UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

Commission file number:  0-12668

Hills Bancorporation

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

131 MAIN STREET, HILLS, IOWA 52235

Telephone number: (319) 679-2291

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

þ Yes  o No

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

þ Yes  o No

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

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

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

o Yes  þ No

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

	SHARES OUTSTANDING
CLASS	At April 30, 2013
Common Stock, no par value	4,737,640

Page 1

HILLS BANCORPORATION

Index to Form 10-Q

Part I

FINANCIAL INFORMATION

		Page
		Number
Item 1.	Financial Statements
	Consolidated balance sheets, March 31, 2013 (unaudited) and December 31, 2012	3
	Consolidated statements of income (unaudited) for three months ended March 31, 2013 and 2012	4
	Consolidated statements of comprehensive income (unaudited) for three months ended March 31, 2013 and 2012	5
	Consolidated statements of stockholders' equity (unaudited) for three months ended March 31, 2013 and 2012	6
	Consolidated statements of cash flows (unaudited) for three months ended March 31, 2013 and 2012	7
	Notes to consolidated financial statements	9
Item 2.	Management Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	46
	Part II
	OTHER INFORMATION
Item 1.	Legal proceedings	47
Item 1A.	Risk factors	47
Item 2.	Unregistered sales of equity securities and use of proceeds	47
Item 3.	Defaults upon senior securities	47
Item 4.	Mine safety disclosures	47
Item 5.	Other information	47
Item 6.	Exhibits	48
Signatures		49
Exhibits Index		50

Page 2

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

ASSETS	March 31, 2013 (Unaudited)			December 31, 2012
Cash and cash equivalents	$	93,996		$	63,582
Investment securities available for sale at fair value (amortized cost March 31, 2013 $221,444; December 31, 2012 $219,777)		227,049			226,182
Stock of Federal Home Loan Bank		8,057			8,062
Loans held for sale		4,345			28,256
Loans, net of allowance for loan losses (March 31, 2013 $24,620; December 31, 2012 $25,160)		1,708,139			1,697,002
Property and equipment, net		30,646			30,624
Tax credit real estate		18,839			18,745
Accrued interest receivable		8,889			7,851
Deferred income taxes, net		7,349			7,144
Other real estate		776			746
Goodwill		2,500			2,500
Prepaid FDIC insurance		2,725			2,957
Other assets		3,747			6,069
Total Assets	$	2,117,057		$	2,099,720
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Noninterest-bearing deposits	$	235,672		$	273,973
Interest-bearing deposits		1,440,476			1,388,571
Total deposits	$	1,676,148		$	1,662,544
Short-term borrowings		39,923			38,783
Federal Home Loan Bank borrowings		125,000			125,000
Accrued interest payable		1,277			1,361
Other liabilities		18,396			16,121
Total Liabilities	$	1,860,744		$	1,843,809
Redeemable Common Stock Held by Employee Stock Ownership Plan (ESOP)	$	31,158		$	30,715
STOCKHOLDERS' EQUITY
Common stock, no par value; authorized 10,000,000 shares; issued March 31, 2013 5,069,509 shares; December 31, 2012 5,064,383 shares	$	-		$	-
Paid in capital		41,779			42,241
Retained earnings		231,249			229,625
Accumulated other comprehensive income		3,461			3,955
Unearned ESOP shares		(1,513	)		(1,513	)
Treasury stock at cost (March 31, 2013 331,824 shares; December 31, 2012 328,065 shares)		(18,663	)		(18,397	)
Total Stockholders' Equity	$	256,313		$	255,911
Less maximum cash obligation related to ESOP shares		31,158			30,715
Total Stockholders' Equity Less Maximum Cash Obligations Related to ESOP Shares	$	225,155		$	225,196
Total Liabilities & Stockholders' Equity	$	2,117,057		$	2,099,720

See Notes to Consolidated Financial Statements.

Page 3

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Amounts In Thousands, Except Per Share Amounts)

	Three Months Ended March 31,
	2013			2012
Interest income:
Loans, including fees	$	19,925		$	21,395
Investment securities:
Taxable		350			546
Nontaxable		843			850
Federal funds sold		21			16
Total interest income	$	21,139		$	22,807
Interest expense:
Deposits	$	2,965		$	3,574
Short-term borrowings		17			34
FHLB borrowings		1,378			1,990
Total interest expense	$	4,360		$	5,598
Net interest income	$	16,779		$	17,209
Provision for loan losses		(171	)		(560	)
Net interest income after provision for loan losses	$	16,950		$	17,769
Noninterest income:
Net gain on sale of loans	$	741		$	705
Trust fees		1,260			1,161
Service charges and fees		1,909			1,873
Rental revenue on tax credit real estate		319			394
Net gain on sale of other real estate owned and other repossessed assets		40			296
Other noninterest income		614			584
	$	4,883		$	5,013
Noninterest expenses:
Salaries and employee benefits	$	5,963		$	5,819
Occupancy		942			844
Furniture and equipment		1,281			1,111
Office supplies and postage		382			379
Advertising and business development		620			436
Outside services		1,800			1,702
Rental expenses on tax credit real estate		344			655
FDIC insurance assessment		261			268
Other noninterest expense		440			413
	$	12,033		$	11,627
Income before income taxes	$	9,800		$	11,155
Income taxes		2,990			3,255
Net income	$	6,810		$	7,900
Earnings per share:
Basic	$	1.44		$	1.66
Diluted	$	1.44		$	1.66

See Notes to Consolidated Financial Statements.

Page 4

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited) (Amounts In Thousands)

	Three Months Ended March 31,
	2013			2012
Net income	$	6,810		$	7,900
Other comprehensive loss before tax:
Unrealized holding losses arising during the period		(783	)		(1,032	)
Less:  reclassification adjustments for gains included in net income		(17	)		(6	)
Other comprehensive loss, before tax:	$	(800	)	$	(1,038	)
Tax benefit related to other comprehensive loss		306			397
Other comprehensive loss, net of tax	$	(494	)	$	(641	)
Comprehensive income	$	6,316		$	7,259

See Notes to Consolidated Financial Statements.

Page 5

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

	Paid In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Unearned ESOP Shares			Treasury Stock			Maximum Cash Obligation Related To ESOP Shares			Total
Balance, December 31, 2011	$	41,467		$	207,790		$	4,974		$	(2,017	)	$	(15,959	)	$	(27,826	)	$	208,429
Issuance of 3,269 shares of common stock		109			-			-			-			-			-			109
Forfeiture of 149 shares of common stock		(9	)		-			-			-			-			-			(9	)
Share-based compensation		4			-			-			-			-			-			4
Income tax benefit related to share-based compensation		38			-			-			-			-			-			38
Change related to ESOP shares		-			-			-			-			-			(824	)		(824	)
Net income		-			7,900			-			-			-			-			7,900
Cash dividends ($1.05 per share)		-			(4,998	)		-			-			-			-			(4,998	)
Purchase of 9,320 shares of common stock		-			-			-			-			(610	)		-			(610	)
Other comprehensive loss		-			-			(641	)		-			-			-			(641	)
Balance, March 31, 2012	$	41,609		$	210,692		$	4,333		$	(2,017	)	$	(16,569	)	$	(28,650	)	$	209,398
Balance, December 31, 2012	$	42,241		$	229,625		$	3,955		$	(1,513	)	$	(18,397	)	$	(30,715	)	$	225,196
Issuance of 4,946 shares of common stock		177			-			-			-			-			-			177
Issuance of 555 shares of common stock under the employee stock purchase plan		38			-			-			-			-			-			38
Unearned restricted stock compensation		(730	)		-			-			-			-			-			(730	)
Forfeiture of 375 shares of common stock		(24	)		-			-			-			-			-			(24	)
Share-based compensation		7			-			-			-			-			-			7
Income tax benefit related to share-based compensation		70			-			-			-			-			-			70
Change related to ESOP shares		-			-			-			-			-			(443	)		(443	)
Net income		-			6,810			-			-			-			-			6,810
Cash dividends ($1.10 per share)		-			(5,186	)		-			-			-			-			(5,186	)
Purchase of 3,759 shares of common stock		-			-			-			-			(266	)		-			(266	)
Other comprehensive loss		-			-			(494	)		-			-			-			(494	)
Balance, March 31, 2013	$	41,779		$	231,249		$	3,461		$	(1,513	)	$	(18,663	)	$	(31,158	)	$	225,155

See Notes to Consolidated Financial Statements.

Page 6

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

	Three Months Ended March 31,
	2013			2012
Cash Flows from Operating Activities
Net income	$	6,810		$	7,900
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Depreciation		725			716
Provision for loan losses		(171	)		(560	)
Net gain on sale of investment securities		(17	)		(6	)
Share-based compensation		7			4
Forfeiture of common stock		(24	)		(9	)
Compensation expensed through issuance of common stock		66			21
Excess tax benefits from share-based compensation		(70	)		(38	)
Provision for deferred income taxes		101			400
Net gain on sale of other real estate owned and other repossessed assets		(40	)		(296	)
Increase in accrued interest receivable		(1,038	)		(363	)
Amortization of discount on investment securities, net		280			239
Decrease in prepaid FDIC insurance		232			238
Increase in other assets		2,392			615
Increase in accrued interest payable and other liabilities		1,461			1,778
Loans originated for sale		(59,075	)		(65,004	)
Proceeds on sales of loans		83,727			72,729
Net gain on sales of loans		(741	)		(705	)
Net cash and cash equivalents provided by operating activities	$	34,625		$	17,659
Cash Flows from Investing Activities
Proceeds from maturities of investment securities available for sale	$	6,394		$	11,773
Proceeds from sales of investment securities available for sale		566			246
Purchases of investment securities available for sale		(8,885	)		(13,716	)
Loans made to customers, net of collections		(11,090	)		1,635
Proceeds on sale of other real estate owned and other repossessed assets		134			788
Purchases of property and equipment		(747	)		(1,628	)
(Investment in) income from tax credit real estate, net		(94	)		472
Net cash and cash equivalents used in investing activities	$	(13,722	)	$	(430	)
Cash Flows from Financing Activities
Net increase in deposits	$	13,604		$	86,579
Net increase (decrease) in short-term borrowings		1,140			(5,775	)
Stock options exercised		149			88
Excess tax benefits related to share-based compensation		70			38
Purchase of treasury stock		(266	)		(610	)
Dividends paid		(5,186	)		(4,998	)
Net cash and cash equivalents provided by financing activities	$	9,511		$	75,322

(Continued)

Page 7

HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Continued) (Amounts In Thousands)

	Three Months Ended March 31,
	2013		2012
Increase in cash and cash equivalents	$	30,414	$	92,551
Cash and cash equivalents:
Beginning of year		63,582		29,291
End of period	$	93,996	$	121,842
Supplemental Disclosures
Cash payments for:
Interest paid to depositors	$	3,049	$	3,658
Interest paid on other obligations		1,395		2,024
Noncash activities:
Increase in maximum cash obligation related to ESOP shares	$	443	$	824
Transfers to other real estate owned		124		478

See Notes to Consolidated Financial Statements.

Page 8

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Basis of Presentation:

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

Operating results for the three month period ended March 31, 2013 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2013.  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, 2012 filed with the Securities Exchange Commission on March 13, 2013.

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

Recently Adopted Accounting Standards:

In July 2012, the FASB issued AU 2012-02, Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, which permits an entity to make a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset, other than goodwill, is impaired.   Under the new standard, if an entity concludes, based on an evaluation of all relevant qualitative factors, that it is not more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, it will not be required to perform the quantitative impairment test for that asset.  The standard is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted.  The adoption of this standard did not have a material impact on the consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income, to improve the transparency of reporting reclassification out of accumulated other comprehensive income.  The new standard is effective for reporting periods beginning after December 15, 2012, and the amendments should be prospectively applied.  The amendments do not change the current requirement for reporting net income or other comprehensive income.  The amendments require an organization to present on the face of the financial statements or in the footnotes the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income if the item reclassified is required to be reclassified to net income in its entirety in the same reporting period.  Additionally, for other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required to provide additional detail about those amounts.  The adoption of this standard did not have a material impact on the consolidated financial statements.

Page 9

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 2. Earnings Per Share

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

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

	Three months Ended March 31,
	2013		2012
Common shares outstanding at the beginning of the period		4,712,328		4,759,818
Weighted average number of net shares issued (redeemed)		2,521		(2,175	)
Weighted average shares outstanding (basic)		4,714,849		4,757,643
Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method		4,290		7,130
Weighted average number of shares (diluted)		4,719,139		4,764,773
Net income (In thousands)	$	6,810	$	7,900
Earnings per share:
Basic	$	1.44	$	1.66
Diluted	$	1.44	$	1.66

Page 10

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 3. Other Comprehensive Income

The following table summarizes the changes in the balances of each component of accumulated other comprehensive income for the three months ended March 31, 2013 and 2012 (in thousands):

	Three Months Ended March 31, 2013
	Unrealized Gains  on Securities			Accumulated Other Comprehensive Income
Balance at the beginning of the period	$	3,955		$	3,955
Current period, other comprehensive loss		(494	)		(494	)
Balance March 31, 2013	$	3,461		$	3,461

	Three Months Ended March 31, 2012
	Unrealized Gains on Securities			Accumulated Other Comprehensive Income
Balance at the beginning of the period	$	4,974		$	4,974
Current period, other comprehensive loss		(641	)		(641	)
Balance March 31, 2012	$	4,333		$	4,333

Page 11

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 4. Securities

The carrying values of investment securities at March 31, 2013 and December 31, 2012 are summarized in the following table (dollars in thousands):

	March 31, 2013					December 31, 2012
	Amount		Percent			Amount		Percent
Securities available for sale
State and political subdivisions	$	135,534		59.69	%	$	134,332		59.39	%
Other securities (FHLB, FHLMC and FNMA)		91,515		40.31			91,850		40.61
Total securities available for sale	$	227,049		100.00	%	$	226,182		100.00	%

Investment securities have been classified in the consolidated balance sheets according to management’s intent.  Available-for-sale securities consist of debt securities not classified as trading or held to maturity.  Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity.  There were no trading or held to maturity securities as of March 31, 2013 or December 31, 2012. The carrying amount of available-for-sale securities and their approximate fair values were as follows as of March 31, 2013 and December 31, 2012 (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Estimated Fair Value
March 31, 2013:
State and political subdivisions	$	130,708	$	5,040	$	(214	)	$	135,534
Other securities (FHLB, FHLMC and FNMA)		90,736		804		(25	)		91,515
Total	$	221,444	$	5,844	$	(239	)	$	227,049
December 31, 2012:
State and political subdivisions	$	128,848	$	5,593	$	(109	)	$	134,332
Other securities (FHLB, FHLMC and FNMA)		90,929		946		(25	)		91,850
Total	$	219,777	$	6,539	$	(134	)	$	226,182

The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at March 31, 2013, were as follows (in thousands):

	Amortized Cost		Fair Value
Due in one year or less	$	37,970	$	38,330
Due after one year through five years		110,472		113,425
Due after five years through ten years		72,459		74,767
Due over ten years		543		527
Total	$	221,444	$	227,049

As of March 31, 2013 investment securities with a carrying value of $39.92 million were pledged to collateralize short-term borrowings.

Page 12

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 4. Securities (continued)

The following table shows the fair value, gross unrealized losses and the percentage of fair value represented by gross unrealized losses of applicable investment securities owned by the Company, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2013 and December 31, 2012 (in thousands):

	Less than 12 months										12 months or more										Total
March 31, 2013					Unrealized										Unrealized										Unrealized
Description of Securities		#	Fair Value		Loss			%				#	Fair Value		Loss			%				#	Fair Value		Loss			%
State and political subdivisions		74	$	15,372	$	(200	)		1.30	%		2	$	486	$	(14	)		2.88	%		76	$	15,858	$	(214	)		1.35	%
Other securities (FHLB, FHLMC and FNMA)		4		9,617		(25	)		0.26	%		-		-		-			-			4		9,617		(25	)		0.26	%
Total temporarily impaired securities		78	$	24,989	$	(225	)		0.90	%		2	$	486	$	(14	)		2.88	%		80	$	25,475	$	(239	)		0.94	%

	Less than 12 months										12 months or more										Total
December 31, 2012					Unrealized										Unrealized										Unrealized
Description of Securities		#	Fair Value		Loss			%				#	Fair Value		Loss			%				#	Fair Value		Loss			%
State and political subdivisions		37	$	7,854	$	(92	)		1.17	%		2	$	483	$	(17	)		3.52	%		39	$	8,337	$	(109	)		1.31	%
Other securities (FHLB, FHLMC and FNMA)		5		12,865		(25	)		0.19	%		-		-		-			0.00	%		5		12,865		(25	)		0.19	%
Total temporarily impaired securities		42	$	20,719	$	(117	)		0.56	%		2	$	483	$	(17	)		3.52	%		44	$	21,202	$	(134	)		0.63	%

The Company considered the following information in reaching the conclusion that the impairments disclosed in the table above are temporary and  not other-than-temporary impairments.  The state and political subdivision securities with gross unrealized losses greater than twelve months as of March 31, 2013 included two issues.  The two securities are municipal bonds which are rated Ba2.  Bonds with a Ba2 rating are less than investment grade.   The aggregate fair value of these Ba2 rated bonds is $0.49 million while their amortized cost is $0.50 million, representing an unrealized loss of $0.01 million.  None of the unrealized losses in the above table was due to the deterioration in the credit quality of any of the issues that might result in the non-collection of contractual principal and interest.  The unrealized losses are due to changes in interest rates.  The Company has not recognized any unrealized loss in income because management does not have the intent to sell the securities included in the previous table.  Management has concluded that it is more likely than not that the Company will not be required to sell these securities prior to recovery of the amortized cost basis.

Page 13

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans

Classes of loans are as follows:

	March 31, 2013		December 31, 2012
	(Amounts In Thousands)
Agricultural	$	79,819	$	76,190
Commercial and financial		157,538		148,034
Real estate:
Construction, 1 to 4 family residential		26,767		25,788
Construction, land development and commercial		83,327		79,097
Mortgage, farmland		118,223		113,841
Mortgage, 1 to 4 family first liens		575,131		583,567
Mortgage, 1 to 4 family junior liens		103,523		104,278
Mortgage, multi-family		215,122		214,812
Mortgage, commercial		310,714		312,506
Loans to individuals		19,277		20,350
Obligations of state and political subdivisions		42,728		43,102
	$	1,732,169	$	1,721,565
Net unamortized fees and costs		590		597
	$	1,732,759	$	1,722,162
Less allowance for loan losses		24,620		25,160
	$	1,708,139	$	1,697,002

Page 14

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

Changes in the allowance for loan losses, the allowance for loan losses applicable to impaired loans and the related loan balance of impaired loans for the three months ended March 31, 2013 were as follows:

	Agricultural		Commercial and Financial			Real Estate:  Construction and land development			Real Estate:  Mortgage, farmland		Real Estate:  Mortgage, 1 to 4 family			Real Estate:  Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	1,653	$	4,573		$	3,175		$	1,746	$	8,088		$	5,104		$	821		$	25,160
Charge-offs		-		(115	)		(208	)		-		(249	)		(229	)		(42	)		(843	)
Recoveries		15		251			31			-		77			48			52			474
Provision		490		(241	)		249			319		(640	)		(212	)		(136	)		(171	)
Ending balance	$	2,158	$	4,468		$	3,247		$	2,065	$	7,276		$	4,711		$	695		$	24,620
Ending balance, individually evaluated for impairment	$	-	$	30		$	73		$	-	$	94		$	242		$	1		$	440
Ending balance, collectively evaluated for impairment	$	2,158	$	4,438		$	3,174		$	2,065	$	7,182		$	4,469		$	694		$	24,180
Loans:
Ending balance	$	79,819	$	157,538		$	110,094		$	118,223	$	678,654		$	525,836		$	62,005		$	1,732,169
Ending balance, individually evaluated for impairment	$	-	$	2,108		$	3,375		$	375	$	4,677		$	18,187		$	2		$	28,724
Ending balance, collectively evaluated for impairment	$	79,819	$	155,430		$	106,719		$	117,848	$	673,977		$	507,649		$	62,003		$	1,703,445

Changes in the allowance for loan losses for the three months ended March 31, 2012 were as follows:

	Agricultural			Commercial and Financial			Real Estate:  Construction and land development			Real Estate:  Mortgage, farmland		Real Estate:  Mortgage, 1 to 4 family			Real Estate:  Mortgage, multi- family and commercial			Other			Total
	(Amounts In Thousands)
Allowance for loan losses:
Beginning balance	$	1,354		$	6,429		$	4,994		$	1,411	$	9,051		$	6,150		$	761		$	30,150
Charge-offs		-			(415	)		(601	)		-		(269	)		(211	)		(28	)		(1,524	)
Recoveries		22			360			1			-		125			83			73			664
Provision		(94	)		(341	)		379			1		(335	)		(112	)		(58	)		(560	)
Ending balance	$	1,282		$	6,033		$	4,773		$	1,412	$	8,572		$	5,910		$	748		$	28,730
Ending balance, individually evaluated for impairment		-			39			3			-		78			99			1			220
Ending balance, collectively evaluated for impairment	$	1,282		$	5,994		$	4,770		$	1,412	$	8,494		$	5,811		$	747		$	28,510
Loans:
Ending balance	$	66,461		$	143,860		$	107,884		$	101,017	$	686,644		$	531,089		$	51,581		$	1,688,536
Ending balance, individually evaluated for impairment		-			3,115			2,051			556		4,114			20,581			3			30,420
Ending balance, collectively evaluated for impairment	$	66,461		$	140,745		$	105,833		$	100,461	$	682,530		$	510,508		$	51,578		$	1,658,116

Page 15

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

The following table presents the credit quality indicators by type of loans in each category as of March 31, 2013 and December 31, 2012, respectively (amounts in thousands):

	Agricultural		Commercial and Financial		Real Estate:  Construction, 1 to 4 family residential		Real Estate:  Construction, land development and commercial
March 31, 2013
Grade:
Pass	$	71,841	$	129,556	$	20,114	$	72,885
Potential Watch		2,362		8,824		2,850		3,544
Watch		1,869		12,933		2,771		3,426
Substandard		3,747		6,225		1,032		3,472
Total	$	79,819	$	157,538	$	26,767	$	83,327

	Real Estate:  Mortgage, farmland		Real Estate:  Mortgage, 1 to 4 family first liens		Real Estate:  Mortgage, 1 to 4 family junior liens		Real Estate:  Mortgage, multi-family
March 31, 2013
Grade:
Pass	$	109,727	$	509,925	$	93,555	$	174,806
Potential Watch		3,939		22,956		3,689		11,263
Watch		1,588		21,048		3,743		27,895
Substandard		2,969		21,202		2,536		1,158
Total	$	118,223	$	575,131	$	103,523	$	215,122

	Real Estate:  Mortgage, commercial		Loans to individuals		Obligations of state and political subdivisions		Total
March 31, 2013
Grade:
Pass	$	266,796	$	18,764	$	41,659	$	1,509,628
Potential Watch		19,567		96		-		79,090
Watch		16,403		287		1,069		93,032
Substandard		7,948		130		-		50,419
Total	$	310,714	$	19,277	$	42,728	$	1,732,169

Page 16

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

	Agricultural		Commercial and Financial		Real Estate:  Construction, 1 to 4 family residential		Real Estate:  Construction, land development and commercial
December 31, 2012
Grade:
Pass	$	70,821	$	123,005	$	20,698	$	67,011
Potential Watch		1,169		7,996		2,232		4,636
Watch		1,376		10,927		1,826		3,855
Substandard		2,824		6,106		1,032		3,595
Total	$	76,190	$	148,034	$	25,788	$	79,097

	Real Estate:  Mortgage, farmland		Real Estate:  Mortgage, 1 to 4 family first liens		Real Estate: Mortgage, 1 to 4 family junior liens		Real Estate:  Mortgage, multi- family
December 31, 2012
Grade:
Pass	$	106,041	$	517,684	$	94,219	$	173,348
Potential Watch		2,434		24,240		3,839		11,098
Watch		1,863		21,266		3,584		27,936
Substandard		3,503		20,377		2,636		2,430
Total	$	113,841	$	583,567	$	104,278	$	214,812

	Real Estate:  Mortgage, commercial		Loans to individuals		Obligations of state and political subdivisions		Total
December 31, 2012
Grade:
Pass	$	267,883	$	19,763	$	42,022	$	1,502,495
Potential Watch		11,687		118		-		69,449
Watch		24,890		318		1,080		98,921
Substandard		8,046		151		-		50,700
Total	$	312,506	$	20,350	$	43,102	$	1,721,565

The below are descriptions of the credit quality indicators:

Pass – Pass rated loans are supported by sound payment capacity, are adequately collateralized and have no apparent weaknesses that would affect the full repayment of the loan under the established terms and conditions.

Potential Watch – Potential watch rated loans are supported by adequate payment capacity, are adequately collateralized and are performing according to the established terms and conditions.  However, the loan requires more than average monitoring due to a potential weakness.  The potential watch indicator assists the Company in identifying and monitoring loans for which credit quality could deteriorate.

Page 17

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

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

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

Past due loans as of March 31, 2013 and December 31, 2012 were as follows:

					90 Days						Total		Accruing Loans
	30 - 59 Days		60 - 89 Days		or More		Total Past				Loans		Past Due 90
	Past Due		Past Due		Past Due		Due		Current		Receivable		Days or More
	(Amounts In Thousands)
March 31, 2013
Agricultural	$	77	$	21	$	-	$	98	$	79,721	$	79,819	$	-
Commercial and financial		1,221		203		122		1,546		155,992		157,538		50
Real estate:
Construction, 1 to 4 family residential		-		-		-		-		26,767		26,767		-
Construction, land development and commercial		274		1,146		1,089		2,509		80,818		83,327		498
Mortgage, farmland		995		153		81		1,229		116,994		118,223		-
Mortgage, 1 to 4 family first liens		4,928		658		2,737		8,323		566,808		575,131		1,835
Mortgage, 1 to 4 family junior liens		612		247		246		1,105		102,418		103,523		246
Mortgage, multi-family		-		-		253		253		214,869		215,122		-
Mortgage, commercial		495		-		1,496		1,991		308,723		310,714		309
Loans to individuals		-		5		2		7		19,270		19,277		2
Obligations of state and political subdivisions		-		-		-		-		42,728		42,728		-
	$	8,602	$	2,433	$	6,026	$	17,061	$	1,715,108	$	1,732,169	$	2,940
December 31, 2012:
Agricultural	$	374	$	-	$	-	$	374	$	75,816	$	76,190	$	-
Commercial and financial		712		100		100		912		147,122		148,034		10
Real estate:
Construction, 1 to 4 family residential		-		-		-		-		25,788		25,788		-
Construction, land development and commercial		909		15		-		924		78,173		79,097		-
Mortgage, farmland		-		-		512		512		113,329		113,841		-
Mortgage, 1 to 4 family first liens		5,433		1,579		2,033		9,045		574,522		583,567		1,592
Mortgage, 1 to 4 family junior liens		640		43		221		904		103,374		104,278		221
Mortgage, multi-family		840		-		845		1,685		213,127		214,812		592
Mortgage, commercial		2,060		-		1,415		3,475		309,031		312,506		228
Loans to individuals		22		-		-		22		20,328		20,350		-
Obligations of state and political subdivisions		-		-		-		-		43,102		43,102		-
	$	10,990	$	1,737	$	5,126	$	17,853	$	1,703,712	$	1,721,565	$	2,643

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

Page 18

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

Certain impaired loan information by loan type at March 31, 2013 and December 31, 2012, was as follows:

	March 31, 2013						December 31, 2012
	Non-accrual loans		Accruing loans past due 90 days or more (1)		TDR loans (2)		Non- accrual loans		Accruing loans past due 90 days or more (1)		TDR loans (2)
	(Amounts In Thousands)						(Amounts In Thousands)
Agricultural	$	-	$	-	$	-	$	-	$	-	$	-
Commercial and financial		198		50		1,791		265		10		1,824
Real estate:
Construction, 1 to 4 family residential		714		-		-		714		-		-
Construction, land development and commercial		2,069		498		95		2,169		-		95
Mortgage, farmland		81		-		294		512		-		294
Mortgage, 1 to 4 family first liens		1,103		1,835		1,388		580		1,592		1,065
Mortgage, 1 to 4 family junior liens		16		246		89		17		221		90
Mortgage, multi-family		761		-		5,706		2,027		592		5,739
Mortgage, commercial		1,397		309		10,082		1,401		228		10,323
Loans to individuals		-		2		-		-		-		-
	$	6,339	$	2,940	$	19,445	$	7,685	$	2,643	$	19,430

(1) There were $0.17 million TDR loans included within accruing loans past due 90 days or more as of March 31, 2013.  There were no TDR loans included within accruing loans past due 90 days or more as of December 31, 2012.

(2) Total TDR loans were $21.14 million and $22.13 million as of March 31, 2013 and December 31, 2012, respectively.  Included in the total nonaccrual loans were $1.53 million and $2.69 million of TDR loans as of March 31, 2013 and December 31, 2012.

Loans 90 days or more past due that are still accruing interest increased $0.30 million from December 31, 2012 to March 31, 2013 due to an increase in the number of loans past due greater than 90 days. The average accruing loans past due 90 days or more balance was $105,000 as of March 31, 2013 and $110,000 as of December 31, 2012.  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.

Page 19

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

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

Below is a summary of information for TDR loans as of March 31, 2013 and December 31, 2012:

	March 31, 2013						December 31, 2012
	Number						Number
	of		Recorded		Commitments		of		Recorded		Commitments
	contracts		investment		outstanding		contracts		investment		outstanding
			(Amounts In Thousands)						(Amounts In Thousands)
Agriculture		-	$	-	$	-		-	$	-	$	-
Commercial and financial		12		1,917		44		11		1,927		15
Real estate:
Construction, 1 to 4 family residential		-		-		-		-		-		-
Construction, land development and commercial		3		400		-		3		401		-
Mortgage, farmland		1		294		-		1		295		-
Mortgage, 1 to 4 family first liens		10		1,599		-		8		1,277		-
Mortgage, 1 to 4 family junior liens		2		89		-		2		90		8
Mortgage, multi-family		3		6,144		-		5		7,364		-
Mortgage, commercial		8		10,700		-		8		10,771		-
Loans to individuals		-		-		-		-		-		-
		39	$	21,143	$	44		38	$	22,125	$	23

The following is a summary of TDR loans that were modified during the three months ended March 31, 2013:

	Three Months Ended March 31, 2013
	Number		Pre-modification		Post-modification
	of		recorded		recorded
	contracts		investment		investment
			(Amounts In Thousands)
Commercial and financial		1	$	29	$	29
Real estate:
Mortgage, farmland		-		-		-
Mortgage, 1 to 4 family first lien		1		371		337
Mortgage, 1 to 4 family junior liens		-		-		-
Mortgage, multi-family		-		-		-
Mortgage, commercial		-		-		-
		2	$	400	$	366

The Company had commitments to lend $0.04 million in additional borrowings to restructured loan customers as of March 31, 2013.  The Company had commitments to lend $0.02 million in additional borrowings to restructured loan customers as of December 31, 2012.  These commitments were in the normal course of business and allowed the borrowers to build pre-sold homes and commercial property, which was expected to increase their overall cash flow.  The additional borrowings were not used to facilitate payments on these loans.

Page 20

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

There were $0.17 million and $0.0 million of TDR loans that were in payment default (defined as past due 90 days or more) as of March 31, 2013 and December 31, 2012, respectively.  As of March 31, 2013, TDR loans in payment default consisted of a $0.17 million commercial mortgage loan.

Information regarding impaired loans as of and for the three months ended March 31, 2013 is as follows:

	March 31, 2013						Three Months Ended March 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:	(Amounts In Thousands)
Agricultural	$	-	$	-	$	-	$	-	$	-
Commercial and financial		295		1,767		-		300		1
Real estate:
Construction, 1 to 4 family residential		714		946		-		714		-
Construction, land development and commercial		2,163		3,420		-		2,214		1
Mortgage, farmland		375		462		-		580		5
Mortgage, 1 to 4 family first liens		1,801		2,735		-		1,756		8
Mortgage, 1 to 4 family junior liens		67		361		-		68		1
Mortgage, multi-family		761		1,520		-		945		-
Mortgage, commercial		2,522		5,198		-		2,532		15
Loans to individuals		-		20		-		-		-
	$	8,698	$	16,429	$	-	$	9,109	$	31
With an allowance recorded:
Agricultural	$	-	$	-	$	-	$	-	$	-
Commercial and financial		1,813		1,813		30		1,821		23
Real estate:
Construction, 1 to 4 family residential		318		318		64		318		5
Construction, land development and commercial		180		180		9		180		2
Mortgage, farmland		-		-		-		-		-
Mortgage, 1 to 4 family first liens		2,525		2,613		87		2,547		32
Mortgage, 1 to 4 family junior liens		284		284		7		283		4
Mortgage, multi-family		5,706		5,706		223		5,722		69
Mortgage, commercial		9,198		9,261		19		9,261		135
Loans to individuals		2		2		1		2		-
	$	20,026	$	20,177	$	440	$	20,134	$	270
Total:
Agricultural	$	-	$	-	$	-	$	-	$	-
Commercial and financial		2,108		3,580		30		2,121		24
Real estate:
Construction, 1 to 4 family residential		1,032		1,264		64		1,032		5
Construction, land development and commercial		2,343		3,600		9		2,394		3
Mortgage, farmland		375		462		-		580		5
Mortgage, 1 to 4 family first liens		4,326		5,348		87		4,303		40
Mortgage, 1 to 4 family junior liens		351		645		7		351		5
Mortgage, multi-family		6,467		7,226		223		6,667		69
Mortgage, commercial		11,720		14,459		19		11,793		150
Loans to individuals		2		22		1		2		-
	$	28,724	$	36,606	$	440	$	29,243	$	301

Page 21

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

Information regarding impaired loans as of December 31, 2012 is as follows:

	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:	(Amounts In Thousands)
Agricultural	$	-	$	-	$	-
Commercial and financial		364		1,911		-
Real estate:
Construction, 1 to 4 family residential		714		946		-
Construction, land development and commercial		2,264		3,520		-
Mortgage, farmland		806		808		-
Mortgage, 1 to 4 family first liens		952		1,332		-
Mortgage, 1 to 4 family junior liens		68		361		-
Mortgage, multi-family		2,027		2,766		-
Mortgage, commercial		2,369		5,046		-
Loans to individuals		-		20		-
	$	9,564	$	16,710	$	-
With an allowance recorded:
Agricultural	$	-	$	-	$	-
Commercial and financial		1,788		1,788		22
Real estate:
Construction, 1 to 4 family residential		-		-		-
Construction, land development and commercial		-		-		-
Mortgage, farmland		-		-		-
Mortgage, 1 to 4 family first liens		2,286		2,487		83
Mortgage, 1 to 4 family junior liens		259		259		7
Mortgage, multi-family		6,331		6,331		241
Mortgage, commercial		9,530		9,530		20
Loans to individuals		-		-		-
	$	20,194	$	20,395	$	373
Total:
Agricultural	$	-	$	-	$	-
Commercial and financial		2,152		3,699		22
Real estate:
Construction, 1 to 4 family residential		714		946		-
Construction, land development and commercial		2,264		3,520		-
Mortgage, farmland		806		808		-
Mortgage, 1 to 4 family first liens		3,238		3,819		83
Mortgage, 1 to 4 family junior liens		327		620		7
Mortgage, multi-family		8,358		9,097		241
Mortgage, commercial		11,899		14,576		20
Loans to individuals		-		20		-
	$	29,758	$	37,105	$	373

Page 22

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 5. Loans (continued)

Impaired loans decreased $1.03 million from December 31, 2012 to March 31, 2013.  Impaired loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and TDR loans.  Impaired loans also include loans that, based on management’s evaluation of current information and events, the Company expects to be unable to collect in full according to the contractual terms of the original loan agreement.  Impaired loans were 1.66% of loans held for investment as of March 31, 2013 and 1.73% as of December 31, 2012.  The decrease in impaired loans is due mainly to a decrease in nonaccrual loans of $1.35 million from December 31, 2012 to March 31, 2013 primarily resulting from the payoff of $1.24 million in multi-family real estate loans.

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

Specific allowances for losses on impaired loans are established if the loan balances exceed the net present value of the relevant future cash flows or the fair value of the relevant collateral based on updated appraisals and/or updated collateral analysis for the properties if the loan is collateral dependent.  The Company recognizes a charge off related to an impaired loan if there is a collateral shortfall or it is unlikely the borrower can make all principal and interest payments as contractually due.

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

Page 23

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 6. Fair Value Measurements

The carrying value and estimated fair values of the Company's financial instruments as of March 31, 2013 are as follows:

	March 31, 2013
	Carrying Amount		Estimated Fair Value		Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)
	(Amounts In Thousands)
Financial instrument assets:
Cash and cash equivalents	$	93,996	$	93,996	$	93,996	$	-	$	-
Investment securities		235,106		235,106		-		235,106		-
Loans held for sale		4,345		4,345				4,345
Loans
Agricultural		77,661		78,170		-		-		78,170
Commercial and financial		153,070		153,860		-		-		153,860
Real estate:
Construction, 1 to 4 family residential		25,836		25,801		-		-		25,801
Construction, land development and commercial		81,011		81,503		-		-		81,503
Mortgage, farmland		116,158		118,119		-		-		118,119
Mortgage, 1 to 4 family first liens		569,138		582,874		-		-		582,874
Mortgage, 1 to 4 family junior liens		102,240		104,501		-		-		104,501
Mortgage, multi-family		213,508		219,295		-		-		219,295
Mortgage, commercial		307,617		315,183		-		-		315,183
Loans to individuals		18,990		19,169		-		-		19,169
Obligations of state and political subdivisions		42,320		42,024		-		-		42,024
Accrued interest receivable		8,889		8,889		-		8,889		-
Total financial instrument assets	$	2,049,885	$	2,082,835	$	93,996	$	248,340	$	1,740,499
Financial instrument liabilities:
Deposits
Noninterest-bearing deposits	$	235,672	$	235,672	$	-	$	235,672	$	-
Interest-bearing deposits		1,440,476		1,452,059		-		1,452,059		-
Short-term borrowings		39,923		39,923		-		39,923		-
Federal Home Loan Bank borrowings		125,000		136,180		-		136,180		-
Accrued interest payable		1,277		1,277		-		1,277		-
Total financial instrument liabilities	$	1,842,348	$	1,865,111	$	-	$	1,865,111	$	-
	Face Amount
Financial instrument with off-balance sheet risk:
Loan commitments	$	351,037	$	-	$	-	$	-	$	-
Letters of credit		10,943		-		-		-		-
Total financial instrument liabilities with off-balance-sheet risk	$	361,980	$	-	$	-	$	-	$	-

(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.

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HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 6. Fair Value Measurements (continued)

The carrying value and estimated fair values of the Company's financial instruments as of December 31, 2012 are as follows:

	December 31, 2012
	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	$	63,582	$	63,582	$	63,582	$	-	$	-
Investment securities		234,244		234,244		-		234,244		-
Loans held for sale		28,256		28,256		-		28,256		-
Loans
Agricultural		74,537		72,605		-		-		72,605
Commercial and financial		143,461		138,350		-		-		138,350
Real estate:
Construction, 1 to 4 family residential		24,940		25,516		-		-		25,516
Construction, land development and commercial		76,770		78,827		-		-		78,827
Mortgage, farmland		112,095		116,751		-		-		116,751
Mortgage, 1 to 4 family first liens		577,027		603,442		-		-		603,442
Mortgage, 1 to 4 family junior liens		102,730		107,049		-		-		107,049
Mortgage, multi-family		212,972		223,295		-		-		223,295
Mortgage, commercial		309,242		323,639		-		-		323,639
Loans to individuals		19,968		20,148		-		-		20,148
Obligations of state and political subdivisions		42,663		42,487		-		-		42,487
Accrued interest receivable		7,851		7,851		-		7,851		-
Total financial instrument assets	$	2,030,338	$	2,086,042	$	63,582	$	270,351	$	1,752,109
Financial instrument liabilities:
Deposits
Noninterest-bearing deposits	$	273,973	$	273,973	$	-	$	273,973	$	-
Interest-bearing deposits		1,388,571		1,400,509		-		1,400,509		-
Short-term borrowings		38,783		38,783		-		38,783		-
Federal Home Loan Bank borrowings		125,000		136,842		-		136,842		-
Accrued interest payable		1,361		1,361		-		1,361		-
Total financial instrument liabilities	$	1,827,688	$	1,851,468	$	-	$	1,851,468	$	-
	Face Amount
Financial instrument with off-balance sheet risk:
Loan commitments	$	344,120	$	-	$	-	$	-	$	-
Letters of credit		10,778		-		-		-		-
Total financial instrument liabilities with off-balance-sheet risk	$	354,898	$	-	$	-	$	-	$	-

(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.

Page 25

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 6. Fair Value Measurements (continued)

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

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

Level 1 Quoted prices in active markets for identical assets or liabilities.

Level 2 Observable inputs other than quoted prices included within Level 1.  Observable inputs include the quoted prices for similar assets or liabilities in markets that are not active and inputs other than quoted prices that are observable for the asset or liability.

Level 3 Unobservable inputs supported by little or no market activity for financial instruments.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

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

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

ASSETS

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

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

The pricing for investment securities is obtained from an independent source.  There are no level 1 or level 3 investment securities owned by the Company.  The Company obtains an understanding of the independent source’s valuation methodologies used to determine fair value by level of security. The Company validates assigned fair values on a sample basis using an additional third-party provider pricing service to determine if the fair value measurement is reasonable.  Due to the nature of our investment portfolio, we do not expect significant and unusual fluctuations as fair value changes primarily relate to interest rate changes.   No unusual fluctuations were identified during the three months ended March 31, 2013.   If a fluctuation requiring investigation was identified, the Company would research the change with the independent source or other available information.

Page 26

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 6. Fair Value Measurements (continued)

ASSETS (continued)

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

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

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

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

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

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

Page 27

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 6. Fair Value Measurements (continued)

LIABILITIES

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

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

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

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

Page 28

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 6. Fair Value Measurements (continued)

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below represents the balances of assets and liabilities measured at fair value on a recurring basis:

	March 31, 2013
	Readily. Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value
	(Amounts In Thousands)
State and political subdivisions	$	-	$	135,534	$	-	$	135,534
Other securities (FHLB, FHLMC and FNMA)		-		91,515		-		91,515
Total	$	-	$	227,049	$	-	$	227,049
	December 31, 2012
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value
	(Amounts In Thousands)
State and political subdivisions	$	-	$	134,332	$	-	$	134,332
Other securities (FHLB, FHLMC and FNMA)		-		91,850		-		91,850
Total	$	-	$	226,182	$	-	$	226,182

(1) Considered Level 1 under ASC 820.

(2) Considered Level 2 under ASC 820.

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

There were no transfers between Levels 1, 2 or 3 during the three months ended March 31, 2013.

Page 29

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 6. Fair Value Measurements (continued)

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.

									Three Months Ended
	March 31, 2013								March 31, 2013
	Readily Available Market Prices(1)		Observable Market Prices(2)		Company Determined Market Prices(3)		Total at Fair Value		Total Losses
	(Amounts in Thousands)
Loans (4)
Agricultural	$	-	$	-	$	-	$	-	$	-
Commercial and financial		-		-		2,078		2,078		5
Real Estate:
Construction, 1 to 4 family residential		-		-		968		968		-
Construction, land development and commercial		-		-		2,334		2,334		-
Mortgage, farmland		-		-		375		375		-
Mortgage, 1 to 4 family first liens		-		-		4,239		4,239		103
Mortgage, 1 to 4 family junior liens		-		-		344		344		58
Mortgage, multi-family		-		-		6,244		6,244		-
Mortgage, commercial		-		-		11,701		11,701		229
Loans to individuals		-		-		1		1		-
Foreclosed assets (5)		-		-		234		234		-
Total	$	-	$	-	$	28,518	$	28,518	$	395

(1) Considered Level 1 under ASC 820.

(2) Considered Level 2 under ASC 820.

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

(4) Represents carrying value and related write-downs of loans for which adjustments are based on the value of the collateral. The carrying value of loans fully-charged off is zero.

(5) Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

Page 30

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 6. Fair Value Measurements (continued)

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

									Year Ended
	December 31, 2012								December 31, 2012
	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		-		-		2,130		2,130		302
Real Estate:
Construction, 1 to 4 family residential		-		-		714		714		-
Construction, land development and commercial		-		-		2,264		2,264		1,176
Mortgage, farmland		-		-		806		806		-
Mortgage, 1 to 4 family first liens		-		-		3,155		3,155		665
Mortgage, 1 to 4 family junior liens		-		-		320		320		82
Mortgage, multi-family		-		-		8,117		8,117		-
Mortgage, commercial		-		-		11,879		11,879		210
Loans to individuals		-		-		-		-		12
Foreclosed assets (5)		-		-		234		234		164
Total	$	-	$	-	$	29,619	$	29,619	$	2,611

(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.

During the year ended December 31, 2012 the Company revised the classification of impaired loans and foreclosed assets from previous filings.  In previous filings, the Company classified impaired loans and foreclosed assets as Level 2 under ASC 820.  The Company revised the classification to Level 3 as the determination of fair value requires significant management judgment or estimation due to the inherent subjectivity of the inputs used to determine value.  The resulting change in presentation does not have a material impact on the Company’s financial position.

Page 31

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 7. Stock Repurchase Program

On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to a total of 750,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  The authorization was previously set to expire on December 31, 2013.  In September 2012 the Company’s Board of Directors extended the expiration date of the 2005 Stock Repurchase Program to December 31, 2014.  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 331,824 shares of its common stock in privately negotiated transactions from August 1, 2005 through March 31, 2013.  Of these 331,824 shares, 3,759 shares were purchased during the quarter ended March 31, 2013, at an average price per share of $70.53.

Note 8. Commitments and Contingencies

Concentrations of credit risk:  The Bank’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Bank's market area.  Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $64.04 million.  The concentrations of credit by type of loan are set forth in Note 5 to the Consolidated Financial Statements.  Outstanding letters of credit were granted primarily to commercial borrowers.  Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson, Linn and Washington Counties, Iowa.

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

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

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, credit card participations and standby letters of credit is represented by the contractual amount of those instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  A summary of the Bank’s commitments at March 31, 2013 and December 31, 2012 is as follows:

	March 31, 2013		December 31, 2012
	(Amounts In Thousands)
Firm loan commitments and unused portion of lines of credit:
Home equity loans	$	36,381	$	36,030
Credit cards		44,406		44,554
Commercial, real estate and home construction		102,069		96,326
Commercial lines and real estate purchase loans		168,181		167,210
Outstanding letters of credit		10,943		10,778

Page 32

HILLS BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

Note 9. Income Taxes

Federal income tax expense for the three months ended March 31, 2013 and 2012 was computed using the consolidated effective federal tax rate.  The Company also recognized income tax expense pertaining to state franchise taxes payable individually by the subsidiary bank.  The Company files a consolidated tax return for federal purposes and separate tax returns for State of Iowa purposes.  The tax years ended December 31, 2012, 2011, and 2010 remain subject to examination by the Internal Revenue Service.  For state tax purposes, the tax years ended December 31, 2012, 2011, and 2010 remain open for examination.  There were no material unrecognized tax benefits at March 31, 2013  and December 31, 2012 and therefore no interest or penalties on unrecognized tax benefits has been recorded.  As of March 31, 2013, the Company does not anticipate any significant increase in unrecognized tax benefits during the twelve-month period ending March 31, 2014.

Income taxes as a percentage of income before taxes were 30.51% for the three months ended March 31, 2013 and 29.18% for the same period in 2012.  The increase in the effective tax rate is due to tax-exempt interest income and income tax credits and the relationship to total income before income taxes.

Page 33

HILLS BANCORPORATION

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.

· The effects of recent financial market disruptions and the current global economic recession, and monetary and other governmental actions designed to address such disruptions and recession.

· The financial strength of the counterparties with which the Company or the Company’s customers do business and as to which the Company has investment or financial exposure.

· The credit quality and credit agency ratings of the securities in the Company’s investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the affected securities and the recognition of an impairment loss.

· The effects of, and changes in, laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters as well as any laws otherwise affecting the Company.

· The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System.

· The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.

· The ability of the Company to obtain new customers and to retain existing customers.

· The timely development and acceptance of products and services, including products and services offered through alternative electronic delivery channels.

· Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers.

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

· The ability of the Company to develop and maintain secure and reliable electronic systems.

· The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.

· Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely.

· The economic impact of natural disasters, terrorist attacks and military actions.

· Business combinations and the integration of acquired businesses and assets which may be more difficult or expensive than expected.

· The costs, effects and outcomes of existing or future litigation.

· Changes in accounting policies and practices that may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.

· The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

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

Critical Accounting Policies

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these financial statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policies to be those which are related to the allowance for loan losses. The Company's allowance for loan losses methodology incorporates a variety of risk considerations, both quantitative and qualitative in establishing an allowance for loan losses that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in impaired loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include the general economic environment in the Company's markets, including economic conditions throughout the Midwest and the state of certain industries.  Determinations relating to the possible level of future loan losses are based in part on subjective judgments by management.  The future impact of the global recession has introduced additional uncertainty into such determinations.  Future loan losses in excess of current estimates, could materially adversely affect our results of operations or financial position.  Size and complexity of individual credits in relation to loan structure, existing loan policies and pace of portfolio growth are other qualitative factors that are considered in the methodology. As the Company adds new products and increases the complexity of its loan portfolio, it will enhance its methodology accordingly. This discussion of the Company’s critical accounting policies should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes presented elsewhere herein, as well as other relevant portions of Management’s Discussion and Analysis of Financial Condition and Results of Operations.  Although management believes the levels of the allowance as of March 31, 2013 and December 31, 2012 were adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses that cannot be reasonably predicted at this time.

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

Overview

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

The Company is a holding company engaged in the business of commercial banking.  The Company’s subsidiary is Hills Bank and Trust Company, Hills, Iowa (the “Bank”), which is wholly-owned.  The Bank was formed in Hills, Iowa in 1904.  The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona, Wellman, Cedar Rapids and Marion, Iowa.  At March 31, 2013, the Bank has seventeen full-service locations.

Net income for the three month period ended March 31, 2013 was $6.81 million compared to $7.90 million for the same three months of 2012, a decrease of 13.80%.  The $1.09 million decrease in net income was caused by a number of factors.  The principal factors in the decrease in net income for the first three months of 2013 are a decrease in net interest income of $0.43 million, an increase in the provision for loan losses of $0.39 million and an increase in other expenses of $0.41 million.  These changes were offset by decreases in certain expense items including a decrease of $0.27 million in income tax expense.

The Company achieved a return on average assets of 1.25% and a return on average equity of 11.81% for the twelve months ended March 31, 2013, compared to the twelve months ended March 31, 2012, which were 1.43% and 15.04%, respectively. Dividends of $1.10 per share were paid in January 2012 to 2,199 shareholders.  The 2012 dividend was $1.05 per share.

The Bank’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 Bank achieved a net interest margin on a tax-equivalent basis of 3.59% for the three months ended March 31, 2013 compared to 3.75% for the same three months of 2012.  Average earning assets were $1.967 billion in 2013 and $1.908 billion in 2012.

Highlights noted on the balance sheet as of March 31, 2013 for the Company included the following:

· Total assets were $2.117 billion, an increase of $17.34 million since December 31, 2012.

· Cash and cash equivalents were $94.00 million, an increase of $30.41 million since December 31, 2012.

· Net loans were $1.712 billion, a decrease of $12.77 million since December 31, 2012.  Loans held for sale decreased $23.91 million since December 31, 2012.

· Deposit growth of $13.60 million since December 31, 2012.

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

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

Financial Condition

The following table sets forth the composition of the loan portfolio as of March 31, 2013 and December 31, 2012:

	March 31, 2013					December 31, 2012
	Amount		Percent			Amount		Percent
	(Amounts In Thousands)					(Amounts In Thousands)
Agricultural	$	79,819		4.61	%	$	76,190		4.43	%
Commercial and financial		157,538		9.09			148,034		8.60
Real estate:
Construction, 1 to 4 family residential		26,767		1.54			25,788		1.50
Construction, land development and commercial		83,327		4.81			79,097		4.59
Mortgage, farmland		118,223		6.83			113,841		6.61
Mortgage, 1 to 4 family first liens		575,131		33.20			583,567		33.90
Mortgage, 1 to 4 family junior liens		103,523		5.98			104,278		6.06
Mortgage, multi-family		215,122		12.42			214,812		12.48
Mortgage, commercial		310,714		17.94			312,506		18.15
Loans to individuals		19,277		1.11			20,350		1.18
Obligations of state and political subdivisions		42,728		2.47			43,102		2.50
	$	1,732,169		100.00	%	$	1,721,565		100.00	%
Net unamortized fees and costs		590					597
	$	1,732,759				$	1,722,162
Less allowance for loan losses		24,620					25,160
	$	1,708,139				$	1,697,002

Loan demand has been steady and is expected to remain steady or increase throughout the year ended December 31, 2013.  The Bank has an established formal loan origination policy.  In general, the loan origination policy attempts to reduce the risk of credit loss to the Bank by requiring, among other things, maintenance of minimum loan to value ratios, evidence of appropriate levels of insurance carried by borrowers and documentation of appropriate types and amounts of collateral and sources of expected payment.  The collateral relied upon in the loan origination policy is generally the property being financed by the Bank.  The source of expected payment is generally the income produced from the property being financed.  Personal guarantees are required of individuals owning or controlling at least 20% of the ownership of an entity.  Limited or proportional guarantees may be accepted in circumstances if approved by the Company’s Board of Directors.  Financial information provided by the borrower is verified as considered necessary by reference to tax returns, or audited, reviewed or compiled financial statements.  The Bank does not originate subprime loans.  In order to modify, restructure or otherwise change the terms of a loan, the Bank’s policy is to evaluate each borrower situation individually.  Modifications, restructures, extensions and other changes are done to improve the Bank’s position and to protect the Bank’s capital.  If a borrower is not current with its payments, any additional loans to such borrowers are evaluated on an individual borrower basis.

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

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

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

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

The following table presents the allowance for loan losses on loans by type of loans and the percentage in each category to total loans as of March 31, 2013 and December 31, 2012:

	March 31, 2013								December 31, 2012
	Amount		% of Total Allowance			% of Loans to Total Loans			Amount		% of Total Allowance			% of Loans to Total Loans
	(In Thousands)								(In Thousands)
Agricultural	$	2,158		8.77	%		4.61	%	$	1,653		6.57	%		4.43	%
Commercial and financial		4,468		18.15			9.09			4,573		18.18			8.60
Real estate:							-
Construction, 1 to 4 family residential		931		3.78			1.54			848		3.37			1.50
Construction, land development and commercial		2,316		9.40			4.81			2,327		9.25			4.59
Mortgage, farmland		2,065		8.39			6.83			1,746		6.94			6.61
Mortgage, 1 to 4 family first liens		5,993		24.34			33.20			6,540		25.99			33.90
Mortgage, 1 to 4 family junior liens		1,283		5.21			5.98			1,548		6.15			6.06
Mortgage, multi-family		1,614		6.56			12.42			1,840		7.31			12.48
Mortgage, commercial		3,097		12.57			17.94			3,264		12.97			18.15
Loans to individuals		287		1.17			1.11			382		1.52			1.18
Obligations of state and political subdivisions		408		1.66			2.47			439		1.75			2.50
	$	24,620		100.00	%		100.00	%	$	25,160		100.00	%		100.00	%

The allowance for loan losses totaled $24.62 million at March 31, 2013 compared to $25.16 million at December 31, 2012.  The percentage of the allowance to outstanding loans was 1.42% and 1.46% at March 31, 2013 and December 31, 2012, 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 reduction in the allowance in 2013 is the result of a decrease in the historical loss rates used in the allowance for loan losses calculation as well as improvements in asset quality.  Credit quality has improved to levels experienced prior to the recession.  Improvement of credit quality has been trending throughout the Bank’s market.

The adequacy of the allowance is reviewed quarterly and adjusted as appropriate after consideration has been given to the impact of economic conditions on the borrowers’ ability to repay, loan collateral values, past collection experience, the risk characteristics of the loan portfolio and such other factors that deserve current recognition. The growth of the loan portfolio and the trends in problem and watch loans are significant elements in the determination of the provision for loan losses.  Quantitative factors include the Company’s historical loss experience, which is then adjusted for levels and trends in past due, levels and trends in charged-off and recovered loans, trends in volume growth, trends in problem and watch loans, trends in restructured loans, local economic trends and conditions, industry and other conditions, and effects of changing interest rates.

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

Management has determined that the allowance for loan losses was appropriate at March 31, 2013, and that the loan portfolio is diversified and secured, without undue concentration in any specific risk area. This process involves a high degree of management judgment; however, the allowance for loan losses is based on a comprehensive, well documented, and consistently applied analysis of the Company’s loan portfolio. This analysis takes into consideration all available information existing as of the financial statement date, including environmental factors such as economic, industry, geographical and political factors. The relative level of allowance for loan losses is reviewed and compared to industry data. This review encompasses levels of total impaired loans, portfolio mix, portfolio concentrations, current geographic risks and overall levels of net charge-offs.

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

Investment securities available for sale held by the Company increased by $0.87 million from December 31, 2012 to March 31, 2013.  The fair value of securities available for sale was $5.61 million more than the amortized cost of such securities as of March 31, 2013.  At December 31, 2012, the fair value of the securities available for sale was $6.41 million more than the amortized cost of such securities.

Deposit growth was $13.60 million in the first three months of 2013.  Repurchase agreements increased $1.14 million in the same period.  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 $39.37 million as of March 31, 2013 with an average rate of 0.68%.  Brokered deposits were $41.54 million as of December 31, 2012 with an average rate of 0.70%.  As of March 31, 2013 and December 31, 2012, brokered deposits were 2.35% and 2.50% of total deposits, respectively.

Dividends and Equity

In January 2013, Hills Bancorporation paid a dividend of $5.19 million or $1.10 per share.  The dividend was $1.05 per share in January 2012.  After payment of the dividend and the adjustment for accumulated other comprehensive income, stockholders’ equity as of March 31, 2013 totaled $225.16 million.  Under risk-based capital rules, the total amount of Tier 1 risk-based capital was 15.49% and 15.33% as of March 31, 2013 and December 31, 2012, respectively.  The Tier 1 risk-based capital was in excess of the required minimum of 8.00%.  Risk-based capital was 16.75% and 16.59% as of March 31, 2013 and December 31, 2012, respectively. As of March 31, 2013, the most recent notifications from the Federal Reserve System categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  There are no conditions or events since that notification that management believes have changed the Company’s category.

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

Net Income Overview

Net income decreased $1.09 million for the three months ended March 31, 2013 compared to the first three months of 2012.  Total net income was $6.81 million in 2013 and $7.90 million in the comparable period in 2012, a decrease of 13.80%.  The changes in net income in 2013 from the first three months of 2012 were primarily the result of the following:

· Net interest income decreased by $0.43 million.

· The provision for loan losses increased by $0.39 million.

· Other income decreased by $0.13 million.

· Other expenses increased by $0.41 million.

For the three-month periods ended March 31, 2013 and 2012, basic earnings per share were $1.44 and $1.66, respectively. Diluted earnings per share were $1.44 for the three months ended March 31, 2013 compared to $1.66 for the same period in 2012.

The Company’s net income continues to be driven primarily by three important factors.  The first important factor is the interaction between changes in net interest margin and changes in average earnings assets. Net interest income of $16.78 million for the first three months of 2013 was derived from the Company’s $1.967 billion of average earning assets during that period and its tax-equivalent net interest margin of 3.59%.  Average earning assets in the three months ended March 31, 2012 were $1.908 billion and the tax-equivalent net interest margin was 3.75%. The importance of net interest margin is illustrated by the fact that a decrease in the net interest margin of 10 basis points to 3.49% would have resulted approximately in a $0.49 million decrease in income before income taxes in the three month period ended March 31, 2013. Similarly, an increase in the net interest margin of 10 basis points to 3.69% would have resulted in approximately a $0.49 million increase in net interest income before taxes.  Net interest income for the Company decreased due to the decrease in the interest rates on average earning assets.  The decrease in interest rates on average earnings assets result from the assets repricing from pre-recession rates and locking in for an average of 5 years at the current historically low interest rates available.  The Company has been able to lower the average cost of funding to the current level over the past 5 years.  Based on our current rate environment there is diminished opportunity to continue to lower funding costs.

The second significant factor affecting the Company’s net income is the provision for loan losses. The majority of the Company’s interest-earning assets are in loans outstanding, which amounted to more than $1.733 billion at March 31, 2013.  The provision is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio.  The provision reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more.  In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historically higher credit risk.  The provision for loan losses was a reduction in expense of $0.17 million in 2013 compared to a reduction of expense of $0.56 million in 2012.  The reduction in expense in 2013 was the result of a decrease in the historical loss rates used in the allowance for loan losses calculation as well as improvements in asset quality.

The third significant factor affecting the Company’s net income is income tax expense.  Federal and state income tax expenses were $2.99 million and $3.26 million for the three months ended March 31, 2013 and 2012, respectively.  Income taxes as a percentage of income before taxes were 30.51% in 2013 and 29.18% in 2012.

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

Discussion of operations for the three months ended March 31, 2013 and 2012

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.  The factors that have the greatest impact on net interest income are the volume of average earning assets and the net interest margin.  The net interest margin for the first three months of 2013 was 3.59% compared to 3.75% in 2012 for the same period.  The measure is shown on a tax-equivalent basis using a tax rate of 35% to make the interest earned on taxable and non-taxable assets more comparable.  The change in average balances and average rates between periods and the effect on the net interest income on a tax equivalent basis for the three months ended in 2013 compared to the comparable period in 2012 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	$	36,440			(0.40	)%	$	145		$	(1,575	)	$	(1,430	)
Taxable securities		(1,465	)		(0.76	)		(7	)		(189	)		(196	)
Nontaxable securities		16,303			(0.63	)		189			(200	)		(11	)
Federal funds sold		6,864			-			5			-			5
	$	58,142					$	332		$	(1,964	)	$	(1,632	)
Interest expense:
Interest-bearing demand deposits	$	55,949			-	%	$	(27	)	$	(2	)	$	(29	)
Savings deposits		55,481			(0.01	)		(26	)		3			(23	)
Time deposits		(36,230	)		(0.30	)		219			442			661
Short-term borrowings		(3,607	)		(0.08	)		5			7			12
FHLB borrowings		(60,000	)		0.15			660			(48	)		612
Interest-bearing other liabilities		(67	)		(0.82	)		-			5			5
	$	11,526					$	831		$	407		$	1,238
Change in net interest income							$	1,163		$	(1,557	)	$	(394	)

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

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

(Tax Equivalent Basis)	2013			2012
Yield on average interest-earning assets		4.49	%		4.92	%
Rate on average interest-bearing liabilities		1.13			1.44
Net interest spread		3.36	%		3.48	%
Effect of noninterest-bearing funds		0.23			0.27
Net interest margin (tax equivalent interest income divided by average interest-earning assets)		3.59	%		3.75	%

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

Discussion of operations for the three months ended March 31, 2013 and 2012

Net Interest Income (continued)

In pricing loans and deposits, the Bank considers the U.S. Treasury indexes as benchmarks in determining interest rates.  The Federal Open Market Committee met two times during the first three months of 2013.  The target rate remains unchanged since December 31, 2008 at 0.25%.  Interest rates on loans are generally affected by the target rate since interest rates for the U.S. Treasury market normally increase or decrease when the Federal Reserve Board raises or lowers the federal funds rate.  As of March 31, 2013, the rate indexes for the one, three and five year indexes were 0.15%, 0.38% and 0.80%, respectively.  The one year index decreased 25.00% from 0.20% at March 31, 2012, the three year index decreased 34.48% and the five year index decreased 31.03%.  The three year index was 0.58% and the five year index was 1.16% at March 31, 2012.  The targeted federal funds rate was 0.25% at March 31, 2013 and 2012.  The Company anticipates no significant changes in the indexes for 2013.  U.S. Treasury indexes are expected to remain low into 2014.

Provision for Loan Losses

The provision for loan losses was a reduction of expense of $0.17 million in 2013 compared to a reduction of expense of $0.56 million in 2012, an increase of $0.39 million.  The loan loss provision is the amount necessary to adjust the allowance to the level considered appropriate by management.  The provision is computed on a quarterly basis and is a result of management’s determination of the quality of the loan portfolio.  The provision reflects a number of factors, including the size of the loan portfolio, the overall composition of the loan portfolio and loan concentrations, the impact on the borrowers’ ability to repay, past loss experience, loan collateral values, the level of impaired loans and loans past due ninety days or more.  In addition, management considers the credit quality of the loans based on management’s review of problem and watch loans, including loans with historical higher credit risks.  The reduction in expense in 2012 was the result of a decrease in the historical loss rates used in the allowance for loan losses calculation as well as improvements in asset quality.

The allowance for loan losses decreased $0.54 million during the first three months of 2013.  In the first three months of 2013, there was a decrease of $0.93 million due to the volume and composition of loans outstanding and a $0.39 million increase in the amount allocated to the allowance due to a combination of a deterioration in credit quality and charge-offs.

The allowance for loan losses balance is affected by charge-offs, net of recoveries, for the periods presented.  For the three months ended March 31, 2013 and 2012, recoveries were $0.48 million and $0.66 million, respectively; and charge-offs were $0.84 million in 2013 and $1.52 million in 2012.  The allowance for loan losses totaled $24.62 million at March 31, 2013 compared to $25.16 million at December 31, 2012.  The allowance represented 1.42% and 1.46% of loans held for investment at March 31, 2013 and December 31, 2012, respectively.

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

Discussion of operations for the three months ended March 31, 2013 and 2012

Noninterest Income

The following table sets forth the various categories of noninterest income for the three months ended March 31, 2013 and 2012.

	Three Months Ended March 31,
	2013		2012		$ Change			% Change
	(Amounts in thousands)
Net gain on sale of loans	$	741	$	705	$	36			5.11	%
Trust fees		1,260		1,161		99			8.53
Service charges and fees		1,909		1,873		36			1.92
Rental revenue on tax credit real estate		319		394		(75	)		(19.04	)
Net gain on sale of other real estate owned and other reposessed assets		40		296		(256	)		(86.49	)
Other noninterest income		614		584		30			5.14
	$	4,883	$	5,013	$	(130	)

Loans originated for sale in the first three months of 2013 totaled $59.08 million compared to $65.00 million in the same period in 2012, a decrease of 9.11%.  In the three months ended March 31, 2013 and 2012, the net gain on sale of loans was $0.74 million and $0.71 million, respectively.  The amount of the net gain on sale of secondary market mortgage loans in each year can vary significantly.  The volume of activity in these types of loans is directly related to the level of interest rates.  The servicing of the loans sold into the secondary market is not retained by the Company so these loans do not provide an ongoing stream of income.

Trust fees increased $0.10 million in the first three months of 2013 as a result of assets under management increasing from $1.088 billion as of March 31, 2012 to $1.168 billion as of March 31, 2013 due to market conditions and new trust relationships.

Service charges and fees increased $0.04 million in the first three months of 2013 from their level for the comparable period in 2012.  Credit card merchant, debit card and point of sale (POS) pin interchange fees are included in service charges and fees, and that component increased during the same period by $0.05 million due to volume of activity.

The net gain on sale of other real estate owned and other repossessed assets decreased $0.26 million to a net gain of $0.04 million for the three months ended March 31, 2013.  The total net gain on sale of other real estate owned for the three months ended March 31, 2013 consisted of a $0.04 million net gain on sale of 1 property.  During the same period in 2012, the gain consisted of a $0.06 million fair market value adjustment on 2 properties within other real estate owned, offset by a $0.36 million net gain on sale of 6 properties.

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

Discussion of operations for the three months ended March 31, 2013 and 2012

Noninterest Expenses

The following table sets forth the various categories of noninterest expenses for the three months ended March 31, 2013 and 2012.

	Three Months Ended March 31,
	2013		2012		$ Change			% Change
	(Amounts in thousands)
Salaries and employee benefits	$	5,963	$	5,819	$	144			2.47
Occupancy		942		844		98			11.61
Furniture and equipment		1,281		1,111		170			15.30
Office supplies and postage		382		379		3			0.79
Advertising and business development		620		436		184			42.20
Outside services		1,800		1,702		98			5.76
Rental expenses on tax credit real estate		344		655		(311	)		(47.48	)
FDIC insurance assessment		261		268		(7	)		(2.61	)
Other noninterest expense		440		413		27			6.54
	$	12,033	$	11,627	$	406

Other expenses of $12.03 million increased $0.41 million for the three months ended March 31, 2013 from the same period in 2012, an increase of 3.49%.  Salaries and employee benefits expense was $5.96 million for the three months ended March 31, 2013 which was a $0.14 million increase from the same period in 2012.  The increase is primarily due to annual salary adjustments that were effective in March.  Furniture and equipment expense was $1.28 million for the three months ended March 31, 2013 which represents a $0.17 million increase from the 2012 period.  The negative variance is partially due to an increase of $0.06 million in software expense.  Advertising and business development expense was $0.62 million for the three months ended March 31, 2013 which was a $0.18 million increase from the same period in 2012.  The increase is primarily due to an increase in expense related to debit card reward points.  The debit card reward point program was initiated in 2012 and there were no associated expenses with the program as of March 31, 2012.

As of March 31, 2013, the Company has prepaid FDIC insurance of $2.73 million, which represents the FDIC premiums paid by the Bank on December 30, 2009 for the years of 2010, 2011 and 2012.  The prepaid FDIC insurance is being amortized on a quarterly basis as premiums are assessed.  The balance remaining in prepaid FDIC insurance after collection of the amount due on June 30, 2013 will be refunded to the Company.

Income Taxes

Federal and state income tax expenses were $2.99 million and $3.26 million for the three months ended March 31, 2013 and 2012, respectively.  Income taxes as a percentage of income before taxes were 30.51% in 2013 and 29.18% in 2012.

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HILLS BANCORPORATION

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

Liquidity

The Company actively monitors and manages its liquidity position with the objective of maintaining sufficient cash flows to fund operations, meet client commitments, take advantage of market opportunities and provide a margin against unforeseeable liquidity needs.  Federal funds sold and investment securities available for sale are readily marketable assets.  Maturities of all investment securities are managed to meet the Company’s normal liquidity needs, to respond to market changes or to adjust the Company’s interest rate risk position.  Investment securities available for sale comprised 10.72% of the Company’s total assets at March 31, 2013, compared to 10.77% at December 31, 2012.

The Company has historically maintained a stable deposit base and a relatively low level of large deposits, which has mitigated the volatility in the Company’s liquidity position.  As of March 31, 2013, the Company had borrowed $125 million from the Federal Home Loan Bank (“FHLB”) of Des Moines. Advances are used as a means of providing both long and short-term, fixed-rate funding for certain assets and for managing interest rate risk.  The Company had additional borrowing capacity available from the FHLB of approximately $360.37 million at March 31, 2013.

As additional sources of liquidity, the Company has the ability to borrow up to $10.00 million from the Federal Reserve Bank of Chicago, and has lines of credit with three banks totaling $195.14 million. The borrowings under these credit lines would be secured by the Bank’s investment securities.  The combination of high levels of potentially liquid assets, low dependence on volatile liabilities and additional borrowing capacity provided sources of liquidity for the Company which management considered sufficient at March 31, 2013.

As of March 31, 2013, investment securities with a carrying value of $39.92 million were pledged to collateralize public and trust deposits, short-term borrowings and for other purposes, as permitted by law.  As of December 31, 2012, investment securities with a carrying value of $38.78 million were pledged.

Contractual Obligations

There have been no material changes with regard to contractual obligations disclosed in the Company’s Form 10-K for the year ended December 31, 2012.

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HILLS BANCORPORATION

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

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

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

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.

Item 4. Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, as of the end of the period covered by this report, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports it files with the Securities and Exchange Commission.  There have been no changes in the Company’s internal controls over financial reporting during the fiscal quarter ended March 31, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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HILLS BANCORPORATION

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

No material legal proceedings are pending.

Item 1A. Risk Factors

There have been no material changes from the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, 2012.

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

The following table sets forth information about the Company’s stock purchases, all of which were made pursuant to the 2005 Stock Repurchase Program, for the three months ended March 31, 2013:

Period	Total number of shares purchased		Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs		Maximum number of shares that may yet be purchased under the plans or programs (1)
January 1 to January 31		1,450	$	70.00		329,515		420,485
February 1 to February 28		300		70.00		329,815		420,185
March 1 to March 31		2,009		71.00		331,824		418,176
Total		3,759	$	70.53		331,824		418,176

(1)  On July 26, 2005, the Company’s Board of Directors authorized a program to repurchase up to 750,000 shares of the Company’s common stock (the “2005 Stock Repurchase Program”).  This authorization was previously set to expire on December 31, 2013.  At its September 2012 meeting, the Company’s Board of Directors extended the expiration date of the 2005 Stock Repurchase Program to December 31, 2014. 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.

During the first three months of 2013, the Company issued 286 shares of restricted stock under the 2010 Stock Option and Incentive Plan.  The restricted shares were issued to officers of the company for no cash consideration and will vest over a five-year period from the date of grant.  The issuance of these shares was exempt from the registration requirements of the SEC pursuant to Section 4(2) of the Securities Act of 1933.

Item 3. Defaults upon Senior Securities

Hills Bancorporation has no senior securities.

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

None

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HILLS BANCORPORATION

PART II - OTHER INFORMATION (Continued)

Item 6. Exhibits

3.1 Articles of Incorporation of Hills Bancorporation, incorporated by reference to Exhibit 3.1 to the Company’s Form S-3 filed with the Commission on May 12, 2011.

3.2 By-laws of Hills Bancorporation, incorporated by reference to Exhibit 3.2 to the Company’s Form S-3 filed with the Commission on May 12, 2011.

31 Certifications under Section 302 of the Sarbanes-Oxley Act of 2002

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

101.INS XBRL Instance Document (1)

101.SCH XBRL Taxonomy Extension Schema Document (1)

101.CAL XBRL Taxonomy Extension Calculation Linkbase Document (1)

101.DEF XBRL Taxonomy Extension Definition Linkbase Document (1)

101.LAB XBRL Taxonomy Extension Label Linkbase Document (1)

101.PRE XBRL Taxonomy Extension Presentation Linkbase Document (1)

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

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HILLS BANCORPORATION
Date:  May 8, 2013	By:  /s/ Dwight O. Seegmiller
	Dwight O. Seegmiller, Director, President and Chief Executive Officer
Date:  May 8, 2013	By:  /s/ Shari DeMaris
	Shari DeMaris, Secretary, Treasurer and Chief Accounting Officer

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HILLS BANCORPORATION

QUARTERLY REPORT OF FORM 10-Q FOR THE

QUARTER ENDED MARCH 31, 2013

Exhibit Number	Description	Page Number In The Sequential Numbering System March 31, 2013 Form 10-Q
31	Certifications under Section 302 of the Sarbanes-Oxley Act of 2002	51-52
32	Certifications under Section 906 of the Sarbanes-Oxley Act of 2002	53

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