HILLS BANCORPORATION - FORM 10-Q - May 4, 2018

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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 March 31, 2018

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
April 30, 2018
 
 
Common Stock, no par value
9,374,917
 
 
 
 


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) 
 
March 31, 2018
 
December 31, 2017
ASSETS
(Unaudited)
 
Cash and cash equivalents
$
244,097

 
$
154,353

Investment securities available for sale at fair value (amortized cost March 31, 2018 $303,339; December 31, 2017 $286,296)
299,941

 
285,155

Stock of Federal Home Loan Bank
12,973

 
15,005

Loans held for sale
5,584

 
5,162

Loans, net of allowance for loan losses (March 31, 2018 $28,910; December 31, 2017 $29,400)
2,423,915

 
2,431,165

Property and equipment, net
37,687

 
37,857

Tax credit real estate investment
9,686

 
10,076

Accrued interest receivable
11,365

 
10,772

Deferred income taxes, net
8,803

 
8,806

Goodwill
2,500

 
2,500

Other assets
2,657

 
2,509

Total Assets
$
3,059,208

 
$
2,963,360

 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

 
 
 
 
Liabilities
 

 
 

Noninterest-bearing deposits
$
365,042

 
$
363,817

Interest-bearing deposits
2,076,735

 
1,924,748

Total deposits
$
2,441,777

 
$
2,288,565

Other borrowings
—

 
—

Federal Home Loan Bank borrowings
235,000

 
295,000

Accrued interest payable
1,310

 
1,290

Other liabilities
20,824

 
23,481

Total Liabilities
$
2,698,911

 
$
2,608,336

 
 
 
 
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)
$
45,779

 
$
43,308

 
 
 
 
STOCKHOLDERS' EQUITY
 

 
 

Common stock, no par value; authorized 20,000,000 shares; issued March 31, 2018 10,322,064 shares; December 31, 2017 10,320,315 shares
$
—

 
$
—

Paid in capital
51,720

 
48,930

Retained earnings
345,940

 
341,558

Accumulated other comprehensive loss
(3,875
)
 
(2,446
)
Treasury stock at cost (March 31, 2018 943,650 shares; December 31, 2017 985,161 shares)
(33,488
)
 
(33,018
)
Total Stockholders' Equity
$
360,297

 
$
355,024

Less maximum cash obligation related to ESOP shares
45,779

 
43,308

Total Stockholders' Equity Less Maximum Cash Obligations Related to ESOP Shares
$
314,518

 
$
311,716

Total Liabilities & Stockholders' Equity
$
3,059,208

 
$
2,963,360


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 March 31,
 
2018
 
2017
Interest income:
 
 
 
Loans, including fees
$
26,028

 
$
23,890

Investment securities:
 

 
 

Taxable
563

 
393

Nontaxable
889

 
833

Federal funds sold
551

 
64

Total interest income
$
28,031

 
$
25,180

Interest expense:
 

 
 

Deposits
$
3,864

 
$
2,128

Short-term borrowings
—

 
22

FHLB borrowings
1,874

 
1,833

Total interest expense
$
5,738

 
$
3,983

Net interest income
$
22,293

 
$
21,197

Provision for loan losses
(765
)
 
(814
)
Net interest income after provision for loan losses
$
23,058

 
$
22,011

Noninterest income:
 

 
 

Net gain on sale of loans
$
331

 
$
316

Trust fees
2,641

 
1,879

Service charges and fees
2,228

 
2,132

Other noninterest income
428

 
914

 
$
5,628

 
$
5,241

 
 
 
 
Noninterest expenses:
 

 
 

Salaries and employee benefits
$
8,284

 
$
7,980

Occupancy
1,101

 
1,042

Furniture and equipment
1,474

 
1,429

Office supplies and postage
434

 
461

Advertising and business development
630

 
790

Outside services
2,578

 
2,008

FDIC insurance assessment
218

 
207

Other noninterest expense
537

 
494

 
$
15,256

 
$
14,411

Income before income taxes
$
13,430

 
$
12,841

Income taxes
2,572

 
3,967

Net income
$
10,858

 
$
8,874

 
 
 
 
Earnings per share:
 

 
 

Basic
$
1.16

 
$
0.95

Diluted
$
1.16

 
$
0.95

 
See Notes to Consolidated Financial Statements.

Page 5

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

 
Three Months Ended March 31,
 
2018
 
2017
Net income
$
10,858

 
$
8,874

 
 
 
 
Other comprehensive income (loss)
 

 
 

Securities:
 

 
 

Net change in unrealized loss on securities available for sale
$
(2,257
)
 
$
1,373

Reclassification adjustment for net gains realized in net income
—

 
—

Income taxes
563

 
(526
)
Other comprehensive (loss) income on securities available for sale
$
(1,694
)
 
$
847

Derivatives used in cash flow hedging relationships:
 

 
 

Net change in unrealized loss on derivatives
$
1,054

 
$
349

Income taxes
(263
)
 
(133
)
Other comprehensive income on cash flow hedges
$
791

 
$
216

 
 
 
 
Other comprehensive (loss) income, net of tax
$
(903
)
 
$
1,063

 
 
 
 
Comprehensive income
$
9,955

 
$
9,937

 
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)
 
Unearned ESOP
Shares
 
Treasury Stock
 
Maximum Cash
Obligation Related
To ESOP Shares
 
Total
Balance, December 31, 2016
$
44,606

 
$
319,982

 
$
(3,359
)
 
$
—

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

Issuance of 84,638 shares of common stock
3,966

 
—

 
—

 
—

 
—

 
—

 
3,966

Unearned restricted stock compensation
96

 
—

 
—

 
—

 
—

 
—

 
96

Forfeiture of 1,234 shares of common stock
(48
)
 
 
 
 
 
 
 
 
 
 
 
(48
)
Share-based compensation
12

 
—

 
—

 
—

 
—

 
—

 
12

Income tax benefit related to share-based compensation
44

 
—

 
—

 
—

 
—

 
—

 
44

Change related to ESOP shares
—

 
—

 
—

 
—

 
—

 
(2,560
)
 
(2,560
)
Net income
—

 
8,874

 
—

 
—

 
—

 
—

 
8,874

Cash dividends ($0.70 per share)
—

 
(6,485
)
 
—

 
—

 
—

 
—

 
(6,485
)
Purchase of 9,346 shares of common stock
—

 
—

 
—

 
—

 
(465
)
 
—

 
(465
)
Other comprehensive income
—

 
—

 
1,063

 
—

 
—

 
—

 
1,063

Balance, March 31, 2017
$
48,676

 
$
322,371

 
$
(2,296
)
 
$
—

 
$
(31,643
)
 
$
(43,341
)
 
$
293,767

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
$
48,930

 
$
341,558

 
$
(2,446
)
 
$
—

 
$
(33,018
)
 
$
(43,308
)
 
$
311,716

Issuance of 88,943 shares of common stock
2,580

 
—

 
—

 
—

 
2,224

 
—

 
4,804

Issuance of 1,957 shares of common stock under the employee stock purchase plan
100

 
—

 
—

 
—

 
—

 
—

 
100

Unearned restricted stock compensation
118

 
—

 
—

 
—

 
—

 
—

 
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

 
See Notes to Consolidated Financial Statements.

Page 7

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

 
Three Months Ended 
 March 31,
 
2018
 
2017
Cash Flows from Operating Activities
 
 
 
Net income
$
10,858

 
$
8,874

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

 
 

Depreciation
821

 
757

Provision for loan losses
(765
)
 
(814
)
Share-based compensation
—

 
12

Forfeiture of common stock
(8
)
 
(48
)
Compensation expensed through issuance of common stock
91

 
85

Excess tax benefits from share-based compensation
—

 
(44
)
Provision for deferred income taxes
303

 
(104
)
Net gain on sale of other real estate owned and other repossessed assets
(2
)
 
(34
)
Increase in accrued interest receivable
(593
)
 
(1,165
)
Amortization of premium on investment securities, net
134

 
151

(Increase) decrease in other assets
(86
)
 
1,241

(Decrease) increase in accrued interest payable and other liabilities
(1,465
)
 
2,704

Loans originated for sale
(31,571
)
 
(23,735
)
Proceeds on sales of loans
31,480

 
32,201

Net gain on sales of loans
(331
)
 
(316
)
Net cash and cash equivalents provided by operating activities
$
8,866

 
$
19,765

 
 
 
 
Cash Flows from Investing Activities
 

 
 

Proceeds from maturities of investment securities available for sale
$
10,711

 
$
8,206

Purchases of investment securities available for sale
(25,856
)
 
(13,049
)
Loans made to customers, net of collections
7,953

 
(29,401
)
Proceeds on sale of other real estate owned and other repossessed assets
2

 
172

Purchases of property and equipment
(651
)
 
(1,233
)
Income from tax credit real estate, net
390

 
24

Net cash and cash equivalents used in investing activities
$
(7,451
)
 
$
(35,281
)
 
 
 
 
Cash Flows from Financing Activities
 

 
 

Net increase in deposits
$
153,212

 
$
137,020

Net decrease in other borrowings
—

 
(5,403
)
Net decrease in FHLB borrowings
(60,000
)
 
—

Issuance of common stock, net of costs
4,713

 
3,762

Stock options exercised
—

 
119

Excess tax benefits related to share-based compensation
—

 
44

Purchase of treasury stock
(2,694
)
 
(465
)
Proceeds from the issuance of common stock through the employee stock purchase plan
100

 
—

Dividends paid
(7,002
)
 
(6,485
)
Net cash and cash equivalents provided by financing activities
$
88,329

 
$
128,592

 
(Continued)


Page 8

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) (Amounts In Thousands)
 
Three Months Ended 
 March 31,
 
2018
 
2017
Increase in cash and cash equivalents
$
89,744

 
$
113,076

Cash and cash equivalents:
 

 
 

Beginning of period
154,353

 
38,197

End of period
$
244,097

 
$
151,273

 
 
 
 
Supplemental Disclosures
 

 
 

Cash payments for:
 

 
 

Interest paid to depositors
$
3,844

 
$
2,172

Interest paid on other obligations
1,874

 
1,855

Income taxes paid
—

 
—

 
 
 
 
Noncash activities:
 

 
 

Increase in maximum cash obligation related to ESOP shares
$
2,471

 
$
2,560

Transfers to other real estate owned
62

 
95

Sale and financing of other real estate owned
—

 
214

 
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 three month period ended March 31, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2018.  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, 2017 filed with the Securities Exchange Commission on March 5, 2018.  The consolidated balance sheet as of December 31, 2017, 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.

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, 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 did not have a material impact and required additional disclosures on our material noninterest income streams discussed in revenue recognition above.

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

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 6 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 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.

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

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

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

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 adoption of ASU 2017-12 by the Company is not expected to have a material impact.

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.

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 March 31,
 
2018
 
2017
Common shares outstanding at the beginning of the period
9,335,154

 
9,264,227

Weighted average number of net shares issued
48,969

 
61,124

Weighted average shares outstanding (basic)
9,384,123

 
9,325,351

Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method
3,890

 
6,190

Weighted average number of shares (diluted)
9,388,013

 
9,331,541

Net income (In thousands)
$
10,858

 
$
8,874

Earnings per share:
 

 
 

Basic
$
1.16

 
$
0.95

Diluted
$
1.16

 
$
0.95



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 March 31, 2018 and December 31, 2017:

 
March 31,
2018

December 31, 2017
 
(amounts in thousands)
Net unrealized loss on available-for-sale securities
$
(3,398
)
 
$
(1,141
)
Net unrealized loss on derivatives used for cash flow hedges
(1,765
)
 
(2,819
)
Tax effect
$
1,288

 
$
1,514

Net-of-tax amount
$
(3,875
)
 
$
(2,446
)
 
Note 4.
Securities

The carrying values of investment securities at March 31, 2018 and December 31, 2017 are summarized in the following table (dollars in thousands):

 
March 31, 2018
 
December 31, 2017
 
Amount
 
Percent
 
Amount
 
Percent
Securities available for sale
 
 
 
 
 
 
 
U.S. Treasury
$
73,467

 
24.50
%
 
$
54,318

 
19.05
%
Other securities (FHLB, FHLMC and FNMA)
37,805

 
12.60

 
43,959

 
15.42

State and political subdivisions
188,669

 
62.90

 
186,878

 
65.53

Total securities available for sale
$
299,941

 
100.00
%
 
$
285,155

 
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, 2018 or December 31, 2017. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of March 31, 2018 and December 31, 2017 (in thousands):

 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Estimated Fair
Value
March 31, 2018:
 
 
 
 
 
 
 
U.S. Treasury
$
74,286

 
$
16

 
$
(835
)
 
$
73,467

Other securities (FHLB, FHLMC and FNMA)
38,451

 
—

 
(646
)
 
37,805

State and political subdivisions
190,602

 
307

 
(2,240
)
 
188,669

Total
$
303,339

 
$
323

 
$
(3,721
)
 
$
299,941

December 31, 2017:
 

 
 

 
 

 
 

U.S. Treasury
$
54,696

 
$
—

 
$
(378
)
 
$
54,318

Other securities (FHLB, FHLMC and FNMA)
44,470

 
1

 
(512
)
 
43,959

State and political subdivisions
187,130

 
722

 
(974
)
 
186,878

Total
$
286,296

 
$
723

 
$
(1,864
)
 
$
285,155


The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at March 31, 2018, were as follows (in thousands):
 

Page 13
HILLS BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

 
Amortized
Cost
 
Fair Value
Due in one year or less
$
54,989

 
$
54,927

Due after one year through five years
171,227

 
169,601

Due after five years through ten years
76,503

 
74,793

Due over ten years
620

 
620

Total
$
303,339

 
$
299,941


As of March 31, 2018 investment securities with a carrying value of $14.75 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 March 31, 2018 and December 31, 2017 (in thousands):

 
Less than 12 months
 
12 months or more
 
Total
March 31, 2018
Description of Securities
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
U.S. Treasury
27

 
$
66,186

 
$
(835
)
 
1.26
%
 
—

 
$
—

 
$
—

 
—
%
 
27

 
$
66,186

 
$
(835
)
 
1.26
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other securities (FHLB, FHLMC and FNMA)
6

 
15,389

 
(111
)
 
0.72

 
9

 
22,415

 
(535
)
 
2.39

 
15

 
37,804

 
(646
)
 
1.71

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and political subdivisions
375

 
93,917

 
(1,626
)
 
1.73

 
65

 
14,710

 
(614
)
 
4.17

 
440

 
108,627

 
(2,240
)
 
2.06

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
408

 
$
175,492

 
$
(2,572
)
 
1.47
%
 
74

 
$
37,125

 
$
(1,149
)
 
3.09
%
 
482

 
$
212,617

 
$
(3,721
)
 
1.75
%

 
Less than 12 months
 
12 months or more
 
Total
December 31, 2017
Description of Securities
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
U.S. Treasury
22

 
$
54,318

 
$
(378
)
 
0.70
%
 
—

 
$
—

 
$
—

 
—
%
 
22

 
$
54,318

 
$
(378
)
 
0.70
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other securities (FHLB, FHLMC and FNMA)
9

 
21,411

 
(83
)
 
0.39

 
9

 
22,547

 
(429
)
 
—

 
18

 
43,958

 
(512
)
 
1.16

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and political subdivisions
241

 
58,803

 
(573
)
 
0.97

 
65

 
14,944

 
(401
)
 
2.68

 
306

 
73,747

 
(974
)
 
1.32

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
272

 
$
134,532

 
$
(1,034
)
 
0.77
%
 
74

 
$
37,491

 
$
(830
)
 
2.21
%
 
346

 
$
172,023

 
$
(1,864
)
 
1.08
%

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.


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

Note 5.
Loans

Classes of loans are as follows:

 
March 31,
2018
 
December 31,
2017
 
(Amounts In Thousands)
Agricultural
$
83,940

 
$
88,580

Commercial and financial
214,004

 
218,632

Real estate:
 
 
 
Construction, 1 to 4 family residential
69,182

 
69,738

Construction, land development and commercial
97,579

 
109,595

Mortgage, farmland
218,462

 
215,286

Mortgage, 1 to 4 family first liens
836,528

 
831,591

Mortgage, 1 to 4 family junior liens
143,622

 
144,200

Mortgage, multi-family
327,101

 
336,810

Mortgage, commercial
378,475

 
361,196

Loans to individuals
26,105

 
26,417

Obligations of state and political subdivisions
56,927

 
57,626

 
$
2,451,925

 
$
2,459,671

Net unamortized fees and costs
900

 
894

 
$
2,452,825

 
$
2,460,565

Less allowance for loan losses
28,910

 
29,400

 
$
2,423,915

 
$
2,431,165



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 months ended March 31, 2018 were as follows:

Three Months Ended March 31, 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
—

 
(30
)
 
—

 
—

 
(121
)
 
(1
)
 
(115
)
 
(267
)
Recoveries
12

 
248

 
143

 
—

 
98

 
4

 
37

 
542

Provision
(53
)
 
(397
)
 
(352
)
 
40

 
10

 
91

 
(104
)
 
(765
)
 


 


 


 


 


 


 


 


Ending balance
$
2,253

 
$
4,658

 
$
2,780

 
$
3,709

 
$
8,655

 
$
5,794

 
$
1,061

 
$
28,910

 

 

 

 

 

 

 

 

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


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

Changes in the allowance for loan losses for the three months ended March 31, 2017 were as follows:
 
Three Months Ended March 31, 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
—

 
(220
)
 
—

 
—

 
(145
)
 
—

 
(188
)
 
(553
)
Recoveries
38

 
454

 
381

 
—

 
133

 
180

 
101

 
1,287

Provision
(480
)
 
(866
)
 
(177
)
 
90

 
507

 
133

 
(21
)
 
(814
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
2,505

 
$
3,899

 
$
3,094

 
$
3,507

 
$
8,172

 
$
4,358

 
$
915

 
$
26,450

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance, individually evaluated for impairment
$
587

 
$
144

 
$
72

 
$
345

 
$
62

 
$
15

 
$
36

 
$
1,261

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance, collectively evaluated for impairment
$
1,918

 
$
3,755

 
$
3,022

 
$
3,162

 
$
8,110

 
$
4,343

 
$
879

 
$
25,189

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
87,934

 
$
199,702

 
$
188,928

 
$
205,334

 
$
908,128

 
$
637,720

 
$
79,419

 
$
2,307,165

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance, individually evaluated for impairment
$
11,388

 
$
1,787

 
$
671

 
$
8,502

 
$
5,521

 
$
2,034

 
$
36

 
$
29,939

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance, collectively evaluated for impairment
$
76,546

 
$
197,915

 
$
188,257

 
$
196,832

 
$
902,607

 
$
635,686

 
$
79,383

 
$
2,277,226




Page 17
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, 2018 and December 31, 2017, respectively (amounts in thousands):

 
Agricultural
 
Commercial and
Financial
 
Real Estate:
Construction, 1 to 4
family residential
 
Real Estate:
Construction, land
development and
commercial
March 31, 2018
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
3,689

 
$
6,945

 
$
—

 
$
402

Good
15,466

 
48,859

 
7,230

 
13,558

Satisfactory
39,522

 
116,447

 
42,716

 
34,167

Monitor
17,266

 
27,303

 
17,425

 
44,571

Special Mention
1,626

 
9,441

 
1,811

 
3,913

Substandard
6,371

 
5,009

 
—

 
968

Total
$
83,940

 
$
214,004

 
$
69,182

 
$
97,579


 
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, 2018
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
4,742

 
$
2,213

 
$
486

 
$
19,152

Good
52,865

 
30,810

 
4,255

 
69,322

Satisfactory
113,520

 
691,400

 
130,370

 
196,419

Monitor
33,047

 
80,033

 
4,776

 
35,773

Special Mention
5,109

 
10,348

 
1,708

 
—

Substandard
9,179

 
21,724

 
2,027

 
6,435

Total
$
218,462

 
$
836,528

 
$
143,622

 
$
327,101


 
Real Estate:
Mortgage,
commercial
 
Loans to
individuals
 
Obligations of state and
political subdivisions
 
Total
March 31, 2018
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
31,653

 
$
—

 
$
8,626

 
$
77,908

Good
104,823

 
120

 
18,550

 
365,858

Satisfactory
187,871

 
25,047

 
26,230

 
1,603,709

Monitor
44,636

 
585

 
3,521

 
308,936

Special Mention
6,509

 
166

 
—

 
40,631

Substandard
2,983

 
187

 
—

 
54,883

Total
$
378,475

 
$