Index


 
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
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31,June 30, 2019


Commission file number:  0-12668OR
Hills Bancorporation


Incorporated in Iowa☐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.
IowaNo. 42-1208067


131 MAIN STREET, HILLS, IOWAIowa 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


þ Yes  o 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

þ Yes  o 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 filero
☐
Accelerated Filerþ☑
Non-accelerated filero
☐
Small Reporting Companyo☐
Emerging Growth Companyo
☐ 


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


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

o Yes  þ No
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered


Index


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
CLASSApril 30,July 31, 2019
  
Common Stock noNo par value9,351,2999,348,046
  
  


Index


HILLS BANCORPORATION
Index to Form 10-Q


Part I
FINANCIAL INFORMATION
 
  Page
  Number
   
Item 1.Financial Statements 
   
 
Consolidated balance sheets, March 31,June 30, 2019 (unaudited) and December 31, 2018
4
 
Consolidated statements of income (unaudited) for three and six months ended March 31,June 30, 2019 and 2018
5
 
Consolidated statements of comprehensive income (unaudited) for three and six months ended March 31,June 30, 2019 and 2018
6
 
Consolidated statements of stockholders' equity (unaudited) for three and six months ended March 31,June 30, 2019 and 2018
7
 
Consolidated statements of cash flows (unaudited) for threesix months ended March 31,June 30, 2019 and 2018
89
 
Notes to consolidated financial statements (condensed)
1011
   
Item 2.
Management Discussion and Analysis of Financial Condition and Results of Operations
4041
   
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
5256
   
Item 4.
Controls and Procedures
5357
   
 Part II 
 OTHER INFORMATION 
   
Item 1.
Legal proceedings
5357
   
Item 1A.
Risk factors
5357
   
Item 2.
Unregistered sales of equity securities and use of proceeds
5458
   
Item 3.
Defaults upon senior securities
5458
   
Item 4.
Mine safety disclosures
5458
   
Item 5.
Other information
5458
   
Item 6.
Exhibits
5559
   
 
Signatures
5660
   
 
Exhibits Index
5761
Index






HILLS BANCORPORATION CONSOLIDATED BALANCE SHEETS (Amounts In Thousands, Except Share Amounts)
March 31, 2019 December 31, 2018June 30, 2019 December 31, 2018
ASSETS(Unaudited) (Unaudited) 
Cash and cash equivalents$200,476
 $43,305
$249,924
 $43,305
Investment securities available for sale at fair value (amortized cost March 31, 2019 $323,358 December 31, 2018 $321,660)323,917
 318,926
Investment securities available for sale at fair value (amortized cost June 30, 2019 $304,183 December 31, 2018 $321,660)308,052
 318,926
Stock of Federal Home Loan Bank12,266
 12,172
12,266
 12,172
Loans held for sale5,267
 1,984
12,627
 1,984
Loans, net of allowance for loan losses (March 31, 2019 $36,520; December 31, 2018 $37,810)2,607,488
 2,591,085
Loans, net of allowance for loan losses (June 30, 2019 $35,650; December 31, 2018 $37,810)2,603,915
 2,591,085
Property and equipment, net36,631
 37,051
36,158
 37,051
Tax credit real estate investment8,931
 9,193
8,678
 9,193
Accrued interest receivable13,970
 11,784
13,117
 11,784
Deferred income taxes, net9,669
 10,869
9,012
 10,869
Goodwill2,500
 2,500
2,500
 2,500
Other assets6,750
 3,595
7,302
 3,595
Total Assets$3,227,865
 $3,042,464
$3,263,551
 $3,042,464
      
LIABILITIES AND STOCKHOLDERS' EQUITY 
  
 
  
      
Liabilities 
  
 
  
Noninterest-bearing deposits$363,142
 $372,152
$371,408
 $372,152
Interest-bearing deposits2,233,750
 2,048,972
2,247,793
 2,048,972
Total deposits$2,596,892
 $2,421,124
$2,619,201
 $2,421,124
Federal Home Loan Bank borrowings215,000
 215,000
215,000
 215,000
Accrued interest payable2,051
 1,812
2,293
 1,812
Other liabilities23,291
 20,776
23,308
 20,776
Total Liabilities$2,837,234
 $2,658,712
$2,859,802
 $2,658,712
      
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)$49,851
 $48,870
$50,225
 $48,870
      
STOCKHOLDERS' EQUITY 
  
 
  
Common stock, no par value; authorized 20,000,000 shares; issued March 31, 2019 10,326,417 shares; December 31, 2018 10,325,191 shares$—
 $—
Common stock, no par value; authorized 20,000,000 shares; issued June 30, 2019 10,324,105 shares; December 31, 2018 10,325,191 shares$—
 $—
Paid in capital55,295
 52,122
55,515
 52,122
Retained earnings375,394
 371,848
386,614
 371,848
Accumulated other comprehensive loss(1,001) (3,250)
Treasury stock at cost (March 31, 2019 974,357 shares; December 31, 2018 988,750 shares)(39,057) (36,968)
Accumulated other comprehensive income (loss)972
 (3,250)
Treasury stock at cost (June 30, 2019 977,656 shares; December 31, 2018 988,750 shares)(39,352) (36,968)
Total Stockholders' Equity$390,631
 $383,752
$403,749
 $383,752
Less maximum cash obligation related to ESOP shares49,851
 48,870
50,225
 48,870
Total Stockholders' Equity Less Maximum Cash Obligation Related to ESOP Shares$340,780
 $334,882
$353,524
 $334,882
Total Liabilities & Stockholders' Equity$3,227,865
 $3,042,464
$3,263,551
 $3,042,464


See Notes to Consolidated Financial Statements.
Index


HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Amounts In Thousands, Except Per Share Amounts)
Three Months Ended March 31,Three Months Ended June 30,Six Months Ended June 30,
2019 20182019 20182019 2018
Interest income:        
Loans, including fees$29,573
 $26,028
$30,395
 $26,968
$59,968
 $52,996
Investment securities: 
  
 
  
   
Taxable758
 563
792
 682
1,550
 1,245
Nontaxable1,025
 889
955
 866
1,980
 1,755
Federal funds sold491
 551
1,094
 548
1,585
 1,099
Total interest income$31,847
 $28,031
$33,236
 $29,064
$65,083
 $57,095
Interest expense: 
  
 
  
   
Deposits$6,499
 $3,864
$7,257
 $4,540
$13,756
 $8,404
FHLB borrowings1,575
 1,874
1,591
 1,701
3,166
 3,575
Total interest expense$8,074
 $5,738
$8,848
 $6,241
$16,922
 $11,979
Net interest income$23,773
 $22,293
$24,388
 $22,823
$48,161
 $45,116
Provision for loan losses(1,246) (765)(540) 711
(1,786) (54)
Net interest income after provision for loan losses$25,019
 $23,058
$24,928
 $22,112
$49,947
 $45,170
Noninterest income: 
  
 
  
   
Net gain on sale of loans$286
 $331
$577
 $443
$863
 $774
Trust fees2,252
 2,641
2,428
 3,007
4,680
 5,648
Service charges and fees2,275
 2,228
2,648
 2,408
4,923
 4,636
Other noninterest income437
 428
250
 376
687
 804
Loss on sale of investment securities(52) —
(52) —
$5,250
 $5,628
$5,851
 $6,234
$11,101
 $11,862
        
Noninterest expenses: 
  
 
  
   
Salaries and employee benefits$8,722
 $8,284
$9,330
 $8,823
$18,052
 $17,107
Occupancy1,186
 1,101
1,102
 1,022
2,288
 2,123
Furniture and equipment1,673
 1,474
1,664
 1,490
3,337
 2,964
Office supplies and postage459
 434
442
 461
901
 895
Advertising and business development638
 630
555
 607
1,193
 1,237
Outside services2,572
 2,578
2,523
 2,347
5,095
 4,925
FDIC insurance assessment209
 218
195
 213
404
 431
Other noninterest expense590
 537
549
 717
1,139
 1,254
$16,049
 $15,256
$16,360
 $15,680
$32,409
 $30,936
Income before income taxes$14,220
 $13,430
$14,419
 $12,666
$28,639
 $26,096
Income taxes3,017
 2,572
3,199
 2,603
6,216
 5,175
Net income$11,203
 $10,858
$11,220
 $10,063
$22,423
 $20,921
        
Earnings per share: 
  
 
  
   
Basic$1.20
 $1.16
$1.20
 $1.07
$2.40
 $2.23
Diluted$1.20
 $1.16
$1.20
 $1.07
$2.40
 $2.23
 
See Notes to Consolidated Financial Statements.
Index


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


Three Months Ended March 31,Three Months Ended June 30,Six Months Ended June 30,
2019 20182019 20182019 2018
Net income$11,203
 $10,858
$11,220
 $10,063
$22,423
 $20,921
        
Other comprehensive income (loss) 
  
 
  
   
Securities: 
  
 
  
   
Net change in unrealized income (loss) on securities available for sale$3,293
 $(2,257)$3,258
 $(271)$6,551
 $(2,528)
Reclassification adjustment for net gains realized in net income—
 —
Reclassification adjustment for net losses realized in net income52
 —
52
 —
Income taxes(821) 563
(826) 67
(1,647) 630
Other comprehensive income (loss) on securities available for sale$2,472
 $(1,694)$2,484
 $(204)$4,956
 $(1,898)
Derivatives used in cash flow hedging relationships: 
  
 
  
   
Net change in unrealized (loss) income on derivatives$(298) $1,054
$(680) $472
$(978) $1,526
Income taxes75
 (263)169
 (117)244
 (380)
Other comprehensive (loss) income on cash flow hedges$(223) $791
$(511) $355
$(734) $1,146
        
Other comprehensive income (loss), net of tax$2,249
 $(903)$1,973
 $151
$4,222
 $(752)
        
Comprehensive income$13,452
 $9,955
$13,193
 $10,214
$26,645
 $20,169
 
See Notes to Consolidated Financial Statements.
Index


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

 Paid In Capital Retained Earnings 
Accumulated Other
Comprehensive
Income (Loss)
 Treasury Stock 
Maximum Cash
Obligation Related
To ESOP Shares
 Total
Balance, December 31, 2017$48,930
 $341,558
 $(2,446) $(33,018) $(43,308) $311,716
Issuance of 88,943 shares of common stock2,580
 —
 —
 2,224
 —
 4,804
Issuance of 1,957 shares of common stock under the employee stock purchase plan100
 —
 —
 —
 —
 100
Unearned restricted stock compensation118
 —
 —
 —
 —
 118
Forfeiture of 208 shares of common stock(8)         (8)
Change related to ESOP shares—
 —
 —
 —
 (2,471) (2,471)
Net income—
 10,858
 —
 —
 —
 10,858
Cash dividends ($0.75 per share)—
 (7,002) —
 —
 —
 (7,002)
Reclassification of stranded tax effects due to the Tax Cuts and Jobs Act  526
 (526)     —
Purchase of 47,432 shares of common stock—
 —
 —
 (2,694) —
 (2,694)
Other comprehensive loss—
 —
 (903) —
 —
 (903)
Balance, March 31, 2018$51,720
 $345,940
 $(3,875) $(33,488) $(45,779) $314,518
            
Balance, December 31, 2018$52,122
 $371,848
 $(3,250) $(36,968) $(48,870) $334,882
Issuance of 84,164 shares of common stock2,932
 —
 —
 2,202
 —
 5,134
Issuance of 1,929 shares of common stock under the employee stock purchase plan105
 —
 —
 —
 —
 105
Unearned restricted stock compensation170
 —
 —
 —
 —
 170
Forfeiture of 703 shares of common stock(34) —
 —
 —
 —
 (34)
Change related to ESOP shares—
 —
 —
 —
 (981) (981)
Net income—
 11,203
 —
 —
 —
 11,203
Cash dividends ($0.82 per share)—
 (7,657) —
 —
 —
 (7,657)
Purchase of 69,771 shares of common stock—
 —
 —
 (4,291) —
 (4,291)
Other comprehensive income—
 —
 2,249
 —
 —
 2,249
Balance, March 31, 2019$55,295
 $375,394
 $(1,001) $(39,057) $(49,851) $340,780
Three Months Ended June 30, 2019 and 2018
 Paid In Capital Retained Earnings 
Accumulated Other
Comprehensive
Income (Loss)
 Treasury Stock 
Maximum Cash
Obligation Related
To ESOP Shares
 Total
Balance, March 31, 2018$51,720
 $345,940
 $(3,875) $(33,488) $(45,779) $314,518
Issuance of 4,311 shares of common stock141
 —
 —
 107
 —
 248
Issuance of 2,326 shares of common stock under the employee stock purchase plan114
 —
 —
 —
 —
 114
Unearned restricted stock compensation47
 —
 —
 —
 —
 47
Forfeiture of 2,554 shares of common stock(123) —
 —
 —
 —
 (123)
Change related to ESOP shares—
 —
 —
 —
 (365) (365)
Net income—
 10,063
 —
 —
 —
 10,063
Purchase of 8,831 shares of common stock—
 —
 —
 (505) —
 (505)
Other comprehensive loss—
 —
 151
 —
 —
 151
Balance, June 30, 2018$51,899
 $356,003
 $(3,724) $(33,886) $(46,144) $324,148
            
Balance, March 31, 2019$55,295
 $375,394
 $(1,001) $(39,057) $(49,851) $340,780
Issuance of 2,327 shares of common stock84
 —
 —
 61
 —
 145
Issuance of 2,106 shares of common stock under the employee stock purchase plan118
 —
 —
 —
 —
 118
Unearned restricted stock compensation237
 —
 —
 —
 —
 237
Forfeiture of 4,418 shares of common stock(220) —
 —
 —
 —
 (220)
Share-based compensation1
 —
 —
 —
 —
 1
Change related to ESOP shares—
 —
 —
 —
 (374) (374)
Net income—
 11,220
 —
 —
 —
 11,220
Purchase of 5,626 shares of common stock—
 —
 —
 (356) —
 (356)
Other comprehensive income—
 —
 1,973
 —
 —
 1,973
Balance, June 30, 2019$55,515
 $386,614
 $972
 $(39,352) $(50,225) $353,524









Index

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

Six Months Ended June 30, 2019 and 2018
 Paid In Capital Retained Earnings 
Accumulated Other
Comprehensive
Income (Loss)
 Treasury Stock 
Maximum Cash
Obligation Related
To ESOP Shares
 Total
Balance, December 31, 2017$48,930
 $341,558
 $(2,446) $(33,018) $(43,308) $311,716
Issuance of 93,254 shares of common stock2,721
 —
 —
 2,331
 —
 5,052
Issuance of 4,283 shares of common stock under the employee stock purchase plan214
 —
 —
 —
 —
 214
Unearned restricted stock compensation165
 —
 —
 —
 —
 165
Forfeiture of 2,762 shares of common stock(131)         (131)
Change related to ESOP shares—
 —
 —
 —
 (2,836) (2,836)
Net income—
 20,921
 —
 —
 —
 20,921
Cash dividends ($0.75 per share)—
 (7,002) —
 —
 —
 (7,002)
Reclassification of stranded tax effects due to the Tax Cuts and Jobs Act  526
 (526)     —
Purchase of 56,263 shares of common stock—
 —
 —
 (3,199) —
 (3,199)
Other comprehensive loss—
 —
 (752) —
 —
 (752)
Balance, June 30, 2018$51,899
 $356,003
 $(3,724) $(33,886) $(46,144) $324,148
            
Balance, December 31, 2018$52,122
 $371,848
 $(3,250) $(36,968) $(48,870) $334,882
Issuance of 86,491 shares of common stock3,016
 —
 —
 2,263
 —
 5,279
Issuance of 4,035 shares of common stock under the employee stock purchase plan223
 —
 —
 —
 —
 223
Unearned restricted stock compensation407
 —
 —
 —
 —
 407
Forfeiture of 5,121 shares of common stock(254) —
 —
 —
 —
 (254)
Share-based compensation1
 —
 —
 —
 —
 1
Change related to ESOP shares—
 —
 —
 —
 (1,355) (1,355)
Net income—
 22,423
 —
 —
 —
 22,423
Cash dividends ($0.82 per share)—
 (7,657) —
 —
 —
 (7,657)
Purchase of 75,397 shares of common stock—
 —
 —
 (4,647) —
 (4,647)
Other comprehensive income—
 —
 4,222
 —
 —
 4,222
Balance, June 30, 2019$55,515
 $386,614
 $972
 $(39,352) $(50,225) $353,524
 
See Notes to Consolidated Financial Statements.
Index


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


Three Months Ended 
 March 31,		Six Months Ended 
 June 30,
2019 20182019 2018
Cash Flows from Operating Activities      
Net income$11,203
 $10,858
$22,423
 $20,921
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities: 
  
 
  
Depreciation847
 821
1,695
 1,642
Provision for loan losses(1,246) (765)(1,786) (54)
Net loss on sale of investment securities available for sale52
 —
Forfeiture of common stock(34) (8)(254) (131)
Share-based compensation1
 —
Compensation expensed through issuance of common stock108
 91
253
 339
Provision for deferred income taxes454
 303
454
 135
Net gain on sale of other real estate owned and other repossessed assets(11) (2)(11) (6)
Increase in accrued interest receivable(2,186) (593)(1,333) (275)
Amortization of premium on investment securities, net100
 134
194
 258
Decrease (increase) in other assets426
 (86)
Increase in other assets(303) (1,541)
Amortization of operating lease right-of-use assets177
 —
Decrease in accrued interest payable and other liabilities(955) (1,465)(1,140) (2,427)
Loans originated for sale(29,847) (31,571)(63,382) (73,464)
Proceeds on sales of loans26,850
 31,480
53,602
 73,643
Net gain on sales of loans(286) (331)(863) (774)
Net cash and cash equivalents provided by operating activities$5,423
 $8,866
$9,779
 $18,266
      
Cash Flows from Investing Activities 
  
 
  
Proceeds from maturities of investment securities available for sale$10,251
 $10,711
$48,028
 $42,728
Proceeds from sales of investment securities available for sale4,881
 —
Purchases of investment securities available for sale(12,143) (25,856)(35,771) (46,028)
Loans made to customers, net of collections(15,208) 7,953
(11,095) (43,134)
Proceeds on sale of other real estate owned and other repossessed assets62
 2
62
 55
Purchases of property and equipment(427) (651)(802) (1,831)
Income from tax credit real estate, net262
 390
Net cash and cash equivalents used in investing activities$(17,203) $(7,451)
Net changes from tax credit real estate investment515
 651
Net cash and cash equivalents provided by (used in) investing activities$5,818
 $(47,559)
      
Cash Flows from Financing Activities 
  
 
  
Net increase in deposits$175,768
 $153,212
$198,077
 $108,445
Net decrease in FHLB borrowings—
 (60,000)—
 (80,000)
Issuance of common stock, net of costs5,026
 4,713
5,026
 4,713
Purchase of treasury stock(4,291) (2,694)(4,647) (3,199)
Proceeds from the issuance of common stock through the employee stock purchase plan105
 100
223
 214
Dividends paid(7,657) (7,002)(7,657) (7,002)
Net cash and cash equivalents provided by financing activities$168,951
 $88,329
$191,022
 $23,171
 
(Continued)


Index


HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) (Amounts In Thousands)
Three Months Ended 
 March 31,		Six Months Ended 
 June 30,
2019 20182019 2018
Increase in cash and cash equivalents$157,171
 $89,744
Increase (decrease) in cash and cash equivalents$206,619
 $(6,122)
Cash and cash equivalents: 
  
 
  
Beginning of period43,305
 154,353
43,305
 154,353
End of period$200,476
 $244,097
$249,924
 $148,231
      
Supplemental Disclosures 
  
 
  
Cash payments for: 
  
 
  
Interest paid to depositors$6,260
 $3,844
$13,275
 $8,188
Interest paid on other obligations1,575
 1,874
3,166
 3,575
Income taxes paid—
 —
4,909
 4,357
      
Noncash activities: 
  
 
  
Increase in maximum cash obligation related to ESOP shares$981
 $2,471
$1,355
 $2,836
Transfers to other real estate owned51
 62
51
 62
Right-of-use assets obtained in exchange for operating lease obligations3,581
 —
3,581
 —
 
See Notes to Consolidated Financial Statements.




Index


HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Note 1.Summary of Significant Accounting Policies


Basis of Presentation:


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


Operating results for the threesix month period ended March 31,June 30, 2019 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2019.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Form 10-K Annual Report of Hills Bancorporation and subsidiary (the “Company”) for the year ended December 31, 2018 filed with the Securities Exchange Commission on March 5, 2019.  The consolidated balance sheet as of December 31, 2018, 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.


Revenue Recognition


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


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


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


A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity's obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. As of March 31,June 30, 2019, 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 March 31,June 30, 2019.


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




Effect of New Financial Accounting Standards:


In May 2014, The FASB and International Accounting Standards Board (IASB) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of ASU 2014-09 is that a company should recognize revenue to depict the transfer of promised good or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. ASU 2014-09 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The adoption of ASU 2014-09 by the Company did not have a material impact on the recognition of revenue though did require additional disclosures on our material noninterest income streams discussed in revenue recognition above.


In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 created Subtopic 321-10, Investments-Equity Securities which is applicable to all entities except those in industries that account for substantially all investments at fair value through earnings or the change in net assets. Under this new subtopic, equity securities are generally required to be measured at fair value with unrealized holding gains and losses reflected in net income. ASU 2016-01 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The Company adopted ASU 2016-01 for the period ending March 31, 2018. There was no material impact on the financial statements however it required a change in disclosure and related methodology located in Note 67 Fair Value Measurements.


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


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


In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (CECL). The ASU changes the way entities recognize impairment of financial assets by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the "incurred loss" model required under current GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


our allowance. For public companies, ASU 2016-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, early adoption is permitted for the fiscal year beginning after December 15, 2018. The Company has implemented a software solution provided by a third party vendor to assist in the analysis of historical loan data to determine the CECL model that will be implemented. The Company anticipates running parallel calculations of the "incurred loss" and CECL models for the quarter ending September 30, 2019, which was delayed from the previously disclosed quarter ending June 30, 2019.2019 to finalize the CECL model assumptions, calculations and documentation. We expect to recognize a one-time cumulative-effect adjustment to our allowance for loan losses as of the beginningJanuary 1, 2020 upon adoption of the first reporting period in which the new standard is adopted.standard. The amount of the one-time cumulative-effect adjustment has not yet been determined.


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


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


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


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


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


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


In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, including removal of the requirement to disclose the valuation processes for Level 3 fair value measurements and the additional requirement to disclose the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted upon issuance of this ASU. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The adoption of ASU 2018-13 by the Company is not expected to have a material impact.


In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40), Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangements That Is a Service Contract. The amendments in this ASU align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU 2018-15 is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption of the amendments in this ASU is permitted, including adoption in any interim period, for all entities. The amendments in this ASU should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is in the process of evaluating the impact of this ASU on the financial statements.


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





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.

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


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,
 2019 20182019 2018
Common shares outstanding at the beginning of the period9,352,060
 9,378,414
9,336,441
 9,335,154
Weighted average number of net shares issued (redeemed)(1,419) (4,470)27,644
 52,041
Weighted average shares outstanding (basic)9,350,641
 9,373,944
9,364,085
 9,387,195
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method4,191
 4,162
4,083
 3,996
Weighted average number of shares (diluted)9,354,832
 9,378,106
9,368,168
 9,391,191
Net income (In thousands)$11,220
 $10,063
$22,423
 $20,921
Earnings per share: 
  
 
  
Basic$1.20
 $1.07
$2.40
 $2.23
Diluted$1.20
 $1.07
$2.40
 $2.23


 Three Months Ended March 31,
 2019 2018
Common shares outstanding at the beginning of the period9,336,441
 9,335,154
Weighted average number of net shares issued30,816
 48,969
Weighted average shares outstanding (basic)9,367,257
 9,384,123
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method4,008
 3,890
Weighted average number of shares (diluted)9,371,265
 9,388,013
Net income (In thousands)$11,203
 $10,858
Earnings per share: 
  
Basic$1.20
 $1.16
Diluted$1.20
 $1.16

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


Note 3.Other Comprehensive Income (Loss)


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


 June 30,
2019
December 31, 2018
 (amounts in thousands)
Net unrealized income (loss) on available-for-sale securities$3,869
 $(2,734)
Net unrealized loss on derivatives used for cash flow hedges(2,574) (1,596)
Tax effect$(323) $1,080
Net-of-tax amount$972
 $(3,250)
 March 31,
2019
December 31, 2018
 (amounts in thousands)
Net unrealized income (loss) on available-for-sale securities$559
 $(2,734)
Net unrealized loss on derivatives used for cash flow hedges(1,894) (1,596)
Tax effect$334
 $1,080
Net-of-tax amount$(1,001) $(3,250)

 
Note 4.Securities


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


 June 30, 2019 December 31, 2018
 Amount Percent Amount Percent
Securities available for sale       
U.S. Treasury$100,503
 32.63% $83,155
 26.07%
Other securities (FHLB, FHLMC and FNMA)25,175
 8.17
 34,871
 10.93
State and political subdivisions182,374
 59.20
 200,900
 63.00
Total securities available for sale$308,052
 100.00% $318,926
 100.00%

 March 31, 2019 December 31, 2018
 Amount Percent Amount Percent
Securities available for sale       
U.S. Treasury$91,573
 28.27% $83,155
 26.07%
Other securities (FHLB, FHLMC and FNMA)27,531
 8.50
 34,871
 10.93
State and political subdivisions204,813
 63.23
 200,900
 63.00
Total securities available for sale$323,917
 100.00% $318,926
 100.00%


Investment securities have been classified in the consolidated balance sheets according to management’s intent.  Available-for-sale securities consist of debt securities not classified as trading or held to maturity.  Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity.  There were no trading or held to maturity securities as of March 31,June 30, 2019 or December 31, 2018. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of March 31,June 30, 2019 and December 31, 2018 (in thousands):


 Amortized Cost 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Estimated Fair
Value
June 30, 2019:       
U.S. Treasury$98,812
 $1,713
 $(22) $100,503
Other securities (FHLB, FHLMC and FNMA)25,325
 —
 (150) 25,175
State and political subdivisions180,046
 2,519
 (191) 182,374
Total$304,183
 $4,232
 $(363) $308,052
December 31, 2018: 
  
  
  
U.S. Treasury$83,839
 $124
 $(808) $83,155
Other securities (FHLB, FHLMC and FNMA)35,371
 —
 (500) 34,871
State and political subdivisions202,450
 278
 (1,828) 200,900
Total$321,660
 $402
 $(3,136) $318,926

 Amortized Cost 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Estimated Fair
Value
March 31, 2019:       
U.S. Treasury$91,181
 $726
 $(334) $91,573
Other securities (FHLB, FHLMC and FNMA)27,846
 —
 (315) 27,531
State and political subdivisions204,331
 1,189
 (707) 204,813
Total$323,358
 $1,915
 $(1,356) $323,917
December 31, 2018: 
  
  
  
U.S. Treasury$83,839
 $124
 $(808) $83,155
Other securities (FHLB, FHLMC and FNMA)35,371
 —
 (500) 34,871
State and political subdivisions202,450
 278
 (1,828) 200,900
Total$321,660
 $402
 $(3,136) $318,926






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


The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at March 31,June 30, 2019, were as follows (in thousands):
 
 
Amortized
Cost
 Fair Value
Due in one year or less$44,295
 $44,233
Due after one year through five years178,806
 180,869
Due after five years through ten years79,446
 81,234
Due over ten years1,636
 1,716
Total$304,183
 $308,052

 
Amortized
Cost
 Fair Value
Due in one year or less$57,358
 $57,169
Due after one year through five years186,161
 186,388
Due after five years through ten years79,278
 79,787
Due over ten years561
 573
Total$323,358
 $323,917


As of March 31,June 30, 2019 investment securities with a carrying value of $11.72$12.52 million were pledged to collateralize derivative financial instruments and other borrowings.


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

 June 30, 2019 June 30, 2018
Sales proceeds$4,881
 $—
Gross realized gains—
 —
Gross realized losses52
 —



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


Less than 12 months 12 months or more TotalLess than 12 months 12 months or more Total
March 31, 2019
Description of Securities		# Fair Value 
Unrealized
Loss
 % # Fair Value 
Unrealized
Loss
 % # Fair Value 
Unrealized
Loss
 %
June 30, 2019
Description of Securities		# Fair Value 
Unrealized
Loss
 % # Fair Value 
Unrealized
Loss
 % # Fair Value 
Unrealized
Loss
 %
U.S. Treasury—
 $—
 $—
 —% 19
 $46,923
 $(334) 0.71% 19
 $46,923
 $(334) 0.71%—
 $—
 $—
 —% 5
 $12,476
 $(22) 0.18% 5
 $12,476
 $(22) 0.18%
                                              
Other securities (FHLB, FHLMC and FNMA)—
 —
 —
 —
 11
 27,531
 (315) 1.14
 11
 27,531
 (315) 1.14
—
 —
 —
 —
 10
 25,176
 (150) 0.60
 10
 25,176
 (150) 0.60
                                              
State and political subdivisions59
 30,332
 (148) 0.49
 262
 62,104
 (559) 0.90
 321
 92,436
 (707) 0.76
41
 10,735
 (61) 0.57
 99
 23,220
 (130) 0.56
 140
 33,955
 (191) 0.56
                                              
Total temporarily impaired securities59
 $30,332
 $(148) 0.49% 292
 $136,558
 $(1,208) 0.88% 351
 $166,890
 $(1,356) 0.81%41
 $10,735
 $(61) 0.57% 114
 $60,872
 $(302) 0.50% 155
 $71,607
 $(363) 0.51%


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

 Less than 12 months 12 months or more Total
December 31, 2018
Description of Securities		# Fair Value 
Unrealized
Loss
 % # Fair Value 
Unrealized
Loss
 % # Fair Value 
Unrealized
Loss
 %
U.S. Treasury6
 $14,644
 $(49) 0.33% 19
 $46,443
 $(759) 1.63% 25
 $61,087
 $(808) 1.32%
                        
Other securities (FHLB, FHLMC and FNMA)—
 —
 —
 —
 14
 34,871
 (500) 1.43
 14
 34,871
 (500) 1.43
                        
State and political subdivisions113
 31,022
 (162) 0.52
 325
 77,921
 (1,666) 2.14
 438
 108,943
 (1,828) 1.68
                        
Total temporarily impaired securities119
 $45,666
 $(211) 0.46% 358
 $159,235
 $(2,925) 1.84% 477
 $204,901
 $(3,136) 1.53%



The Company considered the following information in reaching the conclusion that the impairments disclosed in the table above are temporary and not other-than-temporary impairments.  None of the unrealized losses in the above table was due to the deterioration in the credit quality of any of the issues that might result in the non-collection of contractual principal and interest. 
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

The unrealized losses are due to changes in interest rates.  The Company has not recognized any unrealized loss in income because management does not have the intent to sell the securities included in the previous table.  Management has concluded that it is more likely than not that the Company will not be required to sell these securities prior to recovery of the amortized cost basis.


Note 5.Loans


Classes of loans are as follows:


 June 30,
2019		 December 31,
2018
 (Amounts In Thousands)
Agricultural$91,215
 $92,673
Commercial and financial225,990
 229,501
Real estate:   
Construction, 1 to 4 family residential72,963
 72,279
Construction, land development and commercial99,777
 113,807
Mortgage, farmland238,779
 236,454
Mortgage, 1 to 4 family first liens916,502
 912,059
Mortgage, 1 to 4 family junior liens152,624
 152,625
Mortgage, multi-family350,745
 352,434
Mortgage, commercial406,124
 383,314
Loans to individuals30,981
 30,072
Obligations of state and political subdivisions52,917
 52,725
 $2,638,617
 $2,627,943
Net unamortized fees and costs948
 952
 $2,639,565
 $2,628,895
Less allowance for loan losses35,650
 37,810
 $2,603,915
 $2,591,085

 March 31,
2019		 December 31,
2018
 (Amounts In Thousands)
Agricultural$93,573
 $92,673
Commercial and financial227,403
 229,501
Real estate:   
Construction, 1 to 4 family residential73,868
 72,279
Construction, land development and commercial105,466
 113,807
Mortgage, farmland238,109
 236,454
Mortgage, 1 to 4 family first liens916,408
 912,059
Mortgage, 1 to 4 family junior liens152,183
 152,625
Mortgage, multi-family351,090
 352,434
Mortgage, commercial402,073
 383,314
Loans to individuals29,739
 30,072
Obligations of state and political subdivisions53,153
 52,725
 $2,643,065
 $2,627,943
Net unamortized fees and costs943
 952
 $2,644,008
 $2,628,895
Less allowance for loan losses36,520
 37,810
 $2,607,488
 $2,591,085


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


Changes in the allowance for loan losses, the allowance for loan losses applicable to impaired loans and the related loan balance of impaired loans for the three and six months ended March 31,June 30, 2019 were as follows:




Three Months Ended March 31, 2019Three Months Ended June 30, 2019
Agricultural 
Commercial and
Financial
 
Real Estate:
Construction and
land development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family
 
Real Estate:
Mortgage, multi-
family and
commercial
 Other TotalAgricultural 
Commercial and
Financial
 
Real Estate:
Construction and
land development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family
 
Real Estate:
Mortgage, multi-
family and
commercial
 Other Total
(Amounts In Thousands)(Amounts In Thousands)
Allowance for loan losses:                              
Beginning balance$2,789
 $5,826
 $3,292
 $3,972
 $12,516
 $8,165
 $1,250
 $37,810
$2,541
 $6,004
 $2,928
 $3,871
 $11,630
 $8,223
 $1,323
 $36,520
Charge-offs—
 (180) (8) —
 (177) (4) (108) (477)—
 (284) (1) —
 (202) (129) (126) (742)
Recoveries10
 184
 2
 5
 110
 85
 37
 433
59
 139
 2
 —
 149
 2
 61
 412
Provision(258) 174
 (358) (106) (819) (23) 144
 (1,246)(65) (256) (283) 20
 (193) 98
 139
 (540)


 

 

 

 

 

 

 

               
Ending balance$2,541
 $6,004
 $2,928
 $3,871
 $11,630
 $8,223
 $1,323
 $36,520
$2,535
 $5,603
 $2,646
 $3,891
 $11,384
 $8,194
 $1,397
 $35,650

 
 
 
 
 
 
 
Ending balance, individually evaluated for impairment$258
 $1,375
 $—
 $—
 $74
 $483
 $59
 $2,249

 
 
 
 
 
 
 
Ending balance, collectively evaluated for impairment$2,283
 $4,629
 $2,928
 $3,871
 $11,556
 $7,740
 $1,264
 $34,271


 

 

 

 

 

 

 

Loans:               
               
Ending balance$93,573
 $227,403
 $179,334
 $238,109
 $1,068,591
 $753,163
 $82,892
 $2,643,065


 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment$2,740
 $4,039
 $832
 $4,189
 $6,879
 $4,333
 $59
 $23,071

 
 
 
 
 
 
 
Ending balance, collectively evaluated for impairment$90,833
 $223,364
 $178,502
 $233,920
 $1,061,712
 $748,830
 $82,833
 $2,619,994


Six Months Ended June 30, 2019
 Agricultural 
Commercial and
Financial
 
Real Estate:
Construction and
land development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family
 
Real Estate:
Mortgage, multi-
family and
commercial
 Other Total
 (Amounts In Thousands)
Allowance for loan losses:               
Beginning balance$2,789
 $5,826
 $3,292
 $3,972
 $12,516
 $8,165
 $1,250
 $37,810
Charge-offs—
 (464) (9) —
 (379) (133) (234) (1,219)
Recoveries69
 323
 4
 5
 259
 88
 97
 845
Provision(323) (82) (641) (86) (1,012) 74
 284
 (1,786)
 

 

 

 

 

 

 

 

Ending balance$2,535
 $5,603
 $2,646
 $3,891
 $11,384
 $8,194
 $1,397
 $35,650
 
 
 
 
 
 
 
 
Ending balance, individually evaluated for impairment$213
 $1,059
 $—
 $—
 $70
 $1
 $40
 $1,383
 
 
 
 
 
 
 
 
Ending balance, collectively evaluated for impairment$2,322
 $4,544
 $2,646
 $3,891
 $11,314
 $8,193
 $1,357
 $34,267
 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment$1,930
 $4,213
 $458
 $4,170
 $6,956
 $2,084
 $40
 $19,851
 
 
 
 
 
 
 
 
Ending balance, collectively evaluated for impairment$89,285
 $221,777
 $172,282
 $234,609
 $1,062,170
 $754,785
 $83,858
 $2,618,766
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


Changes in the allowance for loan losses for the three and six months ended March 31,June 30, 2018 were as follows:



Three Months Ended March 31, 2018Three Months Ended June 30, 2018
Agricultural 
Commercial and
Financial
 
Real Estate:
Construction and
land development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage,
1 to 4 family
 
Real Estate:
Mortgage, multi-
family and
commercial
 Other TotalAgricultural 
Commercial and
Financial
 
Real Estate:
Construction and
land development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family
 
Real Estate:
Mortgage, multi-
family and
commercial
 Other Total
(Amounts In Thousands)(Amounts In Thousands)
Allowance for loan losses:                              
Beginning balance$2,294
 $4,837
 $2,989
 $3,669
 $8,668
 $5,700
 $1,243
 $29,400
$2,253
 $4,658
 $2,780
 $3,709
 $8,655
 $5,794
 $1,061
 $28,910
Charge-offs—
 (30) —
 —
 (121) (1) (115) (267)(5) (176) —
 —
 (205) (53) (108) (547)
Recoveries12
 248
 143
 —
 98
 4
 37
 542
17
 193
 2
 19
 147
 13
 45
 436
Provision(53) (397) (352) 40
 10
 91
 (104) (765)(194) 365
 272
 (253) 305
 (57) 273
 711
                              
Ending balance$2,253
 $4,658
 $2,780
 $3,709
 $8,655
 $5,794
 $1,061
 $28,910
$2,071
 $5,040
 $3,054
 $3,475
 $8,902
 $5,697
 $1,271
 $29,510
               
Ending balance, individually evaluated for impairment$199
 $759
 $40
 $—
 $75
 $493
 $63
 $1,629
               
Ending balance, collectively evaluated for impairment$2,054
 $3,899
 $2,740
 $3,709
 $8,580
 $5,301
 $998
 $27,281
               
Loans: 
  
  
  
  
  
  
  
               
Ending balance$83,940
 $214,004
 $166,761
 $218,462
 $980,150
 $705,576
 $83,032
 $2,451,925
               
Ending balance, individually evaluated for impairment$2,823
 $2,550
 $946
 $3,615
 $6,564
 $8,025
 $63
 $24,586
               
Ending balance, collectively evaluated for impairment$81,117
 $211,454
 $165,815
 $214,847
 $973,586
 $697,551
 $82,969
 $2,427,339




 Six Months Ended June 30, 2018
 Agricultural 
Commercial and
Financial
 
Real Estate:
Construction and
land development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage,
1 to 4 family
 
Real Estate:
Mortgage, multi-
family and
commercial
 Other Total
 (Amounts In Thousands)
Allowance for loan losses:               
Beginning balance$2,294
 $4,837
 $2,989
 $3,669
 $8,668
 $5,700
 $1,243
 $29,400
Charge-offs(5) (206) —
 —
 (326) (54) (223) (814)
Recoveries29
 441
 145
 19
 245
 17
 82
 978
Provision(247) (32) (80) (213) 315
 34
 169
 (54)
                
Ending balance$2,071
 $5,040
 $3,054
 $3,475
 $8,902
 $5,697
 $1,271
 $29,510
                
Ending balance, individually evaluated for impairment$189
 $706
 $36
 $13
��$71
 $443
 $60
 $1,518
                
Ending balance, collectively evaluated for impairment$1,882
 $4,334
 $3,018
 $3,462
 $8,831
 $5,254
 $1,211
 $27,992
                
Loans: 
  
  
  
  
  
  
  
                
Ending balance$81,171
 $219,693
 $184,370
 $227,124
 $1,010,836
 $699,106
 $80,572
 $2,502,872
                
Ending balance, individually evaluated for impairment$3,718
 $3,524
 $942
 $4,276
 $6,980
 $7,958
 $60
 $27,458
                
Ending balance, collectively evaluated for impairment$77,453
 $216,169
 $183,428
 $222,848
 $1,003,856
 $691,148
 $80,512
 $2,475,414

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


Agricultural 
Commercial and
Financial
 
Real Estate:
Construction, 1 to 4
family residential
 
Real Estate:
Construction, land
development and
commercial
Agricultural 
Commercial and
Financial
 
Real Estate:
Construction, 1 to 4
family residential
 
Real Estate:
Construction, land
development and
commercial
March 31, 2019       
June 30, 2019       
Grade:              
Excellent$4,091
 $2,718
 $—
 $203
$4,235
 $3,082
 $—
 $200
Good15,703
 47,718
 12,376
 17,416
13,807
 44,159
 8,472
 19,656
Satisfactory39,421
 123,709
 44,934
 57,452
41,518
 120,512
 46,620
 38,049
Monitor27,703
 38,547
 14,185
 21,312
22,999
 45,685
 15,156
 33,611
Special Mention836
 8,566
 1,978
 7,576
3,132
 7,624
 2,715
 7,540
Substandard5,819
 6,145
 395
 1,507
5,524
 4,928
 —
 721
Total$93,573
 $227,403
 $73,868
 $105,466
$91,215
 $225,990
 $72,963
 $99,777


Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family first liens
 
Real Estate: Mortgage,
1 to 4 family junior
liens
 
Real Estate:
Mortgage, multi-
family
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family first liens
 
Real Estate: Mortgage,
1 to 4 family junior
liens
 
Real Estate:
Mortgage, multi-
family
March 31, 2019       
June 30, 2019       
Grade:              
Excellent$5,469
 $2,307
 $526
 $22,051
$6,181
 $1,917
 $515
 $21,277
Good50,050
 31,571
 4,071
 59,203
51,379
 30,775
 4,224
 50,231
Satisfactory126,988
 756,430
 138,533
 189,192
121,427
 752,345
 138,761
 198,175
Monitor45,440
 97,980
 6,241
 58,506
48,899
 103,686
 6,250
 59,062
Special Mention1,117
 9,414
 1,141
 15,947
3,066
 9,574
 1,240
 15,856
Substandard9,045
 18,706
 1,671
 6,191
7,827
 18,205
 1,634
 6,144
Total$238,109
 $916,408
 $152,183
 $351,090
$238,779
 $916,502
 $152,624
 $350,745


Real Estate:
Mortgage,
commercial
 
Loans to
individuals
 
Obligations of state and
political subdivisions
 Total
Real Estate:
Mortgage,
commercial
 
Loans to
individuals
 
Obligations of state and
political subdivisions
 Total
March 31, 2019       
June 30, 2019       
Grade:              
Excellent$35,391
 $—
 $7,985
 $80,741
$34,711
 $—
 $7,819
 $79,937
Good86,117
 193
 15,414
 339,832
84,394
 141
 15,086
 322,324
Satisfactory195,035
 28,663
 21,563
 1,721,920
197,396
 30,015
 21,597
 1,706,415
Monitor74,094
 588
 8,191
 392,787
78,501
 605
 8,015
 422,469
Special Mention2,901
 229
 —
 49,705
2,807
 179
 400
 54,133
Substandard8,535
 66
 —
 58,080
8,315
 41
 —
 53,339
Total$402,073
 $29,739
 $53,153
 $2,643,065
$406,124
 $30,981
 $52,917
 $2,638,617
 
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


 Agricultural 
Commercial and
Financial
 
Real Estate:
Construction, 1 to 4
family residential
 
Real Estate:
Construction, land
development and
commercial
December 31, 2018       
Grade:       
Excellent$3,667
 $3,322
 $—
 $209
Good15,342
 51,562
 13,029
 16,667
Satisfactory39,897
 121,759
 42,043
 68,123
Monitor27,510
 35,897
 15,045
 19,888
Special Mention647
 11,418
 1,767
 7,635
Substandard5,610
 5,543
 395
 1,285
Total$92,673
 $229,501
 $72,279
 $113,807


 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family first liens
 
Real Estate: Mortgage,
1 to 4 family junior
liens
 
Real Estate:
Mortgage, multi-
family
December 31, 2018       
Grade:       
Excellent$5,619
 $2,715
 $520
 $22,058
Good52,364
 33,134
 4,569
 60,047
Satisfactory126,706
 752,473
 138,533
 187,641
Monitor41,486
 96,187
 6,242
 60,398
Special Mention1,055
 10,439
 1,130
 16,065
Substandard9,224
 17,111
 1,631
 6,225
Total$236,454
 $912,059
 $152,625
 $352,434


 
Real Estate:
Mortgage,
commercial
 
Loans to
individuals
 
Obligations of state and
political subdivisions
 Total
December 31, 2018       
Grade:       
Excellent$34,096
 $—
 $8,117
 $80,323
Good86,453
 315
 15,652
 349,134
Satisfactory177,271
 28,797
 20,685
 1,703,928
Monitor74,990
 647
 8,271
 386,561
Special Mention3,228
 217
 —
 53,601
Substandard7,276
 96
 —
 54,396
Total$383,314
 $30,072
 $52,725
 $2,627,943

 
Real Estate:
Mortgage,
commercial
 
Loans to
individuals
 
Obligations of state and
political subdivisions
 Total
December 31, 2018       
Grade:       
Excellent$34,096
 $—
 $8,117
 $80,323
Good86,453
 315
 15,652
 349,134
Satisfactory177,271
 28,797
 20,685
 1,703,928
Monitor74,990
 647
 8,271
 386,561
Special Mention3,228
 217
 —
 53,601
Substandard7,276
 96
 —
 54,396
Total$383,314
 $30,072
 $52,725
 $2,627,943


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


The below are descriptions of the credit quality indicators:


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


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


Satisfactory – Satisfactory rated loans are loans to borrowers of average financial means not especially vulnerable to changes in economic or other circumstances, where the major support for the extension is sufficient collateral of a marketable nature, and the primary source of repayment is seen to be clear and adequate.


Monitor – Monitor rated loans are identified by management as warranting special attention for a variety of reasons that may bear on ultimate collectability. This may be due to adverse trends, a particular industry, loan structure, or repayment that is dependent on projections, or a one-time occurrence.


Special Mention – Special mention rated loans are supported by a marginal payment capacity and are marginally protected by collateral.  There are identified weaknesses that if not monitored and corrected may adversely affect the Company’s credit position.  A special mention credit would typically have a weakness in one of the general categories (cash flow, collateral position or payment history) but not in all categories.


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








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


Past due loans as of March 31,June 30, 2019 and December 31, 2018 were as follows:


 
30 - 59 Days
Past Due
 
60 - 89 Days
Past Due
 
90 Days
or More
Past Due
 
Total Past
Due
 Current 
Total
Loans
Receivable
 
Accruing Loans
Past Due 90
Days or More
 (Amounts In Thousands)
June 30, 2019             
Agricultural$137
 $95
 $1,302
 $1,534
 $89,681
 $91,215
 $37
Commercial and financial2,897
 2,799
 1,187
 6,883
 219,107
 225,990
 430
Real estate:             
Construction, 1 to 4 family residential505
 145
 —
 650
 72,313
 72,963
 —
Construction, land development and commercial340
 7,056
 32
 7,428
 92,349
 99,777
 —
Mortgage, farmland229
 388
 769
 1,386
 237,393
 238,779
 —
Mortgage, 1 to 4 family first liens1,072
 2,338
 2,559
 5,969
 910,533
 916,502
 347
Mortgage, 1 to 4 family junior liens100
 —
 —
 100
 152,524
 152,624
 —
Mortgage, multi-family—
 105
 —
 105
 350,640
 350,745
 —
Mortgage, commercial—
 276
 182
 458
 405,666
 406,124
 —
Loans to individuals103
 12
 3
 118
 30,863
 30,981
 —
Obligations of state and political subdivisions—
 —
 —
 —
 52,917
 52,917
 —
 $5,383
 $13,214
 $6,034
 $24,631
 $2,613,986
 $2,638,617
 $814
              
December 31, 2018 
  
  
  
  
  
  
Agricultural$1,026
 $—
 $135
 $1,161
 $91,512
 $92,673
 $—
Commercial and financial988
 459
 225
 1,672
 227,829
 229,501
 —
Real estate:       
    
  
Construction, 1 to 4 family residential—
 —
 212
 212
 72,067
 72,279
 212
Construction, land development and commercial233
 202
 —
 435
 113,372
 113,807
 —
Mortgage, farmland193
 388
 —
 581
 235,873
 236,454
 —
Mortgage, 1 to 4 family first liens3,972
 833
 3,234
 8,039
 904,020
 912,059
 158
Mortgage, 1 to 4 family junior liens199
 36
 —
 235
 152,390
 152,625
 —
Mortgage, multi-family—
 —
 —
 —
 352,434
 352,434
 —
Mortgage, commercial733
 344
 —
 1,077
 382,237
 383,314
 —
Loans to individuals195
 —
 22
 217
 29,855
 30,072
 —
Obligations of state and political subdivisions—
 —
 —
 —
 52,725
 52,725
 —
 $7,539
 $2,262
 $3,828
 $13,629
 $2,614,314
 $2,627,943
 $370
 
30 - 59 Days
Past Due
 
60 - 89 Days
Past Due
 
90 Days
or More
Past Due
 
Total Past
Due
 Current 
Total
Loans
Receivable
 
Accruing Loans
Past Due 90
Days or More
 (Amounts In Thousands)
March 31, 2019             
Agricultural$2,057
 $445
 $1,616
 $4,118
 $89,455
 $93,573
 $583
Commercial and financial1,158
 371
 242
 1,771
 225,632
 227,403
 —
Real estate:             
Construction, 1 to 4 family residential692
 —
 —
 692
 73,176
 73,868
 —
Construction, land development and commercial1,036
 32
 —
 1,068
 104,398
 105,466
 —
Mortgage, farmland6,954
 —
 630
 7,584
 230,525
 238,109
 —
Mortgage, 1 to 4 family first liens9,145
 666
 2,790
 12,601
 903,807
 916,408
 —
Mortgage, 1 to 4 family junior liens190
 395
 —
 585
 151,598
 152,183
 —
Mortgage, multi-family143
 —
 —
 143
 350,947
 351,090
 —
Mortgage, commercial1,633
 —
 281
 1,914
 400,159
 402,073
 —
Loans to individuals124
 46
 —
 170
 29,569
 29,739
 —
Obligations of state and political subdivisions—
 —
 —
 —
 53,153
 53,153
 —
 $23,132
 $1,955
 $5,559
 $30,646
 $2,612,419
 $2,643,065
 $583
              
December 31, 2018 
  
  
  
  
  
  
Agricultural$1,026
 $—
 $135
 $1,161
 $91,512
 $92,673
 $—
Commercial and financial988
 459
 225
 1,672
 227,829
 229,501
 —
Real estate:       
    
  
Construction, 1 to 4 family residential—
 —
 212
 212
 72,067
 72,279
 212
Construction, land development and commercial233
 202
 —
 435
 113,372
 113,807
 —
Mortgage, farmland193
 388
 —
 581
 235,873
 236,454
 —
Mortgage, 1 to 4 family first liens3,972
 833
 3,234
 8,039
 904,020
 912,059
 158
Mortgage, 1 to 4 family junior liens199
 36
 —
 235
 152,390
 152,625
 —
Mortgage, multi-family—
 —
 —
 —
 352,434
 352,434
 —
Mortgage, commercial733
 344
 —
 1,077
 382,237
 383,314
 —
Loans to individuals195
 —
 22
 217
 29,855
 30,072
 —
Obligations of state and political subdivisions—
 —
 —
 —
 52,725
 52,725
 —
 $7,539
 $2,262
 $3,828
 $13,629
 $2,614,314
 $2,627,943
 $370

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


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


Certain impaired loan information by loan type at March 31,June 30, 2019 and December 31, 2018, was as follows:


March 31, 2019 December 31, 2018June 30, 2019 December 31, 2018
Non-accrual
loans (1)
 
Accruing loans
past due 90 days
or more
 TDR loans 
Non-
accrual
loans (1)
 
Accruing loans
past due 90 days
or more
 TDR loans
Non-accrual
loans (1)
 
Accruing loans
past due 90 days
or more
 TDR loans 
Non-
accrual
loans (1)
 
Accruing loans
past due 90 days
or more
 TDR loans
(Amounts In Thousands) (Amounts In Thousands)(Amounts In Thousands) (Amounts In Thousands)
Agricultural$1,308
 $583
 $97
 $1,338
 $—
 $120
$1,265
 $37
 $628
 $1,338
 $—
 $120
Commercial and financial1,857
 —
 2,143
 1,476
 —
 2,686
1,621
 430
 2,153
 1,476
 —
 2,686
Real estate: 
  
  
  
  
  
 
  
  
  
  
  
Construction, 1 to 4 family residential395
 —
 —
 —
 212
 —
—
 —
 —
 —
 212
 —
Construction, land development and commercial—
 —
 326
 —
 —
 328
33
 —
 324
 —
 —
 328
Mortgage, farmland1,037
 —
 3,903
 1,062
 —
 3,301
1,037
 —
 3,133
 1,062
 —
 3,301
Mortgage, 1 to 4 family first liens5,833
 —
 1,132
 5,799
 158
 1,143
5,666
 347
 1,020
 5,799
 158
 1,143
Mortgage, 1 to 4 family junior liens—
 —
 24
 —
 —
 24
—
 —
 24
 —
 —
 24
Mortgage, multi-family143
 —
 —
 145
 —
 —
105
 —
 —
 145
 —
 —
Mortgage, commercial1,196
 —
 925
 1,009
 —
 937
1,064
 —
 915
 1,009
 —
 937
$11,769
 $583
 $8,550
 $10,829
 $370
 $8,539
$10,791
 $814
 $8,197
 $10,829
 $370
 $8,539


(1)There were $5.07$4.70 million and $4.84 million of TDR loans included within nonaccrual loans as of March 31,June 30, 2019 and December 31, 2018, respectively.


Loans 90 days or more past due that are still accruing interest increased $0.21$0.44 million from December 31, 2018 to March 31,June 30, 2019 due to an increase in the number of accruing loans past due 90 days or more. As of March 31,June 30, 2019 there were 38 accruing loans past due 90 days or more. The average accruing loans past due as of March 31,June 30, 2019 are $0.19$0.10 million. There were 2 accruing loans past due 90 days or more as of December 31, 2018 and the average loan balance was $0.19 million. The accruing loans past due 90 days or more balances are believed to be adequately collateralized and the Company expects to collect all principal and interest as contractually due under these loans.
 
The Company may modify the terms of a loan to maximize the collection of amounts due.  Such a modification is considered a troubled debt restructuring (“TDR”).  In most cases, the modification is either a reduction in interest rate, conversion to interest only payments or an extension of the maturity date.  The borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term, so a concessionary modification is granted to the borrower that would otherwise not be considered.  TDR loans accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles.


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


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


March 31, 2019 December 31, 2018June 30, 2019 December 31, 2018
Number
of
contracts
 
Recorded
investment
 
Commitments
outstanding
 
Number
of
contracts
 
Recorded
investment
 
Commitments
outstanding
Number
of
contracts
 
Recorded
investment
 
Commitments
outstanding
 
Number
of
contracts
 
Recorded
investment
 
Commitments
outstanding
  (Amounts In Thousands)   (Amounts In Thousands)  (Amounts In Thousands)   (Amounts In Thousands)
Agricultural6
 $1,512
 $12
 5
 $1,316
 $91
9
 $1,758
 $2
 5
 $1,316
 $91
Commercial and financial13
 3,646
 135
 13
 3,867
 75
16
 3,384
 95
 13
 3,867
 75
Real estate:                      
Construction, 1 to 4 family residential—
 —
 —
 —
 —
 —
—
 —
 —
 —
 —
 —
Construction, land development and commercial2
 326
 —
 2
 328
 —
2
 325
 —
 2
 328
 —
Mortgage, farmland9
 4,873
 —
 8
 4,291
 —
8
 4,103
 —
 8
 4,291
 —
Mortgage, 1 to 4 family first liens15
 1,695
 —
 16
 1,710
 —
14
 1,546
 —
 16
 1,710
 —
Mortgage, 1 to 4 family junior liens1
 24
 —
 1
 24
 —
1
 24
 —
 1
 24
 —
Mortgage, multi-family—
 —
 —
 —
 —
 —
—
 —
 —
 —
 —
 —
Mortgage, commercial9
 1,798
 —
 9
 1,839
 —
9
 1,757
 —
 9
 1,839
 —
Loans to individuals—
 —
 —
 —
 —
 —
—
 —
 —
 —
 —
 —
55
 $13,874
 $147
 54
 $13,375
 $166
59
 $12,897
 $97
 54
 $13,375
 $166


The following is a summary of TDR loans that were modified during the three and six months ended March 31,June 30, 2019:
 Three Months Ended June 30, 2019Six Months Ended June 30, 2019
 
Number
of
contracts
 
Pre-modification
recorded
investment
 
Post-modification
recorded
investment
Number
of
contracts
 
Pre-modification
recorded
investment
 
Post-modification
recorded
investment
   (Amounts In Thousands)   
Agricultural3
 $324
 $324
4
 $574
 $574
Commercial and financial3
 303
 303
3
 303
 303
Real estate: 
  
  
 
  
  
Construction, 1 to 4 family residential—
 —
 —
—
 —
 —
Construction, land development and commercial—
 —
 —
—
 —
 —
Mortgage, farmland—
 —
 —
1
 620
 620
Mortgage, 1 to 4 family first lien—
 —
 —
—
 —
 —
Mortgage, 1 to 4 family junior liens—
 —
 —
—
 —
 —
Mortgage, multi-family—
 —
 —
—
 —
 —
Mortgage, commercial—
 —
 —
—
 —
 —
 6
 $627
 $627
8
 $1,497
 $1,497
 Three Months Ended March 31, 2019
 
Number
of
contracts
 
Pre-modification
recorded
investment
 
Post-modification
recorded
investment
   (Amounts In Thousands)
Agricultural1
 $250
 $250
Commercial and financial—
 —
 —
Real estate: 
  
  
Construction, 1 to 4 family residential—
 —
 —
Construction, land development and commercial—
 —
 —
Mortgage, farmland1
 620
 620
Mortgage, 1 to 4 family first lien—
 —
 —
Mortgage, 1 to 4 family junior liens—
 —
 —
Mortgage, multi-family—
 —
 —
Mortgage, commercial—
 —
 —
 2
 $870
 $870

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


The Company had commitments to lend $0.15$0.10 million in additional borrowings to restructured loan customers as of March 31,June 30, 2019.  The Company had commitments to lend $0.17 million in additional borrowings to restructured loan customers as of December 31, 2018.  These commitments were in the normal course of business.  The additional borrowings were not used to facilitate payments on these loans.


There was onewere no TDR loanloans that waswere in payment default (defined as past due 90 days or more) totaling $0.25 million during the period ended March 31,June 30, 2019 and none for the year ended December 31, 2018.








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


Information regarding impaired loans as of and for the three and six months ended March 31,June 30, 2019 is as follows:
March 31, 2019 Three Months Ended 
 March 31, 2019		June 30, 2019 Three Months Ended 
 June 30, 2019		Six Months Ended June 30, 2019
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average Recorded
Investment
 
Interest Income
Recognized
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average Recorded
Investment
 
Interest Income
Recognized
Average Recorded
Investment
 
Interest Income
Recognized
With no related allowance recorded:(Amounts In Thousands)(Amounts In Thousands)   
Agricultural$1,359
 $1,653
 $—
 $1,377
 $9
$1,680
 $2,168
 $—
 $1,777
 $1
$1,757
 $3
Commercial and financial1,639
 2,493
 —
 1,682
 11
1,655
 2,565
 —
 1,844
 15
1,773
 29
Real estate: 
  
  
  
   
  
  
  
   
  
Construction, 1 to 4 family residential110
 148
 —
 111
 —
101
 144
 —
 111
 —
106
 —
Construction, land development and commercial722
 738
 —
 722
 4
357
 381
 —
 364
 4
363
 9
Mortgage, farmland4,189
 4,667
 —
 4,198
 39
4,170
 4,648
 —
 4,198
 39
4,189
 78
Mortgage, 1 to 4 family first liens6,068
 7,860
 —
 6,143
 9
5,820
 7,759
 —
 6,054
 8
5,982
 15
Mortgage, 1 to 4 family junior liens—
 252
 —
 —
 —
—
 250
 —
 —
 —
—
 —
Mortgage, multi-family143
 213
 —
 144
 —
105
 213
 —
 144
 —
125
 —
Mortgage, commercial2,047
 2,745
 —
 2,068
 10
1,906
 2,724
 —
 2,068
 10
1,997
 19
Loans to individuals—
 14
 —
 —
 —
—
 14
 —
 —
 —
—
 —
$16,277
 $20,783
 $—
 $16,445
 $82
$15,794
 $20,866
 $—
 $16,560
 $77
$16,292
 $153
                    
With an allowance recorded: 
  
  
  
  
 
  
  
  
  
 
  
Agricultural$1,381
 $1,552
 $258
 $1,396
 $8
$250
 $250
 $213
 $287
 $4
$269
 $7
Commercial and financial2,400
 2,429
 1,375
 2,476
 23
2,558
 2,856
 1,059
 3,125
 29
2,918
 56
Real estate:                    
Construction, 1 to 4 family residential—
 —
 —
 —
 —
—
 —
 —
 —
 —
—
 —
Construction, land development and commercial—
 —
 —
 —
 —
—
 —
 —
 —
 —
—
 —
Mortgage, farmland—
 —
 —
 —
 —
—
 —
 —
 —
 —
—
 —
Mortgage, 1 to 4 family first liens787
 794
 73
 789
 4
1,112
 1,161
 69
 1,175
 9
1,143
 16
Mortgage, 1 to 4 family junior liens24
 24
 1
 24
 —
24
 24
 1
 24
 —
24
 1
Mortgage, multi-family1,402
 1,402
 282
 1,408
 17
—
 —
 —
 —
 —
—
 —
Mortgage, commercial741
 741
 201
 744
 8
73
 73
 1
 74
 1
74
 2
Loans to individuals59
 59
 59
 56
 2
40
 40
 40
 56
 2
47
 3
$6,794
 $7,001
 $2,249
 $6,893
 $62
$4,057
 $4,404
 $1,383
 $4,741
 $45
$4,475
 $85
                    
Total: 
  
  
  
  
 
  
  
  
  
 
  
Agricultural$2,740
 $3,205
 $258
 $2,773
 $17
$1,930
 $2,418
 $213
 $2,064
 $5
$2,026
 $10
Commercial and financial4,039
 4,922
 1,375
 4,158
 34
4,213
 5,421
 1,059
 4,969
 44
4,691
 85
Real estate: 
  
  
  
  
 
  
  
  
  
 
  
Construction, 1 to 4 family residential110
 148
 —
 111
 —
101
 144
 —
 111
 —
106
 —
Construction, land development and commercial722
 738
 —
 722
 4
357
 381
 —
 364
 4
363
 9
Mortgage, farmland4,189
 4,667
 —
 4,198
 39
4,170
 4,648
 —
 4,198
 39
4,189
 78
Mortgage, 1 to 4 family first liens6,855
 8,654
 73
 6,932
 13
6,932
 8,920
 69
 7,229
 17
7,125
 31
Mortgage, 1 to 4 family junior liens24
 276
 1
 24
 —
24
 274
 1
 24
 —
24
 1
Mortgage, multi-family1,545
 1,615
 282
 1,552
 17
105
 213
 —
 144
 —
125
 —
Mortgage, commercial2,788
 3,486
 201
 2,812
 18
1,979
 2,797
 1
 2,142
 11
2,071
 21
Loans to individuals59
 73
 59
 56
 2
40
 54
 40
 56
 2
47
 3
$23,071
 $27,784
 $2,249
 $23,338
 $144
$19,851
 $25,270
 $1,383
 $21,301
 $122
$20,767
 $238
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


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


 
Recorded
Investment
 
Unpaid Principal
Balance
 
Related
Allowance
With no related allowance recorded:(Amounts In Thousands)
Agricultural$1,395
 $1,663
 $—
Commercial and financial1,650
 2,503
 —
Real estate: 
  
  
Construction, 1 to 4 family residential111
 148
 —
Construction, land development and commercial328
 344
 —
Mortgage, farmland3,612
 4,071
 —
Mortgage, 1 to 4 family first liens6,089
 7,819
 —
Mortgage, 1 to 4 family junior liens—
 254
 —
Mortgage, multi-family145
 213
 —
Mortgage, commercial1,871
 2,486
 —
Loans to individuals—
 14
 —
 $15,201
 $19,515
 $—
      
With an allowance recorded: 
  
  
Agricultural$1,065
 $1,229
 $479
Commercial and financial2,512
 2,512
 1,189
Real estate: 
  
  
Construction, 1 to 4 family residential698
 698
 4
Construction, land development and commercial—
 —
 —
Mortgage, farmland—
 —
 —
Mortgage, 1 to 4 family first liens899
 974
 70
Mortgage, 1 to 4 family junior liens24
 24
 2
Mortgage, multi-family7,447
 7,447
 305
Mortgage, commercial75
 75
 1
Loans to individuals64
 64
 64
 $12,784
 $13,023
 $2,114
      
Total: 
  
  
Agricultural$2,460
 $2,892
 $479
Commercial and financial4,162
 5,015
 1,189
Real estate: 
  
  
Construction, 1 to 4 family residential809
 846
 4
Construction, land development and commercial328
 344
 —
Mortgage, farmland3,612
 4,071
 —
Mortgage, 1 to 4 family first liens6,988
 8,793
 70
Mortgage, 1 to 4 family junior liens24
 278
 2
Mortgage, multi-family7,592
 7,660
 305
Mortgage, commercial1,946
 2,561
 1
Loans to individuals64
 78
 64
 $27,985
 $32,538
 $2,114

 
Recorded
Investment
 
Unpaid Principal
Balance
 
Related
Allowance
With no related allowance recorded:(Amounts In Thousands)
Agricultural$1,395
 $1,663
 $—
Commercial and financial1,650
 2,503
 —
Real estate: 
  
  
Construction, 1 to 4 family residential111
 148
 —
Construction, land development and commercial328
 344
 —
Mortgage, farmland3,612
 4,071
 —
Mortgage, 1 to 4 family first liens6,089
 7,819
 —
Mortgage, 1 to 4 family junior liens—
 254
 —
Mortgage, multi-family145
 213
 —
Mortgage, commercial1,871
 2,486
 —
Loans to individuals—
 14
 —
 $15,201
 $19,515
 $—
      
With an allowance recorded: 
  
  
Agricultural$1,065
 $1,229
 $479
Commercial and financial2,512
 2,512
 1,189
Real estate: 
  
  
Construction, 1 to 4 family residential698
 698
 4
Construction, land development and commercial—
 —
 —
Mortgage, farmland—
 —
 —
Mortgage, 1 to 4 family first liens899
 974
 70
Mortgage, 1 to 4 family junior liens24
 24
 2
Mortgage, multi-family7,447
 7,447
 305
Mortgage, commercial75
 75
 1
Loans to individuals64
 64
 64
 $12,784
 $13,023
 $2,114
      
Total: 
  
  
Agricultural$2,460
 $2,892
 $479
Commercial and financial4,162
 5,015
 1,189
Real estate: 
  
  
Construction, 1 to 4 family residential809
 846
 4
Construction, land development and commercial328
 344
 —
Mortgage, farmland3,612
 4,071
 —
Mortgage, 1 to 4 family first liens6,988
 8,793
 70
Mortgage, 1 to 4 family junior liens24
 278
 2
Mortgage, multi-family7,592
 7,660
 305
Mortgage, commercial1,946
 2,561
 1
Loans to individuals64
 78
 64
 $27,985
 $32,538
 $2,114


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


Impaired loans decreased $4.91$8.13 million from December 31, 2018 to March 31,June 30, 2019.  Impaired loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and TDR loans.  Impaired loans also include loans that, based on management’s evaluation of current information and events, the Company expects to be unable to collect in full according to the contractual terms of the original loan agreement.  Impaired loans were 0.87%0.75% of loans held for investment as of March 31,June 30, 2019 and 1.06% as of December 31, 2018.  The decrease in impaired loans is due mainly to a decrease of $5.99$8.17 million in relationshipsloans with a specific allowance for losses, a decrease in TDR loans of $0.34 million, a decrease in nonaccrual loans of $0.04 million, and is offset by a $0.21$0.44 million increase in 90 days or more accruing loans an increase in TDR loans of $0.50 million, and an increase in nonaccrual loans of $0.94 million from December 31, 2018 to March 31,June 30, 2019.


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


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


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


Note 6.Leases


The Bank leases branch offices, parking facilities and certain equipment under operating leases. The leases have remaining lease terms of 1 year to 16 years, some of which include options to extend the leases for up to 10 years, and some of which include options to terminate the leases within 1 year. As the options are reasonably certain to be exercised, they are recognized as part of the right-of-use assets and lease liabilities.


For the threesix months ended March 31,June 30, 2019, total operating lease expense was $0.17$0.32 million included in occupancy expenses in the consolidated statement of income. Included in this were $0.14$0.27 million of operating lease costs, $0.01$0.02 million of short term lease costs, and $0.02$0.03 million of variable lease costs.
For the threesix months ended March 31,June 30, 2019, cash paid for amounts included in the measurement of operating lease liabilities was $0.14$0.27 million and right-of-use assets obtained in exchange for lease obligations was $3.58 million.





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





As of March 31,June 30, 2019, operating lease right-of-use assets included in other assets and liabilities was $3.58$3.40 million. The weighted average remaining lease term for operating leases was 11.2011.14 years and the weighted average discount rate for operating leases was 3.43%3.44%. Discount rates used were determined from FHLB borrowing rates for comparable terms.
As of March 31,June 30, 2019, maturities of lease liabilities were as follows:
Year ending December 31:(Amounts In Thousands)
2019$234
2020470
2021456
2022447
2023301
Thereafter2,259
Total lease payments4,167
Less imputed interest(763)
Total operating lease liabilities$3,404

Year ending December 31:(Amounts In Thousands)
2019$467
2020470
2021456
2022447
2023301
Thereafter2,259
Total lease payments4,400
Less imputed interest(819)
Total operating lease liabilities$3,581











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 March 31,June 30, 2019 are as follows:
March 31, 2019June 30, 2019
Carrying
Amount
 
Estimated Fair
Value
 
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
Carrying
Amount
 
Estimated Fair
Value
 
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
(Amounts In Thousands)(Amounts In Thousands)
Financial instrument assets:                  
Cash and cash equivalents$200,476
 $200,476
 $200,476
 $—
 $—
$249,924
 $249,924
 $249,924
 $—
 $—
Investment securities336,183
 336,183
 91,573
 244,610
 —
320,318
 320,318
 100,503
 219,815
 —
Loans held for sale5,267
 5,267
 —
 5,267
 —
12,627
 12,627
 —
 12,627
 —
Loans 
  
  
  
  
 
  
  
  
  
Agricultural91,032
 93,028
 —
 —
 93,028
88,680
 93,256
 —
 —
 93,256
Commercial and financial221,399
 225,946
 —
 —
 225,946
220,387
 226,699
 —
 —
 226,699
Real estate: 
 

  
  
  
 
 

  
  
  
Construction, 1 to 4 family residential72,589
 73,965
 —
 —
 73,965
71,764
 74,396
 —
 —
 74,396
Construction, land development and commercial103,817
 105,134
 —
 —
 105,134
98,330
 100,844
 —
 —
 100,844
Mortgage, farmland234,238
 235,465
 —
 —
 235,465
234,888
 240,817
 —
 —
 240,817
Mortgage, 1 to 4 family first liens907,397
 888,705
 —
 —
 888,705
907,736
 896,566
 —
 —
 896,566
Mortgage, 1 to 4 family junior liens150,507
 148,210
 —
 —
 148,210
150,954
 150,275
 —
 —
 150,275
Mortgage, multi-family347,138
 344,083
 —
 —
 344,083
346,891
 347,492
 —
 —
 347,492
Mortgage, commercial397,802
 395,694
 —
 —
 395,694
401,784
 404,621
 —
 —
 404,621
Loans to individuals28,921
 30,424
 —
 —
 30,424
30,113
 32,051
 —
 —
 32,051
Obligations of state and political subdivisions52,648
 52,338
 —
 —
 52,338
52,388
 53,019
 —
 —
 53,019
Accrued interest receivable13,970
 13,970
 —
 13,970
 —
13,117
 13,117
 —
 13,117
 —
Total financial instrument assets$3,163,384
 $3,148,888
 $292,049
 $263,847
 $2,592,992
$3,199,901
 $3,216,022
 $350,427
 $245,559
 $2,620,036
Financial instrument liabilities 
  
  
  
  
 
  
  
  
  
Deposits 
  
  
  
  
 
  
  
  
  
Noninterest-bearing deposits$363,142
 $363,142
 $—
 $363,142
 $—
$371,408
 $371,408
 $—
 $371,408
 $—
Interest-bearing deposits2,233,750
 2,243,433
 —
 2,243,433
 —
2,247,793
 2,256,567
 —
 2,256,567
 —
Other borrowings—
 —
 —
 —
 —
Federal Home Loan Bank borrowings215,000
 208,188
 —
 208,188
 —
215,000
 208,433
 —
 208,433
 —
Interest rate swaps1,894
 1,894
 —
 1,894
 —
2,574
 2,574
 —
 2,574
 —
Accrued interest payable2,051
 2,051
 —
 2,051
 —
2,293
 2,293
 —
 2,293
 —
Total financial instrument liabilities$2,815,837
 $2,818,708
 $—
 $2,818,708
 $—
$2,839,068
 $2,841,275
 $—
 $2,841,275
 $—
                  
Face Amount  
  
  
  
Face Amount  
  
  
  
Financial instrument with off-balance sheet risk: 
  
  
  
  
 
  
  
  
  
Loan commitments$393,424
 $—
 $—
 $—
 $—
$428,828
 $—
 $—
 $—
 $—
Letters of credit8,918
 —
 —
 —
 —
7,856
 —
 —
 —
 —
Total financial instrument liabilities with off-balance-sheet risk$402,342
 $—
 $—
 $—
 $—
$436,684
 $—
 $—
 $—
 $—
(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.
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, 2018 are as follows:

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


December 31, 2018December 31, 2018
Carrying
Amount
 
Estimated Fair
Value
 
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
Carrying
Amount
 
Estimated Fair
Value
 
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
(Amounts In Thousands)(Amounts In Thousands)
Financial instrument assets:                  
Cash and cash equivalents$43,305
 $43,305
 $43,305
 $—
 $—
$43,305
 $43,305
 $43,305
 $—
 $—
Investment securities331,098
 331,098
 83,155
 247,943
 —
331,098
 331,098
 83,155
 247,943
 —
Loans held for sale1,984
 1,984
 —
 1,984
 —
1,984
 1,984
 —
 1,984
 —
Loans 
  
  
  
  
 
  
  
  
  
Agricultural89,884
 93,736
 —
 —
 93,736
89,884
 93,736
 —
 —
 93,736
Commercial and financial223,675
 227,774
 —
 —
 227,774
223,675
 227,774
 —
 —
 227,774
Real estate: 
  
  
  
  
 
  
  
  
  
Construction, 1 to 4 family residential70,982
 72,419
 —
 —
 72,419
70,982
 72,419
 —
 —
 72,419
Construction, land development and commercial111,812
 112,960
 —
 —
 112,960
111,812
 112,960
 —
 —
 112,960
Mortgage, farmland232,482
 235,771
 —
 —
 235,771
232,482
 235,771
 —
 —
 235,771
Mortgage, 1 to 4 family first liens902,261
 882,908
 —
 —
 882,908
902,261
 882,908
 —
 —
 882,908
Mortgage, 1 to 4 family junior liens150,859
 148,128
 —
 —
 148,128
150,859
 148,128
 —
 —
 148,128
Mortgage, multi-family348,351
 342,099
 —
 —
 342,099
348,351
 342,099
 —
 —
 342,099
Mortgage, commercial379,232
 376,257
 —
 —
 376,257
379,232
 376,257
 —
 —
 376,257
Loans to individuals29,349
 29,962
 —
 —
 29,962
29,349
 29,962
 —
 —
 29,962
Obligations of state and political subdivisions52,198
 51,945
 —
 —
 51,945
52,198
 51,945
 —
 —
 51,945
Accrued interest receivable11,784
 11,784
 —
 11,784
 —
11,784
 11,784
 —
 11,784
 —
Total financial instrument assets$2,979,256
 $2,962,130
 $126,460
 $261,711
 $2,573,959
$2,979,256
 $2,962,130
 $126,460
 $261,711
 $2,573,959
Financial instrument liabilities: 
  
  
  
  
 
  
  
  
  
Deposits 
  
  
  
  
 
  
  
  
  
Noninterest-bearing deposits$372,152
 $372,152
 $—
 $372,152
 $—
$372,152
 $372,152
 $—
 $372,152
 $—
Interest-bearing deposits2,048,972
 2,059,336
 —
 2,059,336
 —
2,048,972
 2,059,336
 —
 2,059,336
 —
Other borrowings—
 —
 —
 —
 —
Federal Home Loan Bank borrowings215,000
 207,948
 —
 207,948
 —
215,000
 207,948
 —
 207,948
 —
Interest rate swaps1,596
 1,596
   1,596
  1,596
 1,596
   1,596
  
Accrued interest payable1,812
 1,812
 —
 1,812
 —
1,812
 1,812
 —
 1,812
 —
Total financial instrument liabilities$2,639,532
 $2,642,844
 $—
 $2,642,844
 $—
$2,639,532
 $2,642,844
 $—
 $2,642,844
 $—
                  
Face Amount  
  
  
  
Face Amount  
  
  
  
Financial instrument with off-balance sheet risk: 
  
  
  
  
 
  
  
  
  
Loan commitments$375,940
 $—
 $—
 $—
 $—
$375,940
 $—
 $—
 $—
 $—
Letters of credit9,033
 —
 —
 —
 —
9,033
 —
 —
 —
 —
Total financial instrument liabilities with off-balance-sheet risk$384,973
 $—
 $—
 $—
 $—
$384,973
 $—
 $—
 $—
 $—
 
(1)Considered Level 1 under ASC 820.
(2)Considered Level 2 under ASC 820.
(3)Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Fair value of financial instruments:  FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) provides a single definition for fair value, a framework for measuring fair value and expanded disclosures concerning fair value.  Fair value is
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.


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


 Level 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 threesix months ended March 31,June 30, 2019.   If a fluctuation requiring investigation was identified, the Company would research the change with the independent source or other available information.


Loans held for sale and Loans:  ASU 2016-1, Financial Instruments -Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. This update is effective for financial statement periods beginning after December 15, 2017. Therefore, the fair value presented herein may not be comparable to prior periods. Methodologies utilized for this financial statement period are as follows:


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


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


Fair value has been estimated in accordance with ASC 820, Fair Value Measurements and Disclosures, and is intended to represent the price that would be received in an orderly transaction between market participants as of the measurement date. In general, fair
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

value is based upon quoted market prices, where available. If such quoted market prices are not available, at least one significant assumption not observable in the market was utilized. These unobservable assumptions reflect estimates that market participants would use in pricing the asset or liability. Inputs to these valuation techniques are subjective in nature, involve uncertainties and
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

require significant judgment and therefore cannot be determined with precision. Accordingly, the fair value estimates presented are not necessarily indicative of the amounts to be realized in a current market exchange. Loans are classified as Level 3.
Loans held for sale are carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the short time between origination of the loan and its sale on the secondary market (Level 2). The market is active for these loans and as a result prices for similar assets are available.
Impaired loans: A loan is considered to be impaired when it is probable that all of the principal and interest due may not be collected according to its contractual terms. Generally, when a loan is considered impaired, the amount of reserve required under ASC 310, Receivables, is measured based on the fair value of the underlying collateral. The Company makes such measurements on all material loans deemed impaired using the fair value of the collateral for collateral dependent loans.loans or based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or the fair value of the loan if determinable. The fair value of collateral used by the Company is determined by obtaining an observable market price or by obtaining an appraised value from an independent, licensed or certified appraiser, using observable market data. This data includes information such as selling price of similar properties and capitalization rates of similar properties sold within the market, expected future cash flows or earnings of the subject property based on current market expectations, and other relevant factors. All appraised values are adjusted for market-related trends based on the Company's experience in sales and other appraisals of similar property types as well as estimated selling costs. Each quarter management reviews all collateral dependent impaired loans on a loan-by-loan basis to determine whether updated appraisals are necessary based on loan performance, collateral type and guarantor support. At times, the Company measures the fair value of collateral dependent impaired loans using appraisals with dates prior to one year from the date of review. These appraisals are discounted by applying current, observable market data about similar property types such as sales contracts, estimations of value by individuals familiar with the market, other appraisals, sales or collateral assessments based on current market activity until updated appraisals are obtained. Depending on the length of time since an appraisal was performed, the data provided through reviews and estimated selling costs, collateral values are typically discounted by 0-35%. These loans are considered Level 3 as the instruments used to determine fair market value require significant management judgment and estimation.
Foreclosed assets:  The Company does not record foreclosed assets at fair value on a recurring basis.  Foreclosed assets consist mainly of other real estate owned but may include other types of assets repossessed by the Company.  Foreclosed assets are adjusted to the lower of carrying value or fair value less the cost of disposal.   Fair value is generally based upon independent market prices or appraised values of the collateral, and may include a marketability discount as deemed necessary by management based on its experience with similar types of real estate.  The value of foreclosed assets is evaluated periodically as a nonrecurring fair value adjustment.  Foreclosed assets are classified as Level 3.


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


LIABILITIES


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






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


Assets and Liabilities Recorded at Fair Value on a Recurring Basis


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


March 31, 2019June 30, 2019
Readily
Available
Market
Prices(1)
 
Observable
Market Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at Fair
Value
Readily
Available
Market
Prices(1)
 
Observable
Market Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at Fair
Value
Securities available for sale(Amounts In Thousands)(Amounts In Thousands)
U.S. Treasury$91,573
 $—
 $—
 $91,573
$100,503
 $—
 $—
 $100,503
State and political subdivisions—
 204,813
 —
 204,813
—
 182,374
 —
 182,374
Other securities (FHLB, FHLMC and FNMA)—
 27,531
 —
 27,531
—
 25,175
 —
 25,175
Derivative Financial Instruments              
Interest rate swaps$—
 (1,894) $—
 (1,894)$—
 (2,574) $—
 (2,574)
Total$91,573
 $230,450
 $—
 $322,023
$100,503
 $204,975
 $—
 $305,478


 December 31, 2018
 
Readily
Available
Market
Prices(1)
 
Observable
Market Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at Fair
Value
Securities available for sale(Amounts In Thousands)
U.S. Treasury$83,155
 $—
 $—
 $83,155
State and political subdivisions—
 200,900
 —
 200,900
Other securities (FHLB, FHLMC and FNMA)—
 34,871
 —
 34,871
Derivative Financial Instruments       
Interest rate swaps—
 (1,596) —
 (1,596)
Total$83,155
 $234,175
 $—
 $317,330
 
(1)Considered Level 1 under ASC 820.
(2)Considered Level 2 under ASC 820.
(3)Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.


There were no transfers between Levels 1, 2 or 3 during the threesix months ended March 31,June 30, 2019 and the year ended December 31, 2018.




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


Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis


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


March 31, 2019 Three Months Ended March 31, 2019June 30, 2019 Three Months Ended June 30, 2019Six Months Ended June 30, 2019
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at
Fair
Value
 Total Losses
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at
Fair
Value
 Total Losses
(Amounts in Thousands)  (Amounts in Thousands)  
Loans (4)                  
Agricultural$—
 $—
 $2,090
 $2,090
 $—
$—
 $—
 $1,356
 $1,356
 $—
$—
Commercial and financial—
 —
 2,566
 2,566
 50
—
 —
 2,639
 2,639
 200
250
Real Estate:        —
         —
Construction, 1 to 4 family residential—
 —
 —
 —
 —
—
 —
 —
 —
 —
—
Construction, land development and commercial—
 —
 612
 612
 8
—
 —
 249
 249
 —
8
Mortgage, farmland—
 —
 3,674
 3,674
 —
—
 —
 3,665
 3,665
 —
—
Mortgage, 1 to 4 family first liens—
 —
 6,746
 6,746
 90
—
 —
 6,485
 6,485
 29
119
Mortgage, 1 to 4 family junior liens—
 —
 23
 23
 —
—
 —
 23
 23
 —
—
Mortgage, multi-family—
 —
 1,120
 1,120
 —
—
 —
 105
 105
 —
—
Mortgage, commercial—
 —
 2,108
 2,108
 —
—
 —
 1,506
 1,506
 97
97
Loans to individuals—
 —
 —
 —
 —
—
 —
 —
 —
 —
—
Foreclosed assets (5)—
 —
 —
 —
 —
—
 —
 —
 —
 —
—
Total$—
 $—
 $18,939
 $18,939
 $148
$—
 $—
 $16,028
 $16,028
 $326
$474
 
(1)Considered Level 1 under ASC 820.
(2)Considered Level 2 under ASC 820.
(3)Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.
(4)Represents carrying value and related write-downs of loans for which adjustments are based on the value of the collateral. The carrying value of loans fully-charged off is zero.
(5)Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.


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


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


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


(1)Considered Level 1 under ASC 820.
(2)Considered Level 2 under ASC 820.
(3)Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.
(4)Represents carrying value and related write-downs of loans for which adjustments are based on the value of the collateral. The carrying value of loans fully-charged off is zero.
(5)Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.




Note 8.Stock Repurchase Program


On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of 1,500,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  The Company’s Board of Directors has authorized the 2005 Stock Repurchase Program through December 31, 2020.  The Company expects the purchases pursuant to the 2005 Stock Repurchase Program to be made from time to time in private transactions at a price equal to the most recent quarterly independent appraisal of the shares of the Company’s common stock and with the Board reviewing the overall results of the 2005 Stock Repurchase Program on a quarterly basis.  All purchases made pursuant to the 2005 Stock Repurchase Program since its inception have been made on that basis.  The amount and timing of stock repurchases will be based on various factors, such as the Board’s assessment of the Company’s capital structure and liquidity, the amount of interest shown by shareholders in selling shares of stock to the Company at their appraised value, and applicable regulatory, legal and accounting factors.  The Company has purchased 1,196,6501,202,276 shares of its common stock in privately negotiated transactions from August 1, 2005 through March 31,June 30, 2019.  Of these 1,196,6501,202,276 shares, 69,7715,626 shares were purchased during the quarter ended March 31,June 30, 2019, at an average price per share of $61.50.$63.33.
Index
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)


Note 9.Commitments and Contingencies


Concentrations of credit risk:  The Bank’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Bank's market area.  Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $98.32$75.15 million.  The concentrations of credit by type of loan are set forth in Note 5 to the Consolidated Financial Statements.  Outstanding letters of credit were granted primarily to commercial borrowers.  Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson, Linn and Washington Counties, Iowa.


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


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


The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  A summary of the Bank’s commitments at March 31,June 30, 2019 and December 31, 2018 is as follows:
 
 June 30, 2019 December 31, 2018
 (Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:   
Home equity loans$67,035
 $59,330
Credit cards55,331
 52,802
Commercial, real estate and home construction108,663
 89,171
Commercial lines and real estate purchase loans197,799
 174,637
Outstanding letters of credit7,856
 9,033
 March 31, 2019 December 31, 2018
 (Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:   
Home equity loans$60,782
 $59,330
Credit cards54,165
 52,802
Commercial, real estate and home construction100,245
 89,171
Commercial lines and real estate purchase loans178,232
 174,637
Outstanding letters of credit8,918
 9,033

 
Note 10.Income Taxes


Federal income tax expense for the threesix months ended March 31,June 30, 2019 and 2018 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, 2018, 2017, and 2016 remain subject to examination by the Internal Revenue Service.  For state tax purposes, the tax years ended December 31, 2018, 2017, and 2016 remain open for examination.  There were no material unrecognized tax benefits at March 31,June 30, 2019  and December 31, 2018 and therefore no interest or penalties on unrecognized tax benefits has been recorded.  As of March 31,June 30, 2019, the Company does not anticipate any significant increase in unrecognized tax benefits during the twelve-month period ending March 31,June 30, 2020. Income taxes as a percentage of income before taxes were 21.22%21.70% for the threesix months ended March 31,June 30, 2019 and 19.15%19.83% for the same period in 2018. 


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




Note 11.Derivative Financial Instruments


In the normal course of business, the Bank may use derivative financial instruments to manage its interest rate risk.  These instruments carry varying degrees of credit, interest rate and market or liquidity risks.  Derivative instruments are recognized as either assets or liabilities in the accompanying financial statement and are measured at fair value.  The Bank’s objectives are to add stability to its net interest margin and to manage its exposure to movements in interest rates.  The contract or notional amount of a derivative is used to determine, along with the other terms of the derivative, the amount to be exchanged between the counterparties.  The Bank is exposed to credit risk in the event of nonperformance by counterparties to financial instruments.  The Bank minimizes this risk by entering into derivative contracts with large, stable financial institutions.  The Bank has not experienced any losses from nonperformance by counterparties.  The Bank monitors counterparty risk in accordance with the provisions of ASC 815.  In addition, the Bank’s interest rate-related derivative instruments contain language outlining collateral pledging requirements for each counterparty.  Collateral must be posted when the market value exceeds certain threshold limits which are determined by credit ratings of each counterparty.  The Bank was required to pledge $1.89$2.57 million of collateral as of March 31,June 30, 2019.


Cash Flow Hedges:


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


The table below identifies the balance sheet category and fair values of the Bank’s derivative instruments designated as cash flow hedges as of March 31,June 30, 2019 and December 31, 2018:


 
Notional
Amount
 
Fair
Value
 
Balance
Sheet
Category
 Maturity
 (Amounts in Thousands)  
June 30, 2019          
Interest rate swap$25,000
 $(343) Other Liabilities 11/9/2020
Interest rate swap25,000
 (2,231) Other Liabilities 11/7/2023
        
December 31, 2018 
  
       
Interest rate swap$25,000
 $(120) Other Liabilities 11/9/2020
Interest rate swap25,000
 (1,476) Other Liabilities 11/7/2023

 
Notional
Amount
 
Fair
Value
 
Balance
Sheet
Category
 Maturity
 (Amounts in Thousands)  
March 31, 2019          
Interest rate swap$25,000
 $(182) Other Liabilities 11/9/2020
Interest rate swap25,000
 (1,712) Other Liabilities 11/7/2023
        
December 31, 2018 
  
       
Interest rate swap$25,000
 $(120) Other Liabilities 11/9/2020
Interest rate swap25,000
 (1,476) Other Liabilities 11/7/2023




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


The table below identifies the gains and losses recognized on the Bank’s derivative instruments designated as cash flow hedges for the threesix months ended March 31,June 30, 2019 and year ended December 31, 2018:


    
 
Recognized
in OCI
 
Reclassified from AOCI into
Income
 
Recognized in Income on
Derivatives
 
Amount of
Gain (Loss)
 Category 
Amount
of Gain
(Loss)
 Category 
Amount
of Gain
(Loss)
 (Amounts in Thousands)
June 30, 2019         
Interest rate swap$(168) Interest Expense $—
 Other Income $—
Interest rate swap(566) Interest Expense —
 Other Income —
          
December 31, 2018 
    
    
Interest rate swap$347
 Interest Expense $—
 Other Income $—
Interest rate swap571
 Interest Expense —
 Other Income —

    
 
Recognized
in OCI
 
Reclassified from AOCI into
Income
 
Recognized in Income on
Derivatives
 
Amount of
Gain (Loss)
 Category 
Amount
of Gain
(Loss)
 Category 
Amount
of Gain
(Loss)
 (Amounts in Thousands)
March 31, 2019         
Interest rate swap$(46) Interest Expense $—
 Other Income $—
Interest rate swap(177) Interest Expense —
 Other Income —
          
December 31, 2018 
    
    
Interest rate swap$347
 Interest Expense $—
 Other Income $—
Interest rate swap571
 Interest Expense —
 Other Income —


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


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


Special Note Regarding Forward Looking Statements


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


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


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


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


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


Index


HILLS BANCORPORATION


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


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


Index


HILLS BANCORPORATION


Critical Accounting Policies


The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these financial statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policies to be those which are related to the allowance for loan losses. The Company's allowance for loan losses methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan losses that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in impaired loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include the general economic environment in the Company's markets, including
economic conditions throughout the Midwest and the state of certain industries.  Determinations relating to the possible level of future loan losses are based in part on subjective judgments by management.  Future loan losses in excess of current estimates, could materially adversely affect our results of operations or financial position.  Size and complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. As the Company adds new products and increases the complexity of its loan portfolio, it will enhance its methodology accordingly. This discussion of the Company’s critical accounting policies should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes presented elsewhere herein, as well as other relevant portions of Management’s Discussion and Analysis of Financial Condition and Results of Operations.  Although management believes the levels of the allowance as of March 31,June 30, 2019 and December 31, 2018 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.


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 March 31,June 30, 2019, the Bank has nineteen full-service locations.


Net income for the threesix month period ended March 31,June 30, 2019 was $11.20$22.42 million compared to $10.86$20.92 million for the same threesix months of 2018, an increase of 3.18%7.18%.  The $0.34$1.50 million increase in net income was caused by a number of factors.  The principal factors in the increase in net income for the first threesix months of 2019 are an increase in net interest income of $1.48$3.05 million and a decrease in the provision for loan losses of $0.48$1.73 million. These changes were offset by a decrease in noninterest income of $0.38$0.76 million, an increase in income tax expense of $0.45$1.04 million and an increase in noninterest expenses of $0.79$1.47 million.


The Company achieved a return on average assets of 1.23%1.24% and a return on average equity of 11.36%11.48% for the twelve months ended March 31,June 30, 2019, compared to the twelve months ended March 31,June 30, 2018, which were 1.07%1.17% and 9.82%10.82%, respectively.  Dividends of $0.82 per share were paid in January 2019 to 2,481 shareholders.  The 2018 dividend was $0.75 per share.


The Company’s net interest income is the largest component of revenue and it is primarily a function of the average earning assets and the net interest margin percentage.  The Company achieved a net interest margin on a tax-equivalent basis of 3.27%3.23% for the threesix months ended March 31,June 30, 2019 compared to 3.25%3.26% for the same threesix months of 2018.  Average earning assets were $3.013$3.065 billion year to date in 2019 and $2.875$2.879 billion in 2018.


Index


HILLS BANCORPORATION


Highlights noted on the balance sheet as of March 31,June 30, 2019 for the Company included the following:


Total assets were $3.228$3.264 billion, an increase of $185.40$221.09 million since December 31, 2018.
Cash and cash equivalents were $200.48$249.92 million, an increase of $157.17$206.62 million since December 31, 2018. Cash and cash equivalents growth included approximately $84.00$85 million of temporary public funds.certificates of deposit and approximately $42 million of brokered deposits.
Net loans were $2.613$2.617 billion, an increase of $19.69$23.47 million since December 31, 2018.  Loans held for sale increased $3.28$10.64 million since December 31, 2018.
Deposits increased $175.77$198.08 million since December 31, 2018. Deposit growth included approximately $84.00 million in temporary public funds.


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


Financial Condition


Loan demand is expected to remain steady throughout the year ending December 31, 2019 and into 2020.  As indicated in the table below, growth is primarily in farmland, mortgage 1 to 4 family first liens and commercial real estate loans. 


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


March 31, 2019 December 31, 2018June 30, 2019 December 31, 2018
Amount Percent Amount PercentAmount Percent Amount Percent
(Amounts In Thousands) (Amounts In Thousands)(Amounts In Thousands) (Amounts In Thousands)
Agricultural$93,573
 3.54% $92,673
 3.53%$91,215
 3.46% $92,673
 3.53%
Commercial and financial227,403
 8.60
 229,501
 8.73
225,990
 8.56
 229,501
 8.73
Real estate: 
    
   
    
  
Construction, 1 to 4 family residential73,868
 2.79
 72,279
 2.75
72,963
 2.77
 72,279
 2.75
Construction, land development and commercial105,466
 3.99
 113,807
 4.33
99,777
 3.78
 113,807
 4.33
Mortgage, farmland238,109
 9.01
 236,454
 9.00
238,779
 9.05
 236,454
 9.00
Mortgage, 1 to 4 family first liens916,408
 34.67
 912,059
 34.71
916,502
 34.73
 912,059
 34.71
Mortgage, 1 to 4 family junior liens152,183
 5.76
 152,625
 5.81
152,624
 5.78
 152,625
 5.81
Mortgage, multi-family351,090
 13.28
 352,434
 13.41
350,745
 13.29
 352,434
 13.41
Mortgage, commercial402,073
 15.21
 383,314
 14.58
406,124
 15.39
 383,314
 14.58
Loans to individuals29,739
 1.13
 30,072
 1.14
30,981
 1.18
 30,072
 1.14
Obligations of state and political subdivisions53,153
 2.01
 52,725
 2.01
52,917
 2.01
 52,725
 2.01
$2,643,065
 100.00% $2,627,943
 100.00%$2,638,617
 100.00% $2,627,943
 100.00%
Net unamortized fees and costs943
  
 952
  
948
  
 952
  
$2,644,008
  
 $2,628,895
  
$2,639,565
  
 $2,628,895
  
Less allowance for loan losses36,520
  
 37,810
  
35,650
  
 37,810
  
$2,607,488
  
 $2,591,085
  
$2,603,915
  
 $2,591,085
  


Index


HILLS BANCORPORATION




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


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


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


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


Index


HILLS BANCORPORATION


The following table presents the allowance for loan losses on loans by loan category, the percentage of the allowance for each category to the total allowance, and the percentage of all loans in each category to total loans as of March 31,June 30, 2019 and December 31, 2018:
 
March 31, 2019 December 31, 2018June 30, 2019 December 31, 2018
Amount 
% of Total
Allowance
 
% of Loans to
Total Loans
 Amount 
% of Total
Allowance
 
% of Loans to
Total Loans
Amount 
% of Total
Allowance
 
% of Loans to
Total Loans
 Amount 
% of Total
Allowance
 
% of Loans to
Total Loans
(In Thousands)     (In Thousands)    (In Thousands)     (In Thousands)    
Agricultural$2,541
 6.96% 3.54% $2,789
 7.38% 3.53%$2,535
 7.11% 3.46% $2,789
 7.38% 3.53%
Commercial and financial6,004
 16.44
 8.60
 5,826
 15.41
 8.73
5,603
 15.72
 8.56
 5,826
 15.41
 8.73
Real estate: 
      
  
   
      
  
  
Construction, 1 to 4 family residential1,279
 3.50
 2.79
 1,297
 3.43
 2.75
1,199
 3.36
 2.77
 1,297
 3.43
 2.75
Construction, land development and commercial1,649
 4.52
 3.99
 1,995
 5.28
 4.33
1,447
 4.06
 3.78
 1,995
 5.28
 4.33
Mortgage, farmland3,871
 10.60
 9.01
 3,972
 10.51
 9.00
3,891
 10.91
 9.05
 3,972
 10.51
 9.00
Mortgage, 1 to 4 family first liens9,954
 27.26
 34.67
 10,750
 28.43
 34.71
9,714
 27.25
 34.73
 10,750
 28.43
 34.71
Mortgage, 1 to 4 family junior liens1,676
 4.59
 5.76
 1,766
 4.67
 5.81
1,670
 4.68
 5.78
 1,766
 4.67
 5.81
Mortgage, multi-family3,952
 10.82
 13.28
 4,083
 10.80
 13.41
3,854
 10.81
 13.29
 4,083
 10.80
 13.41
Mortgage, commercial4,271
 11.69
 15.21
 4,082
 10.80
 14.58
4,340
 12.17
 15.39
 4,082
 10.80
 14.58
Loans to individuals818
 2.24
 1.13
 723
 1.91
 1.14
868
 2.43
 1.18
 723
 1.91
 1.14
Obligations of state and political subdivisions505
 1.38
 2.01
 527
 1.38
 2.01
529
 1.50
 2.01
 527
 1.38
 2.01
$36,520
 100.00% 100.00% $37,810
 100.00% 100.00%$35,650
 100.00% 100.00% $37,810
 100.00% 100.00%


The allowance for loan losses totaled $36.52$35.65 million at March 31,June 30, 2019 compared to $37.81 million at December 31, 2018.  The percentage of the allowance to outstanding loans was 1.38%1.35% and 1.44% at March 31,June 30, 2019 and December 31, 2018, respectively.  The allowance was based on management’s consideration of a number of factors, including composition of the loan portfolio, loans with higher credit risks and the overall amount of loans outstanding.  The decrease in the allowance in 2019 is the result of change in the composition and allocation of loans within credit quality ratings, and improvements in the credit quality of the Bank's loan portfolio.portfolio, decreases in specific allowances on loans and improving qualitative factors.


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


Management has determined that the allowance for loan losses was appropriate at March 31,June 30, 2019, and that the loan portfolio is diversified and secured, without undue concentration in any specific risk area. This process involves a high degree of management judgment; however, the allowance for loan losses is based on a comprehensive, well documented, and consistently applied analysis of the Company’s loan portfolio. This analysis takes into consideration all available information existing as of the financial statement date, including environmental factors such as economic, industry, geographical and political factors. The relative level of allowance for loan losses is reviewed and compared to industry data. This review encompasses levels of total impaired loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs.


Index


HILLS BANCORPORATION


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


Investment securities available for sale held by the Company increaseddecreased by $4.99$10.87 million from December 31, 2018 to March 31,June 30, 2019.  The fair value of securities available for sale was $0.56$3.87 million more than the amortized cost of such securities as of March 31,June 30, 2019.  At December 31, 2018, the fair value of the securities available for sale was $2.73 million less than the amortized cost of such securities.


Deposits increased $175.77$198.08 million in the first threesix months of 2019 primarily due to increases in temporary public funds deposits, broker deposits and rate specials on certificate of deposits. 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 $137.87$174.86 million as of March 31,June 30, 2019 with an average rate of 2.57%2.47%.  Brokered deposits were $132.46 million as of December 31, 2018 with an average interest rate of 2.46%. As of March 31,June 30, 2019 and December 31, 2018, brokered deposits were 5.31%6.68% and 5.47% of total deposits, respectively.


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


Dividends and Equity


In January 2019, Hills Bancorporation paid a dividend of $7.66 million or $0.82 per share.  The dividend was $0.75 per share in January 2018.  After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of March 31,June 30, 2019 totaled $340.78$353.52 million. On January 1, 2015, the final rules of the Federal Reserve Board went into effect implementing in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision. The final rule also adopted changes to the agencies’ regulatory capital requirements that meet the requirements of section 171 and section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.


Under the BASEL III rules, the minimum capital ratios are 4% for Tier 1 Leverage Capital Ratio, 4.5% for the Common Equity Tier 1 Capital Ratio, 6% for the Tier 1 Risk-Based Capital Ratio and 8% for the Total Risk-Based Capital Ratio. A new capital conservation buffer is being phased in beginning January 1, 2016, at 0.625% of risk-weighted assets and increased each subsequent year by an additional 0.625% until reaching 2.5% on January 1, 2019. As of March 31,June 30, 2019 and December 31, 2018, 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 March 31,June 30, 2019 and December 31, 2018 are presented below (amounts in thousands):


Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action ProvisionsActual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount Ratio Ratio RatioAmount Ratio Ratio Ratio
As of March 31, 2019:       
As of June 30, 2019:       
Company:              
Total risk-based capital$419,583
 17.27% 8.000% 10.000%$430,648
 17.76% 8.000% 10.000%
Tier 1 risk-based capital389,132
 16.01
 6.000
 8.000
400,277
 16.51
 6.000
 8.000
Tier 1 common equity389,132
 16.01
 4.500
 6.500
400,277
 16.51
 4.500
 6.500
Leverage ratio389,132
 12.50
 4.000
 5.000
400,277
 12.43
 4.000
 5.000
Bank: 
  
  
  
 
  
  
  
Total risk-based capital420,141
 17.30
 8.000
 10.000
431,664
 17.81
 8.000
 10.000
Tier 1 risk-based capital389,708
 16.05
 6.000
 8.000
401,309
 16.56
 6.000
 8.000
Tier 1 common equity389,708
 16.05
 4.500
 6.500
401,309
 16.56
 4.500
 6.500
Leverage ratio389,708
 12.53
 4.000
 5.000
401,309
 12.47
 4.000
 5.000
Index


HILLS BANCORPORATION




 Actual For Capital Adequacy Purposes To Be Well Capitalized Under Prompt Corrective Action Provisions
 Amount Ratio Ratio Ratio
As of December 31, 2018:       
Company:       
Total risk-based capital$414,772
 17.18% 8.00% 10.00%
Tier 1 risk-based capital384,502
 15.93
 6.00
 8.00
Tier 1 common equity384,502
 15.93
 4.50
 6.50
Leverage ratio384,502
 12.68
 4.00
 5.00
Bank: 
  
  
  
Total risk-based capital416,198
 17.25
 8.00
 10.00
Tier 1 risk-based capital385,943
 16.00
 6.00
 8.00
Tier 1 common equity385,943
 16.00
 4.50
 6.50
Leverage ratio385,943
 12.73
 4.00
 5.00






Index


HILLS BANCORPORATION


Discussion of operations for the threesix months ended March 31,June 30, 2019 and 2018


Net Income Overview


Net income increased $0.34$1.50 million for the threesix months ended March 31,June 30, 2019 compared to the first threesix months of 2018.  Total net income was $11.20$22.42 million in 2019 and $10.86$20.92 million in the comparable period in 2018, an increase of 3.18%7.18%.  The changes in net income in 2019 from the first threesix months of 2018 were primarily the result of the following:


Net interest income increased by $1.48$3.05 million, before provision expense. Total interest income increased by $3.82$7.99 million as a result of growth in the volume of earning assets.assets and rising interest rates. Total interest expense increased by $2.34$4.94 million primarily due to rising interest rates increasing the costs of funding.
The provision for loan losses decreased by $0.48$1.73 million.
Noninterest income decreased by $0.38$0.76 million.
Noninterest expenses increased by $0.79$1.47 million.
Income tax expense increased by $0.45$1.04 million.
 
For the threesix month period ended March 31,June 30, 2019 and March 31,June 30, 2018 basic earnings per share was $1.20$2.40 and $1.16,$2.23, respectively. Diluted earnings per share was $1.20$2.40 for the threesix months ended March 31,June 30, 2019 compared to $1.16$2.23 for the same period in 2018.


The Company’s net income is driven primarily by three important factors.  The first important factor is the interaction between changes in net interest margin and changes in average volumes of the Bank's earnings assets.  Net interest income of $23.77$48.16 million for the first threesix months of 2019 was derived from the Company’s $3.013$3.065 billion of average earning assets during that period and its tax-equivalent net interest margin of 3.27%3.23%.  Average earning assets in the threesix months ended March 31,June 30, 2018 were $2.875$2.879 billion and the tax-equivalent net interest margin was 3.25%3.26%.  The importance of net interest margin is illustrated by the fact that an increase or decrease in the net interest margin of 10 basis points would have resulted approximately in a $0.75$1.53 million change in income before income taxes in the threesix month period ended March 31,June 30, 2019.  Net interest income for the Company increased primarily as a result of growth in the volume of earning assets.  The Company expects net interest compression to impact earnings for the foreseeable future.future with increased costs of funding in the short-term due to competition for deposits combined with the potential future interest rate decreases by the Federal Reserve Board.  The Company believes growth in net interest income will be contingent on the growth of the Company’s earnings assets.


The second significant factor affecting the Company’s net income is the provision for loan losses. The majority of the Company’s interest-earning assets are in loans outstanding, which amounted to more than $2.613$2.617 billion at March 31,June 30, 2019.  The provision is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio.  The provision reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more.  In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historically higher credit risk.  The provision for loan losses was a reduction of expense of $1.25$1.79 million in 2019 compared to a reduction of expense of $0.77$0.05 millionin 2018.  The Company believes that the provision for loan losses may increase for the foreseeable future resulting from projected increases in the size of the Company’s loan portfolio.


The third significant factor affecting the Company’s net income is income tax expense.  Federal and state income tax expenses were $3.02$6.22 million and $2.57$5.18 million for the threesix months ended March 31,June 30, 2019 and 2018, respectively.  Income taxes as a percentage of income before taxes were 21.22%21.70% in 2019 and 19.15%19.83% in 2018. The increase in income taxes as a percentage of income before taxes is due to tax credits related to investments in tax credit real estate being fully utilized. On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cut and Jobs Act (the “Tax Act”). The Tax Act established new tax laws that reduced the U.S. federal corporate income tax rate from 35% to 21% in 2018. The quarter ended March 31, 2019 will bewas the first with all comparable periods on a Post-Tax Act basis, therefore the Company expects income taxes as a percentage of income before taxes to be more comparable in current and future periods than it was over the previous fiscal year.










Index


HILLS BANCORPORATION


Discussion of operations for the threesix months ended March 31,June 30, 2019 and 2018


Net Interest Income


Net interest income increased for the threesix months ended March 31,June 30, 2019 compared to the comparable period in 2018.  The increase was as a result of growth in the average volume of earning assets.  Net interest income is the excess of the interest and fees earned on interest-earning bearing assets over the interest expense of the interest-bearing liabilities.  The factors that have the greatest impact on net interest income are the average volume of earning assets for the period and the net interest margin.  The net interest margin for the first threesix months of 2019 was 3.27%3.23% compared to 3.25%3.26% in 2018 for the same period.  Interest expense increased $2.34$4.94 million for the threesix months ended March 31,June 30, 2019 compared to the threesix months ended March 31,June 30, 2018 primarily due to increasing interest rates on deposits. The measure is shown on a tax-equivalent basis using a tax rate of 21% to make the interest earned on taxable and non-taxable assets more comparable.  The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the six months ended in 2019 compared to the comparable period in 2018 are shown in the following table:

     Increase (Decrease) in Net Interest Income
 
Change in
Average Balance
 
Change in
Average Rate
 Volume Changes Rate Changes Net Change
 (Amounts in Thousands)
Interest income:         
Loans, net$163,163
 0.25 % $3,592
 $3,377
 $6,969
Taxable securities10,973
 0.27
 120
 185
 305
Nontaxable securities11,469
 (0.22) 146
 157
 303
Federal funds sold350
 0.73
 3
 483
 486
 $185,955
  
 $3,861
 $4,202
 $8,063
          
Interest expense: 
  
  
  
  
Interest-bearing demand deposits$36,494
 0.31 % $(99) $(1,078) $(1,177)
Savings deposits35,042
 0.35
 (143) (1,482) (1,625)
Time deposits119,533
 0.52
 (937) (1,613) (2,550)
FHLB borrowings(26,134) (0.02) 387
 22
 409
Interest-bearing other liabilities(2) 0.93
 —
 —
 —
 $164,933
  
 $(792) $(4,151) $(4,943)
Change in net interest income 
  
 $3,069
 $51
 $3,120

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

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

(Tax Equivalent Basis) 2019 2018
Yield on average interest-earning assets 4.34% 4.10%
Rate on average interest-bearing liabilities 1.42
 1.08
Net interest spread 2.92% 3.02%
Effect of noninterest-bearing funds 0.31
 0.24
Net interest margin (tax equivalent interest income divided by average interest-earning assets) 3.23% 3.26%
Index

HILLS BANCORPORATION

Discussion of operations for the six months ended June 30, 2019 and 2018

In pricing loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates.  The Federal Open Market Committee met three times during the first six months of 2019.  The target rate remained at 2.50% as of June 30, 2019.  Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally increase or decrease when the Federal Reserve Board raises or lowers the federal funds rate.  As of June 30, 2019, the rate indexes for the one, three and five year indexes were 1.92%, 1.71% and 1.76%, respectively.  The one year index decreased 17.60% from 2.33% at June 30, 2018, the three year index decreased 34.98% and the five year index decreased 35.53%.  The three year index was 2.63% and the five year index was 2.73% at June 30, 2018.  The targeted federal funds rate was 2.50% and 2.00% at June 30, 2019 and 2018, respectively.  The Company anticipates short term and long term rates in the indexes to remain consistent for 2019.

Provision for Loan Losses

The provision for loan losses was a reduction of expense of $1.79 million for the six months ended June 30, 2019 compared to a reduction of expense of $0.05 million in 2018, a reduction of expense of $1.73 million.  The loan loss provision is the amount necessary to adjust the allowance for loan losses to the level considered by management to appropriately account for the estimated impairment to the Bank's loan portfolio.  The provision expense taken to fund the allowance for loan losses is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio.  The provision reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact on the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more.  In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historically higher credit risks.  The decrease in expense in 2019 is the result of a change in the composition and allocation of loans within credit quality ratings as compared to June 30, 2018 and improvements in the credit quality of the Bank's loan portfolio.

The allowance for loan losses decreased $2.16 million during the first six months of 2019 as compared to December 31, 2018.  In the first six months of 2019, there was a decrease of $1.44 million due to changes in average balances and composition of loans outstanding and a $0.72 million decrease in the amount allocated to the allowance due to improvements in credit quality.

The allowance for loan losses balance is affected by charge-offs, net of recoveries, for the periods presented.  For the six months ended June 30, 2019 and 2018, recoveries were $0.85 million and $0.98 million, respectively; and charge-offs were $1.22 million in 2019 and $0.81 million in 2018.  The allowance for loan losses totaled $35.65 million at June 30, 2019 compared to $37.81 million at December 31, 2018.  The allowance represented 1.35% and 1.44% of loans held for investment at June 30, 2019 and December 31, 2018.

Noninterest Income

The following table sets forth the various categories of noninterest income for the sixmonths ended June 30, 2019 and 2018.

 Six Months Ended June 30,    
 2019 2018 $ Change % Change
 (Amounts in thousands)    
Net gain on sale of loans$863
 $774
 $89
 11.50 %
Trust fees4,680
 5,648
 (968) (17.14)
Service charges and fees4,923
 4,636
 287
 6.19
Other noninterest income687
 804
 (117) (14.55)
Loss on sale of investment securities(52) —
 (52) —
 $11,101
 $11,862
 $(761) (6.42)

Noninterest income categories experienced marginal period-to-period fluctuations for the six months ended June 30, 2019.



Index

HILLS BANCORPORATION


Discussion of operations for the six months ended June 30, 2019 and 2018

Loans originated for sale in the first sixmonths of 2019 totaled $63.38 million compared to $73.46 million in the same period in 2018, a decrease of 13.72%.  In the six months ended June 30, 2019 and 2018, the net gain on sale of loans was $0.86 million and $0.77 million, respectively.  The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly.  The volume of activity in these types of loans is directly related to the level of interest rates.  The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income. 

Noninterest Expenses

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

 Six Months Ended June 30,    
 2019 2018 $ Change % Change
 (Amounts in thousands)    
Salaries and employee benefits$18,052
 $17,107
 $945
 5.52 %
Occupancy2,288
 2,123
 165
 7.77
Furniture and equipment3,337
 2,964
 373
 12.58
Office supplies and postage901
 895
 6
 0.67
Advertising and business development1,193
 1,237
 (44) (3.56)
Outside services5,095
 4,925
 170
 3.45
FDIC insurance assessment404
 431
 (27) (6.26)
Other noninterest expense1,139
 1,254
 (115) (9.17)
 $32,409
 $30,936
 $1,473
 4.76

In the six months ended June 30, 2019 and 2018, salaries and employee benefits expense increased $0.95 million. The increase is primarily the result of annual salary adjustments and hiring of additional employees to staff growth.

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

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

Net Income Overview

Net income increased $1.16 million for the three months ended June 30, 2019 compared to the same period in 2018.  Total net income was $11.22 million in 2019 and $10.06 million in the comparable period in 2018, an increase of 11.50%.  For the three month period ended June 30, 2019 and June 30, 2018 basic earnings per share was $1.20 and $1.07, respectively. Diluted earnings per share was $1.20 for the three months ended June 30, 2019 compared to $1.07 for the same period in 2018.

Index

HILLS BANCORPORATION

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

Net Interest Income

Net interest income increased for the three months ended June 30, 2019 compared to the comparable period in 2018.  The increase was primarily the result of growth in the volume of earning assets.  Net interest income is the excess of the interest and fees earned on interest-earning bearing assets over the interest expense of the interest-bearing liabilities.  Interest expense increased $2.61 million for the three months ended June 30, 2019 compared to the three months ended June 30, 2018 primarily due to increasing interest rates on deposits.The factors that have the greatest impact on net interest income are the volume of average earning assets and the net interest margin.  The net interest margin for the three months ended June 30, 2019 was 3.20% compared to 3.28% in 2018 for the same period.  The measure is shown on a tax-equivalent basis using a tax rate of 21% to make the interest earned on taxable and non-taxable assets more comparable.  The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the three months ended in 2019 compared to the comparable period in 2018 are shown in the following table:


    Increase (Decrease) in Net Interest Income    Increase (Decrease) in Net Interest Income
Change in
Average Balance
 
Change in
Average Rate
 Volume Changes Rate Changes Net Change
Change in
Average Balance
 
Change in
Average Rate
 Volume Changes Rate Changes Net Change
(Amounts in Thousands)(Amounts in Thousands)
Interest income:                  
Loans, net$169,047
 0.25% $1,857
 $1,682
 $3,539
$157,279
 0.26 % $1,734
 $1,696
 $3,430
Taxable securities14,054
 0.36
 67
 128
 195
7,892
 0.20
 52
 58
 110
Nontaxable securities14,551
 0.20
 92
 102
 194
8,387
 (0.26) 54
 65
 119
Federal funds sold(59,155) 0.84
 (232) 172
 (60)59,854
 0.61
 268
 278
 546
$138,497
  
 $1,784
 $2,084
 $3,868
$233,412
  
 $2,108
 $2,097
 $4,205
                  
Interest expense: 
  
  
  
  
 
  
  
  
  
Interest-bearing demand deposits$6,058
 0.32% $(8) $(533) $(541)$64,325
 0.31 % $(93) $(544) $(637)
Savings deposits29,532
 0.39
 (49) (809) (858)40,553
 0.32
 (98) (667) (765)
Time deposits116,749
 0.53
 (439) (797) (1,236)122,317
 0.50
 (499) (816) (1,315)
Other borrowings—
 —
 —
 —
 —
FHLB borrowings(255,661) —
 299
 —
 299
(11,393) (0.04) 86
 24
 110
Interest-bearing other liabilities(4) 1.18
 —
 —
 —
—
 0.24
 —
 —
 —
$(103,326)  
 $(197) $(2,139) $(2,336)$215,802
   $(604) $(2,003) $(2,607)
Change in net interest income 
  
 $1,587
 $(55) $1,532
 
  
 $1,504
 $94
 $1,598


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


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


(Tax Equivalent Basis) 2019 2018 2019 2018
Yield on average interest-earning assets 4.35% 4.05% 4.34% 4.14%
Rate on average interest-bearing liabilities 1.39
 1.04
 1.45
 1.12
Net interest spread 2.96% 3.01% 2.89% 3.02%
Effect of noninterest-bearing funds 0.31
 0.24
 0.31
 0.26
Net interest margin (tax equivalent interest income divided by average interest-earning assets) 3.27% 3.25% 3.20% 3.28%

Index


HILLS BANCORPORATION


Discussion of operations for the three months ended March 31,June 30, 2019 and 2018

In pricing loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates.  The Federal Open Market Committee met two times during the first three months of 2019.  The target rate remained at 2.50% as of March 31, 2019.  Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally increase or decrease when the Federal Reserve Board raises or lowers the federal funds rate.  As of March 31, 2019, the rate indexes for the one, three and five year indexes were 2.40%, 2.21% and 2.23%, respectively.  The one year index increased 14.83% from 2.09% at March 31, 2018, the three year index decreased 7.53% and the five year index decreased 12.89%.  The three year index was 2.39% and the five year index was 2.56% at March 31, 2018.  The targeted federal funds rate was 2.50% and 1.75% at March 31, 2019 and 2018, respectively.  The Company anticipates short term and long term rates in the indexes to remain consistent for 2019.


Provision for Loan Losses


The provision for loan losses was a reduction of expense of $1.25$0.54 million for the three months ended March 31,June 30, 2019 compared to a reduction ofan expense of $0.77$0.71 million in 2018, a reductionan expense increase of expense of $0.48$1.25 million. The loan loss provision is the amount necessary to adjust the allowance for loan losses to the level considered by management to appropriately account for the estimated impairment to the Bank's loan portfolio.  The provision expense taken to fund the allowance for loan losses is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio.  The provision reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact on the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more.  In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historical higher credit risks. The decrease in expense in 2019 is the result of a changechanges in the composition and allocation of loans within credit quality ratings as compared to March 31,June 30, 2018 and improvementsa reduction in the credit qualityspecific reserves as of the Bank's loan portfolio.June 30, 2019 as compared to June 30, 2018.

The allowance for loan losses decreased $1.29$0.87 million during the first three months ofended June 30, 2019 as compared to DecemberMarch 31, 2018.2019.  In the first three months ofended June 30, 2019, there was a decrease of $2.55$1.98 million due to changes in average balances and composition of loans outstanding and a $1.26 million increasedecrease in the amount allocated to the allowance due to declines in credit quality.quality and a $1.11 million increase due to the composition of loans outstanding.


The allowance for loan losses balance is affected by charge-offs, net of recoveries, for the periods presented.  For the three months ended March 31,June 30, 2019 and 2018, recoveries were $0.43$0.41 million and $0.54$0.44 million, respectively; and charge-offs were $0.48$0.74 million in 2019 and $0.27$0.55 million in 2018.  The allowance for loan losses totaled $36.52$35.65 million at March 31,June 30, 2019 compared to $37.81 million at December 31, 2018.  The allowance represented 1.38%1.35% and 1.44% of loans held for investment at March 31,June 30, 2019 and December 31, 2018.2018, respectively.


Noninterest Income


The following table sets forth the various categories of noninterest income for the threemonths ended March 31,June 30, 2019 and 2018.


Three Months Ended March 31,    Three Months Ended June 30,    
2019 2018 $ Change % Change2019 2018 $ Change % Change
(Amounts in thousands)    (Amounts in thousands)    
Net gain on sale of loans$286
 $331
 $(45) (13.60)%$577
 $443
 $134
 30.25 %
Trust fees2,252
 2,641
 (389) (14.73)2,428
 3,007
 (579) (19.26)
Service charges and fees2,275
 2,228
 47
 2.11
2,648
 2,408
 240
 9.97
Other noninterest income437
 428
 9
 2.10
250
 376
 (126) (33.51)
Loss on sale of investment securities(52) —
 (52) —
$5,250
 $5,628
 $(378) (6.72)$5,851
 $6,234
 $(383) (6.14)


Noninterest income categories experienced marginal period-to-period fluctuations for the three months ended March 31, 2019.



Index

HILLS BANCORPORATION


Discussion of operations for the three months ended March 31, 2019 and 2018

Loans originated for sale in the first threemonths of 2019 totaled $29.85 million compared to $31.57 million in the same period in 2018, a decrease of 5.45%.  In the three months ended March 31,June 30, 2019 and 2018, the net gain on sale of loans was $0.29$0.58 million and $0.33$0.44 million, respectively.  The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly.  The volume of activity in these types of loans is directly related to the level of interest rates.  The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income. The Company believes residential mortgage interest rates will continue to rise

Noninterest income categories experienced marginal period-to-period fluctuations for the foreseeable future resulting in decreased net gain on salethree months ended June 30, 2019.
Index

HILLS BANCORPORATION


Discussion of loan income.operations for the three months ended June 30, 2019 and 2018


Noninterest Expenses


The following table sets forth the various categories of noninterest expenses for the three months ended March 31,June 30, 2019 and 2018.


Three Months Ended March 31,    Three Months Ended 
 June 30,		    
2019 2018 $ Change % Change2019 2018 $ Change % Change
(Amounts in thousands)    (Amounts in thousands)    
Salaries and employee benefits$8,722
 $8,284
 $438
 5.29 %$9,330
 $8,823
 $507
 5.75 %
Occupancy1,186
 1,101
 85
 7.72
1,102
 1,022
 80
 7.83
Furniture and equipment1,673
 1,474
 199
 13.50
1,664
 1,490
 174
 11.68
Office supplies and postage459
 434
 25
 5.76
442
 461
 (19) (4.12)
Advertising and business development638
 630
 8
 1.27
555
 607
 (52) (8.57)
Outside services2,572
 2,578
 (6) (0.23)2,523
 2,347
 176
 7.50
FDIC insurance assessment209
 218
 (9) (4.13)195
 213
 (18) (8.45)
Other noninterest expense590
 537
 53
 9.87
549
 717
 (168) (23.43)
$16,049
 $15,256
 $793
 5.20
$16,360
 $15,680
 $680
 4.34


In the three months ended March 31,June 30, 2019 and 2018, salaries and employee benefits expense increased $0.44$0.51 million. The increase is primarily the result of annual salary adjustments and hiring of additional employees to staff branch growth.

Outside business services increased $0.18 million for the three months ended June 30, 2019 due to outsourcing services previously managed by the Company. Other noninterest expense categories experienced marginal period-to-period fluctuations for the three months ended March 31,June 30, 2019.


Income Taxes


Federal and state income tax expenses were $3.02$3.20 million and $2.57$2.60 million for the three months ended March 31,June 30, 2019 and 2018, respectively.  Income taxes as a percentage of income before taxes were 21.22%22.19% in 2019 and 19.15%20.55% in 2018. On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cut and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that affects 2017, including, but not limited to, accelerated depreciation that will allow for full expensing of qualified property. The Tax Act also established new tax laws that reduced the U.S. federal corporate income tax rate from 35% to 21% in 2018. The quarter ended March 31, 2019 will bewas the first with all comparable periods on a Post-Tax Act basis, therefore the Company expects income taxes as a percentage of income before taxes to be more comparable in current and future periods than it was over the previous fiscal year.
Index


HILLS BANCORPORATION


Liquidity


The Company actively monitors and manages its liquidity position with the objective of maintaining sufficient cash flows to fund operations, meet client commitments, take advantage of market opportunities and provide a margin against unforeseeable liquidity needs.  Federal funds sold and investment securities available for sale are readily marketable assets.  Maturities of all investment securities are managed to meet the Company’s normal liquidity needs, to respond to market changes or to adjust the Company’s interest rate risk position.  Investment securities available for sale comprised 10.04%9.44% of the Company’s total assets at March 31,June 30, 2019 compared to 10.48% at December 31, 2018.


The Company has historically maintained a stable deposit base and a relatively low level of large deposits, which has mitigated the volatility in the Company’s liquidity position.  As of March 31,June 30, 2019, the Company had borrowed $215.00 million from the Federal Home Loan Bank (“FHLB”) of Des Moines.  Advances are used as a means of providing both long and short-term, fixed-rate funding for certain assets and for managing interest rate risk.  The Company had additional borrowing capacity available from the FHLB of approximately $742.79$697.93 million at March 31,June 30, 2019.


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 $449.72$461.31 million.  The borrowings under these credit lines would be secured by the Bank’s investment securities.  The combination of high levels of potentially liquid assets, low dependence on volatile liabilities and additional borrowing capacity provided sources of liquidity for the Company which management considered sufficient at March 31,June 30, 2019.


As of March 31,June 30, 2019, investment securities with a carrying value of $11.72$12.52 million were pledged to collateralize public and trust deposits, derivative financial instruments, and other borrowings.  As of December 31, 2018, investment securities with a carrying value of $9.78 million were pledged.


Contractual Obligations


There have been no material changes with regard to contractual obligations disclosed in the Company’s Form 10-K for the year ended December 31, 2018.
Item 3.Quantitative and Qualitative Disclosures about Market Risk


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


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


Index


HILLS BANCORPORATION


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


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


The Bank's interest rate risk, as monitored by management, has not changed materially from December 31, 2018.
Item 4.Controls and Procedures


The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, as of the end of the period covered by this report, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports it files with the Securities and Exchange Commission.  There have been no changes in the Company’s internal controls over financial reporting during the threesix months ended March 31,June 30, 2019 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
 
There have been no material changes from the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, 2018.
Index


Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
 
The following table sets forth information about the Company’s stock purchases, all of which were made pursuant to the 2005 Stock Repurchase Program, for the three months ended March 31,June 30, 2019:


Period
Total number of shares
purchased
Average price paid per
share
Total number of
shares purchased
as part of publicly
announced plans
or programs
Maximum number
of shares that may
yet be purchased
under the plans
or programs (1)
January 1 to January 3120,497
$61.00
20,497
352,624
February 1 to February 2814,100
61.00
14,100
338,524
March 1 to March 3135,174
62.00
35,174
303,350
Total69,771
$61.50
69,771
303,350
Period
Total number of shares
purchased
Average price paid per
share
Total number of
shares purchased
as part of publicly
announced plans
or programs
Maximum number
of shares that may
yet be purchased
under the plans
or programs (1)
April 1 to April 30499
$62.10
499
302,851
May 1 to May 31588
63.04
588
302,263
June 1 to June 304,539
63.50
4,539
297,724
Total5,626
$63.33
5,626
297,724
 
(1)  On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to 1,500,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  The Company’s Board of Directors has authorized the 2005 Stock Repurchase Program through December 31, 2020.  The Company expects the purchases pursuant to the 2005 Stock Repurchase Program to be made from time to time in private transactions at a price equal to the most recent quarterly independent appraisal of the shares of the Company’s common stock and with the Board reviewing the overall results of the 2005 Stock Repurchase Program on a quarterly basis.  All purchases made pursuant to the 2005 Stock Repurchase Program since its inception have been made on that basis.  The amount and timing of stock repurchases will be based on various factors, such as the Board’s assessment of the Company’s capital structure and liquidity, the amount of interest shown by shareholders in selling shares of stock to the Company at their appraised value, and applicable regulatory, legal and accounting factors. 
Item 3.Defaults upon Senior Securities
 
Hills Bancorporation has no senior securities.


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


None.


Index


Item 6.Exhibits


3.1
Restated Articles of Incorporation, incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q Filed with the Commission on May 6, 2015.
3.2
Amended and Restated Bylaws of Hills Bancorporation.Bancorporation, incorporated by reference to Exhibit 3.2 to the Company's Form 10-Q Filed with the Commission on May 6, 2019.
31
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
32
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002
101.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)
(1)Users of this data are advised that, pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and are otherwise not subject to liability under these sections.
(2)The instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document.
Index


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


   HILLS BANCORPORATION
    
Date:May 6August 5 2019 By:  /s/ Dwight O. Seegmiller
   Dwight O. Seegmiller, Director, President and Chief Executive Officer
    
Date:May 6August 5 2019 By:  /s/ Shari DeMaris
   Shari DeMaris, Secretary, Treasurer and Chief Accounting Officer


Index


HILLS BANCORPORATION
QUARTERLY REPORT OF FORM 10-Q FOR THE
QUARTER ENDED MARCH 31,JUNE 30, 2019
Exhibit
Number
Description
Page Number In The Sequential
Numbering System
March 31, 2019 Form 10-Q
Description
Page Number In The Sequential
Numbering System
June 30, 2019 Form 10-Q
    
3.2
Amended and Restated Bylaws of Hills Bancorporation.
58-67
  
31
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
68-69
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
62-63
    
32
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002
70
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002
64




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