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HILLS BANCORPORATION - Quarter Report: 2023 June (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2023

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from  ___________ to ___________
Commission file number:  0-12668
Hills Bancorporation

(State or other jurisdiction of incorporation or organization)
I.R.S. Employer Identification No.
Iowa42-1208067

131 MAIN STREET, HILLS, Iowa 52235

Telephone number: (319) 679-2291

Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   No

Indicate by checkmark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). Yes  No

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

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

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


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APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date.
 SHARES OUTSTANDING
CLASSJuly 31, 2023
  
Common StockNo par value9,172,005



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HILLS BANCORPORATION
Index to Form 10-Q

Part I
FINANCIAL INFORMATION
 
  Page
 Number
   
Item 1.Financial Statements 
   
 
 
 
 
 
 
   
Item 2.
   
Item 3.
   
Item 4.
   
 Part II 
 OTHER INFORMATION 
   
Item 1.
   
Item 1A.
   
Item 2.
   
Item 3.
   
Item 4.
   
Item 5.
   
Item 6.
   
   

Page 3

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HILLS BANCORPORATION CONSOLIDATED BALANCE SHEETS (Amounts In Thousands, Except Share Amounts) 
June 30, 2023December 31, 2022
ASSETS(Unaudited)
Cash and cash equivalents$41,162 $36,641 
Investment securities available for sale at fair value (amortized cost June 30, 2023 $771,964; December 31, 2022 $830,302)
720,973 776,104 
Stock of Federal Home Loan Bank17,985 6,461 
Loans held for sale8,815 1,663 
Loans, net of allowance for credit losses June 30, 2023 $44,270; December 31, 2022 $41,440
3,253,172 3,066,981 
Property and equipment, net33,570 33,518 
Tax credit real estate investments8,345 9,152 
Accrued interest receivable16,875 15,782 
Deferred income taxes, net24,129 24,061 
Goodwill2,500 2,500 
Other assets7,440 7,618 
Total Assets$4,134,966 $3,980,481 
LIABILITIES AND STOCKHOLDERS' EQUITY  
Liabilities  
Noninterest-bearing deposits$632,463 $647,450 
Interest-bearing deposits2,649,314 2,709,917 
Total deposits$3,281,777 $3,357,367 
Other short-term borrowings, federal funds purchased6,053 82,061 
Federal Home Loan Bank borrowings330,000 40,000 
Accrued interest payable2,850 1,394 
Allowance for credit losses on off-balance sheet credit exposures3,830 4,430 
Other liabilities18,094 15,958 
Total Liabilities$3,642,604 $3,501,210 
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)$44,380 $51,011 
STOCKHOLDERS' EQUITY  
Common stock, no par value; authorized 20,000,000 shares; issued June 30, 2023 10,346,126 shares; December 31, 2022 10,348,123 shares
$ $— 
Paid in capital63,586 63,220 
Retained earnings527,181 512,841 
Accumulated other comprehensive loss (38,661)(41,060)
Treasury stock at cost (June 30, 2023 1,172,989 shares; December 31, 2022 1,122,639 shares)
(59,744)(55,730)
Total Stockholders' Equity$492,362 $479,271 
Less maximum cash obligation related to ESOP shares44,380 51,011 
Total Stockholders' Equity Less Maximum Cash Obligation Related to ESOP Shares$447,982 $428,260 
Total Liabilities & Stockholders' Equity$4,134,966 $3,980,481 

See Notes to Consolidated Financial Statements.
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HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Amounts In Thousands, Except Per Share Amounts)
 Three Months Ended June 30,Six Months Ended
June 30,
 2023202220232022
Interest income:
Loans, including fees$37,700 $27,542 $72,407 $53,307 
Investment securities:  
Taxable2,579 2,445 5,276 3,577 
Nontaxable1,168 996 2,355 2,000 
Federal funds sold236 801 432 1,136 
Total interest income$41,683 $31,784 $80,470 $60,020 
Interest expense:  
Deposits$9,455 $3,094 $16,729 $6,150 
Short-term borrowings3,416 — 5,728 — 
Total interest expense$12,871 $3,094 $22,457 $6,150 
Net interest income$28,812 $28,690 $58,013 $53,870 
Credit loss expense2,679 2,502 3,047 3,606 
Net interest income after credit loss expense $26,133 $26,188 $54,966 $50,264 
Noninterest income:  
Net gain on sale of loans$443 $326 $588 $1,137 
Trust fees3,407 3,211 6,677 6,479 
Service charges and fees3,348 3,282 6,381 6,162 
Other noninterest income146 132 79 650 
 $7,344 $6,951 $13,725 $14,428 
Noninterest expenses:  
Salaries and employee benefits$10,828 $10,776 $22,331 $21,172 
Occupancy1,064 1,109 2,241 2,241 
Furniture and equipment1,683 1,683 3,375 3,380 
Office supplies and postage464 468 912 952 
Advertising and business development620 558 1,494 1,288 
Outside services3,209 2,966 6,119 5,916 
FDIC insurance assessment609 267 879 548 
Other noninterest expense221 747 757 1,152 
 $18,698 $18,574 $38,108 $36,649 
Income before income taxes$14,779 $14,565 $30,583 $28,043 
Income taxes3,214 3,239 6,556 6,065 
Net income$11,565 $11,326 $24,027 $21,978 
Earnings per share:  
Basic$1.26 $1.22 $2.61 $2.37 
Diluted$1.26 $1.22 $2.61 $2.37 
 
See Notes to Consolidated Financial Statements.
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HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited) (Amounts In Thousands)

 Three Months Ended June 30,Six Months Ended
June 30,
 2023202220232022
Net income$11,565 $11,326 $24,027 $21,978 
Other comprehensive income (loss)  
Securities:  
Net change in unrealized gain (loss) on securities available for sale$(5,280)$(13,485)$3,207 $(43,249)
Income taxes1,277 3,365 (808)10,791 
Other comprehensive income (loss) on securities available for sale$(4,003)$(10,120)$2,399 $(32,458)
Other comprehensive income (loss), net of tax$(4,003)$(10,120)$2,399 $(32,458)
Comprehensive income (loss)$7,562 $1,206 $26,426 $(10,480)
 
See Notes to Consolidated Financial Statements.



































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HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited) (Amounts In Thousands, Except Share Amounts)
Three Months Ended June 30, 2023 and 2022
Paid in CapitalRetained EarningsAccumulated Other Comprehensive Income (Loss)Treasury StockMaximum Cash Obligation Related to ESOP SharesTotal
Balance, March 31, 2022$61,334 $475,740 $(20,861)$(50,112)$(51,939)$414,162 
Issuance of 24,595 shares of common stock
1,513   96  1,609 
Issuance of 1,637 shares of common stock under the employee stock purchase plan
102     102 
Unearned restricted stock compensation89     89 
Forfeiture of 1,193 shares of common stock
(75)    (75)
Share-based compensation6     6 
Change related to ESOP shares    2,007 2,007 
Net income 11,326    11,326 
Purchase of 34,774 shares of common stock
   (2,456) (2,456)
Other comprehensive loss  (10,120)  (10,120)
Balance, June 30, 2022$62,969 $487,066 $(30,981)$(52,472)$(49,932)$416,650 
Balance, March 31, 2023$63,458 $515,616 $(34,658)$(57,956)$(49,804)$436,656 
Issuance of 4,859 shares of common stock
194   134  328 
Issuance of 1,604 shares of common stock under the employee stock purchase plan
95     95 
Unearned restricted stock compensation53     53 
Forfeiture of 3,446 shares of common stock
(220)    (220)
Share-based compensation6     6 
Change related to ESOP shares    5,424 5,424 
Net income 11,565    11,565 
Purchase of 27,116 shares of common stock
   (1,922) (1,922)
Other comprehensive income  (4,003)  (4,003)
Balance, June 30, 2023$63,586 $527,181 $(38,661)$(59,744)$(44,380)$447,982 

 See Notes to Consolidated Financial Statements.
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HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(Amounts In Thousands, Except Share Amounts)
Six Months Ended June 30, 2023 and 2022
Paid in CapitalRetained EarningsAccumulated Other Comprehensive Income (Loss)Treasury StockMaximum Cash Obligation Related to ESOP SharesTotal
Balance, December 31, 2021$60,938 $474,392 $1,477 $(48,344)$(50,013)$438,450 
Issuance of 29,934 shares of common stock
1,702   144  1,846 
Issuance of 3,434 shares of common stock under the employee stock purchase plan
212     212 
Unearned restricted stock compensation355     355 
Forfeiture of 4,412 shares of common stock
(250)    (250)
Share-based compensation12     12 
Change related to ESOP shares    81 81 
Net income 21,978    21,978 
Cash dividends ($1.00 per share)
 (9,304)   (9,304)
Purchase of 61,186 shares of common stock
   (4,272) (4,272)
Other comprehensive loss  (32,458)  (32,458)
Balance, June 30, 2022$62,969 $487,066 $(30,981)$(52,472)$(49,932)$416,650 
Balance, December 31, 2022$63,220 $512,841 $(41,060)$(55,730)$(51,011)$428,260 
Issuance of 9,448 shares of common stock
398   260  658 
Issuance of 3,320 shares of common stock under the employee stock purchase plan
206     206 
Unearned restricted stock compensation95     95 
Forfeiture of 5,317 shares of common stock
(345)    (345)
Share-based compensation12     12 
Change related to ESOP shares    6,631 6,631 
Net income 24,027    24,027 
Cash dividends ($1.05 per share)
 (9,687)   (9,687)
Purchase of 59,798 shares of common stock
   (4,274) (4,274)
Other comprehensive loss  2,399   2,399 
Balance, June 30, 2023$63,586 $527,181 $(38,661)$(59,744)$(44,380)$447,982 

 See Notes to Consolidated Financial Statements.
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HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Amounts In Thousands)
 Six Months Ended
June 30,
 20232022
Cash Flows from Operating Activities
Net income$24,027 $21,978 
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:  
Depreciation1,232 1,393 
Credit loss expense3,047 3,606 
Forfeiture of common stock(345)(250)
Share-based compensation12 12 
Compensation expensed through issuance of common stock658 365 
Provision for deferred income taxes(876)(1,167)
Net gain on sale of other real estate owned and other repossessed assets(93)(62)
Increase in accrued interest receivable(1,093)(1,302)
(Accretion of discount) amortization of premium on investment securities, net(235)828 
Net change in other assets247 (300)
Amortization of operating lease right-of-use assets161 106 
Increase in accrued interest payable and other liabilities3,687 2,956 
Loans originated for sale(74,100)(75,480)
Proceeds on sales of loans67,536 80,733 
Net gain on sales of loans(588)(1,137)
Net cash and cash equivalents provided by operating activities$23,277 $32,279 
Cash Flows from Investing Activities  
Proceeds from maturities of investment securities available for sale$59,885 $81,746 
Proceeds from sales of investment securities available for sale509 — 
Purchases of investment securities available for sale(1,820)(341,891)
Net purchases of stock of Federal Home Loan Bank(11,524)(316)
Loans made to customers, net of collections(190,256)(145,487)
Proceeds on sale of other real estate owned and other repossessed assets280 124 
Purchases of property and equipment(1,284)(813)
Net changes from tax credit real estate investment807 228 
Net cash and cash equivalents used in investing activities$(143,403)$(406,409)
Cash Flows from Financing Activities  
Net decrease in deposits$(75,590)$(88,163)
Net decrease in short-term borrowings(76,008)(249)
Net change in short-term FHLB borrowings290,000  
Issuance of common stock, net of costs 1,243 
Stock options exercised 238 
Purchase of common stock(4,274)(4,272)
Proceeds from the issuance of common stock through the employee stock purchase plan206 212 
Dividends paid(9,687)(9,304)
Net cash and cash equivalents provided by (used in) financing activities$124,647 $(100,295)
 
(Continued)

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HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) (Amounts In Thousands)
 Six Months Ended
June 30,
 20232022
Increase (decrease) in cash and cash equivalents$4,521 $(474,425)
Cash and cash equivalents:  
Beginning of period36,641 781,918 
End of period$41,162 $307,493 
Supplemental Disclosures  
Cash payments for:  
Interest paid to depositors$15,273 $6,278 
Interest paid on other obligations5,728 — 
Income taxes paid5,698 5,171 
Noncash activities:  
(Decrease) in maximum cash obligation related to ESOP shares$(6,631)$(81)
Transfers to other real estate owned418 — 
 
See Notes to Consolidated Financial Statements.

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1.Summary of Significant Accounting Policies

Basis of Presentation:

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

Operating results for the six month period ended June 30, 2023 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2023.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Form 10-K Annual Report of Hills Bancorporation and subsidiary (the “Company”) for the year ended December 31, 2022 filed with the Securities Exchange Commission on March 3, 2023.  The consolidated balance sheet as of December 31, 2022, has been derived from the audited consolidated financial statements for that period.

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

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 credit 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 June 30, 2023 may change in the near-term and the effect could be material to the consolidated financial statements. Actual amounts and values as of the balance sheet dates may be materially different than the amounts and values reported due to the inherent uncertainty in the estimation process.

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. Interest income on loans and investment securities is recognized on the accrual method in accordance with written contracts.

Descriptions of the Company’s revenue-generating activities that are within the scope of ASC 606 are the following: Service charges and fees on deposit accounts represent general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue which includes interchange income, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when the Company’s performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied. Trust income represents monthly fees due from wealth management
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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
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 June 30, 2023, the Company did not have any significant contract balances.

An entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company has not incurred or capitalized any contract acquisition costs as of June 30, 2023.

Tax credit real estate: Tax credit real estate represents three 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 of which are affordable housing projects as of June 30, 2023. The Company 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. On a regular basis, the Company evaluates recoverability of the carrying value of the tax credit real estate investments to determine if an allowance for credit losses is necessary. The allowance for credit losses is measured by a comparison of the carrying amount of the investments to the future undiscounted cash flows expected to be generated by the investment properties, including the low-income housing tax credits and any estimated proceeds from eventual disposition. If there is an indication of impairment, the allowance for credit losses would be established with a charge to credit loss expense. There were no indications of impairment based on management's evaluation and therefore no allowance for credit losses was determined necessary as of June 30, 2023. 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.

The investments in tax credit real estate are recorded for all years presented using the equity method of accounting, with the exception of the investment in the affordable housing project described below. 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 Company and reduces the consolidated federal tax liability of the Company.

In February 2021, the Company provided construction financing and contributed capital of $4.18 million to Del Ray Ridge LP, as limited partner, which owns and operates an affordable housing property in Iowa City, Iowa. The Company accounts for the investment in this tax credit real estate using the proportional amortization method as provided for under Accounting Standards Codification (ASC) 323-740. The investment qualifies for the proportional amortization method as it meets all of the criteria under ASC 323-740-25-1. Substantially all of the projected benefits are from tax credits and other tax benefits due to the minimum buyout clause included in the partnership agreement.

Available-for-sale debt securities and the allowance for credit losses on available-for-sale debt securities: Available-for-sale ("AFS") 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 June 30, 2023 or 2022. Fair value measurement is based upon quoted market prices in active markets, if available. If quoted prices in active markets are not available, fair value is measured using pricing models or other model-based valuation techniques such as present value of future cash flows, which consider prepayment assumptions and other factors such as credit losses and market liquidity. Unrealized gains and losses are excluded from earnings and reported, net of tax, in other comprehensive income ("OCI"). 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). Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
AFS debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. For AFS debt securities, a decline in fair value due to credit loss results in recording an allowance for credit losses to the extent the fair value is less than the amortized cost basis. Declines in fair value that have not been recorded through an allowance for credit losses, such as declines due to changes in market interest rates, are recorded through other comprehensive income, net of applicable taxes.

Impairment may result from credit deterioration of the issuer or collateral underlying the security. In performing an assessment of whether any decline in fair value is due to a credit loss, all relevant information is considered at the individual security level. For asset-backed securities performance indicators considered related to the underlying assets include default rates, delinquency rates, percentage of nonperforming assets, debt-to-collateral ratios, third-party guarantees, current levels of subordination, vintage, geographic concentration, analyst reports and forecasts, credit ratings and other market data. In assessing whether a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount the fair value is less than amortized cost basis.

If we intend to sell a debt security or more likely than not we will be required to sell the security before recovery of its amortized cost basis, the debt security is written down to its fair value and the write down is charged against the allowance for credit losses with any incremental impairment reported in earnings.

Accrued interest receivable on AFS debt securities totaled $3.15 million at June 30, 2023 and is excluded from the estimate of credit losses.

Loans held for sale: 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.

Loans held for investment: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost net of the allowance for credit losses ("ACL"). Amortized cost is the principal balance outstanding, net of deferred loan fees and costs. Accrued interest receivable on loans held for investment totaled $13.72 million at June 30, 2023 and is excluded from the estimate of credit losses. Interest income is accrued on the unpaid principal balance. Nonrefundable loan fees and origination costs are deferred and recognized as a yield adjustment over the life of the related loan.

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 unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, all previously accrued and unpaid interest is reversed against interest income. 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.

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, 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.

Allowance for credit losses for loans held for investment: The allowance for credit losses is an estimate of the expected losses over the remaining life of the Company's existing loans held for investment portfolio. The allowance for credit losses for loans held for investment, as reported in our consolidated balance sheet, is adjusted by a credit loss expense, which is reported in earnings, and reduced by the charge-off of loan amounts, net of recoveries.

The loan loss estimation process involves procedures to appropriately consider the unique characteristics of loan portfolio
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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
segments which consist of agricultural, 1 to 4 family first and junior liens, commercial, and consumer lending. These segments are further disaggregated into loan classes, the level at which credit risk is monitored. For each of these pools, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speed, curtailments, time to recovery, probability of default, and loss given default. The modeling of expected prepayment speeds, curtailment rates, and time to recovery are based on historical internal data. The following provides the credit quality indicators and risk elements that are most relevant and most carefully considered and monitored for each loan portfolio segment.

Agricultural - Agricultural operating loans include loans made to finance agricultural production and other loans to farmers and farming operations. Agricultural loans also include mortgage loans secured by farmland. Agricultural operating 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 operating loans is dependent upon the profitable operation or management of the agricultural entity. Agricultural operating loans generally have a term of one year and may have a fixed or variable rate.

Mortgage loans secured by farmland are made to individuals and businesses within the Company'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. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the Iowa real gross domestic product (GDP).

1 to 4 Family First and Junior Liens - The 1 to 4 family first and junior liens portfolio segment is comprised of the single family and home equity loan classes, which are underwritten after evaluating a borrower's capacity to repay, credit, and collateral. Several factors are considered when assessing a borrower's capacity, including the borrower's employment, income, current debt, assets, and level of equity in the property. Credit refers to how well a borrower manages their current and prior debts as documented by a credit report that provides credit scores and the borrower's current and past information about their credit history. Collateral refers to the type and use of property, occupancy, and market value. Property appraisals are obtained to assist in evaluating collateral. Loan-to-property value and debt-to-income ratios, loan amount, and lien position are also considered in assessing whether to originate a loan. These borrowers are particularly susceptible to downturns in economic trends such as conditions that negatively affect housing prices and demand and levels of unemployment. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the all-transactions house price index for Iowa.

Commercial - The commercial loan portfolio segment is comprised of the commercial real estate mortgage including obligations of states and political subdivisions, multifamily residential mortgage, construction/land development and commercial and financial loan classes, whose underwriting standards consider the factors described for single family and home equity loan classes as well as others when assessing the borrower's and associated guarantors or other related party's financial position. These other factors include assessing liquidity, the level and composition of net worth, leverage, considering all other lender amounts and position, an analysis of cash expected to flow through the obligors including the outflow to other lenders, vacancies and prior experience with the borrower. This information is used to assess adequate financial capacity, profitability, and experience. Ultimate repayment of these loans is sensitive to interest rate changes, general economic conditions, liquidity, and availability of long-term financing. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate, the all-transactions house price index for Iowa and the Iowa real GDP.

Consumer Lending - The Company offers consumer loans to individuals including personal loans and automobile loans. These consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than real estate-related loans. Consumer collections are dependent on the borrower's continuing financial stability and are more likely to be affected by adverse personal circumstances. Collateral for these loans generally includes automobiles, boats, recreational vehicles and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time,
Page 14

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
may be difficult to recover and may fluctuate in value based on condition. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the Iowa real GDP.

The allowance level is influenced by loan volumes, loan credit quality indicator migration or delinquency status, historic loss experience and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics; and second, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans. Depending on the nature of the pool of financial assets with similar risk characteristics, the Company uses a discounted cash flow method or remaining life method to estimate expected credit losses.

Discounted cash flow method: In estimating the component of the allowance for credit losses for loans that share similar risk characteristics with other loans, such loans are segregated into loan classes. Loans are designated into loan classes based on loans pooled by product types and similar risk characteristics or areas of risk concentration. In determining the allowance for credit losses, we derive an estimated credit loss assumption from a model that categorizes loan pools based on loan type and purpose. This model calculates an expected loss percentage for each loan class by considering the probability of default, using life-of-loan analysis periods for all loan segments, and the historical severity of loss, based on the aggregate net lifetime losses incurred per loan class. The default and severity factors used to calculate the allowance for credit losses for loans that share similar risk characteristics with other loans are adjusted for differences between the historical period used to calculate historical default and loss severity rates and expected conditions over the remaining lives of the loans in the portfolio related to: (1) lending policies and procedures; (2) international, national, regional and local economic business conditions and developments that affect the collectability of the portfolio; (3) the nature and volume of the loan portfolio including the terms of the loans; (4) the experience, ability, and depth of the lending management and other relevant staff; (5) the volume and severity of past due and adversely classified or graded loans and the volume of nonaccrual loans; (6) the quality of our loan review system and (7) the value of underlying collateral for collateralized loans. Additional factors include the existence and effect of any concentrations of credit, and changes in the level of such concentrations and the effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio. Such factors are used to adjust the historical probabilities of default and severity of loss so that they reflect management expectation of future conditions based on a reasonable and supportable forecast. The Company uses regression analysis of historical internal and peer data to determine which variables are best suited to be economic variables utilized when modeling lifetime probability of default and loss given default. This analysis also determines how expected probability of default and loss given default will react to forecasted levels of the economic variables.

For all DCF models, management has determined that four quarters represents a reasonable and supportable forecast period and reverts back to a historical loss rate over twelve quarters on a straight-line basis. Other internal and external indicators of economic forecasts are also considered by management when developing the forecast metrics.

Remaining life method: Expected credit losses for credit cards and overdrafts are determined through use of the remaining life method. The remaining life method utilizes average annual charge-off rates and remaining life to estimate the allowance for credit losses. This is done by estimating the amount and timing of principal payments expected to be received as payment for the balance outstanding as of the reporting period and applying those principal payments against the balance outstanding as of the reporting period along with the average annual charge-off rate until the expected payments have been fully allocated.

Collateral dependent financial assets: For a loan that does not share risk characteristics with other loans, expected credit loss is measured based on net realizable value, that is, the difference between the discounted value of the expected future cash flows, based on the original effective interest rate, and the amortized cost basis of the loan. For these loans, we recognize expected credit loss equal to the amount by which the net realizable value of the loan is less than the amortized cost basis of the loan (which is net of previous charge- offs and deferred loan fees and costs), except when the loan is collateral dependent, that is, when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In these cases, expected credit loss is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral. The fair value of the collateral is adjusted for the estimated cost to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral.

The Company’s estimate of the ACL reflects losses expected over the contractual life of the assets, adjusted for estimated prepayments or curtailments. The contractual term does not consider extensions, renewals or modifications unless the Company
Page 15

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
has identified a modification including a concession to a borrower experiencing financial difficulties. A modification of a loan to a borrower experiencing financial difficulties occurs when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics.

Allowance for credit losses on off-balance sheet credit exposures, including unfunded loan commitments: The Company maintains a separate allowance for credit losses from off-balance-sheet credit exposures, including unfunded loan commitments, which is disclosed on the balance sheet. Management estimates the amount of expected losses by calculating a commitment usage factor over the contractual period for exposures that are not unconditionally cancellable by the Company and applying the loss factors used in the ACL methodology to the results of the usage calculation to estimate the liability for credit losses related to unfunded commitments for each loan type. No credit loss estimate is reported for off-balance-sheet (OBS) credit exposures that are unconditionally cancellable by the Company, such as credit card receivables, or for undrawn amounts under such arrangements that may be drawn prior to the cancellation of the arrangement. The allowance for credit losses on OBS credit exposures is adjusted as credit loss expense. Categories of OBS credit exposures correspond to the loan portfolio segments described previously.

Troubled debt restructurings (“TDR loans”):  Prior to January 1, 2023, a loan was accounted for and reported as a troubled debt restructuring ("TDR") when, for economic or legal reasons, the Company granted a concession to a borrower experiencing financial difficulty that the Company 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 restructuring that results in only an insignificant delay in payment is not considered a concession. A delay may be considered insignificant if the payments subject to the delay are insignificant relative to the unpaid principal or collateral value and the contractual amount due, or the delay in timing of the restructured payment period is insignificant relative to the frequency of payments, the debt's original contractual maturity or original expected duration. TDRs performing in accordance with their modified contractual terms for a reasonable period of time may be included in the Company’s existing pools based on the underlying risk characteristics of the loan to measure the ACL.

TDRs that are performing and on accrual status as of the date of the modification remain on accrual status. TDRs that are nonperforming as of the date of modification generally remain as nonaccrual until the prospect of future payments in accordance with the modified loan agreement is reasonably assured, generally demonstrated when the borrower maintains compliance with the restructured terms for a predetermined period, normally at least six months. TDRs with temporary below-market concessions remain designated as a TDR regardless of the accrual or performance status until the loan is paid off. However, if the TDR loan has been modified in a subsequent restructure with market terms and the borrower is not currently experiencing financial difficulty, then the loan is no longer classified as a TDR in the quarter following the modification.

Effect of New Financial Accounting Standards:

In May 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity's Own Equity (Subtopic 815-40), Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options. The amendments in this ASU affect entities that issue freestanding written call options that are classified in equity. Specifically, the amendments affect those entities when a freestanding equity-classified written call option is modified or exchanged and remains equity classified after the modification or exchange. An entity should recognize the effect of a modification or an exchange of a freestanding equity-classified written call option to compensate for goods or services in accordance with the guidance in Topic 718, Compensation-Stock Compensation. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date of the amendments. The adoption of the ASU by the Company on January 1, 2022 did not have a material impact on the financial statements.

In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 815) Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The amendments in this Update require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. At the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts. To achieve this, an acquirer may assess how the acquiree applied Topic 606 to determine what to record for the acquired revenue contracts. The amendments in this ASU are effective for all entities for fiscal years beginning
Page 16

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
after December 15, 2022, including interim periods within those fiscal years. An entity should apply the amendments prospectively to business combinations occurring on or after the effective date of the amendments. The adoption of the ASU by the Company on January 1, 2023 did not have a material impact on the financial statements.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures. The FASB issued these amendments to eliminate accounting guidance for TDRs by creditors in Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty, and to require that an entity disclose current-period gross writeoffs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, Financial Instruments-Credit Losses-Measured at Amortized Cost. The amendments in this Update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, and should be applied prospectively, except as provided in the next sentence. For the transition method related to the recognition and measurement of TDRs, an entity has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. Early adoption is permitted if an entity has adopted the amendments in Update 2016-03, including adoption in an interim period. The adoption of the ASU on a prospective basis by the Company on January 1, 2023 did not have a material impact on the financial statements

In March 2023, the FASB issued ASU 2023-02, Investments - Equity Method and Joint Ventures (Topic 323) Accounting for Investments in Tax Credit Structures Using Proportional Amortization Method. The FASB is issuing this ASU to allow reporting entities to consistently account for equity investments made primarily for the purposes of receiving income tax credits and other income tax benefits. The ASU permits reporting entities to elect to account for tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method if certain conditions are met. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for all entities in any interim period. If an entity adopts the amendments in an interim period, it shall adopt them as of the beginning of the fiscal year that includes that interim period. The Company is in the process of evaluating the impact of this ASU on the financial statements.


Note 2.Earnings Per Share

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

The computation of basic and diluted earnings per share for the periods presented is as follows:
 Three Months Ended June 30,Six Months Ended
June 30,
 2023202220232022
Common shares outstanding at the beginning of the period9,197,236 9,277,145 9,225,484 9,299,640 
Weighted average number of net shares redeemed (14,023)(5,420)(24,378)(18,484)
Weighted average shares outstanding (basic)9,183,213 9,271,725 9,201,106 9,281,156 
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method735 1,581 731 2,348 
Weighted average number of shares (diluted)9,183,948 9,273,306 9,201,837 9,283,504 
Net income (In thousands)$11,565 $11,326 $24,027 $21,978 
Earnings per share:    
Basic$1.26 $1.22 $2.61 $2.37 
Diluted$1.26 $1.22 $2.61 $2.37 

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 3.Accumulated Other Comprehensive Income (Loss)

The following table summarizes the balances of each component of accumulated other comprehensive (loss) income (AOCI), included in stockholders’ equity, at June 30, 2023 and December 31, 2022:

 June 30, 2023December 31, 2022
 (amounts in thousands)
Net unrealized loss on available-for-sale securities$(50,991)$(54,198)
Tax effect12,330 13,138 
Net-of-tax amount$(38,661)$(41,060)
 
Note 4.Securities

The carrying values of investment securities at June 30, 2023 and December 31, 2022 are summarized in the following table (dollars in thousands):

 June 30, 2023December 31, 2022
 AmountPercentAmountPercent
Securities available for sale
U.S. Treasury$425,992 59.08 %$445,392 57.39 %
Other securities (FHLB, FHLMC and FNMA)32,205 4.47 31,934 4.11 
State and political subdivisions214,484 29.75 248,582 32.03 
Mortgage-backed securities and collateralized mortgage obligations48,292 6.70 50,196 6.47 
Total securities available for sale$720,973 100.00 %$776,104 100.00 %

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.  Municipal bonds are comprised of general obligation bonds and revenue bonds issued by various municipal corporations. As of June 30, 2023 and December 31, 2022, all securities held were rated investment grade based upon external ratings where available and, where not available, based upon management knowledge of the local issuers and their financial situations. There were no trading or held to maturity securities as of June 30, 2023 or December 31, 2022.


















Page 18

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The carrying amount of available-for-sale securities, fair values and allowance for credit losses were as follows as of June 30, 2023 and December 31, 2022 (in thousands):
 Amortized CostGross
Unrealized
Gains
Gross
Unrealized
(Losses)
Allowance for Credit LossesEstimated Fair
Value
June 30, 2023
U.S. Treasury$448,798 $— $(22,806)$— $425,992 
Other securities (FHLB, FHLMC and FNMA)35,205 — (3,000)— 32,205 
State and political subdivisions233,185 269 (18,970)— 214,484 
Mortgage-backed securities and collateralized mortgage obligations54,776 — (6,484)— $48,292 
Total$771,964 $269 $(51,260)$— $720,973 
December 31, 2022:    
U.S. Treasury$470,581 $— $(25,189)$— $445,392 
Other securities (FHLB, FHLMC and FNMA)35,255 — (3,321)— 31,934 
State and political subdivisions267,351 239 (19,008)— 248,582 
Mortgage-backed securities and collateralized mortgage obligations57,115 — (6,919)— 50,196 
Total$830,302 $239 $(54,437)$— $776,104 

The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at June 30, 2023, were as follows (in thousands) below. Expected maturities of MBS may differ from contractual maturities because the mortgages underlying the securities may be called or prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following summary.
 
 Amortized
Cost
Fair Value
Due in one year or less$161,021 $157,923 
Due after one year through five years414,674 389,583 
Due after five years through ten years115,340 102,950 
Due over ten years26,153 22,225 
$717,188 $672,681 
Mortgage-backed securities and collateralized mortgage obligations54,776 48,292 
$771,964 $720,973 

As of June 30, 2023, investment securities with a carrying value of $9.19 million were pledged to collateralize other borrowings. As of March 31, 2023, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders' equity.

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

 June 30, 2023June 30, 2022
Sale proceeds$509 $— 
Gross realized gains— — 
Gross realized losses— — 




Page 19

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

The following table shows the fair value, gross unrealized losses and the percentage of fair value represented by gross unrealized losses of applicable investment securities owned by the Company, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2023 and December 31, 2022 (in thousands):

 Less than 12 months12 months or moreTotal
June 30, 2023
Description of Securities
#Fair ValueUnrealized
Loss
%#Fair ValueUnrealized
Loss
%#Fair ValueUnrealized
Loss
%
U.S. Treasury$9,401 $(192)2.04 %138 $416,592 $(22,614)5.43 %142 $425,993 $(22,806)5.35 %
Other securities (FHLB, FHLMC and FNMA)— — — — 14 32,205 (3,000)9.32 14 32,205 (3,000)9.32 
State and political subdivisions284 77,657 (1,350)1.74 489 123,293 (17,620)14.29 773 200,950 (18,970)9.44 
Mortgage-backed securities and collateralized mortgage obligations4,229 (322)7.61 17 44,063 (6,162)13.98 18 48,292 (6,484)13.43 
Total temporarily impaired securities289 $91,287 $(1,864)2.04 %658 $616,153 $(49,396)8.02 %947 $707,440 $(51,260)7.25 %

 Less than 12 months12 months or moreTotal
December 31, 2022
Description of Securities
#Fair ValueUnrealized
Loss
%#Fair ValueUnrealized
Loss
%#Fair ValueUnrealized
Loss
%
U.S. Treasury89 $306,407 $(10,695)3.49 %60 $136,486 $(14,494)10.62 %149 $442,893 $(25,189)5.69 %
Other securities (FHLB, FHLMC and FNMA)— — — — 14 31,934 (3,321)10.40 14 31,934 (3,321)10.40 
State and political subdivisions479 124,647 (3,351)2.69 337 87,221 (15,657)17.95 816 211,868 (19,008)8.97 
Mortgage-backed securities and collateralized mortgage obligations14 43,035 (5,314)12.35 7,160 (1,605)22.42 18 50,195 (6,919)13.78 
Total temporarily impaired securities582 $474,089 $(19,360)4.08 %415 $262,801 $(35,077)13.35 %997 $736,890 $(54,437)7.39 %

The Company considered the following information in reaching the conclusion that the impairments disclosed in the table above are not attributable to credit losses.  None of the unrealized losses in the above table was due to the deterioration in the credit quality of any of the issues that might result in the non-collection of contractual principal and interest.  The unrealized losses are due to changes in interest rates. The Company has not recognized any unrealized loss in income because management does not have the intent to sell the securities included in the previous table.  Management has concluded that it is more likely than not that the Company will not be required to sell these securities prior to recovery of the amortized cost basis. The securities are of high credit quality (investment grade credit ratings) and principal and interest payments are made timely with no payments past due as of June 30, 2023. The fair value is expected to recover as the securities approach maturity. The U.S. Treasury and other securities are issued and guaranteed by U.S. government-sponsored entities and agencies. The mortgage-
Page 20

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
backed securities and collateralized mortgage obligations have implied U.S. government guarantees of the agency securities. The Company evaluates if a credit loss exists by monitoring to ensure it has adequate credit support considering the nature of the investment, number and significance of investments in an unrealized loss position, collectability or delinquency issues, the underlying financial statements of the issuers, credit ratings and subsequent changes thereto, and other available relevant information. Considering the above factors, management has determined that no allowance for credit losses is necessary for the securities portfolio as of June 30, 2023.

Note 5.Loans

Classes of loans are as follows:

 June 30, 2023December 31,
2022
 (Amounts In Thousands)
Agricultural$103,588 $112,705 
Commercial and financial289,903 269,568 
Real estate:
Construction, 1 to 4 family residential81,092 92,408 
Construction, land development and commercial265,630 196,240 
Mortgage, farmland269,103 256,570 
Mortgage, 1 to 4 family first liens1,193,995 1,130,989 
Mortgage, 1 to 4 family junior liens133,718 124,951 
Mortgage, multi-family455,718 436,952 
Mortgage, commercial417,483 402,842 
Loans to individuals39,444 36,675 
Obligations of state and political subdivisions47,431 48,213 
 $3,297,105 $3,108,113 
Net unamortized fees and costs337 308 
 $3,297,442 $3,108,421 
Less allowance for credit losses44,270 41,440 
 $3,253,172 $3,066,981 





















Page 21

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

Changes in the allowance for credit losses for the three and six months ended June 30, 2023 were as follows:
Three Months Ended June 30, 2023
AgriculturalCommercial 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
OtherTotal
(Amounts In Thousands)
Allowance for credit losses:
Beginning balance$2,156 $5,563 $4,730 $2,851 $14,735 $9,697 $1,338 $41,070 
Charge-offs— (159)(4)— (141)— (247)(551)
Recoveries11 101 98 40 73 332 
Credit loss expense (benefit)109 1,734 499 (1)1,054 (233)257 3,419 
Ending balance$2,276 $7,239 $5,227 $2,857 $15,746 $9,504 $1,421 $44,270 
Six Months Ended June 30, 2023
 AgriculturalCommercial 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
OtherTotal
 (Amounts In Thousands)
Allowance for credit losses:
Beginning balance$2,542 $6,259 $4,189 $2,989 $14,208 $9,416 $1,837 $41,440 
Charge-offs(440)(249)(4)— (227)— (518)(1,438)
Recoveries18 184 34 179 66 137 621 
Credit loss expense (benefit)156 1,045 1,039 (166)1,586 22 (35)3,647 
Ending balance$2,276 $7,239 $5,227 $2,857 $15,746 $9,504 $1,421 $44,270 
Loans:
Ending balance$103,588 $289,903 $346,722 $269,103 $1,327,713 $873,201 $86,875 $3,297,105 











Page 22

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Changes in the allowance for credit losses for the three and six months ended June 30, 2022 were as follows:
Three Months Ended June 30, 2022
AgriculturalCommercial 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
OtherTotal
(Amounts In Thousands)
Allowance for credit losses:
Beginning balance$2,414 $4,895 $2,347 $3,310 $11,438 $10,234 $1,212 $35,850 
Charge-offs(1)(243)— (20)(109)— (76)(449)
Recoveries54 89 247 336 28 21 777 
Credit loss expense (benefit)(202)453 423 (207)568 971 76 2,082 
Ending balance$2,265 $5,194 $2,772 $3,330 $12,233 $11,233 $1,233 $38,260 
Six Months Ended June 30, 2022
 AgriculturalCommercial 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
OtherTotal
 (Amounts In Thousands)
Allowance for credit losses:
Beginning balance$2,261 $4,269 $2,300 $3,433 $11,498 $10,498 $1,211 $35,470 
Charge-offs(1)(291)— (20)(249)(1)(226)(788)
Recoveries68 212 290 543 50 64 1,232 
Credit loss expense (benefit)(63)1,004 467 (373)441 686 184 2,346 
Ending balance$2,265 $5,194 $2,772 $3,330 $12,233 $11,233 $1,233 $38,260 
Loans:        
Ending balance$96,917 $228,675 $236,117 $240,811 $1,112,666 $806,703 $84,174 $2,806,063 
The allowance for credit losses and the related loan balances as of December 31, 2022:
 AgriculturalCommercial and FinancialReal Estate: Construction
and land
development
Real Estate:
Mortgage,
farmland
Real Estate:
Mortgage, 1 to 4 family
Real Estate:
Mortgage, multi-family and
commercial
OtherTotal
 (Amounts In Thousands)
2022
Allowance for credit losses:
Ending balance$2,542 $6,259 $4,189 $2,989 $14,208 $9,416 $1,837 $41,440 
Loan balances:        
Ending balance$112,705 $269,568 $288,648 $256,570 $1,255,940 $839,794 $84,888 $3,108,113 
Page 23

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Changes in the allowance for credit losses for off-balance sheet credit exposures for the three and six months ended June 30, 2023 and 2022 were as follows:
Three Months Ended June 30, 2023
AgriculturalCommercial 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
OtherTotal
(Amounts In Thousands)
Allowance for credit losses for off-balance sheet credit exposures:
Beginning balance$272$1,070$2,603$54$457$88$26$4,570
Credit loss expense (benefit)119(117)(867)5445224(740)
(Charge-offs), net recoveries
Ending balance$391 $953 $1,736 $59 $501 $140 $50 $3,830 
Six Months Ended June 30, 2023
AgriculturalCommercial 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
OtherTotal
(Amounts In Thousands)
Allowance for credit losses for off-balance sheet credit exposures:
Beginning balance$525 $1,099 $2,126 $55 $471 $122 $32 $4,430 
Credit loss expense (benefit)(134)(146)(390)4301818(600)
(Charge-offs), net recoveries
Ending balance$391 $953 $1,736 $59 $501 $140 $50 $3,830 
Page 24

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Three Months Ended June 30, 2022
AgriculturalCommercial 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
OtherTotal
(Amounts In Thousands)
Allowance for credit losses for off-balance sheet credit exposures:
Beginning balance$513 $1,420 $1,126 $100 $925 $593 $13 $4,690 
Credit loss expense (benefit)146 356 56 15 100 (293)40 420 
(Charge-offs), net recoveries— — — — — — — — 
Ending balance$659 $1,776 $1,182 $115 $1,025 $300 $53 $5,110 
Six Months Ended June 30, 2022
AgriculturalCommercial 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
OtherTotal
(Amounts In Thousands)
Allowance for credit losses for off-balance sheet credit exposures:
Beginning balance$383 $1,118 $849 $113 $794 $559 $34 $3,850 
Credit loss expense (benefit)2766583332231(259)191,260
(Charge-offs), net recoveries— — — — — — — — 
Ending balance$659 $1,776 $1,182 $115 $1,025 $300 $53 $5,110 

The allowance for credit losses for off-balance sheet credit exposures as of December 31, 2022 were as follows:
Year Ended December 31, 2022
AgriculturalCommercial 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
OtherTotal
(Amounts In Thousands)
Ending balance$525 $1,099 $2,126 $55 $471 $122 $32 $4,430 



Page 25

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Credit loss expense for off-balance sheet credit exposures is included in credit loss expense on the consolidated statement of income for the six months ended June 30, 2023 and 2022.

Management regularly reviews loans in the portfolio to assess credit quality indicators and to determine appropriate loan classification and grading in accordance with applicable bank regulations. The Company's risk rating methodology assigns risk ratings ranging from 1 to 6, where a higher rating represents higher risk. The Company differentiates its lending portfolios into loans sharing common risk characteristics for which expected credit loss is measured on a pool basis and loans not sharing common risk characteristics for which credit loss is measured individually.

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. Loans are secured with cash, cash equivalents, or collateral with very low loan to values. The borrower would qualify for unsecured debt and guarantors provide excellent secondary support to the relationship. The borrower has a long-term relationship with the Company, maintains high deposit balances and has an established payment history with the Company and an established business in an established industry.

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. The relationship is not quite as strong as a borrower that is assigned an excellent rating but still has a very strong liquidity position, low leverage, and track record of strong performance. These loans have a strong collateral position with limited risk to bank capital. The collateral will not materially lose value in a distressed liquidation. Guarantors provide additional secondary support to mitigate possible bank losses. The borrower has a long-term relationship with the Company with an established track record of payments; loans with shorter remaining loan amortization; deposit balances are consistent; loan payments could be made from cash reserves in the interim period; and source of income is coming from a stable industry.

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. The borrower's financial performance is consistent, ratios and trends are positive and the primary repayment source can clearly be identified and supported with acceptable financial information. The loan relationship could be vulnerable to changes in economic or industry conditions but have the ability to absorb unexpected issues. The loan collateral coverage is considered acceptable and guarantors can provide financial support but net worth might not be as liquid as a 1 or 2 rated relationship. The borrower has an established relationship with the Company. The relationship is making timely loan payments, any operating line is revolving and deposit balances are positive with limited to no overdrafts. Management and industry is considered stable.

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. The relationship liquidity levels are minimal and the borrower’s leverage position is brought into question. The primary repayment source is showing signs of being stressed or is not proven. If the borrower performs as planned, the loan will be repaid. The collateral coverage is still considered acceptable but there might be some concern with the type of real estate securing the debt or highly dependent on chattel assets. Some loans may be better secured than others. Guarantors still provide some support but there is not an abundance of financial strength supporting the guaranty. A monitor credit may be appropriate when the borrower is experiencing rapid growth which is impacting liquidity levels and increasing debt levels. Other attributes to consider would include if the business is a start-up or newly acquired, if the relationship has significant financing relationships with other financial institutions, the quality of financial information being received, management depth of the company, and changes to the business model. The track history with the Company has some deficiencies such as slow payments or some overdrafts.

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. Potential indicators of a special mention would include past due
Page 26

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HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
payments, overdrafts, management issues, poor financial performance, industry issues, or the need for additional short-term borrowing. The ability to continue to make payments is in question; there are “red flags” such as past due payments, non-revolving credit lines, overdrafts, and the inability to sell assets. The borrower is experiencing delinquent taxes, legal issues, etc., obtaining financial information has become a challenge, collateral coverage is marginal at best, and the value and condition could be brought into question. Collateral document deficiencies have been noted and if not addressed, could become material. Guarantors provide minimal support for this relationship. The credit may include an action plan or follow up established in the asset quality process. There is a change in the borrower’s communication pattern. Industry issues may be impacting the relationship. Adverse credit scores or history of payment deficiencies could be noted.

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.  Full repayment of the loan(s) according to the original terms and conditions is in question or not expected. For these loans, it is more probable than not that the Company could sustain some loss if the deficiency(ies) is not corrected. There are identified shortfalls in the primary repayment source such as carry over debt, past due payments, and overdrafts. Obtaining quality and timely financial information is a weakness. The loan is under secured with exposure that could impact the Company's capital. It appears the liquidation of collateral has become the repayment source. The collateral may be difficult to foreclose or have little to no value. Collateral documentation deficiencies have been noted during the review process. Guarantor(s) provide minimal to no support of the relationship. The borrower’s communication with the Company continues to decrease and the borrower is not addressing the situation. There is some concern about the borrower’s ability and willingness to repay the loans. Problems may be the result of external issues such as economic or industry related issues.

The following tables present the credit quality indicators and origination years by type of loan in each category as of June 30, 2023 (amounts in thousands):
Agricultural
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$410 $1,061 $— $175 $10 $— $4,433 $6,089 
Good2,443 2,428 605 943 401 17 7,593 14,430 
Satisfactory5,419 11,475 3,277 2,037 644 953 28,580 52,385 
Monitor2,180 3,069 1,171 559 324 413 12,024 19,740 
Special Mention175 604 158 65 — — 2,562 3,564 
Substandard1,765 314 118 581 438 — 4,164 7,380 
Total$12,392 $18,951 $5,329 $4,360 $1,817 $1,383 $59,356 $103,588 
Current-period gross write offs$— $416 $— $— $ $— $24 $440 


Page 27

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Commercial and Financial
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$780 $1,248 $551 $594 $— $138 $3,653 $6,964 
Good6,389 11,517 6,225 1,998 371 140 12,254 38,894 
Satisfactory31,461 48,174 19,970 8,094 2,939 1,789 63,217 175,644 
Monitor9,361 15,326 6,582 4,507 709 71 21,928 58,484 
Special Mention194 804 72 245 393 234 1,946 
Substandard1,483 1,033 604 504 451 3,890 7,971 
Total$49,668 $78,102 $34,004 $15,942 $4,474 $2,537 $105,176 $289,903 
Current-period gross write offs$12 $91 $134 $— $12 $— $— $249 


Real Estate: Construction, 1 to 4 Family Residential
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$— $— $— $— $— $— $— $— 
Good— 924 — — — — 17,200 18,124 
Satisfactory1,325 3,413 — — — — 41,379 46,117 
Monitor648 2,043 — — — — 8,454 11,145 
Special Mention— 347 — — — — — 347 
Substandard680 2,123 — — — — 2,556 5,359 
Total$2,653 $8,850 $— $— $— $— $69,589 $81,092 
Current-period gross write offs$— $$— $— $— $— $— $

Page 28

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Real Estate: Construction, Land Development and Commercial
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$— $375 $— $— $— $115 $1,293 $1,783 
Good2,985 1,697 830 947 — 210 9,393 16,062 
Satisfactory9,174 17,541 7,609 1,016 303 1,037 168,403 205,083 
Monitor2,923 2,355 788 117 — 112 18,526 24,821 
Special Mention1,208 — — — — — 2,085 3,293 
Substandard10,003 3,938 — 53 — — 594 14,588 
Total$26,293 $25,906 $9,227 $2,133 $303 $1,474 $200,294 $265,630 
Current-period gross write offs$— $$— $— $— $— $— $


Real Estate: Mortgage, Farmland
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$1,735 $4,757 $2,055 $212 $63 $— $108 $8,930 
Good4,434 21,651 12,404 7,684 1,028 1,295 6,783 55,279 
Satisfactory19,115 59,213 39,064 17,782 3,647 10,517 15,107 164,445 
Monitor3,853 13,505 3,034 4,935 515 1,606 810 28,258 
Special Mention518 825 2,023 110 — 15 2,888 6,379 
Substandard1,229 1,691 — — 2,697 195 — 5,812 
Total$30,884 $101,642 $58,580 $30,723 $7,950 $13,628 $25,696 $269,103 
Current-period gross write offs$— $— $— $— $— $— $— $— 

Page 29

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Real Estate: Mortgage, 1 to 4 Family First Liens
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$450 $1,456 $1,185 $345 $— $709 $— $4,145 
Good9,086 18,736 5,106 8,002 1,283 11,574 2,048 55,835 
Satisfactory119,572 342,473 189,554 132,564 48,304 152,599 17,465 1,002,531 
Monitor8,001 38,464 19,041 17,300 3,423 13,535 7,274 107,038 
Special Mention672 962 2,682 2,830 767 2,512 38 10,463 
Substandard— 1,924 2,088 2,761 1,079 5,939 192 13,983 
Total$137,781 $404,015 $219,656 $163,802 $54,856 $186,868 $27,017 $1,193,995 
Current-period gross write offs$— $80 $$46 $$25 $$160 


Real Estate: Mortgage, 1 to 4 Family Junior Liens
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$— $— $— $$— $— $$11 
Good— 476 187 448 89 494 2,905 4,599 
Satisfactory6,524 14,257 9,935 7,303 3,911 10,359 70,327 122,616 
Monitor82 556 232 512 378 408 2,077 4,245 
Special Mention138 78 224 194 19 129 264 1,046 
Substandard— 108 78 221 41 181 572 1,201 
Total$6,744 $15,475 $10,656 $8,683 $4,438 $11,571 $76,151 $133,718 
Current-period gross write offs$— $34 $— $11 $— $22 $— $67 

Page 30

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Real Estate: Mortgage, Multi-Family
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$— $5,936 $3,058 $2,921 $— $265 $— $12,180 
Good516 14,549 22,980 25,694 — 8,326 935 73,000 
Satisfactory59,094 118,454 51,446 25,401 2,199 14,271 10,817 281,682 
Monitor9,156 17,475 23,898 19,736 166 1,171 3,339 74,941 
Special Mention— 10,076 1,033 — — — 2,806 13,915 
Substandard— — — — — — — — 
Total$68,766 $166,490 $102,415 $73,752 $2,365 $24,033 $17,897 $455,718 
Current-period gross write offs$— $— $— $— $— $— $— $— 

Real Estate: Mortgage, Commercial
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$1,508 $1,734 $566 $17,662 $— $1,062 $— $22,532 
Good6,764 18,634 18,168 14,884 1,612 4,398 14,691 79,151 
Satisfactory21,199 49,845 51,285 45,560 10,195 17,691 32,470 228,245 
Monitor7,299 25,462 17,871 11,172 303 8,361 6,879 77,347 
Special Mention942 762 1,349 1,319 — — — 4,372 
Substandard259 — 3,079 1,106 619 92 681 5,836 
Total$37,971 $96,437 $92,318 $91,703 $12,729 $31,604 $54,721 $417,483 
Current-period gross write offs$— $— $— $— $— $— $— $— 


Page 31

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Loans to Individuals
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$— $— $— $— $— $— $— $— 
Good93 33 — — 12 — 140 
Satisfactory8,316 9,734 4,228 1,761 486 13,815 188 38,528 
Monitor127 210 108 14 16 477 
Special Mention14 62 61 — — — 142 
Substandard86 59 — 157 
Total$8,636 $10,098 $4,403 $1,778 $504 $13,833 $192 $39,444 
Current-period gross write offs$391 $51 $64 $$$— $$518 


Obligations of State and Political Subdivisions
June 30, 202320232022202120202019PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$— $— $— $— $— $4,378 $— $4,378 
Good— — — 1,811 — 7,984 — 9,795 
Satisfactory680 2,331 818 2,399 1,179 13,694 5,509 26,610 
Monitor— 460 — — 461 2,337 3,088 6,346 
Special Mention— — — 302 — — — 302 
Substandard— — — — — — — — 
Total$680 $2,791 $818 $4,512 $1,640 $28,393 $8,597 $47,431 
Current-period gross write offs$— $— $— $— $— $— $— $— 

Page 32

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The following table presents the credit quality indicators by type of loans in each category as of December 31, 2022 (amounts in thousands):
 
Agricultural
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$395 $— $199 $20 $$— $4,196 $4,813 
Good3,823 550 1,003 427 23 13 9,671 15,510 
Satisfactory17,417 4,144 2,659 855 1,250 48 24,233 50,606 
Monitor12,835 1,885 1,770 891 272 225 19,623 37,501 
Special Mention— — — — — — 62 62 
Substandard1,450 — 278 59 166 — 2,260 4,213 
Total$35,920 $6,579 $5,909 $2,252 $1,714 $286 $60,045 $112,705 

Commercial and Financial
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$1,644 $690 $691 $— $176 $— $8,404 $11,605 
Good14,733 6,854 2,504 546 105 1,059 15,836 41,637 
Satisfactory57,920 24,028 11,139 4,339 1,979 356 53,618 153,379 
Monitor16,153 7,570 6,031 1,172 260 24,434 55,621 
Special Mention1,201 343 278 196 29 391 668 3,106 
Substandard746 477 291 68 — — 2,638 4,220 
Total$92,397 $39,962 $20,934 $6,321 $2,549 $1,807 $105,598 $269,568 

Page 33

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Real Estate: Construction, 1 to 4 Family Residential
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$— $— $— $— $— $— $— $— 
Good322 — — — — — 21,467 21,789 
Satisfactory1,962 328 — — — — 47,229 49,519 
Monitor775 182 — — — — 19,886 20,843 
Special Mention— — — — — — 38 38 
Substandard— 105 — — — — 114 219 
Total$3,059 $615 $— $— $— $— $88,734 $92,408 

Real Estate: Construction, Land Development and Commercial
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$375 $— $— $— $— $127 $1,424 $1,926 
Good2,383 958 947 — — 221 18,349 22,858 
Satisfactory23,004 7,222 1,191 311 251 828 90,511 123,318 
Monitor8,121 4,788 119 33 71 27,551 40,689 
Special Mention— — — — — — — — 
Substandard7,043 191 53 — — — 162 7,449 
Total$40,926 $13,159 $2,310 $317 $284 $1,247 $137,997 $196,240 

Real Estate: Mortgage, Farmland
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$4,058 $58 $261 $68 $— $$115 $4,564 
Good24,552 13,966 7,541 1,582 846 917 7,034 56,438 
Satisfactory47,617 41,878 20,908 3,628 5,258 8,184 11,927 139,400 
Monitor24,754 5,803 5,440 3,478 887 1,221 8,992 50,575 
Special Mention4,284 96 112 — — 15 — 4,507 
Substandard539 — — 60 307 180 — 1,086 
Total$105,804 $61,801 $34,262 $8,816 $7,298 $10,521 $28,068 $256,570 

Page 34

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Real Estate: Mortgage, 1 to 4 Family First Liens
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$1,507 $450 $352 $— $$360 $— $2,675 
Good23,270 5,522 8,346 1,342 2,391 10,401 4,688 55,960 
Satisfactory369,706 201,488 142,417 52,727 47,736 124,754 14,992 953,820 
Monitor29,274 20,868 19,766 3,624 4,546 10,638 6,823 95,539 
Special Mention903 1,216 2,058 1,048 952 2,844 463 9,484 
Substandard1,756 2,086 2,419 833 1,690 3,980 747 13,511 
Total$426,416 $231,630 $175,358 $59,574 $57,321 $152,977 $27,713 $1,130,989 

Real Estate: Mortgage, 1 to 4 Family Junior Liens
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$23 $— $$— $— $— $32 $62 
Good493 189 465 91 — 527 2,023 3,788 
Satisfactory15,543 10,915 7,921 4,523 4,822 7,024 64,649 115,397 
Monitor248 244 507 83 286 188 2,442 3,998 
Special Mention114 134 214 37 12 120 72 703 
Substandard122 69 198 87 57 47 423 1,003 
Total$16,543 $11,551 $9,312 $4,821 $5,177 $7,906 $69,641 $124,951 

Real Estate: Mortgage, Multi-Family
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$6,162 $3,123 $3,018 $— $— $292 $— $12,595 
Good14,175 23,485 26,302 — — 8,538 1,362 73,862 
Satisfactory97,449 85,441 26,513 2,355 471 14,295 10,604 237,128 
Monitor44,719 26,633 26,252 169 — 1,201 6,219 105,193 
Special Mention8,174 — — — — — — 8,174 
Substandard— — — — — — — — 
Total$170,679 $138,682 $82,085 $2,524 $471 $24,326 $18,185 $436,952 

Page 35

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Real Estate: Mortgage, Commercial
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$1,946 $576 $21,269 $— $— $1,145 $— $24,936 
Good19,682 23,000 14,286 2,026 1,271 4,413 11,689 76,367 
Satisfactory61,055 61,844 38,772 10,590 8,255 14,568 21,933 217,017 
Monitor22,542 13,111 21,909 3,318 1,515 8,212 7,089 77,696 
Special Mention— 3,298 779 — — — 689 4,766 
Substandard259 513 927 75 190 96 — 2,060 
Total$105,484 $102,342 $97,942 $16,009 $11,231 $28,434 $41,400 $402,842 

Loans to Individuals
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$24 $— $— $— $— $— $— $24 
Good47 — — 16 — — 65 
Satisfactory14,053 6,091 2,647 869 335 11,722 133 35,850 
Monitor253 146 49 24 — 478 
Special Mention88 34 — — — 136 
Substandard45 36 30 122 
Total$14,510 $6,307 $2,704 $901 $363 $11,752 $138 $36,675 

Obligations of State and Political Subdivisions
December 31, 202220222021202020192018PriorRevolving Loans Amortized Cost BasisTotal
Grade:
Excellent$— $— $— $— $— $4,816 $— $4,816 
Good— — 1,870 — — 8,342 — 10,212 
Satisfactory2,224 820 1,961 1,492 573 15,677 8,848 31,595 
Monitor344 — 830 181 99 136 — 1,590 
Special Mention— — — — — — — — 
Substandard— — — — — — — — 
Total$2,568 $820 $4,661 $1,673 $672 $28,971 $8,848 $48,213 








Page 36

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Past due loans as of June 30, 2023 and December 31, 2022 were as follows:
 30 - 59 Days
Past Due
60 - 89 Days
Past Due
90 Days
or More
Past Due
Total Past
Due
CurrentTotal
Loans
Receivable
Accruing Loans
Past Due 90
Days or More
 (Amounts In Thousands)
June 30, 2023
Agricultural$347 $— $— $347 $103,241 $103,588 $— 
Commercial and financial1,434 377 250 2,061 287,842 289,903 246 
Real estate:
Construction, 1 to 4 family residential6,007 3,166 277 9,450 71,642 81,092 — 
Construction, land development and commercial615 915 — 1,530 264,100 265,630 — 
Mortgage, farmland348 21 60 429 268,674 269,103 — 
Mortgage, 1 to 4 family first liens951 2,141 2,779 5,871 1,188,124 1,193,995 304 
Mortgage, 1 to 4 family junior liens210 61 277 133,441 133,718 — 
Mortgage, multi-family5,862 — — 5,862 449,856 455,718 — 
Mortgage, commercial2,359 493 — 2,852 414,631 417,483 — 
Loans to individuals202 191 35 428 39,016 39,444 — 
Obligations of state and political subdivisions— — — — 47,431 47,431 — 
 $18,335 $7,365 $3,407 $29,107 $3,267,998 $3,297,105 $550 
December 31, 2022       
Agricultural$314 $— $— $314 $112,391 $112,705 $— 
Commercial and financial421 132 559 269,009 269,568 — 
Real estate:   
Construction, 1 to 4 family residential— — 105 105 92,303 92,408 — 
Construction, land development and commercial— 1,183 191 1,374 194,866 196,240 — 
Mortgage, farmland24 162 60 246 256,324 256,570 — 
Mortgage, 1 to 4 family first liens3,421 45 3,029 6,495 1,124,494 1,130,989 553 
Mortgage, 1 to 4 family junior liens473 19 500 124,451 124,951 — 
Mortgage, multi-family— — — — 436,952 436,952 — 
Mortgage, commercial247 — 75 322 402,520 402,842 — 
Loans to individuals314 53 — 367 36,308 36,675 — 
Obligations of state and political subdivisions— — — — 48,213 48,213 — 
 $5,214 $1,594 $3,474 $10,282 $3,097,831 $3,108,113 $553 
 The Company does not have a material amount of loans that are past due less than 90 days where there are serious doubts as to the ability of the borrowers to comply with the loan repayment terms.
Page 37

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

Certain nonaccrual and TDR loan information by loan type at June 30, 2023 and December 31, 2022, was as follows:

 June 30, 2023December 31, 2022
 Non-accrual
loans (1)
Accruing loans
past due 90 days
or more
TDR loansNon-
accrual
loans (1)
Accruing loans
past due 90 days
or more
TDR loans
 (Amounts In Thousands)(Amounts In Thousands)
Agricultural$356 $— $13 $— $— $20 
Commercial and financial327 246 963 265 — 1,124 
Real estate:   
Construction, 1 to 4 family residential115 — — 105 — — 
Construction, land development and commercial162 — — 191 — — 
Mortgage, farmland81 — 1,532 623 — 1,039 
Mortgage, 1 to 4 family first liens5,449 304 1,128 4,550 553 1,156 
Mortgage, 1 to 4 family junior liens143 — 18 175 — 19 
Mortgage, multi-family— — 613 — — 620 
Mortgage, commercial620 — 2,059 906 — 1,927 
Loans to individuals— — — — — — 
Obligations of state and political subdivisions — — —  — 
 $7,253 $550 $6,326 $6,815 $553 $5,905 

(1)There were $0.66 million and $1.75 million of TDR loans included within nonaccrual loans as of June 30, 2023 and December 31, 2022, respectively.

Loans 90 days or more past due that are still accruing interest decreased $0.003 million from December 31, 2022 to June 30, 2023. As of June 30, 2023, there were 5 accruing loans past due 90 days or more with an average loan balance of $0.11 million. There were 4 accruing loans past due 90 days or more as of December 31, 2022 with an average loan balance of $0.14 million. The accruing loans past due 90 days or more balances are believed to be adequately collateralized and the Company expects to collect all principal and interest as contractually due under these loans. There was no interest income recognized on nonaccrual loans for the six months ended June 30, 2023 and year ended December 31, 2022.
The Company may modify the terms of a loan to maximize the collection of amounts due.  Such a modification was considered a troubled debt restructuring (“TDR”) prior to adoption of ASU 2022-02 on January 1, 2023.  In most cases, the modification is either a reduction in interest rate, conversion to interest only payments or an extension of the maturity date.  The borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term, so a concessionary modification is granted to the borrower that would otherwise not be considered.  TDR loans accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles.

Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” allows financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time during the COVID-19 pandemic. As of June 30, 2023, the total amount of the eligible loans in deferral (deferral of principal and/or interest) that met the requirements set forth under the CARES Act and therefore were not considered TDRs was 14 loans, totaling $6.6 million. As of December 31, 2022, there were 16 loans, totaling $7.3 million that met the requirements and were not considered TDRs.

Page 38

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

Below is a summary of information for TDR loans as of June 30, 2023 and December 31, 2022:

 June 30, 2023December 31, 2022
Number
of
contracts
Recorded
investment
Commitments
outstanding
Number
of
contracts
Recorded
investment
Commitments
outstanding
 (Amounts In Thousands)(Amounts In Thousands)
Agricultural$13 $170 $20 $100 
Commercial and financial10 1,161 11 1,379 49 
Real estate:
Construction, 1 to 4 family residential— — — 105 — 
Construction, land development and commercial— — — 191 — 
Mortgage, farmland1,532 — 1,578 — 
Mortgage, 1 to 4 family first liens1,128 — 1,156 — 
Mortgage, 1 to 4 family junior liens18 — 19 — 
Mortgage, multi-family613 — 620 — 
Mortgage, commercial10 2,518 — 2,584 — 
Loans to individuals— — — — — — 
Obligations of state and political subdivisions— — — — — — 
 35 $6,983 $177 37 $7,652 $149 



























Page 39

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The following is a summary of TDR loans that were modified during the three and six months ended June 30, 2022:
 Three Months Ended June 30, 2022Six Months Ended June 30, 2022
Number
of
contracts
Pre-modification
recorded
investment
Post-modification
recorded
investment
Number
of
contracts
Pre-modification
recorded
investment
Post-modification
recorded
investment
 (Amounts In Thousands)(Amounts In Thousands)
Agricultural— $— $— — $— $— 
Commercial and financial— — — 371 371 
Real estate:     
Construction, 1 to 4 family residential— — — 105 105 
Construction, land development and commercial— — — 191 191 
Mortgage, farmland1,021 1,021 1,021 1,021 
Mortgage, 1 to 4 family first lien— — — — — — 
Mortgage, 1 to 4 family junior liens— — — — — — 
Mortgage, multi-family— — — — — — 
Mortgage, commercial— — — 274 274 
Loans to individuals— — — — — — 
Obligations of state and political subdivisions— — — — — — 
 $1,021 $1,021 $1,962 $1,962 

The Company has allocated $0.46 million of allowance for TDR loans and the Company had commitments to lend $0.18 million in additional borrowings to restructured loan customers as of June 30, 2023.  The Company had commitments to lend $0.15 million in additional borrowings to restructured loan customers as of December 31, 2022.  These commitments were in the normal course of business.  The additional borrowings were not used to facilitate payments on these loans. The modifications of the terms of loans performed during the six months ended June 30, 2022 included extensions of the maturity date.

There were no TDR loans that were in payment default (defined as past due 90 days or more) during the period ended June 30, 2023 and the year ended December 31, 2022.

The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon asset origination or acquisition. The starting point for the estimate of the allowance for credit losses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification.

Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification.

Page 40

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
In some cases, the Company will modify a certain loan by providing multiple types of concessions. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness, may be granted.

The following table shows the amortized cost basis at the end of the reporting period of the loans modified to borrowers experiencing financial difficulty, disaggregated by class of financing receivable and type of concession granted (numbers in thousands):

Loan Modifications Made to Borrowers Experiencing Financial Difficulty
Term Extension
Amortized Cost Basis at June 30, 2023% of Total Class of Financing Receivable
Loan Type
Mortgage, Farmland$1,229 0.46%
Agricultural474 0.46%
Commercial and financial261 0.09%
Total$1,964 

The following table describes the financial effect of the modifications made to borrowers experiencing financial difficulty:
Term Extension
Loan TypeFinancial Effect
Mortgage, Farmland
Added a weighted-average 5.3 years to the life of loans, which reduced monthly payment amounts for the borrowers.
Agricultural
Added a weighted-average 1.19 year to the life of loans, which reduced monthly payment amounts for the borrowers.
Commercial and financial
Added a weighted-average 2.98 year to the life of loans, which reduced monthly payment amounts for the borrowers.

Upon the Company's determination that a modified loan (or portion of a loan) has subsequently been deemed uncollectible, the loan (or a portion of the loan) is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses is adjusted by the same amount.

There were no financing receivables that had a payment default during the period and were modified in the 12 months before default to borrowers experiencing financial difficulty.

The Company closely monitors the performance of the loans that are modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. The following table depicts the performance of loans that have been modified in the last 12 months (numbers in thousands):
Payment Status (Amortized Cost Basis)
Current30-89 Days Past Due90+ Days Past Due
Loan Type
Mortgage, Farmland$1,229 $— $— 
Agricultural474 — — 
Commercial and financial261 — — 
$1,964 $— $— 
Page 41

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

The following table presents the amortized cost basis of collateral dependent loans, by the primary collateral type, which are individually evaluated to determine expected credit losses, and the related ACL allocated to these loans:

Primary Type of Collateral
Real EstateAccounts ReceivableEquipmentOtherTotalACL Allocation
(Amounts In Thousands)
June 30, 2023
Agricultural$487 $— $— $— $487 $— 
Commercial and financial2,440 — 180 — 2,620 1,260 
Real estate:
Construction, 1 to 4 family residential115 — — — 115 
Construction, land development and commercial162 — — — 162 10 
Mortgage, farmland2,673 — 169 — 2,842 — 
Mortgage, 1 to 4 family first liens6,881 — — — 6,881 42 
Mortgage, 1 to 4 family junior liens161 — — — 161 — 
Mortgage, multi-family613 — — — 613 — 
Mortgage, commercial2,679 — — — 2,679 — 
Loans to individuals— — — — 
Obligations of state and political subdivisions— — — — — — 
$16,211 $— $350 $— $16,561 $1,319 

Page 42

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Primary Type of Collateral
Real EstateAccounts ReceivableEquipmentOtherTotalACL Allocation
(Amounts In Thousands)
December 31, 2022
Agricultural$197 $— $— $— $197 $— 
Commercial and financial1,385 — 74 — 1,459 
Real estate:
Construction, 1 to 4 family residential382 — — — 382 105 
Construction, land development and commercial191 — — — 191 — 
Mortgage, farmland1,482 — 180 — 1,662 — 
Mortgage, 1 to 4 family first liens6,012 — — — 6,012 44 
Mortgage, 1 to 4 family junior liens193 — — — 193 
Mortgage, multi-family620 — — — 620 — 
Mortgage, commercial2,833 — — — 2,833 
Loans to individuals30 — — — 30 29 
Obligations of state and political subdivisions— — — — — — 
$13,325 $— $254 $— $13,579 $184 









Page 43

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The changes in the ACL in 2023 compared to December 31, 2022 is the result of the following factors: slight increase in forecasted Iowa unemployment used in the ACL calculation which resulted in an increase of $0.37 million; increase in loan volume which resulted in an increase of $1.30 million; changes in prepayment and curtailment rates resulting in a decrease of $0.004 million; increase in the individually analyzed loans reserve of $1.14 million; decreases in qualitative factors determined necessary by management which resulted in a decrease of $1.24 million and an increase in other changes of $1.26 million, primarily increased historical loss rates. The decrease in the allowance for credit losses on off-balance sheet credit exposures is primarily a result of the decreased outstanding unfunded commitments as of June 30, 2023.

The extent to which collateral secures collateral-dependent loans is provided in the previous individually analyzed loans table and changes in the extent to which collateral secures its collateral-dependent loans are described below. Collateral-dependent loans increased $2.98 million from December 31, 2022 to June 30, 2023.  Collateral-dependent loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more, TDR loans and loans made to borrowers with financial difficulties. Collateral-dependent loans also include loans that, based on management’s evaluation of current information and events, the Company expects to be unable to collect in full according to the contractual terms of the original loan agreement.  Collateral-dependent loans were 0.50% of loans held for investment as of June 30, 2023 and 0.44% as of December 31, 2022.  The increase in collateral-dependent loans is due to an increase in loans facing financial difficulties of $1.96 million, an increase in loans with a specific reserve of $0.66 million, a decrease in nonaccrual loans of $0.03 million, a decrease in 90 days or more accruing loans of $0.003 million and an increase in TDR loans of $0.42 million from December 31, 2022 to June 30, 2023. There were no significant changes noted in the extent to which collateral secures collateral-dependent loans.

The Company regularly reviews a substantial portion of the loans in the portfolio and assesses whether the loans share common risk characteristics for which expected credit loss is measured on a pool basis or if the loans do not share common risk characteristics and therefore expected credit loss is measured on an individual loan basis.  If the loans are assessed for credit losses on an individual basis, the Company determines if a specific allowance is appropriate.  In addition, the Company's management also reviews and, where determined necessary, provides allowances for particular loans based upon (1) reviews of specific borrowers and (2) management’s assessment of areas that management considers are of higher credit risk, including loans that have been restructured or modified to a borrower experiencing financial difficulties.  Loans that are determined not to be collateral-dependent and for which there are no specific allowances are classified into one or more risk categories and expected credit loss is measured on a pool basis. See Note 1 for further discussion of the allowance for credit losses for loans held for investment.

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

For loans that are collateral-dependent, losses are evaluated based on the portion of a loan that exceeds the fair market value of the collateral.  In general, this is the amount that the carrying value of the loan exceeds the related appraised value less estimated costs to sell the collateral.  Generally, it is the Company’s policy not to rely on appraisals that are older than one year prior to the date the credit loss 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 variables affecting its value may have changed since the appraisal was performed. The charge off or loss adjustment supported by an appraisal is considered the minimum charge off.  Any adjustments made to the appraised value are to provide an additional charge off or specific reserve based on the applicable facts and circumstances.  In instances where there is an estimated decline in value, a specific reserve may be provided or a charge off taken pending confirmation of the amount of the loss from an updated appraisal.  Upon receipt of the new appraisals, an additional specific reserve may be provided or charge off taken based on the appraised value of the collateral.  On average, appraisals are obtained within one month of order.

Note 6.Leases

The Bank leases certain of its branch offices, parking facilities and certain equipment under operating leases. The leases have remaining lease terms of 1 year to 10 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.
Page 44

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

For the six months ended June 30, 2023 and 2022, total operating lease expense was $0.26 million and $0.30 million respectively, and is included in occupancy expenses in the consolidated statements of income. Included in this for the six months ended June 30, 2023 and 2022 were $0.22 million and $0.26 million, respectively, of operating lease costs, $0.02 million and $0.02 million, respectively, of short term lease costs, and $0.02 million and $0.02 million, respectively, of variable lease costs.
For the six months ended June 30, 2023 and 2022, cash paid for amounts included in the measurement of operating lease liabilities was $0.22 million and $0.26 million, respectively.
As of June 30, 2023 and December 31, 2022, operating lease right-of-use assets included in other assets was $1.95 million and $2.11 million respectively. Operating lease liabilities included in other liabilities were $2.04 million and $2.19 million as of June 30, 2023 and December 31, 2022. As of June 30, 2023 and December 31, 2022, the weighted average remaining lease term for operating leases was 9.56 years and 9.72 years, respectively, and the weighted average discount rate for operating leases was 3.56% and 3.54%, respectively. Discount rates used were determined from FHLB borrowing rates for comparable terms.
As of June 30, 2023, maturities of lease liabilities were as follows:
Year ending December 31:(Amounts In Thousands)
2023 (excluding the six months ended June 30, 2023)$141 
2024260 
2025263 
2026266 
2027264 
Thereafter1,239 
Total lease payments2,433 
Less imputed interest(395)
Total operating lease liabilities$2,038 

Page 45

Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 7.Fair Value Measurements

The carrying value and estimated fair values of the Company's financial instruments as of June 30, 2023 are as follows:
 June 30, 2023
 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$41,162 $41,162 $41,162 $ $ 
Investment securities738,958 738,958 425,992 312,966  
Loans held for sale8,815 8,815  8,815  
Loans, net of allowance for credit losses
Agricultural101,312 100,062   100,062 
Commercial and financial282,664 277,578   277,578 
Real estate:
Construction, 1 to 4 family residential80,065 80,403   80,403 
Construction, land development and commercial261,430 253,335   253,335 
Mortgage, farmland266,246 248,153   248,153 
Mortgage, 1 to 4 family first liens1,181,877 1,107,271   1,107,271 
Mortgage, 1 to 4 family junior liens130,427 125,114   125,114 
Mortgage, multi-family450,736 426,816   426,816 
Mortgage, commercial412,961 388,732   388,732 
Loans to individuals38,307 36,820   36,820 
Obligations of state and political subdivisions47,147 45,854   45,854 
Accrued interest receivable16,875 16,875  16,875  
Total financial instrument assets$4,058,982 $3,895,948 $467,154 $338,656 $3,090,138 
Financial instrument liabilities     
Deposits     
Noninterest-bearing deposits$632,463 $632,463 $ $632,463 $ 
Interest-bearing deposits2,649,314 2,649,985  2,649,985  
Other borrowings6,053 6,053  6,053  
Federal Home Loan Bank borrowings330,000 330,009  330,009  
Accrued interest payable2,850 2,850  2,850  
Total financial instrument liabilities$3,620,680 $3,621,360 $ $3,621,360 $ 
 Face Amount    
Financial instrument with off-balance sheet risk:     
Loan commitments$652,675 $ $ $ $— 
Letters of credit6,899    — 
Total financial instrument liabilities with off-balance-sheet risk$659,574 $ $ $ $ 
(1)Considered Level 1 under Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”).
(2)Considered Level 2 under ASC 820.
(3)Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.

Page 46

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


The carrying value and estimated fair values of the Company's financial instruments as of December 31, 2022 are as follows:

 December 31, 2022
 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$36,641 $36,641 $36,641 $ $ 
Investment securities782,565 782,565 445,392 337,173  
Loans held for sale1,663 1,663  1,663  
Loans, net of allowance for credit losses     
Agricultural110,163 108,992   108,992 
Commercial and financial263,309 259,500   259,500 
Real estate:     
Construction, 1 to 4 family residential91,297 91,279   91,279 
Construction, land development and commercial193,162 188,726   188,726 
Mortgage, farmland253,581 237,849   237,849 
Mortgage, 1 to 4 family first liens1,120,150 1,055,091   1,055,091 
Mortgage, 1 to 4 family junior liens121,890 118,279   118,279 
Mortgage, multi-family432,517 411,092   411,092 
Mortgage, commercial397,861 377,753   377,753 
Loans to individuals35,278 36,934   36,934 
Obligations of state and political subdivisions47,773 45,653   45,653 
Accrued interest receivable15,782 15,782  15,782  
Total financial instrument assets$3,903,632 $3,767,799 $482,033 $354,618 $2,931,148 
Financial instrument liabilities:     
Deposits     
Noninterest-bearing deposits$647,450 $647,450 $ $647,450 $ 
Interest-bearing deposits2,709,917 2,711,088  2,711,088  
Other borrowings82,061 82,061  82,061  
Federal Home Loan Bank borrowings40,000 40,000  40,000  
Accrued interest payable1,394 1,394  1,394  
Total financial instrument liabilities$3,480,822 $3,481,993 $ $3,481,993 $ 
 Face Amount    
Financial instrument with off-balance sheet risk:     
Loan commitments$701,729 $ $ $ $— 
Letters of credit6,618    — 
Total financial instrument liabilities with off-balance-sheet risk$708,347 $ $ $ $ 
 Considered Level 1 under ASC 820.
(1)Considered Level 2 under ASC 820.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
(2)Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.

Fair value of financial instruments:  FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) provides a single definition for fair value, a framework for measuring fair value and expanded disclosures concerning fair value.  Fair value is 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 1Quoted prices in active markets for identical assets or liabilities.
Level 2Observable 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 3Unobservable 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 six months ended June 30, 2023. If a fluctuation requiring investigation was identified, the Company would research the change with the independent source or other available information.
Individually analyzed loans under ASC 326 CECL: See Note 1 for further discussion of individually analyzed loans under CECL.
A loan is considered to be non-performing 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 non-performing, the amount of reserve is measured based on the fair value of the underlying collateral. The Company makes such measurements on all material loans deemed non-performing 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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
appraisals of similar property types as well as estimated selling costs. These loans are considered Level 3 as the instruments used to determine fair market value require significant management judgment and estimation.
Foreclosed assets:  The Company does not record foreclosed assets at fair value on a recurring basis.  Foreclosed assets consist mainly of other real estate owned but may include other types of assets repossessed by the Company.  Foreclosed assets are adjusted to the lower of carrying value or fair value less the cost of disposal.   Fair value is generally based upon independent market prices or appraised values of the collateral, and may include a marketability discount as deemed necessary by management based on its experience with similar types of real estate.  The value of foreclosed assets is evaluated periodically as a nonrecurring fair value adjustment.  Foreclosed assets are classified as Level 3.

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

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

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

 June 30, 2023
 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$425,992 $— $— $425,992 
State and political subdivisions— 214,484 — 214,484 
Mortgage-backed securities and collateralized mortgage obligations— 48,292 — 48,292 
Other securities (FHLB, FHLMC and FNMA)— 32,205 — 32,205 
Total$425,992 $294,981 $— $720,973 

 December 31, 2022
 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$445,392 $— $— $445,392 
State and political subdivisions— 248,582 — 248,582 
Mortgage-backed securities and collateralized mortgage obligations— 50,196 — 50,196 
Other securities (FHLB, FHLMC and FNMA)— 31,934 — 31,934 
Total$445,392 $330,712 $— $776,104 
 
(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 six months ended June 30, 2023 and the year ended December 31, 2022.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

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

 June 30, 2023Three Months Ended June 30, 2023Six Months Ended June 30, 2023
 Readily
Available
Market
Prices(1)
Observable
Market
Prices(2)
Company
Determined
Market
Prices(3)
Total at
Fair
Value
Total LossesTotal Losses
 (Amounts in Thousands)
Loans (4)
Agricultural$— $— $474 $474 $419 $419 
Commercial and financial— — 1,068 1,068 11 26 
Real Estate:— 
Construction, 1 to 4 family residential— — 108 108 — — 
Construction, land development and commercial— — 152 152 — — 
Mortgage, farmland— — 2,842 2,842 — — 
Mortgage, 1 to 4 family first liens— — 6,511 6,511 90 111 
Mortgage, 1 to 4 family junior liens— — 161 161 — — 
Mortgage, multi-family— — 613 613 — — 
Mortgage, commercial— — 2,627 2,627 — — 
Loans to individuals— — — — 
Foreclosed assets (5)— — — — — — 
Total$— $— $14,557 $14,557 $520 $556 
 
(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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis (continued)
 December 31, 2022Year Ended December 31, 2022
 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$— $— $— $— $— 
Commercial and financial— — 1,324 1,324 225 
Real Estate:
Construction, 1 to 4 family residential— — 277 277 — 
Construction, land development and commercial— — 191 191 — 
Mortgage, farmland— — 1,662 1,662 123 
Mortgage, 1 to 4 family first liens— — 5,639 5,639 367 
Mortgage, 1 to 4 family junior liens— — 193 193 
Mortgage, multi-family— — 620 620 50 
Mortgage, commercial— — 2,778 2,778 — 
Loans to individuals— — — — — 
Foreclosed assets (5)— — — — — 
Total$— $— $12,684 $12,684 $770 
(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 8.Stock Repurchase Program

On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of 1,500,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  On August 9, 2022, the Company’s Board of Directors authorized the expansion of the 2005 Stock Repurchase Program to allow an additional 750,000 shares for repurchase and the continuation through December 31, 2027. The Company expects the purchases pursuant to the 2005 Stock Repurchase Program to be made from time to time in private transactions at a price equal to the most recent quarterly independent appraisal of the shares of the Company’s common stock and with the Board reviewing the overall results of the 2005 Stock Repurchase Program on a quarterly basis.  All purchases made pursuant to the 2005 Stock Repurchase Program since its inception have been made on that basis.  The amount and timing of stock repurchases will be based on various factors, such as the Board’s assessment of the Company’s capital structure and liquidity, the amount of interest shown by shareholders in selling shares of stock to the Company at their appraised value, and applicable regulatory, legal and accounting factors.  The Company has purchased 1,576,263 shares of its common stock in privately negotiated transactions from August 1, 2005 through June 30, 2023.  Of these 1,576,263 shares, 27,116 shares were purchased during the quarter ended June 30, 2023, at an average price per share of $70.84.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 9. Commitments and Contingencies

Concentrations of credit risk:  The Company’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Company's market area.  Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $77.64 million.  The concentrations of credit by type of loan are set forth in Note 5 to the Consolidated Financial Statements.  Outstanding letters of credit were granted primarily to commercial borrowers.  Although the Company 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.

Financial instruments with off-balance sheet risk:  The Company 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 Company’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 Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  A summary of the Company’s commitments at June 30, 2023 and December 31, 2022 is as follows:
 
 June 30, 2023December 31, 2022
 (Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:
Home equity loans$86,617 $84,869 
Credit cards69,245 66,535 
Commercial, real estate and home construction201,055 241,983 
Commercial lines and real estate purchase loans295,758 308,342 
Outstanding letters of credit6,899 6,618 
 
Note 10.Income Taxes

Federal income tax expense for the six months ended June 30, 2023 and 2022 was computed using the consolidated effective federal tax rate.  The Company also recognized income tax expense pertaining to state franchise taxes payable individually by the subsidiary bank.  The Company files a consolidated tax return for federal purposes and separate tax returns for State of Iowa purposes.  The tax years ended December 31, 2022, 2021, and 2020 remain subject to examination by the Internal Revenue Service.  For state tax purposes, the tax years ended December 31, 2022, 2021, and 2020 remain open for examination.  There were no material unrecognized tax benefits at June 30, 2023  and December 31, 2022 and therefore no interest or penalties on unrecognized tax benefits has been recorded.  As of June 30, 2023, the Company does not anticipate any significant increase in unrecognized tax benefits during the twelve-month period ending June 30, 2024. Income taxes as a percentage of income before taxes were 21.44% for the six months ended June 30, 2023 and 21.63% for the same period in 2022. 

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

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

Special Note Regarding Forward Looking Statements

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

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

The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets. This includes current concerns related to higher inflation, rising energy prices, the Russia-Ukraine war and supply chain imbalances.

The effects of recent financial market disruptions and/or an economic recession, and monetary and other governmental actions designed to address such disruptions, including in response to the COVID-19 pandemic.

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 recognition of an allowance for credit losses on the affected securities and the recognition of a credit 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, including, but not limited to, potential changes in U.S. tax laws and regulations.

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.

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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, diseases and/or pandemics, and terrorist attacks and military actions.

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

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

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

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

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

Economic Environment

Economic conditions have created significant uncertainty about the future economic environment which will continue to evolve and potentially impact our business in future periods. Concerns over interest rate levels, energy prices, domestic and global policy issues, trade policy in the U.S. and geopolitical events, as well as the implications of those events on the markets in general, further add to the global uncertainty. Currently, however, the U.S. economy remains surprisingly strong, given the collective impact of the recent global pandemic, significant inflationary pressures, severe supply chain issues, and a war in Eastern Europe affecting a key global energy supplier. In addition, current labor market conditions suggest there is some potential support for the idea that the economy can achieve the desired “soft landing.” Inflation, however, continues to remain a concern, but much less of one than it was a year ago. While the risk that interest rate increases to fight inflation could lead to a recession remains a pressing concern assuming that U.S. policymakers can avoid any materially damaging policy moves, signs are hopeful that the U.S. economy can begin to stabilize in the near-term. Nonetheless, interest rate levels and energy prices, in combination with global economic conditions, fiscal and monetary policy and the level of regulatory and government scrutiny of financial institutions will likely continue to impact our results throughout the remainder of 2023 and possibly into 2024.

Our credit administration continues to closely monitor and analyze the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. Based on the Company’s capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, senior management is cautiously optimistic that the Company is positioned to continue managing the impact of the varied set of risks and uncertainties currently impacting the economy and remain adequately capitalized. However, the Company may be required to make additional credit loss provisions as warranted by the extremely fluid economic condition.



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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 credit losses.

Allowance for Credit Losses

On January 1, 2021, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires the allowance for credit losses use the current expected credit loss (CECL) methodology. The following is a discussion of the methodologies used by the Company with the adoption of ASC 326.

The preparation of financial statements in accordance with the accounting principles generally accepted in the United States ("U.S. GAAP") requires management to make a number of judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expense in the financial statements. Various elements of our accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions. Some of these policies and estimates relate to matters that are highly complex and contain substantial inherent uncertainties. Management has made significant estimates in several areas, including the allowance for credit losses (see Note 5 - Loans and Note 4 - Securities) and the fair value of debt securities (see Note 4 - Securities).

We have identified the following accounting policies and estimates that, due to the inherent judgments and assumptions and the potential sensitivity of the financial statements to those judgments and assumptions, are critical to an understanding of our financial statements. We believe that the judgments, estimates and assumptions used in the preparation of the Company's financial statements are appropriate. For a further description of our accounting policies, see Note 1 - Summary of Significant Accounting Policies in the financial statements included in this Form 10-Q.

The allowance for credit losses for loans represents management's estimate of all expected credit losses over the expected contractual life of our existing loan portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods.

We employ a disciplined process and methodology to establish our allowance for credit losses that has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics.

Based upon this methodology, management establishes an asset-specific allowance for loans that do not share risk characteristics with other loans based on the amount of expected credit losses calculated on those loans and charges off amounts determined to be uncollectible. Factors we consider in measuring the extent of expected credit loss include payment status, collateral value, borrower financial condition, guarantor support and the probability of collecting scheduled principal and interest payments when due.

When a loan does not share risk characteristics with other loans, we measure expected credit loss as the difference between the amortized cost basis in the loan and the present value of expected future cash flows discounted at the loan's effective interest rate except that, for collateral- dependent loans, credit loss is measured as the difference between the amortized cost basis in the loan and the fair value of the underlying collateral. The fair value of the collateral is adjusted for the estimated cost to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral. In accordance with our appraisal policy, the fair value of collateral-dependent loans is based upon independent third-party appraisals or on collateral valuations prepared by in-house evaluations. Once a third-party appraisal is greater than one year old, or if its determined that market conditions, changes to the property, changes in intended use of the property or other factors indicate that an appraisal is no longer reliable, we perform an internal collateral valuation to assess whether a change in collateral value requires an additional adjustment to carrying value. When we receive an updated appraisal or collateral valuation, management reassesses the need for adjustments to the loan's expected credit loss measurements and, where appropriate, records an
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adjustment. If the calculated expected credit loss is determined to be permanent, fixed or nonrecoverable, the credit loss portion of the loan will be charged off against the allowance for credit losses. Loans designated having significantly increased credit risk are generally placed on nonaccrual and remain in that status until all principal and interest payments are current and the prospects for future payments in accordance with the loan agreement are reasonably assured, at which point the loan is returned to accrual status.

In estimating the component of the allowance for credit losses for loans that share common risk characteristics, loans are segregated into loan classes. Loans are designated into loan classes based on loans pooled by product types and similar risk characteristics or areas of risk concentration. Credit loss assumptions are estimated using a model that categorizes loan pools based on loan type and purpose. This model calculates an expected life-of-loan loss percentage for each loan category by considering the probability of default using historical life-of-loan analysis periods for agricultural, 1 to 4 family first and junior liens, commercial and consumer segments, and the severity of loss, based on the aggregate net lifetime losses incurred per loan class.

The component of the allowance for credit losses for loans that share common risk characteristics also considers factors for each loan class to adjust for differences between the historical period used to calculate historical default and loss severity rates and expected conditions over the remaining lives of the loans in the portfolio related to:
Lending policies and procedures;
International, national, regional and local economic business conditions and developments that affect the collectability of the portfolio, including the condition of various markets;
The nature of the loan portfolio, including the terms of the loans;
The experience, ability and depth of the lending management and other relevant staff;
The volume and severity of past due and adversely classified or graded loans and the volume of nonaccrual loans;
The quality of our loan review and process;
The value of underlying collateral for collateral-dependent loans;
The existence and effect of any concentrations of credit and changes in the level of such concentrations; and
The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

Such factors are used to adjust the historical probabilities of default and severity of loss so that they reflect management expectation of future conditions based on a reasonable and supportable forecast. To the extent the lives of the loans in the portfolio extend beyond the period for which a reasonable and supportable forecast can be made, the Company reduces, on a straight-line basis over the remaining life of the loans, the adjustments so that model reverts back to the historical rates of default and severity of loss.

The credit loss expense recorded through earnings is the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors.

The allowance for credit losses for loans, as reported in our consolidated balance sheet, is adjusted by an expense for credit losses, which is recognized in earnings, and reduced by the charge-off of loan amounts, net of recoveries. For further information on the allowance for credit losses for loans, see Note 1 - Summary of Significant Accounting Policies and Note 5 - Loans in the notes to the financial statements of this Form 10-Q.













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Overview

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

The Company is a holding company engaged in the business of commercial banking.  The Company’s subsidiary is Hills Bank and Trust Company, Hills, Iowa (the “Bank”), which is wholly-owned.  The Bank was formed in Hills, Iowa in 1904.  The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona, Wellman, Cedar Rapids, Marion, and Washington, Iowa.  At June 30, 2023, the Bank has eighteen full-service locations.

Net income for the six month period ended June 30, 2023 was $24.03 million compared to $21.98 million for the same six months of 2022, an increase of $2.05 million or 9.32%.  The principal factors in the increase in net income for the first six months of 2023 were an increase in net interest income of $4.14 million, a decrease in credit loss expense of $0.56 million, offset by a decrease in noninterest income of $0.70 million and an increase in noninterest expense of $1.46 million.

The Company achieved a return on average assets of 1.24% and a return on average equity of 11.64% for the twelve months ended June 30, 2023, compared to the twelve months ended June 30, 2022, which were 1.03% and 9.66%, respectively. The return on average assets and return on average equity for the six months ended June 30, 2023 were 1.20% and 11.19%, respectively, compared to the six months ended June 30, 2022, which were 1.10% and 10.49%, respectively.  Dividends of $1.05 per share were paid in January 2023 to 2,718 shareholders.  The dividend paid in January 2022 was $1.00 per share.

The Company’s net interest income is the largest component of revenue and it is primarily a function of the average earning assets and the net interest margin percentage.  The Company achieved a net interest margin on a tax-equivalent basis of 2.98% for the six months ended June 30, 2023 compared to 2.80% for the same six months of 2022.  Average earning assets were $3.994 billion year to date in 2023 and $3.945 billion in 2022.

Highlights noted on the balance sheet as of June 30, 2023 for the Company included the following:

Total assets were $4.135 billion, an increase of $154.49 million since December 31, 2022.
Cash and cash equivalents were $41.16 million, an increase of $4.52 million since December 31, 2022.
Net loans were $3.262 billion, an increase of $193.34 million since December 31, 2022. The increase is primarily attributable to approximately $69.39 million growth in land development and commercial construction loans, $12.53 million growth in farmland mortgages, $71.77 million growth in 1-4 family mortgages, $20.34 million in commercial and financial loans and $18.77 million growth in multi-family mortgages since December 31, 2022. Loans held for sale increased $7.15 million since December 31, 2022.
Deposits decreased $75.59 million since December 31, 2022.

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

















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Financial Condition

There has been continued loan demand in 2023, primarily in land development and commercial construction, farmland mortgages, 1 to 4 family mortgages, commercial and financial, multi-family, and commercial real estate. The lingering inflationary pressures have created significant uncertainty regarding projecting loan demand throughout the remainder of 2023.

The following table sets forth the composition of the loan portfolio as of June 30, 2023 and December 31, 2022:

 June 30, 2023December 31, 2022
 AmountPercentAmountPercent
 (Amounts In Thousands)(Amounts In Thousands)
Agricultural$103,588 3.14 %$112,705 3.63 %
Commercial and financial289,903 8.79 269,568 8.67 
Real estate:  
Construction, 1 to 4 family residential81,092 2.46 92,408 2.97 
Construction, land development and commercial265,630 8.06 196,240 6.31 
Mortgage, farmland269,103 8.16 256,570 8.25 
Mortgage, 1 to 4 family first liens1,193,995 36.21 1,130,989 36.40 
Mortgage, 1 to 4 family junior liens133,718 4.06 124,951 4.02 
Mortgage, multi-family455,718 13.82 436,952 14.06 
Mortgage, commercial417,483 12.66 402,842 12.96 
Loans to individuals39,444 1.20 36,675 1.18 
Obligations of state and political subdivisions47,431 1.44 48,213 1.55 
 $3,297,105 100.00 %$3,108,113 100.00 %
Net unamortized fees and costs337  308  
 $3,297,442  $3,108,421  
Less allowance for credit losses44,270  41,440  
 $3,253,172  $3,066,981  

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

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

In accordance with Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues, and Staff Accounting Bulletin No. 119, which aligns the staff's guidance with FASB ASC Topic 326, or CECL, the Company
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determines and assigns ratings to loans using factors that include the following: an assessment of the financial condition of the borrower; a realistic determination of the value and adequacy of underlying collateral; the condition of the local economy and the condition of the specific industry of the borrower; an analysis of the levels and trends of loan categories; and a review of delinquent and classified loans.

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

The following table presents the allowance for credit losses as of June 30, 2023 and December 31, 2022 by loan category, the percentage of the allowance for each category to the total allowance, and the percentage of all loans in each category to total loans:
 
 June 30, 2023December 31, 2022
 Amount% of Total
Allowance
% of Loans to
Total Loans
Amount% of Total
Allowance
% of Loans to
Total Loans
 (In Thousands)(In Thousands)
Agricultural$2,276 5.14 %3.14 %$2,542 6.13 %3.63 %
Commercial and financial7,239 16.35 8.79 6,259 15.10 8.67 
Real estate:   
Construction, 1 to 4 family residential1,027 2.32 2.46 1,111 2.68 2.97 
Construction, land development and commercial4,200 9.49 8.06 3,078 7.43 6.31 
Mortgage, farmland2,857 6.45 8.16 2,989 7.21 8.25 
Mortgage, 1 to 4 family first liens12,455 28.13 36.21 11,147 26.91 36.40 
Mortgage, 1 to 4 family junior liens3,291 7.43 4.06 3,061 7.39 4.02 
Mortgage, multi-family4,982 11.25 13.82 4,435 10.70 14.06 
Mortgage, commercial4,522 10.21 12.66 4,981 12.02 12.96 
Loans to individuals1,137 2.58 1.20 1,397 3.37 1.18 
Obligations of state and political subdivisions284 0.65 1.44 440 1.06 1.55 
 $44,270 100.00 %100.00 %$41,440 100.00 %100.00 %

The allowance for credit losses (ACL) totaled $44.27 million at June 30, 2023 compared to the allowance of $41.44 million at December 31, 2022. The percentage of the allowance to outstanding loans was 1.34% and 1.33% at June 30, 2023 and December 31, 2022, respectively.  The allowance was based on management’s consideration of a number of factors, including composition of the loan portfolio, loans with higher credit risks and the overall amount of loans outstanding. The changes in the ACL in 2023 compared to December 31, 2022 is the result of the following factors: slight increase in the forecasted Iowa unemployment used in the ACL calculation which resulted in an increase of $0.37 million; increase in loan volume which resulted in an increase of $1.30 million; changes in prepayment and curtailment rates resulting in a decrease of $0.004 million; increase in the individually analyzed loans reserve of $1.14 million; changes in qualitative factors determined necessary by
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management which resulted in a decrease of $1.24 million and an increase in other changes of $1.26 million, primarily increased historical loss rates.

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

Management has determined that the allowance for credit losses was adequate at June 30, 2023, 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 credit losses is based on a comprehensive, well documented, and consistently applied analysis of the Company’s loan portfolio. This analysis takes into consideration all available information existing as of the financial statement date, including environmental factors such as economic, industry, geographical and political factors. The relative level of allowance for credit losses is reviewed and compared to industry data. This review encompasses levels of total collateral-dependent loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs.

Investment securities available for sale held by the Company decreased by $55.13 million from December 31, 2022 to June 30, 2023.  The fair value of securities available for sale was $50.99 million less than the amortized cost of such securities as of June 30, 2023.  At December 31, 2022, the fair value of the securities available for sale was $54.20 million less than the amortized cost of such securities.

Deposits decreased $75.59 million in the first six months of 2023. In the opinion of the Company’s management, the Company continues to have sufficient liquidity resources available to fund expected additional loan growth.

Brokered deposits are included in total deposits and totaled $23.97 million as of June 30, 2023 with an average rate of 4.70%.  Brokered deposits were $31.74 million as of December 31, 2022 with an average interest rate of 2.60%. As of June 30, 2023 and December 31, 2022, brokered deposits were 0.73% and 0.95% of total deposits, respectively.

There were $330 million and $40 million of Federal Home Loan Bank (FHLB) borrowings as of June 30, 2023 and December 31, 2022, respectively. There were $6.05 million of Federal Funds purchased as of June 30, 2023 and $82.06 million as of December 31, 2022. It is expected that the FHLB and Federal Funds funding sources 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 Federal Funds are favorable compared to other funding alternatives. Also, the Bank Term Funding Program was established by the Federal Reserve in March 2023 to provide an additional source of liquidity against high-quality securities. As of June 30, 2023, the Company had no borrowings from the Bank Term Funding Program though has provided investment securities as collateral for potential future funding needs.

Dividends and Equity

In January 2023, Hills Bancorporation paid a dividend of $9.69 million or $1.05 per share.  The dividend paid in January 2022 was $1.00 per share. After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of June 30, 2023 totaled $447.98 million.

The Company elected to use the Community Bank Leverage Ratio (CBLR) framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act. Under the CBLR framework, the Company is required to maintain a CBLR of greater than 9%, as measured by dividing the Bank's Tier 1 capital by its average total consolidated assets. As of June 30, 2023 and December 31, 2022, the Company had regulatory capital in excess of the Federal Reserve’s minimum and well-capitalized definition requirements. The actual amounts and capital ratios as of June 30, 2023 and December 31, 2022 are presented below (amounts in thousands):
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 Actual
 Amount of Tier 1 CapitalRatio
As of June 30, 2023:
Company:
Community Bank Leverage ratio$528,523 12.90 %
Bank:  
Community Bank Leverage ratio528,954 12.92 
 Actual
 Amount of Tier 1 CapitalRatio
As of December 31, 2022:
Company:
Community Bank Leverage ratio$517,831 13.27 %
Bank:  
Community Bank Leverage ratio520,149 13.33 



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Discussion of operations for the six months ended June 30, 2023 and 2022

Net Income Overview
Total net income was $24.03 million in 2023 and $21.98 million in the comparable period in 2022, an increase of $2.05 million or 9.32%.  The change in net income in 2023 from the first six months of 2022 was primarily the result of the following:

Net interest income increased by $4.14 million, before credit loss expense.
For the six months ended June 30, 2023, credit loss expense was $3.05 million. This represents a decrease in expense of $0.56 million from the credit loss expense of $3.61 million for the six months ended June 30, 2022.
Noninterest income decreased by $0.70 million.
Noninterest expenses increased by $1.46 million.
Income tax expense increased by $0.49 million.
For the six month period ended June 30, 2023 and June 30, 2022 basic earnings per share was $2.61 and $2.37, respectively. Diluted earnings per share was $2.61 for the six months ended June 30, 2023 compared to $2.37 for the same period in 2022.

The Company’s net income for the period was driven primarily by four factors.  The first factor is credit loss expense. The majority of the Company’s interest-earning assets are in loans outstanding, which amounted to more than $3.262 billion at June 30, 2023. Credit loss expense was $3.05 million in 2023 compared to $3.61 million in 2022. The decrease in expense when compared to the same period in 2022 is primarily attributable to qualitative factor decreases determined necessary by management given historical charge-offs for agriculture and commercial loan classes compared to allowances recorded for these loan classes. The Company believes that credit loss expense is expected to be dependent on the Company’s loan growth, local economic conditions and asset quality.

The second factor affecting the Company’s net income is the interaction between changes in net interest margin and changes in average volumes of the Company's earnings assets.  Net interest income of $58.01 million for the first six months of 2023 was derived from the Company’s $3.994 billion of average earning assets during that period and its tax-equivalent net interest margin of 2.98%.  Average earning assets in the six months ended June 30, 2022 were $3.945 billion and the tax-equivalent net interest margin was 2.80%. Net interest income for the Company increased primarily as a result of interest income on increased loan volume and rates partially offset by increased interest expense from increased interest rates, including on borrowings, certificates of deposit, and interest-bearing deposits. The Company expects net interest compression to impact earnings for the foreseeable future due to competition for loans and deposits. The Company believes growth in net interest income will be contingent on the growth of the Company’s earning assets, increasing yield on loans and the ongoing interest rate stance of the Federal Reserve Board.

The third factor affecting the Company’s net income is noninterest income, primarily the decrease in net gain on the sale of loans. The net gain on the sale of loans was $0.59 million and $1.14 million for the six months ended June 30, 2023 and 2022, respectively, a decrease of 48.28% for the six months ended June 30, 2023 compared to the same period in 2022. The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly. The volume of activity in these types of loans is directly related to the level of interest rates as well as the current origination and refinancing activity. The volume was significantly impacted by the Federal Reserve Board's increases to the federal funds rate in 2023 and 2022, resulting in a significant decline in the amount of mortgage loan origination and refinance activity.

The fourth factor affecting the Company’s net income is noninterest expenses, primarily the increase in salaries and related employee benefits due to increased employee levels and annual compensation increases.












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Discussion of operations for the six months ended June 30, 2023 and 2022

Net Interest Income

Net interest income is the excess of the interest and fees earned on interest-earning bearing assets over the interest expense of the interest-bearing liabilities. Net interest income on a tax equivalent basis increased $4.31 million for the six months ended June 30, 2023 compared to the comparable period in 2022.  The increase was primarily attributable to higher interest income on increased loan volume and rates partially offset by increased interest expense from increased interest rates, including on borrowings, certificates of deposit, and interest-bearing deposits. The net interest margin for the first six months of 2023 was 2.98% compared to 2.80% in 2022 for the same period. The measure is shown on a tax-equivalent basis using a tax rate of 21% to make the interest earned on taxable and non-taxable assets more comparable.  The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the six months ended in 2023 compared to the comparable period in 2022 are shown in the following table:
 Increase (Decrease) in Net Interest Income
 Change in
Average Balance
Change in
Average Rate
Volume ChangesRate ChangesNet Change
 (Amounts in Thousands)
Interest income:
Loans, net$482,959 0.60 %$9,101 $10,005 $19,106 
Taxable securities106,249 0.27 950 749 1,699 
Nontaxable securities3,757 0.46 40 473 513 
Interest-bearing bank balances(544,773)4.54 (1,101)397 (704)
 $48,192  $8,990 $11,624 $20,614 
Interest expense:     
Interest-bearing demand deposits$(139,951)0.74 %$136 $(3,744)$(3,608)
Savings deposits(146,490)0.53 117 (2,738)(2,621)
Time deposits89,057 1.13 (642)(3,708)(4,350)
Fed funds borrowed/FHLB overnight225,695 4.36 (897)(4,831)(5,728)
 $28,311  $(1,286)$(15,021)$(16,307)
Change in net interest income  $7,704 $(3,397)$4,307 

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. Interest on nontaxable securities and loans is shown on a tax-equivalent basis.

A summary of the net interest spread and margin is as follows:
(Tax Equivalent Basis)20232022
Yield on average interest-earning assets4.12 %3.11 %
Rate on average interest-bearing liabilities1.54 0.43 
Net interest spread2.58 %2.68 %
Effect of noninterest-bearing funds0.40 0.12 
Net interest margin (tax equivalent net interest income divided by average interest-earning assets)2.98 %2.80 %





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Discussion of operations for the six months ended June 30, 2023 and 2022

In pricing loans and deposits, the Company considers the U.S. Treasury indexes as benchmarks in determining interest rates.  The Federal Open Market Committee met four times during the first six months of 2023.  The federal funds target rate increased to 5.25% as of June 30, 2023 from 1.75% as of the same period in 2022.  Interest rates on loans are generally affected by the federal funds target rate since interest rates for the U.S. Treasury market normally increase or decrease when the Federal Reserve Board raises or lowers the federal funds rate.  As of June 30, 2023, the rate indexes for the one, three and five year indexes were 5.40%, 4.49% and 4.13%, respectively.  The one year index increased 92.86% from 2.80% at June 30, 2022, the three year index increased 50.17% and the five year index increased 37.21%.  The three year index was 2.99% and the five year index was 3.01% at June 30, 2022. 

Credit Loss Expense

Credit loss expense was $3.05 million for the six months ended June 30, 2023 compared to $3.61 million in 2022, a decrease of expense of $0.56 million.  Credit loss expense is the amount necessary to adjust the allowance for credit losses to the level considered by management to appropriately account for the estimated current expected credit losses within the Company's loan portfolio.

A significant component of the Company's approach to estimating expected credit losses are economic forecasts such as Iowa unemployment, all-transactions house price index for Iowa and Iowa real gross domestic product. The decrease in expense when compared to the same period in 2022 is attributable to qualitative factor decreases determined necessary by management given historical charge-offs for agriculture and commercial loan classes compared to allowances recorded for these loan classes.

The allowance for credit losses balance is impacted by charge-offs, net of recoveries, for the periods presented.  For the six months ended June 30, 2023 and 2022, recoveries were $0.62 million and $1.23 million, respectively; and charge-offs were $1.44 million in 2023 and $0.79 million in 2022.  The allowance for credit losses totaled $44.27 million at June 30, 2023 compared to $41.44 million as of December 31, 2022. The allowance represented 1.34% and 1.33% of loans held for investment at June 30, 2023 and December 31, 2022.

Noninterest Income

The following table sets forth the various categories of noninterest income for the six months ended June 30, 2023 and 2022.
 Six Months Ended June 30,
 20232022$ Change% Change
 (Amounts in thousands)
Net gain on sale of loans$588 $1,137 $(549)(48.28)%
Trust fees6,677 6,479 198 3.06 
Service charges and fees6,381 6,162 219 3.55 
Other noninterest income79 650 (571)(87.85)
 $13,725 $14,428 $(703)(4.87)


In the six months ended June 30, 2023 and 2022, the net gain on sale of loans was $0.59 million and $1.14 million, respectively.  The amount of the net gain on sale of secondary market mortgage loans in each period can vary significantly.  The volume of activity, margin and demand in these types of loans is directly related to the changes in interest rates and new originations and refinancing activity. The primary reason for the decrease in 2023 compared to 2022 is the increased mortgage interest rates in 2023 and 2022 leading to the significant decrease in loans originated for sale. The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income.

Other noninterest income decreased $0.57 million for the six months ended June 30, 2023 compared to the same period in 2022, primarily due to the decrease in tax credit real estate investments based on the investments year-end audited financial statements.

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Other noninterest income categories experienced marginal period-to-period fluctuations for the six months ended June 30, 2023.

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the six months ended June 30, 2023 and 2022.
 Six Months Ended June 30,
 20232022$ Change% Change
 (Amounts in thousands)
Salaries and employee benefits$22,331 $21,172 $1,159 5.47 %
Occupancy2,241 2,241 — — 
Furniture and equipment3,375 3,380 (5)(0.15)
Office supplies and postage912 952 (40)(4.20)
Advertising and business development1,494 1,288 206 15.99 
Outside services6,119 5,916 203 3.43 
FDIC insurance assessment879 548 331 60.40 
Other noninterest expense757 1,152 (395)(34.29)
 $38,108 $36,649 $1,459 3.98 

In the six months ended June 30, 2023, salaries and benefits increased $1.16 million compared to the same period in 2022. The increase is primarily the result of increased employee levels and annual compensation increases.

Other noninterest expense categories experienced marginal period-to-period fluctuations for the six months ended June 30, 2023.

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Discussion of operations for the three months ended June 30, 2023 and 2022

Net Income Overview

Net income increased $0.24 million for the three months ended June 30, 2023 compared to the same period in 2022.  Total net income was $11.57 million in 2023 and $11.33 million in the comparable period in 2022, an increase of 2.11%.  For the three month periods ended June 30, 2023 and 2022 basic earnings per share was $1.26 and $1.22, respectively. Diluted earnings per share was $1.26 for the three months ended June 30, 2023 compared to $1.22 for the same period in 2022.

Net Interest Income

Net interest income is the excess of the interest and fees earned on interest-earning bearing assets over the interest expense of the interest-bearing liabilities. Net interest income on a tax equivalent basis increased $0.19 million for the three months ended June 30, 2023 compared to the comparable period in 2022. The slight increase was a result of higher loan volume and interest rates. This is offset by higher interest expense attributable to higher rates on interest-bearing demand and savings deposits, time deposits and borrowings. The net interest margin for the three months ended June 30, 2023 was 2.92% compared to 2.96% in 2022 for the same period.  The measure is shown on a tax-equivalent basis using a tax rate of 21% to make the interest earned on taxable and non-taxable assets more comparable.  The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the three months ended in 2023 compared to the comparable period in 2022 are shown in the following table:

 Increase (Decrease) in Net Interest Income
 Change in
Average Balance
Change in
Average Rate
Volume ChangesRate ChangesNet Change
 (Amounts in Thousands)
Interest income:
Loans, net$488,090 0.65 %$4,660 $5,501 $10,161 
Taxable securities(8,144)0.11 (10)144 134 
Nontaxable securities864 0.40 231 236 
Interest-bearing bank balances(403,185)4.33 (766)201 (565)
 $77,625  $3,889 $6,077 $9,966 
Interest expense:     
Interest-bearing demand deposits$(160,026)0.80 %$85 $(1,937)$(1,852)
Savings deposits(177,770)0.55 77 (1,409)(1,332)
Time deposits152,854 1.48 (539)(2,638)(3,177)
Fed funds borrowed/FHLB overnight257,939 4.50 (517)(2,899)(3,416)
 $72,997 $(894)$(8,883)$(9,777)
Change in net interest income  $2,995 $(2,806)$189 

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. Interest on nontaxable securities and loans is shown on a tax-equivalent basis.










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Discussion of operations for the three months ended June 30, 2023 and 2022

A summary of the net interest spread and margin is as follows:
(Tax Equivalent Basis)20232022
Yield on average interest-earning assets4.21 %3.24 %
Rate on average interest-bearing liabilities1.74 0.43 
Net interest spread2.47 %2.81 %
Effect of noninterest-bearing funds0.45 0.15 
Net interest margin (tax equivalent net interest income divided by average interest-earning assets)2.92 %2.96 %

Credit Loss Expense

Credit loss expense was $2.68 million for the three months ended June 30, 2023 compared to expense of $2.50 million in 2022, an increase of expense of $0.18 million. The increase in credit loss expense when compared to the same period in 2022 is primarily attributable to increases in specific reserves on individually analyzed loans for the quarter ended June 30, 2023. Credit loss expense is the amount necessary to adjust the allowance for credit losses to the level considered by management to appropriately account for the estimated current expected credit losses within the Bank's loan portfolio. A significant component in estimating expected credit losses are economic forecasts such as Iowa unemployment, all-transactions house price index for Iowa and Iowa real gross domestic product.

The allowance for credit losses balance is impacted by charge-offs, net of recoveries, for the periods presented.  For the three months ended June 30, 2023 and 2022, recoveries were $0.33 million and $0.78 million, respectively; and charge-offs were $0.55 million in 2023 and $0.45 million in 2022. 

Noninterest Income

The following table sets forth the various categories of noninterest income for the three months ended June 30, 2023 and 2022.
 Three Months Ended June 30,
 20232022$ Change% Change
 (Amounts in thousands)
Net gain on sale of loans$443 $326 $117 35.89 %
Trust fees3,407 3,211 196 6.10 
Service charges and fees3,348 3,282 66 2.01 
Other noninterest income146 132 14 10.61 
 $7,344 $6,951 $393 5.65 

Noninterest income categories experienced marginal period-to-period fluctuations for the three months ended June 30, 2023.















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Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the three months ended June 30, 2023 and 2022.

 Three Months Ended
June 30,
 20232022$ Change% Change
 (Amounts in thousands)
Salaries and employee benefits$10,828 $10,776 $52 0.48 %
Occupancy1,064 1,109 (45)(4.06)
Furniture and equipment1,683 1,683 — — 
Office supplies and postage464 468 (4)(0.85)
Advertising and business development620 558 62 11.11 
Outside services3,209 2,966 243 8.19 
FDIC insurance assessment609 267 342 128.09 
Other noninterest expense221 747 (526)(70.41)
 $18,698 $18,574 $124 0.67 

All noninterest expense categories experienced marginal period-to-period fluctuations for the three months ended June 30, 2023.

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Income Taxes

Federal and state income tax expenses were $6.56 million and $6.07 million for the six months ended June 30, 2023 and 2022, respectively. Income taxes as a percentage of income before taxes were 21.44% in 2023 and 21.63% in 2022.

Liquidity

The Company actively monitors and manages its liquidity position with the objective of maintaining sufficient cash flows to fund operations, meet commitments, take advantage of market opportunities and provide a margin against unforeseeable liquidity needs.  Federal funds sold and investment securities available for sale are readily marketable assets.  Maturities of all investment securities are managed to meet the Company’s normal liquidity needs, to respond to market changes or to adjust the Company’s interest rate risk position.  Investment securities available for sale comprised 17.44% of the Company’s total assets at June 30, 2023 compared to 19.50% at December 31, 2022. As of June 30, 2023, investment securities with a carrying value of $9.19 million were pledged to collateralize public and trust deposits and other borrowings.  As of December 31, 2022, investment securities with a carrying value of $9.13 million were pledged.

The Company has historically maintained a stable deposit base and a relatively low level of large deposits, which has mitigated the volatility in the Company’s liquidity position.  Deposit inflows and outflows can vary widely based on prevailing market interest rates, competition, economic conditions, our business customers' liquidity needs and by recent developments in the financial services industry. Uninsured deposits as of June 30, 2023 and December 31, 2022 were approximately $699.15 million and $800.81 million, respectively, which comprised 21.30% and 23.85% of total deposits.

As of June 30, 2023, the Company had $330.00 million of outstanding borrowings from the Federal Home Loan Bank (“FHLB”) of Des Moines compared to $40.00 million as of December 31, 2022.  The Company also had $6.05 million of Fed Funds purchased as of June 30, 2023 compared to $82.06 million of Fed Funds purchased as of December 31, 2022. These borrowings are used as a means of providing both long and short-term funding for certain assets and for managing interest rate risk.  The Company had additional borrowing capacity available from the FHLB of approximately $868.64 million at June 30, 2023.

As additional sources of liquidity, the Company has the ability to borrow up to $10.00 million from the Federal Reserve Bank of Chicago, and has lines of credit with three banks totaling $160.00 million.  The borrowings under these credit lines would be secured by the Company’s investment securities.  In addition, the Company has the option of issuing short-, medium-, and long-term debt, should the Company decide to do so. The Bank Term Funding Program was established by the Federal Reserve in March 2023 to provide an additional source of liquidity against high-quality securities. As of June 30, 2023, the Company had no borrowings from the Bank Term Funding Program though has provided investment securities as collateral for potential future funding needs. The combination of high levels of potentially liquid assets, low dependence on volatile liabilities, positive cash flows from operations, and both additional borrowing and brokered deposits capacity provided sources of liquidity for the Company which management considered sufficient at June 30, 2023.



Contractual Obligations

There have been no material changes with regard to contractual obligations disclosed in the Company’s Form 10-K for the year ended December 31, 2022.
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Item 3.Quantitative and Qualitative Disclosures about Market Risk

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

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

The Company 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 Company uses a simulation model to review various assumptions relating to interest rate movement. The Company engages a third party that utilizes a modeling program to measure the Company’s exposure to potential interest rate changes. For various assumed hypothetical changes in market interest rates, this analysis measures the estimated change in net interest income. The simulations allow for ongoing assessment of interest rate sensitivity and can include the impact of potential new business strategies. The modeled scenarios begin with a base case in which rates are unchanged and include parallel and nonparallel rate shocks. The results of these shocks are measured in two forms: first, the impact on the net interest margin and earnings over one and two year time frames; and second, the impact on the market value of equity. The results of the simulation are compared against approved policy limits. The model attempts to limit rate risk even if it appears the Company’s asset and liability maturities are perfectly matched and a favorable interest margin is present.  The Company’s policy is to generally maintain a balance between profitability and interest rate risk.

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

The Company's interest rate risk, as monitored by management, has continued to increase somewhat since year-end. Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including domestic and local economic conditions and the policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. The FOMC, with particular attention being given to ongoing supply chain disruptions, rising energy and commodity prices and the global economic impact of the Russia-Ukraine conflict, has signaled that additional increases may be appropriate if inflation pressures remain elevated or intensify. Further increases to prevailing interest rates could influence the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings. For instance, if our liabilities are positioned to reprice faster than our assets in a rising-rate environment, our net interest income could be detrimentally impacted as a result. Moreover, additional increases to the target range for the federal funds rate, combined with recent bank failures and ongoing geopolitical instability, raise the risk of economic recession. Any such downturn, especially in the regions in which we operate, may adversely affect our asset quality, deposit levels, loan demand and results of operations.

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Item 4.Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Principal Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Based upon that evaluation, the Company’s Principal Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, as of the end of the period covered by this report, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports it files with the Securities and Exchange Commission.  There have been no changes in the Company’s internal controls over financial reporting during the six months ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.


HILLS BANCORPORATION
PART II - OTHER INFORMATION
Item 1.Legal Proceedings

None.

Item 1A.Risk Factors
 
Except as otherwise indicated below, there have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

Economic and Market Risks

Recent Events Impacting the Financial Services Industry May Negatively Affect our Financial Condition and Results of Operation

Recent events impacting the financial services industry, including the failure of Silicon Valley Bank, Signature Bank, and First Republic Bank have resulted in decreased confidence in banks among consumer and commercial depositors, other counterparties and investors, as well as significant disruption, volatility and reduced valuations of equity and other securities of banks in the capital markets. These events occurred during a period of rapidly rising interest rates which, among other things, has resulted in unrealized losses in longer duration securities and loans held by banks, more competition for bank deposits and may increase the risk of a potential recession. These recent events could adversely impact the market price and volatility of the Company’s common stock.

These recent events may also result in potentially adverse changes to laws or regulations governing banks and bank holding companies or result in the impositions of restrictions through supervisory or enforcement activities, including higher capital requirements, which could have a material impact on our business. Inability to access short-term funding or the loss of client deposits could increase our cost of funding, limit access to capital markets or negatively impact our overall liquidity or capitalization. Moreover, we may be impacted by concerns regarding the soundness or creditworthiness of other financial institutions, which can cause substantial and cascading disruption within the financial markets and increased expenses. In addition, the cost of resolving the recent bank failures may prompt the FDIC to increase its premiums above the recently increased levels or to issue additional special assessments.
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Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
 
The following table sets forth information about the Company’s stock purchases, all of which were made pursuant to the 2005 Stock Repurchase Program, for the three months ended June 30, 2023:

PeriodTotal number of shares
purchased
Average price paid per
share
Total number of
shares purchased
as part of publicly
announced plans
or programs
Maximum number
of shares that may
yet be purchased
under the plans
or programs (1)
April 1 to April 3010,816 $72.00 10,816 690,037 
May 1 to May 3111,055 72.00 11,055 678,982 
June 1 to June 305,245 66.00 5,245 673,737 
Total27,116 $70.84 27,116 673,737 
 
(1)  On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to 1,500,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  On August 9, 2022, the Company’s Board of Directors authorized the expansion of the 2005 Stock Repurchase Program to allow an additional 750,000 shares for repurchase and the continuation through December 31, 2027. The Company expects the purchases pursuant to the 2005 Stock Repurchase Program to be made from time to time in private transactions at a price equal to the most recent quarterly independent appraisal of the shares of the Company’s common stock and with the Board reviewing the overall results of the 2005 Stock Repurchase Program on a quarterly basis. All purchases made pursuant to the 2005 Stock Repurchase Program since its inception have been made on that basis.  The amount and timing of stock repurchases will be based on various factors, such as the Board’s assessment of the Company’s capital structure and liquidity, the amount of interest shown by shareholders in selling shares of stock to the Company at their appraised value, and applicable regulatory, legal and accounting factors. 
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Item 3.Defaults upon Senior Securities
 
Hills Bancorporation has no senior securities.

Item 4.Mine Safety Disclosure
 
Not applicable.
Item 5.Other Information

Director or Officer Rule 10b5-1 and Non-Rule 10b5-1 Trading Arrangements

None.

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Item 6.Exhibits

3.1
3.2
4.1
31
32
101.INSXBRL Instance Document (1), (2)
101.SCHXBRL Taxonomy Extension Schema Document (1)
101.CALXBRL Taxonomy Extension Calculation Linkbase Document (1)
101.DEFXBRL Taxonomy Extension Definition Linkbase Document (1)
101.LABXBRL Taxonomy Extension Label Linkbase Document (1)
101.PREXBRL Taxonomy Extension Presentation Linkbase Document (1)
104Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
(1)Users of this data are advised that, pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and are otherwise not subject to liability under these sections.
(2)The instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document.
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

  HILLS BANCORPORATION
   
Date:August 4, 2023 By:  /s/ Dwight O. Seegmiller
  Dwight O. Seegmiller, Director, President and Chief Executive Officer
   
Date:August 4, 2023 By:  /s/ Anthony V. Roetlin
  Anthony V. Roetlin, Treasurer, Chief Financial Officer and Chief Accounting Officer

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