HILLS BANCORPORATION 10-K

Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company's primary market risk exposure is to changes in interest rates. Interest rate risk is the risk to current or anticipated earnings or capital arising from movements in interest rates. Interest rate risk arises from repricing risk, basis risk, yield curve risk and options risk. Repricing risk is the difference between the timing of rate changes and the timing of cash flows. Basis risk is the difference from changing rate relationships among different yield curve affecting Bank activities. Yield curve risk is the difference from changing rate relationships across the spectrum of maturities. Option risk is the difference resulting from interest-related options imbedded in Bank products. The Bank’s primary source of interest rate risk exposure arises from repricing risk. To measure this risk the Bank uses a static gap measurement system that identifies the repricing gaps across the full maturity spectrum of the Bank’s assets and liabilities and an earnings simulation approach. The gap schedule is known as the interest rate sensitivity report. The report reflects the repricing characteristics of the Bank’s assets and liabilities. The report details the calculation of the gap ratio. This ratio indicated the amount of interest-earning assets repricing within a given period in comparison to the amount of interest-bearing liabilities repricing within the same period of time. A gap ratio of 1.0 indicates a matched position, in which case the effect on net interest income due to interest rate movements will be minimal. A gap ratio of less than 1.0 indicates that more liabilities than assets reprice within the time period, and a ratio greater than 1.0 indicates that more assets reprice than liabilities. The Company's asset/liability management, or its management of interest rate risk, is focused primarily on evaluating and managing net interest income given various risk criteria. Factors beyond the Company's control, such as market interest rates and competition, may also have an impact on the Company's interest income and interest expense. In the absence of other factors, the Company's overall yield on interest-earning assets will increase as will its cost of funds on its interest-bearing liabilities when market interest rates increase over an extended period of time. Inversely, the Company's yields and cost of funds will decrease when market rates decline. The Company is able to manage these swings to some extent by attempting to control the maturity or rate adjustments of its interest-earning assets and interest-bearing liabilities over given periods of time. The Bank maintains an Asset/Liability Committee, which meets at least quarterly to review the interest rate sensitivity position and to review and develop various strategies for managing interest rate risk within the context of the following factors: 1) capital adequacy, 2) asset/liability mix, 3) economic outlook, 4) market characteristics and 5) the interest rate forecast. In addition, the Bank uses a simulation model to review various assumptions relating to interest rate movement. The model attempts to limit rate risk even if it appears the Bank’s asset and liability maturities are perfectly matched and a favorable interest margin is present. The Bank’s policy is to generally maintain a balance between profitability and interest rate risk. Page 51 Table of Contents The Bank uses derivative financial instruments, when needed, to manage the impact of changes in interest rates on future interest income or interest expense. The Bank is exposed to credit-related losses in the event of nonperformance by the counterparties to these derivative instruments, but believe the risk of these losses has been minimized by entering into the contracts with large, stable financial institutions. The estimated fair market value of these derivative instruments are presented in Note 17 to the Consolidated Financial Statements. In order to minimize the potential effects of adverse material and prolonged increases or decreases in market interest rates on the Company's operations, management has implemented an asset/liability program designed to mitigate the Company's interest rate sensitivity. The program emphasizes the origination of adjustable rate loans, which are held in the portfolio, the investment of excess cash in short or intermediate term interest-earning assets, and the solicitation of transaction deposit accounts, which are less sensitive to changes in interest rates and can be re-priced rapidly. The table set forth below includes the portion of the balances in interest-bearing checking, savings and money market accounts that management has estimated to mature within one year. The classifications are used because the Bank’s historical data indicates that these have been very stable deposits without much interest rate fluctuation. Historically, these accounts would not need to be adjusted upward as quickly in a period of rate increases so the interest risk exposure would be less than the re-pricing schedule indicates. The FHLB borrowings are classified based on either their due date or if they are callable on their most likely call date based on the interest rate. Repricing Maturities Days More Than Immediately 2-30 31-90 91-180 181-365 One Year Total (Amounts in Thousands) Earning assets: Excess Cash $ 752,985 $ — $ — $ — $ — $ — $ 752,985 Federal funds sold — — — — — — — Investment securities — 2,704 11,346 36,317 18,495 487,038 555,900 Loans 10,834 285,704 60,100 114,160 167,225 2,028,225 2,666,248 Total earning assets 763,819 288,408 71,446 150,477 185,720 2,515,263 3,975,133 Sources of funds: Interest-bearing checking and savings accounts 136,417 — — — — 2,167,223 2,303,640 Certificates of deposit — 23,507 42,034 82,355 172,868 276,489 597,253 FHLB borrowings — — — — — — — Federal funds and repurchase agreements 249 — — — — — 249 136,666 23,507 42,034 82,355 172,868 2,443,712 2,901,142 Other sources, primarily noninterest-bearing — — — — — 1,070,804 1,070,804 Total sources 136,666 23,507 42,034 82,355 172,868 3,514,516 3,971,946 Interest Rate Gap $ 627,153 $ 264,901 $ 29,412 $ 68,122 $ 12,852 $ (999,253) $ 3,187 Cumulative Interest Rate Gap at December 31, 2021 $ 627,153 $ 892,054 $ 921,466 $ 989,588 $ 1,002,440 $ 3,187 Gap Ratio 5.59 12.27 1.70 1.83 1.07 0.72 Cumulative Gap Ratio 5.59 6.57 5.56 4.48 3.19 1.00 Page 52 Table of Contents Based on the data following, net interest income should decline with instantaneous increases in interest rates while net interest income should increase with instantaneous declines in interest rates. Generally, during periods of increasing interest rates, the Company's interest rate sensitive liabilities would re-price faster than its interest rate sensitive assets causing a decline in the Company's interest rate spread and margin. This would tend to reduce net interest income because the resulting increase in the Company’s cost of funds would not be immediately offset by an increase in its yield on earning assets. In times of decreasing interest rates, fixed rate assets could increase in value and the lag in re-pricing of interest rate sensitive assets could be expected to have a positive effect on the Company's net interest income. The following table, which presents principal cash flows and related weighted average interest rates by expected maturity dates, provides information about the Company's loans, investment securities and deposits that are sensitive to changes in interest rates. 2022 2023 2024 2025 2026 Thereafter Total Fair Value (Amounts In Thousands) Assets: Loans, fixed: Balance $ 401,352 $ 81,748 $ 168,627 $ 444,786 $ 369,196 $ 229,370 $ 1,695,079 $ 1,451,558 Average interest rate 3.93 % 4.51 % 4.21 % 3.91 % 3.76 % 2.43 % 3.74 % Loans, variable: Balance $ 170,357 $ 78,954 $ 75,639 $ 261,210 $ 205,479 $ 173,515 $ 965,154 $ 1,161,122 Average interest rate 3.60 % 4.14 % 4.31 % 3.77 % 3.57 % 3.40 % 3.70 % Investments (1): Balance $ 73,781 $ 60,885 $ 79,654 $ 81,239 $ 89,749 $ 170,592 $ 555,900 $ 555,900 Average interest rate 1.98 % 2.19 % 1.48 % 0.92 % 1.25 % 1.99 % 1.66 % Liabilities: Liquid deposits (2): Balance $ — $ — $ — $ — $ — $ — $ 2,303,640 $ 2,303,642 Average interest rate — % — % — % — % — % — % 0.15 % Deposits, certificates: Balance $ 320,764 $ 174,043 $ 63,193 $ 23,108 $ 16,145 $ — $ 597,253 $ 603,424 Average interest rate 1.11 % 2.51 % 1.16 % 0.79 % 0.95 % — % 1.51 % 1.11 (1) Includes all available-for-sale investments, federal funds and Federal Home Loan Bank stock. (2) Includes NOW and other demand, savings and money market funds. Item 8. Consolidated Financial Statements and Supplementary Data The consolidated financial statements and supplementary data are included on pages 54 through 118. Page 53 Report of Independent Registered Public Accounting Firm To the Shareholders, Board of Directors and Audit Committee Hills Bancorporation Hills, Iowa Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Hills Bancorporation (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively referred to as the “financial statements”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2021, based on Internal Control-Integrated Framework (2013 edition) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 4, 2022, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. Adoption of New Accounting Standard As discussed in Notes 1 and 3 to the consolidated financial statements, the Company has changed its method of accounting for the allowance for credit losses in 2021 due to the adoption of ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . As discussed below, auditing the Company’s allowance for credit losses, including adoption of the new accounting guidance related to the estimate of allowance for credit losses, was a critical audit matter. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to an account or disclosure that is material to the financial statements and (2) involved especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, Page 54 and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Allowance for Credit Losses As discussed in Notes 1 and 3 , the Company adopted Topic 326 effective January 1, 2021. The Company uses the discounted cash flow (DCF) method to estimate expected losses for most of the Company’s loan pools that exhibit similar risk characteristics. For each of these loan pools, the Company generates cash flow projections at the instrument level adjusting payment expectations for estimated prepayment speed, curtailments, time to recovery, probability of default and loss given default. The Company uses regression analysis of historical internal and peer data to determine suitable loss drivers when modeling lifetime probability of default and loss given default. The Company’s analysis also determines how expected probability of default and loss given default will react to forecasted levels of the loss drivers. Additional qualitative adjustments are applied for risk factors that are not considered within the modeling process but are relevant in assessing the expected credit losses within the loan pools. Loans that do not share risk characteristics are evaluated on an individual basis. For loans individually evaluated, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The Company applies expected funding percentages to the respective model loss rates to estimate the allowance related to unfunded commitments. Auditing management’s estimate of the allowances for loan credit losses (ACL) and unfunded commitments involved a high degree of subjectivity due to the complexities of the probability of default and loss given default models and the nature of the qualitative factor adjustments. Management’s qualitative factor adjustments are highly judgmental and had a significant effect on the ACL.   How the Critical Audit Matter was Addressed in the Audit Our audit procedures related to the ACL and allowance for unfunded commitments included the following procedures, among others: • Obtained an understanding of the Company’s process for establishing the ACL, including the implementation of models and assumptions and the qualitative factor adjustments of the ACL. • Obtained an understanding, evaluated the design and tested the operating effectiveness of controls, including information technology, over the reliability and accuracy of data used to calculate and estimate the various components of the ACL including: ◦ Loan data completeness and accuracy ◦ Grouping of loans by segment ◦ Model inputs utilized ◦ Approval of model assumptions selected ◦ Establishment of qualitative factors • Tested the mathematical accuracy of the calculation of the ACL • Tested individual loan files to evaluate the reasonableness of loan credit risk ratings • Tested the completeness and accuracy of inputs utilized in the calculation of the ACL • Evaluated the reasonableness of selected loss drivers utilized and loss driver forecasts for each loan segment • Tested the reasonableness of specific reserves on individually evaluated loans • Tested estimated funding rate of unfunded loan commitments • Evaluated the qualitative adjustments, including assessing the reasonableness and basis for adjustments BKD, LLP We have served as the Company’s auditor since 2012. Springfield, Missouri March 4, 2022 Page 55 Report of Independent Registered Public Accounting Firm To the Shareholders, Board of Directors and Audit Committee Hills Bancorporation Hills, Iowa Opinion on the Internal Control over Financial Reporting We have audited Hills Bancorporation’s (the “Company”) internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company and our report dated March 4, 2022, expressed an unqualified opinion. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definitions and Limitations of Internal Control over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of reliable financial statements in accordance with accounting principles generally accepted in the United States of America. Because management’s assessment and our audit also were conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), our audit of Hills Bancorporation’s internal control over financial reporting included controls over the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C). A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Page 56 Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. BKD, LLP Springfield, Missouri March 4, 2022 Page 57 Table of Contents HILLS BANCORPORATION CONSOLIDATED BALANCE SHEETS December 31, 2021 and 2020 (Amounts In Thousands, Except Shares) ASSETS 2021 2020 Cash and cash equivalents $ 781,918 $ 574,310 Investment securities available for sale at fair value (amortized cost 2021 $ 549,386 ; 2020 $ 396,670 ) (Notes 1, 2 and 13) 551,354 408,372 Stock of Federal Home Loan Bank 4,546 8,172 Loans held for sale 5,716 43,947 Loans, net of allowance for credit losses (2021 $ 35,470 ; 2020 $ 37,070 ) (Notes 1, 3, and 12) 2,625,062 2,674,012 Property and equipment, net (Note 4) 34,290 35,878 Tax credit real estate 9,815 7,273 Accrued interest receivable 11,437 12,177 Deferred income taxes, net (Notes 1 and 10) 9,125 6,088 Goodwill 2,500 2,500 Other assets 8,799 9,633 Total Assets $ 4,044,562 $ 3,782,362 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Noninterest-bearing deposits $ 633,101 $ 532,190 Interest-bearing deposits (Note 6) 2,900,893 2,660,378 Total deposits 3,533,994 3,192,568 Other borrowings, federal funds purchased 249 — Federal Home Loan Bank borrowings (Note 7) — 105,000 Accrued interest payable 1,165 1,733 Allowance for credit losses on off-balance sheet credit exposures 3,850 — Other liabilities 16,841 19,656 Total Liabilities 3,556,099 3,318,957 Commitments and Contingencies (Notes 9 and 15) Redeemable Common Stock Held By Employee Stock Ownership Plan (ESOP) (Note 9) 50,013 47,329 Stockholders' Equity (Note 11) Common stock, no par value; authorized 20,000,000 shares; issued 2021 10,329,493 shares; 2020 10,330,242 shares — — Paid in capital 60,938 60,233 Retained earnings 474,392 439,831 Accumulated other comprehensive gain (Note 8) 1,477 8,782 Treasury stock at cost (2021 1,029,853 shares; 2020 999,247 shares) ( 48,344 ) ( 45,441 ) Total Stockholders' Equity 488,463 463,405 Less maximum cash obligation related to ESOP shares (Note 9) 50,013 47,329 Total Stockholders' Equity Less Maximum Cash Obligations Related To ESOP Shares 438,450 416,076 Total Liabilities & Stockholders' Equity $ 4,044,562 $ 3,782,362 See Notes to Consolidated Financial Statements. Page 58 Table of Contents HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2021, 2020 and 2019 (Amounts In Thousands, Except Per Share Amounts) 2021 2020 2019 Interest income: Loans, including fees $ 113,648 $ 120,196 $ 121,269 Investment securities: Taxable 3,604 3,512 3,239 Nontaxable 3,854 3,876 3,844 Federal funds sold 983 945 3,980 Total interest income 122,089 128,529 132,332 Interest expense: Deposits 14,712 21,553 28,540 FHLB borrowings 2,915 5,399 6,333 Total interest expense 17,627 26,952 34,873 Net interest income 104,462 101,577 97,459 Credit loss (benefit) expense (Note 3) ( 5,507 ) 4,358 ( 2,880 ) Net interest income after credit loss (benefit) expense 109,969 97,219 100,339 Noninterest income: Net gain on sale of loans 7,588 6,678 3,539 Trust fees 13,521 10,275 9,579 Service charges and fees 11,774 10,186 10,276 Other noninterest income 581 1,187 1,426 Gain (loss) on sale of investment securities — 10 ( 28 ) 33,464 28,336 24,792 Noninterest expenses: Salaries and employee benefits 42,458 40,621 36,709 Occupancy 4,152 4,343 4,336 Furniture and equipment 7,276 7,357 6,795 Office supplies and postage 1,739 1,799 1,841 Advertising and business development 2,132 2,082 2,595 Outside services 12,592 11,069 10,360 FDIC insurance assessment 1,043 856 194 Other noninterest expenses 9,949 7,504 4,434 81,341 75,631 67,264 Income before income taxes 62,092 49,924 57,867 Income taxes (Note 10) 14,007 11,277 12,549 Net income $ 48,085 $ 38,647 $ 45,318 Earnings per share: Basic $ 5.16 $ 4.12 $ 4.85 Diluted 5.16 4.12 4.85 See Notes to Consolidated Financial Statements. Page 59 Table of Contents HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31, 2021, 2020 and 2019 (Amounts In Thousands) 2021 2020 2019 Net income $ 48,085 $ 38,647 $ 45,318 Other comprehensive income (loss) Securities: Net change in unrealized (loss) gain on securities available for sale ( 9,734 ) 7,478 6,940 Reclassification adjustment for net (gains) losses realized in net income — ( 10 ) 28 Income taxes 2,429 ( 1,864 ) ( 1,738 ) Other comprehensive (loss) income on securities available for sale ( 7,305 ) 5,604 5,230 Derivatives used in cash flow hedging relationships: Net change in unrealized loss on derivatives — ( 335 ) ( 753 ) Reclassification adjustment for losses realized in net income — 2,684 — Income taxes — ( 586 ) 188 Other comprehensive income (loss) on cash flow hedges — 1,763 ( 565 ) Other comprehensive (loss) income, net of tax ( 7,305 ) 7,367 4,665 Comprehensive income $ 40,780 $ 46,014 $ 49,983 See Notes to Consolidated Financial Statements. Page 60 Table of Contents HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 2021, 2020 and 2019 (Amounts In Thousands, Except Share Data) Paid In Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock Maximum Cash Obligation Related To ESOP Shares Total Balance, December 31, 2018 $ 52,122 $ 371,848 $ ( 3,250 ) $ ( 36,968 ) $ ( 48,870 ) $ 334,882 Issuance of 101,912 shares of common stock 3,549 — — 2,672 — 6,221 Issuance of 7,720 shares of common stock under the employee stock purchase plan 434 — — — — 434 Unearned restricted stock compensation 86 — — — — 86 Forfeiture of 5,255 shares of common stock ( 262 ) — — — — ( 262 ) Share-based compensation 14 — — — — 14 Change related to ESOP shares — — — — ( 2,956 ) ( 2,956 ) Net income — 45,318 — — — 45,318 Cash dividends ($ 0.82 per share) — ( 7,657 ) — — — ( 7,657 ) Purchase of 89,124 shares of common stock — — — ( 5,534 ) — ( 5,534 ) Other comprehensive (loss) — — 4,665 — — 4,665 Balance, December 31, 2019 $ 55,943 $ 409,509 $ 1,415 $ ( 39,830 ) $ ( 51,826 ) $ 375,211 Issuance of 110,337 shares of common stock 4,177 — — 2,939 — 7,116 Issuance of 7,449 shares of common stock under the employee stock purchase plan 413 — — — — 413 Unearned restricted stock compensation ( 68 ) — — — — ( 68 ) Forfeiture of 4,863 shares of common stock ( 257 ) — — — — ( 257 ) Share-based compensation 25 — — — — 25 Change related to ESOP shares — — — — 4,497 4,497 Net income — 38,647 — — — 38,647 Cash dividends ($ 0.89 per share) — ( 8,325 ) — — — ( 8,325 ) Purchase of 133,622 shares of common stock — — — ( 8,550 ) — ( 8,550 ) Other comprehensive income — — 7,367 — — 7,367 Balance, December 31, 2020 $ 60,233 $ 439,831 $ 8,782 $ ( 45,441 ) $ ( 47,329 ) $ 416,076 Cumulative change in accounting principle (Note 1) — ( 4,751 ) — — — ( 4,751 ) Balance, January 1, 2021 (as adjusted for change in accounting principle) 60,233 435,080 8,782 ( 45,441 ) ( 47,329 ) 411,325 Issuance of 24,513 shares of common stock 952 — — 666 — 1,618 Issuance of 7,334 shares of common stock under the employee stock purchase plan 427 — — — — 427 Unearned restricted stock compensation ( 244 ) — — — — ( 244 ) Forfeiture of 8,083 shares of common stock ( 455 ) — — — — ( 455 ) Share-based compensation 25 — — — — 25 Change related to ESOP shares — — — — ( 2,684 ) ( 2,684 ) Net income — 48,085 — — — 48,085 Cash dividends ($ 0.94 per share) — ( 8,773 ) — — — ( 8,773 ) Purchase of 55,119 shares of common stock — — — ( 3,569 ) — ( 3,569 ) Other comprehensive income — — ( 7,305 ) — — ( 7,305 ) Balance, December 31, 2021 $ 60,938 $ 474,392 $ 1,477 $ ( 48,344 ) $ ( 50,013 ) $ 438,450 See Notes to Consolidated Financial Statements. Page 61 Table of Contents HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2021, 2020 and 2019 (Amounts In Thousands) 2021 2020 2019 Cash Flows from Operating Activities Net income $ 48,085 $ 38,647 $ 45,318 Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities: Depreciation 3,052 3,128 3,072 Credit loss (benefit) expense ( 5,507 ) 4,358 ( 2,880 ) Net (gain) loss on sale of investment securities available for sale — ( 10 ) 28 Share-based compensation 25 25 14 Compensation expensed through issuance of common stock 1,618 1,272 1,133 Forfeiture of common stock ( 455 ) ( 257 ) ( 262 ) Provision for deferred income taxes 971 ( 520 ) 1,301 Net gain on sale of other real estate owned and other repossessed assets ( 51 ) ( 120 ) ( 94 ) Decrease (increase) in accrued interest receivable 740 265 ( 658 ) Amortization of premium on investment securities, net 1,203 818 441 Decrease (increase) in other assets 392 1,228 ( 2,681 ) Amortization of operating lease right of use assets 397 386 354 (Decrease) increase in accrued interest and other liabilities ( 3,627 ) ( 5,527 ) 650 Loans originated for sale ( 429,343 ) ( 475,187 ) ( 299,223 ) Proceeds on sales of loans 475,162 446,318 296,346 Net gain on sales of loans ( 7,588 ) ( 6,678 ) ( 3,539 ) Net cash and cash equivalents provided by operating activities 85,074 8,146 39,320 Cash Flows from Investing Activities Proceeds from maturities of investment securities available for sale 91,459 85,530 63,301 Proceeds from sale of investment securities available for sale — 313 12,467 Purchases of investment securities available for sale ( 245,378 ) ( 129,359 ) ( 104,539 ) Proceeds from sale of stock of FHLB 4,201 — — Purchases of stock of FHLB ( 575 ) — — Loans made to customers, net of collections 52,018 ( 72,138 ) ( 13,024 ) Proceeds on sale of other real estate owned and other repossessed assets 55 120 818 Purchases of property and equipment ( 1,464 ) ( 1,860 ) ( 3,167 ) Investment in tax credit real estate ( 4,183 ) — — Net changes from tax credit real estate investment 1,641 1,007 913 Net cash and cash equivalents used in investing activities ( 102,226 ) ( 116,387 ) ( 43,231 ) (Continued) Page 62 Table of Contents HILLS BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended December 31, 2021, 2020 and 2019 (Amounts In Thousands) 2021 2020 2019 Cash Flows from Financing Activities Net increase in deposits 341,426 531,204 240,240 Net increase in short-term borrowings 249 — — Net decrease in FHLB borrowings ( 105,000 ) ( 80,000 ) ( 30,000 ) Borrowings from FRB 1 1 1 Payments on FRB borrowings ( 1 ) ( 1 ) ( 1 ) Issuance of common stock, net of costs — 5,844 5,026 Stock options exercised — — 62 Purchase of treasury stock ( 3,569 ) ( 8,550 ) ( 5,534 ) Proceeds from the issuance of common stock through the employee stock purchase plan 427 413 434 Dividends paid ( 8,773 ) ( 8,325 ) ( 7,657 ) Net cash and cash equivalents provided by financing activities 224,760 440,586 202,571 Increase in cash and cash equivalents 207,608 332,345 198,660 Cash and cash equivalents: Beginning of year 574,310 241,965 43,305 End of year $ 781,918 $ 574,310 $ 241,965 Supplemental Disclosures Cash payments for: Interest paid to depositors $ 15,280 $ 22,294 $ 27,878 Interest paid on other obligations 2,915 5,399 6,333 Income taxes paid 9,565 9,874 10,784 Noncash financing activities: Increase (decrease) in maximum cash obligation related to ESOP shares $ 2,684 $ ( 4,497 ) $ 2,956 Transfers to other real estate owned 96 45 712 Sale and financing of other real estate owned 137 — 97 Right of use assets obtained in exchange for operating lease obligations — 48 3,581 See Notes to Consolidated Financial Statements. Page 63 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Activities and Significant Accounting Policies Nature of activities : Hills Bancorporation (the "Company") is a holding company engaged in the business of commercial banking. The Company's subsidiary is Hills Bank and Trust Company, Hills, Iowa (the “Bank”), which is wholly-owned. The Bank is a full-service commercial bank extending its services to individuals, businesses, governmental units and institutional customers primarily in the communities of Hills, Iowa City, Coralville, North Liberty, Lisbon, Mount Vernon, Kalona, Wellman, Cedar Rapids, Marion and Washington, Iowa. The Bank competes with other financial institutions and non-financial institutions providing similar financial products. Although the loan activity of the Bank is diversified with commercial and agricultural loans, real estate loans, automobile, installment and other consumer loans, the Bank's credit is concentrated in real estate loans. All of the Company’s operations are considered to be one reportable operating segment. Accounting estimates : The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain significant estimates : The allowance for credit losses, fair values of securities and other financial instruments, and share-based compensation expense involve certain significant estimates made by management. These estimates are reviewed by management routinely and it is reasonably possible that circumstances that exist at December 31, 2021 may change in the near-term and the effect could be material to the consolidated financial statements. Principles of consolidation : The consolidated financial statements include the accounts of the Company and its subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation. Reclassification of prior year presentation : Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations. Revenue recognition : Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606"), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the Company’s contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied. The majority of the Company’s revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans, letters of credit and investment securities as these activities are not subject to the requirements of ASC 606. Interest income on loans and investment securities is recognized on the accrual method in accordance with written contracts. Loan origination fees of mortgage loans originated for sale are recognized when the loans are sold. Descriptions of the Company’s revenue-generating activities that are within the scope of ASC 606 are the following: Service charges and fees on deposit accounts represent general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue which includes interchange income, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when the Company’s performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied. Trust income represents monthly fees due from wealth management customers as consideration for managing the customers' assets. Wealth management and trust services include custody of assets, investment management, fees for trust services and similar fiduciary activities. Revenue is recognized when our performance obligation is completed each month, which is generally the time that payment is received. A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an Page 64 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS entity's obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. As of December 31, 2021 and 2020, the Company did not have any significant contract balances. An entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company did not capitalize any contract acquisition costs for the years ending December 31, 2021 and 2020. Cash and cash equivalents : The Company considers all investments with original maturities of three months or less to be cash equivalents. At December 31, 2021 and 2020, cash equivalents consisted primarily of deposits with other banks. Investment securities : Available-for-sale ("AFS") securities consist of debt securities not classified as trading or held to maturity. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders' equity. There were no trading or held to maturity securities as of December 31, 2021 or 2020. Fair value measurement is based upon quoted market prices in active markets, if available. If quoted prices in active markets are not available, fair value is measured using pricing models or other model-based valuation techniques such as present value of future cash flows, which consider prepayment assumptions and other factors such as credit losses and market liquidity. Unrealized gains and losses are excluded from earnings and reported, net of tax, in other comprehensive income ("OCI"). Premiums on debt securities are amortized to the earliest call date and discounts on debt securities are accreted over the period to maturity of those securities. The method of amortization results in a constant effective yield on those securities (the interest method). Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. AFS debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. For AFS debt securities, a decline in fair value due to credit loss results in recording an allowance for credit losses to the extent the fair value is less than the amortized cost basis. Declines in fair value that have not been recorded through an allowance for credit losses, such as declines due to changes in market interest rates, are recorded through other comprehensive income, net of applicable taxes. Impairment may result from credit deterioration of the issuer or collateral underlying the security. In performing an assessment of whether any decline in fair value is due to a credit loss, all relevant information is considered at the individual security level. For asset-backed securities performance indicators considered related to the underlying assets include default rates, delinquency rates, percentage of nonperforming assets, debt-to-collateral ratios, third-party guarantees, current levels of subordination, vintage, geographic concentration, analyst reports and forecasts, credit ratings and other market data. In assessing whether a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount the fair value is less than amortized cost basis. If we intend to sell a debt security or more likely than not we will be required to sell the security before recovery of its amortized cost basis, the debt security is written down to its fair value and the write down is charged against the allowance for credit losses with any incremental impairment reported in earnings. Accrued interest receivable on AFS debt securities totaled $ 2.05 million at December 31, 2021 and is excluded from the estimate of credit losses. Stock of the Federal Home Loan Bank is carried at cost. The Company has evaluated the stock and determined there is no impairment. Loans held for sale : Loans held for sale are stated at the lower of aggregate cost or estimated fair value. Loans are sold on a non-recourse basis with servicing released and gains and losses are recognized based on the difference between sales proceeds and the carrying value of the loan. The Company has had very few experiences of repurchasing loans previously sold into the Page 65 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS secondary market. A specific reserve was not considered necessary based on the Company’s historical experience with repurchase activity. Loans held for investment : Loans are stated at the amount of unpaid principal, net of deferred loan fees, and reduced by the allowance for credit losses ("ACL"). Accrued interest receivable on loans held for investment totaled $ 9.29 million at December 31, 2021 and is excluded from the estimate of credit losses. Interest income is accrued on the unpaid principal balance. Nonrefundable loan fees and origination costs are deferred and recognized as a yield adjustment over the life of the related loan. The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower's ability to meet payments of interest or principal when they become due, which is generally when a loan is 90 days or more past due. When a loan is placed on nonaccrual status, all previously accrued and unpaid interest is reversed. Loans are returned to an accrual status when all of the principal and interest amounts contractually due are brought current and repayment of the remaining contractual principal and interest is expected. A loan may also return to accrual status if additional collateral is received from the borrower and, in the opinion of management, the financial position of the borrower indicates that there is no longer any reasonable doubt as to the collection of the amount contractually due. Payment received on nonaccrual loans are applied first to principal. Once principal is recovered, any remaining payments received are applied to interest income. As of December 31, 2021, none of the Company’s nonaccrual loans were earning interest on a cash basis. The policy for charging off loans is consistent throughout all loan categories. A loan is charged off based on criteria that includes but is not limited to: delinquency status, financial condition of the entire customer credit line and underlying collateral coverage, economic or external conditions that might impact full repayment of the loan, legal issues, overdrafts, and the customer’s willingness to work with the Company. Allowance for credit losses for loans held for investment : The allowance for credit losses is an estimate of expected losses inherent within the Company's existing loans held for investment portfolio. The allowance for credit losses for loans held for investment, as reported in our consolidated balance sheet, is adjusted by a credit loss expense, which is reported in earnings, and reduced by the charge-off of loan amounts, net of recoveries. The loan loss estimation process involves procedures to appropriately consider the unique characteristics of loan portfolio segments which consist of agricultural, 1 to 4 family first and junior liens, commercial, and consumer lending. These segments are further disaggregated into loan classes, the level at which credit risk is monitored. For each of these pools, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speed, curtailments, time to recovery, probability of default, and loss given default. The modeling of expected prepayment speeds, curtailment rates, and time to recovery are based on historical internal data. The following provides the credit quality indicators and risk elements that are most relevant and most carefully considered and monitored for each loan portfolio segment. Agricultural - Agricultural operating loans include loans made to finance agricultural production and other loans to farmers and farming operations. Agricultural loans also include mortgage loans secured by farmland. Agricultural operating loans, most of which are secured by crops and machinery, are provided to finance capital improvement and farm operations as well as acquisitions of livestock and machinery. The ability of the borrower to repay may be affected by many factors outside of the borrower’s control including adverse weather conditions, loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations. The ultimate repayment of agricultural operating loans is dependent upon the profitable operation or management of the agricultural entity. Agricultural operating loans generally have a term of one year and may have a fixed or variable rate. Mortgage loans secured by farmland are made to individuals and businesses within the Company's trade area. The primary source of repayment is the cash flow generated by the collateral underlying the loan. The secondary repayment source would be the liquidation of the collateral. Terms for real estate loans secured by farmland range from one to ten years with an amortization period of 25 years or less. Generally, interest rates are fixed for mortgage loans secured by farmland. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the Iowa real gross domestic product (GDP). Page 66 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1 to 4 Family First and Junior Liens - The 1 to 4 family first and junior liens portfolio segment is comprised of the single family and home equity loan classes, which are underwritten after evaluating a borrower's capacity to repay, credit, and collateral. Several factors are considered when assessing a borrower's capacity, including the borrower's employment, income, current debt, assets, and level of equity in the property. Credit refers to how well a borrower manages their current and prior debts as documented by a credit report that provides credit scores and the borrower's current and past information about their credit history. Collateral refers to the type and use of property, occupancy, and market value. Property appraisals are obtained to assist in evaluating collateral. Loan-to-property value and debt-to-income ratios, loan amount, and lien position are also considered in assessing whether to originate a loan. These borrowers are particularly susceptible to downturns in economic trends such as conditions that negatively affect housing prices and demand and levels of unemployment. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the all-transactions house price index for Iowa. Commercial - The commercial loan portfolio segment is comprised of the commercial real estate mortgage, multifamily residential mortgage, construction/land development and commercial and financial loan classes, whose underwriting standards consider the factors described for single family and home equity loan classes as well as others when assessing the borrower's and associated guarantors or other related party's financial position. These other factors include assessing liquidity, the level and composition of net worth, leverage, considering all other lender amounts and position, an analysis of cash expected to flow through the obligors including the outflow to other lenders, vacancies and prior experience with the borrower. This information is used to assess adequate financial capacity, profitability, and experience. Ultimate repayment of these loans is sensitive to interest rate changes, general economic conditions, liquidity, and availability of long-term financing. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate, the all-transactions house price index for Iowa and the Iowa real GDP. Consumer Lending - The Bank offers consumer loans to individuals including personal loans and automobile loans. These consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than real estate-related loans. Consumer loans collections are dependent on the borrower's continuing financial stability and are more likely to be affected by adverse personal circumstances. Collateral for these loans generally includes automobiles, boats, recreational vehicles and real estate. However, depending on the overall financial condition of the borrower, some loans are made on an unsecured basis. The collateral securing these loans may depreciate over time, may be difficult to recover and may fluctuate in value based on condition. Key economic forecasts used in estimating expected credit losses for this segment include the Iowa unemployment rate and the Iowa real GDP. The allowance level is influenced by loan volumes, loan credit quality indicator migration or delinquency status, historic loss experience and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The methodology for estimating the amount of expected credit losses reported in the allowance for credit losses has two basic components: first, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics; and second, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans. Depending on the nature of the pool of financial assets with similar risk characteristics, the Company uses a discounted cash flow method or remaining life method to estimate expected credit losses. Discounted cash flow method : In estimating the component of the allowance for credit losses for loans that share similar risk characteristics with other loans, such loans are segregated into loan classes. Loans are designated into loan classes based on loans pooled by product types and similar risk characteristics or areas of risk concentration. In determining the allowance for credit losses, we derive an estimated credit loss assumption from a model that categorizes loan pools based on loan type and purpose. This model calculates an expected loss percentage for each loan class by considering the probability of default, using life-of-loan analysis periods for all loan segments, and the historical severity of loss, based on the aggregate net lifetime losses incurred per loan class. The default and severity factors used to calculate the allowance for credit losses for loans that share similar risk characteristics with other loans are adjusted for differences between the historical period used to calculate historical default and loss severity rates and expected conditions over the remaining lives of the loans in the portfolio related to: (1) lending policies and procedures; (2) international, national, regional and local economic business conditions and developments that affect the collectability of the portfolio; (3) the nature and volume of the loan portfolio including the terms of the loans; (4) the experience, ability, and depth of the lending management and other relevant staff; (5) the volume and severity of past due and adversely classified or graded loans and the volume of nonaccrual loans; (6) the quality of our loan review system and (7) Page 67 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the value of underlying collateral for collateralized loans. Additional factors include the existence and effect of any concentrations of credit, and changes in the level of such concentrations and the effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio. Such factors are used to adjust the historical probabilities of default and severity of loss so that they reflect management expectation of future conditions based on a reasonable and supportable forecast. The Company uses regression analysis of historical internal and peer data to determine which variables are best suited to be economic variables utilized when modeling lifetime probability of default and loss given default. This analysis also determines how expected probability of default and loss given default will react to forecasted levels of the economic variables. For all DCF models, management has determined that four quarters represents a reasonable and supportable forecast period and reverts back to a historical loss rate over twelve quarters on a straight-line basis. Other internal and external indicators of economic forecasts are also considered by management when developing the forecast metrics. Remaining life method: Expected credit losses for credit cards and overdrafts are determined through use of the remaining life method. The remaining life method utilizes average annual charge-off rates and remaining life to estimate the allowance for credit losses. This is done by estimating the amount and timing of principal payments expected to be received as payment for the balance outstanding as of the reporting period and applying those principal payments against the balance outstanding as of the reporting period along with the average annual charge-off rate until the expected payments have been fully allocated. Collateral dependent financial assets : For a loan that does not share risk characteristics with other loans, expected credit loss is measured based on net realizable value, that is, the difference between the discounted value of the expected future cash flows, based on the original effective interest rate, and the amortized cost basis of the loan. For these loans, we recognize expected credit loss equal to the amount by which the net realizable value of the loan is less than the amortized cost basis of the loan (which is net of previous charge- offs and deferred loan fees and costs), except when the loan is collateral dependent, that is, when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In these cases, expected credit loss is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral. The fair value of the collateral is adjusted for the estimated cost to sell if repayment or satisfaction of a loan is dependent on the sale (rather than only on the operation) of the collateral. The Company’s estimate of the ACL reflects losses expected over the contractual life of the assets, adjusted for estimated prepayments or curtailments. The contractual term does not consider extensions, renewals or modifications unless the Company has identified an expected troubled debt restructure (TDR). A loan that has been modified or renewed is considered a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. The Company’s ACL reflects all effects of a TDR when an individual asset is specifically identified as a reasonably expected TDR. The Company has determined that a TDR is reasonably expected no later than the point when the lender concludes that modification is the best course of action and it is at least reasonably possible that the troubled borrower will accept some form of concession from the lender to avoid a default. Reasonably expected TDRs and executed non-performing TDRs are evaluated individually to determine the required ACL. TDRs performing in accordance with their modified contractual terms for a reasonable period of time may be included in the Company’s existing pools based on the underlying risk characteristics of the loan to measure the ACL. Allowance for credit losses on off-balance sheet credit exposures, including unfunded loan commitments : The Company maintains a separate allowance for credit losses from off-balance-sheet credit exposures, including unfunded loan commitments, which is disclosed on the balance sheet. Management estimates the amount of expected losses by calculating a commitment usage factor over the contractual period for exposures that are not unconditionally cancellable by the Company and applying the loss factors used in the ACL methodology to the results of the usage calculation to estimate the liability for credit losses related to unfunded commitments for each loan type. No credit loss estimate is reported for off-balance-sheet (OBS) credit exposures that are unconditionally cancellable by the Company, such as credit card receivables, or for undrawn amounts under such arrangements that may be drawn prior to the cancellation of the arrangement. The allowance for credit losses on OBS credit exposures is adjusted as credit loss expense. Categories of OBS credit exposures correspond to the loan portfolio segments described previously. Troubled debt restructurings (“TDR loans”) : A loan is accounted for and reported as a troubled debt restructuring ("TDR") when, for economic or legal reasons, we grant a concession to a borrower experiencing financial difficulty that we would not Page 68 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS otherwise consider. These concessions may include rate reductions, principal forgiveness, extension of maturity date and other actions intended to minimize potential losses to the Company. A restructuring that results in only an insignificant delay in payment is not considered a concession. A delay may be considered insignificant if the payments subject to the delay are insignificant relative to the unpaid principal or collateral value and the contractual amount due, or the delay in timing of the restructured payment period is insignificant relative to the frequency of payments, the debt's original contractual maturity or original expected duration. TDRs that are performing and on accrual status as of the date of the modification remain on accrual status. TDRs that are nonperforming as of the date of modification generally remain as nonaccrual until the prospect of future payments in accordance with the modified loan agreement is reasonably assured, generally demonstrated when the borrower maintains compliance with the restructured terms for a predetermined period, normally at least six months. TDRs with temporary below-market concessions remain designated as a TDR regardless of the accrual or performance status until the loan is paid off. However, if the TDR loan has been modified in a subsequent restructure with market terms and the borrower is not currently experiencing financial difficulty, then the loan is no longer classified as a TDR in the quarter following the modification. Management evaluates loans where there is a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower for purposes of estimating the allowance for credit losses. Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” allows financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time during the COVID-19 pandemic. Under Section 4013 of the CARES Act, loan modifications that qualify for such suspension are those where the borrower was not more than 30 days past due as of December 31, 2019. In addition, the loan modification being made in response to the COVID-19 pandemic must include a deferral or delay in the payment of principal or interest, or change in the interest rate on the loan. In March 2020, various regulatory agencies, including the FRB and the FDIC, issued an interagency statement, effective immediately, on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not to be considered TDRs. This includes short-term (e.g., six months) modifications, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. The relief related to TDRs expired on January 1, 2022. See Note 3 for further discussion. Transfers of financial assets : Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Credit related financial instruments : In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded. Tax credit real estate : Tax credit real estate represents three multi-family rental properties, three assisted living rental properties, a multi-tenant rental property for persons with disabilities, and a multi-family senior living rental property, all which are affordable housing projects as of December 31, 2021. The Bank has a 99 % or greater limited partnership interest in each limited partnership. The investment in each was completed after the projects had been developed by the general partner. The Company evaluates the recoverability of the carrying value on a regular basis. If the recoverability was determined to be in doubt, a valuation allowance would be established by way of a charge to expense. Depreciation expense is provided on a straight-line basis over the estimated useful life of the assets. Expenditures for normal repairs and maintenance are charged to expense as incurred. The investments in tax credit real estate are recorded for all years presented using the equity method of accounting, with the exception of the investment in the affordable housing project described below. The operations of the properties are not expected to contribute significantly to the Company’s income before income taxes. However, the properties do contribute in the form of income tax credits, which lowers the Company’s effective tax rate. Once established, the credits on each property last for ten Page 69 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS years and are passed through from the limited partnerships to the Bank and reduces the consolidated federal tax liability of the Company. In February 2021, the Company provided construction financing and contributed capital of $ 4.18 million to Del Ray Ridge LP, as limited partner, which owns and operates an affordable housing property in Iowa City, Iowa. The Company accounts for the investment in this tax credit real estate using the proportional amortization method as provided for under Accounting Standards Codification (ASC) 323-740. The investment qualifies for the proportional amortization method as it meets all of the criteria under ASC 323-740-25-1. Substantially all of the projected benefits are from tax credits and other tax benefits due to the minimum buyout clause included in the partnership agreement. On a regular basis, the Company evaluates recoverability of the carrying value of the tax credit real estate investments to determine if an allowance for credit losses is necessary. The allowance for credit losses is measured by a comparison of the carrying amount of the investments to the future undiscounted cash flows expected to be generated by the investment properties, including the low-income housing tax credits and any estimated proceeds from eventual disposition. If there is an indication of impairment, the allowance for credit losses would be established with a charge to credit loss expense. There were no indications of impairment based on management's evaluation and therefore no allowance for credit losses was determined necessary as of December 31, 2021. Property and equipment : Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using primarily declining-balance methods over the estimated useful lives of 7 - 40 years for buildings and improvements and 3 - 10 years for furniture and equipment. Deferred income taxes : Deferred income taxes are provided under the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating loss, and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50 % likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Interest and penalties on unrecognized tax benefits are classified as other noninterest expense. As of December 31, 2021, the Company had no material unrecognized tax benefits. Goodwill : Goodwill represents the excess of cost over the fair value of the net assets acquired, and is not subject to amortization, but requires, at a minimum, annual impairment tests for intangibles that are determined to have an indefinite life. Other real estate : Other real estate represents property acquired through foreclosures and settlements of loans. Property acquired is carried at the lower of the principal amount of the loan outstanding at the time of acquisition, plus any acquisition costs, or the estimated fair value of the property, less disposal costs. The Bank will obtain updated appraisals to determine the estimated fair value of the property based on the type of collateral securing the loan and the date of the latest appraisal. Subsequent write downs estimated on the basis of later valuations are charged to net loss on sale of other real estate owned and other repossessed assets. Net operating expenses incurred in maintaining such properties are charged to other non-interest expense. Net capital expenditures incurred are capitalized to the property. Derivative financial instruments : The Bank uses interest rate swaps as part of its interest rate risk management. Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 815 establishes accounting and reporting standards for derivative instruments and hedging activities. The Bank records all interest rate swaps on the balance sheet at fair value. Derivatives used to hedge the exposure to variability in expected future cash flows are considered cash flow hedges. To qualify for hedge accounting, the Bank must comply with the detailed rules and documentation requirements at the inception of the hedge, and hedge effectiveness is assessed at inception and periodically throughout the life of the hedging relationship. As of December 31, 2021 and 2020, the Bank did not have any outstanding interest rate swaps. For derivatives designated as cash flow hedges, the changes in the fair value of the derivatives is initially reported in other comprehensive income and subsequently reclassified to interest income or expense when the hedged transaction affects Page 70 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS earnings. The Bank assesses the effectiveness of each hedging relationship by comparing the cumulative changes in cash flows of the derivative hedging instruments with the cumulative changes in cash flows of the designated hedged item or transaction. No component of the change in the fair value of the hedging instrument is excluded from the assessment of hedge effectiveness. The Bank does not use derivatives for trading or speculative purposes. Earnings per share: Basic earnings per share is computed using the weighted average number of actual common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that would occur from the exercise of common stock options outstanding. ESOP shares are considered outstanding for this calculation unless unearned. The following table presents calculations of earnings per share: Year Ended December 31, 2021 2020 2019 (Amounts In Thousands, except share and per share data) Computation of weighted average number of basic and diluted shares: Common shares outstanding at the beginning of the year 9,330,995 9,351,694 9,336,441 Weighted average number of net shares (redeemed) issued ( 23,793 ) 17,571 19,304 Weighted average shares outstanding (basic) 9,307,202 9,369,265 9,355,745 Weighted average of potential dilutive shares attributable to stock options granted, computed under the treasury stock method 3,660 3,640 4,035 Weighted average number of shares (diluted) 9,310,862 9,372,905 9,359,780 Net income $ 48,085 $ 38,647 $ 45,318 Earnings per share: Basic $ 5.16 $ 4.12 $ 4.85 Diluted $ 5.16 $ 4.12 $ 4.85 Stock awards and options : Compensation expense for stock issued through the stock award plan is accounted for using the fair value method prescribed by FASB ASC 718, “Share-Based Payment” (“ASC 718”). Under this method, compensation expense is measured and recognized for all stock-based awards made to employees and directors based on the fair value of each award as of the date of the grant. Common stock held by ESOP : The Company's maximum cash obligation related to these shares is classified outside stockholders' equity because the shares are not readily traded and could be put to the Company for cash. Treasury stock : Treasury stock is accounted for by the cost method, whereby shares of common stock reacquired are recorded at their purchase price. Trust department assets : Property held for customers in fiduciary or agency capacities is not included in the accompanying consolidated balance sheets, as such items are not assets of the Company. Effect of New Financial Accounting Standards Accounting guidance adopted in 2021 On January 1, 2021, the Company adopted Accounting Standards Update (ASU) 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , which requires the recognition of the allowance for credit losses be estimated using the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet (OBS) credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with Topic 842 on leases. In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a Page 71 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS write-down on available-for-sale debt securities management does not intend to sell or believes that it is more likely than not they will be required to sell. The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and OBS credit exposures. Results for reporting periods beginning January 1, 2021 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net decrease to retained earnings of $ 4.75 million as of January 1, 2021 for the cumulative effect of adopting ASC 326, which includes deferred taxes of $ 1.58 million. The transition adjustment includes a $ 2.75 million increase to the Allowance for Credit Losses and the recording of a $ 3.58 million Allowance for Credit Losses on OBS Credit Exposures. The following table illustrates the impact of ASC 326 (amounts in thousands). January 1, 2021 As Reported Under ASC 326 Pre-ASC 326 Adoption Impact of ASC 326 Adoption Assets: Loans Allowance for credit losses on loans $ 39,816 $ 37,070 $ 2,746 Liabilities: Allowance for credit losses on off-balance sheet credit exposures $ 3,584 $ — $ 3,584 In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes. The amendments in this ASU simplify the accounting for income taxes by removing specific exceptions included in Topic 740, introducing other simplifications and making technical corrections. For public business entities, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption is permitted. The adoption of ASU 2019-12 by the Company on January 1, 2021 did not have a material impact on the financial statements. In October 2020, the FASB issued ASU 2020-08, Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable Fees and Other Costs . The amendments in this Update clarify that an entity should reevaluate whether a callable debt security is within the scope of paragraph 310-20-35-33 for each reporting period. For each reporting period, to the extent that the amortized cost basis of an individual callable debt security exceeds the amount repayable by the issuer at the next call date, the excess (that is, the premium) shall be amortized to the next call date, unless the guidance in paragraph 310-20-35-26 is applied to consider estimated prepayments. For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early application is not permitted. The adoption of the ASU by the Company on January 1, 2021 did not have a material impact on the financial statements. In October 2020, the FASB issued ASU 2020-10, Codification Improvements, which consists of two sections. The first applicable section contains amendments that improve the consistency of the Codification by including all disclosure guidance in the appropriate disclosure section and provide the option to give certain information either on the face of the financial statements or in the notes to the financial statements. The second section contains Codification improvements that vary in nature. The amendments in this Update do not change GAAP and, therefore, are not expected to result in a significant change in practice. For public business entities, these amendments are effective for annual periods beginning after December 15, 2020. The adoption of the ASU by the Company on January 1, 2021 did not have a material impact on the financial statements. Page 72 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Accounting guidance pending adoption as of December 31, 2021 In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity's Own Equity (Subtopic 815-40), Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options . The amendments in this ASU affect entities that issue freestanding written call options that are classified in equity. Specifically, the amendments affect those entities when a freestanding equity-classified written call option is modified or exchanged and remains equity classified after the modification or exchange. An entity should recognize the effect of a modification or an exchange of a freestanding equity-classified written call option to compensate for goods or services in accordance with the guidance in Topic 718, Compensation-Stock Compensation. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date of the amendments. The adoption of the ASU by the Company on January 1, 2022 is not expected to have a material impact on the financial statements. In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 815) Accounting for Contract Assets and Contract Liabilities from Contracts with Customers . The amendments in this Update require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. At the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts. To achieve this, an acquirer may assess how the acquiree applied Topic 606 to determine what to record for the acquired revenue contracts. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. An entity should apply the amendments prospectively to business combinations occurring on or after the effective date of the amendments. The Company is in the process of evaluating the impact of this ASU on the financial statements. Note 2. Investment Securities The carrying values of investment securities at December 31, 2021 and December 31, 2020 are summarized in the following table (Amounts in Thousands): December 31, 2021 December 31, 2020 Amount Percent Amount Percent Securities available for sale U.S. Treasury $ 243,925 44.24 % $ 148,646 36.40 % Other securities (FHLB, FHLMC and FNMA) 34,467 6.25 % 35,160 8.61 % State and political subdivisions 263,516 47.80 % 224,566 54.99 % Mortgage-backed securities and collateralized mortgage obligations 9,446 1.71 % — — % Total securities available for sale $ 551,354 100.00 % $ 408,372 100.00 % Investment securities have been classified in the consolidated balance sheets according to management’s intent. Available-for-sale securities consist of debt securities not classified as trading or held to maturity. Available-for-sale securities are stated at fair value, and unrealized holding gains and losses, net of the related deferred tax effect, are reported as a separate component of stockholders’ equity. Municipal bonds are comprised of general obligation bonds and revenue bonds issued by various municipal corporations. As of December 31, 2021 and 2020, all securities held were rated investment grade based upon external ratings where available and, where not available, based upon management knowledge of the local issuers and their financial situations. The Company had no securities designated as trading or held to maturity in its portfolio at December 31, 2021 or 2020. Page 73 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The carrying amount of available-for-sale securities and their approximate fair values were as follows (Amounts in Thousands): Amortized Cost Gross Unrealized Gains Gross Unrealized (Losses) Allowance for Credit Losses Estimated Fair Value December 31, 2021: U.S. Treasury $ 244,192 $ 2,011 $ ( 2,278 ) $ — $ 243,925 Other securities (FHLB, FHLMC and FNMA) 35,353 — ( 886 ) — 34,467 State and political subdivisions 260,266 4,420 ( 1,170 ) — 263,516 Mortgage-backed securities and collateralized mortgage obligations 9,575 — ( 129 ) — 9,446 Total $ 549,386 $ 6,431 $ ( 4,463 ) $ — $ 551,354 December 31, 2020: U.S. Treasury $ 143,467 $ 5,179 $ — $ — $ 148,646 Other securities (FHLB, FHLMC and FNMA) 35,195 35 ( 70 ) — 35,160 State and political subdivisions 218,008 6,674 ( 116 ) — 224,566 Total $ 396,670 $ 11,888 $ ( 186 ) $ — $ 408,372 The amortized cost and estimated fair value of available-for-sale securities classified according to their contractual maturities at December 31, 2021, were as follows (Amounts in Thousands). Amortized Cost Fair Value Due in one year or less $ 68,862 $ 69,235 Due after one year through five years 308,895 309,142 Due after five years through ten years 113,536 115,364 Due over ten years 48,518 48,167 $ 539,811 $ 541,908 Mortgage-backed securities and collateralized mortgage obligations 9,575 9,446 $ 549,386 $ 551,354 Expected maturities of MBS may differ from contractual maturities because the mortgages underlying the securities may be called or prepaid without any penalties. Therefore, these securities are not included in the maturity categories in the above summary. As of December 31, 2021, investment securities with a carrying value of $ 10.03 million were pledged to collateralize other borrowings. As of December 31, 2021, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders' equity. Sales proceeds and gross realized gains and losses on available-for-sale securities were as follows (in thousands): December 31, 2021 December 31, 2020 Sales proceeds $ — $ 313 Gross realized gains — 10 Gross realized losses — — Page 74 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2021 and 2020 (Amounts in Thousands): Less than 12 months 12 months or more Total 2021 Description # Fair Value Unrealized Loss % # Fair Value Unrealized Loss % # Fair Value Unrealized Loss % of Securities U.S. Treasury 55 $ 136,867 $ ( 2,203 ) 1.61 % 1 $ 2,416 $ ( 75 ) 3.10 % 56 $ 139,283 $ ( 2,278 ) 1.64 % Other securities (FHLB, FHLMC and FNMA) 5 12,484 ( 303 ) 2.43 % 9 21,984 ( 583 ) 2.65 % 14 34,468 ( 886 ) 2.57 % State and political subdivisions 231 70,542 ( 1,055 ) 1.50 % 14 9,248 ( 115 ) 1.24 % 245 79,790 ( 1,170 ) 1.47 % Mortgage-backed securities and collateralized mortgage obligations 4 9,446 ( 129 ) 1.37 % — — — — % 4 9,446 ( 129 ) 1.37 % 295 $ 229,339 ( 3,690 ) 1.61 % 24 $ 33,648 $ ( 773 ) 2.30 % 319 $ 262,987 $ ( 4,463 ) 1.70 % Less than 12 months 12 months or more Total 2020 Description # Fair Value Unrealized Loss % # Fair Value Unrealized Loss % # Fair Value Unrealized Loss % of Securities U.S. Treasury — $ — $ — — % — $ — $ — — % — $ — $ — — % Other securities (FHLB, FHLMC and FNMA) 8 20,019 ( 70 ) 0.35 % — — — — % 8 20,019 ( 70 ) 0.35 % State and political subdivisions 35 14,168 ( 110 ) 0.78 % 4 370 ( 6 ) 1.62 % 39 14,538 ( 116 ) 0.80 % 43 $ 34,187 $ ( 180 ) 0.53 % 4 $ 370 $ ( 6 ) 1.62 % 47 $ 34,557 $ ( 186 ) 0.54 % The Company considered the following information in reaching the conclusion that the impairments disclosed in the table above are temporary and not other-than-temporary impairments. None of the unrealized losses in the above table was due to the deterioration in the credit quality of any of the issues that might result in the non-collection of contractual principal and interest. The unrealized losses are due to changes in interest rates. The Company has not recognized any unrealized loss in income because management does not have the intent to sell the securities included in the previous table. Management has concluded that it is more likely than not that the Company will not be required to sell these securities prior to recovery of the amortized cost basis. The securities are of high credit quality (investment grade credit ratings) and principal and interest payments are made timely with no payments past due as of December 31, 2021. The fair value is expected to recover as the securities approach maturity. The U.S. Treasury and other securities are issued and guaranteed by U.S. government-sponsored entities and agencies. The mortgage-backed securities and collateralized mortgage obligations have implied U.S. government guarantees of the agency securities. The Company evaluates if a credit loss exists by monitoring to ensure it has adequate credit support considering the nature of the investment, number and significance of investments in an unrealized loss position, collectability or delinquency issues, the underlying financial statements of the issuers, credit ratings and subsequent changes thereto, and other available relevant information. Considering the above factors, management has determined that no allowance for credit losses is necessary for the securities portfolio as of December 31, 2021. Page 75 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 3. Loans Classes of loans are as follows: December 31, 2021 2020 (Amounts In Thousands) Agricultural $ 106,933 $ 94,842 Commercial and financial 222,002 286,242 Real estate: Construction, 1 to 4 family residential 80,486 71,117 Construction, land development and commercial 127,021 111,913 Mortgage, farmland 232,744 247,142 Mortgage, 1 to 4 family first liens 909,564 892,089 Mortgage, 1 to 4 family junior liens 114,342 127,833 Mortgage, multi-family 382,792 374,014 Mortgage, commercial 401,377 417,139 Loans to individuals 32,687 31,325 Obligations of state and political subdivisions 50,285 56,488 2,660,233 2,710,144 Net unamortized fees and costs 299 938 2,660,532 2,711,082 Less allowance for credit losses (2021) and loan losses (2020) 35,470 37,070 $ 2,625,062 $ 2,674,012 As of December 31, 2021 and 2020, the Company has outstanding balances of $ 5.34 million and $ 86.5 million of loans issued under the Paycheck Protection Program (PPP). For the year ended December 31, 2021, the Company recognized $ 5.81 million of deferred PPP loan fees in interest income and received forgiveness payments totaling $ 140.1 million from the SBA. For the year ended December 31, 2020, the Company recognized $ 2.88 million of PPP loan fees in interest income and has received forgiveness payments totaling $ 40.4 million from the SBA. Page 76 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Changes in the allowance for credit losses, the allowance for credit losses applicable to individually evaluated loans and the related loan balances for the years ended December 31, 2021, 2020 and 2019 are as follows: Agricultural Commercial and Financial Real Estate: Construction and land development Real Estate: Mortgage, farmland Real Estate: Mortgage, 1 to 4 family Real Estate: Mortgage, multi-family and commercial Other Total (Amounts In Thousands) 2021 Allowance for credit losses: Beginning balance, prior to adoption of ASC 326 $ 2,508 $ 4,885 $ 2,319 $ 4,173 $ 12,368 $ 9,415 $ 1,402 $ 37,070 Impact of adopting ASC 326 ( 328 ) 298 327 763 522 1,396 ( 232 ) 2,746 Charge-offs ( 106 ) ( 136 ) ( 3 ) ( 1 ) ( 482 ) ( 265 ) ( 323 ) ( 1,316 ) Recoveries 142 1,103 94 25 964 263 152 2,743 Credit loss (benefit) expense 45 ( 1,881 ) ( 437 ) ( 1,527 ) ( 1,874 ) ( 311 ) 212 ( 5,773 ) Ending balance $ 2,261 $ 4,269 $ 2,300 $ 3,433 $ 11,498 $ 10,498 $ 1,211 $ 35,470 Ending balance, individually evaluated for credit losses $ 1 $ 189 $ 124 $ — $ 49 $ 1 $ 20 $ 384 Ending balance, collectively evaluated for credit losses $ 2,260 $ 4,080 $ 2,176 $ 3,433 $ 11,449 $ 10,497 $ 1,191 $ 35,086 Loan balances: Ending balance $ 106,933 $ 222,002 $ 207,507 $ 232,744 $ 1,023,906 $ 784,169 $ 82,972 $ 2,660,233 Ending balance, individually evaluated for credit losses $ 788 $ 2,062 $ 603 $ 1,277 $ 6,187 $ 5,696 $ 20 $ 16,633 Ending balance, collectively evaluated for credit losses $ 106,145 $ 219,940 $ 206,904 $ 231,467 $ 1,017,719 $ 778,473 $ 82,952 $ 2,643,600 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) 2020 Allowance for loan losses: Beginning balance $ 2,400 $ 4,988 $ 2,599 $ 3,950 $ 10,638 $ 7,859 $ 1,326 $ 33,760 Charge-offs ( 43 ) ( 1,425 ) ( 43 ) ( 1 ) ( 738 ) ( 291 ) ( 381 ) ( 2,922 ) Recoveries 63 670 118 10 784 49 180 1,874 Provision 88 652 ( 355 ) 214 1,684 1,798 277 4,358 Ending balance $ 2,508 $ 4,885 $ 2,319 $ 4,173 $ 12,368 $ 9,415 $ 1,402 $ 37,070 Ending balance, individually evaluated for impairment $ 86 $ 411 $ 7 $ — $ 93 $ 14 $ 51 $ 662 Ending balance, collectively evaluated for impairment $ 2,422 $ 4,474 $ 2,312 $ 4,173 $ 12,275 $ 9,401 $ 1,351 $ 36,408 Loan balances: Ending balance $ 94,842 $ 286,242 $ 183,030 $ 247,142 $ 1,019,922 $ 791,153 $ 87,813 $ 2,710,144 Ending balance, individually evaluated for impairment $ 1,543 $ 2,191 $ 1,266 $ 2,061 $ 7,417 $ 6,200 $ 51 $ 20,729 Ending balance, collectively evaluated for impairment $ 93,299 $ 284,051 $ 181,764 $ 245,081 $ 1,012,505 $ 784,953 $ 87,762 $ 2,689,415 Page 77 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Agricultural Commercial and Financial Real Estate: Construction and land development Real Estate: Mortgage, farmland Real Estate: Mortgage, 1 to 4 family Real Estate: Mortgage, multi-family and commercial Other Total (Amounts In Thousands) 2019 Allowance for loan losses: Beginning balance $ 2,789 $ 5,826 $ 3,292 $ 3,972 $ 12,516 $ 8,165 $ 1,250 $ 37,810 Charge-offs ( 266 ) ( 981 ) ( 45 ) ( 6 ) ( 896 ) ( 341 ) ( 434 ) ( 2,969 ) Recoveries 95 646 8 5 700 180 165 1,799 Provision ( 218 ) ( 503 ) ( 656 ) ( 21 ) ( 1,682 ) ( 145 ) 345 ( 2,880 ) Ending balance $ 2,400 $ 4,988 $ 2,599 $ 3,950 $ 10,638 $ 7,859 $ 1,326 $ 33,760 Ending balance, individually evaluated for impairment $ 87 $ 792 $ — $ — $ 111 $ 1 $ 93 $ 1,084 Ending balance, collectively evaluated for impairment $ 2,313 $ 4,196 $ 2,599 $ 3,950 $ 10,527 $ 7,858 $ 1,233 $ 32,676 Loan balances: Ending balance $ 91,317 $ 221,323 $ 188,619 $ 242,730 $ 1,059,969 $ 752,942 $ 82,204 $ 2,639,104 Ending balance, individually evaluated for impairment $ 1,730 $ 2,742 $ 421 $ 4,081 $ 8,670 $ 3,188 $ 93 $ 20,925 Ending balance, collectively evaluated for impairment $ 89,587 $ 218,581 $ 188,198 $ 238,649 $ 1,051,299 $ 749,754 $ 82,111 $ 2,618,179 Changes in the allowance for credit losses for off-balance sheet credit exposures for the year ended December 31, 2021 were as follows: Year Ended December 31, 2021 Agricultural Commercial and Financial Real Estate: Construction and land development Real Estate: Mortgage, farmland Real Estate: Mortgage, 1 to 4 family Real Estate: Mortgage, multi- family and commercial Other Total (Amounts In Thousands) Allowance for credit losses for off-balance sheet credit exposures: Beginning balance, prior to adoption of ASC 326 $ — $ — $ — $ — $ — $ — $ — $ — Impact of adopting ASC 326 385 1,585 736 180 471 212 15 3,584 Credit loss (benefit) expense ( 2 ) ( 467 ) 113 ( 67 ) 323 347 19 266 (Charge-offs), net recoveries — — — — — — — — Ending balance $ 383 $ 1,118 $ 849 $ 113 $ 794 $ 559 $ 34 $ 3,850 Credit loss (benefit) expense for off-balance sheet credit exposures is included in credit loss (benefit) expense on the consolidated statement of income for the year ended December 31, 2021. Page 78 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Management regularly reviews loans in the portfolio to assess credit quality indicators and to determine appropriate loan classification and grading in accordance with applicable bank regulations. The Company's risk rating methodology assigns risk ratings ranging from 1 to 6, where a higher rating represents higher risk. The Company differentiates its lending portfolios into loans sharing common risk characteristics for which expected credit loss is measured on a pool basis and loans not sharing common risk characteristics for which credit loss is measured individually. The below are descriptions of the credit quality indicators: Excellent – Excellent rated loans are prime quality loans covered by highly liquid collateral with generous margins or supported by superior current financial conditions reflecting substantial net worth, relative to total credit extended, and based on assets of a stable and non-speculative nature whose values can be readily verified. Identified repayment source or cash flow is abundant and assured. Loans are secured with cash, cash equivalents, or collateral with very low loan to values. The borrower would qualify for unsecured debt and guarantors provide excellent secondary support to the relationship. The borrower has a long-term relationship with Hills Bank, maintains high deposit balances and has an established payment history with Hills Bank and an established business in an established industry. Good – Good rated loans are adequately secured by readily marketable collateral or good financial condition characterized by liquidity, flexibility and sound net worth. Loans are supported by sound primary and secondary payment sources and timely and accurate financial information. The relationship is not quite as strong as a borrower that is assigned an excellent rating but still has a very strong liquidity position, low leverage, and track record of strong performance. These loans have a strong collateral position with limited risk to bank capital. The collateral will not materially lose value in a distressed liquidation. Guarantors provide additional secondary support to mitigate possible bank losses. The borrower has a long-term relationship with Hills Bank with an established track record of payments; loans with shorter remaining loan amortization; deposit balances are consistent; loan payments could be made from cash reserves in the interim period; and source of income is coming from a stable industry. Satisfactory – Satisfactory rated loans are loans to borrowers of average financial means not especially vulnerable to changes in economic or other circumstances, where the major support for the extension is sufficient collateral of a marketable nature, and the primary source of repayment is seen to be clear and adequate. The borrower's financial performance is consistent, ratios and trends are positive and the primary repayment source can clearly be identified and supported with acceptable financial information. The loan relationship could be vulnerable to changes in economic or industry conditions but have the ability to absorb unexpected issues. The loan collateral coverage is considered acceptable and guarantors can provide financial support but net worth might not be as liquid as a 1 or 2 rated relationship. The borrower has an established relationship with Hills Bank. The relationship is making timely loan payments, any operating line is revolving and deposit balances are positive with limited to no overdrafts. Management and industry is considered stable. Monitor – Monitor rated loans are identified by management as warranting special attention for a variety of reasons that may bear on ultimate collectability. This may be due to adverse trends, a particular industry, loan structure, or repayment that is dependent on projections, or a one-time occurrence . The relationship l iquidity levels are minimal and the borrower’s leverage position is brought into question. The primary repayment source is showing signs of being stressed or is not proven. If the borrower performs as planned, the loan will be repaid. The collateral coverage is still considered acceptable but there might be some concern with the type of real estate securing the debt or highly dependent on chattel assets. Some loans may be better secured than others. Guarantors still provide some support but there is not an abundance of financial strength supporting the guaranty. A monitor credit may be appropriate when the borrower is experiencing rapid growth which is impacting liquidity levels and increasing debt levels. Other attributes to consider would include if the business is a start-up or newly acquired, if the relationship has significant financing relationships with other financial institutions, the quality of financial information being received, management depth of the company, and changes to the business model. The track history with Hills Bank has some deficiencies such as slow payments or some overdrafts. Special Mention – Special mention rated loans are supported by a marginal payment capacity and are marginally protected by collateral. There are identified weaknesses that if not monitored and corrected may adversely affect the Company’s credit position. A special mention credit would typically have a weakness in one of the general categories (cash flow, collateral position or payment history) but not in all categories. Potential indicators of a special mention would include past due payments, overdrafts, management issues, poor financial performance, industry issues, or the need for additional short-term borrowing. The ability to continue to make payments is in question; there are “red flags” such as past due payments, non- Page 79 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS revolving credit lines, overdrafts, and the inability to sell assets. The borrower is experiencing delinquent taxes, legal issues, etc., obtaining financial information has become a challenge, collateral coverage is marginal at best, and the value and condition could be brought into question. Collateral document deficiencies have been noted and if not addressed, could become material. Guarantors provide minimal support for this relationship. The credit may include an action plan or follow up established in the asset quality process. There is a change in the borrower’s communication pattern. Industry issues may be impacting the relationship. Adverse credit scores or history of payment deficiencies could be noted. Substandard – Substandard loans are not adequately supported by the paying capacity of the borrower and may be inadequately collateralized. These loans have a well-defined weakness or weaknesses. Full repayment of the loan(s) according to the original terms and conditions is in question or not expected. For these loans, it is more probable than not that the Company could sustain some loss if the deficiency(ies) is not corrected. There are identified shortfalls in the primary repayment source such as carry over debt, past due payments, and overdrafts. Obtaining quality and timely financial information is a weakness. The loan is under secured with exposure that could impact bank capital. It appears the liquidation of collateral has become the repayment source. The collateral may be difficult to foreclose or have little to no value. Collateral documentation deficiencies have been noted during the review process. Guarantor(s) provide minimal to no support of the relationship. The borrower’s communication with the Bank continues to decrease and the borrower is not addressing the situation. There is some concern about the borrower’s ability and willingness to repay the loans. Problems may be the result of external issues such as economic or industry related issues. The following tables present the credit quality indicators and origination years by type of loan in each category as of December 31, 2021 (amounts in thousands): Agricultural December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ 762 $ 213 $ 30 $ 10 $ — $ — $ 2,312 $ 3,327 Good 1,799 1,767 603 46 52 26 7,593 11,886 Satisfactory 10,335 6,404 1,476 1,770 403 66 26,285 46,739 Monitor 8,125 5,017 998 765 164 253 23,995 39,317 Special Mention 1,662 11 85 — 7 — 2,807 4,572 Substandard 592 69 203 — — — 228 1,092 Total $ 23,275 $ 13,481 $ 3,395 $ 2,591 $ 626 $ 345 $ 63,220 $ 106,933 Page 80 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Commercial and Financial December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ 965 $ 924 $ 4 $ 235 $ 31 $ — $ 3,391 $ 5,550 Good 13,722 5,570 1,105 1,086 276 1,494 20,709 43,962 Satisfactory 44,964 20,847 7,684 3,582 2,106 331 41,832 121,346 Monitor 18,337 8,019 3,591 1,123 297 416 13,368 45,151 Special Mention 603 525 353 70 102 4 174 1,831 Substandard 1,092 670 266 54 92 — 1,988 4,162 Total $ 79,683 $ 36,555 $ 13,003 $ 6,150 $ 2,904 $ 2,245 $ 81,462 $ 222,002 Real Estate: Construction, 1 to 4 Family Residential December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ — $ — $ — $ — $ — $ — $ — $ — Good 212 — — — — — 18,755 18,967 Satisfactory 7,457 94 — — — — 42,988 50,539 Monitor 1,307 — — — — — 9,187 10,494 Special Mention — — — — — — 374 374 Substandard 111 — — — — — 1 112 Total $ 9,087 $ 94 $ — $ — $ — $ — $ 71,305 $ 80,486 Real Estate: Construction, Land Development and Commercial December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ 5,079 $ — $ — $ — $ 143 $ 4 $ — $ 5,226 Good 3,294 1,200 — — 153 242 12,678 17,567 Satisfactory 22,907 4,354 2,356 263 1,081 21 40,048 71,030 Monitor 5,694 547 7 38 74 — 18,832 25,192 Special Mention — — — — — — — — Substandard 7,515 298 193 — — — — 8,006 Total $ 44,489 $ 6,399 $ 2,556 $ 301 $ 1,451 $ 267 $ 71,558 $ 127,021 Page 81 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Real Estate: Mortgage, Farmland December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ — $ 3,568 $ 124 $ 60 $ 80 $ 41 $ 134 $ 4,007 Good 17,827 14,308 2,144 2,460 5,932 3,929 3,844 50,444 Satisfactory 51,639 35,616 4,689 8,358 6,745 8,339 8,242 123,628 Monitor 8,532 16,925 5,518 3,901 2,154 4,866 5,695 47,591 Special Mention 4,031 288 — — 298 190 — 4,807 Substandard 1,283 447 291 47 — 199 — 2,267 Total $ 83,312 $ 71,152 $ 12,766 $ 14,826 $ 15,209 $ 17,564 $ 17,915 $ 232,744 Real Estate: Mortgage, 1 to 4 Family First Liens December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ 462 $ 914 $ 427 $ 19 $ 149 $ 404 $ 1 $ 2,376 Good 9,598 12,300 3,124 3,443 3,091 10,943 2,496 44,995 Satisfactory 233,412 189,247 69,037 65,201 60,906 118,608 8,443 744,854 Monitor 24,908 33,863 5,038 6,527 7,273 12,203 4,066 93,878 Special Mention 1,682 3,422 887 962 1,051 3,168 — 11,172 Substandard 1,571 1,261 1,129 1,609 576 6,142 1 12,289 Total $ 271,633 $ 241,007 $ 79,642 $ 77,761 $ 73,046 $ 151,468 $ 15,007 $ 909,564 Real Estate: Mortgage, 1 to 4 Family Junior Liens December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ — $ 13 $ — $ — $ — $ — $ 6 $ 19 Good 193 611 96 — 108 482 1,374 2,864 Satisfactory 13,684 10,116 5,854 7,309 5,230 6,053 55,496 103,742 Monitor 326 1,233 70 365 140 281 2,801 5,216 Special Mention 103 489 35 56 42 110 142 977 Substandard 77 209 79 441 74 99 545 1,524 Total $ 14,383 $ 12,671 $ 6,134 $ 8,171 $ 5,594 $ 7,025 $ 60,364 $ 114,342 Page 82 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Real Estate: Mortgage, Multi-Family December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ 2,539 $ 4,513 $ — $ — $ — $ 701 $ — $ 7,753 Good 16,931 35,396 1,555 — — 9,289 — 63,171 Satisfactory 107,192 69,287 13,635 2,030 1,561 14,660 14,764 223,129 Monitor 26,088 35,886 176 — 131 1,584 5,669 69,534 Special Mention 640 — 820 — — — — 1,460 Substandard 12,186 — — — — 5,559 — 17,745 Total $ 165,576 $ 145,082 $ 16,186 $ 2,030 $ 1,692 $ 31,793 $ 20,433 $ 382,792 Real Estate: Mortgage, Commercial December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ 597 $ 16,781 $ — $ — $ 3,313 $ 350 $ 1 $ 21,042 Good 20,143 36,773 2,619 1,356 3,811 7,085 9,812 81,599 Satisfactory 75,040 52,653 14,727 12,091 9,707 17,398 16,333 197,949 Monitor 18,664 49,774 3,923 2,202 3,037 8,461 3,387 89,448 Special Mention 5,791 795 303 — 554 337 — 7,780 Substandard 1,528 1,721 — 208 — 102 — 3,559 Total $ 121,763 $ 158,497 $ 21,572 $ 15,857 $ 20,422 $ 33,733 $ 29,533 $ 401,377 Loans to Individuals December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ — $ — $ — $ — $ — $ — $ — $ — Good — — 67 21 5 — 1 94 Satisfactory 12,162 5,606 2,212 967 141 10,867 57 32,012 Monitor 200 160 15 46 3 — 1 425 Special Mention 37 32 29 4 — — 1 103 Substandard 12 24 12 — 1 3 1 53 Total $ 12,411 $ 5,822 $ 2,335 $ 1,038 $ 150 $ 10,870 $ 61 $ 32,687 Page 83 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Obligations of State and Political Subdivisions December 31, 2021 2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Total Grade: Excellent $ — $ — $ — $ — $ — $ 6,076 $ — $ 6,076 Good — 1,984 — — — 9,051 — 11,035 Satisfactory 1,009 2,034 1,551 706 11,557 3,634 9,400 29,891 Monitor — 933 203 249 — 1,898 — 3,283 Special Mention — — — — — — — — Substandard — — — — — — — — Total $ 1,009 $ 4,951 $ 1,754 $ 955 $ 11,557 $ 20,659 $ 9,400 $ 50,285 Page 84 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents the credit quality indicators by type of loans in each category as of December 31, 2020: Agricultural Commercial and Financial Real Estate: Construction, 1 to 4 family residential Real Estate: Construction, land development and commercial (Amounts In Thousands) 2020 Grade: Excellent $ 3,761 $ 9,024 $ — $ 227 Good 12,369 62,310 13,675 15,187 Satisfactory 42,015 144,999 41,616 64,301 Monitor 29,381 56,439 13,654 23,368 Special Mention 5,143 8,258 1,857 7,137 Substandard 2,173 5,212 315 1,693 Total $ 94,842 $ 286,242 $ 71,117 $ 111,913 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 2020 Grade: Excellent $ 5,706 $ 2,303 $ 204 $ 14,650 Good 41,878 47,233 3,707 57,281 Satisfactory 129,210 701,273 115,731 197,493 Monitor 61,298 114,207 5,153 70,885 Special Mention 6,074 12,890 1,307 15,374 Substandard 2,976 14,183 1,731 18,331 Total $ 247,142 $ 892,089 $ 127,833 $ 374,014 Real Estate: Mortgage, commercial Loans to individuals Obligations of state and political subdivisions Total 2020 Grade: Excellent $ 26,940 $ 1 $ 6,752 $ 69,568 Good 92,699 145 13,094 359,578 Satisfactory 196,310 30,487 26,571 1,690,006 Monitor 77,125 479 9,924 461,913 Special Mention 19,731 127 147 78,045 Substandard 4,334 86 — 51,034 Total $ 417,139 $ 31,325 $ 56,488 $ 2,710,144 Page 85 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Past due loans as of December 31, 2021 and 2020 were as follows: 30 - 59 Days Past Due 60 - 89 Days Past Due 90 Days or More Past Due Total Past Due Current Total Loans Receivable Accruing Loans Past Due 90 Days or More (Amounts In Thousands) December 31, 2021 Agricultural $ 41 $ — $ 219 $ 260 $ 106,673 $ 106,933 $ 6 Commercial and financial 300 537 468 1,305 220,697 222,002 91 Real estate: Construction, 1 to 4 family residential 276 — — 276 80,210 80,486 — Construction, land development and commercial 194 66 96 356 126,665 127,021 — Mortgage, farmland 503 362 — 865 231,879 232,744 — Mortgage, 1 to 4 family first liens 5,085 864 2,481 8,430 901,134 909,564 104 Mortgage, 1 to 4 family junior liens 246 41 124 411 113,931 114,342 — Mortgage, multi-family 640 — — 640 382,152 382,792 — Mortgage, commercial 466 — 829 1,295 400,082 401,377 — Loans to individuals 177 26 5 208 32,479 32,687 — Obligations of state and political subdivisions 394 — — 394 49,891 50,285 — $ 8,322 $ 1,896 $ 4,222 $ 14,440 $ 2,645,793 $ 2,660,233 $ 201 Page 86 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 30 - 59 Days Past Due 60 - 89 Days Past Due 90 Days or More Past Due Total Past Due Current Total Loans Receivable Accruing Loans Past Due 90 Days or More (Amounts In Thousands) December 31, 2020 Agricultural $ 438 $ — $ 629 $ 1,067 $ 93,775 $ 94,842 $ 111 Commercial and financial 867 195 140 1,202 285,040 286,242 20 Real estate: Construction, 1 to 4 family residential 190 — 536 726 70,391 71,117 536 Construction, land development and commercial — — — — 111,913 111,913 — Mortgage, farmland 279 28 — 307 246,835 247,142 — Mortgage, 1 to 4 family first liens 4,969 1,342 2,486 8,797 883,292 892,089 342 Mortgage, 1 to 4 family junior liens 436 21 155 612 127,221 127,833 47 Mortgage, multi-family — — — — 374,014 374,014 — Mortgage, commercial 783 — 461 1,244 415,895 417,139 — Loans to individuals 218 59 4 281 31,044 31,325 — Obligations of state and political subdivisions — — — — 56,488 56,488 — $ 8,180 $ 1,645 $ 4,411 $ 14,236 $ 2,695,908 $ 2,710,144 $ 1,056 The Company does not have a significant amount of loans that are past due less than 90 days where there are serious doubts as to the ability of the borrowers to comply with the loan repayment terms. Accruing loans past due 90 days or more decreased $ 0.86 million from December 31, 2020 to December 31, 2021. As of December 31, 2021 and 2020, accruing loans past due 90 days or more were 0.01 % and 0.04 % of total loans, respectively. The average balance of the accruing loans past due 90 days or more decreased in 2021 as compared to 2020. The average 90 days or more past due accruing loan balance per loan was $ 0.03 million as of December 31, 2021 compared to $ 0.09 million as of December 31, 2020. The loans 90 days or more past due and still accruing are believed to be adequately collateralized. Loans are placed on nonaccrual status when management believes the collection of future principal and interest is not reasonably assured. Page 87 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Certain nonaccrual and TDR loan information by loan type at December 31, 2021 and 2020 was as follows: December 31, 2021 December 31, 2020 Nonaccrual loans (1) Interest income recognized on non-accrual Accruing loans past due 90 days or more TDR loans Nonaccrual loans (1) Accruing loans past due 90 days or more TDR loans (Amounts In Thousands) (Amounts In Thousands) Agricultural $ 221 $ — $ 6 $ 374 $ 1,252 $ 111 $ 85 Commercial and financial 707 — 91 1,085 479 20 1,263 Real estate: Construction, 1 to 4 family residential 111 — — — 315 536 — Construction, land development and commercial 290 — — 202 204 — 211 Mortgage, farmland 251 — — 1,206 446 — 1,616 Mortgage, 1 to 4 family first liens 4,685 — 104 1,364 4,331 342 1,751 Mortgage, 1 to 4 family junior liens 200 — — 20 193 47 20 Mortgage, multi-family — — — 1,460 79 — 1,695 Mortgage, commercial 2,026 — — 2,210 1,550 — 3,610 Loans to individuals — — — — — — — $ 8,491 $ — $ 201 $ 7,921 $ 8,849 $ 1,056 $ 10,251 (1) There were $ 2.28 million and $ 2.97 million of TDR loans included within nonaccrual loans as of December 31, 2021 and 2020, respectively. The Company may modify the terms of a loan to maximize the collection of amounts due. In most cases, the modification is a reduction in interest rate, conversion to interest only payments or an extension of the maturity date. The borrower is experiencing financial difficulties or is expected to experience financial difficulties in the near-term, so a concessionary modification is granted to the borrower that would otherwise not be considered. TDR loans accrue interest as long as the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles. Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” allows financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time during the COVID-19 pandemic. As of December 31, 2021, the total amount of the eligible loans in deferral (deferral of principal and/or interest) that met the requirements set forth under the CARES Act and therefore were not considered TDRs was 16 loans, totaling $ 9.4 million. As of December 31, 2020, there were 13 loans, totaling $ 9.4 million that met the requirements and were not considered TDRs. Throughout 2020, COVID-19 related payment deferrals provided for customers totaled approximately 14.82 % of total loans. As of December 31, 2021 and 2020, COVID-19 related payment deferrals were approximately 0.12 % and 1.20 % of total loans, respectively. Page 88 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Below is a summary of information for TDR loans as of December 31, 2021 and 2020: December 31, 2021 Number of contracts Recorded investment Commitments outstanding (Dollar Amounts In Thousands) Agricultural 4 $ 586 $ — Commercial and financial 12 1,116 60 Real estate: Construction, 1 to 4 family residential — — — Construction, land development and commercial 1 202 — Mortgage, farmland 5 1,409 — Mortgage, 1 to 4 family first liens 14 1,441 — Mortgage, 1 to 4 family junior liens 1 20 — Mortgage, multi-family 2 1,460 — Mortgage, commercial 11 3,963 — Loans to individuals — — — 50 $ 10,197 $ 60 December 31, 2020 Number of contracts Recorded investment Commitments outstanding (Dollar Amounts In Thousands) Agricultural 6 $ 1,028 $ — Commercial and financial 17 1,743 35 Real estate: Construction, 1 to 4 family residential — — — Construction, land development and commercial 1 211 4 Mortgage, farmland 6 2,009 — Mortgage, 1 to 4 family first liens 17 1,898 — Mortgage, 1 to 4 family junior liens 1 20 — Mortgage, multi-family 2 1,695 — Mortgage, commercial 13 4,621 — Loans to individuals — — — 63 $ 13,225 $ 39 Page 89 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A summary of TDR loans that were modified during the year ended December 31, 2021 and 2020 was as follows: December 31, 2021 Number of Contracts Pre-modification recorded investment Post-modification recorded investment ( Dollar Amounts In Thousands) Agricultural 1 $ 178 $ 178 Commercial and financial — — — Real estate: Construction, 1 to 4 family residential — — — Construction, land development and commercial — — — Mortgage, farmland 1 319 319 Mortgage, 1 to 4 family first liens 4 112 112 Mortgage, 1 to 4 family junior liens — — — Mortgage, multi-family — — — Mortgage, commercial 1 232 232 Loans to individuals — — — 7 $ 841 $ 841 December 31, 2020 Number of Contracts Pre-modification recorded investment Post-modification recorded investment ( Dollar Amounts In Thousands) Agricultural 2 $ 93 $ 93 Commercial and financial 7 623 623 Real estate: Construction, 1 to 4 family residential — — — Construction, land development and commercial — — — Mortgage, farmland — — — Mortgage, 1 to 4 family first liens 6 283 283 Mortgage, 1 to 4 family junior liens 1 20 20 Mortgage, multi-family — — — Mortgage, commercial 7 3,635 3,635 Loans to individuals — — — 23 $ 4,654 $ 4,654 . The Company has allocated $ 0.01 million of allowance for TDR loans and the Company had commitments to lend $ 0.06 million in additional borrowings to restructured loan customers as of December 30, 2021. The Company allocated $ 0.25 million of allowance for TDR loans and had commitments to lend $ 0.04 million in additional borrowings to restructured loan customers as of December 31, 2020. These commitments were in the normal course of business. The additional borrowings were not used to facilitate payments on these loans. The modifications of the terms of loans performed during the years ended December 31, 2021 and 2020 included extensions of the maturity date. There were no TDR loans modified that were in payment default (defined as past due 90 days or more) during the years ended December 31, 2021 and 2020. Page 90 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents the amortized cost basis of collateral dependent loans, by the primary collateral type, which are individually evaluated to determine expected credit losses, and the related ACL allocated to these loans: Primary Type of Collateral Real Estate Accounts Receivable Equipment Other Total ACL Allocation (Amounts In Thousands) December 31, 2021 Agricultural $ 734 $ — $ 54 $ — $ 788 $ 1 Commercial and financial 1,951 — 111 — 2,062 189 Real estate: Construction, 1 to 4 family residential 111 — — — 111 111 Construction, land development and commercial 492 — — — $ 492 13 Mortgage, farmland 1,277 — — — 1,277 — Mortgage, 1 to 4 family first liens 5,967 — — — $ 5,967 31 Mortgage, 1 to 4 family junior liens 220 — — — 220 18 Mortgage, multi-family 1,460 — — — $ 1,460 — Mortgage, commercial 4,236 — — — 4,236 1 Loans to individuals 20 — — — $ 20 20 Obligations of state and political subdivisions — — — — — — $ 16,468 $ — $ 165 $ — $ 16,633 $ 384 Page 91 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Pre-ASC 326 (CECL) adoption impaired loan information as of December 31, 2020 is as follows: Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Income Recognized (Amounts in Thousands) 2020 With no related allowance recorded: Agricultural $ 1,337 $ 1,928 $ — $ 1,518 $ 24 Commercial and financial 1,520 2,907 — 2,054 85 Real estate: Construction, 1 to 4 family residential 315 337 — 475 — Construction, land development and commercial 415 421 — 420 13 Mortgage, farmland 2,061 2,598 — 3,008 120 Mortgage, 1 to 4 family first liens 6,253 8,013 — 6,578 108 Mortgage, 1 to 4 family junior liens 108 350 — 134 — Mortgage, multi-family 1,773 1,898 — 1,795 80 Mortgage, commercial 4,124 4,960 — 4,315 126 Loans to individuals — 47 — — — $ 17,906 $ 23,459 $ — $ 20,297 $ 556 With an allowance recorded: Agricultural $ 206 $ 206 $ 86 $ 141 $ 14 Commercial and financial 671 724 411 755 27 Real estate: Construction, 1 to 4 family residential 536 536 7 486 24 Construction, land development and commercial — — — — — Mortgage, farmland — — — — — Mortgage, 1 to 4 family first liens 924 975 56 955 25 Mortgage, 1 to 4 family junior liens 132 158 37 149 2 Mortgage, multi-family — — — — — Mortgage, commercial 303 304 14 306 3 Loans to individuals 51 51 51 53 3 $ 2,823 $ 2,954 $ 662 $ 2,845 $ 98 Total: Agricultural $ 1,543 $ 2,134 $ 86 $ 1,659 $ 38 Commercial and financial 2,191 3,631 411 2,809 112 Real estate: Construction, 1 to 4 family residential 851 873 7 961 24 Construction, land development and commercial 415 421 — 420 13 Mortgage, farmland 2,061 2,598 — 3,008 120 Mortgage, 1 to 4 family first liens 7,177 8,988 56 7,533 133 Mortgage, 1 to 4 family junior liens 240 508 37 283 2 Mortgage, multi-family 1,773 1,898 — 1,795 80 Mortgage, commercial 4,427 5,264 14 4,621 129 Loans to individuals 51 98 51 53 3 $ 20,729 $ 26,413 $ 662 $ 23,142 $ 654 Page 92 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Information regarding impaired loans as of and for the year ended December 31, 2019 is as follows: Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Income Recognized (Amounts in Thousands) 2019 With no related allowance recorded: Agricultural $ 1,596 $ 2,157 $ — $ 1,785 $ 37 Commercial and financial 1,340 2,220 — 1,617 64 Real estate: Construction, 1 to 4 family residential 101 144 — 106 — Construction, land development and commercial 320 336 — 324 18 Mortgage, farmland 4,081 4,613 — 4,144 157 Mortgage, 1 to 4 family first liens 7,157 9,015 — 6,822 51 Mortgage, 1 to 4 family junior liens — 246 — — — Mortgage, multi-family 1,816 1,930 — 1,873 83 Mortgage, commercial 1,302 1,852 — 1,364 26 Loans to individuals — 14 — — — $ 17,713 $ 22,527 $ — $ 18,035 $ 436 With an allowance recorded: Agricultural $ 134 $ 134 $ 87 $ 287 $ 17 Commercial and financial 1,402 1,539 792 1,510 83 Real estate: Construction, 1 to 4 family residential — — — — — Construction, land development and commercial — — — — — Mortgage, farmland — — — — — Mortgage, 1 to 4 family first liens 1,280 1,501 64 1,318 29 Mortgage, 1 to 4 family junior liens 233 233 47 239 6 Mortgage, multi-family — — — — — Mortgage, commercial 70 70 1 73 4 Loans to individuals 93 93 93 62 2 $ 3,212 $ 3,570 $ 1,084 $ 3,489 $ 141 Total: Agricultural $ 1,730 $ 2,291 $ 87 $ 2,072 $ 54 Commercial and financial 2,742 3,759 792 3,127 147 Real estate: Construction, 1 to 4 family residential 101 144 — 106 — Construction, land development and commercial 320 336 — 324 18 Mortgage, farmland 4,081 4,613 — 4,144 157 Mortgage, 1 to 4 family first liens 8,437 10,516 64 8,140 80 Mortgage, 1 to 4 family junior liens 233 479 47 239 6 Mortgage, multi-family 1,816 1,930 — 1,873 83 Mortgage, commercial 1,372 1,922 1 1,437 30 Loans to individuals 93 107 93 62 2 $ 20,925 $ 26,097 $ 1,084 $ 21,524 $ 577 Page 93 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Post-ASC 326 CECL Adoption: The changes in the ACL in 2021 compared to December 31, 2020 is the result of the following factors: $ 2.75 million increase upon adoption of ASC 326 (CECL) on January 1, 2021; changes after adoption for the year ended December 31, 2021 include improvements in the economic factor forecasts, primarily Iowa unemployment, used in the ACL calculation which resulted in a decrease of $ 2.46 million; decrease in loan volume which resulted in a decrease of $ 0.37 million; changes in prepayment and curtailment rates resulting in a decrease of $ 0.03 million; decreases in historical loss rates along with net recoveries resulting in a decrease of $ 2.00 million; decreases in the individually analyzed loans reserve of $ 0.25 million; and increases in qualitative factors determined necessary by management which resulted in an increase of $ 0.76 million. The extent to which collateral secures collateral-dependent loans is provided in the previous individually analyzed loans table and changes in the extent to which collateral secures its collateral-dependent loans are described below. Collateral-dependent loans decreased $ 4.10 million from December 31, 2020 to December 31, 2021. Collateral-dependent loans include any loan that has been placed on nonaccrual status, accruing loans past due 90 days or more and TDR loans. Collateral-dependent loans also include loans that, based on management’s evaluation of current information and events, the Company expects to be unable to collect in full according to the contractual terms of the original loan agreement. Collateral-dependent loans were 0.63 % of loans held for investment as of December 31, 2021 and 0.76 % as of December 31, 2020. The decrease in collateral-dependent loans is due to a decrease of $ 0.55 million in loans with a specific reserve, a decrease in nonaccrual loans of $ 0.36 million, a decrease in 90 days or more accruing loans of $ 0.86 million and a decrease in TDR loans of $ 2.33 million from December 31, 2020 to December 30, 2021. There were no significant changes noted in the extent to which collateral secures collateral-dependent loans. The Company regularly reviews a substantial portion of the loans in the portfolio and assesses whether the loans share common risk characteristics for which expected credit loss is measured on a pool basis or if the loans do not share common risk characteristics and therefore expected credit loss is measured on an individual loan basis. If the loans are assessed for credit losses on an individual basis, the Company determines if a specific allowance is appropriate. In addition, the Company's management also reviews and, where determined necessary, provides allowances for particular loans based upon (1) reviews of specific borrowers and (2) management’s assessment of areas that management considers are of higher credit risk, including loans that have been restructured or where a TDR is reasonably possible. Loans that are determined not to be collateral-dependent and for which there are no specific allowances are classified into one or more risk categories and expected credit loss is measured on a pool basis. See Note 1 Effect of New Financial Accounting Standards for further discussion of the allowance for credit losses for loans held for investment. Specific allowances for credit losses on loans assessed individually are established if the loan balances exceed the net present value of the relevant future cash flows or the fair value of the relevant collateral based on updated appraisals and/or updated collateral analysis for the properties if the loan is collateral dependent. The Company may recognize a charge off or record a specific allowance related to an individually analyzed loan if there is a collateral shortfall or it is unlikely the borrower can make all principal and interest payments as contractually due. For loans that are collateral dependent, losses are evaluated based on the portion of a loan that exceeds the fair market value of the collateral. In general, this is the amount that the carrying value of the loan exceeds the related appraised value less estimated costs to sell the collateral. Generally, it is the Company’s policy not to rely on appraisals that are older than one year prior to the date the credit loss is being measured. The most recent appraisal values may be adjusted if, in the Company’s judgment, experience and other market data indicate that the property’s value, use, condition, exit market or other variables affecting its value may have changed since the appraisal was performed. The charge off or loss adjustment supported by an appraisal is considered the minimum charge off. Any adjustments made to the appraised value are to provide an additional charge off or specific reserve based on the applicable facts and circumstances. In instances where there is an estimated decline in value, a specific reserve may be provided or a charge off taken pending confirmation of the amount of the loss from an updated appraisal. Upon receipt of the new appraisals, an additional specific reserve may be provided or charge off taken based on the appraised value of the collateral. On average, appraisals are obtained within one month of order. The Company has not experienced any significant time lapses in recognizing the required provisions for collateral dependent loans, nor has the Company delayed appropriate charge-offs. When an updated appraisal value has been obtained, the Company has used the appraisal amount in helping to determine the appropriate charge-off or required reserve. The Company also evaluates any changes in the financial condition of the borrower and guarantors (if applicable), economic conditions, and Page 94 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. Loans that exhibit probable or observed credit weaknesses, as well as loans that have been modified in a TDR, are subject to individual review for credit losses. When individual loans are reviewed for credit loss, the Company determines allowances based on management's estimate of the borrower's ability to repay the loan given the availability of the collateral, other sources of cash flow, as well as evaluation of legal options available. The allowance for credit losses on individually evaluated loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral. Page 95 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 4. Property and Equipment The major classes of property and equipment and the total accumulated depreciation are as follows: December 31, 2021 2020 (Amounts In Thousands) Land $ 11,266 $ 11,266 Buildings and improvements 38,041 37,512 Furniture and equipment 40,989 40,053 90,296 88,831 Less accumulated depreciation 56,006 52,953 Net $ 34,290 $ 35,878 Note 5. Leases The Bank leases branch offices, parking facilities and certain equipment under operating leases. The leases have remaining lease terms of 1 year to 15 years, some of which include options to extend the leases for up to 10 years, and some of which include options to terminate the leases within 1 year. As the options are reasonably certain to be exercised, they are recognized as part of the right-of-use assets and lease liabilities. For the years ended December 31, 2021 and 2020, total operating lease expense was $ 0.59 million and $ 0.56 million, respectively, and is included in occupancy expenses in the consolidated statement of income. Included in this were $ 0.51 million and $ 0.47 million of operating lease costs, respectively, $ 0.03 million and $ 0.03 million of short term lease costs, respectively, and $ 0.05 million and $ 0.06 million of variable lease costs, respectively. For the years ended December 31, 2021 and 2020, cash paid for amounts included in the measurement of operating lease liabilities was $ 0.51 million and $ 0.47 million, respectively, and right-of-use assets obtained in exchange for lease obligations was none and $ 0.05 million, respectively. As of December 31, 2021 and 2020, operating lease right-of-use assets included in other assets were $ 2.47 million and $ 2.86 million, respectively. Operating lease liabilities included in other liabilities were $ 2.53 million and $ 2.91 million, respectively. The weighted average remaining lease term for operating leases was 9.94 years and 10.27 years, respectively, and the weighted average discount rate for operating leases was 3.49 % and 3.45 %, respectively. Discount rates used were determined from FHLB borrowing rates for comparable terms. Page 96 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2021, maturities of lease liabilities were as follows: Year ending December 31: (Amounts In Thousands) 2022 464 2023 317 2024 250 2025 253 2026 257 Thereafter 1,499 Total lease payments 3,040 Less imputed interest ( 507 ) Total operating lease liabilities $ 2,533 Note 6. Interest - Bearing Deposits A summary of these deposits is as follows: December 31, 2021 2020 (Amounts In Thousands) NOW and other demand $ 964,730 $ 801,550 Savings 1,338,910 1,161,324 Time, $250,000 and over 88,517 114,260 Other time 508,736 583,244 $ 2,900,893 $ 2,660,378 Brokered deposits totaled $ 51.59 million and $ 74.08 million as of December 31, 2021 and 2020, respectively, with an average interest rate of 0.36 % and 0.34 % as of December 31, 2021 and 2020, respectively. As of December 31, 2021, brokered deposits of $ 51.59 million are included in savings deposits. At December 31, 2020, brokered deposits of $ 74.08 million were included in savings deposits. Time deposits have a maturity as follows: December 31, 2021 2020 (Amounts In Thousands) Due in one year or less $ 320,764 $ 307,962 Due after one year through two years 174,043 190,763 Due after two years through three years 63,193 150,275 Due after three years through four years 23,108 39,089 Due over four years 16,145 9,415 $ 597,253 $ 697,504 Page 97 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 7. Federal Home Loan Bank Borrowings As of December 31, 2021 and 2020, the borrowings were as follows: 2021 2020 (Effective interest rates as of December 31, 2021) (Amounts In Thousands) Due 2025, 2.81 % to 2.94 % — 45,000 Due 2026, 2.52 % to 2.86 % — 30,000 Due 2027, 2.76 % to 2.95 % — 30,000 $ — $ 105,000 On December 21, 2021 the Company paid the remaining $ 105.00 million in FHLB Borrowings due in 2025 through 2027. Fees incurred with the 2021 prepayments were $ 7.69 million and were recorded in other noninterest expenses. On November 9, 2020 the Company paid $ 25.00 million in FHLB Borrowings due in 2020. On December 30, 2020 the Company paid $ 25.00 million in FHLB Borrowings that were due in 2023, $ 15.00 million in FHLB Borrowings due in 2024 and $ 15.00 million in FHLB Borrowings due in 2025. Fees incurred with the 2020 prepayments were $ 2.53 million and recorded in other noninterest expenses. To participate in the FHLB advance program, the Company is required to have an investment in FHLB stock. The Company’s investment in FHLB stock was $ 4.55 million and $ 8.17 million at December 31, 2021 and 2020, respectively. Collateral is provided by the Company’s 1 to 4 family mortgage loans totaling none at December 31, 2021 and $ 141.75 million at December 31, 2020. The Company has the ability to borrow against agricultural real estate, commercial real estate and multi-family loans totaling $ 300.93 million as of December 31, 2021 and $ 315.86 million as of December 31, 2020 and there was $ 0 borrowed against this collateral as of December 31, 2021 or 2020. Note 8. Accumulated Other Comprehensive Income The components of accumulated other comprehensive income (AOCI), included in stockholders’ equity, are as follows: December 31, 2021 2020 (amounts in thousands) Net unrealized gain on available-for-sale securities $ 1,968 $ 11,702 Net unrealized loss on derivatives used for cash flow hedges — — Tax effect ( 491 ) ( 2,920 ) Net-of-tax amount $ 1,477 $ 8,782 Note 9. Employee Benefit Plans The Company has an Employee Stock Purchase Plan (the “ESPP”). For each quarterly offering period, eligible employees can elect to contribute from 1 % to 15 % of his or her compensation. The purchase price is the lesser of 90 % of the fair market value on the first day of the offering period or the last day of the offering period. The maximum dollar amount any one employee can elect to contribute in a year is $ 9,000 . During the year ended December 31, 2021, 7,334 shares of stock were purchased by employees of the Bank through the ESPP. 7,449 shares of stock were purchased by employees of the Bank through the ESPP for the year ended December 31, 2020. Page 98 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company has an Employee Stock Ownership Plan (the "ESOP") to which it makes discretionary cash contributions. The Company's contribution to the ESOP totaled $ 1.27 million, $ 1.27 million and $ 1.08 million for the years ended December 31, 2021, 2020 and 2019, respectively. The 2021, 2020 and 2019 discretionary contribution rate was 4.5 % of qualified salaries. In the event a terminated plan participant desires to sell his or her shares of the Company stock, or for certain employees who elect to diversify their account balances, the Company may be required to purchase the shares from the participant at their fair value. To the extent that shares of common stock held by the ESOP are not readily traded, a sponsor must reflect the maximum cash obligation related to those securities outside of stockholders' equity. The Company obtains a quarterly independent appraisal of the shares of stock. As of December 31, 2021 and 2020, the shares held by the ESOP, fair value and maximum cash obligation were as follows: 2021 2020 Shares held by the ESOP 735,482 757,262 Fair value per share $ 68.00 $ 62.50 Maximum cash obligation $ 50,013,000 $ 47,329,000 The Company has a profit-sharing plan with a 401(k) feature, which provides for discretionary annual contributions in amounts to be determined by the Board of Directors. The Company made a 4.50 % or $ 1.27 million contribution to the profit sharing plan for the year ended December 31, 2021. The Company made a 4.50 % or $ 1.27 million contribution to the profit sharing plan for the year ended December 31, 2020. The Company made a 4.50 % or $ 1.08 million contribution to the profit sharing plan for the year ended December 31, 2019. The Company made matching contributions under its 401(k) plan of $ 0.26 million in 2021, $ 0.26 million in 2020, and $ 0.22 million in 2019 and each such amount is included in salaries and employee benefits expense. The Company provides a deferred compensation program for executive officers. This program allows executive officers to elect to defer a portion of their salaried compensation for payment by the Company at a subsequent date. The executive officers can defer up to 30 % of their base compensation and up to 100 % of any bonus into the deferral plan. Any amount so deferred is credited to the executive officer’s deferred compensation account and converted to units equivalent in value to the fair market value of a share of stock in Hills Bancorporation. The “stock units” are book entry only and do not represent an actual purchase of stock. The executive officer’s account is adjusted each year for dividends paid and the change in the market value of Hills Bancorporation stock. The deferrals and earnings grow tax deferred until withdrawn from the plan. Earnings credited to the individual’s accounts are recorded as compensation expense when earned. The deferred compensation liability is recorded in other liabilities and totals $ 1.94 million and $ 3.31 million at December 31, 2021 and 2020, respectively. Expense related to the deferred compensation plan was $ 0.25 million for 2021, $( 0.02 ) million for 2020 and $ 0.42 million for 2019 and is included in salaries and employee benefits expense. The Company also provides a deferred compensation program for its Board of Directors. Under the plan, each director may elect to defer up to 50 % of such director’s cash compensation from retainers and meeting fees for payment by the Company at a subsequent date. Any amount so deferred is credited to the director’s deferred compensation account and converted to units equivalent in value to the fair market value of a share of stock in Hills Bancorporation. The “stock units” are book entry only and do not represent an actual purchase of stock. The director’s account is adjusted each year for dividends paid and the change in the market value of Hills Bancorporation stock. The deferred compensation liability for the directors’ plan is recorded in other liabilities and totaled $ 4.08 million and $ 3.78 million at December 31, 2021 and 2020, respectively. Expense related to the directors’ deferred compensation plan was $ 0.38 million for 2021, $( 0.09 ) million for 2020 and $ 0.28 million for 2019 and is included in other noninterest expense. The Company has a Stock Option and Incentive Plan for certain key employees and directors whereby shares of common stock have been reserved for awards in the form of stock options or restricted stock awards. Under the plan, the aggregate number of options and shares granted cannot exceed 250,000 shares. A Stock Option Committee may grant options at prices equal to the fair value of the stock at the date of the grant. Options expire 10 years from the date of the grant. Director options and officers' rights under the plan vest over a five-year period from the date of the grant. The fair value of each option is estimated as of the date of grant using a Black Scholes option pricing model. The expected lives of options granted incorporate historical employee exercise behavior. The risk-free rate for periods that coincide with the expected life of the options is based on the ten year interest rate swap rate as published by the Federal Reserve Bank on the date Page 99 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of issuance. Expected volatility is based on volatility levels of the Company’s peers’ common stock as the Company’s stock has limited trading activity. Expected dividend yield was based on historical dividend rates. Significant assumptions at the date of grant on May 14, 2019 include the risk-free interest rate of 2.39 %, expected option life of 7.5 years, expected volatility of 33 % and expected dividends of 1.23 %. There were no stock options granted in 2021 and 2020 and 5,805 in 2019. The weighted-average fair value of options granted in 2019 was $ 21.31 per share. The intrinsic value of options exercised was $ 0.00 million , $ 0.00 million and $ 0.06 million for 2021, 2020 and 2019, respectively. A summary of the stock options is as follows: Number of Shares Weighted- Average Exercise Price Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (In Thousands) Balance, December 31, 2018 9,020 $ 33.30 3.41 250 Granted 5,805 Exercised ( 1,800 ) Balance, December 31, 2019 13,025 $ 45.92 5.47 248 Granted — Exercised — Balance, December 31, 2020 13,025 $ 45.92 4.47 216 Granted — Exercised — Balance, December 31, 2021 13,025 $ 45.92 3.47 $ 288 Other pertinent information related to the options outstanding at December 31, 2021 is as follows: Exercise Price Number Outstanding Remaining Contractual Life Number Exercisable 33.00 7,220 4 months 7,220 62.00 5,805 89 months — 13,025 7,220 As of December 31, 2021, the outstanding options have a weighted-average exercise price of $ 45.92 per share and a weighted average remaining contractual term of 3.47 years. There was $ 0.06 million in unrecognized compensation cost for stock options granted under the plan as of December 31, 2021. The cost is expected to be recognized over a weighted-average period of 2.40 years. As of December 31, 2021, the vested options totaled 7,220 shares with a weighted-average exercise price of $ 33.00 per share. As of December 31, 2021, 208,543 shares were available for stock options and awards under the 2020 Stock Option and Incentive Plan (2020 Plan). The 2010 Stock Option and Incentive Plan (2010 Plan) was discontinued upon the approval of the 2020 Plan in April 2020. No stock options or stock awards will be issued from the 2010 Plan after April 2020. The Compensation and Incentive Stock Committee is also authorized to grant awards of restricted common stock. A summary of the restricted stock option activity for the year ended December 31, 2021 is as follows: Page 100 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2020 Stock Option and Incentive Plan 2010 Stock Option and Incentive Plan Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Balance, December 31, 2020 231,425 22,864 Authorization of shares — — Granted 24,513 $ 66.01 — $ 0.00 Forfeited 1,631 $ 62.81 6,452 $ 54.61 Balance, December 31, 2021 208,543 29,316 The Company authorized the issuance of 24,513 shares in 2021, 20,427 shares in 2020, and 23,527 shares in 2019 to certain employees. The vesting period for these awards is five years and the Bank amortizes the expense on a straight line basis during the vesting period. The expense relating to these awards for the years ended December 31, 2021, 2020 and 2019 was $ 0.92 million, $ 0.95 million and $ 0.96 million, respectively. 12,800 , 10,800 and 7,200 shares of the restricted common stock shares awarded in December 31, 2021, 2020 and 2019, are subject to forfeiture upon termination of the employee's employment with the Company within eight years of the award. Note 10. Income Taxes Income taxes for the years ended December 31, 2021, 2020 and 2019 are summarized as follows: 2021 2020 2019 (Amounts In Thousands) Current: Federal $ 10,383 $ 9,124 $ 8,857 State 2,653 2,673 2,391 Deferred: Federal 757 ( 417 ) 1,068 State 214 ( 103 ) 233 $ 14,007 $ 11,277 $ 12,549 Page 101 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Temporary differences between the amounts reported in the consolidated financial statements and the tax basis of assets and liabilities result in deferred taxes. Deferred tax assets and liabilities at December 31, 2021 and 2020 were as follows: December 31, 2021 2020 (Amounts In Thousands) Deferred income tax assets: Allowance for credit losses $ 8,849 $ 9,249 Deferred compensation and unearned restricted stock 2,239 2,401 Allowance for credit losses on off-balance sheet credit exposures 961 — Accrued expenses 611 589 State net operating loss 1,094 1,011 Gross deferred tax assets $ 13,754 $ 13,250 Valuation allowance ( 1,094 ) ( 1,011 ) Deferred tax asset, net of valuation allowance $ 12,660 $ 12,239 Deferred income tax liabilities: Property and equipment 1,852 1,941 Unrealized gains on investment securities 491 2,920 Goodwill 407 407 Prepaid expenses 400 431 Other 385 452 Gross deferred tax liabilities $ 3,535 $ 6,151 Net deferred tax assets $ 9,125 $ 6,088 The Company has recorded a deferred tax asset for the future tax benefits of Iowa net operating loss carry-forwards. The net operating loss carry-forwards are generated by the Company largely from its investment in tax credit real estate properties. The Company is required to file a separate Iowa tax return and cannot be consolidated with the Bank. The net operating loss carry-forwards will expire, if not utilized, between 2022 and 2040. The Company has recorded a valuation allowance to reduce the deferred tax asset attributable to the net operating loss carry-forwards. At December 31, 2021 and 2020, the Company believes it is more likely than not that the Iowa net operating loss carry-forwards will not be realized. A valuation allowance related to the remaining deferred tax assets has not been provided because management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. The valuation allowance increased by $ 83,000 and $ 82,000 for the years ended December 31, 2021 and 2020, respectively. The net change in the deferred income taxes for the years ended December 31, 2021, 2020 and 2019 is reflected in the consolidated financial statements as follows: Year Ended December 31, 2021 2020 2019 (Amounts In Thousands) Consolidated statements of income $ 971 $ ( 520 ) $ 1,301 Consolidated statements of stockholders' equity ( 4,008 ) 2,450 1,550 $ ( 3,037 ) $ 1,930 $ 2,851 Page 102 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Income tax expense for the years ended December 31, 2021, 2020 and 2019 are less than the amounts computed by applying the maximum effective federal income tax rate to the income before income taxes because of the following items: 2021 2020 2019 Amount % Of Pretax Income Amount % Of Pretax Income Amount % Of Pretax Income (Amounts In Thousands) Expected tax expense $ 13,039 21.0 % $ 10,484 21.0 % $ 12,152 20.9 % Tax-exempt interest ( 1,176 ) ( 1.9 ) ( 1,219 ) ( 2.4 ) ( 1,201 ) ( 2.1 ) Interest expense limitation 50 0.1 79 0.1 109 0.2 State income taxes, net of federal income tax benefit 2,265 3.7 2,030 4.1 2,073 3.5 Income tax credits ( 475 ) ( 0.8 ) ( 51 ) ( 0.1 ) ( 531 ) ( 0.9 ) Other 304 0.5 ( 46 ) ( 0.1 ) ( 53 ) 0.1 $ 14,007 22.6 % $ 11,277 22.6 % $ 12,549 21.7 % Federal income tax expense for the years ended December 31, 2021, 2020 and 2019 was computed using the consolidated effective federal tax rate. The Company also recognized income tax expense pertaining to state franchise taxes payable individually by the subsidiary bank. The Company files a consolidated tax return for federal purposes and separate tax returns for the State of Iowa purposes. The tax years ended December 31, 2021, 2020, 2019 and 2018 , remain subject to examination by the Internal Revenue Service. For state tax purposes, the tax years ended December 31, 2021, 2020, 2019 and 2018 , remain open for examination. There were no material unrecognized tax benefits at December 31, 2021 and December 31, 2020. No interest or penalties on these unrecognized tax benefits has been recorded. As of December 31, 2021, the Company does no t anticipate any significant increase or decrease in unrecognized tax benefits during the twelve month period ending December 31, 2022. Note 11. Regulatory Capital Requirements, Restrictions on Subsidiary Dividends and Cash Restrictions The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial results. Under capital adequacy guidelines and the regulatory frameworks for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classifications of the Company and the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by the regulations to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of capital. Under the BASEL III rules, the minimum capital ratios are 4% for Tier 1 Leverage Capital Ratio, 4.5% for the Common Equity Tier 1 Capital Ratio, 6% for the Tier 1 Risk-Based Capital Ratio and 8% for the Total Risk-Based Capital Ratio. A capital conservation buffer of 2.5% of risk-weighted assets was completely phased in beginning January 1, 2019. As of March 31, 2020, the Bank elected to use the Community Bank Leverage Ratio (CBLR) framework as provided for in the Economic Growth, Regulatory Relief and Consumer Protection Act. Under the CBLR framework, the Bank is required to maintain a CBLR of greater than 9%. The Coronavirus Aid, Relief and Economic Security ("CARES") Act reduced the minimum ratio to 8% beginning in the 2nd quarter of 2020 through December 31, 2020, increasing to 8.5% for 2021 and returning to 9% beginning January 1, 2022. Management believes that, as of December 31, 2021 and 2020, the Company and the Bank met all capital adequacy requirements to which they are subject. As of December 31, 2021 and 2020, the most recent notifications from the Federal Reserve System categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 common equity and Tier 1 leverage ratios as set forth in the table that follows. There are no conditions or events since that notification that management believes have changed the Bank's category. Page 103 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The actual amounts and capital ratios as of December 31, 2021 and 2020, with the minimum regulatory requirements for the Company and Bank are presented below (amounts in thousands): Actual For Capital Adequacy Purposes Amount Ratio Ratio As of December 31, 2021: Company: Community Bank Leverage Ratio $ 484,486 11.80 % 8.50 % Bank: Community Bank Leverage Ratio 484,429 11.80 8.50 Actual For Capital Adequacy Purposes Amount Ratio Ratio As of December 31, 2020: Company: Community Bank Leverage Ratio $ 452,123 11.91 % 8.00 % Bank: Community Bank Leverage Ratio 453,073 11.94 8.00 The ability of the Company to pay dividends to its stockholders is dependent upon dividends paid by the Bank. The Bank is subject to certain statutory and regulatory restrictions on the amount it may pay in dividends. To maintain acceptable capital ratios in the Bank, certain of its retained earnings are not available for the payment of dividends. To maintain a ratio of capital to assets of 8.50%, retained earnings of $ 135.62 million as of December 31, 2021 are available for the payment of dividends to the Company. The Bank is required to maintain reserve balances in cash or with the Federal Reserve Bank. Reserve balances totaled $ 752.99 million and $ 541.05 million as of December 31, 2021 and 2020, respectively. Note 12. Related Party Transactions Certain directors of the Company and the Bank, companies with which the directors are affiliated, and certain principal officers are customers of, and have banking transactions with, the Bank in the ordinary course of business. Such indebtedness has been incurred on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons. Page 104 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following is an analysis of the changes in the loans to related parties during the years ended December 31, 2021 and 2020: Year Ended December 31, 2021 2020 (Amounts In Thousands) Balance, beginning $ 54,053 $ 55,717 Net increase due to change in related parties 735 — Advances 23,671 14,406 Collections ( 25,614 ) ( 16,070 ) Balance, ending $ 52,845 $ 54,053 Deposits from these related parties totaled $ 21.27 million and $ 13.18 million as of December 31, 2021 and 2020, respectively. Deposits from related parties are accepted subject to the same interest rates and terms as those from nonrelated parties. Page 105 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13. Fair Value Measurements The carrying value and estimated fair values of the Company’s financial instruments as of December 31, 2021 are as follows: December 31, 2021 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 $ 781,918 $ 781,918 $ 781,918 $ — $ — Investment securities 555,900 555,900 243,925 311,975 — Loans held for sale 5,716 5,716 — 5,716 — Loans Agricultural 104,672 103,745 — — 103,745 Commercial and financial 217,733 216,466 — — 216,466 Real estate: Construction, 1 to 4 family residential 79,668 79,311 — — 79,311 Construction, land development and commercial 125,539 124,466 — — 124,466 Mortgage, farmland 229,311 228,365 — — 228,365 Mortgage, 1 to 4 family first liens 901,523 897,255 — — 897,255 Mortgage, 1 to 4 family junior liens 111,184 110,903 — — 110,903 Mortgage, multi-family 379,077 378,193 — — 378,193 Mortgage, commercial 394,594 391,950 — — 391,950 Loans to individuals 31,916 31,871 — — 31,871 Obligations of state and political subdivisions 49,845 50,155 — — 50,155 Accrued interest receivable 11,437 11,437 — 11,437 — Total financial instrument assets $ 3,980,033 $ 3,967,651 $ 1,025,843 $ 329,128 $ 2,612,680 Financial instrument liabilities: Deposits Noninterest-bearing deposits $ 633,101 $ 633,101 $ — $ 633,101 $ — Interest-bearing deposits 2,900,893 2,909,243 — 2,909,243 — Other borrowings 249 249 — 249 — Federal Home Loan Bank borrowings — — — — — Accrued interest payable 1,165 1,165 — 1,165 — Total financial instrument liabilities $ 3,535,408 $ 3,543,758 $ — $ 3,543,758 $ — Face Amount Financial instrument with off-balance sheet risk: Loan commitments $ 614,324 $ — $ — $ — $ — Letters of credit 7,179 — — — — Total financial instrument liabilities with off-balance-sheet risk $ 621,503 $ — $ — $ — $ — (1) Considered Level 1 under Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”). (2) Considered Level 2 under ASC 820. (3) Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market. Page 106 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The carrying value and estimated fair values of the Company’s financial instruments as of December 31, 2020 are as follows: December 31, 2020 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 $ 574,310 $ 574,310 $ 574,310 $ — $ — Investment securities 416,544 416,544 148,646 267,898 — Loans held for sale 43,947 43,947 — 43,947 — Loans Agricultural 92,334 92,922 — — 92,922 Commercial and financial 281,357 282,015 — — 282,015 Real estate: Construction, 1 to 4 family residential 70,210 70,432 — — 70,432 Construction, land development and commercial 110,501 110,039 — — 110,039 Mortgage, farmland 242,969 242,978 — — 242,978 Mortgage, 1 to 4 family first liens 882,156 890,409 — — 890,409 Mortgage, 1 to 4 family junior liens 126,336 124,945 — — 124,945 Mortgage, multi-family 369,552 370,538 — — 370,538 Mortgage, commercial 412,186 413,409 — — 413,409 Loans to individuals 30,573 31,164 — — 31,164 Obligations of state and political subdivisions 55,838 59,300 — — 59,300 Accrued interest receivable 12,177 12,177 — 12,177 — Total financial instrument assets $ 3,720,990 $ 3,735,129 $ 722,956 $ 324,022 $ 2,688,151 Financial instrument liabilities: Deposits Noninterest-bearing deposits $ 532,190 $ 532,190 $ — $ 532,190 $ — Interest-bearing deposits 2,660,378 2,673,815 — 2,673,815 — Federal Home Loan Bank Borrowings 105,000 115,259 — 115,259 — Accrued interest payable 1,733 1,733 — 1,733 — Total financial instrument liabilities $ 3,299,301 $ 3,322,997 $ — $ 3,322,997 $ — Face Amount Financial instrument with off-balance sheet risk: Loan commitments $ 483,602 $ — $ — $ — $ — Letters of credit 8,056 — — — — Total financial instrument liabilities with off-balance-sheet risk $ 491,658 $ — $ — $ — $ — (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 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 Page 107 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company determines the fair market value of its financial instruments based on the fair value hierarchy established in ASC 820. There are three levels of inputs that may be used to measure fair value as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included within Level 1. Observable inputs include the quoted prices for similar assets or liabilities in markets that are not active and inputs other than quoted prices that are observable for the asset or liability. Level 3 Unobservable inputs supported by little or no market activity for financial instruments. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. It is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. The Company is required to use observable inputs, to the extent available, in the fair value estimation process unless that data results from forced liquidations or distressed sales. The following is a description of valuation methodologies used for assets and liabilities recorded at fair value. Investment securities available for sale : Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If a quoted price is not available, the fair value is obtained from benchmarking the security against similar securities. U.S. Treasury securities are considered Level 1 with the remaining securities considered Level 2. The pricing for investment securities is obtained from an independent source. There are no Level 3 investment securities owned by the Company. The Company obtains an understanding of the independent source’s valuation methodologies used to determine fair value by level of security. The Company validates assigned fair values on a sample basis using an additional third-party provider pricing service to determine if the fair value measurement is reasonable. Due to the nature of our investment portfolio, we do not expect significant and unusual fluctuations as fair value changes primarily relate to interest rate changes. No unusual fluctuations were identified during the year ended December 31, 2021. If a fluctuation requiring investigation was identified, the Company would research the change with the independent source or other available information. Individually analyzed loans under ASC 326 CECL : See Note 1 for further discussion of individually analyzed loans under CECL. A loan is considered to be non-performing when it is probable that all of the principal and interest due may not be collected according to its contractual terms. Generally, when a loan is considered non-performing, the amount of reserve is measured based on the fair value of the underlying collateral. The Company makes such measurements on all material loans deemed non-performing using the fair value of the collateral for collateral dependent loans or based on the present value of the estimated future cash flows of interest and principal discounted at the loans effective interest rate or the fair value of the loan if determinable. The fair value of collateral used by the Company is determined by obtaining an observable market price or by obtaining an appraised value from an independent, licensed or certified appraiser, using observable market data. This data includes information such as selling price of similar properties and capitalization rates of similar properties sold within the market, expected future cash flows or earnings of the subject property based on current market expectations, and other relevant factors. All appraised values are adjusted for market-related trends based on the Company's experience in sales and other appraisals of similar property types as well as estimated selling costs. These loans are considered Level 3 as the instruments used to determine fair market value require significant management judgment and estimation. Foreclosed assets : The Company does not record foreclosed assets at fair value on a recurring basis. Foreclosed assets consist mainly of other real estate owned but may include other types of assets repossessed by the Company. Foreclosed assets are adjusted to the lower of carrying value or fair value less the costs of disposal. Fair value is generally based upon independent Page 108 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS market prices or appraised values of the collateral, and may include a marketability discount as deemed necessary by management based on its experience with similar types of real estate. The value of foreclosed assets is evaluated periodically as a nonrecurring fair value adjustment. Foreclosed assets are classified as Level 3. Off-balance sheet instruments : Fair values for outstanding letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of the outstanding letters of credit is not significant. Unfunded loan commitments are not valued since the loans are generally priced at market at the time of funding (Level 2). Assets and Liabilities Recorded at Fair Value on a Recurring Basis The table below represents the balances of assets and liabilities measured at fair value on a recurring basis: December 31, 2021 Readily Available Market Prices(1) Observable Market Prices(2) Company Determined Market Prices(3) Total at Fair Value Securities available for sale (Amounts in Thousands) U.S. Treasury $ 243,925 $ — $ — $ 243,925 State and political subdivisions — 263,516 — 263,516 Mortgage-backed securities and collateralized mortgage obligations — 9,446 — 9,446 Other securities (FHLB, FHLMC and FNMA) — 34,467 — 34,467 Total $ 243,925 $ 307,429 $ — $ 551,354 December 31, 2020 Readily Available Market Prices(1) Observable Market Prices(2) Company Determined Market Prices(3) Total at Fair Value Securities available for sale (Amounts in Thousands) U.S. Treasury $ 148,646 $ — $ — $ 148,646 State and political subdivisions — 224,566 — 224,566 Other securities (FHLB, FHLMC and FNMA) — 35,160 — 35,160 Total $ 148,646 $ 259,726 $ — $ 408,372 (1) Considered Level 1 under ASC 820. (2) Considered Level 2 under ASC 820. (3) Considered Level 3 under ASC 820 and are based on valuation models that use significant assumptions that are not observable in an active market. There were no transfers between Levels 1, 2 or 3 during the years ended December 31, 2021 and 2020. Page 109 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis The Company is required to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. The valuation methodologies used to measure these fair value adjustments are described above. For assets measured at fair value on a nonrecurring basis that were still held on the balance sheet at December 31, 2021 and 2020, the following tables provide the level of valuation assumptions used to determine the adjustment and the carrying value of the related individual assets at year end. December 31, 2021 Year Ended December 31, 2021 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 $ — $ — $ 399 $ 399 $ — Commercial and financial — — 1,527 1,527 — Real Estate: Construction, 1 to 4 family residential — — 383 383 — Construction, land development and commercial — — 96 96 — Mortgage, farmland — — 1,114 1,114 — Mortgage, 1 to 4 family first liens — — 5,902 5,902 212 Mortgage, 1 to 4 family junior liens — — 202 202 9 Mortgage, multi-family — — 1,460 1,460 — Mortgage, commercial — — 4,176 4,176 255 Loans to individuals — — — — — Foreclosed assets (5) — — — — — Total $ — $ — $ 15,259 $ 15,259 $ 476 (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 110 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2020 Year Ended December 31, 2020 Readily Available Market Prices(1) Observable Market Prices(2) Company Determined Market Prices(3) Total at Fair Value Total Losses (Amounts in Thousands) Loans (4) Agricultural $ — $ — $ 1,081 $ 1,081 $ — Commercial and financial — — 1,692 1,692 385 Real Estate: Construction, 1 to 4 family residential — — 414 414 — Construction, land development and commercial — — 315 315 — Mortgage, farmland — — 1,718 1,718 — Mortgage, 1 to 4 family first liens — — 5,906 5,906 252 Mortgage, 1 to 4 family junior liens — — 176 176 19 Mortgage, multi-family — — 1,773 1,773 — Mortgage, commercial — — 5,082 5,082 250 Loans to individuals — — — — — Foreclosed assets (5) — — — — — Total $ — $ — $ 18,157 $ 18,157 $ 906 (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 111 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 14. Parent Company Only Financial Information Following is condensed financial information of the Company (parent company only): CONDENSED BALANCE SHEETS December 31, 2021 and 2020 (Amounts In Thousands) ASSETS 2021 2020 Cash and cash equivalents at subsidiary bank $ 2,176 $ 1,100 Investment in subsidiary bank 488,406 464,355 Other assets 2,067 1,846 Total assets $ 492,649 $ 467,301 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities $ 4,186 $ 3,896 Redeemable common stock held by ESOP 50,013 47,329 Stockholders' equity: Capital stock 60,938 60,233 Retained earnings 474,392 439,831 Accumulated other comprehensive gain 1,477 8,782 Treasury stock at cost ( 48,344 ) ( 45,441 ) 488,463 463,405 Less maximum cash obligation related to ESOP shares 50,013 47,329 Total stockholders' equity 438,450 416,076 Total liabilities and stockholders' equity $ 492,649 $ 467,301 CONDENSED STATEMENTS OF INCOME Years Ended December 31, 2021, 2020 and 2019 (Amounts In Thousands) 2021 2020 2019 Dividends received from subsidiary $ 12,273 $ 14,822 $ 7,657 Other expenses ( 836 ) ( 362 ) ( 708 ) Income before income tax benefit and equity in undistributed income of subsidiary 11,437 14,460 6,949 Income tax benefit 297 173 271 11,734 14,633 7,220 Equity in undistributed income of subsidiary 36,351 24,014 38,098 Net income $ 48,085 $ 38,647 $ 45,318 Page 112 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED STATEMENTS OF CASH FLOWS Years Ended December 31, 2021, 2020 and 2019 (Amounts In Thousands) 2021 2020 2019 Cash flows from operating activities: Net income $ 48,085 $ 38,647 $ 45,318 Adjustments to reconcile net income to cash and cash equivalents provided by operating activities: Equity in undistributed income of subsidiary ( 36,351 ) ( 24,014 ) ( 38,098 ) Share-based compensation 25 25 14 Compensation expensed through issuance of common stock 1,618 1,272 1,133 Forfeiture of common stock ( 455 ) ( 257 ) ( 262 ) Increase in other assets ( 221 ) ( 515 ) ( 100 ) Increase (decrease) in other liabilities 290 ( 3,554 ) 1,036 Net cash and cash equivalents provided by operating activities 12,991 11,604 9,041 Cash flows from financing activities: Issuance of common stock, net of costs — 5,844 5,026 Stock options exercised — — 62 Purchase of treasury stock ( 3,569 ) ( 8,550 ) ( 5,534 ) Proceeds from the issuance of common stock through the employee stock purchase plan 427 413 434 Capital contribution to subsidiary — ( 5,000 ) — Dividends paid ( 8,773 ) ( 8,325 ) ( 7,657 ) Net cash and cash equivalents used by financing activities ( 11,915 ) ( 15,618 ) ( 7,669 ) Increase (decrease) in cash and cash equivalents 1,076 ( 4,014 ) 1,372 Cash and cash equivalents: Beginning of year 1,100 5,114 3,742 Ending of year $ 2,176 $ 1,100 $ 5,114 Supplemental Disclosures Noncash financing activities: Increase (decrease) in maximum cash obligation related to ESOP shares $ 2,684 $ ( 4,497 ) $ 2,956 Note 15. Commitments and Contingencies Concentrations of credit risk : The Bank’s loans, commitments to extend credit, unused lines of credit and outstanding letters of credit have been granted to customers within the Bank's market area. Investments in securities issued by state and political subdivisions within the state of Iowa totaled approximately $ 98.92 million. The concentrations of credit by type of loan are set forth in Note 3 to the Consolidated Financial Statements. Outstanding letters of credit were granted primarily to commercial borrowers. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the economic conditions in Johnson, Linn and Washington Counties, Iowa. Contingencies : In the normal course of business, the Company and its subsidiaries are subject to pending and threatened legal actions, some of which seek substantial relief or damages. While the ultimate outcome of such legal proceedings cannot be predicted with certainty, after reviewing pending and threatened litigation with counsel, management believes at this time that the outcome of such litigation will not have a material adverse effect on the Company’s business, financial conditions, or results of operations. The outbreak of Coronavirus Disease 2019 (“COVID-19”) continues to adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. The World Page 113 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Health Organization declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused significant disruptions in the U.S. economy and is highly likely to disrupt banking and other financial activity in the areas in which the Company operates and could also potentially create widespread business continuity issues for the Company. The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. While significant progress has been made to combat the outbreak of COVID-19, and while it appears that the epidemiological and macroeconomic conditions are trending in a positive direction, if there is a resurgence in the virus, the Company could experience further adverse effects on its business, financial condition, results of operations and cash flows. See Note 3 for further discussion regarding the financial impact of COVID-19. 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 December 31, 2021 and 2020 is as follows: 2021 2020 (Amounts In Thousands) Firm loan commitments and unused portion of lines of credit: Home equity loans $ 78,961 $ 69,974 Credit cards 65,913 60,535 Commercial, real estate and home construction 170,539 118,186 Commercial lines and real estate purchase loans 298,911 234,907 Outstanding letters of credit 7,179 8,056 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties. Credit card commitments are the unused portion of the holders' credit limits. Such amounts represent the maximum amount of additional unsecured borrowings. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank holds collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the commitment. The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above. If the commitment is funded the Bank would be entitled to seek recovery from the customer. At December 31, 2021 and 2020, no amounts have been recorded as liabilities for the Bank’s potential obligations under these guarantees. Page 114 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Lease commitments: The Company leases certain facilities under operating leases. The minimum future rental commitments as of December 31, 2021 for all non-cancellable leases relating to Bank premises were as follows: Year ending December 31: (Amounts In Thousands) 2022 $ 319 2023 316 2024 82 2025 1 2026 1 Thereafter 3 $ 722 Rent expense was $ 0.40 million, $ 0.38 million and $ 0.40 million for the years ended December 31, 2021, 2020 and 2019, respectively. Note 16. Quarterly Results of Operations (unaudited, amounts in thousands, except per share amounts) Quarter Ended March June September December Year 2021 Interest income $ 31,127 $ 30,794 $ 31,196 $ 28,972 $ 122,089 Interest expense 4,894 4,598 4,172 3,963 17,627 Net interest income $ 26,233 $ 26,196 $ 27,024 $ 25,009 $ 104,462 Credit loss (benefit) expense ( 2,984 ) ( 1,659 ) 82 ( 946 ) ( 5,507 ) Other income 9,038 7,982 8,244 8,200 33,464 Other expense 18,699 18,219 18,198 26,225 81,341 Income before income taxes $ 19,556 $ 17,618 $ 16,988 $ 7,930 $ 62,092 Income taxes 4,359 4,008 3,863 1,777 14,007 Net income $ 15,197 $ 13,610 $ 13,125 $ 6,153 $ 48,085 Basic earnings per share $ 1.63 $ 1.46 $ 1.41 $ 0.66 $ 5.16 Diluted earnings per share 1.63 1.46 1.41 0.66 5.16 2020 Interest income $ 32,452 $ 32,246 $ 31,675 $ 32,156 $ 128,529 Interest expense 7,862 6,645 6,465 5,980 26,952 Net interest income $ 24,590 $ 25,601 $ 25,210 $ 26,176 $ 101,577 Provision for loan losses 4,649 8 ( 157 ) ( 142 ) 4,358 Other income 6,167 6,531 7,510 8,128 28,336 Other expense 17,227 16,872 18,055 23,477 75,631 Income before income taxes $ 8,881 $ 15,252 $ 14,822 $ 10,969 $ 49,924 Income taxes 1,806 3,541 3,392 2,538 11,277 Net income $ 7,075 $ 11,711 $ 11,430 $ 8,431 $ 38,647 Basic earnings per share $ 0.75 $ 1.25 $ 1.22 $ 0.90 $ 4.12 Diluted earnings per share 0.75 1.25 1.22 0.90 4.12 Page 115 Table of Contents HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17. Derivative Financial Instruments In the normal course of business, the Bank may use derivative financial instruments to manage its interest rate risk. These instruments carry varying degrees of credit, interest rate and market or liquidity risks. Derivative instruments are recognized as either assets or liabilities in the accompanying consolidated financial statements and are measured at fair value. The Bank’s objectives are to add stability to its net interest margin and to manage its exposure to movements in interest rates. The contract or notional amount of a derivative is used to determine, along with the other terms of the derivative, the amount to be exchanged between the counterparties. The Bank is exposed to credit risk in the event of nonperformance by counterparties to financial instruments. The Bank minimizes this risk by entering into derivative contracts with large, stable financial institutions. The Bank has not experienced any losses from nonperformance by counterparties. The Bank monitors counterparty risk in accordance with the provisions of ASC 815. In addition, the Bank’s interest rate-related derivative instruments contain language outlining collateral pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits which are determined by credit ratings of each counterparty. The Bank terminated one interest rate swap in December 2020 and the other matured in November 2020, therefore the Bank was no t required to pledge collateral as of December 31, 2021 and 2020. Cash Flow Hedges: The Bank executed two forward-starting interest rate swap transactions on November 7, 2013. One of the interest rate swap transactions had an effective date of November 9, 2015, and an expiration date of November 9, 2020 , effectively converting $ 25.00 million of variable rate debt to fixed rate debt. The other interest rate swap transaction had an effective date of November 7, 2016 and an expiration date of November 7, 2023 , effectively converting $ 25.00 million of variable rate debt to fixed rate debt. For accounting purposes, these swap transactions were designated as a cash flow hedge of the changes in cash flows attributable to changes in three-month LIBOR , the benchmark interest rate being hedged, associated with the interest payments made on an amount of the Bank’s debt principal equal to the then-outstanding swap notional amount. At inception, the Bank asserted that the underlying principal balance would remain outstanding throughout the hedge transaction making it probable that sufficient LIBOR-based interest payments would exist through the maturity date of the swaps. The Bank terminated the remaining interest rate swap in December 2020 and in connection with the termination paid $ 2.684 million to the counterparty. The losses realized on the interest rate swap were reclassified into the income statement from other comprehensive income. In connection with the termination of the swap, the related FHLB borrowings were paid off. There were no remaining derivative instruments designated as cash flow hedges as of December 31, 2021 and 2020. There were no gains or losses recognized on the Bank's derivative instruments designated as cash flow hedges for the year ended December 31, 2021. The table below identifies the gains and losses recognized on the Bank’s derivative instruments designated as cash flow hedges for the year ended December 31, 2020: Recognized in OCI Reclassified from AOCI into Income Recognized in Income on Derivatives Amount of Gain (Loss) Category Amount of Gain (Loss) Category Amount of Gain (Loss) (Amounts in Thousands) December 31, 2020 Interest rate swap $ 209 Interest Expense $ — Other Income $ — Interest rate swap ( 438 ) Interest Expense ( 1,992 ) Other Income — Note 18. Subsequent Events Subsequent events have been evaluated through March 4, 2022. Page 116 Table of Contents Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure None.