UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION 
Washington, D.C.  20549 FORM
10-Q QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For
the quarterly period ended September 30, 2005 Commission file
number: 0-12668 Hills
Bancorporation Incorporated in Iowa
  
  I.R.S. Employer
  IdentificationNo. 42-1208067 131 MAIN STREET,
HILLS, IOWA 52235 Telephone number:
(319) 679-2291 Indicate by checkmark whether the Registrant (1) has
filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
 x Yes o No
  Indicate by checkmark whether the Registrant is an
accelerated filer (as defined by Rule 12b-2 of the Securities Exchange Act of
1934).
 x Yes o No
 APPLICABLE
ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of
the issuers classes of common stock, as of the latest practical date. CLASS
  
  SHARES
  OUTSTANDINGAt October 31, 2005Common
  Stock, no par value
  
  4,553,173 Page 1 of 31    HILLS
BANCORPORATION
Index to Form 10-Q

Part
I
FINANCIAL INFORMATION

Page 
  NumberItem 1.
  Financial StatementsConsolidated
  balance sheets, September 30, 2005 (unaudited) and December 31, 2004.
  3Consolidated
  statements of income, (unaudited) for three and nine months ended September
  30, 2005 and 2004.
  4Consolidated
  statements of comprehensive income, (unaudited) for three and nine months
  ended September 30, 2005 and 2004.
  5Consolidated
  statements of stockholders equity, (unaudited) for nine months ended
  September 30, 2005 and 2004.
  6Consolidated
  statements of cash flows (unaudited) for nine months ended September 30, 2005
  and 2004.
  7 -
8Notes
  to consolidated financial statements
  9
  - 10Item 2.
  Managements
  Discussion and Analysis of Financial Condition and Results of Operations
  11
  - 23Item 3.
  Quantitative and Qualitative
  Disclosures About Market Risk
  24Item 4.
  Controls and Procedures
  25Part
IIOTHER
  INFORMATIONItem 1.
  Legal Proceedings
  26Item 2.
  Unregistered Sales of Equity
  Securities and Use of Proceeds
  26Item 3.
  Defaults Upon Senior Securities
  26Item 4.
  Submission of Matters to a Vote of
  Security Holders
  26Item 5.
  Other Information
  26Item 6.
  Exhibits
  26Signatures
  
  27Exhibits Index
  28Page 2 of 31


HILLS
BANCORPORATIONCONSOLIDATED BALANCE SHEETS
(Amounts In Thousands, Except Shares)

September 30,
2005ASSETS
  
  (Unaudited)
  
  December
  31, 2004*Cash
and due from banks
  
  $
  31,828
  
  $
  23,008Federal funds
sold
  
  
  5,473
  
  
  Total cash and cash equivalents
  
  
  37,301
  
  
  23,008Investment
securities:Available for sale (amortized cost at September
30, 2005 $205,131;
  December 31, 2004 $203,208)
  
  
  203,486
  
  
  204,123Held to maturity (fair value at September 30,
2005 $328; December
31,
  2004 $4,986)
  
  
  315
  
  
  5,000Stock
of Federal Home Loan Bank
  
  
  11,276
  
  
  8,893Loans held for
sale
  
  
  2,706
  
  
  3,908Loans,
net
  
  
  1,100,097
  
  
  998,231Property and equipment,
net
  
  
  21,725
  
  
  21,814Tax
credit real estate
  
  
  7,690
  
  
  8,010Accrued interest
receivable
  
  
  8,604
  
  
  7,349Deferred income taxes
  
  
  5,996
  
  
  4,506Goodwill
  
  
  2,500
  
  
  2,500Other
assets
  
  
  3,739
  
  
  3,107$
  1,405,435
  
  $
  1,290,449LIABILITIES
  AND STOCKHOLDERS EQUITYLiabilitiesNoninterest-bearing deposits
  
  $
  140,365
  
  $
  131,256Interest-bearing deposits
  
  
  897,298
  
  
  825,980Total deposits
  
  $
  1,037,663
  
  $
  957,236Short-term borrowings
  
  
  24,389
  
  
  37,985Federal Home Loan Bank borrowings
  
  
  207,411
  
  
  167,542Accrued interest payable
  
  
  1,952
  
  
  1,632Other liabilities
  
  
  7,102
  
  
  5,915$
  1,278,517
  
  $
  1,170,310REDEEMABLE COMMON STOCK HELD BY EMPLOYEE STOCK OWNERSHIP PLAN
(ESOP)
  
  $
  19,959
  
  $
  16,336STOCKHOLDERS
  EQUITYCapital stock, no par value; authorized
10,000,000 shares; issued
at
  September 30, 2005 4,554,300; December 31, 2004 4,549,656 shares
  
  $
  
  
  $
  Paid in capital
  
  
  11,541
  
  
  11,364Retained earnings
  
  
  116,455
  
  
  108,199Accumulated other comprehensive income
(loss)
  
  
  (1,036
  )
  
  576Treasury stock at cost (939 shares at September
30, 2005 and none
at
  December 31, 2004)
  
  
  (42
  )
  
  $
  126,918
  
  $
  120,139Less maximum cash obligation related to ESOP
shares
  
  
  19,959
  
  
  16,336$
  106,959
  
  $
  103,803$
  1,405,435
  
  $
  1,290,449* Derived from audited
financial statements.
See Notes to Consolidated Financial Statements.

Page 3 of 31


HILLS
BANCORPORATIONCONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Amounts In Thousands, Except Per Share Amounts)

Three Months
Ended
  
  Nine Months
EndedSeptember
30,
  
  September
30,2005
  
  2004
  
  2005
  
  2004Interest income:Loans, including
  fees
  
  $
  17,152
  
  $
  14,685
  
  $
  48,545
  
  $
  42,156Investment
  securities:Taxable
  
  
  1,148
  
  
  1,251
  
  
  3,607
  
  
  4,027Nontaxable
  
  
  682
  
  
  625
  
  
  1,985
  
  
  1,843Federal funds
  sold
  
  
  102
  
  
  1
  
  
  205
  
  
  22Total interest income
  
  $
  19,084
  
  $
  16,562
  
  $
  54,342
  
  $
  48,048Interest
  expense:Deposits
  
  $
  5,209
  
  $
  3,513
  
  $
  13,933
  
  $
  10,411Short-term
  borrowings
  
  
  131
  
  
  170
  
  
  438
  
  
  361FHLB borrowings
  
  
  2,668
  
  
  2,290
  
  
  7,268
  
  
  6,822Total interest expense
  
  $
  8,008
  
  $
  5,973
  
  $
  21,639
  
  $
  17,594Net interest income
  
  $
  11,076
  
  $
  10,589
  
  $
  32,703
  
  $
  30,454Provision for
  loan losses
  
  
  239
  
  
  602
  
  
  998
  
  
  1,117Net interest income after provision
  for loan losses
  
  $
  10,837
  
  $
  9,987
  
  $
  31,705
  
  $
  29,337Other
income:Net gain on sale
  of loans
  
  $
  313
  
  $
  292
  
  $
  857
  
  $
  1,259Trust fees
  
  
  749
  
  
  661
  
  
  2,208
  
  
  2,002Service charges
  and fees
  
  
  1,576
  
  
  1,332
  
  
  4,260
  
  
  3,845Rental revenue
  on tax credit real estate
  
  
  171
  
  
  150
  
  
  559
  
  
  450Other
  noninterest income
  
  
  600
  
  
  616
  
  
  1,782
  
  
  1,802Net loss on sale
  of investment securities
  
  
  
  
  
  
  
  
  (234
  )
  
  $
  3,409
  
  $
  3,051
  
  $
  9,432
  
  $
  9,358Other
expenses:Salaries and
  employee benefits
  
  $
  4,336
  
  $
  4,156
  
  $
  12,682
  
  $
  12,427Occupancy
  
  
  554
  
  
  575
  
  
  1,615
  
  
  1,583Furniture and
  equipment
  
  
  869
  
  
  810
  
  
  2,554
  
  
  2,394Office supplies
  and postage
  
  
  281
  
  
  304
  
  
  931
  
  
  880Advertising and
  business development
  
  
  519
  
  
  484
  
  
  1,312
  
  
  1,271Outside services
  
  
  1,287
  
  
  1,008
  
  
  3,538
  
  
  3,105Rental expenses
  on tax credit real estate
  
  
  273
  
  
  244
  
  
  715
  
  
  595Other
  noninterest expense
  
  
  382
  
  
  214
  
  
  921
  
  
  774$
  8,501
  
  $
  7,795
  
  $
  24,268
  
  $
  23,029Income before income taxes
  
  $
  5,745
  
  $
  5,243
  
  $
  16,869
  
  $
  15,666Federal and
  state income taxes
  
  
  1,776
  
  
  1,636
  
  
  5,200
  
  
  4,902Net income
  
  $
  3,969
  
  $
  3,607
  
  $
  11,669
  
  $
  10,764Earnings per
  share:Basic
  
  $
  0.87
  
  $
  0.80
  
  $
  2.56
  
  $
  2.37Diluted
  
  
  0.86
  
  
  0.79
  
  
  2.55
  
  
  2.36See Notes to Consolidated Financial Statements.

Page 4 of 31


HILLS
BANCORPORATIONCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Amounts In Thousands)

Three
  Months Ended
    

  
  Nine
  Months EndedSeptember
  30,
    

  
  September
  30,2005
  
  2004
    

  
  2005
  
  2004Net
income
  
  $
  3,969
  
  $
  3,607
    

  
  $
  11,669
  
  $
  10,764Other
  comprehensive income (loss):Unrealized holding gains (losses) arising during
the
period
  
  $
  (1,705
  )
  $
  1,436
    

  
  $
  (2,787
  )
  $
  (2,522
  )Income tax effect of unrealized gains
(losses)
  
  
  631
  
  
  (532
  )
    

  
  1,031
  
  
  933$
  (1,074
  )
  $
  904
    

  
  $
  (1,756
  )
  $
  (1,589
  )Less: reclassification adjustment for realized
losses included in
net
  income, net of income taxes
  
  
  
  
  
  
    

  
  
  144
  
  
  Other
  comprehensive income (loss)
  
  
  (1,074
  )
  
  904
    

  
  
  (1,612
  )
  
  (1,589
  )Comprehensive
  income
  
  $
  2,895
  
  $
  4,511
    

  
  $
  10,057
  
  $
  9,175See Notes to Consolidated Financial Statements.

Page 5 of 31


HILLS BANCORPORATIONCONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (Unaudited)
(Amounts In Thousands, Except Share Amounts)

Paid In
  Capital
  
  Retained
  Earnings
  
  Accumulated
  Other
  Comprehensive
  Income (Loss)
  
  Maximum
  Cash
  Obligation
  Related
  To ESOP
  Shares
  
  Treasury 
  Stock
  
  TotalBalance, December 31, 2004
  
  $
  11,364
  
  $
  108,199
  
  $
  576
  
  $
  (16,336
  )
  $
  
  
  $
  103,803Issuance of 5,355 shares of common
stock
  
  
  191
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  191Redemption of 711 shares of common
stock
  
  
  (22
  )
  
  
  
  
  
  
  
  
  
  
  
  
  
  (22
  )Change related to ESOP shares
  
  
  
  
  
  
  
  
  
  
  
  (3,623
  )
  
  
  
  
  (3,623
  )Net income
  
  
  
  
  
  11,669
  
  
  
  
  
  
  
  
  
  
  
  11,669Income tax benefit related to stock based
compensation
  
  
  8
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  8Cash dividends ($.75 per share)
  
  
  
  
  
  (3,413
  )
  
  
  
  
  
  
  
  
  
  
  (3,413
  )Purchase of 939 shares of common stock
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  (42
  )
  
  (42
  )Other comprehensive income (loss)
  
  
  
  
  
  
  
  
  (1,612
  )
  
  
  
  
  
  
  
  (1,612
  )Balance, September 30,
2005
  
  $
  11,541
  
  $
  116,455
  
  $
  (1,036
  )
  $
  (19,959
  )
  $
  (42
  )
  $
  106,959Balance, December 31, 2003
  
  $
  11,353
  
  $
  97,189
  
  $
  3,087
  
  $
  (14,864
  )
  
  
  
  $
  96,765Issuance of 74 shares of common stock
  
  
  7
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  7Change related to ESOP shares
  
  
  
  
  
  
  
  
  
  
  
  (1,141
  )
  
  
  
  
  (1,141
  )Net income
  
  
  
  
  
  10,764
  
  
  
  
  
  
  
  
  
  
  
  10,764Cash dividends ($.70 per share)
  
  
  
  
  
  (3,184
  )
  
  
  
  
  
  
  
  
  
  
  (3,184
  )Other comprehensive income (loss)
  
  
  
  
  
  
  
  
  (1,589
  )
  
  
  
  
  
  
  
  (1,589
  )Balance, September 30, 2004
  
  $
  11,360
  
  $
  104,769
  
  $
  1,498
  
  $
  (16,005
  )
  
  
  
  $
  101,622See Notes to Consolidated Financial Statements.

Page 6 of 31


HILLS BANCORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)(Amounts
In Thousands)

Nine
  Months Ended 
  September 30,2005
  
  2004Cash Flows from Operating ActivitiesNet income
  
  $
  11,669
  
  $
  10,764Adjustments to reconcile net income to net cash provided by
operating
  activities:Depreciation
  
  
  1,883
  
  
  1,860Provision for loan losses
  
  
  998
  
  
  1,117Net loss on sale of investment securities
  
  
  234
  
  
  Compensation expensed through issuance of common stock
  
  
  163
  
  
  7Deferred income taxes
  
  
  (541
  )
  
  (600
  )Increase in accrued interest receivable
  
  
  (1,255
  )
  
  (284
  )Amortization of discount on investment securities, net
  
  
  600
  
  
  961Increase in other assets
  
  
  (633
  )
  
  (911
  )Increase in accrued interest and other liabilities
  
  
  1,507
  
  
  2,096Loans originated for sale
  
  
  (88,270
  )
  
  (119,003
  )Proceeds on sales of loans
  
  
  90,329
  
  
  118,770Net gain on sales of loans
  
  
  (857
  )
  
  (1,259
  )Net cash provided by operating activities
  
  $
  15,827
  
  $
  13,518Cash Flows from Investing ActivitiesProceeds from maturities of investment
securities:Available for sale
  
  $
  43,910
  
  $
  58,674Held to maturity
  
  
  4,685
  
  
  5,690Proceeds from sales of investment securities available for
sale
  
  
  10,465
  
  
  Purchases of investment securities:Available for sale
  
  
  (59,515
  )
  
  (46,188
  )Held to maturity
  
  
  
  
  
  (3,945
  )Loans made to customers, net of collections
  
  
  (102,864
  )
  
  (103,105
  )Purchases of property and equipment
  
  
  (1,794
  )
  
  (1,828
  )Investment in tax credit real estate, net
  
  
  320
  
  
  (5,720
  )Net cash used in investing activities
  
  $
  (104,793
  )
  $
  (96,422
  )Cash Flows from Financing ActivitiesNet increase in deposits
  
  $
  80,427
  
  $
  64,608Net (decrease) increase in short-term borrowings
  
  
  (13,596
  )
  
  6,744Borrowings from FHLB
  
  
  40,000
  
  
  Payments on FHLB borrowings
  
  
  (131
  )
  
  (32
  )Stock options exercised
  
  
  28
  
  
  Income tax benefits related to stock based compensation
  
  
  8
  
  
  Redemption of common stock
  
  
  (22
  )
  
  Purchase of treasury stock
  
  
  (42
  )
  
  Dividends paid
  
  
  (3,413
  )
  
  (3,184
  )Net cash provided by financing activities
  
  $
  103,259
  
  $
  68,136(Continued)Page 7 of 31


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

Nine
  Months Ended 
  September 30,2005
  
  2004Increase (decrease) in cash and cash equivalents
  
  $
  14,293
  
  $
  (14,768
  )Cash and cash equivalents:Beginning of year
  
  
  23,008
  
  
  37,427End of period
  
  $
  37,301
  
  $
  22,659Supplemental DisclosuresCash payments for:Interest paid to depositors
  
  $
  13,613
  
  $
  10,633Interest paid on other obligations
  
  
  7,706
  
  
  7,183Income taxes paid
  
  
  4,962
  
  
  4,139Noncash financing activities:Increase in maximum cash obligation related to ESOP
shares
  
  $
  3,623
  
  $
  1,141See Notes to Consolidated Financial Statements.Page 8 of 31


HILLS BANCORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)

Note
  1.
  Basis
  of PresentationThe accompanying unaudited consolidated financial
  statements have been prepared in accordance with accounting principles
  generally accepted in the United States of America for interim financial
  reporting and with instructions for Form 10-Q and Regulation S-X.  These financial statements include all
  adjustments (consisting of normal recurring accruals) which in the opinion of
  management are considered necessary for the fair presentation of the
  financial position and results of operations for the periods shown.  Certain prior year amounts may be
  reclassified to conform to the current year presentation.  The Company considers that it operates as
  one business segment, a commercial bank.Operating results for the nine-month period ended
  September 30, 2005 are not necessarily indicative of the results that may be
  expected for the fiscal year ending December 31, 2005.  For further information, refer to the
  consolidated financial statements and footnotes thereto included in the Form
  10-K Annual Report of Hills Bancorporation and subsidiary (the Company) for
  the year ended December 31, 2004 filed with the Securities Exchange
  Commission on March 10, 2005.Note
  2.
  Earnings
  Per ShareBasic earnings per share amounts are computed by
  dividing net income (the numerator) by the weighted average number of common
  shares outstanding (the denominator) during the period.  Diluted per share amounts assume the
  conversion, exercise or issuance of all potential common stock equivalents
  unless the effect is to reduce the loss or increase the income per common
  share from continuing operations.The computation of basic
  and diluted earnings per share for the periods presented is as follows:Three months ended 
  September 30,
  
  Nine months ended 
  September 30,2005
  
  2004
  
  2005
  
  2004Common shares
  outstanding at the beginning of the period
  
  
  4,549,656
  
  
  4,550,256
  
  
  4,549,656
  
  
  4,550,034Weighted average
  number of net shares issued (redemption)
  
  
  3,740
  
  
  0
  
  
  2,024
  
  
  178Weighted
  average shares outstanding (basic)
  
  
  4,553,396
  
  
  4,550,256
  
  
  4,551,680
  
  
  4,550,212Weighted average
  of potential dilutive shares attributable to stock options granted, computed
  under the treasury stock method
  
  
  19,682
  
  
  14,605
  
  
  20,844
  
  
  14,933Weighted
  average number of shares (diluted)
  
  
  4,573,078
  
  
  4,564,861
  
  
  4,572,524
  
  
  4,565,145Net income (In
  Thousands)
  
  $
  3,969
  
  $
  3,607
  
  $
  11,669
  
  $
  10,764Earnings per
  share:Basic
  
  $
  0.87
  
  $
  0.80
  
  $
  2.56
  
  $
  2.37Diluted
  
  $
  0.86
  
  $
  0.79
  
  $
  2.55
  
  $
  2.36Page 9 of 31


HILLS
BANCORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)(Unaudited)

Note 3.
  Recent Accounting PronouncementsIn December 2004, the
Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standard (SFAS) No. 123 (Revised 2004), Share-Based Payment. SFAS
No 123R is a revision of SFAS No. 123, Accounting for Stock-Based
Compensation and supersedes Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees and its related implementation guidance.
SFAS No. 123R focuses primarily on accounting for transactions in which an
entity obtains employee services through share-based payment transactions. SFAS
No 123R requires a public entity to measure the cost of employee services
received in exchange for the award of equity instruments based on the fair
value of the award at the date of grant. The cost will be recognized over the
period during which an employee is required to provide services in exchange for
the award. The date at which SFAS No. 123R is expected to apply to the Company
was recently extended from the beginning of the first interim or annual
reporting period which begins after June 15, 2005 to January 1, 2006.  While the Company cannot precisely determine
the impact on net earnings as a result of the adoption of SFAS No 123R,
estimated compensation expense can be found in the table below. The ultimate
amount of increased compensation expense will be dependent on whether the
Company adopts SFAS 123R using the modified prospective or retrospective
method, the number of option shares granted during the year, their timing and
vesting period, and the method used to calculate the fair value of the awards,
among other factors.

Three months ended 
  September 30,
  
  Nine months ended 
  September 30,2005
  
  2004
  
  2005
  
  2004Net income (In
  Thousands):As reported
  
  $
  3,969
  
  $
  3,607
  
  $
  11,669
  
  $
  10,764Deduct total
  stock-based employee compensation expense determined under fair value based
  method for all awards, net of related tax effects
  
  
  (7
  )
  
  (6
  )
  
  (21
  )
  
  (18
  )Pro forma
  
  $
  3,962
  
  $
  3,601
  
  $
  11,648
  
  $
  10,746Basic earnings
  per share:As reported
  
  $
  0.87
  
  $
  0.80
  
  $
  2.56
  
  $
  2.37Pro forma
  
  $
  0.87
  
  $
  0.80
  
  $
  2.56
  
  $
  2.37Diluted earnings
  per share:As reported
  
  $
  0.86
  
  $
  0.79
  
  $
  2.55
  
  $
  2.36Pro forma
  
  $
  0.86
  
  $
  0.79
  
  $
  2.55
  
  $
  2.36Page 10 of 31


HILLS
BANCORPORATION

Item 2.
  Managements Discussion and Analysis of Financial Condition
  And Results of OperationsThe following is managements discussion and analysis
of the financial condition and results of operations of Hills Bancorporation
(Hills Bancorporation or the Company) and its banking subsidiary Hills Bank
and Trust Company (the Bank) for the dates and periods indicated.  The discussion and analysis should be read
in conjunction with the consolidated financial statements and the accompanying
footnotes.

Special Note Regarding Forward Looking Statements

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

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


  The strength of the United
  States economy in general and the strength of the local economies in which
  the Company conducts its operations which may be less favorable than expected
  and may result in, among other things, a deterioration in the credit quality
  and value of the Companys assets.
  The effects of, and
  changes in, laws, regulations and policies affecting banking, securities,
  insurance and monetary and financial matters as well as any laws otherwise
  affecting the Company.
  The effects of changes in
  interest rates (including the effects of changes in the rate of prepayments
  of the Companys assets) and the policies of the Board of Governors of the
  Federal Reserve System.
  The ability of the Company
  to compete with other financial institutions as effectively as the Company
  currently intends due to increases in competitive pressures in the financial
  services sector.
  The ability of the Company
  to obtain new customers and to retain existing customers.
  The timely development and
  acceptance of products and services, including products and services offered
  through alternative delivery channels such as the Internet.
  Technological changes
  implemented by the Company and by other parties, including third party
  vendors, which may be more difficult or more expensive than anticipated or
  which may have unforeseen consequences to the Company and its customers.
  The ability of the Company
  to develop and maintain secure and reliable electronic systems.Page 11 of 31


HILLS
BANCORPORATION

Item 2.
  Managements Discussion and Analysis of Financial Condition
  And Results of Operations (continued)
  The ability of the Company
  to retain key executives and employees and the difficulty that the Company
  may experience in replacing key executives and employees in an effective
  manner.
  Consumer spending and
  saving habits which may change in a manner that affects the Companys
  business adversely.
  The economic impact of
  terrorist attacks and military actions.
  Business combinations and
  the integration of acquired businesses and assets which may be more difficult
  or expensive than expected.
  The costs, effects and
  outcomes of existing or future litigation.
  Changes in accounting
  policies and practices, as may be adopted by state and federal regulatory
  agencies and the Financial Accounting Standards Board.
  The ability of the Company
  to manage the risks associated with the foregoing as successfully as
  anticipated.These risks and
uncertainties should be considered in evaluating forward-looking statements and
undue reliance should not be placed on such statements. Additional information
concerning the Company and its business, including other factors that could
materially affect the Companys financial results, is included in the Companys
filings with the Securities and Exchange Commission.

Critical
Accounting Policy

The Companys financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America. The
financial information contained within these statements is, to a significant
extent, financial information that is based on approximate measures of the
financial effects of transactions and events that have already occurred. Based
on its consideration of accounting policies that involve the most complex and
subjective decisions and assessments, management has identified its most
critical accounting policies to be those which are related to the allowance for
loan losses. The Companys allowance for loan loss methodology incorporates a
variety of risk considerations, both quantitative and qualitative in
establishing an allowance for loan loss that management believes is appropriate
at each reporting date. Quantitative factors include the Companys historical
loss experience, delinquency and charge-off trends, collateral values, changes
in non-performing loans, and other factors. Quantitative factors also
incorporate known information about individual loans, including borrowers
sensitivity to interest rate movements. Qualitative factors include the general
economic environment in the Companys markets, including economic conditions
throughout the Midwest and in particular, the state of certain industries. Size
and complexity of individual loans in relation to loan structure, existing loan
policies and pace of portfolio growth are other qualitative factors that are
considered in the methodology. As the Company adds new products and increases
the complexity of its loan portfolio, it will enhance its methodology
accordingly. This discussion and analysis should be read in conjunction with
the Companys financial statements and the accompanying notes presented
elsewhere herein, as well as the Managements Discussion and Analysis of
Financial Condition and Results of Operation that is included. Although
management believes the levels of the allowance as of September 30, 2005 and
December 31, 2004 were adequate to absorb probable losses inherent in the loan
portfolio, a decline in local economic conditions, or other factors, could
result in increasing losses that cannot be reasonably predicted at this time.

Page 12 of 31


HILLS
BANCORPORATION

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

The Company is a holding
company engaged through its subsidiary in the business of commercial banking.
The Companys subsidiary is Hills Bank and Trust Company, Hills, Iowa (the
Bank), which is wholly-owned. The Bank was formed in Hills, Iowa in 1904. The
Bank is a full-service commercial bank extending its services to individuals,
businesses, governmental units and institutional customers primarily in the
communities of Hills, Iowa City, Coralville, North Liberty, Mount Vernon,
Kalona, Cedar Rapids and Marion, Iowa. On June 28, 2005, the Bank opened a
limited purpose office at the Oaknoll Retirement Residence in Iowa City, Iowa
for the exclusive use of Oaknoll residents and staff (the Oaknoll Office).
The Oaknoll Office is staffed by existing Bank personnel and is open on the
second and fourth Tuesday of each month. The Oaknoll Office opens deposit
accounts and provides deposit services, trust and investment services and check
cashing. The Oaknoll Office does not perform loan origination activities. At
September 30, 2005 the Bank had twelve full service locations.

Net income for the
nine-month period ended September 30, 2005 was $11.67 million compared to
$10.76 million for the same nine months of 2004. The increase in 2005 of
$905,000 is an 8.41% increase over the 2004 amount. The factors that resulted
in this increase in net income compared to the comparable period in 2004 are
discussed below in the Net Income Overview section. Return on average equity
was 12.79% and return on average assets was 1.16% for the nine months of 2005,
compared to 12.72% and 1.18%, respectively for the same period in 2004.
Dividends of $.75 per share were paid in January of 2005 to 1,485 shareholders.
The 2005 dividend was a 7.14% increase over the prior years dividend of $.70.

The Banks net interest
income is the largest component of revenue and it is primarily a function of
the average earnings assets and the net interest margin percentage. For the
nine-month period ended September 30, 2005, the average earning assets grew by
$125.7 million from $1.143 billion to $1.268 billion, which was the major
factor in a $2.25 million increase in net interest income. The Bank achieved a
net interest margin of 3.58% compared to 3.69% in 2004.

Highlights noted on the
balance sheet as of September 30, 2005 for the Company include the following:


  Net loans are $1.100
  billion.
  Loans grew by $100.66
  million and deposits grew by $80.43 million since December 31, 2004.A detailed discussion of the
financial condition and results of operations follows this overview.

Financial
Condition

The asset growth of $115.0
million included a net loan increase of $100.66 million and an increase in
federal funds sold of $5.47 million. Since December 31, 2004, the federal funds
target rate has been raised by the Federal Reserve Open Market Committee from
2.25% to 3.75% with six increases of .25% each or a total of 1.50%. The upward
movement of the federal funds target rate started on June 30, 2004 when the
rate was 1.00% and created opportunities for consumers to place funds with
institutions offering higher interest rates. Interest rates on loans are
generally affected by these increases since interest rates determined by the
U.S. Treasury market normally increase when the Federal Reserve Board raises
the federal funds target rate. The Bank prices its real estate loans based on
the U.S. Treasury indexes. Loans secured by real estate accounted for $82.42
million or 81.88% of the increase in loans. Increases in interest rates may at
some point reduce loan demand and slow the economy, but at the current interest
rate levels, demand for loans remains good. The overall economy in the
Companys principal place of business, Johnson and Linn Counties, remains good
with unemployment levels that remain low.

Page 13 of 31


HILLS
BANCORPORATION

Item 2.
  Managements Discussion and Analysis of Financial Condition
  And Results of Operations (continued)The tables below set forth the composition of the loan
portfolio as of September 30, 2005 and December 31, 2004 (dollars in
thousands), along with changes in the allowance for loan losses and
non-performing loan information:

September 30, 2005
  
  December 31, 2004Amount
  
  Percent
  
  Amount
  
  Percent(Amounts In Thousands)
  
  (Amounts In Thousands)Agricultural
  
  $
  40,927
  
  
  3.67
  %
  $
  39,116
  
  
  3.87
  %Commercial and financial
  
  
  86,535
  
  
  7.76
  
  
  68,214
  
  
  6.74Real estate:Construction
  
  
  72,730
  
  
  6.52
  
  
  72,388
  
  
  7.15Mortgage
  
  
  882,273
  
  
  79.16
  
  
  800,197
  
  
  79.07Loans to individuals
  
  
  32,242
  
  
  2.89
  
  
  32,106
  
  
  3.17$
  1,114,707
  
  
  100.00
  %
  $
  1,012,021
  
  
  100.00
  %Less allowance for loan
  losses
  
  
  14,610
  
  
  
  
  
  13,790$
  1,100,097
  
  
  
  
  $
  998,231The Bank has an established formal loan origination
policy. In general, the loan origination policy attempts to reduce the risk of
credit loss to the Bank by requiring that, among other things, maintenance of
minimum loan to value ratios, evidence of appropriate levels of insurance
carried by borrowers and documentation of appropriate types and amounts of
collateral and sources of expected payment.

Changes in the allowance for loan losses for the
periods shown in the following table were as follows:

Three Months Ended
  September 30,
  
  Nine Months Ended
  September 30,2005
  
  2004
  
  2005
  
  2004(Amounts In Thousands)
  
  (Amounts In Thousands)Balance, beginning of
  period
  
  $
  14,370
  
  $
  13,060
  
  $
  13,790
  
  $
  12,585Provision charged to expenses
  
  
  239
  
  
  602
  
  
  998
  
  
  1,117Recoveries
  
  
  447
  
  
  299
  
  
  1,031
  
  
  858Loans charged off
  
  
  (446
  )
  
  (291
  )
  
  (1,209
  )
  
  (890
  )Balance, end of period
  
  $
  14,610
  
  $
  13,670
  
  $
  14,610
  
  $
  13,670Page 14 of 31


HILLS
BANCORPORATION

Item 2.
  Managements Discussion and Analysis of Financial Condition
  And Results of Operations (continued)Non-performing loan information at September 30, 2005
and December 31, 2004, was as follows:

September 30, 2005
  
  December 31, 2004(Amounts in thousands)Impaired loans,
  non-accrual
  
  $
  588
  
  $
  808Loans past due ninety days
  or more and still accruing
  
  
  3,783
  
  
  2,313Restructured loans
  
  
  
  
  
  As discussed below, deposit growth of $80.43 million
and an increase of $40 million in advances from the Federal Home Loan Bank
(FHLB), which more than offset a $13.6 million reduction in short-term
borrowings, generated funds in excess of those required for loan growth. Such
excess funds were invested on a temporary basis in federal funds sold, which
increased from zero at December 31, 2004 to $5.47 million at September 30,
2005. It is expected that some or all of such excess funds will be used to fund
loan growth in the fourth quarter of 2005.

The estimated fair value of the investment securities
held by the Company decreased by $5.3 million, primarily as a result of the
maturity in June of 2005 of a short-term $3.9 million tax-exempt bond that was
not replaced. As a result of increasing interest rates, the market value of
securities available for sale was $1.645 million less than the amortized cost
of such securities at September 30, 2005, which was a decline from the $915,000
by which the market value of securities available for sale exceeded the
amortized cost of such securities at December 31, 2004. The carrying values of
investment securities for September 30, 2005 and December 31, 2004 are
summarized in the following table (dollars in thousands):



September 30, 2005
  
  December 31, 2004Amount
  
  Percent
  
  Amount
  
  PercentSecurities available for saleU.S. Government agencies and corporations
  
  $
  124,762
  
  
  61.31
  %
  $
  133,929
  
  
  65.61
  %State and political subdivisions
  
  
  78,724
  
  
  38.69
  
  
  70,194
  
  
  34.39Total securities available for sale
  
  $
  203,486
  
  
  100.00
  %
  $
  204,123
  
  
  100.00
  %Securities held to maturityState and political subdivisions
  
  $
  315
  
  
  100.00
  %
  $
  5,000
  
  
  100.00
  %Deposit growth was $80.43
million in the first nine months of 2005 and included $34.00 million in
additional retail deposits and $46.43 million in additional commercial and
municipal deposit increases. The borrowings from the Federal Home Loan Bank
(FHLB) were increased in May, 2005 by $40 million as the Bank decided to borrow
longer-term funds. The borrowings have an interest rate of 3.70% and are fixed
for five years. Increased deposits and FHLB advances which were in excess of
funds needed for loan growth were used to reduce federal funds borrowed from
$19.2 million at December 31, 2004 to zero and to invest on a temporary basis in
$5.473 million of federal funds sold. The reduction in short-term borrowings
resulted from a combination of the reduction in federal funds borrowed and an
increase in repurchase agreements to $24.4 million at September 30, 2004 from
$18.74 million at December 31, 2004. In the opinion of the Companys
management, the Company continues to have sufficient liquidity resources
available to fund expected additional loan growth.

Page 15 of 31


HILLS
BANCORPORATION

Item 2.
  Managements Discussion and Analysis of Financial Condition
  And Results of Operations (continued)In March of 2005, the Bank
relocated its downtown Iowa City office to the Old Capitol Town Center. The
relocation doubled the size of the Banks downtown presence in Iowa City to
5,800 square feet. It is expected that the expanded space will assist in the
growth of both retail and commercial deposits and will permit the Bank to offer
real estate and commercial loan products at the downtown location.

Dividends
and Equity

In January 2005, Hills Bancorporation paid a dividend
of $3,413,000 or $.75 per share, a 7.14% increase from the $.70 per share paid
in January 2004. After payment of the dividend and the adjustment for
accumulated other comprehensive income, stockholders equity as of September 30,
2005 totaled $107.0 million. Under risk-based capital rules, the total amount
of risk based capital as of September 30, 2005, was 13.80% of risk-adjusted
assets, and is substantially in excess of the required minimum of 8.00%.

Discussion of operations for the
nine months ended September 30, 2005 and 2004.

Net Income Overview

Net income increased
$905,000 or 8.41% for the nine months ended September 30, 2005 compared to the
first nine months of 2004. Total net income was $11,669,000 in 2005 and
$10,764,000 in the comparable period in 2004. The changes in net income in 2005
from the first nine months of 2004 are as follows and are discussed in detail
in the following review of operations:


  Net interest income
  increased by $2,249,000.
  The provision for loan
  losses decreased by $119,000.
  Other income increased by
  $74,000.
  Other expenses increased
  by $1,239,000.
  Income taxes increased by
  $298,000.For the nine-month periods
ended September 30, 2005 and 2004, basic earnings per share were $2.56 and
$2.37. Diluted earnings were $2.55 for the nine months ended September 30, 2005
compared to $2.36 for the same period in 2004.

Quarterly fluctuations in
the Companys net income continue to be driven primarily by three important
factors. The first important factor is net interest margin. Net interest income
of $32.7 million for the first nine months of 2005 was derived from the
Companys $1.268 billion of average earning assets and its net interest margin
of 3.58%. Average earning assets in the nine months ending September 30, 2004
were $1.143 billion and the net interest margin was 3.69%. The margin
compression was the result of the continued flattening of the yield curve and
pricing pressure on short-term deposits. The importance of net interest margin
is illustrated by the fact that a decrease in the net interest margin of 10
basis points to 3.48% would have resulted approximately in a $951,000 decrease
in income before income taxes in the nine month period ending September 30,
2005. Similarly, an increase in the net interest margin of 10 basis points to
3.68% would have increased income before income taxes by $951,000 for the nine
month period ended September 30, 2005. In 2005, despite the decline in the net
interest margin, net interest income for the Company increased due to the
additional volume of earning assets over the similar nine month period in 2004.

The second significant
factor affecting the Companys net income is the provision for loan losses. The
majority of the Companys interest-earning assets are in loans outstanding,
which amounted to more than $1.100 billion at September 30, 2005. The provision
adjustment is computed on a quarterly basis and is a result of managements
determination of the quality of the loan portfolio. The provision reflects a
number of factors, including the size of the loan portfolio, loan
concentrations, the level of impaired loans (which are non-accrual) and loan
past due ninety days or more. An increase in loans and problem loans results in
a higher allocation to the provision for loan losses. The provision for loan
losses was $998,000 in 2005 compared to $1,117,000 in 2004.

Page 16 of 31


HILLS
BANCORPORATION

Item 2.
  Managements Discussion and Analysis of Financial Condition
  And Results of Operations (continued)Discussion of operations for the
nine months ended September 30, 2005 and 2004 (continued).

The amount of mortgage loans
sold on the secondary market is the third factor that can cause fluctuations in
net income. For the nine months ended September 30, 2005 and 2004, the net gain
on sale of loans was $857,000 and $1,259,000, respectively. The sale of loans
is influenced by the real estate market and interest rates. As a result in
2003, when rates were at their lowest level in recent years, the volume of
loans sold was high. The net gain on sale of loans for the nine months ended
September 30, 2003 was $3,972,000. Due primarily to higher rates in 2004 and
2005, there has been a continuing decline in mortgage activity volume from the
levels seen in 2003.

Net Interest Income

Net interest income is the
excess of the interest and fees received on interest-earning bearing assets
over the interest expense of the interest-bearing liabilities. The factors that
have the greatest impact on net interest income are the volume of average
earning assets and the net interest margin. The net interest margin for the
first nine months of 2005 was 3.58% compared to 3.69% in 2004 for the same
period. The measure is shown on a tax-equivalent basis using a tax rate of 35%
to make the interest earned on taxable and non-taxable assets more comparable.
Included in the volume changes column in the table that follows is the time
variance between 2005 and 2004 since the nine months ended September 30, 2004
had one additional day. The changes in average balances and average rates and
the effect on the net interest income on a tax equivalent basis for the nine
months ended in 2005 compared to the comparable period in 2004 are shown in the
following table:

Increase (Decrease) in Net Interest IncomeChange in
  Average Balance
  
  Change in
  Average RateVolume Changes
  
  Rate Changes
  
  Net Change(Amounts in Thousands)Interest income:Loans, net
  
  $
  124,193
  
  
  0.09
  %
  $
  5,723
  
  $
  671
  
  $
  6,394Taxable
  securities
  
  
  (8,951
  )
  
  (0.17
  )
  
  (295
  )
  
  (125
  )
  
  (420
  )Nontaxable
  securities
  
  
  5,648
  
  
  (0.01
  )
  
  228
  
  
  (8
  )
  
  220Federal funds
  sold
  
  
  4,842
  
  
  2.37
  
  
  29
  
  
  154
  
  
  183$
  125,732
  
  
  
  
  $
  5,685
  
  $
  692
  
  $
  6,377Interest
  expense:Interest-bearing
  demand deposits
  
  $
  3,140
  
  
  0.15
  
  $
  (27
  )
  $
  (159
  )
  $
  (186
  )Savings deposits
  
  
  25,228
  
  
  0.63
  
  
  (127
  )
  
  (1,221
  )
  
  (1,348
  )Time deposits
  
  
  67,629
  
  
  0.14
  
  
  (1,497
  )
  
  (491
  )
  
  (1,988
  )Short-term
  borrowings
  
  
  (11,531
  )
  
  0.90
  
  
  130
  
  
  (207
  )
  
  (77
  )FHLB borrowings
  
  
  16,836
  
  
  (0.17
  )
  
  (686
  )
  
  240
  
  
  (446
  )$
  101,302
  
  
  
  
  $
  (2,207
  )
  $
  (1,838
  )
  
  (4,045
  )Change in net
  interest income
  
  
  
  
  
  
  
  $
  3,478
  
  $
  (1,146
  )
  $
  2,332Page 17 of 31


HILLS
BANCORPORATION

Item 2.
  Managements Discussion and Analysis of Financial Condition
  And Results of Operations (continued)Discussion of operations for the
nine months ended September 30, 2005 and 2004 (continued).

A summary of interest spread
and margin information for the nine-month periods ended September 30 is as
follows:

(Tax
  Equivalent Basis)
  
  2005
  
  2004Yield on average
  interest-earning assets
  
  
  5.85
  %
  
  5.75
  %Rate on average
  interest-bearing liabilities
  
  
  2.68
  
  
  2.40Net interest spread
  
  
  3.17
  %
  
  3.35
  %Effect of
  noninterest-bearing funds
  
  
  0.41
  
  
  0.34Net interest
  margin (tax equivalent interest income divided by average interest-earning
  assets)
  
  
  3.58
  %
  
  3.69
  %Provision for Loan Losses

The
provision for loan losses was $998,000 in 2005 compared to $1,117,000 in 2004.
The provision adjustment is computed on a quarterly basis and is a result of
managements determination of the quality of the loan portfolio. The provision
reflects a number of factors, including the size of the loan portfolio, loan
concentrations, the level of impaired loans (which are non-accrual) and loans
past due ninety days or more. The amount of problem or watch loans considered
in the reserve computation increased approximately $775,000 or 5.95% from the
end of 2004 to September 30, 2005. For the similar period one year ago from the
end of 2003 to September 30, 2004, the amount of problem or watch loans
considered in the reserve computation increased $1,026,000 or 8.63%. The methodology
used in 2005 is consistent with 2004. The larger increase in 2004 was
reflective of the reserve at that point in time and not any group or types of
loans for which estimated losses were higher than expected. Overall, the volume
of loans outstanding continues to have significant increases with loan growth
of $102.9 million and $103.2 million for the nine months ended September 30,
2005 and 2004, respectively. The allowance for loan losses balance is also
affected by the charge-offs, net of recoveries, for the periods presented. For
the nine months ended September 30, 2005 and 2004 net charge-off loans were
$178,000 and $32,000, respectively.

The allowance for loan
losses totaled $14,610,000 at September 30, 2005 compared to $13,790,000 at
December 31, 2004. The allowance represented 1.31% and 1.36% of outstanding
loans at September 30, 2005 and December 31, 2004, respectively. The allowance
was based on managements consideration of a number of factors, including loan
concentrations, loans with higher credit risks (primarily agriculture loans and
spec real estate construction) and overall increases in net loans outstanding.

Net Gain on Sale of Loans

Net gain on sale of loans
for the nine months ended September 30, 2005 was $857,000 compared to $1,259,000
for the comparable period ended September 30, 2004. The number of loans sold in
2005 was approximately 70% of the volume in 2004. The decrease in the volume of
loans sold, given the current interest rate environment, was not expected
because many consumers had taken advantage of lower interest rates in 2003 and
2004 to refinance loans.

Page 18 of 31


HILLS
BANCORPORATION

Item 2.
  Managements Discussion and Analysis of Financial Condition
  And Results of Operations (continued)Discussion of operations for the
nine months ended September 30, 2005 and 2004 (continued).

Other Income

Other income, excluding the
net gain on sale of loans discussed above, increased by $476,000. The
significant items accounting for the net change were a $206,000 increase in trust
fees, $415,000 in additional service charges and fees, an increase in rental
revenue on tax credit real estate of $109,000 and investment securities losses
of $234,000. The losses were recorded on $10.5 million of U.S. Agencies
securities and after replacement purchases the average yield on similar
securities increased from 2.71% to 3.77%. No investment losses were taken in
2004. The trust fees increase is due primarily to a 10.23% increase in assets
under management in the last twelve months with ending assets at September 30,
2005 of $743.8 million. The increase in service charges is due to volume
increases of debit card interchange fees which increased $293,000 and credit
card fees on merchant accounts that had an increase of $122,000. The rental revenue
increase of $109,000 is due to the additional property added in January 2004
being fully rented as of September 30, 2005.

Other Expenses

Other expenses increased
$1,239,000 in 2005 to $24,268,000 from the same period in 2004. This increase
of 5.38% resulted from the combination of a number of factors. One factor was
an increase of $255,000 in salaries and benefits. Direct salary expense was up
$162,000, or 1.74% from the same period ended September 30, 2004. A net
increase of three full-time equivalents occurred during the period from
September 30, 2004 to September 30, 2005. Total full-time equivalents at
September 30, 2005 were 364. Partially offsetting the increase in direct salary
expense was a reduction in medical expense for employees health insurance of
$105,000 due primarily to a change in the Companys medical plan from a
self-insured plan prior to 2005 to a full-premium plan in 2005. Another
component of salaries and employee benefits expense is compensation expense
related to the officers deferred compensation plan, which increased by
$238,000. This increase is primarily the result of an increase in the appraised
value of the Companys common stock. Beginning effective June 30, 2005, as a
result of the Companys program to repurchase up to a total of 750,000 shares
of the Companys common stock the Company is now obtaining a quarterly
independent appraisal of the shares of stock. The final appraisal for each
quarter will be completed approximately forty days after each quarter end.
Compensation expense related to the officers deferred compensation plan at
September 30, 2005, was based on the appraised value at June 30, 2005, which
was $45.00 per share compared to the appraised value of $37.00 per share which
was used to compute such compensation expense at December 30, 2004.

Occupancy expense increased
$32,000 with rent expense higher by $27,000 due to the new office location in
the Old Capitol Town Center which opened in 2005. In 2005, furniture and
equipment expense included depreciation expense of $1,445,000 and $732,000 in
equipment and software maintenance contracts. These expenses one year ago were
$1,442,000 for depreciation and $579,000 for the maintenance contracts. The
increase in 2005 is due to more equipment and software purchases in 2004 and
2005 and the related five year maintenance contracts.

Advertising and business development expense increased
$41,000 at September 30, 2005 compared to the same period in 2004. Total
expenses for 2005 included a $50,000 contribution to the American Red Cross to
assist the victims of Hurricane Katrina and to provide assistance to the
victims of other disasters. Hills Bank employees donated an additional $8,730
in personal contributions.

Page 19 of 31


HILLS
BANCORPORATION

Item
  2.
  Managements
  Discussion and Analysis of Financial Condition And Results of Operations (continued)Discussion of operations for the nine months ended September
30, 2005 and 2004.

Outside services increased $433,000 in 2005 to
$3,528,000 as of September 30, 2005 compared to the same period in 2004.
Outside services include professional fees, courier services and ATM fees and
processing charges for the merchant credit card program, retail credit cards
and other data processing services.
Professional fees increased $234,000 from 2004 to a total of $1,120,000
as of September 30, 2005.  Services
related to Sarbanes-Oxley compliance account for approximately $80,000 of the
increase.  Outsourcing of a portion of
the internal audit work in 2005 accounts for an additional $40,000 and
consulting fees for a new fee income strategy were $140,000.  Processing charges for credit card,
merchants card and debit card transactions increased $216,000 to $1,079,000 in
2005 due to increased volume which resulted in the $415,000 increase in fee
income discussed above under other income.
The increase in the rental expenses on tax credit real estate compared
to the same nine months of 2004 was $595,000 to $715,000.  The change is due to the new property added
in January, 2004 and the property being fully rented in 2005.

Income Taxes

Federal and state income tax expenses were $5,200,000
and $4,902,000 for the nine months ended September 30, 2005 and 2004,
respectively.  Income taxes as a
percentage of income before taxes were 30.83% in 2005 and 31.29% in 2004.  The dollar amount increase of $298,000 is
primarily due to an increase of $1,203,000 in income before income taxes for
the nine months ended September 30, 2005.
Additional nontaxable income of $142,000 in 2005 reduces the expected
increase in income taxes by approximately $50,000 and such expected increase in
income taxes is further reduced by the amount of tax credits in 2005 which were
$506,000, compared to $396,000 in 2004.

Page 20 of 31


HILLS
BANCORPORATION

Item
  2.
  Managements
  Discussion and Analysis of Financial Condition And Results of Operations (continued)Discussion of operations for the three months ended September
30, 2005 and 2004.

Net
Income

Net income increased to $3,969,000 in the three months
ended September 30, 2005 from $3,607,000 in the three months ended September
30, 2004.  Return on average equity was
12.57% and return on average assets was 1.14% for the three months of 2005,
compared to 12.43% and 1.15%, respectively, for the same period in 2004.  Net interest income increased by $487,000
and there was a $363,000 decrease in the loan loss provision.  Other income increased for the quarter by
$358,000 and other expenses increased $706,000.

Net Interest Income

Net interest income increased for the three-month
period ended September 30, 2005 by $487,000 from the similar period in
2004.  The net interest margin in 2005
was 3.49% compared to 3.73% in 2004.
The decrease in net interest margin is primarily due to an increase in
rates on core deposit accounts, including insured money market accounts and
short-term certificates of deposits.
These rates were increased due to the upward movement of the federal
fund rates.  The increase in the volume
of interest earning assets accounted for a significant portion of the net
interest income improvement.  Net
interest income changes on a tax-equivalent basis for the three months ended
September 30, 2005 and 2004 were as follows:

Change in
  Average Balance
  
  Change in
  Average Rate
  
  Increase (Decrease) in Net Interest IncomeVolume Changes
  
  Rate Changes
  
  Net Change(Amounts in Thousands)Interest income:Loans, net
  
  $
  122,561
  
  
  0.19
  %
  $
  1,932
  
  $
  518
  
  $
  2,450Taxable
  securitities
  
  
  (4,380
  )
  
  (0.17
  )
  
  (41
  )
  
  (58
  )
  
  (99
  )Nontaxable
  securities
  
  
  5,323
  
  
  0.09
  
  
  71
  
  
  17
  
  
  88Federal funds
  sold
  
  
  11,641
  
  
  1.49
  
  
  57
  
  
  44
  
  
  101$
  135,145



  
  $
  2,019
  
  $
  521
  
  $
  2,540Interest
  expense:Interest-bearing
  demand deposits
  
  $
  1,165
  
  
  0.24
  
  $
  (7
  )
  $
  (85
  )
  $
  (92
  )Savings deposits
  
  
  13,359
  
  
  0.77
  
  
  (27
  )
  
  (497
  )
  
  (524
  )Time deposits
  
  
  85,788
  
  
  0.37
  
  
  (628
  )
  
  (452
  )
  
  (1,080
  )Short-term
  borrowings
  
  
  (25,311
  )
  
  1.06
  
  
  111
  
  
  (72
  )
  
  39FHLB borrowings
  
  
  39,914
  
  
  (0.32
  )
  
  (546
  )
  
  168
  
  
  (378
  )$
  114,915
  
  
  
  
  $
  (1,097
  )
  $
  (938
  )
  $
  (2,035
  )Change in net
  interest income
  
  
  
  
  
  
  
  $
  922
  
  $
  (417
  )
  $
  505Page 21 of 31


HILLS
BANCORPORATION

Item
  2.
  Managements
  Discussion and Analysis of Financial Condition And Results of Operations (continued)Discussion
of operations for the three months ended September 30, 2005 and 2004
(continued)

A summary of net interest
spread and margin information for the three-month periods ended September 30 is
as follows:

(Tax Equivalent Basis)
  
  2005
  
  2004Yield on average
  interest-earning assets
  
  
  5.91
  %
  
  5.74
  %Rate on average
  interest-bearing liabilities
  
  
  2.84
  
  
  2.37Net interest
  spread
  
  
  3.07
  %
  
  3.37
  %Effect of
  noninterest-bearing funds
  
  
  0.42
  
  
  0.36Net interest
  margin (tax equivalent interest income divided by average interest-earning
  assets)
  
  
  3.49
  %
  
  3.73
  %Provision
for Loan Losses

The provision for loan losses was $239,000 for the
quarter ended September 30, 2005 compared to $602,000 in 2004.  The provision for loan losses was decreased
due to managements analysis of the outstanding loans at September 30, 2005,
which indicated the level of problem or watch loans for the quarter considered
in the reserve computation had increased only $232,000 since June 30, 2005 and
since net recoveries of loans were $1,000, a quarterly provision of $239,000
was required.  In 2004, the amount of
problem or watch loans used in the reserve computation for the quarter ended
September 30, 2004 was $584,000 higher than at June 30, 2004 and net recoveries
were $8,000.

The allowance for loan losses balance is also affected
by the charge-offs, net of recoveries, for the periods presented.  For the three months ended September 30,
2005 and 2004, recoveries were $447,000 and $299,000, respectively; charge-offs
were $446,000 in 2005 and $291,000 in 2004.
The allowance for loan losses totaled $14,610,000 at September 30, 2005
compared to $13,670,000 at September 30, 2004.
The allowance represented 1.31% and 1.39% of outstanding loans at
September 30, 2005 and September 30, 2004, respectively.

Other Income

Total other income was $3,409,000 and $3,051,000 for
the three months ended September 30, 2005 and 2004.  The Trust Department fees for 2005 were $88,000 higher than 2004
due to the growth of assets under management.
Other income items for debit card fees and credit card merchant fees
were up $133,000 for the quarter ended September 30, 2005, as compared to the
same quarter of 2004.

Other Expenses

Total expenses for the 2005 quarter compared to the
2004 quarter increased $706,000 to $8,501,000.
Salaries and employee benefits increased $180,000 for the quarter ended
September 30, 2005 compared to 2004.
Direct salary expense was $125,000 higher.  The increase of $238,000 in compensation expense related to the
officers deferred compensation plan, which is explained above in the
discussion of operations for the nine months ended September 30, 2005, occurred
in the quarter ended September 30.
These increases were partially offset by medical insurance savings of
$164,000 for the quarter ended September 30, 2005, resulting from the change in
the Companys medical plan from a self-insured plan prior to 2005 to a
full-premium plan in 2005.

Page 22 of 31


HILLS
BANCORPORATION

Item
  2.
  Managements
  Discussion and Analysis of Financial Condition And Results of Operations (continued)Discussion of operations for the three months ended September
30, 2005 and 2004 (continued).

Outside services items that increased in the three
months ended September 30, 2005 compared to 2004 included $40,000 for
outsourcing internal audit work and approximately $40,000 for Sarbanes-Oxley
compliance work.  In addition, the
$140,000 cost of consulting work for a new fee income strategy project was
incurred in the third quarter of 2005.
Maintenance on equipment and computer software included in furniture and
equipment expense increased $64,000 from 2004 for the quarter ended September
30, 2005 to a total of $262,000.  The
increase is due to purchases made the last half of 2004 and the resulting five
year maintenance contracts.  As a result
of an increase in the volume of activity, credit card and debit card processing
charges increased $52,000 and these expenses are included in outside services expense.

Income Taxes

Income tax expense as a percentage of income before
taxes decreased from 31.20% in 2004 to 30.91% in 2005.  Income tax expense is $140,000 more in 2005
compared to 2004 primarily due to a $502,000 increase in income before income
taxes.  The increase was primarily
offset by an additional $37,000 in tax credits in 2005 compared to 2004 as the
new tax credit real estate investment in 2004 became fully leased.

Liquidity

The Company actively monitors and manages its
liquidity position with the objective of maintaining sufficient cash flows to
fund operations, meet client commitments, take advantage of market
opportunities and provide a margin against unforeseeable liquidity needs.  Federal funds sold and investment securities
available for sale are readily marketable assets.  Maturities of all investment securities are managed to meet the
Companys normal liquidity needs, to respond to market changes or to adjust the
Companys interest rate risk position.
Federal funds sold and investment securities available for sale
comprised 14.87% of the Companys total assets at September 30, 2005, compared
to 15.82% at December 31, 2004.

The Company has historically maintained a stable
deposit base and a relatively low level of large deposits, which has mitigated
the volatility in the Companys liquidity position.  As of September 30, 2005, the Company had borrowed $207.4 million
from the Federal Home Loan Bank (FHLB) of Des Moines.  This includes a new advance in May 2005 for
$40 million.  These advances were used
as a means of providing both long and short-term, fixed-rate funding for
certain assets and for managing interest rate risk.  The Company had additional borrowing capacity available from the
FHLB of approximately $206 million at September 30, 2005.

As additional sources of liquidity, the Company has
the ability to borrow up to $10 million from the Federal Reserve Bank of
Chicago, and has lines of credit with two banks totaling $113 million. Those
two lines of credit require the pledging of investment securities when drawn
upon.  The combination of high levels of
potentially liquid assets, low dependence on volatile liabilities and
additional borrowing capacity provided sources of liquidity for the Company
which management considered sufficient at September 30, 2005.

Page 23 of 31


HILLS
BANCORPORATION

Item
  3.
  Quantitative and Qualitative Disclosures About Market RiskMarket
Risk Management

The Companys primary market risk exposure is to
changes in interest rates.  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.
Conversely, 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 and rate adjustments of its interest-earning assets and
interest-bearing liabilities over given periods of time.

The Company does not maintain a trading account for
any class of financial instrument nor does it engage in hedging activities
through the purchase of derivative instruments.  The Company has no material exposure to foreign currency exchange
rate risk or commodity price risk.

Asset/Liability
Management

The Bank maintains an asset/liability committee, which
meets at least quarterly to review the Banks interest rate sensitivity
position and to review various strategies as to interest rate risk
management.  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.

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 passbook or transaction deposit accounts, which are less
sensitive to changes in interest rates and can be re-priced rapidly.

Net interest income should decline as interest rates
increase, while net interest income should increase as interest rates
decline.  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.

Page 24 of 31


HILLS
BANCORPORATION

Item 4.
  Controls
  and ProceduresThe Company carried out an evaluation, under the
supervision and with the participation of the Companys management, including
the Companys Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Companys disclosure controls
and procedures as defined in Exchange Act of 1934 Rule 13a-15(f).  Based upon that evaluation, the Companys
Chief Executive Officer and Chief Financial Officer concluded that the
Companys disclosure controls and procedures are effective in recording,
processing, summarizing and reporting, on a timely basis, information required
to be disclosed by the Company in the reports it files with the Securities and
Exchange Commission.  There have been no
changes in the Companys internal controls over financial reporting during the
first nine months of 2005 that have materially affected, or are reasonably
likely to materially affect, the Companys internal controls over financial
reporting.

page 25 of 31


HILLS
BANCORPORATION
PART II - OTHER INFORMATION

Item 1.
  Legal
ProceedingsNo material
  legal proceedings are pending.Item 2.
  Unregistered
Sales of Equity Securities and Use of ProceedsOn July 26,
2005, the Companys Board of Directors authorized a program to repurchase up to
a total of 750,000 shares of the Companys common stock. This authorization
will expire on December 31, 2009. The Company expects the purchases to be made
from time to time in private transactions at a price equal to the most recent
quarterly independent appraisal of the shares of the Companys common stock and
with the Board reviewing the overall results of the program on a quarterly
basis. The amount and timing of stock repurchases will be based on various
factors, such as the Boards assessment of the Companys capital structure and
liquidity, the amount of interest shown by shareholders in selling shares of
stock to the Company at their appraised value, and applicable regulatory, legal
and accounting factors.

The following
table sets forth information about the Companys stock purchases for the three
months ended September 30, 2005:

Period in
  2005
  
  Total
  number 
  of shares
  purchased (1)
  
  Average 
  price paid 
  per 
  share
  
  Total
  number 
  of shares purchased as part of 
  publicly announced 
  plans
  or programs
  
  Maximum 
  number of 
  shares that 
  may yet be 
  purchased 
  under the 
  plans 
  or programsJuly 1 to
  July 31
  
  
  
  0
  
  
  
  
  N/A
  
  
  
  
  0
  
  
  
  
  750,000August 1 to
  August 31
  
  
  
  605
  
  
  
  $
  45.00
  
  
  
  
  605
  
  
  
  
  749,395September 1
  to September 30
  
  
  
  334
  
  
  
  
  45.00
  
  
  
  
  939
  
  
  
  
  749,061Total
  
  
  
  939
  
  
  
  $
  45.00
  
  
  
  
  939
  
  
  
  
  749,061(1) All of these shares were
purchased pursuant to the Companys publicly announced stock repurchase
program. On August 8, 2005, the Company announced this stock repurchase
program, pursuant to which the Company was authorized to repurchase up to
750,000 shares of its common stock. This stock repurchase plan has an
expiration date of December 31, 2009.

Item 3.
  Defaults
  Upon Senior SecuritiesHills
  Bancorporation has no senior securities.Item 4.
  Submission
  of Matters to a Vote of Security HoldersNo matters
  were submitted to a vote of security holders during the quarter ended
  September 30, 2005.Item 5.
  Other
  InformationNoneItem 6.
  Exhibits31
  Certifications
  under Section 302 of the Sarbanes-Oxley Act of 200232
  Certifications
  under Section 906 of the Sarbanes-Oxley Act of 2002Page 26 of 31


SIGNATURES

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



HILLS BANCORPORATIONDate: 11/7/05
  
  By: /s/ Dwight O. SeegmillerDwight O. Seegmiller, Director and PresidentDate: 11/7/05
  
  By: /s/ James G. PrattJames G. Pratt, Treasurer and Chief Accounting OfficerPage 27 of 31

HILLS BANCORPORATION
QUARTERLY REPORT OF FORM 10-Q FOR THE
QUARTER ENDED SEPTEMBER 30, 2005

Exhibit 
Number
  Description
  Page Number
In The Sequential
Numbering System 
September 30, 2005 Form 10-Q31
  Certifications
  under Section 302 of the Sarbanes-Oxley Act of 2002
  29 - 30 of 3032
  Certifications
  under Section 906 of the Sarbanes-Oxley Act of 2002
  31 of 31Page 28 of 31