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EX-32 - EXHIBIT 32 - HILLS BANCORPORATIONexhibit3263018.htm
EX-31 - EXHIBIT 31 - HILLS BANCORPORATIONexhibit3163018.htm

 
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, 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
July 31, 2018
 
 
Common Stock, no par value
9,352,074
 
 
 
 



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) 
 
June 30, 2018
 
December 31, 2017
ASSETS
(Unaudited)
 
Cash and cash equivalents
$
148,231

 
$
154,353

Investment securities available for sale at fair value (amortized cost June 30, 2018 $292,170; December 31, 2017 $286,296)
288,501

 
285,155

Stock of Federal Home Loan Bank
12,173

 
15,005

Loans held for sale
5,757

 
5,162

Loans, net of allowance for loan losses (June 30, 2018 $29,510; December 31, 2017 $29,400)
2,474,291

 
2,431,165

Property and equipment, net
38,046

 
37,857

Tax credit real estate investment
9,425

 
10,076

Accrued interest receivable
11,047

 
10,772

Deferred income taxes, net
8,921

 
8,806

Goodwill
2,500

 
2,500

Other assets
4,063

 
2,509

Total Assets
$
3,002,955

 
$
2,963,360

 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

 
 
 
 
Liabilities
 

 
 

Noninterest-bearing deposits
$
386,020

 
$
363,817

Interest-bearing deposits
2,010,990

 
1,924,748

Total deposits
$
2,397,010

 
$
2,288,565

Federal Home Loan Bank borrowings
215,000

 
295,000

Accrued interest payable
1,506

 
1,290

Other liabilities
19,147

 
23,481

Total Liabilities
$
2,632,663

 
$
2,608,336

 
 
 
 
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)
$
46,144

 
$
43,308

 
 
 
 
STOCKHOLDERS' EQUITY
 

 
 

Common stock, no par value; authorized 20,000,000 shares; issued June 30, 2018 10,321,836 shares; December 31, 2017 10,320,315 shares
$

 
$

Paid in capital
51,899

 
48,930

Retained earnings
356,003

 
341,558

Accumulated other comprehensive loss
(3,724
)
 
(2,446
)
Treasury stock at cost (June 30, 2018 948,170 shares; December 31, 2017 985,161 shares)
(33,886
)
 
(33,018
)
Total Stockholders' Equity
$
370,292

 
$
355,024

Less maximum cash obligation related to ESOP shares
46,144

 
43,308

Total Stockholders' Equity Less Maximum Cash Obligation Related to ESOP Shares
$
324,148

 
$
311,716

Total Liabilities & Stockholders' Equity
$
3,002,955

 
$
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 June 30,
Six Months Ended June 30,
 
2018
 
2017
2018
 
2017
Interest income:
 
 
 
 
 
 
Loans, including fees
$
26,968

 
$
24,845

$
52,996

 
$
48,735

Investment securities:
 

 
 

 
 
 
Taxable
682

 
407

1,245

 
800

Nontaxable
866

 
809

1,755

 
1,642

Federal funds sold
548

 
72

1,099

 
136

Total interest income
$
29,064

 
$
26,133

$
57,095

 
$
51,313

Interest expense:
 

 
 

 
 
 
Deposits
$
4,540

 
$
2,283

$
8,404

 
$
4,411

Short-term borrowings

 
27


 
49

FHLB borrowings
1,701

 
1,872

3,575

 
3,705

Total interest expense
$
6,241

 
$
4,182

$
11,979

 
$
8,165

Net interest income
$
22,823

 
$
21,951

$
45,116

 
$
43,148

Provision for loan losses
711

 
2,511

(54
)
 
1,697

Net interest income after provision for loan losses
$
22,112

 
$
19,440

$
45,170

 
$
41,451

Noninterest income:
 

 
 

 
 
 
Net gain on sale of loans
$
443

 
$
380

$
774

 
$
696

Trust fees
3,007

 
2,024

5,648

 
3,903

Service charges and fees
2,408

 
2,228

4,636

 
4,360

Other noninterest income
376

 
369

804

 
1,283

 
$
6,234

 
$
5,001

$
11,862

 
$
10,242

 
 
 
 
 
 
 
Noninterest expenses:
 

 
 

 
 
 
Salaries and employee benefits
$
8,823

 
$
8,593

$
17,107

 
$
16,573

Occupancy
1,022

 
1,019

2,123

 
2,061

Furniture and equipment
1,490

 
1,436

2,964

 
2,865

Office supplies and postage
461

 
510

895

 
971

Advertising and business development
607

 
705

1,237

 
1,495

Outside services
2,347

 
1,858

4,925

 
3,866

FDIC insurance assessment
213

 
212

431

 
419

Other noninterest expense
717

 
868

1,254

 
1,362

 
$
15,680

 
$
15,201

$
30,936

 
$
29,612

Income before income taxes
$
12,666

 
$
9,240

$
26,096

 
$
22,081

Income taxes
2,603

 
2,783

5,175

 
6,750

Net income
$
10,063

 
$
6,457

$
20,921

 
$
15,331

 
 
 
 
 
 
 
Earnings per share:
 

 
 

 

 
 

Basic
$
1.07

 
$
0.69

$
2.23

 
$
1.64

Diluted
$
1.07

 
$
0.69

$
2.23

 
$
1.64

 
See Notes to Consolidated Financial Statements.

Page 5


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

 
Three Months Ended June 30,
Six Months Ended June 30,
 
2018
 
2017
2018
 
2017
Net income
$
10,063

 
$
6,457

$
20,921

 
$
15,331

 
 
 
 
 
 
 
Other comprehensive income (loss)
 

 
 

 
 
 
Securities:
 

 
 

 
 
 
Net change in unrealized (loss) income on securities available for sale
$
(271
)
 
$
1,726

$
(2,528
)
 
$
3,099

Reclassification adjustment for net gains realized in net income

 


 

Income taxes
67

 
(660
)
630

 
(1,186
)
Other comprehensive (loss) income on securities available for sale
$
(204
)
 
$
1,066

$
(1,898
)
 
$
1,913

Derivatives used in cash flow hedging relationships:
 

 
 

 
 
 
Net change in unrealized income (loss) on derivatives
$
472

 
$
(134
)
$
1,526

 
$
215

Income taxes
(117
)
 
51

(380
)
 
(82
)
Other comprehensive income (loss) on cash flow hedges
$
355

 
$
(83
)
$
1,146

 
$
133

 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
$
151

 
$
983

$
(752
)
 
$
2,046

 
 
 
 
 
 
 
Comprehensive income
$
10,214

 
$
7,440

$
20,169

 
$
17,377

 
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 90,346 shares of common stock
4,139

 

 

 

 
4

 

 
4,143

Issuance of 2,402 shares of common stock under the employee stock purchase plan
113

 

 

 

 

 

 
113

Unearned restricted stock compensation
201

 

 

 

 

 

 
201

Forfeiture of 1,734 shares of common stock
(66
)
 
 
 
 
 
 
 
 
 
 
 
(66
)
Share-based compensation
97

 

 

 

 

 

 
97

Income tax benefit related to share-based compensation

 

 

 

 

 

 

Change related to ESOP shares

 

 

 

 

 
(1,266
)
 
(1,266
)
Net income

 
15,331

 

 

 

 

 
15,331

Cash dividends ($0.70 per share)

 
(6,486
)
 

 

 

 

 
(6,486
)
Purchase of 25,727 shares of common stock

 

 

 

 
(1,307
)
 

 
(1,307
)
Other comprehensive income

 

 
2,046

 

 

 

 
2,046

Balance, June 30, 2017
$
49,090

 
$
328,827

 
$
(1,313
)
 
$

 
$
(32,481
)
 
$
(42,047
)
 
$
302,076

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
$
48,930

 
$
341,558

 
$
(2,446
)
 
$

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

Issuance of 93,254 shares of common stock
2,721

 

 

 

 
2,331

 

 
5,052

Issuance of 4,283 shares of common stock under the employee stock purchase plan
214

 

 

 

 

 

 
214

Unearned restricted stock compensation
165

 

 

 

 

 

 
165

Forfeiture of 2,762 shares of common stock
(131
)
 

 

 

 

 

 
(131
)
Change related to ESOP shares

 

 

 

 

 
(2,836
)
 
(2,836
)
Net income

 
20,921

 

 

 

 

 
20,921

Cash dividends ($0.75 per share)

 
(7,002
)
 

 

 

 

 
(7,002
)
Reclassification of stranded tax effects due to the Tax Cuts and Jobs Act

 
526

 
(526
)
 

 

 

 

Purchase of 56,263 shares of common stock

 

 

 

 
(3,199
)
 

 
(3,199
)
Other comprehensive loss

 

 
(752
)
 

 

 

 
(752
)
Balance, June 30, 2018
$
51,899

 
$
356,003

 
$
(3,724
)
 
$

 
$
(33,886
)
 
$
(46,144
)
 
$
324,148

 
See Notes to Consolidated Financial Statements.

Page 7


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

 
Six Months Ended 
 June 30,
 
2018
 
2017
Cash Flows from Operating Activities
 
 
 
Net income
$
20,921

 
$
15,331

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

 
 

Depreciation
1,642

 
1,514

Provision for loan losses
(54
)
 
1,697

Share-based compensation

 
97

Forfeiture of common stock
(131
)
 
(66
)
Compensation expensed through issuance of common stock
339

 
139

Provision for deferred income taxes
135

 
(1,412
)
Net gain on sale of other real estate owned and other repossessed assets
(6
)
 
(56
)
Increase in accrued interest receivable
(275
)
 
(726
)
Amortization of premium on investment securities, net
258

 
296

(Increase) decrease in other assets
(1,541
)
 
843

(Decrease) increase in accrued interest payable and other liabilities
(2,427
)
 
938

Loans originated for sale
(73,464
)
 
(65,166
)
Proceeds on sales of loans
73,643

 
68,762

Net gain on sales of loans
(774
)
 
(696
)
Net cash and cash equivalents provided by operating activities
$
18,266

 
$
21,495

 
 
 
 
Cash Flows from Investing Activities
 

 
 

Proceeds from maturities of investment securities available for sale
$
42,728

 
$
39,396

Purchases of investment securities available for sale
(46,028
)
 
(22,433
)
Loans made to customers, net of collections
(43,134
)
 
(93,045
)
Proceeds on sale of other real estate owned and other repossessed assets
55

 
239

Purchases of property and equipment
(1,831
)
 
(1,662
)
Income from tax credit real estate, net
651

 
286

Net cash and cash equivalents used in investing activities
$
(47,559
)
 
$
(77,219
)
 
 
 
 
Cash Flows from Financing Activities
 

 
 

Net increase in deposits
$
108,445

 
$
49,678

Net decrease in other borrowings

 
(21,213
)
Net (decrease) increase in FHLB borrowings
(80,000
)
 
30,000

Issuance of common stock, net of costs
4,713

 
3,766

Stock options exercised

 
238

Purchase of treasury stock
(3,199
)
 
(1,307
)
Proceeds from the issuance of common stock through the employee stock purchase plan
214

 
113

Dividends paid
(7,002
)
 
(6,486
)
Net cash and cash equivalents provided by financing activities
$
23,171

 
$
54,789

 
(Continued)


Page 8


HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) (Amounts In Thousands)
 
Six Months Ended 
 June 30,
 
2018
 
2017
Decrease in cash and cash equivalents
$
(6,122
)
 
$
(935
)
Cash and cash equivalents:
 

 
 

Beginning of period
154,353

 
38,197

End of period
$
148,231

 
$
37,262

 
 
 
 
Supplemental Disclosures
 

 
 

Cash payments for:
 

 
 

Interest paid to depositors
$
8,188

 
$
4,420

Interest paid on other obligations
3,575

 
3,754

Income taxes paid
4,357

 
6,851

 
 
 
 
Noncash activities:
 

 
 

Increase in maximum cash obligation related to ESOP shares
$
2,836

 
$
1,266

Transfers to other real estate owned
62

 
80

Sale and financing of other real estate owned

 
262

 
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 six month period ended June 30, 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, 2017. 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.

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

Page 10

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

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, the company should describe the status of its process to implement the new standards and the significant implementation matters yet to be addressed.


Page 11

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

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.

In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718), Improvements to Nonemployee Share-Based Payment Accounting. The amendments in this ASU expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. ASU 2018-07 is effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The adoption of ASU 2018-07 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 June 30,
Six Months Ended June 30,
 
2018
 
2017
2018
 
2017
Common shares outstanding at the beginning of the period
9,378,414

 
9,337,397

9,335,154

 
9,264,227

Weighted average number of net shares (redeemed) issued
(4,470
)
 
(2,552
)
52,041

 
65,871

Weighted average shares outstanding (basic)
9,373,944

 
9,334,845

9,387,195

 
9,330,098

Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method
4,162

 
4,551

3,996

 
5,299

Weighted average number of shares (diluted)
9,378,106

 
9,339,396

9,391,191

 
9,335,397

Net income (In thousands)
$
10,063

 
$
6,457

$
20,921

 
$
15,331

Earnings per share:
 

 
 

 

 
 

Basic
$
1.07

 
$
0.69

$
2.23

 
$
1.64

Diluted
$
1.07

 
$
0.69

$
2.23

 
$
1.64



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 June 30, 2018 and December 31, 2017:

 
June 30,
2018

December 31, 2017
 
(amounts in thousands)
Net unrealized loss on available-for-sale securities
$
(3,669
)
 
$
(1,141
)
Net unrealized loss on derivatives used for cash flow hedges
(1,293
)
 
(2,819
)
Tax effect
$
1,238

 
$
1,514

Net-of-tax amount
$
(3,724
)
 
$
(2,446
)
 
Note 4.
Securities

The carrying values of investment securities at June 30, 2018 and December 31, 2017 are summarized in the following table (dollars in thousands):

 
June 30, 2018
 
December 31, 2017
 
Amount
 
Percent
 
Amount
 
Percent
Securities available for sale
 
 
 
 
 
 
 
U.S. Treasury
$
80,440

 
27.89
%
 
$
54,318

 
19.05
%
Other securities (FHLB, FHLMC and FNMA)
34,753

 
12.04

 
43,959

 
15.42

State and political subdivisions
173,308

 
60.07

 
186,878

 
65.53

Total securities available for sale
$
288,501

 
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 June 30, 2018 or December 31, 2017. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of June 30, 2018 and December 31, 2017 (in thousands):

 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Estimated Fair
Value
June 30, 2018:
 
 
 
 
 
 
 
U.S. Treasury
$
81,541

 
$
5

 
$
(1,106
)
 
$
80,440

Other securities (FHLB, FHLMC and FNMA)
35,426

 

 
(673
)
 
34,753

State and political subdivisions
175,203

 
239

 
(2,134
)
 
173,308

Total
$
292,170

 
$
244

 
$
(3,913
)
 
$
288,501

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






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 June 30, 2018, were as follows (in thousands):
 
 
Amortized
Cost
 
Fair Value
Due in one year or less
$
44,049

 
$
43,970

Due after one year through five years
175,532

 
173,535

Due after five years through ten years
71,768

 
70,175

Due over ten years
821

 
821

Total
$
292,170

 
$
288,501


As of June 30, 2018 investment securities with a carrying value of $14.72 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 June 30, 2018 and December 31, 2017 (in thousands):

 
Less than 12 months
 
12 months or more
 
Total
June 30, 2018
Description of Securities
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
 
#
 
Fair Value
 
Unrealized
Loss
 
%
U.S. Treasury
32

 
$
77,979

 
$
(1,106
)
 
1.42
%
 

 
$

 
$

 
%
 
32

 
$
77,979

 
$
(1,106
)
 
1.42
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other securities (FHLB, FHLMC and FNMA)
5

 
12,386

 
(116
)
 
0.94

 
9

 
22,367

 
(557
)
 
2.49

 
14

 
34,753

 
(673
)
 
1.94

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
State and political subdivisions
377

 
95,078

 
(1,503
)
 
1.58

 
68

 
15,635

 
(631
)
 
4.04

 
445

 
110,713

 
(2,134
)
 
1.93

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
414

 
$
185,443

 
$
(2,725
)
 
1.47
%
 
77

 
$
38,002

 
$
(1,188
)
 
3.13
%
 
491

 
$
223,445

 
$
(3,913
)
 
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. 

Page 14

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

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

Note 5.
Loans

Classes of loans are as follows:

 
June 30,
2018
 
December 31,
2017
 
(Amounts In Thousands)
Agricultural
$
81,171

 
$
88,580

Commercial and financial
219,693

 
218,632

Real estate:
 
 
 
Construction, 1 to 4 family residential
68,918

 
69,738

Construction, land development and commercial
115,452

 
109,595

Mortgage, farmland
227,124

 
215,286

Mortgage, 1 to 4 family first liens
862,818

 
831,591

Mortgage, 1 to 4 family junior liens
148,018

 
144,200

Mortgage, multi-family
318,244

 
336,810

Mortgage, commercial
380,862

 
361,196

Loans to individuals
26,607

 
26,417

Obligations of state and political subdivisions
53,965

 
57,626

 
$
2,502,872

 
$
2,459,671

Net unamortized fees and costs
929

 
894

 
$
2,503,801

 
$
2,460,565

Less allowance for loan losses
29,510

 
29,400

 
$
2,474,291

 
$
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 and six months ended June 30, 2018 were as follows:

 
Three Months Ended June 30, 2018
 
Agricultural
 
Commercial and
Financial
 
Real Estate:
Construction and
land development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family
 
Real Estate:
Mortgage, multi-
family and
commercial
 
Other
 
Total
 
(Amounts In Thousands)
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,253

 
$
4,658

 
$
2,780

 
$
3,709

 
$
8,655

 
$
5,794

 
$
1,061

 
$
28,910

Charge-offs
(5
)
 
(176
)
 

 

 
(205
)
 
(53
)
 
(108
)
 
(547
)
Recoveries
17

 
193

 
2

 
19

 
147

 
13

 
45

 
436

Provision
(194
)
 
365

 
272

 
(253
)
 
305

 
(57
)
 
273

 
711

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
2,071

 
$
5,040

 
$
3,054

 
$
3,475

 
$
8,902

 
$
5,697

 
$
1,271

 
$
29,510



Six Months Ended June 30, 2018
 
Agricultural
 
Commercial and
Financial
 
Real Estate:
Construction and
land development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4
family
 
Real Estate:
Mortgage, multi-
family and
commercial
 
Other
 
Total
 
(Amounts In Thousands)
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,294

 
$
4,837

 
$
2,989

 
$
3,669

 
$
8,668

 
$
5,700

 
$
1,243

 
$
29,400

Charge-offs
(5
)
 
(206
)
 

 

 
(326
)
 
(54
)
 
(223
)
 
(814
)
Recoveries
29

 
441

 
145

 
19

 
245

 
17

 
82

 
978

Provision
(247
)
 
(32
)
 
(80
)
 
(213
)
 
315

 
34

 
169

 
(54
)
 


 


 


 


 


 


 


 


Ending balance
$
2,071

 
$
5,040

 
$
3,054

 
$
3,475

 
$
8,902

 
$
5,697

 
$
1,271

 
$
29,510

 

 

 

 

 

 

 

 

Ending balance, individually evaluated for impairment
$
189

 
$
706

 
$
36

 
$
13

 
$
71

 
$
443

 
$
60

 
$
1,518

 

 

 

 

 

 

 

 

Ending balance, collectively evaluated for impairment
$
1,882

 
$
4,334

 
$
3,018

 
$
3,462

 
$
8,831

 
$
5,254

 
$
1,211

 
$
27,992

 


 


 


 


 


 


 


 


Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
81,171

 
$
219,693

 
$
184,370

 
$
227,124

 
$
1,010,836

 
$
699,106

 
$
80,572

 
$
2,502,872

 


 


 


 


 


 


 


 


Ending balance, individually evaluated for impairment
$
3,718

 
$
3,524

 
$
942

 
$
4,276

 
$
6,980

 
$
7,958

 
$
60

 
$
27,458

 

 

 

 

 

 

 

 

Ending balance, collectively evaluated for impairment
$
77,453

 
$
216,169

 
$
183,428

 
$
222,848

 
$
1,003,856

 
$
691,148

 
$
80,512

 
$
2,475,414


Page 16

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

Changes in the allowance for loan losses for the three and six months ended June 30, 2017 were as follows:

 
Three Months Ended June 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
$
2,505

 
$
3,899

 
$
3,094

 
$
3,507

 
$
8,172

 
$
4,358

 
$
915

 
$
26,450

Charge-offs
(39
)
 
(237
)
 
(114
)
 

 
(63
)
 
(43
)
 
(110
)
 
(606
)
Recoveries
29

 
210

 
29

 

 
234

 
49

 
44

 
595

Provision
(154
)
 
714

 
156

 
502

 
(3
)
 
1,050

 
246

 
2,511

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
$
2,341

 
$
4,586

 
$
3,165

 
$
4,009

 
$
8,340

 
$
5,414

 
$
1,095

 
$
28,950


 
Six Months Ended June 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
(39
)
 
(457
)
 
(114
)
 

 
(208
)
 
(43
)
 
(298
)