HILLS BANCORPORATION - FORM 10-Q - November 7, 2017

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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 September 30, 2017

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 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 filer  o
Accelerated Filer                     þ   
Non-accelerated filer    o
Small Reporting Company     o
Emerging Growth Company    o
 

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).

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
October 31, 2017
 
 
Common Stock, no par value
9,339,712
 
 
 
 


HILLS BANCORPORATION
Index to Form 10-Q

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

Page 3



HILLS BANCORPORATION CONSOLIDATED BALANCE SHEETS (Amounts In Thousands, Except Share Amounts) 
 
September 30, 2017
 
December 31, 2016
ASSETS
(Unaudited)
 
Cash and cash equivalents
$
36,792

 
$
38,197

Investment securities available for sale at fair value (amortized cost September 30, 2017 $253,689; December 31, 2016 $269,039)
254,984

 
267,537

Stock of Federal Home Loan Bank
16,126

 
12,413

Loans held for sale
6,717

 
9,806

Loans, net of allowance for loan losses (September 30, 2017 $29,350; December 31, 2016 $26,530)
2,391,430

 
2,251,445

Property and equipment, net
37,799

 
37,859

Tax credit real estate investment
10,016

 
10,563

Accrued interest receivable
11,484

 
9,121

Deferred income taxes, net
12,871

 
12,611

Other real estate
144

 
237

Goodwill
2,500

 
2,500

Other assets
2,906

 
3,481

Total Assets
$
2,783,769

 
$
2,655,770

 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

 
 
 
 
Liabilities
 

 
 

Noninterest-bearing deposits
$
349,883

 
$
348,505

Interest-bearing deposits
1,723,159

 
1,687,807

Total deposits
$
2,073,042

 
$
2,036,312

Other borrowings
13,761

 
33,489

Federal Home Loan Bank borrowings
323,000

 
235,000

Accrued interest payable
1,079

 
984

Other liabilities
20,850

 
19,934

Total Liabilities
$
2,431,732

 
$
2,325,719

 
 
 
 
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)
$
42,471

 
$
40,781

 
 
 
 
STOCKHOLDERS' EQUITY
 

 
 

Common stock, no par value; authorized 20,000,000 shares; issued September 30, 2017 10,318,906 shares; December 31, 2016 10,227,178 shares
$
—

 
$
—

Paid in capital
49,194

 
44,606

Retained earnings
337,380

 
319,982

Accumulated other comprehensive loss
(1,339
)
 
(3,359
)
Treasury stock at cost (September 30, 2017 1,000,774 shares; December 31, 2016 962,951 shares)
(33,198
)
 
(31,178
)
Total Stockholders' Equity
$
352,037

 
$
330,051

Less maximum cash obligation related to ESOP shares
42,471

 
40,781

Total Stockholders' Equity Less Maximum Cash Obligations Related to ESOP Shares
$
309,566

 
$
289,270

Total Liabilities & Stockholders' Equity
$
2,783,769

 
$
2,655,770


See Notes to Consolidated Financial Statements.

Page 4

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Amounts In Thousands, Except Per Share Amounts)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Interest income:
 
 
 
 
 
 
 
Loans, including fees
$
25,643

 
$
23,626

 
$
74,378

 
$
68,974

Investment securities:
 

 
 

 
 
 
 
Taxable
437

 
362

 
1,237

 
1,080

Nontaxable
783

 
786

 
2,425

 
2,414

Federal funds sold
9

 
6

 
145

 
124

Total interest income
$
26,872

 
$
24,780

 
$
78,185

 
$
72,592

Interest expense:
 

 
 

 
 
 
 
Deposits
$
2,319

 
$
1,917

 
$
6,730

 
$
5,742

Short-term borrowings
100

 
70

 
149

 
127

FHLB borrowings
2,233

 
1,935

 
5,938

 
6,224

Total interest expense
$
4,652

 
$
3,922

 
$
12,817

 
$
12,093

Net interest income
$
22,220

 
$
20,858

 
$
65,368

 
$
60,499

Provision for loan losses
130

 
(1,832
)
 
1,827

 
(2,004
)
Net interest income after provision for loan losses
$
22,090

 
$
22,690

 
$
63,541

 
$
62,503

Noninterest income:
 

 
 

 
 
 
 
Net gain on sale of loans
$
423

 
$
602

 
$
1,119

 
$
1,437

Trust fees
1,980

 
1,731

 
5,883

 
5,185

Service charges and fees
2,197

 
2,243

 
6,557

 
6,516

Net gain on sale of other real estate owned and other repossessed assets
33

 
342

 
89

 
376

Other noninterest income
372

 
396

 
1,599

 
1,541

 
$
5,005

 
$
5,314

 
$
15,247

 
$
15,055

 
 
 
 
 
 
 
 
Noninterest expenses:
 

 
 

 
 
 
 
Salaries and employee benefits
$
8,134

 
$
8,158

 
$
24,707

 
$
22,617

Occupancy
1,087

 
1,017

 
3,148

 
3,001

Furniture and equipment
1,491

 
1,350

 
4,356

 
4,111

Office supplies and postage
516

 
436

 
1,487

 
1,282

Advertising and business development
628

 
800

 
2,123

 
2,426

Outside services
2,077

 
1,845

 
5,943

 
5,386

FDIC insurance assessment
217

 
315

 
636

 
938

Other noninterest expense
671

 
510

 
2,033

 
1,585

 
$
14,821

 
$
14,431

 
$
44,433

 
$
41,346

Income before income taxes
$
12,274

 
$
13,573

 
$
34,355

 
$
36,212

Income taxes
3,722

 
4,397

 
10,472

 
11,369

Net income
$
8,552

 
$
9,176

 
$
23,883

 
$
24,843

 
 
 
 
 
 
 
 
Earnings per share:
 

 
 

 
 
 
 
Basic
$
0.92

 
$
0.99

 
$
2.56

 
$
2.67

Diluted
$
0.92

 
$
0.99

 
$
2.56

 
$
2.67

 
See Notes to Consolidated Financial Statements.

Page 5

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

 
Three Months Ended September 30,
Nine Months Ended September 30,
 
2017
 
2016
2017
 
2016
Net income
$
8,552

 
$
9,176

$
23,883

 
$
24,843

 
 
 
 
 
 
 
Other comprehensive income (loss)
 

 
 

 
 
 
Securities:
 

 
 

 
 
 
Net change in unrealized (loss) gain on securities available for sale
$
(302
)
 
$
(1,090
)
$
2,797

 
$
1,104

Reclassification adjustment for net gains realized in net income
—

 
—

—

 
—

Income taxes
116

 
417

(1,070
)
 
(423
)
Other comprehensive (loss) income on securities available for sale
$
(186
)
 
$
(673
)
$
1,727

 
$
681

Derivatives used in cash flow hedging relationships:
 

 
 

 
 
 
Net change in unrealized gain (loss) on derivatives
$
259

 
$
500

$
474

 
$
(1,931
)
Income taxes
(99
)
 
(192
)
(181
)
 
738

Other comprehensive income (loss) on cash flow hedges
$
160

 
$
308

$
293

 
$
(1,193
)
 
 
 
 
 
 
 
Other comprehensive (loss) income, net of tax
$
(26
)
 
$
(365
)
$
2,020

 
$
(512
)
 
 
 
 
 
 
 
Comprehensive income
$
8,526

 
$
8,811

$
25,903

 
$
24,331

 
See Notes to Consolidated Financial Statements.

Page 6

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, 2015
$
43,697

 
$
294,487

 
$
(1,195
)
 
$
(27,252
)
 
$
(37,562
)
 
$
272,175

Issuance of 7,646 shares of common stock
348

 
—

 
—

 
—

 
—

 
348

Issuance of 3,482 shares of common stock under the employee stock purchase plan
154

 
—

 
—

 
—

 
—

 
154

Unearned restricted stock compensation
112

 
—

 
—

 
—

 
—

 
112

Forfeiture of 1,264 shares of common stock
(52
)
 
—

 
—

 
—

 
—

 
(52
)
Share-based compensation
22

 
—

 
—

 
—

 
—

 
22

Income tax benefit related to share-based compensation
64

 
—

 
—

 
—

 
—

 
64

Change related to ESOP shares
—

 
—

 
—

 
—

 
(2,220
)
 
(2,220
)
Net income
—

 
24,843

 
—

 
—

 
—

 
24,843

Cash dividends ($0.65 per share)
—

 
(6,060
)
 
—

 
—

 
—

 
(6,060
)
Purchase of 62,266 shares of common stock
—

 
—

 
—

 
(2,819
)
 
—

 
(2,819
)
Other comprehensive loss
—

 
—

 
(512
)
 
—

 
—

 
(512
)
Balance, September 30, 2016
$
44,345

 
$
313,270

 
$
(1,707
)
 
$
(30,071
)
 
$
(39,782
)
 
$
286,055

 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2016
$
44,606

 
$
319,982

 
$
(3,359
)
 
$
(31,178
)
 
$
(40,781
)
 
$
289,270

Issuance of 92,621 shares of common stock
4,208

 
—

 
—

 
55

 
—

 
4,263

Issuance of 4,483 shares of common stock under the employee stock purchase plan
210

 
—

 
—

 
—

 
—

 
210

Unearned restricted stock compensation
277

 
—

 
—

 
—

 
—

 
277

Forfeiture of 2,934 shares of common stock
(118
)
 
—

 
—

 
—

 
—

 
(118
)
Share-based compensation
11

 
—

 
—

 
—

 
—

 
11

Change related to ESOP shares
—

 
—

 
—

 
—

 
(1,690
)
 
(1,690
)
Net income
—

 
23,883

 
—

 
—

 
—

 
23,883

Cash dividends ($0.70 per share)
—

 
(6,485
)
 
—

 
—

 
—

 
(6,485
)
Purchase of 40,265 shares of common stock
—

 
—

 
—

 
(2,075
)
 
—

 
(2,075
)
Other comprehensive income
—

 
—

 
2,020

 
—

 
—

 
2,020

Balance, September 30, 2017
$
49,194

 
$
337,380

 
$
(1,339
)
 
$
(33,198
)
 
$
(42,471
)
 
$
309,566

 
See Notes to Consolidated Financial Statements.

Page 7

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

 
Nine Months Ended 
 September 30,
 
2017
 
2016
Cash Flows from Operating Activities
 
 
 
Net income
$
23,883

 
$
24,843

Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
 

 
 

Depreciation
2,270

 
2,182

Provision for loan losses
1,827

 
(2,004
)
Share-based compensation
11

 
22

Forfeiture of common stock
(118
)
 
(52
)
Compensation expensed through issuance of common stock
208

 
348

Excess tax benefits from share-based compensation
—

 
(64
)
Provision for deferred income taxes
(1,513
)
 
54

Net gain on sale of other real estate owned and other repossessed assets
(89
)
 
(376
)
Increase in accrued interest receivable
(2,363
)
 
(1,867
)
Amortization of premium on investment securities, net
437

 
452

Decrease in other assets
1,049

 
650

Increase (decrease) in accrued interest payable and other liabilities
1,288

 
(92
)
Loans originated for sale
(109,522
)
 
(151,545
)
Proceeds on sales of loans
113,730

 
150,047

Net gain on sales of loans
(1,119
)
 
(1,437
)
Net cash and cash equivalents provided by operating activities
$
29,979

 
$
21,161

 
 
 
 
Cash Flows from Investing Activities
 

 
 

Proceeds from maturities of investment securities available for sale
$
48,937

 
$
46,148

Purchases of investment securities available for sale
(37,735
)
 
(31,456
)
Loans made to customers, net of collections
(141,994
)
 
(97,285
)
Proceeds on sale of other real estate owned and other repossessed assets
364

 
764

Purchases of property and equipment
(2,210
)
 
(4,180
)
Income from tax credit real estate, net
547

 
545

Net cash and cash equivalents used in investing activities
$
(132,091
)
 
$
(85,464
)
 
 
 
 
Cash Flows from Financing Activities
 

 
 

Net increase in deposits
$
36,730

 
$
105,710

Net decrease in other borrowings
(19,728
)
 
(4,148
)
Net increase (decrease) in FHLB borrowings
88,000

 
(15,000
)
Issuance of common stock, net of costs
3,762

 
—

Stock options exercised
238

 
—

Excess tax benefits related to share-based compensation
—

 
64

Issuance of treasury stock
55

 
—

Purchase of treasury stock
(2,075
)
 
(2,819
)
Proceeds from the issuance of common stock through the employee stock purchase plan
210

 
154

Dividends paid
(6,485
)
 
(6,060
)
Net cash and cash equivalents provided by financing activities
$
100,707

 
$
77,901

 

Page 8

(Continued)

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) (Amounts In Thousands)
 
Nine Months Ended 
 September 30,
 
2017
 
2016
(Decrease) increase in cash and cash equivalents
$
(1,405
)
 
$
13,598

Cash and cash equivalents:
 

 
 

Beginning of period
38,197

 
35,427

End of period
$
36,792

 
$
49,025

 
 
 
 
Supplemental Disclosures
 

 
 

Cash payments for:
 

 
 

Interest paid to depositors
$
6,635

 
$
5,776

Interest paid on other obligations
6,087

 
6,351

Income taxes paid
10,530

 
10,201

 
 
 
 
Noncash activities:
 

 
 

Increase in maximum cash obligation related to ESOP shares
$
1,690

 
$
2,220

Transfers to other real estate owned
182

 
310

Sale and financing of other real estate owned
262

 
135

 
See Notes to Consolidated Financial Statements.



Page 9

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 nine month period ended September 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2017.  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, 2016 filed with the Securities Exchange Commission on March 3, 2017.  The consolidated balance sheet as of December 31, 2016, 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.

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. For financial institutions, significant changes are not expected given that most financial instruments are not in the scope of the accounting standard update. ASU 2014-09 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. In August 2015, FASB issued ASU 2015-14 deferring the effective date for annual periods and interim periods within those annual periods after December 15, 2017. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company has evaluated all of its noninterest income streams and contracts to determine potential impact. The adoption of ASU 2014-09 by the Company will not have a material impact.

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 adoption of ASU 2016-01 by the Company is not expected to have a material impact.

In February 2016, the FASB issued ASU No. 2016-02 (Topic 842), Leases. The ASU provides guidance requiring lessees to recognize right-of-use 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 is in the process of analyzing a comprehensive list of lease agreements. The adoption of ASU 2016-02 by the Company is not expected to have a material impact.


Page 10
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

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 adoption of ASU 2016-04 by the Company is not expected to have a material impact.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting. The ASU simplifies several aspects of the accounting for share-based payment transaction, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public companies, ASU 2016-09 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The Company adopted ASU 2016-09 for the period ending March 31, 2017. There was no material impact on the financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (CECL). The ASU changes the way entities recognize impairment of financial assets by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the "incurred loss" model required under current GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase our allowance. For public companies, ASU 2016-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, early adoption is permitted for the fiscal year beginning after December 15, 2018. The Company is in the process of implementing a software solution to assist in the analysis of historical loan data to determine the CECL model that will be implemented. We expect to recognize a one-time cumulative-effect adjustment to our allowance for loan losses as of the beginning of the first reporting period in which the new standard is adopted. 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.


Page 11
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

In March 2017, the FASB issued ASU No. 2017-08, Receivable - Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities. This ASU shortens the amortization period for certain callable debt securities held at a premium. The premium will be amortized to the earliest call date. For public companies, ASU 2017-08 is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2018. The Company adopted ASU 2017-08 for the period ending March 31, 2017. There was no material impact on the financial statements.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities. This ASU requires companies to change the recognition and presentation of the effects of hedge accounting by eliminating the requirement to separately measure and report hedge ineffectiveness and requiring companies to present all of the elements of hedge accounting that affect earnings in the same income statement line as the hedged item. Furthermore, the standard eases the requirements for effectiveness testing, hedge documentation and applying the critical terms match method and introduces new alternatives that will permit companies to reduce the risk of material error corrections if they misapply the shortcut method. For public companies, ASU 2017-12 is effective for fiscal years, and interim periods within those fiscal years beginning after December 15, 2018. The adoption of ASU 2017-12 by the Company is not expected to have a material impact.


Note 2.
Earnings Per Share

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

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

 
Three Months Ended September 30,
Nine Months Ended September 30,
 
2017
 
2016
2017
 
2016
Common shares outstanding at the beginning of the period
9,329,514

 
9,283,341

9,264,227

 
9,322,054

Weighted average number of net shares (redeemed) issued
(4,596
)
 
(7,633
)
64,144

 
(31,950
)
Weighted average shares outstanding (basic)
9,324,918

 
9,275,708

9,328,371

 
9,290,104

Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method
3,559

 
6,584

4,874

 
6,357

Weighted average number of shares (diluted)
9,328,477

 
9,282,292

9,333,245

 
9,296,461

Net income (In thousands)
$
8,552

 
$
9,176

$
23,883

 
$
24,843

Earnings per share:
 

 
 

 

 
 

Basic
$
0.92

 
$
0.99

$
2.56

 
$
2.67

Diluted
$
0.92

 
$
0.99

$
2.56

 
$
2.67



Page 12
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 September 30, 2017 and December 31, 2016:

 
September 30,
2017

December 31, 2016
 
(amounts in thousands)
Net unrealized gain (loss) on available-for-sale securities
$
1,295

 
$
(1,502
)
Net unrealized loss on derivatives used for cash flow hedges
(3,464
)
 
(3,938
)
Tax effect
$
830

 
$
2,081

Net-of-tax amount
$
(1,339
)
 
$
(3,359
)
 
Note 4.
Securities

The carrying values of investment securities at September 30, 2017 and December 31, 2016 are summarized in the following table (dollars in thousands):

 
September 30, 2017
 
December 31, 2016
 
Amount
 
Percent
 
Amount
 
Percent
Securities available for sale
 
 
 
 
 
 
 
U.S. Treasury
$
39,894

 
15.65
%
 
$
27,482

 
10.27
%
Other securities (FHLB, FHLMC and FNMA)
48,759

 
19.12

 
61,660

 
23.05

State and political subdivisions
166,331

 
65.23

 
178,395

 
66.68

Total securities available for sale
$
254,984

 
100.00
%
 
$
267,537

 
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 September 30, 2017 or December 31, 2016. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of September 30, 2017 and December 31, 2016 (in thousands):

 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated Fair
Value
September 30, 2017:
 
 
 
 
 
 
 
U.S. Treasury
$
39,823

 
$
90

 
$
(19
)
 
$
39,894

Other securities (FHLB, FHLMC and FNMA)
48,992

 
11

 
(244
)
 
48,759

State and political subdivisions
164,874

 
1,721

 
(264
)
 
166,331

Total
$
253,689

 
$
1,822

 
$
(527
)
 
$
254,984

December 31, 2016:
 

 
 

 
 

 
 

U.S. Treasury
$
27,418

 
$
82

 
$
(18
)
 
$
27,482

Other securities (FHLB, FHLMC and FNMA)
62,047

 
65

 
(452
)
 
61,660

State and political subdivisions
179,574

 
626

 
(1,805
)
 
178,395

Total
$
269,039

 
$
773

 
$
(2,275
)
 
$
267,537



Page 13
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 September 30, 2017, were as follows (in thousands):
 
 
Amortized
Cost
 
Fair Value
Due in one year or less
$
42,320

 
$
42,423

Due after one year through five years
138,727

 
139,316

Due after five years through ten years
72,022

 
72,625

Due over ten years
620

 
620

Total
$
253,689

 
$
254,984


As of September 30, 2017 investment securities with a carrying value of $30.46 million were pledged to collateralize repurchase agreements, derivative financial instruments, and other borrowings.

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 September 30, 2017 and December 31, 2016 (in thousands):

 
Less than 12 months
 
12 months or more
 
Total
September 30, 2017
Description of Securities
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
U.S. Treasury
4

 
$
10,006

 
$
(19
)
 
0.19
%
 
—

 
$
—

 
$
—

 
—
%
 
4

 
$
10,006

 
$
(19
)
 
0.19
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other securities (FHLB, FHLMC and FNMA)
11

 
26,539

 
(81
)
 
0.31

 
4

 
10,208

 
(163
)
 
1.60

 
15

 
36,747

 
(244
)
 
0.66

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and political subdivisions
45

 
11,566

 
(66
)
 
0.57

 
65

 
15,212

 
(198
)
 
1.30

 
110

 
26,778

 
(264
)
 
0.99

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
60

 
$
48,111

 
$
(166
)
 
0.35
%
 
69

 
$
25,420

 
$
(361
)
 
1.42
%
 
129

 
$
73,531

 
$
(527
)
 
0.72
%

 
Less than 12 months
 
12 months or more
 
Total
December 31, 2016
Description of Securities
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
U.S. Treasury
2

 
$
4,957

 
$
(18
)
 
0.36
%
 
—

 
$
—

 
$
—

 
—
%
 
2

 
$
4,957

 
$
(18
)
 
0.36
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other securities (FHLB, FHLMC and FNMA)
14

 
34,648

 
(452
)
 
1.30

 
—

 
—

 
—

 
—

 
14

 
34,648

 
(452
)
 
1.30

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and political subdivisions
365

 
87,841

 
(1,762
)
 
2.01

 
11

 
1,486

 
(43
)
 
2.89

 
376

 
89,327

 
(1,805
)
 
2.02

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
381

 
$
127,446

 
$
(2,232
)
 
1.75
%
 
11

 
$
1,486

 
$
(43
)
 
2.89
%
 
392

 
$
128,932

 
$
(2,275
)
 
1.76
%


Page 14
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

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.  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:

 
September 30,
2017
 
December 31,
2016
 
(Amounts In Thousands)
Agricultural
$
76,484

 
$
92,871

Commercial and financial
214,199

 
192,995

Real estate:
 
 
 
Construction, 1 to 4 family residential
73,404

 
57,864

Construction, land development and commercial
107,170

 
121,561

Mortgage, farmland
208,982

 
202,340

Mortgage, 1 to 4 family first liens
823,529

 
767,469

Mortgage, 1 to 4 family junior liens
137,271

 
125,400

Mortgage, multi-family
335,439

 
302,831

Mortgage, commercial
359,332

 
334,198

Loans to individuals
26,223

 
25,157

Obligations of state and political subdivisions
57,861

 
54,462

 
$
2,419,894

 
$
2,277,148

Net unamortized fees and costs
886

 
827

 
$
2,420,780

 
$
2,277,975

Less allowance for loan losses
29,350

 
26,530

 
$
2,391,430

 
$
2,251,445



Page 15
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 nine months ended September 30, 2017 were as follows:
 
Three Months Ended September 30, 2017
 
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
$
2,341

 
$
4,586

 
$
3,165

 
$
4,009

 
$
8,340

 
$
5,414

 
$
1,095

 
$
28,950

Charge-offs
(27
)
 
(21
)
 
—

 
(3
)
 
(55
)
 
(86
)
 
(113
)
 
(305
)
Recoveries
56

 
219

 
33

 
—

 
203

 
7

 
57

 
575

Provision
92

 
(43
)
 
(182
)
 
2

 
98

 
107

 
56

 
130

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
2,462

 
$
4,741

 
$
3,016

 
$
4,008

 
$
8,586

 
$
5,442

 
$
1,095

 
$
29,350

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Nine Months Ended September 30, 2017
 
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
$
2,947

 
$
4,531

 
$
2,890

 
$
3,417

 
$
7,677

 
$
4,045

 
$
1,023

 
$
26,530

Charge-offs
(66
)
 
(478
)
 
(114
)
 
(3
)
 
(263
)
 
(130
)
 
(410
)
 
(1,464
)
Recoveries
123

 
882

 
443

 
—

 
570

 
236

 
203

 
2,457

Provision
(542
)
 
(194
)
 
(203
)
 
594

 
602

 
1,291

 
279

 
1,827

 


 


 


 


 


 


 


 


Ending balance
$
2,462

 
$
4,741

 
$
3,016

 
$
4,008

 
$
8,586

 
$
5,442

 
$
1,095

 
$
29,350

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment
$
653

 
$
913

 
$
46

 
$
784

 
$
110

 
$
409

 
$
85

 
$
3,000

 

 

 

 

 

 

 

 

Ending balance, collectively evaluated for impairment
$
1,809

 
$
3,828

 
$
2,970

 
$
3,224

 
$
8,476

 
$
5,033

 
$
1,010

 
$
26,350

 


 


 


 


 


 


 


 


Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
76,484

 
$
214,199

 
$
180,574

 
$
208,982

 
$
960,800

 
$
694,771

 
$
84,084

 
$
2,419,894

 


 


 


 


 


 


 


 


Ending balance, individually evaluated for impairment
$
6,181

 
$
2,985

 
$
1,161

 
$
8,179

 
$
7,097

 
$
8,097

 
$
85

 
$
33,785

 

 

 

 

 

 

 

 

Ending balance, collectively evaluated for impairment
$
70,303

 
$
211,214

 
$
179,413

 
$
200,803

 
$
953,703

 
$
686,674

 
$
83,999

 
$
2,386,109


Page 16
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Changes in the allowance for loan losses for the three and nine months ended September 30, 2016 were as follows:
 
Three Months Ended September 30, 2016
 
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
$
2,997

 
$
4,011

 
$
2,898

 
$
3,927

 
$
8,226

 
$
4,201

 
$
1,030

 
$
27,290

Charge-offs
(19
)
 
(38
)
 
—

 
(105
)
 
(176
)
 
—

 
(140
)
 
(478
)
Recoveries
—

 
289

 
186

 
—

 
276

 
358

 
51

 
1,160

Provision
201

 
(252
)
 
(75
)
 
(204
)
 
(425
)
 
(589
)
 
(86
)
 
(1,832
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
2,777

 
$
4,010

 
$
3,009

 
$
3,618

 
$
7,901

 
$
3,970

 
$
855

 
$
26,140

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016
 
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
$
3,082

 
$
4,517

 
$
2,280

 
$
3,342

 
$
8,172

 
$
4,223

 
$
894

 
$
26,510

Charge-offs
(44
)
 
(172
)
 
—

 
(116
)
 
(704
)
 
(66
)
 
(416
)