10-K 1 hbia2014123110k.htm 10-K HBIA 2014.12.31 10K
 
 
 
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
 
ý  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2014.
 
Commission File Number 0-12668
HILLS BANCORPORATION
(Exact name of Registrant as specified in its charter)
Iowa
 
42-1208067
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)
 
131 Main Street, Hills, Iowa 52235
(Address of principal executive offices)

Registrant's telephone number, including area code:  (319) 679-2291
Securities Registered pursuant to Section 12 (b) of the Act:  None
Securities Registered pursuant to Section 12 (g) of the Act:

No par value common stock
Title of Class

Indicate by check mark if the Registrant is well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No þ
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No þ

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes þ No­­­ o

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).  Yes þ No­­ o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Registrant S-K (§229.405 of this chapter) is not contained herein, and will not be contained to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
Large accelerated filer o Accelerated filer þ Non-accelerated filer o Smaller Reporting Company o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No þ

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2014, based on the most recent sale price of $77.50 per share, and 3,892,411 shares held was $301,661,853.  Common stock held by non-affiliates excludes 819,810 shares held by directors, executive officers, and under the Registrant’s Employee Stock Ownership Plan.

The number of shares outstanding of the Registrant's common stock as of February 28, 2015 is 4,689,094 shares of no par value common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement dated March 20, 2015 for the Annual Meeting of the Shareholders of the Registrant to be held April 20, 2015 (the Proxy Statement) are incorporated by reference in Part III of this Form 10-K.

 
 
 
 
 



HILLS BANCORPORATION
FORM 10-K

TABLE OF CONTENTS
 
 
PART I
 
Item 1.
 
 
 
 
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
 
PART II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
 
PART III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
 
PART IV
 
Item 15.




Page 2

PART I

References in this report to “we,” “us,” “our,” “Bank,” or the “Company” or similar terms refer to Hills Bancorporation and its subsidiary.

Item 1.
Business

GENERAL

Hills Bancorporation (the "Company") is a holding company principally engaged, through its subsidiary bank, in the business of banking.  The Company was incorporated December 12, 1982 and all operations are conducted within the state of Iowa.  The Company became owner of 100% of the outstanding stock of Hills Bank and Trust Company, Hills, Iowa (“Hills Bank and Trust” or the “Bank”) as of January 23, 1984 when stockholders of Hills Bank and Trust exchanged their shares for shares of the Company.  Effective July 1, 1996, the Company formed a new subsidiary, Hills Bank, which acquired for cash all the outstanding shares of a bank in Lisbon, Iowa.  Subsequently an office of Hills Bank was opened in Mount Vernon, Iowa, a community that is contiguous to Lisbon.  Effective November 17, 2000, Hills Bank was merged into the Bank.  On September 20, 1996, another subsidiary, Hills Bank Kalona, acquired cash and other assets and assumed the deposits of the Kalona, Iowa office of Boatmen's Bank Iowa, N.A.  Effective October 26, 2001, Hills Bank Kalona was merged into the Bank.

Through its internet website (www.hillsbank.com), the Company makes available the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, all amendments to those reports, and other filings with the Securities and Exchange Commission, as soon as reasonably practicable after they are filed or furnished.

The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers.  The Bank is actively engaged in all areas of commercial banking, including acceptance of demand, savings and time deposits; making commercial, real estate, agricultural and consumer loans; maintaining night and safe deposit facilities; and performing collection, exchange and other banking services tailored for individual customers.  The Bank administers estates, personal trusts, and pension plans and provides farm management, investment advisory and custodial services for individuals, corporations and nonprofit organizations.  In addition, the Bank earns substantial fees from originating mortgages that are sold on the secondary residential real estate market without mortgage servicing rights being retained.

Lending Activities

Real Estate Loans

Real estate loans totaled $1.635 billion and comprised 82.39% of the Bank’s loan portfolio as of December 31, 2014.  The Bank’s real estate loans include construction loans and mortgage loans.

Mortgage Loans.  The Bank offers residential, commercial and agricultural real estate loans.  As of December 31, 2014, mortgage loans totaled $1.512 billion and comprised 76.19% of the Bank’s loan portfolio.

Residential real estate loans totaled $782.96 million and were 39.44% of the Bank’s loan portfolio as of December 31, 2014.  These loans include first and junior liens on 1 to 4 family residences.  The Bank originates 1 to 4 family mortgage loans to individuals and businesses within its trade area.  The Bank sells certain mortgage loans to third parties on the secondary market.  For the loans sold on the secondary market, the Bank does not retain any percentage of ownership or servicing rights.  Interest rates for residential real estate mortgages are determined by competitive pricing factors on the secondary market and within the Bank’s trade area.  Collateral for residential real estate mortgages is generally the underlying property.  Generally, repayment of these loans is from monthly principal and interest payments from the borrower’s personal cash flows and liquidity, and collateral values are a function of residential real estate values in the markets that the Bank serves.

Commercial real estate loans totaled $321.60 million and were 16.20% of the Bank’s loan portfolio at December 31, 2014.  The Bank originates loans for commercial properties to individuals and businesses within its trade area.  The primary source of repayment is the cash flow generated by the collateral underlying the loan.  The secondary repayment source would be the liquidation of the collateral.  Generally, terms for commercial real estate loans range from one to five years with an amortization period of 25 years or less.  The Bank offers both fixed and variable rate loans for commercial real estate.


Page 3

Multi-family real estate loans totaled $245.21 million and were 12.36% of the Bank’s loan portfolio at December 31, 2014.  Multi-family real estate loans are made to individuals and businesses in the Bank’s trade area.  These loans are primarily secured by properties such as apartment complexes.  The primary source of repayment is the cash flow generated by the collateral underlying the loan.  The secondary repayment source would be the liquidation of the collateral.  Generally, terms for commercial real estate loans range from one to five years with an amortization period of 25 years or less.  Generally, interest rates for multi-family loans are fixed for the loan term.

Mortgage loans secured by farmland totaled $162.50 million and were 8.19% of the Bank’s loan portfolio at December 31, 2014.  Loans for farmland are made to individuals and businesses within the Bank’s trade area.  The primary source of repayment is the cash flow generated by the collateral underlying the loan.  The secondary repayment source would be the liquidation of the collateral.  Terms for real estate loans secured by farmland range from one to ten years with an amortization period of 25 years or less.  Generally, interest rates are fixed for mortgage loans secured by farmland.

Construction Loans.  The Bank offers loans both to individuals that are constructing personal residences and to real estate developers and building contractors for the acquisition of land for development and the construction of homes and commercial properties.  The Bank makes these loans to established borrowers in the Bank’s trade area.  Construction loans generally have a term of one year or less, with interest payable at maturity.  Interest rate arrangements are variable for construction projects.  Generally, collateral for construction loans is the underlying construction project.

As of December 31, 2014, construction loans for personal residences totaled $45.95 million and were 2.32% of the Bank’s loan portfolio.  Construction loans for land development and commercial projects totaled $77.02 million and were 3.88% of the Bank’s loan portfolio.  In total, construction loans totaled $122.97 million and were 6.20% of the Bank’s loan portfolio as of December 31, 2014.

Commercial and Financial Loans

The Bank’s commercial and financial loan portfolio totaled $174.74 million and comprised 8.80% of the total loan portfolio at December 31, 2014.  The Bank’s commercial and financial loans include loans to contractors, retailers and other businesses.  The Bank provides a wide range of business loans, including lines of credit for working capital and operational purposes and term loans for the acquisition of equipment.  Although most loans are made on a secured basis, loans may be made on an unsecured basis where warranted by the overall financial condition of the borrower.  Terms of commercial and financial loans generally range from one to five years.  Interest rates for commercial loans can be fixed or variable.

The Bank’s commercial and financial loans are primarily made based on the reported cash flow of the borrower and secondarily on the underlying collateral provided by the borrower.  The collateral support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of personal guarantees, if applicable.  The primary repayment risks of commercial loans are that the cash flows of the borrower may be unpredictable, and the collateral securing these loans may fluctuate in value.

Agricultural Loans

Agricultural loans include loans made to finance agricultural production and other loans to farmers and farming operations.  These loans totaled $97.65 million and constituted 4.92% of the total loan portfolio at December 31, 2014.  Agricultural loans, most of which are secured by crops and machinery, are provided to finance capital improvement and farm operations as well as acquisitions of livestock and machinery.  The ability of the borrower to repay may be affected by many factors outside of the borrower’s control including adverse weather conditions, loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations.  The ultimate repayment of agricultural loans is dependent upon the profitable operation or management of the agricultural entity.  Agricultural loans generally have a term of one year and may have a fixed or variable rate.

Consumer Lending

The Bank offers consumer loans including personal loans and automobile loans.  These consumer loans typically have shorter terms and lower balances.  At December 31, 2014, consumer loans totaled $21.34 million and were 1.08% of the Bank’s total loan portfolio.


Page 4

Loans to State and Political Subdivisions

Loans to State and Political Subdivisions include only tax-exempt loans. These loans totaled $55.73 million and comprised 2.81% of the Bank’s total loan portfolio at December 31, 2014.

Deposit Activities

The Bank’s primary funding source for its loan portfolio and other investments consist of the acceptance of demand savings and time deposits.

Average Daily Balances

The following tables show (1) average balances of assets, liabilities and stockholders’ equity, (2) interest income and expense on a tax equivalent basis, (3) interest rates and interest differential and (4) changes in interest income and expense.

AVERAGE BALANCES
(Average Daily Basis)
 
Years Ended December 31,
 
2014
 
2013
 
2012
 
(Amounts In Thousands)
ASSETS
 
 
 
 
 
Noninterest-bearing cash and cash equivalents
$
25,496

 
$
25,785

 
$
26,831

Interest-bearing cash and cash equivalents
13,895

 
29,047

 
52,724

Taxable securities
95,375

 
99,535

 
101,199

Nontaxable securities
149,947

 
132,688

 
118,008

Federal funds sold
20

 
19

 
18

Loans, net
1,870,128

 
1,738,960

 
1,677,642

Property and equipment, net
29,169

 
30,238

 
30,986

Other assets
45,293

 
46,306

 
55,007

 
$
2,229,323

 
$
2,102,578

 
$
2,062,415

LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

 
 

Noninterest-bearing demand deposits
$
259,602

 
$
241,697

 
$
225,284

Interest-bearing demand deposits
414,438

 
376,940

 
321,225

Savings deposits
564,940

 
481,108

 
419,098

Time deposits
516,169

 
559,687

 
611,260

Other borrowings
43,147

 
36,580

 
46,192

FHLB borrowings
129,521

 
125,000

 
173,900

Noninterest-bearing other liabilities
17,672

 
15,686

 
16,608

Interest-bearing other liabilities
2,687

 
2,740

 
2,805

Redeemable common stock held by Employee Stock Ownership Plan
32,073

 
30,145

 
29,271

Stockholders' equity
249,074

 
232,995

 
216,772

 
$
2,229,323

 
$
2,102,578

 
$
2,062,415

 
Other Information

The Bank’s business is not seasonal.  As of December 31, 2014, the Company had no employees and the Bank had 374 full-time and 54 part-time employees.

For additional discussion of the impact of the economy on the financial condition and results of operations of the Company, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.


Page 5

MARKET AREA

Johnson County

The Bank’s trade area includes the Johnson County communities of Iowa City, Coralville, Hills and North Liberty, located near Interstate 80 and Interstate 380 in Eastern Iowa.  These communities have a combined population of approximately 108,600.  Johnson County, Iowa has a population of approximately 140,100.  The University of Iowa in Iowa City has approximately 31,400 students and 35,900 full and part-time employees, including 8,100 employees of The University of Iowa Hospitals and Clinics.

Linn County

The Bank operates offices in the Linn County, Iowa communities of Lisbon, Marion, Mount Vernon and Cedar Rapids, Iowa.  Lisbon has a population of approximately 2,200 and Mount Vernon, located two miles from Lisbon, has a population of about 4,600.  Both communities are within easy commuting distances to Cedar Rapids and Iowa City, Iowa.  Cedar Rapids has a metropolitan population of approximately 165,700, including approximately 36,000 from adjoining Marion, Iowa and is located approximately 10 miles west of Lisbon, Iowa and approximately 25 miles north of Iowa City on Interstate 380.  The total population of Linn County is approximately 217,400.  The largest employer in the Cedar Rapids area is Rockwell Collins, Inc., manufacturer of communications instruments, with over 9,200 employees.

Washington County

The Bank has offices located in Kalona and Wellman, Iowa, which are in Washington County.  Kalona is located approximately 20 miles south of Iowa City.  Wellman is located approximately 5 miles west of Kalona.  Kalona has a population of approximately 2,800 and Wellman has a population of about 1,500.  The population of Washington County is approximately 22,000.  Both Kalona and Wellman are primarily agricultural communities, but are located within easy driving distance for employment in Iowa City, Coralville and North Liberty (combined population 108,600) and Washington, Iowa (population 7,400).  The Bank intends to open an office in Washington, Iowa by May, 2015.
 
COMPETITION

Competition among financial institutions in attracting and retaining deposits and making loans is intense.  Traditionally, the Company’s most direct competition for deposits has come from commercial banks, savings institutions and credit unions doing business in its areas of operation.  Increasingly, the Company has experienced additional competition for deposits from nonbanking sources, such as securities firms, insurance companies, money market mutual funds and financial services subsidiaries of commercial and manufacturing companies.  Competition for loans comes primarily from other commercial banks, savings institutions, consumer finance companies, credit unions, mortgage banking companies, insurance companies and other institutional lenders.  The Company competes primarily on the basis of products offered, customer service and price.  A number of institutions with which the Company competes enjoy the benefits of fewer regulatory constraints and lower cost structures including favorable income tax treatments.  Some have greater assets and capital than the Company does and, thus, are better able to compete on the basis of price than the Company is.  Technological advances, which may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties, could make it more difficult for the Company to compete in the future.


Page 6

The Bank is in direct competition for loans and deposits and financial services with a number of other banks and credit unions in Johnson, Linn and Washington County.  A comparison of the number of office locations and deposits in the three counties as of June, 2014 (most recent date of available data from the FDIC and national credit union websites) is as follows:
 
Johnson County
 
Linn County
 
Washington County
 
Offices
 
Deposits
(in millions)
 
Offices
 
Deposits
(in millions)
 
Offices
 
Deposits
(in millions)
Hills Bank and Trust Company
9

 
$
1,267

 
6

 
$
346

 
2

 
$
115

Branches of largest competing national bank
7

 
254

 
9

 
1,066

 
1

 
24

Largest competing independent bank
7

 
597

 
8

 
560

 
2

 
190

Largest competing credit union (1)
6

 
1,815

 
8

 
688

 
1

 
1

All other bank and credit union offices
27

 
816

 
78

 
3,033

 
8

 
215

Total Market in County
56

 
$
4,749

 
109

 
$
5,693

 
14

 
$
545


(1)
Deposit balance of the largest competing credit union in Johnson County and Linn County includes the credit union’s deposit balance for its entire trade area.  County specific deposit balances for the credit union are unavailable.

SUPERVISION AND REGULATION

Financial institutions and their holding companies are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions but also by the requirements of applicable state and federal statutes and regulations and the policies of various governmental regulatory authorities, including the Iowa Superintendent of Banking (the “Superintendent”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”), the Internal Revenue Service and state taxing authorities and the Securities and Exchange Commission (the “SEC”).  The effect of applicable statutes, regulations and regulatory policies can be significant and cannot be predicted with a high degree of certainty.

Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends.  The system of supervision and regulation applicable to the Company and its subsidiary Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds and the depositors, rather than the stockholders, of financial institutions.  The enforcement powers available to federal and state banking regulators are substantial and include, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions.

The following is a summary of the material elements of the regulatory framework applicable to the Company and its subsidiary Bank.  It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of the statutes, regulations and regulatory policies that are described.  As such, the following is qualified in its entirety by reference to the applicable statutes, regulations and regulatory policies.  Any change in applicable law, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiary Bank.

Regulation of the Company

General.  The Company, as the sole shareholder of the Bank, is a bank holding company.  As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the “BHCA”). According to Federal Reserve Board policy, bank/financial holding companies are expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each such subsidiary. This support may be required at times when a bank/financial holding company may not be able to provide support. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve.  The Company is also required to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the Company and its subsidiary as the Federal Reserve may require.


Page 7

Investments and Activities.  Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the shares of the other bank or bank holding company (unless it already owns or controls the majority of such shares), (ii) acquiring all or substantially all of the assets of another bank or (iii) merging or consolidating with another bank holding company.  Subject to certain conditions (including certain deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located.  On approving interstate acquisitions, however, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws which require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.

Investments and Activities (Continued) The BHCA also generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries.  This general prohibition is subject to a number of exceptions.  The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking . . . as to be a proper incident thereto.”  Under current regulations of the Federal Reserve, the Company either directly or through non-bank subsidiaries would be permitted to engage in a variety of banking-related businesses, including the operation of a thrift, sales and consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and mortgage banking and brokerage.  The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.

Federal law also prohibits any person from acquiring “control” of a bank holding company without prior notice to the appropriate federal bank regulator.  “Control” is defined in certain cases as the acquisition of 10% or more of the outstanding shares of a bank or a bank holding company depending on the circumstances surrounding the acquisition.

Regulatory Capital Requirements.  Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines.  If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.

The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital (common stockholder’s equity, non-cumulative perpetual preferred stock and minority interest in the equity accounts of consolidated subsidiaries), and the remainder may be Tier II supplementary capital (perpetual debt, intermediate-term preferred stock, cumulative perpetual, long-term and convertible preferred stock, and loan loss reserve up to a maximum of 1.25% of risk-weighted assets).  The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 4%.  Total risk-weighted assets are determined by weighting the assets according to their risk characteristics.

The risk-based and leverage standards described above are minimum requirements.  Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations.  For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentration of credit, nontraditional activities or securities trading activities.  Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios (i.e., Tier 1 capital less all intangible assets), well above the minimum levels.  Current Federal Reserve minimum requirements for a well-capitalized organization experiencing significant growth are a leverage ratio of 5%, a Tier 1 risk-based capital ratio of 6% and total risk-based capital ratio of 10%.  As of December 31, 2014, the Company had regulatory capital in excess of the Federal Reserve’s minimum and well-capitalized definition requirements, with a leverage ratio of 12.54%, with total Tier 1 risk-based capital ratio of 15.96% and a total risk-based capital ratio of 17.21%.


Page 8

In July 2013, the Officer of the Comptroller of the Currency and Board of Governors of the Federal Reserve System adopted a final rule implementing agreements reached by the Basel Committee on Banking Supervision in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems”(BASEL III).   The final rule also adopts changes to the agencies’ regulatory capital requirements that meet the requirements of section 171 and section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The rule implements a revised definition of regulatory capital, a new 4.50% common equity tier 1 minimum capital requirement, a 6.00% tier 1 capital requirement, and a tier 1 risk-based capital ratio of 8.00%.  The rule becomes effective on January 1, 2015. The Company expects to remain categorized as well capitalized under the final rule when it files its March 31, 2015 call report.

Dividends.  The ability of the Company to pay dividends to its shareholders is dependent upon the earnings and capital adequacy of its subsidiary Bank, which directly impact the ability of the Bank to pay dividends to the Company.  The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends.  The Iowa Business Corporation Act (“IBCA”) allows the Company to make distributions, including cash dividends, to its shareholders unless, after giving effect to such distributions, either (i) the Company would not be able to pay its debts as they become due in the ordinary course of business or (ii) the Company’s total assets would be less than the sum of its total liabilities plus the amount that would be needed to satisfy preferential shareholder rights, if any, that are superior to the rights of those receiving the distribution.  Additionally, the Federal Reserve has issued a policy statement with regard to the payment of cash dividends by bank holding companies.  The policy statement provides that a bank holding company should not pay cash dividends which exceed its net income or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing.  The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations.  Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.

Federal Securities Regulation.  The Company’s common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.

Regulation of the Bank

General. The Bank is an Iowa-chartered bank, the deposit accounts of which are insured by the FDIC.  As an Iowa-chartered, FDIC insured bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the Superintendent of Banking of the State of Iowa (the “Superintendent”), as the chartering authority for Iowa banks, and the FDIC, as the Bank’s primary federal regulator.

Deposit Insurance. The deposits of the Bank are insured up to regulatory limits set by the FDIC, and, accordingly in 2014, were subject to deposit insurance assessments based on the Federal Deposit Insurance Reform Act of 2005, as adopted and effective on April 21, 2006.  The FDIC maintains the Deposit Insurance Fund (“DIF”) by assessing depository institutions an insurance premium (assessment).  The amount assessed to each institution is based on the average total assets of the Company less average tangible equity as well as the degree of risk the institution poses to the DIF.  The FDIC assesses higher rates to those institutions that pose greater risks to the insurance fund.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation (FICO), a mixed-ownership government corporation established in the 1980’s to recapitalize the Federal Savings and Loan Insurance Corporation.  The current annualized assessment rate is 0.60 basis points, or approximately 0.15 basis points per quarter.  These assessments will continue until the FICO bonds mature in 2019.

Capital Requirements.  The Bank is an insured state bank, incorporated under the laws of the state of Iowa.  As such, the Bank is subject to regulation, supervision and periodic examination by the Superintendent of Banking of the State of Iowa (the “Superintendent”).  Among the requirements and restrictions imposed upon state banks by the Superintendent are the requirements to maintain reserves against deposits, restrictions on the nature and amount of loans, and restrictions relating to investments, opening of bank offices and other activities of state banks.  Changes in the capital structure of state banks are also approved by the Superintendent.  State banks must have a Tier 1 risk-based leverage ratio of 6.50% plus a fully funded loan loss reserve. In certain instances, the Superintendent may mandate higher capital, but the Superintendent has not imposed such a requirement on the Bank.  In determining the Tier 1 risk-based leverage ratio, the Superintendent uses total equity capital without unrealized securities gains and the allowance for loan losses less any intangible assets.   At December 31, 2014, the Tier 1 risk-based leverage ratio of the Bank was 12.51% and exceeded the ratio required by the Superintendent.


Page 9

Capital adequacy for banks took on an added dimension with the establishment of a formal system of prompt corrective action under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) which provides the federal banking regulators of the Bank with broad power to take prompt corrective action to resolve the problems of undercapitalized banking institutions.  The extent of the regulators’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation.  Under prompt corrective action, banks that are inadequately capitalized face a variety of mandatory and discretionary supervisory actions.  For example, “undercapitalized banks” must restrict asset growth, obtain prior approval for business expansion, and have an approved plan to restore capital.  “Critically undercapitalized banks” must be placed in receivership or conservatorship within 90 days unless some other action would result in lower long-term costs to the deposit insurance fund.

The actual amounts of risk-based capital and risk-based capital ratios as of December 31, 2014 and the minimum regulatory requirements for the Company and the Bank are presented below (amounts in thousands):
 
Actual
 
For Capital Adequacy Purposes
 
To Be Well Capitalized Under Prompt Corrective Action Provisions
 
Amount
 
Ratio
 
Ratio
 
Ratio
As of December 31, 2014:
 
 
 
 
 
 
 
Company:
 
 
 
 
 
 
 
Total risk-based capital
$
310,622

 
17.21
%
 
8.00
%
 
10.00
%
Tier 1 risk-based capital
288,047

 
15.96

 
4.00

 
6.00

Leverage ratio
288,047

 
12.54

 
4.00

 
5.00

Bank:
 

 
 

 
 

 
 

Total risk-based capital
310,066

 
17.19

 
8.00

 
10.00

Tier 1 risk-based capital
287,504

 
15.94

 
5.00

 
6.00

Leverage ratio
287,504

 
12.51

 
4.00

 
5.00


Supervisory Assessments.  All Iowa banks are required to pay supervisory assessments to the Superintendent to fund the Superintendent’s examination and supervision operations.  Effective July 1, 2002, the Superintendent changed the method of computation of the supervisory assessment from billing for each state examination completed based on an hourly rate, to billing on an annual basis based on the assets of the bank, the expected hours needed to conduct examinations of that size bank and an additional amount if more work is required.

Community Investment and Consumer Protection Laws.  The Community Reinvestment Act requires insured institutions to offer credit products and take other actions that respond to the credit needs of the community.  Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations.  These laws include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Fair Credit Opportunity Act, the Fair Debt Collection Act and the Home Mortgage Disclosure Act.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) signed by the President on July 21, 2010 posed a significant impact on financial regulations.  The Dodd-Frank Act created an independent regulatory body, the Bureau of Consumer Financial Protection (“Bureau”), with authority and responsibility to set rules and regulations for most consumer protection laws applicable to all banks – large and small - adds another regulator to scrutinize and police financial activities.    Transfer to the Bureau of all consumer financial protection functions for designated laws by the other federal agencies was completed on July 21, 2011.   The Bureau has responsibility for mortgage reform and enforcement, as well as broad new powers over consumer financial activities which could impact what consumer financial services would be available and how they are provided.   The following consumer protection laws are the designated laws that will fall under the Bureau’s rulemaking authority:  the Alternative Mortgage Transactions Parity Act of 1928, the Consumer Leasing Act of 1976, the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Billing Act, the Fair Credit Reporting Act subject to certain exclusions, the Fair Debt Collection Practices Act, the Home Owners Protection Act, certain privacy provisions of the Gramm-Leach-Bliley Act, the Home Mortgage Disclosure Act (HMDA), the Home Ownership and Equity Protection Act of 1994, the Real Estate Settlement Procedures Act (RESPA), the S.A.F.E. Mortgage Licensing Act of 2008 (SAFE Act), and the Truth in Lending Act.



Page 10

Dividends.  The Iowa Banking Act provides that an Iowa bank may not pay dividends in an amount greater than its undivided profits. The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized.  As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2014.  Notwithstanding the availability of funds for dividends, however, the Superintendent may prohibit the payment of any dividends by the Bank if the Superintendent determines such payment would constitute an unsafe or unsound practice.  The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Bank.  The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends.  To maintain acceptable capital ratios in the Bank, certain of its retained earnings are not available for the payment of dividends.  To maintain a ratio of total risk-based capital to assets of 8%, $103.71 million of the Bank’s Tier 1 capital of $287.50 million as of December 31, 2014 are available for the payment of dividends to the Company.

Insider Transactions.  The Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company and its subsidiary, on investments in the stock or other securities of the Company and its subsidiary and the acceptance of the stock or other securities of the Company or its subsidiary as collateral for loans.  Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of the Company and its subsidiary, to principal stockholders of the Company, and to “related interests” of such directors, officers and principal stockholders.  In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal stockholder of the Company may obtain credit from banks with which the Bank maintains a correspondent relationship.

Safety and Soundness Standards.  The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions.  The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals.  If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance.  If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency.  Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances.  Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.

Branching Authority.  Historically, Iowa’s intrastate branching statutes have been rather restrictive when compared with those of other states.  Effective July 1, 2004, all limitations on bank office locations were repealed, which effectively allowed statewide branching.  Since that date, banks have been allowed to establish an unlimited number of offices in any location in Iowa subject only to regulatory approval.

Under the Riegle-Neal Act, both state and national banks are allowed to establish interstate branch networks through acquisitions of other banks, subject to certain conditions, including certain limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates.  The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state law.  The legislation allowed individual states to “opt-out” of certain provisions of the Riegle-Neal Act by enacting appropriate legislation prior to June 1, 1997.  Iowa permits interstate bank mergers, subject to certain restrictions, including a prohibition against interstate mergers involving an Iowa bank that has been in existence and continuous operation for fewer than five years.

State Bank Activities.  Under federal law and FDIC regulations, FDIC insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank.  Federal law and FDIC regulations also prohibit FDIC insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the Bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the Bank is a member.  These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.


Page 11

Financial Privacy.  In accordance with the Gramm-Leach-Bliley Financial Modernization Act of 1999 (the “GLB Act”), federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties.  These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party.  The privacy provisions of the GLB Act affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.

Anti-Money Laundering Initiatives and the USA Patriot Act.  A major focus of governmental policy on financial institutions has been aimed at combating money laundering and terrorist financing.  The USA PATRIOT Act of 2001 (the “USA Patriot Act”) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States.  The U. S. Treasury Department has issued a number of regulations that apply various requirements of the USA Patriot Act to financial institutions such as the Bank.  These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers.  Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.

Depositor Preference Statute.  In the "liquidation or other resolution" of an institution by any receiver, U.S. federal legislation provides that deposits and certain claims for administrative expenses and employee compensation against the insured depository institution would be afforded a priority over general unsecured claims against that institution, including federal funds and letters of credit.

Government Monetary Policy. The earnings of the Company are affected primarily by general economic conditions and to a lesser extent by the fiscal and monetary policies of the federal government and its agencies, particularly the Federal Reserve.  Its policies influence, to some degree, the volume of bank loans and deposits, and interest rates charged and paid thereon, and thus have an effect on the earnings of the Company's subsidiary Bank.

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


Page 12

Item 1A.
Risk Factors

The performance of our Company is subject to various risks.  We consider the risks described below to be the most significant risks we face, but such risks are not the only risk factors that could affect us.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition or results of operations.  For a discussion of the impact of risks on our financial condition and results of operations in recent years and on forward looking statements contained in this report, reference is made to Item 7 below.

We may be adversely affected by economic conditions in the local economies in which we conduct our operations, and in the United States in general.

The Bank’s primary markets include the Iowa counties of Johnson, Linn and Washington.  Johnson and Linn Counties have been one of the strongest economic areas in Iowa exhibiting substantial economic growth over the past ten years.  The unemployment rate for the Bank’s prime market area is favorable and the rate historically has been lower than the unemployment rates for both the United States and the State of Iowa.  However, unfavorable or uncertain economic and market conditions may adversely affect our business and profitability.  Our business faces various material risks, including credit risk and the risk that the demand for our products and services will decrease.  Decreases in consumer confidence, real estate values, interest rates and investment returns, usually associated with a downturn, could make the types of loans we originate less profitable and could increase our credit risk and litigation expense.  And while the presence of the University of Iowa and its affiliated institutions has a significant favorable impact upon the regional economy, it is unclear what impact the State budget and change in funding models will have on the University of Iowa and the University of Iowa Hospitals and Clinics.

We may be adversely impacted by recent legislation and potential additional legislation and rulemaking.

The 2008-2009 recession produced a number of new laws that impact financial institutions including the Dodd-Frank Act.  The Dodd-Frank Act established the Consumer Financial Protection Bureau (the “CFPB”) and granted it the broad authority to administer and enforce a new federal regulatory framework of consumer financial regulation.  In particular, the liquidity, capital and stress testing requirements of Basel III and the CFPB could negatively impact operations.  Any changes to state and federal banking laws and regulations may negatively impact our ability to expand services and to increase the value of our business.  We are subject to extensive state and federal regulation, supervision, and legislation that govern almost all aspects of our operations.  These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds.  In addition, the Company’s earnings are affected by the monetary policies of the Board of Governors of the Federal Reserve.  These policies, which include regulating the national supply of bank reserves and bank credit, can have a major effect upon the source and cost of funds and the rates of return earned on loans and investments.  The Federal Reserve influences the size and distribution of bank reserves through its open market operations and changes in cash reserve requirements against member bank deposits.  We cannot predict what effect such act and any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, but such changes could be materially adverse to our financial performance.

Our profitability and liquidity may be adversely affected by deterioration in the credit quality of, or defaults by, third parties who owe us money or other assets.

We are exposed to the risk that third parties that owe us money or other assets will not perform their obligations.  These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons.  Our rights against third parties may not be enforceable in all circumstances.  In addition, deterioration in the credit quality of third parties whose securities or obligations we hold could result in losses and/or adversely affect our ability to use those securities or obligations for liquidity purposes.  We rely on representations of potential borrowers and/or guarantors as to the accuracy and completeness of certain financial information.  Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements or other information that is materially misleading.

Our financial condition has not been materially impacted by the deterioration in the credit quality of third parties except as related to borrower credit quality. Management believes that the allowance for loan losses is adequate to absorb probable losses on any existing loans that may become uncollectible but cannot predict loan losses with certainty and cannot assure that our allowance for loan losses will prove sufficient to cover actual losses in the future.


Page 13

Changing interest rates may adversely affect our profits.

Our income and cash flows depend to a great extent on the difference between the interest rates earned by us on interest-earning assets such as loans and investment securities and the interest rates paid by us on interest-bearing liabilities such as deposits and borrowings.  If interest rates decrease, our net interest income could be negatively affected if interest earned on interest-earning assets, such as loans, mortgage-related securities, and other investment securities, decreases more quickly than interest paid on interest-bearing liabilities, such as deposits and borrowings.  This would cause our net income to go down.  In addition, if interest rates decline, our loans and investments may be prepaid earlier than expected, which may also lower our income.  Rising interest rates may hurt our income because they may reduce the demand for loans, reduce the value of our investment securities, and increase the the cost paid on interest-bearing liabilities.  Higher interest rates could adversely affect housing and other sectors of the economy that are interest-rate sensitive.  Higher interest rates could cause deterioration in the quality of our loan portfolio.  Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and monetary policies established by the Federal Reserve Board. Interest rates do and will continue to fluctuate, and we cannot predict future Federal Reserve Board actions or other factors that will cause rates to change.

We experience intense competition for loans and deposits.

Competition among financial institutions in attracting and retaining deposits and making loans is intense.  Traditionally, our most direct competition for deposits has come from commercial banks, savings institutions and credit unions (which don’t pay federal or state income taxes) doing business in our areas of operation.  Increasingly, we have experienced additional competition for deposits from nonbanking sources, such as securities firms, insurance companies, money market mutual funds and corporate and financial services subsidiaries of commercial and manufacturing companies.  Competition for loans comes primarily from other commercial banks, savings institutions, consumer finance companies, credit unions, mortgage banking companies, insurance companies and other institutional lenders.  We compete primarily on the basis of products offered, customer service and price.  A number of institutions with which we compete enjoy the benefits of fewer regulatory constraints and lower cost structures.  Some have greater assets and capital than we do and, thus, are better able to compete on the basis of price than we are.  The increasingly competitive environment is primarily a result of changes in regulation, technology and product delivery systems.  These competitive trends are likely to continue.

If we do not continue to meet or exceed regulatory capital requirements and maintain our “well capitalized” status, there could be an adverse effect on the manner in which we do business and on the confidence of our customers in us.

Under regulatory capital adequacy guidelines, we must meet guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items.  Failure to meet minimum capital requirements could have a material effect on our financial condition and could subject us to a variety of enforcement actions, as well as certain restrictions on our business.  Failure to maintain the status of “well capitalized” under the regulatory framework could adversely affect the confidence that our customers have in us, which can lead to a decline in the demand for or a reduction in the prices that we are able to charge for our products and services.  We may at some point need to raise additional capital to maintain our “well capitalized” status.  Any capital we obtain may result in the dilution of the interests of existing holders of our common stock.  Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance.  Accordingly, we cannot make assurances of our ability to raise additional capital if needed, or if the terms will be acceptable to us.

Our allowance for loan losses may not be adequate to cover actual losses.

Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and non-performance.  Our allowance for loan losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, current economic conditions and concentrations within the portfolio.  The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes.  Economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.  In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management.  In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses.  Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material negative effect on our financial condition and results of operations.


Page 14

Our loan portfolio has a large concentration of real estate loans, which involve risks specific to real estate value.

Real estate loans, which constitute a large portion of our loan portfolio, include home equity, commercial, construction and residential loans, and such loans are concentrated in the Bank’s trade area, a small geographic area in Southeast Iowa.  As of December 31, 2014, approximately 82.39% of our loans had real estate as a primary or secondary component of collateral.  The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located.  Adverse developments affecting real estate values in our market could increase the credit risk associated with our loan portfolio.  Also, real estate lending typically involves higher loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service.  Economic events or governmental regulations outside of the control of the borrower could negatively impact the future cash flow and market values of the affected properties.

If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.

Our real estate loans also include construction loans, including land acquisition and development.  Construction, land acquisition and development lending involve additional risks because funds are advanced based upon estimates of costs and the estimated value of the completed project.  Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio.  As a result, commercial construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest.  If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project.

Commercial loans make up a significant portion of our loan portfolio.

Our commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower.  Repayment of our commercial loans is often dependent on the cash flows of the borrower, which may be unpredictable.  Most often, this collateral is accounts receivable, inventory, machinery or real estate.  In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.  The other types of collateral securing these loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

Our agricultural loans may involve a greater degree of risk than other loans, and the ability of the borrower to repay may be affected by many factors outside of the borrower’s control.

Payments on agricultural real estate loans are dependent on the profitable operation or management of the farm property securing the loan.  The success of the farm may be affected by many factors outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products (both domestically and internationally) and the impact of government regulations (including changes in price supports, subsidies and environmental regulations). In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm.  If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired. The primary crops in our market areas are corn and soybeans.  Accordingly, adverse circumstances affecting these crops could have an adverse effect on our agricultural real estate loan portfolio.

We also originate agricultural operating loans.  As with agricultural real estate loans, the repayment of operating loans is dependent on the successful operation or management of the farm property.  Likewise, agricultural operating loans involve a greater degree of risk than lending on residential properties, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment or assets such as livestock or crops.  The primary livestock in our market areas is hogs.  In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.


Page 15

We depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors if made available. If this information is inaccurate, we may be subject to regulatory action, reputational harm or other adverse effects with respect to the operation of our business, our financial condition and our results of operation.

Growth in local and national real estate markets may impact our operations and/or financial condition.

There has been growth in the national housing market as evidenced by reports of increased levels of new and existing home sales, decreasing inventories of houses on the market, increasing property values, an increase in building permits, and a decrease in the time houses remain on the market.  In past history of real estate growth, some lenders made many adjustable-rate mortgage loans, and lowered their credit standards with respect to mortgage loans and home equity loans.  A subsequent slowdown in the national housing market created uncertainty and liquidity issues relating to the value of such mortgage loans, which caused disruption in credit markets.  Management will continue to monitor that the Bank has maintained appropriate lending standards in times of real estate growth and decline.  No assurance can be given that these conditions will not directly or indirectly affect our operations.

If we are unable to continuously attract deposits and other short-term funding, our financial condition, including our capital ratios, our results of operations and our business prospects could be harmed.

In managing our liquidity, our primary source of short-term funding is customer deposits.  Our ability to continue to attract these deposits, and other short-term funding sources, is subject to variability based upon a number of factors, including the relative interest rates we are prepared to pay for these liabilities and the perception of safety of those deposits or short-term obligations relative to alternative short-term investments.  The availability and cost of credit in short-term markets depends upon market perceptions of our liquidity and creditworthiness.  Our efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated changes in event-driven reductions in liquidity.  In such events, our cost of funds may increase, thereby reducing our net interest revenue, or we may need to dispose of a portion of our investment portfolio, which, depending on market conditions, could result in our realizing a loss or experiencing other adverse consequences.

Conditions in the financial markets may limit our access to funding to meet our liquidity needs.

Liquidity is essential to our business, as we must maintain sufficient funds to respond to the needs of depositors and borrowers.  An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a substantial negative effect on our liquidity.  Our access to funding sources in the amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general.  Factors that could negatively affect our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or negative regulatory action against us.  Our ability to borrow could also be impaired by factors that are not specific to us, such as severe disruption of the financial markets or negative news and expectations about the prospects for the financial services industry as a whole, as evidenced by recent turmoil in the domestic and worldwide credit markets.

As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments.  These sources include brokered money markets and certificates of deposit, repurchase agreements, federal funds purchased, lines of credit and Federal Home Loan Bank advances.  Negative operating results or changes in industry conditions could lead to an inability to replace these additional funding sources at maturity.  Our financial flexibility could be constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates.  Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs.  In this case, our results of operations and financial condition would be negatively affected.

Our growth strategy relies heavily on our management team, and the unexpected loss of key managers and/or officers may adversely affect our operations.

The Company’s success is dependent on experienced senior management with a strong local community network.  Our ability to retain the current management team and executive officers are key to the successful implementation of our growth strategy.  It is equally important that the Company be able to continue to attract and retain quality and community-focused managers and officers.  The unexpected loss of one of the Company’s key managers and/or officers or the inability to attract qualified personnel could have a negative effect on our operations, financial condition and reputation.

Page 16

We are subject to risks associated with technological changes and the resources needed to implement the changes.

Our industry is susceptible to significant technological changes in the future as there continue to be a high level of new technology driven products and services introduced.  Technological advancement aids the Company in providing customer service and increases efficiency.  Our national competitors have more resources to invest in technological changes and associated required resources.  As a result they may be able to offer products and services that are more technologically advanced and that may put us at a competitive disadvantage.  Our future depends on our ability to analyze technological changes to determine the best course of action for our business, customers and shareholders.

We rely heavily on our network security and any system failure or data breach could subject the Company to increased costs as well as reputational risk.

Our operations are dependent on our ability to process financial transactions in a secure manner.  Failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers could disrupt our businesses or the businesses of our customers, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses. We must ensure that information is properly protected from a variety of threats such as cyber attacks, error, fraud, sabotage, terrorism, industrial espionage, privacy violation, service interruption, and natural disaster.  The Company, with the assistance of third-party service providers, intends to continue to implement security technology and establish procedures to maintain network security, but there is no assurance that these measures will be successful. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any activity that jeopardizes our network and the security of the information stored on our network may result in significant cost to the Company and have a significant negative effect on our reputation.

Loss of key third party vendor relationships or failure of a vendor to protect information of our customers or employees could adversely affect our business or result in losses.

We rely on third party vendors to provide key components of our business operations such as data processing, recording and monitoring transactions, online and mobile banking interfaces and services, Internet connections and network access. While we have performed due diligence procedures in selecting vendors, we do not control their actions. In the event that one or more of our vendors suffers a bankruptcy or otherwise becomes unable to continue to provide products or services, or fails to protect personal information of our customers or employees, we may suffer operational impairments, reputational damage and financial losses. Replacing these third party vendors could create significant delay and expense. Accordingly, use of such third parties creates an unavoidable inherent risk to our business operations.

We are subject to risks associated with negative publicity.

Reputational risk arises from the potential that negative publicity regarding the Company’s business practices, whether true or not, could cause a decline in the customer base, costly litigation, or revenue reductions.  In addition, the Company’s success in maintaining its reputation depends on the ability to adapt to a rapidly changing environment including increasing reliance on social media.
Item 1B.
Unresolved Staff Comments

None.


Page 17

Item 2.
Properties

The Company's office and the main office of the Bank are located at 131 Main Street, Hills, Iowa.  This is a brick building containing approximately 45,000 square feet. A portion of the building was built in 1977, a two-story addition was completed in 1984, and a two-story brick addition was completed in February 2001.  With the completion of the 2001 addition, the entire Bank’s processing and administrative systems were consolidated in Hills, Iowa.  The Bank operates its business from its main office and its 16 full service branches in the Iowa counties of Johnson, Linn and Washington.  The Bank owns its main office complex and 12 of its branch offices.  Four of the Bank’s branches are leased.

The Bank purchased land in Washington, Iowa during the year ended December 31, 2013.  The Bank plans to open a new branch in Washington by May, 2015. The Bank purchased property in Marion, Iowa on January 30, 2015. The Bank plans to open a new branch in Marion by December, 2015.

All of the properties owned by the Bank are free and clear of any mortgages or other encumbrances of any type.  See Note 15 to the Consolidated Financial Statements for minimum future rental commitments for leased properties.

Item 3.
Legal Proceedings

On April 24, 2014, a suit was filed against the Bank in the Iowa District Court for Johnson County by a customer alleging that the fees associated with the Bank’s automated overdraft program in connection with its debit and ATM cards constitute unlawful interest in violation of Iowa’s usury laws and that the collection of such interest violates the Iowa Debt Collection Practices Act. The suit seeks class-action status for Bank customers who have paid overdraft fees arising from debit or ATM card transactions on their consumer accounts. The Bank filed a motion to dismiss the case, which the Court denied. The Bank filed an application for interlocutory appeal to the Iowa Supreme Court, which the Court denied. The parties and District Court have put the case on hold pending a ruling by the Iowa Supreme Court in an appeal filed by West Bank on a similar issue under dispute in the Hills Bank case. At this stage of the proceedings, it is not possible for management of the Bank to determine the probability of a material adverse outcome or reasonably estimate the amount of any potential loss.

Item 4.
Mine Safety Disclosures

Not applicable.



Page 18

PART II

Item 5.
Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

As of January 31, 2015, the Company had 2,284 stockholders.  There is no established trading market for the Company's common stock, and the Company's stock is not actively traded.  Our common stock is not listed on the NASDAQ stock market or any other stock exchange.  While there is no established public trading market for our common stock, our shares are currently quoted in the inter-dealer quotation, or “over-the-counter,” marketplace under the trading symbol “HBIA.”  The principal over-the-counter market is operated by OTC Markets Group, Inc., which provides quotes for the Company on its middle tier, the OTCQB.  All OTCQB companies are reporting with the SEC or a U.S. banking regulator, but there are no financial or qualitative standards to be in this tier.

The high and low bid information for the Company’s stock for each quarter of the two most recent fiscal years, as reported by OTC Market Groups, Inc., is provided below.  The prices indicated reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

 
2014
2013
 
High
Low
High
Low
1st quarter
$
74.00

$
72.00

$
72.00

$
67.00

2nd quarter
75.00

71.50

72.00

70.00

3rd quarter
80.10

74.25

73.00

70.75

4th quarter
82.50

78.00

73.00

70.00


In addition, based on the Company’s stock transfer records and information informally provided to the Company, stock trading transactions have been as follows:
 
Year
Number of Shares Traded
Number of Transactions
High Selling Price
Low Selling Price
 
2014
83,027

144

$
82.50

$
75.00

(1)
2013
31,812

83

$
75.00

$
70.00

(2)
2012
51,802

89

$
70.00

$
64.00

(3)
 
(1)
2014 transactions included repurchases by the Company of 51,442 shares of stock under the 2005 Stock Repurchase Program.  2014 transactions made under the 2005 Stock Repurchase Program were made at prices that ranged from $75.00 to $82.50 per share.
(2)
2013 transactions included repurchases by the Company of 19,204 shares of stock under the 2005 Stock Repurchase Program.  2013 transactions made under the 2005 Stock Repurchase Program were made at prices that ranged from $70.00 to $75.00 per share.
(3)
2012 transactions included repurchases by the Company of 35,982 shares of stock under the 2005 Stock Repurchase Program.  2012 transactions made under the 2005 Stock Repurchase Program were made at prices that ranged from $64.00 to $70.00 per share.

All transactions under the 2005 Stock Repurchase Program were at a price equal to the most recent quarterly independent appraisal of the shares of the Company's common stock.

The Company paid aggregate annual cash dividends in 2014, 2013 and 2012 of $5.42 million, $5.19 million and $5.00 million respectively, or $1.15 per share in 2014, $1.10 per share in 2013 and $1.05 per share in 2012.  In January 2015, the Company declared and paid a dividend of $1.25 per share totaling $5.85 million.  The decision to declare any such cash dividends in the future and the amount thereof rests within the discretion of the Board of Directors and will remain subject to, among other things, certain regulatory restrictions imposed on the payment of dividends by the Bank, and the future earnings, capital requirements and financial condition of the Company.


Page 19

The following performance graph provides information regarding cumulative, five-year shareholder returns on an indexed basis of the Company's Common Stock compared to the NASDAQ Market Index and the Regional-Southwest Banks Index prepared by MORNINGSTAR of Chicago, IL. The latter index reflects the performance of twenty-five bank holding companies operating principally in the Midwest as selected by MORNINGSTAR. The indexes assume the investment of $100 on December 31, 2009 in Company Common Stock, the NASDAQ Index and the Regional-Southwest Banks Index, with all dividends reinvested.
 
2009
2010
2011
2012
2013
2014
HILLS BANCORPORATION
$
100.00

$
112.27

$
124.93

$
138.88

$
151.14

$
168.80

REGIONAL-SOUTHWEST BANKS
$
100.00

$
114.16

$
114.44

$
127.35

$
179.55

$
173.54

NASDAQ MARKET INDEX
$
100.00

$
118.02

$
117.04

$
137.46

$
192.61

$
221.03


Note regarding the performance graph: Cumulative five-year Shareholder returns on an indexed basis The indexes assume the investment of $100 in year with all dividends reinvested.

The following table sets forth the Company’s equity compensation plan information as of December 31, 2014, all of which relates to stock options issued under stock option plans approved by stockholders of the Company:
Plan Category
Number of securities to
be issued upon exercise of
outstanding options,
warrants and rights (a)
Weighted-average
exercise price of
outstanding options,
warrants and rights (b)
Number of securities
remaining available for
future issuance under equity
compensation plans
[excluding securities reflected
in column (a)] (c)
Equity compensation plans approved by security holders
9,690

$
59.85

61,186

Equity compensation plans not approved by security holders
—

—

—

Total
9,690

$
59.85

61,186

 

Page 20

On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of 750,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  The Company’s Board of Directors has authorized the 2005 Stock Repurchase Program through December 31, 2016.  The Company expects the purchases pursuant to the 2005 Stock Repurchase Program to be made from time to time in private transactions at a price equal to the most recent quarterly independent appraisal of the shares of the Company’s common stock and with the Board reviewing the overall results of the 2005 Stock Repurchase Program on a quarterly basis.  All purchases made pursuant to the 2005 Stock Repurchase Program since its inception have been made on that basis.  The amount and timing of stock repurchases will be based on various factors, such as the Board’s assessment of the Company’s capital structure and liquidity, the amount of interest shown by shareholders in selling shares of stock to the Company at their appraised value, and applicable regulatory, legal and accounting factors.

The following table sets forth information about the Company’s stock purchases pursuant to the 2005 Stock Repurchase Program for the quarter ended December 31, 2014:
Period in 2014
Total number of
shares purchased
Average price paid
per share
Total number of
shares purchased
as part of publicly
announced plans
or programs
Maximum number
of shares that may
yet be purchased
under the plans or
programs
October 1 to October 31
2,619

$
80.00

393,970

356,030

November 1 to November 30
2,901

80.02

396,871

353,129

December 1 to December 31
1,840

82.50

398,711

351,289

Total
7,360

$
80.63

398,711

351,289



Page 21

Item 6.
Selected Financial Data

CONSOLIDATED FIVE-YEAR STATISTICAL SUMMARY

The following table sets forth certain of our financial and statistical information for each of the years in the five-year period ended December 31, 2014.  This data should be read in conjunction with the consolidated financial statements and the accompanying notes thereto included or incorporated by reference elsewhere in this document.
 
2014
 
2013
 
2012
 
2011
 
2010
YEAR-END TOTALS (Amounts in Thousands)
 
 
 
 
 
 
 
 
 
Total assets
$
2,334,318

 
$
2,167,795

 
$
2,099,720

 
$
2,018,927

 
$
1,931,283

Investment securities
267,240

 
246,089

 
234,244

 
222,095

 
216,603

Loans held for sale
4,476

 
4,927

 
28,256

 
24,615

 
10,390

Loans, net
1,961,369

 
1,801,247

 
1,697,002

 
1,661,916

 
1,561,430

Deposits
1,835,069

 
1,709,877

 
1,662,544

 
1,525,477

 
1,480,741

Federal Home Loan Bank borrowings
140,000

 
125,000

 
125,000

 
185,000

 
195,000

Redeemable common stock
34,571

 
29,574

 
30,715

 
27,826

 
24,945

Stockholders' equity
255,528

 
243,789

 
225,196

 
208,429

 
166,269

 
 
 
 
 
 
 
 
 
 
EARNINGS (Amounts in Thousands)
 

 
 

 
 

 
 

 
 

Interest income
$
86,582

 
$
84,895

 
$
89,215

 
$
93,350

 
$
94,987

Interest expense
15,037

 
16,848

 
21,527

 
24,361

 
27,839

Provision for loan losses
1,042

 
1,131

 
(2,849
)
 
5,661

 
8,925

Other income
19,356

 
19,205

 
20,769

 
18,504

 
20,099

Other expenses
51,756

 
49,278

 
53,931

 
44,226

 
45,748

Income taxes
11,129

 
10,912

 
10,542

 
10,829

 
9,258

Net income
26,974

 
25,931

 
26,833

 
26,777

 
23,316

 
 
 
 
 
 
 
 
 
 
PER SHARE
 

 
 

 
 

 
 

 
 

Net income:
 

 
 

 
 

 
 

 
 

Basic
$
5.75

 
$
5.51

 
$
5.69

 
$
6.02

 
$
5.29

Diluted
5.74

 
5.50

 
5.68

 
6.01

 
5.28

Cash dividends
1.15

 
1.10

 
1.05

 
1.00

 
0.91

Book value as of December 31
54.48

 
51.57

 
47.55

 
43.79

 
37.80

Increase (decrease) in book value due to:
 

 
 

 
 

 
 

 
 

ESOP obligation
(7.37
)
 
(6.26
)
 
(6.48
)
 
(5.85
)
 
(5.67
)
Accumulated other comprehensive income
(0.10
)
 
0.34

 
0.84

 
1.04

 
0.63

 
 
 
 
 
 
 
 
 
 
SELECTED RATIOS
 

 
 

 
 

 
 

 
 

Return on average assets
1.21
%
 
1.23
%
 
1.30
%
 
1.36
%
 
1.25
%
Return on average equity
10.83

 
11.13

 
12.38

 
14.96

 
14.61

Net interest margin
3.49

 
3.49

 
3.60

 
3.85

 
3.95

Average stockholders' equity to average total assets
11.17

 
11.08

 
10.51

 
9.09

 
8.57

Dividend payout ratio
20.09

 
20.00

 
18.63

 
16.42

 
17.26


Page 22

Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operation

The following discussion by management is presented regarding the financial results for Hills Bancorporation (the “Company”) for the dates and periods indicated.  The discussion should be read in conjunction with the “Selected Consolidated Five-Year Statistical Summary” and the consolidated financial statements and the accompanying notes thereto included or incorporated by reference elsewhere in this document.

An overview of the year 2014 is presented following the section discussing a special note regarding forward looking statements.

Special Note Regarding Forward Looking Statements

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

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

•
The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets.
•
The effects of financial market disruptions and/or an economic recession, and monetary and other governmental actions designed to address such disruptions and recession.
•
The financial strength of the counterparties with which the Company or the Company’s customers do business and as to which the Company has investment or financial exposure.
•
The credit quality and credit agency ratings of the securities in the Company’s investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the affected securities and the recognition of an impairment loss.
•
The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company.
•
The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System.
•
The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.
•
The ability of the Company to obtain new customers and to retain existing customers.
•
The timely development and acceptance of products and services, including products and services offered through alternative electronic delivery channels.
•
Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers.
•
The ability of the Company to develop and maintain secure and reliable electronic systems.
•
The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.
•
Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely.
•
The economic impact of natural disasters, terrorist attacks and military actions.

Page 23

•
Business combinations and the integration of acquired businesses and assets which may be more difficult or expensive than expected.
•
The costs, effects and outcomes of existing or future litigation.
•
Changes in accounting policies and practices that may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.
•
The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

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

Overview

The Company is a bank holding company engaged, through its wholly-owned subsidiary bank, in the business of commercial banking.  The Company’s subsidiary is Hills Bank and Trust Company, Hills, Iowa (the “Bank”).  The Bank was formed in Hills, Iowa in 1904.  The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona, Wellman, Cedar Rapids and Marion, Iowa.

The Company’s net income for 2014 was $26.97 million compared to $25.93 million in 2013.  Diluted earnings per share were $5.74 and $5.50 for the years ended December 31, 2014 and 2013, respectively.

The Bank’s net interest income is the largest component of the Bank’s revenue, and it is a function of the average earning assets and the net interest margin percentage.  Net interest margin is the ratio of net interest income to average earning assets.  For the years ended December 31, 2014 and 2013, the Bank achieved a net interest margin of 3.49%. For the year ended December 31, 2014, net interest income on a tax equivalent basis increased by $4.51 million. In 2014, net interest income increased $9.72 million due to growth of $126.75 million in the Bank's average earning assets and was offset by a decrease of $5.21 million due to interest rate changes.

In anticipation of the continuing net interest margin compression in future years, the Bank deleveraged the balance sheet in an effort to benefit net interest margin and mitigate interest rate risk.  The Bank prepaid $60.00 million of Federal Home Loan Bank borrowings during the year ended December 31, 2012.  The Bank incurred a prepayment penalty of $5.93 million recorded as loss on extinguishment of debt in 2012.

Highlights with respect to items on the Company’s balance sheet as of December 31, 2014 included the following:

•
Loans, net of allowance for loan losses and unamortized fees and costs, totaling $1.966 billion.
•
Loan growth, net in 2014 of $160.12 million.
•
Deposit growth of $125.19 million in 2014.  Deposits increased to $1.835 billion and included $64.49 million of brokered deposits.
•
Short-term borrowings increased $20.48 million.
•
Stockholders’ equity increased $11.74 million to $255.53 million in 2014, with dividends having been paid in 2014 of $5.42 million.
Reference is made to Note 13 of the Company’s consolidated financial statements for a discussion of fair value measurements which relate to methods used by the Company in recording assets and liabilities on its consolidated financial statements.

The return on average equity was 10.83% in 2014 compared to 11.13% in 2013.  The returns for the three previous years, 2012, 2011 and 2010, were 12.38%, 14.96% and 14.61%, respectively.  The Company remains well capitalized as of December 31, 2014 with total risk-based capital at 17.21% and Tier 1 risk-based capital at 15.96%.  The minimum regulatory guidelines are 8% and 4% respectively.  The Company paid a dividend per share of $1.15 in 2014, $1.10 in 2013 and $1.05 in the year ended December 31, 2012.

A detailed discussion of the financial position and results of operations follows this overview.


Page 24

Critical Accounting Policies

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these financial statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policies to be those which are related to the allowance for loan losses. The Company refined its allowance for loan loss methodology during the year ended December 31, 2014 as described below.

Allowance for Loan Losses

The Company separates its portfolio loans and leases into segments for determining the allowance for loan losses. The Company's portfolio segments includes agricultural, commercial and financial, real estate, loans to individuals and obligations of state and political subdivisions. The Company further separates its portfolio into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes with the real estate portfolio segment includes 1 to 4 family residential constructions, land development and commercial construction, farmland, 1 to 4 family first liens, 1 to 4 family junior liens, multi-family and commercial. For an analysis of the Company's allowance for loan losses by portfolio segment and credit risk rating information by class, see Note 3 of the Notes to Consolidated Financial Statements.

Loans that exhibit probable or observed credit weaknesses, as well as loans that have been modified in a troubled debt restructuring ("TDR loans"), are subject to individual review for impairment. When individual loans are reviewed for impairment, the Company determines allowances based on management's estimate of the borrower's ability to repay the loan given the availability of the collateral, other sources of cash flow, as well as evaluation of legal options available. Allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral.

Historical loss rates are applied to loans that are not individually reviewed for impairment. For reporting periods prior to December 31, 2014 the Company calculated its historical loss experience using a trailing 10 quarter portfolio loss history method in which the Company tracked the net charge-offs as a percentage of total loans by loan category. The portfolio loss history method did not factor in the credit risk ratings of the loans in determination of the historical loss rate to be applied in the allowance for loan losses calculation. During the year ended December 31, 2014, to refine the Company's allowance for loan losses calculation, management performed a 20 quarter migration analysis. Management determined that increasing the look-back period to a 20 quarter period would improve the estimation of the entire credit and economic cycle of a credit relationship. The migration analysis performed by management uses loan level attributes to track the movement of loans through the various credit risk rating categories in order to estimate the percentage of historical loss to apply to each specific credit risk rating in each loan category. The credit risk rating system currently utilized for allowance analysis purposes encompasses six categories.

The Company's allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan losses that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in impaired loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include changes in lending policies and procedures; changes in national and local economic and business conditions; changes in the nature and volume of the loan portfolio; changes in the experience, ability and depth of lending management and staff; changes in the quality of the Bank's loan review system; the existence and effect of concentrations of credit; and the effect of any other identified external factors.

Determinations relating to the possible level of future loan losses are based in part on subjective judgments by management. Future loan losses in excess of current estimates, could materially adversely affect our results of operations or financial position.  As the Company adds new products and increases the complexity of its loan portfolio, it will enhance its methodology accordingly. This discussion of the Company’s critical accounting policies should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes presented elsewhere herein, as well as other relevant portions of Management’s Discussion and Analysis of Financial Condition and Results of Operations.   Although management believes the levels of the allowance for loan losses as of December 31, 2014 and 2013 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.


Page 25

Financial Position
Year End Amounts
2014
 
2013
 
2012
 
2011
 
2010
 
(Amounts In Thousands)
Total assets
$
2,334,318

 
$
2,167,795

 
$
2,099,720

 
$
2,018,297

 
$
1,931,283

Investment securities
267,240

 
246,089

 
234,244

 
222,095

 
216,603

Loans held for sale
4,476

 
4,927

 
28,256

 
24,615

 
10,390

Loans, net
1,961,369

 
1,801,247

 
1,697,002

 
1,661,916

 
1,561,430

Deposits
1,835,069

 
1,709,877

 
1,662,544

 
1,525,477

 
1,480,741

Federal Home Loan Bank borrowings
140,000

 
125,000

 
125,000

 
185,000

 
195,000

Redeemable common stock
34,571

 
29,574

 
30,715

 
27,826

 
24,945

Stockholders' equity
255,528

 
243,789

 
225,196

 
208,429

 
166,269

 
Total assets at December 31, 2014 increased $166.52 million, or 7.68%, from the prior year-end.  Asset growth from 2012 to 2013 was $68.08 million and represented a 3.24% increase.  The largest growth in assets occurred in Net Loans, which increased $160.12 million and $104.25 million for the years ended December 31, 2014 and 2013, respectively.  Loans held for sale to the secondary market decreased $0.45 million and $23.33 million for the years ended December 31, 2014 and 2013, respectively.  Loans held for investment represent the largest component of the Bank’s earning assets.  Loans held for investment were $1.985 billion and $1.827 billion at December 31, 2014 and 2013, respectively.

The local economy that generated increased demand for loans was a significant factor in the trend of increasing net loans in each of the last five years.  The trend of increasing Net Loans may not continue, and as a result, may not be indicative of future performance.

Loans secured by real estate represent the largest increase in loan growth.  These loans increased $122.32 million in 2014 and increased $79.04 million in 2013.  Loans secured by real estate include loans for 1 to 4 family residential properties, multi-family properties, agricultural real estate and commercial real estate.

On a net basis, the Company originated $162.66 million and $106.94 million in loans to customers for the years ended December 31, 2014 and 2013, respectively.  Net loan originations increased 53.69% in 2014 compared to 2013.  The increase in loan originations in 2014 as compared to 2013 is reflective of improvement in the overall economic conditions in the Company’s trade area.  The Company does not engage in significant participation activity and does not purchase participations from outside its established trade area.  The Company’s policy allows for the purchase or sale of participations related to existing customers or to participate in community development activity.  The Company had participations purchased of $15.31, $10.93 and $10.44 million as of December 31, 2014, 2013 and 2012, respectively.  The participations purchased were less than one percent of loans held for investment for each of the three years.

The Company did not experience a material change in the composition of its loans held for investment in 2014 or 2013.  Residential real estate loans, including first and junior liens, were $782.96 million, $711.47 million and $687.85 million as of December 31, 2014, 2013 and 2012, respectively.  The dollar total of residential real estate loans increased 10.05% in 2014 and 3.43% in 2013.  Residential real estate loans were 39.44% of the loan portfolio at December 31, 2014, 38.95% at December 31, 2013 and 39.98% at December 31, 2012.  Commercial real estate loans totaled $321.60 million at December 31, 2014, a 2.03% increase over the December 31, 2013 total of $315.19 million.  Commercial real estate loans increased 0.86% in 2013.  Commercial real estate loans totaled $312.51 million at December 31, 2012.  Commercial real estate loans represented 16.20%, 17.26% and 18.15% of the Company’s loan portfolio as of December 31, 2014, 2013 and 2012, respectively.  The Company monitors its commercial real estate level so that it does not have a concentration in that category that exceeds 300% of its capital.  Commercial real estate loan concentration was 111.65% of Tier 1 capital as of December 31, 2014.


Page 26

The following table shows the composition of loans (before deducting the allowance for loan losses) as of December 31 for each of the last five years.  The table does not include loans held for sale to the secondary market.
 
December 31,
 
2014
 
2013
 
2012
 
2011
 
2010
 
(Amounts In Thousands)
Agricultural
$
97,645

 
$
82,138

 
$
76,190

 
$
68,556

 
$
65,004

Commercial and financial
174,738

 
166,102

 
148,034

 
143,174

 
141,619

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
45,949

 
30,309

 
25,788

 
22,308

 
25,232

Construction, land development and commercial
77,020

 
69,182

 
79,097

 
84,508

 
86,552

Mortgage, farmland
162,503

 
142,685

 
113,841

 
99,799

 
90,448

Mortgage, 1 to 4 family first liens
672,674

 
605,687

 
583,567

 
577,318

 
519,029

Mortgage, 1 to 4 family junior liens
110,284

 
105,785

 
104,278

 
104,915

 
109,036

Mortgage, multi-family
245,213

 
244,090

 
214,812

 
222,851

 
202,630

Mortgage, commercial
321,601

 
315,187

 
312,506

 
316,329

 
302,020

Loans to individuals
21,342

 
19,824

 
20,350

 
20,598

 
23,627

Obligations of state and political subdivisions
55,729

 
45,167

 
43,102

 
31,147

 
24,959

 
$
1,984,698

 
$
1,826,156

 
$
1,721,565

 
$
1,691,503

 
$
1,590,156

Net unamortized fees and costs
691

 
641

 
597

 
563

 
504

 
$
1,985,389

 
$
1,826,797

 
$
1,722,162

 
$
1,692,066

 
$
1,590,660

Less allowance for loan losses
24,020

 
25,550

 
25,160

 
30,150

 
29,230

 
$
1,961,369

 
$
1,801,247

 
$
1,697,002

 
$
1,661,916

 
$
1,561,430


There were no foreign loans outstanding for any of the years presented.

The following table shows the principal payments due on loans as of December 31, 2014:
 
Amount
Of Loans
 
One Year
Or Less (1)
 
One To
Five Years
 
Over Five
Years
 
(Amounts In Thousands)
Commercial and Agricultural
$
1,128,238

 
$
319,617

 
$
727,080

 
$
81,541

Real Estate (2)
778,805

 
90,786

 
390,427

 
297,592

Other
77,655

 
5,874

 
16,396

 
55,385

Totals
$
1,984,698

 
$
416,277

 
$
1,133,903

 
$
434,518

 
 
 
 
 
 
 
 
The types of interest rates applicable to these principal payments are shown below:
 
 
 
 
 
 
 
 
Fixed rate
$
1,093,040

 
$
284,376

 
$
580,709

 
$
227,955

Variable rate
891,658

 
131,901

 
553,194

 
206,563

 
$
1,984,698

 
$
416,277

 
$
1,133,903

 
$
434,518

 
(1)
A significant portion of the commercial loans are due in one year or less.  A significant percentage of the loans will be re-evaluated prior to their maturity and are likely to be extended.
(2)
Commercial, multi-family and agricultural real estate loans are reflected in the Commercial and Agricultural total.

The sales and building permit trends in the Company’s trade area have followed similar increases as national, regional and state trends.  The increased level of building permits is reflective of the overall economic improvement in the Company’s trade area.


Page 27

The overall economy in the Company’s trade area, Johnson, Linn and Washington Counties, remains in stable condition with levels of unemployment that remain below national and state levels.  The following table shows unemployment as of December 31, 2014, 2013 and 2012 and median income information as of December 31, 2013, 2012 and 2011, as December 31, 2014 information is not available as of the date of this report:

 
Unemployment Rate %
 
Median Income
 
2014
 
2013
 
2012
 
2013
 
2012
 
2011
United States
5.6
%
 
6.7
%
 
7.8
%
 
$
53,046

 
$
53,046

 
$
50,502

State of Iowa
4.1
%
 
4.2
%
 
4.9
%
 
51,843

 
51,129

 
49,545

Johnson County
2.6
%
 
3.0
%
 
3.6
%
 
53,424

 
53,993

 
53,570

Linn County
4.1
%
 
4.5
%
 
5.3
%
 
57,260

 
56,790

 
55,772

Washington County
3.4
%
 
3.5
%
 
4.1
%
 
54,554

 
52,636

 
50,559

 
Competition for quality loans and deposits may continue to be a challenge.  The increased competition for both loans and deposits could result in a lower interest rate margin that could result in lower net interest income if the volume of loans and deposits does not increase to offset any such reduction in the interest margin.

Total deposits increased by $125.19 million in 2014 of which $6.72 million was from brokered deposits.  Short-term borrowings, which include federal funds purchased and securities sold under agreements to repurchase, increased from $42.02 million to $47.50 million.  Deposits increased by $47.33 million in 2013.  As of June 30, 2014 (latest data available), Johnson County total deposits were $4.749 billion and the Company’s deposits were $1.267 billion, which represent a 26.7% market share.  The Company had nine office locations in Johnson County as of June 30, 2014.  The total banking locations in Johnson County was 56 as of June 30, 2014.  At June 30, 2013, the Company’s deposits were $1.188 billion or a 27.9% market share.  At $5.693 billion as of June 30, 2014, the Linn County deposit market is significantly larger than the Johnson County deposit market of $4.749 billion.  As of June 30, 2014, Linn County had 109 total banking locations.  The six Linn County offices of the Company had deposits of $346.20 million or a 6.1% share of the market.  The Company’s Linn County deposits at June 30, 2013 were $343.55 million and represented a 6.4% market share.  As of June 30, 2014, the Company’s two Washington County offices had deposits of $115.04 million which was 21.1% of the County’s total deposits of $545.21 million.  Washington County had a total of 14 banking locations as of June 30, 2014.  In 2013, the Company’s Washington County deposits were $110.06 million or a 20.5% market share.

Investment securities increased $21.15 million in 2014.  In 2013, investment securities increased by $11.85 million.  The investment portfolio consists of $267.24 million of securities that are stated at fair value, with any unrealized gain or loss, net of income taxes, reported as a separate component of stockholders’ equity.  The securities portfolio is used for liquidity and pledging purposes and to provide a rate of return that is acceptable to management.

The following tables show the carrying value of the investment securities held by the Bank, including stock of the Federal Home Loan Bank, as of December 31, 2014, 2013 and 2012 and the maturities and weighted average yields of the investment securities, computed on a tax-equivalent basis using a federal tax rate of 35%, as of December 31, 2014:
 
December 31,
 
2014
 
2013
 
2012
 
(Amounts In Thousands)
Carrying value:
 
 
 
 
 
U.S. Treasury
$
22,333

 
$
—

 
$
—

Other securities (FHLB, FHLMC and FNMA)
67,691

 
87,144

 
91,850

Stock of the Federal Home Loan Bank
8,248

 
7,579

 
8,062

Obligations of state and political subdivisions
168,968

 
151,366

 
134,332

 
$
267,240

 
$
246,089

 
$
234,244

 

Page 28

 
December 31, 2014
 
Carrying
Value
 
Weighted
Average
Yield
 
(Amounts In Thousands)
U.S. Treasury
 
 
 
  From 1 to 5 years
$
22,333

 
1.38
%
 
$
22,333

 
 
Other securities (FHLB, FHLMC and FNMA), maturities:
 
 
 
Within 1 year
$
17,293

 
0.69
%
From 1 to 5 years
50,398

 
1.06

From 5 to 10 years
—

 
—

 
$
67,691

 
 

 
 
 
 
Stock of the Federal Home Loan Bank
$
8,248

 
2.50
%
 
 
 
 
Obligations of state and political subdivisions, maturities:
 

 
 

Within 1 year
$
24,993

 
2.32
%
From 1 to 5 years
70,219

 
3.64

From 5 to 10 years
72,431

 
2.83

Over 10 years
1,325

 
5.09

 
$
168,968

 
 

Total
$
267,240

 
 


As of December 31, 2014, the Company held no investment securities exceeding 10% of stockholders’ equity, other than securities of the U.S. Government agencies and corporations.  The Company does not hold any investments in FNMA preferred stock, any pooled trust preferred stocks or other preferred stock type investments.  See Note 2 to the Company’s Consolidated Financial Statements.

During 2014, a major funding source for the growth in loans was the $125.19 million increase in deposits.  In 2013, the major source of funding for the growth in loans was deposit growth of $47.33 million.  Brokered deposits totaled $64.49 million and $57.77 million as of December 31, 2014 and 2013, respectively.  Total advances from the FHLB were $125.00 million at December 31, 2014 and 2013.  It is expected that the FHLB funding source and brokered deposits funding will be considered in the future if loan growth exceeds deposit increases and the interest rates on funds borrowed from the FHLB and interest rates on brokered deposits are favorable compared to other funding alternatives.

The following tables show the amounts of average deposits and average rates paid on such deposits for the years ended December 31, 2014, 2013 and 2012 and the composition of the certificates of deposit issued in denominations in excess of $100,000 as of December 31, 2014, 2013 and 2012:
 
December 31,
 
2014
 
Rate
 
2013
 
Rate
 
2012
 
Rate
 
(Amounts In Thousands)
Average noninterest-bearing deposits
$
259,602

 
—

 
$
241,697

 
—

 
$
225,284

 
—

Average interest-bearing demand deposits
414,438

 
0.15
%
 
376,940

 
0.20
%
 
321,225

 
0.21
%
Average savings deposits
564,940

 
0.20

 
481,108

 
0.23

 
419,098

 
0.24

Average time deposits
516,169

 
1.46

 
559,687

 
1.65

 
611,260

 
1.96

 
$
1,755,149

 
 

 
$
1,659,432

 
 

 
$
1,576,867

 
 



Page 29

Time certificates issued in amounts of $100,000 or more with maturity in:
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
(Amounts In Thousands)
3 months or less
$
10,772

 
0.95
%
 
$
13,131

 
1.02
%
 
$
33,920

 
1.33
%
3 through 6 months
16,830

 
1.63

 
28,628

 
1.45

 
30,928

 
1.55

6 through 12 months
50,847

 
1.43

 
31,073

 
1.03

 
68,591

 
1.37

Over 12 months
99,346

 
1.46

 
95,633

 
1.83

 
168,739

 
2.01

 
$
177,795

 
 

 
$
168,465

 
 

 
$
302,178

 
 


Stockholders’ equity was $255.53 million at December 31, 2014 compared to $243.79 million at December 31, 2013.  The Company’s capital resources are discussed in detail in the Liquidity and Capital Resources section.  Over the last five years, the Company has realized cumulative earnings of $129.83 million and paid shareholders dividends of $24.03 million, or 18.51% of earnings, while still maintaining capital ratios in excess of regulatory requirements.

The following table presents the return on average assets, return on average stockholders' equity, the dividend payout ratio and average stockholders’ equity to average assets ratio for the years ended December 31, 2014, 2013 and 2012:
 
2014
 
2013
 
2012
Return on average assets
1.21
%
 
1.23
%
 
1.30
%
Return on average stockholders' equity
10.83

 
11.13

 
12.38

Dividend payout ratio
20.09

 
20.00

 
18.63

Average stockholders' equity to average assets ratio
11.17

 
11.08

 
10.51


Net Income Overview

Net income and diluted earnings per share for the last five years are as presented below:
Year
Net Income
 
% (Decrease) Increase
 
Earnings Per
Share - Diluted
 
(In Thousands)
 
 
 
 
2014
$
26,974

 
4.02
 %
 
$
5.74

2013
25,931

 
(3.36
)
 
5.50

2012
26,833

 
0.21

 
5.68

2011
26,777

 
14.84

 
6.01

2010
23,316

 
45.86

 
5.28


Net income for 2014 increased by $1.04 million or 4.02% and diluted earnings per share increased by 4.36%.  In 2014, net interest income increased $9.72 million due to growth of $126.75 million in the Bank's average earning assets and was offset by a decrease of $5.21 million due to interest rate changes. Other income increased by $0.15 million, the provision for loan losses decreased by $0.09 million and total other expenses increased by $2.48 million.

Annual fluctuations in the Company's net income continue to be driven primarily by three generally recurring important factors. The first important factor is net interest margin. Net interest income of $71.55 million in 2014 was derived from the Company's $2.129 billion of average earning assets and its net interest margin of 3.49%, compared to $2.000 billion of average earning assets and a 3.49% net interest margin in 2013. The importance of net interest margin is illustrated by the fact that a decrease or an increase in the net interest margin of 10 basis points would result in a $2.13 million decrease or increase in income before taxes.  Net interest margin decreased in 2013 to 3.49% from 3.60% in 2012.  Based on the current interest rate environment, the Company expects continued net interest compression to impact earnings for the foreseeable future.  The Company believes net interest margin in dollars will be contingent on the growth of the Company’s earnings assets.
 

Page 30

The second significant factor affecting the Company's net income is the provision for loan losses. The majority of the Company's interest-earning assets are in loans outstanding, which amounted to $1.990 billion at the end of 2014.  The Company’s allowance for loan losses was $24.02 million at December 31, 2014.  The allowance in 2014 decreased in comparison to 2013 due to an increase in net charge-offs of $1.83 million, a decreased provision for loan losses of $0.09 million and change in the Company's historical loss rates.  The loan loss provision, which is the amount necessary to adjust the allowance to the level considered appropriate by management, totaled an expense of $1.04 million for 2014, an expense of $1.13 million for 2013 and reduction of expense of $2.85 million of expense for 2012.  Management expects credit quality to remain steady through 2015.  Provision expense is expected to be dependent on the Company’s loan growth through the end of 2015.  (See Note 3 to the Consolidated Financial Statements.)  A detailed discussion is included in the Provision for Loan Losses section below.

The amount of mortgage loans sold on the secondary market and the resulting gain or loss is the third factor that can cause fluctuations in net income.  Loans originated in 2014 for sale in the secondary market totaled $114.73 million compared to $204.88 million in 2013 and $328.58 million in 2012, a decrease of 44.00% from 2013 and a decrease of 65.08% from 2012.  For the years ended December 31, 2014, 2013 and 2012, the net gain on sale of loans was $0.89, $1.93 and $3.55 million, respectively.  The sale of loans is influenced by the real estate market and interest rates.  The average interest rate for a 30 year fixed rate loan during the year ended December 31, 2014 was 4.03%.  The average interest rate for the same type of loan was 3.83% for the year ended December 31, 2013.  The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly.  The volume of activity in these types of loans is directly related to the level of interest rates.  The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income.  The Company cannot predict the extent to which the discontinuation of purchases of agency-guaranteed mortgage-backed securities by the Federal Reserve may result in secondary market rates becoming less favorable and a reduction in secondary market activity involving mortgage loans.

Net income for 2013 was $25.93 million, or diluted earnings per share of $5.50.  For 2013, diluted earnings per share decreased by $0.18 per share compared to 2012.  Net interest income increased $0.36 million for the year ended December 31, 2013 compared to 2012.  This increase in net interest income was due to an increase in average earning assets of $50.66 million in 2013.  Noninterest income decreased 7.53% in 2013 to $19.21 million.  Noninterest expense decreased from $53.93 million in 2012 to $49.28 million in 2013, or 8.62%.


Page 31

Net Interest Income

Net interest income is the excess of the interest and fees received on interest-earning assets over the interest expense of the interest-bearing liabilities. The factors that have the greatest impact on net interest income are the volume of average earning assets and the net interest margin.  The volume of average earning assets has continued to grow each year, primarily due to net loan growth.  The net interest margin was 3.49% in 2014, 3.49% in 2013, 3.60% in 2012, 3.85% in 2011, and 3.59% in 2010.  The measure is shown on a tax-equivalent basis using a rate of 35% to make the interest earned on taxable and nontaxable assets more comparable.  Interest income and expense for 2014, 2013 and 2012 are indicated on the following table: 
 
Years Ended December 31,
 
2014
 
2013
 
2012
 
(Amounts In Thousands)
Income:
 
 
 
 
 
Loans (1)
$
83,015

 
$
80,172

 
$
84,453

Taxable securities
1,099

 
1,254

 
1,897

Nontaxable securities (1)
5,182

 
5,134

 
5,227

Interest-bearing cash and cash equivalents
36

 
74

 
134

Total interest income
89,332

 
86,634

 
91,711

Expense:
 

 
 

 
 

Interest-bearing demand deposits
622

 
764

 
692

Savings deposits
1,124

 
1,091

 
989

Time deposits
7,559

 
9,257

 
12,043

Other borrowings
124

 
112

 
180

FHLB borrowings
5,603

 
5,590

 
7,583

Interest-bearing other liabilities
4

 
34

 
40

Total interest expense
15,036

 
16,848

 
21,527

Net interest income
$
74,296

 
$
69,786

 
$
70,184

 
(1)  Presented on a tax equivalent basis using a rate of 35% for the three years presented.

Net interest income on a tax-equivalent basis changed in 2014 as follows:
 
Change In
 
Change In
 
Increase (Decrease)
 
Average
Balance
 
Average
Rate
 
Volume
Changes
 
Rate
Changes
 
Net
Change
 
(Amounts In Thousands)
Interest income:
 
 
 
 
 
 
 
 
 
Loans, net
$
131,168

 
(0.17
)%
 
$
8,708

 
$
(5,864
)
 
$
2,844

Taxable securities
(4,160
)
 
(0.11
)
 
(28
)
 
(127
)
 
(155
)
Nontaxable securities
17,259

 
(0.41
)
 
668

 
(620
)
 
48

Interest-bearing cash and cash equivalents
(15,152
)
 
0.01

 
(38
)
 
—

 
(38
)
Federal funds sold
1

 
(0.01
)
 
—

 
—

 
—

 
$
129,116

 
 

 
$
9,310

 
$
(6,611
)
 
$
2,699

Interest expense:
 

 
 

 
 

 
 

 
 

Interest-bearing demand deposits
$
37,498

 
(0.05
)%
 
$
(76
)
 
$
218

 
$
142

Savings deposits
83,832

 
(0.03
)
 
(192
)
 
159

 
(33
)
Time deposits
(43,518
)
 
(0.19
)
 
720

 
978

 
1,698

Other borrowings
6,567

 
(0.02
)
 
(30
)
 
17

 
(13
)
FHLB borrowings
4,521

 
(0.10
)
 
(13
)
 
—

 
(13
)
Interest-bearing other liabilities
(53
)
 
(1.08
)
 
1

 
29

 
30

 
$
88,847

 
 

 
$
410

 
$
1,401

 
$
1,811

Change in net interest income
 

 
 

 
$
9,720

 
$
(5,210
)
 
$
4,510



Page 32

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

Net interest income on a tax equivalent basis changes for 2013 were as follows:
 
Change In Average Balance
 
Change In Average Rate
 
Increase (Decrease)
 
 
 
Volume
Changes
 
Rate
Changes
 
Net
Change
 
(Amounts In Thousands)
Interest income:
 
 
 
 
 
 
 
 
 
Loans, net
$
61,318

 
(0.36
)%
 
$
1,845

 
$
(6,126
)
 
$
(4,281
)
Taxable securities
(1,664
)
 
(0.61
)
 
(61
)
 
(582
)
 
(643
)
Nontaxable securities
14,680

 
(0.56
)
 
650

 
(743
)
 
(93
)
Interest-bearing cash and cash equivalents
(23,677
)
 
—

 
(60
)
 
—

 
(60
)
Federal funds sold
1

 
0.03
 %
 
—

 
—

 
—

 
$
50,658

 
 

 
$
2,374

 
$
(7,451
)
 
$
(5,077
)
Interest expense:
 

 
 

 
 

 
 

 
 

Interest-bearing demand deposits
$
55,715

 
(0.01
)%
 
$
(118
)
 
$
46

 
$
(72
)
Savings deposits
62,011

 
(0.01
)
 
(127
)
 
26

 
(101
)
Time deposits
(51,573
)
 
(0.31
)
 
1,046

 
1,739

 
2,785

Short-term borrowings
(9,612
)
 
(0.08
)
 
37

 
31

 
68

FHLB borrowings
(48,900
)
 
0.12

 
2,147

 
(154
)
 
1,993

Interest-bearing other liabilities
(65
)
 
(0.19
)
 
1

 
5

 
6

 
$
7,576

 
 

 
$
2,986

 
$
1,693

 
$
4,679

Change in net interest income
 

 
 

 
$
5,360

 
$
(5,758
)
 
$
(398
)


Page 33

A summary of the net interest spread and margin is as follows:
 
Years Ended December 31,
 
2014
 
2013
 
2012
Average yields:
 
 
 
 
 
Loans (1)
4.39
%
 
4.61
%
 
4.99
%
Loans (tax equivalent basis) (1)
4.44

 
4.66

 
5.02

Taxable securities
1.15

 
1.26

 
1.87

Nontaxable securities
2.25

 
2.52

 
2.88

Nontaxable securities (tax equivalent basis)
3.46

 
3.87

 
4.43

Interest-bearing cash and cash equivalents
0.26

 
0.25

 
0.25

Federal funds sold
0.14

 
0.15

 
0.12

Average rates paid:
 

 
 

 
 

Interest-bearing demand deposits
0.15

 
0.20

 
0.21

Savings deposits
0.20

 
0.23

 
0.24

Time deposits
1.46

 
1.65

 
1.96

Short-term borrowings
0.29

 
0.31

 
0.39

FHLB borrowings
4.31

 
4.41

 
4.29

Interest-bearing other liabilities
0.16

 
1.24

 
1.43

Yield on average interest-earning assets
4.20

 
4.33

 
4.69

Rate on average interest-bearing liabilities
0.90

 
1.06

 
1.36

Net interest spread (2)
3.30

 
3.27

 
3.33

Net interest margin (3)
3.49

 
3.49

 
3.60

 
(1)
Non-accruing loans are not significant and have been included in the average loan balances for purposes of this computation.
(2)
Net interest spread is the difference between the yield on average interest-earning assets and the yield on average interest-paying liabilities stated on a tax equivalent basis using a federal rate of 35% for the three years presented.  The net interest spread increased 3 basis points in 2014 and decreased 6 basis points in 2013.
(3)
Net interest margin is net interest income, on a tax equivalent basis, divided by average interest-earning assets.  The net interest margin decreased 11 basis points in 2013.  The net interest margin remained unchanged in 2014 due to the continued low rate environment. 

During 2012, the Federal Open Market Committee maintained the target rate at 0.25%.  The target rate has remained at 0.25% since December 2008.  Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally correlate to the Federal Reserve Board federal funds rate.  In pricing of loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates.  As of December 31, 2014, the average rate indexes for the one, three and five year indexes were 0.27%, 1.17% and 1.74%, respectively.  The one year index increased 107.69% from December 31, 2013, the three year index increased 48.10% and the five year index increased 1.16%.  During 2014 and 2013, the average federal funds rate remained the same at 0.25%.


Page 34

Provision for Loan Losses

Management has determined that the allowance for loan losses was appropriate at December 31, 2014, and that the loan portfolio is diversified and secured, without undue concentration in any specific risk area. This process involves a high degree of management judgment; however the allowance for loan losses is based on a comprehensive and well-documented applied analysis of the Company’s loan portfolio. This analysis takes into consideration all available information existing as of the financial statement date, including environmental factors such as economic, industry, geographical and political factors. The relative level of allowance for loan losses is reviewed and compared to industry peers. This review encompasses levels of total impaired loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs.

The allowance for loan losses totaled $24.02 million at December 31, 2014 compared to $25.55 million at December 31, 2013.  The decrease in 2014 is the result of enhanced credit quality relative to increased loan volume.  Specifically for 2014, there was an increase of $1.47 million due to the volume increase in pass rated loans outstanding of $167.72 million as well as the composition of new loans added in 2014.  There was a decrease of $3.00 million in the amount allocated to the allowance due to a change in the composition and allocation of loan balances within the credit quality ratings.  The percentage of the allowance to outstanding loans was 1.21% and 1.40% at December 31, 2014 and 2013, respectively.  The percentage decrease was due to a combination of loan growth, lower historical loss rates and changes in the composition of loans among the credit risk ratings.  The provision for loan losses totaled an expense of $1.04 million in 2014, an expense of $1.13 million in 2013 and reduction of expense of $2.85 million for 2012.  Loan charge-offs net of recoveries were $2.57 million in 2014, $0.74 million in 2013 and $2.14 million in 2012.

The provision for loan losses is the amount necessary to adjust the allowance for loan losses to the level considered appropriate by management.  The adequacy of the allowance for loans and any related provision is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio.  The provision reflects a number of significant factors, including the size and growth of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact on the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more and the trends in problem and watch loans.  In addition, management considers the credit quality of the loans based on management’s review of special mention and substandard loans, including loans with historical higher credit risks.  Quantitative factors include the Company’s historical loss experience, which is then adjusted for levels and trends in past due, levels and trends in charged-off and recovered loans, trends in volume growth, trends in problem and watch loans, trends in TDR loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates.

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

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

In certain circumstances, the Bank may modify the terms of a loan to maximize the collection of amounts due.  In most cases, the modification is either a reduction in interest rate, conversion to interest only payments, deferral of payments or extension of the maturity date.  Generally, the borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term, so concessionary modification is granted to the borrower that otherwise would not be considered.  TDR loans accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles.  The Bank’s TDR loans occur on a case-by-case basis in connection with ongoing loan collection processes.


Page 35

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

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

The Bank regularly reviews loans in the portfolio and assesses whether the loans are impaired in accordance with ASC 310-10-35, Accounting by Creditors for Impairment of a Loan.  If the loans are impaired, the Bank determines if a specific allowance is appropriate.  In addition, the Bank's management also reviews and, where determined necessary, provides allowances for particular loans based upon (1) reviews of specific borrowers and (2) management’s assessment of areas that management considers are of higher credit risk, including loans that have been restructured.  Loans that are determined not to be impaired and for which there are no specific allowances are classified into one or more risk categories. Based upon the risk category assigned, the Bank allocates a percentage, as determined by management, for a required allowance needed.  The determination concerning the appropriate percentage begins with historical loss experience factors, which are then adjusted for levels and trends in past due loans, levels and trends in charged-off and recovered loans, trends in volume growth, trends in problem and watch loans, trends in TDR loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates.

Specific allowances for losses on impaired loans are established if the loan balances exceed the net present value of the relevant future cash flows or the fair value of the relevant collateral based on updated appraisals and/or updated collateral analysis for the properties if the loan is collateral dependent.  The Company may recognize a charge-off related to an impaired loan when loan balances exceed net present value of cash flows or collateral.  Impaired loans decreased by $5.76 million from December 31, 2013 to December 31, 2014.  Impaired loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and TDR loans.  Impaired loans also include loans that, based on management’s evaluation of current information and events, the Bank expects to be unable to collect in full according to the contractual terms of the original loan agreement.  The decrease in impaired loans is due to a decrease in nonaccrual loans of $1.11 million, TDR loans of $4.04 million and a decrease in accruing loans past due 90 days or more of $0.61 million from December 31, 2013 to December 31, 2014.

Special mention loan balances were $89.86 million at December 31, 2014 and $84.51 million at December 31, 2013.  These asset quality changes decreased the provision by $0.29 million based upon the relative mix of special mention loans by category.  The $5.35 million increase in special mention loans is related to management’s evaluation of its loan portfolio.  The total increase of $5.35 million is comprised of approximately $11.99 million in agricultural operating loans, $5.02 million in construction land development and commercial real estate, $2.93 million in real estate farmland and $0.40 million in loans to individuals. The increase is offset by a decrease in the special mention classification of $5.38 million in commercial real estate mortgages, $3.67 million in 1 to 4 family residential mortgages, $1.94 million in commercial loans, $1.55 million for multi-family real estate mortgages, $1.06 million for loans to state and political subdivisions, $0.67 million in 1 to 4 family junior mortgages and $0.36 million in construction 1 to 4 family residential. 

Substandard loan balances were $41.33 million at December 31, 2014 and $48.71 million at December 31, 2013.  These asset quality changes decreased the provision by $2.67 million at December 31, 2014 due to the mix of the substandard loans and reduced balances.  The decrease of $7.38 million in substandard loans at December 31, 2014 includes $2.45 million in agricultural operating loans, $2.08 million in commercial real estate mortgages, $1.89 million of 1 to 4 family residential mortgages, $1.48 million in construction land development and commercial real estate, $0.60 million in multi-family real estate mortgages, and $0.04 million in loans to individuals.  The decrease is offset by an increase in the substandard classification of $0.28 million in commercial loans, $0.21 million in construction 1 to 4 family residential, $0.44 million in real estate farmland, and $0.23 million in 1 to 4 family junior mortgages.

Page 36

The following table summarizes the Company's impaired loans and non-performing assets as of December 31 for each of the years presented:
 
2014
 
2013
 
2012
 
2011
 
2010
 
(Amounts In Thousands)
Nonaccrual loans
$
6,081

 
$
7,192

 
$
7,685

 
$
7,378

 
$
8,246

Accruing loans past due 90 days or more (1)
348

 
959

 
2,643

 
3,212

 
5,345

Troubled debt restructurings ("TDR loans") (2)
14,340

 
18,375

 
19,430

 
17,889

 
17,957

Total impaired loans
$
20,769

 
$
26,526

 
$
29,758

 
$
28,479

 
$
31,548

Other real estate
1,213

 
541

 
746

 
1,327

 
2,233

Non-performing assets (includes impaired loans and other real estate)
$
21,982

 
$
27,067

 
$
30,504

 
$
29,806

 
$
33,781

Loans held for investment
1,984,698

 
1,826,156

 
1,721,565

 
1,691,503

 
1,590,156

Ratio of allowance for loan losses to loans held for investment
1.21
%
 
1.40
%
 
1.46
%
 
1.78
%
 
1.84
%
Ratio of allowance for loan losses to impaired loans
115.65

 
96.32

 
84.55

 
105.87

 
92.65

Ratio of impaired loans to total loans held for investment
1.05

 
1.45

 
1.73

 
1.68

 
1.98

Ratio of non-performing assets to total assets
0.94

 
1.25

 
1.45

 
1.48

 
1.75


(1)
As of December 31, 2012 there were $0.26 million of TDR loans included within accruing loans past due 90 days or more.  There were no TDR loans within accruing loans past due 90 days or more as of December 31, 2014, 2013, 2011 and 2010.  The accruing loans past due 90 days or more are still believed to be adequately collateralized.  Loans are placed on nonaccrual status when management believes the collection of future principal and interest is not reasonably assured.
(2)
Total TDR loans were $16.48, $21.09, $22.12, $21.40, and $22.36 million as of December 31, 2014, 2013, 2012, 2011, and 2010, respectively.  Included in the total nonaccrual loans were $2.14 ,$2.72, $2.69, $3.25 and $4.40 million of TDR loans as of December 31, 2014, 2013, 2012, 2011 and 2010, respectively.

The ratio of allowance for loan losses to impaired loans increased to 115.65% as of December 31, 2014 compared to 96.32% as of December 31, 2013.  The increase in 2014 is the result of the decrease in total impaired loans.  The ratio of impaired loans to total gross loans was 1.05% and 1.45% at December 31, 2014 and 2013, respectively.  The decrease in the 2014 ratio is due to the decrease in all three impaired loan categories.

Other factors that are considered in determining the credit quality of the Company’s loan portfolio are the vacancy rates for both residential and commercial and retail space, current equity the borrower has in the property and overall financial strength of the customer including cash flow to continue to fund loan payments.  The Company also considers the state of the total economy including unemployment levels, vacancy rates of rental units and demand for commercial and retail space.  In most instances, the borrowers have used in their rental projections of income at least a 10% vacancy rate.  As of December 31, 2014, the unemployment levels in Johnson County and Linn County were 2.6% and 4.1%, respectively, compared to 3.0% and 4.5% in December of 2013.  These levels compare favorably to the State of Iowa at 4.1% and the national unemployment level at 5.6% in December 2014 compared to 4.2% and 6.7%, respectively in December 2013.

The residential rental vacancy rates in 2013 and 2014 in Johnson and Linn County were estimated at below 5.0%. The State of Iowa vacancy rate is 6.1% and the national rate is 7.0% with the Midwest rate at 7.5%.  These vacancy rates one year ago were 6.1%, 8.2% and 8.6%, respectively.  The Company continues to consider those vacancy rates among other factors in its current evaluation of the real estate portion of its loan portfolio.   Favorable vacancy rates may not continue in 2015, vacancy rates may rise and affect the overall quality of the loan portfolio.

See Note 3 to the Consolidated Financial Statements for additional disclosures on loans.


Page 37

SUMMARY OF LOAN LOSS EXPERIENCE

The allowance for loan losses balance is also affected by the charge-offs and recoveries for the periods presented.  For the years ended December 31, 2014, 2013 and 2012, recoveries were $2.98 million, $2.61 million and $2.89 million, respectively; charge-offs were $5.55 million, $3.35 million and $5.03 million in 2014, 2013 and 2012, respectively.
 
Overall credit quality may deteriorate in 2015.  Such deterioration could cause increases in impaired loans, allowance for loan losses provision expense and net charge-offs.  Management will monitor changing market conditions as a part of its allowance for loan loss methodology.  The following table summarizes the Bank's loan loss experience for the years ended December 31 for each of the years presented:
 
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)
2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,852

 
$
4,733

 
$
2,918

 
$
2,557

 
$
7,064

 
$
4,787

 
$
639

 
$
25,550

Charge-offs
(174
)
 
(3,388
)
 
(250
)
 
—

 
(1,195
)
 
(217
)
 
(325
)
 
(5,549
)
Recoveries
66

 
1,128

 
390

 
—

 
870

 
377

 
146

 
2,977

Provision
(229
)
 
1,758

 
(817
)
 
115

 
680

 
(752
)
 
287

 
1,042

Ending balance
$
2,515

 
$
4,231

 
$
2,241

 
$
2,672

 
$
7,419

 
$
4,195

 
$
747

 
$
24,020

 
 
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)
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
1,653

 
$
4,573

 
$
3,175

 
$
1,746

 
$
8,088

 
$
5,104

 
$
821

 
$
25,160

Charge-offs
—

 
(1,692
)
 
(245
)
 
—

 
(887
)
 
(356
)
 
(166
)
 
(3,346
)
Recoveries
35

 
1,002

 
323

 
—

 
618

 
464

 
163

 
2,605

Provision
1,164

 
850

 
(335
)
 
811

 
(755
)
 
(425
)
 
(179
)
 
1,131

Ending balance
$
2,852

 
$
4,733

 
$
2,918

 
$
2,557

 
$
7,064

 
$
4,787

 
$
639

 
$
25,550


 
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)
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
1,354

 
$
6,429

 
$
4,994

 
$
1,411

 
$
9,051

 
$
6,150

 
$
761

 
$
30,150

Charge-offs
(12
)
 
(1,395
)
 
(1,648
)
 
—

 
(1,448
)
 
(318
)
 
(205
)
 
(5,026
)
Recoveries
71

 
1,583

 
52

 
—

 
521

 
403

 
255

 
2,885

Provision
240

 
(2,044
)
 
(223
)
 
335

 
(36
)
 
(1,131
)
 
10

 
(2,849
)
Ending balance
$
1,653

 
$
4,573

 
$
3,175

 
$
1,746

 
$
8,088

 
$
5,104

 
$
821

 
$
25,160



Page 38

 
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)
2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,170

 
$
6,742

 
$
4,394

 
$
1,482

 
$
7,952

 
$
5,657

 
$
833

 
$
29,230

Charge-offs
(81
)
 
(2,678
)
 
(549
)
 
(1
)
 
(2,892
)
 
(708
)
 
(220
)
 
(7,129
)
Recoveries
45

 
896

 
17

 
4

 
934

 
298

 
194

 
2,388

Provision
(780
)
 
1,469

 
1,132

 
(74
)
 
3,057

 
903

 
(46
)
 
5,661

Ending balance
$
1,354

 
$
6,429

 
$
4,994

 
$
1,411

 
$
9,051

 
$
6,150

 
$
761

 
$
30,150


 
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)
2010
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,967

 
$
7,090

 
$
4,811

 
$
1,417

 
$
7,484

 
$
4,742

 
$
649

 
$
29,160

Charge-offs
(18
)
 
(3,647
)
 
(1,202
)
 
(52
)
 
(4,343
)
 
(1,507
)
 
(423
)
 
(11,192
)
Recoveries
248

 
946

 
81

 
44

 
583

 
152

 
283

 
2,337

Provision
(1,027
)
 
2,353

 
704

 
73

 
4,228

 
2,270

 
324

 
8,925

Ending balance
$
2,170

 
$
6,742

 
$
4,394

 
$
1,482

 
$
7,952

 
$
5,657

 
$
833

 
$
29,230


The ratio of net charge-offs to average net loans outstanding during the years ended December 31, 2014, 2013, 2012, 2011, and 2010 was 0.14%, 0.04%, 0.13%, 0.29%, and 0.58%, respectively.


Page 39

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

The Company evaluates the following loans to determine impairment:  1) all nonaccrual and TDR loans, 2) all non-consumer and non 1 to 4 family residential loans with prior charge-offs, 3) all non-consumer and non 1 to 4 family loan relationships classified as substandard and 4) loans with indications of or suspected deteriorating credit quality.

The following table presents the allowance for loan losses by type of loans and the percentage in each category to total loans as of December 31, 2014, 2013, 2012, 2011, and 2010:
 
2014
 
2013
 
Amount
 
% of Total Allowance
 
% of Loans
to Total Loans
 
Amount
 
% of Total Allowance
 
% of Loans
to Total Loans
 
(In Thousands)
 
 
 
 
 
(In Thousands)
 
 
 
 
Agricultural
$
2,515

 
10.47
%
 
4.92
%
 
$
2,852

 
11.17
%
 
4.50
%
Commercial and financial
4,231

 
17.61

 
8.80

 
4,733

 
18.52

 
9.10

Real estate:
 

 
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
810

 
3.37

 
2.32

 
1,011

 
3.96

 
1.66

Construction, land development and commercial
1,431

 
5.96

 
3.88

 
1,907

 
7.46

 
3.79

Mortgage, farmland
2,672

 
11.12

 
8.19

 
2,557

 
10.01

 
7.81

Mortgage, 1 to 4 family first liens
6,268

 
26.11

 
33.88

 
6,101

 
23.87

 
33.16

Mortgage, 1 to 4 family junior liens
1,151

 
4.79

 
5.56

 
963

 
3.77

 
5.79

Mortgage, multi-family
1,490

 
6.20

 
12.36

 
2,064

 
8.08

 
13.37

Mortgage, commercial
2,705

 
11.26

 
16.20

 
2,723

 
10.66

 
17.26

Loans to individuals
299

 
1.24

 
1.08

 
369

 
1.44

 
1.09

Obligations of state and political subdivisions
448

 
1.87

 
2.81

 
270

 
1.06

 
2.47

 
$
24,020

 
100.00
%
 
100.00
%
 
$
25,550

 
100.00
%
 
100.00
%

 
2012
 
2011
Agricultural
$
1,653

 
6.57
%
 
4.43
%
 
$
1,354

 
4.49
%
 
4.05
%
Commercial and financial
4,573

 
18.18

 
8.60

 
6,429

 
21.32

 
8.46

Real estate:
 

 
 

 
 
 
 

 
 

 
 

Construction, 1 to 4 family residential
848

 
3.37

 
1.50

 
564

 
1.87

 
1.32

Construction, land development and commercial
2,327

 
9.25

 
4.59

 
4,430

 
14.69

 
4.99

Mortgage, farmland
1,746

 
6.94

 
6.61

 
1,411

 
4.68

 
5.90

Mortgage, 1 to 4 family first liens
6,540

 
25.99

 
33.90

 
7,037

 
23.34

 
34.16

Mortgage, 1 to 4 family junior liens
1,548

 
6.15

 
6.06

 
2,014

 
6.68

 
6.20

Mortgage, multi-family
1,840

 
7.31

 
12.48

 
1,888

 
6.26

 
13.17

Mortgage, commercial
3,264

 
12.97

 
18.15

 
4,262

 
14.14

 
18.69

Loans to individuals
382

 
1.52

 
1.18

 
371

 
1.24

 
1.22

Obligations of state and political subdivisions
439

 
1.75

 
2.50

 
390

 
1.29

 
1.84

 
$
25,160

 
100.00
%
 
100.00
%
 
$
30,150

 
100.00
%
 
100.00
%


Page 40

 
2010
Agricultural
$
2,170

 
7.42
%
 
4.09
%
Commercial and financial
6,742

 
23.07

 
8.90

Real estate:
 

 
 
 
 

Construction, 1 to 4 family residential
752

 
2.57

 
1.59

Construction, land development and commercial
3,642

 
12.46

 
5.44

Mortgage, farmland
1,482

 
5.07

 
5.69

Mortgage, 1 to 4 family first liens
5,782

 
19.78

 
32.66

Mortgage, 1 to 4 family junior liens
2,170

 
7.42

 
6.85

Mortgage, multi-family
1,486

 
5.09

 
12.74

Mortgage, commercial
4,171

 
14.27

 
18.99

Loans to individuals
525

 
1.80

 
1.48

Obligations of state and political subdivisions
308

 
1.05

 
1.57

 
$
29,230

 
100.00
%
 
100.00
%

The Company believes that the allowance for loan losses is at a level commensurate with the overall risk exposure of the loan portfolio.  However, if economic conditions do not continue to improve, certain borrowers may experience difficulty and the level of impaired loans, charge-offs and delinquencies could rise and require increases in the provision for loan losses.   The Company will continue to monitor the adequacy of the allowance on a quarterly basis and will consider the impact of economic conditions on the borrowers’ ability to repay, loan collateral values, past collection experience, the risk characteristics of the loan portfolio and such other factors that deserve current recognition.

Noninterest Income

The following table sets forth the various categories of noninterest income for the year ended December 31, 2014, 2013 and 2012.
 
Year Ended December 31,
 
$ Change
 
% Change
 
2014
 
2013
 
2012
 
2014/2013

 
2013/2012

 
2014/2013

 
2013/2012

 
(Amounts in thousands)
 
 

 
 

 
 

 
 

Net gain on sale of loans
$
894

 
$
1,925

 
$
3,549

 
$
(1,031
)
 
$
(1,624
)
 
(53.56
)%
 
(45.76
)%
Trust fees
6,065

 
5,294

 
4,616

 
771

 
678

 
14.56

 
14.69

Service charges and fees
8,025

 
7,805

 
7,815

 
220

 
(10
)
 
2.82

 
(0.13
)
Rental revenue on tax credit real estate
1,490

 
1,511

 
1,587

 
(21
)
 
(76
)
 
(1.39
)
 
(4.79
)
Net gain on sale of other real estate owned and other repossessed assets
386

 
183

 
782

 
203

 
(599
)
 
110.93

 
(76.60
)
Other noninterest income
2,496

 
2,487

 
2,420

 
9

 
67

 
0.36

 
2.77

 
$
19,356

 
$
19,205

 
$
20,769

 
$
151

 
$
(1,564
)
 
0.79
 %
 
(7.53
)%

The noninterest income of the Company was $19.36 million in 2014 compared to $19.21 million in 2013.  The increase of $0.15 million in 2014 was the result of a combination of factors discussed below.  In 2013, the total noninterest income decreased $1.56 million from 2012.

The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly.  The gain was $0.89 million in 2014, $1.93 million in 2013 and $3.55 million in 2012.  The dollar volume of loans sold in 2014 was approximately 60.00% of the volume in 2013 and 34.92% of the activity experienced in 2012.  The volume of activity in these types of loans is directly related to the level of interest rates and the number of new home sales and refinancings. The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income.


Page 41

Trust fees increased $0.77 million to $6.07 million in 2014.  Trust fees increased $0.68 million in 2013.  As of December 31, 2014, the Bank’s Trust Department had $1.298 billion in assets under management compared to $1.200 billion and $1.121 billion at December 31, 2013 and 2012, respectively.  Trust fees are based on total assets under management.  The trust assets that are the most volatile are those that are held in common stocks, which amount to approximately 60.00% of assets under management.  In 2014, the Dow Jones Industrial Average increased 7.52%.  The market value of the Dow Jones Industrial Average increased over 26.50% in 2013 and increased over 7.26% in 2012.

The net gain on sale of other real estate owned and other repossessed assets increased $0.20 million to $0.39 million for the year ended December 31, 2014.  The total net gain on sale of other real estate owned consisted of a $0.21 million fair market value loss adjustment on 9 properties within other real estate owned and a $0.60 million net gain on sale of 20 properties for a net gain of $0.39 million.  During the same period in 2013, the gain consisted of a $0.07 million fair market value loss adjustment on 5 such properties, a $0.25 million net gain on sale of 14 such properties for a net gain of $0.18 million.  The net gain on sale of other real estate owned increased in 2014 due to the value of such sales, fair value adjustments and the volume of property sales.

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the year ended December 31, 2014, 2013 and 2012.
 
Year Ended December 31,
 
$ Change
 
% Change
 
2014
 
2013
 
2012
 
2014/2013

 
2013/2012

 
2014/2013

 
2013/2012

 
(Amounts in thousands)
 
 

 
 

 
 

 
 

Salaries and employee benefits
$
26,450

 
$
24,845

 
$
23,793

 
$
1,605

 
$
1,052

 
6.46
 %
 
4.42
 %
Occupancy
3,807

 
3,699

 
3,332

 
108

 
367

 
2.92

 
11.01

Furniture and equipment
4,975

 
4,711

 
4,573

 
264

 
138

 
5.60

 
3.02

Office supplies and postage
1,546

 
1,706

 
1,481

 
(160
)
 
225

 
(9.38
)
 
15.19

Advertising and business development
3,073

 
2,638

 
2,721

 
435

 
(83
)
 
16.49

 
(3.05
)
Outside services
6,741

 
6,782

 
6,712

 
(41
)
 
70

 
(0.60
)
 
1.04

Rental expenses on tax credit real estate
2,189

 
1,985

 
2,548

 
204

 
(563
)
 
10.28

 
(22.10
)
FDIC insurance assessment
1,098

 
1,016

 
1,036

 
82

 
(20
)
 
8.07

 
(1.93
)
Loss on extinguishment of debt - Federal Home Loan Bank borrowings
—

 
—

 
5,925

 
—

 
(5,925
)
 
—

 
(100.00
)
Other noninterest expense
1,877

 
1,896

 
1,810

 
(19
)
 
86

 
(1.00
)
 
4.75

 
$
51,756

 
$
49,278

 
$
53,931

 
$
2,478

 
$
(4,653
)
 
5.03
 %
 
(8.63
)%

Total noninterest expenses were $51.76 and $49.28 million for the years ended December 31, 2014 and 2013, respectively.  The increase is $2.48 million or 5.03% in 2014 and a decrease of $4.65 million or 8.63% in 2013.

Advertising and business development expenses increased $0.44 million in 2014. The increase in expenses in 2014 is the result of an increase of $0.06 million in direct mail expense and $0.16 million in business promotions expense. Also, charitable contributions increased by $0.10 million for the year ended December 31, 2014.

Rental expenses on tax credit real estate increased $0.20 million in 2014.  The increase is the result of an increase in operating expenses of the tax credit real estate in which the Company invests.


Page 42

Total noninterest expenses were $53.93 million for the year ended December 31, 2012.  The decrease in expenses in 2013 was $4.65 million.  This included an increase of $1.05 million in salaries and benefits, which was the direct result of salary adjustments and restricted stock awards increases due to the increase in the appraised value of the Company stock.  There was a decrease of $5.93 million in expenses from 2012 due to a loss on extinguishment of debt recorded in 2012. In an effort to utilize the Bank’s liquidity, improve net interest margin and decrease interest rate risk in the future the Bank prepaid $60.00 million of Federal Home Loan Bank borrowings during the year ended December 31, 2012.  The Bank incurred a prepayment penalty of $5.93 million recorded as loss on extinguishment of debt during the year ended December 31, 2012.

Income Taxes

Income tax expense was $11.13, $10.91 and $10.54 million for the years ended December 31, 2014, 2013 and 2012, respectively.  Income taxes as a percentage of income before income taxes were 29.21% in 2014, 29.62% in 2013 and 28.21% in 2012.  The amount of tax credits were $1.55, $1.99 and $1.99 million for 2014, 2013, and 2012, respectively.

Effects of Inflation

The consolidated financial statements and the accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America.  These principles require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation.  The impact of inflation is reflected in the increased cost of the Company’s operations.  Unlike industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature.  As a result, interest rates have a more significant impact in the Company’s performance than do the effects of general levels of inflation.  Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.  Liquidity and interest rate adjustments are features of the Company’s asset/liability management, which are important to the maintenance of acceptable performance levels.  Item 7A of this Form 10-K contains a more thorough discussion of interest rate risk.  The Company attempts to maintain a balance between monetary assets and monetary liabilities to offset the potential effects of changing interest rates.

Risk Management

The Company is exposed to risks as part of the normal course of business. Risk exposure requires sound risk management practices that comprise an comprehensive framework of programs and processes that apply to the Company. The Company has established a risk management framework to manage risks and provide reasonable assurance of the achievement of the Company's strategic objectives.

The primary risks identified and managed through the framework are strategic, liquidity, market, credit, trust, information technology and security, operational, legal and reputational risks. Strategic risk arises from the potential that adverse business decisions, improper implementation of those decisions, or lack of responsiveness to industry changes will negatively impact current or anticipated earnings, capital, or franchise/enterprise value. Liquidity risk is the potential that the Company will be unable to meet its obligations as they come due because of an inability to liquidate assets or obtain funding or that it cannot easily unwind or offset specific exposures without significantly lowering market prices because of inadequate market depth or market disruptions. Market risk is the risk that the Company's earnings and capital, or its ability to meet its business objectives, will be adversely affected by movements in market rates or prices such as interest rates, equity prices and/or credit spreads. Credit risk is the current and prospective risk to earnings or capital arising from an obligor's failure to meet the terms of any contract with the Company or otherwise perform as agreed. Trust risk arises from the potential inability to perform certain agreed upon functions in the delivery of trust products or services, noncompliance of applicable laws, sound fiduciary principles, internal policies or procedures, or ethical standards. Information technology and security risk encompasses the negative impact of operations and service delivery which can bring reduction of the value of the Company, but also the benefit/value enabling risk associated to missing opportunities to use technology to enable or enhance business or the IT project management for aspects like overspending or late delivery with adverse business impact. Information technology and security risk also involves the protection of information assets that is necessary to establish and maintain trust between the Company and its customers, maintain compliance with the law, and protect the reputation of the institution. Operational risk arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses. Legal risk arises from the potential that unenforceable contracts, lawsuits, or adverse judgments can disrupt or otherwise negatively affect the operations, financial condition or reputation of a banking organization. Legal risk includes compliance with regulatory requirements. Reputational risk arises from the potential that negative publicity regarding the Company's business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions.


Page 43

The principal risk management functions of the Board are to oversee processes for evaluating the adequacy of internal controls, risk management, financial reporting and compliance with laws and regulations. The Board has developed a formal plan to address Enterprise Risk Management ("ERM") within the Company. The Company's ERM includes a formal process to identify and document the key risk to the Company and provides a common framework and terminology to ensure consistency in identification, reporting and management of key risks. The Board annually approves a Risk Appetite and Tolerance Statement that reflects core business principles and provides the foundation of the Company's risk appetite, which is the aggregate amount of risk the Company is willing to accept in pursuit of its mission. By establishing boundaries around risk taking and business decisions, and by incorporating the needs and goals of its shareholders, regulators, customers and other stakeholders, the Company's risk appetite is aligned with its priorities and goals.

The Board has formed an Enterprise Risk Management Committee ("ERMC") of the Company comprised of the Company's business unit leaders and led by the Company's Vice President, Risk Management, to help ensure the consistent application of the Company's risk management approach. The primary activities of the ERMC include:

•
Annual comprehensive risk assessments for all of the risks identified in the Company's risk management framework;
•
Monitoring signals that may indicate possible risk issues for the Company;
•
Identifying risks and determining which Company areas and/or products will be affected;
•
Ensuring there are mechanisms in place to specifically determine how risks will affect the Company or its products;
•
Monitoring and reporting on risk tolerance thresholds approved by the Board;
•
Reviewing the limits, policies, and procedures in place to ensure the continued appropriateness of risk controls.

The Company has also formed an Officers Risk Management Committee ("ORMC") which consists of the next level of management from within the Company. The primary activities of the ORMC include:

•
New product and/or service risk assessments;
•
Discussion and identification of potential risk issues to report to the ERMC;
•
Tactical working groups to identify additional risk management activities to be pursued by the Company.

As part of the risk assessment process, the ERMC and ORMC makes recommendations to management and the Board regarding adjustments to controls as conditions or risk tolerances change. In addition, the Internal Audit department of the Company provides an independent assessment of the Company's internal control structure and related systems and processes. External factors beyond management's control may result in losses despite the Board's, ERMC's and ORMC's efforts.

Liquidity and Capital Resources

On an unconsolidated basis, the Company had cash balances of $1.88 million as of December 31, 2014.  In 2014, the Company received dividends of $7.44 million from its subsidiary Bank and used those funds to pay dividends to its stockholders of $5.42 million and to fund purchases of treasury stock under the 2005 Stock Repurchase Program.  The total purchase of treasury stock under the 2005 Stock Repurchase Program totaled $4.01 and $1.39 million for the years ended December 31, 2014 and 2013, respectively.

As of December 31, 2014 and 2013, stockholders' equity, before deducting for the maximum cash obligation related to the ESOP, was $290.10 million and $273.36 million, respectively.  This measure of stockholders’ equity as a percent of total assets was 12.43% at December 31, 2014 and 12.61% at December 31, 2013.  As of December 31, 2014, total equity, after deducting the maximum cash value related to the ESOP, was 10.95% of assets compared to 11.25% of assets at the prior year end.

The Company and the Bank are subject to the Federal Deposit Insurance Corporation Improvement Act of 1991, and the Bank is subject to Prompt Corrective Action Rules as determined and enforced by the Federal Reserve.  These regulations establish minimum capital requirements that member banks must maintain.

The Bank is classified as "well capitalized" by FDIC capital guidelines.  For more information regarding regulatory capital requirements, see the section under Part I, Item 1 to this 10-K captioned “Supervision and Regulation.”

On a consolidated basis, 2014 cash flows from operations provided $33.15 million and net increases in deposits provided $125.19 million.  These cash flows were invested in Net Loans of $163.63 million and $79.85 million in purchases of investment securities.  In addition, $1.79 million was used to purchase property and equipment and leasehold improvements.


Page 44

The Bank has a contingency funding plan to address liquidity issues in times of crisis.  The primary source of funding will be the Bank’s customer deposit base.  The Bank has established alternative sources of funding available to increase liquidity.  The availability of the funding sources is tested on an annual basis.  The Bank performs quarterly stress testing to determine if the Bank has an appropriate amount of funding sources to address potential liquidity needs. At December 31, 2014, the Bank had total outstanding loan commitments and unused portions of lines of credit totaling $346.54 million (see Note 15 to the Consolidated Financial Statements).  Management believes that its liquidity levels are sufficient at this time, but the Bank may increase its liquidity by limiting the growth of its assets, by selling more loans in the secondary market or selling portions of loans to other banks through participation agreements.  Another liquidity source includes obtaining additional funds from the Federal Home Loan Bank (FHLB).  As of December 31, 2014, the Bank can obtain an additional $468.30 million from the FHLB based on the current real estate mortgage loans held.  In addition, the Bank has arranged $201.24 million of credit lines at three banks.  The borrowings under these credit lines would be secured by the Bank’s investment securities.  Other liquidity sources include a $10.00 million line of credit with the Federal Reserve Bank of Chicago and various sources of brokered deposits.

The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of federal funds purchased and securities sold under agreements to repurchase during 2014, 2013 and 2012:
 
2014
 
2013
 
2012
 
(Amounts In Thousands)
Outstanding balance as of December 31
$
47,499

 
$
42,016

 
$
38,783

Weighted average interest rate at year end
0.26
%
 
0.29
%
 
0.34
%
Maximum month-end balance
68,572

 
42,500

 
50,286

Average month-end balance
42,227

 
36,579

 
46,192

Weighted average interest rate for the year
0.29
%
 
0.31
%
 
0.39
%
 
The following table shows outstanding balances, weighted average interest rates at year end, maximum month-end balances, average month-end balances and weighted average interest rates of Federal Home Loan Bank borrowings during 2014, 2013 and 2012:
 
2014
 
2013
 
2012
 
(Amounts In Thousands)
Outstanding balance as of December 31
$
140,000

 
$
125,000

 
$
185,000

Weighted average interest rate at year end
3.97
%
 
4.41
%
 
4.26
%
Maximum month-end balance
145,000

 
185,000

 
195,000

Average month-end balance
129,521

 
173,900

 
187,043

Weighted average interest rate for the year
4.31
%
 
4.29
%
 
4.22
%

The Bank has off-balance sheet commitments to fund additional borrowings of customers as well as derivative financial instruments, consisting of interest rate swaps as disclosed in Note 17 to the Consolidated Financial Statements.  Contractual commitments to fund loans are met from the proceeds of federal funds sold or investment securities and additional borrowings.  Many of the contractual commitments to extend credit will not be funded because they represent the credit limits on credit cards and home equity lines of credits.


Page 45

As disclosed in Note 15 to the Consolidated Financial Statements, the Company has certain obligations and commitments to make future payments under contracts. The following table summarizes significant contractual obligations and other commitments as of December 31, 2014:

 
Payments Due By Period
 
(Amounts In Thousands)
 
Total
 
Less Than
One Year
 
One -
Three Years
 
Three -
Five Years
 
More Than
Five Years
Contractual obligations:
 
 
 
 
 
 
 
 
 
Long-term debt obligations
$
140,000

 
$
15,000

 
$
125,000

 
$
—

 
$
—

Operating lease obligations
1,585

 
457

 
1,052

 
75

 
1

Total contractual obligations:
$
141,585

 
$
15,457

 
$
126,052

 
$
75

 
$
1

Other commitments:
 

 
 

 
 

 
 

 
 

Lines of credit
$
334,100

 
$
231,378

 
$
83,516

 
$
13,408

 
$
5,798

Standby letters of credit
12,437

 
12,437

 
—

 
—

 
—

Total other commitments
$
346,537

 
$
243,815

 
$
83,516

 
$
13,408

 
$
5,798

 
The Company and the Bank have no material commitments or plans that will materially affect liquidity or capital resources.  Property and equipment may be acquired in cash purchases, or they may be financed if favorable terms are available.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk

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

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

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


Page 46

The Bank uses derivative financial instruments, when needed, to manage the impact of changes in interest rates on future interest income or interest expense.  The Bank is exposed to credit-related losses in the event of nonperformance by the counterparties to these derivative instruments, but believe the risk of the these losses has been minimized by entering into the contracts with large, stable financial institutions.  The estimated fair market value of these derivative instruments are presented in Note 17 to the Consolidated Financial Statements.

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

The table set forth below includes the portion of the balances in interest-bearing checking, savings and money market accounts that management has estimated to mature within one year. The classifications are used because the Bank’s historical data indicates that these have been very stable deposits without much interest rate fluctuation.  Historically, these accounts would not need to be adjusted upward as quickly in a period of rate increases so the interest risk exposure would be less than the re-pricing schedule indicates. The FHLB borrowings are classified based on either their due date or if they are callable on their most likely call date based on the interest rate.
 
Repricing
 
 
 
 
 
 
 
 
 
 
 
 
 
Maturities
 
Days
 
More Than
 
 
 
Immediately
 
2-30
 
31-90
 
91-180
 
181-365
 
One Year
 
Total
 
(Amounts in Thousands)
Earning assets:
 
 
 

 
 

 
 

 
 

 
 
 
 
Excess Cash
$
2,286

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
2,286

Federal funds sold
—

 
—

 
—

 
—

 
—

 
—

 
—

Investment securities
—

 
4,155

 
6,301

 
19,336

 
12,607

 
224,841

 
267,240

Loans
9,866

 
169,656

 
37,992

 
64,095

 
146,169

 
1,562,087

 
1,989,865

Total
12,152

 
173,811

 
44,293

 
83,431

 
158,776

 
1,786,928

 
2,259,391

Sources of funds:
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing checking and savings accounts
122,679

 
—

 
—

 
—

 
—

 
916,588

 
1,039,267

Certificates of deposit
—

 
16,868

 
30,125

 
55,519

 
140,804

 
263,768

 
507,084

FHLB borrowings
15,000

 
—

 
—

 
—

 
—

 
125,000

 
140,000

Federal funds and repurchase agreements
47,499

 
—

 
—

 
—

 
—

 
—

 
47,499

 
185,178

 
16,868

 
30,125

 
55,519

 
140,804

 
1,305,356

 
1,733,850

Other sources, primarily noninterest-bearing
—

 
—

 
—

 
—

 
—

 
288,718

 
288,718

Total sources
185,178

 
16,868

 
30,125

 
55,519

 
140,804

 
1,594,074

 
2,022,568

Interest
 

 
 

 
 

 
 

 
 

 
 

 
 

Rate Gap
$
(173,026
)
 
$
156,943

 
$
14,168

 
$
27,912

 
$
17,972

 
$
192,854

 
$
236,823

Cumulative Interest
 

 
 

 
 

 
 

 
 

 
 

 
 

Rate Gap at December 31, 2014
$
(173,026
)
 
$
(16,083
)
 
$
(1,915
)
 
$
25,997

 
$
43,969

 
$
236,823

 
 

Gap Ratio
0.07

 
10.30

 
1.47

 
1.50

 
1.13

 
1.12

 
 

Cumulative Gap Ratio
0.07

 
0.92

 
0.99

 
1.09

 
1.10

 
1.12

 
 



Page 47

Based on the data following, net interest income should decline with instantaneous increases in interest rates while net interest income should increase with instantaneous declines in interest rates.  Generally, during periods of increasing interest rates, the Company's interest rate sensitive liabilities would re-price faster than its interest rate sensitive assets causing a decline in the Company's interest rate spread and margin.  This would tend to reduce net interest income because the resulting increase in the Company’s cost of funds would not be immediately offset by an increase in its yield on earning assets. In times of decreasing interest rates, fixed rate assets could increase in value and the lag in re-pricing of interest rate sensitive assets could be expected to have a positive effect on the Company's net interest income.

The following table, which presents principal cash flows and related weighted average interest rates by expected maturity dates, provides information about the Company's loans, investment securities and deposits that are sensitive to changes in interest rates.
 
2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
 
Total
 
Fair Value
 
(Amounts In Thousands)
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, fixed:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance
$
284,376

 
$
79,538

 
$
182,428

 
$
172,440

 
$
146,303

 
$
227,955

 
$
1,093,040

 
$
1,061,649

Average interest rate
4.53
%
 
4.75
%
 
4.31
%
 
4.16
%
 
4.33
%
 
4.05
%
 
4.32
%
 
 

Loans, variable:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance
$
131,901

 
$
100,808

 
$
124,030

 
$
158,215

 
$
170,141

 
$
206,563

 
$
891,658

 
$
930,356

Average interest rate
3.69
%
 
4.53
%
 
4.28
%
 
4.03
%
 
4.20
%
 
4.17
%
 
4.13
%
 
 

Investments (1):
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance
$
50,533

 
$
34,563

 
$
40,980

 
$
41,281

 
$
26,127

 
$
73,756

 
$
267,240

 
$
267,240

Average interest rate
1.81
%
 
1.83
%
 
2.35
%
 
2.36
%
 
3.06
%
 
2.87
%
 
2.39
%
 
 

Liabilities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Liquid deposits (2):
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance
$
1,039,267

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
1,039,267

 
$
1,039,257

Average interest rate
0.17
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
0.17
%
 
 

Deposits, certificates:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance
$
243,316

 
$
128,927

 
$
74,493

 
$
43,490

 
$
16,858

 
$
—

 
$
507,084

 
$
509,836

Average interest rate
1.36
%
 
1.53
%
 
1.29
%
 
1.33
%
 
1.53
%
 
—
%
 
1.46
%
 
 


(1)
Includes all available-for-sale investments, federal funds and Federal Home Loan Bank stock.
(2)
Includes NOW and other demand, savings and money market funds.

Page 48

Item 8.
Consolidated Financial Statements and Supplementary Data

The consolidated financial statements and supplementary data are included on pages 50 through 105.


Page 49

Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors and Stockholders
Hills Bancorporation
Hills, Iowa

We have audited the accompanying consolidated balance sheets of Hills Bancorporation as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2014. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. Our audits included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hills Bancorporation as of December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Hills Bancorporation’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 11, 2015, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
BKD, LLP
Springfield, Missouri
March 11, 2015


Page 50

Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
Hills Bancorporation
Hills, Iowa

We have audited Hills Bancorporation’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of reliable financial statements in accordance with accounting principles generally accepted in the United States of America. Because management’s assessment and our audit were conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), our examination of Hills Bancorporation’s internal control over financial reporting included controls over the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C). A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Hills Bancorporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Hills Bancorporation and our report dated March 11, 2015, expressed an unqualified opinion thereon.
BKD, LLP
Springfield, Missouri
March 11, 2015

Page 51

HILLS BANCORPORATION

CONSOLIDATED BALANCE SHEETS
December 31, 2014 and 2013
(Amounts In Thousands, Except Shares) 
ASSETS
2014
 
2013
Cash and cash equivalents
$
29,174

 
$
43,702

Investment securities available for sale at fair value (amortized cost 2014 $256,920; 2013 $236,702) (Notes 1, 2 and 13)
258,992

 
238,510

Stock of Federal Home Loan Bank
8,248

 
7,579

Loans held for sale
4,476

 
4,927

Loans, net of allowance for loan losses (2014 $24,020; 2013 $25,550) (Notes 1, 3, and 12)
1,961,369

 
1,801,247

Property and equipment, net (Note 4)
29,071

 
29,836

Tax credit real estate
17,259

 
18,180

Accrued interest receivable
8,276

 
7,676

Deferred income taxes, net (Note 10)
9,938

 
8,605

Other real estate
1,213

 
541

Goodwill
2,500

 
2,500

Other assets
3,802

 
4,492

Total Assets
$
2,334,318

 
$
2,167,795

LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

Liabilities
 

 
 

Noninterest-bearing deposits
$
288,718

 
$
256,788

Interest-bearing deposits (Note 5)
1,546,351

 
1,453,089

Total deposits
1,835,069

 
1,709,877

Other borrowings (Note 6)
47,499

 
42,016

Federal Home Loan Bank borrowings (Note 7)
140,000

 
125,000

Accrued interest payable
902

 
1,102

Other liabilities
20,749

 
16,437

Total Liabilities
2,044,219

 
1,894,432

Commitments and Contingencies (Notes 9 and 15)


 


Redeemable Common Stock Held By Employee Stock
 

 
 

Ownership Plan (ESOP) (Note 9)
34,571

 
29,574

Stockholders' Equity (Note 11)
 

 
 

Common stock, no par value; authorized 10,000,000 shares; issued 2014 5,088,927 shares; 2013 5,074,894 shares
—

 
—

Paid in capital
42,925

 
42,194

Retained earnings
271,924

 
250,370

Accumulated other comprehensive (loss) income (Note 8)
(448
)
 
1,591

Unearned ESOP shares
(504
)
 
(1,008
)
Treasury stock at cost (2014 398,711 shares; 2013 347,269 shares)
(23,798
)
 
(19,784
)
Total Stockholders' Equity
290,099

 
273,363

Less maximum cash obligation related to ESOP shares (Note 9)
34,571

 
29,574

Total Stockholders' Equity Less Maximum Cash Obligations Related To ESOP Shares
255,528

 
243,789

Total Liabilities & Stockholders' Equity
$
2,334,318

 
$
2,167,795

 
See Notes to Consolidated Financial Statements.


Page 52

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2014, 2013 and 2012
(Amounts In Thousands, Except Per Share Amounts)
 
2014
 
2013
 
2012
Interest income:
 
 
 
 
 
Loans, including fees
$
82,079

 
$
80,230

 
$
83,787

Investment securities:
 

 
 

 
 

Taxable
1,099

 
1,254

 
1,897

Nontaxable
3,368

 
3,337

 
3,397

Federal funds sold
36

 
74

 
134

Total interest income
86,582

 
84,895

 
89,215

Interest expense:
 

 
 

 
 

Deposits
9,305

 
11,112

 
13,724

Other borrowings
129

 
146

 
220

FHLB borrowings
5,603

 
5,590

 
7,583

Total interest expense
15,037

 
16,848

 
21,527

Net interest income
71,545

 
68,047

 
67,688

Provision for loan losses (Note 3)
1,042

 
1,131

 
(2,849
)
Net interest income after provision for loan losses
70,503

 
66,916

 
70,537

Noninterest income:
 

 
 

 
 

Net gain on sale of loans
894

 
1,925

 
3,549

Trust fees
6,065

 
5,294

 
4,616

Service charges and fees
8,025

 
7,805

 
7,815

Rental revenue on tax credit real estate
1,490

 
1,511

 
1,587

Net gain on sale of other real estate owned and other repossessed assets
386

 
183

 
782

Other noninterest income
2,496

 
2,487

 
2,420

 
19,356

 
19,205

 
20,769

Noninterest expenses:
 

 
 

 
 

Salaries and employee benefits
26,450

 
24,845

 
23,793

Occupancy
3,807

 
3,699

 
3,332

Furniture and equipment
4,975

 
4,711

 
4,573

Office supplies and postage
1,546

 
1,706

 
1,481

Advertising and business development
3,073

 
2,638

 
2,721

Outside services
6,741

 
6,782

 
6,712

Rental expenses on tax credit real estate
2,189

 
1,985

 
2,548

FDIC insurance assessment
1,098

 
1,016

 
1,036

Loss on extinguishment of debt - Federal Home Loan Bank borrowings
—

 
—

 
5,925

Other noninterest expenses
1,877

 
1,896

 
1,810

 
51,756

 
49,278

 
53,931

Income before income taxes
38,103

 
36,843

 
37,375

Income taxes (Note 10)
11,129

 
10,912

 
10,542

Net income
$
26,974

 
$
25,931

 
$
26,833

Earnings per share:
 

 
 

 
 

Basic
$
5.75

 
$
5.51

 
$
5.69

Diluted
5.74

 
5.50

 
5.68


See Notes to Consolidated Financial Statements.


Page 53

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2014, 2013 and 2012
(Amounts In Thousands)
 
2014
 
2013
 
2012
Net income
$
26,974


$
25,931


$
26,833

Other comprehensive (loss) income
 


 


 

Securities:
 


 


 

Net change in unrealized gain (loss) on securities available for sale
$
264


$
(4,580
)

$
(1,656
)
Reclassification adjustment for net (gains) losses realized in net income
—


(17
)

6

Income taxes
(101
)

1,758


631

Other comprehensive income (loss) on securities available for sale
$
163

 
$
(2,839
)
 
$
(1,019
)
Derivatives used in cash flow hedging relationships:
 

 
 

 
 

Net change in unrealized (loss) gain on derivatives
$
(3,565
)

$
769


$
—

Income taxes
1,363


(294
)

—

Other comprehensive (loss) income on cash flow hedges
$
(2,202
)
 
$
475

 
$
—

Other comprehensive loss, net of tax
$
(2,039
)
 
$
(2,364
)
 
$
(1,019
)
Comprehensive income
$
24,935

 
$
23,567

 
$
25,814

 
See Notes to Consolidated Financial Statements.


Page 54

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2014, 2013 and 2012
(Amounts In Thousands, Except Share Data)
 
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, 2011
$
41,467

 
$
207,790

 
$
4,974

 
$
(2,017
)
 
$
(15,959
)
 
$
(27,826
)
 
$
208,429

Issuance of 12,825 shares of common stock
647

 
—

 
—

 
—

 
—

 
—

 
647

Issuance of 375 shares of common stock under the employee stock purchase plan
25

 
—

 
—

 
—

 
—

 
—

 
25

Forfeiture of 718 shares of common stock
(41
)
 
—

 
—

 
—

 
—

 
—

 
(41
)
Share-based compensation
20

 
—

 
—

 
—

 
—

 
—

 
20

Income tax benefit related to share-based compensation
92

 
—

 
—

 
—

 
—

 
—

 
92

Change related to ESOP shares
—

 
—

 
—

 
—

 
—

 
(2,889
)
 
(2,889
)
Release of 8,724 shares of common stock under the employee stock ownership plan
31

 
—

 
—

 
504

 
—

 
—

 
535

Net income


 
26,833

 
—

 
—

 
—

 
—

 
26,833

Cash dividends ($1.05 per share)
—

 
(4,998
)
 
—

 
—

 
—

 
—

 
(4,998
)
Purchase of 35,892 shares of common stock
—

 
—

 
—

 
—

 
(2,438
)
 
—

 
(2,438
)
Other comprehensive income
—

 
—

 
(1,019
)
 
—

 
—

 
—

 
(1,019
)
Balance, December 31, 2012
$
42,241

 
$
229,625

 
$
3,955

 
$
(1,513
)
 
$
(18,397
)
 
$
(30,715
)
 
$
225,196

Issuance of 8,964 shares of common stock
443


—


—


—


—


—

 
443

Issuance of 2,072 shares of common stock under the employee stock purchase plan
146


—


—


—


—


—

 
146

Unearned restricted stock compensation
(800
)

—


—


—


—


—

 
(800
)
Forfeiture of 525 shares of common stock
(35
)

—


—


—


—


—

 
(35
)
Share-based compensation
28


—


—


—


—


—

 
28

Income tax benefit related to share-based compensation
92


—


—


—


—


—

 
92

Change related to ESOP shares
—


—


—


—


—


1,141

 
1,141

Release of 8,360 shares of common stock under the employee stock ownership plan
79


—


—


505


—


—

 
584

Net income
—


25,931


—


—


—


—

 
25,931

Cash dividends ($1.10 per share)
—


(5,186
)

—


—


—


—

 
(5,186
)
Purchase of 19,204 shares of common stock
—


—


—


—


(1,387
)

—

 
(1,387
)
Other comprehensive loss
—


—


(2,364
)

—


—


—

 
(2,364
)
Balance, December 31, 2013
$
42,194

 
$
250,370

 
$
1,591

 
$
(1,008
)
 
$
(19,784
)
 
$
(29,574
)
 
$
243,789

Issuance of 12,512 shares of common stock
862

 
—

 
—

 
—

 
—

 
—

 
862

Issuance of 2,092 shares of common stock under the employee stock purchase plan
158

 
—

 
—

 
—

 
—

 
—

 
158

Unearned restricted stock compensation
(464
)
 
—

 
—

 
—

 
—

 
—

 
(464
)
Forfeiture of 571 shares of common stock
(40
)
 
—

 
—

 
—

 
—

 
—

 
(40
)
Share-based compensation
29

 
—

 
—

 
—

 
—

 
—

 
29

Income tax benefit related to share-based compensation
60

 
—

 
—

 
—

 
—

 
—

 
60

Change related to ESOP shares
—

 
—

 
—

 
—

 
—

 
(4,997
)
 
(4,997
)
Release of 8,002 shares of common stock under the employee stock ownership plan
126

 
—

 
—

 
504

 
—

 
—

 
630

Net income
—

 
26,974

 
—

 
—

 
—

 
—

 
26,974

Cash dividends ($1.15 per share)
—

 
(5,420
)
 
—

 
—

 
—

 
—

 
(5,420
)
Purchase of 51,442 shares of common stock
—

 
—

 
—

 
—

 
(4,014
)
 
—

 
(4,014
)
Other comprehensive loss
—

 
—

 
(2,039
)
 
—

 
—

 
—

 
(2,039
)
Balance, December 31, 2014
$
42,925

 
$
271,924

 
$
(448
)
 
$
(504
)
 
$
(23,798
)
 
$
(34,571
)
 
$
255,528

See Notes to Consolidated Financial Statements.

Page 55

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2014, 2013 and 2012
(Amounts In Thousands)
 
2014
 
2013
 
2012
Cash Flows from Operating Activities
 
 
 
 
 
Net income
$
26,974

 
$
25,931

 
$
26,833

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

 
 

 
 

Depreciation
2,559

 
2,790

 
2,788

Provision for loan losses
1,042

 
1,131

 
(2,849
)
Net (gain) loss on sale of investment securities
—

 
(17
)
 
6

Share-based compensation
29

 
28

 
20

Compensation expensed through issuance of common stock
1,549

 
997

 
1,032

Excess tax benefits related to share-based compensation
(60
)
 
(92
)
 
(92
)
Forfeiture of common stock
(40
)
 
(35
)
 
(41
)
Provision for deferred income taxes
(71
)
 
3

 
2,018

Net gain on sale of other real estate owned and other repossessed assets
(386
)
 
(183
)
 
(782
)
(Increase) decrease in accrued interest receivable
(600
)
 
175

 
838

Amortization of discount on investment securities, net
865

 
1,089

 
1,027

Decrease in prepaid FDIC insurance
—

 
2,957

 
922

(Increase) decrease in other assets
(19
)
 
2,438

 
(975
)
Increase (decrease) in accrued interest and other liabilities
852

 
(743
)
 
(1,298
)
Loans originated for sale
(114,725
)
 
(204,875
)
 
(328,577
)
Proceeds on sales of loans
116,070

 
230,129

 
328,485

Net gain on sales of loans
(894
)
 
(1,925
)
 
(3,549
)
Net cash and cash equivalents provided by operating activities
33,145

 
59,798

 
25,806

Cash Flows from Investing Activities
 

 
 

 
 

Proceeds from maturities of investment securities available for sale
58,094

 
40,423

 
48,615

Proceeds from sales of investment securities available for sale
—

 
566

 
721

Purchases of investment securities available for sale
(79,846
)
 
(58,503
)
 
(64,167
)
Loans made to customers, net of collections
(162,658
)
 
(106,941
)
 
(33,564
)
Proceeds on sale of other real estate owned and other repossessed assets
1,208

 
1,003

 
2,690

Purchases of property and equipment
(1,794
)
 
(2,002
)
 
(3,091
)
Income from tax credit real estate, net
921

 
565

 
1,385

Net cash and cash equivalents used in investing activities
(184,075
)
 
(124,889
)
 
(47,411
)
 
(Continued)

Page 56

HILLS BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31, 2014, 2013 and 2012
(Amounts In Thousands)
 
2014
 
2013
 
2012
Cash Flows from Financing Activities
 
 
 
 
 
Net increase in deposits
125,192

 
47,333

 
137,067

Net increase (decrease) in short-term borrowings
20,483

 
3,233

 
(14,002
)
Payments on FHLB borrowings
—

 
—

 
(60,000
)
Borrowings from FRB
1

 
1

 
1

Payments on FRB borrowings
(1
)
 
(1
)
 
(1
)
Stock options exercised
101

 
175

 
175

Excess tax benefits related to share-based compensation
60

 
93

 
92

Purchase of treasury stock
(4,014
)
 
(1,387
)
 
(2,438
)
Dividends paid
(5,420
)
 
(5,186
)
 
(4,998
)
Net cash and cash equivalents provided by financing activities
136,402

 
44,261

 
55,896

 
 
 
 
 
 
(Decrease) Increase in cash and cash equivalents
(14,528
)
 
(19,880
)
 
34,291

 
 
 
 
 
 
Cash and cash equivalents:
 

 
 

 
 

Beginning of year
43,702

 
63,582

 
29,291

End of year
$
29,174

 
$
43,702

 
$
63,582

 
 
 
 
 
 
Supplemental Disclosures
 

 
 

 
 

Cash payments for:
 

 
 

 
 

Interest paid to depositors
$
9,505

 
$
11,371

 
$
13,988

Interest paid on other obligations
5,732

 
5,736

 
7,803

Income taxes paid
11,546

 
9,616

 
9,773

Noncash financing activities:
 

 
 

 
 

Increase (decrease) in maximum cash obligation related to ESOP shares
$
4,997

 
$
(1,141
)
 
$
2,889

Transfers to other real estate owned
2,470

 
1,090

 
1,815

Sale and financing of other real estate owned
976

 
475

 
488

 
See Notes to Consolidated Financial Statements.

Page 57

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1.
Nature of Activities and Significant Accounting Policies

Nature of activities:  Hills Bancorporation (the "Company") is a holding company engaged in the business of commercial banking.  The Company's subsidiary is Hills Bank and Trust Company, Hills, Iowa (the “Bank”), which is wholly-owned.  The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Washington, Kalona, Wellman, Cedar Rapids and Marion, Iowa.

The Bank competes with other financial institutions and non-financial institutions providing similar financial products.  Although the loan activity of the Bank is diversified with commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans, the Bank's credit is concentrated in real estate loans.  All of the Company’s operations are considered to be one reportable operating segment.

Accounting estimates:  The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Certain significant estimates:  The allowance for loan losses, fair values of securities and other financial instruments, and share-based compensation expense involve certain significant estimates made by management.  These estimates are reviewed by management routinely and it is reasonably possible that circumstances that exist at December 31, 2014 may change in the near-term and the effect could be material to the consolidated financial statements.

Principles of consolidation:  The consolidated financial statements include the accounts of the Company and its subsidiary.  All significant intercompany balances and transactions have been eliminated in consolidation.

Revenue recognition: Interest income on loans and investment securities is recognized on the accrual method. Loan origination fees are recognized when the loans are sold. Trust fees, deposit account service charges and other fees are recognized when the services are provided or when customers use the services.

Cash and cash equivalents:  The Company considers all investments with original maturities of three months or less to be cash equivalents.  At December 31, 2014 and 2013, cash equivalents consisted primarily of deposits with other banks.

Investment securities:  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 December 31, 2014 or 2013.

Stock of the Federal Home Loan Bank is carried at cost.  The Company has evaluated the stock and determined there is no impairment.

Premiums and discounts on debt securities are amortized or accreted over the period to maturity of those securities.  The method of amortization results in a constant effective yield on those securities (the interest method).  Realized gains and losses on investment securities are included in income, determined on the basis of the cost of the specific securities sold.

Page 58

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Declines in the fair value of investment securities available for sale (with certain exceptions for debt securities noted below) that are deemed to be other-than-temporary are charged to earnings as a realized loss, and a new cost basis for the securities is established.  In evaluating other-than-temporary impairment, the Company considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term.  Declines in the fair value of debt securities below amortized cost are deemed to be other-than-temporary in circumstances where: (1) the Company has the intent to sell a security; (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the Company does not expect to recover the entire amortized cost basis of the security.  If the Company intends to sell a security or if it is more likely than not that the Company will be required to sell the security before recovery, an other-than-temporary impairment write-down is recognized in earnings equal to the difference between the security’s amortized cost basis and its fair value.  If the Company does not intend to sell the security or it is not more likely than not that the Company will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into an amount representing credit loss, which is recognized in earnings, and an amount related to all other factors, which is recognized in other comprehensive income.  Realized securities gains or losses on securities sales (using specific identification method) and declines in value judged to be other-than-temporary are included in investment securities gains (losses), net, in the consolidated statements of income.

Loans:  Loans are stated at the amount of unpaid principal, reduced by the allowance for loan losses.  Interest income is accrued on the unpaid balances as earned.

Loans held for sale are stated at the lower of aggregate cost or estimated fair value.  Loans are sold on a non-recourse basis with servicing released and gains and losses are recognized based on the difference between sales proceeds and the carrying value of the loan.  The Company has had very few experiences of repurchasing loans previously sold into the secondary market.  A specific reserve was not considered necessary based on the Company’s historical experience with repurchase activity.

The allowance for loan losses is established through a provision for loan losses charged to expense.  Loans are charged against the allowance when management believes the collectability of principal is unlikely.  The allowance for loan losses is maintained at a level considered adequate to provide for probable losses that can be reasonably anticipated.  The allowance is increased by provisions charged to expense and is reduced by net charge-offs.  The Bank makes continuous reviews of the loan portfolio and considers current economic conditions, historical loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance.  Management classifies loans within the following categories: excellent, good, satisfactory, monitor, special mention and substandard.

The policy for charging off loans is consistent throughout all loan categories.  A loan is charged off based on criteria that includes but is not limited to:  delinquency status, financial condition of the entire customer credit line and underlying collateral coverage, economic or external conditions that might impact full repayment of the loan, legal issues, overdrafts, and the customer’s willingness to work with the Company.

Loans are considered impaired when, based on current information and events, it is probable the Bank will not be able to collect all amounts due.  An impaired loan includes any loan that has been placed on nonaccrual status, loans greater than 90 days past due and still accruing and TDR loans.  They also include loans, based on current information and events, that it is likely the Bank will be unable to collect all amounts due according to the contractual terms of the original loan agreement.  The portion of the allowance for loan losses applicable to impaired loans has been computed based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or on the fair value of the collateral for collateral dependent loans.  The entire change in present value of expected cash flows of impaired loans or of collateral value is reported as provision expense in the same manner in which impairment initially was recognized or as a reduction in the amount of provision expense that otherwise would be reported.  Interest income on nonaccrual loans is recognized once principal has been recovered.

Page 59

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower's ability to meet payments of interest or principal when they become due, which is generally when a loan is 90 days or more past due.  When a loan is placed on nonaccrual status, all previously accrued and unpaid interest is reversed.  Loans are returned to an accrual status when all of the principal and interest amounts contractually due are brought current and repayment of the remaining contractual principal and interest is expected.   A loan may also return to accrual status if additional collateral is received from the borrower and, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the collection of the amount contractually due.  Payment received on nonaccrual loans are applied first to principal.  Once principal is recovered, any remaining payments received are applied to interest income.  As of December 31, 2014, none of the Company’s nonaccrual loans were earning interest on a cash basis.

Nonrefundable loan fees and origination costs are deferred and recognized as a yield adjustment over the life of the related loan.

Troubled debt restructurings (“TDR loans”):  A loan is classified as a troubled debt restructuring when a borrower is experiencing financial difficulties that leads to a restructuring of the loan, and the Company grants concessions to the borrower in the restructuring that it would not otherwise consider.  These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses to the Company.  A loan that is modified at a market rate of interest is no longer classified as troubled debt restructuring in the quarter following the modification if the borrower is no longer experiencing financial difficulties.  Performance prior to the restructuring is considered when assessing whether the borrower can meet the new terms.  At the time of restructuring, the majority of loans included in a troubled debt restructuring are considered nonaccrual loans.  TDR loans are returned to accrual status under the same criteria noted under loans above.

Transfers of financial assets:  Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Credit related financial instruments:  In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit.  Such financial instruments are recorded when they are funded.

Tax credit real estate:  Tax credit real estate represents two multi-family rental properties, three assisted living rental properties, a multi-tenant rental property for persons with disabilities, and a multi-family senior living rental property, all which are affordable housing projects as of December 31, 2014.  The Bank has a 99% or greater limited partnership interest in each limited partnership.  The investment in each was completed after the projects had been developed by the general partner.  The properties are recorded at cost less accumulated depreciation.  The Company evaluates the recoverability of the carrying value on a regular basis.  If the recoverability was determined to be in doubt, a valuation allowance would be established by way of a charge to expense.  Depreciation expense is provided on a straight-line basis over the estimated useful life of the assets.  Expenditures for normal repairs and maintenance are charged to expense as incurred.

The financial condition, results of operations and cash flows of each limited partnership is consolidated in the Company’s consolidated financial statements.  The operations of the properties are not expected to contribute significantly to the Company’s income before income taxes.  However, the properties do contribute in the form of income tax credits, which lowers the Company’s effective tax rate.  Once established, the credits on each property last for ten years and are passed through from the limited partnerships to the Bank and reduces the consolidated federal tax liability of the Company.

Property and equipment:  Property and equipment is stated at cost less accumulated depreciation.  Depreciation is computed using primarily declining-balance methods over the estimated useful lives of 7-40 years for buildings and improvements and 3-10 years for furniture and equipment.

Page 60

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Deferred income taxes:  Deferred income taxes are provided under the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating loss, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.   The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained.  Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized.  Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.  Interest and penalties on unrecognized tax benefits are classified as other noninterest expense.  As of December 31, 2014, the Company had no material unrecognized tax benefits.

Goodwill:  Goodwill represents the excess of cost over the fair value of the net assets acquired, and is not subject to amortization, but requires, at a minimum, annual impairment tests for intangibles that are determined to have an indefinite life.

Other real estate:   Other real estate represents property acquired through foreclosures and settlements of loans.  Property acquired is carried at the lower of the principal amount of the loan outstanding at the time of acquisition, plus any acquisition costs, or the estimated fair value of the property, less disposal costs.  The Bank will obtain updated appraisals to determine the estimated fair value of the property based on the type of collateral securing the loan and the date of the latest appraisal.  Subsequent write downs estimated on the basis of later valuations are charged to net loss on sale of other real estate owned and other repossessed assets.  Net operating expenses incurred in maintaining such properties are charged to other non-interest expense. Net capital expenditures incurred are capitalized to the property.

Derivative financial instruments:  The Bank uses interest rate swaps as part of its interest rate risk management.  FASB Accounting Standards Codification (ASC) Topic 815 establishes accounting and reporting standards for derivative instruments and hedging activities.  The Bank records all interest rate swaps on the balance sheet at fair value.  Derivatives used to hedge the exposure to variability in expected future cash flows are considered cash flow hedges.  To qualify for hedge accounting, the Bank must comply with the detailed rules and documentation requirements at the inception of the hedge, and hedge effectiveness is assessed at inception and periodically throughout the life of the hedging relationship.

For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivatives is initially reported in other comprehensive income and subsequently reclassified to interest income or expense when the hedged transaction affects earnings, while the ineffective portion of changes in fair value of the derivative, if any, is recognized immediately in other noninterest income or expense.  The Bank assesses the effectiveness of each hedging relationship by comparing the cumulative changes in cash flows of the derivative hedging instruments with the cumulative changes in cash flows of the designated hedged item or transaction.  No component of the change in the fair value of the hedging instrument is excluded from the assessment of hedge effectiveness.

The Bank does not use derivatives for trading or speculative purposes.

Page 61

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 following table presents calculations of earnings per share:
 
Year Ended December 31,
 
2014
 
2013
 
2012
 
(Amounts In Thousands, except share and per share data)
Computation of weighted average number of basic and diluted shares:
 
 
 
 
 
Common shares outstanding at the beginning of the year
4,727,625

 
4,712,328

 
4,727,104

Weighted average number of net shares redeemed
(33,511
)
 
(2,110
)
 
(11,116
)
Weighted average shares outstanding (basic)
4,694,114

 
4,710,218

 
4,715,988

Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method
2,350

 
3,635

 
5,289

Weighted average number of shares (diluted)
4,696,464

 
4,713,853

 
4,721,277

Net income
$
26,974

 
$
25,931

 
$
26,833

Earnings per share:
 

 
 

 
 

Basic
$
5.75

 
$
5.51

 
$
5.69

Diluted
$
5.74

 
$
5.50

 
$
5.68


Stock awards and options:   Compensation expense for stock issued through the stock award plan is accounted for using the fair value method prescribed by FASB ASC 718, “Share-Based Payment” (“ASC 718”).  Under this method, compensation expense is measured and recognized for all stock-based awards made to employees and directors based on the fair value of each option as of the date of the grant.

Common stock held by ESOP:  The Company's maximum cash obligation related to these shares is classified outside stockholders' equity because the shares are not readily traded and could be put to the Company for cash.

Treasury Stock:  Treasury stock is accounted for by the cost method, whereby shares of common stock reacquired are recorded at their purchase price.

Trust Department Assets:  Property held for customers in fiduciary or agency capacities is not included in the accompanying consolidated balance sheets, as such items are not assets of the Company.

Effect of New Financial Accounting Standards:

In January 2014, the FASB issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects", to amend FASB ASC Topic 323, Investments – Equity Method and Joint Ventures.  The objective of this standard is to provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit.  The amendments in the standard permit, but do not require, reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met.  Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit).  The standard will be effective for the Company beginning January 1, 2015; however, early adoption is permitted.  The Company has significant investments in such qualified affordable housing projects and has decided not to adopt this standard.


Page 62

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In January 2014, the FASB issued ASU No. 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.  ASU 2014-4 clarifies that an in-substance foreclosure repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either the creditor obtaining legal title to the residential real estate property upon foreclosure or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.  Additional disclosures are required.  ASU 2014-4 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2014.  The adoption of ASU 2014-4 by the Company is not expected to have a material impact.

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. Early adoption is not permitted. The Company is currently reviewing the provisions of this standard to determine the application to financial institutions. The adoption of ASU 2014-09 by the Company is not expected to have a material impact.


Note 2.
Investment Securities

The carrying values of investment securities at December 31, 2014 and December 31, 2013 are summarized in the following table (Amounts in Thousands):

 
December 31, 2014
 
December 31, 2013
 
Amount
 
Percent
 
Amount
 
Percent
Securities available for sale
 
 
 
 
 
 
 
U.S. Treasury
$
22,333

 
8.62
%
 
$
—

 
—
%
Other securities (FHLB, FHLMC and FNMA)
67,691

 
26.14
%
 
87,144

 
36.54
%
State and political subdivisions
168,968

 
65.24
%
 
151,366

 
63.46
%
Total securities available for sale
$
258,992

 
100.00
%
 
$
238,510

 
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.  The Company had no securities designated as trading or held to maturity in its portfolio at December 31, 2014 or 2013.  The carrying amount of available-for-sale securities and their approximate fair values were as follows (Amounts in Thousands):
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Estimated
Fair
Value
December 31, 2014:
 
 
 
 
 
 
 
U.S. Treasury
$
22,351

 
$
18

 
$
(36
)
 
$
22,333

Other securities (FHLB, FHLMC and FNMA)
67,644

 
147

 
(100
)
 
67,691

State and political subdivisions
166,925

 
2,499

 
(456
)
 
168,968

Total
$
256,920

 
$
2,664

 
$
(592
)
 
$
258,992

December 31, 2013:
 

 
 

 
 

 
 

U.S. Treasury
$
—

 
$
—

 
$
—

 
$
—

Other securities (FHLB, FHLMC and FNMA)
86,998

 
316

 
(170
)
 
87,144

State and political subdivisions
149,704

 
3,182

 
(1,520
)
 
151,366

Total
$
236,702

 
$
3,498

 
$
(1,690
)
 
$
238,510


Page 63

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at December 31, 2014, were as follows (Amounts in Thousands):
 
Amortized
Cost
 
Fair
Value
Due in one year or less
$
42,164

 
$
42,286

Due after one year through five years
141,292

 
142,950

Due after five years through ten years
72,139

 
72,431

Due over ten years
1,325

 
1,325

Total
$
256,920

 
$
258,992


As of December 31, 2014, investment securities with a carrying value of $68.12 million were pledged to collateralize repurchase agreements, derivative financial instruments and other borrowings.

Sales proceeds and gross realized gains and losses on available-for-sale securities were as follows (Amounts in Thousands):
 
2014
 
2013
 
2012
Sales proceeds
$
—

 
$
566

 
$
721

Gross realized gains
—

 
17

 
11

Gross realized losses
—

 
—

 
(17
)

The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2014 and 2013 (Amounts in Thousands):
 
Less than 12 months
 
12 months or more
 
Total
2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Description
#

 
Fair Value
 
Unrealized Loss
 
%
 
#

 
Fair Value
 
Unrealized Loss
 
%
 
#

 
Fair Value
 
Unrealized Loss
 
%
of Securities
 

 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
 
 
 
U.S. Treasury
5

 
$
12,396

 
$
(36
)
 
0.29
%
 
—

 
$
—

 
$
—

 
—

 
5

 
$
12,396

 
$
(36
)
 
0.29
%
Other securities (FHLB, FHLMC and FNMA)
10

 
24,382

 
(100
)
 
0.41
%
 
—

 
—

 
—

 
—

 
10

 
24,382

 
(100
)
 
0.41
%
State and political subdivisions
91

 
21,724

 
(124
)
 
0.57
%
 
78

 
16,154

 
(332
)
 
2.06
%
 
169

 
37,878

 
(456
)
 
1.20
%
Total temporarily impaired securities
106

 
$
58,502

 
$
(260
)
 
0.44
%
 
78

 
$
16,154

 
$
(332
)
 
2.06
%
 
184

 
$
74,656

 
$
(592
)
 
0.79
%
 
Less than 12 months
 
12 months or more
 
Total
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Description
#

 
Fair Value
 
Unrealized Loss
 
%
 
#

 
Fair Value
 
Unrealized Loss
 
%
 
#

 
Fair Value
 
Unrealized Loss
 
%
of Securities
 

 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
 
 
 
U.S. Treasury
—

 
$
—

 
$
—

 
—

 
—

 
$
—

 
$
—

 
—

 
—

 
$
—

 
$
—

 
—

Other securities (FHLB, FHLMC and FNMA)
10

 
21,810

 
(149
)
 
0.68
%
 
1

 
2,557

 
(21
)
 
0.82
%
 
11

 
24,367

 
(170
)
 
0.70
%
State and political subdivisions
164

 
36,212

 
(1,259
)
 
3.48
%
 
25

 
5,565

 
(261
)
 
4.69
%
 
189

 
41,777

 
(1,520
)
 
3.64
%
Total temporarily impaired securities
174

 
$
58,022

 
$
(1,408
)
 
2.43
%
 
26

 
$
8,122

 
$
(282
)
 
3.47
%
 
200

 
$
66,144

 
$
(1,690
)
 
2.56
%


Page 64

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 credit quality 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 3.
Loans

Classes of loans are as follows:
 
December 31,
 
2014
 
2013
 
(Amounts In Thousands)
Agricultural
$
97,645

 
$
82,138

Commercial and financial
174,738

 
166,102

Real estate:
 

 
 

Construction, 1 to 4 family residential
45,949

 
30,309

Construction, land development and commercial
77,020

 
69,182

Mortgage, farmland
162,503

 
142,685

Mortgage, 1 to 4 family first liens
672,674

 
605,687

Mortgage, 1 to 4 family junior liens
110,284

 
105,785

Mortgage, multi-family
245,213

 
244,090

Mortgage, commercial
321,601

 
315,187

Loans to individuals
21,342

 
19,824

Obligations of state and political subdivisions
55,729

 
45,167

 
1,984,698

 
1,826,156

Net unamortized fees and costs
691

 
641

 
1,985,389

 
1,826,797

Less allowance for loan losses
24,020

 
25,550

 
$
1,961,369

 
$
1,801,247



Page 65

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Changes in the allowance for loan losses and the allowance for loan loss balance applicable to impaired loans and the related loan balance of impaired loans for the year ended December 31, 2014, 2013 and 2012 are as follows:
 
Agricultural
 
Commercial and Financial
 
Real Estate: Construction
and land
development
 
Real Estate:
Mortgage,
farmland
 
Real Estate:
Mortgage, 1 to 4 family
 
Real Estate:
Mortgage, multi-family and
commercial
 
Other
 
Total
 
(Amounts In Thousands)
2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,852


$
4,733


$
2,918


$
2,557


$
7,064


$
4,787


$
639


$
25,550

Charge-offs
(174
)

(3,388
)

(250
)

—


(1,195
)

(217
)

(325
)

(5,549
)
Recoveries
66


1,128


390


—


870


377


146


2,977

Provision
(229
)

1,758


(817
)

115


680


(752
)

287


1,042

Ending balance
$
2,515


$
4,231


$
2,241


$
2,672


$
7,419


$
4,195


$
747


$
24,020

Ending balance, individually evaluated for impairment
$
44

 
$
9

 
$
28

 
$
12

 
$
52

 
$
9

 
$
—

 
$
154

Ending balance, collectively evaluated for impairment
$
2,471

 
$
4,222

 
$
2,213

 
$
2,660

 
$
7,367

 
$
4,186

 
$
747

 
$
23,866

Loan balances:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance
$
97,645

 
$
174,738

 
$
122,969

 
$
162,503

 
$
782,958

 
$
566,814

 
$
77,071

 
$
1,984,698

Ending balance, individually evaluated for impairment
$
1,844

 
$
2,709

 
$
560

 
$
2,318

 
$
3,826

 
$
9,512

 
$
—

 
$
20,769

Ending balance, collectively evaluated for impairment
$
95,801

 
$
172,029

 
$
122,409

 
$
160,185

 
$
779,132

 
$
557,302

 
$
77,071

 
$
1,963,929


 
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)
2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
1,653

 
$
4,573

 
$
3,175

 
$
1,746

 
$
8,088

 
$
5,104

 
$
821

 
$
25,160

Charge-offs
—

 
(1,692
)
 
(245
)
 
—

 
(887
)
 
(356
)
 
(166
)
 
(3,346
)
Recoveries
35

 
1,002

 
323

 
—

 
618

 
464

 
163

 
2,605

Provision
1,164

 
850

 
(335
)
 
811

 
(755
)
 
(425
)
 
(179
)
 
1,131

Ending balance
$
2,852

 
$
4,733

 
$
2,918

 
$
2,557

 
$
7,064

 
$
4,787

 
$
639

 
$
25,550

Ending balance, individually evaluated for impairment
$
3

 
$
16

 
$
—

 
$
14

 
$
66

 
$
205

 
$
—

 
$
304

Ending balance, collectively evaluated for impairment
$
2,849

 
$
4,717

 
$
2,918

 
$
2,543

 
$
6,998

 
$
4,582

 
$
639

 
$
25,246

Loan balances:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance
$
82,138

 
$
166,102

 
$
99,491

 
$
142,685

 
$
711,472

 
$
559,277

 
$
64,991

 
$
1,826,156

Ending balance, individually evaluated for impairment
$
120

 
$
2,407

 
$
1,410

 
$
284

 
$
4,542

 
$
17,763

 
$
—

 
$
26,526

Ending balance, collectively evaluated for impairment
$
82,018

 
$
163,695

 
$
98,081

 
$
142,401

 
$
706,930

 
$
541,514

 
$
64,991

 
$
1,799,630



Page 66

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
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)
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
1,354

 
$
6,429

 
$
4,994

 
$
1,411

 
$
9,051

 
$
6,150

 
$
761

 
$
30,150

Charge-offs
(12
)
 
(1,395
)
 
(1,648
)
 
—

 
(1,448
)
 
(318
)
 
(205
)
 
(5,026
)
Recoveries
71

 
1,583

 
52

 
—

 
521

 
403

 
255

 
2,885

Provision
240

 
(2,044
)
 
(223
)
 
335

 
(36
)
 
(1,131
)
 
10

 
(2,849
)
Ending balance
$
1,653

 
$
4,573

 
$
3,175

 
$
1,746

 
$
8,088

 
$
5,104

 
$
821

 
$
25,160

Ending balance, individually evaluated for impairment
$
—

 
$
22

 
$
—

 
$
—

 
$
90

 
$
261

 
$
—

 
$
373

Ending balance, collectively evaluated for impairment
$
1,653

 
$
4,551

 
$
3,175

 
$
1,746

 
$
7,998

 
$
4,843

 
$
821

 
$
24,787

Loan balances:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Ending balance
$
76,190

 
$
148,034

 
$
104,885

 
$
113,841

 
$
687,845

 
$
527,318

 
$
63,452

 
$
1,721,565

Ending balance, individually evaluated for impairment
$
—

 
$
2,152

 
$
2,978

 
$
806

 
$
3,565

 
$
20,257

 
$
—

 
$
29,758

Ending balance, collectively evaluated for impairment
$
76,190

 
$
145,882

 
$
101,907

 
$
113,035

 
$
684,280

 
$
507,061

 
$
63,452

 
$
1,691,807


The Company evaluates the following loans to determine impairment:  1) all nonaccrual and TDR loans, 2) all non consumer and non 1 to 4 family residential loans with prior charge-offs, 3) all non consumer and non 1 to 4 family loan relationships classified as substandard and 4) loans with indications of or suspected deteriorating credit quality.


Page 67

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the credit quality indicators by type of loans in each category as of December 31, 2014:
 
Agricultural
 
Commercial
and Financial
 
Real Estate:
Construction, 1 to 4
family residential
 
Real Estate:
Construction, land
development and commercial
 
(Amounts In Thousands)
2014
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
1,375

 
$
4,820

 
$
—

 
$
276

Good
13,214

 
37,941

 
6,893

 
13,875

Satisfactory
51,107

 
94,158

 
27,738

 
47,852

Monitor
15,243

 
20,445

 
8,435

 
2,811

Special Mention
13,070

 
11,031

 
1,881

 
11,870

Substandard
3,636

 
6,343

 
1,002

 
336

Total
$
97,645

 
$
174,738

 
$
45,949

 
$
77,020


 
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
2014
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
2,867

 
$
474

 
$
—

 
$
7,011

Good
36,680

 
22,094

 
2,875

 
73,852

Satisfactory
103,552

 
571,546

 
99,095

 
111,650

Monitor
11,754

 
41,805

 
3,377

 
35,812

Special Mention
4,721

 
18,428

 
2,520

 
16,611

Substandard
2,929

 
18,327

 
2,417

 
277

Total
$
162,503

 
$
672,674

 
$
110,284

 
$
245,213


 
Real Estate:
Mortgage,
commercial
 
Loans to
individuals
 
Obligations of state
and political
subdivisions
 
Total
2014
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
15,416

 
$
87

 
$
2,440

 
$
34,766

Good
87,612

 
94

 
43,108

 
338,238

Satisfactory
178,069

 
20,465

 
10,181

 
1,315,413

Monitor
25,165

 
251

 
—

 
165,098

Special Mention
9,371

 
353

 
—

 
89,856

Substandard
5,968

 
92

 
—

 
41,327

Total
$
321,601

 
$
21,342

 
$
55,729

 
$
1,984,698



Page 68

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the credit quality indicators by type of loans in each category as of December 31, 2013:
 
Agricultural
 
Commercial
and Financial
 
Real Estate:
Construction, 1 to 4
family residential
 
Real Estate:
Construction, land
development and commercial
 
(Amounts In Thousands)
2013
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
1,505

 
$
5,914

 
$
—

 
$
33

Good
15,518

 
52,135

 
5,194

 
21,083

Satisfactory
54,347

 
76,556

 
21,325

 
35,439

Monitor
3,579

 
12,469

 
758

 
3,963

Special Mention
1,076

 
12,971

 
2,242

 
6,854

Substandard
6,113

 
6,057

 
790

 
1,810

Total
$
82,138

 
$
166,102

 
$
30,309

 
$
69,182


 
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
2013
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
2,398

 
$
859

 
$
—

 
$
7,494

Good
42,955

 
26,158

 
3,459

 
72,605

Satisfactory
87,635

 
505,904

 
94,683

 
116,517

Monitor
5,413

 
30,454

 
2,273

 
28,438

Special Mention
1,795

 
22,097

 
3,187

 
18,161

Substandard
2,489

 
20,215

 
2,183

 
875

Total
$
142,685

 
$
605,687

 
$
105,785

 
$
244,090


 
Real Estate:
Mortgage,
commercial
 
Loans to
individuals
 
Obligations of state
and political
subdivisions
 
Total
2013
 
 
 
 
 
 
 
Grade:
 
 
 
 
 
 
 
Excellent
$
17,494

 
$
—

 
$
3,871

 
$
39,568

Good
86,494

 
93

 
33,150

 
358,844

Satisfactory
158,264

 
19,170

 
6,026

 
1,175,866

Monitor
30,140

 
117

 
1,061

 
118,665

Special Mention
14,749

 
316

 
1,059

 
84,507

Substandard
8,046

 
128

 
—

 
48,706

Total
$
315,187

 
$
19,824

 
$
45,167

 
$
1,826,156



Page 69

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The below are descriptions of the credit quality indicators:

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

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

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

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

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

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


Page 70

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Past due loans as of December 31, 2014 and 2013 were as follows:
 
30 - 59 Days
Past Due
 
60 - 89 Days
Past Due
 
90 Days
or More
Past Due
 
Total Past
Due
 
Current
 
Total
Loans
Receivable
 
Accruing Loans
Past Due 90
Days or More
 
(Amounts In Thousands)
December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural
$
310

 
$
99

 
$
—

 
$
409

 
$
97,236

 
$
97,645

 
$
—

Commercial and financial
397

 
14

 
1,048

 
1,459

 
173,279

 
174,738

 
—

Real estate:


 
 

 
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
—

 
—

 
45,949

 
45,949

 
—

Construction, land development and commercial
937

 
—

 
—

 
937

 
76,083

 
77,020

 
—

Mortgage, farmland
753

 
—

 
—

 
753

 
161,750

 
162,503

 
—

Mortgage, 1 to 4 family first liens
3,594

 
1,656

 
1,582

 
6,832

 
665,842

 
672,674

 
348

Mortgage, 1 to 4 family junior liens
181

 
12

 
244

 
437

 
109,847

 
110,284

 
—

Mortgage, multi-family
—

 
21

 
—

 
21

 
245,192

 
245,213

 
—

Mortgage, commercial
359

 
557

 
34

 
950

 
320,651

 
321,601

 
—

Loans to individuals
27

 
—

 
—

 
27

 
21,315

 
21,342

 
—

Obligations of state and political subdivisions
—

 
—

 
—

 
—

 
55,729

 
55,729

 
—

 
$
6,558

 
$
2,359

 
$
2,908

 
$
11,825

 
$
1,972,873

 
$
1,984,698

 
$
348



Page 71

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
30 - 59 Days
Past Due
 
60 - 89 Days
Past Due
 
90 Days
or More
Past Due
 
Total Past
Due
 
Current
 
Total
Loans
Receivable
 
Accruing Loans
Past Due 90
Days or More
 
(Amounts In Thousands)
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural
$
8

 
$
10

 
$
—

 
$
18

 
$
82,120

 
$
82,138

 
$
—

Commercial and financial
526

 
177

 
951

 
1,654

 
164,448

 
166,102

 
—

Real estate:
 

 
 

 
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
—

 
—

 
30,309

 
30,309

 
—

Construction, land development and commercial
276

 
144

 
731

 
1,151

 
68,031

 
69,182

 
—

Mortgage, farmland
108

 
—

 
—

 
108

 
142,577

 
142,685

 
—

Mortgage, 1 to 4 family first liens
4,418

 
1,649

 
2,223

 
8,290

 
597,397

 
605,687

 
959

Mortgage, 1 to 4 family junior liens
835

 
43

 
29

 
907

 
104,878

 
105,785

 
—

Mortgage, multi-family
—

 
150

 
—

 
150

 
243,940

 
244,090

 
—

Mortgage, commercial
1,350

 
—

 
493

 
1,843

 
313,344

 
315,187

 
—

Loans to individuals
7

 
4

 
—

 
11

 
19,813

 
19,824

 
—

Obligations of state and political subdivisions
14

 
—

 
—

 
14

 
45,153

 
45,167

 
—

 
$
7,542

 
$
2,177

 
$
4,427

 
$
14,146

 
$
1,812,010

 
$
1,826,156

 
$
959


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

Accruing loans past due 90 days or more decreased $0.61 million from December 31, 2013 to December 31, 2014.  As of December 31, 2014 and 2013, accruing loans past due 90 days or more were 0.02% and 0.05% of total loans, respectively.  The average balance of the past due loans also decreased in 2014 as compared to 2013.  The average 90 days or more past due loan balance per loan was $0.07 million as of December 31, 2014 compared to $0.08 million as of December 31, 2013.  The loans 90 days or more past due and still accruing are believed to be adequately collateralized.   Loans are placed on nonaccrual status when management believes the collection of future principal and interest is not reasonably assured.


Page 72

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Certain impaired loan information by loan type at December 31, 2014 and 2013 was as follows:
 
December 31, 2014
 
December 31, 2013
 
Nonaccrual
loans (1)
 
Accruing loans
past due 90
days or more
 
TDR
loans
 
Nonaccrual
loans (1)
 
Accruing loans
past due 90
days or more
 
TDR
loans
 
(Amounts In Thousands)
 
(Amounts In Thousands)
Agricultural
$
—

 
$
—

 
$
1,942

 
$
—

 
$
—

 
$
120

Commercial and financial
1,343

 
—

 
1,366

 
1,462

 
—

 
945

Real estate:
 

 
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
431

 
—

 
—

 
—

Construction, land development and commercial
127

 
—

 
—

 
1,319

 
—

 
—

Mortgage, farmland
—

 
—

 
2,220

 
—

 
—

 
284

Mortgage, 1 to 4 family first liens
1,912

 
348

 
1,199

 
2,209

 
959

 
1,272

Mortgage, 1 to 4 family junior liens
369

 
—

 
—

 
178

 
—

 
—

Mortgage, multi-family
55

 
—

 
5,470

 
456

 
—

 
5,608

Mortgage, commercial
2,275

 
—

 
1,712

 
1,568

 
—

 
10,146

Loans to individuals
—

 
—

 
—

 
—

 
—

 
—

 
$
6,081

 
$
348

 
$
14,340

 
$
7,192

 
$
959

 
$
18,375


(1)
There were $2.14 million and $2.72 million of TDR loans included within nonaccrual loans as of December 31, 2014 and 2013, respectively.

The Company may modify the terms of a loan to maximize the collection of amounts due.  In most cases, the modification is either a reduction in interest rate, conversion to interest only payments or an extension of the maturity date.  The borrower is experiencing financial difficulties or is expected to experience financial difficulties in the near-term, so a concessionary modification is granted to the borrower that would otherwise not be considered.  TDR loans accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles.


Page 73

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Below is a summary of information for TDR loans as of December 31, 2014 and 2013:
 
December 31, 2014
 
Number of
contracts
 
Recorded
investment
 
Commitments
outstanding
 
 
 
(Dollar Amounts In Thousands)
Agricultural
9

 
$
1,942

 
$
272

Commercial and financial
13

 
2,202

 
53

Real estate:
 

 
 

 
 

Construction, 1 to 4 family residential
3

 
431

 
111

Construction, land development and commercial
1

 
127

 
—

Mortgage, farmland
4

 
2,220

 
—

Mortgage, 1 to 4 family first liens
11

 
1,467

 
—

Mortgage, 1 to 4 family junior liens
1

 
225

 
65

Mortgage, multi-family
2

 
5,470

 
—

Mortgage, commercial
8

 
2,398

 
—

Loans to individuals
—

 
—

 
—

 
52

 
$
16,482

 
$
501

 
 
December 31, 2013
 
Number of
contracts
 
Recorded
investment
 
Commitments
outstanding
 
 
 
(Dollar Amounts In Thousands)
Agricultural
1

 
$
120

 
$
4

Commercial and financial
12

 
2,214

 
101

Real estate:
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
—

Construction, land development and commercial
1

 
13

 
—

Mortgage, farmland
1

 
284

 
—

Mortgage, 1 to 4 family first liens
12

 
1,697

 
—

Mortgage, 1 to 4 family junior liens
—

 
—

 
177

Mortgage, multi-family
3

 
6,000

 
—

Mortgage, commercial
9

 
10,766

 
10

Loans to individuals
—

 
—

 
—

 
39

 
$
21,094

 
$
292



Page 74

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A summary of TDR loans that were modified during the year ended December 31, 2014 and 2013 was as follows:
 
December 31, 2014
 
Number of
Contracts
 
Pre-modification
recorded
investment
 
Post-modification
recorded
investment
 
 
 
( Dollar Amounts In Thousands)
Agricultural
8

 
$
2,033

 
$
2,033

Commercial and financial
5

 
803

 
803

Real estate:
 

 
 

 
 

Construction, 1 to 4 family residential
3

 
443

 
431

Construction, land development and commercial
1

 
132

 
132

Mortgage, farmland
3

 
2,007

 
2,007

Mortgage, 1 to 4 family first liens
3

 
433

 
433

Mortgage, 1 to 4 family junior liens
1

 
225

 
225

Mortgage, multi-family
—

 
—

 
—

Mortgage, commercial
1

 
319

 
319

Loans to individuals
—

 
—

 
—

 
25

 
$
6,395

 
$
6,383

 
December 31, 2013
 
Number of
Contracts
 
Pre-modification
recorded
investment
 
Post-modification
recorded
investment
 
 
 
( Dollar Amounts In Thousands)
Agricultural
1

 
$
125

 
$
125

Commercial and financial
—

 
—

 
—

Real estate:
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
—

Construction, land development and commercial
—

 
—

 
—

Mortgage, farmland
—

 
—

 
—

Mortgage, 1 to 4 family first liens
4

 
613

 
578

Mortgage, 1 to 4 family junior liens
—

 
—

 
—

Mortgage, multi-family
1

 
255

 
255

Mortgage, commercial
3

 
559

 
559

Loans to individuals
—

 
—

 
—

 
9

 
$
1,552

 
$
1,517



The Bank has commitments to lend additional borrowings to TDR loan customers.  These commitments are in the normal course of business and allow the borrowers to build pre-sold homes and commercial property which increase their overall cash flow.  The additional borrowings are not used to facilitate payments on these loans.

There were no TDR loans modified during the year that were in payment default (defined as past due 90 days or more) as of December 31, 2014 or 2013.


Page 75

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Information regarding impaired loans as of and for the year ended December 31, 2014 is as follows:
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
(Amounts in Thousands)
2014
 
 
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Agricultural
$
1,634

 
$
1,696

 
$
—

 
$
1,496

 
$
71

Commercial and financial
2,076

 
3,695

 
—

 
1,930

 
29

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
89

 
89

 
—

 
44

 
1

Construction, land development and commercial
128

 
220

 
—

 
142

 
—

Mortgage, farmland
2,040

 
2,040

 
—

 
1,897

 
90

Mortgage, 1 to 4 family first liens
2,951

 
3,705

 
—

 
2,980

 
47

Mortgage, 1 to 4 family junior liens
369

 
673

 
—

 
386

 
—

Mortgage, multi-family
5,525

 
5,632

 
—

 
5,598

 
249

Mortgage, commercial
3,290

 
4,588

 
—

 
3,534

 
53

Loans to individuals
—

 
20

 
—

 
—

 
—

 
$
18,102

 
$
22,358

 
$
—

 
$
18,007

 
$
540

With an allowance recorded:
 

 
 

 
 

 
 

 
 

Agricultural
$
210

 
$
247

 
$
44

 
$
220

 
$
11

Commercial and financial
633

 
633

 
9

 
694

 
36

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
343

 
354

 
28

 
348

 
19

Construction, land development and commercial
—

 
—

 
—

 
—

 
—

Mortgage, farmland
278

 
278

 
12

 
281

 
14

Mortgage, 1 to 4 family first liens
506

 
596

 
52

 
526

 
22

Mortgage, 1 to 4 family junior liens
—

 
—

 
—

 
—

 
—

Mortgage, multi-family
—

 
—

 
—

 
—

 
—

Mortgage, commercial
697

 
697

 
9

 
706

 
37

Loans to individuals
—

 
—

 
—

 
—

 
—

 
$
2,667

 
$
2,805

 
$
154

 
$
2,775

 
$
139

Total:
 

 
 

 
 

 
 

 
 

Agricultural
$
1,844

 
$
1,943

 
$
44

 
$
1,716

 
$
82

Commercial and financial
2,709

 
4,328

 
9

 
2,624

 
65

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
432

 
443

 
28

 
392

 
20

Construction, land development and commercial
128

 
220

 
—

 
142

 
—

Mortgage, farmland
2,318

 
2,318

 
12

 
2,178

 
104

Mortgage, 1 to 4 family first liens
3,457

 
4,301

 
52

 
3,506

 
69

Mortgage, 1 to 4 family junior liens
369

 
673

 
—

 
386

 
—

Mortgage, multi-family
5,525

 
5,632

 
—

 
5,598

 
249

Mortgage, commercial
3,987

 
5,285

 
9

 
4,240

 
90

Loans to individuals
—

 
20

 
—

 
—

 
—

 
$
20,769

 
$
25,163

 
$
154

 
$
20,782

 
$
679



Page 76

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Information regarding impaired loans as of and for the year ended December 31, 2013 is as follows:
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
(Amounts in Thousands)
2013
 
 
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Agricultural
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Commercial and financial
1,602

 
3,140

 
—

 
1,645

 
45

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
1,270

 
2,974

 
—

 
1,727

 
4

Construction, land development and commercial
140

 
140

 
—

 
229

 
—

Mortgage, farmland
—

 
—

 
—

 
—

 
—

Mortgage, 1 to 4 family first liens
2,597

 
3,542

 
—

 
2,691

 
24

Mortgage, 1 to 4 family junior liens
177

 
451

 
—

 
198

 
—

Mortgage, multi-family
456

 
1,068

 
—

 
666

 
—

Mortgage, commercial
2,494

 
5,303

 
—

 
2,793

 
46

Loans to individuals
—

 
20

 
—

 
—

 
—

 
$
8,736

 
$
16,638

 
$
—

 
$
9,949

 
$
119

With an allowance recorded:
 

 
 

 
 

 
 

 
 

Agricultural
$
120

 
$
120

 
$
3

 
$
123

 
$
5

Commercial and financial
805

 
838

 
16

 
871

 
46

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
—

 
—

 
—

Construction, land development and commercial
—

 
—

 
—

 
—

 
—

Mortgage, farmland
284

 
284

 
14

 
289

 
14

Mortgage, 1 to 4 family first liens
1,768

 
1,897

 
66

 
1,821

 
79

Mortgage, 1 to 4 family junior liens
—

 
—

 
—

 
—

 
—

Mortgage, multi-family
5,608

 
5,608

 
188

 
5,673

 
255

Mortgage, commercial
9,205

 
9,205

 
17

 
9,300

 
535

Loans to individuals
—

 
—

 
—

 
—

 
—

 
$
17,790

 
$
17,952

 
$
304

 
$
18,077

 
$
934

Total:
 

 
 

 
 

 
 

 
 

Agricultural
$
120

 
$
120

 
$
3

 
$
123

 
$
5

Commercial and financial
2,407

 
3,978

 
16

 
2,516

 
91

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
1,270

 
2,974

 
—

 
1,727

 
4

Construction, land development and commercial
140

 
140

 
—

 
229

 
—

Mortgage, farmland
284

 
284

 
14

 
289

 
14

Mortgage, 1 to 4 family first liens
4,365

 
5,439

 
66

 
4,512

 
103

Mortgage, 1 to 4 family junior liens
177

 
451

 
—

 
198

 
—

Mortgage, multi-family
6,064

 
6,676

 
188

 
6,339

 
255

Mortgage, commercial
11,699

 
14,508

 
17

 
12,093

 
581

Loans to individuals
—

 
20

 
—

 
—

 
—

 
$
26,526

 
$
34,590

 
$
304

 
$
28,026

 
$
1,053



Page 77

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Information regarding impaired loans as of and for the year ended December 31, 2012 is as follows:
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
(Amounts in Thousands)
2012
 
 
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
Agricultural
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Commercial and financial
364

 
1,911

 
—

 
750

 
19

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
714

 
946

 
—

 
1,262

 
—

Construction, land development and commercial
2,264

 
3,520

 
—

 
2,835

 
7

Mortgage, farmland
806

 
808

 
—

 
830

 
18

Mortgage, 1 to 4 family first liens
952

 
1,332

 
—

 
994

 
24

Mortgage, 1 to 4 family junior liens
68

 
361

 
—

 
71

 
3

Mortgage, multi-family
2,027

 
2,766

 
—

 
2,097

 
—

Mortgage, commercial
2,369

 
5,046

 
—

 
2,427

 
52

Loans to individuals
—

 
20

 
—

 
—

 
—

 
$
9,564

 
$
16,710

 
$
—

 
$
11,266

 
$
123

With an allowance recorded:
 

 
 

 
 

 
 

 
 

Agricultural
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Commercial and financial
1,788

 
1,788

 
22

 
1,902

 
99

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
—

 
—

 
—

Construction, land development and commercial
—

 
—

 
—

 
—

 
—

Mortgage, farmland
—

 
—

 
—

 
—

 
—

Mortgage, 1 to 4 family first liens
2,286

 
2,487

 
83

 
2,284

 
106

Mortgage, 1 to 4 family junior liens
259

 
259

 
7

 
262

 
16

Mortgage, multi-family
6,331

 
6,331

 
241

 
6,399

 
320

Mortgage, commercial
9,530

 
9,530

 
20

 
9,618

 
568

Loans to individuals
—

 
—

 
—

 
—

 
—

 
$
20,194

 
$
20,395

 
$
373

 
$
20,465

 
$
1,109

Total:
 

 
 

 
 

 
 

 
 

Agricultural
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Commercial and financial
2,152

 
3,699

 
22

 
2,652

 
118

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
714

 
946

 
—

 
1,262

 
—

Construction, land development and commercial
2,264

 
3,520

 
—

 
2,835

 
7

Mortgage, farmland
806

 
808

 
—

 
830

 
18

Mortgage, 1 to 4 family first liens
3,238

 
3,819

 
83

 
3,278

 
130

Mortgage, 1 to 4 family junior liens
327

 
620

 
7

 
333

 
19

Mortgage, multi-family
8,358

 
9,097

 
241

 
8,496

 
320

Mortgage, commercial
11,899

 
14,576

 
20

 
12,045

 
620

Loans to individuals
—

 
20

 
—

 
—

 
—

 
$
29,758

 
$
37,105

 
$
373

 
$
31,731

 
$
1,232



Page 78

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Impaired loans decreased by $5.76 million from December 31, 2013 to December 31, 2014.  Impaired loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and TDR loans.  Impaired loans also include loans that, based on management’s evaluation of current information and events, the Bank expects to be unable to collect in full according to the contractual terms of the original loan agreement.  The decrease in impaired loans is due mainly to a decrease in TDR Loans of $4.04 million from December 31, 2013 to December 31, 2014. The net decrease in TDR loans is the result of loans reclassified from TDR loans as a result of the borrowers not experiencing financial difficulty and no concessions granted to the borrower when the loan was modified during the year ended December 31, 2014.

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

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

The Company separates its portfolio loans and leases into segments for determining the allowance for loan losses. The Company's portfolio segments includes agricultural, commercial and financial, real estate, loans to individuals and obligations of state and political subdivisions. The Company further separates its portfolio into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes with the real estate portfolio segment includes 1 to 4 family residential constructions, land development and commercial construction, farmland, 1 to 4 family first liens, 1 to 4 family junior liens, multi-family and commercial.

Loans that exhibit probable or observed credit weaknesses, as well as loans that have been modified in a TDR, are subject to individual review for impairment. When individual loans are reviewed for impairment, the Company determines allowances based on management's estimate of the borrower's ability to repay the loan given the availability of the collateral, other sources of cash flow, as well as evaluation of legal options available. Allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral.

Historical loss rates are applied to loans that are not individually reviewed for impairment. For reporting periods prior to December 31, 2014 the Company calculated its historical loss experience using a trailing 10 quarter portfolio loss history method in which the Company tracked the net charge-offs as a percentage of total loans by loan category. The portfolio loss history method did not factor in the credit risk ratings of the loans in determination of the historical loss rate to be applied in the allowance for loan losses calculation. During the year ended December 31, 2014, to refine the Company's allowance for loan losses calculation, management performed a 20 quarter migration analysis. Management determined that increasing the look-back period to a 20 quarter period would improve the estimation of the entire credit and economic cycle of a credit relationship. The migration analysis performed by management uses loan level attributes to track the movement of loans through the various credit risk rating categories in order to estimate the percentage of historical loss to apply to each specific credit risk rating in each loan category. The credit risk rating system currently utilized for allowance analysis purposes encompasses six categories.


Page 79

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company's allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan losses that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in impaired loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include changes in lending policies and procedures; changes in national and local economic and business conditions; changes in the nature and volume of the loan portfolio; changes in the experience, ability and depth of lending management and staff; changes in the quality of the Bank's loan review system; the existence and effect of concentrations of credit; and the effect of any other identified external factors.

Determinations relating to the possible level of future loan losses are based in part on subjective judgments by management. Future loan losses in excess of current estimates, could materially adversely affect our results of operations or financial position.  As the Company adds new products and increases the complexity of its loan portfolio, it will enhance its methodology accordingly.   Although management believes the levels of the allowance for loan losses as of December 31, 2014 and 2013 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.


Note 4.
Property and Equipment

The major classes of property and equipment and the total accumulated depreciation are as follows:

 
December 31,
 
2014
 
2013
 
(Amounts In Thousands)
Land
$
7,835

 
$
7,835

Buildings and improvements
29,402

 
28,210

Furniture and equipment
27,298

 
26,696

 
64,535

 
62,741

Less accumulated depreciation
35,464

 
32,905

Net
$
29,071

 
$
29,836

 

Page 80

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 5.
Interest - Bearing Deposits

A summary of these deposits is as follows:
 
December 31,
 
2014
 
2013
 
(Amounts In Thousands)
NOW and other demand
$
450,486

 
$
384,752

Savings
588,781

 
537,167

Time, $100,000 and over
177,795

 
168,465

Other time
329,289

 
362,705

 
$
1,546,351

 
$
1,453,089


Brokered deposits totaled $64.49 million and $57.77 million as of December 31, 2014 and 2013, respectively with an average interest rate of 0.39% and 0.44% as of December 31, 2014 and 2013, respectively.  As of December 31, 2014, brokered deposits of $55.48 million are included in savings deposits and $9.01 million are included in time deposits.  At December 31, 2013, brokered deposits of $48.99 million were included in savings deposits and $8.78 million were included in time deposits. Brokered time deposits in increments greater than $100,000 as of December 31, 2014 and 2013 were $7.25 million and $6.63 million, respectively.

Time deposits have a maturity as follows:
 
December 31,
 
2014
 
2013
 
(Amounts In Thousands)
Due in one year or less
$
243,316

 
$
230,274

Due after one year through two years
128,927

 
156,489

Due after two years through three years
74,493

 
82,552

Due after three years through four years
43,490

 
42,711

Due over four years
16,858

 
19,144

 
$
507,084

 
$
531,170



Page 81

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 6.
Other Borrowings

The following table sets forth selected information for other borrowings each of which having a maturity of less than one year:
 
December 31,
 
2014
 
2013
 
(Amounts In Thousands)
Federal funds purchased, secured by other securities (FHLB, FHLMC and FNMA)
$
6,945

 
$
—

Repurchase agreements with customers, renewable daily, interest payable monthly, secured by other securities (FHLB, FHLMC and FNMA)
40,554

 
42,016

 
$
47,499

 
$
42,016


The weighted average interest rate on other borrowings outstanding as of December 31, 2014 and 2013 was 0.26% and 0.29%, respectively.
 
Customer repurchase agreements are used by the Bank to acquire funds from customers where the customer is required or desires to have their funds supported by collateral consisting of investment securities.  The repurchase agreement is a commitment to sell these securities to a customer at a certain price and repurchase them at a future date at that same price plus interest accrued at an agreed upon rate.  The Bank uses customer repurchase agreements in its liquidity plan as well as an accommodation to customers.  At December 31, 2014, $40.55 million of securities sold under repurchase agreements with a weighted average interest rate of 0.25%, maturing in 2014, were collateralized by investment securities having an amortized cost of $58.10 million.

Note 7.
Federal Home Loan Bank Borrowings

As of December 31, 2014 and 2013, the borrowings were as follows:
 
2014
 
2013
(Effective interest rates as of December 31, 2014)
(Amounts In Thousands)
Due 2015, 0.28%
$
15,000

 
$
—

Due 2016, 4.46% to 4.69%
45,000

 
45,000

Due 2017, 4.09% to 4.89%
60,000

 
60,000

Due 2018, 3.65%
20,000

 
20,000

 
$
140,000

 
$
125,000


The $15.00 million borrowing due in 2015 is an overnight borrowing. All of the remaining borrowings are callable by the FHLB with call dates during 2015.  The advances are unlikely to be called unless rates would increase significantly.  The borrowings with the FHLB have prepayment fees associated with them; therefore, the Company cannot prepay without incurring fees.

To participate in the FHLB advance program, the Company is required to have an investment in FHLB stock.  The Company’s investment in FHLB stock was $8.25 million and $7.58 million at December 31, 2014 and 2013, respectively.  Collateral is provided by the Company’s 1 to 4 family mortgage loans totaling $189.00 million at December 31, 2014 and $168.75 million at December 31, 2013.  The Company also has the ability to borrow against commercial real estate and multi-family loans totaling $185.28 million as of December 31, 2014 and $167.35 million as of December 31, 2013 and there was $0 borrowed against this collateral as of December 31, 2014 or 2013.

The Bank prepaid $60 million of Federal Home Loan Bank borrowings during the year ended December 31, 2012 as part of a strategy to utilize the Bank’s liquidity, improve net interest margin and decrease interest rate risk in the future.  As a result, the Bank incurred a one-time prepayment penalty of $5.93 million, which it recorded as loss on extinguishment of debt.


Page 82

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 8.
Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income (AOCI), included in stockholders’ equity, are as follows:
 
December 31,
 
2014
 
2013
 
(amounts in thousands)
Net unrealized gain on available-for-sale securities
$
2,072

 
$
1,808

Net unrealized (loss) gain on derivatives used for cash flow hedges
(2,796
)
 
769

Tax effect
276

 
(986
)
Net-of-tax amount
$
(448
)
 
$
1,591

 
Amounts reclassified from AOCI and the affected line items in the statements of income during the years ended December 31, 2014, 2013 and 2012, were as follows: 
 
Amounts reclassified from AOCI
 
Affected Line Item in the Statements of Income
 
2014
 
2013
 
2012
 
 
(amounts in thousands)
 
 
Unrealized gains (losses) on available-for-sale securities
$
—

 
$
17

 
$
(6
)
 
Other noninterest income
Tax effect
—

 
(7
)
 
2

 
Tax (expense) benefit
Total reclassification out of AOCI
$
—

 
$
10

 
$
(4
)
 
 


Note 9.
Employee Benefit Plans

The Company has an Employee Stock Purchase Plan (the “ESPP”).  For each quarterly offering period, eligible employees can elect to contribute from 1% to 15% of his or her compensation.  The purchase price is the lesser of the fair market value on the first day of the offering period or the last day of the offering period.  The maximum dollar amount any one employee can elect to contribute in an offering period is $10,000.  During the year ended December 31, 2014, 2,092 shares of stock were purchased by employees of the Bank through the ESPP.  2,072 shares of stock were purchased by employees of the Bank through the ESPP for the year ended December 31, 2013.

The Company has an Employee Stock Ownership Plan (the "ESOP") to which it makes discretionary cash contributions.  The Company's contribution to the ESOP totaled $1.61 million, $1.57 million and $1.49 million for the years ended December 31, 2014, 2013 and 2012, respectively.  The 2014, 2013 and 2012 discretionary contribution rates were 9% of qualified salaries.

During the year ended December 31, 2011, the ESOP purchased an additional 40,028 shares of common stock in the Company with a loan from the Company.  The note payable bears interest at the prime rate subject to a floor of 5.0% with principal and interest payable annually for five consecutive years.  The loan is collateralized by the unreleased shares of stock purchased as well as a certificate of deposit the Company holds at the Bank in the original amount of the note.  The note payable and certificate of deposit are not included in the consolidated balance sheets. There was no interest income or expense recognized in the consolidated statements of income.

As the note payable is repaid by the ESOP, shares are released from collateral and allocated to qualified employees based on the proportion of principal and interest paid in the year to total principal and interest payments anticipated for the life of the loan.  The number of shares released from collateral totaled 8,002; 8,360 and 8,724 shares for the years ended December 31, 2014, 2013 and 2012, respectively. The shares pledged as collateral are reported as a reduction of stockholder’s equity in the consolidated balance sheet.  As shares are committed to be released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations.  Unallocated shares were 7,628; 15,630 and 23,990 as of December 31, 2014, 2013 and 2012, respectively. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings.  Dividends on unallocated ESOP shares are used to reduce debt.

Page 83

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


In the event a terminated plan participant desires to sell his or her shares of the Company stock, or for certain employees who elect to diversify their account balances, the Company may be required to purchase the shares from the participant at their fair value.  To the extent that shares of common stock held by the ESOP are not readily traded, a sponsor must reflect the maximum cash obligation related to those securities outside of stockholders' equity.  The Company obtains a quarterly independent appraisal of the shares of stock.  As of December 31, 2014 and 2013, the shares held by the ESOP, fair value and maximum cash obligation were as follows:
 
2014
 
2013
Shares held by the ESOP
419,044

 
394,323

Fair value per share
$
82.50

 
$
75.00

Maximum cash obligation
$
34,571,000

 
$
29,574,000


The Company has a profit-sharing plan with a 401(k) feature, which provides for discretionary annual contributions in amounts to be determined by the Board of Directors.  The Company did not make a profit sharing plan contribution in the years ended December 31, 2014, 2013, and 2012. The Company made matching contributions under its 401(k) plan of $0.16 million in 2014, $0.15 million in 2013, and $0.14 million in 2012 and each such amount is included in salaries and employee benefits expense.

The Company provides a deferred compensation program for executive officers.  This program allows executive officers to elect to defer a portion of their salaried compensation for payment by the Company at a subsequent date.  The executive officers can defer up to 30% of their base compensation and up to 100% of any bonus into the deferral plan.  Any amount so deferred is credited to the executive officer’s deferred compensation account and converted to units equivalent in value to the fair market value of a share of stock in Hills Bancorporation.  The “stock units” are book entry only and do not represent an actual purchase of stock.  The executive officer’s account is adjusted each year for dividends paid and the change in the market value of Hills Bancorporation stock.  The deferrals and earnings grow tax deferred until withdrawn from the plan.  Earnings credited to the individual’s accounts are recorded as compensation expense when earned.  The deferred compensation liability is recorded in other liabilities and totals $5.04 million and $4.63 million at December 31, 2014 and 2013, respectively.  Expense related to the deferred compensation plan was $0.54 million for 2014, $0.39 million for 2013 and $0.45 million for 2012 and is included in salaries and employee benefits expense.

The Company also provides a deferred compensation program for its Board of Directors.  Under the plan, each director may elect to defer up to 50% of such director’s cash compensation from retainers and meeting fees for payment by the Company at a subsequent date.  Any amount so deferred is credited to the director’s deferred compensation account and converted to units equivalent in value to the fair market value of a share of stock in Hills Bancorporation.  The “stock units” are book entry only and do not represent an actual purchase of stock.  The director’s account is adjusted each year for dividends paid and the change in the market value of Hills Bancorporation stock.  The deferred compensation liability for the directors’ plan is recorded in other liabilities and totaled $2.26 million and $2.10 million at December 31, 2014 and 2013, respectively.  Expense related to the directors’ deferred compensation plan was $0.23 million for 2014, $0.17 million for 2013 and $0.20 million for 2012 and is included in other noninterest expense.

The Company has a Stock Option and Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or restricted stock awards. Under the plan, the aggregate number of options and shares granted cannot exceed 94,000 shares. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Director options granted on or before December 31, 2006 may be exercised immediately.  Director options granted on or after January 1, 2007, and officers' rights under the plan vest over a five-year period from the date of the grant.


Page 84

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A summary of the stock options is as follows: 
 
Number of Shares
 
Weighted-
Average
Exercise Price
 
Weighted-Average
Remaining
Contractual Term
(Years)
 
Aggregate
Intrinsic Value
(In Thousands)
Balance, December 31, 2011
18,840

 
$
36.60

 
2.51
 
$
690

Granted
5,110

 
 

 
 
 
 

Exercised
(5,965
)
 
 

 
 
 
 

Balance, December 31, 2012
17,985

 
47.62

 
4.25
 
856

Granted
—

 
 

 
 
 
 

Exercised
(5,355
)
 
 

 
 
 
 

Balance, December 31, 2013
12,630

 
53.95

 
4.72
 
681

Granted
—

 
 

 
 
 
 

Exercised
(2,940
)
 
 

 
 
 
 

Balance, December 31, 2014
9,690

 
$
59.85

 
5.03
 
$
580


There were 5,110 stock options granted in 2012 and no stock options granted in 2013 or 2014.  The weighted-average fair value of options granted in 2012 was $24.89 per share.  The intrinsic value of options exercised was $0.10 million, $0.18 million and $0.23 million for 2014, 2013 and 2012, respectively.

The fair value of each option is estimated as of the date of grant using a Black Scholes option pricing model.  The expected lives of options granted incorporate historical employee exercise behavior.  The risk-free rate for periods that coincide with the expected life of the options is based on the ten year interest rate swap rate as published by the Federal Reserve Bank on the date of issuance.  Expected volatility is based on volatility levels of the Company’s peers’ common stock as the Company’s stock has limited trading activity.  Expected dividend yield was based on historical dividend rates. Significant assumptions at date of grant include:
 
2014
 
2013
 
October 9, 2012
 
April 24, 2012
Risk-free interest rate
n/a
 
n/a
 
1.77
%
 
2.08
%
Expected option life
n/a
 
n/a
 
7.5 years

 
7.5 years

Expected volatility
n/a
 
n/a
 
39.50
%
 
39.80
%
Expected dividends
n/a
 
n/a
 
1.64
%
 
1.64
%

Other pertinent information related to the options outstanding at December 31, 2014 is as follows:
Exercise Price
 
Number Outstanding
 
Remaining Contractual Life
 
Number Exercisable
$
52.00

 
4,580

 
28 months
 
4,580

66.00

 
3,610

 
88 months
 
—

69.00

 
1,500

 
94 months
 
—

 

 
9,690

 
 
 
4,580


As of December 31, 2014, the outstanding options have a weighted-average exercise price of $59.85 per share and a weighted average remaining contractual term of 5.03 years.  There was $0.06 million in unrecognized compensation cost for stock options granted under the plan as of December 31, 2014.  This cost is expected to be recognized over a weighted-average period of 2.45 years.

As of December 31, 2014, the vested options totaled 4,580 shares with a weighted-average exercise price of $52.00 per share and a weighted-average remaining contractual term of 2.33 years.  There were 4,580 shares that vested in 2012 and no shares that vested in 2013 or 2014.  The fair value of the 4,580 options vested during 2012 was $0.31 million.


Page 85

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2014, 61,186 shares were available for stock options and awards.  The Compensation and Incentive Stock Committee is also authorized to grant awards of restricted common stock, and it authorized the issuance of 9,572 shares of common stock in 2014, 3,584 shares in 2013 and 6,885 shares in 2012 to certain employees.  The vesting period for these awards is five years and the Bank amortizes the expense on a straight line basis during the vesting period.  The expense relating to these awards for the years ended December 31, 2014, 2013 and 2012 was $0.26 million, $0.21 million and $0.17 million, respectively. In 2014, 5,400 shares of the restricted common stock shares awarded are subject to forfeiture upon termination of the employee's employment with the Company within eight years of the award.

Note 10.
Income Taxes

Income taxes for the years ended December 31, 2014, 2013 and 2012 are summarized as follows:
 
2014
 
2013
 
2012
 
(Amounts In Thousands)
Current:
 
 
 
 
 
Federal
$
9,412

 
$
9,120

 
$
6,479

State
1,788

 
1,789

 
2,045

Deferred:
 

 
 

 
 

Federal
(27
)
 
(78
)
 
1,823

State
(44
)
 
81

 
195

 
$
11,129

 
$
10,912

 
$
10,542


Temporary differences between the amounts reported in the consolidated financial statements and the tax basis of assets and liabilities result in deferred taxes.  Deferred tax assets and liabilities at December 31, 2014 and 2013 were as follows:

 
December 31,
 
2014
 
2013
 
(Amounts In Thousands)
Deferred income tax assets:
 
 
 
Allowance for loan losses
$
9,188

 
$
9,773

Deferred compensation
2,718

 
2,505

Unrealized losses on interest rate swaps
1,069

 
—

Accrued expenses
1,099

 
850

State net operating loss
600

 
489

Gross deferred tax assets
$
14,674

 
$
13,617

Valuation allowance
(600
)
 
(489
)
Deferred tax asset, net of valuation allowance
$
14,074

 
$
13,128

Deferred income tax liabilities:
 

 
 

Property and equipment
1,878

 
1,967

Unrealized gains on investment securities
793

 
692

Unrealized gains on interest rate swaps
—

 
294

Goodwill
624

 
624

Other
841

 
946

Gross deferred tax liabilities
$
4,136

 
$
4,523

Net deferred tax assets
$
9,938

 
$
8,605



Page 86

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company has recorded a deferred tax asset for the future tax benefits of Iowa net operating loss carry-forwards.  The net operating loss carry-forwards are generated by the Company largely from its investment in tax credit real estate properties.  The Company is required to file a separate Iowa tax return and cannot be consolidated with the Bank.  The net operating loss carry-forwards will expire, if not utilized, between 2015 and 2035.  The Company has recorded a valuation allowance to reduce the deferred tax asset attributable to the net operating loss carry-forwards.  At December 31, 2014 and 2013, the Company believes it is more likely than not that the Iowa net operating loss carry-forwards will not be realized.  The increase in net operating loss carry-forward in 2014 compared to 2013 reflects the additional Iowa income tax net operating loss generated during 2014 less any expiring carry-forward.  A valuation allowance related to the remaining deferred tax assets has not been provided because management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. The valuation allowance increased by $111,000 and $7,000 for the years ended December 31, 2014 and 2013, respectively.

The net change in the deferred income taxes for the years ended December 31, 2014, 2013 and 2012 is reflected in the consolidated financial statements as follows:
 
Year Ended December 31,
 
2014
 
2013
 
2012
 
(Amounts In Thousands)
Consolidated statements of income
$
71

 
$
(3
)
 
$
(2,018
)
Consolidated statements of stockholders' equity
1,262

 
1,464

 
631

 
$
1,333

 
$
1,461

 
$
(1,387
)

Income tax expense for the years ended December 31, 2014, 2013 and 2012 are less than the amounts computed by applying the maximum effective federal income tax rate to the income before income taxes because of the following items:
 
2014
 
2013
 
2012
 
Amount
 
% Of
Pretax
Income
 
Amount
 
% Of
Pretax
Income
 
Amount
 
% Of
Pretax
Income
 
(Amounts In Thousands)
Expected tax expense
$
13,336

 
35.0
 %
 
$
12,895

 
35.0
 %
 
$
13,081

 
35.0
 %
Tax-exempt interest
(1,788
)
 
(4.7
)
 
(1,690
)
 
(4.6
)
 
(1,622
)
 
(4.3
)
Interest expense limitation
96

 
0.3

 
99

 
0.3

 
112

 
0.3

State income taxes, net of federal income tax benefit
1,134

 
3.0

 
1,216

 
3.3

 
1,456

 
3.9

Income tax credits
(1,546
)
 
(4.1
)
 
(1,992
)
 
(5.4
)
 
(2,046
)
 
(5.5
)
Other
(103
)
 
(0.3
)
 
384

 
1.0

 
(439
)
 
(1.2
)
 
$
11,129

 
29.2
 %
 
$
10,912

 
29.6
 %
 
$
10,542

 
28.2
 %

Federal income tax expense for the years ended December 31, 2014, 2013 and 2012 was computed using the consolidated effective federal tax rate.  The Company also recognized income tax expense pertaining to state franchise taxes payable individually by the subsidiary bank.  The Company files a consolidated tax return for federal purposes and separate tax returns for the State of Iowa purposes.  The tax years ended December 31, 2014, 2013, 2012 and 2011, remain subject to examination by the Internal Revenue Service.  For state tax purposes, the tax years ended December 31, 2014, 2013, 2012 and 2011, remain open for examination.  There were no material unrecognized tax benefits at December 31, 2014 and December 31, 2013.  No interest or penalties on these unrecognized tax benefits has been recorded.  As of December 31, 2014, the Company does not anticipate any significant increase or decrease in unrecognized tax benefits during the twelve month period ending December 31, 2015.


Page 87

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 11.
Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and Cash Restrictions

The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial results.  Under capital adequacy guidelines and the regulatory frameworks for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices.  Capital amounts and classifications of the Company and the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by the regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the tables that follow) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).  Management believes that, as of December 31, 2014 and 2013, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of December 31, 2014, the most recent notifications from the Federal Reserve System categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table that follows.  There are no conditions or events since that notification that management believes have changed the Bank's category.

The actual amounts and capital ratios as of December 31, 2014 and 2013, with the minimum regulatory requirements for the Company and Bank are presented below (amounts in thousands):
 
Actual
 
For Capital Adequacy Purposes
 
To Be Well Capitalized Under Prompt Corrective Action Provisions
 
Amount
 
Ratio
 
Ratio
 
Ratio
As of December 31, 2014:
 
 
 
 
 
 
 
Company:
 
 
 
 
 
 
 
Total risk-based capital
$
310,622

 
17.21
%
 
8.00
%
 
10.00
%
Tier 1 risk-based capital
288,047

 
15.96

 
4.00

 
6.00

Leverage ratio
288,047

 
12.54

 
4.00

 
5.00

Bank:
 

 
 

 
 

 
 

Total risk-based capital
310,066

 
17.19

 
8.00

 
10.00

Tier 1 risk-based capital
287,504

 
15.94

 
5.00

 
6.00

Leverage ratio
287,504

 
12.51

 
4.00

 
5.00



Page 88

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
Actual
 
For Capital Adequacy Purposes
 
To Be Well Capitalized Under Prompt Corrective Action Provisions
 
Amount
 
Ratio
 
Ratio
 
Ratio
As of December 31, 2013:
 
 
 
 
 
 
 
Company:
 
 
 
 
 
 
 
Total risk-based capital
$
290,121

 
17.44
%
 
8.00
%
 
10.00
%
Tier 1 risk-based capital
269,272

 
16.19

 
4.00

 
6.00

Leverage ratio
269,272

 
12.57

 
4.00

 
5.00

Bank:
 

 
 

 
 

 
 

Total risk-based capital
288,875

 
17.37

 
8.00

 
10.00

Tier 1 risk-based capital
268,031

 
16.12

 
4.00

 
6.00

Leverage ratio
268,031

 
12.51

 
4.00

 
5.00


The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Bank.  The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends.  To maintain acceptable capital ratios in the Bank, certain of its retained earnings are not available for the payment of dividends.  To maintain a ratio of capital to assets of 8.00%, retained earnings of $103.71 million as of December 31, 2014 are available for the payment of dividends to the Company.

The Bank is required to maintain reserve balances in cash or with the Federal Reserve Bank.  Reserve balances totaled $0.54 million and $15.27 million as of December 31, 2014 and 2013, respectively.

In July 2013, the Officer of the Comptroller of the Currency and Board of Governors of the Federal Reserve System adopted a final rule implementing agreements reached by the Basel Committee on Banking Supervision in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems”(BASEL III).   The final rule also adopts changes to the agencies’ regulatory capital requirements that meet the requirements of section 171 and section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The rule implements a revised definition of regulatory capital, a new 4.50% common equity tier 1 minimum capital requirement, a 6.00% tier 1 capital requirement, and a tier 1 risk-based capital ratio of 8.00%.   The rule becomes effective on January 1, 2015. The Company expects to remain categorized as well capitalized under the final rule when it files its March 31, 2015 call report.


Page 89

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 12.
Related Party Transactions

Certain directors of the Company and the Bank, companies with which the directors are affiliated, and certain principal officers are customers of, and have banking transactions with, the Bank in the ordinary course of business.  Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons.

The following is an analysis of the changes in the loans to related parties during the years ended December 31, 2014 and 2013:
 
Year Ended December 31,
 
2014
 
2013
 
(Amounts In Thousands)
Balance, beginning
$
19,717

 
$
23,507

Net increase due to change in related parties
—

 
165

Advances
11,760

 
12,200

Collections
(12,231
)
 
(16,155
)
Balance, ending
$
19,246

 
$
19,717


Deposits from these related parties totaled $6.21 million and $5.73 million as of December 31, 2014 and 2013, respectively.  Deposits from related parties are accepted subject to the same interest rates and terms as those from nonrelated parties.


Page 90

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 13.
Fair Value Measurements

The carrying value and estimated fair values of the Company’s financial instruments as of December 31, 2014 are as follows:
 
December 31, 2014
 
Carrying
Amount
 
Estimated
Fair Value
 
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
 
(Amounts In Thousands)
Financial instrument assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
29,174

 
$
29,174

 
$
29,174

 
$
—

 
$
—

Investment securities
267,240

 
267,240

 
—

 
267,240

 
—

Loans held for sale
4,476

 
4,476

 
—

 
4,476

 
—

Loans
 

 
 

 
 

 
 

 
 

Agricultural
95,130

 
95,126

 
—

 
—

 
95,126

Commercial and financial
170,507

 
171,081

 
—

 
—

 
171,081

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
45,139

 
45,159

 
—

 
—

 
45,159

Construction, land development and commercial
75,589

 
75,623

 
—

 
—

 
75,623

Mortgage, farmland
159,831

 
159,623

 
—

 
—

 
159,623

Mortgage, 1 to 4 family first liens
666,406

 
665,428

 
—

 
—

 
665,428

Mortgage, 1 to 4 family junior liens
109,133

 
115,726

 
—

 
—

 
115,726

Mortgage, multi-family
243,723

 
246,191

 
—

 
—

 
246,191

Mortgage, commercial
318,896

 
318,211

 
—

 
—

 
318,211

Loans to individuals
21,043

 
21,016

 
—

 
—

 
21,016

Obligations of state and political subdivisions
55,281

 
54,800

 
—

 
—

 
54,800

Accrued interest receivable
8,276

 
8,276

 
—

 
8,276

 
—

Total financial instrument assets
$
2,269,844

 
$
2,277,150

 
$
29,174

 
$
279,992

 
$
1,967,984

Financial instrument liabilities:
 

 
 

 
 

 
 

 
 

Deposits
 

 
 

 
 

 
 

 
 

Noninterest-bearing deposits
$
288,718

 
$
288,718

 
$
—

 
$
288,718

 
$
—

Interest-bearing deposits
1,546,351

 
1,550,974

 
—

 
1,550,974

 
—

Other borrowings
47,499

 
47,499

 
—

 
47,499

 
—

Federal Home Loan Bank borrowings
140,000

 
145,210

 
—

 
145,210

 
—

Interest rate swap
2,796

 
2,796

 
—

 
2,796

 
—

Accrued interest payable
902

 
902

 
—

 
902

 
—

Total financial instrument liabilities
$
2,026,266

 
$
2,036,099

 
$
—

 
$
2,036,099

 
$
—

 
Face Amount
 
 

 
 

 
 

 
 

Financial instrument with off-balance sheet risk:
 

 
 

 
 

 
 

 
 

Loan commitments
$
334,100

 
$
—

 
$
—

 
$
—

 
$
—

Letters of credit
12,437

 
—

 
—

 
—

 
—

Total financial instrument liabilities with off-balance-sheet risk
$
346,537

 
$
—

 
$
—

 
$
—

 
$
—


(1)
Considered Level 1 under Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”).
(2)
Considered Level 2 under ASC 820.
(3)
Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.


Page 91

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The carrying value and estimated fair values of the Company’s financial instruments as of December 31, 2013 are as follows:
 
December 31, 2013
 
Carrying
Amount
 
Estimated
Fair Value
 
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
 
(Amounts In Thousands)
Financial instrument assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
43,702

 
$
43,702

 
$
43,702

 
$
—

 
$
—

Investment securities
246,089

 
246,089

 
—

 
246,089

 
—

Loans held for sale
4,927

 
4,927

 
—

 
4,927

 
—

Loans
 

 
 

 
 

 
 

 
 

Agricultural
79,286

 
86,137

 
—

 
—

 
86,137

Commercial and financial
161,369

 
176,385

 
—

 
—

 
176,385

Real estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
29,298

 
28,364

 
—

 
—

 
28,364

Construction, land development and commercial
67,275

 
65,544

 
—

 
—

 
65,544

Mortgage, farmland
140,128

 
137,938

 
—

 
—

 
137,938

Mortgage, 1 to 4 family first liens
599,586

 
595,054

 
—

 
—

 
595,054

Mortgage, 1 to 4 family junior liens
104,822

 
104,133

 
—

 
—

 
104,133

Mortgage, multi-family
242,026

 
240,595

 
—

 
—

 
240,595

Mortgage, commercial
312,464

 
310,558

 
—

 
—

 
310,558

Loans to individuals
19,554

 
19,710

 
—

 
—

 
19,710

Obligations of state and political subdivisions
44,798

 
45,184

 
—

 
—

 
45,184

Interest rate swap
769

 
769

 
—

 
769

 
—

Accrued interest receivable
7,676

 
7,676

 
—

 
7,676

 
—

Total financial instrument assets
$
2,103,769

 
$
2,112,765

 
$
43,702

 
$
259,461

 
$
1,809,602

Financial instrument liabilities:
 

 
 

 
 

 
 

 
 

Deposits
 

 
 

 
 

 
 

 
 

Noninterest-bearing deposits
$
256,788

 
$
256,788

 
$
—

 
$
256,788

 
$
—

Interest-bearing deposits
1,453,089

 
1,461,454

 
—

 
1,461,454

 
—

Other borrowings
42,016

 
42,016

 
—

 
42,016

 
—

Federal Home Loan Bank borrowings
125,000

 
132,469

 
—

 
132,469

 
—

Accrued interest payable
1,102

 
1,102

 
—

 
1,102

 
—

Total financial instrument liabilities
$
1,877,995

 
$
1,893,829

 
$
—

 
$
1,893,829

 
$
—

 
Face Amount
 
 

 
 

 
 

 
 

Financial instrument with off-balance sheet risk:
 

 
 

 
 

 
 

 
 

Loan commitments
$
360,945

 
$
—

 
$
—

 
$
—

 
$
—

Letters of credit
11,019

 
—

 
—

 
—

 
—

Total financial instrument liabilities with off-balance-sheet risk
$
371,964

 
$
—

 
$
—

 
$
—

 
$
—


(1)
Considered Level 1 under Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”).
(2)
Considered Level 2 under ASC 820.
(3)
Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market

Page 92

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Fair value of financial instruments:  FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) provides a single definition for fair value, a framework for measuring fair value and expanded disclosures concerning fair value.  Fair value is defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

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

 
Level 1
Quoted prices in active markets for identical assets or liabilities.
 
Level 2
Observable inputs other than quoted prices included within Level 1.  Observable inputs include the quoted prices for similar assets or liabilities in markets that are not active and inputs other than quoted prices that are observable for the asset or liability.
 
Level 3
Unobservable inputs supported by little or no market activity for financial instruments.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

It is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements.  The Company is required to use observable inputs, to the extent available, in the fair value estimation process unless that data results from forced liquidations or distressed sales.  Despite the Company’s best efforts to maximize the use of relevant observable inputs, the current market environment has diminished the observability of trades and assumptions that have historically been available.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for assets or liabilities not recorded at fair value.

ASSETS

Cash and cash equivalents:  The carrying amounts reported in the consolidated balance sheets for cash and short-term instruments approximate their fair values (Level 1).

Investment securities available for sale:  Investment securities available for sale are recorded at fair value on a recurring basis.  Fair value measurement is based upon quoted prices, if available.  If a quoted price is not available, the fair value is obtained from benchmarking the security against similar securities.  All of the Company’s securities are considered Level 2.

The pricing for investment securities is obtained from an independent source.  There are no level 1 or level 3 investment securities owned by the Company.  The Company obtains an understanding of the independent source’s valuation methodologies used to determine fair value by level of security. The Company validates assigned fair values on a sample basis using an additional third-party provider pricing service to determine if the fair value measurement is reasonable.  Due to the nature of our investment portfolio, we do not expect significant and unusual fluctuations as fair value changes primarily relate to interest rate changes.   No unusual fluctuations were identified during the year ended December 31, 2014.   If a fluctuation requiring investigation was identified, the Company would research the change with the independent source or other available information.

Loans held for sale:  Loans held for sale are carried at historical cost.  The carrying amount is a reasonable estimate of fair value because of the short time between origination of the loan and its sale on the secondary market (Level 2).  The market is active for these loans and as a result prices for similar assets are available.


Page 93

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Loans:  The Company does not record loans at fair value on a recurring basis.  For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values (Level 3).  The fair values for other loans are determined using estimated future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality utilizing an entrance price concept (Level 3).  The Company does record nonrecurring fair value adjustments to impaired loans to reflect (1) partial write-downs that are based on the observable market price or appraised value of the collateral or (2) the full charge-off of the loan carrying value (Level 3).  These loans are considered Level 3 as the instruments used to determine fair market value require significant management judgment and estimation.

A loan is considered to be impaired when it is probable that all of the principal and interest due may not be collected according to its contractual terms. Generally, when a loan is considered impaired, the amount of reserve required under ASC 310, Receivables, is measured based on the fair value of the underlying collateral. The Company makes such measurements on all material loans deemed impaired using the fair value of the collateral for collateral dependent loans. The fair value of collateral used by the Company is determined by obtaining an observable market price or by obtaining an appraised value from an independent, licensed or certified appraiser, using observable market data. This data includes information such as selling price of similar properties and capitalization rates of similar properties sold within the market, expected future cash flows or earnings of the subject property based on current market expectations, and other relevant factors. All appraised values are adjusted for market-related trends based on the Company's experience in sales and other appraisals of similar property types as well as estimated selling costs. Each quarter management reviews all collateral dependent impaired loans on a loan-by-loan basis to determine whether updated appraisals are necessary based on loan performance, collateral type and guarantor support. At times, the Company measures the fair value of collateral dependent impaired loans using appraisals with dates prior to one year from the date of review. These appraisals are discounted by applying current, observable market data about similar property types such as sales contracts, estimations of value by individuals familiar with the market, other appraisals, sales or collateral assessments based on current market activity until updated appraisals are obtained. Depending on the length of time since an appraisal was performed, the data provided through reviews and estimated selling costs, collateral values are typically discounted by 0-25%.

Foreclosed assets:  The Company does not record foreclosed assets at fair value on a recurring basis.  Foreclosed assets consist mainly of other real estate owned but may include other types of assets repossessed by the Company.  Foreclosed assets are adjusted to the lower of carrying value or fair value less the costs of disposal.   Fair value is generally based upon independent market prices or appraised values of the collateral, and may include a marketability discount as deemed necessary by management based on its experience with similar types of real estate.  The value of foreclosed assets is evaluated periodically as a nonrecurring fair value adjustment.  Foreclosed assets are classified as Level 3.

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

Accrued interest receivable:  The fair value of accrued interest receivable equals the amount receivable due to the current nature of the amounts receivable (Level 2).

Non-marketable equity investments:  Non-marketable equity investments are recorded under the cost or equity method of accounting.  There are generally restrictions on the sale and/or liquidation of these investments, including stock of the Federal Home Loan Bank.  The carrying value of stock of the Federal Home Loan Bank approximates fair value (Level 2).

LIABILITIES

Deposit liabilities:  Deposit liabilities are carried at historical cost.  The fair value of demand deposits, savings accounts and certain money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.  If the fair value of the fixed maturity certificates of deposit is calculated at less than the carrying amount, the carrying value of these deposits is reported as the fair value (Level 2).  Deposit liabilities are classified as Level 2 due to available prices for similar liabilities in the market.


Page 94

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Other borrowings:  Other borrowings are carried at historical cost and include federal funds purchased and securities sold under agreements to repurchase.  The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the liability and its expected realization (Level 2).  Other borrowings are classified as Level 2 due to available prices for similar liabilities in the market.

Federal Home Loan Bank borrowings:  Federal Home Loan Bank borrowings are recorded at historical cost.  The fair values of the Company’s Federal Home Loan Bank borrowings are estimated using discounted cash flow analysis, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements (Level 2).  Federal Home Loan Bank borrowings are classified as Level 2 due to available prices for similar liabilities in the market.

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

Accrued interest payable:  The fair value of accrued interest payable equals the amount payable due to the current nature of the amounts payable (Level 2).

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below represents the balances of assets and liabilities measured at fair value on a recurring basis:
 
December 31, 2014
 
Readily Available
Market Prices(1)
 
Observable
Market Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at
Fair Value
Securities available for sale
(Amounts in Thousands)
U.S. Treasury
$
—

 
$
22,333

 
$
—

 
$
22,333

State and political subdivisions
—

 
168,968

 
—

 
168,968

Other securities (FHLB, FHLMC and FNMA)
—

 
67,691

 
—

 
67,691

Derivative Financial Instruments
 
 
 
 
 
 
 
Interest rate swaps
—

 
(2,796
)
 
—

 
(2,796
)
Total
$
—

 
$
256,196

 
$
—

 
$
256,196


 
December 31, 2013
 
Readily Available
Market Prices(1)
 
Observable
Market Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at
Fair Value
Securities available for sale
(Amounts in Thousands)
U.S. Treasury
$
—

 
$
—

 
$
—

 
$
—

State and political subdivisions
—

 
151,366

 
—

 
151,366

Other securities (FHLB, FHLMC and FNMA)
—

 
87,144

 
—

 
87,144

Derivative Financial Instruments
 
 
 
 
 
 
 
Interest rate swaps
—

 
769

 
—

 
769

Total
$
—

 
$
239,279

 
$
—

 
$
239,279


(1)
Considered Level 1 under ASC 820.
(2)
Considered Level 2 under ASC 820.
(3)
Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market.

There were no transfers between Levels 1, 2 or 3 during the years ended December 31, 2014 and 2013.

Page 95

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company is required to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP.  These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets.  The valuation methodologies used to measure these fair value adjustments are described above.  For assets measured at fair value on a nonrecurring basis that were still held on the balance sheet at December 31, 2014 and 2013, the following tables provide the level of valuation assumptions used to determine the adjustment and the carrying value of the related individual assets at year end.
 
December 31, 2014
 
Year Ended December 31, 2014
 
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at
Fair Value
 
Total
Losses
 
(Amounts in Thousands)
 
 
Loans (4)
 
 
 
 
 
 
 
 
 
Agricultural
$
—

 
$
—

 
$
1,679

 
$
1,679

 
$
25

Commercial and financial
—

 
—

 
1,709

 
1,709

 
206

Real Estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
315

 
315

 
—

Construction, land development and commercial
—

 
—

 
—

 
—

 
—

Mortgage, farmland
—

 
—

 
2,040

 
2,040

 
—

Mortgage, 1 to 4 family first liens
—

 
—

 
2,500

 
2,500

 
576

Mortgage, 1 to 4 family junior liens
—

 
—

 
369

 
369

 
24

Mortgage, multi-family
—

 
—

 
5,525

 
5,525

 
—

Mortgage, commercial
—

 
—

 
1,918

 
1,918

 
328

Loans to individuals
—

 
—

 
—

 
—

 
—

Foreclosed assets (5)
—

 
—

 
301

 
301

 
210

Total
$
—

 
$
—

 
$
16,356

 
$
16,356

 
$
1,369


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



Page 96

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
December 31, 2013
 
Year Ended December 31, 2013
 
Readily
Available
Market
Prices(1)
 
Observable
Market
Prices(2)
 
Company
Determined
Market
Prices(3)
 
Total at
Fair Value
 
Total
Losses
 
(Amounts in Thousands)
 
 
Loans (4)
 
 
 
 
 
 
 
 
 
Agricultural
$
—

 
$
—

 
$
117

 
$
117

 
$
—

Commercial and financial
—

 
—

 
2,391

 
2,391

 
53

Real Estate:
 

 
 

 
 

 
 

 
 

Construction, 1 to 4 family residential
—

 
—

 
1,270

 
1,270

 
—

Construction, land development and commercial
—

 
—

 
140

 
140

 
—

Mortgage, farmland
—

 
—

 
270

 
270

 
—

Mortgage, 1 to 4 family first liens
—

 
—

 
4,299

 
4,299

 
424

Mortgage, 1 to 4 family junior liens
—

 
—

 
177

 
177

 
59

Mortgage, multi-family
—

 
—

 
5,876

 
5,876

 
69

Mortgage, commercial
—

 
—

 
11,682

 
11,682

 
229

Loans to individuals
—

 
—

 
—

 
—

 
—

Foreclosed assets (5)
—

 
—

 
427

 
427

 
68

Total
$
—

 
$
—

 
$
26,649

 
$
26,649

 
$
902


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




Page 97

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 14.
Parent Company Only Financial Information

Following is condensed financial information of the Company (parent company only):

CONDENSED BALANCE SHEETS
December 31, 2014 and 2013
(Amounts In Thousands) 
ASSETS
2014
 
2013
Cash and cash equivalents at subsidiary bank
$
1,881

 
$
3,018

Investment in subsidiary bank
289,556

 
272,122

Other assets
1,527

 
1,422

Total assets
$
292,964

 
$
276,562

LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 

Liabilities
$
2,361

 
$
2,191

Redeemable common stock held by ESOP
34,571

 
29,574

Stockholders' equity:
 

 
 

Capital stock
42,925

 
42,194

Retained earnings
271,924

 
250,370

Accumulated other comprehensive (loss) income
(448
)
 
1,591

Treasury stock at cost
(23,798
)
 
(19,784
)
 
290,603

 
274,371

Less maximum cash obligation related to ESOP shares
34,571

 
29,574

Total stockholders' equity
256,032

 
244,797

Total liabilities and stockholders' equity
$
292,964

 
$
276,562


CONDENSED STATEMENTS OF INCOME
Years Ended December 31, 2014, 2013 and 2012
(Amounts In Thousands) 
 
2014
 
2013
 
2012
Dividends received from subsidiary
$
7,438

 
$
5,213

 
$
6,998

Other expenses
(637
)
 
(471
)
 
(452
)
Income before income tax benefit and equity in undistributed income of subsidiary
6,801

 
4,742

 
6,546

Income tax benefit
254

 
141

 
199

 
7,055

 
4,883

 
6,745

Equity in undistributed income of subsidiary
19,919

 
21,048

 
20,088

Net income
$
26,974

 
$
25,931

 
$
26,833



Page 98

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2014, 2013 and 2012
(Amounts In Thousands) 
 
2014
 
2013
 
2012
Cash flows from operating activities:
 
 
 
 
 
Net income
$
26,974

 
$
25,931

 
$
26,833

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

 
 

 
 

Equity in undistributed income of subsidiary
(19,919
)
 
(21,048
)
 
(20,088
)
Share-based compensation
29

 
28

 
20

Compensation expensed through issuance of common stock
1,045

 
467

 
528

Excess tax benefits related to share-based compensation
(60
)
 
(92
)
 
(92
)
Forfeiture of common stock
(40
)
 
(35
)
 
(41
)
Increase (decrease) in other assets
(63
)
 
647

 
97

Increase in other liabilities
170

 
59

 
396

Net cash and cash equivalents provided by operating activities
8,136

 
5,957

 
7,653

Cash flows from financing activities:
 

 
 

 
 

Stock options exercised
101

 
175

 
175

Excess tax benefits related to share-based compensation
60

 
92

 
95

Purchase of treasury stock
(4,014
)
 
(1,387
)
 
(2,438
)
Dividends paid
(5,420
)
 
(5,186
)
 
(4,998
)
Net cash and cash equivalents used by financing activities
(9,273
)
 
(6,306
)
 
(7,166
)
(Decrease) increase in cash and cash equivalents
(1,137
)
 
(349
)
 
484

Cash and cash equivalents:
 

 
 

 
 

Beginning of year
3,018

 
3,367

 
2,883

Ending of year
$
1,881

 
$
3,018

 
$
3,367



Note 15.
Commitments and Contingencies

Concentrations of credit risk:  The Bank’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Bank's market area.  Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $89.73 million.  The concentrations of credit by type of loan are set forth in Note 3 to the consolidated financial statements.  Outstanding letters of credit were granted primarily to commercial borrowers.  Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson, Linn and Washington Counties, Iowa.

Contingencies:  In the normal course of business, the Company and Bank are involved in various legal proceedings.  In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the accompanying consolidated financial statements.

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


Page 99

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  A summary of the Bank’s commitments at December 31, 2014 and 2013 is as follows:

 
2014
 
2013
 
(Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:
 
 
 
Home equity loans
$
40,484

 
$
38,243

Credit cards
46,573

 
44,326

Commercial, real estate and home construction
81,613

 
106,241

Commercial lines and real estate purchase loans
165,430

 
172,135

Outstanding letters of credit
12,437

 
11,019


Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Bank evaluates each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the party.  Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties.  Credit card commitments are the unused portion of the holders' credit limits.  Such amounts represent the maximum amount of additional unsecured borrowings.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.  The Bank holds collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary.  In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment.  The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above.  If the commitment is funded the Bank would be entitled to seek recovery from the customer.  At December 31, 2014 and 2013, no amounts have been recorded as liabilities for the Bank’s potential obligations under these guarantees.

Lease commitments: The Company leases certain facilities under operating leases.  The minimum future rental commitments as of December 31, 2014 for all non-cancelable leases relating to Bank premises were as follows:
Year ending December 31:
(Amounts In Thousands)
2015
$
457

2016
448

2017
317

2018
287

2019
75

Thereafter
1

 
$
1,585


Rent expense was $0.32 million, $0.33 million and $0.31 million for the years ended December 31, 2014, 2013 and 2012, respectively.


Page 100

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 16.
Quarterly Results of Operations (unaudited, amounts in thousands, except per share amounts)
 
Quarter Ended
 
March
 
June
 
September
 
December
 
Year
2014
 
 
 
 
 
 
 
 
 
Interest income
$
20,865

 
$
21,473

 
$
21,794

 
$
22,450

 
$
86,582

Interest expense
3,850

 
3,760

 
3,704

 
$
3,723

 
15,037

Net interest income
$
17,015

 
$
17,713

 
$
18,090

 
$
18,727

 
$
71,545

Provision for loan losses
45

 
(246
)
 
(1,008
)
 
2,251

 
1,042

Other income
4,421

 
4,947

 
5,247

 
4,741

 
19,356

Other expense
12,258

 
12,537

 
12,821

 
14,140

 
51,756

Income before income taxes
$
9,133

 
$
10,369

 
$
11,524

 
$
7,077

 
38,103

Income taxes
2,389

 
3,188

 
3,625

 
1,927

 
11,129

Net income
$
6,744

 
$
7,181

 
$
7,899

 
$
5,150

 
$
26,974

Basic earnings per share
$
1.43

 
$
1.53

 
$
1.69

 
$
1.10

 
$
5.75

Diluted earnings per share
1.43

 
1.53

 
1.68

 
1.10

 
5.74

2013
 

 
 

 
 

 
 

 
 

Interest income
$
21,139

 
$
21,131

 
$
21,241

 
$
21,384

 
$
84,895

Interest expense
4,360

 
4,277

 
4,134

 
$
4,077

 
16,848

Net interest income
$
16,779

 
$
16,854

 
$
17,107

 
$
17,307

 
$
68,047

Provision for loan losses
(171
)
 
(250
)
 
112

 
1,440

 
1,131

Other income
4,883

 
5,095

 
4,745

 
4,482

 
19,205

Other expense
12,033

 
12,422

 
12,411

 
12,412

 
49,278

Income before income taxes
$
9,800

 
$
9,777

 
$
9,329

 
$
7,937

 
36,843

Income taxes
2,990

 
2,863

 
2,705

 
2,354

 
10,912

Net income
$
6,810

 
$
6,914

 
$
6,624

 
$
5,583

 
$
25,931

Basic earnings per share
$
1.44

 
$
1.47

 
$
1.41

 
$
1.19

 
$
5.51

Diluted earnings per share
1.44

 
1.47

 
1.40

 
1.19

 
5.50


Note 17.
Derivative Financial Instruments

In the normal course of business, the Bank may use derivative financial instruments to manage its interest rate risk.  These instruments carry varying degrees of credit, interest rate and market or liquidity risks.  Derivative instruments are recognized as either assets or liabilities in the accompanying consolidated financial statements and are measured at fair value.  The Bank’s objectives are to add stability to its net interest margin and to manage its exposure to movements in interest rates.  The contract or notional amount of a derivative is used to determine, along with the other terms of the derivative, the amount to be exchanged between the counterparties.  The Bank is exposed to credit risk in the event of nonperformance by counterparties to financial instruments.  The Bank minimizes this risk by entering into derivative contracts with large, stable financial institutions.  The Bank has not experienced any losses from nonperformance by counterparties.  The Bank monitors counterparty risk in accordance with the provisions of ASC 815.  In addition, the Bank’s interest rate-related derivative instruments contain language outline collateral pledging requirements for each counterparty.  Collateral must be posted when the market value exceeds certain threshold limits which are determined by credit ratings of each counterparty.  The Bank was required to pledge $2.80 million of collateral as of December 31, 2014.


Page 101

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Cash Flow Hedges:

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

The table below identifies the balance sheet category and fair values of the Bank’s derivative instruments designated as cash flow edges as of December 31, 2014 and 2013: 
 
Notional
Amount
 
Fair Value
 
Balance
Sheet
Category
 
Maturity
 
(Amounts in Thousands)
 
 
December 31, 2014
 
 
 
 
 
 
    
Interest rate swap
$
25,000

 
$
(864
)
 
Other Liabilities
 
11/9/2020
Interest rate swap
25,000

 
(1,932
)
 
Other Liabilities
 
11/7/2023
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
    
Interest rate swap
25,000

 
357

 
Other Assets
 
11/9/2020
Interest rate swap
25,000

 
412

 
Other Assets
 
11/7/2023
 
The table below identifies the gains and losses recognized on the Bank’s derivative instruments designated as cash flow hedges for the year ended December 31, 2014 and 2013:

 
Effective Portion
 
Ineffective Portion
 
Recognized in OCI
 
Reclassified from AOCI into Income
 
Recognized in Income on Derivatives
 
Amount of Gain (Loss)
 
Category
 
Amount of Gain (Loss)
 
Category
 
Amount of Gain (Loss)
 
(Amounts in Thousands)
December 31, 2014
 
 
 
 
 
 
 
 
 
Interest rate swap
$
(754
)
 
Interest Expense
 
$
—

 
Other Income
 
$
—

Interest rate swap
(1,448
)
 
Interest Expense
 
—

 
Other Income
 
—

 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
Interest rate swap
220

 
Interest Expense
 
—

 
Other Income
 
—

Interest rate swap
255

 
Interest Expense
 
—

 
Other Income
 
—





Page 102

Item 9.
Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

None.


Item 9A.
Controls and Procedures

Disclosure Controls and Procedures

As of the end of the period covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934).  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

Management’s Report on Internal Control over Financial Reporting

The Company’s management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Securities Exchange Act of 1934).  Internal control over financial reporting of the Company includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s consolidated financial statements.  Important features of the Company’s system of internal control over financial reporting include the adoption and implementation of written policies and procedures, careful selection and training of financial management personnel, a continuing management commitment to the integrity of the system and through examinations by an internal audit function that coordinates its activities with the Company’s Independent Registered Public Accounting Firm.

All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls.  Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation.  Further, because of changes in conditions, the effectiveness of internal control may vary over time.

The Company’s management conducted an evaluation of the effectiveness of the Company’s internal controls over financial reporting as of December 31, 2014.  Management’s assessment is based on the criteria described in “Internal Control – Integrated Framework” issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this assessment, the Company’s management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2014.

Attestation Report of the Registered Public Accounting Firm

The Company’s independent registered public accounting firm, that audited the consolidated financial statements included in this annual report, has issued a report on the Company’s internal control over financial reporting as of December 31, 2014.  Reference is made to the Report of Independent Registered Public Accounting Firm included in this Annual Report.

Changes in Internal Control over Financial Reporting

There was no change in the Company’s internal control over financial reporting during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


Item 9B.
Other Information

Not applicable

Page 103

PART III

Item 10.
Directors, Executive Officers and Corporate Governance

The information required by Item 10 of Part III is presented under the items entitled “Certain Information Regarding Directors and Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Definitive Proxy Statement dated March 20, 2015 for the Annual Meeting of Stockholders on April 20, 2015.  Such information is incorporated herein by reference.

The Company has a Code of Ethics in place for the Chief Executive Officer and Chief Financial Officer.  A copy of the Company’s Code of Ethics will be provided free of charge, upon written request to:

Shari DeMaris
Treasurer
Hills Bancorporation
131 Main Street
Hills, Iowa  52235

The executive officers of the Company and the Bank, along with their respective ages and positions held, are identified in the table below.
 
Name
 
 
Age
 
Position
Company
 
 
Dwight O. Seegmiller
62
Mr. Seegmiller, who joined the Company in 1975, has served as its President since 1986.   Prior to 1986, Mr. Seegmiller was the Senior Vice President of Lending.
 
 
 
Shari J. DeMaris
45
Ms. DeMaris has held the position of Secretary, Treasurer and Principal Financial Officer since 2012.
 
 
 
Bank
 
 
Timothy D. Finer
53
Mr. Finer has held the position of Senior Vice President, Director of Real Estate Lending since 2005.
 
 
 
Marty J. Maiers
57
Mr. Maiers has held the position of Senior Vice President, Director of Retail Banking since 2008.
 
 
 
Steven R. Ropp
54
Mr. Ropp has held the position of Senior Vice President, Director of Commercial Banking since 2008.
 
 
 
Bradford C. Zuber
58
Mr. Zuber has held the position of Senior Vice President, Director of Trust Services since 1987.

Item 11.
Executive Compensation

The information required by Item 11 of Part III is presented under the items entitled  “Compensation Discussion and Analysis,” “Summary of Cash and Certain Other Compensation Paid to the Named Executive Officers,” “Compensation and Incentive Stock Committee Interlocks and Certain other Transactions with Executive Officers and Directors,” and “Compensation and Incentive Stock Committee Report”  in the Company’s Definitive Proxy Statement dated March 20, 2015 for the Annual Meeting of Stockholders on April 20, 2015. Such information is incorporated herein by reference.


Page 104

Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by Item 12 of Part III is presented under the item entitled “Security Ownership of Principal Stockholders and Management” and “Report on Executive Compensation,” in the Company’s Definitive Proxy Statement dated March 20, 2015 for the Annual Meeting of Stockholders on April 20, 2015.  Such information is incorporated herein by reference.

The following table sets forth information regarding the Company’s equity compensation plan as of December 31, 2014, all of which relates to stock options issued under stock option plans approved by stockholders of the Company.

 
 Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for future
issuance under equity
compensation plans
[excluding securities
reflected in column (a)]
Plan Category
(a)
(b)
(c)
Equity compensation plans approved by security holders
9,690

$
59.85

61,186

Equity compensation plans not approved by security holders
—

—

—

Total
9,690

$
59.85

61,186

 
Item 13.
Certain Relationships and Related Transactions, and Director Independence

The information required by Item 13 of Part III is presented under the items entitled “Corporate Governance and the Boards of Directors,” and “Compensation and Incentive Stock Committee Interlocks and Certain other Transactions with Executive Officers and Directors” in the Company’s Definitive Proxy Statement dated March 20, 2015 for the Annual Meeting of Stockholders on April 20, 2015. Such information is incorporated herein by reference.

Item 14.
Principal Accounting Fees and Services

Information required by this item is contained in the Company’s Definitive Proxy Statement dated March 20, 2015 for the Annual Meeting of Shareholders on April 20, 2015, under the heading “Independent Registered Public Accounting Firm – Audit and Other Fees,” which section is incorporated herein by this reference.



Page 105

PART IV

Item 15.
Exhibits, Consolidated Financial Statement Schedules

 
 
 
 
 
 
 
 
Form 10-K
(a)
 
1
 
 
 
Financial Statements
 
Reference
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Independent registered public accounting firm's report on the financial statements
 
Page 50-51
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated balance sheets as of December 31, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated statements of income for the years ended December 31, 2014, 2013, and 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated statements of comprehensive income for the years ended December 31, 2014, 2013 and 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated statements of stockholders' equity for the years ended December 31, 2014, 2013 and 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated statements of cash flows for the years ended December 31, 2014, 2013 and 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Notes to consolidated financial statements
 
 
 
 
 
 
 
 
 
 
 
 
2
 
 
 
Financial Statements Schedules
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
All schedules are omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto.
 
 
 
 
 
 
 
 
 
 
 
(b)
 
3
 
 
 
Exhibits
 
 
 
 
 
 
 
 
 
 
 
 
 
3.1
 
 
 
Restated Articles of Incorporation, as amended, are attached on Pages 110-121.
 
 
 
 
 
 
 
 
 
 
 
 
 
3.2
 
 
 
Amended and Restated ByLaws are attached on Page 122-128.
 
 
 
 
 
 
 
 
 
 
 
 
 
10.1
 
 
 
Employee Stock Ownership Plan filed as Exhibit 10(a) in Form 10-K for the year ended December 31, 1993 is incorporated by reference.
 
 
 
 
 
 
 
 
 
 
 
 
 
10.2
 
 
 
1995 Deferred Compensation Plans filed as Exhibit 10(c) in Form 10-K for the year ended December 31, 1995 is incorporated by reference.
 
 
 
 
 
 
 
 
 
 
 
 
 
10.3
 
 
 
2010 Stock Option and Incentive Plan filed on Form S-8 dated June 29, 2012 is incorporated by reference.
 
 
 
 
 
 
 
 
 
 
 
 
 
10.4
 
 
 
Employee Stock Purchase Plan filed on Form S-8 dated June 29, 2012 is incorporated by reference.
 
 
 
 
 
 
 
 
 
 
 

Page 106

 
 
11
 
 
 
Statement Regarding Computation of Basic and Diluted Earnings Per Share. (Note:  Statement included in Note 1 under Item 8 of Part II above)
 
 
 
 
 
 
 
 
 
 
 
 
 
21
 
 
 
Subsidiary of the Registrant is attached on Page 129.
 
 
 
 
 
 
 
 
 
 
 
 
 
23.1
 
 
 
Consent of Independent Registered Public Accounting Firm is attached on Page 130. BKD LLP
 
 
 
 
 
 
 
 
 
 
 
 
 
31
 
 
 
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 on Pages 131-132.
 
 
 
 
 
 
 
 
 
 
 
 
 
32
 
 
 
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002 on Page 133.
 
 
 
 
 
 
 
 
 
 
 
 
 
101
 
**
 
The following material from Hills Bancorporation Form 10-K Report for the year ended December 31, 2014, formatted in XBRL: (1) Unaudited Condensed Consolidated Balance Sheets, (2) Unaudited Condensed Consolidated Statements of Income, (3) Unaudited Condensed Consolidated Statements of Comprehensive Income, (4) Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity, (5) Unaudited Condensed Consolidated Statements of Cash Flows, and (6) the Notes to Unaudited Condensed Consolidated Financial Statements.
 
 

Page 107

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
 
HILLS BANCORPORATION
 
 
 
 
 
Date:
March 11, 2015
By: /s/Dwight O. Seegmiller
 
 
 
Dwight O. Seegmiller, Director, President and Chief Executive Officer
 
 
 
 
 
Date:
March 11, 2015
By: /s/Shari DeMaris
 
 
 
Shari DeMaris, Secretary, Treasurer and Chief Accounting Officer
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 
 
 
DIRECTORS OF THE REGISTRANT
 
 
 
 
 
Date:
March 11, 2015
By: /s/Michael S. Donovan
 
 
 
Michael S. Donovan, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/Thomas J. Gill
 
 
 
Thomas J. Gill, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/Michael E. Hodge
 
 
 
Michael E. Hodge, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/Emily A. Hughes
 
 
 
Emily A. Hughes, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/James A. Nowak
 
 
 
James A. Nowak, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/Theodore H. Pacha
 
 
 
Theodore H. Pacha, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/John W. Phelan
 
 
 
John W. Phelan, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/Ann M. Rhodes
 
 
 
Ann M. Rhodes, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/Thomas R. Wiele
 
 
 
Thomas R. Wiele, Director
 
 
 
 
 
Date:
March 11, 2015
By: /s/Sheldon E. Yoder
 
 
 
Sheldon E. Yoder, Director
 



Page 108

HILLS BANCORPORATION
ANNUAL REPORT OF FORM 10-K FOR THE
FISCAL YEAR ENDED DECEMBER 31, 2014

 
 
Page Number
 
 
In The Sequential
Exhibit
 
Numbering System
Number
Description
For 2014 Form 10-K
 
 
 
3.1
Restated Articles of Incorporation, as amended
110-121

 
 
 
3.2
Amended and Restated By-laws
122-128

 
 
 
11
Statement Re Computation of Basic and Diluted Earnings Per Share
 
 
(Note:  Statement included in Note 1 under Item 8 of Part II above)
 
 
 
 
21
Subsidiary of the Registrant
129

 
 
 
23.1
Consent of Independent Registered Public Accounting Firm, BKD LLP
130

 
 
 
31.1
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
131

 
 
 
31.2
Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
132

 
 
 
32
Certifications under Section 906 of the Sarbanes-Oxley Act of 2002
133

 
 


Page 109