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, 2009





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.





þ  Yes   ̈  No





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





 ̈  Yes   ̈  No





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





Large
      accelerated filer   ̈
            Accelerated
      Filer  þNon-accelerated
      filer   ̈
            Small
      Reporting Company   ̈





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





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
      OUTSTANDING
              At October 31, 2009Common
      Stock, no par value
            
            4,408,581







Page 1 of
44


HILLS BANCORPORATION


Index
to Form 10-Q





Part
I


FINANCIAL
INFORMATION








Page
      NumberItem
      1.
            
            Financial
      StatementsConsolidated
      balance sheets, September 30, 2009 (unaudited) and December 31,
      2008
            
            
            3Consolidated
      statements of income (unaudited) for three and nine months ended September
      30, 2009 and 2008
            
            
            4Consolidated
      statements of comprehensive income (unaudited) for three and nine months
      ended September 30, 2009 and 2008
            
            
            5Consolidated
      statements of stockholders' equity (unaudited) for nine months ended
      September 30, 2009 and 2008
            
            
            6Consolidated
      statements of cash flows (unaudited) for nine months ended September 30,
      2009 and 2008
            
            
            7 -
      8Notes
      to consolidated financial statements
            
            
            9 -
      16Item
      2.
            
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            
            17
      - 38Item
      3.
            
            Quantitative
      and Qualitative Disclosures About Market Risk
            
            
            39Item
      4.
            
            Controls
      and Procedures
            
            
            40Part
      IIOTHER
      INFORMATIONItem
      1.
            
            Legal
      proceedings
            
            
            41Item
      1A.
            
            Risk
      factors
            
            
            41Item
      2.
            
            Unregistered
      sales of equity securities and use of proceeds
            
            
            41Item
      3.
            
            Defaults
      upon senior securities
            
            
            41Item
      4.
            
            Submission
      of matters to a vote of security holders
            
            
            42Item
      5.
            
            Other
      information
            
            
            42Item
      6.
            
            Exhibits
            
            
            42Signatures
            
            
            43Exhibits
      Index
            
            
            44


Page 2 of
44
 Index


HILLS BANCORPORATION


CONSOLIDATED
BALANCE SHEETS


(Amounts
In Thousands, Except Shares)








September
      30, 2009ASSETS
            
            (Unaudited)
            
            
            December
      31, 2008Cash
      and cash equivalents
            
            $
            57,033
            
            
            $
            22,575Investment
      securities available for sale at fair value (amortized cost September 30,
      2009 $195,827; December 31, 2008 $194,402)
            
            
            203,835
            
            
            
            200,312Stock
      of Federal Home Loan Bank
            
            
            14,247
            
            
            
            14,247Loans
      held for sale
            
            
            3,731
            
            
            
            8,490Loans,
      net of allowance for loan losses (September 30, 2009
    $30,720;December
      31, 2008 $27,660)
            
            
            1,481,369
            
            
            
            1,469,840Property
      and equipment, net
            
            
            24,126
            
            
            
            23,606Tax
      credit real estate
            
            
            18,877
            
            
            
            12,065Accrued
      interest receivable
            
            
            9,949
            
            
            
            10,437Deferred
      income taxes, net
            
            
            9,125
            
            
            
            8,959Other
      real estate
            
            
            3,779
            
            
            
            5,155Goodwill
            
            
            2,500
            
            
            
            2,500Other
      assets
            
            
            3,166
            
            
            
            2,607$
            1,831,737
            
            
            $
            1,780,793LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilitiesNoninterest-bearing
      deposits
            
            $
            172,296
            
            
            $
            169,299Interest-bearing
      deposits
            
            
            1,217,237
            
            
            
            1,068,587Total
      deposits
            
            $
            1,389,533
            
            
            $
            1,237,886Short-term
      borrowings
            
            
            29,304
            
            
            
            99,937Federal
      Home Loan Bank borrowings
            
            
            225,000
            
            
            
            265,000Accrued
      interest payable
            
            
            2,682
            
            
            
            2,914Other
      liabilities
            
            
            14,669
            
            
            
            11,879$
            1,661,188
            
            
            $
            1,617,616Redeemable
      Common Stock Held by Employee StockOwnership
      Plan (ESOP)
            
            $
            22,873
            
            
            $
            23,815STOCKHOLDERS'
      EQUITYCapital
      stock, no par value; authorized 10,000,000 shares; issued September 30,
      2009 4,598,692 shares; December 31, 2008 4,597,427 shares
            
            $
            -
            
            
            $
            -Paid
      in capital
            
            
            13,513
            
            
            
            13,447Retained
      earnings
            
            
            161,787
            
            
            
            154,176Accumulated
      other comprehensive income
            
            
            4,945
            
            
            
            3,649Treasury
      stock at cost (September 30, 2009 186,678 shares;December
      31, 2008 156,882 shares)
            
            
            (9,696
            )
            
            
            (8,095
            )$
            170,549
            
            
            $
            163,177Less
      maximum cash obligation related to ESOP shares
            
            
            22,873
            
            
            
            23,815$
            147,676
            
            
            $
            139,362$
            1,831,737
            
            
            $
            1,780,793





See Notes
to Consolidated Financial Statements.


Page 3 of
44
 Index


HILLS BANCORPORATION


CONSOLIDATED
STATEMENTS OF INCOME (Unaudited)


(Amounts
In Thousands, Except Per Share Amounts)





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Interest
      income:Loans,
      including fees
            
            $
            22,235
            
            
            $
            22,362
            
            
            $
            66,566
            
            
            $
            66,854Investment
      securities:Taxable
            
            
            924
            
            
            
            1,181
            
            
            
            2,839
            
            
            
            3,667Nontaxable
            
            
            856
            
            
            
            853
            
            
            
            2,537
            
            
            
            2,526Federal
      funds sold
            
            
            25
            
            
            
            3
            
            
            
            42
            
            
            
            17Total
      interest income
            
            $
            24,040
            
            
            $
            24,399
            
            
            $
            71,984
            
            
            $
            73,064Interest
      expense:Deposits
            
            $
            6,296
            
            
            $
            6,615
            
            
            $
            19,630
            
            
            $
            22,259Short-term
      borrowings
            
            
            137
            
            
            
            535
            
            
            
            539
            
            
            
            1,469FHLB
      borrowings
            
            
            2,636
            
            
            
            3,247
            
            
            
            8,605
            
            
            
            9,616Total
      interest expense
            
            $
            9,069
            
            
            $
            10,397
            
            
            $
            28,774
            
            
            $
            33,344Net
      interest income
            
            $
            14,971
            
            
            $
            14,002
            
            
            $
            43,210
            
            
            $
            39,720Provision
      for loan losses
            
            
            2,357
            
            
            
            1,026
            
            
            
            8,274
            
            
            
            6,785Net
      interest income after provision for loan losses
            
            $
            12,614
            
            
            $
            12,976
            
            
            $
            34,936
            
            
            $
            32,935Other
      income:Net
      gain on sale of loans
            
            $
            651
            
            
            $
            265
            
            
            $
            3,297
            
            
            $
            975Trust
      fees
            
            
            928
            
            
            
            963
            
            
            
            2,588
            
            
            
            2,980Service
      charges and fees
            
            
            2,097
            
            
            
            2,029
            
            
            
            5,863
            
            
            
            5,896Rental
      revenue on tax credit real estate
            
            
            373
            
            
            
            242
            
            
            
            894
            
            
            
            748Other
      noninterest income
            
            
            632
            
            
            
            573
            
            
            
            1,814
            
            
            
            2,031$
            4,681
            
            
            $
            4,072
            
            
            $
            14,456
            
            
            $
            12,630Other
      expenses:Salaries
      and employee benefits
            
            $
            5,357
            
            
            $
            5,211
            
            
            $
            16,102
            
            
            $
            15,308Occupancy
            
            
            705
            
            
            
            590
            
            
            
            2,196
            
            
            
            1,796Furniture
      and equipment
            
            
            912
            
            
            
            891
            
            
            
            2,733
            
            
            
            2,699Office
      supplies and postage
            
            
            335
            
            
            
            345
            
            
            
            1,025
            
            
            
            1,009Advertising
      and business development
            
            
            410
            
            
            
            520
            
            
            
            1,250
            
            
            
            1,284Outside
      services
            
            
            1,628
            
            
            
            1,513
            
            
            
            4,565
            
            
            
            4,113Rental
      expenses on tax credit real estate
            
            
            751
            
            
            
            408
            
            
            
            1,351
            
            
            
            1,001FDIC
      insurance assessment
            
            
            431
            
            
            
            309
            
            
            
            2,276
            
            
            
            657Loss
      on extinguishment of debt - Federal Home Loan Bank
    borrowings
            
            
            -
            
            
            
            -
            
            
            
            584
            
            
            
            -Net
      loss on sale of other real estate owned and other repossessed
      assets
            
            
            234
            
            
            
            32
            
            
            
            866
            
            
            
            54Flood-related
      expenses
            
            
            24
            
            
            
            157
            
            
            
            40
            
            
            
            822Other
      noninterest expense
            
            
            339
            
            
            
            325
            
            
            
            841
            
            
            
            891$
            11,126
            
            
            $
            10,301
            
            
            $
            33,829
            
            
            $
            29,634Income
      before income taxes
            
            $
            6,169
            
            
            $
            6,747
            
            
            $
            15,563
            
            
            $
            15,931Income
      taxes
            
            
            1,436
            
            
            
            2,058
            
            
            
            3,911
            
            
            
            4,603Net
      income
            
            $
            4,733
            
            
            $
            4,689
            
            
            $
            11,652
            
            
            $
            11,328Earnings
      per share:Basic
            
            $
            1.07
            
            
            $
            1.05
            
            
            $
            2.63
            
            
            $
            2.53Diluted
            
            
            1.06
            
            
            
            1.05
            
            
            
            2.62
            
            
            
            2.52





See Notes
to Consolidated Financial Statements.


Page 4 of
44
 Index


HILLS BANCORPORATION


CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)


(Amounts
In Thousands)








Three Months Ended September
      30,
            
            
            Nine Months Ended September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      income
            
            $
            4,733
            
            
            $
            4,689
            
            
            $
            11,652
            
            
            $
            11,328Other
      comprehensive income:Unrealized
      holding gains arising during the period
            
            $
            2,412
            
            
            $
            477
            
            
            $
            2,098
            
            
            $
            381Income
      tax effect of unrealized gains
            
            
            (923
            )
            
            
            (183
            )
            
            
            (802
            )
            
            
            (146
            )Other
      comprehensive income
            
            $
            1,489
            
            
            $
            294
            
            
            $
            1,296
            
            
            $
            235Comprehensive
      income
            
            $
            6,222
            
            
            $
            4,983
            
            
            $
            12,948
            
            
            $
            11,563





See Notes
to Consolidated Financial Statements.


Page 5 of
44
 Index


HILLS BANCORPORATION


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)


(Amounts
In Thousands, Except Share Amounts)








Paid
      In Capital
            
            
            Retained
      Earnings
            
            
            Accumulated
      Other Comprehensive Income
            
            
            Maximum
      Cash Obligation Related To ESOP Shares
            
            
            Treasury
      Stock
            
            
            TotalBalance,
      December 31, 2007
            
            $
            12,823
            
            
            $
            144,122
            
            
            $
            647
            
            
            $
            (22,205
            )
            
            $
            (4,697
            )
            
            $
            130,690Issuance
      of 3,653 shares of common stock
            
            
            183
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            183Forfeiture
      of 988 shares of common stock
            
            
            (41
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (41
            )Share-based
      compensation
            
            
            16
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            16Income
      tax benefit related to share-based compensation
            
            
            4
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4Change
      related to ESOP shares
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (251
            )
            
            
            -
            
            
            
            (251
            )Net
      income
            
            
            -
            
            
            
            11,328
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            11,328Cash
      dividends ($.91 per share)
            
            
            -
            
            
            
            (4,086
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,086
            )Purchase
      of 29,358 shares of common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,560
            )
            
            
            (1,560
            )Other
      comprehensive income
            
            
            -
            
            
            
            -
            
            
            
            235
            
            
            
            -
            
            
            
            -
            
            
            
            235Balance,
      September 30, 2008
            
            $
            12,985
            
            
            $
            151,364
            
            
            $
            882
            
            
            $
            (22,456
            )
            
            $
            (6,257
            )
            
            $
            136,518Balance,
      December 31, 2008
            
            $
            13,447
            
            
            $
            154,176
            
            
            $
            3,649
            
            
            $
            (23,815
            )
            
            $
            (8,095
            )
            
            $
            139,362Issuance
      of 1,767 shares of common stock
            
            
            68
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            68Forfeiture
      of 502 shares of common stock
            
            
            (23
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (23
            )Share-based
      compensation
            
            
            11
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            11Income
      tax benefit related to share-based compensation
            
            
            10
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            10Change
      related to ESOP shares
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            942
            
            
            
            -
            
            
            
            942Net
      income
            
            
            -
            
            
            
            11,652
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            11,652Cash
      dividends ($.91 per share)
            
            
            -
            
            
            
            (4,041
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,041
            )Purchase
      of 29,796 shares of common stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,601
            )
            
            
            (1,601
            )Other
      comprehensive income
            
            
            -
            
            
            
            -
            
            
            
            1,296
            
            
            
            -
            
            
            
            -
            
            
            
            1,296Balance,
      September 30, 2009
            
            $
            13,513
            
            
            $
            161,787
            
            
            $
            4,945
            
            
            $
            (22,873
            )
            
            $
            (9,696
            )
            
            $
            147,676





See Notes
to Consolidated Financial Statements.


Page 6 of
44
 Index


HILLS BANCORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)


(Amounts
In Thousands)





Nine
      Months Ended September 30,2009
            
            
            2008Cash
      Flows from Operating ActivitiesNet
      income
            
            $
            11,652
            
            
            $
            11,328Adjustments
      to reconcile net income to net cash and cash equivalents provided by
      operating activities:Depreciation
            
            
            1,805
            
            
            
            1,690Provision
      for loan losses
            
            
            8,274
            
            
            
            6,785Share-based
      compensation
            
            
            11
            
            
            
            16Forfeiture
      of common stock
            
            
            (23
            )
            
            
            (41
            )Compensation
      expensed through issuance of common stock
            
            
            42
            
            
            
            173Excess
      tax benefits from share-based compensation
            
            
            (10
            )
            
            
            (4
            )Provision
      for deferred income taxes
            
            
            (968
            )
            
            
            (2,045
            )Net
      loss on sale of other real estate owned and other repossessed
      assets
            
            
            866
            
            
            
            54Loss
      on disposal of property and equipment
            
            
            -
            
            
            
            355Decrease
      in accrued interest receivable
            
            
            488
            
            
            
            91Amortization
      of discount on investment securities, net
            
            
            550
            
            
            
            293(Increase)
      decrease in other assets
            
            
            (549
            )
            
            
            866Increase
      in accrued interest and other liabilities
            
            
            2,558
            
            
            
            4,226Loans
      originated for sale
            
            
            (241,972
            )
            
            
            (99,273
            )Proceeds
      on sales of loans
            
            
            250,028
            
            
            
            105,514Net
      gain on sales of loans
            
            
            (3,297
            )
            
            
            (975
            )Net
      cash and cash equivalents provided by operating activities
            
            $
            29,455
            
            
            $
            29,053Cash
      Flows from Investing ActivitiesProceeds
      from maturities of investment securities available for
sale
            
            $
            41,774
            
            
            $
            37,913Purchases
      of investment securities available for sale
            
            
            (43,749
            )
            
            
            (33,567
            )Loans
      made to customers, net of collections
            
            
            (24,367
            )
            
            
            (87,337
            )Proceeds
      on sale of other real estate owned and other repossessed
      assets
            
            
            5,074
            
            
            
            829Purchases
      of property and equipment
            
            
            (2,325
            )
            
            
            (2,986
            )Investment
      in tax credit real estate, net
            
            
            (6,812
            )
            
            
            (3,531
            )Net
      cash used in investing activities
            
            $
            (30,405
            )
            
            $
            (88,679
            )Cash
      Flows from Financing ActivitiesNet
      increase in deposits
            
            $
            151,647
            
            
            $
            49,953Net
      (decrease) increase in short-term borrowings
            
            
            (70,633
            )
            
            
            6,504Stock
      options exercised
            
            
            26
            
            
            
            10Excess
      tax benefits related to share-based compensation
            
            
            10
            
            
            
            4Borrowings
      from FHLB
            
            
            -
            
            
            
            20,000Payments
      on FHLB borrowings
            
            
            (40,000
            )
            
            
            (20,348
            )Borrowings
      from FRB
            
            
            -
            
            
            
            1,650Payments
      on FRB borrowings
            
            
            -
            
            
            
            (1,650
            )Purchase
      of treasury stock
            
            
            (1,601
            )
            
            
            (1,560
            )Dividends
      paid
            
            
            (4,041
            )
            
            
            (4,086
            )Net
      cash provided by financing activities
            
            $
            35,408
            
            
            $
            50,477





(Continued)


Page 7 of
44
 Index


HILLS
BANCORPORATION


CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (Continued)


(Amounts
In Thousands)





Nine
      Months Ended September 30,2009
            
            
            2008Increase
      (decrease) in cash and cash equivalents
            
            $
            34,458
            
            
            $
            (9,149
            )Cash
      and cash equivalents:Beginning
      of year
            
            
            22,575
            
            
            
            32,383End
      of period
            
            $
            57,033
            
            
            $
            23,234Supplemental
      DisclosuresCash
      payments for:Interest
      paid to depositors
            
            $
            19,862
            
            
            $
            22,644Interest
      paid on other obligations
            
            
            9,144
            
            
            
            11,047Income
      taxes paid
            
            
            4,703
            
            
            
            4,973Noncash
      financing activities:(Decrease)
      increase in maximum cash obligation related to ESOP shares
            
            $
            (942
            )
            
            $
            251Transfers
      to other real estate owned
            
            
            4,176
            
            
            
            1,832





See Notes
to Consolidated Financial Statements.


Page 8 of
44
 Index


HILLS BANCORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Note
      1.
            Basis
      of Presentation





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





Operating
results for the nine month period ended September 30, 2009 are not necessarily
indicative of the results that may be expected for the fiscal year ending
December 31, 2009.  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, 2008 filed with the Securities and Exchange Commission on March 11,
2009.





Note
      2.
            Earnings
      Per Share





Basic
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 30,2009
            
            
            2008
            
            
            2009
            
            
            2008Common
      shares outstanding at the beginning of the period
            
            
            4,417,505
            
            
            
            4,468,542
            
            
            
            4,440,545
            
            
            
            4,490,107Weighted
      average number of net shares issued (redeemed)
            
            
            (1,837
            )
            
            
            (2,095
            )
            
            
            (13,692
            )
            
            
            (15,124
            )Weighted
      average shares outstanding (basic)
            
            
            4,415,668
            
            
            
            4,466,447
            
            
            
            4,426,853
            
            
            
            4,474,983Weighted
      average of potential dilutive shares attributable to stock options
      granted, computed under the treasury stock method
            
            
            14,628
            
            
            
            20,009
            
            
            
            14,577
            
            
            
            20,031Weighted
      average number of shares (diluted)
            
            
            4,430,296
            
            
            
            4,486,456
            
            
            
            4,441,430
            
            
            
            4,495,014Net
      income (In Thousands)
            
            $
            4,733
            
            
            $
            4,689
            
            
            $
            11,652
            
            
            $
            11,328Earnings
      per share:Basic
            
            $
            1.07
            
            
            $
            1.05
            
            
            $
            2.63
            
            
            $
            2.53Diluted
            
            $
            1.06
            
            
            $
            1.05
            
            
            $
            2.62
            
            
            $
            2.52


Page 9 of
44
 Index


HILLS
BANCORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


(Unaudited)





Note 3.
            Recent Accounting
      Pronouncements





As of
January 1, 2009, the Company adopted FASB ASC 815, Derivatives and Hedging (“ASC
815”).  The standard requires qualitative disclosures about objectives
and strategies for using derivatives, quantitative disclosures about fair value
amounts of gains and losses on derivative instruments, and disclosures about
credit-risk related contingent features in derivative agreements.  The
adoption of ASC 815 did not have a significant effect on the Company’s
consolidated financial statements.





In April
2009, the FASB issued FASB ASC 820-10-65-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly (“ASC
820-10-65-4”).  ASC 820-10-65-4 provides additional guidance for
estimating fair value in accordance with FASB ASC 820, Fair Value Measurements and
Disclosures, when the volume and level of activity for the asset or
liability have significantly decreased.  ASC 820-10-65-4 also provides
guidance on identifying circumstances that indicate a transaction is not
orderly.  ASC 820-10-65-4 is effective for financial statements issued
after June 15, 2009.  The adoption of ASC 820-10-65-4 did not have a
significant effect on the Company’s consolidated financial
statements.





In April
2009, the FASB issued FASB ASC 320-10-65-1, Recognition and Presentation of
Other-Than-Temporary Impairments (“ASC 320-10-65-1”).  ASC
320-10-65-1 amends the other-than-temporary impairment guidance for debt
securities to make the guidance more operational and to improve the presentation
and disclosure of other-than-temporary impairments on debt and equity securities
in the financial statements.  ASC 320-10-65-1 does not amend existing
recognition and measurement guidance related to other-than-temporary impairment
of equity securities.  ASC 320-10-65-1 is effective for financial
statements issued after June 15, 2009.  The adoption of ASC
320-10-65-1 did not have a significant effect on the Company’s consolidated
financial statements.





In April
2009, the FASB issued FASB ASC 825-10-65-1, Interim Disclosures about Fair Value
of Financial Instruments (“ASC 825-10-65-1”).  ASC 825-10-65-1
amends FASB ASC 825, Financial
Instruments, to require disclosures about fair value of financial
instruments for interim reporting periods of publicly traded companies as well
as in annual financial statements.  ASC 825-10-65-1 also amends FASB
ASC 270, Interim Financial
Reporting, to require those disclosures in summarized financial
information at interim reporting periods.  ASC 825-10-65-1 is
effective for financial statements issued after June 15, 2009.  The
adoption of ASC 825-10-65-1 did not have a significant effect on the Company’s
consolidated financial statements.  See Note 4 for fair value
information at September 30, 2009 and December 31, 2008.





In May
2009, the FASB issued FASB ASC 855, Subsequent Events (“ASC
855”).  ASC 855 establishes general standards of accounting for a
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued.  ASC
855 is effective for financial statements issued after June 15,
2009.  The adoption of ASC 855 did not have a significant effect on
the Company’s consolidated financial statements.  The Company has
evaluated subsequent events through November 6, 2009 which is the date the
financial statements have been issued.
 
 In June
2009, the SEC issued Staff Accounting Bulletin No. 112 (“SAB
112”).  SAB 112 conforms SEC staff guidance on business combinations
and noncontrolling interests to FASBASC 805, Business Combinations, and
FASB ASC 810-10-65-1, Noncontrolling Interests in
Consolidated Financial Statements.  SAB 112 is effective as of
June 10, 2009.  The adoption of SAB 112 did not have a significant
effect on the Company’s consolidated financial statements.





In June
2009, the FASB issued FASB Statement No. 166, Accounting for Transfers of
Financial Assets – an amendment of FASBASC 860 (“FAS
166”).  FAS 166 eliminates the concept of a qualified special-purpose
entity and its exemption from consolidation in a transferor’s financial
statements, establishes conditions for reporting a transfer of a portion of a
financial asset as a sale, modifies the financial-asset derecognition criteria,
revises how interests retained by the transferor in a sale of financial assets
are initially measured, removes the guaranteed mortgage securitization
recharacterization provisions and requires additional
disclosures.   FAS 166 is effective for financial statements
issued after November 15, 2009.  The Company is assessing the impact
of the adoption of FAS 166 on the Company’s consolidated financial
statements.


Page 10 of
44
 Index


HILLS
BANCORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


(Unaudited)





Note
      3.
            Recent
      Accounting Pronouncements
(continued)





In June
2009, the FASB issued FASB Statement No. 167, Amendments to FASB ASC 810
(“FAS 167”).  FAS 167 eliminates FASB ASC 810’s exceptions to
consolidated qualified special-purpose entities, contains new criteria for
determining the primary beneficiary, and increases the frequency of required
reassessments to determine whether a company is the primary beneficiary of a
variable interest entity (“VIE”).  FAS 167 also clarifies the
characteristics that identify a VIE.  In addition, FAS 167 contains a
new requirement that any term, transaction, or arrangement that does not have a
substantive effect on an entity’s status as a VIE, a company’s power over a VIE,
or a company’s obligation to absorb losses or its right to receive benefits of
an entity must be disregarded in applying the provision of FASB ASC
810.  FAS 167 is effective for financial statements issued after
November 15, 2009.  The Company is assessing the impact of the
adoption of FAS 167 on the Company’s consolidated financial
statements.





In July
2009, the FASB issued FASB ASC 105, Generally Accepted Accounting
Principles(“ASC 105”).  ASC 105 establishes the FASB’s
Accounting Standards Codification as the exclusive authoritative reference for
nongovernmental US GAAP, except for SEC rules and interpretive releases, which
are also authoritative GAAP for SEC registrants.  ASC 105 is effective
for financial statements issued after September 15, 2009.  The
adoption of ASC 105 did not have a significant effect on the Company’s
consolidated financial statements.





In August
2009, the FASB issued Accounting Standards Update No. 2009-05, Measuring Liabilities at Fair
Value (“ASU No. 2009-05”).   ASU No. 2009-05 modifies FASB
ASC 820, Fair Value
Measurements and Disclosures.  ASU No. 2009-05 provides
clarification on measuring liabilities at fair value when a quoted price in an
active market is not available.  In such circumstances, ASU No.
2009-05 specifies that a valuation technique should be applied that uses either
the quote of the liability when traded as an asset, the quoted prices for
similar liabilities or similar liabilities when traded as assets, or another
valuation technique consistent with existing fair value measurement
guidance.  ASU No. 2009-05 is effective for financial statements
issued after August 27, 2009.  The adoption of ASU No. 2009-05 did not
have a significant effect on the Company’s consolidated financial
statements.


Page 11 of
44
 Index


HILLS
BANCORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


(Unaudited)





Note
      4.
            Fair
      Value Measurements





The
carrying value and estimated fair values of the Company's financial instruments
under FASB ASC 825, Financial
Instruments, as of September 30, 2009 and December 31, 2008 are as
follows:





September
      30, 2009
            
            
            December
      31, 2008Carrying
      Amount
            
            
            Estimated
      Fair Value
            
            
            Carrying
      Amount
            
            
            Estimated
      Fair Value(Amounts
      In Thousands)Cash
      and due from banks
            
            $
            57,033
            
            
            $
            57,033
            
            
            $
            22,575
            
            
            $
            22,575Investment
      securities
            
            
            218,082
            
            
            
            218,082
            
            
            
            214,559
            
            
            
            214,559Loans
            
            
            1,485,100
            
            
            
            1,587,779
            
            
            
            1,478,330
            
            
            
            1,565,525Accrued
      interest receivable
            
            
            9,949
            
            
            
            9,949
            
            
            
            10,437
            
            
            
            10,437Deposits
            
            
            1,389,533
            
            
            
            1,389,533
            
            
            
            1,237,886
            
            
            
            1,237,886Federal
      funds purchased and securities sold under agreements to
      repurchase
            
            
            29,304
            
            
            
            29,304
            
            
            
            99,937
            
            
            
            99,937Borrowings
      from Federal Home Loan Bank
            
            
            225,000
            
            
            
            237,254
            
            
            
            265,000
            
            
            
            275,727Accrued
      interest payable
            
            
            2,682
            
            
            
            2,682
            
            
            
            2,914
            
            
            
            2,914Face
      Amount
            
            
            
            
            
            
            Face
      AmountOff-balance
      sheet instruments:Loan
      commitments
            
            $
            330,266
            
            
            $
            -
            
            
            $
            309,305
            
            
            $
            -Letters
      of credit
            
            
            10,149
            
            
            
            -
            
            
            
            12,365
            
            
            
            -








The
Company adopted FASB ASC 820, Fair Value Measurements and
Disclosures (“ASC 820”), in its entirety on January 1,
2008.  ASC 820 provides a single definition for fair value, a
framework for measuring fair value and expanded disclosures concerning fair
value.  Fair value is defined under ASC 820 as the exchange price that
would be received for an asset or paid to transfer a liability (an exit price)
in the principal or most advantageous market for the asset or liability in an
orderly transaction between market participants on the measurement
date.





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





Level
      1
            Valuations
      for assets and liabilities traded in active markets for identical assets
      or liabilities.  Level 1 includes securities purchased from the
      Federal Home Loan Bank (“FHLB”), Federal Home Loan Mortgage Corporation
      (“FHLMC”) and Federal National Mortgage Association (“FNMA”) that are
      traded by dealers or brokers in active markets. Valuations are obtained
      from readily available pricing sources for market transactions involving
      identical assets or liabilities.





Level
      2
            Valuations
      for assets and liabilities traded in less active dealer or broker
      markets.  Level 2 includes securities issued by state and
      political subdivisions.  Valuations are obtained from third
      party pricing services for identical or comparable assets or
      liabilities.


Page 12 of
44
 Index


HILLS
BANCORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


(Unaudited)





Note
      4.
            Fair
      Value Measurements (continued)





Level
      3
            Valuations
      for assets and liabilities that are derived from other valuation
      methodologies, including discounted cash flow models and similar
      techniques, and not based on market exchange, dealer or broker traded
      transactions. Level 3 valuations incorporate certain assumptions and
      projections in determining the fair value assigned to such assets and
      liabilities.  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.  The Company does not have any Level 3
      assets or liabilities.





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





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





ASSETS





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





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.  Level 1 securities include
securities from the FHLB, FHLMC and FNMA.  Level 2 securities include
securities issued by state or political subdivisions.





Loans held for
sale:  Loans held for sale are carried at historical
cost.  The carrying amount is a reasonable estimate of fair value
because of the short time between origination of the loan and its sale on the
secondary market.





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





Foreclosed
assets:  Foreclosed assets consist mainly of other real estate
owned but may include other types of assets repossessed by the
Company.  Foreclosed assets are adjusted to the lower of carrying
value or fair value less the cost of disposal upon transfer of the loans to
foreclosed assets.   Fair value is generally based upon
independent market prices or appraised values of the collateral.  The
value of foreclosed assets is evaluated periodically.  Foreclosed
assets are classified as Level 2.





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.


Page 13 of
44
 Index


HILLS
BANCORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


(Unaudited)





Note
      4.
            Fair
      Value Measurements (continued)





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





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





LIABILITIES





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





Short-term
borrowings:  Short-term borrowings are carried at historical
cost and include federal funds purchased and securities sold under agreements to
repurchase.  The carrying amount is a reasonable estimate of fair
value because of the relatively short time between the origination of the
liability and its expected realization.





Long-term
borrowings:  Long-term borrowings are recorded at historical
cost.  The fair values of the Company’s long-term borrowings are
estimated using discounted cash flow analyses, based on the Company’s current
incremental borrowing rates for similar types of borrowing
arrangements.





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





Valuation
methodologies have not changed during the quarter ended September 30,
2009.





Assets
and Liabilities Recorded at Fair Value on a Recurring Basis





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





September
      30, 2009Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            Total(Amounts
      in Thousands)Investment
      securities available for sale
            
            $
            99,705
            
            
            $
            104,130
            
            
            $
            -
            
            
            $
            203,835Total
            
            $
            99,705
            
            
            $
            104,130
            
            
            $
            -
            
            
            $
            203,835





All
securities from the FHLB, FHLMC and FNMA are included in Level
1.


Page 14 of
44
 Index


HILLS
BANCORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


(Unaudited)





Note
      4.
            Fair
      Value Measurements (continued)





Assets
and Liabilities Recorded at Fair Value on a Nonrecurring Basis





The
Company is required to measure certain assets at fair value on a nonrecurring
basis in accordance with GAAP.  These adjustments to fair value
usually result from application of lower-of-cost-or-market accounting or
write-downs of individual assets.  The valuation methodologies used to
measure these fair value adjustments are described above.  For assets
measured at fair value on a nonrecurring basis in 2009 that were still held on
the balance sheet at September 30, 2009, the following table provides the level
of valuation assumptions used to determine the adjustment and the carrying value
of the related individual assets at quarter end.





September
      30, 2009
            
            
            September
      30, 2009Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            Total
            
            
            Total
      Losses(Amounts
      in Thousands)Loans
      (1)
            
            $
            -
            
            
            $
            4,887
            
            
            $
            -
            
            
            $
            4,887
            
            
            $
            384Foreclosed
      assets (2)
            
            
            -
            
            
            
            1,172
            
            
            
            -
            
            
            
            1,172
            
            
            
            217Total
            
            $
            -
            
            
            $
            6,059
            
            
            $
            -
            
            
            $
            6,059
            
            
            $
            601




(1)
            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.


(2)
            Represents
      the fair value and related losses of foreclosed real estate and other
      collateral owned that were measured at fair value subsequent to their
      initial classification as foreclosed
assets.





Note
      5.
            Stock
      Repurchase Program





In July
of 2005, the Company’s Board of Directors authorized a program to repurchase up
to a total of 750,000 shares of the Company’s common stock (the “2005 Stock
Repurchase Program”).  This authorization will expire on December 31,
2013.  The Company expects the purchases pursuant to the 2005 Stock
Repurchase Program to be made from time to time in private transactions at a
price equal to the most recent quarterly independent appraisal of the shares of
the Company’s common stock and with the Board reviewing the overall results of
the 2005 Stock Repurchase Program on a quarterly basis.  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 and legal
factors.  The Company has purchased 186,678 shares of its common stock
in privately negotiated transactions from August 1, 2005 through September 30,
2009.  Of these 186,678 shares, 5,491 shares were purchased during the
quarter ended September 30, 2009, at an average price per share of
$52.84.  In the nine-month period ended September 30, 2009, 29,796
shares were purchased at an average price per share of $53.72.





Note
      6.
            Commitments
      and Contingencies





The
Company’s subsidiary, Hills Bank and Trust Company (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.


Page 15 of
44
 Index


HILLS
BANCORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


(Unaudited)





Note
      6.
            Commitments
      and Contingencies (continued)





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 September
30, 2009 and December 31, 2008 is as follows:





September
      30, 2009
            
            
            December
      31, 2008(Amounts
      In Thousands)Firm
      loan commitments and unused portion of lines of credit:Home
      equity loans
            
            $
            36,565
            
            
            $
            38,519Credit
      card participations
            
            
            50,797
            
            
            
            35,407Commercial,
      real estate and home construction
            
            
            84,765
            
            
            
            86,073Commercial
      lines and real estate purchase loans
            
            
            158,139
            
            
            
            149,306Outstanding
      letters of credit
            
            
            10,149
            
            
            
            12,365








Note
      7.
            Income
      Taxes





Federal
income tax expense for the nine months ended September 30, 2009 and 2008 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 year ended December 31, 2008 remains
subject to examination by the Internal Revenue Service.  For state tax
purposes, the tax years ended December 31, 2008, 2007 and 2006, remain open for
examination.  There were no material unrecognized tax benefits at
December 31, 2008 and September 30, 2009.  No interest or penalties on
these unrecognized tax benefits has been recorded.  As of September
30, 2009, the Company does not anticipate any significant increase or decrease
in unrecognized tax benefits during the twelve-month period ending September 30,
2010.


Page 16 of
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HILLS
BANCORPORATION





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





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





Special
Note Regarding Forward Looking Statements





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





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





·
            The
      strength of the United States economy in general and the strength of the
      local economies in which the Company conducts its operations which may be
      less favorable than expected and may result in, among other things, a
      deterioration in the credit quality and value of the Company’s
      assets.





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





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





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





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





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





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





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





·
            The
      timely development and acceptance of products and services, including
      products and services offered through alternative delivery channels such
      as the Internet.


Page 17 of
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 Index


HILLS
BANCORPORATION





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





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





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





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





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





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





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





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





·
            Changes
      in accounting policies and practices, 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 well as anticipated.





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





Critical
Accounting Policies





The
Company's 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, 2009 and December 31,
2008 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 18 of
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 Index


HILLS
BANCORPORATION





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





Overview





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





The
Company is a holding company engaged in the business of commercial
banking.  The Company’s subsidiary is Hills Bank and Trust Company,
Hills, Iowa (the “Bank”), which is wholly-owned.  The Bank was formed
in Hills, Iowa in 1904.  The Bank is a full-service commercial bank
extending its services to individuals, businesses, governmental units and
institutional customers primarily in the communities of Hills, Iowa City,
Coralville, North Liberty, Mount Vernon, Kalona, Wellman, Cedar Rapids and
Marion, Iowa.  At September 30, 2009, the Bank has fourteen
full-service locations and a trust and wealth management location.





Net
income for the nine month period ended September 30, 2009 was $11.65 million
compared to $11.33 million for the same nine months of 2008, an increase of
2.86%.  The $324,000 increase in net income was caused by a number of
factors.  The principal factors in the increase in net income for the
first nine months of 2009 are an increase in net interest income of $3,490,000
and an increase in the gain on sale of loans of $2,322,000.  The
increases in these income items were partially offset by increases in certain
expense items including $1,619,000 in FDIC insurance assessments, $584,000 in
early repayment penalties related to FHLB borrowings and $839,000 in net losses
on the sale of other real estate owned and other repossessed
assets.  In addition, provision expense for the nine months ended
September 30, 2009 was $8,274,000, an increase of $1,489,000 over the nine
months ended September 30, 2008.  The 2008 provision expense totaled
$6,785,000 and included $4,129,000 of additional provision expense related to
the June 2008 floods.  In the 2008 period, provision expense of
$2,656,000 was not flood related.  When comparing provision expense
between the 2009 and 2008 nine month periods, the 2009 expense increased
$5,618,000 over the 2008 non-flood provision expense.  Net income for
the first nine months of 2008 was significantly impacted by the June 2008
flood-related expenses of $3,057,000, net of tax.  The flood-related
expenses consisted of (1) a $4,129,000 addition to the provision for loan
losses, (2) recognition of a $355,000 loss in the value of property and
equipment and (3) $467,000 of expenses incurred in dealing with the
floods.  A tax benefit of $1,849,000 was recorded as a result of the
$4,951,000 in flood-related expenses.





Return on
average equity was 10.82% for the nine months ended September 30, 2009 compared
to 11.16% for the same period in 2008. Return on average assets was 0.86% in
2009 compared to 0.90% in 2008.  Return on average assets and return
on average equity are calculated based on annualized income for the first nine
months of the year.  Dividends of $.91 per share were paid in January
2009 to 1,635 shareholders.  The 2009 dividend was the same dividend
per share as paid in January 2008.





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.  The Bank achieved a net interest margin on a
tax-equivalent basis of 3.48% in 2009 compared to 3.45% in
2008.  Average earning assets were $1.723 billion in 2009 and $1.603
billion in 2008.





Highlights
noted on the balance sheet as of September 30, 2009 for the Company included the
following:


Ÿ
            Total
      assets are $1.832 billion.


Ÿ
            Net
      loans are $1.485 billion.


Ÿ
            Net
      loans increased $6.8 million since December 31,
  2008.


Ÿ
            Deposit
      growth of $151.6 million since December 31,
  2008.


Ÿ
            Short-term
      borrowings decreased $70.6 million since December 31,
  2008.


Ÿ
            Federal
      Home Loan Bank borrowings decreased $40.0 million since December 31,
      2008.





Reference
is made to Note 4 for a discussion of fair value measurements which relate to
methods used by the Company in recording assets and liabilities on its financial
statements.


Page 19 of
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HILLS
BANCORPORATION





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





In
pricing loans and deposits, the Bank considers the U.S. Treasury indexes as
benchmarks in determining interest rates.  The Federal Open Market
Committee met six times during the first nine months of 2009.  The
target rate remains unchanged since December 31, 2008 at
0.25%.  Interest rates on loans are generally affected by the target
rate since interest rates for the U.S. Treasury market normally increase or
decrease when the Federal Reserve Board raises or lowers the federal funds
rate.  As of September 30, 2009, the average rate indexes for the one,
three and five year indexes were 0.40%, 1.45% and 2.31%,
respectively.  The one year index decreased 77.53% from 1.78% at
September 30, 2008, the three year index decreased 36.40% and the five year
index decreased 22.48%.  The three year index was 2.28% and the five
year index was 2.98% at September 30, 2008.  The targeted federal
funds rate was 0.25% at September 30, 2009 and 2.00% at September 30,
2008.





A
detailed discussion of the financial condition and results of operations follows
this overview.





Financial
Condition





The
tables below set forth the composition of the loan portfolio as of September 30,
2009 and December 31, 2008, along with changes in the allowance for loan losses
and non-performing loan information:





September
      30, 2009
            
            
            December
      31, 2008Amount
            
            
            Percent
            
            
            Amount
            
            
            Percent(Amounts
      In Thousands)
            
            
            (Amounts
      In Thousands)Agricultural
            
            $
            60,817
            
            
            
            4.02
            %
            
            $
            64,198
            
            
            
            4.29
            %Commercial
      and financial
            
            
            166,223
            
            
            
            10.99
            
            
            
            162,170
            
            
            
            10.83Real
      estate:Construction,
      1 to 4 family residential
            
            
            25,510
            
            
            
            1.69
            
            
            
            29,343
            
            
            
            1.96Construction,
      land development and commercial
            
            
            95,902
            
            
            
            6.34
            
            
            
            111,006
            
            
            
            7.41Mortgage,
      farmland
            
            
            86,477
            
            
            
            5.72
            
            
            
            83,499
            
            
            
            5.58Mortgage,
      1 to 4 family first liens
            
            
            451,906
            
            
            
            29.89
            
            
            
            444,474
            
            
            
            29.68Mortgage,
      1 to 4 family junior liens
            
            
            112,151
            
            
            
            7.42
            
            
            
            117,086
            
            
            
            7.82Mortgage,
      multi-family
            
            
            186,782
            
            
            
            12.35
            
            
            
            180,525
            
            
            
            12.06Mortgage,
      commercial
            
            
            289,122
            
            
            
            19.12
            
            
            
            270,158
            
            
            
            18.04Loans
      to individuals
            
            
            25,911
            
            
            
            1.71
            
            
            
            26,823
            
            
            
            1.78Obligations
      of state and political subdivisions
            
            
            11,288
            
            
            
            0.75
            
            
            
            8,218
            
            
            
            0.55$
            1,512,089
            
            
            
            100.00
            %
            
            $
            1,497,500
            
            
            
            100.00
            %Less
      allowance for loan losses
            
            
            30,720
            
            
            
            
            
            
            
            27,660$
            1,481,369
            
            
            
            
            
            
            $
            1,469,840





The Bank
has an established formal loan origination policy.  In general, the
loan origination policy attempts to reduce the risk of credit loss to the Bank
by requiring, among other things, maintenance of minimum loan to value ratios,
evidence of appropriate levels of insurance carried by borrowers and
documentation of appropriate types and amounts of collateral and sources of
expected payment.  Each customer is evaluated as a part of the Bank’s
underwriting process and through periodic reviews.  Loan and overall
customer credit approval levels are established so that larger borrower
relationships are approved through various credit committees.  For
consumer loans, a third-party credit scoring model is used to help determine
eligibility for credit.


Page 20 of
44
 Index


HILLS
BANCORPORATION





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





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 30,2009
            
            
            2008
            
            
            2009
            
            
            2008(Amounts
      In Thousands)
            
            
            (Amounts
      In Thousands)Balance,
      beginning
            
            $
            30,130
            
            
            $
            24,550
            
            
            $
            27,660
            
            
            $
            19,710Charge-offs:Agricultural
            
            
            79
            
            
            
            96
            
            
            
            82
            
            
            
            99Commercial
      and financial
            
            
            697
            
            
            
            433
            
            
            
            2,720
            
            
            
            1,011Real
      estate:Construction,
      1 to 4 family residential
            
            
            47
            
            
            
            -
            
            
            
            48
            
            
            
            47Construction,
      land development and commercial
            
            
            70
            
            
            
            2
            
            
            
            195
            
            
            
            15Mortgage,
      farmland
            
            
            22
            
            
            
            -
            
            
            
            22
            
            
            
            -Mortgage,
      1 to 4 family first liens
            
            
            449
            
            
            
            735
            
            
            
            977
            
            
            
            763Mortgage,
      1 to 4 family junior liens
            
            
            301
            
            
            
            222
            
            
            
            915
            
            
            
            578Mortgage,
      multi-family
            
            
            220
            
            
            
            92
            
            
            
            315
            
            
            
            92Mortgage,
      commercial
            
            
            128
            
            
            
            100
            
            
            
            363
            
            
            
            100Loans
      to individuals
            
            
            89
            
            
            
            157
            
            
            
            369
            
            
            
            4532,102
            
            
            
            1,837
            
            
            
            6,006
            
            
            
            3,158Recoveries:Agricultural
            
            
            11
            
            
            
            13
            
            
            
            17
            
            
            
            39Commercial
      and financial
            
            
            166
            
            
            
            137
            
            
            
            322
            
            
            
            243Real
      estate:Construction,
      1 to 4 family residential
            
            
            49
            
            
            
            -
            
            
            
            49
            
            
            
            -Mortgage,
      farmland
            
            
            -
            
            
            
            1
            
            
            
            1
            
            
            
            5Mortgage,
      1 to 4 family first liens
            
            
            6
            
            
            
            1
            
            
            
            45
            
            
            
            13Mortgage,
      1 to 4 family junior liens
            
            
            39
            
            
            
            40
            
            
            
            149
            
            
            
            68Mortgage,
      multi-family
            
            
            -
            
            
            
            95
            
            
            
            -
            
            
            
            95Mortgage,
      commercial
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            33Loans
      to individuals
            
            
            64
            
            
            
            44
            
            
            
            209
            
            
            
            237335
            
            
            
            331
            
            
            
            792
            
            
            
            733Net
      charge-offs
            
            
            1,767
            
            
            
            1,506
            
            
            
            5,214
            
            
            
            2,425Provision
      charged to expense
            
            
            2,357
            
            
            
            1,026
            
            
            
            8,274
            
            
            
            6,785Balance,
      ending
            
            $
            30,720
            
            
            $
            24,070
            
            
            $
            30,720
            
            
            $
            24,070


Page 21 of
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 Index


HILLS
BANCORPORATION





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





Non-performing
loan information at September 30, 2009 and December 31, 2008, was as
follows:





September
      30, 2009
            
            
            December
      31, 2008(Amounts
      in thousands)Non-accrual
      loans
            
            $
            1,995
            
            
            $
            2,535Accruing
      loans past due ninety days or more
            
            
            9,220
            
            
            
            5,049Restructured
      loans
            
            
            7,084
            
            
            
            4,478Non-performing
      loans (includes non-accrual and restructured loans)
            
            
            77,723
            
            
            
            52,186Loans
      held for investment
            
            
            1,512,089
            
            
            
            1,497,500Ratio
      of allowance for loan losses to loans held for investment
            
            
            2.03
            %
            
            
            1.85
            %Ratio
      of allowance for loan losses to non-performing loans
            
            
            39.52
            
            
            
            53.00





Certain
non-performing loan information by loan type at September 30, 2009 and December
31, 2008, was as follows:





September
      30, 2009
            
            
            December
      31, 2008Non-accrual
      loans
            
            
            Accruing
      loans past due 90 days
            
            
            Restructured
      loans
            
            
            Non-accrual
      loans
            
            
            Accruing
      loans past due 90 days
            
            
            Restructured
      loans(Amounts
      In Thousands)
            
            
            (Amounts
      In Thousands)Commercial
      and financial
            
            $
            801
            
            
            $
            2,054
            
            
            $
            349
            
            
            $
            661
            
            
            $
            429
            
            
            $
            199Real
      estate:Construction,
      1 to 4 family residential
            
            
            218
            
            
            
            855
            
            
            
            1,010
            
            
            
            1,325
            
            
            
            208
            
            
            
            1,010Construction,
      land development and commercial
            
            
            -
            
            
            
            856
            
            
            
            2,966
            
            
            
            -
            
            
            
            515
            
            
            
            3,269Mortgage,
      farmland
            
            
            -
            
            
            
            172
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Mortgage,
      1 to 4 family first liens
            
            
            406
            
            
            
            4,128
            
            
            
            876
            
            
            
            549
            
            
            
            2,741
            
            
            
            -Mortgage,
      1 to 4 family junior liens
            
            
            27
            
            
            
            603
            
            
            
            -
            
            
            
            -
            
            
            
            363
            
            
            
            -Mortgage,
      multi-family
            
            
            543
            
            
            
            -
            
            
            
            1,883
            
            
            
            -
            
            
            
            90
            
            
            
            -Mortgage,
      commercial
            
            
            -
            
            
            
            542
            
            
            
            -
            
            
            
            -
            
            
            
            605
            
            
            
            -Loans
      to individuals
            
            
            -
            
            
            
            10
            
            
            
            -
            
            
            
            -
            
            
            
            98
            
            
            
            -$
            1,995
            
            
            $
            9,220
            
            
            $
            7,084
            
            
            $
            2,535
            
            
            $
            5,049
            
            
            $
            4,478





Non-performing
loans increased by $25.5 million from December 31, 2008 to September 30,
2009.  Non-performing loans include any loan that has been placed on
nonaccrual status and restructured loans.  Non-performing loans also
include loans that, based on management’s evaluation of current information and
events, the Bank expects to be unable to collect in full according to the
contractual terms of the original loan agreement.  These loans are
also considered impaired loans.  Non-performing loans were 5.14% of
loans held for investment as of September 30, 2009 and 3.48% as of December 31,
2008.  The increase in non-performing loans is due to the
deterioration of credit quality related to multiple borrowers including five
unrelated land development borrowers with aggregate loan balances of $12.0
million, one agricultural production operation with an aggregate loan balance of
$4.8 million, five unrelated borrowers with multi-family real estate loans with
aggregate balances of $3.5 million and four unrelated borrowers with commercial
real estate loans with aggregate balances of $4.1 million.  The
remainder of the increase in non-performing loans is related to unrelated
borrower relationships of less than $1.0 million and the continued deterioration
in economic conditions.  Non-performing loans at September 30, 2009
includes $15.1 million of loans related to the June 2008 floods in the Bank’s
trade area.  Most of the non-performing loans are secured by real
estate and are believed to be adequately collateralized.





Loans 90
days past due that are still accruing interest increased $4.2 million from
December 31, 2008 to September 30, 2009. This increase is due to an additional
38 loans that are 90 days past due as of September 30, 2009 as compared to
December 31, 2008.  The average balance of the past due loans also
increased as of September 30, 2009.  The average past due loan balance
was $90,000 as of September 30, 2009 compared to $78,000 as of December 31,
2008.  The loans 90 days past due and still accruing are believed to
be adequately collateralized.   Loans are placed on non-accrual
status when management believes the collection of future principal and interest
is not reasonably assured.


Page 22 of
44
 Index


HILLS
BANCORPORATION





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





The Bank
regularly reviews a substantial portion of the loans in the portfolio and
assesses whether the loans are impaired.  If the loans are impaired,
the Bank determines if a specific allowance is appropriate.  In
addition, the Bank's management also reviews and, where determined necessary,
provides allowances based upon (1) reviews of specific borrowers and (2)
management’s assessment of areas that management considers are of higher credit
risk (e.g., agricultural loans and constructed model real estate
loans).  Loans for which there are no specific allowances are
classified into one or more risk categories. Based upon the risk category
assigned, the Bank allocates a percentage, as determined by management, for a
required allowance needed.  The percentage begins with historical loss
experience factors, which are then adjusted for current economic
factors.





The
following table presents the allowance for loan losses on loans by type of loans
and the percentage in each category to total loans as of September 30, 2009 and
December 31, 2008:





September
      30, 2009
            
            
            December
      31, 2008Amount
            
            
            %
      of Total Allowance
            
            
            %
      of Loans to Total Loans
            
            
            Amount
            
            
            %
      of Total Allowance
            
            
            %
      of Loans to Total Loans(In
      Thousands)
            
            
            
            
            
            
            
            
            (In
      Thousands)Agricultural
            
            $
            2,906
            
            
            
            9.46
            %
            
            
            4.02
            %
            
            $
            2,258
            
            
            
            8.17
            %
            
            
            4.29Commercial
      and financial
            
            
            7,272
            
            
            
            23.67
            
            
            
            10.99
            
            
            
            5,357
            
            
            
            19.37
            
            
            
            10.83Real
      estate:Construction,
      1 to 4 family residential
            
            
            2,595
            
            
            
            8.45
            
            
            
            1.69
            
            
            
            626
            
            
            
            2.26
            
            
            
            1.96Construction,
      land development and commercial
            
            
            2,412
            
            
            
            7.85
            
            
            
            6.34
            
            
            
            3,986
            
            
            
            14.41
            
            
            
            7.41Mortgage,
      farmland
            
            
            1,427
            
            
            
            4.65
            
            
            
            5.72
            
            
            
            1,210
            
            
            
            4.37
            
            
            
            5.58Mortgage,
      1 to 4 family first liens
            
            
            5,514
            
            
            
            17.95
            
            
            
            29.89
            
            
            
            6,035
            
            
            
            21.82
            
            
            
            29.68Mortgage,
      1 to 4 family junior liens
            
            
            1,361
            
            
            
            4.43
            
            
            
            7.42
            
            
            
            1,346
            
            
            
            4.87
            
            
            
            7.82Mortgage,
      multi-family
            
            
            1,686
            
            
            
            5.49
            
            
            
            12.35
            
            
            
            1,569
            
            
            
            5.67
            
            
            
            12.06Mortgage,
      commercial
            
            
            4,896
            
            
            
            15.94
            
            
            
            19.12
            
            
            
            4,642
            
            
            
            16.78
            
            
            
            18.04Loans
      to individuals
            
            
            639
            
            
            
            2.08
            
            
            
            1.71
            
            
            
            611
            
            
            
            2.21
            
            
            
            1.78Obligations
      of state and political subdivisions
            
            
            12
            
            
            
            0.03
            
            
            
            0.75
            
            
            
            20
            
            
            
            0.07
            
            
            
            0.55$
            30,720
            
            
            
            100.00
            %
            
            
            100.00
            %
            
            $
            27,660
            
            
            
            100.00
            %
            
            
            100.00
            %








The
Company believes that the allowance for loan losses is at a level commensurate
with the overall risk exposure of the loan portfolio.  However, if
economic conditions continue to deteriorate, certain borrowers may experience
difficulty and the level of nonperforming loans, chargeoffs and delinquencies
could continue to rise and require increases in the provision for loan
losses.  The
Company will continue to monitor the adequacy of the allowance on a quarterly
basis and will consider the impact of economic conditions on the borrowers’
ability to repay, loan collateral values, past collection experience, the risk
characteristics of the loan portfolio and such other factors that deserve
current recognition.


Page 23 of
44
 Index


HILLS
BANCORPORATION





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





The Bank
restructured loans totaling $4.5 million during 2008.  These loans
related to two customers.  The first 2008 customer relationship
consisted of six loans totaling $1.2 million and is flood
related.  The Bank would have recorded $47,000 in interest income
during the first nine months of 2009 related to these loans if the loans had
been current in accordance with their original terms.  Instead, the
Bank recorded $18,000 of interest for the nine months ended September 30, 2009,
and a loss of interest income of $29,000 due to the restructure of the first
borrowing relationship.  The Bank loaned an additional $658,000 to the
borrower during 2008 and 2009 after the completion of the restructuring of the
loans.  In addition, the Bank has committed to lend an additional $1.4
million to the customer.  The second 2008 restructured customer
relationship consisted of four loans that totaled $3.3 million at the time of
the 2008 restructure.  As of September 30, 2009, these loans totaled
$2.9 million.  The Bank would have recorded $118,000 in interest
income during the first nine months of 2009 related to these loans if the loans
had been current in accordance with their original terms.  Instead,
the Bank recorded $94,000 of interest for the nine months ended September 30,
2009, and a loss of interest income of $24,000 due to the restructure of the
second borrower relationship.  One of the restructured loans related
to the second borrower is a line of credit for $1.4
million.  Currently, the borrower could obtain an additional $559,000
on the line of credit.  The Bank loaned an additional $1.1 million to
the borrower during 2008 and 2009 after the completion of the restructuring of
the loans.  In addition, the Bank has committed to lend an additional
$391,000 to the customer.





The Bank
restructured loans totaling $3.0 million during 2009.  These 2009
restructures related to two customers.  The first 2009 customer
relationship consisted of seven loans totaling $2.8 million.  The
loans currently require interest-only payments at market rates.  The
Bank loaned an additional $286,000 to the borrower during 2009 after the
completion of the restructuring of the loans.  In addition, the Bank
has committed to lend an additional $10,000 to the customer.  The
second 2009 customer relationship consisted of two loans totaling $279,000 and
is flood related.  Since the date of restructure, the Bank would have
recorded $4,000 in interest income if the loans had been current in accordance
with their original terms.  Instead, the Bank recorded $1,000 of
interest income for the nine months ended September 30, 2009, and a loss of
interest income of $3,000 due to the restructure of this customer
relationship.  The Bank does not have any commitments to lend this
customer additional funds.





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


Page 24 of
44
 Index


HILLS
BANCORPORATION





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





Investment
securities available for sale held by the Company increased by $3.5 million from
December 31, 2008 to September 30, 2009.  The fair value of securities
available for sale was $8.0 million more than the amortized cost of such
securities as of September 30, 2009.  The fair value of the securities
in excess of amortized cost was $5.9 million at December 31, 2008. The carrying
values of investment securities at September 30, 2009 and December 31, 2008 are
summarized in the following table (dollars in thousands):




September
      30, 2009
            
            
            December
      31, 2008Amount
            
            
            Percent
            
            
            Amount
            
            
            PercentSecurities
      available for saleState
      and political subdivisions
            
            $
            104,130
            
            
            
            51.09
            %
            
            $
            100,463
            
            
            
            50.15
            %Other
      securities (FHLB, FHLMC and FNMA)
            
            
            99,705
            
            
            
            48.91
            
            
            
            99,849
            
            
            
            49.85Total
      securities available for sale
            
            $
            203,835
            
            
            
            100.00
            %
            
            $
            200,312
            
            
            
            100.00
            %








Investment
securities have been classified in the consolidated balance sheets according to
management’s intent.  The Company had no securities designated as
trading in its portfolio at September 30, 2009 or December 31,
2008.  The carrying amount of available-for-sale securities and their
approximate fair values were as follows as of September 30, 2009 and December
31, 2008 (in thousands):





Amortized
      Cost
            
            
            Gross
      Unrealized Gains
            
            
            Gross
      Unrealized (Losses)
            
            
            Estimated
      Fair ValueSeptember
      30, 2009State
      and political subdivisions
            
            $
            99,942
            
            
            $
            4,214
            
            
            $
            (26
            )
            
            $
            104,130Other
      securities (FHLB, FHLMC and FNMA)
            
            
            95,885
            
            
            
            3,820
            
            
            
            -
            
            
            
            99,705Total
            
            $
            195,827
            
            
            $
            8,034
            
            
            $
            (26
            )
            
            $
            203,835December
      31, 2008:State
      and political subdivisions
            
            $
            98,760
            
            
            $
            1,774
            
            
            $
            (71
            )
            
            $
            100,463Other
      securities (FHLB, FHLMC and FNMA)
            
            
            95,642
            
            
            
            4,207
            
            
            
            -
            
            
            
            99,849Total
            
            $
            194,402
            
            
            $
            5,981
            
            
            $
            (71
            )
            
            $
            200,312





The
amortized cost and estimated fair value of available-for-sale securities
classified according to their contractual maturities at September 30, 2009, were
as follows (in thousands):





Amortized
      Cost
            
            
            Fair
      ValueDue
      in one year or less
            
            $
            29,220
            
            
            $
            29,712Due
      after one year through five years
            
            
            119,431
            
            
            
            124,578Due
      after five years through ten years
            
            
            46,448
            
            
            
            48,787Due
      after ten years
            
            
            728
            
            
            
            758Total
            
            $
            195,827
            
            
            $
            203,835


Page 25 of
44
 Index


HILLS
BANCORPORATION





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





The
following table shows the fair value, gross unrealized losses and the percentage
of fair value represented by gross unrealized losses of applicable investment
securities owned by the Company, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position at September 30, 2009 and December 31, 2008 (in
thousands):




September
      30, 2009
            
            Less
      than 12 months
            
            
            12
      months or more
            
            
            TotalDescription
      of Securities
            
            
            #
            
            
            Fair
      Value
            
            
            Unrealized
      Loss
            
            
            %
            
            
            
            #
            
            
            Fair
      Value
            
            
            Unrealized
      Loss
            
            
            %
            
            
            
            #
            
            
            Fair
      Value
            
            
            Unrealized
      Loss
            
            
            %State
      and municipal bonds
            
            
            10
            
            
            $
            2,004
            
            
            $
            (26
            )
            
            
            1.30
            %
            
            
            -
            
            
            $
            -
            
            
            $
            -
            
            
            
            -
            %
            
            
            10
            
            
            $
            2,004
            
            
            $
            (26
            )
            
            
            1.30
            %Other
      securities (FHLB, FHLMC and FNMA)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      temporarily impaired securities
            
            
            10
            
            
            $
            2,004
            
            
            $
            (26
            )
            
            
            1.30
            %
            
            
            -
            
            
            $
            -
            
            
            $
            -
            
            
            
            -
            %
            
            
            10
            
            
            $
            2,004
            
            
            $
            (26
            )
            
            
            1.30
            %






December
      31, 2008
            
            Less
      than 12 months
            
            
            12
      months or more
            
            
            TotalDescription
      of Securities
            
            
            #
            
            
            Fair
      Value
            
            
            Unrealized
      Loss
            
            
            %
            
            
            
            #
            
            
            Fair
      Value
            
            
            Unrealized
      Loss
            
            
            %
            
            
            
            #
            
            
            Fair
      Value
            
            
            Unrealized
      Loss
            
            
            %State
      and municipal bonds
            
            
            27
            
            
            $
            8,538
            
            
            $
            (56
            )
            
            
            0.66
            %
            
            
            10
            
            
            $
            1,684
            
            
            $
            (15
            )
            
            
            0.89
            %
            
            
            37
            
            
            $
            10,222
            
            
            $
            (71
            )
            
            
            0.69
            %Other
      securities (FHLB, FHLMC and FNMA)
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      temporarily impaired securities
            
            
            27
            
            
            $
            8,538
            
            
            $
            (56
            )
            
            
            0.66
            %
            
            
            10
            
            
            $
            1,684
            
            
            $
            (15
            )
            
            
            0.89
            %
            
            
            37
            
            
            $
            10,222
            
            
            $
            (71
            )
            
            
            0.69
            %





The
Company considered the following information in reaching the conclusion that the
impairments disclosed in the table above are temporary and not
other-than-temporary impairments.  The state and municipal bonds with
gross unrealized losses as of September 30, 2009 included 5 issues which are
non-rated local issues and 5 issues which are A3 or better rated, general
obligation bonds.  Therefore, 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 cause of the unrealized losses is due to changes in
interest rates.  The Company has not recognized any unrealized loss in
income because management has the intent and ability to hold the securities for
the foreseeable future.





Deposit
growth was $151.6 million in the first nine months of
2009.  Repurchase agreements decreased $17.2 million in the same
period.  Short-term borrowings at December 31, 2008 included federal
funds purchased that decreased $53.4 million to zero as of September 30,
2009.  In the opinion of the Company’s management, the Company
continues to have sufficient liquidity resources available to fund expected
additional loan growth.





Brokered
deposits totaled $30.4 million as of September 30, 2009 with an average rate of
2.31%.  Brokered deposits were $10.4 million as of December 31, 2008
with an average rate of 3.28%.


Page 26 of
44
 Index


HILLS
BANCORPORATION





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





Dividends
and Equity





In
January 2009, Hills Bancorporation paid a dividend of $4,041,000 or $.91 per
share.  The dividend was also $.91 per share in January
2008.  After payment of the dividend and the adjustment for
accumulated other comprehensive income, stockholders’ equity as of September 30,
2009 totaled $147.7 million.  Under risk-based capital rules, the
total amount of risk-based capital as of September 30, 2009, was 12.45% of
risk-adjusted assets, and is in excess of the required minimum of
8.00%.  Risk-based capital was 12.84% and 12.64% as of September 30,
2008 and December 31, 2008, respectively. As of September 30, 2009, the Bank is
considered well capitalized under the regulatory framework for prompt corrective
action.  There are no conditions or events that management believes
have changed the Company’s category.





In 2008, the Bank opted to
participate in both programs under the FDIC’s Temporary Liquidity Guarantee
Program (“TLGP”).  The first program was the Transaction Account
Guarantee Program under which, through June 30, 2010, all non-interest bearing
transaction accounts are fully guaranteed by the FDIC for the entire amount of
the account.  Coverage under the Transaction Account Guarantee Program
is in addition to and separate from the coverage available under the FDIC’s
general deposit insurance rules.  The second TLGP program in which the
Bank elected to participate was the Debt Guarantee Program.  The Debt
Guarantee Program guarantees certain newly issued senior, unsecured debt of
participating financial institutions.  Under the FDIC's Final Rule
adopted on November 21, 2008, certain senior, unsecured debt issued before June
30, 2009, with a maturity of greater than 30 days that matures on or prior to
June 30, 2012, is automatically included in the program.  The fees
associated with this program range from 50 to 100 basis points on an annualized
basis and vary according to the maturity of the debt issuance.  On
February 10, 2009, it was announced that, for an additional premium, the FDIC
will extend the Debt Guarantee Program through October 2009.  The
Company did not have any senior unsecured debt as of September 30,
2009.





In
response to the financial crisis affecting the banking system, financial
markets, investment banks and other financial institutions, on October 3, 2008,
the Emergency Economic Stabilization Act of 2008 (the "EESA") was signed into
law.  Pursuant to the EESA, the limit on FDIC insurance coverage for
deposits was temporarily increased to $250,000 through December 31,
2009.  On May 22, 2009,  the Helping Families Save Their
Homes Act extended the temporary limit through December 31,
2013.  Also under EESA, the United States Department of the Treasury
(the "Treasury") has the authority to, among other things, make equity
investments in certain financial institutions and purchase mortgage-backed and
other securities from financial institutions for an aggregate amount of up to
$700 billion.  The Treasury exercised its authority to make such
equity investments by developing the Capital Purchase Program.  Under
the terms of the Capital Purchase Program as they relate to companies other than
S corporations, the Treasury may purchase preferred shares and warrants issued
by such companies.  Additional preferred shares are issued to the
Treasury upon exercise of the Warrants.  An investment by the Treasury
subjects participants to a number of restrictions, including the need to obtain
the Treasury's consent to increase common stock dividends or repurchase common
stock.  The Company elected not to apply for the capital available
under the Treasury's Capital Purchase Program.  The Company and the
Bank are well capitalized with capital ratios that exceed regulatory
requirements.


Page 27 of
44
 Index


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, 2009 and 2008





Net
Income Overview





Net
income increased $324,000 for the nine months ended September 30, 2009 compared
to the first nine months of 2008.  Total net income was $11,652,000 in
2009 and $11,328,000 in the comparable period in 2008, an increase of
2.86%.  The changes in net income in 2009 from the first nine months
of 2008 were the result of the following:





Ÿ
            Net
      interest income increased by $3,490,000, or $3,507,000 on a tax-equivalent
      basis.


Ÿ
            The
      provision for loan losses increased by
  $1,489,000.


Ÿ
            Other
      income increased by $1,826,000.


Ÿ
            Other
      expenses increased by $4,195,000.


Ÿ
            Income
      taxes decreased by $692,000.





For the
nine-month periods ended September 30, 2009 and 2008, basic earnings per share
were $2.63 and $2.53, respectively. Diluted earnings per share were $2.62 for
the nine months ended September 30, 2009 compared to $2.52 for the same period
in 2008.





Fluctuations
in the Company’s net income continue to be driven primarily by three important
factors.  The first important factor is the interaction between
changes in net interest margin and changes in average earnings
assets.  Net interest income of $43.2 million for the first nine
months of 2009 was derived from the Company’s $1.723 billion of average earning
assets during that period and its tax-equivalent net interest margin of
3.48%.  Average earning assets in the nine months ended September 30,
2008 were $1.603 billion and the tax-equivalent net interest margin was
3.45%.  The importance of net interest margin is illustrated by the
fact that a decrease in the net interest margin of 10 basis points to 3.38%
would have resulted approximately in a $1,289,000 decrease in income before
income taxes in the nine month period ended September 30,
2009.  Similarly, an increase in the net interest margin of 10 basis
points to 3.58% would have resulted in approximately a $1,289,000 increase in
net interest income before taxes.  Net interest income for the Company
increased due to the increase in average earning assets over the same period in
2008 and the increase in the net interest margin of 3 basis points.





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 $1.512 billion at September 30,
2009.  The provision is computed on a quarterly basis and is a result
of management’s determination of the quality of the loan
portfolio.  The provision reflects a number of factors including the
size of the loan portfolio, loan concentrations, the level of non-performing
loans (which includes non-accrual and restructured loans) and loans past due 90
days or more.  The provision for loan losses was $8,274,000 in the
first nine months of 2009 compared to $6,785,000 the same period in
2008.





The
amount of mortgage loans sold on the secondary market and the resulting gain or
loss is the third factor that can cause fluctuations in net
income.  Loans originated in the first nine months of 2009 totaled
$242.0 million compared to $99.3 million in the same period in 2008, an increase
of 144%.  In the nine months ended September 30, 2009 and 2008, the
net gain on sale of loans was $3,297,000 and $975,000,
respectively.  The sale of loans is influenced by the real estate
market and interest rates.  The average interest rate for a 30 year
fixed rate loan during the first nine months of 2009 was 5.243%.  The
average interest rate for the same type of loan was 6.104% for the first nine
months of 2008.  The amount of the net gain on sale of secondary
market mortgage loans in each year can vary significantly.  The volume
of activity in these types of loans is directly related to the level of interest
rates.  During the nine months ended September 30, 2009, secondary
market rates were favorable resulting in a substantial increase in the volume of
loans sold.  The servicing of the loans sold into the secondary market
is not retained by the Company so these loans do not provide an ongoing stream
of income.


Page 28 of
44
 Index


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, 2009 and 2008
(continued)





Net
Interest Income





Net
interest income is the excess of the interest and fees earned on
interest-earning bearing assets over the interest expense of the
interest-bearing liabilities.  The factors that have the greatest
impact on net interest income are the volume of average earning assets and the
net interest margin.  The net interest margin for the first nine
months of 2009 was 3.48% compared to 3.45% in 2008 for the same
period.  The measure is shown on a tax-equivalent basis using a tax
rate of 35% to make the interest earned on taxable and non-taxable assets more
comparable.  The change in average balances and average rates between
periods and the effect on the net interest income on a tax equivalent basis for
the nine months ended in 2009 compared to the comparable period in 2008 are
shown in the following table:





Change
      in
            
            
            Change
      in
            
            
            Increase
      (Decrease) in Net Interest IncomeAverage
      Balance
            
            
            Average
      Rate
            
            
            Volume
      Changes
            
            
            Rate
      Changes
            
            
            Net
      Change(Amounts
      in Thousands)Interest
      income:Loans,
      net
            
            $
            83,480
            
            
            
            (0.39
            )
      %
            
            $
            3,960
            
            
            $
            (4,237
            )
            
            $
            (277
            )Taxable
      securities
            
            
            (5,252
            )
            
            
            (0.80
            )
            
            
            (192
            )
            
            
            (636
            )
            
            
            (828
            )Nontaxable
      securities
            
            
            2,820
            
            
            
            (0.13
            )
            
            
            114
            
            
            
            (97
            )
            
            
            17Federal
      funds sold
            
            
            38,275
            
            
            
            (1.97
            )
            
            
            25
            
            
            
            -
            
            
            
            25$
            119,323
            
            
            
            
            
            
            $
            3,907
            
            
            $
            (4,970
            )
            
            $
            (1,063
            )Interest
      expense:Interest-bearing
      demand deposits
            
            $
            37,198
            
            
            
            (0.27
            )
            
            $
            (253
            )
            
            $
            439
            
            
            $
            186Savings
      deposits
            
            
            61,448
            
            
            
            (0.33
            )
            
            
            (862
            )
            
            
            1,001
            
            
            
            139Time
      deposits
            
            
            63,752
            
            
            
            (0.88
            )
            
            
            (1,985
            )
            
            
            4,289
            
            
            
            2,304Short-term
      borrowings
            
            
            (40,023
            )
            
            
            (0.70
            )
            
            
            741
            
            
            
            189
            
            
            
            930FHLB
      borrowings
            
            
            (18,458
            )
            
            
            (0.17
            )
            
            
            715
            
            
            
            296
            
            
            
            1,011$
            103,917
            
            
            
            
            
            
            $
            (1,644
            )
            
            $
            6,214
            
            
            $
            4,570Change
      in net interest income
            
            
            
            
            
            
            
            
            
            $
            2,263
            
            
            $
            1,244
            
            
            $
            3,507





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





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





(Tax
      Equivalent Basis)
            
            2009
            
            
            2008Yield
      on average interest-earning assets
            
            
            5.70
            %
            
            
            6.21
            %Rate
      on average interest-bearing liabilities
            
            
            2.61
            
            
            
            3.26Net
      interest spread
            
            
            3.09
            %
            
            
            2.95
            %Effect
      of noninterest-bearing funds
            
            
            0.39
            
            
            
            0.50Net
      interest margin (tax equivalent interest income divided by average
      interest-earning assets)
            
            
            3.48
            %
            
            
            3.45
            %


Page 29 of
44
 Index


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, 2009 and 2008
(continued)





Provision
for Loan Losses





The
provision for loan losses was $8,274,000 in 2009 compared to $6,785,000 in 2008,
an increase of $1,489,000.  The 2008 provision expense included
$4,129,000 of additional expense related to the June 2008 floods.  In
the 2008 period, provision expense of $2,656,000 was not flood
related.  When comparing provision expense between the 2009 and 2008
nine month periods, the 2009 expense increased $5,618,000 over the 2008
non-flood provision expense.  The loan loss provision is the amount
necessary to adjust the allowance for loan losses to the level considered
appropriate by management.  The provision is computed on a quarterly
basis and is a result of management's determination of the quality of the loan
portfolio. The provision reflects a number of factors, including the size of the
loan portfolio, loan concentrations, the impact of borrowers’ ability to repay,
loan collateral values, the level of impaired loans and loans past due ninety
days or more.  In addition, management considers the credit quality of
the loans based on management’s review of problem and watch loans, including
loans with historically higher credit risks (primarily agricultural, land
development, spec real estate construction and commercial loans).





In the
first nine months of 2009, problem and watch loans increased $42.3 million while
there was an increase of $21.7 million in substandard loans in the same
period.  These asset quality changes increased the provision by $4.0
million.  In the first nine months of 2008, problem and watch loans
increased $21.0 million and substandard loans increased $3.2
million.  The 2008 asset quality changes increased the provision
expense $3.1 million.  In the first nine months of 2009, pass loan
balances declined $52.8 million which decreased the provision for loan losses
$1.1 million.  In the comparable period in 2008, pass loan balances
increased $53.7 million which increased the provision for loan losses $1.1
million.  The 2008 provision expense and asset quality changes were
significantly affected by the June 2008 floods.  Approximately $21.8
million of the growth in potential watch, watch and problem loans during the
first nine months of 2008 was due to loans to customers affected by flooding,
accounting for an increase in the provision of $4.1 million.  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, 2009 and 2008, recoveries were $792,000 and $733,000,
respectively; and charge-offs were $6,006,000 in 2009 and $3,158,000 in
2008.  The allowance for loan losses totaled $30,720,000 at September
30, 2009 compared to $27,660,000 at December 31, 2008.  The allowance
represented 2.03% and 1.85% of loans held for investment at September 30, 2009
and December 31, 2008, respectively.  As of September 30, 2009, the
allowance included $3.3 million in flood-related provisions.  The
methodology used in 2009 is consistent with 2008.





Net
Gain on Sale of Loans





Loans
originated in the first nine months of 2009 totaled $242.0 million compared to
$99.3 million in the same period in 2008, an increase of 144%.  In the
nine months ended September 30, 2009 and 2008, the net gain on sale of loans was
$3,297,000 and $975,000, respectively.  The sale of loans is
influenced by the real estate market and interest rates.  The average
interest rate for a 30 year fixed rate loan during the first nine months of 2009
was 5.243%.  The average interest rate for the same type of loan was
6.104% for the first nine months of 2008.  The amount of the net gain
on sale of secondary market mortgage loans in each year can vary
significantly.  The volume of activity in these types of loans is
directly related to the level of interest rates.  During the nine
months ended September 30, 2009, secondary market rates were favorable resulting
in a substantial increase in the volume of loans sold.  The servicing
of the loans sold into the secondary market is not retained by the Company so
these loans do not provide an ongoing stream of income.


Page 30 of
44
 Index


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, 2009 and 2008
(continued)





Other
Income





Other
income, other than the net gain on sale of loans discussed above, decreased
$496,000 for the nine months ended September 30, 2009 from the prior
year.  Trust fees decreased $392,000 as average assets under
management were less for the nine months ended September 30, 2009 than for the
same period in 2008.  The quarter-end balance of assets under
management increased from $854.1 million as of September 30, 2008 to $868.5
million as of September 30, 2009.  Service charges and fees decreased
$33,000 in the first nine months of 2009 from their level for the comparable
period in 2008.  The principal reason for this decrease was a
reduction of $199,000 in service fees on deposit accounts as a result of
diminished results from fee income strategies.  Debit card and point
of sale (POS) interchange fees are also included in service charges and fees,
and that component increased during 2009 by $184,000 due to volume of
activity.





Rental
revenue on tax credit real estate increased $146,000 for the nine-month period
ended September 30, 2009.  This increase was due to the addition of
one tax credit real estate property in the third quarter of 2009.





Other
noninterest income was $1,814,000 for the nine months ended September 30, 2009,
a $217,000 decrease from the same period in 2008.   Included in
the 2008 period’s other noninterest income were amounts related to Visa, Inc.
(“Visa”).  The Company received $114,000 in proceeds from the
redemption of shares as a part of the Visa IPO and was recorded as a
gain.  In conjunction with the IPO, Visa created a litigation escrow
which is to be used to pay the litigation settlement payments.  As a
result, the Company recorded a receivable equal to the $50,000 reserve during
2008.  This receivable was recorded as a contra-liability to the
reserve.  Both the liability and receivable are reflected in other
liabilities on the Company’s consolidated financial statements.  The
economic benefit of the receivable was recorded in other noninterest income in
2008. In addition, rental income decreased $228,000 in the first nine months of
2009 compared to the same period in 2008.  The decrease is due to the
expiration of an ATM rental contract which was not renewed.





Other
Expenses





Other
expenses of $33,829,000 in 2009 increased $4,195,000 from the same period in
2008.  This increase of 14.16% included an increase of $794,000 in
salaries and benefits.  Direct salary expense was up $1,074,000, or
9.32%, due to annual pay adjustments and bonuses paid to real estate lenders
related to the loan sales production discussed in the net gain on sale of loans
section.  Another component of salaries and employee benefits expense
is compensation expense related to the officers’ deferred compensation plan
which decreased $254,000.  This decrease is primarily the result of
the change in the quarterly appraised value of the Company’s common
stock.  The appraised value of the Company’s stock was $53.00 as of
September 30, 2009 and $55.00 as of December 31, 2008.  Another
component of salaries and employee benefits expense is profit sharing plan
expense which totaled $1,018,000 for the first nine months of
2009.  This expense increased $55,000, or 5.71%, over the same nine
month period in 2008 and includes the Company’s contributions to its Profit
Sharing and ESOP plans.  The majority of the increase is due to growth
in the underlying salary base for eligible
employees.    Medical insurance expense decreased $130,000
for the nine-month period ended September 30, 2009 from the same period in 2008
due to additional plan options offered to employees.





Occupancy
expenses increased $400,000 in 2009 due mainly to increases related to operating
two additional locations in 2009.  The Company leases an additional
location at a cost of $7,000 per month, or $63,000 for the nine months ended
September 30, 2009.  Building depreciation has increased $93,000 due
mainly to the addition of certain leasehold improvements at the new leased
location which are being depreciated over the four-year term of the
lease.  The Company also opened a modular temporary office on the site
of its fourteenth location.  Rents for the temporary office are $3,000
a month, or $27,000 for the nine months ended September 30,
2009.  Rent expense for the Company’s ATM locations is also included
in occupancy expense.  ATM rent expense increased $113,000 in the
first nine months of 2009 compared to the same period in 2008.  This
increase is related to placement of additional ATMs in the Company’s trade
area.


Page 31 of
44
 Index


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, 2009 and 2008
(continued)





Outside
services expense increased $452,000 for the nine months ended September 30, 2009
compared to the same period in 2008.  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. Credit card, debit card and merchant card processing expenses
increased $101,000 due to an increase in the volume of transactions in 2009
compared to 2008.  Professional fees were $1,314,000 for the nine
months ended September 30, 2009, an increase of $35,000 over the same period in
2008.  This increase includes $156,000 in attorney fees and is due to
credit-related matters.  Expenses related to courier services
decreased $81,000 in 2009 due to the expiration of an ATM rental contract which
was not renewed.  Data processing expense increased $64,000 in the
nine months ended September 30, 2009 when compared to the same period in
2008.  This increase is due to monthly fees for a new trust processing
system.  In addition, expenses related to other real estate owned and
other repossessed assets were $233,000 for the first nine months of 2009, an
increase of $174,000 from the same period in 2008.  The increased
expenses are due to the number of properties in other real estate owned in
2009.





Rental
expenses on tax credit real estate were $1,351,000 in 2009, an increase of
$350,000 from the nine-month period ended September 30, 2008.  This
increase is due mainly to the addition of the tax credit property noted under
the other income section.





FDIC
insurance assessment expense was $2,276,000 for the nine months ended September
30, 2009.  This is an increase of $1,619,000 when compared to the same
period in 2008.  As of June 30, 2009, the FDIC imposed a five basis
point special assessment on each bank’s total assets less Tier 1,
capital.  The Bank’s special assessment totaled
$820,000.  In addition, the FDIC has raised assessment rates for all
banks as part of its restoration plan for the deposit insurance
fund.  Another component of the increase is an additional 10 basis
point assessment related to the Transaction Account Guarantee
Program.  This Program increased insurance coverage for non-interest
bearing deposit accounts in excess of $250,000.


During
the first nine months of 2009, the Company pre-paid $40.0 million of FHLB
advances incurring an early payment penalty of $584,000.  There were
no penalties incurred during the first nine months of 2008.  The $40.0
million in advances consisted of $20.0 million due in June 2009 and $20.0
million due in October 2009, at rates from 5.66% to 6.22%.  As a
result of the early payment of the FHLB borrowings, the Company’s interest
expense on FHLB borrowings decreased.  The net impact of the early
payment penalty and decreased interest expense is expected to be revenue neutral
for 2009.





The net
loss on sale of other real estate owned and other repossessed assets increased
$812,000 to $866,000 for the nine months ended September 30,
2009.  The 2009 loss resulted from the sale of 26 properties and a
write-down in fair market value of $389,000 related to twelve properties
previously transferred to other real estate owned.  During the
comparable period in 2008, eight properties and other repossessed assets were
sold at a loss of $54,000.





Flood-related
expenses were $40,000 and $822,000 for the nine-month periods ended September
30, 2009 and 2008, respectively.  In the 2008 period, the Company
recognized a loss of $355,000 on the net book value of property and equipment at
its two damaged locations.  In addition, the Company recorded $467,000
of expenses including approximately $264,000 for decontaminating, drying and
preparing the two flooded offices for remodeling and $70,000 in expenses related
to the evacuation of the two damaged locations.  The remaining expense
of $65,000 includes various items including meals, sandbagging and other
supplies and extra mileage due to road closings and relocation of
offices.





Other
noninterest expense decreased $50,000 in the first nine months of 2009 to
$841,000.  This decrease is mainly due to expenses related to the
deferred compensation plan for the Company’s Board of Directors.  This
expense decreased $91,000 for the first nine months of 2009 in comparison to the
same period in 2008.  This decrease is primarily the result of the
change in the appraised value of the Company’s common stock.


Page 32 of
44
 Index


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, 2009 and 2008
(continued)





Income
Taxes





Federal
and state income tax expenses were $3,911,000 and $4,603,000 for the nine months
ended September 30, 2009 and 2008, respectively.  Income taxes as a
percentage of income before taxes were 25.13% in 2009 and 28.89% in
2008.  The amount of tax credits was $1,078,000 and $530,000 for the
nine month period ended September 30, 2009 and 2008,
respectively.   The decrease in the effective tax rate is due
mainly to the increase in the amount of tax credits for 2009.  The
additional $548,000 of tax credits reduced the 2009 effective tax rate by
3.60%.


Page 33 of
44
 Index


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, 2009 and 2008
(continued)





Net
Income





Net
income increased to $4,733,000 for the three months ended September 30, 2009
from $4,689,000 for the same period in 2008, an increase of
0.94%.  Earnings per share, both basic and diluted, increased for the
three months ended September 30, 2009 compared to the same period in
2008.  For the three-month period ended September 30, 2009, basic
earnings per share was $1.07 and diluted earnings per share was
$1.06.  For the three months ended September 30, 2008, basic and
diluted earnings per share were $1.05.  Return on average equity was
12.93% for the three months ended September 30, 2009 compared to 13.77%, for the
same period in 2008.  Return on average assets was 1.04% in 2009 and
1.09% in 2008.  Return on average assets and return on average equity
are calculated based on annualized results for the third quarter.





Net
Interest Income





Net
interest income increased for the three month period ended September 30, 2009 by
$969,000, or $982,000 on a tax-equivalent basis, from the similar period in
2008. The net interest margin in 2009 was 3.58% compared to 3.56% in
2008.  Net interest income changes on a tax-equivalent basis for the
three months ended September 30, 2009 and 2008 are as follows:





Change
      in
            
            
            Change
      in
            
            
            Increase
      (Decrease) in Net Interest IncomeAverage
      Balance
            
            
            Average
      Rate
            
            
            Volume
      Changes
            
            
            Rate
      Changes
            
            
            Net
      Change(Amounts
      in Thousands)Interest
      income:Loans,
      net
            
            $
            49,820
            
            
            
            (0.26
            )
      %
            
            $
            840
            
            
            $
            (956
            )
            
            $
            (116
            )Taxable
      securities
            
            
            (1,901
            )
            
            
            (0.86
            )
            
            
            (20
            )
            
            
            (237
            )
            
            
            (257
            )Nontaxable
      securities
            
            
            614
            
            
            
            (0.02
            )
            
            
            9
            
            
            
            (4
            )
            
            
            5Federal
      funds sold
            
            
            39,936
            
            
            
            (2.08
            )
            
            
            22
            
            
            
            -
            
            
            
            22$
            88,469
            
            
            
            
            
            
            $
            851
            
            
            $
            (1,197
            )
            
            $
            (346
            )Interest
      expense:Interest-bearing
      demand deposits
            
            $
            32,990
            
            
            
            (0.15
            )
            
            $
            (65
            )
            
            $
            80
            
            
            $
            15Savings
      deposits
            
            
            88,120
            
            
            
            (0.19
            )
            
            
            (307
            )
            
            
            230
            
            
            
            (77
            )Time
      deposits
            
            
            65,275
            
            
            
            (0.63
            )
            
            
            (640
            )
            
            
            1,021
            
            
            
            381Short-term
      borrowings
            
            
            (70,232
            )
            
            
            (0.36
            )
            
            
            379
            
            
            
            19
            
            
            
            398FHLB
      borrowings
            
            
            (40,153
            )
            
            
            (0.20
            )
            
            
            493
            
            
            
            118
            
            
            
            611$
            76,000
            
            
            
            
            
            
            $
            (140
            )
            
            $
            1,468
            
            
            $
            1,328Change
      in net interest income
            
            
            
            
            
            
            
            
            
            $
            711
            
            
            $
            271
            
            
            $
            982





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





(Tax
      Equivalent Basis)
            
            2009
            
            
            2008Yield
      on average interest-earning assets
            
            
            5.66
            %
            
            
            6.07
            %Rate
      on average interest-bearing liabilities
            
            
            2.46
            
            
            
            2.98Net
      interest spread
            
            
            3.20
            %
            
            
            3.09
            %Effect
      of noninterest-bearing funds
            
            
            0.38
            
            
            
            0.47Net
      interest margin (tax equivalent interest income divided by average
      interest-earning assets)
            
            
            3.58
            %
            
            
            3.56
            %


Page 34 of
44
 Index


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, 2009 and 2008
(continued)





Provision
for Loan Losses





The
provision for loan losses was $2,357,000 for the quarter ended September 30,
2009 compared to $1,026,000 for the comparable quarter in 2008, an increase of
$1,331,000.  As discussed in connection with the results of operations
for the nine months, the allowance for loan losses was increased due to
management’s analysis of the outstanding loans at September 30,
2009.





In the
third quarter of 2009, problem and watch loans increased $28.3 million while
there was an increase of $5.9 million in substandard loans in the same
period.  These asset quality changes increased the provision $0.8
million.  In the third quarter of 2008, problem and watch loans
decreased $1.3 million and substandard loans decreased $8.4
million.  The 2008 asset quality changes decreased the provision
expense $1.4 million.  In the third quarter of 2009, pass loan
balances declined $15.8 million which decreased the provision for loan losses
$0.2 million.  In the comparable period in 2008, pass loan balances
increased $36.3 million which increased the provision for loan losses $0.9
million.





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, 2009 and 2008, recoveries were $335,000 and $331,000; and
charge-offs were $2,102,000 in 2009 and $1,837,000 in 2008.   The
allowance for loan losses totaled $30,720,000 at September 30, 2009 compared to
$24,070,000 at September 30, 2008.  The allowance represented 2.03%
and 1.65% of loans held for investment at September 30, 2009 and 2008,
respectively.





Other
Income





Total
other income was $4,681,000 and $4,072,000 for the three months ended September
30, 2009 and 2008, respectively.  Net gain on sale of loans increased
by $386,000 in the quarter ended September 30, 2009 as compared to the same
quarter in 2008 due to an increase in the volume of loans sold in
2009.  Service charges and fees increased $68,000 in the three months
ended September 30, 2009 from their level for the comparable period in
2008.  The principal reason for this increase was debit card and point
of sale (POS) interchange fees which increased $79,000 in the third quarter of
2009 over the third quarter of 2008 due to the volume of
activity.  Rental revenue on tax credit real estate increased $131,000
for the three-month period ended September 30, 2009.  This increase
was due to the addition of one tax credit real estate property in the third
quarter of 2009.





Other
noninterest income was $632,000 for the three months ended September 30, 2009, a
$59,000 increase from the same period in 2008.   For the third
quarter of 2009, volume rebates received from loans sold on the secondary market
increased $92,000 over the same period in 2008.  The increase in
volume rebates is due to the volume of loans sold throughout
2009.  Rental income decreased $69,000 in the third quarter of 2009
compared to the third quarter of 2008.  The decrease is due to the
expiration of an ATM rental contract which was not renewed in late
2008.





Other
Expenses




Total
expenses for the 2009 third quarter compared to the 2008 third quarter increased
$825,000 to $11,126,000.  This increase of 8.01% included an increase
of $146,000 in salaries and benefits.  Direct salary expense was up
$221,000, or 5.64%, due to annual pay adjustments and bonuses paid to real
estate lenders related to the loan sales production discussed in the net gain on
sale of loans section.   Medical insurance expense decreased
$47,000 for the three-month period ended September 30, 2009 from the same period
in 2008.


Page 35 of
44
 Index


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, 2009 and 2008
(continued)





Occupancy
expenses increased $115,000 in the third quarter of 2009 due mainly to increases
related to operating two additional locations in 2009.  The Company
leases an additional location at a cost of $6,600 per month.  Building
depreciation has increased due to the addition of certain leasehold improvements
at the new leased location which are being depreciated over the term of the
four-year term of the lease.  The Company also opened a modular
temporary office on the site of its fourteenth location.  Rents for
the temporary office are $3,250 a month.  Rent expense for the
Company’s ATM locations is also included in occupancy expense.  ATM
rent expense increased $35,000 in the three months ended September 30, 2009
compared to the same period in 2008.  This increase is related to
placement of additional ATMs in the Company’s trade area.





Advertising
and business development expenses decreased $110,000 to $410,000 for the quarter
ended September 30, 2009.  This decrease is due in part to expenses
related to the Company’s credit card incentive program which was $27,000 less in
2009. The remainder of the decrease was due to timing of the Company’s promotion
and shareholder expenses.





Outside
services expense increased $115,000 for the three months ended September 30,
2009 compared to the same period in 2008.  Credit card, debit card and
merchant card processing expenses increased $73,000 due to an increase in the
volume of transactions in 2009 compared to 2008.  Professional fees
were $423,000 for the three months ended September 30, 2009, a decrease of
$87,000 over the same period in 2008.  The decrease is due in part to
a recovery of forced insurance premiums paid by the Company on behalf of a
customer totaling $66,000.  This decrease was offset by $50,000 more
in attorney fees for the three months ended September 30, 2009, and is due to
credit-related matters.  Expenses related to courier services
decreased $30,000 in the third quarter of 2009 due to the expiration of an ATM
rental contract which was not renewed.  In addition, expenses related
to other real estate owned and other repossessed assets were $147,000 for the
three months ended September 30, 2009, an increase of $111,000 from the same
period in 2008.  The increased expenses are due to an increase in the
number of properties in other real estate owned in 2009.





Rental
expenses on tax credit real estate were $751,000 in the third quarter of 2009,
an increase of $343,000 from the third quarter of 2008.  This increase
is due mainly to the additional of the tax credit property noted under the other
income section.





FDIC
insurance assessment expense was $431,000 for the three months ended September
30, 2009.  This is an increase of $122,000 when compared to the same
period in 2008.  This increase is due in part to an additional 10
basis point assessment related to Transaction Account Guarantee
Program.  This Program increased insurance coverage for non-interest
bearing deposit accounts in excess of $250,000.  In addition, the FDIC
has raised assessment rates for all banks as part of its restoration plan for
the deposit insurance fund.





The net
loss on sale of other real estate owned and other repossessed assets increased
$202,000 to $234,000 for the three months ended September 30,
2009.  The third quarter 2009 loss resulted from the sale of twelve
properties and a write-down in fair market value of $217,000 related to
properties previously transferred to other real estate owned.  During
the comparable period in 2008, three properties and other repossessed assets
were sold at a loss of $32,000.





Flood-related
expenses were $24,000 and $157,000 for the three-month periods ended September
30, 2009 and 2008, respectively.


Page 36 of
44
 Index


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, 2009 and 2008
(continued)





Income
Taxes





Income
tax expense for the three months ended September 30, 2009 and 2008 was less than
the amounts computed by applying the maximum effective federal income tax rate
to the income before income taxes.  Income tax expense as a percentage
of income before taxes decreased to 23.28% in 2009 from 30.50% in
2008.  The amount of tax credits was $598,000 and $177,000 for the
three month period ended September 30, 2009 and 2008,
respectively.   The decrease in the effective tax rate is due
mainly to the increase in the amount of tax credits for 2009.  The
additional $421,000 of tax credits reduced the 2009 effective tax rate by
7.07%.


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HILLS
BANCORPORATION





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





Liquidity





The
Company actively monitors and manages its liquidity position with the objective
of maintaining sufficient cash flows to fund operations, meet client
commitments, take advantage of market opportunities and provide a margin against
unforeseeable liquidity needs.  Investment securities available for
sale are readily marketable assets.  Maturities of all investment
securities are managed to meet the Company’s normal liquidity needs, to respond
to market changes or to adjust the Company’s interest rate risk
position.  Investment securities available for sale comprised 11.13%
of the Company’s total assets at September 30, 2009, compared to 11.25% at
December 31, 2008.





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, 2009, the Company had
borrowed $225.0 million from the Federal Home Loan Bank (“FHLB”) of Des
Moines.  In April 2009, four advances of $10 million each were repaid
early.  $20 million of these advances were to mature in June 2009 and
$20 million were to mature in October 2009.  The Company incurred an
early payment penalty of $584,000.  FHLB 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 $196.2 million at September
30, 2009.





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 $149.6 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, 2009.





As of
September 30, 2009, investment securities with a carrying value of $29,304,000
were pledged to collateralize public and trust deposits, short-term borrowings
and for other purposes, as permitted by law.  As of December 31, 2008,
investment securities with a carrying value of $99,937,000 were
pledged.





Contractual
Obligations





The
Company is constructing an additional office location during
2009.  The office under construction will be the Company’s fourteenth
office location.  The Company signed a contract for the construction
of the office in April 2009 with costs of construction not to exceed $3.0
million.  The Company will not incur any debt during the construction
of the new office.  In April 2009, four FHLB advances of $10 million
each were repaid early.  $20 million of these advances were to mature
in June 2009 and $20 million were to mature in October 2009.  There
are no other material changes in the Company’s contractual obligations from
those disclosed in its Annual Report in Form 10-K for the year ended December
31, 2008.


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HILLS
BANCORPORATION





Item 3.
            Quantitative
      and Qualitative DisclosuresAbout Market
  Risk





Market
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 or rate
adjustments of its interest-earning assets and interest-bearing liabilities over
given periods of time.





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 savings 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.


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HILLS
BANCORPORATION





Item4.
            Controls
      and Procedures





The
Company carried out an evaluation, under the supervision and with the
participation of the Company’s management, including the Company’s Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company’s disclosure controls and procedures as
defined in the Securities Exchange Act of 1934 Rule 13a-15(e).  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 2009 that have materially affected, or are reasonably
likely to materially affect, the Company’s internal controls over financial
reporting.


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HILLS
BANCORPORATION


PART
II - OTHER INFORMATION





Item1.
            Legal
      Proceedings





No
material legal proceedings are pending.





Item
      1A.
            Risk
      Factors





Since the
initial adoption of its restoration plan on October 7, 2008, the FDIC has(1) extended
from five to seven years the time within which the reserve ratio mustbe restored
to 1.15, (2) made adjustments to its risk-based assessment system, (3)made
adjustments, which became effective on April 1, 2009, to its assessmentrates, and
(4) established a special assessment of five basis points on assets minusTier 1
capital as of June 30, 2009 collected on September 30, 2009.  In
addition, the FDIC has proposed a prepayment of three years of insurance
premiums which would be paid by December 31, 2009.  The prepayment
would be intended to cover the Bank’s premiums through 2012.  Based on
the current FDIC rates in effect for 2010 and the proposed rates for 2011 and
2012, this prepayment would be approximately $7,500,000.  The FDIC
stated it will not impose another special assessment in the fourth quarter of
2009 but did not rule out additional special assessments in future
years.  In all other respects, there have been nomaterial
changes from the risk factors disclosed in the Company’s Annual Reporton Form 10-K
for the year ended December 31, 2008.





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





The
following table sets forth information about the Company’s stock purchases, all
of which were made pursuant to the 2005 Stock Repurchase Program, for the three
months ended September 30, 2009:





Period
            
            Total
      number of shares purchased
            
            
            Average
      price paid per share
            
            
            Total
      number of shares purchased as part of publicly announced plans or
      programs
            
            
            Maximum
      number of shares that may yet be purchased under the plans or programs
      (1)July
      1 to July 31
            
            
            1,023
            
            
            $
            52.50
            
            
            
            182,210
            
            
            
            567,790August
      1 to August 31
            
            
            720
            
            
            
            52.50
            
            
            
            182,930
            
            
            
            567,070September
      1 to September 30
            
            
            3,748
            
            
            
            53.00
            
            
            
            186,678
            
            
            
            563,322Total
            
            
            5,491
            
            
            $
            52.84
            
            
            
            186,678
            
            
            
            563,322





(1) On
July 26, 2005, the Company’s Board of Directors authorized a program to
repurchase up to 750,000 shares of the Company’s common stock (the “2005 Stock
Repurchase Program”).  This authorization will expire on December 31,
2013.  The Company expects the purchases pursuant to the 2005 Stock
Repurchase Program to be made from time to time in private transactions at a
price equal to the most recent quarterly independent appraisal of the shares of
the Company’s common stock and with the Board reviewing the overall results of
the 2005 Stock Repurchase Program on a quarterly basis.  All purchases
made pursuant to the 2005 Stock Repurchase Program since its inception have been
made on that basis.  The amount and timing of stock repurchases will
be based on various factors, such as the Board’s assessment of the Company’s
capital structure and liquidity, the amount of interest shown by shareholders in
selling shares of stock to the Company at their appraised value, and applicable
regulatory and legal factors.





Item
      3.
            Defaults
      upon Senior Securities





Hills
Bancorporation has no senior securities.


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HILLS
BANCORPORATION


PART
II - OTHER INFORMATION


(continued)





Item4.
            Submission
      of Matters to a Vote of Security
Holders





No
matters were submitted to a vote of security holders during the quarter ended
September 30, 2009.





Item
      5.
            Other
      Information





None





Item6.
            Exhibits





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





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


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SIGNATURES








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





HILLS
      BANCORPORATIONDate:  November
      6, 2009
            
            By:  /s/
      Dwight O. SeegmillerDwight
      O. Seegmiller, Director, President and Chief Executive
    OfficerDate:  November
      6, 2009
            
            By:  /s/
      James G. PrattJames
      G. Pratt, Secretary, Treasurer and Chief Accounting
  Officer


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HILLS BANCORPORATION


QUARTERLY
REPORT OF FORM 10-Q FOR THE


QUARTER
ENDED SEPTEMBER 30, 2009








Exhibit
      Number
            
            Description
            
            Page
      Number In The Sequential Numbering System September 30, 2009 Form
      10-Q31
            
            Certifications
      under Section 302 of the Sarbanes-Oxley Act of 2002
            
            45
      - 46 of 4732
            
            Certifications
      under Section 906 of the Sarbanes-Oxley Act of 2002
            
            47
      of 47






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