UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2015

Commission file number:  0-12668

Hills Bancorporation

Incorporated in Iowa	I.R.S. Employer Identification
	No. 42-1208067

131 MAIN STREET, HILLS, IOWA 52235

Telephone number: (319) 679-2291

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

þ Yes  o No

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

þ Yes  o No

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

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

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

o Yes  þ No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date.

	SHARES OUTSTANDING
CLASS	April 30, 2015
Common Stock, no par value	4,685,170

HILLS BANCORPORATION

Index to Form 10-Q

Part I

FINANCIAL INFORMATION

		Page
		Number
Item 1.	Financial Statements
	Consolidated balance sheets, March 31, 2015 (unaudited) and December 31, 2014	4
	Consolidated statements of income (unaudited) for three months ended March 31, 2015 and 2014	5
	Consolidated statements of comprehensive income (unaudited) for three months ended March 31, 2015 and 2014	6
	Consolidated statements of stockholders' equity (unaudited) for three months ended March 31, 2015 and 2014	7
	Consolidated statements of cash flows (unaudited) for three months ended March 31, 2015 and 2014	8
	Notes to consolidated financial statements (condensed)	10
Item 2.	Management Discussion and Analysis of Financial Condition and Results of Operations	36
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	48
Item 4.	Controls and Procedures	49
	Part II
	OTHER INFORMATION
Item 1.	Legal proceedings	50
Item 1A.	Risk factors	50
Item 2.	Unregistered sales of equity securities and use of proceeds	51
Item 3.	Defaults upon senior securities	51
Item 4.	Mine safety disclosures	51
Item 5.	Other information	51
Item 6.	Exhibits	52
	Signatures	53
	Exhibits Index	54

Page 3

HILLS BANCORPORATION CONSOLIDATED BALANCE SHEETS (Amounts In Thousands, Except Share Amounts)

	March 31, 2015			December 31, 2014
ASSETS	(Unaudited)
Cash and cash equivalents	$	83,345		$	29,174
Investment securities available for sale at fair value (amortized cost March 31, 2015 $256,673; December 31, 2014 $256,920)	259,878			258,992
Stock of Federal Home Loan Bank	8,446			8,248
Loans held for sale	8,311			4,476
Loans, net of allowance for loan losses (March 31, 2015 $24,360; December 31, 2014 $24,020)	1,970,499			1,961,369
Property and equipment, net	32,466			29,071
Tax credit real estate	17,045			17,259
Accrued interest receivable	9,102			8,276
Deferred income taxes, net	10,219			9,938
Other real estate	1,228			1,213
Goodwill	2,500			2,500
Other assets	4,218			3,802
Total Assets	$	2,407,257		$	2,334,318
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Noninterest-bearing deposits	$	280,432		$	288,718
Interest-bearing deposits	1,626,903			1,546,351
Total deposits	$	1,907,335		$	1,835,069
Other borrowings	40,928			47,499
Federal Home Loan Bank borrowings	140,000			140,000
Accrued interest payable	859			902
Other liabilities	26,545			20,749
Total Liabilities	$	2,115,667		$	2,044,219
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)	$	35,007		$	34,571
STOCKHOLDERS' EQUITY
Common stock, no par value; authorized 10,000,000 shares; issued March 31, 2015 5,089,298 shares; December 31, 2014 5,088,927 shares	$	—		$	—
Paid in capital	43,060			42,925
Retained earnings	273,449			271,924
Accumulated other comprehensive loss	(422		)	(448		)
Unearned ESOP shares	(504		)	(504		)
Treasury stock at cost (March 31, 2015 401,075 shares; December 31, 2014 398,711 shares)	(23,993		)	(23,798		)
Total Stockholders' Equity	$	291,590		$	290,099
Less maximum cash obligation related to ESOP shares	35,007			34,571
Total Stockholders' Equity Less Maximum Cash Obligations Related to ESOP Shares	$	256,583		$	255,528
Total Liabilities & Stockholders' Equity	$	2,407,257		$	2,334,318

See Notes to Consolidated Financial Statements.

Page 4

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Amounts In Thousands, Except Per Share Amounts)

	Three Months Ended March 31,
	2015			2014
Interest income:
Loans, including fees	$	21,080		$	19,749
Investment securities:
Taxable	286			270
Nontaxable	843			836
Federal funds sold	5			10
Total interest income	$	22,214		$	20,865
Interest expense:
Deposits	$	2,164		$	2,469
Short-term borrowings	17			3
FHLB borrowings	1,454			1,378
Total interest expense	$	3,635		$	3,850
Net interest income	$	18,579		$	17,015
Provision for loan losses	(62		)	45
Net interest income after provision for loan losses	$	18,641		$	16,970
Noninterest income:
Net gain on sale of loans	$	308		$	111
Trust fees	1,569			1,460
Service charges and fees	1,946			1,837
Rental revenue on tax credit real estate	511			357
Net gain on sale of other real estate owned and other repossessed assets	7			72
Other noninterest income	649			584
	$	4,990		$	4,421
Noninterest expenses:
Salaries and employee benefits	$	6,651		$	6,257
Occupancy	1,015			1,009
Furniture and equipment	1,298			1,231
Office supplies and postage	441			382
Advertising and business development	774			628
Outside services	1,814			1,535
Rental expenses on tax credit real estate	602			530
FDIC insurance assessment	289			270
Other noninterest expense	315			416
	$	13,199		$	12,258
Income before income taxes	$	10,432		$	9,133
Income taxes	3,052			2,389
Net income	$	7,380		$	6,744
Earnings per share:
Basic	$	1.58		$	1.43
Diluted	$	1.58		$	1.43

See Notes to Consolidated Financial Statements.

Page 5

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited) (Amounts In Thousands)

	Three Months Ended March 31,
	2015			2014
Net income	$	7,380		$	6,744
Other comprehensive income (loss)
Securities:
Net change in unrealized gain on securities available for sale	$	1,133		$	84
Reclassification adjustment for net gains realized in net income	—			—
Income taxes	(433		)	(32		)
Other comprehensive income on securities available for sale	$	700		$	52
Derivatives used in cash flow hedging relationships:
Unrealized loss on derivatives	$	(1,092	)	$	(1,079	)
Income taxes	418			413
Other comprehensive loss on cash flow hedges	$	(674	)	$	(666	)
Other comprehensive income (loss), net of tax	$	26		$	(614	)
Comprehensive income	$	7,406		$	6,130

See Notes to Consolidated Financial Statements.

Page 6

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited) (Amounts In Thousands, Except Share Amounts)

	Paid In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Unearned ESOP Shares			Treasury Stock			Maximum Cash Obligation Related To ESOP Shares			Total
Balance, December 31, 2013	$	42,194		$	250,370		$	1,591		$	(1,008	)	$	(19,784	)	$	(29,574	)	$	243,789
Issuance of 3,067 shares of common stock	111			—			—			—			—			—			111
Issuance of 535 shares of common stock under the employee stock purchase plan	39			—			—			—			—			—			39
Unearned restricted stock compensation	59			—			—			—			—			—			59
Forfeiture of 166 shares of common stock	(12		)	—			—			—			—			—			(12		)
Share-based compensation	7			—			—			—			—			—			7
Income tax benefit related to share-based compensation	50			—			—			—			—			—			50
Change related to ESOP shares	—			—			—			—			—			(395		)	(395		)
Net income	—			6,744			—			—			—			—			6,744
Cash dividends ($1.15 per share)	—			(5,421		)	—			—			—			—			(5,421		)
Purchase of 6,855 shares of common stock	—			—			—			—			(517		)	—			(517		)
Other comprehensive loss	—			—			(614		)	—			—			—			(614		)
Balance, March 31, 2014	$	42,448		$	251,693		$	977		$	(1,008	)	$	(20,301	)	$	(29,969	)	$	243,840
Balance, December 31, 2014	$	42,925		$	271,924		$	(448	)	$	(504	)	$	(23,798	)	$	(34,571	)	$	255,528
Issuance of 146 shares of common stock	12			—			—			—			—			—			12
Issuance of 566 shares of common stock under the employee stock purchase plan	45			—			—			—			—			—			45
Unearned restricted stock compensation	89			—			—			—			—			—			89
Forfeiture of 341 shares of common stock	(22		)	—			—			—			—			—			(22		)
Share-based compensation	7			—			—			—			—			—			7
Income tax benefit related to share-based compensation	4			—			—			—			—			—			4
Change related to ESOP shares	—			—			—			—			—			(436		)	(436		)
Net income	—			7,380			—			—			—			—			7,380
Cash dividends ($1.25 per share)	—			(5,855		)	—			—			—			—			(5,855		)
Purchase of 2,364 shares of common stock	—			—			—			—			(195		)	—			(195		)
Other comprehensive income	—			—			26			—			—			—			26
Balance, March 31, 2015	$	43,060		$	273,449		$	(422	)	$	(504	)	$	(23,993	)	$	(35,007	)	$	256,583

See Notes to Consolidated Financial Statements.

Page 7

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

	Three Months Ended   March 31,
	2015			2014
Cash Flows from Operating Activities
Net income	$	7,380		$	6,744
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation	685			681
Provision for loan losses	(62		)	45
Share-based compensation	7			7
Forfeiture of common stock	(22		)	(12		)
Compensation expensed through issuance of common stock	57			49
Excess tax benefits from share-based compensation	(4		)	(50		)
Provision for deferred income taxes	(295		)	(321		)
Net gain on sale of other real estate owned and other repossessed assets	(7		)	(72		)
Increase in accrued interest receivable	(826		)	(1,075		)
Amortization of discount on investment securities, net	172			216
Increase in other assets	(413		)	(265		)
Increase in accrued interest payable and other liabilities	4,750			3,994
Loans originated for sale	(40,577		)	(16,518		)
Proceeds on sales of loans	37,050			19,686
Net gain on sales of loans	(308		)	(111		)
Net cash and cash equivalents provided by operating activities	$	7,587		$	12,998
Cash Flows from Investing Activities
Proceeds from maturities of investment securities available for sale	$	11,906		$	22,806
Purchases of investment securities available for sale	(12,029		)	(23,480		)
Loans made to customers, net of collections	(9,131		)	(24,557		)
Proceeds on sale of other real estate owned and other repossessed assets	55			489
Purchases of property and equipment	(4,080		)	(190		)
Income from tax credit real estate, net	214			209
Net cash and cash equivalents used in investing activities	$	(13,065	)	$	(24,723	)
Cash Flows from Financing Activities
Net increase in deposits	$	72,266		$	64,326
Net decrease in other borrowings	(6,571		)	(1,439		)
Stock options exercised	—			101
Excess tax benefits related to share-based compensation	4			50
Purchase of treasury stock	(195		)	(517		)
Dividends paid	(5,855		)	(5,421		)
Net cash and cash equivalents provided by financing activities	$	59,649		$	57,100

(Continued)

Page 8

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued) (Amounts In Thousands)
	Three Months Ended   March 31,
	2015		2014
Increase in cash and cash equivalents	$	54,171	$	45,375
Cash and cash equivalents:
Beginning of year	29,174		43,702
End of period	$	83,345	$	89,077
Supplemental Disclosures
Cash payments for:
Interest paid to depositors	$	2,207	$	2,535
Interest paid on other obligations	1,471		1,381
Income taxes paid	120		502
Noncash activities:
Increase in maximum cash obligation related to ESOP shares	$	436	$	395
Transfers to other real estate owned	63		800
Sale and financing of other real estate owned	113		—

See Notes to Consolidated Financial Statements.

Page 9

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Basis of Presentation:

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

Operating results for the three month period ended March 31, 2015 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2014.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Form 10-K Annual Report of Hills Bancorporation and subsidiary (the “Company”) for the year ended December 31, 2014 filed with the Securities Exchange Commission on March 11, 2015.  The consolidated balance sheet as of December 31, 2014, has been derived from the audited consolidated financial statements for that period.

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

Effect of New Financial Accounting Standards:

In May 2014, The FASB and International Accounting Standards Board (IASB) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of ASU 2014-09 is that a company should recognize revenue to depict the transfer of promised good or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. For financial institutions, significant changes are not expected given that most financial instruments are not in the scope of the accounting standard update. ASU 2014-09 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. 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.

In April 2015, the FASB issued ASU No. 2015-05, Intangibles – Goodwill and Other Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement.  ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015.  The adoption of ASU 2015-05 by the Company is not expected to have a material impact.

Page 10

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 2. Earnings Per Share

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

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

	Three Months Ended March 31,
	2015			2014
Common shares outstanding at the beginning of the period	4,690,216			4,711,995
Weighted average number of net shares redeemed	(8,568		)	(1,502		)
Weighted average shares outstanding (basic)	4,681,648			4,710,493
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method	2,490			2,591
Weighted average number of shares (diluted)	4,684,138			4,713,084
Net income (In thousands)	$	7,380		$	6,744
Earnings per share:
Basic	$	1.58		$	1.43
Diluted	$	1.58		$	1.43

Note 3. Other Comprehensive Income (Loss)

The following table summarizes the balances of each component of accumulated other comprehensive income (AOCI), included in stockholders’ equity, at March 31, 2015 and December 31, 2014:

	March 31, 2015			December 31, 2014
	(amounts in thousands)
Net unrealized gain on available-for-sale securities	$	3,205		$	2,072
Net unrealized loss on derivatives used for cash flow hedges	(3,888		)	(2,796		)
Tax effect	261			276
Net-of-tax amount	$	(422	)	$	(448	)

Page 11

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 4. Securities

The carrying values of investment securities at March 31, 2015 and December 31, 2014 are summarized in the following table (dollars in thousands):

	March 31, 2015				December 31, 2014
	Amount		Percent		Amount		Percent
Securities available for sale
U.S. Treasury	$	22,569	8.68	%	$	22,333	8.62	%
Other securities (FHLB, FHLMC and FNMA)	65,951		25.38		67,691		26.14
State and political subdivisions	171,358		65.94		168,968		65.24
Total securities available for sale	$	259,878	100.00	%	$	258,992	100.00	%

Investment securities have been classified in the consolidated balance sheets according to management’s intent.  Available-for-sale securities consist of debt securities not classified as trading or held to maturity.  Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity.  There were no trading or held to maturity securities as of March 31, 2015 or December 31, 2014. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of March 31, 2015 and December 31, 2014 (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
March 31, 2015:
U.S. Treasury	$	22,362	$	207	$	—		$	22,569
Other securities (FHLB, FHLMC and FNMA)	65,693		294		(36		)	65,951
State and political subdivisions	168,618		2,921		(181		)	171,358
Total	$	256,673	$	3,422	$	(217	)	$	259,878
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

The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at March 31, 2015, were as follows (in thousands):

	Amortized Cost		Fair Value
Due in one year or less	$	41,404	$	41,510
Due after one year through five years	143,583		145,765
Due after five years through ten years	70,361		71,278
Due over ten years	1,325		1,325
Total	$	256,673	$	259,878

As of March 31, 2015 investment securities with a carrying value of $62.34 million were pledged to collateralize repurchase agreements, derivative financial instruments, and other borrowings.

Page 12

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The following table shows the fair value, gross unrealized losses and the percentage of fair value represented by gross unrealized losses of applicable investment securities owned by the Company, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2015 and December 31, 2014 (in thousands):

	Less than 12 months								12 months or more								Total
March 31, 2015 Description of Securities	#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%
U.S. Treasury	—	$	—	$	—		—	%	—	$	—	$	—		—	%	—	$	—	$	—		—	%
Other securities (FHLB, FHLMC and FNMA)	5	13,423		(36		)	0.27	%	—	—		—			—	%	5	13,423		(36		)	0.27	%
State and political subdivisions	66	14,617		(70		)	0.48	%	28	6,070		(111		)	1.83	%	94	20,687		(181		)	0.87	%
Total temporarily impaired securities	71	$	28,040	$	(106	)	0.38	%	28	$	6,070	$	(111	)	1.83	%	99	$	34,110	$	(217	)	0.64	%

	Less than 12 months								12 months or more								Total
December 31, 2014 Description of Securities	#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%		#	Fair Value		Unrealized Loss			%
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	%

The Company considered the following information in reaching the conclusion that the impairments disclosed in the table above are temporary and not other-than-temporary impairments.  None of the unrealized losses in the above table was due to the deterioration in the credit quality of any of the issues that might result in the non-collection of contractual principal and interest.  The unrealized losses are due to changes in interest rates.  The Company has not recognized any unrealized loss in income because management does not have the intent to sell the securities included in the previous table.  Management has concluded that it is more likely than not that the Company will not be required to sell these securities prior to recovery of the amortized cost basis.

Page 13

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans

Classes of loans are as follows:

	March 31, 2015		December 31, 2014
	(Amounts In Thousands)
Agricultural	$	88,574	$	97,645
Commercial and financial	180,392		174,738
Real estate:
Construction, 1 to 4 family residential	50,541		45,949
Construction, land development and commercial	76,003		77,020
Mortgage, farmland	169,058		162,503
Mortgage, 1 to 4 family first liens	678,054		672,674
Mortgage, 1 to 4 family junior liens	110,728		110,284
Mortgage, multi-family	243,441		245,213
Mortgage, commercial	321,216		321,601
Loans to individuals	21,003		21,342
Obligations of state and political subdivisions	55,160		55,729
	$	1,994,170	$	1,984,698
Net unamortized fees and costs	689		691
	$	1,994,859	$	1,985,389
Less allowance for loan losses	24,360		24,020
	$	1,970,499	$	1,961,369

Page 14

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Changes in the allowance for loan losses, the allowance for loan losses applicable to impaired loans and the related loan balance of impaired loans for the three months ended March 31, 2015 were as follows:

	Three Months Ended March 31, 2015
	Agricultural			Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	2,515		$	4,231		$	2,241		$	2,672	$	7,419		$	4,195		$	747		$	24,020
Charge-offs	(43		)	(66		)	(84		)	—		(347		)	(179		)	(48		)	(767		)
Recoveries	82			401			151			6		413			70			46			1,169
Provision	(10		)	(208		)	(58		)	99		(29		)	39			105			(62		)
Ending balance	$	2,544		$	4,358		$	2,250		$	2,777	$	7,456		$	4,125		$	850		$	24,360
Ending balance, individually evaluated for impairment	$	13		$	7		$	33		$	26	$	68		$	8		$	—		$	155
Ending balance, collectively evaluated for impairment	$	2,531		$	4,351		$	2,217		$	2,751	$	7,388		$	4,117		$	850		$	24,205
Loans:
Ending balance	$	88,574		$	180,392		$	126,544		$	169,058	$	788,782		$	564,657		$	76,163		$	1,994,170
Ending balance, individually evaluated for impairment	$	1,851		$	2,284		$	954		$	2,464	$	3,559		$	9,536		$	—		$	20,648
Ending balance, collectively evaluated for impairment	$	86,723		$	178,108		$	125,590		$	166,594	$	785,223		$	555,121		$	76,163		$	1,973,522

Page 15

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Changes in the allowance for loan losses for the three months ended March 31, 2014 were as follows:

	Three Months Ended March 31, 2014
	Agricultural			Commercial and Financial			Real Estate: Construction and land development			Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family			Real Estate: Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	2,852		$	4,733		$	2,918		$	2,557	$	7,064		$	4,787		$	639		$	25,550
Charge-offs	(100		)	(84		)	(2		)	—		(307		)	—			(33		)	$	(526	)
Recoveries	3			350			186			—		179			41			32			$	791
Provision	1,307			(480		)	(141		)	225		(315		)	(564		)	13			$	45
Ending balance	$	4,062		$	4,519		$	2,961		$	2,782	$	6,621		$	4,264		$	651		$	25,860
Ending balance, individually evaluated for impairment	$	3		$	14		$	14		$	—	$	58		$	208		$	—		$	297
Ending balance, collectively evaluated for impairment	$	4,059		$	4,505		$	2,947		$	2,782	$	6,563		$	4,056		$	651		$	25,563
Loans:
Ending balance	$	88,218		$	162,855		$	99,830		$	145,620	$	715,688		$	564,919		$	73,054		$	1,850,184
Ending balance, individually evaluated for impairment	$	274		$	2,669		$	1,285		$	284	$	4,011		$	17,662		$	—		$	26,185
Ending balance, collectively evaluated for impairment	$	87,944		$	160,186		$	98,545		$	145,336	$	711,677		$	547,257		$	73,054		$	1,823,999

Page 16

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The following table presents the credit quality indicators by type of loans in each category as of March 31, 2015 and December 31, 2014, respectively (amounts in thousands):

	Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial
March 31, 2015
Grade:
Excellent	$	1,270	$	4,428	$	—	$	271
Good	12,913		29,593		7,011		16,109
Satisfactory	37,680		107,829		30,039		44,116
Monitor	11,883		21,105		8,729		3,652
Special Mention	22,156		12,009		3,586		11,658
Substandard	2,672		5,428		1,176		197
Total	$	88,574	$	180,392	$	50,541	$	76,003

	Real Estate: Mortgage, farmland		Real Estate: Mortgage, 1 to 4 family first liens		Real Estate: Mortgage, 1 to 4 family junior liens		Real Estate: Mortgage, multi- family
March 31, 2015
Grade:
Excellent	$	2,701	$	464	$	—	$	6,925
Good	34,038		21,627		3,166		72,585
Satisfactory	105,477		575,973		99,103		111,397
Monitor	12,233		43,324		3,963		35,196
Special Mention	11,119		18,082		2,425		16,972
Substandard	3,490		18,584		2,071		366
Total	$	169,058	$	678,054	$	110,728	$	243,441

	Real Estate: Mortgage, commercial		Loans to individuals		Obligations of state and political subdivisions		Total
March 31, 2015
Grade:
Excellent	$	15,466	$	—	$	2,422	$	33,947
Good	82,434		95		42,677		322,248
Satisfactory	184,925		20,095		10,035		1,326,669
Monitor	22,407		340		—		162,832
Special Mention	10,076		287		26		108,396
Substandard	5,908		186		—		40,078
Total	$	321,216	$	21,003	$	55,160	$	1,994,170

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

	Agricultural		Commercial and Financial		Real Estate: Construction, 1 to 4 family residential		Real Estate: Construction, land development and commercial
December 31, 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
December 31, 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
December 31, 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 18

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

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 19

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Past due loans as of March 31, 2015 and December 31, 2014 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)
March 31, 2015
Agricultural	$	1,797	$	—	$	70	$	1,867	$	86,707	$	88,574	$	—
Commercial and financial	1,662		—		208		1,870		178,522		180,392		—
Real estate:
Construction, 1 to 4 family residential	276		—		199		475		50,066		50,541		—
Construction, land development and commercial	1,136		74		—		1,210		74,793		76,003		—
Mortgage, farmland	—		—		—		—		169,058		169,058		—
Mortgage, 1 to 4 family first liens	4,273		271		759		5,303		672,751		678,054		—
Mortgage, 1 to 4 family junior liens	172		16		—		188		110,540		110,728		—
Mortgage, multi-family	821		—		—		821		242,620		243,441		—
Mortgage, commercial	1,463		227		33		1,723		319,493		321,216		—
Loans to individuals	28		—		—		28		20,975		21,003		—
Obligations of state and political subdivisions	—		—		—		—		55,160		55,160		—
	$	11,628	$	588	$	1,269	$	13,485	$	1,980,685	$	1,994,170	$	—
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 20

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The Company does not have a material 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.

Certain impaired loan information by loan type at March 31, 2015 and December 31, 2014, was as follows:

	March 31, 2015						December 31, 2014
	Non-accrual loans (1)		Accruing loans past due 90 days or more		TDR loans		Non- accrual loans (1)		Accruing loans past due 90 days or more		TDR loans
	(Amounts In Thousands)						(Amounts In Thousands)
Agricultural	$	70	$	—	$	1,781	$	—	$	—	$	1,942
Commercial and financial	1,402		—		882		1,343		—		1,366
Real estate:
Construction, 1 to 4 family residential	503		—		326		—		—		431
Construction, land development and commercial	—		—		125		127		—		—
Mortgage, farmland	—		—		2,464		—		—		2,220
Mortgage, 1 to 4 family first liens	2,060		—		1,343		1,912		348		1,199
Mortgage, 1 to 4 family junior liens	129		—		27		369		—		—
Mortgage, multi-family	148		—		5,436		55		—		5,470
Mortgage, commercial	2,113		—		1,839		2,275		—		1,712
Loans to individuals	—		—		—		—		—		—
	$	6,425	$	—	$	14,223	$	6,081	$	348	$	14,340

(1) There were $2.07 million and $2.14 million of TDR loans included within nonaccrual loans as of March 31, 2015 and December 31, 2014, respectively.

Loans 90 days or more past due that are still accruing interest decreased $0.35 million from December 31, 2014 to March 31, 2015 due to a decrease in the number of loans past due greater than 90 days. As of March 31, 2015 there were no accruing loans past due 90 days or more. The average accruing loans past due 90 days or more as of December 31, 2014 was $0.07 million. The accruing loans past due 90 days or more balances are believed to be adequately collateralized and the Company expects to collect all principal and interest as contractually due under these loans.

The Company may modify the terms of a loan to maximize the collection of amounts due.  Such a modification is considered a troubled debt restructuring (“TDR”).  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 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 21

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Below is a summary of information for TDR loans as of March 31, 2015 and December 31, 2014:

	March 31, 2015					December 31, 2014
	Number of contracts	Recorded investment		Commitments outstanding		Number of contracts	Recorded investment		Commitments outstanding
		(Amounts In Thousands)					(Amounts In Thousands)
Agricultural	8	$	1,782	$	130	9	$	1,942	$	272
Commercial and financial	12	1,844		87		13	2,202		53
Real estate:
Construction, 1 to 4 family residential	3	499		11		3	431		111
Construction, land development and commercial	1	135		—		1	127		—
Mortgage, farmland	6	2,464		—		4	2,220		—
Mortgage, 1 to 4 family first liens	12	1,608		45		11	1,467		—
Mortgage, 1 to 4 family junior liens	1	27		—		1	225		65
Mortgage, multi-family	2	5,436		—		2	5,470		—
Mortgage, commercial	9	2,505		—		8	2,398		—
Loans to individuals	—	—		—		—	—		—
	54	$	16,300	$	273	52	$	16,482	$	501

The following is a summary of TDR loans that were modified during the three months ended March 31, 2015:

	Three Months Ended March 31, 2015
	Number of contracts	Pre-modification recorded investment		Post-modification recorded investment
		(Amounts In Thousands)
Agricultural	3	$	160	$	160
Commercial and financial	1	191		177
Real estate:
Construction, 1 to 4 family residential	—	—		—
Construction, land development and commercial	—	—		—
Mortgage, farmland	3	644		531
Mortgage, 1 to 4 family first lien	1	157		157
Mortgage, 1 to 4 family junior liens	1	27		27
Mortgage, multi-family	—	—		—
Mortgage, commercial	1	178		146
	10	$	1,357	$	1,198

Page 22

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The Company had commitments to lend $0.27 million in additional borrowings to restructured loan customers as of March 31, 2015.  The Company had commitments to lend $0.50 million in additional borrowings to restructured loan customers as of December 31, 2014.  These commitments were in the normal course of business.  The additional borrowings were not used to facilitate payments on these loans.

There were $0.26 million and $0.00 million of TDR loans that were in payment default (defined as past due 90 days or more) as of March 31, 2015 and December 31, 2014, respectively.  As of March 31, 2015, TDR loans in payment default consisted of a $0.17 million 1 to 4 family residential construction mortgage loan and a $0.09 million 1 to 4 family first lien real estate loan.

Page 23

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Information regarding impaired loans as of and for the three months ended March 31, 2015 is as follows:

	March 31, 2015						Three Months Ended   March 31, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:	(Amounts In Thousands)
Agricultural	$	1,683	$	1,709	$	—	$	1,576	$	18
Commercial and financial	1,678		3,197		—		1,724		4
Real estate:
Construction, 1 to 4 family residential	183		244		—		179		1
Construction, land development and commercial	125		220		—		126		1
Mortgage, farmland	2,332		2,445		—		2,354		28
Mortgage, 1 to 4 family first liens	3,089		3,769		—		3,175		12
Mortgage, 1 to 4 family junior liens	129		426		—		136		—
Mortgage, multi-family	5,584		5,677		—		5,609		61
Mortgage, commercial	3,259		4,735		—		3,363		15
Loans to individuals	—		20		—		—		—
	$	18,062	$	22,442	$	—	$	18,242	$	140
With an allowance recorded:
Agricultural	$	168	$	168	$	13	$	170	$	2
Commercial and financial	606		606		7		620		8
Real estate:
Construction, 1 to 4 family residential	646		658		33		646		2
Construction, land development and commercial	—		—		—		—		—
Mortgage, farmland	132		132		26		132		2
Mortgage, 1 to 4 family first liens	314		313		63		313		3
Mortgage, 1 to 4 family junior liens	27		27		5		27		—
Mortgage, multi-family	—		—		—		—		—
Mortgage, commercial	693		693		8		695		9
Loans to individuals	—		—		—		—		—
	$	2,586	$	2,597	$	155	$	2,603	$	26
Total:
Agricultural	$	1,851	$	1,877	$	13	$	1,746	$	20
Commercial and financial	2,284		3,803		7		2,344		12
Real estate:
Construction, 1 to 4 family residential	829		902		33		825		3
Construction, land development and commercial	125		220		—		126		1
Mortgage, farmland	2,464		2,577		26		2,486		30
Mortgage, 1 to 4 family first liens	3,403		4,082		63		3,488		15
Mortgage, 1 to 4 family junior liens	156		453		5		163		—
Mortgage, multi-family	5,584		5,677		—		5,609		61
Mortgage, commercial	3,952		5,428		8		4,058		24
Loans to individuals	—		20		—		—		—
	$	20,648	$	25,039	$	155	$	20,845	$	166

Page 24

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Information regarding impaired loans as of December 31, 2014 is as follows:

	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:	(Amounts In Thousands)
Agricultural	$	1,634	$	1,696	$	—
Commercial and financial	2,076		3,695		—
Real estate:
Construction, 1 to 4 family residential	89		89		—
Construction, land development and commercial	128		220		—
Mortgage, farmland	2,040		2,040		—
Mortgage, 1 to 4 family first liens	2,951		3,705		—
Mortgage, 1 to 4 family junior liens	369		673		—
Mortgage, multi-family	5,525		5,632		—
Mortgage, commercial	3,290		4,588		—
Loans to individuals	—		20		—
	$	18,102	$	22,358	$	—
With an allowance recorded:
Agricultural	$	210	$	247	$	44
Commercial and financial	633		633		9
Real estate:
Construction, 1 to 4 family residential	343		354		28
Construction, land development and commercial	—		—		—
Mortgage, farmland	278		278		12
Mortgage, 1 to 4 family first liens	506		596		52
Mortgage, 1 to 4 family junior liens	—		—		—
Mortgage, multi-family	—		—		—
Mortgage, commercial	697		697		9
Loans to individuals	—		—		—
	$	2,667	$	2,805	$	154
Total:
Agricultural	$	1,844	$	1,943	$	44
Commercial and financial	2,709		4,328		9
Real estate:
Construction, 1 to 4 family residential	432		443		28
Construction, land development and commercial	128		220		—
Mortgage, farmland	2,318		2,318		12
Mortgage, 1 to 4 family first liens	3,457		4,301		52
Mortgage, 1 to 4 family junior liens	369		673		—
Mortgage, multi-family	5,525		5,632		—
Mortgage, commercial	3,987		5,285		9
Loans to individuals	—		20		—
	$	20,769	$	25,163	$	154

Page 25

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Impaired loans decreased $0.12 million from December 31, 2014 to March 31, 2015.  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 Company expects to be unable to collect in full according to the contractual terms of the original loan agreement.  Impaired loans were 1.04% of loans held for investment as of March 31, 2015 and 1.05% as of December 31, 2014.  The decrease in impaired loans is due mainly to a decrease in accruing loans past due 90 days or more of $0.35 million from December 31, 2014 to March 31, 2015.

The Company regularly reviews a substantial portion of the loans in the portfolio and assesses whether the loans are impaired in accordance with ASC 310.  If the loans are impaired, the Company determines if a specific allowance is appropriate.  In addition, the Company'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 Company allocates a percentage, as determined by management, for a required allowance needed.  The determination of 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 restructured 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 recognizes a charge off related to an impaired loan if there is a collateral shortfall or it is unlikely the borrower can make all principal and interest payments as contractually due.

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.  In general, this is the amount that the carrying value of the loan exceeds the related appraised value less estimated costs to sell the collateral.  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 an additional charge off or specific reserve based on the applicable facts and circumstances.  In instances where there is an estimated decline in value, a specific reserve 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 specific reserve 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.

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(Unaudited)

Note 6. Fair Value Measurements

The carrying value and estimated fair values of the Company's financial instruments as of March 31, 2015 are as follows:

	March 31, 2015
	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	$	83,345	$	83,345	$	83,345	$	—	$	—
Investment securities	268,324		268,324		—		268,324		—
Loans held for sale	8,311		8,311		—		8,311		—
Loans
Agricultural	86,030		86,067		—		—		86,067
Commercial and financial	176,034		176,493		—		—		176,493
Real estate:
Construction, 1 to 4 family residential	49,679		49,317		—		—		49,317
Construction, land development and commercial	74,615		73,978		—		—		73,978
Mortgage, farmland	166,281		167,086		—		—		167,086
Mortgage, 1 to 4 family first liens	671,734		674,531		—		—		674,531
Mortgage, 1 to 4 family junior liens	109,592		115,978		—		—		115,978
Mortgage, multi-family	241,971		244,840		—		—		244,840
Mortgage, commercial	318,561		318,022		—		—		318,022
Loans to individuals	20,594		20,560		—		—		20,560
Obligations of state and political subdivisions	54,719		54,394		—		—		54,394
Accrued interest receivable	9,102		9,102		—		9,102		—
Total financial instrument assets	$	2,338,892	$	2,350,348	$	83,345	$	285,737	$	1,981,266
Financial instrument liabilities
Deposits
Noninterest-bearing deposits	$	280,432	$	280,432	$	—	$	280,432	$	—
Interest-bearing deposits	1,626,903		1,629,897		—		1,629,897		—
Other borrowings	40,928		40,928		—		40,928		—
Federal Home Loan Bank borrowings	140,000		144,697		—		144,697		—
Interest rate swaps	3,888		3,888		—		3,888		—
Accrued interest payable	859		859		—		859		—
Total financial instrument liabilities	$	2,093,010	$	2,100,701	$	—	$	2,100,701	$	—
	Face Amount
Financial instrument with off-balance sheet risk:
Loan commitments	$	386,613	$	—	$	—	$	—	$	—
Letters of credit	9,582		—		—		—		—
Total financial instrument liabilities with off-balance-sheet risk	$	396,195	$	—	$	—	$	—	$	—

(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.

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(Unaudited)

(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.

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 swaps	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 ASC 820.

(2) Considered Level 2 under ASC 820.

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(Unaudited)

(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.

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. 

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 three months ended March 31, 2015.   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.

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(Unaudited)

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 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.

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 cost 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.

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).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

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:

	March 31, 2015
	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	$	—	$	22,569		$	—	$	22,569
State and political subdivisions	—		171,358			—		171,358
Other securities (FHLB, FHLMC and FNMA)	—		65,951			—		65,951
Derivative Financial Instruments
Interest rate swaps	$	—	(3,888		)	$	—	(3,888		)
Total	$	—	$	255,990		$	—	$	255,990

	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

(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 three months ended March 31, 2015 and the year ended December 31, 2014.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

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.    The following tables present the Company’s assets that are measured at fair value on a nonrecurring basis.

	March 31, 2015								Three Months Ended March 31, 2015
	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	$	—	$	—	$	1,733	$	1,733	$	—
Commercial and financial	—		—		1,402		1,402		—
Real Estate:
Construction, 1 to 4 family residential	—		—		639		639		61
Construction, land development and commercial	—		—		—		—		—
Mortgage, farmland	—		—		2,438		2,438		—
Mortgage, 1 to 4 family first liens	—		—		2,781		2,781		254
Mortgage, 1 to 4 family junior liens	—		—		150		150		—
Mortgage, multi-family	—		—		5,584		5,584		38
Mortgage, commercial	—		—		2,091		2,091		140
Loans to individuals	—		—		—		—		—
Foreclosed assets (5)	—		—		698		698		30
Total	$	—	$	—	$	17,516	$	17,516	$	523

(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.

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(Unaudited)

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis (continued)

	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.

Note 7. Stock Repurchase Program

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 Company has purchased 401,075 shares of its common stock in privately negotiated transactions from August 1, 2005 through March 31, 2015.  Of these 401,075 shares, 2,364 shares were purchased during the quarter ended March 31, 2015, at an average price per share of $82.83.

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(Unaudited)

Note 8. 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 $90.98 million.  The concentrations of credit by type of loan are set forth in Note 5 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.  While the ultimate outcome of such legal proceedings cannot be predicted with certainty, after reviewing pending and threatened litigation with counsel, management believes at this time that the outcome of such litigation will not have a material adverse effect on the Company's business, financial condition or results of operations.

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.

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 March 31, 2015 and December 31, 2014 is as follows:

	March 31, 2015		December 31, 2014
	(Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:
Home equity loans	$	41,478	$	40,484
Credit cards	47,873		46,573
Commercial, real estate and home construction	114,570		81,613
Commercial lines and real estate purchase loans	182,692		165,430
Outstanding letters of credit	9,582		12,437

Note 9. Income Taxes

Federal income tax expense for the three months ended March 31, 2015 and 2014 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 State of Iowa purposes.  The tax years ended December 31, 2014, 2013, and 2012 remain subject to examination by the Internal Revenue Service.  For state tax purposes, the tax years ended December 31, 2014, 2013, and 2012 remain open for examination.  There were no material unrecognized tax benefits at March 31, 2015  and December 31, 2014 and therefore no interest or penalties on unrecognized tax benefits has been recorded.  As of March 31, 2015, the Company does not anticipate any significant increase in unrecognized tax benefits during the twelve-month period ending March 31, 2016.

Income taxes as a percentage of income before taxes were 29.26% for the three months ended March 31, 2015 and 26.16% for the same period in 2014.  The increase in the effective tax rate is due to a decrease in the amount of low-income housing tax credits earned by the Company in 2015.

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(Unaudited)

Note 10. 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 financial statement 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 outlining 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 $1.50 million of collateral as of March 31, 2015.

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 hedges as of March 31, 2015 and December 31, 2014:

	Notional Amount		Fair Value			Balance Sheet Category	Maturity
	(Amounts in Thousands)
March 31, 2015
Interest rate swap	$	25,000	$	(1,340	)	Other Liabilities	11/9/2020
Interest rate swap	25,000		(2,548		)	Other Liabilities	11/7/2023
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

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The table below identifies the gains and losses recognized on the Bank’s derivative instruments designated as cash flow hedges as of March 31, 2015 and December 31, 2014:

	Effective Portion						Ineffective Portion
	Recognized in OCI			Reclassifed 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)
March 31, 2015
Interest rate swap	$	(294	)	Interest Expense	$	—	Other Income	$	—
Interest rate swap	(380		)	Interest Expense	—		Other Income	—
December 31, 2014
Interest rate swap	$	(754	)	Interest Expense	$	—	Other Income	$	—
Interest rate swap	(1,448		)	Interest Expense	—		Other Income	—

Note 11. Subsequent Events

On March 24, 2015, the Board of Directors of Hills Bancorporation approved an amendment (the "Amendment") to the Company's Restated Articles of Incorporation (the "Articles") to increase the number of shares of stock that the Company is authorized to issue from 10,000,000 shares of common stock, no par value, to 20,000,000 shares of common stock, no par value. The Amendment was adopted by the Board in order to effect a two-for-one split of each issued and unissued share of the Company's common stock (the "Stock Split"). The Board of Directors determined that one additional share of common stock will be issued to shareholders of record as of the close of business on April 27, 2015 (the "Record Date") for each share held thereby on the Record date, which shares shall be paid on May 4, 2015. Articles of Amendment to the Restated Articles of Incorporation were filed with the Iowa Secretary of State to effect the Amendment on April 8, 2015.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion and analysis of the financial condition of Hills Bancorporation (“Hills Bancorporation” or “the Company”) and its banking subsidiary Hills Bank and Trust Company (“the Bank”) for the dates and periods indicated.  The discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying footnotes.

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:

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HILLS BANCORPORATION

• 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 recent financial market disruptions, and monetary and other governmental actions designed to address such disruptions.

• 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.

• 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.

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HILLS BANCORPORATION

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's allowance for loan losses 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 the general economic environment in the Company's markets, including

economic conditions throughout the Midwest and the state of certain industries.  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.  Size and complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. 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 as of March 31, 2015 and December 31, 2014 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.

Overview

This overview highlights selected information and may not contain all of the information that is important to you in understanding our performance during the period.  For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates, you should carefully read this entire report.

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 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.  At March 31, 2015, the Bank has seventeen full-service locations.

Net income for the three month period ended March 31, 2015 was $7.38 million compared to $6.74 million for the same three months of 2014, an increase of 9.43%.  The $0.64 million increase in net income was caused by a number of factors.  The principal factors in the increase in net income for the first three months of 2015 are an increase in net interest income of $1.56 million, an increase in noninterest income of $0.57 million and a decrease in the provision for loan losses of $0.11 million.  These changes were offset by an increase in income tax expense of $0.66 million and an increase in noninterest expenses of $0.94 million.

The Company achieved a return on average assets of 1.22% and a return on average equity of 11.02% for the twelve months ended March 31, 2015, compared to the twelve months ended March 31, 2014, which were 1.22% and 10.94%, respectively.  Dividends of $1.25 per share were paid in January 2015 to 2,284 shareholders.  The 2014 dividend was $1.15 per share.

The Company’s net interest income is the largest component of revenue and it is primarily a function of the average earning assets and the net interest margin percentage.  The Company achieved a net interest margin on a tax-equivalent basis of 3.50% for the three months ended March 31, 2015 compared to 3.47% for the same three months of 2014.  Average earning assets were $2.234 billion in 2015 and $2.066 billion in 2014.

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HILLS BANCORPORATION

Highlights noted on the balance sheet as of March 31, 2015 for the Company included the following:

• Total assets were $2.407 billion, an increase of $72.94 million since December 31, 2014.

• Cash and cash equivalents were $83.35 million, an increase of $54.17 million since December 31, 2014.

• Net loans were $1.979 billion, an increase of $12.97 million since December 31, 2014.  Loans held for sale increased $3.84 million since December 31, 2014.

• Deposit growth of $72.27 million since December 31, 2014.  Deposit growth included approximately $78.00 million of temporary public funds.

Reference is made to Note 6 for a discussion of fair value measurements which relate to methods used by the Company in recording assets and liabilities on its financial statements.

Financial Condition

The following table sets forth the composition of the loan portfolio as of March 31, 2015 and December 31, 2014:

	March 31, 2015				December 31, 2014
	Amount		Percent		Amount		Percent
	(Amounts In Thousands)				(Amounts In Thousands)
Agricultural	$	88,574	4.44	%	$	97,645	4.92	%
Commercial and financial	180,392		9.05		174,738		8.80
Real estate:
Construction, 1 to 4 family residential	50,541		2.53		45,949		2.32
Construction, land development and commercial	76,003		3.81		77,020		3.88
Mortgage, farmland	169,058		8.48		162,503		8.19
Mortgage, 1 to 4 family first liens	678,054		34.00		672,674		33.89
Mortgage, 1 to 4 family junior liens	110,728		5.55		110,284		5.56
Mortgage, multi-family	243,441		12.21		245,213		12.36
Mortgage, commercial	321,216		16.11		321,601		16.20
Loans to individuals	21,003		1.05		21,342		1.08
Obligations of state and political subdivisions	55,160		2.77		55,729		2.81
	$	1,994,170	100.00	%	$	1,984,698	100.00	%
Net unamortized fees and costs	689				691
	$	1,994,859			$	1,985,389
Less allowance for loan losses	24,360				24,020
	$	1,970,499			$	1,961,369

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HILLS BANCORPORATION

Loan demand has been steady and is expected to remain steady or increase throughout the year ending December 31, 2015 and into 2016.  As indicated above growth in the commercial and financial, construction and 1 to 4 family real estate loans have been primarily responsible for the increase in total loans.  Management expects overall portfolio loan growth to increase as a result of general improvement in market conditions resulting in increased loan demand.

The Bank has an established formal loan origination policy.  In general, the loan origination policy attempts to reduce the risk of credit loss to the Bank by requiring, among other things, maintenance of minimum loan to value ratios, evidence of appropriate levels of insurance carried by borrowers and documentation of appropriate types and amounts of collateral and sources of expected payment.  The collateral relied upon in the loan origination policy is generally the property being financed by the Bank.  The source of expected payment is generally the income produced from the property being financed.  Personal guarantees are required of individuals owning or controlling at least 20% of the ownership of an entity.  Limited or proportional guarantees may be accepted in circumstances if approved by the Company’s Board of Directors.  Financial information provided by the borrower is verified as considered necessary by reference to tax returns, or audited, reviewed or compiled financial statements.  The Bank does not originate subprime loans.  In order to modify, restructure or otherwise change the terms of a loan, the Bank’s policy is to evaluate each borrower situation individually.  Modifications, restructures, extensions and other changes are done to improve the Bank’s position and to protect the Bank’s capital.  If a borrower is not current with its payments, any additional loans to such borrowers are evaluated on an individual borrower basis.

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.

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 non-accrual 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 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 the Company determines 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 actual losses.

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HILLS BANCORPORATION

The following table presents the allowance for loan losses on loans by type of loans and the percentage in each category to total loans as of March 31, 2015 and December 31, 2014:

	March 31, 2015						December 31, 2014
	Amount		% of Total Allowance		% of Loans to Total Loans		Amount		% of Total Allowance		% of Loans to Total Loans
	(In Thousands)						(In Thousands)
Agricultural	$	2,544	10.44	%	4.44	%	$	2,515	10.47	%	4.92	%
Commercial and financial	4,358		17.89		9.05		4,231		17.61		8.80
Real estate:
Construction, 1 to 4 family residential	862		3.54		2.53		810		3.37		2.32
Construction, land development and commercial	1,388		5.70		3.81		1,431		5.96		3.88
Mortgage, farmland	2,777		11.40		8.48		2,672		11.12		8.19
Mortgage, 1 to 4 family first liens	6,320		25.95		34.00		6,268		26.11		33.88
Mortgage, 1 to 4 family junior liens	1,136		4.66		5.55		1,151		4.79		5.56
Mortgage, multi-family	1,470		6.03		12.21		1,490		6.20		12.36
Mortgage, commercial	2,655		10.90		16.11		2,705		11.26		16.20
Loans to individuals	409		1.68		1.05		299		1.24		1.08
Obligations of state and political subdivisions	441		1.81		2.77		448		1.87		2.81
	$	24,360	100.00	%	100.00	%	$	24,020	100.00	%	100.00	%

The allowance for loan losses totaled $24.36 million at March 31, 2015 compared to $24.02 million at December 31, 2014.  The percentage of the allowance to outstanding loans was 1.22% and 1.21% at March 31, 2015 and December 31, 2014, respectively.  The allowance was based on management’s consideration of a number of factors, including composition of the loan portfolio, loans with higher credit risks and the overall amount of loans outstanding.  The increase in the allowance in 2015 is the result of a change in the composition and allocation of loans within credit quality ratings.

The adequacy of the allowance is reviewed quarterly and adjusted as appropriate after consideration has been given to 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. The growth of the loan portfolio and the trends in problem and watch loans are significant elements in the determination of the provision for loan losses.  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 restructured loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates.

Management has determined that the allowance for loan losses was appropriate at March 31, 2015, 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, well documented, and consistently 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 data. This review encompasses levels of total impaired loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs.

Residential real estate loan products that include features such as loan-to-values in excess of 100% or interest only payments, which expose a borrower to payment increases in excess of changes in the market interest rate, increase the credit risk of a loan.  The Bank has not offered and does not intend to offer this type of loan product.

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HILLS BANCORPORATION

Investment securities available for sale held by the Company increased by $0.89 million from December 31, 2014 to March 31, 2015.  The fair value of securities available for sale was $3.21 million more than the amortized cost of such securities as of March 31, 2015.  At December 31, 2014, the fair value of the securities available for sale was $2.07 million more than the amortized cost of such securities.

Deposit growth was $72.27 million in the first three months of 2015. Repurchase agreements decreased $0.35 million since December 31, 2014.  In the opinion of the Company’s management, the Company continues to have sufficient liquidity resources available to fund expected additional loan growth.

Brokered deposits are included in total deposits and totaled $66.19 million as of March 31, 2015 with an average rate of 0.39%.  Brokered deposits were $64.49 million as of December 31, 2014 with an average interest rate of 0.39%.  As of March 31, 2015 and December 31, 2014, brokered deposits were 3.47% and 3.51% of total deposits, respectively.

Dividends and Equity

In January 2015, Hills Bancorporation paid a dividend of $5.85 million or $1.25 per share.  The dividend was $1.15 per share in January 2014.  After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of March 31, 2015 totaled $256.58 million. On January 1, 2015, the final rules of the Federal Reserve Board went into effect implementing in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Under the final rule, minimum requirements increased for both the quality and quantity of capital held by banking organizations. The rule requires a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.50% and a common equity tier 1 capital conservation buffer of 2.50% of risk-weighted assets that will apply to all supervised financial institutions. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4.00% to 6.00% and includes a minimum leverage ratio of 4.00% for all banking organizations.

The Company continues to be well-capitalized in accordance with Federal regulatory capital requirements as the capital ratios below show:

	March 31, 2015
Common equity tier 1 capital ratio	14.51	%
Tier 1 capital ratio	14.51	%
Total capital ratio	15.73	%
Leverage ratio	12.40	%

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HILLS BANCORPORATION

Discussion of operations for the three months ended March 31, 2015 and 2014

Net Income Overview

Net income increased $0.64 million for the three months ended March 31, 2015 compared to the first three months of 2014.  Total net income was $7.38 million in March 2015 and $6.74 million in the comparable period in 2014, an increase of 9.43%.  The changes in net income in 2015 from the first three months of 2014 were primarily the result of the following:

• Net interest income increased by $1.56 million, before provision expense, as a result of growth in the volume of earning assets and reductions in interest expense.

• The provision for loan losses decreased by $0.11 million.

• Noninterest income increased by $0.57 million.

• Noninterest expenses increased by $0.94 million.

• Income tax expense increased by $0.66 million.

For the three month period ended March 31, 2015 and March 31, 2014 basic earning per share was $1.58 and $1.43, respectively. Diluted earnings per share was $1.58 for the three months ended March 31, 2015 compared to $1.43 for the same period in 2014.

The Company’s net income continues to be driven primarily by three important factors.  The first important factor is the interaction between changes in net interest margin and changes in average volumes of the Bank's earnings assets.  Net interest income of $18.58 million for the first three months of 2015 was derived from the Company’s $2.234 billion of average earning assets during that period and its tax-equivalent net interest margin of 3.50%.  Average earning assets in the three months ended March 31, 2014 were $2.066 billion and the tax-equivalent net interest margin was 3.47%.  The importance of net interest margin is illustrated by the fact that an increase or decrease in the net interest margin of 10 basis points would have resulted approximately in a $0.56 million change in income before income taxes in the three month period ended March 31, 2015.  Net interest income for the Company increased as a result of growth in the volume of earning assets and a decrease in net interest expense due to the mix of interest bearing liabilities of the Company as well as a reduction in dollar amount and rate on time deposits.  The Company expects net interest compression to continue to impact earnings for the foreseeable future.  The Company believes growth in net interest income will be contingent on the growth of the Company’s earnings assets.

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 more than $1.979 billion at March 31, 2015.  The 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 factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more.  In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historically higher credit risk.  The provision for loan losses was a reduction of expense of $0.06 million in 2015 compared to an expense of $0.05 million in 2014.  The Company believes that the provision for loan losses will remain stable for the foreseeable future resulting from projected increases in the size of the Company’s loan portfolio offset by continued improvement in credit quality.

The third significant factor affecting the Company’s net income is income tax expense.  Federal and state income tax expenses were $3.05 million and $2.39 million for the three months ended March 31, 2015 and 2014, respectively.  Income taxes as a percentage of income before taxes were 29.26% in 2015 and 26.16% in 2014.

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Discussion of operations for the three months ended March 31, 2015 and 2014

Net Interest Income

Net interest income increased for the three months ended March 31, 2015 compared to the comparable period in 2014.  The increase was as a result of growth in the volume of earning assets and a decrease in net interest expense due to the mix of interest bearing liabilities of the Company as well as a reduction in dollar amount and rate on time deposits.  Net interest income is the excess of the interest and fees earned on interest-earning bearing assets over the interest expense of the interest-bearing liabilities.  The factors that have the greatest impact on net interest income are the average volume of earning assets for the period and the net interest margin.  The net interest margin for the first three months of 2015 was 3.50% compared to 3.47% in 2014 for the same period.  The measure is shown on a tax-equivalent basis using a tax rate of 35% to make the interest earned on taxable and non-taxable assets more comparable.  The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the three months ended in 2015 compared to the comparable period in 2014 are shown in the following table:

						Increase (Decrease) in Net Interest Income
	Change in Average Balance			Change in Average Rate		Volume Changes			Rate Changes			Net Change
	(Amounts in Thousands)
Interest income:
Loans, net	$	156,860		(0.08	)%	$	2,347		$	(983	)	$	1,364
Taxable securities	477			0.06		8			8			16
Nontaxable securities	18,597			(0.37	)	162			(151		)	11
Federal funds sold	(7,689		)	—		(5		)	—			(5		)
	$	168,245				$	2,512		$	(1,126	)	$	1,386
Interest expense:
Interest-bearing demand deposits	$	62,046		(0.02	)%	$	(25	)	$	23		$	(2	)
Savings deposits	50,323			(0.03	)	(27		)	46			19
Time deposits	(21,326		)	(0.17	)	81			207			288
Other borrowings	8,300			(0.03	)	(13		)	10			(3		)
FHLB borrowings	11,935			(0.16	)	(132		)	56			(76		)
Interest-bearing other liabilities	(53		)	1.71		(1		)	(10		)	(11		)
	$	111,225				$	(117	)	$	332		$	215
Change in net interest income						$	2,395		$	(794	)	$	1,601

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 on a tax-equivalent basis.

A summary of the net interest spread and margin is as follows:

(Tax Equivalent Basis)	2015		2014
Yield on average interest-earning assets	4.16	%	4.22	%
Rate on average interest-bearing liabilities	0.84		0.95
Net interest spread	3.32	%	3.27	%
Effect of noninterest-bearing funds	0.18		0.20
Net interest margin (tax equivalent interest income divided by average interest-earning assets)	3.50	%	3.47	%

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HILLS BANCORPORATION

Discussion of operations for the three months ended March 31, 2015 and 2014

In pricing loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates.  The Federal Open Market Committee met two times during the first three months of 2014.  The target rate remains unchanged since December 31, 2008 at 0.25%.  Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally increase or decrease when the Federal Reserve Board raises or lowers the federal funds rate.  As of March 31, 2015, the rate indexes for the one, three and five year indexes were 0.26%, 0.94% and 1.42%, respectively.  The one year index increased 85.71% from 0.14% at March 31, 2014, the three year index increased 10.59% and the five year index decreased 14.97%.  The three year index was 0.85% and the five year index was 1.67% at March 31, 2014.  The targeted federal funds rate was 0.25% at March 31, 2015 and 2014.  The Company anticipates possible increases in short term and long term rates in the indexes for 2015.

Provision for Loan Losses

The provision for loan losses was a reduction of expense of $0.06 million in 2015 compared to an expense of $0.05 million in 2014, an expense reduction of $0.11 million.  The loan loss provision is the amount necessary to adjust the allowance for loan losses to the level considered by management to appropriately account for the estimated impairment to the Bank's loan portfolio.  The provision expense taken to fund the allowance for loan losses 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 factors, including the size 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.  In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historical higher credit risks.  The decrease in expense in 2015 is the result of a change in the composition and allocation of loans within credit quality ratings.

The allowance for loan losses increased $0.34 million during the first three months of 2015.  In the first three months of 2015, there was a decrease of $0.35 million due to the volume and composition of loans outstanding and a $0.69 million increase in the amount allocated to the allowance due to a combination of credit quality improvements.

The allowance for loan losses balance is affected by charge-offs, net of recoveries, for the periods presented.  For the three months ended March 31, 2015 and 2014, recoveries were $1.17 million and $0.79 million, respectively; and charge-offs were $0.77 million in 2015 and $0.53 million in 2014.  The allowance for loan losses totaled $24.36 million at March 31, 2015 compared to $24.02 million at December 31, 2014.  The allowance represented 1.22% and 1.21% of loans held for investment at March 31, 2015 and December 31, 2014.

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HILLS BANCORPORATION

Discussion of operations for the three months ended March 31, 2015 and 2014

Noninterest Income

The following table sets forth the various categories of noninterest income for the threemonths ended March 31, 2015 and 2014.

	Three Months Ended March 31,
	2015		2014		$ Change			% Change
	(Amounts in thousands)
Net gain on sale of loans	$	308	$	111	$	197		177.48	%
Trust fees	1,569		1,460		109			7.47
Service charges and fees	1,946		1,837		109			5.93
Rental revenue on tax credit real estate	511		357		154			43.14
Net gain on sale of other real estate owned and other repossessed assets	7		72		(65		)	(90.28	)
Other noninterest income	649		584		65			11.13
	$	4,990	$	4,421	$	569		12.87

Loans originated for sale in the first threemonths of 2015 totaled $40.58 million compared to $16.52 million in the same period in 2014, an increase of 145.64%.  In the three months ended March 31, 2015 and 2014, the net gain on sale of loans was $0.31 million and $0.11 million, respectively.  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 believes residential mortgage interest rates will continue to rise for the foreseeable future resulting in decreased net gain on sale of loan income.

The net gain on sale of other real estate owned and other repossessed assets decreased $0.65 million to a net gain of $0.01 million for the three months ended March 31, 2015.  The total net gain on sale of other real estate owned for the three months ended consisted of a $0.04 million net gain on the sale of 3 properties offset by a $0.03 million fair market value adjustment on 3 properties.  During the same period in 2014, the gain consisted of a $0.09 million net gain on sale of 3 properties offset by a $0.02 million fair market value adjustment on one property.

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HILLS BANCORPORATION

Discussion of operations for the three months ended March 31, 2015 and 2014

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the three months ended March 31, 2015 and 2014.

	Three Months Ended March 31,
	2015		2014		$ Change			% Change
	(Amounts in thousands)
Salaries and employee benefits	$	6,651	$	6,257	$	394		6.30	%
Occupancy	1,015		1,009		6			0.59
Furniture and equipment	1,298		1,231		67			5.44
Office supplies and postage	441		382		59			15.45
Advertising and business development	774		628		146			23.25
Outside services	1,814		1,535		279			18.18
Rental expenses on tax credit real estate	602		530		72			13.58
FDIC insurance assessment	289		270		19			7.04
Other noninterest expense	315		416		(101		)	(24.28	)
	$	13,199	$	12,258	$	941		7.68

Advertising and business development expense increased $0.15 million in the first three months of 2015 compared to 2014 as a result of $0.08 million in business and product promotions and $0.03 million in debit card reward expenses. Outside services expenses increased $0.28 million in the first three months of 2015 from their level for the comparable period in 2014.  Credit and debit card processing increased $0.05 million, data processing expense increased $0.03 million and online banking expense increased $0.07 million.  Most other noninterest expense categories experienced marginal period-to-period fluctuations for the three months ended March 31, 2015.

Income Taxes

Federal and state income tax expenses were $3.05 million and $2.39 million for the three months ended March 31, 2015 and 2014, respectively.  Income taxes as a percentage of income before taxes were 29.26% in 2015 and 26.16% in 2014.

Liquidity

The Company actively monitors and manages its liquidity position with the objective of maintaining sufficient cash flows to fund operations, meet client commitments, take advantage of market opportunities and provide a margin against unforeseeable liquidity needs.  Federal funds sold and investment securities available for sale are readily marketable assets.  Maturities of all investment securities are managed to meet the Company’s normal liquidity needs, to respond to market changes or to adjust the Company’s interest rate risk position.  Investment securities available for sale comprised 10.80% of the Company’s total assets at March 31, 2015 compared to 11.09% at December 31, 2014.

The Company has historically maintained a stable deposit base and a relatively low level of large deposits, which has mitigated the volatility in the Company’s liquidity position.  As of March 31, 2015, the Company had borrowed $140.00 million from the Federal Home Loan Bank (“FHLB”) of Des Moines.  Advances are used as a means of providing both long and short-term, fixed-rate funding for certain assets and for managing interest rate risk.  The Company had additional borrowing capacity available from the FHLB of approximately $477.02 million at March 31, 2015.

As additional sources of liquidity, the Company has the ability to borrow up to $10.00 million from the Federal Reserve Bank of Chicago, and has lines of credit with three banks totaling $208.64 million.  The borrowings under these credit lines would be secured by the Bank’s investment securities.  The combination of high levels of potentially liquid assets, low dependence on volatile liabilities and additional borrowing capacity provided sources of liquidity for the Company which management considered sufficient at March 31, 2015.

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HILLS BANCORPORATION

As of March 31, 2015, investment securities with a carrying value of $62.34 million were pledged to collateralize public and trust deposits, repurchase agreements, derivative financial instruments, and other borrowings.  As of December 31, 2014, investment securities with a carrying value of $68.12 million were pledged.

Contractual Obligations

There have been no material changes with regard to contractual obligations disclosed in the Company’s Form 10-K for the year ended December 31, 2014.

Item 3. 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 indicates 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.

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 Bank's interest rate risk, as monitored by management, has not changed materially from December 31, 2014.

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HILLS BANCORPORATION

Item 4. Controls and Procedures

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) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, as of the end of the period covered by this report, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports it files with the Securities and Exchange Commission.  There have been no changes in the Company’s internal controls over financial reporting during the three months ended March 31, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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HILLS BANCORPORATION

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

In the normal course of business, the Company and its subsidiaries are subject to pending and threatened legal actions, some of which seek substantial relief or damages.  While the ultimate outcome of such legal proceedings cannot be predicted with certainty, after reviewing pending and threatened litigation with counsel, management believes at this time that the outcome of such litigation will not have a material adverse effect on the Company’s business, financial condition or results of operations.

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 1A. Risk Factors

There have been no material changes from the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, 2014.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth information about the Company’s stock purchases, all of which were made pursuant to the 2005 Stock Repurchase Program, for the three months ended March 31, 2015:

Period	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 (1)
January 1 to January 31	1,269	$	82.50	399,980	350,020
February 1 to February 28	565	82.50		400,545	349,455
March 1 to March 31	530	83.50		401,075	348,925
Total	2,364	$	82.83	401,075	348,925

(1)  On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to 750,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  The Company’s Board of Directors 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.  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 Board reviews the overall results of the 2005 Stock Repurchase Program on a quarterly basis.

During the first three months of 2014, the Company issued 146 shares of restricted stock under the 2010 Stock Option and Incentive Plan.  The restricted shares were issued to officers of the company for no cash consideration and will vest over a five-year period from the date of grant.  The issuance of these shares was exempt from the registration requirements of the SEC pursuant to Section 4(2) of the Securities Act of 1933.

Item 3. Defaults upon Senior Securities

Hills Bancorporation has no senior securities.

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

None

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Item 6. Exhibits

3.1	Restated Articles of Incorporation of Hills Bancorporation, as amended.
3.2	Amended and Restated By-laws of Hills Bancorporation, incorporated by reference to Exhibit 3.2 to the Company’s Form 10-K filed with the Commission on March 11, 2015.
31	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002
32	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document (1)
101.SCH	XBRL Taxonomy Extension Schema Document (1)
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document (1)
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document (1)
101.LAB	XBRL Taxonomy Extension Label Linkbase Document (1)
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document (1)

(1) Users of this data are advised that, pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and are otherwise not subject to liability under these sections.

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SIGNATURES

Pursuant to the requirements 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:	May 6, 2015	By:  /s/ Dwight O. Seegmiller
		Dwight O. Seegmiller, Director, President and Chief Executive Officer
Date:	May 6, 2015	By:  /s/ Shari DeMaris
		Shari DeMaris, Secretary, Treasurer and Chief Accounting Officer

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HILLS BANCORPORATION

QUARTERLY REPORT OF FORM 10-Q FOR THE

QUARTER ENDED MARCH 31, 2015

Exhibit Number	Description	Page Number In The Sequential Numbering System March 31, 2015 Form 10-Q
3.1	Restated Articles of Incorporation of Hills Bancorporation, as amended	55-67
31	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002	68-69
32	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002	70

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