UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2023

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from  ___________ to ___________

Commission file number:  0-12668

Hills Bancorporation

(State or other jurisdiction of incorporation or organization)	I.R.S. Employer Identification No.
Iowa	42-1208067

131 MAIN STREET, HILLS, Iowa 52235

Telephone number: (319) 679-2291

Securities registered pursuant to Section 12(b) of the Act:

Title of each class Trading Symbol(s) Name of each exchange on which registered

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. ☑ Yes  ☐ No

Indicate by checkmark whether the Registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). ☑ Yes  ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated Filer	☑
Non-accelerated filer	☐	Small Reporting Company	☐
Emerging Growth Company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes  ☑ No

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

		SHARES OUTSTANDING
CLASS		October 31, 2023
Common Stock	No par value	9,144,899

HILLS BANCORPORATION

Index to Form 10-Q

Part I

FINANCIAL INFORMATION

		Page
		Number
Item 1.	Financial Statements
	Consolidated balance sheets, September 30, 2023 (unaudited) and December 31, 2022	4
	Consolidated statements of income (unaudited) for three and nine months ended September 30, 2023 and 2022	5
	Consolidated statements of comprehensive income (loss) (unaudited) for three and nine months ended September 30, 2023 and 2022	6
	Consolidated statements of stockholders' equity (unaudited) for three and nine months ended September 30, 2023 and 2022	7
	Consolidated statements of cash flows (unaudited) for nine months ended September 30, 2023 and 2022	9
	Notes to consolidated financial statements (condensed)	11
Item 2.	Management Discussion and Analysis of Financial Condition and Results of Operations	54
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	71
Item 4.	Controls and Procedures	72
	Part II
	OTHER INFORMATION
Item 1.	Legal proceedings	72
Item 1A.	Risk factors	72
Item 2.	Unregistered sales of equity securities and use of proceeds	74
Item 3.	Defaults upon senior securities	75
Item 4.	Mine safety disclosures	75
Item 5.	Other information	75
Item 6.	Exhibits	76
	Signatures	77

Page 3

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

	September 30, 2023		December 31, 2022
ASSETS	(Unaudited)
Cash and cash equivalents	$	109,609	$	36,641
Investment securities available for sale at fair value (amortized cost September 30, 2023 $757,168; December 31, 2022 $830,302)	695,734		776,104
Stock of Federal Home Loan Bank	19,345		6,461
Loans held for sale	4,236		1,663
Loans, net of allowance for credit losses September 30, 2023 $48,400; December 31, 2022 $41,440	3,316,111		3,066,981
Property and equipment, net	34,009		33,518
Tax credit real estate investments	8,057		9,152
Accrued interest receivable	19,667		15,782
Deferred income taxes, net	27,801		24,061
Goodwill	2,500		2,500
Other assets	8,665		7,618
Total Assets	$	4,245,734	$	3,980,481
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Noninterest-bearing deposits	$	605,697	$	647,450
Interest-bearing deposits	2,757,601		2,709,917
Total deposits	$	3,363,298	$	3,357,367
Other short-term borrowings, federal funds purchased	—		82,061
Federal Home Loan Bank borrowings	364,000		40,000
Accrued interest payable	4,641		1,394
Allowance for credit losses on off-balance sheet credit exposures	4,430		4,430
Other liabilities	19,214		15,958
Total Liabilities	$	3,755,583	$	3,501,210
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)	$	44,817	$	51,011
STOCKHOLDERS' EQUITY
Common stock, no par value; authorized 20,000,000 shares; issued September 30, 2023 10,344,832 shares; December 31, 2022 10,348,123 shares	$	—	$	—
Paid in capital	63,850		63,220
Retained earnings	534,424		512,841
Accumulated other comprehensive loss	(46,579)		(41,060)
Treasury stock at cost (September 30, 2023 1,199,462 shares; December 31, 2022 1,122,639 shares)	(61,544)		(55,730)
Total Stockholders' Equity	$	490,151	$	479,271
Less maximum cash obligation related to ESOP shares	44,817		51,011
Total Stockholders' Equity Less Maximum Cash Obligation Related to ESOP Shares	$	445,334	$	428,260
Total Liabilities & Stockholders' Equity	$	4,245,734	$	3,980,481

See Notes to Consolidated Financial Statements.

Page 4

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Amounts In Thousands, Except Per Share Amounts)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2023		2022		2023		2022
Interest income:
Loans, including fees	$	40,333	$	29,474	$	112,740	$	82,781
Investment securities:
Taxable	2,598		2,543		7,874		6,120
Nontaxable	1,140		1,036		3,495		3,036
Federal funds sold	130		1,366		562		2,502
Total interest income	$	44,201	$	34,419	$	124,671	$	94,439
Interest expense:
Deposits	$	10,886	$	4,104	$	27,615	$	10,254
Short-term borrowings	5,013		—		10,741		—
Total interest expense	$	15,899	$	4,104	$	38,356	$	10,254
Net interest income	$	28,302	$	30,315	$	86,315	$	84,185
Credit loss expense (benefit)	6,927		(336)		9,974		3,270
Net interest income after credit loss expense	$	21,375	$	30,651	$	76,341	$	80,915
Noninterest income:
Net gain on sale of loans	$	547	$	240	$	1,135	$	1,377
Trust fees	3,310		2,859		9,987		9,338
Service charges and fees	3,354		3,282		9,735		9,444
Other noninterest income	159		164		238		814
	$	7,370	$	6,545	$	21,095	$	20,973
Noninterest expenses:
Salaries and employee benefits	$	11,039	$	10,818	$	33,370	$	31,990
Occupancy	1,177		1,024		3,418		3,265
Furniture and equipment	1,815		1,770		5,190		5,150
Office supplies and postage	443		425		1,355		1,377
Advertising and business development	601		586		2,095		1,874
Outside services	3,468		3,491		9,587		9,407
FDIC insurance assessment	461		267		1,340		815
Other noninterest expense	662		650		1,419		1,802
	$	19,666	$	19,031	$	57,774	$	55,680
Income before income taxes	$	9,079	$	18,165	$	39,662	$	46,208
Income taxes	1,835		4,425		8,391		10,490
Net income	$	7,244	$	13,740	$	31,271	$	35,718
Earnings per share:
Basic	$	0.79	$	1.48	$	3.40	$	3.85
Diluted	$	0.79	$	1.48	$	3.40	$	3.85

See Notes to Consolidated Financial Statements.

Page 5

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited) (Amounts In Thousands)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2023		2022		2023		2022
Net income	$	7,244	$	13,740	$	31,271	$	35,718
Other comprehensive (loss)
Securities:
Net change in unrealized loss on securities available for sale	$	(10,443)	$	(25,983)	$	(7,236)	$	(69,232)
Income taxes	2,525		6,005		1,717		16,796
Other comprehensive loss on securities available for sale	$	(7,918)	$	(19,978)	$	(5,519)	$	(52,436)
Other comprehensive loss, net of tax	$	(7,918)	$	(19,978)	$	(5,519)	$	(52,436)
Comprehensive income (loss)	$	(674)	$	(6,238)	$	25,752	$	(16,718)

See Notes to Consolidated Financial Statements.

Page 6

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited) (Amounts In Thousands, Except Share Amounts)

Three Months Ended September 30, 2023 and 2022
	Paid in Capital		Retained Earnings		Accumulated Other Comprehensive (Loss)		Treasury Stock		Maximum Cash Obligation Related to ESOP Shares		Total
Balance, June 30, 2022	$	62,969	$	487,066	$	(30,981)	$	(52,472)	$	(49,932)	$	416,650
Issuance of 4,475 shares of common stock	195		—		—		123		—		318
Issuance of 1,529 shares of common stock under the employee stock purchase plan	98		—		—		—		—		98
Unearned restricted stock compensation	239		—		—		—		—		239
Forfeiture of 6,089 shares of common stock	(392)		—		—		—		—		(392)
Share-based compensation	6		—		—		—		—		6
Change related to ESOP shares	—		—		—		—		(1,079)		(1,079)
Net income	—		13,740		—		—		—		13,740
Purchase of 7,541 shares of common stock	—		—		—		(539)		—		(539)
Other comprehensive loss	—		—		(19,978)		—		—		(19,978)
Balance, September 30, 2022	$	63,115	$	500,806	$	(50,959)	$	(52,888)	$	(51,011)	$	409,063
Balance, June 30, 2023	$	63,586	$	527,180	$	(38,661)	$	(59,744)	$	(44,380)	$	447,981
Issuance of 1,226 shares of common stock	39		—		—		28		—		67
Issuance of 1,666 shares of common stock under the employee stock purchase plan	99		—		—		—		—		99
Unearned restricted stock compensation	301		—		—		—		—		301
Forfeiture of 2,960 shares of common stock	(182)		—		—		—		—		(182)
Share-based compensation	7		—		—		—		—		7
Change related to ESOP shares	—		—		—		—		(437)		(437)
Net income	—		7,244		—		—		—		7,244
Purchase of 27,699 shares of common stock	—		—		—		(1,828)		—		(1,828)
Other comprehensive loss	—		—		(7,918)		—		—		(7,918)
Balance, September 30, 2023	$	63,850	$	534,424	$	(46,579)	$	(61,544)	$	(44,817)	$	445,334

 See Notes to Consolidated Financial Statements.

Page 7

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)

(Amounts In Thousands, Except Share Amounts)

Nine Months Ended September 30, 2023 and 2022
	Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Treasury Stock		Maximum Cash Obligation Related to ESOP Shares		Total
Balance, December 31, 2021	$	60,938	$	474,392	$	1,477	$	(48,344)	$	(50,013)	$	438,450
Issuance of 34,409 shares of common stock	1,897		—		—		267		—		2,164
Issuance of 4,963 shares of common stock under the employee stock purchase plan	310		—		—		—		—		310
Unearned restricted stock compensation	594		—		—		—		—		594
Forfeiture of 10,501 shares of common stock	(642)		—		—		—		—		(642)
Share-based compensation	18		—		—		—		—		18
Change related to ESOP shares	—		—		—		—		(998)		(998)
Net income	—		35,718		—		—		—		35,718
Cash dividends ($1.00 per share)	—		(9,304)		—		—		—		(9,304)
Purchase of 68,727 shares of common stock	—		—		—		(4,811)		—		(4,811)
Other comprehensive loss	—		—		(52,436)		—		—		(52,436)
Balance, September 30, 2022	$	63,115	$	500,806	$	(50,959)	$	(52,888)	$	(51,011)	$	409,063
Balance, December 31, 2022	$	63,220	$	512,841	$	(41,060)	$	(55,730)	$	(51,011)	$	428,260
Issuance of 10,674 shares of common stock	437		—		—		288		—		725
Issuance of 4,986 shares of common stock under the employee stock purchase plan	305		—		—		—		—		305
Unearned restricted stock compensation	396		—		—		—		—		396
Forfeiture of 8,277 shares of common stock	(527)		—		—		—		—		(527)
Share-based compensation	19		—		—		—		—		19
Change related to ESOP shares	—		—		—		—		6,194		6,194
Net income	—		31,271		—		—		—		31,271
Cash dividends ($1.05 per share)	—		(9,688)		—		—		—		(9,688)
Purchase of 87,497 shares of common stock	—		—		—		(6,102)		—		(6,102)
Other comprehensive loss	—		—		(5,519)		—		—		(5,519)
Balance, September 30, 2023	$	63,850	$	534,424	$	(46,579)	$	(61,544)	$	(44,817)	$	445,334

 See Notes to Consolidated Financial Statements.

Page 8

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

	Nine Months Ended September 30,
	2023		2022
Cash Flows from Operating Activities
Net income	$	31,271	$	35,718
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation	1,848		2,089
Credit loss expense	9,974		3,270
Forfeiture of common stock	(527)		(642)
Share-based compensation	19		18
Compensation expensed through issuance of common stock	725		683
Provision for deferred income taxes	(2,023)		(944)
Net gain on sale of other real estate owned and other repossessed assets	(120)		(57)
Increase in accrued interest receivable	(3,885)		(3,083)
(Accretion of discount) amortization of premium on investment securities, net	(354)		724
Net change in other assets	(645)		(86)
Amortization of operating lease right-of-use assets	224		105
Increase in accrued interest payable and other liabilities	6,589		3,011
Loans originated for sale	(121,326)		(100,362)
Proceeds on sales of loans	119,888		104,791
Net gain on sales of loans	(1,135)		(1,377)
Net cash and cash equivalents provided by operating activities	$	40,523	$	43,858
Cash Flows from Investing Activities
Proceeds from maturities of investment securities available for sale	$	81,817	$	97,891
Proceeds from sales of investment securities available for sale	509		—
Purchases of investment securities available for sale	(8,838)		(364,047)
Net purchases of stock of Federal Home Loan Bank	(12,884)		(316)
Loans made to customers, net of collections	(259,855)		(285,559)
Proceeds on sale of other real estate owned and other repossessed assets	555		161
Purchases of property and equipment	(2,339)		(1,502)
Net changes from tax credit real estate investment	1,095		523
Net cash and cash equivalents used in investing activities	$	(199,940)	$	(552,849)
Cash Flows from Financing Activities
Net increase (decrease) in deposits	$	5,931	$	(18,233)
Net decrease in short-term borrowings	(82,061)		(249)
Net change in short-term FHLB borrowings	324,000		—
Issuance of common stock, net of costs	—		1,243
Stock options exercised	—		238
Purchase of common stock	(6,102)		(4,811)
Proceeds from the issuance of common stock through the employee stock purchase plan	305		310
Dividends paid	(9,688)		(9,304)
Net cash and cash equivalents provided by (used in) financing activities	$	232,385	$	(30,806)

(Continued)

Page 9

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

	Nine Months Ended September 30,
	2023		2022
Increase (decrease) in cash and cash equivalents	$	72,968	$	(539,797)
Cash and cash equivalents:
Beginning of period	36,641		781,918
End of period	$	109,609	$	242,121
Supplemental Disclosures
Cash payments for:
Interest paid to depositors	$	24,368	$	10,363
Interest paid on other obligations	10,741		—
Income taxes paid	9,957		9,178
Noncash activities:
(Decrease) increase in maximum cash obligation related to ESOP shares	$	(6,194)	$	998
Transfers to other real estate owned	751		—
Right-of-use assets obtained in exchange for operating lease obligations	310		—

See Notes to Consolidated Financial Statements.

Page 10

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.  The Company considers that it operates as one business segment, a commercial bank.

Operating results for the nine month period ended September 30, 2023 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2023.  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, 2022 filed with the Securities Exchange Commission on March 3, 2023.  The consolidated balance sheet as of December 31, 2022, 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.

Accounting Estimates:

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

Certain Significant Estimates:

The allowance for credit losses, fair values of securities and other financial instruments, and share-based compensation expense involve certain significant estimates made by management. These estimates are reviewed by management routinely and it is reasonably possible that circumstances that exist at September 30, 2023 may change in the near-term and the effect could be material to the consolidated financial statements. Actual amounts and values as of the balance sheet dates may be materially different than the amounts and values reported due to the inherent uncertainty in the estimation process.

Revenue Recognition:

Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606"), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the Company’s contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

The majority of the Company’s revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans, letters of credit and investment securities. Interest income on loans and investment securities is recognized on the accrual method in accordance with written contracts.

Descriptions of the Company’s revenue-generating activities that are within the scope of ASC 606 are the following: Service charges and fees on deposit accounts represent general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue which includes interchange income, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when the Company’s performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied. Trust income represents monthly fees due from wealth management

Page 11

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

customers as consideration for managing the customers' assets. Wealth management and trust services include custody of assets, investment management, fees for trust services and similar fiduciary activities. Revenue is recognized when our performance obligation is completed each month, which is generally the time that payment is received.

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity's obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. As of September 30, 2023, the Company did not have any significant contract balances.

An entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company has not incurred or capitalized any contract acquisition costs as of September 30, 2023.

Tax credit real estate: Tax credit real estate represents three multi-family rental properties, three assisted living rental properties, a multi-tenant rental property for persons with disabilities, and a multi-family senior living rental property, all of which are affordable housing projects as of September 30, 2023. The Company has a 99% or greater limited partnership interest in each limited partnership. The investment in each was completed after the projects had been developed by the general partner. On a regular basis, the Company evaluates recoverability of the carrying value of the tax credit real estate investments to determine if an allowance for credit losses is necessary. The allowance for credit losses is measured by a comparison of the carrying amount of the investments to the future undiscounted cash flows expected to be generated by the investment properties, including the low-income housing tax credits and any estimated proceeds from eventual disposition. If there is an indication of impairment, the allowance for credit losses would be established with a charge to credit loss expense. There were no indications of impairment based on management's evaluation and therefore no allowance for credit losses was determined necessary as of September 30, 2023. Depreciation expense is provided on a straight-line basis over the estimated useful life of the assets. Expenditures for normal repairs and maintenance are charged to expense as incurred.

The investments in tax credit real estate are recorded for all years presented using the equity method of accounting, with the exception of the investment in the affordable housing project described below. The operations of the properties are not expected to contribute significantly to the Company’s income before income taxes. However, the properties do contribute in the form of income tax credits, which lowers the Company’s effective tax rate. Once established, the credits on each property last for ten years and are passed through from the limited partnerships to the Company and reduces the consolidated federal tax liability of the Company.

In February 2021, the Company provided construction financing and contributed capital of $4.18 million to Del Ray Ridge LP, as limited partner, which owns and operates an affordable housing property in Iowa City, Iowa. The Company accounts for the investment in this tax credit real estate using the proportional amortization method as provided for under Accounting Standards Codification (ASC) 323-740. The investment qualifies for the proportional amortization method as it meets all of the criteria under ASC 323-740-25-1. Substantially all of the projected benefits are from tax credits and other tax benefits due to the minimum buyout clause included in the partnership agreement.

Available-for-sale debt securities and the allowance for credit losses on available-for-sale debt securities: Available-for-sale ("AFS") securities consist of debt securities not classified as trading or held to maturity.  Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity.  There were no trading or held to maturity securities as of September 30, 2023 or 2022. Fair value measurement is based upon quoted market prices in active markets, if available. If quoted prices in active markets are not available, fair value is measured using pricing models or other model-based valuation techniques such as present value of future cash flows, which consider prepayment assumptions and other factors such as credit losses and market liquidity. Unrealized gains and losses are excluded from earnings and reported, net of tax, in other comprehensive income ("OCI"). Premiums on debt securities are amortized to the earliest call date and discounts on debt securities are accreted over the period to maturity of those securities. The method of amortization results in a constant effective yield on those securities (the interest method). Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Page 12

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

AFS debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. For AFS debt securities, a decline in fair value due to credit loss results in recording an allowance for credit losses to the extent the fair value is less than the amortized cost basis. Declines in fair value that have not been recorded through an allowance for credit losses, such as declines due to changes in market interest rates, are recorded through other comprehensive income, net of applicable taxes.

Impairment may result from credit deterioration of the issuer or collateral underlying the security. In performing an assessment of whether any decline in fair value is due to a credit loss, all relevant information is considered at the individual security level. For asset-backed securities performance indicators considered related to the underlying assets include default rates, delinquency rates, percentage of nonperforming assets, debt-to-collateral ratios, third-party guarantees, current levels of subordination, vintage, geographic concentration, analyst reports and forecasts, credit ratings and other market data. In assessing whether a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount the fair value is less than amortized cost basis.

If we intend to sell a debt security or more likely than not we will be required to sell the security before recovery of its amortized cost basis, the debt security is written down to its fair value and the write down is charged against the allowance for credit losses with any incremental impairment reported in earnings.

Accrued interest receivable on AFS debt securities totaled $3.86 million at September 30, 2023 and is excluded from the estimate of credit losses.

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

Loans held for investment: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost net of the allowance for credit losses ("ACL"). Amortized cost is the principal balance outstanding, net of deferred loan fees and costs. Accrued interest receivable on loans held for investment totaled $15.80 million at September 30, 2023 and is excluded from the estimate of credit losses. Interest income is accrued on the unpaid principal balance. Nonrefundable loan fees and origination costs are deferred and recognized as a yield adjustment over the life of the related loan.

The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the

borrower's ability to meet payments of interest or principal when they become due, which is generally when a loan is 90 days or

more past due unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, all previously accrued and unpaid interest is reversed against interest income. Loans are returned to an accrual status when all of the principal and interest amounts contractually due are brought current and repayment of the remaining contractual principal and interest is expected. A loan may also return to accrual status if additional collateral is received from the borrower and, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the collection of the amount contractually due. Payment received on nonaccrual loans are applied first to principal. Once principal is recovered, any remaining payments received are applied to interest income.

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

Allowance for credit losses for loans held for investment: The allowance for credit losses is an estimate of the expected losses over the remaining life of the Company's existing loans held for investment portfolio. The allowance for credit losses for loans held for investment, as reported in our consolidated balance sheet, is adjusted by a credit loss expense, which is reported in earnings, and reduced by the charge-off of loan amounts, net of recoveries.

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(Unaudited)

The loan loss estimation process involves procedures to appropriately consider the unique characteristics of loan portfolio segments which consist of agricultural, 1 to 4 family first and junior liens, commercial, and consumer lending. These segments are further disaggregated into loan classes, the level at which credit risk is monitored. For each of these pools, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speed, curtailments, time to recovery, probability of default, and loss given default. The modeling of expected prepayment speeds, curtailment rates, and time to recovery are based on historical internal data. The following provides the credit quality indicators and risk elements that are most relevant and most carefully considered and monitored for each loan portfolio segment.

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

Mortgage loans secured by farmland are made to individuals and businesses within the Company's trade area. The primary source of repayment is the cash flow generated by the collateral underlying the loan. The secondary repayment source would be the liquidation of the collateral. Terms for real estate loans secured by farmland range from one to ten years with an amortization period of 25 years or less. Generally, interest rates are fixed for mortgage loans secured by farmland. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the Iowa real gross domestic product (GDP).

1 to 4 Family First and Junior Liens - The 1 to 4 family first and junior liens portfolio segment is comprised of the single family and home equity loan classes, which are underwritten after evaluating a borrower's capacity to repay, credit, and collateral. Several factors are considered when assessing a borrower's capacity, including the borrower's employment, income, current debt, assets, and level of equity in the property. Credit refers to how well a borrower manages their current and prior debts as documented by a credit report that provides credit scores and the borrower's current and past information about their credit history. Collateral refers to the type and use of property, occupancy, and market value. Property appraisals are obtained to assist in evaluating collateral. Loan-to-property value and debt-to-income ratios, loan amount, and lien position are also considered in assessing whether to originate a loan. These borrowers are particularly susceptible to downturns in economic trends such as conditions that negatively affect housing prices and demand and levels of unemployment. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the all-transactions house price index for Iowa.

Commercial - The commercial loan portfolio segment is comprised of the commercial real estate mortgage including obligations of states and political subdivisions, multifamily residential mortgage, construction/land development and commercial and financial loan classes, whose underwriting standards consider the factors described for single family and home equity loan classes as well as others when assessing the borrower's and associated guarantors or other related party's financial position. These other factors include assessing liquidity, the level and composition of net worth, leverage, considering all other lender amounts and position, an analysis of cash expected to flow through the obligors including the outflow to other lenders, vacancies and prior experience with the borrower. This information is used to assess adequate financial capacity, profitability, and experience. Ultimate repayment of these loans is sensitive to interest rate changes, general economic conditions, liquidity, and availability of long-term financing. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate, the all-transactions house price index for Iowa and the Iowa real GDP.

Consumer Lending - The Company offers consumer loans to individuals including personal loans and automobile loans. These consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than real estate-related loans. Consumer collections are dependent on the borrower's continuing financial stability and are more likely to be affected by adverse personal circumstances. Collateral for these loans generally includes automobiles, boats, recreational vehicles and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time,

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(Unaudited)

may be difficult to recover and may fluctuate in value based on condition. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the Iowa real GDP.

The allowance level is influenced by loan volumes, loan credit quality indicator migration or delinquency status, historic loss experience and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics; and second, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans. Depending on the nature of the pool of financial assets with similar risk characteristics, the Company uses a discounted cash flow method or remaining life method to estimate expected credit losses.

Discounted cash flow method: In estimating the component of the allowance for credit losses for loans that share similar risk characteristics with other loans, such loans are segregated into loan classes. Loans are designated into loan classes based on loans pooled by product types and similar risk characteristics or areas of risk concentration. In determining the allowance for credit losses, we derive an estimated credit loss assumption from a model that categorizes loan pools based on loan type and purpose. This model calculates an expected loss percentage for each loan class by considering the probability of default, using life-of-loan analysis periods for all loan segments, and the historical severity of loss, based on the aggregate net lifetime losses incurred per loan class. The default and severity factors used to calculate the allowance for credit losses for loans that share similar risk characteristics with other loans are adjusted for differences between the historical period used to calculate historical default and loss severity rates and expected conditions over the remaining lives of the loans in the portfolio related to: (1) lending policies and procedures; (2) international, national, regional and local economic business conditions and developments that affect the collectability of the portfolio; (3) the nature and volume of the loan portfolio including the terms of the loans; (4) the experience, ability, and depth of the lending management and other relevant staff; (5) the volume and severity of past due and adversely classified or graded loans and the volume of nonaccrual loans; (6) the quality of our loan review system and (7) the value of underlying collateral for collateralized loans. Additional factors include the existence and effect of any concentrations of credit, and changes in the level of such concentrations and the effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio. Such factors are used to adjust the historical probabilities of default and severity of loss so that they reflect management expectation of future conditions based on a reasonable and supportable forecast. The Company uses regression analysis of historical internal and peer data to determine which variables are best suited to be economic variables utilized when modeling lifetime probability of default and loss given default. This analysis also determines how expected probability of default and loss given default will react to forecasted levels of the economic variables.

For all DCF models, management has determined that four quarters represents a reasonable and supportable forecast period and reverts back to a historical loss rate over twelve quarters on a straight-line basis. Other internal and external indicators of economic forecasts are also considered by management when developing the forecast metrics.

Remaining life method: Expected credit losses for credit cards and overdrafts are determined through use of the remaining life method. The remaining life method utilizes average annual charge-off rates and remaining life to estimate the allowance for credit losses. This is done by estimating the amount and timing of principal payments expected to be received as payment for the balance outstanding as of the reporting period and applying those principal payments against the balance outstanding as of the reporting period along with the average annual charge-off rate until the expected payments have been fully allocated.

Collateral dependent financial assets: For a loan that does not share risk characteristics with other loans, expected credit loss is measured based on net realizable value, that is, the difference between the discounted value of the expected future cash flows, based on the original effective interest rate, and the amortized cost basis of the loan. For these loans, we recognize expected credit loss equal to the amount by which the net realizable value of the loan is less than the amortized cost basis of the loan (which is net of previous charge- offs and deferred loan fees and costs), except when the loan is collateral dependent, that is, when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In these cases, expected credit loss is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral. The fair value of the collateral is adjusted for the estimated cost to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral.

The Company’s estimate of the ACL reflects losses expected over the contractual life of the assets, adjusted for estimated prepayments or curtailments. The contractual term does not consider extensions, renewals or modifications unless the Company

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(Unaudited)

has identified a modification including a concession to a borrower experiencing financial difficulties. A modification of a loan to a borrower experiencing financial difficulties occurs when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics.

Allowance for credit losses on off-balance sheet credit exposures, including unfunded loan commitments: The Company maintains a separate allowance for credit losses from off-balance-sheet credit exposures, including unfunded loan commitments, which is disclosed on the balance sheet. Management estimates the amount of expected losses by calculating a commitment usage factor over the contractual period for exposures that are not unconditionally cancellable by the Company and applying the loss factors used in the ACL methodology to the results of the usage calculation to estimate the liability for credit losses related to unfunded commitments for each loan type. No credit loss estimate is reported for off-balance-sheet (OBS) credit exposures that are unconditionally cancellable by the Company, such as credit card receivables, or for undrawn amounts under such arrangements that may be drawn prior to the cancellation of the arrangement. The allowance for credit losses on OBS credit exposures is adjusted as credit loss expense. Categories of OBS credit exposures correspond to the loan portfolio segments described previously.

Troubled debt restructurings (“TDR loans”):  Prior to January 1, 2023, a loan was accounted for and reported as a troubled debt restructuring ("TDR") when, for economic or legal reasons, the Company granted a concession to a borrower experiencing financial difficulty that the Company would not otherwise consider. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses to the Company. A restructuring that results in only an insignificant delay in payment is not considered a concession. A delay may be considered insignificant if the payments subject to the delay are insignificant relative to the unpaid principal or collateral value and the contractual amount due, or the delay in timing of the restructured payment period is insignificant relative to the frequency of payments, the debt's original contractual maturity or original expected duration. TDRs performing in accordance with their modified contractual terms for a reasonable period of time may be included in the Company’s existing pools based on the underlying risk characteristics of the loan to measure the ACL.

TDRs that are performing and on accrual status as of the date of the modification remain on accrual status. TDRs that are nonperforming as of the date of modification generally remain as nonaccrual until the prospect of future payments in accordance with the modified loan agreement is reasonably assured, generally demonstrated when the borrower maintains compliance with the restructured terms for a predetermined period, normally at least six months. TDRs with temporary below-market concessions remain designated as a TDR regardless of the accrual or performance status until the loan is paid off. However, if the TDR loan has been modified in a subsequent restructure with market terms and the borrower is not currently experiencing financial difficulty, then the loan is no longer classified as a TDR in the quarter following the modification.

Effect of New Financial Accounting Standards:

In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 815) Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The amendments in this Update require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. At the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts. To achieve this, an acquirer may assess how the acquiree applied Topic 606 to determine what to record for the acquired revenue contracts. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. An entity should apply the amendments prospectively to business combinations occurring on or after the effective date of the amendments. The adoption of the ASU by the Company on January 1, 2023 did not have a material impact on the financial statements.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures. The FASB issued these amendments to eliminate accounting guidance for TDRs by creditors in Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty, and to require that an entity disclose current-period gross writeoffs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, Financial Instruments-Credit Losses-Measured at Amortized Cost. The amendments in this Update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, and should be applied prospectively, except as provided in the next sentence. For the transition method related to the recognition and measurement of TDRs, an entity has the option to apply a modified retrospective transition

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(Unaudited)

method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. Early adoption is permitted if an entity has adopted the amendments in Update 2016-03, including adoption in an interim period. The adoption of the ASU on a prospective basis by the Company on January 1, 2023 did not have a material impact on the financial statements

In March 2023, the FASB issued ASU 2023-02, Investments - Equity Method and Joint Ventures (Topic 323) Accounting for Investments in Tax Credit Structures Using Proportional Amortization Method. The FASB is issuing this ASU to allow reporting entities to consistently account for equity investments made primarily for the purposes of receiving income tax credits and other income tax benefits. The ASU permits reporting entities to elect to account for tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method if certain conditions are met. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for all entities in any interim period. If an entity adopts the amendments in an interim period, it shall adopt them as of the beginning of the fiscal year that includes that interim period. The Company is in the process of evaluating the impact of this ASU on the financial statements.

Note 2.Earnings Per Share

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

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2023		2022		2023		2022
Common shares outstanding at the beginning of the period	9,173,137		9,267,410		9,225,484		9,299,640
Weighted average number of net shares redeemed	(10,230)		(3,569)		(37,111)		(24,256)
Weighted average shares outstanding (basic)	9,162,907		9,263,841		9,188,373		9,275,384
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method	614		676		689		1,935
Weighted average number of shares (diluted)	9,163,521		9,264,517		9,189,062		9,277,319
Net income (In thousands)	$	7,244	$	13,740	$	31,271	$	35,718
Earnings per share:
Basic	$	0.79	$	1.48	$	3.40	$	3.85
Diluted	$	0.79	$	1.48	$	3.40	$	3.85

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(Unaudited)

Note 3.Accumulated Other Comprehensive (Loss)

The following table summarizes the balances of each component of accumulated other comprehensive (loss) income (AOCI), included in stockholders’ equity, at September 30, 2023 and December 31, 2022:

	September 30, 2023		December 31, 2022
	(amounts in thousands)
Net unrealized loss on available-for-sale securities	$	(61,434)	$	(54,198)
Tax effect	14,855		13,138
Net-of-tax amount	$	(46,579)	$	(41,060)

Note 4.Securities

The carrying values of investment securities at September 30, 2023 and December 31, 2022 are summarized in the following table (dollars in thousands):

	September 30, 2023				December 31, 2022
	Amount		Percent		Amount		Percent
Securities available for sale
U.S. Treasury	$	412,238	59.24	%	$	445,392	57.39	%
Other securities (FHLB, FHLMC and FNMA)	32,324		4.65		31,934		4.11
State and political subdivisions	206,396		29.67		248,582		32.03
Mortgage-backed securities and collateralized mortgage obligations	44,776		6.44		50,196		6.47
Total securities available for sale	$	695,734	100.00	%	$	776,104	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.  Municipal bonds are comprised of general obligation bonds and revenue bonds issued by various municipal corporations. As of September 30, 2023 and December 31, 2022, all securities held were rated investment grade based upon external ratings where available and, where not available, based upon management knowledge of the local issuers and their financial situations. There were no trading or held to maturity securities as of September 30, 2023 or December 31, 2022.

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(Unaudited)

The carrying amount of available-for-sale securities, fair values and allowance for credit losses were as follows as of September 30, 2023 and December 31, 2022 (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)		Allowance for Credit Losses		Estimated Fair Value
September 30, 2023
U.S. Treasury	$	434,142	$	—	$	(21,904)	$	—	$	412,238
Other securities (FHLB, FHLMC and FNMA)	35,181		—		(2,857)		—		32,324
State and political subdivisions	234,398		6		(28,008)		—		206,396
Mortgage-backed securities and collateralized mortgage obligations	53,447		—		(8,671)		—		$	44,776
Total	$	757,168	$	6	$	(61,440)	$	—	$	695,734
December 31, 2022:
U.S. Treasury	$	470,581	$	—	$	(25,189)	$	—	$	445,392
Other securities (FHLB, FHLMC and FNMA)	35,255		—		(3,321)		—		31,934
State and political subdivisions	267,351		239		(19,008)		—		248,582
Mortgage-backed securities and collateralized mortgage obligations	57,115		—		(6,919)		—		50,196
Total	$	830,302	$	239	$	(54,437)	$	—	$	776,104

The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at September 30, 2023, were as follows (in thousands) below. Expected maturities of MBS may differ from contractual maturities because the mortgages underlying the securities may be called or prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the following summary.

	Amortized Cost		Fair Value
Due in one year or less	$	197,763	$	193,863
Due after one year through five years	363,648		339,019
Due after five years through ten years	115,162		96,371
Due over ten years	27,148		21,705
	$	703,721	$	650,958
Mortgage-backed securities and collateralized mortgage obligations	53,447		44,776
	$	757,168	$	695,734

As of September 30, 2023, investment securities with a carrying value of $417.77 million were pledged to collateralize other borrowings. As of September 30, 2023, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders' equity.

Sales proceeds and gross realized gains and losses on available-for-sale securities were as follows (in thousands):

	September 30, 2023		September 30, 2022
Sale proceeds	$	509	$	—
Gross realized gains	—		—
Gross realized losses	—		—

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(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 September 30, 2023 and December 31, 2022 (in thousands):

	Less than 12 months							12 months or more							Total
September 30, 2023 Description of Securities	#	Fair Value		Unrealized Loss		%		#	Fair Value		Unrealized Loss		%		#	Fair Value		Unrealized Loss		%
U.S. Treasury	1	$	2,319	$	(64)	2.76	%	134	$	404,919	$	(21,840)	5.39	%	135	$	407,238	$	(21,904)	5.38	%
Other securities (FHLB, FHLMC and FNMA)	—	—		—		—		14	32,324		(2,857)		8.84		14	32,324		(2,857)		8.84
State and political subdivisions	190	53,497		(2,388)		4.46		635	151,896		(25,620)		16.87		825	205,393		(28,008)		13.64
Mortgage-backed securities and collateralized mortgage obligations	—	—		—		—		18	44,776		(8,671)		19.37		18	44,776		(8,671)		19.37
Total temporarily impaired securities	191	$	55,816	$	(2,452)	4.39	%	801	$	633,915	$	(58,988)	9.31	%	992	$	689,731	$	(61,440)	8.91	%

	Less than 12 months							12 months or more							Total
December 31, 2022 Description of Securities	#	Fair Value		Unrealized Loss		%		#	Fair Value		Unrealized Loss		%		#	Fair Value		Unrealized Loss		%
U.S. Treasury	89	$	306,407	$	(10,695)	3.49	%	60	$	136,486	$	(14,494)	10.62	%	149	$	442,893	$	(25,189)	5.69	%
Other securities (FHLB, FHLMC and FNMA)	—	—		—		—		14	31,934		(3,321)		10.40		14	31,934		(3,321)		10.40
State and political subdivisions	479	124,647		(3,351)		2.69		337	87,221		(15,657)		17.95		816	211,868		(19,008)		8.97
Mortgage-backed securities and collateralized mortgage obligations	14	43,035		(5,314)		12.35		4	7,160		(1,605)		22.42		18	50,195		(6,919)		13.78
Total temporarily impaired securities	582	$	474,089	$	(19,360)	4.08	%	415	$	262,801	$	(35,077)	13.35	%	997	$	736,890	$	(54,437)	7.39	%

The Company considered the following information in reaching the conclusion that the impairments disclosed in the table above are not attributable to credit losses.  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. The securities are of high credit quality (investment grade credit ratings) and principal and interest payments are made timely with no payments past due as of September 30, 2023. The fair value is expected to recover as the securities approach maturity. The U.S. Treasury and other securities are issued and guaranteed by U.S. government-sponsored entities and agencies. The

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(Unaudited)

mortgage-backed securities and collateralized mortgage obligations have implied U.S. government guarantees of the agency securities. The Company evaluates if a credit loss exists by monitoring to ensure it has adequate credit support considering the nature of the investment, number and significance of investments in an unrealized loss position, collectability or delinquency issues, the underlying financial statements of the issuers, credit ratings and subsequent changes thereto, and other available relevant information. Considering the above factors, management has determined that no allowance for credit losses is necessary for the securities portfolio as of September 30, 2023.

Note 5.Loans

Classes of loans are as follows:

	September 30, 2023		December 31, 2022
	(Amounts In Thousands)
Agricultural	$	108,275	$	112,705
Commercial and financial	293,261		269,568
Real estate:
Construction, 1 to 4 family residential	82,495		92,408
Construction, land development and commercial	296,177		196,240
Mortgage, farmland	273,084		256,570
Mortgage, 1 to 4 family first liens	1,205,185		1,130,989
Mortgage, 1 to 4 family junior liens	140,625		124,951
Mortgage, multi-family	459,721		436,952
Mortgage, commercial	418,433		402,842
Loans to individuals	40,275		36,675
Obligations of state and political subdivisions	46,631		48,213
	$	3,364,162	$	3,108,113
Net unamortized fees and costs	349		308
	$	3,364,511	$	3,108,421
Less allowance for credit losses	48,400		41,440
	$	3,316,111	$	3,066,981

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Changes in the allowance for credit losses for the three and nine months ended September 30, 2023 were as follows:

	Three Months Ended September 30, 2023
	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 credit losses:
Beginning balance	$	2,276	$	7,239	$	5,227	$	2,857	$	15,746	$	9,504	$	1,421	$	44,270
Charge-offs	(341)		(1,306)		(460)		(21)		(116)		(121)		(431)		(2,796)
Recoveries	5		162		2		19		183		160		68		599
Credit loss expense (benefit)	470		1,597		2,428		364		1,192		(135)		411		6,327
Ending balance	$	2,410	$	7,692	$	7,197	$	3,219	$	17,005	$	9,408	$	1,469	$	48,400
	Nine Months Ended September 30, 2023
	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 credit losses:
Beginning balance	$	2,542	$	6,259	$	4,189	$	2,989	$	14,208	$	9,416	$	1,837	$	41,440
Charge-offs	(781)		(1,555)		(464)		(21)		(343)		(121)		(949)		(4,234)
Recoveries	23		346		5		55		362		226		203		1,220
Credit loss expense (benefit)	626		2,642		3,467		196		2,778		(113)		378		9,974
Ending balance	$	2,410	$	7,692	$	7,197	$	3,219	$	17,005	$	9,408	$	1,469	$	48,400
Loans:
Ending balance	$	108,275	$	293,261	$	378,672	$	273,084	$	1,345,810	$	878,154	$	86,906	$	3,364,162

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Changes in the allowance for credit losses for the three and nine months ended September 30, 2022 were as follows:

	Three Months Ended September 30, 2022
	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 credit losses:
Beginning balance	$	2,265	$	5,194	$	2,772	$	3,330	$	12,233	$	11,233	$	1,233	$	38,260
Charge-offs	—		(18)		—		(1)		(222)		—		(163)		(404)
Recoveries	10		233		2		6		143		26		50		470
Credit loss expense (benefit)	195		(213)		690		(473)		631		(345)		169		654
Ending balance	$	2,470	$	5,196	$	3,464	$	2,862	$	12,785	$	10,914	$	1,289	$	38,980
	Nine Months Ended September 30, 2022
	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 credit losses:
Beginning balance	$	2,261	$	4,269	$	2,300	$	3,433	$	11,498	$	10,498	$	1,211	$	35,470
Charge-offs	(1)		(309)		—		(21)		(471)		(1)		(389)		(1,192)
Recoveries	78		445		7		296		686		76		114		1,702
Credit loss expense (benefit)	132		791		1,157		(846)		1,072		341		353		3,000
Ending balance	$	2,470	$	5,196	$	3,464	$	2,862	$	12,785	$	10,914	$	1,289	$	38,980
Loans:
Ending balance	$	98,555	$	248,179	$	254,810	$	248,103	$	1,179,214	$	832,714	$	84,546	$	2,946,121

The allowance for credit losses and the related loan balances as of December 31, 2022:

	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)
2022
Allowance for credit losses:
Ending balance	$	2,542	$	6,259	$	4,189	$	2,989	$	14,208	$	9,416	$	1,837	$	41,440
Loan balances:
Ending balance	$	112,705	$	269,568	$	288,648	$	256,570	$	1,255,940	$	839,794	$	84,888	$	3,108,113

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Changes in the allowance for credit losses for off-balance sheet credit exposures for the three and nine months ended September 30, 2023 and 2022 were as follows:

	Three Months Ended September 30, 2023
	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 credit losses for off-balance sheet credit exposures:
Beginning balance	$	391	$	953	$	1,736	$	59	$	501	$	140	$	50	$	3,830
Credit loss expense (benefit)	(10)		89		520		28		46		(96)		23		600
(Charge-offs), net recoveries	—		—		—		—		—		—		—		—
Ending balance	$	381	$	1,042	$	2,256	$	87	$	547	$	44	$	73	$	4,430
	Nine Months Ended September 30, 2023
	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 credit losses for off-balance sheet credit exposures:
Beginning balance	$	525	$	1,099	$	2,126	$	55	$	471	$	122	$	32	$	4,430
Credit loss expense (benefit)	(144)		(57)		130		32		76		(78)		41		—
(Charge-offs), net recoveries	—		—		—		—		—		—		—		—
Ending balance	$	381	$	1,042	$	2,256	$	87	$	547	$	44	$	73	$	4,430

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

	Three Months Ended September 30, 2022
	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 credit losses for off-balance sheet credit exposures:
Beginning balance	$	659	$	1,776	$	1,182	$	115	$	1,025	$	300	$	53	$	5,110
Credit loss expense (benefit)	(140)		(714)		424		50		(399)		(192)		(19)		(990)
(Charge-offs), net recoveries	—		—		—		—		—		—		—		—
Ending balance	$	519	$	1,062	$	1,606	$	165	$	626	$	108	$	34	$	4,120
	Nine Months Ended September 30, 2022
	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 credit losses for off-balance sheet credit exposures:
Beginning balance	$	383	$	1,118	$	849	$	113	$	794	$	559	$	34	$	3,850
Credit loss expense (benefit)	136		(56)		757		52		(168)		(451)		—		270
(Charge-offs), net recoveries	—		—		—		—		—		—		—		—
Ending balance	$	519	$	1,062	$	1,606	$	165	$	626	$	108	$	34	$	4,120

The allowance for credit losses for off-balance sheet credit exposures as of December 31, 2022 were as follows:

	Year Ended December 31, 2022
	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)
Ending balance	$	525	$	1,099	$	2,126	$	55	$	471	$	122	$	32	$	4,430

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Credit loss expense for off-balance sheet credit exposures is included in credit loss expense on the consolidated statement of income for the nine months ended September 30, 2023 and 2022.

Management regularly reviews loans in the portfolio to assess credit quality indicators and to determine appropriate loan classification and grading in accordance with applicable bank regulations. The Company's risk rating methodology assigns risk ratings ranging from 1 to 6, where a higher rating represents higher risk. The Company differentiates its lending portfolios into loans sharing common risk characteristics for which expected credit loss is measured on a pool basis and loans not sharing common risk characteristics for which credit loss is measured individually.

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. Loans are secured with cash, cash equivalents, or collateral with very low loan to values. The borrower would qualify for unsecured debt and guarantors provide excellent secondary support to the relationship. The borrower has a long-term relationship with the Company, maintains high deposit balances and has an established payment history with the Company and an established business in an established industry.

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. The relationship is not quite as strong as a borrower that is assigned an excellent rating but still has a very strong liquidity position, low leverage, and track record of strong performance. These loans have a strong collateral position with limited risk to bank capital. The collateral will not materially lose value in a distressed liquidation. Guarantors provide additional secondary support to mitigate possible bank losses. The borrower has a long-term relationship with the Company with an established track record of payments; loans with shorter remaining loan amortization; deposit balances are consistent; loan payments could be made from cash reserves in the interim period; and source of income is coming from a stable industry.

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. The borrower's financial performance is consistent, ratios and trends are positive and the primary repayment source can clearly be identified and supported with acceptable financial information. The loan relationship could be vulnerable to changes in economic or industry conditions but have the ability to absorb unexpected issues. The loan collateral coverage is considered acceptable and guarantors can provide financial support but net worth might not be as liquid as a 1 or 2 rated relationship. The borrower has an established relationship with the Company. The relationship is making timely loan payments, any operating line is revolving and deposit balances are positive with limited to no overdrafts. Management and industry is considered stable.

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. The relationship liquidity levels are minimal and the borrower’s leverage position is brought into question. The primary repayment source is showing signs of being stressed or is not proven. If the borrower performs as planned, the loan will be repaid. The collateral coverage is still considered acceptable but there might be some concern with the type of real estate securing the debt or highly dependent on chattel assets. Some loans may be better secured than others. Guarantors still provide some support but there is not an abundance of financial strength supporting the guaranty. A monitor credit may be appropriate when the borrower is experiencing rapid growth which is impacting liquidity levels and increasing debt levels. Other attributes to consider would include if the business is a start-up or newly acquired, if the relationship has significant financing relationships with other financial institutions, the quality of financial information being received, management depth of the company, and changes to the business model. The track history with the Company has some deficiencies such as slow payments or some overdrafts.

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. Potential indicators of a special mention would include past due

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(Unaudited)

payments, overdrafts, management issues, poor financial performance, industry issues, or the need for additional short-term borrowing. The ability to continue to make payments is in question; there are “red flags” such as past due payments, non-revolving credit lines, overdrafts, and the inability to sell assets. The borrower is experiencing delinquent taxes, legal issues, etc., obtaining financial information has become a challenge, collateral coverage is marginal at best, and the value and condition could be brought into question. Collateral document deficiencies have been noted and if not addressed, could become material. Guarantors provide minimal support for this relationship. The credit may include an action plan or follow up established in the asset quality process. There is a change in the borrower’s communication pattern. Industry issues may be impacting the relationship. Adverse credit scores or history of payment deficiencies could be noted.

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.  Full repayment of the loan(s) according to the original terms and conditions is in question or not expected. For these loans, it is more probable than not that the Company could sustain some loss if the deficiency(ies) is not corrected. There are identified shortfalls in the primary repayment source such as carry over debt, past due payments, and overdrafts. Obtaining quality and timely financial information is a weakness. The loan is under secured with exposure that could impact the Company's capital. It appears the liquidation of collateral has become the repayment source. The collateral may be difficult to foreclose or have little to no value. Collateral documentation deficiencies have been noted during the review process. Guarantor(s) provide minimal to no support of the relationship. The borrower’s communication with the Company continues to decrease and the borrower is not addressing the situation. There is some concern about the borrower’s ability and willingness to repay the loans. Problems may be the result of external issues such as economic or industry related issues.

The following tables present the credit quality indicators and origination years by type of loan in each category as of September 30, 2023 (amounts in thousands):

	Agricultural
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	410	$	1,042	$	—	$	119	$	10	$	—	$	5,057	$	6,638
Good	2,268		2,513		408		704		381		15		8,378		14,667
Satisfactory	6,711		8,999		3,048		1,909		561		291		30,007		51,526
Monitor	2,759		3,142		787		476		264		763		15,334		23,525
Special Mention	1,164		912		242		63		14		—		2,786		5,181
Substandard	961		13		110		—		407		—		5,247		6,738
Total	$	14,273	$	16,621	$	4,595	$	3,271	$	1,637	$	1,069	$	66,809	$	108,275
Current-period gross write offs	$	56	$	416	$	—	$	—	$	—	$	—	$	309	$	781

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

	Commercial and Financial
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	3,148	$	517	$	481	$	545	$	—	$	132	$	2,728	$	7,551
Good	6,476		10,164		5,523		1,797		299		125		12,008		36,392
Satisfactory	37,896		43,511		18,009		7,365		2,718		1,411		66,847		177,757
Monitor	9,897		14,924		6,091		4,224		610		60		20,773		56,579
Special Mention	3,089		1,641		302		252		60		12		2,850		8,206
Substandard	723		1,476		567		380		363		383		2,884		6,776
Total	$	61,229	$	72,233	$	30,973	$	14,563	$	4,050	$	2,123	$	108,090	$	293,261
Current-period gross write offs	$	1,091	$	169	$	181	$	—	$	104	$	10	$	—	$	1,555

	Real Estate: Construction, 1 to 4 Family Residential
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	—	$	—	$	—	$	—	$	—	$	—	$	4	$	4
Good	101		1,061		—		—		—		—		16,590		17,752
Satisfactory	1,691		1,952		—		—		—		—		35,262		38,905
Monitor	694		957		—		—		—		—		13,212		14,863
Special Mention	610		364		—		—		—		—		2,784		3,758
Substandard	680		6,136		—		—		—		—		397		7,213
Total	$	3,776	$	10,470	$	—	$	—	$	—	$	—	$	68,249	$	82,495
Current-period gross write offs	$	29	$	225	$	—	$	—	$	—	$	—	$	—	$	254

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

	Real Estate: Construction, Land Development and Commercial
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	—	$	250	$	—	$	—	$	—	$	111	$	1,292	$	1,653
Good	3,440		795		826		947		—		205		9,276		15,489
Satisfactory	18,549		12,184		7,525		572		299		1,022		197,762		237,913
Monitor	2,180		2,264		654		115		—		110		16,690		22,013
Special Mention	1,234		223		118		582		—		—		2,379		4,536
Substandard	10,078		3,775		—		427		—		—		293		14,573
Total	$	35,481	$	19,491	$	9,123	$	2,643	$	299	$	1,448	$	227,692	$	296,177
Current-period gross write offs	$	77	$	119	$	—	$	2	$	—	$	—	$	12	$	210

	Real Estate: Mortgage, Farmland
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	1,580	$	4,695	$	1,985	$	185	$	44	$	—	$	104	$	8,593
Good	5,569		22,379		11,970		7,467		995		1,046		6,795		56,221
Satisfactory	23,712		55,586		38,370		17,215		3,388		9,436		16,054		163,761
Monitor	6,295		14,605		2,978		4,635		273		1,558		555		30,899
Special Mention	2,098		914		1,771		109		231		15		2,854		7,992
Substandard	3,801		1,653		—		—		—		164		—		5,618
Total	$	43,055	$	99,832	$	57,074	$	29,611	$	4,931	$	12,219	$	26,362	$	273,084
Current-period gross write offs	$	21	$	—	$	—	$	—	$	—	$	—	$	—	$	21

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

	Real Estate: Mortgage, 1 to 4 Family First Liens
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	448	$	1,432	$	1,175	$	342	$	—	$	685	$	—	$	4,082
Good	9,642		18,756		5,203		8,330		1,672		11,415		3,051		58,069
Satisfactory	163,621		326,641		182,622		126,161		46,400		140,530		15,176		1,001,151
Monitor	11,890		41,679		17,369		17,411		3,206		12,786		9,258		113,599
Special Mention	1,429		2,535		4,136		1,621		977		3,144		636		14,478
Substandard	262		1,555		2,387		3,181		986		5,246		189		13,806
Total	$	187,292	$	392,598	$	212,892	$	157,046	$	53,241	$	173,806	$	28,310	$	1,205,185
Current-period gross write offs	$	—	$	110	$	6	$	46	$	12	$	25	$	1	$	200

	Real Estate: Mortgage, 1 to 4 Family Junior Liens
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	—	$	—	$	—	$	3	$	—	$	—	$	31	$	34
Good	86		468		186		439		87		478		3,644		5,388
Satisfactory	8,662		13,812		9,415		6,871		3,709		9,160		76,074		127,703
Monitor	514		573		193		448		403		255		2,356		4,742
Special Mention	136		109		335		198		3		104		499		1,384
Substandard	—		35		159		232		41		164		743		1,374
Total	$	9,398	$	14,997	$	10,288	$	8,191	$	4,243	$	10,161	$	83,347	$	140,625
Current-period gross write offs	$	—	$	34	$	7	$	11	$	15	$	66	$	10	$	143

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

	Real Estate: Mortgage, Multi-Family
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	—	$	5,871	$	3,025	$	3,550	$	—	$	252	$	1	$	12,699
Good	29,329		49,951		22,729		24,361		—		8,219		710		135,299
Satisfactory	37,921		79,702		54,534		24,437		2,168		14,045		10,446		223,253
Monitor	10,038		19,322		19,354		19,567		164		1,156		707		70,308
Special Mention	—		1,940		1,018		—		—		—		5,734		8,692
Substandard	169		8,123		—		—		—		—		1,178		9,470
Total	$	77,457	$	164,909	$	100,660	$	71,915	$	2,332	$	23,672	$	18,776	$	459,721
Current-period gross write offs	$	—	$	83	$	—	$	—	$	—	$	—	$	—	$	83

	Real Estate: Mortgage, Commercial
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	1,489	$	1,627	$	560	$	17,201	$	—	$	593	$	—	$	21,470
Good	6,200		18,515		18,140		14,600		1,578		4,018		12,275		75,326
Satisfactory	25,738		46,846		54,008		43,128		10,015		15,807		36,140		231,682
Monitor	9,784		25,522		11,675		11,626		300		8,105		8,441		75,453
Special Mention	183		—		537		547		—		10		1,297		2,574
Substandard	3,445		758		3,825		2,520		613		90		677		11,928
Total	$	46,839	$	93,268	$	88,745	$	89,622	$	12,506	$	28,623	$	58,830	$	418,433
Current-period gross write offs	$	2	$	—	$	36	$	—	$	—	$	—	$	—	$	38

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

	Loans to Individuals
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Good	95		8		—		—		6		—		2		111
Satisfactory	25,314		7,952		3,629		1,418		366		127		224		39,030
Monitor	476		194		78		16		—		14		1		779
Special Mention	101		97		53		—		3		—		—		254
Substandard	40		53		7		1		—		—		—		101
Total	$	26,026	$	8,304	$	3,767	$	1,435	$	375	$	141	$	227	$	40,275
Current-period gross write offs	$	841	$	57	$	30	$	11	$	7	$	—	$	3	$	949

	Obligations of State and Political Subdivisions
September 30, 2023	2023		2022		2021		2020		2019		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	—	$	—	$	—	$	—	$	—	$	4,179	$	—	$	4,179
Good	—		—		—		1,782		—		7,806		—		9,588
Satisfactory	675		2,328		818		2,373		1,171		13,148		5,409		25,922
Monitor	—		334		—		—		290		613		—		1,237
Special Mention	—		115		—		302		165		2,060		3,063		5,705
Substandard	—		—		—		—		—		—		—		—
Total	$	675	$	2,777	$	818	$	4,457	$	1,626	$	27,806	$	8,472	$	46,631
Current-period gross write offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

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(Unaudited)

The following table presents the credit quality indicators by type of loans in each category as of December 31, 2022 (amounts in thousands):

	Agricultural
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	395	$	—	$	199	$	20	$	3	$	—	$	4,196	$	4,813
Good	3,823		550		1,003		427		23		13		9,671		15,510
Satisfactory	17,417		4,144		2,659		855		1,250		48		24,233		50,606
Monitor	12,835		1,885		1,770		891		272		225		19,623		37,501
Special Mention	—		—		—		—		—		—		62		62
Substandard	1,450		—		278		59		166		—		2,260		4,213
Total	$	35,920	$	6,579	$	5,909	$	2,252	$	1,714	$	286	$	60,045	$	112,705

	Commercial and Financial
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	1,644	$	690	$	691	$	—	$	176	$	—	$	8,404	$	11,605
Good	14,733		6,854		2,504		546		105		1,059		15,836		41,637
Satisfactory	57,920		24,028		11,139		4,339		1,979		356		53,618		153,379
Monitor	16,153		7,570		6,031		1,172		260		1		24,434		55,621
Special Mention	1,201		343		278		196		29		391		668		3,106
Substandard	746		477		291		68		—		—		2,638		4,220
Total	$	92,397	$	39,962	$	20,934	$	6,321	$	2,549	$	1,807	$	105,598	$	269,568

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(Unaudited)

	Real Estate: Construction, 1 to 4 Family Residential
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Good	322		—		—		—		—		—		21,467		21,789
Satisfactory	1,962		328		—		—		—		—		47,229		49,519
Monitor	775		182		—		—		—		—		19,886		20,843
Special Mention	—		—		—		—		—		—		38		38
Substandard	—		105		—		—		—		—		114		219
Total	$	3,059	$	615	$	—	$	—	$	—	$	—	$	88,734	$	92,408

	Real Estate: Construction, Land Development and Commercial
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	375	$	—	$	—	$	—	$	—	$	127	$	1,424	$	1,926
Good	2,383		958		947		—		—		221		18,349		22,858
Satisfactory	23,004		7,222		1,191		311		251		828		90,511		123,318
Monitor	8,121		4,788		119		6		33		71		27,551		40,689
Special Mention	—		—		—		—		—		—		—		—
Substandard	7,043		191		53		—		—		—		162		7,449
Total	$	40,926	$	13,159	$	2,310	$	317	$	284	$	1,247	$	137,997	$	196,240

	Real Estate: Mortgage, Farmland
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	4,058	$	58	$	261	$	68	$	—	$	4	$	115	$	4,564
Good	24,552		13,966		7,541		1,582		846		917		7,034		56,438
Satisfactory	47,617		41,878		20,908		3,628		5,258		8,184		11,927		139,400
Monitor	24,754		5,803		5,440		3,478		887		1,221		8,992		50,575
Special Mention	4,284		96		112		—		—		15		—		4,507
Substandard	539		—		—		60		307		180		—		1,086
Total	$	105,804	$	61,801	$	34,262	$	8,816	$	7,298	$	10,521	$	28,068	$	256,570

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(Unaudited)

	Real Estate: Mortgage, 1 to 4 Family First Liens
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	1,507	$	450	$	352	$	—	$	6	$	360	$	—	$	2,675
Good	23,270		5,522		8,346		1,342		2,391		10,401		4,688		55,960
Satisfactory	369,706		201,488		142,417		52,727		47,736		124,754		14,992		953,820
Monitor	29,274		20,868		19,766		3,624		4,546		10,638		6,823		95,539
Special Mention	903		1,216		2,058		1,048		952		2,844		463		9,484
Substandard	1,756		2,086		2,419		833		1,690		3,980		747		13,511
Total	$	426,416	$	231,630	$	175,358	$	59,574	$	57,321	$	152,977	$	27,713	$	1,130,989

	Real Estate: Mortgage, 1 to 4 Family Junior Liens
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	23	$	—	$	7	$	—	$	—	$	—	$	32	$	62
Good	493		189		465		91		—		527		2,023		3,788
Satisfactory	15,543		10,915		7,921		4,523		4,822		7,024		64,649		115,397
Monitor	248		244		507		83		286		188		2,442		3,998
Special Mention	114		134		214		37		12		120		72		703
Substandard	122		69		198		87		57		47		423		1,003
Total	$	16,543	$	11,551	$	9,312	$	4,821	$	5,177	$	7,906	$	69,641	$	124,951

	Real Estate: Mortgage, Multi-Family
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	6,162	$	3,123	$	3,018	$	—	$	—	$	292	$	—	$	12,595
Good	14,175		23,485		26,302		—		—		8,538		1,362		73,862
Satisfactory	97,449		85,441		26,513		2,355		471		14,295		10,604		237,128
Monitor	44,719		26,633		26,252		169		—		1,201		6,219		105,193
Special Mention	8,174		—		—		—		—		—		—		8,174
Substandard	—		—		—		—		—		—		—		—
Total	$	170,679	$	138,682	$	82,085	$	2,524	$	471	$	24,326	$	18,185	$	436,952

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(Unaudited)

	Real Estate: Mortgage, Commercial
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	1,946	$	576	$	21,269	$	—	$	—	$	1,145	$	—	$	24,936
Good	19,682		23,000		14,286		2,026		1,271		4,413		11,689		76,367
Satisfactory	61,055		61,844		38,772		10,590		8,255		14,568		21,933		217,017
Monitor	22,542		13,111		21,909		3,318		1,515		8,212		7,089		77,696
Special Mention	—		3,298		779		—		—		—		689		4,766
Substandard	259		513		927		75		190		96		—		2,060
Total	$	105,484	$	102,342	$	97,942	$	16,009	$	11,231	$	28,434	$	41,400	$	402,842

	Loans to Individuals
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	24	$	—	$	—	$	—	$	—	$	—	$	—	$	24
Good	47		—		—		16		—		—		2		65
Satisfactory	14,053		6,091		2,647		869		335		11,722		133		35,850
Monitor	253		146		49		5		24		—		1		478
Special Mention	88		34		5		9		—		—		—		136
Substandard	45		36		3		2		4		30		2		122
Total	$	14,510	$	6,307	$	2,704	$	901	$	363	$	11,752	$	138	$	36,675

	Obligations of State and Political Subdivisions
December 31, 2022	2022		2021		2020		2019		2018		Prior		Revolving Loans Amortized Cost Basis		Total
Grade:
Excellent	$	—	$	—	$	—	$	—	$	—	$	4,816	$	—	$	4,816
Good	—		—		1,870		—		—		8,342		—		10,212
Satisfactory	2,224		820		1,961		1,492		573		15,677		8,848		31,595
Monitor	344		—		830		181		99		136		—		1,590
Special Mention	—		—		—		—		—		—		—		—
Substandard	—		—		—		—		—		—		—		—
Total	$	2,568	$	820	$	4,661	$	1,673	$	672	$	28,971	$	8,848	$	48,213

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(Unaudited)

Past due loans as of September 30, 2023 and December 31, 2022 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)
September 30, 2023
Agricultural	$	209	$	—	$	—	$	209	$	108,066	$	108,275	$	—
Commercial and financial	1,141		1,117		—		2,258		291,003		293,261		—
Real estate:
Construction, 1 to 4 family residential	1,629		4,452		2,803		8,884		73,611		82,495		—
Construction, land development and commercial	464		1,399		7,935		9,798		286,379		296,177		—
Mortgage, farmland	151		—		—		151		272,933		273,084		—
Mortgage, 1 to 4 family first liens	3,404		464		2,264		6,132		1,199,053		1,205,185		642
Mortgage, 1 to 4 family junior liens	221		120		214		555		140,070		140,625		186
Mortgage, multi-family	1,275		7,639		—		8,914		450,807		459,721		—
Mortgage, commercial	934		—		—		934		417,499		418,433		—
Loans to individuals	222		35		—		257		40,018		40,275		—
Obligations of state and political subdivisions	—		—		—		—		46,631		46,631		—
	$	9,650	$	15,226	$	13,216	$	38,092	$	3,326,070	$	3,364,162	$	828
December 31, 2022
Agricultural	$	314	$	—	$	—	$	314	$	112,391	$	112,705	$	—
Commercial and financial	421		132		6		559		269,009		269,568		—
Real estate:
Construction, 1 to 4 family residential	—		—		105		105		92,303		92,408		—
Construction, land development and commercial	—		1,183		191		1,374		194,866		196,240		—
Mortgage, farmland	24		162		60		246		256,324		256,570		—
Mortgage, 1 to 4 family first liens	3,421		45		3,029		6,495		1,124,494		1,130,989		553
Mortgage, 1 to 4 family junior liens	473		19		8		500		124,451		124,951		—
Mortgage, multi-family	—		—		—		—		436,952		436,952		—
Mortgage, commercial	247		—		75		322		402,520		402,842		—
Loans to individuals	314		53		—		367		36,308		36,675		—
Obligations of state and political subdivisions	—		—		—		—		48,213		48,213		—
	$	5,214	$	1,594	$	3,474	$	10,282	$	3,097,831	$	3,108,113	$	553

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.

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(Unaudited)

Certain nonaccrual and TDR loan information by loan type at September 30, 2023 and December 31, 2022, was as follows:

	September 30, 2023						December 31, 2022
	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	$	—	$	—	$	9	$	—	$	—	$	20
Commercial and financial	1,434		—		858		265		—		1,124
Real estate:
Construction, 1 to 4 family residential	7,144		—		—		105		—		—
Construction, land development and commercial	8,081		—		—		191		—		—
Mortgage, farmland	—		—		1,495		623		—		1,039
Mortgage, 1 to 4 family first liens	4,956		642		920		4,550		553		1,156
Mortgage, 1 to 4 family junior liens	140		186		18		175		—		19
Mortgage, multi-family	7,809		—		508		—		—		620
Mortgage, commercial	6,313		—		2,032		906		—		1,927
Loans to individuals	—		—		—		—		—		—
Obligations of state and political subdivisions	—		—		—		—		—		—
	$	35,877	$	828	$	5,840	$	6,815	$	553	$	5,905

(1)There were $0.60 million and $1.75 million of TDR loans included within nonaccrual loans as of September 30, 2023 and December 31, 2022, respectively.

The increase in nonaccrual loans as of September 30, 2023 compared to December 31, 2022 is primarily due to two significant relationships accounting for approximately 85% of the increase. Loans 90 days or more past due that are still accruing interest increased $0.275 million from December 31, 2022 to September 30, 2023. As of September 30, 2023, there were 10 accruing loans past due 90 days or more with an average loan balance of $0.08 million. There were 4 accruing loans past due 90 days or more as of December 31, 2022 with an average loan balance of $0.14 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. There was no interest income recognized on nonaccrual loans for the nine months ended September 30, 2023 and year ended December 31, 2022.

The Company may modify the terms of a loan to maximize the collection of amounts due.  Such a modification was considered a troubled debt restructuring (“TDR”) prior to adoption of ASU 2022-02 on January 1, 2023.  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.

Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” allows financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time during the COVID-19 pandemic. As of September 30, 2023, the total amount of the eligible loans in deferral (deferral of principal and/or interest) that met the requirements set forth under the CARES Act and therefore were not considered TDRs was 14 loans,

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(Unaudited)

totaling $6.5 million. As of December 31, 2022, there were 16 loans, totaling $7.3 million that met the requirements and were not considered TDRs.

Below is a summary of information for TDR loans as of September 30, 2023 and December 31, 2022:

	September 30, 2023					December 31, 2022
	Number of contracts	Recorded investment		Commitments outstanding		Number of contracts	Recorded investment		Commitments outstanding
		(Amounts In Thousands)					(Amounts In Thousands)
Agricultural	1	$	9	$	170	1	$	20	$	100
Commercial and financial	9	1,022		6		11	1,379		49
Real estate:
Construction, 1 to 4 family residential	—	—		—		1	105		—
Construction, land development and commercial	—	—		—		1	191		—
Mortgage, farmland	4	1,495		—		4	1,578		—
Mortgage, 1 to 4 family first liens	7	1,084		—		8	1,156		—
Mortgage, 1 to 4 family junior liens	1	18		—		1	19		—
Mortgage, multi-family	1	508		—		1	620		—
Mortgage, commercial	9	2,472		—		9	2,584		—
Loans to individuals	—	—		—		—	—		—
Obligations of state and political subdivisions	—	—		—		—	—		—
	32	$	6,608	$	176	37	$	7,652	$	149

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

The following is a summary of TDR loans that were modified during the three and nine months ended September 30, 2022:

	Three Months Ended September 30, 2022					Nine Months Ended September 30, 2022
	Number of contracts	Pre-modification recorded investment		Post-modification recorded investment		Number of contracts	Pre-modification recorded investment		Post-modification recorded investment
		(Amounts In Thousands)					(Amounts In Thousands)
Agricultural	—	$	—	$	—	—	$	—	$	—
Commercial and financial	—	—		—		1	371		371
Real estate:
Construction, 1 to 4 family residential	—	—		—		1	105		105
Construction, land development and commercial	—	—		—		1	191		191
Mortgage, farmland	—	—		—		2	1,021		1,021
Mortgage, 1 to 4 family first lien	—	—		—		—	—		—
Mortgage, 1 to 4 family junior liens	—	—		—		—	—		—
Mortgage, multi-family	—	—		—		—	—		—
Mortgage, commercial	—	—		—		1	274		274
Loans to individuals	—	—		—		—	—		—
Obligations of state and political subdivisions	—	—		—		—	—		—
	—	$	—	$	—	6	$	1,962	$	1,962

The Company has allocated $0.43 million of allowance for TDR loans and the Company had commitments to lend $0.18 million in additional borrowings to restructured loan customers as of September 30, 2023.  The Company had commitments to lend $0.15 million in additional borrowings to restructured loan customers as of December 31, 2022.  These commitments were in the normal course of business. The additional borrowings were not used to facilitate payments on these loans. The modifications of the terms of loans performed during the nine months ended September 30, 2022 included extensions of the maturity date.

There was one TDR loan that was in payment default (defined as past due 90 days or more) during the period ended September 30, 2023 and no TDR loans that were in payment default during the year ended December 31, 2022.

The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon asset origination or acquisition. The starting point for the estimate of the allowance for credit losses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification.

Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification.

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(Unaudited)

In some cases, the Company will modify a certain loan by providing multiple types of concessions. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness, may be granted.

The following table shows the amortized cost basis at the end of the reporting period of the loans modified to borrowers experiencing financial difficulty, disaggregated by class of financing receivable and type of concession granted (numbers in thousands):

Loan Modifications Made to Borrowers Experiencing Financial Difficulty
	Term Extension
	Amortized Cost Basis at September 30, 2023		% of Total Class of Financing Receivable
Loan Type
Mortgage, Farmland	$	1,227	0.45%
Agricultural	117		0.11%
Commercial and financial	139		0.05%
Total	$	1,483

The following table describes the financial effect of the modifications made to borrowers experiencing financial difficulty:

Term Extension
Loan Type	Financial Effect
Mortgage, Farmland	Added a weighted-average 5.3 years to the life of loans, which reduced monthly payment amounts for the borrowers.
Agricultural	Added a weighted-average 0.30 year to the life of loans, which reduced monthly payment amounts for the borrowers.
Commercial and financial	Added a weighted-average 5.09 year to the life of loans, which reduced monthly payment amounts for the borrowers.

Upon the Company's determination that a modified loan (or portion of a loan) has subsequently been deemed uncollectible, the loan (or a portion of the loan) is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses is adjusted by the same amount.

There were no financing receivables that had a payment default during the period and were modified in the 12 months before default to borrowers experiencing financial difficulty.

The Company closely monitors the performance of the loans that are modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. The following table depicts the performance of loans that have been modified in the last 12 months (numbers in thousands):

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(Unaudited)

Payment Status (Amortized Cost Basis)
	Current		30-89 Days Past Due		90+ Days Past Due
Loan Type
Mortgage, Farmland	$	1,227	$	—	$	—
Agricultural	117		—		—
Commercial and financial	139		—		—
	$	1,483	$	—	$	—

The following table presents the amortized cost basis of collateral dependent loans, by the primary collateral type, which are individually evaluated to determine expected credit losses, and the related ACL allocated to these loans:

	Primary Type of Collateral
	Real Estate		Accounts Receivable		Equipment		Other		Total		ACL Allocation
	(Amounts In Thousands)
September 30, 2023
Agricultural	$	126	$	—	$	—	$	—	$	126	$	—
Commercial and financial	2,285		—		146		—		2,431		1,349
Real estate:
Construction, 1 to 4 family residential	7,144		—		—		—		7,144		873
Construction, land development and commercial	8,081		—		—		—		8,081		312
Mortgage, farmland	2,553		—		169		—		2,722		—
Mortgage, 1 to 4 family first liens	6,517		—		—		—		6,517		14
Mortgage, 1 to 4 family junior liens	344		—		—		—		344		—
Mortgage, multi-family	8,317		—		—		—		8,317		—
Mortgage, commercial	8,345		—		—		—		8,345		1,070
Loans to individuals	—		—		—		—		—		—
Obligations of state and political subdivisions	—		—		—		—		—		—
	$	43,712	$	—	$	315	$	—	$	44,027	$	3,618

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(Unaudited)

	Primary Type of Collateral
	Real Estate		Accounts Receivable		Equipment		Other		Total		ACL Allocation
	(Amounts In Thousands)
December 31, 2022
Agricultural	$	197	$	—	$	—	$	—	$	197	$	—
Commercial and financial	1,385		—		74		—		1,459		4
Real estate:
Construction, 1 to 4 family residential	382		—		—		—		382		105
Construction, land development and commercial	191		—		—		—		191		—
Mortgage, farmland	1,482		—		180		—		1,662		—
Mortgage, 1 to 4 family first liens	6,012		—		—		—		6,012		44
Mortgage, 1 to 4 family junior liens	193		—		—		—		193		1
Mortgage, multi-family	620		—		—		—		620		—
Mortgage, commercial	2,833		—		—		—		2,833		1
Loans to individuals	30		—		—		—		30		29
Obligations of state and political subdivisions	—		—		—		—		—		—
	$	13,325	$	—	$	254	$	—	$	13,579	$	184

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(Unaudited)

The changes in the ACL in 2023 compared to December 31, 2022 is the result of the following factors: slight increase in forecasted Iowa unemployment used in the ACL calculation which resulted in an increase of $0.32 million; increase in loan volume which resulted in an increase of $1.45 million; changes in prepayment and curtailment rates resulting in an increase of $0.73 million; increase in the individually analyzed loans reserve of $3.44 million; decreases in qualitative factors determined necessary by management which resulted in a decrease of $1.01 million and an increase in other changes of $2.03 million, primarily increased charge-offs leading to higher loss rates.

The extent to which collateral secures collateral-dependent loans is provided in the previous individually analyzed loans table and changes in the extent to which collateral secures its collateral-dependent loans are described below. Collateral-dependent loans increased $30.45 million from December 31, 2022 to September 30, 2023.  Collateral-dependent loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more, TDR loans and loans made to borrowers with financial difficulties. Collateral-dependent 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.  Collateral-dependent loans were 1.31% of loans held for investment as of September 30, 2023 and 0.44% as of December 31, 2022.  The increase in collateral-dependent loans is due to an increase in loans facing financial difficulties of $1.48 million, a decrease in loans with a specific reserve of $0.28 million, an increase in nonaccrual loans of $29.06 million, an increase in 90 days or more accruing loans of $0.28 million and a decrease in TDR loans of $0.07 million from December 31, 2022 to September 30, 2023. There were no significant changes noted in the extent to which collateral secures collateral-dependent loans.

The Company regularly reviews a substantial portion of the loans in the portfolio and assesses whether the loans share common risk characteristics for which expected credit loss is measured on a pool basis or if the loans do not share common risk characteristics and therefore expected credit loss is measured on an individual loan basis.  If the loans are assessed for credit losses on an individual basis, 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 or modified to a borrower experiencing financial difficulties.  Loans that are determined not to be collateral-dependent and for which there are no specific allowances are classified into one or more risk categories and expected credit loss is measured on a pool basis. See Note 1 for further discussion of the allowance for credit losses for loans held for investment.

Specific allowances for credit losses on loans assessed individually are established if the loan balances exceed the net present value of the relevant future cash flows or the fair value of the relevant collateral based on updated appraisals and/or updated collateral analysis for the properties if the loan is collateral dependent.  The Company may recognize a charge off or record a specific allowance related to an individually analyzed 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 credit loss 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 variables affecting its value may have changed since the appraisal was performed. 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.

Note 6.Leases

The Bank leases certain of its branch offices, parking facilities and certain equipment under operating leases. The leases have remaining lease terms of 1 year to 10 years, some of which include options to extend the leases for up to 10 years, and some of which include options to terminate the leases within 1 year. As the options are reasonably certain to be exercised, they are recognized as part of the right-of-use assets and lease liabilities.

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(Unaudited)

For the nine months ended September 30, 2023 and 2022, total operating lease expense was $0.38 million and $0.44 million respectively, and is included in occupancy expenses in the consolidated statements of income. Included in this for the nine months ended September 30, 2023 and 2022 were $0.33 million and $0.38 million, respectively, of operating lease costs, $0.02 million and $0.03 million, respectively, of short term lease costs, and $0.03 million and $0.03 million, respectively, of variable lease costs.

For the nine months ended September 30, 2023 and 2022, cash paid for amounts included in the measurement of operating lease liabilities was $0.33 million and $0.38 million, respectively.

As of September 30, 2023 and December 31, 2022, operating lease right-of-use assets included in other assets was $1.89 million and $2.11 million respectively. Operating lease liabilities included in other liabilities were $1.98 million and $2.19 million as of September 30, 2023 and December 31, 2022. As of September 30, 2023 and December 31, 2022, the weighted average remaining lease term for operating leases was 9.35 years and 9.72 years, respectively, and the weighted average discount rate for operating leases was 3.49% and 3.54%, respectively. Discount rates used were determined from FHLB borrowing rates for comparable terms.

As of September 30, 2023, maturities of lease liabilities were as follows:

Year ending December 31:	(Amounts In Thousands)
2023 (excluding the nine months ended September 30, 2023)	$	69
2024	260
2025	263
2026	266
2027	264
Thereafter	1,239
Total lease payments	2,361
Less imputed interest	(383)
Total operating lease liabilities	$	1,978

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(Unaudited)

Note 7.Fair Value Measurements

The carrying value and estimated fair values of the Company's financial instruments as of September 30, 2023 are as follows:

	September 30, 2023
	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	$	109,609	$	109,609	$	109,609	$	—	$	—
Investment securities	715,079		715,079		412,238		302,841		—
Loans held for sale	4,236		4,236		—		4,236		—
Loans, net of allowance for credit losses
Agricultural	105,865		104,528		—		—		104,528
Commercial and financial	285,569		280,278		—		—		280,278
Real estate:
Construction, 1 to 4 family residential	80,556		80,357		—		—		80,357
Construction, land development and commercial	290,919		280,908		—		—		280,908
Mortgage, farmland	269,865		250,169		—		—		250,169
Mortgage, 1 to 4 family first liens	1,192,031		1,104,320		—		—		1,104,320
Mortgage, 1 to 4 family junior liens	137,123		131,432		—		—		131,432
Mortgage, multi-family	455,578		427,281		—		—		427,281
Mortgage, commercial	413,168		390,365		—		—		390,365
Loans to individuals	39,085		37,771		—		—		37,771
Obligations of state and political subdivisions	46,352		44,198		—		—		44,198
Accrued interest receivable	19,667		19,667		—		19,667		—
Total financial instrument assets	$	4,164,702	$	3,980,198	$	521,847	$	326,744	$	3,131,607
Financial instrument liabilities
Deposits
Noninterest-bearing deposits	$	605,697	$	605,697	$	—	$	605,697	$	—
Interest-bearing deposits	2,757,601		2,758,739		—		2,758,739		—
Federal Home Loan Bank borrowings	364,000		364,532		—		364,532		—
Accrued interest payable	4,641		4,641		—		4,641		—
Total financial instrument liabilities	$	3,731,939	$	3,733,609	$	—	$	3,733,609	$	—
	Face Amount
Financial instrument with off-balance sheet risk:
Loan commitments	$	670,780	$	—	$	—	$	—	$	—
Letters of credit	7,265		—		—		—		—
Total financial instrument liabilities with off-balance-sheet risk	$	678,045	$	—	$	—	$	—	$	—

(1)Considered Level 1 under Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”).

(2)Considered Level 2 under ASC 820.

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

The carrying value and estimated fair values of the Company's financial instruments as of December 31, 2022 are as follows:

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(Unaudited)

	December 31, 2022
	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	$	36,641	$	36,641	$	36,641	$	—	$	—
Investment securities	782,565		782,565		445,392		337,173		—
Loans held for sale	1,663		1,663		—		1,663		—
Loans, net of allowance for credit losses
Agricultural	110,163		108,992		—		—		108,992
Commercial and financial	263,309		259,500		—		—		259,500
Real estate:
Construction, 1 to 4 family residential	91,297		91,279		—		—		91,279
Construction, land development and commercial	193,162		188,726		—		—		188,726
Mortgage, farmland	253,581		237,849		—		—		237,849
Mortgage, 1 to 4 family first liens	1,120,150		1,055,091		—		—		1,055,091
Mortgage, 1 to 4 family junior liens	121,890		118,279		—		—		118,279
Mortgage, multi-family	432,517		411,092		—		—		411,092
Mortgage, commercial	397,861		377,753		—		—		377,753
Loans to individuals	35,278		36,934		—		—		36,934
Obligations of state and political subdivisions	47,773		45,653		—		—		45,653
Accrued interest receivable	15,782		15,782		—		15,782		—
Total financial instrument assets	$	3,903,632	$	3,767,799	$	482,033	$	354,618	$	2,931,148
Financial instrument liabilities:
Deposits
Noninterest-bearing deposits	$	647,450	$	647,450	$	—	$	647,450	$	—
Interest-bearing deposits	2,709,917		2,711,088		—		2,711,088		—
Other short-term borrowings, federal funds purchased	82,061		82,061		—		82,061		—
Federal Home Loan Bank borrowings	40,000		40,000		—		40,000		—
Accrued interest payable	1,394		1,394		—		1,394		—
Total financial instrument liabilities	$	3,480,822	$	3,481,993	$	—	$	3,481,993	$	—
	Face Amount
Financial instrument with off-balance sheet risk:
Loan commitments	$	701,729	$	—	$	—	$	—	$	—
Letters of credit	6,618		—		—		—		—
Total financial instrument liabilities with off-balance-sheet risk	$	708,347	$	—	$	—	$	—	$	—

 Considered Level 1 under ASC 820.

(1)Considered Level 2 under ASC 820.

(2)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

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(Unaudited)

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.

ASSETS

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. U.S. Treasury securities are considered Level 1 with the remaining securities considered Level 2.

The pricing for investment securities is obtained from an independent source.  There are no 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 nine months ended September 30, 2023. If a fluctuation requiring investigation was identified, the Company would research the change with the independent source or other available information.

Individually analyzed loans under ASC 326 CECL: See Note 1 for further discussion of individually analyzed loans under CECL.

A loan is considered to be non-performing when it is probable that all of the principal and interest due may not be collected according to its contractual terms. Generally, when a loan is considered non-performing, the amount of reserve is measured based on the fair value of the underlying collateral. The Company makes such measurements on all material loans deemed non-performing using the fair value of the collateral for collateral dependent loans or based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or the fair value of the loan if determinable. The fair value of collateral used by the Company is determined by obtaining an observable market price or by obtaining an appraised value from an independent, licensed or certified appraiser, using observable market data. This data includes information such as selling price of similar properties and capitalization rates of similar properties sold within the market, expected future cash flows or earnings of the subject property based on current market expectations, and other relevant factors. All appraised values are adjusted for market-related trends based on the Company's experience in sales and other appraisals of similar property types as well as estimated selling costs. 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

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(Unaudited)

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).

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:

	September 30, 2023
	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	$	412,238	$	—	$	—	$	412,238
State and political subdivisions	—		206,396		—		206,396
Mortgage-backed securities and collateralized mortgage obligations	—		44,776		—		44,776
Other securities (FHLB, FHLMC and FNMA)	—		32,324		—		32,324
Total	$	412,238	$	283,496	$	—	$	695,734

	December 31, 2022
	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	$	445,392	$	—	$	—	$	445,392
State and political subdivisions	—		248,582		—		248,582
Mortgage-backed securities and collateralized mortgage obligations	—		50,196		—		50,196
Other securities (FHLB, FHLMC and FNMA)	—		31,934		—		31,934
Total	$	445,392	$	330,712	$	—	$	776,104

(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 nine months ended September 30, 2023 and the year ended December 31, 2022.

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(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.

	September 30, 2023								Three Months Ended September 30, 2023		Nine Months Ended September 30, 2023
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Total Losses		Total Losses
	(Amounts in Thousands)
Loans (4)
Agricultural	$	—	$	—	$	117	$	117	$	—	$	419
Commercial and financial	—		—		1,047		1,047		3		29
Real Estate:											—
Construction, 1 to 4 family residential	—		—		6,271		6,271		—		—
Construction, land development and commercial	—		—		7,768		7,768		—		—
Mortgage, farmland	—		—		2,722		2,722		—		—
Mortgage, 1 to 4 family first liens	—		—		6,004		6,004		9		120
Mortgage, 1 to 4 family junior liens	—		—		158		158		—		—
Mortgage, multi-family	—		—		8,317		8,317		—		—
Mortgage, commercial	—		—		7,224		7,224		—		—
Loans to individuals	—		—		—		—		—		—
Foreclosed assets (5)	—		—		—		—		—		—
Total	$	—	$	—	$	39,628	$	39,628	$	12	$	568

(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, 2022								Year Ended December 31, 2022
	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	$	—	$	—	$	—	$	—	$	—
Commercial and financial	—		—		1,324		1,324		225
Real Estate:
Construction, 1 to 4 family residential	—		—		277		277		—
Construction, land development and commercial	—		—		191		191		—
Mortgage, farmland	—		—		1,662		1,662		123
Mortgage, 1 to 4 family first liens	—		—		5,639		5,639		367
Mortgage, 1 to 4 family junior liens	—		—		193		193		5
Mortgage, multi-family	—		—		620		620		50
Mortgage, commercial	—		—		2,778		2,778		—
Loans to individuals	—		—		—		—		—
Foreclosed assets (5)	—		—		—		—		—
Total	$	—	$	—	$	12,684	$	12,684	$	770

(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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Note 8.Stock Repurchase Program

On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of 1,500,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  On August 9, 2022, the Company’s Board of Directors authorized the expansion of the 2005 Stock Repurchase Program to allow an additional 750,000 shares for repurchase and the continuation through December 31, 2027. 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 1,603,962 shares of its common stock in privately negotiated transactions from August 1, 2005 through September 30, 2023.  Of these 1,603,962 shares, 27,699 shares were purchased during the quarter ended September 30, 2023, at an average price per share of $66.00.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 9. Commitments and Contingencies

Concentrations of credit risk:  The Company’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Company's market area.  Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $75.92 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 Company 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 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 conditions, or results of operations.

Financial instruments with off-balance sheet risk:  The Company 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 Company’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 Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  A summary of the Company’s commitments at September 30, 2023 and December 31, 2022 is as follows:

	September 30, 2023		December 31, 2022
	(Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:
Home equity loans	$	85,973	$	84,869
Credit cards	71,008		66,535
Commercial, real estate and home construction	214,969		241,983
Commercial lines and real estate purchase loans	298,830		308,342
Outstanding letters of credit	7,265		6,618

Note 10.Income Taxes

Federal income tax expense for the nine months ended September 30, 2023 and 2022 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, 2022, 2021, and 2020 remain subject to examination by the Internal Revenue Service.  For state tax purposes, the tax years ended December 31, 2022, 2021, and 2020 remain open for examination.  There were no material unrecognized tax benefits at September 30, 2023  and December 31, 2022 and therefore no interest or penalties on unrecognized tax benefits has been recorded.  As of September 30, 2023, the Company does not anticipate any significant increase in unrecognized tax benefits during the twelve-month period ending September 30, 2024. Income taxes as a percentage of income before taxes were 21.16% for the nine months ended September 30, 2023 and 22.70% for the same period in 2022. 

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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:

•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. This includes current concerns related to higher inflation, rising energy prices, the Russia-Ukraine war, Israeli-Palestinian conflict, and supply chain imbalances.

•The effects of recent financial market disruptions and/or an economic recession, and monetary and other governmental actions designed to address such disruptions, including in response to the COVID-19 pandemic.

•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 recognition of an allowance for credit losses on the affected securities and the recognition of a credit 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, including, but not limited to, potential changes in U.S. tax laws and regulations.

•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.

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•The ability of the Company to develop and maintain secure and reliable technology 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, diseases and/or pandemics, and 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.

Economic Environment

The global economy continues to shrug off elevated inflation and rising interest rates, though economic growth is likely to moderate into year-end. Global inflation may also continue to moderate slowly, with some supply constraints a key risk. After a strong first half, higher interest rates are likely to begin dampening U.S. consumer spending as year-end approaches and temper inflation somewhat in the process. Many economists continue to expect U.S. economic conditions consistent with a soft-landing as the economy decelerates into early next year. However, persistent inflation may force additional Fed rate hikes, raising the odds of a mild recession in 2024. The tight labor market, with 1.5 job openings per unemployed worker in July, is likely to ease in coming months, and the restart of student loan payments and tougher lending standards should further decelerate economic activity. Higher borrowing costs continue to present a risk to the economy, with consumer and business budgets accounting for higher interest costs. In addition, federal debt service costs totaled 14% of federal spending as of July 2023. Nonetheless, interest rate levels and energy prices, in combination with global economic conditions, fiscal and monetary policy and the level of regulatory and government scrutiny of financial institutions will likely continue to impact our results throughout the remainder of 2023 and possibly into 2024.

Our credit administration continues to closely monitor and analyze the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. Based on the Company’s capital levels, prudent underwriting policies, loan concentration diversification and our geographic footprint, senior management is cautiously optimistic that the Company is positioned to continue managing the impact of the varied set of risks and uncertainties currently impacting the economy and remain adequately capitalized. However, the Company may be required to make additional credit loss provisions as warranted by the extremely fluid economic condition.

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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 credit losses.

Allowance for Credit Losses

On January 1, 2021, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires the allowance for credit losses use the current expected credit loss (CECL) methodology. The following is a discussion of the methodologies used by the Company with the adoption of ASC 326.

The preparation of financial statements in accordance with the accounting principles generally accepted in the United States ("U.S. GAAP") requires management to make a number of judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expense in the financial statements. Various elements of our accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions. Some of these policies and estimates relate to matters that are highly complex and contain substantial inherent uncertainties. Management has made significant estimates in several areas, including the allowance for credit losses (see Note 5 - Loans and Note 4 - Securities) and the fair value of debt securities (see Note 4 - Securities).

We have identified the following accounting policies and estimates that, due to the inherent judgments and assumptions and the potential sensitivity of the financial statements to those judgments and assumptions, are critical to an understanding of our financial statements. We believe that the judgments, estimates and assumptions used in the preparation of the Company's financial statements are appropriate. For a further description of our accounting policies, see Note 1 - Summary of Significant Accounting Policies in the financial statements included in this Form 10-Q.

The allowance for credit losses for loans represents management's estimate of all expected credit losses over the expected contractual life of our existing loan portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods.

We employ a disciplined process and methodology to establish our allowance for credit losses that has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics.

Based upon this methodology, management establishes an asset-specific allowance for loans that do not share risk characteristics with other loans based on the amount of expected credit losses calculated on those loans and charges off amounts determined to be uncollectible. Factors we consider in measuring the extent of expected credit loss include payment status, collateral value, borrower financial condition, guarantor support and the probability of collecting scheduled principal and interest payments when due.

When a loan does not share risk characteristics with other loans, we measure expected credit loss as the difference between the amortized cost basis in the loan and the present value of expected future cash flows discounted at the loan's effective interest rate except that, for collateral- dependent loans, credit loss is measured as the difference between the amortized cost basis in the loan and the fair value of the underlying collateral. The fair value of the collateral is adjusted for the estimated cost to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral. In accordance with our appraisal policy, the fair value of collateral-dependent loans is based upon independent third-party appraisals or on collateral valuations prepared by in-house evaluations. Once a third-party appraisal is greater than one year old, or if its determined that market conditions, changes to the property, changes in intended use of the property or other factors indicate that an appraisal is no longer reliable, we perform an internal collateral valuation to assess whether a change in collateral value requires an additional adjustment to carrying value. When we receive an updated appraisal or collateral valuation, management reassesses the need for adjustments to the loan's expected credit loss measurements and, where appropriate, records an

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adjustment. If the calculated expected credit loss is determined to be permanent, fixed or nonrecoverable, the credit loss portion of the loan will be charged off against the allowance for credit losses. Loans designated having significantly increased credit risk are generally placed on nonaccrual and remain in that status until all principal and interest payments are current and the prospects for future payments in accordance with the loan agreement are reasonably assured, at which point the loan is returned to accrual status.

In estimating the component of the allowance for credit losses for loans that share common risk characteristics, loans are segregated into loan classes. Loans are designated into loan classes based on loans pooled by product types and similar risk characteristics or areas of risk concentration. Credit loss assumptions are estimated using a model that categorizes loan pools based on loan type and purpose. This model calculates an expected life-of-loan loss percentage for each loan category by considering the probability of default using historical life-of-loan analysis periods for agricultural, 1 to 4 family first and junior liens, commercial and consumer segments, and the severity of loss, based on the aggregate net lifetime losses incurred per loan class.

The component of the allowance for credit losses for loans that share common risk characteristics also considers factors for each loan class to adjust for differences between the historical period used to calculate historical default and loss severity rates and expected conditions over the remaining lives of the loans in the portfolio related to:

•Lending policies and procedures;

•International, national, regional and local economic business conditions and developments that affect the collectability of the portfolio, including the condition of various markets;

•The nature of the loan portfolio, including the terms of the loans;

•The experience, ability and depth of the lending management and other relevant staff;

•The volume and severity of past due and adversely classified or graded loans and the volume of nonaccrual loans;

•The quality of our loan review and process;

•The value of underlying collateral for collateral-dependent loans;

•The existence and effect of any concentrations of credit and changes in the level of such concentrations; and

•The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

Such factors are used to adjust the historical probabilities of default and severity of loss so that they reflect management expectation of future conditions based on a reasonable and supportable forecast. To the extent the lives of the loans in the portfolio extend beyond the period for which a reasonable and supportable forecast can be made, the Company reduces, on a straight-line basis over the remaining life of the loans, the adjustments so that model reverts back to the historical rates of default and severity of loss.

The credit loss expense recorded through earnings is the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors.

The allowance for credit losses for loans, as reported in our consolidated balance sheet, is adjusted by an expense for credit losses, which is recognized in earnings, and reduced by the charge-off of loan amounts, net of recoveries. For further information on the allowance for credit losses for loans, see Note 1 - Summary of Significant Accounting Policies and Note 5 - Loans in the notes to the financial statements of this Form 10-Q.

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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, Marion, and Washington, Iowa.  At September 30, 2023, the Bank has eighteen full-service locations.

Net income for the nine month period ended September 30, 2023 was $31.27 million compared to $35.72 million for the same nine months of 2022, a decrease of $4.45 million or 12.45%.  The principal factors in the decrease in net income for the first nine months of 2023 were an increase in credit loss expense of $6.70 million and an increase in noninterest expense of $2.09 million, offset by an increase in net interest income of $2.13 million.

The Company achieved a return on average assets of 1.07% and a return on average equity of 10.01% for the twelve months ended September 30, 2023, compared to the twelve months ended September 30, 2022, which were 1.05% and 9.85%, respectively. The return on average assets and return on average equity for the nine months ended September 30, 2023 were 1.03% and 9.58%, respectively, compared to the nine months ended September 30, 2022, which were 1.19% and 11.28%, respectively.  Dividends of $1.05 per share were paid in January 2023 to 2,718 shareholders.  The dividend paid in January 2022 was $1.00 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 2.92% for the nine months ended September 30, 2023 compared to 2.92% for the same nine months of 2022.  Average earning assets were $4.022 billion year to date in 2023 and $3.924 billion in 2022.

Highlights noted on the balance sheet as of September 30, 2023 for the Company included the following:

•Total assets were $4.246 billion, an increase of $265.25 million since December 31, 2022.

•Cash and cash equivalents were $109.61 million, an increase of $72.97 million since December 31, 2022. The majority of the increase can be attributed to approximately $100 million of temporary public funds.

•Net loans were $3.320 billion, an increase of $251.70 million since December 31, 2022. The increase is primarily attributable to approximately $99.94 million growth in land development and commercial construction loans, $16.51 million growth in farmland mortgages, $89.87 million growth in 1-4 family mortgages, $23.69 million in commercial and financial loans and $22.77 million growth in multi-family mortgages since December 31, 2022. Loans held for sale increased $2.57 million since December 31, 2022.

•Deposits increased $5.93 million since December 31, 2022.

•Borrowings have increased $241.94 million since December 31, 2022, primarily to fund loan growth during 2023.

Refer to Note 7 for a discussion of fair value measurements which relate to methods used by the Company in recording assets and liabilities on its financial statements.

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Financial Condition

There has been continued loan demand in 2023, primarily in land development and commercial construction, farmland mortgages, 1 to 4 family mortgages, commercial and financial, multi-family, and commercial real estate. The lingering inflationary pressures have created significant uncertainty regarding projecting loan demand throughout the remainder of 2023.

The following table sets forth the composition of the loan portfolio as of September 30, 2023 and December 31, 2022:

	September 30, 2023				December 31, 2022
	Amount		Percent		Amount		Percent
	(Amounts In Thousands)				(Amounts In Thousands)
Agricultural	$	108,275	3.22	%	$	112,705	3.63	%
Commercial and financial	293,261		8.72		269,568		8.67
Real estate:
Construction, 1 to 4 family residential	82,495		2.45		92,408		2.97
Construction, land development and commercial	296,177		8.80		196,240		6.31
Mortgage, farmland	273,084		8.11		256,570		8.25
Mortgage, 1 to 4 family first liens	1,205,185		35.82		1,130,989		36.40
Mortgage, 1 to 4 family junior liens	140,625		4.18		124,951		4.02
Mortgage, multi-family	459,721		13.67		436,952		14.06
Mortgage, commercial	418,433		12.44		402,842		12.96
Loans to individuals	40,275		1.20		36,675		1.18
Obligations of state and political subdivisions	46,631		1.39		48,213		1.55
	$	3,364,162	100.00	%	$	3,108,113	100.00	%
Net unamortized fees and costs	349				308
	$	3,364,511			$	3,108,421
Less allowance for credit losses	48,400				41,440
	$	3,316,111			$	3,066,981

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 Company 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 Company.  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 Company does not originate subprime loans.  In order to modify, restructure or otherwise change the terms of a loan, the Company’s policy is to evaluate each borrower situation individually.  Modifications, restructures, extensions and other changes are done to improve the Company’s position and to protect the Company’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.

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In accordance with Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues, and Staff Accounting Bulletin No. 119, which aligns the staff's guidance with FASB ASC Topic 326, or CECL, 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 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 may be downgraded and the uncollectible amount charged-off or recorded as a specific allowance for losses.  The Company’s credit and legal departments undertake a thorough and ongoing analysis to determine if additional specific reserves and/or charge-offs are appropriate and to begin a workout plan for the loan to minimize actual losses.

The following table presents the allowance for credit losses as of September 30, 2023 and December 31, 2022 by loan category, the percentage of the allowance for each category to the total allowance, and the percentage of all loans in each category to total loans:

	September 30, 2023						December 31, 2022
	Amount		% of Total Allowance		% of Loans to Total Loans		Amount		% of Total Allowance		% of Loans to Total Loans
	(In Thousands)						(In Thousands)
Agricultural	$	2,410	4.98	%	3.22	%	$	2,542	6.13	%	3.63	%
Commercial and financial	7,692		15.89		8.72		6,259		15.10		8.67
Real estate:
Construction, 1 to 4 family residential	1,939		4.01		2.45		1,111		2.68		2.97
Construction, land development and commercial	5,258		10.86		8.80		3,078		7.43		6.31
Mortgage, farmland	3,219		6.65		8.11		2,989		7.21		8.25
Mortgage, 1 to 4 family first liens	13,503		27.90		35.82		11,147		26.91		36.40
Mortgage, 1 to 4 family junior liens	3,502		7.23		4.18		3,061		7.39		4.02
Mortgage, multi-family	4,143		8.56		13.67		4,435		10.70		14.06
Mortgage, commercial	5,265		10.88		12.44		4,981		12.02		12.96
Loans to individuals	1,190		2.46		1.20		1,397		3.37		1.18
Obligations of state and political subdivisions	279		0.58		1.39		440		1.06		1.55
	$	48,400	100.00	%	100.00	%	$	41,440	100.00	%	100.00	%

The allowance for credit losses (ACL) totaled $48.40 million at September 30, 2023 compared to the allowance of $41.44 million at December 31, 2022. The percentage of the allowance to outstanding loans was 1.44% and 1.33% at September 30, 2023 and December 31, 2022, 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 changes in the ACL in 2023 compared to December 31, 2022 is the result of the following factors: slight increase in the forecasted Iowa unemployment used in the ACL calculation which resulted in an increase of $0.32 million; increase in loan

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volume which resulted in an increase of $1.45 million; changes in prepayment and curtailment rates resulting in an increase of $0.73 million; increase in the individually analyzed loans reserve of $3.44 million; changes in qualitative factors determined necessary by management which resulted in a decrease of $1.01 million and an increase in other changes of $2.03 million, primarily increased charge-offs leading to higher loss rates.

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 nonperforming loans are significant elements in the determination of the provision for credit 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 nonperforming loans, trends in modified loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates.

Management has determined that the allowance for credit losses was adequate at September 30, 2023, 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 credit 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 credit losses is reviewed and compared to industry data. This review encompasses levels of total collateral-dependent loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs.

Investment securities available for sale held by the Company decreased by $80.37 million from December 31, 2022 to September 30, 2023.  The fair value of securities available for sale was $61.43 million less than the amortized cost of such securities as of September 30, 2023.  The decrease in investment securities is due to unrealized losses from the increases in interest rates over the last two years as well as the Company utilizing investment maturities to fund loan growth the last two years. At December 31, 2022, the fair value of the securities available for sale was $54.20 million less than the amortized cost of such securities.

Deposits increased $5.93 million in the first nine months of 2023. The increase can be attributed to approximately $100 million of temporary public funds received in September 2023. 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 $24.10 million as of September 30, 2023 with an average rate of 5.35%.  Brokered deposits were $31.74 million as of December 31, 2022 with an average interest rate of 2.60%. As of September 30, 2023 and December 31, 2022, brokered deposits were 0.72% and 0.95% of total deposits, respectively.

There were $364 million and $40 million of Federal Home Loan Bank (FHLB) borrowings as of September 30, 2023 and December 31, 2022, respectively. There were no Federal Funds purchased as of September 30, 2023 and $82.06 million as of December 31, 2022. It is expected that the FHLB and Federal Funds funding sources will be considered in the future if loan growth continues to exceed core deposit increases and the interest rates on funds borrowed from the FHLB and Federal Funds are favorable compared to other funding alternatives. Also, the Bank Term Funding Program was established by the Federal Reserve in March 2023 to provide an additional source of liquidity against high-quality securities. As of September 30, 2023, the Company had no borrowings from the Bank Term Funding Program though has provided investment securities as collateral for potential future funding needs.

Dividends and Equity

In January 2023, Hills Bancorporation paid a dividend of $9.69 million or $1.05 per share.  The dividend paid in January 2022 was $1.00 per share. After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of September 30, 2023 totaled $445.33 million.

The Company elected to use the Community Bank Leverage Ratio (CBLR) framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act. Under the CBLR framework, the Company is required to maintain a CBLR of greater than 9%, as measured by dividing the Bank's Tier 1 capital by its average total consolidated assets. As of September 30, 2023 and December 31, 2022, the Company had regulatory capital in excess of the Federal Reserve’s minimum

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and well-capitalized definition requirements. The actual amounts and capital ratios as of September 30, 2023 and December 31, 2022 are presented below (amounts in thousands):

	Actual
	Amount of Tier 1 Capital		Ratio
As of September 30, 2023:
Company:
Community Bank Leverage ratio	$	534,230	12.88	%
Bank:
Community Bank Leverage ratio	536,634		12.94

	Actual
	Amount of Tier 1 Capital		Ratio
As of December 31, 2022:
Company:
Community Bank Leverage ratio	$	517,831	13.27	%
Bank:
Community Bank Leverage ratio	520,149		13.33

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Discussion of operations for the nine months ended September 30, 2023 and 2022

Net Income Overview

Total net income was $31.27 million in 2023 and $35.72 million in the comparable period in 2022, a decrease of $4.45 million or 12.45%.  The change in net income in 2023 from the first nine months of 2022 was primarily the result of the following:

•Net interest income increased by $2.13 million, before credit loss expense.

•For the nine months ended September 30, 2023, credit loss expense was $9.97 million. This represents an increase in expense of $6.70 million from the credit loss expense of $3.27 million for the nine months ended September 30, 2022.

•Noninterest income increased by $0.12 million.

•Noninterest expenses increased by $2.09 million.

•Income tax expense decreased by $2.10 million.

For the nine month period ended September 30, 2023 and September 30, 2022 basic earnings per share was $3.40 and $3.85, respectively. Diluted earnings per share was $3.40 for the nine months ended September 30, 2023 compared to $3.85 for the same period in 2022.

The Company’s net income for the period was driven primarily by four factors.  The first factor is credit loss expense. The majority of the Company’s interest-earning assets are in loans outstanding, which amounted to more than $3.320 billion at September 30, 2023. Credit loss expense was $9.97 million in 2023 compared to $3.27 million in 2022. The increase in expense when compared to the same period in 2022 is primarily attributable to the decreased credit quality in specific relationships leading to an increased allowance for credit losses for individually analyzed loans, increases in loan volume during 2023, and an increase in loss rates resulting from increased charge-off activity. The Company believes that credit loss expense is expected to be dependent on the Company’s loan growth, local economic conditions and asset quality.

The second factor affecting the Company’s net income is the interaction between changes in net interest margin and changes in average volumes of the Company's earnings assets.  Net interest income of $86.32 million for the first nine months of 2023 was derived from the Company’s $4.022 billion of average earning assets during that period and its tax-equivalent net interest margin of 2.92%.  Average earning assets in the nine months ended September 30, 2022 were $3.924 billion and the tax-equivalent net interest margin was 2.92%. Net interest income for the Company increased primarily as a result of interest income on increased loan volume and rates partially offset by increased interest expense from increased interest rates, including on borrowings, certificates of deposit, and interest-bearing deposits. The Company expects net interest compression to impact earnings for the foreseeable future due to competition for loans and deposits. The Company believes growth in net interest income will be contingent on the growth of the Company’s earning assets, increasing yield on loans and the ongoing interest rate stance of the Federal Reserve Board.

The third factor affecting the Company’s net income is noninterest income, primarily the increase in trust fees and service charges and fees income. Trust fees were $9.99 million and $9.34 million for the nine months ended September 30, 2023 and 2022, respectively, an increase of 6.95%. This is primarily driven by the increase in assets under management of $0.322 billion from $2.102 billion as of September 30, 2022 to $2.424 billion as of September 30, 2023. Service charges and fees were $9.74 million and $9.44 million for the nine months ended September 30, 2023 and 2022, respectively, an increase of 3.08%. This is primarily driven by increased overdraft and non-sufficient funds fees.

The fourth factor affecting the Company’s net income is noninterest expenses, primarily the increase in salaries and related employee benefits due to increased employee levels and annual compensation increases and increased FDIC insurance assessment expense from rate increases.

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Net Interest Income

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. Net interest income on a tax equivalent basis increased $2.33 million for the nine months ended September 30, 2023 compared to the comparable period in 2022.  The increase was primarily attributable to higher interest income on increased loan volume and rates partially offset by increased interest expense from increased interest rates, including on borrowings, certificates of deposit, and interest-bearing deposits. The Company has continued to experience the migration of funds into time deposits with higher yields as well as increased borrowings leading to the increased interest expense. The net interest margin for the first nine months of 2023 was 2.92% compared to 2.92% in 2022 for the same period. The measure is shown on a tax-equivalent basis using a tax rate of 21% 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 nine months ended in 2023 compared to the comparable period in 2022 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	$	476,931	0.65	%	$	13,803	$	16,164	$	29,967
Taxable securities	60,647		0.21		903		851		1,754
Nontaxable securities	968		0.41		16		637		653
Interest-bearing bank balances	(440,483)		4.29		(2,421)		481		(1,940)
	$	98,063			$	12,301	$	18,133	$	30,434
Interest expense:
Interest-bearing demand deposits	$	(139,732)	0.72	%	$	278	$	(5,275)	$	(4,997)
Savings deposits	(169,258)		0.52		280		(4,007)		(3,727)
Time deposits	135,309		1.36		(1,481)		(7,156)		(8,637)
Fed funds borrowed/FHLB overnight	228,563		3.85		(2,407)		(6,593)		(9,000)
FHLB Borrowings	$	42,154	5.44		(1,741)		—		(1,741)
	$	97,036			$	(5,071)	$	(23,031)	$	(28,102)
Change in net interest income					$	7,230	$	(4,898)	$	2,332

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. 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)	2023		2022
Yield on average interest-earning assets	4.20	%	3.27	%
Rate on average interest-bearing liabilities	1.73		0.48
Net interest spread	2.47	%	2.79	%
Effect of noninterest-bearing funds	0.45		0.13
Net interest margin (tax equivalent net interest income divided by average interest-earning assets)	2.92	%	2.92	%

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In pricing loans and deposits, the Company considers the U.S. Treasury indexes as benchmarks in determining interest rates.  The Federal Open Market Committee met six times during the first nine months of 2023.  The federal funds target rate increased to 5.50% as of September 30, 2023 from 3.25% as of the same period in 2022.  Interest rates on loans are generally affected by the federal funds 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 September 30, 2023, the rate indexes for the one, three and five year indexes were 5.46%, 4.80% and 4.60%, respectively.  The one year index increased 34.81% from 4.05% at September 30, 2022, the three year index increased 12.94% and the five year index increased 13.30%.  The three year index was 4.25% and the five year index was 4.06% at September 30, 2022. 

Credit Loss Expense

Credit loss expense was $9.97 million for the nine months ended September 30, 2023 compared to $3.27 million in 2022, an increase of expense of $6.70 million.  Credit loss expense is the amount necessary to adjust the allowance for credit losses to the level considered by management to appropriately account for the estimated current expected credit losses within the Company's loan portfolio.

A significant component of the Company's approach to estimating expected credit losses are economic forecasts such as Iowa unemployment, all-transactions house price index for Iowa and Iowa real gross domestic product. The increase in expense when compared to the same period in 2022 is primarily attributable to the decreased credit quality in specific relationships leading to an increased allowance for credit losses for individually analyzed loans, increases in loan volume during 2023, and an increase in loss rates resulting from increased charge-off activity.

The allowance for credit losses balance is impacted by charge-offs, net of recoveries, for the periods presented.  For the nine months ended September 30, 2023 and 2022, recoveries were $1.22 million and $1.70 million, respectively; and charge-offs were $4.23 million in 2023 and $1.19 million in 2022.  The allowance for credit losses totaled $48.40 million at September 30, 2023 compared to $41.44 million as of December 31, 2022. The allowance represented 1.44% and 1.32% of loans held for investment at September 30, 2023 and December 31, 2022.

Noninterest Income

The following table sets forth the various categories of noninterest income for the nine months ended September 30, 2023 and 2022.

	Nine Months Ended September 30,
	2023		2022		$ Change		% Change
	(Amounts in thousands)
Net gain on sale of loans	$	1,135	$	1,377	$	(242)	(17.57)	%
Trust fees	9,987		9,338		649		6.95
Service charges and fees	9,735		9,444		291		3.08
Other noninterest income	238		814		(576)		(70.76)
	$	21,095	$	20,973	$	122	0.58

Trust fees were $9.99 million and $9.34 million for the nine months ended September 30, 2023 and 2022, respectively, an increase of 6.95%. This is primarily driven by the increase in assets under management of $0.322 billion from $2.102 billion as of September 30, 2022 to $2.424 billion as of September 30, 2023.

Other noninterest income decreased $0.58 million for the nine months ended September 30, 2023 compared to the same period in 2022, primarily due to the decrease in tax credit real estate investments based on the investments year-end audited financial statements.

Other noninterest income categories experienced marginal period-to-period fluctuations for the nine months ended September 30, 2023.

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Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the nine months ended September 30, 2023 and 2022.

	Nine Months Ended September 30,
	2023		2022		$ Change		% Change
	(Amounts in thousands)
Salaries and employee benefits	$	33,370	$	31,990	$	1,380	4.31	%
Occupancy	3,418		3,265		153		4.69
Furniture and equipment	5,190		5,150		40		0.78
Office supplies and postage	1,355		1,377		(22)		(1.60)
Advertising and business development	2,095		1,874		221		11.79
Outside services	9,587		9,407		180		1.91
FDIC insurance assessment	1,340		815		525		64.42
Other noninterest expense	1,419		1,802		(383)		(21.25)
	$	57,774	$	55,680	$	2,094	3.76

In the nine months ended September 30, 2023, salaries and benefits increased $1.38 million compared to the same period in 2022. The increase is primarily the result of increased employee levels and annual compensation increases.

In the nine months ended September 30, 2023, FDIC insurance assessment expense increased $0.53 million due to rate increases beginning in the first quarter of 2023.

Other noninterest expense categories experienced marginal period-to-period fluctuations for the nine months ended September 30, 2023.

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Discussion of operations for the three months ended September 30, 2023 and 2022

Net Income Overview

Net income decreased $6.50 million for the three months ended September 30, 2023 compared to the same period in 2022.  Total net income was $7.24 million in 2023 and $13.74 million in the comparable period in 2022, a decrease of (47.28)%.  For the three month periods ended September 30, 2023 and 2022 basic earnings per share was $0.79 and $1.48, respectively. Diluted earnings per share was $0.79 for the three months ended September 30, 2023 compared to $1.48 for the same period in 2022.

Net Interest Income

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. Net interest income on a tax equivalent basis decreased $1.98 million for the three months ended September 30, 2023 compared to the comparable period in 2022. The decrease was a result of higher interest expense attributable to higher rates on interest-bearing demand and savings deposits, time deposits and borrowings partially offset by higher loan volume and interest rates. The Company has continued to experience the migration of funds into time deposits with higher yields as well as increased borrowings leading to the increased interest expense. The net interest margin for the three months ended September 30, 2023 was 2.81% compared to 3.15% in 2022 for the same period.  The measure is shown on a tax-equivalent basis using a tax rate of 21% 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 2023 compared to the comparable period in 2022 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	$	464,874	0.73	%	$	4,703	$	6,157	$	10,860
Taxable securities	(30,558)		0.14		(96)		151		55
Nontaxable securities	(4,612)		0.29		(27)		166		139
Interest-bearing bank balances	(231,903)		3.01		(1,311)		75		(1,236)
	$	197,801			$	3,269	$	6,549	$	9,818
Interest expense:
Interest-bearing demand deposits	$	(141,780)	0.67	%	$	148	$	(1,536)	$	(1,388)
Savings deposits	(214,794)		0.53		167		(1,275)		(1,108)
Time deposits	227,812		1.74		(852)		(3,434)		(4,286)
Fed funds borrowed/FHLB overnight	250,020		2.90		(1,574)		(1,811)		(3,385)
FHLB Borrowings	110,738		5.75		(1,628)		—		(1,628)
	$	231,996			$	(3,739)	$	(8,056)	$	(11,795)
Change in net interest income					$	(470)	$	(1,507)	$	(1,977)

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. Interest on nontaxable securities and loans is shown on a tax-equivalent basis.

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

(Tax Equivalent Basis)	2023		2022
Yield on average interest-earning assets	4.35	%	3.53	%
Rate on average interest-bearing liabilities	2.08		0.58
Net interest spread	2.27	%	2.95	%
Effect of noninterest-bearing funds	0.54		0.20
Net interest margin (tax equivalent net interest income divided by average interest-earning assets)	2.81	%	3.15	%

Credit Loss Expense

Credit loss expense was $6.93 million for the three months ended September 30, 2023 compared to a credit loss benefit of $(0.34) million in 2022, an increase of expense of $7.26 million. The increase in credit loss expense when compared to the same period in 2022 is primarily attributable to increases in specific reserves on certain individual loans for the quarter ended September 30, 2023. Credit loss expense is the amount necessary to adjust the allowance for credit losses to the level considered by management to appropriately account for the estimated current expected credit losses within the Bank's loan portfolio. A significant component in estimating expected credit losses are economic forecasts such as Iowa unemployment, all-transactions house price index for Iowa and Iowa real gross domestic product.

The allowance for credit losses balance is impacted by charge-offs, net of recoveries, for the periods presented.  For the three months ended September 30, 2023 and 2022, recoveries were $0.60 million and $0.47 million, respectively; and charge-offs were $2.80 million in 2023 and $0.40 million in 2022. 

Noninterest Income

The following table sets forth the various categories of noninterest income for the three months ended September 30, 2023 and 2022.

	Three Months Ended September 30,
	2023		2022		$ Change		% Change
	(Amounts in thousands)
Net gain on sale of loans	$	547	$	240	$	307	127.92	%
Trust fees	3,310		2,859		451		15.77
Service charges and fees	3,354		3,282		72		2.19
Other noninterest income	159		164		(5)		(3.05)
	$	7,370	$	6,545	$	825	12.61

Noninterest income categories experienced marginal period-to-period fluctuations for the three months ended September 30, 2023.

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Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the three months ended September 30, 2023 and 2022.

	Three Months Ended September 30,
	2023		2022		$ Change		% Change
	(Amounts in thousands)
Salaries and employee benefits	$	11,039	$	10,818	$	221	2.04	%
Occupancy	1,177		1,024		153		14.94
Furniture and equipment	1,815		1,770		45		2.54
Office supplies and postage	443		425		18		4.24
Advertising and business development	601		586		15		2.56
Outside services	3,468		3,491		(23)		(0.66)
FDIC insurance assessment	461		267		194		72.66
Other noninterest expense	662		650		12		1.85
	$	19,666	$	19,031	$	635	3.34

All noninterest expense categories experienced marginal period-to-period fluctuations for the three months ended September 30, 2023.

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Income Taxes

Federal and state income tax expenses were $8.39 million and $10.49 million for the nine months ended September 30, 2023 and 2022, respectively. Income taxes as a percentage of income before taxes were 21.16% in 2023 and 22.70% in 2022.

Liquidity

The Company actively monitors and manages its liquidity position with the objective of maintaining sufficient cash flows to fund operations, meet 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 16.39% of the Company’s total assets at September 30, 2023 compared to 19.50% at December 31, 2022. The decrease in investment securities is due to unrealized losses from the increases in interest rates over the last two years as well as the Company utilizing investment maturities to fund loan growth the last two years. As of September 30, 2023, investment securities with a carrying value of $417.77 million were pledged to collateralize public and trust deposits and other borrowings.  As of December 31, 2022, investment securities with a carrying value of $9.13 million were pledged.

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.  Deposit inflows and outflows can vary widely based on prevailing market interest rates, competition, economic conditions, our business customers' liquidity needs and by recent developments in the financial services industry. Uninsured deposits as of September 30, 2023 and December 31, 2022 were approximately $801.01 million and $800.81 million, respectively, which comprised 23.82% and 23.85% of total deposits.

As of September 30, 2023, the Company had $364.00 million of outstanding borrowings from the Federal Home Loan Bank (“FHLB”) of Des Moines compared to $40.00 million as of December 31, 2022.  The Company had no Fed Funds purchased as of September 30, 2023 compared to $82.06 million of Fed Funds purchased as of December 31, 2022. These borrowings are used as a means of providing both long and short-term funding for certain assets and for managing interest rate risk.  The Company had additional borrowing capacity available from the FHLB of approximately $801.32 million at September 30, 2023.

As additional sources of liquidity, the Company has the ability to borrow up to $100.00 million from the Federal Reserve Bank of Chicago, and has lines of credit with three banks totaling $175.00 million.  The borrowings under these credit lines would be secured by the Company’s investment securities.  In addition, the Company has the option of issuing short-, medium-, and long-term debt, should the Company decide to do so. The Bank Term Funding Program was established by the Federal Reserve in March 2023 to provide an additional source of liquidity against high-quality securities. As of September 30, 2023, the Company had no borrowings from the Bank Term Funding Program though has provided investment securities as collateral to borrow up to $300 million if necessary. The combination of high levels of potentially liquid assets, low dependence on volatile liabilities, positive cash flows from operations, and both additional borrowing and brokered deposits capacity provided sources of liquidity for the Company which management considered sufficient at September 30, 2023.

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, 2022.

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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 curves 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 embedded in Company products.  The Company’s primary source of interest rate risk exposure arises from repricing risk.  To measure this risk the Company uses a static gap measurement system that identifies the repricing gaps across the full maturity spectrum of the Company’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 Company’s assets and liabilities.  The report details the calculation of the gap ratio.  This ratio indicates the amount of 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 Company 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 Company uses a simulation model to review various assumptions relating to interest rate movement. The Company engages a third party that utilizes a modeling program to measure the Company’s exposure to potential interest rate changes. For various assumed hypothetical changes in market interest rates, this analysis measures the estimated change in net interest income. The simulations allow for ongoing assessment of interest rate sensitivity and can include the impact of potential new business strategies. The modeled scenarios begin with a base case in which rates are unchanged and include parallel and nonparallel rate shocks. The results of these shocks are measured in two forms: first, the impact on the net interest margin and earnings over one and two year time frames; and second, the impact on the market value of equity. The results of the simulation are compared against approved policy limits. The model attempts to limit rate risk even if it appears the Company’s asset and liability maturities are perfectly matched and a favorable interest margin is present.  The Company’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 Company's interest rate risk, as monitored by management, has not significantly increased since year-end. Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including domestic and local economic conditions and the policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. The FOMC, with particular attention being given to ongoing supply chain disruptions, rising energy and commodity prices and the global economic impact of the Russia-Ukraine and Israeli-Palestinian conflicts, has signaled that additional increases may be appropriate if inflation pressures remain elevated or intensify. Further increases to prevailing interest rates could influence the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings. For instance, if our liabilities are positioned to reprice faster than our assets in a rising-rate environment, our net interest income could be detrimentally impacted as a result. Moreover, additional increases to the target range for the federal funds rate, combined with recent bank failures and ongoing geopolitical instability, raise the risk of economic recession. Any such downturn, especially in the regions in which we operate, may adversely affect our asset quality, deposit levels, loan demand and results of operations.

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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 Principal 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 Principal 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 nine months ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

HILLS BANCORPORATION

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

Except as otherwise indicated below, there have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

Economic and Market Risks

Recent Events Impacting the Financial Services Industry May Negatively Affect our Financial Condition and Results of Operation

Recent events impacting the financial services industry, including the failure of Silicon Valley Bank, Signature Bank, and First Republic Bank have resulted in decreased confidence in banks among consumer and commercial depositors, other counterparties and investors, as well as significant disruption, volatility and reduced valuations of equity and other securities of banks in the capital markets. These events occurred during a period of rapidly rising interest rates which, among other things, has resulted in unrealized losses in longer duration securities and loans held by banks, more competition for bank deposits and may increase the risk of a potential recession. These recent events could adversely impact the market price and volatility of the Company’s common stock.

These recent events may also result in potentially adverse changes to laws or regulations governing banks and bank holding companies or result in the impositions of restrictions through supervisory or enforcement activities, including higher capital requirements, which could have a material impact on our business. Inability to access short-term funding or the loss of client deposits could increase our cost of funding, limit access to capital markets or negatively impact our overall liquidity or capitalization. Moreover, we may be impacted by concerns regarding the soundness or creditworthiness of other financial institutions, which can cause substantial and cascading disruption within the financial markets and increased expenses. In addition, the cost of resolving the recent bank failures may prompt the FDIC to increase its premiums above the recently increased levels or to issue additional special assessments.

Inflationary Pressures in the global economy continue to persist

With the reopening of economies from strict COVID-19 lockdowns and the Ukraine war-induced increases in food, energy and other commodity prices, core inflation has risen sharply over the prior two year period and has become increasingly persistent. While inflationary pressures related to the cost of goods and services, including labor, generally have minimal direct impact on the Bank's financial condition or results of operation, such pressures do directly impact the ability of both our commercial and consumer borrowers to meet their own financial obligations as they come due, including their loan payments to the Company. In addition, while the Federal Reserve’s moves over the 2022 and 2023 fiscal years to raise interest rates in order to quell inflation appear to be working, such rapid increases in interest rates can have the impact of reducing demand for both the Company’s consumer and commercial products, as well as impact the ability of both our commercial and consumer borrowers to meet their own financial obligations as they come due, including their loan payments to the Company.

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We could experience an unexpected inability to obtain needed liquidity which could adversely affect our business, profitability, and viability as a going concern.

Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets, and its access to alternative sources of funds. The bank failures in 2023 exemplify the potentially catastrophic results of the unexpected inability of insured depository institutions to obtain needed liquidity to satisfy deposit withdrawal requests, including how quickly such requests can accelerate once uninsured depositors lose confidence in an institution’s ability to satisfy its obligations to depositors. We continually strive to ensure our funding needs are met by maintaining a level of liquidity through asset and liability management. If we become unable to obtain funds when needed, it could have a material adverse effect on our business, financial condition, and results of operations.

Rising interest rates have decreased the value of the Company’s securities portfolio, and the Company would realize losses if it were required to sell such securities to meet liquidity needs.

As a result of inflationary pressures and the resulting rapid increases in interest rates over the prior two fiscal years, the trading value of previously issued government and other fixed income securities has declined significantly. These securities make up a majority of the securities portfolio of most banks in the U.S., including the Company’s, resulting in unrealized losses embedded in the held-to-maturity portion of U.S. banks’ securities portfolios. While the Company does not currently intend to sell its securities, and none of the Company's securities are classified as held-to-maturity, if the Company were required to sell securities to meet liquidity needs, it may incur losses, which could negatively impact its profitability. Such a sale of securities, even if losses were incurred, would not further impair the Company's capital position. While the Company has taken actions to maximize its funding sources, there is no guarantee that such actions will be successful or sufficient in the event of sudden liquidity needs. Furthermore, while the Federal Reserve Board has announced a Bank Term Funding Program available to eligible depository institutions secured by U.S. treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral at par, to mitigate the risk of potential losses on the sale of such instruments, there is no guarantee that such programs will be effective in addressing liquidity needs as they arise.

The proportion of our deposit account balances that exceed FDIC insurance limits may expose the Bank to enhanced liquidity risk in times of financial distress.

As of September 30, 2023, approximately 23.82% of our total deposits were not insured by the FDIC. Uninsured deposits historically have been viewed by the FDIC as less stable than insured deposits. According to statements made by the FDIC staff and the leadership of the federal banking agencies, customers with larger uninsured deposit account balances often are small- and mid-sized businesses that rely upon deposit funds for payment of operational expenses and, as a result, are more likely to closely monitor the financial condition and performance of their depository institutions. As a result, in the event of financial distress, uninsured depositors historically have been more likely to withdraw their deposits. If a significant portion of our deposits were to be withdrawn within a short period of time such that additional sources of funding would be required to meet withdrawal demands, we may be unable to obtain funding at favorable terms, which may have an adverse effect on our net interest margin. Obtaining adequate funding to meet our deposit obligations may be more challenging during periods of elevated prevailing interest rates, such as the present, and our ability to attract depositors during a time of actual or perceived distress or instability in the marketplace may be limited. Further, interest rates paid for non-deposit borrowings generally exceed the interest rates paid on deposits, and this spread may be exacerbated by higher prevailing interest rates.

We are constantly at risk of increased losses from fraud

Criminals are committing fraud at an increasing rate and are using more sophisticated techniques. In some cases, these individuals are part of larger criminal rings, which allow them to be more effective. Such fraudulent activity has taken many forms, ranging from debit card fraud, check fraud, mechanical devices attached to ATM machines, social engineering and phishing attacks to obtain personal information, or impersonation of clients through the use of falsified or stolen credentials. Additionally, an individual or business entity may properly identify itself, yet seek to establish a business relationship for the purpose of perpetrating fraud. An emerging type of fraud even involves the creation of synthetic identification in which fraudsters “create” individuals for the purpose of perpetrating fraud. Further, in addition to fraud committed directly against us, the Company may suffer losses as a result of fraudulent activity committed against third parties. Increased deployment of technologies, such as chip card technology and multi-factor authentication, defray and reduce certain aspects of fraud; however, criminals are turning to other sources to steal personally identifiable information, such as unaffiliated healthcare providers and government entities, in order to impersonate the consumer and thereby commit fraud.

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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 September 30, 2023:

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)
July 1 to July 31	2,716	$	66.00	2,716	671,021
August 1 to August 31	14,178	66.00		14,178	656,843
September 1 to September 30	10,805	66.00		10,805	646,038
Total	27,699	$	66.00	27,699	646,038

(1)  On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to 1,500,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  On August 9, 2022, the Company’s Board of Directors authorized the expansion of the 2005 Stock Repurchase Program to allow an additional 750,000 shares for repurchase and the continuation through December 31, 2027. 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. 

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Item 3. Defaults upon Senior Securities

Hills Bancorporation has no senior securities.

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

Director or Officer Rule 10b5-1 and Non-Rule 10b5-1 Trading Arrangements

None.

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Item 6. Exhibits

3.1	Restated Articles of Incorporation, incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q Filed with the Commission on May 6, 2015.
3.2	Amended and Restated Bylaws of Hills Bancorporation, incorporated by reference to Exhibit 3.2 to the Company's Form 10-Q Filed with the Commission on May 6, 2019.
4.1	Description of Registered Securities, incorporated by reference to Exhibit 4.1 to the Company's Form 10-K filed with the Commission on March 6, 2020.
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), (2)
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)
104	Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

(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.

(2)The instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL document.

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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:	November 3, 2023	By:  /s/ Dwight O. Seegmiller
		Dwight O. Seegmiller, Director, President and Chief Executive Officer
Date:	November 3, 2023	By:  /s/ Anthony V. Roetlin
		Anthony V. Roetlin, Treasurer, Chief Financial Officer and Chief Accounting Officer

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