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

FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2011

Commission file number:  0-12668

Hills Bancorporation

Incorporated in Iowa
I.R.S. Employer Identification
 
No. 42-1208067
 
131 MAIN STREET, HILLS, IOWA 52235
 
Telephone number: (319) 679-2291

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

þ Yes  o No

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

þ Yes  o No

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

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

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes  þ No
 
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
CLASS
At June 30, 2011
   
Common Stock, no par value
 4,358,392
 

 
 
Page 1

 

HILLS BANCORPORATION

   
Part I
 
   
FINANCIAL INFORMATION
 
       
     
Page
     
Number
       
Item 1.
 
Financial Statements
 
       
   
3
   
4
   
5
   
6
   
7
   
9
       
Item 2.
 
25
       
Item 3.
 
43
       
Item 4.
   43
       
   
Part II
 
   
OTHER INFORMATION
 
       
Item 1.
 
44
       
Item 1A.
 
44
       
Item 2.
 
44
       
Item 3.
 
44
       
Item 4.
 
44
       
Item 5.
 
44
       
Item 6.
 
44
       
   
45
       
 
46


 
Page 2

 
 
HILLS BANCORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts In Thousands, Except Shares)
 
             
             
ASSETS
 
June 30, 2011 (Unaudited)
   
December 31, 2010
 
             
Cash and cash equivalents
  $ 25,010     $ 62,978  
Investment securities available for sale at fair value (amortized cost June 30, 2011 $208,556; December 31, 2010 $200,995)
    215,082       205,498  
Stock of Federal Home Loan Bank
    10,757       11,105  
Loans held for sale
    8,191       10,390  
Loans, net of allowance for loan losses (June 30, 2011 $29,260; December 31, 2010 $29,230)
    1,602,768       1,561,430  
Property and equipment, net
    26,879       26,806  
Tax credit real estate
    20,316       20,960  
Accrued interest receivable
    9,232       8,686  
Deferred income taxes, net
    9,267       9,870  
Other real estate
    2,284       2,233  
Goodwill
    2,500       2,500  
Prepaid FDIC insurance
    4,331       5,038  
Other assets
    4,513       3,789  
    $ 1,941,130     $ 1,931,283  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Liabilities
               
Noninterest-bearing deposits
  $ 195,915     $ 198,791  
Interest-bearing deposits
    1,286,995       1,281,950  
Total deposits
  $ 1,482,910     $ 1,480,741  
Short-term borrowings
    52,023       46,928  
Federal Home Loan Bank borrowings
    185,000       195,000  
Accrued interest payable
    1,823       1,996  
Other liabilities
    19,706       15,404  
    $ 1,741,462     $ 1,740,069  
                 
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)
  $ 26,289     $ 24,945  
                 
STOCKHOLDERS' EQUITY
               
Capital stock, no par value; authorized 10,000,000 shares; issued June 30, 2011 4,627,402 shares; December 31, 2010 4,624,519 shares
  $ -     $ -  
Paid in capital
    14,997       14,875  
Retained earnings
    195,144       185,412  
Accumulated other comprehensive income
    4,030       2,781  
Treasury stock at cost (June 30, 2011 269,010 shares; December 31, 2010 226,182 shares)
    (14,503 )     (11,854 )
    $ 199,668     $ 191,214  
Less maximum cash obligation related to ESOP shares
    26,289       24,945  
    $ 173,379     $ 166,269  
    $ 1,941,130     $ 1,931,283  
                 
See Notes to Consolidated Financial Statements.
               


 
Page 3

 
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Amounts In Thousands, Except Per Share Amounts)
 
                         
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Interest income:
                       
  Loans, including fees
  $ 21,742     $ 22,193     $ 43,107     $ 43,992  
  Investment securities:
                               
    Taxable
    725       850       1,490       1,725  
    Nontaxable
    866       828       1,725       1,652  
  Federal funds sold
    33       26       65       28  
    Total interest income
  $ 23,366     $ 23,897     $ 46,387     $ 47,397  
Interest expense:
                               
  Deposits
  $ 4,146     $ 4,882     $ 8,454     $ 9,980  
  Short-term borrowings
    101       120       196       263  
  FHLB borrowings
    1,990       2,005       3,971       4,068  
    Total interest expense
  $ 6,237     $ 7,007     $ 12,621     $ 14,311  
    Net interest income
  $ 17,129     $ 16,890     $ 33,766     $ 33,086  
Provision for loan losses
    (266 )     853       1,199       2,918  
    Net interest income after provision for loan losses
  $ 17,395     $ 16,037     $ 32,567     $ 30,168  
Other income:
                               
  Net gain on sale of loans
  $ 171     $ 496     $ 653     $ 1,041  
  Trust fees
    1,106       1,042       2,195       2,002  
  Service charges and fees
    1,921       2,101       3,732       4,023  
  Rental revenue on tax credit real estate
    395       404       678       866  
  Other noninterest income
    736       545       1,405       1,624  
    $ 4,329     $ 4,588     $ 8,663     $ 9,556  
Other expenses:
                               
  Salaries and employee benefits
  $ 5,534     $ 5,563     $ 11,084     $ 11,005  
  Occupancy
    824       755       1,655       1,516  
  Furniture and equipment
    817       1,000       1,782       2,015  
  Office supplies and postage
    317       346       654       691  
  Advertising and business development
    447       449       776       806  
  Outside services
    1,497       1,543       3,223       3,435  
  Rental expenses on tax credit real estate
    648       710       882       1,222  
  FDIC insurance assessment
    86       271       786       1,045  
  Net (gain) loss on sale of other real estate owned and other repossessed assets
    (384 )     42       (385 )     183  
  Other noninterest expense
    484       414       738       731  
    $ 10,270     $ 11,093     $ 21,195     $ 22,649  
    Income before income taxes
  $ 11,454     $ 9,532     $ 20,035     $ 17,075  
Income taxes
    3,501       2,811       5,904       4,969  
    Net income
  $ 7,953     $ 6,721     $ 14,131     $ 12,106  
                                 
Earnings per share:
                               
Basic
  $ 1.82     $ 1.52     $ 3.22     $ 2.74  
Diluted
    1.81       1.52       3.21       2.73  
                                 
See Notes to Consolidated Financial Statements.
                               


 
Page 4

 
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Amounts In Thousands)
 
                         
    Three Months Ended June 30,    
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Net income
  $ 7,953     $ 6,721     $ 14,131     $ 12,106  
                                 
Other comprehensive income (loss):
                               
  Unrealized holding gains (losses) arising during the period
  $ 1,421     $ 346     $ 2,023     $ (312 )
  Income tax effect of unrealized (gains) losses
    (543 )     (132 )     (774 )     119  
    $ 878     $ 214     $ 1,249     $ (193 )
                                 
Comprehensive income
  $ 8,831     $ 6,935     $ 15,380     $ 11,913  
                                 
See Notes to Consolidated Financial Statements.
                               

 
Page 5

 
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
(Amounts In Thousands, Except Share Amounts)
 
                                     
   
Paid In Capital
   
Retained Earnings
   
Accumulated Other Comprehensive Income (Loss)
   
Maximum Cash Obligation Related to ESOP Shares
   
Treasury Stock
   
Total
 
                                     
Balance, December 31, 2009
  $ 14,582     $ 166,120     $ 4,200     $ (22,900 )   $ (10,227 )   $ 151,775  
  Issuance of 302 shares of common stock
    16       -       -       -       -       16  
  Forfeiture of 393 shares of common stock
    (18 )     -       -       -       -       (18 )
  Share-based compensation
    8       -       -       -       -       8  
  Income tax benefit related to share-    based compensation
    -       -       -       -       -       -  
  Change related to ESOP shares
    -       -       -       (890 )     -       (890 )
  Net income
    -       12,106       -       -       -       12,106  
  Dividends ($.91 per share)
    -       (4,024 )     -       -       -       (4,024 )
  Purchase of 18,731 shares of common stock
    -       -       -       -       (1,018 )     (1,018 )
  Other comprehensive loss
    -       -       (193 )     -       -       (193 )
Balance, June 30, 2010
  $ 14,588     $ 174,202     $ 4,007     $ (23,790 )   $ (11,245 )   $ 157,762  
                                                 
                                                 
Balance, December 31, 2010
  $ 14,875     $ 185,412     $ 2,781     $ (24,945 )   $ (11,854 )   $ 166,269  
  Issuance of 3,401 shares of common stock
    98       -       -       -       -       98  
  Forfeiture of 518 shares of common stock
    (28 )     -       -       -       -       (28 )
  Share-based compensation
    8       -       -       -       -       8  
  Income tax benefit related to share-
    based compensation
    44       -       -       -       -       44  
  Change related to ESOP shares
    -       -       -       (1,344 )     -       (1,344 )
  Net income
    -       14,131       -       -       -       14,131  
  Dividends ($1.00 per share)
    -       (4,399 )     -       -       -       (4,399 )
  Purchase of 42,828 shares of common stock
    -       -       -       -       (2,649 )     (2,649 )
  Other comprehensive income
    -       -       1,249       -       -       1,249  
Balance, June 30, 2011
  $ 14,997     $ 195,144     $ 4,030     $ (26,289 )   $ (14,503 )   $ 173,379  
                                                 
See Notes to Consolidated Financial Statements.
                                         


 
Page 6

 
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Amounts In Thousands)
 
             
   
Six Months Ended June 30,
 
   
2011
   
2010
 
Cash Flows from Operating Activities
           
  Net income
  $ 14,131     $ 12,106  
  Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
         
    Depreciation
    1,241       1,351  
    Provision for loan losses
    1,199       2,918  
    Share-based compensation
    8       8  
    Forfeiture of common stock
    (28 )     (18 )
    Compensation expensed through issuance of common stock
    19       16  
    Excess tax benefits from share-based compensation
    44       -  
    Provision for deferred income taxes
    (171 )     117  
    Net (gain) loss on sale of other real estate owned and other repossessed assets
    (385 )     183  
    (Increase) decrease in accrued interest receivable
    (546 )     275  
    Amortization of discount on investment securities, net
    468       432  
    Decrease in prepaid FDIC insurance
    707       943  
    (Increase) decrease in other assets
    (768 )     212  
    Increase in accrued interest payable and other liabilities
    4,129       4,423  
    Loans originated for sale
    (48,152 )     (80,489 )
    Proceeds on sales of loans
    51,004       79,623  
    Net gain on sales of loans
    (653 )     (1,041 )
       Net cash and cash equivalents provided by operating activities
  $ 22,247     $ 21,059  
                 
Cash Flows from Investing Activities
               
  Proceeds from maturities of investment securities available for sale
  $ 26,092     $ 28,344  
  Purchases of investment securities available for sale
    (33,773 )     (26,961 )
  Loans made to customers, net of collections
    (44,161 )     (14,158 )
  Proceeds on sale of other real estate owned and other repossessed assets
    1,958       1,354  
  Purchases of property and equipment
    (1,314 )     (698 )
  Investment in tax credit real estate, net
    644       (2,813 )
       Net cash used in investing activities
  $ (50,554 )   $ (14,932 )
                 
Cash Flows from Financing Activities
               
  Net increase in deposits
  $ 2,169     $ 54,675  
  Net increase (decrease) in short-term borrowings
    5,095       (24,322 )
  Stock options exercised
    79       -  
  Excess tax benefits related to share-based compensation
    44       -  
  Borrowings from FHLB
    -       10,000  
  Payments on FHLB borrowings
    (10,000 )     (40,000 )
  Purchase of treasury stock
    (2,649 )     (1,018 )
  Dividends paid
    (4,399 )     (4,024 )
       Net cash used in financing activities
  $ (9,661 )   $ (4,689 )
                 
(Continued)
               

 
Page 7

 
HILLS BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Continued) (Amounts In Thousands)
 
             
   
Six Months Ended June 30,
 
   
2011
   
2010
 
             
(Decrease) increase in cash and cash equivalents
  $ (37,968 )   $ 1,438  
                 
Cash and cash equivalents:
               
  Beginning of year
    62,978       24,095  
  End of period
  $ 25,010     $ 25,533  
                 
Supplemental Disclosures
               
  Cash payments for:
               
    Interest paid to depositors
  $ 8,627     $ 10,264  
    Interest paid on other obligations
    4,167       4,331  
    Income taxes paid
    4,843       2,874  
                 
  Noncash financing activities:
               
    Increase in maximum cash obligation related to ESOP shares
  $ 1,344     $ 890  
    Transfers to other real estate owned
    1,624       2,139  
                 
See Notes to Consolidated Financial Statements.
               


 
Page 8

 
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

                
 
Note 1.  Basis of Presentation
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and with instructions for Form 10-Q and Regulation S-X.  These financial statements include all adjustments (consisting of normal recurring accruals) which in the opinion of management are considered necessary for the fair presentation of the financial position and results of operations for the periods shown.  Certain prior year amounts may be reclassified to conform to the current year presentation.  The Company considers that it operates as one business segment, a commercial bank.

Operating results for the six month period ended June 30, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011.  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, 2010 filed with the Securities Exchange Commission on March 10, 2011.

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

Note 2.
Earnings Per Share

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

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

 
   
Three months ended June 30,
   
Six months ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Common shares outstanding at the beginning of the period
    4,395,911       4,416,683       4,398,337       4,422,274  
Weighted average number of net shares redeemed
    (16,013 )     (3,200 )     (9,629 )     (5,828 )
    Weighted average shares outstanding (basic)
    4,379,898       4,413,483       4,388,708       4,416,446  
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method
    11,180       13,143       10,638       13,236  
    Weighted average number of shares
    4,391,078       4,426,626       4,399,346       4,429,682  
Net income (In Thousands)
  $ 7,953     $ 6,721     $ 14,131     $ 12,106  
                                 
Earnings per share:
                               
Basic
  $ 1.82     $ 1.52     $ 3.22     $ 2.74  
Diluted
  $ 1.81     $ 1.52     $ 3.21     $ 2.73  

 
Page 9


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

Note 3.  Recent Accounting Pronouncements and Recent Lesgislative Developments

Recent Accounting Pronouncements

On April 5, 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring, which provides additional guidance clarifying when the restructuring of a receivable should be considered a troubled debt restructuring (“TDR”).  The ASU provides additional guidance for determining whether the creditor has granted a concession and whether the debtor is experiencing financial difficulty.  The ASU also ends the deferral of activity based disclosures about TDRs and public entities will be required to disclose activity based information beginning in the period the ASU is adopted.  For the Company, this ASU is effective for interim and annual reporting periods beginning on or after June 15, 2011.  The Company is currently evaluating the impact the recently issued guidance will have to the consolidated financial statements.

On May 12, 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  This ASU provides guidance about how fair value should be determined where it already is required or permitted under IFRS or U.S. GAAP.  For U.S. GAAP, most of the changes are clarifications of existing guidance or wording changes to align with IFRS.  For the Company, this ASU is effective for interim and annual periods beginning after December 15, 2011.  The ASU will not have a material impact on the Company’s consolidated financial statements.

Recent Legislative Developments
 
Dodd-Frank Wall Street Reform and Consumer Protection Act.  The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was signed into law on July 21, 2010.  The Dodd-Frank Act represents the most sweeping financial services industry reform since the 1930’s.  Generally, the Dodd-Frank Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the Dodd-Frank Act.  The Dodd-Frank Act is expected to be fully phased in over twelve years.  Among other things, the Dodd-Frank Act may result in added costs of doing business and regulatory compliance burdens and affect competition among financial services entities.  Uncertainty exists as to the ultimate impact of many provisions of the Dodd-Frank Act, which could have a material adverse impact on the financial services industry as a whole and on the Company’s business, results of operations and financial condition.  Additional information, including a summary of certain provisions of the Dodd-Frank Act, is available on the Federal Deposit Insurance Corporation website at www.fdic.gov/regulations/reform/index.html.
 
 
 
 
Page 10

 
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
 
Note 4.   Loans

The composition of loans is as follows:
   
June 30, 2011
   
December 31, 2010
 
   
(Amounts In Thousands)
 
             
Agricultural
  $ 60,903     $ 65,004  
Commercial and financial
    143,381       141,619  
Real estate:
               
  Construction, 1 to 4 family residential
    23,645       25,232  
  Construction, land development and commercial
    84,077       86,552  
  Mortgage, farmland
    94,085       90,448  
  Mortgage, 1 to 4 family first liens
    550,427       519,533  
  Mortgage, 1 to 4 family junior liens
    105,469       109,036  
  Mortgage, multi-family
    210,674       202,630  
  Mortgage, commercial
    308,262       302,020  
Loans to individuals
    20,122       23,627  
Tax exempt
    30,983       24,959  
    $ 1,632,028     $ 1,590,660  
Less allowance for loan losses
    29,260       29,230  
    $ 1,602,768     $ 1,561,430  

Changes in the allowance for loan losses and the allowance for loan losses applicable to impaired loans and the related loan balance of impaired loans for the six months ended June 30, 2011 were as follows:

   
Agricultural
   
Commercial and Financial
   
Real Estate: 
Construction
and land
development
   
Real Estate: 
Mortgage, farmland
   
Real Estate: 
Mortgage,
1 to 4 family
   
Real Estate: 
Mortgage,
multi-family
and
commercial
   
Other
   
Total
 
   
(Amounts In Thousands)
 
                                                 
Allowance for loan losses:
                                               
Beginning balance
  $ 1,759     $ 6,772     $ 4,408     $ 1,469     $ 8,840     $ 5,743     $ 829     $ 29,820  
     Charge-offs
    -       (367 )     (13 )     -       (619 )     (9 )     (87 )     (1,095 )
     Recoveries
    1       204       5       -       358       169       64       801  
     Provision
    (357 )     25       (189 )     (40 )     303       (26 )     18       (266 )
                                                                 
Ending balance
  $ 1,403     $ 6,634     $ 4,211     $ 1,429     $ 8,882     $ 5,877     $ 824     $ 29,260  
                                                                 
Ending balance, individually evaluated for impairment
  $ -     $ 26     $ -     $ 2     $ 69     $ 90     $ -     $ 187  
                                                                 
Ending balance, collectively evaluated for impairment
  $ 1,403     $ 6,608     $ 4,211     $ 1,427     $ 8,813     $ 5,787     $ 824     $ 29,073  
                                                                 
Loans:
                                                               
                                                                 
Ending balance
  $ 60,903     $ 143,381     $ 107,722     $ 94,085     $ 655,896     $ 518,936     $ 51,105     $ 1,632,028  
                                                                 
Ending balance, individually evaluated for impairment
    -       2,066       1,738       227       4,094       17,616       6       25,747  
                                                                 
Ending balance, collectively evaluated for impairment
    60,903       141,315       105,984       93,858       651,802       501,320       51,099       1,606,281  

 
Page 11

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

 
Note 4.  
Loans (continued)
 
Changes in the allowance for loan losses for the three months ended June 30, 2011 were as follows:
 
   
Agricultural
   
Commercial and Financial
   
Real Estate: Construction and land development
   
Real Estate: Mortgage, farmland
   
Real Estate: Mortgage, 1 to 4 family
   
Real Estate: Mortgage, multi-family and commercial
   
Other
   
Total
 
   
(Amounts In Thousands)
 
Allowance for loan losses:
                                               
Beginning balance
  $ 1,759     $ 6,772     $ 4,408     $ 1,469     $ 8,840     $ 5,743     $ 829     $ 29,820  
     Charge-offs
    -       (367 )     (13 )     -       (619 )     (9 )     (87 )     (1,095 )
     Recoveries
    1       204       5       -       358       169       64       801  
     Provision
    (357 )     25       (189 )     (40 )     303       (26 )     18       (266 )
                                                                 
Ending balance
  $ 1,403     $ 6,634     $ 4,211     $ 1,429     $ 8,882     $ 5,877     $ 824     $ 29,260  
 
Changes in the allowance for loan losses for the three and six months ended June 30, 2010 (amounts in thousands) are as follows:
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2010
 
             
Balance, beginning
  $ 29,840     $ 29,160  
Charge-offs:
               
  Agricultural
    -       8  
  Commercial and financial
    937       1,821  
  Real estate:
               
    Construction and land development
    576       732  
    Mortgage, farmland
    26       39  
    Mortgage, 1 to 4 family
    1,028       1,446  
    Mortgage, multi-family and commercial
    348       536  
  Other
    126       207  
      3,041       4,789  
                 
Recoveries:
               
  Agricultural
    3       5  
  Commercial and financial
    288       439  
  Real estate:
               
    Construction and land development
    1       2  
    Mortgage, farmland
    -       -  
    Mortgage, 1 to 4 family
    289       373  
    Mortgage, multi-family and commercial
    48       79  
  Other
    69       163  
      698       1,061  
  Net charge-offs
    2,343       3,728  
  Provision charged to expense
    853       2,918  
  Balance, ending
  $ 28,350     $ 28,350  

 
 
 
Page 12

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

Note 4.  
Loans (continued)

The following table presents the credit quality indicators by type of loans in each category as of June 30, 2011 and December 31, 2010, respectively (amounts in thousands):


   
Agricultural
       
Commercial and
Financial
       
Real Estate: 
Construction, 1 to 4
family residential
   
Real Estate: 
Construction, land development
and commercial
 
June 30, 2011
                       
Grade:
                       
     Pass
  $ 50,059     $ 114,002     $ 20,803     $ 61,309  
     Potential Watch
    1,166       4,523       -       6,549  
     Watch
    6,904       14,333       2,344       5,159  
     Substandard
    2,774       10,523       498       11,060  
Total
  $ 60,903     $ 143,381     $ 23,645     $ 84,077  
                                 
       
Real Estate: 
Mortgage, farmland
       
Real Estate: 
Mortgage, 1 to 4
family first liens
       
Real Estate: 
Mortgage, 1 to 4
family junior liens
   
Real Estate: 
Mortgage,
multi-family
 
June 30, 2011
                               
Grade:
                               
     Pass
  $ 84,428     $ 485,193     $ 93,552     $ 169,930  
     Potential Watch
    1,425       17,632       3,461       11,504  
     Watch
    3,307       23,870       4,341       13,875  
     Substandard
    4,925       23,732       4,115       15,365  
Total
  $ 94,085     $ 550,427     $ 105,469     $ 210,674  
                                 
       
Real Estate: 
Mortgage,
commercial
   
Loans to
individuals
   
Tax exempt
   
Total
 
June 30, 2011
                               
Grade:
                               
     Pass
  $ 258,071     $ 19,279     $ 30,916     $ 1,387,542  
     Potential Watch
    9,734       289       -       56,283  
     Watch
    33,888       264       67       108,352  
     Substandard
    6,569       290       -       79,851  
Total
  $ 308,262     $ 20,122     $ 30,983     $ 1,632,028  
                                 

 
Page 13


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

Note 4.  
Loans (continued)
 
   
Agricultural
       
Commercial and
Financial
       
Real Estate: 
Construction, 1 to 4
family residential
   
Real Estate: 
Construction, land development
 and commercial
 
December 31, 2010
                       
Grade:
                       
     Pass
  $ 53,240     $ 109,345     $ 20,448     $ 65,494  
     Potential Watch
    465       2,818       -       3,620  
     Watch
    5,325       16,411       3,967       6,621  
     Substandard
    5,974       13,045       817       10,817  
Total
  $ 65,004     $ 141,619     $ 25,232     $ 86,552  
                                 
       
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, 2010
                               
Grade:
                               
     Pass
  $ 80,860     $ 459,651     $ 97,831     $ 167,254  
     Potential Watch
    3,453       12,658       3,071       8,808  
     Watch
    2,317       21,330       4,244       14,614  
     Substandard
    3,818       25,894       3,890       11,954  
Total
  $ 90,448     $ 519,533     $ 109,036     $ 202,630  
                                 
       
Real Estate: 
Mortgage,
commercial
   
Loans to individuals
   
Tax exempt
   
Total
 
December 31, 2010
                               
Grade:
                               
     Pass
  $ 248,805     $ 22,669     $ 24,887     $ 1,350,484  
     Potential Watch
    8,893       261       -       44,047  
     Watch
    36,002       404       72       111,307  
     Substandard
    8,320       293       -       84,822  
Total
  $ 302,020     $ 23,627     $ 24,959     $ 1,590,660  

The below are descriptions of the credit quality indicators:

Pass – Pass rated loans are supported by sound payment capacity, are adequately collateralized and have no apparent weaknesses that would affect the full repayment of the loan under the established terms and conditions.

Potential Watch – Potential watch rated loans are supported by adequate payment capacity, are adequately collateralized and are performing according to the established terms and conditions.  However, the loan requires more than average monitoring due to a potential weakness.  The potential watch indicator assists the Company in identifying and monitoring loans for which credit quality could deteriorate.

 
Page 14


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

Note 4.  
Loans (continued)

Watch – Watch rated loans are supported by a marginal payment capacity and may be marginally collateralized.  There are identified weaknesses that if not monitored and corrected may adversely affect the Company’s credit position.  A watch 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.

Past due loans as of June 30, 2011 and December 31, 2010 were as follows:

               
90 Days
               
Total
   
Accruing Loans
 
   
30 - 59 Days
   
60 - 89 Days
   
or More
   
Total Past
         
Loans
   
Past Due 90
 
   
Past Due
   
Past Due
   
Past Due
   
Due
   
Current
   
Receivable
   
Days or More
 
   
(Amounts In Thousands)
 
                                           
June 30, 2011
                                         
Agriculture
  $ 132     $ 84     $ -     $ 216     $ 60,687     $ 60,903     $ -  
Commercial and financial
    1,017       212       491       1,720       141,661       143,381       128  
Real estate: