold	(25		)	0.99		—			—			—
	$	250,794				$	7,898		$	4,011		$	11,909
Interest expense:
Interest-bearing demand deposits	$	96,114		0.42	%	$	(205	)	$	(2,679	)	$	(2,884	)
Savings deposits	83,910			0.41		(389		)	(3,288		)	(3,677		)
Time deposits	86,367			0.38		(1,156		)	(2,072		)	(3,228		)
Other borrowings	(28,593		)	2.07		184			—			184
FHLB borrowings	(40,345		)	(0.02	)	1,209			45			1,254
Interest-bearing other liabilities	—			—		—			—			—
	$	197,453				$	(357	)	$	(7,994	)	$	(8,351	)
Change in net interest income						$	7,541		$	(3,983	)	$	3,558

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A summary of the average yields, average rates paid, net interest spread and margin is as follows:



	Years Ended December 31,
	2019		2018		2017
Average yields:
Loans (1)	4.64	%	4.45	%	4.30	%
Loans (tax equivalent basis) (1)	4.67		4.47		4.34
Taxable securities	2.27		2.13		1.63
Nontaxable securities	2.04		1.96		1.91
Nontaxable securities (tax equivalent basis)	2.72		2.61		2.94
Interest-bearing cash and cash equivalents	2.09		1.84		1.17
Federal funds sold	2.89		1.75		0.76
Average rates paid:
Interest-bearing demand deposits	0.87		0.63		0.21
Savings deposits	0.92		0.75		0.34
Time deposits	2.19		1.72		1.34
Short-term borrowings	2.64		2.71		0.64
FHLB borrowings	2.93		2.94		2.96
Yield on average interest-earning assets	4.29		4.15		4.10
Rate on average interest-bearing liabilities	1.42		1.17		0.87
Net interest spread (2)	2.86		2.99		3.23
Net interest margin (3)	3.18		3.25		3.43


(1)	Non-accruing loans have been included in the average loan balances for purposes of this computation.


(2)	Net interest spread is the difference between the yield on average interest-earning assets and the yield on average interest-paying liabilities stated on a tax equivalent basis using a federal rate of 21% for 2019 and 2018 and 35% for 2017. The net interest spread decreased 13 basis points in 2019 compared to 2018 and the net interest spread decreased 24 basis points compared to 2017.


(3)	Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning assets. The net interest margin decreased 7 basis points in 2019. The net interest margin decreased 18 basis points in 2018 compared to 2017.

In October 2019, the Federal Open Market Committee decreased the target rate to 1.75%. Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally correlate to the Federal Reserve Board federal funds rate. In pricing of loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates. As of December 31, 2019, the average rate indexes for the one, three and five year indexes were 1.59%, 1.62% and 1.69%, respectively. The one year index decreased 39.54% from December 31, 2018, the three year index decreased 34.15% and the five year index decreased 32.67%.

Provision for Loan Losses

Management has determined that the allowance for loan losses was appropriate at December 31, 2019, 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 and well-documented 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 peers. This review encompasses levels of total impaired loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs.

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The allowance for loan losses totaled $33.76 million at December 31, 2019 compared to $37.81 million at December 31, 2018. The decrease in 2019 is the result of the decrease in specific reserve loans, historical loss rates improving and management's evaluation of qualitative factors. Specifically for 2019, there was a decrease of $2.76 million due to changes in average balances and composition of loans outstanding. There was a decrease of $1.29 million in the amount allocated to the allowance due to improvements in credit quality. The percentage of the allowance to outstanding loans was 1.28% and 1.44% at December 31, 2019 and 2018, respectively. The provision for loan losses totaled a reduction of expense of $2.88 million in 2019, an expense of $8.50 million in 2018 and an expense of $1.69 million for 2017. Loan charge-offs net of recoveries were $1.17 million in 2019. Loan charge-offs net of recoveries were $0.88 million in 2018 and loan recoveries net of charge-offs were $1.18 million in 2017.

The provision for loan losses is the amount necessary to adjust the allowance for loan losses to the level considered appropriate by management. The adequacy of the allowance for loans and any related 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 significant factors, including the size and growth of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact of the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more and the trends in problem and watch loans. In addition, management considers the credit quality of the loans based on management’s review of special mention and substandard loans, including loans with historical higher credit risks. Quantitative factors include the Company’s historical loss experience, which is 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 TDR loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates.

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 nonaccrual 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 payment 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 we determine that a loan amount, or portion thereof, is uncollectible, the loan’s credit risk rating is immediately downgraded and the uncollectible amount is charged-off. The Bank’s credit and legal departments undertake a thorough and ongoing analysis to determine if additional impairment and/or charge-offs are appropriate and to begin a workout plan for the loan to minimize realized loss.

In certain circumstances, the Bank may modify the terms of a loan to maximize the collection of amounts due. In most cases, the modification is either a reduction in interest rate, conversion to interest only payments, deferral of payments or extension of the maturity date. Generally, the borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term, so concessionary modification is granted to the borrower that otherwise would 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. The Bank’s TDR loans occur on a case-by-case basis in connection with ongoing loan collection processes.

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 that can be identified as uncollectible. In general, this is the amount that the carrying value of the loan exceeds the related appraised value less estimated selling costs. 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 additional charge-off or loss allocations based on the applicable facts and circumstances. In instances where there is an estimated decline in value, a loss allocation 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 loss allocation 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.

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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.

The Bank regularly reviews loans in the portfolio and assesses whether the loans are impaired in accordance with ASC 310-10-35, Accounting by Creditors for Impairment of a Loan. If the loans are impaired, the Bank determines if a specific allowance is appropriate. In addition, the Bank'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 Bank allocates a percentage, as determined by management, for a required allowance needed. The determination concerning 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 TDR 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 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 related to an impaired loan when loan balances exceed net present value of cash flows or collateral. Impaired loans decreased by $7.06 million from December 31, 2018 to December 31, 2019. 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 Bank expects to be unable to collect in full according to the contractual terms of the original loan agreement. The decrease in impaired loans is primarily due to a decrease in specific reserve loans of $8.07 million from December 31, 2018 to December 31, 2019.

Special mention loan balances were $66.81 million at December 31, 2019 and $53.60 million at December 31, 2018. These asset quality changes decreased the provision by $0.14 million based upon the relative mix of special mention loans by category. The $13.21 million increase in special mention loans is related to management’s evaluation of its loan portfolio. The total increase of $13.21 million is comprised of approximately $2.46 million in agricultural operating loans, $0.72 million in construction 1 to 4 family residential, $1.98 million in real estate farmland, $0.73 million in 1 to 4 family residential mortgages, $0.34 million in 1 to 4 family junior mortgages, $11.49 million for multi-family real estate mortgages, $1.57 million for commercial real estate mortgages, and $0.40 million for obligations of state and political subdivisions. The increase is offset by a decrease in the special mention classification of $6.25 million in commercial loans, $0.19 million in construction land development and commercial, and $0.04 million in individual loans.

Substandard loan balances were $43.34 million at December 31, 2019 and $54.40 million at December 31, 2018. These asset quality changes decreased the provision by $0.11 million at December 31, 2019 due to the mix of the reserve required for certain substandard loans. The decrease of $11.06 million in substandard loans at December 31, 2019 includes an increase of $0.08 million in 1 to 4 family junior mortgages. The increase is offset by a decrease in the substandard classification of $1.54 million in agricultural operating loans, $2.34 million in commercial loans, $0.40 million in construction 1 to 4 family residential, $0.70 million in construction land development, $1.16 million in real estate farmland, $0.79 million of 1 to 4 family residential mortgages, $0.21 million in multi-family real estate mortgages, $3.96 million in commercial real estate mortgages, and $0.04 million in loans to individuals. A description of the Bank's credit quality indicators are discussed in Note 3 to the Company's Consolidated Financial Statements.

The Company evaluates the following loans to determine impairment: 1) all nonaccrual and TDR loans, 2) all non-consumer and non 1 to 4 family residential loans with prior charge-offs, 3) all non-consumer and non 1 to 4 family loan relationships classified as substandard and 4) loans with indications of or suspected deteriorating credit quality.

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The following table summarizes the Company's impaired loans and non-performing assets as of December 31 for each of the years presented:



	2019			2018			2017			2016			2015
	(Amounts In Thousands)
Nonaccrual loans (1)	$	10,768		$	10,829		$	9,096		$	9,938		$	7,415
Accruing loans past due 90 days or more (2)	606			370			971			635			467
Specific reserve loans	243			8,247			12,950			17,683			100
Troubled debt restructurings ("TDR loans")(1) (3)	9,308			8,539			8,470			5,408			8,279
Total impaired loans	$	20,925		$	27,985		$	31,487		$	33,664		$	16,261
Other real estate	—			—			—			237			439
Non-performing assets (includes impaired loans and other real estate)	$	20,925		$	27,985		$	31,487		$	33,901		$	16,700
Loans held for investment	$2,639,104			$2,627,943			$2,459,671			$2,277,148			$2,124,916
Ratio of allowance for loan losses to loans held for investment	1.28		%	1.44		%	1.20		%	1.17		%	1.25		%
Ratio of allowance for loan losses to impaired loans	161.34			135.11			93.37			78.81			163.03
Ratio of impaired loans to total loans held for investment	0.79			1.06			1.28			1.48			0.77
Ratio of non-performing assets to total assets	0.63			0.92			1.06			1.28			0.67

(1)

The gross interest income that would have been recorded if the loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period was $0.58 million in 2019 and $0.79 million in 2018. The amount of interest income on the loans that was included in income was $0.53 million in 2019 and $0.40 million in 2018.


(2)	The accruing loans past due 90 days or more are still believed to be adequately collateralized. Loans are placed on nonaccrual status when management believes the collection of future principal and interest is not reasonably assured.


(3)	Total TDR loans were $13.71, $13.38, $12.09, $9.64 and $10.59 million as of December 31, 2019, 2018, 2017, 2016, and 2015, respectively. Included in the total nonaccrual loans were $4.34, $4.84, $3.62, $4.23, and $2.31 million of TDR loans as of December 31, 2019, 2018, 2017, 2016, and 2015, respectively.

The ratio of allowance for loan losses to impaired loans increased to 161.34% as of December 31, 2019 compared to 135.11% as of December 31, 2018. The increase in 2019 is the result of a decrease in impaired loans with specific reserves. The ratio of impaired loans to total gross loans was 0.79% and 1.06% at December 31, 2019 and 2018, respectively. The decrease in the 2019 ratio is primarily due to the decrease in specific reserve loans.

Other factors that are considered in determining the credit quality of the Company’s loan portfolio are the vacancy rates for both residential and commercial space, current equity the borrower has in the property and overall financial strength of the customer including cash flow to continue to fund loan payments. The Company also considers the state of the total economy including unemployment levels. In most instances, the borrowers have used in their rental projections of income at least a 10% vacancy rate. As of December 31, 2019, the unemployment levels in Johnson County and Linn County were 2.2% and 3.1%, respectively, compared to 1.7% and 2.7% in December of 2018. These levels compare favorably to the State of Iowa at 2.7% and the national unemployment level at 3.5% in December 2019 compared to 2.5% and 3.9%, respectively in December 2018.

The residential rental vacancy rates in 2018 and 2019 in Johnson and Linn County were estimated between 5.0% and 7.0%. The State of Iowa vacancy rate is 6.7% and the national rate is 6.4% with the Midwest rate at 6.8%. These vacancy rates one year ago were 7.0%, 6.6% and 7.1%, respectively. The Company continues to consider those vacancy rates among other factors in its current evaluation of the real estate portion of its loan portfolio. Favorable vacancy rates may not continue in 2020, and vacancy rates may rise and affect the overall quality of the loan portfolio.

See Note 3 to the Company's Consolidated Financial Statements for additional disclosures on loans.

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SUMMARY OF LOAN LOSS EXPERIENCE

The allowance for loan losses balance is also affected by the charge-offs and recoveries for the periods presented. For the years ended December 31, 2019, 2018 and 2017, recoveries were $1.80 million, $2.23 million and $3.29 million, respectively; charge-offs were $2.97 million, $2.32 million and $2.10 million in 2019, 2018 and 2017, respectively.

Overall credit quality may deteriorate in 2020. Such deterioration could cause increases in impaired loans, allowance for loan losses provision expense and net charge-offs. Management will monitor changing market conditions as a part of its allowance for loan loss methodology. The following table summarizes the Bank's loan loss experience for the years ended December 31 for each of the years presented:



	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)
2019
Allowance for loan losses:
Beginning balance	$	2,789		$	5,826		$	3,292		$	3,972		$	12,516		$	8,165		$	1,250		$	37,810
Charge-offs	(266		)	(981		)	(45		)	(6		)	(896		)	(341		)	(434		)	(2,969		)
Recoveries	95			646			8			5			700			180			165			1,799
Provision	(218		)	(503		)	(656		)	(21		)	(1,682		)	(145		)	345			(2,880		)
Ending balance	$	2,400		$	4,988		$	2,599		$	3,950		$	10,638		$	7,859		$	1,326		$	33,760



	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)
2018
Allowance for loan losses:
Beginning balance	$	2,294		$	4,837		$	2,989	$	3,669	$	8,668		$	5,700		$	1,243		$	29,400
Charge-offs	(95		)	(585		)	—		—		(830		)	(251		)	(561		)	(2,322		)
Recoveries	119			1,057			148		30		612			107			162			2,235
Provision	471			517			155		273		4,066			2,609			406			8,497
Ending balance	$	2,789		$	5,826		$	3,292	$	3,972	$	12,516		$	8,165		$	1,250		$	37,810



	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)
2017
Allowance for loan losses:
Beginning balance	$	2,947		$	4,531		$	2,890		$	3,417		$	7,677		$	4,045		$	1,023		$	26,530
Charge-offs	(167		)	(583		)	(114		)	(3		)	(553		)	(130		)	(554		)	(2,104		)
Recoveries	146			1,183			662			—			661			376			258			3,286
Provision	(632		)	(294		)	(449		)	255			883			1,409			516			1,688
Ending balance	$	2,294		$	4,837		$	2,989		$	3,669		$	8,668		$	5,700		$	1,243		$	29,400

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	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)
2016
Allowance for loan losses:
Beginning balance	$	3,082		$	4,517		$	2,280		$	3,342		$	8,172		$	4,223		$	894		$	26,510
Charge-offs	(226		)	(315		)	(34		)	(116		)	(1,181		)	(66		)	(693		)	(2,631		)
Recoveries	181			1,169			849			—			1,043			385			187			3,814
Provision	(90		)	(840		)	(205		)	191			(357		)	(497		)	635			(1,163		)
Ending balance	$	2,947		$	4,531		$	2,890		$	3,417		$	7,677		$	4,045		$	1,023		$	26,530



	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)
2015
Allowance for loan losses:
Beginning balance	$	2,515		$	4,231		$	2,241		$	2,672	$	7,419		$	4,195		$	747		$	24,020
Charge-offs	(325		)	(526		)	(285		)	—		(1,108		)	(723		)	(438		)	(3,405		)
Recoveries	123			1,370			501			6		762			1,310			168			4,240
Provision	769			(558		)	(177		)	664		1,099			(559		)	417			1,655
Ending balance	$	3,082		$	4,517		$	2,280		$	3,342	$	8,172		$	4,223		$	894		$	26,510

The ratio of net charge-offs to average net loans outstanding during the years ended December 31, 2019, 2018, 2017, 2016 and 2015 was 0.04%, 0.00%, (0.05)%, (0.05)% and (0.04)%, respectively.

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ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

The following table presents the allowance for loan losses by type of loans, the percentage of the allocation for each category to the total allowance and the percentage of all loans in each category to total loans as of December 31, 2019, 2018, 2017, 2016, and 2015:



	2019						2018
	Amount		% of Total Allowance		% of Loans to Total Loans		Amount		% of Total Allowance		% of Loans to Total Loans
	(In Thousands)						(In Thousands)
Agricultural	$	2,400	7.11	%	3.46	%	$	2,789	7.38	%	3.53	%
Commercial and financial	4,988		14.77	%	8.39		5,826		15.41	%	8.73
Real estate:
Construction, 1 to 4 family residential	1,113		3.30	%	3.04		1,297		3.43	%	2.75
Construction, land development and commercial	1,486		4.40	%	4.11		1,995		5.28	%	4.33
Mortgage, farmland	3,950		11.70	%	9.20		3,972		10.51	%	9.00
Mortgage, 1 to 4 family first liens	9,045		26.79	%	34.51		10,750		28.43	%	34.71
Mortgage, 1 to 4 family junior liens	1,593		4.72	%	5.65		1,766		4.67	%	5.81
Mortgage, multi-family	3,823		11.32	%	13.29		4,083		10.80	%	13.41
Mortgage, commercial	4,036		11.95	%	15.24		4,082		10.80	%	14.58
Loans to individuals	853		2.53	%	1.22		723		1.91	%	1.14
Obligations of state and political subdivisions	473		1.41		1.89		527		1.38		2.01
	$	33,760	100.00	%	100.00	%	$	37,810	100.00	%	100.00	%



	2017						2016
Agricultural	$	2,294	7.80	%	3.60	%	$	2,947	11.11	%	4.08	%
Commercial and financial	4,837		16.45	%	8.89		4,531		17.08		8.48
Real estate:
Construction, 1 to 4 family residential	1,193		4.06	%	2.84		1,023		3.86		2.54
Construction, land development and commercial	1,796		6.11	%	4.46		1,867		7.04		5.34
Mortgage, farmland	3,669		12.48	%	8.75		3,417		12.88		8.89
Mortgage, 1 to 4 family first liens	7,369		25.07	%	33.81		6,560		24.72		33.70
Mortgage, 1 to 4 family junior liens	1,299		4.42	%	5.86		1,117		4.21		5.51
Mortgage, multi-family	2,791		9.49	%	13.69		1,669		6.29		13.30
Mortgage, commercial	2,909		9.89	%	14.69		2,376		8.95		14.67
Loans to individuals	782		2.66	%	1.07		642		2.42		1.10
Obligations of state and political subdivisions	461		1.57		2.34		381		1.44		2.39
	$	29,400	100.00	%	100.00	%	$	26,530	100.00	%	100.00	%

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	2015
	Amount		% of Total Allowance		% of Loans to Total Loans
	(In Thousands)
Agricultural	$	3,082	11.63	%	4.78	%
Commercial and financial	4,517		17.04		8.67
Real estate:
Construction, 1 to 4 family residential	866		3.27		2.42
Construction, land development and commercial	1,414		5.33		3.91
Mortgage, farmland	3,342		12.61		8.84
Mortgage, 1 to 4 family first liens	6,931		26.14		34.22
Mortgage, 1 to 4 family junior liens	1,241		4.68		5.55
Mortgage, multi-family	1,713		6.46		12.80
Mortgage, commercial	2,510		9.47		15.22
Loans to individuals	501		1.89		1.13
Obligations of state and political subdivisions	393		1.48		2.46
	$	26,510	100.00	%	100.00	%

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 deteriorate, certain borrowers may experience difficulty and the level of impaired loans, charge-offs and delinquencies could 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.

Noninterest Income

The following table sets forth the various categories of noninterest income for the year ended December 31, 2019, 2018 and 2017.



	Year Ended December 31,							$ Change						% Change
	2019			2018		2017		2019/2018			2018/2017			2019/2018		2018/2017
	(Amounts in thousands)
Net gain on sale of loans	$	3,539		$	1,517	$	1,547	$	2,022		$	(30	)	133.29	%	(1.94	)%
Trust fees	9,579			10,007		8,043		(428		)	1,964			(4.28	)	24.42
Service charges and fees	10,276			9,614		8,850		662			764			6.89		8.63
Other noninterest income	1,426			2,680		2,378		(1,254		)	302			(46.79	)	12.70
Loss on sale of investment securities	$	(28	)	$	—	$	—	(28		)	—			—		—
	$	24,792		$	23,818	$	20,818	$	974		$	3,000		4.09	%	14.41	%

The noninterest income of the Company was $24.79 million in 2019 compared to $23.82 million in 2018. The increase of $0.97 million in 2019 was the result of a combination of factors discussed below. In 2018, the total noninterest income increased $3.00 million from 2017.

Net gain on sale of loans increased 2.02 million in 2019 primarily due to the decreasing interest rate environment. The amount of the gain on sale of secondary market mortgage loans in each year can vary significantly. The volume of activity in these types of loans is directly related to the level of interest rates. The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income.

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Table of Contents

Trust fees decreased $0.43 million to $9.58 million in 2019. Trust fees increased $1.96 million in 2018. As of December 31, 2019, the Bank’s Trust Department had $1.919 billion in assets under management compared to $1.618 billion and $1.649 billion at December 31, 2018 and 2017, respectively. The trust assets that are the most volatile are those that are held in common stocks, which amount to approximately 68.00% of assets under management. In 2019, the Dow Jones Industrial Average increased 22.34%. The market value of the Dow Jones Industrial Average decreased 5.63% in 2018 and increased 25.08% in 2017.

Service charges and fees increased $0.66 million in 2018 from increased debit and credit card interchange income. Service charges and fees increased $0.76 million in 2018.

Other noninterest income decreased $1.25 million in 2019 primarily due to the sale of the insurance department in August 2018 for a gain of $885,000.

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the year ended December 31, 2019, 2018 and 2017.



	Year Ended December 31,						$ Change						% Change
	2019		2018		2017		2019/2018			2018/2017			2019/2018		2018/2017
	(Amounts in thousands)
Salaries and employee benefits	$	36,709	$	34,981	$	33,197	$	1,728		$	1,784		4.94	%	5.37	%
Occupancy	4,336		4,374		4,189		(38		)	185			(0.87	)	4.42
Furniture and equipment	6,795		5,741		5,580		1,054			161			18.36		2.89
Office supplies and postage	1,841		1,778		1,961		63			(183		)	3.54		(9.33	)
Advertising and business development	2,595		2,513		2,764		82			(251		)	3.26		(9.08	)
Outside services	10,360		10,076		8,303		284			1,773			2.82		21.35
FDIC insurance assessment	194		856		845		(662		)	11			(77.34	)	1.30
Other noninterest expense	4,434		1,804		2,673		2,630			(869		)	145.79		(32.51	)
	$	67,264	$	62,123	$	59,512	$	5,141		$	2,611		8.28	%	4.39	%

Total noninterest expenses were $67.26 and $62.12 million for the years ended December 31, 2019 and 2018, respectively. The increase is $5.14 million or 8.28% in 2019 and an increase of $2.61 million or 4.39% in 2018.

Salaries and employee benefits increased $1.73 million in 2019. The increase is the result of annual salary increases and hiring additional employees.

Furniture and equipment increased $1.05 million in 2019 primarily due to increases in software maintenance contract costs.

Other noninterest expenses increased $2.63 million in 2019 primarily due to $2.09 million in fees incurred from the prepayment of FHLB borrowings.

Total noninterest expenses were $59.51 million for the year ended December 31, 2017. The increase in expenses in 2018 was $2.61 million. This included an increase of $1.78 million in salaries and benefits, which was the direct result of salary adjustments and restricted stock awards increases due to the increase in the appraised value of the Company stock.

Income Taxes

Income tax expense was $12.55, $8.91 and $19.54 million for the years ended December 31, 2019, 2018 and 2017, respectively. Income taxes as a percentage of income before income taxes were 21.69% in 2019, 19.50% in 2018 and 41.05% in 2017. The amount of tax credits were $0.53, $1.29 and $1.43 million for 2019, 2018, and 2017, respectively.

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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 affected 2017, including, but not limited to, accelerated depreciation that allowed for full expensing of qualified property. The Tax Act also established new tax laws that affected 2018 and thereafter, including a reduction in the U.S. federal corporate income tax rate from 35% to 21%. As a result of the reduction of the federal corporate income tax rate, we revalued our net deferred tax asset, excluding after tax credits, as of December 22, 2017. Based on this revaluation, we recorded a net tax expense of $4.71 million to reduce our net deferred tax asset balance, which was recorded as additional income tax expense for the year ended December 31, 2017. Our effective tax rate increased by 30.99% to 41.05% primarily as a result of the revaluation of our net deferred tax asset. While the Tax Act negatively impacted earnings for the Company's fiscal year ended December 31, 2017, the lower corporate rate has been a significant ongoing benefit to the Company. For the year ended December 31, 2018, net income was $5.81 million higher than it would have been under the tax laws in effect before the Tax Act.

Effects of Inflation

The consolidated financial statements and the accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact in the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. Liquidity and interest rate adjustments are features of the Company’s asset/liability management, which are important to the maintenance of acceptable performance levels. Item 7A of this Form 10-K contains a more thorough discussion of interest rate risk. The Company attempts to maintain a balance between monetary assets and monetary liabilities to offset the potential effects of changing interest rates.

Liquidity and Capital Resources

The objective of liquidity management is to ensure the availability of sufficient cash flows to fund operations, to meet depositor withdrawals, to provide for our customers' credit needs and to meet maturing obligations and existing commitments. The Company's principal source of funds is deposits. Other sources include loan principal repayments, proceeds from the maturity and sale of investment securities, federal funds purchased, advances from the FHLB, advances on bank lines of credit, brokered deposit relationships and funds provided by operations. Liquidity management is conducted on both a daily and a long-term basis. Investments in liquid assets are adjusted based on expected loan demand, projected loan and investment securities maturities and payments, expected deposit flows and the objectives set by the Company's asset-liability management, liquidity and contingency funding policies.

As of December 31, 2019, the Company had additional borrowing capacity available from the FHLB of $719.37 million. In addition, the Company had $491.31 million in borrowing capacity available through secured and unsecured lines of credit with correspondent banks. The Company had no amounts outstanding under those federal funds lines as of December 31, 2019.

On an unconsolidated basis, the Company had cash balances of $5.11 million as of December 31, 2019. In 2019, the Company received dividends of $7.66 million from its subsidiary Bank and used those funds to pay dividends to its stockholders of $7.66 million and to fund purchases of treasury stock under the 2005 Stock Repurchase Program. The total purchase of treasury stock under the 2005 Stock Repurchase Program totaled $5.53 and $6.78 million for the years ended December 31, 2019 and 2018, respectively.

As of December 31, 2019 and 2018, stockholders' equity, before deducting for the maximum cash obligation related to the ESOP, was $427.04 million and $383.75 million, respectively. This measure of stockholders’ equity as a percent of total assets was 12.94% at December 31, 2019 and 12.61% at December 31, 2018. As of December 31, 2019, total equity, after deducting the maximum cash value related to the ESOP, was 11.37% of assets compared to 11.01% of assets at the prior year end.

The Company and the Bank are subject to the Federal Deposit Insurance Corporation Improvement Act of 1991, and the Bank is subject to Prompt Corrective Action Rules as determined and enforced by the Federal Reserve. These regulations establish minimum capital requirements that member banks must maintain.

The Bank is classified as "well-capitalized" by FDIC capital guidelines. For more information regarding regulatory capital requirements, see the section under Part I, Item 1 to this 10-K captioned “Supervision and Regulation.”

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On a consolidated basis, 2019 cash flows from operations provided $39.32 million and net increases in deposits provided $240.24 million. These cash flows were invested in Net Loans of $13.02 million and $104.54 million in purchases of investment securities. In addition, $3.17 million was used to purchase property and equipment and leasehold improvements.

The Bank has a contingency funding plan to address liquidity issues in times of crisis. The primary source of funding will be the Bank’s customer deposit base. The Bank has established alternative sources of funding available to increase liquidity. The availability of the funding sources is tested on an annual basis. The Bank performs quarterly stress testing to determine if the Bank has an appropriate amount of funding sources to address potential liquidity needs. At December 31, 2019, the Bank had total outstanding loan commitments and unused portions of lines of credit totaling $432.73 million (see Note 15 to the Company's Consolidated Financial Statements). Management believes that its liquidity levels are sufficient at this time, but the Bank may increase its liquidity by limiting the growth of its assets, by selling more loans in the secondary market or selling portions of loans to other banks through participation agreements. Another liquidity source includes obtaining additional funds from the Federal Home Loan Bank (FHLB). As of December 31, 2019, the Bank can obtain an additional $719.37 million from the FHLB based on the current real estate mortgage loans held. In addition, the Bank has arranged $481.31 million of credit lines at three banks. The borrowings under these credit lines would be secured by the Bank’s investment securities. Other liquidity sources include a $10.00 million line of credit with the Federal Reserve Bank of Chicago and various sources of brokered deposits.

The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of federal funds purchased and securities sold under agreements to repurchase during 2019, 2018 and 2017:



	2019			2018			2017
	(Amounts In Thousands)
Outstanding balance as of December 31	$	—		$	—		$	—
Weighted average interest rate at year end	—		%	—		%	0.73		%
Maximum month-end balance	—			—			44,588
Average month-end balance	—			—			25,360
Weighted average interest rate for the year	2.64		%	2.71		%	0.64		%

The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of Federal Home Loan Bank borrowings during 2019, 2018 and 2017:



	2019			2018			2017
	(Amounts In Thousands)
Outstanding balance as of December 31	$	185,000		$	215,000		$	295,000
Weighted average interest rate at year end	2.93		%	2.94		%	2.82		%
Maximum month-end balance	215,000			280,000			345,000
Average month-end balance	212,500			228,066			268,411
Weighted average interest rate for the year	2.93		%	2.94		%	2.96		%

The Bank has off-balance sheet commitments to fund additional borrowings of customers as well as derivative financial instruments, consisting of interest rate swaps as disclosed in Note 17 to the Company's Consolidated Financial Statements. Contractual commitments to fund loans are met from the proceeds of federal funds sold or investment securities and additional borrowings. Many of the contractual commitments to extend credit will not be funded because they represent the credit limits on credit cards and home equity lines of credits.

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As disclosed in Note 15 to the Company's Consolidated Financial Statements, the Company has certain obligations and commitments to make future payments under contracts. The following table summarizes significant contractual obligations and other commitments as of December 31, 2019:



	Payments Due By Period
	(Amounts In Thousands)
	Total		Less Than One Year		One - Three Years		Three - Five Years		More Than Five Years
Contractual obligations:
Long-term debt obligations	$	185,000	$	25,000	$	25,000	$	15,000	$	120,000
Operating lease obligations	1,562		469		694		398		1
Total contractual obligations:	$	186,562	$	25,469	$	25,694	$	15,398	$	120,001
Other commitments:
Lines of credit	$	424,165	$	288,487	$	101,560	$	21,605	$	12,513
Standby letters of credit	8,569		8,569		—		—		—
Total other commitments	$	432,734	$	297,056	$	101,560	$	21,605	$	12,513

The Company and the Bank have no additional material commitments or plans that will materially affect liquidity or capital resources. Property and equipment may be acquired in cash purchases, or they may be financed if favorable terms are available.



Item 7A.	Quantitative and Qualitative Disclosures About Market Risk

The Company's primary market risk exposure is to changes in interest rates. Interest rate risk is the risk to current or anticipated earnings or capital arising from movements in interest rates. Interest rate risk arises from repricing risk, basis risk, yield curve risk and options risk. Repricing risk is the difference between the timing of rate changes and the timing of cash flows. Basis risk is the difference from changing rate relationships among different yield curve affecting Bank activities. Yield curve risk is the difference from changing rate relationships across the spectrum of maturities. Option risk is the difference resulting from interest-related options imbedded in Bank products. The Bank’s primary source of interest rate risk exposure arises from repricing risk. To measure this risk the Bank uses a static gap measurement system that identifies the repricing gaps across the full maturity spectrum of the Bank’s assets and liabilities and an earnings simulation approach. The gap schedule is known as the interest rate sensitivity report. The report reflects the repricing characteristics of the Bank’s assets and liabilities. The report details the calculation of the gap ratio. This ratio indicated 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.

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.

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The Bank uses derivative financial instruments, when needed, to manage the impact of changes in interest rates on future interest income or interest expense. The Bank is exposed to credit-related losses in the event of nonperformance by the counterparties to these derivative instruments, but believe the risk of the these losses has been minimized by entering into the contracts with large, stable financial institutions. The estimated fair market value of these derivative instruments are presented in Note 17 to the Consolidated Financial Statements.

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 table set forth below includes the portion of the balances in interest-bearing checking, savings and money market accounts that management has estimated to mature within one year. The classifications are used because the Bank’s historical data indicates that these have been very stable deposits without much interest rate fluctuation. Historically, these accounts would not need to be adjusted upward as quickly in a period of rate increases so the interest risk exposure would be less than the re-pricing schedule indicates. The FHLB borrowings are classified based on either their due date or if they are callable on their most likely call date based on the interest rate.



	Repricing
	Maturities		Days								More Than
	Immediately		2-30		31-90		91-180		181-365		One Year			Total
	(Amounts in Thousands)
Earning assets:
Excess Cash	$	213,673	$	—	$	—	$	—	$	—	$	—		$	213,673
Federal funds sold	—		—		—		—		—		—			—
Investment securities	—		3,071		5,135		35,095		19,890		303,177			366,368
Loans	10,919		225,178		57,890		98,057		243,868		2,012,526			2,648,438
Total earning assets	224,592		228,249		63,025		133,152		263,758		2,315,703			3,228,479
Sources of funds:
Interest-bearing checking and savings accounts	165,465		—		—		—		—		1,426,633			1,592,098
Certificates of deposit	—		19,096		45,604		112,123		147,731		357,100			681,654
FHLB borrowings	—		—		—		—		25,000		160,000			185,000
Federal funds and repurchase agreements	—		—		—		—		—		—			—
	165,465		19,096		45,604		112,123		172,731		1,943,733			2,458,752
Other sources, primarily noninterest-bearing	—		—		—		—		—		763,949			763,949
Total sources	165,465		19,096		45,604		112,123		172,731		2,707,682			3,222,701
Interest
Rate Gap	$	59,127	$	209,153	$	17,421	$	21,029	$	91,027	$	(391,979	)	$	5,778
Cumulative Interest
Rate Gap at December 31, 2019	$	59,127	$	268,280	$	285,701	$	306,730	$	397,757	$	5,778
Gap Ratio	1.36		11.95		1.38		1.19		1.53		0.86
Cumulative Gap Ratio	1.36		2.45		2.24		1.90		1.77		1.00

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Based on the data following, net interest income should decline with instantaneous increases in interest rates while net interest income should increase with instantaneous declines in interest rates. 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.

The following table, which presents principal cash flows and related weighted average interest rates by expected maturity dates, provides information about the Company's loans, investment securities and deposits that are sensitive to changes in interest rates.



	2020			2021			2022			2023			2024			Thereafter			Total			Fair Value
	(Amounts In Thousands)
Assets:
Loans, fixed:
Balance	$	422,029		$	160,434		$	250,725		$	205,525		$	321,253		$	183,680		$	1,543,646		$	1,329,731
Average interest rate	4.77		%	4.30		%	4.40		%	4.84		%	4.71		%	4.06		%	4.57		%
Loans, variable:
Balance	$	186,326		$	162,841		$	235,606		$	200,295		$	169,059		$	141,331		$	1,095,458		$	1,273,502
Average interest rate	5.11		%	4.19		%	4.12		%	4.30		%	4.48		%	4.35		%	4.42		%
Investments (1):
Balance	$	74,254		$	47,118		$	52,019		$	50,593		$	48,829		$	93,555		$	366,368		$	366,368
Average interest rate	2.25		%	2.10		%	2.39		%	2.60		%	1.99		%	2.87		%	2.42		%
Liabilities:
Liquid deposits (2):
Balance	$	—		$	—		$	—		$	—		$	—		$	—		$	1,592,041		$	1,591,997
Average interest rate	—		%	—		%	—		%	—		%	—		%	—		%	0.82		%
Deposits, certificates:
Balance	$	324,554		$	124,527		$	90,009		$	130,252		$	12,312		$	—		$	681,654		$	695,221
Average interest rate	1.92		%	1.95		%	2.65		%	3.19		%	2.22		%	—		%	2.27		%


(1)	Includes all available-for-sale investments, federal funds and Federal Home Loan Bank stock.


(2)	Includes NOW and other demand, savings and money market funds.



Item 8.	Consolidated Financial Statements and Supplementary Data

The consolidated financial statements and supplementary data are included on pages 52 through 107.

Page 51

Report of Independent Registered Public Accounting Firm

To the Shareholders, Board of Directors and Audit Committee

Hills Bancorporation

Hills, Iowa

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Hills Bancorporation (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively referred to as the "financial statements"). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on Internal Control-Integrated Framework (2013) and our report dated March 6, 2020, expressed an unqualified opinion.

Basis for Opinion

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits.

We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

BKD, LLP

We have served as the Company’s auditor since 2012.

Springfield, Missouri

March 6, 2020

Page 52

Report of Independent Registered Public Accounting Firm

To the Shareholders, Board of Directors and Audit Committee

Hills Bancorporation

Hills, Iowa

Opinion on the Internal Control over Financial Reporting

We have audited Hills Bancorporation's (the "Company") internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the consolidated financial statements of the Company and our report dated March 6, 2020, expressed an unqualified opinion.

Basis for Opinion

The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.

Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definitions and Limitations of Internal Control over Financial Reporting

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of reliable financial statements in accordance with accounting principles generally accepted in the United States of America. Because management's assessment and our audit also were conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), our examination of Hills Bancorporation's internal control over financial reporting included controls over the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C). A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Page 53

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

BKD, LLP

Springfield, Missouri

March 6, 2020

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HILLS BANCORPORATION

CONSOLIDATED BALANCE SHEETS

December 31, 2019 and 2018

(Amounts In Thousands, Except Shares)



ASSETS	2019			2018
Cash and cash equivalents	$	241,965		$	43,305
Investment securities available for sale at fair value (amortized cost 2019 $351,069; 2018 $321,660) (Notes 1, 2 and 13)	355,303			318,926
Stock of Federal Home Loan Bank	11,065			12,172
Loans held for sale	8,400			1,984
Loans, net of allowance for loan losses (2019 $33,760; 2018 $37,810) (Notes 1, 3, and 12)	2,606,277			2,591,085
Property and equipment, net (Note 4)	37,146			37,051
Tax credit real estate	8,280			9,193
Accrued interest receivable	12,442			11,784
Deferred income taxes, net (Note 10)	8,018			10,869
Goodwill	2,500			2,500
Other assets	9,491			3,595
Total Assets	$	3,300,887		$	3,042,464
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Noninterest-bearing deposits	$	387,612		$	372,152
Interest-bearing deposits (Note 6)	2,273,752			2,048,972
Total deposits	2,661,364			2,421,124
Federal Home Loan Bank borrowings (Note 7)	185,000			215,000
Accrued interest payable	2,474			1,812
Other liabilities	25,012			20,776
Total Liabilities	2,873,850			2,658,712
Commitments and Contingencies (Notes 9 and 15)
Redeemable Common Stock Held By Employee Stock
Ownership Plan (ESOP) (Note 9)	51,826			48,870
Stockholders' Equity (Note 11)
Common stock, no par value; authorized 20,000,000 shares; issued 2019 10,327,656 shares; 2018 10,325,191 shares	—			—
Paid in capital	55,943			52,122
Retained earnings	409,509			371,848
Accumulated other comprehensive gain (loss) (Note 8)	1,415			(3,250		)
Treasury stock at cost (2019 975,962 shares; 2018 988,750 shares)	(39,830		)	(36,968		)
Total Stockholders' Equity	427,037			383,752
Less maximum cash obligation related to ESOP shares (Note 9)	51,826			48,870
Total Stockholders' Equity Less Maximum Cash Obligations Related To ESOP Shares	375,211			334,882
Total Liabilities & Stockholders' Equity	$	3,300,887		$	3,042,464

See Notes to Consolidated Financial Statements.

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HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31, 2019, 2018 and 2017

(Amounts In Thousands, Except Per Share Amounts)



	2019			2018		2017
Interest income:
Loans, including fees	$	121,269		$	110,588	$	100,579
Investment securities:
Taxable	3,239			2,759		1,709
Nontaxable	3,844			3,511		3,231
Federal funds sold	3,980			1,939		433
Total interest income	132,332			118,797		105,952
Interest expense:
Deposits	28,540			19,531		9,742
Other borrowings	—			—		184
FHLB borrowings	6,333			6,792		8,046
Total interest expense	34,873			26,323		17,972
Net interest income	97,459			92,474		87,980
Provision for loan losses (Note 3)	(2,880		)	8,497		1,688
Net interest income after provision for loan losses	100,339			83,977		86,292
Noninterest income:
Net gain on sale of loans	3,539			1,517		1,547
Trust fees	9,579			10,007		8,043
Service charges and fees	10,276			9,614		8,850
Other noninterest income	1,426			2,680		2,378
Loss on sale of investment securities	(28		)	—		—
	24,792			23,818		20,818
Noninterest expenses:
Salaries and employee benefits	36,709			34,981		33,197
Occupancy	4,336			4,374		4,189
Furniture and equipment	6,795			5,741		5,580
Office supplies and postage	1,841			1,778		1,961
Advertising and business development	2,595			2,513		2,764
Outside services	10,360			10,076		8,303
FDIC insurance assessment	194			856		845
Other noninterest expenses	4,434			1,804		2,673
	67,264			62,123		59,512
Income before income taxes	57,867			45,672		47,598
Income taxes (Note 10)	12,549			8,905		19,537
Net income	$	45,318		$	36,767	$	28,061
Earnings per share:
Basic	$	4.85		$	3.93	$	3.01
Diluted	4.85			3.92		3.01

See Notes to Consolidated Financial Statements.

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HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years Ended December 31, 2019, 2018 and 2017

(Amounts In Thousands)



	2019			2018			2017
Net income	$	45,318		$	36,767		$	28,061
Other comprehensive income (loss)
Securities:
Net change in unrealized gain (loss) on securities available for sale	6,940			(1,593		)	361
Reclassification adjustment for net losses realized in net income	28			—			—
Income taxes	(1,738		)	397			(139		)
Other comprehensive income (loss) on securities available for sale	5,230			(1,196		)	222
Derivatives used in cash flow hedging relationships:
Net change in unrealized (loss) gain on derivatives	(753		)	1,223			1,119
Income taxes	188			(305		)	(428		)
Other comprehensive (loss) income on cash flow hedges	(565		)	918			691
Other comprehensive income (loss), net of tax	4,665			(278		)	913
Comprehensive income	$	49,983		$	36,489		$	28,974

See Notes to Consolidated Financial Statements.

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HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

Years Ended December 31, 2019, 2018 and 2017

(Amounts In Thousands, Except Share Data)



	Paid In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Maximum Cash Obligation Related To ESOP Shares			Total
Balance, December 31, 2016	$	44,606		$	319,982		$	(3,359	)	$	(31,178	)	$	(40,781	)	$	289,270
Issuance of 114,935 shares of common stock	4,851			—			—			595			—			5,446
Issuance of 6,892 shares of common stock under the employee stock purchase plan	325			—			—			—			—			325
Unearned restricted stock compensation	(707		)	—			—			—			—			(707		)
Forfeiture of 3,934 shares of common stock	(156		)	—			—			—			—			(156		)
Share-based compensation	11			—			—			—			—			11
Change related to ESOP shares	—			—			—			—			(2,527		)	(2,527		)
Net income	—			28,061			—			—			—			28,061
Cash dividends ($0.70 per share)	—			(6,485		)	—			—			—			(6,485		)
Purchase of 46,966 shares of common stock	—			—			—			(2,435		)	—			(2,435		)
Other comprehensive income	—			—			913			—			—			913
Balance, December 31, 2017	$	48,930		$	341,558		$	(2,446	)	$	(33,018	)	$	(43,308	)	$	311,716
Issuance of 113,373 shares of common stock	3,386			—			—			2,834			—			6,220
Issuance of 8,172 shares of common stock under the employee stock purchase plan	421			—			—			—			—			421
Unearned restricted stock compensation	(463		)	—			—			—			—			(463		)
Forfeiture of 3,296 shares of common stock	(152		)	—			—			—			—			(152		)
Change related to ESOP shares	—			—			—			—			(5,562		)	(5,562		)
Net income	—			36,767			—			—			—			36,767
Cash dividends ($0.75 per share)	—			(7,003		)	—			—			—			(7,003		)
Reclassification of stranded tax effects due to the Tax Cuts and Jobs Act	—			526			(526		)	—			—			—
Purchase of 116,962 shares of common stock	—			—			—			(6,784		)	—			(6,784		)
Other comprehensive (loss)	—			—			(278		)	—			—			(278		)
Balance, December 31, 2018	$	52,122		$	371,848		$	(3,250	)	$	(36,968	)	$	(48,870	)	$	334,882
Issuance of 101,912 shares of common stock	3,549			—			—			2,672			—			6,221
Issuance of 7,720 shares of common stock under the employee stock purchase plan	434			—			—			—			—			434
Unearned restricted stock compensation	86			—			—			—			—			86
Forfeiture of 5,255 shares of common stock	(262		)	—			—			—			—			(262		)
Share-based compensation	14			—			—			—			—			14
Change related to ESOP shares	—			—			—			—			(2,956		)	(2,956		)
Net income	—			45,318			—			—			—			45,318
Cash dividends ($0.82 per share)	—			(7,657		)	—			—			—			(7,657		)
Purchase of 89,124 shares of common stock	—			—			—			(5,534		)	—			(5,534		)
Other comprehensive income	—			—			4,665			—			—			4,665
Balance, December 31, 2019	$	55,943		$	409,509		$	1,415		$	(39,830	)	$	(51,826	)	$	375,211

See Notes to Consolidated Financial Statements.

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HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2019, 2018 and 2017

(Amounts In Thousands)



	2019			2018			2017
Cash Flows from Operating Activities
Net income	$	45,318		$	36,767		$	28,061
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation	3,072			3,012			2,856
Provision for loan losses	(2,880		)	8,497			1,688
Net loss on sale of investment securities available for sale	28			—			—
Share-based compensation	14			—			11
Compensation expensed through issuance of common stock	1,133			1,466			1,446
Forfeiture of common stock	(262		)	(152		)	(156		)
Provision for deferred income taxes	1,301			(1,971		)	3,238
Net gain on sale of other real estate owned and other repossessed assets	(94		)	(18		)	(60		)
Increase in accrued interest receivable	(658		)	(1,012		)	(1,651		)
Amortization of premium on investment securities, net	441			480			586
(Increase) decrease in other assets	(2,681		)	(1,086		)	972
Amortization of operating lease right of use assets	354			—			—
Increase (decrease) in accrued interest and other liabilities	650			(1,423		)	4,263
Loans originated for sale	(299,223		)	(136,746		)	(150,264		)
Proceeds on sales of loans	296,346			141,441			156,455
Net gain on sales of loans	(3,539		)	(1,517		)	(1,547		)
Net cash and cash equivalents provided by operating activities	39,320			47,738			45,898
Cash Flows from Investing Activities
Proceeds from maturities of investment securities available for sale	63,301			57,284			65,339
Proceeds from sale of investment securities available for sale	12,467			—			—
Purchases of investment securities available for sale	(104,539		)	(90,295		)	(85,772		)
Loans made to customers, net of collections	(13,024		)	(168,567		)	(181,631		)
Proceeds on sale of other real estate owned and other repossessed assets	818			168			520
Purchases of property and equipment	(3,167		)	(2,206		)	(2,854		)
Net changes from tax credit real estate investment	913			883			487
Net cash and cash equivalents used in investing activities	(43,231		)	(202,733		)	(203,911		)

(Continued)

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HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

Years Ended December 31, 2019, 2018 and 2017

(Amounts In Thousands)



	2019			2018			2017
Cash Flows from Financing Activities
Net increase in deposits	240,240			132,559			252,253
Net decrease in short-term borrowings	—			—			(33,489		)
Net (decrease) increase in FHLB borrowings	(30,000		)	(80,000		)	60,000
Borrowings from FRB	1			1			820
Payments on FRB borrowings	(1		)	(1		)	(820		)
Issuance of common stock, net of costs	5,026			4,713			3,762
Stock options exercised	62			41			238
Purchase of treasury stock	(5,534		)	(6,784		)	(2,435		)
Proceeds from the issuance of common stock through the employee stock purchase plan	434			421			325
Dividends paid	(7,657		)	(7,003		)	(6,485		)
Net cash and cash equivalents provided by financing activities	202,571			43,947			274,169

Increase (decrease) in cash and cash equivalents	198,660			(111,048		)	116,156

Cash and cash equivalents:
Beginning of year	43,305			154,353			38,197
End of year	$	241,965		$	43,305		$	154,353

Supplemental Disclosures
Cash payments for:
Interest paid to depositors	$	27,878		$	19,009		$	9,436
Interest paid on other obligations	6,333			6,792			8,230
Income taxes paid	10,784			9,924			14,488
Noncash financing activities:
Increase in maximum cash obligation related to ESOP shares	$	2,956		$	5,562		$	2,527
Transfers to other real estate owned	712			150			223
Sale and financing of other real estate owned	97			96			433
Right-of-use assets obtained in exchange for operating lease obligations	3,581			—			—

See Notes to Consolidated Financial Statements.

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 1.	Nature of Activities and Significant Accounting Policies

Nature of activities: Hills Bancorporation (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 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.

The Bank competes with other financial institutions and non-financial institutions providing similar financial products. Although the loan activity of the Bank is diversified with commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans, the Bank's credit is concentrated in real estate loans. All of the Company’s operations are considered to be one reportable operating segment.

Accounting estimates: The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Certain significant estimates: The allowance for loan losses, fair values of securities and other financial instruments, and share-based compensation expense involve certain significant estimates made by management. These estimates are reviewed by management routinely and it is reasonably possible that circumstances that exist at December 31, 2019 may change in the near-term and the effect could be material to the consolidated financial statements.

Principles of consolidation: The consolidated financial statements include the accounts of the Company and its subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.

Revenue recognition: Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606"), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the Company’s contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

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. Loan origination fees of mortgage loans originated for sale are recognized when the loans are sold.

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 December 31, 2019 and 2018, the Company did not have any significant contract balances.

In connection with the adoption of ASC 606, 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

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to immediately expense 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 did not capitalize any contract acquisition costs for the years ending December 31, 2019 and 2018.

Cash and cash equivalents: The Company considers all investments with original maturities of three months or less to be cash equivalents. At December 31, 2019 and 2018, cash equivalents consisted primarily of deposits with other banks.

Investment securities: 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 December 31, 2019 or 2018.

Stock of the Federal Home Loan Bank is carried at cost. The Company has evaluated the stock and determined there is no impairment.

Premiums on debt securities are amortized to the earliest call date and discounts on debt securities are accreted over the period to maturity of those securities. The method of amortization results in a constant effective yield on those securities (the interest method). Realized gains and losses on investment securities are included in income, determined on the basis of the cost of the specific securities sold.

Declines in the fair value of investment securities available for sale (with certain exceptions for debt securities noted below) that are deemed to be other-than-temporary are charged to earnings as a realized loss, and a new cost basis for the securities is established. In evaluating other-than-temporary impairment, the Company considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Declines in the fair value of debt securities below amortized cost are deemed to be other-than-temporary in circumstances where: (1) the Company has the intent to sell a security; (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the Company does not expect to recover the entire amortized cost basis of the security. If the Company intends to sell a security or if it is more likely than not that the Company will be required to sell the security before recovery, an other-than-temporary impairment write-down is recognized in earnings equal to the difference between the security’s amortized cost basis and its fair value. If the Company does not intend to sell the security or it is not more likely than not that the Company will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into an amount representing credit loss, which is recognized in earnings, and an amount related to all other factors, which is recognized in other comprehensive income. Realized securities gains or losses on securities sales (using specific identification method) and declines in value judged to be other-than-temporary are included in investment securities gains (losses), net, in the consolidated statements of income.

Loans: Loans are stated at the amount of unpaid principal, reduced by the allowance for loan losses. Interest income is accrued on the unpaid balances as earned.

Loans held for sale are stated at the lower of aggregate cost or estimated fair value. Loans are sold on a non-recourse basis with servicing released and gains and losses are recognized based on the difference between sales proceeds and the carrying value of the loan. The Company has had very few experiences of repurchasing loans previously sold into the secondary market. A specific reserve was not considered necessary based on the Company’s historical experience with repurchase activity.

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance when management believes the collectability of principal is unlikely. The allowance for loan losses is maintained at a level considered adequate to provide for probable losses that can be reasonably anticipated. The allowance is increased by provisions charged to expense and is reduced by net charge-offs. The Bank makes continuous reviews of the loan portfolio and considers current economic conditions, historical loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance. Management classifies loans within the following categories: excellent, good, satisfactory, monitor, special mention and substandard.

The policy for charging off loans is consistent throughout all loan categories. A loan is charged off based on criteria that includes but is not limited to: delinquency status, financial condition of the entire customer credit line and underlying collateral coverage,

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

economic or external conditions that might impact full repayment of the loan, legal issues, overdrafts, and the customer’s willingness to work with the Company.

Loans are considered impaired when, based on current information and events, it is probable the Bank will not be able to collect all amounts due. An impaired loan includes any loan that has been placed on nonaccrual status, loans greater than 90 days past due and still accruing and TDR loans. They also include loans, based on current information and events, that it is likely the Bank will be unable to collect all amounts due according to the contractual terms of the original loan agreement. The portion of the allowance for loan losses applicable to impaired loans has been computed based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or on the fair value of the collateral for collateral dependent loans. The entire change in present value of expected cash flows of impaired loans or of collateral value is reported as provision expense in the same manner in which impairment initially was recognized or as a reduction in the amount of provision expense that otherwise would be reported. Interest income on nonaccrual loans is recognized once principal has been recovered.

The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower's ability to meet payments of interest or principal when they become due, which is generally when a loan is 90 days or more past due. When a loan is placed on nonaccrual status, all previously accrued and unpaid interest is reversed. Loans are returned to an accrual status when all of the principal and interest amounts contractually due are brought current and repayment of the remaining contractual principal and interest is expected. A loan may also return to accrual status if additional collateral is received from the borrower and, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the collection of the amount contractually due. Payment received on nonaccrual loans are applied first to principal. Once principal is recovered, any remaining payments received are applied to interest income. As of December 31, 2019, none of the Company’s nonaccrual loans were earning interest on a cash basis.

Nonrefundable loan fees and origination costs are deferred and recognized as a yield adjustment over the life of the related loan.

Troubled debt restructurings (“TDR loans”): A loan is classified as a troubled debt restructuring when a borrower is experiencing financial difficulties that leads to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses to the Company. A loan that is modified at a market rate of interest is no longer classified as troubled debt restructuring in the quarter following the modification if the borrower is no longer experiencing financial difficulties. Performance prior to the restructuring is considered when assessing whether the borrower can meet the new terms. At the time of restructuring, loans included in a troubled debt restructuring may be considered nonaccrual loans. TDR loans are returned to accrual status under the same criteria noted under loans above.

Transfers of financial assets: Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Credit related financial instruments: In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.

Tax credit real estate: Tax credit real estate represents two multi-family rental properties, three assisted living rental properties, a multi-tenant rental property for persons with disabilities, and a multi-family senior living rental property, all which are affordable housing projects as of December 31, 2019. The Bank has a 99% or greater limited partnership interest in each limited partnership. The investment in each was completed after the projects had been developed by the general partner. The Company evaluates the recoverability of the carrying value on a regular basis. If the recoverability was determined to be in doubt, a valuation allowance would be established by way of a charge to expense. Depreciation expense is provided on a straight-line basis over the estimated useful life of the assets. Expenditures for normal repairs and maintenance are charged to expense as incurred.

In February 2019, the Company entered into a Letter of Intent to invest in a limited partnership, as limited partner, which will own and operate an affordable housing property in Iowa City, Iowa. The Company provides construction financing for the project and will contribute capital of $4.18 million upon construction completion which is anticipated to be in April 2020.

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In 2016, the Company adopted ASU 2015-02 and the investments in tax credit real estate are recorded for all years presented using the equity method of accounting. The operations of the properties are not expected to contribute significantly to the Company’s income before income taxes. However, the properties do contribute in the form of income tax credits, which lowers the Company’s effective tax rate. Once established, the credits on each property last for ten years and are passed through from the limited partnerships to the Bank and reduces the consolidated federal tax liability of the Company.

Property and equipment: Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using primarily declining-balance methods over the estimated useful lives of 7-40 years for buildings and improvements and 3-10 years for furniture and equipment.

Deferred income taxes: Deferred income taxes are provided under the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating loss, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Interest and penalties on unrecognized tax benefits are classified as other noninterest expense. As of December 31, 2019, the Company had no material unrecognized tax benefits.

Goodwill: Goodwill represents the excess of cost over the fair value of the net assets acquired, and is not subject to amortization, but requires, at a minimum, annual impairment tests for intangibles that are determined to have an indefinite life.

Other real estate: Other real estate represents property acquired through foreclosures and settlements of loans. Property acquired is carried at the lower of the principal amount of the loan outstanding at the time of acquisition, plus any acquisition costs, or the estimated fair value of the property, less disposal costs. The Bank will obtain updated appraisals to determine the estimated fair value of the property based on the type of collateral securing the loan and the date of the latest appraisal. Subsequent write downs estimated on the basis of later valuations are charged to net loss on sale of other real estate owned and other repossessed assets. Net operating expenses incurred in maintaining such properties are charged to other non-interest expense. Net capital expenditures incurred are capitalized to the property.

Derivative financial instruments: The Bank uses interest rate swaps as part of its interest rate risk management. Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 815 establishes accounting and reporting standards for derivative instruments and hedging activities. The Bank records all interest rate swaps on the balance sheet at fair value. Derivatives used to hedge the exposure to variability in expected future cash flows are considered cash flow hedges. To qualify for hedge accounting, the Bank must comply with the detailed rules and documentation requirements at the inception of the hedge, and hedge effectiveness is assessed at inception and periodically throughout the life of the hedging relationship.

For derivatives designated as cash flow hedges, the changes in the fair value of the derivatives is initially reported in other comprehensive income and subsequently reclassified to interest income or expense when the hedged transaction affects earnings. The Bank assesses the effectiveness of each hedging relationship by comparing the cumulative changes in cash flows of the derivative hedging instruments with the cumulative changes in cash flows of the designated hedged item or transaction. No component of the change in the fair value of the hedging instrument is excluded from the assessment of hedge effectiveness.

The Bank does not use derivatives for trading or speculative purposes.

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.

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The following table presents calculations of earnings per share:



	Year Ended December 31,
	2019		2018		2017
	(Amounts In Thousands, except share and per share data)
Computation of weighted average number of basic and diluted shares:
Common shares outstanding at the beginning of the year	9,336,441		9,335,154		9,264,227
Weighted average number of net shares issued (redeemed)	19,304		31,160		65,776
Weighted average shares outstanding (basic)	9,355,745		9,366,314		9,330,003
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method	4,035		4,027		4,632
Weighted average number of shares (diluted)	9,359,780		9,370,341		9,334,635
Net income	$	45,318	$	36,767	$	28,061
Earnings per share:
Basic	$	4.85	$	3.93	$	3.01
Diluted	$	4.85	$	3.92	$	3.01

Stock awards and options: Compensation expense for stock issued through the stock award plan is accounted for using the fair value method prescribed by FASB ASC 718, “Share-Based Payment” (“ASC 718”). Under this method, compensation expense is measured and recognized for all stock-based awards made to employees and directors based on the fair value of each award as of the date of the grant.

Common stock held by ESOP: The Company's maximum cash obligation related to these shares is classified outside stockholders' equity because the shares are not readily traded and could be put to the Company for cash.

Treasury Stock: Treasury stock is accounted for by the cost method, whereby shares of common stock reacquired are recorded at their purchase price.

Trust Department Assets: Property held for customers in fiduciary or agency capacities is not included in the accompanying consolidated balance sheets, as such items are not assets of the Company.

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 goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. ASU 2014-09 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The Company has evaluated all of its noninterest income streams and contracts to determine potential impact. 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 the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes and eliminated the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The revised disclosures are in Note 13 Fair Value Measurements.

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In February 2016, the FASB issued ASU No. 2016-02 (Topic 842), Leases. The ASU provides guidance requiring lessees to recognize right-of-use (ROU) assets and lease liabilities for all leases other than those that meet the definition of short-term leases. For short-term leases, lessees may elect an accounting policy by class of underlying asset under which these assets and liabilities are not recognized and lease payments are generally recognized over the lease term on a straight-line basis. Under this new ASU, lessees will recognize right-of use assets and lease liabilities for most leases currently accounted for as operating leases under generally accepted accounting principles. For public companies, ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company adopted the ASU on January 1, 2019 and used the effective date as the date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019. The new standard provides a number of optional practical expedients in transition. We elected the 'package of practical expedients', which permits us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. We did not elect the use-of-hindsight or the practical expedient pertaining to land easements; the latter not being applicable to us. The most significant impact upon adoption relates to the recognition of new ROU assets and lease liabilities on our balance sheet for our equipment and real estate operating leases. Upon adoption, we recognized additional operating liabilities of $3.58 million, with corresponding ROU assets of the same amount based on the present value of the remaining minimum rental payments under current leasing standards for existing operating leases.

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.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (CECL). The ASU changes the way entities recognize impairment of financial assets by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the "incurred loss" model required under current GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase 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. The Company has implemented a software solution provided by a third party vendor to assist in the determination of the CECL model. The CECL model is being finalized and we completed the validation process for the CECL model using an independent outside party in January 2020. Our current planned approach for estimating expected life-time credit losses for loans upon adoption includes the following key components:


•	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 obtain estimated life-time credit losses using the conceptual components described above.

Based on our portfolio composition upon adoption and the current economic environment, we anticipate an increase in our Allowance for Credit Losses (ACL) for loans of approximately $3 million to $4 million. We also anticipate an unfunded commitments liability of approximately $1 million to $2 million. We will continue to evaluate and refine the results of our loss estimates throughout the first quarter of 2020. The future effects of CECL on our ACL will depend on the size and composition of our portfolio, the portfolio’s credit quality and economic conditions, as well as any refinements to our model, methodology and other key assumptions. We will recognize a one-time cumulative-effect adjustment to our ACL upon adoption of the new standard. The increase in the ACL will result in a decrease to our regulatory capital amounts and ratios.

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In January 2017, the FASB issued ASU No. 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments - Equity Method and Joint Ventures (Topic 323), Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings. This ASU adds an SEC paragraph and amends other Topics pursuant to an SEC staff Announcement made at the September 22, 2016 Emerging Issues Task Force (EITF) meeting. The SEC paragraph applies to ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606); ASU No. 2016-02, Leases (Topic 842); and ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU provides that a company should evaluate ASUs that have not yet been adopted to determine the appropriate financial statement disclosures about the potential material effects of those ASUs on the financial statements when adopted. If the company does not know or cannot reasonably estimate the impact that adoption of the ASUs referenced in this announcement is expected to have on the financial statements, then in addition to making a statement to that effect, the company should consider additional qualitative financial statement disclosures to assist the reader in assessing the significance of the impact that the standard will have on the financial statements of the company when adopted. Additional qualitative disclosures should include a description of the effect of the accounting policies that the company expects to apply and a comparison to the company's current accounting policies. Also, the company should describe the status of its process to implement the new standards and the significant implementation matters yet to be addressed.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 250), Simplifying the Test for Goodwill Impairment. The ASU simplifies the goodwill impairment test by requiring a company to perform its annual or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized when the carrying amount exceeds fair value. For public companies, ASU 2017-04 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The adoption of ASU No. 2017-04 by the Company on January 1, 2020 did not have a material impact on the financial statements.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities. This ASU requires companies to change the recognition and presentation of the effects of hedge accounting by eliminating the requirement to separately measure and report hedge ineffectiveness and requiring companies to present all of the elements of hedge accounting that affect earnings in the same income statement line as the hedged item. Furthermore, the standard eases the requirements for effectiveness testing, hedge documentation and applying the critical terms match method and introduces new alternatives that will permit companies to reduce the risk of material error corrections if they misapply the shortcut method. For public companies, ASU 2017-12 is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2018. The Company adopted ASU 2017-12 for the period ending March 31, 2019. There was no material impact on the financial statements.

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. Upon adoption, there was a $0.53 million reclassification recorded in stockholders' equity.

In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718), Improvements to Nonemployee Share-Based Payment Accounting. The amendments in this ASU expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. ASU 2018-07 is effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The Company adopted ASU 2018-07 for the period ending March 31, 2019. There was no material impact on the financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, including removal of the requirement to disclose the valuation processes for Level 3 fair value measurements and the additional requirement to disclose the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively

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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 ASU 2018-13 by the Company on January 1, 2020 did not have a material impact on the financial statements.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40), Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangements That Is a Service Contract. The amendments in this ASU align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption of the amendments in this ASU is permitted, including adoption in any interim period, for all entities. The amendments in this ASU should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The adoption of ASU 2018-15 by the Company on January 1, 2020 did not have a material impact on the financial statements.

In October 2018, the FASB issued ASU No. 2018-16, Derivatives and Hedging (Topic 815), Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. The amendments in this ASU permit use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the interest rates on direct Treasury obligations of the U.S. government, the London Interbank Offered Rate (LIBOR) swap rate, the Overnight Index Swap (OIS) Rate based on the Fed Funds Effective Rate and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. The amendments in this ASU are required to be adopted concurrently with the amendments in ASU 2017-12. For public companies, this would be for fiscal years, and interim periods within those fiscal years beginning after December 15, 2018. The Company adopted ASU No. 2018-16 for the period ending March 31, 2019 concurrently with ASU 2017-12. There was no material impact on the financial statements.

In July 2019, the FASB issued ASU No. 2019-07, Codification Updates to SEC Sections, Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization, and Miscellaneous Updates. The amendments in this ASU update the Codification to reflect the amendments of various SEC disclosure requirements that the agency determined were redundant, duplicative, overlapping, outdated or superseded. The SEC amended its disclosure rules in 2018 with the aim of providing investors with useful disclosure information and to simplify compliance without significantly altering the mix of the information being provided. This ASU was effective upon release and there was no material impact on the financial statements.

In November 2019, the FASB issued ASU No. 2019-08, Compensation - Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606), Codification Improvements - Share-Based Consideration Payable to a Customer. The amendments in this ASU require that an entity measure and classify share-based payment awards granted to a customer by applying the guidance in Topic 718. The amount recorded as a reduction of the transaction price is required to be measured on the basis of the grant-date fair value of the share-based payment award in accordance with Topic 718. The grant date is the date at which a grantor (supplier) and a grantee (customer) reach a mutual understanding of the key terms and conditions of a share-based payment award. The classification and subsequent measurement of the award are subject to the guidance in Topic 718 unless the share-based payment award is subsequently modified and the grantee is no longer a customer. The Company adopted ASU 2019-08 for the period ending December 31, 2019. There was no material impact on the financial statements.

In November 2019, the FASB issued ASU No. 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses. The amendments in this ASU clarify or address stakeholders' specific issues about certain aspects of the amendments in ASU 2016-13 in the following areas: expected recoveries for purchased financial assets with credit deterioration, transition relief for troubled debt restructurings, disclosures related to accrued interest receivables and financial assets secured by collateral maintenance provisions. For public companies, ASU 2019-11 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 and will be adopted concurrently with ASU 2016-13.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes. The amendments in this ASU simplify the accounting for income taxes by removing specific exceptions included in Topic 740, introducing other simplifications and making technical corrections. For public business entities, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted. The Company is currently evaluating the impact the adoption of this ASU will have on the financial statements.

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Note 2.	Investment Securities

The carrying values of investment securities at December 31, 2019 and December 31, 2018 are summarized in the following table (Amounts in Thousands):



	December 31, 2019				December 31, 2018
	Amount		Percent		Amount		Percent
Securities available for sale
U.S. Treasury	$	128,585	36.19	%	$	83,155	26.07	%
Other securities (FHLB, FHLMC and FNMA)	15,229		4.29	%	34,871		10.93	%
State and political subdivisions	211,489		59.52	%	200,900		63.00	%
Total securities available for sale	$	355,303	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. The Company had no securities designated as trading or held to maturity in its portfolio at December 31, 2019 or 2018. The carrying amount of available-for-sale securities and their approximate fair values were as follows (Amounts in Thousands):



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
December 31, 2019:
U.S. Treasury	$	127,096	$	1,626	$	(137	)	$	128,585
Other securities (FHLB, FHLMC and FNMA)	15,287		—		(58		)	15,229
State and political subdivisions	208,686		2,938		(135		)	211,489
Total	$	351,069	$	4,564	$	(330	)	$	355,303
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

The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at December 31, 2019, were as follows (Amounts in Thousands):



	Amortized Cost		Fair Value
Due in one year or less	$	63,191	$	63,189
Due after one year through five years	196,456		198,559
Due after five years through ten years	81,854		84,025
Due over ten years	9,568		9,530
Total	$	351,069	$	355,303

As of December 31, 2019, investment securities with a carrying value of $12.93 million were pledged to collateralize derivative financial instruments and other borrowings.

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Sales proceeds and gross realized gains and losses on available-for-sale securities were as follows (in thousands):



	December 31, 2019		December 31, 2018
Sales proceeds	$	12,467	$	—
Gross realized gains	24		—
Gross realized losses	52		—

The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2019 and 2018 (Amounts in Thousands):



	Less than 12 months								12 months or more								Total
2019
Description	#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%
of Securities
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
2018
Description	#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%
of Securities
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 credit quality 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.

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Note 3.	Loans

Classes of loans are as follows:



	December 31,
	2019		2018
	(Amounts In Thousands)
Agricultural	$	91,317	$	92,673
Commercial and financial	221,323		229,501
Real estate:
Construction, 1 to 4 family residential	80,209		72,279
Construction, land development and commercial	108,410		113,807
Mortgage, farmland	242,730		236,454
Mortgage, 1 to 4 family first liens	910,742		912,059
Mortgage, 1 to 4 family junior liens	149,227		152,625
Mortgage, multi-family	350,761		352,434
Mortgage, commercial	402,181		383,314
Loans to individuals	32,308		30,072
Obligations of state and political subdivisions	49,896		52,725
	2,639,104		2,627,943
Net unamortized fees and costs	933		952
	2,640,037		2,628,895
Less allowance for loan losses	33,760		37,810
	$	2,606,277	$	2,591,085

Changes in the allowance for loan losses and the allowance for loan loss balance applicable to impaired loans and the related loan balance of impaired loans for the years ended December 31, 2019, 2018 and 2017 are as follows:



	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)
2019
Allowance for loan losses:
Beginning balance	$	2,789		$	5,826		$	3,292		$	3,972		$	12,516		$	8,165		$	1,250		$	37,810
Charge-offs	(266		)	(981		)	(45		)	(6		)	(896		)	(341		)	(434		)	(2,969		)
Recoveries	95			646			8			5			700			180			165			1,799
Provision	(218		)	(503		)	(656		)	(21		)	(1,682		)	(145		)	345			(2,880		)
Ending balance	$	2,400		$	4,988		$	2,599		$	3,950		$	10,638		$	7,859		$	1,326		$	33,760
Ending balance, individually evaluated for impairment	$	87		$	792		$	—		$	—		$	111		$	1		$	93		$	1,084
Ending balance, collectively evaluated for impairment	$	2,313		$	4,196		$	2,599		$	3,950		$	10,527		$	7,858		$	1,233		$	32,676
Loan balances:
Ending balance	$	91,317		$	221,323		$	188,619		$	242,730		$	1,059,969		$	752,942		$	82,204		$	2,639,104
Ending balance, individually evaluated for impairment	$	1,730		$	2,742		$	421		$	4,081		$	8,670		$	3,188		$	93		$	20,925
Ending balance, collectively evaluated for impairment	$	89,587		$	218,581		$	188,198		$	238,649		$	1,051,299		$	749,754		$	82,111		$	2,618,179

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



	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)
2018
Allowance for loan losses:
Beginning balance	$	2,294		$	4,837		$	2,989	$	3,669	$	8,668		$	5,700		$	1,243		$	29,400
Charge-offs	(95		)	(585		)	—		—		(830		)	(251		)	(561		)	(2,322		)
Recoveries	119			1,057			148		30		612			107			162			2,235
Provision	471			517			155		273		4,066			2,609			406			8,497
Ending balance	$	2,789		$	5,826		$	3,292	$	3,972	$	12,516		$	8,165		$	1,250		$	37,810
Ending balance, individually evaluated for impairment	$	479		$	1,189		$	4	$	—	$	72		$	306		$	64		$	2,114
Ending balance, collectively evaluated for impairment	$	2,310		$	4,637		$	3,288	$	3,972	$	12,444		$	7,859		$	1,186		$	35,696
Loan balances:
Ending balance	$	92,673		$	229,501		$	186,086	$	236,454	$	1,064,684		$	735,748		$	82,797		$	2,627,943
Ending balance, individually evaluated for impairment	$	2,460		$	4,162		$	1,137	$	3,612	$	7,012		$	9,538		$	64		$	27,985
Ending balance, collectively evaluated for impairment	$	90,213		$	225,339		$	184,949	$	232,842	$	1,057,672		$	726,210		$	82,733		$	2,599,958



	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)
2017
Allowance for loan losses:
Beginning balance	$	2,947		$	4,531		$	2,890		$	3,417		$	7,677		$	4,045		$	1,023		$	26,530
Charge-offs	(167		)	(583		)	(114		)	(3		)	(553		)	(130		)	(554		)	(2,104		)
Recoveries	146			1,183			662			—			661			376			258			3,286
Provision	(632		)	(294		)	(449		)	255			883			1,409			516			1,688
Ending balance	$	2,294		$	4,837		$	2,989		$	3,669		$	8,668		$	5,700		$	1,243		$	29,400
Ending balance, individually evaluated for impairment	$	133		$	1,018		$	39		$	238		$	66		$	482		$	190		$	2,166
Ending balance, collectively evaluated for impairment	$	2,161		$	3,819		$	2,950		$	3,431		$	8,602		$	5,218		$	1,053		$	27,234
Loan balances:
Ending balance	$	88,580		$	218,632		$	179,333		$	215,286		$	975,791		$	698,006		$	84,043		$	2,459,671
Ending balance, individually evaluated for impairment	$	4,916		$	2,768		$	957		$	7,962		$	6,654		$	8,040		$	190		$	31,487
Ending balance, collectively evaluated for impairment	$	83,664		$	215,864		$	178,376		$	207,324		$	969,137		$	689,966		$	83,853		$	2,428,184

The Company evaluates the following loans to determine impairment: 1) all nonaccrual and TDR loans, 2) all non consumer and non 1 to 4 family residential loans with prior charge-offs, 3) all non consumer and non 1 to 4 family loan relationships classified as substandard and 4) loans with indications of or suspected deteriorating credit quality.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the credit quality indicators by type of loans in each category as of December 31, 2019:



	Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial
	(Amounts In Thousands)
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



	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
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
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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the credit quality indicators by type of loans in each category as of December 31, 2018:



	Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial
	(Amounts In Thousands)
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
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
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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Past due loans as of December 31, 2019 and 2018 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)
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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



	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)
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

The Company does not have a significant 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.

Accruing loans past due 90 days or more increased $0.24 million from December 31, 2018 to December 31, 2019. As of December 31, 2019 and 2018, accruing loans past due 90 days or more were 0.02% and 0.01% of total loans, respectively. The average balance of the accruing loans past due 90 days or more decreased in 2019 as compared to 2018. The average 90 days or more past due accruing loan balance per loan was $0.08 million as of December 31, 2019 compared to $0.19 million as of December 31, 2018. The loans 90 days or more past due and still accruing are believed to be adequately collateralized. Loans are placed on nonaccrual status when management believes the collection of future principal and interest is not reasonably assured.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Certain impaired loan information by loan type at December 31, 2019 and 2018 was as follows:



	December 31, 2019						December 31, 2018
	Nonaccrual loans (1)		Accruing loans past due 90 days or more		TDR loans		Nonaccrual loans (1)		Accruing loans past due 90 days or more		TDR loans
	(Amounts In Thousands)						(Amounts In Thousands)
Agricultural	$	1,192	$	48	$	404	$	1,338	$	—	$	120
Commercial and financial	679		65		1,934		1,476		—		2,686
Real estate:
Construction, 1 to 4 family residential	—		—		—		—		212		—
Construction, land development and commercial	—		—		320		—		—		328
Mortgage, farmland	1,369		—		2,712		1,062		—		3,301
Mortgage, 1 to 4 family first liens	6,558		354		1,626		5,799		158		1,143
Mortgage, 1 to 4 family junior liens	94		139		—		—		—		24
Mortgage, multi-family	97		—		1,719		145		—		—
Mortgage, commercial	779		—		593		1,009		—		937
Loans to individuals	—		—		—		—		—		—
	$	10,768	$	606	$	9,308	$	10,829	$	370	$	8,539


(1)	There were $4.34 million and $4.84 million of TDR loans included within nonaccrual loans as of December 31, 2019 and 2018, respectively.

The Company may modify the terms of a loan to maximize the collection of amounts due. In most cases, the modification is 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 financial 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Below is a summary of information for TDR loans as of December 31, 2019 and 2018:



	December 31, 2019
	Number of contracts	Recorded investment		Commitments outstanding
		(Dollar Amounts In Thousands)
Agricultural	9	$	1,552	$	3
Commercial and financial	16	2,641		95
Real estate:
Construction, 1 to 4 family residential	—	—		—
Construction, land development and commercial	2	320		—
Mortgage, farmland	8	4,021		—
Mortgage, 1 to 4 family first liens	16	2,083		—
Mortgage, 1 to 4 family junior liens	—	—		—
Mortgage, multi-family	2	1,719		—
Mortgage, commercial	7	1,373		—
Loans to individuals	—	—		—
	60	$	13,709	$	98



	December 31, 2018
	Number of contracts	Recorded investment		Commitments outstanding
		(Dollar Amounts In Thousands)
Agricultural	5	$	1,316	$	91
Commercial and financial	13	3,867		75
Real estate:
Construction, 1 to 4 family residential	—	—		—
Construction, land development and commercial	2	328		—
Mortgage, farmland	8	4,291		—
Mortgage, 1 to 4 family first liens	16	1,710		—
Mortgage, 1 to 4 family junior liens	1	24		—
Mortgage, multi-family	—	—		—
Mortgage, commercial	9	1,839		—
Loans to individuals	—	—		—
	54	$	13,375	$	166

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A summary of TDR loans that were modified during the year ended December 31, 2019 and 2018 was as follows:



	December 31, 2019
	Number of Contracts	Pre-modification recorded investment		Post-modification recorded investment
		( Dollar Amounts In Thousands)
Agricultural	4	$	574	$	574
Commercial and financial	5	503		503
Real estate:
Construction, 1 to 4 family residential	—	—		—
Construction, land development and commercial	—	—		—
Mortgage, farmland	1	620		620
Mortgage, 1 to 4 family first liens	3	705		705
Mortgage, 1 to 4 family junior liens	—	—		—
Mortgage, multi-family	2	1,719		1,719
Mortgage, commercial	—	—		—
Loans to individuals	—	—		—
	15	$	4,121	$	4,121



	December 31, 2018
	Number of Contracts	Pre-modification recorded investment		Post-modification recorded investment
		( Dollar Amounts In Thousands)
Agricultural	1	$	163	$	163
Commercial and financial	6	2,294		2,294
Real estate:
Construction, 1 to 4 family residential	—	—		—
Construction, land development and commercial	1	218		218
Mortgage, farmland	2	4,944		4,944
Mortgage, 1 to 4 family first liens	6	627		627
Mortgage, 1 to 4 family junior liens	—	—		—
Mortgage, multi-family	—	—		—
Mortgage, commercial	2	852		852
Loans to individuals	—	—		—
	18	$	9,098	$	9,098

The Bank has commitments to lend additional borrowings to TDR loan customers. These commitments are in the normal course of business and allow the borrowers to build pre-sold homes and commercial property which increase their overall cash flow. The additional borrowings are not used to facilitate payments on these loans.

There was one TDR loan totaling $0.065 million modified during the year that was in payment default (defined as past due 90 days or more) as of December 31, 2019 and none as of December 31, 2018.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Information regarding impaired loans as of and for the year ended December 31, 2019 is as follows:



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Amounts in Thousands)
2019
With no related allowance recorded:
Agricultural	$	1,596	$	2,157	$	—	$	1,785	$	37
Commercial and financial	1,340		2,220		—		1,617		64
Real estate:
Construction, 1 to 4 family residential	101		144		—		106		—
Construction, land development and commercial	320		336		—		324		18
Mortgage, farmland	4,081		4,613		—		4,144		157
Mortgage, 1 to 4 family first liens	7,157		9,015		—		6,822		51
Mortgage, 1 to 4 family junior liens	—		246		—		—		—
Mortgage, multi-family	1,816		1,930		—		1,873		83
Mortgage, commercial	1,302		1,852		—		1,364		26
Loans to individuals	—		14		—		—		—
	$	17,713	$	22,527	$	—	$	18,035	$	436
With an allowance recorded:
Agricultural	$	134	$	134	$	87	$	287	$	17
Commercial and financial	1,402		1,539		792		1,510		83
Real estate:
Construction, 1 to 4 family residential	—		—		—		—		—
Construction, land development and commercial	—		—		—		—		—
Mortgage, farmland	—		—		—		—		—
Mortgage, 1 to 4 family first liens	1,280		1,501		64		1,318		29
Mortgage, 1 to 4 family junior liens	233		233		47		239		6
Mortgage, multi-family	—		—		—		—		—
Mortgage, commercial	70		70		1		73		4
Loans to individuals	93		93		93		62		2
	$	3,212	$	3,570	$	1,084	$	3,489	$	141
Total:
Agricultural	$	1,730	$	2,291	$	87	$	2,072	$	54
Commercial and financial	2,742		3,759		792		3,127		147
Real estate:
Construction, 1 to 4 family residential	101		144		—		106		—
Construction, land development and commercial	320		336		—		324		18
Mortgage, farmland	4,081		4,613		—		4,144		157
Mortgage, 1 to 4 family first liens	8,437		10,516		64		8,140		80
Mortgage, 1 to 4 family junior liens	233		479		47		239		6
Mortgage, multi-family	1,816		1,930		—		1,873		83
Mortgage, commercial	1,372		1,922		1		1,437		30
Loans to individuals	93		107		93		62		2
	$	20,925	$	26,097	$	1,084	$	21,524	$	577

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Information regarding impaired loans as of and for the year ended December 31, 2018 is as follows:



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Amounts in Thousands)
2018
With no related allowance recorded:
Agricultural	$	1,395	$	1,663	$	—	$	1,071	$	23
Commercial and financial	1,650		2,503		—		1,977		58
Real estate:
Construction, 1 to 4 family residential	111		148		—		113		—
Construction, land development and commercial	328		344		—		333		18
Mortgage, farmland	3,612		4,071		—		3,068		89
Mortgage, 1 to 4 family first liens	6,089		7,819		—		6,435		36
Mortgage, 1 to 4 family junior liens	—		254		—		—		—
Mortgage, multi-family	145		213		—		153		—
Mortgage, commercial	1,871		2,486		—		1,940		42
Loans to individuals	—		14		—		—		—
	$	15,201	$	19,515	$	—	$	15,090	$	266
With an allowance recorded:
Agricultural	$	1,065	$	1,229	$	479	$	980	$	7
Commercial and financial	2,512		2,512		1,189		2,793		107
Real estate:
Construction, 1 to 4 family residential	698		698		4		622		28
Construction, land development and commercial	—		—		—		—		—
Mortgage, farmland	—		—		—		—		—
Mortgage, 1 to 4 family first liens	899		974		70		888		25
Mortgage, 1 to 4 family junior liens	24		24		2		25		1
Mortgage, multi-family	7,447		7,447		305		7,543		346
Mortgage, commercial	75		75		1		77		4
Loans to individuals	64		64		64		77		9
	$	12,784	$	13,023	$	2,114	$	13,005	$	527
Total:
Agricultural	$	2,460	$	2,892	$	479	$	2,051	$	30
Commercial and financial	4,162		5,015		1,189		4,770		165
Real estate:
Construction, 1 to 4 family residential	809		846		4		735		28
Construction, land development and commercial	328		344		—		333		18
Mortgage, farmland	3,612		4,071		—		3,068		89
Mortgage, 1 to 4 family first liens	6,988		8,793		70		7,323		61
Mortgage, 1 to 4 family junior liens	24		278		2		25		1
Mortgage, multi-family	7,592		7,660		305		7,696		346
Mortgage, commercial	1,946		2,561		1		2,017		46
Loans to individuals	64		78		64		77		9
	$	27,985	$	32,538	$	2,114	$	28,095	$	793

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Information regarding impaired loans as of and for the year ended December 31, 2017 is as follows:



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Amounts in Thousands)
2017
With no related allowance recorded:
Agricultural	$	1,822	$	2,193	$	—	$	2,044	$	19
Commercial and financial	1,725		2,487		—		2,080		51
Real estate:
Construction, 1 to 4 family residential	114		150		—		116		5
Construction, land development and commercial	338		371		—		344		14
Mortgage, farmland	2,523		2,902		—		2,476		56
Mortgage, 1 to 4 family first liens	6,045		7,507		—		6,286		80
Mortgage, 1 to 4 family junior liens	7		482		—		23		—
Mortgage, multi-family	218		355		—		231		—
Mortgage, commercial	1,564		2,274		—		1,706		45
Loans to individuals	—		14		—		—		—
	$	14,356	$	18,735	$	—	$	15,306	$	270
With an allowance recorded:
Agricultural	$	3,094	$	3,149	$	133	$	3,526	$	160
Commercial and financial	1,043		1,043		1,018		1,249		60
Real estate:
Construction, 1 to 4 family residential	—		—		—		—		—
Construction, land development and commercial	505		505		39		321		14
Mortgage, farmland	5,439		5,439		238		5,596		242
Mortgage, 1 to 4 family first liens	577		593		63		585		20
Mortgage, 1 to 4 family junior liens	25		25		3		26		1
Mortgage, multi-family	6,179		6,179		480		6,247		281
Mortgage, commercial	79		79		2		81		4
Loans to individuals	190		190		190		179		20
	$	17,131	$	17,202	$	2,166	$	17,810	$	802
Total:
Agricultural	$	4,916	$	5,342	$	133	$	5,570	$	179
Commercial and financial	2,768		3,530		1,018		3,329		111
Real estate:
Construction, 1 to 4 family residential	114		150		—		116		5
Construction, land development and commercial	843		876		39		665		28
Mortgage, farmland	7,962		8,341		238		8,072		298
Mortgage, 1 to 4 family first liens	6,622		8,100		63		6,871		100
Mortgage, 1 to 4 family junior liens	32		507		3		49		1
Mortgage, multi-family	6,397		6,534		480		6,478		281
Mortgage, commercial	1,643		2,353		2		1,787		49
Loans to individuals	190		204		190		179		20
	$	31,487	$	35,937	$	2,166	$	33,116	$	1,072

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Impaired loans decreased by $7.06 million from December 31, 2018 to December 31, 2019. Impaired loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more, TDR loans and specific reserve loans. Impaired 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. Impaired loans were 0.79% and 1.06% of loans held for investment as of December 31, 2019 and 2018, respectively. The decrease in impaired loans is due mainly to a decrease of $8.07 million in specific reserve loans and a decrease in nonaccrual loans of $0.06 million and offset by an increase of accruing loans past due 90 days or more of $0.24 million, and an increase in TDR loans of $0.77 million from December 31, 2018 to December 31, 2019.

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 that can be identified as uncollectible. In general, this is the amount that the carrying value of the loan exceeds the related appraised value. 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 additional charge-off or loss allocations based on the applicable facts and circumstances. In instances where there is an estimated decline in value, either a loss allocation is 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 loss allocation 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 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 helping to determine 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.

The Company separates its portfolio loans and leases into segments for determining the allowance for loan losses. The Company's portfolio segments includes agricultural, commercial and financial, real estate, loans to individuals and obligations of state and political subdivisions. The Company further separates its portfolio into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes with the real estate portfolio segment includes 1 to 4 family residential constructions, land development and commercial construction, farmland, 1 to 4 family first liens, 1 to 4 family junior liens, multi-family and commercial.

Loans that exhibit probable or observed credit weaknesses, as well as loans that have been modified in a TDR, are subject to individual review for impairment. When individual loans are reviewed for impairment, the Company determines allowances based on management's estimate of the borrower's ability to repay the loan given the availability of the collateral, other sources of cash flow, as well as evaluation of legal options available. Allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral.

Historical loss rates are applied to loans that are not individually reviewed for impairment. The 20 quarter migration analysis performed by management uses loan level attributes to track the movement of loans through the various credit risk rating categories in order to estimate the percentage of historical loss to apply to each specific credit risk rating in each loan category. The credit risk rating system currently utilized for allowance analysis purposes encompasses six categories.

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Note 4.	Property and Equipment

The major classes of property and equipment and the total accumulated depreciation are as follows:



	December 31,
	2019		2018
	(Amounts In Thousands)
Land	$	11,261	$	10,899
Buildings and improvements	37,261		36,815
Furniture and equipment	38,449		36,090
	86,971		83,804
Less accumulated depreciation	49,825		46,753
Net	$	37,146	$	37,051


Note 5.	Leases

The Bank leases branch offices, parking facilities and certain equipment under operating leases. The leases have remaining lease terms of 1 year to 16 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 year ended December 31, 2019, total operating lease expense was $0.62 million included in occupancy expenses in the consolidated statement of income. Included in this were $0.53 million of operating lease costs, $0.03 million of short term lease costs, and $0.06 million of variable lease costs.

For the year ended December 31, 2019, cash paid for amounts included in the measurement of operating lease liabilities was $0.53 million and right-of-use assets obtained in exchange for lease obligations was $3.58 million.

As of December 31, 2019, operating lease right-of-use assets included in other assets was $3.20 million and liabilities was $3.23 million. The weighted average remaining lease term for operating leases was 10.86 years and the weighted average discount rate for operating leases was 3.46%. Discount rates used were determined from FHLB borrowing rates for comparable terms.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2019, maturities of lease liabilities were as follows:



Year ending December 31:	(Amounts In Thousands)
2020	470
2021	456
2022	447
2023	301
2024	250
Thereafter	2,009
Total lease payments	3,933
Less imputed interest	(706		)
Total operating lease liabilities	$	3,227


Note 6.	Interest - Bearing Deposits

A summary of these deposits is as follows:



	December 31,
	2019		2018
	(Amounts In Thousands)
NOW and other demand	$	610,271	$	542,388
Savings	981,827		925,214
Time, $100,000 and over	292,982		228,551
Other time	388,672		352,819
	$	2,273,752	$	2,048,972

Brokered deposits totaled $109.29 million and $132.46 million as of December 31, 2019 and 2018, respectively, with an average interest rate of 1.65% and 2.46% as of December 31, 2019 and 2018, respectively. As of December 31, 2019, brokered deposits of $109.29 million are included in savings deposits. At December 31, 2018, brokered deposits of $132.46 million were included in savings deposits.

Time deposits have a maturity as follows:



	December 31,
	2019		2018
	(Amounts In Thousands)
Due in one year or less	$	324,554	$	229,091
Due after one year through two years	124,527		223,254
Due after two years through three years	90,009		44,610
Due after three years through four years	130,252		35,002
Due over four years	12,312		49,413
	$	681,654	$	581,370

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 7.	Federal Home Loan Bank Borrowings

As of December 31, 2019 and 2018, the borrowings were as follows:



	2019		2018
(Effective interest rates as of December 31, 2019)	(Amounts In Thousands)
Due 2020, 3.05%	25,000		25,000
Due 2023, 3.77%	25,000		25,000
Due 2024, 2.38%	15,000		15,000
Due 2025, 2.54% to 2.94%	60,000		90,000
Due 2026, 2.52% to 2.86%	30,000		30,000
Due 2027, 2.76% to 2.95%	30,000		30,000
	$	185,000	$	215,000

On December 13, 2019 the Company paid $30.00 million in FHLB Borrowings due in 2025. On January 17, 2018 the Company paid $15.00 million in FHLB Borrowings due in 2019 and $15.00 million due in 2021. On February 6, 2018 the Company paid $15.00 million in FHLB Borrowings due in 2021. On February 28, 2018 the Company paid $15.00 million in FHLB Borrowings due in 2022. There were no prepayment fees incurred with these prepayments. Fees incurred with the 2019 prepayments were $2.09 million. The remaining borrowings with the FHLB may have prepayment fees based on the current FHLB borrowing rate.

To participate in the FHLB advance program, the Company is required to have an investment in FHLB stock. The Company’s investment in FHLB stock was $11.06 million and $12.17 million at December 31, 2019 and 2018, respectively. Collateral is provided by the Company’s 1 to 4 family mortgage loans totaling $249.75 million at December 31, 2019 and $290.25 million at December 31, 2018. The Company also has the ability to borrow against agricultural real estate, commercial real estate and multi-family loans totaling $306.86 million as of December 31, 2019 and $296.53 million as of December 31, 2018 and there was $0 borrowed against this collateral as of December 31, 2019 or 2018.


Note 8.	Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income (AOCI), included in stockholders’ equity, are as follows:



	December 31,
	2019			2018
	(amounts in thousands)
Net unrealized gain (loss) on available-for-sale securities	$	4,234		$	(2,734	)
Net unrealized loss on derivatives used for cash flow hedges	(2,349		)	(1,596		)
Tax effect	(470		)	1,080
Net-of-tax amount	$	1,415		$	(3,250	)


Note 9.	Employee Benefit Plans

The Company has an Employee Stock Purchase Plan (the “ESPP”). For each quarterly offering period, eligible employees can elect to contribute from 1% to 15% of his or her compensation. The purchase price is the lesser of 90% of the fair market value on the first day of the offering period or the last day of the offering period. The maximum dollar amount any one employee can elect to contribute in a year is $9,000. During the year ended December 31, 2019, 7,720 shares of stock were purchased by employees of the Bank through the ESPP. 8,172 shares of stock were purchased by employees of the Bank through the ESPP for the year ended December 31, 2018.

The Company has an Employee Stock Ownership Plan (the "ESOP") to which it makes discretionary cash contributions. The Company's contribution to the ESOP totaled $1.08 million, $1.05 million and $1.01 million for the years ended December 31, 2019, 2018 and 2017, respectively. The 2019, 2018 and 2017 discretionary contribution rate was 4.5% of qualified salaries.

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In the event a terminated plan participant desires to sell his or her shares of the Company stock, or for certain employees who elect to diversify their account balances, the Company may be required to purchase the shares from the participant at their fair value. To the extent that shares of common stock held by the ESOP are not readily traded, a sponsor must reflect the maximum cash obligation related to those securities outside of stockholders' equity. The Company obtains a quarterly independent appraisal of the shares of stock. As of December 31, 2019 and 2018, the shares held by the ESOP, fair value and maximum cash obligation were as follows:



	2019		2018
Shares held by the ESOP	797,317		801,147
Fair value per share	$	65.00	$	61.00
Maximum cash obligation	$	51,826,000	$	48,870,000

The Company has a profit-sharing plan with a 401(k) feature, which provides for discretionary annual contributions in amounts to be determined by the Board of Directors. The Company made a 4.50% or $1.08 million contribution to the profit sharing plan for the year ended December 31, 2019. The Company made a 4.50% or $1.05 million contribution to the profit sharing plan for the year ended December 31, 2018. The Company made a 4.50% or $1.01 million contribution to the profit sharing plan for the year ended December 31, 2017. The Company made matching contributions under its 401(k) plan of $0.22 million in 2019, $0.21 million in 2018, and $0.20 million in 2017 and each such amount is included in salaries and employee benefits expense.

The Company provides a deferred compensation program for executive officers. This program allows executive officers to elect to defer a portion of their salaried compensation for payment by the Company at a subsequent date. The executive officers can defer up to 30% of their base compensation and up to 100% of any bonus into the deferral plan. Any amount so deferred is credited to the executive officer’s deferred compensation account and converted to units equivalent in value to the fair market value of a share of stock in Hills Bancorporation. The “stock units” are book entry only and do not represent an actual purchase of stock. The executive officer’s account is adjusted each year for dividends paid and the change in the market value of Hills Bancorporation stock. The deferrals and earnings grow tax deferred until withdrawn from the plan. Earnings credited to the individual’s accounts are recorded as compensation expense when earned. The deferred compensation liability is recorded in other liabilities and totals $4.89 million and $5.90 million at December 31, 2019 and 2018, respectively. Expense related to the deferred compensation plan was $0.42 million for 2019, $0.85 million for 2018 and $0.81 million for 2017 and is included in salaries and employee benefits expense.

The Company also provides a deferred compensation program for its Board of Directors. Under the plan, each director may elect to defer up to 50% of such director’s cash compensation from retainers and meeting fees for payment by the Company at a subsequent date. Any amount so deferred is credited to the director’s deferred compensation account and converted to units equivalent in value to the fair market value of a share of stock in Hills Bancorporation. The “stock units” are book entry only and do not represent an actual purchase of stock. The director’s account is adjusted each year for dividends paid and the change in the market value of Hills Bancorporation stock. The deferred compensation liability for the directors’ plan is recorded in other liabilities and totaled $3.94 million and $3.52 million at December 31, 2019 and 2018, respectively. Expense related to the directors’ deferred compensation plan was $0.28 million for 2019, $0.43 million for 2018 and $0.37 million for 2017 and is included in other noninterest expense.

The Company has a Stock Option and Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or restricted stock awards. Under the plan, the aggregate number of options and shares granted cannot exceed 188,000 shares. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Director options and officers' rights under the plan vest over a five-year period from the date of the grant.

The fair value of each option is estimated as of the date of grant using a Black Scholes option pricing model. The expected lives of options granted incorporate historical employee exercise behavior. The risk-free rate for periods that coincide with the expected life of the options is based on the ten year interest rate swap rate as published by the Federal Reserve Bank on the date of issuance. Expected volatility is based on volatility levels of the Company’s peers’ common stock as the Company’s stock has limited trading activity. Expected dividend yield was based on historical dividend rates. Significant assumptions at the date of grant on May 14, 2019 include the risk-free interest rate of 2.39%, expected option life of 7.5 years, expected volatility of 33% and expected dividends of 1.23%.

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There were 5,805 stock options granted in 2019 and none in 2018 and 2017. The weighted-average fair value of options granted in 2019 was $21.31 per share. The intrinsic value of options exercised was $0.06 million, $0.03 million and $0.24 million for 2019, 2018 and 2017, respectively.

A summary of the stock options is as follows:



	Number of Shares		Weighted- Average Exercise Price		Weighted-Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value (In Thousands)
Balance, December 31, 2016	19,380		$	29.92	3.03	$	580
Granted	—
Exercised	(9,160	)
Balance, December 31, 2017	10,220		$	33.44	4.45	342
Granted	—
Exercised	(1,200	)
Balance, December 31, 2018	9,020		$	33.30	3.41	250
Granted	5,805
Exercised	(1,800	)
Balance, December 31, 2019	13,025		$	45.92	5.47	$	248

Other pertinent information related to the options outstanding at December 31, 2019 is as follows:



Exercise Price	Number Outstanding	Remaining Contractual Life	Number Exercisable
33.00	7,220	28 months	7,220
62.00	5,805	113 months	—
	13,025		7,220

As of December 31, 2019, the outstanding options have a weighted-average exercise price of $45.92 per share and a weighted average remaining contractual term of 5.47 years. There was $0.11 million in unrecognized compensation cost for stock options granted under the plan as of December 31, 2019. The cost is expected to be recognized over a weighted-average period of 4.40 years. As of December 31, 2019, the vested options totaled 7,220 shares with a weighted-average exercise price of $33.00 per share.

As of December 31, 2019, 19,853 shares were available for stock options and awards. The Compensation and Incentive Stock Committee is also authorized to grant awards of restricted common stock. A summary of the restricted stock option activity for the year ended December 31, 2019 is as follows:



	Number of Shares	Weighted Average Grant Date Fair Value
Balance, December 31, 2018	38,125
Granted	23,527	$63.96
Forfeited	5,255	$49.91
Balance, December 31, 2019	19,853

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company authorized the issuance of 23,527 shares in 2019, 24,899 shares in 2018, and 27,407 shares in 2017 to certain employees. The vesting period for these awards is five years and the Bank amortizes the expense on a straight line basis during the vesting period. The expense relating to these awards for the years ended December 31, 2019, 2018 and 2017 was $0.96 million, $0.85 million and $0.58 million, respectively. 7,200, 15,200 and 15,200 shares of the restricted common stock shares awarded in December 31, 2019, 2018 and 2017, are subject to forfeiture upon termination of the employee's employment with the Company within eight years of the award.


Note 10.	Income Taxes

Income taxes for the years ended December 31, 2019, 2018 and 2017 are summarized as follows:



	2019		2018			2017
	(Amounts In Thousands)
Current:
Federal	$	8,857	$	7,783		$	13,770
State	2,391		3,093			2,529
Deferred:
Federal	1,068		(1,560		)	3,426
State	233		(411		)	(188		)
	$	12,549	$	8,905		$	19,537

Temporary differences between the amounts reported in the consolidated financial statements and the tax basis of assets and liabilities result in deferred taxes. Deferred tax assets and liabilities at December 31, 2019 and 2018 were as follows:



	December 31,
	2019			2018
	(Amounts In Thousands)
Deferred income tax assets:
Allowance for loan losses	$	8,423		$	9,434
Deferred compensation	2,047			2,211
Unrealized losses on interest rate swaps	586			398
Accrued expenses	716			668
State net operating loss	929			795
Unrealized losses on investment securities	—			682
Gross deferred tax assets	$	12,701		$	14,188
Valuation allowance	(929		)	(795		)
Deferred tax asset, net of valuation allowance	$	11,772		$	13,393
Deferred income tax liabilities:
Property and equipment	1,955			1,728
Unrealized gains on investment securities	1,056			—
Goodwill	407			407
Other	336			389
Gross deferred tax liabilities	$	3,754		$	2,524
Net deferred tax assets	$	8,018		$	10,869

The Company has recorded a deferred tax asset for the future tax benefits of Iowa net operating loss carry-forwards. The net operating loss carry-forwards are generated by the Company largely from its investment in tax credit real estate properties. The Company is required to file a separate Iowa tax return and cannot be consolidated with the Bank. The net operating loss carry-forwards will expire, if not utilized, between 2020 and 2038. The Company has recorded a valuation allowance to reduce the deferred tax asset attributable to the net operating loss carry-forwards. At December 31, 2019 and 2018, the Company believes

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it is more likely than not that the Iowa net operating loss carry-forwards will not be realized. A valuation allowance related to the remaining deferred tax assets has not been provided because management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. The valuation allowance increased (decreased) by $134,000 and ($41,000) for the years ended December 31, 2019 and 2018, respectively.

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 made broad and complex changes to the U.S. tax code that affected 2017, including, but not limited to, accelerated depreciation that allows for full expensing of qualified property. The Tax Act also established new tax laws that affects 2018 and after, including a reduction in the U.S. federal corporate income tax rate from 35% to 21%.

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provided guidance on accounting for the tax effects of the Tax Act. SAB 118 provided that a measurement period should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740, Income Taxes. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete.

As a result of the reduction of the federal corporate income tax rate, we revalued our net deferred tax asset, excluding after tax credits, as of December 22, 2017. Based on this revaluation, we recorded a net tax expense of $4.71 million to reduce the net deferred tax asset balance, which was recorded as additional income tax expense for the year ended December 31, 2017. Our effective tax rate increased by 30.99% to 41.0% primarily as a result of the revaluation of our net deferred tax asset for the year ended December 31, 2017.

The net change in the deferred income taxes for the years ended December 31, 2019, 2018 and 2017 is reflected in the consolidated financial statements as follows:



	Year Ended December 31,
	2019		2018		2017
	(Amounts In Thousands)
Consolidated statements of income	$	1,301	$	1,971	$	(3,238	)
Consolidated statements of stockholders' equity	1,550		92		(567		)
	$	2,851	$	2,063	$	(3,805	)

Income tax expense for the years ended December 31, 2019, 2018 and 2017 are less than the amounts computed by applying the maximum effective federal income tax rate to the income before income taxes because of the following items:



	2019					2018					2017
	Amount			% Of Pretax Income		Amount			% Of Pretax Income		Amount			% Of Pretax Income
	(Amounts In Thousands)
Expected tax expense	$	12,152		20.9	%	$	9,591		21.0	%	$	16,659		35.0	%
Tax-exempt interest	(1,201		)	(2.1	)	(1,122		)	(2.5	)	(1,771		)	(3.7	)
Interest expense limitation	109			0.2		87			0.2		103			0.2
State income taxes, net of federal income tax benefit	2,073			3.5		2,119			4.6		1,522			3.2
Income tax credits	(531		)	(0.9	)	(1,292		)	(2.8	)	(1,426		)	(3.0	)
Deferred tax asset revaluation	—			—		—			—		4,710			9.9
Other	(53		)	0.1		(478		)	(1.0	)	(260		)	(0.6	)
	$	12,549		21.7	%	$	8,905		19.5	%	$	19,537		41.0	%

Federal income tax expense for the years ended December 31, 2019, 2018 and 2017 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

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subsidiary bank. The Company files a consolidated tax return for federal purposes and separate tax returns for the State of Iowa purposes. The tax years ended December 31, 2019, 2018, 2017 and 2016, remain subject to examination by the Internal Revenue Service. For state tax purposes, the tax years ended December 31, 2019, 2018, 2017 and 2016, remain open for examination. There were no material unrecognized tax benefits at December 31, 2019 and December 31, 2018. No interest or penalties on these unrecognized tax benefits has been recorded. As of December 31, 2019, the Company does not anticipate any significant increase or decrease in unrecognized tax benefits during the twelve month period ending December 31, 2020.


Note 11.	Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and Cash Restrictions

The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial results. Under capital adequacy guidelines and the regulatory frameworks for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications of the Company and the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.Quantitative measures established by the regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of capital. 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 capital conservation buffer was phased in 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. Management believes that, as of December 31, 2019 and 2018, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of December 31, 2019, the most recent notifications from the Federal Reserve System categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 common equity and Tier 1 leverage ratios as set forth in the table that follows. There are no conditions or events since that notification that management believes have changed the Bank's category.

The actual amounts and capital ratios as of December 31, 2019 and 2018, with the minimum regulatory requirements for the Company and Bank 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 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

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	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

The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Bank. The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends. To maintain acceptable capital ratios in the Bank, certain of its retained earnings are not available for the payment of dividends. To maintain a ratio of capital to assets of 8.00%, retained earnings of $223.92 million as of December 31, 2019 are available for the payment of dividends to the Company.

The Bank is required to maintain reserve balances in cash or with the Federal Reserve Bank. Reserve balances totaled $221.18 million and $14.68 million as of December 31, 2019 and 2018, respectively.


Note 12.	Related Party Transactions

Certain directors of the Company and the Bank, companies with which the directors are affiliated, and certain principal officers are customers of, and have banking transactions with, the Bank in the ordinary course of business. Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons.

The following is an analysis of the changes in the loans to related parties during the years ended December 31, 2019 and 2018:



	Year Ended December 31,
	2019			2018
	(Amounts In Thousands)
Balance, beginning	$	51,216		$	42,496
Net increase (decrease) due to change in related parties	2,481			188
Advances	17,243			28,194
Collections	(15,223		)	(19,662		)
Balance, ending	$	55,717		$	51,216

Deposits from these related parties totaled $11.16 million and $7.13 million as of December 31, 2019 and 2018, respectively. Deposits from related parties are accepted subject to the same interest rates and terms as those from nonrelated parties.

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Note 13.	Fair Value Measurements

The carrying value and estimated fair values of the Company’s financial instruments as of December 31, 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 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.

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



	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 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

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

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



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



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



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

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

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

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 year ended December 31, 2019. 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 2016-1, 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. 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 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

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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.

The Company does record nonrecurring fair value adjustments to impaired 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 (Level 3).

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 costs 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

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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).

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:



	December 31, 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	$	128,585	$	—		$	—	$	128,585
State and political subdivisions	—		211,489			—		211,489
Other securities (FHLB, FHLMC and FNMA)	—		15,229			—		15,229
Derivative Financial Instruments
Interest rate swaps	—		(2,349		)	—		(2,349		)
Total	$	128,585	$	224,369		$	—	$	352,954



	December 31, 2018
	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	$	83,155	$	—		$	—	$	83,155
State and political subdivisions	—		200,900			—		200,900
Other securities (FHLB, FHLMC and FNMA)	—		34,871			—		34,871
Derivative Financial Instruments
Interest rate swaps	—		(1,596		)	—		(1,596		)
Total	$	83,155	$	234,175		$	—	$	317,330


(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 years ended December 31, 2019 and 2018.

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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 that were still held on the balance sheet at December 31, 2019 and 2018, the following tables provide the level of valuation assumptions used to determine the adjustment and the carrying value of the related individual assets at year end.



	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.

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	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


(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.

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Note 14.	Parent Company Only Financial Information

Following is condensed financial information of the Company (parent company only):

CONDENSED BALANCE SHEETS

December 31, 2019 and 2018

(Amounts In Thousands)



ASSETS	2019			2018
Cash and cash equivalents at subsidiary bank	$	5,114		$	3,742
Investment in subsidiary bank	428,042			385,193
Other assets	1,331			1,231
Total assets	$	434,487		$	390,166
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities	$	7,450		$	6,414
Redeemable common stock held by ESOP	51,826			48,870
Stockholders' equity:
Capital stock	55,943			52,122
Retained earnings	409,509			371,848
Accumulated other comprehensive gain (loss)	1,415			(3,250		)
Treasury stock at cost	(39,830		)	(36,968		)
	427,037			383,752
Less maximum cash obligation related to ESOP shares	51,826			48,870
Total stockholders' equity	375,211			334,882
Total liabilities and stockholders' equity	$	434,487		$	390,166

CONDENSED STATEMENTS OF INCOME

Years Ended December 31, 2019, 2018 and 2017

(Amounts In Thousands)



	2019			2018			2017
Dividends received from subsidiary	$	7,657		$	11,502		$	7,485
Other expenses	(708		)	(786		)	(741		)
Income before income tax benefit and equity in undistributed income of subsidiary	6,949			10,716			6,744
Income tax benefit	271			273			73
	7,220			10,989			6,817
Equity in undistributed income of subsidiary	38,098			25,778			21,244
Net income	$	45,318		$	36,767		$	28,061

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2019, 2018 and 2017

(Amounts In Thousands)



	2019			2018			2017
Cash flows from operating activities:
Net income	$	45,318		$	36,767		$	28,061
Adjustments to reconcile net income to cash and cash equivalents provided by operating activities:
Equity in undistributed income of subsidiary	(38,098		)	(25,778		)	(21,244		)
Share-based compensation	14			—			11
Compensation expensed through issuance of common stock	1,133			1,466			1,446
Forfeiture of common stock	(262		)	(152		)	(156		)
(Increase) decrease in other assets	(100		)	162			237
Increase in other liabilities	1,036			574			3,212
Net cash and cash equivalents provided by operating activities	9,041			13,039			11,567
Cash flows from financing activities:
Issuance of common stock, net of costs	5,026			4,713			3,762
Stock options exercised	62			41			238
Purchase of treasury stock	(5,534		)	(6,784		)	(2,435		)
Proceeds from the issuance of common stock through the employee stock purchase plan	434			421			325
Capital contribution to subsidiary	—			(4,700		)	(3,500		)
Dividends paid	(7,657		)	(7,003		)	(6,485		)
Net cash and cash equivalents used by financing activities	(7,669		)	(13,312		)	(8,095		)
Increase (decrease) in cash and cash equivalents	1,372			(273		)	3,472
Cash and cash equivalents:
Beginning of year	3,742			4,015			543
Ending of year	$	5,114		$	3,742		$	4,015


Note 15.	Commitments and Contingencies

Concentrations of credit risk: The Bank’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Bank's market area. Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $101.94 million. The concentrations of credit by type of loan are set forth in Note 3 to the Consolidated Financial Statements. Outstanding letters of credit were granted primarily to commercial borrowers. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson, Linn and Washington Counties, Iowa.

Contingencies: In the normal course of business, the Company and 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.

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank’s commitments at December 31, 2019 and 2018 is as follows:



	2019		2018
	(Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:
Home equity loans	$	65,203	$	59,330
Credit cards	57,421		52,802
Commercial, real estate and home construction	94,490		89,171
Commercial lines and real estate purchase loans	207,051		174,637
Outstanding letters of credit	8,569		9,033

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties. Credit card commitments are the unused portion of the holders' credit limits. Such amounts represent the maximum amount of additional unsecured borrowings.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank holds collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the commitment is funded the Bank would be entitled to seek recovery from the customer. At December 31, 2019 and 2018, no amounts have been recorded as liabilities for the Bank’s potential obligations under these guarantees.

Lease commitments: The Company leases certain facilities under operating leases. The minimum future rental commitments as of December 31, 2019 for all non-cancelable leases relating to Bank premises were as follows:



Year ending December 31:	(Amounts In Thousands)
2020	$	469
2021	375
2022	319
2023	316
2024	82
Thereafter	1
	$	1,562

Rent expense was $0.40 million, $0.36 million and $0.37 million for the years ended December 31, 2019, 2018 and 2017, respectively.

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 16.	Quarterly Results of Operations (unaudited, amounts in thousands, except per share amounts)



	Quarter Ended
	March			June			September		December			Year
2019
Interest income	$	31,847		$	33,236		$	33,969	$	33,280		$	132,332
Interest expense	8,074			8,848			9,274		8,677			34,873
Net interest income	$	23,773		$	24,388		$	24,695	$	24,603		$	97,459
Provision for loan losses	(1,246		)	(540		)	144		(1,238		)	(2,880		)
Other income	5,250			5,851			6,638		7,053			24,792
Other expense	16,049			16,360			16,604		18,251			67,264
Income before income taxes	$	14,220		$	14,419		$	14,585	$	14,643		$	57,867
Income taxes	3,017			3,199			3,303		3,030			12,549
Net income	$	11,203		$	11,220		$	11,282	$	11,613		$	45,318
Basic earnings per share	$	1.20		$	1.20		$	1.21	$	1.24		$	4.85
Diluted earnings per share	1.20			1.20			1.21		1.24			4.85
2018
Interest income	$	28,031		$	29,064		$	30,411	$	31,291		$	118,797
Interest expense	5,738			6,241			6,891		7,453			26,323
Net interest income	$	22,293		$	22,823		$	23,520	$	23,838		$	92,474
Provision for loan losses	(765		)	711			1,593		6,958			8,497
Other income	5,628			6,234			6,668		5,288			23,818
Other expense	15,256			15,680			15,955		15,232			62,123
Income before income taxes	$	13,430		$	12,666		$	12,640	$	6,936		$	45,672
Income taxes	2,572			2,603			2,590		1,140			8,905
Net income	$	10,858		$	10,063		$	10,050	$	5,796		$	36,767
Basic earnings per share	$	1.16		$	1.07		$	1.07	$	0.63		$	3.93
Diluted earnings per share	1.16			1.07			1.07		0.62			3.92


Note 17.	Derivative Financial Instruments

In the normal course of business, the Bank may use derivative financial instruments to manage its interest rate risk. These instruments carry varying degrees of credit, interest rate and market or liquidity risks. Derivative instruments are recognized as either assets or liabilities in the accompanying consolidated financial statements 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 $2.35 million of collateral as of December 31, 2019.

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Cash Flow Hedges:

The Bank executed two forward-starting interest rate swap transactions on November 7, 2013. One 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.

The table below identifies the balance sheet category and fair values of the Bank’s derivative instruments designated as cash flow hedges as of December 31, 2019 and 2018:



	Notional Amount		Fair Value			Balance Sheet Category	Maturity
	(Amounts in Thousands)
December 31, 2019
Interest rate swap	$	25,000	$	(279	)	Other Liabilities	11/9/2020
Interest rate swap	25,000		(2,070		)	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

The table below identifies the gains and losses recognized on the Bank’s derivative instruments designated as cash flow hedges for the years ended December 31, 2019 and 2018:




	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)
December 31, 2019
Interest rate swap	$	(119	)	Interest Expense	$	—	Other Income	$	—
Interest rate swap	(446		)	Interest Expense	—		Other Income	—

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

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 18.	Subsequent Events

Subsequent events have been evaluated through March 6, 2020.



Item 9.	Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

None.



Item 9A.	Controls and Procedures

Disclosure Controls and Procedures

As of the end of the period covered by this report, 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) and Rule 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

Management’s Report on Internal Control over Financial Reporting

The Company’s management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Securities Exchange Act of 1934). Internal control over financial reporting of the Company includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s consolidated financial statements. Important features of the Company’s system of internal control over financial reporting include the adoption and implementation of written policies and procedures, careful selection and training of financial management personnel, a continuing management commitment to the integrity of the system and through examinations by an internal audit function that coordinates its activities with the Company’s Independent Registered Public Accounting Firm.

All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.

The Company’s management conducted an evaluation of the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2019. Management’s assessment is based on the criteria described in “Internal Control – Integrated Framework” issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, the Company’s management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2019.

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Attestation Report of the Registered Public Accounting Firm

The Company’s independent registered public accounting firm that audited the consolidated financial statements included in this annual report, has issued a report on the Company’s internal control over financial reporting as of December 31, 2019. Reference is made to the Report of Independent Registered Public Accounting Firm included in this Annual Report.

Changes in Internal Control over Financial Reporting

There was no change in the Company’s internal control over financial reporting during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.



Item 9B.	Other Information

Not applicable.

PART III



Item 10.	Directors, Executive Officers and Corporate Governance

The information required by Item 10 of Part III is presented under the items entitled “Information Concerning Nominees for Election as Directors,” "Information Concerning Directors other than Nominees," "Corporate Governance and Board of Directors," and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Definitive Proxy Statement dated March 20, 2020 for the Annual Meeting of Stockholders on April 20, 2020. Such information is incorporated herein by reference.

The Company has a Code of Ethics in place for the Chief Executive Officer and Chief Financial Officer. A copy of the Company’s Code of Ethics will be provided free of charge, upon written request to:

Shari DeMaris

Treasurer

Hills Bancorporation

131 Main Street

PO Box 160

Hills, Iowa 52235

Information about our Executive Officers is incorporated into this section by reference to Part I, Item 1 of this Form 10-K.

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Item 11.	Executive Compensation

The information required by Item 11 of Part III is presented under the items entitled “Compensation Discussion and Analysis,” “Summary of Cash and Certain Other Compensation Paid to the Named Executive Officers,” “Compensation and Incentive Stock Committee Interlocks and Certain other Transactions with Executive Officers and Directors,” "Schedule of Director Fees," "Director Compensation Table," and “Compensation and Incentive Stock Committee Report” in the Company’s Definitive Proxy Statement dated March 20, 2020 for the Annual Meeting of Stockholders on April 20, 2020. Such information is incorporated herein by reference.



Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by Item 12 of Part III is presented under the item entitled “Security Ownership of Certain Beneficial Owners and Management” in the Company’s Definitive Proxy Statement dated March 20, 2020 for the Annual Meeting of Stockholders on April 20, 2020. Such information is incorporated herein by reference.

The following table sets forth information regarding the Company’s equity compensation plan as of December 31, 2019, all of which relates to stock options issued under stock option plans approved by stockholders of the Company.



	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans [excluding securities reflected in column (a)]
Plan Category	(a)	(b)		(c)
Equity compensation plans approved by security holders	13,025	$	45.92	19,853
Equity compensation plans not approved by security holders	—	—		—
Total	13,025	$	45.92	19,853



Item 13.	Certain Relationships and Related Transactions, and Director Independence

The information required by Item 13 of Part III is presented under the items entitled “Corporate Governance and the Boards of Directors,” and “Compensation and Incentive Stock Committee Interlocks and Certain other Transactions with Executive Officers and Directors” in the Company’s Definitive Proxy Statement dated March 20, 2020 for the Annual Meeting of Stockholders on April 20, 2020. Such information is incorporated herein by reference.



Item 14.	Principal Accounting Fees and Services

Information required by this item is contained in the Company’s Definitive Proxy Statement dated March 20, 2020 for the Annual Meeting of Shareholders on April 20, 2020, under the heading “Audit Committee,” which information is incorporated herein by this reference.

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PART IV



Item 15.	Exhibits, Consolidated Financial Statement Schedules



			Form 10-K
(a)	1	Financial Statements	Reference

		Independent registered public accounting firm's report on the financial statements	Page 52-54

		Consolidated balance sheets as of December 31, 2019 and 2018	Page 55

		Consolidated statements of income for the years ended December 31, 2019, 2018, and 2017	Page 56

		Consolidated statements of comprehensive income for the years ended December 31, 2019, 2018 and 2017	Page 57

		Consolidated statements of stockholders' equity for the years ended December 31, 2019, 2018 and 2017	Page 58

		Consolidated statements of cash flows for the years ended December 31, 2019, 2018 and 2017	Page 59

		Notes to consolidated financial statements	Page 61

	2	Financial Statements Schedules

		All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto.

(b)	3	Exhibits

	3.1	Restated Articles of Incorporation filed as Exhibit 3.1 in Form 10-K for the year ended December 31, 2014 is incorporated by reference.

	3.2	Amended and Restated ByLaws filed as Exhibit 3.2 to the Company's Form 10-Q for the quarter ended March 31, 2019 filed with the Commission on May 6, 2019 is incorporated by reference.

	4.1	Description of Registered Securities is attached on Page 113.

	10.1	1995 Deferred Compensation Plans filed as Exhibit 10(c) in Form 10-K for the year ended December 31, 1995 is incorporated by reference.

	10.2	2010 Stock Option and Incentive Plan filed on Form S-8 dated June 29, 2012 is incorporated by reference.

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		10.3				Form of Stock Option Grant Agreement under the 2010 Stock Option and Incentive Plan filed as Exhibit 10.3 in Form 10-K for the year ended December 31, 2018 is incorporated by reference.

		10.4				Form of Restricted Stock 5 Year Agreement under the 2010 Stock Option and Incentive Plan filed as Exhibit 10.4 in Form 10-K for the year ended December 31, 2018 is incorporated by reference.

		10.5				Form of Restricted Stock 8 Year Agreement under the 2010 Stock Option and Incentive Plan filed as Exhibit 10.5 in Form 10-K for the year ended December 31, 2018 is incorporated by reference.

		11				Statement Regarding Computation of Basic and Diluted Earnings Per Share. (Note: Statement included in Note 1 under Item 8 of Part II above)

		21				Subsidiary of the Registrant is attached on Page 116.

		23.1				Consent of Independent Registered Public Accounting Firm is attached on Page 117. BKD LLP

		31				Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 on Pages 118-119.

		32				Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 on Page 120.

		101.INS				XBRL Instance Document (1)

		101.SCH				XBRL Taxonomy Extension Schema Document

		101.CAL				XBRL Taxonomy Extension Calculation Linkbase Document

		101.LAB				XBRL Taxonomy Extension Label Linkbase Document

		101.PRE				XBRL Taxonomy Extension Presentation Linkbase Document

		101.DED				XBRL Taxonomy Extension Definitions Linkbase Document

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

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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:	March 6, 2020	By: /s/Dwight O. Seegmiller
		Dwight O. Seegmiller, Director, President and Chief Executive Officer

Date:	March 6, 2020	By: /s/Shari DeMaris
		Shari DeMaris, Secretary, Treasurer and Chief Accounting Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.



		DIRECTORS OF THE REGISTRANT

Date:	March 6, 2020	By: /s/Michael S. Donovan
		Michael S. Donovan, Director

Date:	March 6, 2020	By: /s/Kirsten H. Frey
		Kirsten H. Frey, Director

Date:	March 6, 2020	By: /s/Michael E. Hodge
		Michael E. Hodge, Director

Date:	March 6, 2020	By: /s/Emily A. Hughes
		Emily A. Hughes, Director

Date:	March 6, 2020	By: /s/Theodore H. Pacha
		Theodore H. Pacha, Director

Date:	March 6, 2020	By: /s/Casey L. Peck
		Casey L. Peck, Director

Date:	March 6, 2020	By: /s/John W. Phelan
		John W. Phelan, Director

Date:	March 6, 2020	By: /s/Ann M. Rhodes
		Ann M. Rhodes, Director

Date:	March 6, 2020	By: /s/James C. Schmitt
		James C. Schmitt, Director

Date:	March 6, 2020	By: /s/Thomas R. Wiele
		Thomas R. Wiele, Director

Date:	March 6, 2020	By: /s/Sheldon E. Yoder
		Sheldon E. Yoder, Director

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HILLS BANCORPORATION

ANNUAL REPORT OF FORM 10-K FOR THE

FISCAL YEAR ENDED DECEMBER 31, 2019



		Page Number
		In The Sequential
Exhibit		Numbering System
Number	Description	For 2019 Form 10-K

4.1	Description of Registered Securities	113

11	Statement Re Computation of Basic and Diluted Earnings Per Share
	(Note: Statement included in Note 1 under Item 8 of Part II above)

21	Subsidiary of the Registrant	116

23.1	Consent of Independent Registered Public Accounting Firm, BKD LLP	117

31.1	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002	118

31.2	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002	119

32	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002	120

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